<PAGE>
REGISTRATION NO. 333-
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 11, 1998
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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CDNOW, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
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PENNSYLVANIA 5735 23-2813867
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
INCORPORATION OR
ORGANIZATION)
610 OLD YORK ROAD
SUITE 300
JENKINTOWN, PA 19046
(215) 517-7325
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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JASON OLIM
PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD
610 OLD YORK ROAD
SUITE 300
JENKINTOWN, PA 19046
(215) 517-7325
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF AGENT FOR SERVICE)
COPIES TO:
ALAN SINGER, ESQ. ALAN H. LIEBLICH, ESQ.
MORGAN, LEWIS & BOCKIUS LLP SCHNADER HARRISON SEGAL & LEWIS LLP
2000 ONE LOGAN SQUARE 1600 MARKET STREET
PHILADELPHIA, PA 19103 SUITE 3600
(215) 963-5000 PHILADELPHIA, PA 19103
(215) 751-2000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
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If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED
PROPOSED MAXIMUM
AMOUNT MAXIMUM AGGREGATE AMOUNT OF
TITLE OF EACH CLASS OF TO BE OFFERING PRICE OFFERING REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED PER UNIT(1) PRICE(1) FEE
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<S> <C> <C> <C> <C>
Common Stock, no par
value.................... 2,875,000 26.38 $75,842,500 $22,373.54
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</TABLE>
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(1) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(a) and (c) under the Securities Act of 1933.
--------------
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, AS AMENDED, OR UNTIL THIS
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION,
ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion
May 11, 1998
2,500,000 SHARES
LOGO
CDNOW
COMMON STOCK
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All of the shares of Common Stock offered hereby will be sold by CDnow, Inc.
("CDnow" or the "Company"). The Company's Common Stock is quoted on the Nasdaq
National Market under the symbol "CDNW". On May 8, 1998, the last reported sale
price of the Common Stock, as reported on the Nasdaq National Market, was
$26.375 per share. See "Price Range of Common Stock."
-----------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 7.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO DISCOUNTS AND TO
PUBLIC COMMISSIONS(1) COMPANY(2)
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<S> <C> <C> <C>
Per Share................................. $ $ $
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Total(3).................................. $ $ $
</TABLE>
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(1) See "Underwriting" for information relating to indemnification of the
Underwriters.
(2) Before deducting expenses for this Offering, payable by the Company,
estimated at $500,000.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
375,000 additional shares of Common Stock, solely to cover over-allotments,
if any. To the extent that the option is exercised, the Underwriters will
offer the additional shares at the Price to Public shown above. If the
option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions and Proceeds to Company will be $ ,
$ and $ , respectively. See "Underwriting."
-----------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject
to the right of the Underwriters to reject any order in whole or in part. It is
expected that delivery of the shares of Common Stock will be made at the
offices of BT Alex. Brown Incorporated, Baltimore, Maryland, on or about ,
1998.
BT ALEX.BROWN
NATIONSBANC MONTGOMERY
SECURITIES LLC
HAMBRECHT & QUIST
THE DATE OF THIS PROSPECTUS IS , 1998
<PAGE>
[ARTWORK APPEARS HERE]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE COMMON
STOCK OFFERING AND MAY BID FOR AND PURCHASE SHARES OF THE COMMON STOCK IN THE
OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and financial statements of the
Company and the notes thereto included elsewhere in this Prospectus. Unless
otherwise indicated, all information presented in this Prospectus assumes no
exercise of the over-allotment option granted by the Company to the
Underwriters. Unless the context otherwise requires, each reference to the
"Company" or "CDnow" refers to CDnow, Inc. and its subsidiaries and each
reference to "CDs" refers collectively to compact discs, cassettes and vinyl
records. All share numbers used herein reflect all stock splits that have been
effected prior to the date hereof.
THE COMPANY
CDnow is the leading online retailer of CDs and other music-related products.
Its early entry into the online music retailing industry has helped the Company
gain a well-recognized brand and a large customer base. The Company strives to
combine the advantages of online commerce with superior customer focus in order
to be the authoritative source for CDs and other music-related products. The
Company's online store, cdnow.com, offers broad selection, informative content,
easy-to-use navigation and search capabilities, a high level of customer
service, competitive pricing and personalized merchandising and
recommendations. With over 250,000 items, the Company believes that it provides
a selection of readily-available products that is five to ten times that of a
typical music retailer. To assist customers in making music selections, the
CDnow store contains approximately 115,000 product notes, reviews and related
articles and 300,000 sound samples. The CDnow store is open 24 hours a day,
seven days a week and offers its customers convenient and timely product
fulfillment, including an overnight delivery option.
CDnow has grown rapidly since its inception in 1994. Of the 432,000 customers
who have made purchases from inception through March 31, 1998, 135,000 made
their initial purchases during the three month period ending March 31, 1998.
Average daily visits to the CDnow store have grown from approximately 12,000 in
January 1996 to approximately 165,000 in March 1998. The Company's net sales
grew to $10.0 million in the first quarter of 1998 compared to $7.9 million and
$2.6 million in the fourth and first quarters of 1997, respectively. The
Company has also generated significant customer loyalty. Despite the Company's
rapid acquisition of new customers, repeat customers accounted for
approximately 51% of net sales in the first quarter of 1998.
The Company believes that a significant opportunity exists for the retailing
of music on the Internet. According to the International Federation of the
Phonographic Industry, worldwide sales of pre-recorded music in 1996 were
approximately $39.8 billion, of which one-third was in North America. Online
music retailers currently account for a small but growing portion of total
sales. According to Jupiter Communications, Inc. ("Jupiter"), worldwide sales
of pre-recorded music over the Internet are projected to grow from
approximately $47 million in 1997 to $1.6 billion in 2002.
A number of characteristics of online music retailing make the sale of pre-
recorded music via the Internet particularly attractive relative to traditional
retail stores. The Internet offers many data management and multimedia features
which enable consumers to listen to sound samples, search for music by genre,
title or artist and access a wealth of information and events, including
reviews, related articles, music history, news and recommendations. Internet-
based retailers can also offer consumers significantly broader product
selection, the convenience of home shopping and 24-hour-a-day, seven-day-a-week
operations. In addition, Internet-based retailers can serve international
consumers without significant incremental cost and more effectively target
their direct marketing activities as a result of the extensive customer
demographic and behavioral data that they are able to obtain.
3
<PAGE>
The Company's business strategy is designed to promote the CDnow brand and
expand its leadership position by (i) focusing on recorded music retailing,
(ii) providing an innovative and easy-to-use retail concept, (iii) acquiring
customers on an efficient basis, (iv) maximizing customer retention, (v)
enhancing its international capabilities and (vi) expanding its customer base
through multiple marketing channels. The Company believes that the use of
multiple marketing channels allows it to reduce its reliance on any one source
of customers, maximize brand awareness and lower average customer acquisition
costs. These marketing channels include:
. Online and Traditional Advertising. The Company promotes its brand
through an aggressive marketing campaign using a combination of online
and traditional advertising. The Company advertises on the sites of
major Internet content and service providers, including AltaVista,
Infoseek and Microsoft Network, and targeted music-related sites, such
as Billboard. CDnow's traditional advertising efforts have included
radio advertising in major markets, such as advertising on the Howard
Stern program, and print advertising in music-related publications,
including Spin and Variety. In the first quarter of 1998, the Company
initiated television advertising, including national advertising during
the Grammy Awards and the American Music Awards. The Company intends to
continue television advertising on a selected basis and has purchased
advertising on such programs as The Late Show with David Letterman.
. Strategic Alliances with Major Content and Service Providers. The
Company seeks to enter into strategic alliances with major Internet
content and service providers in order to enhance its new customer
acquisition efforts, increase purchases by current customers and expand
brand recognition. Since February 1998, the Company has broadened its
strategic alliance with Yahoo! to include Yahoo! Mail and Yahoo!'s music
chat space. The Company has also entered into new strategic alliances
with Lycos and Tripod, Lycos Bertelsmann and JAMtv and Straight Arrow
Publishers (the latter two, collectively, "Rolling Stone Network"). In
addition, CDnow has preexisting alliances with GeoCities and Excite's
WebCrawler service. CDnow's alliances generally provide for the Company
to be the premier online recorded music retailer on certain of the sites
of these providers with the exclusive right to place music banner
advertisements and integrated links to the CDnow store on certain music-
related or other specified pages. The alliance with Rolling Stone
Network also entitles CDnow to use the Rolling Stone brand name in
conjunction with the display of cover art and excerpts of feature
stories, record reviews, artist biographies and music news from current
and past editions of Rolling Stone magazine.
. Cosmic Credit Program. Through its Cosmic Credit Program, CDnow has
arrangements with over 19,000 small Web sites, typically fan sites
devoted to particular musical artists. Approximately 9,000 of these
sites have enrolled since December 1997. The Company provides Cosmic
Credit sites with embedded hyperlinks through which potential customers
can immediately be connected to the CDnow store.
. Direct Marketing Techniques. The Company uses direct marketing
techniques to target new and existing customers with communications and
promotions. The Company sends a personalized e-mail newsletter to its
customers that includes purchase recommendations based on demonstrated
customer preferences and prior purchases. The Company also targets e-
mail campaigns to specific customer and prospect segments based upon
their recent activity at the CDnow store.
The business of the Company was commenced as a sole proprietorship in
February 1994. The Company was incorporated in Pennsylvania in April 1995. Its
principal offices are located at 610 Old York Road, Suite 300, Jenkintown,
Pennsylvania, 19046 and its telephone number is (215) 517-7325.
4
<PAGE>
THE OFFERING
Common Stock offered by the Company... 2,500,000 shares
Common Stock to be outstanding after the Offering..
18,506,302 shares(1)
Use of proceeds....................... For sales and marketing expenses,
including payments due under strategic
alliances; improvements to the
Company's Web site and other capital
expenditures; working capital; and
other general corporate purposes.
Nasdaq National Market symbol......... CDNW
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(1) As of April 30, 1998 and excludes (i) 859,262 shares of Common Stock
issuable upon the exercise of options outstanding as of April 30, 1998
under the Company's 1996 Equity Compensation Plan (the "Equity Compensation
Plan") at a weighted average exercise price of $8.03 per share, (ii)
740,738 shares reserved for future grants under the Equity Compensation
Plan and (iii) 367,253 shares of Common Stock issuable upon the exercise of
warrants outstanding as of April 30, 1998 at a weighted average exercise
price of $4.06 per share. See "Management--Equity Compensation Plan" and
"Description of Capital Stock."
This Prospectus contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. These forward looking
statements address, among other things, growth in Internet usage and online
commerce; future music retailing opportunities on the Internet; the Company's
business strategy, including its sales and marketing plans; expectation of
future losses; competitive factors; reliance on online and traditional
advertising and strategic alliances; use of proceeds; reliance on certain
vendors; projected capital expenditures; liquidity; possible business
relationships; possible effects of changes in government regulation; dependence
on key personnel; exposure to Year 2000; increased net sales in future periods;
increased sales to international customers; and pricing policy. These
statements may be found under "Prospectus Summary," "Risk Factors," "Use of
Proceeds," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and "Business" as well as in the Prospectus generally.
Actual events or results may differ materially from those discussed in forward-
looking statements as a result of various factors, including those factors
discussed below under "Risk Factors" and set forth in this Prospectus
generally.
5
<PAGE>
SUMMARY FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 12, THREE MONTHS ENDED
1994) TO YEAR ENDED DECEMBER 31, MARCH 31,
DECEMBER 31, ------------------------------------- -----------------------
1994(1) 1995(1) 1996 1997 1997 1998
------------- ---------- ----------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales....................... $103,116 $2,176,474 $ 6,300,294 $ 17,372,795 $2,581,578 $10,013,889
Cost of sales................... 92,962 1,844,612 5,217,789 14,316,028 2,049,541 8,554,549
-------- ---------- ----------- ------------ ---------- -----------
Gross profit................... 10,154 331,862 1,082,505 3,056,767 532,037 1,459,340
Operating expenses:
Operating and development...... 26,946 149,982 669,280 2,541,434 321,128 1,081,049
Sales and marketing............ 12,945 200,972 621,454 9,139,348 417,302 8,785,724
General and administrative..... 28,712 180,573 563,593 1,953,078 339,303 850,285
Dispute settlement(2).......... -- -- 1,024,030 -- -- --
-------- ---------- ----------- ------------ ---------- -----------
Total operating expenses....... 68,603 531,527 2,878,357 13,633,860 1,077,733 10,717,058
-------- ---------- ----------- ------------ ---------- -----------
Operating loss................. (58,449) (199,665) (1,795,852) (10,577,093) (545,696) (9,257,718)
Interest income (expense), net.. -- (1,248) (14,556) (170,312) 1,390 59,525
-------- ---------- ----------- ------------ ---------- -----------
Net loss(3)..................... $(58,449) $ (200,913) $(1,810,408) $(10,747,405) $ (544,306) $(9,198,193)
======== ========== =========== ============ ========== ===========
Net loss per share(4)........... $ (1.42) $ (0.07) $ (0.78)
============ ========== ===========
Weighted average number of
common shares outstanding(4)... 7,845,684 7,845,684 12,015,090
============ ========== ===========
OPERATING DATA:
Customers(5).................... 1,787 26,953 87,859 296,450 113,362 431,565
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
--------------------------
ACTUAL AS ADJUSTED(6)
BALANCE SHEET DATA: ----------- --------------
<S> <C> <C>
Cash and cash equivalents........................... $60,521,171 $122,496,952
Working capital .................................... 56,141,498 118,117,279
Total assets........................................ 66,227,754 128,203,535
Long-term debt, excluding current portion........... 984,512 984,512
Total shareholders' equity.......................... 57,688,989 119,664,770
</TABLE>
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(1) The business of the Company was established as a sole proprietorship in
February 1994 and commercial operations were commenced in August 1994. The
Company was incorporated in April 1995.
(2) In December 1996, in settlement of a dispute, the Company issued 882,606
shares of Common Stock to certain persons. See "Certain Relationships and
Related Transactions" and Note 7 to Notes to Consolidated Financial
Statements.
(3) Before the accretion of the redemption premium on Preferred Stock in 1997
and the first three months of 1998 of $410,103 and $115,542, respectively.
(4) See Note 2 to Notes to Consolidated Financial Statements for an
explanation of the determination of the number of common shares used in
computing the per share amount.
(5) Cumulative number of customers who have purchased products from the
Company from inception of its business in August 1994 through the end of
period.
(6) Represents actual data as adjusted to give effect to the sale of 2,500,000
shares of Common Stock offered by the Company (at an assumed offering
price of $26.375 per share and after deducting underwriting discounts and
commissions and estimated offering expenses) and the application of the
estimated net proceeds therefrom. See "Capitalization" and "Use of
Proceeds."
6
<PAGE>
RISK FACTORS
The following risk factors, as well as the other information contained in
this Prospectus, should be considered carefully before purchasing the Common
Stock offered hereby.
Limited Operating History; History of Losses and Expectation of Future
Losses. The Company was founded in February 1994 and began selling music-
related products in August 1994. Accordingly, the Company has only a limited
operating history on which to base an evaluation of its business and
prospects. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving
markets such as online commerce. Such risks include, but are not limited to,
possible inability to respond promptly to changes in a rapidly evolving and
unpredictable business environment and the risk of inability to manage growth.
To address these risks, the Company must, among other things, expand its
customer base, successfully implement its business and marketing strategies,
continue to develop and upgrade its Web site and transaction-processing
systems, provide superior customer service, respond to competitive
developments, and attract and retain qualified personnel. If the Company is
not successful in addressing such risks, it will be materially adversely
affected.
Since inception, the Company has incurred significant losses, and as of
March 31, 1998 had accumulated losses of $22.0 million. For the quarter ended
March 31, 1998 and the year ended December 31, 1997, the Company's net loss
was $9.2 million and $10.7 million, respectively. The Company intends to
invest heavily in marketing and promotion, Web site development and
technology, and development of its administrative organization. As a result,
the Company believes that it will incur substantial operating losses for the
foreseeable future, and that the rate at which such losses will be incurred
may increase significantly from current levels. Because the Company has
relatively low product gross margins, achieving profitability given planned
investment levels depends upon the Company's ability to generate and sustain
substantially increased revenue levels. There can be no assurance that the
Company will be able to generate sufficient revenues to achieve or sustain
profitability in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Dependence on Continued Growth of Online Commerce. The Company's long-term
viability is substantially dependent upon the widespread consumer acceptance
and use of the Internet as a medium of commerce. Use of the Internet as a
means of effecting retail transactions is at an early stage of development,
and demand and market acceptance for recently introduced services and products
over the Internet is very uncertain. The Company cannot predict the extent to
which consumers will be willing to shift their purchasing habits from
traditional retailers to online retailers.
The Internet may not become a viable commercial marketplace for a number of
reasons, including potentially inadequate development of the necessary network
infrastructure, delayed development of enabling technologies and inadequate
performance improvements. In addition, the Internet's viability as a
commercial marketplace could be adversely affected by delays in the
development of services or due to increased government regulation. Changes in
or insufficient availability of telecommunications services to support the
Internet also could result in slower response times and adversely affect usage
of the Internet generally and CDnow in particular. Moreover, adverse publicity
and consumer concern about the security of transactions conducted on the
Internet and the privacy of users may also inhibit the growth of commerce on
the Internet. If the use of the Internet does not continue to grow or grows
more slowly than expected, or if the infrastructure for the Internet does not
effectively support growth that may occur, the Company would be materially
adversely affected.
Competition. The online commerce market is new, rapidly evolving and
intensely competitive, and the Company expects that competition will further
intensify in the future. Barriers to entry are minimal, and current and new
competitors can launch new sites at a relatively low cost. According to
Jupiter, there were approximately 100 online music retailers as of June 1997.
In addition, the broader retail music
7
<PAGE>
industry is intensely competitive. The Company currently competes with a
variety of companies, including (i) online vendors of music, music videos and
other related products, (ii) online vendors of movies, books and other related
products, (iii) online service providers which offer music products directly
or cooperation with other retailers, (iv) traditional retailers of music
products, including specialty music retailers, (v) other retailers that offer
music products, including mass merchandisers, superstores and consumer
electronic stores; and (vi) non-store retailers such as music clubs. Many of
these traditional retailers also support dedicated Web sites which compete
directly with the Company.
The Company believes that the principal competitive factors in its online
market are brand recognition, selection, price, effectiveness of advertising,
strategic alliances and other customer acquisition efforts, variety of value-
added services, ease of use, site content, quality of service and technical
expertise. Many of the Company's current and potential competitors have longer
operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than the
Company. The Company is aware that certain of its competitors have adopted and
may continue to adopt aggressive pricing or inventory availability policies
and devote substantially more resources to Web site and systems development
than the Company. Increased competition may result in reduced operating
margins, loss of market share and diminished brand recognition.
There can be no assurance that the Company will be able to compete
successfully against current and future competitors. New technologies and the
expansion of existing technologies may increase the competitive pressures of
the Company. For example, applications that select specific titles from a
variety of Web sites based on factors such as price may channel customers to
online retailers that compete with the Company. In addition, many companies
that allow access to transactions through network access or Web browsers
promote the Company's competitors and could charge the Company a substantial
fee for inclusion.
Increased Reliance Upon Online and Traditional Advertising and Strategic
Alliances. The Company increasingly relies on online and traditional
advertising and strategic alliances to attract users to its Web site. The
Company has recently committed substantial resources to promoting its brand
name through a campaign that includes online, radio and television
advertising. The Company has entered into strategic alliances with Yahoo! Inc.
("Yahoo!"), Excite, Inc. ("Excite"), GeoCities Inc. ("GeoCities"), Lycos, Inc.
and Tripod, Inc. (collectively, "Lycos"), Lycos Bertelsmann GMBH & Co. KG
("Lycos Bertelsmann"), and Rolling Stone Network. The Company's ability to
generate increased revenues largely will depend on increased traffic and
purchases through these alliances. There can be no assurance that the
Company's strategic alliances will generate a substantial number of new
customers or net sales or that the Company's infrastructure will be sufficient
to handle the increased traffic that may result therefrom. Moreover, there can
also be no assurance that the Company will be able to renew successful
advertising programs or maintain its strategic alliances beyond their initial
terms or that additional third-party alliances will be available to the
Company on acceptable commercial terms or at all. The inability to maintain
and further develop its advertising campaign or strategic alliances could have
a material adverse effect on the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" and "Business--Marketing and Promotion--Strategic
Alliances."
Risk of Inability to Manage Potential Growth. The Company has rapidly
expanded its operations. This expansion has placed, and is expected to
continue to place, a significant strain on the Company's management,
operations, systems, and financial resources. From December 31, 1994 to April
30, 1998, the Company has grown from three to 127 employees, and several
members of the Company's senior management have only recently joined the
Company. CDnow's recently hired employees also include a number of key
managerial, technical and operations personnel, and the Company expects to add
additional key personnel in the near future. To manage its recent growth and
any further growth of its operations and personnel, the Company must improve
existing operations and systems and expand and
8
<PAGE>
integrate its employee base. If the Company is unable to manage its growth
effectively, it will be materially adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business--Employees."
Possible Need for Additional Funds. The Company anticipates that the net
proceeds from this Offering, together with other available resources, will be
sufficient to fund the Company's operations for at least the next 12 months.
However, the Company's capital requirements depend on several factors,
including the rate of market acceptance, the ability to expand the Company's
customer base, the level of expenditures for sales and marketing, the cost of
Web site upgrades and other factors. If capital requirements vary materially
from those currently planned, the Company may require additional financing.
There can be no assurance that financing will be available in amounts or on
terms acceptable to the Company. If equity securities are issued in connection
with a financing, dilution to the Company's shareholders may result, and if
additional funds are raised through the incurrence of debt, the Company may
become subject to restrictions on its operations and finances. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation."
Reliance on Certain Vendors. The Company's primary provider of order
fulfillment for recorded music titles is Valley Record Distributors, Inc.
("Valley"). For the quarter ended March 31, 1998 and year ended December 31,
1997, payments to Valley accounted for approximately 82% and 78%, respectively
of the Company's cost of sales. The Company has no fulfillment operation or
facility of its own and, accordingly, is dependent upon maintaining its
existing relationship with Valley or establishing a new fulfillment
relationship with one of the few other fulfillment operations. There can be no
assurance that the Company will maintain its relationship with Valley beyond
the term of its existing two year agreement with Valley, which expires in June
1999, or that it will be able to find an alternative, comparable vendor
capable of providing fulfillment services on terms satisfactory to the Company
should its relationship with Valley terminate. An unanticipated termination of
the Company's relationship with Valley, particularly during the fourth quarter
of the calendar year in which a high percentage of recorded music sales are
made, could materially adversely affect the Company's results of operations
for the quarter in which such termination occurred even if the Company was
able to establish a relationship with an alternative vendor. Valley may
terminate its existing agreement with the Company upon 30 days' written
notice, in the event that Valley decides to discontinue providing fulfillment
services to all of Valley's online service customers. To date, Valley has
satisfied the Company's requirements on a timely basis. However, to the extent
that Valley does not have sufficient capacity and is unable to satisfy on a
timely basis increasing requirements of the Company, the Company would be
materially adversely affected.
As is the case with Valley, the Company generally relies on a single vendor
for order fulfillment with respect to each product line carried by the
Company. Therefore, the loss of any one vendor could materially and adversely
affect the Company's sales of that product line. While the Company seeks to
negotiate multi-year contracts with its vendors to ensure the availability of
merchandise, there can be no assurance that the Company's current vendors will
continue to sell merchandise to the Company on current terms or that the
Company will be able to establish new vendor relationships to ensure
acquisition of merchandise in a timely and efficient manner and on acceptable
commercial terms. If the Company were unable to develop and maintain
relationships with vendors that would allow it to obtain sufficient quantities
of merchandise on acceptable commercial terms, it would be materially
adversely affected. See "Business--Fulfillment."
Risk of System Failure; Absence of Redundant Facilities; Capacity
Constraints. The Company's business is dependent on the efficient and
uninterrupted operation of its computer and communications hardware systems.
The Company's systems and operations are vulnerable to damage or interruption
from fire, flood, power loss, telecommunications failure, break-ins,
earthquake and similar events. Any system interruptions, including any
interruptions in the Company's Internet connections or internal systems
problems, that result in the unavailability of the Company's Web site or
reduced transaction processing performance would reduce the volume of products
sold and the attractiveness of the Company's product
9
<PAGE>
and service offerings and could, therefore, materially adversely affect the
Company. The Company has, from time to time, experienced periodic systems
interruptions, and anticipates that such interruptions will occur in the
future. The Company does not presently have fully redundant systems or a
formal disaster recovery plan and does not carry sufficient business
interruption insurance to compensate it for losses that may occur.
Substantially all of the Company's computer and communications hardware is
located at a single leased facility in Jenkintown, Pennsylvania. The Company
intends to move to a new facility by year -end, and chances of system
disruption during the move will increase.
Any substantial increase in the volume of traffic on the Company's Web site
or the number of orders placed by customers will require the Company to expand
and upgrade further its technology, transaction-processing systems and network
infrastructure. There can be no assurance that the Company will be able to
accurately project the rate or timing of increases, if any, in the use of its
Web site or expand and upgrade its systems and infrastructure to accommodate
such increases. The failure to appropriately upgrade its systems and
infrastructure would have a material adverse effect on the Company.
Security Risks. A significant barrier to online commerce is concern
regarding the security of transmission of confidential information. The
Company relies on encryption and authentication technology licensed from third
parties that is designed to facilitate the secure transmission of confidential
information, such as customer credit card numbers. Nevertheless, the Company's
infrastructure is potentially vulnerable to physical or electronic computer
break-ins, viruses and similar disruptive problems. A party who is able to
circumvent the Company's security measures could misappropriate proprietary
information or cause interruptions in the Company's operations. To the extent
that activities of the Company or third-party contractors involve the storage
and transmission of proprietary information, such as credit card numbers,
security breaches could damage the Company's reputation and expose the Company
to a risk of loss or litigation and possible liability. Therefore, the Company
may be required to expend significant capital and other resources to protect
against such security breaches or to alleviate problems caused by such
breaches. There can be no assurance that the Company's security measures will
prevent security breaches or that failure to prevent such security breaches
will not have a material adverse effect on the Company. See "Business--
Technology."
Risk of Reliance on Internally Developed Systems. The Company uses an
internally developed system for its Web site, search engine and substantially
all aspects of its transaction processing and order management. The Company's
inability to modify this system as necessary to accommodate increased traffic
on its Web site or increased volume through its transaction processing and
order management systems may cause unanticipated system disruptions, slower
response times, impaired quality and speed of order fulfillment, degradation
in customer service, and delays in reporting accurate financial information.
Any of these events could have a material adverse effect on the Company.
Potential Fluctuation in Quarterly Operating Results. The Company expects to
experience significant fluctuations in its future quarterly operating results
due to a variety of factors, many of which are outside the Company's control.
Factors that may affect the Company's quarterly operating results include (i)
its ability to retain existing customers, attract new customers and maintain
customer satisfaction, (ii) the introduction of new or enhanced Web pages,
services, products and strategic alliances by the Company and its competitors,
(iii) price competition or higher wholesale prices, (iv) the level of use of
the Internet and consumer acceptance of the Internet for the purchase of
recorded music, (v) seasonality of recorded music sales, (vi) its ability to
upgrade and develop its systems and infrastructure and attract qualified
personnel, (vii) technical difficulties, system downtime or Internet
brownouts, (viii) the amount and timing of operating costs and capital
expenditures relating to expansion of the Company's business, operations and
infrastructure, (ix) the timing of Company promotions and sales programs,
(xii) the level of merchandise returns experienced by the Company, (xi)
government regulation and (xii) general economic conditions and economic
conditions specific to the Internet and the music industry.
10
<PAGE>
The Company expects that it will experience seasonality in its business,
reflecting a combination of seasonal fluctuations in Internet usage and
traditional retail seasonality patterns affecting sales of recorded music.
Sales in the traditional retail music industry are significantly higher in the
fourth calendar quarter of each year than in the preceding three quarters.
However, to date, the Company's limited operating history and rapid growth
make it difficult to ascertain the effects of seasonality on its business.
Therefore, the Company believes that period-to-period comparisons of the
Company's historical results are not necessarily meaningful and should not be
relied upon as an indication of future results. The Company's results of
operations in future periods may not meet the expectations of securities
analysts and investors, in which case the price of the Common Stock would
likely be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Quarterly Results
and Seasonality."
Possible Volatility of Stock Price. The market price of the Common Stock has
been, and is likely to remain, highly volatile as is frequently the case with
new public companies and Internet companies in particular. Quarterly operating
results of the Company, deviations in results of operations from estimates of
securities analysts, changes in general conditions in the economy, in Internet
commerce and in the music retailing industry, or other developments affecting
the Company or its competitors could cause the market price of the Common
Stock to fluctuate substantially. The equity markets have, on occasion,
experienced significant price and volume fluctuations that have affected the
market prices for many companies' securities and that have often been
unrelated to the operating performance of these companies. Any such
fluctuations that occur following completion of the Offering may adversely
affect the market price of the Common Stock.
Rapid Technological Change. To remain competitive, the Company must continue
to enhance and improve the responsiveness, functionality and features of its
site and develop new features to meet customer needs. The Internet is
characterized by rapid technological change, changes in user and customer
requirements and preferences, frequent new product and service introductions
and the emergence of new industry standards and practices that could render
the Company's existing Web site, technology and systems obsolete. The
Company's success will depend, in part, on its ability to license leading
technologies useful in its business, enhance its existing services, develop
new services and technology that address the needs of its customers, and
respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis. If the Company is unable to
use new technologies effectively or adapt its Web site, proprietary technology
and transaction-processing systems to customer requirements or emerging
industry standards, it would be materially adversely affected. See "Business--
Technology."
No Designated Use for Substantial Portion of Net Proceeds. At March 31,
1998, the Company had approximately $60.5 million in cash and cash
equivalents. The Company has not designated any specific use for a significant
portion of the Company's existing cash and cash equivalents and the net
proceeds from the sale by the Company of the Common Stock offered hereby. The
net proceeds of the Offering, together with its existing cash and cash
equivalents, will be used by the Company to fund its obligations under its
strategic alliances, to finance its sales and marketing campaign, to make
improvements to and expand the capacity of its Web site, to make certain other
capital expenditures and for working capital and other general corporate
purposes. However, the Company cannot, with precision, estimate the portion of
the net proceeds to be devoted to certain of these uses. From time to time,
the Company may evaluate potential acquisitions involving complementary
businesses, content, products or technologies. However, the Company has no
present agreement with respect to any material acquisition or investment.
Accordingly, management will have significant flexibility in applying the net
proceeds of this Offering. See "Use of Proceeds."
Trademarks and Proprietary Rights; Unlicensed Arrangements and Materials;
Risk of Claims Resulting from Lack of License Rights. The Company regards its
trademarks, trade secrets and similar
11
<PAGE>
intellectual property as valuable to its business, and relies on trademark and
copyright law, trade secret protection and confidentiality and/or license
agreements with its employees and others to protect its proprietary rights.
There can be no assurance that the steps taken by the Company will be adequate
to prevent misappropriation or infringement of its proprietary property.
The Company has licensed in the past, and expects that it may license in the
future, certain of its proprietary rights, such as trademarks or copyrighted
material, to third parties. While the Company attempts to ensure that the
quality of its brand is maintained by such licensees, there can be no
assurance that such licensees will not take actions that might materially
adversely affect the value of the Company's proprietary rights or reputation,
which could have a material adverse effect on the Company.
Through its Cosmic Credit Program, the Company is establishing a network of
links with numerous small Web sites, typically fan sites devoted to particular
musical artists, that permit customers to connect to the Company's site
through an embedded hyperlink. See "Business--Marketing and Promotion. " Many
of the sites are not officially sanctioned by the artists to which they
relate, nor do they have licenses from the artists for use of any intellectual
property of the artists, their licensees or record companies which the sites
may display. There can be no assurance that the artists, their licensees or
record companies will not assert infringement claims against the Cosmic Credit
sites and the Company because of its relationships with these sites. In
addition, the Company's primary provider of artist and music-related
information, such as reviews, articles, photographs and images, which the
Company displays in its online retail store, has represented to the Company
that it may not have a license to distribute a portion of such information.
There can be no assurance that the owners (or their licensees) of intellectual
property rights in such information will not assert infringement claims
against the provider and the Company. Moreover, the Company has been subject
to claims and expects to be subject to legal proceedings and claims from time
to time in the ordinary course of its business, including claims of alleged
infringement of the trademarks and other intellectual property rights of third
parties by the Company and its licensees. Such claims could result in
substantial costs and diversion of resources, even if ultimately decided in
favor of the Company, and could have a material adverse effect on the Company,
particularly if judgments on such claims are adverse to the Company. If a
claim is asserted alleging that the Company has infringed the proprietary
rights of a third party, the Company may be required to seek licenses to
continue to use such intellectual property. The failure to obtain the
necessary licenses or other rights at a reasonable cost could have a material
adverse effect on the Company.
Government Regulation and Legal Uncertainties. The Company is subject, both
directly and indirectly, to various laws and regulations relating to its
business, although there are few laws or regulations directly applicable to
access to the Internet. However, due to the increasing popularity and use of
the Internet, it is possible that a number of laws and regulations may be
adopted with respect to the Internet. Such laws and regulations may cover
issues such as user privacy, pricing, content, copyrights, distribution and
characteristics and quality of products and services. Furthermore, the growth
and development of the market for online commerce may prompt calls for more
stringent consumer protection laws that may impose additional burdens on those
companies conducting business online. The enactment of any additional laws or
regulations may impede the growth of the Internet which could, in turn,
decrease the demand for the Company's products and services and increase the
Company's cost of doing business, or otherwise have an adverse effect on the
Company.
The applicability to the Internet of existing laws in various jurisdictions
governing issues such as property ownership, sales and other taxes, contests
and sweepstakes, libel, personal privacy, rights of publicity, language
requirements and content restrictions, is uncertain and could expose the
Company to substantial liability. The laws of certain foreign countries
provide the owner of copyrighted products with the exclusive right to expose,
through sound and video samples, copyrighted items for sale to the public and
the right to distribute such products. Any new legislation or regulation, or
the application of existing laws and regulations to the Internet could have a
material adverse effect on the Company. For example,
12
<PAGE>
major U.S.-based online services (and personnel) have been challenged by
German authorities for making certain content accessible in Germany. If the
Company were alleged to violate federal, state or foreign, civil or criminal
law, even if the Company could successfully defend such claims, it could have
a material, adverse impact on the Company.
A foreign distribution affiliate of a major record label has sought to
enjoin the sale of music-related products by another Internet retailer in
Germany. Moreover, in February and March of 1998 the Company received
correspondence from the foreign distribution affiliates of two other labels,
demanding that the Company cease the sale of certain titles in Germany and pay
damages. The Company has retained counsel and is in discussions with these
affiliates, each of which is represented by the same counsel, regarding a
possible resolution of this matter. There can be no assurance that this matter
will be resolved on a satisfactory basis, if at all, or that this and other
distribution affiliates will not seek to enjoin, or otherwise prevent, the
sale by the Company of music-related products in Germany and other countries.
If successful, these actions could materially adversely affect the Company.
The Company believes that its use of third party material on its Web sites
is permitted under current provisions of copyright law. However, legal rights
to certain aspects of Internet content and commerce are not clearly settled
and the Company's ability to rely upon one or more exemptions or defenses
under copyright law is uncertain. There can be no assurance that the Company
will be able to continue to provide rights to information, including
downloadable music samples and artist, record and other information. The
failure to be able to offer such information could have a material adverse
effect on the Company.
In addition, several telecommunications carriers are seeking to have
telecommunications over the Internet regulated by the Federal Communications
Commission (the "FCC") in the same manner as other telecommunications
services. For example, America's Carriers Telecommunications Association has
filed a petition with the FCC for this purpose. In addition, because the
growing popularity and use of the Internet has burdened the existing
telecommunications infrastructure and many areas with high Internet use have
begun to experience interruptions in phone service, local telephone carriers,
such as Pacific Bell, have petitioned the FCC to regulate Internet service
providers and online service providers in a manner similar to long distance
telephone carriers and to impose access fees on such providers. If either of
these petitions are granted, or the relief sought therein is otherwise
granted, the costs of communicating on the Internet could increase
substantially, potentially slowing the growth in use of the Internet. Any such
new legislation or regulation or application or interpretation of existing
laws could have a material adverse effect on the Company's business, results
of operations and financial condition.
U.S. and foreign laws regulate certain uses of customer information and
development and sale of mailing lists. The Company believes that it is in
material compliance with such laws, but new restrictions may arise in this
area that could have an adverse affect on the Company.
The law regarding linking to and framing of third party Web sites without
permission is uncertain. The Company believes that its linking and framing
activities are lawful, but there is a possibility that it may be asked to pay
a license fee or cease linking or framing.
Possible Liability for Publishing or Distributing Content over the
Internet. Due to the fact that the Company may be considered a publisher or
distributor of both its own and third party content, as well as the fact that
such material may be downloaded or copied from its Web sites and may be
subsequently distributed to others, there is a potential that claims will be
made against the Company for defamation, negligence, copyright or trademark
infringement, invasion of privacy and publicity, unfair competition or other
theories based on the nature and content of such material. Such claims have
been brought, and sometimes successfully pressed, against online services in
the past. For example, claims could be made against the Company if material
deemed inappropriate for viewing by young children could be accessed though
the Company Web sites. Although the Company carries general liability
insurance, the Company's insurance may not cover potential claims of this type
or may not be adequate to cover all costs incurred
13
<PAGE>
in defense of potential claims or to indemnify the Company for all liability
that may be imposed. Any costs or imposition of liability that is not covered
by insurance or is in excess of insurance coverage could have a material
adverse effect on the Company.
Potential Liability for Sales and Other Taxes. The Company does not
currently collect sales or other similar taxes in respect of shipments of
goods into states other than Pennsylvania, California and Florida. New state
tax regulations may subject the Company to the assessment of sales and income
taxes in additional states. Tax authorities in a number of states are
currently reviewing the appropriate tax treatment of companies engaged in
Internet and catalogue retailing and are currently considering an agreement
with certain of these companies regarding the assessment and collection of
sales taxes. The Company is not a party to any such discussions. As the
Company's service is available over the Internet in multiple states and
foreign countries, such jurisdictions may claim that the Company is required
to qualify to do business as a foreign corporation in each such state and
foreign country. The failure by the Company to qualify as a foreign
corporation in a jurisdiction where it is required to do so could subject the
Company to taxes and penalties for the failure to qualify.
Dependence on Key Personnel; Need for Additional Personnel. The Company's
success is substantially dependent on the ability and experience of its senior
management and other key personnel, particularly Jason Olim, its President,
Chief Executive Officer and Chairman of the Board. Moreover, to accommodate
its current size and manage its anticipated growth, the Company must maintain
and expand its employee base. Competition for personnel, particularly persons
having software development and other technical expertise, is intense, and
there can be no assurance that the Company will retain existing personnel or
hire additional, qualified personnel. The inability of the Company to retain
and attract the necessary personnel or the loss of services of any of its key
personnel could have a material adverse effect on the Company. See "Business--
Employees" and "Management."
Control of the Company. Immediately upon completion of the Offering,
approximately 16.0%, 16.0%, 9.3% and 12.5% of the outstanding Common Stock
will be beneficially owned by Jason Olim, the Company's President, Chief
Executive Officer and Chairman of the Board; Matthew Olim, the Company's
Technical Lead and Jason Olim's brother; Alan Meltzer, a director of the
Company; and Grotech Partners, IV, one of the managing directors of which is
Patrick Kerins, a director of the Company. As a result, such persons, acting
together, will have the ability to control all matters submitted to
shareholders of the Company for approval (including the election and removal
of directors and any merger, consolidation or sale of all or substantially all
of the Company's assets) and to control the management and affairs of the
Company. Such concentration of ownership may have the effect of delaying,
deferring or preventing a change in control of the Company, impede a merger,
consolidation, takeover or other business combination involving the Company or
discourage a potential acquirer from making a tender offer or otherwise
attempting to obtain control of the Company, which in turn could have an
adverse effect on the market price of the Company's Common Stock. See
"Principal Shareholders" and "Certain Relationships and Related Transactions."
Risks Associated with the Year 2000. The Year 2000 issue is the result of
computer programs being written using two digits rather than four to define
the applicable year. In other words, date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in system failures or miscalculations causing disruptions of operations,
including, among others, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
The Company does not believe that it has material exposure to the Year 2000
issue with respect to its own information systems since its existing systems
correctly define the year 2000. The Company intends to conduct an analysis in
1998 to determine the extent to which its major suppliers' systems (insofar as
they relate to the Company's business) are subject to the Year 2000 issue. The
Company is currently unable to predict the extent to which the Year 2000 issue
will affect its suppliers, or the extent
14
<PAGE>
to which it would be vulnerable to the suppliers' failure to remediate any
Year 2000 issues on a timely basis. The failure of a major supplier subject to
the Year 2000 to convert its systems on a timely basis or a conversion that is
incompatible with the Company's systems could have a material adverse effect
on the Company. In addition, most of the purchases from the Company's store
are made with credit cards via the Internet, and the Company's operations may
be materially adversely affected to the extent its customers are unable to use
their credit cards or access the Internet due to the Year 2000 issues that are
not rectified by their credit card vendors.
Risks Associated with International Sales. For the quarter ended March 31,
1998 and the year ended December 31, 1997, international sales accounted for
approximately 21% and 29%, respectively of the Company's net sales. While the
Company expects that its percentage of net sales from international markets
may decrease in future periods due to a substantial increase in domestic
marketing and advertising, it expects that international sales will continue
to represent a significant portion of its net sales. The Company's
international business activities are subject to a variety of potential risks,
including the adoption of laws, political and economic conditions and actions
by third parties that would restrict or eliminate the Company's ability to do
business in certain jurisdictions. See "--Government Regulation and Legal
Uncertainties." While the Company currently transacts business in U.S.
dollars, to the extent that it determines to transact business in foreign
currencies, the Company will become subject to the risks attendant to
transacting in foreign currencies, including potential adverse effects of
exchange rate fluctuations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Potential Adverse Market Impact of Shares Eligible for Future Sale. The
2,500,000 shares of Common Stock offered hereby, together with the 4,715,000
shares of Common Stock sold in the Company's February 1998 registered
offering, will be freely tradeable immediately following the Offering. All of
the 11,291,302 remaining outstanding shares (the "Restricted Shares"), have or
will become available for sale in the public market during 1998 subject, in
certain instances, to the applicable resale limitations of Rule 144
promulgated under the Securities Act of 1933, as amended (the "Securities
Act"). In addition, the Company has filed a Registration Statement on Form S-8
covering up to 1,600,000 shares issuable upon exercise of stock options under
the Equity Compensation Plan. Such shares, upon issuance, will be immediately
available for resale (in the case of holders that are affiliates of the
Company, subject to certain limitations under Rule 144). The Company's
officers, directors and certain shareholders, who hold, in the aggregate,
approximately 10,329,802 shares of Common Stock, have agreed not to sell any
shares of Common Stock (excluding shares of Common Stock offered by this
Prospectus or shares purchased in the open market) for a period of 90 days
following the consummation of the Offering without the prior written consent
of BT Alex. Brown Incorporated. In addition, the holders of approximately
827,356 shares of Common Stock have agreed not to sell any shares of Common
Stock (excluding any shares purchased in the open market) until after August
8, 1998. Thereafter, these shares may become either freely resalable or
eligible for sale pursuant to the applicable resale limitations of Rule 144.
In addition, beneficial owners of approximately 5,330,008 shares of Restricted
Stock have demand and piggyback registration rights with respect to those
shares. Sales of substantial amounts of Common Stock in the public market or
the availability of substantial amounts of such stock for sale subsequent to
the Offering could adversely affect the prevailing market price of the Common
Stock and could impair the Company's ability to raise capital through the sale
of its equity securities.
Anti-Takeover Provisions; Possible Issuances of Preferred Stock and
Classified Board. Certain provisions of Pennsylvania law could make it more
difficult for a third party to acquire, or could discourage a third party from
attempting to acquire control of the Company. Such provisions could limit the
price that certain investors might be willing to pay in the future for shares
of the Common Stock. In addition, shares of the Company's Preferred Stock, no
par value (the "Preferred Stock"), may be issued by the Board of Directors
without shareholder approval on such terms and conditions, and having such
rights, privileges and preferences, as the Board of Directors may determine.
The rights of the holders of the Common Stock will be subject to, and may be
adversely affected by, the rights of the holders of any
15
<PAGE>
Preferred Stock that may be issued in the future. In addition, the Company's
Amended and Restated Bylaws divide the Board of Directors into three classes,
each serving a staggered three-year term. The issuance of Preferred Stock and
the existence of a classified board could have the effect of delaying,
deterring or preventing a change in control of the Company. The Company has no
current plans to issue any shares of Preferred Stock. See "Management" and
"Description of Capital Stock--Preferred Stock."
Immediate and Substantial Dilution. The purchasers of the shares of Common
Stock offered hereby will experience immediate and substantial dilution in the
net tangible book value of their shares of Common Stock. See "Dilution." In
the event the Company offers additional Common Stock in the future, including
shares that may be issued upon exercise of stock options, purchasers of Common
Stock in the Offering may experience further dilution in the net tangible book
value per share of the Common Stock of the Company.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been quoted on the Nasdaq National Market
since February 10, 1998. The following table sets forth, for the periods
indicated, the high and low sales prices for Common Stock on the Nasdaq
National Market.
<TABLE>
<CAPTION>
HIGH LOW
----- ------
<S> <C> <C>
1998
First Quarter (beginning February 10, 1998)................. $ $16.00
Second Quarter (through May 8, 1998)........................ $ $
</TABLE>
On May 8, 1998, the last reported sale price of the Common Stock on the
Nasdaq National Market was $26.375 per share. As of April 30, 1998, there were
16,006,302 shares of Common Stock outstanding, held by approximately 36
holders of record. This figure does not reflect beneficial ownership of shares
held in street or nominee name.
16
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of 2,500,000 shares of Common
Stock offered hereby are estimated to be $62.0 million (approximately $71.3
million if the Underwriters' over allotment option is exercised in full)
assuming an offering price of $26.375 per share and after deducting
underwriting discounts and commissions and estimated offering expenses.
The net proceeds from the Offering, together with the Company's existing
cash and cash equivalents, will be used by the Company as follows: an
aggregate minimum of approximately $18.9 million expected to be due under the
Company's strategic alliance agreements during the next 12 months;
approximately $17.0 on advertising and promotion; approximately $4.5 million
to make enhancements to, and expand the capacity of, the Company's Web site
and other capital expenditures; and the balance for working capital and other
general corporate purposes, which may include additional payments due under
the Company's existing strategic alliances, payments due under any new
strategic alliances and future advertising and promotion activities. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The amount actually expended for each purpose, other than the payments due
under strategic alliance agreements described above, will be determined at the
discretion of the Company. The Company's future capital requirements and the
allocation of the net proceeds of the Offering, will depend on many factors,
including the entrance into new strategic alliances, increases in advertising
and promotions, growth of the Company's customer base and other factors.
Accordingly, the actual amount of proceeds devoted to each purpose may vary
substantially from the amount set forth above. From time to time the Company
may evaluate potential acquisitions involving complementary businesses,
content, products or technologies. The Company has no agreement or
understanding with respect to any material acquisition.
Pending utilization of the net proceeds of the Offering, the Company intends
to invest the funds in short-term, interest-bearing, investment-grade
obligations. The Company believes that the net proceeds from the Offering,
together with its current cash and cash equivalents, will be sufficient to
meet its anticipated cash needs for working capital and capital expenditures
for at least the next 12 months. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
DIVIDEND POLICY
The Company has not paid any cash dividends on its Common Stock and does not
anticipate paying any cash dividends in the foreseeable future. The Company
currently intends to retain future earnings, if any, to fund the development
and growth of its business. Any future determination to pay cash dividends
will be at the discretion of the Board of Directors and will be dependent upon
the Company's financial condition, operating results, capital requirements,
applicable contractual restrictions and such other factors as the Board of
Directors deems relevant.
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<PAGE>
CAPITALIZATION
The following table sets forth, as of March 31, 1998, (i) the actual
capitalization of the Company and (ii) the capitalization, as adjusted to
reflect the issuance and sale of the 2,500,000 shares of Common Stock offered
by the Company hereby and the application of the estimated net proceeds
therefrom. See "Use of Proceeds." This table should be read in conjunction
with the Financial Statements and the notes thereto and the other financial
information included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1998
-------------------------
ACTUAL AS ADJUSTED
----------- ------------
<S> <C> <C>
Cash and cash equivalents........................... $60,521,171 $122,496,952
=========== ============
Long-term debt, excluding current portion........... $ 984,512 $ 984,512
----------- ------------
Shareholders' equity:
Preferred Stock, no par value; 20,000,000 shares
authorized; no shares issued and outstanding
actual and as adjusted........................... -- --
Common Stock, no par value; 50,000,000 shares
authorized; 16,006,302 shares issued and
outstanding actual; shares issued and
outstanding as adjusted(1)....................... 77,265,547 139,241,328
Additional paid-in capital........................ 1,325,817 1,325,817
Deferred compensation............................. (365,600) (365,600)
Accumulated deficit............................... (20,536,775) (20,536,775)
----------- ------------
Total shareholders' equity...................... 57,688,989 119,664,770
----------- ------------
Total capitalization.......................... $58,673,501 $120,849,282
=========== ============
</TABLE>
- ---------------------
(1) Excludes (i) 859,262 shares of Common Stock issuable upon the exercise of
options outstanding as of April 30, 1998 under the Company's 1996 Equity
Compensation Plan (the "Equity Compensation Plan") at a weighted average
exercise price of $8.03 per share, (ii) 740,738 shares of Common Stock
reserved for future grants under the Equity Compensation Plan and (iii)
367,253 shares of Common Stock issuable upon the exercise of warrants
outstanding as of April 30, 1998 at a weighted average exercise price of
$4.06 per share. See "Management--Equity Compensation Plan" and
"Description of Capital Stock."
DILUTION
At March 31, 1998, the net tangible book value of the Company was
approximately $57.7 million or $3.60 per share of Common Stock. Net tangible
book value per share is equal to the Company's total tangible assets less its
total liabilities, divided by the total number of shares of Common Stock
outstanding for the period immediately prior to the Offering. After giving
effect to the sale by the Company of 2,500,000 shares of Common Stock offered
hereby of at assumed offering price of $26.375 per share and after deducting
underwriting discounts and commissions and estimated offering expenses, the
pro forma net tangible book value of the Company at March 31, 1998 would have
been $119.7 million or approximately $6.47 per share. This represents an
immediate increase in the net tangible book value of $2.87 per share of
existing shareholders and immediate dilution of $19.91 per share to new
investors purchasing shares of Common Stock in the Offering. The following
table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed Offering price per share.............................. $26.38
Net tangible book value per share as of March 31, 1998...... $3.60
Increase in net tangible book value per share attributable
to new investors........................................... 2.87
-----
Pro forma net tangible book value per share after the
Offering..................................................... 6.47
------
Dilution per share to new investors........................... $19.91
======
</TABLE>
18
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and notes thereto
appearing elsewhere in this Prospectus. The statement of operations data for
the years ended December 31, 1995, 1996 and 1997 and the balance sheet data as
of December 31, 1996 and 1997 have been derived from the Consolidated
Financial Statements, which have been audited by Arthur Andersen LLP,
independent public accountants, and are included elsewhere in this Prospectus.
The statement of operations data for the period from inception (February 12,
1994) to December 31, 1994 and the selected balance sheet data as of December
31, 1994 and 1995 have been derived from financial statements audited by
Arthur Andersen LLP, independent public accountants, not included in this
Prospectus. The statement of operations data for the three months ended March
31, 1997 and 1998 and the balance sheet data as of March 31, 1998 have been
derived from unaudited financial statements of the Company that, in the
opinion of the Company , include all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the results of
operations for the period in accordance with generally accepted accounting
principles. The results of operations for the three months ended March 31,
1998 are not necessarily indicative of the results that may be expected for
any interim period or for the full year.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 12, THREE MONTHS ENDED
1994) TO YEAR ENDED DECEMBER 31, MARCH 31,
DECEMBER 31, ------------------------------------ -----------------------
1994(1) 1995(1) 1996 1997 1997 1998
------------- ---------- ---------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net sales.............. $103,116 $2,176,474 $6,300,294 $ 17,372,795 $2,581,578 $10,013,889
Cost of sales.......... 92,962 1,844,612 5,217,789 14,316,028 2,049,541 8,554,549
-------- ---------- ---------- ------------ ---------- -----------
Gross profit.......... 10,154 331,862 1,082,505 3,056,767 532,037 1,459,340
Operating expenses:
Operating and develop-
ment................. 26,946 149,982 669,280 2,541,434 321,128 1,081,049
Sales and marketing... 12,945 200,972 621,454 9,139,348 417,302 8,785,724
General and adminis-
trative.............. 28,712 180,573 563,593 1,953,078 339,303 850,285
Dispute settle-
ment(2).............. -- -- 1,024,030 -- -- --
-------- ---------- ---------- ------------ ---------- -----------
Total operating ex-
penses............... 68,603 531,527 2,878,357 13,633,860 1,077,733 10,717,058
-------- ---------- ---------- ------------ ---------- -----------
Operating loss........ (58,449) (199,665) (1,795,852) (10,577,093) (545,696) (9,257,718)
Interest expense, net.. -- (1,248) (14,556) (170,312) 1,390 59,525
-------- ---------- ---------- ------------ ---------- -----------
Net loss............... (58,449) (200,913) (1,810,408) (10,747,405) (544,306) (9,198,193)
Accretion of preferred
stock to redemption
value................. -- -- -- (410,103) -- (115,542)
-------- ---------- ---------- ------------ ---------- -----------
Net loss applicable to
common shareholders... $ 58,449 $ 200,913 $1,810,408 $(11,157,508) $ (544,306) $(9,313,735)
======== ========== ========== ============ ========== ===========
Net loss per share(3).. $ (1.42) $ (0.07) $ (0.78)
============ ========== ===========
Weighted average number
of common shares
outstanding(3)........ 7,845,684 7,845,684 12,015,090
============ ========== ===========
OPERATING DATA:
Customers(4)........... 1,787 26,953 87,859 296,450 113,362 431,565
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------- MARCH 31,
1994 1995 1996 1997 1998
-------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents........... $ 2,008 $ 43,812 $ 775,865 $10,686,001 $60,521,171
Working capital
(deficit)............. (42,206) (235,478) 231,455 (1,218,005) 56,141,498
Total assets........... 25,765 268,468 1,575,459 16,448,425 66,227,754
Long-term debt,
excluding current
portion............... -- 9,519 91,133 962,144 984,512
Redeemable convertible
preferred stock....... -- -- -- 9,492,594 --
Total shareholders'
equity (deficit)...... (18,449) (99,362) 514,017 (9,752,450) 57,688,989
</TABLE>
- ---------------------
(1) The business of the Company was established as a sole proprietorship in
February 1994 and commercial operations were commenced in August 1994.
The Company was incorporated in April 1995.
(2) In December 1996, in settlement of a dispute, the Company issued 882,606
shares of Common Stock to certain persons. See "Certain Relationships and
Related Transactions" and Note 7 to Notes to Consolidated Financial
Statements.
(3) See Note 2 to Notes to Consolidated Financial Statements for an
explanation of the determination of the number of common shares used in
computing the per share amount.
(4) Cumulative number of customers who have purchased products from the
Company from inception of its business in August 1994 through the end of
period.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Prospectus contains certain statements of a forward-looking nature
relative to future events or the financial performance of the Company. Actual
events or results may differ materially from those indicated by such forward-
looking statements for a variety of reasons, including the matters set forth
under the caption "Risk Factors."
CDnow is the leading online retailer of CDs and other music-related
products. Its early entrance into the online music retailing industry has
helped the Company gain a well-recognized brand and a large customer base. The
Company strives to combine the advantages of online commerce with superior
customer focus in order to be the authoritative source for CDs and other
music-related products. CDnow offers broad selection, informative content,
easy-to-use navigation and search capabilities, a high level of customer
service, competitive pricing and personalized communication. Due to the
Company's dedicated retail focus, revenues are almost entirely derived from
the sale of pre-recorded music and related products, drawing from its
comprehensive selection of over 250,000 items. The Company does not seek to
generate advertising or other ancillary revenues.
CDnow has grown rapidly since its inception in 1994. Of the 432,000
customers who have made purchases since inception through March 31, 1998,
135,000 made their initial purchases during the three month period ending
March 31, 1998. Average daily visits to the CDnow store have grown from
approximately 12,000 in January 1996 to approximately 165,000 in March 1998.
The Company's net sales grew to $10.0 million in the first quarter of 1998
compared to $7.9 million and $2.6 million in the fourth and first quarters of
1997, respectively. The Company has also generated significant customer
loyalty. Despite the Company's rapid acquisition of new customers, repeat
customers accounted for approximately 51% of net sales in the first quarter of
1998.
The Company believes that the key factors affecting its long-term financial
success include its ability to obtain new customers at reasonable costs,
retain customers and encourage repeat purchases. The Company seeks to expand
its customer base through multiple marketing channels which include (i)
pursuing an aggressive marketing campaign using a combination of online and
traditional marketing, (ii) establishing strategic alliances with major
Internet content and service providers, (iii) entering into linking
arrangements with other Web sites as part of its Cosmic Credit Program, and
(iv) using direct marketing techniques to target new and existing customers
with personalized communications. The Company entered into strategic alliances
with Yahoo!, Excite and GeoCities in August 1997, September 1997 and January
1998, respectively, and has accelerated its marketing campaign since the
Company's initial public offering in February 1998 by expanding its
relationship with Yahoo! and entering into additional alliances with Lycos,
Lycos Bertelsmann and Rolling Stone Network.
Since its inception, the Company has incurred significant net losses and, as
of March 31, 1998, had accumulated losses of $22.0 million. As it seeks to
expand aggressively, the Company believes that its operating expenses will
significantly increase as a result of the financial commitments related to the
development of marketing channels, future strategic relationships, and
improvements to its Web site and other capital expenditures. The Company
expects that it will continue to incur losses and generate negative cash flow
from operations for the foreseeable future as it continues to develop its
business. Since the Company has relatively low product gross margins, the
ability of the Company to generate and enhance profitability depends upon its
ability to substantially increase its net sales. To the extent that
significantly higher net sales do not result from the Company's marketing
efforts, the Company will be materially adversely affected. There can be no
assurance that the Company will be able to generate sufficient revenues from
the sale of CDs and other music-related products to achieve or maintain
profitability on a quarterly or annual basis.
For the quarter ended March 31, 1998 and year ended December 31, 1997,
international sales accounted for approximately 21% and 29%, respectively of
net sales. While the Company expects that net sales from international markets
will continue to represent a significant portion of net sales, the Company
20
<PAGE>
believes that the percentage of its net sales from international markets may
decrease in future periods due to the substantial increase in the Company's
domestic marketing and advertising expenditures.
The Company's business started as a sole proprietorship in February 1994.
The Company, which was incorporated in April 1995, was taxed as an S-
corporation until December 6, 1996 and has been taxed as a C-corporation since
such date.
RESULTS OF OPERATIONS
The following table sets forth statement of operations data as a percentage
of net sales for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
--------------------- --------------
1995 1996 1997 1997 1998
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Net sales................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales............. 84.8 82.8 82.4 79.4 85.4
----- ----- ----- ------ ------
Gross profit............ 15.2 17.2 17.6 20.6 14.6
Operating Expenses:
Operating and
development............ 6.9 10.6 14.6 12.4 10.8
Sales and marketing..... 9.2 9.9 52.6 16.2 87.7
General and
administrative......... 8.3 8.9 11.3 13.1 8.5
Dispute settlement...... -- 16.3 -- -- --
----- ----- ----- ------ ------
Total operating
expenses............... 24.4 45.7 78.5 41.7 107.0
----- ----- ----- ------ ------
Operating loss.......... (9.2) (28.5) (60.9) (21.1) (92.4)
Interest income (expense),
net...................... -- (0.2) (1.0) -- 0.5
----- ----- ----- ------ ------
Net loss.................. (9.2)% (28.7)% (61.9)% (21.1)% (91.9)%
===== ===== ===== ====== ======
</TABLE>
Beginning in 1998, the Company determined to include royalties paid on CD
sales in return for licensing of ratings, reviews and other information
("Information Royalties") in operating and development expenses rather than in
cost of sales, as was previously the case. This change was made based on
management's determination that including Information Royalties in operating
and development expense was more consistent with the treatment of such
expenses by retailers generally. The financial information in this Prospectus
related to the Company's results of operations for periods prior to 1998 has
been restated to reflect this change. Information Royalties were $146,200,
$225,737, $52,027, and $49,140 during the years ended December 31, 1996 and
1997 and the three months ended March 31, 1997 and 1998, respectively. There
were no Information Royalties paid in 1995. If Information Royalties were
included in cost of sales, gross profit margins would have been 14.9%, 16.3%,
18.6%, and 14.1% during the years ended December 31, 1996 and 1997 and the
three months ended March 31, 1997 and 1998, respectively.
QUARTER ENDED MARCH 31, 1998 COMPARED TO THE QUARTER ENDED MARCH 31, 1997
Net Sales. Net sales primarily reflect the sales of CDs and related
merchandise, net of estimated returns, and include outbound shipping and
handling charges. Net sales increased by $7.4 million, or 288%, to $10.0
million for the quarter ended March 31, 1998 compared to $2.6 million for the
quarter ended March 31, 1997. Net sales increased by $2.1 million, or 26%,
compared to $7.9 million for the quarter ended December 31, 1997. The increase
from prior periods is attributable to continued growth of the Company's
customer base and repeat purchases from existing customers. Net sales were
favorably affected by increased advertising and promotional activities,
including the Company's Grammy Awards promotion and March 1998 storewide sale,
as well as the continued implementation of its strategic alliances. In the
quarter ended March 31, 1998, the Company added approximately 135,000 new
customers, bringing the total number of customers since inception to 432,000
from 296,000 and 113,000 at December 31, 1997 and March 31, 1997,
respectively. International sales represented 21% and 35% of net sales for the
quarters ended March 31, 1998 and March 31, 1997, respectively. The Company
believes
21
<PAGE>
that the decrease in international sales as a percentage of net sales is due
to a proportionally larger increase in domestic sales resulting from the
substantial increase in domestic marketing and advertising expenditures.
Nevertheless, international sales increased to $2.1 million for the quarter
ended March 31, 1998 from $2.0 million and $914,000 in the quarters ended
December 31, 1997 and March 31, 1997, respectively.
Cost of Sales. Cost of sales consists primarily of the cost of merchandise
sold to customers, including product fulfillment and outbound shipping and
handling. Cost of sales also includes fees charged by credit card processors.
Cost of sales increased by $6.5 million, or 317%, to $8.6 million for the
quarter ended March 31, 1998 compared to $2.1 million for the quarter ended
March 31, 1997. Cost of sales increased by $1.8 million, or 27%, compared to
$6.7 million for the quarter ended December 31, 1997. The Company's gross
profit margin decreased to 14.6% for the quarter ended March 31, 1998 compared
to 14.9% and 20.6% for the quarters ended December 31, 1997 and March 31,
1997, respectively. The decline in gross margin was attributable to increased
sales discounts offered by the Company in connection with its Grammy Awards
promotion and March 1998 storewide sale. The decrease over the quarter ended
March 31, 1997 also resulted from more aggressive pricing of recent releases
and popular titles.
Operating and Development Expense. Operating and development expense
consists primarily of payroll and related expenses for store management,
design, development and network operations personnel, systems and
telecommunications infrastructure, and royalties paid by the Company on CD
sales in return for licensing of ratings, reviews, sound samples and other
information. Store development costs are charged to expense as incurred.
Operating and development expense increased by $759,000, or 236%, to $1.1
million for the quarter ended March 31, 1998 compared to $322,000 for the
quarter ended March 31, 1997. Operating and development expense for the
quarter ended March 31, 1998 remained relatively constant compared to the
quarter ended December 31, 1997. This increase, as compared to the quarter
ended March 31, 1997, is attributable to increased staffing and associated
cost related to enhancing the features and functionality of the Company's Web
site and transaction-processing systems, as well as increased investment in
store content, systems and telecommunications infrastructure. As a percentage
of net sales, operating and development expense decreased to 10.8% for the
quarter ended March 31, 1998 compared to 13.9% and 12.4% for the quarters
ended December 31, 1997 and March 31, 1997, respectively, as operating and
development expenses were spread over a larger revenue base.
Sales and Marketing Expense. Sales and marketing expense consists primarily
of payments related to advertising, promotion and strategic alliances as well
as payroll and related expenses for personnel engaged in marketing, selling
and customer service activities. Sales and marketing expense increased by $8.4
million to $8.8 million for the quarter ended March 31, 1998 compared to
$417,000 for the quarter ended March 31, 1997. Sales and marketing expense
increased by $3.0 million, or 52%, compared to $5.8 million for the quarter
ended December 31, 1997. As a percentage of net sales, sales and marketing
expense grew to 87.7% for the quarter ended March 31, 1998 compared to 73.0%
and 16.2% for the quarters ended December 31, 1997 and March 31, 1997,
respectively. This increase in both absolute dollars and as a percentage of
net sales was primarily attributable to increased online and traditional
advertising, including advertising costs incurred in connection with the
Company's Grammy Awards and American Music Awards promotions, costs associated
with the Company's strategic alliances, and promotional and public relations
expenditures. The Company increased its advertising expense to $7.3 million
for the quarter ended March 31, 1998 compared to $4.7 million and $132,000 for
the quarters ended December 31, 1997 and March 31, 1997, respectively. In
addition, the Company incurred increased staffing and related costs in
connection with the implementation of its marketing strategy and customer
service activities necessary to support its increased customer base. The
Company expects the dollar amount of sales and marketing expense generally,
and advertising expense in particular, to continue to increase significantly
in future periods. While the Company is hopeful that its net sales will also
increase in future periods so that its sales and marketing expense will not
continue to represent an increasing percentage of net sales, the Company is
not able to predict whether its net sales will increase by a sufficient amount
for this to occur. No assurance can be given that the Company will achieve
increased net sales or that sales and marketing expense will not continue to
increase as a percentage of net sales.
22
<PAGE>
General and Administrative Expense. General and administrative expense
consists of payroll and related expenses for executive, accounting and
administrative personnel, insurance, professional fees and other general
corporate expenses. General and administrative expense increased by $511,000,
or 151%, to $850,000 for the quarter ended March 31, 1998 compared to $339,000
for the quarter ended March 31, 1997 and increased by $163,000, or 24%,
compared to $687,000 for the quarter ended December 31, 1997. The increase in
general and administrative expense was primarily due to the hiring of
additional personnel and increases in professional fees, as well as the costs
associated with becoming a public company. As a percentage of net sales,
general and administrative expense decreased to 8.5% for the quarter ended
March 31, 1998 compared to 8.6% and 13.1% for the quarters ended December 31,
1997 and March 31, 1997, respectively, as the Company's fixed costs were
spread over a larger revenue base.
Net Loss. The Company's net loss was $9.2 million for the quarter ended
March 31, 1998, an increase of $8.7 million and $2.6 million compared to net
losses of $544,000 and $6.6 million for the quarters ended March 31, 1997 and
December 31, 1997, respectively.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Net Sales. Net sales increased by $11.1 million, or 176%, to $17.4 million
for the year ended December 31, 1997 from $6.3 million for the year ended
December 31, 1996. This increase is primarily attributable to the significant
growth of the Company's customer base and repeat purchases from the Company's
existing customers, who have typically purchased more units per order than new
customers. International sales represented approximately 29% and 40% of net
sales for the years ended December 31, 1997 and December 31, 1996,
respectively. The Company believes that this decrease in international sales
as a percentage of net sales is due to the substantial increase in the
Company's domestic marketing and advertising expenditures. At December 31,
1997, the Company had approximately 296,000 customer accounts compared to
approximately 88,000 customer accounts at December 31, 1996.
Cost of Sales. Cost of sales increased by $9.1 million, or 174%, to $14.3
million for the year ended December 31, 1997 from $5.2 million for the year
ended December 31, 1996. This increase is primarily attributable to the
Company's increased sales volume. The Company's gross profit margin was 17.6%
for the year ended December 31, 1997 compared to 17.2% for the year ended
December 31, 1996. The increase in gross margin as a percentage of net sales
was primarily due to price reductions from the Company's suppliers and a
change to a lower-price supplier for imported music and music-related
products. The Company's gross profit margin declined in the fourth quarter of
1997 due to increased sales promotions during the holiday season.
Operating and Development Expense. Operating and development expense
increased by $1.9 million to $2.5 million for the year ended December 31, 1997
from $669,000 for the year ended December 31, 1996. As a percentage of net
sales, these expenses were 14.6% for the year ended December 31, 1997 and
10.6% for the year ended December 31, 1996. This increase was due to increased
staffing and associated costs related to enhancing the features, content and
functionality of the Company's Web site and transaction-processing systems, as
well as increased investment in systems and telecommunications infrastructure.
Sales and Marketing Expense. Sales and marketing expense increased by $8.5
million to $9.1 million for the year ended December 31, 1997 from $621,000 for
the year ended December 31, 1996, with $5.8 million of this expense incurred
in the fourth quarter. As a percentage of net sales, these expenses increased
to 52.6% for the year ended December 31, 1997 from 9.9% for the year ended
December 31, 1996. This increase was due to the significant expansion of the
Company's advertising expenditures, costs associated with the strategic
alliances with Yahoo! and Excite and to the increased staffing and associated
costs related to implementing the Company's marketing strategy and supporting
the Company's increased customer base. The Company increased its advertising
expense to $6.8 million for the year ended December 31, 1997 compared to
$61,000 for the year ended December 31, 1996.
23
<PAGE>
General and Administrative Expense. General and administrative expense
increased by $1.4 million to $2.0 million for the year ended December 31, 1997
from $564,000 for the year ended December 31, 1996. As a percentage of net
sales, these expenses increased to 11.3% for the year ended December 31, 1997
compared to 8.9% for the year ended December 31, 1996. This increase was
primarily due to the recruitment and hiring of additional personnel and
increases in professional fees and travel expenses.
Net Loss. The Company's net loss increased by $8.9 million to a loss of
$10.7 million for the year ended December 31, 1997 from a net loss of $1.8
million for the year ended December 31, 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
Net Sales. Net sales increased 189% to $6.3 million for the year ended
December 31, 1996 from $2.2 million for the year ended December 31, 1995 as a
result of the significant growth of the Company's customer base and repeat
purchases from existing customers. International sales represented
approximately 40% and 22% of net sales for the year ended December 31, 1996
and the year ended December 31, 1995, respectively. At December 31, 1996, the
Company had approximately 88,000 customer accounts compared to approximately
27,000 customer accounts at December 31, 1995.
Cost of Sales. Cost of sales increased 183% to $5.2 million for the year
ended December 31, 1996 from $1.8 million for the year ended December 31,
1995, reflecting the Company's increased sales volume. The Company's gross
profit margin increased to 17.2% for the year ended December 31, 1996 from
15.2% for the year ended December 31, 1995.
Operating and Development Expense. Operating and development expense
increased to $669,000 for the year ended December 31, 1996 from $150,000 for
the year ended December 31, 1995. As a percentage of net sales, operating and
development expense grew to 10.6% for the year ended December 31, 1996 from
6.9% for the year ended December 31, 1995. This increase in both absolute
dollars and as a percentage of net sales was primarily attributable to
increased staffing and associated costs related to enhancing the features,
content and functionality of the Company's Web site and transaction-processing
systems, as well as increased investment in systems and telecommunications
infrastructure.
Sales and Marketing Expense. Sales and marketing expense increased to
$621,000 for the year ended December 31, 1996 from $201,000 for the year ended
December 31, 1995. As a percentage of net sales, sales and marketing expense
grew to 9.9% for the year ended December 31, 1996 from 9.2% for the year ended
December 31, 1995. This increase in both absolute dollars and as a percentage
of net sales was primarily attributable to increased staffing and associated
costs related to implementing the Company's marketing strategy and supporting
the Company's increased customer base, as well as to expansion of the
Company's online advertising, promotional and public relations expenditures.
General and Administrative Expense. General and administrative expense
increased to $564,000 for the year ended December 31, 1996 from $181,000 for
the year ended December 31, 1995. As a percentage of net sales, general and
administrative expense grew to 8.9% for the year ended December 31, 1996 from
8.3% for the year ended December 31, 1995. This increase in both absolute
dollars and as a percentage of net sales was primarily due to the hiring of
additional personnel and increases in professional fees and travel expenses.
Dispute Settlement. In December 1996, in settlement of a dispute related to
certain business arrangements and discussions among the Company and certain
persons who are now shareholders of the Company, the Company issued Common
Stock valued at approximately $1.0 million to the three shareholders of MBL
Entertainment Inc. See "Certain Relationships and Related Transactions--Stock
Purchase and Shareholders' Agreement" and Note 7 to Notes to Financial
Statements.
Net Loss. The Company's net loss increased by $1.6 million to a loss of $1.8
million for the year ended December 31, 1996 from a net loss of $201,000 for
the year ended December 31, 1995.
24
<PAGE>
QUARTERLY RESULTS OF OPERATIONS AND SEASONALITY
The following table sets forth certain unaudited quarterly statement of
operations data for the nine quarters ended March 31, 1998. This unaudited
quarterly information has been derived from unaudited financial statements of
the Company and, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the information for the periods covered. The quarterly data
should be read in conjunction with the Financial Statements and the notes
thereto. The operating results for any quarter are not necessarily indicative
of the operating results for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997 1997 1997 1997 1998
-------- -------- --------- -------- -------- -------- --------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............... $1,128 $1,352 $1,629 $ 2,191 $2,582 $ 2,964 $ 3,907 $ 7,920 $10,014
Cost of sales........... 944 1,137 1,373 1,764 2,050 2,363 3,167 6,736 8,555
------ ------ ------ ------- ------ ------- ------- ------- -------
Gross profit............ 184 215 256 427 532 601 740 1,184 1,459
Operating expenses:
Operating and
development........... 101 138 185 246 322 489 632 1,099 1,081
Sales and marketing..... 91 127 174 229 417 707 2,234 5,781 8,786
General and
administrative........ 81 115 157 210 339 404 523 687 850
Dispute settlement...... -- -- -- 1,024 -- -- -- -- --
------ ------ ------ ------- ------ ------- ------- ------- -------
Total operating
expenses............... 273 380 516 1,709 1,078 1,600 3,389 7,567 10,717
------ ------ ------ ------- ------ ------- ------- ------- -------
Operating loss.......... (89) (165) (260) (1,282) (546) (999) (2,649) (6,383) (9,258)
Interest income
(expense), net........ (2) (3) (6) (3) 2 (6) 69 (235) 60
------ ------ ------ ------- ------ ------- ------- ------- -------
Net loss................ $ (91) $ (168) $ (266) $(1,285) $ (544) $(1,005) $(2,580) $(6,618) $(9,198)
====== ====== ====== ======= ====== ======= ======= ======= =======
<CAPTION>
AS A PERCENTAGE OF NET SALES
---------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997 1997 1997 1997 1998
-------- -------- --------- -------- -------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales........... 83.7 84.1 84.3 80.5 79.4 79.7 81.1 85.1 85.4
------ ------ ------ ------- ------ ------- ------- ------- -------
Gross profit............ 16.3 15.9 15.7 19.5 20.6 20.3 18.9 14.9 14.6
Operating expenses:
Operating and
development............ 9.0 10.2 11.4 11.2 12.4 16.5 16.2 13.9 10.8
Sales and marketing..... 8.1 9.4 10.7 10.5 16.2 23.9 57.2 73.0 87.7
General and
administrative......... 7.1 8.5 9.6 9.6 13.1 13.6 13.3 8.6 8.5
Dispute settlement...... -- -- -- 46.7 -- -- -- -- --
------ ------ ------ ------- ------ ------- ------- ------- -------
Total
operating expenses..... 24.2 28.1 31.7 78.0 41.7 54.0 86.7 95.5 107.0
------ ------ ------ ------- ------ ------- ------- ------- -------
Operating loss.......... (7.9) (12.2) (16.0) (58.5) (21.1) (33.7) (67.8) (80.6) (92.4)
Interest income
(expense), net......... (0.2) (0.2) (0.3) (0.1) -- (0.2) 1.8 (3.0) 0.5
------ ------ ------ ------- ------ ------- ------- ------- -------
Net loss................ (8.1)% (12.4)% (16.3)% (58.6)% (21.1)% (33.9)% (66.0)% (83.6)% (91.9)%
====== ====== ====== ======= ====== ======= ======= ======= =======
</TABLE>
The Company expects to experience significant fluctuations in its future
quarterly operating results due to a variety of factors, many of which are
outside the Company's control. Factors that may affect the Company's quarterly
operating results include (i) its ability to retain existing customers,
attract new customers and maintain customer satisfaction, (ii) the
introduction of new or enhanced Web pages, services, products and strategic
alliances by the Company and its competitors, (iii) price competition or
higher wholesale prices, (iv) the level of use of the Internet and consumer
acceptance of the Internet for the purchase of recorded music, (v) seasonality
of recorded music sales, (vi) its ability to upgrade and develop its systems
and infrastructure and attract qualified personnel, (vii) technical
difficulties, system
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downtime or Internet brownouts, (viii) the amount and timing of operating
costs and capital expenditures relating to expansion of the Company's
business, operations and infrastructure, (ix) the timing of Company promotions
and sales programs, (xii) the level of merchandise returns experienced by the
Company, (xi) government regulation and (xii) general economic conditions and
economic conditions specific to the Internet and the music industry.
The Company expects that it will experience seasonality in its business,
reflecting a combination of seasonal fluctuations in Internet usage and
traditional retail seasonality patterns affecting sales of recorded music.
Sales in the traditional retail music industry are significantly higher in the
fourth calendar quarter of each year than in the preceding three quarters.
However, to date, the Company's limited operating history and rapid growth
make it difficult to ascertain the effects of seasonality on its business. The
Company believes that period-to-period comparisons of the Company's historical
results are not necessarily meaningful and should not be relied upon as an
indication of future results.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998 the Company's cash and cash equivalents were $60.5
million, compared to $729,000 at March 31, 1997. In February 1998, the Company
consummated its initial public offering, selling an aggregate of 4,561,250
shares of Common Stock and raising net proceeds of approximately $67.1
million. Prior to February 1998, the Company primarily financed its operations
through private sales of capital stock (which, through December 31, 1997,
totaled $10.5 million, including $9.3 million raised in July and August of
1997), the private sale of $5.8 million of the Series A Notes in November
1997, internally-generated cash flow, advances from related parties and
certain other short-term loans.
Net cash used in operating activities of $11.7 million for the quarter ended
March 31, 1998 was primarily attributable to a net loss of $9.2 million, a
decrease of $3.1 million in accounts payable an increase of $332,000 in
accounts receivable and depreciation and amortization of $517,000. For the
quarter ended March 31, 1997, cash used in operating activities of $272,000
resulted primarily from a net loss of $544,000 largely offset by increases in
accounts payable and other accrued expenses.
Net cash provided by investing activities was $289,000 for the quarter ended
March 31, 1998, and consisted of the sale of short-term investments of $1.0
million and purchases of equipment of $714,000. Net cash used in investing
activities of $29,000 for the quarter ended March 31, 1997 was attributable to
purchases of equipment of $248,000 partially offset by sales and maturities of
short-term investments of $219,000.
Net cash provided by financing activities of $61.2 million for the three
months ended March 31, 1998 consisted of net proceeds of approximately $67.1
million from the Company's initial public offering offset by the retirement of
$5.8 million of the Company's Series A Notes.
Net cash used in operating activities was $3.2 million and $116,000 for the
years ended December 31, 1997 and 1996, respectively, while net cash provided
by operating activities was $41,000 in the year ended December 31, 1995. For
the year ended December 31, 1997, cash used in operating activities was
attributable to a $10.7 million net loss and increases in prepaid expenses of
$2.4 million, partially offset by an $8.5 million increase in accounts payable
and $1.1 million of depreciation and amortization expense (including
amortization of deferred compensation, deferred financing costs and debt
discount). Net cash used in operating activities for the year ended December
31, 1996 was attributable to a net loss of $1.8 million (however, $1.0 million
of the net loss was attributable to the issuance of common stock in settlement
of a dispute, which had no cash effect on the Company) and increases in
accounts receivable and prepaid expenses, partially offset by increases in
certain current liabilities and non-cash items, including $118,000
representing the deemed fair value of services contributed by the Company's
founders (one of whom served as President and the other developed the
Company's systems architecture and transactions systems).
Net cash used in investing activities totaled $1.7 million, $445,000 and
$136,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The increases were attributable to purchases of short-term marketable
securities and increased purchases of property and equipment.
Net cash provided by financing activities was $14.8 million, $1.3 million,
and $136,000 for the years ended December 31, 1997, 1996 and 1995,
respectively. Cash flows from financing activities in 1997
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<PAGE>
increased compared to 1996 primarily as the result of $10.0 million in
proceeds received from the sale of Series A Preferred Stock and Series B
Preferred Stock, net of issuance costs of approximately $700,000; $5.8 million
in proceeds from the sale of Series A Notes, net of issuance costs of
approximately $175,000; and the proceeds from term loans payable of $219,000.
The Company also repaid $200,000 of short-term loans from private investors
that were outstanding as of December 31, 1996. Cash flows from financing
activities in 1996 increased compared to 1995 principally as the result of
$1.2 million in proceeds from the sale of Common Stock in December 1996 to
Alan Meltzer, a director of the Company. See "Certain Relationships and
Related Transactions."
On July 15, 1997, the Company sold 254,582 shares of Series A Preferred
Stock to Keystone Ventures IV, L.P. ("Keystone Ventures") for an aggregate
price of $1.3 million. The outstanding shares of Series A Preferred Stock
automatically converted in February 1998 into an aggregate of 381,873 shares
of Common Stock. On August 5, 1997, the Company sold 1,543,505 shares of
Series B Preferred Stock to Grotech Partners IV, LP ("Grotech") and 62,000
shares of Series B Preferred Stock to ABS Employees' Venture Fund Limited
Partnership ("ABS") for an aggregate price of $8.7 million. The outstanding
shares of Series B Preferred Stock automatically converted in February 1998
into an aggregate of 2,408,258 shares of Common Stock. See "Certain
Relationships and Related Transactions."
On August 21, 1997, the Company entered into a one-year Advertising and
Promotion Agreement with Yahoo! (the "Yahoo! Agreement") which automatically
extends for an additional one-year period unless CDnow provides Yahoo! with a
notice of termination prior to July 1998. The Company is required to pay
Yahoo! minimum fees of $3.9 million during the first year of the Agreement, of
which an aggregate of $1.8 million was paid through March 31, 1998, and $2.1
million is due in periodic installments through October 1998. If the Yahoo!
Agreement is extended for an additional one year period, the Company will be
required to pay Yahoo! certain additional fees during such period based on the
number of users that access the CDnow Web site through the links with Yahoo!
during the last two months of the initial term, provided that such fees may
not be less than $4.5 million in the aggregate. In addition, during the term
of the Yahoo! Agreement, the Company is required to pay Yahoo! an additional
variable fee based on the number of users that access the CDnow Web site
through the links with Yahoo! in excess of certain stated minimums.
On September 30, 1997, the Company and Excite entered into a two-year
Linking Agreement (the "Excite Agreement") with respect to Excite's Webcrawler
Service. The Company is required to pay Excite $2.0 million and $2.5 million
in fees during the first and second years, respectively, of the Excite
Agreement. As of March 31, 1998, the Company had paid Excite $2.0 million. The
Company is required to pay Excite additional variable fees based on the number
of users which access the CDnow site through links with the WebCrawler service
in excess of certain minimums. The Company has the right to terminate the
Excite Agreement and eliminate any obligation to pay Excite any of the fees
scheduled to be paid during the second year of the term if a certain minimum
level of links and advertising banners have not been delivered by the
WebCrawler service within 30 days after the first anniversary of such
Agreement.
In November 1997, the Company issued $5.8 million aggregate principal amount
of Series A Notes to a group of investors, including Grotech. These Notes,
which bore interest at 12% per annum, were retired in February 1998. The
Company issued warrants to these investors to purchase an aggregate of 48,550
shares of Common Stock at an exercise price of $11.90 per share.
On March 26, 1998, the Company entered into a three-year Linking Agreement
with Lycos (the "Lycos Agreement"). The Company is required to pay Lycos $4.5
million, $5.5 million and $6.5 million in fixed fees during the first, second
and third years, respectively, of the Lycos Agreement. The Company is also
required to pay Lycos certain variable fees based on the number of new
customers that access, and new Cosmic Credit sites that are enrolled, through
links with the Lycos and Tripod Web sites. In addition, the Company is
obligated to issue 61,665 shares of Common Stock to Lycos.
On April 2, 1998, the Company entered into a three-year linking agreement
with Lycos Bertelsmann (the "Lycos Bertelsmann Agreement"). The Company is
required to pay Lycos Bertelsmann $1.4 million,
27
<PAGE>
$1.9 million and $2.2 million in fixed fees during the first, second and third
years, respectively, of the Lycos Bertelsmann Agreement. The Company is also
required to pay Lycos Bertelsmann certain variable fees based on the number of
new customers acquired, and new Cosmic Credit sites enrolled, through links
with the Lycos Bertelsmann Web sites.
The Company is required to pay aggregate minimum fixed fees of $5.4 million,
$3.4 million and $2.5 million during the remainder of 1998, 1999 and 2000,
respectively, under the Company's other strategic alliances.
The Company expects to fund its future payment obligations under its
strategic alliances from its cash and cash equivalents, including a portion of
the net proceeds from the Offering. See "Use of Proceeds" and "Business--
Marketing and Promotion."
As of March 31, 1998, the Company had $60.5 million of cash and cash
equivalents. As of that date, the Company's principal commitments consisted of
obligations under its strategic alliances as well as obligations outstanding
under capital and operating leases. Although the Company has no material
commitments for capital expenditures, it anticipates substantial increases in
its capital expenditures and lease commitments consistent with anticipated
growth in operations, infrastructure and personnel.
The Company believes that the net proceeds from this Offering, together with
its current cash and cash equivalents, will be sufficient to meet its
anticipated cash needs for working capital and capital expenditures for at
least the next 12 months. However, the Company's capital requirements depend
on several factors, including the rate of market acceptance, the ability to
expand the Company's customer base, the cost of Web site upgrades, the level
of expenditures for sales and marketing, and other factors. The timing and
amount of such capital requirements cannot accurately be predicted. If capital
requirements vary materially from those currently planned, the Company may
require additional financing sooner than anticipated. The Company has no
commitments for any additional financing, and there can be no assurance that
any such commitments can be obtained on favorable terms, if at all. Any
additional equity financing may be dilutive to the Company's shareholders, and
debt financing, if available, may involve restrictive covenants with respect
to dividends, raising future capital and other financial and operational
matters which could restrict its operations or finances. If the Company is
unable to obtain additional financing as needed, the Company may be required
to reduce the scope of its operations or its anticipated expansion, which
could have a material adverse effect on the Company.
At December 31, 1997, the Company had a net operating loss ("NOL")
carryforward of approximately $9.7 million, which begins to expire in 2005.
The utilization of the NOL carryforward will be limited pursuant to the Tax
Reform Act of 1986, due to cumulative changes in ownership in excess of 50%.
See Note 5 to Notes to Consolidated Financial Statements.
See Note 2 to Notes to Consolidated Financial Statements for information
regarding recently issued accounting standards.
Risks Associated with the Year 2000. The Year 2000 issue is the result of
computer programs being written using two digits rather than four to define
the applicable year. In other words, date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in system failures or miscalculations causing disruptions of operations,
including, among others, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
The Company does not believe that it has material exposure to the Year 2000
issue with respect to its own information systems since its existing systems
correctly define the year 2000. The Company intends to conduct an analysis in
1998 to determine the extent to which its major suppliers' systems (insofar as
they relate to the Company's business) are subject to the Year 2000 issue. The
Company is currently unable to predict the extent to which the Year 2000 issue
will affect its suppliers, or the extent to which it would be vulnerable to
the suppliers' failure to remediate any Year 2000 issues on a timely basis.
The failure of a major supplier subject to the Year 2000 to convert its
systems on a timely basis or a conversion that is incompatible with the
Company's systems could have a material adverse effect on the Company. In
addition, most of the purchases from the Company's store are made with credit
cards via the Internet, and the Company's operations may be materially
adversely affected to the extent its customers are unable to use their credit
cards or access the Internet due to the Year 2000 issues that are not
rectified by their credit card vendors.
28
<PAGE>
BUSINESS
INTRODUCTION
CDnow is the leading online retailer of CDs and other music-related
products. Its early entry into the online music retailing industry has helped
the Company gain a well-recognized brand and a large customer base. The
Company strives to combine the advantages of online commerce with superior
customer focus in order to be the authoritative source for CDs and other
music-related products. The Company's online store, cdnow.com, offers broad
selection, informative content, easy-to-use navigation and search
capabilities, a high level of customer service, competitive pricing and
personalized merchandising and communication. With over 250,000 items, the
Company believes that it provides a selection of readily-available products
that is five to ten times that of a typical music retailer. To assist
customers in making music selections, the CDnow store contains approximately
115,000 product notes, reviews and related articles and 300,000 sound samples.
The CDnow store is open 24 hours a day, seven days a week and offers its
customers convenient and timely product fulfillment, including an overnight
delivery option.
CDnow has grown rapidly since its inception in 1994. Of the 432,000
customers who have made purchases from inception through March 31, 1998,
135,000 made their initial purchases during the three month period ending
March 31, 1998. Average daily visits to the CDnow store have grown from
approximately 12,000 in January 1996 to approximately 165,000 in March 1998 .
The Company's net sales grew to $10.0 million for the first quarter of 1998
compared to $7.9 million and $2.6 million for the fourth and first quarters of
1997, respectively. The Company has also generated significant customer
loyalty. Despite the Company's rapid acquisition of new customers, repeat
customers accounted for approximately 51% of net sales in the first quarter of
1998.
INDUSTRY OVERVIEW
The Internet is an increasingly significant global medium for
communications, information and commerce. International Data Corporation
("IDC") estimates that the number of Web users grew to approximately 69
million by the end of 1997 and will grow to approximately 320 million by 2002.
The Company believes that the growth in Internet usage has resulted from a
number of factors, including the large and growing installed base of PCs in
the workplace and home, advances in the performance and speed of PCs and
modems, improvements in network infrastructure, easier and cheaper access to
the Internet and increased awareness of the Internet among businesses and
consumers. Jupiter Communications ("Jupiter") estimates that the number of
online households (households using e-mail, the Internet or a consumer online
service) making purchases will grow from an estimated 15.2 million households
in 1996 to 57.0 million households, representing over 50% of U.S. households,
by the year 2002. IDC estimates that the total value of services and products
purchased over the Web grew from $296 million in 1995 to approximately $12.4
billion in 1997, and will increase to approximately $426 billion by 2002.
The Company believes that a significant opportunity exists for the retailing
of music on the Internet. According to the International Federation of the
Phonographic Industry, worldwide sales of pre-recorded music and music videos
in 1996 were approximately $39.8 billion, of which one-third was in North
America. Online music retailers currently account for a small but growing
portion of total sales. According to Jupiter, sales of pre-recorded music over
the Internet are projected to grow on a worldwide basis from approximately $47
million in 1997 to $1.6 billion in 2002.
A number of characteristics of online music retailing make the sale of pre-
recorded music via the Internet particularly attractive relative to
traditional retail stores. The Internet offers many data management and
multimedia features which enable consumers to listen to sound samples, search
for music by genre, title or artist and access a wealth of information and
events, including reviews, related articles, music history, news and
recommendations. Internet retailers can more easily obtain extensive
29
<PAGE>
demographic and behavioral data about their customers, providing them with
greater direct marketing opportunities and the ability to offer a more
personalized shopping experience. In addition, Internet retailers can also
offer consumers significantly broader product selection, the convenience of
home shopping and 24-hour-a-day, seven-day-a-week operations, available to any
location, foreign or domestic, that has access to the Internet.
While physical store-based music retailers must make significant investments
in inventory, real estate and personnel for each store location, online
retailers incur a fraction of these costs, generally use centralized
distribution, and have virtually unlimited merchandising space. Traditional
retailers are compelled to limit the amount of inventory they carry at each
store and focus on a smaller selection of faster-selling hit releases. As a
result, the Company believes that a typical music store may carry up to 12,000
SKUs and a megastore may carry up to 50,000 SKUs, compared to the more than
250,000 SKUs carried by the CDnow store. According to Jupiter, approximately
80% of unit sales at traditional retail stores come from approximately 20% of
the available titles. Online retailers can offer consumers a broader range of
titles and information and can also offer products from a wider range of music
labels, including smaller independent labels which account for an increasing
percentage of new titles. According to Soundscan, independent labels accounted
for 21% of the total music market in 1996 versus 12% in 1992. While
independent labels released 66% of new titles in 1996, traditional music
stores often lack the capacity to stock or promote the vast majority of these
titles.
The Company also believes that online retailers will benefit from the
changing demographic profile of music consumers. According to the Recording
Industry Association of America, domestic purchases of recorded music by
persons age 30 and over have increased from approximately 34% of total U.S.
sales in 1986 to approximately 48% of sales, or approximately $5.9 billion, in
1997. The Company believes that the Internet represents a particularly
attractive medium for retailing to customers in this age group as they are
typically less "hits-driven" than younger age groups and are more likely to
purchase a wide variety of titles. These customers generally can afford to buy
more titles at one time, have access to computers and use the Internet, and
have credit cards with which to make electronic payments.
STRATEGY
The Company focuses on promoting its brand and extending its leadership
position through the following key strategies:
Focus on Recorded Music Retailing. CDnow is dedicated to online music
retailing. By focusing on its core competency, the Company is able to offer a
high quality, customer-oriented online music store and build a clearly
delineated brand, which the Company believes will make CDnow the site of
choice for recorded music customers. The Company believes that this focus
enables it to better direct its sales and marketing campaigns, form effective
relationships with Internet content and service providers, and minimize
potential conflicts of interest with alternate distribution channels or
recorded music labels.
Provide Innovative and Easy-to-Use Retail Concept. The Company strives to
make its customer experience informative, efficient and intuitive by
constantly updating and improving its store format and features. The CDnow
store incorporates "point and click" options, supported by technical
enhancements including easy-to-use search capabilities (by artist, album
title, song title or record label), personalized music suggestions, order
tracking and confirmation. The CDnow store promotes music learning and
discovery by enabling visitors to access information on titles, music reviews,
ratings, articles on music topics and approximately 300,000 sound samples.
These features are designed to make shopping at the store entertaining and
informative and encourage purchases and repeat visits. The Company is
dedicated to providing its customers with a comprehensive selection of both
popular and hard-to-find CDs and offers over 250,000 items. The Company
continually evaluates the feasibility and marketability of new products and
services. Among the products currently under consideration by the Company are
custom compilation discs which contain individual songs selected online by the
customer.
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<PAGE>
Expand Customer Base Through Multiple Marketing Channels. The Company seeks
to expand its customer base through multiple marketing channels. The Company
believes that this strategy enables it to reduce reliance on any one source of
customers, maximize brand awareness and lower average customer acquisition
cost.
. Online and Traditional Advertising. The Company promotes its brand
through an aggressive marketing campaign using a combination of online
and traditional advertising. The Company advertises on the sites of
major Internet content and service providers, including AltaVista,
Infoseek and Microsoft Network, and targeted music-related sites, such
as Billboard. As part of these arrangements, the Company typically
purchases the right to display its banners and hyperlinks, often in
conjunction with specified search keywords such as "music store".
CDnow's traditional advertising efforts have included radio advertising
in major markets, such as advertising on the Howard Stern program, and
print advertising in music-related publications, including Spin and
Variety. In the first quarter of 1998, the Company initiated television
advertising, including national advertising during the Grammy Awards and
the American Music Awards. The Company intends to continue television
advertising on a selected basis and has purchased advertising on such
programs as The Late Show with David Letterman.
. Strategic Alliances with Major Content and Service Providers. The
Company believes it can enhance its new customer acquisition efforts,
increase purchases by current customers and expand brand recognition
through strategic alliances with major Internet content and service
providers. Since February 1998, the Company has broadened its strategic
alliance with Yahoo! to include Yahoo! Mail and Yahoo!'s music chat
space. The Company has also entered into new strategic alliances with
Lycos and Tripod, Lycos Bertelsmann and Rolling Stone Network. In
addition, CDnow has preexisting alliances with GeoCities and Excite's
WebCrawler service. CDnow's alliances generally provide for the Company
to be the premier online recorded music retailer on certain of the sites
of these providers with the exclusive right to place music banner
advertisements and integrated links to the CDnow store on certain music-
related or other specified pages. These pages will prominently feature
the CDnow branded link that allows users to click through to the CDnow
site. The alliance with Rolling Stone Network also entitles CDnow to use
the Rolling Stone brand name in conjunction with the display of cover
art and excerpts of feature stories, record reviews, artist biographies
and music news from current and past editions of Rolling Stone magazine.
The Company has also entered into marketing arrangements with, among
others, America Online with respect to Love@AOL, ABC News Starwave
Partners, USA TODAY Information Network and CBS Broadcasting Inc. with
respect to its Web site, and will seek to develop relationships with
other major content and service providers.
. Cosmic Credit Program. Through its Cosmic Credit program, CDnow has
arrangements with over 19,000 small Web sites, typically fan sites
devoted to particular musical artists. Approximately 9,000 of these
sites have enrolled since December 31, 1997. The Company provides Cosmic
Credit sites with embedded hyperlinks through which potential customers
can immediately be connected to the CDnow site. The Company believes
that highly-focused, music-oriented sites, while having less traffic
than major content providers, are likely to have a high percentage of
users that will be attracted to the CDnow store.
. Direct Marketing Techniques. The Company uses direct marketing
techniques to target new and existing customers with communications and
promotions. The Company sends a personalized e-mail newsletter to its
customers that includes purchase recommendations based on demonstrated
customer preferences and prior purchases, as well as more general
information concerning new releases and Company promotions. The Company
also targets e-mail campaigns to specific customer and prospect segments
based upon their recent activity at the CDnow store. The Internet allows
rapid and effective experimentation and analysis, instant user feedback
and efficient personalization of the store for each customer, all of
which CDnow seeks to incorporate in its merchandising.
Acquire Customers Efficiently. The Company seeks to target its marketing
expenditures towards sources that most efficiently attract new customers. The
Company utilizes its three years of online retailing
31
<PAGE>
experience and its database of approximately 432,000 customers to better
evaluate and predict the effectiveness of potential advertising opportunities
and strategic relationships. To enhance the possibility that its banners and
other links will be effective, the Company works closely with Internet content
and service providers with respect to the placement of banners and other links
as well as the surrounding content. As a result, the Company believes that it
can acquire new customers and retain existing customers on a more cost-
effective basis.
Maximize Customer Retention. The Company seeks to maximize customer
retention through its emphasis on customer service and personalized
communications. The success of this strategy is evidenced by CDnow's high
level of repeat customers, who accounted for approximately 51% of net sales
during the quarter ended March 31, 1998. The Company strives to accommodate
its customers by providing 24-hour-a-day, seven-day-a-week operations and
rapid order fullfillment. Products are typically shipped within two business
days after an order is placed and confirmation is provided within minutes via
e-mail. Customers can make separate inquiries through e-mail or telephone
access during extended business hours. The Company strives to respond to
customer inquiries within 24 hours of receipt. The Company also maintains
ongoing customer contact through its customized e-mail newsletter, The CDnow
Update.
Enhance International Capabilities. The Company believes that there is a
substantial opportunity to increase its sales to international customers.
International music sales in 1997 were estimated to be approximately twice
that of the U.S. and many products offered by CDnow are not available in these
markets. In April 1998, the Company entered into a strategic alliance with
Lycos Bertelsmann, a European Internet content and service provider, under
which the Company has been designated as the exclusive music retailer for
Lycos Bertelsmann's Web services in various European countries. The Company
has also entered into a letter of intent with MSI of Miami, Inc. ("MSI") under
which MSI would provide an additional 150,000 international titles and create
a fulfillment center in the Netherlands to serve European markets commencing
in mid-1998. The Company has nine foreign language versions of its Web site
that contain translations of account registration and ordering instructions.
CDnow supports its international sales efforts with customer service
representatives fluent in these languages.
THE CDNOW ONLINE RETAIL STORE
The Company strives to make the CDnow store informative and authoritative,
allowing customers to easily learn about, discover and purchase CDs and other
music-related products. The store is designed to be intuitive and easy to use
and to enable the ordering process to be completed with a minimum of customer
effort. Customers enter the CDnow store through its Web site, cdnow.com, and
in addition to ordering music products, can conduct targeted searches, browse
among top sellers and other featured titles, read reviews, listen to music
samples, register for personalized communications, participate in promotions
and check order status. New users may access a page specifically designed to
provide a quick understanding of the site and its many features.
Merchandising. CDnow believes that its ability to offer a substantially
larger selection than traditional retail stores is a significant competitive
advantage. The Company currently offers over 200,000 CDs, 40,000 movies and
10,000 music videos as well as t-shirts, music books, DVDs and CD-ROMs. To
encourage purchases, the Company features various promotions on a rotating
basis throughout the store. The Company also launched its Gift Center in
November 1997 and an Album Advisor in January 1998, both featuring an online
recommendation service. The Company adjusts pricing strategies and tactics as
necessary to maintain competitiveness and generally prices all recent releases
and popular titles aggressively. The Company seeks to encourage the purchase
of multiple titles by providing more favorable shipping terms for larger
orders.
Searching. Through the Company's "FastFind" search engine, customers can
quickly and easily navigate the store to find CDs or other products of
interest. Customers can search for products based on
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artist, album title, song title, record label, musical genre or release date
for new releases. By clicking on the "Info" buttons, a visitor can browse
among CDnow's database of reviews, cover art, sound samples and album notes.
Through the Company's "Lexicon" feature, customers can browse alphabetical
lists based on artists, types of products, record labels and album cover art.
Content and Music Discovery. The Company believes that effective use of
content encourages purchases by customers who may be browsing the site without
a specific title in mind. The Company's Web site contains approximately
300,000 sound samples, extensive information with regard to titles, reviews,
ratings, articles on music topics and other information. To help customers
browse and discover CDs, CDnow recently launched six music spaces organized by
genre: Rock/Pop, Jazz/Blues, Urban/Electronic, Country/Folk, World/New Age and
Classical. The main page of each space features links to genre-specific lists,
articles, reviews and contests. Within each space, customers can browse sale
items, new releases, advance orders and charts, read exclusive CDnow reviews,
listen to sound samples and purchase CDs recommended by the Company. Since
February 1998, the Company has entered into agreements with Rolling Stone
Network and the College Music Journal to enhance the content available in the
CDnow store. The agreement with Rolling Stone Network entitles CDnow to use
Rolling Stone's brand name in conjunction with the display of cover art and
excerpts of feature stories, record reviews, artist biographies and music news
from current and past editions of Rolling Stone magazine. The agreement with
College Music Journal provides the Company with access to more than 25,000
reviews from this publication.
Purchasing. Once a CD has been selected, customers simply click on the price
to add products (including, advance orders of yet-to-be released products) to
their virtual shopping carts. Customers can add and remove products from their
shopping carts as they browse, prior to making a final purchase. The shopping
cart page displays each item that has been placed in the cart, including
title, price and any applicable discount. To execute orders, customers click
on the "Place Order" button and are prompted to select shipping and payment
methods online or by e-mail, facsimile or telephone. Customers can also add
products which they may wish to purchase on future visits to their "lunch
box," a special section of the shopping cart where items may be stored over
multiple visits.
Payment. In paying for orders, customers may use credit cards, personal
checks or money orders. For convenience, the Company enables customers to
store credit card information on the Company's secure server, thereby avoiding
the need to re-enter this information when making future purchases. Customers
are offered a variety of shipping options, including overnight delivery. The
Company automatically confirms each order by e-mail within minutes after the
order is placed and subsequently confirms shipment of each order by e-mail.
The Company offers a money back returns policy.
Distribution and Fulfillment. All of the Company's inventory is owned and
held by outside vendors and shipped directly from these vendors to customers.
The breadth of the inventory maintained by these vendors provides CDnow with
the ability to maintain high order fill rates. CDnow updates its site daily
with inventory information received from its vendors, which enables customers
to check the availability of products before ordering. The Company
electronically transmits orders to its outside vendors at least once daily.
Orders are shipped by these vendors using a CDnow label and invoice, in most
cases within a day after an order is placed with the Company. A customer's
credit card is charged once an order is shipped.
Multilingual Capabilities. Approximately 21% of the Company's sales for the
quarter ended March 31, 1998 were generated from international markets. The
Company offers Spanish, French, German, Italian, Portuguese, Japanese, Dutch,
Norwegian and Korean language versions of its Web site that contain
translation of account registration and ordering instructions and supports its
international sales efforts with customer service representatives fluent in
these languages. The Company may introduce additional foreign language
versions in the future.
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MARKETING AND PROMOTION
CDnow's marketing and promotion strategy is designed to broaden awareness of
the CDnow brand, increase customer traffic to the Company's Web site and
encourage new and repeat purchases. The Company utilizes multiple channels to
market and promote its brand, including online and traditional advertising,
strategic alliances, the Company's Cosmic Credit Program, and direct
marketing. The Company believes that the use of multiple marketing channels
reduces reliance on any one source of customers, maximizes brand awareness and
lowers average customer acquisition cost.
Online and Traditional Advertising
The Company promotes its brand through an aggressive marketing campaign
using a combination of online and traditional advertising. The Company
advertises on the sites of major Internet content and service providers,
including AltaVista, Infoseek and Microsoft Network, and targeted music-
related sites, such as Billboard. As part of these arrangements, the Company
typically purchases banner advertisements, often in conjunction with specified
search keywords or on contextually appropriate pages, that allow consumers to
immediately click through to the CDnow site. The significant flexibility of
online advertising allows the Company to quickly adjust its advertising plans
in response to seasonal and promotional activities.
CDnow believes that traditional advertising is a key ingredient in building
brand recognition and promoting the benefits of online retail shopping.
Traditional advertising can be an effective means of promoting widespread
brand awareness and attracting traditional retail consumers to the Company's
Web site, including consumers with little or no history of online purchases.
CDnow's traditional advertising efforts have included radio advertising in
major markets, such as advertising on the Howard Stern program, and print
advertising in music-related publications, including Spin and Variety. In the
first quarter of 1998, the Company initiated television advertising, including
national advertising during the Grammy Awards and the American Music Awards.
The Company intends to continue television advertising on a selected basis and
has purchased advertising on such programs as The Late Show with David
Letterman.
Strategic Alliances
The Company believes that the Web sites of major Internet service and
content providers can be a source of a significant number of new customers.
These sites have a high volume of user traffic, and the Company believes that
the utilization of carefully targeted links and other advertising on the sites
can be very effective in attracting potential customers. The Company has
entered into the following agreements and arrangements, which are listed in
chronological order.
Yahoo! The Company and Yahoo! have entered into the Yahoo! Agreement, under
which CDnow has been granted exclusivity on music-related pages on the main
Yahoo! site, including the Yahoo! Metro Sites and My Yahoo! (collectively,
the "Yahoo! Service"). In particular, Yahoo! has agreed to place integrated
links to the CDnow store and banner advertisements on certain pages
generated from the Yahoo! Service. The Yahoo! Agreement requires Yahoo! to
deliver a minimum number of page views during each quarter of the term of
the Agreement and limits the ability of other music retailers to place
links or advertise on these pages. In addition, CDnow was granted a right-
of-first-refusal regarding any promotional opportunity developed by Yahoo!
that is similar in scope and nature to that provided by the Yahoo!
Agreement. The initial term of the Yahoo! Agreement expires in October
1998, subject to an automatic one year renewal, unless otherwise terminated
by the Company. The Company and Yahoo! recently amended the Yahoo!
Agreement to include Yahoo!'s e-mail service, Yahoo! Mail, and music chat
space for a period ending in December 1998.
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WebCrawler. The Company and Excite have entered into the Excite Agreement,
under which the Company has been designated as the exclusive online music
retailer within Excite's WebCrawler service and has been granted the
exclusive right to sponsor targeted links, advertising banners and specific
keywords for online retail music purchases within WebCrawler. The Excite
Agreement also requires Excite to deliver a minimum number of links and
banners on the WebCrawler service during each year of the Agreement and
limits the ability of Excite to include advertising for other music
retailers on the WebCrawler service.
GeoCities. The Company and GeoCities, Inc. have entered into the GeoCities
Agreement, under which the Company has been designated as the exclusive
retailer of music and video products and one of the four key commerce
partners that will occupy a premier position on certain portions of the
GeoCities Web site. The GeoCities Agreement requires GeoCities to deliver a
minimum number of impressions per month, with each impression consisting of
a user's viewing of a page on the GeoCities site containing a link to the
Company's Web site. The initial term of the GeoCities Agreement expires 12
months after GeoCities implements links to the Company's Web site, which
expiration date is expected to be in January 1999, subject to the Company's
option to renew the GeoCities agreement for a 12 month renewal term.
Lycos. The Company and Lycos have entered into the Lycos Agreement, under
which the Company has been designated as the exclusive music retailer for
the Lycos and Tripod Web sites, and has been granted the exclusive right to
sponsor targeted links, relevant content and promotions throughout the
Lycos and Tripod Web sites. In addition, the Company was granted a right-
of-first-refusal regarding any music retail opportunities on the Lycos and
Tripod Web sites. The Lycos Agreement requires Lycos and Tripod to deliver
a minimum number of CDnow-branded page views during each year of the term,
and precludes Lycos and Tripod from entering into new agreements regarding
advertising for other music retailers throughout the Lycos and Tripod Web
sites. The Lycos Agreement expires in April 2001.
Lycos Bertelsmann. The Company and Lycos Bertelsmann have entered into the
Lycos Bertelsmann Agreement under which the Company has been designated as
the exclusive music retailer for Lycos Bertelsmann's Web services in
various European countries and has been granted the exclusive right to
sponsor targeted links, advertising banners, specific keywords, and
relevant content on the Lycos Bertelsmann sites. In addition, the Company
was granted a right-of-first-refusal regarding any opportunities which
Lycos Bertelsmann offers to any other entity which principally sells music
products. The Lycos Bertelsmann Agreement requires Lycos Bertelsmann to
deliver a minimum number of page views during each year of the term. The
term of the Lycos Bertelsmann Agreement expires in April 2001.
Rolling Stone Network. The Company and Rolling Stone Network have entered
into an agreement under which the Company has been designated the exclusive
World Wide Web-based music retailer that may use the Rolling Stone brand
name in conjunction with the display of cover art and excerpts of feature
stories, record reviews, artist biographies and music news from current and
past editions of Rolling Stone magazine. In addition, the Company will be
the exclusive online music retailer on the JAMtv and Rolling Stone Network
Web sites with the exclusive right to sponsor targeted links, relevant
content and promotions. The Rolling Stone Agreement also requires the
delivery of a minimum number of page views on the JAMtv and Rolling Stone
Network Web sites during each year of the agreement. The Company has also
agreed to purchase targeted print, radio broadcast and other promotional
advertising from JAMtv and Straight Arrow, the publisher of Rolling Stone
magazine.
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Other Alliances. The Company has established relationships with other major
Internet content and service providers, including America Online ("AOL")
with respect to its Love@AOL service, ABC News Starwave Partners, USA TODAY
Information Network ("USA TODAY") and CBS Broadcasting, Inc. ("CBS"),
designed to attract additional users to, and increase brand awareness of,
the Company's Web site. The Company and AOL are parties to an agreement
whereby CDnow is the exclusive music retailer on the Love@AOL service. The
Company and ABC News Starwave Partners are parties to an agreement under
which ABC News Starwave Partners has created links to the Company's Web
site from certain music-related pages of its Mr. Showbiz, CelebSite and
Wall of Sound Web sites and is required to provide the Company with a
minimum number of banner advertisements per month on these Web sites. The
Company and USA TODAY are parties to an agreement under which USA TODAY
places links to the Company's Web site from the Market Place segment of its
Web site and shares in a portion of the revenues realized by the Company as
a result of these links. The Company and CBS are parties to an agreement
under which, in addition to purchasing commercial advertising time during
the 1998 Grammy Awards, the Company has been designated as the exclusive
online music retailer on the CBS Web site.
Cosmic Credit Program
Through its Cosmic Credit Program, CDnow has entered into arrangements with
over 19,000 small Web sites, typically fan sites devoted to particular music
artists. Approximately 9,000 of these sites have enrolled since December 31,
1997. The Company provides Cosmic Credit sites with embedded hyperlinks
through which potential customers can immediately be connected to the CDnow
site. The Company pays Cosmic Credit participants commissions in store credit
or cash based upon the dollar amount of purchases made by persons using the
link. The Company believes that highly focused, music-oriented sites, while
having less traffic than major content providers, are likely to have a high
percentage of users that will be attracted to the CDnow store. Cosmic Credit
participants sign up online at a special Web page, cdnow.com/credit, and are
listed inside the CDnow store to assist the Company's customers in finding
these sites. The Company rewards the best Cosmic Credit sites with special
incentives.
Direct Marketing
The Company uses direct marketing techniques to target new and existing
customers with communications and promotions. The Company sends a personalized
e-mail newsletter to its customers, The CDnow Update, that includes purchase
recommendations based on demonstrated customer preferences and prior
purchases. The newsletter also includes more general information concerning
new releases and Company promotions. In addition, the Company targets e-mail
communications to persons who have registered at the CDnow store but who have
not actually purchased, to new customers and to customers who have not made
purchases in recent periods. Through these customized programs, the Company
hopes to further stimulate demand, increase repeat purchases, build customer
loyalty, and better understand customer preferences. The Internet allows rapid
and effective experimentation analysis and instant user feedback and efficient
personalization of the store for each customer, all of which CDnow seeks to
incorporate in its marketing and merchandising activities.
CUSTOMER SERVICE
The Company believes that a high level of customer service and support is
critical to retaining and expanding its user base. CDnow customer service
representatives are available 24 hours a day on weekdays and 10:00 AM to 6:00
PM Eastern Time on weekends to provide assistance via e-mail, phone or fax.
The Company strives to answer all inquiries within 24 hours. The Company
currently has 34 customer service representatives, including representatives
fluent in nine foreign languages. These customer service representatives
handle questions about orders, assist customers in finding CDs and other
music-related products, and register customer's credit card information over
the telephone. The customer service representatives are a valuable source of
feedback regarding user satisfaction. CDnow uses BizRate, an online market
research company, to compile customer comments on their experiences. BizRate
provides monthly reports that enable CDnow to make improvements in response to
its customers' comments. The
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CDnow store also contains a customer service page that outlines store policies
and provides answers to frequently asked questions.
DISTRIBUTION AND FULFILLMENT
The Company does not carry any inventory and relies exclusively on third
party vendors for distribution and fulfillment. The Company believes that this
distribution strategy allows it to offer extensive selection while avoiding
the high fixed costs and capital requirements associated with owning and
warehousing product inventory and the significant operational effort
associated with same-day shipment. CDnow has experienced a return rate of
approximately one percent of all merchandise sold.
Since August 1994, the Company has primarily used Valley Record Distributors
to fulfill orders for CDs, cassettes and vinyl records produced in the U.S.
CDnow transmits data to Valley through a secure network to ensure customer
security and data integrity. Valley picks, packs and ships customer orders and
charges CDnow for merchandise, shipping and handling. In most cases, products
are shipped within two business days after an order is placed with the
Company. Customer billing is performed by CDnow through a third-party credit
card processor. To date, Valley has satisfied the Company's requirements on a
timely basis. For the quarter ended March 31, 1998 and the year ended December
31, 1997, payments to Valley accounted for approximately 82% and 78%,
respectively of the Company's cost of sales. The Company's agreement with
Valley expires in June 1999, although Valley may terminate its existing
agreement with the Company upon 30 days' written notice, if Valley
discontinues providing fulfillment services to all of its online service
customers.
Since May 1997, the Company has used MSI to fulfill orders for CDs produced
by non-U.S. labels. The Company has also entered into a letter of intent for
MSI to provide an additional 150,000 international titles and create a
fulfillment center in the Netherlands to serve European markets commencing in
mid-1998.
TECHNOLOGY
CDnow has developed technologies and implemented systems to support
distributed, reliable and scalable online retailing in a secure and easy-to-
use format. Using a combination of proprietary solutions and commercially
available, licensed technologies, the Company has deployed systems for online
content dissemination, online transaction processing, customer service, market
analysis and electronic data interchange.
Multimedia and User Database. CDnow has developed a database management
system to index, retrieve and manipulate product information, content, product
catalog, orders and transactions, and customer information. This system allows
for rapid searching, sorting, viewing and distribution of a large volume of
content including audio samples, music reviews, track lists, cover art and
photos. The Company uses Oracle 7.3 as the technology for database management.
In December 1997, the Company deployed a data warehouse that enables it to
access detailed transaction and customer interaction data and perform
sophisticated market analysis and predictive modeling.
Store Architecture. The Company's hardware and software systems are based
upon a distributed transaction processing model that allows applications to be
distributed among multiple parallel servers. Many of the software components,
and the pages of the Web site, are developed using a proprietary technology
that extends HTML with product, transaction, retail, and advanced programming
constructs. This technology results in the separation of the page look and
feel from the individual data elements and their associated database lookups
thus reducing software updates for Web site changes and minimizing the
engineering required to maintain a growing amount of items and content.
CDnow's technology also enables Web sites with different formats to integrate
CDnow store elements such as search, discography (artist) and product (album)
pages.
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Interfaces. CDnow has developed technologies and tools for managing
interfaces with Internet service and content providers. A switchboard system
and linking interface are made available to businesses with which the Company
has developed strategic alliances and to Cosmic Credit sites. These allow the
linking of external Web sites, banners, and promotions to items and functions
contained in the CDnow store. Proprietary tools are used by the Company's
Client Relations department to manage the strategic alliances and Cosmic
Credit relationships in an efficient and scalable manner. Similar systems and
tools have been developed by CDnow for its Customer Service department. The
ability to manage customer accounts and orders enables CDnow's Customer
Service department to scale effectively and communicate efficiently, thereby
responding to most inquiries within 24 hours. These systems automate many
routine communications and allow customers to better manage their accounts and
orders.
Fault Tolerance and Scalability. CDnow's hardware servers, storage systems,
Internet connections and networks allow its online systems to operate
continuously and enable it to maintain a 24-hour-a-day, seven-day-a-week
retail store. The Company runs its Oracle databases and Web servers on a
series of Sun Enterprise 4000 servers with fault tolerant characteristics
including "hot-swappable" components. The Company maintains dedicated DS-3
connections to the Internet lines provided by multiple Internet service
providers. This technology, combined with the architecture of the systems,
allows the Company to scale by adding new components or servers while
maintaining performance and cost effectiveness. Both proprietary and
commercially available tools are used to monitor and manage these systems with
minimal operator participation.
Security. The Company employs both commercial and proprietary firewalls
integrated into the architecture of its system to keep its Internet
connections secure. The Company uses the Netscape SSL Commerce Server for
secure electronic transactions over the Internet and uses proprietary EDI
interfaces and private networks to ensure the security of customer order
information and credit card transactions shared with its vendors and credit
card processor.
Advanced Technologies. The Company continually evaluates emerging
technologies and new developments in many areas including electronic commerce,
database management, and networking. The Company is currently evaluating
technologies that allow for the digital distribution of music recordings.
Since April 1997, the Company has been using collaborative filtering to make
personal music recommendations in its customer newsletter, The CDnow Update.
In November 1997, as part of the Company's Gift Center, online recommendation
technology was made available to all CDnow shoppers, and this application was
expanded with the introduction of the Album Advisor feature in January 1998.
COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive, and the Company expects that competition will further intensify
in the future. Barriers to entry are minimal, and current and new competitors
can launch new sites at a relatively low cost. According to Jupiter, there
were approximately 100 online music retailers as of June 1997. In addition,
the broader retail music industry is intensely competitive. The Company
currently competes with a variety of companies, including (i) online vendors
of music, music videos and other related products, (ii) online vendors of
movies, books and other related products, (iii) online service providers which
offer music products directly or in cooperation with other retailers, (iv)
traditional retailers of music products, including specialty music retailers,
(v) other retailers that offer music products, including mass merchandisers,
superstores and consumer electronic stores; and (vi) non-store retailers such
as music clubs. Many of these traditional retailers also support dedicated Web
sites which compete directly with the Company.
The Company believes that the principal competitive factors in its online
market are brand recognition, selection, price, effectiveness of advertising
and other customer acquisition efforts, variety of value-added services, ease
of use, site content, quality of service and technical expertise. Many of the
Company's current and potential competitors have longer operating histories,
larger customer bases,
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greater brand recognition and significantly greater financial, marketing and
other resources than the Company. The Company is aware that certain of its
competitors have adopted and may continue to adopt aggressive pricing or
inventory availability policies and devote substantially more resources to Web
site and systems development than the Company. Increased competition may
result in reduced operating margins, loss of market share and a diminished
brand franchise.
There can be no assurance that the Company will be able to compete
successfully against current and future competitors. New technologies and the
expansion of existing technologies may increase the competitive pressures of
the Company. For example, applications that select specific titles from a
variety of Web sites based on factors such as price may channel customers to
online retailers that compete with the Company. In addition, many companies
that allow access to transactions through network access or Web browsers
promote the Company's competitors and could charge the Company a substantial
fee for inclusion.
INTELLECTUAL PROPERTY
The Company regards its trademarks, trade secrets and similar intellectual
property as valuable to its business, and relies on trademark and copyright
law, trade secret protection and confidentiality and/or license agreements
with its employees, partners and others to protect its proprietary rights.
There can be no assurance that the steps taken by the Company will be adequate
to prevent misappropriation or infringement of its intellectual property.
The Company has licensed in the past, and expects that it may license in the
future, certain of its proprietary rights, such as trademarks or copyrighted
material, to third parties. While the Company attempts to ensure that the
quality of its brand is maintained by such licensees, there can be no
assurance that such licensees will not take actions that might materially
adversely affect the value of the Company's proprietary rights or reputation,
which could have a material adverse effect on the Company. See "Risk Factors--
Trademarks and Proprietary Rights; Unlicensed Arrangements; Risk of Claims
Resulting from Lack of License Rights."
EMPLOYEES
As of April 30, 1998, the Company had 115 full-time and 12 part-time
employees. The Company also employs independent contractors and other
temporary employees in its editorial, operations and administrative functions.
None of the Company's employees is represented by a labor union, and the
Company considers its employee relations to be good. Competition for qualified
personnel in the Company's industry is intense, particularly among software
development and other technical staff. The Company believes that its future
success will depend in part on its continued ability to attract, hire and
retain qualified personnel. See "Risk Factors--Risk of Inability to Manage
Potential Growth" and "--Dependence on Key Personnel; Need for Additional
Personnel."
FACILITIES
The Company's executive offices are located in, and substantially all of its
operating activities are conducted from, leased office space located in
Jenkintown, Pennsylvania. The Company has leased this facility, which contains
approximately 17,000 square feet, under a lease that expires in September
2002. The Company has signed a non-binding letter of intent to relocate to a
nearby facility, which contains approximately 60,000 square feet, under a
lease that would expire in 2006. The Company believes that additional space
may be required as its business expands and believes that it will be able to
obtain suitable space as needed. The Company does not own any real estate.
LEGAL PROCEEDINGS
From time-to-time, the Company may be involved in litigation relating to
claims arising out of its ordinary course of business. The Company is not
currently engaged in litigation. See "Risk Factors--Government Regulation and
Legal Uncertainties" for information regarding a demand by certain foreign
distributors that the Company cease the sale of certain titles in Germany.
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MANAGEMENT
OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Jason Olim.............. 28 President, Chief Executive Officer and Chairman of the Board of Directors
Matthew Olim............ 28 Technical Lead, Secretary, Treasurer and Director
Rod Parker.............. 55 Senior Vice President of Product Management and Marketing
Joel Sussman............ 49 Vice President and Chief Financial Officer
Michael Krupit.......... 34 Vice President of Technology
Robert Saltzman......... 46 Vice President of Strategic Business Development
David Capozzi........... 42 Vice President and General Counsel
Steve Dong.............. 39 Vice President of Operations
Alan Meltzer(2)......... 53 Director
Patrick Kerins(1)(2).... 43 Director
John Regan(1)(2)........ 39 Director
</TABLE>
- ---------------------
(1) Member of the Audit Committee of the Company's Board of Directors.
(2) Member of the Compensation Committee of the Company's Board of Directors.
Jason Olim co-founded the Company in February 1994 and has been its
President since the Company's inception and its Chief Executive Officer since
November 1997. Previously, Mr. Olim was employed in the Professional Services
group of Soft-Switch, Inc. where he designed and built software systems for
routing mail and documents for domestic and international clients. Mr. Olim
has a Bachelor of Arts degree in Computer Science from Brown University.
Matthew Olim co-founded the Company in February 1994 and has been
responsible for the development of the Company's system architecture and
transactions systems. Mr. Olim has a Bachelor of Arts degree in Astrophysics
from Columbia University.
Rod Parker has been the Senior Vice President of Product Management and
Marketing since June 1997. Mr. Parker served as the Vice President of
Interactive Merchandising at Time Warner Cable Programming from September 1995
to June 1997; General Manager of Catalog I, a joint venture between Time
Warner and Spiegel, Inc., from October 1993 to September 1995; and in various
other positions with Spiegel, Inc. (including Vice President, New Media and
Vice President, Creative Division) from April 1987 to September 1995. Mr.
Parker spent more than twenty years in the advertising industry, including
service as a Senior Vice President in account management with Ogilvy and
Mather.
Joel Sussman has been a Vice President and Chief Financial Officer since
September 1997. From June 1995 to September 1997, Mr. Sussman was an
independent financial management consultant and served as Interim Chief
Financial Officer of a number of companies, including CDnow. From July 1994 to
June 1995, Mr. Sussman was Vice President, Finance and Administration, and
Chief Financial Officer of Personnel Data Systems, Inc. From January 1991 to
December 1994, Mr. Sussman was Vice President of Finance and Chief Financial
Officer of The Devereux Foundation. Prior to January 1991, Mr. Sussman served
for 10 years as Treasurer of Decision Data, Inc. and six years in commercial
banking and leasing. Mr. Sussman is a Certified Public Accountant and
Certified Management Accountant and holds a Masters degree in Business
Administration from the Wharton School of the University of Pennsylvania.
Michael Krupit has been the Vice President of Technology since October 1997
and was the Director of Technology from April 1997 to October 1997. Mr. Krupit
was the Director of Technology and Product Development at Infonautics, Inc., a
provider of searching, viewing, and retrieval applications for the Internet,
from February 1994 to March 1997. Mr. Krupit was the Development Manager at
Verity, Inc., a provider of online information and archive services, from
October 1989 to November 1993.
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Robert Saltzman has been the Vice President of Strategic Business
Development since December 1997. Mr. Saltzman served as the Director of
Business Development at Bell Atlantic Network Integration from November 1995
to December of 1997. From 1987 to 1995, Mr. Saltzman held various sales and
marketing positions with Unisys Corporation.
David Capozzi has been a Vice President and General Counsel since April
1998. From February 1996 to April 1998, Mr. Capozzi was an attorney with the
law firm of Morgan, Lewis & Bockius LLP. Mr Capozzi also has over 14 years of
experience in varying capacities in software design and development, including
seven years with Marriott Corporation. Mr. Capozzi holds a Juris Doctorate
from The American University, Washington College of Law, a Masters in Business
Administration from the Katz Graduate School of Business of the University of
Pittsburgh and a Bachelor of Science in Computer Science from the University
of Pittsburgh.
Steve Dong has agreed to become the Vice President of Operations effective
May 25, 1998. Mr. Dong served as the Director of Operations at Egghead
Computer from July of 1995 to May of 1998. From January 1994 to July 1995, Mr.
Dong was Chief Operating Officer of Mac's Place, a wholly owned subsidiary of
Egghead Computer. From 1987 to 1994, Mr. Dong held various management
positions with Egghead Software including Director of Distribution and
Transportation.
Alan Meltzer has been a director since December 1996. Mr. Meltzer has been
the Chairman and Chief Executive Officer of Wind-up Entertainment, Inc., a New
York based record label distributed through Bertelsman Music Group. Mr.
Meltzer was the founder of CD One Stop, Inc., a distributor of CDs, and was
its Chief Executive Officer from April 1986 to August 1993 and was the
President of Alliance Entertainment, a distributor and the successor to CD One
Stop, Inc., from September 1993 to September 1994. Mr. Meltzer was elected to
the Board of Directors in December 1996 pursuant to an agreement among certain
shareholders of the Company that terminated in February 1998.
Patrick Kerins has been a director since August 1997. Mr. Kerins is a
Managing Director of Grotech Capital Group IV, LLC ("Grotech Capital"). From
1987 to March 1997, he served in the Investment Banking Division of Alex.
Brown & Sons Incorporated, most recently as a Managing Director beginning in
January 1994.
John Regan has been a director since July 1997. Since February 1995, Mr.
Regan has been a Vice President of Keystone Venture IV Management Company,
L.P. which is the general partner of Keystone Venture IV, L.P. From 1989 to
February 1995, he was an associate and then general partner of Apex Management
Partnership, a venture capital partnership.
The Company's Amended and Restated Bylaws divide the Board of Directors into
three classes, and each director will serve for a staggered three year term.
Messrs. Kerins and Regan will initially serve as the Class I directors until
the annual meeting of shareholders held in 1998, or until their respective
successors have been elected and qualified. Matthew Olim will initially serve
as the Class II director until the annual meeting of shareholders held in
1999, or until his successor has been elected and qualified. Alan Meltzer and
Jason Olim will initially serve as the Class III directors until the annual
meeting of shareholders held in 2000, or until their respective successors
have been elected and qualified. At each meeting of shareholders, a class of
directors will be elected for a three-year term to succeed the directors of
the same class whose terms are then expiring. To the extent there is an
increase in the number of directors, additional directorships resulting
therefrom will be distributed among the three classes so that, as nearly as
possible, each class will consist of an equal number of directors.
Executive officers of the Company are elected by, and serve at the pleasure
of, the Board of Directors. Jason Olim and Matthew Olim are brothers.
DIRECTOR COMPENSATION
The Company will reimburse its directors for out-of-pocket expenses incurred
in connection with their rendering of services as directors. The Company
currently does not intend to pay cash fees to directors for attendance at
meetings. Directors who are not currently receiving compensation as officers
or employees of the Company will be eligible to receive options under the 1996
Equity Compensation Plan.
41
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Since August 1997, recommendations concerning the aggregate compensation of
the Company's employees were made to the Compensation Committee by the
Company's President. The Compensation Committee was formed in August 1997. The
members of the Compensation Committee are Alan Meltzer, Patrick Kerins and
John Regan. Mr. Kerins is a Managing Director of Grotech Capital, the general
partner of Grotech Capital Partners IV, L.P., a significant shareholder of the
Company. See "Certain Transactions." Prior to August 1997, decisions
concerning the compensation of the Company's employees, including its
executive officers, were made by the Company's Board of Directors, which
included Jason Olim and Matthew Olim.
EXECUTIVE COMPENSATION
The following table provides information concerning compensation paid or
accrued in the year ended December 31, 1997 with respect to the Company's
President and Chief Executive Officer and the two other most highly
compensated executive officers of the Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
----------------
ANNUAL COMPENSATION SHARES OF COMMON
NAME AND --------------------- STOCK UNDERLYING
PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#)
- ------------------ ---- ---------- --------- ----------------
<S> <C> <C> <C> <C>
Jason Olim.......................... 1997 $ 95,630 $ -- --
President, Chief Executive Officer
and Chairman of the Board of
Directors
Matthew Olim........................ 1997 95,630 -- --
Technical Lead, Secretary and
Treasurer
Rod Parker.......................... 1997 122,098 55,000 120,000
Senior Vice President of Product
Management and Marketing
</TABLE>
The following table sets forth certain information regarding stock options
granted by the Company during 1997 to Rod Parker. Neither Jason Olim nor
Matthew Olim have been granted any options by the Company.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
--------------------------------------------
POTENTIAL
REALIZABLE
VALUE AT ASSUMED
PERCENT OF ANNUAL RATES OF
NUMBER OF TOTAL STOCK PRICE
SHARES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(1)
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION ---------------------
NAME GRANTED FISCAL YEAR SHARE DATE 5% 10%
- ---- ---------- ------------ --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Rod Parker.. 120,000 16.6% $1.33 5/29/2007 $2,968,000 $4,820,000
</TABLE>
- ---------------------
(1) Based on the Company's initial public offering price of $16.00 on February
9, 1998.
The following table sets forth information regarding stock options held as
of December 31, 1997 by Rod Parker. Mr. Parker did not exercise any stock
options in 1997.
FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED IN-
NUMBER OF SECURITIES UNDERLYING THE-
UNEXERCISED OPTIONS AT MONEY OPTIONS AT
DECEMBER 31, 1997 DECEMBER 31, 1997(1)
----------------------------------- -------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------------- ----------------- ----------- -------------
<S> <C> <C> <C> <C>
Rod Parker.... -- 120,000 -- $1,760,400
</TABLE>
- ---------------------
(1) There was no public trading market for the Common Stock as of December 31,
1997. These values have been calculated based on the difference between
the Company's initial public offering price of $16.00 on February 9, 1998
and the applicable exercise price.
42
<PAGE>
EQUITY COMPENSATION PLAN
The Company has adopted the Equity Compensation Plan pursuant to which it
has awarded and expects to award in the future stock options to its employees,
officers, non-employee directors and certain independent contractors and
consultants.
The Equity Compensation Plan provides for the issuance to employees, non-
employee directors and eligible independent contractors and consultants of up
to 1,600,000 shares of Common Stock pursuant to the grant of incentive stock
options ("ISOs"), non-qualified stock options ("NQSOs"), Stock Appreciation
Rights ("SARs") and restricted stock. The Equity Compensation Plan is
administered by a Committee of directors appointed by the Board of Directors
(the "Committee") that currently consists of Messrs. Meltzer, Kerins and
Regan. Upon the completion of this Offering, the Committee will consist of two
directors that are not employees of the Company. Subject to the provisions of
the Equity Compensation Plan, the Committee has the authority to determine to
whom stock options will be granted and the terms of any such grant, including
the number of shares subject to, the exercise price and the vesting provisions
of, the award. Subject to the terms of the Equity Compensation Plan, the
Committee may also amend the terms of any outstanding award.
As of April 30, 1998, options to purchase a total of 859,262 shares of
Common Stock at a weighted average exercise price per share of $8.03 were
outstanding. Of these options, options to purchase 99,992 shares of Common
Stock were fully vested and exercisable as of April 30, 1998. As of April 30,
1998, the Company had an additional 740,738 shares of Common Stock available
for future grants under the Equity Compensation Plan.
The option price per share of Common Stock under the Equity Compensation
Plan is determined by the Committee at the time of each grant, provided,
however, that the option price per share for any ISO may not be less than the
fair market value of the Common Stock at the time of the grant. In addition,
if a person who owns 10 percent or more of the Company's Common Stock (a "10%
Shareholder") is granted an ISO, the exercise price for such ISO may not be
less than 110% of the fair market value on the date of grant. The term of each
stock option may not exceed ten years; in the case of a 10% shareholder, the
term may not exceed five years. Payment for the exercise of an option may be
made by cash, check or other instrument as the Committee may accept,
including, in the discretion of the Committee, unrestricted Common Stock of
the Company. The Committee may also allow an option holder to surrender all or
a portion of a stock option and receive a number of shares of Common Stock
with a value equal to the excess of the fair market value over the option
price of the surrendered stock option or portion of the stock option.
43
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SERIES A PREFERRED STOCK
Pursuant to the terms of the Stock Purchase Agreement dated July 15, 1997 by
and among the Company, Keystone Ventures, Jason Olim and Matthew Olim (the
"Stock Purchase Agreement"), Keystone Ventures purchased 254,582 shares of
Series A Convertible Preferred Stock, no par value (the "Series A Preferred
Stock"), of the Company at a purchase price of $4.91 per share. The
outstanding shares of Series A Preferred Stock converted into an aggregate of
381,873 shares of Common Stock in February 1998. John Regan is a Vice
President of the general partner of Keystone Ventures and was elected to the
Company's Board of Directors pursuant to an agreement among certain
shareholders of the Company that was terminated in February 1998. Keystone
Ventures received certain registration rights in connection with this
transaction. See "Shares Eligible for Future Sale--Registration Rights."
SERIES B PREFERRED STOCK
Pursuant to the terms of the Stock Purchase Agreement, as amended by the
Amendment No. 1 to the Stock Purchase Agreement dated as of August 5, 1997 by
and among the Company, Keystone Ventures, Jason Olim, Matthew Olim, Grotech
and ABS, (i) Grotech purchased 1,543,505 shares of Series B Convertible
Preferred Stock, no par value (the "Series B Preferred Stock"), of the Company
at a purchase price of $5.45 per share, (ii) ABS purchased 62,000 shares of
Series B Preferred Stock at a purchase price of $5.45 per share, (iii) the
Company issued to Grotech Capital a warrant to purchase up to 18,349 shares of
Series B Preferred Stock at an exercise price of $5.45 per share, and (iv) the
Company issued to Alex. Brown & Sons Incorporated, a predecessor-in-interest
to BT Alex. Brown Incorporated ("BT Alex. Brown"), a warrant to purchase up to
103,211 shares of Common Stock at an exercise price of $5.45 per share in
partial consideration of its services as the placement agent for the offering
of the Series A and Series B Preferred Stock. The outstanding shares of Series
B Preferred Stock converted into an aggregate of 2,408,258 shares of Common
Stock in February 1998. Patrick Kerins is a Managing Director of Grotech
Capital, the general partner of Grotech IV, and was elected to the Company's
Board of Directors pursuant to an agreement among certain shareholders of the
Company that was terminated in February 1998. Grotech IV, Grotech Capital, ABS
and BT Alex. Brown received certain registration rights in connection with
this transaction. See "Shares Eligible for Future Sale--Registration Rights."
STOCK PURCHASE AND SHAREHOLDERS' AGREEMENT
In May 1995, Milo Productions, Inc. ("Milo"), a corporation owned by Jason
and Matthew Olim, entered into a general partnership with MBL Entertainment,
Inc. ("MBL") to form a partnership company known as "Music Now." In December
1995, MBL, Alan Meltzer and Jason and Matthew Olim entered into non-binding
discussions for the purpose of creating a new company ("NewCo") which would
merge with Music Now. These discussions contemplated, among other things, that
Alan Meltzer would make a significant cash investment in, and Jason and
Matthew Olim would contribute all of the outstanding capital stock of both
Milo and CDnow to, NewCo. The parties abandoned these discussions and, in
August 1996, MBL and Alan Meltzer instituted a legal action against CDnow,
Milo and Jason and Matthew Olim (the "Legal Action"). On December 6, 1996, the
Company entered into a Stock Purchase and Shareholders' Agreement (the "Stock
Purchase and Shareholders Agreement") with Milo, Jason Olim, Matthew Olim,
Alan Meltzer, Jeffrey McClusky, Anthony Lucenti, William Brennan and MBL
pursuant to which (i) Mr. Meltzer purchased, for an aggregate purchase price
of $1,200,000, 921,834 shares of Common Stock and a warrant exercisable for
871,710 shares of Common Stock, and (ii) an aggregate of 882,606 shares of
Common Stock were issued to Messrs. McClusky, Lucenti and Brennan, the sole
shareholders of MBL, in exchange for substantially all of the assets and
business of MBL. Mr. Meltzer effected a cashless exercise of this warrant in
February 1998 and received 809,237 shares. A primary inducement for these
transactions was the mutual release by all parties to the Stock Purchase
Agreement relating to (i) the Legal Action and
44
<PAGE>
(ii) all other prior agreements and relationships among such parties. At the
time of the settlement, MBL and Music Now were inactive and had no assets or
liabilities. In addition, pursuant to the terms of the Stock Purchase and
Shareholders Agreement, each of Jason and Matthew Olim is generally restricted
from competing with the Company's business for a three-year period ending on
the termination of his relationship (either as an employee, director or
consultant) with the Company.
SHAREHOLDER ADVANCES
The Company had indebtedness due to Dave Olim, the father of Jason and
Matthew Olim, in the amount of $74,740, at December 31, 1995. During 1996,
Dave Olim advanced additional funds to the Company and on August 16, 1996, in
consideration of the cancellation of the $81,923 balance of this debt, the
Company issued 41,244 shares of the Company's Common Stock to Dave Olim. The
exchange ratio used to convert the debt into shares of Common Stock was
negotiated among Jason and Matthew Olim and their father, Dave Olim, and
therefore cannot be considered an arms-length transaction.
NOTES PAYABLE
On December 31, 1995, the Company issued a note for $100,000 to Alan
Meltzer, a director of the Company. The proceeds from this loan were used for
working capital purposes. All remaining amounts due under the note, which bore
interest at the rate of 10%, were repaid on December 31, 1996.
From November 16, 1996 through January 31, 1997, the Company received short-
term loans aggregating $190,000 from Saltzman Music Partners and Nathan
Schwartz and $60,000 from Robert Saltzman, an Executive Officer of the Company
and a partner in Saltzman Music Partners. The proceeds from these loans, which
bore interest at the rate of 6%, were used for working capital purposes. On
May 15, 1997, the Company repaid $110,000 of the principal amount due under
these loans. The remaining principal balance was repaid on July 16, 1997. As
additional consideration for these loans, these private investors received
warrants to purchase an aggregate of 136,362 shares of Common Stock (32,727
with respect to Robert Saltzman) at a price of $1.83 per share. The warrants
expire on May 16, 1998 with respect to 59,997 shares of Common Stock and July
16, 1998 with respect to 76,365 shares of Common Stock.
In 1997, the Company obtained three term loans at rates ranging from 8 to 9%
from a bank for an aggregate amount of $219,000. The proceeds from these loans
were used to purchase equipment and are secured by a lien on such equipment.
These loans are guaranteed by Jason Olim and Matthew Olim.
In November 1997, the Company issued $5.8 million aggregate principal amount
of Series A Notes to a group of investors, including $1.0 million to Grotech
and $127,500 to the ABS Employees' Venture Fund Limited Partnership ("ABS").
The Series A Notes, which were repaid in February 1998, bore interest at the
rate of 12% per annum. In addition, the Company issued warrants to these
investors to purchase an aggregate of 48,550 shares of Common Stock at an
exercise price of $11.90 per share, including warrants issued to Grotech and
ABS exercisable for 8,403 and 1,071 shares of Common Stock, respectively. The
warrants issued to ABS have an exercise price equal to $16.00 per share. See
"Underwriting."
45
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Common Stock as of the date of this Prospectus and as
adjusted to reflect the sale of the shares offered hereby by (i) each person
known by the Company to own beneficially more than 5% of the outstanding
shares of Common Stock, (ii) each director of the Company, (iii) each
executive officer of the Company and (iv) all directors and executive officers
of the Company as a group. Unless otherwise indicated below, to the knowledge
of the Company, all persons listed below have sole voting and investment power
with respect to their shares of Common Stock, except to the extent authority
is shared by spouses under applicable law.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO OFFERING AFTER OFFERING#
----------------------- -----------------------
NAME OF BENEFICIAL OWNER SHARES PERCENT SHARES PERCENT
- ------------------------ ------------ ---------- ------------ ----------
<S> <C> <C> <C> <C>
EXECUTIVE OFFICERS AND
DIRECTORS
Jason Olim(1).................. 2,960,025 19.0% 2,960,025 16.0%
Matthew Olim(1)................ 2,960,025 19.0 2,960,025 16.0
Alan Meltzer(2)................ 1,712,621 11.0 1,712,621 9.3
Robert Saltzman(3)............. 42,102 * 42,102 *
Rod Parker(4).................. 30,000 * 30,000 *
Michael Krupit(4).............. 4,500 * 4,500 *
Joel Sussman(4)................ 3,000 * 3,000 *
Patrick Kerins(5).............. 1,569 * 1,569 *
John Regan(6).................. -- -- -- --
All executive officers and
directors as a group
(9 persons)(7)................ 7,713,842 47.9 7,713,842 41.5
FIVE PERCENT HOLDERS
Grotech Partners IV, L.P.(8)... 2,315,258 14.5 2,315,258 12.5
</TABLE>
- ---------------------
# Assumes no exercise of the Underwriters' over-allotment option.
* Less than one percent.
(1) Excludes 41,244 shares owned by Dave Olim, the father of Jason and
Matthew Olim. Jason and Matthew Olim each disclaim beneficial ownership
of these shares. The address of Jason and Matthew Olim is 610 Old York
Road, Suite 300, Jenkintown, Pennsylvania 19046.
(2) The address of Mr. Meltzer is 944 Park Avenue, New York, New York 10028.
(3) Represents 32,727 shares of Common Stock obtainable upon conversion of a
presently exercisable warrant held by a trust of which Mr. Saltzman is
the beneficiary and 9,375 shares of Common Stock obtainable upon the
exercise of a stock option granted under the Equity Compensation Plan.
(4) Represents shares of Common Stock presently obtainable, or obtainable
within the next 60 days, upon the exercise of a stock option granted
under the Equity Compensation Plan.
(5) Represents 1,569 shares of Common Stock obtainable upon the conversion of
a presently exercisable warrant held by Patrick Kerins. Excludes
2,315,258 shares of Common Stock held by Grotech Partners IV, L.P.
Patrick Kerins is a managing director of Grotech Partners IV, L.P. Mr.
Kerins disclaims beneficial ownership of any shares owned by Grotech
Partners IV L.P.
(6) Excludes 381,873 shares of Common Stock held by Keystone Ventures IV,
L.P. ("Keystone"). John Regan is a Vice President of the general partner
of Keystone and disclaims beneficial ownership of any shares owned by
Keystone.
(7) Includes an aggregate of 81,171 shares of Common Stock obtainable upon
the exercise of presently exercisable options and warrants.
(8) The address of Grotech Partners IV, L.P. is 9690 Deereco Road, Timonium,
Maryland 21093. Grotech Partners IV, L.P. disclaims beneficial ownership
of any shares beneficially owned by Patrick Kerins.
46
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares of
Common Stock, no par value (the "Common Stock"), and 20,000,000 shares of
Preferred Stock, no par value (the "Preferred Stock"). Immediately after the
sale of the 2,500,000 shares of Common Stock offered hereby, there will be
18,5706,302 shares of Common Stock outstanding and no shares of Preferred
Stock outstanding. The following summary is qualified in its entirety by
reference to the Company's Amended and Restated Articles of Incorporation (the
"Articles of Incorporation"), which is included as an exhibit to the
Registration Statement of which this Prospectus is a part.
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of shareholders and do not have
cumulative voting rights. The election of directors is determined by a
plurality of the votes cast and, except as otherwise required by law, all
other matters are determined by a majority of the votes cast. The holders of
Common Stock are entitled to receive ratably such dividends, if any, as may be
declared by the Board of Directors out of funds legally available therefor,
subject to any preferential dividend rights of outstanding Preferred Stock.
Upon the liquidation, dissolution or winding up of the Company, subject to any
preferential liquidation rights of any outstanding shares of Preferred Stock,
the holders of Common Stock are entitled to receive ratably the net assets of
the Company available after the payment of all debts and other liabilities.
The holders of Common Stock have no preemptive, subscription, redemption,
sinking fund or conversion rights. The rights and preferences of holders of
Common Stock will be subject to the rights of any series of Preferred Stock
which the Company may issue in the future.
PREFERRED STOCK
The Company, by resolution of the Board of Directors and without any further
vote or action by the shareholders, has the authority, subject to certain
limitations prescribed by law, to issue from time to time up to an aggregate
of 20,000,000 shares of Preferred Stock in one or more classes or series and
to determine the designation and the number of shares of any class or series
as well as the voting rights, preferences, limitations and special rights, if
any, of the shares of any such class or series, including the dividend rights,
conversion rights, voting rights, redemption rights, and liquidation
preferences. The issuance of Preferred Stock may have the effect of delaying,
deferring or preventing a change of control of the Company.
PENNSYLVANIA ANTI-TAKEOVER LAWS
The Pennsylvania Business Corporation Law of 1988, as amended (the "BCL"),
contains provisions applicable to publicly held Pennsylvania corporations that
may be deemed to have an anti-takeover effect. The Company has specifically
opted out of all but one of these provisions. The following is a description
of the provision of the BCL that remains applicable to the Company.
Under Section 1715 of the BCL, directors of the corporation are not required
to regard the interests of the shareholders as being dominant or controlling
in considering the best interests of the corporation. The directors may
consider, to the extent they deem appropriate, such factors as the effects of
any action upon any group affected by such action (including shareholders,
employees, suppliers, customers and creditors of the corporation and upon
communities in which offices or other establishments of the corporation are
located); the short term and long term interests of the corporation (including
benefits that may accrue to the corporation from its long term plans and the
possibility that these interests may be best served by the continued
independence of the corporation); the resources, intent and conduct of any
person seeking to acquire control of the corporation; and all other pertinent
factors. Section 1715 of the BCL further provides that any act of the board of
directors, a committee of the board or an individual
47
<PAGE>
director relating to or affecting an acquisition or potential or proposed
acquisition of control to which a majority of disinterested directors have
assented will be presumed to satisfy the standard of care set forth in the
BCL, unless it is proven by clear and convincing evidence that the
disinterested directors did not consent to such act in good faith after
reasonable investigation. As a result of this and the other provisions of
Section 1715 of the BCL, directors are provided with broad discretion with
respect to actions that may be taken in response to acquisitions or proposed
acquisitions of corporate control.
Section 1715 of the BCL may discourage open market purchases of Common Stock
or a non-negotiated tender or exchange offer for the Common Stock and,
accordingly, may be considered disadvantageous by a shareholder who would
desire to participate in any such transaction. In addition, Section 1715 of
the BCL may have a depressive effect on the price of the Common Stock.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar with respect to the Common Stock is
StockTrans, Inc., Ardmore, Pennsylvania.
48
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
The market price of the Common Stock will be adversely affected by the sale
of substantial amounts of the Common Stock in the public market following this
Offering. Upon completion of this Offering, the Company will have 18,706,302
shares of Common Stock outstanding (19,111,302 shares if the over-allotment
option is fully exercised). Of these shares, the Common Stock sold in this
Offering, together with 4,715,000 shares of Common Stock sold in a registered
offering in February 1998, will be freely tradeable without restriction or
further registration under the Act. The remaining 11,291,302 shares of Common
Stock (the "Restricted Shares") were sold by the Company in reliance on
exemptions from the registration requirements of the Securities Act and are
"restricted securities" as defined in Rule 144 and may not be sold in the
absence of registration under the Securities Act unless an exemption is
available, including an exemption afforded by Rule 144 or Rule 701 under the
Securities Act. Subject to the contractual restrictions described below,
approximately Restricted Shares are currently eligible for sale,
subject to certain restrictions imposed by Rule 144. Certain restrictions
apply to any shares of Common Stock purchased in this Offering by affiliates
of the Company, which may be sold subject to volume limitations and certain
other conditions of Rule 144.
The Common Stock that may be issued pursuant to the options granted under
the Equity Compensation Plan have been registered on a Form S-8 Registration
Statement. These shares of Common Stock generally may be resold in the public
market without restriction or limitation, except in the case of affiliates of
the Company, who generally may only resell such shares in accordance with the
provisions of Rule 144, other than the holding period requirement.
The Company and its officers, directors and certain shareholders who
collectively beneficially own 10,329,802 shares of Common Stock, have agreed
with the underwriters that they will not sell or otherwise dispose of any
shares of Common Stock (excluding shares offered by this Prospectus or shares
purchased in the open market) for a period of 90 days from the date of this
Prospectus without the prior written consent of BT Alex. Brown Incorporated.
In addition, the holders of approximately 827,356 shares of Common Stock have
agreed not to sell any shares of Common Stock (excluding any shares purchased
in the open market) until after August 8, 1998.
Keystone Ventures, Grotech, ABS, BT Alex. Brown, Alan Meltzer, Jeffrey
McClusky, Anthony Lucenti and William Brennan (collectively, the "Registration
Rights Holders"), who collectively beneficially own 5,330,008 shares of Common
Stock, have been granted by the Company certain demand and incidental
registration rights. Under these registration rights, the Registration Rights
Holders may require, on not more than two occasions at any time after six
months following the date of this Offering, that the Company use its best
efforts to file a registration statement covering the public sale of Common
Stock having an aggregate public offering price of at least $10,000,000;
provided, however, that the Company will have the right to delay such a demand
registration under certain circumstances for a period not in excess of 120
days each in any 12-month period. The Registration Rights Holders will also
have piggyback registration rights, subject to underwriter cut back, and the
Registration Rights Holders, as separate classes, will have the right to one
demand registration every 12 months on Form S-3, provided at least 30% of the
securities within such class join in the demand, at least $500,000 worth of
securities are to be sold in the registration and the Company will have the
right to delay the registration for up to 120 days if, in the good faith
judgment of the Company, the registration would be seriously detrimental to
the Company and its shareholders. The registration rights expire in February
2004, and no Registration Rights Holder can exercise any registration rights
for an intended sale that can be effectuated in compliance with Rule 144 under
the Securities Act.
49
<PAGE>
UNDERWRITING
Subject to the terms and conditions set forth in the underwriting agreement
(the "Underwriting Agreement"), the Company has agreed to sell to the
underwriters named below (the "Underwriters"), and each of the Underwriters,
for whom BT Alex. Brown Incorporated, NationsBanc Montgomery Securities LLC
and Hambrecht & Quist LLC are acting as representatives (the
"Representatives"), has severally agreed to purchase from the Company, the
aggregate number of shares of Common Stock set forth opposite its name below.
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
BT Alex. Brown Incorporated..............................
NationsBanc Montgomery Securities LLC....................
Hambrecht & Quist LLC....................................
--------
Total..................................................
========
</TABLE>
In the Underwriting Agreement, the Underwriters have agreed, subject to the
terms and conditions set forth therein, to purchase all of the shares of
Common Stock offered by this Prospectus (other than those subject to the Over-
allotment Option described below) if any such shares are purchased. In the
event of a default by the Underwriters, the Underwriting Agreement provides
that, in certain circumstances, the purchase commitments of non-defaulting
Underwriters may be increased or the Underwriting Agreement may be terminated.
The Company has granted to the Underwriters an option, exercisable by the
Representatives during the 30-day period after the date of this Prospectus, to
purchase up to an aggregate of 405,000 shares of Common Stock at the same
price per share as the initial shares of Common Stock to be purchased by the
Underwriters. The Representatives may exercise such option only to cover over-
allotments in the sale of shares of Common Stock. To the extent that the
Representatives exercise such option, the Underwriters will have a firm
commitment, subject to certain conditions, to purchase the same proportion of
such additional shares of Common Stock as the number of shares of Common Stock
to be purchased and offered by such Underwriters in the above table bears to
the total number of shares in the above table.
The Company has been advised by the Representatives that the Underwriters
propose initially to offer the shares of Common Stock to the public at the
offering price set forth on the cover page of this Prospectus, and through the
Representatives to certain dealers at such price less a concession not in
excess of $. per share. The Underwriters may allow, and such dealers may
reallow, a concession not in excess of $. per share to certain other
dealers. After the Offering, the public offering price and other selling terms
may be changed.
The Company and its officers, directors and certain shareholders have agreed
that, except for shares offered by this Prospectus, the underlying shares sold
by the Company upon the exercise of options or warrants or shares purchased in
the open market, they will not offer, sell, contract to sell, or otherwise
dispose of, directly or indirectly, any shares of Common Stock, or any
interests therein, or any securities convertible into, or exchangeable for,
shares of Common Stock, or rights to acquire the same, for a period of 90 days
from the date of this Prospectus without the prior written consent of the
Representatives. Such consent may be given without any public notice.
50
<PAGE>
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute
to payments that the Underwriters may be required to make in respect thereof.
In connection with the Offering, certain persons participating in the
Offering may engage in transactions that stabilize, maintain or otherwise
affect the price of the Common Stock. Specifically, the Representatives may
bid for and purchase Common Stock in the open market to stabilize the price of
the Common Stock. The Underwriters may also over-allot the Offering, creating
a syndicate short position, and may bid for and purchase Common Stock in the
open market to cover the syndicate short position. The Representatives may
also impose a penalty bid pursuant to which the Representatives may reclaim
from any Underwriter or dealer participating in the Offering the selling
concession on shares sold by them and purchased by the Representatives in
stabilizing or short covering transactions. In addition, the Underwriters may
bid for and purchase the Common Stock above market levels that may otherwise
prevail. The Underwriters are not required to engage in these activities, and
may end these activities at any time.
The Underwriters have informed the Company that they do not intend to
confirm sales of Common Stock offered hereby for accounts over which they
exercise discretionary authority.
On August 5, 1997 the Company issued to a predecessor-in-interest to BT
Alex. Brown a warrant (the "Warrant") to purchase 154,817 shares of Series B
Preferred Stock at an exercise price of $3.63 per share in partial
consideration of its services as the placement agent for the offering by the
Company of the Series A Preferred Stock and Series B Preferred Stock. On the
same date the ABS Employees' Venture Fund Limited Partnership ("ABS")
purchased 93,000 shares of Series B Preferred Stock (the "ABS Shares") at a
purchase price of $3.63 per share. Pursuant to the terms of an Investor Rights
Agreement dated July 15, 1997 among BT Alex. Brown, ABS, Grotech, Keystone
Ventures and certain holders of Common Stock, the shares of Common Stock owned
by ABS and the Warrant and the shares of Common Stock receivable by BT Alex.
Brown through exercise of the Warrant may not be sold or otherwise transferred
prior to August 9, 1998. On November 26, 1997, ABS was issued $127,500 of the
Series A Notes with associated warrants ("Associated Warrants") to purchase
1,071 shares of Common Stock at an exercise price of $11.90 per share.
Pursuant to the rules and regulations of the National Association of
Securities Dealers, Inc., the Associated Warrants beneficially held by current
BT Alex. Brown employees have been deemed compensation of BT Alex. Brown in
connection with the Company's February 1998 initial public offering. Pursuant
to such rules and regulations, the Associated Warrants have an exercise price
equal to $16.00 per share, the initial public offering price in the Company's
initial public offering, and the Associated Warrants and the Common Stock
receivable by ABS upon exercise of the Associated Warrants may not be sold or
otherwise transferred, assigned, pledged or hypothecated until February 9,
1999.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Certain
legal matters in connection with the Offering are being passed upon for the
Underwriters by Schnader Harrison Segal & Lewis LLP, Philadelphia,
Pennsylvania.
EXPERTS
The financial statements of the Company, as of December 31, 1996 and 1997
and for the years ended December 31, 1995, 1996 and 1997, included in this
Prospectus have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, and are
included herein in reliance upon the authority of such firm as experts in
giving said report.
51
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act (the "Registration Statement") with respect to
the Common Stock offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Common Stock offered hereby, reference is hereby made to the Registration
Statement and to the exhibits and schedules filed therewith. Statements
contained in this Prospectus as to the contents of any agreement or other
document are not necessarily complete, and in each instance, reference is made
to the copy of such agreement or document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. A copy of the Registration Statement may be inspected without
charge at the Commission's principal office in Washington, D.C. at 450 Fifth
Street, N.W., Washington, D.C. 20549, and at the Commissions's Regional
Offices at Seven World Trade Center, Suite 1300, New York, New York 10048, and
Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661, and copies may be obtained at prescribed rates from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549. In addition, the Registration Statement and certain other filings
made with the Commission through its Electronic Data Gathering Analysis and
Retrieval ("EDGAR") system are publicly available through the Company's Web
site located at http://www.sec.gov. The Registration Statement has been filed
with the Commission through EDGAR.
52
<PAGE>
CDNOW, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants.................................. F-2
Consolidated Balance Sheets............................................... F-3
Consolidated Statements of Operations..................................... F-4
Consolidated Statements of Redeemable Convertible Preferred Stock and
Shareholders' Equity (Deficit)........................................... F-5
Consolidated Statements of Cash Flows..................................... F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To CDnow, Inc.:
We have audited the accompanying consolidated balance sheets of CDnow, Inc.
(a Pennsylvania Corporation) and Subsidiaries as of December 31, 1996 and
1997, and the related consolidated statements of operations, redeemable
convertible preferred stock and shareholders' equity (deficit) and cash flows
for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CDnow, Inc. and
Subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ ARTHUR ANDERSEN LLP
Philadelphia, Pa.,
January 14, 1998 (except for the
stock split discussed in Note 2,
as to which the date is February
3, 1998)
F-2
<PAGE>
CDNOW, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
----------------------- ------------
1996 1997 1998
---------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.............. $ 775,865 $10,686,001 $ 60,521,171
Short-term investments................. 245,641 1,003,045 --
Accounts receivable, net of reserve of
$12,000, $77,000 and $89,564.......... 130,437 324,411 564,967
Prepaid expenses and other............. 49,821 2,457,958 2,508,313
---------- ----------- ------------
Total current assets.................. 1,201,764 14,471,415 63,594,451
PROPERTY AND EQUIPMENT, net............. 362,035 1,884,296 2,528,473
OTHER ASSETS............................ 11,660 92,714 104,830
---------- ----------- ------------
$1,575,459 $16,448,425 $ 66,227,754
========== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
CURRENT LIABILITIES:
Notes payable.......................... $ 200,000 $ 5,575,288 $ --
Current portion of term loans payable.. -- 54,091 58,551
Current portion of capitalized lease
obligations........................... 35,942 307,471 376,535
Accounts payable....................... 435,682 8,981,430 5,873,430
Accrued expenses....................... 129,317 579,413 1,020,122
Deferred revenues...................... 166,107 188,466 124,315
Advances due to related parties........ 3,261 3,261 --
---------- ----------- ------------
Total current liabilities............. 970,309 15,689,420 7,452,953
---------- ----------- ------------
TERM LOANS PAYABLE...................... -- 136,293 117,941
---------- ----------- ------------
CAPITALIZED LEASE OBLIGATIONS........... 91,133 825,851 866,571
---------- ----------- ------------
DEFERRED RENT LIABILITY................. -- 56,717 101,300
---------- ----------- ------------
REDEEMABLE SERIES A AND B CONVERTIBLE
PREFERRED STOCK........................ -- 9,492,594 --
---------- ----------- ------------
COMMITMENTS AND CONTINGENCIES (Note 10)
SHAREHOLDERS' EQUITY (DEFICIT):
Preferred stock, no par value,
20,000,000 shares authorized, 254,582
Redeemable Series A Convertible shares
and 1,605,505 Redeemable Series B
Convertible shares issued and
outstanding at December 31, 1997...... -- -- --
Common stock, no par value, 50,000,000
shares authorized, 7,845,684,
7,845,684, and 16,006,302 shares
issued and outstanding at December 31,
1996, 1997 and March 31, 1998......... 579,549 579,549 77,265,547
Additional paid-in capital............. -- 1,325,817 1,325,817
Deferred compensation.................. -- (434,776) (365,600)
Accumulated deficit.................... (65,532) (11,223,040) (20,536,775)
---------- ----------- ------------
Total shareholders' equity (deficit).. 514,017 (9,752,450) 57,688,989
---------- ----------- ------------
$1,575,459 $16,448,425 $ 66,227,754
========== =========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
CDNOW, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------- -----------------------
1995 1996 1997 1997 1998
---------- ----------- ------------ ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
NET SALES............... $2,176,474 $ 6,300,294 $ 17,372,795 $2,581,578 $10,013,889
COST OF SALES........... 1,844,612 5,217,789 14,316,028 2,049,541 8,554,549
---------- ----------- ------------ ---------- -----------
Gross profit.......... 331,862 1,082,505 3,056,767 532,037 1,459,340
---------- ----------- ------------ ---------- -----------
OPERATING EXPENSES:
Operating and
development........... 149,982 669,280 2,541,434 321,128 1,081,049
Sales and marketing.... 200,972 621,454 9,139,348 417,302 8,785,724
General and
administrative........ 180,573 563,593 1,953,078 339,303 850,285
Dispute settlement
(Note 7).............. -- 1,024,030 -- -- --
---------- ----------- ------------ ---------- -----------
531,527 2,878,357 13,633,860 1,077,733 10,717,058
---------- ----------- ------------ ---------- -----------
Operating loss........ (199,665) (1,795,852) (10,577,093) (545,696) (9,257,718)
INTEREST INCOME......... -- -- 201,650 1,390 506,039
INTEREST EXPENSE........ (1,248) (14,556) (371,962) -- (446,514)
---------- ----------- ------------ ---------- -----------
NET LOSS................ (200,913) (1,810,408) (10,747,405) (544,306) (9,198,193)
ACCRETION OF PREFERRED
STOCK TO REDEMPTION
VALUE.................. -- -- (410,103) -- (115,542)
---------- ----------- ------------ ---------- -----------
NET LOSS APPLICABLE TO
COMMON SHAREHOLDERS.... $ (200,913) $(1,810,408) $(11,157,508) $ (544,306) $(9,313,735)
========== =========== ============ ========== ===========
NET LOSS PER COMMON
SHARE.................. $ (1.42) $ (0.07) $ (0.78)
============ ========== ===========
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING............ 7,845,684 7,845,684 12,015,090
============ ========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
CDNOW, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
SHAREHOLDERS' EQUITY (DEFICIT)
---------------------------------------------------------------------------
REDEEMABLE
CONVERTIBLE COMMON STOCK ADDITIONAL
PREFERRED ----------------------- PAID-IN DEFERRED ACCUMULATED
STOCK SHARES AMOUNT CAPITAL COMPENSATION DEFICIT TOTAL
----------- ----------- ----------- ---------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1994................... $ -- -- $ -- $ 40,000 $ -- $ (58,449) $ (18,449)
Issuance of common
stock to founders..... -- 6,000,000 -- -- -- -- --
Services contributed by
the founders (Note
9).................... -- -- -- 120,000 -- -- 120,000
Net loss............... -- -- -- -- -- (200,913) (200,913)
---------- ----------- ----------- ---------- --------- ------------ -----------
BALANCE, DECEMBER 31,
1995................... -- 6,000,000 -- 160,000 -- (259,362) (99,362)
Sale of common stock
and warrants.......... -- 921,834 1,069,250 130,750 -- -- 1,200,000
Issuance of common
stock in settlement of
a dispute (Note 7).... -- 882,606 1,024,030 -- -- -- 1,024,030
Issuance of common
stock to repay
advances due to a
related party......... -- 41,244 81,923 -- -- -- 81,923
Services contributed by
the founders (Note
9).................... -- -- -- 117,834 -- -- 117,834
Termination of S
Corporation status.... -- -- (1,595,654) (408,584) -- 2,004,238 --
Net loss............... -- -- -- -- -- (1,810,408) (1,810,408)
---------- ----------- ----------- ---------- --------- ------------ -----------
BALANCE, DECEMBER 31,
1996................... -- 7,845,684 579,549 -- -- (65,532) 514,017
Sale of Redeemable
Series A and B
Convertible Preferred
Stock, net of expenses
and value of warrants
issued................ 9,082,491 -- -- 170,000 -- -- 170,000
Value of warrants
issued with Series A
Convertible Notes..... -- -- -- 404,425 -- -- 404,425
Grant of common stock
options below deemed
fair value for
accounting purposes... -- -- -- 751,392 (751,392) -- --
Amortization of
deferred
compensation.......... -- -- -- -- 316,616 -- 316,616
Accretion of preferred
stock to redemption
value................. 410,103 -- -- -- -- (410,103) (410,103)
Net loss............... -- -- -- -- -- (10,747,405) (10,747,405)
---------- ----------- ----------- ---------- --------- ------------ -----------
BALANCE, DECEMBER 31,
1997................... 9,492,594 7,845,684 579,549 1,325,817 (434,776) (11,223,040) (9,752,450)
Mandatory conversion of
Redeemable Series A
and B Convertible
Preferred Stock to
Common Stock
(unaudited)........... (9,608,136) 2,790,131 9,608,136 -- -- -- 9,608,136
Issuance of common
stock from
consummation of
initial public
offering, net of
offering costs
(unaudited)........... -- 4,561,250 67,077,862 -- -- -- 67,077,862
Cashless exercise of
warrants (unaudited).. -- 809,237 -- -- -- -- --
Amortization of
deferred compensation
(unaudited)........... -- -- -- -- 69,176 -- 69,176
Accretion of preferred
stock to redemption
value (unaudited)..... 115,542 -- -- -- -- (115,542) (115,542)
Net loss (unaudited)... -- -- -- -- -- (9,198,193) (9,198,193)
---------- ----------- ----------- ---------- --------- ------------ -----------
BALANCE MARCH 31,1998
(unaudited)............ $ -- $16,006,302 $77,265,547 $1,325,817 $(365,600) $(20,536,775) $57,688,989
========== =========== =========== ========== ========= ============ ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
CDNOW, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH
YEAR ENDED DECEMBER 31, 31,
------------------------------------ ---------------------------
1995 1996 1997 1997 1998
--------- ----------- ------------ --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss................. $(200,913) $(1,810,408) $(10,747,405) $(544,306) $(9,198,193)
Adjustments to reconcile
net loss to net cash
provided by (used in)
operating activities--
Depreciation and
amortization........... 32,999 105,439 1,066,815 51,000 517,408
Provision for returns
and doubtful accounts.. -- 12,000 65,000 -- 91,564
Common stock issued in
settlement of a
dispute................ -- 1,024,030 -- -- --
Services contributed by
the founders........... 120,000 117,834 -- -- --
Increase in operating
assets and
liabilities--
Accounts receivable.... (56,127) (86,310) (258,974) (18,320) (332,120)
Prepaid expenses and
other................. (26,994) (34,487) (2,401,794) 1,343 (62,471)
Accounts payable....... 109,386 326,296 8,545,748 252,886 (3,108,000)
Accrued expenses....... 58,124 68,139 450,096 -- 440,709
Deferred revenue....... 4,952 161,155 22,359 3,857 (64,151)
Deferred rent
liability............. -- -- 56,717 (18,183) 44,583
--------- ----------- ------------ --------- -----------
Net cash provided by
(used in)
operating activities.. 41,427 (116,312) (3,201,438) (271,723) (11,670,671)
--------- ----------- ------------ --------- -----------
INVESTING ACTIVITIES:
Purchases of short-term
investments............. -- (245,641) (1,005,501) -- --
Sales and maturities of
short-term investments.. -- -- 248,097 248,097 1,003,045
Purchases of property and
equipment............... (135,777) (198,985) (912,560) (218,794) (713,786)
--------- ----------- ------------ --------- -----------
Net cash provided by
(used in) investing
activities........... (135,777) (444,626) (1,669,964) 29,303 289,259
--------- ----------- ------------ --------- -----------
FINANCING ACTIVITIES:
Borrowings on term loans
payable................. -- -- 218,563 147,286 --
Payments on term loans
payable................. -- -- (28,179) -- (13,892)
Borrowings on notes
payable................. 100,000 200,000 -- 57,500 --
Payments on notes
payable................. -- (100,000) (200,000) -- --
Proceeds from sale of
common stock and
warrants................ -- 1,200,000 -- -- --
Proceeds from (repayment
of) issuance of Series A
Notes and warrants...... -- -- 5,602,706 -- (5,777,500)
Proceeds from sale of
preferred stock......... -- -- 9,252,491 -- --
Proceeds from (repayment
of) advances due to
related parties......... 37,683 6,341 -- -- (3,261)
Payments on capitalized
lease obligations....... (1,529) (13,350) (64,043) (8,985) (66,627)
Proceeds from issuance of
common stock, net....... -- -- -- -- 67,077,862
--------- ----------- ------------ --------- -----------
Net cash provided by
financing
activities........... 136,154 1,292,991 14,781,538 195,801 61,216,582
--------- ----------- ------------ --------- -----------
INCREASE (DECREASE) IN
CASH AND
CASH EQUIVALENTS......... 41,804 732,053 9,910,136 (46,619) 49,835,170
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD...... 2,008 43,812 775,865 775,865 10,686,001
--------- ----------- ------------ --------- -----------
CASH AND CASH EQUIVALENTS,
END OF PERIOD............ $ 43,812 $ 775,865 $ 10,686,001 $ 729,246 $60,521,171
========= =========== ============ ========= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED MARCH 31,
1997 AND 1998 IS UNAUDITED)
1. THE COMPANY:
CDnow, Inc. and Subsidiaries (the "Company") is an online retailer of
compact discs ("CDs") and other music-related products. The Company strives to
combine the advantages of online commerce with superior customer focus in
order to be the authoritative source for CDs and other music-related products.
The Company contracts with outside warehouses for fulfillment services to
deliver products to customers and, therefore, the Company maintains no
inventories.
Since inception (February 12, 1994), the Company has incurred significant
losses, and as of December 31, 1998 had accumulated losses of $22.0 million.
For the year ended December 31, 1997, and the three months ended March 31,
1998 the Company's net loss was $10.7 million and $9.2 million, respectively.
The Company intends to invest heavily in marketing and promotion, strategic
alliances, Web site development and technology, and development of its
administration organization. As a result, the Company believes that it will
incur substantial operating losses for the foreseeable future, and that the
rate at which such losses will be incurred will increase significantly from
current levels. Because the Company has relatively low product gross margins,
achieving profitability given planned investment levels depends upon the
Company's ability to generate and sustain substantially increased revenue
levels. There can be no assurance that the Company will be able to generate
sufficient revenues to achieve or sustain profitability in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Prospectus.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of CDnow, Inc.
and its wholly owned subsidiaries. All intercompany balances and transactions
have been eliminated in consolidation.
Interim Financial Statements
The financial statements for the three-month periods ended March 31, 1997
and 1998 are unaudited and, in the opinion of management, include all
adjustments (consisting only of normal and recurring adjustments) necessary
for a fair presentation of results for these interim periods. The results of
operations for the three-months ended March 31, 1998 are not necessarily
indicative of the results expected for the entire year.
Management's 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.
Net Loss Per Common Share
The Company has presented net loss per share for 1997 and for the three
months ended March 31, 1997 and 1998 pursuant to Statement of Financial
Accounting Standards (SFAS) No. 128 "Earnings per Share" and the Securities
and Exchange Commission Staff Accounting Bulletin No. 98. Net loss per share
has not been presented for any period prior to 1997, since such amounts are
not considered meaningful as a result of the Company's S Corporation status
during those periods.
F-7
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Basic loss per share was computed by dividing net loss applicable to common
shareholders by the weighted average number of shares of Common Stock
outstanding during 1997 and the three months ended March 31, 1997 and 1998.
Diluted loss per share has not been presented, since the impact on loss per
share using the treasury stock method is anti-dilutive due to the Company's
losses.
Cash and Cash Equivalents
Cash equivalents are carried at cost plus accrued interest, which
approximates fair value. The Company considers all highly liquid investments
with an original maturity date of three months or less to be cash equivalents.
Cash equivalents of $742,784, $10,005,132, and $57,001,059 at December 31,
1996 and 1997 and March 31, 1998, respectively, included government mortgage-
backed bonds and highly rated corporate securities.
Short-Term Investments
At December 31, 1996 and 1997, short-term investments represented government
mortgage-backed bonds maturing in less than a year and each was classified as
available-for-sale. Pursuant to SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," available-for-sale securities are
carried at fair value, based on quoted market prices, with unrealized gains
and losses, net of tax, reported as a separate component of shareholders'
equity. At December 31, 1996 and 1997, amortized cost approximated fair value
and unrealized gains and losses were immaterial. Gross unrealized holding
gains and losses were immaterial in 1995, 1996 and 1997. The gross proceeds
from sales and maturities of short-term investments were $248,097 in 1997. No
short-term investments were sold or matured prior to 1997. Gross realized
gains and losses were immaterial. For the purpose of determining gross
realized gains and losses, the cost of the securities sold is based upon
specific identification.
Prepaid Expenses
At December 31, 1997 prepaid expenses included $87,397 of net deferred
financing costs related to the Series A Notes. Amortization of deferred
financing costs was $87,397 in 1997 and $87,397 in the three month period
ended March 31, 1998 and is included in interest expense. Prepaid expenses
included $2,000,000 and $1,310,000 at December 31, 1997 and March 31, 1998,
respectively, related to linking agreements (see Note 10).
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
provided using the straight-line basis over the estimated useful lives of the
assets or the lease term, whichever is shorter.
Internally Developed Systems and Software
The costs to develop internal systems and software, primarily payroll and
related expenses for development and design of software, are charged to
expense as incurred.
Revenue Recognition
Net sales, which consist primarily of recorded music sold via the Internet,
include outbound shipping and handling charges and are recognized when the
products are shipped. The Company records a reserve for estimated returns,
which is based on historical return rates.
F-8
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Operating and Development
Operating and development expenses consist principally of payroll and
related expenses for development, editorial, and network operations personnel
and consultants and expenses for systems and telecommunications
infrastructure.
Sales and Marketing
Advertising costs are included in sales and marketing expenses and are
charged to expense as incurred. Such costs were $40,523, $61,432, $6,834,000,
$131,851, and $7,327,900 for the years ended December 31, 1995, 1996, 1997 and
for the three months ended March 1997 and 1998 respectively. The Company gives
merchandise credit to the providers of various small Web sites through its
Cosmic Credit Program. Expenses related to this program are included in sales
and marketing expenses and, to date, have been immaterial. The Company
estimates the amount of unused credits and includes this amount in accrued
expenses.
Gift Certificates and Coupons
Gift certificates are included in deferred revenues in the accompanying
balance sheets and are recognized as net sales when they are redeemed. The
Company estimates the amount of outstanding coupons which will be redeemed and
includes that amount in accrued expenses. This accrual is immaterial for all
periods presented. Coupon expense is included in sales and marketing expenses.
Supplemental Cash Flow Information
For the years ended December 31, 1995, 1996 and 1997, and the three months
ended March 31, 1997 and 1998, the Company paid interest of $2,329, $19,467,
$284,565, $2,715, and $234,402 respectively. In addition, the Company incurred
$15,000, $126,954, $1,070,290, $52,271 and $190,385 in capitalized lease
obligations for the years ended December 31, 1995, 1996 and 1997, and the
three months ended March 31, 1997 and 1998, respectively. Prior to 1995, the
Company incurred no capitalized lease obligations and paid no interest. In
1996 the Company issued 41,244 shares of common stock to retire $81,923 of
advances due to a related party (see Note 9).
Recapitalization
In April 1996, the Company amended its Articles of Incorporation to effect a
10,000-for-1 split of its common shares and to change the number of authorized
common shares to 5,000,000. In July 1997, the Company amended its Articles of
Incorporation to effect a 4-for-1 split of its common shares, to change the
number of authorized common shares to 50,000,000, and to authorize 20,000,000
shares of preferred stock. In January 1998, the Company amended its Articles
of Incorporation to effect a 1.5-for-1 split of its common shares. All
references in the financial statements to the number of shares and to per
share amounts have been retroactively restated to reflect all of these
changes.
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SFAS 130"). This statement requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement
of financial position. SFAS 130 is effective for financial statements issued
for fiscal years beginning after December 15, 1997. The Company has adopted
SFAS 130 in the first quarter of 1998. The Company has had no other
comprehensive income items to report.
F-9
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Initial Public Offering
On February 13, 1998 the Company consummated an initial public offering of
its Common Stock (the "Initial Public Offering"). The company sold 4,561,250
shares of its common stock, no par value, at an initial public offering price
of $16.00 per share. After deducting the underwriters' discount and other
offering expenses, the net proceeds to the company were approximately
$67,077,862.
Recently Issued Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information" ("SFAS 131"). This statement establishes
additional standards for segment reporting in the financial statements and is
effective for fiscal years beginning after December 15, 1997. Management
believes that SFAS 131 will not have an effect on the Company's financial
statements.
Reclassification
The statement of operations for 1996 and 1997 and the quarter ended March
31, 1997 have been reclassified to conform with the presentation of March 31,
1998. Beginning in 1998, the Company determined to include royalties paid on
CD sales in return for licensing of ratings, reviews, sound samples and other
information ("Information Royalties") in operating and development expenses
rather than in cost of sales, as was previously the case. This change was made
based on Management's determination that including Information Royalties in
operating and development expense was more consistent with the treatment of
such expenses by retailers generally. The financial information for periods
prior to 1998 has been restated to reflect this change. Information Royalties
were $146,200, $225,737, $52,027, and $49,140 during the years ended December
31, 1996 and 1997 and the three months ended March 31, 1997 and 1998,
respectively. There were no Information Royalties paid in 1995.
3. RISKS AND UNCERTAINTIES:
The Company's future results of operations involve a number of risks and
uncertainties. Factors that could affect the Company's future operating
results and cause actual results to vary materially from expectations include,
but are not limited to, dependence on key personnel, uncertain growth of
online commerce, reliance on suppliers of entertainment products, government
regulation, online commerce security risks, substantial competition, reliance
on certain vendors, risk of system failure, absence of redundant facilities,
risks associated with the Year 2000, and capacity constraints. See "Risk
Factors" in the Prospectus.
Dependence on Suppliers
The Company's primary provider of order fulfillment for recorded music
titles is Valley Record Distributors ("Valley"). The Company has no
fulfillment operation or facility of its own and, accordingly, is dependent
upon maintaining its existing relationship with Valley or establishing a new
fulfillment relationship with one of the few other fulfillment operations.
There can be no assurance that the Company will maintain its relationship with
Valley beyond the term of its existing two year agreement, which expires in
June 1999, or that it will be able to find an alternative, comparable vendor
capable of providing fulfillment services on terms satisfactory to the Company
should its relationship with Valley terminate. Valley accounted for 70%, 74%,
78%, 74% and 82% of the cost of sales for the years ended 1995, 1996 and 1997
and the three months ended March 31, 1997 and 1998 respectively. Additionally,
the Company purchased all of its import music titles from another vendor. This
vendor accounted for 21%, 14% and
F-10
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. RISKS AND UNCERTAINTIES: (CONTINUED)
15% of the cost of sales in 1995, 1996 and the three months ended March 31,
1997. The Company replaced this vendor during the year ended December 31, 1997
and neither the current nor the former vendor accounted for more than 10% of
cost of sales in the year ended December 31, 1997 and the three months ended
March 31, 1998.
International Sales
The Company derived 22%, 40%, 29%, 35% and 21% of revenues for the years
ended 1995, 1996 and 1997, and for the three months ended March 31, 1997 and
1998, respectively, from customers outside the United States. All
international sales are paid in U.S. dollars.
4. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
DECEMBER 31,
USEFUL LIFE/ ------------------------------- MARCH 31,
LEASE TERM 1995 1996 1997 1998
------------ -------- --------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Computers and
equipment.............. 3 years $164,530 $ 387,348 $2,090,144 $2,904,396
Office furniture and
equipment.............. 5 years 14,755 117,876 397,930 445,367
-------- --------- ---------- ----------
179,285 505,224 2,488,074 3,349,763
Less--Accumulated
depreciation and
amortization........... (37,750) (143,189) (603,778) (821,290)
-------- --------- ---------- ----------
$141,535 $ 362,035 $1,884,296 $2,528,473
======== ========= ========== ==========
</TABLE>
Depreciation and amortization expense for the years ended 1995, 1996 and
1997 and the three months ended March 31, 1997 and 1998 was $32,999, $105,439,
$460,589, $51,000 and $246,020, respectively. Total property and equipment
under capital leases was $15,000, $141,954, $1,217,130, $141,954 and
$1,407,515 less accumulated amortization of $2,500, $25,659 and $252,988,
$37,489 and $369,656, at December 31, 1995, 1996 and 1997 and the three months
ended March 31, 1997 and 1998, respectively.
5. INCOME TAXES:
The Company records income taxes using 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 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.
From inception (February 12, 1994) until April 25, 1995, the Company
operated as an unincorporated entity. From April 25, 1995 until December 5,
1996, the Company was incorporated and elected to be taxed under Subchapter S
of the Internal Revenue Code. As a result, the Company was not subject to
federal or state income taxes, and the taxable loss of the Company was
included in the shareholders' individual tax returns. On December 6, 1996, the
Company terminated its status as an S corporation and is now subject to
federal and state income taxes.
At December 31, 1997, the Company had a net operating loss carryforward for
federal income tax purposes of approximately $9,700,000. The net operating
loss carryforward will begin to expire in 2011.
F-11
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. INCOME TAXES: (CONTINUED)
The Company's utilization of its loss carryforward will be limited pursuant to
the Tax Reform Act of 1986, due to cumulative changes in ownership in excess
of 50%.
The approximate income tax effect of each type of temporary difference and
the loss carryforward is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
--------- -----------
<S> <C> <C>
Accruals and reserves not currently deductible.......... $ 6,275 $ 38,590
Benefit of net operating loss carryforward.............. 1,592 3,240,322
Development expenses not currently deductible........... 160,062 476,736
Depreciation methods.................................... 12,134 37,634
Deferred revenues....................................... 42,500 64,078
--------- -----------
222,563 3,857,360
Valuation allowance..................................... (222,563) (3,857,360)
--------- -----------
$ -- $ --
========= ===========
</TABLE>
Due to the Company's history of operating losses the realization of the
deferred tax asset is uncertain. The Company has, therefore, provided a full
valuation allowance against the deferred tax asset.
6. DEBT:
On December 31, 1995, the Company issued a note for $100,000 to a private
investor who is also a member of the Company's Board of Directors. The note
plus accrued interest of 10% was repaid on December 31, 1996.
From November 16, 1996 through January 31, 1997, the Company received short-
term loans of $250,000 from certain unrelated investors. The investors
received warrants as part of the consideration for the loans (see Note 8).
These loans bore interest at 6% per year. On May 15, 1997, the Company repaid
$110,000 of the loans and, on July 16, 1997, the remaining unpaid balance plus
accrued interest was paid.
In 1997, the Company obtained three term loans from a bank for an aggregate
of $218,563. The proceeds from the loans were used to purchase equipment,
which equipment collateralizes the loans. The two founders of the Company have
personally guaranteed the loans. The loans bear interest at rates ranging from
8.0% to 9.0% and are repayable in installments over 36 to 48 months. Annual
principal repayments are $57,351 in 1998, $62,300 in 1999, $45,676 in 2000 and
$25,061 in 2001.
In November 1997, the Company sold $5,777,500 of Series A Convertible Notes
(Series A Notes) to certain investors, including $1,000,000 to an existing
shareholder. The notes bear interest at an annual rate of 12% and are due upon
consummation of the Offering. In connection with the sale of the Series A
Notes, the Company issued warrants to these investors. The warrants allow the
investors to purchase 48,550 shares of common stock at an exercise price of
$11.90 per share. The warrants were valued using the Black-Scholes model, and
the Series A Notes were recorded net of the value of $404,425 assigned to the
warrants. The notes were amortized to their face amount over their estimated
term, with $202,213 of amortization included in interest expense for the year
ended December 31, 1997 and $202,212 in the three months ended March 31, 1998.
The notes were repaid in February 1998.
F-12
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. DISPUTE SETTLEMENT:
In May 1995, MILO Productions, Inc. ("MILO"), which was owned by the
Company's then shareholders, entered into a partnership with MBL
Entertainment, Inc. ("MBL") called Music Now. In December 1995, MBL, an
investor and the Company's then shareholders entered into nonbinding
discussions for the purpose of creating a new company ("NewCo") which would
merge with Music Now. These discussions contemplated, among other things, that
the private investor would make a significant cash investment in, and the
Company's then shareholders would contribute all of the outstanding capital
stock of both MILO and the Company, to NewCo. The parties abandoned these
discussions in August 1996, and MBL and the private investor subsequently
instituted a legal action against the Company, MILO and the Company's then
shareholders. On December 6, 1996, the Company and all parties involved in
this dispute negotiated a settlement pursuant to which (i) the private
investor made an investment in the Company (see Note 8) and (ii) the
shareholders of MBL were issued an aggregate of 882,606 shares of common
stock. The shares issued to the shareholders of MBL were valued at $1,024,030
based on the sale of common stock to the investor, which valued the common
stock at $1.16 per share (see Note 8), with the related charge recorded as an
expense in the accompanying statement of operations for the year ended
December 31, 1996. At the time of the settlement, MBL and Music Now were
inactive and had no assets or liabilities.
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY:
Common Stock
In December 1996, the Company sold to an investor 921,834 shares of common
stock and a warrant to purchase an additional 871,710 common shares at $1.15
per share, for aggregate consideration of $1,200,000. Using the Black-Scholes
model, the warrants were valued at $130,750. The remaining amount of the
proceeds of $1,069,250 was allocated to common stock, resulting in a value per
share of $1.16. The warrant expires on June 16, 1998. The investor received
the right to appoint two members of the Company's Board of Directors, each
having one-half vote. This right terminated upon the consummation of the
Company's initial public offering. The investor, who is a director of the
Company, exercised the warrant upon consummation of the initial public
offering, by tendering to the Company 62,473 shares received upon exercise to
satisfy the $999,561 exercise price. This cashless exercise resulted in
809,237 net shares of common stock being received by the investor.
Preferred Stock
As of December 31, 1997, the Company had 20,000,000 shares of preferred
stock authorized, of which 254,582 were designated, issued and outstanding as
no par value Redeemable Series A Convertible Preferred Stock ("Series A
Preferred") and 1,605,505 were designated, issued and outstanding as no par
value Redeemable Series B Convertible Preferred Stock ("Series B Preferred").
The Series A Preferred was sold to an investor in July 1997 for $4.91 per
share, resulting in proceeds to the Company of $1,152,186, net of expenses.
The Series B Preferred was sold to investors in August 1997 for $5.45 per
share, resulting in proceeds to the Company of $8,100,305, net of expenses.
Each share of Series A and B Preferred converted into shares of the
Company's common stock upon the consummation of the Initial Public Offering in
February 1998, on a 1.5-for-1 basis.
F-13
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS' EQUITY: (CONTINUED)
Beginning January 1, 2003, the Series A and B Preferred would have been
redeemable at the option of a majority of the holders at $4.91 per share and
$5.45 per share, respectively, plus accrued but unpaid dividends, if any. The
Series A and B Preferred were being accreted to their redemption values for
accounting purposes. The holders of Series A and B Preferred were entitled to
receive cumulative dividends of 8% per share per year, when and if declared by
the Company; no dividends could have been declared or paid on common stock
unless all cumulative dividends were declared and paid on the preferred stock.
The Series A and Series B Preferred had liquidation preferences equal to $4.91
per share and $5.45 per share, respectively, plus any accrued and unpaid
dividends.
Equity Compensation Plan
On June 1, 1996, the Company adopted the Equity Compensation Plan (the
"Plan"). Under the Plan, incentive and nonqualified stock options, restricted
stock and stock appreciation rights may be granted to employees, officers,
employee directors and independent contractors and consultants. An aggregate
of 1,600,000 shares of common stock have been reserved for issuance under the
Plan. No stock options, restricted stock or stock appreciation rights were
granted in 1996.
Information relative to the Plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
RANGE OF AGGREGATE EXERCISE
SHARES EXERCISE PRICES EXERCISE PRICE PRICE
------- --------------- -------------- --------
<S> <C> <C> <C> <C>
Outstanding January 1,
1997..................... -- -- -- --
Granted................... 721,914 $1.33-$10.00 $2,157,680 $ 2.99
------- ------------ ---------- ------
Outstanding December 31,
1997..................... 721,914 $1.33-$10.00 2,157,680 $ 2.99
Granted................... 7,750 $14.00 108,500 $14.00
Cancelled................. (2,734) $3.00 (8,202) $ 3.00
------- ------------ ---------- ------
Outstanding March 31,
1998..................... 726,930 $1.33-$14.00 $2,257,978 $ 3.10
======= ============ ========== ======
</TABLE>
As of March 31, 1998, there were options to purchase 98,492 shares of common
stock exercisable with a weighted average exercise price of $1.69 per share.
In addition, as of March 31, 1998, there were options to purchase and 873,070
shares of common stock available for grant under the Plan.
The Company accounts for its option grants under APB Opinion No. 25 and
related interpretations. Accordingly, compensation has been recorded for the
Plan based on the intrinsic value of the stock option at the date of grant
(i.e., the difference between the exercise price and the fair value of the
Company's stock). Compensation, if any, is deferred and recorded as expense
over the vesting period. For the year ended December 31, 1997, deferred
compensation of $751,392 was recorded for options granted, of which $316,616
and $69,176 was charged to compensation expense for the year ended December
31, 1997 and the three months ended March 31, 1998.
In 1995, the FASB issued SFAS No. 123 "Accounting for Stock Based
Compensation" (SFAS 123). SFAS 123 establishes a fair value based method of
accounting for stock-based compensation plans.
This statement also applies to transactions in which an entity issues its
equity instruments to acquire goods or services from non-employees. SFAS 123
requires that an employer's financial statements include certain disclosures
about stock-based employee compensation arrangements regardless of the method
F-14
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS' EQUITY: (CONTINUED)
used to account for the plan. Had the Company recognized compensation cost for
its stock option plan consistent with the provisions of SFAS 123, the
Company's pro forma net loss and net loss per common share for the year ended
December 31, 1997 would have been as follows:
<TABLE>
<CAPTION>
YEAR
ENDED
DECEMBER 31,
1997
------------
<S> <C>
Net loss applicable to common shareholders:
As reported................................................. $(11,157,508)
============
Pro forma................................................... $(11,265,003)
============
Net loss per common share:
As reported................................................. $ (1.42)
============
Pro forma................................................... $ (1.45)
============
</TABLE>
The weighted average fair value of the stock options granted during the year
ended December 31, 1997 was $2.63. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model,
with the following weighted average assumptions: risk free interest rates
ranging from 6.4% to 6.8% based on the rates in effect on the date of grant, a
volatility of 60% for options granted subsequent to the filing date of the
Company's registration statement, no expected dividend yield, and an expected
life of eight years for the options.
Warrants
In August 1997, the Company issued warrants to purchase 121,560 shares of
Series B Preferred at an exercise price of $5.45 per share in connection with
the Series B Preferred financing. The warrants were issued to one of the
investors in the Series B Preferred and to the agent who represented the
Company in that financing. These warrants expire in August 2002. Upon the
closing of the Initial Public Offering, the warrants converted to warrants to
purchase 182,341 shares of common stock at $3.63 per share. Using the Black-
Scholes model, the warrants were valued at $170,000. This amount was recorded
as a reduction in the carrying value of the preferred stock and was amortized
and included in the accretion to the redemption value of the preferred stock
recorded in each period.
As consideration for certain loans, the lenders received warrants to
purchase 59,997 and 76,365 shares of common stock at a price of $1.83 per
share until May 16, 1998 and July 16, 1998, respectively (see Note 6). Based
on the warrants' 18-month term and exercise price, the Black-Scholes model
calculated a minimal value for the warrants.
9. RELATED-PARTY TRANSACTIONS:
Additional paid-in capital represents the deemed fair value of services
contributed to the Company by the founders in 1994, 1995 and 1996. During this
period, one of the founders served as President and the other was responsible
for the development of the Company's system architecture and transactions
systems. In 1994 and 1995, the founders were paid no compensation and in 1996
the founders' compensation was below market. The fair value of services
contributed by the founders was determined by the Company's Board of
Directors. In determining the value, the Board considered the founders' level
of experience, position in the Company, the compensation level of other
employees, the Company's financial resources and the status of the Company's
development.
F-15
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. RELATED-PARTY TRANSACTIONS: (CONTINUED)
The Company had a $3,261 advance due to a founder at December 31, 1996 and
1997 this advance was repaid in the three months ended March 31, 1998. At
December 31, 1995 the Company had advances due to a founder and his father of
$4,103 and $74,740, respectively. During 1996, the father advanced additional
funds to the Company and, on August 16, 1996, in consideration of the
cancellation of $81,923 debt due to the father, the Company issued 41,244
shares of the Company's common stock. The exchange ratio used to convert the
debt into shares of common stock was negotiated between the founders and their
father and cannot be considered arms-length.
10. COMMITMENTS AND CONTINGENCIES:
Yahoo Agreement
In August 1997, the Company entered into an agreement with Yahoo! Inc. (the
"Yahoo Agreement"), pursuant to which the Company was granted exclusivity on
music-related pages on the www.yahoo.com Web site. The Yahoo Agreement
consists of two one-year terms. The initial term began in October 1997 and
will expire on October 5, 1998. The Company can terminate the contract after
the first year by providing Yahoo with notice, as defined, and paying a
termination fee. During the first one-year term, the Company is required to
pay Yahoo $3,900,000 (of which $900,000 was paid in 1997) in exchange for a
specified number of page views. The Company expects to amortize the costs
associated with the Yahoo Agreement over the contract term, with the
amortization method primarily based on the rate of delivery of a guaranteed
number of impressions to be received during the contract term. In connection
with the Yahoo Agreement, the Company paid Yahoo an additional $600,000 for
advertising in August and September 1997, which amount was charged to expense.
Excite Agreement
On September 30, 1997, the Company entered into a two-year agreement with
Excite, Inc. (the "Excite Agreement"), pursuant to which the Company became
the exclusive retail music store sponsor of the WebCrawler.com Web site. The
Excite Agreement requires the Company to pay Excite a set-up fee, an annual
exclusivity fee and an annual sponsorship fee for ongoing programming, links,
placements, advertisements and promotions. The Company has agreed to pay
Excite a minimum of $4,500,000 over the contract term, of which $500,000 was
paid by December 31, 1997, $2,125,000 will be paid in 1998 and $1,875,000 will
be paid in 1999. The Company expects to amortize the costs associated with
Excite agreement over the contract term, with the amortization method
primarily based on the rate of the delivery of a guaranteed number of
impressions to be received during the contract term.
Lycos Agreement
On March 26, 1998, the Company entered into an agreement with Lycos, Inc.
(the "Lycos Agreement"), pursuant to which the Company became the exclusive
retail music store sponsor of the www.Lycos.com and www.Tripod.com Web sites.
The Lycos Agreement has a term of three years which will commence on the
launch date, as defined. The Company has agreed to pay Lycos $4,500,000,
$5,500,000 and $6,500,000 during the first, second and third years,
respectively of the contract term in exchange for a specified number of page
views. In addition, the Company has committed to issue 61,665 shares (the
"Lycos Shares") of common stock to Lycos. The Lycos Shares vest as Lycos
delivers certain required minimum page views, as defined. The Company has the
right to repurchase any of the Lycos shares that do not become vested at a
price of $0.01 per share. The Company will measure the stock
F-16
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
granted as it vests. If Lycos is unable to deliver a number of guaranteed
minimum impressions the Company will not be required to make all of the
minimum payments and all of the Lycos shares may not vest. The Company expects
to amortize the costs associated with the Lycos Agreement over the contract
term, with the amortization method primarily based on the rate of delivery of
a guaranteed number of impressions to be received during the contract term.
Lycos Bertelsmann Agreement
On April 2, 1998, the Company entered into an agreement with Lycos
Bertelsmann GMBH & Co. KG (the "Lycos Bertelsmann Agreement), pursuant to
which the Company became the exclusive music retailer on certain Lycos branded
Web services, as defined, in Europe. The Lycos Bertelsmann Agreement has a
three year term which will commence on the launch date, as defined. The
Company has agreed to pay Lycos Bertelsmann $1,420,000, $1,880,000 and
$2,200,000 during the first, second and third years of the contract term. The
Company expects to amortize the costs associated with the Lycos Bertelsmann
Agreement over the contract term, with the amortization method primarily based
on the rate of delivery of a guaranteed number of impressions to be received
during the contract term.
Other Agreements
On January 5, 1998 the Company entered into a strategic alliance with
GeoCities pursuant to which the Company has been designated as the exclusive
music retailer as well as one of four key commerce partners that will occupy a
premier position on certain pages of the GeoCities Web site. The Company has
committed to make payments under advertising and linking agreements with
Rolling Stone Network, America Online with respect to the Love@AOL service,
and with certain other parties and has expanded its agreement with Yahoo. The
Company's aggregate commitment under these arrangements, together with certain
other advertising commitments, is approximately $4,786,000, $2,827,000,
$2,435,000 and $766,000 in the remaining nine months of 1998, and in the years
ending December 31, 1999, 2000 and 2001, respectively.
Many of the Company's agreements including the Yahoo, Exite, Lycos and Lycos
Bertelsmann Agreements contain provisions which may require additional
payments to be made by the Company based on factors such as click-throughs and
new customers generated. No such payments have been incurred to date. Such
payments will be expensed as incurred. The Company will continue to evaluate
the realizability of assets recorded, if any, related to the Yahoo, Excite,
Lycos, Lycos Bertelsmann and other agreements, and, if necessary, write down
the assets to realizable value.
F-17
<PAGE>
CDNOW, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
Leases
The Company has entered into various noncancelable operating and capital
leases for office space, telephones and other equipment. Future minimum lease
payments under operating and capital leases as of December 31, 1997 are as
follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
---------- ----------
<S> <C> <C>
1997.................... $ 291,033 $ 464,103
1998.................... 302,044 453,629
1999.................... 320,714 388,761
2000.................... 316,775 146,407
2001.................... 226,037 --
---------- ----------
Total minimum lease
payments............... $1,456,603 1,452,900
==========
Less--Amount
representing interest.. (319,578)
----------
Present value of minimum
capitalized lease
payments............... $1,133,322
==========
</TABLE>
Rent expense under operating leases was $51,836, $16,905, $264,441, $18,607
and $113,119, for the years ended 1995, 1996 and 1997 and for the months ended
March 31, 1997 and 1998, respectively.
Legal Actions
From time-to-time, the Company may be involved in litigation relating to
claims arising out of its ordinary course of business. The Company believes
that there are no claims or actions pending or threatened against the Company,
the ultimate disposition of which, would have a materially adverse effect on
the Company.
F-18
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO
WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO
ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Price Range of Common Stock.............................................. 16
Use of Proceeds.......................................................... 16
Dividend Policy.......................................................... 16
Capitalization........................................................... 17
Selected Financial and Operating Data.................................... 19
Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................ 20
Business................................................................. 28
Management............................................................... 38
Certain Relationships and Related Transactions........................... 42
Principal and Selling Shareholders....................................... 44
Description of Capital Stock............................................. 45
Shares Eligible for Future Sale.......................................... 47
Underwriting............................................................. 48
Legal Matters............................................................ 50
Experts.................................................................. 50
Additional Information................................................... 50
Index to Financial Statements............................................ F-1
</TABLE>
----------------
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN
ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
2,700,000 Shares
LOGO
Common Stock
----------------
PROSPECTUS
----------------
BT ALEX. BROWN
NATIONSBANC MONTGOMERY SECURITIES LLC
HAMBRECHT & QUIST
, 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the estimated expenses, other than
underwriting discounts and commissions, in connection with the issuance and
distribution of the shares of Common Stock being registered, all of which are
being borne by the Company:
<TABLE>
<S> <C>
Registration fee................................................... $ 22,374
NASD filing fee.................................................... 8,084
Transfer agent and registrar fees.................................. 5,000
Printing and engraving............................................. 100,000
Legal fees......................................................... 100,000
Blue Sky fees and expenses......................................... 5,000
Nasdaq National Market listing fee................................. 17,500
Accounting fees.................................................... 100,000
Miscellaneous...................................................... 142,042
Total.............................................................. $500,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Chapter 17, Subchapter D of the Pennsylvania Business Corporation Law of
1988, as amended (the "PBCL") contains provisions permitting indemnification
of officer and directors of a business corporation in Pennsylvania. Sections
1741 and 1742 of the PBCL provide that a business corporation may indemnify
directors and officers against liabilities and expenses they may incur as such
in connection with any threatened, pending or completed civil, administrative
or investigative proceeding, provided that the particular person acted in good
faith and in a manner he or she reasonably believed to be in, or not opposed
to, the best interests of the corporation, and, with respect to any criminal
proceeding, had no reasonable cause to believe his or her conduct was
unlawful. In general, the power to indemnify under these sections does not
exist in the case of actions against a director or officer by or in the right
of the corporation if the person otherwise entitled to indemnification shall
have been adjudged to be liable to the corporation unless it is judicially
determined that, despite the adjudication of liability but in view of all the
circumstances of the case, the person is fairly and reasonably entitled to
indemnification for specified expenses. Section 1743 of the PBCL provides that
the corporation is required to indemnify directors and officers against
expenses they may incur in defending actions against them in such capacities
if they are successful on the merits or otherwise in the defense of such
actions.
Section 1746 of the PBCL grants a corporation broad authority to indemnify
its directors and officers for liabilities and expenses incurred in such
capacity, except in circumstances where the act or failure to act giving rise
to the claim for indemnification is determined by a court to have constituted
willful misconduct or recklessness.
Section 1747 of the PBCL permits a corporation to purchase and maintain
insurance on behalf of any person who is or was a director or officer of the
corporation, or is or was serving at the request of the corporation as a
representative of another corporation or other enterprise, against any
liability asserted against such person and incurred by him or her in any such
capacity, or arising out of his or her status as such, whether or not the
corporation would have the power to indemnify the person against such
liability under Chapter 17, Subchapter D of the PBCL.
II-1
<PAGE>
Section 8.01 of the Bylaws provides that the Registrant will indemnify any
director or officer of the Registrant or any other person designated by the
Board of Directors of the Registrant (which may, but need not, include any
person serving at the request of the Registrant as a director or officer,
employee, agent, fiduciary or trustee of another corporation, partnership,
joint venture, trust, employee benefit plan or other entity or enterprise)
against any damage, judgment, amount paid in settlement, fine, penalty,
punitive damages, excise tax assessed with respect to an employee benefit
plan, or cost or expense of any nature (including, without limitation,
attorneys' fees and disbursements) incurred in connection with any proceeding
in which such person may be involved as a party or otherwise by reason of the
fact that such person is or was serving in such capacity, including, without
limitation, liabilities resulting from any actual or alleged breach of duty,
error, misstatement or misleading statement, negligent, gross negligence or
act giving rise to strict or products liability. Notwithstanding the
foregoing, the Registrant shall not indemnify any person for any act or
failure to act which is (i) prohibited by applicable law or (ii) finally
determined to have constituted willful misconduct or recklessness or to be
based upon or attributable to the receipt by such person of a personal benefit
to which such person is not legally entitled. Section 8.03 of the Bylaws
provides for the advancement of expenses to an indemnified party upon receipt
of an undertaking by the party to repay those amounts if it is ultimately
determined that the indemnified party is not entitled to indemnification.
Section 8.04 of the Bylaws authorizes the Registrant to use any mechanism or
arrangement, as determined by the Board of Directors, to further effect,
satisfy or secure its indemnification obligations, including purchasing and
maintaining insurance, obtaining a letter of credit, creating a reserve,
trust, escrow or other fund or account, entering into indemnification
agreements or granting security interests.
Section 8.08 of the Bylaws mandates indemnification against expenses
(including attorney's fees and disbursements) actually and reasonably incurred
by any authorized representative of the Registrant who has been successful on
the merits or otherwise in defense of any action, suit or proceeding referred
to in Sections 1741 or 1742 of the PBCL.
Section 8.09 of the Bylaws provides that the rights of indemnification under
the Bylaws will be deemed a contract between the Registrant and each person
entitled to indemnification.
Section 8.10 of the Bylaws states that the indemnification authorized by the
Bylaws will not be exclusive of any other rights to which persons seeking
indemnification or advancement of expenses may be entitled.
The Registrant maintains, on behalf of its directors and officers, insurance
protection against certain liabilities arising out of the discharge of their
duties.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since the Company's incorporation in April 1995, the Company has issued and
sold the following unregistered securities:
1. On August 16, 1996, the Company issued 41,244 shares to an accredited
investor in exchange for the cancellation of $81,923 of debt owed by the
Company to this investor.
2. On December 6, 1996, the Company issued 921,834 shares of Common Stock
to an accredited investor for $1,200,000 and an aggregate of 882,606 shares
of Common Stock to three investors in exchange for substantially all of the
business and assets of an organization owned by these investors.
3. On July 15, 1997, the Company issued 254,582 shares of Series A
Preferred Stock to an accredited investor for $1,250,000.
4. On August 5, 1997, the Company issued 1,605,605 shares of Common Stock
to two accredited investors for an aggregate of $8,750,000.
5. On November 26, 1997, the Company issued $5,777,500 in aggregate
principal amount of its Series A Convertible Notes and associated warrants
exercisable for capital stock of the Company.
6. On March 26, 1998, the Company became obligated to issue 61,665 shares
of Common Stock to an accredited investor as a partial inducement to enter
into an agreement with the Company.
II-2
<PAGE>
The Company believes that the transactions described above were exempt from
registration under Section 4(2) of the Act because the subject securities were
sold to a limited group of persons, each of whom was believed to have been
either an accredited investor or a sophisticated investor or had a pre-
existing business or personal relationship with the Company or its management
and was purchasing for investment without a view to further distribution.
Restrictive legends were placed on stock certificates evidencing the shares
and/or agreements relating to the right to purchase such shares described
above.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
The following is a list of exhibits filed as part of this Registration
Statement.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1 Form of Underwriting Agreement.**
3.1 Amended and Restated Articles of Incorporation of the Company.#
3.2 Amended and Restated Bylaws of the Registrant.#
3.3 Amendment No. 1 to Amended and Restated Bylaws of the Registrant.#
5.1 Opinion of Morgan, Lewis & Bockius LLP regarding legality of the
shares of Common Stock being registered.**
10.1 Stock Purchase Agreement dated as of July 15, 1997 by the Registrant
and certain shareholders of the Registrant.#
10.2 Amendment No. 1 to Stock Purchase Agreement dated as of August 5, 1997
by the Registrant and certain shareholders of the Registrant.#
10.3 Investors' Rights Agreement dated as of July 15, 1997 by the
Registrant and certain shareholders of the Registrant.#
10.4 CDnow, Inc. 1996 Equity Compensation Plan.#
10.5 Amendment 1997-1 to the CDnow, Inc. 1996 Equity Compensation Plan.#
10.6 Warrant dated August 5, 1997 issued by the Registrant to Alex. Brown &
Sons Incorporated#
10.7 Warrant dated August 5, 1997 issued by the Registrant to Grotech
Capital Group IV, L.L.P.#
10.8+ Linking Agreement dated September 30, 1997 by and between the
Registrant and Excite, Inc.#
10.9+ Advertising and Promotion Agreement dated as of August 21, 1997 by and
between the Registrant and Yahoo! Inc.#
10.10 Stock Purchase and Shareholders' Agreement dated December 6, 1996
among Registrant and others.#
10.11+ Order Fulfillment Agreement dated as of June 24, 1997 between
Registrant and Sound Delivery.#
10.12 Amendment 1998-1 to the CDNow, Inc. 1996 Equity Compensation Plan.#
10.13+ Linking Agreement dated April 2, 1998 between the Registrant and Lycos
Bertelsmann GMBH & Co. KG*
10.14+ Linking Agreement dated March 26, 1998 between the Registrant and
Lycos, Inc.*
10.15+ Linking, Content Licensing and Advertising Agreement dated April 8,
1998 by and among the Registrant, JAMtv Corporation and Straight Arrow
Publishers.*
11.1 Statement re: Computation of Per Share Earnings.*
23.1 Consent of Arthur Andersen LLP. *
23.2 Consent of Morgan, Lewis & Bockius LLP (included in its opinion filed
as Exhibit 5 hereto).
24.1 Power of Attorney (included on signature page to this Registration
Statement).*
27.1 Financial Data Schedule.*
</TABLE>
- ---------------------
* Filed herewith.
**To be filed by amendment.
# Incorporated by Reference to the Registrant's Registration Statement on Form
S-1 (File No. 333-41241).
+ Portions of this Exhibit were omitted and filed separately with the Secretary
of the Commission pursuant to an application for confidential treatment filed
with the Commission pursuant to Rule 406 under the Securities Act.
II-3
<PAGE>
ITEM 17. UNDERTAKINGS.
(i) The undersigned Registrant hereby undertakes to provide to the
Underwriters at the closing specified in the Underwriting Agreement
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.
(ii) 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 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.
(iii) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THE
REGISTRANT HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS
BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN JENKINTOWN,
PENNSYLVANIA ON MAY 11, 1998.
CDnow, Inc.
/s/ Jason Olim
By: ----------------------------------
JASON OLIM, PRESIDENT, CHIEF
EXECUTIVE OFFICER AND CHAIRMAN OF
THE BOARD
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES
EACH PERSON IN SO SIGNING ALSO MAKES, CONSTITUTES AND APPOINTS JASON OLIM
AND JOEL SUSSMAN AND EACH OF THEM ACTING ALONE, HIS TRUE AND LAWFUL ATTORNEY-
IN-FACT, WITH FULL POWER OF SUBSTITUTION, TO EXECUTE AND CAUSE TO BE FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO THE REQUIREMENTS OF
THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO THE REQUIREMENTS OF THE
SECURITIES ACT OF 1933, AS AMENDED, ANY AND ALL AMENDMENTS AND POST-EFFECTIVE
AMENDMENTS TO THIS REGISTRATION STATEMENT, AND INCLUDING ANY REGISTRATION
STATEMENT FOR THE SAME OFFERING THAT IS TO BE EFFECTIVE UPON FILING PURSUANT
TO RULE 462(B) UNDER THE SECURITIES ACT, WITH EXHIBITS THERETO AND OTHER
DOCUMENTS IN CONNECTION THEREWITH, AND HEREBY RATIFIES AND CONFIRMS ALL THAT
SAID ATTORNEY-IN-FACT OR HIS SUBSTITUTE OR SUBSTITUTES MAY DO OR CAUSE TO BE
DONE BY VIRTUE HEREOF.
NAME CAPACITY DATE
/s/ Jason Olim President, Chief May 11, 1998
- ------------------------------------- Executive Officer
JASON OLIM and Chairman of the
Board (principal
executive officer)
/s/ Joel Sussman Vice President and May 11, 1998
- ------------------------------------- Chief Financial
JOEL SUSSMAN Officer (principal
financial and
accounting officer)
/s/ Matthew Olim Director May 11, 1998
- -------------------------------------
MATTHEW OLIM
/s/ Alan Meltzer Director May 11, 1998
- -------------------------------------
ALAN MELTZER
/s/ Patrick Kerins Director May 11, 1998
- -------------------------------------
PATRICK KERINS
/s/ John Regan Director May 11, 1998
- -------------------------------------
JOHN REGAN
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE
------- ----------- ----
<C> <S> <C>
1.1 Form of Underwriting Agreement.**
3.1 Amended and Restated Articles of Incorporation of the Company.#
3.2 Amended and Restated Bylaws of the Registrant.#
3.3 Amendment No. 1 to Amended and Restated Bylaws of the
Registrant#
5.1 Opinion of Morgan, Lewis & Bockius LLP regarding legality of
the shares of Common Stock being registered.**
10.1 Stock Purchase Agreement dated as of July 15, 1997 by the
Registrant and certain shareholders of the Registrant.#
10.2 Amendment No. 1 to Stock Purchase Agreement dated as of August
5, 1997 by the Registrant and certain shareholders of the
Registrant.#
10.3 Investors' Rights Agreement dated as of July 15, 1997 by the
Registrant and certain shareholders of the Registrant.#
10.4 CDnow, Inc. 1996 Equity Compensation Plan.#
10.5 Amendment 1997-1 to the CDnow, Inc. 1996 Equity Compensation
Plan.#
10.6 Warrant dated August 5, 1997 issued by the Registrant to Alex.
Brown & Sons Incorporated#
10.7 Warrant dated August 5, 1997 issued by the Registrant to
Grotech Capital
Group IV, L.L.P.#
10.8+ Linking Agreement dated September 30, 1997 by and between the
Registrant and Excite, Inc.#
10.9+ Advertising and Promotion Agreement dated as of August 21, 1997
by and between the Registrant and Yahoo! Inc.#
10.10 Stock Purchase and Shareholders' Agreement dated December 6,
1996 among Registrant and others.#
10.11+ Order Fulfillment Agreement dated as of June 24, 1997 between
Registrant and Sound Delivery.#
10.12 Amendment 1998-1 to the CDnow, Inc. 1996 Equity Compensation
Plan.#
10.13+ Linking Agreement dated April 2, 1998 between the Registrant
and Lycos Bertelsmann GMBH & Co. KG*
10.14+ Linking Agreement dated March 26, 1998 between the Registrant
and Lycos, Inc.*
10.15+ Linking, Content Licensing and Advertising Agreement dated
April 8, 1998 by and among the Registrant, JAMtv Corporation
and Straight Arrow Publishers.*
11.1 Statement re: Computation of Per Share Earnings.*
23.1 Consent of Arthur Andersen LLP.*
23.2 Consent of Morgan, Lewis & Bockius LLP (included in its opinion
filed as Exhibit 5 hereto).
24.1 Power of Attorney (included on the signature page to this
Registration Statement).*
27.1 Financial Data Schedule.*
</TABLE>
- ---------------------
* Filed herewith.
** To be filed by amendment.
# Incorporated by reference to the Registrant's Registration Statement on Form
S-1 (File No. 333-41241).
+ Portions of this Exhibit were omitted and filed separately with the
Secretary of the Commission pursuant to an application for confidential
treatment filed with the Commission pursuant to Rule 406 under the Securities
Act.
<PAGE>
EXHIBIT 10.13
LINKING AGREEMENT
THIS LINKING AGREEMENT ("Agreement") is made this 2nd day of April, 1998
("Effective Date"), by and between LYCOS BERTELSMANN GMBH & CO. KG, a German
Limited Partnership with a principal place of business at Carl Bertelsmann
Strasse 161 L. D - 33311 Guetersloh, Germany ("Lycos"), and CDNOW, INC., a
Pennsylvania corporation with a principal place of business at 610 Old York
Road, Suite 300, Jenkintown, PA 19046 USA ("CDnow").
RECITALS
WHEREAS, CDnow is a retailer of compact discs and other items for sale through
its Web service which is accessible through the URL www.cdnow.com (the "CDnow
Site");
WHEREAS, Lycos is the owner or licensee of certain Lycos branded Web services
and other search and content areas in Europe as defined in Section 1(j) below;
WHEREAS, CDnow desires that Lycos integrate links form the Lycos Sites to a
co-branded version of the CDnow Site so that Lycos users may have convenient
access to the CDnow Site;
NOW, THEREFORE, the parties hereto for good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged and intending to be
legally bound, hereby agree as follows:
1. DEFINITIONS. Capitalized terms not otherwise defined in this Agreement will
have the following meanings:
(a) "Above-the-fold" shall mean situated within the portion of a page that
is designed to be visible on a standard computer screen with a resolution of 640
pixels by 480 pixels without requiring the user to scroll horizontally or
vertically throughout the page.
(b) "Active Cosmic Credit Site" shall mean a website that has been
registered in CDnow's affiliate website program known as the "Cosmic Credit
Program" through the Cosmic Credit links provided by CDnow on any of the Lycos
Sites and which has generated one non-returned purchase of a product on the
CDnow Site.
(c) "Beyond the Banner" shall mean any type of promotion which involves
promotional techniques other than the placement of standard advertising banners
or standard advertising buttons and links.
(d) "Carry-through Bar" shall mean a linking bar containing one or more of
the Proprietary Features of both of the parties which connects the Co-branded
Pages and the Lycos Sites, as set forth in Exhibit A.
(e) "CDnow Branded Link" shall mean a link which contains a CDnow approved
Proprietary Feature of CDnow, is located on the Lycos Sites and will take Lycos
users to the Co-branded Pages.
(f) "Co-branded Pages" shall mean pages of the CDnow Site which a visitor
from the Lycos Sites will link to and which shall display certain Proprietary
Features of both Lycos and CDnow. The Co-branded Pages can only be viewed by a
visitor who links to them directly from the Lycos Sites or through
1
[Confidential treatment requested for redacted portions of document]
<PAGE>
a stored URL (e.g. bookmark or similar technological storage mechanism). The
Co-branded Pages will reside on CDnow's server(s). The URL of the Co-branded
Pages shall be displayed as "cdnow.lycos.de", the implementation and timing of
which shall be subject to reasonable commercial and technological considerations
by both parties. The URL shall be only be used for the purpose of pointing to a
webserver of CDnow's choice.
(g) "Competitive Marketing" shall mean any link (which does not transfer to
the Co-branded Pages or CDnow's Site) and/or displayed message which promotes an
Entity which [XXX].
(h) "Entity" shall mean any individual, limited liability company,
partnership, corporation, or division, subsidiary or business unit thereof,
retail site, World Wide Web site, organizational department or other entity.
(i) "Launch Date" shall mean the date on which Lycos makes the CDnow
Branded Links available to users in accordance with the placement terms set
forth in Sections 2(a) and 2(b), provided that CDnow has approved such
placements (which approval shall not be unreasonably withheld or delayed) prior
to the launch. CDnow and Lycos shall use commercially reasonable efforts to
develop and deliver as necessary to each other, within two (2) weeks of the
Effective Date, any and all URLs, URL formats (as applicable), content, and
other materials necessary for Lycos to make available the CDnow Branded Links.
Subsequent to delivery of all necessary materials to Lycos, Lycos shall use
commercially reasonable efforts to make available the CDnow Branded Links to its
users within two (2) weeks of such delivery. If CDnow does not deliver
sufficient materials necessary to implement this Agreement within two (2) weeks
of the Effective Date, then the Launch Date shall be May 1.
(j) "Lycos Sites" shall mean the Lycos branded web sites developed by or
for Lycos which are accessible through and are developed for the United Kingdom,
Germany, the Benelux Countries, France, Italy, Spain and Switzerland, and may be
developed for the other countries listed in Exhibit E (which is attached hereto
and made a part hereof), provided that Lycos shall have the right to choose the
music partner for the Web Sites, and including any upgraded or extended Lycos
branded services to those Sites:
(k) "New Customer" shall mean any user that transfers from the Lycos Sites
directly to the Co-Branded Pages, creates a first-time account and at that time
or at any time thereafter during the Term of this Agreement makes a first
purchase of any product at the CDnow Site, which product is also shipped by
CDnow's distributor.
(l) "Page View" shall mean a user's viewing of any webpage of the Lycos
Sites containing a CDnow Branded Link.
(m) "Promotion Schedule" shall mean a written term sheet signed by an
authorized representative of each party pertaining to a promotion or special
marketing event entered into by both parties and describing the obligations of
each party with regard to such promotion or special marketing event.
(n) "Proprietary Feature" shall mean any trademark, service mark, trade
name, domain name, text message, navigational element or design logo which is
proprietary to Lycos and/or CDnow.
(o) "Term" is defined in Section 12 of this Agreement.
2
[Confidential treatment requested for redacted portions of document]
<PAGE>
(p) "URL" shall mean Universal Resource Locator.
2. LINKING.
(a) CDNOW BRANDED LINK PLACEMENT. Lycos shall place CDnow Branded
Links on the Lycos Sites, except for Lycos Benelux which will be available as of
[XXX] in accordance with the requirements set forth in this Section 2(a).
(i) Lycos will place the following links on the pages indicated
(and all existing or future equivalents, extensions, additions or replacements
of such areas/pages on the Lycos Sites). The links shall be placed in accordance
with Exhibit B (which is attached hereto and made a part hereof) unless
otherwise agreed by the parties.
(A) [XXX].
(B) [XXX].
(C) Keyword Targeted Banners: Lycos will deliver [XXX]. The
parties agree to use commercially reasonable efforts to implement emerging
technologies (i.e. html dynamic banners) to improve and enhance advertising
performance and functionality in the banner ads. At a minimum, the Keywords
shall include those Keywords set forth in Exhibit D (which is attached hereto
and made a part hereof). CDnow may choose additional Keywords, provided such
Keywords are or will become available, in whole or in part, at the time of
request, subject to Lycos approval, which approval shall not be unreasonably
withheld or delayed. In addition, Lycos shall provide CDnow any and all
available Page Views of the [XXX].
(D) Sound Search: Every Search Sound result page will
include a permanent, non-rotating, Above-the-fold graphic CDnow Branded Link to
CDnow.
(E) Search Results: Lycos shall place(I) text and graphic
CDnow Branded Links on all of the music-related search results pages, up to
[XXX] Keywords in total, which CDnow may amend at any time and from time to
time, and CDnow shall provide in a mutually agreed upon file format, and (II)
graphic CDnow Branded Links on [XXX] or more, at Lycos discretion, of the
general search results pages. Such links will transfer users to the related
CDnow artist discography pages or musical genre pages. The implementation of the
CDnow Branded Links on the search results pages will be based on a data file
provided by CDnow. Wording for the actual text links shall be mutually agreed
upon by the parties, but the CDnow text links will be incorporated in an Above-
3
[Confidential treatment requested for redacted portions of document]
<PAGE>
the-fold, non-banner position. Lycos shall make commercially reasonable efforts
to make available to CDnow any and all music-related Keywords.
(F) [XXX]: CDnow will provide content for a [XXX] to be hosted on
the Lycos Sites across Europe. CDnow represents and warrants that it will use
commercially reasonable efforts to provide current, relevant content, localized
as necessary, for each of the Lycos Sites. Lycos shall have editorial approval
over the [XXX], such approval not to be unreasonably withheld or delayed. Such
content will include:
(I) A CDnow graphic logo Above-the-fold;
(II) A CDnow Search box, Above-the-fold, as well as a CDnow
Branded Link to CDnow's classical music Search page. The Search boxes will take
users directly to corresponding, co-branded artist discography pages;
(III) CDnow promotional links (the sizes to be mutually
agreed upon by the parties, but there will be a maximum of three links, each
link not to be smaller than 120 X 60 pixels) where CDnow can advertise its
current in store promotions (i.e. 3 CD's for $30);
Additional content provided by CDnow may include, but is not limited to:
(IV) News and reviews for various musical genres:
(V) Chats and online music events calendar:
(VI) Advanced orders; and
(VII) New releases.
(G) [XXX]: The parties agree to work together to create a
mutually acceptable [XXX]. The [XXX] will include content and commerce offerings
to provided by CDnow. The parties will work together to develop a mutually
agreeable look and feel for the [XXX].
(H) Other [XXX]: CDnow shall have a presence on other suitable
[XXX] in the form of a graphic CDnow Branded Link, Above-the-fold. The parties
agree to work together to maximize commerce opportunities that may arise in
other web guides.
(ii) Lycos represents and warrants that it will place the CDnow
Branded Links on its Sites in a manner that is at least as good or better than
any other third party links on such Sites that are of a substantially similar
nature and function as the CDnow Branded Links. Lycos agrees that CDnow may vary
the elements of the CDnow Branded Links not more than [XXX] upon five (5)
business days notice in writing (including e-mail). Furthermore, the parties
agree to work together in good faith to identify and implement appropriate
placement of the CDnow Branded Links throughout the Lycos Sites, including all
necessary testing of the performance of such CDnow Branded Links. Prior to
implementing any modifications to the CDnow Branded Links not requested by
CDnow. Lycos will consult with CDnow in good faith regarding such changes. CDnow
agrees to collaborate with Lycos' production staff in designing and implementing
changes to CDnow Branded Links. In addition, Lycos agrees to reasonably consider
recommendations from CDnow regarding placement of CDnow Branded Links in areas
of the Lycos Sites not set forth in this Agreement.
(iii) CDnow acknowledges that the depictions of webpages attached as
Exhibits to this Agreement reflect the current iterations of webpages, and that
Lycos, consistent with its need to maintain creative control of its Sites, may
modify those webpages; provided, however, that the relative
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prominence of the CDnow Branded Links shall be maintained on the redesigned
webpages in accordance with the obligations of the parties under Section
2(a)(i).
(b) MINIMUM PAGE VIEW GUARANTEES.
(i) During the first full year of the Term, Lycos will deliver
a minimum of [XXX] Page Views according to the following schedule:
<TABLE>
<CAPTION>
Quarter/*/ Page Views
--------- ----------
<S> <C>
1 [XXX]
2 [XXX]
3 [XXX]
4 [XXX]
</TABLE>
(ii) During the second full year of the Term, Lycos will deliver
a minimum of [XXX] Page Views according to the following schedule:
<TABLE>
<CAPTION>
Quarter/*/ Page Views
--------- ----------
<S> <C>
1 [XXX]
2 [XXX]
3 [XXX]
4 [XXX]
</TABLE>
(iii) During the third full year of the Term, Lycos will deliver
a minimum of [XXX] Page Views according to the following schedule:
<TABLE>
<CAPTION>
Quarter/*/ Page Views
--------- ----------
<S> <C>
1 [XXX]
2 [XXX]
3 [XXX]
4 [XXX]
</TABLE>
/*/following the Launch Date
(c) LINK DEVELOPMENT AND TRANSLATION. Lycos shall produce the CDnow
Branded Links and Carry-through Bar, and CDnow will supply Lycos with all
information, artwork, logos, trademarks and URLs needed to produce such CDnow
Branded Links and Carry-through Bar. In the event that CDnow is requested by
Lycos to produce the CDnow Branded Links, Carry-through Bar or other elements of
the Co-branded Pages, CDnow shall produce such items and Lycos (as appropriate)
will supply CDnow with all information, artwork, logos, trademarks and URLs
necessary in a format specified by CDnow. CDnow shall be responsible for all
translation of the CDnow Branded Links and other CDnow content, such translation
to be performed at CDnow's sole discretion and cost.
(d) LINKS TO COBRANDED PAGES. When users transfer from the Lycos Sites to
CDnow, the initial Cobranded Page to which the users transfer shall have the
principal purpose of the promotion or sale of music-related products.
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3. PAYMENTS; AUDIT; REPORTING.
(a) MARKETING FEE. During the Term, in consideration of Lycos
fulfilling its obligations under this Agreement and subject to terms of this
Agreement, CDnow will pay Lycos marketing fees, in US dollars as follows:
(i) Payment of $5,500,000 based on the following schedule:
<TABLE>
<CAPTION>
Year 1
------
Date Payment
---- -------
<S> <C>
Upon the Effective Date $500,000
Upon the Launch Date $380,000 (Implementation Fee)
First day of the 2nd quarter/*/ $180,000
First day of the 3rd quarter/*/ $180,000
First day of the 4th quarter/*/ $180,000
</TABLE>
<TABLE>
<CAPTION>
Year 2
------
Date Payment
---- -------
<S> <C>
First day of the 5th quarter/*/ $180,000
Last day of the 5th quarter/*/ $425,000
Last day of the 6th quarter/*/ $425,000
Last day of the 7th quarter/*/ $425,000
Last day of the 8th quarter/*/ $425,000
</TABLE>
<TABLE>
<CAPTION>
Year 3
------
Date Payment
---- -------
<S> <C>
Last day of the 9th quarter/*/ $550,000
Last day of the 10th quarter/*/ $550,000
Last day of the 11th quarter/*/ $550,000
Last day of the 12th quarter/*/ $550,000
</TABLE>
/*/following the Launch Date
(ii) $[XXX] in cash for each New Customer to be paid within
thirty (30) days of the end of each quarter in which such New Customers are
acquired.
(iii) $[XXX] in cash for each Active Cosmic Credit Site to be
paid within thirty (30) days of the end of each quarter in which such Active
Cosmic Credit Sites are acquired. In no event will a New Customer fee be paid to
Lycos as part of the creation of an Active Cosmic Credit Site.
(b) AUDIT RIGHTS; UNDER/OVER PAYMENTS. Each party shall maintain complete
and accurate records in accordance with US Generally Accepted Accounting
Principles (GAAP) or the German
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equivalent for all transactions which are the subject of this Agreement for not
less than (3) years after the last payment is due under this Agreement. A "big
six" or other mutually acceptable accounting firm that is independent to Lycos
and CDnow retained by a party (the auditing party) shall have access to such
records of the other party (the audited party), upon reasonable notice, for the
purposes of audit during normal business hours, for so long as such records are
required to be maintained. If such accounting firm determines that any
additional payment is due the auditing party by the audited party, and such
payment is not the subject of a good faith dispute between the parties, then the
audited party shall promptly make payment of such amount to the auditing party.
If a party overpays the other party, the party that has made such overpayment
shall be entitled to a credit against the next payment due to the other party in
the amount of the overpayment, unless such overpayment is the subject of a good
faith dispute between the parties or no further payments are due under this
Agreement, in which case, the party that has received the overpayment will
promptly refund to the other party the amount of the overpayment.
(c) REPORTING.
(i) CDnow shall provide Lycos with a monthly report listing the
number of New Customers and Active Cosmic Credit Sites generated from the Lycos
Sites and calculated, in sufficient detail, for Lycos to determine the amounts
payable by CDnow to Lycos hereunder. Such report is to be used by Lycos to
actively track whether CDnow is fulfilling its obligations under this Agreement.
(ii) Beginning on the Effective Date. Lycos will provide CDnow with
weekly reports of Page Views (categorized by the areas set forth in Section
2(a)(i) or any future equivalent thereto or newly developed area which would
contain CDnow Branded Links) delivered to users of the Lycos Sites during the
immediately preceding week in a form and via media mutually agreeable to the
parties. Such report is to be used by CDnow to actively track whether Lycos is
fulfilling its obligations under this Agreement.
4. [XXX]
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5. EXCLUSIVITY.
(a) In no event will Lycos: [XXX].
(b) Lycos shall offer to CDnow a right-of-first-offer and right-of-first-
negotiation for any and all opportunities that Lycos intends to offer to any
other Entity which principally sells pre-recorded music products. Once Lycos
informs CDnow of each such opportunity and if CDnow informs Lycos of its
interest in each such opportunity, Lycos and CDnow agree to diligently negotiate
in good faith for not less than [XXX] a binding agreement concerning each such
opportunity. Lycos will use best efforts to obtain a right-of-first-offer and
right-of-first-negotiation for any and all opportunities that may be available
to any other music seller for any international properties in which Lycos
maintains an ownership interest or licensing arrangement.
6. THE CO-BRANDED PAGES. CDnow shall place a Carry-through Bar on the top and
bottom of the Co-branded Pages which will allow the visitor to return to the
Lycos Sites. CDnow and Lycos shall mutually agree upon the overall design of the
Carry-through Bar within the specifications provided by CDnow in the
Carry-through Bar Specifications, which is attached hereto as Exhibit A and made
a part hereof. In the event that CDnow should redesign its Site, CDnow shall
use good faith efforts to provide substantially similar functionality and
prominence. The final determination of any new design shall be at CDnow's sole
discretion.
7. FULFILLMENT. CDnow shall have the sole right and responsibility for
processing all orders which it receives through every aspect of the retail
transaction, including receiving, filling, shipping and handling, collecting
payment, tracking and transaction security. All orders for CDnow's products
shall be placed by customers directly with CDnow and shall be subject to
acceptance by CDnow. All orders accepted shall be subject to the terms and
conditions of CDnow's then current terms and conditions of sale. Such terms may
be changed at any time, without notice to Lycos. CDnow shall have no obligation
to ship any orders unless payment in full is received in advance. Prices for the
products shall be set solely by CDnow. CDnow may, at its discretion, change its
prices at any time, without notice to Lycos.
8. SPECIAL PROMOTIONS. Lycos acknowledges that in the event that the parties
enter into any special marketing and promotional activities together, there may
be additional costs including, but not limited to warehousing costs, management
fees and fulfillment fees, associated with such activities. The parties shall
agree in advance in a Promotion Schedule as to the scope of such special
marketing and promotional activities and the amount of funds and/or other
resources to be contributed to such activities by CDnow and Lycos. Any and all
Promotion Schedules shall be appended to this Agreement. CDnow and Lycos shall
mutually agree upon a joint promotion, such as a musical concert, to announce
this Agreement, such
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promotion to physically take place in Continental Europe or the United Kingdom
and executed within [XXX] of the Launch Date. CDnow and Lycos shall
share the cost of the promotion equally, up to [XXX] each.
9. STAFFING. Each party agrees to provide staffing sufficient for such party to
meet its obligations under this Agreement in a timely manner. Further, each
party shall appoint a relationship manager who shall have responsibility for
managing the day-to-day activities of the party under this Agreement.
10. RIGHT OF NEGOTIATION. In the event that CDnow desires to renew this
Agreement at the end of the Term, Lycos agrees to promptly and diligently
negotiate with CDnow in good faith to determine reasonable terms and conditions
of renewal, beginning not less than [XXX] prior to the end of the Term of this
Agreement. During the Term, Lycos agrees not to enter into any discussions,
negotiations, agreements or the like with any seller of music regarding the
Lycos Sites: provided, however, that Lycos is free to do so in the last [XXX] of
the Term if Lycos and CDnow have not agreed upon renewal terms prior to such
time.
11. LICENSE; OWNERSHIP.
(a) Each party hereby grants to the other party, during the Term of this
Agreement, a non-exclusive, non-transferable license to use its names, logos,
trademarks and service marks, copyrights and proprietary technology solely as
reasonably necessary to perform its obligations under this Agreement: provided,
however, that any promotional materials containing a party's name will be
subject to the other party's prior written approval.
(b) Each party owns and shall retain all right, title and interest in
its names, logos, trademarks and service marks, copyrights and proprietary
technology including without limitation, those names, logos, trademarks and
service marks, copyrights and proprietary technology currently used or any which
may be developed in the future. Neither party shall copy, distribute, reproduce
or use the other party's names, logos, trademarks and service marks, copyrights
and proprietary technology except as expressly permitted under this Agreement.
Upon notice from the one party, the other party shall immediately terminate the
use of any advertising materials using the notifying party's name or logo.
(c) Neither party shall contest or impair, directly or indirectly, the
other party's ownership of any of such other party's names, logos, trademarks
and service marks, copyrights, Proprietary Features and proprietary technology,
anywhere, nor the fact that the use of such names, logos, trademarks and service
marks, copyrights and proprietary technology by it will inure to the benefit of
the other party. Neither party will assist others to contest or impair the same
and each party hereby expressly acknowledges the other party's superior rights
therein.
12. TERM AND TERMINATION. The term of this Agreement shall commence upon the
Effective Date and shall continue for three (3) years from the Launch Date
(the "Term"), unless previously terminated as set forth below. The first year
of the Term shall end twelve months after the Launch Date. The second year of
the Term shall end twenty-four months after the Launch Date, and so on.
(a) During the Term:
(i) Any party may terminate this Agreement at any time: (A)
immediately upon written notice if another party becomes insolvent,
files a petition in bankruptcy or makes an assignment for the benefit of
its creditors; or (B) thirty (30) days after written notice to another
party of such
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<PAGE>
other party's breach of any of its material obligations under this
Agreement, which breach is not remedied within such 30-day period. Such
termination shall not relieve the party in breach from liability for the
performance of its obligations prior to such termination and shall be in
addition to all other rights and remedies the terminating party may have
available to it under this Agreement or at law or in equity:
(ii) Lycos failure to meet the Launch Date shall constitute a
breach of a material obligation under this Agreement.
(b) Upon the termination or expiration of this Agreement, each party
will: (i) immediately cease any and all use of the other parties intellectual
property, including, without limitation, the other party's trademarks,
tradenames, service marks, and other proprietary indicia; and (ii) promptly
(within ten (10) days) return all assets (digital, proprietary or otherwise)
belonging to the other.
(c) Upon the termination or expiration of this Agreement, Lycos shall
continue to point the URL "cdnow.lycos.de" to a URL of CDnow's choice for one
year. Subsequent to such period, Lycos shall cease all use of such URL.
(d) 1, 3(b), 7, 11(b), 11(c), 12(b), 12(c), 14, 15 and 16 shall survive
termination of this Agreement.
13. REPRESENTATIONS.
(a) Each party represents and warrants that it has, and will retain
during the Term hereof, all right, title and authority to enter into this
Agreement to grant the other parties the rights and licenses herein granted and
to perform all of its obligations under this Agreement.
(b) Each party represents and warrants that (i) there are no
restrictions, agreements or understandings whatsoever to which the representing
party is a party which would prevent or make unlawful its execution of this
Agreement or its engagement hereunder; and (ii) that its execution of this
Agreement and its engagement hereunder shall not constitute a breach of any
contract, agreement or understanding, oral or written, to which it is a party or
by which it is bound.
(c) CDnow represents and warrants that to its knowledge any content
provided by CDnow and displayed on the CDnow Site, the Co-branded Pages or the
Lycos Sites does not constitute defamation or invasion of the right of privacy
or publicity, or infringement of the copyright, trademark or other intellectual
property right, of any third party. This representation and warranty shall
specifically not apply to content provided by visitors to the Co-branded Pages,
the Lycos Sites, or the CDnow Site such as visitors who use chat rooms, bulletin
boards, or other forums on such Site which allow visitors to display material
that is not within the control of CDnow.
(d) Lycos represents and warrants that to its knowledge any content
provided by Lycos and displayed on the Co-branded Pages, the CDnow Site or the
Lycos Sites does not constitute defamation or invasion of the right of privacy
or publicity, or infringement of the copyright, trademark or other intellectual
property right, of any third party. This representation and warranty shall
specifically not apply to content provided by visitors to the Co-branded Pages,
the Lycos Sites or the CDnow Site such as
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<PAGE>
visitors who use chat rooms, bulletin boards, or other forums on such Site which
allow visitors to display material that is not within the control of Lycos.
(e) Lycos represents and warrants that (i) it will continue to expend at
least a substantially similar amount of resources (e.g. budget, staff) as it is
currently committing as of the time of execution of this Agreement for the Lycos
Sites: and (ii) it will not develop or promote any space on the Lycos Sites
which would contain any Competitive Marketing and which functions in a
substantially similar manner to or provides the user with a substantially
similar experience as the spaces on the Lycos Sites that contain CDnow Branded
Links as contemplated by this Agreement.
14. INDEMNIFICATION.
(a) INDEMNIFICATION BY CDNOW. CDnow shall indemnify, defend and hold
harmless Lycos and its affiliates, and their respective shareholders,
directors, officers, employees and agents, against any and all claims, actions,
liabilities, losses, and expenses (including reasonable attorneys' fees) brought
by a third party relating to or arising out of any claim that any content
provided by CDnow and displayed on the Co-branded Pages, the CDnow Site, or the
Lycos Sites constitutes a defamation or invasion of the right of privacy or
publicity, or infringement of the copyright, trademark or other intellectual
property right, of any third party, including any claims arising out of the
offer of sale of pre-recorded music products and the performance of sound
samples related thereto via the Internet. This indemnity shall specifically not
apply to content provided by visitors to the Co-branded Pages, the CDnow Site,
or the Lycos Sites such as visitors who use CDnow's chat rooms, bulletin boards,
or other forums which allow visitors to display material that is not within the
control of CDnow.
(b) INDEMNIFICATION BY LYCOS. Lycos shall indemnify, defend and hold
harmless CDnow and its affiliates, and their respective shareholders, directors,
officers, employees and agents, against any and all claims, actions,
liabilities, losses, and expenses (including reasonable attorneys' fees) brought
by a third party relating to or arising out of any claim that any content
provided by Lycos and displayed on the Co-branded Pages, the CDnow Site or the
Lycos Sites constitutes a defamation or invasion of the right of privacy or
publicity, or infringement of the copyright, trademark or other intellectual
property right, of any third party. This indemnity shall specifically not apply
to content provided by visitors to the Co-branded Pages, the Lycos Sites or the
CDnow Site such as visitors who use chat rooms, bulletin boards, or other forums
on such Site which allow visitors to display material that is not within the
control of Lycos.
(c) OBLIGATIONS OF THE INDEMNIFIED PARTY. The indemnified party shall
promptly provide the indemnifying party with written notice of any claim which
the indemnified party believes falls within the scope of this Section 14(c);
provided, however, that, except to the extent the indemnifying party is actually
prejudiced by the indemnified party's failure to provide such prompt notice,
such failure to provide prompt notice hereunder shall not limit the indemnified
party's rights under this Paragraph 14(c). The indemnified party may, at its own
expense, assist in the defense of any such claim if it so chooses, provided that
the indemnifying party shall control such defense and all negotiations relative
to the settlement of any such claim.
(d) SETTLEMENT. No party shall, without the prior written consent of
another party, settle, compromise or consent to the entry of any judgment with
respect to any pending or threatened claim unless the settlement, compromise or
consent provides for and includes an express, unconditional release of all
claims, damages, liabilities, costs and expenses, including reasonable legal
fees and expenses, against the indemnified party.
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15. CONFIDENTIALITY; PUBLIC RELATIONS.
(a) NON-DISCLOSURE AGREEMENT. The parties acknowledge that, as a result
of negotiating, entering into and performing this Agreement, each party has and
will have access to certain of the other party's Confidential Information (as
defined below). Each party also understands that misuse and/or disclosure of
that information could adversely affect the other party's business. Accordingly,
during the Term of this Agreement and thereafter, each party shall use and
reproduce the other party's Confidential Information only for purposes of this
Agreement and only to the extent necessary for such purpose and shall restrict
disclosure of the other party's Confidential Information to its employees,
consultants or independent contractors with a need to know and shall not
disclose the other party's Confidential Information to any third party without
the prior written approval of the other party. Notwithstanding the foregoing, it
shall not be a breach of this Agreement for either party to disclose
Confidential Information of the other party if required to do so under law in a
judicial or other governmental investigation or proceeding, provided the other
party has been given prior notice and the disclosing party has sought all
available safeguards against widespread dissemination prior to such disclosure.
(b) CONFIDENTIAL INFORMATION DEFINED. As used in this Agreement, the term
"Confidential Information" refers to: (i) the terms and conditions of this
Agreement; (ii) each party's trade secrets, business plans, strategies, methods
and/or practices; and (iii) other information relating to either party that is
not generally known to the public, including information about either party's
personnel, products, customers, marketing strategics, services or future
business plans. Notwithstanding the foregoing, the term "Confidential
Information" specifically excludes (A) information that is now in the public
domain or subsequently enters the public domain by publication or otherwise
through no action or fault of the other party; (B) information that is known to
either party without restriction, prior to receipt from the other party under
this Agreement, from its own independent sources as evidenced by such party's
written records, and which was not acquired, directly or indirectly, from the
other party; (C) information that either party receives from any third party
reasonably known by such receiving party to have a legal right to transmit such
information, and not under any obligation to keep such information confidential;
and (D) information independently developed by either party's employees or
agents provided that either party can show that those same employees or agents
had no access to the Confidential Information received hereunder.
(c) NOTIFICATIONS REQUIRED BY LAW OR REGULATION. The parties agree that
it shall not be deemed a breach of this Agreement for any party to disclose the
terms and conditions of this Agreement in any regulatory filing with the
Securities & Exchange Commission, any stock exchange or the NASDAQ National
Market, which such party determines in good faith is required, provided such
party seeks confidential treatment of the material financial terms and
conditions of this Agreement.
(d) PUBLICITY. No party will make any detailed announcements or
statements to the public or create any written materials concerning the
relationship between them without the prior written consent of the other, which
is not to be unreasonably withheld or delayed. In no event shall either party or
any content, products or services present on either party's website or service
disparage the other party or any of the other party's affiliates.
(e) PRESS RELEASES. Lycos and CDnow shall jointly prepare a press release
concerning the existence of this Agreement and mutually agree upon the contents
of such press release. Unless required by law, legal process or governmental
regulation. CDnow agrees not to issue any press release regarding European
marketing or expansion prior to issuing a press release regarding this
Agreement.
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16. MISCELLANEOUS
(a) INDULGENCES. ETC. Neither the failure nor any delay on the part of
either party to exercise any right, remedy, power or privilege under this
Agreement shall operate as a waiver thereof, nor shall any single or partial
exercise of any right, remedy, power or privilege preclude any other or further
exercise of the same or of any other right, remedy, power or privilege, nor
shall any waiver of any right, remedy, power or privilege with respect to any
occurrence be construed as a waiver of such right, remedy, power, or privilege
with respect to any occurrence or as a waiver of any other right, remedy, power
or privilege.
(b) DISPUTE RESOLUTION. If a dispute arises out of or relates to this
Agreement, or its breach, and cannot otherwise be amicably resolved within
thirty (30) days of the date one party notifies the other party of the existence
of such dispute, the parties agree to submit the dispute to arbitration by and
under the rules of the International Chamber of Commerce ("ICC"), and to an
arbitrator that they shall mutually select and agree upon, and the arbitration
shall be held in New York, New York. In the event the parties are unable to
agree on an arbitrator within fifteen (15) days after the dispute is submitted
for arbitration, the arbitrator shall be selected by the ICC. An award shall be
made within (6) months of selection of the arbitrator. The arbitrator shall
determine issues to be arbitrated, but may not limit, expand or otherwise modify
the terms of this Agreement nor have authority to award punitive damages or
other damages in excess of compensatory damages and each party irrevocably
waives any claim thereto. At the request of either party, the arbitrator shall
provide to the parties findings of facts and conclusions of law supporting any
decision and/or award. The decision and/or award of the arbitrator shall be
final and binding upon the parties and may be entered in any court of competent
jurisdiction. The parties shall provide the arbitrator and any expert witnesses
with any and all information pertaining to the dispute between the parties that
the arbitrator or expert witnesses may request in such arbitration, provided
such information shall be deemed the Confidential Information of the disclosing
party. The parties, their representatives and counsel, other participants and
the arbitrator shall hold the existence, content and results of the arbitration
in confidence, except as may be required to be disclosed by applicable law.
(c) NOTICES. All notices, requests, demands, and other communications
required or permitted under this Agreement and the transactions contemplated
herein shall be in writing and shall be deemed to have been duly given, made and
received when delivered against receipt or when sent by registered air mail,
return receipt requested, postage prepaid, address as set forth below:
(i) If to CDnow: (ii) If to Lycos:
CDnow, Inc. Lycos Bertelsmann
610 Old York Road GmbH & Co. KG
Jenkintown, PA 19046 Carl Bertelsmann Str. 161 L
USA Postfach 315
D 33311 Guetersloh
Attn: General Counsel Germany
Attn: CEO
with a copy to:
Dr. Dannhoff
Bertelsman AG
Legal Department
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Carl Bertelsmann Str. 270
D 33311 Guetersloh
Any party may alter the address to which communications or copies are to be sent
by giving notice of such change of address in the manner set forth herein.
(d) PROVISIONS SEPARABLE. The provisions of this Agreement are independent
of and separable from each other, and no provision shall be affected or rendered
invalid or unenforceable by virtue of the fact that for any reason any other or
others of them may be invalid or unenforceable in whole or in part.
(e) ENTIRE AGREEMENT. The terms and conditions of this Agreement and any
and all Exhibits attached hereto represent the entire understanding between the
parties hereto with respect to the subject matter hereof, and supersede all
prior and contemporaneous agreements and understandings, inducements or
conditions, express or implied, oral or written. The express terms hereof
control and supersede any course of performance and/or usage of trade
inconsistent with any of the terms hereof. This Agreement may not be modified or
amended other than by an agreement in writing signed by both parties.
(f) SECTION HEADINGS. The section headings in this Agreement are for
convenience only; they form no part of this Agreement and shall not affect its
interpretation.
(g) TELEFAXES CONSTITUTE VALID DOCUMENTS. This Agreement and subsequent
modifications may be transmitted by telecopy facsimile machine and such
facsimile copy shall be deemed an original if all pages thereof are initialed
and the Agreement or modifications are signed by the duly authorized
representative of the parties. Such facsimiles shall constitute valid, binding
documents and shall be regarded as such upon receipt. The original of the
document sent by telefax shall be promptly sent within seventy-two (72) hours
overnight courier or first class mail to the receiving party so that accurate
files may be maintained. Failure to send timely any original document shall not
affect the validity or binding nature of such document.
(h) FORCE MAJEURE. Neither party shall be held to be in breach of this
Agreement by any reason of any failure or delay in its performance hereunder if
such failure is due to causes beyond its reasonable control, including but not
limited to acts of the other party, acts of God, delays in transportation,
inability beyond its reasonable control to obtain necessary labor or materials,
or events such as fires, floods, earthquakes, storms, war, act of public enemy,
civil commotions and the like or by any law, rule, regulation, order or other
action by public authority. To the extent failure to perform is caused by such
an event, such party shall be excused from performance hereunder so long as such
event continues to prevent such performance and provided the non-performing
party takes all reasonable steps to resume full performance.
(i) INDEPENDENT CONTRACTOR. Each party shall act as independent contractor
and shall have no authority to obligate or bind the other in any respect.
Neither the employees of Lycos nor the employees of CDnow shall represent
themselves to the employees of the other.
(j) COMPLIANCE WITH LAWS. Each party shall comply with all federal, state
and local laws, licensing regulations and rulings of governmental bodies having
jurisdiction over its business. Nothing in this Agreement shall be construed to
require either party to perform any act in violation of any laws, regulations or
rulings.
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(k) DISCLAIMER OF WARRANTY. EXCEPT AS OTHERWISE PROVIDED FOR IN THIS
AGREEMENT. EACH PARTY'S SITE(S) IS PROVIDED ON AN "AS IS" BASIS WITHOUT
WARRANTIES OF ANY KIND, EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO
WARRANTIES OF TITLE OR IMPLIED WARRANTIES OR MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE. OTHER THAN THOSE WARRANTIES WHICH ARE IMPLIED BY OR
INCAPABLE OF EXCLUSION. RESTRICTION OR MODIFICATION UNDER THE LAWS APPLICABLE TO
THIS AGREEMENT.
(l) LIMITATION OF LIABILITY. UNDER NO CIRCUMSTANCES SHALL EITHER PARTY BE
LIABLE TO THE OTHER PARTY FOR INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR
EXEMPLARY DAMAGES (EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF
SUCH DAMAGES), ARISING FROM ANY PROVISION OF THIS AGREEMENT (INCLUDING SUCH
DAMAGES INCURRED BY THIRD PARTIES), SUCH AS, BUT NOT LIMITED TO, LOSS OF REVENUE
OR ANTICIPATED PROFITS OR LOST BUSINESS. IN NO EVENT SHALL ANY PARTY BE LIABLE
FOR DAMAGES IN EXCESS OF THE AMOUNT RECEIVED OR PAID BY SUCH PARTY UNDER THIS
AGREEMENT, PROVIDED THAT THIS SECTION DOES NOT LIMIT ANY PARTY'S LIABILITY FOR
(A) WILLFUL AND MALICIOUS MISCONDUCT: (B) DIRECT DAMAGES TO REAL OR TANGIBLE
PERSONAL PROPERTY: (C) BODILY INJURY OR DEATH CAUSED BY NEGLIGENCE: OR (D) SUCH
PARTY'S INDEMNIFICATION OBLIGATIONS HEREUNDER.
(m) LIABILITY FOR TERMINATION. In the event of proper termination as set
forth herein, the terminating party shall not be liable for reimbursement of
damages as a result of such proper termination on account of any loss of
prospective profits or on account of expenditures, investments, leases or other
commitments relating to the other party's business or good will.
(n) EXPENSES. Except as otherwise provided for in this Agreement, each
party shall be responsible for any and all expenses, charges and fees incurred
by it in connection with its duties hereunder, and it shall not be reimbursed
for the same by the other party.
(o) BINDING NATURE OF AGREEMENT. This Agreement shall be binding upon the
parties hereto and their respective heirs, executors, successors and assigns.
No part may, without the prior written consent of the other, assign or transfer
this Agreement or any obligation incurred hereunder. Any attempt to do so in
contravention of this Section 16(o) shall be void and of no force and effect.
(p) TIMELY PERFORMANCE. Each party acknowledges that in the performance of
this Agreement, time shall be considered of the essence.
(q) CONTROLLING LAW. This Agreement and all questions relating to its
validity, interpretation, performance and enforcement shall be governed by and
construed in accordance with the laws of the Commonwealth of Massachusetts,
other than conflicting choice-of-law provisions.
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IN WITNESS WHEREOF, the party's duly authorized representatives have executed
this Agreement as of the Effective Date.
CDNOW, INC. LYCOS BERTELSMANN GMBH & CO
KG
By: /s/ Jason Olim By: /s/ Christoph Mohn
----------------------------- --------------------------
Name: JASON OLIM Name: CHRISTOPH MOHN
--------------------------- --------------------------
Date: April 2, 1998 Date: April 2, 1998
--------------------------- --------------------------
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EXHIBIT A
CARRY-THROUGH BAR SPECIFICATIONS AS OF 4/15/97
SIZE
Total Carry-through Bar Size: 468(w) x 25(h) pixels as of April 1, 1997 all
Carry-through Bar sizes must be 468(w) x 25(h) to comply with the Internet
Advertising Bureau's (IAB) banner standards.
Live area for Partner Logo: 360(w) x 24(h) pixels
COLOR
Bar is black at all times.
Only partner logos icons can be as many colors as desired with a black
background "Return to... " copy is mandatory and must be set up as white
Helvetica Neue Black 10pt type, centered and 5 pixels in from the left-hand
side of the first black bar
We recommend all copy to be white
To pick up a template go to http://cdnow.com/cobrand_template
FORMAT
Must be saved in a GIF file format
PLACEMENT
Carry-through bar is placed on the top and bottom of each CDnow page. Only those
people who visit CDnow from your site will see the Carry-through bar
URL/ADDRESS
Partners have the option of 1 to 3 links on their Carry-through bar -- The URLs
will be provided by the partner
If more than one link is desired, the bar must consist of multiple gif images
that reference previous Carry-through bar specifications. When using multiple
gif images keep two pixels between each bar. No image maps are permitted. Please
see the following page for more examples of possible banner solutions.
[Graphics intentionally omitted.]
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SOURCE CODE
CDnow will provide the partner with a from equals (from=) tag. This tag allows
us to indentify customers coming from the Partners site to CDnow.
TIMING
CDnow requires a minimum of five business days from when we receive the
Carry-through bar to implement it on our site.
CARRY-THROUGH BAR SAMPLES
[Graphics intentionally omitted.]
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EXHIBIT B
CDNOW BRANDED LINK PLACEMENTS
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EXHIBIT C
COMPLIANCE WITH EXISTING CONTRACTS
The following list the existing agreements which constitute and exception to
Competitive Marketing and the dates by which they terminate.
[XXX]
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EXHIBIT D
Keywords:
[XXX]
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EXHIBIT C
---------
TERRIRORY
---------
[XXX]
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EXHIBIT 10.14
LINKING AGREEMENT
THIS LINKING AGREEMENT ("Agreement") is made this 26th day of March, 1998
("Effective Date"), by and among LYCOS, INC., a corporation organized under the
laws of Delaware ("Lycos"), TRIPOD, INC., a corporation organized under the laws
of Delaware ("Tripod") and a wholly owned subsidiary of Lycos, and CDNOW, INC.,
a corporation organized under the laws of Pennsylvania ("CDnow").
RECITALS
WHEREAS, CDnow is a retailer of compact discs and other items for sale through
its Web service which is accessible through the URL www.cdnow.com (the "CDnow
Site");
WHEREAS, Lycos is the owner or licensee of certain Web services and other search
and content areas, which are accessible through the URL www.lycos.com (the
"Lycos Site");
WHEREAS, Tripod is the owner or licensee of certain Web services and other
search and content areas, which are accessible through the URL www.tripod.com
(the "Tripod Site");
WHEREAS, CDnow desires that Lycos integrate links from the Lycos Site and the
Tripod Site to a co-branded version of the CDnow Site so that Lycos' and
Tripod's users may have convenient access to the CDnow Site;
NOW, THEREFORE, the parties hereto for good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, and intending to be
legally bound, hereby agree as follows:
1. DEFINITIONS. Capitalized terms not otherwise defined in this Agreement will
have the following meanings:
(a) "Above-the-fold" shall mean situated within the portion of a page that
is designed to be visible on a standard computer screen with a resolution of 640
pixels by 480 pixels without requiring the user to scroll horizontally or
vertically throughout the page.
(b) "Active Cosmic Credit Site" shall mean a website that has been
registered in CDnow's affiliate website program known as the "Cosmic Credit
Program" through the Cosmic Credit links provided by CDnow on either Lycos' Site
or Tripod's Site, and which has generated one non-returned purchase of a product
on CDnow's Site.
(c) "Beyond the Banner" shall mean any type of promotion which involves
promotional techniques other than the placement of standard advertising banners
or standard advertising buttons and links.
(d) "Carry-through Bar" shall mean a linking bar containing one or more of
the Proprietary Features of any or all of the parties which connects the
Co-branded Pages and Lycos' Site and Tripod's Site.
(e) "CDnow Branded Link" shall mean a link which contains a CDnow approved
Proprietary Feature of CDnow, is located on Lycos' Site or Tripod's Site and
will take Lycos' or Tripod's users to the Co-branded Pages where such users may
purchase CDnow's products.
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(f) "Click-through" shall mean a user presence at the Co-branded Pages
which originated from a CDnow Branded Link found on a guaranteed Page View, and
which initiates a Session.
(g) "Co-branded Pages" shall mean pages of CDnow's Site which a visitor
from Lycos' Site or Tripod's Site will link to and which shall display certain
Proprietary Features of both Lycos or Tripod and CDnow. The Co-branded Pages can
only be viewed by a visitor who links to them directly from Lycos or Tripod or
through a stored URL (e.g. bookmark or similar technological storage mechanism).
The Co-branded Pages will reside will reside on CDnow's server(s).
(h) "Competitor" shall mean (i) any of the Entities listed on Exhibit A,
attached hereto and made a part hereof, and (ii) any Entity that is [XXX].
(i) "Entity" means any individual, limited liability company,
partnership, corporation, or division, subsidiary or business unit thereof,
retail site, World Wide Web site or other entity.
(j) "Launch Date" shall mean the date on which Lycos and Tripod make the
CDnow Branded Links available to users in accordance with the placement terms
set forth in Sections 2(a) and 2(b), provided that CDnow has approved such
placements (which approval shall not be unreasonably withheld or delayed) prior
to the launch. CDnow, Lycos and Tripod shall use commercially reasonable efforts
to develop and deliver as necessary to each other, within three (3) weeks of the
Effective Date, any and all URLs, URL formats (as applicable), content, and
other materials necessary for Lycos and Tripod to make available the CDnow
Branded Links. Subsequent to the delivery of all necessary materials to Lycos
and Tripod, Lycos and Tripod shall use commercially reasonable efforts to make
available the CDnow Branded Links to their respective users within three (3)
weeks of such delivery.
(k) "Lycos Branded Link" shall mean a link which contains a Lycos
Proprietary Feature, is located on CDnow's Site and will take CDnow's users to
pages on Lycos' Site which pages will contain a Carry-through Bar which can
return users to the Co-branded Pages.
(l) "New Customer" shall mean any user that transfers from Lycos' Site or
Tripod's Site directly to a Co-Branded Page, cerates a first-time account and at
that time or at any time thereafter during the Term of this Agreement makes a
first purchase of any product at CDnow's Site, which product is also shipped by
CDnow's distributor.
(m) "Page View" shall mean a user's viewing of any webpage of Lycos' Site
or Tripod's Site containing a CDnow Branded Link.
(n) "Promotion Schedule" shall mean a written term sheet signed by an
authorized representative of each party pertaining to a promotion or special
marketing event entered into by both parties and describing the obligations of
each party with regard to such promotion or special marketing event.
(o) "Proprietary Feature" shall mean any trademark, service mark, trade
name, domain name, text message, navigational element or design logo which is
proprietary to Lycos/Tripod and/or CDnow.
(p) "Session" shall mean the delivery of any or all of the Co-branded
Pages to a user where no two pages are delivered more than two hours apart.
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(q) "Term" is defined in Section 12 of this Agreement.
(r) "Tripod Branded Link" shall mean a link which contains a Tripod
Proprietary Feature, is located on CDnow's Site and will take CDnow's users to
pages on Tripod's Site (which pages will contain a Carry-through Bar which can
return users to the Co-branded Pages) where such users may use Tripod's
proprietary "Homepage Builder" Software.
(s) "URL" shall mean Universal Resource Locator.
2. LINKING.
(a) CDNOW BRANDED LINK PLACEMENT. Lycos and Tripod shall place CDnow
Branded Links on Lycos' Site and Tripod's Site in accordance with the
requirements set forth in this Section 2(a).
(i) Lycos and Tripod will place the following on the pages indicated
(and all existing or future equivalents, extensions, additions or replacements
of such areas/pages on the Lycos and Tripod Sites). Unless otherwise specified
herein, such links shall be permanent and non-rotating and where practically
feasible, Above-the-fold. The links shall be placed in accordance with Exhibit
B (which is attached hereto and made a part hereof) unless otherwise agreed by
the parties.
(1) On the Lycos Site, Lycos shall place:
(A) CDnow Branded Links on the following pages: [XXX]
(B) CDnow branded text links on the following pages: [XXX]
(2) On the Tripod Site, Tripod shall place:
(A) CDnow Branded Links on the following pages: [XXX]
(ii) Tripod will place a permanent CDnow Branded Link on the [XXX]
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(iii) Lycos and Tripod represent and warrant that they will place the
CDnow Branded Links on their respective Sites in a manner that is at least as
good or better than any other third party links on such Sites that are of a
similar nature and function as the CDnow Branded Links. Lycos and Tripod agree
that CDnow may vary the elements of the CDnow Branded Links not more than [XXX]
per month upon [XXX] notice in writing (including e-mail). Futhermore, the
parties agree to work together in good faith to identify and implement
appropriate placement of the CDnow Branded Links throughout Lycos' Site and
Tripod's Site, including all necessary testing of the performance of such CDnow
Branded Links. Prior to implementing any modifications to the CDnow Branded
Links not requested by CDnow, Lycos and Tripod will consult with CDnow in good
faith regarding such changes. CDnow, agrees to collaborate with Lycos' and
Tripod's production staff in designing and implementing changes to CDnow Branded
Links.
(iv) Lycos and Tripod will place a CDnow "mini-store" consisting of
HTML pages on their respective Sites (the design, placement and content of such
"mini-store" to be mutually agreed upon by the parties, although generally the
content shall contain brief descriptions of musical genres and albums, as well
as links to CDnow's Site enabling users to purchase such albums), as soon as
practicably feasible after the Effective Date, based on the parties acting
diligently and in good faith beginning on the Effective Date to implement such
mini-store.
(v)
(A) Each quarter of the Term, each of Lycos and Tripod agree to
provide CDnow with two [XXX] of promotional placement on their respective home
pages, such promotions to be provided by CDnow as demonstrated in Exhibit B.
(B) During the Term, Lycos shall provide CDnow with the
opportunity to participate in [XXX] of the promotions which Lycos develops for
its home page. Lycos will provide CDnow with reasonable advance notice of each
such promotion. CDnow shall receive all user information available from such
promotions within two weeks of the end of the promotions.
(vi) CDnow acknowledges that the depictions of webpages attached as
Exhibits to this Agreement reflect the current iterations of those webpages, and
that Lycos and Tripod, consistent with their need to maintain creative control
of their respective Sites, may modify those webpages; provided, however, that
the relative prominence of the CDnow Branded Links shall be maintained on the
redesigned webpages in accordance with the obligations of the parties under
Section 2(a)(ii). In addition, Lycos and Tripod agree to reasonably consider
recommendations from CDnow regarding placement of CDnow Branded Links in areas
of Lycos' Site and Tripod's Site not set forth in this Agreement. Nothing in
this section shall be construed as obliging Lycos or Tripod to accept CDnow's
recommendations.
(vii) Lycos will place CDnow Branded Links and certain promotional
content provided by CDnow (such content to be mutually agreed upon by the
parties and updated as necessary by CDnow) in the [XXX].
(b) MINIMUM PAGE VIEW GUARANTEES.
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(i) During the first year of the Term, Lycos and Tripod,
collectively, will deliver a minimum aggregate of [XXX] Page Views. Lycos
will deliver [XXX] of such aggregate Page Views and Tripod will
deliver [XXX] of such aggregate Page Views. If Lycos fails to
deliver such minimum guaranteed Page Views, [XXX].
(ii) During the second year of the Term, Lycos and Tripod,
collectively, will deliver a minimum aggregate of [XXX] Page Views. The
distribution of such aggregate Page Views between Lycos and Tripod shall be the
[XXX].
(iii) During the third year of the Term, Lycos and Tripod,
collectively, will deliver a minimum aggregate of [XXX] Page Views. The
distribution of such aggregate Page Views between Lycos and Tripod shall be the
[XXX].
(c) LINK DEVELOPMENT. Lycos and Tripod shall produce the CDnow Branded
Links and Carry-through Bar, and CDnow will supply Lycos and Tripod with all
information, artwork, logos, trademarks and URLs needed to produce such CDnow
Branded Links and Carry-through Bar. In the event that CDnow is requested by
Lycos or Tripod to produce the CDnow Branded Links, Carry-through Bar or other
elements of the Co-branded Pages, CDnow shall produce such items and Lycos or
Tripod (as appropriate) will supply CDnow with all information, artwork, logos,
trademarks and URLs necessary, in a format specified by CDnow.
(d) TRIPOD BRANDED LINKS. Tripod shall be a premier "Homepage Builder"
provider for CDnow users, and CDnow shall place a Tripod Branded Link on CDnow's
Site, at its discretion. CDnow agrees that if it places the Tripod Branded Links
on its Site such links shall be placed in a manner at least as good as any third
party links that provide similar services as Tripod under similar business
conditions.
(e) LYCOS BRANDED LINKS. Lycos shall be a premier "Search, Directory and
Navigation" provider for CDnow users, and CDnow shall place a Lycos Branded Link
on CDnow's Site, at its discretion. CDnow agrees that if it places the Lycos
Branded Links on its Site such links shall be placed in a manner at least as
good as any third party links that provide similar services as Lycos under
similar business conditions.
(f) COSMIC CREDIT. Lycos will include CDnow's Cosmic Credit websites in
its search result listings. CDnow will provide Lycos with the URLs of both
existing and future Cosmic Credit websites.
3. PAYMENTS; AUDIT; REPORTING.
(a) MARKETING FEE. During the Term, in consideration of Lycos and Tripod
fulfilling their obligations under this Agreement and subject to terms of this
Agreement, CDnow will pay Lycos marketing fees, as follows:
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(i) $16,500,000 in accordance with the following schedules:
Year 1
------
Date Payment
---- -------
Upon the Effective Date $1,500,000.00
Upon the Launch Date $1,500,000.00
Upon the date on which all
competitive advertising is
removed from Lycos's and Tripod's
Sites as set forth in Exhibit D and
When Lycos and Tripod are in full
compliance with the provisions set
forth in Article 5 of this Agreement $1,500,000.00
Year 2
------
Date Payment
---- -------
First day of the 5th quarter/*/ $1,375,000.00
First day of the 6th quarter/*/ $1,375,000.00
First day of the 7th quarter/*/ $1,375,000.00
First day of the 8th quarter/*/ $1,375,000.00
Year 3
------
Date Payment
---- -------
First day of the 9th quarter/*/ $1,625,000.00
First day of the 10th quarter/*/ $1,625,000.00
First day of the 11th quarter/*/ $1,625,000.00
First day of the 12th quarter/*/ $1,625,000.00
*following the Launch Date
(ii) [XXX] in cash for each New Customer to be paid within thirty
(30) days of the end of each quarter in which such New Customer are acquired.
(iii) [XXX] in cash for each Active Cosmic Credit Site to be paid
within thirty (30) days of the end of each quarter in which such Active Cosmic
Credit Sites are acquired.
(B) STOCK ISSUANCE AND VESTING TERMS.
(i) In consideration of Lycos' and Tripod's fulfilling their
obligations under this Agreement and subject to the terms of this Agreement,
CDnow shall issued to Lycos, on the Effective Date, a number of shares (the
"Shares") of Common Stock, no par value (the "Common Stock") to
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be determined by dividing [XXX] by the average closing price of CDnow's
Common Stock on the NASDAQ National Market System for the five (5) trading days
prior to the Effective Date. [XXX]
(ii) Notwithstanding anything to the contrary set forth herein, if
[XXX]
(iii) The certificates representing shares subscribed for hereunder
will bear the following legends:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED, OR UNDER ANY APPLICABLE STATE SECURITIES
LAW. SUCH SHARES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE SOLD,
TRANSFERRED, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION
STATEMENT FOR SUCH SHARES UNDER THE SECURITIES ACT OF 1933, UNLESS, IN THE
OPINION (WHICH SHALL BE IN FORM AND SUBSTANCE
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REASONABLY SATISFACTORY TO THE CORPORATION) OF COUNSEL REASONABLY SATISFACTORY
TO THE CORPORATION, SUCH REGISTRATION IS NOT REQUIRED.
THE SALE, TRANSFER OR ASSIGNMENT OF THE SECURITIES REPRESENTED BY THIS
CERTIFICATE ARE SUBJECT TO THE TERMS AND CONDITIONS OF A CERTAIN LINKING
AGREEMENT DATED AS OF MARCH ___, 1998, AS AMENDED FROM TIME TO TIME, BY AND
AMONG CDNOW, INC. AND CERTAIN OTHER PARTIES. COPIES OF SUCH AGREEMENT MAY BE
OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS
CERTIFICATE TO THE SECRETARY OF THE CDNOW, INC.
(iv) The total authorized capital stock of CDnow consists of
50,000,000 shares of Common Stock, no par value, and 10,000,000 shares of
preferred stock, no par value (of which no shares are outstanding). All of the
outstanding shares of Common Stock have been duly authorized and are validly
issued, fully paid and non-assessable. None of the Lycos Shares are subject to
any preemptive rights. The Lycos Shares, when issued and delivered against
payment thereof in accordance with this Agreement, will be duly authorized,
validly issued, fully paid and nonassessable
(v) The Shares are being acquired for investment and not with a
view to the distribution or resale thereof, the effect of which is that such
Shares must be held indefinitely unless subsequently registered under the
Securities Act of 1933, as amended (the "Act"), or an exemption from such
registration is available.
(vi) Lycos is an "accredited investor" as such term is defined in
Rule 501(a) of Regulation D promulgated under the Act. Lycos' present and
anticipated financial position permits it to purchase and hold the Shares
indefinitely for investment purposes. Lycos acknowledges that it is thoroughly
familiar with the business of CDnow and has made all investigations which it
deems necessary or desirable in connection with the acquisition of the Shares.
(vii) CDnow has informed Lycos that:
(A) the Shares have not and will not be registered under the
Act or under any applicable state securities law and must be held by it
indefinitely unless they are subsequently so registered or unless an
exemption from such registration is available;
(B) CDnow is under no obligation to register the Shares under
any circumstances or to attempt to make available any exemption from
registration under the Act or any applicable state securities law, at its
expense or otherwise; and
(C) if, at a time when registration is required, it is legally
and contractually permissible for Lycos to sell the Shares privately
without registration, any Shares so sold will be restricted in the hands of
the purchaser.
(viii) Lycos will not make any sale or other transfer of the Shares in
violation of the Act, any state securities laws or the terms of this Agreement.
(c) AUDIT RIGHTS; UNDER/OVER PAYMENTS. Each party shall maintain complete
and accurate records in accordance with US Generally Accepted Accounting
Principles (GAAP) for all transactions which are the subject of this Agreement
for not less than (3) years after the last payment is due under this Agreement.
A "big six" or other mutually acceptable accounting firm that is independent to
Lycos, Tripod and CDnow retained by a party (the auditing party) shall have
access to such records of the other party (the audited party), upon reasonable
notice, for the purposes of audit during normal business hours, for so long as
such records are required to be maintained. If such
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accounting firm determines that any additional payment is due the auditing party
by the audited party, and such payment is not the subject of a good faith
dispute between the parties, then the audited party shall promptly make payment
of such amount to the auditing party. If a party overpays the other party, the
party that has made such overpayment shall be entitled to a credit against the
next payment due to the other party in the amount of the overpayment, unless
such overpayment is the subject of a good faith dispute between the parties or
no further payments are due under this Agreement, in which case, the party that
has received the overpayment will promptly refund to the other party the amount
of the overpayment.
(d) REPORTING.
(i) CDnow shall provide Lycos and Tripod with a monthly report
listing the number of New Customers and Active Cosmic Credit Sites generated
from Lycos' Site and Tripod's Site and calculated, in sufficient detail, for
Lycos to determine the amounts payable by CDnow to Lycos and Tripod hereunder.
Such report is to be used by Lycos and Tripod to actively track whether CDnow is
fulfilling its obligations under this Agreement.
(ii) Beginning on the Effective Date, Lycos and Tripod will provide
CDnow with weekly reports of Page Views [XXX] delivered to users of Lycos' Site
and Tripod's Site during the immediately preceding week in a form and via media
mutually agreeable to the parties. Such report is to be used by CDnow to
actively track whether Lycos and Tripod are fulfilling their collective
obligations under this Agreement.
4. [XXX]
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5. EXCLUSIVITY.
(a) In no event will Lycos or Tripod: [XXX]
(b) [XXX]
(c) Lycos and Tripod shall offer to CDnow a right-of-first-offer and
right-of-first-negotiation for any and all opportunities that Lycos and/or
Tripod (as the case may be) intend to offer to any other music seller, and, once
Lycos and/or Tripod (as the case may be) inform CDnow of each such opportunity
and if CDnow informs Lycos and/or Tripod (as the case may be) of its interest in
each such opportunity, Lycos and/or Tripod (as the case may be) and CDnow agree
to diligently negotiate in good faith for not less than [XXX] a binding
agreement concerning each such opportunity. Lycos will use best efforts to
obtain a right-of-first-offer and right-of-first-negotiation for any and all
opportunities that may be available to any other music seller for any
international properties in which Lycos maintains an ownership interest or
licensing arrangement. In particular, Lycos shall immediately introduce CDnow to
the appropriate business development personnel responsible for electronic
commerce at the Lycos/European joint venture, Lycos Bertelsmann Gmbh.
6. THE CO-BRANDED PAGES. CDnow shall place a Carry-through Bar on the Co-branded
Pages which will allow the visitor to return to Lycos' Site and Tripod's Site.
CDnow, Lycos and Tripod shall mutually agree upon the overall design of the
Carry-through Bar within the specifications provided by CDnow in the Carry-
through Bar Specifications, attached hereto as Exhibit C and made a part hereof.
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7. FULFILLMENT. CDnow shall have the sole right and responsibility for
processing all orders through every aspect of the retail transaction, including
receiving, filling, shipping and handling, collecting payment, tracking and
transaction security. All orders for CDnow's products shall be placed by
customers directly with CDnow and shall be subject to acceptance by CDnow. All
orders accepted shall be subject to acceptance by CDnow. All order accepted
shall be subject to the terms and conditions of CDnow's then current terms and
conditions of sale. Such terms may be changed at any time, without notice to
Lycos or Tripod. CDnow shall have no obligation to ship any orders unless
payment in full is received in advance. Prices for the products shall be set
solely by CDnow. CDnow may, at its discretion, change its prices at any time,
without notice to Lycos or Tripod.
8. SPECIAL PROMOTIONS.
(a) Lycos and Tripod acknowledge that in the event that the parties enter
into any special marketing and promotional activities together there may be
additional costs including, but not limited to warehousing costs, management
fees and fulfillment fees, associated with such activities. The parties shall
agree in advance in a Promotion Schedule as to the scope of such special
marketing and promotional activities and the amount of funds and/or other
resources to be contributed to such activities by CDnow, Lycos and Tripod. Any
and all Promotion Schedules shall be appended to this Agreement.
(b) During each year of the Term, Tripod agrees to prominently promote
CDnow in [XXX] of its electronic newsletters which it sends to its users
(minimum [XXX] deliveries per month). CDnow will provide the material for
inclusion in a format specified by Tripod. CDnow agrees to cooperate with
Tripod's editorial staff in formulating the content of its promotion to ensure
that it is consistent with Tripod's editorial content. The timing of CDnow's
inclusion will be mutually agreed upon in advance by the parties.
9. STAFFING. Each party agrees to provide staffing sufficient for such party to
meet its obligations under this Agreement in a timely manner. Further, each
party shall appoint a relationship manager who shall have responsibility for
managing the day-to-day activities of the party under this Agreement.
10. RIGHT OF NEGOTIATION. In the event that CDnow desires to renew this
Agreement at the end of the Term, Lycos and Tripod agree to promptly and
diligently negotiate with CDnow in good faith to determine reasonable terms and
conditions of renewal, beginning not less than [XXX] prior to the end of the
Term of this Agreement. During the Term, Lycos and Tripod agree not to enter
into any discussions, negotiations, agreements or the like with any seller of
music regarding Lycos' Site and Tripod's Site; provided, however, that Lycos and
Tripod are free to do so in the last [XXX] of the Term if Lycos' Site and the
parties have not agreed upon renewal terms prior to such time.
11. LICENSE; OWNERSHIP.
(a) Each party hereby grants to the other party, during the Term of this
Agreement, a non-exclusive, non-transferable license to use its names, logos,
trademarks and service marks, copyrights and proprietary technology solely as
reasonably necessary to perform its obligations under this Agreement; provided,
however, that any promotional materials containing a party's name will be
subject to the other party's prior written approval.
(b) Each party owns and shall retain all right, title and interest in its
names, logos, trademarks and service marks, copyrights and proprietary
technology including without limitation, those names, logos, trademarks and
service marks, copyrights and proprietary technology currently used or any which
may be developed in the future. No party shall copy, distribute, reproduce or
use the other
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parties' names, logos, trademarks and service marks, copyrights and proprietary
technology except as expressly permitted under this Agreement. Upon notice from
a party, the other party shall immediately terminate the use of any advertising
materials using the notifying party's name or logo.
(c) No party shall contest or impair, directly or indirectly, the other
parties' ownership of any of such other party's names, logos, trademarks and
service marks, copyrights, Proprietary Features and proprietary technology,
anywhere, nor the fact that the use of such names, logos, trademarks and service
marks, copyrights and proprietary technology by it will inure to the benefit of
the other party. No party will assist others to contest or impair the same and
each party hereby expressly acknowledges the other parties' superior rights
therein.
12. TERM AND TERMINATION. The term of this Agreement shall commence upon the
Effective Date and shall continue for three (3) years from the Launch Date
(the "Term"), unless previously terminated as set forth below. The first year
of the Term shall end twelve months after the Launch Date. The second year of
the Term shall end twenty-four months after the Launch Date, and so on.
(a) During the Term:
(i) Any party may terminate this Agreement at any time: (A)
immediately upon written notice if another party becomes insolvent,
files a petition in bankruptcy or makes an assignment for the benefit of
its creditors; or (B) thirty (30) days after the written notice to another
party of such other party's breach of any of its material obligations
under this Agreement, which breach is not remedied within such 30-day
period. Such termination shall not relieve the party in breach from
liability for the performance of its obligations prior to such termination
and shall be in addition to all other rights and remedies the terminating
party may have available to it under this Agreement or at law or in
equity;
(ii) Lycos or Tripod's failure to meet the Launch Date shall
constitute a breach of a material obligation under this Agreement.
(iii) CDnow shall have the right to terminate this Agreement
upon thirty (30) days written notice in the event that Lycos enters into any
merger, acquisition, transfer of control, sale of substantial assets or similar
transaction with any Competitor.
(b) Upon the termination or expiration of this Agreement, each party
will: (i) immediately cease any and all use of the other parties intellectual
property, including, without limitation, the other party's trademarks,
tradenames, service marks, and other proprietary indicia; and (ii) promptly
(within ten (10) days) return all assets (digital, proprietary or otherwise)
belonging to the other.
(c) 1, 3(b)(ii), 3(b)(iii), 3(b)(v), 3(b)(vii), 3(b)(viii), 3(c), 7,
11(b), 11(C), 14, 15 and 16 shall survive termination of this Agreement.
13. REPRESENTATIONS.
(a) Each party represents and warrants that it has, and will retain
during the Term hereof, all right, title and authority to enter into this
Agreement, to grand the other parties the rights and licenses herein granted to
perform all of its obligations under this Agreement.
(b) Each party represents and warrants that (i) there are no
restrictions, agreements or understandings whatsoever to which the representing
party is a party which would prevent or make unlawful its execution of this
Agreement or its engagement hereunder; and (ii) that its execution of
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this Agreement and its engagement hereunder shall not constitute a breach of any
contract, agreement or understanding, oral or written, to which it is a party or
by which it is bound.
(c) CDnow represents and warrants that to its knowledge any content
provided by CDnow and displayed on CDnow's Site, the Co-branded Pages or Lycos'
or Tripod's Sites does not constitute defamation or invasion of the right of
privacy or publicity, or infringement of the copyright, trademark or other
intellectual property right, of any third party. This representation and
warranty shall specifically not apply to content provided by visitors to the Co-
branded Pages, Lycos' Site, Tripod's Site or CDnow's Site such as visitors who
use chat rooms, bulletin boards, or other forums on such Site which allow
visitors to display material that is not within the control of CDnow.
(d) Lycos and Tripod jointly and severally represent and warrant that to
the knowledge of either party any content provided by Lycos or Tripod and
displayed on the Co-branded Pages, CDnow's Site or Lycos' Site and Tripod's Site
does not constitute defamation or invasion of the right or privacy or publicity,
or infringement of the copyright, trademark or other intellectual property
right, of any third party. This representation and warranty shall specifically
not apply to content provided by visitors to the Co-branded Pages, Lycos' Site
and Tripod's Site or Cdnow's Site such as visitors who use chat rooms, bulletin
boards, or other forums on such Site which allow visitors to display material
that is not within the control of Lycos or Tripod.
(e) Lycos and Tripod jointly and severally represent and warrant that (i)
they will continue to expend at least the same amount of resources (e.g. budget,
staff) as they are currently committing as of the time of execution of this
Agreement for Lycos' Site and Tripod's Site; and (ii) they will not develop or
promote any space on Lycos' Site or Tripod's Site which would contain any
Competitor's advertising or promotions for the category of music and which
functions in a substantially similar manner to or provides the user with a
substantially similar experience as the spaces on Lycos' Site and Tripod's Site
that contain CDnow Branded Links as contemplated by this Agreement.
14. INDEMNIFICATION.
(a) INDEMNIFICATION BY CDNOW. CDnow shall indemnify, defend and hold
harmless Lycos and Tripod and its affiliates, and their respective shareholders,
directors, officers, employees and agents, against any and all claims, actions,
liabilities, losses, and expenses (including reasonable attorneys' fees) brought
by a third party relating to or arising out of any claim that any content
provided by CDnow and displayed on the Co-branded Pages. CDnow's Site, Lycos'
Site and Tripod's Site constitutes a defamation or invasion of the right of
privacy or publicity, or infringement of the copyright, trademark or other
intellectual property right, of any third party. This indemnity shall
specifically not apply to content provided by visitors to the Co-branded Pages,
CDnow's Site, Lycos' Site and Tripod's Site such as visitors who use CDnow's
chat rooms, bulletin boards, or other forums which allow visitors to display
material that is not within the control of CDnow.
(b) INDEMNIFICATION BY LYCOS AND TRIPOD. Lycos and Tripod shall
indemnify, defend and hold harmless CDnow and its affiliates, and their
respective shareholders, directors, officers, employees and agents, against any
and all claims, actions, liabilities, losses, and expenses (including reasonable
attorneys' fees) brought by a third party relating to or arising out of any
claim that any content provided by Lycos and Tripod and displayed on the
Co-branded Pages, CDnow's Site or Lycos' Site and Tripod's Site constitutes a
defamation or invasion of the right of privacy or publicity, or infringement of
the copyright, trademark or other intellectual property right, of any third
party. This indemnity shall specifically not apply to content provided by
visitors to the Co-branded Pages, Tripod's Site or CDnow's Site such as visitors
who use chat rooms bulletin boards, or other forums on such Site which allow
visitors who use chat rooms, bulletin boards, or other forums on such Site
which allow visitors to display material that is not within the control of Lycos
and Tripod.
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(c) OBLIGATIONS OF THE INDEMNIFIED PARTY. The indemnified party shall
promptly provide the indemnifying party with written notice of any claim which
the indemnified party believes falls within the scope of this Section 14(c);
provided, however, that, except to the extent the indemnifying party is actually
prejudiced by the indemnified party's failure to provide such prompt notice,
such failure to provide prompt notice hereunder shall not limit the indemnified
party's rights under this Paragraph 15(c). The indemnified party may, at its own
expense, assist in the defense of any such claim if it so chooses, provided that
the indemnifying party shall control such defense and all negotiations relative
to the settlement of any such claim.
(d) SETTLEMENT. No party shall, without the prior written consent of
another party, settle, compromise or consent to the entry of any judgement with
respect to any pending or threatened claim unless the settlement, compromise or
consent provides for and includes an express, unconditional release of all
claims, damages, liabilities, costs and expenses, including reasonable legal
fees and expenses, against the indemnified party.
15. CONFIDENTIALITY; PUBLIC RELATIONS.
(a) NON-DISCLOSURE AGREEMENT. The parties acknowledge that, as a result of
negotiating, entering into and performing this Agreement, each party has and
will have access to certain of the other party's Confidential Information (as
defined below). Each party also understands that misuse and/or disclosure of
that information could adversely affect the other party's business. Accordingly,
during the Term of this Agreement and thereafter, each party shall use and
reproduce the other party's Confidential Information only for purposes of this
Agreement and only to the extent necessary for such purpose and shall restrict
disclosure of the other party's Confidential Information to its employees,
consultants or independent contractors with a need to know and shall not
disclose the other party's Confidential Information to any third party without
the prior written approval of the other party. Notwithstanding the foregoing, it
shall not be a breach of this Agreement for either party to disclose
Confidential Information of the other party if required to do so under law or in
a judicial or other governmental investigation or proceeding, provided the other
party has been given prior notice and the disclosing party has sought all
available safeguards against widespread dissemination prior to such disclosure.
(b) CONFIDENTIAL INFORMATION DEFINED. As used in this Agreement, the term
"Confidential Information" refers to: (i) the terms and conditions of this
Agreement; (ii) each party's trade secrets, business plans, strategies, methods
and/or practices; and (iii) other information relating to either party that is
not generally known to the public, including information about either party's
personnel, products, customers, marketing strategies, services or future
business plans. Notwithstanding the foregoing, the term "Confidential
Information" specifically excludes (A) information that is now in the public
domain or subsequently enters the public domain by publication or otherwise
through no action or fault of the other party; (B) information that is known to
either party without restriction, prior to receipt from the other party under
this Agreement, from its own independent sources as evidenced by such party's
written records, and which was not acquired, directly or indirectly, from the
other party; (C) information that either party receives from any third party
reasonably known by such receiving party to have a legal right to transmit such
information, and not under any obligation to keep such information confidential;
and (D) information independently developed by either party's employees or
agents provided that either party can show that those same employees or agents
had no access to the Confidential Information received hereunder.
(c) NOTIFICATIONS REQUIRED BY LAW OR REGULATION. The parties agree that it
shall not be deemed a breach of this Agreement for any party to disclose the
terms and conditions of this Agreement in any regulatory filing with the
Securities & Exchange Commission, any stock exchange
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or the NASDAQ National Market, which such party determines in good faith is
required, provided such party seeks confidential treatment of the material
financial terms and conditions of this Agreement.
(d) PUBLICITY. No party will make any detailed announcements or statements
to the public or create any written materials concerning the relationship
between them without the prior written consent of the other, which is not to be
unreasonably withheld or delayed. In no event shall either party or any content,
products or services present on either party's website or service disparage the
other party or any of the other party's affiliates.
(e) PRESS RELEASES. Lycos, Tripod and CDnow shall jointly prepare a press
release concerning the existence of this Agreement and mutually agree upon the
contents of such press release.
16. MISCELLANEOUS.
(a) INDULGENCES, ETC. Neither the failure nor any delay on the part of any
party to exercise any right, remedy, power or privilege under this Agreement
shall operate as a waiver thereof, nor shall any single or partial exercise of
any right, remedy, power or privilege preclude any other or further exercise of
the same or of any other right, remedy, power or privilege, nor shall any waiver
of any right, remedy, power or privilege with respect to any occurrence be
construed as a waiver of such right, remedy, power or privilege with respect to
any other occurrence or as a waiver of any other right, remedy, power or
privilege.
(b) CONTROLLING LAW. This Agreement and all questions relating to its
validity, interpretation, performance and enforcement, shall be governed by and
construed in accordance with the laws of the Commonwealth of Massachusetts,
other than conflicting choice of law provisions.
(c) NOTICES. All notices, requests, demands, and other communications
required or permitted under this Agreement and the transactions contemplated
herein shall be in writing and shall be deemed to have been duly given, made and
received when delivered against receipt or when sent by United States registered
mail, return receipt requested, postage prepaid, addressed as set forth below:
<TABLE>
<S> <C> <C>
(i) If to CDnow: (ii) If to Lycos or Tripod: (iii) With a copy to:
CDnow, Inc. Lycos, Inc. Michael J. Riccio, Esq.
610 Old York Road 400-2 Totten Pond Rd. Hutchins, Wheeler & Dittmar
Jenkintown, PA 19046 Waltham, MA 02154 101 Federal Street
Attn: General Counsel Attn: CFO Boston, MA 02110
</TABLE>
In addition, notice by mail shall be by air mail if posted outside of the
continental United States. Any party may alter the address to which
communications or copies are to be sent by giving notice of such change of
address in the manner set forth herein.
(d) PROVISIONS SEPARABLE. The provisions of this Agreement are independent
of and separable from each other, and no provision shall be affected or rendered
invalid or unenforceable by virtue of the fact that for any reason any other or
others of them may be invalid or unenforceable in whole or in part.
(e) ENTIRE AGREEMENT. The terms and conditions of this Agreement
represent the entire understanding between the parties hereto with respect to
the subject matter hereof, and supersede all prior and contemporaneous
agreements and understandings, inducements or conditions, express or implied,
oral or written. The express terms hereof control and supersede any course of
performance
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and/or usage of trade inconsistent with any of the terms hereof. This Agreement
may not be modified or amended other than by an agreement in writing signed by
all parties.
(f) SECTION HEADINGS. The section headings in this Agreement are for
convenience only; they form no part of this Agreement and shall not affect its
interpretation.
(g) TELEFAXES CONSTITUTE VALID DOCUMENTS. This Agreement and subsequent
modifications may be transmitted by telecopy facsimile machine and such
facsimile copy shall be deemed an original if all pages thereof are initialed
and the Agreement or modifications are signed by the duly authorized
representative of the parties. Such facsimiles shall constitute valid, binding
documents and shall be regarded as such upon receipt. The original of the
document sent by telefax shall be promptly sent within seventy-two (72) hours
overnight courier or first class mail to the receiving party so that accurate
files may be maintained. Failure to send timely any original document shall not
affect the validity or binding nature of such document.
(h) FORCE MAJEURE. No party shall be held to be in breach of this
Agreement by reason of any failure or delay in its performance hereunder if such
failure is due to causes beyond its reasonable control, including but not
limited to, acts of the other party, acts of God, delays in transportation,
inability beyond its reasonable control to obtain necessary labor or materials,
or events such as fires, floods, earthquakes, storms, war, act of public enemy,
civil commotions and the like or by any law, rule, regulation, order or other
action by any public authority. To the extent failure to perform is caused by
such an event, such party shall be excused from performance hereunder so long as
such event continues to prevent such performance, and provided the non-
performing party takes all reasonable steps to resume full performance.
(i) INDEPENDENT CONTRACTOR. Each party shall act as an independent
contractor and shall have no authority to obligate or bind the other in any
respect. Neither the employees of Lycos or Tripod nor the employees of CDnow
shall represent themselves to be employees of the other.
(j) COMPLIANCE WITH LAWS. Each party shall comply with all federal, state
and local laws, licensing regulations and rulings of governmental bodies having
jurisdiction over its business. Nothing in this Agreement shall be construed to
require either party to perform any act in violation of any laws, regulations or
rulings.
(k) DISCLAIMER OF WARRANTY. EXCEPT AS OTHERWISE PROVIDED FOR IN THIS
AGREEMENT, EACH PARTY'S SITE IS PROVIDED ON AN "AS IS" BASIS WITHOUT WARRANTIES
OF ANY KIND, EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO WARRANTIES
OF TITLE OR IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR
PURPOSE, OTHER THAN THOSE WARRANTIES WHICH ARE IMPLIED BY OR INCAPABLE OF
EXCLUSION, RESTRICTION OR MODIFICATION UNDER THE LAWS APPLICABLE TO THIS
AGREEMENT.
(l) LIMITATION OF LIABILITY. UNDER NO CIRCUMSTANCES SHALL ANY PARTY BE
LIABLE TO THE OTHER PARTIES FOR INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR
EXEMPLARY DAMAGES (EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF
SUCH DAMAGES), ARISING FROM ANY PROVISION OF THIS AGREEMENT (INCLUDING SUCH
DAMAGES INCURRED BY THIRD PARTIES), SUCH AS, BUT NOT LIMITED TO, LOSS OF REVENUE
OR ANTICIPATED PROFITS OR LOST BUSINESS. IN NO EVENT SHALL ANY PARTY BE LIABLE
FOR DAMAGES IN EXCESS OF THE AMOUNT RECEIVED OR PAID BY SUCH PARTY UNDER THIS
AGREEMENT, PROVIDED THAT THIS SECTION DOES NOT LIMIT ANY PARTY'S LIABILITY FOR
(A) WILLFUL AND MALICIOUS MISCONDUCT; (B) DIRECT DAMAGES TO REAL OR TANGIBLE
PERSONAL PROPERTY; (C)
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BODILY INJURY OR DEATH CAUSED BY NEGLIGENCE; OR (D) SUCH PARTY'S INDEMNIFICATION
OBLIGATIONS HEREUNDER. BY WAY OF EXAMPLE ONLY, IF CDNOW PAID $2,000,000 UNDER
THIS AGREEMENT, CDNOW WOULD BE LIABLE FOR NO MORE THAN AN ADDITIONAL $2,000,000.
(m) LIABILITY FOR TERMINATION. In the event of proper termination as set
forth herein, the terminating party shall not be liable for reimbursement of
damages on account of any loss of prospective profits or on account of
expenditures, investments, leases or other commitments relating to the other
party's business or good will.
(n) EXPENSES. Except as otherwise provided for in this Agreement, each
party shall be responsible for any and all expenses, charges and fees incurred
by it in connection with its duties hereunder, and it shall not be reimbursed
for the same by the other parties.
(o) BINDING NATURE OF AGREEMENT. This Agreement shall be binding upon the
parties hereto and their respective heirs, executors, successors and assignee.
No party may, without the prior written consent of the other, assign or transfer
this Agreement or any obligation incurred hereunder. Any attempt to do so in
contravention of this Section 16(o) shall be void and of no force and effect.
(p) TIMELY PERFORMANCES. Each party acknowledges that in the performance
of this Agreement, time shall be considered of the essence.
IN WITNESS WHEREOF, the parties duly authorized representatives have executed
this Agreement as of the Effective Date.
CDNOW, INC. LYCOS, INC.
By: /s/ Jason Olim By: /s/ Robert Davis
---------------------------------- ---------------------------------
Name: JASON OLIM Name: Robert Davis
-------------------------------- ----------------------------------
Date: April 26, 1998 Date: April 26, 1998
-------------------------------- --------------------------------
TRIPOD,INC.
By: Robert Davis
--------------------------------
Name: Robert Davis
--------------------------------
Date: April 26, 1998
--------------------------------
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EXHIBIT A
COMPETITORS IN MUSIC AND/OR VIDEO CATEGORIES
Pursuant to Paragraph 1(h) of the agreement, Competitor includes [XXX].
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EXHIBIT B
CDNOW BRANDED LINK PLACEMENTS
[Graphics intentionally omitted]
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EXHIBIT C
CARRY-THROUGH BAR SPECIFICATIONS AS OF 4/15/97
SIZE
Total Carry-through Bar Size: 468(w) x 25(h) pixels as of April 1, 1997 all
Carry-through Bar sizes must be 468(w) x 25(h) to comply with the Internet
Advertising Bureau's (IAB) banner standards.
Live area for Partner Logo: 360(w) x 24(h) pixels
COLOR
Bar is black at all times.
Only partner logos/icons can be as many colors as desired with a black
background "Return to..." copy is mandatory and must be set up as white
Helvetica Neue Black 10pt type, centered and 5 pixels in from the left-hand side
of the first black bar
We recommend all copy to be white
To pick up a template go to http://cdnow.com/cobrand_template
FORMAT
Must be saved in a GIF file format
PLACEMENT
Carry-through bar is placed on the top and bottom of each CDnow page. Only those
people who visit CDnow from your site will see the Carry-through bar
URL/ADDRESS
Partners have the option of 1 to 3 links on their Carry-through-bar -- The URLs
will be provided by the partner
If more than one link is desired, the bar must consist of mutliple gif images
that reference previous Carry-through bar specifications. When using multiple
gif images keep two pixel between each bar. No image maps are permitted. Please
see the following page for more examples of possible banner solutions.
[Graphics intentionally omitted.]
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SOURCE CODE
CDnow will provide the partner with a from equals (from=) tag. This tag allows
us to indentify customers coming from the Partners site to CDnow.
TIMING
CDnow requires a minimum of five business days from when we receive the
Carry-through bar to implement it on our site.
CARRY-THROUGH BAR SAMPLES
[Graphics intentionally omitted.]
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EXHIBIT D
COMPLIANCE WITH EXISTING CONTRACTS
The following lists those agreements with CDnow Competitors that currently
exists, the dates by which they terminate and the exceptions to CDnow's right of
exclusivity.
[XXX]
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EXHIBIT E
[XXX]
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Exhibit 10.15
LINKING, CONTENT LICENSING AND ADVERTISING AGREEMENT
THIS LINKING, CONTENT LICENSING AND ADVERTISING AGREEMENT ("Agreement") is made
this 8th day of April, 1998 ("Effective Date"), by and among JAMtv Corporation,
a Delaware corporation with its principal offices at 640 North LaSalle Street,
Suite 560, Chicago, Illinois 60610 ("Jam"), Straight Arrow Publishers, a New
York partnership with its principal offices at 1290 Avenue of Americas, 2nd
Floor, New York, New York 10104 ("Straight Arrow"), and CDnow, Inc., a
Pennsylvania corporation, with its principal offices at Jenkins Court, Suite
300, 610 Old York Road, Jenkintown, Pennsylvania 19046 ("CDnow"); each a "party"
and collectively the "parties."
CDnow sells a variety of entertainment products through a retail vending site on
the Internet's World Wide Web at the Universal Resource Locator ("URL") of:
www.cdnow.com (the "CDnow Site").
Straight Arrow owns and operates Rolling Stone magazine and owns certain content
related thereto and the name, trademark and brand "Rolling Stone" (hereinafter
collectively known as "RS").
Jam and Straight Arrow have entered into a legally binding agreement to form a
joint venture arrangement for the Rolling Stone Network ("RSN") whereby Jam will
operate RSN-branded Sites ("RSN Sites" is defined in Section 1 below), and
Straight Arrow is providing the Straight Arrow Content to Jam for its exclusive
use with the RSN Sites.
CDnow, Jam and Straight Arrow wish to enter into this Agreement whereby CDnow
will be the exclusive Music Seller with a license to use, copy and display the
Content and advertise and have links on the RSN Sites. Additionally, CDnow will
purchase online advertising on the RSN Sites, radio air time from the radio
airtime available through Jam and advertising space in RS print publications.
NOW THEREFORE, in consideration of the mutual promises contained herein and for
other good and valuable consideration, the receipt and sufficiency of which is
hereby acknowledged, and intending to be legally bound, the parties hereby agree
as follows:
1. DEFINITIONS Capitalized terms not otherwise defined in this Agreement will
have the following meanings:
(a) "Above-the-Fold" means situated within the portion of a page that is
designed to be visible on a standard computer screen with a resolution of 640
pixels by 480 pixels without requiring the user to scroll horizontally or
vertically through the page.
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"Agreement" is defined in the first paragraph of the preamble to this Agreement.
(c) "[XXX]" and "[XXX] Agreement" are defined in Section 2(b)(ii)(A) of
this Agreement.
(d) "[XXX] Content" is defined in Section 2(e) of this Agreement.
(e) "Carry-Through Bar" means a bar, which, when clicked, links an RSN user
back to the RSN Site from the Co-branded Pages.
(f) "CDnow is defined in the first paragraph of the preamble to this
Agreement.
(g) "CDnow Link" means any form of link that contains a CDnow designed
and/or approved proprietary feature, is located on a page on an RSN Site and
takes an RSN user to a Co-branded Page. CDnow will provide screen shot mockups
of the Co-branded Pages as set forth in Exhibit C to this Agreement.
(h) "CDnow Site" is defined in the second paragraph of the preamble to this
Agreement.
(i) "Co-branded Page" means a page residing on CDnow's servers that a
visitor from RSN's Site will link to, which displays certain proprietary
features of both RSN and CDnow, and where such visitor can purchase CDnow
products. A Co-branded Page can only be viewed by a visitor who links to it
directly from RSN's Site or through a stored URL (e.g. bookmark or similar
technological storage mechanism).
(j) "Competitive Marketing" is any advertising, promotion, sponsorship,
link or displayed message (not provided or sponsored by CDnow) that [XXX].
(k) "Confidential Information" is defined in Section 15(a) of this
Agreement.
(l) "Content" means, collectively, the Straight Arrow Content (as defined
in Section 1(aa) below) and the Jam Content (as defined in Section 1(p) below).
(m) "Content Indices" is defined in Section 2(c)(i) of this Agreement.
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(n) "Effective Date" is defined in the first paragraph of the preamble to
this Agreement.
(o) "Entity" means any natural person, partnership, corporation, or
division, subsidiary or business unit thereof, retail site, Internet site, World
Wide Web site or other form of business organization.
(p) "Exclusive [XXX] Content" means, as of the Effective Date, the
following content provided to [XXX] under the [XXX] Agreement: (i) "Interactive
Cover Story" consisting of a supplemental story or supplemental content (e.g., a
brief synopsis, additional content or pictures, or sound or video clips related
to the cover story) to RS's current cover story; (ii) certain elements of the
Rolling Stone Photo Gallery;" (iii) certain elements of the "Rewind" section'
and (iv) the "Read Me Now" section, featuring a welcome screen, letters to RS,
sections allowing members to write letters to RS and to participate or vote in
RS polls, contests and online programs, previews of forthcoming features in the
RS area within the [XXX] proprietary online service and other special features
such as offerings, contests and quizzes.
(q) "Finder's Fee Advance" is defined in Section 6(c)(i) of this Agreement.
(r) "Jam" is defined in the first paragraph of the preamble to this
Agreement.
(s) "Jam Content" means all existing and future digitized and non-digitized
articles, reviews, digital or transcribed interviews, video and audio libraries,
photographs, books and any other content which Jam has created, published or
produced, or which Jam has access to through a licensing arrangement with any
other Entity, provided Jam has the right to license or sublicense the foregoing.
(t) "Launch Event" is defined in Article 5 of this Agreement.
(u) "Marks" means a party's names, brand names, logos, trademarks,
tradenames, servicemarks and other proprietary indicia
(v) "Music Seller" means any Entity, which sells pre-recorded music or
enables a person to purchase pre-recorded music online through the Internet, the
World Wide Web or any other open or proprietary online service.
(w) "New Customer" is defined in Section 6(c)(i) of this Agreement.
(x) In this Agreement, "party" and "parties" are defined in the first
paragraph of the preamble.
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(y) "RS" is defined in the third paragraph of the preamble to this
Agreement.
(z) "RSN" is defined in the fourth paragraph of the preamble to this
Agreement.
(aa) "RSN Sites" means collectively, all Jam Sites, all RSN Sites and all
Sites operated by Jam for Straight Arrow.
(ab) "Site" means a site on the Internet, the World Wide Web or on any open
or proprietary online service.
(ac) "Straight Arrow" is defined in the first paragraph of the preamble to
this Agreement.
(ad) "Straight Arrow Content" means the content specified in Exhibit B -
"Rolling Stone Content" to this Agreement
(ae) "Straight Arrow/Jam Exclusive License Agreement" is defined in Section
2(d) of this Agreement.
(af) "Term" is defined in Article 12 of this Agreement.
(ag) "URL" is defined in the second paragraph of the preamble to this
Agreement.
2. CONTENT.
(A) LICENSE.
(i) Subject to the terms of this Agreement, JAM hereby grants to CDnow
during the Term a worldwide license to access, use, copy, modify and
reformat for display purposes and display the Content solely on CDnow's
Site or its servers. By way of example, and not limitation, permitted uses
includes digitizing non-digitized content.
(ii) CDnow will: (A) use [XXX] from each Content article, review or
the like without the prior consent of Jam; (B) provide a textual link-back
to the RSN Sites as part of such usage, [XXX] and (C) not distribute the
Content to any third party, except as permitted under an agreement mutually
acceptable to the parties.
(iii) For Content requested by CDnow where Jam or Straight Arrow do
not have the requisite rights to provide CDnow with such Content for its
use pursuant to this
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Agreement, Jam and Straight Arrow will use their respective best efforts to
assist CDnow in obtaining such rights, provided CDnow shall bear all costs
or expenses in connection therewith.
(B) EXCLUSIVITY AND LIMITATIONS ON EXCLUSIVITY.
(i) Exclusivity. During the Term and except as set forth in Section
-----------
2(b)(ii) below, Jam and Straight Arrow represent and warrant that CDnow
will be the exclusive Music Seller anywhere in the world that is permitted
to access, use, copy, modify and reformat for display purposes and display
the Content on any Site.
(ii) Limitations on Exclusivity.
--------------------------
(A) [XXX]
(B) [XXX]
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(C) [XXX]
(C) ACCESS TO AND DELIVERY OF CONTENT.
(i) Content Indices. Within forty-eight hours of the Effective Date
---------------
and continuing throughout the Term, Jam will make available to CDnow, and
upon CDnow's request, reasonably provide access to CDnow, any and all
indices in any form of the Content (the "Content Indices"). During the
Term, as updated new Content Indices become available, Jam will immediately
provide access to such updated or new Content Indices to CDnow.
(ii) Content Delivery. Within three (3) business days of each receipt
----------------
of a request from CDnow, Jam will deliver to CDnow the Content requested.
If the Content is available in digitized form, Jam will deliver it in such
form to CDnow in a manner mutually agreeable to the parties. If the
Content is not available in digitized form, then Jam will deliver it in the
best form in which it is available, and, at CDnow's discretion, (A)
promptly (but in no event more than three (3) business days after receipt
of a request) digitize the requested Content, which digitized Content shall
be deemed to also be part of the Content, in a form mutually agreeable to
the parties; or (B) CDnow may have a third party digitize the Content for
CDnow, at no expense to Jam, and CDnow will provide a copy of all such
digitized material to Jam, at no cost. CDnow and Jam agree to reasonably
cooperate in fulfilling CDnow's requests for Content.
(iii) Access to the Jam and Straight Arrow Libraries. At CDnow's
----------------------------------------------
request at any time and from time to time, Jam will make available a
librarian knowledgeable in the Content and the structure of the Jam and
Straight Arrow Content libraries in the possession
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of Straight Arrow or Jam (as the case may be), and such librarian will
assist CDnow in accessing, digitizing and delivering the Content. CDnow
will pay a reasonable hourly rate for such librarian's time devoted to
assisting CDnow, which rate CDnow and Jam will mutually agree upon based on
good faith and diligent negotiations.
(D) OTHER REPRESENTATIONS AND WARRANTIES OF JAM. Jam represents and
warrants that as of the Effective Date and continuing throughout the Term: (i)
the Content available to CDnow under this Agreement is all of the Content owned
or licensed by Jam from Straight Arrow; (ii) except for the exclusivity
limitations set forth in Section 2(b)(ii) above, Jam has an exclusive, worldwide
license with Straight Arrow for use of all of the Straight Arrow Content in
connection with the RSN Sites, which is stated as such in the exclusive license
agreement entered in by and between Jam and Straight Arrow, dated as of _______
(the "Straight Arrow/Jam Exclusive License Agreement"), and Straight Arrow has
expressly consented to Jam sub-licensing the Straight Arrow Content to CDnow so
that Jam can fulfill its obligations under this Agreement, and CDnow can access
and use the Content as set forth in this Agreement; (iii) the Straight Arrow
Content has not been altered, redacted or modified in any manner from the
original substance provided to Jam from Straight Arrow; (iv) except as set forth
in Section 3(a)(ii)(B) below, Jam will not operate any Sites anywhere in the
world (other than the RSN Sites) independently of or in conjunction with
Straight Arrow that contains the Content in whole or in part and any Competitive
Marketing; and (v) Jam shall license and deliver to CDnow the [XXX] Content,
subject to and consistent with the terms and conditions of this Agreement.
(E) OTHER REPRESENTATIONS AND WARRANTIES OF STRAIGHT ARROW. Straight Arrow
represents and warrants that as of the Effective Date and continuing throughout
the Term: (i) the Straight Arrow Content licensed to Jam under the Straight
Arrow/Jam Exclusive License Agreement is all of the Straight Arrow Content owned
or licensed by Straight Arrow; (ii) except for the exclusivity limitations set
forth in Section 2(b)(ii) above, Jam has an exclusive, worldwide license with
Straight Arrow for use of all of the Straight Arrow Content in connection with
the RSN Sites, which is stated as such in the Straight Arrow/Jam Exclusive
License Agreement, and Straight Arrow has expressly consented to Jam sub-
licensing the Straight Arrow Content to CDnow so that Jam can fulfill its
obligations under this Agreement, and CDnow can access and use the Straight
Arrow Content as set forth in this Agreement; (iii) except for the exclusivity
limitations set forth in Section 2(b)(ii) above, Straight Arrow has not licensed
the Straight Arrow Content, in whole or in part, to any third party for use
online or on any Site; (iv) during the Term, Straight Arrow will not operate,
independently of or in conjunction with Jam, any Sites (other than the RSN
Sites) that contain the Content in whole or in part and any Competitive
Marketing; and (v) any and all Content (other than the Exclusive [XXX] Content)
made available or delivered to [XXX] or any third party under or pursuant to the
[XXX] Agreement ("[XXX] Content"), shall also be licensed and delivered to Jam
pursuant to the Straight Arrow/Jam Exclusive License Agreement, and Jam is
permitted to license and deliver to CDnow the [XXX] Content subject to and
consistent with the terms of this Agreement.
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(F) REPRESENTATIONS AND WARRANTIES OF CDNOW. CDnow acknowledges that the
Straight Arrow Content is the valuable intellectual property of Straight Arrow
and the Jam Content is the valuable intellectual property of Jam, and CDnow
agrees that it shall not use or modify any of the Content, except as otherwise
permitted under this Agreement or as otherwise permitted by Jam or Straight
Arrow in their reasonable business judgment or, if applicable, by Straight Arrow
in its discretion as set forth in Section 8 of Exhibit B to this Agreement.
3. RSN SITES.
(A) EXCLUSIVITY AND LIMITATIONS ON EXCLUSIVITY.
(i) Exclusivity. Except as set forth in Section 3(a)(ii) below,
-----------
during the Term:
(1) Jam represents and warrants that CDnow will be the exclusive
Music Seller throughout the world that can sell recorded music
through, and place advertising, promotions, buttons, banners or other
forms of links for the sale of recorded music on, the RSN Sites.
(2) Jam will use its best efforts to encourage [XXX].
(3) If Jam, Straight Arrow or a third party wishes to sell one or
more recorded music products on the RSN Sites that are not offered by
CDnow, Jam shall give CDnow a right of first refusal to offer such
products. If CDnow, within twenty (20) days of being provided such
offer by Jam, determines not to offer such products, then Jam may
permit such third party to offer such products for sale on the RSN
Sites; provided that if and when CDnow offers such products, Jam shall
terminate such third party's right to offer such products for sale on
the RSN Sites as soon as practicably feasible, and, thereafter, CDnow
shall be the exclusive Music Seller with the right to offer such
products on the RSN Sites.
(ii) Limitations on Exclusivity.
--------------------------
(A) This terms of Section 3(a) shall not apply to: [XXX]
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(B) [XXX]
(B) DELIVERY AND PLACEMENT OF CDNOW LINKS. During the Term, Jam shall
place the CDnow Links on the RSN Sites in accordance with the requirements set
forth in this Section 3(b).
(i) Jam shall place the CDnow Links on the pages on the RSN Sites, and
all existing and future equivalents, extensions or replacements of such
pages on the RSN Sites, in accordance with the specifications set forth in
Exhibit C to this Agreement. Unless
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otherwise specified in this Section 3(b), during the Term, the CDnow Links
shall be permanent and non-rotating.
(ii) On Jam's Sites, Jam shall place [XXX].
(iii) On the RSN Sites, Jam shall place [XXX].
(iv) Jam agrees that CDnow may vary the elements of the CDnow Links no
less than [XXX] per month, upon five (5) business days notice.
(v) Prior to implementing any modifications to the CDnow Links not
requested by CDnow, Jam will obtain the written consent of CDnow, which
consent shall not be unreasonably withheld.
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(C) MINIMUM CDNOW LINK GUARANTEES. During the Term, Jam and RSN will
deliver to users of the RSN Sites a minimum of [XXX] CDnow Links on pages
on the RSN Sites in accordance with the following schedule: (i) the first twelve
months beginning on the date the CDnow Links are fully implemented and
operational on the RSN Sites -- [XXX] CDnow Links; (ii) the twelve months
following the first twelve months -- [XXX] CDnow Links; and (iii) the
twelve months following the second twelve months -- [XXX] CDnow Links.
(D) CONTINUED DEVELOPMENT OF OTHER CDNOW LINK PLACEMENT OPPORTUNITIES. The
parties agree to work together during the Term in good faith to identify and
implement appropriate placement of the CDnow Links throughout the RSN Sites,
including all necessary testing of the performance of such links.
4. BUSINESS DEVELOPMENT OPPORTUNITIES.
(A) Throughout the Term, the parties will mutually work together in good
faith to identify, create, develop and implement marketing and public relations
opportunities for additional sales, advertising and promotion of CDnow on the
RSN Sites and other Jam and Straight Arrow Sites and media properties, sale of
RSN merchandise and co-branding of traffic flows between the Co-branded Pages,
the CDnow Site and the RSN Sites.
(B) Throughout the Term, the parties will mutually work together in good
faith to identify, create, develop and implement opportunities for CDnow to
distribute the Content to CDnow business partners. CDnow will not distribute
the Content except as permitted under agreement mutually acceptable to the
parties.
(C) Throughout the Term, Jam and Straight Arrow will, in good faith and
where feasible, offer CDnow, and CDnow will, in good faith and where feasible
offer Jam and Straight Arrow, the opportunity and right of first refusal to
participate in other business relationships (similar to the business
relationships envisioned under this Agreement) Jam, Straight Arrow or CDnow (as
the case may be) have entered into or are considering entering into, and, upon
receipt of such offer by, and expression of interest from, a party, the parties
agree to negotiate diligently and in good faith to develop a definitive
agreement concerning each such opportunity.
5. LAUNCH EVENT. During the Term, the parties will [XXX].
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6. PAYMENTS. During the Term and in consideration of Jam and Straight Arrow
fulfilling their respective obligations under this Agreement, CDnow will make
the payments to Jam and Straight Arrow (as appropriate) as set forth in Sections
6(a) through (c) below:
(A) CONTENT LICENSE FEES. CDnow agrees to pay Jam (provided the Straight
Arrow/Jam Exclusive License Agreement remains continually in effect during the
Term so that Jam can fulfill its obligations as stated hereunder) [XXX] for the
exclusive right to use the Content during the term of this Agreement as set
forth in Article 2 above. Payment will be made in the following manner: [XXX]
upon execution of this Agreement, [XXX] ninety (90) days and one hundred and
eighty (180) days, respectively, after the Effective Date, and, thereafter,
commencing in the second year of the Term through the Term, equal quarterly
payments of [XXX] within ten (10) days of the first day of each calendar quarter
for the upcoming quarter, provided the CDnow Links are continuously fully
implemented and operational on the RSN Sites.
(B) PRINT, BROADCAST AND WEBSITE ADVERTISING, PROMOTION AND LINKING FEES.
CDnow agrees to purchase a total of [XXX] from (A) Jam in RSN Site advertising,
promotions and links, (B) [XXX] from Straight Arrow, (C) [XXX] from Jam and (D)
promotions in media properties controlled (currently and in the future) by
Straight Arrow and/or Jam or its radio affiliates, during the Term and as
follows:
(i) CDnow will allocate the print, broadcast and other promotional
advertising dollars as follows: (i) [XXX] and (ii) [XXX]. Jam will receive
a commission of [XXX], which amount shall be over and above the [XXX] in
advertising fees, and such commission shall be payable in equal
installments of [XXX] on the Effective Date, the first day of the second
year of the Term and the first day of the third year of the Term. Payment
for [XXX], including the appropriate pro rata portion of the [XXX], will be
made within thirty (30) days of the date on which such [XXX], as the case
may be.
(ii) CDnow will pay Jam [XXX] for delivery of the minimum number
of guaranteed CDnow Links on the RSN Sites pursuant to Article 3 of this
Agreement according to the payment schedule set forth in this Section
6(b)(ii). Payments for delivery of CDnow Links shall be made quarterly
with the first payment due within thirty (30) days following the date on
which the parties mutually agree that the CDnow Links have been fully
implemented, are fully operational and are available to users on the RSN
Sites. Payment for each subsequent quarter shall be made within thirty
(30) days following the end of the quarter. [XXX]
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(iii) Straight Arrow shall [XXX]. Jam shall use its best efforts to
obtain [XXX].
(C) NEW CUSTOMER FINDER'S FEE.
(i) CDnow agrees to pay Jam a one-time finder's fee of [XXX] for each
new customer acquired via a direct online link between CDnow's Site and any
of the RSN Sites, provided such New Customer makes a non-returned purchase
on CDnow's Site when first linking from a RSN Site to a Co-branded Page
("New Customer"). For purposes of this Section 6(c), the same customer who
may repeatedly link to a Co-branded Page from the RSN Sites over any length
of time shall be considered a new customer only the first time the customer
links to a Co-branded Page from a RSN Site. CDnow will pay a [XXX] advance
on such fees of [XXX], amounting to a total of [XXX] (the "Finder's Fee
Advance") during the term of this Agreement, and such quarterly advances
shall be due and payable within ten (10) days following the first day of
the quarter. Each New Customer shall result in a decrement of the
outstanding credit balance of the Finder's Fee Advance by [XXX], until such
balance shall equal [XXX], at which time, CDnow shall pay Jam [XXX] in cash
for each New Customer, with such payments due on a quarterly basis.
(ii) If, upon termination of this Agreement [XXX]
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(D) PAYMENT SUMMARY. The following summarizes the payments terms set forth
in Sections 6(a) through (c) above: [XXX]
7. AUDIT RIGHTS; REPORTING
(A) AUDIT RIGHTS; UNDER/OVER PAYMENTS. Each party shall maintain complete
and accurate records in accordance with U.S. Generally Accepted Accounting
Principles (GAAP) for all transactions which are the subject of this Agreement
for not less than (3) years after the last payment is due under this Agreement.
A "big six" independent accounting firm retained by a party (the auditing party)
shall have access to such records of the other party (the audited party), upon
reasonable notice, for the purposes of audit during normal business hours, for
so long as such records are required to be maintained. If such accounting firm
determines that any additional payment is due the auditing party by the audited
party and such payment is not the subject of a good faith dispute between the
parties, then the audited party shall promptly make payment of such amount plus
interest at a rate of six percent (6%) per annum to the auditing party. If a
party overpays the other party, the party that has made such overpayment shall
be entitled to a credit against the next payment due to the other party in the
amount of the overpayment, unless such overpayment is the subject of a good
faith dispute between the parties or if no further payments are due under this
Agreement, in which case, the party that has received the overpayment will
promptly refund to the other party the amount of the overpayment.
(B) REPORTING.
(i) Within thirty (30) days after the end of each calendar month
during the Term, CDnow shall provide Jam with a report listing the number
of New Customers and the
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Finder's Fees due to Jam. Such report is to be used by Jam solely to
track whether CDnow is fulfilling its obligations under this Agreement.
(ii) On the first business day of each week during the Term, Jam will
provide CDnow with a weekly report of CDnow Links delivered to users of
RSN's Site during the immediately preceding week in a form and via media
mutually agreeable to the parties.
(iii) During the Term, each of Jam and Straight Arrow will provide
CDnow with monthly reports of total [XXX] promotions delivered by each
party in a form and via a method mutually acceptable to CDnow and Jam or
Straight Arrow (as the case may be). Such reports are to be used by CDnow
solely to track whether Jam and Straight Arrow are fulfilling their
obligations under this Agreement.
8. FRAMING AND RETURN LINKS. During the Term and thereafter, Jam shall not
frame in any manner the CDnow Site or any Co-branded Pages or pages from the
CDnow Site. When an RSN user clicks on a button, banner or any other form of
link to a Co-branded Page, such user shall be transferred directly to the Co-
branded Page without such framing. CDnow shall place a Carry-Through Bar on the
Co-branded Pages that will provide a user that has linked to a Co-branded Page
from a RSN Site with an opportunity to return to the RSN Site. CDnow and Jam
shall mutually agree upon the overall design of the Carry-Through Bar within the
specifications provided by CDnow in the Carry-Through Bar Specifications,
attached hereto as Exhibit A to this Agreement.
9. FULFILLMENT. During the Term and thereafter, CDnow shall have the sole
right and responsibility for processing all orders through every aspect of a
transaction, including receiving, filling, shipping and handling, collecting
payment, tracking and transaction security. All orders for CDnow's products
shall be placed by customers directly with CDnow and shall be subject to
acceptance by CDnow. All orders accepted shall be subject to the terms and
conditions of CDnow's then current terms and conditions of sale. Such terms may
be changed at any time, without notice to Jam, RSN or its customers. CDnow
shall have no obligation to ship any orders unless payment in full is received
in advance. Prices for the products shall be set solely by CDnow. CDnow
reserves the right to change its prices at any time, without notice to Jam, RSN
or its customers.
10. STAFFING. During the Term, each party agrees to provide staffing
sufficient for such party to meet its obligations under this Agreement in a
timely manner. Further, each party shall appoint a relationship manager who
shall have responsibility for managing the day-to-day activities of the party
under this Agreement.
11. LICENSE; OWNERSHIP.
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(a) License to the "Rolling Stone" Brand Name and Straight Arrow Marks.
------------------------------------------------------------------
Straight Arrow hereby grants to CDnow, during the Term, a limited, worldwide,
non-transferable license to use the "Rolling Stone" brand name and other
Straight Arrow Marks (as authorized by Straight Arrow from time to time) as
reasonably necessary for CDnow to exercise its rights, promote and sell its
products and fulfill its obligations under this Agreement. CDnow shall be the
exclusive Music Seller licensed to use the Rolling Stone brand name in
connection with online sales, except for sales by third parties licensed to sell
music compilations under the Rolling Stone brand name and except as otherwise
licensed to [XXX] under the [XXX] Agreement. Straight Arrow shall have the right
to approve all initial uses of the "Rolling Stone" brand name, which approval
shall not be unreasonably withheld or delayed.
(b) License Between Jam and CDnow for Use of Marks. CDnow hereby grants to
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Jam, during the Term, a limited, non-exclusive, non-transferable license to use
CDnow's Marks (as authorized by CDnow from time to time) solely as reasonably
necessary for Jam to perform its obligations under this Agreement. Jam hereby
grants to CDnow, during the Term, a limited, non-exclusive, non-transferable
license to use Jam's Marks (as authorized by Jam from time to time) solely as
reasonably necessary for CDnow to perform its obligations under this Agreement.
Each of CDnow and Jam shall have the right to approve all initial uses of its
Marks by the other party, which approval shall not be unreasonably withheld or
delayed.
(c) Each party owns and shall retain all right, title and interest in its
Marks and other intellectual property. No party shall copy, distribute,
reproduce or use the other party's Marks or other intellectual property, except
as expressly permitted under this Agreement.
(d) No party shall at any time contest, impair or disparage in any manner,
or assist another party or any third party in contesting, impairing or
disparaging in any manner, either directly or indirectly, another party's (the
owning party's) Marks or its ownership rights in its Marks. Any and all
goodwill arising from the use by a party of another party's Marks shall inure
solely to the benefit of the owning party, and each party hereby expressly
acknowledges the other party's superior rights therein.
12. TERM AND TERMINATION.
(A) TERM AND RENEWAL.
(i) Term. The term of this Agreement shall commence upon the
----
Effective Date and shall continue for three (3) years thereafter (the
"Term") unless previously terminated as set forth below. The Term shall
include any renewal terms (as discussed in Section 12(a)(ii) below).
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(ii) Renewals; Right-of-First-Negotiation.
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(A) If CDnow desires to renew this Agreement, then CDnow shall
notify Jam and Straight Arrow of its intention to renew not less than
seventy-five (75) days prior to the expiration of the Term, and,
beginning not less than sixty (60) days prior to the expiration of the
Term, Jam and Straight Arrow agree to diligently and in good faith
negotiate with CDnow to determine reasonable terms and conditions for
renewal of this Agreement and extension of the Term prior to the end
of the Term. If the parties are not able to conclude such negotiations
within thirty (30) days of their start, then Jam or Straight Arrow
shall be free to initiate negotiations with any third party.
(B) Except as set forth in Section 12(a)(ii )(A) above, Straight
Arrow and Jam shall not negotiate with any third party while the
Agreement is in effect and while any such negotiations are in
progress.
(C) If the Straight Arrow/Jam Exclusive License Agreement is
terminated at any time during the Term or while CDnow is negotiating a
renewal of the Term, then CDnow shall have the right of first
negotiation to use the Straight Arrow Content (similar to the license
set forth in Article 2 above) directly with Straight Arrow, and
Straight Arrow will diligently and in good faith negotiate such
license for a reasonable period of time.
(B) TERMINATION FOR CAUSE.
(i) If a party becomes insolvent, files a petition in bankruptcy,
makes an assignment for the benefit of its creditors or dissolves or
ceases to do business, any of the other parties may terminate the
party's rights and obligations under this Agreement (except for the
obligations applicable to the party specified in Section 12(e) below).
The occurrence of a party becoming insolvent, filing a petition in
bankruptcy, making an assignment for the benefit of creditors or
otherwise being no longer able to fully perform its obligations under
this Agreement and thereby terminating or having terminated its rights
and obligations under this Agreement will not cause this Agreement to
be terminated with respect to the remaining parties. Notwithstanding
the foregoing, such termination shall not relieve the terminated party
from liability for the performance of its obligations prior to such
termination, and termination by a party shall be in addition to all
other rights and remedies the terminating parties may have available
to them under this Agreement or at law or in equity.
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(ii) If a party materially breaches any of the terms of this
Agreement, any other party may terminate the breaching party's rights
and obligations under this Agreement (except for the obligations
applicable to the party specified in Section 12(e) below) thirty (30)
days after written notice to the party of such party's breach of such
terms, which breach is not remedied within such 30-day period to the
reasonable satisfaction of the non-breaching parties. Notwithstanding
the foregoing, such termination shall not relieve the terminated party
in breach from liability for the performance of its obligations prior
to such termination, and termination by a party shall be in addition
to all other rights and remedies the terminating parties may have
available to them under this Agreement or at law or in equity.
(C) TERMINATION FOR BREACH OF EXCLUSIVITY. CDnow may terminate this
Agreement immediately upon providing written notice of termination to Jam and
Straight Arrow in the event that Jam or Straight Arrow breaches any of the
exclusivity provisions or their respective representations and warranties set
forth in this Agreement.
(D) TERMINATION AS A RESULT OF TERMINATION OF THE STRAIGHT ARROW/JAM
EXCLUSIVE LICENSE AGREEMENT. If the Straight Arrow/Jam Exclusive License
Agreement is terminated or modified (such that Jam cannot fulfill its
obligations to CDnow under this Agreement) at any time during the Term, then
CDnow shall have the right to immediately terminate this Agreement, receive a
pro rata refund of all outstanding, unearned advance payments made in advance to
Jam, and the provisions of Section 12(a)(ii)(C) shall apply.
(E) EFFECTS OF TERMINATION. Upon the termination or expiration of this
Agreement, each party will immediately cease any and all existing, and not make
any future, use of the other party's name, brand names, Marks and other
proprietary indicia, and CDnow shall cease all use of the Content, and each
party shall certify the same (as applicable) in writing to the other party.
(F) SURVIVAL. Paragraphs 1, 7(a), 11(c), 11(d), 14 (for any actions that
arose during the term of the Agreement), 15 and 16 shall survive termination of
this Agreement.
13. GENERAL REPRESENTATIONS.
(a) Each party represents and warrants that it has, and will retain during
the Term, all necessary rights, title and authority to enter into and fulfill
its obligations under this Agreement, to grant the other party the rights and
licenses herein granted and to perform all of its obligations under this
Agreement.
(b) Each party represents and warrants that as of the Effective Date and
continuing throughout the Term (i) there are no restrictions, agreements or
understandings whatsoever to which
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the representing party is a party that would prevent or make unlawful its
execution of this Agreement or its engagement hereunder; and (ii) that its
execution of this Agreement and its engagement hereunder shall not constitute
a breach of any contract, agreement or understanding, oral or written, to
which it is a party or by which it is bound.
(c) CDnow represents and warrants that to the best of its knowledge any
content provided by CDnow and displayed on CDnow's Site during the Term does not
constitute defamation or invasion of the right of privacy or publicity, or
infringement of the copyrights, Marks or other intellectual property rights, of
any third party. This representation and warranty shall specifically not apply
to content provided by visitors to CDnow's Site such as visitors who use chat
rooms, bulletin boards, or other forums, which allow visitors to display
material that is not within the control of CDnow.
(d) Jam represents and warrants that to the best of its knowledge any
Content provided by Jam to CDnow during the Term under this Agreement does not
constitute defamation or invasion of the right of privacy or publicity, or
infringement of the copyrights, Marks or other intellectual property rights, of
any third party.
14. INDEMNIFICATION.
(A) CDNOW INDEMNIFICATION. CDnow shall indemnify, defend and hold harmless
each of Jam and Straight Arrow and their respective affiliates, directors,
officers, employees and agents, against any and all claims, actions,
liabilities, losses, and expenses (including reasonable attorneys' fees) brought
by a third party relating to or arising out of any claim that any content
provided by CDnow and displayed on the Co-branded Pages or the RSN Sites during
the Term constitutes a defamation or invasion of the right of privacy or
publicity, or infringement of the Marks, copyrights, or other intellectual
property rights, of any third party. This indemnity shall specifically not
apply to content provided by visitors to CDnow's Site who use CDnow's chat
rooms, bulletin boards, or other forums which allow visitors to display material
that is not within the control of CDnow.
(B) JAM INDEMNIFICATION. Jam shall indemnify, defend and hold harmless
CDnow and its respective affiliates, directors, officers, employees and agents,
against any and all claims, actions, liabilities, losses, and expenses
(including reasonable attorneys' fees) brought by a third party relating to or
arising out of any claim that any content provided by Jam that is displayed on
the Co-branded Pages, CDnow's Site or the RSN Sites during the Term constitutes
a defamation or invasion of the right of privacy or publicity, or infringement
of the copyrights, Marks or other intellectual property rights, of any third
party.
(C) DUTIES OF THE INDEMNIFYING PARTY. The indemnified party shall promptly
provide the indemnifying party with written notice of any claim, which the
indemnified party believes falls
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within the scope of this Article 14; provided, however, that, except to the
extent the indemnifying party is actually prejudiced by the indemnified
party's failure to provide such prompt notice, such failure to provide prompt
notice hereunder shall not limit the indemnified party's rights under this
Article 14. The indemnifying party shall have the right to control the
defense and, if applicable settlement of such claim; provided that in defending
or settling such claim the indemnifying party shall not prejudice the rights
of or disclose the Confidential Information of the indemnified party, without
the prior written consent of the indemnified party. The indemnified party may,
at its own expense, assist in the defense of any such claim if it so chooses,
provided that the indemnifying party shall control such defense and all
negotiations relative to the settlement of any such claim.
15. CONFIDENTIALITY; PUBLIC RELATIONS.
(A) PROTECTION OF CONFIDENTIAL INFORMATION. Each party agrees that the
Confidential Information of the other parties will be held in confidence to the
same extent and the same manner as each party protects its own Confidential
Information, but each party agrees that in no event will less than reasonable
care be used. Each party shall, however, be permitted to disclose relevant
aspects of such Confidential Information to its officers, employees and
consultants on a need-to-know basis for the purpose of such party's performance
of its obligations under this Agreement, provided such persons agree to protect
the other parties' Confidential Information to the same extent as required under
this Agreement. Each party agrees to use all reasonable steps to ensure that
the other parties' Confidential Information received under this Agreement is not
disclosed in violation of this Section 15(a). For purposes of this Agreement,
"Confidential Information" means the terms of this Agreement, except as
otherwise specifically provided in this Agreement; each parties' trade secrets,
financial information, processes, formulas, specifications, programs,
instructions, source code, technical know-how, methods and procedures for
operation, benchmark test results, information about employees, customers,
marketing strategies, services, business or technical plans and proposals, in
any form; and any other information relating to either party that is not
generally known to the public at large.
(B) EXCLUSIONS FROM CONFIDENTIAL INFORMATION. Confidential Information
shall not include information that (i) is or becomes generally known or
available to the public at large through no negligent act or omission of either
party; (ii) can be demonstrated to have been available lawfully to either party
prior to the disclosure or had thereafter been furnished to either party without
restrictions to disclosure or use; or (iii) can be demonstrated to be
independently developed by the recipient of Confidential Information without use
of such Confidential Information and such independent development is proven on
the basis of either party's records related to such development.
(C) REGULATORY DISCLOSURES. Each party agrees that it shall not be deemed
a breach of this Agreement for any other party to disclose the terms and
conditions of this Agreement in any required regulatory filing with the
Securities & Exchange Commission, a national stock exchange
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or the NASDAQ, which the other party, in good faith, determines is required,
provided the other party seeks confidential treatment of the material financial
terms and conditions of this Agreement.
(D) PUBLICITY. No party will make any announcements or statements to the
public or create any written materials concerning the relationship between them
without the prior written consent of the other parties, which consent is not to
be unreasonably withheld or delayed. The parties agree to issue a joint press
release within five (5) business days of the Effective Date in a form and
containing language reasonably acceptable to both parties.
16. MISCELLANEOUS.
(A) INDULGENCES, ETC. Neither the failure nor any delay on the part of any
party to exercise any right, remedy, power or privilege under this Agreement
shall operate as a waiver thereof, nor shall any single or partial exercise of
any right, remedy, power or privilege preclude any other or further exercise of
the same or of any other right, remedy, power or privilege, nor shall any waiver
of any right, remedy, power or privilege with respect to any occurrence be
construed as a waiver of such right, remedy, power or privilege with respect to
any other occurrence or as a waiver of any other right, remedy, power or
privilege.
(B) CONTROLLING LAW. This Agreement and all questions relating to its
validity, interpretation, performance and enforcement, shall be governed by and
construed in accordance with the laws of the Commonwealth of Pennsylvania, other
than conflicting choice-of-law provisions.
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(C) NOTICES. All notices, requests, demands, and other communications
required or permitted under this Agreement and the transactions contemplated
herein shall be in writing and shall be deemed to have been duly given, made and
received when delivered against receipt when sent by United States certified
mail, return receipt requested, postage prepaid, or reputable overnight courier,
addressed as set forth below:
(i) If to CDnow:
CDnow, Inc.
Jenkins Court, Suite 300
610 Old York Road
Jenkintown, PA 19046
Attn: General Counsel
(ii) If to JAMtv: (iii) If to Straight Arrow:
JAMtv Corporation Straight Arrow Publishers
640 North LaSalle Street, Suite 560 1290 Avenue of the Americas
Chicago, Illinois 60610 2nd Floor
Attn: Howard Tullman New York, New York 10104
Attn: John Lagana
In addition, notice by mail shall be by air mail if posted outside of
the continental United States. Any party may change the address to which
communications or copies are to be sent by giving notice of such change of
address in the manner set forth herein.
(D) PROVISIONS SEPARABLE. The provisions of this Agreement are independent
of and separable from each other, and no provision shall be affected or rendered
invalid or unenforceable by virtue of the fact that for any reason any other or
others of them may be invalid or unenforceable in whole or in part.
(E) ENTIRE AGREEMENT The terms and conditions of this Agreement and any and
all Exhibits attached hereto represent the entire understanding between the
parties with respect to the subject matter hereof, and supersede all prior and
contemporaneous agreements and understandings, inducements or conditions,
express or implied, oral or written. The express terms hereof control and
supersede any course of performance and/or usage of trade inconsistent with any
of the terms hereof. This Agreement may not be modified or amended other than by
an agreement in writing signed by both parties.
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(F) PARAGRAPH HEADINGS. The paragraph headings in this Agreement are for
convenience only; they form no part of this Agreement and shall not affect its
interpretation.
(G) TELEFAXES CONSTITUTE VALID DOCUMENTS. This Agreement and subsequent
modifications may be transmitted by telecopy facsimile machine and such
facsimile copy shall be deemed an original if all pages thereof are initialed
and the Agreement or modifications are signed by the duly authorized
representative of the parties. Such facsimiles shall constitute valid, binding
documents and shall be regarded as such upon receipt. The original of the
document sent by telefax shall be promptly sent within seventy-two (72) hours by
overnight courier to the receiving party so that accurate files may be
maintained. Failure to send timely any original document shall not affect the
validity or binding nature of such document.
(H) FORCE MAJEURE. No party shall be held to be in breach of this
Agreement by reason of any failure or delay in its performance hereunder if such
failure is due to causes beyond its reasonable control, including but not
limited to, acts of the other party, acts of God, delays in transportation,
inability beyond its reasonable control to obtain necessary labor or materials,
or events such as fires, floods, earthquakes, storms, war, act of public enemy,
civil commotions and the like or by any law, rule, regulation, order or other
action by any public authority. To the extent failure to perform is caused by
such an event, such party shall be excused from performance hereunder so long as
such event continues to prevent such performance, and provided the non-
performing party takes all reasonable steps to resume full performance.
(I) INDEPENDENT CONTRACTORS. Each party shall act as an independent
contractor and shall have no authority to obligate or bind the other parties in
any respect. No employee of a party shall represent himself or herself to be an
employee of any other party.
(J) COMPLIANCE WITH LAWS. Each party shall comply with all federal, state
and local laws, licensing regulations and rulings of governmental bodies having
jurisdiction over its business. Nothing in this Agreement shall be construed to
require either party to perform any act in violation of any laws, regulations or
rulings.
(K) DISCLAIMER OF WARRANTY. EXCEPT AS OTHERWISE PROVIDED FOR IN THIS
AGREEMENT, CDNOW'S SITE, THE RSN SITES AND THE CO-BRANDED PAGES ARE PROVIDED ON
AN "AS IS" BASIS WITHOUT WARRANTIES OF ANY KIND, EITHER EXPRESS OR IMPLIED,
INCLUDING BUT NOT LIMITED TO WARRANTIES OF TITLE OR IMPLIED WARRANTIES OF
MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE, OTHER THAN THOSE WARRANTIES
WHICH ARE IMPLIED BY OR INCAPABLE OF EXCLUSION, RESTRICTION OR MODIFICATION
UNDER THE LAWS APPLICABLE TO THIS AGREEMENT.
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LIMITATIONS OF LIABILITY.
(i) IN NO EVENT SHALL ANY PARTY HERETO BE LIABLE FOR ANY INDIRECT,
SPECIAL, EXEMPLARY, CONSEQUENTIAL OR INCIDENTAL DAMAGES, OF ANY NATURE
UNDER THIS AGREEMENT WHETHER SUCH DAMAGES ARE ALLEGED IN TORT, CONTRACT OR
INDEMNITY, EVEN IF THE PARTY IS INFORMED OF THE POSSIBILITY OF SUCH
DAMAGES, UNLESS SUCH DAMAGES ARE DUE TO SUCH PARTY'S GROSS NEGLIGENCE OR
WILLFUL MISCONDUCT.
(ii) AS BETWEEN CDNOW AND JAM, CDNOW AGREES THAT JAM SHALL NOT BE
LIABLE TO CDNOW FOR CLAIMS ARISING SOLELY AS A RESULT OF A BREACH BY
STRAIGHT ARROW OF ANY OF ITS REPRESENTATIONS, WARRANTIES OR OBLIGATIONS
HEREUNDER. AS BETWEEN CDNOW AND STRAIGHT ARROW, STRAIGHT ARROW SHALL NOT BE
LIABLE TO CDNOW FOR CLAIMS ARISING SOLELY AS A RESULT OF A BREACH BY JAM OF
ANY OF ITS REPRESENTATIONS, WARRANTIES OR OBLIGATIONS HEREUNDER.
(M) BINDING NATURE OF AGREEMENT. This Agreement shall be binding upon the
parties hereto and their respective heirs, executors, successors and assigns.
Neither party may, without the prior written consent of the other party, assign
or transfer this Agreement or any obligation incurred hereunder. Any attempt to
do so in contravention of this Section 16(m) shall be void and of no force and
effect.
(N) TIMELY PERFORMANCE. Each party acknowledges that in the performance of
this Agreement, time shall be considered of the essence.
[Signatures on next page.]
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IN WITNESS WHEREOF, the parties' duly authorized representatives have executed
this Agreement as of the day and year first above written.
CDNOW, INC. STRAIGHT ARROW PUBLISHERS
(A NEW YORK PARTNERSHIP)
By:/s/ Jason Olim By: /s/ John M. Lagana
Name: Jason Olim Name: John M. Lagana
Date: April 8, 1998 Date: April 9, 1998
JAMTV CORPORATION
By: /s/ Howard Tullman
Name: Howard Tullman
Date: April 8, 1998
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EXHIBIT A
CARRY-THROUGH BAR SPECIFICATIONS AS OF 4/15/97
SIZE
Total Carry-through Bar Size: 468(w) x 25(h) pixels as of April 1, 1997 all
Carry-through Bar sizes must be 468(w) x 25(h) to comply with the Internet
Advertising Bureau's (IAB) banner standards.
Live area for Partner Logo: 360(w) x 24(h) pixels
COLOR
Bar is black at all times.
Only partner logos/icons can be as many colors as desired with a black
background "Return to..." copy is mandatory and must be set up as white
Helvetica Neue Black 10pt type, centered and 5 pixels in from the left-hand side
of the first black bar
We recommend all copy to be white
To pick up a template go to http://cdnow.com/cobrand_template
FORMAT
Must be saved in a GIF file format
PLACEMENT
Carry-through bar is placed on the top and bottom of each CDnow page. Only those
people who visit CDnow from your site will see the Carry-through bar
URL/ADDRESS
Partners have the option of 1 to 3 links on their Carry-through bar-- The URLs
will be provided by the partner
If more than one link is desired, the bar must consist of multiple gif images
that reference previous Carry-through bar specifications. When using multiple
gif images keep two pixels between each bar. No image maps are permitted. Please
see the following page for more examples of possible banner solutions.
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SOURCE CODE
CDnow will provide the partner with a from equals (from=) tag. This tag allows
us to identify customers coming from the Partners site to CDnow.
TIMING
CDnow requires a minimum of five business days from when we receive the Carry-
through bar to implement it on our site.
CARRY-THROUGH BAR SAMPLES
[Graphics intentionally omitted.]
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EXHIBIT B - ROLLING STONE CONTENT
The Rolling Stone Content shall include the following [XXX]
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or which Straight Arrow has access to through a licensing arrangement with
any other Entity, in the possession and control of Straight Arrow, Wenner
Media and/or Rolling Stone magazine, which may be used to create new and/or
supplementary or re-purposed audio/visual and multimedia material for the
Rolling Stone Network, all to be provided in Straight Arrow's discretion.
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EXHIBIT C - MOCKUPS GUIDELINES FOR PLACEMENT OF CDNOW LINKS ON THE RSN SITES
[graphics intentionally omitted]
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Exhibit 11.1
CDNOW, INC.
COMPUTATION OF PER SHARE EARNINGS
Three Months Ended
March 31,
Year Ended -----------------------
December 31, 1997 1997 1998
----------------- ---------- -----------
Net loss $ (10,745,405) $ (544,306) $(9,198,193)
Accretion of preferred stock
to redemption value (410,103) - (115,542)
Net loss applicable to common
shareholders $ (11,157,508) $ (544,306) $(9,313,755)
================= ========== ===========
Weighted average number of
common shares outstanding 7,845,684 7,845,684 12,015,090
================= ========== ===========
Net loss per common share $ (1.42) (0.07) $ (0.78)
================= ========== ============
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report and all references to our firm included in or made part of this
registration statement.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Philadelphia, Pa.
May 11, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1996 JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1996 DEC-31-1997 MAR-31-1998
<CASH> 775,865 10,686,001 60,521,171
<SECURITIES> 245,641 1,003,045 0
<RECEIVABLES> 130,437 180,312 654,531
<ALLOWANCES> 12,000 77,000 (89,564)
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 1,201,764 14,471,415 63,594,451
<PP&E> 505,224 2,488,074 3,349,763
<DEPRECIATION> 143,189 (603,778) (821,290)
<TOTAL-ASSETS> 1,575,459 16,448,425 66,227,754
<CURRENT-LIABILITIES> 970,309 15,689,420 7,452,953
<BONDS> 0 0 0
0 9,492,594 0
0 0 0
<COMMON> 579,549 579,549 77,265,542
<OTHER-SE> (65,532) (10,331,999) (19,576,558)
<TOTAL-LIABILITY-AND-EQUITY> 1,575,459 16,448,425 66,227,754
<SALES> 6,300,294 17,372,795 10,013,889
<TOTAL-REVENUES> 6,300,294 17,372,795 10,013,889
<CGS> 5,217,789 14,316,028 8,554,549
<TOTAL-COSTS> 2,878,357 13,633,860 10,717,058
<OTHER-EXPENSES> 0 201,650 506,039
<LOSS-PROVISION> 12,000 5,000 0
<INTEREST-EXPENSE> 14,556 (371,962) (446,515)
<INCOME-PRETAX> (1,810,408) (11,157,508) (9,198,193)
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> (1,810,408) (11,157,508) (9,198,193)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (1,810,408) (11,157,508) (9,198,193)
<EPS-PRIMARY> 0 (0.07) (0.78)
<EPS-DILUTED> 0 0 0
</TABLE>
