<PAGE>
As filed with the Securities and Exchange Commission on January 31, 2000
Registration No. 333-_____
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
MEDIABAY, INC.
(Exact name of registrant as specified in its charter)
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<S> <C> <C>
Florida 5961 65-0429858
(State or other jurisdiction of (Primary standard industrial (IRS employer
incorporation or organization) classification number) identification number)
</TABLE>
---------------------
20 Community Place
Morristown, New Jersey 07960
(973) 539-9528
(Address and telephone number of principal executive offices)
---------------------
20 Community Place
Morristown, NJ 07960
(Address of principal place of business)
---------------------
Michael Herrick, Chief Executive Officer
MediaBay, Inc.
20 Community Place
Morristown, New Jersey 07960
(973) 539-9528
(Name, address and telephone number of agent for service)
---------------------
Copies to:
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<S> <C>
Robert J. Mittman, Esq. Stephen T. Burdumy, Esq.
Blank Rome Tenzer Greenblatt Klehr, Harrison, Harvey, Branzburg & Ellers LLP
The Chrysler Building 260 S. Broad Street
405 Lexington Avenue Philadelphia, PA 19102-5003
New York, NY 10174 Telephone No. (215) 569-4646
Telephone No. (212) 885-5000 Telecopier No. (215) 568-6603
elecopier No. (212) 885-5001
</TABLE>
Approximate date of commencement of proposed sale to the public: As soon
as practicable after the effective date of this registration statement.
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same
offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
CALCULATION OF REGISTRATION FEE
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=====================================================================================================
Proposed
Amount Maximum Proposed
Title of Each Class of to be Offering Price Maximum Amount of
Securities to be Registered Registered Per Share(1) Offering Price(1) Registration Fee
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, no par value .. 4,600,000 $ 12.00(1) $55,200,000 $ 14,572.80
=====================================================================================================
</TABLE>
(1) This price is used solely for the purpose of computing the amount of the
registration fee pursuant to Rule 457 of the Securities Act and is
estimated, based upon the average of the high and low sales prices on
January 27, 2000.
<PAGE>
The information in this prospectus is not complete and may be changed. MediaBay
may not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an
offer to sell these securities and is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, JANUARY 31, 2000
PROSPECTUS
4,000,000 Shares
[GRAPHIC OMITTED]
Common Stock
---------------------
We are a leading provider of premium spoken word content and products via the
Internet, direct mail and retail. We are offering 4,000,000 shares of common
stock.
Our shares are listed on the Nasdaq National Market under the symbol "MBAY." On
January 27, 2000, the last reported sale price on the Nasdaq National Market
was $12.125 per share.
See "Risk Factors" on pages 9 to 16 for factors that should be considered
before investing in our Common Stock.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
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Per Share Total
<S> <C> <C>
Public offering price ........................... $ $
Underwriting discounts and commissions .......... $ $
Proceeds, before expenses, to MediaBay .......... $ $
</TABLE>
The underwriters may, under certain circumstances, for 45 days after the date
of this prospectus, purchase up to 600,000 additional shares from us at the
public offering price, less underwriting discounts and commissions.
CRUTTENDEN ROTH L.H. FRIEND, WEINRESS,
INCORPORATED FRANKSON & PRESSON, LLC
The date of this prospectus is , 2000
<PAGE>
INSIDE FRONT COVER
[GRAPHICS OMITTED: Image of the Audio Book Club logo with headphone and
book service mark, selected audiobookclub.com web pages, marketing
materials and covers of audiobooks.]
INSIDE FRONT COVER - GATE FOLD
[GRAPHICS OMITTED: Image of the MediaBay.com logo and home web page, as
well as web pages illustrating the audiobook, video, old time radio and
music channels. Images of our products.]
<PAGE>
TABLE OF CONTENTS
Page
-----
Prospectus Summary ............................ 3
Risk Factors .................................. 9
Forward-Looking Statements .................... 17
Use of Proceeds ............................... 18
Price Range of Common Stock ................... 19
Dividend Policy ............................... 19
Capitalization ................................ 20
Selected Consolidated Financial Data .......... 21
Management's Discussion and Analysis of
Financial Condition and Results of
Operations ................................. 23
Page
----
Business ...................................... 30
Management .................................... 42
Principal Shareholders ........................ 48
Related Party Transactions .................... 50
Description of Capital Stock .................. 52
Shares Eligible for Future Sale ............... 54
Underwriting .................................. 55
Legal Matters ................................. 56
Experts ....................................... 56
Additional Information ........................ 56
Index to Financial Statements ................. F-1
- --------------------------------------------------------------------------------
"MediaBay," "MediaBay.com," "audiobookclub.com," and the Audio Book Club
and MediaBay logos are trademarks of MediaBay.
- --------------------------------------------------------------------------------
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with different information. We are
not making an offer of these securities in any jurisdiction where the offer or
sale is not permitted. You should not assume that the information contained in
this prospectus is accurate as of any date other than the date on the front
cover of this prospectus.
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this
prospectus. This summary is not complete and may not contain all of the
information that investors should consider before investing in the common stock
of MediaBay. Investors should read the entire prospectus carefully.
MediaBay
MediaBay, Inc. is a leading provider of premium spoken word content and
products in hard goods and digital download formats via the Internet and
offline methods. Our content library includes approximately 72,000 audiobook
titles, 59,000 old time radio programs and 3,500 classic video programs. We
market our audiobooks through Audio Book Club, the largest membership-based
club of its kind with approximately 1.8 million members, and our
audiobookclub.com web site. Our old time radio and classic video programs are
marketed through the Internet and direct mail catalogs and, on a wholesale
basis, to major retailers, including Costco, Best Buy, Sam's Club, Barnes &
Noble, Waldenbooks, B. Dalton Booksellers and Amazon.com. All of our products
are available for purchase over the Internet through our content-rich portal
located at MediaBay.com. In addition, we are currently encoding our library of
proprietary and licensed content to offer products in digital download format.
We believe that we were the first significant entrant into the spoken word
content e-commerce market. We operate the MediaBay network which consists of
MediaBay.com, audiobookclub.com and bestbookclubs.com. MediaBay.com is an
innovative content and e-commerce web site that combines the entertainment of
content driven web sites with the product selection and service of e-commerce
sites, while providing a sense of community for visitors. We launched
MediaBay.com to (1) capitalize on our substantial customer base and ability to
drive traffic to our web sites and (2) transport our unique spoken word,
audiobook, old time radio and video content library online. MediaBay.com
utilizes our extensive library of premium spoken word content and various
product offerings to attract visitors, increase the duration and frequency of
their visits and expand our e-commerce opportunities.
According to PC Data Online, audiobookclub.com ranked as the third most
visited web site for books, the 69th most visited retail shopping web site and
the 34th fastest growing web site during November 1999. From January 1998 to
December 1999, over 100,000 members have enrolled at audiobookclub.com and we
are currently attracting over 1.1 million unique visitors per month. We
evaluate our click-through rates and rate of conversions of visitors to
customers on a daily basis and alter our initiatives to maximize our Internet
marketing and advertising activities. This focus and our ability to negotiate
favorable agreements has resulted in a cost to acquire new members on the
Internet which is lower than our offline cost. We intend to increasingly use
the Internet to acquire new audiobookclub.com members. We have also established
an Associates Network program of over 13,500 affiliate web sites which
advertise audiobookclub.com and receive a commission for each member obtained
through a link from their site.
We have consolidated the club industry for audiobooks by acquiring what we
believe to be our only competitors, The Columbia House Company's Audiobook Club
and Doubleday Direct Inc.'s Audiobooks Direct club. As part of these
acquisitions, we added over 1.1 million members and gained access to their other
club mailing lists of over 34 million existing members, as well as future
members they acquire. We have the exclusive right to market audiobooks to these
members without paying list rental or insertion fees. We also acquired
businesses within the old time radio and classic video area which provided us
with a content library of over 59,000 old time radio programs, most of which are
exclusively licensed, and provided us with a list of over 400,000 customers of
old time radio and classic video programs. Our recent acquisitions have provided
us with increased economies of scale by greatly expanding our customer database
to 2.2 million names, which has enabled us to negotiate better pricing for
products and lower our per unit advertising, mailing and printing costs.
3
<PAGE>
We emphasize the use of our offline marketing efforts to our 2.2 million
customer data base to attract visitors to our web sites. We promote
MediaBay.com and audiobookclub.com by inserting promotional advertisements in
our product packages, product shipments, direct mailings, inserts and other
selected mailings.
From 1989 through 1998, the market for audiobooks grew at a compound annual
growth rate of approximately 27% from an estimated $250 million in 1989 to
approximately $2.2 billion in 1998. According to a 1998 industry report, the
United States market for collectibles, which we believe includes old time radio
and classic video products, was estimated to exceed $10 billion. According to
Jupiter Communications, almost 33% of online consumers, representing 43 million
people worldwide, often listen to spoken word content on their personal
computers. An industry research analyst estimates that sales of
Internet-connected portable audio players will increase from under 1.0 million
units in 1999 to over 6.5 million units in 2002.
We consider ourselves the market leader in the market for spoken word
content and are implementing the following strategies to capture additional
market share:
o Increase Internet Presence. MediaBay.com combines the entertainment of
content-driven web sites with the product selection and service of
e-commerce sites, while providing a sense of community for visitors. We
are continuously enhancing our web sites and are actively leveraging our
customer base, web site visitor traffic, Internet marketing, customer
service and fulfillment expertise and capabilities to grow our online
business.
o Capitalize on Emerging Digital Delivery Technologies. We have entered
into arrangements with Microsoft and Reciprocal and now have the
infrastructure necessary to provide customers with secure digital
downloads of our content. As digital download becomes an increasingly
accepted method for delivery of spoken word content, we will expand our
offering of products in this format.
o Expand Marketing Strategy. We have developed a marketing strategy which
incorporates a broad range of online and offline marketing methods to
increase our customer base and revenues, including Internet marketing and
advertising, targeted e-mails to our database, growing our online
Affiliate Network and direct marketing. We devote significant efforts to
developing and testing various online and offline marketing strategies in
a concerted effort to increase revenue and reduce marketing costs.
o Leverage our Unique Content. We offer approximately 135,000 spoken word
and video products which we sell online and offline. We are able to use
this content to attract and retain web site visitors and to offer this
content to strategic partners in exchange for directing traffic to our
sites.
We were incorporated in Florida in August 1993 under the name Audio Book
Club, Inc. In October 1999, we changed our name to MediaBay, Inc. Our principal
executive offices are located at 20 Community Place, Morristown, New Jersey
07960. Our telephone number is (973) 539-9528. Our principal Internet addresses
are MediaBay.com and audiobookclub.com. Information contained on these web
sites and our other web sites is not deemed part of this prospectus.
4
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The Offering
Shares offered by MediaBay........... 4,000,000 shares
Total shares outstanding after
this offering........................ 13,538,159 shares
Use of proceeds...................... To repay outstanding indebtedness,
Internet marketing and advertising, for
membership recruitment advertising, for
content acquisition and digital encoding
and for general corporate purposes.
Nasdaq National Market symbol........ MBAY
The information above in regard to the number of shares outstanding is as
of January 28, 2000. You should be aware that the total shares outstanding
after this offering does not include:
o Approximately 7.2 million shares reserved for issuance upon the
conversion of convertible promissory notes and upon the exercise of
outstanding warrants, non-plan options and options granted under our stock
option and incentive plans with a weighted average exercise or conversion
price of $9.54 per share; and
o 600,000 shares that the underwriters may purchase if they exercise their
over-allotment option in full.
Risk Factors
You should consider the risk factors before investing in our common stock
and the impact from various events which could adversely affect our business.
5
<PAGE>
Summary Financial Data
The following tables present our summary historical consolidated financial
data for each year in the five-year period ended December 31, 1998 and for the
nine-month periods ended September 30, 1998 and 1999, as well as pro forma
combined and as adjusted financial data. The summary historical consolidated
annual financial data was derived from our audited consolidated financial
statements. The summary historical consolidated financial data as of September
30, 1999 and for the nine-month periods ended September 30, 1998 and 1999 was
derived from our unaudited interim financial statements. The unaudited interim
financial statements include all adjustments, consisting of normal recurring
accruals, which we consider necessary for a fair presentation of the financial
position and results of operations for these periods. Operating results for the
nine-month period ended September 30, 1999 are not necessarily indicative of
the results that may be expected for the entire year ending December 31, 1999.
You should read this financial information in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical and pro forma financial statements and the related notes
included elsewhere in this prospectus.
The unaudited interim historical financial data presented in this
prospectus gives effect to the purchase of Doubleday Direct's Audiobooks Direct
club on June 15, 1999. The balance sheet and statement of operations data for
the year ended December 31, 1998 gives effect to the following transactions:
o The acquisitions of Radio Spirits, Inc., the assets of an affiliated
company, Buffalo Productions, Inc., and a 50% interest in a joint venture
owned by the sole shareholder of Radio Spirits on December 14, 1998.
o The acquisition of substantially all of the assets used by Metacom, Inc.
in connection with its Adventures in Cassettes business on December 14,
1998.
o The acquisition of substantially all of the assets used by Premier
Electronic Laboratories, Inc. in connection with its business of
producing, marketing, and selling old time radio and classic video
programs on December 14, 1998.
o The acquisition of substantially all of the assets of Columbia House's
Audiobook Club on December 31, 1998.
The unaudited combined pro forma statement of operations data being
presented for the year ended December 31, 1998 combines (1) the results of
operations for MediaBay for the year ended December 31, 1998, which includes the
results of operations for the acquisitions discussed above since the closing
dates of the respective acquisitions; and (2) the results of operations for the
latest 12-month period available immediately before the closing dates of these
acquisitions, which are as follows: Radio Spirits for the period from January 1,
1998 through December 14, 1998, the date of the acquisition; Metacom for the
twelve months ended October 31, 1998; Premier for the twelve months ended
October 31, 1998; Columbia House's Audiobook Club for the year ended December
18, 1998; and Doubleday Direct's Audiobooks Direct club for the twelve months
ended March 31, 1999.
The unaudited combined pro forma statement of operations data being
presented for the nine months ended September 30, 1999 combines (1) the
historical consolidated statement of operations of MediaBay and its
subsidiaries, which includes the effect of the acquisitions completed in
December 1998 discussed above for the entire nine-month period ended September
30, 1999 and the statement of operations of Doubleday Direct's Audiobooks Direct
from the closing date of the acquisition through September 30, 1999; and (2)
Doubleday Direct's Audiobooks Direct's statement of operations for the six
months ended March 31, 1999 as if this acquisition was completed on January 1,
1999.
6
<PAGE>
The unaudited combined pro forma financial information is intended for
information purposes only and are not necessarily indicative of the future
financial position or future results of operations of our combined company, or
of the financial position or results of operations of our combined company that
would have actually occurred had the acquisitions taken place as of the date or
for the periods presented. See our Pro Forma Combined Financial Statements
included elsewhere in this prospectus.
Our statement of operations data, selected operating data and balance sheet
data include the following items that require further explanation:
o Our total customer file includes all active and inactive members of Audio
Book Club and customers of our old time radio and classic video programs.
o Total customers acquired represents new members obtained by Audio Book
Club through our marketing efforts, as well as the addition of
approximately (1) 625,000 customers in December 1998 through our
acquisition of Columbia House's Audiobook Club, (2) 400,000 customers of
old time radio and classic video programs through our acquisitions in
December 1998 and (3) 500,000 customers in June 1999 through our
acquisition of Doubleday Direct's Audiobooks Direct club.
o The pro forma information included in the balance sheet data gives effect
to the following events which occurred after September 30, 1999:
o the conversion of $4.2 million of indebtedness into 379,662 shares of
our common stock;
o the issuance of 21,600 shares of our common stock upon the exercise of
an option and the receipt of $95,000 as payment of the exercise price;
o the incurrence of $2.0 million of indebtedness; and
o the termination of put rights relating to 50,000 shares of our common
stock valued at $644,000.
o The as adjusted information included in the balance sheet data gives
effect to the sale of 4,000,000 shares of our common stock at an assumed
public offering price of $__ per share and our anticipated use of the
estimated net proceeds, after deducting underwriting discounts and
commissions and estimated expenses of this offering, including the
repayment of $35.1 million of indebtedness.
7
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<TABLE>
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Years Ended December 31,
-----------------------------------------------------------------------------------------------
1998 Pro
1994 1995 1996 1997 1998 Forma(1)
--------------- --------------- ------------- ------------- ------------- ----------------
(in thousands, except per share data)
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Statement of
Operations Data:
Sales ...................... $ 337 $ 3,406 $ 8,343 $ 15,119 $ 22,242 $ 74,144
Returns, discounts and
allowances ................ 87 771 2,743 5,041 7,348 16,863
-------- -------- --------- --------- ---------- -------------
Sales, net ................. 250 2,635 5,600 10,078 14,894 57,281
Cost of sales .............. 388 2,146 4,327 5,495 9,452 25,936
-------- -------- --------- --------- ---------- -------------
Gross profit (loss) ........ (138) 490 1,273 4,583 5,442 31,345
Advertising and
promotion expense ......... 973 2,671 5,470 6,843 8,910 28,413
General and
administrative
expense ................... 482 1,209 2,048 2,217 3,330 11,950
Depreciation and
amortization expense 1 2 5 8 367 6,193
Interest (expense)
income, net ............... (4) (4) (211) (436) 180 (5,155)
Income taxes ............... -- -- -- -- -- 279
---------- ---------- --------- --------- ---------- -------------
Net loss ................... $ (1,598) $ (3,396) $ (6,461) $ (4,921) $ (6,985) $ (20,645)
========== ========== ========= ========= ========== =============
Basic and diluted net loss
per share ................ $ (.49) $ (1.04) $ (1.98) $ (1.29) $ (1.13) $ (2.92)
Weighted average
number of shares
outstanding ............... 3,256 3,256 3,256 3,820 6,188 7,079
Selected Operating
Data:
Total customer file at
end of period ............. 12,000 64,000 155,000 260,000 1,474,000 1,919,000
Total customers acquired
during period ............. 12,000 52,000 90,000 105,000 1,214,000 1,714,000
Customers acquired via
Internet during
period .................... 0 0 0 2,000 41,000 41,000
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Nine Months Ended September 30,
---------------------------------------------
1999 Pro
1998 1999 Forma(1)
------------- ------------- ---------------
(in thousands, except per share data)
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Statement of
Operations Data:
Sales ...................... $ 16,190 $ 41,986 $ 54,250
Returns, discounts and
allowances ................ 4,655 11,297 14,840
--------- ---------- ----------
Sales, net ................. 11,535 30,689 39,410
Cost of sales .............. 7,558 15,037 19,119
--------- ---------- ----------
Gross profit (loss) ........ 3,977 15,652 20,291
Advertising and
promotion expense ......... 6,108 5,356 9,048
General and
administrative
expense ................... 1,878 6,604 8,309
Depreciation and
amortization expense 233 4,862 6,014
Interest (expense)
income, net ............... 249 (3,362) (4,101)
Income taxes ............... -- -- --
--------- ---------- ----------
Net loss ................... $ (3,993) $ (4,532) $ (7,181)
========= ========== ==========
Basis and diluted net loss
per share ................. $ (.65) $ (.57) $ (.91)
Weighted average
number of shares
outstanding ............... 6,154 7,882 7,882
Selected Operating
Data:
Total customer file at
end of period ............. 371,000 2,136,000 2,136,000
Total customers acquired
during period ............. 109,000 664,000 664,000
Customers acquired via
Internet during
period .................... 23,000 41,000 41,000
</TABLE>
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December 31, 1998 September 30, 1999
------------------- ---------------------------------------
Actual Pro Forma As Adjusted
---------- ----------- ------------
(in thousands)
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Balance Sheet Data:
Working capital ................................. $ 6,571 $ 7,736 $ 9,831 $
Total assets .................................... 64,339 89,317 91,412
Current liabilities ............................. 8,231 13,813 13,813
Long-term debt .................................. 40,000 39,313 37,089
Common stock subject to contingent puts ......... 8,284 4,283 3,639
Shareholders' equity ........................... 7,823 31,908 36,871
</TABLE>
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(1) The pro forma combined financial statements do not include any adjustments
for any realized or anticipated elimination of duplicative costs,
including, but not limited to, payroll, rent and other general and
administrative costs, or economies of scale resulting from the
acquisitions.
8
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RISK FACTORS
You should carefully consider the following risk factors, in addition to
the other information set forth in this prospectus before purchasing shares of
our common stock. Each of these risks could adversely affect our business,
operating results and financial condition, as well as adversely affect the
value of an investment in our common stock. This investment involves a high
degree of risk.
Risks Related to our Financial Condition
We have a history of losses, are not currently profitable and may incur
future losses.
Since our inception, we have incurred significant losses. We had losses of
$4.9 million during the year ended December 31, 1997, $7.0 million during the
year ended December 31, 1998 and $4.5 million during the nine months ended
September 30, 1999. On a pro forma basis, giving effect to our acquisitions,
our loss for the year ended December 31, 1998 was $20.6 million and our loss
for the nine months ended September 30, 1999 was $7.2 million. As of September
30, 1999, we had an accumulated deficit of $28.0 million.
As we continue to implement our growth strategy, we intend to incur
significant expenses in acquiring additional customers, attracting visitors to
our web sites and enhancing our product offerings by adopting new technologies,
including digital download capabilities. We will incur these expenses before
any related anticipated revenues are received. As a result, losses and negative
cash flow from operations may continue. We are not currently profitable and may
not become profitable in the future.
Our intangible assets and goodwill represent a significant portion of our
assets. Amortization of our intangible assets will adversely impact our net
income, and we may never realize the full value of our intangible assets.
As of September 30, 1999, we had $60.8 million of intangible assets,
representing approximately 68.1% of our total assets. These intangible assets
consist primarily of goodwill arising from our acquisitions. We will incur
amortization expenses relating to these intangible assets of $6.4 million in
1999 and $7.4 million in each of 2000 and 2001. These expenses will decrease
from $3.7 million in 2002 to $2.4 million in 2018. These expenses will reduce
our future earnings or increase our future losses. We may not receive the
recorded value for our intangible assets if we sell or liquidate our business
or assets. In addition, if the value of any of our intangible assets declines,
we could incur significant additional non-cash charges, and the market price of
our common stock could be adversely affected.
We may not be able to meet our obligations to repurchase shares of our
common stock in the future.
We granted sellers in our recent acquisitions the right to sell back to us
shares of our common stock that we issued to them. Unless our common stock
satisfies specific price targets and/or trading volume requirements, these
rights could require us to purchase up to 305,000 shares in the future as
follows:
o 25,000 shares at a price of $14.00 per share beginning on December 31,
2003;
o up to 230,000 shares at a price of $15.00 per share beginning on December
31, 2004; and
o 50,000 shares at a price of $15.00 per share beginning on December 31,
2005.
If we were required to repurchase all 305,000 shares, it would cost us
$4.6 million. We may not have sufficient funds to meet these obligations to
repurchase stock in the future.
Risks Related to our Operations
Our products are sold in a niche market that is still evolving and may have
limited future growth potential.
We believe that the market for audiobooks and old time radio and classic
video programs has expanded rapidly in recent years. However, consumer interest
in audiobooks and old time radio and classic video programs may decline in the
future, and growth trends in these markets may stagnate or decline. The sale of
audiobooks through mail order clubs and over the Internet are emerging retail
concepts, and audiobooks are
9
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still evolving as a niche market. As is typically the case in an evolving
industry, the ultimate level of demand and market acceptance for our products
is subject to a high degree of uncertainty. A decline in the popularity of
audiobooks and old time radio and classic video programs would limit our future
growth potential and negatively impact our future operating results.
We may be unable to anticipate changes in consumer preference for our
products and may lose capital or sales opportunities.
Our success depends largely on our ability to anticipate and respond to a
variety of changes in the audiobook, old time radio and classic video
industries. These changes include economic factors affecting discretionary
consumer spending, modifications in consumer demographics and the availability
of other forms of entertainment. The audiobook, old time radio and classic
video markets are characterized by changing consumer preferences, which could
affect our ability to:
o plan for catalog offerings;
o introduce new titles;
o anticipate order lead time;
o accurately assess inventory requirements; and
o develop new product delivery methods.
Although we evaluate many factors and attempt to anticipate the popularity
and life cycle of audiobook titles, the ultimate level of demand for specific
titles is subject to a high level of uncertainty. Sales of audiobook titles
typically decline rapidly after the first few months following release. If
sales of specific titles decline more rapidly than we expect, we could be left
with excess inventory, which we might be forced to sell at reduced prices. If
we fail to anticipate and respond to factors affecting the audiobook industry
in a timely manner, we could lose significant amounts of capital or potential
sales opportunities.
The market for digital download of spoken word content is uncertain, and we
may not be able to participate in this market effectively or at all.
Digital download of spoken word content from the Internet is a relatively
new method of distribution and its growth and market acceptance is uncertain.
Purchasing spoken word content over the Internet in digital download format
involves adjustments in general consumer purchasing patterns, and consumers may
not be willing to purchase spoken word content in digital download format. If
we invest significant amounts of money and effort in developing digital
download products which do not achieve widespread popularity, or if the market
for digital download of spoken word content does not evolve as we anticipate,
we may not be able to recover our investment.
Since pricing patterns for the supply and sale of digital download of
spoken word content have not yet been established, we may not be able to buy
these products on the same terms as our existing products. Our profit margin
for these products also may not be as favorable as our profit margins for our
existing products.
We may not be able to license or produce desirable spoken word content,
which could reduce our revenues.
We could lose sales opportunities if we are unable to continue to obtain
the rights to additional audiobook libraries or selected audiobook titles. Many
of our license agreements with audiobook publishers are short-term,
non-exclusive agreements, typically one to three years in length, and some of
our agreements will expire over the next several months unless they are
renewed. We may not be able to renew existing license and supply arrangements
for audiobook publishers' libraries or enter into additional arrangements for
the supply of new audiobook titles.
If our third-party providers fail to perform their services properly, our
business and results of operations could be adversely affected.
Third-party providers conduct all of our Audio Book Club customer service
operations, process orders and collect payments for us. If these providers fail
to perform their services properly, Audio Book Club members could develop
negative perceptions of our business, collections of receivables could be
delayed and our operations might not function efficiently.
10
<PAGE>
We could experience delays or difficulties with the consolidation of our
operations, which could result in a material interruption of our
operations.
We are in the process of consolidating all of our fulfillment, warehousing
and distribution operations with Doubleday Direct, and, based on prior
experience, we expect this consolidation to be completed by February 2000. If
we experience delays or difficulties in effecting this transition, our
operations could be materially interrupted and we may not achieve expected cost
savings and efficiencies.
Our marketing strategy to acquire new members could result in increased
costs, and we may not acquire as many members as we anticipate, which would
inhibit our sales growth.
If our direct mail and other marketing strategies are not successful, our
per member acquisition costs may increase, and we may acquire fewer new members
than anticipated, which would slow our sales growth. We use a variety of
modeling and list analysis procedures and techniques as part of our efforts to
target our direct mail campaigns efficiently, and we intend to increase the
number of prospective members to which member solicitation packages will be
mailed. However, the success of our planned direct mail campaigns is subject to
a high degree of risk and uncertainty, and we may fail to accurately target the
type of persons who are likely to join our Audio Book Club.
Increased member attrition could negatively impact our future revenues and
operating results.
Increases in membership attrition above the rates we anticipate could
materially reduce our future revenues. We incur significant up front
expenditures in connection with acquiring new members. A member may not honor
his or her commitment, or we may choose to terminate a specific membership for
several reasons, including failure to pay for purchases, excessive returns or
cancelled orders. As a result, we may not be able to fully recoup our costs
associated with acquiring new members. In addition, once a member has satisfied
his or her initial commitment to purchase additional audiobooks at regular
prices, the member has no further commitment to make purchases.
If third parties obtain unauthorized access to our member and customer
databases and other proprietary information, we would lose a competitive
advantage.
We believe that our Audio Book Club member file and customer lists are
valuable proprietary resources, and we have expended significant amounts of
capital in acquiring these names. Our member and customer lists, trade secrets,
trademarks and other proprietary information have limited protection. Third
parties may copy or obtain unauthorized access to our member and customer
databases and other proprietary know-how, trade secrets, ideas and concepts.
Competitors could also independently develop or otherwise obtain access to our
proprietary information. In addition, we rent our lists for one-time use only
to third parties that do not compete with us. This practice subjects us to the
risk that these third parties may use our lists for unauthorized purposes,
including selling them to our competitors. Our confidentiality agreements with
our executive officers, employees, list managers and appropriate consultants
and service suppliers may not adequately protect our trade secrets. If our
lists or other proprietary information were to become generally available, we
would lose a significant competitive advantage.
Higher than anticipated product return rates could reduce our future
operating results.
We experienced a product return rate of approximately 33% in 1997 and
1998. If members and customers return products to us in the future at higher
rates than in the past or than we currently anticipate, our net sales would be
reduced and our operating results would be adversely affected.
If we are unable to collect our receivables in a timely manner, it may
negatively impact our cash flow and our operating results.
We are subject to the risks associated with selling products on credit,
including delays in collection or uncollectibility of accounts receivable. As
of September 30, 1999, our allowance for doubtful accounts was approximately
$1.8 million. If we experience significant delays in collection or
uncollectibility of accounts receivable, our liquidity and working capital
position could suffer and we could be required to increase our allowance for
doubtful accounts which would increase our expenses. Our accounts receivable
have historically increased from period to period, and we expect them to
continue to increase as our revenues increase.
11
<PAGE>
Increases in costs of postage could negatively impact our operating
results.
We distribute millions of mailings each year, and postage is a significant
expense in the operation of our business. We do not pass on the costs of member
mailings and member solicitation packages. Even small increases in the cost of
postage multiplied by the millions of mailings we conduct would result in
increased expenses and would negatively impact our operating results.
We face significant competition from a wide variety of sources for the
sale of our products.
We compete with other web sites which offer similar entertainment products
or content, including digital download of spoken word content. New competitors,
including large companies, may elect to enter the markets for audiobooks and
spoken word content. We also compete for discretionary consumer spending with
mail order clubs and catalogs, other direct marketers and retailers that offer
products with similar entertainment value as audiobooks and old time radio and
classic video programs, such as music on cassettes and compact discs, printed
books, videos, and laser and digital video discs. Many of these competitors are
well-established companies which have greater financial resources that enable
them to better withstand substantial price competition or downturns in the
market for spoken word content.
The audiobook and mail order industries are intensely competitive. We
compete with all other outlets through which audiobooks and other spoken word
content are offered, including:
o bookstores;
o audiobook stores which rent or sell only audiobooks;
o mail order companies that offer audiobooks for rental and sale through
catalogs; and
o retail establishments such as convenience stores, video rental stores and
wholesale clubs.
The loss or unavailability of our key personnel could have a material
adverse effect on our business.
Our success depends largely on the efforts of Norton Herrick, our
Chairman, and Michael Herrick, our Chief Executive Officer and President.
Norton Herrick is actively involved in the management and operation of several
businesses and is required to devote only as much time to our business and
affairs as he deems necessary to perform his duties. Norton Herrick may
experience a conflict in the allocation of his time among his various business
ventures. The loss of the service of either of these officers or of other key
personnel could have a material adverse effect on our business. We do not
maintain key-man insurance on the lives of these officers or any other key
personnel.
Risks Related to the Internet and Technology
We have a limited history of operations on the Internet, which makes it
difficult to evaluate our future Internet prospects.
In January 1998, we launched our Internet marketing strategy to acquire
members online and began to enter into agreements to attract visitors to our
web site. We launched MediaBay.com in July 1999 and jointly launched
bestbookclubs.com, our co-branded web site with Doubleday Direct, in September
1999. We are still developing some of the other web sites in our networked
community. Although we devote significant resources to develop and promote our
networked community of web sites, our efforts may not result in profits from
our Internet operations. In addition to the risks of our business generally,
the risks associated with developing operations in a new and rapidly evolving
market, such as online commerce, include our ability to:
o successfully implement our brand awareness and marketing campaigns;
o successfully compete against other companies that sell similar products
online;
o develop new strategic and marketing relationships, including agreements
with Internet portals, to advertise and direct customers to our web
sites;
o continue to develop and upgrade our technology;
o respond to changes in a rapidly evolving and unpredictable business
environment, including the risk that the Internet may not continue to
grow as rapidly as expected; and
o attract, retain and motivate qualified personnel.
12
<PAGE>
We may not be able to continue to license rights to sell spoken word
content in new formats, such as digital download of audio files, or to
respond rapidly to technological developments in the spoken word content
industry.
If we are unable to adapt our content and our web sites to evolving
entertainment technologies and to continue to license the rights to sell spoken
word content in new and emerging formats, such as digital download of audio
files and enabling technologies, our product offerings may become obsolete and
consumers may purchase spoken word content elsewhere. Some of our arrangements
with audiobook publishers permit us to produce and sell audiobooks in cassette
and CD format, and they may not permit us to adapt our licenses to new
technologies. Although we have the ability to offer secure digital download of
our spoken word content to personal computers, we believe that the introduction
by third parties of portable consumer electronic devices will be necessary for
broad consumer acceptance of digital download files. In addition, the
technology used in delivering spoken word content over the Internet may
continue to evolve rapidly.
We may experience system interruptions which affect access to our web sites
and our ability to sell products over the Internet.
Our marketing efforts have increasingly focused on our Internet
operations, and our future revenues may depend in part on the number of web
site visitors who join as Audio Book Club members and who make online
purchases. The satisfactory performance, reliability and availability of our
web sites, transaction-processing systems and network infrastructure are
critical to our ability to attract and retain visitors at our web sites. If we
experience system interruptions that prevent customers and potential customers
from accessing our web sites, consumer perception of our on-line business could
be adversely affected, and we could lose sales opportunities and visitor
traffic.
Security risks of electronic commerce could discourage the purchase of our
products over the Internet or expose us to claims.
The transmission of private information, such as credit card numbers, over
the Internet is vulnerable to exposure and use by hackers and other
unauthorized persons. Advances in computer hacking or cryptographic decoding
could result in a compromise of the technology or other software used by us to
protect customer transactions and other data. If there is any significant
compromise of our systems' security or if customers perceive our web sites as
not secure, we could lose business or be exposed to potential claims of failure
to protect or misuse of confidential information.
Unauthorized duplication of our licensed content could adversely affect
our business.
Our attempts to ensure secure delivery of spoken word content to customers
over the Internet may not prevent the unauthorized duplication of content that
we license for distribution. Unauthorized duplication of our content could
discourage content providers from entering into future licensing agreements
with us. If we inadvertently permit unauthorized duplication of the content we
sell, we could become liable to content providers for substantial damages.
Furthermore, we may be required to spend increasing amounts of time and money
to attempt to reduce possible unauthorized duplication of the content we offer.
We could be sued for content that we distribute over the Internet and could
become subject to substantial damage claims.
As a distributor and publisher of content over the Internet, we could
become liable for copyright or trademark infringement, defamation, indecency or
other claims based on the nature and content of materials that we offer to
consumers. Lawsuits based on our content could be expensive to defend and
damaging to our business. We could be liable for damage claims in excess of the
amount of indemnification payments or insurance reimbursement, if any, that we
might obtain.
The inability to acquire or maintain effective Internet web domain names
could create confusion and direct traffic away from our web sites.
We currently hold various Internet web addresses relating to our network.
If we are not able to prevent third parties from acquiring web addresses that
are similar to our addresses, third parties could acquire similar domain names
which could create confusion that diverts traffic away from our web sites,
which would
13
<PAGE>
adversely affect our business. In addition, infringement claims by third
parties which challenge our use of these names could result in the expenditure
of significant financial and managerial resources or cause us to lose such
names and the benefits of brand awareness we are spending resources to develop.
The acquisition and maintenance of web addresses generally is regulated by
governmental agencies and their designees. The regulation of web addresses in
the United States and in foreign countries is subject to change. As a result,
we may not be able to acquire or maintain relevant web addresses in all
countries where we conduct business. Furthermore, the relationship between
regulations governing these addresses and laws protecting proprietary rights is
unclear.
The Internet is subject to legal uncertainties and potential government
regulation that could impair the growth of the Internet, decrease demand
for products we offer on our web sites and increase our costs.
The application of existing laws to the Internet, particularly with
respect to property ownership, libel, pricing and user privacy is uncertain.
Government agencies and regulatory authorities may adopt future laws and
regulations governing electronic commerce or Internet consumer protection.
These laws and regulations could:
o impose burdensome requirements on our ability to conduct our business
over the Internet;
o discourage consumer use of the Internet;
o decrease demand for our products; or
o increase our costs.
We may become subject to liability for taxes in connection with our
Internet sales.
We currently are not required to collect sales or other taxes on Internet
sales of content products in most states. Our business could be harmed if
additional sales or similar taxes are imposed on us or if jurisdictions in
which purchasers of our content reside require that we collect sales or similar
taxes when selling over the Internet. Significant tax requirements could
increase our costs associated with Internet sales. Additionally, increased
costs associated with taxes passed on to consumers could discourage consumers
from making purchases from us.
Year 2000
We have not experienced any business interruptions or supplier delays from
year 2000 problems to date and have not discovered any year 2000 problems in
internal computer systems material to our operations. We intend to continue to
monitor our internal system for year 2000 problems. There can be no assurance,
however, that we or our suppliers may not face future problems as a result of
year 2000 issues.
Risks Related to our Capital Structure and this Offering
The Herrick family will continue to exert significant influence over
shareholder matters after this offering.
Following this offering, Norton Herrick, Michael Herrick and Howard
Herrick and their affiliates will own approximately 27.3% of our outstanding
common stock (26.2% if the underwriters exercise their over-allotment option in
full). As significant shareholders and directors, they will be able generally
to direct our affairs, including electing our Board of Directors, amending our
Articles of Incorporation or approving the dissolution, merger, or sale of
MediaBay or its subsidiaries. This concentration of ownership in the Herrick
family could also delay or prevent a change in control, even when a change in
control might be in the best interests of other stockholders.
The terms of our debt impose restrictions on our business.
Following this offering and the intended use of proceeds, we will have $4.8
million principal amount of debt outstanding under a convertible promissory
note. In addition to limiting our ability to incur additional indebtedness, our
existing indebtedness limits or prohibits us from:
o merging or consolidating with another corporation;
o selling all or substantially all of our assets;
o declaring or paying cash dividends; or
o materially changing the nature of our business.
In addition, if an event of default occurs under the convertible
promissory note, the indebtedness could become due and payable. We might not
have sufficient funds to repay this indebtedness in the future.
14
<PAGE>
Our stock price has been and could continue to be extremely volatile.
The market price of our common stock has been subject to significant
fluctuations since our initial public offering in October 1997. The securities
markets have experienced, and are likely to experience in the future,
significant price and volume fluctuations which could adversely affect the
market price of our common stock without regard to our operating performance.
In addition, the trading price of our common stock could be subject to
significant fluctuations in response to:
o actual or anticipated variations in our quarterly operating results;
o announcements by us or other industry participants;
o factors affecting the market for spoken word content;
o changes in national or regional economic conditions;
o changes in securities analysts' estimates for us, our competitors or our
industry or our failure to meet securities analysts' expectations; and
o general market conditions.
Most of our shares of common stock are currently eligible for sale and
could be sold in the market in the near future, which could depress our
stock price.
After this offering, we will have outstanding 13,538,159 shares of common
stock (14,138,159 shares if the underwriters exercise their over-allotment
option in full). This includes the 4,000,000 shares we are selling in this
offering (4,600,000 shares if the underwriters exercise their over-allotment
option in full) and the 3,520,282 shares which are currently freely tradeable
without restriction under the Securities Act of 1933. The remaining 6,017,877
shares of our total outstanding shares are or will become available for resale
in the public market.
The sale of a significant number of shares of common stock following the
closing of this offering could adversely affect the market price of our common
stock. Moreover, as these shares are sold, the market price could drop
significantly if the holders of these restricted shares sell them or if the
market perceives that the holders intend to sell these shares.
The following table sets forth the approximate number of restricted shares
of common stock, including shares issuable upon exercise or conversion of
outstanding options, warrants and convertible securities, and the dates on
which these shares become available for resale in the public market.
<TABLE>
<CAPTION>
Approximate
Number of
Restricted
Shares Date of availability of restricted shares for resale into public market
- ------------ ------------------------------------------------------------------------------------
<S> <C>
_________ Immediately available.
_________ 60-180 days after the date of this prospectus due to lock-up agreements between the
managing underwriter and some shareholders not affiliated with us.
</TABLE>
There are currently outstanding options and warrants and other convertible
securities to purchase approximately 7.2 million shares of common stock at
prices ranging from $3.50 to $18.00 per share, as well as options to purchase
8,000 shares at a price of $.10 per share. Substantially all of the shares
issuable upon exercise of these options, warrants and convertible notes have
been registered for resale and may be sold, subject, in some cases, to lock-up
agreements, in the public market by their holders upon exercise. To the extent
they are exercised or converted, your percentage ownership will be further
diluted and our stock price could be further adversely affected. This could
also adversely affect the terms upon which we will be able to obtain additional
equity capital, since the holders of outstanding options and warrants can be
expected to exercise them at a time when we would, in all likelihood, be able
to obtain any needed capital on terms more favorable to us than those provided
in the outstanding options and warrants.
15
<PAGE>
You will incur immediate and substantial dilution because the net tangible
book value per share of our common stock issued in this offering will be
less than the offering price.
Purchasers of common stock in this offering will experience an immediate
and substantial dilution of $____per share in the net tangible book value per
share of common stock from the public offering price. Assuming an offering
price of $____per share, our net tangible book value as of September 30, 1999
would have been $____per share after giving effect to this offering.
16
<PAGE>
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. We have
based these forward-looking statements largely on our current expectations and
projections about future events and financial trends affecting the financial
condition of our business. These forward-looking statements are subject to a
number of risks, uncertainties and assumptions about MediaBay, including, among
other things:
o general economic and business conditions, both nationally and in our
markets,
o our history of losses,
o our expectations and estimates concerning future financial performance,
financing plans and the impact of competition,
o our ability to implement our growth strategy,
o anticipated trends in our business,
o advances in technologies,
o our dependence on third party providers and suppliers,
o acquisition opportunities,
o other risk factors set forth under "Risk Factors" in this prospectus.
In addition, in this prospectus, the words "believe", "may", "will",
"estimate", "continue", "anticipate", "intend", "expect", "plan" and similar
expressions, as they relate to MediaBay, our business or our management, are
intended to identify forward-looking statements.
We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise after the date of this prospectus. In light of these risks
and uncertainties, the forward-looking events and circumstances discussed in
this prospectus may not occur and actual results could differ materially from
those anticipated or implied in the forward-looking statements.
17
<PAGE>
USE OF PROCEEDS
The net proceeds to MediaBay from the sale of common stock in this
offering, assuming a public offering price of $____per share, are estimated to
be $_______($_____if the underwriters exercise their over-allotment option in
full), after deducting underwriting discounts and commissions and estimated
offering expenses of $______. We intend to use these net proceeds as follows:
o to repay $28.3 million of indebtedness under our credit agreement, the
approximately $4.8 million principal amount of a convertible promissory
note held by Norton Herrick, our Chairman, and $2.0 million principal
amount of convertible promissory notes held by Evan Herrick, Norton
Herrick's son and brother of Michael Herrick and Howard Herrick, officers
and directors of MediaBay;
o for Internet marketing and advertising;
o for membership recruitment advertising, including direct mail campaigns;
o for content acquisition and digital encoding; and
o for general corporate purposes, including capital expenditures and
potential acquisitions.
Borrowings under our credit agreement consist of $21.2 million as a term
loan and $7.1 million under a revolving line of credit. The principal amount of
the term loan is payable in quarterly payments through March 2003. For more
information regarding repayment of the term loan, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources." The revolving line of credit expires on December 31, 2003.
The interest rate is currently 3.75% above LIBOR. Interest on the convertible
promissory note is payable monthly. The interest rate of the approximately $4.8
principal amount note is 11% per year and the interest rate of the $2.0 million
principal amount note is 9% per year. These notes are due December 31, 2004.
The proceeds from these borrowings were used primarily to finance our
acquisitions in December 1998 and June 1999 and for working capital and general
corporate purposes.
Pending these uses, we may invest the net proceeds temporarily in U.S.
government or investment grade securities, short-term certificates of deposit,
money market funds or other short-term interest bearing investments.
18
<PAGE>
PRICE RANGE OF COMMON STOCK
MediaBay's common stock has been quoted in the Nasdaq National Market
under the symbol "MBAY" since November 15, 1999. From October 23, 1997 until
November 12, 1999, MediaBay's common stock was listed on the American Stock
Exchange under the symbol "KLB". The following table shows the high and low
sales prices of our common stock as reported by the Nasdaq National Market
since November 15, 1999 and by the American Stock Exchange until November 12,
1999.
<TABLE>
<CAPTION>
High Low
------------ -----------
<S> <C> <C>
1997
Fourth Quarter (from October 23, 1997) ........... $ 11.13 $ 4.00
1998
First Quarter .................................... 7.38 4.00
Second Quarter ................................... 13.25 3.38
Third Quarter .................................... 20.88 3.94
Fourth Quarter ................................... 16.63 5.00
1999
First Quarter .................................... 14.38 7.38
Second Quarter ................................... 19.94 10.00
Third Quarter .................................... 15.88 7.25
Fourth Quarter ................................... 15.00 10.25
2000
First Quarter (through January 27, 2000) ......... 13.50 10.25
</TABLE>
On January 27, 2000, the last reported sale price of our common stock on
the Nasdaq National Market was $12.25 per share. As of January 27, 2000, there
were approximately 78 record owners of our common stock.
DIVIDEND POLICY
We have never declared or paid and do not anticipate declaring or paying
any dividends on our common stock in the near future. The terms of our debt
agreements prohibit us from declaring or paying any dividends or distributions.
Any future determination as to the declaration and payment of dividends will be
at the discretion of our Board of Directors and will depend on then existing
conditions, including our financial condition, results of operations, capital
requirements, business factors and other factors as our Board of Directors
deems relevant.
19
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999
on (1) an actual basis, (2) a pro forma basis and (3) an as adjusted basis. The
following table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and MediaBay's
financial statements and related notes included elsewhere in this prospectus.
The pro forma information gives effect to the following events which
occurred after September 30, 1999:
o the conversion of $4.2 million of indebtedness into 379,662 shares of
our common stock;
o the issuance of 21,600 shares of our common stock upon the exercise of an
option and the receipt of $95,000 as payment of the exercise price;
o the incurrence of $2.0 million of indebtedness; and
o the termination of put rights relating to 50,000 shares of our common
stock valued at $644,000.
The as adjusted information in the table below gives effect to the sale of
4,000,000 shares of our common stock at an assumed public offering price of
$_____ per share and our anticipated use of the estimated net proceeds, after
deducting underwriting discounts and commissions and estimated expenses of this
offering, including the repayment of $35.1 million of indebtedness.
<TABLE>
<CAPTION>
September 30, 1999
---------------------------------------------
Actual Pro Forma As Adjusted
------------ --------------- ------------
(in thousands)
<S> <C> <C> <C>
Current portion of long-term debt ...................... $ 3,120 $ 3,120 $
--------- --------- --------
Long-term debt ......................................... $ 39,313 $ 37,089 $
--------- --------- --------
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized; no shares issued or outstanding ......... -- --
Common stock subject to contingent puts ............... 4,283 3,639
Common stock, no par value;
75,000,000 shares authorized; 9,136,897 shares
issued and outstanding, actual; 9,538,159
shares issued and outstanding, pro forma; and
__________ shares issued and outstanding, as
adjusted ............................................ 57,576 62,539
Contributed capital ................................... 2,323 2,323
Accumulated deficit ................................... (27,991) (27,991)
--------- ---------
Total shareholders' equity .......................... $ 31,908 $ 36,871 $
--------- --------- --------
Total capitalization ............................... $ 78,624 $ 80,719 $
========= ========= ========
</TABLE>
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following tables present our selected historical consolidated
financial data for each year in the five-year period ended December 31, 1998
and for the nine-month periods ended September 30, 1998 and 1999, as well as
pro forma combined and as adjusted financial data. The selected historical
consolidated annual financial data was derived from our audited consolidated
financial statements. The selected historical consolidated financial data as of
September 30, 1999 and for the nine-month periods ended September 30, 1998 and
1999 was derived from our unaudited interim financial statements. The unaudited
interim financial statements include all adjustments, consisting of normal
recurring accruals, which we consider necessary for a fair presentation of the
financial position and results of operations for these periods. Operating
results for the nine-month period ended Sepember 30, 1999 are not necessarily
indicative of the results that may be expected for the entire year ending
December 31, 1999. You should read this financial information in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the historical and pro forma financial statements and the
related notes included elsewhere in this prospectus.
The unaudited interim historical financial data presented in this
prospectus gives effect to the purchase of Doubleday Direct's Audiobooks Direct
club on June 15, 1999. Additionally, the balance sheet and statement of
operations data for the year ended December 31, 1998 gives effect to the
following transactions:
o The acquisitions of Radio Spirits, Inc., the assets of an affiliated
company, Buffalo Productions, Inc., and a 50% interest in a joint venture
owned by the sole shareholder of Radio Spirits on December 14, 1998.
o The acquisition of substantially all of the assets used by Metacom, Inc.
in connection with its Adventures in Cassettes business on December 14,
1998.
o The acquisition of substantially all of the assets used by Premier
Electronic Laboratories, Inc. in connection with its business of
producing, marketing, and selling old time radio and classic video
programs on December 14, 1998.
o The acquisition of substantially all of the assets of Columbia House's
Audiobook Club on
December 31, 1998.
21
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------------------
1994 1995 1996 1997 1998
-------------- ------------- ------------ ------------ ------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Opera-
tions Data:
Sales .................... $ 337 $ 3,406 $ 8,343 $ 15,119 $ 22,242
Returns, discounts and
allowances .............. 87 771 2,743 5,041 7,348
Sales, net ............... 250 2,635 5,600 10,078 14,894
Cost of sales ............ 388 2,146 4,327 5,495 9,452
Gross profit (loss) ...... (138) 490 1,273 4,583 5,442
Advertising and
promotion expense ....... 973 2,671 5,470 6,843 8,910
General and
administrative
expense ................. 482 1,209 2,048 2,217 3,330
Depreciation and
amortization expense..... 1 2 5 8 367
Interest (expense)
income, net ............. (4) (4) (211) (436) 180
Income taxes ............. -- -- -- -- --
--------- --------- -------- -------- --------
Net loss ................. $(1,598) $(3,396) $ (6,461) $ (4,921) $ (6,985)
========= ========= ======== ======== ========
Basic and diluted net loss
per share ............... $ (.49) $ (1.04) $ (1.98) $ (1.29) $ (1.13)
========= ========== ========= ========= =========
Weighted average num-
ber of shares out-
standing ................ 3,256 3,256 3,256 3,820 6,188
========= ========== ========= ========= =========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
--------------------------------
1998 1999
------------- -------------
<S> <C> <C>
Statement of Opera-
tions Data:
Sales .................... $ 16,190 $ 41,986
Returns, discounts and
allowances .............. 4,655 11,297
Sales, net ............... 11,535 30,689
Cost of sales ............ 7,558 15,037
Gross profit (loss) ...... 3,977 15,652
Advertising and
promotion expense ....... 6,108 5,356
General and
administrative
expense ................. 1,878 6,604
Depreciation and
amortization expense..... 233 4,862
Interest (expense)
income, net ............. 249 (3,362)
Income taxes ............. -- --
-------- --------
Net loss ................. $ (3,993) $ (4,532)
======== ========
Basic and diluted net
loss per share .......... $ (.65) $ (.57)
======== ========
Weighted average num-
ber of shares out-
standing ................ 6,154 7,882
======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1999
------------------- -------------------
(in thousands)
<S> <C> <C>
Balance Sheet Data:
Working capital ................................. $ 6,571 $ 7,736
Total assets .................................... 64,339 89,317
Current liabilities ............................. 8,231 13,813
Long-term debt .................................. 40,000 39,313
Common stock subject to contingent puts ......... 8,284 4,283
Shareholders' equity ........................... 7,823 31,908
</TABLE>
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and the accompanying financial statements and related
notes included elsewhere in this prospectus.
Overview
We are a leading provider of premium spoken word content and products in
hard goods and digital download formats via the Internet and offline methods. We
market our audiobooks through Audio Book Club, the largest membership-based club
of its kind with approximately 1.8 million members, and our audiobookclub.com
web site. We sell audiobooks in a club format through our Audio Book Club and
via the Internet through our audiobookclub.com site, and on a retail basis
through the audiobook channel on MediaBay.com. We sell our old time radio and
classic video programs on a retail basis through direct marketing and via the
Internet through the old time radio and classic video channels on MediaBay.com,
as well as on a wholesale basis to major retailers.
Our marketing programs have consisted primarily of direct mail, media
advertising and marketing on the Internet. Online and offline direct response
marketing costs to current members are expensed on the date the promotional
materials are mailed. Online and offline direct response costs for any
premiums, gifts or discounted audiobooks in the promotional offer to new
members are expensed as incurred. Beginning in January 1999, we were required
to capitalize direct response marketing costs for the acquisition of new
members in accordance with AICPA Statement of Position 93-7 and amortize these
costs over the period of future benefit which was estimated at 30 months based
on our historical experience over the last five years.
We have also grown our membership base through acquisitions. On December
14, 1998, we completed a series of acquisitions and combined the acquired
businesses within the old time radio and classic video programs area. On
December 31, 1998, we acquired from Columbia House substantially all of the
assets of its Audiobook Club and on June 15, 1999, we acquired Audiobooks
Direct from Doubleday Direct. When reading the following results of operations,
please note:
o Our results of operations for the year ended December 31, 1997 and nine
months ended September 30, 1998 reflect the operations of our Audio Book
Club.
o Our results of operations for the year ended December 31, 1998 reflect
the operations of Audio Book Club for the entire year and the operations
of the acquired companies in the old time radio and classic video programs
area from December 15, 1998 through December 31, 1998.
o Our results of operations for the nine months ended September 30, 1999
reflect the operations of our Audio Book Club, including Columbia House's
Audiobook Club, and our old time radio and classic video programs area for
the nine months, and the operations of Audiobooks Direct from June 16,
1999 through September 30, 1999.
As a result of the timing of our marketing activities within a given year
or quarter, the impact of capitalizing new member direct response marketing
costs and the timing of these acquisitions and related costs, including
increased interest expense and goodwill and other intangible asset amortization
expense, comparisons of our historical operating results from period to period
may not be meaningful to you.
23
<PAGE>
Results of Operations
The following table sets forth, for the periods indicated, historical
operating data as a percentage of net sales.
<TABLE>
<CAPTION>
Year Ended Nine Months
December 31, Ended September 30,
--------------------- -------------------
1997 1998 1998 1999
---------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales ..................................... 100% 100% 100% 100%
=== === === ===
Cost of sales ................................. 55% 63% 66% 49%
Gross profit .................................. 45 37 34 51
Advertising and promotion expense ............. 68 60 54 17
General and administrative expense ............ 22 25 16 22
Depreciation and amortization expense ......... -- -- 2 16
Interest income (expense), net ................ (4) 1 2 (11)
Net loss ...................................... (49) (47) (35) (15)
</TABLE>
Nine months ended September 30, 1999 compared to nine months ended
September 30, 1998
Gross sales increased $25.8 million, or 159.3%, to $42.0 million for the
nine months ended September 30, 1999 from $16.2 million for the nine months
ended September 30, 1998. The increase in gross sales was primarily
attributable to (1) increased sales of audiobooks resulting from the continued
expansion of Audio Book Club's membership base, (2) sales from the Columbia
House Audiobook Club acquisition for the full nine months ended September 30,
1999, (3) sales from our acquired old time radio and classic video programs
area, and (4) the inclusion of sales from Audiobooks Direct since its
acquisition on June 15, 1999.
Returns, discounts and allowances for the nine months ended September 30,
1999 were $11.3 million, or 26.9% of gross sales, compared to $4.7 million, or
28.8% of gross sales, for the prior comparable period. The decrease in returns
as a percentage of gross sales is due to historically lower return rates from
sales of our old time radio and classic video programs and lower returns from
sales to members of the Columbia House Audiobook Club partially offset by an
increase in returns at the Audio Book Club for the nine month period ended
September 30, 1999. The dollar increase in returns, discounts and allowances
was primarily due to the increased gross sales.
Principally as a result of higher gross sales, net sales for the nine
months ended September 30, 1999 increased $19.2 million or 166.1% to $30.7
million from $11.5 million.
Cost of sales increased $7.5 million, or 99.0%, to $15.0 million for the
nine months ended September 30, 1999 from $7.6 million in the prior comparable
period. Cost of sales as a percentage of net sales decreased to 49.0% from
65.5%. Gross profit increased $11.7 million, or 293.6%, to $15.7 million for
the nine months ended September 30, 1999 from $4.0 million in the prior
comparable period. Gross profit as a percentage of net sales increased to 51.0%
from 34.5% due to improvement in the price we paid for products for our Audio
Book Club based on increased volume purchases as a result of our recent
acquisitions, better fulfillment arrangements and higher gross profit as a
percentage of net sales of our old time radio and classic video products.
Advertising and promotion expenses (for acquisition and retention of
members) decreased $752,000, or 12.3%, to $5.4 million for the nine months
ended September 30, 1999 as compared to $6.1 million in the prior comparable
period. The decrease is due to the capitalization of direct response
advertising in the nine months ended September 30, 1999, partially offset by
higher advertising expenses to existing Audio Book Club members and to old time
radio and classic video customers which are expensed in the period incurred.
The higher advertising expenses to existing Audio Book Club members resulted
from an increase in membership through continued expansion and acquisitions.
General and administrative expenses increased $4.7 million, or 251.7%, to
$6.6 million for the nine months ended September 30, 1999 from $1.9 million for
the prior comparable period. General and administrative expense increases are
principally attributable to the acquisition and integration of the old time
radio and classic video operations, including its personnel and facilities,
increased bad debt expenses as a result of sales increases and increased
personnel and related costs as we continue to grow and internalize services
previously performed by outside vendors. We did not retain any personnel from
the acquisitions of Columbia House Audiobook Club and Audiobooks Direct.
24
<PAGE>
Depreciation and amortization expenses increased $4.6 million for the nine
months ended September 30, 1999 from $233,000 for the prior comparable period.
The increase in depreciation expense relates to the acquisition of fixed assets
of our old time radio and classic video operations and the depreciation of
Internet development costs. The increase in amortization is attributable to the
amortization of goodwill and other intangible assets in connection with our
various acquisitions.
Net interest expense for the nine months ended September 30, 1999 was $3.4
million as compared to net interest income of $249,000 for the nine months
ended September 30, 1998. The interest expense in 1999 is attributable to debt
incurred in connection with our various acquisitions.
Primarily due to increased gross sales of $25.8 million, improvements in
gross profit as a percentage of net sales and the capitalization of direct
response advertising, our earnings before interest, taxes, depreciation and
amortization (EBITDA) increased $7.5 million to $3.7 million for the nine months
ended September 30, 1999. Management believes that EBITDA is a relevant measure
of performance because it reflects our operations without giving effect to
acquisition related costs. The calculation of EBITDA may not be consistent with
methods used by other companies. Net loss for the nine months ended September
30, 1999 was $4.5 million or $.57 per share of common stock as compared to a net
loss of $4.0 million or $.65 per share of common stock for the nine months ended
September 30, 1998. The increase in net loss was primarily attributable to
increased interest expense and amortization of goodwill and other intangibles in
connection with our various acquisitions, partially offset by the improvement in
gross profit.
Year ended December 31, 1998 compared with year ended December 31, 1997
Gross sales increased $7.1 million, or 47%, to $22.2 million for the year
ended December 31, 1998 from $15.1 million for the year ended December 31,
1997. The increase in gross sales was primarily attributable to increased sales
of audiobooks resulting from Audio Book Club's internal member growth. Our
total member file increased by approximately 740,000 names in the year ended
December 31, 1998, primarily as a result of the Columbia House Audiobook Club
acquisition and internal membership growth of approximately 133,000 names.
Returns, discounts and allowances as a percentage of gross sales were
unchanged, however, they increased by $2.3 million or 45.8% to $7.3 million for
the year ended December 31, 1998 from $5.0 million for the year ended December
31, 1997 as a result of increases in gross sales.
Expansion of Audio Book Club's membership base, increased revenue from
members and increased new member revenue resulted in an increase in net sales of
$4.8 million, or 47.8%, to $14.9 million for the year ended December 31, 1998
from $10.1 million for the year ended December 31, 1997. The increase in net
sales was primarily attributable to increased sales of audiobooks resulting from
Audio Book Club's internal member growth.
Cost of sales for the year ended December 31, 1998 increased $4.0 million,
or 72.0%, to $9.5 million from $5.5 million for the year ended December 31,
1997. Cost of sales as a percentage of percentage of sales increased from 55% to
63% primarily due to the timing of, and an increase in, new member enrollment in
1998. Gross profit increased $859,000 or 18.7% to $5.4 million for the year
ended December 31, 1998 from $4.6 million for the year ended December 31, 1997.
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 us which is
expected to be recovered through additional member purchases at regular prices.
Advertising and promotion expenses decreased $2.6 million, or 37.4%, to
approximately $4.3 million for the year ended December 31, 1998 from $6.8
million for the year ended December 31, 1997. This decrease was due to fewer
new member solicitation pieces mailed during 1998 and the timing of direct mail
campaigns. We mailed approximately 5 million new member solicitation packages
during December 1997 and received the benefits of that member recruitment
campaign during 1998.
We began engaging in significant Internet marketing and promotion
activities in 1998 and allocated a portion of our advertising expenses for such
purposes. Internet expenses for the year ended December 31, 1998 were $4.6
million. These expenses related to a series of agreements with various Internet
companies to provide permanent placements and banner advertisements through
their web sites, expansion and improvements to our web site and the launching
of an Internet web site and membership club designed for online consumers.
During the year ended December 31, 1997, Internet expenses were only $115,000
and were included in advertising and promotion expense.
25
<PAGE>
General and administrative expenses for the year ended December 31, 1998
increased $1.5 million, or 66.2%, to $3.7 million from $2.2 million for the
year ended December 31, 1997. General and administrative expenses as a
percentage of net sales, for the year ended December 31, 1998, were 24.8%, an
increase from 22.1%. The increase in general and administrative expenses is
primarily due to increases in personnel, travel expenses, professional fees and
general office expenses due, in part, to our becoming a public company in
October 1997.
We had net interest income of $180,000 for the year ended December 31,
1998, as compared to interest expense, net of interest income, of $436,000 for
the year ended December 31, 1997. Our interest income during the year ended
December 31, 1998 was derived from the investment of a portion of the net
proceeds of our initial public offering prior to its use. During the year ended
December 31, 1997, interest expense was incurred because we financed our
operating loss through borrowings.
Net loss for the year ended December 31, 1998 increased $2.1 million to
$7.0 million, or $1.13 per share of common stock, as compared to a net loss of
$4.9 million, or $1.29 per share of common stock, for the year ended December
31, 1997. The increase in net loss was primarily due to expenses incurred in
connection with the acquisition of Audio Book Club members, a substantial
portion of which was used to increase our Internet activities.
Liquidity and Capital Resources
Historically, we have funded our cash requirements through sales of our
equity and debt securities and borrowings from financial institutions and our
principal shareholders. Our capital requirements have been and will continue to
be significant due to expanded operations, costs associated with direct mail
campaigns, other new member recruitment advertising, promotion and brand
building and expanding Internet operations.
For the nine months ended September 30, 1999, our cash decreased by $1.8
million as we used net cash of $5.8 million for operating and $19.8 million for
investing activities and had cash provided by financing activities of $23.7
million. Net cash used in operations principally consisted of the net loss of
$4.5 million, an increase in accounts receivable of $2.0 million, an increase in
prepaid expenses of $811,000, an increase in royalty advances of $1.2 million
and an increase in deferred member acquisition costs of $7.3 million, partially
offset by an increase in accounts payable and accrued expenses of $4.3 million.
To arrive at net cash used in operations, we added back depreciation and
amortization expenses of $5.9 million included in the net loss. The increase in
accounts receivable during the nine months ended September 30, 1999 is
principally due to higher sales. The increase in prepaid expenses is principally
attributable to both direct mail and Internet advertising agreement expenses
paid in advance of the related campaigns. The increase in royalty advances
relates to the advance payments to publishers and rights holders of our various
licensed products and is attributable to the growth of our business. The
increase in accounts payable and accrued expenses was primarily attributable to
timing of vendor payments and invoicing.
Cash used in investing activities for the nine months ended September 30,
1999 was primarily attributable to the acquisition of Audiobooks Direct. For
the nine months ended September 30, 1999, net cash provided by financing
activities consisted of increased borrowings under our credit agreement for the
acquisition of Audiobooks Direct, proceeds from the sales of common stock and
the issuance of a related party subordinated note in connection with the
acquisition of Audiobooks Direct. These increases were partially offset by
principal payments on our long-term bank debt and payments on the previous
related-party subordinated loans.
During the year ended December 31, 1998, our cash decreased by $1.0
million, as we used net cash of $9.4 million in operating activities and $33.7
million in investing activities and had cash provided by financing activities
of $42.1 million. Net cash used in operating activities resulted primarily from
the net loss of $7.0 million, increases in inventory of $1.3 million, total
prepaid expenses of $1.1 million and accounts receivable of $895,000. Net cash
used in operations was partially reduced by an increase in accounts payable and
accrued expenses of $605,000. The increase in accounts receivable during the
year ended December 31, 1998 is principally due to higher sales and an increase
in new members. Increases in inventory and total prepaid expenses are primarily
attributable to the acquisitions completed in December 1998.
26
<PAGE>
For the year ended December 31, 1998, we used $36.7 million of cash for
acquisitions. Cash was also used in the purchase of a twelve month bank
certificate of deposit of $500,000 and to acquire $944,000 of fixed assets.
Cash was further reduced by the $693,000 of costs incurred in acquisitions.
Cash was increased by the redemption of short-term investments, principally
bank certificates of deposit and accrued interest thereon, in the amount of
$5.1 million.
For the year ended December 31, 1998, cash provided from financing
activities consisted primarily of the issuance of the $27.0 million of bank
debt and $15.0 million of notes payable to a related party described below.
During the year ended December 31, 1998, based upon a pre-existing agreement,
we sold to a director, five-year options to purchase 75,000 shares of our
common stock at an exercise price of $5.00 per share, the market value on the
purchase date, for $75,000.
Based on our projected level of operations, including the integration of
our recent acquisitions and anticipated cost savings and revenue growth, we
believe that the net proceeds of this offering, our cash flow from operations
and available cash will be adequate to meet our future liquidity needs for at
least twelve months after this offering.
Recent Acquisitions and Financings
In December 1998, we completed the following acquisitions of old time
radio and classic video businesses:
o We acquired Radio Spirits, Inc., a company which specialized in
syndicating, selling and licensing old time radio programs, from Carl
Amari, who became an officer of MediaBay upon the closing. The purchase
price for the acquisition was $340,000 in cash, 425,000 shares of our
common stock and options to purchase 175,000 shares of our common stock at
an exercise price of $12.875 per share. We also paid $1.8 million of
liabilities of Radio Spirits at the closing. In connection with the Radio
Spirits acquisition, we also acquired from Mr. Amari (1) the assets of
Buffalo Productions, Inc. relating to its business of duplicating
pre-recorded compact discs for $369,000 and (2) a 50% interest in a joint
venture engaged in the production, broadcast, marketing and distribution
of old time radio programs for $2.3 million. We also assumed liabilities
of $224,446 of the joint venture.
o We acquired the assets used by Metacom, Inc. for its Adventures in
Cassettes business of producing, marketing and selling old time radio
programs for $1.1 million, 50,000 shares of our common stock and warrants
to purchase 50,000 shares of our common stock.
o We acquired the assets used by Premier Electronic Laboratories, Inc.
relating to its business of producing, marketing and selling old time
radio and classic video programs for $240,000 and 125,000 shares of our
common stock.
On December 31, 1998, we acquired from Columbia House substantially all of
the assets of its Audiobook Club, including its membership file of over 600,000
members. We also entered into a marketing agreement with Columbia House in
which we received access to Columbia House's current and future club mailing
lists, which currently consist of over 20 million names of active and inactive
members, through 2006. In addition, Columbia House entered into a
non-competition agreement. As consideration for the acquisition, we paid to
Columbia House $30.8 million in cash and issued to Columbia House and its
designees, Sony Music Entertainment, Inc. and WCI Record Club Inc., a
subsidiary of Time Warner, a total of 325,000 shares of our common stock and
warrants to purchase an additional 100,000 shares of our common stock at a
price of $11.125 per share.
In December 1998, we obtained financing for these acquisitions from (1)
Fleet National Bank and ING (U.S.) Capital Corporation and (2) Norton Herrick,
our Chairman. Under the credit facility with Fleet and ING, we borrowed an
aggregate of $27.0 million, consisting of a $25.0 million term loan and a $2.0
million advance under a $9.0 million revolving line of credit. The term loan is
payable as follows: four quarterly payments of $930,000 in the year 2000; four
quarterly payments of $1,550,000 in the year 2001; four quarterly payments of
$2,170,000 in the year 2002; and the balance due on March 31, 2003. We granted
to the lenders a security interest in substantially all of our assets and the
assets of our subsidiaries and pledged the capital stock of our subsidiaries to
the lenders as collateral under the credit facility. We also issued to the
lenders three-year warrants to purchase up to 197,450 shares of
27
<PAGE>
common stock at an exercise price of $9.967 per share. Our borrowings from Mr.
Herrick were made under a $15.0 million principal amount 9% convertible
promissory note due December 31, 2004, of which $1.0 million principal amount
was repaid in January 1999. Mr. Herrick subsequently sold $5.0 million
principal amount of the note to a third party. The interest rate of the portion
of the note sold by Mr. Herrick is payable quarterly at an annual rate of 9%.
In December 1999 and January 2000, Mr. Herrick sold approximately $4.2
principal amount of the remaining note to a third party. The third party
converted the portion of the note it purchased into 379,662 shares. See
"Related Party Transactions."
In connection with the acquisitions described above, we granted the
sellers the right, under specified conditions, to sell back to us up to an
aggregate of 675,000 shares issued to the sellers in connection with the
acquisitions. These rights have terminated as to 370,000 shares. The sellers
have the right under certain conditions to sell the remaining 305,000 shares of
stock to us at prices ranging from $14.00 to $15.00 per share at various times
commencing in December 2003 and expiring in December 2008, unless the rights
are terminated earlier as a result of our satisfying common stock price and/or
performance targets prior to exercise. If all of the rights are exercised prior
to termination, the maximum amount we could be required to pay for the
repurchase of all of the shares is approximately $4.6 million, payable as
follows: (1) $350,000 commencing December 2003; (2) $3.5 million commencing
December 2004; and (3) $750,000 commencing December 2005.
From April through August 1999, we sold 2,040,000 shares of common stock
to qualified institutional buyers for gross proceeds of $24.9 million. We used
the proceeds primarily to finance the Audiobooks Direct acquisition described
below. Cash fees associated with these sales were $295,000 and were paid to an
unaffiliated third party.
In June 1999, we acquired from Doubleday Direct the assets of Audiobooks
Direct, including its membership file of approximately 500,000 members. We also
entered into a marketing agreement with Doubleday Direct in which we received
access to Doubleday Direct's existing and future club mailing lists, which
currently consist of over 14 million names of active and inactive members. In
addition, Doubleday Direct entered into a non-competition agreement and a
transitional services agreement with us. As consideration for the acquisition,
we paid Doubleday Direct $18.6 million in cash. We also incurred cash costs and
fees of $184,000 and estimated additional costs and fees of approximately
$175,000.
In connection with the acquisition of Audiobooks Direct, we, Fleet and ING
amended the terms of our existing credit agreement to provide for an additional
$6.0 million of term loans. The interest rate under the credit agreement is
currently 3.75% above LIBOR and interest is payable at the expiration of the
respective LIBOR contracts. In connection with the additional loan in June
1999, we issued the lenders three-year warrants to purchase up to 119,940
shares at an exercise price of $14.20 per share. In August 1999, we repaid $8.6
million of indebtedness under the credit agreement.
We also obtained a portion of the financing for our acquisition of the
business of Doubleday Direct's Audiobooks Direct club by borrowing $4.4 million
from Norton Herrick under a convertible promissory note. This loan was repaid
in full in July 1999. See "Related Party Transactions."
At September 30, 1999, an aggregate of $28.6 million principal amount of
indebtedness was outstanding under our credit agreement with Fleet and ING. At
December 31, 1999, indebtedness outstanding under the credit agreement was
$28.3 million.
In December 1999 and January 2000, we borrowed a total of $2.0 million from
Evan Herrick, a son of Norton Herrick and brother of Michael Herrick and Howard
Herrick, by issuing to Evan Herrick 9% convertible promissory notes due December
31, 2004. We used the proceeds of these loans for working capital and corporate
purposes.
28
<PAGE>
We intend to use a portion of the proceeds of this offering to repay the
$28.3 million of indebtedness outstanding under the credit agreement, the
approximately $4.8 million principal amount convertible promissory note held by
Norton Herrick and the $2.0 million principal amount convertible promissory
notes held by Evan Herrick.
As a result of recent acquisition activity and sales of our common stock,
MediaBay, Fleet and ING amended the terms of our existing credit agreement
whereby certain covenants under the agreement were adjusted. In connection
therewith we paid legal expenses and fees of $317,000.
Year 2000
We have not experienced any business interruptions or supplier delays from
year 2000 problems to date and have not discovered any year 2000 problems in
internal computer systems material to our operations. We intend to continue to
monitor our internal system for year 2000 problems. There can be no assurance,
however, that we or our suppliers may not face future problems as a result of
year 2000 issues.
Quarterly Fluctuations
Our operating results vary from period to period as a result of purchasing
patterns of members, the timing, costs, magnitude and success of direct mail
campaigns and Internet initiatives and other new member recruitment
advertising, member attrition, the timing and popularity of new audiobook
releases and product returns. The timing of new member enrollment varies
depending on the timing, magnitude and success of new member advertising,
particularly Internet advertising and direct mail campaigns.
Our gross profit margin is affected by the percentage of new Audio Book
Club member enrollment purchases. Initial purchases by new members are at
substantially reduced prices to encourage enrollment. These offers, which are
typically four audiobooks for either $.99 or $.01 plus shipping and handling,
result in an initial loss to us which is expected to be recovered through
additional member purchases at regular prices. New member enrollment purchases
typically account for a higher percentage of sales following significant Audio
Book Club direct marketing activities.
We believe that a significant portion of our sales of old time radio and
classic video programs are gift purchases by consumers. Therefore, we tend to
experience increased sales of these products in the fourth quarter in
anticipation of the holiday season and the second quarter in anticipation of
Fathers' Day.
29
<PAGE>
BUSINESS
General
MediaBay, Inc. is a leading provider of premium spoken word content and
products in hard goods and digital download formats via the Internet and
offline methods. Our content library includes approximately 72,000 audiobook
titles, 59,000 old time radio programs and 3,500 classic video programs. We
market our audiobooks through Audio Book Club, the largest membership-based
club of its kind with approximately 1.8 million members, and our
audiobookclub.com web site. Our old time radio and classic video programs are
marketed through the Internet and direct mail catalogs and, on a wholesale
basis, to major retailers, including Costco, Best Buy, Sam's Club, Barnes &
Noble, Waldenbooks, B. Dalton Booksellers and Amazon.com. All of our products
are available for purchase over the Internet through our content-rich portal
located at MediaBay.com. MediaBay.com utilizes our extensive library of premium
spoken word content and various product offerings to attract visitors, increase
the duration and frequency of their visits and expand our e-commerce
opportunities. According to PC Data Online, audiobookclub.com ranked as the
third most visited web site for books, the 69th most visited retail shopping
web site and the 34th fastest growing web site during November 1999. In
addition, we are currently encoding our library of proprietary and licensed
content and are beginning to offer products in a digital download format.
We have consolidated the club industry for audiobooks by acquiring what we
believe to be our only competitors. As part of the acquisitions of Columbia
House's Audiobook Club and Doubleday Direct's Audiobooks Direct club, we
acquired over 1.1 million members and gained the exclusive right to access their
other club mailing lists of over 34 million existing active and inactive
members, as well as future members they acquire, without any list rental or
insertion fees. As a result of these acquisitions and our expanded customer
database, we have been able to negotiate better prices for products, enjoy
increased economies of scale with our advertising, printing and mailing costs,
stratify our member mailings to better serve our members and form specialty
clubs for audiobooks. In December 1998, we also acquired the assets of three
companies that produce, license, broadcast, syndicate and sell old time radio
and classic video programs. Through these acquisitions we obtained an extensive
library of over 59,000 old time radio and classic video programs, most of which
are exclusively licensed, and a customer list of over 400,000 names. We have
also enhanced our product offerings by acquiring and licensing diverse media
content and increased our customer base from approximately 260,000 customers at
December 31, 1997 to over 2.2 million customers at December 31, 1999.
Business Strategy
The market for spoken word content is large and growing rapidly. We
consider ourselves the market leader in this market and are implementing the
following strategies to capture additional market share:
o Increase Internet Presence. MediaBay.com is an innovative content and
e-commerce web site that combines the entertainment of content-driven web
sites, with the product selection and service of e-commerce sites, while
providing a sense of community for visitors. We launched MediaBay.com to
(1) capitalize on our substantial customer base and ability to drive
traffic to our web sites and (2) transport our unique spoken word,
audiobook and old time radio, and classic video content library online. We
believe that we were the first significant entrant into the spoken word
content e-commerce market. Since we launched our online strategy in January
1998, we have added over 100,000 Audio Book Club members through
audiobookclub.com. New members are enrolling online at an average rate of
over 6,000 per month and the number of unique visitors to our web sites is
approximately 1.2 million per month. Since our current cost of acquiring
new members via the Internet is lower than through our offline marketing
activities, we intend to increasingly emphasize this method of membership
acquisition. We currently have a database of over 440,000 e-mail addresses.
We are continuously enhancing our web sites and are actively leveraging our
marketing, customer service and fulfillment expertise and capabilities to
grow our online business.
We believe that the club model used by Audio Book Club translates well to
an Internet model because the club model ensures communication between us
and our members and engenders a sense of belonging to a community. In
addition, the model provides a significant breadth of product offerings
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and substantial information about our products. Unlike traditional web
retailers, our members have a purchase obligation associated with their
membership and there is a strong likelihood that they will remain members
and repeat buyers for a sustained period.
o Capitalize on Emerging Digital Delivery Technologies. We have entered
into arrangements with Microsoft and Reciprocal and now have the
infrastructure necessary to provide customers with secure digital
downloads of our content. We are currently encoding our library of old
time radio programs and selected audiobook titles to offer these products
in a secure digital download format. We are finalizing agreements with
publishers of other forms of spoken word content, including audio versions
of newspapers, magazines and newsletters, to obtain the rights to market
these items on our sites in secure digital download format. As digital
download becomes an increasingly accepted method for delivery of spoken
word content, we will expand our offering of products in this format. We
believe that these distribution methods will further improve our product
margins as they eliminate the costs of reproduction, packaging and
warehousing.
o Expand Marketing Strategy. We have developed a marketing strategy which
incorporates a broad range of online and offline marketing methods to
increase our customer base and revenues, including Internet marketing and
advertising, targeted e-mails to our database, growing our online
Affiliate Network and direct marketing. We utilize our 2.2 million name
customer list, product inserts into our 750,000 retail packages, 3.7
million mail order packages and inserts into our 13.5 million mailings to
our customers to drive traffic to MediaBay.com and audiobookclub.com. We
continuously add affiliates to our Affiliate Network program, which
currently consists of approximately 13,500 other Internet sites which
promote our web sites. We also have the exclusive right to use Columbia
House's and Doubleday Direct's mailing lists, which provide us access to
over 34 million of their other club members for direct mail campaigns and
inserts into club member mailings to acquire Audio Book Club members
without any list rental or insertion fees. We use our substantial
knowledge relating to the use of third-party mailing lists to efficiently
and cost effectively target buyers on these lists and to continue to
acquire new members from third-party lists.
We devote significant efforts to developing and testing various online and
offline marketing strategies in a concerted effort to increase revenue and
reduce marketing costs. Through constant testing and refinement of our
marketing efforts we have grown, and are continuing to grow, our customer
lists and have reduced, and continue to reduce, our per-customer
acquisition costs. We have significantly reduced our costs to acquire
Audio Book Club members online to less than 5% of the per-member costs of
our initial Internet marketing campaigns and to less than the per-member
acquisition costs of our offline marketing campaigns while continuing to
attract qualified and desirable members.
o Leverage Our Unique Content. We offer approximately 135,000 spoken word
and video products which we sell online and offline. We are able to use
this content to attract and retain web site visitors and to offer this
content to strategic partners in exchange for directing traffic to our
sites. One method of attracting and retaining web site visitors is to
enable them to sample video and audio clips free of charge from our
library of audio books, old time radio programs and classic videos. Unlike
many web sites which purchase third-party content and resell products, we
own or license and manufacture a majority of our products and content. We
license the rights to sell audiobooks in a club format from major
publishers and pay royalties for each audiobook sold. We also own or
exclusively license substantially all of our old time radio and classic
video products. As a result, we believe that we have a low product cost
compared to retailers and online book sellers. We also utilize our content
to enter into content alliances whereby we offer leading web sites samples
or full length programs in exchange for their directing traffic to our web
sites. We currently have content alliances with Microsoft's
windowsmedia.com, Diamond Rio's media portal, rioport.com, and Real
Network's real.com.
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Industry Overview
Audiobooks and Other Spoken Word Entertainment
First introduced to the mass market in 1985, audiobooks are literary
works, including best-selling selections from today's most popular writers, and
other printed materials, many of which are made more marketable through the use
of readings by the author, a celebrity actor, or an ensemble of readers or
actors. Audiobooks are recorded on cassettes and on compact discs. Most
best-selling hardcover books printed today are released simultaneously as
audiobooks. Audiobooks are usually author approved abridged versions of the
original works converted to an audio format and are typically three to six
hours in length.
The audiobook market has increased at a nine-year compound annual growth
rate of approximately 27% from an estimated $250 million in 1989 to
approximately $2.2 billion in 1998. We believe that this sales growth is driven
by several factors, including:
o the expanding number of available titles in audiobook format;
o an increase in the number of retailers selling audiobooks;
o an increase in product quality;
o broadening public awareness of the portability and convenience of
audiobooks as a viable alternative to printed books and music
recordings; and
o increasing time constraints on consumers.
As the market for audiobooks grows, some titles are being released only in
audio format. In December 1999, Simon & Schuster published a Stephen King
title, Blood and Smoke in audio format only and not in the written format.
Audiobook titles span every genre, including non-fiction, fiction,
self-help, mystery, fantasy, business, science fiction, biography, romance,
religion, motivational and children's, among others. Audiobooks cover new
releases as well as many of the literary classics.
Consumers of audiobooks are traditionally individuals who do not read as
often as they desire due to time constraints. As an alternative, these
individuals listen to audiobooks while engaging in other activities such as
driving or exercising. This demographic group has expanded to encompass a wide
variety of consumers. A 1996 market study by the Yankee Group indicates that
87% of automobile commuters listened to the radio an average of 50 minutes a
day while commuting. As individuals look to use their commuting time more
efficiently and manage an increasing amount of available content, we believe
that audiobooks have emerged as a personalized pay-to-listen alternative to
radio.
Old Time Radio and Classic Video Products
Old time radio programs include radio dramas, mysteries, detective
stories, comedies, westerns, science fiction and adventure stories that
originally aired from the 1930s to the 1970s. Classic video programs include
films originally released from the silent film era of the 1930s through the
1970s.
We believe there has been a resurgence in consumer interest for old time
radio and classic radio programs, as demonstrated by the growth of our sales of
these products and increased opportunities to enter into co-branding and
cross-marketing agreements, such as our agreements with the Frank Sinatra
estate, Walter Cronkite, the Smithsonian Institute and American Movie Classics.
We also believe that these programs have become a niche entertainment market,
appealing to those consumers who remember the "golden age of radio" and their
childhood film favorites with nostalgia and to younger listeners seeking new
forms of entertainment. According to a 1998 industry report, the United States
market for collectibles, which we believe includes old time radio and classic
video products, was estimated to exceed $10 billion. We believe that our old
time radio and classic video products can increase their share of this market.
Digital Delivery of Spoken Word Content
The Internet has recently emerged as a significant global communications
resource enabling millions of people to access and share information,
experience entertainment offerings and purchase products. Through the Internet,
users have the ability to quickly receive information in various forms, from
text and multimedia to
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newer technologies such as streaming audio. According to Jupiter
Communications, almost 33% of online consumers, representing 43 million people
worldwide, often listen to spoken word content on their personal computers. The
current environment available on the Internet generally restricts consumers to
listening at their personal computers. However, consumer electronics and
computer manufacturers are addressing this constraint by developing a new
generation of mobile devices that are capable of playing back digital downloads
of spoken word content. An industry research analyst estimates that sales of
Internet-connected portable audio players will increase from under 1.0 million
units in 1999 to over 6.5 million units in 2002. As a result, we believe that
this market will expand rapidly and that we are positioned to capitalize on its
growth.
MediaBay Network
We operate the MediaBay network of web sites which consists of
MediaBay.com, audiobookclub.com and bestbookclubs.com.
MediaBay.com
Our MediaBay.com media portal site is an innovative content and e-commerce
web site offering our 2.2 million customers and approximately 1.2 million
unique web site monthly visitors a single location for premium spoken word
content and products. MediaBay.com combines the entertainment of content-driven
web sites with the product selection and service of e-commerce sites, while
providing a sense of community for visitors. In July 1999, we launched
MediaBay.com to (1) capitalize on our substantial customer base and ability to
drive traffic our websites and (2) transport our unique spoken word, radio and
video content library online. We believe we were the first significant entrant
into the spoken word content e-commerce market.
In addition to providing our own content, we have entered into several
arrangements to provide unique content, such as webcasts, including the
American Express Blue concert series, celebrity and author interviews and audio
horoscopes to attract and retain web site visitors.
MediaBay.com was originally designed to network our various e-commerce
sites and is currently being redesigned as a true portal site. Redesigning
MediaBay.com into a channel format enables visitors to conveniently purchase
products from multiple channels in a single transaction and navigate
MediaBay.com without leaving the site. The redesigned site, which we expect to
re-launch by the end of the first quarter of 2000, will be comprised of the
following channels which are representative of our content and commerce
offerings:
o Audiobook channel. At this channel, visitors can purchase on a retail
basis almost any of the 72,000 audiobook titles in existence, sample
15,000 audio clips from various audiobook titles, listen to streaming
audio and digital downloads of selected audiobooks, read reviews, receive
recommendations and visit our chatrooms.
o Old time radio channel. This channel provides visitors with a searchable
database to select from over 59,000 programs from our old time radio
program library to purchase and offers free full-length programs in
streaming audio and digital download formats, information on the programs,
celebrities and talent of the Golden Age of Radio and contests and trivia
information. This site is heavily promoted by our nationally-syndicated
radio program "When Radio Was," which is heard by over 3 million listeners
weekly.
o Classic video channel. This channel is devoted to classic, nostalgic and
other unique film and video programs. This channel has a fully searchable
database of over 3,500 video programs from our classic video library for
purchase by visitors. We also intend to offer a large library of current
and vintage video programs in the near future.
o Newsstand channel. This channel offers newspapers, newsletters, magazines
and other time sensitive content for purchase as hard goods, as well as in
secure digital download formats and non-secure formats such as the mp3
format.
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o Music channel. This channel is devoted to old time and current music in
CD format and has a searchable database of tens of thousands of titles in
addition to unique content, such as concert webcasts and archived
performances from prior webcasts.
Audiobookclub.com
Audiobookclub.com provides visitors the opportunity to become members of
our Audio Book Club and provides our members with the ability to order almost
any audiobook in existence. Audiobookclub.com has acquired over 100,000 members
online since January 1998 and is currently enrolling new members at an average
rate of over 6,000 per month. This site currently receives over 1.0 million
unique visitors per month, according to recent measurements by PC Data Online.
Approximately 20% of the traffic to this site comes directly to
audiobookclub.com, and the remainder is driven to the site through links with
other sites. According to PC Data Online, audiobookclub.com ranked as the third
most visited web site for books, the 69th most visited retail shopping web site
and the 34th fastest growing web site during November 1999.
Audiobookclub.com utilizes Net Perceptions GroupLens Recommendation
Engine, an advanced tool designed to deliver highly personalized content, to
attempt to create personalized audiobook buying experiences customized for each
member. Once members have logged onto audiobookclub.com, they are offered
audiobook selections that correspond to their previous buying patterns. Online
members also receive e-mail alerts that inform them of the addition of new
titles that may appeal to them. Members visiting audiobookclub.com are able to
sample over 15,000 audio clips from various audiobook titles, read reviews,
visit our chat room, "Coffee Talk", to discuss audiobook interests with other
members, and visit special sections such as CD Central and Unabridged Only.
Audiobookclub.com is updated simultaneously with the Audio Book Club catalog to
add new selections and the new current featured selection, as well as to add
new book cover images and audio clips to preview.
Bestbookclubs.com
Bestbookclubs.com, a co-branded web site with Doubleday Direct, was
established to accumulate a database of e-mail addresses, acquire new Audio
Book Club members and attract visitors to our web sites. We promote Doubleday
Direct's clubs and this joint web site on our audiobookclub.com and
MediaBay.com sites and Doubleday promotes our products and services on its web
sites, including doubledaybookclub.com, crossings.com and literaryguild.com.
Audio Book Club
We believe that we are the largest marketer of audiobooks through our
Audio Book Club, the largest membership-based club of its kind. Our total
member file, which includes active and inactive members, has grown
significantly from approximately 64,000 names at December 31, 1995 to
approximately 1.8 million names at December 31, 1999. Of these members, 625,000
members were added as a result of our acquisition of Columbia House's Audiobook
Club and 500,000 members were added as a result of our acquisition of Doubleday
Direct's Audiobooks Direct club. In addition, we added 200,000 members in 1999
through internal growth.
We emphasize the timely introduction of new audiobook titles to our
catalogs and attempt to offer a balance between various genres and between
unabridged and abridged audiobooks, cassettes and compact discs to satisfy
differing member preferences. We also offer a special order service which
enables members to call us and order virtually any of the approximately 72,000
published titles in existence, whether or not listed in our member mailings.
We are in the process of creating specialty clubs for audiobooks based on
consumer preferences which we have identified from our extensive database of
member information including a Christian audiobook club which is expected to be
launched by the second quarter of 2000. Our specialty clubs will feature a
specific interest, such as self help, religion, mystery, romance and science
fiction.
We engage in list rental programs to maximize the revenue generation
potential of these programs. As Audio Book Club's membership base continues to
grow, we anticipate that our member list will continue to be attractive to
direct marketers as a source of potential customers.
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Our Audio Book Club is modeled after the Book-of-the-Month Club. Audio
Book Club members can enroll in the club through the mail by responding to
direct mail or print media advertisements, online through our web site or by
calling or faxing us. We typically offer new members four audiobooks at an
introductory price of $.99 or less. By enrolling, the member commits to
purchase a minimum number of additional audiobooks, typically two or four, at
Audio Book Club's regular prices which generally range from $10.00 to $35.00
per audiobook. Our members continue to receive member mailings and typically
purchase audiobooks beyond their minimum purchase commitment.
Unique Spoken Word and Video Content
We have exclusive rights to a substantial portion of our library of
popular old time radio and classic video programs, including vintage comedy,
mystery, detective, adventure and suspense programs. Our library consists of
over 59,000 radio programs, most of which are licensed on an exclusive basis,
including:
o H.G. Wells' "War of the Worlds" broadcast;
o hit series, such as The Lone Ranger, Superman, Tarzan, Sherlock Holmes, The
Life of Riley and Lights Out;
o recordings of stars, such as Humphrey Bogart, Lucille Ball, Frank Sinatra
and Jack Benny; and
o recordings of comedy teams, such as Abbott and Costello, Burns and Allen,
Martin and Lewis and Baby Snooks and Daddy.
We also produce and syndicate three national "classic" radio programs:
"When Radio Was" hosted by Stan Freberg, "Radio Movie Classics" hosted by
Jeffrey Lyons, and "Radio Super Heroes." These three programs are collectively
heard in more than 450 markets, including one of the nation's largest radio
stations, KNX1070 Los Angeles, by over 3 million listeners weekly. Our library
of old time radio programs provides the content and the basis for these
programs.
We leverage the content of our old time radio and classic video library by
entering into marketing and co-branding arrangements which provide us a means
to repackage these programs. We offer the following collections:
o "The Greatest Old-Time Radio Shows of the 20th Century -- hand-picked by
Walter Cronkite" -- a collection of approximately 60 old time radio
programs. We have entered into a license agreement to use Mr. Cronkite's
name and likeness. This collection includes approximately 30 hours of
radio's most memorable programs, a spoken foreword by Mr. Cronkite and a
companion informational booklet.
o "The Smithsonian Collection" -- a collection of old time radio programs
branded under this name. We entered into an agreement with the Smithsonian
Institution to produce a series of recordings of nostalgic radio programs
to be sold through all major bookstore chains carrying audio programs.
Each Smithsonian collection features a foreword by a recognized celebrity
from radio's golden age such as George Burns, Jerry Lewis and Ray
Bradbury.
o "AMC's Audio Movies to Go" -- a collection of old time radio adaptations
of classic movies branded under this name featuring film stars such as
Humphrey Bogart, Jimmy Stewart, John Wayne and Betty Davis. We entered
into an exclusive agreement with American Movie Classics in October 1999.
This product line is being sold on American Movie Classics' cable channels
reaching 69 million homes, in retail chains carrying audio and video
programs, in our product catalogs and on our web site and AMC's web site.
In the second quarter of 2000, we expect to release a collection of Frank
Sinatra's Greatest Radio Performances which we anticipate will contain
approximately 60 of Frank Sinatra's old time radio appearances. We have entered
into an agreement with Mr. Sinatra's estate for the use of Mr. Sinatra's name
and likeness in connection with a collection of his performances.
We also have an extensive library of over 3,500 video programs, including
an extensive collection of foreign and silent films, as well as classic films
from the 1930s through the 1970s.
We sell our old time radio and classic video programs on a retail basis
through our catalogs and direct mail. We maintain a list of over 400,000 names
of customers of radio and video programs through our
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catalogs. This list includes all customers to which our radio and video
programs or catalogs have been mailed. We engage in list rental programs to
maximize the revenue generation potential of our customer list. We also sell
our radio and video programs on a wholesale basis through major retailers and
online retailers, including Costco, Best Buy, Sam's Club, Barnes & Noble,
Waldenbooks, B. Dalton Booksellers and Amazon.com.
Marketing
Since our inception, we have engaged in an aggressive marketing program to
expand our Audio Book Club member base, expand our Internet presence, develop
alliances with other Internet companies and attract visitors to our web sites.
We devote significant efforts to developing various online and offline
marketing strategies in a concerted effort to increase revenue and reduce
marketing costs. We continually analyze the results of our marketing activities
in an effort to maximize sales, extend membership life cycles, and efficiently
target our marketing efforts to increase response rates to our advertisements
and reduce our per-member and per-customer acquisition costs.
Internet Marketing
Our marketing activities on the Internet have resulted in the enrollment
of over 100,000 new Audio Book Club members through our web sites since January
1998, with an average of over 6,000 new members currently enrolling over the
Internet each month. Audiobookclub.com currently attracts over 1.0 million
unique visitors per month.
Our Internet marketing program focuses on developing alliances with other
Internet companies to attract visitors to our web sites to sell products and
obtain Audio Book Club members. We have entered into advertisement arrangements
with various Internet companies such as America Online, Yahoo!, Broadcast.com,
Mail.com, iVillage, Go2Net, Inc. and Microsoft for several of its web sites,
including its MSN.com portal site and its HotMail, WebTV and Link Exchange
properties, and we continue to explore arrangements with other Internet
companies. Most of the arrangements provide us with the flexibility to promote
one or more of our web sites to direct visitor traffic to the web site or sites
that we expect will benefit the most from the promotion.
We established an Internet department which evaluates our click-through
rates and rate of conversions of visitors to customers on a daily basis and
alters our initiatives to maximize our Internet marketing and advertising
activities. We believe that this focus and our ability to negotiate favorable
agreements has resulted in a cost to acquire new members on the Internet which
is lower than our offline cost. Since our current cost of acquiring new members
via the Internet is lower than through offline marketing activities, we intend
to increasingly emphasize this method of member acquisition.
We have established an Associates Network program of over 13,500 affiliate
web sites which advertise audiobookclub.com and receive a commission for each
member obtained through a link from their site.
We also use push-marketing programs consisting of targeted e-mail
campaigns to our existing e-mail address database of over 440,000 e-mail
addresses.
We utilize our content to enter into alliances with many leading web
sites, including Microsoft's windowsmedia.com, Diamond Rio's media portal,
rioport.com, and Real Network's real.com which enable us to drive traffic to
our web sites to sell products and build our e-mail address database.
In the belief that enticing, easy to use web sites are the best source of
marketing for repeat visitors, we continually make technological improvements
to our web sites to facilitate user access. By offering an increasingly varied
array of fresh content, audio and video clips and other features, we aim to
attract visitors to our Internet web sites both to remain at our sites to
purchase additional products and to return to our network of sites when they
choose to browse the Internet for entertainment options.
Offline Marketing to Attract Online Customers
We emphasize the use of our offline marketing efforts to attract visitors
to our web sites. We promote MediaBay.com and audiobookclub.com by inserting
promotional advertisements in our product packages, product shipments, direct
mailings, inserts and other selected mailings. In addition, we advertise our
web sites on our nationally syndicated radio program "When Radio Was," which is
heard seven days a week and has a weekly audience of over 3 million listeners.
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Club Member Acquisition
We have historically acquired new Audio Book Club members primarily
through direct mailings of member solicitation packages, acquisitions, Internet
advertising, and to a lesser extent from advertisements in magazines,
newspapers and other publications and package insert programs. We seek to
attract a financially sound and responsible membership base and target these
types of persons in our direct mail and other advertising efforts.
We select lists of names of membership candidates based on the extensive
knowledge and experience we have gained which we believe are characteristic of
persons who are likely to join Audio Book Club, purchase sufficient quantities
of audiobooks to be a profitable source of sales for us and remain long-term
members. We analyze our existing mailing lists and our promotional campaigns to
target membership lists which are more likely to yield higher response rates.
We have gained substantial knowledge relating to the use of third-party mailing
lists and believe we can target potential members efficiently and cost
effectively by utilizing third-party mailing lists.
In connection with our acquisitions of Columbia House's Audiobook Club and
Doubleday's Audiobooks Direct club, we obtained the exclusive right to use
their other current and future club mailing lists, which currently consist of
over 34 million active and inactive members, over the next several years,
without paying rental and insertion fees. Since these club mailing lists are
comprised of individuals who have previously joined other membership clubs, we
anticipate favorable future response rates and improved per-member acquisition
costs.
We also acquired mailing lists with an aggregate of approximately 400,000
names of buyers and prospective buyers of old time radio and classic video
programs in connection with the acquisition of our old time radio and classic
video operations in December 1998. Since these persons have previously
purchased spoken word content through direct marketing, we have begun to target
them as potential customers or members of Audio Book Club.
Member Retention and Recurring Revenue
We encourage Audio Book Club members to purchase more than their minimum
purchase commitment by offering all members special discount pricing and other
incentives based on the volume of their purchases. Audio Book Club members
receive one mailing approximately every three weeks. Audio Book Club mailings
typically include a multi-page catalog which, together with the "more titles"
insert, offers approximately 500 titles, including a featured selection, which
is usually one of the most popular titles at the time of mailing; alternate
selections, which are best selling and other current popular titles; and
backlist selections, which are long-standing titles that have continuously sold
well. Each member mailing also includes an order form and a
"Member-Get-a-Member" form.
In order to encourage members to maintain their relationship with Audio
Book Club and to maximize the long-term value of members, we seek to provide
friendly, efficient, personalized service. Our goal is to simplify the order
process and to make members comfortable shopping via the Internet and by mail
order. Audio Book Club's membership club format makes it easy for members to
receive the featured selection without having to take any action. Under the
membership club reply system, the member receives the featured selection unless
he or she replies by the date specified on the order form by returning the
order form, calling us with a reply, faxing a reply to us or replying online
via our Internet web site with a decision not to receive such selection.
Members can also use any of these methods to order additional selections from
each catalog.
We maintain a database of information on each name in our member file,
including number and genre of titles ordered, payment history and the marketing
campaign from which the member joined. We also maintain a lifetime value
analysis of each mailing list we use and each promotional campaign we
undertake. The substantially increased size of our database enables us to
better stratify our member mailings by sending marketing materials and monthly
selections that better reflect members' particular interests as evidenced by
their buying patterns and purchasing preferences, rather than sending the same
mailing and monthly selection to all members. Our objective is to use this
stratification technique and our database analysis expertise to decrease
members' returns of monthly selections, increase members' positive response to
our product offerings and thereby increase net sales and extend the membership
lifecycle.
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Marketing of Old Time Radio and Classic Video Products
We sell our old time radio and classic video products primarily through
direct mail, radio and print advertisements and online marketing and promotion
of our web sites. Our catalogs offer cassettes and compact discs from our old
time radio library and videos from our classic video library. We mail our
catalogs four to six times each year to all persons on our customer list, as
well as to portions of our Audio Book Club member list. We also include product
insert advertisements for our radio and video programs in selected Audio Book
Club member mailings.
We advertise these products on our nationally syndicated programs, which
reach an audience of 3 million listeners of old time radio programs weekly. We
also place advertisements in selected publications, including Reader's Digest,
TV Guide and Parent Magazine. We also offer our old time radio and classic
video programs to retail customers through our web sites, primarily on the old
time radio and classic video channels on MediaBay.com.
We market our old time radio and classic video programs to wholesale
customers through our inhouse sales personnel and through third-party
distributors. We also engage in cooperative advertising to induce retailers to
purchase our products.
Supply and Production
We have established relationships with substantially all of the major
audiobook publishers, including Random House Audio Publishing Group, Simon &
Schuster Audio, Harper Audio and Time Warner Audio Books for the supply of
audiobooks. For the year ended December 31, 1998 and the nine months ended
September 30, 1999, approximately 55% and 47% of our gross sales were from
sales of titles licensed from the Random House Audio Publishing Group.
As a membership club, our Audio Book Club enjoys a cost of goods advantage
over traditional audiobook retailers. Retailers and other online book sellers
purchase audiobooks from the finished inventory of either a publisher or a
third-party distributor. As a club operator, we license a recording or group of
recordings from the publisher for sale in a club format on a royalty or per
copy basis and subcontract the manufacturing, duplicating and printing to a
third party. As a result of the improved economies of scale achieved from our
acquisitions of Columbia House's Audiobook Club and Doubleday Direct's
Audiobooks Direct club, we have achieved significant cost savings in the
production of audiobooks.
Our licensing agreements generally are non-exclusive, have one to
three-year terms, require us to pay an advance against future royalties upon
signing the license, permit us to sell audiobooks in our inventory at the
expiration of the term during a sell-off period and prohibit us from selling an
audiobook prior to the publisher's release date for each audiobook. Most of the
license agreements permit us to make our own arrangements for the packaging,
printing and cassette duplication of audiobooks. Most of our license agreements
permit us to produce and sell audiobook titles in cassette and compact disc
form. A few of our license agreements grant us digital rights to the titles as
well. We are negotiating with publishers to obtain the rights to produce and
sell additional titles in a digital download format.
We have acquired exclusive licensing rights to a substantial majority of
our old time radio library. These rights have been principally acquired from
the original rights holders (actors, directors, writers, producers or others)
or their estates. Engineers in our Illinois facility use digital sound
equipment to improve the sound quality of our old time radio programs. We then
contract with third-party manufacturers to duplicate and manufacture the old
time radio cassettes and CDs which we sell. We duplicate or use third parties
to manufacture most of our videos.
We are also in the process of encoding some of our old time radio products
and audiobooks which we license to provide digital download delivery of these
products.
Fulfillment and Customer Service
Doubleday Direct currently provides order processing and data processing
services, warehousing and distribution services for our Audio Book Club
members. Doubleday Direct's services include accepting
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member orders, implementing our credit policies, inventory tracking, billing,
invoicing and generating periodic reports, such as reports of sales activity,
accounts receivable aging, customer profile and marketing effectiveness.
Doubleday Direct also packs and ships the order, using the invoice as a packing
list, to the club member.
Doubleday Direct continued to provide these services to the members we
acquired through our acquisition of their Audiobooks Direct club in June 1999
and has provided these services for all of our Audio Book Club members since
January 2000. We were able to negotiate a favorable pricing structure with
Doubleday Direct for these services based on the increased volume of business
we will provide to them. As a result, we currently anticipate that we will
begin to experience cost savings for these functions in the first quarter of
2000.
For our Audio Book Club members, we offer fast ordering options, including
placing orders online through our web site, calling us with an order and faxing
an order to us. Orders are sent fourth class mail and are typically delivered
10 to 14 days following our receipt of orders. For an additional fee, members
can receive faster delivery of an order either by priority delivery, which
takes three to five days, or by overnight delivery.
Members are billed for their purchases at the time their orders are
shipped and are required to make payment promptly. We generally allow members
in good standing to order up to $50 of products on credit, which may be
increased if the member maintains a good credit history with us.
Our policy is to accept returns of damaged audiobooks. In order to
maintain favorable customer relations, we generally also accept prompt returns
of unopened audiobooks. We monitor each member's account to determine if the
member has made excessive returns. Our policy is to either terminate a
membership or change member status to positive option, if the member makes
three to five consecutive returns of either audiobooks ordered or of featured
selections received because the member did not return the reply card on time.
We will fulfill MediaBay.com orders from National Fulfillment Services,
Inc. National Fulfillment will accept orders, aggregate old time radio, classic
video, audiobook and third-party products, ship products to customers, invoice,
accept and apply collections and generate periodic reporting. We used National
Fulfillment for fulfillment services to our Audio Book Club prior to our using
Doubleday Direct.
We fulfill retail orders for old time radio programs at our Illinois
facility. Wholesale product orders are drop shipped directly from our tape
duplicator or our facility.
For our old time radio and classic video products, we only accept credit
card orders from retail customers and require wholesale customers to pay
invoices within 90 days. We maintain a toll-free customer service telephone
hotline for these customers and we can also be contacted by mail and e-mail.
Our policy is to accept returns of damaged products sold on a retail basis. We
accept returns of unsold products sold on a wholesale basis.
Competition
The audiobook and mail order industries are intensely competitive.
However, we believe that we operate the only club for audiobooks in the United
States and that we are the largest marketer of old time radio programs.
We compete with all other outlets through which audiobooks and other
spoken word content are offered, including bookstores, audiobook stores which
rent or sell only audiobooks, mail order companies that offer audiobooks for
rental and sale through catalogs and retail establishments such as convenience
stores, video rental stores and wholesale clubs.
As the markets for spoken word content increasingly shifts towards the
Internet, we face competition for the marketing and distribution of these
products from other highly trafficked sites, offering a variety of
39
<PAGE>
competing products, including Amazon.com and Barnes and Noble.com. Currently,
there are several other sites offering streaming audio content and products in
digital download format, including audiohighway.com and audible.com, which offer
digital download spoken word content, including audiobooks.
We also compete for discretionary consumer spending with mail order clubs
and catalogs, other direct marketers and retailers that offer products with
similar entertainment value as audiobooks and old time radio and classic video
programs, such as music cassettes and compact discs, printed books, videos, and
laser and digital video discs.
Intellectual Property
We have a United States registered trademark for the Audio Book Club logo
and have several pending United States trademark and service mark
registrations, including "MediaBay," "MediaBay.com," "audiobookclub.com" and
the MediaBay logos. We have applied for several additional service marks
relating to slogans and designs used in our advertisements, member mailings and
member solicitation packages. We believe that our trademarks and service marks
have significant value and are important to our marketing. We also own or
license the rights to the radio and video programs in our content library.
We rely on trade secrets and proprietary know-how and employ various
methods to protect our ideas, concepts and membership database. In addition, we
typically obtain confidentiality agreements with our executive officers,
employees, list managers and appropriate consultants and service suppliers.
Employees
As of January 24, 2000, we had 70 full-time employees. Of these employees,
7 served in management and 32 served in operational positions at our Audio Book
Club operations and 4 served in management and 27 served in operational
positions at our old time radio and classic video operations. We believe our
employee relations to be good. None of our employees is covered by a collective
bargaining agreement.
Properties
We lease 1,155 square feet of office space in Boca Raton, Florida pursuant
to a lease agreement which expires in November 2000 at a monthly rent of
$1,307. We have the option to renew the lease for two consecutive three-year
periods.
We sublease 828 square feet of space in Morristown, New Jersey from H.H.
Realty Investors, Inc., an affiliate of Norton Herrick, pursuant to a sublease
agreement that expires in December 2003 at a monthly rate of $1,340, the amount
paid by the related party to the landlord under the master lease.
We sublease 2,793 square feet of space in Morristown, New Jersey from H.H.
Realty Investors, Inc., an affiliate of Norton Herrick pursuant to a sublease
agreement on a month to month basis at a monthly rate of $3,215, the amount
paid by the related party to the landlord under the master lease.
We also lease approximately 3,655 square feet of space in Morristown, New
Jersey on a month to month basis at a current rent of $5,735 per month.
We lease 8,000 square feet of space in Schaumburg, Illinois pursuant to a
lease agreement which expires in December 2005, subject to a three-year renewal
option. Monthly rent under this lease is $4,667.
Legal Proceedings
We have been named as a co-defendant together with an established
collection agency we use in a lawsuit filed in March 1999 in the United States
District Court for the Northern District of Illinois, Eastern Division,
alleging violations by the collection agency and by us of the Fair Debt
Collection Practices Act. The lawsuit has been brought as a class action on
behalf of individuals who were sent certain collection letters
40
<PAGE>
within the State of Illinois during the one year period preceding the filing of
the lawsuit. The lawsuit has not yet been certified as a class action. The
collection agency has agreed to indemnify us. Therefore, we believe that the
outcome of the action will not have a material impact on us.
We are not a party to any other lawsuit or proceeding which we believe is
likely to have a material adverse effect on us.
41
<PAGE>
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors are:
<TABLE>
<CAPTION>
Name Age Position
- -------------------------------- ----- ------------------------------------------------------
<S> <C> <C>
Norton Herrick ................. 61 Chairman and Director
Michael Herrick ................ 32 Chief Executive Officer, President and Director
Stephen M. McLaughlin .......... 33 Executive Vice President and Chief Technology Officer
Howard Herrick ................. 34 Executive Vice President and Director
John F. Levy ................... 44 Executive Vice President and Chief Financial Officer
Robert Toro .................... 35 Senior Vice President of Finance
Jesse Faber .................... 45 President of Audio Book Club, Inc. and Director
Carl P. Amari .................. 36 President of Radio Operations and Director
Roy Abrams ..................... 56 Director
Carl T. Wolf ................... 56 Director
</TABLE>
Norton Herrick, 61, is our co-founder and has been Chairman and Director
since our inception. Mr. Herrick served as our President from our inception
until January 1996 and was Chief Executive Officer from January 1996 through
January 2000. Mr. Herrick has been a private businessman for over 30 years and
through his wholly-owned affiliates, Mr. Herrick has completed transactions,
including building, managing and marketing primarily real estate valued at an
aggregate of approximately $2 billion. Mr. Herrick serves on the advisory board
of the Make-A-Wish Foundation, the advisory committee of the National Multi
Housing Council and the National Board of Directors for People for the American
Way. Mr. Herrick is the father of Michael Herrick, our Chief Executive Officer,
President, and a director, and Howard Herrick, our Executive Vice President and
a director.
Michael Herrick, 32, is our co-founder and has been our Chief Executive
Officer and President since January 2000 and a director since our inception.
Mr. Herrick was our Co-Chief Executive Officer from April 1998 to January 2000
and has held various other offices with us since our inception. Since August
1993, Michael Herrick has been an officer (since January 1994, Vice President)
of the corporate general partner of a limited partnership which is a principal
shareholder of The Walking Company, a nationwide retailer of comfort and
walking footwear and related apparel and accessories. Mr. Herrick is a member
of the Board of Directors of the Audio Publisher's Association. Mr. Herrick is
the son of Norton Herrick, our Chairman, and brother of Howard Herrick, our
Executive Vice President and a director. Mr. Herrick received his B.A. degree
from the University of Michigan.
Stephen M. McLaughlin, 33, has been our Executive Vice President and Chief
Technology Officer since February 1999. Prior to joining us, Mr. McLaughlin was
Vice President, Information Technology for Preferred Healthcare Staffing, Inc.,
a nurse-staffing division of Preferred Employers Holdings, Inc. Mr. McLaughlin
co-founded and was a director, Chief Operating Officer and Chief Information
Officer of NET Healthcare, Inc., from 1997 until it was acquired by Preferred
Employers Holdings in August 1998. In 1994, Mr. McLaughlin founded FX Media,
Inc., an Internet and multimedia development company. As CEO of FX Media, he
served as senior software engineer for all of its projects. Mr. McLaughlin
holds a degree in Computer Science and Engineering from the Massachusetts
Institute of Technology and conducted research at the MIT Media and Artificial
Intelligence labs.
Howard Herrick, 34, is our co-founder and has been our Executive Vice
President, Editorial Director and a director since our inception. Since August
1993, Howard Herrick has been Vice President of the corporate general partner
of a limited partnership which is a principal shareholder of The Walking
Company. Since 1988, Mr. Herrick has been an officer of The Herrick Company,
Inc. and is currently its President. Mr. Herrick is also an officer of the
corporate general partners of numerous limited partnerships which acquire,
finance, manage and lease office, industrial and retail properties; and which
acquire, operate, manage, redevelop and sell residential rental properties. Mr.
Herrick is the son of Norton Herrick, our Chairman and brother of Michael
Herrick, our Chief Executive Officer, President and director.
42
<PAGE>
John F. Levy, 44, has been our employee since November 1997 and has served
as our Executive Vice President and Chief Financial Officer since January 1998.
Prior to joining us, Mr. Levy was Senior Vice President of Tamarix Capital
Corporation and had previously served as Chief Financial Officer of both public
and private entertainment and consumer goods companies. During 1994, Mr. Levy
served as Chief Financial Officer of the Continuum Entertainment Group, Inc., a
publicly-held record label which filed for protection under Chapter 11 of the
United States Bankruptcy Code in 1995 after Mr. Levy had left that company. Mr.
Levy is a Certified Public Accountant with nine years experience with the
national public accounting firms of Ernst & Young, Laventhol & Horwath and
Grant Thornton.
Robert Toro, 35, has been our Senior Vice President of Finance since July
1999 and an employee since April 1999. Prior to joining us, Mr. Toro was Senior
Vice President of AM Cosmetics Co. and had previously served in senior
financial positions in both public and private entertainment and publishing
companies. From 1992 through early 1997, Mr. Toro served in various senior
financial positions with Marvel Entertainment Group, Inc., a publicly traded
youth entertainment company. Mr. Toro is a Certified Public Accountant with six
years of progressive experience with the national public accounting firm of
Arthur Andersen where he was employed immediately prior to joining Marvel
Entertainment Group.
Jesse Faber, 45, has been President of Audio Book Club, Inc. since January
2000 and a director since October 1997. Mr. Faber was our President from
October 1996 through January 2000. From 1989 to October 1996, Mr. Faber was
Senior Vice President and Partner of AyerDirect, a direct response advertising
agency wholly-owned by McManus, Inc., one of the ten largest advertising and
marketing agencies in the world.
Carl P. Amari, 36, has been the President of Radio Operations since we
acquired our old time radio and classic video operations in December 1998 and a
director of MediaBay since September 1999. Since 1989, Mr. Amari was the CEO
and principal shareholder of Radio Spirits, Inc. Radio Spirits is recognized as
the largest company in the world specializing in the syndication, sales and
licensing of old time radio programming. He is also the executive producer of a
nationally syndicated version of "When Radio Was" which airs on 450 affiliates,
as well as for three other related syndicated radio programs. Radio Spirits
twice made Inc's list of the fastest growing privately held companies. In
connection with our acquisition of Radio Spirits, Inc. from Mr. Amari, Norton
Herrick agreed to vote his shares to elect Mr. Amari as a director.
Roy Abrams, 56, has been a director of MediaBay since October 1997. Since
April 1993 and from 1986 through March 1990, Mr. Abrams has owned and operated
Abrams Direct Marketing, a marketing consulting firm.
Carl T. Wolf, 56, has been a director of MediaBay since March 1998. Mr.
Wolf is the managing partner of the Lakota Investment Group. Mr. Wolf was
formerly Chairman of the Board, President and Chief Executive Officer of Alpine
Lace Brands, Inc. Mr. Wolf founded Alpine Lace and its predecessors and had
been the Chief Executive Officer of each of them since the inception of Alpine
Lace in 1983. Mr. Wolf became a director of Alpine Lace shortly after its
incorporation in February 1986.
Our Board of Directors is classified into three classes, each with a term
of three years, with only one class of directors standing for election by the
shareholders in any year. Norton Herrick and Jesse Faber are Class I directors
and stand for re-election at the 2001 annual meeting of shareholders, Michael
Herrick, Roy Abrams and Carl Amari are Class II directors and stand for
re-election at the 2002 annual meeting of shareholders and Howard Herrick and
Carl Wolf are Class III directors and stand for re-election at the 2000 annual
meeting of shareholders. Our executive officers serve at the direction of the
Board and until their successors are duly elected and qualified.
We have agreed with L.H. Friend, Weinress, Frankson & Presson, LLC who
conducted our October 1997 initial public offering, to use our best efforts to
nominate and elect one director designated by the underwriters to serve on our
Board of Directors. This agreement expires on October 22, 2000. To date, they
have not exercised this right. Our Board of Directors held one meeting during
the fiscal year ended December 31, 1999. The meeting was attended by all of the
directors, either in person or by telephone. The Board also took action by
unanimous written consent in lieu of meetings.
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<PAGE>
Board Committee
We have established an Audit Committee, which is responsible for making
recommendations concerning the engagement of independent public accountants,
reviewing the plans and results of the audit engagement with the independent
public accountants, approving professional services provided by the independent
public accountants and reviewing the adequacy of our internal accounting
controls. The Audit Committee is currently comprised of Messrs. Michael
Herrick, Roy Abrams and Carl T. Wolf. We do not have standing compensation or
nominating committees.
We reimburse our directors for reasonable travel expenses incurred in
connection with their activities on our behalf, but we do not pay our directors
any fees for Board participation.
Executive Compensation
The following table discloses, for the periods indicated, compensation
paid to our Chief Executive Officers and other executive officers whose salary,
together with any bonus, exceeded $100,000 during the fiscal year ended
December 31, 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term Compensation Awards
------------------------------
Annual Compensation
-------------------------------- Securities Underlying
Name and Principal Position Year Salary Bonus Options/SAR's (#)
- --------------------------------------- ------ ----------- --------- ------------------------------
<S> <C> <C> <C> <C>
Norton Herrick ........................ 1998 $100,000 $ 0 1,000,000
Chairman 1997 19,354 0 0
1996 0 0 0
Michael Herrick ....................... 1998 125,000 0 250,000
Chief Executive Officer and President 1997 72,879 0 0
1996 59,500 0 0
Jesse Faber ........................... 1998 140,000 35,000 50,000
President of Audio Book Club, Inc. 1997 128,417 40,000 50,000
1996 15,062 25,000 0
Howard Herrick ........................ 1998 125,000 0 250,000
Executive Vice President 1997 115,129 0 0
1996 102,000 0 0
John F. Levy .......................... 1998 137,083 7,500 50,000
Executive Vice President and Chief 1997 19,125 0 0
Financial Officer 1996 0 0 0
</TABLE>
Norton Herrick served as our Chief Executive Officer during the years
presented in the above table and Michael Herrick served as Co-Chief Executive
Officer from April 1998 through January 2000 and has served as Chief Executive
Officer and President since January 2000. Jesse Faber served as our President
from October 1996 through January 2000 and is currently President of Audio Book
Club, Inc.
The 50,000 options reflected above for Mr. Faber were originally granted
in the fiscal year ended December 31, 1997, but their exercise price was
reduced during the fiscal year ended December 31, 1998 to the fair market value
of the underlying common stock at the time of repricing. The options reflected
in the above table do not include warrants issued to Norton Herrick in
connection with financing provided by Mr. Herrick. For more information about
these warrants, see "Related Party Transactions."
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<PAGE>
The following table discloses options granted during the fiscal year ended
December 31, 1998 to these executives:
Option/SAR Grants in Fiscal Year Ending December 31, 1998
<TABLE>
<CAPTION>
Number of
Shares Underlying % of Total Options Granted to Exercise Price
Name Options Granted Employees in Fiscal Year ($/share) Expiration Date
- ------------------------- ------------------- ------------------------------- --------------- ---------------------------
<S> <C> <C> <C> <C>
Norton Herrick .......... 250,000 13.8 $ 3.50 6/16/03
750,000 41.5 $ 5.25 9/10/03
Michael Herrick ......... 100,000 5.5 $ 3.50 2/09/03
150,000 8.3 $ 7.88 11/05/03
Jesse Faber ............. 50,000(1) 2.8 $ 3.50 Five Years from Vesting(1)
Howard Herrick .......... 100,000 5.5 $ 3.50 2/09/03
150,000 8.3 $ 7.88 11/05/03
John F. Levy ............ 30,000(2) 1.7 $ 3.50 Five Years from
20,000(3) 1.1 $ 3.50 Vesting(2)(3)
</TABLE>
- ------------
(1) On September 17, 1997, we granted to Mr. Faber options to purchase 50,000
shares of our common amount stock at an exercise price of $11.00 per
share, which amount was in excess of fair market value on the date of
grant. In June 1998, the exercise price of the options was reduced to the
fair market value of the underlying common stock on that date. Those
options vest annually in equal one-fifth increments commencing on October
31, 1998 and are exercisable for a period of five years commencing
immediately upon the applicable vesting period. However, the options shall
terminate and be canceled if Mr. Faber is no longer employed by us prior
to the date on which the options vest.
(2) One third of the 30,000 options granted to Mr. Levy vested on January 1,
1999, and the balance will vest on January 1, 2000. All of the options are
exercisable for a period of five years commencing immediately upon the
applicable vesting period, subject to earlier expiration if Mr. Levy is
not employed by us.
(3) One half of the 20,000 options granted to Mr. Levy vested on June 16, 1999,
and the balance will vest on June 16, 2000. All of the options are
exercisable for a period of five years commencing immediately upon the
applicable vesting period, subject to earlier expiration if Mr. Levy is
not employed by us.
The following table sets forth information concerning the number of
options owned by these executives and the value of any in-the-money unexercised
options as of December 31, 1998. No options were exercised by any of these
executives during fiscal 1998:
Aggregated Option Exercises And Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Underlying
Value of Unexercised
Unexercised Options at In-the-Money
December 31, 1998 Options at December 31, 1998
------------------------------- ------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------------------- ------------- --------------- ------------- --------------
<S> <C> <C> <C> <C>
Norton Herrick .......... 1,000,000 0 $6,812,500 $ 0
Michael Herrick ......... 250,000 0 1,374,250 0
Jesse Faber ............. 10,000 40,000 81,250 325,000
Howard Herrick .......... 250,000 0 1,374,250 0
John F. Levy ............ 10,000 40,000 81,250 325,000
</TABLE>
The year-end values for unexercised in-the-money options represent the
positive difference between the exercise price of such options and the fiscal
year end market value of the common stock. An option is "in-the-money" if the
fiscal year-end fair market value of the common stock exceeds the option
exercise price. The closing sale price of our common stock on December 31, 1998
was $11.625.
45
<PAGE>
Employment Agreements
Effective as of October 22, 1999, we entered into a one-year employment
agreement with Norton Herrick which provides for an annual base salary of
$100,000 and such increases and bonuses as the Board of Directors may determine
from time to time. The employment agreement does not require that Mr. Herrick
devote any stated amount of time to our business and activities and contains
noncompetition and nonsolicitation provisions for the term of the employment
agreement and for two years thereafter. If Mr. Herrick's employment is
terminated under circumstances described in the employment agreement, including
as a result of a change in control, Mr. Herrick will be entitled to receive
severance pay equal to the greater of $600,000 or six times the total
compensation received by Mr. Herrick from us during the twelve months prior to
the date of termination. If the severance payment is triggered, it is possible
that the payments may be deemed "excess parachute payments" under Section
280(g) of the Internal Revenue Code and, as a result, we may not receive a tax
deduction for those payments.
Effective October 22, 1997, we entered into three-year employment
agreements with each of Michael Herrick and Howard Herrick which provide for an
annual base salary of $125,000 and such increases and bonuses as the Board of
Directors may determine from time to time. The employment agreements require
each of Michael and Howard Herrick to devote substantially all of his business
time to our business and affairs. The agreements contain noncompetition and
nonsolicitation provisions for the term of the employment agreements and for
two years thereafter. In the event of termination of employment under
circumstances described in the employment agreements, including as a result of
a change in control, we will be required to provide severance pay equal to the
greater of $375,000 or three times the total compensation received from us
during the twelve months prior to the date of termination.
On October 22, 1999, we entered into an employment agreement with Jesse
Faber which provides for an annual base salary of $165,000. The agreement
expires on October 31, 2000 and provides for a bonus of $55,000 payable if Mr.
Faber is employed by us at the end of the term. Pursuant to the agreement, we
granted to Mr. Faber options to purchase 10,000 shares of the common stock at
an exercise price of $12.00 per share. The options vest on October 31, 2000,
provided that Mr. Faber is employed by us on such date.
We have entered into a two-year employment agreement with John Levy which
expires in November 2001. The agreement provides for an annual base salary of
$165,000, in the first year of the agreement and an annual base compensation of
$180,000 in the second year of the agreement. Mr. Levy's agreement also
provides for a minimum bonus of $15,000 in the first year of the agreement and
a minimum bonus of $17,500 in the second year of the agreement, provided Mr.
Levy is employed by us on each bonus date. Pursuant to the agreement, we agreed
to grant to Mr. Levy options to purchase 30,000 shares of common stock at an
exercise price of $13.00 per share. Options for 10,000 shares vest at the end
of the first year of the employment agreement and options for 20,000 shares
vest at the end of the second year of employment, provided Mr. Levy is employed
by us on the vesting dates. However, in the event of a change in control, all
options shall immediately vest and become exercisable.
We entered into a two-year employment agreement with Stephen McLaughlin,
effective February 15, 1999, which provides for an annual base salary of
$150,000, a performance-based bonus of $15,000 payable if Mr. McLaughlin is
employed by us at the end of the first year of the employment term, $10,000
reimbursement for moving expenses and a $35,000 interest free loan. Pursuant to
the agreement, we granted to Mr. McLaughlin options to purchase 150,000 shares
of the common stock at an exercise price of $9.75 per share and options to
purchase 8,000 shares of the common stock at an exercise price of $0.10 per
share. The 8,000 options exercisable at $0.10 per share vested on February 15,
1999. The 150,000 options exercisable at $9.75 vest as follows: options for
25,000 shares vested on February 15, 1999; options for 25,000 shares vest on
February 15, 2000; options for 30,000 shares vest on February 15, 2001; and
options for 35,000 shares vest on each of February 15, 2002 and February 15,
2003.
In December 1998, we entered into a three-year employment agreement with
Carl Amari. Pursuant to the agreement, Mr. Amari is entitled to receive a base
salary of $200,000 per year during the first 18 months of the agreement and
$300,000 per year during the second 18 months of the agreement. The agreement
also provides that Mr. Amari shall also be appointed as a member of our Board
of Directors for as long as he is employed by us.
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<PAGE>
Stock Plans
Our 1997 Stock Option Plan provides for the grant of stock options to
purchase up to 2,000,000 shares. As of January 19, 2000, options to purchase an
aggregate of 1,986,100 shares of our common stock have been granted under the
1997 plan.
Our 1999 Stock Incentive Plan provides for the grant of any or all of the
following types of awards: (1) stock options, which may be either incentive
stock options or non-qualified stock options, (2) restricted stock, (3)
deferred stock and (4) other stock-based awards. A total of 2,500,000 shares of
common stock have been reserved for distribution pursuant to the 1999 plan. As
of January 19, 2000, options to purchase an aggregate of 1,877,350 shares of
our common stock have been granted under the 1999 plan.
Limitation on Liability and Indemnification Matters
Our Articles of Incorporation and By-Laws provide that we shall indemnify,
and upon request shall advance expenses to, our directors and officers to the
fullest extent permitted by the Florida Business Corporation Act. Our Articles
of Incorporation also include a provision that limits, to the fullest extent
now or hereafter permitted by the Florida Act, the personal liability of our
directors to us or our shareholders for monetary damages arising from a breach
of their fiduciary duties as directors. The Florida Act provides that no
director or officer shall be personally liable to us or our shareholders for
damages for breach of any duty owed to us or our shareholders, except for
liability for (1) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (2) any unlawful payment
of a dividend or unlawful stock repurchase or redemption in violation of the
Florida Act, (3) any transaction from which the director received an improper
personal benefit or (4) a violation of a criminal law.
We have entered into indemnification agreements with some of our
employees, officers and consultants in which we have agreed to indemnify them,
to the fullest extent permitted under law, against any amounts which the
employee, officer or consultant may become legally obligated to pay in
connection with any claim relating to any services performed on our behalf and
some related expenses. However, each employee, officer or consultant shall be
required to reimburse us if the individual is found not to have been entitled
to such indemnification, as finally judicially determined by a court of
competent jurisdiction.
Insofar as indemnification for liabilities arising under the Securities
Act of 1993 may be permitted to our directors, officers and controlling persons
pursuant to any charter provision, by-law, contract, arrangement, statute or
otherwise, we have been advised that, in the opinion of the SEC, such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
47
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth information regarding the beneficial
ownership of common stock, based on information provided by the persons named
below in publicly available filings, as of January 28, 2000 and as adjusted to
reflect the completion of this offering by:
o each of MediaBay's directors and executive officers;
o all directors and executive officers of MediaBay as a group; and
o each person who is known by MediaBay to beneficially own more than five
percent of our outstanding shares of common stock.
Unless otherwise indicated, the address of each beneficial owner is care
of MediaBay, Inc., 20 Community Place, Morristown, New Jersey 07960. Unless
otherwise indicated, we believe that all persons named in the following table
have sole voting and investment power with respect to all shares of common
stock that they beneficially own.
For purposes of this table, a person is deemed to be the beneficial owner
of the securities that person can acquire upon the exercise of options,
warrants or other convertible securities within 60 days of the date of this
prospectus. In determining the percentage ownership of the persons in the table
above, we assumed in each case that the person exercised and converted all
options, warrants or convertible securities which are currently held by that
person and which are exercisable within 60 days of the date of this prospectus,
but that options, warrants or other convertible securities held by all other
persons were not exercised or converted.
As of the date of this prospectus, 9,538,159 shares of our common stock
were issued and outstanding.
<TABLE>
<CAPTION>
Percentage of Shares
Beneficially Owned
Number of Shares -----------------------------------
Name and Address of Beneficial Owner Beneficially Owned Before Offering After Offering
- -------------------------------------------------- -------------------- ----------------- ---------------
<S> <C> <C> <C>
Norton Herrick ................................... 3,696,660(1) 29.0% 22.1%
Howard Herrick ................................... 3,602,640(2) 36.2 25.8
Michael Herrick .................................. 1,038,460(3) 10.3 7.4
Quantum Partners LDC ............................. 750,000 7.9 5.5
Kaya Flamboya
Willemsted, Curacao
Netherlands, Antilles
President and Fellows of Harvard College ......... 700,000 7.3 5.2
c/o Harvard Management Company, Inc.
600 Atlantic Avenue
Boston, Massachusetts 02210
Carl P. Amari .................................... 447,875(4) 4.7 3.3
Carl T. Wolf ..................................... 102,750(5) 1.1 *
Stephen M. McLaughlin ............................ 58,300(6) * *
John F. Levy ..................................... 41,000(7) * *
Jesse Faber ...................................... 30,000(8) * *
Roy Abrams ....................................... 10,000(9) * *
Robert Toro ...................................... 0(10) * *
All directors and executive officers as a group
(10 persons) 8,539,225 61.1% 47.5%
</TABLE>
- ------------
* Less than 1%
48
<PAGE>
(1) Represents (a) 8,200 shares of common stock held by Norton Herrick, (b)
488,460 shares of common stock held by Howard Herrick, (c) 2,075,000
shares of common stock issuable upon exercise of options, (d) 150,000
shares of common stock issuable upon exercise of options granted to Evan
Herrick and (e) 975,000 shares of common stock issuable upon exercise of
warrants issued on December 31, 1998. Does not include 2,714,180 shares
held by the Norton Herrick Irrevocable Trust. Evan Herrick has irrevocably
granted to Norton Herrick sole voting and dispositive power with respect
to the shares of common stock issuable upon exercise of the options held
by Evan Herrick.
(2) Represents (a) 2,714,180 shares held by the Norton Herrick Irrevocable ABC
Trust, (b) 488,460 shares of common stock held by Howard Herrick, and (c)
400,000 shares of common stock issuable upon exercise of options. Howard
Herrick is the sole trustee and Norton Herrick is the sole beneficiary of
the Norton Herrick Irrevocable ABC Trust. The trust agreement provides
that Howard Herrick shall have sole voting and dispositive power over the
shares held by the trust. Howard Herrick has irrevocably granted to Norton
Herrick sole dispositive power with respect to the shares of common stock
held by Howard Herrick.
(3) Represents 488,460 shares and 550,000 shares of common stock issuable upon
exercise of options.
(4) Represents 395,125 shares of common stock and options to purchase 52,750
shares of common stock held by Mr. Amari. Does not include options to
purchase 100,000 shares of common stock held in escrow subject to release
to Mr. Amari if specific earnings performance targets are met by our old
time radio and classic video operations acquired from Mr. Amari.
(5) Includes 5,000 shares of common stock and 97,500 shares of common stock
issuable upon exercise of options.
(6) Represents 300 shares and 58,000 shares of common stock issuable upon
exercise of options. Does not include 100,000 shares of common stock
issuable upon exercise of options.
(7) Represents 1,000 shares of common stock and 40,000 shares of common stock
issuable upon exercise of options. Does not include 40,000 shares issuable
upon exercise of options.
(8) Represents shares of common stock issuable upon exercise of options. Does
not include 40,000 shares of common stock issuable upon exercise of
options.
(9) Represents shares of common stock issuable upon exercise of options.
(10) Does not include 50,000 shares issuable upon exercise of options.
49
<PAGE>
RELATED PARTY TRANSACTIONS
Companies wholly-owned by Norton Herrick, our Chairman, have in the past
provided accounting, administrative and general office services to us and
obtained insurance coverage for us at cost since our inception. We paid these
entities $60,000, $73,000 and $42,000 for these services during the years ended
December 31, 1997 and 1998 and the nine months ended September 30, 1999
respectively. In addition, a company wholly-owned by Norton Herrick provides us
access to a corporate airplane. We generally pay the fuel, fees and other costs
related to our use of the airplane directly to the service providers. For use
of this airplane, we paid rental fees of less than $25,000 in 1998 and
approximately $10,000 the nine months ended September 30, 1999 to Mr. Herrick's
affiliate. We anticipate obtaining similar services from time to time from
companies affiliated with Norton Herrick, and we will reimburse their costs in
providing the services to us.
On March 18, 1998, we sold to Carl Wolf, one of our directors, a five-year
option to purchase 50,000 shares of our common stock at an exercise price of
$5.00 per share, the market value on the purchase date. The purchase price of
the option was $50,000. We also granted to Mr. Wolf the right to acquire a
second five-year option to purchase 25,000 shares at an exercise price of $5.00
per share for $25,000. Mr. Wolf exercised this right and purchased the
additional option in September 1998.
In December 1998, we acquired Radio Spirits, Inc. from Carl Amari, who
subsequently became one of our directors, as described under "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Recent Acquisitions and Financings."
In December 1998, we obtained a portion of the financing for our
acquisitions of Columbia House's Audiobook Club and our old time radio and
classic video operations from Norton Herrick by issuing him a $15.0 million
principal amount 9% convertible subordinated promissory note due December 31,
2004. In January 1999, we repaid $1.0 million of the note. In August 1999, Mr.
Herrick sold $5.0 million principal amount of the note to a third party.
Interest on this note is payable monthly. The note was initially convertible,
in whole or in part, at the holder's option, into shares of our common stock at
$11.125 per share. As additional consideration for the bridge loan, we issued
to Mr. Herrick five-year warrants to purchase 500,000 shares of our common
stock at an exercise price of $12.00 per share, subject to adjustment. Because
the bridge loan was not refinanced, repaid or replaced by September 30, 1999,
(1) the interest rate of the note increased to 11%, (2) the conversion price of
the note was adjusted to the lesser of $11.125 per share and the average
closing bid price of our common stock for the five trading days prior to
conversion and (3) the exercise price of the warrants was adjusted to $8.41.
The additional 2% interest on the note through December 31, 1999 is being added
to the principal amount of the note and is due on the maturity of the note, and
the additional 2% interest commencing January 1, 2000 is payable monthly. The
note is subordinated to our obligations under our credit facility with Fleet
and ING and is secured by a second lien security interest on assets of our old
time radio and classic video operations. The terms of Mr. Herrick's loan to us
were approved by the independent members of our Board of Directors. We also
received a fairness opinion in connection with this loan.
In December 1998, we also agreed that if the note is refinanced, repaid or
replaced by anyone other than Norton Herrick or a family member or affiliate of
Mr. Herrick, we will issue to Mr. Herrick warrants to purchase an additional
350,000 shares of our common stock on the same terms as those issued to him in
December 1998. In September 1999, we issued to Mr. Herrick warrants to purchase
140,000 shares of our common stock at a price of $8.41 per share.
In December 1999 and January 2000, Norton Herrick sold $4,223,750
principal amount of the note issued to him in December 1998 to a third party
and, in January 2000, we issued to the third party warrants to purchse 340,000
shares of our common stock at an exercise price of $12.50 per share. Under the
December 1998 agreement, we issued to Mr. Herrick warrants to purchase 98,554
shares of our common stock at an exercise price of $8.41 per share on terms
which were identical to the warrants issued to Mr. Herrick in December 1998.
Upon the repayment of the remaining $4,776,250 owed to Mr. Herrick under the
note with a portion of the proceeds of this offering, under the December 1998
agreement we will issue to Mr. Herrick warrants to purchase 111,446 shares of
our common stock at an exercise price of $8.41 per share on terms which are
identical to the warrants issued to Mr. Herrick in December 1998.
50
<PAGE>
In June 1999, we obtained a portion of the financing for our acquisition
of the business of Doubleday Direct's Audiobooks Direct club through a $4.4
million loan from Norton Herrick. In connection with this loan, we agreed,
subject to shareholder approval, that we would issue to Mr. Herrick warrants to
purchase 125,000 shares of our common stock at an exercise price of $8.41 per
share and on the same terms as the warrants issued to him in December 1998.
This loan was intended to be a bridge financing and was repaid in full in July
1999. Shareholder approval was obtained in September 1999, and we issued the
warrants to Mr. Herrick.
In December 1999 and January 2000, Evan Herrick, loaned the Company $2.0
million for which he received $2.0 million principal amount 9% convertible
promissory notes due December 31, 2004. The notes are convertible into shares
of our common stock at $11.25 per share. We intend to repay these notes from
the proceeds of this offering. Evan Herrick is Norton Herrick's son and Michael
Herrick's and Howard Herrick's brother.
We lease office space in New Jersey and Florida from affiliates of Norton
Herrick and other facilities in Illinois from Carl Amari. The terms of these
leases are described under "Business-Properties."
Companies affiliated with Norton Herrick may continue to provide
accounting and general and administrative services to us, provide us with
access to a corporate airplane and obtain insurance coverage for us at cost. It
is our policy that each transaction between us and our officers, directors and
5% or greater shareholders will be on terms no less favorable than could be
obtained from independent third parties.
51
<PAGE>
DESCRIPTION OF CAPITAL STOCK
General
We are authorized to issue 75,000,000 shares of common stock, no par
value, and 5,000,000 shares of preferred stock, no par value. As of January 28,
2000, there were 9,538,159 shares of common stock outstanding and no shares of
preferred stock outstanding.
Common Stock
The holders of our common stock are entitled to one vote per share on all
matters submitted to a vote of the shareholders, including the election of
directors, and, subject to preferences that may be applicable to any preferred
stock outstanding at the time, are entitled to receive ratably dividends, if
any, as may be legally declared from time to time by the board of directors. In
the event of liquidation or dissolution of MediaBay, the holders of common
stock are entitled to receive all assets available for distribution to the
shareholders, subject to any preferential rights of the holders of any
preferred stock then outstanding. The holders of our common stock have no
preemptive, subscription, conversion or redemption rights. The rights,
preferences and privileges of the holders of our common stock are subject to,
and may be adversely affected by, the right of the holders of any shares of
preferred stock which our board of directors may designate in the future.
Preferred Stock
Authorized but undesignated shares of preferred stock may be issued from
time to time in one or more series upon authorization by our board of
directors. Our board of directors, without further approval of the
shareholders, is authorized to fix the dividend rights and terms, conversion
rights, voting rights, redemption rights and terms, liquidation preferences,
and other rights, preferences, privileges and restrictions applicable to each
series of preferred stock. The issuance of preferred stock, while providing
flexibility in connection with possible acquisitions and other corporate
purposes could adversely affect the voting power of the holders of common stock
and make it more difficult for a third party to gain control of MediaBay,
prevent or substantially delay a change of control, discourage bids for our
common stock at a premium or otherwise adversely affect the market price of our
common stock.
Other Securities
Our 1997 Stock Option Plan provides for the grant of options to purchase up
to 2,000,000 shares of common stock. A total of 2,500,000 shares of common stock
have been reserved for distribution pursuant to our 1999 Stock Incentive Plan.
We have issued options to purchase an aggregate of 3,864,450 shares of common
stock at a weighted average price of $8.23 per share pursuant to the 1997 Stock
Option Plan and the 1999 Stock Incentive Plan. We have also issued non-plan
options and warrants to purchase approximately 3.8 million shares of common
stock at a weighted average price of approximately $11.00 per share.
Warrants to purchase a total of 197,450 shares at an exercise price of
$9.967 per share and warrants to purchase 119,940 shares at an exercise price
of $14.20 per share are subject to antidilution adjustment provisions for the
exercise price and number of warrants in connection with issuances below market
price, including the issuance of shares in this offering.
Warrants to purchase a total of 975,000 shares held by Norton Herrick, our
Chairman, are subject to anti-dilution protection for issuances below their
exercise price, currently $8.41 per share.
The conversion price of a $4.8 million convertible promissory note that
will be outstanding after this offering is subject to anti-dilution protection
for issuances of securities below the conversion price, currently $11.125 per
share. The conversion price of the convertible promissory note may be adjusted
as a result of this offering.
As a result of this offering, the number of shares of common stock
issuable upon exercise of outstanding warrants or upon conversion of the note
may increase, and the exercise or conversion prices may decrease as a result of
future issuances of our securities.
52
<PAGE>
Anti-Takeover Provisions under Florida Law
We are subject to several anti-takeover provisions under Florida law that
apply to public corporations organized under Florida law unless the corporation
has elected to opt out of those provisions in its articles of incorporation or
its bylaws. We have not elected to opt out of these provisions.
The Florida Business Corporation Act prohibits the voting of shares in a
publicly-held Florida corporation that are acquired in a "control share
acquisition" unless the board of directors approves the control share
acquisition or the holders of a majority of the corporation's voting shares
approve the granting of voting rights to the acquiring party. A "control share
acquisition" is defined as an acquisition that immediately thereafter entitles
the acquiring party, directly or indirectly, to vote in the election of
directors within any of the following ranges of voting power:
o 1/5 or more but less than 1/3;
o 1/3 or more but less than a majority; or
o a majority or more.
There are some exceptions to the "control share acquisition" rules.
Florida law also contains an "affiliated transaction" provision that
prohibits a publicly-held Florida corporation from engaging in a broad range of
business combinations or other extraordinary corporate transactions with an
"interested shareholder" unless:
o the transaction is approved by a majority of disinterested directors
before the person becomes an interested shareholder;
o the corporation has not had more than 300 stockholders of record during the
past three years;
o the interested shareholder has owned at least 80% of the corporation's
outstanding voting shares for at least five years;
o the interested shareholder is the beneficial owner of at least 90% of the
voting shares (excluding shares acquired directly from the corporation
in a transaction not approved by a majority of the disinterested
directors);
o consideration is paid to the holders of the corporation's shares equal to
the highest amount per share paid by the interested shareholder for the
acquisition of the corporation's shares in the last two years or fair
market value, and other specified conditions are met; or
o the transaction is approved by the holder of two-thirds of the company's
voting shares other than those owned by the interested shareholder.
An "interested shareholder" is defined as a person who, together with
affiliates and associates, beneficially owns more than 10% of a company's
outstanding voting shares. Florida law defines "beneficial ownership" in more
detail.
Classified Board of Directors
Our by-laws divide our board of directors into three classes, serving
staggered three-year terms. The staggered terms of the classes of directors may
make it more difficult for a third party to gain control of our board or to
acquire MediaBay and may discourage bids for our common stock at a premium. In
addition, our Articles of Incorporation provide that shareholders may not call
special meetings of shareholders unless they represent at least 25% of our
outstanding voting shares of stock.
Transfer Agent
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company, New York, New York.
53
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
The market price of our common stock could drop due to sales of large
number of shares of our common stock or the perception that these sales could
occur. These factors could also make it more difficult to raise funds through
future offerings of common stock.
After this offering, 13,538,159 shares of common stock will be outstanding
(14,138,159 shares if the underwriters exercise their over-allotment option in
full). Of these shares, 7,520,282 shares (8,120,282 shares if the underwriters
exercise their over-allotment option in full), including the 4,000,000 shares
sold in this offering, will be freely tradeable without restriction under the
Securities Act, except for any shares purchased by any of our affiliates, as
that term is defined in Rule 144 under the Securities Act. The remaining
6,017,877 shares are restricted securities within the meaning of Rule 144 under
the Securities Act. The restricted securities generally may not be sold unless
they are registered under the Securities Act or are sold pursuant to an
exemption from registration, such as the exemption provided by Rule 144 under
the Securities Act. Approximately 2.3 million of these restricted shares, plus
an approximately 3.2 million additional shares issuable upon exercise of
outstanding options, warrants and convertible notes, are currently registered
for resale and may, subject to lock-up agreements with the managing underwriter,
as described below, be sold in the public market by their holders.
Our officers and directors, their affiliates, our employees and
consultants and other shareholders have entered into lock-up agreements
pursuant to which they have agreed not to offer or sell any shares of common
stock or securities exercisable or convertible into common stock for periods of
60-180 days after the date of this prospectus without the prior written consent
of the managing underwriter, on behalf of the underwriters. The managing
underwriter may, at any time and without notice, waive any of the terms of
these lock-up agreements specified in the underwriting agreement.
The following table sets forth the approximate number of restricted shares
of common stock, including shares issuable upon exercise or conversion of
outstanding options, warrants and convertible securities, and the dates on
which these shares become available for resale in the public market.
<TABLE>
<CAPTION>
Approximate
Number of
Restricted Shares Date of availability of restricted shares for resale into public market
- ------------------- ------------------------------------------------------------------------------------
<S> <C>
- ------ Immediately available.
- ------ 60-180 days after the date of this prospectus due to lock-up agreements with the
managing underwriter.
</TABLE>
In general, under Rule 144 as currently in effect, any person (or persons
whose shares are aggregated), including an affiliate, who has beneficially
owned shares for a period of at least one year is entitled to sell, within any
three-month period, a number of shares that does not exceed the greater of
o 1% of the then-outstanding shares of common stock and
o the average weekly trading volume in the common stock during the four
calendar weeks immediately preceding the date on which the notice of such
sale on Form 144 is filed with the SEC.
Sales under Rule 144 are also subject to provisions relating to notice and
manner of sale and the availability of current public information about us.
In addition, a person (or persons whose shares are aggregated) who has not
been an affiliate of ours at any time during the 90 days immediately preceding
a sale, and who has beneficially owned the shares for at least two years, would
be entitled to sell such shares under Rule 144(k) without regard to the volume
limitation and other conditions described above. Therefore, unless otherwise
restricted, Rule 144(k) shares may be sold immediately upon the completion of
this offering. The foregoing summary of Rule 144 is not intended to be a
complete description.
54
<PAGE>
UNDERWRITING
We have entered into an underwriting agreement with the underwriters named
below, for whom Cruttenden Roth Incorporated and L.H. Friend, Weinress, Frankson
& Presson, LLC are acting as representatives. We are obligated to sell, and the
underwriters are obligated to purchase, all of the shares offered on the cover
page of this prospectus, if any are purchased. Subject to certain conditions of
the underwriting agreement, each underwriter has severally agreed to purchase
the shares indicated opposite its name:
Number
Underwriters of Shares
- -------------------------------------------------------- ----------
Cruttenden Roth Incorporated ...........................
L.H. Friend, Weinress, Frankson & Presson, LLC .........
----------
Total ...............................................
The underwriters may sell more shares than the total number of shares
offered on the cover page of this prospectus and they have, for a period of 45
days from the date of this prospectus, an over-allotment option to purchase up
to 600,000 additional shares from us. If any additional shares are purchased,
the underwriters will severally purchase the shares in the same proportion as
per the table above.
The representatives of the underwriters have advised us that the shares
will be offered to the public at the offering price indicated on the cover page
of this prospectus. The underwriters may allow to selected dealers a concession
not in excess of $.___ per share and such dealers may reallow a concession not
in excess of $.___ per share to certain other dealers. After the shares are
released for sale to the public, the representatives may change the offering
price and the concessions.
We have agreed to pay to the underwriters the following fees, assuming
both no exercise and full exercise of the underwriters' over-allotment option
to purchase additional shares.
<TABLE>
<CAPTION>
Total Fees
--------------------------------------------------------------
Fee Without Exercise of Full Exercise of
Per Share Over-Allotment Option Over-Allotment Option
----------- ----------------------- ----------------------
<S> <C> <C> <C>
Fees paid by us ......... $ $ $
</TABLE>
In addition, we estimate that we will spend approximately $_____in
expenses for this offering. We have agreed to indemnify the underwriters
against certain liabilities, including liabilities under the Securities Act, or
contribute to payments that the underwriters may be required to make in respect
of these liabilities.
Our officers, directors, their affiliates, our employees and some
consultants and other shareholders have entered into lock-up agreements
pursuant to which they have agreed not to offer or sell any shares of common
stock or securities convertible into or exchangeable or exercisable for shares
of common stock for periods ranging from 60 to 180 days from the date of this
prospectus without the prior written consent of Cruttenden Roth Incorporated,
on behalf of the underwriters. Cruttenden Roth Incorporated may, at any time
and without notice, waive the terms of these lock-up agreements specified in
the underwriting agreement.
Cruttenden Roth Incorporated, on behalf of the underwriters, may engage in
the following activities in accordance with applicable securities rules:
o Over-allotments involving sales in excess of the offering size, creating
a short position. Cruttenden Roth Incorporated may elect to reduce this
short position by exercising some or all of the over-allotment option.
o Stabilizing and short covering; stabilizing bids to purchase the shares
are permitted if they do not exceed a specified maximum price. After the
distribution of shares has been completed, short covering purchases in the
open market may also reduce the short position. These activities may cause
the price of the shares to be higher than would otherwise exist in the
open market.
55
<PAGE>
o Penalty bids permitting the representatives to reclaim concessions from a
syndicate member for the shares purchased in the stabilizing or short
covering transactions.
These activities, which may be commenced and discontinued at any time, may
be effected on the Nasdaq National Market, in the over-the-counter market or
otherwise.
We have agreed with L.H. Friend, Weinress, Frankson & Presson, LLC who
conducted our October 1997 initial public offering, to use our best efforts to
nominate and elect one director designated by the underwriters to serve on our
Board of Directors. This agreement expires on October 22, 2000. To date, they
have not exercised this right.
LEGAL MATTERS
Blank Rome Tenzer Greenblatt, New York, New York will pass upon the
validity of the common stock offered by us with this prospectus. Certain legal
matters in connection with this offering have been passed upon for the
underwriters by Klehr, Harrison, Harvey, Branzburg & Ellers LLP, Philadelphia,
Pennsylvania.
EXPERTS
The financial statements of Audio Book Club, Inc. and the related financial
statement schedule as of and for the year ended December 31, 1998 and the
financial statements of The Columbia House Audiobook Club, a division of The
Columbia House Company, as of and for the year ended December 18, 1998 included
in this prospectus have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their reports appearing herein, and are included in
reliance upon the reports of such firm given upon their authority as experts in
accounting and auditing. The report of Deloitte & Touche LLP on the financial
statements of The Columbia House Audiobook Club as of and for the year ended
December 18, 1998 includes an explanatory paragraph stating that the financial
statements have been prepared from the separate records maintained by The
Columbia House Company and may not necessarily be indicative of conditions that
would have existed or results of operations if The Columbia House Audiobook Club
had been operated as an unaffiliated company.
The financial statements of Audio Book Club, Inc. as of December 31, 1997
and for the year ended December 31, 1997 included in the Registration Statement
of which this prospectus is a part have been audited by KPMG LLP, independent
certified public accountants. Such financial statements are included in the
Registration Statement of which this prospectus is a part in reliance upon the
report of KPMG LLP and upon the authority of said firm as experts in accounting
and auditing.
The financial statements of Radio Spirits, Inc. as of December 31, 1997
and for the years then ended are included in this prospectus in reliance on the
report of BD&A Certified Public Accountants, Ltd., independent accountants,
given on the authority of said firm as experts in auditing and accounting.
The audited carve-out financial statements of The Columbia House Audiobook
Club as of December 19, 1997 and December 20, 1996 and for the years then ended
are included in this prospectus in reliance on the report of
PricewaterhouseCoopers, independent accountants, given on the authority of said
firm as experts in auditing and accounting.
The financial statements of Audio Books Direct (a wholly-owned operation of
Doubleday Direct, Inc.) as of June 30, 1998 and June 30, 1997 and for the years
then ended included in the Registration Statement of which this prospectus is a
part have been audited by KPMG LLP, independent certified public accountants.
Such financial statements are included in the Registration Statement of which
this prospectus is a part in reliance upon the report of KPMG LLP and upon the
authority of said firm as experts in accounting and auditing. The report of KPMG
LLP includes an explanatory paragraph stating that the club was operated as an
integral part of Doubleday Direct, Inc. and had no separate legal existence.
ADDITIONAL INFORMATION
We are subject to the reporting requirements of the Securities Exchange
Act of 1934, as amended, and file reports, proxy statements and other
information with the SEC. These reports, proxy statements and other information
may be inspected and copied at the public reference facilities maintained by
the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC's
regional offices located at the Northwestern Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, IL 60661 and Seven World Trade Center, 13th Floor,
New York, New York 10048. You can obtain copies of these materials from the
Public Reference Section of the SEC upon payment of fees prescribed by the SEC.
You may obtain information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. The SEC's Web site contains reports, proxy
and information statements and other information regarding registrants that
file electronically with the SEC. The address of that site is
http://www.sec.gov.
56
<PAGE>
We have filed a registration statement on Form SB-2 with the SEC under the
Securities Act with respect to the securities offered in this prospectus. This
prospectus, which is filed as part of a registration statement, does not
contain all of the information set forth in the registration statement, some
portions of which have been omitted in accordance with the SEC's rules and
regulations. Statements made in this prospectus as to the contents of any
contract, agreement or other document referred to in this prospectus are not
necessarily complete and are qualified in their entirety by reference to each
such contract, agreement or other document which is filed as an exhibit to the
registration statement. The registration statement may be inspected without
charge at the public reference facilities maintained by the SEC, and copies of
such materials can be obtained from the Public Reference Section of the SEC at
prescribed rates.
57
<PAGE>
MediaBay, Inc. (Formerly Audio Book Club, Inc.)
Index to Financial Statements
<TABLE>
<CAPTION>
Page
-----
<S> <C>
Combined Pro Forma Financial Statements
Introduction .......................................................................... F-2
Combined Statement of Operations for the nine months ended September 30, 1999 and
related Notes (unaudited) ............................................................ F-3
Combined Statement of Operations for the year ended December 31, 1998 and related Notes
(unaudited) .......................................................................... F-4
Consolidated Financial Statements of MediaBay, Inc. (formerly Audio Book Club, Inc.)
Consolidated Balance Sheet as of September 30, 1999 (unaudited) ....................... F-5
Consolidated Statements of Operations for the three and nine months ended September
30, 1999 and 1998 (unaudited) ........................................................ F-6
Consolidated Statements of Cash Flows for the nine months ended September 30, 1999 and
1998 (unaudited) ..................................................................... F-7
Notes to Consolidated Financial Statements (unaudited) ................................ F-8
Independent Auditors' Reports ......................................................... F-13
Consolidated Balance Sheets as of December 31, 1998 and 1997 .......................... F-15
Consolidated Statements of Operations for the years ended December 31, 1998 and 1997 .. F-16
Consolidated Statements of Stockholders' Equity (Deficiency) for the years ended
December 31, 1998 and 1997 ........................................................... F-17
Consolidated Statements of Cash Flows for the year ended December 31, 1998 and 1997 ... F-18
Notes to Consolidated Financial Statements ............................................ F-19
Financial Statements of Audio Books Direct (a wholly-owned operation of Doubleday Direct,
Inc.) Independent Auditors' Report ................................................... F-33
Balance Sheets as of June 30, 1998 and 1997 ........................................... F-34
Statements of Operations for the years ended June 30, 1998 and 1997 ................... F-35
Statements of Divisional Deficit for the years ended June 30, 1998 and 1997 ........... F-36
Statements of Cash Flows for the years ended June 30, 1998 and 1997 ................... F-37
Notes to Financial Statements ......................................................... F-38
Carve-Out Financial Statements of The Columbia House Audiobook Club (a Division of the
Columbia House Company)
Independent Auditors' Report .......................................................... F-42
Balance Sheet as of December 18, 1998 ................................................. F-43
Statement of Operations for the fiscal year ended December 18, 1998 ................... F-44
Statement of Cash Flows for the fiscal year ended December 18, 1998 ................... F-45
Notes to Financial Statements ......................................................... F-46
Report of Independent Accountants ..................................................... F-49
Carve-Out Balance Sheet as of December 19, 1997 and December 20, 1996 ................. F-50
Carve-Out Statements of Income for the fiscal years ended December 19, 1997 and
December 20, 1996 .................................................................... F-51
Carve-Out Statements of Cash Flows for the fiscal years ended December 19, 1997 and
December 20, 1996 .................................................................... F-52
Notes to Carve-Out Financial Statements ............................................... F-53
Financial Statements of Radio Spirits, Inc.
Independent Auditors' Report .......................................................... F-57
Balance Sheet as of December 31, 1997 ................................................. F-58
Statement of Income for the year ended December 31, 1997 .............................. F-59
Statement of Retained Earnings for the year ended December 31, 1997 ................... F-60
Statement of Cash Flows for the year ended December 31, 1997 .......................... F-61
Notes to Financial Statements ......................................................... F-62
Schedules of Direct and Indirect Cost of Goods Sold for the year ended
December 31, 1997..................................................................... F-66
Schedules of Selling and Administrative Expenses for the year ended December 31, 1997 . F-67
Schedule II-- Valuation and Qualifying Accounts and Reserves ............................. S-1
</TABLE>
F-1
<PAGE>
Combined Pro Forma Financial Statements
(Unaudited)
The unaudited interim historical financial data presented for MediaBay,
Inc. (formerly Audio Book Club, Inc.) herein gives effect to the purchase of
Doubleday Direct's Audiobooks Direct club on June 15, 1999. Additionally, the
balance sheet and statement of operations for the year ended December 31, 1998
gives effect to the following transactions:
o The acquisitions of Radio Spirits, Inc., the assets of an affiliated
company, Buffalo Productions, Inc., and a 50% interest in a joint venture
owned by the sole shareholder of Radio Spirits on December 14, 1998.
o The acquisition of substantially all of the assets used by Metacom, Inc.
in connection with its Adventures in Cassettes business on December 14,
1998.
o The acquisition of substantially all of the assets used by Premier
Electronic Laboratories, Inc. in connection with its business of
producing, marketing, and selling old time radio and classic video
programs on December 14, 1998.
o The acquisition of substantially all of the assets of Columbia House's
Audiobook Club on December 31, 1998.
The unaudited combined pro forma statement of operations being presented
for the year ended December 31, 1998 combines (1) the results of operations for
MediaBay for the year ended December 31, 1998, which includes the results of
operations for the acquisitions discussed above since the closing dates of the
respective acquisitions; and (2) the results of operations for the latest
12-month period available immediately before the closing date of those
acquisitions; which are as follows: Radio Spirits for the period from January
1, 1998 through December 14, 1998, Metacom for the twelve months ended October
31, 1998, Premier for the twelve months ended October 31, 1998, Columbia
House's Audiobook Club for the year ended December 31, 1998 and Doubleday
Direct's Audiobooks Direct club for the twelve months ended March 31, 1999.
The unaudited combined pro forma statement of operations being presented
for the nine months ended September 30, 1999 combines (1) the historical
consolidated statements of operations of MediaBay and its subsidiaries, which
includes the effect of the acquisitions completed in December 1998 discussed
above for the entire nine month period ended September 30,1999 and the
statement of operations of Audiobooks Direct from the closing date of the
acquisition through September 30, 1999; and (2) Audiobooks Direct's statement
of operations for the six months ended March 31, 1999 as if this acquisition
was completed on January 1, 1999.
The unaudited combined pro forma financial statements are intended for
information purposes only and are not necessarily indicative of the future
financial position or future results of operations of our combined company, or
of the financial position or results of operations of our combined company that
would have actually occurred had the acquisitions taken place as of the date or
for the periods presented. You should also note that the combined pro forma
financial statements do not include any adjustments for any realized or
anticipated elimination of duplicative costs, including but not limited to,
payroll, rent and other general and administrative costs, or economies of scale
resulting from the acquisitions.
These unaudited combined pro forma financial statements should be read in
conjunction with the historical financial statements, including the
accompanying notes included elsewhere in this prospectus.
F-2
<PAGE>
Combined Pro Forma Statement of Operations
For the nine months ended September 30, 1999
(Dollars in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Combined
Audiobooks Pro Forma Pro forma
MediaBay Direct Adjustments Notes 9/30/99
------------ ------------ ------------- --------- ------------
<S> <C> <C> <C> <C> <C>
Dollars in thousands
Statement of Operations Data:
Gross Sales ............................... $ 41,986 $12,264 $ 54,250
Returns, discounts and allowances ......... (11,297) (3,543) (14,840)
-------- ------- --------
Net sales ................................ 30,689 8,721 39,410
Cost of sales ............................. 15,037 4,082 19,119
-------- ------- --------
Gross profit ............................. 15,652 4,639 20,291
Advertising and promotion ................ 5,356 3,692 9,048
General and administrative ............... 6,604 1,705 8,309
Depreciation and Amortization ............ 4,862 1,152 (1) 6,014
-------- ----- --- --------
Operating income (loss) ................. (1,170) (758) (1,152) (3,080)
Interest (income) expense, net ........... 3,362 739 (2) 4,101
-------- ------ --- --------
Income (loss) before provision for income
taxes .................................. (4,532) (758) (1,891) (7,181)
Provision for income taxes ............... --
--------
Net income (loss) ....................... ($ 4,532) ($ 758) ($ 1,891) ($ 7,181)
======== ======= ======= ========
Net loss per share of common stock
(basic and diluted) .................... ($ 0.57) ($ 0.91)
======== ========
Weighted average number of common shares
outstanding (in thousands) ............. 7,882 7,882
======== ========
</TABLE>
- ------------
Notes:
(1) Represents amortization of goodwill and identifiable intangible assets in
connection with the acquisition of Doubleday Direct's Audiobooks Direct
club based on their estimated useful lives as follows:
Goodwill 20 years
Customer list 3 years
Covenant not to compete 5 years
Mailing agreement 4 years
(2) Represents interest expense and amortization of deferred financing fees
associated with the acquisition of Doubleday Direct's Audiobooks Direct
club as described elsewhere in this document.
F-3
<PAGE>
Combined Pro Forma Statement of Operations
For the year ended December 31, 1998
(Dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Radio Columbia
MediaBay Group(1) House
------------ ---------- ------------
<S> <C> <C> <C>
Sales ..................................... $22,242 $12,772 $17,244
Returns, discounts and allowances ......... 7,348 228 2,857
------- ------- -------
Sales, net ............................... 14,894 12,544 14,387
Cost of sales ............................. 9,452 5,505 6,118
------- ------- -------
Gross profit ............................. 5,442 7,039 8,269
Expenses:
Advertising and promotion ................ 8,910 1,552 8,857
General and administrative ............... 3,673 4,153 1,307
Depreciation and amortization ............ 24 183
------- -------
Operating income (loss) ................. (7,165) 1,151 (1,895)
Interest (expense) income, net ........... 180 (115)
------- -------
Income (loss) before provision for
income taxes ........................... (6,985) 1,036 (1,895)
Provision for income taxes ............... 279
-------
Net income .............................. ($ 6,985) $ 757 ($ 1,895)
======= ======= =======
Net loss per share of common stock
(basic and diluted) ..................... ($ 1.13)
=======
Weighted average number of common shares
outstanding (in thousands) ............... 6,154
=======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Audiobooks Pro Forma
Combined Direct Adjustments Notes Combined
------------ ------------ ------------- --------- ------------
<S> <C> <C> <C> <C> <C>
Sales ..................................... $52,258 $21,886 $ 74,144
Returns, discounts and allowances ......... 10,433 6,430 16,863
------- ------- --------
Sales, net ............................... 41,825 15,456 57,281
Cost of sales ............................. 21,075 4,861 25,936
------- ------- --------
Gross profit ............................. 20,750 10,595 31,345
Expenses:
Advertising and promotion ................ 19,319 9,094 28,413
General and administrative ............... 9,133 2,978 (161) (2) 11,950
Depreciation and amortization ............ 207 5,986 (3) 6,193
------- ----- --------
Operating income (loss) ................. (7,909) (1,477) (5,825) (15,211)
Interest (expense) income, net ........... 65 (5,220) (4) (5,155)
------- ------ --------
Income (loss) before provision for
income taxes ........................... (7,844) (1,477) (11,045) (20,366)
Provision for income taxes ............... 279 279
------- --------
Net income .............................. ($ 8,123) ($ 1,477) ($ 11,045) ($ 20,645)
======= ======= ======== ========
Net loss per share of common stock
(basic and diluted) ..................... ($ 2.92)
========
Weighted average number of common shares
outstanding (in thousands) ............... 925 7,079
======== ========
</TABLE>
- ------------
Notes:
(1) Includes the results of operations of Radio Spirits, Metacom and Premier
for the periods specified in the Combined Pro Forma Financial Statements
Introduction.
(2) Represents a reduction in officer's salary and rent based on executed
agreements pursuant to the transactions.
(3) Represents amortization of goodwill and identifiable intangible assets in
connection with the transactions based on their estimated useful lives
follows:
Goodwill 20 years
Customer Lists 3 years
Covenant not to compete 5 years
Mailing Agreements 4-7 years
(4) Represents interest expense and amortization of deferred financing fees
associated with the transactions as described elsewhere in this document.
F-4
<PAGE>
MEDIABAY, INC.
Consolidated Balance Sheet
September 30, 1999
(Dollars in thousands)
(Unaudited)
<TABLE>
<S> <C>
Assets
Current assets:
Cash and cash equivalents ...................................................... $ 865
Short-term investments to be held to maturity .................................. 100
Accounts receivable, net of allowances for sales returns and doubtful accounts
of $3,983 ..................................................................... 6,874
Inventory ...................................................................... 5,564
Royalty advances ............................................................... 3,414
Prepaid expenses ............................................................... 1,787
Deferred member acquisition costs -- current ................................... 2,945
---------
Total current assets ......................................................... 21,549
Fixed assets, at cost, net of accumulated depreciation of $744 .................... 1,349
Deferred member acquisition costs - non-current ................................... 3,585
Deferred financing costs .......................................................... 1,814
Prepaid expenses -- non-current ................................................... 233
Other intangibles, net ............................................................ 13,779
Goodwill, net ..................................................................... 47,008
---------
$ 89,317
=========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ............................................................... $ 4,939
Accrued expenses ............................................................... 5,754
Current portion of long-term debt .............................................. 3,120
---------
Total current liabilities .................................................... 13,813
---------
Long-term debt .................................................................... 39,313
---------
Commitments and contingencies
Preferred stock, no par value, authorized 5,000,000 shares; no shares issued
and outstanding ...............................................................
Common stock subject to contingent put ......................................... 4,283
Common stock; no par value, authorized 75,000,000 shares; 9,136,897 issued
and outstanding ............................................................... 57,576
Contributed capital ............................................................ 2,323
Accumulated deficit ............................................................ (27,991)
---------
Total common stockholders' equity ............................................ 31,908
---------
$ 89,317
=========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
MEDIABAY, INC.
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales ..................................... $ 16,614 $ 5,778 $ 41,986 $ 16,190
Returns, discounts and allowances ......... 4,817 1,903 11,297 4,655
--------- --------- --------- ---------
Sales, net .............................. 11,797 3,875 30,689 11,535
Cost of sales ............................. 5,729 2,448 15,037 7,558
--------- --------- --------- ---------
Gross profit ............................ 6,068 1,427 15,652 3,977
Expenses:
Advertising and promotion .............. 2,259 2,423 5,356 6,108
General and administrative ............. 2,565 691 6,604 1,878
Depreciation and Amortization .......... 1,997 222 4,862 233
--------- --------- --------- ---------
Operating loss ......................... (753) (1,909) (1,170) (4,242)
Interest (expense) income, net of inter-
est income of $31 and $118 for three
and nine months ended September
30, 1999, respectively ................ (1,190) 58 (3,362) 249
--------- --------- --------- ---------
Net loss ............................ $ (1,943) $ (1,851) $ (4,532) $ (3,993)
========= ========= ========= =========
Net loss per share of common
stock (basic and diluted) .......... $ (.22) $ (.30) $ (.57) $ (.65)
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
MEDIABAY, INC.
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended September
30,
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss ............................................................. $ (4,532) $ (3,993)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ....................................... 4,862 233
Amortization of deferred member acquisition costs ................... 807 --
Amortization of deferred financing fees ............................. 273 --
Changes in asset and liability accounts:
Increase in accounts receivable, net .............................. (1,951) (1,373)
Increase in inventory ............................................. (234) (242)
Increase in prepaid expenses ...................................... (811) (582)
Increase in royalty advances ...................................... (1,167) (407)
Increase in deferred member acquisition costs ..................... (7,337) --
Increase in accounts payable and accrued expenses ................. 4,288 1,049
--------- ---------
Net cash used in operating activities .......................... (5,802) (5,315)
--------- ---------
Cash flows from investing activities:
Acquisition of fixed assets, software and Internet development costs . (404) (788)
Maturity of short-term investment .................................... 500 5,135
Purchase of short-term investment .................................... (100) (500)
Acquisition of Audiobooks Direct ..................................... (18,875) --
Additions to goodwill relating to acquisitions ....................... (850) --
--------- ---------
Net cash (used in) provided by investing activities ............ (19,729) 3,847
--------- ---------
Cash flows from financing activities:
Increase in borrowings under amended credit agreement ................ 11,080 --
Net proceeds from issuance of common stock ........................... 23,840 --
Proceeds from issuance of long-term debt ............................. 4,350 --
Payments of long-term debt ........................................... (14,797) --
Increase in deferred financing costs ................................. (763) --
Proceeds from issuance of options .................................... -- 75
--------- ---------
Net cash provided by financing activities ...................... 23,710 75
--------- ---------
Net decrease in cash and cash equivalents ............................... (1,821) (1,393)
Cash and cash equivalents at beginning of period ........................ 2,686 3,655
--------- ---------
Cash and cash equivalents at end of period .............................. $ 865 $ 2,262
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
MEDIABAY, INC.
(Dollars in thousands, except per share data)
Notes to Consolidated Financial Statements
(Unaudited)
(1) Organization
MediaBay, Inc. (formerly Audio Book Club, Inc.) (the "Company"), a Florida
corporation, was formed on August 16, 1993. MediaBay, Inc. is a leading
marketer of premium spoken word content, including audiobooks and old time
radio and classic video programs. The Company markets audiobooks primarily
through its Audio Book Club, the largest membership-based club of its kind. Our
old time radio and classic video programs are marketed through direct-mail
catalogues and, on a wholesale basis, to major retailers. All of the Company's
products are also available for purchase over the Internet through its
content-rich media portal at MediaBay.com and its community of sites, including
audiobookclub.com, audiobook.com, radiospirits.com, videoyesteryear. com and
downloadbay.com.
(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, 1998. 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.
Advertising and Promotional Costs
Promotional costs directed at current members are expensed on the date the
promotional materials are mailed. The cost of any premiums, gifts or the
discounted audiobooks in the promotional offer to new members is expensed as
incurred. The Company accounts for direct response advertising for the
acquisition of new members in accordance with AICPA Statement of Position 93-7,
Reporting on Advertising Costs (SOP 93-7). SOP 93-7 states that the cost of
direct response advertising (a) whose primary purpose is to elicit sales to
customers who could be shown to have responded specifically to the advertising
and (b) that results in probable future benefits should be reported as assets
net of accumulated amortization. Prior to 1999, the Company had expensed these
costs as incurred. Beginning in 1999, the Company must capitalize such direct
response advertising costs and amortize these costs over the period of future
benefit, which has been determined to be 30 months, in accordance with SOP 93-7
because the Company, after five years of operations, now has a sufficient
historical pattern of results. The costs are being amortized on a straight-line
basis. If the Company had expensed the cost of direct response advertising,
which resulted in new members in the Company's Audio Book Club who will
generate revenue in the future, as incurred contrary to SOP 93-7, the Company
would have reported a net loss of $ 4,022 and $11,062 and a net loss per share
of common stock of $.46 and $1.40 for the three and nine months ended September
30, 1999, respectively. The majority of this loss would have been primarily due
to the direct response advertising, which resulted in new members in the
Company's Audio Book Club who will generate revenue in the future, amortization
of goodwill and other intangibles of $1,858 and $4,479 and net interest expense
of $1,190 and $3,362 for the three and nine months ended September 30, 1999,
respectively, in connection with the Company's various acquisitions.
F-8
<PAGE>
MEDIABAY, INC.
(Dollars in thousands, except per share data)
Notes to Consolidated Financial Statements -- (Continued)
(Unaudited)
(2) Significant Accounting Policies -- (Continued)
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
(3) Acquisition
On June 15, 1999, a wholly-owned subsidiary of the Company acquired from
Doubleday Direct, Inc. ("Doubleday") its business of direct marketing and
distribution of audiobooks and related products through Doubleday's Audiobooks
Direct Club ("Audiobooks Direct"). At the time of the acquisition, Audiobooks
Direct was one of the industry's leading direct marketers of audiobooks using a
membership club format.
As part of the acquisition, the Company acquired Audiobooks Direct's total
membership file of over 500,000 members as well as some other assets relating
exclusively to the Audiobooks Direct Club. The Company also entered into a
reciprocal marketing arrangement with Doubleday pursuant to which it received
the exclusive rights, with respect to audiobooks, for three years, subject to a
one-year extension, at no additional cost and an additional three years, at
market rates, to insert its new member acquisition materials into the member
mailings of Doubleday's consumer book clubs and Doubleday Select's professional
book clubs, as well as rights to distribute its member solicitation packages
via direct mail campaigns to the Doubleday and Doubleday Select book club
membership lists. Subject to exceptions, we will also be Doubleday's exclusive
source for audiobooks.
In addition, the Company entered into a non-compete agreement whereby
Doubleday agreed not to engage in designated activities which compete with the
operation of the Company's Audio Book Club for five years. Moreover, the
Company entered into a transitional services agreement with Doubleday.
At the time of the acquisition, together with Doubleday, the Company
announced the launch of a co-branded website to be coupled with an online
cross-marketing and advertising campaign. The website at bestbookclubs.com was
launched on September 15, 1999.
As consideration for the acquisition and the related transactions,
including the mailing, non-compete, and transitional services agreements,
Doubleday received from the Company cash consideration of $18,615.
The Company also incurred cash costs and fees of $320 and estimates
additional costs and fees of approximately $115. The Company has accounted for
the acquisition using the purchase method of accounting. The total purchase
price of approximately $19,050 has been allocated on a preliminary basis as
follows: royalty advances ($1,286), identifiable intangible assets ($5,400,
representing customer lists, covenant not to compete and certain agreements
acquired in the acquisition) and goodwill ($12,364). Identifiable intangible
assets will be amortized over their estimated useful lives (ranging from 3 to 5
years) and goodwill will be amortized over a period not to exceed 20 years.
The following unaudited combined pro forma results of operations for the
nine months ended September 30, 1999 and 1998 assume that the acquisition of
Doubleday occurred as of January 1, 1998. Additionally, the unaudited pro forma
consolidated results of operations for the nine months ended September 30, 1998
assumes that the following transactions also occurred as of January 1, 1998:
(1) The acquisitions of Radio Spirits, Inc., certain assets of an
affiliated company, Buffalo Productions, Inc. and a 50% interest in a
joint venture owned by the sole shareholder of Radio Spirits on December
14, 1998.
(2) The acquisition of substantially all of the assets used by Metacom,
Inc. in connection with its Adventures in Cassettes business on December
14, 1998.
F-9
<PAGE>
MEDIABAY, INC.
(Dollars in thousands, except per share data)
Notes to Consolidated Financial Statements -- (Continued)
(Unaudited)
(3) Acquisition -- (Continued)
(3) The acquisition of substantially all of the assets used by Premier
Electronic Laboratories, Inc. in connection with its business of
producing, marketing, and selling old time radio and classic videos
programs on December 14, 1998
(4) The acquisition of substantially all of the assets used by The Columbia
House Company in its Audio Book Club on December 31, 1998.
Nine Months ended September
30,
----------------------------
1999 1998
------------ -------------
Net sales .................................. $ 39,410 $ 41,122
======== =========
Net loss ................................... $ (7,181) $ (15,969)
======== =========
Loss per share (basic and diluted) ......... $ (.91) $ (2.26)
======== =========
(4) Financings
In June 1999, in connection with the acquisition of Audiobooks Direct, the
Company, Fleet National Bank and ING (U.S.) Capital Corporation amended the
terms of the Company's existing credit agreement to provide for an additional
$6,000 of term loans. The interest rate under the credit agreement is currently
3.75% above LIBOR and interest is payable at the expiration of the respective
LIBOR contracts.
At September 30, 1999, an aggregate of $28,633 principal amount of
indebtedness was outstanding under the credit agreement, $21,553 as a term loan
and $7,080 under a revolving line of credit. The principal amount outstanding
under the term advance is payable in quarterly installments as follows: a
quarterly payment of $330 on December 31, 1999, four quarterly payments of $930
in the year 2000, four quarterly payments of $1,550 in the year 2001, four
quarterly payments of $2,170 in the year 2002 and the balance on due on March
31, 2003.
In connection with the additional loan in June 1999, the Company granted
the lenders three-year warrants to purchase up to 119,941 shares of the
Company's common stock at an exercise price of $14.20, subject to adjustment.
The warrants have been valued at $2.63 using the Black-Scholes valuation model
and have been included in deferred financing costs.
The Company also obtained a portion of the financing for the acquisition
of Audio Books Direct by borrowing $4,350 from Norton Herrick, Chairman of the
Board and Co-Chief Executive Officer, under a bridge convertible senior
subordinated promissory note. In a separate letter agreement, the Company
agreed, that if the Company refinanced or replaced this note with debt or
equity financing provided by anyone other than Mr. Herrick or a family member
or affiliate of Mr. Herrick, the Company would issue to Mr. Herrick warrants to
purchase an additional 125,000 shares of common stock at $8.41 per share, which
warrants will also be identical to the warrants issued to him in connection
with the initial note issued to Mr. Herrick in December 1998. In July 1999,
this promissory note was repaid and the warrants were issued upon receipt of
stockholder approval in September 1999.
As a result of recent acquisition activity and sales of common stock, the
Company, Fleet National Bank and ING (U.S.) Capital Corporation amended the
terms of the Company's existing credit agreement whereby certain covenants
under the agreement were adjusted. In connection therewith the Company paid
legal expenses and fees of $317.
In August 1999, Norton Herrick, Chairman of the Board and Co-Chief
Executive Officer sold $5,000 of the remaining $14,000 9% convertible senior
subordinated promissory note due December 31, 2004 issued to
F-10
<PAGE>
MEDIABAY, INC.
(Dollars in thousands, except per share data)
Notes to Consolidated Financial Statements -- (Continued)
(Unaudited)
(4) Financings -- (Continued)
him in December 1998 in connection with various acquisitions by the Company to
ABC Investment, L.L.C., an unaffiliated third party. The $5,000 promissory note
has substantially the same terms and conditions as the original promissory note
bearing interest at 9% per annum and convertible at $11.125 per share.
(5) Stockholders' Equity and Stock Options and Warrants
In March 1999, the Company's stockholders approved (i) an amendment to the
Company's Articles of Incorporation to increase the Company's authorized common
stock to 75,000,000 shares and (ii) the adoption of the Company's 1999 Stock
Incentive Plan. The 1999 Stock Incentive Plan provides for grants of awards of
stock options, restricted stock, deferred stock or other stock based awards. A
total of 2,500,000 shares of common stock have been reserved for issuance
pursuant to the plan.
In April and June 1999, the Company sold 800,000 shares of its common
stock for gross proceeds of $8,800 to qualified institutional buyers as such
term is defined in Rule 144A of the Securities Act of 1933.
In July and August 1999, the Company sold 1,240,000 shares of its common
stock for gross proceeds of $16,120 to qualified institutional buyers as such
term is defined in Rule 144A of the Securities Act of 1933. Fees paid to an
unaffiliated third party in connection with the August 1999 sale were $273.
In addition to 244,941 warrants granted in connection with the various
financings described in footnote (4) above, during the nine months ended
September 30, 1999, the Company granted both plan and non-plan options and
warrants to purchase a total of 1,478,050 shares of the Company's common stock
to officers, directors, Advisory Board members, employees and consultants. The
options and warrants vest at various times and have exercise periods of five
and ten years. Exercise prices range from $8.00 to $13.50 per share except for
8,000 warrants which have an exercise price of $.10 per share. In addition, the
Company canceled five-year options to purchase a total of 29,500 shares of the
Company's common stock.
(6) Net Loss Per Share of Common Stock
The weighted average number of common shares used in the net loss per
share computations for the three and nine months ended September 30, 1999 were
8,794,455 and 7,882,324, respectively and 6,153,920 for each of the comparable
periods of the prior year.
Common equivalent shares that could potentially dilute basic earnings per
share in the future and that were not included in the computation of diluted
loss per share because of antidilution were 6,212,290 at September 30, 1999 and
1,742,100 at September 30, 1998. Included in the September 30, 1999 common
share equivalents are 1,240,450 shares assuming the conversion of $13,800 in
convertible senior subordinated promissory notes.
(7) Supplemental Cash Flow Information
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 as compensation for
the costs incurred in transferring to the Company the toll free phone numbers,
(800) AUDIOBOOK and (888) AUDIOBOOK. Such options were immediately vested and
exercisable and have a five-year term. The Company has recorded an asset in the
amount of $54, the negotiated cost of transferring the phone numbers and is
amortizing the asset over six years. Subsequent to September 30, 1999 these
options were exercised yielding proceeds of $95.
During the nine months ended September 30, 1999, 8,000 of the options and
warrants granted were granted to an officer of the Company below the current
market price at the date of grant. These options have been valued at $7.16 each
using the Black-Scholes valuation model and have been included in prepaid
expenses and are being amortized over the term of the related employment
agreement.
F-11
<PAGE>
MEDIABAY, INC.
(Dollars in thousands, except per share data)
Notes to Consolidated Financial Statements -- (Continued)
(Unaudited)
(7) Supplemental Cash Flow Information -- (Continued)
In April 1999, the Company formed a Technology Advisory Board ("Advisory
Board") to further enhance its Internet strategy. The Advisory Board consists
of five members. The Advisory Board will work with the Company to increase its
online business and its strategic alliances on the Internet. Included in the
total options and warrants granted during the nine months ended September 30,
1999 were options and warrants granted to the Internet Advisory Board members.
These options were valued at $113 using the Black-Scholes valuation model and
have been included in prepaid expenses and are being amortized over the period
of service.
Included in the total options and warrants granted during the nine months
ended September 30, 1999 were warrants granted to a law firm as partial payment
for legal services provided in connection with the Company's various
acquisitions. The warrants have been valued at $50 using the Black-Scholes
valuation model and have been included in the cost of the acquisitions.
In August 1999, ABC Investment LLP, the holder of a $5,000 9% convertible
senior subordinated promissory note due December 31, 2004 converted $200 of the
note into 17,977 shares of the Company's common stock.
Cash paid for interest expense was $2,739 for the nine months ended
September 30, 1999.
(8) Subsequent Events
Subsequent to September 30, 1999, the Company granted plan options to
purchase 62,600 shares of the Company's common stock to officers, employees and
consultants at exercise prices ranging from $11.375 to $13.3125. The options
have an exercise period of five years and vest over various periods. The
Company canceled five-year plan options to purchase a total of 1,000 shares of
common stock. Additionally, non-plan options to purchase 21,600 shares of
common stock were exercised yielding proceeds of $95.
F-12
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Audio Book Club, Inc. (now known as MediaBay, Inc.)
We have audited the accompanying consolidated balance sheet of Audio Book Club,
Inc. (the Company) as of December 31, 1998, and the related statements of
operations, stockholders' equity (deficiency), and cash flows for the year then
ended. Our audit also included the financial statement schedule listed in the
Index to Financial Statements on Page F-1. These financial statements and
financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our 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, such 1998 financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 1998, and the
results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
March 22, 1999
F-13
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Audio Book Club, Inc.
We have audited the accompanying consolidated balance sheet of Audio Book Club,
Inc. and subsidiaries (the Company) as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity (deficiency), and
cash flows for the year then ended. In connection with our audit of the
consolidated financial statements, we have also audited the financial statement
schedule as listed in the accompanying index. These financial statements and
financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our 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, such 1997 consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of December 31,
1997, and the results of their operations and their cash flows for the year
then ended in conformity with generally accepted accounting principles. Also,
in our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
March 13, 1998
New York, New York
F-14
<PAGE>
AUDIO BOOK CLUB, INC.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31,
1998 1997
---------------- ----------------
<S> <C> <C>
Assets
Current assets: ........................................................
Cash and cash equivalents ........................................... $ 2,686,330 $ 3,655,053
Short-term investment ............................................... 500,000 5,143,699
Accounts receivable, net of allowances for sales returns and doubtful
accounts of $1,418,275 and $1,449,445 at December 31, 1998 and
1997, respectively ................................................. 4,923,077 1,783,456
Inventory ........................................................... 5,330,319 1,700,374
Prepaid expenses .................................................... 401,154 111,896
Royalty advances .................................................... 961,320 267,518
------------- -------------
Total current assets ............................................. 14,802,200 12,661,996
Fixed assets, net ...................................................... 1,328,575 59,805
Deferred financing costs ............................................... 1,515,800 --
Non-current prepaid expenses ........................................... 121,552 48,219
Other intangibles ...................................................... 11,300,000 --
Goodwill ............................................................... 35,270,747 --
------------- -------------
$ 64,338,874 $ 12,770,020
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable .................................................... $ 4,869,422 $ 2,776,544
Accrued expenses .................................................... 1,361,590 240,124
Current portion -- long-term debt ................................... 2,000,000 --
------------- -------------
Total current liabilities ........................................ 8,231,012 3,016,668
------------- -------------
Long term debt ......................................................... 40,000,000 --
------------- -------------
Preferred Stock, no par value, authorized 5,000,000 shares; no shares
issued and outstanding ............................................. -- --
Common stock subject to contingent put .............................. 8,284,375 --
Common stock; no par value, authorized 25,000,000 shares; issued
and outstanding 7,078,920 and 6,153,920, at December 31, 1998
and 1997, respectively ............................................. 28,959,812 25,741,063
Contributed capital ................................................. 2,322,867 486,217
Accumulated deficit ................................................. (23,459,192) (16,473,928)
------------- -------------
Total common stockholders' equity ................................ 7,823,487 9,753,352
------------- -------------
$ 64,338,874 $ 12,770,020
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-15
<PAGE>
AUDIO BOOK CLUB, INC.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years ended December 31.
1998 1997
---------------- ----------------
<S> <C> <C>
Sales ................................................................. $ 22,242,155 $ 15,119,093
Returns, discounts and allowances ..................................... 7,348,584 5,040,939
------------ ------------
Sales, net ........................................................ 14,893,571 10,078,154
Cost of sales ......................................................... 9,451,601 5,495,358
------------ ------------
Gross profit ...................................................... 5,441,970 4,582,796
Expenses:
Internet expenses for acquisition and retention of members ......... 4,624,701 --
Direct mail and other advertising and promotion expenses for
acquisition and retention of members .............................. 4,285,459 6,843,250
General and administrative ......................................... 3,697,444 2,224,889
------------ ------------
Operating loss .................................................. (7,165,634) (4,485,343)
Interest income (expense), net of interest (expense) income of
($93,750) and $105,631 in 1998 and 1997, respectively ............. 180,370 (435,508)
------------ ------------
Net loss ......................................................... $ (6,985,264) $ (4,920,851)
============ ============
Net loss per share of common stock (basic and diluted) ............. $ (1.13) $ (1.29)
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-16
<PAGE>
AUDIO BOOK CLUB, INC.
Consolidated Statements of Stockholders' Equity (Deficiency)
Years Ended December 31, 1997 and 1998
<TABLE>
<CAPTION>
Common Common
stock stock subject Common
number of contingent stock; no par Contributed Accumulated
shares puts value capital deficit
----------- --------------- --------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 ............ 200 -- $ 200 $ 231,325 $ (11,553,077)
16,282 to 1 stock split ................ 3,256,200 -- -- -- --
Imputed interest on notes payable
-- related parties ................... -- -- -- 254,892 --
Conversion of notes payable --
related parties to common stock . 597,520 -- 5,975,200 -- --
Proceeds from sale of common
stock, net of offering expenses
of $3,234,337 ........................ 2,300,000 -- 19,765,663 -- --
Net loss ............................... (4,920,851)
-------------
Balance at December 31, 1997 ............ 6,153,920 -- 25,741,063 486,217 (16,473,928)
Options sold to director ............... -- -- -- 75,000 --
Warrants for URL and phone
numbers .............................. -- -- -- 104,000 --
Warrants granted in acquisitions ....... -- -- -- 1,002,000 --
Warrants granted for financing and
consulting in connection with the
acquisitions ......................... -- -- -- 655,650 --
Common stock issued in the
acquisitions ......................... 925,000 8,284,375 3,218,749 -- --
Net loss ............................... -- -- -- -- (6,985,264)
--------- --------- ----------- ---------- -------------
Balance at December 31, 1998 ............ 7,078,920 8,284,375 28,959,812 $2,322,867 $ (23,459,192)
========= ========= =========== ========== =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-17
<PAGE>
AUDIO BOOK CLUB, INC.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years ended December 31,
-----------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss .................................................................. $ (6,985,264) $ (4,920,851)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................... 366,825 8,334
Imputed interest on notes payable -- related parties .................... -- 254,892
Changes in asset and liability accounts:
(Increase) in accounts receivable, net ................................. (894,920) (1,187,826)
Decrease in due from related party ..................................... -- 20,000
(Increase) in inventory ................................................ (1,265,685) (863,714)
(Increase) in prepaid expenses ......................................... (521,589) (111,896)
(Increase) in prepaid expenses -- non-current .......................... (601,173) (48,219)
(Increase) in royalty advances ......................................... (71,802) (32,078)
Increase in accounts payable and accrued expenses ...................... 605,404 1,375,227
------------- ------------
Net cash used in operating activities ............................... (9,368,204) (5,506,131)
------------- ------------
Cash flows from investing activities:
Purchase of short-term investment ......................................... (500,000) (5,143,699)
Acquisition of fixed assets ............................................... (944,383) (48,636)
Sale of short term investments ............................................ 5,143,699 --
Cash payments for acquisitions ............................................ (36,681,581) --
Cost incurred in acquisitions ............................................. (693,254) --
------------- ------------
Net cash used in investing activities ............................... (33,675,519) (5,192,335)
============= ============
Cash flows from financing activities:
Proceeds from issuance of notes payable -- related parties ................ 15,000,000 1,295,000
Repayment of notes payable -- related parties ............................. -- (6,800,000)
Proceeds from issuance of long-term debt .................................. 27,000,000 9,000,000
Repayment of long-term debt ............................................... -- (9,000,000)
Proceeds of issuance of options ........................................... 75,000 --
Proceeds of sale of common stock, net of offering costs ................... -- 19,765,663
------------- ------------
Net cash provided by financing activities ........................... 42,075,000 14,260,663
------------- ------------
Net (decrease) increase in cash and cash equivalents ....................... (968,723) 3,562,197
Cash and cash equivalents at beginning of period ........................... 3,655,053 92,856
------------- ------------
Cash and cash equivalents at end of period ................................. $ 2,686,330 $ 3,655,053
============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-18
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements
(1) Organization
Audio Book Club, Inc., now known as MediaBay, 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 and other forms of audio entertainment by mail order and
via the Internet.
(2) Significant Accounting Policies
Principals of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts have
been eliminated.
Cash and Cash Equivalents
Securities with maturities of three months or less when purchased are
considered to be cash equivalents.
Fair Value of Financial Instruments
The carrying amount of cash, short-term investments, accounts receivable,
accounts payable and accrued expenses approximates fair value due to the short
maturity of those instruments.
The fair value of long-term debt is estimated based on the interest rates
currently available for borrowings with similar terms and maturities. The
Company's long-term debt is at a variable rate; therefore, the carrying value
approximates market prices.
Inventory
Inventory, consisting primarily of audiocassettes held for resale, is
valued at the lower of cost (weighted average cost method) or market.
Prepaid Expenses
Prepaid expenses consist principally of deposits and other amounts being
expensed over the period of benefit. All current prepaid expenses will be
expensed over a period no greater than the next twelve months.
Fixed Assets, Computer Software and Internet Web Site Development Costs
Fixed assets, consisting primarily of furniture, leasehold improvements,
computer equipment, 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, seven years for
furniture and fixtures, five years for leasehold improvements, 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.
Intangible Assets
Intangible assets, consisting of customer lists and certain agreements
acquired in the acquisitions, are being amortized over their estimated useful
life.(Note 3).
Goodwill
Goodwill is the excess of the purchase price over the fair value of net
assets acquired in business combinations accounted for using the purchase
method of accounting. Goodwill will be amortized over the estimated period of
benefit not to exceed 20 years. Goodwill is reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount may not be
recoverable using the expected undiscounted future cash flow model.
F-19
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(2) Significant Accounting Policies -- (Continued)
Revenue Recognition
Revenue is recorded upon shipment of merchandise and simultaneous billing.
Allowances for doubtful accounts and future returns are based upon historical
experience and evaluation of current trends.
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, were
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.
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
basis and operating loss and tax credit carryforwards. A valuation allowance is
provided when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the period that includes the enactment date.
Advertising and Promotional Costs
The Company expenses all production costs of advertising. Direct-mail
advertising consists primarily of print advertisements and mailings to
individuals that include order forms for the Company's products. The
capitalized costs of the direct mail 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. As of December 31, 1998 and 1997, costs of all
direct mail advertising have been expensed and, accordingly, there were no
capitalized costs of direct mail advertising.
Promotional costs for new and current members are expensed on the date the
promotional materials are mailed.
Royalties
The Company is liable for royalties to licensors based upon revenue earned
from the respective licensed product. Royalties, in excess of advances, are
payable based on contractual terms. Royalty advances not expected to be
recovered through royalties on sales are charged to royalty expense. For the
years ended December 31, 1998 and 1997, no writedowns of royalty advances were
required.
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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-20
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(2) Significant Accounting Policies -- (Continued)
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
(3) Acquisitions
Radio Companies Acquisitions
In December 1998, through its wholly-owned subsidiary, Classic Radio
Holding Corp. ("Classic"), the Company acquired Radio Spirits, Inc. ("Radio
Spirits") for an aggregate base purchase price of $340,000, 425,000 shares of
its common stock valued on the date of acquisition at $12.875 per share,
warrants to purchase an additional 175,000 shares of its common stock at an
exercise price of $13.125 per share and payment of $1,840,784 of liabilities at
closing. The warrants have been valued at $3.04 per share using the
Black-Scholes valuation model. A total of 100,000 of the 425,000 shares and
100,000 of the 175,000 warrants were placed in escrow and are subject to
release if certain specified "EBITDA" (as defined in the purchase agreement)
levels for the acquired company are met for the year ending December 31, 1999
(with respect to the escrowed shares) and for the year ending December 31, 2000
(with respect to the escrowed options). The Company also entered into a put
agreement which granted the seller and his designees the right, under certain
circumstances, commencing three years from the closing, to require the Company
to repurchase up to 175,000 shares of common stock issued in connection with
the acquisition at prices ranging from $4.00 to $12.00 per share. The
acquisition was accounted for under the purchase method.
At the time of the acquisition, Radio Spirits specialized in the
syndication, sales and licensing of popular radio programs which originally
aired from the 1930's through the late 1950's. Radio Spirits also produced and
syndicated three national "classic" radio programs that are collectively heard
in more than 500 markets by over 3 million listeners weekly. Through its
in-house production and mail order services, Radio Spirits also produced and
distributed audiocassettes and compact discs of vintage comedy, mystery,
detective, adventure and suspense programs to customers worldwide. Radio
Spirits also controlled the licensing rights to many popular serials and had an
exclusive licensing arrangement with the Smithsonian Institute to market
products under the Smithsonian name.
In connection with its acquisition of Radio Spirits, through its
indirectly wholly-owned subsidiary, CRAC, the Company also acquired certain
assets of Buffalo Productions, Inc. ("Buffalo"), an affiliate of Carl Amari
(who was the sole stockholder and Chairman of Radio Spirits prior to the
acquisition), for $369,000, and Mr. Amari's 50% interest in a joint venture
engaged in producing, broadcasting, marketing and distributing a series of
old-time radio programs for $2,325,554, and assumed liabilities of $224,446.
The Company also paid cash costs and fees of $169,504 and non-cash costs and
fees of $18,301 related to the acquisition. The assets acquired from Buffalo
were those relating to its business of duplicating pre-recorded compact discs.
The total purchase price of the acquisitions was $11,067,018. The Company has
accounted for the acquisitions using the purchase method of accounting and has
allocated a portion of the total purchase price to certain identifiable
intangible assets, based on their relative fair values which will be amortized
over their useful lives. The Company has recorded $8,152,779 of goodwill which
will be amortized over a period not to exceed 20 years.
In December 1998, through CRAC, the Company acquired all of the assets
used by Metacom, Inc. ("Metacom") in connection with its "Adventures in
Cassettes" business of producing, marketing, and selling old-time radio
programs for $1,060,829, 50,000 shares of the Company's common stock valued on
the date of acquisition at $12.875 per share and warrants to purchase up to
50,000 shares of the Company's common stock at an exercise price of $8.125 per
share. The warrants have been valued at $4.18 per share using the Black-Scholes
valuation model. In addition, the Company granted Metacom the right, subject to
certain limitations, to sell such shares back to the Company at a price of
$10.00 per share between the third and tenth
F-21
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(3) Acquisitions -- (Continued)
anniversary of the closing. The Company also paid cash costs and fees of
$25,981 and non-cash costs and fees of $2,805 in the acquisition. The total
purchase price of $1,942,365 has been accounted for under the purchase method
of accounting. The Company has recorded $1,621,536 of goodwill which will be
amortized over a period not to exceed 20 years.
In December 1998, through CRAC, the Company acquired all the assets used
by Premier Electronic Laboratories, Inc. ("Premier") in connection with its
business of licensing, producing, marketing and selling classic videos and
radio programs through mail order catalogs, phone solicitations and specialty
mail organizations for $240,000, 125,000 shares of the Company's common stock
valued at the date of closing at $12.875. The Company also paid cash costs and
fees of $25,109 and non-cash costs and fees of $2,711 relating to the
acquisition, for a total purchase price of $1,877,195. The Company has recorded
$1,691,269 of goodwill which will be amortized over a period not to exceed 20
years. The Company also granted Premier the right, under certain circumstances
and subject to certain limitations, to sell the 125,000 shares received by it
back to the Company at prices ranging from $7.00 per share for the first 25,000
shares so sold to $15.00 per share for the last 50,000 shares so sold, at
various times between the second and tenth year anniversary of the closing of
the acquisition.
Acquisition of Columbia House's Audiobook Club Division
On December 31, 1998, a wholly-owned subsidiary of the Company acquired
substantially all of the assets used in the audiobook club division (the "CH
Audiobook Club") of The Columbia House Company ("Columbia House").
As part of the acquisition, the Company acquired Columbia House's
audiobook club's membership file of approximately 600,000 members, as well as
substantially all of Columbia House's other assets relating exclusively to the
CH Audiobook Club, including inventory and certain accounts receivable. The
Company also entered into a mailing agreement which allows the Company to (i)
use Columbia House's compact disc, VHS, laser and DVD video club's membership
lists for Audio Book Club new member acquisition campaigns, (ii) insert new
member acquisition material into Columbia House's member mailing programs sent
to various other clubs maintained by Columbia House and (iii) be referred to as
the Columbia House recommended source for audiobooks in a club format, for a
period of seven years. In addition, Columbia House entered into a non-compete
agreement pursuant to which it agreed not to engage in certain activities that
compete with our operation of Audio Book Club for a period of five years.
Moreover, the Company entered into a transitional services agreement with
Columbia House.
As consideration for the acquisition and the related transactions,
including the mailing agreement, the non-compete agreement and the transitional
services agreement, Columbia House received from the Company cash consideration
of $30,750,000 plus expenses of $24,345. In addition, the Company issued to
Columbia House's designees (Sony Music Entertainment Inc. and WCI Record Club
Inc.) an aggregate of 325,000 shares of its common stock (the "Shares") valued
on the date of acquisition at $11.625 and warrants to purchase an additional
100,000 shares of its common stock at a price of $11.125 per share. The
warrants have been valued at $2.61 using the Black-Scholes valuation model. The
Company also granted to Columbia House the right, under certain circumstances,
commencing six years from the Closing, to require the Company to purchase from
Columbia House and its designees the Shares at a price of $15.00 per Share.
The Company also incurred cash costs and fees of $472,660 and non-cash
costs and fees of $51,033 related to the acquisition. The total purchase price
of $35,337,163 has been accounted for using the purchase method of accounting.
The Company has specifically identified $10,600,000 of intangible assets
(customer lists, covenants not to compete and certain agreements acquired in
the acquisitions) which will be amortized over their useful lives (ranging
between 3 and 7 years) and $23,805,163 of goodwill which will be amortized over
a period not to exceed 20 years.
F-22
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(3) Acquisitions -- (Continued)
The following unaudited pro forma consolidated results of operations for
the years ended December 31, 1998 and 1997 assume the acquisitions occurred as
of January 1, 1997 (in thousands, except per share data):
1998 1997
------------ ----------
Net sales ............................. $ 40,360 $ 36,954
Net loss (basic and diluted) .......... (11,366) (7,079)
--------- --------
Loss per share ........................ $ (1.61) $ (1.00)
========= ========
The following table represents the allocation of the purchase price:
<TABLE>
<CAPTION>
Columbia Radio
House Spirits Premier Metacom Total
--------------- --------------- ------------ -------------- ---------------
<S> <C> <C> <C> <C> <C>
Cash ......................... $ -- $ 268,931 $ -- $ -- $ 268,931
Accounts receivable .......... -- 2,244,701 -- -- 2,244,701
Inventory .................... 629,000 1,179,828 155,432 400,000 2,364,260
Other current assets ......... 622,000 -- -- 70,829 692,829
Fixed assets ................. -- 659,471 30,494 -- 689,965
Goodwill ..................... 23,805,163 8,152,779 1,691,269 1,621,536 35,270,747
Other intangibles ............ 10,600,000 700,000 -- -- 11,300,000
Liabilities assumed .......... (319,000) (2,138,692) -- (150,000) (2,607,692)
----------- ------------ ---------- ---------- ------------
$35,337,163 $ 11,067,018 $1,877,195 $1,942,365 $ 50,223,741
=========== ============ ========== ========== ============
</TABLE>
(4) Fixed Assets
Fixed Assets consist of the following:
<TABLE>
<CAPTION>
1998 1997
------------- ------------
<S> <C> <C>
Office equipment .............................. $ 408,260 $ 70,629
Furniture and fixtures ........................ 90,535 4,423
Leasehold improvements ........................ 419,081 1,300
Web site development costs .................... 780,584 --
---------- ---------
Total ...................................... 1,698,460 76,352
Accumulated depreciation ...................... (369,885) (16,547)
---------- ---------
Property, plant and equipment -- net .......... $1,328,575 $ 59,805
========== =========
</TABLE>
(5) Short-Term Investments to be Held to Maturity
At December 31, 1998, short-term investments to be held to maturity
consisted of a $500,000 bank certificate of deposit plus accrued interest
bearing interest at 5.40% maturing on April 1, 1999. At December 31, 1997,
short-term investment to be held to maturity consisted of a bank certificate of
deposit in the amount of $500,000 bearing interest at 5.5% maturing on May 2,
1998 and a bank certificate of deposit in the amount of $100,000 bearing
interest at 5.9% maturing on May 6, 1998 plus accrued interest on both
certificates of deposit.
F-23
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(6) Long-Term Debt
1998
--------------
Credit agreement, senior secured bank debt .......... $27,000,000
Related party note .................................. 15,000,000
-----------
42,000,000
Less: Current maturities ............................ 2,000,000
-----------
Long term debt ...................................... $40,000,000
===========
Bank Debt
In December 1998, the Company obtained Senior Secured Bank Debt from (i)
Fleet National Bank ("Fleet") and (ii) ING (U.S.) Capital Corporation pursuant
to a Credit Agreement dated as of December 31, 1998.
Pursuant to the Credit Agreement, the Company borrowed an aggregate of
$27,000,000, consisting of a $25,000,000 Term Advance (as defined in the Credit
Agreement) and a $2,000,000 Revolving Credit Advance (as defined in the Credit
Agreement). The Term Advance and Revolving Credit Advances bear interest at a
rate of 2.00% above the bank's price rate payable quarterly. Subject to certain
limitations set forth in the Credit Agreement, the maximum principal amount of
all advances under the Credit Agreement cannot exceed $30,000,000 through and
including March 30, 1999, thereafter increasing to a maximum of $34,000,000.
The principal amount outstanding under the Credit Agreement is payable in
quarterly installments commencing on March 31, 1999 through December 31, 2003.
The quarterly payments will begin at $250,000 on March 31, 1999 and increase by
$500,000 increments on each March 31, to $2,250,000 on March 31, 2003,
provided, however, that the final principal installment on December 31, 2003
will be equal to the aggregate principal amount outstanding on such date. The
Company granted to the lenders a security interest in substantially all of the
Company's assets and the assets of its subsidiaries and pledged the capital
stock of its subsidiaries to the lenders as collateral under the Credit
Agreement. The Company also agreed to a number of financial and business
covenants including a restriction on the payment of dividends. The covenants do
not take effect until March 31, 1999. The Company also issued to the lenders
three-year warrants to purchase up to an aggregate of 196,800 shares of our
common stock at an exercise price of $10.00 per share.
On May 9, 1997, the Company borrowed $6,000,000 from a major bank which
was used to repay a portion of the outstanding notes payable to the Company's
Chairman, Chief Executive Officer and founder. The loan has a one-year term,
had an interest rate which was 1/2% under the bank's reference rate and had
interest payable monthly.
On August 2, 1997, the Company borrowed an additional $2,250,000 from the
same major bank to fund working capital. The loan was to be due October 31,
1998, and had an interest rate which was 1/2% under the bank's reference rate
and which was payable monthly.
On September 16, 1997, the Company borrowed an additional $750,000 from
the same major bank to fund working capital. The loan was also to be due
October 31, 1998, and had an interest rate which was 1/2% under the bank's
reference rate and was payable monthly.
The Company used a portion of the proceeds of its initial public offering
to repay the loans from a major bank in the aggregate principal amount of
$9,000,000 plus accrued interest thereon of $56,167.
F-24
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(6) Long-Term Debt -- (Continued)
The loan maturities for the next five years are as follows:
Year ending
December 31,
- ------------------------------
1999 ....................... $ 1,000,000
2000 ....................... 3,000,000
2001 ....................... 5,000,000
2002 ....................... 7,000,000
2003 ....................... 11,000,000
-----------
Total maturities ........... $27,000,000
===========
Related Party Debt
In December 1998, the Company borrowed $15,000,000 from its Chairman and
Chief Executive Officer, pursuant to a $15,000,000 principal amount 9%
Convertible Senior Subordinated Promissory Note due December 31, 2004 (the
"Note"). Pursuant to the Note, the Company borrowed $15,000,000, of which
$1,000,000 was repaid on January 12, 1999. The Note is due December 31, 2004,
bears interest at the initial rate of 9% per annum, payable monthly in arrears
and is convertible, in whole or in part, at the holder's option, into shares of
our common stock at the rate of one share per $11.125 of principal or interest
outstanding under the Note. The Company issued to its Chairman and Chief
Executive Officer five-year warrants to purchase 500,000 shares of our common
stock at an exercise price of $12.00 per share. Pursuant to the terms of a
letter agreement dated December 31, 1998 between the Company and its Chairman
and Chief Executive Officer, the interest rate of the Note will increase to
11%, the conversion rate of the Note is subject to adjustment and the exercise
price of the warrants is subject to adjustment, in the event that the Note is
not refinanced on or prior to September 30, 1999. Pursuant to the Letter
Agreement, the Company also agreed that if the Note is refinanced by anyone
other than its Chairman and Chief Executive Officer or a family member or
affiliate of its Chairman and Chief Executive Officer, the Company will issue
to its Chairman and Chief Executive Officer warrants to purchase an additional
350,000 shares of our common stock, which warrants shall be identical to the
warrants issued to him in connection with the Note. The Note is subordinated to
the Company's obligations under the Credit Agreement and is secured by a second
lien security interest of certain assets of Classic and CRAC. Additionally,
pursuant to the terms of a letter agreement, its Chairman and Chief Executive
Officer agreed with Fleet not to take certain actions with respect to the Note
as long as he held the Note. The terms of its Chairman and Chief Executive
Officer's investment were approved by the independent members of the Company's
Board of Directors. Prior to consummating the transaction the Board obtained a
fairness opinion from an investment banker.
On November 17, 1995, the Company executed a loan agreement with its
Chairman, Chief Executive Officer and founder in the amount of $8,000,000, of
which $5,805,000 had been granted in the form of unsecured, non-interest
bearing advances as of December 31, 1995.
On February 6, 1997, the loan agreement was amended to increase the
maximum borrowing amount to $13,000,000 from $12,000,000. On May 12, 1997, the
loan agreement was further amended to stipulate that the loan does not and will
not bear interest, and removed all references to interest in prior documents.
Immediately prior to the consummation of the Company's initial public
offering, the Company's Chairman, Chief Executive Officer, and founder (Norton
Herrick) converted the outstanding $5,975,200 of indebtedness owed to him under
the loan agreement into 597,520 shares of common stock at a price per share
equal to the initial offering price of the common stock. The loan agreement
between the Company and Norton Herrick was terminated on October 22, 1997.
In June 1994, the Company received $50,000 from both the Chief Operating
Officer and Executive Vice President for a total of $100,000, in exchange for
the Company issuing two notes payable of $50,000 each.
F-25
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(6) Long-Term Debt -- (Continued)
In February 1997, the Company's Executive Vice President loaned the
Company an additional $350,000 pursuant to a loan agreement (the "1997 HH
Loan"). On May 12, 1997, loans payable to the Company's Executive Vice
President in the amounts of $50,000 and $350,000 were consolidated via a
consolidated and restated loan agreement. The consolidated loan balance of
$400,000 did not bear interest until August 1, 1997, after which time interest
was calculated at an annual rate of 10%.
On May 12, 1997, the Chief Operating Officer loaned the Company $350,000
pursuant to a loan agreement (the "1997 MEH Loan"). Borrowings under the 1997
MEH Loan were consolidated via a loan agreement with the $50,000 loan balance
originated in June of 1994. The consolidated loan balance of $400,000 did not
bear interest until August 1, 1997, after which time interest was calculated at
an annual rate of 10%.
On September 15, 1997, the Company repaid the $800,000 of outstanding
notes payable plus accrued interest in the amount of $10,082 to the Company's
Chief Operating Officer and Executive Vice President.
In accordance with Staff Accounting Bulletin Topic 5:T, the Company
imputed an interest cost on the portion of the non-interest bearing notes
payable to related parties which were not converted to equity upon the
completion of the Company's initial public offering. The imputed rate used was
based on the terms negotiated by the Company for its bank debt and was 8.00%
for the year ended December 31, 1997. Interest expense imputed was $254,892 for
the year ended December 31, 1997.
(7) Commitments and Contingencies
Leases -- Related Parties
Rent expense for each of the years ended December 31, 1998 and 1997
amounted to $58,320 and $38,000, respectively.
The Company sublets office space from an entity, HH Realty Investors,
Inc., wholly-owned by officers and directors of the Company.
In 1999, the New Jersey location subleased with HH Realty Investors, Inc.
was amended to a month by month lease at $2,900 per month. Also on March 1,
1999 additional space was directly leased in New Jersey for a period to expire
on the earlier of December 31, 1999 or 30 days from the occurrence of a defined
event.
During 1998, the Company subleased office space in Florida from The
Herrick Company, a company owned by Norton Herrick, Co-CEO, at $653 per month.
Such sublease was terminated on March 1, 1999.
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 December
1998, the lease was amended to provide for a month to month lease. 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 $1,307 per
month through November 2000 and is subject to two extension periods of three
years each under certain conditions.
Leases -- Other
In September 1998, the Company entered into a lease for a kiosk at a major
shopping mall. The lease which commenced in November 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.
F-26
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(7) Commitments and Contingencies -- (Continued)
In connection with the acquisition of Radio Spirits, the Company leases
8,000 square feet of space in South Schaumburg, Illinois from a trust owned by
the President of the Company's radio group. The lease agreement expires in
December 2005, subject to a three year renewal option. Monthly rent under the
leases is $4,667.
In connection with the acquisition of Premier, the Company entered into
two ten-year leases on 7,000 square feet of space in Bethel, Connecticut and
3,000 square feet in Sandy Hook, Connecticut. Lease payments on each lease are
$100 per year with mandatory capital improvement payments starting in 2004 of
$3,500 per year and $1,500 per year on the Bethel and Sandy Hook properties,
respectively.
Minimum annual lease commitments including capital improvement payments
under non-cancelable operating leases are as follows:
Year ending
December 31,
- -------------------------------------
1999 .............................. $123,187
2000 .............................. 70,573
2001 .............................. 56,200
Thereafter ........................ 250,400
--------
Total lease commitments ........... $500,360
========
Employment Agreements
The Company has commitments pursuant to employment agreements with certain
of its officers. The Company's aggregate commitments under such employment
agreements are approximately $841,517 and $452,054 during 1999 and 2000,
respectively. In connection with the Radio Spirits acquisition, the Company
hired Carl Amari as President of Classic, to manage the combined, post-merger
radio operations pursuant to a three-year employment agreement that provides
for an annual salary of $200,000 for the first 18 months and $300,000 for the
next 18 months.
(8) Initial Public Offering
The Company's Registration Statement on Form SB-2 for its initial public
offering was declared effective by the Securities and Exchange Commission on
October 22, 1997. On October 27, 1997, the Company closed its initial public
offering of 2,300,000 shares of Common Stock, with no par value, at a price of
$10.00 per share of Common Stock. In connection with the public offering, the
underwriters were granted an over-allotment option to purchase an additional
345,000 shares of Common Stock, exercisable until December 6, 1997. The
underwriters partially exercised their over allotment option by purchasing
110,000 shares from a minority shareholder (with holdings of less than 5% of
the Company's common stock.) The Company incurred expenses of $3,234,337
related to its initial public offering, including underwriting discounts and
commissions, legal and accounting fees, printing expenses and other expenses.
Upon completion of the offering, the associated costs were deducted from net
proceeds of the offering.
(9) Stock Option Plan
In June 1998, the Company amended the 1997 Stock Option Plan, under the
amendment the Company is now authorized to grant up to 2,000,000 shares of
authorized but unissued common stock.
In June 1997, the Company adopted the 1997 Stock Option Plan, pursuant to
which the Company's Board of Directors may grant stock options to key employees
of the Company. The Plan authorizes grants of options to purchase up to 750,000
shares of authorized but unissued common stock. Under the Plan, the
F-27
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(9) Stock Option Plan -- (Continued)
Company may grant incentive and non-qualified stock options. The terms and
conditions of options granted under the Plan may vary at the discretion of the
Company's Board of Directors. In addition, shares issued pursuant to the
exercise of the options may be restricted as to their transferability.
Stock option activity is as follows:
Weighted
average
Shares exercise price
------------ ---------------
Outstanding at December 31, 1996 ......... -- --
Granted ................................. 50,000 $ 11.00
Exercised ............................... -- --
Canceled ................................ -- --
Outstanding at December 31, 1997 ......... 50,000 $ 11.00
Granted ................................. 1,808,500 $ 5.37
Exercised ............................... -- --
Canceled ................................ -- --
--------- -------
Outstanding at December 31, 1998 ......... 1,858,500 $ 5.52
========= =======
The per share weighted-average fair value of stock options granted during
the year ended December 31, 1997 was $4.55 on the date of the grant using the
Black-Scholes option-pricing model with the following assumptions for the year
ended December 31, 1997; risk free rate of return 5.56%; option life five years
from date of vesting; and no dividend yield.
The per share weighted-average fair value of stock options granted during
the year ended December 31, 1998 is as follows using the Black-Scholes
option-pricing model with the following assumptions and no dividend yield. The
shares were granted as follows:
<TABLE>
<CAPTION>
No. of Exercise Assumed Risk-free Fair Value
Date Shares Price Volatility interest rate per Share
- ------------------------ ------------ --------------- ------------ --------------- -----------
<S> <C> <C> <C> <C> <C>
June 1998 .............. 551,500 $ 3.50 25% 5.49% $ .86
September 1998 ......... 750,000 $ 5.25 25% 4.58% $ 1.21
November 1998 .......... 450,000 $ 7.875 25% 4.50% $ 1.82
Various ................ 57,000 $6.00 - $10.81
-------
Total .................. 1,808,500
=========
</TABLE>
At December 31, 1998, there were 141,500 additional shares available for
grant under the Plan.
The Company applies the intrinsic value method to account for its Plan
and, accordingly, no compensation cost has been recognized for its stock
options in the financial statements because the exercise price was equal to or
greater than the fair value at the date of grant.
At December 31, 1998, the weighted average remaining contractual life of
outstanding options was five years. At December 31, 1998, 1,682,500 options
were exercisable.
(10) 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 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).
F-28
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(10) Income Taxes -- (Continued)
Income tax benefit for the year ended December 31, 1998 differed from the
amount computed by applying the U.S. Federal income tax rate of 34% and the
state income tax rate of 5.39% to the pre-tax loss as a result of the
following:
<TABLE>
<CAPTION>
1998 1997
---------------- ----------------
<S> <C> <C>
Computed tax benefit (Federal and State at 39.39%) ..................... $ (2,751,215) $ (1,673,089)
Adjustment for partial-year C-corporation status ....................... 1,347,673
Adjusted computed tax benefit at 34% ................................... (325,416)
Valuation allowance for Federal and State deferred tax assets .......... 2,751,215 325,416
------------ ------------
Income tax expense ..................................................... $ -0- $ -0-
============ ============
</TABLE>
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets are as follows:
<TABLE>
<CAPTION>
1998 1997
--------------- -------------
<S> <C> <C>
Deferred tax assets:
Federal and state net operating loss carry-forwards .......... $ 3,099,025 $ 269,715
Accounts receivable, principally due to allowance for doubtful
accounts and reserve for returns ........................... 547,312 112,778
Fixed assets ................................................. (9,251)
------------
Total gross deferred tax assets .............................. 3,637,086 382,493
Less valuation allowance ..................................... (3,637,086) (382,493)
------------ ----------
Net deferred tax assets ...................................... $ -0- $ -0-
============ ==========
</TABLE>
The Company has provided a valuation allowance of $3,637,086 and $382,493
for deferred tax assets as of December 31, 1998 and 1997, respectively. In
assessing the realizability of deferred tax assets, management has determined
that the Company does not have a history of earnings on which to base its
determination. The ultimate realization of deferred tax assets is dependent on
the generation of future taxable income during the periods in which those
temporary timing differences become deductible. The Company's limited operating
history does not allow management to make a judgment regarding future taxable
income over those periods.
The Company has approximately $7,591,631 of net operating loss
carry-forwards which may be used to offset possible future earnings, if any, in
computing future income tax liabilities. The net operating losses will expire
between December 31, 2017 and December 31, 2018 for federal income tax
purposes. For state purposes, the net operating losses will expire at varying
times, as the Company is subject to corporate income tax in several states.
(11) Net Loss Per Share of Common Stock
Basic net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding during the applicable reporting
periods. The computation of diluted net loss per share is similar to the
computation of basic net loss per share except that the denominator is
increased to include the number of additional common shares that would have
been outstanding if the dilutive potential common shares had been issued.
However, the Company's computation of dilutive net loss per share does not
assume any conversion or exercise of securities as their effect is antidilutive
for all periods presented.
The weighted average number of shares outstanding used in the net loss per
share computations for the years ended December 31, 1998 and 1997 were
6,187,687 and 3,820,027, respectively.
F-29
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
Common equivalent shares that could potentially dilute basic earnings per
share in the future and that were not included in the computation of diluted
loss per share because of antidilution were 4,670,927 for the year ended
December 31, 1998 and 50,000 for the year ended December 31, 1997.
(12) Supplemental Cash Flow Information
No cash has been expended for income taxes for the years ended December
31, 1998 and 1997. Cash expended for interest was -0- and $286,246 for the
years ended December 31, 1998 and 1997, respectively.
In connection with its acquisitions, the Company provided a total of
925,000 shares of its common stock and 380,000 options and warrants to the
former owners of the acquired companies, and attorneys and advisors to the
transactions. The total value of the stock, $11,503,124 and warrants of
$1,002,000 has been recorded as part of the acquisition prices to be amortized
over periods not to exceed 20 years. The Company also provided 35,000 warrants
to advisors to the transaction. The value of warrants of $75,650 has been
included in the cost of the acquisitions and recorded as goodwill. The Company
also provided 196,800 warrants to the banks providing financing for the
acquisitions. The value of the warrants of $580,000 has been included in
deferred financing fees.
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
("URL"), audiobook.com and audiobook.net. The Company has included the value of
the options of $50,000 in the asset value 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.
During the year ended December 31, 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.
Immediately prior to the consummation of the Company's initial public
offering, the Company's Chairman, Chief Executive Officer, and founder
converted the outstanding $5,975,200 of indebtedness owed to him into 597,520
shares of common stock at a price per share of $10.00.
(13) Related Party Transactions
Companies wholly-owned by Norton Herrick provided certain accounting,
administrative and general office services to, and obtained insurance coverage
for, the Company. In connection with such services the Company paid to such
entities the aggregate of $73,000 and $60,000, during the years ended December
31, 1998 and 1997, respectively. The Company anticipates obtaining similar
services from time to time from companies affiliated with Norton Herrick for
which it will reimburse such companies' cost to provide such services to the
Company.
(14) Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Standards ("SFAS") No. 131, "Disclosures about Segments of an
Enterprise and Related Disclosures" ("SFAS 131") which requires that a public
enterprise disclose financial and descriptive information about segments of
their operations using a management approach. The approach involves reporting
financial information on the basis used internally by management to evaluate
segment performance and decide how resources are allocated to
F-30
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(14) Recently Issued Accounting Standards -- (Continued)
segments. SFAS 131 additionally requires that a public business report a
measure of segment profit or loss, certain specific revenue and expense items
and segment assets. Management has not disclosed any segment information as it
does not operate more than one segment.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes new
disclosure requirements, which provide a comprehensive standard for recognition
and measurement of derivatives and hedging activities. This will require all
derivatives to be recorded on the balance sheet at fair value and special
accounting for certain types of hedges. SFAS 133 will take effect in 2000. The
Company has not entered into any derivative or hedge transactions and,
therefore, does not believe that SFAS 133 will have a material effect on the
combined financial condition or results of operations.
(15) Subsequent Events
On March 18, 1999, the Company entered into a definitive agreement to
acquire substantially all of the assets used by Doubleday Direct, Inc. in the
direct marketing and distribution of audiobooks and related products through
Doubleday's Audiobooks Direct club, including its membership file of
approximately 450,000 names. In connection with the closing of this
acquisition, Doubleday will grant to the Company the exclusive right to include
Audio Book Club new member solicitation inserts in Doubleday's club mailings
and to send direct mail new member solicitation packages to Doubleday's book
club members for the next four years. This agreement will relate to all of
Doubleday's existing and future clubs. In addition, as part of the acquisition,
the companies have agreed to enter into a broad Internet marketing and
promotion agreement including the development of a co-branded web site. The
Company cannot be assured that this acquisition or the related agreements will
be completed.
In March 1999, the Company granted to employees of the Company or its
subsidiaries, five year options under the 1997 Stock Option plan to purchase an
aggregate of 62,600 shares of its common stock at $12.00 per share, vesting
over the next two years.
In March 1999, the Company has been named as a co-defendant together with
a collection agency used by the Company, in a lawsuit in the United States
District Court for the Northern District of Illinois, alleging violations by
such collection agency and the Company of the Fair Debt Collection Practices
Act. Such lawsuit has been brought by a Class Action on behalf of individuals,
limited to those who were sent certain collection letters within the state of
Illinois during the one year period preceding the filing of the lawsuit. The
lawsuit has not yet been certified as a Class Action. The collection agency has
agreed to indemnify the Company and therefore the Company believes that the
outcome of the action will not have a material adverse impact on the Company.
In February 1999, the Company granted to employees of the Company five
year options under the 1997 Stock Option plan to purchase 20,000 shares of its
common stock at $8.00 per share, vesting over the next two years.
In February 1999, the Company's Board of Directors approved (i) an
amendment to the Company's Articles of Incorporation to increase the Company's
authorized common stock to 75,000,000 shares and (ii) the adoption of the
Company's 1999 Stock Incentive Plan, in each case, subject to shareholder
approval. The 1999 Stock Incentive Plan provides for grants of awards of stock
options, restricted stock, deferred stock or other stock-based awards. A total
of 2,500,000 shares of common stock have been reserved for distribution
pursuant to the plan.
<PAGE>
AUDIO BOOK CLUB, INC.
Notes to Consolidated Financial Statements -- (Continued)
(15) Subsequent Events -- (Continued)
Effective February 15, 1999, the Company entered into an employment
agreement with its new Executive Vice President and Chief Technology Officer,
which provides for an annual base compensation of $150,000 and a
performance-based bonus of $15,000 payable at the end of the first year of
employment. Pursuant to the agreement, the Company granted five year options to
purchase 150,000 shares of common stock at an exercise price of $9.75, vesting
at various times over a three year period, and five year options to purchase
8,000 shares of common stock at $.10 vesting on February 15, 1999.
F-32
<PAGE>
Independent Auditors' Report
The Board of Directors
Doubleday Direct, Inc.:
We have audited the accompanying balance sheets of Audio Books Direct (the
"Club"), a wholly-owned operation of Doubleday Direct, Inc., as of June 30,
1998 and 1997, and the related statements of operations, divisional deficit,
and cash flows for the years then ended. These financial statements are the
responsibility of the Club's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
Audio Books Direct has been operated as an integral part of Doubleday Direct,
Inc., and has no separate legal existence. The basis of presentation of the
accompanying financial statements is described in note 2 to the financial
statements.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Audio Books Direct, a
wholly-owned operation of Doubleday Direct, Inc., as of June 30, 1998 and 1997,
and the results of its operations and its cash flows for the years then ended
on the basis described in the preceding paragraph and in conformity with
generally accepted accounting principles.
/s/ KPMG LLP
New York, New York
March 12, 1999
F-33
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
Balance Sheets
(Dollars in Thousands)
June 30, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
Assets
Current assets:
Accounts receivable, net ............................ $ 1,887 1,404
Inventory, net ...................................... 1,878 2,276
--------- -----
Total current assets ............................. 3,765 3,680
Royalty advances, net .................................. 954 231
--------- -----
Total assets ..................................... 4,719 3,911
========= =====
Liabilities and Divisional Deficit
Current liabilities:
Accrued royalties payable ........................... 62 59
Accrued promotional expenses, net ................... 840 13
--------- -----
Total current liabilities ........................ 902 72
Due to DDI and affiliates .............................. 15,567 13,332
Commitments
Divisional deficit ..................................... (11,750) (9,493)
--------- ------
Total liabilities and divisional deficit ......... $ 4,719 3,911
========= ======
</TABLE>
See accompanying notes to financial statements.
F-34
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
Statements of Operations
(Dollars in Thousands)
Years ended June 30, 1998 and 1997
1998 1997
------------ -----------
Net revenues ................................. $ 15,001 9,693
Cost of revenues ............................. 5,440 4,023
-------- -----
Gross profit ........................... 9,561 5,670
-------- -----
Operating expenses:
Selling and new member promotion .......... 8,971 10,126
General and administrative ................ 2,847 1,878
-------- ------
11,818 12,004
-------- ------
Net loss ............................... $ (2,257) (6,334)
======== ======
See accompanying notes to financial statements.
F-35
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
Statements of Divisional Deficit
(Dollars in Thousands)
Years ended June 30, 1998 and 1997
Balance at July 1, 1996 .......... $ (3,159)
Net loss ....................... (6,334)
---------
Balance at June 30, 1997 ......... (9,493)
Net loss ....................... (2,257)
---------
Balance at June 30, 1998 ......... $ (11,750)
=========
See accompanying notes to financial statements.
F-36
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
Statements of Cash Flows
(Dollars in Thousands)
Years ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss ................................................ $ (2,257) (6,334)
Adjustments to reconcile net loss to net cash used in
operating activities:
Change in net accounts receivable .................... (483) (841)
Change in net inventory .............................. 398 (610)
Change in royalty advances ........................... (723) (191)
Change in accrued royalties payable .................. 3 42
Change in net accrued promotional expenses ........... 827 (372)
-------- ------
Net cash used in operating activities ............. (2,235) (8,306)
-------- ------
Cash flows from financing activities:
Net advances from DDI and affiliates .................... 2,235 8,306
-------- ------
Net cash provided by financing activities ......... 2,235 8,306
-------- ------
Net change in cash ......................................... -- --
Cash at beginning of year .................................. -- --
-------- ------
Cash at end of year ........................................ $ -- --
======== ======
</TABLE>
See accompanying notes to financial statements.
F-37
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
NOTES TO FINANCIAL STATEMENTS
June 30, 1998 and 1997
(Dollars in Thousands)
(1) The Company and Nature of Operations
Audio Books Direct (the "Club") is a direct marketer of audio books
primarily through negative option direct mail campaigns to members located
predominately in the United States. Audio books are literary works that are
narrated on audiocassette. The Club represents the audio book operations of
Doubleday Direct, Inc., ("DDI", an indirect wholly-owned subsidiary of
Bertelsmann AG, a privately-owned German corporation). The Club has never been
operated as a separate legal entity, but rather an integral part of DDI.
In February 1999, DDI signed a letter of intent with Audio Book Club, Inc.
("ABC") to sell substantially all of the assets of the Club to ABC for
approximately $21,000, plus the assumption of all unpaid publisher royalty
commitments.
(2) Significant Accounting Policies
Basis of Presentation
The accompanying financial statements have been prepared in accordance
with generally accepted accounting principles which are consistent with those
employed by DDI. Included in the accompanying statements of operations are net
revenues and costs of revenues that substantially relate directly to the
Club. Selling, general and administrative expenses include those accounts that
relate directly to the Club as well as allocations from DDI (see note 6). These
allocations are considered by management to be reasonable under the
circumstances. However, there can be no assurances that such allocations will
be indicative of future results.
The accompanying financial statements have been prepared on a
going-concern basis and do not reflect the pending sale of the Club to ABC or
any purchase accounting adjustments that may be made by ABC. These financial
statements are not necessarily indicative of results that would have occurred
if the Club had been a separate stand-alone entity during the periods presented
or of future results of the Club.
Supplemental Cash Flow Information
The Club does not maintain any cash balances. All cash transactions are
handled through DDI inter-company accounts and are therefore reflected as
adjustments to the amounts due to DDI. An analysis of the inter-company balance
with DDI as of and for the years ended June 30, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Balance as of the beginning of the year .......... $ 13,332 $ 5,027
Net cash collections by DDI ...................... (13,694) (10,109)
Charges and allocations from DDI ................. 15,929 18,414
--------- ---------
Balance as of the end of the year ................ $ 15,567 $ 13,332
========= =========
</TABLE>
The Club did not expend any amounts relative to income taxes or third party
interest expense during the years ended June 30, 1998 or 1997.
Revenue Recognition
Current member sales, including shipping and handling charges, are
recorded and club members are billed upon shipment of merchandise. Net sales
represent sales less actual returns and allowances (i.e., claims) for the
period and an estimated provision for future returns and allowances on sales
made during the period.
F-38
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
NOTES TO FINANCIAL STATEMENTS
June 30, 1998 and 1997
(Dollars in Thousands) -- (Continued)
(2) Significant Accounting Policies -- (Continued)
The provision for future returns is based upon historical experience and an
evaluation of current trends. A provision for estimated bad debts is also
recognized based upon historical experience and an evaluation of current trends
at the time of sale and is included in general and administrative expenses.
Cost of Sales
The Club charges inventory, shipping and postage and all royalty expenses
for current members to cost of sales.
Inventory
Inventory, consisting primarily of pre-recorded audio books held for
resale, is valued at the lower of cost (weighted average first-in-first-out
method) or market.
Promotional Expenses
The Club expenses the capitalized 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
both prospective and current members that include order forms for the Club's
products, and to a lesser extent print advertisements to prospective members.
Promotional costs for prospective and current members are expensed on the date
the promotional materials are mailed. Accrued promotional expenses represent
amounts due for promotional campaigns which have not yet been paid. Such
amounts are paid by DDI.
Royalties
The Club is liable for royalties to licensors based upon revenue earned
from the respective licensed product. Advances made for the right to distribute
audio book products are recorded as advances and expensed as the related sales
are made. An allowance is established for advances not considered recoverable
based upon projected sales. Such allowance was approximately $480 and $316 as
of June 30, 1998 and 1997, respectively.
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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Income Taxes
The Club is not subject to income taxes directly. However the accompanying
financial statements reflect the accounting for income taxes as if the Club
were to have been a separate tax filer in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. If the Club were to have been a separate tax filer
hypothetical deferred tax assets, primarily representing the tax effected net
operating loss carryforwards in various jurisdictions, amounted to
approximately $3,000 at June
F-39
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
NOTES TO FINANCIAL STATEMENTS
June 30, 1998 and 1997
(Dollars in Thousands) -- (Continued)
(2) Significant Accounting Policies -- (Continued)
30, 1998. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during
future periods. Management has determined that a valuation allowance for the
entire amount is necessary.
Fair Value of Financial Instruments
In estimating the fair value for financial instruments, the Club has
assumed that the carrying amount of accounts receivable and royalties payable
approximates fair value because of the short maturity of those instruments. It
is not practical to estimate the fair market value of the amount due to DDI and
affiliates due to the related party nature of the underlying transactions.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders, which is not currently required. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. Adoption of this statement will not
impact the Club's financial position, results of operations, or cash flows, and
any effect will be limited to the form and content of its disclosure. This
statement is effective for fiscal years beginning after December 15, 1997.
(3) Liquidity
The Club is dependent on DDI to fund working capital and operational cash
requirements. If the Club was operated as a stand-alone entity, it would
require alternative sources of financing. DDI has committed to provide
continued funding through June of 1999 if the Club remains as a wholly-owned
operation.
(4) Accounts Receivable
Accounts receivable as of June 30, 1998 and 1997, consists of the
following:
1998 1997
---------- ---------
Accounts receivable, trade ................... $ 2,799 2,391
Less: Allowance for sales returns ............ (418) (377)
Allowance for doubtful accounts .......... (494) (610)
------- -----
$ 1,887 1,404
======= =====
(5) Inventory
Inventory as of June 30, 1998 and 1997, consists of the following:
1998 1997
---------- ---------
Audio books .................... $ 2,215 2,408
Promotional and other .......... 187 99
Allowances ..................... (524) (231)
------- -----
$ 1,878 2,276
======= =====
F-40
<PAGE>
AUDIO BOOKS DIRECT
(A Wholly-Owned Operation of Doubleday Direct, Inc.)
NOTES TO FINANCIAL STATEMENTS
June 30, 1998 and 1997
(Dollars in Thousands) -- (Continued)
(6) Transactions with Related Parties
DDI, as owner of the Club, is responsible for fulfillment and warehousing
activities related to the Club's operations. Amounts allocated to the Club for
these services were approximately $960 and $734 for the years ended June 30,
1998 and 1997, respectively and are included in general and administrative
expenses in the accompanying statements of operations.
DDI, as owner of the Club, also provides certain administrative and
support services to the Club including: personnel and related employee benefits
and other overhead such as rent, utilities, finance, human resource and
information technology support, and interest. Amounts allocated to the Club for
these services were approximately $1,942 and $1,137 for the years ended June
30, 1998 and 1997, respectively and are included in general and administrative
expenses in the accompanying statements of operations.
Certain Bertelsmann publishing affiliates received royalty payments of
$143 and $218 for the years ended June 30, 1998 and 1997.
Inventory of approximately $526 and $802 for the years ended June 30, 1998
and 1997 was purchased from a Bertelsmann affiliate.
(7) Commitments
Future advance payments to publishers required under existing royalty
agreements, upon the availability of the underlying titles, as of June 30, 1998
are as follows:
Affiliated publisher agreement for multiple titles .......... $125
Third party publisher agreement for multiple titles ......... 500
Agreements for individual titles ............................ 289
----
$914
====
F-41
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Representatives of
The Columbia House Company
New York, New York
We have audited the accompanying balance sheet of The Columbia House Audiobook
Club, a division of The Columbia House Company, as of December 18, 1998 and the
related statements of operations and cash flows for the fiscal year then ended.
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.
The accompanying financial statements have been prepared from the separate
records maintained by The Columbia House Company and may not necessarily be
indicative of the conditions that would have existed or the results of
operations if The Columbia House Audiobook Club had been operated as an
unaffiliated company. Portions of certain assets, liabilities, income and
expenses represent allocations made from the home-office items applicable to
the company as a whole.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of The Columbia House Audiobook Club as of
December 18, 1998, and the results of its operations and its cash flows for the
fiscal year then ended in conformity with generally accepted accounting
principles.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
March 18, 1999
F-42
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
(A Division of The Columbia House Company)
BALANCE SHEET
DECEMBER 18, 1998
(Amounts in Thousands, except share and per-share data)
CURRENT ASSETS:
Cash ........................................................ $ --
Accounts receivable, net (Note 3) ........................... 1,881
Inventory, net (Note 4) ..................................... 581
Royalty advances ............................................ 867
Prepaid expense and other current assets .................... 42
------
Total current assets ..................................... 3,371
LONG-TERM ASSETS
Deferred member acquisition costs (Note 5) .................. 2,420
------
TOTAL ASSETS ................................................... $5,791
======
CURRENT LIABILITIES:
Accounts payable ............................................ $ 708
Accrued royalties ........................................... 1,017
Accrued advertising ......................................... 355
Other current liabilities ................................... 191
------
Total current liabilities ................................ 2,271
COMMITMENTS AND CONTINGENCIES (Note 8)
COLUMBIA HOUSE EQUITY INVESTMENT (Note 6) ...................... 3,520
------
TOTAL LIABILITIES AND COLUMBIA HOUSE EQUITY INVESTMENT ......... $5,791
======
See notes to financial statements.
F-43
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
(A Division of The Columbia House Company)
STATEMENT OF OPERATIONS
FISCAL YEAR ENDED DECEMBER 18, 1998
(Amounts in Thousands, except share and per-share data)
NET SALES ............................................... $ 14,387
--------
EXPENSES:
Cost of sales ........................................ 6,118
Selling, general and administrative expenses ......... 10,164
--------
Total expenses .................................... 16,282
--------
NET LOSS ................................................ $ (1,895)
========
See notes to financial statements.
F-44
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
(A Division of The Columbia House Company)
STATEMENT OF CASH FLOWS
FISCAL YEAR ENDED DECEMBER 18, 1998
(Amounts in Thousands, except share and per-share data)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................................. $ (1,895)
--------
Adjustments to reconcile net loss to net cash used in operating activities:
Changes in assets and liabilities:
Decrease in accounts receivable ........................................ 28
Decrease in inventory .................................................. 215
Decrease in deferred member acquisition costs .......................... 561
Increase in royalty advances ........................................... (380)
Increase in other assets ............................................... (42)
Increase in accounts payable ........................................... 352
Increase in accrued royalties .......................................... 128
Decrease in accrued advertising ........................................ (496)
Increase in other current liabilities .................................. 191
--------
Total adjustments ................................................... 557
--------
Net cash used in operating activities ............................... (1,338)
--------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net distributions to Columbia House ....................................... (1,314)
Amounts paid by Columbia House ............................................ 2,652
--------
Net cash provided by financial activities .............................. 1,338
--------
NET CHANGE IN CASH ........................................................... --
CASH, BEGINNING OF YEAR ...................................................... --
--------
CASH, END OF YEAR ............................................................ $ --
========
</TABLE>
See notes to financial statements.
F-45
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
(A Division of The Columbia House Company)
NOTES TO FINANCIAL STATEMENTS
FISCAL YEAR ENDED DECEMBER 18, 1998
(Amounts in Thousands, except share and per-share data)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
The Columbia House Audiobook Club (The "Club"), a division of The Columbia
House Company ("Columbia House"), is a membership club which markets and sells
audio books by mail order in the United States. The Club commenced operations
during July 1994 and acquires members primarily through direct mailings of
member solicitation materials and advertisements in magazines, newspapers and
other publications. The Club does not maintain any full or part-time employees
as all operations of The Club are performed by employees of Columbia House. As
described in Note 7, Columbia House charges The Club for all services rendered
on behalf of The Club.
As described in Note 9 Columbia House sold The Club effective December 31,
1998.
2. SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year and Reporting Period -- The Club's fiscal year consists of 52
or 53 weeks ending on the third Friday of December in each year. The fiscal
year ended December 18, 1998 included 52 weeks.
Basis of Presentation -- The carve-out financial statements include the
accounts of The Club and reflect the carve-out historical results of
operations, financial position and cash flows of The Club.
As described in Note 7, because The Club operates as a division within
Columbia House, only those assets, liabilities, revenues and expenses of
Columbia House directly related to or allocated to The Club are in the
accompanying financial statements. Certain expenses of The Club reflected in
the accompanying financial statements included allocations of costs from
Columbia House for certain executive and administrative functions. Allocations
of certain assets, liabilities, and costs among Columbia House divisions are
based on revenues, personnel, space, estimates of usage or time spent to
provide services, or other appropriate bases. The accompanying financial
statements may not necessarily be indicative of the financial position or
results of operations if The Club had operated as an unaffiliated company.
Columbia House funds the working capital requirements of its Club
businesses based upon a centralized cash management system. The Columbia House
Equity Investment (Note 6) includes an accumulated deficit as well as payables
and receivables due from Columbia House resulting from cash transfers.
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 revenues and expenses
during the reporting period. Actual results could subsequently differ from
those estimates. The significant estimates that affect the financial statements
include, but are not limited to, audiobook returns, doubtful accounts,
inventory obsolescence, related party charges and the recoverability of royalty
advances to publishers and deferred member acquisition costs.
Revenue Recognition -- The Club recognizes sales, which include amounts
charged to Club members for shipping and handling, upon shipment of merchandise
and simultaneous billing. Allowance for doubtful accounts and future returns
are based upon historical experience and evaluation of current trends.
Inventory -- Inventory, consisting primarily of audiobooks held for
resale, is valued at the lower of cost (weighted average cost method) or
market.
Deferred Member Acquisition Costs -- Member acquisition costs include
direct response advertising costs, consisting primarily of the cost of direct
mailings, magazine and newspaper advertising that include enrollment forms for
The Club's members.
F-46
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
(A Division of The Columbia House Company)
NOTES TO FINANCIAL STATEMENTS -- (Continued)
FISCAL YEAR ENDED DECEMBER 18, 1998
(Amounts in Thousands, except share and per-share data)
2. SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
Member's acquisition costs are deferred and amortized in relation to the
revenue stream estimated from the new Club members. The Club's estimate of
future revenues is based on historical experience and is limited to revenues
expected within two years of members joining The Club which corresponds to the
membership commitment period.
Royalties -- The Club is liable for royalties to licensors based upon
revenue earned from the respective licensed product. Advances made for the
right to distribute audiobook products are recorded as prepayments and
reflected in the cost of sales as royalty expense as the related sales are
made. An allowance is established for amounts considered recoupable. For the
fiscal year ended December 18, 1998, no writedown of royalty advances were
recorded.
Income Taxes -- Columbia House is a United States partnership and,
therefore, not subject to federal or state income taxes. Accordingly, no
provision has been reflected in The Club's financial statements for federal or
state income taxes since The Columbia House partners are taxed thereon
directly.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
Accounts receivable, trade .................. $ 2,764
Less:
Allowance for sales returns ............... 301
Allowance for doubtful accounts ........... 582
-------
$ 1,881
=======
The provision for doubtful accounts charged to expense was $869 for the
fiscal year ended December 18, 1998.
4. INVENTORIES
Inventories consist of the following:
Raw materials .............................. $ 163
Finished goods ............................. 958
------
1,121
Less: allowance for obsolescence ........... 540
------
$ 581
======
5. DEFERRED MEMBER ACQUISITION COSTS
Deferred member acquisition costs were $2,420 at December 18, 1998.
Advertising expense was $5,498 for the same period. Included in advertising
expense is $1,534 of deferred member acquisition costs that were written down
to net realizable value.
F-47
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
(A Division of The Columbia House Company)
NOTES TO FINANCIAL STATEMENTS -- (Continued)
FISCAL YEAR ENDED DECEMBER 18, 1998
(Amounts in Thousands, except share and per-share data)
6. COLUMBIA HOUSE EQUITY INVESTMENT
An analysis of The Columbia House equity investment activity is as
follows:
Balance at December 19, 1997 ............. $ 4,077
Net loss ........................................... (1,895)
Net cash distributions to Columbia House ........... (1,314)
Allocated charges from Columbia House .............. 2,652
--------
Balance at December 18, 1998 ............. $ 3,520
========
7. RELATED PARTY TRANSACTIONS
Columbia House provides The Club with warehousing, fulfillment, marketing
and customer service functions. For the fiscal year ended December 18, 1998,
$1,164 of warehouse expenses is included as a component of costs of sales and
$402 represent allocated charges. Allocated charges during 1998 for
fulfillment, marketing and customer service functioning which are included as a
component of selling, general and administrative were as follows:
Fulfillment ............................ $ 1,123
Marketing and customer service ......... 689
-------
$ 1,812
=======
Columbia House also provides The Club with all general and administrative
services, including insurance, legal, financial and other corporate functions,
including purchasing, accounting and systems technology support. Such charges
amounted to $438 for the fiscal year ended December 18, 1998.
8. COMMITMENTS AND CONTINGENCIES
The Club provides advances to publishers for the right to distribute
audiobook products. Such advances are recoupable against royalties earned by
publishers. Future advance payments required under existing contracts are as
follows as of December 18, 1998:
Year Ended Amount
- --------------------------------- -------
1999 .......................... $ 325
Thereafter .................... --
-----
$ 325
=====
9. SUBSEQUENT EVENT
On December 31, 1998, Columbia House entered into an agreement (the "Sales
Agreement") to sell The Club to The Audio Book Club, Inc. for (i) $30,750 in
cash plus the first $2,000 in collection of accounts receivable; (ii) 325,000
shares of common stock of The Audio Book Club Inc.; and (iii) a warrant to
purchase 100,000 common shares of The Audio Book Club, Inc. at an exercise
price equal to $11.125 per share, exercisable during the period from the
closing date of the Sales Agreement to the fifth anniversary of such date.
Under the Sales Agreement, effective December 31, 1998 Columbia House
agreed to provide certain warehousing, fulfillment, marketing and customer
service operations for The Audiobook Club, Inc. through June 30, 1999.
F-48
<PAGE>
Report of Independent Accountants
December 30, 1998
To the Board of Representatives of
The Columbia House Company
In our opinion, the accompanying carve-out balance sheets and the related
carve-out statements of operations and of cash flows present fairly, in all
material respects, the financial position of The Columbia House Audiobook Club,
a division of The Columbia House Company (the "Company"), at December 19, 1997
and December 20, 1996, and the results of its operations and its cash flows for
each of the fiscal years then ended in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
F-49
<PAGE>
The Columbia House Audiobook Club
Carve-Out Balance Sheet
(Amounts in thousands)
<TABLE>
<CAPTION>
December 19, December 20,
1997 1996
-------------- -------------
<S> <C> <C>
Assets
Current assets
Cash .............................................................. $ -- --
Accounts receivable, net (Note 3) ................................. 1,909 1,809
Inventories, net (Note 4) ......................................... 796 826
Deferred member acquisition costs (Note 5) ........................ 2,632 2,685
Royalty advances .................................................. 487 753
Prepaid expenses and other current assets ......................... -- 296
------ -----
Total current assets ........................................... 5,824 6,369
------ -----
Long-term assets
Deferred member acquisition costs (Note 5) ........................ 349 414
------ -----
Total assets ................................................... $6,173 $6,783
====== ======
Liabilities and Columbia House Equity Investment
Current liabilities
Accounts payable .................................................. $ 356 $ 628
Accrued royalties ................................................. 889 989
Accrued advertising ............................................... 851 --
------ ------
Total current liabilities ...................................... 2,096 1,617
Commitments and contingencies (Note 8)
Columbia House Equity Investment (Note 6) ............................ 4,077 5,166
------ ------
Total liabilities and Columbia House Equity Investment ......... $6,173 $6,783
====== ======
</TABLE>
The accompanying notes are an integral part of these carve-out financial
statements.
F-50
<PAGE>
The Columbia House Audiobook Club
Carve-Out Statement of Income
(Amounts in thousands)
<TABLE>
<CAPTION>
Fiscal Year Ended
December 19, December 20,
1997 1996
-------------- -------------
<S> <C> <C>
Net sales ............................................... $ 16,555 $15,188
Expenses
Cost of sales ........................................ 7,019 5,862
Selling, general and administrative expenses ......... 10,587 8,407
-------- -------
Total expenses .................................... 17,606 14,269
-------- -------
Operating (loss) income ................................. (1,051) 919
(Benefit) provision for income taxes (Note 2) ........... -- --
-------- -------
Net (loss) income ....................................... $ (1,051) $ 919
======== =======
</TABLE>
The accompanying notes are an integral part of these carve-out financial
statements.
F-51
<PAGE>
THE COLUMBIA HOUSE AUDIOBOOK CLUB
Carve-Out Statement of Cash Flows
(Amounts in thousands)
<TABLE>
<CAPTION>
Fiscal Year Ended
December 19, December 20,
1997 1996
-------------- -------------
<S> <C> <C>
Cash flows from operating activities
Net (loss) income ..................................................... $ (1,051) $ 919
Adjustments to reconcile net (loss) income to net cash
from operating activities
Changes in assets and liabilities
Increase in accounts receivable .................................. (100) (250)
Decrease in inventories .......................................... 30 319
Decrease (increase) in deferred member acquisition costs ......... 118 (814)
Decrease (increase) in royalty advances .......................... 266 (511)
Decrease (increase) in other assets .............................. 296 (25)
Decrease in accounts payable ..................................... (272) (677)
(Decrease) increase in accrued royalties ......................... (100) 412
Increase in accrued advertising .................................. 851 --
-------- --------
Net cash flow from operating activities ................................ 38 (627)
-------- --------
Financing activities
Net distributions to Columbia House ................................... (2,823) (1,920)
Amounts paid by Columbia House ........................................ 2,785 2,547
-------- --------
Net cash flow from financing activities ................................ (38) 627
-------- --------
Net change in cash ..................................................... -- --
Cash at beginning of year .............................................. -- --
-------- --------
Cash at end of year .................................................... $ -- $ --
======== ========
</TABLE>
The accompanying notes are an integral part of these carve-out financial
statements.
F-52
<PAGE>
The Columbia House Audiobook Club
Notes to Carve-Out Financial Statements
December 19, 1997 and December 20, 1996
(Amounts in thousands, except share data)
1. Organization and Description of Business
The Columbia House Audiobook Club (the "Club"), a division of the Columbia
House Company ("Columbia House"), is a membership club which markets and sells
audio books by mail order in the United States. The Club commenced operations
during July 1994 and acquires members primarily through direct mailings of
member solicitation materials and advertisements in magazines, newspapers and
other publications. The Club does not maintain any full or part-time employees
as all operations of the Club are performed by employees of Columbia House. As
described in Note 7, Columbia House charges the Club for all services rendered
on behalf of the Club.
On December 30, 1998, Columbia House entered into an agreement (the "Sales
Agreement") to sell the Club to The Audio Book Club, Inc. for (i) $32,750 in
cash; (ii) 325,000 shares of common stock of The Audio Book Club Inc.; and
(iii) a warrant to purchase 100,000 common shares of The Audio Book Club, Inc.
at an exercise price equal to $11.125 per share, exercisable during the period
from the closing date of the Sales Agreement to the fifth anniversary of such
date.
2. Significant Accounting Policies
Fiscal year and reporting period
The Club's fiscal year consists of 52 or 53 weeks ending on the third
Friday of December in each year. The year ended December 19, 1997 included 52
weeks while the year ended December 20, 1996 included 53 weeks.
Basis of presentation
The carve-out financial statements include the accounts of the Club and
reflect the carve-out historical results of operations, financial position and
cash flows of the Club. These financial statements are not necessarily
indicative of results that would have occurred if the Club had been a separate
stand-alone entity during the periods presented or of future results of the
Club.
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 revenues and expenses during the
reporting period. Actual results could subsequently differ from those
estimates. The significant estimates that affect the financial statements
include, but are not limited to, audiobook returns, doubtful accounts,
inventory obsolescence, related party charges and the recoverability of royalty
advances to publishers and deferred member acquisition costs.
Revenue recognition
The Club recognizes sales, which include amounts charged to Club members
for shipping and handling, upon shipment of merchandise and simultaneous
billing. Allowance for doubtful accounts and future returns are based upon
historical experience and evaluation of current trends.
Inventory
Inventory, consisting primarily of audiobooks held for resale, is valued
at the lower of cost (weighted average cost method) or market.
F-53
<PAGE>
The Columbia House Audiobook Club
Notes to Carve-Out Financial Statements -- (Continued)
December 19, 1997 and December 20, 1996
(Amounts in thousands, except share data)
2. Significant Accounting Policies -- (Continued)
Deferred member acquisition costs
Member acquisition costs include direct response advertising costs,
consisting primarily of the cost of direct mailings, magazine and newspaper
advertising that include enrollment forms for the Club's members, and the cost
of audiobook products provided to new members at a nominal price (introductory
product shipments) as incentives to join the Club.
Member acquisition costs are deferred and amortized in relation to the
revenue stream estimated from the new Club members. The Club's estimate of
future revenues is based on historical experience and is limited to revenues
expected within two years of members joining the Club which corresponds to the
membership commitment period.
Royalties
The Club is liable for royalties to licensors based upon revenue earned
from the respective licensed product. Advances made for the right to distribute
audiobook products are recorded as prepayments and reflected in the cost of
sales as royalty expense as the related sales are made. An allowance is
established for amounts considered unrecoupable. For the years ended December
19, 1997 and December 20, 1996 no writedown of royalty advances were recorded.
Income taxes
Columbia House is a United States partnership not subject to federal or
state income tax. Accordingly, no (benefit) provision has been reflected in the
Club's financial statements for federal or state income taxes on Club (loss)
income since the Columbia House partners are taxed thereon directly.
Recent accounting pronouncements
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 128, "Earnings per Share"
which establishes standards for computing and presenting earnings per share and
is effective for financial statements for both interim and annual periods
ending after December 15, 1997. Given the nature of the capital structure of
the Club, earnings per share data has not been presented.
There are no other recently issued accounting pronouncements that are
expected to have a material impact on the Club.
3. Accounts Receivable
Accounts receivable consist of the following:
December 19, December 20,
1997 1996
-------------- -------------
Accounts receivable, trade ............... $3,549 $3,337
Less:
Allowance for sales returns ............. 599 543
Allowance for doubtful accounts ......... 1,041 985
------ ------
$1,909 $1,809
====== ======
The provision for doubtful accounts charged to expense was $1,634 in 1997
and $1,538 in 1996. The Club has no significant concentrations of credit risk
with respect to trade receivables because of the large number of customers
spread across many domestic geographic areas.
F-54
<PAGE>
The Columbia House Audiobook Club
Notes to Carve-Out Financial Statements -- (Continued)
December 19, 1997 and December 20, 1996
(Amounts in thousands, except share data)
4. Inventories
Inventories consist of the following:
December 19, December 20,
1997 1996
-------------- -------------
Raw materials ............................ $ 192 $ 94
Finished goods ........................... 1,014 807
------ ----
1,206 901
Less: allowance for obsolescence ......... 410 75
------ ----
$ 796 $826
====== ====
5. Deferred Member Acquisition Costs
Deferred member acquisition costs consist of the following:
December 19, December 20,
1997 1996
-------------- -------------
Current
Advertising ............................ $2,428 $2,448
Introductory product shipments ......... 204 237
------ ------
Total current .......................... $2,632 $2,685
====== ======
Non-current
Advertising ............................ 320 386
Introductory product shipments ......... 29 28
------ ------
Total non-current ...................... $ 349 $ 414
====== ======
Advertising expense was $5,453 and $3,745 in 1997 and 1996, respectively.
Advertising expense for 1997 includes $504 of deferred advertising that was
written down to net realizable value. Introductory product shipment expense was
$1,642 and $1,643 in 1997 and 1996, respectively.
6. Columbia House Equity Investment
An analysis of the Columbia House equity investment activity is as
follows:
<TABLE>
<CAPTION>
Year Ended
------------------------------
December 19, December 20,
1997 1996
-------------- -------------
<S> <C> <C>
Balance as of the beginning of the year .......... $ 5,166 $ 3,620
Net (loss) income ................................ (1,051) 919
Net cash distributions to Columbia House ......... (2,823) (1,920)
Allocated charges from Columbia House ............ 2,785 2,547
-------- --------
Balance as of the end of the year ................ $ 4,077 $ 5,166
======== ========
</TABLE>
Columbia House funds the working capital requirements of its club
businesses based upon a centralized cash management system. The Columbia House
equity investment includes an accumulated deficit as well as payables and
receivables due to/from Columbia House resulting from cash transfers. Columbia
House does not charge the Club interest on intercompany balances.
F-55
<PAGE>
The Columbia House Audiobook Club
Notes to Carve-Out Financial Statements -- (Continued)
December 19, 1997 and December 20, 1996
(Amounts in thousands, except share data)
7. Related Party Transactions
Columbia House provides the Club with fulfillment, marketing and customer
service and warehousing functions. Allocated charges for 1997 and 1996 for
fulfillment and marketing and customer service functions which are included as
a component of selling, general and administrative expenses were as follows:
Year Ended
------------------------------
December 19, December 20,
1997 1996
-------------- -------------
Fulfillment ............................ $1,344 $1,251
Marketing and customer service ......... 445 456
------ ------
$1,789 $1,707
====== ======
During 1997 and 1996, the Club incurred $1,364 and $1,291, respectively,
of warehousing expense that is included as a component of costs of sales. Of
such amounts, $513 and $447 represent allocated charges for warehousing
services provided by Columbia House for 1997 and 1996, respectively.
Columbia House also provides the Club with all general and administrative
services, including insurance, legal, financial and other corporate functions,
including purchasing, accounting and systems technology support. Such charges
amounted to $483 and $393 for 1997 and 1996, respectively, and are included in
selling, general and administrative expenses. The cost of financing activities
and certain other corporate functions, which did not benefit the Club, were
absorbed by Columbia House.
Management believes that the methodologies used to allocate charges for
the services described above from Columbia House are reasonable.
8. Commitments and Contingencies
The Club provides advances to publishers for the right to distribute
audiobook products. Such advances are recoupable against royalties earned by
publishers. Future advance payments required under existing contracts are as
follows:
Fiscal years ended December
1998 ................... $ 867
1999 ................... 250
Thereafter ............. --
------
$1,117
======
Columbia House is involved in litigation that impacts its various club
businesses including the Club. Such litigation includes claims surrounding
Columbia House's shipping and handling practices that Columbia House believes
are customary in mail order retail marketing. Columbia House believes the
claims are without merit and intends to defend the claims vigorously. In
connection with the sale of the Club that is further described in Note 1,
Columbia House has agreed to indemnify The Audio Book Club, Inc. from any
ultimate liability arising since the inception of the Club through the closing
date of the Sales Agreement which may result from these claims.
F-56
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Radio Spirits, Inc.
Schaumburg, Illinois
We have audited the accompanying balance sheet of Radio Spirits, Inc. as of
December 31, 1997 and the related statements of income and retained earnings
and cash flows for the year then ended. 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 referred to above present fairly, in
all material respects, the financial position of Radio Spirits, Inc. as of
December 31, 1997, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The supplementary information presented on pages
10 and 11 is presented for purposes of additional analysis and is not a
required part of the basic financial statements. Such information has been
subjected to the procedures applied in the audit of the basic financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic financial statements taken as a whole.
/s/ B D & A Certified Public Accountants, Ltd.
November 24, 1998
F-57
<PAGE>
RADIO SPIRITS, INC.
BALANCE SHEET
DECEMBER 31, 1997
<TABLE>
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash ..................................................... $ 77,175
Accounts receivable, net of allowance of $140,000......... 1,273,317
Other receivables ........................................ 25,200
Inventory (Note 1) ....................................... 1,103,274
Loans to shareholder (Note 6) ............................ 1,667
Prepaid expenses ......................................... 49,098
----------
Total Current Assets ................................... 2,529,731
PROPERTY AND EQUIPMENT (Note 2)
Leasehold improvements ................................... $ 533,989
Equipment ................................................ 567,259
Furniture and fixtures ................................... 81,193
Vehicles ................................................. 23,226
Old time radio collection ................................ 113,375
----------
Total Property and Equipment ............................. 1,319,042
Less: accumulated depreciation ........................... (426,610)
----------
Property and Equipment-- net ........................... 892,432
OTHER ASSETS
Due from affiliates (Note 6) ............................. $ 75,587
Deposits ................................................. 40
Goodwill, net of amortization of $52,367 (Note 3)......... 396,494
----------
Total Other Assets ..................................... 472,121
----------
$3,894,284
==========
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Line of credit (Note 4) .................................. $ 781,833
Current portion of long term debt (Note 5) ............... 201,411
Accounts payable ......................................... 1,010,604
Accrued expenses ......................................... 184,261
Accrued profit sharing (Note 8) .......................... 89,343
Accrued payroll taxes .................................... 5,416
Income taxes payable (Note 9) ............................ 18,720
Deferred income taxes payable (Note 1) ................... 185,000
----------
Total Current Liabilities .............................. 2,476,588
LONG TERM DEBT (Note 5) ................................... 876,417
STOCKHOLDER'S EQUITY
Common stock, No par value
Authorized 1,000 shares
Issued 1000 shares ..................................... $ 1,000
Retained earnings ........................................ 540,279
----------
Total Stockholder's Equity ............................. 541,279
----------
$3,894,284
==========
</TABLE>
The accompanying notes are an integral part of the financial statements
F-58
<PAGE>
RADIO SPIRITS, INC.
STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Amount %
------------- -----------
<S> <C> <C>
SALES ......................................... $5,184,906 100.00
DIRECT COST OF GOODS SOLD ..................... 2,409,119 46.46
---------- ------
GROSS PROFIT .................................. 2,775,787 53.54
INDIRECT COST OF GOODS SOLD ................... 763,395 14.72
---------- ------
NET INCOME BEFORE OPERATING EXPENSES .......... 2,012,392 38.81
---------- ------
OPERATING EXPENSES
Selling ...................................... 199,947 3.86
Administrative ............................... 1,452,023 28.00
---------- ------
Total Operating Expenses ..................... 1,651,970 31.86
---------- ------
INCOME FROM OPERATIONS ........................ 360,422 6.95
---------- ------
OTHER INCOME (EXPENSE)
Penalties .................................... (3,386) ( 0.07)
Interest expense ............................. (153,188) ( 2.95)
Miscellaneous income ......................... 1,000 0.02
Loss on sale of assets ....................... (31,790) ( 0.61)
---------- -------
Total Other Expense ........................ (187,364) ( 3.61)
---------- -------
INCOME BEFORE INCOME TAX ...................... 173,058 3.34
INCOME TAXES (Note 9) ......................... 64,139 1.24
---------- -------
NET INCOME .................................... $ 108,919 2.10
========== =======
</TABLE>
The accompanying notes are an integral part of the financial statements
F-59
<PAGE>
RADIO SPIRITS, INC.
STATEMENT OF RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1997
BALANCE -- BEGINNING OF PERIOD ......... $431,360
NET INCOME ............................. 108,919
--------
BALANCE -- END OF PERIOD ............... $540,279
========
The accompanying notes are an integral part of the financial statements
F-60
<PAGE>
RADIO SPIRITS, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ...................................................................... 108,919
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ................................................. 137,506
Loss on sale of fixed assets .................................................. 31,790
Deferred income taxes ......................................................... 47,000
(Increase) decrease in:
Accounts receivable .......................................................... (716,429)
Other receivables ............................................................ (25,200)
Inventory .................................................................... (151,031)
Prepaid expenses ............................................................. (33,323)
Deposits ..................................................................... 1,639
Increase (decrease) in:
Accounts payable ............................................................. 519,595
Accrued expenses ............................................................. 59,828
Accrued profit sharing ....................................................... 30,000
Accrued payroll taxes ........................................................ 3,556
Income taxes payable ......................................................... (18,692)
--------
NET CASH USED IN OPERATING ACTIVITIES ........................................... (4,842)
--------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of assets .................................................... 20,000
Purchase of fixed assets ........................................................ (771,255)
--------
NET CASH USED INVESTING ACTIVITIES .............................................. (751,255)
--------
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in shareholder loan .................................................... 5,333
Increase in due from affiliates ................................................. (45,885)
Increase in line of credit ...................................................... 416,833
Proceeds from long-term debt .................................................... 583,226
Payments on long-term debt ...................................................... (152,106)
--------
NET CASH PROVIDED BY FINANCING ACTIVITIES ........................................ 807,401
--------
NET INCREASE IN CASH ............................................................. 51,304
CASH AT BEGINNING OF YEAR ........................................................ 25,871
--------
CASH AT END OF YEAR .............................................................. $ 77,175
==========
SUPPLEMENTAL DISCLOSURES
Interest paid ................................................................... 150,234
Income taxes paid ............................................................... 37,412
</TABLE>
The accompanying notes are an integral part of the financial statements
F-61
<PAGE>
RADIO SPIRITS, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of significant accounting policies of Radio Spirits, Inc.
(the Company) is presented to assist in understanding the Company's financial
statements. The financial statements and notes are representations of the
Company's management who is responsible for their integrity and objectivity.
These accounting policies conform to generally accepted accounting principles
and have been consistently applied in the preparation of the financial
statements.
Nature of Business
The Company specializes in the syndication, sales and licensing of popular
radio programs originally aired from the early 1930s through the late 1950s.
The Company has an in-house mail order service in which it distributes audio
cassettes and compact discs of vintage comedy, mystery, detective, adventure
and suspense programs to customers worldwide.
Inventory
Inventory consists of packaging materials for the cassettes and compact
discs, and cassettes and compact discs ready for sale. Inventory is carried at
cost and is reviewed at year end for slow moving items, which are written off
as obsolete.
Deferred Income Taxes
For income tax reporting, the Company uses accounting methods that
recognize expenses sooner than for financial statement reporting. As a result,
the basis of inventory and property and equipment for financial reporting
exceeds its tax basis. Deferred income taxes have been recorded for the excess,
which will be taxable in future periods.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect certain reported amounts and disclosures. Accordingly,
actual results could differ from those estimates.
2. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation of equipment is
computed using accelerated methods and amortization of leasehold improvements
is computed using the straight-line method. Depreciation and amortization
amounted to $107,582 for the year ended December 31, 1997.
3. GOODWILL
Goodwill resulted from the purchase of stock from a former shareholder and
is being amortized using the straight-line method over 15 years. Amortization
expense amounted to $29,924 for the year ended December 31, 1997.
4. LINE OF CREDIT
The Company has a line of credit with a bank in the amount of $850,000
expiring September 4, 1998. The line was subsequently renewed until September
4, 1999. The line of credit is collateralized by substantially all of the
assets of the Company and the personal guarantee of the shareholder of the
Company. Interest only is payable monthly at 1% over the prime rate. The
outstanding balance was $781,833 at December 31, 1997.
F-62
<PAGE>
RADIO SPIRITS, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
5. NOTES PAYABLE
Notes payable consists of the following:
<TABLE>
<S> <C>
Note payable dated March 7, 1996 to former shareholder for purchase of
stock, payable $6,747 per month including interest at 6.5%, due March 2006.
Secured by a second position of substantially all assets and the guarantee of
the shareholder of the Company. ............................................... $ 512,012
Note payable to West Suburban Bank, payable in monthly installments of
$1,136 including interest at 8%, due October 1998, secured by equipment. ...... 10,943
Note payable to Beverly Bank, payable in monthly installments of $1,300
including interest at 7.5%, due July 1999, secured by a vehicle. .............. 23,214
Note payable to West Suburban Bank, payable in monthly installments of
$1,365 including interest at 9.5%, due September 2002, secured by
equipment. .................................................................... 61,557
Note payable to West Suburban Bank, payable in monthly installments of
$9,509 including interest at 9.75%, due May 2002, secured by substantially all
assets. ....................................................................... 408,018
Note payable to Honda, payable in monthly installments of $444 including
interest at 7.75%, due June 2001, secured by a vehicle. ....................... 16,295
Note payable to Peter Tararo, interest only is payable monthly at 8.5%,
principal and unpaid interest due January 1998. ............................... 25,000
Note payable to West Suburban Bank, payable in monthly installments of
$892 including interest at 8%, due February 2000, secured by equipment ........ 20,789
---------
1,077,828
Less current portion .......................................................... (201,411)
---------
$876,417
=========
</TABLE>
Maturities of long-term debt are as follows:
Year Ending,
December 31,
- --------------
1998 $ 201,411
1999 173,596
2000 170,329
2001 180,935
2002 120,391
Thereafter 231,166
----------
$1,077,828
==========
6. RELATED PARTY TRANSACTIONS
The Company is owed $1,666 from the shareholder at December 31, 1997. The
amount is a short-term loan and no interest is being accrued.
The Company is also owed $75,587 from affiliated companies owned by the
shareholder. The amounts are short-term loans and no interest is being accrued.
F-63
<PAGE>
RADIO SPIRITS, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
6. RELATED PARTY TRANSACTIONS -- (Continued)
On December 1, 1996 the Company entered into a lease agreement for its
current facilities with its shareholder. Monthly base rent is $3,667 plus
insurance and real estate taxes, and the lease expires November 30, 2001. Rent
expense amounted to $58,422 for the year ended December 31, 1997. Future
minimum rental payments are as follows:
Year ending,
December 31,
- -------------
1998 $ 44,004
1999 44,004
2000 44,004
2001 40,337
--------
$172,349
========
7. COMMITMENTS
Licensing Agreements
The Company has entered into various agreements for the use of the
original programs it broadcasts and sells. Rights expense under these
agreements amounted to $180,455 for the year ended December 31, 1997.
Consulting Agreement
The Company has a consulting agreement with Dennis Levin & Associates. The
agreement expires December 31, 1997. The Company pays a monthly fee of $5,630
plus a year end amount based on net income before taxes as adjusted for items
in the agreement. Consulting expense amounted to $95,965 for the year ended
December 31, 1997.
Sales Agreement
The Company has agreements with various independent sales representatives
for the Company's products, to certain customers and markets per the agreement.
The agreement may be terminated at any time by either party with 60 days
written notice. Commissions of 7% or 10%, depending on the customer, are paid
monthly in the following month based on net cash receipts from the customers.
Commissions expense amounted to $104,650 for the year ended December 31, 1997.
8. PROFIT SHARING PLAN
The Company has a profit sharing plan covering all employees who have met
the eligibility requirements. The plan is noncontributory for the employees and
discretionary for the employer. A contribution of $30,000 was made for the year
ended December 31, 1997.
9. INCOME TAXES
The provisions for income tax consist of the following components:
Current .......... $17,139
Deferred ......... 47,000
-------
$64,139
=======
F-64
<PAGE>
RADIO SPIRITS, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
10. SUBSEQUENT EVENTS
Sale of Business
During July, 1998, the Company's shareholder agreed to a letter of intent
to sell the stock of the Company to a publicly traded company. The letter of
intent is subject to acceptable results of due diligence by both parties.
F-65
<PAGE>
RADIO SPIRITS, INC.
SCHEDULES OF DIRECT AND INDIRECT
COST OF GOODS SOLD
FOR THE YEAR ENDED DECEMBER 31, 1997
Amount %
------------ ---------
Direct Cost of Goods Sold
Tapes ....................................... $ 21,768 0.42
Production materials ........................ 523 0.01
Finished product ............................ 1,479,074 28.53
Printing .................................... 4,399 0.08
Outside services ............................ 110,659 2.13
Rights ...................................... 180,455 3.48
Shipping supplies ........................... 16,603 0.32
Purchases ................................... 22,614 0.44
Artwork and design .......................... 7,780 0.15
Artwork and design-product .................. 45,784 0.88
Printing-product ............................ 311,157 6.00
Warehouse labor ............................. 64,070 1.24
Engineering ................................. 144,233 2.78
---------- -----
Total Direct Cost of Goods Sold ........... $2,409,119 46.46
========== =====
Indirect Cost of Goods Sold
Artwork and design-catalog .................. $ 38,297 0.74
Printing-catalog ............................ 111,697 2.15
Printing-promo mailings ..................... 8,290 0.16
Freight and delivery ........................ 64,166 1.24
Postage-catalog mailings .................... 282,313 5.44
Postage-promo mailings ...................... 22,610 0.44
Postage-orders delivery ..................... 236,022 4.55
---------- -----
Total Indirect Cost of Goods Sold ......... $ 763,395 14.72
========== =====
F-66
<PAGE>
RADIO SPIRITS, INC.
SCHEDULES OF SELLING AND
ADMINISTRATIVE EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1997
Amount %
------------- ---------
Selling Expenses
Commissions ............................. $ 104,650 2.02
Advertising ............................. 58,891 1.14
Mailing lists-names ..................... 23,978 0.46
Mailing services ........................ 12,428 0.24
---------- -----
Total Selling Expenses ................ $ 199,947 3.86
========== =====
Administrative Expenses
Salaries and wages ...................... $ 192,890 3.72
Officer's salaries ...................... 293,428 5.66
Consulting .............................. 95,965 1.85
Computer consulting ..................... 16,941 0.33
Auto expense ............................ 5,175 0.10
Auto lease .............................. 19,146 0.37
Bank service charges .................... 53,849 1.04
Contributions ........................... 25 0.00
Depreciation expense .................... 107,582 2.07
Amortization ............................ 29,924 0.58
Dues and subscriptions .................. 2,496 0.05
Equipment rental ........................ 5,576 0.11
Utilities ............................... 20,012 0.39
Insurance-group ......................... 16,629 0.32
Insurance-general ....................... 11,721 0.23
Insurance-officer's life ................ 7,560 0.15
Legal and accounting .................... 76,095 1.47
Office expense .......................... 17,127 0.33
Office supplies ......................... 10,989 0.21
Outside services ........................ 10,260 0.20
Postage expense ......................... 18,861 0.36
Profit sharing expense .................. 30,000 0.58
Rent expense ............................ 58,422 1.13
Repairs and maintenance ................. 37,287 0.72
Supplies expense ........................ 7,738 0.15
Taxes-payroll ........................... 46,473 0.90
Taxes-other ............................. 10,501 0.20
Telephone ............................... 61,330 1.18
Answering service ....................... 79,234 1.53
Travel and entertainment ................ 26,360 0.51
Bad debts ............................... 81,719 1.58
Moving expense .......................... 708 0.01
---------- -----
Total Administrative Expenses ......... $1,452,023 28.00
========== =====
F-67
<PAGE>
INSIDE BACK COVER
[GRAPHICS OMITTED: Images of various old time radio web pages from our
MediaBay.com site, offline marketing materials and our products. Images of
classic video marketing materials, products and images of film actors.]
<PAGE>
- --------------------------------------------------------------------------------
[GRAPHIC OMITTED]
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers.
The Florida Business Corporation Act (the "Florida Act") contain
provisions entitling the Registrant's directors and officers to indemnification
from judgments, settlements, penalties, fines, and reasonable expenses
(including attorney's fees) as the result of an action or proceeding in which
they may be involved by reason of having been a director or officer of the
Registrant. In its Articles of Incorporation, the Registrant has included a
provision that limits, to the fullest extent now or hereafter permitted by the
Florida Act, the personal liability of its directors to the Registrant or its
shareholders for monetary damages arising from a breach of their fiduciary
duties as directors. Under the Florida Act as currently in effect, this
provision limits a director's liability except where such director breaches a
duty. The Registrant's Articles of Incorporation and By-Laws provide that the
Registrant shall indemnify, and upon request shall advance expenses to, its
directors and officers to the fullest extent permitted by the Florida Act. The
Florida Act provides that no director or officer of the Registrant shall be
personally liable to the Registrant or its shareholders for damages for breach
of any duty owed to the Registrant or its shareholders, except for liability
for (i) acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (ii) any unlawful payment of a
dividend or unlawful stock repurchase or redemption in violation of the Florida
Act, (iii) any transaction from which the director received an improper
personal benefit or (iv) a violation of a criminal law. This provision does not
prevent the Registrant or its shareholders from seeking equitable remedies,
such as injunctive relief or rescission. If equitable remedies are found not to
be available to shareholders in any particular case, shareholders may not have
any effective remedy against actions taken by directors that constitute
negligence or gross negligence.
The Registrant has entered into indemnification agreements with certain
employees, officers and consultants. Pursuant to the terms of the indemnity
agreements, the Registrant has agreed to indemnify, to the fullest extent
permitted under applicable law, against any amounts which the employee, officer
or consultant may become legally obligated to pay in connection with any claim
arising from or out of the actions of the employee, officer or consultant, in
connection with any services performed by or on behalf of our company and
certain expenses related thereto; provided, however, that the employee, officer
or consultant shall reimburse the Registrant for such amounts if the such
individual is found, as finally judicially determined by a court of competent
jurisdiction, not to have been entitled to such indemnification.
Insofar as indemnification for liabilities arising under the Securities
Act of 1993, as amended (the "Securities Act") may be permitted to directors,
officers and controlling persons of the Registrant pursuant to any charter
provision, by-law, contract, arrangement, statute or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
(the "Commission") such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable.
Reference is made to the Underwriting Agreement, the proposed form of
which is filed as Exhibit 1.1, pursuant to which the underwriter agrees to
indemnify the directors and certain officers of the Registrant and certain
other persons against certain civil liabilities.
II-1
<PAGE>
Item 25. Other Expenses of Issuance and Distribution.
The following table sets forth the expenses (other than the underwriting
discounts and commissions and the Underwriter's Non-Accountable Expense
Allowance) expected to be incurred in connection with the issuance and
distribution of the securities being reistered.
<TABLE>
<S> <C>
SEC Registration ................................................... $
NASD Filing Fee .................................................... $
Legal Fees and Expenses* ........................................... $ **
Printing and Engraving Costs* ...................................... $ **
Accounting Fees* ................................................... $ **
American Stock Exchange Listing Fees and Related Expenses* ......... $ **
Transfer Agent Fees ................................................ $ **
Miscellaneous* ..................................................... $ **
-----------
Total ............................................................
===========
</TABLE>
- ------------
* Estimated
** To be provided by amendment.
Item 26. Recent Sales of Unregistered Securities.
The Registrant has made the following sales of unregistered securities in
the past three years:
(i) On March 18, 1998, the Registrant sold to Carl Wolf an option to
purchase 50,000 shares of common stock. The Registrant granted to Mr. Wolf the
right to purchase a second option to purchase an additional 25,000 shares. The
price to purchase the second option was $25,000. The Registrant relied on the
exemption offered by Section 4(2) under the Securities Act of 1993 for a
transaction by an issuer not involving a public offering.
(ii) In September 1998, Mr. Wolf exercised his right to purchase the
second option referred to in (i) above. The Registrant relied on the exemption
offered by Section 4(2) under the Securities Act for a transaction by an issuer
not involving a public offering.
(iii) On April 17, 1998, the Registrant issued to 800 Long Distance, Inc.
an option to purchase 21,600 shares of common stock as consideration for costs
incurred in transferring certain toll-free telephone numbers to the Registrant.
The option was valued at $2.50 per share. The Registrant relied on the
exemption from registration offered by Section 4(2) under the Securities Act
for a transaction by an issuer not involving a public offering.
(iv) On May 30, 1998, the Registrant issued to an individual an option to
purchase 20,000 shares of common stock as consideration for the acquisition of
the URLs www.audiobook.com and www.audiobook.net. The option was valued at
$2.50 per share. The Registrant relied on the exemption from registration
offered by Section 4(2) of the Securities Act for a transaction by an issuer
not involving a public offering.
(v) In November 1998, the Registrant issued a warrant to purchase 25,000
shares of common stock pursuant to a consulting agreement under which the
consultant provided services and advice relating to acquisitions proposed at
that time. The Registrant valued the consultant's services at $48,750. The
Registrant relied on the exemption from registration offered by Section 4(2)
under the Securities Act for a transaction by an issuer not involving a public
offering.
(vi) In December 1998, the Registrant issued 425,000 shares of common
stock valued at $12.875 per share and options to purchase an additional 175,000
shares of common stock in connection with its acquisition of Radio Spirits,
Inc. The Registrant granted the holders of these shares the right to require it
to repurchase up to 175,000 of these shares under certain circumstances,
commencing December 2001 at prices ranging from $4.00 to $12.00 per share. The
Registrant relied on the exemption from registration offered by Section 4(2)
under the Securities Act for a transaction by an issuer not involving a public
offering.
II-2
<PAGE>
(vii) In December 1998, the Registrant issued options to purchase 25,000
shares to two individuals as consideration for entering into consulting
agreements. The Registrant relied on the exemption from registration offered by
Section 4(2) under the Securities Act for a transaction by an issuer not
involving a public offering.
(viii) In December 1998, the Registrant issued 50,000 shares of common
stock valued at $12.875 per share and options to purchase an additional 50,000
shares of common stock as partial consideration for its acquisition of the
assets used by Metacom, Inc. in connection with its "Adventures in Cassettes"
business of licensing, producing, marketing and selling old time radio
programs. The Registrant granted the holders of the 50,000 shares the right,
under certain circumstances, to require it to repurchase the 50,000 shares
between the December 2001 and December 2008 at a price of $10.00 per share. The
Registrant relied on the exemption from registration offered by Section 4(2)
under the Securities Act for a transaction by an issuer not involving a public
offering.
(ix) In December 1998, the Registrant issued 125,000 shares of common
stock valued at $12.875 per share as partial consideration for its acquisition
of the assets used by Premier Electronic Laboratories, Inc. in connection with
its business of producing, marketing and selling old time radio and classic
video programs. The Registrant granted the holders of these shares the right,
under certain circumstances, to require it to repurchase the shares between
December 2000 and December 2008 at a price of $15.00 per share. The Registrant
relied on the exemption from registration offered by Section 4(2) of the
Securities Act for a transaction by an issuer not involving a public offering.
(x) In December 1998, the Registrant issued to The Columbia House Company,
Sony Music Entertainment Inc. and WCI Record Club Inc. an aggregate of 325,000
shares of common stock valued at $11.625 per share and warrants to purchase an
additional 100,000 shares of common stock in connection with its acquisition of
Columbia House's Audiobook Club. The Registrant granted the holders of the
325,000 shares the right to require it to repurchase these shares, under
certain circumstances, commencing December 2004 at a price of $15.00 per share.
The Registrant relied on the exemption from registration offered by Section
4(2) of the Securities Act for a transaction by an issuer not involving a
public offering.
(xi) In December 1998, the Registrant issued three-year warrants to
purchase an aggregate of 196,800 shares of common stock per share as partial
consideration to the lenders for providing a credit facility which warrants
have been subsequently adjusted pursuant to their anti-dilution provisions. The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
(xii) In December 1998, the Registrant issued to its Chairman a
$15,000,000 principal amount convertible note due December 31, 2004 and
five-year warrants to purchase 500,000 shares of common stock. The Registrant
also agreed that if the note is refinanced, repaid or replaced, it will issue
to its Chairman, warrants to purchase an additional 350,000 shares. The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
(xiii) In February 1999, the Registrant granted to an employee five year
options to purchase 158,000 shares of common stock as consideration for
entering into an agreement employment. The Registrant relied on the exemption
from registration offered by Section 4(2) of the Securities Act for a
transaction by an issuer not involving a public offering.
(xiv) In March 1999, the Registrant granted to a law firm five year
warrants to purchase 20,000 shares of common stock as partial payment for legal
services provided in the acquisitions. The warrants were valued at $2.46 using
the Black-Scholes valuation model. The Registrant relied on the exemption from
registration offered by Section 4(2) of the Securities Act for a transaction by
an issuer not involving a public offering.
(xv) In April 1999, the Registrant completed the sale of 750,000 shares of
common stock to a qualified institutional buyer, as that term is defined under
Rule 144A under the Securities Act, for $8,250,000 and issued warrants to
purchase 50,000 shares in connection with a consulting agreement. The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
II-3
<PAGE>
(xvi) In June 1999, the Registrant sold 50,000 shares of common stock for
gross proceeds of $550,000 to three qualified institutional buyers. The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
(xvii) In June 1999, in connection with an additional bank loan to partly
finance an acquisition, the Registrant granted the lenders three-year warrants
to purchase up to 119,546 shares of common stock which warrants have been
subsequently adjusted pursuant to their anti-dilution provisions. The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
(xviii) In June 1999, the Registrant issued a $4,350,000 principal amount
convertible promissory note to its Chairman for $4,350,000. The Registrant also
agreed that if the note is refinanced, repaid or replaced, it will issue to its
Chairman warrants to purchase 125,000 shares of common stock as partial
consideration for the financing. The Registrant relied on the exemption from
registration offered by Section 4(2) under the Securities Act for a transaction
by an issuer not involving a public offering.
(xix) In July 1999, the Registrant sold 540,000 shares of common stock to
three qualified institutional buyers for $7,020,000. The Registrant relied on
the exemption from registration offered by Section 4(2) under the Securities
Act for a transaction by an issuer not involving a public offering.
(xx) In August 1999, the Registrant sold 700,000 shares of common stock to
a qualified institutional buyer for $9,100,000. The Registrant relied on the
exemption from registration offered by Section 4(2) under the Securities Act
for a transaction by an issuer not involving a public offering.
(xxi) In August 1999, the Registrant issued 17,977 shares of common stock
upon conversion of $200,000 principal amount of a convertible note. The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
(xxii) In September 1999, the Registrant issued to its Chairman warrants
to purchase 265,000 shares of common stock as described in (xii). The
Registrant relied on the exemption from registration offered by Section 4(2) of
the Securities Act for a transaction by an issuer not involving a public
offering.
(xxiii) In October 1999, the Registrant issued 21,600 shares of common
stock upon exercise of an outstanding option. The Registrant relied on the
exemption from registration offered by Section 4(2) of the Securities Act for a
transaction by an issuer not involving a public offering.
(xxiv) In December 1999 and January 2000, the Registrant issued $2,000,000
principal amount convertible promissory notes to its Chairman's son for
$2,000,000. The Registrant relied on the exemption from registration offered by
Section 4(2) of the Securities Act for a transaction by an issuer not involving
a public offering.
(xxv) In December 1999 and January 2000, the Registrant issued 379,662
shares of common stock upon conversion of convertible notes. The Registrant
relied on the exemption from registration offered by Section 4(2) of the
Securities Act for a transaction by an issuer not involving a public offering.
(xxvi) in January 2000, the Registrant issued warrants to purchase 340,000
shares to an accredited investor. The Registrant relied on the exemption from
registration offered by Section 4 (2) of the Securities Act for a transaction by
an issuer not involving a public offering.
(xxvii) From October 1997 through the date of this prospectus, the
Registrant issued options to purchase 3,863,450 shares of common stock under its
1997 Stock Option Plan and 1999 Stock Incentive Plan. The Registrant relied on
the exemption from registration offered by Section 4(2) of the Securities Act
for a transaction by an issuer not involving a public offering.
(xxviii) In January 2000, the Registrant issued warrants to purchase
300,000 shares of common stock as consideration for public relations consulting
services. The Registrant relied on the exemption from registration offered by
Section 4(2) of the Securities Act for a transaction by an issuer not involving
a public offering.
Item 27. Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------
<S> <C>
1.1 Form of Underwriting Agreement between the Registrant and the Underwriters.*
3.1 Restated Articles of Incorporation of the Registrant.+
3.2 Articles of Amendment to Articles of Incorporation.++++++++
3.3 Articles of Amendment to Articles of Incorporation.
3.4 Amended and Restated By-Laws of the Registrant.+
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ---------------- ------------------------------------------------------------------------------------------
<S> <C>
5.1 Opinion of Blank Rome Tenzer Greenblatt*
10.1 Employment Agreement between the Registrant and Norton Herrick.*
10.2 Employment Agreement between the Registrant and Michael Herrick.+
10.3 Employment Agreement between the Registrant and Jesse Faber.
10.4 Employment Agreement between the Registrant and Stephen McLaughlin.+++++
10.5 Employment Agreement between the Registrant and Howard Herrick.+
10.6 Employment Agreement between the Registrant and John Levy.
10.7 Employment Agreement between our subsidiary and Carl Amari.+++++
10.8 Supplemental Agreement, dated as of December 11, 1998, by and among the Registrant,
Classic Radio Holding Corp. (now Radio Spirits, Inc.), Radio Spirits, Inc. and Carl
Amari.+++
10.9 Put Agreement, dated as of December 11, 1998, by and between the Registrant and Premier
Electronic Laboratories, Inc.+++++
10.10 Registration and Shareholder Rights Agreement, dated as of December 30, 1998, by and
among the Registrant and The Columbia House Company, WCI Record Club Inc. and Sony
Music Entertainment Inc.+++++
10.11 $9,000,000 Principal Amount 9% Convertible Senior Subordinated Promissory Note of the
Registrant to Norton Herrick due December 31, 2004.*
10.12 $4,800,000 Principal Amount 9% Convertible Senior Subordinated Promissory Note of the
Registrant to ABC Investment, L.L.C. due December 31, 2004.
10.13 Modification Letter, dated December 31, 1998, among Norton Herrick, the Registrant and
Fleet National Bank+++++
10.14 Security Agreement, dated as of December 31, 1998, by and among the Registrant, Classic
Radio Holding Corp. and Classic Radio Acquisition Corp. and Norton Herrick.+++++
10.15 Credit Agreement, dated as of December 31, 1998, among the Registrant and Fleet National
Bank.+++++
10.16 Amendment and Supplement No. 1 to Credit Agreement dated June 14, 1999 by and among
the Registrant, Fleet National Bank, as administrative agent, and ING (U.S.) Capital
Corporation.+++++++
10.17 Security Agreement, dated as of December 31, 1998, from the Registrant, ABC Internet
Services, Inc., Classic Radio Holding Corp., Classic Radio Acquisition Corp., ABC
Investment Corp., and CH Acquisitions Corp. as grantors to Fleet National Bank as
administrative agent.+++++
10.18 1997 Stock Option Plan+
10.19 1999 Stock Incentive Plan++++++
21.1 Subsidiaries of the Company.*
23.1 Consent of Deloitte & Touche LLP
23.2 (a) Consent of KPMG LLP
23.2 (b) Consent of KPMG LLP
23.3 Consent of BD&A Certified Public Accountants, Ltd.
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- -----------------------------------------------------------------------------------
<S> <C>
23.4 Consent of PricewaterhouseCoopers LLP.
23.5 Consent of Blank Rome Tenzer Greenblatt (included in opinion filed as Exhibit 5)*
24.1 Power of Attorney (included in the signature page of this Registration Statement).
27.1 Financial Data Schedule (SEC use only).*
</TABLE>
- ------------
* To be filed by amendment.
+ Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-30665) effective
October 22, 1997.
++ Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997.
+++ Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for reportable event dated December 14,
1998.
++++ Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K dated January 13, 1999.
+++++ Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1998.
++++++ Incorporated by reference to the applicable exhibit contained in our
Proxy Statement dated February 23, 1999.
+++++++ Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K dated June 29, 1999.
++++++++ Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended June
30, 1999.
Item 28. Undertakings.
(a) Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a
director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such
issue.
(b) The undersigned Registrant hereby undertakes for the purpose of determining
any liability under the Securities Act, to treat the information omitted
from the form of prospectus filed as part of this Registration Statement
in reliance upon Rule 430A and contained in a form of prospectus filed by
the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act as part of this Registration Statement as of the time the
Securities and Exchange Commission declares it effective; and for the
purpose of determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of prospectus as a new
registration statement for the securities offered in the registration
statement, and treat that offering of the securities at that time as the
initial bonafide offering of those securities.
II-6
<PAGE>
Signatures
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned in the City of
Morristown, State of New Jersey, on January 28, 2000.
MEDIABAY, INC.
By: /s/ Michael Herrick
-------------------------------------------
Michael Herrick
Chief Executive Officer and Director
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints each of
Norton Herrick and Michael Herrick or either of them, his or her true and
lawful attorney-in-fact and agent, acting alone, with full powers of
substitution and resubstitution, for him or her and in his or her name, place
and stead, in any and all capacities, to sign any and all amendments (including
pre-effective and post-effective amendments) to this Registration Statement,
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he or she might or
could do in person, hereby ratifying and confirming all that said
attorney-in-fact and agent, acting alone, or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities
and on the dates stated.
<TABLE>
<CAPTION>
Signature Title Date
- --------------------------- ---------------------------------------------- -----------------
<S> <C> <C>
/s/ Norton Herrick Director and Chairman January 28, 2000
- -------------------------
Norton Herrick
/s/ Michael Herrick Director, Chief Executive Officer and January 28, 2000
- ------------------------- President (Principal Executive Officer)
Michael Herrick
/s/ Jesse Faber Director and President of Audio Book Club, January 28, 2000
- ------------------------- Inc.
Jesse Faber
/s/ Howard Herrick Director and Executive Vice President January 28, 2000
- -------------------------
Howard Herrick
/s/ John F. Levy Executive Vice President and Chief Financial January 28, 2000
- ------------------------- Officer (Principal Financial and Accounting
John F. Levy Officer)
/s/ Carl P. Amari Director and President of Radio Operations January 28, 2000
- -------------------------
Carl P. Amari
/s/ Carl T. Wolf Director January 28, 2000
- -------------------------
Carl T. Wolf
/s/ Roy Abrams Director January 28, 2000
- -------------------------
Roy Abrams
</TABLE>
<PAGE>
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
Balance Amounts Write-Offs Balance
Beginning of Charged to Against End of
Period Net Income Reserves Period
-------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Allowances for sales returns and doubtful accounts:
Year Ended December 31, 1998 $1,449,445 $8,256,989 $8,288,159 $1,418,275
Year Ended December 31, 1997 $ 831,669 $6,073,746 $5,455,970 $1,449,445
</TABLE>
S-1
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------- ------------------------------------------------------------------------------------------
<S> <C>
1.1 Form of Underwriting Agreement between the Registrant and the Underwriters.*
3.1 Restated Articles of Incorporation of the Registrant.+
3.2 Articles of Amendment to Articles of Incorporation.++++++++
3.3 Articles of Amendment to Articles of Incorporation.
3.4 Amended and Restated By-Laws of the Registrant.+
5.1 Opinion of Tenzer Greenblatt LLP*
10.1 Employment Agreement between the Registrant and Norton Herrick.*
10.2 Employment Agreement between the Registrant and Michael Herrick.+
10.3 Employment Agreement between the Registrant and Jesse Faber.
10.4 Employment Agreement between the Registrant and Stephen McLaughlin.+++++
10.5 Employment Agreement between the Registrant and Howard Herrick.+
10.6 Employment Agreement between the Registrant and John Levy.
10.7 Employment Agreement between our subsidiary and Carl Amari.+++++
10.8 Supplemental Agreement, dated as of December 11, 1998, by and among the Registrant,
Classic Radio Holding Corp. (now Radio Spirits, Inc.), Radio Spirits, Inc. and Carl
Amari.+++
10.9 Put Agreement, dated as of December 11, 1998, by and between the Registrant and Premier
Electronic Laboratories, Inc.+++++
10.10 Registration and Shareholder Rights Agreement, dated as of December 30, 1998, by and
among the Registrant and The Columbia House Company, WCI Record Club Inc. and Sony
Music Entertainment Inc.+++++
10.11 $9,000,000 Principal Amount 9% Convertible Senior Subordinated Promissory Note of the
Registrant to Norton Herrick due December 31, 2004.*
10.12 $4,800,000 Principal Amount 9% Convertible Senior Subordinated Promissory Note of the
Registrant to ABC Investment, L.L.C. due December 31, 2004.
10.13 Modification Letter, dated December 31, 1998, among Norton Herrick, the Registrant and
Fleet National Bank+++++
10.14 Security Agreement, dated as of December 31, 1998, by and among the Registrant, Classic
Radio Holding Corp. and Classic Radio Acquisition Corp. and Norton Herrick.+++++
10.15 Credit Agreement, dated as of December 31, 1998, among the Registrant and Fleet National
Bank.+++++
10.16 Amendment and Supplement No. 1 to Credit Agreement dated June 14, 1999 by and among
the Registrant, Fleet National Bank, as administrative agent, and ING (U.S.) Capital
Corporation.+++++++
10.17 Security Agreement, dated as of December 31, 1998, from the Registrant, ABC Internet
Services, Inc., Classic Radio Holding Corp., Classic Radio Acquisition Corp., ABC
Investment Corp., and CH Acquisitions Corp. as grantors to Fleet National Bank as
administrative agent.+++++
10.18 1997 Stock Option Plan+
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------------- -----------------------------------------------------------------------------------
<S> <C>
10.19 1999 Stock Incentive Plan++++++
21.1 Subsidiaries of the Company.*
23.1 Consent of Deloitte & Touche LLP
23.2 (a) Consent of KPMG LLP
23.2 (b) Consent of KPMG LLP
23.3 Consent of BD&A Certified Public Accountants, Ltd.
23.4 Consent of PricewaterhouseCoopers LLP.
23.5 Consent of Tenzer Greenblatt LLP (included in opinion filed as Exhibit 5)*
24.1 Power of Attorney (included in the signature page of this Registration Statement).
27.1 Financial Data Schedule (SEC use only).*
</TABLE>
- ------------
* To be filed by amendment.
+ Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-30665) effective
October 22, 1997.
++ Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997.
+++ Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for reportable event dated December 14,
1998.
++++ Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K dated January 13, 1999.
+++++ Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1998.
++++++ Incorporated by reference to the applicable exhibit contained in our
Proxy Statement dated February 23, 1999.
+++++++ Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K dated June 29, 1999.
++++++++ Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended June
30, 1999.
<PAGE>
ARTICLES OF AMENDMENT
TO
ARTICLES OF INCORPORATION
OF
AUDIO BOOK CLUB, INC.
- --------------------------------------------------------------------------------
---------------------------------------------------------
(present name)
Pursuant to the provisions of section 607.1006, Florida Statutes, this Florida
profit corporation adopts the following articles of amendment to its articles of
incorporation:
FIRST: Amendment(s) adopted: (indicate article number(s) being amended, added or
deleted)
ARTICLE I, which is hereby amended to change the name of the
corporation, shall read as follows:
"The name of the corporation shall be:
MediaBay, Inc."
SECOND: If an amendment provides for an exchange, reclassification or
cancellation of issued shares, provisions for implementing the amendment if not
contained in the amendment itself, are as follows:
<PAGE>
THIRD: The date of each amendment's adoption: September 27, 1999
FOURTH: Adoption of Amendment(s) (CHECK ONE)
|X| The amendment(s) was/were approved by the shareholders. The
number of votes cast for the amendment(s) was/were sufficient
for approval.
|_| The amendment(s) was/were approved by the shareholders through
voting groups. The following statement must be separately
provided for each voting group entitled to vote separately on
the amendment(s):
"The number of votes cast for the amendment(s)
was/were sufficient for approval by ______________
________________________________________________ ."
voting group
|_| The amendment(s) was/were adopted by the board of directors
without shareholder action and shareholder action was not
required.
|_| The amendment(s) was/were adopted by the incorporators without
shareholder action and shareholder action was not required.
Signed this 27 day of September, 1999.
Signature /s/ Norton Herrick
-----------------------------------------------------------------------
(By the Chairman or Vice Chairman of the Board of Directors,
President or other officer if adopted by the shareholders)
OR
(By a director if adopted by the directors)
OR
(By an incorporator if adopted by the incorporators)
Typed or printed name
Title
<PAGE>
October 22, 1999
Mr. Jesse Faber
1 Nutting Place
West Caldwell, NJ 07006
Re: AUDIO BOOK CLUB, INC. (the "Company")
Dear Jesse:
This letter will cover the period of your employment with the Company from
November 1, 1999 until October 31, 2000 (the "Employment Term").
In this regard, the Company will pay you a base salary, commencing November 1,
1999 of $165,000 (One Hundred and Sixty Five Thousand) per annum. Such salary
will be paid monthly in arrears on the last day of the month at the rate of
$13,750 per month.
In addition to this base salary, you will receive a bonus, provided you are
still employed by the Company at the conclusion of the Employment Term, of
$55,000 (Fifty Five Thousand Dollars) to be paid to you on October 31, 2000.
You will receive options to acquire 10,000 shares of common stock in the Company
pursuant to and in accordance with the Company's stock option plan. Such options
shall vest on October 31, 2000; provided, however, that such options shall
terminate and be canceled if you are no longer employed by the Company prior to
the date such options vest. Such options shall be exercisable at a price per
share equal to $12.00 and will be exercisable for a period of five years
commencing immediately upon vesting, provided, however, if you are no longer
employed by the Company, such options shall expire on the earlier of 30 days
following the date you are no longer employed by the Company or five years from
the date such options initially became exercisable.
You will also receive four weeks paid vacation during the Employment Term.
You acknowledge and agree that: all mailing lists; customer, member and prospect
names; licensor arrangements; front end and back end marketing performance;
financial statements; operating systems, data base and other computer software
specific to the Company; and all information which is known by you to be subject
to a confidentiality agreement or obligation of confidentiality, even without a
confidentiality agreement between the Company and another person or party, shall
be maintained by you in a confidential manner and you agree that you will not
use such information to the detriment of the Company or disclose such
information to any third party, except as may be necessary in the course of
performing your job responsibilities. You further agree that your obligations of
confidentiality with respect to such information shall continue for five years
after you cease to be employed by the Company.
<PAGE>
You acknowledge that this letter and the May 1, 1997 employment letter between
the Company and you and the Employee Handbook embodies and constitutes the
entire understanding between the Company and you with respect to your employment
by the Company and such employment arrangement may not be modified except by a
writing signed by the Company and you.
Very truly yours,
AUDIO BOOK CLUB, INC.
/s/ Michael Herrick
- ----------------------------------
Michael Herrick, COO
AGREED AND ACCEPTED this 22nd
day of October, 1999
/s/ Jesse Faber
- ----------------------------------
Jesse Faber
Enclosure
cc: Norton Herrick
<PAGE>
EMPLOYMENT AGREEMENT
THIS AGREEMENT entered into as of the 22nd day of October, 1999, by and
between Audio Book Club, Inc., a Florida corporation, with offices at 2295
Corporate Boulevard, N.W., Suite 222, P.O. Box 5002, Boca Raton, Florida
33431-0802 (the "Company"), and John F. Levy, residing at 110 Oak Tree Pass,
Westfield, New Jersey (the "Executive").
W I T N E S S E T H:
WHEREAS, the Company is engaged in the audio book club business; and
WHEREAS, the Company desires to continue to employ the Executive beyond
the expiration date of the current Employment Agreement between the Company and
the Executive; and
WHEREAS, the Executive is willing to commit himself to continue to
serve and to establish a minimum period during which he will continue to serve
the Company on the terms and conditions herein provided.
NOW, THEREFORE, in consideration of the premises and the respective
covenants and agreements of the parties herein contained and intending to be
legally bound hereby, the parties agree as follows:
1. Recitals. The Whereas clauses recited above are hereby incorporated
by reference as though they were fully set forth herein.
2. Employment. The Company shall employ the Executive and the Executive
shall serve the Company, on the terms and conditions set forth herein.
3. Term. The employment of the Executive by the Company as provided in
paragraph 2 shall commence on November 10, 1999 and end on the second (2nd)
anniversary of such commencement, subject, however, to the other termination
provisions contained herein.
4. Position and Duties. The Executive shall be employed by the Company
as an Executive Vice President and Chief Financial Officer. His power and
authority shall be and remain subject to the direction and control of the Board
of Directors and all officers senior to him including but not limited to the
Co-Chief Executive Officers Michael Herrick and Norton Herrick. The Executive
shall have responsibility for the financial oversight of the business and
affairs of the Company, including without limitation responsibility for all
filings with the Securities and Exchange Commission, the Internal Revenue
Service and all other agencies (federal, state or local) and/or stock
1
<PAGE>
exchanges to which the Company must report, subject to appropriate review and
approval of the Board of Directors and senior officers and such further
revisions as the Executive deems necessary. The scope of his duties and the
extent of his responsibilities shall be substantially the same as the duties and
responsibilities of other chief financial officers of public companies. The
Executive shall be required to spend his full time and attention, without other
outside business interests, in the performance of his duties and the Company's
business and affairs.
5. Compensation and Related Matters.
(a) Salary. During the term of this Agreement, the Company
shall pay to the Executive, as compensation for his services, an initial annual
salary of $165,000 in equal monthly installments during the first year of the
term of this Agreement; and $180,000 during the second year of the term of this
Agreement. In addition, the Executive may receive a performance-based bonus to
be determined by the Chief Executive Officer in his sole and absolute discretion
with a minimum bonus at the end of year one, provided the Executive is still
employed by the Company at that time, of Fifteen Thousand and 00/100 U.S.
Dollars ($15,000.00) and a minimum bonus at the end of year two, provided the
Executive is still employed by the Company at that time, of Seventeen Thousand
Five Hundred and 00/100 U.S. Dollars ($17,500.00); such bonuses shall be paid
within forty-five (45) days after the end of each year.
(b) Expenses. The Executive shall receive prompt reimbursement
for all reasonable travel and business expenses in connection with services
performed hereunder in accordance with normal Company policy, as the same may be
determined from time to time.
(c) Insurance and Employee Benefits. The Executive shall
receive employee benefits applicable to all officers of the Company except the
executive will not receive medical insurance unless his wife is no longer
employed at a position which provides family coverage. In addition, the
Executive shall be reimbursed for reasonable costs associated with up to
twenty-four (24) hours of continuing education courses with respect to topics
germane to his duties, including reasonable local travel costs to attend such
courses and reasonable fees for such courses. In addition, the Company will
reimburse the Executive for his dues to the AICPA and ISCPA and subscriptions to
the Wall Street Journal, Business Week, Forbes Magazine and America Online. The
Executive will be provided with a portable computer, cellular phone and pocket
electronic organizer at the Company's expense.
2
<PAGE>
(d) Vacation. The Executive shall receive, prorata during each
full year of his employment, three (3) weeks paid vacation approved one (1)
month in advance. The Executive will make every effort to schedule the vacation
time at a time most convenient for the Company, with the Company recognizing
that the Executive's flexibility is limited by school calendars. Notwithstanding
the foregoing, the Executive shall not be entitled to vacation during the three
(3) week period prior to the date on which the Company's Annual Report on Form
10-KSB (or Form 10-K) or Quarterly Report on Form 10-QSB (or Form 10-Q) are
required to be filed with the Securities and Exchange Commission. In addition,
the Executive will receive normal Company holidays, plus two (2) days off for
Rosh Hashanah and one (1) day off for Yom Kippur unless such holy days fall on a
weekend.
(e) Stock Options. The Executive is hereby granted stock
options to acquire thirty thousand (30,000) shares of Common Stock in the
Company pursuant to and in accordance with the Company's Stock Option Plan.
Options with respect to ten thousand (10,000) shares shall vest on November 10,
2000, provided that the Executive is an employee of the Company at that time and
options with respect to twenty thousand (20,000) shares will vest on November
10, 2001, provided that the Executive is still employed by the Company at that
time. Such options shall be exercisable at a price per share of Thirteen Dollars
($13.00), and will be on the terms and conditions as more specifically provided
for in the Company's Stock Option Plan.
6. Termination by the Company. The Executive's employment hereunder may
be terminated by the Company without any breach of this Agreement only under the
circumstances described below.
(a) Death. The Executive's employment hereunder shall
terminate upon his death.
(b) Disability. If, as a result of the Executive's incapacity
due to physical or mental illness, as determined by a physician mutually chosen
by the Executive and the Company, the Executive shall have been absent from his
duties hereunder for a consecutive period of forty-five (45) days and after
notice of termination is given (which may be given before or after the end of
such 45 day period but which will in no event be effective until, at the
earliest, the day following the forty- fifth day of the period) shall not have
returned to the performance of his duties hereunder, as that concept is
contemplated in this Agreement, within ten (10) days after the notice of
termination is given, the Company may terminate the Executive's employment
hereunder.
3
<PAGE>
(c) Cause. The Company may terminate the Executive's
employment under this Agreement at any time for cause. For purposes of this
Agreement, the term "cause" shall include one or more of the following: (i)
willful misconduct, (ii) continued failure by the Executive to perform his
duties, as contemplated in this Agreement, as Chief Financial Officer (other
than through disability as defined in paragraph 6(b), above), (iii) conviction
of a crime or alcohol or drug abuse, or (iv) the Executive's breach of this
Agreement. The termination shall be evidenced by written notice thereof to the
Executive.
(d) Without Cause. In addition to any other rights the Company
has to terminate the Executive's employment under this Agreement, the Company
may, at any time, by a vote of not less than sixty percent (60%) of the
directors then in office (excluding the vote of the Executive if he is also a
director), terminate the Executive without cause upon ninety (90) days' prior
written notice to the Executive setting forth the reasons, if any, for the
termination. For purposes of this Agreement, the term "without cause" shall mean
termination by the Company on any grounds other than those set forth in
paragraphs 6(a), (b) or (c) hereof. It shall also be a termination without
cause, at the election of the Executive, if the Executive is asked to work at a
business location of the Company which is more than fifty (50) miles from
Westfield, New Jersey. Notwithstanding the foregoing, it is understood that
travel in connection with the performance of Executive's duties shall not be
deemed to be termination without cause and that the 10 West Building on Route
10, Parsippany-Troy Hills is within fifty (50) miles.
(e) Severance Pay. In the event that the Company has
terminated the Executive's employment under this Agreement (i) "without cause"
or (ii) in the event there is a "Change of Control" (as defined below), then the
Executive will be entitled to receive severance pay equal to fifty percent (50%)
of his base salary for the unexpired period of his two (2) year employment term;
such payment, if any, shall be made to the Executive within thirty (30) days of
such termination of the Executive's employment.
(f) Change of Control. For purposes of this Agreement, a
"Change of Control" shall be deemed to occur, unless previously consented to in
writing by the Executive, and only if the Executive is not offered continued
employment, upon (i) the actual acquisition of fifty percent (50%) or more of
the voting securities of the Company by any company or entity or affiliated
group of companies or entities (other than pursuant to a bona fide underwriting
agreement relating to a public distribution of securities of the Company), (ii)
the completion of a tender or exchange offer for more than fifty percent (50%)
of the voting securities of the Company by any company or entity or affiliated
group of companies or entities not affiliated with the Executive, (iii) the
completion of a
4
<PAGE>
proxy contest against the management for the election of a majority of the Board
of Directors of the Company if the group conducting the proxy contest owns, has
or gains the power to vote at least fifty percent (50%) of the voting securities
of the Company, or (iv) a merger or consolidation in which the Company is not
the surviving entity or a sale of or substantially all of the assets of the
Company.
(g) Change of Control Compensation. In the event of a
completion of a tender or exchange offer for more than fifty percent (50%) of
the voting securities of the Company by any company or entity or affiliated
group of companies or entities not affiliated with the Executive, the stock
options, described in paragraph 5(e), shall immediately be exercisable and any
unvested shall immediately vest.
(h) The Executive shall not be required to mitigate the amount
of any payment provided for in this paragraph 6 by seeking other employment or
otherwise nor shall the amount of any payment provided for in this paragraph 6
be reduced by any compensation earned by the Executive as the result of
employment by another employer or business or by profits earned by the Executive
from any other source at any time before and after the date of termination. The
amounts payable to the Executive under this Agreement shall not be treated as
damages, but as severance pay to which the Executive is entitled by reason of
his employment and the circumstances contemplated by this Agreement.
(i) The severance pay which the Executive will be entitled to
receive as a result of the termination of his employment under this Agreement,
shall be the Executive's exclusive remedy in the event of such termination.
7. Non-Competition and Confidentiality Covenant. The Executive hereby
covenants and agrees that he will not serve as an officer of or perform any
functions for any other company during the term of his employment under this
Agreement, except that the Executive shall be permitted to serve as a board
member of the Israel Histradrut Group Foundation, a not-for-profit entity,
provided serving as a board member for such entity does not interfere with the
performance of the Executive's duties under this Agreement. In addition, during
the term of this Agreement and for a period of two (2) years immediately
following the termination of his employment, whether said termination is
occasioned by the Company, the Executive or a mutual agreement of the parties,
the Executive shall not, for himself or on behalf of any other person, persons,
firm, partnership, corporation or company, engage or participate in any
activities which are in direct or indirect conflict with the interests of the
Company or solicit or attempt to solicit the business or patronage of any
person, firm, corporation, company or partnership, which had previously been a
customer of the
5
<PAGE>
Company, for the purpose of selling products and services similar to those
provided by the Company.
Furthermore, the Executive acknowledges and agrees that: all
mailing lists; customer, member and prospect names; license or arrangement;
front-end and back-end marketing performance; financial statements; operating
system, database and other computer software, specific to the Company; and all
information which is known by the Executive to be subject to a confidentiality
agreement or obligation of confidentiality, even without a confidentiality
agreement between the Company and another person or party, shall be maintained
by the Executive in a confidential manner and the Executive agrees that the
Executive will not use such information to the detriment of the Company or
disclose such information to any third party, except as may be necessary in the
course of performing the Executive's job responsibilities. The Executive further
agrees that these obligations of confidentiality with respect to such
information shall continue after the Executive ceases to be employed by the
Company. Disclosure of the aforementioned information shall not be prohibited if
such disclosure is directly pursuant to a valid and existing order of a court or
other governmental body or agency within the United States; provided, however,
that (i) the Executive shall first have given prompt notice to the Company of
any such possible or prospective order (or proceeding pursuant to which any such
order may result), (ii) the Company shall have been afforded a reasonable
opportunity to review such disclosure and to prevent or limit any such
disclosure, and (iii) the Executive shall, if requested by the Company and at
the Company's cost and expense, use his best efforts to prevent or limit any
such disclosure by means of a protective order or a request for confidential
treatment.
The Executive further acknowledges that the Executive will not
disclose any information with respect to the Company, its operations or its
officers and directors, whether or not such information is confidential, to
Stephen Swid or any entity or company in which Stephen Swid has an ownership
interest or is a director, officer or employee or to any attorneys, accountants,
agents or representatives of Stephen Swid or any of the aforementioned companies
or entities.
8. Indemnification. To the maximum extent permitted under the corporate
laws of the State of Florida or, if more favorable, the Articles of
Incorporation and/or By-Laws of the Company as in effect on the date of this
Agreement, (a) the Executive shall be indemnified and held harmless by the
Company, as provided under such corporate laws or such Articles of Incorporation
and/or ByLaws, as applicable, for any and all actions taken or matters
undertaken, directly or indirectly, in the performance of his duties and
responsibilities under this Agreement or otherwise on behalf of the
6
<PAGE>
Company, provided the Executive did not act wantonly or recklessly or was not
grossly negligent or engaged in willful misconduct, and (b) without limiting
clause (a), the Company shall indemnify and hold harmless the Executive from and
against (i) any claim, loss, liability, obligation, damage, cost, expense,
action, suit, proceeding or cause of action (collectively, "Claims") arising
from or out of or relating to the Executive's acting as an officer, director,
employee or agent of the Company or any of its affiliates or in any other
capacity, including, without limitation, any fiduciary capacity, in which the
Executive serves at the request of the Company, and (ii) any cost or expense
(including, without limitation, fees and disbursements of counsel)
(collectively, "Expenses") incurred by the Executive in connection with the
defense or investigation thereof. If any Claim is asserted or other matter
arises with respect to which the Executive believes in good faith the Executive
is entitled to indemnification as contemplated hereby, the Company shall, at its
election, to be determined in its sole and absolute discretion, either assume
the defense or investigation of such Claim or matter or pay the Expenses
incurred by the Executive in connection with the defense or investigation of
such Claim or matter, provided that the Executive shall reimburse the Company
for such amounts, plus simple interest thereon at the then current Prime Rate as
in effect from time to time, compounded annually, if the Executive shall be
found, as finally judicially determined by a court of competent jurisdiction,
not to have been entitled to indemnification hereunder.
9. Binding Agreement. This Agreement and all rights of the Executive
hereunder shall inure to the benefit of and be enforceable by the Executive's
personal or legal representatives, executors, administrators, successors, heirs,
distributees, divisees and legatees. In addition, this Agreement and the
obligations and rights of the Company hereunder shall be binding on any person,
firm or corporation which is a successor-in-interest to the Company.
10. Notice. For the purpose of this Agreement, notices, demands and all
other communications provided for in this Agreement shall be in writing and
shall be deemed to have been duly given when delivered personally, or by private
overnight courier or mail service, postage prepaid or (unless otherwise
specified) mailed by United States registered or certified mail, return receipt
requested, postage prepaid, addressed as follows:
If to the Executive: To the address at the head of this
Agreement
7
<PAGE>
If to the Company: Audio Book Club, Inc.
2295 Corporate Boulevard, N.W., Suite 222
P.O. Box 5002
Boca Raton, Florida 33431-0802
(561) 241-1426
or to such other address as the parties may furnish to each other in writing.
Copies of all notices, demands and communications shall be sent to the home
addresses of all members of the Board of Directors of the Company.
11. Miscellaneous.
(a) No provision of this Agreement may be modified, waived or
discharged unless such waiver, modification or discharge is agreed to in writing
signed by the parties hereto, provided, however, that this Agreement may be
modified, waived or discharged by mutual agreement in writing.
(b) No delay, waiver, omission or forbearance (whether by
conduct or otherwise) by any party hereto at any time to exercise any right,
option, duty or power arising out of breach or default by the other party of any
of the terms, conditions or provisions of this Agreement to be performed by such
other party shall constitute a waiver by such party or a waiver of such party's
rights to enforce any right, option or power as against the other party or as to
subsequent breach or default by such other party, and no explicit waiver shall
constitute a waiver of similar or dissimilar terms, provisions or conditions at
the same time or at any prior or subsequent time.
12. Governing Law. This Agreement shall be construed in accordance with
the laws of the State of Florida and any action brought by either party shall be
commenced in the courts of the State of Florida. The Executive and the Company
hereby irrevocably and unconditionally consent to submit to the exclusive
jurisdiction of the courts of the State of Florida and the United States of
America located in Palm Beach County, Florida for any and all actions, suits or
proceedings arising out of or resulting from or relating to this Agreement and
the transactions contemplated hereby and the parties agree not to commence any
action, suit or proceeding relating thereto except in such courts. The parties
hereby irrevocably and unconditionally waive any objection to the laying of
venue of any such action, suit or proceeding arising out of, resulting from or
relating to this Agreement or the transactions contemplated hereby in such
courts and hereby further irrevocably and
8
<PAGE>
unconditionally waive and agree not to plead or claim in any such court that
such action, suit or proceeding brought in any such court has been brought in an
inconvenient forum.
13. Validity. The invalidity or unenforceability of any provision or
provisions of this Agreement shall not affect the validity or enforceability of
any other provision of this Agreement, which shall remain in full force and
effect.
14. Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall be deemed to be an original but all of which
together will constitute one and the same instrument.
15. Entire Agreement. This Agreement contains the entire understanding
of the Company and the Executive with respect to his employment by the Company.
This Agreement supersedes all prior agreements and understandings whether
written or oral between the Executive and the Company, and there are no
restrictions, agreements, promises, warranties or covenants other than those
stated in this Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement on the
date shown below effective as of the date first written above.
"COMPANY"
Date Signed: October 22, 1999 AUDIO BOOK CLUB, INC., a Florida
corporation
By: /s/ Michael Herrick
-------------------------------------
Printed Name: Michael Herrick
--------------------------
Title: Co-CEO
----------------------------------
"EXECUTIVE"
Date Signed: October 22, 1999 John F. Levy
----------------------------------------
Printed Name: John F. Levy
--------------------------
9
<PAGE>
NEITHER THIS NOTE, NOR ANY SECURITY ISSUABLE UPON CONVERSION HEREOF, HAS BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR
APPLICABLE STATE SECURITIES LAWS. NO INTEREST IN THIS NOTE MAY BE OFFERED OR
SOLD EXCEPT PURSUANT TO (i) AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT,
OR (ii) AN EXEMPTION FROM REGISTRATION UNDER THE ACT WHERE THE HOLDER HAS
FURNISHED TO THE COMPANY AN OPINION OF ITS COUNSEL REASONABLY SATISFACTORY TO
THE COMPANY THAT AN EXEMPTION FROM REGISTRATION UNDER THE ACT IS AVAILABLE.
AUDIO BOOK CLUB, INC.
9% CONVERTIBLE SENIOR SUBORDINATED PROMISSORY NOTE
DUE DECEMBER 31, 2004
$4,800,000.00 August 26, 1999
AUDIO BOOK CLUB, INC. (together with its successors, the "Company"), a
Florida corporation, for value received, hereby promises to pay to ABC
Investment, L.L.C. or registered assigns (the "Holder"), the principal sum of
FOUR MILLION EIGHT HUNDRED THOUSAND DOLLARS ($4,800,000) on December 31, 2004
(the "Maturity Date"), and to pay interest on the unpaid principal balance
hereof from the date hereof to the Maturity Date at the rate of nine percent
(9.0%) per annum, in arrears, quarterly on March 31, June 30, September 30 and
December 31 in each year, commencing on September 30, 1999, until the principal
amount hereof shall become due and payable; and to pay on demand interest on any
overdue principal (including any overdue partial payment of principal and
principal payable at the maturity hereof), and (to the extent permitted by
applicable law) on any overdue installment of interest (the due date of such
payments to be determined without giving effect to any grace period) at the rate
of eleven percent (11.0%) per annum.
-1-
<PAGE>
1. Interest and Payment
1.1 Interest shall be computed on the basis of a 360 day year of twelve 30
day months for the actual time elapsed.
1.2 At the option of the Holder, the Company may pay a scheduled interest
payment in a number of whole shares of common stock, without par value ("Common
Stock"), of the Company, in lieu of paying such interest in cash, equal to the
quotient of dividing the amount of accrued and unpaid interest payable on such
interest payment date by an amount equal to the then current Conversion Price
(as hereinafter defined). No fractional shares of Common Stock will be issued to
the Holder in lieu of cash interest. Instead of any fractional share which would
otherwise be issuable in lieu of cash interest, the Company will calculate and
pay a cash adjustment in respect of such fraction (calculated to the nearest
1/100th of a share) in an amount equal to the same fraction of the Conversion
Price at the close of business on the fifth business day immediately preceding
such interest payment date. The Holder may exercise its option to cause the
Company to issue shares of Common Stock, in lieu of cash interest payable on an
interest payment date, by giving the Company written notice of its exercise of
such option at least five business days prior to such interest payment date and
the Company will deliver or cause its transfer agent to deliver, to the Holder
or its designee on such interest payment date, duly executed certificates for
the number of whole shares of Common Stock so issuable to the Holder registered
in the Holder's name or such other name or names and in such denominations as
the Holder shall have designated in its notice of exercise, and, if applicable,
a check payable to the Holder for any cash adjustment in lieu of a fractional
share.
1.3 Except as provided in Section 1.2 hereof, payments of principal, Change
in Control Purchase Price (as hereinafter defined), if any, and accrued interest
shall be made in such coin or currency of the United States of America as at the
time of payment is legal tender for the payment of public and private Debts to
the Holder hereof at its address shown in the register maintained by the Company
for such purpose.
1.4 (a) The Company shall pay all amounts payable with respect to this Note
(without any presentment of this Note) by crediting, by federal funds bank wire
transfer, the account of the Holder in any bank in the United States of America
as may be designated in writing by the Holder or in such other manner or to such
other address in the United States of America as may be designated in writing by
the Holder (and as to which, absent subsequent notice from the Holder, the
Company may conclusively rely). Annex 1 shall be deemed to constitute notice,
direction or designation (as appropriate) by the payee of this Note to the
Company with respect to payments to be made to such payee as above provided. In
the absence of such written direction, all amounts payable with respect to this
Note shall be paid by check mailed and addressed to the Holder at its address
shown in the register maintained by the Company pursuant to Section 2.1.
(b) All payments received on account of this Note shall be
applied first to the payment of accrued and unpaid interest on this Note and
then to the reduction of the unpaid principal amount of this Note. In case the
entire principal amount of this Note is paid or this Note is purchased by the
Company, this Note shall be surrendered to the Company for cancellation and
shall not be reissued, and no Note shall be issued in lieu of the paid principal
amount of any Note.
1.5 (a) If any payment due on account of this Note shall fall due on a day
other than a business day, then such payment shall be made on the first business
day following the day on which such payment shall have so fallen due; provided
that if all or any portion of such payment shall consist of a payment of
interest, for purposes of calculating such interest, such payment shall be
deemed to have been originally due on such first following Business Day, such
interest shall accrue and be payable to (but not including) the actual date of
payment, and the amount of the next succeeding interest payment shall be
adjusted accordingly.
(b) Any payment to be made to the Holder on account of this
Note shall be deemed to have been made on the business day such payment actually
becomes available at such Holder's bank prior to the close of business of such
bank, provided that interest for one day at the non-default interest rate of
this Note shall be due on the amount of any such payment that actually becomes
available to the Holder at the Holder's bank after 1:00 p.m. (local time of such
bank).
1.6 The Company may, upon at least three business days prior written notice
to the Holder specifying the date of the prepayment (the "Prepayment Date") and
the principal amount to be prepaid, prepay the unpaid principal balance of this
Note in whole at any time or in part from time to time, without penalty or
premium, in multiples of $100,000 (or if the outstanding principal amount is
less than $100,000 at such time, then such principal amount) together with
interest on the principal amount being prepaid accrued to the designated
Prepayment Date.
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1.7 In the event of a Change in Control, the Company will, within 15
business days after the occurrence of such event, give notice of such Change in
Control to the Holder. Such notice shall contain an irrevocable offer to the
Holder to repurchase this Note on a date (the "Change in Control Payment Date")
specified in such notice that is not less than thirty (30) days and not more
than ninety (90) days after the date of such notice, at a purchase price equal
to 100% of the aggregate principal amount thereof and all interest accrued and
unpaid on such principal amount to the Change in Control Payment Date (the
"Change in Control Purchase Price"). Each such notice shall: (i) be dated the
date of the sending of such notice; (ii) be executed by an executive officer of
the Company; (ii) specify, in reasonable detail, the nature and date of the
Change in Control; (iv) specify the Change in Control Payment Date; (v) specify
the principal amount of this Note outstanding; (vi) specify the interest that
would be due on this Note, accrued to the Change in Control Payment Date; and
(vii) specify that this Note shall be purchased at the Change in Control
Purchase Price. The Holder shall have the option to accept or reject such
offered payment. In order to accept such offered payment, the Holder shall cause
a notice of such acceptance to be delivered to the Company at least five days
prior to the Change in Control Payment Date. A failure to accept in writing such
written offer of payment as provided in this Section 1.7, or a written rejection
of such offered prepayment, shall be deemed to constitute a rejection of such
offer. The offered payment shall be made at the Change in Control Purchase Price
determined as of the Change in Control Payment Date.
1.8 Upon any partial payment of the outstanding principal amount of this
Note, the Holder shall mark this Note with a notation of the principal amount so
paid and the date of such payment.
2. Registration; Exercise; Substitution
2.1 The Company will keep at its principal executive office a register for
the registration and transfer of this Note. The name and address of the Holder
of this Note, each transfer hereof made in accordance with Section 2.2(a) and
the name and address of each transferee of this Note shall be registered in such
register. The person in whose name this Note shall be registered shall be deemed
and treated as the owner and holder thereof, and the Company shall not be
affected by any notice or knowledge to the contrary, other than in accordance
with Section 2.2(a)
2.2 (a) Upon surrender of this Note at the principal executive office of
the Company, duly endorsed or accompanied by a written instrument of transfer
duly executed by the Holder or the Holder's attorney duly authorized in writing,
the Company will execute and deliver, at the Company's expense (except as
provided in Section 2.2(c)), a new Note (or Notes) in exchange therefor, in an
aggregate principal amount equal to the unpaid principal amount of the
surrendered Note. Subject to Section 2.2(b), the new Note(s) shall be registered
in such name(s) as the Holder may request. Each such new Note shall be dated and
bear interest from the date to which interest shall have been paid on the
surrendered Note or dated the date of the surrendered Note, if no interest shall
have been paid thereon. Each such new Note shall carry the same rights to unpaid
interest and interest to accrue on the unpaid principal amount thereof as were
carried by the Note so exchanged or transferred.
(b) This Note has been acquired for investment and has not
been registered under the securities laws of the United States of America or any
state thereof. Accordingly, notwithstanding Section 2.2(a), neither this Note
nor any interest thereon may be offered for sale, sold or transferred in the
absence of registration and qualification of this Note under applicable federal
and state securities laws or an opinion of counsel of the Holder reasonably
satisfactory to the Company that such registration and qualification are not
required. This Note shall not be transferred in denominations of less than
$100,000 and integral multiples thereof, provided that the Holder may transfer
this Note as an entirety regardless of the principal amount thereof.
(c) The Company may require payment of a sum sufficient to
cover any stamp tax or governmental change imposed in respect of any such
transfer of this Note.
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2.3 Upon receipt by the Company from the Holder of evidence reasonably
satisfactory to the Company of the loss, theft, destruction or mutilation of
this Note (which evidence shall be, if the Holder is the payee or an
institutional investor, notice from the payee or such institutional investor of
such loss, theft, destruction or mutilation), and (a) in the case of loss, theft
or destruction, of indemnity reasonably satisfactory to the Company; provided,
however, that if the Holder is the payee or an institutional investor, the
unsecured agreement of indemnity of the payee or such institutional investor
shall be deemed to be satisfactory; or (b) in the case of mutilation, upon
surrender and cancellation thereof; the Company at its own expense will execute
and deliver, in lieu thereof, a replacement Note, dated and bearing interest
from the date to which interest shall have been paid on such lost, stolen,
destroyed or mutilated Note or dated the date of such lost, stolen, destroyed or
mutilated Note, if no interest shall have been paid thereon.
2.4 The Company will pay taxes (if any) due (but not, in any event, income
taxes of the Holder) in connection with and as the result of the initial
issuance of this Note and in connection with any modification, waiver or
amendment of this Note and shall save the Holder harmless, without limitation as
to time, against any and all liabilities with respect to all such taxes.
3. Subordination
3.1 Notwithstanding any other provision contained in this Agreement, the
Subordinated Debt is subordinate and junior in right of payment to all Senior
Debt to the extent provided in this Section 3.
3.2 In the event of: (a) any insolvency, bankruptcy, receivership,
liquidation, reorganization, readjustment, composition or other similar
proceeding relating to the Company; (b) any proceeding for the liquidation,
dissolution or other winding-up of the Company, voluntary or involuntary,
whether or not involving insolvency or bankruptcy proceedings; (c) any general
assignment by the Company for the benefit of creditors; or (d) any other
marshaling of the assets of the Company; all Senior Debt shall first be paid in
full, in cash or Cash Equivalents (as defined in Section 8 hereof and, for all
purposes of this Section 3, as so defined), before any payment or distribution,
whether in cash, securities or other property, shall be made to any holder of
any Subordinated Debt on account of any Subordinated Debt. Any payment or
distribution, whether in cash, securities or other property (other than
securities of the Company or any other corporation provided for by a plan of
reorganization or readjustment, the payment of which is subordinated, at least
to the extent provided in this Section 3 with respect to Subordinated Debt, to
the payment of all Senior Debt at the time outstanding and to any securities
issued in respect thereof under any such plan of reorganization or readjustment,
but only if the rights of the holders of the Senior Debt are not impaired by
such plan without their consent), which would otherwise (but for this Section 3)
be payable or deliverable in respect of Subordinated Debt, shall be paid or
delivered directly to the holders of Senior Debt in accordance with the
priorities then existing among such holders, until all Senior Debt shall have
been paid in full, in cash or Cash Equivalents.
3.3 If any holder of Subordinated Debt does not file a proper claim or
proof of Debt therefor prior to 20 days before the expiration of the time to
file such claim or proof, then the Senior Agent is hereby authorized and
empowered (but not obligated) as the agent and attorney-in-fact for such holder
for the specific and limited purpose set forth in this Section 3.3 to file such
claim or proof for or on behalf of such holder; provided, however, that the
Senior Agent shall have, prior to taking any such action, given 15 days prior
written notice (which notice may be given up to 60 days prior to the expiration
of the time to file such claim or proof) to such holder of Subordinated Debt
that it intends to file such claim or proof of Debt. In no event may the Senior
Agent or any holder of the Senior Debt vote any claim on behalf of any holder of
the Subordinated Debt, and such agency and appointment of attorney-in-fact shall
not extend to any such right to vote any such claim.
3.4 If (a) the Company shall default in the payment or prepayment of any
principal of, premium, if any, or interest on, or commitment fee or letter of
credit fee or Administrative Agent fee or indemnity under Section 2.10 or 2.12
or 11.4(c) (or comparable sections under any replacement Senior Debt) in respect
of, any Senior Debt (a "Senior Payment Default") when the same becomes due and
payable, whether at maturity, at a date fixed for prepayment, by declaration of
acceleration or otherwise, or shall fail to comply with any covenant or
agreement in respect of Senior Debt which covenant or agreement default results
in actual acceleration of the maturity of such Senior Debt ("Covenant
Acceleration"); and (b) the Company receives from the Senior Agent written
notice of the happening of such Senior Payment Default or Covenant Acceleration,
stating that such notice is a payment blockage notice pursuant to this Section
3.4; no direct or indirect payment (in cash, property or securities or by
set-off or otherwise) shall be made or agreed to be made on account of any
Subordinated Debt, or as a sinking fund for any Subordinated Debt, or in respect
of any redemption, retirement, purchase, prepayment or other acquisition or
payment of any Subordinated Debt, unless and until such Senior Payment Default
shall have been cured or waived or otherwise shall have ceased to exist or such
Covenant Acceleration shall have been rescinded and the underlying covenant
default shall have been cured or waived or shall have otherwise ceased to exist.
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The Company shall give prompt written notice to each holder of Subordinated
Debt of its receipt of any such notice from the Senior Agent under this Section
3.4.
3.5 If (a) any Significant Nonpayment Default shall have occurred; and (b)
the Company and the Holder receive from the Senior Agent written notice (a "Stop
Payment Notice") of the happening of such Significant Nonpayment Default,
stating that such notice is a payment blockage notice pursuant to this Section
3.5; no direct or indirect payment (in cash, property or securities or by
set-off or otherwise) shall be made or agreed to be made for or on account of
any Subordinated Debt, or as a sinking fund for any Subordinated Debt, or in
respect of any redemption, retirement, repurchase, prepayment, purchase or other
acquisition or payment of any Subordinated Debt, for a period (each, a "Payment
Blockage Period") commencing on the date such Stop Payment Notice is delivered
to the Company and ending on the earliest to occur of the following: (a) the
time as of which each Significant Nonpayment Default which is the subject of
such Stop Payment Notice shall have been waived or cured (whether by amendment
of any provisions of the Senior Credit Agreement or otherwise), (b) a number of
days shall have elapsed as is necessary to prevent the total number of days that
a Stop Payment Notice (or Stop Payment Notices in the event that more than one
Stop Payment Notice has been given) is in effect during any consecutive 365 day
period from exceeding 180 days in the aggregate, and (c) the date of the
repayment in full in cash or Cash Equivalents of the Senior Debt and the
termination of any commitment to make further loans or advances in respect of
the Senior Debt; provided, however, that (i) the Senior Agent shall not be
permitted to issue a Stop Payment Notice more than six times in the aggregate;
(ii) only two Stop Payment Notices may be issued in any period of 365
consecutive days; (iii) Payment Blockage Periods may not be in effect for more
than 180 days (whether or not such days are consecutive) during any period of
365 consecutive days, and if any Payment Blockage Period is in effect on the
181st day in any period of 365 consecutive days, such Payment Blockage Period
will terminate immediately; and (iv) no Payment Blockage Period may be imposed
as a result of a Significant Nonpayment Default which served as the basis for or
was continuing during any previous Payment Blockage Period, unless any such
Significant Nonpayment Default shall have been cured or waived or otherwise
ceased to exist for a period of not less than 60 consecutive days after the date
that the previous Stop Payment Notice was given.
3.6 If, at any time during which the Senior Credit Facility is in effect,
the Holder elects to exercise any Remedies in respect of any Event of Default,
the Holder shall deliver to the Company and to the Senior Agent written notice
(an "Enforcement Notice") specifying the Event or Events of Default which are
the basis for the exercise of such Remedies and stating that the Holder intends
to exercise Remedies; provided, however, that the failure to deliver such
Enforcement Notice to the Senior Agent shall not affect the validity of the
Enforcement Notice as between such holder or holders and the Company.
3.7 Notwithstanding anything contained in this Note to the contrary, for so
long as any amount is outstanding under the Senior Credit Facility including any
letter of credit reimbursement obligations or commitments, the Holder shall not
exercise any Remedies in respect thereof during any period (a "Standstill
Period") commencing on the first date the Holder, but for the provisions of this
Section 3, would have been entitled to exercise any Remedies and ending upon the
earliest of:
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(a) the date which is 10 business days after the Enforcement Notice is
delivered to the Company and the Senior Agent pursuant to Section 3.6;
provided, however, that if any Payment Blockage Period arising from the
giving of a Stop Payment Notice is in effect on such 10th business day
after the Enforcement Notice is so delivered, this clause (a) shall be
ineffective to terminate such Standstill Period;
(b) in the event that a Payment Blockage Period arising from the
giving of a Stop Payment Notice is in effect on the date which is 10
business days after an Enforcement Notice is delivered to the Company and
the Senior Agent pursuant to Section 3.6, the expiration of such Payment
Blockage Period;
(c) the date that any holder of any Senior Debt commences the exercise
of any Remedies in respect of such Senior Debt; and
(d) the first date upon which any of the Events of Default described
in Section 7.1(f) and (g) shall have occurred and be continuing beyond any
period of grace specified therein; and, in such event, the automatic
acceleration of this Note contemplated in respect of such Event of Default
pursuant to Section 7.2(a) shall occur immediately upon the termination of
the Standstill Period.
3.8 If (a) any payment or distribution shall be paid to or collected or
received by any holders of Subordinated Debt in contravention of any of the
terms of this Section 3 but whether or not any Stop Payment Notice or (pursuant
to Section 3.4) payment blockage notice shall theretofore have been given (i.e.,
if paid, collected or received at a time when either such notice could have been
given had the Senior Agent been aware of circumstances giving rise to the right
to deliver any such notice); and (b) the Senior Agent shall have notified the
holders of Subordinated Debt in writing, within 30 days after the date such
payment or distribution is made, of the facts by reason of which such payment or
collection or receipt so contravenes this Section 3 or constituted a Significant
Nonpayment Default; then such holders of Subordinated Debt will deliver such
payment or distribution, to the extent necessary to pay all such Senior Debt in
full, in cash or Cash Equivalents, to the Senior Agent, on behalf of the holders
of the Senior Debt, and, until so delivered, the same shall be held in trust by
such holders of Subordinated Debt as the property of the holders of such Senior
Debt. If any amount is delivered to the Senior Agent pursuant to this Section
3.8, whether or not such amounts have been applied to the payment of Senior
Debt, and the outstanding Senior Debt shall thereafter be paid in full, in cash
or Cash Equivalents, by the Company or otherwise other than pursuant to this
Section 3.8, the holders of Senior Debt shall return to such holders of
Subordinated Debt an amount equal to the amount delivered to such holders of
Senior Debt pursuant to this Section 3.8, so long as after the return of such
amounts the Senior Debt shall remain indefeasibly paid in full, in cash or Cash
Equivalents.
3.9 Except as provided in this Section 3, the rights set forth in this
Section 3 of the holders of the Senior Debt as against each holder of
Subordinated Debt shall remain in full force and effect without regard to, and
shall not be impaired by:
(a) any act or failure to act on the part of the Company;
(b) any extension or indulgence in respect of or change in the time,
manner or place of any payment or prepayment of the Senior Debt or any part
thereof or in respect of any other amount payable to any holder of Senior
Debt, including, without limitation, any increase in the Senior Debt
resulting from extension of additional credit to the Company or any
subsidiary or otherwise and permitted by Section 6.3(iii) or (iv) hereof;
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(c) any amendment, modification, restatement, refinancing or waiver
of, or addition or supplement to, or deletion from, or compromise, release,
consent or other action in respect of, any of the terms of any Senior Debt
or any other agreement which may be relating to any Senior Debt, other than
such as would cause all or any portion of such Debt to fail to meet the
definition of "Senior Debt;"
(d) any exercise or non-exercise by any holder of Senior Debt of any
right, power, privilege or remedy under or in respect of any Senior Debt or
Subordinated Debt or any waiver of any such right, power, privilege or
remedy or any default in respect of any Senior Debt or the Subordinated
Debt, any dealing with or action against or application of proceeds from
any collateral security therefor or any receipt by any holder of Senior
Debt of any security, or any failure by any holder of Senior Debt to
perfect a security interest in, or any release by any such Senior Debt of,
any security for or guaranty of the payment of any Senior Debt or any
manner of sale or other disposition of any assets of the Company or any
subsidiary;
(e) any merger or consolidation of the Company or any of its
subsidiaries into or with any other subsidiaries of the Company or into or
with any person, or any transfer of any or all of the property of the
Company or any of its subsidiaries to any other person or any change,
restructuring or termination of the corporate structure or existence of the
Company or any of its subsidiaries;
(f) the absence of any notice to, or knowledge by, any holder of
Subordinated Debt of the existence or occurrence of any of the matters or
events set forth in the foregoing clauses (a) through (e).
(g) any lack of validity or enforceability of any instrument or
agreement evidencing or securing any Senior Debt or any other agreement or
instrument relating thereto; or
(h) any other circumstance which might otherwise constitute a defense
available to, or a discharge of, the Company or any holder of Subordinated
Debt.
3.10 Each holder of Subordinated Debt and the Company hereby waives
promptness, diligence, notice of appearance and any other notice with respect to
any of the Senior Debt and these provisions and any requirement that any holder
of the Senior Debt protect, secure, perfect or insure any security interest or
lien or any property subject thereto or exhaust any right to take any action
against the Company or any other person or entity or any collateral.
3.11 The Company will, and will use its reasonable efforts to cause each
holder of Subordinated Debt to, at the Company's expense and at any time and
from time to time, promptly execute and deliver all further instruments and
documents, and take all further actions, that may be necessary or desirable, or
that any holder of any Senior Debt may reasonably request, in order to protect
any right or interest granted or purported to be granted under this Section 3 or
enable the holders of the Senior Debt to exercise and enforce their rights and
remedies under these provisions.
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3.12 Each holder of Subordinated Debt waives any and all notices of the
acceptance of the provisions of this Section 3 or of the creation, renewal,
extension or accrual, now or at any time in the future, of any Senior Debt.
3.13 The obligations of each holder of Subordinated Debt under the
provisions set forth in this Section 3 shall continue to be effective, or be
reinstated, as the case may be, as to any payment in respect of any Senior Debt
that is rescinded or must otherwise be returned by the holder of such Senior
Debt upon the occurrence or as a result of any bankruptcy or judicial
proceeding, all as though such payment had not been made.
3.14 Nothing contained in this Section 3 shall impair, as between the
Company and any holder of Subordinated Debt, the obligation of the Company to
pay to such holder the principal thereof and interest thereon as and when the
same shall become due and payable in accordance with the terms thereof and to
comply with each and every provision of this Note or prevent any holder of any
Subordinated Debt from exercising all rights, powers and remedies otherwise
permitted by applicable law or under this Note, all subject to the rights of the
holders of the Senior Debt hereunder including rights to receive cash,
securities or other property otherwise payable or deliverable to the holders of
Subordinated Debt.
3.15 Upon the payment in full of all Senior Debt, the holders of
Subordinated Debt shall be subrogated to all rights of any holder of Senior Debt
to receive any further payments or distributions applicable to the Senior Debt
until the Subordinated Debt shall have been paid in full, and such payments or
distributions received by the holders of Subordinated Debt by reason of such
subrogation, of cash, securities or other property which otherwise would be paid
or distributed to the holders of Senior Debt, shall, as between the Company and
its creditors other than the holders of Senior Debt, on the one hand, and the
holders of Subordinated Debt, on the other hand, be deemed to be a payment by
the Company on account of Senior Debt and not on account of Subordinated Debt.
Notwithstanding the foregoing provisions of this Section 3.15 or any other
provision of this Note each holder of Subordinated Debt hereby waives any and
all exoneration and impairment defenses that it may at any time have by law or
otherwise in respect of subrogation rights.
3.16 Each holder of Subordinated Debt, by its acceptance thereof, shall be
deemed to acknowledge and agree that the foregoing subordination provisions are,
and are intended to be, an inducement to and a consideration of each holder of
any Senior Debt, whether such Senior Debt was created or acquired before or
after the creation of Subordinated Debt, to acquire and hold, or to continue to
hold, such Senior Debt, and such holder of Senior Debt shall be deemed
conclusively to have relied on such subordination provisions in acquiring and
holding, or in continuing to hold, such Senior Debt. Each such holder of Senior
Debt is intended to be, and is, a third party beneficiary of this Section 3.
Each holder of Subordinated Debt acknowledges and agrees that the provisions set
forth in this Section 3 shall be enforceable against such holder of Subordinated
Debt by the holders of the Senior Debt. Notwithstanding anything contained in
this Note to the contrary, none of the provisions of this Section 3 (including,
without limitation, this Section 3.16 and defined terms used herein) may,
directly or indirectly, be amended, modified, supplemented or waived without the
prior written consent of the Senior Agent, on behalf of the holders of the
Senior Debt.
3.17 Notwithstanding the other provisions of this Section 3.17, no
amendment to or refinancing of the Senior Debt or any agreement or instrument
related thereto shall be entitled to the benefits of this Section 3 without the
consent of the Holder to the extent that such amendment would prohibit directly
and expressly the Company or any subsidiary from making scheduled payments in
respect of the Subordinated Debt in accordance with the terms of this Agreement
as in effect on the date hereof or as may be amended to the extent permitted by
the Senior Credit Agreement; provided that no change of financial covenants or
increase in the restrictiveness of negative covenants or events of default under
the Senior Debt documents (that do not by their terms refer to this Note) shall
be deemed to constitute a prohibition from making scheduled payments, even if
the ultimate effect of any such change would cause the Company to be in default
under the Senior Debt if such a scheduled payment were made.
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3.18 As used in this Section 3 and elsewhere in this Agreement, the
following terms have the respective meanings set forth below:
"Credit Facility" means and includes a credit agreement or
similar agreement pursuant to which the lender or lenders commit(s) to permit
the Company, subject to the conditions therein, to obtain from time to time
thereunder term or revolving loans and/or letters of credit and periodically
repay the same.
"Junior Subordinated Debt" means any Debt of the Company or
any subsidiary which is (a) issued on or after the Issue Date of this Note and
which is expressly subordinated in right of payment to any Debt of the Company,
or (b) owing to any subsidiary or affiliate of the Company.
"Remedies" means and includes, with respect to any Debt
(including, without limitation, the Senior Debt and the Subordinated Debt):
(a) the acceleration of the maturity of any of such Debt;
(b) the exercise of any put right or other similar right to
require the Company or any subsidiary to repurchase any of such Debt prior to
the stated maturity thereof;
(c) the collection or commencement of proceedings against the
Company, any subsidiary thereof or any other person obligated on such Debt or
any of their respective property, to enforce or collect any of such Debt;
(d) taking possession of or foreclosing upon (whether by
judicial proceedings or otherwise) any Liens or other collateral security for
such Debt; or causing a marshaling of any property of the Company or any
subsidiary;
(e) the making of a demand in respect of any Guaranty given by
the Company or any subsidiary of the Company of such Debt;
(f) commencing or joining in or causing the Company to
commence or join in or assist the Company in commencing, any proceeding of the
nature referred to in Section 7.1(f) or 7.1(g); or
(g) exercising any other remedies with respect to such Debt or
any claim with respect thereto.
"Senior Agent" means, for so long as the Senior Credit
Agreement remains outstanding, Fleet National Bank, as administrative agent in
respect of the Senior Credit Agreement, and thereafter, any one agent or lender
in respect of the Senior Credit Facility, or a representative of either,
designated in writing to the Holder by the Company as being the "Senior Agent".
"Senior Credit Agreement" means the Credit Agreement dated as
of the date hereof among the Company, Fleet National Bank as administrative
agent (together with its successors in such capacity) and the banks, financial
institutions and other institutional lenders from time to time named therein, as
it may be amended, supplemented, extended, renewed, refinanced, restated or
replaced in whole or in part.
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"Senior Credit Facility" means and includes:
(a) the Senior Credit Agreement; and
(b) any Credit Facility (whether or not secured), which Credit
Facility has refinanced in whole or in part the Senior Debt governed by the
terms of a Senior Credit Facility which the Company has designated in writing to
the Holder as being the "Senior Credit Facility;" provided, however, that, by
making such designation, the predecessor Senior Credit Facility shall cease to
be the Senior Credit Facility (but any Debt outstanding or incurred thereunder
shall continue to be Senior Debt for so long as such Debt meets the definition
thereof).
"Senior Debt" means and includes all obligations, liabilities
and indebtedness of the Company now or hereafter existing, whether fixed or
contingent, and whether for principal or interest (including interest (at the
rate specified in the applicable Senior Credit Facility) accruing after the
filing of a petition under the Bankruptcy Code, whether or not allowed), fees,
expenses, indemnification or otherwise (including letter of credit reimbursement
obligations whether or not any draw has occurred), in respect of:
(a) the Senior Credit Facility; and
(b) any other Debt of the Company owing to the Senior Agent or
any lender under the Senior Credit Facility (whether or not such lender
continues to be a lender thereunder) with respect to any obligations under Bank
Hedge Agreements (as defined in the Senior Credit Agreement) related to the
Senior Credit Agreement that are or may become owed by the Company directly or
indirectly, other than Debt incurred pursuant to a Senior Credit Facility.
Notwithstanding the foregoing, in no event shall "Senior Debt"
include any Junior Subordinated Debt.
"Significant Nonpayment Default" means and includes:
(a) an event of default under the Senior Credit Facility in
respect of the failure of the Company to comply with any material covenant or
agreement in respect of the Senior Credit Facility or documents executed or
delivered in connection therewith (it being understood that the provisions of
Sections 2.14, 5.2, 5.5, 5.6, 5.7, 5.13 and 5.14, Article 6 and Article 8 of the
Senior Credit Agreement, as in effect on the date hereof and any comparable
provisions in effect after the date hereof, are "material covenants" for such
purpose); and any event of default under Sections 9.2, 9.5, 9.7 through 9.14
(inclusively) under the Senior Credit Agreement (or any comparable provision in
effect after the date hereof); and
(b) an event of default in respect of the Senior Credit
Facility arising out of any Event of Default in respect of this Note.
"Subordinated Debt" means and includes all obligations,
liabilities and indebtedness of the Company now or hereafter existing, whether
fixed or contingent, and whether for principal, interest (including interest
accruing after the filing of a petition under the Federal Bankruptcy Code, to
the extent allowed), fees, expenses, indemnification or otherwise, in respect of
this Note.
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4. Conversion
4.1 The Holder may convert the outstanding principal amount of this Note,
and accrued and unpaid interest thereon (or a portion of such outstanding
principal amount as provided in Section 4.3) into fully paid and nonassessable
shares of Common Stock of the Company ("Conversion Shares") at any time prior to
the time the outstanding principal amount of this Note, and accrued and unpaid
interest thereon is paid in full, at the Conversion Price then in effect, except
that if this Note is to be prepaid in full or repurchased pursuant to the
provisions hereof, such conversion right shall terminate at the close of
business on the Prepayment Date or the Change in Control Purchase Date, as the
case may be. The number of shares of Common Stock issuable upon conversion of
this Note shall be determined by dividing the principal amount (and accrued and
unpaid interest, if any) to be converted by the conversion price in effect on
the Conversion Date (the "Conversion Price"). The initial Conversion Price is
$11.125 and is subject to adjustment as provided in this Section 4.
The provisions of this Note that apply to conversion of the outstanding
principal amount of this Note and accrued and unpaid interest thereon also apply
to a partial conversion of this Note. The Holder is not entitled to any rights
of a holder of Conversion Shares until the Holder has converted this Note (or a
portion thereof) into Conversion Shares, and only to the extent that this Note
is deemed to have been converted into Conversion Shares under this Section 4.
4.2 To convert all or a portion of this Note, the Holder must (a) complete
and sign a notice of election to convert substantially in the form annexed
hereto (each, a "Conversion Notice"), (b) surrender the Note to the Company, (c)
furnish appropriate endorsements or transfer documents if required by the
Company and (d) pay any transfer or similar tax, if required. The date on which
the Holder satisfies all of such requirements is the conversion date (the
"Conversion Date"). As soon as practicable, and in any event within three (3)
business days, after the Conversion Date, the Company will deliver, or cause to
be delivered, to the Holder a certificate for the number of whole Conversion
Shares issuable upon such conversion and a check for any fractional Conversion
Share determined pursuant to Section 4.4 and for interest on this Note accrued
and unpaid through the Conversion Date (unless such interest has also been
converted as permitted by this Section 4). The person in whose name the
certificate for Conversion Shares is to be registered shall become the
shareholder of record on the Conversion Date and, as of the Conversion Date, the
rights of the Holder shall cease as to the portion thereof so converted;
provided, however, that no surrender of a Note on any date when the stock
transfer books of the Company shall be closed shall be effective to constitute
the person entitled to receive the Conversion Shares upon such conversion as the
shareholder of record of such Conversion Shares on such date, but such surrender
shall be effective to constitute the person entitled to receive such Conversion
Shares as the shareholder of record thereof for all purposes at the close of
business on the next succeeding day on which such stock transfer books are open;
provided further that such conversion shall be at the Conversion Price in effect
on the date that this Note shall have been surrendered for conversion, as if the
stock transfer books of the Company had not been closed.
4.3 In the case of a partial conversion of this Note, upon such conversion,
the Company shall execute and deliver to the Holder, at the expense of the
Company, a new Note in an aggregate principal amount equal to the unconverted
portion of the principal amount. This Note may be converted in part in a
principal amount equal $100,000 or an integral multiple thereof, unless the
outstanding principal amount of this Note is less than $100,000, in which case,
only such outstanding principal amount and accrued and unpaid interest thereon
is convertible into Conversion Shares.
4.4 No fractional Conversion Shares shall be issued upon conversion of this
Note. Instead of any fractional Conversion Share which would otherwise be
issuable upon conversion of this Note, the Company shall calculate and pay a
cash adjustment in respect of such fraction (calculated to the nearest 1/100th
of a share) in an amount equal to the same fraction of the Conversion Price at
the close of business on the Conversion Date.
4.5 The issuance of certificates for Conversion Shares upon the conversion
of any Security shall be made without charge to the Holder for such certificates
or for any tax in respect of the issuance of such certificates, and such
certificates shall be issued in the name of, or in such names as may be directed
by, the Holder; provided, however, that in the event that certificates for
Conversion Shares are to be issued in a name or names other than the name of the
Holder, such Note, when surrendered for conversion, shall be accompanied by an
instrument of transfer, in form satisfactory to the Company, duly executed by
the Holder or his duly authorized attorney; and provided further, moreover, that
the Company shall not be required to pay any tax which may be payable in respect
of any transfer involved in the issuance and delivery of any such certificates
in a name or names other than that of the Holder, and the Company shall not be
required to issue or deliver such certificates unless or until the person or
persons requesting the issuance thereof shall have paid to the Company the
amount of such tax or shall have established to the satisfaction of the Company
that such tax has been paid or is not applicable.
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4.6 (a) In case the Company shall at any time after the date hereof issue,
grant or sell any Additional Stock (as hereinafter defined) for a consideration,
exercise or conversion price per share less than the Conversion Price in effect
immediately prior to the issuance or sale of such Additional Stock, or without
consideration, then forthwith upon such issuance or sale, the Conversion Price
shall (upon such issuance or sale) be reduced to a price determined by dividing
(i) an amount equal to the sum of (a) the total number of shares of Common Stock
outstanding immediately prior to such issuance or sale multiplied by the
Conversion Price then in effect, plus (b) the consideration, if any, received by
the Company upon such issuance or sale, by (ii) the total number of shares of
Common Stock outstanding immediately after such issuance or sale; provided,
however, that in no event shall the Conversion Price be adjusted pursuant to
this computation to an amount in excess of the Conversion Price in effect
immediately prior to such computation, except as provided in 4.6(d) hereof.
"Additional Stock" shall mean Common Stock or options, warrants or other rights
to acquire or securities convertible into or exchangeable for shares of Common
Stock, including shares held in the Company's treasury, and shares of Common
Stock issued upon the exercise of any options, rights or warrants to subscribe
for shares of Common Stock and shares of Common Stock issued upon the direct or
indirect conversion or exchange of securities for shares of Common Stock, other
than:
(A) This Note.
(B) Common Stock issued or issuable upon conversion of this
Note.
(C) Common Stock issued or issuable upon the conversion or
exercise of options, warrants, rights and other securities or debt
convertible into or exercisable or exchangeable for Common Stock
outstanding on the date hereof;
(D) The grant of options, warrants, stock appreciation rights
or other rights available for future grant under the Company's stock
option plan or any future stock option or incentive plan approved by
the Company's shareholders;
(E) Common Stock issuable upon exercise of options, warrants,
stock appreciation rights or other rights outstanding or available for
future grant under the Company's stock option plan or any future stock
option or incentive plan approved by the Company's shareholders;
provided, that, any such options, warrants, stock appreciation rights
or other rights provide for an exercise price or conversion price at
least equal to the lesser of the Market Price (as hereinafter defined)
or the last sale price of the Common Stock on the day of or day prior
to (i) the date of approval of such grant by the Board of Directors or
(ii) the date of execution of an agreement relating to such grant;
(F) Warrants to be issued in connection with the Senior Credit
Agreement and shares of Common Stock issuable upon the exercise
thereof, and
(G) Common Stock or options, warrants, rights or other
securities or debt convertible into, or exercisable or exchangeable
for, Common Stock (or shares of Common Stock issuable upon the
conversion or exercise thereof) in connection with future acquisitions.
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The term "Market Price" shall mean the average of the daily closing prices
of a share of Common Stock for the 10 consecutive trading days immediately prior
to the day in question. The closing price for each day shall be (a) the last
reported sales price or, in the case no such reported sale takes place on such
day, the average of the reported closing bid and asked prices, in either case on
the principal national securities exchange on which the Common stock is listed
or admitted to trading or, if the Common Stock is not listed or admitted to
trading on any national securities exchange, on The Nasdaq Stock Market, Inc.
("Nasdaq"), (b) if the Common Stock is not listed or admitted to trading on any
national securities exchange or quoted on Nasdaq, the average of the closing bid
and asked prices in the over-the-counter market as furnished by any New York
Stock Exchange member firm reasonably selected from time to time by the Company
for that purpose, or (c) if the Common Stock is not listed or admitted to
trading on any national securities exchange or quoted on Nasdaq and the average
price cannot be determined as contemplated by clause (b), the fair market value
of the Common Stock as determined in good faith by resolution of the independent
directors of the Company. For the purposes of the preceding sentence, the term
"trading day" shall mean each Monday, Tuesday, Wednesday, Thursday and Friday,
other than any day on which securities are not traded on such exchange or in
such market.
(b) For the purpose of any computation to be made in accordance with
Section 4.6(a), the following provisions shall apply:
(i) In case of the issuance or sale of shares of
Common Stock for a consideration part or all of which shall be cash, the amount
of the cash consideration therefor shall be deemed to be the amount of cash
received by the Company for such shares (or, if shares of Common Stock are
offered by the Company for subscription, the subscription price, or, if such
securities shall be sold to underwriters or dealers for public offering without
a subscription offering, the initial public offering price) before deducting
therefrom any compensation paid or discount allowed in the sale, underwriting or
purchase thereof by underwriters or dealers or others performing similar
services, or any expenses incurred in connection therewith.
(ii) In the case of the issuance or sale (otherwise
than as a dividend or other distribution on any stock of the Company) of shares
of Common Stock for a consideration part or all of which shall be other than
cash, the amount of the consideration therefor other than cash shall be deemed
to be the fair market value of such consideration as determined in good faith by
the Board of Directors.
(iii) The reclassification of securities of the
Company other than shares of Common Stock into securities including shares of
Common Stock shall be deemed to involve the issuance of such shares of Common
Stock for a consideration other than cash immediately prior to the close of
business on the date fixed for the determination of security holders entitled to
receive such shares, and the value of the consideration allocable to such shares
of Common Stock shall be determined as provided in Section 4.6(b)(ii).
(iv) In the case of the issuance of options, rights,
or warrants to purchase or subscribe for shares of Common Stock, securities
convertible into or exchangeable for shares of Common Stock, or options, rights
or warrants to purchase or subscribe for any such convertible or exchangeable
securities, the following provisions shall apply:
(A) The aggregate maximum number of shares of Common Stock
issuable under such options, rights or warrants shall be deemed to be issued and
outstanding at the time such options, rights or warrants were issued, and shall
be deemed to be issued for a consideration equal to the minimum purchase price
per share provided for in such options, rights or warrants at the time of
issuance plus the consideration, if any, received by the Company in connection
with sale or issuance of such options, rights or warrants; provided, however,
that upon the expiration or other termination of such options, rights or
warrants, if any thereof shall not have been exercised, the number of shares of
Common Stock deemed to be issued and outstanding pursuant to this subsection (A)
shall be reduced by such number of shares as to which options, warrants and/or
rights shall have expired or terminated unexercised, and such number of shares
of Common Stock shall no longer be deemed to be issued and outstanding, and the
Conversion Price then in effect shall forthwith be readjusted and thereafter be
the price which it would have been had such adjustment been made on the basis of
the issuance only of shares of Common Stock actually issued or issuable upon the
exercise of those options, rights or warrants as to which the exercise of rights
shall not have expired or terminated unexercised.
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<PAGE>
(B) The aggregate maximum number of shares of Common Stock
issuable upon conversion or exchange of any convertible or exchangeable
securities shall be deemed to be issued and outstanding at the time of issuance
of such securities, and shall be deemed to be issued for a consideration equal
to the consideration received by the Company in connection with the sale of such
securities plus the consideration, if any, receivable by the Company upon the
conversion or exchange thereof; provided, however, that upon the termination of
the right to convert or exchange such convertible or exchangeable securities
(whether by reason of redemption or otherwise), the number of shares deemed to
be issued and outstanding pursuant to this subsection (B) shall be reduced by
such number of shares as to which the conversion or exchange rights shall have
expired or terminated unexercised, and such number of shares shall no longer be
deemed to be issued and outstanding and the Conversion Price then in effect
shall forthwith be readjusted and thereafter be the price which it would have
been had such adjustment been made on the basis of the issuance only of shares
actually issued or issuable upon the conversion or exchange of those convertible
or exchangeable securities as to which the conversion or exchange rights shall
not have expired or terminated unexercised.
(C) If any change shall occur in the price per share provided
for in any of the options, rights or warrants referred to in Section
4.6(b)(iv)(A), or in the price per share at which the securities referred to in
Section 4.6(b)(iv)(B) are convertible or exchangeable, such options, rights or
warrants or conversion or exchange rights, as the case may be, shall be deemed
to have expired or terminated on the date when such price change became
effective in respect of shares not theretofore issued pursuant to the exercise
or conversion or exchange thereof, and the Company shall be deemed to have
issued upon such date new options, rights or warrants or convertible or
exchangeable securities at the new price in respect of the number of shares
issuable upon the exercise of such options, rights or warrants or the conversion
or exchange of such convertible or exchangeable securities.
(D) Except as otherwise provided in this Section 4.6(b), no
adjustment of the Conversion Price shall be made upon the actual issuance of
such Common Stock upon exercise of options, rights or warrants or upon the
actual issuance of such Common Stock upon conversion or exchange of any
convertible or exchangeable securities.
(c) In case the Company shall pay or make a dividend or other distribution
to all holders of its Common Stock in shares of Common Stock, the Conversion
Price in effect at the opening of business on the day next following the date
fixed for the determination of shareholders entitled to receive such dividend or
other distribution shall be reduced by multiplying such Conversion Price by a
fraction, of which the numerator shall be the number of shares of Common Stock
outstanding at the close of business on the date fixed for such determination,
and the denominator shall be the sum of the numerator and the total number of
shares constituting such dividend or other distribution, such reduction to
become effective immediately after the opening of business on the day next
following the date fixed for such determination. For the purposes of this
Section 4.6(c), the number of shares of Common Stock at any time outstanding
shall not include shares of Common Stock held in the treasury of the Company.
The Company will not pay any dividend or make any distribution on shares of
Common Stock held in the treasury of the Company.
(d) In the event that the Company shall at any time prior to the conversion
in full of the Note declare a dividend (other than a dividend consisting solely
of shares of Common Stock or a cash dividend or distribution payable out of
current or retained earnings) or otherwise distribute to its shareholders any
monies, assets, property, rights, evidences of indebtedness, securities (other
than shares of Common Stock), whether issued by the Company or by another person
or entity, or any other thing of value, the Holder or Holders of the Note to the
extent of the unconverted portion thereof shall thereafter be entitled, in
addition to the shares of Common Stock or other securities receivable upon the
conversion thereof, to receive, upon conversion of such unconverted portion of
the Note, the same monies, property, assets, rights, evidences of indebtedness,
securities or any other thing of value that they would have been entitled to
receive at the time of such dividend or distribution. At the time of any such
dividend or distribution, the Company shall make appropriate reserves to ensure
the timely performance of the provisions of this Subsection.
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(e) In case the outstanding shares of Common Stock shall be subdivided into
a greater number of shares of Common Stock, the Conversion Price in effect at
the opening of business on the day following the day upon which such subdivision
becomes effective shall be proportionately reduced, and, conversely, in case the
outstanding shares of Common Stock shall each be combined into a smaller number
of shares of Common Stock, the Conversion Price in effect at the opening of
business on the day following the day upon which such combination becomes
effective shall be proportionately increased, such reduction or increase, as the
case may be, to become effective immediately after the opening of business on
the day following the day upon which such subdivision or combination becomes
effective.
(f) In case the Company shall fail to take a record of the holders of its
shares of Common Stock for the purpose of entitling them to receive a dividend
or other distribution payable in shares of Common Stock, then such record date
shall be deemed to be the date of the issue of the shares of Common Stock deemed
to have been issued as a result of the declaration of such dividend or other
distribution or the date of the granting of such right of subscription or
purchase, as the case may be.
4.7 No adjustment in the Conversion Price shall be required unless such
adjustment would require an increase or decrease of at least one cent ($.01) in
the Conversion Price; provided, however, that any adjustments which by reason of
this Section 4.7 are not required to be made shall be carried forward and taken
into account in any subsequent adjustment.
4.8 Notice of Certain Events.
(a) In the event that: (i) the Company takes any action which would require
an adjustment in the Conversion Price; (ii) the Company takes any action
described in Section 4.9(a), (b) or (c); or (iii) there is a dissolution or
liquidation of the Company; the Holder may wish to convert this Note into shares
of Conversion Shares prior to the record date for or the effective date of the
transaction so that such Holder may receive the securities or assets which a
holder of shares of Common Stock on that date may receive. Therefore, the
Company shall give notice to the Holder in accordance with the provisions of
this Section 4.8 stating the proposed record or effective date, as the case may
be, which notice shall be given prior to the proposed record or effective date
and, in any case, no later than notice of such transaction is given to holders
of Common Stock. Failure to give such notice or any defect therein shall not
affect the validity of any transaction referred to in clause (i), (ii) or (iii)
of this Section.
(b) Upon the occurrence of each adjustment or readjustment of the
Conversion Price pursuant to this Section 4, the Company, at its expense, shall
promptly compute such adjustment or readjustment in accordance with the terms
hereof and prepare and furnish to each Holder a statement, signed by its chief
financial officer, setting forth such adjustment or readjustment and showing in
reasonable detail the facts upon which such adjustment or readjustment is based.
The Company shall, upon the written request at any time of any Holder, furnish
or cause to be furnished to such Holder a like certificate setting forth (i)
such adjustment and readjustment, (ii) the Conversion Price at the time in
effect, and (iii) the number of shares of Common Stock and the amount, if any,
of other property which at the time would be received upon the Conversion of the
portion of this Note specified in such request.
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4.9 If any of the following shall occur, namely:
(a) any reclassification or change of outstanding shares of Common Stock
issuable upon conversion of this Note (other than a change in par value, or from
par value to no par value, or from no par value to par value, or as a result of
a subdivision or combination);
(b) any consolidation or merger to which the Company is a party, other than
a merger in which the Company is the continuing corporation and which does not
result in any reclassification of, or change (other than a change in name, or
par value, or from par value to no par value, or from no par value to par value
or as a result of a subdivision or combination) in, outstanding shares of Common
Stock; or
(c) any sale or conveyance of all or substantially all of the property or
business of the Company and its subsidiaries as an entirety;
then the Company, or such successor or purchasing corporation, as the case may
be, shall, as a condition precedent to such reclassification, change,
consolidation, merger, sale or conveyance, execute and deliver to the Holder, an
agreement in form satisfactory to the Holder providing that the Holder shall
have the right to convert this Note into the kind and amount of shares of stock
and other securities and property (including cash) receivable upon such
reclassification, change, consolidation, merger, sale or conveyance by a holder
of the number of shares of Common Stock deliverable upon conversion of this Note
immediately prior to such reclassification, change, consolidation, merger, sale
or conveyance. Such agreement shall provide for adjustments of the Conversion
Price which shall be as nearly equivalent as may be practicable to the
adjustments of the Conversion Price provided for in this Section 4. If, in the
case of any such consolidation, merger, sale or conveyance, the stock or other
securities and property (including cash) receivable thereupon by a holder of
Common Stock includes shares of stock or other securities and property of a
corporation other than the successor or purchasing corporation, as the case may
be, in such consolidation, merger, sale or conveyance, then such agreement shall
also be executed by such other corporation and shall contain such additional
provisions to protect the interests of the Holder as the Board of Directors
shall reasonably consider necessary by reason of the foregoing. The provisions
of this Section 4.9 shall similarly apply to successive reclassifications,
changes, consolidations, mergers, sales or conveyances.
4.10 The Company shall at all times reserve and keep available, free from
preemptive rights, out of its authorized and unissued Common Stock, solely for
the purpose of effecting the conversion of this Note, the full number of
Conversion Shares then issuable upon the conversion in full of this Note.
4.11 If the Company or an affiliate of the Company shall at any time after
the date hereof and prior to the conversion of the Note in full issue any rights
to subscribe for shares of Common Stock or any other securities of the Company
or of such affiliate to all the shareholders of the Company, the Holder of the
unconverted portion of the Note shall be entitled, in addition to the shares of
Common Stock or other securities receivable upon the Conversion thereof, to
receive such rights at the time such rights are distributed to the other
shareholders of the Company.
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5. Affirmative Covenants
The Company covenants that on and after the Issue Date and so long as any
portion of the Note shall be outstanding:
5.1 The Company will, and will cause each of its Subsidiaries to, pay
before they become delinquent: (a) all taxes, assessments and governmental
charges or levies imposed upon it or its property; and (b) all claims or demands
of materialmen, mechanics, carriers, warehousemen, vendors, landlords and other
like persons that, if unpaid, might by law become a Lien upon its property;
provided, that items of the foregoing description need not be paid so long as
such items are being contested in good faith and by appropriate proceedings and
as to which appropriate reserves in accordance with GAAP have been established
and maintained with respect thereto, unless and until any Lien resulting
therefrom attaches to its property and becomes enforceable, unless such Lien is
effectively stayed or fully bonded pending the disposition of such proceedings.
5.2 The Company will, and will cause each of its subsidiaries to:
(a) maintain its property that is reasonably necessary in the
conduct of its business in good working order and condition, ordinary
wear and tear, obsolescence and insured casualty losses excepted;
(b) maintain, with insurers reasonably believed to be financially
sound and reputable, insurance with respect to its property and
business against such casualties and contingencies, of such types and
in such amounts as is customary in the case of corporations engaged in
the same or a similar business and similarly situated;
(c) keep proper books of record and account, in which full and
correct entries shall be made of all dealings and transactions of or
in relation to the properties and business thereof;
(d) do or cause to be done all things reasonably necessary to
preserve and keep in full force and effect its corporate existence,
corporate rights (charter and statutory) and corporate franchises,
except as permitted by Section 6.1;
(e) comply, in all material respects, with all applicable laws,
rules and regulations (including, without limitation, ERISA,
Environmental Laws and Environmental Permits) and obtain all licenses,
permits, franchises and other governmental authorizations necessary
for the ownership of its properties and the conduct of its business,
except where its obligation to so comply being contested in good faith
and by appropriate proceedings and adequate resources have been
established are being maintained in accordance with GAAP, and except
where failure to comply could not reasonably be expected to have a
Material Adverse Effect; and
(f) conduct its business so as not to become subject to any
liability under any Environmental Law that, individually or in the
aggregate, could reasonably be expected to have a Material Adverse
Effect and except where any such liability is being contested in good
faith by appropriate proceedings and adequate reserves have been
established and are being maintained in accordance with GAAP.
5.3 The Company will conduct, and cause each of its subsidiaries to
conduct, all transactions otherwise permitted by this Note with any of their
Affiliates on terms that are fair and reasonable and no less favorable to the
Company or any such subsidiary than it could obtain in a comparable arms-length
transaction with a person not an Affiliate; provided, however, that this Section
5.3 shall not be deemed to prohibit any transactions solely between the Company
and its wholly-owned subsidiaries carried out in the ordinary course of
business, subject, however, to any applicable provisions of Section 6, the
transactions contemplated hereby, the provisions of any agreements or
instruments existing as of the date hereof or payments pursuant to the
Acquisition Documents and the Future Acquisition Puts (as those terms are
defined in the Senior Credit Agreement, collectively, the "Acquisition
Obligations" and, individually, an "Acquisition Obligation").
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5.4 The Company shall deliver to the Holder, except during any period in
which the Holder or an Affiliate thereof is serving as a director or executive
officer of the Company:
(a) as soon as available and in any event within thirty (30) days
after the end of each month which is not a fiscal quarter end, a
consolidated balance sheet, statement of income and cash flows
commencing April 1999, of the Company and its subsidiaries, as of the
end of such month and for the period commencing at the end of the
previous month and ending with the end of such month and consolidated
statement of income and a consolidated statement of cash flows of the
Company and its subsidiaries, for the period commencing at the end of
the previous fiscal year of the Company and ending with the end of
such month, setting forth in each case commencing April 2000 in
comparative form the corresponding figures for the corresponding
period of the prior fiscal year, all in reasonable detail and duly
certified by the chief financial officer of the Company.
(b) as soon as practicable after the end of each of the first
three quarterly fiscal periods in each fiscal year of the Company, and
in any event within 55 days thereafter: (i) a consolidated balance
sheet as at the end of such quarter; and (ii) consolidated statements
of income and cash flows for such quarter and (in the case of the
second and third quarters) for the portion of the fiscal year ending
with such quarter; for the Company and its subsidiaries, setting forth
in each case, in comparative form, the financial statements for the
corresponding periods in the previous fiscal year, all in reasonable
detail, prepared in accordance with GAAP applicable to quarterly
financial statements generally, and certified as complete and correct
by the Chief Financial Officer of the Company, and accompanied by the
certificate required by Section 5.5; provided, that timely delivery of
copies of the Company's Quarterly Report on Form 10-QSB filed with the
Securities and Exchange Commission ("SEC") shall be deemed to satisfy
the requirements of this Section 5.4(b) so long as such Quarterly
Report contains or is accompanied by the information specified in this
Section 5.4(b);
(c) as soon as practicable after the end of each fiscal year of
the Company, and in any event within 110 days thereafter: (i) a
consolidated balance sheet as at the end of such year; and (ii)
consolidated statements of income, stockholders' equity and cash flows
for such year; for the Company and its subsidiaries, setting forth, in
comparative form, the financial statement for the previous fiscal
year, all in reasonable detail, prepared in accordance with GAAP, and
accompanied by: (A) an audit report thereon of independent certified
public accountants of recognized national standing, which report shall
state without qualifications related to the scope of the audit, the
compliance of the audit with generally accepted auditing standards or
the ability of the Company or a material subsidiary thereof to
continue as a going concern, that such financial statements have been
prepared and are in conformity with GAAP; and (B) the certificates
required by Section 5.5 and Section 5.6; provided, that timely
delivery of the Company's Annual Report on Form 10-KSB for such fiscal
year filed with the SEC shall be deemed to satisfy the requirements of
this Section 5.4(c) so long as such Annual Report contains or is
accompanied by the reports and other information otherwise specified
in this Section 5.4(c);
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(d) promptly upon their becoming available, and in any event
within 15 days thereafter: (i) each financial statement, report,
notice or proxy statement sent by the Company to stockholders
generally; (ii) each regular or periodic report (including, without
limitation, each Form 10-KSB, Form 10-QSB and Form 8-K), any
registration statement which shall have become effective with respect
to a public offering of securities of the Company for its own account,
and all amendments thereto filed by the Company or any subsidiary
thereof with the SEC;
(e) within 15 business days after any executive officer of the
Company becoming aware (i) of the existence of any condition or event
which constitutes a Default or an Event of Default; or (ii) that the
holder of any Debt in a principal amount of $400,000 or more (other
than this Note) shall have given notice or taken any other action with
respect to a claimed or default or event of default; a notice
specifying the nature of the claimed Default, Event of Default or
default or event of default and the notice given or action taken (if
any) by such holder of Debt (other than this Note) and what action the
Company is taking or proposes to take with respect thereto;
(f) promptly upon receipt thereof, a copy of each report or
management letter submitted to the Company or any subsidiary thereof
by independent accountants in connection with any annual, interim or
special audit made of the books of the Company or such subsidiary;
(g) promptly after the commencement of any action or proceeding
relating to the Company or any subsidiary thereof in any court or
before any court, other governmental authority or arbitration tribunal
as to which there is a reasonable possibility of an adverse
determination and that, if adversely determined, would have a Material
Adverse Effect, a notice specifying the nature and period of existence
thereof and what action the Company or such subsidiary is taking or
proposes to take with respect thereto; and
(h) with reasonable promptness, such other data and information
as from time to time may be reasonably requested by the Holder.
5.5 Each set of financial statements delivered to the Holder pursuant to
Section 5.4(a), Section 5.4(b), or Section 5.4(c) shall be accompanied by a
certificate of the Chief Financial Officer, setting forth a statement that the
signer has reviewed the relevant terms hereof and has made, or caused to be
made, under his supervision or authority, a review of the transactions and
conditions of the Company and its subsidiaries from the beginning of the
accounting period covered by the income statements being delivered therewith to
the date of the certificate and that such review shall not have disclosed the
existence during such period of any condition or event that constitutes a
Default or an Event of Default or, if any such condition or event existed or
exists, specifying the nature and period of existence thereof and what action
the Company shall have taken or proposes to take with respect thereto.
5.6 Each set of annual financial statements delivered pursuant to Section
5.4(c) shall be accompanied by a certificate of the accountants that audited
such financial statements, stating that they have reviewed this Note and stating
further, whether, in making their audit, such accountants have become aware of
any condition or event that then constitutes a Default or an Event of Default,
and, if such accountants are aware that any such condition or event then exists,
specifying the nature and period of existence thereof.
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5.7 The Company will, except during any period in which the Holder or any
Affiliate thereof is serving as a director or executive officer of the Company,
permit the representatives of the Holder to visit and inspect any of the
properties of the Company or any of its Subsidiaries, to examine all their
respective books of account, records, reports and other papers, to make copies
and extracts therefrom, and to discuss their respective affairs, finances and
accounts with their respective executive officers and independent public
accountants (and by this provision the Company authorizes said accountants to
discuss the finances and affairs of the Company and its Subsidiaries) all at
such reasonable times and as often as may be reasonably requested. At all times
during which there exists a Default or Event of Default, except during any
period in which the Holder or any Affiliate thereof is serving as a director or
executive officer of the Company, expenses incurred by the Holder of this Note
in connection with this Section 5.7 shall be reimbursed by the Company to the
Holder.
5.8 The Company will make all payments and otherwise perform, or cause the
relevant subsidiary of the Company to pay or otherwise perform, all obligations
in respect of all leases of real property to which the Company or any of its
subsidiaries is a party, keep such leases in full force and effect and not allow
such leases to lapse or be terminated or any rights to renew such leases to be
forfeited or canceled, notify the Holder of any default by any party with
respect to such leases (except during any period in which the Holder or any
Affiliate thereof is serving as a director or executive officer of the Company)
and cooperate with the Holder in all respects to cure any such default, and
cause each of its subsidiaries to do so except, in any case, where the failure
to do so, either individually or in the aggregate, could not reasonably be
expected to have a Material Adverse Effect and except where its failure to do so
is being contested in good faith and by proper proceedings.
5.9 The Company will perform and observe, and cause each of its
subsidiaries to perform and observe, all of the material terms and provisions of
each Material Contract (as that term is defined in the Senior Credit Agreement)
to which it is a party to be performed or observed by it, maintain, and cause
each of its subsidiaries to maintain, each such Material Contract to which it is
a party in full force and effect, and enforce, and cause each of its
subsidiaries to enforce, each such Material Contract to which it is a party in
accordance with its terms, except where the failure to do so would not be
reasonably likely to have a Material Adverse Effect and except where its failure
to do so is being contested in good faith and by proper proceedings.
5.10 The Company will perform and observe, or cause the relevant subsidiary
of the Company to perform and observe, all of the material terms and provisions
of each Acquisition Obligation to be performed or observed by it or such
subsidiary, maintain each such Acquisition Obligation in full force and effect,
enforce each such Acquisition Obligation in accordance with its terms, take all
such action to such end as may be from time to time requested by the Holder
required in order to enforce its material rights under the Acquisition
Obligations and, upon request of the Holder, make to each other party to each
such Acquisition Obligation such demands and requests for action or for
information and reports as the Company or any subsidiary of the Company is
entitled to make under such Acquisition Obligation required in order to enforce
its material rights under the Acquisition Obligations.
5.11 The Company shall promptly, and in any case within 30 days after the
date hereof, cause each of its existing direct and indirect wholly-owned
subsidiaries and any such subsidiaries of the Company hereafter formed and/or
acquired by the Company (or any subsidiary of the Company) to issue to the
Holder a guaranty of the Company's obligations under this Note, which guaranties
shall be substantially similar to the Subsidiary Guaranties issued pursuant to
the Senior Credit Agreement, except that such guaranties will be subordinated to
the obligations of such subsidiaries under the Subsidiary Guaranties issued or
to be issued by such subsidiaries under the Senior Credit Agreement consistent
with the subordination provisions set forth in Section 3 of this Note, will
guaranty the obligations of the Company under this Note and will otherwise be in
form and substance reasonably satisfactory to the Holder and the Senior Agent.
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6. Negative Covenants
6.1 The Company will not, and will not permit any subsidiary thereof to,
(a) merge with or into or consolidate with any other person, permit any other
person to merge or consolidate with or into it, or (b) sell all or substantially
all of its property to any other person; provided, however, that the foregoing
restriction does not apply to the merger or consolidation of the Company with
another corporation or transfer of all or substantially all of the property of
the Company to any other person if: (i) the corporation that results from such
merger or consolidation or to which all or substantially all of the property of
the Company is transferred (the "Surviving Corporation") (a) is organized under
the laws of, and conducts substantially all of its business and has
substantially all of its properties within, the United States of America or any
jurisdiction or jurisdictions thereof and (b) has shareholders' equity
immediately after such transaction that is equal to or greater than the
shareholders' equity of the Company immediately prior to such transaction; (ii)
the due and punctual payment of the principal of, and interest on this Note,
according to their tenor, and the due and punctual performance and observance of
all the covenants in this Note, to be performed or observed by the Company, are
expressly assumed pursuant to such assumption agreements and instruments in such
forms as shall be approved reasonably by the Holder, or assumed by operation of
law, by the Surviving Corporation; and (iii) immediately prior to, and
immediately after the consummation of the transaction, and after giving effect
thereto, no Default or Event of Default exists or would exist. Notwithstanding
the foregoing, a subsidiary of the Company may merge into the Company so long as
the Company is the Surviving Corporation, and a subsidiary of the Company, may
merge with or into a wholly-owned subsidiary of the Company, so long as such
wholly-owned subsidiary is the Surviving Corporation. Notwithstanding anything
contained herein to the contrary, the Company may (i) sell all or substantially
all of its property to, or enter into a merger transaction with, any other
person if such sale or merger follows and is the result of an acceleration of
the Senior Debt and the transaction has been approved by the Senior Agent and
the banks which are parties to the Senior Credit Agreement and (ii) in
compliance with Section 6.19 of the Senior Credit Agreement, transfer its assets
to a wholly-owned subsidiary so long as such subsidiary executes and delivers a
guaranty in favor of the Holder that is reasonably acceptable to the Holder,
subordinated on terms and conditions acceptable to the Senior Agent consistent
with the terms of subordination set forth in Section 3 hereof.
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6.2 The Company will not, and will not permit any subsidiary of the Company
to, sell, lease as lessor, transfer or otherwise dispose of its property
(collectively, "Transfers"), except:
(A) Transfers of inventory and of unnecessary, obsolete or
worn-out assets, in each case in the ordinary course of business of
the Company or such subsidiary;
(B) Transfers from a subsidiary of the Company to the Company or
a wholly-owned subsidiary of the Company, or from the Company to a
wholly-owned subsidiary of the Company provided such subsidiary issues
a guaranty of the Company's obligations under this Note consistent
with the provisions of Section 5.11;
(C) any other Transfer at any time of any property to a person
for such consideration as determined, in each case by the Board of
Directors, in its good faith opinion, to be in the best interest of
the Company and to reflect the fair market value of such property if
the conditions specified in each of the following clauses (A) and (B)
would be satisfied with respect to such Transfer: (A) the sum of: (1)
the book value of such property at the time of Transfer; plus (2) the
aggregate book value of all other property Transferred (other than in
transactions described in clauses (A) and (B) above), after the Issue
Date, would not exceed 25% of consolidated total assets of the Company
and its subsidiaries (determined in accordance with GAAP) measured as
of the last day of the immediately preceding fiscal quarter of the
Company; and (B) immediately before and after the consummation of the
Transfer, and after giving effect thereto, no Default or Event of
Default would exist;
(D) any other Transfer of property to the extent that the
proceeds of such Transfer, net of transaction costs and expenses
incurred and actually paid in connection with such Transfer (including
sales, transfer or gains taxes), within 365 days after such Transfer
are applied by the Company or such subsidiary (A) to fund its working
capital and capital expenditure or acquisitions requirements, and/or
(B) to pay or prepay a principal amount of Debt of the Company or any
subsidiary thereof (other than Junior Subordinated Debt) equal to the
amount of such net proceeds; and, in connection with any such payment,
the Company shall pay all accrued interest thereon and any premium or
make-whole amount required to be paid in connection therewith;
provided, however, that in the event that any Debt so prepaid is not
Senior Debt, then the Company shall prepay, together with such
prepayment of such other Debt, a proportional and ratable principal
amount of this Note pursuant to Section 1.6.;
(E) any Transfers pursuant to the Acquisition Obligations; and
(F) any other Transfer permitted to be made by the Company or any
of its subsidiaries consistent with the terms of the Senior Credit
Agreement as in effect on the Issue Date.
6.3 The Company will not, and will not permit any subsidiary to, directly
or indirectly, create, incur, assume, guarantee, or otherwise become directly or
indirectly liable with respect to, any Debt, other than:
(A) this Note and any guaranties thereof;
(B) Debt owing by the Company to any wholly-owned subsidiary of
the Company and Debt of a subsidiary of the Company owing to the
Company or a wholly-owned subsidiary of the Company;
(C) Debt existing on the Issue Date and listed on Schedule 6.3
(including Debt under the Senior Credit Agreement, provided that loans
thereunder shall not exceed an aggregate of $34 million plus an
additional $6 million to be used solely for working capital and
general corporate purposes of the Company, including, but not limited
to, acquisitions);
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(D) Debt incurred under the Senior Credit Facility from time to
time following the Issue Date, provided that loans thereunder shall
not exceed an aggregate of $34 million plus an additional $6 million
to be used solely for working capital and general corporate purposes
of the Company, including, but not limited to, acquisitions;
(E) Debt incurred or created to refinance any of the Debt
permitted by clauses (C) and (D) of this Section 6.3, provided that in
the case of Debt listed on Schedule 6.3 (other than Senior Debt and
refinancing thereof), the principal amount does not exceed the
principal amount of Debt being refinanced;
(F) Debt (other than Debt incurred under the Senior Credit
Facility) incurred or assumed in connection with "Permitted
Acquisitions" and "Permitted Club Acquisitions" (as those terms are
defined in the Senior Credit Agreement);
(G) Debt incurred in connection with conversion of the
obligations of the Company or any subsidiary thereof under the
Acquisition Puts (as defined in the Senior Credit Agreement) pursuant
to the terms of the Acquisition Documents (as defined in the Senior
Credit Agreement) or the conversion of obligations under Future
Acquisition Puts (as defined in the Senior Credit Agreement) into Debt
of the Company or its subsidiaries under the terms of the agreements
governing such Future Acquisition Puts;
(H) Debt (other than this Note) owing by the Company or a
subsidiary thereof to Norton Herrick, Michael Herrick and/or Howard
Herrick (together, the "Herricks") and/or any of their respective
Affiliates;
(I) Debt incurred by the Company or a subsidiary thereof to
finance the payment of the Change in Control Purchase Price of this
Note;
(J) Debt, in addition to the Debt permitted to be incurred by the
clauses (A) through (I) of this Section 6.3, in the principal amount
at any time outstanding not to exceed $1,000,000;
(K) Any Guaranties made or issued by the Company of Debt
permitted to be incurred by any of its subsidiaries pursuant to
clauses (E), (F), (G), (H), (I), (J) and (L) above and Guaranties made
or issued by subsidiaries of the Company of Debt permitted to be
incurred by the Company pursuant to clauses (C), (D), (E), (F), (G),
(H), (I), (J) and (L) above; and
(L) Any other Debt permitted to be incurred by the Company or any
of its subsidiaries consistent with the terms of the Senior Credit
Agreement as in effect on the Issue Date.
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6.4 The Company will not, and will not permit any subsidiary thereof to,
incur, assume or Guaranty any Debt which is subordinated in right of payment to
any other Debt of the Company or any subsidiary thereof, unless such Debt is
also subordinated in right of payment to the obligations of the Company in
respect of this Note on terms reasonably acceptable to the Holder. The Company
will not, and will not permit any subsidiary thereof to, incur or create any
Debt in favor of an Affiliate or another subsidiary (other than Debt in favor of
the Company or a wholly-owned subsidiary thereof which is a guarantor of Debt
under the Senior Credit Facility) unless such Debt is also subordinated in right
of payment to the obligations of the Company in respect of this Note on terms
reasonably acceptable to the Holders.
6.5 The Company will not, and will not permit any subsidiary thereof to,
engage in any business if, as a result, the general nature of the business in
which the Company and its subsidiaries, taken as a whole, would then be engaged
would be substantially changed from the general nature of the business in which
the Company and the Subsidiaries, taken as a whole, are engaged on the Issue
Date.
7. Events of Default
7.1 An "Event of Default" exists at any time if any of the following occurs
(whether such occurrence shall be voluntary or come about or be effected by
operation of law or otherwise):
(a) The Company defaults in the payment of the principal of this Note
when due (whether at the Maturity Date or any Prepayment Date) or in the
payment of the Change in Control Purchase Price when due or defaults in the
payment of any accrued interest on this Note when due and such default
continues for a period of 30 business days after the date such interest
became due;
(b) The Company or any subsidiary thereof defaults in the performance
or observance of any of the covenants contained in Section 5.2(d) or
Section 6 hereof or defaults in the performance or observance of any of the
covenants contained in Sections 5.2(e), 5.3, 5.4 (e) or 5.10 hereof and
such default remains uncured for more than 30 days;
(c) The Company or any subsidiary thereof defaults in the performance
of any covenants contained in this Note, and such default remains uncured,
after notice and an opportunity to cure, for more than 60 days;
(d) Any warranty, representation or other statement by or on behalf of
the Company contained in this Note or in any certificate, financial
statement, report or notice furnished after the date hereof to Holder
pursuant to the terms of this Note, or in any written amendment,
supplement, modification or waiver with respect to any such document shall
be false or misleading in any material respect when made;
(e) Either (i) the Company or any subsidiary thereof fails to pay when
due and within any applicable period of grace, any principal of, premium,
if any, or interest in respect of any Debt for borrowed money of the
Company or such subsidiary in the aggregate principal amount of $2 million;
or (ii) any event shall occur or any condition shall exist in respect of
such Debt, or under any agreement securing or relating to such Debt, and in
either case, as a result thereof: (A) the maturity of such Debt, or a
material portion thereof, is accelerated, or (B) any one or more of the
holders thereof or a trustee therefor is permitted to require the Company
or such subsidiary to repurchase such Debt from the holders thereof, and
any such trustee or holder exercises such option; or (C) any such one or
more of such holders or such trustee declares an acceleration of the
maturity of such Debt;
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(f) a receiver, liquidator, custodian or trustee of the Company or any
subsidiary thereof or of all or any substantial part of the property of
either is appointed by court order and such order remains in effect for
more than 60 days; or an order for relief is entered with respect to the
Company or any such subsidiary, or the Company or any subsidiary thereof is
adjudicated a bankrupt or insolvent; or all or any substantial part of the
property of the Company or any subsidiary thereof is sequestered by court
order and such order remains in effect for more than 60 days; or an
involuntary case or proceeding is commenced against the Company or any
subsidiary thereof under the Federal Bankruptcy Code or any other
bankruptcy reorganization, arrangement, insolvency, readjustment of debt,
dissolution or liquidation law of any jurisdiction, whether now or
hereafter in effect, and is not dismissed within 60 days after such filing;
(g) The Company or any subsidiary thereof: (i) commences a voluntary
case or proceeding or seeks relief under any provision of the Federal
Bankruptcy Code or any other bankruptcy, reorganization, arrangement,
insolvency, readjustment of debt, dissolution or liquidation law of any
jurisdiction, whether now or hereafter in effect, or consents to the filing
of any petition against it under any such law; or (ii) makes an assignment
for the benefit of creditors, or admits in writing its inability or fails,
to pay its debts generally as they become due, or consents to the
appointment of a receiver, liquidator or trustee of the Company or a
subsidiary thereof or of all or a substantial part of its property; or
(h) A final, non-appealable judgment or final, non-appealable
judgments for the payment of money aggregating in excess of $2.0 million
(in excess of any insurance relating to such judgments or judgments or any
claim or claims underlying such judgment or judgments and the relevant
insurer or insurers shall not have denied liability under such insurance or
rejected any claims made with respect thereto) is or are outstanding
against one or more of the Company and its subsidiaries and any one of such
judgments shall have been outstanding for more than 60 days from the date
of its entry and shall not have been discharged in full or stayed; or
(i) The Note shall cease to be in full force and effect or shall be
declared by a court of competent jurisdiction to be void, voidable or
unenforceable, or the validity or enforceability of the Note shall be
contested by the Company or any Affiliate, or the Company or any Affiliate
shall deny that the Company has any further liability or obligation under
the Note.
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7.2 Default Remedies
(a) If any Event of Default specified in Section 7.1(f) or (g) shall exist,
the principal amount of this Note at the time outstanding, together with
interest accrued and unpaid thereon, shall automatically immediately become due
and payable, without presentment, demand, protest or notice of any kind, all of
which are hereby expressly waived.
(b) Subject to Section 3.6 and Section 3.7, if any Event of Default, other
than those specified in Section 7.1(a), shall exist, the Holder may exercise any
right, power or Remedy permitted to such Holder by law, and shall have in
particular, without limiting the generality of the foregoing, the right to
declare the entire principal of, and all interest accrued and unpaid on, this
Note then outstanding to be, and this Note shall thereupon become, forthwith due
and payable, without any presentment, demand, protest or other notice of any
kind, all of which are hereby expressly waived, and the Company shall forthwith
pay to the Holder such principal and interest.
(c) Subject to Sections 3.6 and 3.7, during the continuance of an Event of
Default described in Section 7.1(a) and irrespective of whether the Note shall
have become due and payable pursuant to Section 7.2(b), the Holder may, at the
Holder's option, by notice in writing to the Company, declare the principal
amount of this Note at the time outstanding, and accrued and unpaid interest
thereon, to be, and the same shall thereupon become, forthwith due and payable,
without any presentment, demand, protest or other notice of any kind, all of
which are hereby expressly waived, and the Company shall forthwith pay to the
Holder such principal and interest.
(d) During the continuance of an Event or Default and irrespective of
whether this Note shall become due and payable pursuant to Section 7.2(a), (b)
or (c) and irrespective of whether the Holder shall otherwise have pursued or be
pursuing any other rights or Remedies, subject to Section 3.6 and Section 3.7,
the Holder may proceed to protect and enforce its rights under this Note by
exercising such Remedies as are available to such holder in respect thereof
under applicable law, either by suit in equity or by action at law, or both,
whether for specific performance of any agreement contained herein or in aid of
the exercise of any power granted herein.
(e) No course of dealing on the part of the Holder nor any delay or failure
on the part of the Holder to exercise any right shall operate as a waiver of
such right or otherwise prejudice the Holder's rights, powers and Remedies. All
rights and Remedies of the Holder hereunder and under applicable law are
cumulative to, and not exclusive of, any other rights or Remedies the Holder
would otherwise have.
(f) The rights of the Holder to receive payments in respect of this Note,
and to exercise any Remedies, solely as between the Holder and the holders of
the Senior Debt, shall be subject in all respects to the provisions of Section
3; provided, however, that all such rights shall remain unconditional and
absolute as between the Holder and the Company.
7.3 If a declaration is made pursuant to Section 7.2(b) arising solely out
of an Event of Default described in Section 7.1(e) regarding the Senior Debt,
then and in every such case, if the holders of the Senior Debt waive such
default in respect of the Senior Debt or such default is cured, and the holders
of the Senior Debt rescind or annul any and all accelerations of the maturity of
all or any portion of the Senior Debt and any required or demanded repurchase of
all or any portion thereof, then, upon written notice to the Holder of such
events with respect to the Senior Debt, any declaration made pursuant to Section
7.2(b) and the consequences thereof, shall automatically and without any further
action on the part of the Holder, be annulled and rescinded; provided, however,
that at the time such declaration is deemed annulled and rescinded: (i) no
judgment or decree shall have been entered for the payment of any moneys due on
or pursuant to this Note; and (ii) no other Default or Event of Default shall be
continuing; provided further that no such rescission and annulment shall extend
to or affect any subsequent Default or Event of Default or impair any right
consequent thereon.
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8. Interpretation of this Note
8.1. As used herein, the following terms have the respective meanings set
forth below or set forth in the Section hereof following such term:
"Affiliate" means and includes with respect to any person, at
any time, each other person (other than, with respect to the Company, a
subsidiary of the Company): (a) that directly or indirectly through one or more
intermediaries controls, or is controlled by, or is under common control with,
such person; (b) that beneficially owns or holds five percent or more of any
class of the Voting Stock of such person; (c) five percent or more of the Voting
Stock (or if such other person is not a corporation, five percent or more of the
equity interest) of which is beneficially owned or held by such person; or (d)
that is an officer or director of or holds a position of comparable authority
with such person; at such time; provided, however, that no person holding this
Note shall be deemed to be an "Affiliate" of the Company solely by virtue of the
ownership of such securities. As used in this definition: "control" means the
possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of a person, whether through the
ownership of voting securities, by contract or otherwise.
"Applicable Interest Law" means any present or future law (including,
without limitation, the laws of the State of New York and the United States of
America) which has application to the interest and other charges pursuant to
this Note.
"Board of Directors" means, at any time, the board of directors of the
Company or any committee thereof that, in the instance, shall have the lawful
power to exercise the power and authority of such board of directors.
"Capital Lease" means, at any time, a lease of any property with respect to
which the lessee is required to recognize the acquisition of an asset and the
incurrence of a liability in accordance with GAAP.
"Cash Equivalents" means, for all purposes of Section 3 hereof, equivalents
of cash that are acceptable to the Senior Agent in its reasonable business
judgment.
"Change in Control" means, at any time, an occurrence or event or failure
of an event to occur, as a result of which a person or group of related persons
(other than the Herricks, an Affiliate of any of the Herricks, or any trust for
the benefit of any of the Herricks) acquires more than 50% of the Voting Stock
of the Company.
"Debt" with respect to any person, means, without duplication, the
liabilities of such person with respect to: (a) borrowed money; (b) the deferred
purchase price of property acquired by such person (excluding accounts payable
and accrued expenses arising in the ordinary course of business, but including
all liabilities created or arising under any conditional sale or other title
retention agreement with respect to any such property); (c) borrowed money
secured by any Lien existing on property owned by such person (whether or not
such liabilities have been assumed); (d) Capital Leases of such person; (e)
letters of credit, bankers acceptances or similar instruments serving a similar
function issued or accepted by banks and other financial institutions for the
account of such person (whether or not representing obligations for borrowed
money), other than undrawn trade letters of credit in the ordinary course of
business; (f) Swaps of such person; and (g) any Guaranty of such person of any
obligation or liability of another person of obligations of the type listed in
clause (a) through clause (f) of this definition of Debt; provided that, with
respect to the Company, Debt shall not include any unfunded obligations which
may now or hereafter exist with respect to Company's Plans. As used in this
definition, "Swaps" means, with respect to any person, obligations with respect
to interest rate swaps and currency swaps and similar obligations obligating
such person to make payments, whether periodically or upon the happening of a
contingency, except that if any agreement relating to such obligation provides
for the netting of amounts payable by and to such person thereunder or if any
such agreement provides for the simultaneous payment of amounts by and to such
person, then in each such case, the amount of such obligations shall be the net
amount thereof. The aggregate net obligation of Swaps at any time shall be the
aggregate amount of the obligations of such person under all Swaps assuming all
such Swaps had been terminated by such person as of the end of the then most
recently ended fiscal quarter of such person. If such net aggregate obligation
shall be an amount owing to such person, then the amount shall be deemed to be
zero. Unless the context otherwise requires, "Debt" means Debt of the Company or
of a subsidiary of the Company.
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"Default" means any event which, with the giving of notice or the passage
of time, or both, would become an Event of Default.
"Environmental Law" means any law, statute or regulation enacted by any
governmental authority in connection with or relating to the protection or
regulation of the environment, including, without limitation, those laws,
statutes and regulations regulating the disposal, removal, production, storing,
refining, handling, transferring, processing or transporting of Hazardous
Materials and any applicable orders, decrees or judgments issued by any court of
competent jurisdiction in connection with any of the foregoing.
"Environmental Permit" means any permit, approval, identification number or
other authorization required by any Environmental Law.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time.
"ERISA Affiliate" means any trade or business (whether or not incorporated)
that is treated as a single employer together with the Company under Section 414
of the IRC.
"GAAP" means accounting principles as promulgated from time to time in
statements, opinions and pronouncements by the American Institute of Certified
Public Accountants and the Financial Accounting Standards Board and in such
statements, opinions and pronouncements of such other entities with respect to
financial accounting of for-profit entities as shall be accepted by a
substantial segment of the accounting profession in the United States.
"Guaranty" means with respect to any person (for the purposes of this
definition, the "Guarantor") any obligation (except the endorsement in the
ordinary course of business of negotiable instruments for deposit or collection)
of such person guaranteeing or in effect guaranteeing any indebtedness, dividend
or other obligation of any other person (the "Primary Obligor") in any manner,
whether directly or indirectly, including, without limitation, obligations
incurred through an agreement, contingent or otherwise, by the Guarantor: (a) to
purchase such indebtedness or obligation or any property constituting security
therefor; (b) to advance or supply funds (i) for the purchase or payment of such
indebtedness, dividend or obligation; or (ii) to maintain working capital or
other balance sheet condition or any income statement condition of the Primary
Obligor or otherwise to advance or make available funds for the purchase or
payment of such indebtedness, dividend or obligation; (c) to lease property or
to purchase securities or other property or services primarily for the purpose
of assuring the owner of such indebtedness or obligation of the ability of the
Primary Obligor to make payment of the indebtedness or obligation; or (d)
otherwise to assure the owner of the indebtedness or obligation of the Primary
Obligor against loss in respect thereof.
"Hazardous Material" means all or any of the following: (a) substances that
are defined or listed in, or otherwise classified pursuant to, any applicable
Environmental Laws as "hazardous substances", "hazardous materials", "hazardous
wastes", "toxic substances" or any other formulation intended to define, list or
classify substances by reason of deleterious properties such as ignitability,
corrosivity, reactivity, carcinogenicity, reproductive toxicity, "TLCP toxicity"
or "EP toxicity"; (b) oil, petroleum or petroleum derived substances, natural
gas, natural gas liquids or synthetic gas and drilling fluids, produced waters
and other wastes associated with the exploration, development or production of
crude oil, natural gas or geothermal resources; (c) any flammable substances or
explosives or any radioactive materials; (d) asbestos or urea formaldehyde in
any form; and (e) dielectric fluid containing levels of polychlorinated
biphenyls in excess of fifty parts per million.
"IRC" means the Internal Revenue Code of 1986, together with all rules and
regulations promulgated pursuant thereto, as amended from time to time.
"Issue Date" means December 31, 1998
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<PAGE>
"Lien" means any interest in property securing an obligation owed to, or a
claim by, a person other than the owner of such property (for purposes of this
definition, the "Owner"), whether such interest is based on the common law,
statute or contract, and includes but is not limited to: (a) the security
interest lien arising from a mortgage, encumbrance, pledge, conditional sale or
trust receipt or a lease, consignment or bailment for security purposes, and the
filing of any financing statement under the Uniform Commercial Code of any
jurisdiction, or an agreement to give any of the foregoing; (b) reservations,
exceptions, encroachments, easements, rights-of-way, covenants, conditions,
restrictions, leases and other title exceptions and encumbrances affecting real
property; and (c) any interest in any property held by the owner evidenced by a
conditional sale agreement, Capital Lease or other arrangement pursuant to which
title to such property has been retained by or vested in some other person for
security purposes. The term "Lien" does not include negative pledge clauses in
loan agreements and equal and ratable security clauses in loan agreements.
"Material Adverse Effect" means, with respect to any event or circumstance
(either individually or in the aggregate with all other events and
circumstances), an effect caused thereby or resulting therefrom that would be
materially adverse as to, or in respect of: (a) the business, operations,
profits, financial condition or properties of the Company and its subsidiaries,
taken as a whole; (b) the ability of the Company to perform its obligations
under this Note; or (c) the validity or enforceability of this Note.
"Note" means and includes each 9% Convertible Senior Subordinated Note due
December 31, 2004 issued by the Company, as the same may be amended, modified,
supplemented, refunded, refinanced or extended from time to time.
"Plan" means an "employee benefit plan" (as defined in section 3(3) of
ERISA) that is or, within the preceding five years, has been established or
maintained, or to which contributions are or, within the preceding five years,
have been made or required to be made, by the Company or any ERISA Affiliate or
with respect to which the Company or any ERISA Affiliate may have any liability.
"Voting Stock" means with respect to any corporation, any shares of stock
of such corporation whose holders are entitled under ordinary circumstances to
vote for the election of directors of such corporation (irrespective of whether
at the time any stock of any other class or classes shall have or might have
voting power by reason of the happening of any contingency), and, in the case of
the Company, shall include the Common Stock. Except as otherwise provided,
references herein to "Voting Stock" shall mean Voting Stock of the Company.
8.2. (a) Unless otherwise provided herein, all financial statements
delivered in connection herewith will be prepared in accordance with GAAP. Where
the character or amount of any asset or liability or item of income or expense,
or any consolidation or other accounting computation is required to be made for
any purpose hereunder, it shall be done in accordance with GAAP; provided,
however, that if any term defined herein includes or excludes amounts, items or
concepts that would not be included in or excluded from such term if such term
were defined with reference solely to GAAP, such term will be deemed to include
or exclude such amounts, items or concepts as set forth herein.
(b) Whenever accounting amounts of a group of persons are to be determined
"on a consolidated basis" it shall mean that, as to balance sheet amounts to be
determined as of a specific time, the amount that would appear on a consolidated
balance sheet of such persons prepared as of such time, and as to income
statement amounts to be determined for a specific period, the amount that would
appear on a consolidated income statement of such persons prepared in respect of
such period, in each case with all transactions among such persons eliminated,
and prepared in accordance with GAAP except as otherwise required hereby.
8.3. Where any provision herein refers to action to be taken by any person,
or which such person is prohibited from taking, such provision shall be
applicable whether such action is taken directly or indirectly by such person,
including actions taken by or on behalf of any partnership in which such person
is a general partner.
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<PAGE>
8.4. (a) The titles of the Sections of this Note appear as a matter of
convenience only, do not constitute a part hereof and shall not affect the
construction hereof. The words "herein," "hereof," "hereunder" and "hereto"
refer to this Note as a whole and not to any particular Section or other
subdivision. References to Annexes and Sections are, unless otherwise specified,
references to Sections of this Note. References to Annexes and Schedules are,
unless otherwise specified, references to Schedules attached to this Note.
(b) Each covenant contained herein shall be construed (absent an express
contrary provision herein) as being independent of each other covenant contained
herein, and compliance with any one covenant shall not (absent such an express
contrary provision) be deemed to excuse compliance with one or more other
covenants.
8.5. THIS NOTE SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN
ACCORDANCE WITH, THE LAWS OF THE STATE OF FLORIDA, WITHOUT REGARD TO ANY CHOICE
OF LAW RULES WHICH WOULD REQUIRE THE APPLICATION OF THE LAW OF ANY OTHER
JURISDICTION. IN ADDITION, THE PARTIES HERETO SELECT, TO THE EXTENT THEY MAY
LAWFULLY DO SO, THE INTERNAL LAWS OF THE STATE OF FLORIDA AS THE APPLICABLE
INTEREST LAW.
9. Miscellaneous
9.1. All communications under this Note shall be in writing and shall be
delivered either by nationwide overnight courier or by facsimile transmission
(confirmed by delivery by nationwide overnight courier sent on the day of the
sending of such facsimile transmission). Communications to the Company shall be
addressed as set forth on Annex 1, or at such other address of which the Company
shall have notified the Holder. Communications to the Holder shall be addressed
as set forth on Annex 1, or at such other address of which such Holder shall
have notified the Company (and the Company shall record such address in the
register for the registration and transfer of this Note). Any communication
addressed and delivered as herein provided shall be deemed to be received when
actually delivered to the address of the addressee (whether or not delivery is
accepted) or received by the telecopy machine of the recipient. Any
communication not so addressed and delivered shall be ineffective.
Notwithstanding the foregoing provisions of this Section 9.1, service of process
in any suit, action or proceeding arising out of or relating to this Note or any
transaction contemplated hereby, or any action or proceeding to execute or
otherwise enforce any judgment in respect of any breach hereunder or under any
document hereby, shall be delivered in the manner provided in Section 9.6(c).
9.2. All warranties, representations, statements of fact, certifications
and covenants contained in this Note or in any certificate, financial statement,
report or notice delivered or provided hereunder shall be considered to have
been relied upon by the other party hereto and shall survive the delivery to
such party regardless of any investigation made by or on behalf of any party
hereto. All statements in any certificate, delivered pursuant to the terms
hereof shall constitute warranties and representations hereunder. All
obligations hereunder (other than payment of this Note, but including, without
limitation, reimbursement obligations in respect of costs, expenses and fees)
shall survive the payment of this Note and the termination hereof. Subject to
the preceding, this Note embodies the entire agreement and understanding between
the Company and the Holder, and supersedes all prior agreements and
understandings, relating to the subject matter hereof.
9.3. The provisions hereof are intended to be for the benefit of the
Holder, from time to time, of this Note, and shall be enforceable by any such
Holder whether or not an express assignment to such Holder of rights hereunder
shall have been made by the payee or his successors or assigns. In the event
that the payee named herein transfers or assigns less than all of this Note, the
term "Holder" as used herein shall be deemed to refer to the assignor and
assignee or assignees hereof, collectively, and any action permitted to be taken
by the Holder hereunder shall be taken only upon the consent or approval of
persons comprising the Holder that own that percentage interest in the principal
amount of this Note as shall be designated by the payee named herein at the time
of such assignment. Anything contained in this Section 9.3 notwithstanding, the
Company may not assign any of its respective rights, duties or obligations
hereunder other without the prior written consent of the Holder. For purposes of
the avoidance of doubt, the Holder of this Note shall be permitted to pledge or
otherwise grant a lien in and to this Note; provided, however, that any such
pledgee or holder of a Lien shall not be considered a Holder hereunder until it
shall have foreclosed upon this Note in accordance with applicable law and
informed the Company, in writing, of the same.
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<PAGE>
9.4. (a) This Note may be amended, and the observance of any term hereof
may be waived, with (and only with) the written consent of the Company and the
Holder, provided, however, that without the written consent of the holders of
Senior Debt, no amendment, supplement or modification of the provisions of
Section 3, or any defined term to the extent used therein, shall be effective as
to any holder of Senior Debt who has not consented to such amendment, supplement
or modification.
Any amendment or waiver consented to as provided in this Section 9.4 shall
be binding upon the then current Holder and upon each future holder of this Note
and upon the Company whether or not this Note shall have been marked to indicate
such amendment or waiver. No such amendment or waiver shall extend to or affect
any obligation, covenant, agreement, Default or Event of Default not expressly
amended or waived or impair any right consequent thereon.
9.5. (a) The Company shall pay when billed the reasonable costs and
expenses (including reasonable attorneys' fees) incurred by the Holder in
connection with the consideration, negotiation, preparation or execution of any
amendments, waivers, consents, standstill agreements and other similar
agreements with respect to this Note (whether or not any such amendments,
waivers, consents, standstill agreements or other similar agreements are
executed).
(b) At any time when the Company and the Holder are conducting
restructuring or workout negotiations in respect hereof, or a Default or Event
of Default exists, the Company shall pay when billed the reasonable costs and
expenses (including reasonable attorneys' fees and the fees of professional
advisors) incurred by the Holder in connection with the assessment, analysis or
enforcement of any rights or remedies that are or may be available to the
Holder.
(c) If the Company shall fail to pay when due any principal of, or interest
on, this Note, the Company shall pay to the Holder, to the extent permitted by
law, such amounts as shall be sufficient to cover the costs and expenses,
including but not limited to reasonable attorneys' fees, incurred by the Holder
in collecting any sums due on this Note.
9.6. (a) THE PARTIES HERETO VOLUNTARILY AND INTENTIONALLY WAIVE ANY RIGHT
ANY OF THEM MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION ARISING OUT
OF, UNDER OR IN CONNECTION WITH THIS NOTE OR TRANSACTIONS CONTEMPLATED HEREBY.
(b) ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS NOTE
OR TRANSACTIONS CONTEMPLATED HEREBY OR ANY ACTION OR PROCEEDING TO EXECUTE OR
OTHERWISE ENFORCE ANY JUDGMENT IN RESPECT OF ANY BREACH UNDER THIS NOTE MAY BE
BROUGHT BY SUCH PARTY IN ANY FEDERAL DISTRICT COURT LOCATED IN NEW YORK COUNTY,
NEW YORK, OR ANY NEW YORK STATE COURT LOCATED IN NEW YORK COUNTY, NEW YORK AS
SUCH PARTY MAY IN ITS SOLE DISCRETION ELECT, AND BY THE EXECUTION AND DELIVERY
OF THIS NOTE, THE PARTIES HERETO IRREVOCABLY AND UNCONDITIONALLY SUBMIT TO THE
NON-EXCLUSIVE IN PERSONAM JURISDICTION OF EACH SUCH COURT, AND EACH OF THE
PARTIES HERETO IRREVOCABLY WAIVES AND AGREES NOT TO ASSERT IN ANY PROCEEDING
BEFORE ANY TRIBUNAL, BY WAY OF MOTION, AS A DEFENSE OR OTHERWISE, ANY CLAIM THAT
IT IS NOT SUBJECT TO THE IN PERSONAM JURISDICTION OF ANY SUCH COURT. IN
ADDITION, EACH OF THE PARTIES HERETO IRREVOCABLY WAIVES, TO THE FULLEST EXTENT
PERMITTED BY LAW, ANY OBJECTION THAT IT MAY NOW OR HEREAFTER HAVE TO THE LAYING
OF VENUE IN ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS
NOTE OR TRANSACTION CONTEMPLATED HEREBY BROUGHT IN ANY SUCH COURT, AND HEREBY
IRREVOCABLY WAIVES ANY CLAIM THAT ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN
ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM.
(c) EACH PARTY HERETO IRREVOCABLY AGREES THAT PROCESS PERSONALLY SERVED OR
SERVED BY U.S. EXPRESS, REGISTERED OR CERTIFIED MAIL OR BY NATIONWIDE OVERNIGHT
COMMERCIAL COURIER OR DELIVERY SERVICE AT THE ADDRESSES PROVIDED HEREIN FOR
NOTICES SHALL CONSTITUTE, TO THE EXTENT PERMITTED BY LAW, ADEQUATE SERVICE OF
PROCESS IN ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS
NOTE OR TRANSACTION CONTEMPLATED HEREBY, OR ANY ACTION OR PROCEEDING TO EXECUTE
OR OTHERWISE ENFORCE ANY JUDGMENT IN RESPECT OF ANY BREACH HEREUNDER. RECEIPT OF
PROCESS SO SERVED SHALL BE CONCLUSIVELY PRESUMED AS EVIDENCED BY A DELIVERY
RECEIPT FURNISHED BY THE UNITED STATES POSTAL SERVICE OR ANY COMMERCIAL DELIVERY
SERVICE.
(d) NOTHING HEREIN SHALL IN ANY WAY BE DEEMED TO LIMIT THE ABILITY OF ANY
HOLDER OF THIS NOTE TO SERVE ANY WRITS, PROCESS OR SUMMONSES IN ANY MANNER
PERMITTED BY APPLICABLE LAW OR TO OBTAIN JURISDICTION OVER THE COMPANY IN SUCH
OTHER JURISDICTION, AND IN SUCH OTHER MANNER, AS MAY BE PERMITTED BY APPLICABLE
LAW.
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<PAGE>
IN WITNESS WHEREOF, the Company has caused this Promissory Note to be
duly executed and delivered by one of its duly authorized officers or
representatives.
AUDIO BOOK CLUB, INC.
By: /s/ John Levy
-----------------------------------------
Name: John Levy
Title: Executive Vice President and
Chief Financial Officer
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<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the inclusion in this Registration Statement of MediaBay, Inc.
(previously Audio Book Club, Inc.) on Form SB-2, expected to be filed on or
about October 26, 1999, of our report on the financial statements of Audio Book
Club, Inc. dated March 22, 1999, appearing in the Annual Report on Form 10-KSB
of Audio Book Club, Inc. for the year ended December 31, 1998 and of the
inclusion of our report on the financial statements of The Columbia House
Audiobook Club, a division of The Columbia House Company, dated March 18, 1999
for the year ended December 31, 1998 and to the reference to us under the
heading "Experts" in the Prospectus, which is part of this Registration
Statement.
/S/ DELOITTE & TOUCHE LLP
Parsippany, New Jersey
January 28, 2000
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
MediaBay, Inc. (formerly Audio Book Club, Inc.):
We consent to the use of our report dated March 13, 1998, related to the
financial statements of MediaBay, Inc., formerly known as Audio Book Club, Inc.,
as of December 31, 1997 and for the year then ended, included herein and to the
reference to our firm under the heading "Experts" in the registration statement.
/s/ KPMG LLP
- -------------------
KPMG LLP
New York, New York
January 28, 2000
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
The Board of Directors
Doubleday Direct, Inc.:
We consent to the use in the registration statement on Form SB-2 of MediaBay,
Inc. (formerly Audio Book Club, Inc.) of our report dated March 12, 1999, with
respect to the balance sheets of Audio Books Direct, a wholly-owned operation of
Doubleday Direct, Inc. (the "Club"), as of June 30, 1998 and 1997, and the
related statements of operations, divisional deficit, and cash flows for the
years then ended. Our report includes an explanatory paragraph stating that the
Club was operated as an integral part of Doubleday Direct, Inc. and had no
separate legal existence. We also consent to the reference to our firm under the
heading "Experts" in the registration statement and related prospectus.
KPMG LLP
New York, New York
January 28, 2000
<PAGE>
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
MediaBay, Inc. (formerly Audio Book Club, Inc.)
Boca Raton, Florida
We hereby consent to the inclusion in this Registration Statement on Form SB-2
of MediaBay, Inc. (formerly Audio Book Club, Inc.) of our report dated November
20, 1998 relating to the financial statements of Radio Spirits, Inc. as of
December 31, 1997 and for the year then ended and to the reference to us under
the heading "Experts" in the Prospectus, which is part of this Registration
Statement.
/s/ BD&A Certified Public Accountants, Ltd.
- ------------------------------------------
BD&A Certified Public Accountants, Ltd.
Elmhurst, Illinois
January 28, 2000
<PAGE>
Consent of Independent Accountants
We hereby consent to the use in this Registration Statement on Form SB-2 of our
report dated December 30, 1998 relating to the carve-out financial statements of
The Columbia House Company Audiobook Club, which appears in such Registration
Statement. We also consent to the reference to us under the heading "Experts" in
such Registration Statement.
/s/ PricewaterhouseCoopers LLP
- --------------------------------
PricewaterhouseCoopers LLP
New York, New York
January 28, 2000
