SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
/X/ Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934.
For the fiscal year ended December 31, 2000
OR
/ / Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the transition period from ___________ to ____________
Commission File Number 001-13469
MEDIABAY, INC.
(Name of Small Business Issuer in Its Charter)
Florida 65-0429858
(State or other jurisdiction (IRS employer
of incorporation or organization) identification no.)
2 Ridgedale Avenue 07927
Cedar Knolls, NJ (Zip Code)
(Address of principal executive offices)
973-539-9528
(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock
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(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by Section
13, or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filling requirements for the past 90 days. Yes /X/ No / /
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB. /X/
State issuer's revenues for its most recent fiscal year (ending December 31,
2000) were $59,880,926.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of April 6, 2001 was approximately $4,815,783. As of April 6,
2001, there were 13,861,688 shares of the issuer's Common Stock outstanding.
Documents Incorporated by Reference:
None
MEDIABAY, INC.
Form 10-KSB
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Table of Contents
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PART I
Item 1. Description of Business 1
Item 2. Description of Property 23
Item 3. Legal Proceedings 23
Item 4. Submission of Matters to a Vote of Security Holders 24
PART II
Item 5. Market for Common Equity and Related Stockholder Matters 24
Item 6. Management's Discussion and Analysis of
Financial Condition and Results of Operations 25
Item 7. Financial Statements 31
Item 8. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 31
PART III
Item 9. Directors, Executive Officers, Promoters
and Control Persons; with Section 16(a)
of the Exchange Act 32
Item 10. Executive Compensation 35
Item 11. Security Ownership of Certain Beneficial
Owners and Management 38
Item 12. Certain Relationships and Related Transactions 40
Item 13. Exhibits, Lists and Reports on Form 8-K 43
PART I
Item 1. Description of Business.
Forward-looking Statements
Certain statements in this Form 10-KSB and in the documents incorporated by
reference in this Form 10-KSB 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 express
or implied by such forward-looking statements. Important factors that could
cause actual results to differ materially from our expectations, include,
without limitation, our history of losses, our ability to meet stock repurchase
obligations, anticipate and respond to changing customer preferences, license
and produce desirable content, protect our databases and other intellectual
property from unauthorized access, pay our trade creditors and collect
receivables, successfully implement our Internet strategy, license content for
digital download, the growth of the digital download market and other advances
in technologies, our ability to successfully implement our growth strategy,
dependence on third party providers and suppliers; competition; the costs and
success of our marketing strategies, product returns and member attrition..
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
MediaBay, Inc. ("We", "Our", the "Company") is a leading 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.
Our content library consists of more than 50,000 hours of spoken audio
content including audiobooks, old-time radio shows, audio versions of
newspapers, magazines and other unique spoken word content. The majority of our
content is acquired under license from the rights holders enabling us to
manufacture the product giving us significantly better product margins than
other companies.
Our customer base includes over 2.55 million spoken audio buyers who have
purchased via catalogs and direct mail marketing. We also currently have an
additional 2.2 million e-mail addresses of spoken audio buyers and enthusiasts
online. Our old-time radio products are sold in over 4,750 retail locations
including Costco, Target, Best Buy, Sam's Club, Barnes & Noble, Waldenbooks, B.
Dalton Booksellers, Books-A-Million and The Museum Company.
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Our web sites receive more than 2 million unique monthly web site visitors
and are among the most heavily trafficked bookselling web sites on the Internet.
We serve more than 300,000 classic radio and nostalgia video streams of our
content on a monthly basis to web site visitors at RadioSpirits.com and
MediaBay.com.
We have undertaken a significant review of our strategic objectives and
operations. While we remain committed to growth and believe strongly in both the
potential of our core markets and the future of digital downloads of premium
spoken word content, our priorities for the next twelve months are to operate
our core businesses on a more profitable basis and to improve cash flow. To this
end, we have recently implemented a number of key initiatives as follows:
o As a result of implementing a standardized merchandising program in our
catalogs, we have reduced the number of SKUs (Stock Keeping Units) in our
inventory.
o We have revised the logic used in determining customer shipments which we
believe reduces the level of customer returns and decreases the level of
required inventory.
o We have eliminated our Audio Book Club every day low price discounting
structure and currently sell most titles to members at full manufacturers'
suggested retail prices.
o We have discontinued doing cost per thousand guaranteed impressions and
cost per click advertising on the Internet in favor of cost per customer
acquired agreements only.
o We have streamlined the operations structure of our divisions and have been
able to eliminate positions that are no longer necessary to achieve our
goals.
o We have revised our marketing strategies to focus on the acquisition of
customers who generate higher profits, therefore we have reduced, and will
continue to reduce the amounts expended on advertising both on the Internet
and in direct mail.
We believe these initiatives have had a positive impact to date and will
substantially increase the profitability and improve the cash flow of our
operations.
Business Divisions
Our business is divided into four divisions, each of which serves a unique
market segment within the spoken word audio industry. The four divisions are as
follows:
o Audio Book Club ("ABC") - the largest membership-based club of its kind
with over 1.95 million members; marketed via direct mail and the Internet
at www.audiobookclub.com. Audio Book Club is the largest audiobook club;
having acquired Doubleday's Audiobooks Direct and the Columbia House
Audiobook Club.
o Radio Spirits ("Radio Spirits" or "RSI")- old-time radio and classic video
programs marketed to over 600,000 RSI catalog buyers through direct mail
catalogs and, on a wholesale basis, to more than 4,750 major retailers,
including Costco, Target, Best Buy, Sam's Club, Barnes & Noble,
Waldenbooks, B. Dalton Booksellers, Books-A-Million, The Museum Company and
Amazon.com and the Internet at www.radiospirits.com.
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o MediaBay.com - our content-rich media portal located at www.MediaBay.com
offers our extensive library of premium spoken word audio content in secure
digital download formats.
o Radio Classics ("RCI")- the distribution of our three national "classic"
radio programs which are collectively heard on more than 500 traditional
radio stations in more than 350 markets by over 3 million listeners weekly.
We plan to distribute our old-time radio programming across multiple
digital distribution platforms including digital cable television,
satellite television (DBS), satellite radio and the Internet. We are
currently in discussions with numerous companies in this space regarding
the carriage of our programming on their satellite and cable systems.
Audio Book Club
We believe that we are the largest marketer of audiobooks in the world
through our Audio Book Club, the largest membership-based club of its kind. Our
total member file, which includes active and inactive members, has grown
significantly from approximately 64,000 names at December 31, 1995 to
approximately 1.95 million names at December 31, 2000.
Our Audio Book Club is modeled after the "Book-of-the-Month Club". Audio
Book Club members can enroll in the club through the mail by responding to
direct mail advertisements, online through our web site or by calling us. We
typically offer new members four audiobooks at an introductory price of $.99 or
less. By enrolling, the member commits to purchase a minimum number of
additional audiobooks, typically two or four, at Audio Book Club's regular
prices, which generally range from $10.00 to $35.00 per audiobook. Our members
continue to receive member mailings and typically purchase audiobooks beyond
their minimum purchase commitment.
We emphasize the timely introduction of new audiobook titles to our
catalogs and attempt to offer a balance between various genres and between
unabridged and abridged audiobooks, cassettes and compact discs to satisfy
differing member preferences.
We are in the process of creating specialty clubs for audiobooks based on
consumer preferences, which we have identified from our extensive database of
member information. Our first such specialty club, Audio Passages, a Christian
Audiobook Club, was launched in the second quarter of 2000. We anticipate
launching additional specialty clubs, which will feature a specific interest,
such as self-help, religion, mystery, romance and science fiction.
We engage in list rental programs to maximize the revenue generation
potential of these programs. As Audio Book Club's membership base and Radio
Spirits' catalog customer base continue to grow, we anticipate that our customer
and member lists will continue to be attractive to non-competitive direct
marketers as a source of potential customers.
Audiobookclub.com
Audiobookclub.com provides visitors the opportunity to become members of
our Audio Book Club and provides our members with the ability to order online,
audiobooks offered through our catalog. Audiobookclub.com acquired 41,000
members online in 1998; 60,000 members online in 1999 and 97,000 members online
in 2000 for a total of approximately 200,000 members online since January 1998
and continues to enroll thousands of new members each month. This site currently
receives over 1.6 million unique visitors per month and is one of the most
heavily trafficked bookselling web sites on the Internet.
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Audiobookclub.com uses recommendation engine software designed to deliver
highly personalized content, to attempt to create personalized audiobook buying
experiences customized for each member. Once members have logged onto
audiobookclub.com, they are offered audiobook selections that correspond to
their previous buying patterns. Online members also receive e-mail alerts that
inform them of the addition of new titles that may appeal to them. Members
visiting audiobookclub.com are able to sample over 15,000 audio clips from
various audiobook titles, read reviews, visit our chat room, "CelebrityBay", to
hear and participate in author interviews with best-selling authors such as Mary
Higgins Clark, Nelson Demille, Ed McBain, Olivia Goldsmith and many more,
discuss audiobook interests with other members, and visit special sections such
as CD Central and Unabridged Only. Audiobookclub.com is updated simultaneously
with the Audio Book Club catalog to add new selections and the new current
featured selection, as well as to add new book cover images and audio clips to
preview.
Marketing
Since our inception, we have engaged in an aggressive marketing program to
expand our Audio Book Club member base, expand our Internet presence, develop
alliances with other Internet companies and attract visitors to our web sites.
We devote significant efforts to developing various online and offline marketing
strategies in a concerted effort to increase revenue and reduce marketing costs.
We continually analyze the results of our marketing activities in an effort to
maximize sales, extend membership life cycles, and efficiently target our
marketing efforts to increase response rates to our advertisements and reduce
our per-member and per-customer acquisition costs.
We have historically acquired new Audio Book Club members primarily through
direct mailings of member solicitation packages, acquisitions, Internet
advertising, and to a lesser extent from advertisements in magazines, newspapers
and other publications and package insert programs. We seek to attract a
financially sound and responsible membership base and target these types of
persons in our direct mail, Internet and other advertising efforts.
We select lists of names of membership candidates based on the extensive
knowledge and experience we have gained which we believe are characteristic of
persons who are likely to join Audio Book Club, purchase sufficient quantities
of audiobooks to be a profitable source of sales for us and remain long-term
members. We analyze our existing mailing lists and our promotional campaigns to
target membership lists, which are more likely to yield higher response rates.
We have gained substantial knowledge relating to the use of third-party mailing
lists and believe we can target potential members efficiently and cost
effectively by using third-party mailing lists.
In connection with our acquisitions of Columbia House's Audiobook Club and
Doubleday Direct's Audiobooks Direct club, we obtained the exclusive right to
use their other current and future club mailing lists, which currently consist
of over 34 million active and inactive members, over the next several years,
without paying rental and insertion fees. We also acquired mailing lists with an
aggregate of approximately 400,000 names of buyers and prospective buyers of
old-time radio and classic video programs in connection with the acquisition of
our old-time radio and classic video operations in December 1998.
Our Internet marketing program focuses on acquiring Audio Book Club members
through advertising agreements with other web sites that require payment only
when we enroll a bona fide member in Audio Book Club. This cost -per
-acquisition or "CPA" arrangement results in substantially lower marketing costs
and direct control over the cost of acquiring members. These agreements have
resulted in a cost to acquire new members on the Internet, which is
approximately 50% lower than our offline cost. Unlike traditional web retailers,
our
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members have a purchase obligation associated with their membership and there is
a strong likelihood that they will remain members and repeat buyers for a
sustained period.
We have established an Associates Network program of over 24,000 affiliate
web sites, which advertise audiobookclub.com and receive a commission for each
member obtained through a link from their site.
We also use push-marketing programs consisting of targeted e-mail campaigns
to our existing e-mail address database of over 2.2 million e-mail addresses.
Member Retention and Recurring Revenue
We encourage Audio Book Club members to purchase more than their minimum
purchase commitment by offering members discount pricing on their featured
selection audiobook and other incentives based on the volume of their purchases.
Audio Book Club members receive one mailing approximately every three weeks.
Audio Book Club mailings typically include a multi-page catalog which offers
hundreds of titles, including a featured selection, which is usually one of the
most popular titles at the time of mailing; alternate selections, which are best
selling and other current popular titles; and backlist selections, which are
long-standing titles that have continuously sold well. Each member mailing also
includes an order form and a "Member-Get-a-Member" form.
In order to encourage members to maintain their relationship with Audio
Book Club and to maximize the long-term value of members, we seek to provide
friendly, efficient, and personalized service. Our goal is to simplify the order
process and to make members comfortable shopping via the Internet and by mail
order. Audio Book Club's membership club format makes it easy for members to
receive the featured selection without having to take any action. Under the
membership club reply system, the member receives the featured selection unless
he or she replies by the date specified on the order form by returning the order
form, calling us with a reply, faxing a reply to us or replying online via our
Internet web site with a decision not to receive such selection. Members can
also use any of these methods to order additional selections from each catalog.
We maintain a database of information on each name in our member file,
including number and genre of titles ordered, payment history and the marketing
campaign from which the member joined. We also maintain a lifetime value
analysis of each mailing list we use and each promotional campaign we undertake.
The substantially increased size of our database enables us to better stratify
our member mailings by sending marketing materials and monthly selections that
better reflect members' particular interests as evidenced by their buying
patterns and purchasing preferences, rather than sending the same mailing and
monthly selection to all members. Our objective is to use this stratification
technique and our database analysis expertise to decrease members' returns of
monthly selections, increase members' positive response to our product offerings
and thereby increase net sales and extend the membership lifecycle.
Supply and Production
We have established relationships with substantially all of the major
audiobook publishers, including Random House Audio Publishing Group, Simon &
Schuster Audio, Harper Audio and Time Warner Audio Books for the supply of
audiobooks. As a membership club, our Audio Book Club enjoys a cost of goods
advantage over traditional audiobook retailers. Retailers and other online
booksellers purchase audiobooks from the finished inventory of either a
publisher or a third-party distributor. As a club operator, we license a
recording or group of recordings from the publisher for sale in a club format on
a royalty or per copy basis and subcontract the manufacturing, including
duplicating and printing to a third party. As a result of
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the improved economies of scale achieved from our acquisitions of Columbia
House's Audiobook Club and Doubleday Direct's Audiobooks Direct club, we have
achieved significant cost savings in the production of audiobooks.
Our licensing agreements generally are non-exclusive, have one to
three-year terms, require us to pay an advance against future royalties upon
signing the license, permit us to sell audiobooks in our inventory at the
expiration of the term during a sell-off period and prohibit us from selling an
audiobook prior to the publisher's release date for each audiobook.
Substantially all of the license agreements permit us to make our own
arrangements for the packaging, printing and cassette duplication of audiobooks.
Substantially all of our license agreements permit us to produce and sell
audiobook titles in cassette and compact disc form. Some of our license
agreements grant us digital rights to the titles as well. We have signed a
number of agreements with publishers, including Simon & Schuster, obtaining the
rights to produce and sell additional titles in a digital download format.
Fulfillment and Customer Service
Bookspan, formerly Doubleday Direct, currently provides order processing
and data processing services, warehousing and distribution services for our
Audio Book Club members. Bookspan's services include accepting member orders,
implementing our credit policies, inventory tracking, billing, invoicing and
generating periodic reports, such as reports of sales activity, accounts
receivable aging, customer profile and marketing effectiveness. Bookspan also
packs and ships the order, using the invoice as a packing list, to the club
member.
For our Audio Book Club members, we offer fast ordering options, including
placing orders online through our web site and calling us with an order. Orders
are sent fourth class mail and are typically delivered 10 to 14 days following
our receipt of orders. For an additional fee, members can receive faster
delivery of an order either by priority delivery, which takes three to five
days, or by overnight delivery.
Members are billed for their purchases at the time their orders are shipped
and are required to make payment promptly. We generally allow members in good
standing to order up to fifty dollars of products on credit, which may be
increased if the member maintains a good credit history with us.
Our policy is to accept returns of damaged audiobooks. In order to maintain
favorable customer relations, we generally also accept prompt returns of
unopened audiobooks. We monitor each member's account to determine if the member
has made excessive returns. Our policy is to either terminate a membership or
change member status to positive option, if the member makes three to five
consecutive returns of either audiobooks ordered or of featured selections
received because the member did not return the reply card on time.
We have implemented a number of initiatives, which have reduced the returns
from our Audio Book Club members. We have substantially reduced the number of
SKUs (Stock Keeping Units) in our inventory, resulting in fewer back orders on
items ordered and less delay in fulfilling orders. We have also extended the
period of time between when a catalog is mailed and when we ship the featured
selection, allowing members additional time to decline the featured selection if
they choose.
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Radio Spirits
History
RSI was formed in December 1998 by our acquisition of three businesses:
o Radio Spirits, Inc., a company which specialized in syndicating, selling
and licensing old-time radio programs, from Carl Amari, who became
President of RSI upon the closing. In connection with the Radio Spirits,
Inc. acquisition, we also acquired from Mr. Amari the assets of Buffalo
Productions, Inc. relating to its business of duplicating pre-recorded
compact discs.
o The assets used by Metacom, Inc. for its Adventures in Cassettes business
of producing, marketing and selling old-time radio programs.
o The assets used by Premier Electronic Laboratories, Inc. relating to its
business of producing, marketing and selling old-time radio and classic
video programs.
Following the closing of these acquisitions, these businesses were combined
to form RSI.
RSI Content
RSI has exclusive rights to a substantial portion of its library of popular
old-time radio and classic video programs, including vintage comedy, mystery,
detective, adventure and suspense programs. RSI's old-time radio library of
rights has been appraised at $24 million by a reputable independent appraiser.
RSI's library consists of over 59,000 radio programs, most of which are licensed
on an exclusive basis, including:
o H.G. Wells' "War of the Worlds" broadcast;
o hit series, such as The Lone Ranger, Superman, Tarzan, Sherlock Holmes, The
Life of Riley and Lights Out;
o recordings of stars, such as Humphrey Bogart, Lucille Ball, Frank Sinatra
and Jack Benny; and
o recordings of comedy teams, such as Abbott and Costello, Burns and Allen,
and Martin and Lewis.
RSI leverages the content of its old-time radio and classic video library
by entering into marketing and co-branding arrangements, which provides RSI a
means to repackage these programs. RSI offers the following collections, among
others:
o "The Greatest Old-Time Radio Shows of the 20th Century - selected by Walter
Cronkite" - a collection of approximately 60 old-time radio programs. RSI
has entered into a license agreement to use Mr. Cronkite's name and
likeness. This collection includes approximately 30 hours of radio's most
memorable programs, a spoken foreword by Mr. Cronkite and a companion
informational booklet.
o "The Smithsonian Collection" - a collection of old-time radio programs
branded under this name. RSI has entered into an agreement with the
Smithsonian Institution to produce a series of recordings of nostalgic
radio programs to be sold through all major bookstore chains carrying audio
programs. Each Smithsonian collection features a foreword by a recognized
celebrity from radio's golden age such as George Burns, Jerry Lewis and Ray
Bradbury.
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o "AMC's Audio Movies to Go" - a collection of old-time radio adaptations of
classic movies branded under this name featuring film stars such as
Humphrey Bogart, Jimmy Stewart, John Wayne and Betty Davis. RSI entered
into an exclusive agreement with American Movie Classics in October 1999.
This product line is being sold in retail chains carrying audio and video
programs, in RSI's product catalogs and on RSI's web site.
o "The Sixty Greatest Old-Time Radio Shows Starring Frank Sinatra and
Friends" which contains 60 of Frank Sinatra's old-time radio appearances.
RSI has entered into an agreement with Mr. Sinatra's estate for the use of
Mr. Sinatra's name and likeness in connection with a collection of his
performances.
o "The Sixty Greatest Old-Time Radio Christmas Shows Selected by Andy
Williams" featuring classic Christmas episodes of old-time radios most
popular shows. RSI has entered into a license agreement to use Mr.
Williams' name and likeness. This collection includes approximately 30
hours of radio's most memorable programs, a spoken foreword by Mr. Williams
and a companion informational booklet.
o "The 60 Greatest Old-Time Radio Science-Fiction Programs as Selected by Ray
Bradbury" which includes 30 hours of radio's most famous science-fiction
broadcasts. The collection will contain a 64-page booklet, audio and
written forewords by Mr. Bradbury and feature "The War of the Worlds" and
"Donovan's Brain" both starring Orson Welles, classic episodes of "X Minus
One," "Dimension X," and "Suspense" as well as several works written for
radio by Mr. Bradbury.
Marketing
RSI markets its library of old-time radio and video programs through direct
marketing, Internet, and retail channels. RSI's marketing efforts are aimed at
the direct marketing channel of distribution, via internally developed catalog,
as well as through retail and online channels of distribution. RSI produces
several catalogs per year and mails them to its customer list and selected
third-party mailing lists three times per year. RSI has also developed retail
distribution through several large, national book retailers, including Barnes &
Noble, Books-A-Million, B. Dalton, and Waldenbooks; gift stores such as The
Museum Company and Discovery Stores; mass retailers like Costco, Sam's Club,
Target and Best Buy, and catalogs such as Wireless and Critics Choice as well as
on the Internet at Amazon.com. RSI also sells its products through its web site
at Radiospirits.com
Direct Mail
RSI maintains a list of over 600,000 names of customers of radio and video
programs through RSI's catalogs and other channels. This list includes all
customers to which RSI's radio and video programs or catalogs have been mailed.
RSI engages in list rental programs to maximize the revenue generation potential
of its customer list.
RSI's catalogs offer cassettes and compact discs from its old-time radio
library and videos from its classic video library and RSI's line of DVDs, which
combine classic radio and classic television programs on a single DVD.
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Radio and Print Advertising
RSI advertises these products on RadioClassics' nationally syndicated
old-time radio broadcast, which reaches an audience of 3 million listeners of
old-time radio programs weekly on over 500 radio stations. To a lesser extent,
RSI also places advertisements in selected publications, including Reader's
Digest, TV Guide and Parent Magazine.
Wholesale
RSI also sells its radio programs on a wholesale basis through major
retailers and online retailers, including Target, Costco, Best Buy, Sam's Club,
Barnes & Noble, Waldenbooks, B. Dalton Booksellers, Books-A-Million and
Amazon.com. RSI's products are currently sold in approximately 4,750 retail
locations.
RSI markets its old-time radio and classic video programs to wholesale
customers through its in-house sales personnel and through third-party
distributors. RSI also engages in cooperative advertising to induce retailers to
purchase its products.
Internet
RSI also sells its old-time radio and classic video programs in cassette,
compact disc and DVD to retail customers through its web site, Radiospirits.com.
RSI also sells secure digital downloads of individual episodes and collections
at both Radiospirits.com and MediaBay.com.
RSI's web site, Radiospirits.com, is an innovative content and e-commerce
web site, offering visitors a single location for the largest selection of
old-time radio content and products in digital download and physical formats
(cassette, CD and DVD). Consumers may download old-time radio content from the
Internet at both Radiospirits.com and MediaBay.com. This service enables the
secure delivery of old-time radio content over the Internet for playback on
personal computers and portable playback devices. RSI has encoded over 10,000
programs from its old-time radio content library and currently provides digital
download delivery of many of these programs and products, and is continuing to
encode additional programs for digital download delivery.
Radiospirits.com provides visitors with a searchable database to preview
and purchase titles from RSI's old-time radio program library. This site offers
free full-length programs in streaming audio and digital download formats,
information on the programs, celebrities and talent of the Golden Age of Radio,
contests and trivia information. This web site also offers classic, nostalgic
and other unique film and video programs in videocassette format for purchase by
consumers as well as free full-length streaming movies and video shorts. This
web site is promoted in RSI's catalogs and on the nationally syndicated radio
programs including "When Radio Was," which is heard by over 3 million listeners
weekly.
Supply and Production
RSI has exclusive licensing rights to a substantial majority of its
old-time radio library. These rights have been principally acquired from the
original rights holders (actors, directors, writers, producers or others) or
their estates. Engineers in RSI's Illinois facility use digital sound equipment
to improve the sound quality of RSI's old-time radio programs. RSI then
contracts with third-party manufacturers to duplicate and manufacture the
old-time radio cassettes and CDs, which it sells. Because RSI's old-time radio
content is acquired under license from the rights holders, which give the
ability to manufacture the programs, RSI enjoys a cost of goods advantage,
resulting in favorable product margins. RSI uses third parties to manufacture
most of its videos.
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RSI has encoded over 10,000 programs from its old-time radio content
library and currently provides digital download delivery of many of these
programs and products, and is continuing to encode additional programs for
digital download delivery.
Fulfillment and Customer Service
RSI currently fulfills retail orders for old-time radio programs at its
Illinois facility. Wholesale product orders are drop shipped directly from its
duplicators or its facility.
RSI only accepts credit card orders from retail customers and requires
wholesale customers to generally pay invoices within 90 days. RSI maintains a
toll-free customer service telephone hotline for these customers and can also be
contacted by mail and e-mail. RSI's policy is to accept returns of damaged
products sold on a retail basis. RSI accepts returns of unsold products sold on
a wholesale basis.
Video Library
RSI also has an extensive library of over 3,500 video programs, including
an extensive collection of foreign and silent films, as well as classic films
from the 1930s through the 1970s. These programs include films starring Jack
Nicholson, John Wayne, James Stewart, Frank Sinatra, Bruce Lee, Orsen Welles,
Roy Rogers and Jack Palance. RSI's video library has been valued at over $12.0
million by a reputable independent appraiser.
DVDs
RSI has recently introduced a new line of DVDs, which will be in stores for
Father's Day 2001. This new line combines three classic television favorites
with three old-time radio shows of the same series. Because of RSI's old-time
radio licenses, RSI combines the classic television programs with the radio
shows that inspired them. RSI has introduced the following as the first eight
products in this line:
o COMEDIES: The Adventures of Ozzie and Harriet/ Duffy's Tavern/ The Jack
Benny Show
o COMEDIES: Fibber McGee and Molly/ The George Burns and Gracie Allen Show/
The Great Gildersleeve
o COMEDIES: The Edgar Bergen and Charlie McCarthy Show/ The Life of Riley/
Our Miss Brooks
o FAVORITES: The Halls of Ivy/ Mr. District Attorney/ The Third Man
o DETECTIVES: The Adventures of Ellery Queen/ Boston Blackie/ Dragnet
o DETECTIVES: Dangerous Assignment/ Philip Marlowe, Detective/ Richard
Diamond, Private Detective
o DETECTIVES: Gangbusters/ Mr. and Mrs. North/ Sherlock Holmes
o ADVENTURE: Flash Gordon/ The Lone Ranger/ The Roy Rogers Show
New Product Lines
o RSI intends to launch a number of additional new product lines as well as
individual product collections and compilations in the third quarter of
2001 in anticipation of the 2001 holiday selling season in order to both
expand its presence in retail outlets and its offerings in its catalogs.
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MediaBay.com
Our MediaBay.com media portal site is an innovative content and e-commerce
web site offering our 2.55 million customers, 2.2 million email addresses and
approximately 1.6 million unique web site monthly visitors a single location for
digital downloads of premium spoken word content. Portions of these downloads
are provided as free samples, however, the majority of the content is offered
for sale in either on a per download basis or as part of a monthly subscription.
Our objective is to position MediaBay.com as the leading digital download
provider of premium spoken word audio content.
We have created a service, which enables the secure delivery of a wide
variety of premium spoken audio content over the Internet from our website,
MediaBay.com, for playback on both personal computers and on portable playback
devices. This content includes entertainment, news and business information. We
have more than 50,000 hours of audio content, including audio versions of books,
periodicals and radio programs such as Jack Benny, The Shadow, Burns & Allen and
Superman. We provide audio versions of books from publishers including Simon &
Schuster Audio and Hay House Audio as well as certain Time, Inc. magazines. We
believe that our extensive audio content collection and our secure delivery
system provide benefits to our customers, content providers, manufacturers of
hand-held portable devices, and other companies, which distribute or promote our
service.
We are aggressively working to expand our reach and brand recognition
through partnership agreements with major online retailers, top manufacturers of
portable digital audio devices, content portals and other audio industry
leaders. We have entered into numerous digital marketing and distribution
agreements, including agreements with Books-A-Million, Inc., I-Jam Multimedia,
Iomega Corporation, RioPort, Inc., iUniverse.com and Creative Labs. These
companies have agreed to support and promote the playback of our content on
their websites and/or their portable devices. In addition to supporting the
necessary technology, these companies have agreed to incorporate our spoken
audio content offerings into their own content portals, in many cases on an
exclusive or preferred basis. These companies typically receive a percentage of
the profits generated from customer purchases of MediaBay.com content, which
they generated. We have also entered into marketing and distribution
arrangements with Microsoft, RealNetworks, Voquette, Savos, KNX1070.com and
others to promote our content to their customers. In return, we have access to
additional distribution outlets and receive additional revenue for each download
purchased.
We are developing relationships with cell phone and wireless phone
companies and other wireless technology providers to offer our products in
download format to wireless phone and other hand-held digital audio players. 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.
Supply and Production
We have acquired licensing rights to a substantial majority of our
digitally downloadable content library. These rights have been principally
acquired from the original rights holders, including audiobook publishers and
magazine and newspaper content creators such as Time, Inc. Since there are no
manufacturing costs, inventory carrying costs or receivables, we may enjoy
better product margins than on sales of physical goods.
RadioClassics
Our RadioClassics subsidiary intends to syndicate our old-time radio
library across multiple distribution platforms including traditional radio,
digital cable television, satellite
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television (DBS), satellite radio and the Internet. We produce and syndicate
three national "classic" radio programs: "When Radio Was" hosted by Stan
Freberg, "Radio Movie Classics" hosted by Jeffrey Lyons, and "Radio Super
Heroes." These three programs are collectively heard on more than 500 radio
stations in more than 350 markets including one of the nation's largest radio
stations, KNX1070 Los Angeles, by over 3 million listeners weekly. Our library
of old-time radio programs provides the content and the basis for these
programs.
Our current syndicated radio shows provide an excellent forum to introduce
our old-time radio programs to existing and potential new listeners. The
syndication agreements also provide us with an average of 1 to 2 minutes per
hour for our own advertising and promotional use. We use this advertising and
promotional forum as a means to develop broader name recognition for Radio
Spirits and additional sales of old-time radio products from existing and first
time buyers as well. We believe that by providing our programs on the additional
distribution platforms targeted by RadioClassics, and allowing Radio Spirits to
advertise without charge, sales of our old-time radio products could increase
significantly.
Our success with our traditional radio syndication programs provide a
natural extension for the syndication of our content on a 24/7 basis via
numerous other distribution platforms through our RadioClassics subsidiary.
RadioClassics is currently in discussions with leading cable television,
satellite radio and satellite television companies to establish distribution
capabilities for Radio Spirit's old-time radio content. We believe that when
RadioClassics secures access to these distribution platforms, it will be the
first time that a company will be able to offer advertisers the ability to
cross-promote across multiple distribution platforms such as these.
In addition to traditional broadcast radio and the Internet, the other
channels of distribution being pursued by RadioClassics for Radio Spirits
old-time radio content include satellite radio, satellite television and cable
television.
Industry Overview
Audiobooks
The market for audiobooks in 1999, according to the Audio Publishers
Association, exceeded $2.3 billion. The market for audiobooks grew at a compound
annual growth rate of approximately 27% from an estimated $250 million in 1989
to approximately $2.3 billion in 1999. The market for audiobooks had cumulative
growth of 39.6% from 1995-1998.
The Audiobook Publishers Association recently conducted a survey and
released the following information:
o The average audiobook listening household listens to 13.9 audiobooks
per year, and within that household, the main user listens to 13.1 of
those 13.9. The average audiobook listener has now been listening for
3.7 years, and 65% of audiobook households are "married" households.
o Audiobook listeners aged 35-64 form a broad loyal demographic group;
they listen to more titles and they spend more time listening each
week than other groups. The fact that the most concentrated use falls
into the 35-64 age range bodes generally well for the success of
audiobooks among the U.S. population.
o The top three situations in which audiobooks are used are at home
(37.4%); in the car but not commuting (26%); and in the car while
commuting (18.5%). In 1999, 44.5% of listening was done in the car, as
opposed to 55% in 1995. Women aged 35-64 account for more of the
listening done at home. Less common situations
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include listening while exercising (7.6%), and at work (3.8%.)
Audiobooks are also being used at school or daycare (4%) on a plane
(1.3%) and on mass transit (1.3%).
According to the Audiobook Publishers Association, the popularity of
various genres of audiobooks among listeners is as follows:
o The single most popular audiobook category is "book-based unabridged
fiction," which accounted for 30% of the market.
o Book-based fiction as a whole (an aggregate of specific categories) -
48%.
o General/Misc. non-fiction - 21%.
o Religious/inspirational audiobooks - 8%.
o Children's audiobook product - 14%.
o Language instruction programs - 2%.
According to the Audiobook Publishers Association, although the most
popular reason to listen to audio is "listening while doing other things (24%),
second is "enjoy listening to audiobooks" (14%), followed by entertainment
(11%).
Initially, many people begin to listen to audiobooks because it allows them
to do two things at once, however the long-term appeal of audiobooks becomes the
pleasure of listening. Fifty percent of respondents to the Audiobook Publishers
Association survey mentioned audiobooks as an alternative to radio, while 6%
listen for self-improvement or enrichment.
Among those surveyed, 85% owned car cassette players, 25% have CD players
in their cars and 71% own computers.
A 1996 market study by the Yankee Group indicates that 87% of automobile
commuters listened to the radio an average of 50 minutes a day while commuting.
According to the Department of Transportation, in 1990, 84 million people drove
to and from work alone, an increase of 35% from 1980. As individuals look to use
their commuting time more efficiently and manage an increasing amount of
available content, audiobooks have emerged as a personalized alternative to
radio, which does not allow listeners to control when they listen to a
particular program or what they listen to.
Old-time Radio
Old-time radio programs include radio dramas, mysteries, detective stories,
comedies, westerns, science fiction and adventure stories that originally aired
from the 1930s to the 1970s. Classic video programs include films originally
released from the silent film era of the 1930s through the 1970s.
Radio's creative forces fired the imagination of listeners with drama,
comedy, music and even re-enactments of popular movies. The medium's writers,
producers and talent laid the foundation for the advent of television. Many of
Radio's shows and stars made the transition to early television.
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Today "Old-time" radio programming is still a very popular listening
option. In a recent ten market survey, Arbitron research showed that our
nationally syndicated old-time radio shows ranked first in New York, Los
Angeles, Chicago, Salt Lake City and Milwaukee in the period when they aired.
We believe, there is a large audience for this great treasure trove of
entertainment - some for nostalgic reasons - others because of curiosity and
still more because they truly enjoy the kind of entertainment that stimulates
the theatre of their minds.
We believe there has been a resurgence in consumer interest for old-time
radio programs, as demonstrated by the growth of our sales of these products and
increased opportunities to enter into co-branding and cross-marketing
agreements, such as our agreements with the Frank Sinatra estate, Walter
Cronkite, the Smithsonian Institute and American Movie Classics. We also believe
that these programs have become a unique entertainment market, appealing to
those consumers who remember the "golden age of radio" and their childhood film
favorites with nostalgia and to younger listeners seeking new forms of
entertainment.
Digital Downloads
Public demand for new sources of entertainment, information and educational
media continues to grow as the amount of content and sources of such content
proliferate. Veronis, Suhler & Associates estimate that the communications
industry exceeded $300 billion in revenues in 1997. This is an increase from
less than $60 billion in 1977. During 1997, Americans on average spent more than
3,300 hours reading, watching or listening to media content. We believe that
many consumers seek a better way to manage this content. Listening is a way for
individuals to consume spoken word content at times when they are unable to
read, such as when they are driving, exercising or doing chores.
The Internet has emerged as a significant global communications medium
giving millions of people the ability to access and share large amounts of
information and to experience entertainment offerings. Through the Internet,
people can quickly receive various forms of information and entertainment, from
traditional types of publishing such as text to the newer technologies like
streaming and downloadable audio.
According to a May 2000 Forrester Research Report entitled, "The Self-Serve
Audio Evolution", Internet audio listening is not a niche activity - 56% of
respondents to a Forrester survey listen to audio on their PC every week. Even
the downloading of music files is gaining popularity - the survey shows that 36%
of respondents download music at least once a month, while 17% do so at least
once a week.
In the past, the audio environment available to Internet users restricted
consumers to listening directly from their PCs or through players that allowed
short lengths of audio content. Consumer electronics and computer manufacturers
have been addressing this constraint by developing mobile devices that are
capable of storing more audio content for consumers to play. An International
Data Corporation (IDC) analysis calculated that shipments of hand-held companion
devices exceeded 4.5 million units worldwide in 1998 and will increase to over
14 million worldwide by 2002. We believe seven million of these mobile devices
will be audio-enabled by the year 2002. This estimate does not include the
recent appearance of Internet-connected digital audio players. According to
Forrester Research, the installed base of Internet-connected digital audio
players reached one million units in 1999 and is estimated to be 34 million
units by 2003. We believe this increase in digital audio players will directly
translate into increased demand for premium spoken word content to be heard on
these players.
We believe that wireless telephone and wireless applications protocol
("WAP")
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technology is the ideal match for hand-held digital audio players. 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. Forrester predicts that carmakers will install personal
audio recorders. By placing hard drives in cars and partnering with technology
companies, vehicle manufacturers will be able to provide commuters a solution
for on-demand audio. On July 31, 2000, automaker Ford Motor Co. and Qualcomm
Inc., a provider of wireless phone technology, announced a new company to
develop and deliver wireless information services into cars and trucks. Known as
Wingcast, the new company will be based in San Diego and will offer
communication, information, navigation, entertainment, Internet access and
safety services to drivers of Ford vehicles. The first services are expected to
be available in late 2001. It is expected that with the technology they develop,
commuters will be able to wirelessly transfer the content they downloaded
overnight to the car's hard drive and listen to it on their morning commute.
This freedom to download wirelessly will allow unprecedented convenience for
consumers.
Competition
The audiobook and mail order industries are intensely competitive. However,
we believe that we operate the only club for audiobooks in the United States and
that we are the largest marketer of old-time radio programs.
We compete with all other outlets through which audiobooks and other spoken
word content are offered, including bookstores, audiobook stores which rent or
sell only audiobooks, mail order companies that offer audiobooks for rental and
sale through catalogs and retail establishments such as convenience stores,
video rental stores and wholesale clubs.
As the markets for spoken word content increasingly shifts towards the
Internet, we face competition for the marketing and distribution of these
products from other highly trafficked sites, offering a variety of competing
products, including Amazon.com and Barnesandnoble.com. Currently, there are
several other sites offering streaming audio content and products in digital
download format, including audible.com, which offer digital download spoken word
content, including audiobooks.
We also compete for discretionary consumer spending with mail order clubs
and catalogs, other direct marketers and retailers that offer products with
similar entertainment value as audiobooks and old-time radio and classic video
programs, such as music cassettes and compact discs, printed books, videos, and
laser and digital video discs.
Intellectual Property
We have a United States registered trademark for the Audio Book Club logo
and have several pending United States trademark and service mark registrations,
including "MediaBay," "Radio Spirits", "MediaBay.com," "audiobookclub.com" and
the MediaBay logos. We have applied for several additional service marks
relating to slogans and designs used in our advertisements, member mailings and
member solicitation packages. 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 the radio and video 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.
15
Employees
As of March 13, 2001, we had 68 full-time employees. Of these employees, 2
served in corporate management; 6 served in management and 23 served in
operational positions at our Audio Book Club operations; 2 served in management
and 7 served in operational positions at our MediaBay.com operations and 6
served in management and 22 served in operational positions at our old-time
radio and classic video operations. We believe our employee relations to be
good. None of our employees is covered by a collective bargaining agreement.
RISK FACTORS
Risks Related to Our Financial Condition
We have a history of losses, are not currently profitable and may incur future
losses.
Since our inception, we have incurred significant losses. We had losses of
$6.7 million during the year ended December 31, 1999 and $54.6 million during
the year ended December 31, 2000. As of December 31, 2000, we had an accumulated
deficit of $84.8 million. We are not currently profitable and may not become
profitable in the future.
We may not be able to meet our obligations to repurchase shares of our common
stock in the future.
We granted sellers in our acquisitions the right to sell back to us shares
of our common stock that we issued to them. Unless our common stock satisfies
specific price targets and/or trading volume requirements, these rights could
require us to purchase up to 305,000 shares in the future as follows:
o 25,000 shares at a price of $14.00 per share beginning on December 31,
2003;
o up to 230,000 shares at a price of $15.00 per share beginning on
December 31, 2004; and
o 50,000 shares at a price of $15.00 per share beginning on December 31,
2005.
If we were required to repurchase all 305,000 shares, it would cost us
approximately $4.6 million. We may not have sufficient funds to meet these
obligations to repurchase stock in the future.
Risks Related to our Operations
Our products are sold in a niche market that is still evolving and may have
limited future growth potential.
We believe that the market for audiobooks and old-time radio and classic
video programs has expanded rapidly in recent years. However, consumer interest
in audiobooks and old-time radio and classic video programs may decline in the
future, and growth trends in these markets may stagnate or decline. The sale of
audiobooks through mail order clubs and over the Internet are emerging retail
concepts, and audiobooks are still evolving as a niche market. As is typically
the case in an evolving industry, the ultimate level of demand and market
acceptance for our products is subject to a high degree of uncertainty. A
decline in the popularity of audiobooks and old-time radio and classic video
programs would limit our future growth potential and negatively impact our
future operating results.
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, old-time radio and classic video
industries. These changes include economic factors affecting discretionary
consumer spending, modifications in consumer
16
demographics and the availability of other forms of entertainment. The
audiobook, old-time radio and classic video markets are characterized by
changing consumer preferences, which could affect our ability to:
o plan for catalog offerings;
o introduce new titles;
o anticipate order lead time;
o accurately assess inventory requirements; and
o develop new product delivery methods.
Although we evaluate many factors and attempt to anticipate the popularity
and life cycle of audiobook titles, the ultimate level of demand for specific
titles is subject to a high level of uncertainty. Sales of audiobook titles
typically decline rapidly after the first few months following release. If sales
of specific titles decline more rapidly than we expect, we could be left with
excess inventory, which we might be forced to sell at reduced prices. If we fail
to anticipate and respond to factors affecting the audiobook industry in a
timely manner, we could lose significant amounts of capital or potential sales
opportunities.
The market for digital download of spoken word content is uncertain, and we may
not be able to participate in this market effectively or at all.
Digital download of spoken word content from the Internet is a relatively
new method of distribution and its growth and market acceptance is uncertain.
Purchasing spoken word content over the Internet in digital download format
involves adjustments in general consumer purchasing patterns, and consumers may
not be willing to purchase spoken word content in digital download format. If we
invest significant amounts of money and effort in developing digital download
products which do not achieve widespread popularity, or if the market for
digital download of spoken word content does not evolve as we anticipate, we may
not be able to recover our investment.
Since pricing patterns for the supply and sale of digital download of
spoken word content have not yet been established, we may not be able to buy
these products on the same terms as our existing products. Our profit margin for
these products also may not be as favorable as our profit margins for our
existing products.
We may not be able to license or produce desirable spoken word content, which
could reduce our revenues.
We could lose sales opportunities if we are unable to continue to obtain
the rights to additional audiobook libraries or selected audiobook titles. Many
of our license agreements with audiobook publishers are short-term,
non-exclusive agreements, typically one to three years in length, and some of
our agreements will expire over the next several months unless they are renewed.
We may not be able to renew existing license and supply arrangements for
audiobook publishers' libraries or enter into additional arrangements for the
supply of new audiobook titles.
If our third-party providers fail to perform their services properly, our
business and results of operations could be adversely affected.
Third-party providers conduct all of our Audio Book Club customer service
operations, process orders and collect payments for us. If these providers fail
to perform their services properly, Audio Book Club members could develop
negative perceptions of our business, collections of receivables could be
delayed and our operations might not function efficiently.
17
Our marketing strategy to acquire new members for Audio Book Club could result
in increased costs, and we may not acquire as many members as we anticipate,
which would inhibit our sales growth.
If our direct mail and other marketing strategies are not successful, our
per member acquisition costs may increase, and we may acquire fewer new members
than anticipated, which would slow our sales growth. We use a variety of
modeling and list analysis procedures and techniques as part of our efforts to
target our direct mail campaigns efficiently, and we intend to increase the
number of prospective members to which member solicitation packages will be
mailed. However, the success of our planned direct mail campaigns is subject to
a high degree of risk and uncertainty, and we may fail to accurately target the
type of persons who are likely to join our Audio Book Club.
Increased member attrition could negatively impact our future revenues and
operating results.
Increases in membership attrition above the rates we anticipate could
materially reduce our future revenues. We incur significant up front
expenditures in connection with acquiring new members. A member may not honor
his or her commitment, or we may choose to terminate a specific membership for
several reasons, including failure to pay for purchases, excessive returns or
cancelled orders. As a result, we may not be able to fully recoup our costs
associated with acquiring new members. In addition, once a member has satisfied
his or her initial commitment to purchase additional audiobooks at regular
prices, the member has no further commitment to make purchases.
If third parties obtain unauthorized access to our member and customer databases
and other proprietary information, we would lose the competitive advantage they
provide.
We believe that our Audio Book Club member file and customer lists are
valuable proprietary resources, and we have expended significant amounts of
capital in acquiring these names. Our member and customer lists, trade secrets,
trademarks and other proprietary information have limited protection. Third
parties may copy or obtain unauthorized access to our member and customer
databases and other proprietary know-how, trade secrets, ideas and concepts.
Competitors could also independently develop or otherwise obtain access to our
proprietary information. In addition, we rent our lists for one-time use only to
third parties that do not compete with us. This practice subjects us to the risk
that these third parties may use our lists for unauthorized purposes, including
selling them to our competitors. Our confidentiality agreements with our
executive officers, employees, list managers and appropriate consultants and
service suppliers may not adequately protect our trade secrets. If our lists or
other proprietary information were to become generally available, we would lose
a significant competitive advantage.
If we are unable to pay our accounts payable in a timely manner, our suppliers
and service providers may refuse to supply us with products or provide services
to us.
At December 31, 2000, we owed approximately $16.7 million to trade and
other creditors. Approximately $9.9 million of these accounts payable were
either past due under the vendor's ordinary terms or more than 90 days old. If
we do not make satisfactory payments to our vendors they may refuse to continue
to provide us products or services on credit, which could interrupt our supply
of products or services. Moreover, a few of our vendors are closely monitoring
our credit and it is difficult to secure credit with new vendors. We do not
expect these circumstances to change until we improve our financial position and
reduce the level of our payables.
18
Higher than anticipated product return rates could reduce our future operating
results.
We experienced a product return rate of approximately 25.8% in 2000 and
26.4% in 1999. 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.
If we are unable to collect our receivables in a timely manner, it may
negatively impact our cash flow and our operating results.
We are subject to the risks associated with selling products on credit,
including delays in collection or uncollectibility of accounts receivable. If we
experience significant delays in collection or uncollectibility of accounts
receivable, our liquidity and working capital position could suffer and we could
be required to increase our allowance for doubtful accounts which would increase
our expenses. Our accounts receivable have historically increased from period to
period, and we expect them to continue to increase as our revenues increase.
Increases in costs of postage could negatively impact our operating results.
We distribute millions of mailings each year, and postage is a significant
expense in the operation of our business. We do not pass on the costs of member
mailings and member solicitation packages. Even small increases in the cost of
postage multiplied by the millions of mailings we conduct would result in
increased expenses and would negatively impact our operating results.
We face significant competition from a wide variety of sources for the sale of
our products.
We compete with other web sites which offer similar entertainment products
or content, including digital download of spoken word content. New competitors,
including large companies, may elect to enter the markets for audiobooks and
spoken word content. We also compete for discretionary consumer spending with
mail order clubs and catalogs, other direct marketers and retailers that offer
products with similar entertainment value as audiobooks and old-time radio and
classic video 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 greater financial resources that enable
them to better withstand substantial price competition or downturns in the
market for spoken word content.
The audiobook and mail order industries are intensely competitive. We
compete with all other outlets through which audiobooks and other spoken word
content are offered, including:
o bookstores;
o audiobook stores which rent or sell only audiobooks;
o mail order companies that offer audiobooks for rental and sale through
catalogs; and
o retail establishments such as convenience stores, video rental stores
and wholesale clubs.
The loss or unavailability of our key personnel could have a material adverse
effect on our business.
Our success depends largely on the efforts of Norton Herrick, our Chairman,
Michael Herrick, our Chief Executive Officer and President, Hakan Lindskog, our
Chief Operating Officer, and Stephen McLaughlin, our Executive Vice President
and Chief Technology Officer. Norton Herrick is actively involved in the
management and operation of several businesses and is required to devote only as
much time to our business and affairs as he deems necessary to perform his
duties. Norton Herrick may experience a conflict in the allocation of his time
among
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his various business ventures. The loss of the service of these officers or of
other key personnel could have a material adverse effect on our business. We do
not maintain key-man insurance on the lives of these officers or any other key
personnel.
Risks Related to the Internet and Technology
We may not be able to continue to license rights to sell spoken word content in
new formats, such as digital download of audio files, or to respond rapidly to
technological developments in the spoken word content industry.
If we are unable to adapt our content and our web sites to evolving
entertainment technologies and to continue to license the rights to sell spoken
word content in new and emerging formats, such as digital download of audio
files and enabling technologies, our product offerings may become obsolete and
consumers may purchase spoken word content elsewhere. Some of our arrangements
with audiobook publishers permit us to produce and sell audiobooks in a cassette
and CD format, and they may not permit us to adapt our licenses to new
technologies. Although we have the ability to offer secure digital download of
our spoken word content to personal computers, we believe that the introduction
by third parties of portable consumer electronic devices will be necessary for
broad consumer acceptance of digital download files. In addition, the technology
used in delivering spoken word content over the Internet may continue to evolve
rapidly.
We may experience system interruptions, which affect access to our web sites and
our ability to sell products over the Internet.
Our marketing efforts have increasingly focused on our Internet operations,
and our future revenues may depend in part on the number of web site visitors
who join as Audio Book Club members and who make online purchases. The
satisfactory performance, reliability and availability of our web sites,
transaction-processing systems and network infrastructure are critical to our
ability to attract and retain visitors at our web sites. If we experience system
interruptions that prevent customers and potential customers from accessing our
web sites, consumer perception of our on-line business could be adversely
affected, and we could lose sales opportunities and visitor traffic.
Security risks of electronic commerce could discourage the purchase of our
products over the Internet or expose us to claims.
The transmission of private information, such as credit card numbers, over
the Internet is vulnerable to exposure and use by hackers and other unauthorized
persons. Advances in computer hacking or cryptographic decoding could result in
a compromise of the technology or other software used by us to protect customer
transactions and other data. If there is any significant compromise of our
systems' security or if customers perceive our web sites as not secure, we could
lose business or be exposed to potential claims of failure to protect or misuse
of confidential information.
Unauthorized duplication of our licensed content could affect our business.
Our attempts to ensure secure delivery of spoken word content to purchasers
over the Internet may not prevent the unauthorized replication of content that
we license for distribution. Unauthorized duplication of our content could
discourage content providers from entering into future licensing agreements with
us. If we permit unauthorized duplication of the content we sell, we could
become liable to content providers for substantial damages. Furthermore, we may
be required to spend increasing amounts of time and money to attempt to reduce
possible unauthorized duplication of the content we offer.
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We could be sued for content that we distribute over the Internet and could
become subject to substantial damage claims.
As a distributor and publisher of content over the Internet, we could
become liable for copyright or trademark infringement, defamation, indecency or
other claims based on the nature and content of materials that we offer to
consumers. Lawsuits based on our content could be expensive to defend and
damaging to our business. We could be liable for damage claims in excess of the
amount of indemnification payments or insurance reimbursement, if any, that we
might obtain.
The inability to acquire or maintain effective Internet web domain names could
create confusion and direct traffic away from our web sites.
We currently hold various Internet web addresses relating to our network.
If we are not able to prevent third parties from acquiring web addresses that
are similar to our addresses, third parties could acquire similar domain names
which could create confusion that diverts traffic away from our web sites, which
would adversely affect our business. In addition, infringement claims by third
parties which challenge our use of these names could result in the expenditure
of significant financial and managerial resources or cause us to lose such names
and the benefits of brand awareness we are spending resources to develop. The
acquisition and maintenance of web addresses generally is regulated by
governmental agencies and their designees. The regulation of web addresses in
the United States and in foreign countries is subject to change. As a result, we
may not be able to acquire or maintain relevant web addresses in all countries
where we conduct business. Furthermore, the relationship between regulations
governing these addresses and laws protecting proprietary rights is unclear.
The Internet is subject to legal uncertainties and potential government
regulation that could impair the growth of the Internet, decrease demand for
products we offer on our web sites and increase our costs.
The application of existing laws to the Internet, particularly with respect
to property ownership, libel, pricing and user privacy is uncertain. Government
agencies and regulatory authorities may adopt future laws and regulations
governing electronic commerce or Internet consumer protection. These laws and
regulations could:
o impose burdensome requirements on our ability to conduct our business
over the Internet;
o discourage consumer use of the Internet;
o decrease demand for our products; or
o increase our costs.
We may become subject to liability for taxes in connection with our Internet
sales.
We currently are not required to collect sales or other taxes on Internet
sales of content products in most states. Our business could be harmed if
additional sales or similar taxes are imposed on us or if jurisdictions in which
purchasers of our content reside require that we collect sales or similar taxes
when selling over the Internet. Significant tax requirements could increase our
costs associated with Internet sales. Additionally, increased costs associated
with taxes passed on to consumers could discourage consumers from making
purchases from us.
Risks Related to Our Capital Structure
The Herrick family exerts significant influence over shareholder matters.
Norton Herrick, Michael Herrick, Howard Herrick and Evan Herrick and their
affiliates own approximately 31.6% of our outstanding common stock. As
significant shareholders and
21
directors, they are able generally to direct our affairs and exert significant
influence over matters which require director or shareholder vote, including the
election of directors, amendments to our Articles of Incorporation or approval
of the dissolution, merger, or sale of MediaBay, our subsidiaries or
substantially all of our assets. This concentration of ownership by the Herrick
family could delay or prevent a change in our control, even when a change in
control might be in the best interests of other shareholders.
The terms of our debt impose restrictions on our business.
As of April 6, 2001, we had approximately $6.6 million of debt outstanding
under our revolving line of credit and $9.7 million principal amount of debt
outstanding under convertible promissory notes. Our line of credit restricts our
ability to raise financing for working capital purposes because it prohibits us
from incurring additional debt without the lenders permission and requires us to
use certain proceeds from equity financings to repay amounts outstanding under
the credit agreement. In addition to limiting our ability to incur additional
indebtedness, our existing indebtedness under our revolving line of credit
limits or prohibits us from, among other things:
o merging into or consolidating with another corporation;
o selling all or substantially all of our assets;
o declaring or paying cash dividends; or
o materially changing the nature of our business.
We have agreed upon a term sheet with our lenders to extend the maturity
date of our revolving credit facility to September 30, 2002 and are currently
amending the loan documents. We expect that a definitive agreement will be
executed.
Moreover, the term sheet with our lenders permits us to incur up to an
additional $3.0 million of secured debt over the next few months and we expect
to grant a security interest in some of our assets in connection with $800,000
of advances we recently received. We expect this debt to contain similar
limitations and prohibitions on our operations.
In addition, if an event of default occurs under the convertible promissory
note or senior credit facility, the indebtedness could become due and payable.
We might not have sufficient funds to repay this outstanding indebtedness when
it becomes due.
Our ability to use our net operating losses may 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. The additional equity financing we obtained in
connection with recent financings has resulted in an ownership change and, thus,
may limit our use of prior net operating losses. 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.
Our stock price has been and could continue to be extremely volatile.
The market price of our common stock has been subject to significant
fluctuations since our initial public offering in October 1997. The securities
markets have experienced, and are
22
likely to experience in the future, significant price and volume fluctuations,
which could adversely affect the market price of our common stock without regard
to our operating performance. In addition, the trading price of our common stock
could be subject to significant fluctuations in response to:
o our ability to maintain listing of our common stock on NASDAQ;
o actual or anticipated variations in our quarterly operating results;
o announcements by us or other industry participants;
o factors affecting the market for spoken word content;
o changes in national or regional economic conditions;
o changes in securities analysts' estimates for us, our competitors' or
our industry or our failure to meet such analysts' expectations; and
o general market conditions.
All of our shares of restricted common stock are currently eligible for sale and
could be sold in the market in the near future, which could depress our stock
price.
As of April 6, 2001, we have outstanding 13,861,866 shares of common stock.
Approximately 8,600,000 of our shares are currently freely trading without
restriction under the Securities Act of 1933. All of the remaining shares have
been registered for resale or have been held by their holders for over two years
and are eligible for sale under Rule 144(e).
There are currently outstanding options and warrants and other convertible
securities to purchase approximately 11,696,361 shares of common stock at a
weighted average price of $6.65 per share. Substantially all of these shares
have been registered for resale and may be sold in the public market by their
holders upon exercise. To the extent they are exercised or converted, existing
stockholders' ownership will be further diluted and our stock price could be
further adversely affected. This could also adversely affect the terms upon
which we will be able to obtain additional equity capital, since the holders of
outstanding options and warrants can be expected to exercise them at a time when
we would, in all likelihood, be able to obtain any needed capital on terms more
favorable to us than those provided in the outstanding options and warrants.
Item 2. Description of Property.
We lease 11,451 square feet of office space in Cedar Knolls, New Jersey
pursuant to a lease agreement that expires in August 2003 at a monthly rate of
$15,000. We have the option to renew the lease for an additional three-year
period. We lease 8,000 and 8,400 square feet in Schaumberg, Illinois pursuant to
two lease agreements which both expire in December 2005, subject to a three-year
renewal option. Monthly rent for the first lease is $5,000. These spaces contain
both office and warehouse space for RSI. Monthly rent for the second lease is
$4,000 base rent and $2,000 per month related to lessor's leasehold
improvements.
The Company entered into two ten-year leases on 7,000 square feet of office
and warehouse space in Bethel, Connecticut and 3,000 square feet of warehouse
space in Sandy Hook, Connecticut, respectively. Lease payments and mandatory
capital improvement payments, starting in 2004, are $4,000 per year and $2,000
per year on the Bethel and Sandy Hook properties, respectively.
Item 3. Legal Proceedings
We are not a party to any lawsuit or proceeding which we believe is likely
to have a
23
material adverse effect on us.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of our security holders during the
fourth quarter of the fiscal year covered by this report.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
MediaBay's common stock has been quoted in the Nasdaq National Market under
the symbol "MBAY" since November 15, 1999. From October 23, 1997 until November
12, 1999, MediaBay's common stock was listed on the American Stock Exchange
under the symbol "KLB". The following table shows the high and low sales prices
of our common stock as reported by the Nasdaq National Market since November 15,
1999 and the high and low sales prices reported by the American Stock Exchange
until November 12, 1999.
High Low
Fiscal Year Ended December 31, 1999
First Quarter 14.38 7.38
Second Quarter 19.94 10.00
Third Quarter 15.88 7.25
Fourth Quarter 15.00 10.25
Fiscal Year Ended December 31, 2000
First Quarter 15.75 7.13
Second Quarter 7.06 3.06
Third Quarter 3.06 1.63
Fourth Quarter 3.38 .69
Fiscal Year Ending December 31, 2001
First Quarter 1.63 .53
Second Quarter (through April 6, 2001) .69 .50
On April 6, 2001 the last reported sale price of our common stock on the
Nasdaq National Market was $0.50 per share. As of April 6, 2001, there were
approximately 91 record owners of our common stock. We believe that there are
more than 400 beneficial owners of our common stock.
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 debt
agreements 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.
Sales of Securities and Use of Proceeds
In November 2000, we issued warrants to purchase 100,000 shares of common
stock at an exercise price of $4.00 per share pursuant to a consulting
agreement. In December 2000, we issued warrants to purchase 18,480 shares of our
common stock at an exercise price of $8.41 pursuant to a 1998 letter agreement.
24
During the three months ended December 31, 2000, we issued options under
our 2000 Stock Incentive Plan to purchase a total of 124,000 shares of our
common stock to employees.
We relied on the exemptions provided by Section 4(2) of the Securities Act
of 1933 in connection with such issuances.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are a leading provider of premium spoken word audio content and products
in hard goods and digital download formats via the Internet and various offline
methods. We market and sell our audiobooks through Audio Book Club, the largest
membership-based club of its kind with approximately 1.95 million members, and
our Audiobookclub.com web site. We sell our old-time radio and classic video
programs direct to consumer through our direct marketing catalog and web site,
Radiospirits.com, as well as on a wholesale basis to major retailers. We offer
downloads of audiobooks, old-time radio shows and current and archived
newspapers and magazines at MediaBay.com. Our Radio Classics subsidiary intends
to distribute our old-time radio library across multiple distribution platforms
including traditional radio, digital cable television, satellite television
(DBS), satellite radio and the Internet.
We have undertaken a significant review of our strategic objectives and
operations. While we remain committed to growth and believe strongly in both the
potential of our core markets and the future of digital downloads of premium
spoken word content, our priorities for the next twelve months are to operate
our core businesses on a more profitable basis and to improve cash flow. To this
end, we have implemented a number of key initiatives as follows:
o As a result of implementing a standardized merchandising program in
our catalogs, we have reduced the number of SKUs (Stock Keeping Units)
in our inventory.
o We have revised the logic used in determining customer shipments which
we believe reduces the level of customer returns and decreases the
level of required inventory.
o We have eliminated our Audio Book Club every day low price discounting
structure and currently sell most titles to members at full
manufacturers' suggested retail price.
o We have discontinued doing cost per thousand guaranteed impressions
and cost per click advertising on the Internet in favor of cost per
customer acquired agreements only.
o We have streamlined the operations structure of our divisions and have
been able to eliminate positions that are no longer necessary to
achieve our goals.
o We have revised our marketing strategies to focus on the acquisition
of customers who generate higher profits, have therefore reduced, and
will continue to reduce the amounts expended on advertising both on
the Internet and in direct mail.
We believe these initiatives have had a positive impact to date and will
substantially increase the profitability and improve the cash flow of our
operations.
Our marketing programs have consisted primarily of direct mail, media
advertising and marketing on the Internet. Online and offline direct response
marketing costs to current members
25
are expensed on the date the promotional materials are mailed. Online and
offline direct response costs for any premiums, gifts or discounted audiobooks
in the promotional offer to new members are expensed as incurred. Beginning in
January 1999, we were required to capitalize direct response marketing costs for
the acquisition of new members in accordance with AICPA Statement of Position
93-7 "Reporting on Advertising Costs" and amortize these costs over the period
of future benefit which was estimated at 30 months for our Audio Book Club and
60 months for our old-time radio business, based on our historical experience.
Since 1999 was the first year the Company capitalized new member acquisitions
costs the Company capitalized a very large portion of direct response
advertising expenditures. Therefore, the comparison of marketing expenses
between 1999 and 2000 may not be as meaningful.
As a result of the timing of our marketing activities within a given year
or quarter, the impact of capitalizing new member direct response marketing
costs, the timing of the Audiobooks Direct acquisition and related costs,
including interest expense and goodwill and other intangible asset amortization
expense, and the write-down of goodwill, comparisons of our historical operating
results from period to period may not be as meaningful.
Results of Operations
The following table sets forth, for the periods indicated, historical
operating data as a percentage of net sales.
Year Ended
December 31,
---------------------
2000 1999
---- ----
Net sales ................................................ 100% 100%
==== ====
Cost of sales ............................................ 52 51
Gross profit ............................................. 48 49
Advertising and promotion expense ........................ 25 18
General and administrative expense ....................... 31 21
Depreciation and amortization expense .................... 18 15
Non-cash write-down of goodwill .......................... 86 --
Interest income (expense), net ........................... (6) (10)
Extraordinary loss on early extinguishment of debt ....... (5) --
Net loss ................................................. (123) (15)
Year ended December 31, 2000 compared with year ended December 31, 1999
Gross sales decreased $2.9 million, or 4.7%, to $59.9 million for the year
ended December 31, 2000 from $62.8 million for the year ended December 31, 1999.
The decrease in gross sales was primarily attributable to a slowdown in the
aggressive marketing at both the Audio Book Club and Radio Spirits. In addition,
we revised the logic used in determining customer product shipments, which
resulted in lower gross sales but also lower return rates. We also instituted a
policy of offering higher discounts, which resulted in lower dollar sales. This
practice has since been eliminated. We have subsequently changed our discounting
policy to restrict discounts to only selected titles. Returns, discounts and
allowances declined $1.1 million, or 6.8%, to $15.5 million for the year ended
December 31, 2000 from $16.6 million for the year ended December 31, 1999.
Returns, discounts and allowances as percentage of gross sales were 25.8% in
2000 as compared to 26.4% of gross sales for the prior comparable period. The
decrease in returns is due to aforementioned revisions in the logic used in
determining customer shipments, as well as lower gross sales.
26
Principally as a result of lower gross sales, partially offset by lower
return rates, net sales for the year ended December 31, 2000 decreased $1.8
million, or 3.9%, to $44.4 million from $46.2 million.
Cost of sales decreased $0.6 million, or 2.7%, to $23.0 million for the
year ended December 31, 2000 from $23.7 million for the year ended December 31,
1999. Gross profit decreased $1.2 million, or 5.1%, to $21.4 million for the
year ended December 31, 2000 from $22.5 million for the year ended December 31,
1999. Gross profit as a percentage of net sales was 48.1% as compared to 48.8%
in the prior comparable period. In 2000, we offered an "everyday low pricing"
discount structure to Audio Book Club members via both the catalog and at
Audiobookclub.com. Previously, we had believed, based on test results and
experiences at the clubs we acquired, that additional purchases would more than
offset lower prices. Our experience revealed that while purchasing did increase
it was not sufficient to offset the lower prices and our gross profit margin
suffered. Beginning in 2001, we are offering only selected discounts in our
catalogs and on our web site. We also implemented a standardized merchandising
program in our catalogs, which reduced the numbers of SKUs (Stock Keeping Units)
in our inventory and concentrated our inventory and sales on those items, which
offer us the greatest gross profit per item. We also discounted our old-time
radio products in an attempt to increase overall sales. These discounts have
been largely discontinued and we have already begun to see increases in our
gross profit percentage.
Advertising and promotion expenses (for acquisition and retention of
members) increased $2.9 million or 35.8%, to $11.0 million for the year ended
December 31, 2000 compared to $8.1 million for the year ended December 31, 1999.
Actual amounts expended for advertising and promotion in the year ended December
31, 2000 were $14.3 million a decrease of $3.1 million from the amount expended
in the year ended December 31, 1999 of $17.4 million. The difference between the
amount expended and the amount recorded as expense is due to the capitalization
of direct response advertising. Beginning in January 1999, the Company was
required to capitalize direct response marketing costs for the acquisition of
new members in accordance with AICPA Statement of Position 93-7 "Reporting on
Advertising Costs" and amortize these costs over the period of future benefit.
Since 1999 was the first year we capitalized new member acquisitions costs, we
capitalized a very large portion of direct response advertising expenditures.
The difference between amounts expended for direct response advertising and the
amounts recorded as expenses is expected to be lower beginning in the first
quarter of 2001 which will result in improved comparability between periods.
General and administrative expenses increased $4.2 million, or 42.5%, to
$14.0 million for the year ended December 31, 2000 from $9.8 million for the
prior comparable period. General and administrative expense increases are
principally attributable to increased personnel and related costs, investor and
public relation expenses and consulting expenses, including outside Internet
development and maintenance expenses. Included in general and administrative
expenses , for the year ended December 31, 2000, are $.3 million of non-cash
expenses related to the issuance of warrants and options. We have taken several
steps to reduce general and administrative expenses, including reducing
personnel, terminating relationships with investor and public relation firms and
terminating consulting agreements including those with outside Internet
development and maintenance firms.
Depreciation and amortization expenses increased $1.2 million to $8.0
million for the year ended December 31, 2000 from $6.8 million for the year
ended December 31, 1999. The increase is principally due to amortization of
goodwill and other intangible assets in connection with our acquisition of
Doubleday Direct's Audiobooks Direct.
27
During the fourth quarter of 2000, the Company reviewed long-lived assets
and certain related identifiable intangibles, including goodwill, for impairment
in accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" ("FASB 121") due to a change in facts and circumstances. In the
fourth quarter of 2000, the Company made a strategic decision to reduce spending
on marketing to customers acquired in the Company's acquisitions of the Columbia
House Audiobook Club, Doubleday Direct's Audiobooks Direct and Adventures in
Cassettes in order to focus its resources on more profitable revenue sources. In
addition, the Company has sold the remaining inventory acquired in its
acquisition of Adventures in Cassettes and does not expect to derive any future
revenues associated with this business. Consequently, the Company determined
that the revised estimates of cash flows from such operations would no longer be
sufficient to recover the carrying value of goodwill associated with these
businesses. As a result, in the fourth quarter of 2000, the Company determined
that the goodwill associated with these businesses was impaired and has recorded
an impairment charge of $38.2 million. The impairment charge was measured as the
difference between the carrying value of the goodwill and its fair value which
was based upon discounted cash flows.
Net interest expense for the year ended December 31, 2000 decreased $1.8
million to $2.7 million as compared to net interest expense of $4.5 million for
the year ended December 31,1999. The Company has reduced its debt by $24.8
million since December 31, 1999.
Net loss before an extraordinary item for the year ended December 31, 2000
was $52.5 million or $4.13 per share as compared to a net loss of $6.7 million
or $.82 per share for the year ended December 31, 1999.
In April 2000, we repaid $20.3 million of our bank debt out of the net
proceeds from our follow-on primary offering. Accordingly, the Company recorded
an extraordinary loss of $2.2 million relating to the write-off of deferred
financing fees incurred in connection with such debt.
Primarily due to the write-off of goodwill of $38.2 million, net loss for
the year ended December 31, 2000 was $54.6 million or $4.30 per share of common
stock as compared to a net loss of $6.7 million or $.82 per share of common
stock for the year ended December 31, 1999.
Liquidity and Capital Resources
Historically, we have funded our cash requirements through sales of our
equity and debt securities and borrowings from financial institutions and our
principal shareholders. We have implemented a series of initiatives to increase
cash flow. While these initiatives have successfully increased cash generated
subsequent to year-end, there can be no assurance that we will not in the future
require additional capital to fund the expansion of operations, acquisitions,
working capital or other related uses.
For the year ended December 31, 2000, our cash increased by $0.3 million as
we used net cash of $5.6 million for operating and $4.0 million for investing
activities and had cash provided by financing activities of $10.0 million. Net
cash used in operations principally consisted of the net loss of $54.6 million,
which included a non-cash charge to earnings for impairment of goodwill, of
$38.2 million, depreciation and amortization expenses of $8.0 million and an
extraordinary loss on early extinguishment of debt of $2.2 million, an increase
in royalty advances of $0.8 million and a net increase in deferred member
acquisition costs of $3.3 million, partially offset by decreases in net accounts
receivable of $3.5 million, inventory of $0.5 million, prepaid expenses of $0.3
million and an increase in accounts payable and accrued expenses of $0.1
million.
The increase in royalty advances relates to the advance payments to
publishers and rights
28
holders of our various licensed products including the acquisition of
downloadable rights. The net increase in deferred member acquisition costs is
attributable to amounts expended for both Audio Book Club and old-time radio
direct response advertising campaigns less amounts previously capitalized and
amortized in the current year. The decrease in accounts receivable during the
year ended December 31, 2000 is principally due to lower sales in the fourth
quarter of 2000 as compared to 1999 of our old-time radio products. The decrease
in inventory specifically relates to our initiative described above in which we
have implemented a standardized merchandising program in our catalogs and
reduced the numbers of SKUs (Stock Keeping Units) in our inventory. We also
revised the logic used in determining customer shipments which allows us to use
returned units to fulfill customer orders.
Cash used in investing activities for the year ended December 31, 2000 was
primarily our investment of $2.0 million in I-Jam MultiMedia LLC, a pioneer in
the development of portable digital audio devices. We acquired a 4% equity
interest in I-Jam with an option to purchase an additional equity interest.
Fixed assets increased $0.9 million, including capitalized Internet development
costs of $0.5 million, and we incurred additional costs of $1.3 million relating
to our acquisition of Audiobooks Direct.
Cash provided by financing activities consisted of the completion of a
follow-on public offering of our common stock, resulting in net proceeds to us
of $29.4 million and increases in our notes payable to related parties of $2.5
million partially offset by the repayment of $21.7 million of long-term debt.
These transactions are described in more detail below.
Recent Financings
In January and February 2000, Evan Herrick, the son of our chairman, loaned
the Company an additional $2.0 million in the form of 9% convertible promissory
notes due December 31, 2004. The loans evidenced by the notes were intended to
be short-term and serve as a "bridge" to replacement financing. At the time of
issuance of the convertible notes, our board of directors resolved to seek to
replace or refinance the convertible notes and accept a proposal for
refinancing, whether or not (i) as favorable as the convertible notes including,
without limitation, providing for a higher interest rate or lower conversion
price, (ii) requiring the issuance of equity securities and/or (iii) requiring
the payment of fees.
In January and February 2000, two unaffiliated third parties converted $4.2
million principal amount of convertible promissory notes into 379,662 shares of
our common stock.
In March 2000, we closed our public offering of 3,650,000 shares of our
common stock at a price of $9.00 per share for gross proceeds of $32.9 million.
Net proceeds after expenses of $3.5 million, including the underwriting discount
and accountable expenses, legal and accounting fees and printing expenses, were
$29.4 million.
In March 2000, we made a quarterly payment of principal on our term debt of
$0.9 million. In April 2000, we repaid $20.3 million of our bank debt out of the
net proceeds from the follow-on primary offering, representing the remaining
term portion of such debt. In April 2000, we amended the terms of our remaining
revolving debt with our lenders to calculate the amount available to be borrowed
based on a formula of eligible receivables and inventory, as defined. In June
2000, we paid down our bank debt by $0.5 million. In March 2001, the terms of
our revolving debt were amended and the maturity of the principal amount of $6.6
million was extended to April 15, 2001. We have agreed upon a term sheet with
our lenders extending the maturity date to September 30, 2002 and are currently
amending the loan documents. We expect that a definitive agreement will be
executed. In the event that a definitive agreement is not executed, we believe
that we can obtain alternative financing. At December 31, 2000 the interest rate
was 14% on $1.7
29
million of the borrowings and 12% on $4.9 million of the borrowings. The term
sheet for the extension to the revolving credit facility contemplates that
interest will be payable at the prime rate plus 2% and that we will make
mandatory prepayments as follows: $100,000 on September 30, 2001 and $300,000 on
each of December 31 2001, March 31, 2002 and June 30, 2002.
In April and August 2000, the conversion price of the $3.0 million
principal amount 9% convertible notes due December 31, 2004 issued to Evan
Herrick was reduced to the then current market value of our common stock. In
return, Mr. Herrick agreed to the following: interest on the note was forgiven
by Mr. Herrick for the period from July 1, 2000 through December 31, 2000; Mr.
Herrick gave us, under certain circumstances, the option of paying future
interest in our common stock; all anti-dilution provisions, other than
mechanical anti-dilution provisions were deleted; Mr. Herrick agreed, under
certain conditions to lend us an additional $0.5 million and Mr. Herrick agreed
not to convert $1.3 million of the principal amount of the note without our
consent prior to June 1, 2001. The notes are currently convertible into shares
of the Company's common stock at $1.75 per share, which was the market value on
the date the terms were revised.
In August 2000, Mr. Norton Herrick sold his $2.8 million convertible note
to two unaffiliated third parties. The terms of subordinated debt were modified
so that the two third parties agreed to waive any interest due to them and they
also agreed to convert the entire subordinated debt by December 31, 2000. In
October and November of 2000, one of the third parties converted $0.8 million
principal amount of the notes into 440,000 shares of common stock. The third
parties failed to pay Mr. Herrick the entire purchase price of the note they
purchased. In December 2000, the parties rescinded the transaction as to $2.0
million principal amount of the note, which was not converted or paid for.
In December 2000, an affiliate of Norton Herrick lent us $0.5 million and
in February 2001, Mr. Herrick's affiliate lent us an additional $0.3 million.
We have reached an agreement with an affiliate of Norton Herrick for an
additional $2.5 million loan. It is currently contemplated that $1.0 million
will be funded upon execution of a definitive agreement; and $0.5 million will
be funded on or before April 30, May 31 and June 30, 2001, respectively.
The proposed terms of Mr. Herrick's affiliate's advances of $0.8 million
and proposed $2.5 million loan are described under the caption "Certain
Relationships and Related Transactions." These terms are subject to the
execution of definitive agreements, as well as the execution of definitive
agreements relating to the extension of the revolving credit facility described
above and related agreements among these lenders. We require this additional
financing to satisfy some of our key vendors to ensure product supply and
fulfillment services.
30
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", subsequently amended by SFAS No.
137 and SFAS No. 138, which is effective beginning January 1, 2001. SFAS No. 133
provides a comprehensive standard for the recognition and measurement of
derivatives and hedging activities. The statement requires all derivatives to be
recorded on the balance sheet at fair value and also prescribes special
accounting for certain types of hedges. We have not entered into any derivative
or hedging transactions, and therefore, have concluded that upon adoption of
SFAS No. 133 as of January 1, 2001, our transition adjustment is zero.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". SAB 101 summarized certain of the SEC's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Company has determined that the adoption of SAB 101 in the fourth quarter of
2000 had no impact on the Company's financial position or results of operations.
Revenues continue to be recognized upon shipment of merchandise consistent with
the shipping terms. A reserve for future returns is recorded based upon
historical experience and an evaluation of current trends.
Net Operating Losses
Our net operating loss carryforwards expire beginning in 2018. 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. The additional equity financing we obtained in
connection with recent financings may result in an ownership change and, thus,
may limit our use of our prior net operating losses. 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 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.
Quarterly Fluctuations
Our operating results vary from period to period as a result of purchasing
patterns of members, the timing, costs, magnitude and success of direct mail
campaigns and Internet initiatives and other new member recruitment advertising,
member attrition, the timing and popularity of new audiobook and old-time radio
releases and product returns. The timing of new member enrollment varies
depending on the timing, magnitude and success of new member advertising,
particularly Internet advertising and direct mail campaigns.
Our gross profit margin is affected by the percentage of new Audio Book
Club member enrollment purchases. Initial purchases by new members are at
substantially reduced prices to encourage enrollment. These offers, which are
typically four audiobooks for either $.99 or $.01 plus shipping and handling,
result in an initial loss to us which is expected to be recovered through
additional member purchases at regular prices. New member enrollment purchases
typically account for a higher percentage of sales following significant Audio
Book Club direct marketing activities.
We believe that a significant portion of our sales of old-time radio and
classic video
31
programs are gift purchases by consumers. Therefore, we tend to experience
increased sales of these products in the fourth quarter in anticipation of the
holiday season and the second quarter in anticipation of Fathers' Day.
Item 7. Financial Statements.
The financial statements appear in a separate section of this report
following Part III.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
32
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act.
The directors, executive officers and other key employees of our company
are as follows:
Name Age Position
Norton Herrick 62 Chairman and Director
Michael Herrick 34 Chief Executive Officer, President and Director
Howard Herrick 36 Executive Vice President and Director
Hakan Lindskog 40 Chief Operating Officer
Stephen M. McLaughlin 34 Executive Vice President and Chief Technology Officer
John F. Levy 45 Executive Vice President and Chief Financial Officer
Robert Toro 36 Senior Vice President of Finance
Carl P. Amari 37 President of Radio Operations and Director
Roy Abrams 57 Director
Carl T. Wolf 57 Director
Norton Herrick, 62, is our co-founder and has been Chairman and Director
since our inception. Mr. Herrick served as our President from our inception
until January 1996 and was Chief Executive Officer from January 1996 through
January 2000. Mr. Herrick has been a private businessman for over 30 years and
through his wholly-owned affiliates, Mr. Herrick has completed transactions,
including building, managing and marketing primarily real estate valued at an
aggregate of approximately $2 billion. Mr. Herrick serves on the advisory board
of the Make-A-Wish Foundation, the advisory committee of the National Multi
Housing Council and the National Board of Directors for People for the American
Way. Mr. Herrick is the father of Michael Herrick, our Chief Executive Officer,
President, and a director, and Howard Herrick, our Executive Vice President and
a director.
Michael Herrick, 34, is our co-founder and has been our Chief Executive
Officer and President since January 2000 and a director since our inception. Mr.
Herrick was our Co-Chief Executive officer from April 1998 to January 2000 and
has held various other offices with us since our inception. Since August 1993,
Michael Herrick has been an officer (since January 1994, Vice President) of the
corporate general partner of a limited partnership which is a principal
shareholder of The Walking Company, a nationwide retailer of comfort and walking
footwear and related apparel and accessories. Mr. Herrick is a member of the
Board of Directors of the Audio Publisher's Association. Mr. Herrick is the son
of Norton Herrick, our Chairman, and brother of Howard Herrick, our Executive
Vice President and a director. Mr. Herrick received his B.A. degree from the
University of Michigan.
Howard Herrick, 36, is our co-founder and has been our Executive Vice
President, Editorial Director and a director since our inception. Since August
1993, Howard Herrick has been Vice President of the corporate general partner of
a limited partnership, which is a principal shareholder of The Walking Company.
Since 1988, Mr. Herrick has been an officer of The Herrick Company, Inc. and is
currently its President. Mr. Herrick is also an officer of the corporate general
partners of numerous limited partnerships which acquire, finance, manage and
lease office, industrial and retail properties; and which acquire, operate,
manage, redevelop and sell residential rental properties. Mr. Herrick is the son
of Norton Herrick, our Chairman and brother of Michael Herrick, our Chief
Executive Officer, President and director.
Hakan Lindskog, 40, joined MediaBay in July 2000 as Chief Operating Officer
for
33
MediaBay and Chief Executive Officer for its Audio Book Club division. In that
capacity, Mr. Lindskog manages all day-to-day operations including the Audio
Book Club division. Mr. Lindskog has 15 years management experience in direct
marketing, publishing and Internet consumer services. Before joining our
company, he was the former Executive Vice President and Chief Operating Officer
of RealHome.com, a free membership web service that provides information and
services regarding home buying and home ownership. Prior to joining
RealHome.com, Mr. Lindskog was Group Executive Vice President and Chief
Operating Officer of International Masters Publishers Group (IMP), a $740
million direct marketer, operating in 19 countries. Mr. Lindskog doubled revenue
of its U.S. subsidiary to $330 million and took net income from a $1 million
loss to a $33 million profit over a three-year period.
Stephen M. McLaughlin, 34, has been our Executive Vice President and Chief
Technology Officer since February 1999. Prior to joining us, Mr. McLaughlin was
Vice President, Information Technology for Preferred Healthcare Staffing, Inc.,
a nurse-staffing division of Preferred Employers Holdings, Inc. Mr. McLaughlin
co-founded and was a director, Chief Operating Officer and Chief Information
Officer of NET Healthcare, Inc., from 1997 until it was acquired by Preferred
Employers Holdings in August 1998. In 1994, Mr. McLaughlin founded FX Media,
Inc., an Internet and multimedia development company. As CEO of FX Media, he
served as senior software engineer for all of its projects. Mr. McLaughlin holds
a degree in Computer Science and Engineering from the Massachusetts Institute of
Technology and conducted research at the MIT Media and Artificial Intelligence
labs.
John F. Levy, 45, joined us in November 1997 and has served as our
Executive Vice President and Chief Financial Officer since January 1998. Prior
to joining us, Mr. Levy was Senior Vice President of Tamarix Capital Corporation
and had previously served as Chief Financial Officer of both public and private
entertainment and consumer goods companies. Mr. Levy is a Certified Public
Accountant with nine years experience with the national public accounting firms
of Ernst & Young, Laventhol & Horwath and Grant Thornton.
Robert Toro, 36, has been our Senior Vice President of Finance since July
1999 and an employee since April 1999. Before 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 the national public accounting firm of Arthur
Andersen where he was employed immediately prior to joining Marvel Entertainment
Group.
Carl P. Amari, 37, has been the President of Radio Operations since we
acquired our old-time radio and classic video operations in December 1998 and a
director of MediaBay since September 1999. Since 1989, Mr. Amari was the CEO and
principal shareholder of Radio Spirits, Inc. Radio Spirits is recognized as the
largest company in the world specializing in the syndication, sales and
licensing of old-time radio programming. He is also the executive producer of a
nationally syndicated version of "When Radio Was" which airs on 500 affiliates,
as well as for three other related syndicated radio programs. Radio Spirits
twice made Inc's list of the fastest growing privately held companies. In
connection with our acquisition of Radio Spirits, Inc. from Mr. Amari, Norton
Herrick agreed to vote his shares to elect Mr. Amari as a director.
Roy Abrams, 57, has been a director of MediaBay since October 1997. Since
April 1993 and from 1986 through March 1990, Mr. Abrams has owned and operated
Abrams Direct Marketing, a marketing consulting firm.
34
Carl T. Wolf, 57, has been a director of MediaBay since March 1998. Mr.
Wolf is the managing partner of the Lakota Investment Group. Mr. Wolf was
formerly Chairman of the Board, President and Chief Executive Officer of Alpine
Lace Brands, Inc. Mr. Wolf founded Alpine Lace and its predecessors and had been
the Chief Executive Officer of each of them since the inception of Alpine Lace
in 1983. Mr. Wolf became a director of Alpine Lace shortly after its
incorporation in February 1986.
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. Norton Herrick is a Class I director and will stand
for re-election at the 2001 annual meeting of shareholders. Michael Herrick, Roy
Abrams and Carl Amari are Class II directors and stand for re-election at the
2002 annual meeting of shareholders. Howard Herrick and Carl Wolf are Class III
directors and stand for re-election at the 2000 annual meeting of shareholders.
Our executive officers serve at the direction of the Board and until their
successors are duly elected and qualified.
Our Board of Directors held three meetings during the fiscal year ended
December 31, 2000. The meetings were attended by all of the directors. The Board
also took action by unanimous written consent in lieu of meetings.
Board Committee
We have established an Audit Committee, which is responsible for making
recommendations concerning the engagement of independent public accountants,
reviewing the plans and results of the audit engagement with the independent
public accountants, approving professional services provided by the independent
public accountants and reviewing the adequacy of our internal accounting
controls. The Audit Committee is currently comprised of Messrs. Michael Herrick,
Roy Abrams and Carl T. Wolf. We do not have standing compensation or nominating
committees.
We reimburse our directors for reasonable travel expenses incurred in
connection with their activities on our behalf, but we do not pay our directors
any fees for Board participation.
Technology Advisory Board
We have a Technology Advisory Board to assist in the further development
and implementation of our new technologies, partnerships, joint ventures and
strategic initiatives. The members of the Technology Advisory Board are as
follows:
Name Position Company
Stephen McLaughlin, Executive Vice President MediaBay, Inc.
Chairman and Chief Technology Officer
Rob Green Business Development Manager, Microsoft Corporation
Digital Media Division,
Mort Greenberg Director, Integrated IWON.com
Partnerships
Timothy W. Mattox Director, Enterprise System Dell Corporation
Group Strategic Planning
John Ramsey Chief Technology Officer Virtacon, Inc.
Michael Schoen Managing Director Credit Suisse First Boston
Harvey Stober Managing Partner Greystone Partners, L.P.
Carl T. Wolf Managing Partner Lakota Investment Group
35
Compliance with Section 16(a) of the Exchange Act
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 2000, all filing requirements
applicable to our officers, directors, and greater than 10% shareholders were
complied with.
Item 10. Executive Compensation
The following table discloses, for the periods indicated, compensation paid
to our Chief Executive Officer and other executive officers whose salary,
together with any bonus, exceeded $100,000 during the fiscal year ended December
31, 2000.
Summary Compensation Table
Long-Term
Compensation
Awards
Securities
Annual Compensation Underlying
Options/SAR's
Name and Principal Position Year Salary Bonus (#)
Michael Herrick 2000 $154,167 $ 50,000 600,000
Chief Executive Officer and President 1999 125,000 --
1998 125,000 -- 250,000
John F. Levy 2000 167,027 15,000 --
Executive Vice President and Chief 1999 152,125 12,500 30,000
Financial Officer 1998 137,083 7,500 50,000
Steven M. McLaughlin 2000 167,500 25,000 35,000
Executive Vice President and Chief 1999 131,250 15,000 158,000
Technology Officer
Howard Herrick 2000 139,583 15,000 300,000
Executive Vice President 1999 125,000 -- --
1998 125,000 -- 250,000
Robert Toro 2000 141,784 10,000 20,000
Senior Vice President Finance 1999 97,125 -- 50,000
Mr. McLaughlin joined our company in February 1999 and Mr. Toro joined our
company in April 1999.
36
The following table discloses options granted during the fiscal year ended
December 31, 2000 to these executives:
Option/SAR Grants in Fiscal Year Ending December 31, 2000
Number of % of
Shares Total Options
Underlying Granted to
Options Employees Exercise Price Expiration
Name Granted in Fiscal Year ($/share) Date
---- ------- -------------- --------- ----
Michael Herrick 300,000 7.28% $ 10.38 01/04/10
300,000 7.28% $ 4.00 05/30/10
Howard Herrick 150,000 3.64% $ 10.38 01/04/10
150,000 3.64% $ 4.00 05/30/05
Steven M. McLaughlin 25,000 0.61% $ 4.00 04/18/05
10,000 0.24% $ 4.00 05/30/05
Robert Toro 10,000 0.24% $ 4.00 04/18/05
10,000 0.24% $ 4.00 05/30/05
John F. Levy -- -- -- --
The following table sets forth information concerning the number of options
owned by these executives and the value of any in-the-money unexercised options
as of December 31, 2000. No options were exercised by any of these executives
during fiscal 2000.
Aggregated Option Exercises And Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Name Options at December 31, 2000 December 31, 2000
---- ---------------------------- -----------------
Exercisable Unexercisable Exercisable Unexercisable
Michael Herrick 850,000 -- $ -- $ --
Howard Herrick 550,000 -- -- --
Steven McLaughlin 68,000 125,000 12,200 --
John F. Levy 60,000 20,000 -- --
Robert Toro 35,000 35,000 -- --
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 31, 2000
was $1.63.
Employment Agreements
Effective as of October 22, 1999, we entered into a two-year employment
agreement with Norton Herrick which provides for an annual base salary of
$100,000 and such increases and bonuses as the Board of Directors may determine
from time to time. The employment agreement does not require that Mr. Herrick
devote any stated amount of time to our business and activities and contains
non-competition and non-solicitation provisions for the term of the employment
agreement and for two years thereafter. If Mr. Herrick's employment is
terminated under circumstances described in the employment agreement, including
as a result of a change in control, Mr. Herrick will be entitled to receive
severance pay equal to the greater of $600,000
37
or six times the total compensation received by Mr. Herrick from us during the
twelve months prior to the date of termination. If the severance payment is
triggered, it is possible that the payments may be deemed "excess parachute
payments" under Section 280(g) of the Internal Revenue Code and, as a result, we
may not receive a tax deduction for those payments.
Effective June 1, 2000, we entered into an eighteen-month employment
agreement with Michael Herrick, which provides for an annual base salary of
$175,000 and an annual bonus of $50,000. The employment agreement requires
Herrick to devote substantially all of his business time to our business and
affairs. The agreement contains non-competition and non-solicitation provisions
for the term of the employment agreements and for two years thereafter. In the
event of termination of employment under circumstances described in the
employment agreement, including as a result of a change in control, we will be
required to provide severance pay equal to the greater of $525,000 or three
times the total compensation received from us during the twelve months prior to
the date of termination.
Effective June 1, 2000, we entered into a thirty-month employment agreement
with Howard Herrick, which provides for an annual base salary of $150,000 and an
annual bonus of $15,000. The employment agreement requires Herrick to devote
substantially all of his business time to our business and affairs. The
agreement contains non-competition and non-solicitation provisions for the term
of the employment agreements and for two years thereafter. In the event of
termination of employment under circumstances described in the employment
agreement, including as a result of a change in control, we will be required to
provide severance pay equal to the greater of $450,000 or three times the total
compensation received from us during the twelve months prior to the date of
termination.
We have entered into a two-year employment agreement with John Levy, which
expires in November 2001. The agreement provides for an annual base salary of
$165,000, in the first year of the agreement and an annual base compensation of
$180,000 in the second year of the agreement. Mr. Levy's agreement also provides
for a minimum bonus of $15,000 in the first year of the agreement and a minimum
bonus of $17,500 in the second year of the agreement, provided Mr. Levy is
employed by us on each bonus date. Pursuant to the agreement, we agreed to grant
to Mr. Levy options to purchase 30,000 shares of common stock at an exercise
price of $13.00 per share. Options for 10,000 shares have vested and options for
20,000 shares vest at the end of the second year of employment, provided Mr.
Levy is employed by us on the vesting dates. However, in the event of a change
in control, all options shall immediately vest and become exercisable.
We entered into an employment agreement with Carl Amari, which expires
December 31, 2002. Under the agreement, Mr. Amari receives annual compensation
of $300,000. The agreement also provides that Mr. Amari shall also be appointed
as a member of our Board of Directors for as long as he is employed by us.
Stock Plans
Our 1997 Stock Option Plan provides for the grant of stock options to
purchase up to 2,000,000 shares. As of March 27, 2001, options to purchase an
aggregate of 1,864,500 shares of our common stock have been granted under the
1997 plan.
Our 1999 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 2,500,000 shares of common
stock have been reserved for distribution pursuant to the 1999 plan. As of March
27, 2001, options to purchase an aggregate of 2,461,850 shares of our common
38
stock 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 3,500,000 shares of common
stock have been reserved for distribution pursuant to the 2000 plan. As of April
6, 2001, options to purchase an aggregate of 2,259,250 shares of our common
stock have been granted under the 2000 plan.
Of the options granted under our plans, options to purchase 5,472,500
shares of our common stock have been granted to our officers and directors as
follows: Norton Herrick -- 3,575,000 shares; Michael Herrick -- 850,000 shares;
Howard Herrick -- 550,000 shares; Hakan Lindskog - 150,000 shares; Carl Amari -
100,000 shares; John F. Levy -- 80,000 shares; Robert Toro -- 70,000 shares;
Carl Wolf - 42,500 shares; Stephen McLaughlin - 35,000 shares and Roy Abrams --
20,000 shares.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding the beneficial
ownership of common stock, based on information provided by the persons named
below in publicly available filings, as of March 27, 2001:
o each of MediaBay's directors and executive officers;
o all directors and executive officers of MediaBay as a group; and
o each person who is known by MediaBay to beneficially own more than
five percent of our outstanding shares of common stock.
Unless otherwise indicated, the address of each beneficial owner is care of
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.
For purposes of this table, a person is deemed to be the beneficial owner
of the securities if that person can currently acquire such securities upon the
exercise of options, warrants or other convertible securities. In determining
the percentage ownership of the persons in the table above, 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.
39
Name and Address of Beneficial Owner Number of Shares Percentage of Shares
Beneficially Owned Beneficially Owned
Norton Herrick 5,613,720 (1) 30.0%
Howard Herrick 4,002,640 (2) 27.8
Evan Herrick 1,445,080 (3) 9.5
Michael Herrick 1,338,460 (4) 9.1
President and Fellows of Harvard College 700,000 5.0
c/o Harvard Management Company, Inc.
600 Atlantic Avenue
Boston, Massachusetts 02210
Carl P. Amari 547,875 (5) 3.9
Stephen M. McLaughlin 133,300 (6) *
Carl T. Wolf 112,750 (7) *
John F. Levy 61,000 (8) *
Robert Toro 45,000 (9) *
Roy Abrams 20,000(10) *
Hakan Lindskog (11)
------------- -----------
All directors and executive officers
as a group (10 persons) 11,386,285 55.2%
============= ===========
* Less than 1%
(1) Represents (a) 8,200 shares of common stock held by Norton Herrick, (b)
488,460 shares of common stock held by Howard Herrick, (c) 3,575,000 shares
of common stock issuable upon exercise of options, (d) 150,000 shares of
common stock issuable upon exercise of options granted to Evan Herrick, (e)
928,701 shares of common stock issuable upon exercise of warrants issued on
December 31, 1998 or under a December 1998 letter agreement, (f) 178,359
shares issuable upon conversion of a convertible promissory note, based on
an $11.125 conversion price and (g) 285,000 shares held by M. Huddleston
Enterprises, Inc. Does not include (i) 2,964,180 shares held by the Norton
Herrick Irrevocable Trust, (ii) 46,229 shares which may become issuable to
Mr. Herrick upon exercise of warrants which may be required to be issued to
Mr. Herrick and (ii) additional shares if the promissory note is converted
at a conversion price less than $11.125 per share. Evan Herrick has
irrevocably granted to Norton Herrick sole voting and dispositive power
with respect to the shares of common stock issuable upon exercise of the
options held by Evan Herrick. Also does not include any securities which
may become issuable to an affiliate of Mr. Herrick for advances made by Mr.
Herrick's affiliate or for loans proposed to be made to us by Mr. Herrick's
affiliate. See "Certain Relationships and Related Transactions."
(2) Represents (a) 2,964,180 shares held by the Norton Herrick Irrevocable ABC
Trust, (b) 488,460 shares of common stock held by Howard Herrick, and (c)
550,000 shares of common stock issuable upon exercise of options. Howard
Herrick is the sole trustee and Norton Herrick is the sole beneficiary of
the Norton Herrick Irrevocable ABC Trust. The trust agreement provides that
Howard Herrick shall have sole voting and dispositive power over the shares
held by the trust. Howard Herrick has irrevocably granted to Norton Herrick
sole dispositive power with respect to the shares of common stock held by
Howard Herrick.
(3) Represents (a) 145,080 shares of common stock, (b) 1,000,000 shares of
common stock issuable upon conversion of a convertible promissory note and
(c) 300,000 shares of common stock issuable upon exercise of options. Does
not include 714,284 shares of
40
common stock issuable upon conversion of convertible promissory notes. Evan
Herrick has irrevocably granted to Norton Herrick sole voting and
dispositive power with respect to the shares of common stock issuable upon
exercise of the options held by Evan Herrick. See "Certain Relationships
and Related Transactions."
(4) Represents 488,460 shares and 850,000 shares of common stock issuable upon
exercise of options.
(5) Represents 395,125 shares of common stock and options to purchase 152,750
shares of common stock held by Mr. Amari.
(6) Represents 300 shares and 133,000 shares of common stock issuable upon
exercise of options. Does not include 70,000 shares of common stock
issuable upon exercise of options.
(7) Represents 5,000 shares of common stock and 107,500 shares of common stock
issuable upon exercise of options.
(8) Represents 1,000 shares of common stock and 60,000 shares of common stock
issuable upon exercise of options. Does not include 20,000 shares issuable
upon exercise of options.
(9) Represents shares of common stock issuable upon exercise of options. Does
not include 25,000 shares of common stock issuable upon exercise of
options.
(10) Represents shares of common stock issuable upon exercise of options.
(11) Does not include 150,000 shares issuable upon exercise of options.
Item 12. Certain Relationships and Related Transactions
Companies wholly-owned by Norton Herrick, our Chairman, have in the past
provided accounting, administrative and general office services to us and
obtained insurance coverage for us at cost since our inception. We paid these
entities $133,000 and $90,000 for these services during the years ended December
31, 2000 and 1999. In addition, a company wholly-owned by Norton Herrick
provides us access to a corporate airplane. We generally pay the fuel, fees and
other costs related to our use of the airplane directly to the service
providers. For use of this airplane, we paid rental fees of approximately
$25,000 in each of 2000 and 1999 to Mr. Herrick's affiliate. We anticipate
obtaining similar services from time to time from companies affiliated with
Norton Herrick, and we will reimburse their costs in providing the services to
us.
In December 1998, we obtained a portion of the financing for our
acquisitions of Columbia House's Audiobook Club and our old-time radio and
classic video operations from Norton Herrick by issuing him a $15.0 million
principal amount 9% convertible subordinated promissory note due December 31,
2004. In January 1999, we repaid $1.0 million of the note.
In December 1998, we also agreed that if the note is refinanced, repaid or
replaced by anyone other than Norton Herrick or a family member or affiliate of
Mr. Herrick, we will issue to Mr. Herrick warrants to purchase an additional
350,000 shares of our common stock on the same terms as those issued to him in
December 1998. In September 1999, we issued to Mr. Herrick warrants to purchase
140,000 shares of our common stock at a price of $8.41 per share pursuant to the
agreement.
From December 1999 through February 2000, Norton Herrick sold $6.2 million
principal amount of the note issued to him in December 1998 to two third parties
and, in January 2000, we issued to one of the third parties warrants to purchase
340,000 shares of our common stock at an exercise price of $12.50 per share.
Under the December 1998 agreement, we issued to Mr. Herrick warrants to purchase
145,221 shares of our common stock at an exercise price of $8.41 per share on
terms which were identical to the warrants issued to Mr. Herrick in December
1998.
In June 1999, we obtained a portion of the financing for our acquisition of
the business of Doubleday Direct's Audiobooks Direct club through a $4.4 million
loan from Norton Herrick. In
41
connection with this loan, we agreed, subject to shareholder approval, that we
would issue to Mr. Herrick warrants to purchase 125,000 shares of our common
stock at an exercise price of $8.41 per share and on the same terms as the
warrants issued to him in December 1998. This loan was intended to be a bridge
financing and was repaid in full in July 1999. Shareholder approval was obtained
in September 1999, and we issued the warrants to Mr. Herrick
In January and February 2000, Norton Herrick sold $4.2 million principal
amount of the note issued to him in December 1998 to two unaffiliated third
parties. Under the December 1998 letter agreement, we issued to Norton Herrick
warrants to purchase an additional 98,554 shares of its common stock at an
exercise price of $8.41 per share. No compensation has been recognized in
relation to this transaction.
From December 1999 through February 2000, Evan Herrick, son of our
Chairman, loaned us an additional $3.0 million for which he received $3.0
million principal amount 9% convertible promissory notes due December 31, 2004.
The notes were initially convertible into shares of our common stock at $11.125
per share, which was the market value on the date the note was issued. The loans
evidenced by the notes were intended to be short-term and serve as a "bridge" to
replacement financing. At the time of issuance of the convertible notes, our
Board of Directors resolved to seek to replace or refinance the convertible
notes and accept a proposal for refinancing, whether or not (i) as favorable as
the convertible notes including, without limitation, providing for a higher
interest rate or lower conversion price, (ii) requiring the issuance of equity
securities and/or (iii) requiring the payment of fees.
In April and August 2000, our Board of Directors determined that reducing
the conversion price of the $3.0 million principal amount 9% convertible notes
due December 31, 2004 issued to Evan Herrick to the then current market value of
our common stock would be more favorable to us than accepting the alternatives
available to us to refinance or replace the notes. We revised the terms of the
$3.0 million principal amount 9% convertible promissory notes due December 31,
2004 to Evan Herrick. The note is currently convertible into shares of our
common stock at $1.75 per share, which was the market value on the date the
terms were revised. Evan Herrick has waived interest on the notes from July 1,
2000 to December 31, 2000 and after December 31, 2000 has agreed to accept
payment of interest in cash or common stock at our option under certain
circumstances.
In August 2000, Norton Herrick sold the remaining $2.8 million principal
amount of the note issued to him in December 1998 to two unaffiliated third
parties. The terms of subordinated debt were modified so that the third parties
agreed to waive any interest due to them and convert the entire subordinated
debt by December 31, 2000. One of the unaffiliated third parties converted $0.8
million principal amount of the note into 440,000 shares of our common stock.
The third parties failed to pay Mr. Herrick the entire purchase price of the
note they purchased. In December 2000, the parties rescinded the transaction as
to $2.0 million principal amount of the note, which was not converted or paid
for. As a result of these transactions, under the December 1998 letter
agreement, we issued to Mr. Herrick warrants to purchase an additional 18,480
shares of our common stock at an exercise price of $8.41 per share. No
compensation has been recognized in relation to this transaction.
In the fourth quarter of 2000, Glebe Resources, Inc., a company
wholly-owned by Norton Herrick ("Glebe"), purchased $200,000 of audiobook
inventory from Doubleday Direct, Inc. The audiobooks were subsequently sold by
MediaBay, Inc. and the funds were remitted to Glebe in March 2001. The inventory
was sold at Glebe's cost and Glebe did not profit by the
42
transaction.
Interest on subordinated debentures held by a third party in the amount of
$97,000 for the three months ended September 30, 2000 was paid by a company
wholly-owned by the Herrick family in November 2000. Subsequent to year end, the
same company paid an additional $97,000 in interest for the three months ended
December 31, 2000 to the same third party. The Company owes the interest to this
company wholly-owned by the Herrick family.
Subsequent to year-end, Glebe, on MediaBay's behalf, provided a security
deposit to a vendor in the amount of $100,000. Glebe received no compensation
for and did not profit from this transaction.
In December 2000, an affiliate of Norton Herrick lent us $0.5 million and
in February 2001, Mr. Herrick's affiliate lent us an additional $0.3 million.
The terms of these advances are currently being negotiated, however, it is
anticipated that Mr. Herrick's affiliate will be issued a senior subordinated
convertible note secured by a second lien on all of our assets and the assets of
our subsidiaries, except inventory, receivables and cash. The note will bear
interest at 12%, with such interest being payable in kind, common stock or cash
at the holder's option, provided that, if the holder elects to receive an
interest payment in cash, that payment will accrue until we are permitted under
our revolving credit facility to make the cash payment. The notes will be
convertible into shares of our common stock at the rate of $0.56 principal
amount per share.
We have agreed with an affiliate of Norton Herrick for Mr. Herrick's
affiliate to loan us an additional $2.5 million. It is contemplated that $1.0
million will be funded on completion of a definitive agreement; and $0.5 million
will be funded on or before April 30, May 31 and June 30, 2001. Each advance
will be evidenced by a convertible note which will be convertible into shares of
our common stock at the rate of $0.56 principal amount per share and will mature
on September 30, 2002. The convertible notes will rank pari passu with the
current revolving credit facility and will have a security interest in all of
our assets except inventory, receivables and cash. Interest on these notes will,
at the holder's option, be payable -in-kind, common stock or cash at the
holder's option, provided that, if the holder elects to receive an interest
payment in cash, that payment will accrue until we are permitted under our
revolving credit facility to make the cash payment. The note will bear interest
at the prime rate plus 2%.
Mr. Herrick's affiliate, at its option, will be permitted to increase its
$2.5 million loan to us to $3.0 million, on the same terms. Mr. Herrick's
affiliate will be granted warrants to purchase 1,650,000 shares of common stock
at an exercise price of $0.56 per share as consideration of the $0.8 million of
advances and the $2.5 million of loans, plus warrants to purchase an additional
250,000 shares of common stock at an exercise price of $0.56 per share if Mr.
Herrick's affiliate loans us an additional $0.5 million. We will grant Mr.
Herrick's affiliate registration rights relating to the shares of common stock
issuable upon conversion of the notes and exercise of the
43
warrants.
Mr. Herrick's affiliate has agreed to the terms relating to the advances of
$0.8 million and loan of $2.5 million, subject to the finalization and execution
of definitive agreements which include the agreement of our senior lenders to
extend our revolving credit facility to September 30, 2002, and the execution of
related agreements among our senior lenders and Mr. Herrick's affiliate.
We lease office space and other facilities in Illinois from Carl Amari
under two separate leases. The terms of these leases are described under
"Business-Properties."
Companies affiliated with Norton Herrick may continue to provide accounting
and general and administrative services to us, provide us with access to a
corporate airplane and obtain insurance coverage for us at cost. It is our
policy that each transaction between us and our officers, directors and 5% or
greater shareholders will be on terms no less favorable than could be obtained
from independent third parties.
Item 13. Exhibits, Lists and Reports on Form 8-K.
(a) Exhibits
------------
3.1 Restated Articles of Incorporation of the Registrant.+
3.2 Articles of Amendment to Articles of Incorporation.++++++++
3.3 Articles of Amendment to Articles of Incorporation.+++++++++
3.4 Amended and Restated By-Laws of the Registrant.+++++++++
10.1 Employment Agreement between the Registrant and Norton
Herrick.+++++++++
10.2 Employment Agreement between the Registrant and Michael Herrick.
10.3 Employment Agreement between the Registrant and Howard Herrick.
10.4 Employment Agreement between the Registrant and John Levy.+++++++++
10.5 Employment Agreement between our subsidiary and Carl Amari.+++++
10.6 Supplemental Agreement, dated as of December 11, 1998, by and among the
Registrant, Classic Radio Holding Corp. (now Radio Spirits, Inc.),
Radio Spirits, Inc. and Carl Amari.+++
10.7 Put Agreement, dated as of December 11, 1998, by and between the
Registrant and Premier Electronic Laboratories, Inc.+++++
10.8 Registration and Shareholder Rights Agreement, dated as of December 30,
1998, by and among the Registrant and The Columbia House Company, WCI
Record Club Inc. and Sony Music Entertainment Inc.+++++
10.9 $1,984,250 Principal Amount 9% Convertible Senior Subordinated
Promissory Note of the Registrant to Norton Herrick due December 31,
2004.
10.10 $4,200,000 Principal Amount 9% Convertible Senior Subordinated
Promissory Note of the Registrant to ABC Investment, L.L.C. due
December 31, 2004.
10.11 Modification Letter, dated December 31, 1998, among Norton Herrick, the
Registrant and Fleet National Bank+++++
10.12 Security Agreement, dated as of December 31, 1998, by and among the
Registrant, Classic Radio Holding Corp. and Classic Radio Acquisition
Corp. and Norton Herrick.+++++
10.13 Credit Agreement, dated as of December 31, 1998, among the Registrant
and Fleet National Bank.+++++
44
10.14 Amendment and Supplement No. 1 to Credit Agreement dated June 14, 1999
by and among the Registrant, Fleet National Bank, as administrative
agent, and ING (U.S.) Capital Corporation.+++++++
10.15 Security Agreement, dated as of December 31, 1998, from the Registrant,
ABC Internet Services, Inc., Classic Radio Holding Corp., Classic Radio
Acquisition Corp., ABC Investment Corp., and CH Acquisitions Corp. as
grantors to Fleet National Bank as administrative agent.+++++
10.16 1997 Stock Option Plan+
10.17 1999 Stock Incentive Plan++++++
10.18 2000 Stock Incentive Plan++++++++++
21.1 Subsidiaries of the Company.
23.1 Consent of Deloitte and Touche LLP
+ Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-30665) effective
October 22, 1997.
++ Incorporated by reference to the applicable exhibit contained in
our Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1997.
+++ Incorporated by reference to the applicable exhibit contained in
our Current Report on Form 8-K for reportable event dated
December 14, 1998.
++++ Incorporated by reference to the applicable exhibit contained in
our Current Report on Form 8-K dated January 13, 1999.
+++++ Incorporated by reference to the applicable exhibit contained in
our Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1998.
++++++ Incorporated by reference to the applicable exhibit contained
in our Proxy Statement dated February 23, 1999.
+++++++ Incorporated by reference to the applicable exhibit contained
in our Current Report on Form 8-K dated June 29, 1999.
++++++++ Incorporated by reference to the applicable exhibit contained
in our Quarterly Report on Form 10-QSB for the quarterly period
ended June 30, 1999.
+++++++++ Incorporated by reference to the applicable exhibit
contained in our Registration Statement on Form SB-2 (file no.
333-95793) effective March 14, 2000.
++++++++++ Incorporated by reference to the applicable exhibit
contained in our Proxy Statement dated May 23, 2000.
(b) Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts and Reserves
(c) Reports on Form 8-K filed during the quarter ended December 31, 1998.
None.
45
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
MEDIABAY, INC.
By: /s/ Norton Herrick
--------------------------
Norton Herrick, Chairman
In accordance with the requirements of the Exchange Act, this report has been
signed below by the following persons on behalf of the registrant in the
capacities and on the dates stated.
Signature Title Date
--------- ----- ----
/s/ Norton Herrick Director and Chairman April 13, 2001
--------------------------- (Principal Executive Officer)
Norton Herrick
/s/ Michael Herrick Director, Chief Executive April 13, 2001
--------------------------- Officer and President
Michael Herrick
/s/ Howard Herrick Director and April 13, 2001
--------------------------- Executive Vice President
Howard Herrick
s/ John F. Levy Executive Vice President April 13, 2001
--------------------------- and Chief Financial Officer
John F. Levy (Principal Financial and
Accounting Officer)
/s/ Roy Abrams Director April 13, 2001
---------------------------
Roy Abrams
/s/ Carl Wolf Director April 13, 2001
---------------------------
Carl Wolf
/s/ Carl Amari Director April 13, 2001
---------------------------
Carl Amari
46
MediaBay, Inc.
Form 10-KSB
Item 7
Index to Financial Statements
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999 F-3
Consolidated Statements of Operations for the years ended
December 31, 2000 and 1999 F-4
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2000 and 1999 F-5
Consolidated Statements of Cash Flows for the year ended
December 31, 2000 and 1999 F-6
Notes to Consolidated Financial Statements F-7
Schedule II-Valuation and Qualifying Accounts and Reserves S-1
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
MediaBay, Inc.
We have audited the accompanying consolidated balance sheets of MediaBay, Inc.
and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the
related consolidated statements of operations, stockholders equity, and cash
flows for the years then ended. Our audits also included the financial statement
schedule listed in the index at Item 13-b. These financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 2000 and 1999,
and the results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/S/ Deloitte & Touche LLP
Parsippany, New Jersey
March 30, 2001
F-2
MEDIABAY , INC.
Consolidated Balance Sheets
(Dollars in thousands)
December 31,
2000 1999
-------------- --------------
Assets
Current assets:
Cash and cash equivalents .................................................. $ 498 $ 198
Short-term investments ..................................................... -- 100
Accounts receivable, net of allowances for sales returns and doubtful
accounts of $4,516 and $5,911 at December 31, 2000 and 1999,
respectively ............................................................. 5,415 8,892
Inventory .................................................................. 6,687 7,386
Prepaid expenses and other current assets .................................. 1,104 1,517
Royalty advances ........................................................... 3,712 3,781
Deferred member acquisition costs .......................................... 7,520 4,368
-------- --------
Total current assets ..................................................... 24,936 26,242
Fixed assets, net ............................................................ 1,708 1,519
Deferred member acquisition costs ............................................ 5,062 4,928
Deferred financing costs ..................................................... -- 1,723
Non-current prepaid expenses ................................................. 177 311
Investment in I-Jam Multimedia LLC ........................................... 2,000 --
Other intangibles, net of accumulated amortization of $8,781 and $4,071 at
December 31, 2000 and 1999, respectively ................................... 6,891 11,601
Goodwill, net of accumulated amortization of $1,009 and $2,137 at December 31,
2000 and 1999, respectively ................................................ 9,158 47,649
-------- --------
$ 49,932 $ 93,973
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses ...................................... $ 16,703 $ 16,555
Current portion -- long-term debt .......................................... 400 3,720
-------- --------
Total current liabilities .................................................... 17,103 20,275
-------- --------
Long-term debt ............................................................... 15,864 37,383
-------- --------
Preferred Stock, no par value, authorized 5,000,000 shares; no shares issued
and outstanding ............................................................ -- --
Common stock subject to contingent put rights ...--........................... 4,550 4,283
Common stock; no par value, authorized 150,000,000 shares; issued and
outstanding 13,861,866 and 9,338,272, at December 31, 2000 and 1999,
respectively ............................................................... 93,468 58,743
Contributed capital .......................................................... 3,761 3,455
Accumulated deficit .......................................................... (84,814) (30,166)
-------- --------
Total common stockholders' equity ............................................ 12,415 32,032
-------- --------
$ 49,932 $ 93,973
======== ========
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,
2000 1999
------------- -------------
Sales ................................................................. $ 59,881 $ 62,805
Returns, discounts and allowances ..................................... 15,455 16,578
-------- -------
Net sales ....................................................... 44,426 46,227
Cost of sales ......................................................... 23,044 23,687
-------- -------
Gross profit .................................................... 21,382 22,540
Expenses:
Advertising and promotion expenses for acquisition and retention of
members ......................................................... 11,023 8,118
General and administrative ........................................ 13,964 9,799
Depreciation and amortization ..................................... 7,984 6,812
Non-cash write-down of goodwill ................................... 38,226 --
-------- -------
Operating loss .................................................. (49,815) (2,189)
Interest expense ...................................................... (2,787) (4,645)
Interest income ....................................................... 106 127
-------- -------
Loss before extraordinary item .................................. (52,496) (6,707)
Extraordinary loss on early extinguishment of debt .................... (2,152) --
-------- -------
Net loss ........................................................ $(54,648) $ (6,707)
======== ========
Basic and diluted loss per share:
Loss before extraordinary item ...................................... $ (4.13) $ (.82)
Extraordinary loss on early extinguishment of debt .................. (.17) --
-------- --------
Net loss ........................................................ $ (4.30) $ (.82)
======== ========
See accompanying notes to consolidated financial statements.
F-4
MEDIABAY, INC.
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2000 and 1999
(Amounts in thousands)
Common stock Common stock;
number of no par value Contributed Accumulated
shares capital deficit
---------------- ----------------- ----------------- ----------------
Balance at January 1, 1999 ......... 7,079 $ 28,960 $ 2,323 $(23,459)
Sale of common stock ............. 2,040 24,921 -- --
Fees and costs related to equity --
offerings ...................... -- (1,434) --
Contingent put activity........... -- 4,001 -- --
Proceeds from exercise of stock -- --
options ........................ 21 95
Warrants granted for financing and
consulting services ............ -- -- 1,132 --
Conversion of convertible
subordinated notes ............. 198 2,200 -- --
Net loss ......................... -- -- -- (6,707)
-------- -------- -------- --------
Balance at December 31, 1999 ....... 9,338 58,743 3,455 (30,166)
Sale of common stock ............. 3,650 32,850 -- --
Fees and costs related to equity . --
offerings ...................... -- (3,474) --
Contingent put activity .......... -- (267) -- --
Proceeds from exercise of stock
options ........................ -- -- -- --
Warrants granted for financing and
consulting services ............ -- -- 306 --
Conversion of convertible
subordinated notes ............. 874 5,616 -- --
Net loss ......................... -- -- -- (54,648)
-------- -------- -------- --------
Balance at December 31, 2000 ....... 13,862 $ 93,468 $ 3,761 $(84,814)
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
F-5
MEDIABAY, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)
Years ended December 31,
2000 1999
------------ ------------
Cash flows from operating activities:
Net loss .................................................................. $(54,648) $ (6,707)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................... 7,984 6,812
Amortization of deferred member acquisition costs ....................... 6,029 1,603
Amortization of deferred financing costs ................................ 349 407
Non-cash write-down of goodwill ......................................... 38,226 --
Extraordinary loss on early extinguishment of debt ...................... 2,152
Changes in asset and liability accounts, net of acquisitions:
Decrease (increase) in accounts receivable, net ....................... 3,476 (3,969)
Decrease (increase) in inventory ...................................... 495 (2,055)
Decrease (increase) in prepaid expenses and other current assets ...... 251 (383)
Increase in royalty advances .......................................... (777) (1,534)
Increase in deferred member acquisition costs ......................... (9,313) (10,899)
Increase in accounts payable and accrued expenses ..................... 148 10,149
-------- --------
Net cash used in operating activities ............................... (5,628) (6,576)
-------- --------
Cash flows from investing activities:
Purchase of short-term investments ........................................ -- (100)
Purchase of fixed assets .................................................. (873) (713)
Maturity of short-term investments ........................................ 100 500
Investment in I-Jam Multimedia LLC ........................................ (2,000) --
Cash paid in acquisitions ................................................. (1,250) (19,985)
-------- --------
Net cash used in investing activities ............................... (4,023) (20,298)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of notes payable - related parties ................. 2,500 5,350
Proceeds from borrowings with banks ....................................... 11,080
Repayment of long-term debt ............................................... (21,723) (15,127)
Increase in deferred financing costs ...................................... (203) (838)
Proceeds from exercise of stock options ................................... -- 95
Proceeds from sale of common stock, net of costs .......................... 29,377 23,826
-------- --------
Net cash provided by financing activities ........................... 9,951 24,386
-------- --------
Net increase (decrease) in cash and cash equivalents ........................ 300 (2,488)
Cash and cash equivalents at beginning of period ............................ 198 2,686
-------- --------
Cash and cash equivalents at end of period .................................. $ 498 $ 198
======== ========
See accompanying notes to consolidated financial statements.
F-6
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(1) Organization
MediaBay, Inc. (the "Company"), a Florida corporation, was formed on August
16, 1993. MediaBay, Inc. is a leading seller of spoken audio and nostalgia
products, including audiobooks and old-time radio shows, through direct
response, retail and Internet channels. The Company markets audiobooks primarily
through its Audio Book Club. Its old-time radio and classic video programs are
marketed through direct-mail catalogs and, on a wholesale basis, to major
retailers. All of the Company's products are also available for purchase over
the Internet through its content-rich media portal at MediaBay.com and its
channels and audiobookclub.com.
(2) Significant Accounting Policies
Principals of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. 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, short-term investments, 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
Company's long-term debt is at a variable rate; therefore, the carrying value
approximates market prices.
Inventory
Inventory, consisting primarily of audiocassettes 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, Computer Software and Internet Web Site Development Costs
Fixed assets, consisting primarily of furniture, leasehold improvements,
computer equipment, and 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 for sound equipment (the lease term) 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 as are all
internal costs and charges.
Intangible Assets
Intangible assets, consisting of customer lists and certain agreements
acquired in the acquisitions, are being amortized over their estimated useful
life.
F-7
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(2) Significant Accounting Policies (continued)
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. Goodwill is amortized over the estimated period of benefit
not to exceed 20 years. The carrying value of acquired assets, including
goodwill, is reviewed if the facts and circumstances, such as significant
declines in sales, earnings or cash flows or material adverse changes in the
business climate, suggest that it may be impaired. Goodwill associated with
assets acquired in a purchase business combination is included in impairment
evaluations when events or circumstances indicate that the carrying amount of
these assets may not be recoverable. If this evaluation indicates that acquired
assets and goodwill may not be recoverable, as determined based on the estimated
undiscounted cash flows of the entity acquired, impairment is measured by
comparing the carrying value of goodwill to fair value. Fair value is determined
based on quoted market values, discounted cash flows or appraisals
During the fourth quarter of 2000, the Company reviewed its long-lived
assets and certain identifiable intangibles, including goodwill, for impairment
in accordance with FASB 121 due to a change in facts and circumstances. See Note
6.
Revenue Recognition
The Company recognizes revenue upon shipment of merchandise. Allowances for
doubtful accounts and future returns are based upon historical experience and
evaluation of current trends.
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. 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.
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
F-8
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(2) Significant Accounting Policies (continued)
future benefits should be reported as assets net of accumulated amortization.
Prior to 1999, the Company had expensed these costs as incurred. Beginning in
1999, the Company was required to capitalize such direct response advertising
costs and amortize these costs over the period of future benefit, which has been
determined to be 30 months for its Audio Book Club and 60 months for its
old-time radio business, in accordance with SOP 93-7.. The costs are being
amortized on a straight-line basis.
Royalties
The Company is liable for royalties to licensors based upon revenue earned
from the respective licensed product. Royalties, in excess of advances, are
payable based on contractual terms. Royalty advances not expected to be
recovered through royalties on sales are charged to royalty expense. For the
years ended December 31, 2000 and 1999, no writedowns of royalty advances was
required.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Such estimates include, but are not limited to the realizability of the carrying
value of goodwill and the collectibility of accounts receivable.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
(3) Acquisitions
Acquisition of Doubleday's Direct Audiobooks Direct
On June 15, 1999, a wholly-owned subsidiary of the Company acquired from
Doubleday Direct, Inc. ("Doubleday") its business of direct marketing and
distribution of audiobooks and related products through Doubleday's Audiobooks
Direct Club ("Audiobooks Direct"). At the time of the acquisition, Audiobooks
Direct was one of the industry's leading direct marketers of audiobooks using a
membership club format.
As part of the acquisition, the Company acquired Audiobooks Direct's total
membership file of over 500,000 members as well as some other assets relating
exclusively to the Audiobooks Direct Club. The Company also entered into a
reciprocal marketing arrangement with Doubleday pursuant to which it received
the exclusive rights, with respect to audiobooks, for three years, subject to a
one-year extension, at no additional cost and an additional three years, at
market rates, to insert its new member acquisition materials into the member
mailings of Doubleday's consumer book clubs and Doubleday Select's professional
book clubs, as well as rights to distribute its member solicitation packages via
direct mail campaigns to the Doubleday and Doubleday Select book club membership
lists. Subject to exceptions, we will also be Doubleday's exclusive source for
audiobooks.
In addition, the Company entered into a non-compete agreement whereby
Doubleday agreed not to engage in designated activities, which compete with the
operation of the Company's Audio Book Club for five years. Moreover, the Company
entered into a transitional services agreement with Doubleday.
F-9
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(3) Acquisitions (continued)
At the time of the acquisition, together with Doubleday, the Company
announced the launch of a co-branded website to be coupled with an online
cross-marketing and advertising campaign. The website at bestbookclubs.com was
launched on September 15, 1999.
As consideration for the acquisition and the related transactions,
including the mailing, non-compete, and transitional services agreements,
Doubleday received from the Company cash consideration of $19,865. The Company
also incurred costs and fees of $646. The Company has accounted for the
acquisition using the purchase method of accounting. The total purchase price of
$20,511 has been accounted for under the purchase method of accounting. The
Company has identified $4,372 of intangible assets (representing customer lists,
a covenant not to compete and certain agreements acquired in the acquisition)
and $15,076 of goodwill. Identifiable intangible assets will be amortized over
their estimated useful lives (ranging from 3 to 5 years). In the fourth quarter
of 2000, the Company reviewed long-lived assets and certain identifiable
intangibles, including goodwill, for impairment in accordance with FASB
Statement of Standards 121," Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets To Be Disposed Of" ("FASB 121"). Goodwill relating to
the Doubleday acquisition has been written off (see Note 6).
The following unaudited combined pro forma results of operations for the
year ended December 31, 1999 assume the acquisition of substantially all of the
assets used by Doubleday Direct, Inc. in its Doubleday's Audiobooks Direct Club
on June 15, 1999 occurred as of January 1, 1999:
Year ended December 31, 1999
Net sales ............................. $ 54,273
========
Net loss .............................. $ (9,345)
========
Loss per share (basic and diluted) .... $ (1.14)
========
The following table represents the allocation of the purchase price of the
acquisition of Audiobooks Direct:
Other current assets .................. $ 1,063
Goodwill .............................. 15,076
Other intangibles ..................... 4,372
-------
$20,511
=======
(4) Short-Term Investments to be Held to Maturity
At December 31, 1999, short-term investment to be held to maturity
consisted of a bank certificate of deposit in the amount of $100 bearing
interest at 4.9%, which matured on May 16, 2000.
F-10
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(5) Fixed Assets
Fixed Assets consist of the following:
2000 1999
Capitalized leases ...................... $ 270 $ 136
Equipment ............................... 758 660
Furniture and fixtures .................. 165 96
Leasehold improvements .................. 476 419
Web site development costs .............. 1,615 1,100
------- -------
Total ................................... 3,284 2,411
Accumulated depreciation ................ (1,576) (892)
------- -------
$ 1,708 $ 1,519
======= =======
Depreciation expense for the years ended December 31, 2000 and 1999 was
$684 and $522, respectively.
(6) Goodwill
During the fourth quarter of 2000, the Company reviewed long-lived assets
and certain related identifiable intangibles, including goodwill, for impairment
in accordance with FASB 121 due to a change in facts and circumstances. In the
fourth quarter of 2000, the Company made a strategic decision to reduce spending
on marketing to customers acquired in the Company's acquisitions of the Columbia
House Audiobook Club, Doubleday Direct's Audiobooks Direct and Adventures in
Cassettes in order to focus its resources on more profitable revenue sources. In
addition, the Company has sold the remaining inventory acquired in its
acquisition of Adventures in Cassettes and does not expect to derive any future
revenues associated with this business. Consequently, the Company determined
that the revised estimates of cash flows from such operations would no longer be
sufficient to recover the carrying value of goodwill associated with these
businesses. As a result, in the fourth quarter of 2000, the Company determined
that the goodwill associated with these businesses was impaired and has recorded
an impairment charge of $38,226. The impairment charge was measured as the
difference between the carrying value of the goodwill and its fair value which
was based upon discounted cash flows.
(7) Long-Term Debt
2000 1999
Credit agreement, senior secured bank debt ..... $ 6,580 $ 28,303
Subordinated debt .............................. 4,200 4,800
Related party note ............................. 5,484 8,000
-------- --------
16,264 41,103
Less: current maturities ....................... (400) (3,720)
-------- --------
$ 15,864 $ 37,383
======== ========
F-11
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(7) Long-Term Debt (continued)
Bank Debt
In December 1998, the Company obtained Senior Secured Bank Debt from (i)
Fleet National Bank ("Fleet") and (ii) ING (U.S.) Capital Corporation pursuant
to a Credit Agreement dated December 31, 1998. The Company granted to the
lenders a security interest in substantially all of the Company's assets and the
assets of its subsidiaries and pledged the capital stock of its subsidiaries to
the lenders as collateral under the Credit Agreement. In June 1999, in
connection with the acquisition of Audiobooks Direct, the Company, Fleet
National Bank and ING (U.S.) Capital Corporation amended the terms of the
Company's existing credit agreement to provide for an additional $6,000 of term
loans.
In connection with the 1999 financing, the Company issued to the lenders
three-year warrants to purchase up to an aggregate of 119,940 shares of our
common stock with an expiration date of June 15, 2004, an exercise price of
$14.20, and a valuation of $2.63 per warrant using the Black-Scholes valuation
model. All warrants are subject to certain adjustments and the total value of
the warrants has been included in deferred financing costs.
In March 2000, the Company made a quarterly payment of principal on its
term debt of $930. In April 2000, the Company repaid $20,293 of its bank debt
out of the net proceeds from the follow-on primary offering, representing the
remaining term portion of such debt. Accordingly, the Company recorded an
extraordinary loss of $2,152 relating to the write-off of deferred financing
fees incurred in connection with such debt. In April 2000, the Company amended
the terms of its remaining revolving debt with its lenders to calculate the
amount available to be borrowed based on a formula of eligible receivables and
inventory, as defined. In June 2000, the Company paid down its bank debt by
$500. In March 2001, the terms of our revolving debt were amended and the
maturity of the principal amount of $6,600 was extended to April 15, 2001. We
have agreed upon a term sheet with our lenders extending the maturity date to
September 30, 2002 and are currently amending the loan documents. We expect that
a definitive agreement will be executed. In the event that a definitive
agreement is not executed, the Company believes that it can obtain alternative
financing. At December 31, 2000 the interest rate was 14% on $1,700 of the
borrowings and 12% on $4,900 of the borrowings. The term sheet for the extension
to the revolving credit facility contemplates that interest will be payable at
the prime rate plus 2% and that we will make mandatory prepayments as follows:
$100 on September 30, 2001 and $300 on each of December 31 2001, March 31, 2002
and June 30, 2002.
Related Party Debt
In December 1998, the Company obtained a portion of the financing for its
acquisitions of Columbia House's Audiobook Club and its old-time radio and
classic video products from Norton Herrick, Chairman of the Company, by issuing
him a $15,000 principal amount 9% convertible subordinated promissory note due
December 31, 2004. Interest on this note is payable monthly. In January 1999,
$1,000 of the note was repaid. The note was initially convertible, in whole or
in part, at the holder's option, into shares of our common stock at $11.125 per
share. As additional consideration for the bridge loan, Mr. Herrick was issued
five-year warrants to purchase 500,000 shares of our common stock at an exercise
price of $12.00 per share, subject to adjustment. Pursuant to the terms of a
letter agreement dated December 31, 1998 between the Company and Mr. Herrick,
because the bridge loan was not refinanced, repaid or replaced by September 30,
1999, (1) the interest rate of the note increased to 11%, (2) the conversion
price of the note is adjustable to the lesser of $11.125 per share and the
average closing bid price of our common stock for the five trading days prior to
conversion, and (3) the exercise price of the warrants was adjusted to $8.41.
Also pursuant to the letter agreement, the Company agreed that if the note was
refinanced by anyone other than Mr. Herrick, a family member or an affiliate,
the Company
F-12
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(7) Long-Term Debt (continued)
would issue Mr. Herrick warrants to purchase an additional 350,000 shares of
common stock, which warrants would be identical to the warrants issued to him in
connection with the subordinated note. No compensation was recognized in
relation to these warrants. The additional 2% interest on the note is being
accrued and will be due on the maturity of the note. The note is subordinated to
the Company's obligations under its credit facility with Fleet and ING and is
secured by a second lien security interest on assets of the Company's old-time
radio and classic video operations. The independent members of the Company's
Board of Directors approved the terms of Mr. Herrick's loan. The Company also
received a fairness opinion in connection with this loan.
The Company also obtained a portion of the financing for the acquisition of
Audio Books Direct by borrowing $4,350 from Mr. Herrick under a bridge
convertible senior subordinated promissory note. In a separate letter agreement,
the Company agreed, that if the Company repaid or refinanced this note with debt
or equity financing provided by anyone other than Mr. Herrick or a family member
or affiliate of Mr. Herrick, the Company would issue to Mr. Herrick warrants to
purchase an additional 125,000 shares of common stock at $8.41 per share, which
warrants would be identical to the warrants issued to him in connection with the
initial note issued to Mr. Herrick in December 1998. In July 1999, this
promissory note was repaid and the warrants were issued upon receipt of
stockholder approval in September 1999.
In August 1999, Norton Herrick sold $5,000 of the $14,000 9% convertible
senior subordinated promissory note to ABC Investment, L.L.C., an unaffiliated
third party. The $5,000 promissory note has substantially the same terms and
conditions as the original promissory note bearing interest at 9% per annum and
convertible at $11.125 per share. In August 1999, ABC Investment converted $200
of the note into 17,977 shares of the Company's common stock.
In December 1999, Mr. Herrick sold an additional $2,000 principal amount of
the note issued to him in December 1998 to an unaffiliated third party, which
was converted into 179,775 shares of the Company's common stock.
Under the December 1998 letter agreement, the Company issued to Mr. Herrick
warrants to purchase 140,000 and 46,667 shares of its common stock in September
1999 and December 1999, respectively, at an exercise price of $8.41 per share.
From December 1999 to February 2000, Evan Herrick, loaned the Company $3.0
million for which he received $3.0 million principal amount 9% convertible
promissory notes due December 31, 2004. The notes were originally convertible
into shares of our common stock at $11.125 per share. Evan Herrick is Norton
Herrick's son and Michael Herrick's and Howard Herrick's brother. The loans
evidenced by the notes were intended to be short-term and served as a "bridge"
to replacement financing. At the time of issuance of the convertible notes, the
Company's board of directors resolved to seek to replace or refinance the
convertible notes and accept a proposal for refinancing, whether or not the
refinancing was as favorable as the convertible notes. Such refinancing could
include, without limitation, a higher interest rate, lower conversion price,
issuance of equity securities and/or the payment of fees.
In April and August 2000, the Company's Board of Directors determined that
reducing the conversion price of the $3,000 principal amount 9% convertible
notes due December 31, 2004 issued to Evan Herrick to the then current market
value of the Company's common stock would be more favorable to the Company than
accepting the alternatives available to the Company to refinance or replace the
notes. The Company revised the terms of the $3,000 principal amount 9%
convertible promissory notes due December 31, 2004 to Evan Herrick.
F-13
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(7) Long-Term Debt (continued)
The note is currently convertible into shares of the Company's common stock at
$1.75 per share, which was the market value on the date the terms were revised.
Evan Herrick has waived interest on the notes from July 1, 2000 to December 31,
2000 and after December 31, 2000 has agreed to accept payment of interest in
cash or common stock at the Company's option under certain circumstances.
In January and February 2000, Norton Herrick sold $4,224 principal amount
of the note issued to him in December 1998 to two unaffiliated third parties
which was converted into 379,662 shares of the Company's common stock. Under the
December 1998 letter agreement, the Company issued to Norton Herrick warrants to
purchase an additional 98,554 shares of its common stock at an exercise price of
$8.41 per share. No compensation has been recognized in relation to this
transaction. In February 2000, the unaffiliated third-party holder of the $4,800
9% promissory note converted $600 of the note into 53,932 shares of the
Company's common stock.
In August 2000, Mr. Herrick sold the remaining $2,776 principal amount of
the note issued to him in December 1998 to two unaffiliated third parties. The
terms of subordinated debt were modified so that the third parties agreed to
waive any interest due to them and convert the entire subordinated debt by
December 31, 2000. One of the unaffiliated third parties converted $800
principal amount of the note into 440,000 shares of our common stock. The third
parties failed to pay Mr. Herrick the entire purchase price of the note they
purchased. In December 2000, the parties rescinded the transaction as to $2,000
principal amount of the note, which was not converted or paid for. As a result
of these transactions under a December 1998 letter agreement, the Company issued
to Norton Herrick warrants to purchase an additional 18,480 shares of its common
stock at an exercise price of $8.41 per share. No compensation has been
recognized in relation to this transaction.
In December 2000, an affiliate of Norton Herrick lent us $0.5 million and
in February 2001, Mr. Herrick's affiliate lent us an additional $0.3 million.
The terms of these advances are currently being negotiated, however, it is
anticipated that Mr. Herrick's affiliate will be issued a senior subordinated
convertible note secured by a second lien on all of our assets and the assets of
our subsidiaries, except inventory, receivables and cash. The note will bear
interest at 12%, with such interest being payable in kind, common stock or cash
at the holder's option, provided that, if the holder elects to receive an
interest payment in cash, that payment will accrue until we are permitted under
our revolving credit facility to make the cash payment. The notes will be
convertible into shares of our common stock at the rate of $0.56 principal
amount per share.
The loan maturities for the next five years are as follows:
Year Ending December 31,
2001 ..................................... $ 400
2002 ..................................... 6,680
2003 ..................................... --
2004 ..................................... 9,184
-------
Total maturities ......................... $16,264
=======
F-14
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(8) Commitments and Contingencies
Rent expense for the years ended December 31, 2000 and 1999 amounted to
$351 and $234, respectively.
Leases - Related Parties
The Company leases 8,000 and 8,400 square feet of space in Schaumburg,
Illinois pursuant to two lease agreements which both expire December 2005,
subject to a three-year renewal option. The lease agreements are from a trust
owned by the President of the Company's old-time radio business. The leases both
expire in December 2005, and are subject to three-year renewal options. The
monthly rent for the first lease is $5. Monthly rent for the second lease is $4
plus $2 per month related to Lessor's leasehold improvements.
Other Real Estate Leases
The Company leases approximately 11,451 square feet of space in Cedar
Knolls, New Jersey pursuant to a lease agreement, which expires in August 2003
at a monthly rent of $15. The Company has the option to renew the lease for an
additional three-year period.
The Company entered into two ten-year leases on 7,000 square feet of space
in Bethel, Connecticut and 3,000 square feet in Sandy Hook, Connecticut. Lease
payments and mandatory capital improvement payments, starting in 2004, are $4
per year and $2 per year on the Bethel and Sandy Hook properties, respectively.
Capital Equipment Leases
The company has two capital leases. The Company leases computer equipment
under a three-year lease, which expires in June 2002. Total annual rent
payments, including interest, are $55 and the lease provides for a bargain
purchase option of $14 at the end of the lease term. Rents under this agreement
in 2000 and 1999 were $55 and $28, respectively. The Company leases sound
equipment under a 5-year lease, which expires in May 2006. Total annual rent
payments, including interest, are $33 and the lease provides for a bargain
purchase of $7. Rent under this agreement in 2000 was $22. The amount of
equipment capitalized under the two leases and included in fixed assets and the
obligations under the leases included in accounts payable and accrued expenses
on the consolidated balance sheet at December 31, 2000 was $270.
Minimum annual lease commitments including capital improvement payments
under non-cancelable operating leases are as follows:
Year ending December 31,
2001 .......................................... $ 333
2002 .......................................... 328
2003 .......................................... 264
2004 .......................................... 132
2005 .......................................... 137
Thereafter .................................... 20
------
Total lease commitments ....................... $1,214
======
Employment Agreements
The Company has commitments pursuant to employment agreements with certain
of its officers. The Company's aggregate commitments under such employment
agreements are approximately $1,513 and $583 during 2001 and 2002, respectively.
F-15
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(8) Commitments and Contingencies (continued)
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.
(9) Stock Option Plan
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 2,000,000 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 2,500,000 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 3,500,000 shares
of common stock have been reserved for issuance pursuant to the plan.
Stock option activity under the plans is as follows:
Weighted average
Shares exercise price
---------- ----------------
Outstanding at January 1, 1999 1,858,500 $ 5.37
Granted 1,195,950 11.29
Exercised -- --
Canceled (40,500) 11.76
---------- ------
Outstanding at December 31, 1999 3,013,950 7.63
Granted 4,118,500 5.69
Exercised
Canceled (479,350) 6.35
---------- ------
Outstanding at December 31, 2000 6,653,100 $ 6.52
========== ======
The per share weighted-average fair value of stock options granted during
the year ended December 31, 2000 and 1999 is as follows using the Black-Scholes
option-pricing model with the following assumptions and no dividend yield. The
shares were granted as follows:
F-16
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(9) Stock Option Plan (continued)
No. Exercise Assumed Risk-free Fair Value per
Date of Shares Price Volatility interest rate per Share
---- --------- ----- ---------- ------------- ----------
1999 Grants:
First Quarter 83,600 $ 11.04 25% 5.07% $ 3.59
Second Quarter 875,500 $ 11.05 25% 4.99% $ 5.15
Third Quarter 152,750 $ 12.01 25% 5.71% $ 4.07
Fourth Quarter 84,100 $ 12.64 25% 6.13% $ 4.40
---------
Total ............ 1,195,950
=========
2000 Grants:
First Quarter 931,000 $ 10.42 100% 6.46% $ 9.78
Second Quarter 2,950,500 $ 4.37 100% 6.40% $ 3.04
Third Quarter 113,000 $ 3.32 100% 6.01% $ 1.63
Fourth Quarter 124,000 $ 3.94 100% 5.78% $ 2.31
---------
Total ............ 4,118,500
=========
The following table summarizes information for options outstanding and
exercisable at December 31, 2000:
Options Exercisable
---------------------------------------------
Range of Options Outstanding Weighted Weighted Average Weighted Average
Prices Number Average Remaining Life Exercise Price Number Exercixe Price
----------------- ------------- ----------------------- ---------------------- ---------------- ----------------------------
$1.63 - 5.25 3,982,250 7.55 $4.14 3,629,750 $4.17
6.00-8.69 689,250 6.54 7.62 497,500 7.82
10.00-14.88 1,981,600 7.87 10.94 1,866,850 10.85
----------------- ------------- ----------------------- ---------------------- ---------------- ------------------------
$1.63-14.88 6,653,100 7.54 $6.52 5,994,100 $6.56
================= ============= ======================= ====================== ================ ========================
At December 31, 2000, there were 78,500 additional shares available for
grant under the 1997 Plan, 29,150 additional shares available for grant under
the 1999 Plan and 1,239,250 additional shares available for grant under the 2000
Plan.
The Company accounts for employee stock options in accordance with
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees." Under APB 25, the Company recognizes no compensation
expense related to employee stock options, as no options are granted at a price
below market price on the day of grant. In October 1995, Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation"
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
hypothetical fair value method application. Had compensation expense for the
Company's stock options been recognized based on the fair value on the grant
date under SFAS 123, the Company's net loss and net loss per share for the years
ended December 31, 2000 and 1999 would have been $73,185 and $5.75, and $12,508
and $1.52, respectively.
F-17
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(10) Warrants and Non-Plan Options
In addition to the 117,034 warrants granted in 2000 described in Note 7
above, during the year ended December 31, 2000, the Company granted non-plan
options and warrants to purchase a total of 682,500 shares of the Company's
common stock to consultants and advisors, and the fair values of $306, computed
using the Black-Scholes option-pricing model, have been included in prepaid
expenses and contributed capital and are being amortized to expense over their
respective service periods. The options and warrants vest at various times and
have exercise periods ranging from two to five years. Exercise prices range from
$3.00 to $12.00 per share.
In October 1999, non-plan options for 21,600 shares of the Company's common
stock, which had been granted in 1998, were exercised and the Company received
$95 as payment of the exercise price.
(11) Common Stock Subject to Contingent Put Rights
In connection with its various acquisitions, the Company granted the
sellers the right, under specified conditions, to sell back to the Company up to
an aggregate of 675,000 shares issued to the sellers in connection with the
acquisitions. At December 31, 2000, rights have terminated as to 370,000 shares.
The sellers have the right under certain conditions to sell the remaining
305,000 shares of stock to the Company at prices ranging from $14.00 to $15.00
per share at various times commencing in December 2003 and expiring in December
2008, unless the rights are terminated earlier as a result of the Company's
stock meeting common stock price and/or performance targets prior to exercise.
If all of the rights were exercised prior to termination, the maximum amount the
Company would be required to pay for the repurchase of all of the shares is
approximately $4,550, payable as follows: (1) $350 commencing December 2003; (2)
$3,450 commencing December 2004; and (3) $750 commencing December 2005.
(12) Equity
In June 2000, the Company's stockholders approved an amendment to the
Company's Articles of Incorporation to increase the Company's authorized common
stock to 150,000,000 shares.
The Company's Registration Statement on Form SB-2 for a follow-on primary
offering was declared effective by the Securities and Exchange Commission on
March 15, 2000. On March 20, 2000, the Company closed its offering of 3,650,000
shares of Common Stock at a price of $9.00 per share for gross proceeds of
$32,850. The Company incurred expenses of $3,473 related to the offering,
including the underwriting discount and accountable expenses, legal and
accounting fees and printing expenses.
From April through August 1999, the Company sold 2,040,000 shares of common
stock to qualified institutional investors for proceeds of $23,487 net of cash
and non-cash fees and expenses of $1,434.
(13) Income Taxes
Income tax benefit for the years ended December 31, 2000 and 1999 differed
from the amount computed by applying the U.S. Federal income tax rate of 34% and
the state income tax rate of 7.00% in both 2000 and 1999 to the pre-tax loss as
a result of the following:
F-18
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(13) Income Taxes (continued)
2000 1999
-------- -------
Computed tax benefit $(22,473) $(2,991)
Valuation allowance for
Federal and State deferred tax assets 22,473 2,991
-------- -------
Income tax expense $ -- $ --
======== =======
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets are as follows:
Deferred tax assets: 2000 1999
-------- -------
Federal and state net operating loss carry-forwards $ 14,801 $ 7,340
Accounts receivable, principally due to allowance for doubtful accounts and
reserve for returns 1,274 1,769
Fixed assets/Intangibles 13,026 (2,481)
-------- -------
Total gross deferred tax assets 29,101 6,628
Less valuation allowance (29,101) (6,628)
-------- -------
Net deferred tax assets $ -- $ --
======== =======
The Company has provided a valuation allowance of $29,101 and $6,628 for
deferred tax assets as of December 31, 2000 and 1999, respectively. In assessing
the realizability of deferred tax assets, management has determined that the
Company does not have a history of earnings on which to base its determination.
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which those temporary timing
differences become deductible. The Company's limited operating history does not
allow management to make a judgment regarding future taxable income over those
periods.
The Company has approximately $14,801 of net operating loss carry-forwards
which may be used to offset possible future earnings, if any, in computing
future income tax liabilities. The net operating losses will expire between
December 31, 2018 and December 31, 2020 for federal income tax purposes. For
state purposes, the net operating losses will expire at varying times, as the
Company is subject to corporate income tax in several states.
(14) 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 net 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. However,
the Company's computation of dilutive net loss per share does not assume any
conversion or exercise of securities as their effect is antidilutive for all
periods presented.
The weighted average number of shares outstanding used in the net loss per
share computations for the years ended December 31, 2000 and 1999 were
12,718,065 and 8,204,543, respectively.
Common equivalent shares that could potentially dilute basic earnings per
share in the future and that were not included in the computation of diluted
loss per share because of antidilution were 472,589 for the year ended December
31, 2000 and 1,658,980 for the year ended December 31, 1999.
F-19
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(15) Supplemental Cash Flow Information
No cash has been expended for income taxes for the years ended December 31,
2000 and 1999. Cash expended for interest was $2,157 and $3,937 for the years
ended December 31, 2000 and 1999, respectively.
In connection with its acquisition of Audiobooks Direct in 1999, the
Company provided 119,940 warrants to the banks providing financing for the
acquisition. The value of the warrants of $315 was included in deferred
financing fees and subsequently written off when the loan was repaid.
In February 1999, 8,000 options were granted to an officer of the Company
below the current market price at the date of grant. These options have been
valued at $7.16 each using the Black-Scholes valuation model and have been
included in prepaid expenses and are being amortized over two years, the term of
the related employment agreement.
In April 1999, the Company formed a Technology Advisory Board ("Advisory
Board") to further enhance its Internet strategy. The Advisory Board will work
with the Company to increase its online business and its strategic alliances on
the Internet. Included in the total options and warrants granted during the year
ended September 30, 1999 were warrants granted to the Internet Advisory Board
members. These warrants were valued at $113 using the Black-Scholes valuation
model and have been included in prepaid expenses and are being amortized over
the period of service.
In 1999, the Company granted 96,000 warrants to advisors in connection with
its equity financings. The total value of these warrants using the Black-Scholes
method has been recorded at $380 and included in contributed capital.
Included in the total options and warrants granted during the year ended
December 31, 1999 were warrants granted to a law firm as partial payment for
legal services provided in connection with the Company's various acquisitions.
The warrants have been valued at $50 using the Black-Scholes valuation model and
have been included in the cost of the acquisitions.
In 2000, third parties converted portions of the Company's subordinated
notes totaling $5,616 into 873,594 shares of the Company's common stock. In
1999, third parties converted portions of the Company's subordinated notes
totaling $2,200 into 197,752 shares of the Company's common stock.
(16) Related Party Transactions
Companies wholly-owned by Norton Herrick provided certain accounting,
administrative and general office services to, and obtained insurance coverage
for, the Company. In connection with such services, the Company paid to such
entities the aggregate of $133 and $90 during the years ended December 31, 2000
and 1999, respectively. In addition, a company wholly-owned by Norton Herrick
provides us access to a corporate airplane. The Company generally pays the fuel,
fees and other costs related to its use of the airplane directly to the service
providers. For the use of this airplane, the Company paid rental fees of
approximately $25 in each of 2000 and 1999 to Mr. Herrick's affiliate. The
Company anticipates obtaining similar services from time to time from companies
affiliated with Norton Herrick for which it will reimburse such companies' cost
to provide such services to the Company.
F-20
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(16) Related Party Transaction (continued)
In the fourth quarter of 2000, Glebe Resources, Inc., a company
wholly-owned by Norton Herrick, purchased $200 of audiobook inventory from
Doubleday Direct, Inc. The audiobooks were subsequently sold by MediaBay, Inc.
and the funds were remitted to Glebe Resources, Inc. The inventory was sold at
Glebe's cost and Glebe did not profit by the transaction.
Interest on subordinated debt held by a third party in the amount of $97
for the three months ended September 30, 2000 was paid by a company wholly-owned
by the Herrick family in November 2000. Subsequent to year end, the same company
paid an additional $97 in interest for the three months ended December 31, 2000
to the same third party. The Company owes the interest to this company
wholly-owned by the Herrick family.
(17) Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", subsequently amended by SFAS No.
137 and SFAS No. 138, which will be effective beginning January 1, 2001. SFAS
No. 133 provides a comprehensive standard for the recognition and measurement of
derivatives and hedging activities. The statement requires all derivatives to be
recorded on the balance sheet at fair value and also prescribes special
accounting for certain types of hedges. We have not entered into any derivative
or hedging transactions, and therefore, have concluded that upon adoption of
SFAS No. 133 as of January 1, 2001 the Company's transition adjustment is zero.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". SAB 101 summarized certain of the SEC's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Company has determined that the adoption of SAB 101 in the fourth quarter of
2000 had no impact on the Company's financial position or results of operations.
Revenues continue to be recognized upon shipment of merchandise consistent with
the shipping terms. A reserve for future returns is recorded based upon
historical experience and an evaluation of current trends.
(18) Segment Reporting
For 1999 and 2000, 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 did not expend any funds or receive any income in the years ended
December 31, 1999 and 2000 from its newest subsidiary RadioClassics. The
accounting policies of the reportable segments are the same as those described
in Note 2. Inter-segment sales are recorded at prevailing sales prices.
F-21
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(18) Segment Reporting (continued)
Year ended December 31, 2000
Audio Book Radio MediaBay. Inter-
Corporate Club Spirits com segment Total
--------- ---- ------- --- ------- -----
Net Revenue $ -- $ 31,442 $ 12,252 $ 1,566 $ (834) $ 44,426
Profit (loss) before depreciation,
amortization, non-cash
write-down of goodwill,
interest expense and
extraordinary loss on early (2,773) (1,051) 1,150 (967) 36 (3,605)
extinguishment of debt
Depreciation and amortization -- 6,586 970 428 7,984
Non-cash write-down of goodwill -- 36,792 1,434 -- -- 38,226
Net interest expense 2,672 -- 9 -- -- 2,681
Extraordinary loss on early
extinguishment of debt 2,152 -- -- -- -- 2,152
Net income (7,597) (44,429) (1,263) (1,396) 37 (54,648)
Assets 2,000 28,179 18,431 1,498 (176) 49,932
Net additions to deferred member
acquisition costs -- 1,691 1,593 -- -- 3,284
Additions to fixed assets -- 123 288 462 -- 873
Year ended December 31, 1999
Audio Book Radio MediaBay. Inter-
Corporate Club Spirits com segment Total
--------- ---- ------- --- ------- -----
Net Revenue $ -- $ 32,160 $14,658 $ -- $ (592) $ 46,227
Profit (loss) before depreciation,
amortization, non-cash
write-down of goodwill,
interest expense and
extraordinary loss on early (2,100) 4,922 2,605 (700) (105) 4,623
extinguishment of debt
Depreciation and amortization -- 5,547 925 340 6,812
Net interest expense 4,518 -- -- -- -- 4,518
Net income (6,619) (624) 1,681 (1,040) (106) (6,707)
Assets -- 74,255 19,831 -- (113) 93,973
Net additions to deferred member
acquisition costs -- 9,296 -- -- -- 9,296
Additions to fixed assets -- 286 107 320 -- 713
(19) Subsequent Events
In March 2001, we have agreed with an affiliate of Norton Herrick for Mr.
Herrick's affiliate to loan us an additional $2,500. It is contemplated that
$1,000 will be funded on completion of a definitive agreement; and $500
will be funded on or before April 30, May 31 and June 30, 2001. Each advance
will be evidenced by a convertible note which will be convertible into shares of
our common stock at the rate of $0.56 principal amount per share and will mature
on September 30, 2002. The convertible notes will rank pari passu with the
current revolving credit facility and will have a security interest in all of
our assets except inventory, receivables and cash. Interest on these notes will,
at the holder's option, be payable -in-kind, common stock or cash at the
holder's option, provided that, if the holder elects to receive an interest
payment in cash, that payment will accrue until we are permitted under our
revolving credit facility to make the cash payment. The note will bear interest
at the prime rate plus 2%.
F-22
MEDIABAY, INC.
Notes to Consolidated Financial Statements
Years ended December 31, 2000 and 1999
(Dollars in thousands, except per share data)
(19) Subsequent Events (continued)
Mr. Herrick's affiliate, at its option, will be permitted to increase its
$2,500 loan to the Company to $3,000, on the same terms. Mr. Herrick's affiliate
will be granted warrants to purchase 1,650,000 shares of common stock at an
exercise price of $0.56 per share as consideration of the $800 of advances and
the $2,500 of loans, plus warrants to purchase an additional 250,000 shares of
common stock at an exercise price of $0.56 per share if Mr. Herrick's affiliate
loans us an additional $500. We will grant Mr. Herrick's affiliate registration
rights relating to the shares of common stock issuable upon conversion of the
notes and exercise of the warrants.
Subsequent to year-end, Glebe Resources, Inc., a company wholly-owned by
Norton Herrick provided a security deposit to a vendor in the amount of $100.
Glebe received no compensation for and did not profit from this transaction.
F-23
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
for the years ended December 31, 2000 and 1999
Balance Amounts Write-Offs Balance
Beginning Charged to Amounts Against End of
of Period Net Income Acquired Reserves Period
----------- ------------ ----------- ------------ ------------
Allowances for sales returns and doubtful accounts:
Year Ended December 31, 2000 $5,911 $18,038 -- $19,433 $4,516
Year Ended December 31, 1999 $1,840 $18,848 $1,264 $16,041 $5,911
S-1