<PAGE>
As filed with the Securities and Exchange Commission on July 8, 1999
Registration No. 333-77707
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
Under The Securities Act of 1933
---------------
LIQUID AUDIO, INC.
(Exact name of Registrant as specified in its charter)
---------------
<TABLE>
<CAPTION>
Delaware 7373 77-0421089
<S> <C> <C>
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
810 Winslow Street
Redwood City, CA 94063
(650) 549-2000
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
---------------
GERALD W. KEARBY
Chief Executive Officer
LIQUID AUDIO, INC.
810 Winslow Street
Redwood City, CA 94063
(650) 549-2000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
---------------
Please send copies of all communications to:
HANK V. BARRY, ESQ. LAIRD H. SIMONS, III, ESQ.
ISSAC J. VAUGHN, ESQ. ROBERT A. FREEDMAN, ESQ.
KELLY AMES MOREHEAD, ESQ. SCOTT J. LEICHTNER, ESQ.
Wilson Sonsini Goodrich & Rosati, Fenwick & West LLP
P.C. Two Palo Alto Square
650 Page Mill Road Palo Alto, CA 94306
Palo Alto, CA 94304 (650) 494-0600
(650) 493-9300
---------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration Statement.
---------------
If the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), please check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in the prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion dated July 8, 1999
PROSPECTUS
3,600,000 Shares
[LIQUID AUDIO LOGO]
Common Stock
- --------------------------------------------------------------------------------
This is our initial public offering of shares of common stock. We are
offering 3,600,000 shares. No public market currently exists for our shares.
We propose to list the shares on the Nasdaq National Market under the symbol
"LQID." Anticipated price range of $10 to $12 per share.
Investing in the shares involves risks. "Risk Factors" begin on page 7.
<TABLE>
<CAPTION>
Per
Share Total
----- -----
<S> <C> <C>
Public Offering Price............................................... $ $
Underwriting Discount............................................... $ $
Proceeds to Liquid Audio............................................ $ $
</TABLE>
We have granted the underwriters a 30-day option to purchase up to 540,000
additional shares of common stock on the same terms and conditions as set forth
above solely to cover over-allotments, if any.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is accurate or complete. Any representation to the contrary is
a criminal offense.
Lehman Brothers expects to deliver the shares on or about , 1999.
- --------------------------------------------------------------------------------
Lehman Brothers
BancBoston Robertson Stephens
U.S. Bancorp Piper Jaffray
, 1999
<PAGE>
[INSIDE FRONT COVER]
Music is encoded using the Liquifier Pro software and is published to Liquid
Servers through multiple data centers.
Music is syndicated and promoted over the Internet through the Liquid Music
Network and, in the future, to online retailers through RIFFS.
Consumers preview, purchase and download music to their computer using the
Liquid Player software. Music can be recorded on a recordable compact disc or,
in the future, to portable consumer digital devices. We also provide e-
commerce and reporting services for artists and labels for digital music
sales.
[GRAPHIC DEPICTING OUR PLATFORM]
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Use of Proceeds.......................................................... 19
Dividend Policy.......................................................... 19
Capitalization........................................................... 20
Dilution................................................................. 21
Selected Financial Data.................................................. 22
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 23
Business................................................................. 34
Management............................................................... 52
Related Party Transactions............................................... 59
Principal Stockholders................................................... 60
Description of Capital Stock............................................. 62
Shares Available for Future Sale......................................... 65
Underwriting............................................................. 66
Legal Matters............................................................ 68
Experts.................................................................. 68
Available Information.................................................... 68
Index to Financial Statements............................................ F-1
</TABLE>
ABOUT THIS PROSPECTUS
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of common stock.
This preliminary prospectus is subject to completion prior to this offering.
Among other things, this preliminary prospectus describes our company as we
currently expect it to exist at the time of this offering.
See the section of this prospectus entitled "Risk Factors" for a discussion
of certain factors that you should consider before investing in the common
stock offered in this prospectus.
Certain statements under the captions "Prospectus Summary," "Risk Factors,"
"Use of Proceeds," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business" and elsewhere in this prospectus are
forward-looking statements. These forward-looking statements include, but are
not limited to, statements about our plans, objectives, expectations and
intentions and other statements contained in the prospectus that are not
historical facts. When used in this prospectus, the words "expects,"
"anticipates," "intends," "plans," "believes," "seeks" and "estimates" and
similar expressions are generally intended to identify forward-looking
statements. Because these forward-looking statements involve risks and
uncertainties, there are important factors that could cause actual results to
differ materially from those expressed or implied by these forward-looking
statements, including our plans, objectives, expectations and intentions and
other factors discussed under "Risk Factors."
All trademarks and trade names appearing in this prospectus are the property
of their respective holders.
Until , 1999, all dealers selling shares of the common stock, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to the obligation of dealers to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our financial statements and notes to those statements appearing
elsewhere in this prospectus.
Except as otherwise indicated, all information in this prospectus assumes
that the underwriters do not exercise the option granted by Liquid Audio to
purchase additional shares in this offering and assumes the conversion of all
of our preferred stock into common stock upon the closing of this offering. See
"Underwriting."
Liquid Audio
We provide a leading open platform that enables the digital delivery of music
over the Internet. Our open platform is a comprehensive, flexible solution
comprised of software products and services that gives artists, record
companies, websites and retailers the ability to create, syndicate and sell
recorded music with copy protection and copyright management. Through our
Liquid Music Network website affiliates, we help artists and record companies
promote and sell their recorded music. From our growing catalog of syndicated
music, consumers can preview and purchase digital music. Consumers then can
transfer downloaded music to recordable compact discs and, later in 1999, to
digital consumer devices.
Our solution is based on an open technical architecture, which means that it
is designed to support multiple leading digital music formats, including mp3
(an audio compression format developed by the Fraunhofer Institut) and Dolby
AC-3 (an audio compression format developed by Dolby Laboratories, Inc.). These
formats use compression technology to reduce the size of audio files,
facilitating the digital delivery of music over the Internet. Numerous
recording artists and record companies have used our platform to promote music
releases including BMG North America, Capitol Records, Columbia House,
Dreamworks Records, EMI Classics, Bruce Hornsby, The Dave Matthews Band, Sarah
McLachlan and Rounder Records.
The recorded music industry, which was approximately $38.7 billion worldwide
in 1998, represents one of the largest opportunities for online digital
delivery and commerce. The growing popularity of music on the Internet,
combined with recent technology advances, has made the Internet a compelling
medium for digital music delivery. Forrester Research has estimated that sales
of recorded music through digital transmission will grow from less than 1% of
all recorded music sales in the United States in 1999 to 7% of these sales in
2003.
We believe we are the first company to offer a complete, commercially-
available solution for the digital delivery of music over the Internet. Our
"end-to-end" solution facilitates the digital delivery of music from the point
where a musician prepares music for delivery over the Internet, through
transmission, to the point where the consumer downloads and listens to it. We
began licensing our software in March 1997 and our comprehensive solution that
incorporates the Liquid Music Network became commercially available in July
1998. Our platform, which has generated approximately $3.6 million of revenue
through March 31, 1999, provides the following benefits:
. Superior Consumer Experience. We make it simple for consumers to search
for, sample and buy digital music recordings from our growing catalog of
syndicated music.
. Global Reach. Our platform allows artists, record companies and retailers
to use the Internet as an additional global distribution channel to reach
more consumers.
. Increased Revenues and Lower Costs. Record companies and artists can
increase their revenues by offering consumers their entire catalog of
music online and achieve significant cost savings by reducing costs
associated with manufacturing, warehousing and shipping.
. Security and Compliance. Our platform protects against piracy by offering
copyright management and copy protection for songs. Our services are able
to restrict digital sales to consumers within specified geographic areas,
enabling resellers to comply with distribution restrictions.
3
<PAGE>
We offer artists, record companies and websites a range of products and
services for creating, syndicating and selling music digitally over the
Internet.
. Create Music. Our Liquifier Pro software product encodes, or prepares,
music for delivery over the Internet. Encoded music is published to our
Liquid Server software product, which manages the secure digital transfer
and sale of music to consumers. We also offer complete turnkey digital
music encoding and hosting services to artists and record companies.
. Syndicate Music. We help artists reach more consumers and sell more music
by syndicating their music for sale through our growing network of Liquid
Music Network affiliates, which is a group of over 200 music-related
websites and music retailer websites.
. Sell Music. Using our Liquid Player desktop software product, consumers
can preview, purchase and digitally download music to their computers.
Music can then be transferred to a recordable compact disc or, in the
future, to portable digital consumer devices. We also provide e-commerce
and reporting services for artists and labels for digital music sales.
Our objective is to be the premier enabling platform for the digital delivery
of music over the Internet. Our strategies include:
.Providing a Superior Consumer Experience;
. Continuing to Broaden our Distribution Reach;
. Expanding Syndicated Music Content;
. Extending Technology Leadership; and
. Generating Multiple Revenue Streams.
Since early 1999, we have increased our emphasis on developing and marketing
our digital delivery services. Many independent record labels have chosen to
use our solution for promotion and sale of their music, including Beggars
Banquet, Rounder Records, Rykodisc, Sub Pop Records and Twin/Tone Records. We
have increased the number of these syndicated music recordings for sale from
approximately 5,000 at the beginning of 1999 to more than 60,000 committed as
of June 30, 1999. In addition, in the second half of 1999, our Liquid Music
Network will begin offering syndicated music through music retailer websites.
We have established relationships with industry leaders to build brand
recognition and enhance our content creation, syndication and sales
opportunities worldwide. Our relationships include: Adaptec; Amazon.com; Dolby
Laboratories; EMI Recorded Music; Intel; Muze; RealNetworks; Sanyo; Texas
Instruments; Toshiba and Towerrecords.com. We have also established
international alliances in Korea and Japan to build our presence and
infrastructure outside the United States.
We currently generate the majority of our revenues from software product
licensing fees and business development agreements to establish our presence
internationally. As we expand our music delivery services, we expect to
generate increasing revenues from the following areas:
. Digital music downloads to consumers;
. Hosting and e-commerce services for artists; and
. Advertising and sponsorships.
Less than 1% of our total net revenues was attributable to our music delivery
services in the year ended December 31, 1998 and the three months ended March
31, 1999. Our accumulated deficit as of March 31, 1999 was approximately $20.2
million. In addition, we had net losses of approximately $8.5 million in 1998
and $4.1 million in the first quarter of 1999. Given our planned operating and
capital expenditures, we expect to continue to incur losses and negative cash
flows through at least 2002.
We incorporated in California in January 1996 and reincorporated in Delaware
in April 1999. Our principal executive offices are located at 810 Winslow
Street, Redwood City, California 94063. Our phone number is (650) 549-2000 and
our internet address is www.liquidaudio.com. Information contained on our
website does not constitute a part of this prospectus.
4
<PAGE>
The Offering
<TABLE>
<C> <S>
Common stock offered by Liquid Audio.. 3,600,000 shares
Common stock outstanding after the
offering............................. 17,507,064 shares
Use of proceeds....................... We estimate that we will receive net
proceeds from this offering of
$35,878,000, or $41,402,200 if the
underwriters exercise their over-
allotment option in full. We expect to
use the net proceeds for general
corporate purposes, including working
capital and capital expenditures,
enhancing research and development and
attracting key personnel. See "Use of
Proceeds."
Proposed Nasdaq National Market
symbol............................... "LQID"
</TABLE>
In addition to the 17,507,064 shares of common stock to be outstanding after
the offering, as of June 15, 1999 we may issue additional shares of common
stock under the following plans and arrangements:
. 2,595,252 shares issuable under our 1996 Equity Incentive Plan,
consisting of:
. 891,119 shares underlying options outstanding at a weighted average
exercise price of $1.25 per share, of which 886,119 were exercisable;
and
. 1,704,133 shares available for future grants;
. 461,913 shares issuable upon the exercise of warrants outstanding at a
weighted average exercise price of $6.36 per share; and
. 500,000 shares available for issuance under our 1999 Employee Stock
Purchase Plan.
5
<PAGE>
Summary Financial Data
The following table summarizes the financial data of our business. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The financial results as of March 31, 1999 and for the three
months ended March 31, 1998 and 1999 are unaudited.
<TABLE>
<CAPTION>
Period From
January 30,
1996 (inception) Year Ended Three Months
Through December 31, Ended March 31,
December 31, --------------------- ---------------------
1996 1997 1998 1998 1999
---------------- --------- ---------- --------- ----------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Total net revenues...... $ -- $ 256 $ 2,803 $ 224 $ 531
Gross profit (loss)..... -- (137) 2,034 71 204
Net loss................ (1,264) (6,216) (8,539) (1,985) (4,143)
Basic and diluted net
loss per share......... $(14.93) $ (4.95) $ (3.60) $ (0.99) $ (1.39)
Shares used in per share
calculation............ 84,635 1,256,114 2,370,564 1,998,865 2,972,398
Pro forma basic and
diluted net loss per
share.................. $(0.85) $(0.33)
Shares used in pro forma
per share
calculation............ 10,041,546 12,716,597
</TABLE>
The following table provides a summary of our balance sheet as of March 31,
1999. The pro forma column gives effect to the conversion of all outstanding
shares of preferred stock into common stock upon the closing of this offering.
The pro forma as adjusted column reflects the sale of 3,600,000 shares of
common stock in this offering at an assumed initial public offering price of
$11.00 per share and after deducting the estimated underwriting discount and
offering expenses payable by us. See "Use of Proceeds" and "Capitalization."
<TABLE>
<CAPTION>
As of March 31, 1999
-------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents..................... $ 15,497 $15,497 $51,375
Working capital............................... 11,708 11,708 47,586
Total assets.................................. 17,729 17,729 53,607
Long-term debt................................ 1,519 1,519 1,519
Mandatorily redeemable convertible preferred
stock and warrants........................... 29,801 -- --
Total stockholders' equity (deficit).......... (17,851) 11,950 47,828
</TABLE>
6
<PAGE>
RISK FACTORS
You should carefully consider the risks described below before making a
decision to buy our common stock. The risks and uncertainties described below
are not the only ones we face. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial may also impair our business
operations. If any of the following risks actually occurs, our business could
be harmed. In that case, the trading price of our common stock could decline,
and you might lose all or part of your investment. You should also refer to the
other information set forth in this prospectus, including our financial
statements and the related notes.
Risks Related to Our Business
Our Limited Operating History in the New Market of Digital Delivery of Music
Over the Internet Increases the Possibility that the Value of Your Investment
Will Decline
We incorporated in January 1996. We did not start generating revenues until
the first quarter of 1997. In early 1999, we began to place greater emphasis on
developing and marketing our digital music delivery services. Accordingly, we
are still in the early stages of development and have only a limited operating
history upon which you can evaluate our business. You should evaluate our
chances of financial and operational success in light of the risks,
uncertainties, expenses, delays and difficulties associated with starting a new
business, many of which may be beyond our control.
Fluctuations in Our Quarterly Revenues and Operating Results Might Lead to
Reduced Prices for Our Stock
Our quarterly results of operation have varied in the past, and you should
not rely on quarter-to-quarter comparisons of our results of operations as an
indication of our future performance. In some future periods, our results of
operations are likely to be below the expectations of public market analysts
and investors. In this event, the price of our common stock would likely
decline. Factors that have caused our results to fluctuate in the past and that
are likely to affect us in the future including the following:
. competition for consumers from traditional retailers as well as providers
of online music services;
. the announcement and introduction of new products and services by us and
our competitors;
. our ability to increase the number of websites that will use our platform
for digital music delivery;
. the timing of our partners' introduction of new products and services for
digital music sales; and
. variability and length of the sales cycle associated with our product and
service offerings.
In addition, other factors may also affect us, including:
. market adoption and growth of sales of digitally downloaded recorded
music over the Internet;
. our ability to attract significant numbers of music recordings to be
syndicated in our format;
. market acceptance of new and enhanced versions of our products and
services;
. our ability to provide reliable and scalable service, including our
ability to avoid potential system failures; and
. the price and mix of products and services we offer.
Some of these factors are within our control and others are outside of our
control.
7
<PAGE>
We Have a History of Losses, We Expect Losses to Continue and We Might Not
Achieve or Maintain Profitability
Our accumulated deficit as of March 31, 1999 was approximately $20.2 million.
We had net losses of approximately $8.5 million in 1998 and $4.1 million in the
first quarter of 1999. Given the level of our planned operating and capital
expenditures, we expect to continue to incur losses and negative cash flows
through at least 2002. Even if we ultimately do achieve profitability, we may
not be able to sustain or increase profitability on a quarterly or annual
basis. If our revenues grow more slowly than we anticipate, or if our operating
expenses exceed our expectations and cannot be adjusted accordingly, our
business will be harmed. See "Selected Financial Data" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
If We Do Not Increase the Number of Websites That Use Our Platform, Our
Business Will Not Grow
In order to grow our business, we need to increase the number of websites,
including websites operated by music retailers, that use our technology and our
syndicated content to digitally deliver recorded music. To increase the number
of websites, we must do the following:
. offer competitive products and services that meet industry standards;
. attract more music content;
. make it easy and cost-effective for music-related websites to sell
digital music;
. develop relationships with online retailers, music websites, online
communities, broadband providers and Internet broadcasters; and
. develop relationships with international music websites, retailers and
broadband providers.
Any failure to achieve one or more of these objectives would harm our
business. We may not be successful in achieving any of these objectives.
We also intend to increase our expenditures on marketing the Liquid Audio
brand because we believe brand awareness will be critical to increasing our
affiliates and end-user awareness. If we do not increase our revenues as a
result of our branding and other marketing efforts or if we otherwise fail to
promote our brand successfully, our business would be harmed.
If Artists and Record Labels Are Not Satisfied That They Can Securely Digitally
Deliver Their Music Over the Internet, We Might Not Have Sufficient Content to
Attract Consumers
Our success depends on our ability to aggregate a sufficient amount and
variety of digital recorded music for syndication. In particular, until a
significant number of artists and their record labels adopt a strategy of
digitally delivering music over the Internet, the growth of our business might
be limited. We currently do not create our own content; rather, we rely on
record companies and artists for digital recorded music to be syndicated using
our format. We believe record companies will remain reluctant to distribute
their recorded music digitally unless they are satisfied that the digital
delivery of their music over the Internet will not result in the unauthorized
copying and distribution of that music. If record companies do not believe that
recorded music can be securely delivered over the Internet, they will not allow
the digital distribution of their recorded music and we might not have
sufficient content to attract consumers. If we cannot offer a sufficient amount
and variety of digital recorded music for syndication, our business might be
harmed.
8
<PAGE>
Due to the Many Factors that Influence Market Acceptance, Consumers Might Not
Accept Our Platform
Our success will depend on growth in consumer acceptance of our platform as a
method for digital delivery of recorded music over the Internet. Factors that
might influence market acceptance of our platform include the following, over
which we have little or no control:
. the availability of sufficient bandwidth on the Internet to enable
consumers to download digital recorded music rapidly and easily;
. the willingness of consumers to invest in computer technology that
facilitates the downloading of digital music;
. the cost of time-based Internet access;
. the number and variety of digital recordings available for purchase
through our system relative to those available through other online
digital delivery companies, digital music websites or through traditional
physical delivery of recordings;
. the availability of portable devices to which digital recorded music can
be transferred;
. the fidelity and quality of the sound of the digital recorded music; and
. the level of consumer comfort with the process of downloading and paying
for digital music over the Internet, including ease of use and lack of
concern about transaction security.
The Market for Digital Delivery of Music Over the Internet is Highly
Competitive, and if We Cannot Compete Effectively, Our Revenues Might Decline
Competition among companies in the business of digital delivery of music over
the Internet is intense. If we do not compete effectively or if we experience
pricing pressures, reduced margins or loss of market share resulting from
increased competition, our business might be harmed.
Competition is likely to increase as new companies enter the market and
current competitors expand their products and services. Many of these potential
competitors are likely to enjoy substantial competitive advantages, including
the following:
. larger audiences;
. larger technical, production and editorial staffs;
. greater brand recognition;
. access to more recorded music content;
. a more established Internet presence;
. a larger advertiser base; and
. substantially greater financial, marketing, technical and other
resources.
See "Business--Competition."
If Standards for the Secure Digital Delivery of Recorded Music Are Not Adopted,
the Piracy Concerns of Record Companies and Artists Might Not Be Satisfied, and
They Might Not Use Our Platform for Digital Delivery of Their Music
Because other digital recorded music formats, such as mp3, do not contain
mechanisms for tracking the source or ownership of digital recordings, users
are able to download and distribute unauthorized or "pirated"
9
<PAGE>
copies of copyrighted recorded music over the Internet. This piracy is a
significant concern to record companies and artists, and is the reason many
record companies and artists are reluctant to digitally deliver their recorded
music over the Internet. The Secure Digital Music Initiative (SDMI) is a
committee formed by the Recording Industry Association of America (RIAA) to
propose a standard format for the secure digital delivery and use of recorded
music. If a standard format is not adopted, however, pirated copies of recorded
music will continue to be available on the Internet, and record companies and
artists might not permit the digital delivery of their music. Additionally, as
long as pirated recordings are available, many consumers will choose free
pirated recordings rather than paying for legitimate recordings. Accordingly,
if a standard format for the secure digital delivery of music is not adopted,
our business might be harmed.
We have designed our current products to be adaptable to different music
industry and technology standards. Numerous standards in the marketplace,
however, could cause confusion as to whether our products and services are
compatible. If a competitor were to establish the dominant industry standard,
our business would be harmed.
If Our Platform Does Not Provide Sufficient Rights Reporting Information,
Record Companies and Artists Are Unlikely to Digitally Deliver Their Recorded
Music Using Our Platform
Record companies and artists must be able to track the number of times their
recorded music is downloaded so that they can make appropriate payments to
music rights organizations, such as the American Society of Composers, Authors
and Publishers, Broadcast Music Incorporated and SESAC, Inc. If our products
and services do not accurately or completely provide this rights reporting
information, record companies and artists might not use our platform to
digitally deliver their recorded music, and our business might be harmed.
Our Business Might Be Harmed if We Fail to Price Our Products and Services
Appropriately
The price of Internet products and services is subject to rapid and frequent
change. We may be forced for competitive or technical reasons to reduce or
eliminate prices for certain of our products or services. If this happens, our
business might be harmed.
If Our Relationships With Our International Partners Terminate, Our Revenues
Might Decline
We derive a portion of our revenues from business development fees generated
from relationships with our international partners, SK Group and Super Stage.
These relationships vary in size and scope. If one of these relationships, or
any other relationship that accounts for a significant portion of our revenues
in a given period, does not generate a similar amount of revenue, or any, in
subsequent periods, then our business could be harmed. As a consequence, our
revenues are not recurring from period-to-period, which might result in
unpredictability of our revenues.
Our Revenues Would Be Negatively Affected by the Loss of a Significant Customer
We have derived, and we believe that we will continue to derive, a
substantial portion of our net revenues from a limited number of customers and
projects. Our ten largest customers for the four quarters of 1998 represented
approximately 81%, 96%, 89%, and 88%, respectively, of our total net revenues.
The loss of Liquid Audio Japan, Liquid Audio Korea or Adaptec, Inc. or any
other significant customer or any significant reduction of total net revenues
generated by these or other significant customers would harm our business. The
volume of products or services we sell to specific customers is likely to vary
year to year, and a major customer in one year may not use our services in a
subsequent year. A customer's decision not to use our services in a subsequent
year might harm our business.
We Might Not Be Able to Scale Our Technology Infrastructure to Meet Demand for
Our Products and Services
Our success will depend on our ability to scale our technology infrastructure
to meet the demand for our products and services. Adding this new capacity will
be expensive, and we might not be able to do so
10
<PAGE>
successfully. In addition, we might not be able to protect our new or existing
data centers from unexpected events as we scale our systems. To the extent that
we do not address any capacity constraints effectively, our business would be
harmed.
We Might Not Be Successful In Our Attempts to Keep Up With Rapid Technological
Change and Evolving Industry Standards
The markets for our products and services are characterized by rapidly
changing technology, evolving industry standards, changes in customer needs,
emerging competition, and frequent new product and service introductions. Our
future success will depend, in part, on our ability to:
. use leading technologies effectively;
. continue to develop our strategic and technical expertise;
. enhance our current products and services;
. develop new products and services that meet changing customer needs;
. advertise and market our products and services; and
. influence and respond to emerging industry standards and other
technological changes.
This must be accomplished in a timely and cost-effective manner. We may not
be successful in effectively using new technologies, developing new products or
services or enhancing our existing products or services on a timely basis.
These new technologies or enhancements may not achieve market acceptance. Our
pursuit of necessary technological advances may require substantial time and
expense. Finally, we may not succeed in adapting our services to new
technologies as they emerge.
Companies Might Not Develop or Consumers Might Not Adopt Devices That Will Play
Digitally Downloaded Music
We believe that the market for digital recorded music delivered over the
Internet will not develop significantly until consumers are able to enjoy this
music other than solely through the use of a personal computer. Several
consumer electronics companies have introduced or announced plans to introduce
devices that will allow digital music delivered over the Internet to be played
away from the personal computer. If companies fail to introduce additional
devices, consumers do not adopt these devices or our products and services are
incompatible with these devices, our business would be harmed. In addition,
digital music can be transferred to a compact disc, but that transfer requires
a compact disc recorder (CD-R). Many desktop computer manufacturers offer CD-Rs
in their computers. If companies do not continue to offer CD-Rs in their
computers, consumers do not adopt CD-Rs or our products and services are
incompatible with CD-Rs, our business might be harmed.
We Might Not Be Successful in the Development and Introduction of New Products
and Services
We depend in part on our ability to develop new or enhanced products and
services in a timely manner and to provide new products and services that
achieve rapid and broad market acceptance. We may fail to identify new product
and service opportunities successfully and develop and bring to market new
products and services in a timely manner. In addition, product innovations may
not achieve the market penetration or price stability necessary for
profitability.
As the online medium continues to evolve, we plan to leverage our technology
by developing complementary products and services as additional sources of
revenue. Accordingly, we may change our business model to take advantage of new
business opportunities, including business areas in which we do not have
extensive experience. For example, we recently focused on, and will continue to
devote significant resources to, the development of digital music delivery
services, as well as our software licensing business. If we fail to develop
these or other businesses successfully, our business would be harmed.
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<PAGE>
We Might Experience Delays in the Development of New Products and Services
We must continue to innovate and develop new versions of our software to
remain competitive in the market for digital delivery of recorded music
solutions. Our software products and services development efforts are
inherently difficult to manage and keep on schedule. Our failure to manage and
keep those development projects on schedule might harm our business.
Our Products and Services Might Contain Errors
We offer complex products and services. They may contain undetected errors
when first introduced or when new versions are released. If we market products
and services that have errors or that do not function properly, then we may
experience negative publicity, loss of or delay in market acceptance, or claims
against us by customers, any of which might harm our business.
We Might Have Liability for the Content of the Recorded Music that We Digitally
Deliver
Because we digitally deliver recorded music to third parties, we might be
sued for negligence, copyright or trademark infringement or other reasons.
These types of claims have been brought, sometimes successfully, against
providers of online products and services in the past. Others could also sue us
for the content that is accessible from our website through links to other
websites. These claims might include, among others, claims that by hosting,
directly or indirectly, the websites of third parties, we are liable for
copyright or trademark infringement or other wrongful actions by these third
parties through these websites. Our insurance may not adequately protect us
against these types of claims and, even if these claims do not result in
liability, we could incur significant costs in investigating and defending
against these claims.
We have taken steps to prevent these claims. For example, we have
arrangements with companies that use our hosting services that will allow us to
delete potentially infringing or misappropriating materials quickly and
securely. We also have put into place indemnification agreements with music
content providers, where practicable. Under the Digital Millenium Copyright Act
of 1999, Internet service providers are insulated from several types of these
claims, upon compliance with the requirement that they appoint an agent to
receive claims relating to their service, and we intend to appoint an agent.
In 1998, Congress passed the Internet Freedom Act, which imposes a three-year
moratorium on state and local taxes on Internet-based transactions. We cannot
assure you that this moratorium will be extended. Failure to renew this
moratorium would allow various states to impose taxes on e-commerce, which
might harm our business.
Several of Our Customers Have Had Limited Operating Histories, are Unprofitable
and Might Have Difficulty Meeting Their Payment Obligations to Us
Several of our significant customers, including our international partners
Liquid Audio Japan and Liquid Audio Korea, have had limited operating histories
and have not achieved profitability. We believe that this will be true of other
customers in the future. You should evaluate the ability of these companies to
meet their payment obligations to us in light of the risks, expenses and
difficulties encountered by companies with limited operating histories. If one
or more of our customers were unable to pay for our services in the future, or
paid more slowly than we anticipate, our business might be harmed. As of March
31, 1999, 97% of trade accounts receivable, or $320,492, was more than 30 days
past due. We have provided adequate reserves for past due amounts.
System Failures or Delays Might Harm Our Business
Our operations depend on our ability to protect our computer systems against
damage from fire, water, power loss, telecommunications failures, computer
viruses, vandalism and other malicious acts, and similar unexpected adverse
events. Interruptions or slowdowns in our services have resulted from the
failure of our telecommunications providers to supply the necessary data
communications capacity in the time frame we
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<PAGE>
required, as well as from deliberate acts. Despite precautions we have taken,
unanticipated problems affecting our systems could in the future cause
temporary interruptions or delays in the services we provide. Our customers
might become dissatisfied by any system failure or delay that interrupts our
ability to provide service to them or slows our response time. Sustained or
repeated system failures or delays would affect our reputation, which would
harm our business. Slow response time or system failures could also result from
straining the capacity of our software or hardware due to an increase in the
volume of products and services delivered through our servers. While we carry
business interruption insurance, it might not be sufficient to cover any
serious or prolonged emergencies, and our business might be harmed.
We Might Be Unable to License or Acquire Technology
We rely on certain technologies that we license or acquire from third
parties, including Dolby Laboratories Licensing Corporation, Fraunhofer
Institut and RSA Data Security, Inc. These technologies are integrated with our
internally-developed software and used in our products, to perform key
functions and to enhance the value of our platform. These third-party licenses
or acquisitions may not continue to be available to us on commercially
reasonable terms or at all. Any inability to acquire such licenses or software
on commercially reasonable terms might harm our business.
Our Future Success Depends on Our Key Personnel
Our future success depends to a significant extent on the continued service
of our key technical, sales and senior management personnel and their ability
to execute our growth strategy. The loss of the services of any of our senior
level management, or certain other key employees, could harm our business. Our
future performance will depend, in part, on the ability of our executive
officers to work together effectively. Our executive officers may not be
successful in carrying out their duties or running our company. Any dissent
among executive officers could impair our ability to make strategic decisions
quickly in a rapidly changing market.
Our future success also depends on our ability to attract, retain and
motivate highly skilled employees. Competition for employees in our industry is
intense. Although we provide compensation packages that include incentive stock
options, cash incentives and other employee benefits, we may be unable to
retain our key employees or to attract, assimilate and retain other highly
qualified employees in the future. We have from time to time in the past
experienced, and we expect to continue to experience in the future, difficulty
in hiring and retaining highly skilled employees with appropriate
qualifications.
Our Management and Internal Systems Might Be Inadequate to Handle the Potential
Growth of Our Personnel
To manage future growth, our management must continue to improve our
operational and financial systems and expand, train, retain and manage our
employee base. Our management may not be able to manage our growth effectively.
If our systems, procedures and controls are inadequate to support our
operations, our expansion would be halted and we could lose our opportunity to
gain significant market share. Any inability to manage growth effectively may
harm our business.
We Depend on Proprietary Rights to Develop and Protect Our Technology
Our success and ability to compete substantially depends on our internally
developed technologies and trademarks, which we protect through a combination
of patent, copyright, trade secret and trademark laws. Patent applications or
trademark registrations may not be approved. Even if they are approved, our
patents or trademarks may be successfully challenged by others or invalidated.
If our trademark registrations are not approved because third parties own these
trademarks, our use of these trademarks would be restricted unless we enter
into arrangements with the third-party owners, which might not be possible on
commercially reasonable terms or at all.
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<PAGE>
The primary forms of intellectual property protection for our products and
services internationally are patents and copyrights. Patent protection
throughout the world is generally established on a country-by-country basis. To
date, we have not applied for any patents outside the United States. We may do
so in the future. Copyrights throughout the world are protected by several
international treaties, including the Berne Convention for the Protection of
Literary and Artistic Works. Despite these international laws, the level of
practical protection for intellectual property varies among countries. In
particular, United States government officials have criticized countries such
as China and Brazil for inadequate intellectual property protection. If our
intellectual property is infringed in any country without a high level of
intellectual property protection, our business could be harmed.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally control access to
and distribution of our technologies, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights from
unauthorized use or disclosure, parties may attempt to disclose, obtain or use
our solutions or technologies. The steps we have taken may not prevent
misappropriation of our solutions or technologies, particularly in foreign
countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States. See "Business--
Intellectual Property."
We have licensed, and we may license in the future, certain proprietary
rights to third parties. While we attempt to ensure that the quality of our
brand is maintained by our business partners, they may take actions that could
impair the value of our proprietary rights or our reputation. In addition,
these business partners may not take the same steps we have taken to prevent
misappropriation of our solutions or technologies.
We Face and Might Face Intellectual Property Infringement Claims That Might Be
Costly to Resolve
In May 1999, Microtome, Inc. notified us that it believes our Liquifier Pro
Encoding Tool, when used in conjunction with our Liquid Music Player, infringes
two of its patents. In June 1999, we received a letter from another corporation
suggesting that we review patents to which they claim rights. These claims may
result in litigation. Although we do not believe we infringe the proprietary
rights of Microtome, Inc. or any other party, we cannot assure you that parties
will not assert additional claims in the future or that any claims will not be
successful. We could incur substantial costs and diversion of management
resources to defend any claims relating to proprietary rights, which could harm
our business. In addition, we are obligated under certain agreements to
indemnify the other party for claims that we infringe on the proprietary rights
of third parties. If we are required to indemnify parties under these
agreements, our business could be harmed. If someone asserts a claim against us
relating to proprietary technology or information, we might seek licenses to
this intellectual property. We might not be able to obtain licenses on
commercially reasonable terms, or at all. The failure to obtain the necessary
licenses or other rights might harm our business. See "Business--Litigation and
Patent Infringement Claims."
Difficulties Presented by International Economic, Political, Legal, Accounting
and Business Factors Could Harm Our Business in International Markets
A key component of our strategy is to expand into international markets. The
following risks are inherent in doing business on an international level and we
have little or no control over them:
. unexpected changes in regulatory requirements;
. export restrictions;
. export controls relating to encryption technology;
. longer payment cycles;
. problems in collecting accounts receivable;
. political and economic instability; and
. potentially adverse tax consequences.
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<PAGE>
In addition, other factors that may also affect us and over which we have
some control include the following:
. difficulties in staffing and managing international operations;
. differences in music rights reporting structures; and
. seasonal reductions in business activity.
We have entered into individual agreements in Japan and Korea, and we may
enter into similar arrangements in the future in other countries. One or more
of the factors listed above may harm our present or future international
operations and, consequently, our business.
We Might Need Additional Capital in the Future and Additional Financing Might
Not Be Available
We currently anticipate that our available cash resources, combined with the
net proceeds from this offering and financing available under existing
equipment loan and lease agreements, will be sufficient to meet our anticipated
working capital and capital expenditure requirements for the next 18 months.
However, our resources may not be sufficient for these working capital and
capital expenditure requirements. We may need to raise additional funds through
public or private debt or equity financing in order to:
. take advantage of opportunities, including more rapid international
expansion or acquisitions of complementary businesses or technologies;
. develop new products or services; or
. respond to competitive pressures.
Any additional financing we may need may not be available on terms favorable
to us, or at all. If adequate funds are not available or are not available on
acceptable terms, we might not be able to take advantage of unanticipated
opportunities, develop new products or services, or otherwise respond to
unanticipated competitive pressures, and our business could be harmed. Our
forecast of the period of time through which our financial resources will be
adequate to support our operations is a forward-looking statement that involves
risks and uncertainties, and actual results could vary materially as a result
of a number of factors, including those set forth in this "Risk Factors"
section. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Potential Year 2000 Risks Might Harm Our Business
Many currently installed computer systems and software products worldwide are
coded to accept only two-digit entries to identify a year in the date code
field. Consequently, on January 1, 2000, many of these systems could fail or
malfunction because they are not able to distinguish between the year 1900 and
the year 2000. Accordingly, many companies, including Liquid Audio and our
customers, potential customers, vendors and strategic partners, may need to
upgrade their systems to comply with applicable year 2000 requirements.
Because we and our customers depend, to a very substantial degree, upon the
proper functioning of computer systems, a failure of these systems to correctly
recognize dates beyond January 1, 2000 could disrupt operations. Any
disruptions could harm our business. Additionally, our failure to provide year
2000 compliant solutions to our customers could result in financial loss,
reputational harm and legal liability to us. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Year 2000
Compliance."
Risks Related to Our Industry
Internet Security Concerns Could Hinder E-Commerce
A significant barrier to e-commerce and communications over the Internet has
been the need for secure transmission of confidential information. Internet
usage may not increase at the rate we expect unless some of those concerns are
adequately addressed and found acceptable by the market. Internet usage could
also decline
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<PAGE>
if any well-publicized compromise of security occurs. We may incur significant
costs to protect against the threat of security breaches or to alleviate
problems caused by these breaches. Protections may not be available at a
reasonable price or at all. If a third person were able to misappropriate a
user's personal information, users could bring claims against us.
Imposition of Sales and Other Taxes On E-Commerce Transactions Might Hinder E-
Commerce
We do not collect sales and other taxes when we sell our products and
services over the Internet. States or local governments may seek to impose
sales tax collection obligations on out-of-state companies, such as ours, which
engage in or facilitate e-commerce. A number of proposals have been made at the
state and local level that would impose additional taxes on the sale of
products and services through the Internet. These proposals, if adopted, could
substantially impair the growth of e-commerce and could reduce our opportunity
to derive profits from e-commerce. Moreover, if any state or local government
or foreign country were to successfully assert that we should collect sales or
other taxes on the exchange of products and services on our system, our
business might be harmed.
Demand for Our Products and Services Might Decrease if Growth in the Use of the
Internet Declines
Our future success substantially depends upon the continued growth in the use
of the Internet. The number of users on the Internet may not increase and
commerce over the Internet may not become more accepted and widespread for a
number of reasons, including the following, over which we have little or no
control:
. actual or perceived lack of security of information, such as credit card
numbers;
. lack of access and ease of use;
. inconsistent quality of service and lack of availability of cost-
effective, high speed service;
. possible outages due to year 2000 difficulties or other damage to the
Internet;
. excessive governmental regulation; and
. uncertainty regarding intellectual property rights.
If the necessary infrastructure, products, services or facilities are not
developed, or if the Internet does not become a viable commercial medium, our
business would be harmed.
Government Regulation of the Internet Might Harm Our Business
The applicability to the Internet of existing laws governing issues such as
property ownership, libel and personal privacy is uncertain. In addition,
governmental authorities may seek to further regulate the Internet with respect
to issues such as user privacy, pornography, acceptable content, e-commerce,
taxation, and the pricing, characteristics and quality of products and
services. Finally, the global nature of the Internet could subject us to the
laws of a foreign jurisdiction in an unpredictable manner. Any new legislation
regulating the Internet could inhibit the growth of the Internet and decrease
the acceptance of the Internet as a communications and commercial medium, which
might harm our business.
In addition, the growing use of the Internet has burdened the existing
telecommunications infrastructure and has caused interruptions in telephone
service. Telephone carriers have petitioned the government to regulate the
Internet and impose usage fees on Internet service providers. Any regulations
of this type could increase the costs of using the Internet and impede its
growth, which could in turn decrease the demand for our services or otherwise
harm our business.
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<PAGE>
Risks Related to This Offering
The Price of Our Common Stock is Likely to Be Volatile and Subject to Wide
Fluctuations
The market prices of the securities of Internet-related companies have been
especially volatile and these securities may be overvalued. Thus, the market
price of our common stock is likely to be subject to wide fluctuations. If our
revenues do not grow or grow more slowly than we anticipate, or if operating or
capital expenditures exceed our expectations and cannot be adjusted
accordingly, or if some other event adversely affects us, the market price of
our common stock could decline. In addition, if the market for Internet-related
stocks or the stock market in general experiences a loss in investor confidence
or otherwise fails, the market price of our common stock could fall for reasons
unrelated to our business, results of operations and financial condition.
Investors might be unable to resell their shares of our common stock at or
above the offering price. In the past, companies that have experienced
volatility in the market price of their stock have been the subject of
securities class action litigation. If we were to become the subject of
securities class action litigation, it could result in substantial costs and a
diversion of management's attention and resources.
You Might Not Be Able to Sell Your Stock if No Market Develops for Our Stock
Prior to this offering, you could not buy or sell our common stock publicly.
We have filed an application for the quotation of our common stock on The
Nasdaq National Market. However, an active public market for our common stock
may not develop or be sustained after the offering. If a market does not
develop or is not sustained, it may be difficult for you to sell your shares of
common stock at a price that is attractive to you or at all. The initial public
offering price of the common stock will be determined through negotiations
between the representatives of the underwriters and us and may not be
representative of the price that will prevail in the open market. See
"Underwriting."
Provisions in Our Charter Documents Might Deter Acquisition Bids for Us
We have adopted a classified board of directors and our stockholders are
unable to call special meetings of stockholders, to act by written consent, to
remove any director or the entire board of directors without cause, or to fill
any vacancy on the board of directors, and must meet advance notice
requirements for stockholder proposals. Our board of directors may also issue
preferred stock without any vote or further action by the stockholders. These
provisions and other provisions under Delaware law could make it more difficult
for a third party to acquire us, even if doing so would benefit our
stockholders. See "Description of Capital Stock."
Our Officers and Directors Exert Substantial Influence Over Us
We anticipate that our executive officers, our directors and entities
affiliated with them together will beneficially own approximately 42.5% of our
outstanding common stock following the completion of this offering. As a
result, these stockholders will be able to exercise substantial influence over
all matters requiring approval by our stockholders, including the election of
directors and approval of significant corporate transactions. This
concentration of ownership may also have the effect of delaying or preventing a
change in our control.
Management Could Invest or Spend the Proceeds of This Offering in Ways with
which the Stockholders Might Not Agree
We have no specific allocations for the net proceeds of this offering.
Consequently, management will retain a significant amount of discretion over
the application of these proceeds. Because of the number and variability of
factors that will determine our use of these proceeds, our applications may
vary substantially from our current intentions to invest the net proceeds of
the offering in short-term, interest bearing, investment grade marketable
securities.
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<PAGE>
Future Sales of Shares by Existing Stockholders Could Affect Our Stock Price
If our existing stockholders sell substantial amounts of our common stock in
the public market following this offering, the market price of our common stock
could decline. Based on shares outstanding as of June 15, 1999, upon completion
of this offering we will have outstanding 17,507,064 shares of common stock,
assuming no exercise of the underwriters' over-allotment option. Of these
shares, only the 3,600,000 shares of common stock sold in this offering will be
freely tradeable, without restriction, in the public market. After the lockup
agreements pertaining to this offering expire 180 days from the date of this
prospectus, an additional 13,802,993 shares will be eligible for sale in the
public market.
In addition, the 1,353,032 shares subject to outstanding options and warrants
and 2,204,133 shares reserved for future issuance under our stock option and
purchase plans and a stock purchase agreement are not available for sale for
180 days from the date of this prospectus.
You Will Incur Immediate and Substantial Dilution
The initial public offering price is expected to be substantially higher than
the pro forma net book value per share of the outstanding common stock. As a
result, investors purchasing common stock in this offering will incur immediate
substantial dilution in the amount of $8.22 per share. In addition, we have
issued options and warrants to acquire common stock at prices significantly
below the initial public offering price. To the extent these outstanding
options and warrants are exercised, there will be further dilution to investors
in this offering. See "Dilution."
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<PAGE>
USE OF PROCEEDS
We estimate the net proceeds from the offering to be approximately
$35,878,000, or $41,402,200 if the underwriters exercise their over-allotment
option in full, assuming an initial public offering price of $11.00 per share
and after deducting the estimated underwriting discount and offering expenses.
We expect to use the net proceeds from the offering for general corporate
purposes, including working capital and capital expenditures, enhancing
research and development and attracting key personnel. As of the date of this
prospectus, we cannot specify the particular uses for the net proceeds.
Accordingly, our management will have broad discretion in the application of
the net proceeds.
We intend to invest the net proceeds in short-term, interest bearing,
investment grade marketable securities.
DIVIDEND POLICY
We have never declared or paid any dividends on our common stock. We do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to finance operations and the
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of the board of directors and will depend upon our
financial condition, operating results, capital requirements and other factors
the board of directors deems relevant.
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<PAGE>
CAPITALIZATION
The following table sets forth our short-term debt and capitalization as of
March 31, 1999. Our capitalization is presented:
. on an actual basis;
. on a pro forma basis to give effect to the automatic conversion of all
outstanding shares of preferred stock into common stock upon the
consummation of the offering; and
. on a pro forma as adjusted basis to reflect our receipt of the estimated
net proceeds from the sale of 3,600,000 shares of common stock offered in
the offering at an assumed initial public offering price of $11.00 per
share and after deducting the estimated underwriting discount and
offering expenses.
<TABLE>
<CAPTION>
As of March 31, 1999
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands, unaudited)
<S> <C> <C> <C>
Short-term debt................................ $ 632 $ 632 $ 632
======== ======== ========
Long-term debt, less current portion........... $ 1,519 $ 1,519 $ 1,519
Mandatorily redeemable convertible preferred
stock, $0.001 par value; 10,905,489 shares
authorized, 9,744,199 shares issued and
outstanding, actual; none authorized, issued
or outstanding, pro forma or pro forma as
adjusted...................................... 29,801 -- --
Stockholders' equity (deficit):
Preferred stock, $0.001 par value; 5,000,000
shares authorized; none issued or
outstanding, actual, pro forma or pro forma
as adjusted.................................. -- -- --
Common stock, $0.001 par value; 25,878,000
shares authorized; 3,892,293 shares issued
and outstanding, actual; 50,000,000 shares
authorized; 13,636,492 issued and
outstanding, pro forma; and 17,236,492 shares
issued and outstanding, pro forma as
adjusted..................................... 4 14 17
Additional paid-in capital.................... 4,450 34,241 70,116
Unearned compensation......................... (2,143) (2,143) (2,143)
Accumulated deficit........................... (20,162) (20,162) (20,162)
-------- -------- --------
Total stockholders' equity (deficit)......... (17,851) 11,950 47,828
-------- -------- --------
Total capitalization........................ $ 13,469 $ 13,469 $ 49,347
======== ======== ========
</TABLE>
We expect there to be 17,236,493 shares of common stock outstanding after the
offering. In addition to the shares of common stock to be outstanding after the
offering, as of March 31, 1999 we may issue additional shares of common stock
under the following plans and arrangements:
. 2,761,752 shares issuable under our 1996 Equity Incentive Plan,
consisting of:
. 1,050,528 shares underlying options outstanding at a weighted average
exercise price of $0.89 per share, of which 1,040,528 were
exercisable; and
. 1,711,224 shares available for future grants; and
. 71,710 shares issuable upon the exercise of warrants outstanding at a
weighted average exercise price of $5.27 per share.
Please read the capitalization table together with the sections of this
prospectus entitled "Selected Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the financial
statements included in this prospectus.
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DILUTION
As of March 31, 1999, our net tangible book value on a pro forma basis giving
effect to the conversion of our preferred stock was $11,950,000, or $0.88 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. As of
March 31, 1999, our net tangible book value, on a pro forma basis as adjusted
for the sale of 3,600,000 shares offered in the offering at an assumed initial
public offering price of $11.00 per share and after deducting the estimated
underwriting discount and offering expenses, would have been approximately
$2.78 per share. This represents an immediate increase of $1.90 per share to
existing stockholders and an immediate dilution of $8.22 per share to new
investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $11.00
Pro forma net tangible book value per share as of March 31,
1999............................................................ $0.88
Increase per share attributable to new investors................. 1.90
-----
Pro forma net tangible book value per share after the offering.... 2.78
------
Dilution per share to new investors............................... $ 8.22
======
</TABLE>
The following table summarizes on a pro forma basis as of March 31, 1999 the
differences between the total consideration paid and the average price per
share paid by the existing stockholders and the new investors with respect to
the number of shares of common stock purchased from us based on an assumed
initial public offering price of $11.00 per share:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ ------------------- Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 13,636,492 79.1% $29,822,000 43.0% $ 2.19
New investors............. 3,600,000 20.9 39,600,000 57.0 11.00
---------- ----- ----------- ----- ------
Total.................... 17,236,492 100.0% $69,422,000 100.0%
========== ===== =========== =====
</TABLE>
We expect there to be 17,236,493 shares of common stock outstanding after the
offering. In addition to the shares of common stock outstanding after the
offering, as of March 31, 1999 we may issue additional shares of common stock
under the following plans and arrangements:
. 2,761,752 shares issuable under our 1996 Equity Incentive Plan,
consisting of:
. 1,050,528 shares underlying options outstanding at a weighted average
exercise price of $0.89 per share, of which 1,040,528 were
exercisable; and
.1,711,224 shares available for future grants; and
. 71,710 shares issuable upon the exercise of warrants outstanding at a
weighted average exercise price of $5.27 per share.
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SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with our
financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this prospectus. The statement of operations data for the period from
January 30, 1996 (inception) through December 31, 1996 and for the years ended
December 31, 1997 and 1998, and the balance sheet data at December 31, 1997 and
1998, are derived from financial statements that PricewaterhouseCoopers LLP,
independent accountants, have audited and are included elsewhere in this
prospectus. The balance sheet data at December 31, 1996 are derived from
audited financial statements not included in this prospectus. The statement of
operations data for the three-month periods ended March 31, 1998 and 1999, and
the balance sheet data at March 31, 1999, are derived from unaudited interim
financial statements included elsewhere in this prospectus. The unaudited
financial statements have been prepared on substantially the same basis as the
audited financial statements and, in the opinion of management, include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the results of operations for such periods. Historical
results are not necessarily indicative of the results to be expected in the
future, and results of interim periods are not necessarily indicative of
results for the entire year.
<TABLE>
<CAPTION>
Period From
January 30,
1996
(inception) Year Ended Three Months Ended
Through December 31, March 31,
December 31, ----------------------- ----------------------
1996 1997 1998 1998 1999
------------ ---------- ----------- --------- -----------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net revenues:
License................ $ -- $ 246 $1,235 $192 $259
Services............... -- 10 268 32 89
Business development... -- -- 1,300 -- 183
------- ---------- ----------- --------- -----------
Total net revenues..... -- 256 2,803 224 531
Cost of net revenues:
License................ -- 302 312 49 47
Services............... -- 91 457 104 280
------- ---------- ----------- --------- -----------
Total cost of net reve-
nues.................. -- 393 769 153 327
------- ---------- ----------- --------- -----------
Gross profit (loss)..... -- (137) 2,034 71 204
Operating expenses:
Sales and marketing.... 237 2,820 4,879 942 2,339
Research and develop-
ment.................. 692 1,880 3,050 569 1,214
General and administra-
tive.................. 327 898 1,642 278 502
Stock compensation ex-
pense................. 31 534 1,241 259 425
------- ---------- ----------- --------- -----------
Total operating ex-
penses................ 1,287 6,132 10,812 2,048 4,480
------- ---------- ----------- --------- -----------
Loss from operations.... (1,287) (6,269) (8,778) (1,977) (4,276)
Interest income......... 24 125 379 12 184
Interest expense........ (1) (72) (140) (20) (51)
------- ---------- ----------- --------- -----------
Net loss................ $(1,264) $(6,216) $(8,539) $(1,985) $(4,143)
======= ========== =========== ========= ===========
Basic and diluted net
loss per share......... $(14.93) $(4.95) $(3.60) $(0.99) $(1.39)
Shares used in per share
calculation............ 84,635 1,256,114 2,370,564 1,998,865 2,972,398
Pro forma basic and
diluted net loss per
share.................. $(0.85) $(0.33)
Shares used in pro forma
per share calculation.. 10,041,546 12,716,597
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------- March 31,
1996 1997 1998 1999
------ ------ ------- ---------
(in thousands)
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.................. $ 864 $2,387 $14,143 $15,497
Short-term investments..................... -- -- 3,001 --
Working capital............................ 660 858 15,060 11,708
Total assets............................... 1,086 3,335 20,026 17,729
Long-term debt............................. 103 218 969 1,519
Mandatorily redeemable convertible
preferred stock and warrants.............. 2,001 8,247 29,801 29,801
Total stockholders' deficit................ (1,228) (6,879) (14,133) (17,851)
</TABLE>
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations
should be read together with the financial statements and related notes that
are included later in this prospectus. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results may differ
materially from those anticipated in these forward-looking statements as a
result of various factors, including those set forth under "Risk Factors" or in
other parts of this prospectus.
Overview
We are a leading provider of software products and services that enable
artists, record companies and retailers to create, syndicate and sell digital
recorded music over the Internet. Our products and services are based on an
open technical architecture that is designed to support a variety of digital
music formats. From our inception in January 1996 through early 1997, we
devoted substantially all of our efforts to product development, raising
capital and recruiting personnel. We first generated revenues in the first
quarter of 1997 through the licensing of our Liquifier Pro, Liquid Server and
Liquid Player software products. In November 1997, we introduced a
subscription-based hosting service for digital recorded music utilizing our
technology. In July 1998, to enhance consumer access to the music we were
hosting, we launched the Liquid Music Network (LMN), a syndicated network that
currently links over 200 affiliated music-related and music retailer websites.
In early 1999, we began to place greater emphasis on developing and marketing
our digital music delivery services. Since that time, we have invested
significant resources to increase our distribution reach by expanding the LMN,
building our syndicated music catalog available for sale, actively
participating in standards initiatives and establishing our international
presence. We also have established initiatives within Korea and Japan to lay
the groundwork for offering digital music download services to consumers in
these markets. The increased emphasis on digital music delivery services
resulted in a sequential decline in revenue from the fourth quarter of 1998 to
the first quarter of 1999. As a provider of digital music delivery services, we
expect our revenue sources to expand beyond software license sales to include
sales of digital recorded music and hosting service fees. Revenue from our
music delivery services represented less than 1% of total net revenues in 1998
and the first quarter of 1999. Our Liquid Music Network will begin offering
syndicated music through music retailer websites in the second half of 1999.
To date, we have derived our revenues principally from the licensing of
software products and fees associated with business development contracts. We
license our software products to record companies, artists and websites.
Software license revenues, net of a provision for estimated sales returns, are
recognized upon shipment of the product to the customer. We also generate
services revenues from maintenance fees related to our licensed software
products and hosting fees from record companies and artists. We defer and
recognize maintenance and hosting fees as service revenue ratably over the life
of the related contract, which is typically one year. We intend to increase our
services revenues by significantly expanding our hosting and music delivery
services. Revenue derived from hosting services will include subscription fees
from artists for encoding and storing music files, e-commerce services and
transaction reporting. Music delivery services revenue will include transaction
fees from sales of digital recorded music through our LMN website affiliates
and fees from music retailers and websites related to the Liquid Muze Previews
service for sample music clips. Business development revenues primarily consist
of fees from agreements under which we assist strategic partners with the
development of businesses that use our digital recorded music delivery
technology. These U.S. dollar-denominated, nonrefundable fees are based upon
agreements under which the strategic partners are contractually obligated to
pay us a fixed fee for the opportunity to develop businesses in various
countries using our proprietary technology. We recognize the fees as they are
earned; the specific timing of this recognition depends on the terms and
conditions of the particular contractual arrangements. We bear full credit risk
with respect to substantially all sales.
23
<PAGE>
We expense all research and development as incurred. Development costs
incurred in the period from achievement of technological feasibility, which we
define as the establishment of a working model, until the general availability
of this software to customers, have been short, and therefore software
development costs qualifying for capitalization have been insignificant.
Accordingly, we have not capitalized any software development costs to date.
We have a limited operating history upon which investors may evaluate our
business and prospects. Since inception we have incurred significant losses,
and as of March 31, 1999 we had an accumulated deficit of approximately $20.2
million. We intend to continue to expend significant financial and management
resources on the development of additional products and services, sales and
marketing, improved technology and expanded operations. As a result, we expect
to incur additional losses and continued negative cash flow from operations
through at least 2002. Our revenues may not increase or even continue at their
current levels or we may not achieve or maintain profitability or generate cash
from operations in future periods. Our prospects must be considered in light of
the risks, expenses and difficulties frequently encountered by companies in
their early stages of development, particularly companies in new and rapidly
evolving markets such as the digital delivery of recorded music. We may not be
successful in addressing these risks, and our failure to do so would harm our
business.
Results of Operations
The following table sets forth our statement of operations expressed as a
percentage of total net revenues:
<TABLE>
<CAPTION>
Year Ended Three Months
December Ended
31, March 31,
------------- ---------------
1997 1998 1998 1999
------ ---- ------ ------
<S> <C> <C> <C> <C>
Statement of Operations
Data:
Net revenues:
License.................. 96% 44% 86% 49%
Services................. 4 10 14 17
Business development..... -- 46 -- 34
------ ---- ------ ------
Total net revenues...... 100 100 100 100
Cost of net revenues:
License.................. 118 11 22 9
Services................. 36 16 46 53
------ ---- ------ ------
Total cost of net
revenues............... 154 27 68 62
------ ---- ------ ------
Gross profit (loss)....... (54) 73 32 38
Operating expenses:
Sales and marketing...... 1,101 174 421 440
Research and
development............. 734 109 254 229
General and
administrative.......... 351 59 124 94
Stock compensation
expense................. 209 44 116 80
------ ---- ------ ------
Total operating
expenses............... 2,395 386 915 843
------ ---- ------ ------
Loss from operations...... (2,449) (313) (883) (805)
Interest income........... 49 13 5 35
Interest expense.......... (29) (5) (8) (10)
------ ---- ------ ------
Net loss.................. (2,428)% (305)% (886)% (780)%
====== ==== ====== ======
</TABLE>
24
<PAGE>
Three Months Ended March 31, 1998 and 1999
Total Net Revenues
Total net revenues increased 137% from $224,000 for the three months ended
March 31, 1998 to $531,000 for the three months ended March 31, 1999.
License. License revenues increased 35% from $192,000 for the three months
ended March 31, 1998 to $259,000 for the three months ended March 31, 1999.
This increase was due to the recognition of deferred revenues on a specific
license of our Liquid Player software in the 1999 period. Due to our shift in
marketing emphasis from software licensing to the delivery of digital music
services, however, revenues from licensing of our Liquifier Pro and Liquid
Server software decreased from the 1998 period to the 1999 period, which
partially offset the increase in Liquid Player revenues described above.
Services. Services revenues increased 178% from $32,000 for the three months
ended March 31, 1998 to $89,000 for the three months ended March 31, 1999. This
increase was due to the recognition of revenues on a larger base of maintenance
and hosting fees in the 1999 period.
Business Development. Business development revenues increased from $0 for the
three months ended March 31, 1998 to $183,000 for the three months ended March
31, 1999. We derived these revenues from contracts signed with related parties
after March 31, 1998. Business development fees of $83,000 were earned from our
strategic partner in Japan and relate to a non-refundable fee of $1.0 million
that was received and is being recognized as business development revenue over
the 12-month term of the related agreement. Other fees of $100,000 relate to
the delivery of products to Liquid Audio Japan.
Two customers represented approximately 47% of total net revenues for the
three months ended March 31, 1998 and three customers represented approximately
75% of total net revenues for the three months ended March 31, 1999.
International revenues represented approximately 29% and 36% of total net
revenues for the three months ended March 31, 1998 and 1999, respectively.
Total Cost of Net Revenues
Our gross profit increased from approximately 32% of total net revenues for
the three months ended March 31, 1998 to approximately 38% of total net
revenues for the three months ended March 31, 1999.
License. Cost of license revenues primarily consists of royalties paid to
third-party technology vendors and costs of documentation, duplication and
packaging. Cost of license revenues was $49,000 for the three months ended
March 31, 1998 and $47,000 for the three months ended March 31, 1999, a
decrease of 4%. Cost of license revenues remained relatively constant because,
while we decided not to renew certain third-party software licenses, the
resulting reductions were offset by higher royalties paid due to the increase
in license revenues in the 1999 period.
Services. Cost of services revenues primarily consists of compensation for
customer service, operations and encoding personnel, Internet service provider
(ISP) connectivity charges, depreciation of website operations equipment, and
an allocation of our occupancy costs and other overhead. Cost of services
revenues increased 169% from $104,000 for the three months ended March 31, 1998
to $280,000 for the three months ended March 31, 1999. The increase in cost of
services revenues was due primarily to the addition of encoding and customer
service personnel, increased ISP connectivity charges for supporting our
services business and higher depreciation due to capital investments.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation for our sales, marketing and business development personnel,
advertising, trade show and other promotional costs, design and creation
expenses for marketing literature and our website, and an allocation of our
occupancy costs and other
25
<PAGE>
overhead. Sales and marketing expenses increased 148% from $942,000 for the
three months ended March 31, 1998 to $2.3 million for the three months ended
March 31, 1999. This increase was primarily due to increases in the number of
sales and marketing personnel from 17 to 32, the impairment loss on our
investment in Liquid Audio Japan of $378,000 due to substantial doubt regarding
recoverability of our investment and the significant losses that we expect this
entity to incur during its initial operating periods, and increased expenses
associated with promotion and marketing efforts. The impairment conclusion was
based upon the lack of sufficient earnings and cash flows for LAJ for the
foreseeable future, the lack of a commercially viable product to introduce into
the Japan marketplace, the lack of a proven business model that will sustain
the competitive and technological challenges inherent in the local environment,
and the unstable nature of the economy in Japan. We expect that sales and
marketing expenses will increase both in absolute dollars and as a percentage
of total net revenues in future periods due to expanded efforts to market and
promote our products and services both domestically and internationally.
Research and Development. Research and development expenses consist primarily
of compensation for our research and development personnel and payments to
outside contractors and, to a lesser extent, depreciation on equipment used for
research and development and an allocation of our occupancy costs and other
overhead. Research and development expenses increased 113% from $569,000 for
the three months ended March 31, 1998 to $1.2 million for the three months
ended March 31, 1999. This increase was primarily due to increased personnel
and outside contractors needed to enhance our existing software products,
develop and enhance our online services and develop new products and services.
We expect that research and development expenses will increase in absolute
dollars in future periods due to expanded investments in the development of
enhanced and new products and online services.
General and Administrative. General and administrative expenses consist
primarily of compensation for personnel and payments to outside contractors for
general corporate functions, including finance, information systems, human
resources, facilities, legal and general management, fees for professional
services, bad debt expense, and an allocation of our occupancy costs and other
overhead. General and administrative expenses increased 81% from $278,000 for
the three months ended March 31, 1998 to $502,000 for the three months ended
March 31, 1999. This increase was primarily due to increases in the number of
personnel and outside contractors needed to support the growth of our business,
bad debt expense and professional fees. General and administrative expenses
decreased as a percentage of total net revenues because of the growth of total
net revenues. We expect that general and administrative expenses will increase
in absolute dollars as we hire additional personnel and incur additional
expenses relating to the growth of our business, such as costs associated with
increased infrastructure and our public company status.
Stock Compensation Expense. Stock compensation expense relates to stock-based
employee compensation arrangements. Stock compensation expense is based on the
difference between the fair market value of our common stock and the exercise
price of options to purchase that stock on the date of the grant, and is being
recognized on an appropriate accelerated basis over the vesting periods of the
related options, usually four years. The total unearned compensation recorded
by us from inception to March 31, 1999 was $4.4 million. The fair value per
share used to determine unearned compensation was derived by reference to the
preferred stock values, reduced by a nominal discount factor of 10%, since
inception with ratable increases between preferred stock issuance dates. We
recognized $259,000 and $425,000 of stock compensation expense for the three
months ended March 31, 1998 and 1999, an increase of 64%. We expect quarterly
amortization related to those options to be between $375,000 and $265,000 per
quarter during 1999 and between $205,000 and $135,000 per quarter during 2000
and annual amortization to be $340,000 during 2001 and $100,000 during 2002.
These future compensation charges would be reduced if any employee terminates
employment prior to the expiration of the employee's option vesting period.
Interest Income. Interest income consists of earnings on our cash, cash
equivalents and short-term investments. Interest income increased from $12,000
for the three months ended March 31, 1998 to $184,000 for the three months
ended March 31, 1999. This increase was primarily due to interest received on
higher average cash and cash equivalent balances resulting from private sales
of preferred stock in the third quarter of 1998.
26
<PAGE>
Interest Expense. Interest expense consists of expenses related to our
financing obligations, which include borrowings under equipment loans, short-
term loans and capital lease obligations. Interest expense increased 155% from
$20,000 for the three months ended March 31, 1998 to $51,000 for the three
months ended March 31, 1999. This increase was primarily due to higher average
financing obligation balances resulting from additional capital leases and
borrowings under the equipment loans during 1998.
Period From January 30, 1996 (inception) Through December 31, 1996 and Years
Ended December 31, 1997 and 1998
Total Net Revenues
We had no revenues in 1996, as we were still in an early development stage.
Total net revenues increased 995% from $256,000 in 1997 to $2.8 million in
1998.
License. License revenues increased 402% from $246,000 in 1997 to $1.2
million in 1998. This increase was due to higher sales of software product
licenses, resulting from the introduction in 1998 of new versions of our
software products and expansion to international markets.
Services. Services revenues increased from $10,000 in 1997 to $268,000 in
1998. This increase was due to higher maintenance fees related to the increase
in license revenues and increased sales of hosting services, which were
introduced in November 1997.
Business Development. Business development revenues were $0 in 1997 and $1.3
million in 1998. Business development revenues were recorded when contracts
with related parties in Korea and Japan were executed and related contractual
obligations were satisfied. Business development fees totalling $950,000 and
$250,000 were earned from our strategic partners in Korea and Japan,
respectively. For the year ended December 31, 1998, we recognized our
proportionate share (40%) of losses recorded by Liquid Audio Korea (LAK). Our
share of the equity losses amounted to $400,000, which equaled our total
investment in LAK. These equity losses were offset against the revenue earned
in 1998 from our strategic partner in Korea in order to more clearly reflect
the substance of the business development transactions with our strategic
partner. Other fees of $100,000 relate to the delivery of products to the
Korean joint-venture entity.
Three customers represented approximately 71% of total net revenues for the
year ended December 31, 1997 and one customer represented approximately 34% of
total net revenues for the year ended December 31, 1998. International revenues
represented approximately 65% and 66% of total net revenues for the years ended
December 31, 1997 and 1998.
Total Cost of Net Revenues
Our gross profit (loss) increased from approximately (54)% for the year ended
December 31, 1997 to approximately 73% for the year ended December 31, 1998.
Total cost of net revenues increased 96% from $393,000 in 1997 to $769,000 in
1998.
License. Cost of license revenues was $302,000 in 1997 and $312,000 in 1998,
an increase of 3%. Cost of license revenues remained relatively constant
because, while we decided not to renew certain third-party software licenses,
the resulting reductions were offset by higher royalties paid due to the
increase in license revenues in the 1999 period.
Services. Cost of services revenues was $91,000 in 1997 and $457,000 in 1998,
an increase of 402%. This increase was primarily due to the addition of
customer service, operations and encoding personnel, higher depreciation due to
capital investments and ISP connectivity charges for supporting our services
business.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased from $237,000 to
$2.8 million to $4.9 million for the period from January 30, 1996 (inception)
through December 31, 1996 and the years ended December 31, 1997 and 1998,
respectively. The increases from period to period were primarily due to the
27
<PAGE>
addition of marketing personnel starting in the first quarter of 1998,
increased expenses associated with promotion and marketing efforts, and the
addition of a direct sales force, which we began building in the second half of
1997.
Research and Development. Research and development expenses increased 172%
and 62% from $692,000 to $1.9 million to $3.1 million for the period from
January 30, 1996 (inception) through December 31, 1996 and the years ended
December 31, 1997 and 1998, respectively. The increases from period to period
were primarily due to increased personnel and outside contractors needed to
enhance our existing software products, develop and enhance online services and
develop new products and services.
General and Administrative. General and administrative expenses increased
175% and 83% from $327,000 to $898,000 to $1.6 million for the period from
January 30, 1996 (inception) through December 31, 1996 and the years ended
December 31, 1997 and 1998, respectively. The increases from period to period
were primarily due to increases in the number of personnel and outside
contractors, the higher level of professional services required to support the
growth of our operations and increased infrastructure costs.
Stock Compensation Expense. We recognized $31,000, $534,000 and $1.2 million
of stock compensation expense for the period from January 30, 1996 (inception)
through December 31, 1996 and the years ended December 31, 1997 and 1998.
Interest Income. Interest income increased 421% and 203% from $24,000 to
$125,000 to $379,000 for the period from January 30, 1996 (inception) through
December 31, 1996 and the years ended December 31, 1997 and 1998, respectively.
The increases from period to period were primarily due to interest received on
higher average cash and cash equivalent balances resulting from private sales
of preferred stock in the second quarter of 1997 and the third quarter of 1998.
Interest Expense. Interest expense increased from $1,000 to $72,000 to
$140,000 for the period from January 30, 1996 (inception) through December 31,
1996 and the years ended December 31, 1997 and 1998, respectively. The
increases were primarily due to higher average financing obligation balances
resulting from borrowings under short-term loan agreements in 1997 and 1998,
additional capital leases in 1997 and 1998, and borrowings under the equipment
line of credit during 1998.
Income Taxes. At December 31, 1998, we had $13.0 million of federal and $12.9
million of state net operating loss carryforwards available to offset future
taxable income, which will expire in varying amounts beginning in 2011 and
2004, respectively. At December 31, 1998, we had $210,000 of federal and
$170,000 of state research and development credit carryforwards available to
offset future taxable income. The federal carryforwards expire in varying
amounts beginning in 2011. Under the Tax Reform Act of 1986, the amounts of and
benefits from net operating loss carryforwards may be impaired or limited in
certain circumstances. Subsequent to this offering, management has estimated
that the net operating loss carryforwards from inception will be limited to
$7.5 million annually. See note 8 of notes to financial statements.
28
<PAGE>
Quarterly Results of Operations
The following table sets forth statement of operations data for the three
months ended March 31, June 30, September 30 and December 31, 1998, and March
31, 1999. The information for each of these quarters has been prepared on
substantially the same basis as the audited financial statements included
elsewhere in this prospectus and, in our opinion, includes all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the results of operations for these periods. Historical results
are not necessarily indicative of the results to be expected in the future, and
results of interim periods are not necessarily indicative of results for the
entire year.
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------
June Sept. Dec.
March 31, 30, 30, 31, March 31,
1998 1998 1998 1998 1999
--------- ------- ------- ------- ---------
(in thousands, unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues:
License......................... $ 192 $ 242 $ 374 $ 427 $ 259
Services........................ 32 33 104 99 89
Business development............ -- 225 525 550 183
------- ------- ------- ------- -------
Total net revenues............. 224 500 1,003 1,076 531
Cost of net revenues:
License......................... 49 63 63 137 47
Services........................ 104 69 128 156 280
------- ------- ------- ------- -------
Total cost of net revenues..... 153 132 191 293 327
------- ------- ------- ------- -------
Gross profit..................... 71 368 812 783 204
Operating expenses:
Sales and marketing............. 942 1,198 1,098 1,641 2,339
Research and development........ 569 645 759 1,077 1,214
General and administrative...... 278 329 548 487 502
Stock compensation expense...... 259 284 339 359 425
------- ------- ------- ------- -------
Total operating expenses....... 2,048 2,456 2,744 3,564 4,480
------- ------- ------- ------- -------
Loss from operations............. (1,977) (2,088) (1,932) (2,781) (4,276)
Interest income.................. 12 1 138 228 184
Interest expense................. (20) (46) (34) (40) (51)
------- ------- ------- ------- -------
Net loss......................... $(1,985) $(2,133) $(1,828) $(2,593) $(4,143)
======= ======= ======= ======= =======
</TABLE>
Our total net revenues increased in each quarter of 1998, but declined in the
quarter ended March 31, 1999. The increases in license revenues through the
quarter ended December 31, 1998 were due to higher sales of our software
product licenses and sales expansion in international markets. License revenues
declined in the quarter ended March 31, 1999 due to the shift of our marketing
efforts towards the development of our digital music delivery services
business. The increases in services revenues through the quarter ended
September 30, 1998 included consulting fees from non-recurring projects. The
decreases in services revenues from the quarter ended September 30, 1998 to the
quarter ended March 31, 1999 were due to decreases in software maintenance
revenues. Business development revenues fluctuated from quarter to quarter due
to the terms and conditions of the contractual arrangements with our strategic
partners in Korea and Japan.
Total cost of net revenues declined in the quarter ended June 30, 1998 and
increased in succeeding quarters through the quarter ended March 31, 1999. Cost
of license revenues fluctuated with total net revenues for the corresponding
periods and the varying timing of addition and elimination of certain third-
party software licenses. Cost of services revenues has increased since June 30,
1998 primarily due to the addition of customer service, operations and encoding
personnel, higher depreciation due to capital investments and ISP connectivity
charges for supporting our services business.
29
<PAGE>
Total operating expenses have increased in each of the quarters presented
reflecting the growth of our operations. The increase in sales and marketing
expenses for the quarter ended March 31, 1999 included the write-off of our
$378,000 investment in Liquid Audio Japan.
Our quarterly and annual operating results are likely to fluctuate
significantly in the future due to a variety of factors, many of which are
outside our control. Additionally, as a result of our limited operating history
and the emerging nature of the digital delivery of recorded music market in
which we compete, it is difficult for us to forecast our revenues or earnings
accurately. Our current and future expense levels are based largely on our
investment plans and estimates of future revenues and are, to a large extent,
fixed. We may be unable to adjust spending in a timely manner to compensate for
any unexpected revenue shortfall. Any significant shortfall in revenues
relative to our planned expenditures would harm our business. Due to these
factors, our quarterly revenues and operating results are difficult to
forecast. We believe that period to period comparisons of our operating results
may not be meaningful and should not be relied upon as an indication of future
performance. In addition, it is likely that in one or more future quarters our
operating results will fall below the expectations of securities analysts and
investors. In that event, the trading price of our common stock would likely
fall. See "Risk Factors--Our Limited Operating History in the New Market of
Digital Delivery of Music Over the Internet Increases the Possibility that the
Value of Your Investment Will Decline" and "--Fluctuations in Our Quarterly
Revenues and Operating Results Might Lead to Reduced Prices for Our Stock."
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through the
private placement of our preferred stock, equipment financing, lines of credit
and short-term loans. As of March 31, 1999, we had raised $29.8 million through
the sale of our preferred stock and had approximately $15.5 million of cash and
cash equivalents.
Net cash used in operating activities in the period from January 30, 1996
(inception) through December 31, 1996, the years ended December 31, 1997 and
1998 and the three months ended March 31, 1998 and 1999 was $1.1 million, $4.8
million, $5.8 million, $1.6 million, respectively. Net cash used for operating
activities in each of these periods was primarily the result of net losses
before non-cash charges, which include equity investment losses in Liquid Audio
Korea and Liquid Audio Japan, offset by increases in deferred revenue and
accrued expenses and other current liabilities. We established an allowance for
doubtful accounts based on our estimate of customer accounts that may not be
collected by us. The allowance for doubtful accounts increased from $231,000 at
December 31, 1998 to $294,000 at March 31, 1999, representing 38% and 89% of
gross accounts receivable, respectively. This increase in the allowance is due
to our placing greater emphasis on developing and marketing our digital
delivery services in early 1999. This greater emphasis has resulted in our
making an assessment of receivables due from customers in markets in which we
previously focused. The increase in the allowance for doubtful accounts did not
have a material affect on our liquidity.
Net cash provided by (used in) investing activities in the period from
January 30, 1996 (inception) through December 31, 1996, the years ended
December 31, 1997 and 1998 and the three months ended March 31, 1998 and 1999
was $(83,000), $(319,000), $(4.4) million, $(114,000) and $2.7 million,
respectively. Net cash used in investing activities was related to the
acquisition of property and equipment, the purchase of short-term investments
and the equity investment in Liquid Audio Korea in 1998 and the sale of short-
term investments in the three months ended March 31, 1999.
Net cash provided by (used in) financing activities in the period from
January 30, 1996 (inception) through December 31, 1996, the years ended
December 31, 1997 and 1998 and the three months ended March 31, 1998 and 1999
was $2.0 million, $6.6 million, $21.9 million, $(16,000) and $318,000,
respectively. The net cash provided by financing activities for the period from
January 30, 1996 (inception) through December 31, 1996 and the years ended
December 31, 1997 and 1998 was due primarily to the sales of shares of our
preferred stock. Net cash was also provided by borrowings under a line of
credit in 1997 that was repaid in 1998, and proceeds from an equipment loan in
1998 and the three months ended March 31, 1999.
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We have a bank revolving line of credit for up to $1.0 million based on 80%
of eligible accounts receivable. As of March 31, 1999, we had no borrowings
under the revolving line of credit. Any advances would bear interest at the
bank's prime interest rate, 7.75% at March 31, 1999, and would be
collateralized by substantially all of our assets. We have a bank equipment
loan facility that provides for advances of up to $3.0 million through November
1999. Borrowings under the equipment loan facility are repayable in monthly
installments over three years and bear interest at the bank's prime interest
rate plus 0.25%, 8.0% at March 31, 1999. Borrowings are secured by the related
equipment and other assets. Under the equipment loan facility, we had borrowed
amounts totaling $1.3 million through March 31, 1999. We also have lease
financing agreements that provide for the lease of computers and office
equipment of up to $1.0 million. As of March 31, 1999, we had borrowed $737,000
under the lease financing agreements. Our other significant commitments consist
of obligations under non-cancelable operating leases, which totaled $880,000 as
of December 31, 1998 and are payable in monthly installments through 2002 and a
related party note in the amount of $378,000 that was issued in the three
months ended March 31, 1999. The related party note payable was issued to Super
Factory, Inc., an entity affiliated with our Japanese strategic partner, Super
Stage Itochu, and is repayable in Japanese yen and bears interest at 0.5% above
a Japanese bank's prime rate (approximately 3.1% at March 31, 1999). The
principal is due on December 31, 2003, with quarterly interest payments.
For the year ended December 31, 1998, we recorded equity losses of $400,000
related to our investment in Liquid Audio Korea (LAK) and, for the three months
ended March 31, 1999 we recorded an impairment loss of $378,000 related to our
investment in Liquid Audio Japan (LAJ). Although high risk in nature, we
believe that these types of investments outside of the United States are
important to establish a complementary international distribution
infrastructure. In Korea, we have partnered with the SK Group to have LAK focus
on Kiosk-based retail applications of our technology. These applications are
intended to allow consumers to preview and purchase compact discs and other
transportable media from retail entertainment centers. LAK is planning to open
these kiosks in the second half of 1999. In Japan, we have partnered with Super
Stage Itochu, Hikari Tsushin and Hapinet to have LAJ exclusively resell and
distribute a Japanese version of our software technology. LAJ anticipates
having a Japanese version of our software available for distribution in the
second half of 1999.
Although we have no material commitments for capital expenditures or
strategic investments, we anticipate an increase in the rate of capital
expenditures consistent with our anticipated growth in operations,
infrastructure and personnel. We anticipate that we will continue to add
computer hardware resources, deploy additional computer data centers worldwide
and expand our primary office facility during the next 12 months. We may also
use cash to acquire or license technology, products or businesses related to
our current business. In addition, we anticipate that we will continue to
experience significant growth in our operating expenses for the foreseeable
future and that our operating expenses will be a material use of our cash
resources.
We believe that the net proceeds from this offering, together with existing
cash and cash equivalents and our lines of credit will be sufficient to meet
our anticipated cash needs for working capital and capital expenditures for at
least the next 18 months, although we may seek to raise additional capital
during that period. The sale of additional equity or convertible debt
securities could result in additional dilution to our stockholders. There can
be no assurance that financing will be available in amounts or on terms
acceptable to us, if at all.
Market Risk Disclosure
At December 31, 1998, we had an investment portfolio of money market funds,
commercial securities and U.S. Government bonds including those classified as
short-term investments of $3.0 million. We had a related party loan outstanding
at March 31, 1999 of $378,000, which was denominated in Japanese yen and bore
interest at 3.1%. These instruments, like all fixed income instruments, are
subject to interest rate risk. The fixed income portfolio will fall in value
and the related party note payable interest would increase if there were an
increase in interest rates. If market interest rates were to increase
immediately and uniformly by 10% from
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levels as of December 31, 1998 and March 31, 1999, the decline of the fair
value of the fixed income portfolio and related party note payable would not be
material. See notes 1 and 2 of notes to financial statements.
Recent Accounting Pronouncements
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AICPA) issued Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" (SOP 98-1). SOP 98-1 requires all costs related to the
development of internal use software other than those incurred during the
application development stage to be expensed as incurred. Costs incurred during
the application development stage are required to be capitalized and amortized
over the estimated useful life of the software. SOP 98-1 is effective for our
fiscal year ending December 31, 1999. We do not expect its adoption to have a
material effect on our financial statements.
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 is effective
for fiscal years beginning after June 15, 1999. SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if so, the type of hedge
transaction. We do not expect that the adoption of SFAS No. 133 will have a
material effect on our financial statements.
In December 1998, the AICPA issued Statement of Position 98-9, "Modification
of SOP 97-2, Software Revenue Recognition, with Respect to Certain
Transactions" (SOP 98-9). SOP 98-9 amends certain elements of SOP 97-2 and
provides additional authoritative guidance on software revenue recognition. SOP
98-9 is effective for fiscal years beginning after March 15, 1999. We do not
expect its adoption to have a material effect on our financial statements. See
note 1 of notes to financial statements.
Year 2000 Compliance
Many currently installed computer systems and software products worldwide are
coded to accept only two-digit entries to identify a year in the date code
field. Consequently, on January 1, 2000, many of these systems could fail or
malfunction because they are not able to distinguish between the year 1900 and
the year 2000. Accordingly, many companies, including ourselves and our
customers, potential customers, vendors and strategic partners, may need to
upgrade their systems to comply with applicable year 2000 requirements.
Because we and our customers depend, to a very substantial degree, upon the
proper functioning of computer systems, a failure of these systems to correctly
recognize dates beyond January 1, 2000 could disrupt operations. Any
disruptions could harm our business. Additionally, our failure to provide year
2000 compliant solutions to our customers could result in financial loss,
reputational harm and legal liability to us. We believe that our products and
services are year 2000 compliant; however, our products and services are often
integrated with other systems that may not be compliant.
In 1998, we formed a year 2000 assessment and contingency planning committee
to review both our information technology systems and our non-information
technology systems, and where necessary to plan for and supervise the
remediation of those systems. The committee is headed by our Chief Technology
Officer. We believe the committee has identified all of our critical hardware
and software systems. The providers of these systems have confirmed that they
are year 2000 compliant. We have conducted tests and expect to conduct
additional tests of these systems as part of our year 2000 efforts.
We have initiated communication with our significant vendors to determine the
extent to which they are vulnerable to year 2000 issues. We have not yet
received sufficient information on year 2000 remediation plans of these vendors
to predict the outcome of their efforts.
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We estimate that our cost to become year 2000 compliant has been $150,000,
and we believe that any additional costs related to becoming year 2000
compliant will not be material.
We have not made a full assessment of the extent to which our customers might
be vulnerable to year 2000 issues. Likewise, we have not made a full assessment
of the extent to which other third parties with which we transact business have
determined their vulnerability to year 2000 issues.
We are developing contingency plans for critical individual information
technology systems and non-information technology systems to address year 2000
risks not fully resolved by our year 2000 program. We believe that the year
2000 risk will not present significant operational problems for us. However,
there can be no assurance that our year 2000 program will prevent any harm to
our business.
If our Year 2000 program is inadequate and our business operations are
materially impacted, we could incur additional costs to recover any lost
information and replace affected systems. We believe that these systems could
be replaced without significant difficulty as replacement systems are generally
available on commercially reasonable terms. We also have regular data back-up
procedures that would assist in the recovery of lost business information.
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BUSINESS
We provide a leading open platform that enables the digital delivery of music
over the Internet. Our software products and services give artists, record
companies, websites and retailers the ability to create, syndicate and sell
recorded music with copy protection and copyright management. Through our
Liquid Music Network website affiliates, we help artists and record companies
promote and sell their recorded music. From our growing catalog of syndicated
music, consumers can preview and purchase digital music. Consumers then can
transfer downloaded music to recordable compact discs and, later in 1999, to
digital consumer devices. Our solution is based on an open technical
architecture that is designed to support multiple leading digital music
formats, including mp3 and Dolby AC-3. Numerous recording artists and record
companies have used our platform to promote music releases including BMG North
America, Capitol Records, Columbia House, Dreamworks Records, EMI Classics,
Bruce Hornsby, The Dave Matthews Band, Sarah McLachlan and Rounder Records.
Industry Background
The Recorded Music Industry
The recorded music industry represents one of the largest opportunities for
online digital delivery and commerce. According to the International Federation
of the Phonographic Industry (IFPI), worldwide recorded music sales represented
a $38.7 billion market in 1998. The United States music industry, which
represents nearly one-third of worldwide recorded music sales, encompasses more
than 200,000 professional musicians, 7,500 record labels, 100 distributors,
4,000 independent retailers and millions of consumers. The recorded music
industry has operated under the same basic business model for many years.
Typically, record companies sign artists to exclusive contracts under which the
record companies develop and promote artists' music. The companies then sell
this recorded music through wholesale and retail distribution channels to
consumers. In addition, there are millions of amateur musicians who do not have
access to distribution through traditional channels.
The Major Labels. Five major global record companies--BMG Entertainment, EMI
Music, Sony Corporation, Universal Music Group and Warner Communications Inc.--
and their numerous affiliated labels account for more than 80% of all recorded
music sales worldwide. Each of these companies is organized worldwide on a
geographic basis, with each local subsidiary having control over distribution
within its territory. These companies invest significant resources in
infrastructure to support their operations. They are vertically integrated and
operate recording, manufacturing, distribution, warehousing, and sales and
marketing organizations.
Each of the major record companies signs and introduces only a small number
of new artists each year. New artists are generally required to sign exclusive,
long-term agreements that do not obligate the record company to release any
records. In return, artists receive a royalty, typically based on a percentage
of the suggested retail list price of a record, but only after the record
company recoups production costs and other advances. For new artists in the
United States, this royalty generally ranges from 7% to 12%. Record companies
engage in large-scale promotional and marketing programs that utilize local
offices and staff in major cities to coordinate these programs through radio,
television and other traditional media. Each of these companies supports
multiple manufacturing plants, distribution centers and warehouses and uses
ground transportation to ship recorded music to retailers and wholesalers.
Independent Labels and Artists. In addition to the five major record
companies, there are thousands of independent record companies. Some of the
better-known independent labels are Beggars Banquet, Platinum Entertainment,
Rounder Records and Rykodisc. These independent labels account for a large
portion of the
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sound recordings published each year in the United States, and represent a
rapidly growing revenue segment of the United States recorded music industry.
These companies differ significantly from the major record companies in a
number of ways, including:
. they usually pay higher royalties to artists and offer shorter-term
recording agreements;
. they have more limited capital resources available for recording,
manufacturing and promotion costs; and
. they find national distribution difficult to obtain and expensive when
available.
The inherent difficulties and costs associated with this model have caused
many independent record companies to begin marketing programs to sell recorded
music directly to consumers. One notable example is The Artist Formerly Known
As Prince, who markets his recordings on his own label through his website and
through independent distributors.
Traditional Retail Distribution and Sales. The distribution channels for and
the retail sales of recorded music are becoming concentrated due to increased
competition and consolidation. Retail sales are primarily "hit" driven, with a
small number of titles accounting for the majority of retail sales in most
periods. In addition, in order to offer consumers a wide variety of music,
retailers bear the infrastructure costs necessary to stock recordings that are
not currently hits, known as catalog recordings. Current hits and catalog
recordings sold through retail stores represent only a small fraction of all
recorded music. In addition, distributors of recorded music are subject to
territorial restrictions, which limit the countries in which they can
distribute and sell.
The Recorded Music Industry and the Internet
The Internet presents a significant opportunity for the rapid and cost-
effective distribution, promotion and sale of recorded music. Music is one of
the most popular topics on the Internet as reflected by the increasing number
of music-related websites and the growth of online sales of compact discs. To
date, online recorded music sales have occurred primarily through the purchase
of compact discs through online retailers. Forrester Research expects online
vendors such as Amazon.com Inc. and CDnow Inc. to drive total online sales of
compact discs in the United States from an estimated $890 million in 1999 to an
estimated $6.7 billion in 2003. These online retailers generally do not take
physical custody of recordings, but rather refer their orders to fulfillment
houses that are responsible for shipping the compact discs to customers. The
popularity of online buying is also forcing traditional retailers to sell
recorded music using the Internet, either through their own websites or in the
future through in-store kiosks.
Advances in digital compression technologies now allow the transmission of
near-compact disc quality audio over the Internet. Due to the size of the
transmitted files, most digital music transmitted to date has been song samples
used by online retailers to allow shoppers to preview music. More recently,
however, many websites have begun to offer "full length," three to four minute,
single music recordings for transmission and storage in compressed formats.
Several audio compression standards are currently used, including AAC, AC-3 and
mp3. To date, most digital music downloads have been promotional in nature.
Recorded music sales delivered through digital transmission have been minimal,
but are expected to reach 7% of all United States recorded music sales by 2003,
according to Forrester Research. Several manufacturers have introduced or
announced plans to introduce portable devices, such as the Rio from Diamond
Multimedia and the Lyra from Thomson Consumer Electronics, that will play
downloaded digital music.
Challenges of Digital Music Delivery and Commerce over the Internet
Music consumers increasingly want both to hear recorded music in real time on
their computers and to store these recordings for later playback on portable
devices as well as computers. But, as downloading music from the Internet has
become increasingly popular, music content copyright owners, including the
major record
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companies, have expressed concerns about unauthorized copying, or "pirating,"
of copyrighted sound recordings. Many compression technologies, including the
basic mp3 standard specification, lack copy protection. This can result in the
unauthorized downloading and replication of digital music. The major recording
industry association, the Recording Industry Association of America (RIAA), has
formed a committee, the Secure Digital Music Initiative (SDMI), to propose a
standard for the secure digital distribution and use of recorded music.
The e-commerce market for downloadable recorded music is just emerging and
there is limited availability of digital music on the Internet. The major
record companies to date have engaged only in limited efforts to sell recorded
music through digital transmission. The Internet as a commerce medium presents
several challenges to the record companies, including the ability to comply
with geographical territorial restrictions and copyright and trading concerns.
Most artists, restricted by their existing contracts with record companies,
have not been able to take advantage of selling their music over the Internet
directly to consumers. Retailers have had success selling compact discs online,
but have not had a way to integrate the sale of digital recorded music into
existing online stores.
We believe that there is a need for a comprehensive solution to create,
syndicate and sell music over the Internet. This solution must address the
following:
. Systems Optimized for Music Creation. Systems for encoding digital music
recordings must be easy to use, capable of being integrated into the
creative tools that recording producers use every day, create high
fidelity recordings, and be scalable--capable of encoding a significant
volume of material in a relatively short time.
. Copy Protection and Copyright Management. Systems must provide the
ability to limit and track the number of copies made of a particular
sound recording. A successful system must also have utilities for
cataloging, auditing and reporting sales and uses in a manner that is
consistent with existing industry practices. In addition, it must be
capable of distinguishing and reporting purchasers based on their
geographic location.
. Syndication. Systems must have an open architecture that will allow for a
large number of retailers and websites to easily integrate and offer a
large number of digital music recordings for promotion and sale.
. Standards-based. Systems must be compatible with existing technical
standards and be adaptable to emerging industry standards for the secure
digital delivery of music.
. Consumer Experience. Systems must provide consumers with a large variety
of digital music that is high fidelity and easy to acquire, catalog,
access and transfer to personal devices such as stand-alone players.
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The Liquid Audio Solution
We provide a leading open platform for the digital delivery of music over the
Internet. Our products and services enable the creation, syndication and sale
of digital recorded music through an open technical architecture that is
designed to support leading standards and formats. Our solutions enable
artists, record companies, music websites and retailers to promote and sell
high quality digital recorded music, while providing copy protection, copyright
management, syndication and e-commerce services. Our products and services give
consumers easy access to a large and growing volume of digital recorded music
that is high fidelity and accessible through a variety of sources, including
personal computers and portable devices.
The Liquid Audio Platform
[Graphic depicting our platform]
We provide a variety of products and services to enable the creation and
publication, syndication, and promotion and sale of downloadable digital music
over the Internet:
. Creation and Publication. We offer software tools to encode digital
music, and services that can encode up to approximately 20,000 individual
music samples per day. We also offer server software that hosts and
distributes encoded music files.
. Syndication. Our delivery service, the Liquid Music Network, makes
syndicated music content available to websites, including websites
operated by music retailers. We also offer Internet hosting services for
artists and record labels. In addition, we are developing software
applications to enable digital music delivery through kiosks located in
retail stores.
. Promotion and Sale. We offer server software and services to manage the
secure transfer and sale of digital music and report and audit digital
music sales. Our Liquid Player software, a desktop software application,
also allows the consumer to preview or purchase and download digital
recorded music. Our next version of the Liquid Player, targeted for
release in the second half of 1999, will enable the output of digital
music to portable consumer devices. We also provide a set of e-commerce
services, including credit card processing, the remittance of royalty
payments and detailed transaction reports.
Our solution provides the following benefits:
. Superior Consumer Experience. Our solution enables consumers to purchase
and download a wide variety of near compact-disc quality music online. We
make it simple to search for, sample and buy selected digital recorded
music from a rapidly growing inventory. Our Liquid Player also enables
digital music to be transferred to a compact disc by means of a
recordable compact disc device.
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. Global Reach. Our platform allows the Internet to be used as a global
distribution channel for artists, record companies and retailers. This is
particularly significant to independent record labels and amateur
musicians who have limited access to traditional retail distribution
channels.
. Increased Revenues and Lower Costs. Through our solution, record
companies and artists can generate increased revenues by offering their
entire catalog of existing music as well as singles and periodic
releases. Our products and services provide a cost-effective way to
digitally offer entire music catalogs to consumers by reducing the costs
associated with physical manufacturing, warehousing and shipping.
. Security and Compliance. Our platform protects against piracy by
authenticating, limiting and tracking the number of copies made of a
digitally delivered sound recording. Our platform also enables the sale
over the Internet of digital recorded music in compliance with geographic
distribution limitations.
Strategy
Our objective is to be the leading open platform for the creation,
syndication and sale of digital recorded music on the Internet. We seek to
achieve this objective through the following key strategies:
Provide a Superior Consumer Experience. In order to facilitate and promote
consumer adoption of digital music delivered over the Internet, we plan to
continue to improve the consumer experience. We are pioneers in providing music
consumers with a media rich music experience. Our Liquid Player not only
provides high quality audio delivery but also offers consumers music
information such as song lyrics, album liner notes and graphics. We believe
that by continuing to improve music search capabilities, we will enhance the
consumer experience and increase digital recorded music sales.
Continue to Broaden our Distribution Reach. We intend to expand our
distribution capabilities to reach greater numbers of consumers and to increase
the number of digital music purchase transactions. Since its launch in July
1998, the Liquid Music Network has grown to encompass more than 200 websites.
In the second half of 1999, we plan to expand sales of syndicated music through
music retailer websites. To enhance our ability to attract more music content,
we will continue to broaden this effort to music-related and other websites
that use our technology for digital distribution. We also have agreements with
strategic partners to distribute our Liquid Player with their products.
Expand Syndicated Music Content. We plan to increase the amount of music
content available through our delivery services to stimulate demand for digital
music by consumers and to further increase the number of digital music purchase
transactions. Currently, there are more than one million individual songs and
song samples that have been encoded using our technology and are available
through our Liquid Music Network and our Liquid Muze Previews service for
streaming or downloading. This compares to approximately 50,000 at the
beginning of 1999. We also offer a variety of hosting and software licensing
packages in order to provide content owners flexibility in the ways they make
their content available to consumers.
Leverage Strategic Industry Relationships. We have established strategic
relationships with a variety of partners including software and computer
hardware vendors, music copyright societies, entertainment and media companies,
consumer electronics manufacturers and music-oriented website companies. We
have also assembled an experienced management team with strong relationships in
the traditional music industry.
We intend to leverage our relationships to achieve a variety of goals
including:
. maximizing the distribution and adoption of our platform;
. solidifying our position as the technology leader in digital delivery of
music;
. acquiring premium content for syndication; and
. developing international markets.
Extend Technology Leadership. We intend to play a leadership role in
developing standards that will shape the digital music industry. We believe
that we are the first to market a comprehensive solution for digital music
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delivery, and our software products are already in their fourth generation of
commercial release. In accordance with our strategy, we have taken an active
role in SDMI, and are leaders in the Genuine Music coalition.
Generate Multiple Revenue Streams. We believe that we can leverage our market
penetration, technology leadership and industry position to diversify our
revenue base. We believe that the potential market for digital music delivery
over the Internet is substantial, and will present multiple revenue
opportunities for the leading companies. In early 1999, we increased our
emphasis on digital delivery services in order to take advantage of these
opportunities, leveraging our software licensing business. We anticipate
generating revenues from multiple sources in the future, including digital
recorded music sales, hosting services and advertising and sponsorship
revenues.
Strategic Relationships and Customers
We currently have relationships in four principal areas: music syndication;
player distribution; technology and international.
Music Syndication Relationships. We plan to continue to build relationships
with key third parties engaged in the distribution, promotion and syndication
of digital music. We believe that these relationships will enhance our ability
to provide a rich variety of music to consumers.
. Amazon.com. In April 1999, two new Sarah McLachlan recordings were made
exclusively available on Amazon.com for downloading using our technology.
This retailing experiment increased consumer interest for her upcoming
album. Based on the success of this event, in June 1999 we entered into
an Advertising Agreement with Amazon.com. Under that agreement, we are
collaborating with Amazon.com on event-based advertising using our
digital delivery services.
[Graphic of screen shot Amazon.com website]
. EMI Recorded Music. In June 1999, we entered into a letter agreement with
Virgin Holdings, Inc., an affiliate of EMI Recorded Music. Under this
agreement, we are granted the right, for a period of 3 years, to create
digitally encoded copies of designated EMI sound recordings using the
Liquid Audio and Genuine mp3 formats.
. Muze Inc. We are collaborating with Muze Inc. to jointly market and
operate the Liquid Muze Previews service. The Liquid Muze Previews
service will offer online music retailers a database of more than one
million sample audio clips to enhance the promotion and sale of music. We
launched the Liquid Muze Previews service in the second quarter of 1999.
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. Towerrecords.com. We have entered into an agreement with MTS, Inc., the
parent company of Tower Records, to provide digital delivery of music
titles to consumers through its online retail website, Towerrecords.com.
Through our Liquid Music Network, we will enable the Towerrecords.com
website to offer for sale syndicated music content.
[Graphic of screen shot TowerRecords.com website]
In addition, many independent record labels have chosen to make their
catalogs available using our solution, including Beggars Banquet, Del-Fi
Records, Rounder Records, Sub Pop Records, Twin/Tone Records and Vanguard
Records. As of June 30, 1999, record labels have chosen to promote and sell
more than 60,000 digital music recordings through our Liquid Music Network and,
once available, to music retailer websites. This compares to approximately
5,000 digital music recordings at the beginning of 1999.
Player Distribution Relationships. We have entered into several strategic
relationships to promote the distribution of our Liquid Player software.
Companies that have agreed to distribute our Liquid Player with certain of
their product lines include Adaptec, Intel and Iomega.
. Adaptec. Adaptec is licensing our Liquid Player software for distribution
with its compact disc recorder software, which allows consumers to copy
music from a personal computer to a compact disc, using a compact disc
recorder.
. Intel. We are working with Intel to distribute our Liquid Player software
to members of the Intel WebOutfitter Service, which enables Pentium(R)
III processor-based personal computer owners to access the latest
Internet plug-ins and applications. Our Liquid Player is included on the
Intel WebOutfitter Service tool kit compact disc that is delivered to
Pentium III processor-based owners that join the service.
. Iomega. We are collaborating with Iomega to offer consumers a way to
securely download music from the Internet directly onto Iomega's Zip(R)
disks. As part of this initiative, Iomega will be bundling the Liquid
Music Player with selected Zip drives.
Technology Relationships. We have established relationships with many of the
companies providing innovative technologies for the distribution of digital
recorded music. These include the following:
. Dolby Laboratories Inc. and Fraunhofer Institut. We have licensed Dolby's
AC-3 and Fraunhofer's AAC and mp3 audio compression technologies. These
technologies are used in our Liquifier Pro, Liquid Server and Liquid
Player products.
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. RealNetworks Inc. We have developed a software "plug-in" that enables
RealNetwork's RealPlayer G2 software to play music encoded in our format.
The plug-in, which will be distributed by RealNetworks, enables
syndicated music in our Liquid Music Network to be previewed by
RealPlayer G2 users.
. Texas Instruments Inc. We are collaborating with Texas Instruments to
develop a reference design based on our SP3 specification for secure
music delivery. Texas Instruments intends to use our SP3 reference design
in chipsets that will enable future flash memory-based consumer
electronics devices to be compatible with our platform.
. Toshiba Corporation and Sanyo Corporation. We are collaborating with
Toshiba and Sanyo to develop portable digital music playback devices that
are compatible with our SP3 specification.
International Relationships. We believe that relationships with key partners
outside the United States are important to establish a complementary
international distribution infrastructure. Because personal computers have not
achieved high levels of penetration in most international markets, our emphasis
in these markets has been and will continue to be on enabling the distribution
of digital music through physical kiosks and other consumer-oriented
technologies. In Korea, Liquid Audio and the SK Group have established Liquid
Audio Korea. Liquid Audio Korea is currently focused on kiosk-based retail
applications of our technology. These applications will allow consumers to
preview and purchase compact discs and other transportable media from retail
entertainment centers. Liquid Audio Korea expects to open these kiosks in the
second half of 1999. In Japan, along with Super Stage Itochu, Hikari Tsushin
and Hapinet, we have established Liquid Audio Japan. Liquid Audio Japan is the
exclusive reseller and distributor of our software products in Japan.
Customers. We license our software products and offer services to a variety
of customers from various market segments. A selected list of our customers
includes the following, each of which accounted for more than $10,000 of our
license revenues in 1998:
<TABLE>
<S> <C>
Amplified.com Audio Highway
Capitol Records Cell Ventures
Columbia House K-Tel International
Platinum Entertainment, Inc. The Music Connection
Warner Bros. Animation Web Music Company
</TABLE>
In 1997, Music.co.jp, Columbia House and DreamNet accounted for 49%, 12% and
10% of our total net revenues, respectively. In 1998, SK Group accounted for
34% of our total net revenues. In the first quarter of 1999, Adaptec, Liquid
Audio Japan, and Super Stage accounted for 40%, 19% and 16% of our total net
revenues, respectively.
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Promotional Relationships. Numerous recording artists and record labels have
used our products and services to promote new releases and create consumer
awareness. These mutually beneficial promotional efforts have generated little
or no direct revenue for us, individually or in the aggregate. The following
table lists artists and record labels for whom we have provided promotional
services:
Record Labels
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Almo Records Angel Records Arista Records Inc.
Atomic Pop Blue Note Records BMG North America
Dreamworks Records EMI Classics Fuel 2000 Records
Geffen Records Giant/Revolution Hollywood Records
Interscope Records LaFace Records Mammoth Records
MCA Records RCA Records TVT Records
V2 Records Virgin Classics Windham Hill Records
- -------------------------------------------------------------------------------------
Recording Artists
- -------------------------------------------------------------------------------------
Alison Krauss and Union Station Beck Beth Orton
Brian Setzer Orchestra Bruce Hornsby Carlos Santana
Crash Test Dummies Creed Dar Williams
The Dave Matthews Band Duran Duran Emmylou Harris
Essence Fastball Herbie Hancock
Hole Jesus and Mary Chain Jimi Hendrix
Julian Lennon Primus Sarah McLachlan
</TABLE>
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<PAGE>
Products and Services
Our platform includes a suite of software products and services that enable
the secure digital delivery and sale of recorded music over the Internet. Our
products and services can be represented graphically as follows:
[GRAPHIC OF LIQUID OPERATIONS CENTER]
- --------
Shaded area denotes future service.
Create and Publish
Liquifier Pro. This product is an audio mastering and encoding software tool
that enables the user to encode and publish music files for distribution on the
Internet. Our Liquifier Pro software is also used to set rules by which the
content can be used by consumers. It utilizes security features, including
encryption and watermarking, in order to provide copy protection. Our Liquifier
Pro software also enables the user to attach descriptive text, such as lyrics
or album liner notes, graphics such as compact disc cover art, and copyright
information to the music file. We include Liquifier Pro Software with various
hosted service offerings.
Encoding Services. These services prepare music for publishing through our
Liquid Server for artists and record companies that do not license our
Liquifier Pro software. These are scalable services and we have developed an
automated high capacity encoding production service that is currently able to
encode up to approximately 20,000 individual sample sound recordings per day.
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<PAGE>
Liquid Server. Our Liquid Server software manages and delivers encoded music
files for streaming or downloading. We have built transaction, security and
copyright management functionality into the Liquid Server. Users can integrate
this product with a variety of e-commerce and database software applications so
that a large volume of digital music and associated information can be securely
sold or distributed through the Internet. Licenses for our Liquid Server start
at $10,000 and are priced based on the number of concurrent streams licensed
and digital music "tracks" available for sale.
Liquid Hosting Services. We can store and serve digital music for both
professional and amateur recording artists and labels. Artists can use our
service to feature music links on their websites and sell music without buying
our software products. Since launching these services in December 1997, more
than 1,300 artists have used our hosting services. These artists have made
9,000 songs available for downloading through the Liquid Music Network and
their own websites.
Syndicate
Liquid Music Network (LMN). The LMN, launched in July 1998, is a distributed
music network of more than 200 music-related and music retailer websites. The
LMN provides the music-related websites with a ready-made online music store
through which consumers can preview, purchase and download digital recorded
music. LMN participants sign up for the service and add hyperlinks to their
home page to begin selling digital music. Our LMN music-related website
affiliates include The Ultimate Band List and Atomic Pop. The LMN provides
music retailer websites with the ability to sell our syndicated music catalog
through their existing e-commerce websites. Retailer participants may choose
any of the music titles encoded in our Liquid Music format. Towerrecords.com is
our first LMN music retailer website affiliate and will be enabled to digitally
deliver our catalog in the second half of 1999.
Kiosks. We provide retailers with the ability to digitally deliver music
using the Liquid Audio platform through in-store physical kiosks located in
entertainment centers or other retail locations. With our partners in Korea, we
are developing Total Music Centers where consumers can preview music through
individual kiosks and then purchase songs which can be transferred on-site to a
compact disc. The first Total Music Center is scheduled to be opened in Korea
in the second half of 1999.
Promote and Sell
Liquid Player. Our Liquid Player is a consumer desktop software application
that communicates with our Liquid Server to manage playback streaming, display
data in the media fields, and manage the downloading of music content. Once
content is downloaded, our Liquid Player can be used to organize the content
into playlists for listening from the computer, to transfer the digital music
to a recordable compact disc or, in the future, to output to other consumer
electronics devices for later playback. Our Liquid Player can be downloaded
free of charge from our website and currently is distributed by a number of
third parties either in combination with their own products or as downloads
from their websites.
Liquid Muze Previews. Beginning in the second quarter of 1999, the Liquid
Muze Previews service will assist retailers in promoting and selling both
physical compact discs and digital downloads by providing a comprehensive
database of sample music recordings. Retailers and music sites will also be
able to offer digital music samples provided by the Liquid Muze Previews
service to let customers preview and learn about music and potentially
transform browsers into buyers.
Liquid Promotions. Liquid Promotions are event-based, Internet music
marketing and promotional services that help build awareness of artists and
increase consumer traffic to retail and music sites. Liquid Promotions include
Internet advertisements, promotional Internet events such as Liquid Live
performances and featured placement of artists' music on hundreds of websites.
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<PAGE>
Liquid Operations Center (LOC). The LOC operates primarily as a security and
copyright management center. The LOC issues digital certificates for our Liquid
Server and our Liquid Player so that both of these pieces of software can be
used to deliver music securely. In addition, the LOC is in direct communication
with every Liquid Server and transmits streaming, downloading and purchase
information through tamper-resistant logs. This information is used for
commerce management and to generate reports and invoices for the appropriate
copyright owners.
Standards
We believe that a successful solution for digital music commerce must
incorporate technical and industry standards. We have participated in or are
leading standard-setting initiatives.
Secure Digital Music Initiative (SDMI). The SDMI is sponsored by the RIAA to
develop an open standard for the secure digital delivery and use of recorded
music. Over 200 companies are participating in this effort. To date, this
effort has focused on requirements for consumer portable music devices, such as
the Diamond Rio hand-held player. We are actively participating in these
efforts, and our Chief Technical Officer is currently the SDMI Specification
Editor.
Genuine Music. We have led an industry initiative to develop a standard for
an open form of the mp3 format that supports authentication functions. These
functions will protect consumers by providing visual confirmation that
downloaded mp3 or other digital recorded music files are authentic. Digital
recorded music formatted in this manner will play on all standard mp3 players
and will additionally contain information identifying the copyright owner and
the encoder. The copyright owner can also provide Internet links for additional
promotions. These features are not found in standard mp3 files. This initiative
has received support from 48 other companies, including mp3.com, Diamond
Multimedia, MediaOne Group, Inc. and Fraunhofer Institut.
Rights Reporting Organizations. A major portion of worldwide music industry
revenues is based on the reporting of sales and music performance information.
For example, the individuals and companies that administer the copyrights in
musical compositions receive payment each time a composition is publicly
performed. These individuals and companies believe that both the delivery of a
streaming digital music file and the downloading of a digital music file are
"performances" entitling them to receive a payment. These companies are
represented by several international rights reporting organizations. We are
engaged in the following initiatives with these organizations to simplify
rights information reporting:
. United States. ASCAP, BMI and SESAC--We have entered into agreements with
the American Society of Composers, Authors and Publishers, Broadcast
Music Incorporated and SESAC, the major rights reporting organizations in
the United States. Under each of these agreements, we have developed
technology to provide information regarding digital music delivered using
our products. This technology will enable the accurate payment of fees
based on Internet transmissions. We are also conducting a trial of
digital watermarking technologies with BMI.
. Europe. Imprimatur project--The Imprimatur project is an effort by the
major rights reporting organizations in Europe to integrate standardized
reporting efforts in a common data reporting format. We are providing
technology for the infrastructure for this effort focused on the
MusicTrial.com initiative website.
Secure Portable Player Protocol (SP3). Our SP3 initiative is intended to
provide an open technical architecture and reference specification for portable
digital music playback devices that satisfy music industry and technology
industry requirements. Any SP3-compatible digital music would be able to be
played on any compliant device while unauthorized copies would not be able to
be played. We have entered into an agreement with Texas Instruments for the
collaborative development of a reference design for a consumer playback device
based on this specification. We are also collaborating with Fraunhofer, the
developer of the leading digital audio encoder and encoding technology, on the
specifications for the SP3 standard.
45
<PAGE>
Technology
We have developed a technology base that is designed to optimize the digital
delivery of music. Our architecture is based on four principal technology
layers: component technologies, system technologies, network services and
content syndication. We have developed technology in all of these layers to
provide specific advantages for our music delivery products and services. The
implementation of our component and system technologies enables us to provide
our network services and content syndication offerings. Our network services
include the LOC and processing and rights reporting. Our content syndication
services encompass the LMN and kiosks. We have invested significant amounts
toward research and development to date. Our expenses in this area totaled
approximately $692,000, $1.9 million, $3.1 million and $1.2 million in the
period from January 30, 1996 (inception) through December 31, 1996, the years
ended December 31, 1997 and 1998, and the three months ended March 31, 1999,
respectively.
The Liquid Audio Architecture
[Graphic depicting our architecture.]
CONTENT SYNDICATION
-------------------
NETWORK SERVICES
----------------
SYSTEM TECHNOLOGIES
|
---------------------------------------------------------------
| | | | |
Open Secure Territory Device Passports
Interfaces Protocols Restrictions Interfaces
COMPONENT TECHNOLOGIES
|
-------------------------------------------
| | |
Watermarking Audio Multi-format
Compression Distribution Container
Component Technologies. Our architecture begins with component technologies,
which include watermarking, audio compression and a multi-format distribution
container.
. Watermarking. Watermarking embeds indelible and inaudible digital
information into the audio waveform. We have developed our own
watermarking technology that is specifically designed to operate in
conjunction with compression technologies. The embedded information is
useful for identifying and tracking audio usage and cannot be removed
without destroying the recorded music.
. Audio compression. Audio compression reduces the bandwidth required to
stream and download music over network connections. We have developed a
version of Dolby Digital technology (AC-3) that is optimized for online
music distribution. We have also implemented the AAC audio compression
technology, to which we have added extensions that further improve audio
quality. In addition, we have developed an exclusive, proprietary
lossless compression algorithm that is useful for professional audio
applications.
. Multi-format Distribution Container. We have developed a master media
container format that facilitates the delivery of media throughout our
system. This container structure is designed to permit
46
<PAGE>
extension to other media types such as video. The container is optimized
for music distribution and includes multiple images that can be used to
preview and purchase media content in multiple formats and at multiple
resolutions.
System Technologies. Our system technologies build on top of the base
features provided through our component technologies to enable our digital
music delivery services.
. Open Interfaces. We have developed interfaces to third-party systems for
commerce, databases and general purpose media delivery. Our commerce
interfaces allow our platform to take advantage of many payment methods
from credit cards to micro-payment solutions. The database interfaces
allow our system to dynamically update time sensitive information, such
as pricing, without requiring expensive re-encoding of content. Our
third-party system interfaces permit us to connect and provide
compatibility with general purpose media delivery systems such as those
provided by RealNetworks and Microsoft Corporation.
. Secure Protocols. We have created secure protocols for communication
between all parts of the system. Secure communications are necessary to
prevent theft of content as it moves through the system. Secure links
exist between the Liquid Server and content creation tools for
publishing, the server and Liquid Player for consumer downloading, and
the server and the LOC for transaction reporting.
. Territory Restrictions. We have developed specific technology that
identifies the approximate geographic location of consumers. We use this
technology to enforce rules for content access related to territory. This
enforcement is necessary since some content can only be sold in specific
territories.
. Device Interfaces. We have developed the Secure Portable Player Protocol
(SP3), which provides a set of security interfaces and techniques for
next generation portable devices. SP3 has been developed as an open
specification for use by many device manufacturers. SP3 is consistent
with the goals of the SDMI and is intended to be compatible with the
specification that results from the SDMI.
. Passports. We have developed a digital identification system, Liquid
Passport, that permits consumers to move their music to multiple machines
while still providing anti-piracy protections.
We believe that our technology architecture and our advanced stage of
development and deployment provide distinct competitive advantages. We are
currently developing the fifth generation of our digital music delivery
products. The advantages of our technology are summarized below:
. Open Technical Architecture. An open system design is important because
standard formats are not yet available for online music distribution. Our
technology has been designed to provide an open and flexible solution
that can adapt to many competing formats, including MPEGII Layer 3 (mp3)
and the MPEG Advanced Audio Codec (AAC), as well as future changes that
may occur in digital music distribution. Our open system design allows
the integration of new technologies while maintaining compatibility with
existing content. In addition, our flexible architecture allows us to
continue to integrate technologies such as audio compression and audio
watermarking as they continue to improve in the future.
. Robust and Scalable System Architecture. A comprehensive and robust
system architecture is important to meet the demands that may result from
large scale consumer adoption. We have developed a broad range of
technologies that enables efficient music distribution services. We have
developed specific technologies that permit our system to scale across
multiple systems and locations. This technology provides unique
advantages for efficiently delivering music and other media to a global
audience. We have also developed technology that allows us to extend our
system beyond online applications to include physical locations for sales
of music via kiosks, broadening our reach to include both online and
traditional consumers.
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<PAGE>
. Superior Audio Quality. We believe consumers will pay for quality music,
and we believe that we have consistently provided superior audio quality
for digital music. We employ specific techniques and optimize industry
algorithms to improve sound quality. We believe that our use of
standardized compression algorithms such as MPEG AAC and mp3 provides
greater compatibility than proprietary audio compression solutions.
. Effective Copyright Management. Artists and labels have been reluctant to
embrace digital distribution of music given the current lack of copyright
management technologies. We have developed technology to address the
copyright management issue for online music distribution. Our security
technologies protect content from the time it is created to the time it
is consumed. These technologies include secure communication protocols
that allow content creators to publish and manage their content in the
distribution system. We have also developed specific anti-piracy
technology such as watermarking that embeds unique identification
information in the recorded music.
. Automated Production and Publication. We have created technologies that
improve the efficiency of online music distribution and reduce operating
costs. Our content encoding system allows us to format large amounts of
quality audio content for online use in a timely and cost effective
manner. We also have automated services, such as account creation, that
are necessary for content creators to publish and manage their content.
This automation avoids manual intervention for the publishing of content.
We have also developed database technology that permits us to manage the
large volume of content in our distribution system.
Sales and Marketing
Our sales and marketing efforts are principally concentrated on aggregating
digital music recordings for syndication and sale, and broadening our content
syndication reach by expanding the number of Liquid Music Network music-related
and music retailer website affiliates. We sell our products and services to
artists, record companies, websites and online retailers through a 34-person
sales and marketing organization. These employees are located in Redwood City,
Los Angeles and New York. Our software products and services are also bundled
and distributed by third-party manufacturers of various computer hardware,
software and musical instrument products.
We use a variety of marketing programs to create market awareness and
generate demand for our products and services. Our marketing activities include
event-based promotions with popular recording artists and record labels, web
advertising and sponsorships, press tours, participation in trade events and
conferences, and other public relations activities.
In addition to maintaining relationships with worldwide rights societies and
expanding the distribution opportunities for our products and services, our
business development group works to develop new international markets and
business opportunities for our products and services. We believe that
establishing strategic relationships in each of the major international markets
will accelerate the international deployment of our products and services.
Intellectual Property
Our success will depend in part on our ability to protect our proprietary
software and other intellectual property. To protect our proprietary rights, we
rely generally on patent, copyright, trademark and trade secret laws,
confidentiality agreements with employees and third parties, and license
agreements with consultants, vendors and customers. Despite these protections,
a third party could, without authorization, copy or otherwise obtain and use
our products or technology to develop similar technology independently.
Our agreements with employees, consultants and others who participate in
product and service development activities may be breached, we may not have
adequate remedies for any breach, and our trade secrets may become known or
independently developed by competitors.
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We currently have 17 patents pending in the United States relating to our
product architecture and technology and hold one patent. That patent expires in
October 2015. Any pending or future patent applications may not be granted,
existing or future patents may be challenged, invalidated or circumvented, and
the rights granted under a patent that has issued or any patent that may issue
may not provide competitive advantages to us. Many of our current and potential
competitors dedicate substantially greater resources to protection and
enforcement of intellectual property rights, especially patents. If a blocking
patent has issued or issues in the future, we would need either to obtain a
license or to design around the patent. We may not be able to obtain a required
license on acceptable terms, if at all, or to design around the patent. See "--
Litigation and Patent Infringement Claims."
We pursue the registration of our trademarks and service marks in the United
States and in other countries, although we have not secured registration of all
our marks. A significant portion of our marks begin with the word "Liquid." We
are aware of other companies that use "Liquid" in their marks, alone or in
combination with other words, and we do not expect to be able to prevent all
third-party uses of the word "Liquid." In addition, the laws of some foreign
countries do not protect our proprietary rights to the same extent as do the
laws of the U.S., and effective patent, copyright, trademark and trade secret
protection may not be available in these jurisdictions. We license our
proprietary rights to third parties, and these licensees may fail to abide by
compliance and quality control guidelines with respect to our proprietary
rights or take actions that would harm our business.
To license many of our products, we rely in part on "shrinkwrap" and
"clickwrap" licenses that are not signed by the end user and, therefore, may be
unenforceable under the laws of certain jurisdictions. As with other software
products, our products are susceptible to unauthorized copying and uses that
may go undetected. Policing unauthorized use is difficult.
We attempt to avoid infringing known proprietary rights of third parties in
our product and service development efforts. We have not, however, conducted
and do not conduct comprehensive patent searches to determine whether the
technology used in our products infringes patents held by third parties. In
addition, it is difficult to proceed with certainty in a rapidly evolving
technological environment in which there may be numerous patent applications
pending, many of which are confidential when filed, with regard to similar
technologies. If we were to discover that our products violate third-party
proprietary rights, we might not be able to obtain licenses to continue
offering these products without substantial reengineering. Effort to undertake
this reengineering might not be successful, licenses might be unavailable on
commercially reasonable terms, if at all, and litigation might not be avoided
or settled without substantial expense and damage awards.
Any claims relating to the infringement of third-party proprietary rights,
even if not meritorious, could result in the expenditure of significant
financial and managerial resources and could result in injunctions preventing
us from distributing certain products and services. These claims could harm our
business. We also rely on technology that we license from third parties,
including software that is integrated with internally developed software and
used in our products and services, to perform key functions. Third-party
technology licenses may not continue to be available to us on commercially
reasonable terms. The loss of any of these technologies could harm our
business. Moreover, although we are generally indemnified against claims that
third-party technology infringes the proprietary rights of others, this
indemnification may be unavailable for all types of intellectual property
rights, for example, patents may be excluded, and in some cases the scope of
indemnification is limited. Even if we receive broad indemnification, third-
party indemnitors are not always well capitalized and may not be able to
indemnify us in the event of infringement, resulting in substantial exposure to
us. Infringement or invalidity claims may arise from the incorporation of
third-party technology, and our customers may make claims for indemnification.
These claims, even if not meritorious, could result in the expenditure of
significant financial and managerial resources in addition to potential product
and service redevelopment costs and delays, all of which could harm our
business. Microtome, Inc., has recently claimed that our products infringe its
patent rights. Additionally, in late June 1999, we received a letter from
another corporation suggesting that we review patents to which they claim
rights. See "--Litigation and Patent Infringement Claims."
49
<PAGE>
Competition
Competition among companies in the business of delivering digital music over
the Internet is intense. We compete against a number of technology companies
that are offering or plan to offer products, services or technologies for the
delivery of digital music over the Internet. The number of websites competing
for the attention and spending of consumers and advertisers has increased, and
we expect it to continue to increase. We may also compete with consumer
electronics companies as they begin to market Internet music player devices.
See "Risk Factors--The Market for Digital Delivery of Music Over the Internet
is Highly Competitive, and If We Cannot Compete Effectively, Our Revenues Might
Decline."
We compete with the following types of companies with respect to the
aggregation of content and the syndication and distribution of digital music:
. providers of infrastructure technology, products and services such as
Microsoft, RealNetworks, IBM, AT&T/a2b, Sonique and MusicMatch;
. providers of online music services, such as mp3.com, RioPort.com,
SonicNet and UBL;
. internet retrieval and other "portal" companies, such as Excite,
Infoseek, Lycos and Yahoo!, and
. online music retailers, such as CDnow and Amazon.com.
We believe that the primary competitive factors in our market are the
following:
. quantity and variety of digital recorded music content;
. availability of sufficient bandwidth for the rapid and easy downloading
of digital recorded music;
. brand awareness;
. fidelity and quality of sound of digital recorded music; and
. ability to ensure secure digital delivery of recorded music.
We believe our products and services offer significant advantages over those
of our competitors:
. our Liquid Music Network features over 1,300 artists and 300 individual
record labels. We believe that we offer more artists and more labels than
most digital music distribution services;
. through our Liquid Music Network, we believe we have the potential to
reach more music consumers than other digital music delivery solutions;
. we believe our platform offers better copy-protection and copyright
management than mp3-based solutions; and
. we believe the fidelity and sound quality of music encoded by our
products and services to be superior to competitive systems due to
optimizations we perform on audio compression technologies used in our
products and services.
Employees
As of June 30, 1999, we had 101 full-time employees including 39 in sales and
marketing, 38 in research and development, 14 in general and administrative,
and 10 in operations. We consider our relationships with employees to be good.
None of our employees is covered by collective bargaining agreements.
Facilities
Our headquarters are located in 18,200 square feet of leased office space in
Redwood City, California. The lease term extends to November 15, 2002 with two
five-year renewals, at our option. We lease an office suite adjacent to our
headquarters in Redwood City on a month to month basis, for additional office
space and
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storage needs. We have recently leased an additional 11,400 square feet of
office space near our headquarters. The lease term for this additional space
extends to April 14, 2002 with a three-year renewal at our option.
Litigation and Patent Infringement Claims
On April 23, 1999, Arne Frager and Rose G. Frager filed a complaint against
us and our president, Gerald Kearby, in the Superior Court of the State of
California for the County of Marin (case number CV 991826). The complaint
alleges breach of contract and related claims. In particular, plaintiffs allege
that in January 1996, in connection with the formation of Liquid Audio, we
agreed to issue plaintiffs 750,000 shares of common stock. Plaintiffs further
allege that Liquid Audio entered into a consulting agreement with Mr. Frager
under which we allegedly agreed not to terminate Mr. Frager without good cause.
Plaintiffs allege that we breached each of these agreements, and seek 587,870
shares of our common stock, the portion of the 750,000 shares that have not
previously been issued. We believe, after consultation with counsel, that
plaintiffs' claims are without merit, and intend to vigorously defend the
lawsuit. However, should we have to issue additional shares to the plaintiffs,
then-existing stockholders would experience dilution of their ownership
interests and we would need to record an accounting charge in our statement of
operations equal to the fair market value of the shares at the time of
issuance.
On May 13, 1999, John Hempe filed a complaint against us, our president,
Gerald W. Kearby, our chief technical officer, Philip R. Wiser, and other
defendants not employed by us, in the San Mateo Superior Court (case number
409032). The complaint alleges, among other things, discrimination under the
provisions of the California Fair Employment and Housing Act, breach of
contract and breach of the covenant of good faith and fair dealing, in
connection with his termination, and seeks unspecified damages. We believe,
after consultation with counsel, that plaintiff's claims are without merit and
intend to vigorously defend the lawsuit. However, should this litigation be
decided adversely to us, we may be required to pay damages to plaintiff.
On May 25, 1999, Microtome, Inc. notified us that it believes our Liquifier
Pro Encoding Tool, when used in conjunction with our Liquid Music Player,
infringes United States Patents Nos. 5,734,823 and 5,734,891, in which
Microtome asserts it has rights, and asked us to cease and desist the
manufacture, sale and use of these products. To our knowledge, Microtome has
not yet filed a lawsuit alleging infringement of these patents, but it has
indicated an intention to do so if our response is not satisfactory. Microtome
has also indicated that it is willing to grant us a non-exclusive license to
these patents. In the event that we cannot come to an agreement with Microtome,
we might be drawn into litigation with them. We believe, after consultation
with counsel, that we have meritorious defenses to any claim that the
identified products infringe the claims of these patents and intend to
vigorously defend any lawsuit asserting infringement of those patents. However,
should any litigation be decided adversely to us, we might be required to pay
substantial damages to Microtome and could be enjoined from selling those of
our products that are held to infringe Microtome's patents unless and until we
are able to negotiate a license from them. See "Risk Factors--We Face and Might
Face Intellectual Property Infringement Claims That Might Be Costly to
Resolve."
On June 29, 1999, a corporation suggested by letter that we review patents to
which they claim rights. They also imply that we might wish to obtain a license
from them in connection with their patent rights.
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MANAGEMENT
Directors and Executive Officers
The following table sets forth our directors and executive officers, their
ages and the positions held by them as of July 7, 1999:
<TABLE>
<CAPTION>
Name Age Position
---------------------------- --- -----------------------------------------
<C> <C> <S>
Gerald W. Kearby............ 51 President, Chief Executive Officer and
Director
Robert G. Flynn............. 45 Senior Vice President of Business
Development and Secretary
Philip R. Wiser............. 32 Senior Vice President of Engineering,
Chief Technical Officer and Director
Gary J. Iwatani............. 37 Senior Vice President and Chief Financial
Officer
Scott A. Steinberg.......... 35 Senior Vice President of Marketing
Kevin M. Malone............. 33 Vice President of Sales
Richard W. Wingate.......... 47 Vice President of Content Development and
Label Relations
Mathieu ("Charly") Prevost.. 50 Vice President of Promotions
Andrea Cook Fleming......... 32 Vice President of Corporate Marketing
Heather Furmidge............ 45 Vice President of Internet Business
Ann Winblad................. 48 Director
Silvia Kessel............... 48 Director
Sanford R. Climan........... 43 Director
Eric P. Robison............. 39 Director
</TABLE>
Mr. Kearby co-founded Liquid Audio in January 1996. Since January 1996, Mr.
Kearby has served as our President and Chief Executive Officer and one of our
directors. From June 1995 to December 1995, Mr. Kearby was co-founder and Chief
Executive Officer of Integrated Media Systems, a manufacturer of computer-based
professional audio equipment. From January 1989 until June 1995, Mr. Kearby
served as Vice President of Sales and Marketing at Studer Editech Corporation,
a professional audio recording equipment company. Mr. Kearby holds a B.A. in
broadcast management and audio engineering from San Francisco State University.
Mr. Flynn co-founded Liquid Audio in January 1996. Since July 1999, Mr. Flynn
has served as our Senior Vice President of Business Development and Secretary.
From January 1996 to July 1999, Mr. Flynn served as our Vice President of
Business Development and Secretary. Mr. Flynn also served as our Chief
Financial Officer from January 1996 to August 1997 and as one of our directors
from January 1996 to June 1996. From March 1987 until November 1995, Mr. Flynn
served as a general partner of Entertainment Media Venture Partners I, L.P., an
institutional venture capital fund investing in the entertainment, media and
communications technology industries. During this time, Mr. Flynn also served
on the board of directors of Integrated Media Systems. Mr. Flynn holds a B.A.
in English from Stanford University and an M.B.A. from UCLA.
Mr. Wiser co-founded Liquid Audio in January 1996. Since July 1999, Mr. Wiser
has served as our Senior Vice President of Engineering and Chief Technical
Officer. From May 1996 to July 1999, Mr. Wiser served as our Vice President of
Engineering and from November 1998 to July 1999 as our Chief Technical Officer.
Since June 1996, he has also served as one of our directors. From July 1995 to
May 1996, Mr. Wiser served as a senior software engineer, directing audio
compression work at Chromatic Research, a multimedia semiconductor device
company. From October 1994 to July 1995, Mr. Wiser was a senior software
engineer and the director of digital signal processing research for Studer
Editech Corporation. From June 1994 to October 1994, Mr. Wiser was a software
engineer for Sonic Solutions, a developer of digital media tools. Mr. Wiser
holds a B.S. in electrical engineering from the University of Maryland, College
Park and an M.S. in electrical engineering from Stanford University.
Mr. Iwatani has served as our Senior Vice President since July 1999 and as
our Chief Financial Officer since August 1997. From May 1995 to April 1997, Mr.
Iwatani was the Chief Financial Officer of Berkeley
52
<PAGE>
Systems, Inc., a developer and marketer of multimedia entertainment consumer
software. From May 1991 to March 1995, Mr. Iwatani served as Director of
Finance and Operations at Insignia Solutions, Inc., a utility software company.
Mr. Iwatani holds a B.S. in accounting from Santa Clara University, as well as
a C.P.A. from the State of California.
Mr. Steinberg has served as our Senior Vice President of Marketing since July
1999. From September 1998 to July 1999, Mr. Steinberg was the Senior Vice
President of Marketing of Eidos Interactive, Inc., a developer and marketer of
multimedia entertainment consumer software. From August 1996 to September 1998,
Mr. Steinberg was the Vice President of Marketing of Crystal Dynamics, Inc., an
entertainment software studio. From October 1994 to September 1998, Mr.
Steinberg served as Director of Marketing of Crystal Dynamics, Inc. Prior to
October 1994, Mr. Steinberg served as Product Marketing Manager for Crystal
Dynamics, Inc. Mr. Steinberg holds a B.S. in marketing from San Francisco State
University.
Mr. Malone has served as our Vice President of Sales since February 1998.
From June 1997 to February 1998, Mr. Malone was our Director, International
Sales. From May 1993 to June 1997, Mr. Malone held a variety of positions at
Silicon Graphics, Inc., a manufacturer of work stations, servers and
supercomputing systems, including Manager, Strategic Marketing, Operations
Manager, Portugal and International Business Development Manager. Mr. Malone
holds a B.S. in business administration from the University of Arizona and an
M.B.A. in international business studies from the University of South Carolina.
Mr. Wingate has served as our Vice President of Content Development and Label
Relations since August 1998. Mr. Wingate operated his own new media marketing
consulting company, Wingate Marketing, from July 1996 until June 1998. From
August 1997 to June 1998, Mr. Wingate was also a private music industry
consultant. From June 1994 to July 1996, Mr. Wingate was Senior Vice President,
Marketing for Arista Records Incorporated, a music recording company. Prior to
June 1994, Mr. Wingate held several senior management positions with major
music industry record labels, including Polygram, Inc. and Columbia Records.
Mr. Wingate holds a B.A. in communications from Brown University.
Mr. Prevost has served as our Vice President of Promotions since December
1998. From April 1996 to November 1998, Mr. Prevost was Vice President, Retail
at The Album Network, a media company trade journal. Prior to April 1996, Mr.
Prevost was president of his own company, the Charly Prevost Company, a
multimedia management company. Mr. Prevost has also held several senior
management positions within the music recording industry, including president
of Island Records.
Ms. Fleming has served as our Vice President of Corporate Marketing since
June 1999. From February 1999 to June 1999, Ms. Fleming was our Director of
Corporate Marketing. From December 1995 to February 1999, Ms. Fleming served as
Public Relations Director at Netscape Communications Corporation, an Internet
services provider. From June 1994 to December 1995, Ms. Fleming was a Corporate
Public Relations Manager for Microsoft Corporation, a software company. Ms.
Fleming holds a B.A. in English from Stanford University.
Ms. Furmidge has served as our Vice President of Internet Business since June
1999. From January 1999 to June 1999, Ms. Furmidge was an Executive Producer
for ZD TV LLC, an Internet cable channel integrating television and Internet
programming. From June 1997 to January 1999, Ms. Furmidge was an Executive
Producer for Netscape Communications Corporation. From December 1995 to June
1997, Ms. Furmidge served as a Senior Producer for Netscape Communications
Corporation. Prior to December 1995, Ms. Furmridge served as an Engineering
Project Manager for Apple Computer, Inc., a software company. Ms. Furmidge
holds a B.A. in international relations from Stanford University and an M.B.A.
in telecommunications from the University of San Francisco.
Ms. Winblad has served as one of our directors since May 1996. Ms. Winblad
has been a general partner of Hummer Winblad Venture Partners, a venture
capital investment firm, since 1989. She is a member of the board of trustees
of the University of St. Thomas and is an advisor to numerous entrepreneurial
groups such as the Software Development Forum, the Stanford/MIT Venture Forum
and the Massachusetts Computer Software Council, Software Industry Business
Practices. Ms. Winblad also serves on the boards of directors of Net
Perceptions Inc., a developer and supplier of realtime recommendation
technology for the Internet, and several private companies. Ms. Winblad holds a
B.S. in mathematics and business administration from the College of Saint
Catherine and an M.A. in education with an economics focus from the University
of St. Thomas.
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<PAGE>
Ms. Kessel has served as one of our directors since October 1998. Since
November 1995, Ms. Kessel has held several positions at Metromedia
International Group, Inc., a global communications and media company, including
Executive Vice President, Chief Financial Officer and Treasurer. From January
1993 to June 1997, Ms. Kessel was Executive Vice President and a director of
Orion Pictures Corporation, a movie production company. Since January 1994, Ms.
Kessel has served as Senior Vice President of Metromedia Company, a privately-
held partnership. Ms. Kessel has also served as President of Kluge & Company, a
privately-held company, for over five years. Ms. Kessel is currently a director
and Executive Vice President of Metromedia Fiber Network, Inc., a fiber optic
network provider, and Big City Radio, Inc., an owner and operator of radio
station combinations in New York City, Chicago and Los Angeles. Ms. Kessel
received an M.B.A. in finance from Columbia University.
Mr. Climan has served as one of our directors since April 1999. Since
February 1999, Mr. Climan has been President of Entertainment Media Ventures,
Inc., an investment and advisory company focused on traditional and new media.
From October 1995 to May 1997, Mr. Climan was Executive Vice President and
President of Worldwide Business Development for Universal Studios, Inc., a
media production company. From June 1997 to February 1999 and from June 1986 to
September 1995, Mr. Climan was a member of the senior management team at
Creative Artists Agency, a talent and literary representation firm. Mr. Climan
also serves on the boards of directors of Equity Marketing, Inc., a provider of
custom promotional programs, and Sunterra Corporation, a developer and operator
of vacation ownership resorts. Mr. Climan holds a B.A. in chemistry from
Harvard College, an M.S. in health policy and management from the Harvard
School of Public Health and an M.B.A. from Harvard Business School.
Mr. Robison has served as one of our directors since April 1999. Since
January 1994, Mr. Robison has been a business development associate for Vulcan
Northwest, Inc., the holding company that manages all personal and business
interests for new media investor Paul G. Allen. Mr. Robison serves as a
Business Development Associate for Vulcan Ventures, Inc., the venture fund
division of Vulcan. Mr. Robison also serves on the boards of directors of
C|NET, Inc., Egghead.com, Inc. and ARI Network Services, Inc. Mr. Robison holds
a B.A. in communication studies from California State University, Sacramento
and an M.A. from the University of California, Davis.
Board Composition
We currently have six directors. Our restated certificate of incorporation,
to be filed upon the closing of this offering, states that the board of
directors will be divided into three classes: Class I, whose term will expire
at the annual meeting of stockholders to be held in 2000; Class II, whose term
will expire at the annual meeting of stockholders to be held in 2001; and Class
III, whose term will expire at the annual meeting of stockholders to be held in
2002. The Class I directors will be Sanford R. Climan and Eric P. Robison, the
Class II directors will be Silvia Kessel and Ann Winblad and the Class III
directors will be Gerald W. Kearby and Philip R. Wiser. At each annual meeting
of stockholders after the initial classification, the successors to directors
whose terms have expired will be elected to serve from the time of election and
qualification until the third annual meeting following their election. In
addition, our bylaws, to be adopted upon the closing of this offering, provide
that the authorized number of directors may be changed only by resolution of
the board of directors. Any additional directorships resulting from an increase
in the number of directors will be distributed among the three classes so that,
as nearly as possible, each class will consist of one-third of the total number
of directors. This classification of the board of directors may have the effect
of delaying or preventing changes in our control or management. See
"Description of Capital Stock."
Each officer is elected by, and serves at the discretion of, the board of
directors. Each of our officers and directors, other than nonemployee
directors, devotes his or her full time to our affairs. Our nonemployee
directors devote the amount of time necessary to discharge their duties to us.
There are no family relationships among any of our directors, officers or key
employees.
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<PAGE>
Board Committees
The audit committee of the board of directors reviews our internal accounting
procedures and consults with and reviews the services provided by our
independent accountants. The audit committee currently consists of Silvia
Kessel and Eric P. Robison.
The compensation committee of the board of directors reviews and recommends
to the board of directors the compensation and benefits of all of our executive
officers, administers our stock and option plans and establishes and reviews
general policies relating to compensation and benefits of our employees. The
compensation committee currently consists of Ann Winblad and Sanford R. Climan.
No interlocking relationships exist between our board of directors or
compensation committee and the board of directors or compensation committee of
any other company, nor has an interlocking relationship existed in the past.
Director Compensation
Our directors do not receive cash compensation for their service as members
of the board of directors, although they are reimbursed for certain expenses in
connection with attendance at board and committee meetings. We do not provide
additional compensation for committee participation or special assignments of
the board of directors. In April 1999, we granted Sanford R. Climan options to
purchase 20,000 shares of common stock under our 1996 Equity Incentive Plan.
See "--Stock Plans."
Change of Control Arrangements
We have sold shares of our common stock to each of Gerald W. Kearby, Robert
G. Flynn and Philip R. Wiser. These shares are subject to a vesting schedule
that accelerates with respect to the lesser of 25% of their total shares or
their remaining unvested shares upon certain corporate transactions, as
described in their individual Founders Restricted Stock Purchase Agreements and
the amendments to those agreements. We have also granted an option to purchase
common stock to Gary J. Iwatani. The shares underlying the option are subject
to a vesting schedule that accelerates with respect to the lesser of 25% of the
total number of shares subject to the option or the remaining unvested shares
upon certain corporate transactions, as described in his individual option
grant.
Executive Compensation
The following table sets forth the total compensation received for services
rendered to us during 1998 by our Chief Executive Officer and our four other
most highly compensated executive officers who received salary and bonus in
1998 in excess of $100,000 (Named Executive Officers).
<TABLE>
<CAPTION>
Annual
Compensation
-------------------
Name and Principal Position Salary Bonus
- ----------------------------------------------------------- -------- -------
<S> <C> <C>
Gerald W. Kearby, President and Chief Executive Officer.... $158,077 $45,000
Robert G. Flynn, Vice President of Business Development.... 118,077 26,250
Philip R. Wiser, Vice President of Engineering and
Chief Technical Officer................................... 118,077 26,250
Gary J. Iwatani, Chief Financial Officer................... 126,930 26,250
Kevin M. Malone, Vice President of Sales................... 160,343(1) 26,250
</TABLE>
- --------
(1) Includes $34,694 earned as commissions.
We did not grant any stock options to any of the Named Executive Officers
during 1998. We have never granted any stock appreciation rights.
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<PAGE>
Fiscal Year End Option Values
The following table provides summary information concerning stock options
held as of December 31, 1998 by each of the Named Executive Officers. None of
these officers exercised options in 1998.
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at Fiscal In-the-Money Options at
Year-End Fiscal Year-End(1)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Gerald W. Kearby............ -- -- -- --
Robert G. Flynn............. -- -- -- --
Philip R. Wiser............. -- -- -- --
Gary J. Iwatani............. 150,000 -- $271,000 --
Kevin M. Malone............. 112,500 -- 203,250 --
</TABLE>
- --------
(1) The value of unexercised in-the-money options at fiscal year-end is based
on a price per share of $2.00, as determined in good faith by the board of
directors, less the exercise price.
Stock Plans
1996 Equity Incentive Plan. Our 1996 Equity Incentive Plan provides for the
granting to employees of incentive stock options within the meaning of Section
422 of the Internal Revenue Code of 1986 (Code), and for the granting to
employees, directors and consultants of nonstatutory stock options and stock
purchase rights (SPRs). The 1996 Plan was approved by the board of directors
and the stockholders in September 1996. Unless terminated sooner, the 1996 Plan
will terminate automatically in 2009. A total of 3,272,354 shares of common
stock is reserved for issuance pursuant to the 1996 Plan, plus annual increases
on January 1st of each year equal to the least of (1) 1,500,000 shares, (2) 5%
of the outstanding shares on that date or (3) an amount determined by the
board.
The 1996 Plan may be administered by the board of directors or a committee of
the board, which committee must, in the case of options intended to qualify as
"performance-based compensation" within the meaning of Section 162(m) of the
Code, consist of two or more "outside directors" within the meaning of Section
162(m). The administrator has the power to determine the terms of the options
or SPRs granted, including the exercise price, the number of shares subject to
each option or SPR, the exercisability of the option or SPR, and the form of
consideration payable upon exercise. The board has the authority to amend,
suspend or terminate the 1996 Plan, provided that no action may affect any
share of common stock previously issued and sold or any option previously
granted under the 1996 Plan, unless the board and the option holder mutually
agree otherwise.
Options and SPRs granted under the 1996 Plan are not generally transferable
by the optionee, and each option or SPR is exercisable during the lifetime of
the optionee only by the optionee. Options granted under the 1996 Plan must
generally be exercised within three months of the optionee's separation of
service from us, or within twelve months after the optionee's termination by
death or disability, but in no event later than the expiration of the option's
ten-year term. In the case of SPRs, unless the administrator determines
otherwise, the restricted stock purchase agreement must grant us a repurchase
option exercisable upon the voluntary or involuntary termination of the
purchaser's service to us for any reason, including death or disability. The
purchase price for shares repurchased under the restricted stock purchase
agreement must be the original price paid by the purchaser and may be paid by
cancellation of any indebtedness of the purchaser to us. The repurchase option
will lapse at a rate determined by the administrator. The exercise price of all
incentive stock options granted under the 1996 Plan must be at least equal to
the fair market value of the common stock on the date of grant. The exercise
price of nonstatutory stock options and SPRs granted under the 1996 Plan is
determined by the administrator, but with respect to nonstatutory stock options
intended to qualify as
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<PAGE>
"performance-based compensation" within the meaning of Section 162(m) of the
Code, the exercise price must be at least equal to the fair market value of the
common stock on the date of grant. With respect to any participant who owns
stock possessing more than 10% of the voting power of all classes of our
outstanding capital stock, the exercise price of any incentive stock option
granted must equal at least 110% of the fair market value of the common stock
on the date of grant and its term must not exceed five years. The terms of all
other options granted under the 1996 Plan may not exceed ten years.
The 1996 Plan provides that, in the event of a merger of us with or into
another corporation or a sale of substantially all of our assets, each
outstanding option and SPR must be assumed or an equivalent option or SPR
substituted by the successor corporation. If the successor corporation refuses
to assume or substitute each outstanding option or SPR, each option or SPR will
expire on the completion of the transaction, except as may otherwise be
determined by the administrator.
1999 Employee Stock Purchase Plan. Our 1999 Employee Stock Purchase Plan was
adopted by the board of directors in April 1999 and by the stockholders in June
1999. A total of 500,000 shares of common stock has been reserved for issuance
under the 1999 Purchase Plan, plus annual increases on January 1st of each year
equal to the least of (1) 750,000 shares, (2) 3% of the outstanding shares on
that date or (3) an amount determined by the board.
The 1999 Purchase Plan, which is intended to qualify under Section 423 of the
Code, contains consecutive, overlapping, 24-month offering periods. Each
offering period includes four six-month purchase periods. The offering periods
start on the first trading day on or after June 1 and December 1 of each year,
except for the first offering period, which commences on the first trading day
on or after the effective date of this offering and ends on the last trading
day on or before May 31, 2001.
Employees are eligible to participate if they are customarily employed by us
or any participating subsidiary for at least 20 hours per week and more than
five months in any calendar year. However, any employee who (1) immediately
after grant owns stock possessing 5% or more of the total combined voting power
or value of all classes of our capital stock, or (2) whose rights to purchase
stock under all of our employee stock purchase plans accrues at a rate that
exceeds $25,000 worth of stock for each calendar year may be not be granted an
option to purchase stock under the 1999 Purchase Plan. The 1999 Purchase Plan
permits participants to purchase common stock through payroll deductions of up
to 15% of the participant's "compensation." Compensation is defined as the
participant's base straight time gross earnings, bonuses, commissions, payments
for overtime, shift premium payments and other cash compensation, exclusive of
any non-cash compensation. The maximum number of shares a participant may
purchase during a single purchase period is 2,500 shares.
Amounts deducted and accumulated by the participant are used to purchase
shares of common stock at the end of each purchase period. The price of stock
purchased under the 1999 Purchase Plan is generally 85% of the lower of the
fair market value of the common stock (1) at the beginning of the offering
period or (2) at the end of the purchase period. In the event the fair market
value at the end of a purchase period is less than the fair market value at the
beginning of the offering period, the participants will be withdrawn from the
current offering period following exercise and automatically re-enrolled in a
new offering period. The new offering period will use the fair market value as
of the first date of the new offering period to determine the purchase price
for future purchase periods. Participants may end their participation at any
time during an offering period, and they will be paid their payroll deductions
to date. Participation ends automatically upon termination of employment with
us.
Rights granted under the 1999 Purchase Plan are not transferable by a
participant other than by will, the laws of descent and distribution, or as
otherwise provided under the 1999 Purchase Plan. The 1999 Purchase Plan
provides that, in the event of a merger of us with or into another corporation
or a sale of substantially all of our assets, each outstanding option may be
assumed or substituted for by the successor corporation. If the successor
corporation refuses to assume or substitute for the outstanding options, the
offering period then in
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<PAGE>
progress will be shortened and a new exercise date will be set. The 1999
Purchase Plan will terminate in 2009. The board of directors has the authority
to amend or terminate the 1999 Purchase Plan, except that no action may
adversely affect any outstanding rights to purchase stock under the 1999
Purchase Plan.
401(k) Plan
We maintain a tax-qualified employee savings and retirement plan, a 401(k)
Plan, which covers all of our eligible employees. Pursuant to the 401(k) Plan,
participants may elect to reduce their current compensation, on a pre-tax
basis, up to the maximum annual limit under the Code and have the amount of the
reduction contributed to the 401(k) Plan. Participants' salary reduction
contributions are fully vested at all times. We may make matching employer
contributions and additional employer contributions to the 401(k) Plan.
Participants' interests in their matching contributions and additional employer
contributions, if any, vest in accordance with a four-year graduated vesting
schedule. Participants are eligible for a distribution from the 401(k) Plan
upon their reaching age 59, death, disability or separation from service with
us. The 401(k) Plan is intended to qualify under Section 401(a) of the Code,
and its accompanying trust is intended to be a tax-exempt trust under Section
501(a) of the Code. Contributions made on behalf of participants, on a pre-tax
basis, to the 401(k) Plan, and income earned on these contributions, are not
currently taxable to participants. All contributions are tax deductible by us.
Limitation of Liability and Indemnification Matters
Our restated certificate of incorporation limits the liability of directors
to the maximum extent permitted by Delaware law. Delaware law provides that
directors of a corporation will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, except liability for:
. breach of their duty of loyalty to the corporation or its stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions; and
. any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal or state securities laws and does not affect the availability of
equitable remedies such as injunctive relief or rescission.
Our bylaws provide that we must indemnify our directors, officers, employees
and other agents to the fullest extent permitted by law. We believe that
indemnification under our bylaws covers negligence on the part of indemnified
parties. Our bylaws also permit us to secure insurance on behalf of any
officer, director, employee or other agent for any liability arising out of his
or her actions on behalf of us, regardless of whether our bylaws permit
indemnification under those circumstances.
We have entered into agreements to indemnify our directors and executive
officers, in addition to the indemnification provided for in our bylaws. These
agreements, among other things, indemnify our directors and executive officers
for certain expenses, including attorneys' fees, judgments, fines and
settlement amounts, incurred in any action or proceeding, including any action
on our behalf arising out of their services as a director, officer, employee,
agent or fiduciary, or on behalf of any of our subsidiaries or any other
company or enterprise to which the person provides services at our request. We
believe that these provisions and agreements are necessary to attract and
retain qualified persons as directors and executive officers.
At present, there is no material litigation or proceeding pending involving
any of our directors or officers in which indemnification is required or
permitted, and we are not aware of any threatened material litigation or
proceeding that may result in a claim for indemnification.
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<PAGE>
RELATED PARTY TRANSACTIONS
Since our inception in January 1996, we have never been a party to, and we
have no plans to be a party to, any transaction or series of similar
transactions in which the amount involved exceeded or will exceed $60,000 and
in which any director, executive officer or holder of more than 5% of our
common stock had or will have an interest, other than as described under
"Management" and the transactions described below.
Gerald W. Kearby, Philip R. Wiser and Robert G. Flynn, all current executive
officers, were involved in our founding and organization and may be considered
as our promoters. Following our inception in January 1996, we issued 937,500
shares of common stock to Mr. Kearby, 843,750 shares of common stock to
Mr. Wiser and 750,000 shares of common stock to Mr. Flynn. Mr. Kearby, Mr.
Wiser and Mr. Flynn each contributed a nominal amount of capital for our
initial capitalization.
From May to July 1996, we sold an aggregate of 3,049,989 shares of Series A
preferred stock to certain investors at a purchase price of $0.656 per share.
In May 1997, we sold an aggregate of 3,186,888 shares of Series B preferred
stock to certain investors at a purchase price of $1.96 per share. In July and
September 1998, we sold an aggregate of 3,507,322 shares of Series C preferred
stock to certain investors at a purchase price of $6.14 per share. The shares
of Series A, Series B and Series C preferred stock will automatically convert
into 9,744,199 shares of common stock upon the closing of this offering.
The holders of converted shares of common stock are entitled to demand and
piggy-back registration rights. See "Description of Capital Stock--Registration
Rights."
The investors in the preferred stock included the following entities, which
are 5% stockholders, affiliated with directors, or both:
<TABLE>
<CAPTION>
Shares of Shares of Shares of
Series A Series B Series C
Investor Preferred Stock Preferred Stock Preferred Stock
- ------------------------------- --------------- --------------- ---------------
<S> <C> <C> <C>
5% Stockholder Entities
Affiliated with Directors:
Entities affiliated with Ann
Winblad(1)................... 1,829,272 788,928 81,431
(Entities affiliated with
Hummer Winblad Venture
Partners)(2)
Entity affiliated with Eric P.
Robison(1)................... -- 510,204 488,599
(Vulcan Ventures, Inc.)
Entity affiliated with Silvia
Kessel(1).................... -- -- 977,198
(Metromedia Company)
Other 5% Stockholders:
Intel Corporation............. 763,398 612,245 1,140,065
Entities affiliated with The
Phoenix Partners(3).......... -- 637,756 162,866
</TABLE>
- --------
(1) Ann Winblad, Eric P. Robison and Silvia Kessel are each members of our
board of directors. Ms. Winblad is a general partner of Hummer Winblad
Venture Partners. Mr. Robison is a business development associate of Vulcan
Ventures, Inc. Ms. Kessel is a Senior Vice President of Metromedia Company.
(2) Hummer Winblad Venture Partners II, L.P. holds 1,756,098 shares of Series A
preferred stock, 757,370 shares of Series B preferred stock and 80,943
shares of Series C preferred stock. Hummer Winblad Technology Fund II, L.P.
holds 62,198 shares of Series A preferred stock and 26,825 shares of Series
B preferred stock. Hummer Winblad Technology Fund IIA, L.P. holds 10,976
shares of Series A preferred stock, 4,733 shares of Series B preferred
stock and 488 shares of Series C preferred stock.
(3) The Phoenix Partners III Liquidating Trust holds 177,154 shares of Series B
preferred stock and 45,241 shares of Series C preferred stock. The Phoenix
Partners IIIB Limited Partnership holds 141,724 shares of Series B
preferred stock and 36,192 shares of Series C preferred stock. The Phoenix
Partners IV Limited Partnership holds 318,878 shares of Series B preferred
stock and 81,433 shares of Series C preferred stock.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to beneficial
ownership of our common stock before and after the offering by:
. each person who beneficially owns more than 5% of the common stock;
. each of our executive officers;
. each of our directors; and
. all executive officers and directors as a group.
Except as otherwise noted, the address of each 5% stockholder listed in the
table is c/o Liquid Audio, Inc., 810 Winslow Street, Redwood City, CA 94063.
The table includes all shares of common stock issuable within 60 days of June
15, 1999 upon the exercise of options and other rights beneficially owned by
the indicated stockholders on that date. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission and
includes voting and investment power with respect to shares. To our knowledge,
except under applicable community property laws or as otherwise indicated, the
persons named in the table have sole voting and sole investment control with
respect to all shares beneficially owned. The applicable percentage of
ownership for each stockholder is based on 13,907,064 shares of common stock
outstanding as of June 15, 1999, together with applicable options for that
stockholder. Shares of common stock issuable upon exercise of options and other
rights beneficially owned are deemed outstanding for the purpose of computing
the percentage ownership of the person holding those options and other rights,
but are not deemed outstanding for computing the percentage ownership of any
other person.
<TABLE>
<CAPTION>
Percent of
Number of Ownership
Shares of -----------------
Common Stock Before After
Name of Beneficial Owner Beneficially Owned Offering Offering
- ---------------------------------------- ------------------ -------- --------
<S> <C> <C> <C>
Entities affiliated with Hummer Winblad
Venture Partners(1).................... 2,699,631 19.4% 15.4%
Two South Park, Second Floor
San Francisco, CA 94107
Intel Corporation....................... 2,515,708 18.1 14.3
2200 Mission College Boulevard
Santa Clara, CA 95052
Vulcan Ventures, Inc.(2)................ 998,803 7.2 5.7
110 110th Avenue NE, Suite 500
Bellevue, WA 98004
Metromedia Company(3)................... 977,198 7.0 5.6
1 Meadowlands Plaza East
Rutherford, NJ 07073
Gerald W. Kearby........................ 937,500 6.7 5.4
Philip R. Wiser......................... 843,750 6.1 4.8
The Phoenix Partners(4)................. 800,622 5.8 4.6
1000 Second Avenue, Suite 3600
Seattle, WA 98104
Robert G. Flynn......................... 750,000 5.4 4.3
Gary J. Iwatani(5)...................... 150,000 1.1 *
Kevin M. Malone(6)...................... 112,500 * *
Richard W. Wingate(7)................... 86,000 * *
Mathieu Prevost(8)...................... 40,000 * *
Ann Winblad(1).......................... 2,699,631 19.4 15.4
Eric P. Robison(2)...................... 998,803 7.2 5.7
Silvia Kessel(3)........................ 977,198 7.0 5.6
Sanford R. Climan(9).................... 20,000 * *
All executive officers and directors as
a group (11 persons)(10)............... 7,615,382 53.2 42.5
</TABLE>
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<PAGE>
- --------
* Less than 1%
(1) Consists of common stock issuable upon automatic conversion of 2,594,411
shares of preferred stock owned by Hummer Winblad Venture Partners II,
L.P., 89,023 shares of preferred stock owned by Hummer Winblad Technology
Fund II, L.P. and 16,197 shares of preferred stock owned by Hummer Winblad
Technology Fund IIA, L.P. (collectively, the "Hummer Winblad Funds"). John
Hummer, Ann Winblad (one of our directors) and Mark Gorenberg are general
partners of Hummer Winblad Equity Partners II, L.P. ("HWII"), the general
partner of each of the Hummer Winblad Funds. Consequently, HWII and Mr.
Hummer, Ms. Winblad and Mr. Gorenberg may each be deemed to beneficially
own all of the shares held by the Hummer Winblad Funds. HWII, Mr. Hummer,
Ms. Winblad and Mr. Gorenberg each disclaim beneficial ownership of such
shares, except to the extent of their respective pecuniary interest
therein.
(2) Consists of common stock issuable upon automatic conversion of 998,803
shares of preferred stock owned by Vulcan Ventures, Inc. Paul Allen is the
sole shareholder of Vulcan Ventures, Inc. and the beneficial owner of the
shares held by Vulcan Ventures, Inc. Mr. Robison, one of our directors, is
a business development associate of Vulcan Ventures, Inc. Mr. Robison
possesses no investment or voting power over and disclaims beneficial
ownership of the shares held by Vulcan Ventures, Inc.
(3) Consists of common stock issuable upon automatic conversion of 977,198
shares of preferred stock owned by Metromedia Company. Ms. Kessel, one of
our directors is Senior Vice President of Metromedia Company. Ms. Kessel
disclaims beneficial ownership of shares held by Metromedia Company.
(4) Consists of common stock issuable upon automatic conversion of 222,395
shares of preferred stock owned by The Phoenix Partners III Liquidating
Trust, 177,916 shares of preferred stock owned by The Phoenix Partners
IIIB Limited Partnership and 400,311 shares of preferred stock owned by
The Phoenix Partners IV Limited Partnership (collectively, the "Phoenix
Funds"). David Johnston is the general partner and the beneficial owner of
the shares held by the Phoenix Funds.
(5) Consists of 150,000 shares of common stock issuable upon the exercise of
options exercisable within 60 days of June 15, 1999.
(6) Consists of 112,500 shares of common stock issuable upon the exercise of
options exercisable within 60 days of June 15, 1999.
(7) Consists of 86,000 shares of common stock issuable upon the exercise of
options exercisable within 60 days of June 15, 1999.
(8) Consists of 40,000 shares of common stock issuable upon the exercise of
options exercisable within 60 days of June 15, 1999.
(9) Consists of 20,000 shares of common stock issuable upon the exercise of
stock options exercisable within 60 days of June 15, 1999.
(10) Includes 408,500 shares of common stock issuable upon the exercise of
stock options exercisable within 60 days of June 15, 1999.
61
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
Our restated certificate of incorporation, which will become effective upon
the closing of this offering, authorizes the issuance of up to 50,000,000
shares of common stock, par value $0.001 per share, and 5,000,000 shares of
preferred stock, par value $0.001 per share, the rights and preferences of
which may be established from time to time by our board of directors. As of
June 15, 1999, 4,162,865 shares of common stock were outstanding and 9,744,199
shares of mandatorily redeemable convertible preferred stock convertible into
9,744,199 shares of common stock upon the completion of this offering were
issued and outstanding. As of June 15, 1999, we had 59 stockholders.
Common Stock
Each holder of common stock is entitled to one vote for each share on all
matters to be voted upon by the stockholders and there are no cumulative voting
rights. Subject to preferences to which holders of preferred stock issued after
the sale of the common stock in this offering may be entitled, holders of
common stock will be entitled to receive ratably any dividends that may be
declared from time to time by the board of directors out of funds legally
available for that purpose. See "Dividend Policy." In the event of our
liquidation, dissolution or winding up, holders of common stock will be
entitled to share in our assets remaining after the payment of liabilities and
the satisfaction of any liquidation preference granted to the holders of any
outstanding shares of preferred stock. Holders of common stock have no
preemptive or conversion rights or other subscription rights and there are no
redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are, and the shares of common stock offered
by us in this offering, when issued and paid for, will be, fully paid and
nonassessable. The rights, preferences and privileges of the holders of common
stock are subject to, and may be adversely affected by, the rights of the
holders of shares of any series of preferred stock that we may designate in the
future.
Preferred Stock
Upon the closing of this offering, the board of directors will be authorized,
subject to any limitations prescribed by law, without stockholder approval,
from time to time to issue up to an aggregate of 5,000,000 shares of preferred
stock, par value $0.001 per share, in one or more series, each series to have
rights and preferences, including voting rights, dividend rights, conversion
rights, redemption privileges and liquidation preferences, as may be determined
by the board of directors. The issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, a majority of our outstanding voting stock. We have no present plans
to issue any shares of preferred stock.
Warrants
As of June 15, 1999, giving effect to the conversion of all preferred stock
into common stock, we had outstanding a warrant to purchase 15,306 shares of
common stock at an exercise price of $1.96 per share, warrants to purchase a
total of 53,404 shares of common stock at an exercise price of $6.14 per share
and warrants to purchase a total of 393,203 shares of common stock at an
exercise price of $6.56 per share. Each warrant has a net exercise provision
under which the holder may, in lieu of payment of the exercise price in cash,
surrender the warrant and receive a net amount of shares, based on the fair
market value of our stock at the time of the exercise of the warrant, after
deducting the aggregate exercise price.
Registration Rights
Pursuant to our Second Amended and Restated Investor Rights Agreement dated
July 31, 1998, among us and our holders of preferred stock or warrants to
purchase preferred stock, the holders of approximately
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<PAGE>
9,764,049 shares of common stock, 9,744,199 shares of which are issuable upon
conversion of an aggregate of 9,744,199 shares of preferred stock and 19,850 of
which are issuable upon conversion of preferred stock issuable upon exercise of
warrants, will have rights to register those shares under the Securities Act of
1933 within 180 days of this offering. Subject to limitations in the Rights
Agreement, the holders of at least 25% of the outstanding shares of registrable
securities, or a lesser number of shares if the anticipated aggregate offering
price, before underwriting discounts and commissions, would exceed $5,000,000,
may require, on two occasions, that we use our best efforts to register their
shares of registrable securities for public resale. If we register any of our
common stock for our own account or for the account of other security holders,
the parties to the Rights Agreement may include their shares of common stock in
the registration, subject to the ability of the underwriters to limit the
number of shares included in the offering. Subject to limitations in the Rights
Agreement, the holders of at least 20% of our outstanding shares of registrable
securities may require us to register all or a portion of their registrable
securities on Form S-3 when we are eligible to use that form, provided that the
proposed aggregate price to the public would equal or exceed $500,000. We will
bear all fees, costs and expenses of any registration on Form S-3, other than
underwriting discounts and commissions. Upon the effectiveness of any
registration statement filed to register our common stock, all shares so
registered would become freely tradable, without any restrictions imposed by
the Securities Act. The holders of registration rights have agreed to waive
their registration rights with respect to this offering.
Effect of Provisions of Our Certificate of Incorporation and Bylaws and the
Delaware Anti-takeover Statute
Provisions of our restated certificate of incorporation and bylaws, to be
effective following the offering, may have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, control of us. These provisions could limit the price
that certain investors might be willing to pay in the future for shares of our
common stock. These provisions:
. divide our board of directors into three classes serving staggered three-
year terms;
. eliminate the right of stockholders to act by written consent without a
meeting;
. eliminate the right of stockholders to call special meetings;
. eliminate cumulative voting in the election of directors; and
. allow us to issue preferred stock without any vote or further action by
the stockholders.
The classification system of electing directors may tend to discourage a
third party from making a tender offer or otherwise attempting to obtain
control of us and may maintain the incumbency of our board of directors, as the
classification of the board of directors increases the difficulty of replacing
a majority of the directors. These provisions may have the effect of deferring
hostile takeovers, delaying changes in our control or management, or may make
it more difficult for stockholders to take certain corporate actions. The
amendment of any of these provisions would require approval by holders of at
least 66 2/3% of the outstanding common stock.
In addition, we are subject to Section 203 of the Delaware General
Corporation Law, which, subject to certain exceptions, prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder, unless:
. prior to the date of the proposed action, the board of directors of the
corporation approved either the business combination or the transaction
that resulted in the stockholder's becoming an interested stockholder;
. upon completion of the transaction that resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned by persons who are
directors and also officers and by employee stock
63
<PAGE>
plans in which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be tendered in
a tender or exchange offer; or
. on or subsequent to the date of the proposed action, the business
combination is approved by the board of directors and authorized at an
annual or special meeting of stockholders, and not by written consent, by
the affirmative vote of at least 66 2/3% of the outstanding voting stock
that is not owned by the interested stockholder.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is Chase Mellon
Shareholder Services.
64
<PAGE>
SHARES AVAILABLE FOR FUTURE SALE
Sales of substantial amounts of our common stock in the public market
following the offering could cause the market price of our common stock to fall
and could affect our ability to raise capital on terms favorable to us.
Of the 17,507,064 shares to be outstanding after the offering, assuming that
the underwriters do not exercise their over-allotment option, only the
3,600,000 shares of common stock sold in this offering will be freely tradable
without restriction in the public market unless the shares are held by
"affiliates," as that term is defined in Rule 144(a) under the Securities Act
of 1933. For purposes of Rule 144, an "affiliate" of an issuer is a person
that, directly or indirectly through one or more intermediaries, controls, or
is controlled by or is under common control with, the issuer. The remaining
shares of common stock to be outstanding after the offering are "restricted
securities" under the Securities Act of 1933 and may be sold in the public
market upon the expiration of the holding periods under Rule 144, described
below, subject to the volume, manner of sale and other limitations of Rule 144.
In general, under Rule 144 as currently in effect, a person who has
beneficially owned shares for at least one year, including an "affiliate," is
entitled to sell, within any three-month period, a number of shares that does
not exceed the greater of:
. 1% of the then outstanding shares of our common stock (approximately
175,071 shares immediately following the offering); or
. the average weekly trading volume during the four calendar weeks
preceding filing of notice of the sale of shares of common stock.
Sales under Rule 144 are also subject to certain manner of sale provisions,
notice requirements and the availability of current public information about
us. A stockholder who is deemed not to have been an "affiliate" of ours at any
time during the 90 days preceding a sale, and who has beneficially owned
restricted shares for at least two years, would be entitled to sell shares
under Rule 144(k) without regard to the volume limitations, manner of sale
provisions or public information requirements.
In addition, as of June 15, 1999, there were outstanding warrants to purchase
19,850 shares of preferred stock, warrants to purchase 442,063 shares of common
stock and options to purchase 891,119 shares of common stock, of which 395,796
options were fully vested. An additional 1,704,133 shares are reserved for
issuance under our 1996 Equity Incentive Plan. We intend to register the shares
of common stock issuable or reserved for issuance under the plan as soon as
practicable following the date of this prospectus.
Holders of warrants to purchase 19,850 shares of preferred stock and holders
of 9,744,199 shares of common stock issuable upon conversion of the preferred
stock are entitled to registration rights with respect to these shares for
resale under the Securities Act of 1933. If these holders, by exercising their
registration rights, cause a large number of shares to be registered and sold
in the public market, these sales could harm the market price for our common
stock. These registration rights may not be exercised prior to the expiration
of 180 days from the date of this prospectus. See "Description of Capital
Stock--Registration Rights."
Lock-Up Arrangements
Along with our officers and directors, all holders of our preferred stock,
common stock, warrants and options have agreed not to sell or otherwise dispose
of any shares of common stock for a period of 180 days after the date of this
prospectus without prior written consent.
65
<PAGE>
UNDERWRITING
Under the underwriting agreement, which is filed as an exhibit to the
registration statement relating to this prospectus, the underwriters named
below, for whom Lehman Brothers Inc., BancBoston Robertson Stephens Inc. and
U.S. Bancorp Piper Jaffray Inc. are acting as representatives, have each agreed
to purchase from us the respective number of shares of common stock shown
opposite its name below:
<TABLE>
<CAPTION>
Number of
Underwriters Shares
----------------------------------------------------------------- ---------
<S> <C>
Lehman Brothers Inc. ............................................
BancBoston Robertson Stephens Inc. ..............................
U.S. Bancorp Piper Jaffray Inc. .................................
---------
Total........................................................... 3,600,000
=========
</TABLE>
The underwriting agreement provides that the underwriters' obligations to
purchase shares of common stock depend on the satisfaction of the conditions
contained in the underwriting agreement and that, if any of the shares of
common stock are purchased by the underwriters under the underwriting
agreement, all of the shares of common stock that the underwriters have agreed
to purchase under the underwriting agreement, must be purchased. The conditions
contained in the underwriting agreement include the requirement that the
representations and warranties made by us to the underwriters are true, that
there is no material change in the financial markets and that we deliver to the
underwriters customary closing documents.
The representatives have advised us that the underwriters propose to offer
the shares of common stock directly to the public at the public offering price
set forth on the cover page of this prospectus, and to dealers, who may include
the underwriters, at this public offering price less a selling concession not
in excess of $ per share. The underwriters may allow, and the dealers may
reallow, a concession not in excess of $ per share to brokers and dealers.
After the offering, the underwriters may change the offering price and other
selling terms.
We have granted to the underwriters an option to purchase up to an aggregate
of 540,000 additional shares of common stock, exercisable solely to cover over-
allotments, if any, at the public offering price less the underwriting
discounts shown on the cover page of this prospectus. The underwriters may
exercise this option at any time until 30 days after the date of the
underwriting agreement. If this option is exercised, each underwriter will be
committed, so long as the conditions of the underwriting agreement are
satisfied, to purchase a number of additional shares of common stock
proportionate to the underwriter's initial commitment as indicated in the table
above and we will be obligated, under the over-allotment option, to sell the
shares of common stock to the underwriters.
We have agreed that, without the prior consent of Lehman Brothers, we will
not, directly or indirectly, offer, sell or otherwise dispose of any shares of
common stock or any securities that may be converted into or exchanged for any
shares of common stock for a period of 180 days from the date of this
prospectus. All of our executive officers and directors and stockholders
holding all of the shares of our capital stock, including all of the holders of
the preferred stock and the warrants, have agreed under lock-up agreements
that, without prior written consent, they will not, directly or indirectly,
offer, sell or otherwise dispose of any shares of common stock or any
securities that may be converted into or exchanged for any shares of common
stock for the period ending 180 days after the date of this prospectus. See
"Shares Eligible for Future Sale."
66
<PAGE>
Prior to the offering, there has been no public market for the shares of
common stock. The initial public offering price will be negotiated between the
representatives and us. In determining the initial public offering price of the
common stock, the representatives will consider, among other things and in
addition to prevailing market conditions:
. our historical performance and capital structure;
. estimates of our business potential and earning prospects;
. an overall assessment of our management; and
. the above factors in relation to market valuations of companies in
related businesses.
Application has been made to have our common stock approved for quotation on
the Nasdaq National Market under the symbol "LQID."
We have agreed to indemnify the underwriters against liabilities, including
liabilities under the Securities Act and liabilities arising from breaches of
the representations and warranties contained in the underwriting agreement, and
to contribute to payments that the underwriters may be required to make for
these liabilities.
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters
and selling group members to bid for and purchase shares of common stock. As an
exception to these rules, the representatives are permitted to engage in
transactions that stabilize the price of the common stock. These transactions
may consist of bids or purchases for the purposes of pegging, fixing or
maintaining the price of the common stock.
The underwriters may create a short position in the common stock in
connection with the offering, which means that they may sell more shares than
are set forth on the cover page of this prospectus. If the underwriters create
a short position, then the representatives may reduce that short position by
purchasing common stock in the open market. The representatives also may elect
to reduce any short position by exercising all or part of the over-allotment
option.
The representatives also may impose a penalty bid on underwriters and selling
group members. This means that, if the representatives purchase shares of
common stock in the open market to reduce the underwriters' short position or
to stabilize the price of the common stock, they may reclaim the amount of the
selling concession from the underwriters and selling group members that sold
those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a syndicate short position could cause the price of the security to be
higher than it might otherwise be in the absence of these purchases. The
imposition of a penalty bid might have an effect on the price of a security to
the extent that it were to discourage resales of the security by purchasers in
an offering.
Neither we nor any of the underwriters makes any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the common stock. In addition, neither we nor
any of the underwriters makes any representation that the representatives will
engage in these transactions or that these transactions, once commenced, will
not be discontinued without notice.
Any offers in Canada will be made only under an exemption from the
requirements to file a prospectus in the relevant province of Canada in which
the sale is made.
Purchasers of the shares of common stock offered in this prospectus may be
required to pay stamp taxes and other charges under the laws and practices of
the country of purchase, in addition to the offering price listed on the cover
page of this prospectus.
67
<PAGE>
The representatives have informed us that they do not intend to confirm the
sales of shares of common stock offered by this prospectus to any accounts over
which they exercise discretionary authority.
At our request, the underwriters have reserved up to 180,000 shares of the
common stock offered by this prospectus for sale to our officers, directors,
employees and their family members and to our business associates at the
initial public offering price set forth on the cover page of this prospectus.
These persons must commit to purchase no later than the close of business on
the day following the date of this prospectus. The number of shares available
for sale to the general public will be reduced to the extent these persons
purchase the reserved shares.
LEGAL MATTERS
Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto, California will pass upon
the validity of the common stock that we are selling in this offering. Fenwick
& West LLP, Palo Alto, California will pass upon legal matters for the
underwriters. As of the date of this prospectus, Wilson Sonsini Goodrich &
Rosati and its partners beneficially owned 4,071 shares of our common stock,
and an investment partnership comprised of partners of Fenwick & West
beneficially owned 22,863 shares of our common stock.
EXPERTS
Our financial statements as of December 31, 1997 and 1998 and for the period
from January 30, 1996 (inception) through December 31, 1996, and for the years
ended December 31, 1997 and 1998 have been included in this prospectus and in
the registration statement in reliance upon the reports of
PricewaterhouseCoopers LLP, independent accountants, appearing elsewhere, and
upon the authority of PricewaterhouseCoopers LLP as experts in accounting and
auditing.
AVAILABLE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1, including the exhibits filed with the registration
statement, under the Securities Act of 1933 with respect to the shares to be
sold in this offering. This prospectus does not contain all the information set
forth in the registration statement. For further information with respect to us
and the shares to be sold in this offering, we refer you to the registration
statement. Statements contained in this prospectus as to the contents of any
contract, agreement or other document to which we make reference, are not
necessarily complete, and in each instance we refer you to the copy of the
contract, agreement or other document filed as an exhibit to the registration
statement, each statement being qualified in all respects by the more complete
description of the matter involved.
You may read and copy all or any portion of the registration statement or any
reports, statements or other information we file at the Commission's public
reference room at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549 and at the regional offices of the Commission located at
Seven World Trade Center, 13th Floor, New York, New York 10048 and 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You can request copies of
these documents, upon payment of a duplicating fee, by writing to the
Commission. Please call the Commission at 1-800-SEC-0330 for further
information on the operation of the public reference rooms. Our Commission
filings, including the registration statement, will also be available to you on
the Commission's Internet site, http://www.sec.gov.
We intend to send to our stockholders annual reports containing audited
consolidated financial statements and quarterly reports containing unaudited
financial statements for the first three quarters of each fiscal year.
68
<PAGE>
LIQUID AUDIO, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants.......................................... F-2
Balance Sheet.............................................................. F-3
Statement of Operations.................................................... F-4
Statement of Stockholders' Deficit......................................... F-5
Statement of Cash Flows.................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Liquid Audio, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, of stockholders' deficit and of cash flows present fairly, in all
material respects, the financial position of Liquid Audio, Inc. at December 31,
1997 and 1998, and the results of its operations and its cash flows for the
period from January 30, 1996 (inception) through December 31, 1996, and for the
years ended December 31, 1997 and 1998 in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
February 26, 1999, except
as to Note 10 which is as
of July 8, 1999
F-2
<PAGE>
LIQUID AUDIO, INC.
BALANCE SHEET
(in thousands except share data)
<TABLE>
<CAPTION>
Pro Forma
Stockholders'
December 31, Equity at
----------------- March March 31,
1997 1998 31, 1999 1999
------- -------- -------- -------------
Assets (unaudited)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents............. $ 2,387 $ 14,143 $15,497
Short-term investments................ -- 3,001 --
Accounts receivable, net.............. 84 376 37
Receivables from related parties...... -- 615 177
Other current assets.................. 136 314 257
------- -------- --------
Total current assets................. 2,607 18,449 15,968
------- -------- --------
Property and equipment, net............ 671 1,507 1,671
Other assets........................... 57 70 90
------- -------- --------
Total assets....................... $ 3,335 $ 20,026 $ 17,729
======= ======== ========
<CAPTION>
Liabilities, mandatorily redeemable
convertible preferred stock and
warrants and stockholders' equity
(deficit)
<S> <C> <C> <C> <C>
Current liabilities:
Accounts payable...................... $ 405 $ 802 $ 518
Accrued expenses and other current
liabilities.......................... 732 932 1,337
Deferred revenue...................... 90 1,177 1,773
Capital lease obligations, current
portion.............................. 122 197 192
Equipment loan, current portion....... -- 281 440
Line of credit........................ 400 -- --
------- -------- --------
Total current liabilities............ 1,749 3,389 4,260
------- -------- --------
Capital lease obligations, non-current
portion............................... 218 330 312
Equipment loan, non-current portion.... -- 639 829
Note payable to related party.......... -- -- 378
------- -------- --------
Total liabilities.................. 1,967 4,358 5,779
------- -------- --------
Series A, B and C mandatorily
redeemable convertible preferred stock
and warrants (Note 5)................. 8,247 29,801 29,801 $ --
------- -------- --------
Commitments and contingencies (Note 9)
Stockholders' equity (deficit):
Common stock, $0.001 par value;
25,878,000 shares authorized;
3,899,643, 3,916,045 and 3,892,293
shares issued and outstanding........ 4 4 4 14
Additional paid-in capital............ 2,159 3,917 4,450 34,241
Unearned compensation................. (1,562) (2,035) (2,143) (2,143)
Accumulated deficit................... (7,480) (16,019) (20,162) (20,162)
------- -------- -------- --------
Total stockholders' equity
(deficit)......................... (6,879) (14,133) (17,851) $ 11,950
------- -------- -------- ========
Total liabilities, mandatorily
redeemable convertible preferred
stock and warrants and
stockholders' equity (deficit).... $ 3,335 $ 20,026 $ 17,729
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
LIQUID AUDIO, INC.
STATEMENT OF OPERATIONS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Period From
January 30, Three Months Ended
1996 (inception) Year Ended December 31, March 31,
Through December ------------------------- ---------------------
31, 1996 1997 1998 1998 1999
---------------- ----------- ------------ --------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Net revenues:
License................ $ -- $ 246 $ 1,235 $ 192 $ 259
Services............... -- 10 268 32 89
Business development
(related party)....... -- -- 1,300 -- 183
------- ----------- ------------ --------- ----------
Total net revenues.... -- 256 2,803 224 531
------- ----------- ------------ --------- ----------
Cost of net revenues:
License................ -- 302 312 49 47
Services............... -- 91 457 104 280
------- ----------- ------------ --------- ----------
Total cost of net
revenues............. -- 393 769 153 327
------- ----------- ------------ --------- ----------
Gross profit (loss)..... -- (137) 2,034 71 204
------- ----------- ------------ --------- ----------
Operating expenses:
Sales and marketing.... 237 2,820 4,879 942 2,339
Research and
development........... 692 1,880 3,050 569 1,214
General and
administrative........ 327 898 1,642 278 502
Stock compensation
expense............... 31 534 1,241 259 425
------- ----------- ------------ --------- ----------
Total operating
expenses............. 1,287 6,132 10,812 2,048 4,480
------- ----------- ------------ --------- ----------
Loss from operations.... (1,287) (6,269) (8,778) (1,977) (4,276)
Interest income......... 24 125 379 12 184
Interest expense........ (1) (72) (140) (20) (51)
------- ----------- ------------ --------- ----------
Net loss................ $(1,264) $ (6,216) $ (8,539) $ (1,985) $ (4,143)
======= =========== ============ ========= ==========
Net loss per share:
Basic and diluted...... $(14.93) $ (4.95) $ (3.60) $ (0.99) $ (1.39)
======= =========== ============ ========= ==========
Weighted average
shares................ 84,635 1,256,114 2,370,564 1,998,865 2,972,398
======= =========== ============ ========= ==========
Pro forma net loss per
share:
Basic and diluted
(unaudited)........... $ (0.85) $ (0.33)
============ ==========
Weighted average shares
(unaudited)........... 10,041,546 12,716,597
============ ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
LIQUID AUDIO, INC.
STATEMENT OF STOCKHOLDERS' DEFICIT
(in thousands except share amounts)
<TABLE>
<CAPTION>
Common Stock Additional
----------------- Paid-in Unearned Accumulated
Shares Amount Capital Compensation Deficit Total
--------- ------ ---------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock
to founders............ 3,431,244 $ 3 $ 2 $ -- $ -- $ 5
Unearned compensation... -- -- 239 (239) -- --
Amortization of unearned
compensation........... -- -- -- 31 -- 31
Net loss................ -- -- -- -- (1,264) (1,264)
--------- --- ------ ------- -------- --------
Balance at December 31,
1996................... 3,431,244 3 241 (208) (1,264) (1,228)
Exercise of stock
options................ 468,399 1 30 -- -- 31
Unearned compensation... -- -- 1,888 (1,888) -- --
Amortization of unearned
compensation........... -- -- -- 534 -- 534
Net loss................ -- -- -- -- (6,216) (6,216)
--------- --- ------ ------- -------- --------
Balance at December 31,
1997................... 3,899,643 4 2,159 (1,562) (7,480) (6,879)
Repurchase of founders'
common stock........... (87,868) -- -- -- -- --
Repurchase of common
stock in connection
with unvested stock
options previously
exercised.............. (24,219) -- (2) -- -- (2)
Exercise of stock
options................ 90,173 -- 6 -- -- 6
Issuance of common stock
in connection with
marketing agreement.... 38,316 -- 40 -- -- 40
Unearned compensation... -- -- 1,714 (1,714) -- --
Amortization of unearned
compensation........... -- -- -- 1,241 -- 1,241
Net loss................ -- -- -- -- (8,539) (8,539)
--------- --- ------ ------- -------- --------
Balance at December 31,
1998................... 3,916,045 4 3,917 (2,035) (16,019) (14,133)
Repurchase of common
stock in connection
with unvested stock
options previously
exercised (unaudited).. (28,689) -- (1) -- -- (1)
Exercise of stock
options (unaudited).... 4,937 -- 1 -- -- 1
Unearned compensation
(unaudited)............ -- -- 533 (533) -- --
Amortization of unearned
compensation
(unaudited)............ -- -- -- 425 -- 425
Net loss (unaudited).... -- -- -- -- (4,143) (4,143)
--------- --- ------ ------- -------- --------
Balance at March 31,
1999 (unaudited)....... 3,892,293 $ 4 $4,450 $(2,143) $(20,162) $(17,851)
========= === ====== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
LIQUID AUDIO, INC.
STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Period From
January 30,
1996 (inception) Year Ended Three Months
Through December 31, Ended March 31,
December 31, ---------------- ----------------
1996 1997 1998 1998 1999
---------------- ------- ------- ------- -------
Cash flows from operating
activities: (unaudited)
<S> <C> <C> <C> <C> <C>
Net loss................. $(1,264) $(6,216) $(8,539) $(1,985) $(4,143)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Depreciation and
amortization........... 34 121 451 80 168
Amortization of unearned
compensation........... 31 534 1,241 259 425
Allowance for doubtful
accounts............... -- 55 210 6 93
Equity investment
losses................. -- -- 400 -- 378
Changes in assets and
liabilities:
Accounts receivable..... -- (139) (502) (177) 246
Receivables from related
parties................ -- -- (615) -- 438
Other assets............ (38) (155) (191) (32) 37
Accounts payable........ 21 384 397 (173) (284)
Accrued expenses and
other current
liabilities............ 142 590 259 302 405
Deferred revenue........ 15 75 1,087 78 596
------- ------- ------- ------- -------
Net cash used in
operating activities... (1,059) (4,751) (5,802) (1,642) (1,641)
------- ------- ------- ------- -------
Cash flows from investing
activities:
Acquisition of property
and equipment........... (83) (319) (982) (114) (324)
Sale (purchase) of short-
term investments........ -- -- (3,001) -- 3,001
Equity investment........ -- -- (400) -- --
------- ------- ------- ------- -------
Net cash provided by
(used in) investing
activities............. (83) (319) (4,383) (114) 2,677
------- ------- ------- ------- -------
Cash flows from financing
activities:
Proceeds from issuance of
mandatorily redeemable
convertible preferred
stock................... 1,941 6,246 21,535 -- --
Proceeds from issuance of
common stock............ 5 31 4 5 --
Payments made under
capital leases.......... -- (84) (118) (21) (31)
Proceeds from equipment
loan.................... -- -- 920 -- 401
Payments made under
equipment loan.......... -- -- -- -- (52)
Proceeds from borrowings
under line of credit.... -- 400 -- -- --
Payments made under line
of credit............... -- -- (400) -- --
Proceeds from short-term
loan.................... -- 400 1,330 -- --
Payments on short-term
loan.................... -- (400) (1,330) -- --
Proceeds from issuance of
convertible promissory
note to related party... 60 -- -- -- --
------- ------- ------- ------- -------
Net cash provided by
(used in) financing
activities............. 2,006 6,593 21,941 (16) 318
------- ------- ------- ------- -------
Net increase (decrease)
in cash and cash
equivalents............. 864 1,523 11,756 (1,772) 1,354
Cash and cash equivalents
at beginning of period.. -- 864 2,387 2,387 14,143
------- ------- ------- ------- -------
Cash and cash equivalents
at end of period........ $ 864 $ 2,387 $14,143 $ 615 $15,497
======= ======= ======= ======= =======
Supplemental disclosures:
Cash paid for interest... $ 1 $ 72 $ 121 $ 20 $ 51
Non-cash investing and
financing activities:
Acquisition of property
and equipment through
capital leases.......... $ 135 $ 289 $ 305 $ -- $ 8
Issuance of common stock
for services rendered... $ -- $ -- $ 40 $ -- $ --
Conversion of convertible
promissory note to
Series A mandatorily
redeemable convertible
preferred stock......... $ 60 $ -- $ -- $ -- $ --
Equity investment with
note payable............ $ -- $ -- $ -- $ -- $ 378
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1--THE COMPANY AND SUMMARY OF ITS SIGNIFICANT ACCOUNTING POLICIES:
The Company
Liquid Audio, Inc. (the "Company") was incorporated in California in January
1996 and reincorporated in Delaware in April 1999 (see note 10) with the goal
of becoming the premier provider of software applications and services that
enable the secure delivery and sale of digital music over the Internet. To this
end, the Company has developed an end-to-end solution for promoting and
distributing music over the Internet. The Company's solutions enable the secure
distribution of high quality music files while providing consumers with the
ability to access, preview and purchase that music via the Internet.
Unaudited interim results
The interim financial statements as of March 31, 1999 and for the three
months ended March 31, 1998 and 1999 are unaudited. The unaudited interim
financial statements have been prepared on the same basis as the annual
financial statements and, in the opinion of management, reflect all
adjustments, which include only normal recurring adjustments, necessary to
present fairly the Company's financial position, results of operations and cash
flows as of March 31, 1999 and for the three months ended March 31, 1998 and
1999. The financial data and other information disclosed in these notes to
financial statements related to these periods are unaudited. The results for
the three months ended March 31, 1999 are not necessarily indicative of the
results to be expected for the year ending December 31, 1999.
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires the Company's management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-7
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Cash and cash equivalents and short-term investments
All highly liquid investments with a maturity of three months or less when
purchased are considered to be cash equivalents, and those with maturities
greater than three months are considered short-term investments. Cash and cash
equivalents consist of cash on deposit with banks, money market funds and
commercial securities that are stated at cost, which approximates fair value.
The Company classifies all short-term investments as available-for-sale.
Accordingly, these investments are carried at fair value. The fair value of
such securities approximates cost, and there were no material unrealized gains
or losses at December 31, 1998 and March 31, 1999 (unaudited). The following
schedule summarizes the estimated fair value of the Company's cash, cash
equivalents and short-term investments (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------- March 31,
1997 1998 1999
------ ------- -----------
(unaudited)
<S> <C> <C> <C>
Cash and cash equivalents:
Cash................................................ $ 136 $ 1,034 $ 399
Money market funds.................................. 2,251 3,102 4,072
Commercial securities............................... -- 10,007 11,026
------ ------- -------
$2,387 $14,143 $15,497
====== ======= =======
Short-term investments:
U.S. Government bonds............................... $ -- $ 3,001 $ --
====== ======= =======
</TABLE>
All short-term investments had a contractual maturity of one year or less.
Concentration of credit risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash and cash equivalents,
short-term investments and accounts receivable. Substantially all of the
Company's cash and cash equivalents are invested in a highly-liquid money
market fund and commercial securities with major financial institutions. Short-
term investments are invested in government bonds. The Company performs ongoing
credit evaluations of its customers and maintains an allowance for potential
credit losses. Credit losses to date have been within management's estimates.
The following table sets forth customers comprising 10% or more of the
Company's total net revenues for each of the periods indicated:
<TABLE>
<CAPTION>
Period from
January 30, Three Months
1996 (inception) Year Ended Ended
Through December 31, March 31,
December 31, --------------- ---------------
Customer 1996 1997 1998 1998 1999
-------- ---------------- ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
A....................... -- 49% -- --
B....................... -- 12 -- -- --
C....................... -- 10 -- -- --
D....................... -- -- 34% -- --
E....................... -- -- -- 26% --
F....................... -- -- -- 21 --
G....................... -- -- -- -- 40%
H....................... -- -- -- -- 19
I....................... -- -- -- -- 16
</TABLE>
F-8
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
At December 31, 1997, two customers represented 17% and 16%, respectively, of
gross accounts receivable. At December 31, 1998, one customer represented 26%
of gross accounts receivable. At March 31, 1999, three customers represented
26%, 11% and 10% (unaudited) of gross accounts receivable.
Fair value of financial instruments
The Company's financial instruments, including cash and cash equivalents,
short-term investments, accounts receivable, accounts payable, capital lease
obligations, an equipment loan, a line of credit and a note payable to a
related party are carried at cost. The Company's short-term financial
instruments approximate fair value due to their relatively short maturities.
The carrying value of the Company's long-term financial instruments approximate
fair value as the interest rates approximate current market rates of similar
debt. The Company does not hold or issue financial instruments for trading
purposes.
Property and equipment
Property and equipment, including leasehold improvements, are stated at
historical cost. Depreciation and amortization are computed using the straight-
line method over the estimated useful lives of the assets, generally three
years, or for leasehold improvements, the term of the lease, whichever is
shorter. Assets held under capital leases are amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the life
of the lease, generally three years.
Long-lived assets held and used by the Company, or to be disposed of, are
reviewed for impairment whenever events or changes in circumstances indicate
that their net book value may not be recoverable. An impairment loss is
recognized if the sum of the expected future cash flows (undiscounted and
before interest) from the use of the asset is less than the net book value of
the asset. The amount of the impairment loss will generally be measured as the
difference between net book value of the assets and their estimated fair
values. Based on its most recent analysis, the Company believes that no
impairment of long-lived assets existed at December 31, 1996, 1997, 1998, and
March 31, 1999 (unaudited).
Revenue recognition
The Company's revenues are derived from the licensing of software products
(including maintenance), hosting, music delivery, encoding, integration and
installation services, and business development contracts. Revenues are
recognized for the various contract elements based upon vendor-specific
objective evidence of the fair value for each element, in accordance with
Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2") and
related guidance. License revenues are recognized when persuasive evidence of
an agreement exists, delivery of the product has occurred, no significant
Company obligations with regard to implementation or integration exist, the fee
is fixed or determinable and collectibility is probable. Provisions for sales
returns are provided at the time of revenue recognition based upon estimated
returns.
Maintenance and hosting fees are deferred and recognized as service revenue
on a straight-line basis over the life of the related contract, which is
typically one year. Music delivery service revenue is recognized at the time
digital music is delivered. Encoding, integration and installation service fees
are deferred and recognized as service revenue over the period the services are
provided.
Business development revenue consists of business development fees derived
from contractual agreements with the Company's strategic partners. These U.S.
dollar denominated nonrefundable fees are based upon agreements whereby the
strategic partners are contractually obligated to pay to the Company a fixed
fee for the opportunity to develop businesses in various countries using the
Company's proprietary technology. The fees are recognized by the Company as
earned, the specific timing of which depends on the terms and conditions of the
particular contractual arrangements. In addition to the business development
fees recognized by the Company, other fees are recognized as products are
delivered (see note 2).
F-9
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Research and development costs
Expenditures for research and development are charged to expense as incurred.
Under Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," certain
software development costs are capitalized after technological feasibility has
been established. Development costs incurred in the period from achievement of
technological feasibility, which the Company defines as the establishment of a
working model, until the general availability of such software to customers,
has been short, and therefore software development costs qualifying for
capitalization have been insignificant. Accordingly, the Company has not
capitalized any software development costs as of December 31, 1998 or March 31,
1999 (unaudited).
Advertising
Advertising costs are expensed as incurred. The following table sets forth
advertising costs (in thousands):
<TABLE>
<CAPTION>
Period from
January 30, Three Months
1996 (inception) Year Ended Ended
Through December 31, March 31,
December 31, ------------- -------------
1996 1997 1998 1998 1999
---------------- ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Advertising costs.................. $ -- $ 53 $ 247 $ 50 $ 102
</TABLE>
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25") and Financial
Accounting Standards Board Interpretation No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans", and
complies with the disclosure provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
Under APB No. 25, compensation expense is based on the difference, if any, on
the date of the grant, between the fair value of the Company's stock and the
exercise price. The Company accounts for stock issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
No. 96-18 "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."
Income taxes
Income taxes are accounted for using the asset and liability approach, which
requires the recognition of taxes payable or refundable for the current year
and deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in the Company's financial statements or tax
returns. The measurement of current and deferred tax liabilities and assets are
based on provisions of the enacted tax laws; the effects of future changes in
tax laws or rates are not anticipated. The measurement of deferred tax assets
is reduced, if necessary, by the amount of any tax benefits that, based on
available evidence, are not expected to be realized.
Net loss per share
The Company computes net loss per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128")
and SEC Staff Accounting Bulletin No. 98 ("SAB No. 98"). Under the provisions
of SFAS No. 128 and SAB No. 98, basic and diluted net loss per share
F-10
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
is computed by dividing the net loss available to common stockholders for the
period by the weighted average number of common shares outstanding during the
period. The calculation of diluted net loss per share excludes potential common
shares if the effect is anti-dilutive. Potential common shares consist of
unvested restricted common stock, incremental common shares issuable upon the
exercise of stock options, shares issuable upon conversion of the Series A,
Series B and Series C mandatorily redeemable convertible preferred stock and
common shares issuable upon the exercise of common and mandatorily redeemable
convertible preferred stock warrants.
The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Period from
January 30, Year Ended Three Months
1996 (inception) December 31, Ended March 31,
Through December ---------------- ----------------
31, 1996 1997 1998 1998 1999
---------------- ------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Numerator:
Net loss................. $(1,264) $(6,216) $(8,539) $(1,985) $(4,143)
------- ------- ------- ------- -------
Denominator:
Weighted average shares.. 2,288 3,682 3,888 3,964 3,725
Weighted average unvested
common shares subject to
repurchase.............. (2,203) (2,426) (1,517) (1,965) (753)
------- ------- ------- ------- -------
Denominator for basic and
diluted calculation..... 85 1,256 2,371 1,999 2,972
======= ======= ======= ======= =======
Net loss per share:
Basic and diluted........ $(14.93) $ (4.95) $ (3.60) $ (0.99) $ (1.39)
======= ======= ======= ======= =======
</TABLE>
The following table sets forth potential shares of common stock that are not
included in the diluted net loss per share calculation above because to do so
would be anti-dilutive for the periods indicated (in thousands):
<TABLE>
<CAPTION>
Period From Year Ended
January 30, December Three Months
1996 (inception) 31, Ended March 31,
Through December ----------- ----------------
31, 1996 1997 1998 1998 1999
----------------- ----- ----- ------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
Weighted average effect of
common stock equivalents:
Series A mandatorily redeemable
convertible preferred stock... 1,716 3,050 3,050 3,050 3,050
Series B mandatorily redeemable
convertible preferred stock... -- 1,859 3,187 3,187 3,187
Series C mandatorily redeemable
convertible preferred stock... -- -- 1,434 -- 3,507
Mandatorily redeemable
convertible preferred stock
warrants...................... -- 9 18 15 20
Unvested common shares subject
to repurchase................. 2,203 2,426 1,517 1,965 753
Common stock options........... 103 629 665 770 751
Common stock warrants.......... -- -- 49 49 49
----- ----- ----- ------- --------
4,022 7,973 9,920 9,036 11,317
===== ===== ===== ======= ========
</TABLE>
F-11
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Pro forma net loss per share (unaudited)
Pro forma net loss per share for the year ended December 31, 1998 and the
three months ended March 31, 1999 is computed using the weighted average number
of common shares outstanding, including the pro forma effects of the automatic
conversion of the Company's Series A, Series B and Series C mandatorily
redeemable convertible preferred stock into shares of the Company's common
stock effective upon the closing of the Company's initial public offering
("offering") as if such conversion occurred on January 1, 1998, or at date of
original issuance, if later. The resulting pro forma adjustment includes an
increase in the weighted average shares used to compute basic and diluted net
loss per share of 7,670,982 and 9,744,199 for the year ended December 31, 1998
and the three months ended March 31, 1999, respectively. The calculation of
diluted net loss per share excludes potential common shares as the effect would
be anti-dilutive. Pro forma common equivalent shares are composed of unvested
restricted common stock and incremental common shares issuable upon the
exercise of stock options and warrants.
Pro forma stockholders' equity (unaudited)
Effective upon the closing of this offering, the outstanding shares of Series
A, Series B and Series C mandatorily redeemable convertible preferred stock
will automatically convert into 9,744,199 shares of common stock. The pro forma
effects of these transactions are unaudited and have been reflected in the
accompanying pro forma stockholders' equity at March 31, 1999.
Comprehensive income
The Financial Accounting Standards Board ("FASB") recently issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS No. 130"). SFAS No. 130 establishes standards for reporting
comprehensive income and its components in financial statements. Comprehensive
income, as defined, includes all changes in equity (net assets) during a period
from non-owner sources. The Company adopted SFAS No. 130 on January 1, 1998. To
date, the Company has not had any significant transactions that are required to
be reported as other comprehensive income other than its net loss.
Segment information
The FASB recently issued Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
No. 131"). SFAS No. 131 supersedes Statement of Financial Accounting
Standards No. 14, "Financial Reporting for Segments of a Business Enterprise,"
replacing the "industry segment" approach with the "management approach." The
management approach designates the internal organization that is used by
management for making operating decisions and assessing performance as the
source of the Company's reportable segments. SFAS No. 131 also requires
disclosures about products and services, geographic areas and major customers.
The Company adopted SFAS No. 131 on January 1, 1998. The Company has determined
that it does not have any separately reportable business or geographic
segments.
Recent accounting pronouncements
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires all costs related to
the development of internal use software other than those incurred during the
application development stage to be expensed as incurred. Costs incurred during
the application development stage are required to be capitalized and amortized
over the estimated useful life of the software. SOP 98-1 is effective for the
Company's fiscal year ending December 31, 1999. Adoption is not expected to
have a material effect on the Company's financial statements.
F-12
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"). SFAS No. 133 is effective for fiscal years beginning after June 15,
1999. SFAS No. 133 requires that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designed as part of a hedge transaction
and, if so, the type of hedge transaction. The Company does not expect that the
adoption of SFAS No. 133 will have a material effect on its financial
statements.
In December 1998, the AICPA issued Statement of Position 98-9, "Modification
of SOP 97-2, Software Revenue Recognition, with Respect to Certain
Transactions" ("SOP 98-9"), which amends certain elements of SOP 97-2 and
provides additional authoritative guidance on software revenue recognition. SOP
98-9 is effective for fiscal years beginning after March 15, 1999. The Company
does not expect that the adoption of SOP 98-9 will have a material effect on
its financial statements.
Reclassifications
Certain reclassifications have been made to the prior years' financial
statements to conform to current period presentation.
NOTE 2--RELATED PARTIES:
Investment in Liquid Audio Korea
In December 1998, the Company signed an agreement with a strategic partner
(the "strategic partner") to establish a Korean corporation, Liquid Audio Korea
Co. Ltd. ("LAK"), to develop a local business to enable the digital delivery of
music to customers in Korea. LAK is the exclusive reseller and distributor of
the Company's software products in Korea, under an agreement expiring on
December 31, 2003. The Company paid $400,000 for 40% of the outstanding common
stock of LAK and will account for its investment in LAK using the equity method
of accounting. As of December 31, 1998, the Company's investment in LAK is
recorded at zero due to the recognition of equity investee losses equal to the
investment balance. The equity investee losses of $400,000 were recorded as an
offset to the business development revenue recognized from LAK. The Company
will not record its share of additional losses during this development stage
since there is no obligation on the part of the Company to pay LAK or any other
party for those losses. If LAK generates sufficient profits to recoup its
initial operating losses, the Company will re-instate the equity method of
accounting.
Investment in Liquid Audio Japan
In April 1998, the Company signed an agreement with a strategic partner (the
"strategic partner") to establish a Japanese corporation, Liquid Audio Japan
("LAJ"). LAJ is the exclusive reseller and distributor of the Company's
software products in Japan. At December 31, 1998, the initial capitalization of
LAJ was provided by the strategic partner, and in March 1999, the Company
purchased 18% of the issued and outstanding shares in LAJ from the strategic
partner for $378,000. The Company retains the option, expiring on December 31,
2003, to purchase an additional 2% of the capital of LAJ from the strategic
partner, at the then fair market value of LAJ's shares. The Company also has a
put option whereby the Company can require the strategic partner to purchase
its shares in LAJ at the then fair market value, if certain performance
measures of LAJ, as defined, are not met. The Company's purchase of shares in
LAJ was funded by a loan from a related entity of the Japanese strategic
partner. This loan, denominated in Japanese yen, is repayable on December 31,
2003. Interest on the loan bears interest at 0.5% above a Japanese bank's prime
rate (3.1% at March 31, 1999 (unaudited)) and is payable quarterly. The loan is
classified in the balance sheet as a non-current note payable to a related
party and recorded at the prevailing exchange rate at March 31, 1999
(unaudited). The Company will use the equity method of accounting for this
investment due to the Company's ability to significantly
F-13
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
influence the LAJ operations. As of March 31, 1999 (unaudited), the Company's
investment in LAJ was deemed to be impaired due to substantial doubt regarding
recoverability and the significant losses that are expected to be incurred
during LAJ's initial operating periods. The impairment conclusion was based
upon the lack of sufficient earnings and cash flows for LAJ for the foreseeable
future, the lack of a commercially viable product to introduce into the Japan
marketplace, the lack of a proven business model that will sustain the
competitive and technological challenges inherent in the local environment, and
the unstable nature of the economy in Japan. The $378,000 (unaudited) write-off
of this investment was recorded in March 1999 and is included in sales and
marketing expenses for the three months ended March 31, 1999. The Company will
not record its share of those losses during this development stage since there
is no obligation on the part of the Company to pay LAJ or any other party for
those losses. The Company discontinued use of the equity method of accounting
at March 31, 1999. If LAJ generates sufficient profits to recoup its initial
operating losses, the Company will re-instate the equity method of accounting.
Other transactions
During the year ended December 31, 1998 and the three months ended March 31,
1999, the Company recorded business development revenues totaling $1,300,000
and $183,000 (unaudited), respectively. The components of these amounts are as
follows (in thousands):
<TABLE>
<CAPTION>
Three Months
Year Ended Ended
December 31, March 31,
1998 1999
------------ ------------
(unaudited)
<S> <C> <C>
Business development revenues:
Business development fees from strategic partners.... $1,200 $ 83
Other fees from LAK and LAJ.......................... 100 100
------ ----
$1,300 $183
====== ====
</TABLE>
At March 31, 1999, fees received in advance of recognition as business
development revenues were $917,000 (unaudited). This amount is classified as
deferred revenue on the balance sheet and will be recognized ratably as revenue
over the eleven months ending February 28, 2000.
NOTE 3--BALANCE SHEET COMPONENTS (in thousands):
<TABLE>
<CAPTION>
December
31,
--------- March 31,
1997 1998 1999
---- ---- -----------
(unaudited)
<S> <C> <C> <C>
Accounts receivable, net:
Accounts receivable...................................... $140 $607 $331
Allowance for doubtful accounts.......................... 56 231 294
---- ---- ----
$ 84 $376 $ 37
==== ==== ====
</TABLE>
F-14
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Write-offs against the allowance for doubtful accounts were $34,000 and
$30,000 in the year ended December 31, 1998 and the three months ended March
31, 1999 (unaudited), respectively.
<TABLE>
<CAPTION>
December 31,
------------- March 31,
1997 1998 1999
----- ------ -----------
(unaudited)
<S> <C> <C> <C>
Property and equipment:
Computer equipment and purchased software........... $ 595 $1,460 $1,765
Furniture and fixtures.............................. 193 324 331
Leasehold improvements.............................. 38 329 349
----- ------ ------
826 2,113 2,445
Less: accumulated depreciation and amortization..... (155) (606) (774)
----- ------ ------
$ 671 $1,507 $1,671
===== ====== ======
Property and equipment includes $424,000, $729,000 and $737,000 (unaudited)
of equipment under capital leases at December 31, 1997 and 1998, and March 31,
1999, respectively. Accumulated depreciation and amortization for equipment
under capital leases was $129,000, $352,000 and $415,000 (unaudited) at
December 31, 1997 and 1998, and March 31, 1999, respectively.
<CAPTION>
December 31,
------------- March 31,
1997 1998 1999
----- ------ -----------
(unaudited)
<S> <C> <C> <C>
Accrued expenses and other current liabilities:
Compensation and benefits........................... $ 174 $ 345 $ 569
Consulting and professional services................ 172 147 212
Accrued marketing expenses.......................... 251 162 206
Other............................................... 135 278 350
----- ------ ------
$732 $932 $1,337
===== ====== ======
</TABLE>
NOTE 4--BORROWINGS:
Lines of credit
In 1996, the Company entered into a revolving credit agreement with a bank
(the "Bank") under which it could borrow up to $400,000. The Company had
$400,000 outstanding on this revolving line on December 31, 1997. The revolving
line of credit was collateralized by substantially all of the Company's assets,
bore interest at the Bank's prime rate plus 3% and expired on April 30, 1998,
at which time the principal was repaid.
In November 1998, the Company entered into a revolving line of credit with
the Bank which provides for borrowings of up to 80% of eligible accounts
receivable (as defined) up to a maximum of $1,000,000 through November 1999.
Any advances would bear interest at the Bank's prime interest rate (7.75% at
December 31, 1998 and March 31, 1999 (unaudited)). Borrowings under the line of
credit would be collateralized by substantially all of the Company's assets. No
advances have been obtained to date under the line of credit.
Equipment loan
Pursuant to the terms of an equipment financing agreement with the Bank, the
Company has a $3,000,000 line of credit to be used specifically to purchase
computer and office equipment. The line expires in November 1999. Under the
line, the Company borrowed amounts totalling $920,000 and $1,321,000 from the
F-15
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
date of the agreement (November 1, 1998) through December 31, 1998 and March
31, 1999 (unaudited), respectively. Borrowings under the line are repayable in
monthly installments over three years and bear interest at the Bank's prime
interest rate plus 0.25% (8.0% at December 31, 1998 and March 31, 1999
(unaudited)). Borrowings are secured by the related equipment and other assets
of the Company.
Under the equipment line of credit, the Company is required to meet certain
monthly reporting and financial covenants, including minimum operating results
and certain liquidity, leverage and debt service ratios. At December 31, 1998
and March 31, 1999 (unaudited), the Company was in compliance with all such
covenants.
Future minimum principal payments under the equipment line at December 31,
1998 are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
1999.............................................................. $ 281
2000.............................................................. 307
2001.............................................................. 307
2002.............................................................. 25
-----
920
Less current portion............................................... (281)
-----
Non-current portion................................................ $ 639
=====
</TABLE>
Short-term loans
In May 1997, the Company entered into a short-term loan facility for
$1,000,000 with a bank. The company borrowed $400,000 during the year ended
December 31, 1997 under this facility. In April 1998, the company entered into
a short-term loan facility for $2,400,000 with a bank. The Company borrowed
$1,330,000 during the year ended December 31, 1998 under this facility. Both
short-term loans were repaid and the facilities have expired.
NOTE 5--MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK:
Mandatorily redeemable convertible preferred stock, $0.001 par value at
December 31, 1998, was comprised of the following (in thousands):
<TABLE>
<CAPTION>
Liquidation
Shares and
---------------------- Redemption
Authorized Outstanding Amount
---------- ----------- -----------
<S> <C> <C> <C>
Series A................................ 3,050 3,050 $ 2,001
Series B................................ 3,355 3,187 6,246
Series C................................ 4,500 3,507 21,554
------ ----- -------
10,905 9,744 $29,801
====== ===== =======
</TABLE>
The rights of holders of mandatorily redeemable convertible preferred stock
with respect to voting, dividends, liquidation and conversion and redemption
are as follows:
Voting
Each share of Series A, Series B and Series C mandatorily redeemable
convertible preferred stock has voting rights equal to an equivalent number of
shares of common stock into which it is convertible.
F-16
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Dividends
Holders of Series A, Series B and Series C mandatorily redeemable convertible
preferred stock are entitled to noncumulative, preferential dividends of
$0.059, $0.176 and $0.5526, respectively, per share per annum when and if
declared by the Board of Directors. The holders of Series A, Series B and
Series C mandatorily redeemable convertible preferred stock will also be
entitled to participate in dividends on common stock, when and if declared by
the Board of Directors, based on the number of shares of common stock into
which the mandatorily redeemable convertible preferred stock is convertible. As
of March 31, 1999, no dividends on mandatorily redeemable convertible preferred
stock or common stock had been declared or paid.
Liquidation
In the event of any liquidation, dissolution, winding up, or consolidation or
merger of the Company resulting in an ownership change of greater than 50%,
distributions to stockholders are to be made in the following manner:
The holders of the Series A, Series B and Series C mandatorily redeemable
convertible preferred stock are entitled to receive, prior and in preference to
any distribution of the assets of the Company to the holders of the common
stock, the amounts of $0.656, $1.96 and $6.14 per share, respectively, for each
share of Series A, Series B and Series C mandatorily redeemable convertible
preferred stock then held plus all declared and unpaid dividends, if any, on
such shares. If the assets of the Company are insufficient to permit this
distribution, the assets of the Company would be distributed ratably, between
the holders of Series A, Series B and Series C mandatorily redeemable
convertible preferred stock on a pari passu basis according to the liquidation
preferences of each series and as between the holders of shares of a particular
series, in proportion to the amount of such stock of such series owned by such
holder.
Thereafter, mandatorily redeemable convertible preferred stock and common
stock stockholders would share proceeds pro rata, on an as-converted basis,
until holders of Series A and Series B mandatorily redeemable convertible
preferred stock have recovered an amount of $3.936 per share (excluding amounts
already paid) and holders of Series C mandatorily redeemable convertible
preferred stock have recovered an amount of $8.18 per share (excluding amounts
already paid). All further proceeds would be distributed to the common
stockholders.
Conversion
Each share of Series A, Series B and Series C mandatorily redeemable
convertible preferred stock is convertible at the option of the holder at any
time into shares of common stock based on a conversion rate as defined in the
amended and restated Certificate of Incorporation, which currently results in a
conversion rate of 1:1. Each share of Series A, Series B and Series C
mandatorily redeemable convertible preferred stock will automatically be
converted into shares of common stock at the then effective conversion rate
upon the closing of a firm commitment underwritten initial public offering of
the Company's common stock at a price not less than $8.33 per share with total
proceeds in excess of $15,000,000 or on the date upon which the Company obtains
the consent of the holders of 2/3's of the then outstanding shares of
mandatorily redeemable convertible preferred stock.
Redemption
At the option of the holders of the Series A, Series B and Series C
mandatorily redeemable convertible preferred stock, subsequent to six years
from the date of first issuance of Series C mandatorily redeemable convertible
preferred stock, but within 30 days of written request from holders of not less
than 2/3's of the then
F-17
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
outstanding Series A, Series B and Series C mandatorily redeemable convertible
preferred stock, the Company will redeem the shares specified in such request
for a sum equal to $0.656, $1.96 and $6.14, respectively, per share plus all
declared but unpaid dividends.
Warrants
In connection with certain short-term loans received by the Company in 1997
and 1998 (see note 4), the Company issued warrants to purchase 15,306 shares of
Series B mandatorily redeemable preferred stock for $1.96 per share and 4,544
shares of Series C mandatorily redeemable preferred stock for $6.14 per share
respectively. The warrants expire on the earlier of 2002 and 2005,
respectively, or two years after an initial public offering. The Company
determined the value of the warrants issued in 1997 and in 1998 to be nominal,
based on the Black-Scholes option pricing model.
NOTE 6--COMMON STOCK:
In April 1999, the Company's Certificate of Incorporation was amended and
restated to authorize the issuance of 25,878,000 shares of common stock at
$0.001 par value.
In February 1998, the Company's Board of Directors authorized a three-for-two
stock split (i.e., one existing share is equivalent to one and one-half post-
split shares). All share and per share data in these financial statements have
been restated to reflect this stock split.
In April 1996, the Company issued 3,431,000 shares of restricted common stock
at $0.00133 per share to the Company's founders. The restricted common stock
vests at a rate of 25% at the end of the first year and then 2.083% each month
thereafter until 100% vested. The Company has the right to repurchase unvested
shares, and in October 1998, approximately 88,000 shares of unvested founders'
common stock was repurchased. At December 31, 1997, December 31, 1998 and March
31, 1999, approximately 1,644,000, 2,481,000 and 2,680,000 (unaudited) shares
had vested, respectively.
As of December 31, 1998, the Company had reserved the following number of
shares of common stock for future issuance (in thousands):
<TABLE>
<CAPTION>
December 31,
1998
------------
<S> <C>
Conversion of Series A mandatorily redeemable convertible
preferred stock............................................ 3,050
Conversion of Series B mandatorily redeemable convertible
preferred stock and warrants............................... 3,202
Conversion of Series C mandatorily redeemable convertible
preferred stock and warrants............................... 3,512
Common stock warrant........................................ 49
Options under Stock Option Plan............................. 1,138
------
10,951
======
</TABLE>
Warrants
In February 1997, the Company entered into a marketing agreement whereby the
Company and another company jointly developed and marketed a certain feature
specification of the Company's software products. Pursuant to this agreement,
the Company issued 38,316 shares of the Company's common stock and a warrant to
purchase 48,860 shares of common stock at $6.14 per share. The warrant expires
on January 1, 2001. The Company accrued $107,000 during the year ended December
31, 1997 for the estimated fair value of the warrant, based on the Black-
Scholes option pricing model.
In March 1999, pursuant to a strategic agreement, the Company issued a
warrant for 3,000 shares of common stock at $6.56 per share. The warrant
expires in March 2004.
F-18
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 7--EMPLOYEE BENEFIT PLANS:
401(k) Savings plan
The Company sponsors a 401(k) defined contribution plan covering eligible
employees who elect to participate. The Company may elect to contribute
matching and discretionary contributions to the plan; however, no contributions
have been made by the Company since inception of the plan.
Stock Option Plan
In September 1996, the Board of Directors adopted the 1996 Equity Incentive
Plan (the "Plan") which initially provided for the granting of up to 1,144,000
incentive stock options and nonqualified stock options. In August 1997 and
October 1998, an additional 441,000 and 88,000 shares, respectively, were
authorized for grants under the Plan. Under the Plan, incentive stock options
may be granted to employees of the Company and nonqualified stock options and
stock purchase rights may be granted to consultants, employees, directors and
officers of the Company. Options granted under the Plan are for periods not to
exceed ten years, and must be issued at prices not less than 100% and 85%, for
incentive and nonqualified stock options, respectively, of the fair market
value of the stock on the date of grant as determined by the Board of
Directors. Options granted under the Plan generally vest 25% after the first
year and then 2.083% each month thereafter until 100% vested. Options granted
to stockholders who own greater than 10% of the outstanding stock must be for
periods not to exceed five years and must be issued at prices not less than
110% of the estimated fair market value of the stock on the date of grant as
determined by the Board of Directors.
The following table summarizes stock option activity under the Plan (shares
in thousands):
<TABLE>
<CAPTION>
Options Outstanding
----------------------
Weighted
Options Average
Available Exercise Price
for Grant Shares Per Share
--------- ------ --------------
<S> <C> <C> <C>
Authorized.................................. 1,144 -- $ --
Options granted............................. (419) 419 0.067
------ -----
Balance at December 31, 1996................ 725 419 0.067
Additional options authorized.............. 441 -- --
Options granted............................ (1,108) 1,108 0.154
Options exercised.......................... -- (469) 0.067
Options canceled........................... 197 (197) 0.067
------ -----
Balance at December 31, 1997................ 255 861 0.130
Additional options authorized.............. 88 -- --
Repurchase of common stock in connection
with unvested stock options previously
exercised................................. 24 -- --
Options granted............................ (512) 512 1.01
Options exercised.......................... -- (90) 0.067
Options canceled........................... 216 (216) 0.11
------ -----
Balance at December 31, 1998................ 71 1,067 0.68
Repurchase of common stock in connection
with unvested stock options previously
exercised (unaudited)..................... 29 -- --
Options granted (unaudited)................ (111) 111 3.22
Options exercised (unaudited).............. -- (5) 0.34
Options canceled (unaudited)............... 122 (122) 0.10
------ -----
Balance at March 31, 1999 (unaudited)....... 111 1,051 0.89
====== =====
</TABLE>
F-19
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
During the period from January 30, 1996 (inception) through December 31,
1996, the Company granted options to purchase 22,500 shares of common stock to
consultants in exchange for services at an exercise price of $0.067 per share.
The Company determined the value of the options granted to be nominal. During
the three months ended March 31, 1999 (unaudited), the Company granted an
option to purchase 20,000 shares of common stock to a consultant in exchange
for services at an exercise price of $2.50 per share. The Company determined
the value of the option to be $142,000, based on the Black-Scholes option
pricing model. Of this amount, $71,000 was recognized as research and
development expense in the three months ended March 31, 1999 (unaudited).
The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1998 (shares in thousands):
<TABLE>
<CAPTION>
Options Vested and
Options Outstanding Exercisable
--------------------------------- --------------------
Weighted Weighted
Weighted Average Average
Average Exercise Exercise
Remaining Price Price
Number Contractual Per Number Per
Range of Exercise Prices Outstanding Life (years) Share Outstanding Share
------------------------ ----------- ------------ -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.067................. 129 7.65 $0.067 66 $0.067
0.194................. 534 8.63 0.194 152 0.194
0.333-0.40............ 154 9.24 0.393 -- --
1.50-2.00............. 250 9.76 1.750 30 1.50
----- ---
1,067 248
===== ===
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options as of March 31, 1999 (unaudited, shares in thousands):
<TABLE>
<CAPTION>
Options Vested and
Options Outstanding Exercisable
-------------------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Remaining Exercise Exercise
Contractual Price Price
Number Life Per Number Per
Range of Exercise Prices Outstanding (years) Share Outstanding Share
------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.067.................. 127 7.40 $0.067 75 $0.067
0.194.................. 425 8.42 0.194 211 0.194
0.333-0.40............. 138 9.01 0.400 27 0.390
1.50-2.50.............. 327 9.52 1.930 46 2.500
5.00................... 34 9.93 5.000 -- --
----- ---
1,051 359
===== ===
</TABLE>
Fair value disclosures
Pro forma information regarding net loss and net loss per share is required
by FAS 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted under the fair
value method. The fair value for these options was estimated using the Black-
Scholes option pricing model.
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option pricing models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's options have characteristics significantly different from
those of options of publicly traded
F-20
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
companies and because changes in the subjective input assumptions can
materially affect the fair value estimate, in the opinion of management, the
existing models do not necessarily provide a reliable single measure of the
fair value of its options.
The Company calculated the minimum fair value of each option grant on the
date of grant using the Black-Scholes option pricing method as prescribed by
SFAS No. 123 using the following assumptions:
<TABLE>
<CAPTION>
Period From
January 30, Three Months
1996 (inception) Year Ended Ended March
Through December 31, 31,
December 31, --------------- ---------------
1996 1997 1998 1998 1999
---------------- ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Risk-free rates......... 6.4% 6.2% 5.8% 5.8% 5.6%
Expected lives (in
years)................. 4.0 4.0 4.0 4.0 4.0
Dividend yield.......... 0.0% 0.0% 0.0% 0.0% 0.0%
Expected volatility..... 0.0% 0.0% 0.0% 0.0% 0.0%
</TABLE>
Had compensation costs been determined based upon the fair value at the grant
date for awards under these plans, consistent with the methodology prescribed
under SFAS No. 123, the Company's pro forma net loss attributable to common
stockholders and pro forma basic and diluted net loss per share under SFAS
No. 123 would have been:
<TABLE>
<CAPTION>
Period From
January 30, Three Months
1996 (inception) Year Ended Ended
Through December 31, March 31,
December 31, ------------- -------------
1996 1997 1998 1998 1999
---------------- ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Pro forma net loss (in
thousands)................ $1,267 $6,229 $8,579 $1,995 $4,172
Pro forma net loss per
share..................... $14.91 $4.96 $3.62 $1.00 $1.40
</TABLE>
The weighted average minimum value of options granted with an exercise price
less than the fair market value of stock on the date of grant were:
<TABLE>
<CAPTION>
Period From
January 30, Three Months
1996 (inception) Year Ended Ended
Through December 31, March 31,
December 31, ------------- -------------
1996 1997 1998 1998 1999
---------------- ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Weighted average minimum
value of options granted
during period............ $0.61 $ 1.80 $ 4.84 $ 4.08 $ 8.28
</TABLE>
Unearned stock-based compensation
In connection with certain stock option grants, the Company recognized
unearned compensation which is being amortized over the vesting periods of the
related options, usually four years, using an appropriate accelerated basis.
The total unearned compensation recorded by the Company from January 30, 1996
(inception) through March 31, 1999 was $4,374,000. The fair value per share
used to calculate unearned compensation was derived by reference to the
preferred stock values, reduced by a nominal discount factor (10%), since
inception. Future compensation charges are subject to reduction for any
employee who terminates employment prior to the expiration of such employee's
option vesting period.
F-21
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following table sets forth unearned compensation and the amortization of
unearned compensation (in thousands):
<TABLE>
<CAPTION>
Period From
January 30, Three Months
1996 (inception) Year Ended Ended
Through December 31, March 31,
December 31, ------------- -------------
1996 1997 1998 1998 1999
---------------- ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Unearned compensation....... $239 $1,888 $1,714 $192 $533
Amortization of unearned
compensation............... $ 31 $ 534 $1,241 $259 $425
</TABLE>
NOTE 8--INCOME TAXES:
The Company had approximately $13,000,000 and $16,800,000 (unaudited) of
federal and $12,900,000 and $16,600,000 (unaudited) of state net operating loss
carryforwards available to offset future taxable income at December 31, 1998
and March 31, 1999, respectively. The federal and state net operating loss
carryforwards expire in varying amounts beginning in 2011 and 2004,
respectively. At December 31, 1998, the Company had approximately $210,000 of
federal and $170,000 of state research and development credit carryforwards
available to offset future taxable income, which, in the case of the federal
carryforwards, expire in varying amounts beginning in 2011. Under the Tax
Reform Act of 1986, the amounts of and benefits from net operating loss
carryforwards may be impaired or limited in certain circumstances. Events that
cause limitations in the amount of net operating loss carryforwards that the
Company may utilize in any one year include, but are not limited to, a
cumulative ownership change of more than 50%, as defined, over a three-year
period. As a result of this offering, such a change in ownership is expected to
occur. Management has estimated that the net operating loss carryforwards from
inception will be limited to $7,500,000 annually.
Deferred taxes are composed of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------- March 31,
1997 1998 1999
------- ------- -----------
(unaudited)
<S> <C> <C> <C>
Deferred tax assets (liabilities)
Depreciation and amortization............. $ (17) $ 12 $ 20
Other accruals and liabilities............ 151 102 408
Net operating loss and credit
carryforwards............................ 2,250 5,070 6,700
Research and development credit
carryforwards............................ 181 380 380
------- ------- -------
Total deferred tax assets................. 2,565 5,564 7,508
------- ------- -------
Less: Valuation allowance................. (2,565) (5,564) (7,508)
------- ------- -------
Net deferred tax assets.................... $ -- $ -- $ --
======= ======= =======
</TABLE>
The Company has incurred a loss in each period since its inception. Based on
the available objective evidence, including the Company's history of losses,
management believes it is more likely than not that the net deferred tax assets
will not be fully realizable. Accordingly, the Company has provided for a full
valuation allowance against its total deferred tax assets at December 31, 1997
and 1998 and March 31, 1999 (unaudited).
F-22
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 9--COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases its office facilities and certain equipment under
noncancelable operating lease agreements which expire at various dates through
2002. The terms of the facility lease provide for rental payments on a
graduated scale. The Company recognizes rent expense on a straight-line basis
over the lease period, and has accrued for rent expense incurred but not paid.
The lease requires that the Company pay all costs of maintenance, utilities,
insurance and taxes. Rent expense under these leases is as follows (in
thousands):
<TABLE>
<CAPTION>
Period From
January 30,
1996 Three Months
(inception) Year Ended Ended
Through December 31, March 31,
December 31, ------------- -------------
1996 1997 1998 1998 1999
------------ ------ ------ ------ ------
(unaudited)
<S> <C> <C> <C> <C> <C>
Rent expense..................... $32 $ 111 $ 294 $ 64 $ 77
</TABLE>
Future minimum lease payments under all noncancelable capital and operating
leases at December 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
Capital Operating
Year Ending December 31, Leases Leases
------------------------ ------- ---------
<S> <C> <C>
1999..................................................... $269 $241
2000..................................................... 188 234
2001..................................................... 86 216
2002..................................................... 19 189
---- ----
Total minimum payments............................... 562 $880
====
Less: amount representing interest....................... (35)
----
Present value of capital lease obligations............... 527
Less: Current portion.................................... (197)
----
Capital lease obligations, non-current portion........... $330
====
</TABLE>
Contingencies
From time to time, in the normal course of business, various claims are made
against the Company. In the opinion of the management, there are no pending
claims the outcome of which is expected to result in a material adverse effect
on the financial position or results of operations of the Company.
NOTE 10--SUBSEQUENT EVENTS:
Reincorporation
In April 1999, the Company was reincorporated in the State of Delaware. All
share information included in these financial statements has been adjusted to
reflect this reincorporation.
Employee Stock Purchase Plan
In April 1999, the Board of Directors adopted the 1999 Employee Stock
Purchase Plan (the "Purchase Plan") and reserved 500,000 shares of common stock
for issuance thereunder. The Purchase Plan was
F-23
<PAGE>
LIQUID AUDIO, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
approved by the stockholders in June 1999. On each January 1, the aggregate
number of shares reserved for issuance under the Purchase Plan will be
increased by the lesser of 750,000 shares, 3% of the outstanding shares on such
date or a lesser amount determined by the Board of Directors. The Purchase Plan
will become effective on the first business day on which price quotations for
the Company's common stock are available on the Nasdaq National Market.
Employees are eligible to participate if they are customarily employed by the
Company or any participating subsidiary for at least 20 hours per week and more
than five months in any calendar year and do not (i) immediately after grant
own stock possessing 5% or more of the total combined voting capital stock, or
(ii) possess rights to purchase stock under all of the employee stock purchase
plans at an accrual rate which exceeds $25,000 worth of stock for each calendar
year. The Purchase Plan permits participants to purchase common stock through
payroll deductions up to 15% of the participant's compensation, as defined in
the Purchase Plan, but limited to 2,500 shares per participant per purchase
period. Each offering period includes four six-month purchase periods which
will begin on June 1 and December 1 of each year, except for the offering
period which starts on the first trading day on or after the effective date the
public offering. The price at which the common stock is purchased under the
Purchase Plan is 85% of the lesser of the fair market value at the beginning of
the offering period or at the end of the purchase period. The Purchase Plan
will terminate after a period of ten years unless terminated earlier as
permitted by the Purchase Plan.
Stock Option Plan
In April 1999, the Board of Directors adopted an increase in the number of
shares reserved for issuance under the Company's 1996 Equity Incentive Plan
(the "Plan") by an additional 1,600,000 shares. The Plan was also amended to
provide for annual increases on January 1 equal to the lesser of 1,500,000
shares, 5% of the outstanding shares on such date or a lesser amount determined
by the Board of Directors.
Litigation
In April 1999, a former consultant of the Company filed a complaint against
the Company. The complaint alleges both breach of contract and fraud and seeks
approximately 588,000 shares of common stock. While there can be no assurances
as to the outcome of this litigation, the Company believes the complaint is
without merit, and intends to vigorously defend the complaint. No amount has
been accrued for any potential liability in relation to this matter.
In May 1999, an entity advised the Company that it believes the use of
certain of the Company's software tools and client software products together
infringes two patents to which this entity asserts it has rights. In June 1999,
an entity advised the Company that there may be certain patents to which they
claim rights. While there can be no assurances as to the outcome of these
claims, the Company believes the claims are without merit, and intends to
vigorously defend against the claim. No amount has been accrued for any
potential liability in relation to these matters.
Warrants
In March, May and June 1999, the Company signed strategic agreements with
several entities. Pursuant to these agreements, the Company issued warrants to
purchase approximately 396,000 shares of the Company's common stock at $6.56
per share of which 266,000 shares vest immediately and 127,000 shares vest over
a twelve month period commencing when the Company and the strategic entity sign
a definitive agreement to utilize the Company's technology. The warrants expire
through June 2004. With respect to the immediately vested shares, the Company
expects to value these warrants at approximately $2,200,000 which will be
recognized as sales and marketing expense over the term of the related
agreements.
License agreement
In June 1999, the Company signed an agreement with an entity to facilitate
the production, sale and distribution of music on the Internet utilizing the
Company's technology. Pursuant to this agreement, the Company issued and
delivered 100,000 shares of common stock to this entity. These shares have been
valued at $1,100,000.
F-24
<PAGE>
3,600,000 Shares
[LIQUID AUDIO LOGO]
Common Stock
-------------
PROSPECTUS
, 1999
-------------
Lehman Brothers
BancBoston Robertson Stephens
U.S. Bancorp Piper Jaffray
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than the
underwriting discount, payable by the Registrant in connection with the sale of
the securities being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fee and the Nasdaq National Market listing
fee.
<TABLE>
<S> <C>
SEC Registration Fee............................................... $ 16,680
NASD Filing Fee.................................................... 6,500
Nasdaq National Market Listing Fee................................. 94,000
Printing Costs..................................................... 150,000
Legal Fees and Expenses............................................ 300,000
Accounting Fees and Expenses....................................... 150,000
Blue Sky Fees and Expenses......................................... 10,000
Transfer Agent and Registrar Fees.................................. 10,000
Miscellaneous...................................................... 212,820
--------
Total............................................................ $950,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's Board of Directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
certain circumstances for liabilities (including reimbursement for expenses
incurred) arising under the Securities Act of 1933. Article VII of the Restated
Certificate of Incorporation to be filed upon the completion of this offering
(Exhibit 3.2 hereto) and Article VI of our Bylaws to be adopted upon the
completion of this offering (Exhibit 3.4 hereto) provide for indemnification of
our directors, officers, employees and other agents to the maximum extent
permitted by Delaware law. In addition, we have entered into Indemnification
Agreements (Exhibit 10.1 hereto) with our officers and directors that will
become effective upon the closing of this offering. The Underwriting Agreement
(Exhibit 1.1) also provides for cross-indemnification among Liquid Audio and
the Underwriters with respect to certain matters, including matters arising
under the Securities Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since our incorporation in January 1996, we have sold and issued the
following securities:
1. On April 15, 1996 we issued 3,431,244 shares of common stock to seven
founders for an aggregate consideration of $4,574.99.
2. On May 31, 1996 we issued 2,286,591 shares of Series A mandatorily
redeemable convertible preferred stock (Series A) to seven investors for an
aggregate consideration of $1,500,004.68. On June 28, 1996 we issued
609,753 shares of Series A to one investor for an aggregate consideration
of $399,998.46. On July 30, 1996 we issued 153,645 shares (as adjusted for
stock splits) of Series A to the same investor to which we issued shares of
Series A on June 28, 1996, for an aggregate consideration of $100,791.12.
3. On May 5, 1997 we issued a warrant for 15,306 shares of Series B
mandatorily redeemable convertible preferred stock (Series B) to a bank in
connection with a short-term loan agreement. Such warrant has an exercise
price of $1.96 per share.
4. On May 23, 1997 we issued 2,421,581 shares of Series B to seven
investors for an aggregate consideration of $4,746,294.84. On May 28, 1997
we issued 765,307 shares of Series B to five investors, two of which we
issued shares of Series B to on May 23, 1997, for an aggregate
consideration of $1,499,999.76.
II-1
<PAGE>
5. On January 1, 1998 we issued a warrant for 48,860 shares of common
stock to one strategic partner. Such warrant has an exercise price of
$6.14 per share.
6. On January 1, 1998 we issued 38,316 shares of common stock to one
strategic partner for an aggregate consideration of $2,554.40.
7. On July 31, 1998 we issued 3,179,962 shares of Series C mandatorily
redeemable convertible preferred stock (Series C) to ten investors for an
aggregate consideration of $19,524,966.68. On September 25, 1998 we issued
325,732 shares of Series C to three investors for an aggregate
consideration of $1,999,994.48. On September 29, 1998 we issued 1,628
shares of Series C to one investor for an aggregate consideration of
$9,995.92.
8. On July 31, 1998 we issued a warrant for 4,544 shares of Series C to a
bank in connection with a short term loan agreement. Such warrant has an
exercise price of $6.14 per share.
9. On April 23, 1999 we issued 4,071 shares of common stock to one
employee for an aggregate consideration of $30,532.50.
10. From March 28 through April 30, 1999 we issued warrants exercisable
for a total of 12,000 shares of common stock to five strategic partners.
Such warrants have an exercise price of $6.56 per share.
11. On June 9, 1999 we issued warrants exercisable for a total of 381,203
shares of common stock to Amazon.com, Inc. Such warrants have an exercise
price of $6.56 per share.
12. On June 16, 1999 we issued 100,000 shares of common stock to Virgin
Holdings, Inc., an affiliate of EMI Recorded Music, in consideration for an
encoding license.
13. Since our incorporation, we have issued options to purchase an
aggregate of 2,175,708 shares of common stock with exercise prices ranging
from $0.0667 to $8.00 per share. Since our incorporation through June 15,
1999, we have issued 737,807 shares of common stock pursuant to stock
option exercises for an aggregate consideration of $74,197.63.
There were no underwriters employed in connection with any of the
transactions set forth in Item 15.
The issuances of securities described in Items 15(1) through 15(12) were
deemed to be exempt from registration under the Securities Act in reliance on
Section 4(2) of the Securities Act as transactions by an issuer not involving a
public offering. The issuances of securities described in Item 15(13) were
deemed to be exempt from registration under the Securities Act in reliance on
Section 4(2) or Rule 701 promulgated thereunder as transactions pursuant to
compensatory benefit plans and contracts relating to compensation.
The recipients of securities in each such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate legends
were affixed to the share certificates and other instruments issued in such
transactions. All recipients either received adequate information about the
Registrant or had access, through employment or other relationships, to such
information.
ITEM 16. EXHIBITS.
<TABLE>
<C> <S>
1.1* Form of Underwriting Agreement
3.1* Certificate of Incorporation as currently in effect
3.2* Form of Restated Certificate of Incorporation (to be filed with the
Delaware Secretary of State prior to the closing of the offering covered
by this Registration Statement)
3.3* Bylaws as currently in effect
3.4* Form of Bylaws (to be adopted upon the completion of the offering covered
by this Registration Statement)
4.1* Form of Specimen Stock Certificate
4.2* Second Amended and Restated Investor Rights Agreement dated July 31, 1998
</TABLE>
II-2
<PAGE>
<TABLE>
<C> <S>
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation,
regarding legality of the securities being issued
10.1* Form of Indemnification Agreement, entered into between the Registrant
and each of its directors and officers, to become effective upon the
closing of the offering made under this Registration Statement
10.2* 1996 Equity Incentive Plan
10.3* 1999 Employee Stock Purchase Plan
10.4* Licensing Agreement with SESAC dated May 21, 1998
10.5+* Software Cross License Agreement with Adaptec, Inc. dated June 12,
1998
10.6* Form of Liquid Music Network Agreement
10.7+* Letter Agreement with Compaq Computer Corporation dated March 23, 1998
10.8+* LA Agreement with Real Networks, Inc. dated April 26, 1998
10.9+* Binary Software License Agreement with Precept Software, Inc. dated
September 30, 1997
10.10+* Patent License Agreement with Fraunhofer-Gesellschaft, zur Forderung
der angewandten Forschung e.V. dated August 14, 1998
10.11+* Software License Agreement with Fraunhofer-Gesellschaft, zur Forderung
der angewandten Forschung e.V. dated August 14, 1998
10.12+* OEM Master License Agreement with RSA Data Security, Inc. dated July
18, 1997
10.13+* Agreement in Principle with N2K, Inc. dated February 12, 1997
10.14+* Patent License Agreement with Dolby Laboratories Licensing
Corporation, dated May 3, 1996
10.15+* Adjustment to Patent and License Agreement with Dolby Laboratories
Licensing Corporation, dated September 18, 1997
10.16+* Source Code, Trademark and Know-How License Agreement with Dolby
Laboratories Licensing Corporation dated May 3, 1996
10.17* Founders Restricted Stock Purchase Agreement (with amendments) with
Gerald W. Kearby dated April 25, 1996
10.18* Founders Restricted Stock Purchase Agreement (with amendments) with
Philip R. Wiser dated April 25, 1996
10.19* Founders Restricted Stock Purchase Agreement (with amendments) with
Robert G. Flynn dated April 25, 1996
10.20* Master Equipment Lease No. 0044 (with amendments) with Phoenix Leasing
Incorporated dated as of October 15, 1996
10.21* Summary Plan Description of 401(k) Plan
10.22* Loan and Security Agreement with Silicon Valley Bank dated April 16,
1998
10.23* Loan and Security Agreement with Silicon Valley Bank dated November
16, 1998
10.24* Lease Agreement with Master Lease, a Division of Tokai Financial
Services, Inc., dated March 3, 1998
10.25* Lease Agreement with John Anagnostou Realty and Michael J. Monte,
dated February 16, 1999, for property located at 2221 Broadway,
Redwood City, California
10.26* Lease and Service Agreement with Alliance Business Centers, dated
August 17, 1998, and Office Rider dated February 1, 1999, for
property located at 599 Lexington Avenue, New York, New York
10.27* Lease Agreement with New Retail Concepts Ltd., dated September 1,
1998, for property located at 21 Bridge Square, Westport, Connecticut
</TABLE>
II-3
<PAGE>
<TABLE>
<C> <S>
10.28* Commercial Lease with Jim and Jeannette Beeger, dated November 3,
1998, for property located at 820 Winslow Street, Redwood City,
California
10.29* Commercial Lease with John Anagnostou Realty, dated October 9, 1997,
for property located at 810 Winslow Street, Redwood City, California
10.30+* Software Reseller Agreement with Liquid Audio Japan, dated as of
August 9, 1998
10.31+* Shareholder Agreement with Super Stage, Inc., Liquid Audio Japan,
Inc., ITOCHU Corporation, and Hikari Tsushin, Inc., dated March 31,
1999
10.32* Loan Agreement with Super Factory, Inc., dated March 31, 1999
10.33+* Share Sale and Purchase and Option Agreement with Super Stage, Inc.,
dated March 31, 1999
10.34+ Shareholders Agreement with SKM Limited and Liquid Audio Korea Co.
Ltd. dated December 31, 1998
10.35+* Software Reseller and Services Agreement with Liquid Audio Korea Co.
Ltd. dated December 31, 1998
10.36+* Consulting Agreement with Liquid Audio Korea Co. Ltd. dated December
31, 1998
10.37+* Consulting Agreement with SKM Limited dated December 31, 1998
10.38* Guaranty issued to Liquid Audio, Inc. by SKM Limited dated December
31, 1998
10.39* Software License Agreement with Intel Corporation dated May 4, 1999
10.40* Liquid Remote Inventory Fulfillment System(TM) Merchant Affiliate and
License Agreement with MTS, Inc. dated May 14, 1999
10.41+* OEM Agreement with Sanyo Electric Co., Ltd. dated June 2, 1999
10.42* Amazon.com/Liquid Audio Advertising Agreement, including exhibits,
dated as of June 9, 1999
10.43+ Online Program Agreement with Muze Inc., dated as of February 9, 1999
10.44* Letter Agreement By and Between Texas Instruments Incorporated, dated
as of January 29, 1999
10.45+* OEM Agreement with Toshiba Corporation, dated June 9, 1999
10.46 Agreement with Iomega Corporation, dated November 14, 1999
10.47* Stock Option Agreement with Gary J. Iwatani, dated November 10, 1997
10.48* Letter Agreement with Virgin Holdings, Inc., an affiliate of EMI
Recorded Music, dated June 16, 1999
23.1 Consent of PricewaterhouseCoopers LLP
23.2* Consent of Wilson Sonsini Goodrich & Rosati, Professional Corporation
(contained in Exhibit 5.1)
24.1* Power of Attorney (contained in the signature page to this
Registration Statement)
27.1* Financial Data Schedule
</TABLE>
- --------
* previously filed
+ confidential treatment requested
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise,
II-4
<PAGE>
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer, or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment to registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Palo Alto,
State of California on July 8, 1999.
/s/ Gerald W. Kearby*
By:__________________________________
Gerald W. Kearby
Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT TO
THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATE INDICATED:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Gerald W. Kearby* President, Chief Executive July 8, 1999
____________________________________ Officer and Director
Gerald W. Kearby (Principal Executive
Officer)
/s/ Gary J. Iwatani Senior Vice President and July 8, 1999
____________________________________ Chief Financial Officer
Gary J. Iwatani (Principal Financial and
Accounting Officer)
/s/ Philip R. Wiser * Senior Vice President of July 8, 1999
____________________________________ Engineering, Chief
Philip R. Wiser Technical Officer and
Director
/s/ Ann Winbald * Director July 8, 1999
____________________________________
Ann Winblad
/s/ Silvia Kessel * Director July 8, 1999
____________________________________
Silvia Kessel
/s/ Sanford R. Climan * Director July 8, 1999
____________________________________
Sanford R. Climan
/s/ Eric Robison * Director July 8, 1999
____________________________________
Eric P. Robison
</TABLE>
/s/ Gary J. Iwatani
*By:___________________________
Gary J. Iwatani
Attorney-in-fact
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Title
------- -----
<C> <S>
1.1* Form of Underwriting Agreement
3.1* Certificate of Incorporation as currently in effect
3.2* Form of Restated Certificate of Incorporation (to be filed with the
Delaware Secretary of State prior to the closing of the offering
covered by this Registration Statement)
3.3* Bylaws as currently in effect
3.4* Form of Bylaws (to be adopted upon the completion of the offering
covered by this Registration Statement)
4.1* Form of Specimen Stock Certificate
4.2* Second Amended and Restated Investor Rights Agreement dated July 31,
1998
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation,
regarding legality of the securities being issued
10.1* Form of Indemnification Agreement, entered into between the Registrant
and each of its directors and officers, to become effective upon the
closing of the offering made under this Registration Statement
10.2* 1996 Equity Incentive Plan
10.3* 1999 Employee Stock Purchase Plan
10.4* Licensing Agreement with SESAC dated May 21, 1998
10.5+* Software Cross License Agreement with Adaptec, Inc. dated June 12,
1998
10.6* Form of Liquid Music Network Agreement
10.7+* Letter Agreement with Compaq Computer Corporation dated March 23, 1998
10.8+* LA Agreement with Real Networks, Inc. dated April 26, 1998
10.9+* Binary Software License Agreement with Precept Software, Inc. dated
September 30, 1997
10.10+* Patent License Agreement with Fraunhofer-Gesellschaft, zur Forderung
der angewandten Forschung e.V. dated August 14, 1998
10.11+* Software License Agreement with Fraunhofer-Gesellschaft, zur Forderung
der angewandten Forschung e.V. dated August 14, 1998
10.12+* OEM Master License Agreement with RSA Data Security, Inc. dated July
18, 1997
10.13+* Agreement in Principle with N2K, Inc. dated February 12, 1997
10.14+* Patent License Agreement with Dolby Laboratories Licensing
Corporation, dated May 3, 1996
10.15+* Adjustment to Patent and License Agreement with Dolby Laboratories
Licensing Corporation, dated September 18, 1997
10.16+* Source Code, Trademark and Know-How License Agreement with Dolby
Laboratories Licensing Corporation dated May 3, 1996
10.17* Founders Restricted Stock Purchase Agreement (with amendments) with
Gerald W. Kearby dated April 25, 1996
10.18* Founders Restricted Stock Purchase Agreement (with amendments) with
Philip R. Wiser dated April 25, 1996
10.19* Founders Restricted Stock Purchase Agreement (with amendments) with
Robert G. Flynn dated April 25, 1996
10.20* Master Equipment Lease No. 0044 (with amendments) with Phoenix Leasing
Incorporated dated as of October 15, 1996
10.21* Summary Plan Description of 401(k) Plan
10.22* Loan and Security Agreement with Silicon Valley Bank dated April 16,
1998
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Title
------- -----
<C> <S>
10.23* Loan and Security Agreement with Silicon Valley Bank dated November
16, 1998
10.24* Lease Agreement with Master Lease, a Division of Tokai Financial
Services, Inc., dated March 3, 1998
10.25* Lease Agreement with John Anagnostou Realty and Michael J. Monte,
dated February 16, 1999, for property located at 2221 Broadway,
Redwood City, California
10.26* Lease and Service Agreement with Alliance Business Centers, dated
August 17, 1998, and Office Rider dated February 1, 1999, for
property located at 599 Lexington Avenue, New York, New York
10.27* Lease Agreement with New Retail Concepts Ltd., dated September 1,
1998, for property located at 21 Bridge Square, Westport, Connecticut
10.28* Commercial Lease with Jim and Jeannette Beeger, dated November 3,
1998, for property located at 820 Winslow Street, Redwood City,
California
10.29* Commercial Lease with John Anagnostou Realty, dated October 9, 1997,
for property located at 810 Winslow Street, Redwood City, California
10.30+* Software Reseller Agreement with Liquid Audio Japan, dated as of
August 9, 1998
10.31+* Shareholder Agreement with Super Stage, Inc., Liquid Audio Japan,
Inc., ITOCHU Corporation, and Hikari Tsushin, Inc., dated March 31,
1999
10.32* Loan Agreement with Super Factory, Inc., dated March 31, 1999
10.33+* Share Sale and Purchase and Option Agreement with Super Stage, Inc.,
dated March 31, 1999
10.34+ Shareholders Agreement with SKM Limited and Liquid Audio Korea Co.
Ltd. dated December 31, 1998
10.35+* Software Reseller and Services Agreement with Liquid Audio Korea Co.
Ltd. dated December 31, 1998
10.36+* Consulting Agreement with Liquid Audio Korea Co. Ltd. dated December
31, 1998
10.37+* Consulting Agreement with SKM Limited dated December 31, 1998
10.38* Guaranty issued to Liquid Audio, Inc. by SKM Limited dated December
31, 1998
10.39* Software License Agreement with Intel Corporation dated May 4, 1999
10.40* Liquid Remote Inventory Fulfillment System(TM) Merchant Affiliate and
License Agreement with MTS, Inc. dated May 14, 1999
10.41+* OEM Agreement with Sanyo Electric Co., Ltd. dated June 2, 1999
10.42* Amazon.com/Liquid Audio Advertising Agreement, including exhibits,
dated as of June 9, 1999
10.43+ Online Program Agreement with Muze Inc., dated as of February 9, 1999
10.44* Letter Agreement By and Between Texas Instruments Incorporated, dated
as of January 29, 1999
10.45+* OEM Agreement with Toshiba Corporation, dated June 9, 1999
10.46 Agreement with Iomega Corporation, dated November 14, 1999
10.47* Stock Option Agreement with Gary J. Iwatani, dated November 10, 1997
10.48* Letter Agreement with Virgin Holdings, Inc., an affiliate of EMI
Recorded Music, dated June 16, 1999
23.1 Consent of PricewaterhouseCoopers LLP
23.2* Consent of Wilson Sonsini Goodrich & Rosati, Professional Corporation
(contained in Exhibit 5.1)
24.1* Power of Attorney (contained in the signature page to this
Registration Statement)
27.1* Financial Data Schedule
</TABLE>
- --------
* previously filed
+ confidential treatment requested
<PAGE>
EXHIBIT 10.34
SHAREHOLDERS AGREEMENT
This Shareholders Agreement ("Agreement") is entered into as of December 31,
1998 by Liquid Audio, Inc., a California corporation with its principal place of
business at 810 Winslow Street, Redwood City, California 94063, U.S.A. ("Liquid
Audio"), SKM Limited, a joint-stock company (chusik-hoesa) organized and
existing under the laws of the Republic of Korea ("Korea") with its principal
place of business at HaeSung 1 Building, 5f, 942 Daechi 3-Dong, Kangnam-Gu,
Seoul 135-283, Korea ("SKM"), and Liquid Audio Korea Co. Ltd., a joint-stock
company (chusik-hoesa) organized and existing under the laws of Korea with its
principal place of business at 3f, WonKyung Bldg. 788-16, Yoksam-Dong, Kangnam-
Gu, Seoul, 135-080, Korea ("LAK"). The Parties agree as follows:
1. DEFINITIONS
-----------
For the purpose of this Agreement, the following definitions shall apply:
1.1 "Affiliate" means a Person that directly, or indirectly through one or
more intermediaries, controls, or is controlled by, or is in common control
with, the Person specified. "Control," as used herein, for purposes of defining
an "Affiliate," shall mean the ability to direct the management of a Person,
whether by voting of shares, election of directors, by terms of a contract or
otherwise.
1.2 "Articles" means the Articles of Incorporation of LAK in the form
attached in the English language as Exhibit A, and as hereafter amended. The
Parties agree that among the Parties, the English language version of the
Articles shall be controlling and that if any discrepancies should exist between
the two versions, then the Parties shall take such steps to ensure that the
Korean version of the Articles shall be amended to be in accord with the English
version.
1.3 "Board" means the board of directors of LAK.
1.4 "Change in Control" with respect to a Party means (i) a merger of that
Party with or into another Person, or a sale of all or substantially all of a
Party's assets to another Person, if as a result of the merger or asset sale the
holders of a majority of the Party's voting securities before the transaction
hold less than a majority of the voting securities of the surviving entity (or
its parent), or (ii) the acquisition by a Person or a group acting in concert of
a majority of a Party's voting securities.
1.5 "Code" means the Commercial Code of the Republic of Korea, as amended.
1.6 "Consulting Agreement" means the Consulting Agreement to be entered
into by LAK and Liquid Audio substantially in the form attached hereto as
Exhibit B.
1.7 "Guaranty" means the form of Guaranty to be executed by SKM
substantially in the form attached hereto as Exhibit C.
<PAGE>
1.8 "Holder" means Liquid Audio or SKM or their permitted successors and
assigns, as applicable. "Holders" means Liquid Audio and SKM and their permitted
successors and assigns.
1.9 "Party" means Liquid Audio, SKM or LAK, as applicable. "Parties"
means Liquid Audio, SKM and LAK.
1.10 "Person" means a natural individual, partnership, firm, company,
corporation, and any other form of business association.
1.11 "Pro Rata Share" of a Holder means the percentage interest that the
Holder holds in LAK by virtue of those Shares owned by that Holder, after
assuming conversion or exercise of any warrant, stock option and other equity
securities of LAK.
1.12 "Reseller Agreement" means the Reseller Agreement to be entered into
by Liquid Audio and LAK substantially in the form attached hereto as Exhibit D.
1.13 "Shares" means shares of Common Stock of LAK with a par value of [*]
Won per share.
1.14 "Won" means the Republic of Korea Won.
2. SUBSCRIPTION FOR SHARES
-----------------------
2.1 Company Name. The name of LAK shall be "Liquid Audio Korea Co., Ltd."
------------
in English and "Liquid Audio Korea Chusik Hoesa" in Korean.
2.2 Head Office. The head office of LAK shall be located in Seoul, Korea.
-----------
2.3 Articles of Incorporation. Prior to Liquid Audio's subscription for
-------------------------
Shares as set forth in Section 2.5, SKM shall procure that the current Articles
are amended so that they are substantially the same as Exhibit A. If any
discrepancy is found between this Agreement and the Articles, the terms of this
Agreement shall prevail and the Parties shall amend the Articles so as to be in
accord with this Agreement.
2.4 Authorized Capital. Prior to Liquid Audio's subscription for Shares as
------------------
set forth in Section 2.5, the authorized capital of LAK shall be increased to
[*] Won consisting of one single class of [*] shares of common stock with a par
value of [*] Won each.
2.5 Share Subscription. On the fifth Korean banking day ("Closing Date")
------------------
after Liquid Audio's receipt of confirmation of its foreign investment report
from a foreign exchange bank, designated by Liquid Audio, pursuant to the
Foreign Investment Promotion Act, the Holders shall have subscribed for a total
of [*] Shares in LAK as follows and the paid-in capital of the Company after
such subscription shall be [*] Won:
* Certain information in this Exhibit has been omitted and filed separately
with the Commission. Confidential treatment has been requested with respect
to the omitted portions.
-2-
<PAGE>
(a) SKM and LAK represent and warrant that SKM is currently the sole
shareholder in LAK with [*] Shares, at the aggregate value of [*] Won.
(b) SKM shall subscribe in cash for [*] Shares, the aggregate issue
price of which shall be [*] Won.
(c) Liquid Audio shall subscribe in cash for [*] Shares, the aggregate
issue price of which shall be [*] Won.
2.6 Additional Investment/Loans. SKM shall be responsible for securing any
----------------------------
financing required by LAK beyond that provided for in Section 2.5 hereof. Such
additional financing may be in the form of a third party or shareholder loan,
bearing interest at commercially reasonable rates, or in the form of a capital
investment which shall be in the form of a non-voting, non-participating
preferred stock with a dividend rate equal to the then prevailing rate for
comparable transactions. Notwithstanding the preceding sentence, any such
financing shall require the approval described in Section 3.3(e) hereof.
2.7 Preemptive Rights. Except for the Shares subscribed under Section 2.5,
-----------------
and subject to the pertinent Korean laws, this Agreement and the Articles, each
Holder shall have pre-emptive rights with respect to any new issuance of shares
by LAK in the same ratio as their respective shareholding ratios immediately
prior to such issuance. If any Holder is not permitted by law from exercising
its pre-emptive right to subscribe to new issues of shares, then Holder shall
have the right to transfer its pre-emptive right to a third legally qualified
purchaser who will be able to acquire such Holder's proportion of the new shares
issued by the Company. If any Holder does not wish to exercise its pre-emptive
rights in whole or in part, such Holder shall notify the Board of such intention
within seven (7) days from the day as of which the allocation of the new shares
is to be made. In this case, such Holder shall transfer to the other Holder its
pre-emptive right to such new shares.
2.8 Additional Agreements. Contemporaneously with the execution hereof,
---------------------
SKM and Liquid Audio shall execute and deliver the Guaranty, and LAK and Liquid
Audio shall execute and deliver the Reseller Agreement and Consulting Agreement.
2.9 Covenants. LAK and SKM covenant that from the date of this Agreement
---------
until the Closing Date, (i) LAK shall remain as a dormant company and (ii) no
shares or any other type of securities of LAK shall be issued (other than that
provided under Section 2.5) nor any option or pre-emptive rights be granted to
any party over any shares of LAK.
3. MANAGEMENT OF LAK
-----------------
3.1 Board of Directors.
------------------
(a) Director Positions. The Board shall have [*] authorized
------------------
members. SKM shall have the right to nominate [*] members to the Board, and
Liquid Audio shall have the right to nominate [*] members to the Board. Each
Holder shall have the right to request removal, whether with or without cause,
of any director which such Holder is solely entitled to nominate, at
* Certain information in this Exhibit has been omitted and filed separately
with the Commission. Confidential treatment has been requested with respect
to the omitted portions.
-3-
<PAGE>
any time effective upon notice to LAK, the director to be removed and to the
other Holder, provided, however, that if such dismissal is without cause, the
Holder proposing the dismissal shall indemnify and hold harmless LAK and the
other Holder from any and all damages and other expenses that may arise from
such action. Each Holder shall vote all of its Shares so as to elect the other
Holder's nominees, remove directors for whom removal has been requested, and
maintain the Board constituency described in this Section 3.1. Any vacancy on
the Board shall be filled pursuant to the nomination procedure described in this
Section 3.1.
(b) Compensation and Expenses. LAK shall reimburse reasonable travel
-------------------------
costs of any director attending a Board meeting. No director of LAK shall be
entitled to any additional compensation, unless such director is also serving in
a management capacity with LAK.
3.2 Quorum of the Board; Approval by Board. A quorum of the Board shall be
--------------------------------------
deemed present at any duly noticed Board meeting if a majority of the directors
are present, including at least one (1) director nominated by Liquid Audio and
one (1) director nominated by SKM. A director may be present at a Board meeting
physically or, to the extent subsequently permitted by applicable Korean law, by
telephone or video conference. Any action or determination by the Board shall
require the affirmative vote of a majority of the Board members present at the
meeting. The meetings of the Board shall be held at least quarterly at times and
places to be determined by the Board.
3.3 Liquid Audio's Approval. So long as Liquid Audio is a shareholder of
-----------------------
LAK, the following actions shall not be taken by LAK without prior approval of
Liquid Audio. Such approval of Liquid Audio shall be considered given upon (a) a
special Board resolution approved by three (3) members of the Board of
Directors, or (b) a special shareholder resolution approved by [*] of the
outstanding shares of LAK.
(a) Making any basic change in the general nature or scope of business
of LAK;
(b) Amending the Articles of LAK, including, without limitation, any
increase or decrease in the number of authorized shares of LAK, any change in
the rights, preferences or privileges of the Shares and any increase or decrease
in the authorized number of directors on the Board;
(c) Removing the directors nominated by Liquid Audio;
(d) Dissolving or liquidating LAK;
(e) Issuing any security of LAK, whether shares securities convertible
into shares, other equity securities or debt securities (except that LAK may
issue shares under Section 2.5 without further approval by Liquid Audio);
(f) Merging or consolidating LAK with another Person, or selling,
leasing, pledging, mortgaging, encumbering or otherwise disposing of all or
substantially all of the assets of LAK, whether in one transaction or a series
of transactions;
* Certain information in this Exhibit has been omitted and filed separately
with the Commission. Confidential treatment has been requested with respect
to the omitted portions.
-4-
<PAGE>
(g) Establishing a business relationship with any direct competitor of
Liquid Audio;
(h) Investing in any other Person;
(i) Entering into any agreement or transaction (except this Agreement,
the Reseller Agreement and Consulting Agreement) with or for the benefit of any
director or shareholder of LAK or an Affiliate (or any direct lineal descendent
or ancestor, sibling, spouse, mother-in-law, father-in-law, son-in-law or
daughter-in-law) of such director or shareholder;
(j) Amending the business plan of LAK;
(k) Appointment, employment and compensation decisions and scope of
responsibility for officers of LAK, including salary and wages, cash advances
and relocation expenses;
(l) Capital expenditures for single items of 100,000,000 Won or more;
(m) Entering into contracts that have a term in excess of one year or
that require aggregate payments of 100,000,000 Won or more;
(n) Disposition or transfer to a third party of at least 20% of LAK's
assets;
(o) Authorizing loans by LAK, except for payment terms for trade
credits in the ordinary course of business;
(p) Assuming or incurring any debt, loan, guaranty or liability with
an aggregate value of 500,000,000 Won or more;
(q) Change in the outside accountant to LAK;
(r) Creating any lien on LAK's property, except liens incurred in the
ordinary course of business;
(s) Approving LAK's annual budget;
(t) Changing the strategic direction of LAK and approving LAK's long-
range plans;
(u) Approval of annual financial statements;
(v) Opening or closing an account with a bank or financial house in
Korea or overseas; and
(w) Paying any dividend or making any other distribution;
-5-
<PAGE>
(x) Approving or amending the internal regulations of LAK relating to
important procedures including, but not limited to, employee regulations,
regulations relating to the issuance or transfer of shares and the issuance or
loss of share certificates, Board regulations and regulations governing meetings
of shareholders.
3.4 Board and Shareholder Meetings. All Board and shareholder meetings
------------------------------
shall be conducted in the English language. The minutes of any such meeting will
be prepared in both the Korean and English languages, and compared for accuracy
by the interpreter. In the event of a conflict in terms, the minutes prepared in
the English language shall control.
3.5 Senior Officers.
---------------
(a) President and Chief Executive Officer of LAK. The Board shall
--------------------------------------------
elect as the President and Chief Executive Officer of LAK the candidate selected
by SKM. The President shall also be the sole representative director.
(b) Chief Financial Officer of LAK. The Board shall elect as the Chief
-------------------------------
Financial Officer of LAK the candidate selected by Liquid Audio. The Chief
Financial Officer shall be responsible for oversight of the finance and
accounting functions of LAK.
(c) Other Officers; Management Structure. The other officers of LAK
------------------------------------
shall be selected by the Board.
3.6 Statutory Auditors. Except as required by applicable law, LAK shall
------------------
have two (2) statutory auditors. Liquid Audio shall nominate one (1) statutory
auditor, and SKM shall nominate one (1) statutory auditor.
3.7 Financial Statements. LAK's financial year shall be January 1 through
--------------------
December 31 of the following year. LAK's auditors shall be an independent
accounting firm acceptable to SKM and Liquid Audio, who shall be responsible for
preparing the annual financial statements of LAK in accordance with Korean
generally accepted accounting principles consistently applied, and corresponding
annual financial statements in the English language in compliance with U.S.
generally accepted accounting principles. LAK shall deliver, and SKM shall cause
LAK to deliver, to all Holders (i) such annual audited financial statements
within three (3) months after the end of each financial year and (ii) promptly
after delivery to any other Holder, other financial and operating reports of LAK
prepared for one or more Holders.
3.8 Right of Inspection. During reasonable office hours of LAK, the
-------------------
Holders shall have full access to all properties, books of account, records and
the like of LAK with the right to make copies at the offices of LAK. Any
information obtained by the Holders through exercising this right shall (i) be
used by such Holder only for purposes which are consistent with its status as an
equity holder in LAK and not for the pursuit of business interests outside LAK
(except to the extent such Holder shall otherwise have rights for access to such
information or to the extent used to determine compliance with this Agreement)
and (ii) be subject to the confidentiality provisions of Section 8.1.
-6-
<PAGE>
3.9 Employee Matters. Each employee of LAK, and any employee of another
----------------
entity working for LAK but not a regular employee of LAK, shall sign an
agreement reasonably acceptable to SKM and Liquid Audio providing for
confidentiality of information disclosed by LAK and for ownership by LAK of
inventions or original works of authorship created by such individuals.
3.10 Business Plan. The five-year business plan for LAK has been agreed
-------------
between the Holders and attached as Exhibit E (the "Business Plan"). The Board
-------------
shall discuss and update the Business Plan at least once a year.
4. REPRESENTATIONS
---------------
4.1 Liquid Audio. Liquid Audio represents and warrants as follows to the
------------
other Holders as of the date of this Agreement:
(a) Organization and Good Standing of Liquid Audio. Liquid Audio is a
----------------------------------------------
corporation duly organized, validly existing and in good standing under the laws
of the State of California and has the corporate power and authority to enter
into this Agreement and to perform its obligations hereunder.
(b) Authorization. All corporate action on the part of Liquid Audio
-------------
and Liquid Audio's officers and directors necessary for the authorization,
execution, delivery and performance of this Agreement has been taken. This
Agreement constitutes a valid, legally binding and enforceable obligation of
Liquid Audio, assuming due authorization and delivery hereof by SKM and LAK.
(c) Government and Other Consents. Except for approvals contemplated
-----------------------------
by this Agreement, no consent, authorization, license, permit, registration or
approval of any governmental or public body or authority is required in
connection with Liquid Audio's execution and delivery of this Agreement or with
the performance by Liquid Audio of its obligations hereunder.
(d) Effect of Agreement. Liquid Audio's execution and delivery of this
-------------------
Agreement, performance of its obligations hereunder and its consummation of the
transactions contemplated hereby will not, (i) to its knowledge, violate any
provision of any law, statute, rule or regulation to which it is subject; (ii)
violate any judgment, order, writ, injunction or decree of any court applicable
to it; (iii) to its knowledge, have any effect on its compliance with any laws,
statutes, rules, regulations, orders, decrees, licenses, permits or
authorizations which would materially and adversely affect it; (iv) to its
knowledge, result in the breach of, or be in conflict with, any term, covenant,
condition or provision of, or affect the validity, enforceability and
subsistence of any agreement, lease or other commitment to which it is a party
and which would materially and adversely affect it; or (v) to its knowledge,
result in the creation or imposition of any lien, pledge, mortgage, claim,
charge, or encumbrance upon any of its assets.
(e) Disclosure. No representation or warranty by Liquid Audio
----------
contained in this Agreement and no writing, certificate, exhibit, list or other
instrument required to be furnished pursuant hereto contains or will contain any
untrue statement of a material fact or omits or will omit
-7-
<PAGE>
any material fact necessary in order to make the statements and information
contained therein not misleading.
4.2 SKM. SKM represents and warrants to the other Holders as follows as of
---
the date of this Agreement.
(a) Organization and Good Standing of SKM. SKM is a corporation duly
-------------------------------------
organized, validly existing and in good standing under the laws of the Republic
of Korea and has the corporate power and authority to enter into this Agreement
and to perform its obligations hereunder.
(b) Authorization. All corporate action on the part of SKM and its
-------------
officers and directors necessary for the authorization, execution, delivery an
performance of this Agreement has been taken. This Agreement constitutes a
valid, legally binding and enforceable obligation of SKM, assuming due
authorization, execution and delivery hereof by Liquid Audio and LAK.
(c) Government and Other Consents. Except for approvals contemplated
-----------------------------
by this Agreement no consent, authorization, license, permit, registration or
approval of governmental or public body or authority is required in connection
with execution and delivery of this Agreement by SKM or with the performance by
SKM of any of its respective obligations hereunder.
(d) Effect of Agreement. SKM's execution and delivery of this
-------------------
Agreement, performance of its obligations hereunder and its consummation of the
transactions contemplated hereby will not, (i) to its knowledge, violate any
provision of any law, statute, rule or regulation to which it is subject; (ii)
violate any judgment, order, writ, injunction or decree of any court applicable
to it; (iii) to its knowledge, have any effect on its compliance with any laws,
statutes, rules, regulations, orders, decrees, licenses, permits or
authorizations which would materially and adversely affect it; (iv) to its
knowledge, result in the breach of, or be in conflict with, any term, covenant,
condition or provision of, or affect the validity, enforceability and
subsistence of any agreement, lease or other commitment to which it is a party
and which would materially and adversely affect it; or (v) to its knowledge,
result in the creation or imposition of any lien, pledge, mortgage, claim,
charge, or encumbrance upon any of its assets.
(e) Brokers, Finders. SKM has not retained any person to act on its
----------------
behalf, nor has any person contended that such person was so retained, to assist
as its broker, finder or agent in connection with this transaction.
(f) Disclosure. No representation or warranty by SKM contained in this
----------
Agreement and no writing, certificate, exhibit, list or other instrument
required to be furnished pursuant hereto contains or will contain any untrue
statement of a material fact or omits or will omit any material fact necessary
in order to make the statements and information contained therein not
misleading.
4.3 LAK. LAK and SKM each represent and warrant to Liquid Audio as follows
---
as of the date of this Agreement:
-8-
<PAGE>
(a) Organization and Good Standing of LAK. LAK is a corporation duly
-------------------------------------
organized, validly existing and in good standing under the laws of the Republic
of Korea and has the corporate power and authority to enter into this Agreement
and to perform its obligations hereunder.
(b) Authorization. All corporate action on the part of LAK and its
-------------
officers and directors necessary for the authorization, execution, delivery and
performance of this Agreement has been taken. This Agreement constitutes a
valid, legally binding and enforceable obligation of LAK, assuming due
authorization, execution and delivery hereof by the Holders.
(c) Government and Other Consents. Except for approvals contemplated
-----------------------------
by this Agreement, no consent, authorization, license, permit, registration or
approval of governmental or public body or authority is required in connection
with execution and delivery of this Agreement by LAK or with the performance by
LAK of any of its respective obligations hereunder.
(d) Effect of Agreement. LAK's execution and delivery of this
-------------------
Agreement, performance of its obligations hereunder and its consummation of the
transactions contemplated hereby will not, (i) to its knowledge, violate any
provision of any law, statute, rule or regulation to which it is subject; (ii)
violate any judgment, order, writ, injunction or decree of any court applicable
to it; (iii) to its knowledge, have any effect on its compliance with any laws,
statutes, rules, regulations, orders, decrees, licenses, permits or
authorizations which would materially and adversely affect it; (iv) to its
knowledge, result in the breach of, or be in conflict with, any term, covenant,
condition or provision of, or affect the validity, enforceability and
subsistence of any agreement, lease or other commitment to which it is a party
and which would materially and adversely affect it; or (v) to its knowledge,
result in the creation or imposition of any lien, pledge, mortgage, claim,
charge, or encumbrance upon any of its assets.
(e) Brokers, Finders. LAK has not retained any person to act on its
----------------
behalf, nor has any person contended that such person was so retained, to assist
as its broker, finder or agent in connection with this transaction.
(f) Shares. As of the date of this Agreement and immediately prior to
------
the share subscription set forth in Section 2.5, LAK will have authorized
capital of [*] Won divided into [*] Shares, of which [*] Shares have been duly
issued, fully paid and non-assessable, free of all liens, encumbrances and
restrictions other than those specifically set forth in this Agreement. As of
the Closing Date, the issuance of the Shares under Section 2.5 will have been
duly authorized by LAK and, when delivered and paid for pursuant to this
Agreement, will have been duly and validly issued, fully paid and non-
assessable. As of the date of this Agreement and through the date of share
subscription by Liquid Audio, there are no outstanding securities convertible
into or exchangeable for, or warrants, rights or options to purchase from LAK,
or obligations of LAK to issue (other than those set forth under Section 2.5),
any capital stock.
(g) No Operation of LAK or Outstanding Liabilities. Since its
----------------------------------------------
establishment, LAK has been a dormant company with no business activity, other
than those disclosed to Liquid Audio in writing. As of the date of this
Agreement and through the date of share subscription by Liquid Audio, except as
previously disclosed to Liquid Audio in writing, LAK has no debts or
* Certain information in this Exhibit has been omitted and filed separately
with the Commission. Confidential treatment has been requested with respect
to the omitted portions.
-9-
<PAGE>
liabilities of any kind (including without limitation contingent liabilities)
nor has LAK given any type of Guaranty (including without limitation payment
Guaranties) to any party nor has LAK created or permitted to be created any
charge, lien, pledge, mortgage, or any other encumbrance on its assets nor is
LAK involved in any litigation, arbitration or any quasi-judicial proceeding.
(h) Disclosure. No representation or warranty by LAK contained in this
----------
Agreement and no writing, certificate, exhibit, list or other instrument
required to be furnished pursuant hereto contains or will contain any untrue
statement of a material fact or omits or will omit any material fact necessary
in order to make the statements and information contained therein not
misleading.
5. TERM AND TERMINATION.
--------------------
5.1 Term and Termination. This Agreement shall continue in full force and
--------------------
effect unless and until terminated as provided herein.
(a) Grounds for Termination. This Agreement shall be terminated:
-----------------------
(i) by mutual written agreement of the Parties;
(ii) by a Holder in accordance with this Section 5;
(iii) by Liquid Audio, at its election, effected immediately by
written notice to SKM, upon (A) the permitted termination of the Reseller
Agreement or the Consulting Agreement by Liquid Audio, (B) SKM's failure to pay,
when due, the [*] payable to Liquid Audio pursuant to that certain Consulting
Agreement dated September 30, 1998 between SKM and Liquid Audio, or (C) breach
by SKM of its obligations under the Guaranty;
(iv) by Liquid Audio in the event that any Affiliate of SKM
shall engage in conduct which would, if done by SKM itself, constitute a breach
of Section 7(a) hereof;
(v) at such time as only one Holder remains subject to this
Agreement; or
(vi) otherwise by lawful exercise by a Holder of its rights
under applicable laws.
(vii) by any Party if performance by another party has been
excused pursuant to Section 8.3 by a force majeure condition which has continued
for at least ninety (90) days.
5.2 Termination Upon Bankruptcy or Insolvency of a Holder.
-----------------------------------------------------
(a) Notice of Bankruptcy Event. If any of the following events occurs
--------------------------
with respect to a Holder, such Holder shall immediately notify the other Holders
and LAK of the occurrence of such event:
* Certain information in this Exhibit has been omitted and filed separately
with the Commission. Confidential treatment has been requested with respect
to the omitted portions.
-10-
<PAGE>
(i) Such Holder becomes insolvent or unable to pay any or all of its
debts as they mature or ceases to pay any or all of its debts as they mature in
the ordinary course of business.
(ii) Any application or petition is submitted, by or for such Holder,
for commencement of proceedings of bankruptcy, reorganization, composition or
other similar proceedings under the applicable law.
(b) Right to Terminate. If the event is not cured within sixty (60)
------------------
days following the event, the non-affected Holder shall have the right to
terminate this Agreement by giving notice in writing to all other Holders and
LAK.
(c) Right to Purchase. After notice of termination described in
-----------------
Section 5.3, the Holders shall make a reasonable effort to consult in good faith
for sixty (60) days concerning the disposition of their respective interests in
LAK and the future operations of LAK. If the Holders do not sign a written
agreement regarding such matters during such sixty (60) days, then the Holder
which gave notice of termination shall have the option to purchase the Shares of
such bankrupt Holder pursuant to Section 5.6.
5.3 Termination Upon Bankruptcy or Insolvency of LAK.
------------------------------------------------
(a) Right to Terminate. If any of the following events occurs with
------------------
respect to LAK, any Holder shall have the right to terminate the Agreement by
giving notice in writing to all other Holders:
(i) LAK becomes insolvent or unable to pay any or all of its
debts as they mature or ceases to pay any or all of its debts as they mature in
the ordinary course of business.
(ii) Any application or petition is submitted, by or for LAK,
for commencement of proceedings of bankruptcy, reorganization, composition or
other similar proceedings under the applicable law.
(b) Right to Dissolve. After notice of termination, the Holders
-----------------
shall consult in good faith for sixty (60) days concerning the disposition of
their respective interests in LAK and the future operations of LAK. If the
Holders do not sign a written agreement regarding such matters within such sixty
(60) days and if any application or petition is not submitted for the
commencement of any proceedings described in Section 5.3(a)(ii), then each
Holder shall have the option to cause dissolution of LAK under the Code by
giving written notice of dissolution to the other Holders and LAK. Upon such
notice, each Holder and LAK shall take all actions (including voting of Shares
in favor for dissolution) required to dissolve and liquidate LAK in accordance
with applicable laws and regulations.
5.4 Termination Upon Material Breach.
--------------------------------
(a) Right to Terminate. If a Party commits a material breach of this
------------------
Agreement and such breach is not cured within sixty (60) days following notice
thereof to the breaching Party
-11-
<PAGE>
by any of the other Parties, the Party sending such notice shall have the right
to terminate this Agreement by giving notice thereof in writing to all other
Parties.
(b) Right to Purchase or Sell Shares. After notice of termination, the
--------------------------------
Holders shall consult in good faith for sixty (60) days concerning the
disposition of their respective interests in LAK and the future operations of
LAK. If the Holders do not resolve such matters in writing within such sixty
(60) days, the non-breaching Holder shall have the option to purchase the Shares
of such breaching Holder pursuant to Section 5.6 or to cause the breaching party
to purchase all of the Shares then held by the non-breaching Holder pursuant to
Section 5.6.
(c) Remedies Not Affected. The foregoing shall not limit the ability
---------------------
of any Party to seek such legal and equitable remedies (including damages)
related to a material breach by a Party or the failure of a Party to perform any
other duty or obligation.
5.5 Change in Control.
-----------------
(a) Right to Terminate. If SKM undergoes a Change in Control, Liquid
------------------
Audio shall have the right to terminate this Agreement by giving notice thereof
in writing to all other Holders.
(b) Right to Purchase/Sell. After notice of termination pursuant to
----------------------
Section 5.5(a), the Holders shall consult in good faith for sixty (60) days
concerning the disposition of their respective interests in LAK and the future
operations of LAK. If the Holders do not resolve such matters in writing within
such sixty (60) days, Liquid Audio shall have the option to purchase the Shares
of SKM or to have SKM purchase all of the Shares then held by Liquid Audio,
pursuant to Section 5.6.
5.6 Purchase Procedures.
-------------------
(a) The purchase price for the Shares to be sold pursuant to this
Section shall be the "Fair Market Value" of such Shares.
(b) Fair Market Value per share under this Section 5 shall be
determined as follows:
(i) If the Shares are publicly traded on the Korea Stock Exchange
or KOSDAQ, the Korean OTC market, the value shall be deemed to be the average of
the closing prices of the Shares on such exchange or market, as the case may be,
over the 30-day period ending three (3) business days prior to the closing of
the purchase of the Shares.
(ii) If there is no active public market for the Shares, the value
shall be the fair market value thereof immediately following any act giving rise
to the right to sell or purchase shares under this Section 5, such fair market
value as determined by a good faith negotiation between the Selling Holder or
Holders ("Seller") and the purchasing Holder or Holders ("Purchaser"). If such
negotiation fails to determine the fair market value within forty-five (45) days
after the date of the notice of termination, the fair market value shall be
determined as follows:
-12-
<PAGE>
(A) Seller (as a group if Seller is more than one Holder)
and Purchaser (as a group if Purchaser is more than one Holder) shall each
retain at its expense an investment bank expert in the industry. If Seller or
Purchaser does not select an investment bank within fifteen (15) days after the
end of the 45-day good faith negotiation period (the "Negotiation Period")
referred to in subsection (ii) above, such Holder or Holders shall not be
entitled to retain an investment bank and shall present whatever materials it
has available by the deadline regarding the valuation of LAK.
(B) Subject to execution of customary confidentiality
agreements by the investment banks, LAK shall provide or cause to be provided to
each investment bank all material information, including any material changes in
such information, reasonably necessary to value LAK or reasonably requested by
the investment banks.
(C) During the 15-day period after both Seller and Purchaser
have selected an investment bank, or the end of the Negotiation Period if Seller
and/or Purchaser does not select an investment bank, Seller, Purchaser and their
respective investment banks shall meet on at least two occasions to present
their respective views on valuation and shall negotiate in good faith to reach a
written agreement on the fair market value.
(D) If the fair market value has not been agreed to in
writing by the end of the Negotiation Period, Seller and Purchaser shall each
submit a final valuation proposal with a supporting analysis to the other Holder
or Holders and to the "Arbitrator" within ten (10) days after the end of the
Negotiation Period. The "Arbitrator" shall be a Person with expertise in valuing
high technology companies, shall not have a material business relationship with
any Party and shall be reasonably acceptable to both Seller and Purchaser,
provided however that in the event that the Parties are unable to agree upon the
Arbitrator within ten (10) days of the end of the Negotiation Period, then the
Arbitrator shall be determined within an additional ten (10) days by agreement
of the respective investment banks of the Parties, provided further that (x) if
no such investment bank has been selected by a Party, or if such Party's
investment bank does not recommend an Arbitrator, then the selection of the
other Party shall prevail, and (y) if the investment banks are unable to agree
on an Arbitrator, the valuation shall be determined in accordance with the
dispute resolution provisions of Section 8.2 hereof.
(E) If Seller or Purchaser does not submit in a timely
manner a final valuation proposal, then the valuation proposal of the other
Holder or Holders shall be used to establish the fair market value. If the final
proposals differ by less than 10%, then the average of the proposals shall be
the fair market value. If the final proposals differ by 10% or more, then the
Arbitrator shall choose one or the other proposal. The Arbitrator's
determination shall be final and binding on both Seller and Purchase; provided,
however, that the Arbitrator must select one of the final valuation proposals as
submitted.
(c) Each Holder purchasing Shares under this Section 5.6 shall pay in
cash or other immediately available funds the aggregate purchase price for the
Shares to be sold to such Holder upon receipt of the certificate or certificates
for the Shares to be sold to such Holder.
(d) When Holders have the right to purchase their pro rata share of
another Holder's Shares pursuant to this Section 5 and not all of those Holders
exercise their purchase right,
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<PAGE>
the Holders exercising their purchase right shall also have the right to
purchase the pro rata share of the Shares of the Holders not exercising their
purchase right (the "Remaining Shares"). If more than one Holder elects to
exercise its purchase right as to the Remaining Shares, each Holder who wishes
to purchase the Remaining Shares shall be entitled to purchase that portion of
the Remaining Shares as the total number of Shares then owned by such Holder
bears to the total number of Shares then owned by all Holders who wish to
purchase the Remaining Shares.
5.7 Continuation of Business. During any period in which a Holder has the
------------------------
right to purchase or is purchasing the Shares of any other Holder, or in which
Liquid Audio has the right to cause the other Holders to purchase its Shares,
pursuant to this Section 5, until the closing of the purchase of the Shares
thereunder:
(a) LAK shall continue its business in the ordinary course. All of the
Holders shall use their best efforts to maintain and preserve the business of
LAK pending the consummation of such purchase.
(b) The Holders shall negotiate in good faith an agreement providing
that employees of such selling Holder working full time for LAK shall be made
available full time to LAK for such period as is reasonably required for up to
six (6) months following the closing of such purchase of Shares to effect an
orderly transition to a new ownership by non-selling Holders, and each Holder
shall use its best efforts to make all such employees available on this basis.
6. PERMITTED TRANSFERS; RIGHT OF FIRST REFUSAL
-------------------------------------------
6.1 Restrictions. Each Holder agrees not to sell or transfer in any manner
------------
any of such Holder's Shares or any right or interest therein except as provided
below in this Section:
(a) No Holder may transfer or otherwise dispose of its Shares without
the prior approval of the Board, which shall not be withheld as long as the
requirements of this Section 6 have been satisfied.
(b) For a period of three (3) years after the effective date of the
incorporation of LAK, such Holder may transfer or otherwise dispose of its
Shares only if a Holder or Holders of a majority of Shares owned by all of other
Holders approve in advance in writing such transfer or disposition.
(c) After three (3) years from the effective date of the incorporation
of LAK,
(i) A Holder which wishes to transfer its Shares shall first give
written notice ("Notice") to all of the other Holders stating its bona fide
intention to transfer, the name of the proposed transferee, the number of
offered Shares and the price, terms and conditions of the proposed sale or
transfer.
(ii) Each other, non-offering Holder shall have the right to
purchase that portion of the Shares offered as the total number of Shares then
owned by such Holder bears to the total number of Shares then owned by all of
the non-offering Holders. Such right shall be
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<PAGE>
exercisable by written notice to the offering Holder not later than thirty (30)
days after delivery of the Notice. The price and terms for the non-offering
Holders shall be the price and terms stated in the Notice.
(iii) If all of the non-offering Holders do not exercise their
rights described in paragraph (ii) of Section 6.1(c), the offering Holder shall
so notify in writing ("Second Notice") each Holder which exercised its right
under paragraph (ii) of Section 6.1(c), and each such Holder shall have the
right to purchase all of the remaining Shares offered, which right shall be
exercisable by written notice to the offering Holder within ten (10) days after
delivery of the Second Notice. If more than one Holder elects to purchase such
remaining Shares, each Holder who wishes to purchase such remaining Shares shall
be entitled to purchase that portion of such remaining Shares as the total
number of Shares then owned by such Holder bears to the total number of Shares
then owned by all Holders who wish to purchase such remaining Shares.
(d) The Shares not purchased by the non-offering Holders pursuant to
Section 6.1(c) may, during ninety (90) days beginning on the expiration of the
last applicable right of the non-offering Holders, be transferred to the
transferee named in the Notice; provided that (i) such sale or transfer is not
at a lower price or on terms more favorable to the transferee than those
specified in the Notice; and (ii) prior to such transfer, such transferee agrees
in writing to become bound by the terms and conditions of this Agreement upon
transfer of such Shares.
(e) Notwithstanding any term or condition of this Section 6, each
Holder may transfer its Shares to an Affiliate of that Holder or in connection
with a merger or sale of all or substantially all of the assets of the Holder
provided that: (i) prior to such transfer, such Affiliate or transferee agrees
in writing to become bound by the terms and conditions of this Agreement upon
transfer of such Shares; (ii) the transferring Holder notifies all of the other
Holders not less than thirty (30) days prior to any such transfer; and (iii) any
such transfer shall not serve to excuse or terminate any of the obligations of
the transferring Holder under this Agreement.
(f) Each Holder which has the right to purchase the Shares under
Section 6.1(c) may designate and assign an Affiliate to exercise all or part of
such Holder's rights under Section 6.1(c).
(g) The restrictions and other provisions of this Section 6 shall
apply to any Shares acquired by a Holder during the term of this Agreement.
(h) Since damages arising from a breach of the obligations under this
Section 6.1 may be difficult to determine with precision, the Holders agree that
any Holder found to have breached the terms of Section 6.1 shall pay to the non-
breaching Holders as liquidated damages a sum equivalent to two times the gross
compensation received by the breaching Holder in the transaction whereby the
breach occurred, or two times the aggregate par value of the transferred shares,
whichever is higher. The Parties have understood that such liquidated damages
are fair and reasonable. Application of this liquidated damage provision shall
not prevent a Party from enforcing its rights or augmenting its protection by
such other remedies as may be available.
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<PAGE>
6.2 Legend. The instruments representing the Shares shall bear a legend
------
stating that such Shares are (i) subject to restrictions on transfer and other
provision of this Agreement and (ii) not transferable without the Board's
written approval. Each Holder agrees to cause LAK's Board not to consent to any
transfer or other disposition of any Shares made other than in accordance with
this Agreement.
7. NONCOMPETITION
--------------
(a) SKM agrees that as long as SKM is a shareholder of LAK, SKM will
not engage, either directly or indirectly, as a principal or for its own account
or solely or jointly with others, or as a stockholder in any corporation or
joint stock association (including rights to participate in present or future
profits pursuant to an option or other agreement), in any entity that sells,
resells, or distributes any software product or service that competes with the
sale of the Liquid Audio secure music distribution software carried by LAK, or
in any entity that controls, licenses, distributes or sells pre-recorded music.
(b) If any provision contained in this Section shall for any reason be
held invalid, illegal or unenforceable in any respect, such invalidity,
illegality of unenforceability shall not affect any other provisions of this
Section, but this Section shall be construed as if such invalid, illegal or
unenforceable provision had never been contained herein. It is the intention of
the Parties that if any of the restrictions or covenants contained herein is
held to cover a geographic area or to be for a length of time which is not
permitted by applicable law, or in any way construed to be too broad or to any
extent invalid, such provision shall not be construed to be null, void and of no
effect, but to the extent such provision would be valid or enforceable under
applicable law, a court of competent jurisdiction shall construe and interpret
or reform this Section to provide for a covenant having the maximum enforceable
geographic area, time period and other provisions (not greater than those
contained herein) as shall be valid and enforceable under such applicable law.
(c) SKM acknowledges that Liquid Audio would be irreparably harmed by
any breach or threatened breach of this Section and that there would be no
adequate remedy at law or in damages to compensate Liquid Audio for any such
breach or threatened breach. In recognition of this fact, SKM agrees that, in
the event of such a breach or threatened breach, in addition to any remedies at
law, Liquid Audio, without posting any bond, shall be entitled to obtain
equitable relief in the form of specific performance, temporary restraining
order, temporary or permanent injunction or any other equitable remedy which may
then be available, and SKM consents to the entry thereof.
8. GENERAL PROVISIONS
------------------
8.1 Confidentiality.
---------------
(a) Each Party acknowledges and agrees that certain information it
receives from the other Parties constitutes the confidential and proprietary
trade secrets of the disclosing Party (or of third parties pursuant to
confidentiality agreements between such third parties and the disclosing Party),
and that the receiving Party's protection thereof is essential to this Agreement
and a condition of the receiving Party's use and possession thereof. Each Party
shall retain in strict confidence any and all such confidential information
(collectively "Confidential Information") and use such
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<PAGE>
Confidential Information only as expressly authorized herein. A Party will under
no circumstances distribute or in any way disseminate Confidential Information
to third parties without the prior written permission of the disclosing Party.
(b) Notwithstanding the above, Confidential Information shall not
include information which:
(i) was generally known and available in the public domain at the
time it was disclosed or becomes generally known and available in the public
domain through no fault of the receiving Party;
(ii) was known to the receiving Party at the time of disclosure as
shown by the files of the receiving Party in existence at the time of
disclosure;
(iii) was independently developed by the receiving Party without
any use of Confidential Information and by employees or other agents of the
receiving Party who have not been exposed to such Confidential Information;
(iv) becomes known to the receiving Party from a source other than
the disclosing Party without breach of this Agreement by the receiving Party and
otherwise not in violation of the disclosing Party's rights; or
(v) is disclosed pursuant to the order or requirement of a court,
administrative agency, or other governmental body; provided, that the receiving
Party shall to the extent reasonably practicable, provide prompt, advanced
notice thereof to enable the disclosing Party to seek a protective order or
otherwise prevent such disclosure, and provided that the receiving Party's
disclosure is limited to the extent expressly required by such court,
administrative agency or other governmental body.
(c) Each Party will enter into a confidentiality agreement with each
employee or consultant who is given access to the Confidential Information of
the other Parties which incorporates the protections and restrictions
substantially as set forth herein.
(d) Each Party agrees to notify the other Parties in the event of any
breach of its security under conditions in which it would appear that
Confidential Information was prejudiced or exposed to loss. Each Party shall,
upon request of the disclosing Party, take all other reasonable steps necessary
to recover any compromised Confidential Information disclosed to or placed in
its possession by virtue of this Agreement. The cost of taking such steps shall
be borne solely by the receiving Party.
(e) Each Party acknowledges that any breach of any of its obligations
under this Section 8.1 is likely to cause or threaten irreparable harm to the
other Parties, and, accordingly, each Party agrees that in such event the
disclosing Party shall be entitled to equitable relief to protect its interests,
including but not limited to preliminary and permanent injunctive relief, as
well as money damages.
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<PAGE>
(f) Each Party agrees that such Holder shall return, or cause to be
returned, to the disclosing Party Confidential Information disclosed by such
disclosing Party promptly after such Holder ceases to be a shareholder of LAK.
8.2 Arbitration; Forum.
------------------
(a) Except as otherwise provided herein, all disputes, controversies
or claims arising out of or relating to this Agreement, or the breach,
termination or validity thereof, shall be resolved by one arbitrator under the
Rules of Conciliation and Arbitration of the International Chamber of Commerce
as then in effect ("Rules"). The arbitrator shall be chosen in accordance with
the Rules. The place of arbitration shall be Tokyo, Japan. The language to be
used in the arbitration proceedings shall be English. The arbitrator may be of
any nationality. The arbitral award shall be rendered in writing, state the
reasons for the award and shall be final and binding on the Parties. Judgment on
any award may be entered by any court of competent jurisdiction or application
may be made to such a court for judicial acceptance or recognition of the award
and any appropriate order including enforcement. This arbitration agreement is
intended by the parties to be self-executing. The arbitrator shall have sole
jurisdiction to determine whether (i) a claim is subject to arbitration, (ii)
the arbitration may proceed even if one of the Parties refuses to attend or
participate and (iii) an award against that party may be ordered pursuant to
default or otherwise by the panel. The Parties agree that they will arbitrate
all claims agreed to be arbitrated herein regardless of the existence of any
related dispute, action or special proceeding between any or all of the Parties
hereto and/or any third party.
(b) Notwithstanding the foregoing, each Party may apply to any court
of competent jurisdiction for a temporary restraining order, preliminary
injunction, or other interim or conservatory relief, as necessary, without
breach of this Section, and without any abridgement of the powers of the
arbitrator.
(c) In case of arbitration, the arbitrator shall award reasonable
attorneys' fees and expenses to any of the parties in such manner and to such
extent as the arbitrators deem equitable. In case of a court proceeding arising
out of this Agreement, the prevailing party shall be entitled to recover its
reasonable attorneys' fees and expenses from the other party(ies).
8.3 Force Majeure. If the performance of this Agreement or any obligations
-------------
hereunder is prevented, restricted or interfered with by reason of fire or other
casualty or accident, strikes or labor disputes, war or other violence, any law,
order, proclamation, regulations, ordinance, demand or requirement of any
government agency, or any other act or condition beyond the reasonable control
of the Parties, the Party so affected upon giving prompt notice to the other
Parties shall be excused from such performance during such prevention,
restriction or interference.
8.4 Governing Law. This Agreement shall be governed by the laws of the
-------------
Republic of Korea.
8.5 Publicity. Prior to issuing any reports, statements, press releases or
---------
other disclosures to third parties regarding this Agreement or the transactions
contemplated herein, the Parties shall exchange copies of such documents and
shall consult with each other regarding their content.
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<PAGE>
Except as otherwise required by law, neither Party shall any such disclosure
without the prior approval of the other Party.
8.6 Notices and Other Communications. Every notice by either Party shall
--------------------------------
be in writing and delivered either by personal delivery, or by express mail or
any similar overnight courier service, or by registered or certified mail,
postage prepaid, or by facsimile or electronic mail, addressed to the Party for
whom intended at its address set forth above, or at such other address as the
intended recipient previously shall have designated by written notice to the
other Party. All notices delivered in person shall be deemed to have been
delivered to and received by the addressee and shall be effective on the date of
personal delivery. All notices delivered by express mail or any other similar
overnight courier shall be effective upon the earlier of (i) three days
following the date sent, and (ii) the date received. All notices delivered by
registered or certified mail, or by facsimile or electronic mail, shall be
effective upon receipt.
8.7 Counterparts. This Agreement may be executed in any number of English
------------
language counterparts or duplicate originals, and each such counterpart or
duplicate original shall constitute an original instrument, but all such
separate counterparts or duplicate originals shall constitute one and the same
instrument.
8.8 Written Agreement to Govern. This Agreement sets forth the entire
---------------------------
understanding and supersedes all prior and contemporaneous agreements and
discussions among the Parties relating to the subject matter contained herein
and therein, except for the $850,000 payment obligation of SKM arising pursuant
to that certain Consulting Agreement dated September 30, 1998, between SKM and
Liquid Audio and such agreements as are executed contemporaneously herewith by
the Parties pursuant to the express provisions of this Agreement, and no Party
shall be bound by any definition, condition, representation, warranty, covenant
or provision other than as expressly stated in or contemplated herein or therein
or as subsequently shall be set forth in writing and executed by a duly
authorized representative of the Party to be bound thereby.
8.9 No Waiver of Rights. All waivers hereunder must be made in writing,
-------------------
and failure at any time to require another Party's performance of any obligation
under this Agreement shall not affect the right subsequently to require
performance of that obligation. No waiver of any breach of any provision of this
Agreement shall be construed as a waiver of any continuing or succeeding breach
of such provision or a waiver or modification of such provision.
8.10 Severability. Whenever possible, each provision of this Agreement
------------
shall be interpreted in such manner as to be effective and valid under
applicable law, but if any provision of this Agreement should be prohibited or
invalid under applicable law, such provisions shall be ineffective to the extent
of such prohibition or invalidity without invalidating the remainder of such
provision or the remaining provisions of this Agreement. In such event, the
Parties agree to negotiate, in good faith, a valid, legal and enforceable
substitute provision which most nearly effects the Parties' intent in entering
into this Agreement.
8.11 Subject Headings. The subject headings of the Sections of this
----------------
Agreement are included for the purposes of convenience only, and shall not
affect the construction or interpretations of any of its provisions.
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<PAGE>
8.12 Further Assurances. The Parties shall each perform such acts, execute
------------------
and deliver such instruments and documents, and do all such other things as may
be reasonably necessary to accomplish the transactions contemplated in this
Agreement.
8.13 Expenses and Finder's Fees. The Parties shall each bear their own
--------------------------
costs and expenses (including attorneys' fees) incurred in connection with the
negotiation and preparation of this Agreement and the consummation of the
transactions contemplated hereby. Each Party shall indemnify the other against
any claim for brokerage or finder's fees arising out of the transactions
contemplated herein by any Person claiming to have been engaged by the
indemnifying Party based upon any action or communication, or any alleged action
or communication, by the indemnifying Party or any of its officers or employees.
8.14 Relationship Between Parties. Each Party will in all matters relating
----------------------------
to this Agreement be and act as an independent contractor. Neither Party will
represent that it has any authority to assume or create any obligation, express
or implied, on behalf of the other Party, or to represent the other Party as
agent, employee, or in any other capacity.
8.15 Language. This Agreement is in the English language only, which
--------
language shall be controlling in all respects, and all versions hereof in any
other language shall be for accommodation only and shall not be binding upon the
Parties. All communications and notices to be made or given pursuant to this
Agreement shall be in the English language.
8.16 Assignment. This Agreement shall inure to benefit of, and shall be
----------
binding upon, the Parties and their respective successors and assigns. No Party
may assign or delegate this Agreement or any of its rights or duties under this
Agreement without the prior written consent of the other Parties except as
expressly set forth herein or to a Person into which it has merged or which has
otherwise succeeded to all or substantially all of the assets of the assignor,
and which has assumed in writing or by operation of law the assignor's
obligations under this Agreement.
8.17 SURVIVAL. The Parties' respective obligations pursuant to Sections 7
--------
and 8 shall survive a termination for any reason.
LIQUID AUDIO, INC. SKM LIMITED
By: /s/ Robert Flynn By: Kyu Hwa Lee /s/ K H Lee
----------------
Title: VP Business Development Title: Vice President
----------------------- --------------
Dated: 12/31/98 Dated: 12/31/98
-------- --------
LIQUID AUDIO KOREA CO., LTD.
By: Kyu Hwa Lee /s/ K H Lee
-----------
Title: President
---------
Dated: 12/31/98
--------
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<PAGE>
EXHIBIT A
ARTICLES OF INCORPORATION
[ENGLISH LANGUAGE]
<PAGE>
ARTICLES OF INCORPORATION
OF
LIQUID AUDIO KOREA CO., LTD.
CHAPTER I. GENERAL PROVISIONS
Article 1. Corporate Name
The name of the Company shall be "LIQUID AUDIO KOREA CHUSIK HOESA" in
Korean and "LIQUID AUDIO KOREA CO., LTD." in English.
Article 2. Business Objectives
The business objectives of the Company shall be the following:
(a) to license technology from Liquid Audio, Inc. relating to the
marketing and sale of audio products;
(b) to utilize such technology to host one or more internet based audio
sales and marketing sites;
(c) to resell Liquid Audio, Inc. software and certain related products
for use by end-user sellers of music and other audio products;
(d) to resell Liquid Audio, Inc. products to consumer end-users;
(e) to engage in any and all other conduct, activities or businesses
which are related, directly or indirectly, to the attainment and
continuation of the foregoing purposes.
Article 3. Head Office, Branches, Etc.
3.1 The head office of the Company shall be located in Seoul, the Republic of
Korea ("Korea").
3.2 Branches, other business offices or other agencies may be established,
relocated or closed, as required by resolution of the Board of Directors.
Article 4. Method Of Public Notices
Public notices of the Company shall be given in MAEIL BUSINESS NEWSPAPER, a
daily newspaper of general circulation published in Seoul, Korea.
<PAGE>
CHAPTER II. CAPITAL AND SHARES
Article 5. Shares
5.1 The total number of shares that the Company is authorized to issue shall be
Two Hundred Sixty Thousand (260,000) shares of Common Stock.
5.2 The total number of the shares to be issued by the Company at the time of
incorporation shall be Sixty Thousand (60,000) shares of Common Stock.
5.3 Shares to be issued by the Company shall be one class of Common Stock, in
registered form. The shares of Common Stock shall have a par value of Five
Thousand (5,000) Won, with full voting rights.
Article 6. Share Certificates
6.1 The share certificates of the Company shall be numbered, shall set forth
the number and class of shares represented thereby and the holder's name,
and shall be entered in the Register of Shareholders of the Company upon
issuance.
6.2 The share certificates shall be issued in denominations of one (1), ten
(10), fifty (50), one hundred (100), five hundred (500), one thousand
(1000), and ten thousand (10,000) shares or such other denominations as the
shareholders may reasonably request.
6.3 The share certificates shall bear the following words:
"Transfer of the shares of stock represented by this certificate is subject
to the Shareholders Agreement dated the 31st of December 1998, a copy of
which is on file at the principal office of the Company."
Article 7. Payment For Shares
Unless otherwise decided by the Board of Directors of the Company, payment
for subscribed shares shall be made in cash, payable to a bank or banks
designated by the Company. Only those shares that have been fully paid for
may be issued.
Article 8. Register Of Shareholders
A shareholder desiring an alteration of any entry in the Register of
Shareholders due to the transfer of shares of otherwise, or the
registration of a pledge shall submit an application therefor to the
Company, in the form prescribed by the Company, together with its share
certificates involved and supporting documents as requested by the Company.
Article 9. Transfer Of Shares
9.1 Any transfer of shares in the Company to a non-shareholder must be approved
by the Board of Directors.
2
<PAGE>
9.2 The Company may appoint its transfer agent and entrust it with procedures
of change of entry in the Register of Shareholders of the Company.
Article 10. Report of Addresses and Seals
10.1 Shareholders shall report to the Company their names, addresses, seals and
any changes therein; provided, however, that foreigners who customarily use
signatures may use signatures in place of seals.
10.2 Shareholders who reside in foreign countries may, in addition, inform the
Company of their or their agents' provisional addresses in Korea to which
notices may be dispatched.
10.3 An attorney for a shareholder shall submit to the Company a certificate of
his power of attorney in advance before he acts on behalf of such
shareholder.
Article 11. Record Date and Closing of Register of Shareholders
11.1 Subject to the restrictions provided in the applicable law, in order to
determine persons who are entitled to exercise voting rights, pre-emptive
rights to newly issued shares or other rights as shareholders or pledgees,
the Company may suspend entry of alterations in the Register of
Shareholders for a certain period, or the Company may deem any shareholder
or pledgee whose name appears in the Register of Shareholders on a
specified date to be the shareholder or pledgee who is entitled to exercise
the rights enumerated above in connection with such shares.
11.2 In particular, the Company shall treat the shareholders appearing on the
Register of Shareholders as of the 31st of each December as the
shareholders for the payment of dividends and the Company shall suspend
entry of alterations in the Register of Shareholders during the period from
the next day following the last day of the previous fiscal year to the date
on which the Ordinary General Meeting of Shareholders for such fiscal year
is closed.
11.3 The Company shall give public notice of the period or date referred to in
Paragraphs 11.1 and 11.2 at least two (2) weeks in advance of the
commencement of such period or of the occurrence of such date.
Article 12. Reissuance of Share Certificates
12.1 A shareholder desiring reissuance of a share certificate for reason of
partition or amalgamation of shares, or damage or soiling to a share
certificate, shall submit an application therefor to the Company, in the
form prescribed by the Company, together with the share certificate to be
cancelled. When the damage or soiling is so extreme that the share
certificate is not legible, however, it shall be regarded as lost and the
following provision shall apply for its replacement.
12.2 A shareholder desiring issuance of a new share certificate due to loss of
his share certificate shall submit to the Company an application, in the
form prescribed by the Company, together with the original or the certified
copy of a judgement of nullification with respect to the lost share
certificate.
Article 13. Pre-emptive Rights
3
<PAGE>
Each shareholder shall be entitled to subscribe to new shares issued by the
Company in proportion to its shareholding ratio. If any shareholder is not
permitted by law to exercise its pre-emptive right to subscribe to new
issues of shares, then such shareholder shall have the right to transfer
its pre-emptive right to a third legally qualified purchaser who will be
able to acquire such shareholder's proportion of the new shares issued by
the Company. If any shareholder does not wish to exercise its pre-emptive
rights in whole or in part, such shareholder shall notify the Board of
Directors of such intention at least seven (7) days prior to the day as of
which the allocation of the new shares is to be made. In this case, the
Board shall transfer to the other shareholder(s) such pre-emptive right to
such unsubscribed new shares.
Article 14. Other Matters relating to Shares
All questions and procedures relating to the registration of a transfer of
shares, registration of a pledge or cancellation thereof, indication of
trust property, reissuance of share certificates and other similar matters
and the fees therefor shall be governed by the Share Handling Regulations
to be established by the Board of Directors.
CHAPTER III. GENERAL MEETINGS OF SHAREHOLDERS
Article 15. Types of General Meetings
15.1 Genera Meetings of the Shareholders of the Company shall be of two types:
ordinary and extraordinary.
15.2 The Ordinary General Meeting of Shareholders shall be held within three (3)
months following the last day of each fiscal year.
15.3 An Extraordinary General Meeting of Shareholders may be convened at any
time in compliance with a resolution of the Board of Directors and
applicable laws.
Article 16. Convening of General Meetings
16.1 All General Meetings of Shareholders shall be convened by the
Representative Director upon the resolution of the Board of Directors or
upon the request in writing of one or more shareholders representing at
least five percent (5%) of the issued shares of the Company. The place for
convening each General Meeting of Shareholders shall be the head office of
the Company unless otherwise decided by the Board of Directors.
16.2 Each General Meeting of Shareholders shall be called by the Board of
Directors giving thirty (30) days' prior notice, stating in the English
language the date, time, place and agenda of the meeting and dispatched via
registered mail to the shareholders who are residents of Korea and via
registered airmail, facsimile transmission or telex to all other
shareholders. The notice requirement may be waived by the unanimous written
consent of all shareholders at the meeting. The General Meeting of
Shareholders may not resolve matters other than those stated in the notice
of the meeting, unless all the shareholders entitled to vote, whether
present or not, unanimously agree otherwise.
Article 17. Presiding Officer
4
<PAGE>
The Representative Director shall preside at all General Meetings of
Shareholders. If the Representative Director is absent or fails to serve as
presiding officer at a General Meeting of Shareholders, the Director
designated by the Board of Directors shall preside at such meeting in his
place.
Article 18. Resolution Requirement
18.1 Except as otherwise provided by applicable mandatory requirements of Korean
law or by these Articles of Incorporation, all resolutions of each General
Meeting of Shareholders shall be adopted by the affirmative vote of the
shareholders who hold shares representing more than one-half (1/2) of the
shares of the Company present at the meeting, provided that such
affirmative vote represents at least one-fourth (1/4) of the total shares
issued and outstanding. Notwithstanding the foregoing, the following
matters shall require the vote of more than two-thirds (2/3) of the total
shares issued and outstanding, or such higher rate as is required by the
applicable law:
(a) Any change to the Articles of Incorporation or by-laws of the Company;
(b) A reduction of the paid-in capital of the Company and the manner
thereof;
(c) The liquidation of the Company or its merger into, or consolidation or
amalgamation with any other company;
(d) Transfer or pledge of the whole or a substantial part of the assets or
undertakings of the Company or the acquisition by the Company of the
whole or part of the undertaking of any other person or entity, or the
capital stock of the Company, or entry by the Company into any joint
venture or partnership;
(e) Removal of a director from office; or
(f) Any other matters the adoption of which requires a special resolution
of the shareholders at a General Meeting under the laws of Korea.
Article 19. Voting
19.1 Each shareholder shall have one (1) vote for each share registered in its
name.
19.2 A shareholder may exercise its vote by proxy. In that case, the proxy
holder must file with the Company a document evidencing his proper
authority at each General Meeting of Shareholders at which he acts as
proxy.
Article 20. Minutes of General Meeting
The proceedings and conclusions of each General Meeting of Shareholders
shall be held in the English language and recorded in minutes in the
English and Korean languages, which minutes shall bear the names and the
signatures and/or seals of the presiding officer and of the Directors
present at the meeting, and shall be preserved at the Company's head
office. If any discrepancy should arise between the two versions of the
minutes, the English language version shall be controlling.
CHAPTER IV. DIRECTORS, STATUTORY AUDITOR, BOARD OF DIRECTORS AND OFFICERS
Article 21. Number of Directors and Auditor
5
<PAGE>
The Company shall have at least four (4) Directors and at least two (2)
Statutory Auditors.
Article 22. Election
The Directors and Statutory Auditors shall be elected at and by the General
Meeting of Shareholders, and any such vacancies may be filled at a General
Meeting of Shareholders.
Article 23. Term of Office
23.1 The term of office of a Director shall be three (3) years; provided,
however, that the term of office shall be extended until the close of the
Ordinary General Shareholders Meeting convened in respect of the last
fiscal year which ended in their term of office.
23.2 The term of office of a Statutory Auditor shall commence from the date of
acceptance of office and expire at the close of the Ordinary General
Meeting of Shareholders convened with respect to the last fiscal year
within three (3) years from the date of acceptance of office.
23.3 The term of office of a Director or a Statutory Auditor elected to fill a
vacancy shall be the remainder of the term of office of his predecessor.
Article 24. Board of Directors, Representative Director and Officers
24.1 The Board shall decide by resolution all important matters relative to the
management of the Company except as otherwise required by law or the
Articles of Incorporation.
24.2 The Board of Directors shall elect from among its members one (1)
Representative Director, who shall serve as the President of the Company.
The Representative Director/President shall represent the Company and shall
manage the day-to-day business of the Company under the control and
supervision of the Board of Directors. The Representative
Director/President shall have authority to execute contracts on behalf of
the Company within limitations established by the Board of Directors.
24.3 Other officers may be elected or appointed by the Board of Directors. All
such officers' service with the Company shall be on such basis as is
determined by the Board of Directors.
Article 25. Meetings of Board of Directors
25.1 Meetings of the Board of Directors may be convened from time to time by
three (3) directors or the Representative Director/President when he deems
the same to be necessary or advisable. Each Board meeting shall be called
by the Representative Director/President giving at least fourteen (14)
days' prior notice in the English language, stating the date, time and
place of the meeting, to each Director and Statutory Auditor and stating
the agenda of the meeting. The notice requirement may be waived with the
written consent of all Directors and Statutory Auditors.
6
<PAGE>
25.2 Board meetings shall be held at the Company's head office, unless the Board
of Directors may determine otherwise.
25.3 The Representative Director shall preside at all meetings of the Board of
Directors. If the Representative Director is absent or fails to serve as
presiding officer of any meeting, the Director designated by the Board of
Directors shall preside at such meeting in his place.
Article 26. Adoption of Resolutions
A quorum at any Board meeting shall consist of at least a majority of the
directors then in office. Unless otherwise required by applicable laws or
the Articles of Incorporation , any actions and resolutions taken at a
Board meeting shall be adopted by the affirmative vote of at least a
majority of the directors then in office. Notwithstanding the foregoing,
the following matters shall be for the exclusive authority of the Board,
other than those that require ratification by the general shareholders
meeting under the applicable law, and shall be decided upon the vote of at
least three directors:
(a) Making any basic change in the general nature or scope of business of
the Company;
(b) Issuing any security of the Company, whether shares or securities
convertible into shares, other equity securities or debt securities;
(c) Merging or consolidating the Company with another party, or selling,
leasing, pledging, mortgaging, encumbering or otherwise disposing of
all or substantially all of the assets of the Company, whether in one
transaction or a series of transactions;
(d) Establishing a business relationship with any direct competitor or
shareholder;
(e) Investing in any other party;
(f) Entering into any agreement or transaction with or for the benefit of
any director or shareholder of the Company or an affiliate (or any
direct lineal descendent or ancestor, sibling, spouse, mother-in-law,
father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-
in-law) of such director or shareholder;
(g) Amending the business plan of the Company;
(h) Appointment, employment and compensation decisions and scope of
responsibility for officers of the Company, including salary and
wages, cash advances and relocation expenses;
(i) Capital expenditures for single items of 100,000,000 Won or more;
(j) Entering into contracts that have a term in excess of one year or that
require aggregate payments of 100,000,000 Won or more;
(k) Disposition or transfer to a third party of at least 20% of the
Company's assets;
(l) Authorizing loans by the Company, except for payment terms for trade
credits in the ordinary course of business;
(m) Assuming or incurring any debt, loan, guaranty or liability with an
aggregate value of 500,000,000 Won or more;
(n) Change in the outside accountant to the Company;
(o) Creating any lien on the Company's property, except liens incurred in
the ordinary course of business;
(p) Approving the Company's annual budget;
(q) Changing the strategic direction of the Company and approving the
Company's long-range plans;
(r) Approval of annual financial statements;
7
<PAGE>
(s) Opening or closing an account with a bank or financial house in Korea
or overseas; and
(t) Paying any dividend or making any other distribution.
Article 27. Minutes of Meetings of the Board of Directors
The proceedings and conclusions of each meeting of the Board of Directors
shall be held in the English language and recorded in minutes in the
English and Korean languages, which minutes shall bear the names and the
signatures and/or seals of the presiding officer and all other Directors
and Statutory Auditor in attendance at the meeting and shall be preserved
at the Company's head office. If any discrepancy should arise between the
two versions of the minutes, the English language version shall be
controlling.
Article 28. Compensation
28.1 The compensation of the Directors and Statutory Auditor of the Company
shall be determined by resolution of a General Meeting of Shareholders.
28.2 Severance allowances for the Directors and Statutory Auditor shall be paid
in accordance with the regulations of the Company adopted by resolution of
a General Meeting of Shareholders.
CHAPTER V. ACCOUNTING
Article 29. Fiscal Year
29.1 The fiscal year of the Company shall commence on the 1st of January and end
on the 31st of December each year.
29.2 Notwithstanding the foregoing Paragraph 29.1, the first fiscal year of the
Company shall commence on the date of incorporation of the Company and end
on the following 31st of December.
Article 30. Approval of Financial Statements, etc.
30.1 The Representative Director/President shall submit to the Statutory
Auditors at least six (6) weeks before each Ordinary General Meeting of
Shareholders the following documents, after obtaining approval of such
documents from the Board of Directors in connection with the subject
Ordinary General Meeting of Shareholders:
(a) A balance sheet;
(b) A profit and loss statement;
(c) A statement of disposition of retained earnings or deficit;
(d) Supplementary schedules for (a), (b) and (c) above; and
(e) A business report.
8
<PAGE>
30.2 The Statutory Auditors shall submit an audit report thereof to the
Representative Director/President, within four (4) weeks of receipt of the
documents described in Paragraph 30.1 above.
30.3 The Representative Director/President shall, without delay, give public
notice of the balance sheet approved by the Ordinary General Meeting of
Shareholders.
Article 31. Disposition of Profit
Subject to Korean laws and regulations, profit for each fiscal year shall
be disposed of in the following order of priority:
(a) Establishment of any reserves required by law;
(b) Establishment of such other reserves as may be decided by a General
Meeting of Shareholders; and
(c) Payment of all or a portion of the remainder of such profit as
dividends to shareholders in accordance with the resolution of a
General Meeting of Shareholders.
Article 32. Payment of Dividends
32.1 Dividends, if declared, shall be determined by the General Meeting of
Shareholders, and paid to the shareholders of the Company who were duly
entered in the Register of Shareholder as of the end of the subject fiscal
year.
32.2 Dividends shall be paid within thirty (30) days after the declaration of
dividends, unless otherwise resolved by a General Meeting of Shareholders.
CHAPTER VI. SUPPLEMENTARY PROVISIONS
Article 33. By-laws
The Company may adopt, with the approval of the Board of Directors, by-laws
and other regulations as may be required for the administration of the
affairs of the Company.
Article 34. Execution of Agreements with Representative Director
All agreements, including employment agreements, between the Company and
its Representative Director/President shall be executed or countersigned by
another Director designated in a resolution of the Board of Directors.
Article 35. Other Matters
Matters not specifically provided for herein shall be determined in
conformity with resolutions adopted by the Board of Directors or the
General Meeting of Shareholders of the Company, or with relevant provisions
of the Korean Commercial Code, as the case may be.
9
<PAGE>
EXHIBIT B
CONSULTING AGREEMENT
(Filed as Exhibit 10.36)
<PAGE>
EXHIBIT C
GUARANTY
(Filed as Exhibit 10.38)
<PAGE>
EXHIBIT D
RESELLER AGREEMENT
(Filed as Exhibit 10.35)
<PAGE>
EXHIBIT E
FIVE YEAR BUSINESS PLAN
<PAGE>
LAK Yr 1
Liquid Audio Korea
TMC
- ---
Max Capacity of TMC (Albums) 241,920 * based on 2 CDs sold per hour
at 28 music stations with 12
hour days, 30 day months and
for 12 months.
Total Albums 241,920
Percentage of capacity utilized 50%
Total Albums Sold 120,960 336 per day
Total Songs Sold 1,451,520 * based on 12 song albums.
Sale Price Per Song 1,200 Won
---------
50,000
41.66666667
<TABLE>
<CAPTION>
Budget - Year One
Number of TMCs 0 0 0 0 0 1 1 1
Sales in Units Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99 Jul-99 Aug-99
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Song Units Sold - - - - - 120,960 120,960 120,960
Prepaid Accounts - - - - - - - -
Total Unit Sales - - - - - 120,960 120,960 120,960
Sales Revenue
TMC Network
Reporting Fee
(LOC) 17% - - - - - 24,675,840 24,675,840 24,675,840
Distribution Fee
(LAK) 12% - - - - - 17,418,240 17,418,240 17,418,240
Prepaid Membership
Accounts
29% per account - - - - - - - -
M.O.D. System Sales - - - - - 100,000,000 - -
Music Server - - - - - 18,750,000 - -
Software Sales
Maintenance fee
(20% of software) - - - - - 312,500 312,500 312,500
Total Sales: - - - - - 161,156,580 42,406,580 42,406,580
Korean Won
Total Sales: US 30 30 30 30 30 $134,297 835,339 835,339
Dollar
<CAPTION>
Cost of Goods Sold Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99 Jul-99 Aug-99
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Connection Cost (2 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 8,000,000 8,000,000 8,000,000
El lines)
M.O.D. System Cost - - - - - 80,000,000 - -
Music Server Software
Cost - - - - - 13,125,000 - -
Total Variable COGS 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 101,125,000 8,000,000 8,000,000
% of Total Sales 0.00% 0.00% 0.00% 0.00% 0.00% 62.75% 18.86% 18.86%
Fixed Cost of
Goods & Services
LAK Staff Salaries
President/Managing 8,666,667 8,666,667 8,666,667 8,666,667 8,666,667 8,666,667 8,666,667 8,666,667
Director
Vice President 7,583,333 7,583,333 7,583,333 7,583,333 7,583,333 7,583,333 7,583,333 7,583,333
Secretary (Pres & - 1,534,722 1,534,722 1,534,722 1,534,722 1,534,722 1,534,722 1,534,722
VP)
Director 6,500,000 6,500,000 6,500,000 6,500,000 6,500,000 6,500,000 6,500,000 6,500,000
Office Mger 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167
1 Staff - - - - - 2,256,944 2,256,944 2,256,944
(Personnel &
General Ad)
1 Assistant Staff 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333
(Account)
Team Mger Of 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389
Content
Staff 1 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Staff 2 1,805,556 1,805,556 1,805,556 1,805,556 1,805,556 1,805,556 1,805,556 1,805,556
Team Mger Of - - - 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389
Marketing & Sales
Staff 1 (Marketing) 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056
Staff 2 (Marketing) - - - - - - - -
Web Master - 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Web Staff - - - 1,805,556 1,805,556 1,805,556 1,805,556 1,805,556
Team Mger System 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389 3,701,389
Operations
System Engineer 2,256,994 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
1 System Staff - - - - - - - -
Encoding Staff 1 - 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Encoding Staff 1 - - - - - 1,805,556 1,805,556 1,805,556
Clerk - - - - - - - -
Receptionist 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333 1,408,333
<CAPTION>
Number of TMCs 1 3 3 3 % of
Total
Sales in Units Sep-99 Oct-99 Nov-99 Dec-99 Year 1 Sales
------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Song Units Sold 120,960 362,880 362,880 362,880 1,572,480
Prepaid Accounts - 10,000 10,000 10,000 30,000
Total Unit Sales 120,960 372,880 372,880 372,880 1,602,480 100.00%
Sales Revenue
TMC Network
Reporting Fee 24,675,840 74,027,520 74,027,520 74,027,520 320,785,920 25.59%
(LOC) 17%
Distribution Fee 17,418,240 52,254,720 52,254,720 52,254,720 226,437,120 18.04%
(LAK) 12%
Prepaid Membership
Accounts
29% per account - 116,000,000 116,000,000 116,000,000 348,000,000 27.72%
M.O.D. System Sales - 200,000,000 - - 300,000,000 23.89%
Music Server - 37,500,000 - - 56,250,000 4.48%
Software Sales
Maintenance fee 312,500 937,500 937,500 937,500 4,062,500 0.32%
(20% of software)
Total Sales: 42,406,580 480,719,740 243,219,740 243,219,740 1,255,535,540 100.00%
Korean Won
Total Sales: US 835,339 $400,600 $202,683 $202,683 81,046,280
Dollar
<CAPTION>
% of
Total
Cost of Goods Sold Sep-99 Oct-99 Nov-99 Dec-99 Year 1 Sales
------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Connection Cost (2 8,000,000 8,000,000 8,000,000 8,000,000 76,000,000 6.05%
El lines)
M.O.D. System Cost - 160,000,000 - - 240,000,000 19.12%
Music Service Software
Cost - 26,250,000 - - 39,375,000 3.14%
Total Variable COGS 8,000,000 194,250,000 8,000,000 8,000,000 355,375,000 28.30%
% of Total Sales 18.86% 40.41% 3.29% 3.29% 28.30%
Fixed Cost of
Goods & Services
LAK Staff Salaries
President/Managing 8,666,667 8,666,667 8,666,667 8,666,667 104,000,000 8.28%
Director
Vice President 7,583,333 7,583,333 7,583,333 7,583,333 91,000,000 7.25%
Secretary (Pres & 1,534,722 1,534,722 1,534,722 1,534,722 16,881,944 1.34%
VP)
Director 6,500,000 6,500,000 6,500,000 6,500,000 78,000,000 6.21%
Office Mger 2,979,167 2,979,167 2,979,167 2,979,167 35,750,000 2.85%
1 Staff 2,256,944 2,256,944 2,256,944 2,256,944 15,789,611 1.26%
(Personnel &
General Ad)
1 Assistant Staff 1,408,333 1,408,333 1,408,333 1,408,333 16,900,000 1.39%
(Account)
Team Mger Of 3,701,389 3,701,389 3,701,389 3,701,389 44,416,667 3.54%
Content
Staff 1 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 2.16%
Staff 2 1,805,556 1,805,556 1,805,556 1,805,556 21,666,667 1.73%
Team Mger Of 3,701,389 3,701,389 3,701,389 3,701,389 33,312,500 2.65%
Marketing & Sales
Staff 1 (Marketing) 2,618,056 2,618,056 2,618,056 2,618,056 31,416,667 2.50%
Staff 2 (Marketing) 1,805,556 1,805,556 1,805,556 1,805,556 7,222,222 0.58%
Web Master 2,256,944 2,256,944 2,256,944 2,256,944 24,826,389 1.98%
Web Staff 1,805,556 1,805,556 1,805,556 1,805,556 16,250,000 1.29%
Team Mger System 3,701,389 3,701,389 3,701,389 3,701,389 44,416,667 3.54%
Operations
System Engineer 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 2.16%
1 System Staff 1,805,556 1,805,556 1,805,556 1,805,556 7,222,222 0.58%
Encoding Staff 1 2,256,944 2,256,944 2,256,944 2,256,944 24,826,389 1.98%
Encoding Staff 1 1,805,556 1,805,556 1,805,556 1,805,556 12,638,889 1.01%
Clerk 1,408,333 1,408,333 1,408,333 1,408,333 5,633,333 0.45%
Receptionist 1,408,333 1,408,333 1,408,333 1,408,333 16,900,000 1.35%
</TABLE>
<PAGE>
LAK Yr 1
<TABLE>
<CAPTION>
Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental fee 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Total Fixed Cost of Goods & Services 54,886,111 60,934,722 60,934,722 66,441,667 66,441,667 70,504,167
% of Total Sales 0.00% 0.00% 0.00% 0.00% 0.00% 43.75%
Total Cost of Goods Sold 58,886,111 64,934,722 64,934,722 70,441,667 70,441,667 171,629,167
Gross Profit
% of Total Sales -58,886.11 -64,934,722 -64,934,722 -70,441,667 -70,441,667 -10,472,587
0.00% 0.00% 0.00% 0.00% 0.00% -6.50%
Operating Expenses
Sales & Marketing
Advertising & Promotions 5,000,000 5,000,000 20,000,000 55,000,000 55,000,000 55,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 23,000,000 23,000,000 38,000,000 73,000,000 73,000,000 73,000,000
% Total of Sales 0.00% 0.00% 0.00% 0.00% 0.00% 45.30%
<CAPTION>
General & Administrative Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 4,791,667 4,791,667 21,458,333 21,458,333 21,458,333 21,458,333
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 10,791,667 10,791,667 27,458,333 27,458,333 27,458,333 27,458,333
% Total Sales 0.00% 0.00% 0.00% 0.00% 0.00% 17.04%
Total Operating Expenses 33,791,667 33,791,667 65,458,333 100,458,333 100,458,333 100,458,333
% of Total Sales 0.00% 0.00% 0.00% 0.00% 0 62.34%
Income From Operations -92,677,778 -98,726,389 (130,393,056) (170,900,000) (170,900,000) (110,930,920)
% of Total Sales 0.00% 0.00% 0.00% 0.00% 0.00% -68.83%
Liquid Audio Royalty Payment 125,000,000 - - - - 200,000,000
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) - - 5,625,000 7,031,250 7,968,750 10,406,250
Total Royalty/Loan Interest Payment 125,000,000 - 5,625,000 7,031,250 7,968,750 210,406,250
Income before Taxes -217,677,778 -98,726,389 -136,018,056 -177,931,250 -178,868,750 -321,337,170
Taxes on Income - - - - - -
Net Income After Taxes -217,677,778 -98,726,389 -136,018,056 -177,931,250 -178,868,750 -321,337,170
% of Total Sales 0.00% 0.00% 0.00% 0.00% 0.00% -199.39%
Net Income After Taxes (US$) ($174,142.22) ($78,981.11) ($108,814.44) ($142,345.00) ($143,095.00) ($257,069.74)
Net Income: (Running Total) ($174,142.22)($253,123.33) ($361,937.78) ($504,282.78) ($647,377.78) $(904,447,51)
Liquid Audio Royalty Payment $100,000.00 $160,000.00
LAK Initial Funds $1,040,000.00
Total Loan from SKM $ - $ - $600,000.00 $750,000.00 $850,000.00 $1,110,000.00
Loan from SKM $ - $ - $600,000.00 $150,000.00 $100,000.00 $ 260,000.00
Loan Repayment to SKM $ - $ - $ - $ - $ - $ -
Depreciation (cash-in) $3,833.33 $3,833.33 $ 17,166.67 $ 17,166.67 $ 17,166.67 $ 17,166.67
3 months Exploratory Period $320,000.00 * Office rental Fee; Appt. Rental Fee; Operating Expenses
Total Invest For System $184,000.00 $184,000.00 $824,000.00 $824,000.00 $824,000.00 $824,000.00
Central Repository/additional invest. $184,000.00 $640,000.00
Total Initial Funds Available $536,000.00
Total Funds Available Mon. to Mon. $365,591.11 $298,343.33 $258,859,54 $183,717.22 $157,788.89 $177,885.82
<CAPTION>
Jul-99 Aug-99 Sep-99 Oct-99 Nov-99
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Facility Expense Office rental fee 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Total Fixed Cost of Goods & Services 70,504,167 70,504,167 75,523,611 75,523,611 75,523,611
% of Total Sales 166.26% 166.26% 178.09% 15.71% 31.05%
Total Cost of Goods Sold 78,504,167 78,504,167 83,523,611 269,773,611 83,523,611
Gross Profit -36,097,587 -36,097,587 -41,117,031 210,946,129 159,896,129
% of Total Sales -85.12% -85.12% -96.96% 43.88% 65.66%
Operating Expenses
Sales & Marketing
Advertising & Promotions 55,000,000 60,000,000 70,000,000 55,000,000 55,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
73,000,000 78,000,000 88,000,000 73,000,000 73,000,000
Total Sales & Marketing Costs 172.14% 183.93% 207.51% 15.19% 30.01%
% Total of Sales
<CAPTION>
General & Administrative Jul-99 Aug-99 Sep-99 Oct-99 Nov-99
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 21,458,333 21,458,333 21,458,333 21,458,333 21,458,333
Insurance 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 27,458,333 27,458,333 27,458,333 27,458,333 27,458,333
% Total Sales 64.75% 64.75% 64.75% 5.71% 11.29%
Total Operating Expenses 100,458,333 105,458,333 115,458,333 100,458,333 100,458,333
% of Total Sales 236.89% 248.68% 272.27% 20.90% 41.30%
Income From Operations (136,555,920) (141,555,920) (156,575,364) 110,487,796 59,237,796
% of Total Sales -322.02% -333.81% -369.22% 22.98% 24.36%
Liquid Audio Royalty Payment - - 200,000,000 - -
LA Royalty Tax Payment - - - - -
Loan Interest Payment (9%) 11,343,750 12,281,250 14,718,750 13,781,250 13,312,500
Total Royalty/Loan Interest Payment 11,343,750 12,281,250 214,718,750 13,781,250 13,312,500
Income before Taxes -147,899,670 -153,837,170 -371,294,114 96,706,546 45,925,296
Taxes on Income - - - - -
Net Income After Taxes -147,899,670 -153,837,170 -371,294,114 96,706,546 45,925,296
% of Total Sales -348.77% -362.77% -875.56% 20.12% 18.88%
Net Income After Taxes (US$) ($118,319.74) ($123,069.74) ($297,035.29) $77,365.24 $36,740.24
Net Income: (Running Total) ($1,022,757.25) ($1,145,836.99) ($1,442,872.28) ($1,365,507.04) ($1,328,766.80)
Liquid Audio Royalty Payment $160,000.00
LAK Initial Funds
Total Loan from SKM $1,210,000.00 $1,310,000.00 $1,570,000.00 $1,470,000.00 $1,420,000.00
Loan from SKM $ 100,000.00 $ 100,000.00 $ 260,000.00 $ - $ -
Loan Repayment to SKM $ - $ - $ - $ 100,000.00 $ 50,000.00
Depreciation (cash-in) $17,166.67 $17,166.67 $17,166.67 $17,166.67 $17,166.67
3 months Exploratory Period
Total Invest For System $824,000.00 $824,000.00 $824,000.00 $824,000.00 $824,000.00
Central Repository/additional invest.
Total Initial Funds Available
Total Funds Available Mon. to Mon. $176,732.75 $170,829.68 $130,961.95 $145,192.98 $143,389.86
<CAPTION>
% of
Total
Dec-01 Year 1 Sales
------ ------ -----
<S> <C> <C> <C>
Facility Expense(Office rental fee 10,000 120.000.000 9.56%
Total Fixed Cost of Goods & Services 75,523,611 823,245,833 65.57%
% of Total Sales 31.05% 65.57%
Total Cost of Goods Sold 83,523,611 1,178,620,833 93.87%
Gross Profit 159,696,129 76,914,707 6.13%
% of Total Sales 65.66% 6.13%
Operating Expenses
Sales & Marketing
Advertising & Promotions 90,000,000 580,000,000 46.20%
Commissions 30 0.00%
Entertainment 15,000,000 180,000,000 14.34%
Literature 3,000,000 36,000,000 2.87%
Total Sales & Marketing Costs 108,000,000 796,000,000 63.40%
% Total of Sales 44.40% 63.40%
<CAPTION>
Dec-99 Year 1 Sales
------ ------ -----
<S> <C> <C> <C>
General & Administrative
Accounting & Lawyer Fee 2,500,000 30,000,000 2.39%
Depreciation (4 years) 21,458,333 224,166,667 17.85%
Insurance 500,000 6,000,000 0.48%
License and Legal Fees - - 0.00%
Telephone 1,500,000 18,000,000 1.43%
Utilities 1,500,000 18,000,000 1.43%
Total G & A Costs 27,458,333 296,166,667 23.59%
% Total Sales 11.29% 23.59%
Total Operating Expenses 135,458,333 1,092,166,667 86.99%
% of Total Sales 55.69% 86.99%
Income From Operations 24,237,796 -1,015,251,960 -80.86%
% of Total Sales 9.97% -80.86%
Liquid Audio Royalty Payment 400,000,000 925,000,000 73.67%
LA Royalty Tax Payment - -
Loan Interest Payment (9%) 16,312,500 112,781,250 8.98%
Total Royalty/Loan Interest Payment 416,312,500 1,037,781,250 82.66%
Income before Taxes -392,074,704 -2,053,033,210 -163.52%
Taxes on Income - -
Net Income After Taxes -392,074,704 -2,053,033,210 -163.52%
% of Total Sales -161.20% -163.52%
Net Income After Taxes (US$) ($313,659.76) ($1,642,426.57)
Net Income: (Running Total) ($1,642,426.57)
Liquid Audio Royalty Payment $320,000.00 $740,000.00
LAK Initial Funds $1,740,000.00
Total Loan from SKM
Loan from SKM $320,000.00 $1,890,000.00
Loan Repayment to SKM $ - $150,000.00
Depreciation (cash-in) $17,166.67 $179,333.33
3 months Exploratory Period
Total Invest For System $824,000.00
Central Repository additional invest. $824,000.00
Total Initial Funds Available
Total Funds Available Mon. to Mon. $172,908.77
</TABLE>
<PAGE>
LAK Yr 2
Liquid Audio Korea
TMC
- ---
Max Capacity of TMC (Albums) 241,920 * based on 2 CDs sold per hour
Total Albums 241,920 at 28 music stations with 12
hour days, 30 day months and
for 12 months.
Percentage of capacity utilized 65%
Total Albums Sold 157,248 437 per day
Total Songs Sold 1,886,976 * based on 12 song albums.
Sale Price Per Song: 1,200 Won
-----------
50,000
41.66666667
Budget - Year One
<TABLE>
<CAPTION>
Number of TMCs 3 5 5 5 5 5
Sales in Units Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Song Units Sold 471,744 786,240 786,240 786,240 786,240 786,240
Prepaid Acconts 10,000 10,000 10,000 10,000 10,000 10,000
Total Unit Sales 481,744 796,240 796,240 796,240 796,240 796,240
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 96,235,776 160,392,960 160,392,960 160,392,960 160,392,960 160,392,960
Distribution Fee (LAK) 12% 67,931,136 113,218,560 113,218,560 113,218,560 113,218,560 113,218,560
PrePaid Membership Accounts
29% per account 16,000,000 16,000,000 16,000,000 16,000,000 16,000,000 16,000,000
M.O.D System Sales - 200,000,000 - - - -
Music Server Software Sales - 37,500,000 - - - -
Maintenance fee(20% of software) 937,500 1,562,500 1,562,500 1,562,500 1,562,500 1,562,500
Total Sales: Korean Won 281,104,412 628,674,020 391,174,020 391,174,020 391,174,020 391,174,020
Total Sales: US Dollar $234,254 $523,895 $325,978 $325,978 $325,978 $325,978
Cost of Goods Sold Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00
Connection Cost (2 E1 lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
M.O.D. System Costs - 160,000,000 - - - -
Music Server Software Cost - 26,250,000 - - - -
Total Variable COGS 8,000,000 194,250,000 8,000,000 8,000,000 8,000,000 8,000,000
%of Total Sales 2.85% 30.90% 2.05% 2.05% 2.05% 2.05%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/ Managing Director 8,926,667 8,926,667 8,926,667 8,926,667 8,926,667 8,926,667
Vice President 7,810,833 7,810,833 7,810,833 7,810,833 7,810,833 7,810,833
Secretary (Pres.&VP) 1,606,944 1,606,944 1,606,944 1,606,944 1,606,944 1,606,944
Director 6,695,000 6,695,000 6,695,000 6,695,000 6,695,000 6,695,000
Office Mger 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444
1 Staff (Personnel&General Ad) 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
1 Assistant Staff (Account) 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556
Team Mger Of Content 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667
Staff 1 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Staff 2 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Team Mger. Of Marketing & Sales 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667
Staff 1 (Marketing) 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Staff 2 (Marketing) 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Web Master 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Web Staff 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Team Mger System Operations 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667
System Engineer 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
1 system Staff 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Encoding staff 1 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Encoding staff 1 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Clerk 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556
Receptionist 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556
<CAPTION>
Number of TMCs 8 8 8 8 11 11
Sales in Units Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Song Units Sold 1,257,984 1,257,984 1,257,984 1,257,984 1,729,728 1,729,728
Prepaid Acconts 10,000 10,000 10,000 10,000 10,000 10,000
Total Unit Sales 1,267,984 1,267,984 1,267,984 1,267,984 1,739,728 1,739,728
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 256,628,736 256,628,736 256,628,736 256,628,736 352,864,512 352,864,512
Distribution Fee (LAK) 12% 181,149,696 181,149,696 181,149,696 181,149,696 249,080,832 249,080,832
PrePaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000
M.O.D System Sales 300,000,000 - - - 300,000,000 -
Music Server Software Sales 56,250,000 - - - 56,250,000 -
Maintenance fee(20% of software) 2,500,000 2,500,000 2,500,000 2,500,000 3,437,500 3,437,500
Total Sales: Korean Won 912,528,432 556,278,432 556,278,432 556,278,432 1,077,632,844 721,382,844
Total Sales: US Dollar $760,440 $463,565 $463,565 $463,565 $898,027 $601,152
Cost of Goods Sold Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00
Connection Cost (2 E1 lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
M.O.D. System Costs 240,000,000 - - - 240,000,000 -
Music Server Software Cost 39,375,000 - - - 39,375,000 -
Total Variable COGS 287,375,000 8,000,000 8,000,000 8,000,000 287,375,000 8,000,000
%of Total Sales 31.49% 1.44% 1.44% 1.44% 26.67% 1.11%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/ Managing Director 8,926,667 8,926,667 8,926,667 8,926,667 8,926,667 8,926,667
Vice President 7,810,833 7,810,833 7,810,833 7,810,833 7,810,833 7,810,833
Secretary (Pres.&VP) 1,606,944 1,606,944 1,606,944 1,606,944 1,606,944 1,606,944
Director 6,695,000 6,695,000 6,695,000 6,695,000 6,695,000 6,695,000
Office Mger 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444
1 Staff (Personnel&General Ad) 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
1 Assistant Staff (Account) 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556
Team Mger Of Content 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667
Staff 1 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Staff 2 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Team Mger. Of Marketing & Sales 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667
Staff 1 (Marketing) 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Staff 2 (Marketing) 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Web Master 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Web Staff 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Team Mger System Operations 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667 3,791,667
System Engineer 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
1 system Staff 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Encoding staff 1 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Encoding staff 1 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833 1,895,833
Clerk 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556
Receptionist 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556 1,480,556
<CAPTION>
Number of TMCs % of
Total
Year 2 Sales
Sales in Units ------
<S> <C> <C>
Song Units Sold 12,894,336
Prepaid Acconts 120,000
Total Unit Sales 13,014,336 100.00%
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 2,630,444,544 38.37%
Distribution Fee (LAK) 12% 1,856,784,384 27.00%
PrePaid Membership Accounts
29% per account 1,392,000,000 20.31%
M.O.D System Sales 800,000,000 11.60%
Music Server Software Sales 150,000,000 2.10%
Maintenance fee(20% of software) 25,625,000 0.30%
Total Sales: Korean Won 6,854,853,928 100.00%
Total Sales: US Dollar $5,712,378
%of Total
Cost of Goods Sold Year 2 Sales
Connection Cost (2 E1 lines) 96,000,000 1.40%
M.O.D. System Costs 640,000,000 9.34%
Music Server Software Cost 105,000,000 1.53%
Total Variable COGS 841,000,000 12.27%
%of Total Sales 12.27%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/ Managing Director 107,120,004 1.56%
Vice President 93,729,996 1.37%
Secretary (Pres.&VP) 19,283,333 0.28%
Director 80,340,000 1.17%
Office Mger 36,833,333 0.54%
1 Staff (Personnel&General Ad) 28,166,667 0.41%
1 Assistant Staff (Account) 17,766,667 0.26%
Team Mger Of Content 45,500,000 0.66%
Staff 1 28,166,667 0.41%
Staff 2 22,750,000 0.33%
Team Mger. Of Marketing & Sales 45,500,000 0.66%
Staff 1 (Marketing) 32,500,000 0.47%
Staff 2 (Marketing) 22,750,000 0.33%
Web Master 28,166,667 0.41%
Web Staff 22,750,000 0.33%
Team Mger System Operations 45,500,000 0.66%
System Engineer 28,166,667 0.41%
1 system Staff 22,750,000 0.33%
Encoding staff 1 28,166,667 0.41%
Encoding staff 1 22,750,000 0.33%
Clerk 17,766,667 0.26%
Receptionist 17,766,667 0.26%
</TABLE>
Page 1
<PAGE>
LAK Yr 2
<TABLE>
<CAPTION>
Jan-00 Feb-00 Mar-00 Apr-00 May-00
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Facility Expense/Office rental fee 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Total Fixed Cost of Goods & Services 77,849,167 77,849,167 77,849,167 77,849,167 77,849,167
% of Total Sales 27.69% 12.38% 19.90% 19.90% 19.90%
Total Cost of Goods Sold 85,849,167 272,099,167 85,849,167 85,849,167 85,849,167
Gross Profit 195,255,246 356,574,853 305,324,853 305,324,853 305,324,853
% of Total Sales 69.46% 56.72% 78.05% 78.05% 78.05%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 27.75% 12.41% 19.94% 19.94% 19.94%
General & Administrative
Jan-00 Feb-00 Mar-00 Apr-00 May-00
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 31,875,000 31,875,000 31,875,000 31,875,000 31,875,000
Insurance 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 37,875,000 37,875,000 37,875,000 37,875,000 37,875,000
% Total Sales 13.47% 6.02% 9.68% 9.68% 9.68%
Total Operating Expenses 115,875,000 115,875,000 115,875,000 115,875,000 115,875,000
% of Total Sales 41.22% 18.43% 29.62% 29.62% 29.62%
Income From Operations 79,380,245 240,699,853 189,449,853 189,449,853 189,449,853
% of Total Sales 28.24% 38.29% 48.43% 48.43% 48.43%
Liquid Audio Royalty Payment - - 400,000,000 - -
LA Royalty Tax Payment - - - - -
Loan Interest Payment (9%) 16,312,500 14,906,250 16,031,250 14,625,000 13,687,500
Total Royalty/Loan Interest Payment 16,312,500 14,906,250 416,031,250 14,625,000 13,687,500
Income before Taxes 63,067,745 225,793,603 (226,581,397) 174,824,853 175,762,353
Taxes on Income 17,028,291 60,964,273 (61,176,977) 47,202,710 47,455,835
Net Income After Taxes 46,039,454 164,829,330 (165,404,420) 127,622,143 128,306,518
% of Total Sales 16.38% 26.22% -42.28% 32.63% 32.80%
Net Income After Taxes (US$) $34,831.56 $131,863.46 ($132,323.54) $102,097.71 $ 102,645.21
Net Income: (Running Total) ($1,605,595.00) ($1,473,731.54) ($1,606,055.08) ($1,503,957.36) ($1,401,312.15)
Liquid Audio Royalty Payment $320,000.00
LAK Initial Funds in this year $172,906.77
Total Loan from SKM $1,740,000.00 $1,590,000 $1,710,000.00 $1,560,000.00 $1,460,000.00
Loan from SKM $300,000.00 $ - $320,000.00 $ - $ -
Loan Repayment to SKM $ - $150,000.00 $200,000.00 $150,000.00 $100,000.00
Depreciation (cash-in) $25,500.00 $25,500.00 $25,500.00 $25,500.00 $25,500.00
3 months Exploratory Period
Total Invest For System $1,224,000.00 $1,224,000.00 $1,224,000.00 $1,224,000.00 $1,224,000.00
Central Repository / additional invest. $400,000.00
Total Initial Funds Available ($227,093.23)
Total Funds Available Mon. to Mon. $135,238.33 $142,601.79 $155,778.26 133,373.97 161,321.19
<CAPTION>
Jun-00 Jul-00 Aug-00 Sep-00 Oct-00
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Facility Expense/Office rental fee 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Total Fixed Cost of Goods & Services 77,849,167 77,849,167 77,849,167 77,849,167 77,849,167
% of Total Sales 19.90% 8.53% 13.99% 13.99% 13.99%
Total Cost of Goods Sold 85,849,167 365,224,167 85,849,167 85,849,167 85,849,167
Gross Profit 305,324,853 547,304,265 470,429,265 470,429,265 470,429,265
% of Total Sales 78.05% 59.98% 84.57% 84.57% 84.57%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 19.94% 8.55% 14.02% 14.02% 14.02%
General & Administrative
Jun-00 Jul-00 Aug-00 Sep-00 Oct-00
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 31,875,000 50,625,000 50,625,000 50,625,000 50,625,000
Insurance 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 37,875,000 56,625,000 56,625,000 56,625,000 56,625,000
% Total Sales 9.68% 6.21% 10.18% 10.18% 10.18%
Total Operating Expenses 115,875,000 134,625,000 134,625,000 134,625,000 134,625,000
% of Total Sales 29.62% 14.75% 24.20% 24.20% 24.20%
Income From Operations 189,449,853 412,679,265 335,804,265 335,804,265 335,804,265
% of Total Sales 48.43% 45.22% 60.37% 60.37% 60.37%
Liquid Audio Royalty Payment 500,000,000 - - 500,000,000 -
LA Royalty Tax Payment - - - - -
Loan Interest Payment (9%) 15,093,750 19,312,500 17,437,500 17,906,250 15,562,500
Total Royalty/Loan Interest Payment 515,093,750 19,312,500 17,437,500 517,906,250 15,562,500
Income before Taxes (325,643,897) 393,366,765 318,366,765 (182,101,985) 320,241,765
Taxes on Income (87,923,852) 106,209,027 85,959,027 (49,167,536) 86,465,277
Net Income After Taxes (237,720,045) 287,157,739 232,407,739 (132,934,449) 233,776,489
% of Total Sales -60.77% 31.47% 41.78% -23.90% 42.03%
Net Income After Taxes (US$) ($190,176.04) $229,726.19 $185,926.19 ($106,347.56) $187,021.19
Net Income: (Running Total) ($1,591,488.18) ($1,361,761.99) ($1,175,835.80) ($1,282,183.36) ($1,095,162.17)
Liquid Audio Royalty Payment $400,000.00 $400,000.00
LAK Initial Funds in this year
Total Loan from SKM $1,610,000.00 $2,060,000.00 $1,860,000.00 $1,910,000.00 $1,660,000.00
Loan from SKM $400,000.00 $450,000.00 $ - $400,000.00 $ -
Loan Repayment to SKM $250,000.00 $ - $200,000.00 $350,000.00 $250,000.00
Depreciation (cash-in) $25,500.00 $40,500.00 $40,500.00 $40,500.00 $40,500.00
3 months Exploratory Period
Total Invest For System $1,224,000.00 $1,944,000.00 $1,944,000.00 $1,944,000.00 $1,944,000.00
Central Repository / additional invest. $720,000.00
Total Initial Funds Available
Total Funds Available Mon. to Mon. 146,845.15 147,071.34 173,497.53 137,649.97 135,172.16
<CAPTION>
% of
Total
Nov-00 Dec-00 Year 2 Sales
------ ------ ------
<S> <C> <C> <C> <C>
Facility Expense/Office rental fee 10,000,000 10,000,000 120,000,000 1.75%
Total Fixed Cost of Goods & Services 77,849,167 77,849,167 934,190,000 13.63%
% of Total Sales 7.22% 10.79% 13.63%
Total Cost of Goods Sold 365,224,167 85,849,167 1,775,190,000 25.90%
Gross Profit 712,408,677 635,533,677 5,079,663,928 74.10%
% of Total Sales 66.11% 88.10% 74.10%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 720,000,000 10.50%
Commissions 30 0.00%
Entertainment 15,000,000 15,000,000 180,000,000 2.63%
Literature 3,000,000 3,000,000 36,000,000 0.53%
Total Sales & Marketing Costs 78,000,000 78,000,000 936,000,000 13.65%
% Total of Sales 7.24% 10.81% 13.65%
General & Administrative % of Total
Nov-00 Dec-00 Year 2 Sales
Accounting & Lawyer Fee 2,500,000 2,500,000 30,000,000 0.44%
Depreciation (4 years) 50,625,000 50,625,000 495,000,000 7.22%
Insurance 500,000 500,000 6,000,000 0.09%
License and Legal Fees - - - 0.00%
Telephone 1,500,000 1,500,000 18,000,000 0.26%
Utilities 1,500,000 1,500,000 18,000,000 0.26%
Total G & A Costs 56,625,000 56,625,000 567,000,000 8.27%
% Total Sales 5.25% 7.85% 8.27%
Total Operating Expenses 134,625,000 134,625,000 1,503,000,000 21.93%
% of Total Sales 12.49% 18.66% 21.93%
Income From Operations 577,783,677 500,908,677 3,576,663,928 52.18%
% of Total Sales 53.62% 69.44% 52.18%
Liquid Audio Royalty Payment - 600,000,000 2,000,000,000 29.18%
LA Royalty Tax Payment - - -
Loan Interest Payment (9%) 12,281,250 12,562,500 185,718,750 2.71%
Total Royalty/Loan Interest Payment 12,281,250 612,562,500 2,185,718,750 31.89%
Income before Taxes 565,502,427 (111,653,823) 1,390,945,178 20.29%
Taxes on Income 152,685,655 (30,146,532) 375,555,198
Net Income After Taxes 412,816,772 (81,507,291) 1,015,389,980 14.81%
% of Total Sales 38.31% -11.30% 14.81%
Net Income After Taxes (US$) $330,253.42 ($65,205.83) $812,311.98
Net Income: (Running Total) ($764,908.75) ($830,114.58)
Liquid Audio Royalty Payment $480,000.00 $1,600,000.00
LAK Initial Funds in this year
Total Loan from SKM $1,310,000.00 $1,340,000.00
Loan from SKM $ - 480,000.00 $2,350,000.00
Loan Repayment to SKM $350,000.00 $450,000.00 $2,450,000.00
Depreciation (cash-in) $40,500.00 $40,500.00 $396,000.00
3 months Exploratory Period
Total Invest For System $1,944,000.00 $1,944,000.00
Central Repository / additional invest. $1,120,000.00
Total Initial Funds Available
Total Funds Available Mon. to Mon. $155,924.58 $161,218.75
</TABLE>
Page 2
<PAGE>
LAK Yr 3
Liquid Audio Korea
TMC
- --- 241,920 * based on 2 CDs sold per
hour at 28 music stations
with 12 hour days, 30 day
months and for 12 months.
Max Capacity of TMC (Albums) 241,920
Total Albums
Percentage of capacity utilized 65%
Total Albums Sold 157,248 437 per day
Total Songs Sold 1,886,976 * based on 12 song albums.
Sale Price Per Song 1,200 Won
50,000
41.66666667
<TABLE>
<CAPTION>
Budget - Year One
Number of TMCs 13 13 14 14 16 16 18
Sales in Units Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01
------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Song Units Sold 2,044,224 2,044,224 2,201,472 2,201,472 2,515,968 2,515,968 2,830,464
Prepaid Accounts 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Total Unit Sales 2,054,224 2,054,224 2,211,472 2,211,472 2,525,968 2,525,968 2,840,464
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 417,021,696 417,021,696 449,100,288 449,100,288 513,257,472 513,257,472 577,414,656
Distribution Fee (LAK) 12% 294,368,256 294,368,256 317,011,968 317,011,968 362,299,392 362,299,392 407,586,816
Prepaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000
M.O.D. System Sales 200,000,000 - 280,000,000 - 200,000,000 - 560,000,000
Music Server Software Sales 37,500,000 - 18,750,000 - 37,500,000 - 37,500,000
Maintenance fee (20% of
software) 4,062,500 4,062,500 4,375,000 4,375,000 5,000,000 5,000,000 5,625,000
Total Sales: Korean Won 1,068,952,452 831,452,452 1,185,237,256 886,487,256 1,234,056,864 996,556,864 1,704,126,472
Total Sales: US Dollar $890,794 $692,877 $987,698 $738,739 $1,028,381 $830,464 $1,420,105
<CAPTION>
Cost of Goods Sold Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01
------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Connection Cost (2 El lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
M.O.D. System Cost 160,000,000 - 224,000,000 - 160,000,000 - 448,000,000
Music Server Software Cost 26,250,000 - 13,125,000 - 26,250,000 - 26,250,000
Total Variable COGS 194,250,000 8,000,000 245,125,000 8,000,000 194,250,000 8,000,000 482,250,000
% of Total Sales 18.17% 0.96% 20.68% 0.90% 15.74% 0.80% 28.30%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 9,194,467 9,194,467 9,194,467 9,194,467 9,194,467 9,194,467 9,194,467
Vice President 8,045,158 8,045,158 8,045,158 8,045,158 8,045,158 8,045,158 8,045,158
Secretary (Pres & VP) 1,679,167 1,679,167 1,679,167 1,679,167 1,679,167 1,679,167 1,679,167
Director 6,895,850 6,895,850 6,895,850 6,895,850 6,895,850 6,895,850 6,895,850
Office Mger 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722
1 Staff (Personnel & General
Ad) 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778
1 Assistant Staff (Account) 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778
Team Mger Of Content 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944
Staff 1 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778
Staff 2 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111
Team Mger Of Marketing & Sales 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944
Staff 1 (Marketing) 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167
Staff 2 (Marketing) 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111
Web Master 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778
Web Staff 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111
Team Mger System Operations 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944
System Engineer 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778
1 System Staff 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111
Encoding Staff 1 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778
Encoding Staff 1 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111
Clerk 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778
Receptionist 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778
<CAPTION>
Budget - Year One
Number of TMCs 18 22 22 25 25 % of Total
Sales in Units Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Year 3 Sales
------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Song Units Sold 2,830,464 3,459,456 3,459,456 3,931,200 3,931,200 33,965,568
Prepaid Accounts 10,000 10,000 10,000 10,000 10,000 120,000
Total Unit Sales 2,840,464 3,469,456 3,469,456 3,941,200 3,941,200 34,085,568 100.00%
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 577,414,656 705,729,024 705,729,024 801,964,800 801,964,800 6,928,975,872 43.25%
Distribution Fee (LAK) 12% 407,586,816 498,161,664 498,161,664 566,092,800 566,092,800 4,891,041,792 30.53%
Prepaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 1,392,000,000 8.69%
M.O.D. System Sales - 400,000,000 - 840,000,000 - 2,480,000,000 15.48%
Music Server Software Sales - 75,000,000 - 56,250,000 - 262,500,000 1.64%
Maintenance fee (20% of
software) 5,625,000 6,875,000 6,875,000 7,812,500 7,812,500 67,500,000 0.42%
Total Sales: Korean Won 1,106,626,472 1,801,765,688 1,326,765,688 2,388,120,100 1,491,870,100 16,022,017,664 100.00%
Total Sales: US Dollar $922,189 $1,501,471 $1,105,638 $1,990,100 $1,243,225 $13,351,681
<CAPTION>
% of Total
Cost of Goods Sold Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Year 3 Sales
------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Connection Cost (2 El lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 96,000,000 0.60%
M.O.D. System Cost - 320,000,000 - 672,000,000 - 1,984,000,000 12.38%
Music Server Software Cost - 52,500,000 - 39,375,000 - 183,750,000 1.15%
Total Variable COGS 8,000,000 380,500,000 8,000,000 719,375,000 8,000,000 2,263,750,000 14.13%
% of Total Sales 0.72% 21.12% 0.60% 30.12% 0.54% 14.13%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 9,194,467 9,194,467 9,194,467 9,194,467 9,194,467 110,333,600 0.69%
Vice President 8,045,158 8,045,158 8,045,158 8,045,158 8,045,158 96,541,900 0.60%
Secretary (Pres & VP) 1,679,167 1,679,167 1,679,167 1,679,167 1,679,167 20,150,000 0.13%
Director 6,895,850 6,895,850 6,895,850 6,895,850 6,895,850 82,750,200 0.52%
Office Mger 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722 37,916,667 0.24%
1 Staff (Personnel & General
Ad) 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 30,333,333 0.19%
1 Assistant Staff (Account) 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 18,633,333 0.12%
Team Mger Of Content 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 46,583,333 0.29%
Staff 1 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 30,333,333 0.19%
Staff 2 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 23,833,333 0.15%
Team Mger Of Marketing & Sales 3,881,944 3,881,944 3,881,944 3,881,944 3,881,944 46,583,333 0.29%
Staff 1 (Marketing) 2,979,167 2,979,167 2,979,167 2,979,167 2,979,167 35,750,000 0.22%
Staff 2 (Marketing) 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 23,833,333 0.15%
Web Master 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 30,333,333 0.19%
Web Staff 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 23,833,333 0.15%
Team Mger System Operations 3,881,994 3,881,994 3,881,994 3,881,994 3,881,994 46,583,333 0.29%
System Engineer 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 30,333,333 0.19%
1 System Staff 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 23,833,333 0.15%
Encoding Staff 1 2,527,778 2,527,778 2,527,778 2,527,778 2,527,778 30,333,333 0.19%
Encoding Staff 1 1,986,111 1,986,111 1,986,111 1,986,111 1,986,111 23,833,333 0.15%
Clerk 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 18,633,333 0.12%
Receptionist 1,552,778 1,552,778 1,552,778 1,552,778 1,552,778 18,633,333 0.12%
</TABLE>
Page 1
<PAGE>
LAK Yr 3
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental fee 10,000,000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000
Total Fixed Cost of Goods & 80,827,142 80,827,142 80,827,142 80,827,142 80,827,142 80,827,142
Services
% of Total Sales 7.565% 9.72% 6.82% 9.12% 6.55% 8.11%
Total Cost of Goods Sold 275,077,142 88,827,142 325,952,142 88,827,142 275,077,142 88,827,142
Gross Profit 793,875,310 742,625,310 859,285,114 797,660,114 958,979,722 907,729,722
% of Total Sales 74.27% 89.32% 72.50% 89.98% 77.71% 91.09%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 7.30% 9.38% 6.58% 8.80% 6.32% 7.83%
General & Administrative Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01
------ ------ ------ ------ ------ ------
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 58,958,333 58,958,333 58,958,333 58,958,333 58,958,333 58,958,333
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 64,958,333 64,958,333 64,958,333 64,958,333 64,958,333 64,958,333
% Total Sales 6.08% 7.81% 5.48% 7.33% 5.26% 6.52%
Total Operating Expenses 142,958,333 142,958,333 142,958,333 142,958,333 142,958,333 142,958,333
% of Total Sales 13.37% 17.19% 12.06% 16.13% 11.58% 14.35%
Income From Operations 650,916,977 599,666,977 716,326,781 654,701,781 816,021,389 764,771,389
% of Total Sales 60.89% 72.12% 60.44% 73.85% 66.13% 76.74%
Liquid Audio Royalty Payment - - 600,000,000 - - 800,000,000
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) 12,562,500 8,812,500 7,687,500 3,750,000 - -
Total Royalty/Loan Interest
Payment 12,562,500 8,812,500 607,687,500 3,750,000 - 800,000,000
Income before Taxes 638,354,477 590,854,477 108,639,281 650,951,781 816,021,389 (35,228,611)
Taxes on Income 172,355,709 159,530,709 29,332,606 175,756,981 220,325,775 (9,511,725)
Net Income After Taxes 465,998,768 431,323,768 79,306,675 475,194,800 595,695,614 (25,716,886)
% of Total Sales 43.59% 51.88% 6.69% 53.60% 48.27% -2.58%
Net Income After Taxes (US$) $ 372,799.01 $ 345,059.01 $ 63,445.34 $ 380,155.84 $ 476,556.49 $ (20,573.51)
Net Income: (Running Total) $ (457,315.57) $ (112,256.55) $ (48,811.21) $ 331,344.63 $ 807,901.12 $ 787,327.61
Liquid Audio Royalty Payment $ 480,000.00 $ 640,000.00
LAK Initial Funds in this year $ 161,218.75
Total Loan from SKM $ 1,340,000.00 $ 940,000.00 $ 820,000.00 $ 400,000.00 $ - $ -
Loan from SKM $ - $ - $ 400,000.00 $ - $ - $ 640,000.00
Loan Repayment to SKM $ 100,000.00 $ 400,000.00 $ 600,000.00 $ 420,000.00 $ 400,000.00 $ 640,000.00
Depreciation (cash-in) $ 47,166.67 $ 47,166.67 $ 47,166.67 $ 47,166.67 $ 47,166.67 $ 47,166.67
3 months Exploratory Period $ -
Total Invest For System $ 2,264,000.00 $ 2,264,000.00 $ 2,264,000.00 $ 2,264,000.00 $2,264,000.00$ 2,264,000.00
Central Repository /
additional invest. $ 320,000.00
Total Initial Funds Available $ (158,781.25)
Total Funds Available Mon. to Mon. $ 161,184.43 $ 153,420.11 $ 144,022.12 $ 151,344.63 $ 275,067.78 $ 301,680.94
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental fee 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000
Total Fixed Cost of Goods & 80,827,142 80,827,142 80,827,142 80,827,142 80,827,142 80,827,142
Services
% of Total Sales 4.74% 7.30% 4.49% 6.09% 3.38% 5.42%
Total Cost of Goods Sold 563,077,142 88,827,142 461,327,142 88,827,142 800,202,142 88,827,142
Gross Profit 1,141,049,330 1,017,799,330 1,340,438,546 1,237,938,546 1,587,917,958 1,403,042,958
% of Total Sales 66.96% 91.97% 74.40% 93.30% 66.49% 94.05%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 4.58% 7.05% 4.33% 5.88% 3.27% 5.23%
General & Administrative Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01
------ ------ ------ ------ ------ ------
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 67,291,667 67,291,667 67,291,667 67,291,667 67,291,667 67,291,667
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 73,291,667 73,291,667 73,291,667 73,291,667 73,291,667 73,291,667
% Total Sales 4.30% 6.62% 4.07% 5.52% 3.07% 4.91%
Total Operating Expenses 151,291,667 151,291,667 151,291,667 151,291,667 151,291,667 151,291,667
% of Total Sales 8.88% 13.67% 8.48% 11.40% 6.34% 10.14%
Income From Operations 989,757,664 866,507,664 1,189,146,880 1,086,646,880 1,436,626,292 1,251,751,292
% of Total Sales 58.08% 78.30% 66.00% 81.90% 60.16% 83.90%
Liquid Audio Royalty Payment - - 800,000,000 - - -
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) - - - - - -
Total Royalty/Loan Interest - - 800,000,000 - - -
Payment
Income before Taxes 989,757,664 866,507,664 389,146,880 1,086,646,880 1,436,626,292 1,251,751,292
Taxes on Income 267,234,569 233,957,069 105,069,658 293,394,658 387,889,099 337,972,849
Net Income After Taxes 722,523,094 632,550,594 284,077,222 793,252,222 1,048,737,193 913,778,443
% of Total Sales 42.40% 57.16% 15.77% 59.79% 43.91% 61.25%
Net Income After Taxes (US$) $ 578,018.48 $ 506,040.48 $ 227,261.78 $ 634,601.78 $ 838,909.75 $ 731,022.75
Net Income: (Running Total) $ 1,365,346.0 $ 1,871,386.56 $ 2,098,648.34 $ 2,733,250.11 $ 3,572,239.87 $ 4,303,262.62
Liquid Audio Royalty Payment $ 640,000.00
LAK Initial Funds in this year
Total Loan from SKM $ - $ - $ - $ - $ - $ -
Loan from SKM $ - $ - $ 640,000.00 $ - $ - $ -
Loan Repayment to SKM $ - $ - $ 640,000.00 $ - $ - $ -
Depreciation (cash-in) $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33
3 months Exploratory Period
Total Invest For System $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00$ 2,584,000.00 $2,584,000.00
Central Repository /
additional invest. $ 320,000.00
Total Initial Funds Available
Total Funds Available Mon. to Mon. $ 613,512.73 $ 1,173,386.56 $ 1,434,481.67$ 2,142,916.78 $ 3,035,739.87 $ 3,820,595.96
<CAPTION>
<S> <C> <C>
Facility Expense/Office rental fee 120,00000 0.75%
Total Fixed Cost of Goods &
Services 969,925,700 6.05%
% of Total Sales 6.05%
Total Cost of Goods Sold 3,233,672,700 20.18%
Gross Profit 12,788,341,964 79.82%
% of Total Sales 79.82%
Operating Expenses
Sales & Marketing
Advertising & Promotions 720,000,000 4.49%
Commissions 30 0.00%
Entertainment 180,000,000 1.12%
Literature 36,000,000 0.22%
Total Sales & Marketing Costs 936,000,000 5.84%
% Total of Sales 5.84%
% of
Total
General & Administrative Year 3 Sales
------ -----
Accounting & Lawyer Fee 30,000,000 0.19%
Depreciation (4 years) 757,500,000 4.73%
Insurance 6,000,000 0.04%
License and Legal Fees - 0.00%
Telephone 18,000,000 0.11%
Utilities 18,000,000 0.11%
Total G & A Costs 829,500,000 5.18%
% Total Sales 5.18%
Total Operating Expenses 1,765,500,000 11.02%
% of Total Sales 11.02%
Income From Operations 11,022,841,964 68.80%
% of Total Sales 68.80%
Liquid Audio Royalty Payment 2,200,000,000 13.73%
LA Royalty Tax Payment
Loan Interest Payment (9%) 32,812,500 0.20%
Total Royalty/Loan Interest
Payment 2,232,812,500 13.94%
Income before Taxes 8,790,029,464 54.86%
Taxes on Income 2,373.307,955
Net Income After Taxes 6,416,721,509 40.05%
% of Total Sales 40.05%
Net Income After Taxes (US$) $ 5,133,377.21
Net Income: (Running Total)
Liquid Audio Royalty Payment $ 1,760,000.00
LAK Initial Funds in this year
Total Loan from SKM
Loan from SKM $ 1,760,000.00
Loan Repayment to SKM $ 3,200,000.00
Depreciation (cash-in) $ 606,000.00
3 months Exploratory Period
Total Invest For System
Central Repository /
additional invest. $ 640,000.00
Total Initial Funds Available
Total Funds Available Mon.
to Mon.
</TABLE>
<PAGE>
LAK Yr 4
Liquid Audio Korea
TMC
- ---
Max Capacity of TMC (Albums) 241,920 *based on 2 CDs sold per hour
Total Albums 241,920 at 28 music stations with 12
hour days, 30 day months
and for 12 months.
Percentage of capacity utilized 70% 470 per day
Total Albums Sold 169,344 *based on 12 song albums.
Total Songs Sold 2,032,128
Won
Sale Price Per Song 1,200
50,000
41.66666667
<TABLE>
<CAPTION>
Budget - Year One
Number of TMCs 25 25 25 25 25 25 25
Sales in Units Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02
------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Song Units Sold 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600
Prepaid Accounts 10,000 10,000 10,000 10,000 10,000 10,000 10,000
Total Unit Sales 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400
Distribution Fee (LAK) 12% 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400
Prepaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000
M.O.D. System Sales - - - - - - -
Music Server Software Sales - - - - - - -
Maintenance fee (20% of
software) 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500
Total Sales: Korean Won 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300
Total Sales: US Dollar $1,330,921 $1,330,921 $1,330,921 $1,330,921 $1,330,921 $1,330,921 $1,330,921
<CAPTION>
Cost of Goods Sold Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02
------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Connection Cost (2 El lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
M.O.D. System Cost - - - - - - -
Music Server Software Cost - - - - - - -
Total Variable COGS 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
% of Total Sales 0.50% 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 9,470,301 9,470,301 9,470,301 9,470,301 9,470,301 9,470,301 9,470,301
Vice President 8,286,513 8,286,513 8,286,513 8,286,513 8,286,513 8,286,513 8,286,513
Secretary (Pres & VP) 1,751,389 1,751,389 1,751,389 1,751,389 1,751,389 1,751,389 1,751,389
Director 7,102,726 7,102,726 7,102,726 7,102,726 7,102,726 7,102,726 7,102,726
Office Mger 3,250,000 3,250,000 3,250,000 3,250,000 3,250,000 3,250,000 3,250,000
1 Staff (Personnel & General Ad) 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056
1 Assistant Staff (Account) 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000
Team Mger Of Content 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778
Staff 1 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056
Staff 2 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Team Mger Of Marketing & Sales 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778
Staff 1 (Marketing) 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444
Staff 2 (Marketing) 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Web Master 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056
Web Staff 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Team Mger System Operations 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778
System Engineer 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056
1 System Staff 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Encoding Staff 1 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056
Encoding Staff 1 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944
Clerk 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000
Receptionist 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000
<CAPTION>
Number of TMCs 25 25 25 25 25 % of
Total
Sales in Units Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Year 4 Sales
------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Song Units Sold 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 50,803,200
Prepaid Accounts 10,000 10,000 10,000 10,000 10,000 120,000
Total Unit Sales 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 50,923,200 100.00%
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400 10,363,852,800 54.08%
Distribution Fee (LAK) 12% 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400 7,315,660,800 38.17%
Prepaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 1,392,000,000 7.26%
M.O.D. System Sales - - - - - - 0.00%
Music Server Software Sales - - - - - - 0.00%
Maintenance fee (20% of
software) 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500 93,750,000 0.49%
Total Sales: Korean Won 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 19,165,263,600 100.00%
Total Sales: US Dollar $1,330,921 $1,330,921 $1,330,921 $1,330,921 $1,330,921 $15,971,053
<CAPTION>
% of
Total
Cost of Goods Sold Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Year 4 Sales
------ ------ ------ ------ ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Connection Cost (2 El lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 96,000,000 0.50%
M.O.D. System Cost - - - - - - 0.00%
Music Server Software Cost - - - - - - 0.00%
Total Variable COGS 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 96,000,000 0.50%
% of Total Sales 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 9,470,301 9,470,301 9,470,301 9,470,301 9,470,301 113,643,608 0.59%
Vice President 8,286,513 8,286,513 8,286,513 8,286,513 8,286,513 99,438,157 0.52%
Secretary (Pres & VP) 1,751,389 1,751,389 1,751,389 1,751,389 1,751,389 21,016,667 0.11%
Director 7,102,726 7,102,726 7,102,726 7,102,726 7,102,726 85,232,706 0.44%
Office Mger 3,250,000 3,250,000 3,250,000 3,250,000 3,250,000 39,000,000 0.20%
1 Staff (Personnel & General Ad) 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 31,416,667 0.16%
1 Assistant Staff (Account) 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 19,500,000 0.10%
Team Mger Of Content 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 49,833,333 0.26%
Staff 1 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 31,416,667 0.16%
Staff 2 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 0.14%
Team Mger Of Marketing & Sales 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 49,833,333 0.26%
Staff 1 (Marketing) 3,069,444 3,069,444 3,069,444 3,069,444 3,069,444 36,833,333 0.19%
Staff 2 (Marketing) 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 0.14%
Web Master 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 31,416,667 0.16%
Web Staff 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 0.14%
Team Mger System Operations 4,152,778 4,152,778 4,152,778 4,152,778 4,152,778 49,833,333 0.26%
System Engineer 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 31,416,667 0.16%
1 System Staff 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 0.14%
Encoding Staff 1 2,618,056 2,618,056 2,618,056 2,618,056 2,618,056 31,416,667 0.16%
Encoding Staff 1 2,256,944 2,256,944 2,256,944 2,256,944 2,256,944 27,083,333 0.14%
Clerk 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 19,500,000 0.10%
Receptionist 1,625,000 1,625,000 1,625,000 1,625,000 1,625,000 19,500,000 0.10%
</TABLE>
Page 1
<PAGE>
<TABLE>
<CAPTION>
LAK Yr 4
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental 10,000,000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000
fee
Total Fixed Cost of Goods & 84,638,706 84,638,706 84,638,706 84,638,706 84,638,706 84,638,706
Services
% of Total Sales 5.30% 5.30% 5.30% 5.30% 5.30% 5.30%
Total Cost of Goods Sold 92,638,706 92,638,706 92,638,706 92,638,706 92,638,706 92,638,706
Gross Profit 1,504,466,594 1,504,466,594 1,504,466,594 1,504,466,594 1,504,466,594 1,504,466,594
% of Total Sales 94.20% 94.20% 94.20% 94.20% 94.20% 94.20%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 4.88% 4.88% 4.88% 4.88% 4.88% 4.88%
<CAPTION>
General & Administrative Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 67,291,667 67,291,667 67,291,667 67,291,667 67,291,667 67,291,667
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 73,291,667 73,291,667 73,291,667 73,291,667 73,291,667 73,291,667
% Total Sales 4.59% 4.59% 4.59% 4.59% 4.59% 4.59%
Total Operating Expenses 151,291,667 151,291,667 151,291,667 151,291,667 151,291,667 151,291,667
% of Total Sales 9.47% 9.47% 9.47% 9.47% 9.47% 9.47%
Income From Operations 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927
% of Total Sales 84.73% 84.73% 84.73% 84.73% 84.73% 84.73%
Liquid Audio Royalty Payment - - - - - -
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) - - - - - -
Total Royalty/Loan Interest - - - - - -
Payment
Income before Taxes 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927
Taxes on Income 365,357,230 365,357,230 365,357,230 365,357,230 365,357,230 365,357,230
Net Income After Taxes 987,817,697 987,817,697 987,817,697 987,817,697 987,817,697 987,817,697
% of Total Sales 61.89% 61.89% 61.89% 61.89% 61.89% 61.89%
Net Income After Taxes (US$) $ 790,254.16 $ 790,254.16 $ 790,254.16 $ 790,254.16 $ 790,254.16 $ 790,254.16
Net Income: (Running Total) $ 5,093,516.78 $ 5,883,770.94 $ 6,674,025.10 $ 7,464,279.25 $ 8,254,533.41 $ 9,044,787.57
Liquid Audio Royalty Payment
LAK Initial Funds $ 3,820,595.96
in ths year
Total Loan from SKM $ - $ - $ - $ - $ - $ -
Loan from SKM $ - $ - $ - $ - $ - $ -
Loan Repayment to SKM $ - $ - $ - $ - $ - $ -
Depreciation (cash-in) $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33
3 months Exploratory Period $ -
Total Invest For System $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.0
Central Repository / $ -
additional invest
Total Initial Funds Available $ 3,820,595.96
Total Funds Available Mon. to $ 4,664,583.45 $ 5,508,770.94 $ 6,352,858.43 $ 7,196,945.92 $ 8,041,033.41 $ 8,885,120.9
Mon
<CAPTION>
LAK Yr 4
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000
fee
Total Fixed Cost of Goods & 84,638,706 84,638,706 84,638,706 84,638,706 84,638,706 84,638,706
Services
% of Total Sales 5.30% 5.30% 5.30% 5.30% 5.30% 5.30%
Total Cost of Goods Sold 92,638,706 92,638,706 92,638,706 92,638,706 92,638,706 92,638,706
Gross Profit 1,504,466,594 1,504,466,594 1,504,466,594 1,504,466,594 1,504,466,594 1,504,466,594
% of Total Sales 94.20% 94.20% 94.20% 94.20% 94.20% 94.20%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 4.88% 4.88% 4.88% 4.88% 4.88% 4.88%
<CAPTION>
General & Administrative Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 67,291,667 67,291,667 67,291,667 67,291,667 67,291,667 67,291,667
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 73,291,667 73,291,667 73,291,667 73,291,667 73,291,667 73,291,667
% Total Sales 4.59% 4.59% 4.59% 4.59% 4.59% 4.59%
Total Operating Expenses 151,291,667 151,291,667 151,291,667 151,291,667 151,291,667 151,291,667
% of Total Sales 9.47% 9.47% 9.47% 9.47% 9.47% 9.47%
Income From Operations 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927
% of Total Sales 84.73% 84.73% 84.73% 84.73% 84.73% 84.73%
Liquid Audio Royalty Payment - - - - - -
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) - - - - - -
Total Royalty/Loan Interest - - - - - -
Payment
Income before Taxes 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927 1,353,174,927
Taxes on Income 365,357,230 365,357,230 365,357,230 365,357,230 365,357,230 365,357,230
Net Income After Taxes 987,817,697 987,817,697 987,817,697 987,817,697 987,817,697 987,817,697
% of Total Sales 61.89% 61.89% 61.89% 61.89% 61.89% 61.89%
Net Income After Taxes (US$) $ 790,254.16 $ 790,254.16 $ 790,254.16 $ 790,254.16 $ 790,254.16 $ 790,254.16
Net Income: (Running Total) $ 9,835,041.73 $10,625,295.88 $11,415,550.04 $12,205,804.20 $12,996,058.36 $ 13,786,312.51
Liquid Audio Royalty Payment
LAK Initial Funds
in this year
Total Loan from SKM $ - $ - $ - $ - $ - $ -
Loan from SKM $ - $ - $ - $ - $ - $ -
Loan Repayment to SKM $ - $ - $ - $ - $ - $ -
Depreciation (cash-in) $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33 $ 53,833.33
3 months Exploratory Period
Total Invest For System $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00 $ 2,584,000.00
Central Repository /
additional invest
Total Initial Funds Available
Total Funds Available Mon. to $ 9,729,208.39 $10,573,295.88 $11,417,383.37 $12,261,479.87 $13,105,558.36 $13,949,545.53
Mon
<CAPTION>
LAK Yr 4
<S> <C> <C>
Facility Expense/Office rental 120,000,000 0.63%
fee
Total Fixed Cost of Goods & 1,015,664,471 5.30%
Services
% of Total Sales 5.30%
Total Cost of Goods Sold 1,111,664,471 5.80%
Gross Profit 18,053,599,129 94.20%
% of Total Sales 94.20%
Operating Expenses
Sales & Marketing
Advertising & Promotions 720,000,000 3.76%
Commissions 30 0.00%
Entertainment 180,000,000 0.94%
Literature 36,000,000 0.19%
Total Sales & Marketing Costs 936,000,000 4.88%
% Total of Sales 4.88%
% of
General & Administrative Total
Year 4 Sales
------ -----
Accounting & Lawyer Fee 30,000,000 0.16%
Depreciation (4 years) 807,500,000 4.21%
Insurance 6,000,000 0.03%
License and Legal Fees - 0.00%
Telephone 18,000,000 0.09%
Utilities 18,000,000 0.09%
Total G & A Costs 879,500,000 4.59%
% Total Sales 4.59%
Total Operating Expenses 1,815,500,000 9.47%
% of Total Sales 9.47%
Income From Operations 16,238,099,129 84.73%
% of Total Sales 84.73%
Liquid Audio Royalty Payment - 0.00%
LA Royalty Tax Payment - 0.00%
Loan Interest Payment (9%) - 0.00%
Total Royalty/Loan Interest - 0.00%
Payment
Income before Taxes 16,238,099,129 84.73%
Taxes on Income 4,384,286,765
Net Income After Taxes 11,853,812,364 61.89%
% of Total Sales 61.89%
Net Income After Taxes (US$) 9,483,049.89
Net Income: (Running Total)
Liquid Audio Royalty Payment -
LAK Initial Funds
Total Loan from SKM
Loan from SKM
Loan Repayment to SKM
Depreciation (cash-in)
3 months Exploratory Period
Total Invest For System
Central Repository /
additional invest.
Total Initial Funds Available
Total Funds Available Mon. to
Mon.
</TABLE>
Page 2
<PAGE>
LAK Yr 5
Liquid Audio Korea
TMC
- ---
Max Capacity of TMC (Albums) 241,920 * based on 2 CDs sold per hour
Total Albums 241,920 at 28 music stations with 12
hour days, 30 day months
and for 12 months.
Percentage of capacity utilized 70%
Total Albums Sold 169,344 470 per day
Total Songs Sold 2,032,128 * based on 12 song albums.
Sale Price Per Song 1,200 Won
-----------
50,000
41.66666667
<TABLE>
<CAPTION>
Budget - Year One
Number of TMCs 25 25 25 25 25 25
Sales in Units Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Song Units Sold 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600
Prepaid Accounts 10,000 10,000 10,000 10,000 10,000 10,000
Total Unit Sales 4,243,600 4,243,600 4,243,600 4,243,600 4,243,600 4,243,600
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400
Distribution Fee (LAK) 12% 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400
PrePaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000
M.O.D. System Sales - - - - - -
Music Server Software Sales - - - - - -
Maintenance fee (20% of
software) 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500
Total Sales: Korean Won 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300
Total Sales: US Dollar $1,330.921 $1,330.921 $1,330.921 $1,330.921 $1,330.921 $1,330.921
Cost of Goods Sold Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03
------ ------ ------ ------ ------ ------
Connection Cost (2 E1 lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
M.O.D. System Costs - - - - - -
Music Server Software Cost - - - - - -
Total Variable COGS 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
% of Total Sales 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 9,754,410 9,754,410 9,754,410 9,754,410 9,754,410 9,754,410
Vice President 8,535,108 8,535,108 8,535,108 8,535,108 8,535,108 8,535,108
Secretary (Pres.&VP) 1,823,611 1,823,611 1,823,611 1,823,611 1,823,611 1,823,611
Director 7,315,807 7,315,807 7,315,807 7,315,807 7,315,807 7,315,807
Office Mger 3,340,278 3,340,278 3,340,278 3,340,278 3,340,278 3,340,278
1 Staff (Personnel & General Ad.) 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
1 Assistant Staff (Account) 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222
Team Mger Of Content 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056
Staff 1 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Staff 2 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Team Mger Of Marketing & Sales 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056
Staff 1 (marketing) 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722
Staff 2 (marketing) 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Web Master 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Web Staff 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Team Mger System Operations 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056
System Engineer 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
1 System Staff 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Encoding staff 1 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Encoding staff 1 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Clerk 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222
Receptionist 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222
<CAPTION>
Budget - Year One
Number of TMCs 25 25 25 25 25 25
Sales in Units Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Song Units Sold 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600 4,233,600
Prepaid Accounts 10,000 10,000 10,000 10,000 10,000 10,000
Total Unit Sales 4,243,600 4,243,600 4,243,600 4,243,600 4,243,600 4,243,600
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400 863,654,400
Distribution Fee (LAK) 12% 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400 609,638,400
PrePaid Membership Accounts
29% per account 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000 116,000,000
M.O.D. System Sales - - - - - -
Music Server Software Sales - - - - - -
Maintenance fee (20% of
software) 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500 7,812,500
Total Sales: Korean Won 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300 1,597,105,300
Total Sales: US Dollar $1,330.921 $1,330.921 $1,330.921 $1,330.921 $1,330.921 $1,330.921
Cost of Goods Sold Jan-03 Jan-03 Jan-03 Jan-03 Jan-03 Jan-03
------ ------ ------ ------ ------ ------
Connection Cost (2 E1 lines) 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
M.O.D. System Costs - - - - - -
Music Server Software Cost - - - - - -
Total Variable COGS 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 8,000,000
% of Total Sales 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 9,754,410 9,754,410 9,754,410 9,754,410 9,754,410 9,754,410
Vice President 8,535,108 8,535,108 8,535,108 8,535,108 8,535,108 8,535,108
Secretary (Pres. & VP) 1,823,611 1,823,611 1,823,611 1,823,611 1,823,611 1,823,611
Director 7,315,807 7,315,807 7,315,807 7,315,807 7,315,807 7,315,807
Office Mger 3,340,278 3,340,278 3,340,278 3,340,278 3,340,278 3,340,278
1 Staff (Personnel & General Ad.) 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
1 Assistant Staff (Account) 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222
Team Mger Of Content 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056
Staff 1 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Staff 2 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Team Mger Of Marketing & Sales 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056
Staff 1 (marketing) 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722 3,159,722
Staff 2 (marketing) 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Web Master 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Web Staff 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Team Mger System Operations 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056 4,243,056
System Engineer 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
1 System Staff 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Encoding staff 1 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333 2,708,333
Encoding staff 1 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222 2,347,222
Clerk 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222
Receptionist 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222 1,697,222
<CAPTION>
Budget - Year One
Number of TMCs % of Total
Sales in Units Year 5 Sales
------ -----
<S> <C> <C>
Song Units Sold 50,803,200
Prepaid Accounts 120,000
Total Unit Sales 50,923,200 100.00%
Sales Revenue
TMC Network
Reporting Fee (LOC) 17% 10,363,852,800 54.08%
Distribution Fee (LAK) 12% 7,315,660,800 38.17%
PrePaid Membership Accounts
29% per account 1,392,000,000 7.26%
M.O.D. System Sales - 0.00%
Music Server Software Sales - 0.00%
Maintenance fee (20% of
software) 93,750,000 0.49%
Total Sales: Korean Won 19,165,263,600 100.00%
Total Sales: US Dollar $15,971,053
Cost of Goods Sold Year 5 Sales
------ -----
Connection Cost (2 E1 lines) 96,000,000 0.50%
M.O.D. System Costs - 0.00%
Music Server Software Cost - 0.00%
Total Variable COGS 96,000,000 0.50%
% of Total Sales 0.50%
Fixed Cost of Goods & Services
LAK Staff Salaries
President/Managing Director 117,052,917 0.61%
Vice President 102,421,302 0.53%
Secretary (Pres. & VP) 21,883,233 0.11%
Director 87,789,687 0.46%
Office Mger 40,083,333 0.21%
1 Staff (Personnel & General Ad.) 32,500,000 0.17%
1 Assistant Staff (Account) 20,366,667 0.11%
Team Mger Of Content 50,916,667 0.27%
Staff 1 32,500,000 0.17%
Staff 2 28,166,667 0.15%
Team Mger Of Marketing & Sales 50,916,667 0.27%
Staff 1 (marketing) 37,916,667 0.20%
Staff 2 (marketing) 28,166,667 0.15%
Web Master 32,500,000 0.17%
Web Staff 28,166,667 0.15%
Team Mger System Operations 50,916,667 0.27%
System Engineer 32,500,000 0.17%
1 System Staff 28,166,667 0.15%
Encoding staff 1 32,500,000 0.17%
Encoding staff 1 28,166,667 0.15%
Clerk 20,366,667 0.11%
Receptionist 20,366,667 0.11%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
LAK Yr 5
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental
fee 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Total Fixed Cost of Goods &
Services 87,027,548 87,027,548 87,027,548 87,027,548 87,027,548 87,027,548
% of Total Sales 5.45% 5.45% 5.45% 5.45% 5.45% 5.45%
Total Cost of Goods Sold 95,027,548 95,027,548 95,027,548 95,027,548 95,027,548 95,027,548
Gross Profit 1,502,077,752 1,502,077,752 1,502,077,752 1,502,077,752 1,502,077,752 1,502,077,752
% of Total Sales 94.05% 94.05% 94.05% 94.05% 94.05% 94.05%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 4.88% 4.88% 4.88% 4.88% 4.88% 4.88%
General & Administrative Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03
------ ------ ------ ------ ------ ------
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 62,500,000 62,500,000 45,833,333 45,833,333 45,833,333 45,833,333
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 68,500,000 68,500,000 51,833,333 51,833,333 51,833,333 51,833,333
% Total Sales 4.29% 4.29% 3.25% 3.25% 3.25% 3.25%
Total Operating Expenses 146,500,000 146,500,000 129,833,333 129,833,333 129,833,333 129,833,333
% of Total Sales 9.17% 9.17% 8.13% 8.13% 8.13% 8.13%
Income From Operations 1,355,577,752 1,355,577,752 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419
% of Total Sales 84.88% 84.88% 85.92% 85.92% 85.92% 85.92%
Liquid Audio Royalty Payment - - - - - -
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) - - - - - -
Total Royalty/Loan Interest
Payment - - - - - -
Income before Taxes 1,355,577,752 1,355,577,752 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419
Taxes on Income 366,005,993 366,005,993 370,505,993 370,505,993 370,505,993 370,505,993
Net Income After Taxes 989,571,759 989,571,759 1,001,738,426 1,001,738,426 1,001,738,426 1,001,738,426
% of Total Sales 61.96% 61.96% 62.72% 62.72% 62.72% 62.72%
Net Income After Taxes (US$) $ 791,657.41 $ 791,657.41 $ 801,390.74 $ 801,390.74 $ 801,390.74 $ 801,390.74
Net Income: (Running Total) $14,577,969.92 $15,369,627.33 $16,171,018.07 $16,972,408.81 $17,773,799.55 $18,575,190.29
Liquid Audio Royalty Payment
LAK Initial Funds in this year $13,949,645.85
Total Loan from SKM $ - $ - $ - $ - $ - $ -
Loan from SKM $ - $ - $ - $ - $ - $ -
Loan Repayment to SKM $ - $ - $ - $ - $ - $ -
Depreciation (cash-in) $ 50,000.00 $ 50,000.00 $ 36,666.67 $ 36,666.67 $ 36,666.67 $ 36,666.67
3 months Exploratory Period $ -
Total Invest For System $ 2,400,000.00 $ 2,400,000.00 $ 1,760,000.00 $ 1,760,000.00 $ 1,760,000.00 $ 1,760,000.00
Central Repository / additional
invest $ -
Total Initial Funds Available $13,949,645.85
Total Funds Available Mon. to
Mon $4,791,303.23 $15,632,960.66 $ 16,471,018.07 $17,309,073.48 $18,147,132.88 $18,985,190.29
<CAPTION>
LAK Yr 5
<S> <C> <C> <C> <C> <C> <C>
Facility Expense/Office rental
fee 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Total Fixed Cost of Goods &
Services 87,027,548 87,027,548 87,027,548 87,027,548 87,027,548 87,027,548
% of Total Sales 5.45% 5.45% 5.45% 5.45% 5.45% 5.45%
Total Cost of Goods Sold 95,027,548 95,027,548 95,027,548 95,027,548 95,027,548 95,027,548
Gross Profit 1,502,077,752 1,502,077,752 1,502,077,752 1,502,077,752 1,502,077,752 1,502,077,752
% of Total Sales 94.05% 94.05% 94.05% 94.05% 94.05% 94.05%
Operating Expenses
Sales & Marketing
Advertising & Promotions 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000 60,000,000
Commissions
Entertainment 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000
Literature 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Total Sales & Marketing Costs 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000 78,000,000
% Total of Sales 4.89% 4.89% 4.89% 4.89% 4.89% 4.89%
General & Administrative Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03
------ ------ ------ ------ ------ ------
Accounting & Lawyer Fee 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000
Depreciation (4 years) 45,833,333 45,833,333 45,833,333 45,833,333 45,833,333 45,833,333
Insurance 500,000 500,000 500,000 500,000 500,000 500,000
License and Legal Fees - - - - - -
Telephone 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Utilities 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000 1,500,000
Total G & A Costs 51,833,333 51,833,333 51,833,333 51,833,333 51,833,333 51,833,333
% Total Sales 3.25% 3.25% 3.25% 3.25% 3.25% 3.29%
Total Operating Expenses 129,833,333 129,833,333 129,833,333 129,833,333 129,833,333 129,833,333
% of Total Sales 8.13% 8.13% 8.13% 8.13% 8.13% 8.13%
Income From Operations 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419
% of Total Sales 85.92% 85.92% 85.92% 85.92% 85.92% 85.92%
Liquid Audio Royalty Payment - - - - - -
LA Royalty Tax Payment - - - - - -
Loan Interest Payment (9%) - - - - - -
Total Royalty/Loan Interest - - - - - -
Payment
Income before Taxes 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419 1,372,244,419
Taxes on Income 370,505,993 370,505,993 370,505,993 370,505,993 370,505,993 370,505,993
Net Income After Taxes 1,001,738,426 1,001,738,426 1,001,738,426 1,001,738,426 1,001,738,426 1,001,738,426
% of Total Sales 62.72% 62.72% 62.72% 62.72% 62.72% 62.72%
Net Income After Taxes (US$) $ 801,390.74 $ 801,390.74 $ 801,390.74 $ 801,390.74 $ 801,390.74 $ 801,390.74
Net Income: (Running Total) $19,376,581.03 $20,177,971.77 $20,979,362.51 $1,780,753.25 $22,582,144.00 $23,383,534.74
Liquid Audio Royalty Payment
LAK Initial Funds in this year
Total Loan from SKM $ - $ - $ - $ - $ - $ -
Loan from SKM $ - $ - $ - $ - $ - $ -
Loan Repayment to SKM $ - $ - $ - $ - $ - $ -
Depreciation (cash-in) $ 36,666.67 $ 36,666.67 $ 36,666.67 $ 36,666.67 $ 36,666.67 $ 36,666.67
3 months Exploratory Period
Total Invest For System $ 1,760,000.00 $ 1,760,000.00 $ 1,760,000.00 $1,760,000.00 $ 1,760,000.00 $ 1,760,000.00
Central Repository / additional
invest
Total Initial Funds Available
Total Funds Available Mon. to
Mon $19,823,247.70 $20,661,305.51 $21,499,362.31 $22,337,419.92 $23,175,477.31 $24,513,534.34
<CAPTION>
LAK Yr 5
<S> <C> <C>
Facility Expense/Office rental 120,000 0.63%
fee
Total Fixed Cost of Goods & 1,044,330,572 5.45%
Services
% of Total Sales 5.45%
Total Cost of Goods Sold 1,140,330,572 5.95%
Gross Profit 18,024,933,028 94.05%
% of Total Sales 94.05%
Operating Expenses
Sales & Marketing
Advertising & Promotions 720,000,000 3.76%
Commissions 30 0.00%
Entertainment 180,000,000 0.94%
Literature 36,000,000 0.19%
Total Sales & Marketing Costs 936,000,000 4.88%
% Total of Sales 4.88%
% of Total
General & Administrative Year 5 Sales
------ -----
Accounting & Lawyer Fee 30,000,000 0.16%
Depreciation (4 years) 583,333,333 3.04%
Insurance 6,000,000 0.03%
License and Legal Fees - 0.00%
Telephone 18,000,000 0.09%
Utilities 18,000,000 0.09%
Total G & A Costs 655,333,333 3.42%
% Total Sales 3.42%
Total Operating Expenses 1,591,333,333 8.30%
% of Total Sales 8.30%
Income From Operations 16,433,599,695 85.79%
% of Total Sales 85.75%
Liquid Audio Royalty Payment - 0.00%
LA Royalty Tax Payment - 0.00%
Loan Interest Payment (9%) - 0.00%
Total Royalty/Loan Interest - 0.00%
Payment
Income before Taxes 16,433,599,695 85.75%
Taxes on Income 4,437,071,918 23.15%
Net Income After Taxes 11,996,527,777 62.60%
% of Total Sales 62.6%
Net Income After Taxes (US$) $ 9,597,222.22
Net Income: (Running Total)
Liquid Audio Royalty Payment $ -
LAK Initial Funds in this year
Total Loan from SKM $ -
Loan from SKM $ -
Loan Repayment to SKM $ -
Depreciation (cash-in) $ 466,666.67
3 months Exploratory Period
Total Invest For System
Central Repository / additional
invest.
Total Initial Funds Available
Total Funds Available Mon. to
Mon.
</TABLE>
<PAGE>
EXHIBIT 10.43
ONLINE PROGRAM AGREEMENT
This Online Collaboration Agreement ("Agreement") is effective as of
February 9, 1999 ("Effective Date"), by and between Muze Inc., a New York
corporation with principal offices at 304 Hudson Street, New York, New York
10013 ("Muze"), and Liquid Audio, Inc., a California corporation with principal
offices at 810 Winslow Street, Redwood City, California 94063 ("Liquid").
WHEREAS, Liquid and Muze desire to collaborate in order to encode sound
clips and related content and to provide online services with such encoded sound
clips linked to Muze database information as set forth herein and on Exhibit A
attached hereto and hereby incorporated herein (the "Online Program");
NOW, THEREFORE, in consideration of the mutual covenants and agreements set
forth herein, the parties agree as follows:
1. Online Program.
---------------
1.1 Cooperative Efforts. Each party shall use commercially reasonable
---------------------
efforts to develop, market, and otherwise further the Online Program. Each party
shall cooperate with and assist the other party in all aspects of the Online
Program. The Online Program shall commence on the Effective Date and shall
continue for the duration of the Term of this Agreement, unless the parties
mutually agree to terminate this Agreement.
1.2 Encoding and Technical Responsibilities. Liquid and Muze will jointly
---------------------------------------
undertake the encoding of music samples matched to the Muze database ("Linked
Sound Clips"), which will be encoded using the Liquid file format. The parties
contemplate that the Linked Sound Clips will generally be thirty (30) seconds
long, except with respect to jazz and classical music, for which the Linked
Sound Clips will generally be sixty (60) seconds long. Liquid will develop and
operate the server infrastructure to host and serve the Linked Sound Clips to
Online Merchants pursuant to the Online Program. The parties specific
responsibilities are set forth in Exhibit A.
1.3 Online Merchants Program. Liquid and Muze will jointly collaborate to
--------------------------
develop the Online Program. Each party will use reasonable commercial efforts to
promote and market the Online Program to online retailers, record labels and
other sound recording owners, portals, online service providers, and related
third parties (together, "Online Merchants"). Both parties will work to sign up
Online Program participants and execute appropriate customer agreements with
Online Merchants.
1.4 Customer Contacts. The parties will determine in advance which party,
------------------
if any, is to serve as the primary contact for servicing Online Program customer
relationships with the Online Merchants, and in each case the secondary contact,
if requested, shall refer all Online Program
1
* Some Material in this Exhibit have been omitted pursuant to a request for
confidential treatment. Such material has been filed separately with the
Securities and Exchange Commission.
<PAGE>
customer relationship issues to the primary contact and otherwise cooperate with
the primary contact in serving the customer relationship. If neither party has
been determined to be the primary contact, the parties will co-market and co-
administer the Online Program and will ensure that each party is fully informed
and included as reasonably appropriate in customer relationships that are
formed.
1.5 Online Program Revenue and Expenses. The development of the Online
-----------------------------------
Program shall include documentation of the parties' agreement with respect to
the treatment of revenue and expenses associated with the Online Program,
including the matters already agreed to and set forth in Exhibit A and the
process by which each of Liquid and Muze will recoup expenses against any
revenues generated from providing the Linked Sound Clips to the Online Merchants
pursuant to the Online Program. All further documentation of the parties'
agreement on these subjects shall be mutually agreed to in writing, signed and
attached to this Agreement as a part of Exhibit A. Any agreement to share
expenses or revenues from any source other than as expressly set forth in
Exhibit A shall not be effective unless set forth in writing and signed by both
parties. Further details for Exhibit A will be developed pursuant to the
progress review meeting process set forth in Section 2.1 below, or as otherwise
agreed between the parties.
1.6 Revenue Exclusions. For the avoidance of doubt, the Online Program
-------------------
will not include any revenues from digital downloading and distribution of song
files for sale (whether to current Muze database licensees or others). The
parties agree, however, with respect to digital download and distribution of
song files for sale and related matters that: (i) Muze currently has in place
agreements with many on-line sites licensed to use its databases for
compensation for any sale of music through digital downloading, and any later
agreement with Liquid on such digital sales shall not include revenue sharing by
either party; (ii) Liquid will create its own relationships with any such Muze
licensee on-line sites for digital distribution and downloading of music files;
and (iii) Liquid is not obligated to share the revenue it generates from this
distribution and downloading activity. In addition, Muze will be entitled to
continue to charge Online Program customers for use of Muze's database products
as services consistent with Muze's current practices.
2. Progress and Technical Reporting and Review; Limited Exclusivity of
-------------------------------------------------------------------
Arrangement.
- ------------
2.1 Progress Review Meetings. The parties shall, at the senior management
------------------------
level, review the overall progress of the Online Program no less frequently than
monthly. In addition to those set forth in Exhibit A, the parties may agree upon
milestones for the various phases of the Online Program, and each party shall
use reasonable commercial efforts to achieve all milestones and devote
appropriate resources and a high-level of priority to the Online Program. The
parties acknowledge that certain details of the development, commercialization,
and administration of the Program and other aspects of the Online Program cannot
yet be anticipated. However, any procedures that depart from the allocation of
rights and responsibilities set forth in this Agreement, including Exhibit A,
shall be implemented only by a signed, written amendment of this Agreement.
2
<PAGE>
2.2 Technical Review Meetings. The parties shall, at a technical
-------------------------
management level (senior engineer or higher), review progress of technical
aspects of the Online Program and report their results to each other in a format
and at intervals to be mutually agreed in writing.
2.3 Limited Exclusivity of Arrangement. During the term hereof, neither
--------------------------
party shall operate a service substantially the same as the Online Program.
Other than as expressly set forth in the immediately preceding sentence, neither
party shall be precluded from entering into any similar agreement, program,
alliance, collaboration, or licensing scheme with any third party or parties
regarding the subject matter of this Agreement. For the avoidance of doubt, Muze
shall be permitted to license its music database to third parties, including
links to sound clips that are not Linked Sound Clips, and Liquid shall be
permitted to encode sound clips and create links to music databases that are not
Muze databases.
3. Intellectual Property Rights and Ownership.
-------------------------------------------
3.1 Trademark Rights. Each party grants the other party the right to use
----------------
its trade name and logos solely in promoting and administering the Programs.
Each party covenants with the other that it will in such activities uphold the
high standards of quality and customer service associated with the other's trade
names and adhere to the reasonable trademark guidelines of the other party. Any
breach of this covenant shall be deemed a material breach of this Agreement, and
the parties acknowledge that such breaches may also entitle the aggrieved party
to injunctive relief. All other trademarks and branding developed for use in
connection with the Online Program shall be owned as the parties shall agree,
such agreement to be included in this Agreement as an attachment.
3.2 Independent Development and Ownership. Each party shall retain
-------------------------------------
ownership and control of its pre-existing intellectual property rights, lines of
business, and customers. Each party shall retain ownership of independently
developed intellectual property rights (i.e., developments created without use
of the other parties' intellectual property, including Confidential Information)
during the term of this Agreement. There shall be no joint development of
intellectual property rights under this Agreement unless expressly agreed to in
writing by the parties describing the joint development project and the terms
relating thereto.
3.3 Rights to Linked Sound Clips and Cross-License Among Parties. During
------------------------------------------------------------
the term of this Agreement, each party may retain and use a copy of the Linked
Sound Clips library for use only in conjunction with the Online Program. In
addition, Muze grants to Liquid a royalty-free, nonexclusive license to use the
Muze music database content in connection with the Online Program. Liquid grams
to Muze a royalty-free, nonexclusive license to use its encoding, file, server,
and delivery technology in connection with the Online Program. Such licenses
shall be extended on commercially reasonable terms upon termination or
expiration of this Agreement. Upon termination or expiration of this Agreement,
each party may retain a copy of the Linked Sound Clips library for any and all
purposes, with no duty to account to the other party. Except as expressly set
forth in this Agreement, no other rights or licenses are granted or implied
hereunder.
3
<PAGE>
4. Term and Termination.
---------------------
4.1 Term. The term of this Agreement shall be for two (2) years from the
----
Effective Date. This Agreement shall be renewed automatically for up to five
successive one-year periods unless either party notifies the other of its desire
to avoid such automatic renewal at least sixty (60) days prior to the end of the
term or any successive term.
4.2 Termination. Either party may terminate this Agreement for material
-----------
breach by the other party that remains uncured for more than thirty (30) days
after written notice specifying the breach. Either party may terminate this
Agreement upon written notice to the other party in the event of termination for
default by the other party of any other agreement between the parties. Any party
may terminate this Agreement upon written notice in the event that a voluntary
or involuntary petition in bankruptcy is filed by or against any party, or any
party makes an assignment for the benefit of creditors or is involved in any
other insolvency proceedings.
4.3 Effect of Termination. During the term of this Agreement and after
---------------------
termination or expiration of this Agreement, all rights to receive Linked Sound
Clips granted to third parties pursuant to the Online Program shall continue in
effect according to the terms of the agreement governing such services. Upon
termination or expiration of this Agreement: (i) each party shall retain its
copy of the Linked Sound Clips library, the assets allocated to each as may have
been agreed pursuant to Exhibit A, and all pre-existing rights; (ii) the parties
shall settle any revenue or expense sharing issues, as well as any asset
allocation issues (except for the Linked Sound Clips library, which may be
retained by both parties), as soon as practicable after such termination or
expiration, but in any event within ninety (90) days thereof; and (iii) if
requested by Muze, Liquid shall continue to host the Linked Sound Clips for a
period not to exceed ninety (90) days, as well as assist Muze during such period
in effecting a transfer (or replication, if applicable) of hosting and related
operations from Liquid (or the hosting service provider then in place) to Muze
(or Muze's designated hosting service provider), on commercially reasonable
terms. All rights and obligations that do not by their terms survive this
Agreement shall terminate.
5. Confidential Information.
-------------------------
5.1 Confidential Information. During the Online Program and in the
------------------------
development, commercialization, and operation of the Programs relating thereto,
the parties will have access to certain of each other's proprietary and
confidential information and materials, including, but not limited to, marketing
plans, strategies, software and/or hardware design, and other information and
materials developed by the parties or for them by third parties. Such
information shall be designated in writing as confidential, or if orally
disclosed, confirmed in writing as confidential within thirty (30) days of
disclosure ("Confidential Information").
5.2 Confidentiality Obligations. Nothing contained in this Agreement
---------------------------
shall grant any party rights to use any such Confidential Information of the
other parties in any manner except in the performance of this Agreement (i.e.,
in connection with the Online Program). Each party shall use at least a
reasonable degree of care in protecting the other party's Confidential
Information.
4
<PAGE>
Neither party shall disclose to any third party or make public in any manner any
Confidential Information of the other party without the prior written consent of
that party. Upon the expiration or prior termination of this Agreement, each
party shall return all Confidential Information of the other party in that
party's possession including all copies thereof, and shall continue to keep all
Confidential Information confidential.
5.3 Injunctive Relief. The parties acknowledge that breach of these
-----------------
confidentiality obligations may cause irreparable harm and that a non-breaching
party may be entitled to temporary restraint and/or injunctive relief to prevent
or limit any breach by the other party. In any such proceeding for injunctive
relief, no bond shall be required.
5.4 Exceptions. These obligations shall not apply to Confidential
----------
Information: (a) in the public domain (now or hereafter, unless through fault of
the party against whom enforcement of this provision is sought), (b) rightfully
disclosed to a party by a third party without obligation of confidentiality, (c)
required to be disclosed pursuant to a court order or other government
requirement, provided that the disclosing party is given reasonable opportunity
to seek a protective order or confidential treatment, or (d) independently
developed by the receiving party, as evidenced by that party's business records.
6. Indemnification.
----------------
6.1 Indemnification Obligations. Each party agrees to indemnify the other
---------------------------
party against claims by third parties arising out of the negligence or other
tortious conduct of such party or its employees or agents in performing under
this Agreement. The indemnitor shall have the right and obligation to conduct
the defense of any such claim, subject to: (a) the indemnitee's reasonable right
to participate, (b) the indemnitee's full cooperation in the defense, and (c)
the indemnitee's approval of any settlement that purports to bind it to a term
or condition that is not the payment of money damages (which shall be paid by
the indemnitor), which approval shall not be unreasonably withheld. If relevant,
the indemnitor shall resolve any material restriction on the indemnitee's
exercise of any rights licensed by the indemnitor, at the indemnitor's expense,
by (a) obtaining the necessary license from the third party or (b) providing a
non-infringing substitute or work-around to the indemnitee.
7. Miscellaneous Provisions.
-------------------------
7.1 Independent Contractors. The parties are independent contractors and
-----------------------
nothing contained in this Agreement shall be construed to create a relationship
of agent and principal, partners, joint venturers, or employer and employee.
7.2 Assignment. This Agreement may not be assigned without the prior,
----------
written consent of the other party, which shall not be unreasonably withheld,
except no consent shall be required for assignments to any party that acquires
or succeeds to all or substantially all of the assigning party's business or
assets.
5
<PAGE>
7.3 Governing Law. This Agreement shall be governed by the law of the
-------------
State of California applicable to contracts made and to be performed in the
State of California, without reference to the conflicts of laws principles
thereof.
7.4 Non-Solicitation. During the term of this Agreement and for a period
----------------
of one year thereafter, neither party shall solicit for employment, the
personnel of the other party without that party's written consent.
7.5 Entire Agreement. This Agreement is the entire agreement of the
----------------
parties hereto with respect to the subject matter hereof and shall not be
modified or amended except in writing signed by all parties.
7.6 Limitation of Liability. Other than as may arise from willful
-----------------------
misconduct, in no event shall any party be liable for any consequential,
incidental, indirect or special damages arising out of or related to this
Agreement or its termination, including without limitation lost data or lost
profits, regardless of whether such party has been advised of the possibility of
such damages and notwithstanding the failure of essential purpose of any limited
remedy. All software and services are provided on an as-is basis without
warranty, express or implied.
IN WITNESS WHEREOF, the duly authorized representatives of the parties have
executed this Agreement as of the date first written above.
MUZE INC. LIQUID AUDIO, INC.
By: /s/ Anthony Laudico By: /s/ Gerry Kearby
-------------------------- --------------------------
Anthony Laudico Gerry Kearby
Chief Executive Officer Chief Executive Officer
6
<PAGE>
EXHIBIT A
---------
Online Program, Revenue, & Expense Sharing Points
Revenue and Expense Sharing:
- ----------------------------
. Each party initially bears expenses associated with its responsibilities
under the Online Program
. Each party to share Online Program gross revenues equally
. Each party to account to the other and share Online Program expenses
equally
. Allocation of expenses to the Online Program to be determined according
to agreed-upon guidelines, to be attached to this Exhibit A; parties
each to use separate cost accounting for the Online Program
. Muze to pay expenses arising out of additional MP3 encoded output
destined for in-store listening systems (cost increment expect to be
_________); Muze to also pay for MP3 output program code development by
Liquid (expected to require one (1) engineering man-week)
. Each party bears 50% of capital expenditures (e.g., encoding hardware,
hosting facilities, CDs for encoding)
. Capital costs to be allocated, rather than shared, if accounting and/or
tax advantages dictate, as parties may agree
. Original CDs to reside at Muze's facility (copies at Liquid's facility)
Parties' Specific Responsibilities: Each party will assist the other in
- ----------------------------------
performing its primary responsibilities and the parties will work together to
find the most time- and cost-effective means of developing and promoting the
Program
<TABLE>
<CAPTION>
Muze Liquid Audio
<S> <C>
. License music database to Liquid and provide . License Liquid Music Server and encoding
integration support applications to Muze and provide training
. Obtain and provide to Liquid CDs for encoding . Encode music from CDs provided by Muze for
(both the initial Linked Sound Clips library and initial & new releases Linked Sound Clips
newly released CDs) library
. After Liquid encodes the initial Linked Sound . Create links to music database entries for
Clips library, jointly encode with Liquid new encoded files and supply links to Muze
releases as they become available, and
provide Liquid with a copy of the encoded files . Provide copy of encoded files to Muze
for hosting
. Host and provide all network operations for
. Maintain encoded file/database entry links Linked Sound Clips
library and provide to Online Merchants under
the Program . Provide primary technical support for Online
Merchants with respect to Program issues
. Participate in joint marketing efforts (with
respect to Muze customers, as primary . Assist Muze in setting up its own encoding
marketer) site once the initial Linked Sound Clips library
is encoded
. Appoint and empower a Project Manager
. Participate in joint marketing efforts
. Appoint and empower a Project Manager
</TABLE>
Timelines/Deliverables:
- -----------------------
. Muze to provide CDs at an ongoing rate sufficient to permit Liquid to meet
all encoding deadlines
7
<PAGE>
. Liquid to begin encoding by February 9, 1999, with 50,000 CDs to be encoded
by March 8, 1999 (in time for NARM)
. Liquid to encode 120,000 CDs by May 10, 1999, and continue thereafter at a
rate of 10,000 CDs per week until the initial library of Linked Sound Clips
for approximately 300,000 CDs is encoded.
. Parties to agree on expense sharing accounting guidelines in first Progress
Review Meeting or by February 19, 1999, whichever comes first
Technical Details
- -----------------
. Encoding to be AAC for 28.8 kbps and ISDN streaming rates
. Separate MP3 encoded files for 64 kbps streaming rate for use outside the
Program by Muze (for in-store listening systems)
Product Offerings (Planned and potential)
- -----------------
. Standard Online Program Linked Sound Clip hosting service
. Data mining services (with respect to Linked Sound Clips only)
. Only if necessary for competitive masons, a server and Linked Sound Clips
library product (not service)
. Linked Sound Clips library (AAC or MP3) for use in physical retail or similar
environments with listening systems not equipped for interactive audio
streaming (this product to be offered by Muze only)
Territory
- ---------
. [***]
Branding
- --------
. All Liquid file format players distributed in conjunction with the Online
Program shall contain both Liquid and Muze Branding, in a format to be agreed
upon during the Progress Review Meetings.
* Material has been omitted pursuant to a request for confidential treatment.
Such material has been filed separately with the Securities and Exchange
Commission.
8
<PAGE>
EXHIBIT 10.46
LETTER OF INTENT
IOMEGA CORPORATION - LIQUID AUDIO
Confidential
November 14, 1998
INTRODUCTION
- ------------
The Internet is an increasingly important method of distribution for all
types of knowledge, entertainment and business information. Recent advances in
Internet security have created secure techniques for users of the Internet to
exchange sensitive or confidential information, including credit card numbers
and personal information. Many companies are poised to take advantage of the
convergence of these factors to create powerful and convenient on-line shopping
experiences for their respective customers. Browsing, sampling and purchasing
music on-line is one such area. Today, the bulk of music purchased in the $23
million dollar on-line marketplace from companies like SoundStone and CD-Now are
delivered on pre-recorded compact discs.
The next wave of consumer interest will likely be the ability to download
digital versions of the same music that is purchased on-line today. This
digital music that is delivered to the customer's computer rather than his or
her doorstep will be playable on a variety of portable audio devices and
personal computers. The same content can already be used to create compact
discs on a customer's home computer using CD-R and CD-RW optical disk
technology. Currently there is not much "consumer-demanded" music content on-
line for a variety of reasons, including but not limited to concerns regarding
piracy, channel-conflict, quality and a personal-computer centric model (that
is, people want to listen to music wherever they may be). Along with music
being delivered electronically is the ability to sideband additional content and
information, URL's and even advertising. Also, security techniques like
watermarking and encryption can be enabled.
Iomega Corporation ("Iomega") and Liquid Audio, Inc. ("Liquid Audio") have
been discussing a possible joint marketing activity that would be to their
individual best interests. The current state of negotiations between Iomega and
Liquid Audio is set forth below in Section 2 of this Letter of Intent. Any
omission from the list set forth in Section 2 below does not diminish its
importance or indicate a lack of its necessity in the definitive and binding
agreements among the parties, if any ("Final Agreement"). Except as set forth
in Section 1 below, Iomega and Liquid Audio (the "parties") agree that neither
of them has any legal rights or obligations with respect to the matters set
forth herein, and that either party may withdraw from the discussions at any
time for any or no reason without any obligation to the other.
11/14/98 CONFIDENTIAL Page 1
<PAGE>
SECTION 1 -- BINDING TERMS
- --------------------------
1.01 CONFIDENTIALITY -- The parties agree to continue to abide by the
provisions of the "Mutual Nondisclosure Agreement" executed among them as of
________________, 1998, a copy of which is appended hereto as Appendix A and
incorporated herein by reference.
1.02 PAYMENT OF EXPENSES -- Except as otherwise provided in this Section
1, Iomega and Liquid Audio agree that they will each bear their own expenses
related to the matters set forth in this Letter of Intent.
1.03 PUBLIC DISCLOSURE -- No party hereto shall announce or otherwise
disclose publicly the existence of this Letter of Intent or the existence of the
on-going discussions between the parties as to the matters generally set forth
in Section 2 hereof without the express written consent of the other party.
1.04 REASONABLE EFFORTS -- The parties shall make all reasonable efforts
to conclude negotiations and execute the Final Agreement, if any, concerning the
matters set forth below in Section 2 hereof, prior to 5:00 p.m. M.S.T. on
December 11, 1998.
1.05 COMDEX Technology Demonstration Deliverables
* Liquid Audio will deliver an application demo prior to COMDEX (which
begins on November 16, 1998), as follows:
1. Four copies of one working demo will be required (2 for the LVCC
booth and one each for the booth meeting room and The Beach
press/customer events).
2. Liquid Audio will ensure that the "Record-to-Zip" button included
in the Promo pane of the Liquid Music Player will work with and
link to the SoundStone web site to download music (local or HD
server).
* Iomega will provide all required computer hardware and sound
equipment to run the four demo stations.
* Iomega and Liquid Audio will provide appropriate levels of technical
and marketing support during COMDEX.
1.06 COMDEX -- Events
* Liquid Audio will pay Iomega $25,000 on or before November 16, 1998 to
help defray the costs for the COMDEX customer event to be held at the
Beach on Tuesday, November 17, 1998. Additional investments which may
be required to enhance the event can be made by either party at its
own discretion and will be agreed upon in
11/14/98 CONFIDENTIAL Page 2
<PAGE>
writing and acknowledged by all event participants (Iomega, Liquid
Audio, SoundStone and Texas Instruments).
* Iomega will develop creative and print approximately 5,000 invitations
and envelopes. It will be the responsibility of Liquid Audio to post
and/or deliver its share of the invitations and VIP passes.
Participant PR activities should be coordinated through Iomega PR.
* Liquid Audio will provide its appropriate company signage (to be
coordinated in advance with Iomega event director Jodee Warwick) for
The Beach events.
* Each party will provide a minimum of one event coordinator for Tuesday
November 17 (early a.m. through tear-down) to support planning and
execution of the press luncheon and evening customer event. Liquid
Audio's event coordinator will support/manage event set-up, execution
and tear down and work with Iomega event coordinators.
1.07 COMDEX -- Press Activities
* Iomega and Liquid Audio will announce during COMDEX the signing of
this Letter of Intent for the Record-to-Zip marketing initiative,
including but not limited to, the versions of the Liquid Music Players
that will enable Record-to-Zip functionality as enabled by the
IomegaReady Toolkit with the Record-to-Play extensions.
* Liquid Audio CEO Gerry Kearby (or an Iomega-approved Kearby proxy)
will participate in the Press Luncheon on Tuesday Nov. 17 and will
coordinate with Iomega PR, as appropriate, to:
1. Provide an authorized, pre-briefed company spokesperson
2. Determine target press
3. Develop joint and/or individual press materials and provide to
Iomega PR for review/approval
1.08 NON-EXCLUSIVITY -- The parties acknowledge that each of them may
pursue arrangements similar to those set forth in this Letter of Intent with
third parties without incurring any obligation or liability to the other party.
Notwithstanding the foregoing, the parties shall perform in good faith the
obligations set forth in this Section 1.
SECTION 2 -- NON-BINDING TERMS
- ------------------------------
2.01 IN GENERAL -- Iomega and Liquid Audio propose to work together to
develop techniques to help resolve the music industry's concerns over piracy and
channel conflict, and to promote the new capabilities that are a result of our
cooperation. Specifically, Liquid Audio
11/14/98 CONFIDENTIAL Page 3
<PAGE>
intends to develop a Liquid Music Player to support removable storage products
using Iomega removable storage products only ("Iomega Version"), including but
not limited to Iomega CDs (both CD-Rs and CD-RWs) (as allowable with Liquid
Audio's agreement with Adaptec), Zip disks, Clik! disks, and Jaz cartridges
(collectively "Iomega Media"). Liquid Audio shall also develop and release
enhancements to its existing and future Liquid Music Players so that they
support Iomega Media as well as other devices and media ("Other Versions").
The security enhancements to provide support for Iomega Media will use the
"IomegaReady Toolkit" to detect the presence of Iomega Media. Then, using an
Iomega patent-pending technique to interrogate the Iomega Media to retrieve
the serial number from the Media, the Liquid Music Player will create an
encrypted track on the Iomega Media that cannot be played or used unless the
specific piece of Iomega Media is present and mounted on the player/computer
or recognized by the target player device. The intent of this technique
(referred to herein, as it applies to the Iomega Media, as "Record-to-Zip",
"Record-to-Play", "Record-2-Zip," "R2Z", "Record-2-Play" and "R2P") is to
facilitate the binding of audio content to the Iomega Media in such a way as
to help the music and entertainment industries become more comfortable about
the electronic distribution of audio content. Iomega has other patents pending
to use the aforementioned technique to facilitate the distribution of music,
games, software, entertainment content or intellectual property through the
distribution and use of media. The same technique of serial number
interrogation of Iomega Media will be employed to identify the "download
value" of the target Iomega Media.
2.02 RECORD-TO-ZIP SPECIFICATION DELIVERABLES
A. GRAPHIC STANDARDS AND PROMOTIONAL GUIDELINES
* Iomega will develop graphic standards, including marks used to
designate software applications ability, to support Record-to-Zip. The
use of these graphic standards in any way by Liquid Audio, including
software, advertising, packaging, PR etc., must first be approved in
writing by an authorized Iomega representative.
* Liquid Audio will incorporate the Record-to-Zip logo on the faceplate
in the Iomega Version, and as it deems appropriate on the software,
packaging and promotional materials in Other Versions.
* Iomega and Liquid Audio will promote the availability of tracks that
can be copied to Iomega Media on their respective web sites and in
promotional material as appropriate.
* Iomega and Liquid Audio will jointly develop an announcement strategy
and messaging for specific promotional activity related to the
announcement and promotion of the Liquid Music Player(s) supporting
Record-to-Play.
11/14/98 CONFIDENTIAL Page 4
<PAGE>
* Press releases issued by Liquid Audio relating to Record-to-Play must
first be approved by an authorized Iomega representative. Press
releases issued by Iomega that relate to Liquid Audio must first be
approved by an authorized Liquid Audio representative.
* The aforementioned graphic standards and promotional guidelines as
described in this section must be passed through to Liquid Audio
licensees or partners using the Record-to-Zip capability. Any Liquid
Audio graphics utilized by Iomega or its licensees must adhere to
Liquid Audio's approved style guide.
2.03 RECORDING, COPYING OR TRANSFERRING TO IOMEGA MEDIA
* Liquid Audio will incorporate the IomegaReady Toolkit API in the
Iomega Version, and in the Other Versions, (i) to automatically detect
the presence of valid Iomega Media and (ii) if detected, to
automatically display a "Record-to-Zip button" on the Liquid Music
Player in a manner that Liquid Audio deems appropriate. The foregoing
Versions will include the ability to:
1. Integrate the Iomega patent pending media serialization scheme
detailed in the IomegaReady Toolkit into the Iomega Version so
that it automatically and transparently "locks" a music track to a
particular Iomega Media. Iomega intends to provide a royalty-free
license for the IomegaReady Toolkit for a period of time to be
negotiated by the parties in good faith. Also, the Iomega Version
will provide this functionality in an appropriately transparent
and automatic fashion to end users. This functionality shall
prohibit users from playing the track copied onto any other
removable storage media.
2. Integrate the Iomega patent pending media serialization scheme
detailed in the IomegaReady Toolkit into the Other Versions so
that, as one option, the user can automatically and transparently
"lock" a music track to a particular Iomega Media. Iomega intends
to provide a royalty-free license for the Iomega Ready Toolkit for
a period of time to be negotiated by the parties in good faith.
Also, the Liquid Music Player will provide this functionality in
an appropriately transparent and automatic fashion to end-users.
This functionality shall prohibit users from copying and playing
the track onto any other media without first returning the track
to the control of the Liquid Music Player.
3. In the Iomega Version, give users the option to name the Iomega
Media being used in the download via a pop up screen utilizing the
IomegaReady Toolkit.
2.04 PLAYING FROM IOMEGA MEDIA
* An Iomega Media "track" may be played on an Iomega Version or the
Other Versions by either of the two following methodologies:
11/14/98 CONFIDENTIAL Page 5
<PAGE>
1. Once a user inserts the Iomega Media and clicks on the appropriate
tracks' icons, utilizing the IomegaReady Toolkit, Liquid Music Player
is automatically is started and ready to play.
2. If a track is selected from the disk in Windows Explorer, the Liquid
Music Player is automatically started and ready to play.
2.05 PROMOTIONAL ACTIVITIES & DELIVERABLES
* Iomega and Liquid Audio will attempt to obtain endorsements for
promotional purposes supporting the Record-to-Zip concept and
promoting the use of the Iomega Ready Toolkit with Record-to-Zip
extensions from:
1. SPA, RIAA and other key industry trade associations
1. Major record labels
2. Computer industry press and analysts
3. Music industry press and analysts
4. Tools, OS & Security Vendors etc.
2.06 CONSUMER LAUNCH ACTIVITIES
* Liquid Audio will make best efforts to meet the following release
dates: (i) Iomega Version and the Other Versions on or before January
31, 1999; (ii) alpha code of the Iomega Version by January 1, 1999
(code freeze, all functionality implemented); and (iii) beta code of
the Iomega Version by January 15, 1999 (all data loss bugs fixed).
These releases should be jointly reviewed by both Iomega and Liquid
Audio.
* Iomega will provide resources to implement a web-based beta program
beginning in January 1999 after the release of the beta code.
* Liquid Audio shall make a best effort to deliver localized software
for the Iomega Version in French, German and Japanese June 30, 1999
(Iomega release date for the International version of the IomegaWare
Tools Disk.
* All software for the Iomega Version and the Other Versions must first
be certified by the Iomega Product Assurance team. Iomega will provide
test resources beginning in December 1998 to work jointly with Liquid
Audio on this certification process. Iomega and Liquid Audio agree to
negotiate in good faith to develop a mutually acceptable test plan.
* Iomega will provide technical guidance/assistance for working with
Iomega drives upon request from Liquid Audio.
* Iomega will provide the Iomega branded faceplate using the Faceplate
Developers Kit provided by Liquid Audio.
11/14/98 CONFIDENTIAL Page 6
<PAGE>
* Iomega and Liquid Audio will jointly develop an integrated product
launch plan for the Iomega Version and the Other Versions that could
include but is not limited to press and analysts activities, trade-
show participation, launch event participation and web site
promotional activity.
* Liquid Audio will attempt to obtain "download" and promotional rights
for two Dave Matthew's Band (or an Iomega approved proxy) tracks that
can be played on the Iomega Version and the Other Versions.
Additionally, Liquid Audio will:
1. Ensure those tracks are available for download - along with the
Iomega Version - beginning at launch for an agreed upon and
disclosed amount of time from Iomega's, SoundStone's and Liquid
Audio's web sites, including the Liquid Music Network.
2. Broadly promote the availability of and encourage the download of
those tracks in connection with the Iomega Version.
* Liquid Audio will support the Iomega/SoundStone "Tunus Collectus"
promotion on its web site and in promotional materials and activity
for a period of 12 months.
* For a period of twelve months Iomega will include the Iomega Version
on its IomegaWare disk that is distributed, at a minimum, in-box with
external Zip drives. At its discretion, Iomega may promote the Iomega
Version in the execution of its packaging or in-box promotional
materials. Liquid Audio intends to provide a royalty-free license for
the Iomega Version for a minimum of twelve months.
* For a period of twelve months Iomega will make the Iomega Version
available for download on its web site for 12 months. At its
discretion Iomega may from time-to-time promote the availability of
the Other Versions on its web site and its partner download sites.
* Iomega will feature the introduction of the Iomega Version and the
Tunus Collectus promotion for at least one month from the introduction
of the promotion on the "front-page" of its web site.
* Liquid Audio will make the Iomega Version available for download on
its web site for 12 months. At its discretion Liquid Audio may from
time-to-time promote the availability of the Iomega Version on its web
site and its partner download sites.
* At Liquid Audio's cost, Iomega will send a direct mail promotion about
the Iomega Version to the Iomega installed base 2 times in 1999
providing that the conditions as outlined in this agreement are met.
11/14/98 CONFIDENTIAL Page 7
<PAGE>
2.07 MARKETING ALLIANCE EXTENSIONS
1. Application Development
* Liquid Audio shall incorporate the Iomega-Ready Toolkit with the Other
Versions.
* The parties shall determine distribution terms, cross-promotional
subscriber base opportunities, etc., regarding for the Other Versions.
2. Record-to-Zip Enhancements
* The parties shall further investigate subsequent enhancements to
technical specifications, strategic relationships and promotional
opportunities for the Other Versions to:
1. Create an increasingly robust solution for secure download
(Develop a complete roadmap for this product line)
2. Expand content access, endorsements
3. Potentially encompass new technologies
WHEREFORE, each of the parties has caused this Letter of Intent to be
executed by its duly authorized officer or representative as of the date first
written above.
IOMEGA CORPORATION
Signature: /s/ Mike Lungren
Name: Mike Lungren
Title: Sr. Director Marketing
LIQUID AUDIO
Signature: /s/ Robert Flynn
Name: Robert Flynn
Title: VP Business Development
11/14/98 CONFIDENTIAL Page 8
<PAGE>
Appendix A
Mutual Nondisclosure Agreement
Iomega Corporation, a Delaware corporation, located at 1831 West Iomega Way,
Roy, Utah USA 84067 and Liquid Audio, Inc., located at 810 Winslow St., Redwood
City, CA 94306, desire to explore certain possible business transactions and in
facilitating that, it is understood and agreed that certain business and trade
information which the parties deem confidential may be provided or disclosed by
one to the other.
In consideration of the receiving party being granted access or continued access
to such information, it is agreed as follows:
1. "INFORMATION" shall mean any information, technical data or know-how
relating to the business, services, or procedures of the disclosing party or
a third party, including without limitation any research, products,
services, developments, inventions, procedures, techniques, designs,
components, parts, documents, drawings, electronic files, discs, sketches,
plans, programs, specifications, software, and/or distribution, engineering,
marketing, financial, merchandising and salary information and/or other
materials (hereafter referred to as "INFORMATION") which is disclosed by
each party or on its behalf before or after the date hereof, to the other
party or its employees or agents, directly or indirectly, in writing,
orally, electronically, or by drawings or inspection. "INFORMATION" does not
include information, technical data or know-how which the receiving party
establishes: (i) is already published or available to the public other than
by a breach of this Agreement, or any confidentiality obligation owed to the
disclosing company; (ii) is rightfully received from a third party without,
and not in breach of any obligation of confidentiality; (iii) is
independently developed by personnel or agents of the receiving party
without access to the INFORMATION of the other; (iv) is known to the
receiving party at the time of disclosure without an obligation of
confidentiality; or (v) is produced in compliance with applicable law or
court order, provided that the receiving party first give the disclosing
party reasonable notice of such law or order and gives the disclosing party
opportunity to oppose and/or attempt to limit such production.
2. The receiving party shall hold in trust and confidence and not disclose to
others, by any means, any and all INFORMATION disclosed under the Agreement.
INFORMATION may be used by the receiving party only for the purpose of
considering a business relationship or business transaction with the
disclosing party. The receiving party may disclose INFORMATION received
under this Agreement to persons within the organization who have a need to
know such information and only if such persons are bound in writing
(pursuant for example to a general employee non-disclosure agreement
proceeding third party confidential information as well as the employers
confidential information) to protect the confidentiality of such
INFORMATION. The receiving party further agrees it shall take the same
measures, but no less than reasonable security measures, and use the same
care, but no less than a reasonable degree of care, to preserve and protect
the secrecy of, and to avoid disclosures or unauthorized use of the
disclosing party's INFORMATION, as it uses with its own information of
similar importance. With respect to tangible materials
<PAGE>
containing INFORMATION, the receiving party agrees not to analyze any such
materials for composition or structure.
3. Title to all property received by the receiving party from the disclosing
party, including all INFORMATION, shall remain at all times the sole
property of the disclosing party, and the Agreement shall not be construed
to grant to receiving party any licenses or similar rights to such property
or INFORMATION (including all intellectual property) disclosed to the
receiving party hereafter. Nothing in the Agreement shall limit or restrict
the rights of the disclosing party to assert infringement or other
intellectual property claims against the receiving party or to impose on
either party any obligation to disclose any INFORMATION or to purchase or
sell any products.
4. The receiving party shall, upon request of the disclosing party: (i) return
to the disclosing party all documents, drawings, equipment and other
tangible materials, including all INFORMATION and all manifestations thereof
delivered to the receiving party under this Agreement and all copies and
reproduction thereof; and (ii) certify to the disclosing party that all such
INFORMATION has been returned.
5. The receiving party's duties under Section 2 of this Agreement expire with
respect to any particular item of INFORMATION fifteen years after the time
of disclosure hereunder to the receiving party, or five years after the
expiration or termination of the relationship between the parties of this
Agreement, whichever is later.
6. The parties further agree to the following terms and conditions:
(a) Neither party shall, without the prior written consent of the other
party, disclose to a third party any aspect of the commercial
relationship between the parties including, but not limited to, pricing
terms or quantities offered or sold payment terms, production methods
or schedules, delivery location and means, and suppliers. Each party
agrees not to issue any press release or make any statements on the
Internet, America On Line, CompuServe, Prodigy or any other public
electronic network or to any analysts or reporters concerning the other
party or its products or services without the other party's prior
written authorization.
(b) Receiving party shall adhere to the U.S. Exports Administration Laws
and Regulations and shall not export or re-export any technical data or
products received from the disclosure or the direct product produced of
such technical data to any prescribed countries.
(c) Any breach by the receiving party of its obligations under this
Agreement will result in irreparable injury to the disclosing party for
which damages and other legal remedies will be inadequate. In seeking
enforcement of any of these obligations, the disclosing party will be
entitled (in addition to other remedies) to preliminary and permanent
injunctive and other equitable relief.
(d) If any provision of this Agreement is invalid or unenforceable, such
provision shall be construed and limited to the extent necessary, or
severed if necessary, in
<PAGE>
order to eliminate such invalidity or unenforceability, and the other
provisions of this Agreement shall not be affected thereby.
(e) No delay or omission by either party in exercising any rights under
this Agreement will operate as a waiver of that or any other rights. A
waiver or consent given by either party on any one occasion is
effective only in that instance and will not be construed as a bar to
or waiver of any rights on any other occasion.
(f) This Agreement shall be binding upon and will inure to the benefit of
the parties hereto, and their respective successors and assigns.
(g) This Agreement is governed by and will be construed in accordance with
the laws of the State of Utah, and the state and federal courts of Utah
shall be the decisive force.
(h) This Agreement supercedes all prior agreements, written or oral,
between the disclosing party and receiving party (or their respective
predecessors in interest) relating to the subject matter of this
Agreement. This Agreement may not be amended except by an agreement in
writing signed by both parties that specifically refers to this
Agreement.
IOMEGA CORPORATION
By: Michael S (illegible)
---------------------
Title: Mgr. Strategic S/W and Solutions
--------------------------------
Date: 14 Sept 98
----------
LIQUID AUDIO, INC.
By: Robert Flynn
------------
Title: VP Business Development
-----------------------
Date: September 14, 1998
------------------
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-1 of our report dated February 26, 1999,
except as to Note 10 which is as of July 8, 1999, relating to the financial
statements of Liquid Audio, Inc., which appears in such Prospectus. We also
consent to the references to us under the headings "Experts" and "Selected
Financial Data" in such Prospectus. However, it should be noted that
PricewaterhouseCoopers LLP has not prepared or certified such "Selected
Financial Data".
PricewaterhouseCoopers LLP
San Jose, California
July 8, 1999
