As filed with the Securities and Exchange Commission on _______________, 2000
Registration No. __________
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES OF
SMALL BUSINESS ISSUERS
UNDER SECTION 12(B) OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934
MCY.COM, INC.
(Name of Small Business Issuer in its charter)
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Delaware 13-4049302
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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1133 Avenue of the Americas, 28th Floor
New York, New York 10036
(Address of principal executive offices and zip code)
(212) 944-6664
(Issuer's telephone number, including area code)
Copies to:
Martin Eric Weisberg, Esq.
Parker Chapin LLP
The Chrysler Building
405 Lexington Avenue
New York, New York 10174
Tel: (212) 704-6050; Fax: (212) 704-6288
Securities to be registered under Section 12(b) of the Act:
Title of each class Name of each exchange on which
to be so registered each class is to be registered
None None
Securities to be registered under Section 12(g) of the Act:
Common Stock, par value $ 0.001 per share
(Title of Class)
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TABLE OF CONTENTS
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Item Number Page Number
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PART I..........................................................................................................3
ITEM 1. DESCRIPTION OF BUSINESS.........................................................................3
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.....................................25
ITEM 3. DESCRIPTION OF PROPERTY........................................................................30
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................31
ITEM 5. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS...................................33
ITEM 6. EXECUTIVE COMPENSATION.........................................................................35
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................38
ITEM 8. DESCRIPTION OF SECURITIES......................................................................40
PART II..........................................................................................................42
ITEM 1. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S
COMMON EQUITY AND OTHER STOCKHOLDER MATTERS....................................................42
ITEM 2. LEGAL PROCEEDINGS..............................................................................43
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS..................................................44
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES........................................................45
ITEM 5. INDEMNIFICATION OF DIRECTORS AND OFFICERS......................................................48
PART F/S.........................................................................................................49
PART III.........................................................................................................50
ITEM 1. INDEX TO EXHIBITS..............................................................................50
ITEM 2. DESCRIPTION OF EXHIBITS........................................................................52
SIGNATURES.......................................................................................................53
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ITEM 1...DESCRIPTION OF BUSINESS
MCY.com, Inc. owns and operates an Internet website located at
http://www.mcy.com. Our website provides an interactive environment and virtual
music store where music buyers can: (i) view concert events and purchase various
music products and services including digital music downloads and pay-per-view
"webcast" events, which are events or performances broadcast over the Internet;
(ii) obtain information on various artists, musical genres, new music releases,
concert events, articles and reviews; and (iii) view videotaped and real-time
artist interviews and concerts.
HISTORY
The concept behind our business was developed by Mr. Bernhard Fritsch,
our chief executive officer, who has been involved in the production and
marketing of multi-media and electronic music entertainment products since 1979.
In 1991, Mr. Fritsch formed Fritsch & Friends Audio Produktions GmbH (now
Fritsch & Friends Mediagroup GmbH or "Fritsch & Friends") for high-end audio
post-production and multimedia content production, sales and distribution.
Starting in 1995, Fritsch & Friends entered into the nascent field of Internet
digital music distribution. MCY Music World, Inc. ("MusicWorld") was
incorporated on January 8, 1999 in the state of Delaware to acquire certain
predecessor companies based in Germany and to further develop its planned
operations, which include the creation and opening to the public of an online
service platform to provide worldwide promotional and sales services for the
music buying public and the music industry. On August 2, 1999, MusicWorld
completed a reverse merger into Health Builders International, Inc. ("HBI"), a
public company incorporated in the state of Delaware which had no commercial
operations at the time of the merger. The merger was consummated through an
exchange of shares that resulted in stockholders of MusicWorld holding
43,324,988 shares of common stock (excluding 121,667 shares of common stock
issuable to creditors) or 90.4% of the outstanding common shares of HBI and
1,000,000 shares of Series 1 Preferred Stock (100% of such class) and existing
stockholders of HBI holding 4,611,000 shares of common stock. The merger is
being accounted for as a recapitalization and retroactive effect has been given
to the recapitalization in the accompanying financial statements. In connection
with the merger, HBI changed its name to MCY.com, Inc. (the "Company").
On July 2, 1999, MusicWorld acquired the assets of Datatek Services
Limited ("Datatek") including the stock of MCY America, Inc. ("MCY America") and
Fritsch & Friends (collectively the "predecessor companies") in exchange for
cash of $1,050,000, 4,500,000 shares of MusicWorld's common stock valued at
$22,500,000 and 5-year warrants to acquire 2,000,000 shares of common stock at
an exercise price of $5.00 per share, valued at $3,000,000, for an aggregate
cost of $26,550,000. In addition, the Company agreed to pay to Datatek, on a
quarterly basis, 1% of gross revenues either, (i) for a period of 20 years, or
(ii) until such time as the payments total $9,000,000. As of the date of the
acquisition, the predecessor companies owed MusicWorld $1,243,000 representing
the balance of loans made by MusicWorld prior to the acquisition. MusicWorld's
founder, controlling stockholder and Chairman was the Chief Executive Officer, a
director and owned a 47.5% beneficial interest in Datatek which was transferred
to the other Datatek stockholders for no consideration immediately prior to the
closing of the acquisition. Datatek and its subsidiaries had been involved in
the development, purchase and licensing of the technology, intellectual property
and other business assets that are required for MusicWorld's intended business
operations. The transaction has been accounted for as a purchase by MusicWorld
of a 52.5% ownership in the Datatek assets and a contribution to MusicWorld of
the 47.5% interest formerly owned by MusicWorld's founder and controlling
stockholder. Such contributed interest has been recorded at the predecessor
basis to the controlling stockholder which approximates 47.5% of the
stockholders' deficiency of the predecessor companies at the acquisition date.
In addition, 47.5% of the loss of predecessor companies for the period from
January 1, 1999 through July 2, 1999 is reflected in the Company's results of
operations on the equity method and 100% of the results of operation of the
predecessor companies are consolidated with those of the Company from July 2,
1999. The aggregate cost of the acquisition of the 52.5% interest, amounting to
$27,793,900, including $1,243,000 of loans receivable from predecessor
companies, reduced by $1,069,000 representing 47.5% of the stockholders'
deficiency of the predecessor companies at the acquisition date has been
allocated to assets acquired and liabilities assumed at date of acquisition as
follows:
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Cash $ 565,000
Sundry receivables 137,000
Due from related parties 109,000
Equipment and software, net 370,000
Other assets 146,000
Intangibles 28,321,000
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29,648,000
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Accounts payable, accrued expenses and sundry liabilities 2,884,000
Line of credit 40,000
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2,924,000
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Cost of net assets acquired $ 26,724,000
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The contingent consideration will be accounted for as royalty expense
as it becomes payable. Also in connection with this transaction, founders of
MusicWorld agreed to return 2,000,000 shares of common stock, which were then
canceled. Assuming the acquisition had occurred as of January 8, 1999, the
Company's unaudited pro-forma net loss, including amortization of the acquired
intangibles, would have amounted to $(73,467,000) or $(1.66) per common share
for the period January 8, 1999 through December 31, 1999.
Our principal executive offices are located at 1133 Avenue of the
Americas, 28th Floor, New York, New York 10036, and our telephone number is
(212) 944-6664. We also have the following seven wholly-owned subsidiaries: (i)
MCY Music World, Inc., a Delaware corporation, which acts as our operating
company; (ii) MCY America, Inc., a New York corporation; (iii) MCY Events Inc.,
a Delaware corporation; (iv) MCY Latin, Inc., a Delaware corporation; (v)
Fritsch & Friends Mediagroup GmbH, a German corporation; (vi) MCY Europe GmbH, a
German corporation; and (vii) MCY West, Inc., a California corporation.
MusicWorld is our operating company. From time to time we may use the terms
"we", "our" or the "Company"; such terms refer to MCY.com, Inc. and our
subsidiaries.
PRODUCTS
Our website was launched in June 1999 and features a selection of
digitally downloadable audio files from our music library. Our music library
holds a broad range of music from independent record labels and recording
artists. We currently offer consumers "NETrax downloads" of music and
pay-per-view "streams" of concerts and music performances. "Streaming" is a
method of transmission via the Internet, similar to traditional broadcast of
radio or television, that transmits audio files or video files to a user's
computer in such a manner that the user is unable to make a digital recording
for future use. Prior to the advent of "streaming technology", Internet users
could not initiate the playback of audio or video clips until such content was
downloaded in its entirety, resulting in significant waiting times. As a result,
live broadcasts of audio content over the Internet were not possible.
"Streaming" allows audio or video segments to be played immediately as they are
downloaded from the Internet, rather than first being stored in a file in the
receiving computer. Streaming is accomplished by way of web-browser "plug-ins"
which decompress and play the audio or video file in "real-time". "Plug-ins" are
accessory programs such as software upgrades and additions that enhance a main
application such as enabling an existing software program to be compatible with
or operate with another software program or software file format.
The Moving Pictures Experts Group has developed a popular
non-proprietary format called the MPEG-1 Audio Layer 3 or "MP3" that allows
audio files to be compressed to approximately 1/12th of their original size with
no audible loss of quality. These compressed MP3 files can be downloaded very
quickly (an entire compact disc or CD, converted to MP3 format, can be
downloaded over a cable modem in approximately 20 minutes). We distribute our
audio files using a proprietary enhanced and encrypted version of the MP3 format
called "NETrax." We expect the NETrax format to offer several compelling
advantages compared with the currently available MP3 technology, including:
o Anti-piracy features to prevent unauthorized duplication.
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o Excellent sound quality of downloaded audio files ("16-bit
stereo" which is the quality of stereo sound available on a
CD).
o Instantaneous sales "tracking" ability to drive marketing and
promotional campaign research. "Tracking" is the process by
which we utilize information obtained from users of our
website including purchases by users and payments due to
licensors, rights holders, publishing agents, administrators
and publishers.
o Point of sale royalty tracking to ensure prompt and accurate
payment to artists and license holders.
We intend to offer CDs and music-related merchandise including
T-shirts, videos and books through our website during 2000.
STRATEGY
We intend to become a global retailer of digitally downloadable music,
music-related products and services, and an Internet broadcaster of music
events. Key elements of our business strategy include:
Focus on Digital Music Distribution. We are focused on digital music
distribution. We believe that adoption of digitally downloaded music will
increase slowly over the next two to three years as broadband adoption increases
and as handheld electronic playback devices gain penetration into consumer
markets. Until such time as digital music distribution reaches critical mass, we
offer and intend to continue to offer, in addition to our catalog of digital
music tracks, unique webcast events from "top artists" and mail order
distribution of compact discs ("CD's") to maintain consumer engagement and site
traffic. We believe that the future of the music industry lies with digital
distribution and we will attempt to "convert" our webcast and CD mail order
customers to digital music purchasers by offering special promotions including
free NETrax downloads. Our research and development efforts have been and will
continue to be focused on achieving a position as a premier online distributor
of digital entertainment media. Pending widespread adoption of digital music
distribution by the mass consumer market, we expect that our primary source of
revenue will come from pay-per-view webcasts of live events, sponsorship,
advertising and sublicensing rights. We expect digital download revenues to be
our primary source of revenue commencing in 2003. We currently generate revenue
primarily from advertising on our website and sponsorship of webcast streaming
events. We currently charge for webcast events and digital downloads, however,
revenue from such sources has been minimal.
Broaden Retail Content. We negotiate directly with labels, artists and
rights holders to acquire music for retail digital distribution. We have
licensed an extensive catalog of music in a variety of genres and intend to
continue our efforts in this regard, including a deal signed in February 2000 to
digitally deliver limited content from Arista Records, Inc. (a record label
owned by BMG) artist LFO. Although we do not yet have rights to distribute
content provided by the other three major record label companies, namely Sony
Music Entertainment, Inc., Universal/Polygram Records and Warner/EMI Music
Group, we do not believe that such distribution rights are a requisite for our
business. To the extent that we do not obtain any further content owned or
controlled by the "major" labels, we may proceed with a strategy of dealing
directly with top artists to acquire music directly from such artists. However,
because most internationally recognized artists typically sign multi-year
exclusive recording contracts with record labels, negotiations with such artists
may be limited.
Expand Rights of Ownership and Exploitation. In addition to securing
rights for the digital download of music files and the streaming of music
events, we intend to secure rights for distribution via other media including
CD, CD-ROM, DVD and television. We believe that by acquiring comprehensive
master and/or distribution rights to a music work or performance, we can (i)
generate revenues through sublicensing, (ii) create unique advertising and
sponsorship opportunities, and (iii) control the introduction of and access to
music in the marketplace to maximum benefit.
Expand Entertainment Content. Our strategy is not to be simply a
retail site, but to become a music and digital entertainment destination and
content owner and creator. In order to achieve this goal, we have and intend to
continue to seek out unique content such as videotaped interviews, articles and
music reviews. These items are a part of our library of digital entertainment
content, some of which is only available through MCY. By expanding the type of
content we offer, we intend to differentiate ourselves from our competitors.
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Establish a Brand Name. We promote the "MCY.com" brand through the
exploitation of our "top star" webcast events. We have webcast numerous "top
star" events such as Michael Jackson, Luciano Pavarotti and Paul McCartney on a
no fee basis to bring traffic to our web site and promote our brand. We have and
will continue to offer additional webcasts including, on a pay-per-view basis,
commencing as of March 2000 from leading artists and bands such as The
Backstreet Boys, NSync, Pete Townshend, Puff Daddy, Steel Pulse and others. In
addition, we intend to market and promote the "MCY.com" brand through online and
conventional marketing channels.
Engage in Customer Profiling and Direct Marketing. We obtain
information about our website's use, our customers' preferences and purchase
history through our customers' emails and communications. This data will enable
us to market directly to our customers through email, to further customize our
website, and to tailor product development and promotions to customers' tastes.
Provide Superior Customer Service. Our focus is to provide consumers
with streamlined and efficient shopping processes, advanced features, instant
delivery of digital products, rapid turnaround and delivery of mail order
products and fast and friendly responses to customer inquiries. In key areas
such as fulfillment and order tracking of mail order purchases, we may outsource
all or a portion of these activities to organizations with expertise in these
functions.
Maintain Technological Leadership. Under our technology, unauthorized
access to digital content is prevented using MMP encryption technology licensed
from the Fraunhofer Institute (for a more comprehensive description of this
technology refer to the Encryption subsection of the TECHNOLOGY section). We
intend to continue further research and development to advance our products.
Actively Pursue Globalization. We plan to develop a network of
international region-specific operations that will provide services to regional
music buyers in the United States, Europe, Japan and Latin America in areas such
as selection and local language "interface" (the electronic screen containing
information data fields for information or data to be provided by a computer
user). Through region-specific operations, we aim to provide an interface which
is sensitive to local language, tastes and interests. It is important to note
that many major markets are oriented towards domestic content that most online
providers do not offer. Accordingly, we will attempt to develop a global network
which actively maintains local sites and seeks local content to exploit the
growth of global online markets.
MARKETING
Our marketing efforts are focused initially on the United States and
Germany and will be expanded as appropriate worldwide. Marketing is primarily
focused on: (i) increasing awareness and trial of MCY's digital music
experiences and products, and (ii) increasing consumer and trade awareness and
understanding of the MCY brand and of digital music.
MCY Audiences. Our consumer marketing is focused more on targeting
affinity groups (i.e. "Boy Band fans") than demographic groups. Nonetheless, we
track and assign priority to the four dominant demographic groups: "Boomers"
(ages 34-52); "Gen X" (Ages 25-33); "Gen Y" (ages 18-25), and "Teens" (ages
12-17).
We also target current and potential partners from the music, Internet
and technology industries.
Marketing Plan
We intend to utilize both traditional and alternative conduits in an
effort to reach our target audiences through the following actions:
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Marketing Initiatives. Event sponsorship, online promotion and webcasts
are the predominant vehicles through which we intend to target and attract
consumers. We promote and broadcast premium events and concerts from our website
on a regular basis. Our webcasts to-date include the live 8-hour webcast of the
Michael Jackson & Friends concert from Munich in June 1999, the exclusive
webcast of Luciano Pavarotti from Helsinki in November 1999, the live webcast of
Paul McCartney from the Cavern Club in Liverpool in December 1999 and the
Backstreet Boys Millennium Tour in March 2000. We are under contract to webcast
NSync's No Strings Attached Tour commencing in the summer of 2000, the Puff
Daddy & Friends European Tour, Pete Townshend's Lifehouse Concert and Steel
Pulse. We selectively sponsor the events that we webcast, for which we receive
primary brand positioning at the concert venue and in supporting print,
television and radio promotions.
MCY.com Website and Artist "Portals". Our retail website is designed to
enable customers to quickly find, sample and purchase digital music experiences.
In order to maximize consumer use of and return to the website, we have
developed "portals" for our top artists that showcase our artists' digital music
offerings, including downloads and events, and provide unique information,
interviews and community features. We believe that these portals provide a
"sticky" experience that prolongs repeat fan visits to our website and
reinforces our brand through increased artist affinity and fan service.
Marketing Materials. We have created a range of marketing materials for
distribution to members of the press and business communities. Materials include
a corporate brochure, fact sheet, and press kit (containing press releases, fact
sheets, biographies and photographs).
Global Public Relations. Our public relations are focused on increasing
the exposure of the MCY brand and music offerings to consumers, partners (music,
technology and Internet), investors and "influencers" worldwide. "Influencers"
or "Influentials" are people, companies or organizations who by their nature,
demographic or interests reach and influence a target audience of individuals or
consumers. To date we have received coverage in the United States and in Germany
through media outlets including, but not limited to, Time Magazine online, The
New York Times, Wall Street Journal, the Los Angeles Times, Der Spiegel, Bild,
Billboard, Variety, Hollywood Reporter, ABC, NBC, CNBC and CBS Radio.
Trade Shows. Following our industry launch at Cannes MIDEM in January
1999, we increased our exposure to the music and online industries by attending
trade shows including the AFIM and MIDEM Americas Music Conferences and the New
York Music and Internet Expo. For MIDEM in January 2000, we constructed a new
modular trade show booth for scalable use in future shows. We have attended
several other music industry and Internet trade shows to build excitement
including PopKomm, IMX, IFA, CMC, Webnoize, Internet World, Digital Hollywood
and MIDEM and the New York Music and Internet Expo in 2000. As a result of our
participation in these conferences and our media coverage, we have been asked to
be on panel discussions at Digital Hollywood at the Consumer Electronics Show,
CMC, the American Conference Institute and MIDEM.
Strategic Alliances. We maintain a number of strategic alliances to
obtain marketing, music and technological support for our products, our product
development and for retail purposes. We have established a relationship with
Mediaways GmbH ("Mediaways"), a subsidiary of Daimler-Chrysler Information
Systems or Debis, and the European service provider for America Online, for
networking services and bandwidth services for the operation of our website that
provides digital downloads. Under our agreement with Mediaways we make monthly
payments and certain other payments to lease the server, for server hosting and
for the bandwidth. On December 31, 1999, we entered into a website linking and
co-branded site development agreement with US West Communications Services, Inc.
("US West") under which we have agreed to develop a MCY/US West co-branded
website to sell digital music downloads on the US West Internet and
in-development digital subscriber line ("DSL") sites. The initial term of the
development agreement is for one year from December 31, 1999 to December 30,
2000. We have the right to renew the agreement for an additional two years upon
written notice thirty days prior to the expiration of the initial term. Under
the agreement, we pay a monthly payment of $ 25,000 to US West. In return, US
West has agreed to place our website as a digital music destination in its
narrowband and broadband (DSL) portals. The narrowband portal will be a
co-branded site with a US West navigation bar. The broadband co-branded site
will be part of US West's DSL portal called "Online Avenue". US West will
receive a percentage of all digital download sales, after expenses, made through
the portals. The co-branded site is expected to be implemented in the second
quarter of 2000.
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Advertising. Our advertisements, including but not limited to, banner
advertisements, buttons and newsletters have appeared on internet portals (such
as Yahoo!, MSN and RealNetworks), on official artist fan club sites (such as
www.backstreetboys.com), unofficial artist fan club sites (such as
www.geocities.com), musical destination websites (such as Opera News and Sony)
and musical affinity websites (such as www.bolt.com). Our banner advertisements,
including the banner advertisement for the Pavarotti webcast in November 1999,
are intended to leverage well-known artists who are featured in our catalog,
thus benefiting from the promotional dollars which have already been spent
establishing these artists' reputations. We have also developed and will
continue to expand print advertising campaigns. To date, we have placed
advertisements in newspaper publications including the New York Times, Wall
Street Journal and London Times and entertainment industry magazine publications
including Billboard and Variety. Since inception, we have spent approximately
$2.2 million on advertising and related activities.
On and Offline Advertising. To date, we have advertised our products
and website through co-op radio spots and paid print advertising in the New York
Times, Wall Street Journal, Times of London, Billboard and Variety. We intend to
expand paid and co-op television, radio and print advertising efforts in 2000 in
the United States, Germany and the UK, with primary objectives including: (i)
promoting consumer trial of our "top-star" events and digital music products
(leveraging existing consumer brand awareness of these artists), (ii) building
consumer awareness, understanding and trial of our brand and retail websites,
and (iii) building awareness of key strategic developments among our investor
and trade audiences.
Alternative Online Media. We utilize inexpensive alternative online
media, including chat groups and bulletin boards, to communicate in "real time"
with consumer, investor, trade and business audiences.
OPERATIONS
Potential customers can find MCY on the World Wide Web at the addresses
www.mcy.com, www.mcy.de, www.musiconclick.com and www.entertainmentonclick.com.
Our commercial websites are routed through our main servers in the United States
and in Germany. The websites located at www.mcy.com and www.mcy.de are currently
identical except that the language of the website located at www.mcy.de is in
German. The websites provide details about the full range of our products
including all digital music files stored in our digital warehouse. Our websites
are periodically redesigned to improve appearance and functionality.
Searching and Selecting
Our consumers will be able to search, "pre-listen", select and purchase
items online using our sales platform. A "pre-listen" is a short sample of a
song or musical performance, between 15-25 seconds, that allows the consumer
and/or potential purchaser of a download to listen to a portion of the song for
evaluation purposes. Our search engine allows consumers to locate music
according to song title, artist and album title. Our website also supports
"genre-based" browsing and we have plans to develop approximately 11 music
categories to be further divided into over 100 specific sub-categories.
"Genre-based" refers to classifying music by a certain type or style such as
classical, rock/pop, R&B or country. The customer can base his or her selection
on a wide variety of available pre-listens, including pre-listens for most
digitally downloadable selections. A pre-listen allows a customer to listen to a
short segment of an individual song in 8-bit sound quality at no cost. The
customer can then make a decision whether to purchase such song. Digital
downloads vary in price from $0.99 per song to $1.99 per song. Webcast
pay-per-view events will have varying prices starting from approximately $3.99
depending upon the popularity of the event, length of the segment ordered and
whether other products are ordered with the event.
Ordering and Payment
Orders are made using a customer "shopping cart". A "shopping cart" is
a screen which shows downloads or other items that the consumer has selected for
purchase. The shopping cart may also contain downloads that the consumer or user
has previously purchased on our website. Payments can be made using most major
credit cards. We utilize Cybercash and Paylinx software to transmit transactions
to our merchant bank account. American Express, Bridgeview Bank and The Chase
Manhattan Bank (Visa, Mastercard) provide us with merchant services for
transaction authorization, address verification and transaction processing.
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Delivery of Digital Download
Once a customer has paid for a song for digital download the customer
may obtain that song by clicking on its icon in the customer's browser. The song
is automatically downloaded onto the customer's hard drive. Download time may
range from less than 30 seconds per song (for high-speed connections) to over 10
minutes per song (for 28.8K modems). "28.8K Modems" refers to computer modems
which connect a user's computer to the Internet via traditional phone lines and
have a maximum data transfer rate of approximately 28.8 kilobytes per second. To
listen to digitally downloaded selections, customers must register and download
a free NETrax player which is encoded based on each user's profile. Customers
who download a song can replay that song only on their own NETrax player, which
is fitted with an individual encryption code, making our Internet music sales
more secure than traditional retail sales. Songs can be downloaded 24 hours a
day.
Delivery of Mail Order
Mail order CDs are not currently available on our website but are
expected to be available in 2000. We do not maintain a physical inventory of
CDs, instead, we will rely on an international distribution and fulfillment
provider for our fulfillment and mail order delivery. This should allow us to
offer an extensive selection of CDs while avoiding the high costs and capital
requirements associated with owning, warehousing and distributing product from
inventory. When the customer orders a pre-recorded product for mail order
delivery, we expect that the ordered product will generally be shipped to the
customer within 48 to 72 hours.
Sales Support
We intend to outsource mail order customer service functions to a
fulfillment partner. Otherwise, customers can contact us by e-mail with
questions, comments and suggestions or call a toll-free telephone number. We
plan to hire customer service representatives and intend to expand our staff as
traffic increases. We provide our online customers with answers to frequently
asked questions, such as inquiries about payment, credit card security and
digital downloads.
TECHNOLOGY
We have developed, licensed and integrated systems which enable online
retailing and digital delivery in secure and user-friendly formats. With a
combination of proprietary solutions and licensed technologies, we have
established systems for online content delivery and online transaction
processing, and are close to the completion of systems for sales and royalty
tracking and electronic data interchange. As of January 18, 2000, Mr. Bernhard
Fritsch had filed patent applications based upon previously filed provisional
applications for several key technological inventions including our sales and
royalty tracking systems, shopping list, and the personalized NETrax player
which he has licensed to us. We can give no assurance as to if or when the
patent applications will be approved or the patents granted. The U.S. Patent and
Trademark Office states in its 1998 Annual Report which is located on its
website at www.uspto.gov/web/offices/com/annual/1998/ that "at the end of fiscal
year 1998, cycle time (or processing time) [for applications] averaged 16.9
months, with 32 percent of applications processed in 12 months or less....By the
end of FY 1999....we expect to process 75 percent of inventions in 12 months or
less, with an average cycle time of 10.9 months." In addition, Mr. Fritsch has
licensed certain trademark applications to us under a license agreement. The
exclusive worldwide license has a term of either the later of twenty (20) years
or the expiration of any patents licensed thereunder, and requires that we pay
Mr. Fritsch an annual fee of $1,000. Mr. Fritsch may terminate the license if we
fail to pay Mr. Fritsch compensation equal to 0.25% of our gross revenue
pursuant to the terms of his employment agreement. In December 1999, we also
filed several other strategic trademark applications and registered
corresponding uniform resource locators.
Digitization
When we obtain the rights for digital distribution of a given recording
from a record company or artist, the record company or artist must give us a
copy of the master recording. This recording is immediately sent to our
digitization factory to be digitized. Digitization is the process of converting
digital or analog music into digital audio files that can be compressed into
files which can be downloaded through our website. We use MP3 technology
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which we employ pursuant to a non-exclusive license from Thomson Consumer
Electronic Sales GmbH, the licensor. Under this license agreement, we are
required to pay a royalty payment to the licensor of 1% of our gross revenue
from digital downloads with a US$15,000 annual minimum. The license agreement
was effective on January 1, 1999 and expires on the expiration date of the last
to expire of the licensed patents. In addition to digitization of files,
information on each digitized track (artist, title, length, rightsholder
information, etc.) is entered into our database.
Encryption
To overcome industry fears of online piracy, we use advanced encryption
and security protocols to ensure that transactions conducted on our website are
secure and music selections cannot be pirated or unlawfully distributed over the
Internet. Our download technology is based on an encryption technology called
Multimedia Protection Protocol or "MPP". Our subsidiary, Fritsch & Friends,
currently has a non-exclusive perpetual license from Fraunhofer Institut fur
Integrierte Schaltungen to incorporate Version 1 of its proprietary MMP software
into our products which enables us to offer for download encrypted versions of
songs recorded in the MP3 format. Fritsch & Friends entered into the
non-exclusive perpetual license agreement with the Fraunhofer Institut on March
20, 1997. Under the license agreement, a payment of DM 25,000 was due on March
20, 1997 and a payment of DM 25,000 was due on June 30, 1997. On May 14, 1999,
we entered into a non-exclusive five year license with Fraunhofer Gesellschaft
zur Forderung der angewandten Forschung e.V. for the use of Version 2 of its MMP
software which will enable us to provide more advanced encryption capabilities,
such as downloads that can only be played a limited number of times, and allow
us to sublicense the technology to our strategic alliance partners. Under the
license agreement, we pay a royalty payment of DM 468,000 in consideration of
the rights and license granted to us.
Digital Warehouse
Our digital warehouse is used to store all digital tracks. Our
warehouse is currently run on a SUN E4000 server hosted by the global network of
Mediaways which provides "connectivity" and communication between our network
and global and local internet service providers. "Connectivity" refers to the
connection between various computer resources that make up the MCY web site.
This system allows audio files to be distributed effectively worldwide. Our
current digital warehouse has the capacity to store up to 5,000,000 tracks. Our
servers are monitored on a 24-hour basis by technology personnel and are
protected by firewalls and other security technologies. "Firewalls" are software
security systems that attempt to prevent unauthorized access to the MCY site,
systems and the data contained on those systems.
Sales and Royalty Tracking
To overcome industry concerns about royalty payments, we are offering
proprietary software which, when fully developed, is intended to automatically
track royalty disbursements. Our proprietary software network will also offer
the music industry a number of features including fast, global tracking of sales
and activities which will be continually updated 24 hours a day for instant
marketing feedback and analysis.
RESEARCH AND DEVELOPMENT
Our research and development activities cover various areas, including
database programming, website management, player development, digitization,
interface design, "cybercasting" and network management. "Cybercasting" refers
to the digital transmission, in this case, specifically via the Internet, of
digital entertainment data (by analogy, the computer network version of a
traditional broadcast). Our development team has specialists in each of these
areas which are continuously updated. We have several development priorities
including: (i) the creation of "plug-ins" to allow for compatibility of the
NETrax format with hardware players and other software players; (ii) the
completion and enhancement of sales and royalty tracking software; (iii) the
introduction of personalization software to support "one to one" relationships
with customers; (iv) the further development of genre-based features and other
proprietary content; and (v) the development of advanced marketing tools.
"Plug-ins" are software upgrades and additions that enable an existing software
program to be compatible with or operate with another software program or
software file format. Research and development costs will continue to be
incurred as our business evolves. From inception to December 31, 1999, we have
spent approximately $ 2.1 million on research and development.
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COMPETITION
Key Success Factors
We compete against a number of technology companies that are offering
or plan to offer products, services or technologies for the digital delivery of
music over the Internet. We believe that in the near future, the keys to success
in the market for retail sales of digital downloads will be categorized into the
areas of content and product/technology. Other important factors will include
quality of management, marketing strategy and strategic alliances. Based on an
analysis of our existing competition, our main priorities are (i) the aggressive
acquisition of exclusive premium music distribution rights; (ii) the production
and sale of unique entertainment experiences from these rights; and (iii) the
development of the MCY brand.
DIGITAL DISTRIBUTION
General. There are currently few established players in the field of
retail distribution of digital audio files and fewer still engaged in secure
retail distribution. We believe that eventually only three to five main
competitors will exist and a substantial number of smaller companies focusing on
niche markets. In addition to our company, we believe the main players are
currently Amazon.com, CDNow, Emusic and Liquid Audio. These companies are
expected to have significant market share in the United States. Because major
record labels have been slow to commit themselves to digital distribution, some
companies such as a2b music, Lucent, Microsoft and Liquid Audio have focused on
the development of a standard audio player for digitally downloaded music. The
challenge they represent is that they license their software to major existing
or new distributors (such as EMI's reported licensing of Liquid Audio's
technology), which will then become our main competitors in the digital
distribution market. A second group of potential competitors includes companies
such as Emusic.com Inc., AudioSoft and Artist Direct (MJuice), which appear to
be trying to build a digital distribution presence mainly by licensing content
from small independent labels. A third group of competitors includes the major
record labels themselves which may elect either to operate or launch their own
websites for the delivery of digital music downloads or to partner with online
retailers other than MCY.com, Inc. Finally, a major challenge to our success and
to the recording industry as a whole is the increasingly popular free,
unlicensed distribution of digital downloads for play on the widespread MP3
audio players from companies such as MP3.com, which denies artists and the
record industry their share of the revenue.
Pre-recorded CDs
The online mail order market is currently dominated by several
companies whose major advantage is that they have succeeded in developing brand
awareness. We believe the two dominant players in online CD sales are CDNow and
online retail giant Amazon.com. We do not expect to gain a substantial share of
this market.
INDUSTRY BACKGROUND
Growth of the Internet and Online Commerce
The Internet has become an increasingly significant global medium for
online commerce and communications allowing millions of people to share and
transfer information electronically. International Data Corporation estimates
that 97 million people worldwide in 1998 had access to the Internet, and
projects that this number will almost triple to approximately 310 million users
by the year 2002. The total value of services and products purchased over the
Internet is expected to expand even more rapidly over the next five years to the
extent that online shopping gains greater acceptance among buyers and sellers.
Retail Sales in the Music Industry
The International Federation of the Phonographic Industry estimates
1998 sales reached $38.7 billion. Industry projections anticipate steady growth
in the global market, since sales of music and entertainment products
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traditionally remain strong even during times of economic downturn. Market
Tracking International estimates that revenue from the sale of prerecorded music
will reach nearly $47 billion by the year 2004.
Online Sales of Music
In 1998, Jupiter Communications estimated that online sales of
prerecorded music would increase exponentially, reaching $2.6 billion by the
year 2003. Recent developments suggest that there may be even faster growth,
especially considering both the rapid adoption of Internet shopping by customers
and the superior momentum which the digital music download medium has gained
recently. Online retailers have the potential to build large, global customer
bases quickly, and at a considerably lower cost than traditional music
retailers. Online music retailers can offer 24 hour shopping, the ability to
pre-listen to music samples and the opportunity to download music from a
repertoire much wider than that offered through even the largest music stores.
Online retailers are also free from the physical constraints of traditional
music retailing which requires high-traffic retail locations, considerable
inventory and the need to primarily limit inventory to high turnover items.
Digital Distribution of Music
Industry participants generally expect that digital distribution will
play a major role in the future of the music industry, because it provides
numerous advantages for both consumers and record companies. Currently, digital
distribution is in its infancy and overall revenue is quite low, partially
because the majority of digital distribution is presently done both illegally
and free of charge and partially because of the lack of broadband access
available to the general market (Jupiter Communications estimates less than $1
million in sales occurred in 1998). Nevertheless, many industry participants
believe that the rapid development of the digital distribution market will occur
as broadband access becomes available to most households due to the numerous
advantages of digital distribution for both record companies and consumers (see
figure below). Despite the numerous advantages of digital distribution, there is
still controversy as to how quickly this new medium will be adopted. Factors
which may hinder the development of the digital distribution market are
primarily related to the reluctance of record labels and customers to embrace
the new technology and the slow speed at which music is currently downloaded.
See "Risk Factors".
<TABLE>
<CAPTION>
ADVANTAGES OF DIGITAL DISTRIBUTION
- ---------------------------------------------------------- -----------------------------------------------------
BENEFITS TO THE RECORD COMPANY BENEFITS TO THE CUSTOMER
- ---------------------------------------------------------- -----------------------------------------------------
<S> <C>
Margins can jump from between $2 to $3 per CD (10-15 Immediate availability of all selections for
songs) to between $0.42 to $0.84 per song download -- no need to physically visit the
retailer or to wait for mail order delivery
Elimination of costs of manufacturing, distribution,
packaging and warehousing
Simple, fast, secure online selections and payment
Elimination of inventory obsolescence High quality audio (16-bit stereo)
Tracking of up-to-date, precise information on music Access to pre-listens on 100% of available
sales and trends selections
Ability to pre-test popularity of releases and change Ability to select individual songs, rather than
pricing policy immediately based on sales trends full albums
Improved access to information on customer demographics Lower prices (made possible by the elimination of
and preferences substantial overhead)
Ability to market out-of-print and less popular items at Large assortment of available songs/albums,
no cost to the label including formerly out-of-print items
Worldwide market reach -- all titles available in all
markets
- ---------------------------------------------------------- -----------------------------------------------------
</TABLE>
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We plan to entice customers and record companies to adopt the new
technology at an accelerated pace through strategic alliances, aggressive
promotions, premium content, high-quality digital delivery, high security levels
and excellent service. We believe that the widespread adoption of digital
download technology will occur over the next several years and predict that the
total revenue from digital distribution in the year 2003 could be as much as $2
billion out of overall anticipated online music sales of over $4 billion. This
belief is based on the fact that digital distribution presents clear advantages
to record companies, artists and consumers. In addition, technological solutions
to the major obstacles to industry growth are being rapidly developed. We can
give no assurance, however, that our predictions regarding the total revenue and
margins to be generated from digital distribution will be accurate or that
digital distribution will be able to generate such revenue.
Consumer Market
Recent research by ICONOCAST indicates that there are already 10
million Internet users who shop for music online. The vast majority of these
users are between the ages 25 and 45, with the age group 35 to 44 representing
31% of all purchasers. Previous studies have shown that it was exactly this
generation of customers who have reduced their music purchases as a result of
their frustration with the music shopping experience in consumer-unfriendly
music stores, leading to sluggish market growth. We believe that user-friendly
online shopping will encourage a resurgence of music purchases from this
generation of customers and that the number of online music buyers will increase
dramatically, creating opportunities for both digital and mail order
distributors. In addition, we believe that digital distribution has great
potential to succeed in attracting music customers with several search engines.
Digital distributors are capable of providing greater benefits to the customer
than mail order in almost all of these areas, and especially in the two most
important areas of price and selection.
While we believe that digital distribution as a source of music has
recently become known to consumers, we recognize that there are several
obstacles to be overcome before digital distribution will be widely accepted by
the consumer market. As with the introduction of the compact disc, changes in
customer behavior will need to occur to allow digital distribution to succeed on
a large scale. One aspect of such behavior is that customers must adapt to the
concept of digital downloads, rather than CDs, as a medium for music
distribution. We believe that broadband access and the speed with which music
can be digitally downloaded through broadband access will accelerate the
adoption of the digital distribution of music. The speed with which music
listeners adopted compact disc technology in the 1980s suggests that music
buyers adapt quickly when a superior technology is introduced and made available
at reasonable prices. However, there can be no assurance that music listeners
will adopt digital downloads as they did compact disc technology. A second issue
that the music industry is starting to address is that technology must allow
customers to listen to music obtained through digital downloads where and when
they wish. Although hardware and software that allows for the reproduction of
digital downloads onto CDs, tapes and minidisks currently exists and prices for
such technology have been decreasing rapidly, this new technology has not yet
been fully adopted by the general public.
Supplier Market -- Content
The rights to distribution of musical content are the single most
important "input" for music distributors, including online distributors such as
our company. The supply market is divided among the five major record labels,
which, in the aggregate, account for almost 80% of the record industry's
revenue, and smaller independent record labels which account for the remainder.
The independent labels can be further categorized as large independents, of
which there are approximately 50, medium independents, which number in the
hundreds, and small independents, of which there are several thousand. We
currently acquire download and downstream rights directly from artists, record
labels and master rights owners. We currently have contractual downloading or
downstreaming rights agreements with over 80 record labels. We do not yet have
any rights to distribute content provided by Sony Music Entertainment, Inc.,
Warner/EMI and Universal/Polygram and we have the rights to digitally deliver
only limited content from Arista Records (a record label owned by BMG).
The major obstacle to the development of the digital distribution
market has been the reluctance of major record labels to license their content
for use by online distributors permitting digital downloads. Their hesitation is
based mainly on fears of Internet music piracy, as well as concerns about having
to shut down CD pressing plants, and an unwillingness to create conflict with
existing retail channels. As of April 2000, all of the major record labels have
announced plans to make music available for sale on the Internet in the year
2000; however, the scope and implementation of these plans is presently unclear.
In response to the piracy issue, the major record labels have joined
with the Recording Industry Association of America, a coalition which is
attempting to define
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standards for the digital distribution of music through the Internet, to promote
the Secure Digital Music Initiative ("SDMI"). We are a participant in SDMI and
expect to play an active role in the determination of a secure digital
distribution format. A threat to the major record companies is that the use of
the Internet will not only lead to a shift in the method of purchase but will
also alter the total volume and composition of music actually purchased,
facilitating the direct distribution of material from artists to customers and
the mass distribution of previously localized independent offerings. Thus, there
is great scope for digital music distribution even without the participation of
the leading record labels. At the same time, we believe that the growth of
digital distribution will force the major labels to participate in this
expanding market.
Technology Issues
The Internet, a platform which allows companies to fulfill customer
needs by providing 24-hour sales, ease of use, and effective search and purchase
mechanisms, has become more a competitive necessity than a competitive
advantage. The battle within the mail order industry has thus shifted away from
technology issues to issues of brand and content. For digital distributors,
however, the issue of content raises a crucial technological consideration.
Major record labels and artists will not license their music for digital
distribution without software that protects their music against unauthorized
copying and that allows them to gain quick access to sales and royalty data. We
believe that through our advanced encryption and sales-tracking software, we
will be able to meet the needs of the major record labels although we can give
no assurance that the major record labels will adopt or accept our technology.
A second technological issue is download time. Through the Internet, it
can take over 10 minutes to download an individual song using a 28.8K modem. The
future of digital downloading will thus depend heavily on the spread of
"broadband" high-speed connections through cable and digital subscriber lines.
"Broadband" refers to an Internet connection system which allows a computer to
connect to the Internet with a data transfer rate that exceeds traditional
dial-up services that utilize standard telephone service and connect using 28.8K
and 56K modems.
A third technological issue is the playback of digital downloads. Since
customers are not accustomed to using the computer as a vehicle for music
playback, they will require equipment that allows them to listen to digital
downloads when and where they want. Equipment that makes digitally downloaded
music playable through media other than the computer is becoming widely
available. It is currently possible to record digitally downloaded music from
one's computer onto conventional media such as CDs, cassettes, or minidiscs. In
addition, the first "walkman"-like players of digital downloads have recently
been introduced. The current players generally store from 32MB to 64MB of audio
data (up to 30 songs); however, manufacturers have announced plans to introduce
players with greater memory capacity which will allow music fans to carry a
large volume of music with them in a pocket-sized player. Further developments
are expected to allow the playing of digital downloads through home and
automobile stereos. This field is developing rapidly and we believe that
customers will soon be able to enjoy their digital downloads wherever and
whenever they want. There can be no assurances, however, as to whether or when
such developments will be made available to the public in a format that is
widely accepted.
The Economics of the Business
Gross Margins. Gross margins for digital distribution are expected to
be almost double those for online mail order distribution of compact discs. This
is because the only unit cost items for digital distribution are mechanical
royalties (7-10 cents per song), license fees (40-80 cents per song), credit
card fees (6-8 cents per song) and server charges (20-30 cents per song), which
generally total between 70 cents and a dollar per song. CDs are more expensive
because record companies must also be compensated for manufacturing, packaging,
warehousing, distribution and the cost of pressing unsold albums. For online
mail orders, customers must also bear the added cost of delivery. Advertising
and merchandise sales can further augment margins, but the volume of revenue in
these areas will not be as large.
The following are gross margin estimates:
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<TABLE>
<CAPTION>
TYPE OF SALE PRICE DIRECT COSTS GROSS PROFIT GROSS MARGIN
- ------------ ----- ------------ ------------ ------------
<S> <C> > <C> <C> <C>
Compact Disc (1) $12 - $15/CD $9 - $13 $2 - $3 15% - 25%
Digital Download $1 - $2/song $0.58 - $1.16(3) $0.42 - $0.84 42%
Advertising $40/CPM (2) $6 $34 85%
Merchandise (T-shirts, $10 - $20/unit $5 - $10 $5 - $10 50%
videos, etc.)
- ----------------------
</TABLE>
(1) Does not include postage and handling, which is billed separately.
(2) Cost per thousand impressions.
(3) The following assumptions were used in arriving at the direct costs related
to digital downloads as a percentage of per song revenue:
<TABLE>
<CAPTION>
<S> <C>
- Cost per download based on 1999 megabyte transfer rate: 5%
- Credit card processing cost of 3% per download: 3%
- Thomson MP3 patent license of 1% per download: 1%
- Bernhard Fritsch 0.25% trademark license fee on download revenue: 0.25%
- Mechanical royalty is fixed at $.07 per song or 0.5% of each download: 5%
- Datatek shareholder technology royalty on downloads: 1%
- Master license fee is 40% of sales price to artist for download: 40%
- Commission agents 4% of MCY share; i.e., 2.4% per download: 2.4%
----
Total percentage of download revenue considered direct cost of sale: 58%
====
</TABLE>
Projections and statements regarding gross margins achievable through
the sale of digital downloads are based on current existing and reasonably
foreseeable market conditions. Due to the rapidly changing Internet and online
music markets, however, we can give no assurances that the markets will not
experience significant changes including, but not limited to, increased costs
for the transmission of digital files, increased credit card and transaction
processing fees, a change in the royalty payment structure for digital downloads
and increased licensing costs which changes could have a material adverse effect
on the gross margins achievable from the sale of digital downloads.
Indirect Costs. Brand development requires significant up-front
expenditures on sales and marketing activities. For example, leading electronic
retailers such as Amazon.com and CDNow spend 25-50% of their revenue on sales
and marketing, while smaller Internet companies typically spend an even greater
percentage. Since online banner advertisements cost roughly $30 to $40 per
thousand "impressions" and "click-through rates" are generally 1% to 2%,
advertisers pay $1.50 to $4.00 just to get potential customers to look at their
sites. "Impressions" is an advertising/media term that quantifies the exposure
of media and advertising to members of the target audience, such as consumers.
"Click-through rates" are the rates at which an Internet user clicks on or
selects images, links or advertisement banners which are present on the page of
a website currently being viewed and which bring the user through to the various
pages on the website or to another site represented by the image, link or
advertisement banner on a particular page. With purchase rates of 2% to 3%,
advertisers can pay more than $50 to make a first sale. This investment in new
customer acquisition should be recouped in the long term through repeat
purchases and word-of-mouth. Nevertheless, it is this single cost item which to
date has caused most "E-commerce" companies to remain unprofitable.
"E-commerce", otherwise known as electronic commerce, is the process of
browsing, shopping and making purchases via the Internet. Research and
development is also a significant expense item in this technology-driven
industry. Based on a comparison with selected E-commerce companies, this expense
item typically amounts to 5% to 10% of sales, with the relative percentage
declining as sales increase.
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RISK FACTORS
LIMITED OPERATING HISTORY
We were organized in January 1999. Our predecessors, for operating
history purposes, were Datatek Services Limited, originally formed in November
1997, MCY America, Inc., originally formed in December 1997, and Fritsch &
Friends Audio Productions GmbH, originally formed in 1991. We have no operating
history upon which an evaluation of our prospects can be based. Our prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered by companies in an early stage of development, particularly
companies engaged in new and rapidly evolving markets, such as an Internet-based
digital music delivery service. To achieve and sustain profitability, we believe
we must, among other things, do the following: (i) provide compelling and unique
content to Internet music users; (ii) effectively develop new and maintain
existing relationships with artists and music content providers; (iii) continue
to develop and upgrade our technology and network infrastructure; (iv) respond
to competitive developments; (v) successfully introduce enhancements to our
existing products and services to address new technologies and standards; and
(vi) effectively sell our products and services. We can give no assurance that
we will be able to successfully provide an Internet-based digital music delivery
business.
HISTORY OF LOSSES; ANTICIPATED LOSSES; NEGATIVE CASH FLOW
Our research, development, sales, marketing and general and
administrative expenses have resulted in significant losses and are expected to
continue to result in significant losses for the foreseeable future. The
entities we acquired in the reorganization incurred cumulative net losses of
approximately $5,410,000 through December 31, 1998, while we and the acquired
entities (on a historical basis) incurred consolidated net losses of $69,713,000
(including non-cash charges of approximately $49,904,000 for share compensation)
for the year ended December 31, 1999. As of December 31, 1999, we had generated
only $343,000 in revenues from operations. We can give no assurance that we can
achieve, sustain or increase revenues or profitability in the future. There also
can be no assurance that our revenue will increase in the future or that we will
achieve or maintain profitability or generate cash from operations in future
periods. We expect to incur additional operating losses and to experience
continued negative cash flow from operations for the foreseeable future. We can
give no assurance that we can achieve, sustain or increase revenues or
profitability in the future.
UNPROVEN BUSINESS MODEL; ABILITY TO DEVELOP PRODUCTS AND MARKET
Our business model for generating revenue streams through the
distribution of digital music downloads, online sales of CDs, pay-per-view live
events and website advertising fees from third parties and sublicensing rights
is unproven. Use of the Internet by consumers as a medium for entertainment and
for downloading music is at an early stage of development and acceptance of
related services is highly uncertain. Leading record labels continue to take a
highly conservative approach to permitting the digital distribution of their
recordings through the Internet because they fear illegal copying and are
unwilling to create conflicts with their existing distribution relationships.
As a result, our future success will depend significantly upon our
ability to successfully:
o deliver entertaining and compelling music-related content over
the Internet;
o attract a sufficient number of users to our websites to
purchase digital downloads, streaming pay-per-view events,
music and related merchandise and to attract advertisers to
our websites;
o develop and maintain volume usage of our digital music
distribution services;
o establish and maintain licensing and distribution
relationships with record companies, producers, artists and
other rights holders; and
o maintain our digital distribution technology.
Our business, results of operations and financial condition would be
materially adversely affected if:
o we are unable to develop Internet content that allows us to
attract, retain, and expand a loyal user base;
o downloading of musical content over the Internet is not widely
accepted by consumers;
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o the technology for listening to digitally downloaded material
is not widely available, not available on a timely basis at
reasonable prices or is not otherwise convenient or portable
for the consumer; o the technology we use to prevent illegal
copying of music content proves to be ineffective; o we are
not able to successfully compete with other entities offering
services and products similar or superior to our services and
products;
o we are unable to anticipate, monitor, and successfully respond
to rapidly changing consumer tastes and preferences so as to
continually attract a sufficient number of users to our
websites; or
o there are significant delays in the rollout, penetration or
acceptance of broadband services such as DSL or cable modems
in the consumer market.
DEPENDENCE ON MAJOR RECORD COMPANIES AS SUPPLIERS OF CONTENT
The rights to distribution of musical content are the single most
important "input" for music distributors. The supply market is divided among the
four major record label companies including Bertelsmann Music Group, Inc., Sony
Music Entertainment, Inc., Warner/EMI and Universal/Polygram Records, which in
the aggregate account for the majority of the record industry's revenue, and
smaller independent record label companies. While we recently signed a limited
content agreement with Arista Records, Inc. with respect to the artist LFO, we
do not have any content agreements with Sony Music Entertainment, Inc.,
Warner/EMI or Universal/Polygram Records. If we do not succeed in obtaining
additional or material licenses for digital music distribution from one or more
of the major record labels, we will be limited in the content we can offer on
our website. Although we have established arrangements with artists and
independent labels directly and are developing our own artists, we can give no
assurance that we will be able to enter into arrangements with major record
labels or that we can successfully exploit other sources of revenue.
RAPID GROWTH MAY STRAIN OUR RESOURCES
We expect to grow rapidly in the future. If we are correct in this
expectation, such growth will place a significant strain on our managerial,
operational and financial resources. To manage any such growth, we will be
required to implement and improve our managerial controls and procedures and
operational and financial systems. In addition, we will be required to hire,
train, integrate, manage and retain our workforce including technical support,
advertising, sales and business development staff. Locating and retaining
qualified personnel in our business is extremely competitive. We can give no
assurances that we have adequately allowed for the costs and risks associated
with our proposed expansion or that our systems, procedures or controls will be
adequate to support our operations. We can also give no assurances that we will
be able to successfully locate, train and integrate personnel into our
workforce.
DEPENDENCE ON KEY MANAGEMENT PERSONNEL
Our future success depends upon the continued services of certain key
management personnel including Mr. Bernhard Fritsch. The loss of one or more of
our key management personnel could materially adversely affect our business,
results of operations and financial condition. We have a five year employment
agreement with Mr. Fritsch which includes a non-competition provision which
prohibits Mr. Fritsch from gaining employment with or associating or investing
in any entity in the United States which is involved in the digital distribution
of music for a period of one year after the termination of his employment with
us. We have also entered into a license agreement with Mr. Fritsch for the use
of certain significant intellectual property rights, including with respect to
the technology and patents, when and if granted, for the encryption, shopping
cart and royalty tracking features of our delivery and sales systems. This
license agreement, however, only continues in effect so long as we continue to
pay Mr. Fritsch compensation of 0.25% of our gross revenue as provided in his
employment agreement, and will survive the termination of Mr. Fritsch's
employment, so long as such payments are made. Furthermore, under the terms of
the license agreement between MCY and Mr. Fritsch, Mr. Fritsch possesses sole
discretion over whether further prosecution of any patent applications with
respect to such technology will continue. Several of our employees, including
Mr. Fritsch, have entered into agreements agreeing, among other things, not to
compete with us if they leave MCY. If those employees, including Mr. Fritsch,
breach those agreements and become employed by or associated with one of MCY's
competitors, such action will likely have a materially adverse effect on our
business, results of operations and financial condition. We have no key-man life
insurance for any of our officers or directors.
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NEED FOR ADDITIONAL FINANCING; FINANCING MAY NOT BE AVAILABLE; FUTURE DILUTION
We may need to raise additional funds to do the following:
o Pay cash advances to record labels and artists to gain
distribution rights for top quality content;
o Invest in aggressive marketing, advertising and promotional
campaigns to develop our brands;
o Purchase new hardware and software to support our development,
the development of our websites and the development of our
technology;
o Establish studio/production facilities for creation and
editing of proprietary content;
o Acquire or partner with other complementary businesses or
assets;
o Develop content acquisition and digital retail outlets in
non-U.S. markets to provide cross cultural access for
consumers;
o Fund working capital and/or other obligations.
If we raise additional funds by issuing equity or convertible debt
securities in the future, such securities may have rights, preferences or
privileges senior to those of our existing stockholders and the percentage
ownership of our stockholders will be diluted. We can give no assurance that
additional financing will be available on favorable terms or at all. If adequate
funds are not available or are not available on acceptable terms, our ability to
fund our expansion, take advantage of opportunities, develop or enhance services
or products or otherwise respond to competitive pressures would be significantly
limited.
DIFFICULTIES ASSOCIATED WITH BRAND DEVELOPMENT
The importance of brand recognition will increase in the future as the
number of websites providing digital music delivery increases. There are many
music distributors and other retailers, both online and traditional, which enjoy
customer brand recognition and may attempt to compete with us in the digital
distribution and streaming pay-per-view markets. Many of these distributors have
superior financial strength and resources. We believe that establishing and
increasing awareness of our brand and the technology it represents is a critical
aspect of our efforts to continue to attract customers and content providers. We
will need to invest heavily in "top star" webcasts and brand development in
order to establish, maintain and/or increase our market presence. We can give no
assurances that our efforts to build brand awareness will be successful or that
we will have sufficient financing to pursue brand development successfully.
THE YEAR 2000
The Year 2000 issue is the result of computer programs written using
two digits rather than four to define the applicable year. As a result,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This may have resulted in system failures or miscalculations
causing disruptions of operations, including, among others, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities. Our systems and software (both licensed and proprietary)
are relatively new and we have not experienced any Year 2000 issues related to
our internal systems. We can give no assurance that the systems of suppliers or
other companies on which we rely have been converted in a timely manner and will
not have a material adverse effect on our systems. Additionally, we can give no
assurance that the third party computer systems necessary to maintain the
viability of the Internet or any of the websites that direct consumers to our
websites have not experienced or will not experience Year 2000 problems.
SIGNIFICANT COMPETITION
The market for online promotion and distribution of music and
music-related products is competitive. Barriers to entry on the Internet are
relatively low and competition is likely to increase significantly in the
future. We face competitive pressures from numerous actual and potential
competitors, many of which have longer operating histories, greater brand name
recognition, larger customer bases and significantly greater financial,
technical and marketing resources than we do. Such competition could result in
reduced margins, lower growth or
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loss of market share, any of which could have a material adverse effect on our
business, results of operations and financial condition.
POTENTIAL LIABILITY FOR INFORMATION DISPLAYED ON OUR WEBSITES
We may be subject to claims for defamation, libel, violation of
privacy, copyright or trademark infringement or claims based on other theories
relating to the information we publish or gather on our websites. These types of
claims have been brought, sometimes successfully, against online services in the
past. We could also be subject to claims based upon the content that is
accessible from our websites through links to other websites. Our insurance may
not adequately protect us against these claims.
SECURITY RISKS
A party who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions in our Internet
operations. Consumer concern over Internet security has been, and could continue
to be, a barrier to commercial activities requiring consumers to send their
credit card information over the Internet. Computer viruses, break-ins, or other
security problems could lead to misappropriation of proprietary information and
interruptions, delays, or cessation in service to our customers. Moreover, until
more comprehensive security technologies are developed, the security and privacy
concerns of existing and potential customers may inhibit the growth of the
Internet merchandising medium. In addition, we may be subject to "hacker
attacks" such as those recently made on the sites of companies including Yahoo!,
Inc., eBay, Inc. and E*Trade Group Inc. We may be required to expend significant
capital resources to protect against the threat of such security breaches or
"hacker attacks" or to alleviate problems caused by such events. We can give no
assurance that our Internet operations are completely secure against potential
interruptions or that we can alleviate the problems should they occur.
INTELLECTUAL PROPERTY
We expect to rely on a combination of patent law, copyright law,
trademark law, contract law, and other intellectual property protection methods
to protect our musical content, license rights, and proprietary technology and
information, but we can give no assurance that such laws will provide sufficient
protection or that the laws will not be amended or repealed. Our chief executive
officer, Mr. Fritsch has applied for the registration of trademarks used by us
in the United States and internationally, and has applied for "intent to use"
trademark registrations for a number of trademarks, including "MCY," "MCY.com"
and "NETrax," in the United States Patent and Trademark Office ("USPTO"). In
1999, we also filed several other "intent to use" trademark applications
including for the following: "on click", "music on click" and "entertainment on
click". We can give no assurance that the USPTO will grant the requested
trademarks. We believe that our use of material on our websites is protected
under current provisions of copyright law. However, effective trademark,
copyright, and other intellectual property protection may not be available in
every country in which our musical content and technology are distributed or
made available through the Internet. We can give no assurance that our methods
of protecting our proprietary rights in the United States or abroad will be
adequate. In addition, because patent law relating to the scope of claims in the
technology field in which we do business is still evolving, the degree of future
protection for our proprietary and licensed rights is uncertain.
Mr. Fritsch is pursuing patent protection with respect to certain
technology that is important to us, including the encryption, shopping cart and
royalty tracking technology. Mr. Fritsch has filed patent applications for these
technologies in the United States. We can give no assurance that any patents
will be issued. Until such time as such patents are issued, if ever, the license
will be ineffective to grant any patent rights with respect to this technology.
Moreover, Mr. Fritsch is under no obligation to pursue the prosecution of these
patent claims. See "Risk Factors - Dependence on Key Management Personnel",
"-Dependence on Licensed Technology and Music Rights". We can give no assurance
that others will not develop technologies that are similar or superior to ours,
that third parties will not copy or otherwise obtain and use our content or
technologies without authorization and that we will be able to continue to
maintain our rights to information, including webcasting of popular sound
recordings, downloadable music samples, and artist, entertainment and other
information. If we are unable to offer such information, such failure will be
likely to have a material adverse effect on our business, results of operations,
and financial condition.
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There are no pending lawsuits against us regarding infringement of any
existing patents or other intellectual property rights of others. We can give no
assurance that patent or intellectual property litigation will not be asserted
by third parties in the future. If any such claims are asserted and determined
to be valid, we can give no assurance that we will be able to obtain licenses of
the intellectual property rights in question on reasonable terms. If we become
involved in any patent dispute, other intellectual property dispute, or action
to protect proprietary rights, our involvement, regardless of outcome, will
likely have a material adverse effect on our business, results of operations,
and financial condition. If any litigation is determined against us, such
adverse determination may subject us to significant liabilities to third
parties, require us to seek licenses from third parties, and prevent us from
manufacturing and selling our products. In addition, we can give no assurance
that any of the provisional patent applications to which we have exclusive
rights will result in issued patents, that we will develop additional
proprietary technologies that are patentable, that any patents licensed or
issued to us or our strategic partners will provide a basis for commercially
viable products or will provide us with any competitive advantages or will not
be challenged by third parties, or that patents of others will not have an
adverse effect on our ability to do business. Furthermore, we can give no
assurance that others will not independently develop similar, alternative or
superior technologies, or design around the patented technologies developed by
us. Any of these situations may have a material adverse effect on our business,
results of operations, and financial condition.
POTENTIAL FOR ERRORS IN PRODUCTS AND SERVICES
We offer and expect to offer complex products and services which 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, we may experience negative publicity, loss of or delay in
market acceptance or claims against us by customers, any of which may have a
material adverse effect on our business, results of operation, and financial
condition.
DEPENDENCE ON THE INTERNET; UNCERTAIN ACCEPTANCE OF THE INTERNET AS A MEDIUM FOR
COMMERCE
Use of the Internet by consumers is at an early stage of development,
and market acceptance of the Internet as a medium for commerce is subject to a
high level of uncertainty. The Internet may not prove to be a viable commercial
marketplace because of inadequate development of the necessary infrastructure,
such as reliable network backbones, or complementary services, such as
high-speed modems and security procedures for financial transactions or delays
in the development and adoption of new standards and protocols (for example, the
next generation Internet protocol) to handle increased levels of Internet
activity or due to increased government regulation. Our future success will
depend on our ability to significantly increase revenue which will require the
development and widespread acceptance of the Internet as a medium for commerce.
We can give no assurance that the Internet will be a successful retailing
channel. If use of the Internet does not continue to grow, or if the necessary
Internet infrastructure or complementary services are not developed to
effectively support growth that may occur, our business, results of operations,
and financial condition could be materially adversely affected. We can give no
assurance that we will not continue to be largely dependent on the Internet.
RISKS OF TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS; BANDWIDTH
The delivery of music online is and will continue to be, like the
Internet, characterized by rapidly changing technology, evolving industry
standards, changes in customer requirements, and frequent new service and
product introductions. Online delivery of music, at current compression rates,
requires large amounts of Internet "bandwidth" to download to a customer's
computer in an acceptable time span. "Bandwidth" refers to the capacity of the
Internet, a network or an Internet connection and connections to handle the
transfer of data. Currently, only a limited number of consumers have such
bandwidth capability. Unless there is widespread access to high speed Internet
connections or deeper compression of music files, consumers may become
frustrated with long download times and the market for online digital music
distribution will remain limited. Our success will depend upon the development
of Internet infrastructure that makes large amounts of bandwidth available to a
wide number of users through such high-speed technology as cable and digital
subscriber lines. Our success will also depend on our ability to effectively use
leading technologies to continue to develop our technological expertise to
enhance our current services, to develop new services that meet changing
customer requirements and to influence and respond to emerging industry
standards and other technological changes on a timely and cost-effective basis.
If major record labels or the market accept a universal standard for the
electronic delivery of music, such as contemplated by the
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Secured Digital Music Initiative, which is not compatible or otherwise competes
with NETrax, such acceptance will likely have a material adverse effect on our
business, results of operations, and financial condition. In addition, our
business could be adversely affected if an industry standard for hardware used
in the storage and playback of our products fails to develop in a timely manner
or at all.
DEPENDENCE ON THIRD PARTIES FOR INTERNET OPERATIONS
Our ability to advertise on other Internet sites and the willingness of
the owners of such sites to direct users to our websites through hypertext links
are critical to the success of our Internet operations. We also rely on the
cooperation of owners of copyrighted materials and Internet search services and
on our relationships with third party vendors of Internet development tools and
technologies. We can give no assurance that the necessary cooperation from third
parties will be available on acceptable commercial terms or at all. If we are
unable to develop and maintain satisfactory relationships with such third
parties on acceptable commercial terms, or if our competitors are better able to
leverage such relationships, our business, results of operations and financial
condition will be materially adversely affected.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES RELATING TO THE WORLD WIDE WEB
Existing domestic and international laws or regulations specifically
regulate communications or commerce on the World Wide Web or the Internet.
Furthermore, laws and regulations that address issues such as user privacy,
pricing, online content regulation, taxation and the characteristics and quality
of online products and services are under consideration by federal, state, local
and foreign governments and agencies. Several telecommunications companies have
petitioned the United States Federal Communications Commission to regulate
Internet service providers and online service providers in a manner similar to
the regulation of long distance telephone carriers and to impose access fees on
such companies. This regulation, if imposed, could increase the cost of
transmitting data over the World Wide Web. Moreover, it may take years to
determine the extent to which existing laws relating to issues such as
intellectual property ownership and infringement, libel, obscenity and personal
privacy are applicable to the World Wide Web. The United States Federal Trade
Commission and government agencies in certain states have been investigating
certain Internet companies regarding their use of personal information.
The Children's Online Privacy Protection Act ("COPPA") which becomes
effective on April 21, 2000 and its implementing rules regulates the online
collection and use of personal information provided by and concerning children
under the age of thirteen years. COPPA specifically requires operators of
websites that are either directed to children under the age of thirteen years or
that have actual knowledge that such children are providing information to a
website to provide notice of the information that it collects and how it will
use such information, to provide parents with access to review and change such
information and the manner in which it is used, and to obtain verifiable
parental consent before collecting and using certain personal information. In
addition, such website operators must provide for the secure maintenance of the
collected information, and not collect more information than is reasonably
necessary under the circumstances to allow children to participate in activities
on their website.
We currently share statistical information about users of our website
to our business partners. We do not currently sell information about users of
our website to third parties. Laws such as COPPA, if applicable, could restrict
or limit our ability to share and use information about our users or require us
to incur additional expenses in order to comply with the requirements of such
laws. Any new laws or regulations relating to the World Wide Web, or certain
application or interpretation of existing laws, could decrease the growth in the
use of the World Wide Web, decrease the demand for our website or otherwise
materially adversely affect our business.
DEVELOPMENT OF WEBSITES AND DIGITAL CATALOG
Although we have completed the initial development of our websites, we
have to continually update them to incorporate new features, services and
purchases of new and existing content. The number of digitally downloadable
music tracks which may be acquired by purchasers are limited and we can give no
assurance that we will be able to expand the selection of tracks available for
purchase. If we are unable to increase the number and marketability of NETrax
available for purchase, we will be unable to generate sufficient revenue to
support continued development.
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DEPENDENCE ON LICENSED TECHNOLOGY AND MUSIC RIGHTS
We rely on certain technology licensed from third parties, including
Mr. Fritsch, our chief executive officer, from whom we license certain key
technologies and trademarks. We may need to license additional technologies in
the future in order to support its platform. There can be no assurance that new
third party technology licenses will be available to us on acceptable terms or
at all. In addition, we license music content from record labels and artists,
and we can give no assurance that any particular music content will be available
to us on acceptable terms or at all. The intellectual property upon which we
rely includes certain technology which is licensed to us by Mr. Fritsch. Such
license, however, only continues in effect so long as we pay compensation equal
to 0.25% of gross revenue to Mr. Fritsch (until the later of 20 years or the
expiration of any such patents which may be issued). If we fail to pay Mr.
Fritsch such compensation, we will lose our license and our ability to utilize
such technology. We can give no assurance that Mr. Fritsch will not terminate
the license for other reasons. If Mr. Fritsch were to terminate the license,
such termination will likely have a materially adverse effect on our business.
See "Business - Technology". We have not obtained licenses for the public
performance of all copyrighted musical works which will be the subject of our
business operations. We do not believe such licenses are necessary for the
conduct of our business, but will seek to obtain such licenses if necessary. The
companies that administer the reporting and collection of royalties based on
musical performances believe that the downloading of digital music files is a
"performance," entitling them to receive payment. If such licenses are necessary
and we fail to obtain them, we may become subject to claims of copyright
infringement.
INTERNATIONAL MARKETS
Our success depends on our ability to generate international sales. We
can give no assurance that we will be successful in generating international
sales of our products. Our sales to customers in certain foreign countries may
be subject to a number of risks including: foreign currency risk; the risks that
agreements may be difficult or impossible to enforce and receivables difficult
to collect through a foreign country's legal system; foreign customers may have
longer payment cycles; or foreign countries could impose withholding taxes or
otherwise tax our foreign income, impose tariffs, embargoes, or exchange
controls, or adopt other restrictions on foreign trade. In addition, the laws of
certain countries do not protect our offerings and intellectual property rights
to the same extent as the laws of the United States. Our failure to compete
successfully or to expand the distribution of our offerings in international
markets could have a material adverse effect on our business, results of
operations, and financial condition.
SINGLE STOCKHOLDER CONTROLS APPROXIMATELY 80% OF STOCKHOLDERS' VOTES
Mr. Bernhard Fritsch beneficially owns approximately 23,680,078 shares
of our common stock and all of our outstanding Series 1 preferred stock which
collectively carries approximately 80% of all voting rights held by all of our
stockholders. Mr. Fritsch is able to control all matters requiring approval by
our stockholders, including the election of directors and the approval of
significant corporate transactions. This concentration in ownership will make
some transactions more difficult or impossible without the support of Mr.
Fritsch and may have the effect of delaying, deterring or preventing a change of
control in our company.
LITIGATION
A former trade partner, Mr. Xavier Ghali, contributed DM 1,600,000 to
the development of the our platform and subsequently demanded repayment of DM
1,210,000 of this amount on January 30, 1998. Fritsch & Friends rejected this
demand on February 3, 1998, and since then the partner has not pursued this
alleged claim. In addition, Fritsch & Friends entered into an agreement with an
investment group in November, 1997, which it subsequently revoked. In February
2000, we received a notice from the American Arbitration Association ("AAA")
indicating that a request for arbitration had been filed. To date, however, we
have not received any documents indicating the basis or the grounds for the
claim. We believe that it is unlikely that we will sustain material losses in
connection with these matters in excess of amounts previously accrued. We can
give no assurance that future litigation or arbitration with Mr. Ghali or with
the investment group will not have a materially adverse effect upon our
financial condition.
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On December 16, 1999, Mr. Peter Rohde, a former employee of MusicWorld
filed a complaint against us in New York State Supreme Court. Mr. Rohde, the
plaintiff, had been employed by MCY America, Inc., a subsidiary of MusicWorld,
as an assistant manager in November 1998 pursuant to a letter employment
agreement dated November 10, 1998. The plaintiff entered into a subsequent
employment agreement with MusicWorld dated July 9, 1999 as a content manager and
a trust and confidentiality agreement which contained noncompetition and
confidentiality provisions. In August 1999, the plaintiff was observed entering
our offices at unusual hours. On August 21, 1999, he was observed exiting our
offices with what was believed to be a personal computer and a large bag
containing proprietary information about our company. As a result, we terminated
the plaintiff on August 27, 1999. In his complaint, his claims included breach
of contract, wrongful termination and fraud related to his inability to collect
fees due to alleged fraudulent misrepresentations by the company concerning the
effectiveness of the technology. In his complaint, he asked for damages of
approximately $23,000,000 including 20,000 shares of MCY.com, Inc. common stock,
stock options, fees and royalties. Based upon our understanding of the facts, we
believe that Mr. Rohde's claims lack substantial merit and we intend to
vigorously defend against this action. We filed an answer and counterclaims
against Mr. Rohde in March 2000. To date, the plaintiff has not provided any
calculation to support the financial basis of his claim. If his claim is
adjudicated against us we can give no assurance that such determination will not
have a materially adverse effect upon our financial condition.
POTENTIAL FLUCTUATIONS IN QUARTERLY FINANCIAL RESULTS
If we are unable to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall, any significant revenue shortfall will
likely have an immediate material adverse effect on our business, operating
results and financial condition. In addition, we intend to substantially
increase our operating expenses for product development, sales and marketing. To
the extent such expenses precede or are not subsequently followed by increased
revenue, our operating results will fluctuate and net anticipated losses in a
given quarter may be greater than expected. Accordingly, quarter-to-quarter
comparisons of our revenue and operating results will not necessarily be
meaningful, and such comparisons may not be accurate indicators of future
performance. In addition, quarterly fluctuations in our operating results may
create volatility in the market price for our common stock.
CERTAIN IMPLICATIONS OF TRADING OVER-THE COUNTER; "PENNY STOCK" REGULATIONS
Our common stock is quoted for sale in the over-the-counter market on
the OTC Electronic Bulletin Board. An investor will find it more difficult to
dispose of securities trading over-the-counter than if such securities had been
approved for listing on a national securities exchange or on the NASDAQ SmallCap
market. We have not applied for listing on a national securities exchange or the
NASDAQ SmallCap market, but we intend to so in the future. We can give no
assurance that our securities will be listed on any such market or that any
market will develop for our securities.
The Securities and Exchange Commission (the "Commission") has adopted
"penny stock" regulations which apply to securities traded over-the-counter. Our
common stock is subject to such regulations. These regulations generally define
"penny stock" to be any equity security that has a market price of less than
$5.00 per share, a warrant that has an exercise price of less than $5.00 per
share, an equity security of an issuer (assuming the corporation has been in
existence for at least three years) with net tangible assets of less than
$2,000,000 or an equity security of an issuer with average revenue in the last
three fiscal years of less than $6,000,000 as indicated in audited financial
statements. Subject to certain limited exceptions, the rules for any transaction
involving a "penny stock" require the delivery, prior to the transaction, of a
risk disclosure document prepared by a broker-dealer that contains certain
information describing the nature and level of risk associated with investments
in the penny stock market. A broker-dealer also must disclose the commissions
payable to both the broker-dealer and the registered representative and current
quotations for the securities. Monthly account statements must be sent by the
broker-dealer disclosing the estimated market value of each penny stock held in
the account or indicating that the estimated market value cannot be determined
because of the unavailability of firm quotes. In addition, the rules impose
additional sales practice requirements on broker-dealers who sell such
securities to persons other than established customers and institutional
accredited investors (generally institutions with assets in excess of
$5,000,000). These practices require that, prior to the purchase, the
broker-dealer determined that transactions in penny stocks were suitable for the
purchaser and obtained the purchaser's written consent to the transaction.
Consequently, the "penny stock" rules may in the future restrict the ability of
broker-dealers to sell our securities and may affect the ability of purchasers
of our securities to sell them in the secondary market.
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EMPLOYEES
We have approximately 74 staff members in New York, Munich and Los
Angeles, separated into the following categories:
Operations and Development 24
Sales and Marketing 8
General and Administration 20
Content Acquisition 22
=====
Total 74
None of our employees are covered by a collective bargaining agreement
or are represented by a labor union or works council. We believe that our
relationship with our employees is good.
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
When used in this discussion and analysis, the words "anticipates,"
"estimates," "expects" and similar terms are intended to identify
forward-looking statements, which include statements concerning the timing of
the development of the markets for webcasting pay-per-view and digital
downloading of musical content, the our ability to secure rights to premium
content for distribution or sale of streamed audio visual media and digitally
downloadable music, and announcements or actions of existing and future
competitors, are subject to risks and uncertainties, including those set forth
above under "Risk Factors" that could cause actual results to differ materially
from those projected. These forward-looking statements refer only to the date
hereof. The Company expressly disclaims any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any changes in events, conditions or circumstances on which
any statement is based. You should read this discussion and analysis in
conjunction with the financial statements and other financial information
contained in this Registration Statement on Form 10-SB.
Results of Operations
MusicWorld is a development stage company which commenced operations on
January 8, 1999. Through December 31, 1999, we incurred costs to design,
organize and develop an Internet website to conduct our businesses. We began
selling musical recordings over the Internet in August 1999 and began are first
significant selling and marketing initiatives in the quarter ended September 30,
1999. We may experience significant fluctuations in operating results in future
periods due to a variety of factors, including:
o the demand for downloadable music content and Internet
advertising;
o the addition or loss of advertisers;
o the level of traffic on its Internet sites;
o the amount and timing of capital expenditures and other costs
relating to the expansion of its operations;
o the introduction of new sites and services by us or its
competitors;
o seasonal trends in Internet use, purchases of downloadable
music and advertising placements;
o price competition or pricing changes in the industry; and
o technical difficulties or system downtime o general economic
conditions and economic conditions specific to the Internet.
Because of our limited history, we believe that period-to-period
comparisons of our operations are not meaningful. Accordingly, we have not
included comparisons in the discussions set forth below.
Net Revenues
For the year ended December 31, 1999, our consolidated revenues totaled
$343,000. Our revenues to date consist of advertising revenue and sales of
physical merchandise and downloadable music recordings. In the future, we expect
sales of merchandise to be limited.
Sales, Marketing and Public Relations Expenses
Sales, marketing and public relations expenses consist primarily of:
o Sales and marketing salaries and benefits;
o The cost of free events and trade shows;
o Consulting fees and related expenses for public relations
activities; and
o European promotional activities including travel and
entertainment costs of participating individuals.
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Sales, marketing and public relations costs through December 31, 1999
totaled $8,519,000 most of which was expended in the last six months of 1999. As
part of our marketing strategy and in an effort to aggressively create brand
awareness, a significant portion of these costs were expended on free events,
trade shows and related promotional activities during the six month period ended
December 31, 1999.
We also expect to enter into various strategic alliances, begin other
targeted advertising and direct promotion campaigns, attend tradeshows and begin
other activities to attract new customers. As a result, we expect to incur
significant sales and marketing expenses in future periods.
Approximately $10 million has been budgeted for the next twelve months
for the purpose of engaging in various forms of promotion. We expect to attend a
minimum of 30 key trade shows during 2000, participate in numerous online email
and viral marketing campaigns as well as perform traditional sales and marketing
activities. In addition, our sales force will actively market specific webcast
events to potential sponsors on an event by event basis. Key marketing
opportunities are expected to arise from the recent signings of the Backstreet
Boys Millenium Tour, NSync No Strings Attached Tour and other streaming events
including concerts by Puff Daddy, Pete Townshend and other comparable artists.
Product Development Expenses
We began our development efforts in June 1999. Product development
expenses consist principally of:
o website development, including software engineering, audio
production and graphic design;
o telecommunications charges;
o salaries, rent, depreciation and other expenses related to
building its music distribution business; and
o amortization of music content.
Product development expenses were $2,129,000 for the year ended
December 31, 1999. These costs reflect the ongoing investment in our product
development efforts, particularly in software engineering, graphic design and
development of the infrastructure required to stream webcast pay-per-view events
and to deliver downloadable music to customers. We anticipate incurring
approximately $6,000,000 during the next twelve months on continuing research
and development efforts in this area.
Content Development
Costs incurred with respect to content development relates directly to
amounts paid to secure rights to music and related media for the purpose of
selling digital downloads of songs and the webcasts of concerts and other
footage in connection with pay-per-view activities. Total content development
costs, which include the costs of employee salaries as well as consultants
dedicated to content acquisition activities totaled $1,583,000 through December
31, 1999.
For the concerts and events that we have sponsored and webcasted to
date, costs incurred to obtain the rights to sponsor and webcast the concerts
and events totaled $3.2 million through December 31, 1999 of which $2.7 million
was included in sales, marketing and public relations expense, $350,000 was
capitalized as record company advances and the remaining $150,000 was recorded
as royalty expense. Costs incurred to obtain content in 2000 totaled $2.4
million and warrants to purchase shares of our common stock. The benefits we
realized include: (i) the right to digitally download songs for a fee; (ii) the
right to webcast events on a pay-per-view basis; and (iii) the right to
physically distribute CDs and other music-related merchandise. As of December
31, 1999, the Company had generated no revenues from webcast pay-per-view
events. However, we believe that events currently scheduled in 2000 are expected
to generate revenues from pay-per-views, digital downloads and other bases.
Approximately $15 million has been budgeted for the next twelve months
for the purpose of acquiring various rights to premium content across a number
of genres. Management expects to acquire master rights from master rights
holders (i.e., directly from labels as well as artists) for exploitation via
digital downloads, webcast events, physical distribution and related
sublicensing. The Company's accounting policies require the capitalization of
such costs and their amortization over the term of the rights contracts.
Activities involved in acquiring musical content include identifying premium
musical content, negotiating with master rights holders, obtaining proper
clearances and,
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ultimately, signing rights to such content to exploit through e-commerce.
Currently, we have rights to over 30,000 musical works and performances
including such top acts as the Backstreet Boys and NSync. Further, management is
involved in numerous negotiations with other comparable premium artists and
expects to close on various agreements with the majority of these artists by the
June 2000. Costs incurred as a result of engaging in the above described
activities were primarily concentrated in the rights acquisition area followed
by the payment of salaries in the development of the software to exploit such
rights. The result of such activities and costs incurred in obtaining the
various rights described above prior to the acquisition of the predecessor
companies by MusicWorld was the development of the NETrax player, our
proprietary software for playing downloadable music and proprietary encryption
software contained with the NETrax player. Ongoing research and development is
focused on the transfer of protected digital downloads to player hardware. In
addition, we will continue to evolve and develop new features within the NETrax
software and other web appliances, further develop webcast pay-per-view
technology and create digital warehousing services for digital entertainment
content.
General and Administrative Expenses
General and administrative expenses consist primarily of executive
management, finance, legal, administrative and related overhead costs, such as
rent and insurance. We have incurred costs of $4,470,000 from inception through
December 31, 1999 related to general and administrative expenses. We expect
general and administrative expenses to continue to increase as we expand our
staff and to incur additional costs related to the growth of our business.
Amortization of Acquired Intangibles
During 1999, MusicWorld acquired certain predecessor companies. As a
result, we recorded intangible assets comprised as follows:
<TABLE>
<CAPTION>
<S> <C>
Technology and related contracts $ 4,410,000
Record label contracts and catalogs $ 630,000
Excess of cost over fair value of identifiable net assets acquired $ 23,281,000
------------
$28,321,000
</TABLE>
Amortization of technology and related contracts as well as record
label contracts and catalogs are being amortized over three years while the
excess of cost over fair value of identifiable net assets acquired is being
amortized over 5 years. Total amortization expense for 1999 totaled $3,168,000.
Future amortization related to acquired intangibles will be:
<TABLE>
<CAPTION>
Year Ending December 31, Amount
------------------------ ------
<S> <C>
2000 $6,336,000
2001 $6,336,000
2002 $5,496,000
2003 $4,656,000
2004 $2,328,000
</TABLE>
Prior to MusicWorld's acquisition of the above-referenced predecessor
companies, Bernhard Fritsch and certain other individuals employed by the
predecessor companies engaged in research and development activities which
included the development, purchase, licensing and otherwise acquisition of
rights to utilize technology and property rights including patent, copyright,
trademark and trade secrets. These acquired rights and software assets developed
by Mr. Fritsch and others to distribute media under these rights include:
o Digital distribution and encrypted delivery of all forms of
media;
o Physical distribution and delivery of such media;
o Online, internet or electronic distribution, transfer or
delivery of such media;
o Digital warehousing of such media;
o Physical warehousing of such media;
o Database storage of such media;
o Search of such media by any means and through any medium now
known or as may become known in the future; and
o Operation of a "shopping basket" for the purchase of such
media.
-27-
<PAGE>
Stock Based Compensation
We recorded charges related to stock based compensation for 1999
totaling $49,904,000. Included in this amount is amortization of deferred
compensation arising from options issued to employees and consultants at various
dates amounting to $22,491,000. In addition, we recorded a compensation charge
to operations of approximately $23,741,000 during August 1999 in connection with
a sale by holders of 4,000,000 shares of HBI common stock of approximately
3,970,000 of such shares to certain of our stockholders who also served as
advisors to the Company. The balance of stock based compensation charges arose
from common stock and options issued to employees and consultants for services.
Future amortization related to stock based compensation will be:
<TABLE>
<CAPTION>
Year Ending December 31, Amount
----------------------- ------
<S> <C>
2000 $ 11,207,000
2001 $ 4,902,000
2002 $ 2,847,000
</TABLE>
Liquidity and Capital Resources
Our cash balance as of December 31, 1999 was $26,060,000. For the
period from inception through December 31, 1999, net cash of $15,132,000 was
used for operating activities consisting of net losses of $69,713,000,
substantially offset by:
o non-cash expense of $49,904,000 associated with stock and
stock-based compensation;
o non-cash expense of $3,168,000 associated with amortization of
intangibles; and
o non-cash expense of $663,000 associated with the Company's
share of losses of predecessor companies.
In addition, we purchased approximately $689,000 in capital equipment
from inception through December 31, 1999. We also incurred $777,000 to develop
internal-use software. We expect to incur negative cash flow from operations for
the foreseeable future, as we continue to develop our business.
During the period from May through December 1999, we raised net
proceeds of approximately $45,656,000 through the sale of common stock as
follows:
o 363,636 shares at $2.75 per share less related costs of
$10,000 - May 1999
o 2,400,000 shares at $3.75 per share less related costs of
$310,000 - May 1999
o 200,000 shares at $5.00 per share less related costs of
$10,000 - May 1999
o 6,573,333 shares at $6.00 per share less related costs of
$4,454,000 - August and October 1999
We lease facilities and equipment under noncancellable operating leases
expiring through October, 2004. Such leases provide for annual payments as
detailed below. In connection with the aforementioned leases, we are
-28-
<PAGE>
required to provide security totaling $925,000. Such security has been provided
by deposits totaling $731,000 and letters of credit collateralized by restricted
cash of $194,000.
Future minimum annual lease payments as of December 31, 1999 are as
follows:
For The Period Ending
December 31,
------------
2000 $ 1,263,000
2001 1,130,000
2002 987,000
2003 398,000
2004 332,000
-------------
$ 4,110,000
=============
Since inception, we have experienced significant losses and negative
cash flows from operations. We believe that our existing capital resources will
be sufficient to fund our planned level of operating activities, capital
expenditures and other obligations through the next 12 months. However, we may
need to raise additional funds in future periods through public or private
financings, or other sources, to fund our operations and potential acquisitions,
if any, until we achieve profitability, if ever. We may not be able to obtain
adequate or favorable financing at that time. Failure to raise capital when
needed could harm our business. If we raise additional funds through the
issuance of equity securities, the percentage of ownership of our stockholders
would be reduced. Furthermore, these equity securities might have rights,
preferences or privileges senior to our common stock.
During 1999, we employed 6 employees in Berlin for the purpose of
running a facility for the digitization of music into a database for later use
in distribution of such media via digital download. Management decided that such
facility should be moved to the U.S. due to cost and oversight considerations.
Management does not expect any significant change in the number of staff to run
the facility once moved to the U.S. which is expected to occur by June 2000.
Management expects increases in head count in the following areas:
o Transaction processing - as the number of transactions increase related to
the purchase of webcast events and digital download sales, additional
personnel will be added to handle the related traffic. Assuming we meet
budgeted sales levels for the year 2000, approximately four additional
people will be added in the next twelve months to handle transaction
processing increases. The year to year increase is not expected to be
significant, however, since we currently outsource, and expect to continue
to outsource, a substantial portion of the transaction processing burden to
professional processing companies.
o Content acquisition - management believes that we will need to hire
approximately ten individuals in the next twelve months at all levels in
order to maintain a steady pipeline of premium content acquisition. This
number is expected to increase significantly year after year as we fulfill
our goal of creating one of the most comprehensive catalogues of premium
content.
o Sales, marketing and publicity - considering the importance of drawing
general traffic to our website, generating attention in all media formats
and sponsorship support of webcast events, we plan to hire vice presidents
in charge of marketing and business development in the first quarter of
2000. Further, an additional seven to ten sales, marketing and business
development professionals are expected to be hired in the next twelve
months to support the executive levels in garnering attention and support
for webcast events and increasing website traffic. In addition, we have
engaged and will continue to engage outside consultants to attract webcast
sponsors and other advertisers to our website.
-29-
<PAGE>
ITEM 3. DESCRIPTION OF PROPERTY
Our New York corporate headquarters, located at 1133 Avenue of the
Americas, 28th Floor, New York, New York 10036, contains approximately 14,000
square feet and is leased at a rate of $58,000 per month. We also maintain an
office in New York located at 307 7th Avenue, 23rd Floor, New York, New York
10001, which contains approximately 2,500 square feet and is leased at a rate of
$2,379 per month. 64 full-time employees work in our New York offices, as well
as several programming and creative staff working on a freelance basis.
Our Munich office contains approximately 7,000 square feet and is
leased at a rate of $22,000 per month. 9 employees work in the Munich office.
Our Los Angeles office contains approximately 7,750 square feet and is
leased at a rate of $15,500 per month. 4 employees work in the Los Angeles
office.
-30-
<PAGE>
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of and percentage of
outstanding shares of our securities, as of December 31, 1999, owned by: (i)
holders of our securities known to us to beneficially own more than five (5%)
percent of our securities; (ii) each of our directors; (iii) each executive
officer named in the Summary Compensation Table under the caption "Executive
Compensation" in Item 6 of this registration statement; and (iv) all of our
directors and executive officers as a group. As of December 31, 1999, there were
(i) 54,340,988 shares of our common stock issued and outstanding; and (ii)
1,000,000 shares of our Series 1 preferred stock issued and outstanding.
<TABLE>
<CAPTION>
Shares of Percent of Share of Series 1 Percent of
Name and Address Common Stock Class (2) Preferred Stock Class(2)
- ---------------- ------------ --------- --------------- --------
<S> <C> <C> <C> <C>
Bernhard Fritsch 24,250,078 (3) 44% 1,000,000 100%
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
Tintagle Trading Co., Ltd.** 3,388,700 6%
c/o Chapman Davis & Co.
No. 2 Chapel Court
London SE1 England
William C. Bossung 3,282,000 (4) 6%
25 Cos Cob Road
Greenwich, CT 06807
Hubertus von Hesse 465,000 (5) *
c/o MCY Europe GmbH
Maximilian Strasse 35b
80538 Munich Germany
Lisa Short 195,480 (6) *
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
Norbert Jahns 320,000 (7) *
Bilingerweg 2
14089 Berlin, Germany
Susanne Weblus ______ *
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
Mitchell Lampert 1,105,000 (8) 2%
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
Scott Citron *** 33,000 (9) *
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
Ray Short 20,000 (10) *
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
</TABLE>
-31-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Thomas Noack 5,000 (11) *
c/o MCY.com, Inc.
1133 Avenue of the Americas
New York, New York 10036
All directors and named 26,392,558 47%
executive officers as a group (9
persons***)
</TABLE>
- -----------------------
(1) We believe that the beneficial owners of our common stock listed above
have sole investment and voting power with respect to such shares.
Shares subject to options are considered beneficially owned to the
extent currently exercisable or exercisable within 60 days after
December 31, 1999.
(2) Asterisk indicates less than 1%. Shares subject to such options that
are considered to be beneficially owned are considered outstanding only
for the purpose of computing the percentage of outstanding common stock
which would be owned by the option holder if such options were
exercised, but (except for the calculation of beneficial ownership by
all executive officers and directors as a group) are not considered
outstanding for the purpose of computing the percentage of outstanding
common stock owned by any other person.
(3) Includes: (i) 120,000 shares underlying options exercisable at $1.50
per share; and (ii) 450,000 shares underlying options exercisable at
$3.20 per share, held by Mr. Fritsch.
(4) Includes 20,000 shares underlying options exercisable at $1.50 per
share held by Mr. Bossung.
(5) Includes: (i) 40,000 shares underlying options exercisable at $1.50 per
share; and (ii) 225,000 shares underlying options exercisable for $3.20
per share, held by Mr. von Hesse.
(6) Includes 20,000 shares underlying options exercisable at $1.50 per
share held by Ms. Short.
(7) Includes 20,000 shares underlying options which are exercisable at $
1.50 per share held by Mr. Jahns.
(8) Includes: (i) 120,000 shares underlying options exercisable at $ 1.50
per share; (ii) 225,000 shares underlying options exercisable at $ 3.20
per share; and (iii) 500,000 shares underlying options exercisable at
$3.20 per share, held by Mr. Lampert.
(9) Includes 33,000 shares underlying options exercisable at $ 6.00 per
share held by Mr. Citron. Mr. Citron ceased to be employed by us
effective March 16, 2000.
(10) Includes 20,000 shares underlying options exercisable at $ 9.50 per
share held by Mr. Short.
(11) Includes 5,000 shares underlying options exercisable at $ 12.50 per
share held by Mr. Noack.
** Tintagle Trading Co., Ltd. is an entity which we believe is controlled
by Michael Wilson-Smith.
*** Scott Citron ceased to be employed by us effective March 16, 2000.
-32-
<PAGE>
ITEM 5. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
Directors and Executive Officers
- --------------------------------
Our directors, executive officers and all persons nominated or chosen
to become such and their ages, as of December 31, 1999, are listed on the table
below. All directors hold office until the next annual meeting of shareholders
or until their successors have been duly elected or qualified or until his
earlier death, resignation or removal. Executive officers are appointed by and
serve at the discretion of our board of directors.
<TABLE>
<CAPTION>
- --------------------------------------------- ------------------- ----------------------------------------------------
Name Age Position
- ---- --- --------
- --------------------------------------------- ------------------- ----------------------------------------------------
<S> <C>
Bernard Fritsch 39 Chairman of the Board, Chief
Executive Officer, President and
Director
- --------------------------------------------- ------------------- ----------------------------------------------------
Lisa Short 26 Secretary and Vice President -
Marketing
- --------------------------------------------- ------------------- ----------------------------------------------------
Hubertus von Hesse 40 Director
- --------------------------------------------- ------------------- ----------------------------------------------------
Norbert Jahns 47 Director
- --------------------------------------------- ------------------- ----------------------------------------------------
Susanne Weblus 35 Director
- --------------------------------------------- ------------------- ----------------------------------------------------
</TABLE>
BERNHARD FRITSCH has served as Chairman of the Board, Chief Executive
Officer, President and a Director since the completion of the merger on August
2, 1999. Mr. Fritsch is also Chairman of the Board, Chief Executive Officer,
President and a director of MCY Music World, Inc. Mr. Fritsch is also a member
of our Audit Committee and Compensation Committee. Mr. Fritsch has also served
as President and Chief Executive Officer of Datatek Services Limited since its
formation in 1997. In 1991, Mr. Fritsch founded Fritsch & Friends Mediagroup
GmbH, a company which functioned as a high-end audio post-production house and
also maintained a significant presence in multimedia content production, sales
and distribution. From 1989 to 1991, Mr. Fritsch served on the executive
management team of Harman International where he worked to develop and execute
their digital equipment marketing strategy. Prior to 1989, Mr. Fritsch worked on
radio and television audio productions in West Berlin. Mr. Fritsch received a
Tonmeister Degree from the Technical University of Berlin. For the past six
years, Mr. Fritsch has been a guest lecturer at New York University's
graduate-level studies in Music Technologies.
LISA SHORT has served as Secretary since the completion of the merger
on August 2, 1999. Ms. Short also serves as Secretary of MCY Music World, Inc.
Ms. Short joined the MCY management team in June 1997 as the first employee in
the New York office. Under her direction, MCY operations were shifted from
Berlin to the new headquarters in New York City, New York. Since the start up of
the New York office, Ms. Short has implemented strategic partnerships and
alliances, communications direction and strategy and has set up a public
relations network for us as we move forward. As a company veteran, she has been
involved in the staffing and training of the MCY team. Prior to joining us, she
worked in the production and strategic management of fashion and music shows. In
1996, Ms. Short served in a public relations role in organizing and overseeing
radio spots, promotional material distribution and sponsorship organization for
a mid-sized Salt Lake City-based production studio. Ms. Short holds a Bachelor
of Arts Degree in French and Spanish from the University of Oregon. She has also
studied in Switzerland, France and Spain.
HUBERTUS VON HESSE has served as a Director since the completion of the
merger of August 2, 1999. Mr. von Hesse also serves as a director of MCY Music
World, Inc. Mr. von Hesse, a founding partner of the law firm of Merleker & v.
Hesse, advises on commercial, corporate and real estate law matters. He has
advised MCY on legal matters since its incorporation. After a two year training
program at Hypovereinsbank AG/Munich, he studied law at Munich Ludwig-
Maximilians-University and University of Lausanne. He received his law degree
from Munich LMU. Mr. von Hesse passed the First state exam in 1986 and the
Second (final) in 1989. He was admitted to the Bar in Berlin in 1990.
-33-
<PAGE>
NORBERT JAHNS, has served as a Director since January 18, 2000. Mr.
Jahns is a business consultant and has been self-employed since 1985. Prior to
1985, Mr. Jahns was employed by Wirtschaftspruefergesellschaft Berlin. In 1971,
Mr. Jahns studied business and management at the Technology University of Berlin
and obtained a FU Berlin Business degree in 1973. Mr. Jahns became a
state-licensed accountant in 1974. Mr. Jahns also obtained a Master of Business
degree in 1975. Mr. Jahns is a member of our Audit Committee and Compensation
Committee and was appointed to those committees effective January 18, 2000.
SUSANNE WEBLUS, has served as a Director since January 24, 2000. Ms.
Weblus is an attorney practicing in the areas of tax law and corporate law. Ms.
Weblus worked for the law firm of Merleker & Von Hesse until late 1999. Ms.
Weblus recently formed her own law firm. Ms. Weblus was admitted to the Bar in
Berlin in 1992. Ms. Weblus received her law degree in 1990. Ms. Weblus is a
member of our Audit Committee and Compensation Committee as was appointed to
those committees effective January 24, 2000.
-34-
<PAGE>
ITEM 6. EXECUTIVE COMPENSATION
The following table shows information concerning the annual and
long-term compensation of our chief executive officer and each of the following
executives (collectively, the "Named Executive Officers") at the end of our
fiscal year 1999 for services in all capacities to our company and its
subsidiaries the last fiscal year.
<TABLE>
<CAPTION>
Summary Compensation Table
--------------------------
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
Long-Term
Name and Principal Positions of Fiscal Other Annual Compensation
the Named Executive Officers Year 1999 Annual Salary Bonus Compensation Options
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
<S> <C> <C> <C> <C> <C>
Bernhard Fritsch, 1999 $ 300,000 $100,000 $1,500(1) 400,000(3)
Chief Executive Officer,
Chairman of the Board, $ 6,000(2) 450,000(4)
President and Director (6) 450,000(5)
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
Mitchell Lampert, 1999 $ 250,000 $ 95,000 $ 1,000(1) 400,000(3)
General Counsel 450,000(4)
1,000,000(5)
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
Scott Citron,* 1999 $ 175,000 $ 4,000 -0- 100,000(7)
Senior Website Producer 10,000(8)
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
Ray Short, 1999 $175,000 $ 35,000 $ 600(1) 200,000(9)
Senior Vice President
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
Thomas Noack, 1999 $165,000 $ 2,000 $ 600(1) 50,000(10)
Senior Vice President of
Technology
- ---------------------------------- ---------- ----------------- ---------------- ----------------- -------------------
</TABLE>
- ----------------------------------
(1) We provide the employee with a monthly automobile allowance of up to
such amount.
(2) We reimburse Mr. Fritsch for business-related housing expenses of up to
$6,000 per month.
(3) The option was granted on August 2, 1999. 50,000 options vested on
August 2, 1999. The balance of 350,000 options vest over three years at
an exercise price of $ 1.50 per share.
(4) The option was granted on September 20, 1999. 225,000 options vested on
September 20, 1999 and 225,000 options vest on March 20, 2000 at an
exercise price of $ 3.20 per share.
(5) The option was granted on September 27, 1999. For Mr. Fritsch, 225,000
options vested on September 27, 1999; 225,000 options vest on March 27,
2000 at an exercise price of $ 3.20 per share. For Mr. Lampert, 500,000
options vested on September 27, 1999; 500,000 options vest on March 27,
2000 at an exercise price of $ 3.20 per share.
(6) We have agreed to pay Mr. Fritsch a sum equal to 0.25% of our gross
revenues in accordance with our employment agreement with Mr. Fritsch
dated July 11, 1999, as amended.
(7) The option was granted on August 2, 1999. The options vested 25,000 on
August 2, 1999 and 75, 000 over 36 months at an exercise price of $6.00
per share.
(8) The option was granted on August 31, 1999. The options vest over a 36
month period at an exercise price of $ 12.50 per share.
(9) The option was granted on August 11, 1999. The options vest over a 36
month period at an exercise price of $ 9.50 per share.
(10) The option was granted on October 1, 1999. The options vest over a 36
month period at an exercise price of $ 12.50 per share.
* Scott Citron ceased to be employed by us effective March 16, 2000.
-35-
<PAGE>
Option/SAR Grants in Last Completed Fiscal Year (1999)
- ------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
Market Price
of Shares
Underlying
Option on
Date of Grant
Percent of if the
Number of Total Exercise
Securities Options/SARs Price is less
Underlying Granted to than the
Options/SARs Employees in Exercise or Market Price
Granted in Fiscal Fiscal Year Base Price on the Date
Name of Executive Officer 1999 1999 ($/sh) of Grant Expiration Date
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
<S> <C> <C> <C> <C>
Bernhard Fritsch 400,000 shares 5.7% $ 1.50/sh $ 6.00 Five years
450,000 shares 6.4% $ 3.20/sh $ 12.88 from the date
450,000 shares 6.4% $ 3.20/sh $ 12.69 of grant
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
Mitchell Lampert 400,000 shares 5.7% $ 1.50/sh $ 6.00 Five years
1,450,000 shares 20.7% $ 3.20/sh $ 12.69 from the date
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
Scott Citron* 100,000 shares 1.4% $ 6.00/sh $ 6.00 Five years
10,000 shares 0.1% $12.50/sh $ 13.69 from the date
of grant
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
Ray Short 200,000 shares 2.9% $ 9.50/sh $ 12.88 Five years
from the date
of grant
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
Thomas Noack 50,000 shares 0.7% $12.50/sh $ 12.50 Five years
from the date
of grant
- --------------------------- --------------------- ---------------- ---------------- --------------- ------------------
</TABLE>
* Scott Citron ceased to be employed by us effective March 16, 2000.
-36-
<PAGE>
Aggregated Option/SAR Exercises in Last Completed Fiscal Year (1999) and Fiscal
- -------------------------------------------------------------------------------
Year-End 1999 Option/SARs Values
- --------------------------------
During fiscal year 1999, no options to purchase shares of our common
stock were exercised by any of the Named Executive Officers. The following table
shows certain information concerning the number and value at December 31, 1999
of shares of our common stock subject to unexercised options held by each Named
Executive Officer.
<TABLE>
<CAPTION>
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
Number of
Shares Value of Value of
Underlying Number of Shares Unexercised Unexercised
Unexercised Underlying In-the-Money In-the-Money
Shares Options at Unexercised Options at Options at
Acquired Fiscal Options at Fiscal Year-End Fiscal Year-End
Name of "Named on Value Year-End Fiscal Year-End Year-End Year-End
Executive Officer" Exercise Realized (Exercisable) (Unexercisable) (Exercisable) (Unexercisable)
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C> <C> <C>
Bernhard Fritsch None None 570,000 730,000 $ 4,365,000 $ 5,805,000
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
Mitchell Lampert None None 845,000 1,005,000 $ 6,372,500 $ 7,812,500
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
Scott Citron* None None 33,000 77,000 $ 148,500 $ 301,500
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
Ray Short None None 20,000 180,000 $ 20,000 $ 180,000
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
Thomas Noack None None 0 50,000 $ 0 $ 0
- ------------------------ ----------- ----------- --------------- ------------------ ------------------ -----------------
</TABLE>
* Scott Citron ceased to be employed by us effective March 16, 2000.
Long-Term Incentive Plan ("LTIP") Awards
- ----------------------------------------
During fiscal year 1999, we did not give any LTIP awards to any of our
Named Executive Officers.
Compensation of Directors
- -------------------------
Members of the board of directors are not compensated in such capacity.
However, members of the board are reimbursed for reasonable travel expenses
incurred in attending board of directors meetings.
Employment Contracts and Termination of Employment, and Change-in-Control
- -------------------------------------------------------------------------
Arrangements
- ------------
Bernhard Fritsch entered into a five-year employment agreement with us
on July 11, 1999, as amended, pursuant to which he receives: (i) a base salary
of $300,000 which increases 10% per annum; (ii) a guaranteed bonus of $100,000;
(iii) a sum equal to 0.25 % of annual gross revenue generated by us; (iv) an
automobile allowance of $1,500 per month; (v) reimbursement for business-related
housing of up to $6,000 per month; (vi) upon a change of control, a payment
equal to the product of 2.99 and his base salary; and (vii) such other
compensation as our board of directors may grant.
Mitchell Lampert entered into a three-year employment agreement with us
on July 11, 1999 pursuant to which he receives: (i) a base salary of $ 250,000
which increases 10% per annum; (ii) a guaranteed bonus of $ 65,000; (iii) an
automobile allowance of $ 1,000 per month; (iv) upon a change of control, a
payment equal to the product of 1.00 and his base salary; and (v) such other
compensation as our board of directors may grant.
-37-
<PAGE>
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
All share numbers presented below have been adjusted to reflect the
two-for-one split of our common stock effected on May 20, 1999.
On April 26, 1999, we issued an aggregate of 35,661,352 shares of
common stock to our stockholders (net of 2,000,000 shares returned on July 2,
1999 as described below). This amount includes: 25,282,652 shares (fair value
$0.001 per share) issued to founders; 1,857,480 shares (fair value $0.074 per
share) which we were contractually obligated to issue to employees and
consultants prior to incorporation; and 8,721,220 shares (fair value of $0.28
per share) issued on April 26, 1999 to employees and consultants for services
rendered.
On June 14, 1999, we issued 1,000,000 shares of Series 1 preferred
stock to Mr. Bernhard Fritsch, our Chairman of the Board of Directors, President
and Chief Executive Officer for $1,000.
On July 2, 1999, we acquired the assets of Datatek including the stock
of MCY America, Inc. and Fritsch & Friends or the "Predecessor Companies" in
exchange for an aggregate consideration of $ 26,550,000 structured as: (i) $
1,050,000 in cash; (ii) 4,500,000 shares of our common stock valued at $
22,500,000 (fair value $5.00 per share); and (iii) 5-year warrants to purchase
2,000,000 shares of our common stock at an exercise price of $ 5.00 per share
valued at $ 3,000,000. In addition, we agreed to pay Datatek, on a quarterly
basis, 1% of gross revenues either: (i) for a period of 20 years; or (ii) until
such time as the payments had totaled $ 9,000,000. As of July 2, 1999, the
predecessor companies owed us approximately $ 1,243,000, representing the
balance of loans made by us prior to the acquisition. Mr. Fritsch was Datatek's
chief executive officer, director and a 47.5% beneficial owner of Datatek which
47.5% interest was transferred to other Datatek stockholders for no
consideration. Datatek and its subsidiaries had been involved in the
development, purchase and licensing of the technology, intellectual property and
other business assets required for our business operations. Mr. Fritsch and Mrs.
Sibylle Fritsch, Bernard Fritsch's mother returned an aggregate of 2,000,000
shares of our common stock to us for cancellation.
On July 2, 1999, we issued to Mr. James Burger, our former general
manager and treasurer, options to acquire an aggregate of 400,000 shares of
common stock. Mr. Burger resigned in all capacities in September 1999. In
December 1999 we entered into a termination agreement with Mr. Burger, pursuant
to which we paid him the sum of $100,000 as termination compensation under his
employment agreement and further as compensation for the cancellation of all of
his options.
On July 29, 1999, we entered into a license agreement with Mr. Fritsch
for exclusive worldwide rights to certain technology. The license remains in
effect as long as the compensation equal to 0.25% of gross revenues is paid
annually to Mr. Fritsch until the later of 20 years or the expiration of the
underlying patents as provided in his employment agreement. We believe that the
terms of this license agreement are as fair to us as terms under a license
agreement which we could have obtained from an unrelated third party through
arms-length negotiations.
On August 2, 1999, we completed a merger with MusicWorld, whereby an
acquisition subsidiary merged with and into MusicWorld, with MusicWorld becoming
a subsidiary of our company. As a result, outstanding shares of common stock and
preferred stock of MusicWorld were converted, respectively, on a 1-for-1 basis
into our common stock and preferred stock of having identical rights. In
addition, all holders of options and warrants of MusicWorld were given options
and warrants having identical features under a newly adopted stock option plan
and their existing options and warrants were cancelled.
On August 2, 1999, HBI, our predecessor, enacted a 2-for-1 forward
stock split, increasing the number of issued and outstanding shares of its
common stock to 4,611,000. In connection with the merger, HBI amended its
certificate of incorporation and did the following: (i) increased its authorized
capital from 50,000,000 shares of common stock to 100,000,000 shares of common
stock; (ii) designated 1,000,000 shares of preferred stock "Series 1 Preferred
Stock"; and (iii) changed its corporate name to MCY.com, Inc. In addition, HBI
issued: (A) 42,924,988 shares of our common stock to the holders of the common
stock of MusicWorld, (B) 2,000,000 warrants to the holders of MusicWorld
warrants, (C) options to holders of MusicWorld options to acquire shares under
the HBI 1999 Incentive Option Plan, and (D) 1,000,000 shares of Series 1
preferred stock to Mr. Fritsch. All of our former officers and directors
resigned and the current officers and directors were subsequently elected.
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<PAGE>
In connection with the merger, L. Dee Hall, Glen Hatch, Robert Blackley
and Reed Jensen, the holders of approximately 4,000,000 shares of HBI common
stock, agreed to sell approximately 3,970,000 of such shares to Mr. William
Bossung, Mr. Todd Sanders and their associates for $0.02 per share. Ms. Hall and
Messrs. Hatch, Blackley and Jensen were shareholders of our predecessor and
currently have no affiliation with us. Messrs. Bossung and Sanders were former
consultants to our company and currently have no affiliation with us.
In August, 1999, we issued 5,000 shares (fair value of $6.00 per share)
of our common stock to David Rowland, one of our stockholders, in consideration
for the making a loan to us in the amount of $100,000 and for the accrued
interest on the loan.
In December 1999, we entered into an agreement with DL Hawk
Communications, Inc. (the "Consultant Company"), a company owned by Richard
Lubic, a former director of MusicWorld, pursuant to which we paid such company
the sum of $100,000 as compensation for terminating a consulting agreement with
the Consulting Company. In connection with such agreement, Mr. Lubic resigned as
a director of MusicWorld and we entered into a new consulting agreement with the
Consultant Company. The new agreement is for one year and reduces payments to
the Consulting Company from $175,000 per annum under the old, terminated
agreement to $50,000 per annum.
As of December 31, 1999, we had made non-interest-bearing advances
which contained no repayment terms of approximately $107,000 to Mr. Fritsch.
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<PAGE>
ITEM 8. DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 100,000,000 shares of common
stock, $0.001 par value, and 10,000,000 shares of preferred stock, $0.0001 par
value.
COMMON STOCK
Each holder of our common stock is entitled to one vote for each share
standing in such holder's name in our records on all matters submitted to a vote
of our stockholders, except as otherwise required by law. Holders of our common
stock do not have cumulative voting rights so that, subject to the right of the
holders of our Series 1 voting preferred stock as discussed below, holders of
more than 50% of the combined shares of our common stock voting for the election
of directors may elect all of the directors is they choose to do so and, in that
event, the holders of the remaining shares of our common stock will not be able
to elect any members to our board of directors. In addition, the rights,
privileges and preferences of holders of our common stock will be subject to,
and may be adversely affected by, the rights of the holders of any shares of
preferred stock which we may designate and issue in the future.
Holders of our common stock are entitled to equal dividends and
distributions per share when, as and if declared by our board of directors from
funds legally available. Holders of our common stock do not have pre-emptive
rights to subscribe for any of our securities nor are any shares of our common
stock redeemable or convertible into any of our other securities. If we
liquidate, dissolve or wind up our business or affairs, our assets will be
divided up pro-rata on a share-for-share basis among the holders of our common
stock after creditors and preferred shareholders are paid.
PREFERRED STOCK
Our board of directors has the authority to issue 10,000,000 shares of
our preferred stock in one or more series and to fix the rights, preferences,
privileges and restrictions, including dividend, conversion, voting, redemption
(including sinking fund provisions), and other rights, liquidation preferences,
and the number of shares constituting any series and the designations of such
series, without any further vote or action by our stockholders. To date,
1,000,000 shares of our series 1 preferred stock have been issued to Mr.
Fritsch. Each of these shares entitles the holder to 100 votes for each share
held on all matters submitted to a vote of stockholders. The Series 1 preferred
stock does not carry any dividend, liquidation, conversion or preemptive rights.
REGISTRATION RIGHTS
Individuals who purchased 6,573,333 shares of our common stock in a
private placement of our stock which was completed in October 1999 will be
entitled to certain "piggyback" registration rights with respect to their
shares. If we register any of our securities under the Securities Act, those
individuals who purchased shares in the October 1999 private placement are
entitled, subject to certain restrictions, to include the shares of our common
stock that they purchased in the registration. However, those holders have no
registration rights with respect to our first public offering. The piggyback
registration rights are subordinate to the registration rights of (i) the
Datatek Holders with respect to 4,500,000 shares of our common stock and
2,000,000 shares of our common stock underlying warrants which were previously
issued to the Datatek Holders in connection with the reorganization and are pari
passu with respect to (A) 657,333 shares of our common stock underlying the
warrants which were previously issued to Gruntal & Co., L.L.C.; and (B) 175,075
shares of our common stock owned by Gruntal & Co., L.L.C.
Holders of our common stock who purchased the securities (the
"Registrable Securities") in a private placements which were completed in
October 1999 and March 2000 will be entitled to certain "piggyback" registration
rights with respect to their shares of our common stock. Whenever we propose to
register any of our securities under the Securities Act, those individuals who
purchased the Registrable Securities are entitled, subject to certain
restrictions, to include their Registrable Securities in such registration. We
are required to bear all registration expenses in connection with the
registration of the Registrable Securities (other than underwriting discounts
and commissions). Such holders, however, have no registration rights with
respect to our first public offering. In addition, the piggyback registration
rights granted to such holders are subordinated to the registration rights of
(i) the Datatek Holders with respect to 4,500,000 shares of our common stock and
2,000,000 shares of our common stock underlying warrants which were issued to
the Datatek Holders in connection with the reorganization; (ii) Gruntal & Co.,
L.L.C. with respect to (A) 657,333 shares of our common stock underlying
warrants which were previously issued to Gruntal and (B) 175,075 shares of our
common stock owned by Gruntal; and (iii) warrants issued to U.S. West and the
Backstreet Boys.
On December 31, 1999, we granted piggyback registration rights to U.S. West
Internet Ventures, Inc. with respect to 476,190 shares of our common stock
underlying a warrant issued to U.S. West Internet Ventures, Inc. In addition, we
granted Corporate Capital Research, Inc. (i) the right to register 110,000
shares of our common stock which we agreed to issue on December 31, 1999, in a
registration statement on Form S-8, if available, or additional piggyback
registration rights if a registration statement on Form S-8 is unavailable. On
January 12, 2000, we granted piggyback registration rights to the Backstreet
Boys with respect to 500,000 shares of our common stock underlying warrants
issued to the Backstreet Boys. On March 21, 2000, we granted piggyback
registration rights to NSync with respect to 500,000 shares of our common stock
underlying a warrant to be issued to NSync.
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<PAGE>
We have granted additional piggyback registration rights to U.S. West
Internet Ventures, Inc. with respect to 476,190 shares or our common stock
underlying a warrant issued to U.S. West Internet Ventures, Inc. on December 31,
1999. In addition, we have granted Corporate Capital Research, Inc. the right to
register 100,000 shares of our common stock which we agreed to issue to
Corporate Capital Research, Inc. on December 31, 1999, in a registration
statement on Form S-8, if available, or additional piggyback registration rights
if a registration statement on Form S-8 is unavailable. All of the piggyback
registrations rights granted to U.S. West Internet Ventures, Inc. and to
Corporate Capital Research, Inc., if applicable, are subordinated to the rights
granted to the persons in the preceding paragraph.
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<PAGE>
PART II
ITEM 1. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
OTHER STOCKHOLDER MATTERS
(a) Market Information
------------------
Our common stock is presently traded on the Over-the-Counter Electronic
Bulletin Board ("OTCBB") under the trading symbol "MCYC".
Our common stock's high and low bid information for each quarter within
the last two fiscal years and through the quarterly period ended December 31,
1999 as reported by IDD Information Services, Tradeline (R) is shown below. The
quotations reflect inter-dealer prices, without retail mark-up, markdown or
commission, and may not represent actual transactions. Prior to August 2, 1999,
our common stock traded under the trading symbol "HBII". On August 2, 1999 we
acquired MusicWorld.
<TABLE>
<CAPTION>
Period High Low
- ------ ---- ---
Fiscal Year 1998:
- ----------------
<S> <C> <C>
First Quarter 1998 (January, February, March) $ .61 $ .25
Second Quarter 1998 (April, May, June) $ .61 $ .25
Third Quarter 1998 (July, August, September) $ .63 $ .27
Fourth Quarter 1998 (October, November, December) $ .63 $ .28
Fiscal Year 1999:
- ----------------
First Quarter 1999 (January, February, March) $ .63 $ .28
Second Quarter 1999 (April, May, June) $ 17.75 $ .28
Third Quarter 1999 (July, August, September) $ 27.00 $ 11.88
Fourth Quarter 1999 (October, November, December) $ 13.63 $ 5.50
</TABLE>
(b) Holders of our common stock
---------------------------
As of March 31, 2000, there were approximately 217 holders of record of
our common stock as reported to us by our transfer agent, Interwest Transfer
Co., Inc.
(c) Dividends
---------
To date, we have not paid any dividends on our common stock and do not
expect to do so in the foreseeable future. Instead, we expect to retain all
earnings to finance the growth and development of our business.
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<PAGE>
ITEM 2. LEGAL PROCEEDINGS
A former trade partner, Mr. Xavier Ghali, contributed DM 1,600,000 to
the development of the our platform and subsequently demanded repayment of DM
1,210,000 of this amount on January 30, 1998. Fritsch & Friends rejected this
demand on February 3, 1998, and since then the partner has not pursued this
alleged claim. In addition, Fritsch & Friends entered into an agreement with an
investment group in November, 1997, which it subsequently revoked. In February
2000, we received a notice from the American Arbitration Association ("AAA")
indicating that a request for arbitration had been filed. To date, however, we
have not received any documents indicating the basis or the grounds for the
claim. We believe that it is unlikely that we will sustain material losses in
connection with these matters in excess of amounts previously accrued.
On December 16, 1999, Mr. Peter Rohde, a former employee of MusicWorld
filed a complaint against us in New York State Supreme Court. Mr. Rohde, the
plaintiff, had been employed by MCY America, Inc., a subsidiary of MusicWorld,
as an assistant manager in November 1998 pursuant to a letter employment
agreement dated November 10, 1998. The plaintiff entered into a subsequent
employment agreement with MusicWorld dated July 9, 1999 as a content manager and
a trust and confidentiality agreement which contained noncompetition and
confidentiality provisions. In August 1999, the plaintiff was observed entering
our offices at unusual hours. On August 21, 1999, he was observed exiting our
offices with what was believed to be a personal computer and a large bag
containing proprietary information about our company. As a result, we terminated
the plaintiff on August 27, 1999. In his complaint, his claims included breach
of contract, wrongful termination and fraud related to his inability to collect
fees due to alleged fraudulent misrepresentations by the company concerning the
effectiveness of the technology. In his complaint, he asked for damages of
approximately $23,000,000 including 20,000 shares of MCY.com, Inc. common stock,
stock options, fees and royalties. Based upon our understanding of the facts, we
believe that Mr. Rohde's claims lack substantial merit and we intend to
vigorously defend against this action. We filed an answer and counterclaims
against Mr. Rohde in March 2000. To date, the plaintiff has not provided any
calculation to support the financial basis of his claim.
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<PAGE>
ITEM 3. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
None.
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<PAGE>
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES
The following table sets forth certain information concerning all
securities issued by us which have not been registered under the Securities Act
for the past three years (1997, 1998 and 1999). In the following table, all
references to securities means our common stock, unless otherwise indicated. In
addition, the number of shares of our common stock reflect a 2 for 1 stock split
that was effected as of May 20, 1999.
<TABLE>
<CAPTION>
NOTE REFERENCE SHARES ISSUED DATE ISSUED CONSIDERATION RECEIVED
-------------- ------------- ----------- ----------------------
<S> <C> <C> <C>
(1) 25,282,652 January 8, 1999 $ 25,000
(2) 1,857,480 January 8, 1999 $ 137,000
(3) 8,521,220 April 26, 1999 $ 2,386,000
(4) 200,000 April 29, 1999 $ 56,000
(5) 363,636 May 5, 1999 $ 990,000
(6) 2,400,000 May 7, 1999 $ 8,690,000
(7) 200,000 May 17,1999 $ 990,000
(8) 1,000,000 of series 1 June 14, 1999 $ 1,000
preferred stock
(9) 4,500,000 July 2, 1999 $ 22,500,000
(10) 2,000,000 July 2, 1999 $ 3,000,000
(11) 83,333 July 21,1999 $ 140,000
(12) 2,872,500 August 2, 1999 $ 0
(13) 42,924,988 August 2, 1999 $ 0
(14) 2,000,000 August 2, 1999 $ 0
(15) 116,667 August 2, 1999 $ 700,000
(16) 6,322,333 August 27, 1999 $ 34,500,000
(17) 5,000 August 27, 1999 $ 30,000
(18) 251,000 October 20, 1999 $ 1,384,770
(19) 476,190 December 31, 1999 $ 2,247,000
(20) 110,000 December 31, 1999 $ 1,155,000
(21) 2,268,000 March 7, 2000 $ 15,800,325
(22) 1,700,000 March 9, 2000 $ 12,112,500
(23) 1,013,350 March 28, 2000 $ 7,117,115
(24) 25,040 March 29, 2000 $ 172,753
</TABLE>
- ----------------------------------
(1) As of January 8, 1999, we issued 25,282,652 shares of our common stock,
par value $0.001 per share, net of shares returned on July 2, 1999 to
our founders for no consideration. The 25,282,652 shares of our common
stock is exclusive of: (a) warrants to purchase 2,000,000 shares of our
common stock issued in conjunction with the reorganization; (b) options
to purchase 3,419,400 shares issued under our incentive option plan;
(c) 116,667 shares of our common stock issued to a creditor; (c)
cancellation of 200,000 shares of our common stock issued to a
consultant; (e) warrants for the purchase of 33,333 shares of our
common stock issued to a trade partner; and (f) 5,000 shares issued to
a creditor on completion of an offering on August 2, 1999.
(2) As of January 8, 1999, we issued 1,857,480 shares of our common stock,
valued at $0.074 per share, to employees and consultants in
consideration for services rendered.
(3) On April 26, 1999, we issued 8,521,220 shares of our common stock,
valued at $0.28 per share, to employees, consultants and creditors in
consideration for services rendered.
(4) On April 29, 1999, we issued 200,000 shares of our common stock, valued
at $0.28 per share, to our legal counsel, Lampert, Lampert & Ference
(f/k/a Lampert & Lampert), for services rendered.
(5) On May 5, 1999, we issued 363,636 shares of our common stock, valued at
$2.75 per share less costs, to Mr. Edmund Krix for cash. In connection
with this transaction and the related transactions described in
footnotes 6 and 7, we paid an aggregate $220,000 in commissions to
Gruntal & Co., L.L.C., our placement agent.
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<PAGE>
(6) On May 7, 1999, we issued 2,400,000 shares of our common stock, valued
at $3.75 per share less costs, to Mr. Edmund Krix for cash. (See also
footnote 5 regarding commissions paid).
(7) On May 17, 1999, we issued 200,000 shares of our common stock, valued
at $5.00 per share less costs, to Mr. Thomas Schrank for cash. (See
also footnote 5 regarding commissions paid).
(8) On June 14, 1999, we issued 1,000,000 shares of our series 1 preferred
stock, par value $0.001 per share, to Mr. Fritsch for $1,000.
(9) On July 2, 1999, as consideration for the purchase of the assets of
Datatek Services Limited including the stock of MCY America, Inc. and
Fritsch & Friends Mediagroup GmbH, we paid an aggregate purchase price
of $26,500,000 structured as follows: (i) $1,050,000 cash; (ii) we
issued 4,500,000 shares of our common stock valued at $ 22,500,000; and
(iii) we issued 5-year warrants to purchase 2,000,000 shares of our
common stock at an exercise price of $5.00 per share valued at
$3,000,000.
(10) On July 2, 1999, as consideration for the purchase of the assets of
Datatek Services Limited including the stock of MCY America, Inc. and
Fritsch & Friends Mediagroup GmbH, we paid an aggregate purchase price
of $26,500,000 structured as follows: (i) $1,050,000 cash; (ii) we
issued 4,500,000 shares of our common stock valued at $22,500,000; and
(iii) we issued 5-year warrants to purchase 2,000,000 shares of our
common stock at an exercise price of $5.00 per share valued at
$3,000,000.
(11) On July 21, 1999, we issued warrants for 83,333 shares of our common
stock, at prices ranging from $5.00 to $6.00 per share, to various
creditors for a total consideration of $140,000.
(12) On August 2, 1999, in connection with the merger our predecessor HBI
enacted a two-for-1 forward stock split increasing the number of issued
and outstanding shares of its common stock to 4,611,000 shares (of
which 2,872,500 were unregistered securities).
(13) On August 2, 1999, upon the consummation of the merger, we (f/k/a HBI)
issued: (i) 42,924,988 shares of our common stock to the holders of the
common stock of MusicWorld, a wholly-owned subsidiary, for 42,924,988
shares of MCY.com, Inc.; (ii) warrants to purchase up to 2,000,000
shares, at $5.00 per share, of our common stock to holders of
MusicWorld warrants, for warrants to purchase up to 2,000,000 shares of
MCY.com, Inc. at $5.00 per share; and (iii) to holders of MusicWorld
options, options to purchase up to 3,419,400 shares of common stock, at
exercise prices ranging from $1.50 to $6.00 per share, under the 1999
incentive option plan of our predecessor HBI for options to purchase
3,419,400 shares of MCY.com, Inc. common stock at the same price.
Additionally, 400,000 shares of common stock which were to be issued to
Mark Ross, a consultant, were cancelled for failure of consideration.
(14) On August 2, 1999, upon the consummation of the merger, we (f/k/a HBI)
issued: (i) 42,924,988 shares of our common stock to the holders of the
common stock of MusicWorld, a wholly-owned subsidiary, for 42,924,988
shares of MCY.com, Inc.; (ii) warrants to purchase up to 2,000,000
shares, at $5.00 per share, of our common stock to holders of
MusicWorld warrants, for warrants to purchase up to 2,000,000 shares of
MCY.com, Inc. at $5.00 per share; and (iii) to holders of MusicWorld
options, options to purchase up to 3,419,400 shares of common stock, at
exercise prices ranging from $1.50 to $6.00 per share, under the 1999
incentive option plan of our predecessor HBI for options to purchase
3,419,400 shares of MCY.com, Inc. common stock at the same price.
Additionally, 400,000 shares of common stock which were to be issued to
Mark Ross, a consultant, were cancelled for failure of consideration.
(15) On August 2, 1999, upon the consummation of the merger, we (f/k/a HBI)
issued: (i) 42,924,988 shares of our common stock to the holders of the
common stock of MusicWorld, a wholly-owned subsidiary, for 42,924,988
shares of MCY.com, Inc.; (ii) warrants to purchase up to 2,000,000
shares, at $5.00 per share, of our common stock to holders of
MusicWorld warrants, for warrants to purchase up to 2,000,000 shares of
MCY.com, Inc. at $5.00 per share; and (iii) to holders of MusicWorld
options, options to purchase up to 3,419,400 shares of common stock, at
exercise prices ranging from $1.50 to $6.00 per share, under the 1999
incentive option plan of our predecessor HBI for options to purchase
3,419,400 shares of MCY.com,
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<PAGE>
Inc. common stock at the same price. Additionally, 400,000 shares of
common stock which were to be issued to Mark Ross, a consultant, were
cancelled for failure of consideration.
(16) On August 27, 1999, we issued 4,000,000 shares to Gontard & Metallbank,
500,000 shares to Knorr Capital, and 1,822,333 shares of our common
stock to qualified individual investors at $6.00 per share in
connection with a private offering of securities. The net proceeds of
the offering were approximately $34,500,000. Gruntal & Co., L.L.C., the
placement agent, received warrants to acquire 632,233 shares of our
common stock at an exercise price of $6.00 per share in connection with
the offering. In connection with the August 27, 1999 offering, we paid
$2,054,705 in commissions to Gruntal & Co., LLC and $1,200,000 to
Gontard & Metallbank.
(17) On August 2, 1999, we issued 116,667 shares of our common stock, valued
at $6.00 per share, to Gunter Brinkoff to repay a loan in the amount of
$700,000. On August 27, 1999, we issued 5,000 shares of our common
stock to David Rowland, a stockholder, in consideration for the making
of a loan in the amount of $100,000 and in consideration for the
accrued interest.
(18) In October, 1999, we issued 251,000 shares of our common stock to
qualified individual investors at $6.00 per share pursuant to the prior
offering. The net proceeds of the offering were $1,384,770. Gruntal &
Co., L.L.C., the placement agent, received warrants to acquire 25,100
shares of our common stock at an exercise price of $6.00 per share in
connection with the offering and $120,480 in commissions.
(19) On December 31, 1999, in connection with a transaction with U.S. West
Communications Services, Inc., we issued a warrant to U.S. West
Internet Ventures, Inc. pursuant to which it may acquire up to 476,190
shares of our common stock at $10.50 per share for a five-year period,
for consideration of $2,247,000.
(20) On December 31, 1999, in connection with a transaction with U.S. West
Communications Services, Inc., we agreed to issue to Corporate Capital
Research, Inc., as a finder's fee for the transaction, 110,000 shares
of our common stock at a price of $10.50 per share.
(21) In March 2000, we issued an aggregate of 5,006,390 shares of our common
stock to qualified individual and institutional investors at $7.50 per
share in connection with a private offering of securities. The net
proceeds of the offering were approximately $35,202,693. In connection
with the March 2000 offering, we paid $618,937 in commissions to
Gruntal & Co., LLC, the placement agent, and $1,726,270 in commissions
to Bank Sal. Oppenheim Jr. & CIE. (Schweitz) AG.
(22) See Footnote 21 above.
(23) See Footnote 21 above.
(24) See Footnote 21 above.
The transactions described in the table above were exempt transactions
under Section 4(2) of the Securities Act of 1933, as amended (the "Securities
Act"), Regulation D thereunder as transactions by an issuer not involving a
public offering. All such shares of common stock issued were deemed "restricted
securities" (as such term is defined under the Securities Act) and subject to
substantial restrictions on transfer. All of the shares of common stock were
issued for investment purposes only and without a view to distribution. All of
the persons who acquired such shares were fully informed and advised about
matters concerning our company, including our business, financial affairs and
other matters.
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<PAGE>
ITEM 5. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the General Corporation Law of the State of Delaware
provides, in general, that a corporation incorporated under the laws of the
State of Delaware, such as the registrant, may indemnify any person who was or
is a party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding (other than a derivative action by or in
the right of the corporation) by reason of the fact that such person is or was a
director, officer, employee or agent of the corporation, or is or was serving at
the request of the corporation as a director, officer, employee or agent of
another enterprise, against expenses (including attorney's fees), judgments,
fines and amounts paid in settlement actually and reasonably incurred by such
person in connection with such action, suit or proceeding if such person acted
in good faith and in a manner such person reasonably believed to be in or not
opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, had no reasonable cause to believe such person's
conduct was unlawful.
Article VII of our amended and restated certificate of incorporation
provides that to the fullest extent permitted by the Delaware General
Corporation Law as the same exists or as may hereafter be amended, none of our
directors shall be personally liable to us or to our stockholders for or with
respect to any acts or omissions in the performance of his or her duties as one
of our directors. If Article VII of our amended and restated certificate of
incorporation is amended or repealed, the amendment or repeal will not eliminate
or reduce the effect of any right or protection of our directors that existed
immediately prior to such amendment or repeal.
Our by-laws, as amended, provide that we shall indemnify our officers,
directors and employees. The rights to indemnity continue if even a person has
ceased to be a director, officer, employee or agent and shall inure to the
benefit of the person's heirs, executors and administrators. In addition, we
shall pay for any expenses incurred by a director or officer in defending any
action, suit or proceeding by reason of the fact that he or she is or was one of
our directors or officers unless such officer, director or employee is adjudged
liable for negligence or misconduct in performing his or her duties. If we do
not pay in full the claim for indemnification of any such officer, director or
employee within thirty days after we receive the written claim, the claimant may
at any time thereafter sue us to recover the unpaid amount of the claim and, if
successful in whole or in part, the claimant shall be entitled to be paid also
the expense of prosecuting such claim. We may, by action of our board of
directors, indemnify our employees and agents with the same scope and effect as
the foregoing indemnification of our directors and officers.
We maintain directors and officers liability insurance coverage with a
$10,000,000 annual aggregate limit of liability. National Union Fire Insurance
Company provides us with a primary $ 2,000,000 layer while Royal Insurance
Company provides us with a $ 3,000,000 layer in excess of the National Union
policy. TIG Insurance Company provides us with a $5,000,000 layer in excess over
the National Union and Royal Insurance policies. All of these policies expire on
July 15, 2000.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of our company pursuant to the foregoing paragraphs, or otherwise, we
have been advised that in the opinion of the Securities and Exchange Commission,
the indemnification of our directors, officers and controlling persons is
against public policy as expressed in the Act as is, therefore, unenforceable.
-48-
<PAGE>
PART F/S
(i) Consolidated balance sheet of MCY.com, Inc. and Subsidiaries (a development
stage company) as of December 31, 1999 and the related consolidated statements
of operations, stockholder's equity and cash flows for the period from January
8, 1999 (date of inception) through December 31, 1999.
(ii) Combined financial statements of the Predecessor Companies of
MCY.com, Inc. (development stage companies) for the periods
ended December 31, 1996, 1997, and 1998 and July 2, 1999.
-49-
<PAGE>
PART III
ITEM 1. INDEX TO EXHIBITS
(a) Exhibits and Index
------------------
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibits
-------------- -----------------------
<S> <C>
2.1 Agreement and Plan of Reorganization dated as of August 2, 1999 among Health Builders
International, Inc., HBI Sub, Inc. and MCY Music World, Inc. 1
3.1 Amended and Restated Certificate of Incorporation. 1
3.2 By-laws, as amended. 2
4.1 Warrant to Purchase Common Stock of MCY.com, Inc. issued to U S West Internet Ventures,
Inc., December 31, 1999. 3
10.1 License Agreement dated July 29, 1999 by and between Bernhard Fritsch and MCY Music World,
Inc. 3
10.2 U S West Communications Services, Inc. and MCY Music World, Inc. Collaborative Development
Agreement effective as of December 31, 1999 3
10.3 Confidentiality and Non-Circumvention Agreement effective as of November 28, 1999.3
10.4 Employment Agreement made as of July 11, 1999 by and between MCY Music World, Inc. and
Bernhard Fritsch. 3
10.5 Amendment to Employment Agreement made as of July 28, 1999 by and between MCY Music World,
Inc. and Bernhard Fritsch. 3
10.6 Employment Agreement made as of July 11, 1999 by and between MCY Music World, Inc. and
Mitchell Lampert. 3
10.7 Employment Agreement between MCY Music World, Inc. and Scott Citron dated as of July 21,
1999. 3 *
10.8 Employment Agreement between MCY Music World, Inc. and Ray Short dated as of August 8,
1999. 3
10.9 Employment Agreement dated September 1, 1999 by and between MCY Music World, Inc. and
Thomas Noack. 3
21.1 Subsidiaries of Registrant.3
27.1 Financial Data Schedule.4
</TABLE>
- ----------
1 Incorporated by reference from our current report on Form 8-K dated August
2, 1999 (date of earliest event reported), as filed with the Securities and
Exchange Commission on August 17, 1999; SEC File #: 333-9809.
2 Incorporated by reference from Exhibit 3.3 to our registration statement on
Form SB-2 as filed with the Securities Exchange Commission on August 9,
1996; SEC File #: 333-9809.
3 Incorporated by reference from our Annual Report on Form 10-KSB, as filed
with the Securities and Exchange Commission on March 30, 2000; SEC
File#: 000-29099.
-50-
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
99.1 MCY.com, Inc. Amended and Restated 1999 Stock Incentive Plan 5
</TABLE>
- ----------
4 Filed herewith.
* Scott Citron ceased to be employed by us effective March 16, 2000.
5 Incorporated by reference from our current report on Form 8-K dated October
13, 1999 (date of earliest event reported), as filed with the Securities
and Exchange Commission on October 15, 1999; SEC File#: 333-09809.
-51-
<PAGE>
ITEM 2. DESCRIPTION OF EXHIBITS
Exhibit Number Description of Exhibits
-------------- -----------------------
<TABLE>
<CAPTION>
<S> <C>
2.1 Agreement and Plan of Reorganization dated as of August 2, 1999 among Health Builders
International, Inc., HBI Sub, Inc. and MCY Music World, Inc. 1
3.1 Amended and Restated Certificate of Incorporation. 1
3.2 By-laws, as amended. 2
4.1 Warrant to Purchase Common Stock of MCY.com, Inc. issued to U S West Internet Ventures,
Inc., December 31, 1999. 3
10.1 License Agreement dated July 29, 1999 by and between Bernhard Fritsch and MCY Music World,
Inc. 3
10.2 U S West Communications Services, Inc. and MCY Music World, Inc. Collaborative Development
Agreement effective as of December 31, 1999 3
10.3 Confidentiality and Non-Circumvention Agreement effective as of November 28, 1999.3
10.4 Employment Agreement made as of July 11, 1999 by and between MCY Music World, Inc. and
Bernhard Fritsch. 3
10.5 Amendment to Employment Agreement made as of July 28, 1999 by and between MCY Music World,
Inc. and Bernhard Fritsch. 3
10.6 Employment Agreement made as of July 11, 1999 by and between MCY Music World, Inc. and
Mitchell Lampert. 3
10.7 Employment Agreement between MCY Music World, Inc. and Scott Citron dated as of July 21,
1999. 3 *
10.8 Employment Agreement between MCY Music World, Inc. and Ray Short dated as of August 8,
1999. 3
10.9 Employment Agreement dated September 1, 1999 by and between MCY Music World, Inc. and
Thomas Noack. 3
21.1 Subsidiaries of Registrant.3
27.1 Financial Data Schedule.4
99.1 MCY.com, Inc. Amended and Restated 1999 Stock Incentive Plan 5
</TABLE>
- ----------
1 Incorporated by reference from our current report on Form 8-K dated August
2, 1999 (date of earliest event reported), as filed with the Securities and
Exchange Commission on August 17, 1999; SEC File #: 333-9809.
2 Incorporated by reference from Exhibit 3.3 to our registration statement on
Form SB-2 as filed with the Securities Exchange Commission on August 9,
1996; SEC File #: 333-9809.
3 Incorporated by reference from our Annual Report on Form 10-KSB, as filed
with the Securities and Exchange Commission on March 30, 2000; SEC
File#: 000-29099.
4 Filed herewith.
* Scott Citron ceased to be employed by us effective March 16, 2000.
5 Incorporated by reference from our current report on Form 8-K dated October
13, 1999 (date of earliest event reported), as filed with the Securities
and Exchange Commission on October 15, 1999; SEC File#: 333-09809.
-52-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
DATE: April 18, 2000 MCY.com, Inc.
By: /s/ Bernhard Fritsch
--------------------------------------
Name: Bernhard Fritsch
Title: Chairman of the Board of Directors,
Chief Executive Officer, President
and Director
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
MCY.com, Inc.
New York, New York
We have audited the accompanying consolidated balance sheet of MCY.com, Inc. and
subsidiaries (a development stage company) as of December 31, 1999 and the
related consolidated statements of operations, stockholders' equity and cash
flows for the period from January 8, 1999 (date of inception) through December
31, 1999. 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all
material respects, the consolidated financial position of MCY.com, Inc. and
subsidiaries, as of December 31, 1999, and the consolidated results of their
operations and their cash flows for the period from January 8, 1999 (date of
inception) through December 31, 1999 in conformity with generally accepted
accounting principles.
Richard A. Eisner & Company, LLP
New York, New York
January 21, 2000 except for Note L, as to
which the date is March 9, 2000
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1999
ASSETS
<S> <C>
Current assets:
Cash and cash equivalents $ 26,060,000
Sundry receivables 397,000
Advances to officer 107,000
Other current assets, including prepaid advertising of $2,247,000 2,793,000
----------------
Total current assets 29,357,000
Equipment and software, net 1,585,000
Intangible assets, net 25,153,000
Other assets, including security deposit and record company advances of
$925,000 and $350,000, respectively 1,279,000
----------------
$ 57,374,000
================
LIABILITIES
Current liabilities:
Accounts payable, accrued expenses and sundry liabilities, representing total
current liabilities $ 3,381,000
----------------
Commitments and contingencies (Note G)
STOCKHOLDERS' EQUITY
Preferred stock - $.001 par value; 10,000,000 shares authorized;
1,000,000 shares of Series 1 Preferred Stock issued and outstanding 1,000
Common stock - $.001 par value; 100,000,000 shares authorized;
54,340,988 shares issued and outstanding 54,000
Common stock payable 1,155,000
Additional paid-in capital 144,063,000
Deficit accumulated during the development stage (72,283,000)
Cumulative foreign currency translation adjustment (15,000)
----------------
72,975,000
Unamortized deferred compensation (18,956,000)
Stock subscriptions receivable (26,000)
----------------
53,993,000
----------------
$ 57,374,000
================
</TABLE>
See notes to financial statements 2
<PAGE>
<TABLE>
<CAPTION>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD FROM JANUARY 8, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999
<S> <C>
REVENUE:
Revenues $ 343,000
----------------
EXPENSES:
Sales, marketing and public relations 8,519,000
Product development 2,129,000
Content development 1,583,000
General and administrative 4,470,000
Depreciation and amortization 276,000
Amortization of acquired intangibles 3,168,000
Stock based compensation 49,904,000
----------------
70,049,000
-----------------
Operating loss (69,706,000)
Share of loss of predecessor companies (663,000)
Interest income, net of interest expense 656,000
----------------
NET LOSS $ (69,713,000)
================
NET LOSS PER COMMON SHARE - BASIC AND DILUTED $(1.66)
======
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 41,929,000
================
See notes to financial statements 3
</TABLE>
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM JANUARY 8, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK COMMON
--------------- ------------ STOCK
SHARES AMOUNT SHARES AMOUNT PAYABLE
------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Issuance of common stock at par ($.001 per share) to founders
as of January 8, 1999, net of shares returned (Note B) 25,282,652 $ 25,000
Issuance of common stock to employees and consultants at
$0.074 per share, as of January 8, 1999 1,857,480 2,000
Issuance of common stock to employees, consultants and
creditors at $0.28 per share - April 1999 8,721,220 9,000
Sale of common stock at $2.75 per share - May 1999
less related costs of $10,000 363,636
Sale of common stock at $3.75 per share - May 1999
less related costs of $310,000 2,400,000 2,000
Sale of common stock at $5.00 per share - May 1999
less related costs of $10,000 200,000
Issuance of preferred stock at par ($.001 per share) to a
founder - June 1999 1,000,000 $ 1,000
Issuance of common stock in connection with acquisition at
$5.00 per share - July 1999 4,500,000 5,000
Issuance of warrants to purchase 2,000,000 shares of common
stock
issued in connection with acquisition - July 1999
Issuance of warrants to purchase 50,000 shares of common
stock issued in connection with acquisition - July 1999
Issuance of warrants to purchase 33,333 shares of common
stock for services to the Company - July 1999
Stockholders' deficiency of acquired entities applicable to
47.5%
Interest owned by the Company's controlling stockholder
Cancellation of common stock issued to a consultant - July 1999 (400,000)
Stock issued for outstanding HBI shares - August 2, 1999 in
connection with reverse merger 4,611,000 5,000
Compensation resulting from sale by HBI shareholders of
3,970,000shares at $0.02 per share - August 1999
Sale of common stock at $6.00 per share - August
and October 1999, less related costs of $4,454,000 6,573,333 6,000
Issuance of common stock in payment of debt and accrued
interest at $6.00 per share - August 1999 121,667
Issuance of warrants for minimal consideration to purchase
476,190 shares of common stock in connection with
collaborative
agreement - December 1999
Common stock issuable to a consultant in connection with
collaborative agreement - December 1999 110,000 1,155,000
Options issued to employees & consultants - various dates
Amortization of deferred compensation
Comprehensive loss:
Loss on foreign currency translation
Net loss for period
Total comprehensive loss ----------- -------- ----------- --------- -----------
Balances at December 31, 1999 1,000,000 $ 1,000 54,340,988 $ 54,000 $ 1,155,000
=========== ======== =========== ========= ===========
</TABLE>
<TABLE>
<CAPTION>
DEFICIT CUMULATIVE
ACCUMULATED FOREIGN
ADDITIONAL DURING THE CURRENCY UNAMORTIZED
PAID-IN DEVELOPMENT TRANSLATION DEFERRED
CAPITAL STAGE ADJUSTMENT COMPENSATION
------- ----- ---------- ------------
<S> <C> <C> <C> <C>
Issuance of common stock at par ($.001 per share) to founders
as of January 8, 1999, net of shares returned (Note B)
Issuance of common stock to employees and consultants at
$0.074 per share, as of January 8, 1999 $ 135,000
Issuance of common stock to employees, consultants and
creditors at $0.28 per share - April 1999 2,433,000
Sale of common stock at $2.75 per share - May 1999
less related costs of $10,000 990,000
Sale of common stock at $3.75 per share - May 1999
less related costs of $310,000 8,688,000
Sale of common stock at $5.00 per share - May 1999
less related costs of $10,000 990,000
Issuance of preferred stock at par ($.001 per share) to a
founder - June 1999
Issuance of common stock in connection with acquisition at
$5.00 per share - July 1999 22,495,000
Issuance of warrants to purchase 2,000,000 shares of common
stock
issued in connection with acquisition - July 1999 3,000,000
Issuance of warrants to purchase 50,000 shares of common
stock issued in connection with acquisition - July 1999 90,000
Issuance of warrants to purchase 33,333 shares of common
stock for services to the Company - July 1999 50,000
Stockholders' deficiency of acquired entities applicable to
47.5%
Interest owned by the Company's controlling stockholder 2,164,000 $(2,570,000)
Cancellation of common stock issued to a consultant - July 1999 (112,000)
Stock issued for outstanding HBI shares - August 2, 1999 in
connection with reverse merger (5,000)
Compensation resulting from sale by HBI shareholders of
3,970,000shares at $0.02 per share - August 1999 23,741,000
Sale of common stock at $6.00 per share - August
and October 1999, less related costs of $4,454,000 34,980,000
Issuance of common stock in payment of debt and accrued
interest at $6.00 per share - August 1999 730,000
Issuance of warrants for minimal consideration to purchase
476,190 shares of common stock in connection with
collaborative
agreement - December 1999 2,247,000
Common stock issuable to a consultant in connection with
collaborative agreement - December 1999
Options issued to employees & consultants - various dates 41,447,000 (41,447,000)
Amortization of deferred compensation 22,491,000
Comprehensive loss:
Loss on foreign currency translation $ (15,000)
Net loss for period (69,713,000)
Total comprehensive loss ------------ ------------- ---------- -------------
Balances at December 31, 1999 $144,063,000 $(72,283,000) $ (15,000) $(18,956,000)
-=========== ============ ========= ============
</TABLE>
<TABLE>
<CAPTION>
STOCK
SUBSCRIPTIONS
RECEIVABLE TOTAL
---------- -----
<S> <C> <C>
Issuance of common stock at par ($.001 per share) to founders
as of January 8, 1999, net of shares returned (Note B) $ (25,000) $ 0
Issuance of common stock to employees and consultants at
$0.074 per share, as of January 8, 1999 137,000
Issuance of common stock to employees, consultants and
creditors at $0.28 per share - April 1999 2,442,000
Sale of common stock at $2.75 per share - May 1999
less related costs of $10,000 990,000
Sale of common stock at $3.75 per share - May 1999
less related costs of $310,000 8,690,000
Sale of common stock at $5.00 per share - May 1999
less related costs of $10,000 990,000
Issuance of preferred stock at par ($.001 per share) to a
founder - June 1999 (1,000) 0
Issuance of common stock in connection with acquisition at
$5.00 per share - July 1999 22,500,000
Issuance of warrants to purchase 2,000,000 shares of common
stock
issued in connection with acquisition - July 1999 3,000,000
Issuance of warrants to purchase 50,000 shares of common
stock issued in connection with acquisition - July 1999 90,000
Issuance of warrants to purchase 33,333 shares of common
stock for services to the Company - July 1999 50,000
Stockholders' deficiency of acquired entities applicable to
47.5%
Interest owned by the Company's controlling stockholder (406,000)
Cancellation of common stock issued to a consultant - July 1999 (112,000)
Stock issued for outstanding HBI shares - August 2, 1999 in
connection with reverse merger 0
Compensation resulting from sale by HBI shareholders of
3,970,000shares at $0.02 per share - August 1999 23,741,000
Sale of common stock at $6.00 per share - August
and October 1999, less related costs of $4,454,000 34,986,000
Issuance of common stock in payment of debt and accrued
interest at $6.00 per share - August 1999 730,000
Issuance of warrants for minimal consideration to purchase
476,190 shares of common stock in connection with
collaborative
agreement - December 1999 2,247,000
Common stock issuable to a consultant in connection with
collaborative agreement - December 1999 1,155,000
Options issued to employees & consultants - various dates 0
Amortization of deferred compensation 22,491,000
Comprehensive loss:
Loss on foreign currency translation (15,000)
Net loss for period (69,713,000)
------------
Total comprehensive loss (69,728,000)
--------- ------------
Balances at December 31, 1999 $ (26,000) $ 53,993,000
========= ============
</TABLE>
See notes to financial statements 4
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM JANUARY 8, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999
<TABLE>
<CAPTION>
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C>
Net loss $ (69,713,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of equipment and software 276,000
Amortization of intangibles 3,168,000
Stock-based compensation 49,904,000
Share of loss of predecessor companies 663,000
Changes in:
Receivables (261,000)
Other current assets (350,000)
Other assets (482,000)
Accounts payable, accrued expenses and sundry liabilities 1,663,000
----------------
Net cash used in operating activities (15,132,000)
----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cost of developing internal-use software (777,000)
Datatek acquisition, net of acquired companies cash of $565,000 (1,748,000)
Payment of security deposits (925,000)
Purchase of equipment (689,000)
----------------
Net cash used in investing activities (4,139,000)
----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on line of credit (40,000)
Proceeds from sale of stock, net of related costs 45,656,000
---------------
Net cash provided by financing activities 45,616,000
---------------
Effect of exchange rate changes on cash (285,000)
----------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 26,060,000
================
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of stock for stock subscription receivable $ 26,000
Issuance of stock and warrants in connection with Datatek acquisition $ 25,590,000
Deferred compensation to consultants and employees by issuance of options $ 41,447,000
Issuance of stock for notes payable and accrued interest $ 730,000
Issuance of warrants relating to prepaid advertising and marketing expenses in connection
with joint venture agreement $ 2,247,000
</TABLE>
See notes to financial statements 5
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE A - THE COMPANY
MCY Music World, Inc. ("MusicWorld") was incorporated on January 8, 1999 in the
state of Delaware to acquire certain predecessor companies based in Germany (see
Note B) and to further develop its planned operations, which include the
creation and opening to the public of an online service platform to provide
worldwide promotional and sales services for the music buying public and the
music industry. On August 2, 1999, MusicWorld completed a reverse merger into
Health Builders International, Inc. ("HBI"), an inactive public company
incorporated in the state of Delaware. The merger was consummated through an
exchange of shares that resulted in stockholders of MusicWorld holding
43,324,988 shares of common stock (excluding 121,667 shares of common stock
issuable to creditors) or 90.4% of the outstanding common shares of HBI and
1,000,000 shares of Series 1 Preferred Stock (100% of such class) and existing
stockholders of HBI holding 4,611,000 shares of common stock. The merger is
being accounted for as a recapitalization and retroactive effect has been given
to the recapitalization in the accompanying financial statements. In connection
with the merger, HBI changed its name to MCY.com, Inc. (the "Company").
The Company intends to operate an Internet website offering an interactive
environment and virtual music store where music buyers can purchase digital
music downloads and webcasts in an encrypted and enhanced format, as well as
other products. The Company is in the development stage, since planned
operations have not commenced.
The Company is subject to those general risks associated with development stage
companies, as well as special risks unique to emerging E-commerce companies
which, by definition, seek to create new markets for their innovative products
and services. As shown in the accompanying financial statements, the Company has
incurred a substantial net loss and the Company and its predecessor companies
have generated minimal revenues related to the Company's planned operations.
Further, the Company's business concept and business model are unproven and,
accordingly, the Company's viability is uncertain. These conditions may result
in a future write-down of the carrying value of the intangibles arising from the
acquisition of the predecessor companies (reflecting their impairment), or a
reduction in the remaining estimated lives of said intangibles, which may result
in their accelerated amortization (see Notes C[6] and E). In order to finance
its continued development the Company is presently attempting to raise
additional financing through additional private placements. However, there is no
assurance that the Company will be successful in that effort, nor that it will
ever attain profitable operations and operating cash flow.
NOTE B - ACQUISITION
On July 2, 1999, MusicWorld acquired the assets of Datatek Services Limited
("Datatek") including the stock of MCY America, Inc. ("MCY America") and Fritsch
& Friends Mediagroup GmbH ("Fritsch & Friends") (collectively the "predecessor
companies") in exchange for cash of $1,050,000, 4,500,000 shares of MusicWorld's
common stock valued at $22,500,000 and 5-year warrants to acquire 2,000,000
shares of common stock at an exercise price of $5.00 per share, valued at
$3,000,000, for an aggregate cost of $26,550,000. In addition, the Company
agreed to pay to Datatek, on a quarterly basis, 1% of gross revenues either, (i)
for a period of 20 years, or (ii) until such time as the payments total
$9,000,000. As of the date of the acquisition, the predecessor companies owed
MusicWorld $1,243,000 representing the balance of loans made by MusicWorld prior
to the acquisition. MusicWorld's founder, controlling stockholder and Chairman
was the Chief Executive Officer, a director and owned a 47.5% beneficial
interest in Datatek which was transferred to the other Datatek stockholders for
no consideration immediately prior to the closing of the acquisition. Datatek
and its subsidiaries had been involved in the development, purchase and
licensing of the technology, intellectual property and other business assets
that are required for MusicWorld's intended business operations. The transaction
has been accounted for as a
6
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE B - ACQUISITION (CONTINUED)
purchase by MusicWorld of a 52.5% ownership interest in the Datatek assets and a
contribution to MusicWorld of the 47.5% interest formerly owned by MusicWorld's
founder and controlling stockholder. Such contributed interest has been recorded
at the predecessor basis to the controlling stockholder which approximates 47.5%
of the stockholders' deficiency of the predecessor companies at the acquisition
date. In addition, 47.5% of the loss of predecessor companies for the period
from January 1, 1999 through July 2, 1999 is reflected in the Company's results
of operations on the equity method and 100% of the results of operations of the
predecessor companies are consolidated with those of the Company from July 2,
1999. The aggregate cost of the acquisition of the 52.5% interest, amounting to
$27,793,000, including $1,243,000 of loans receivable from predecessor
companies, reduced by $1,069,000 representing 47.5% of the stockholders'
deficiency of the predecessor companies at the acquisition date has been
allocated to assets acquired and liabilities assumed at date of acquisition as
follows:
Cash $ 565,000
Sundry receivables 137,000
Due from related parties 109,000
Equipment and software, net 370,000
Other assets 146,000
Intangibles (see Note E) 28,321,000
---------------
29,648,000
---------------
Accounts payable, accrued expenses and sundry liabilities 2,884,000
Line of credit 40,000
--------------
2,924,000
---------------
Cost of net assets acquired $ 26,724,000
===============
The contingent consideration will be accounted for as royalty expense as it
becomes payable. Also in connection with this transaction, founders of
MusicWorld agreed to return 2,000,000 shares of common stock, which were then
canceled. The return of the shares was accounted for as an adjustment of the
original issuance of shares to partners.
Assuming the acquisition had occurred as of January 8, 1999, the Company's
unaudited pro-forma net loss, including amortization of the acquired
intangibles, would have amounted to $(73,467,000) or $(1.66) per common share
for the period January 8, 1999 through December 31, 1999.
NOTE C - SIGNIFICANT ACCOUNTING POLICIES
[1] BASIS OF PRESENTATION:
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles and include the accounts of
the Company and it's wholly-owned subsidiaries after elimination of all
significant inter-company transactions and balances.
7
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[2] CASH:
For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three
months or less to be cash equivalents. From time to time, the Company's
cash balances with any single financial institution exceed Federal
Deposit Insurance Corporation ("FDIC") and Securities Investor Protection
Corporation ("SIPC") limits. At December 31, 1999 cash equivalents amount
to $24,962,000 and consist of one investment in a money market fund.
[3] EQUIPMENT AND SOFTWARE, NET:
In accordance with Statement of Position ("SOP") 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use"
costs related to the development of software in connection with the
Company's Internet website, other than those costs incurred during the
application development stage, are expensed as incurred. Costs incurred
during the application development stage are capitalized and amortized
using the straight-line method over an estimated useful life of three
years beginning when the software is ready for its intended use.
Equipment is stated at cost less accumulated depreciation. Depreciation
is computed using the straight-line method over the estimated useful
lives of three to seven years.
[4] USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from these
estimates.
[5] STOCK-BASED COMPENSATION:
The Company has elected to follow the intrinsic value method set forth in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees" in accounting for its stock option incentive plan. As such,
deferred compensation expense is recorded on the date of grant of
employee options if the current market price of the underlying stock
exceeds the exercise price of the option, and such deferral is amortized
and charged to operations over the vesting period of the options. Options
or stock awards issued to non-employees are valued using the fair value
method and expensed over the period services are provided in accordance
with the applicable provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation."
[6] IMPAIRMENT OF LONG-LIVED ASSETS:
The Company evaluates the recoverability of its identifiable intangibles
and other long-lived assets in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed of." SFAS No. 121 requires recognition of impairment of
long-lived assets in the event the net book value of these assets exceeds
the estimated future undiscounted cash flows attributable to these
assets. The Company assesses potential impairment to its long-lived
assets when there is evidence that events or changes in circumstances
have made recovery of the asset's carrying value unlikely. Should an
impairment exist, the impairment loss would be measured based on the
excess of the carrying value of the asset over the asset's fair value or
discounted estimates of future cash flows.
8
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[6] IMPAIRMENT OF LONG-LIVED ASSETS: (CONTINUED)
The Company periodically evaluates the amortization period assigned to
the excess of cost over fair value of identifiable net assets acquired to
determine whether later events and circumstances warrant revised
estimates of useful life. If estimates are changed, the unamortized cost
will be allocated to the revised number of remaining periods. In
addition, a reduction in the carrying amount of the unamortized excess
would be made if it exceeds the estimated future undiscounted cash flows
to be generated by the Company. Should such an impairment exist, the
impairment loss would be measured based on the excess of the carrying
value of the asset over its fair value or discounted estimates of future
cash flows.
[7] REVENUE RECOGNITION:
Upon commencement of planned operations, the Company will recognize
revenue applicable to the delivery of music when the digital files and/or
streams are delivered or, in the case of revenue to be derived from the
sales of CDs or music-related merchandise, upon shipment. Related
royalties will be charged to cost of sales to match the recognition of
revenue, as applicable. Advertising revenue, which consists of
advertising space on the Company web-site, is recorded during the period
in which the advertising services are provided. Included in revenue is
advertising revenue in the amount of $330,000 during the period January
8, 1999 through December 31, 1999. The Company purchased prepaid
television advertising time of $325,000 from the same customer. There
were no amounts due to or from the customer at December 31, 1999.
[8] ADVERTISING:
Advertising expense is comprised of print, television and internet
related marketing expenses. Advertising expenses are charged to
operations during the period incurred, except for expenses related to the
development of major commercial or media campaigns which are charged to
operations during the period in which the advertising campaign is first
presented by the media. Advertising and marketing expenses charged to
operations totaled $1,015,000 during the period January 8, 1999 through
December 31, 1999. Included in prepaid expenses at December 31, 1999 were
$2,247,000 related to prepaid advertising and marketing resulting from
the issuance of warrants in connection with a joint venture arrangement
(see Note K).
[9] NET LOSS PER SHARE:
Basic and diluted net loss per share was computed by dividing the net
loss for the period by the weighted average number of common shares
outstanding during the period including shares issuable to creditors
after giving retroactive effect to a 2-for-1 stock split during May 1999.
All share issuances prior thereto reflected in the statement of
stockholders equity have been retroactively adjusted to reflect the
split.
[10] FOREIGN CURRENCY:
The assets and liabilities of the Company's German subsidiaries, whose
functional currency is the Deutsche Mark, are translated into U.S.
dollars at exchange rates as of the balance sheet date. Expenses are
translated at the average of the rates prevailing during the period.
Translation adjustments are accumulated as a separate component of
stockholders' equity.
9
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[11] COMPREHENSIVE INCOME:
The Company adopted the provisions of SFAS No. 130, "Reporting
Comprehensive Income." 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. Comprehensive loss for
the period consists of the net loss and the loss from foreign currency
translation.
[12] SEGMENT INFORMATION:
The Company adopted the provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS 131 requires
public companies to report financial and descriptive information about
their reportable operating segments. The Company identifies its operating
segments based on how management internally evaluates separate financial
information, business activities and management responsibility. The
Company believes that its operations, as they are presently developing,
constitute a single, reportable segment. Non U.S. results of operations,
equipment and software, and total assets are immaterial.
[13] FINANCIAL INSTRUMENTS:
The carrying amounts of the Company's cash and cash equivalents,
receivables, and accounts payable approximate fair value.
NOTE D - EQUIPMENT AND SOFTWARE
Equipment and software at December 31, 1999 consisted of the following
components:
Equipment $ 1,065,000
Software 796,000
---------------
1,861,000
Less: accumulated depreciation and amortization (276,000)
---------------
$ 1,585,000
===============
10
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE E - INTANGIBLE ASSETS
In connection with MusicWorld's acquisition of the predecessor companies (see
Note B), the Company has recorded intangible assets comprised as follows:
<TABLE>
<CAPTION>
<S> <C>
Technology and related contracts $ 4,410,000
Record label contracts and catalogs 630,000
Excess of cost over fair value of identifiable net assets acquired 23,281,000
---------------
28,321,000
Less: accumulated amortization (3,168,000)
----------
$ 25,153,000
===============
</TABLE>
The identifiable intangible assets are being amortized over a thirty-six month
period and the excess of cost over fair value of identifiable net assets
acquired is being amortized over a sixty-month period.
NOTE F - INCOME TAXES
As of December 31, 1999, the Company has an estimated United States net
operating loss carry-forward of approximately $18,600,000 which expires in 2019.
As of December 31, 1999 Fritsch & Friends and MCY Europe have a combined
estimated net operating loss carry-forward of approximately $3,000,000 (DM
5,900,000) which under German tax law does not expire. The Company has a net
deferred tax asset of $8,562,000 consisting of a deferred tax asset of
$9,895,000, resulting from operating loss carry-forwards and a deferred tax
liability of $1,333,000 resulting from the different tax and financial bases of
the Company's identifiable intangibles. Such net amount is fully offset by a
valuation allowance as the Company has not determined that it is more likely
than not that the available net operating loss carryforwards will be utilized.
The reconciliation of income tax benefit computed at the federal statutory tax
rate to the income tax benefit in the consolidated statement of operations is as
follows:
Federal (34)%
State and local, net of federal benefit (11)%
Increase in valuation allowance 45 %
--
Income tax benefit 0 %
==
The Company has recorded state and local franchise taxes based on capital in the
amount of $94,000 which is included under the caption general and administrative
expenses on the statement of operations.
11
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE G - COMMITMENTS AND CONTINGENCIES
[1] LEASE COMMITMENTS:
The Company leases facilities and equipment under noncancellable
operating leases expiring through October 2004. Such leases provide
for annual payments as detailed below. In connection with the
aforementioned leases, the Company is required to provide security
totaling $925,000. Such security has been provided by deposits
totaling $731,000 and letters of credit collateralized by restricted
cash of $194,000.
Future minimum annual lease payments as of December 31, 1999 are as
follows:
FOR THE PERIOD ENDING
DECEMBER 31,
-----------------------
2000 $ 1,263,000
2001 1,130,000
2002 987,000
2003 398,000
2004 332,000
-------------
$ 4,110,000
=============
Rent expense for the period ended December 31, 1999 approximated
$402,000.
[2] LEGAL PROCEEDINGS:
On December 16, 1999, a former employee of Music World filed a complaint
against the Company in New York Supreme Court. The complaint asserts five
claims including breach of contract, wrongful termination and fraud
related to compensation due to him for the signing and distribution of
content as well as fees related to a private placement of the Company's
stock on October 25, 1999. The complaint asks for damages of
approximately $23,000,000 on each claim including 20,000 shares of the
Company's common stock, stock options, fees and royalties. Due to the
fact that the complaint was only recently filed, discovery in the case
has not started. The Company believes that the former employee's claims
lack substantial merit, and intends to vigorously defend against this
action. On January 14, 2000, the Company filed a motion to dismiss the
complaint. Management believes that the outcome of this litigation will
not have a material adverse effect on the financial position or results
of operations of the Company.
The Company and certain of the predecessor companies, are parties to
various other claims and legal proceedings incidental to their business.
Management believes that adequate liabilities to cover any resulting
losses have been reflected in the accompanying financial statements, and
that the outcome of these claims and proceedings will not have a material
adverse effect on the financial position or results of operations of the
Company.
12
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE H - STOCKHOLDERS' EQUITY
The Board of Directors has the authority to issue 10,000,000 shares of preferred
stock in one or more series and to fix the rights, preferences, privileges and
restrictions, including dividend, conversion, voting, redemption (including
sinking fund provisions), and other rights, liquidation preferences, and the
number of shares constituting any series and the designations of such series,
without any further vote or action by the stockholders of the Company. On June
14, 1999, the Company designated and issued 1,000,000 shares of Series 1
Preferred Stock to its founder and Chairman for $1,000. Each of these shares
entitles the holder to 100 votes for each share held on all matters submitted to
a vote of stockholders. The Series 1 Preferred Stock does not carry any
dividend, liquidation, conversion or preemptive rights.
On August 2, 1999, concurrent with the merger of MusicWorld into HBI (described
below), the Certificate of Incorporation of HBI was amended whereby it:
[.] Effected a 2-for-1 stock split, increasing its authorized capital from
50,000,000 shares of common stock to 100,000,000 shares of common
stock, and increasing its outstanding common stock to 4,611,000
shares;
[.] Designated 1,000,000 shares of its 10,000,000 authorized shares of
preferred stock as Series 1 Preferred Stock, and
[.] Changed its name from Health Builders International, Inc. to MCY.com,
Inc.
Also on August 2, 1999, the Company completed its merger with MusicWorld whereby
a subsidiary of the Company merged with and into MusicWorld with MusicWorld
becoming a subsidiary of the Company. In connection therewith, outstanding
shares of MusicWorld common stock and preferred stock were converted,
respectively, on a 1-for-1 basis into common and preferred shares of MCY.com
having identical rights. Furthermore, all holders of options and warrants of
MusicWorld were given identical options and warrants of the Company under a
newly adopted stock option plan, and their existing options and warrants were
canceled.
In connection with the merger, holders of 4,000,000 shares of HBI common stock
sold approximately 3,970,000 of such shares for $0.02 per share to certain of
the Company's stockholders who also served as advisors to the Company. The
Company recorded a compensation charge to operations of approximately
$23,741,000 in connection with this transaction during August 1999.
In August and October, 1999, the Company sold in a private placement an
aggregate of 6,573,333 shares of common stock at a price of $6.00 per share, for
proceeds of $35,886,000 net of commissions and fees to the placement agent. Also
in connection with this transaction, the Company paid $900,000 to other parties
who facilitated the transaction. Additionally, warrants to acquire 657,333
shares of common stock at $6.00 per share were issued to a placement agent in
connection with this private placement.
On December 31, 1999, the Company issued warrants to purchase 476,190 shares of
common stock at a price of $10.50 per share pursuant to a collaborative
agreement (see Note K). Additionally, the Company authorized the issuance of
110,000 shares of common stock at $10.50 per share to an outside consultant who
initiated the aforementioned joint venture. Such amount was recorded as common
stock payable.
13
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE H - STOCKHOLDERS' EQUITY (CONTINUED)
As of December 31, 1999, outstanding warrants to purchase shares of the
Company's common stock were as follows:
EXERCISE
PRICE SHARES EXPIRATION
----- ------ ----------
$ 5.00 2,033,333 July 2, 2004 and July 21, 2004
$ 6.00 707,333 July 21, 2004 and October 20, 2004
$ 10.50 476,190 December 31, 2004
------------
3,216,856
=========
NOTE I - OPTIONS
The Company adopted the 1999 Stock Incentive Plan, as amended (the "99 Plan")
under which options (qualified or nonqualified) and other stock awards, covering
an aggregate of 15,000,000 shares of common stock may be granted to employees,
nonemployee directors and consultants. The exercise price established for any
awards granted under the 99 Plan shall be determined by a Committee of the
Company's Board of Directors. During the period ended December 31, 1999, options
to purchase 7,760,234 shares of the Company's common stock under the 99 Plan
have been granted to officers, other employees, directors and consultants of the
Company at exercise prices ranging from $1.50 to $12.75 per share. Generally,
options become exercisable over periods ranging from immediately to three years
and expire five years from the date of grant. The Company has reserved
15,000,000 shares of common stock for issuance under the 99 Plan. During the
period ended December 31, 1999 in connection with the resignation of certain
employees, 761,200 non-vested options previously granted were cancelled.
Additionally, with respect to those certain employees, the period over which
vested options are exercisable was modified to 90 days from date of resignation.
None of these vested options were exercised within the shortened period.
Additionally, during January 2000, 42,500 options with an exercise price of
$1.50 per share and 225,000 options with an exercise price of $3.20 per share
were exercised and paid for by the return to the Company of 79,874 shares of
common stock at an estimated market price of $9.8125 per share.
The following table presents information relating to stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------- -------------------
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE EXERCISE LIFE IN EXERCISE
PRICE SHARES PRICE YEARS SHARES PRICE
----- ------ ----- ----- ------ -----
<S> <C> <C> <C> <C> <C>
$ 1.50 2,683,200 4.6 778,080
$ 3.20 2,800,000 4.8 1,400,000
$ 6.00 275,000 4.6 48,000
$ 9.50 200,000 4.6 20,000
$10.00 250,000 4.7 6,000
$11.00 50,000 5.0 0
$12.00 580,834 5.0 108,334
$12.50 60,000 4.8 3,300
$12.75 100,000 5.0 0
------------ ------------
6,999,034 $ 4.08 2,363,714 $ 3.18
============ ============
</TABLE>
14
<PAGE>
MCY.COM, INC. AND SUBSIDIARIES
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE I - OPTIONS (CONTINUED)
The effect of applying SFAS No.123 to the Company's December 31, 1999 net loss
as stated below is not necessarily representative of the effects on reported net
loss for future years due to, among other things, the vesting period of the
stock options and the fair value of additional stock options in future years.
The weighted average fair value of the options granted during the period ended
December 31, 1999, has been estimated at $6.82 per share on the date of grant
using the Black-Scholes option-pricing model with the following assumptions: no
dividend yield, volatility of 60%, a risk-free interest rate range of 5.7-6.0%
and an expected life of three years from date of grant. Had compensation cost to
employees and directors for the Company's stock option plan been determined
based upon the fair value of the options at the grant date for awards under the
plan consistent with the methodology prescribed under SFAS No.123, the Company's
net loss and net loss per share would have been as follows:
Net loss - as reported $(69,713,000)
============
- pro forma $(71,509,000)
============
Net loss per share - as reported $(1.66)
======
- pro forma $(1.71)
======
NOTE J - RELATED PARTY TRANSACTIONS
On July 29, 1999, MusicWorld entered into a license agreement with its principal
stockholder who is also the Company's Chairman and CEO for exclusive worldwide
rights to certain technology. The license shall continue to be in effect as long
as compensation equal to 0.25% of gross revenues is paid annually to the CEO
until the later of 20 years or the expiration of the underlying patents as
provided in his employment agreement.
At December 31, 1999, advances to the Company's Chairman and CEO totaled
$107,000.
See Note B for information with respect to the Datatek acquisition.
NOTE K - COLLABORATIVE AGREEMENT
On December 31, 1999, the Company entered into a collaborative agreement to
develop co-branded Narrowband and Broadband Music Channels on internet sites. In
connection with the agreement, the Company will pay $25,000 per month and share
a percentage of digital music download revenues initiated on specific co-branded
internet sites during the 12 month period ending December 31, 2000. In
connection with this agreement, the Company issued a warrant to purchase 476,190
shares of the Company's common stock at an exercise price of $10.50 per share
for total consideration of $5,000. Such warrant has been valued at $2,252,000.
The excess of the value over the amount paid has been recorded as prepaid
advertising and marketing expense and will be amortized during the year ending
December 31, 2000 commencing with the month in which the music internet sites
are launched. The Company authorized the issuance, to an independent consultant,
of 110,000 shares of common stock valued at $1,155,000 for services rendered in
connection with the collaborative agreement. Such amount has been recorded as
compensation expense during the period ended December 31, 1999.
NOTE L - SUBSEQUENT EVENT
From February 16, 2000 through March 9, 2000, the Company sold in a private
placement an aggregate of approximately 5,000,000 shares of common stock at a
price of $7.50 per share, for proceeds of approximately $35,000,000 net of
commissions and fees to the placement agent.
15
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(DEVELOPMENT STAGE COMPANIES)
COMBINED FINANCIAL STATEMENTS
FOR THE PERIODS ENDED
DECEMBER 31, 1996, 1997 AND 1998,
AND JULY 2, 1999
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
COMBINED FINANCIAL STATEMENTS
<S> <C>
Independent auditors' report 1
Balance sheets as of December 31, 1996, 1997 and 1998 2
Statements of operations for the years ended December 31, 1996, 1997 and
1998, the period from January 1, 1999 through July 2, 1999, and the period
January 1, 1996 through July 2, 1999 3
Statements of stockholders' deficiency for the years ended December 31, 1996, 1997
and 1998 and the period from January 1, 1999 through July 2, 1999 4
Statements of cash flows for the years ended December 31, 1996, 1997 and
1998, the period from January 1, 1999 through July 2, 1999, and the period
January 1, 1996 through July 2, 1999 5
Notes to financial statements 6
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Predecessor Companies of MCY.com, Inc.
New York, New York
We have audited the accompanying combined balance sheets of the predecessor
companies of MCY.com, Inc. (development stage companies) as described in Note A,
as of December 31, 1996, 1997 and 1998 and the related combined statements of
operations, stockholders' deficiency and cash flows for the years ended December
31, 1996, 1997 and 1998, for the period from January 1, 1999 through July 2,
1999 and for the period from January 1, 1996 through July 2, 1999. These
combined financial statements are the responsibility of the predecessor
companies' management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all
material respects, the combined financial position of the predecessor companies
of MCY.com, Inc. as of December 31, 1996, 1997 and 1998, and the combined
results of their operations and their cash flows for the years ended December
31, 1996, 1997 and 1998, for the period from January 1, 1999 through July 2,
1999 and for the period from January 1, 1996 through July 2, 1999 in conformity
with generally accepted accounting principles.
As described in Note B[2] to the financial statements, the predecessor companies
changed their method of accounting for software development costs in the 1999
period.
Richard A. Eisner & Company, LLP
New York, New York
September 17, 1999
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
COMBINED BALANCE SHEETS
(US Dollars)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1998 1997 1996
--------------- --------------- ------------
ASSETS
Current assets:
<S> <C> <C> <C>
Cash and cash equivalents $ 347,000 $ 33,000 $ 65,000
Accounts receivable, net 63,000 10,000 10,000
Advances to officer 109,000 96,000 11,000
Other current assets 7,000 227,000
--------------- --------------- ------------
Total current assets 526,000 139,000 313,000
Equipment, at cost, net 99,000 107,000 44,000
Other assets 15,000 10,000
--------------- --------------- ------------
$ 640,000 $ 256,000 $ 357,000
=============== =============== ============
LIABILITIES
Current liabilities:
Accounts payable, accrued expenses and sundry liabilities $ 2,090,000 $ 1,670,000 $ 419,000
Due to former stockholder 552,000 568,000 180,000
Line of credit payable - bank 115,000 60,000 228,000
--------------- --------------- ------------
Total current liabilities 2,757,000 2,298,000 827,000
--------------- --------------- ------------
Commitments and contingencies (Note E)
STOCKHOLDERS' DEFICIENCY
Common stock 57,000 56,000 56,000
Additional paid-in capital 3,347,000 82,000
Deficit accumulated during the development stage (5,410,000) (2,304,000) (534,000)
Cumulative foreign currency translation adjustments (111,000) 124,000 8,000
--------------- --------------- ------------
(2,117,000) (2,042,000) (470,000)
--------------- --------------- ------------
$ 640,000 $ 256,000 $ 357,000
=============== =============== ============
See notes to financial statements 2
</TABLE>
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
COMBINED STATEMENTS OF OPERATIONS
(US Dollars)
<TABLE>
<CAPTION>
FOR THE
PERIOD FROM
JANUARY 1, JANUARY 1,
1999 1996
THROUGH FOR THE YEARS ENDED DECEMBER 31, THROUGH
JULY 2, -------------------------------- JULY 2,
1999 1998 1997 1996 1999
---- ---- ---- ---- ----
Revenue:
<S> <C> <C> <C> <C> <C>
Sales $ 418,000 $ 418,000
------------ ---------------
Costs and expenses:
Cost of sales 249,000 249,000
Research and development $ 51,000 $ 653,000 $ 582,000 428,000 1,714,000
Selling, general and
administrative expenses 1,344,000 2,453,000 1,188,000 274,000 5,259,000
--------------- -------------- --------------- ------------ ---------------
Total costs and expenses 1,395,000 3,106,000 1,770,000 951,000 7,222,000
--------------- -------------- --------------- ------------ ---------------
NET LOSS $ (1,395,000) $ (3,106,000) $ (1,770,000) $ (533,000) $ (6,804,000)
=============== ============== =============== ============ ===============
</TABLE>
See notes to financial statements 3
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
COMBINED STATEMENT OF STOCKHOLDERS' DEFICIENCY
(US Dollars)
<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED
COMMON ADDITIONAL DURING THE FOREIGN
STOCK PAID-IN DEVELOPMENT CURRENCY
AMOUNT CAPITAL STAGE TRANSLATION
<S> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996 $ 56,000 $ (1,000)
Foreign currency adjustments $ 8,000
Net loss for the year ended December 31, 1996 (533,000)
----------- ------------- ------------- ------------
BALANCE, DECEMBER 31, 1996 56,000 (534,000) 8,000
Capital contributions by parent $ 82,000
Foreign currency adjustments 116,000
Net loss for the year ended December 31, 1997 (1,770,000)
----------- ------------- ------------- ------------
BALANCE, DECEMBER 31, 1997 56,000 82,000 (2,304,000) 124,000
Capital contribution in connection with formation
of MCY America and other entities 1,000 61,000
Capital contributions by parent 3,204,000
Foreign currency adjustments (235,000)
Net loss for the year ended December 31, 1998 (3,106,000)
----------- ------------- ------------- ------------
BALANCE, DECEMBER 31, 1998 57,000 3,347,000 (5,410,000) (111,000)
Capital contributions by parent 1,203,000
Foreign currency adjustments 59,000
Net loss for the period ended July 2, 1999 (1,395,000)
----------- ------------- ------------- ------------
BALANCE, JULY 2, 1999 $ 57,000 $ 4,550,000 $ (6,805,000) $ (52,000)
=========== =============== =============== ============
</TABLE>
<TABLE>
<CAPTION>
COMPREHENSIVE
TOTAL LOSS
BALANCE, JANUARY 1, 1996 <C> <C>
<S> $ 55,000
Foreign currency adjustments 8,000 $8,000
Net loss for the year ended December 31, 1996 (533,000) (533,000)
------------ -----------
BALANCE, DECEMBER 31, 1996 (470,000) $(525,000)
===========
Capital contributions by parent 82,000
Foreign currency adjustments 116,000 $116,000
Net loss for the year ended December 31, 1997 (1,770,000) (1,770,000)
------------ ------------
BALANCE, DECEMBER 31, 1997 (2,042,000) $(1,654,000)
===========
Capital contribution in connection with formation
of MCY America and other entities 62,000
Capital contributions by parent 3,204,000
Foreign currency adjustments (235,000) $(235,000)
Net loss for the year ended December 31, 1998 (3,106,000) (3,106,000)
------------ -----------
BALANCE, DECEMBER 31, 1998 (2,117,000) $(3,341,000)
===========
Capital contributions by parent 1,203,000
Foreign currency adjustments 59,000 $59,000
Net loss for the period ended July 2, 1999 (1,395,000) (1,395,000)
------------ -----------
BALANCE, JULY 2, 1999 $ (2,250,000) $(1,336,000)
=============== ===========
</TABLE>
See notes to financial statements 4
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
COMBINED STATEMENTS OF CASH FLOWS
(US Dollars)
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1,
1999
THROUGH FOR THE YEARS ENDED DECEMBER 31
JULY 2, -------------------------------
1999 1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net loss $(1,395,000) $(3,106,000) $(1,770,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 20,000 39,000 43,000
Salaries and consultants' fees allocated from Datatek 404,000 706,000 0
Changes in:
Accounts receivable (86,000) (51,000) (1,000)
Other current assets 7,000 (7,000) 201,000
Other assets (83,000) (4,000) (9,000)
Accounts payable, accrued expenses and sundry liabilities (101,000) 291,000 1,260,000
----------- ----------- -----------
Net cash used in operating activities (1,234,000) (2,132,000) (276,000)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to officer (13,000) (6,000) (89,000)
Purchase of equipment (62,000) (27,000) (114,000)
Cost of developing software (246,000)
----------- ----------- -----------
Net cash used in investing activities (321,000) (33,000) (203,000)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under line of credit (65,000) 49,000 (141,000)
Advances from (repayments to) former stockholder (56,000) 529,000
Advances from MCY Music World, Inc. 1,243,000
Capital contributions 799,000 2,560,000 82,000
----------- ----------- -----------
Net cash provided by financing activities 1,977,000 2,553,000 470,000
----------- ----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (204,000) (74,000) (23,000)
----------- ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 218,000 314,000 (32,000)
Cash and cash equivalents, beginning of period 347,000 33,000 65,000
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 565,000 $ 347,000 $ 33,000
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1,
FOR THE 1996
YEARS ENDED DECEMBER 31 THROUGH
----------------------- JULY 2,
1996 1999
---- ----
<S> <C> <C>
Net loss $ (533,000) $(6,804,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 22,000 124,000
Salaries and consultants' fees allocated from Datatek 1,110,000
Changes in:
Accounts receivable 345,000 207,000
Other current assets (43,000) 158,000
Other assets (1,000) (97,000)
Accounts payable, accrued expenses and sundry liabilities 1,000 1,451,000
----------- -----------
Net cash used in operating activities (209,000) (3,851,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances to officer (11,000) (119,000)
Purchase of equipment (39,000) (242,000)
(246,000)
Cost of developing software
----------- -----------
Net cash used in investing activities (50,000) (607,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under line of credit 225,000 68,000
Advances from (repayments to) former stockholder 70,000 543,000
Advances from MCY Music World, Inc. 1,243,000
Capital contributions 3,441,000
----------- -----------
Net cash provided by financing activities 295,000 5,295,000
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (5,000) (306,000)
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 31,000 531,000
Cash and cash equivalents, beginning of period 34,000 34,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 65,000 $ 565,000
=========== ===========
</TABLE>
See notes to financial statements 5
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
NOTES TO FINANCIAL STATEMENTS
(US Dollars)
NOTE A - BASIS OF PRESENTATION
On July 2, 1999, MCY Music World, Inc. ("MCY Music World"), which was
incorporated on January 8, 1999, acquired the assets of Datatek Services Limited
("Datatek") including the stock of MCY America, Inc. ("MCY America") and Fritsch
& Friends Mediagroup GmbH ("Fritsch & Friends") in exchange for cash of
$1,050,000, 4,500,000 shares of MCY Music World common stock valued at
$22,500,000 and 5-year warrants to acquire 2,000,000 shares of common stock at
an exercise price of $5.00 per share, valued at $3,000,000, for an aggregate
cost of $26,550,000. On August 2, 1999, MCY Music World became a wholly-owned
subsidiary of MCY.com, Inc. MCY Music World's founder, controlling shareholder
and Chairman was the Chief Executive Officer, a director and owned a 47.5%
beneficial ownership interest in Datatek. Datatek, which functioned primarily as
a holding company, and its subsidiaries had been involved in the development,
purchase and licensing of the technology, intellectual property and other
business assets that are required for MCY Music World's intended business
operations which include the creation and opening to the public of an online
service platform to provide worldwide promotional and sales services for the
music buying public and the music industry. MCY Music World intends to operate
an Internet web site offering an interactive environment and virtual music store
where music buyers can purchase digital music downloads in an encrypted and
enhanced format, as well as other products.
The combined financial statements, which have been prepared in accordance with
generally accepted accounting principles, include the accounts of Fritsch &
Friends and MCY America (collectively the "predecessor companies") after
elimination of all significant intercompany transactions and balances. Fritsch &
Friends was incorporated in Germany in 1991 and MCY America was incorporated in
the United States in December 1997. On June 1, 1999, in connection with the
acquisition, MCY Music of Germany GmbH and Datatek Services Germany GmbH, two
subsidiaries of Datatek, which were incorporated in Germany during October 1998,
transferred all of their assets to Fritsch & Friends. Such transaction has been
accounted for as a merger of entities under common control in a manner similar
to a pooling-of-interests and accordingly, the transferred assets were recorded
at historical carrying amounts and the results of operations of such
subsidiaries are reflected in the accompanying combined financial statements
from their inception.
The predecessor companies are considered to be in the development stage
effective January 1, 1996, which approximates the time Fritsch & Friends
commenced activities in the field of Internet digital music distribution. Sales
during 1996 are not from planned business operations but represent revenue from
processing computer CDs.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
[1] CASH:
For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three
months or less to be cash equivalents.
[2] EQUIPMENT AND SOFTWARE, NET:
During March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." The SOP, which has been adopted
prospectively as of January 1, 1999, requires the capitalization of
certain costs incurred in connection with developing or
6
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
NOTES TO FINANCIAL STATEMENTS
(US Dollars)
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[2] EQUIPMENT AND SOFTWARE, NET: (CONTINUED)
obtaining internal use software. Prior to the adoption of SOP 98-1, the
Company expensed all internal use software related costs as incurred.
Capitalized costs will be amortized using the straight-line method over
their estimated useful life beginning when the software is ready for its
intended use. The effect of adopting SOP 98-1 was to decrease net loss
for the period from January 1, 1999 through July 2, 1999 by $246,000.
Equipment is stated at cost less accumulated depreciation. Depreciation
is computed using the straight-line method over the estimated useful
lives of three to seven years. Accumulated depreciation at the balance
sheet dates amounted to $10,000 (1998), $113,000 (1997) and $79,000
(1996).
[3] USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from these
estimates.
[4] FOREIGN CURRENCY:
The assets and liabilities of Fritsch & Friends, whose functional
currency is the Deutsche Mark, ("DM") are translated into U.S. dollars at
exchange rates as of the balance sheet date. Revenue and expenses are
translated at the average of the rates prevailing during the period.
Adjustments are accumulated as a separate component of the capital
deficiency.
[5] COMPREHENSIVE INCOME:
The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No.
130 establishes standards for reporting comprehensive income and its
components in financial statements. Comprehensive income, as defined,
includes all changes in equity during a period from non-owner sources.
Comprehensive loss for all periods presented consists of the net loss and
foreign currency translation adjustments.
NOTE C - ACCOUNTS PAYABLE, ACCRUED EXPENSES AND SUNDRY LIABILITIES
Accounts payable, accrued expenses and sundry liabilities at December 31, 1998,
1997 and 1996 consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1998 1997 1996
------------- ------------- -----------
<S> <C> <C>
Litigation and claims payable $ 1,139,000 $ 973,000
Trade payables and other liabilities 547,000 522,000 $ 304,000
Employee wages and related benefits 202,000 142,000
Other 202,000 33,000 115,000
------------- ------------- -----------
$ 2,090,000 $ 1,670,000 $ 419,000
============= ============= ===========
</TABLE>
7
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
NOTES TO FINANCIAL STATEMENTS
(US Dollars)
NOTE D - INCOME TAXES
As of December 31, 1998, Fritsch & Friends has an estimated net operating loss
carryforward of approximately $2,169,000 (DM 3,637,000), under German tax law,
which does not expire. The related income tax benefit, approximately $1,085,000
has been fully offset by a valuation allowance as it has not been determined
that it is more likely than not that the available net operating loss
carryforward will be utilized.
NOTE E - COMMITMENTS AND CONTINGENCIES
[1] LEASE:
The predecessor companies lease facilities under a month-to-month lease
which requires a six-month termination notice. Rent expense for the
period ended July 2, 1999 and for the years ended December 31, 1998, 1997
and 1996 totaled approximately $16,000, $32,000, $32,000 and $32,000,
respectively.
[2] LEGAL PROCEEDINGS:
The Company is a party to various claims and legal proceedings incidental
to their business. As of December 31, 1998 and 1997, respectively, the
Company had recorded a liability of $960,000 and $890,000 related to a
claim by a former trade partner, and $179,000 and $83,000 related to
miscellaneous vendors' claims. The Company believes that adequate
liabilities to cover any resulting loss have been reflected in the
accompanying financial statements, and in management's opinion, the
outcome of these claims and proceedings will not have a material adverse
effect on the financial statements of the predecessor companies.
NOTE F - STOCKHOLDERS' EQUITY
In connection with the acquisition by MCY Music World on July 2, 1999, the then
existing intercompany balances of Fritsch & Friends and of MCY America with
Datatek, arising from intercompany transactions, were canceled. Accordingly, the
intercompany transactions during the years ended December 31, 1997 and 1998 and
for the period from January 1, 1999 through July 2, 1999 with Datatek have been
accounted for as capital contributions to the extent of cash received from
Datatek during the respective periods. In addition, salaries and consulting fees
accrued by Datatek to officers and consultants have been reflected as expenses
in the accompanying combined statements of operations and related capital
contributions in the accompanying combined statements of stockholders'
deficiency.
Common stock of the predecessor companies as of July 2, 1999 consists of the
following:
<TABLE>
<CAPTION>
PAR SHARES SHARES ISSUED AND
VALUE AUTHORIZED OUTSTANDING AMOUNT
----- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Fritsch & Friends 1 DM 80,000 80,000 $ 56,000
MCY America None 200 200 1,000
-----------
$ 57,000
===========
</TABLE>
8
<PAGE>
PREDECESSOR COMPANIES OF
MCY.COM, INC.
(development stage companies)
NOTES TO FINANCIAL STATEMENTS
(US Dollars)
NOTE G - RELATED PARTY TRANSACTIONS
During the period ended July 2, 1999, MCY Music World made non-interest bearing
advances to Fritsch & Friends and MCY America. As of July 2, 1999, the
outstanding balances of such advances amounted to approximately $1,243,000.
During 1997, in connection with the purchase of the predecessor companies by
Datatek, a 20% shareholder in Fritsch & Friends agreed to accept from Fritsch &
Friends DM 925,000 ($552,000 and $514,000 at December 31, 1998 and 1997,
respectively) to redeem his shares. At December 31, 1997, $54,000 was due a
former shareholder for advances to Fritsch & Friends. At December 31, 1996,
$112,000 was due a shareholder for rent. All of the balances were noninterest
bearing and due on demand.
NOTE H - OPERATIONS IN GERMANY
Equipment of Fritsch & Friends included in the financial statements amounted to
$44,000, $81,000 and $47,000 as of December 31, 1996, 1997 and 1998,
respectively. Revenue reflected in the statement of operations for 1996 relates
solely to Fritsch & Friends.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains financial information extracted from Balance Sheet,
Statement of Operations, Statement of Cash Flows and Notes thereto
incorporated in Part I, Item 1 of this Form 10-QSB and is qualified in its
entirety by reference to such financial statements
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 26,060,000
<SECURITIES> 0
<RECEIVABLES> 397,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 29,357,000
<PP&E> 1,585,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 57,374,000
<CURRENT-LIABILITIES> 3,381,000
<BONDS> 0
0
1,000
<COMMON> 54,000
<OTHER-SE> 53,938,000
<TOTAL-LIABILITY-AND-EQUITY> 57,374,000
<SALES> 343,000
<TOTAL-REVENUES> 343,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 70,056,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (69,713,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (69,713,000)
<EPS-BASIC> (1.66)
<EPS-DILUTED> (1.66)
</TABLE>
