SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to ________
Commission file number 1-13469
Audio Book Club, Inc.
(Exact name of Small Business Issuer as specified in its charter)
Florida 65-0429858
(State or other jurisdiction of (I.R.S. Employment
incorporation or organization) Identification No.)
2295 Corporate Blvd., N.W., Suite 222, Boca Raton, Florida 33431
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (561) 241-1426
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for shorter period
that the registrant was required to file such report) and (2) has been subject
to such filing requirement for the past 90 days. Yes _X_ No ___
As of November 12, 1998, there were 6,153,920 shares of the Issuer's Common
Stock outstanding.
Transitional Small Business Disclosure Format (check one):
Yes ___ No _X_
<PAGE>
Audio Book Club, Inc.
Quarter ended September 30, 1998
Form 10-QSB
Index
Page
----
PART I: Financial Information.
Item 1: Financial Statements.
Consolidated Balance Sheet at September 30, 1998 (unaudited) 3
Consolidated Statements of Operations for the three months
ended September 30, 1997 and 1998 and the nine months ended
September 30, 1997 and 1998 (unaudited) 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1997 and 1998 (unaudited) 5
Notes to Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations. 10
PART II:
Item 2: Changes in Securities and Use of Proceeds. 18
Item 6: Exhibits and Reports on Form 8-K. 19
<PAGE>
Part I Financial Information
Item 1. Financial Statements
AUDIO BOOK CLUB, INC.
and Subsidiary
Consolidated Balance Sheet
September 30, 1998
(Unaudited)
<TABLE>
<S> <C>
Assets
Current assets:
Cash and cash equivalents $ 2,261,529
Short-term investments to be held to maturity 508,332
Accounts receivable, net of allowances for sales returns
and doubtful accounts of $912,875 3,156,913
Inventory 1,942,314
Royalty advances 674,484
Prepaid expenses 555,694
Postage deposit 100,000
------------
Total current assets 9,199,266
Prepaid expenses - non-current 190,227
Fixed assets, software and Internet development costs, at cost, net of
accumulated depreciation of $249,301 615,518
------------
$ 10,005,011
============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,483,532
Accrued expenses 1,582,473
------------
Total current liabilities 4,066,005
------------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, no par value, authorized 5,000,000 shares;
no shares issued and outstanding
Common stock; no par value, authorized 25,000,000 shares;
6,153,920 issued and outstanding 25,741,063
Contributed capital 665,217
Accumulated deficit (20,467,274)
------------
Total stockholders' equity 5,939,006
============
$ 10,005,011
============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
AUDIO BOOK CLUB, INC.
and Subsidiary
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1997 1998 1997 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales $ 3,783,040 5,777,947 10,282,371 16,190,112
Returns, discounts and allowances 1,677,967 1,902,637 3,087,256 4,654,644
----------- ----------- ----------- -----------
Sales, net 2,105,073 3,875,310 7,195,115 11,535,468
Cost of sales 946,072 2,447,900 3,756,620 7,558,121
----------- ----------- ----------- -----------
Gross profit 1,159,001 1,427,410 3,438,495 3,977,347
Expenses:
Advertising and promotion (for acquisition
and retention of members) 1,662,296 2,422,672 3,912,033 6,107,960
General and administrative 614,493 880,953 1,344,948 1,892,867
Professional fees 40,468 33,121 193,003 219,012
----------- ----------- ----------- -----------
Operating (loss) (1,158,256) (1,909,336) (2,011,489) (4,242,492)
Interest (expense) income (163,972) 58,356 (478,617) 249,146
----------- ----------- ----------- -----------
Net (loss) $(1,322,228) (1,850,980) (2,490,106) (3,993,346)
=========== =========== =========== ===========
Basic net (loss) per share of common stock $ (0.41) (0.30) (0.76) (0.65)
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
AUDIO BOOK CLUB, INC.
and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
1997 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) $(2,490,106) $(3,993,346)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 11,513 232,755
Imputed interest on notes payable - related parties 254,892
Changes in asset and liability accounts:
(Increase) in accounts receivable, net (672,040) (1,373,457)
Decrease in due from related party 20,000
(Increase) in inventory (340,384) (241,940)
(Increase) in prepaid expenses (36,921) (441,548)
(Increase) in deposits (100,000)
(Increase) in prepaid expenses - non-current (40,258)
Decrease (increase) in royalty advances 14,317 (406,966)
Increase in accounts payable and accrued expenses 89,491 1,049,337
----------- -----------
Net cash (used in) operating activities (3,149,238) (5,315,423)
----------- -----------
Cash flows (used in) from investing activities:
Maturity of short-term investment 5,143,699
Purchase of short-term investment (500,000)
Interest earned on short-term investment (8,332)
Acquisition of fixed assets, software and Internet development costs (9,518) (788,468)
----------- -----------
Net cash (used in) from investing activities (9,518) 3,846,899
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes payable - related parties 1,295,000
Repayment of notes payable - related parties (6,800,000)
Proceeds from issuance of bank debt 9,000,000
Prepaid loan costs (36,542)
Deferred offering costs (277,817)
Proceeds of issuance of options 75,000
----------- -----------
Net cash provided by financing activities 3,180,641 75,000
----------- -----------
Net increase (decrease) in cash and cash equivalents 21,885 (1,393,524)
Cash and cash equivalents at beginning of period 92,856 3,655,053
----------- -----------
Cash and cash equivalents at end of period $ 114,741 2,261,529
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
Audio Book Club, Inc.
and Subsidiary
Notes to Consolidated Financial Statements
(Information at September 30, 1998 and for the three month and nine month
periods ended September 30, 1997 and 1998 is unaudited)
(1) Organization
Audio Book Club, Inc. (the "Company"), a Florida corporation, was formed on
August 16, 1993. The Company is a direct marketer of audiobooks through Audio
Book Club, a membership club which markets and sells audiobooks via the Internet
and by mail order. In September 1998, the Company formed ABC Internet Services,
Inc., a New York Corporation, as a wholly-owned subsidiary to provide Internet
media management services to the Company.
(2) Significant Accounting Policies
Basis of Presentation
The interim unaudited financial statements should be read in conjunction
with the Company's audited financial statements contained in its Annual Report
on Form 10-KSB for the year ended December 31, 1997. The preparation of
financial statements in accordance with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from these estimates. On an ongoing basis management reviews its estimates based
on current available information. Changes in facts and circumstances may result
in revised estimates. In the opinion of management, the interim unaudited
financial statements include all material adjustments, all of which are of a
normal recurring nature, necessary to present fairly the Company's financial
position, results of operations and cash flows for the periods presented. The
results for any interim period are not necessarily indicative of results for the
entire year or any other interim period.
Cash and Cash Equivalents
Securities with maturities of three months or less when purchased are
considered to be cash equivalents.
Inventory
Inventory, consisting principally of audio cassettes held for resale, is
valued at the lower of cost (weighted average cost method) or market.
6
<PAGE>
Royalties
The Company is liable for royalties to licensors based upon revenue earned
from the respective licensed product. Royalties, in excess of advances, are
payable on contractural terms. Royalty advances not expected to be recovered
through royalties on sales are charged to royalty expense. For the three months
and nine months ended September 30, 1997 and September 30, 1998, no writedown of
royalty advances was recorded.
Prepaid Expenses
Prepaid expenses consist principally of supplies bought in bulk, insurance
and payments for Internet and other advertising being expensed over the period
of the advertising agreement. All current prepaid expenses will be expensed over
a period no greater than the next twelve months.
Fixed Assets, Computer Software and Internet Web Site Development Costs
Fixed assets, consisting primarily of furniture, computer equipment,
purchased computer software and web site development costs are recorded at cost.
Depreciation is provided by the straight-line method over the estimated useful
life of five years for equipment, three years for software and two years for
Internet web site development costs. Ongoing maintenance and other recurring
charges are expensed as incurred as are all internal costs and charges.
Revenue Recognition
Sales are recorded upon shipment of merchandise and simultaneous billing.
Net sales are sales less actual returns for the period and an estimated
allowance for future returns on sales made during the period. The allowance for
future returns is based upon historical experience and evaluation of current
return trends.
Advertising and Promotional Costs
The Company expenses the production costs of advertising the first time the
advertising takes place or when the advertising is initially mailed.
Direct-response advertising consists primarily of direct mailings to individuals
that include order forms for the Company's products, and to a lesser extent
print advertisements. The capitalized costs of advertising are amortized in the
month of publication of the magazine in which it appears or the month in which
the individual letters are mailed. Promotional costs for new and current members
are expensed on the date the promotional materials are mailed. Internet
advertising is expensed as it occurs.
Fair Value of Financial Instruments
In estimating the fair value of financial instruments, the Company has
assumed that the carrying value of cash, short-term investments, accounts
receivable, accounts payable and accrued expenses approximates fair value
because of the short maturity of those instruments.
Use of Estimates
Management of the Company has made estimates and assumptions relating to
the reporting of assets and liabilities and the disclosure of contingent
liabilities to prepare these financial statements in conformity with generally
accepted accounting principles. Actual results could differ from those
estimates.
7
<PAGE>
Income Taxes
Prior to October 22, 1997, the Company had elected to be taxed as a small
business corporation (S Corporation) under Section 1362 of the Internal Revenue
Code. As a small business corporation, all federal income taxes, if any, are the
obligations of the stockholders. Conversely, any losses incurred by the Company
may be used by the stockholders.
As a result of the consummation of the Company's public offering effective
on October 22, 1997, the Company's S Corporation election terminated and the
Company ceased to be an S corporation. Commencing October 22, 1997, the Company
became taxable as an incorporated entity (C Corporation). Accordingly, losses
incurred by the Company on or after October 22, 1997 may be used by the Company
and not by the stockholders to the extent permitted under the Internal Revenue
Code. Conversely, future federal income taxes, if any, will be the obligation of
the Company.
(3) Internet Agreements
In 1998, the Company entered into a series of agreements with various
Internet companies to provide permanent placements and banner advertisements
throughout their web sites. Each of these agreements require monthly payments
and provide for termination of the agreement by the Company at its option. For
the nine months ended September 30, 1998, the Company recognized an expense of
$2,534,309 related to Internet activities, including spending on the series of
agreements, improvements to the Company's web site and the launching of
BooksAloud.com, an Internet web site and membership club, designed for online
consumers. The Company had minimal Internet related expenses for the nine months
ended September 30, 1997. If the Company chooses to maintain all the agreements
through December 31, 1998, total payments in 1998 under the agreements would be
approximately $3,750,000.
(4) Leases - Related Parties
The Company sublets office space from an entity wholly-owned by officers
and directors of the Company.
In January 1998, the Company amended a sublease agreement to provide for
additional space at its New Jersey location. Minimum monthly rent under the
amended lease is $2,900 per month through December 1998 and is subject to two
extension periods of five years each under certain conditions. In May 1998, the
Company amended a sublease agreement to provide for additional space at its
Florida location. Minimum monthly rent under the amended lease is $1,960 per
month through November 2000 and is subject to two extension periods of three
years each under certain conditions.
In September 1998, the Company entered into a lease for a kiosk at a major
shopping mall. The lease which commences in December 1998 has a one year term,
with monthly rental amounts of $5,000 per month with the provision for increases
based on annual sales in excess of $ 750,000.
Minimum annual lease commitments under noncancelable operating leases are
as follows:
8
<PAGE>
Year ending
December 31, Amount
------------ ------
1998 $ 60,708
1999 78,520
2000 21,566
---------
Total lease commitments $ 160,794
=========
(5) Stock Options
As of September 30, 1998, there were outstanding options under the
Company's 1997 Stock Option Plan to purchase 1,407,500 shares of Common Stock.
In September 1998, a director exercised his right to purchase from the
Company an option to purchase 25,000 shares of Common Stock. The option vests
immediately and is exercisable at an exercise price of $5.00 per share and has a
five-year term. The purchase price of the option was $25,000. The option was
granted under an agreement dated March 18, 1998 between the Company and the
director which provided that if the director served as an active and
participating member of the Company's Board of Directors for six months, then
the director would have the right to purchase the option.
(6) Net Loss Per Share of Common Stock
The weighted average number of shares used in the net loss per share
computations for the three and nine months ended September 30, 1997 were
3,256,400 and for the three and nine months ended September 30, 1998 were
6,153,920.
Common equivalent shares that could potentially dilute basic loss per share
were not included in the computation of diluted loss per share because their
effect would be antidilutive.
(7) Supplemental Cash Flow Information
During the nine months ended September 30, 1997, the Company had a non-cash
financing activity related to the recognition of imputed interest on a portion
of the notes payable - related parties of $254,892. In May 1998, the Company, in
addition to a cash payment of $20,000, granted options to a third party to
purchase 20,000 shares of the Company's Common Stock at $4.81 per share to
acquire the Universal Resource Locators ("URLs"), audiobook.com and
audiobook.net. Such options immediately vest an d are exercisable and have a
five-year term. The Company has recorded an asset in the amount of $70,000, the
negotiated price, and is amortizing the asset over six years. In March 1998, the
Company granted options to purchase 21,600 shares of the Company's Common Stock
at $4.40 per share to a company in compensation for the costs incurred in
transferring to the Company the toll free phone numbers, (800) AUDIOBOOK and
(888) AUDIOBOOK. Such options vest and are exercisable immediately and have a
five-year term. The Company has recorded an asset in the amount of $54,000, the
negotiated cost of transferring the phone numbers, and is amortizing the asset
over six years.
9
<PAGE>
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Introduction
"Safe Harbor " Statement under the Private Securities Litigation Reform Act
of 1995: The statements which are not historical facts contained in this
Quarterly Report are forward looking statements that involve certain known and
unknown risks and uncertainties, including but not limited to, the Company's
ability to successfully implement a strategy of continued growth and other risks
described in the Company's Registration Statement on Form SB-2. The Company's
actual results may differ materially from the results discussed or implied in
any forward-looking statement.
The Company is a direct marketer of audiobooks through Audio Book Club, a
membership club which markets and sells audiobooks by mail and via the Internet.
The Company commenced operations in January 1994 and undertook its first direct
mail campaign in August 1994. As of November 3, 1998, Audio Book Club's total
member file consisted of 385,668 names.
Since its inception, the Company has engaged in an aggressive membership
recruitment program to establish a core Audio Book Club member base and to
continually expand such member base. The Company has acquired Audio Book Club
members primarily through direct mailings of member solicitation packages and
online computer service and Internet advertising.
The Company expenses the production costs of advertising the first time the
advertising takes place or when the advertising is initially mailed.
Direct-response advertising consists primarily of direct mailings to individuals
that include order forms for the Company's products. Promotional costs for new
and current members are expensed on the date the promotional materials are
mailed. Internet advertising is expensed as it occurs. The Company does not
capitalize any new member acquisition costs.
In 1995, the Company established an Internet web site which offers visitors
to the web site the opportunity to join Audio Book Club, execute club
transactions online (if a member), utilize the web site's search engine to
locate many of the web site's thousands of audiobook selections and sample audio
clips of many of the web site's selections. The Company's web site also provides
additional options, such as alerting visitors when a new title of an author or
reader previously specified by the visitor is released and offering reviews of
selected titles.
The Company's web site is updated simultaneously with the Audio Book Club
catalog to add new selections and the new current featured selection, as well as
to add new book cover images and audio clips to preview.
The Company's web site currently has links from numerous search engines and
audiobook related sites. The web site is also linked to catalog listing sites
offered by online computer and Internet services.
10
<PAGE>
In May 1998, the Company created the audiobookclub.com Associates Network
program. The Program allows businesses and organizations to offer to visitors to
their web sites the opportunity to join Audio Book Club online and then receive
a commission on each visitor from their site who joins Audio Book Club. As of
November 3, 1998, the Company had approximately 465 Associates.
In the third quarter of 1998, the Company entered into the following
agreements to increase its Internet presence
o The Company entered into an agreement with Microsoft Corporation's online
network, www.msnbc.com. Under the terms of the agreement, the Company will
be the audiobook seller on the MSNBC web site.
o The Company signed an advertising agreement with WhoWhere? Inc.
("WhoWhere"), a business unit of Lycos, Inc. and a provider of Web-based
communication applications. WhoWhere's web site, www.whowhere.com, will
conduct an advertising program and offer users to link directly to the
www.audiobookclub.com site.
o The Company entered into an agreement to be the exclusive audiobook seller
on the PlanetDirect site (http://www.PlanetDirect.com).
o The Company entered into an agreement with Spinner Networks, Inc. Spinner
Networks' product; Spinner.com is an audio content provider on the
Internet. Under the agreement, Spinner Networks will host two audio
channels on its web site that will each contain audiobook excerpts
programmed by the Company. In addition, a direct link to the Company's web
sites will be provided by Spinner.com and the Company's products will be
promoted throughout Spinner.com.
o The Company signed a marketing and sponsorship agreement with GeoCities, a
community of personal web sites. Under the terms of the agreement, Audio
Book Club will be the audiobook club seller on GeoCities and will manage
several promotions throughout the GeoCities community. Audio Book Club will
be featured in GeoCities' Athens neighborhood, which focuses on literature,
writing, education and philosophy. GeoCities will maintain a co-branded
Audio Book Club area within the Athens neighborhood and will market the
availability of Audio Book Club's products to members who request the
information.
o The Company signed an advertising agreement with Deja News, Inc. whereby it
will be the exclusive book club on the www.dejanews.com site. In addition,
the Company will sponsor the Deja News Entertainment, Arts and Book
Channels and "Mail a Friend" text messaging. Audio Book Club will also have
banners on discussion forums and discussion posting pages. Deja News' free
Web-based service enables consumers to participate in, read and search
discussion forums, including Usenet newsgroups.
11
<PAGE>
The Company also entered into advertising agreements with the following
companies:
o Webstakes.com, an online community which provides a centralized
location for webstakes promotions;
o The Trip.com, a travel reservation and information site for business
travelers;
o Uproar.com, a web site of online game shows.
In October 1998, the Company also entered into the following agreements:
o The Company entered into an advertising agreement with InfoSpace.com, Inc.
whereby it will be the exclusive audiobook club on www.infospace.com. The
agreement calls for a variety of promotional placements throughout many
areas of InfoSpace.com. InfoSpace.com offers consumers an array of
information services including yellow pages listings, white pages, news and
e-commerce services.
o The Company entered into an agreement with LinkShare Corporation to develop
and implement an online sales program whereby Audio Book Club affiliates
link site visitors to www.audiobookclub.com. Web site owners wishing to
become an Audio Book Club affiliate can register for the Audio Book Club
affiliate program at www.audiobookclub.com or www.linkshare.com. Site
owners are provided with an offer to become an Audio Book Club affiliate
and with a corresponding selection of Audio Book Club banners and buttons
that link back to the Company's web sites. LinkShare tracks the hyperlink
through its reporting, tracking and profiling (RTP)(TM) technology and
collects data on the number of click-throughs, time-to-transactions and
commissions due. LinkShare's software (LSN 3.0)(TM) will generate a range
of customized reports for the Company.
In addition to the foregoing, the Company continues to explore arrangements
with additional Internet companies.
In September 1998, the Company formed ABC Internet Services, Inc. (ABCIS),
a wholly owned subsidiary, to provide Internet media management services. Prior
to forming ABCIS, the Company was using a third party for these services.
The Company continues to work to expand and improve its web site including
increasing the number of audiobook titles to select, and audio clips to preview
through its search engine, improving recommendation features and streamlining
the join process.
The Company expects to incur significant expenditures in connection with
its continuing expansion strategy (including costs associated with expansion and
maintenance of its Internet web sites, new member recruitment advertising and
member retention programs) which will result in losses until such time as the
Company is able to further increase its membership base revenue to support both
its operations and continued expansion programs.
12
<PAGE>
Results of Operations
Three Months Ended September 30, 1997 Compared to Three Months Ended
September 30, 1998
Gross sales for the three months ended September 30, 1998 were $5,777,947
an increase of $1,994,907 or 52.7%, as compared to $3,783,040 for the three
months ended September 30, 1997. The increase in gross sales was primarily
attributable to increased sales of audiobooks resulting from the continued
expansion of Audio Book Club's membership base, increased purchases by members
and a significant increase in new members. The Company's total member file
increased by 32,592 names in the third quarter ended September 30, 1998.
Returns, discounts and allowances for the three months ended September 30,
1998 were $1,902,637, or 32.9% of gross sales, as compared to $1,677,967, or
44.4% of gross sales, for the prior comparable period. The decrease in returns,
discounts and allowances as a percentage of gross sales was due to improved
marketing to existing members.
As a result of higher gross sales and improved return experience, net sales
for the three months ended September 30, 1998 increased $1,770,237 or 84.1% to
$3,875,310 from $2,105,073 for the prior comparable period.
Cost of sales for the three months ended September 30, 1998 increased
$1,501,828 to $2,447,900 from $946,072 in the prior comparable period. Gross
profit increased $268,409 to $1,427,410 for the three months ended September 30,
1998 from $1,159,001 in the prior comparable period. The increase in cost of
goods sold is attributable to higher net sales and increases in new member
enrollments in the third quarter of 1998. The gross profit increase was due to
an increase in net sales, partially reduced by new member enrollment purchases
in the third quarter of 1998. These initial purchases by new members are at
substantially reduced prices to encourage enrollment. These offers, which are
typically four audiobooks for either $.99 or $.01 plus shipping and handling,
result in an initial loss to the Company which is recovered through additional
member purchases at regular prices. Because the Company does not capitalize any
new member acquisition costs, the initial purchase has the effect of reducing
gross profit in the period of enrollment.
Advertising and promotion expenses (for acquisition and retention of new
members) increased $760,376 or 45.7% to $2,422,672 for the three months ended
September 30, 1998 as compared to $1,662,296 in the prior comparable period.
This increase was principally due to an investment in Internet activities of
$1,208,201, including spending on a series of agreements with various Internet
companies to provide permanent placements and banner advertisements throughout
their web sites; and expansion and improvements to the Company's web sites.
General and administrative expenses for the three months ended September
30, 1998 increased $266,460 to $880,953 from $614,493 for the three months ended
September 30, 1997. As a percentage of net sales, general and administrative
expenses declined to 22.7% from 29.2% in the three months ended September 30,
1997.
13
<PAGE>
Professional fees for the three months ended September 30, 1998 were
$33,121 a decrease of $7,347 as compared to $40,468 for the prior comparable
period. Net interest income for the three months ended September 30, 1998 was
$58,356 as compared to a net expense of $163,972 for the three months ended
September 30, 1997.
Primarily due to increased advertising and promotion expenses (including
Internet marketing expenses of $1,208,201), the Company's net loss for the three
months ended September 30, 1998 increased $528,752 to $1,850,980, as compared to
a net loss of $1,322,228 for the three months ended September 30, 1997.
Nine Months Ended September 30, 1997 Compared to Nine Months Ended
September 30, 1998
Gross sales for the nine months ended September 30, 1998 were $16,190,112,
an increase of $5,907,741 or 57.5%, as compared to $10,282,371 for the nine
months ended September 30, 1997. The Company's total member file increased by
112,701 names or 43.0% in the nine months ended September 30, 1998.
Returns, discounts and allowances for the nine months ended September 30,
1998 were $4,654,644, or 28.7% of gross sales, as compared to $3,087,256, or
30.0% of gross sales, for the prior comparable period. The decrease in returns,
discounts and allowances as a percentage of gross sales was due to improved
marketing to existing members.
Expansion of Audio Book Club's membership base, increased revenue from
members, increased new member enrollment revenue and better returns experience
resulted in an increase in net sales of $4,340,353 or 60.3% for the nine months
ended September 30, 1998 to $11,535,468 as compared to $7,195,115 for the prior
comparable period.
Cost of sales for the nine months ended September 30, 1998 increased
$3,801,501 to $7,558,121 from $3,756,620 in the prior comparable period. Gross
profit increased $538,852 to $3,977,347 for the nine months ended September 30,
1998 from $3,438,495 in the prior comparable period. The gross profit increase
was due to an increase in net sales, partially reduced by new member enrollment
purchases in the third quarter of 1998. These initial purchases by new members
are at substantially reduced prices to encourage enrollment. These offers, which
are typically four audiobooks for either $.99 or $.01 plus shipping and
handling, result in an initial loss to the Company which is recovered through
additional member purchases at regular prices. Because the Company does not
capitalize any new member acquisition costs, the initial purchase has the effect
of reducing gross profit in the period of enrollment.
Advertising and promotion expenses (for acquisition and retention of new
members) increased $2,195,927 or 56.1% to $6,107,960 for the nine months ended
September 30, 1998 as compared to $3,912,033 in the prior comparable period.
This increase was principally due to increased spending on direct mail and to an
investment in Internet activities of $2,534,309, including spending on a series
of agreements with various Internet companies to provide permanent placements
and banner advertisements throughout their web sites, expansion and improvements
to the Company's web site and the launching of BooksAloud.com, an Internet web
site and membership club, designed for online consumers.
14
<PAGE>
General and administrative expenses for the nine months ended September 30,
1998 increased $547,919 to $1,892,867 from $1,344,948. General and
administrative expenses, as a percentage of net sales, for the nine months ended
September 30, 1998, were 16.4%, a reduction from 18.7%.
Professional fees for the nine months ended September 30, 1998 were
$219,012, an increase of $26,009, as compared to $193,003 for the prior
comparable period. Net interest income for the nine months ended September 30,
1998 was $249,146 as compared to a net expense of $478,617 for the nine months
ended September 30, 1997.
Primarily due to increased advertising of $2,195,927 (including $2,534,309
to expand the Company's Internet activities) the Company's net loss for the nine
months ended September 30, 1998 increased $1,503,240 to $3,993,346 as compared
to a net loss of $2,490,106 for the nine months ended September 30, 1997.
Liquidity and Capital Resources
The Company's capital requirements have been and will continue to be
significant due to, among other things, costs associated with building,
expanding and maintaining Internet web sites (including substantial Internet
advertising expenditures), direct mail campaigns and other new member
recruitment advertising and promotion. Historically, the Company's cash
requirements have exceeded cash flows from operations.
During the nine months ended September 30, 1998, the Company's cash
decreased $1,393,524, as the Company used net cash of $5,315,423 for operating
activities and had cash provided by investing activities and financing
activities of $3,846,899 and $75,000, respectively. For the nine months ended
September 30, 1997, the Company's cash increased by $21,885, as the Company used
net cash of $3,149,238 and $9,518 for operating and investing activities,
respectively, and had cash provided by financing activities of $3,180,641.
For the nine months ended September 30, 1997, net cash used in operating
activities, consisted of a loss of $2,490,106 and increases in net receivables,
inventory and prepaid expenses, of $672,040, $340,384 and $36,921, respectively.
The net cash used in operations was partially reduced by imputed interest on
notes payable to related parties of $254,892, a decrease in due to related
parties of $20,000, a decrease in royalty advances of $14,317, an increase in
accounts payable of $89,491 and depreciation and amortization expense of
$11,513.
For the nine months ended September 30, 1998, the cash used in operating
activities consisted of, in addition to the net loss of $3,993,346, increases in
receivables, inventory, prepaid expenses, royalty advances, deposits and prepaid
expenses - non-current of $1,373,457, $241,940, $441,548, $406,966, $100,000 and
$40,258 respectively. The net cash used in operations was partially reduced by
an increase in accounts payable and accrued expenses of $1,049,337 and
depreciation and amortization of $232,755.
15
<PAGE>
The increase in accounts receivable during the nine months ended September
30, 1998 is principally due to higher sales and an increase in new members. The
increase in prepaid expenses is principally attributable to payments made for
advertising which is being expensed over the life of the agreements as the
advertising occurs. Promotional costs for new and current members are expensed
on the date the promotional materials are mailed. Internet advertising is
expensed as it occurs. The Company does not capitalize any new member
acquisition costs
Cash used in investing activities for the nine months ended September 30,
1997 was for the acquisition of fixed assets, principally for computer
equipment. For the nine months ended September 30, 1998, the Company purchased
furniture and fixtures of $5,000; telephone equipment in the amount of $2,466;
computer hardware and software of $77,663; and capitalized web site development
costs of $703,339. Ongoing web site maintenance and other recurring charges are
expensed as incurred as are all internal costs and charges. Cash was also used
in the purchase of a twelve-month bank certificate of deposit of $500,000 plus
interest earned on the certificate of deposit of $8,332. Cash was increased by
the redemption of short-term investments, principally bank certificates of
deposit and accrued interest thereon in the amount of $5,143,699.
For the nine months ended September 30, 1997, the Company borrowed
$9,000,000 from a major bank and $1,295,000 from officers and directors. During
the nine months ended September 30, 1997, loans outstanding from officers and
directors of the Company were reduced in the amount of $6,800,000. Net cash
provided by financing activities was partially offset by an increase of $277,817
in deferred offering costs. During the nine months ended September 30, 1998, the
Company sold to a director, upon his exercise of a right to purchase, five-year
options to purchase 75,000 shares of Common Stock at an exercise price of $5.00
per share (market value at purchase date.) The purchase price of the options was
$75,000.
In April 1998, the Company entered into an agreement with a major
commercial bank for a line of credit in the amount of $500,000. The interest
rate on the amounts drawn down under the line of credit is 0.50% below the
bank's reference rate. The line of credit is available until April 1, 1999.
There are no commitment or other fees attached to the line of credit. The
Company has not drawn down any amounts under the line of credit.
Year 2000
Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish 21st century dates from 20th century dates. This "Year 2000" issue
potentially affects all individuals and companies (including the Company, its
customers, business partners, vendors, suppliers, service providers and banks.)
The Company believes its systems, and those of its primary service
providers, are Year 2000 compliant and has received notification of such from
its primary service providers. The Company is continuing its communication with
its principal vendors to ensure that they are Year 2000 compliant. Management
does not anticipate that the Company will incur significant operating expenses
or be required to invest in computer systems improvements to be Year 2000
compliant.
16
<PAGE>
The Company is developing contingency plans which identify alternative
vendors, suppliers and service providers in the event current vendors, suppliers
or service providers suffer significant disruption as a result of Year 2000
compliance failures.
Should some of the Company's systems or those of its service providers or
vendors not be available due to Year 2000 problems, in a reasonably likely worst
case scenario, the Company may experience delays in its ability to perform
certain functions, but does not expect an inability to perform critical
functions or to otherwise conduct its business.
Quarterly Fluctuations
The Company's operating results vary from period to period as a result of
purchasing patterns of members, the timing, costs, magnitude and success of
Internet initiatives and direct mail campaigns and other new member recruitment
advertising, member attrition, the timing and popularity of new audiobook
releases and product returns. The timing of new member enrollment varies
depending on the timing, magnitude and success of new member advertising,
particularly direct mail and Internet advertising campaigns. For fiscal periods
in which the Company conducts significant direct mail and Internet advertising
campaigns, the Company's operating results will be adversely affected because
the increased membership acquisition expenses incurred may not generate
corresponding revenues from such campaigns until the following periods.
17
<PAGE>
Part II - Other Information
Item 2. Changes in Securities and Use of Proceeds.
On October 22, 1997, the Company's Registration Statement on Form SB-2 (No.
333-30665) relating to its initial public offering (the "IPO") was declared
effective by the Securities and Exchange Commission. The managing underwriter of
the IPO was L.H. Friend, Weinress, Frankson & Presson, Inc. The Company sold
2,300,000 shares of common stock for gross proceeds of $23,000,000 and a
non-management selling shareholder sold 110,000 shares for gross proceeds of
$1,100,000. The Company incurred aggregate offering expenses of $3,234,337
(including $1,840,000 of underwriting discounts and commissions and $632,500 for
the managing underwriter's non-accountable expense allowance) in connection with
the IPO. As a result, the Company received net proceeds of $19,765,663 from the
IPO.
The Company used a portion of the net proceeds to repay loans from a major
bank in the aggregate principal amount of $9,000,000 plus accrued interest
thereon of $56,167. The Company estimates that it has used the remaining
proceeds of approximately $10,700,000 for direct mail membership recruitment
advertising ($6,200,000), Internet promotion, development and maintenance
($1,900,000) and operating purposes ($1,900,000) and general working capital
purposes ($700,000).
During the three months ended September 30, 1998, the Company issued
options under the Company's 1997 Stock Option Plan (the "Plan") to purchase
771,500 shares of Common Stock to certain individuals including officers and
directors. As of September 30, 1998, there were outstanding options under the
Plan to purchase 1,407,500 shares of Common Stock. The Company relied on the
exemptions provided by Sections 2(3) and/or 4(2) of the Securities Act of 1933,
as amended (the "Act"), in connection with the issuance of such options.
In September 1998, the Company also sold to a director, an option to
purchase 25,000 shares of Common Stock. The option vests immediately and is
exercisable at an exercise price of $5.00 per share and has a five-year term.
The purchase price of the option was $25,000. The option was granted under an
agreement dated March 18, 1998 between the Company and the director which
provided that if the director served as an active and participating member of
the Company's Board of Directors for six months, that the director would have
the right to purchase the option. The Company relied on the exemption provided
by Section 4(2) of the Act in connection with the issuance and sale of such
option.
18
<PAGE>
Item 6: Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
None.
19
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Audio Book Club, Inc. has duly caused this report to be
signed on its behalf by the undersigned thereunto duly authorized.
Audio Book Club, Inc.
Dated: November 12, 1998 By: /s/ Michael Herrick
----------------------------------------
Michael Herrick
Co-Chief Executive Officer
Dated November 12, 1998 By: /s/ John F. Levy
-----------------------------------------
John F. Levy
Chief Financial and Accounting Officer
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The Schedule contains summary financial information extracted from the Company's
financial statements included in this quarterly report on Form 10-QSB, and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,261,529
<SECURITIES> 508,332
<RECEIVABLES> 4,069,788
<ALLOWANCES> 912,875
<INVENTORY> 1,942,314
<CURRENT-ASSETS> 9,199,266
<PP&E> 864,819
<DEPRECIATION> 249,301
<TOTAL-ASSETS> 10,005,011
<CURRENT-LIABILITIES> 4,066,005
<BONDS> 0
0
0
<COMMON> 25,741,063
<OTHER-SE> (19,802,057)
<TOTAL-LIABILITY-AND-EQUITY> 10,005,011
<SALES> 11,535,468
<TOTAL-REVENUES> 11,535,468
<CGS> 7,558,121
<TOTAL-COSTS> 7,558,121
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (249,146)
<INCOME-PRETAX> (3,993,346)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,993,346)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,993,346)
<EPS-PRIMARY> (0.65)
<EPS-DILUTED> (0.65)
</TABLE>
