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PROSPECTUS
3,200,000 SHARES
[LOGO]
NETRADIO CORPORATION
COMMON STOCK
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This is the initial public offering of our common stock. We are offering
3,200,000 shares. No public market currently exists for our common stock. The
common stock has been approved for listing on the Nasdaq National Market under
the symbol "NETR."
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 7.
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PER SHARE TOTAL
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Public Offering Price.............................................. $ 11.00 $ 35,200,000
Underwriting Discount.............................................. $ .77 $ 2,464,000
Proceeds to NetRadio Corporation................................... $ 10.23 $ 32,736,000
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We have granted the underwriters a 30-day option to purchase up to 480,000
additional shares to cover any over-allotments.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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GERARD KLAUER MATTISON & CO., INC. ADVEST, INC.
OCTOBER 14, 1999
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary...................................................................................... 4
Risk Factors............................................................................................ 7
Warning Regarding Our Use of Forward-Looking Statements................................................. 17
Use of Proceeds......................................................................................... 18
Dividend Policy......................................................................................... 18
Capitalization.......................................................................................... 18
Dilution................................................................................................ 19
Selected Financial Data................................................................................. 20
Management's Discussion and Analysis of Financial Condition and Results of Operations................... 21
Our Business............................................................................................ 26
Management.............................................................................................. 40
Related Party Transactions.............................................................................. 45
Principal Shareholders.................................................................................. 49
Description of Capital Stock............................................................................ 50
Shares Eligible for Future Sale......................................................................... 51
Underwriting............................................................................................ 53
Legal Matters........................................................................................... 55
Experts................................................................................................. 55
Where You Can Get More Information...................................................................... 55
Financial Statements.................................................................................... F-1
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Our executive offices are located at NetRadio Corporation, Riverplace
Exposition Hall, 43 Main Street Southeast, Suite 149, Minneapolis, Minnesota
55414. Our telephone number is (612) 378-2211.
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NETRADIO.COM-TM- and design, N NET.RADIO NETWORK-Registered Trademark- and
design, NET.RADIO-Registered Trademark-, CDPOINT-TM- and NETCOMPANION-TM- are
trademarks of NetRadio Corporation. All other trademarks and trade names
referenced in this prospectus are the property of their respective owners.
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You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document. Information on our Web site is not a part of this
prospectus.
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UNTIL NOVEMBER 8, 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS THAT BUY, SELL OR TRADE THESE SHARES OF COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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PROSPECTUS SUMMARY
BECAUSE THIS IS A SUMMARY, IT DOES NOT CONTAIN ALL THE INFORMATION THAT MAY
BE IMPORTANT TO YOU. YOU SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING
THE RISK FACTORS AND FINANCIAL STATEMENTS, BEFORE YOU DECIDE WHETHER TO INVEST
IN OUR COMMON STOCK.
NETRADIO CORPORATION
We are a leading broadcaster of originally programmed audio entertainment
over the Internet through our Web site, www.netradio.com. We organize our music
and information content into highly targeted audio channels grouped as
communities of similar interest or "COSIs." We attract customers using audio
content, rather than relying solely upon a text-based site, to extend the time
visitors spend at NetRadio, thereby creating a "sticky" Web site. I/PRO,
Internet Profiles Corporation, an independent consultant that monitors Web site
traffic, has estimated that in September 1999 1,058,237 different users, each of
whom was counted only once, listened to one or more of our 120 music and news
audio channels. I/PRO has also estimated that in September 1999 the average time
a visitor spent listening to any of our audio channels was approximately 29
minutes. On October 12, 1999 we began the process of launching our redesigned
Web site that reflects our new logo, revamped look and enhanced functionality.
We use audio content to generate revenues from sales of audio merchandise
through our online music store, CDPoint, and from Internet advertising,
including advertisements placed within our audio broadcasts. Our interactive
display, NetCompanion, encourages impulse purchases by providing information
about the music being played, or the products being advertised, and by linking
the listener directly to CDPoint or to our advertisers' Web sites.
OUR MARKET
We believe that broadcast audio is a major step in the continued
transformation of the Internet into a multimedia platform. Broadcast audio over
the Internet combines the passive listening attributes of radio broadcasting
with the interactive aspects of the Internet. According to a study performed in
January 1999 by The Arbitron Company, 27% of Internet users have listened to
Internet radio. As with traditional broadcast radio, our users can listen to our
programming while performing other tasks. Most other Web sites, by contrast,
require active, single-task "clicking" through pages. As with traditional
broadcast radio, we deliver advertising and purchasing opportunities passively
to our listeners. However, our audio broadcasts encourage listeners to react
impulsively to these opportunities.
The Internet improves commerce by substituting automated electronic sales
for traditional retail venues. The Internet can link consumers, while at home or
at work, directly to wholesale distribution channels and provide them with a
broad selection of products, convenience and optimal pricing. Forrester
Research, Inc. estimates that consumer sales over the Internet will account for
6% of the estimated $1.8 trillion of United States consumer retail spending in
2003. Forrester Research also estimates that music sales over the Internet will
grow at an annual rate of 68% from $187 million in 1998 to nearly $2.5 billion
in 2003, and will account for 20% of all estimated online retail spending in the
United States.
OUR CHALLENGE
To succeed, we believe that the Internet broadcaster and online retailer
must build a large loyal audience through content and technology and generate
revenues from advertising and product sales to that audience.
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OUR SOLUTION
We use entertaining audio content to attract and retain listeners and to
generate revenues. To do this, we:
- PROGRAM AND BROADCAST AUDIO CONTENT TO ATTRACT AND RETAIN LISTENERS. We
attract and retain listeners by offering a wide variety of entertaining
audio content broadcast over 120 distinct music and news channels. Our
programming has been assembled by a team of award-winning music
professionals.
- BUILD VISITOR TRAFFIC COST-EFFECTIVELY. We believe our targeted content
will encourage repeat visits, and our low cost marketing campaigns will
efficiently increase traffic to our Web site.
- CREATE STRONG COMMUNITIES OF SIMILAR INTEREST TO ESTABLISH BRAND
LOYALTY. We aggregate communities of listeners attracted to distinct
musical genres. These communities promote brand loyalty and create
targeted marketing opportunities.
- PROGRAM CONTENT TO GENERATE COMMERCE AND ADVERTISING REVENUES. We use our
audio content to generate both e-commerce and advertising revenues. The
extended time listeners spend on our Web site exposes them to multiple
advertising opportunities. Our advertising format combines audio
advertisements with links to our advertisers' Web sites, encouraging an
immediate consumer response.
- BUILD STRATEGIC ALLIANCES. We enter into strategic alliances to develop
our content, build our technology, generate and support traffic to our Web
site and fulfill our product distribution needs. We have alliances with
RealNetworks, AT&T, @Home and major record labels, including EMI Music,
BMG Entertainment and Universal Music Group, as well as product
fulfillment agreements with Navarre Corporation, our majority shareholder,
and Valley Media, Inc., both leading music distributors.
THE OFFERING
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Common stock offered by NetRadio 3,200,000 shares
Corporation................................
Common stock outstanding after the 9,827,900 shares
offering...................................
Use of proceeds.............................. Working capital and other corporate purposes,
including advertising and capital
expenditures. Please see "Use of Proceeds."
Proposed Nasdaq National Market symbol....... NETR
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This information reflects ValueVision's purchase of 550,000 shares of common
stock effective as of the closing of this offering. You should be aware that we
are permitted, and in some cases obligated, to issue shares of common stock in
addition to the common stock to be outstanding after this offering. If and when
we issue these shares, the percentage of the common stock you own may be
diluted. The following is a summary of additional shares of common stock that we
have approved for issuance upon the exercise of options or warrants:
- 1,844,600 shares reserved for issuance upon the exercise of options under
our stock option plan, consisting of: 1,132,350 options outstanding at a
weighted average exercise price of $3.91 per share; and 712,250 shares
reserved for future issuance under the plan. Please see
"Management--Benefit Plans."
- 200,000 shares reserved for issuance upon the exercise of warrants. Please
see "Underwriting."
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SUMMARY FINANCIAL DATA
The following table summarizes important financial information for NetRadio
and our predecessor, Net Radio Corporation, a Nevada corporation ("Net Radio
Nevada"). You should read this table in conjunction with our financial
statements and their notes included elsewhere in this prospectus.
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NET RADIO NEVADA NETRADIO
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PERIOD FROM PERIOD FROM
JANUARY 1, MARCH 21, SIX MONTHS ENDED
YEAR ENDED 1997 THROUGH 1997 THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, MARCH 20, DECEMBER 31, DECEMBER 31, ----------------------
1996 1997 1997 1998 1998 1999
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(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
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STATEMENT OF OPERATIONS DATA:
Net revenues:
Product sales......................... $ -- $ -- $ -- $ 50 $ -- $ 259
Internet advertising.................. -- -- -- 205 113 147
Miscellaneous......................... 321 168 163 -- -- --
------------ ----- ------------ ------------ ---------- ----------
Total net revenues.................. 321 168 163 255 113 406
Gross profit............................ 321 168 146 190 103 163
Loss from operations.................... (2,261) (737) (1,955) (3,952) (1,256) (4,894)
Net loss................................ (2,254) (754) (1,987) (3,977) (1,269) (5,208)
Loss per share--basic and diluted....... $ (.67) $ (.22) $ (.88)
Weighted average shares
outstanding(1)........................ 5,899,167 5,882,500 5,923,902
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JUNE 30, 1999
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(UNAUDITED)
PRO FORMA
PRO AS
ACTUAL FORMA(2) ADJUSTED(3)
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(DOLLARS IN THOUSANDS, EXCEPT PER
SHARE DATA)
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BALANCE SHEET DATA:
Cash and cash equivalents............... $ 16 $ 516 $ 32,716
Working capital (deficit)............... (949) (449 ) 31,751
Total assets............................ 4,541 5,041 36,477
Long term obligations, less current
portion............................... 9,880 4,645 4,645
Total shareholders' equity (deficit).... (8,142) (2,407 ) 29,029
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(1) Please see Note 1 of our financial statements for an explanation of the
determination of the number of shares of our common stock outstanding.
(2) Pro forma to reflect the conversion of $5,234,840 in debt owed to Navarre
into equity and ValueVision's purchase of 550,000 shares of common stock for
$500,000, both occurring at the closing of this offering. Please see
"Related Party Transactions."
(3) Pro forma as adjusted to reflect the sale of 3,200,000 shares of common
stock offered by this prospectus after deducting the estimated offering
expenses of $1.3 million, the underwriting discount and reclassifying
previously paid offering expenses to equity. Please see "Use of Proceeds"
and "Capitalization."
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RECENT OPERATING RESULTS:
For the quarter ended September 30, 1999, we expect to report net revenues
of approximately $370,000 and a net loss of approximately $4,300,000, compared
to net revenues of $50,627 and a net loss of $772,571 for the quarter ended
September 30, 1998.
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RISK FACTORS
Investing in our common stock is very risky. You should be able to bear a
complete loss of your investment. In addition to the other information in this
prospectus, you should consider the following risks carefully in deciding
whether to invest in shares of our common stock.
RISKS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY UPON WHICH YOU MAY EVALUATE US AND WE CANNOT
ASSURE YOU THAT WE WILL ACHIEVE MARKET ACCEPTANCE.
We have a limited operating history on which you may evaluate our business
and prospects. We began broadcasting live audio programming on the Internet in
November 1995 and began selling products over the Internet on a limited basis in
June 1998. We first recognized Internet advertising revenues in April 1998. Our
prospects must be considered in light of the risks, difficulties and
uncertainties frequently encountered by companies in an early stage of
development. This is particularly significant because we operate in a new and
rapidly evolving market.
WE MAY NOT ACHIEVE FUTURE PROFITABILITY DUE TO CONTINUING OPERATING LOSSES.
To date we have not been profitable. We have recorded a net loss for each
year since our inception in 1995. In 1998, we had net revenues of approximately
$255,000 and a net loss of approximately $4.0 million. We had an accumulated
deficit of approximately $11.2 million during the period from March 21, 1997 to
June 30, 1999. At June 30, 1999, we owed approximately $9.7 million to Navarre.
Concurrent with the closing of this offering, $5.2 million of this debt will be
converted into equity of NetRadio without the issuance of additional shares of
capital stock. We have incurred losses in each fiscal quarter since our
inception, and we anticipate that we will continue to incur losses for the
foreseeable future as we increase our operating expenses to expand our business.
IF OUR OPERATING REVENUES CONTINUE TO BE INSUFFICIENT TO SUPPORT OUR BUSINESS WE
MAY NOT BECOME PROFITABLE.
We have historically funded our business by selling capital stock and
borrowing money. We have not achieved sufficient revenues from sales of our
audio merchandise or advertising to meet our expenses in any quarterly or annual
period. We believe that our future profitability and success will depend in
large part on, among other things, our ability to generate sufficient revenues
from sales of compact discs and other audio merchandise and Internet
advertising. There can be no assurance that our revenues will increase or even
continue at their current levels or that we will achieve or maintain
profitability or generate cash from operations in future periods.
FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS MAY NEGATIVELY AFFECT OUR STOCK
PRICE.
Our quarterly operating results may fluctuate significantly in the future as
a result of a variety of factors, many of which are outside of our control.
These factors include:
- availability of compelling content and costs of acquiring and distributing
it,
- demand for our products,
- demand for advertising on our Web site and on the Internet in general,
- seasonal trends in the traditional retail market and in advertising
placements, including expected declines in the summer months and expected
increases in the fourth quarter,
- amount and timing of capital expenditures and other costs relating to the
expansion of our operations,
- technical difficulties or system downtime,
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- new products or services that we, or our competitors, offer, and
- general economic conditions and economic conditions specific to the
Internet or to the retail sales or advertising markets.
As a result of these factors, our operating results for any particular
quarter may not be indicative of future operating results and you should not
rely on them as indications of our future performance. It is also possible that
our operating results in one or more quarters will fail to meet the expectations
of securities market analysts or investors. In such an event, the price of our
common stock could decline.
OUR ADVERTISING REVENUES MAY FLUCTUATE, WHICH MAY NEGATIVELY AFFECT OUR STOCK
PRICE.
Advertising sales in television, radio and print media fluctuate
unpredictably and are typically lower in the first and third calendar quarters
of each year. Advertising expenditures also fluctuate significantly with
economic cycles, which may negatively affect our stock price. A number of
factors may contribute to our ability to generate advertising revenues,
including:
- acceptance and continued growth of the Internet as an advertising medium,
- continued consumer Internet use,
- traffic on our Web site,
- pricing of advertising on other Web sites,
- our ability to generate listener demographic characteristics that are
attractive to advertisers,
- developing and expanding our advertising sales force, and
- establishing and retaining desirable advertising sales agency
relationships.
IF THE INTERNET IS NOT ACCEPTED AS AN ADVERTISING MEDIUM, OUR ADVERTISING
REVENUES MAY DECLINE.
The growth of Internet advertising requires validation of the Internet as an
effective advertising medium. This validation has yet to fully occur. Acceptance
of the Internet among advertisers will also depend on growth in the commercial
use of the Internet. If widespread commercial use of the Internet does not
develop, or if the Internet does not develop as an effective and measurable
medium for advertising, our advertising revenues may decline.
No standards have been widely accepted to measure the effectiveness of
Internet advertising. If these standards do not develop, existing advertisers
may not continue their current levels of Internet advertising and advertisers
who are not currently advertising on the Internet may be reluctant to do so. Our
business could be materially damaged if the market for Internet advertising
fails to develop or develops slower than expected.
WE MAY BE UNABLE TO CONTINUE TO EXPAND OUR TECHNICAL CAPACITY TO MEET AN
EVER-INCREASING USER BASE.
Our success depends in part upon our ability to deploy broadcasting
technology that delivers streaming audio content to an ever-increasing number of
simultaneous users. In the past, we have had periods of time when we were not
able to accommodate all users visiting our Web site. This has resulted in
unanticipated system disruptions, slower response times, impaired quality and
speed of order fulfillment, impaired customer service and lost sales
opportunities. To be successful, we must increase our capacity to deliver
content to larger audiences. We rely upon AT&T to provide bandwidth (i.e.,
transmission capacity) and technical support to meet our traffic needs. If AT&T
substantially increases the fees it charges us or refuses to contract with us
for its services, our business could be materially damaged. In addition, we must
acquire, test and deploy additional network equipment to successfully scale our
network infrastructure to serve mass audiences. There can be no assurance that
we will be successful in doing so. If we fail to scale our broadcasts to large
audiences of simultaneous users, our business could be materially damaged.
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INTENSE COMPETITION FOR THE PRODUCTS AND ADVERTISING WE SELL MAY RESULT IN A
DECLINE IN OUR REVENUES.
The Internet commerce market is new, rapidly evolving and intensely
competitive. We expect competition to further intensify as existing technologies
expand and new technologies are introduced. Barriers to entry into the Internet
commerce market are minimal, and competitors can launch new Web sites at a
relatively low cost. In addition, the retail music industry is highly
competitive. We compete with a variety of other companies for advertising and
market share, including:
- streaming media sites such as Broadcast.com, Imagine Radio, Launch Media
and Spinner,
- online music providers, such as audiohighway.com, E-music, musicmaker.com
and MP3.com, who broadcast music and information,
- online retail competitors, such as Amazon.com, CDNow, K-Tel and GetMusic,
who market audio merchandise, software, and entertainment-related
products,
- traditional radio broadcasters, and
- traditional retail competitors, including large specialty music stores
with significant brand awareness, sales volume and customer bases, such as
MusicLand, Tower Records, Barnes & Noble and Best Buy.
We believe that the principal competitive factors in our markets are brand
recognition, selection, personalized services, convenience, price,
accessibility, customer service, quality of search tools, quality of music, site
content and reliability and speed of product fulfillment. Many of our
competitors have significantly longer operating histories, larger customer
bases, greater brand recognition and greater financial, marketing and other
resources. In addition, online retailers may be acquired by, receive investments
from or enter into other commercial relationships with larger, more
well-established and well-financed companies as use of the Internet and other
online services increases. For example, Yahoo! recently acquired Broadcast.com,
America Online recently acquired Spinner and Viacom acquired Imagine Radio.
IF WE ARE UNABLE TO ADAPT TO RAPID TECHNOLOGICAL CHANGE, OUR BUSINESS COULD BE
MATERIALLY DAMAGED.
The market for Internet audio is characterized by rapid technological
developments, frequent new product introductions, evolving industry standards,
and changes in transmission and content delivery mechanisms. It is possible that
an alternative technology will emerge that offers superior broadcasting
technology over the Internet. The introduction of new technology, products,
services or standards may prove to be too difficult, too costly or impossible to
integrate into our existing or any future products and services. In the event
that our technology is not successfully deployed in a timely manner or such an
alternative technology emerges, we would likely be required to expend
significant resources to deploy such alternative technology. This could
materially damage our business during the period in which we attempted such
deployment. We must also continue to add hardware and enhance software to
accommodate any increased content and use of our Web site. If we are unable to
increase the data storage and processing capacity of our systems at least as
fast as the growth in demand, our Web site may fail to operate at an optimal
level for unknown periods of time. Any difficulty keeping pace with
technological advancements could hurt the growth of our business, retention of
our customers and may materially adversely affect our business, financial
condition and results of operations.
RAPID TECHNOLOGICAL CHANGES IN MUSIC DISTRIBUTION METHODS IN OUR INDUSTRY MAY
MATERIALLY DAMAGE OUR BUSINESS.
Sales and distribution of music digitally could radically alter the current
music distribution methods used by artists, publishers, distributors, retailers
and media companies. One recent technological development is MP3, a standard for
digital music encoding, which generally permits a user to store and replay,
either on a personal computer or a specially-designed MP3 device, music selected
by the user as opposed to an Internet audio broadcaster. For example, a portable
device called the Rio is now
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available to consumers and can be used to play MP3-downloaded music files. This
technology permits the posting of music on Web sites either legally, by artists
or record labels on their own Web sites, or illegally on sites that have pirated
intellectual property owned by the major and independent labels. The ability to
immediately download music eliminates product shipping and handling. As a
result, acceptance of this technology could dramatically change the structure
and competitive dynamics of the market for sales of pre-recorded music over the
Internet. There can be no assurance that we will be able to respond quickly,
cost effectively and sufficiently to this or other technological developments,
and failing to effectively respond to technological developments could
materially damage our business.
Five major record companies have recently begun conducting market trials to
test selling music in digital form transmitted over the Internet. The
transmissions use IBM software and will allow approximately 1,000 cable
subscribers to download music from a library of 1,000 album titles and several
hundred song titles provided by the major record labels. This market trial is
viewed by many as the first step taken by the major record companies to consider
the sale of digital music online. Microsoft has developed a compression software
called MS-Audio, AT&T has developed a proprietary format called a2b, and Liquid
Audio has developed a third format, all of which are intended to compete with
MP3 and other formats. It is uncertain which distribution format will ultimately
achieve widespread market acceptance.
A task force of record companies, software programmers and consumer
electronics makers, called the Secure Digital Music Initiative, or SDMI, is
attempting to develop security and delivery standards by which songs available
in digital format can be disseminated without infringing upon third party
copyright or other intellectual property rights. In May 1999, Matshusita
Electric Industrial Co. Ltd., AT&T, BMG Entertainment and Universal Music Group
announced an alliance to develop a platform for digital delivery within the
network of the SDMI. Also in May 1999, RealNetworks, Inc. announced the
introduction of its RealJukebox, which permits recording and playback of music
CDs, digital downloads through a user's PC, and customization of user playlists.
In June 1999, the SDMI announced completion and adoption of specifications for
portable devices for digital music. If a proprietary music delivery format or
playback device receives widespread industry and consumer acceptance, we will be
required to license additional technology and information from third parties.
There can be no assurance that this third-party technology and information will
be available to us on commercially reasonable terms, or at all.
In order to ensure compliance with existing copyright laws, we provide music
content over the Internet that is licensed from labels in a traditional manner.
The acceptance and integration of any of these new methods of music
distribution, without sufficient protection of intellectual property or industry
uniformity, could materially adversely affect our business, financial condition
and results of operations.
OUR SYSTEMS MAY NOT BE YEAR 2000 COMPLIANT WHICH COULD CAUSE OUR WEB SITE TO BE
UNAVAILABLE.
We may realize exposure and risk if the systems on which we are dependent to
conduct our operations are not Year 2000 compliant. Our potential areas of
exposure include products purchased from third parties, computers, software,
telephone systems and other equipment used internally. If our present efforts to
address Year 2000 compliance issues are not successful, or if distributors,
suppliers and other third parties with whom we conduct business do not
successfully address these issues, our business could be damaged.
In the event that our Web site is not Year 2000 compliant, we would not be
able to broadcast our programming and advertising or sell our products to our
customers. In the event that the technical support provided for our Web site is
not Year 2000 compliant, portions of our Web site may become unavailable. Please
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Compliance" for a further discussion of Year 2000 risks.
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WE MAY BE UNABLE TO CONTINUE TO DEVELOP OUR BRAND, WHICH COULD HARM FUTURE
GROWTH OF OUR BUSINESS.
We believe that our growth has been largely attributable to word of mouth.
Despite this historical organic growth, we believe that continuing to strengthen
our brand is critical to achieving widespread acceptance of NetRadio,
particularly in light of the competitive nature of our industry. Promoting and
positioning our brand will depend largely on the success of our marketing
efforts. Therefore, we expect to increase our marketing budget to create and
maintain brand loyalty among our listeners and other visitors to our Web site.
There can be no assurance that our brand promotion activities will yield
increased revenues or that any such revenues would offset the expenses that we
may incur to build our brand.
IF THE COST OF STREAMING INTERNET AUDIO BECOMES PROHIBITIVELY EXPENSIVE, OUR
BUSINESS COULD BE MATERIALLY DAMAGED.
Our success also depends upon our reliance on streaming media technology
provided to us by RealNetworks. In order to provide our advertising and
products, we depend upon our listeners' ability to download or have installed
RealNetworks' RealPlayer software. If RealNetworks substantially increases the
license fees it charges us for the use of its products, refuses to license its
products to us or requires listeners to pay for its software, our business could
be materially damaged.
CAPACITY CONSTRAINTS ASSOCIATED WITH THE GROWTH OF INTERNET USAGE COULD CAUSE
OUR ADVERTISING AND PRODUCT SALES REVENUES TO DECLINE.
If the Internet continues to experience an increase in the number of users
and frequency of use, there can be no assurance that the Internet as a whole, or
our infrastructure, will be able to deliver high-quality musical content.
Internet experiences are affected by, among other factors, access speed.
Insufficient availability of telecommunications services to support the Internet
could result in unacceptable response times and could adversely affect Internet
use generally and traffic to our Web site in particular. Our revenues depend
upon the number of listeners who access our audio broadcasts and buy products
offered on our Web site, as well as the amount of advertising spots that we can
sell. Any system interruptions that would result in our Web site being
inaccessible would reduce the volume of goods sold, advertising revenue and the
attractiveness of our products and services. We have experienced periodic system
interruptions, which may continue to occur from time to time. If Internet usage
does not support the growth that may occur, our business could be materially
damaged.
IF CORPORATE INTRANETS DO NOT ACCEPT OUR PROGRAMMING, THE NUMBER OF LISTENERS TO
OUR AUDIO CONTENT MAY DECLINE.
A significant portion of our audience is in the workplace. Because of
bandwidth constraints on corporate intranets or fears that computer networks and
other computer systems' security could be compromised, some information systems
managers may block reception of streaming media. Widespread adoption of
streaming media technology depends upon overcoming these obstacles, improving
audio and video quality and educating users in the use of streaming media
technology. If streaming media technology fails to achieve broad commercial
acceptance or acceptance is delayed, our business could be materially damaged.
OUR INTERNALLY DEVELOPED AND COMMERCIALLY AVAILABLE SOFTWARE MAY NOT ADEQUATELY
SUPPORT OUR GROWTH.
We use internally developed and commercially available software for our Web
site, audio channels, search engines and substantially all aspects of
transaction processing, including order management, cash and credit processing,
purchasing, inventory verification and shipping. If we are unable to modify our
software as necessary to accommodate increased traffic to our Web site or
increased volume of transactions, our business could be materially damaged.
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BECAUSE WE HAVE MOST OF OUR OPERATIONS AT A SINGLE LOCATION AND WE HAVE LIMITED
REDUNDANT SYSTEMS, OUR OPERATIONS ARE VULNERABLE TO INTERRUPTIONS DUE TO
UNFORESEEN EVENTS.
Our success depends largely on the efficient and uninterrupted operation of
our computer and communications hardware systems. Our computer and
communications hardware and software are located at a single leased facility in
Minneapolis, Minnesota. Our systems and operations are vulnerable to damage or
interruption from fire, flood, power loss, telecommunications failure,
break-ins, tornadoes and similar events. We presently have limited redundant
systems and no formal disaster recovery plan. We do not carry sufficient
business interruption insurance to compensate us for losses that may occur. Our
servers are also vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions which could lead to interruptions, delays or
loss of data. The occurrence of any of these events could prevent us from
broadcasting our audio programming, selling advertising or accepting and
fulfilling customer orders.
IF WE ARE UNABLE TO INTEGRATE NEW BUSINESSES, OUR BUSINESS MAY NOT GROW.
We may expand our operations by developing new Web sites, promoting new or
complementary products or sales formats, expanding the breadth of our products
and services, or expanding our market presence through relationships with third
parties. In addition, we may acquire new or complementary businesses, products
or technologies, although we have no present commitments for such activities.
There can be no assurance that we will be able to expand operations
cost-effectively, or that any of our efforts will increase market acceptance for
our products and services. Furthermore, any new business, Web site, or channel
that we launch that is not favorably received by consumers could damage our
reputation or brand. Any expansion would likely require significant additional
expenses and other operational resources. If the market does not react favorably
to our efforts, or if we are unable to generate sufficient revenues from our
expanded services or products to offset our costs, our business could be
materially damaged.
BECAUSE OUR INTERCOMPANY AGREEMENTS WERE NOT NEGOTIATED AT ARM'S LENGTH, WE MAY
NOT HAVE OBTAINED TERMS AS FAVORABLE TO US AS THOSE WE COULD HAVE OBTAINED
FROM THIRD PARTIES.
We have entered into intercompany agreements with Navarre that are material
to the conduct of our business. Because we are a majority-owned subsidiary of
Navarre, none of these agreements resulted from arm's-length negotiations and,
therefore, there is no assurance that the terms and conditions of these
agreements are as favorable to us as those that we could have obtained from
unaffiliated third parties. Please see "Related Party Transactions." In
addition, we have indemnification obligations with respect to Navarre in
connection with our agreements. Please see "Related Party
Transactions--Separation Agreement."
IF WE ARE UNABLE TO EXPAND INTO INTERNATIONAL MARKETS, OUR BUSINESS MAY NOT
GROW.
Expansion into international markets will require significant management
attention and resources. There can be no assurance that we will be successful in
expanding into international markets to generate revenues from foreign
operations. In addition, there are certain risks inherent in doing business in
international markets, including, among other things, regulatory requirements,
legal uncertainty regarding liability, tariffs and other trade barriers, longer
payment cycles, differing accounting practices, problems in collecting accounts
receivable, political instability and potentially adverse tax consequences. To
the extent that we expand international operations and additional portions of
our international revenues are denominated in foreign currencies, we could
become subject to increased risks relating to exchange rate fluctuations. One or
more of these factors could materially damage our business.
12
<PAGE>
IF WE ARE UNABLE TO PREVENT THIRD PARTIES FROM ACQUIRING WEB ADDRESSES SIMILAR
TO OURS, OUR BUSINESS MAY BE MATERIALLY DAMAGED.
We currently hold various Internet domain names relating to our products and
services, including the "netradio.net" and "netradio.com" domain names. The
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. In the past, third parties
have acquired domain names that are similar to ours, and we have had to expend
resources to protect our proprietary rights in this area. There can be no
assurance that in the future we will be able to prevent other third parties from
acquiring domain names that are identical to, similar to, infringe upon or
otherwise decrease the value of our trademarks, domain names and other
proprietary rights. If we are unable to protect our domain names from third
parties, our business could be materially damaged.
IF WE ARE UNABLE TO PROTECT OUR TRADEMARKS AND PROPRIETARY RIGHTS, OUR
REPUTATION IN THE MARKETPLACE MAY BE MATERIALLY DAMAGED.
We regard our copyrights, service marks, trademarks, trade dress, trade
secrets and similar intellectual property as important to our success. We rely
upon trademark and copyright law, trade secret protection, confidentiality and
license agreements with employees, customers, partners and others to protect our
proprietary rights. We have registered certain of our trademarks and service
marks with applicable governmental authorities. Effective trademark, service
mark, copyright and trade secret protection may not be available in every
country in which our products and services are made available and we have not
sought protection for our intellectual property in every country where our
broadcasts may be heard. In the future, we may license certain of our
proprietary rights, such as trademarks or copyrighted material, to third
parties. While we will try to ensure that the quality of our brand is maintained
by such licensees, it is possible that such licensees could take actions that
might materially adversely affect the value of our proprietary rights or
reputation. There can be no assurance that the steps we take to protect our
proprietary rights will be adequate or that third parties will not infringe or
otherwise violate our copyrights, trademarks, trade dress or similar proprietary
rights.
WE MAY INFRINGE UPON THE PROPRIETARY RIGHTS OF OTHERS AND ANY RELATED
LITIGATION, REGARDLESS OF ITS MERIT, COULD MATERIALLY DAMAGE OUR BUSINESS.
We believe that our broadcasts of prerecorded music over the Internet are
permitted under the copyright laws of the United States, as long as we obtain
appropriate permission and pay appropriate royalties. We have entered into
licensing agreements with each of the major performing rights organizations,
including the American Society of Composers, Authors and Publishers, Broadcast
Music, Inc. and the Society of European Stage, Authors and Composers, Inc. We
believe that these agreements grant us licenses to broadcast music and other
copyrighted materials over the Internet, and obligate us to pay royalties in
connection with such broadcasts. The royalties that we must pay, or the terms
and conditions of the license agreements, may change, and such changes may
materially damage our business. There is also a risk that some music may not be
available for broadcast over the Internet. In addition, our license agreements
with performing rights organizations may not comply with the copyright laws of
jurisdictions outside the United States, and our broadcasts may violate the
copyright laws of jurisdictions where our Internet broadcasts may be heard.
The Digital Performance Right in Sound Recordings Act of 1995 provides that
the owners of sound recordings have exclusive performance rights in their
recordings, and, if applicable to us, will require us to pay additional
licensing fees for our broadcasts. We are a member of the Digital Media
Association, an industry trade association. The Digital Media Association is
currently in discussions with the Recording Industry Association of America to
determine the framework and fee structure for digital performance rights fees.
These fees are expected to be imposed retroactively to October 1, 1998. The
final determination of license fee structure could adversely affect our
financial results.
13
<PAGE>
We have been, and may continue to be, subject to claims and legal
proceedings, from time to time, in the ordinary course of our business. These
claims could include claims against us for alleged infringement of copyrights,
trademarks and other proprietary rights of third parties. These claims, even if
not meritorious, could result in the expenditure of significant financial and
managerial resources, which could materially damage our business.
IF WE ARE UNABLE TO MAINTAIN OUR STRATEGIC ALLIANCES WITH VALLEY MEDIA, NAVARRE
AND REALNETWORKS OUR BUSINESS COULD BE MATERIALLY DAMAGED.
Our success depends in part upon our strategic alliances. We purchase all of
our music products from two vendors, Valley Media and Navarre. For the fiscal
year ended December 31, 1998, and for the six months ended June 30, 1999, we
purchased approximately 95% of our music products from Valley Media, and the
remainder from Navarre. Our agreement with Navarre expires in December 2003 and
our agreement with Valley Media expires on March 1, 2000. We rely upon these two
vendors for rapid product fulfillment because we carry no inventory and have no
order fulfillment operations of our own. We have no contracts that guarantee the
availability of merchandise, the continuation of particular payment terms, or
the extension of credit. There can be no assurance that our current vendors will
be able to sell merchandise to us on terms as favorable as the current terms, or
that we will be able to establish new or extend current vendor relationships to
ensure order fulfillment in a timely and efficient manner, and on acceptable
commercial terms. We also rely upon relationships with Web site operators,
computer manufacturers, software developers and Internet service providers, or
ISPs, to deliver traffic to our Web site and to promote our brand. For example,
a significant portion of our listening traffic accesses NetRadio through
pre-sets on RealNetworks' audio player. There can be no assurance that our
relationships with ISPs or other providers will be maintained or that traffic
will continue to come from these entities. If any of these alliances were
terminated prematurely, or not extended, and we were not able to obtain the
products or services provided by that strategic partner, our business could be
materially damaged.
IF WE DO NOT CONTINUE TO DELIVER COMPELLING AUDIO CONTENT, TRAFFIC TO OUR WEB
SITE WILL DECREASE.
Our success depends in large part upon our ability to deliver compelling
audio content over the Internet. We do not create our own musical content.
Rather, we rely upon record labels, music publishers, performers and artists for
entertaining content. Our ability to maintain existing relationships with
content providers and build new relationships with additional content providers
is critical to the success of our business. Many of our agreements with third
party content providers are for limited terms or are not memorialized in a
formal written contract, and content providers may choose not to renew, or may
terminate, such agreements. Our inability to secure licenses from content
providers or performing rights societies, or the termination of a significant
number of content provider agreements, would decrease the availability of
content that we can offer our listeners. This may result in decreased traffic on
our Web site and decreased advertising and sales revenues, which could
materially damage our business.
OUR SUCCESS DEPENDS ON KEY PERSONNEL, MANY OF WHOM HAVE ONLY RECENTLY BEEN
HIRED.
We have rapidly and significantly expanded our operations and expect to
continue expanding to address potential market opportunities. This rapid growth
has placed, and is expected to continue to place, a significant strain on our
management. From June 30, 1998 to October 1, 1999, we expanded from 22 to 52
employees. Our new employees include a number of key employees who have not yet
been fully integrated into our management team, and we expect to add additional
personnel in the future. We also will be required to expand our accounting
staff. Historically, we have been dependent upon Navarre for various managerial,
warehousing, distribution and working capital needs. Please see "Related Party
Transactions." There can be no assurance that controls will be adequate to
support our future operations or that management will be able to hire and retain
required personnel. If we are
14
<PAGE>
unable to manage growth effectively, our business could be materially damaged.
Please see "Our Business--Employees" and "Management."
WE MAY BE VULNERABLE TO ONLINE COMMERCE SECURITY RISKS, WHICH COULD RESULT IN A
DECLINE IN OUR PRODUCT SALES REVENUES.
A significant barrier to online commerce and communications is the secure
transmission of confidential information, such as customer credit card
information. We rely upon encryption and authentication technology licensed from
third parties to transmit and protect confidential information. Advances in
computer capabilities, new discoveries in the field of cryptography, or other
developments may result in a compromise or breach of the systems that we use to
protect customer transaction data. If any compromise were to occur, or if our
customers, or Internet users in general believe that data transmissions over the
Internet are not secure, we would have to expend significant capital and other
resources to protect against security breaches or to alleviate concerns or
problems caused by security breaches. Concerns over the security and privacy of
transactions conducted on the Internet may inhibit the continued growth of the
Internet and accompanying growth of Internet commercial transactions. In
addition, security breaches in our storage, or our third party contractors'
storage of customer proprietary information could damage our reputation and
expose us to loss or possible liability. Our security measures may not prevent
security breaches, and if they occur, our business could be materially damaged.
RISKS RELATED TO THIS OFFERING
OUR COMMON STOCK HAS NEVER BEEN PUBLICLY TRADED, SO WE CANNOT PREDICT THE EXTENT
TO WHICH A TRADING MARKET WILL DEVELOP.
Prior to this offering, there has been no public market for our common
stock, and there can be no assurance that an active trading market will develop
or be sustained following this offering. The initial public offering price for
the shares was determined through negotiations between us and the
representatives of the underwriters and may not be indicative of the market
price of our common stock after this offering. Investors may not be able to
resell their shares at or above the initial public offering price. Please see
"Underwriting."
OUR STOCK PRICE MAY BE MATERIALLY AFFECTED BY MARKET VOLATILITY.
The stock market has experienced significant price and volume fluctuations,
and the market prices of securities of technology companies, particularly
Internet-related companies, have been highly volatile. These broad market
fluctuations, as well as general economic, market and political conditions, may
adversely affect the market price of our common stock. In the past, following
periods of volatility in the market price of a company's securities, securities
class action claims have often been brought against that company. This
litigation could result in substantial costs and a diversion of management's
attention and resources.
IF OUR CONTROLLING SHAREHOLDER DOES NOT CONTINUE TO FUND OUR CAPITAL NEEDS, WE
MAY HAVE DIFFICULTY SECURING ADDITIONAL FINANCING, IF REQUIRED.
We operate as a majority-owned subsidiary of Navarre. Prior to this
offering, Navarre has met our financial needs for working capital and general
corporate operations. Immediately following this offering, however, Navarre will
no longer be obligated to provide funds to finance our operations. We intend to
continue to invest in capital equipment, expansion and research and development.
We believe that the net proceeds from the sale of common stock in this offering,
together with existing cash balances and cash flow from operations, will be
sufficient to meet our liquidity and capital requirements for at least the next
18 months. We may, however, seek additional equity or debt financing to fund
further expansion of our broadcasting capacity or to fund other projects. The
timing
15
<PAGE>
and amount of our capital requirements cannot be precisely determined at this
time and will depend upon a number of factors, including demand for our products
and services, product mix, changes in the conditions of the Internet or music
industries and other competitive factors. There can be no assurance that this
additional financing will be available to us when needed or, if available, that
it will be on satisfactory terms or will be completed without dilution to our
shareholders.
ANTI-TAKEOVER PROVISIONS, OUR RIGHT TO ISSUE PREFERRED STOCK, AND OUR STAGGERED
BOARD COULD MAKE A THIRD-PARTY ACQUISITION OF US DIFFICULT.
We are subject to Chapters 302A.671 and 302A.673 of the Minnesota Business
Corporation Act, which may have the effect of limiting third parties from
acquiring significant amounts of our common stock without our approval. These
laws, among others, may have the effect of delaying, deferring or preventing a
third party from acquiring us or may serve as a barrier to shareholders seeking
to amend our articles of incorporation or bylaws. Our articles of incorporation
also grant us the right to issue preferred stock which could allow us to delay
or block a third party from acquiring us. Finally, upon the closing of this
offering, our bylaws will divide our board of directors into three classes to
serve staggered three-year terms. This could make it difficult for a third party
to effect a change in control of us.
MANAGEMENT'S INTEREST IN CONSUMMATING THIS OFFERING MAY DIFFER FROM THE
INTERESTS OF INVESTORS.
Some of our officers and employees will realize benefits from this offering,
including pay raises, additional stock options and bonuses. Please see
"Management--Employment Agreements and Change of Control Considerations." There
is a potential conflict between the immediate economic benefits accruing to
officers and employees upon the closing of this offering and the interests of
investors who may invest with the goal of long-term capital appreciation.
AFTER THIS OFFERING, NAVARRE AND VALUEVISION, ACTING TOGETHER, WILL HAVE THE
ABILITY TO CONTROL THE VOTE ON ALL MATTERS SUBMITTED TO OUR SHAREHOLDERS.
Navarre and ValueVision will beneficially own approximately 65% of our
outstanding common stock after this offering, 62% if the over-allotment option
granted by us is exercised in full. As a result, Navarre and ValueVision
together will have the ability to control the vote on all matters submitted to
shareholders for approval, including, but not limited to, the election of all
directors, and any merger, consolidation or sale of all or substantially all of
our assets, and to control our management and affairs. This concentration of
ownership may have the effect of delaying, deferring or preventing a third party
from acquiring us.
SHARES ELIGIBLE FOR FUTURE SALE BY OUR CURRENT SHAREHOLDERS MAY ADVERSELY AFFECT
OUR STOCK PRICE.
After this offering, the 3,200,000 shares of our common stock sold in this
offering will be freely tradeable. Beginning 180 days after the date of this
offering, approximately 6,562,500 additional shares will become eligible for
sale upon the expiration of lock-up agreements between our securityholders and
the underwriters. Representatives of the underwriters may from time to time, in
their sole discretion, release any of the securities subject to the lock-up
agreements. Of the shares that will first become eligible for sale in the public
market 180 days after this offering, approximately 6,012,500 shares will be
subject to volume and other resale restrictions. With respect to our stock
option plan, outstanding options to purchase 413,217 shares will be vested on
April 1, 2000. We may file a registration statement to register all of our
common stock under our stock option plan. After the registration statement
becomes effective, shares issued upon exercise of stock options will be eligible
for resale in the public market. The supply of substantial additional amounts of
common stock in the public market could lower the price of our common stock.
Please see "Description of Capital Stock" and "Shares Eligible for Future Sale."
16
<PAGE>
RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL UNCERTAINTY
FUTURE REGULATION OF THE INTERNET COULD EXPOSE US TO SIGNIFICANT LIABILITY.
There currently are few laws and regulations directly applicable to the
Internet. However, new laws and regulations may be adopted in the United States
and elsewhere covering issues such as music licensing, broadcast license fees,
copyrights, privacy, pricing, sales taxes and characteristics and quality of
Internet services. Restrictive laws or regulations could slow Internet growth or
expose us to significant liabilities associated with content available on our
Web site. The application of existing laws and regulations governing Internet
issues, such as property ownership, libel and personal privacy, is subject to
substantial uncertainty. New laws and regulations, including laws and
regulations governing issues such as property ownership, content, taxation and
defamation, may expose us to significant liabilities, significantly slow
Internet growth or otherwise materially damage our business.
THE REGULATION OF INDECENT CONTENT OVER THE INTERNET COULD EXPOSE US TO
SIGNIFICANT LIABILITY.
The Communications Decency Act of 1996 proposed to impose criminal penalties
on anyone distributing "indecent" material to minors over the Internet. Although
this provision of this statute was held to be unconstitutional by the United
States Supreme Court, there can be no assurance that similar laws will not be
proposed and adopted. Although we believe that we do not currently distribute
the types of materials that this statute may have deemed illegal, the nature of
such similar legislation and the manner in which it may be interpreted and
enforced cannot be fully determined, and legislation or state or local laws
similar to this law could subject us to potential liability. This in turn could
materially damage our business.
IF WE ARE REQUIRED TO COLLECT SALES TAXES, OUR BUSINESS COULD BE MATERIALLY
DAMAGED.
We collect sales and other taxes only in the states and countries where we
believe we are required by law to do so. One or more states or countries have
sought to impose sales or other tax obligations on companies that engage in
online commerce within their jurisdictions. It is possible that the current tax
moratorium limiting the ability of state and local governments to impose taxes
on Internet-based transactions could fail to be renewed prior to October 2001.
Failure to renew this legislation would allow states to impose new taxes on
Internet-based commerce. A successful assertion by one or more states or
countries that we should collect sales or other taxes on products and services,
or remit payment of sales or other taxes for prior periods, could materially
damage our business.
WARNING REGARDING OUR USE OF FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements which relate to possible
future events, our future performance and future operations. In some cases, you
can identify forward-looking statements by the use of words such as "may,"
"will," "should," "anticipates," "believes," "expects," "plans," "future,"
"intends," "could," "estimate," "predict," "potential," "continue," or the
negative of these terms or other similar expressions. These forward-looking
statements are only our predictions. Our actual results could and likely will
differ materially from these forward-looking statements for many reasons,
including risks described above and appearing elsewhere in this prospectus. We
cannot guarantee future results, levels of activity, performance or
achievements. We are under no duty to update any of the forward-looking
statements after the date of this prospectus to conform them to actual results
or to changes in our expectations.
17
<PAGE>
USE OF PROCEEDS
We estimate that the net proceeds from this offering will be $31,436,000, or
$36,346,400 if the over-allotment option is exercised in full, after deducting
the underwriting discount and estimated offering expenses.
We expect to use the net proceeds for working capital and other corporate
purposes, including advertising, capital expenditures and repayment of interest
on outstanding debt. We have not yet determined the amount of net proceeds to be
used specifically for each of these purposes. Accordingly, we will retain broad
discretion in the allocation of proceeds. We may also use a portion of the net
proceeds for strategic alliances or to acquire or invest in complementary
businesses, technologies or product lines. We have no current plans, agreements
or commitments with respect to any alliances or acquisitions of this kind, and
we are not currently engaged in negotiations related to any alliances or
acquisitions. Until we determine the allocation of these proceeds, we intend to
invest the net proceeds of this offering in short-term, interest-bearing,
investment grade securities.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We
currently anticipate that we will retain all future earnings, if any, to fund
the continued development and growth of our business, and we do not anticipate
paying cash dividends in the foreseeable future.
CAPITALIZATION
The following table sets forth our capitalization at June 30, 1999 on:
- an actual basis;
- a pro forma basis to reflect the conversion of $5,234,840 in debt owed to
Navarre into equity and ValueVision's purchase of 550,000 shares of common
stock for $500,000, both occuring at the closing of this offering; and
- a pro forma as adjusted basis to reflect the receipt of the net proceeds
from this offering after deducting the underwriting discount and estimated
offering expenses.
The outstanding share information excludes 1,209,850 shares of common stock
reserved for issuance upon exercise of options outstanding on June 30, 1999,
with a weighted average exercise price of $3.14 per share, and 784,750 shares of
common stock reserved for future grants under our stock option plan as of June
30, 1999. After June 30, 1999, we granted options to purchase an additional
78,000 shares of common stock at an exercise price equal to the initial public
offering price.
<TABLE>
<CAPTION>
JUNE 30, 1999
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Long term debt................................................................ $ 9,748 $ 4,513 $ 4,513
Capital lease obligations, less current portion............................... 132 132 132
Shareholders' equity:
Common stock, no par value; 20,000,000 shares authorized; 5,927,900 shares
issued and outstanding, actual; 6,477,900 shares issued and outstanding,
pro forma; 9,677,900 shares issued and outstanding, pro forma as
adjusted.................................................................. 3,030 8,765 40,201
Accumulated deficit........................................................... (11,172) (11,172) (11,172)
--------- ----------- -----------
Total shareholders' equity (deficit).......................................... (8,142) (2,407) 29,029
--------- ----------- -----------
Total capitalization.......................................................... $ 1,738 $ 2,238 $ 33,674
--------- ----------- -----------
--------- ----------- -----------
</TABLE>
18
<PAGE>
DILUTION
Our net tangible book value as of June 30, 1999, after giving effect to the
conversion of $5,234,840 in debt owed to Navarre into equity and ValueVision's
purchase of 550,000 shares of common stock for $500,000, both occurring at the
closing of this offering, was $(2,723,188) or $(.42) per share of common stock.
Net tangible book value per share represents the amount of our total tangible
assets, reduced by the amount of our total liabilities, divided by the number of
shares of common stock outstanding. After giving effect to the issuance and sale
of the 3,200,000 shares of common stock in this offering (after deducting the
underwriting discount and estimated offering expenses), the pro forma as
adjusted net tangible book value as of June 30, 1999 would have been $28,712,812
or $2.97 per share. This represents an immediate increase in net tangible book
value of $3.39 per share to existing shareholders and an immediate dilution of
$8.03 per share to new investors purchasing shares in this offering. The
following table illustrates the per share dilution to new investors:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Initial public offering price........................... $ 11.00
Pro forma net tangible book value per share as of June
30, 1999............................................ $ (.42)
Increase per share attributable to new investors...... $ 3.39
---------
Pro forma as adjusted net tangible book value per share
after this offering................................... $ 2.97
---------
Dilution per share to new investors..................... $ 8.03
---------
---------
</TABLE>
The following table summarizes, on a pro forma basis after giving effect to
this offering, as of June 30, 1999, the differences between the existing
shareholders and new investors with respect to the number of shares purchased,
the total cash consideration paid and the average price paid per share. This
table and discussion assume no exercise of any stock options outstanding as of
June 30, 1999.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------- -------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Existing shareholders(1)......................... 6,477,900 67% $ 6,816,640 16% $ 1.05
New investors(2)................................. 3,200,000 33% $ 35,200,000 84% $ 11.00
------------ --- ------------- ---
Total............................................ 9,677,900 100% $ 42,016,640 100%
------------ --- ------------- ---
------------ --- ------------- ---
</TABLE>
- ------------------------
(1) Reflects the conversion of $5,234,840 in debt owed to Navarre at December
31, 1998 into equity, ValueVision's purchase of 882,500 shares for
$1,000,000 in cash in March 1997, ValueVision's purchase of 550,000 shares
of common stock for $500,000 at the closing of this offering, the issuance
of 40,000 shares of common stock for $65,600 in September 1998, and the
issuance of 5,400 shares for $16,200 in May 1999 pursuant to the exercise of
options held by a terminated employee.
(2) If the over-allotment option is exercised in full, the number of shares of
common stock held by new investors will increase to 3,680,000 shares, or 36%
of the total shares of common stock outstanding after this offering.
19
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," our financial statements and their notes, and the other financial
information included elsewhere in this prospectus. The statement of operations
data for the period ended December 31, 1995, the year ended December 31, 1996,
the periods ended March 20, 1997 and December 31, 1997, and the year ended
December 31, 1998, and the balance sheet data at December 31, 1995, 1996, 1997
and 1998 are derived from our audited financial statements. The statement of
operations data for the six months ended June 30, 1998 and 1999 and the balance
sheet data at June 30, 1999 have been derived from unaudited interim financial
statements. The unaudited interim financial statements reflect all adjustments,
consisting only of normal recurring adjustments, which, in the opinion of our
management, are necessary for a fair presentation of the results for the interim
periods presented. Results for the six months ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the full year.
<TABLE>
<CAPTION>
NETRADIO
NET RADIO NEVADA --------------------------------
-------------------------------------------------------------
PERIOD FROM INCEPTION YEAR ENDED PERIOD FROM JANUARY PERIOD FROM MARCH YEAR ENDED
(NOVEMBER 1, 1995) TO DECEMBER 31, 1, 1997 THROUGH 21, 1997 THROUGH DECEMBER 31,
DECEMBER 31, 1995 1996 MARCH 20, 1997 DECEMBER 31, 1997 1998
----------------------- --------------- ------------------- ----------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues:
Product sales................... $ -- $ -- $ -- $ -- $ 50
Internet advertising............ -- -- -- -- 205
Miscellaneous................... 22 321 168 163 --
----- ------- ------ ------- -------------
Total net revenues............ 22 321 168 163 255
Cost of revenues.................. -- -- -- 17 65
----- ------- ------ ------- -------------
Gross profit...................... 22 321 168 146 190
Operating expenses:
Operations and technical
support....................... -- -- -- 672 686
Sales and marketing............. 12 427 53 161 670
General and administrative...... 82 2,154 852 1,268 2,786
----- ------- ------ ------- -------------
Total operating expenses...... 94 2,581 905 2,101 4,142
----- ------- ------ ------- -------------
Loss from operations.............. (72) (2,260) (737) (1,955) (3,952)
Net loss.......................... $ (74) $ (2,254) $ (754) $ (1,987) $ (3,977)
----- ------- ------ ------- -------------
----- ------- ------ ------- -------------
Loss per share--basic and
diluted......................... $ (.67)
Weighted average shares
outstanding(1).................. 5,899,167
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues:
Product sales................... $ -- $ 259
Internet advertising............ 113 147
Miscellaneous................... -- --
--------- ---------
Total net revenues............ 113 406
Cost of revenues.................. 10 243
--------- ---------
Gross profit...................... 103 163
Operating expenses:
Operations and technical
support....................... 606 1,996
Sales and marketing............. 158 785
General and administrative...... 595 2,276
--------- ---------
Total operating expenses...... 1,359 5,057
--------- ---------
Loss from operations.............. (1,256) (4,894)
Net loss.......................... $ (1,269) $ (5,208)
--------- ---------
--------- ---------
Loss per share--basic and
diluted......................... $ (.22) $ (.88)
Weighted average shares
outstanding(1).................. 5,882,500 5,923,902
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1999
--------------------------
(UNAUDITED)
DECEMBER 31, -------------
------------------------------------------ PRO FORMA
1995 1996 1997 1998 ACTUAL (2)
--------- --------- --------- --------- ----------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................... $ 66 $ 91 $ 4 $ 51 $ 16 $ 516
Working capital (deficit)........................... 57 (828) (930) (176) (949) (449)
Total assets........................................ 206 223 2,395 2,740 4,541 5,041
Long term obligations, less current portion......... 111 486 1,389 5,363 9,880 4,645
Total shareholders' equity (deficit)................ 37 (537) 13 (3,830) (8,142) (2,407)
<CAPTION>
PRO FORMA
AS ADJUSTED
(3)
-----------
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................... $ 32,716
Working capital (deficit)........................... 31,751
Total assets........................................ 36,477
Long term obligations, less current portion......... 4,645
Total shareholders' equity (deficit)................ 29,029
</TABLE>
- ----------------------------------
(1) Please see Note 1 of Notes to our Financial Statements for an explanation of
the determination of the number of shares outstanding.
(2) Pro forma to reflect the conversion of $5,234,840 in debt owed to Navarre
into equity, and ValueVision's purchase of 550,000 shares of common stock
for $500,000, both occurring at the closing of this offering. Please see
"Related Party Transactions."
(3) Pro forma as adjusted to reflect the sale of 3,200,000 shares of common
stock offered by this prospectus after deducting the underwriting discount
and estimated offering expenses of $1.3 million, and reclassifying
previously paid offering expenses to equity. Please see "Use of Proceeds"
and "Capitalization."
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION IN CONJUNCTION WITH THE FINANCIAL
STATEMENTS AND NOTES APPEARING ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT REFLECT OUR PLANS, ESTIMATES
AND BELIEFS. OUR ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN
THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF MANY FACTORS INCLUDING, BUT NOT
LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
We are a leading broadcaster of originally programmed audio entertainment
over the Internet. During the period from our inception through June 30, 1999,
we had insignificant revenues and were engaged primarily in developing
infrastructure, assembling our management team, and establishing our audio
channels. Our initial business model consisted of distributing coupons and other
promotional material on behalf of third parties. Substantially all of our
revenues prior to 1998 were derived from these activities. In January 1998, we
decided to add e-commerce to our operations and to discontinue distribution
activities.
Our current revenues are generated from sales of audio merchandise through
our online store, CDPoint, and from Internet advertising. Our Internet
advertising revenues consist of banner advertisements placed on our Web site,
special promotional advertisements and audio advertisements.
We recognize banner advertising revenues over the period in which the
advertisement is displayed on our Web site. We derive promotional advertising
revenues from product or artist related promotions, and recognize these revenues
over the term of the promotion. We derive audio advertising revenues from the
sale of advertising spots, and recognize these revenues when the audio
advertisement is broadcast.
In May 1996, Navarre acquired 50% of the stock of our predecessor, Net Radio
Nevada. On March 21, 1997, Navarre acquired the remaining 50%. This acquisition
was accounted for as a purchase. As a result, the accumulated deficit of Net
Radio Nevada as of March 21, 1997 was eliminated and goodwill of approximately
$1.3 million was recognized by Navarre at the time of the acquisition. The
goodwill has been "pushed down" to NetRadio for financial reporting purposes. As
a result, our financial statements for the periods prior to March 21, 1997 are
reflected as predecessor financial statements and the accumulated deficit at
June 30, 1999 reflects only losses incurred since March 21, 1997. We have
incurred significant losses since our inception. Our accumulated deficit of
approximately $11.2 million reflects our operating results during the period
from March 21, 1997 to June 30, 1999. In addition, we had incurred an
accumulated deficit of approximately $3.1 million prior to that date.
In the following "Results of Operations" section, we have combined the two
separate periods in 1997 to make the year-to-year comparison easier.
We believe that our success will depend largely on our ability to program
and broadcast original audio content to attract and retain listeners and to
generate e-commerce and advertising revenues. Accordingly, we intend to invest
heavily to develop and maintain content and network infrastructure and to expand
e-commerce. We expect to continue to incur substantial operating losses for the
foreseeable future.
In view of the rapidly evolving nature of our business and our limited
operating history, we believe that period-to-period comparisons of revenues and
operating results, including gross margin and operating margin, are not
necessarily meaningful and should not be relied upon as indications of our
future performance.
21
<PAGE>
RESULTS OF OPERATIONS FOR SIX MONTHS ENDED JUNE 30, 1999 AND 1998
NET REVENUES
Net revenues increased to $405,665 for the six months ended June 30, 1999
from $112,796 for the six months ended June 30, 1998, a 260% increase, and
consisted of product sales and Internet advertising revenues.
PRODUCT SALES. Product sales for the six months ended June 30, 1999
consisted of $258,607 of sales of audio merchandise, including shipping and
handling costs, compared with no product sales for the six months ended June 30,
1998. We began selling audio merchandise in the third quarter of 1998 when we
opened our online store, CDPoint, which became fully operational in November
1998.
INTERNET ADVERTISING. Internet advertising revenues for the six months
ended June 30, 1999 were $147,058, compared to $112,796 for the six months ended
June 30, 1998. Internet advertising revenues reflect audio and banner
advertising sales as well as promotional advertising revenues.
COST OF REVENUES
Cost of revenues includes the cost of audio merchandise that we sell,
including fulfillment costs through third party vendors which ship directly to
our customers, and include costs incurred in connection with the development of
specific advertising or promotional campaigns. Costs of revenues increased to
$242,415 for the six months ended June 30, 1999 from $10,058 for the six months
ended June 30, 1998. The increase in cost of revenues was due primarily to the
increased product sales associated with the opening of our online music store.
OPERATING EXPENSES
OPERATIONS AND TECHNICAL SUPPORT. Operations and technical support expenses
consist primarily of data communications expenses, personnel expenses associated
with broadcasting, software and content license fees, operating supplies and
overhead. Operations and technical support expenses were $1,995,516 for the six
months ended June 30, 1999, compared to $605,738 for the six months ended June
30, 1998. The increase in operations and technical support expenses was due
primarily to the building of technical and personnel infrastructure necessary to
meet listener demand and provide e-commerce opportunities to listeners.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel expenses associated with Internet advertising and the marketing of our
Web site. Sales and marketing expenses were $785,438 for the six months ended
June 30, 1999, compared to $157,673 for the six months ended June 30, 1998. The
increase in sales and marketing expenses was due primarily to the growth in our
sales force and marketing staff, use of $150,000 in advertising from
ValueVision, and the undertaking of marketing initiatives.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of administrative personnel expenses, professional fees, depreciation
and amortization, and expenditures for facility costs. General and
administrative expenses were $2,276,477 for the six months ended June 30, 1999,
compared to $595,491 for the six months ended June 30, 1998. The increase in
general and administrative expenses was due primarily to a one-time recognition
of $879,625 in compensation expense as a result of the issuance of stock options
to employees and directors with exercise prices below the estimated fair market
value of our common stock on the date of grant. The remaining increase reflects
the costs associated with adding key personnel and building infrastructure.
Interest expense for the six months ended June 30, 1999 was $314,156,
compared to $13,169 for the six months ended June 30, 1998. The increase was due
to the accrual of interest expense associated
22
<PAGE>
with the advances from Navarre. Interest expense was accrued beginning January
1, 1999 on all outstanding advances from Navarre.
RESULTS OF OPERATIONS FOR FISCAL YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NET REVENUES
Net revenues decreased to $255,062 in 1998, from $330,921 in 1997 and
$320,661 in 1996 due primarily to our change in business model. Net revenues in
1998 and 1999 consisted primarily of product sales and Internet advertising
revenues.
PRODUCT SALES. Product sales in 1998 consisted of $49,639 of sales of audio
merchandise, including shipping and handling costs, compared with no product
sales in 1997 and 1996.
INTERNET ADVERTISING. Internet advertising revenues in 1998 were $205,423,
compared to no Internet advertising revenues in 1997 and 1996. The 1998 Internet
advertising revenues reflect audio and banner advertising sales as well as
promotional advertising revenues.
MISCELLANEOUS REVENUES. We had no miscellaneous revenues in 1998, compared
to $330,921 in 1997 and $320,661 in 1996. Miscellaneous revenues consisted
primarily of payments from third parties for distribution of coupons and other
promotional material. We do not expect future miscellaneous revenues to be
significant.
COST OF REVENUES
Cost of revenues increased to $64,825 in 1998, from $16,989 in 1997 and no
cost of revenues in 1996. The increase in cost of revenues from 1997 to 1998 was
due primarily to the cost associated with the opening of our online music store.
The increase in cost of revenues form 1996 to 1997 was due primarily to costs
associated with the preparation of specific promotional campaigns.
OPERATING EXPENSES
OPERATIONS AND TECHNICAL SUPPORT. Operations and technical support expenses
were $685,767 in 1998, and consisted primarily of data communications expenses,
personnel expenses associated with broadcasting, software and content license
fees, operating supplies and overhead. We incurred operations and technical
support expenses of $672,061 in 1997, reflecting the cost of outside consulting
services for Web site development. We incurred no operations and technical
support expenses in 1996. We expect operations and technical support expenses to
continue to increase as we further develop our Web site.
SALES AND MARKETING. Sales and marketing expenses increased to $670,885 in
1998 from $213,784 in 1997 and $426,884 in 1996. The increase in sales and
marketing expenses in 1998 compared to 1997 was due primarily to growth in our
sales force and marketing staff and to increased advertising expenses. The
decrease in sales and marketing expenses in 1997 compared to 1996 was due
primarily to the scaling back of our marketing efforts during 1997, while we
reviewed our business strategy.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$2,786,385 in 1998, $2,119,567 in 1997 and $2,154,455 in 1996. Goodwill
amortization recognized from Navarre's acquisition of Net Radio Nevada amounted
to $421,000 in 1998 and $316,000 in 1997. The increase in general and
administrative expenses in 1998 compared to 1997 reflects the costs associated
with developing our business strategy, acquiring personnel and building
infrastructure. The decrease in general and administrative expenses in 1997
compared to 1996 reflects a redeployment of our resources to the development of
our Web site operations.
23
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations through private sales
of equity securities and advances from Navarre.
Net cash used in operating activities was $3,126,703 and $1,055,687 for the
six months ended June 30, 1999 and 1998, respectively. Net cash used in
operating activities was $2,771,915 in 1998, $2,125,876 in 1997, and $1,289,352
in 1996. Net cash used in operating activities for the six months ended June 30,
1999 was primarily composed of our net losses offset in part by depreciation and
amortization, an increase in accounts payable and accrued expenses and non-cash
compensation expense associated with the issuance of incentive stock options.
The growth in accounts receivable to $105,128 at June 30, 1999 from $49,002
at June 30, 1998, and to $26,213 in 1998 from $9,084 in 1997, was due primarily
to a change in the mix of revenue from promotional events that had occurred
early in 1997 to advertising revenues and product sales in 1998 and in the six
months ended June 30, 1999. The accounts receivable balances at June 30, 1999
and December 31, 1998 consisted primarily of agency-placed advertising revenue
accounts. Advertising revenues placed by an agency typically are collected in 60
to 90 days. Promotional revenues in 1997 were collected on a chargeback basis
and resulted in a nominal accounts receivable balance at year end 1997.
Accordingly, accounts receivable balances at June 30, 1999 and December 31, 1998
were higher than at December 31, 1997. We expect advertising revenue accounts
generally to be collected within 60 to 90 days in the future.
The increase in prepaid expenses, other current assets, deferred revenue and
accrued expenses from December 31, 1998 to June 30, 1999 was primarily due to
the execution of two contracts with RealNetworks in May 1999.
The increase in accounts payable to $1,093,963 at June 30, 1999 from
$644,055 at June 30, 1998 and to $1,022,639 at December 31, 1998 from $737,300
at December 31, 1997 was due primarily to higher operating expenses as we
developed the infrastructure necessary to manage the growth of our business.
Net cash used in investing activities for the six months ended June 30, 1999
and 1998 was $847,721 and $32,871, respectively. Net cash used in investing
activities was $906,249 in 1998, $11,403 in 1997 and $329,831 in 1996. Net cash
used in investing activities in these periods was related primarily to purchases
of property and equipment.
We generated net cash from financing activities of $3,939,692 and $1,103,450
for the six months ended June 30, 1999 and 1998, respectively. We generated net
cash from financing activities of $3,724,667 in 1998, $2,049,616 in 1997 and
$1,644,629 in 1996. Net cash from financing activities for the six months ended
June 30, 1999 was generated primarily from $4,513,537 in advances from Navarre.
Net cash from financing activities in 1998 was generated primarily from
$4,022,529 in advances from Navarre while net cash from financing activities in
1997 was generated from a $1,000,000 purchase of equity securities by
ValueVision and $1,212,311 in advances from Navarre. Net cash from financing
activities in 1996 resulted primarily from a $1,500,000 purchase of equity
securities by Navarre.
We believe that the net proceeds from this offering, together with our
current cash and cash equivalents, will be sufficient to meet our anticipated
cash needs for working capital and capital expenditures for at least the next 18
months. In connection with this offering, we will convert $5,234,840 in debt
owed to Navarre into equity, and ValueVision has agreed to purchase 550,000
additional shares of our common stock for $500,000, both occurring at the
closing of this offering. We may need to raise additional funds through public
or private financings, or other arrangements. There can be no assurance that
these additional financings, if needed, will be available on terms attractive to
us, if at all. Our failure to raise capital when needed could have a material
adverse effect on our business, results of operations and financial condition.
If additional funds are raised through the issuance of equity securities, the
percentage ownership of our then-current shareholders will be
24
<PAGE>
reduced. Furthermore, these equity securities might have rights, preferences or
privileges senior to those of our common stock.
NET OPERATING LOSS CARRYFORWARDS
As of June 30, 1999, we had available net operating loss carryforwards
totaling approximately $6,600,000, which expire beginning in 2011. Please see
Note 7 of Notes to the Financial Statements included elsewhere herein. The Tax
Reform Act of 1986 imposes limitations on the use of net operating loss
carryforwards if specified stock ownership changes have occurred or could occur
in the future.
YEAR 2000 COMPLIANCE
STATE OF READINESS. Our information technology, or IT, systems (servers,
encoders, routers, etc.) and non-IT systems (desktop computers, printers, etc.)
consist of software developed either in-house or purchased from third parties,
and hardware purchased from vendors. Our systems and other business resources
rely upon IT systems and non-IT systems provided by service providers and,
therefore, may be vulnerable to those service providers' failure to remedy their
own presently unknown Year 2000 issues. These service providers include those
for our network elements and e-mail services and the landlord for our leased
office spaces. We have contacted our principal vendors of hardware and software,
who have notified us that the hardware and software that they have supplied to
us is either presently Year 2000 compliant or will be compliant before the Year
2000. However, we may nonetheless be affected by presently unknown Year 2000
issues related to non-compliant IT systems or non-IT systems operated by us or
by third parties. We currently have underway a substantial assessment of our
internal and external (third-party) IT systems and non-IT systems. At this point
in our assessment, we are not aware of any Year 2000 problems relating to
systems operated by us or by third parties that would have a material adverse
effect on our business, results of operations, or financial conditions without
taking into account our efforts to avoid Year 2000 problems.
COST. Based on our assessment to date, we do not anticipate that costs
associated with remediating our non-compliant IT systems and non-IT systems will
be material.
RISKS. To the extent that our Year 2000 assessment is finalized without
identifying any additional material non-compliant IT systems operated by us or
third parties, the most reasonably likely worst case Year 2000 scenario is a
systems failure beyond our control, such as a prolonged telecommunications or
electrical failure. A failure of this kind could prevent us from operating our
business or prevent users from accessing our Web site. We believe that the
primary business risks, in the event of a failure, would include, but not be
limited to, lost advertising and audio merchandising revenue, increased
operating costs, loss of customers or persons accessing our Web site, or other
business interruption of a material nature, as well as claims of mismanagement,
misrepresentation or breach of contract.
CONTINGENCY PLAN. As discussed above, we are engaged in an ongoing Year
2000 assessment. We plan to conduct a full-scale Year 2000 simulation of our IT
systems. The results of this simulation and assessment will be taken into
account in determining the nature and extent of any contingency plans.
RECENT OPERATING RESULTS
For the quarter ended September 30, 1999, we expect to report net revenues
of approximately $370,000 and a net loss of approximately $4,300,000 compared to
net revenues of $50,627 and a net loss of $772,571 for the quarter ended
September 30, 1998.
25
<PAGE>
OUR BUSINESS
OVERVIEW
NETRADIO.COM
We are a leading broadcaster of originally programmed audio entertainment
over the Internet. I/PRO, an independent consultant which monitors Internet
traffic, has estimated that 1,058,237 different users, each of whom was counted
only once, listened to our 120 music and news channels in September 1999. I/PRO
has also estimated that, during September 1999, the average time a visitor spent
listening to any of our channels was approximately 29 minutes. We believe that
attracting users through audio entertainment creates a "sticky" Web site by
extending the time visitors spend on NetRadio.
INDUSTRY BACKGROUND
THE GROWTH OF THE INTERNET. International Data Corporation, or IDC, an
independent Internet market research firm, expects the number of Internet users
to grow 29% per year from approximately 142 million worldwide in 1998 to exceed
500 million by the end of 2003. In 1998, approximately 150 million devices were
used to access the Internet. By the year 2002, IDC estimates that the number of
Internet devices is expected to increase to more than 720 million, a compound
annual growth rate of 37%. A number of factors are expected to fuel the growth
of the Internet, including:
- the increasing number of computers installed in homes and offices,
- the decreasing cost of computers,
- lower cost and more efficient Internet access,
- improving network infrastructure,
- expanding Internet content, and
- increasing familiarity with and acceptance of the Internet as a resource
for businesses and consumers.
The vast amount of data available on the Internet requires users to find an
effective way to conduct efficient and organized searches for desired
information. The desire of many users to communicate and interact with others
having similar tastes and interests has spurred the growth of virtual Internet
communities. Communities serve an important function because they create a
virtual "town square" where users can meet and exchange ideas. Communities also
play a key role in the development of online commerce by providing advertisers
and businesses with a means to identify and target groups of users characterized
by distinguishing traits. Through its universal appeal, music entertains,
creates communities of people who have similar interests, and promotes sales of
music and other products.
GROWTH OF ELECTRONIC COMMERCE. The Internet has begun to transform much of
the economics of commerce by substituting electronic sales from a single
location for the large infrastructure of traditional retailers, including
management and sales staffs, numerous physical locations and relatively large
inventories. The Internet has the potential to replace many types of retail
stores and distribution methods by linking consumers directly to wholesale
distribution channels that provide superior selection, convenience and
competitive pricing. Online retailers typically offer products and services that
can be described, sampled and shipped easily and do not require the consumer's
physical presence. These products and services include compact discs, audio and
video cassettes, books and computer software. The Internet offers the
opportunity for a retailer with a single location or Web site to inexpensively
develop one-to-one relationships with customers worldwide. In June 1999, IDC
reported that the amount of total commerce conducted over the Internet is
expected to exceed $1 trillion by 2003.
26
<PAGE>
Another independent research firm, Forrester Research, estimates that
Internet sales to consumers in the United States will increase at a compound
annual growth rate of 69%, from an estimated $7.8 billion in 1998 to
approximately $108 billion by 2003. Forrester Research also predicts that by
2003, Internet sales will account for 6% of the estimated $1.8 trillion in
annual United States consumer retail spending.
THE INTERNET AS A BROADCAST, AUDIO STREAMING MEDIUM. The Internet has
quickly evolved from a relatively simple mechanism for the delivery of
text-based Web pages and electronic mail to a multimedia platform, providing an
interactive world of information, entertainment and commerce. The resulting
convergence of every day computer applications with communication, entertainment
and commerce platforms permits the Internet to deliver content in such areas as
music, sports, games, hobbies and shopping opportunities. The development of
streaming audio media, a new technology that permits the simultaneous
transmission and playback of digitized audio and video streams, allows the
Internet to broadcast music, information, advertising and other content to
hundreds of thousands of simultaneous listeners worldwide.
Streaming audio combines the Internet's interactivity with traditional, more
passive radio listening. Music broadcasts can serve as a unifying vehicle,
drawing Internet listeners into communities of similar musical tastes and
allowing them to interact with one another. Communities segregated by specific
musical tastes or interests provide Internet businesses with a target for direct
marketing and advertising programs. According to a study performed in January
1999 by The Arbitron Company, 27% of Internet users have listened to Internet
radio.
The development of the Internet as a broadcast medium suggests a comparison
to traditional radio. The following chart illustrates some of the differences,
in our view, between traditional radio broadcasting and Internet audio
broadcasting:
<TABLE>
<CAPTION>
TRADITIONAL RADIO BROADCASTING INTERNET AUDIO BROADCASTING
------------------------------------ ------------------------------------
<S> <C> <C>
- Generally limited by - Generally limited only by
DISTRIBUTION geographic region availability of Internet
AREA service
- Typically broadcasts to - Flexibility to reach wide or
AUDIENCE general audience narrow audiences
- Advertisers commonly target - Advertisers target immediate
future purchases purchases
PROGRAMMING - Programs typically designed - Programmed often for multiple,
CONTENT for broad audience appeal niche markets
- Programmed to single, licensed - Programmed to multiple,
frequency simultaneous channels
LISTENER - Estimates generally based on - More accurate measurement
TRAFFIC cross section sampling using server log files
MEASUREMENT
- Generally limited to estimates - Current audience measurements
of past listeners - Server logs record additional
listener information
- Audio advertisements are aired - Links audio and banner
LISTENER between songs advertising with other Web
INTERACTIVITY sites
- Advertised products purchased - Advertisements presented in
elsewhere audio, graphic and text
formats
- Listeners interact via - Users can purchase products
telephone, facsimile or in simultaneously, online
person
- Listeners can interact via
e-mail and chat rooms
</TABLE>
27
<PAGE>
DISTRIBUTION AREA. Traditional radio stations broadcast to listeners within
a defined geographic area. Atmospheric conditions and physical barriers can
interfere with radio transmissions. By contrast, Internet broadcasters transmit
music and information using audio streaming technology, which has inherent
advantages over traditional radio broadcasts, such as permitting the continuous
transmission of music to a virtually unlimited geographic region. Because audio
streams are transmitted in digitized form over telephone lines, they are
unaffected by atmospheric or structural barriers. They may, however, be limited
by Internet congestion and other factors unique to Internet traffic, such as a
user's or broadcaster's computer hardware or software. At times when bandwidth
is not available, Internet audio quality may not be as clear as traditional
broadcast radio. However, as bandwidth increases, Internet audio quality is
expected to improve and become comparable to, or even better than, the quality
of traditional broadcast radio.
AUDIENCE MARKETS. Traditional broadcast radio generally targets advertising
at peak listener traffic. For example, "drive time" audiences, listeners who
tune-in to a particular station while driving to or from work, represent a large
captive audience and therefore a potentially lucrative market for traditional
radio advertisers. This specific peak market, however, occurs only during
commuting hours. Traditional radio broadcasts generally must appeal to a broad
spectrum of listeners to capture the widest possible market for their
advertising. Internet audio streaming, by contrast, can be delivered to a large
number of computer users who can listen to music from the broadcaster's Internet
site while working on other applications. Advertisers who buy time or space on
Internet audio broadcasts can typically expect a more targeted audience with the
potential for immediate, impulse purchases.
PROGRAMMING CONTENT. Traditional radio stations generally program for broad
audience appeal by broadcasting content for the entire spectrum of their
audience. For instance, a traditional radio station that broadcasts jazz may be
the only commercially viable jazz station in a given geographic market.
Consequently, the station must design its programming from a number of different
jazz styles to broadly capture jazz listeners in such a market. Traditional
radio stations must consider broad audience appeal in their programming of
music, news, talk, ethnic or religious content. Internet broadcasters, by
contrast, can globally transmit a wide variety of specially designed programming
while targeting specific markets of listeners to enhance sales. An Internet
broadcaster can deliver multiple channels of music and information programmed to
specific markets, and can therefore design programming to maximize revenue
opportunities for its advertisers. The number of transmitted audio streams is
limited only by available bandwidth.
LISTENER TRAFFIC MEASUREMENT. Most traditional broadcast radio stations
rely upon reports from companies, such as The Arbitron Company, that use
statistical sampling methods to determine the size and demographic profile of
the station's audience. These companies periodically capture information
regarding listening habits from a cross section of the market and then estimate
the popularity of competing radio stations in the market. Web site audience
traffic measurements, by contrast, are not limited to statistical sampling and
can provide a more reliable measurement of listener traffic. Web sites or
servers communicate and respond to incoming requests from Internet users. These
servers can record listener and audience information on server log files and
provide current and exact measurements of the number of listeners and the length
of time listeners spend on a Web site.
LISTENER INTERACTIVITY. Traditional broadcast radio typically contains a
significant amount of advertising messages or commercials, often up to 12
minutes per hour. These commercials are designed to have the listener act on the
commercial impulse at a future time, possibly several days later. For example, a
commercial message for a soft drink product is typically acted upon during the
next trip to the supermarket. Similarly, the desire to buy a compact disc
triggered by listening to a song on the radio requires not only a trip to the
music store, but also requires the listener to remember the compact disc or
artist information.
By contrast, Internet audio broadcasting offers listeners the ability to
react immediately to an audio advertisement by clicking on the graphics link
displayed while the audio advertisement is being
28
<PAGE>
played. This link can connect the listener either to additional product
information or directly to a purchase option for the product itself. By
displaying information about the song and artist that is linked directly to a
purchase option, the listener can react immediately to a buying impulse for the
actual compact disc.
OUR CHALLENGE
We believe that there are several challenges to achieving success as an
Internet broadcaster and retailer. To be successful, an Internet broadcaster
must target an audience, develop compelling content, scale broadcasts from small
to large audiences, deploy new transmission and streaming technologies, provide
multimedia advertisements and attract and retain listeners. Internet
broadcasters must serve a large number of simultaneous users around the clock,
which requires complex network elements, extensive bandwidth, streaming
licenses, equipment and technical expertise. To be successful as a retailer, the
Internet broadcaster must integrate and use its content to convert its listeners
into revenue-generating opportunities. The online retailer must provide online
stores that feature broad selections of products and services, and provide a
high degree of customer service at competitive prices to compete with Internet
and non-Internet retailers.
OUR SOLUTION
Our solution is to provide entertaining audio content to attract and retain
large numbers of visitors who generate revenue through commerce and advertising.
The key elements of our strategy are to:
PROGRAM AND BROADCAST AUDIO CONTENT TO ATTRACT AND RETAIN LISTENERS. An
important element of our strategy is to attract and retain listeners by offering
a wide variety of entertaining audio content. We have created over 100 distinct
music channels and 22 information channels. Each music channel is devoted to a
narrow format of music within a broader musical genre, such as jazz or classic
rock and roll. Within the jazz genre, for example, we have created 18 music
channels, each dedicated to a different type of jazz music. The jazz music
channels include Acid Jazz, Big Band, Blues, Blues Revival, Cafe Jazz, Chicago
Blues, Classic Crooners, Divas, Horns, Jazz Rock, Lounge, New Blues, Quiet
Storm, Rockin' Blues, Rounder Blues, Smooth Jazz, Swing and Zydeco.
To program content, we have assembled a team of award-winning radio
professionals with considerable experience in radio programming. This team has
developed a significant inventory of songs from which they program our audio
channels. We believe that our programmed music and rotations: (1) attract and
retain a wide audience, (2) lengthen the time listeners spend listening, and (3)
increase product sales opportunities.
BUILD VISITOR TRAFFIC COST-EFFECTIVELY. Another element of our strategy is
to build Web site traffic. To do this, we focus on (1) providing listeners with
entertaining and highly targeted audio content which we believe will encourage
repeat visits and (2) undertaking low-cost marketing campaigns. Additionally, 14
of our channels are pre-sets on RealNetworks' audio player, which significantly
enhances our presence on the Internet, and increases the traffic to our Web
site.
We also build traffic through our affiliate program. In exchange for a
nominal fee, Web site operators contractually agree to display banners on their
Web sites that permit a visitor to click through to NetRadio. As of October 12,
1999, we had over 1,800 Web sites participating in our affiliate program.
CREATE STRONG COMMUNITIES OF SIMILAR INTEREST TO ESTABLISH BRAND LOYALTY. A
vital component of our strategy is to establish strong brand loyalty by creating
listener communities through niche programming. We believe that creating a
community enhances a listener's Internet experience and
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extends the length of time he spends on our Web site. Our programming is divided
by music genre into 15 communities of similar interest, or COSIs:
<TABLE>
<S> <C>
BroadbandPoint KidzHits
Cafe Jazz & Blues Modern Rock
Christian Hits New Age & Folk
Classical News & Information
Country Pop Hits
Dance/Urban Vintage Rock
Electronica Woodstock Music
World Music
</TABLE>
Each COSI targets a wide audience with similar musical preferences. Within
each COSI we generally have between seven and 20 music and information channels.
For example, the channels in the Country COSI comprise a community within
NetRadio's audience that reflects country music tastes and demographics. Our
online retail site and promotions are designed to respond to these tastes and
are fully integrated into each COSI. We believe that communities play a key role
in the development of online commerce by providing advertisers and businesses
with a means to identify and target groups of users characterized by similar
tastes. As we build communities of listeners through COSIs, we are constantly
developing and promoting the NetRadio brand name.
PROGRAM CONTENT TO GENERATE COMMERCE AND ADVERTISING REVENUES. In addition
to broadcasting entertaining music and information, we program content to
generate revenues from commerce and advertising. We accomplish this through a
marketing strategy we call content-enabled commerce or C-Commerce. This approach
uses music and advertising messages to direct and link listeners to our online
retail store, CDPoint. C-Commerce encourages impulse purchases by motivating and
enabling listeners to simultaneously acquire the music being played or promoted.
We apply a similar concept to advertisers by directing and linking listeners to
advertisers' Web sites through audio and text messages. These messages permit
our listeners to link immediately to the Web site where the product or service
being advertised can be purchased.
Our comprehensive interactive display, NetCompanion, links our audio content
with revenue-generating opportunities. NetCompanion appears on a listener's
computer screen and displays song title information, graphic and text-based
advertising and includes links to our COSIs and CDPoint. While listening to
music through NetCompanion a visitor may:
- change music channels,
- purchase the music that NetRadio is playing or promoting, or purchase
another title,
- browse CDPoint for music or information, or
- read an advertiser's banner and click through to an advertised Web site.
Another significant aspect of our C-Commerce strategy is to
cross-merchandise products, music and artists. For example, while an artist's
song is playing, we may advertise books, apparel, videos, or other
entertainment-related products connected to that artist or title.
BUILD STRATEGIC ALLIANCES. We will continue to capitalize on our
relationships with record labels, Internet traffic and technology companies and
fulfillment partners, including the following:
- RECORD LABELS. Record labels partner with us for artist and title
promotions. These promotions allow the labels to promote specific artists
in a targeted environment.
- INTERNET TRAFFIC AND TECHNOLOGY COMPANIES. We have an agreement with
RealNetworks, which licenses the use of its software to play our audio
streams and whose audio player includes pre-sets to 14 of our channels. We
have an agreement with AT&T to lease scalable bandwidth and provide
additional technical support. We are also in the process of licensing
technology to enable our listeners to download authorized music tracks
using AT&T's proprietary a2b music player.
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We also recently entered into an agreement with Liquid Audio. The
agreement will allow us to provide links from our Web site to a Liquid
Audio Web site where our visitors will have the opportunity to download
over 20,000 authorized music tracks using Liquid Audio's Liquid Player. In
addition, we have an agreement with a leading high-speed data network
services provider, @Home, which carries our programing. We also have an
agreement with Packard Bell/ NEC, whose computers come equipped with a
link to our Web site.
- FULFILLMENT PARTNERS. We have product fulfillment agreements with Navarre
and Valley Media, both major distributors of music and DVD products.
We believe that these strategic alliances have helped and will continue to
help, build content and traffic to our Web site, stimulate product and
advertising revenues, and build brand awareness.
MUSIC AND PROGRAMMING
By focusing on our breadth of music and information content, we seek to
capture a wide audience across a variety of musical tastes. Our programming has
been developed by a team of seven full-time and four part-time experienced,
award-winning content and programming professionals. These music programmers
bring specific musical expertise and an average of more than 17 years of
experience to us. Their awards have included national awards and nominations
from Billboard Magazine (Major Market Country Programmer of the Year--Nominee)
and Gavin Magazine (Programmer of the Year--multiple winner and nominee), as
well as Minnesota Music awards (Club DJ of the Year--Winner). As a result of our
programmers' musical expertise, NetRadio has received the 1998 RealNetworks
Streamers Award for "The Best Real Audio Net-Only Radio" Web site.
Our programming team has experience in traditional radio programming as well
as at club and concert venues. Members of our programming team have served as
music directors of leading "top 40," classic rock, jazz, country and alternative
radio stations in large and small markets throughout the United States. We
believe that our expertise in music and radio programming distinguishes us from
many of our competitors.
Our music professionals use the same song rotation software used by
traditional broadcast radio stations to program songs into light, medium and
heavy rotation patterns. This software enables them to include COSI or channel
identifiers and artist endorsements within the channel and to easily insert
advertising messages into the music programming.
COSIS AND CHANNELS. The NetRadio Web site resembles a hub and spoke
configuration. Our home page acts as the "hub" for each of our 15 COSIs. Each
COSI, whether music or news, reflects a distinctively branded name, look and
identity. Within a COSI, each music or information channel contains content that
can be targeted to specific audience segments and linked to potential revenue
opportunities. For example, if an artist announces a new world tour, that
information can be presented as a news segment in the appropriate COSI and
linked to products available in CDPoint.
The COSI structure provides a format to communicate with a loyal base of
listeners through the following:
- SPECIALIZED AUDIO CONTENT. Each COSI contains multiple specialized music
channels. For example, our Vintage Rock COSI includes Reggae, British
Invasion and Guitar Heroes. We believe these narrowly specialized channels
will appeal to our listeners' tastes and will encourage return visits and
brand loyalty.
- TEXT-BASED CONTENT. Each COSI contains text-based information through
which we communicate with our visitors. We offer articles written by music
professionals as well as information on new releases, concert tours,
ticket sales and other music-related products.
- ADVERTISING AND PROMOTIONAL CONTENT. Each COSI displays advertising
banners while channels within that COSI broadcast audio promotion messages
targeted to the COSI's demographics.
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- MERCHANDISING CONTENT. Each COSI contains a link to CDPoint, where
products specifically tied to the musical taste of the COSI's listeners
are available for sale. The assortment of products offered includes
compact discs and audio cassettes tailored to the COSI's demographics.
The number of songs within each channel ranges from 150 to over 1,000. The
breadth of our selection is significant compared to traditional broadcast radio
station play lists which typically include only 40 to 80 songs. The order and
frequency of the music is designed by our programming staff to reflect current
trends in the music business and the tastes of our listeners. We update
information channels daily.
Except for the BroadbandPoint Channel COSI, all channels can be heard using
a 28.8kbps narrow bandwidth modem through a telephone line. The BroadbandPoint
Channel is a special "higher quality" 40kbps stereo audio streaming channel
featuring music from NetRadio's most popular music channels, and requires a
high-speed connection.
NetRadio's channels as of October 1, 1999, grouped by COSI, are listed
below.
BROADBANDPOINT
Includes selections such as
60's Country and
Blues, Cafe Jazz,
Country, Maestro,
Modern Rock, Pop Hits,
Vintage Rock.
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
CAFE JAZZ & BLUES
MUSIC CHANNELS
Acid Jazz
Big Band
Blues
Blues Revival
Cafe Jazz
Chicago Blues
Classic Crooners
Divas
Horns
Jazz Rock
Lounge
New Blues
Quiet Storm
Rockin' Blues
Rounder Blues
Smooth Jazz
Swing
Zydeco
INFORMATION CHANNELS
CDPoint Update
Jazz Notes
NetRadio Network Today
CHRISTIAN HITS
MUSIC CHANNELS
Christian Hits
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
CLASSICAL
MUSIC CHANNELS
Chamber Music
Chant
Maestro
Opera
Piano
Quiet Classics
Symphony
INFORMATION CHANNELS
CDPoint Update
Classical Notes
NetRadio Network Today
COUNTRY
MUSIC CHANNELS
60's Country
70's Country
Alternative Country
Bluegrass
Dot.Comedy
Rounder Folk
Route 1 Country
INFORMATION CHANNELS
CDPoint Update
Country Music News
NetRadio Network Today
DANCE/URBAN
MUSIC CHANNELS
Acid Jazz
Ambient
Big Beat/Breaks
Club Mix
Disco Dance
Drum & Bass
Electronica
Experimental
Funk
Hip Hop
House
Industrial
Latin
Lounge
Mix Masters
Punk
Rap
Ska
Solid Gold Soul
Techno
Trip Hop
Urban
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
ELECTRONICA
MUSIC CHANNELS
Ambient
DJ Mix
Drum & Bass
Dub Electric
Electronic World
Electronica
Hardcore
Industrial
Jungle Breaks
Musical Starstreams
New Age
Tech House
Techno
Trance/Acid
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
KIDZHITS
MUSIC CHANNELS
KidzHits
KidzNews
INFORMATION CHANNEL
CDPoint Today
NetRadio Network Today
MODERN ROCK
MUSIC CHANNELS
Adult Alternative
Dot.Comedy
Industrial
New Wave
Punk
Ska
The 'X'
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
NEW AGE & FOLK
MUSIC CHANNELS
Acoustic
Ambient
Celtic
Folk
Hearts of Space
Musical Starstreams
Nature Sounds
New Age
Rounder Folk
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
NEWS & INFORMATION
NEWS CHANNELS
Business News
Celebrity News
Health File
Info Junkie
Infobahn News
Movie News
NetRadio News
Showbiz News
This Is True...Really News
World News
MUSIC NEWS CHANNELS
Classical Notes
Country News
Jazz Notes
Music Industry News
This Day in Rock History
SPORTS CHANNELS
Sports
(Various sports channels
depending on seasonal
interest)
Baseball News
Basketball News
Football News
Hockey News
POP HITS
MUSIC CHANNELS
80's Hits
Disco Fever
Dot.Comedy
Fab 60's
Groovin' 70's
Lite Hits
Party Hits
Pop Hits
Showtunes
Solid Gold Soul
Soundtracks
Teen Scene
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
Pop Hits News
VINTAGE ROCK
MUSIC CHANNELS
British Invasion
Dot.Comedy
Guitar Heroes
Hard Rock
Jazz Rock
Party Rock
Pre-Fab 60's
Progressive Rock
Psychedelic Rock
Rockin' Blues
Rockin' Rhythm 50's
Vintage Rock
Vintage Surf
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
This Day In Rock History
WOODSTOCK MUSIC
Woodstock 99
Woodstock 69
WORLD MUSIC
MUSIC CHANNELS
Ambient World
Celtic
Earth Beat
Electronica
Hawaiian
Latin & Salsa
Musical Starstreams
Native American
New Age
Reggae
Rounder Reggae
World Beat
INFORMATION CHANNELS
CDPoint Update
NetRadio Network Today
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C-COMMERCE, PRODUCT SALES AND FULFILLMENT
We believe that our C-Commerce strategy is effective because of the nexus
between playing a song, or viewing or listening to an advertising message, and
providing the listener the opportunity to immediately purchase the music,
product or service being promoted. Listeners do not need to be visually
connected to NetRadio's Web pages in order to receive audio content and
promotional messages. Listeners stay connected to audio content for extended
periods of time while NetRadio exposes them to commerce, advertising and
promotional messages.
CDPOINT. CDPoint (www.cdpoint.com) is our online music store. CDPoint
currently offers over 250,000 stock keeping units, and includes every title that
we play on our channels. CDPoint's wide selection complements and reflects the
breadth of our channels and the diverse tastes of our audience.
Our objective is to make CDPoint informative and authoritative, allowing
customers to easily learn about, discover and purchase compact discs, audio
cassettes and other entertainment-related products. CDPoint is designed to be
intuitive and easy to use. Our goal is to enable the purchasing process to be
completed with minimal customer effort and without interruption of the audio
stream. We offer a wide selection and competitive prices as well as a high
degree of customer service by, among other things, providing our customers with
numerous e-mail updates on the status of their orders, and other information
about our products and services. Customers can enter CDPoint.com directly or
through the NetRadio Web site, NetRadio affiliates' Web sites, a favorite COSI
or NetCompanion.
Once in CDPoint, customers can search for music by artist or title, browse
genres or featured titles, read release notes, participate in promotions,
respond to advertising or check the status of their orders. A search engine
feature remains visible on the user's screen and is always available to search
for artists or titles. To purchase music, a listener simply clicks on an item
and a virtual shopping basket displays the desired item and its purchase price.
Customers can add and remove products from their baskets prior to completing
their purchase.
We accept Visa, MasterCard and American Express for payment. For
convenience, we will soon permit customers to store credit card information on
secure servers to avoid the need to re-input this information when making a
repeat purchase. To maintain security, we rely on recent releases of
transaction-enabling software. We automatically confirm each order by e-mail
within 24 hours of the order, and subsequently confirm shipment of each order by
e-mail. A customer's credit card is charged when the product is shipped. We rely
upon a third party to process credit card billing.
SHIPPING, DISTRIBUTION AND FULFILLMENT. We maintain no product inventory.
Rather, the products we sell are owned and held by outside vendors who ship
directly to purchasers. We periodically update CDPoint with inventory
information that we receive from our fulfillment partners. When a customer's
purchases are completed, the order is electronically communicated to one of our
fulfillment partners. Music orders are electronically sent first to Navarre and
then, if not completely available in Navarre's inventory, to Valley Media. The
fulfillment partner ships products for delivery to the purchaser within two to
10 business days. United Parcel Service, the United States Postal Service or a
comparable ground service handles delivery.
DATABASE DEVELOPMENT AND MAINTENANCE. To more efficiently generate commerce
opportunities, we are building revenues by developing a database reflecting our
customer preferences. We intend to use customer information for internal
purposes only, such as targeted marketing campaigns and other advertising
programs. We disclose to all visitors and consumers that we are collecting this
information.
Our servers record where visitors to our Web site originate, where they go,
what they listen to and what advertising they click on. From CDPoint, we
accumulate product, order size, shipping destination and customer demographic
information. We use information about visitors and listeners to enhance our
content offerings, advertising strategies, marketing campaigns and Web site
design and navigation
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elements. Product and demographic information helps us conduct one-to-one
marketing campaigns with customers. In addition, we use this information to
project purchase patterns and to ensure maximum product availability, selection
and shipping efficiencies.
ADVERTISING AND PROMOTION
We use our content to generate advertising revenues. Our advertising
includes banner advertising, audio advertising and promotional advertising. All
three formats are incorporated into the COSIs, which allow advertisements to be
tailored to particular audiences.
BANNER ADVERTISING. Visitors to our Web site are exposed to banner
advertising messages placed on our Web pages. Banner advertising allows a user
to travel immediately to the Web site displayed in the banner. These banners are
sold to advertisers primarily by our sales staff and through a third party
contractor, 24/7 Media, a nationally recognized advertising placement firm.
AUDIO ADVERTISING. We incorporate audio advertisements into our
programming. We believe that audio advertising is well suited to advertisers
since it reaches listeners who are running multiple applications. Unlike banner
advertising, which requires the viewer to be visually connected to the Web site,
audio advertising allows the listener to hear streamed audio advertising while
he or she is working on other applications. Our innovative advertising format
combines audio advertisements with links to our advertisers' Web sites,
encouraging an immediate consumer response.
TARGETED PROMOTIONAL ADVERTISING. We have developed targeted promotions as
another means to generate revenues. In a targeted promotion, a record label pays
for space and audience exposure within our Web site. For example, NetRadio might
prominently feature a compact disc, artist or song on a Web page. We believe
that these special promotions are attractive to record labels which are
promoting particular artists or compact discs.
Our wide variety of music programming encourages targeted promotions for
niche music. For example, a Celtic record label may have difficulty reaching its
targeted audience due to limited exposure of Celtic music in the programming mix
of most commercial radio stations. NetRadio can offer a dedicated channel for
Celtic music. This has appealed to niche labels who do not want to pay for
traditional advertising in record stores, traditional broadcast radio or other
media.
NEW BUSINESS OPPORTUNITIES
We intend to generate additional revenues by selling other entertainment
products such as DVDs. To capture what we believe will be growing consumer
demand for DVDs, we expect to expand our commerce offerings to include DVDs in
late 1999.
STRATEGIC ALLIANCES
We have entered into several strategic alliances in the areas of content and
programming, Internet traffic and technology, and product fulfillment and
distribution.
CONTENT AND PROGRAMMING ALLIANCES. We have alliances with major record
labels and other content providers that help us continue to develop our
programming. Some of the record labels that have participated in featured
promotions include: A&M, American Gramaphone, Arista, Atlantic, AWA, Beacon,
Blue Note, Brentwood, Capitol, Caroline, CDM, CMC, DA Music, Damian, Decca,
Dreamworks, Durkin Hayes, Elektra, EMD Distribution, EMI/Angel, Forbidden, GRP,
Interscope, J Bird, Jellybean, Leviathan, Macola, MCA, MED, Mercury, Mission,
Moonshine, Motown, Nettwork, Nonesuch, Public Music, RCA, Relativity, Rhino,
RLM, Solid Disc, Un-D-Nyable, Unison, V-Wax, Van Richter, Vesper Alley, Virgin,
Warner Brothers and Windham Hill.
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For example, we have worked closely with the American Gramaphone record
label, which records the artist Mannheim Steamroller, a successful performer of
holiday music. We have developed custom programming for the Mannheim Steamroller
series of album releases, including a custom channel and a dedicated Web page
for Mannheim Steamroller products.
INTERNET ALLIANCES. We have entered into traffic and technology alliances
that we expect will continue to attract customers, build brand loyalty, and
improve the quality of our broadcasts, such as:
- RealNetworks. RealNetworks licenses software that allows our listeners to
hear our audio streams. In addition to providing technology, we believe
that RealNetworks is an important source of traffic to our Web site. We
have 14 channel pre-sets on G2, a recent version of RealNetworks' audio
player. RealNetworks operates a popular audio Web site called the Daily
Briefing. We supply seven information channels to the Daily Briefing.
- AT&T. We have an agreement with AT&T under which AT&T provides scalable
bandwidth, round-the-clock technical support and redundant back-up servers
to meet our increasing listener demand. We are also in the process of
licensing technology to enable our listeners to download authorized music
tracks using AT&T's proprietary a2b music player.
- Liquid Audio. We have an agreement with Liquid Audio under which our
visitors will be able to link to a Liquid Audio Web site and download over
20,000 authorized music tracks using Liquid Audio's Liquid Player.
- @Home Network. We offer two 80kbps channels to @Home Network, a division
of @Home Corporation. @Home provides high-speed, fully-integrated
multimedia Internet and online services using cable television technology.
@Home subscribers have the opportunity to listen to our programming
through a higher quality connection than is normally available through a
standard telephone line.
- Ark Interface II. Since August 1, 1997, we have had an Electronic
Advertising Agreement with Ark Interface II of Seattle, Washington. Ark
Interface II operates a Web site called MySpace Online, formerly known as
Planet Oasis. A radio tower branded "NetRadio" appears on the home page
cityview of MySpace Online. NetRadio also operates a custom,
commerce-enabled audio interface that appears on the MySpace Online Daily
page and provides access to 39 NetRadio music and information channels.
- Packard Bell/NEC, Inc. Under the Ark Interface II agreement, all Packard
Bell and NEC Ready brand multimedia personal computers sold in the United
States since July 1998 with Windows 98 operating systems feature an audio
player interface called Net Media Player on the desktop. The Net Media
Player provides access to 35 NetRadio music and information channels.
- Sonicbox, Inc. In September 1999, we entered into a memorandum of
understanding with Sonicbox, under which we agreed to commence
negotiations toward the execution of a definitive agreement with Sonicbox
whereby we would allow Sonicbox to retransmit our content. If a definitive
agreement is executed, the parties also have agreed to negotiate the
development of a business model focusing on music sales, direct marketing
and targeted advertising. Sonicbox is engaged in the development of a
personal computer accessory that would enable computer listeners to
connect audio streams from a computer to the tuner on nearby FM radios.
FULFILLMENT ALLIANCES. We have entered into fulfillment alliances to sell
products and provide customer service. By integrating multiple fulfillment
sources, we increase product fill rates and enhance customer service.
- Navarre. In December 1998, we entered into a five-year product fulfillment
agreement with Navarre, our majority shareholder, for fulfillment of music
purchases. We look to Navarre first for order fulfillment and delivery. We
currently buy approximately 5 to 10% of our music
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products through Navarre. Purchases through Navarre improve our margins
because we pay lower shipping and handling fees to Navarre than we pay to
Valley Media. We also pay a lower acquisition cost for purchases of titles
available exclusively through Navarre. Finally, through Navarre we gain
access to artists and independent and national record labels.
- Valley Media. In 1998, we entered into a distribution agreement with
Valley Media to provide an alternative fulfillment source for products
that are not available through Navarre. Valley Media is the leading online
fulfillment source for music and other entertainment software products.
Valley Media has approximately 250,000 stock keeping units in inventory,
and a wide selection of music, videos, DVDs, and music-related
merchandise.
TECHNOLOGY AND NETWORK INFRASTRUCTURE
Audio streaming is the one-way transmission of digitized audio data over the
Internet. The audio data begins in digitized form at the source or Internet
server. Upon transmission, the audio is divided into groups of data delivery
packets that are transmitted over the Internet to the receiving computer of the
listener. The receiving computer buffers the initial portion of the transmitted
audio data before sending it to the speakers. This buffering compensates for
momentary delays in packet delivery. Audio streaming technology permits the
simultaneous transmission and playback of continuous streams over the Internet.
Most transmissions over telephone lines occur at a rate of 28.8kbps.
Transmissions also occur at higher speeds using digital subscriber line, or DSL,
cable modem and broadband technologies. Audio clarity varies with speed of
transmission. Audio streaming differs from traditional radio broadcasting in its
ability to be transmitted to a worldwide audience. RealNetworks pioneered the
development of audio streaming technology in 1995. This technology has
transformed the Internet from a graphic and text-based information platform into
a multimedia audio/visual platform.
Our Web site is maintained on a Windows NT and Linux operating system
platform. Our audio content is programmed and housed in an internal computer
network. NetRadio's audio stream is encoded to the Real Audio G-2 format on
Linux servers. These servers are connected through a routing system provided by
Cisco Systems to multiple 45mbps T3 Internet connections.
We also have recently contracted with AT&T to support our bandwidth
requirements. Under our agreement, AT&T agrees to provide us as much bandwidth
as is needed to support the traffic to our Web site. AT&T also provides
round-the-clock technical support and redundant back-up servers in case we
suffer system failures. The agreement with AT&T expires in March 2001.
We have developed proprietary software, together with commercially available
music scheduling products, to produce a traditional radio-style broadcast with
real-time stream information. Our Internet and database servers run
industry-standard server software and are housed in our Minneapolis, Minnesota
facility. All mission-critical equipment is supplied with back-up power and
monitored for 24-hour operation.
We stream all of our audio music content through RealNetworks' current
technology, known as G2 (Generation 2).
To listen to NetRadio, a listener must have a computer with a minimum 486-66
processor (Pentium preferred), or 68040 or PowerPC-based Macintosh or Macintosh
clone, an operating system of either Windows 95, 98 or NT or 0/S 7.5.3 or
better, a modem having 28.8kbps or better connection speed, and a soundcard.
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INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
COPYRIGHTS AND TRADEMARKS. The trademarks N NET.RADIO NETWORK and design
and NET.RADIO have been registered with the United States Patent and Trademark
Office. We have filed applications for registration of the trademarks
NetRadio.com and design, CDPOINT and NETCOMPANION. We have also applied for a
European Community Trademark registration for N NET.RADIO NETWORK and design.
Our success depends in part upon developing, building and protecting our
trademarks, trade secrets and similar intellectual property. We rely upon
trademark and copyright law, trade secret protection and confidentiality and
license agreements with employees, strategic partners and others to protect our
proprietary rights. Notwithstanding these precautions, there can be no assurance
that the steps that we have taken or will take will be adequate to prevent
misappropriation, infringement or other violations of our intellectual property.
A third party could, without authorization, copy or otherwise use our
intellectual property. There also can be no assurance that the United States
intellectual property laws and our agreements with employees, consultants and
others who participate in developing our proprietary rights will adequately
protect our rights, or that our trade secrets will not otherwise become known or
independently developed by competitors. Moreover, the laws of some foreign
countries do not protect our proprietary rights to the same extent as do the
laws of the United States, and effective copyright, trademark and trade secret
protection may not be available in those jurisdictions, and we have not sought
protection for our intellectual property in every country where our broadcasts
may be heard.
We have licensed in the past, and expect to continue to license certain
proprietary rights, such as trademarks or copyrighted material, to third
parties. We expect that the quality of our brand will be maintained and
protected by our licensees. There can be no assurance that such licensees will
not take actions that might materially adversely affect the value of our
proprietary rights or reputation.
LICENSES TO BROADCAST PRE-RECORDED MUSIC ON THE INTERNET. We believe our
broadcasts of pre-recorded music over the Internet are permitted under the
copyright laws of the United States as long as we have permission from
appropriate authorities and pay appropriate royalties. We have entered into
license agreements with the major performing rights organizations, including the
American Society of Composers, Authors and Publishers, Broadcast Music, Inc. and
the Society of European Stage, Authors and Composers, Inc. These agreements
license us to broadcast music and other copyrighted materials over the Internet
and obligate us to pay royalties in connection with our broadcasts. The amount
of royalties that we must pay, or the terms and conditions of the license
agreements, may change, and such changes may be detrimental to us. In addition,
our license agreements with performing rights organizations may not comply with
the copyright laws of jurisdictions outside the United States, and our
broadcasts may violate the copyright laws of those jurisdictions where our
broadcasts may be heard.
We believe our use of third-party material on our Web site is permitted
under current provisions of United States copyright law. However, legal rights
to certain aspects of Internet content and commerce are not clearly settled, and
our ability to rely upon one or more exemptions or defenses under copyright law
is uncertain. We may be unable to continue to provide rights to information,
including downloadable music samples and artist, title and other information.
The law regarding linking to and framing of third party Web sites without
permission is uncertain. NetRadio believes that its linking and limited framing
activities are lawful, but there is a possibility that we may be required to pay
a license fee or cease linking or framing. If we are required to pay fees, or
cease linking or framing, it could have a material adverse effect on us.
COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive. We expect competition to intensify and the number of competitors to
increase in the future. Barriers to entry on
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the Internet are minimal, and current and new competitors can launch Web sites
at a relatively low cost. In addition, the broader retail compact disc, software
and DVD industries are intensely competitive. NetRadio currently or potentially
competes with a variety of other companies. These competitors include:
- streaming media sites such as Broadcast.com, Spinner, Launch and Imagine
Radio,
- online retail vendors of music, computer software and DVDs, including
CDNow, audio highway, E-music, Musicmaker, MP3, Amazon.com, Barnes &
Noble.com, and GetMusic,
- traditional radio broadcasters,
- other small online vendors, and
- publishers and traditional retail vendors of music and software, including
large specialty music stores such as MusicLand, Tower Records and Best
Buy, that have significant brand awareness, sales volume and customer
bases. Many of these traditional retailers also support dedicated Web
sites that compete directly with NetRadio.
We believe that the principal competitive factors in our online market are
brand name recognition, product quality, variety of value-added services, ease
of use, price, quality of customer service, availability of customer support,
reliability, technical expertise, quality of search tools, quality of site
content and speed of order fulfillment. Many current and potential competitors
have longer operating histories, larger customer bases, greater brand
recognition and significantly greater financial, marketing and other resources
than we have. In addition, online retailers may be acquired by, receive
investments from or enter into other commercial relationships with larger, well
established and well financed companies as use of the Internet and other online
services increases. Our competitors may be able to secure merchandise from
vendors on more favorable terms, devote greater resources to marketing and
promotional campaigns, adopt more aggressive pricing or inventory availability
policies and devote substantially more resources to Web sites and systems
development than we can.
In selling music and other consumer entertainment media products, we compete
generally with other content providers for the time and attention of users and
for advertising revenues. We also compete for advertising with online services,
other Web site operators and advertising networks, as well as traditional media
such as television, radio and print, for a share of advertisers' budgets. We
must license and provide high quality, sufficiently compelling and popular audio
content, along with technology and value-added Internet services, to attract
users, support advertising intended to reach those users and attract businesses
seeking Internet broadcasting and distribution services.
We believe that the principal competitive factors for attracting advertisers
include the number of users accessing our Web site, the demographics of those
users, our ability to deliver focused advertising and interactivity through our
Web site, and the overall cost-effectiveness and value of the advertising
offered. There is intense competition for the sale of advertising on
high-traffic Web sites. This has resulted in a wide range of rates quoted by
different vendors for a variety of advertising services and makes it difficult
to project levels of Internet advertising that will be realized generally or by
any specific company. Any competition for advertisers among present and future
Web sites, as well as competition with other traditional media for advertising
placements, could result in significant price competition. We believe that the
number of companies selling Internet-based advertising and the available
inventory of advertising space have recently increased substantially.
Accordingly, we may face increased pricing pressure for the sale of
advertisements.
We also compete for traditional media advertising sales with national radio
networks, as well as local radio stations. Local radio content providers and
national radio networks may have larger and more established sales organizations
than we have. These broadcasters may have greater name recognition and more
established relationships with advertisers and advertising agencies than we
have.
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They also may be able to undertake more extensive marketing campaigns, obtain a
more attractive inventory of advertising spots, adopt more aggressive pricing
policies and devote substantially more resources to selling advertising
inventory.
EMPLOYEES
As of October 1, 1999, we had 42 full-time and 10 part-time employees. We
also employed nine independent contractors and other temporary employees in
connection with our content, operations and administrative functions. None of
our employees are represented by a labor union and we consider our employee
relations to be good. Competition for qualified personnel in our industry is
intense, particularly among software development and other technical staff. We
believe that our future success will depend in part upon our continued ability
to attract, hire and retain qualified personnel.
FACILITIES
Our offices are located in one facility in Minneapolis, Minnesota. We lease
approximately 10,500 square feet of office space under four separate leases,
which includes space for our executive offices, technical center, and content
and commerce area. Our administrative office lease expires on October 31, 1999,
and our technical center lease expires on October 31, 2000. We expect to lease
our administrative offices on a month-to-month basis beginning November 1, 1999.
Our content and commerce area lease is also month-to-month. If we grow as we
expect, we may need to acquire more space. There is no assurance that this space
will be available.
LEGAL PROCEEDINGS
From time to time we have been, and expect to continue to be, subject to
legal proceedings and claims in the ordinary course of business, including
claims for breach of contract and for alleged infringement of third-party
copyrights, trademarks and other intellectual property rights. These claims,
even if not meritorious, could result in the expenditure of significant
financial and managerial resources. We are not aware of any legal proceedings or
claims that we believe will have, individually or in the aggregate, a material
adverse effect on our business, financial condition or results of operations.
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MANAGEMENT
The following table sets forth the name, age as of October 1, 1999 and a
brief account of the business experience of our executive officers and
directors.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- -------------------------------------------------
<S> <C> <C>
Edward A. Tomechko............ 50 Chief Executive Officer, President and Director
Michael P. Wise............... 42 Vice President and Chief Financial Officer
Eric H. Paulson............... 54 Chairman of the Board
Donavan W. Pederson........... 60 Chief Operating Officer, Secretary and Director
Richard W. Hailey............. 43 Chief Technology Officer
David R. Witzig............... 42 Senior Vice President of Content and Programming
Nancy R. Kielty............... 42 Vice President of Commerce
James Caparro(1)(2)........... 47 Director
Charles E. Cheney(2).......... 55 Director
Marc H. Kalman(1)(2).......... 55 Director
Gene McCaffery(1)............. 51 Director
</TABLE>
- ------------------------
(1) Member of our compensation committee.
(2) Member of our audit committee.
EDWARD A. TOMECHKO. Mr. Tomechko has served as our Chief Executive Officer,
President and a director of NetRadio since January 1999 and served as Chief
Financial Officer from August 1998 until March 15, 1999. From April 1997 to
April 1998, Mr. Tomechko served as Senior Vice President and Chief Financial
Officer of David's Bridal, Inc. From January 1996 to April 1997, Mr. Tomechko
was Senior Vice President and Chief Financial Officer of The County Seat Stores,
Inc., and from 1990 to 1996, Mr. Tomechko served as Vice President and Treasurer
of County Seat. In October 1996, County Seat filed a voluntary petition for
reorganization under Chapter 11 of Title 11 of the United States Bankruptcy
Code, in the United States Bankruptcy Court for the District of Delaware. On
October 29, 1997, the Plan of Reorganization was consummated.
MICHAEL P. WISE. Mr. Wise has served as our Vice President and Chief
Financial Officer since March 15, 1999. From December 1997 through March 1999,
Mr. Wise served as Vice President and Corporate Controller for Health Fitness
Corporation, a publicly held, Minneapolis-based manager of fitness centers for
Fortune 500 and large hospital clients. From April 1994 through October 1997,
Mr. Wise served as a consultant to and Chief Financial Officer, Treasurer and
Secretary of The Sled Dogs Company, a publicly held, Minneapolis-based
manufacturer, marketer and distributor of snow skates. On November 5, 1997, The
Sled Dogs Company filed a voluntary petition under Chapter 11 of the Bankruptcy
Code with the United States Bankruptcy Court for the District of Minnesota. From
April 1986 to March 1994, Mr. Wise was employed by National Computer Systems,
Inc., a publicly held, Minneapolis-based developer and marketer of information
systems and services for education, serving in various financial and sales,
marketing and management positions.
ERIC H. PAULSON. Mr. Paulson has served as our Chairman of the Board since
May 1996 and also served as Chief Executive Officer of NetRadio from April 1997
to January 1999. Mr. Paulson has served as Chairman of the Board, Chief
Executive Officer and a director of Navarre since 1983.
DONAVAN W. PEDERSON. Mr. Pederson has served as our Chief Operating Officer
since July 1999 and served as our Chief Technology Officer from September 1997
to June 1999. Mr. Pederson has served as Secretary and a director of NetRadio
since September 1997. From April 1994 to April 1997,
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he was President of ComNet Research Corporation, a marketer and integrator of
fiber channel networks. From 1986 to 1994, Mr. Pederson served as President of
Donavan International, Inc., an international trade services company.
RICHARD W. HAILEY. Mr. Hailey has served as our Chief Technology Officer
since July 1999. From November 1998 to July 1999, he served as the Technology
Services Practice Manager at Pragmatek Consulting Group, a Minneapolis-based
consulting firm. From July 1995 to October 1998, he served in various leadership
positions including Director of Technology for the U.S. Region at
MCI-Systemhouse. From October 1993 to July 1995, he served as a Senior Technical
Architect at Computer Sciences Corporation.
DAVID R. WITZIG. Mr. Witzig has served as our Senior Vice President of
Content and Programming since May 1996. From June 1989 to May 1994, Mr. Witzig
was Branch Manager, Chicago, of EMI Music Distribution, the distribution arm of
EMI Music, Inc. From May 1994 to May 1996, he served as Regional Director,
Chicago, of EMI Music Distribution. Mr. Witzig has more than 17 years of
experience in promotion, special accounts and sales capacities with major record
labels including Regional Director for EMI Music Distribution and National Sales
Director of Capitol Records.
NANCY R. KIELTY. Ms. Kielty has served as our Vice President of Commerce
since February 1999. From December 1996 to August 1998, she served as Divisional
Merchandise Manager, Airport Store Division, for Wilsons The Leather Experts, a
Minneapolis-based retailer of leather outerwear. From January 1992 to January
1996, Ms. Kielty was a Buyer for Fingerhut Companies, a Minneapolis-based direct
sales catalog retailer.
JAMES CAPARRO. Mr. Caparro has served as a director of NetRadio since
January 1999. He is Chairman and Chief Executive Officer of Island/Mercury/Def
Jam Music Group, a division of Universal/PolyGram Music Operations. From 1992 to
1998 he served as President and Chief Executive Officer of PolyGram Group
Distribution.
CHARLES E. CHENEY. Mr. Cheney has served as a director of NetRadio since
May 1996. From March 1997 to September 1998, he also served as our Chief
Financial Officer. Mr. Cheney has served as a director, Chief Financial Officer,
Executive Vice President and Secretary of Navarre since 1985.
MARC H. KALMAN. Mr. Kalman has served as a director of NetRadio since
January 1999. Mr. Kalman is affiliated with Chancellor Media, Inc. and since
1992, he has served as Vice President and General Manager for KDWB-FM, KTCZ-FM
and WRQC-FM, three leading FM stations in the Minneapolis/Saint Paul market.
Since 1993, Mr. Kalman also has served as an Executive Board Member of the
Variety Childrens Association Board of Directors and as a director of the
Minnesota Broadcasters Board of Directors.
GENE MCCAFFERY. Mr. McCaffery has served as a director of NetRadio since
November 1998. He currently is Chief Executive Officer, Chairman of the Board
and a director of ValueVision. Prior to joining ValueVision in 1998, Mr.
McCaffery served as Chief Executive Officer and Managing Partner of Marketing
Advocates, a celebrity-driven product and marketing development company based in
Los Angeles. From 1982 to 1996, Mr. McCaffery was employed in several capacities
with Montgomery Ward & Co., Inc., serving most recently as Senior Executive Vice
President. Montgomery Ward filed for Chapter 11 bankruptcy protection in 1997.
From 1994 to 1996, Mr. McCaffery also served as Vice Chairman of The Signature
Group, one of the nation's largest direct marketing companies. Mr. McCaffery
also serves as a director of Metal Management, Inc.
BOARD OF DIRECTORS
Each director currently serves until the next regular meeting of
shareholders after election or appointment and until his or her successor is
elected and is qualified to serve. Upon the closing of this
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offering, we will divide our board of directors into three classes with
staggered three-year terms. The terms of Messrs. Cheney and Pederson will expire
at the annual meeting of our shareholders in 2000, the terms of Messrs. Caparro
and Kalman will expire at the annual meeting of our shareholders in 2001, and
the terms of Messrs. Tomechko, Paulson and McCaffery will expire at the annual
meeting of our shareholders in 2002.
ARRANGEMENTS FOR NOMINATION AS DIRECTOR
Under the terms of a March 1997 stock purchase agreement among Navarre,
NetRadio and ValueVision, and based upon our total number of directors,
ValueVision has the right to elect the number of directors equal to its
proportionate share of ownership of NetRadio, rounded up to the next whole
number. Following ValueVision's purchase of 550,000 shares of common stock for
$500,000 occurring at the closing of this offering, ValueVision will have the
right to elect two directors of NetRadio. Please see "Related Party
Transactions."
COMMITTEES OF THE BOARD OF DIRECTORS
Our board of directors has established an audit committee and a compensation
committee. Both committees are currently composed entirely of directors who are
not officers or employees of NetRadio.
Our audit committee generally has responsibility for recommending
independent auditors to the board of directors for selection, reviewing the plan
and scope of the annual audit, reviewing our audit and control functions and
reporting to the full board of directors regarding these matters. The members of
our audit committee are Messrs. Caparro, Cheney and Kalman.
Our compensation committee generally has responsibility for recommending to
the board of directors guidelines and standards relating to the determination of
executive compensation, reviewing executive compensation policies and reporting
to our board of directors regarding these matters. Our compensation committee
also has responsibility for administering our stock option plan, determining the
number of options to be granted to the executive officers and reporting to our
board of directors on such matters. The members of our compensation committee
are Messrs. Caparro, Kalman and McCaffery.
COMPENSATION OF DIRECTORS
Each non-employee director receives $500 and reimbursement of any expenses
incurred for each board meeting attended. In connection with their appointment
to our board of directors, in January 1999, we granted each of Messrs. Caparro
and Kalman options to purchase 10,000 shares of our common stock at an exercise
price equal to $5.00 per share. We expect to grant additional options to
non-employee directors in the future in connection with their service on our
board of directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Paulson is Chairman, President and Chief Executive Officer, and Mr.
Cheney is Chief Financial Officer of Navarre. Mr. McCaffery, who serves as a
member of our compensation committee, is also Chief Executive Officer of
ValueVision. Prior to this offering, after giving effect to the purchase of
550,000 shares of common stock by ValueVision, Navarre owned approximately 75%
of our common stock and ValueVision owned approximately 22% of our common stock.
Following this offering, Navarre will own approximately 51% and ValueVision will
own approximately 15% of our common stock, assuming the underwriters'
over-allotment option is not exercised.
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EXECUTIVE COMPENSATION
The following summary compensation table sets forth information concerning
the compensation paid during the fiscal year ended December 31, 1998 to Eric H.
Paulson, who served as our Chief Executive Officer from April 24, 1997 to
January 10, 1999. No other executive officers received salary and bonus in
excess of $100,000 during 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
------------------------------------------- --------------------
OTHER SECURITIES
ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS
- --------------------------------------------------- --------- ----------- ----------- ----------------- --------------------
<S> <C> <C> <C> <C> <C>
Eric H. Paulson, Chief Executive Officer........... 1998 $ 0 $ 0 $ 0 90,000
</TABLE>
OPTION GRANTS IN 1998
The following table sets forth certain information regarding stock options
granted during 1998 to Mr. Paulson.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------------------------- POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED
NUMBER OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE OR FOR OPTION TERM(1)
OPTIONS EMPLOYEES IN BASE PRICE PER EXPIRATION ---------------------
NAME GRANTED FISCAL YEAR SHARE DATE 5% 10%
- --------------------------- ------------- ------------- --------------- --------------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Eric H. Paulson............ 90,000(2) 9.8% $ 1.64 May 31, 2005 $ 60,088 $ 140,031
</TABLE>
- ------------------------
(1) The 5 and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the SEC. Potential realizable value is determined
by multiplying the fair market value at the time of grant as determined by
our board of directors by the stated annual appreciation rate compounded
annually for the term of the option, subtracting the exercise price or base
price per share from the product, and multiplying the remainder by the
number of options granted. Actual gains, if any, on stock option exercises
and common stock holdings are dependent on the future performance of our
common stock and overall stock market conditions. There can be no assurance
that the amounts reflected in this table will be achieved.
(2) The stock option is exercisable in annual increments of 18,000 shares
beginning in June 1998.
FISCAL YEAR END OPTION VALUES
The following table sets forth certain information regarding Mr. Paulson's
unexercised stock options as of December 31, 1998. Mr. Paulson did not exercise
any options in 1998.
FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT DECEMBER AT
31, 1998 DECEMBER 31, 1998(1)
---------------------- ---------------------
NAME VESTED UNVESTED VESTED UNVESTED
- ------------------------------------------------------- --------- ----------- --------- ----------
<S> <C> <C> <C> <C>
Eric H. Paulson........................................ 18,000 72,000 $ 60,480 $ 241,920
</TABLE>
- ------------------------
(1) Based on the fair market value of our common stock at the end of the fiscal
year minus the exercise price, multiplied by the number of securities
underlying the option.
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EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL CONSIDERATIONS
We have entered into employment agreements with Edward A. Tomechko, Michael
P. Wise, Donavan W. Pederson, Richard W. Hailey, David R. Witzig and Nancy R.
Kielty. The term of Mr. Tomechko's agreement commenced on January 11, 1999 and
ends on January 10, 2002. The agreements between us and Mr. Pederson and Mr.
Witzig commenced on August 1, 1998 and end on July 31, 2000. Ms. Kielty's
agreement commenced on February 25, 1999, Mr. Wise's agreement commenced on
April 29, 1999 and Mr. Hailey's agreement commenced on July 26, 1999. Mr.
Tomechko's annual base salary is $175,000, subject to an immediate increase to
$200,000 upon the closing of this offering. Mr. Pederson's annual base salary is
$120,000, subject to an immediate increase to $140,000 upon the closing of this
offering. Mr. Witzig's annual base salary is $100,000, subject to an immediate
increase to $130,000 upon the closing of this offering. Mr. Tomechko will
receive a one-time $20,000 bonus upon the closing of this offering, and Messrs.
Pederson and Witzig will each receive a one-time $10,000 bonus upon the closing
of this offering. The employment agreements further provide that each executive
is eligible to receive an annual performance bonus of up to 60% for Mr.
Tomechko, and 40% for Messrs. Pederson and Witzig, of their respective base
salaries, if we achieve certain operating objectives. Ms. Kielty, Mr. Wise and
Mr. Hailey received termination agreements in February 1999, April 1999 and July
1999, respectively, that provide that if there is a change in control of
NetRadio and they are terminated, their status with NetRadio adversely changes
or their salary is substantially reduced, then they will receive a cash
severance payment equal to six months' salary.
In August 1998, Mr. Tomechko received an option to purchase 75,000 shares of
common stock that vests in equal increments over three years beginning in
September 1999. In January 1999, Mr. Tomechko received an option to purchase
125,000 shares of common stock that vests in equal increments over three years
beginning in January 2000. If Mr. Tomechko is terminated without cause before
these options are fully vested, these options will become exercisable in full
upon such termination. In connection with his initial employment with us and his
relocation to Minnesota, we advanced Mr. Tomechko $62,500 pursuant to a
promissory note. The note bears interest at an annual rate of 7.75% beginning
December 1999 and matures in December 2001. Mr. Tomechko is required to pay
interest on the note and repay principal in an amount equal to the appraised
increase in the value of his residence at December 2001.
In February 1999, Mr. Wise received an option to purchase 50,000 shares of
common stock that vests in equal increments over three years beginning in
February 2000. Also, in February 1999, Mr. Wise executed a stock option
agreement with NetRadio, that provides that if he is terminated without cause,
his stock options will immediately become fully vested. In June 1998, Mr.
Pederson received an option to purchase 100,000 shares of common stock that
vests in equal increments over three years beginning in June 1998. In June 1998,
Mr. Pederson also received an option to purchase 75,000 shares of common stock
that vests if we achieve certain milestones, including the completion of an
initial public offering but in any event in five years. In June 1998, Mr. Witzig
received an option to purchase 75,000 shares of common stock that vests in equal
annual increments over three years beginning in June 1998. In June 1998, Mr.
Witzig also received an option to purchase 75,000 shares of common stock that
vests if we achieve certain milestones, including the completion of an initial
public offering, but in any event in five years. If the employment of Messrs.
Pederson or Witzig is not renewed at the end of the term of his employment
agreement, except for cause, the terminated executive's option to purchase
75,000 shares of common stock will be immediately exercisable in full. In
February 1999, Ms. Kielty received an option to purchase 50,000 shares of common
stock that vests in equal increments over three years beginning in February
2000. In July 1999, Mr. Hailey received an option to purchase 50,000 shares of
common stock that vests in equal annual increments over three years beginning in
July 2000.
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BENEFIT PLANS
THE NETRADIO CORPORATION 1998 STOCK OPTION AND INCENTIVE PLAN. In June
1998, our board of directors adopted, and our shareholders approved, the
NetRadio Corporation 1998 Stock Option and Incentive Plan, pursuant to which
officers, employees, consultants, independent contractors and non-employee
directors are eligible to receive options to purchase shares of our common
stock, stock appreciation rights and awards of deferred or restricted stock. A
total of 2,000,000 shares of common stock may be issued under our stock option
plan. The stock option plan is administered by our board of directors, or a
committee of at least two directors, and the committee must have at least two
members who are "disinterested directors" within the meaning of Rule 16b-3 under
the Securities Exchange Act of 1934. Our board of directors, or the committee,
has the authority to interpret the stock option plan, to determine the eligible
recipients, terms and conditions of awards granted, to prescribe, amend and
rescind the rules and regulations of the stock option plan, to waive any
restriction
on any award, and to make all other determinations necessary or advisable for
the administration of the stock option plan. If our board of directors or the
committee makes an award to an eligible participant, the recipient must enter
into an agreement with NetRadio in a form that our board of directors or the
committee determines is consistent with the stock option plan.
Options granted generally must be exercised within three months of the
optionholder's termination of employment. All outstanding options become
immediately exercisable in full upon certain changes in control of NetRadio. In
the event of a change in control, our board of directors or the committee may,
in its discretion without consent of the recipient, determine to award cash
equal to the fair market value of some or all of a recipient's options.
As of October 12, 1999, there were options to purchase an aggregate of
1,132,350 shares of common stock outstanding with exercise prices ranging from
$1.64 per share to the initial public offering price per share.
401(K) PLAN. At the present time, Navarre sponsors a savings and investment
plan, or 401(k) Plan, for our employees, which is intended to be qualified under
Section 401 of the Internal Revenue Code. Participating employees may make
pre-tax contributions, subject to limitations defined in the 401(k) Plan of a
percentage of their total compensation. Navarre may make discretionary matching
contributions on behalf of our employees. We intend to create our own plan that
will provide benefits similar to the 401(k) Plan currently administered by
Navarre.
LIMITATIONS OF DIRECTORS' LIABILITY AND INDEMNIFICATION
We plan to enter into agreements to indemnify our directors and executive
officers, in addition to the indemnification provided for in our bylaws. Under
these agreements, among other things, we will indemnify our directors and
executive officers for expenses including attorneys' fees, judgments, fines and
settlement amounts incurred by any of them in any action or proceeding,
including any action by or in the right of NetRadio arising out of the person's
services as a director or executive officer of NetRadio, a subsidiary of
NetRadio or any other company or enterprise to which the person provides
services at our request. We believe that these provisions and agreements will be
necessary to attract and retain qualified persons as directors and executive
officers.
At the present time, there is no pending litigation or proceeding involving
directors or officers in which indemnification is required or permitted, and we
are not aware of any threatened litigation or proceeding that may result in a
claim for indemnification.
RELATED PARTY TRANSACTIONS
On May 1, 1996, Navarre purchased 50% of the issued and outstanding common
stock of Net Radio Nevada, our predecessor, for $1,500,000. In addition, Navarre
entered into an option agreement
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with our then existing shareholders under which Navarre issued 190,000 shares of
its common stock to such shareholders in exchange for the right to acquire up to
an additional 20% of the outstanding common stock of our predecessor owned by
these shareholders, pursuant to a formula based upon our future earnings.
On March 7, 1997, Navarre and our predecessor entered into an Agreement and
Plan of Reorganization under which Navarre agreed to acquire all of our
predecessor's remaining issued and outstanding common stock, and our predecessor
was merged into a subsidiary of Navarre. In connection with the transaction,
Navarre issued 125,000 shares of its common stock to our predecessor's
shareholders and certain affiliates, and agreed to issue an additional 2,075,000
shares of its common stock, contingent upon us achieving specified levels of
sales and profits in the two years following the merger. We have not achieved
the levels of sales or profits targeted in the agreement with Navarre, and no
additional shares of Navarre common stock have been issued to our predecessor's
shareholders as of the date of this prospectus. As a result of the two
transactions, Navarre acquired ownership of all of our issued and outstanding
shares of common stock and currently owns 5,000,000 shares.
Concurrent with Navarre's March 1997 acquisition of all of our issued and
outstanding common stock, ValueVision agreed to invest $3,000,000 in NetRadio,
consisting of $1,000,000 in cash and an agreement to provide $2,000,000 worth of
television advertising time, in exchange for 882,500 shares of our common stock.
ValueVision also was granted a right of first refusal to distribute any products
other than music and software sold by us. ValueVision is an integrated
electronic and print media direct marketing company that operates a television
home shopping network. At the time of the ValueVision investment, we determined
to assign a carrying value of $1,000,000 to the $2,000,000 of television
advertising time.
Under the terms of the stock purchase agreement by and among NetRadio,
ValueVision and Navarre, and based upon our total number of directors,
ValueVision has the right to elect the number of directors equal to its
proportionate share of ownership of NetRadio, rounded up to the next whole
number. Following ValueVision's purchase of 550,000 shares of common stock for
$500,000 occurring at the closing of this offering, ValueVision will have the
right to elect two directors of NetRadio.
In connection with ValueVision's investment in NetRadio, ValueVision and
Navarre entered into a conversion agreement. The conversion agreement grants
ValueVision the right to demand that Navarre buy back ValueVision's NetRadio
common stock for $3,000,000, less unused advertising time, or convert
ValueVision's NetRadio common stock into shares of Navarre common stock equal to
$3,000,000, less unused advertising time. These rights are exercisable if, among
other things, NetRadio does not register its common stock under the Securities
Act within five years from March 20, 1997. ValueVision's conversion rights will
terminate upon the closing of this offering.
ValueVision also has preemptive rights which entitle it to purchase
additional shares of our securities to maintain its current percentage ownership
if we issue additional equity securities. ValueVision has waived its future
preemptive rights, effective upon the closing of this offering.
ValueVision also has registration rights with respect to its shares of our
common stock, including the right to have 550,000 shares registered for resale
one year from the closing of this offering, and the right to have its remaining
shares registered two years from the closing of this offering. ValueVision also
has the right to have its shares included in other registration statements filed
by NetRadio. ValueVision has waived any registration rights it may have in
connection with this offering.
In addition, under the terms of the March 1997 stock purchase agreement, if
NetRadio has revenues, other than from product sales, of at least $3,000,000 in
any rolling consecutive four quarter period, NetRadio has a one-time option for
a 12-month period to require ValueVision to purchase 4.95% of the outstanding
shares of common stock of NetRadio for $500,000. ValueVision similarly has the
right during this period to purchase 4.95% of the outstanding common stock of
NetRadio for
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<PAGE>
$500,000. In connection with this offering, NetRadio and ValueVision have
terminated this right in exchange for ValueVision's agreement to purchase
550,000 shares of common stock immediately prior to the closing of this offering
for $500,000.
If as a result of the underwriters' exercise of the over-allotment option,
this offering exceeds 3,499,999 shares, then ValueVision will receive an
additional 10,000 shares of common stock. In addition, for every 100,000 shares
of common stock that we sell in this offering in excess of 3,499,999, including
the over-allotment option, ValueVision will receive an additional 7,000 shares
of common stock. As a result, if the over-allotment option is exercised in full,
ValueVision will receive an aggregate of 567,000 shares of common stock pursuant
to its agreement with us.
The following are summaries of agreements that we have entered into with
Navarre. These summaries do not describe or contain every provision of the
agreements. These agreements are exhibits to the registration statement of which
this prospectus is a part, and you should review those exhibits if you would
like further information with respect to these agreements.
FULFILLMENT AGREEMENT. In December 1998, we entered into a five year
fulfillment agreement with Navarre, under which we are required to fulfill our
customer purchase orders for identified products from Navarre before any other
fulfillment source may be utilized. The fulfillment agreement governs order
procedures, product returns, shipping procedures, payments and price lists. The
fulfillment agreement may be terminated by either party if, among other things,
we discontinue online sales of pre-recorded music or Navarre discontinues
fulfilment services to online customers. For the fiscal year ended December 31,
1998, and for the six months ended June 30, 1999, we purchased approximately 5%
of our music products from Navarre under the fulfillment agreement.
SEPARATION AGREEMENT. In March 1999, NetRadio entered into a separation
agreement with Navarre to be effective upon the closing of this offering. Under
the separation agreement, Navarre and NetRadio will separate the accounting,
finance, human resources and other administrative functions of NetRadio and
Navarre in the 45-day period following the closing of this offering. NetRadio
has agreed to pay Navarre $7,500 for services provided during the transition
period. In addition, concurrent with the closing of this offering, Navarre will
contribute to the capital of NetRadio $5,234,840 of principal indebtedness owed
by NetRadio to Navarre. In exchange for this contribution, we have granted
Navarre registration rights with respect to 600,000 shares of our common stock
owned by Navarre. These registration rights are exercisable beginning six months
after the closing of this offering. Navarre and NetRadio have also agreed that
for a period of four years from the date of the closing of this offering,
Navarre will not directly or indirectly engage in the Internet broadcasting of
music and information or online retail sales of entertainment-related products
in substantially the same manner and format as currently conducted by NetRadio.
NetRadio has indemnification obligations to Navarre and its affiliates under the
separation agreement, including indemnification for liability arising out of
statements made in connection with this offering. Except for the contractual
obligations set forth in the separation agreement or other intercompany
agreements, Navarre and NetRadio have agreed to discharge all claims they may
have against each other existing before the closing of this offering. In
connection with the execution of the separation agreement, NetRadio and Navarre
are entering into a Multiple Advance Term Note. Under the Note, NetRadio will
agree to repay to Navarre all amounts advanced to NetRadio beginning January 1,
1999 plus accrued interest on $5,234,840 of principal indebtedness incurred
through December 31, 1998. The Note bears interest at midwest prime plus one
half percentage point. The total amount of the Note is due on June 1, 2001.
SALES OF RESTRICTED STOCK TO CERTAIN INSIDERS
In September 1998, we sold an aggregate of 40,000 shares of common stock at
a price of $1.64 per share to Donavan W. Pederson, Jan K. Andersen, David R.
Witzig, and Karen W. Paulson, Eric H. Paulson's spouse. Mr. Anderson served as
the Senior Vice President for Global Sales and Marketing of NetRadio from
November 1997 until July 1999.
47
<PAGE>
GRANT OF CERTAIN OPTIONS TO NAVARRE AFFILIATES
In June 1998, we granted options to purchase common stock to the following
executives and affiliates of Navarre:
Eric H. Paulson, Chairman of the Board and Chief Executive Officer of
Navarre and Chairman of the Board of NetRadio, aggregate options to purchase
90,000 shares of common stock at $1.64 per share, vesting annually in increments
of 18,000 shares, commencing June 1, 1998;
Charles E. Cheney, Chief Financial Officer and a director of Navarre and a
director of NetRadio, aggregate options to purchase 60,000 shares of common
stock at $1.64 per share, vesting annually in increments of 12,000 shares,
commencing June 1, 1998; and
James G. Sippl, a director of Navarre and former consultant to NetRadio,
aggregate options to purchase 20,000 shares of common stock at $1.64 per share,
vesting annually in increments of 4,000 shares, commencing June 1, 1998.
48
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth information concerning the beneficial
ownership of our common stock as of October 12, 1999, as adjusted to reflect
ValueVision's purchase of 550,000 shares of common stock effective as of the
closing of this offering, and as adjusted to reflect the sale of shares of
common stock we are offering, for (1) each person who owns beneficially 5% or
more of our common stock (2) each of our directors, and (3) all executive
officers and directors as a group.
<TABLE>
<CAPTION>
PERCENTAGE
BENEFICIALLY OWNED
NUMBER OF SHARES OF ------------------------
COMMON STOCK BENEFICIALLY BEFORE AFTER
NAME OWNED OFFERING OFFERING(1)
- ---------------------------------------------------------------- ------------------------- ----------- -----------
<S> <C> <C> <C>
Eric H. Paulson (2)(4).......................................... 5,046,000 75.7% 51.2%
Charles E. Cheney (2)(5)........................................ 5,024,000 75.5 51.0
Navarre Corporation (2)......................................... 5,000,000 75.4 50.9
ValueVision International, Inc. (3)............................. 1,432,500 21.6 14.6
Gene McCaffery (3)(6)........................................... 1,432,500 21.6 14.6
Donavan W. Pederson (7)......................................... 101,666 1.5 *
Edward A. Tomechko (8).......................................... 25,000 * *
James Caparro................................................... -- 0.0 0.0
Marc H. Kalman.................................................. -- 0.0 0.0
All executive officers and directors as a group
(11 persons)(9)............................................... 6,714,166 97.6% 66.6%
</TABLE>
- ------------------------
* Denotes less than 1%.
(1) Assumes the underwriters' over-allotment option is not exercised.
(2) The address of this shareholder is: Navarre Corporation, 7400 49(th) Avenue
North, New Hope, Minnesota 55428.
(3) The address of this shareholder is: ValueVision International, Inc., 6740
Shady Oak Road, Eden Prairie, Minnesota 55344.
(4) Includes 5,000,000 shares of common stock held by Navarre. Mr. Paulson is an
executive officer, director and shareholder of Navarre. He disclaims
beneficial ownership of the shares held by Navarre except to the extent of
his proportionate interest therein. Also includes 10,000 shares of common
stock owned by Karen W. Paulson, Mr. Paulson's spouse. Also includes options
to purchase 36,000 shares of common stock exercisable within 60 days of
October 12, 1999.
(5) Includes 5,000,000 shares of common stock held by Navarre. Mr. Cheney is an
executive officer, director and shareholder of Navarre. He disclaims
beneficial ownership of the shares held by Navarre except to the extent of
his proportionate interest therein. Also includes options to purchase 24,000
shares of common stock exercisable within 60 days of October 12, 1999.
(6) Includes 882,500 shares of common stock held by ValueVision and 550,000
shares of common stock to be purchased by ValueVision at the closing of the
offering. Mr. McCaffery is an executive officer, director and a
securityholder of ValueVision. He disclaims beneficial ownership of the
shares held by ValueVision except to the extent of his proportionate
interest therein.
(7) Includes options to purchase 91,666 shares of common stock exercisable
within 60 days of October 12, 1999.
(8) Includes options to purchase 25,000 shares of common stock exercisable
within 60 days of October 12, 1999.
(9) Includes options to purchase 251,666 shares of common stock exercisable
within 60 days of October 12, 1999.
49
<PAGE>
DESCRIPTION OF CAPITAL STOCK
As of October 12, 1999, our authorized capital stock consisted of 50,000,000
shares of common stock, no par value, of which 6,077,900 shares were issued and
outstanding and held by seven shareholders. In addition, ValueVision has agreed
to purchase 550,000 shares of common stock concurrent with the closing of this
offering. All share amounts in this prospectus reflect a 500-for-1 stock split
effected June 1, 1998. Our authorized capital stock, as of October 12, 1999,
also included 10,000,000 shares of preferred stock, no par value, of which no
shares were issued and outstanding as of October 12, 1999.
COMMON STOCK
All holders of shares of our common stock are entitled to one vote per share
on all matters to be voted upon by shareholders. Cumulative voting in the
election of directors is not permitted. Each share of common stock is equal to
all other shares of common stock in all respects. All of our issued and
outstanding shares of common stock are, and the shares to be sold in the
offering will be when issued, fully paid and nonassessable. The shares of common
stock in this offering have no preeemptive or conversion rights, no redemption
or sinking fund provisions, and are not liable for further call or assessment.
Subject to the rights of holders of any preferred stock that may be outstanding,
each share of common stock is entitled to share in any distribution of capital
assets remaining after payment of liabilities. Subject to the rights of holders
of any preferred stock that may be outstanding, holders of common stock are
entitled to receive dividends when and as declared by our board of directors out
of legally available funds. Any dividends may be paid in cash, property or
additional shares of common stock.
PREFERRED STOCK
Under our articles of incorporation, our board of directors may issue up to
10,000,000 shares of preferred stock in one or more series with designations,
rights and preferences as may be determined from time to time by the board of
directors. Accordingly, the board of directors is empowered, under governing
Minnesota law and our articles of incorporation and without further shareholder
approval, to issue preferred stock with dividend, liquidation, conversion,
voting or other rights that may adversely affect the voting power or other
rights of the holders of our common stock. In the event of issuance, the
preferred stock could be utilized to discourage, delay or prevent an acquisition
or change in control. We do not currently intend to issue any shares of
preferred stock.
OPTIONS
As of October 12, 1999, we had outstanding options to purchase 1,132,350
shares of common stock, at exercise prices that range from $1.64 to the initial
public offering price per share and we have 712,250 shares of common stock
reserved for future option grants. Previous grants under our stock option plan
have been exempt from registration, and shares issued thereunder are subject to
resale restrictions. We intend to file a registration statement on Form S-8
registering shares to be issued in connection with current and future option
grants.
REGISTRATION RIGHTS
Navarre and ValueVision have rights with respect to the registration of
their common stock. Please see "Related Party Transactions."
ANTI-TAKEOVER PROVISIONS OF MINNESOTA BUSINESS CORPORATION ACT
Section 302A.671 of the Minnesota Business Corporation Act provides that,
unless the acquisition of new percentages of voting control (in excess of 20%,
33 1/3% or 50%) by an existing shareholder or
50
<PAGE>
other person is approved by a majority of our disinterested shareholders, the
shares acquired above new percentage levels will have no voting rights. We are
required to hold a special shareholders' meeting to vote on any such acquisition
within 55 days after the delivery to us by the acquiror of an information
statement describing, among other things, the acquiror and any plans of the
acquiror to liquidate or dissolve us, and copies of definitive financing
agreements for any financing of the acquisition not to be provided by funds of
the acquiror. If any acquiror does not submit an information statement to us
within 10 days after acquiring shares representing a new threshold percentage of
voting control, or if our disinterested shareholders vote not to approve the
acquisition, we may redeem the shares so acquired by the acquiror at their fair
market value. Section 302A.671 generally does not apply to a cash offer to
purchase all shares of voting stock of the issuing corporation if the offer has
been approved by a majority vote of our disinterested board members.
Section 302A.673 of the Minnesota Business Corporation Act restricts
transactions between us and a shareholder who becomes the beneficial holder of
10% or more of our outstanding voting stock (an "interested shareholder") unless
a majority of our disinterested directors have approved, prior to the date on
which the interested shareholder acquired a 10% interest, either the business
combination transaction suggested by the shareholder or the acquisition of
shares that made the shareholder a statutory interested shareholder. If prior
approval is not obtained, the statute imposes a four-year prohibition on
mergers, sales of substantial assets, loans, substantial issuances of stock and
various other transactions involving us and the interested shareholder or its
affiliates.
These statutory provisions could have the effect of delaying or preventing a
change in control of NetRadio.
TRANSFER AGENT AND REGISTRAR
Norwest Bank has been appointed as the transfer agent and registrar for our
common stock.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our shares of
common stock. Future sales of substantial amounts of common stock in the public
market could adversely affect prevailing market prices. As described below, for
a period of 180 days after this offering, all shares of common stock other than
shares sold in this offering will be subject to contractual restrictions
regarding resale. Sales of substantial amounts of common stock in the public
market after the restrictions lapse could adversely affect the prevailing market
price and our ability to raise equity capital in the future.
Upon completion of this offering and assuming no exercise of the
over-allotment option, we will have 9,827,900 shares of common stock
outstanding. Of this amount, the 3,200,000 shares of common stock offered will
be freely tradeable in the public market without restriction under the
Securities Act unless purchased by our "affiliates" as that term is defined in
Rule 144 under the Securities Act.
The remaining 6,627,900 shares of common stock held by existing shareholders
will be "restricted securities" as that term is defined in Rule 144 under the
Securities Act. Restricted securities may be sold in the public market only if
registered under the Securities Act or if they qualify for an exemption from
registration under Rules 144 or 701 promulgated under the Securities Act. Sales
of the restricted securities in the public market, or the availability of such
shares for sale, could adversely affect the market price of our common stock.
The executive officers, directors and shareholders, who in the aggregate
hold 6,562,500 shares of our common stock, and the holders of all options to
purchase shares of common stock under our stock option plan, have entered into
lock-up agreements under which they may not dispose of, directly or indirectly,
any shares of common stock or any securities convertible into or exercisable or
exchangeable for common stock, without the prior written consent of Gerard
Klauer Mattison & Co., Inc. As a result
51
<PAGE>
of these contractual restrictions, notwithstanding possible earlier eligibility
for sale under the provisions of Rule 701, shares subject to lock-up agreements
will not be saleable until the agreements expire. However, Gerard Klauer
Mattison may, in its sole discretion, and at any time without notice, release
all or any portion of the securities subject to these lock-up agreements.
Immediately following expiration of the lock-up agreements, and subject to
limitations on the volume of sales, 6,012,500 shares of common stock will be
eligible for immediate sale pursuant to Rules 144 and 701 under the Securities
Act. Additionally, following expiration of the lock-up agreements, up to 413,217
of the 1,132,350 shares underlying options outstanding as of October 12, 1999,
will be exercisable and eligible for immediate sale pursuant to Rules 144 and
701, subject to certain limitations on the volume of sales.
We intend to file a registration statement approximately 180 days after the
closing of this offering on Form S-8 under the Securities Act covering the
shares of common stock reserved for issuance under our stock option plan. The
registration statement will automatically become effective upon filing.
Accordingly, shares of our common stock registered under the registration
statement will, subject to Rule 144 volume limitations applicable to affiliates,
be available for sale in the open market, unless the shares are subject to our
vesting restrictions or the lock-up agreements described above.
In general, under Rule 144 as currently in effect, a person, or persons
whose shares are combined under the Rule, who has beneficially owned restricted
securities for at least the holding period of any prior owner (except an
affiliate) would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of (1) one percent of the number of
shares of common stock then outstanding (approximately 98,279 shares immediately
after this offering) or (2) the average weekly trading volume of the common
stock during the four calendar weeks preceding the filing of a Form 144 with
respect to the sale. Sales under Rule 144 are also subject to manner-of-sale
provisions and notice requirements and to the availability of current public
information about us. Under Rule 144(k), a person who is not deemed to have been
an affiliate of us at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least one year
(including the holding period of any prior owner except an affiliate), is
entitled to sell his or her shares without complying with the manner of sale,
public information, volume limitation or notice provisions of Rule 144.
52
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement dated the
date of this prospectus, the underwriters named below for whom Gerard Klauer
Mattison & Co., Inc. and Advest, Inc. are acting as representatives, have
severally agreed to purchase from us, and we have agreed to sell to the
underwriters, the following respective number of shares of common stock:
<TABLE>
<CAPTION>
NUMBER
UNDERWRITERS OF SHARES
- ----------------------------------------------------------------- ---------
<S> <C>
Gerard Klauer Mattison & Co., Inc................................ 1,820,000
Advest, Inc...................................................... 980,000
Donaldson, Lufkin & Jenrette Securities Corporation.............. 50,000
SG Cowen......................................................... 50,000
C.E. Unterberg, Towbin........................................... 25,000
Dain Rauscher Wessels............................................ 25,000
Fahnestock & Co. Inc............................................. 25,000
First Union Securities, Inc...................................... 25,000
Janney Montgomery Scott Inc...................................... 25,000
Jefferies & Company, Inc......................................... 25,000
John G. Kinnard & Company, Incorporated.......................... 25,000
Legg Mason Wood Walker, Incorporated............................. 25,000
Morgan Keegan & Company, Incorporated............................ 25,000
Parker/Hunter Incorporated....................................... 25,000
Preferred Capital Markets, Inc................................... 25,000
Volpe Brown Whelan & Company, LLC................................ 25,000
---------
Total.......................................................... 3,200,000
---------
---------
</TABLE>
The underwriting agreement provides that the obligations of the underwriters
thereunder are subject to approval of certain legal matters by their counsel and
to various other conditions. The nature of the underwriters' obligation is such
that they are committed to purchase and pay for all shares of common stock if
any are purchased.
The underwriters propose to offer our shares of common stock directly to the
public at the initial public offering price set forth on the cover page of this
prospectus, and to a number of securities dealers (who may include the
underwriters) at a price, less a concession not in excess of $0.46 per share of
common stock. The underwriters may allow, and the selected dealers may reallow,
a concession not in excess of $0.10 per share of common stock to various brokers
and dealers. After this offering, the price to the public, concession, allowance
and reallowance may be changed by the representatives. The representatives have
informed us that the underwriters do not intend to confirm sales to any account
over which they exercise discretionary authority.
We have granted the underwriters an option, exercisable during the 30-day
period after the date of this prospectus, to purchase up to 480,000 additional
shares of common stock at the initial public offering price solely to cover
over-allotments, if any. To the extent that the underwriters exercise this
option, each of the underwriters will be committed, subject to certain
conditions, to purchase such additional shares of common stock in approximately
the same proportions as set forth in the above table.
The offering of the common stock is made for delivery when, as and if
accepted by the underwriters and subject to prior sale and to withdrawal,
cancellation or modification of the offering without notice. The underwriters
reserve the right to reject any order to purchase common stock.
We have agreed to issue to Gerard Klauer Mattison warrants to purchase
125,000 shares of common stock, at an exercise price per share equal to 120% of
the initial public offering price per
53
<PAGE>
share of common stock. We have also agreed to issue warrants to purchase 75,000
shares of common stock to First Union Securities, Inc. The warrants to be issued
to First Union Securities are for advisory services previously provided to us.
The warrants are exercisable for a period of four years, commencing one year
from the effective date of the registration statement of which this prospectus
is a part and expire five years from the effective date. The warrants will not
be sold, offered for sale, transferred, assigned or hypothecated for a period of
one year from the effective date other than to officers, employees or partners
of the underwriters and members of the selling group and their officers and
partners. The holders of the warrants will have no voting, dividend or other
shareholders' rights until the warrants are exercised. We have granted demand
and piggy-back registration rights in connection with the warrants, which are
applicable during the period that the warrants are exercisable and expire five
years from the effective date.
Subject to certain exceptions, we have agreed not to issue, and all our
officers, directors and securityholders have agreed not to offer, sell or
otherwise dispose of any shares of our common stock or our other equity
securities for a period of 180 days after the date of this prospectus (other
than shares sold pursuant to this prospectus) without the prior written consent
of Gerard Klauer Mattison.
The underwriters have reserved for sale, at the initial public offering
price, 300,000 shares of common stock for some of our directors, officers,
employees, friends and family who have expressed an interest in purchasing
shares of common stock in this offering. These persons are expected to purchase,
in the aggregate, not more than 9.5% of the common stock offered in this
offering. The number of shares available for sale to the general public in this
offering will be reduced to the extent these persons purchase reserved shares.
Any reserved shares not purchased will be offered by the underwriters on the
same basis as other shares offered in this offering.
We have agreed to indemnify the underwriters against material misstatements
and other claims arising under the Securities Act, or to contribute to payments
the underwriters may be required to make in respect thereof.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price was negotiated between us
and the representatives. Among the factors considered in these negotiations
were:
- prevailing market conditions,
- an assessment of our management,
- our results of operations in recent periods,
- the present stage of our development,
- the market capitalizations and stages of development of other companies
which we and the representatives believe to be comparable to us, and
- estimates of our business potential.
There can be no assurance that an active trading market will develop for our
common stock or that our common stock will trade in the public market subsequent
to this offering at or above the initial public offering price. The initial
public offering price should not be considered an indication of the actual value
of our common stock. Such price is subject to change as a result of market
conditions and other factors. We cannot assure you that our common stock can be
resold at or above the initial public offering price.
In order to facilitate this offering, the underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of our
common stock during and after the offering. Specifically, the underwriters may
over-allot or otherwise create a short position in our common stock for their
own account by selling more shares of common stock than have been sold to them
by us. The underwriters
54
<PAGE>
may elect to cover any of these short positions by purchasing shares of common
stock in the open market or by exercising the over-allotment option. In
addition, the underwriters may stabilize or maintain the price of our common
stock by bidding for or purchasing shares of common stock in the open market.
They may also engage in passive market making transactions, including imposing
penalty bids, under which selling concessions allowed to syndicate members of
other broker-dealers participating in this offering are reclaimed if shares of
common stock previously distributed in this offering are repurchased in
connection with stabilization transactions or otherwise. The effect of these
transactions may be to stabilize or maintain the market price at a level above
that which might otherwise prevail in the open market. The imposition of a
penalty bid may also affect the price of our common stock to the extent that it
discourages resales. No representation is made as to the magnitude or effect of
any possible stabilization or other transactions. These transactions may be
effected on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
LEGAL MATTERS
The validity of the issuance of the shares of our common stock offered
hereby will be passed upon for us by Lindquist & Vennum P.L.L.P., Minneapolis,
Minnesota and for the underwriters by Katten Muchin & Zavis, Chicago, Illinois.
EXPERTS
Ernst & Young LLP, independent auditors, has audited our financial
statements as of December 31, 1997 and 1998, and for the year ended December 31,
1996, the periods from January 1, 1997 through March 20, 1997 and March 21, 1997
through December 31, 1997 and the year ended December 31, 1998 as set forth in
their report. We have included our financial statements in the prospectus and
elsewhere in the registration statement in reliance on Ernst & Young LLP's
report, given on their authority as experts in accounting and auditing.
WHERE YOU CAN GET MORE INFORMATION
Our fiscal year ends on December 31. We intend to furnish our shareholders
annual reports containing audited financial statements and other appropriate
reports. In addition, we intend to become a reporting company and file annual,
quarterly and current reports, proxy statements and other information with the
SEC. You may read and copy any reports, statements or other information we file
at the SEC's Public Reference Room, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549 and at the SEC's Regional Offices at 7 World Trade
Center, Suite 1300, New York, New York 10048 and Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You can request copies of
these documents, upon payment of a duplicating fee, by writing the SEC. Please
call the SEC at 1-800-SEC-0330 for further information on the operation of the
Public Reference Room. Our SEC filings are also available to the public on the
SEC Web site at http://www.sec.gov.
55
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
FINANCIAL STATEMENTS
Year ended December 31, 1996, the Periods from January 1, 1997 through
March 20, 1997 and March 21, 1997 through December 31, 1997 and
the Year ended December 31, 1998 and the six Months
ended June 30, 1998 and 1999
(unaudited)
<TABLE>
<S> <C>
CONTENTS
Report of Independent Auditors........................................................ F-2
Balance Sheets........................................................................ F-3
Statements of Operations.............................................................. F-4
Statement of Shareholders' Equity..................................................... F-5
Statements of Cash Flows.............................................................. F-6
Notes to Financial Statements......................................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS AND SHAREHOLDERS
NETRADIO CORPORATION
We have audited the accompanying balance sheets of NetRadio Corporation as
of December 31, 1997 and 1998, and the related statements of operations,
shareholders' equity (deficit) and cash flows for the year ended December 31,
1998 and for the period from March 21, 1997 through December 31, 1997 and the
statements of operations, shareholders' equity (deficit) and cash flows of the
Predecessor for the period from January 1, 1997 through March 20, 1997 and for
the year ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of NetRadio Corporation at
December 31, 1997 and 1998, and the results of its operations and its cash flows
for the year ended December 31, 1998 and for the period from March 21, 1997
through December 31, 1997 and of the Predecessor for the period from January 1,
1997 through March 20, 1997 and for the year ended December 31, 1996, in
conformity with generally accepted accounting principles.
Ernst & Young LLP
Minneapolis, Minnesota
March 1, 1999
F-2
<PAGE>
NETRADIO CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
PRO FORMA
SHAREHOLDERS'
DECEMBER 31, EQUITY
---------------------- JUNE 30, (DEFICIT) AT
1997 1998 1999 JUNE 30, 1999
---------- ---------- ------------ ---------------
(NOTES 3 AND
10)
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash........................................... $ 4,253 $ 50,756 $ 16,024
Accounts receivable, less allowance for
doubtful accounts of $5,000 at December 31,
1997 and 1998 and June 30, 1999.............. 9,084 26,213 105,128
Prepaid advertising............................ 50,000 952,793 802,793
Prepaid expenses............................... -- -- 166,700
Other current assets........................... -- -- 763,333
---------- ---------- ------------
Total current assets............................. 63,337 1,029,762 1,853,978
Property and equipment, net...................... 395,900 881,478 1,538,415
Prepaid advertising.............................. 950,000 -- --
Note receivable--officer......................... -- 62,549 64,992
Deferred offering costs.......................... -- 239,643 764,295
Other assets..................................... 38,902 -- 3,175
Goodwill, net.................................... 947,250 526,250 316,000
---------- ---------- ------------
Total assets..................................... $2,395,389 $2,739,682 $ 4,540,855
---------- ---------- ------------
---------- ---------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable............................... $ 737,300 $1,022,639 $ 1,093,963
Accrued expenses............................... 60,901 86,649 1,340,249
Deferred advertising revenue................... -- -- 250,000
Current maturities of capital lease
obligations.................................. 137,550 96,506 118,527
Current maturities of notes payable............ 57,855 -- --
---------- ---------- ------------
Total current liabilities........................ 993,606 1,205,794 2,802,739
Advances from Navarre............................ 1,212,311 5,234,840 9,748,377 4,513,537
Capital lease obligations, less current
portion........................................ 176,455 128,564 131,767 131,767
Commitments and contingencies....................
Shareholders' equity (deficit):
Common Stock, no par value:
Authorized shares--20,000,000
Issued and outstanding shares--11,765 at
December 31, 1997 and 5,922,500 at December
31, 1998 and 5,927,900 at June 30, 1999,
respectively............................... 2,000,000 2,134,150 3,029,975 8,764,815
---------- ---------- ------------ ---------------
Accumulated deficit............................ (1,986,983) (5,963,666) (11,172,003) (11,172,003)
---------- ---------- ------------ ---------------
Total shareholders' equity (deficit)............. 13,017 (3,829,516) (8,142,028) $ (2,407,188)
---------- ---------- ------------ ---------------
---------- ---------- ------------ ---------------
Total liabilities and shareholders' equity
(deficit)...................................... $2,395,389 $2,739,682 $ 4,540,855
---------- ---------- ------------
---------- ---------- ------------
</TABLE>
See accompanying notes.
F-3
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PREDECESSOR THE COMPANY
--------------------------- ----------------------------------------------------------
PERIOD FROM PERIOD FROM SIX MONTHS
JANUARY 1, MARCH 21, ENDED
YEAR ENDED 1997 THROUGH 1997 THROUGH YEAR ENDED JUNE 30,
DECEMBER 31, MARCH 20, DECEMBER 31, DECEMBER 31, ----------------------------
1996 1997 1997 1998 1998 1999
------------- ------------ ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net revenues:
Product sales............ $ -- $ -- $ -- $ 49,639 $ -- $ 258,607
Internet advertising..... -- -- -- 205,423 112,796 147,058
Miscellaneous............ 320,661 167,950 162,971 -- -- --
------------- ------------ ------------- ------------- ------------- -------------
Total net revenues....... 320,661 167,950 162,971 255,062 112,796 405,665
Cost of revenues........... -- -- 16,989 64,825 10,058 242,415
------------- ------------ ------------- ------------- ------------- -------------
Gross profit............... 320,661 167,950 145,982 190,237 102,738 163,250
Operating expenses:
Operations and technical
support................ -- -- 672,061 685,767 605,738 1,995,516
Sales and marketing...... 426,884 53,036 160,748 670,885 157,673 785,438
General and
administrative......... 2,154,455 851,688 1,267,879 2,786,385 595,491 2,276,477
------------- ------------ ------------- ------------- ------------- -------------
Total operating
expenses............... 2,581,339 904,724 2,100,688 4,143,037 1,358,902 5,057,431
------------- ------------ ------------- ------------- ------------- -------------
Loss from operations....... (2,260,678) (736,774) (1,954,706) (3,952,800) (1,256,164) (4,894,181)
Other (income) expense:
Interest................. (6,650) 17,694 32,277 23,883 13,169 314,156
------------- ------------ ------------- ------------- ------------- -------------
Net loss before taxes...... (2,254,028) (754,468) (1,986,983) (3,976,683) (1,269,333) (5,208,337)
Income tax expense......... -- -- -- -- -- --
------------- ------------ ------------- ------------- ------------- -------------
Net loss................... $ (2,254,028) $ (754,468) $ (1,986,983) $ (3,976,683) $ (1,269,333) $ (5,208,337)
------------- ------------ ------------- ------------- ------------- -------------
------------- ------------ ------------- ------------- ------------- -------------
Loss per share--basic and
diluted.................. $ (.67) $ (.22) $ (.88)
------------- ------------- -------------
------------- ------------- -------------
Weighted average shares
outstanding.............. 5,899,167 5,882,500 5,923,902
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes.
F-4
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
STATEMENT OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------------------ PAID-IN RETAINED SUBSCRIPTION
SHARES AMOUNT CAPITAL EARNINGS RECEIVABLE TOTAL
----------- ----------- ----------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
PREDECESSOR
Balance, December 31, 1995.............. 1,666,664 $ 16,667 $ 94,333 $ (73,706) $ -- $ 37,294
Stock issued.......................... 419,151 4,192 196,058 -- -- 200,250
Stock issued (Navarre)................ 2,085,815 20,858 1,458,946 -- -- 1,479,804
Stock subscriptions issued............ 1,082,430 10,824 647,941 -- (658,765) --
Net loss.............................. -- -- -- (2,254,028) -- (2,254,028)
----------- ----------- ----------- ------------- ------------ -----------
Balance, December 31, 1996.............. 5,254,060 52,541 2,397,278 (2,327,734) (658,765) (536,680)
Net loss.............................. -- -- -- (754,468) -- (754,468)
----------- ----------- ----------- ------------- ------------ -----------
Balance, March 20, 1997................. 5,254,060 52,541 2,397,278 (3,082,202) (658,765) (1,291,148)
THE COMPANY
Record effect of acquisition by
Navarre............................. (5,244,060) (52,541) (2,397,278) 3,082,202 658,765 1,291,148
----------- ----------- ----------- ------------- ------------ -----------
Balance, March 21, 1997................. 10,000 -- -- -- -- --
Stock issued for cash and advertising
rights.............................. 1,765 2,000,000 -- -- -- 2,000,000
Net loss.............................. -- -- -- (1,986,983) -- (1,986,983)
----------- ----------- ----------- ------------- ------------ -----------
Balance, December 31, 1997.............. 11,765 2,000,000 -- (1,986,983) -- 13,017
Stock split........................... 5,870,735 -- -- -- -- --
Stock issued.......................... 40,000 65,600 -- -- -- 65,600
Stock option compensation............. -- 20,500 -- -- -- 20,500
Notes forgiven by shareholders........ -- 48,050 -- -- -- 48,050
Net loss.............................. -- -- -- (3,976,683) -- (3,976,683)
----------- ----------- ----------- ------------- ------------ -----------
Balance, December 31, 1998.............. 5,922,500 2,134,150 -- (5,963,666) -- (3,829,516)
Stock option compensation............... -- 879,625 -- -- -- 879,625
Stock options exercised................. 5,400 16,200 -- -- -- 16,200
Net loss................................ -- -- -- (5,208,337) -- (5,208,337)
----------- ----------- ----------- ------------- ------------ -----------
Balance, June 30, 1999 (unaudited)...... 5,927,900 $ 3,029,975 $ -- $ (11,172,003) $ -- $(8,142,028)
----------- ----------- ----------- ------------- ------------ -----------
----------- ----------- ----------- ------------- ------------ -----------
</TABLE>
See accompanying notes.
F-5
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PREDECESSOR THE COMPANY
--------------------------- ------------------------------------------------------
PERIOD FROM PERIOD FROM
JANUARY 1, MARCH 21, SIX MONTHS
YEAR ENDED 1997 THROUGH 1997 THROUGH YEAR ENDED ENDED JUNE 30,
DECEMBER 31, MARCH 20, DECEMBER 31, DECEMBER 31, ------------------------
1996 1997 1997 1998 1998 1999
------------ ------------ ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................ $(2,254,028) $(754,468) $(1,986,983) $(3,976,683) $(1,269,333) $(5,208,337)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation and amortization......... 239,105 98,474 648,280 843,103 329,462 489,208
Stock option compensation............. -- -- -- 20,500 -- 879,625
Changes in operating assets and
liabilities:
Accounts receivable................. (3,500) (22,480) 16,896 (17,129) (39,918) (78,915)
Prepaid expenses.................... 5,795 -- -- 47,207 220 (16,700)
Accounts payable.................... 759,338 757,612 (780,100) 285,339 (93,245) 71,324
Accrued expenses.................... 153,429 (97,864) (5,243) 25,748 (21,775) 1,253,600
Deferred revenue.................... -- -- -- -- -- 250,000
Other assets........................ (189,491) -- -- -- 38,902 (766,508)
------------ ------------ ------------ ------------ ----------- -----------
Net cash used in operating activities... (1,289,352) (18,726) (2,107,150) (2,771,915) (1,055,687) (3,126,703)
INVESTING ACTIVITIES
Note receivable--officer................ -- -- -- (62,549) -- (2,443)
Purchases of property and equipment..... (329,831) 1,300 (12,703) (843,700) (32,871) (845,278)
------------ ------------ ------------ ------------ ----------- -----------
Net cash provided by (used in) investing
activities............................ (329,831) 1,300 (12,703) (906,249) (32,871) (847,721)
FINANCING ACTIVITIES
Proceeds from notes payable............. -- 36,879 -- -- -- --
Payments on notes payable............... (15,702) -- (68,994) (9,836) (54,494) --
Payments on capital lease obligations... (19,723) (42,848) (41,977) (113,983) (49,780) (65,393)
Deferred offering costs................. -- -- -- (239,643) -- (524,652)
Proceeds from stock issuances........... 1,680,054 -- 1,000,000 65,600 -- 16,200
Mandatory convertible equity............ -- (45,755) -- -- -- --
Advances from Navarre................... -- -- 1,212,311 4,022,529 1,207,724 4,513,537
------------ ------------ ------------ ------------ ----------- -----------
Net cash provided by (used in) financing
activities............................ 1,644,629 (51,724) 2,101,340 3,724,667 1,103,450 3,939,692
------------ ------------ ------------ ------------ ----------- -----------
Net increase (decrease) in cash and cash
equivalents........................... 25,446 (69,150) (18,513) 46,503 14,892 (34,732)
Cash and cash equivalents at beginning
of period............................. 66,470 91,916 22,766 4,253 4,253 50,756
------------ ------------ ------------ ------------ ----------- -----------
Cash and cash equivalents at end of
period................................ $ 91,916 $ 22,766 $ 4,253 $ 50,756 $ 19,145 $ 16,024
------------ ------------ ------------ ------------ ----------- -----------
------------ ------------ ------------ ------------ ----------- -----------
Supplemental cash flow information
Significant noncash investing and
financing activity:...................
Stock issued for advertising
rights............................ $ -- $ -- $ 1,000,000 $ -- -- --
Fixed assets acquired under capital
lease............................. 405,766 -- -- 25,078 -- 90,617
Notes forgiven by shareholders...... -- -- -- 48,050 -- --
</TABLE>
See accompanying notes.
F-6
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
NetRadio conducts commerce on the Internet by providing a wide range of
music and information to attract visitors to its Web site. After attracting
traffic through its entertaining audio content, the Company leverages that
traffic into revenue from the sale of audio merchandise through its online
store, CDPoint, and Internet advertisements.
The Company's business is characterized by rapid technology change, new
product development and evolving industry standards. Inherent in the Company's
business are various risks and uncertainties, including its limited operating
history, unproven business model and the limited history of commerce on the
Internet. The Company's success may depend in part upon the emergence of the
Internet as a communication medium, prospective product development efforts and
the acceptance of the Company's solutions by the marketplace.
UNAUDITED INTERIM FINANCIAL INFORMATION
The financial information as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited, but includes all adjustments (consisting
only of normal recurring adjustments) that we consider necessary for a fair
presentation of the financial position at these dates and the operations and
cash flows for the periods then ended. Operating results for the six months
ended June 30, 1999 are not necessarily indicative of results that may be
expected for the entire year.
BASIS OF PRESENTATION
NetRadio Corporation, Minnesota ("NetRadio Corporation" or "NetRadio") is a
subsidiary of Navarre Corporation ("Navarre"). NetRadio Corporation, Minnesota
commenced operations on March 21, 1997 upon acquiring the former Net Radio
Corporation, Nevada ("Predecessor"). NetRadio Corporation, Minnesota
individually or collectively with the Predecessor is hereafter referred to as
the "Company."
On March 21, 1997, Navarre, which already held a 50% interest of the
Predecessor, acquired the remaining outstanding shares of the Predecessor by
merging it into NetRadio. In connection with the merger, all outstanding common
stock of the Predecessor was cancelled, leaving Navarre as the owner of all of
the 10,000 outstanding shares of NetRadio. In connection with the acquisition,
Navarre issued 125,000 shares of its common stock to shareholders and affiliates
of the Predecessor and agreed to issue an additional 2,075,000 shares contingent
upon NetRadio achieving specified levels of sales and profits in the two years
following the transaction. NetRadio has not achieved the levels of sales or
profits targeted in the agreement with Navarre and no additional shares have
been issued. The acquisition was accounted for as a purchase. Goodwill of
$1,263,000 recognized at the time of the acquisition by Navarre has been "pushed
down" to NetRadio for financial reporting purposes.
Financial information for the Predecessor at dates and for periods prior to
March 21, 1997 is included at the Predecessor's historical cost basis.
Accordingly, the period from January 1, 1997 to
F-7
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
March 20, 1997 and for the year ended December 31, 1996 are not comparable to
the periods after March 20, 1997.
Certain operating expenses for the six months ended June 30, 1998 have been
reclassified to better compare such expenses with how they are being accounted
for in 1999.
CASH AND CASH EQUIVALENTS
The Company considers all short-term investments with a maturity of three
months or less when purchased to be cash equivalents. Cash equivalents are
carried at cost, which approximates market value.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
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.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets, as
follows:
furniture and fixtures--3 to 5 years
computer equipment and software--3 years
office equipment--3 to 5 years
Equipment under capital leases is stated at the present value of minimum lease
payments and is amortized using the straight-line method over the shorter of the
lease term or the estimated useful lives of the assets.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the assets. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
F-8
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company accounts for income taxes using the liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates to be
applied 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 results of operations in
the period that the tax change occurs. Valuation allowances are established,
when necessary, to reduce deferred tax assets to the amount expected to be
realized.
Net Radio Corporation, Nevada, was an electing S corporation through May 1,
1996. As such, the taxable income or loss of the Company was includable in the
individual returns of its shareholders.
During the period March 21, 1997 through March 31, 1998, NetRadio
Corporation, Minnesota was included in the consolidated federal and state income
tax returns of its parent company, Navarre. The tax benefits of net operating
losses of NetRadio Corporation, Minnesota during that period have been retained
by Navarre and no benefit has been shown to NetRadio since it would not have
been able to recognize any benefit on a stand-alone basis.
REVENUE RECOGNITION
The Company's revenues are derived from the sale of audio merchandise at its
online store and Web site banner and audio advertisements. Product sales,
including shipping and handling, are recognized in the period that the
merchandise is shipped to the customer. Advertising revenues are recognized in
the period in which the advertisement is displayed, provided that no significant
Company obligations remain and collection of the resulting receivable is
probable. Company obligations arising from prepayment of advertising fees were
recorded as deferred revenue. There were no prepaid advertising fees received at
December 31, 1997 and 1998.
Promotional revenues consisted of payments from third parties for the
distribution of coupons and other promotional material. Promotional revenues
were recognized at the time the associated services were completed. Collection
of these revenues occurred through a chargeback, or credit, against the advances
from Navarre. Promotional revenue was included in miscellaneous revenue in the
statement of operations.
INTERNAL SOFTWARE DEVELOPMENT COSTS
Internal software development costs incurred through outside contractors
consisting of costs to develop, test and upgrade the Company's Web site and
systems are capitalized and amortized over the estimated useful life of the
software, typically three years, in accordance with AICPA Statement of Position
98-1 "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Uses."
F-9
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING EXPENSES
Advertising expenses are capitalized during the production phase of specific
commercials or campaigns and charged to operations at the time the campaign is
initially presented to the audience. In addition, television advertising time
contributed by ValueVision International, Inc. (see Note 8) is charged to
operations as the advertising time is used. Advertising expenses, including
prepaid advertising costs charged to operations, were $104,943, $10,966, $90,785
and $71,615 and $212,581 in the year ended December 31, 1996, in the period
January 1, 1997 through March 20, 1997, in the period March 21, 1997 through
December 31, 1997, in the year ended December 31, 1998, in the six months ended
June 30, 1998 and the six months ended June 30, 1999 respectively, and are
included in sales and marketing costs in the accompanying statements of
operations.
DEFERRED OFFERING COSTS
Legal, accounting and registration costs directly related to the anticipated
initial public offering of the Company's common stock have been deferred and
will be offset against the gross proceeds of the offering.
GOODWILL
Goodwill is being amortized on the straight-line method over the estimated
useful life of three years. Accumulated amortization at June 30, 1999, December
31, 1998 and December 31, 1997 was $947,250, $737,000 and $316,000,
respectively. The Company periodically reviews goodwill for impairment in value.
NET LOSS PER COMMON SHARE
Basic earnings per share excludes any dilutive effects of options, warrants
and convertible securities, while diluted earnings per share gives effect to
dilutive potential common shares. Net loss per share for fiscal 1998 has been
presented on the face of the statements of operations. Prior year amounts have
not been presented on the statement of operations due to the recapitalization of
the Company in 1997. All earnings per share amounts for all periods have been
presented in this footnote to conform to the Statement No. 128 requirements.
F-10
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table sets forth the computation of basic and diluted earnings
per share:
In June 1998, the board of directors declared a five hundred-for-one stock
split. All per share, weighted average share, and stock option information has
been adjusted to reflect the five hundred-for-one stock split.
<TABLE>
<CAPTION>
PREDECESSOR THE COMPANY
--------------------------- ----------------------------------------------------------
PERIOD FROM PERIOD FROM
JANUARY 1, MARCH 21, SIX MONTHS
YEAR ENDED 1997 THROUGH 1997 THROUGH YEAR ENDED ENDED
DECEMBER 31, MARCH 20, DECEMBER 31, DECEMBER 31, JUNE 30,
1996 1997 1997 1998 1998 1999
------------- ------------ ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Numerator:
Net loss.............. $ (2,254,028) $ (754,468) $ (1,986,983) $ (3,976,683) $ (1,269,333) $ (5,208,337)
Denominator:
Denominator for basic
loss per share
weighted average
shares.............. 3,304,254 5,254,060 5,882,500 5,899,167 5,882,500 5,923,902
Dilutive securities:
Employee stock
options........... -- -- -- -- -- --
------------- ------------ ------------- ------------- ------------- -------------
Denominator for
diluted loss per
share adjusted
weighted-average
shares.............. 3,304,254 5,254,060 5,882,500 5,899,167 5,882,500 5,923,902
------------- ------------ ------------- ------------- ------------- -------------
------------- ------------ ------------- ------------- ------------- -------------
Basic loss per share.... $ (.68) $ (.14) $ (.34) $ (.67) $ (.22) $ (.88)
------------- ------------ ------------- ------------- ------------- -------------
------------- ------------ ------------- ------------- ------------- -------------
Diluted loss per
share................. $ (.68) $ (.14) $ (.34) $ (.67) $ (.22) $ (.88)
------------- ------------ ------------- ------------- ------------- -------------
------------- ------------ ------------- ------------- ------------- -------------
</TABLE>
2. FINANCIAL CONDITION
Since March 1997, Navarre has provided advances to the Company for working
capital and fixed asset purchases. The Company is currently not generating
operating income or positive cash flows and remains dependent on the continuing
financial support of Navarre. It is Navarre's intention to continue to fund
these cash needs and will not require repayment of the advances in the
foreseeable future until the Company is self-sufficient from funds raised from
an anticipated initial public offering of common stock.
F-11
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
3. RELATED PARTY TRANSACTIONS
ADVERTISING SERVICES
The Company provided advertising services to Navarre. Total services
provided were $312,499, $51,188, $0 and $0, $0 and $0 in the year ended December
31, 1996, in the period January 1, 1997 through March 20, 1997, in the period
March 21, 1997 through December 31, 1997, and in the year ended December 31,
1998 in the six months ended June 30, 1998 and in the six months ended June 30,
1999, respectively.
FULFILLMENT AGREEMENT
Navarre and NetRadio have entered into a five-year fulfillment agreement
(the "Fulfillment Agreement") under which NetRadio will seek to fulfill its
customer purchase orders for certain products from Navarre before any other
fulfillment source. The Fulfillment Agreement governs and describes order
procedures, product returns, shipping procedures, payments and price lists. The
Fulfillment Agreement may be terminated by either party if, among other things,
NetRadio discontinues online sales of pre-recorded music or Navarre discontinues
fulfillment services to online customers.
ADMINISTRATIVE SERVICES
Since March 1997, Navarre has supplied NetRadio with executive services,
certain administrative services such as human resources, marketing, accounting,
payroll, legal, and employee benefits for a fee of $5,000 a month. The Company
believes amounts charged are representative of the level of expense that would
have been incurred on a stand-alone basis.
MULTIPLE ADVANCE TERM NOTE
In February 1999, the Company executed a Multiple Advance Term Note ("Note")
pursuant to which NetRadio will repay Navarre all advances that Navarre has
provided to NetRadio to meet NetRadio's working capital needs and for NetRadio's
other general corporate purposes. The Note is due and payable June 1, 2001 and
bears interest at the prime rate plus one-half percent.
Upon the closing of an anticipated initial public offering of common stock,
Navarre, as part of its Separation Agreement with the Company, will convert
$5,234,840 of the Note to equity of NetRadio. No additional shares of NetRadio
common stock will be issued.
4. OTHER CURRENT ASSETS
Other current assets consist of 14 pre-set channels on RealNetworks, Inc.'s
(RealNetworks) RealPlayer and promotional space on RealNetworks' home page that
the Company acquired in May 1999 in exchange for cash and advertising of
RealNetworks on the Company's website. The Company acquired the one-year right
to the pre-set channels for $560,000 payable in four quarterly payments.
RealNetworks is also obligated, for one year, to promote the Company twice per
month on
F-12
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
4. OTHER CURRENT ASSETS (CONTINUED)
RealNetworks' home page in exchange for $250,000 in RealNetworks advertising on
the Company's website. These assets are being amortized over one year.
5. NOTE RECEIVABLE--OFFICER
The note receivable consists of an advance to an officer which is payable on
demand. The note bears interest at 7.75% per annum beginning December 1999.
Interest will accrue through December 2001, the duration of the note.
6. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1997 1998
----------- ------------ SIX MONTHS ENDED
JUNE 30, 1999
-----------------
(UNAUDITED)
<S> <C> <C> <C>
Furniture and fixtures.......................... $ 129,534 $ 129,534 $ 129,534
Computer equipment and software................. 699,432 1,541,700 2,468,714
Office equipment................................ 11,503 11,503 20,386
----------- ------------ -----------------
840,469 1,682,737 2,618,634
Accumulated depreciation........................ (444,569) (801,259) (1,080,219)
----------- ------------ -----------------
$ 395,900 $ 881,478 $ 1,538,415
----------- ------------ -----------------
----------- ------------ -----------------
</TABLE>
7. NOTES PAYABLE
The notes payable consist of advances from former shareholders repayable at
$4,561 per month. The notes bear interest at 10% and were due in 1998. The
remaining balance due of $48,050 was forgiven by the shareholders in 1998.
Interest paid was $3,563, $9,875, $29,627, $23,442, $12,142 and $10,958 for
the year ended December 31, 1996, for the period January 1, 1997 through March
20, 1997, for the period March 21, 1997 through December 31, 1997 and for the
year ended December 31, 1998 for the six months ended June 30, 1998 and for the
six months ended June 30, 1999, respectively.
8. INCOME TAXES
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $5,000,000. These carryforwards are available to offset future
taxable income, expire beginning 2011, and are subject to the limitations of
Internal Revenue Code Section 382 resulting from changes in ownership.
F-13
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
8. INCOME TAXES (CONTINUED)
Components of deferred income taxes are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
<S> <C> <C>
1997 1998
------------- -----------
Gross deferred tax assets:
Net operating loss carryforwards................................ $ 1,400,000 $ 500,000
------------- -----------
Valuation allowance............................................. (1,400,000) (500,000)
------------- -----------
$ -- $ --
------------- -----------
------------- -----------
</TABLE>
9. CAPITAL STOCK
THE COMPANY
The Company is authorized by its articles of incorporation to issue
20,000,000 shares of common stock, no par value, of which 5,922,500 shares were
outstanding and held of record by six shareholders on December 31, 1998.
Concurrent with Navarre's March 1997 acquisition of NetRadio, ValueVision
International, Inc. ("ValueVision") agreed to an investment in NetRadio,
consisting of $1,000,000 in cash and an agreement to provide $2,000,000 worth of
advertising time on television in exchange for 1,765 shares (pre-split, 882,500
shares post-split) of NetRadio common stock. ValueVision is an integrated
electronic and print media direct marketing company and operates a television
home shopping network. For financial reporting purposes, the advertising time
was valued at $1 million at the time of the transaction. Before NetRadio can
offer merchandise not distributed by Navarre or NetRadio prior to March 1997
(music and software), ValueVision has the right to distribute such merchandise
provided that ValueVision offers NetRadio similar terms as those of another
vendor.
ValueVision also had certain preemptive rights which entitled it to purchase
additional shares of NetRadio securities. If NetRadio achieves net revenues
(excluding revenues from product sales) equal to $3,000,000 in any 12-month
period, NetRadio has the right to require ValueVision to purchase for $500,000,
additional shares of common stock equal to 4.95% of NetRadio's outstanding
common stock and ValueVision has a similar right to purchase 4.95% percent of
the outstanding common stock for $500,000. NetRadio and ValueVision have agreed
to cancel these rights in connection with the issuance of 550,000 shares of
NetRadio for $500,000 concurrent with the closing of an initial public offering
by NetRadio.
PREDECESSOR
In May 1996, Net Radio Corporation, Nevada issued 2,085,815 shares of common
stock to Navarre in exchange for $1,000,000 and a $500,000 note receivable
valued at $479,804.
F-14
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
10. STOCK OPTIONS AND GRANTS
All stock option plans prior to the 1998 plan were terminated at the time of
the acquisition by Navarre in March 1997. No options were granted during fiscal
1997.
Pursuant to the 1996 and 1997 exercise of warrants and stock options, the
Company issued 1,082,430 shares of common stock to former shareholders under
non-recourse notes. The notes bore interest at 6% and extended for a term of 27
months upon execution of the note agreement. A subscription receivable of
$659,000 related to these shares was recorded at the time the notes were
executed in 1996. The note agreements were amended at the time of Navarre's
acquisition of the remaining 50% of the Company in March 1997, whereby a certain
pool of Navarre shares will be distributed upon payment of the notes.
In June 1998, the board of directors adopted, and the shareholders approved
the NetRadio Corporation 1998 Stock Option and Incentive Plan (the "1998 Stock
Option Plan") pursuant to which officers, employees, consultants, independent
contractors and non-employee directors are eligible to receive options to
purchase shares of NetRadio common stock, stock appreciation rights and awards
of deferred or restricted stock. A total of 1,475,000 shares of common stock may
be issued under the 1998 Stock Option Plan with vesting periods of up to five
years and maximum option terms of ten years. In February 1999, the board of
directors approved an increase in the number of shares reserved under the 1998
Stock Option Plan from 1,475,000 to 2,000,000 shares.
Option activity for the year ended 1998 and for the six months ended June
30, 1999 is summarized as follows:
<TABLE>
<CAPTION>
PLAN OPTIONS WEIGHTED
AVAILABLE PLAN OPTIONS AVERAGE
FOR GRANT OUTSTANDING EXERCISE PRICE
------------ ------------ ---------------
<S> <C> <C> <C>
Balance on December 31, 1997...................... -- -- --
Shares reserved................................. 1,475,000 -- --
Granted......................................... (939,500) 939,500 $ 2.27
------------ ------------
Balance on December 31, 1998...................... 535,500 939,500 $ 2.27
Shares reserved................................... 525,000
Granted........................................... (307,350) 307,350 $ 5.00
Forfeited......................................... 31,600 (31,600) $ 3.00
Exercised......................................... (5,400) $ 3.00
------------ ------------ -----
Balance on June 30, 1999 (unaudited).............. 784,750 1,209,850 $ 3.14
------------ ------------ -----
------------ ------------ -----
</TABLE>
The weighted average fair value of options granted in 1998 was $1.37. The
exercise price of options outstanding at December 31, 1998 ranged from $1.64 to
$5.00 per share. The number of options exercisable at December 31, 1998 was
117,333 with a weighted average remaining contractual life of 6.5 years.
F-15
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
10. STOCK OPTIONS AND GRANTS (CONTINUED)
Pro forma information regarding net income (loss) and earnings (loss) per
share is required by Statement 123, and has been determined as if the Company
had accounted for its employee stock options under the fair value method of
Statement 123. The fair value for these options was estimated at the date of
grant using the Black Scholes option pricing model with the following weighted
average assumptions for 1998: risk-free interest rate of 4.7%, volatility of the
expected market price of the Company's common stock of 70% and a weighted
average expected life of the option of five years. The volatility used in the
model was based upon the volatility of other publicly traded companies in
similar industries.
The Black Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value statement, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1998
-------------
<S> <C>
Pro forma net loss............................................................. $ (4,123,837)
Pro forma basic and diluted loss per share..................................... $ (.70)
</TABLE>
The Company has granted 20,000 options to a non-employee. The fair value on
the date of grant of the option was treated as expense and was $20,500 in 1998.
In March 1999 NetRadio recognized $879,625 in compensation expense
associated with the issuance of incentive stock options to employees with strike
prices below the estimated fair market value of the Company's common stock on
the date of grant.
EMPLOYMENT AGREEMENTS
As of December 31, 1998, the Company had entered into employment agreements
with four executives. The term of three of the agreements commenced on August 1,
1998 and ends on July 31, 2000. The term of the fourth agreement commenced on
August 31, 1998 and ends on August 30, 2001. One executive will receive a
one-time $20,000 bonus upon completion of an initial public offering, and three
executives will each receive a one-time $10,000 bonus upon completion of an
initial public offering. The employment agreements further provide that each
executive is eligible to receive an annual performance bonus of up to 40% of his
base salary if the Company achieves certain operating objectives.
F-16
<PAGE>
NETRADIO CORPORATION AND PREDECESSOR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996, THE PERIODS FROM JANUARY 1, 1997 THROUGH
MARCH 20, 1997 AND MARCH 21, 1997 THROUGH DECEMBER 31, 1997 AND
THE YEAR ENDED DECEMBER 31, 1998 AND THE SIX MONTHS
ENDED JUNE 30, 1998 AND 1999 (UNAUDITED)
11. COMMITMENTS
The Company is obligated under operating and capital leases for office space
and office equipment. Future annual minimum lease payments under leases in
effect at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
----------- ----------
<S> <C> <C>
1999.................................................................. $ 16,275 $ 120,084
2000.................................................................. -- 84,673
2001.................................................................. -- 58,107
2002.................................................................. -- --
----------- ----------
Total minimum lease payments.......................................... $ 16,275 262,864
-----------
-----------
Less amount representing interest..................................... (37,794)
----------
Present value of minimum capital lease payments....................... $ 225,070
----------
----------
</TABLE>
Rent expense under the operating leases was $54,717, $32,605, $79,852 and
$134,491, in the year ended December 31, 1996, in the period January 1, 1997
through March 20, 1997, in the period March 21, 1997 through December 31, 1997
and in the year ended December 31, 1998, respectively.
F-17
