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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2000
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from__________ to __________
Commission File Number:0-29583
Loudeye Technologies, Inc.
(Exact name of registrant as specified in its charter)
Delaware 91-1908833
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
Times Square Building 414 Olive Way, Suite 300, Seattle, WA 98101
(Address of principal executive offices) (Zip Code)
206-832-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common 37,094,335
----------- -----------------------------
(Class) (Outstanding at October 27,2000)
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Loudeye Technologies, Inc.
Form 10-Q Quarterly Report
For the Quarter Ended September 30, 2000
TABLE OF CONTENTS
<TABLE>
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Page
Number
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<S> <C>
PART I. Financial Information
Item 1 Financial Statements.......................................................................... 2
Condensed Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999 2
Condensed Consolidated Statements of Operations for the three and nine months ended 3
September 30, 2000 and 1999
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 4
2000 and 1999
Notes to Unaudited Condensed Consolidated Financial Statements 5
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 3 Quantitative and Qualitative Disclosures About Market Risk.................................... 33
PART II. Other Information
Item 1 Legal Proceedings............................................................................. 34
Item 2 Changes in Securities and Use of Proceeds..................................................... 34
Item 3 Defaults Upon Senior Securities............................................................... 34
Item 4 Submission of Matters to a Vote of Security Holders........................................... 35
Item 5 Other Information............................................................................. 35
Item 6 Exhibits and Reports on Form 8-K.............................................................. 35
</TABLE>
1
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PART I - FINANCIAL INFORMATION
ITEM I FINANCIAL STATEMENTS
LOUDEYE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Sept. 30, 2000 Dec. 31, 1999
-------------------- --------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 98,495 $ 49,273
Accounts receivable, net of allowance of
$390 and $187, respectively 3,059 955
Short-term investments 1,065 530
Prepaid and other assets 1,561 597
-------------------- --------------------
Total current assets 104,180 51,355
Property and equipment, net 17,289 5,282
Goodwill, net 11,028 14,207
Intangibles and other long-term assets 8,375 5,931
-------------------- --------------------
Total assets $140,872 $ 76,775
==================== ====================
LIABILITIES
Current liabilities:
Accounts payable $ 563 $ 4,778
Accrued compensation and benefits 953 388
Employee Stock Purchase Plan withholding 780 -
Accrued liabilities 816 587
Customer deposits 256 438
Deferred revenues 476 -
Current portion of long-term obligations 3,487 1,132
-------------------- --------------------
Total current liabilities 7,331 7,323
Long-term obligations, less current portion 7,872 1,963
-------------------- --------------------
Total liabilities 15,203 9,286
STOCKHOLDERS' EQUITY
Preferred stock, $0.001 par value, 5,000,000 and 41,000,000
shares authorized, 21,063,236 issued and outstanding in
1999, preference in liquidation of $0 and $60,904 - 58,536
Common stock and additional paid-in capital and common stock
warrants, $0.001 par value, 100,000,000 shares authorized;
37,054,942 and 8,696,257 issued and outstanding 185,925 28,305
Deferred stock compensation (4,770) (6,843)
Beneficial conversion feature - 14,121
Accumulated deficit (55,486) (26,630)
-------------------- --------------------
Total stockholders' equity 125,669 67,489
-------------------- --------------------
Total liabilities and stockholders' equity $140,872 $ 76,775
==================== ====================
</TABLE>
The accompanying notes are an integral part of these financial statements
2
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LOUDEYE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Dollars in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Digital media services $ 3,037 $ 768 $ 6,987 $ 1,597
Digital media applications 381 - 632 -
------------ ----------- ----------- -----------
Total revenues 3,418 768 7,619 1,597
------------ ----------- ----------- -----------
Cost of revenues: (excluding stock-based compensation expense of
$67 and $407 in 2000 and $16 and $17 in 1999 shown below)
Digital media services 3,320 790 8,453 1,707
Digital media applications 76 - 160 -
------------ ----------- ----------- -----------
Total cost of revenues 3,396 790 8,613 1,707
------------ ----------- ----------- -----------
Gross margin 22 (22) (994) (110)
------------ ----------- ----------- -----------
Operating expenses:
Research and development (excluding stock-based compensation 1,816 318 4,909 662
expense of $42 and $253 in 2000 and $10 and $10 in 1999 shown
below)
Sales and marketing (excluding stock-based compensation expense
of $110 and $668 in 2000 and $26 and $27 in 1999 shown below 3,920 826 10,924 2,223
and other non-cash charges of $194 and $491 in 2000 shown below)
General and administrative (excluding stock-based compensation
expense of $816 and $3,074 in 2000 and $144 and $150 in 1999
shown below) 2,016 804 5,548 1,816
Amortization of goodwill and other intangibles 2,051 -- 5,580 --
Stock-based compensation 1,035 196 4,402 204
------------ ----------- ----------- -----------
Total operating expenses 10,838 2,144 31,363 4,905
------------ ----------- ----------- -----------
Interest income 1,659 49 4,075 82
Interest expense and other (298) (49) (574) (103)
------------ ----------- ----------- -----------
Net loss $ (9,455) $ (2,166) $ (28,856) $ (5,036)
======================================================
Basic and diluted net loss per share: $ (0.27) $ (0.41) $ (1.05) $ (0.95)
Weighted average shares outstanding used to compute 35,570,456 5,319,798 27,565,273 5,300,247
basic and diluted net loss per share
Basic and diluted pro forma net loss per share: $ (0.27) $ (0.12) $ (0.87) $ (0.33)
Weighted average shares outstanding used to compute 35,570,456 17,475,554 33,338,160 15,382,294
basic and diluted pro forma net loss per share
</TABLE>
The accompanying notes are an integral part of these statements.
3
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LOUDEYE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Dollars in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
2000 1999
-----------------------------
<S> <C> <C>
Cash flows from operating activities:
Net Loss $(28,856) $(5,036)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 8,590 545
Gain on disposal of property and equipment 24 -
Stock-based compensation 4,402 204
Changes in operating assets and liabilities, net of amounts acquired:
Accounts receivable (1,939) (692)
Prepaid expenses and other current assets (1,190) (331)
Accounts payable (4,332) 545
Accrued compensation and benefits 1,070 253
Other 651 242
-----------------------------
Net cash used in operating activities (21,580) (4,270)
Cash flows from investing activities:
Purchases of property and equipment, net of amounts acquired (14,820) (1,944)
Capitalized software development costs (883) -
Cash paid for acquisition of business, net (1,907) -
Purchases/sales of short-term investments (370) (250)
-----------------------------
Net cash used in operating activities (17,980) (2,194)
Cash flows from financing activities:
Principal payments on long-term obligations (1,333) (183)
Proceeds from sale of stock 80,371 9,327
Exercise and repurchase of common stock options 465 164
Proceeds from long-term obligations 9,279 1,885
-----------------------------
Net cash provided by financing activities 88,782 11,193
-----------------------------
Net increase in cash and cash equivalents 49,222 4,729
Cash and cash equivalents, beginning of period 49,273 1,442
-----------------------------
Cash and cash equivalents, end of period $ 98,495 $ 6,171
=============================
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 402 $ 104
Issuance of common stock for acquisition of business 1,105 -
Issuance of common stock warrants 347 -
Conversion of debt into Series C preferred stock - 750
</TABLE>
The accompanying notes are an integral part of these statements.
4
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LOUDEYE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
1. ORGANIZATION AND DEVELOPMENT STAGE RISKS:
The Company
Loudeye Technologies, Inc. (the Company) provides digital media
infrastructure services and applications that transform audio and video content
from traditional sources into Internet compatible formats. The Company is
headquartered in Seattle, Washington and to date has conducted business in the
United States and Europe in one business segment.
The Company is subject to a number of risks similar to other companies in a
comparable stage of development including reliance on key personnel, successful
marketing of its services in an emerging market, competition from other
companies with greater technical, financial management and marketing resources,
successful development of new services and the enhancement of existing services,
and the ability to secure adequate financing to support future growth.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Unaudited Interim Financial Data
The interim condensed consolidated financial statements are unaudited and
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read in
conjunction with the audited financial statements and notes thereto included in
the Company's final prospectus as filed with the Securities and Exchange
Commission on March 15, 2000. The financial information included herein reflects
all adjustments (consisting only of normal recurring adjustments) that are, in
the opinion of management, necessary for a fair presentation of the results for
interim periods. The results of operations for the nine months ended September
30, 2000 and September 30, 1999 are not necessarily indicative of the results to
be expected for the full years.
Short-term Investments
The Company has established irrevocable standby letters of credit totaling
approximately $900,000 in conjunction with the lease of the Company's primary
office facility and a remote production facility. The letters of credit related
to the leases expire in October 2000 and December 2000; however, they will be
automatically renewed during the term of the leases. The letters of credit are
collateralized by short-term investments and contain an automatic reduction
5
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schedule reducing the amount of the letter of credit each year by a specified
amount until they reach $100,000, where they remain through the end of the term.
Deferred Revenues
The Company records deferred revenues when cash has been received but the
criteria for revenue recognition have not been met. Deferred revenues are
recognized in accordance with the Company's revenue recognition policy.
Revenue Recognition
The Company generates revenues from two sources: (1) digital media services
and (2) licensing and selling digital media applications.
DIGITAL MEDIA SERVICES
Encoding Services consist of encoding services to convert audio and
video content into Internet media formats. Sales of digital media services are
generally under nonrefundable time and materials contracts. Under these same
time and materials contracts, the Company recognizes revenues as services are
rendered and the Company has no continuing involvement in the goods and services
delivered, which is the date of shipment of the finished media to the customer.
Media Restoration and Migration Services consist of services provided
by our VidiPax subsidiary to restore and upgrade old or damaged archives of
traditional media. The Company recognizes revenues as services are rendered and
the Company has no continuing involvement in the goods and services delivered,
which is generally the date of shipment of the finished media to the customer.
Consulting Services consist of services provided by our consulting
services group to enable customers to utilize streaming media within their
websites and Internet applications. Consulting services are provided under
short-term contracts that are fixed-price contracts, time and materials
contracts or milestone-based contracts. Consulting services revenues generated
by short-term fixed-price contracts will be recognized ratably over the term of
the contract. For milestone-based contracts with customer acceptance clauses,
revenues are recognized under the outputs method, with output being measured by
the completion of milestones and acceptance by the customer.
Hosting Services consist of fees associated with hosting content and
Internet applications for customers. Hosting services revenues are generated
generally under noncancelable contracts with the fees paid by the customer on a
recurring monthly basis generally based upon bandwidth provided and amount of
content hosted.
DIGITAL MEDIA APPLICATIONS
Digital Media Applications revenues are generated from licensing and
selling of software. Our revenue recognition policies are in accordance with
Statement of Position (SOP 97-2), Software Revenue Recognition as amended by SOP
98-9. Under SOP 97-2, in general, license revenues are recognized when a non-
cancelable license agreement has been signed and the customer acknowledges an
unconditional obligation to pay, the software product has been delivered, there
are no uncertainties surrounding customer acceptance, the fees are fixed and
determinable, and collection
6
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is considered probable. Revenues recognized from multiple-element software
arrangements are allocated to each element of the arrangement based on the fair
values of the elements, such as software products, upgrades, enhancements, post-
contract customer support, or training. The determination of fair value is based
on objective evidence that is specific to the Company. If such evidence of fair
value for each element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time that evidence of fair value does exist
or until all elements of the arrangement are delivered. The Company records
deferred revenue for software arrangements when cash has been received from the
customer and the arrangement does not qualify for revenue recognition under the
Company's revenue recognition policy.
The Company sells digital media applications in application service
provider arrangements where it is required to host those applications. When the
Company is required to host the application and the customer does not have the
ability to have the application hosted by another entity without penalty to the
customer, revenue is recognized over the term of the initial hosting
arrangement.
Software Development Costs
The Company capitalizes internal costs in developing software products upon
determination that technological feasibility has been established for the
product, if that product is to be sold, leased, or otherwise marketed. Costs
incurred prior to the establishment of technological feasibility are charged to
product development expense. When the product is available for general release
to customers, capitalization is ceased, and such previously capitalized costs
are amortized on a product-by-product basis computed as the greater of (a) the
ratio that current gross revenues for the product bear to the total of current
and anticipated future gross revenues or (b) the straight-line amortization over
the remaining estimated economic useful life of the product. The amortization is
recorded as a component of digital media applications cost of revenues.
Software developed for internal use is capitalized once the preliminary
project stage has been completed and management has committed to funding the
continuation of the development project. Capitalization is ceased when the
software project is substantially complete and ready for its intended use.
At September 30, 2000, approximately $883,000 in software development costs
had been capitalized.
Financial Instruments and Concentrations of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of market risk consist of cash and cash equivalents, short-term
investments, and long-term obligations. Fair values of cash and cash equivalents
and short-term investments approximate cost due to the short period of time to
maturity. The fair values of financial instruments that are short-term and/or
that have little or no market risk are considered to have a fair value equal to
book value. The Company performs initial and ongoing evaluations of its
customers' financial positions, and generally extends credit on open account,
requiring collateral as deemed necessary.
7
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During the nine months ended September 30, 2000 and September 30, 1999, the
company had sales to certain significant customers, as a percentage of revenues,
as follows:
----------------------------------------------------------
September 30, September 30,
2000 1999
----------------------------------------------------------
Customer A - 14%
----------------------------------------------------------
Customer B - 14%
----------------------------------------------------------
Customer C 21% -
----------------------------------------------------------
Customer D 11% -
----------------------------------------------------------
Total 32% 28%
----------------------------------------------------------
Reclassifications
Certain information reported in previous periods has been reclassified to
conform to the current period presentation.
Use of Estimates in the Preparation of Financial Statements
The preparation of the 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, the
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 Share
In accordance with Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings Per Share," basic earnings per share is computed by dividing net
loss by the weighted average number of shares of common stock outstanding during
the period. Diluted earnings per share is computed by dividing net loss by the
weighted average number of common and dilutive common equivalent shares
outstanding during the period. Common equivalent shares consist of shares of
common stock issuable upon the conversion of the convertible preferred stock
(using the if-converted method) and shares issuable upon the exercise of stock
options and warrants (using the treasury stock method); common equivalent shares
are excluded from the calculation if their effects is antidilutive. Diluted net
loss per share for all periods shown does not include the effects of the
convertible preferred stock and shares issuable upon the exercise of stock
options and warrants as the effect of their inclusion is antidilutive during
each period presented.
Basic and diluted pro forma net loss per share is computed based on the
weighted average number of shares of common stock outstanding giving effect to
the conversion of convertible preferred stock into common stock upon the
completion of the Company's initial public offering on March 15, 2000 (using the
if-converted method from the original issue date). Diluted pro forma net loss
per share excludes the impact of stock options and warrants, as the effect of
their inclusion would be antidilutive.
8
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At September 30, 2000 the Company had 1,146,468 stock options that had been
exercised but which were subject to repurchase at a weighted average exercise
price of $0.37 per share. Accordingly, the impact of these unvested but
exercised options has been removed from the calculation of weighted average
shares outstanding for purposes of determining basic and diluted earnings per
share and basic and diluted pro forma earnings per share.
As part of the terms of the acquisition of Alive.com on December 14, 1999,
the following shares were subject to repurchase as of September 30, 2000:
. 347,231 outstanding vested shares issued by Alive.com under the
terms of a stock purchase agreement with Allaire Corporation repurchaseable
at fair market value within 90 days of the termination date of the
licensing and stock purchase agreement assumed by Loudeye as part of the
terms of the acquisition of Alive.com.
. 99,213 outstanding unvested shares issued by Alive.com under the
terms of a stock purchase agreement with Allaire Corporation repurchaseable
at a weighted average exercise price of $0.20 within 90 days of the
termination date of the licensing and stock purchase agreement assumed by
Loudeye as part of the terms of the acquisition of Alive.com. Accordingly,
the impact of these shares has been removed from the calculation of
weighted average shares outstanding for purposes of determining basic and
diluted earnings per share and basic and diluted pro forma earnings per
share.
The following table presents a reconciliation of shares used to calculate
basic and diluted earnings per share:
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, 1999 September 30, 1999
Actual Pro Forma Actual Pro Forma
------ --------- ------- ---------
<S> <C> <C> <C> <C>
Weighted average shares outstanding 5,708,687 17,864,443 5,429,877 15,511,924
Weighted average impact of options exercised but
subject to repurchase (388,889) (388,889) (129,630) (129,630)
-------------------------------------------------------------------
Weighted average shares used to calculate basic and
diluted earnings per share 5,319,798 17,475,554 5,300,247 15,382,294
===================================================================
<CAPTION>
For the three months ended For the nine months ended
September 30, 2000 September 30, 2000
Actual Pro Forma Actual Pro Forma
------ --------- ------ ---------
<S> <C> <C> <C> <C>
Weighted average shares outstanding 36,927,215 36,927,215 29,093,959 34,866,846
Impact of Allaire shares subject to repurchase
(103,071) (103,071) (127,873) (127,873)
Impact of Alive options, exercised but subject to
repurchase (131,764) (131,764) (141,662) (141,662)
Weighted average impact of options exercised but
subject to repurchase (1,121,924) (1,121,924) (1,259,151) (1,259,151)
------------------------------------------------------------------
Weighted average shares used to calculate basic and
diluted earnings per share 35,570,456 35,570,456 27,565,273 33,338,160
==================================================================
</TABLE>
3. STOCK-BASED COMPENSATION
The Company records deferred stock compensation for the difference between
the exercise price of stock options granted and the deemed fair value for
financial statement presentation purposes of the Company's common stock at the
date of grant.
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The deferred compensation is amortized over the vesting period of the related
options, which is generally four and one-half years.
The Company recorded deferred stock compensation related to stock options
granted below deemed fair market value in that period of $3.1 million and $10.9
million in the nine months ended September 30, 2000 and since inception,
respectively. This amount represents the difference between the exercise price
of stock option grants and the deemed fair value of the common stock at the time
of grant. During the nine months ended September 30, 2000, the Company amortized
$3.7 million of deferred stock compensation which is included in stock-based
compensation expense in the accompanying statements of operations. Due to stock
option cancellations, $1.5 million of deferred stock compensation was reversed
and approximately $574,000 in previously amortized deferred stock compensation
was recorded as a credit to stock-based compensation expense in the nine months
ended September 30, 2000. The Company will record additional stock-based
compensation charges totaling $4.8 million in future periods related to options
granted to-date, over the vesting period of the options, which is generally four
and one-half years. As a result, the amortization of stock-based compensation
associated with options granted prior to the date of this report will impact our
reported results of operations through 2005.
Prior to August 1, 2000, the Company had granted approximately 220,000
options to consultants which vested on terms similar to options granted to
employees. Accordingly, these options were marked to fair market value using the
Black-Scholes option pricing model until fully vested. In the seven months ended
July 31, 2000, $1.1 million was recognized in stock-based compensation expense
related to these options. Effective August 1, the Company ended these consulting
relationships, resulting in the immediate vesting of approximately 17,000 shares
with the remaining 80,000 outstanding options being canceled. The impact of the
termination of these consultant options was recorded as a charge to stock-based
compensation of approximately $203,000. As of the date of this report, no
options remain outstanding which require fair value accounting.
4. SEGMENT INFORMATION
The Company operates in one business segment, digital media services, for
which the Company receives revenues from its customers. The Company's Chief
Operating Decision Maker is considered to be the Company's Executive Team (CET)
which is comprised of the Company's Chief Executive Officer, it's Chief
Operating Officer, and it's Vice Presidents. The CET reviews financial
information presented on a consolidated basis accompanied by disaggregated
information about products and services for purposes of making decisions and
assessing financial performance. The CET does not allocate resources by product
or service type and does not review discrete financial information regarding the
Company's different products or services on a disaggregated basis other than as
presented in the following table and, therefore, the Company does not have
operating segments as defined by SFAS 131, "Disclosure About Segments of an
Enterprise and Related Information".
10
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The following table sets forth certain information by product type for the
three and nine month periods ended September 30, 2000 and 1999. (in thousands)
<TABLE>
<CAPTION>
For the three months For the nine months ended
ended September September 30,
--------------------------------------------------------------------
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Revenues from unaffiliated customers:
Digital media services $ 3,037 $ 768 $ 6,987 $ 1,597
Digital media applications 381 - 632 -
--------------------------------------------------------------------
Total revenues 3,418 768 7,619 1,597
Cost of revenues:
Digital media services 3,320 790 8,453 1,707
Digital media applications 76 - 160 -
--------------------------------------------------------------------
Total cost of revenues 3,396 790 8,613 1,707
Gross margin:
Digital media services (283) (22) (1,466) (110)
Digital media applications 305 - 472 -
--------------------------------------------------------------------
Gross margin $ 22 $ (22) $ (994) $ (110)
====================================================================
Profit reconciliation:
Gross margin by product $ 22 $ (22) $ (994) $ (110)
Operating expenses (10,838) (2,144) (31,363) (4,905)
Other income (expenses), net 1,361 - 3,501 (21)
--------------------------------------------------------------------
Net loss $ (9,455) $(2,166) $(28,856) $(5,036)
====================================================================
</TABLE>
5. LONG-TERM OBLIGATIONS
In August 1998, the Company established an equipment line of credit for up
to $1.0 million secured by the Company's property and equipment. Advances under
the equipment line are payable over 36 equal monthly installments commencing on
August 30, 1999. The equipment line bears interest at the bank's prime rate
(9.50% at September 30, 2000) and had an outstanding balance of approximately
$611,000 as of September 30, 2000.
In June 2000, we amended our loan agreement with Imperial Bank to add an
additional credit facility which permits revolving borrowings and standby
letters of credit aggregating up to $2.0 million. Additionally, the amended
facility provides for a term loan of up to $10.0 million for the purchase of
capital equipment. The $2.0 million credit line bears interest at Imperial
Bank's prime rate (9.50% at September 30, 2000), with principal and interest due
at maturity in one year. There were no borrowings outstanding under the amended
credit line at September 30, 2000. The $10.0 million equipment facility bears
interest payable monthly during each draw period at Imperial's prime rates plus
0.75% followed by 36 equal monthly payments of principal plus interest.
Borrowings under this facility are secured by assets financed under the
agreement. At September 30, 2000, $8.9 million was outstanding under the amended
credit facility with Imperial Bank.
As of September 30, 2000, we had amounts outstanding under eight notes
payable, totaling approximately $1.8 million, under our credit facility with
Dominion
11
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Venture Finance LLC. The notes payable to Dominion bear interest at rates
ranging from 8.57% to 9.65%.
The Company's long-term obligations require that the Company maintain
various financial ratios on a quarterly basis. The Company is in compliance with
all necessary financial requirements.
6. RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the staff of the Securities and Exchange Commission
released Staff Accounting Bulletin, or SAB, No. 101, "Revenue Recognition", to
provide guidance on the recognition, presentation, and disclosure of revenues in
financial statements. On March 24, 2000 Staff Accounting Bulletin No. 101A-
Amendment ("SAB101A") was released to effectively delay the implementation of
SAB101 until the second fiscal quarter of the fiscal year beginning after
December 15, 1999. On June 26, 2000, Staff Accounting Bulletin No. 101B- Second
Amendment ("SAB101B") was issued and amends the transition provisions of SAB101
and effectively supersedes the original extension provided for in SAB101A.
SAB101B further delays the required implementation date for SAB101 until the
quarter ending December 31, 2000. We believe that our revenue recognition
practices are currently in conformity with the guidelines in SAB101 as revised,
and therefore this announcement will have no impact on our financial statements.
In March 2000, the Financial Accounting Standards Board, or FASB, released
FASB Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25," which provides
clarification of Opinion 25 for certain issues such as the determination of who
is an employee, the criteria for determining whether a plan qualifies as a
noncompensatory plan, the accounting consequence of various modifications to the
terms of a previously fixed stock option or award, and the accounting for an
exchange of stock compensation awards in a business combination. We believe that
our practices are in conformity with this guidance, and therefore Interpretation
No. 44 had no impact on our financial statements.
In March 2000, the Emerging Issues Task Force of the FASB, or EITF, issued
EITF 00-2, "Accounting for the Costs of Developing a Website." This issue
addresses how an entity should account for costs incurred to develop a website.
To date, we have not capitalized any such costs and believe that our historical
and current practices are in conformity with EITF 00-2 and therefore, this
release had no impact on our financial statements.
In March 2000, the EITF issued EITF 00-3, Application of AICPA SOP 97-2 to
"Arrangements that Include the Right to Use Software Stored on Another Entity's
Hardware." This issue addresses situations where entities license software
applications to a third party and also host those applications. This
pronouncement did not have a material impact on our financial statements.
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In July 2000, the EITF issued EITF 00-10, "Accounting for Shipping and
Handling Fees and Costs". This issue requires that all amounts billed to a
customer in a sale transaction related to shipping and handling to be classified
as revenue. EITF 00-10 is required to be implemented during the quarter ending
December 31, 2000, with reclassification of all prior periods presented. We have
previously reported these amounts as offsets to the related shipping and
handling costs within our financial statements. The impact of the implementation
of this consensus did not have a material impact on our financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning after
June 15, 2000. SFAS 133 requires that all derivatives be recognized in the
balance sheet at their fair market value, and the corresponding derivative gains
or losses be either reported in the statement of operations or as a component of
other comprehensive income depending on the type of hedge relationship that
exists with respect to such derivative. The adoption of SFAS 133 is not expected
to have a material effect on our financial statements.
In September 2000, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS
140). SFAS 140 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities and is
effective for transfers and servicing of financial assets and extinguishments of
liabilities occurring after March 31, 2001. The adoption of SFAS 140 is not
expected to have a material impact on our financial statements.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The following discussion of our financial condition and results of operations
contains forward-looking statements within the meaning of section 27A of the
Securities Act of 1993 and Section 21E of the Securities Exchange Act of 1934.
These statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
may, will, should, expect, plan, anticipate, believe, estimate, predict,
potential or continue, the negative of terms like these or other comparable
terminology. These statements are only predictions. Actual events or results may
differ materially. All forward-looking statements included in this document are
based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. In evaluating these
statements, you should specifically consider various factors, including the
risks outlined under the caption "Risk Factors" set forth at the end of this
Item 2, the Risk Factors set forth in our prospectus dated March 15, 2000 filed
with the Securities and Exchange Commission and those contained from time to
time in our other filings with the SEC. We caution investors that our business
and financial performance are subject to substantial risks and uncertainties.
Overview
We are a leading provider of Internet media infrastructure services and
applications for the media, entertainment and corporate markets that enable our
customers to optimize the use of digital media content over the Internet and
intranets. We provide our customers with outsourced and end-to-end solutions
that include encoding services, management, publication and distribution of rich
media and hosting services. Substantially all of our revenues to date have been
generated by sales of digital media services. Digital media services revenues
consist primarily of encoding services to convert audio and video content into
Internet media formats, media restoration and migration services, which are
services provided by our VidiPax subsidiary to restore and upgrade old or
damaged archives of traditional media, as well as other services for deployment
of media over the Internet. We charge our customers on either a time and
materials basis or a fixed fee basis that depends on a variety of factors, such
as volume and type of content provided and number and type of output formats
requested. We generally recognize digital media services revenues as the service
is provided and we have no further involvement. Payment terms with customers
generally require payment within 30 days of the invoice date. Our digital media
applications strategy consists primarily of the Loudeye Media Syndicator
application.
We have sustained losses on a quarterly and annual basis since inception and
we expect to sustain losses for the foreseeable future as we expand our
operations and production facilities. As of September 30, 2000, we had an
accumulated deficit of $55.5 million. Operating losses resulted from significant
costs incurred in the development and sale of our products and services as well
as significant non-cash charges related to stock-
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based compensation and amortization of intangibles and other assets. We expect
our operating expenses to continue to increase on an annual basis in all
functional areas in order to execute our business plan. Company-wide part-time,
full time and temporary employment has grown to approximately 400 at September
30, 2000. As a result, we anticipate that these operating expenses, as well as
planned capital expenditures, will constitute a material use of our cash
resources. We expect to incur additional losses and continued negative cash flow
from operations in the future. We cannot assure you that we will achieve or
sustain profitability.
Our limited operating history makes the prediction of future operating results
difficult. In view of our limited operating history and the early and rapidly
evolving nature of our business, we believe that interim and annual period-to-
period comparisons of our operating results are not meaningful and should not be
relied upon as an indication of future performance. Our business prospects must
be considered in light of the risks and uncertainties often encountered by
early-stage companies in the Internet-related products and services market. We
may not be successful in addressing these risks and uncertainties. We have
experienced significant percentage growth in revenues in recent periods;
however, we do not believe that prior growth rates are sustainable or indicative
of future growth rates. It is possible that in some future quarter our operating
results may fall below the expectations of securities analysts and investors. In
this event, the trading price of our common stock may fall significantly.
Results of Operations
Three Months Ended September 30, 2000 and 1999
Revenues. Revenues were $3.4 million and $768,000 for the three months ended
September 30, 2000 and 1999, respectively. The increase of 345% was due
primarily to significant new orders from our digital media services customers,
the initial sales of our Media Syndicator application as well as the impact of
our previously announced acquisition of VidiPax. Our digital media services
business was supported by continued strong demand for our consulting services
group, which provides digital media consulting to corporate customers.
Cost of Revenues. Cost of revenues increased 330% to $3.4 million in 2000 from
$790,000 in 1999. Cost of revenues includes the cost of personnel expenses and
the allocated portion of facilities and equipment and other supporting functions
related to the delivery of digital media services and applications. Stock-based
compensation charges of $67,000 and $16,000 for the three months ended September
30, 2000 and 1999, respectively are attributable to employees categorized within
production (cost of revenues) and are presented in the separate operating
expense line item within the statements of operations. Cost of revenues as a
percent of revenues decreased to 99% for the three months ended September 30,
2000 from 103% for the three months ended September 30, 1999. The decrease was
primarily due to the lower costs associated with higher margin services and
applications, as well as increased efficiencies and utilization of employees and
facilities.
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Operating Expenses. Total operating expenses increased 406% to $10.8 million
in the three months ended September 30, 2000 from $2.1 million in the three
months ended September 30, 1999. Without the effect of $ 1.0 million of stock-
based compensation charges and $2.1 million in amortization of intangible assets
and partner acquisition costs, operating expenses for the three months ended
September 30, 2000 would have been $7.7 million, an increase of $5.8 million, or
298% over the three months ended September 30, 1999.
Research and Development Expenses. Research and development expenses increased
471% to $1.8 million, or 53% of revenues in the three months ended September 30,
2000 from $318,000, or 41% of revenues, in the three months ended September 30,
1999. Research and development expenses consist of salaries and consulting fees
paid to support development, costs of technology acquired from third parties to
incorporate into applications and other proprietary technology currently under
development. Additionally, costs of developing Loudeye Media Syndicator for sale
or license to third parties and continued work on enhancing our proprietary
automated encoding processes comprise a significant portion of research and
development expenses. Stock-based compensation charges of $42,000 and $10,000
for the three months ended September 30, 2000 and 1999, respectively, are
attributable to employees categorized within research and development and are
presented in the separate operating expense line item within the statements of
operations. All other research and development costs have been expensed as
incurred. We believe that continued investment in research and development is
critical to attaining our strategic objectives and, as a result, expect research
and development expenses to continue to increase in future periods although at a
slower percentage than in past periods.
Sales and Marketing Expenses. Sales and marketing expenses increased 375% to
$3.9 million, or 115% of revenues; in the three months ended September 30, 2000
from $826,000, or 108% of revenues, in the three months ended September 30,
1999. Sales and marketing expenses consist primarily of salaries, commissions
and product marketing support related to the launch of our Media Syndicator
application, trade show expenses, advertising and cost of marketing collateral.
The increase in sales and marketing expenses was primarily due to growth in the
sales force, commissions paid on the increased sales over the same period in
1999, marketing related to the launch of our Media Syndicator application,
expanded advertising and trade-show related expenses as well as costs associated
with negotiating rights agreements with recording companies. Stock-based
compensation charges of $110,000 and $26,000 for the three months ended
September 30, 2000 and 1999, respectively are attributable to employees
categorized within sales and marketing and are presented in the separate
operating expense line item within the statements of operations.
General and Administrative Expenses. General and administrative expenses
increased 151% to $2.0 million, or 59% of revenues, in the three months ended
September 30, 2000 from $804,000, or 105% of revenues, in the three months ended
September 30, 1999. The increase in absolute terms was primarily driven by new
facilities opened during late 1999 and the first quarter of 2000 and the
increase in
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employees in the finance, information technology, legal, investor relations and
executive areas required to support a larger organization, and increased public
reporting obligations. The decrease as a percentage of revenues was driven by
added focus on cost control measures as compared to the same period of the prior
year and the effect of significantly increased revenues. General and
administrative expenses consist primarily of unallocated rent, facilities and
information technology charges, salaries, legal expenses for general corporate
purposes and investor relations costs associated with being a public company. We
believe that as operations continue to increase in size and scope, general and
administrative expenses will continue to increase although at a slower
percentage than in past periods. Stock-based compensation charges of $816,000
and $144,000 for the three months ended September 30, 2000 and 1999,
respectively are attributable to employees categorized within general and
administrative and are presented in the separate operating expense line item
within the statements of operations.
Amortization of Intangibles and Other Long-Term Assets. Amortization of
intangibles and other long-term assets of $2.1 million in the three months ended
September 30, 2000 includes amortization of the goodwill and identified
intangible assets related to past acquisitions, amortization related to the fair
value of warrants granted to certain partners and the discount on the sale of
securities to Akamai Technologies. There were no intangibles and other long-term
assets as of September 30, 1999, and accordingly, there were no related
amortization charges.
Stock-Based Compensation. Stock-based compensation of $1.0 million in the
three months ended September 30, 2000 consists of $1.1 million in amortization
of deferred stock compensation through September 30, 2000 related to stock
options previously granted below deemed fair market value, $203,000 in
compensation expense related to the termination of our consultant options and
$312,000 in credits related to the reversal of previously amortized deferred
stock compensation due to cancellation of options. There was approximately
$196,000 in stock-based compensation charges in the three months ended September
30, 1999.
Interest Income. Interest income represents earnings on our cash, cash
equivalents and short-term investments. This total was $1.7 million in the three
months ended September 30, 2000 and $49,000 in the three months ended September
30, 1999. The additional income was due primarily to interest earned on our
significantly higher cash and investment balances in 2000.
Interest Expense and other. Interest expense and other consists of interest
payments made on our debt instruments as well as amortization of financing
charges related to our debt instruments. This total was $298,000 in the three
months ended September 30, 2000 and $49,000 in the three months ended September
30, 1999. The increase was due primarily to interest paid on increased levels of
borrowings.
Results of Operations
Nine Months Ended September 30, 2000 and 1999
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Revenues. Revenues were $7.6 million and approximately $1.6 million for the
nine months ended September 30, 2000 and 1999, respectively. The increase of
377% was due primarily to an increase in the number and average size of orders
for our digital media services and continuing orders from repeat customers. The
introduction of new products and services, such as the Media Syndicator
application as well as the impact of our acquisition of VidiPax contributed to
the increase over the same period in 1999. The introduction of our Consulting
Services Group in late 1999 added to the increase in revenues over the same
period last year.
Cost of Revenues. Cost of revenues increased 405% to $8.6 million in 2000 from
$1.7 million in 1999. Cost of revenues includes cost of personnel expenses and
the allocated portion of facilities and equipment and other supporting functions
related to the delivery of digital media services and applications. Stock-based
compensation charges of $407,000 and $17,000 for the nine months ended September
30, 2000 and 1999 are attributable to employees categorized within production
(cost of revenues) and are presented in the separate operating expense line item
within the statements of operations. Cost of revenues as a percent of revenues
increased to 113% for the nine months ended September 30, 2000 from 107% of
revenues for the nine months ended September 30, 1999. The increase was
primarily due to an increase in additional employees and facilities necessary to
expand our scalable production facility to meet increased sales volumes.
Operating Expenses. Total operating expenses increased 540% to $31.4 million
in the nine months ended September 30, 2000 from $4.9 million in the nine months
ended September 30, 1999. Without the effect of $4.4 million of stock-based
compensation charges and $5.6 million in amortization of intangible assets and
partner acquisition costs, operating expenses for the nine months ended
September 30, 2000 would have been $21.4 million, an increase of $16.7 million,
or 355% over the nine months ended September 30, 1999.
Research and Development Expenses. Research and development expenses increased
642% to $4.9 million, or 64% of revenues; in the nine months ended September 30,
2000 from $662,000, or 41% of revenues, in the nine months ended September 30,
1999. The increase was due primarily to increases in applications under
development and additional development personnel. Research and development
expenses consist of salaries and consulting fees to support development, costs
of technology acquired from third parties to incorporate into applications and
other proprietary technology currently under development. Additionally, costs of
developing Loudeye Media Syndicator for license to third parties and continued
work on enhancing our proprietary automated encoding processes comprise a
significant portion of research and development expenses. Stock-based
compensation charges of $253,000 and $10,000 in the nine months ended September
30, 2000 and 1999, respectively are attributable to employees categorized within
research and development and are presented in the separate operating expense
line item within the statements of operations. All other research and
development costs have been expensed as incurred. We believe that continued
investment in research and development is critical to attaining our strategic
objectives and, as a result, expect research and development expenses to
increase in future periods.
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Sales and Marketing Expenses. Sales and marketing expenses increased 392% to
$10.9 million, or 143% of revenues, in the nine months ended September 30, 2000
from $2.2 million, or 139% of revenues, in the nine months ended September 30,
1999. The increase was primarily due to growth in the sales force, commissions
paid on the increased sales over the same period in 1999, launch costs
associated with the opening of our U.K. sales office and costs related to our
increased branding and marketing campaigns. Sales and marketing expenses consist
primarily of salaries, commissions, trade show expenses, marketing related to
the launch of new products, advertising and cost of marketing collateral as well
as costs associated with negotiating rights agreements with recording companies.
Stock-based compensation charges of $668,000 and $27,000 in the nine months
ended September 30, 2000 and 1999, respectively, are attributable to employees
categorized within sales and marketing and are presented in the separate
operating expense line item within the statements of operations.
General and Administrative Expenses. General and administrative expenses
increased 206% to $5.5 million, or 73% of revenues, in the nine months ended
September 30, 2000 from $1.8 million, or 114% of revenues, in the nine months
ended September 30, 1999. The increase in absolute terms was primarily driven by
new facilities opened during late 1999 and the first quarter of 2000 and the
increase in employees in the finance, information technology, legal, investor
relations and executive areas required to support a larger organization, and
increased public reporting obligations. General and administrative expenses
consist primarily of unallocated rent, facilities and information technology
charges, salaries, investor relations costs associated with being a public
company. Another component is legal fees related to general corporate purposes
and patents. We believe that as operations continue to increase in size and
scope, general and administrative expenses will increase. Stock-based
compensation charges of $3.1 million for the nine months ended September 30,
2000 and $150,000 for the nine months ended September 30, 1999 are attributable
to employees and consultants categorized within general and administrative and
are presented within the separate operating expense line item within the
statements of operations. Of the total stock-based compensation charges, $1.3
million is due to marking options granted to consultants to fair value.
Amortization of Intangibles and Other Long-Term Assets. Amortization of
intangibles and other long-term assets of $5.6 million in the nine months ended
September 30, 2000 includes amortization of the goodwill and identified
intangible assets related to past acquisitions, amortization related to the fair
value of warrants granted to certain partners and the discount on the sale of
securities to Akamai Technologies. There were no intangibles and other long-term
assets as of September 30, 1999, and accordingly, there were no related
amortization charges.
Stock-Based Compensation. Stock-based compensation of $4.4 million in the nine
months ended September 30, 2000 consists of $3.7 million in amortization of
deferred stock compensation through September 30, 2000 related to stock options
previously granted below deemed fair market value and $1.3 million in expense
related to marking
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options granted to consultants to fair market value as of September 30, 2000,
offset by $574,000 in credits related to the cancellation of stock options.
Interest Income. Interest income represents earnings on our cash, and cash
equivalents and short-term investments. This total was $4.1 million in the nine
months ended September 30, 2000 and $82,000 in the nine months ended September
30, 1999. The additional income was due primarily to interest earned on our
significantly higher cash and investment balances in 2000.
Interest Expense and Other. Interest expense and other consists of interest
payments made on our debt instruments as well as amortization of financing
charges related to our debt instruments. This total was $574,000 in the nine
months ended September 30, 2000 and $103,000 in the nine months ended September
30, 1999. The increase was due primarily to interest paid on increased levels of
borrowings to finance equipment purchases.
Liquidity and Capital Resources
Net cash used in operating activities was $21.6 million and $4.3 million in
the nine months ended September 30, 2000 and 1999, respectively. For 2000, cash
used in operating activities resulted primarily from a net loss of $28.9
million, a decrease of approximately $4.3 million in accounts payable and an
increase in trade accounts receivable of $1.9 million, partially offset by non-
cash charges of $13.0 million related to stock-based compensation, depreciation
and amortization, increases of $294,000 in customer deposits and deferred
revenues, and an increase of $1.4 million in other accrued expenses. Cash used
in operating activities in 1999 was due primarily to a net loss of $5.0 million.
Net cash used in investing activities was $18.0 million and $2.2 million for
the nine months ended September 30, 2000 and 1999, respectively. This was
primarily related to purchases of equipment, cash paid for acquisition of
businesses and capitalized software development costs.
Net cash provided by financing activities was $88.8 million and $11.2 for the
nine months ended September 30, 2000 and 1999, respectively. The cash provided
by financing activities in 2000 primarily resulted from the net proceeds of our
initial public offering, and the concurrent sale of shares to a strategic
investor. On March 15, 2000, we closed our initial public offering of 4,500,000
shares of common stock at $16.00 per share, for net proceeds of $67.0 million.
On April 14, 2000, the underwriters for the IPO exercised their over-allotment
option and purchased an additional 675,000 shares at $16.00 per share, for net
proceeds of $10.0 million. Concurrent with the initial public offering, we sold
336,022 shares of common stock at a price of $14.88 per share to a strategic
investor. Net proceeds were $5.0 million. The combined net proceeds from the
preceding transactions, less offering costs of $1.5 million, were $80.4 million.
An additional $9.3 million in proceeds were generated from our credit
facilities. Sources of funds from financing activities for the nine months ended
September 30, 1999 were $9.3 million from the sales of convertible preferred
stock and $1.9 million in proceeds from
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long-term debt. As of September 30, 2000, we had $99.6 million of cash, cash
equivalents and short-term investments.
As of September 30, 2000, our principal commitments consisted of obligations
outstanding under operating leases, notes payable totaling $9.5 million under
our credit facility with Imperial Bank and notes payable totaling $1.9 million,
under our credit facility with Dominion Venture Finance LLC. Borrowings from
Imperial Bank bear interest at Imperial's prime rate and prime rate plus 0.75%,
and are secured by assets financed under the agreement. The average interest
rate paid on our borrowings under the Imperial Bank facility was 10.19% and
10.01% in the three and nine months ended September 30, 2000, respectively. The
notes payable to Dominion bear interest at rates ranging from 8.57% to 9.65%.
Interest on the Imperial Bank note is payable monthly, and the principal is due
on August 30, 2002. Interest on the Dominion Venture Finance notes is payable
monthly, and the principal is due in the third and fourth quarters of 2002. For
the foreseeable future we anticipate our capital expenditures and lease
commitments will continue consistent with anticipated growth in operations,
infrastructure and personnel.
In June 2000, we amended our loan agreement with Imperial Bank to add an
additional credit facility which permits revolving borrowings and standby
letters of credit aggregating up to $2.0 million. Additionally, the amended
facility provides for a term loan of up to $10.0 million for the purchase of
capital equipment. The $2.0 million credit line bears interest at Imperial
Bank's prime rate (9.50% at September 30, 2000), with principal and interest due
at maturity in one year. There were no borrowings outstanding under the amended
credit line at September 30, 2000. The $10.0 million equipment facility bears
interest payable monthly during each draw period at Imperial's prime rates plus
0.75% followed by 36 equal monthly payments of principal plus interest.
Borrowings under this facility are secured by assets financed under the
agreement. At September 30, 2000, $8.9 million was outstanding under the amended
credit facility with Imperial Bank.
Since our inception, we have significantly increased our operating expenses.
We currently anticipate that we will continue to experience growth in our
operating expenses for the foreseeable future and that our operating expenses
will be a material use of our cash resources.
We believe that our existing cash, cash equivalents, short-term investments,
the amounts available under the working capital line and the new facility will
be sufficient to meet our working capital and capital expenditure requirements
for at least the next 18 to 24 months. Thereafter, if we cannot fund working
capital and capital expenditure requirements from our operations, we may find it
necessary to obtain additional equity or debt financing, sell assets or reduce
spending plans. In the event additional equity or debt financing is required, we
may not be able to raise it on acceptable terms or at all.
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RISK FACTORS
We have a limited operating history, making it difficult for you to evaluate our
business and your investment
Loudeye was formed as a limited liability company in August 1997 and
incorporated in March 1998. We therefore have a very limited operating history
upon which an investor may evaluate our operations and future prospects. Because
of our limited operating history, we have limited insight into trends that may
emerge and affect our business. In addition, the revenue and income potential of
our business and market are unproven. Because of the recent emergence of the
Internet media infrastructure industry, none of our executives have significant
experience in this industry. As a young company, we face risks and uncertainties
relating to our ability to implement our business plan successfully,
particularly due to the early stage of the streaming media industry. Our
potential for future profitability must be considered in light of the risks,
uncertainties, expenses and difficulties frequently encountered by companies in
their early stages of development, particularly companies in new and rapidly
evolving markets, such as the Internet media infrastructure industry, using new
and unproven business models.
Because we expect to continue to incur net losses, we may not be able to
implement our business strategy and the price of our stock may decline
We have incurred net losses from operations of $41.4 million during the period
August 12, 1997 (inception) through September 30, 2000. Given the level of our
planned operating and capital expenditures, we expect to continue to incur
losses and negative cash flows for the foreseeable future. To achieve
profitability, we must, among other things:
. Achieve customer adoption and acceptance of our products and
services;
. Successfully scale our current operations;
. Introduce new digital media services and applications;
. Implement and execute our business and marketing strategies;
. Develop and enhance our brand;
. Adapt to meet changes in the marketplace;
. Respond to competitive developments in the Internet media
infrastructure industry;
. Continue to attract, integrate, retain and motivate qualified
personnel; and
. Upgrade and enhance our technologies to accommodate expanded
digital media service and application offerings.
We might not be successful in achieving any or all of these objectives.
Failure to achieve any or all of these objectives could have a serious adverse
impact on our business, results of operations and financial position. Even if we
ultimately do achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis. Additionally, we expect to
increase our operating expenses in the future as
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we attempt to expand our digital media service and application offerings, grow
our customer base, enhance our brand image, improve our technology
infrastructure and open new offices. These higher operating costs could increase
our quarterly net losses for the foreseeable future. Accordingly, our ability to
operate our business and implement our business strategy may be hampered and the
value of our stock may decline.
Our quarterly financial results are subject to fluctuations that may make it
difficult to forecast our future performance and could cause our stock price to
decline
Our quarterly operating results have fluctuated in the past, and we expect our
revenues and operating results to vary significantly from quarter to quarter due
to a number of factors, including:
. Variability in demand for our digital media services and
applications;
. Market acceptance of new digital media services and applications
offered by us and our competitors;
. Introduction or enhancement of digital media services and
applications offered by us and our competitors;
. Willingness of our customers to enter into volume purchase orders;
. The mix of distribution channels through which our products are
licensed and sold;
. Changes in the growth rate of Internet usage;
. Variability in average order size or product mix;
. Changes in our pricing policies or the pricing policies of our
competitors;
. Technical difficulties with respect to the use of our products;
. Governmental regulations affecting use of the Internet, including
regulations concerning intellectual property rights and security
measures;
. The amount and timing of operating costs and capital expenditures
related to expansion of our business operations and infrastructure;
. General economic conditions such as fluctuating interest rates and
inflation; and
. Economic conditions specifically related to the Internet such as
fluctuations in the costs of Internet access, hardware and software
and the profitability of the Internet businesses that are our
customers.
Our limited operating history and new and unproven business model further
contribute to the difficulty of making meaningful quarterly comparisons. We
expect our operating expenses to increase in absolute dollars. Our current and
future levels of operating expenses and capital expenditures are based largely
on our growth plans and estimates of future revenues. These expenditure levels
are, to a large extent, fixed in the short term. Thus, we may not be able to
adjust spending in a timely manner to compensate for any unexpected shortfall in
revenues and any significant shortfall in revenues relative to planned
expenditures could have an immediate adverse effect on our business and results
of operations. If our operating results fall below the expectations of
securities analysts and investors in some future periods, our stock price will
likely decline.
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We are increasingly reliant upon the music industry and the music industry
in particular has recently been the focus of heightened concern with respect to
copyright infringement and other misappropriation claims, and the outcome of
developing legal standards in that industry is expected to impact music, video
and other content being distributed over the Internet. If, as a result,
potential customers forego or delay distributing traditional media content over
the Internet, demand for our digital media applications and services could be
reduced which would harm our business.
Historically, we have priced our digital media services based on the
customer's projected service volumes. We generally offer our digital media
services through volume purchase orders with prices determined by customers
committing to specific service volumes and schedules and paying nonrefundable
deposits. We attempt to secure these commitments from customers to enable us to
schedule time in our production facilities, to staff our operations efficiently
and to forecast revenues and cost of revenues. If our customers are not willing
to do business with us on these terms or if they do not fulfill their
commitments under volume purchase orders, our ability to forecast revenues will
be adversely affected and could contribute to increased fluctuation in our
quarterly results, which could seriously harm our business.
Although we have recently achieved significant percentage increases in our
quarterly revenues, this does not mean that future quarters can be expected to
show similar percentage revenue increases.
We are dependent on the development and rate of adoption of digital media and
the delay or failure of this development would seriously harm our business
We are dependent on the development and rate of adoption of digital media and
the delay or failure of this development would seriously harm our business. The
development of commercial applications for digital media content is in its very
early stages. If widespread commercial use of the Internet does not develop, or
if the Internet does not develop as an effective medium for the distribution of
digital media content to consumers, then we will not succeed in executing our
business plan. Many factors could inhibit the growth of electronic commerce in
general and the distribution of digital media content in particular, including
concerns about the profitability of Internet-based businesses, uncertainty about
how to generate revenue by using rich media, uncertainty about music rights
issues, bandwidth constraints, piracy and privacy.
Our success depends on users having access to the necessary hardware, software
and bandwidth, or data transmission capability, to receive high quality digital
media over the Internet. Congestion over the Internet and data loss may
interrupt audio and video streams, resulting in unsatisfying user experiences.
In order to receive digital media adequately, users generally must have
multimedia personal computers with certain microprocessor requirements and a
data transmission capability of at least 28.8 Kbps as well as streaming media
software. The success of digital media over the Internet depends on the
continued rollout of broadband access to consumers on an affordable basis. Users
typically download digital media software and install it on their personal
computers. This installation may require technical expertise that some users do
not possess. Furthermore, some information systems managers block reception of
digital media over corporate intranets because of bandwidth constraints.
Widespread adoption of digital media technology depends on overcoming these
obstacles, identifying viable revenue models
24
<PAGE>
for digital media, improving audio and video quality and educating customers and
users in the use of digital media technology. If digital media technology fails
to overcome these obstacles, our business could be seriously harmed.
We depend on a limited number of customers for a majority of our revenues so the
loss or delay in payment from one or a small number of customers could have a
significant impact on our revenues and operating results
A limited number of customers have accounted for a majority of our revenues
and will continue to do so for the foreseeable future. During the nine months
ended September 30, 1999, two of our customers composed approximately 28% of our
revenues; while in the nine months ended September 30, 2000, two customers
composed approximately 32% of our revenues. We believe that a small number of
customers may continue to account for a significant percentage of our revenues
for the foreseeable future. Due to high revenue concentration among a limited
number of customers, the cancellation, reduction or delay of a customer order or
our failure to timely complete or deliver a project during a given quarter is
likely to significantly reduce revenues for the quarter. If we were to lose a
key customer, our business, financial condition, and operating results could
suffer. In addition, if any customer fails to pay amounts it owes us, or does
not pay those amounts on time, our revenues and operating results could suffer.
If we are unsuccessful in increasing our customer base, our business could be
harmed.
Commercial failure of Internet-based businesses could reduce demand for our
digital media services and applications
Historically, the majority of customers for our digital media services and
applications have been Internet-based businesses. Our business prospects and
revenues would be harmed by the commercial failure or diminished commercial
prospects of these or like customers. In addition, if such customers have
difficulty raising additional capital to fund their operations, our business
prospects and revenues would be harmed
We may be liable to third parties for music, software, and other content that we
encode, distribute, or make available on our site
We may be liable to third parties for the content that we encode, distribute
or make available on our site:
. If the content or the performance of our services violates third
party copyright, trademark, or other intellectual property rights;
. If our customers violate the intellectual property rights of others
by providing content to us or by having us perform digital media
services; or
. If content that we encode or otherwise handle for our customers is
deemed obscene, indecent, or defamatory.
25
<PAGE>
In addition, we face the risk of our customers misrepresenting to us that they
have all necessary ownership rights in the content for us to perform our
encoding services. Any alleged liability could harm our business by damaging our
reputation, requiring us to incur legal costs in defense, exposing us to awards
of damages and costs and diverting management's attention which could have an
adverse effect on our business, results of operations and financial condition.
Our customers for encoding services generally agree to hold us harmless from
claims arising from their failure to have the right to encode the content given
to us for that purpose. However, customers may contest this responsibility or
not have sufficient resources to defend claims and we have limited insurance
coverage for claims of this nature.
Because we host audio and video content on our Web site and on other Web sites
for customers and provide services related to digital media content, we face
potential liability for negligence, infringement of copyright, patent, or
trademark rights, defamation, indecency and other claims based on the nature and
content of the materials we host. Claims of this nature have been brought, and
sometimes successfully pressed, against Internet content distributors. In
addition, we could be exposed to liability with respect to the unauthorized
duplication of content or unauthorized use of other parties' proprietary
technology. Any imposition of liability that is not covered by insurance or is
in excess of insurance coverage could harm our business.
We cannot assure you that third parties will not claim infringement by us with
respect to past, current, or future technologies. We expect that participants in
our markets will be increasingly subject to infringement claims as the number of
services and competitors in our industry segment grows. In addition, these risks
are difficult to quantify in light of the continuously evolving nature of laws
and regulations governing the Internet. Any claim relating to proprietary
rights, whether meritorious or not, could be time-consuming, result in costly
litigation, cause service upgrade delays or require us to enter into royalty or
licensing agreements, and we can not assure you that we will have adequate
insurance coverage or that royalty or licensing agreements will be available on
terms acceptable to us or at all.
We rely on strategic relationships to promote our services and for access to
licensed technology; if we fail to maintain or enhance these relationships, our
ability to serve our customers and develop new services and applications could
be harmed
Our ability to provide our services to users of multiple technologies and
platforms depends significantly on our ability to develop and maintain our
strategic relationships with key streaming media technology companies including,
among others, Apple Computer, Inc., Microsoft Corporation, RealNetworks, Inc.
and Terran Interactive, Inc. and hosting and distribution companies including,
among others, Digital Island, Inc., Akamai Technologies, Inc. and AT&T, Intel.
We rely on these relationships for licensed technology to maintain our ability
to service RealNetworks RealMedia, Microsoft Windows Media and Apple Quicktime
platforms and applications. Due to the evolving nature of the Internet media
infrastructure market, we will need to develop additional relationships to adapt
to changing technologies and standards and to work with newly emerging companies
with whom we do not have pre-existing relationships. We cannot be certain that
we will be successful in developing new
26
<PAGE>
relationships or that our partners will view these relationships as significant
to their own business or that they will continue their commitment to us in the
future. If we are unable to maintain or enhance these relationships, we may have
difficulty strengthening our technology development and increasing the adoption
of our brand and services.
If we are ineffective in managing our growth, our business may be harmed
We have rapidly and significantly expanded our operations and anticipate that
further expansion will be required to execute our business strategy. This growth
has accelerated since January 1, 1999; from January 1, 1999 to September 30,
2000, we have grown from 41 to approximately 400 full-time, part-time and
temporary employees. In December 1999, we acquired Alive.com, Inc. and in June
2000 we acquired VidiPax, Inc.
In addition, we are in the process of installing additional production
equipment for our digital media services. Integrating additional production
facilities with our existing space has placed a significant strain on our
employees, management systems, information systems, accounting systems, encoding
systems and other resources. If we do not manage our growth effectively, our
business, results of operations and financial condition could be seriously
harmed.
Our current systems are insufficient to indefinitely accommodate our targeted
level of future operations. Effectively managing our expected future growth will
require, among other things, that we successfully upgrade and expand our
production processes and systems, expand the breadth of products and services we
offer, improve our management reporting capabilities and strengthen internal
controls and accounting systems. We will also need to attract, hire and retain
highly skilled and motivated officers and employees. We must also maintain close
coordination among our marketing, operations, development and accounting
organizations.
We have recently added new production and/or sales facilities in Santa Monica,
California, New York, New York and London, England. If we are unable to
integrate these effectively into our operations, our business could be harmed.
Technological advances may cause our services and applications to be unnecessary
As more audio and video content is originally created in digital media
formats, the need for our encoding services may decrease. In addition, the
advancement of features in streaming media software applications from Microsoft,
RealNetworks and others may incorporate services and applications we currently
offer, or intend to offer, making our services or applications unnecessary or
obsolete. This could seriously harm our business.
If we are unable to scale our capacity sufficiently as demand increases, we may
lose customers which would seriously harm our business
The average volume of orders we have had to fulfill has been below our
designed capacity, and we cannot be certain that our facilities and employees
will be able to manage a substantially larger number of customer orders or
volume of content while maintaining current levels of performance. If customer
demand increases, our failure to achieve or maintain high capacity for our
production facilities may cause us to lose
27
<PAGE>
customers or fail to gain new ones, reducing our revenues and causing our
business and financial results to suffer.
The failure to retain and attract key technical personnel and other highly
qualified employees could harm our business
Because of the complexity of our services, applications and related
technologies, we are substantially dependent upon the continued service of our
existing product development personnel. In addition, we intend to hire
additional engineers with high levels of experience in designing and developing
software and rich media products in time-pressured environments. There is
intense competition in the Puget Sound region for qualified technical personnel
in the software and technology markets. New personnel will require training and
education and take time to reach full productivity. Our failure to attract,
train, and retain these key technical personnel could seriously harm our
business.
As we continue to introduce additional applications and services, and as our
customer base and revenues grow, we will need to hire additional qualified
personnel in every other area of operations as well. Competition for these
personnel is also extremely intense, and we may not be able to attract, train,
assimilate or retain qualified personnel in the future. Our failure to attract
or retain qualified personnel could seriously harm our business, results of
operations and financial condition.
Finally, our business and operations are substantially dependent on the
performance of our executive officers and key employees, all of whom are
employed on an at-will basis and have worked together for only a short period of
time. We do not maintain "key person" life insurance on any of our executive
officers. The loss of Martin G. Tobias, our founder and chief executive officer,
could seriously harm our business, as could the loss of several other key
executives.
Competition may decrease our market share, revenues, and gross margins, which
may cause our stock price to decline
Our products and services are divided into digital media services, which is
the encoding of audio and video content for deployment over the Internet, and
digital media applications, which are applications that enable our customers to
employ digital media in their Web-based products and services.
The market for digital media services and applications is relatively new, and
we face competition from in-house encoding services by potential customers,
other vendors that provide outsourced digital media services and companies that
directly provide digital media applications. If we do not compete effectively or
if we experience reduced market share from increased competition, our business
will be harmed. In addition, the more successful we are in the emerging market
for Internet media services and applications, the more competitors are likely to
emerge including turnkey Internet media application and service providers such
as Yahoo!, Broadcast Services, and Evoke; streaming media platform developers
such as Apple, Microsoft, RealNetworks, and Liquid Audio, Inc.; and video post-
production houses. Our digital media services business may face competitive
services from companies such as Globix Corporation, Magnum Design and Sonic
Foundry, Media100, Virage, Excalibur and others. Our digital media applications
28
<PAGE>
business may face competitive products from companies like AudioSoft,
AudioTrack, Context Media, InterTrust Technologies Corporation, Microsoft,
RealNetworks, Versifi, Virage and Vignette Corporation.
We also may not compete successfully against current or future competitors,
many of whom have substantially more capital, longer operating histories,
greater brand recognition, larger customer bases and significantly greater
financial, technical and marketing resources than we do. These competitors may
also engage in more extensive development of their technologies, adopt more
aggressive pricing policies and establish more comprehensive marketing and
advertising campaigns than we can. Our competitors may develop products and
service offerings that are more sophisticated than our own. For these and other
reasons, our competitors' products and services may achieve greater acceptance
in the marketplace than our own, limiting our ability to gain market share and
customer loyalty and to generate sufficient revenues to achieve a profitable
level of operations.
Our business model is unproven, making it difficult to forecast our revenues and
operating results
Our business model is based on the premise that digital media content
providers and developers will outsource a large percentage of their encoding
services needs and content management needs. Our potential customers may rely on
internal resources for these needs. In addition, technological advances may
render an outsourced solution unnecessary, particularly as new media content is
created in a digital format. Market acceptance of our services may depend in
part on reductions in the cost of our services so that we may offer a more cost
effective solution than both our competitors and our customers doing the work
internally. Our cost reduction efforts may not allow us to keep pace with
competitive pricing pressures or may not lead to improved gross margins. In
order to remain competitive, we expect to reduce the cost of our services
through design and engineering changes. We may not be successful in reducing the
costs of our services.
Average selling prices of our services may decrease, which may harm our gross
margins
The average selling prices of our services may be lower than expected as a
result of competitive pricing pressures, promotional programs and customers who
negotiate price reductions in exchange for longer term purchase commitments or
otherwise. The pricing of services sold to our customers depends on the duration
of the agreement, the specific requirements of the order, purchase volumes, the
sales and service support and other contractual agreements. We have experienced
and expect to continue to experience pricing pressure and anticipate that the
average selling prices and gross margins for our products will decrease over
product life cycles. We may not be successful in developing and introducing on a
timely basis new products with enhanced features that can be sold at higher
gross margins.
If we fail to enhance our existing services and applications products or develop
and introduce new digital media services, applications and features in a timely
manner
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<PAGE>
to meet changing customer requirements and emerging industry standards, our
ability to grow our business will suffer
The market for Internet media infrastructure solutions is characterized by
rapidly changing technologies and short product life cycles. These market
characteristics are heightened by the emerging nature of the Internet and the
continuing trend of companies from many industries to offer Internet-based
applications and services. The widespread adoption of the new Internet,
networking, streaming media, or telecommunications technologies or other
technological changes could require us to incur substantial expenditures to
modify or adapt our operating practices or infrastructure. Our future success
will depend in large part upon our ability to:
. Identify and respond to emerging technological trends in the
market;
. Develop and maintain competitive digital media services and
applications;
. Enhance our products by adding innovative features that
differentiate our digital media services and applications from
those of our competitors;
. Acquire and license leading technologies;
. Bring digital media services and applications to market on a timely
basis at competitive prices; and
. Respond effectively to new technological changes or new product
announcements by others.
We will not be competitive unless we continually introduce new services and
applications and enhancements to existing services and applications that meet
evolving industry standards and customer needs. In the future, we may not be
able to address effectively the compatibility and interoperability issues that
arise as a result of technological changes and evolving industry standards. The
technical innovations required for us to remain competitive are inherently
complex, require long development schedules and are dependent in some cases on
sole source suppliers. We will be required to continue to invest in research and
development in order to attempt to maintain and enhance our existing
technologies and products, but we may not have the funds available to do so.
Even if we have sufficient funds, these investments may not serve the needs of
customers or be compatible with changing technological requirements or
standards. Most development expenses must be incurred before the technical
feasibility or commercial viability or new or enhanced services and applications
can be ascertained. Revenue from future services and applications or
enhancements to services and applications may not be sufficient to recover the
associated development costs.
We cannot be certain that we will be able to protect our intellectual property,
and we may be found to infringe proprietary rights of others, which could harm
our business
Our intellectual property is important to our business, and we seek to protect
our intellectual property through copyrights, trademarks, patents, trade
secrets, confidentiality provisions in our customer, supplier and strategic
relationship agreements, nondisclosure agreements with third parties, and
invention assignment agreements with our employees and contractors. We presently
have five patent applications on file with the U.S. Patent
30
<PAGE>
and Trademark Office. We cannot assure that any or all of the patent
applications will be granted. We cannot assure you that measures we take to
protect our intellectual property will be successful or that third parties will
not develop alternative solutions that do not infringe upon our intellectual
property. In addition, we could be subject to intellectual property infringement
claims by others. These claims, and any resultant litigation, should it occur,
could subject us to significant liability for damages including treble damages
for willful infringement. In addition, even if we prevail, litigation could be
time-consuming and expensive to defend and could result in the diversion of our
time and attention. Any claims from third parties may also result in limitations
on our ability to use the intellectual property subject to these claims.
Further, we plan to offer our digital media services and applications to
customers worldwide including customers in foreign countries that may offer less
protection for our intellectual property than the United States. Our failure to
protect against misappropriation of our intellectual property, or claims that we
are infringing the intellectual property of third parties could have a negative
effect on our business, revenues, financial condition and results of operations.
The length of our sales cycle is uncertain and therefore could cause significant
variations in our operating results
Our customers typically include large corporations that often require long
testing and approval processes before making a purchase decision. Therefore, the
length of our sales cycle the time between an initial customer contact and
completing a sale has been and may continue to be unpredictable. The time
between the date of our initial contact with a potential new customer and the
execution of a sales contract with that customer ranges from less than two weeks
to more than six months, depending on the size of the customer, the application
of our solution and other factors. Our sales cycle is also subject to delays as
a result of customer-specific factors over which we have little or no control,
including budgetary constraints and internal acceptance procedures. During the
sales cycle, we may expend substantial sales and management resources without
generating corresponding revenues. Our expense levels are relatively fixed in
the short term and are based in part on our expectation of future revenues. As a
result, any delay in our sales cycle could cause significant variations in our
operating results, particularly because a relatively small number of customer
orders represent a large portion of our revenues.
The technology underlying our services and applications is complex and may
contain unknown defects that could harm our reputation, result in product
liability or decrease market acceptance of our services and applications
The technology underlying our digital media services and applications is
complex and includes software that is internally developed and software licensed
from third parties. These software products may contain errors or defects,
particularly when first introduced or when new versions or enhancements are
released. We may not discover software defects that affect our current or new
services and applications or enhancements until after they are sold.
Furthermore, because our digital media services are designed to work in
conjunction with various platforms and applications, we are susceptible to
errors or defects in third-party applications that can result in a lower quality
product for our
31
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customers. Because our customers depend on us for digital media management, any
interruptions could:
. Damage our reputation;
. Cause our customers to initiate product liability suits against us;
. Increase our product development resources;
. Cause us to lose sales; and
. Delay market acceptance of our digital media services and
applications.
We do not possess product liability insurance, and our errors and omissions
coverage is not likely to be sufficient to cover our complete liability
exposure.
Our expansion into international markets will require significant resources and
will subject us to new uncertainties that may limit our return from our
international sales efforts
One of our strategies to increase our sales is to add an international sales
force and operations. In March 2000 we opened a sales office in London, England.
Our further expansion will involve a significant use of management and financial
resources, particularly because we have no previous experience with
international operations. We may not be successful in creating international
operations or sales. In addition, international business activities are subject
to a variety of risks, including:
. The adoption of laws detrimental to our operations such as
legislation relating to the collection of personal data over the
Internet or laws, regulations or treaties governing the export of
encryption related software;
. Currency fluctuations;
. Actions by third parties such as discount pricing and business
techniques unique to foreign countries;
. Political instability; and
. Economic conditions including inflation, high tariffs or wage and
price controls.
We do not possess "political risk" insurance, and any of these risks could
restrict or eliminate our ability to do business in foreign jurisdictions.
Any acquisitions we make could disrupt our business and harm our financial
condition
We expect to search for and acquire businesses, technologies, services, or
products that we believe are a strategic fit with our business. We currently
have no binding commitments or definitive agreements with respect to any
material acquisition. If we do undertake any transaction of this sort, the
process of integrating an acquired business, technology, service, or product may
result in unforeseen operating difficulties and expenditures and may absorb
significant management attention that would otherwise be available for ongoing
development of our business. Moreover, we cannot assure you that the anticipated
benefits of any acquisition will be realized. Future acquisitions could result
in potentially dilutive issuances of equity securities, the incurrence of debt,
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contingent liabilities, or amortization expenses related to goodwill and other
intangible assets and the incurrence of large and immediate write-offs, any of
which could seriously harm our business, results of operations and financial
condition.
In addition, recent changes in the Financial Accounting Standards Board and
SEC rules for merger accounting may affect our ability to make acquisitions or
be acquired. For example, elimination of the "pooling" method of accounting for
mergers increases the amount of goodwill that we would be required to account
for if we acquired another company, which would have an adverse financial impact
on our future net income. Further, the reduced availability of write-offs for
in-process research and development costs under the purchase method of
accounting in connection with an acquisition could make an acquisition more
costly for us.
We may be unable to meet our future capital requirements and execute on our
business strategy.
We expect current cash balances, cash equivalents and investments to meet our
working capital and capital expenditure needs for the next 18 to 24 months.
Because we are not currently generating sufficient cash to fund our operations,
we may be forced to rely on external financing to meet future capital and
operating requirements. Any projections of future cash needs and cash flows are
subject to substantial uncertainty. Our capital requirements depend on several
factors, including the rate of market acceptance, our ability to expand our
customer base and increase revenues, our level of expenditures for marketing and
sales, purchases of equipment, and other factors. If our capital requirements
vary materially from those currently planned, we may require additional
financing sooner than anticipated. We can make no assurance that financing will
be available in amounts or on terms acceptable to us, if at all. Further, if we
issue equity securities, stockholders may experience additional dilution or the
new equity securities may have rights, preferences or privileges senior to those
of existing holders of common stock, and debt financing, if available, may
involve restrictive covenants which could restrict our operations or finances.
If we cannot raise funds, if needed, on acceptable terms, we may not be able to
continue our operations, grow market share, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements
which could negatively impact our business, operating results and financial
condition.
We have in the past experienced returns of our customers' encoded content, and
as our business grows we may experience increased returns, which could harm our
reputation and negatively affect our operating results
In the past, we have had on occasion difficulty monitoring the quality of our
service. A limited number of our customers have returned encoded content to us
for our failure to meet the customer's specifications and requirements. It is
likely that we will experience some level of returns in the future and, as our
business grows, the amount of returns may increase. Also, returns may harm our
relationship with potential customers and business in the future. If returns
increase, our reserves may not be sufficient and our operating results would be
negatively affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We provide Internet media infrastructure services and applications. Our
financial results could be affected by factors such as changes in interest rates
and fluctuations in the stock market. As substantially all sales are currently
made in U.S. dollars, a strengthening of the dollar could make our services less
competitive in foreign markets. We do not use derivative instruments to hedge
our risks. Our interest income is sensitive to changes in the general level of
U.S. interest rates, particularly since the majority of our investments are in
short-term instruments. Due to the nature of our short-term investments, we
anticipate no material market risk exposure. Therefore, no quantitative tabular
disclosures are presented.
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PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Recent Sales of Unregistered Securities
In August 2000, Loudeye issued warrants to purchase an aggregate of
75,000 shares in connection with a commercial agreement. The issuance
of the warrants were deemed to be exempt from registration under the
Securities Act in reliance upon Section 4(2) thereof as transactions
by an issuer not involving any public offering. The receipient had
adequate information about Loudeye.
(d) Use of Proceeds from Sales of Registered Securities
The net proceeds of our initial public offering and the concurrent
sale of shares to Akamai Technologies, Inc. which both closed on March
15, 2000 as well as the exercise of the underwriters' over-allotment
option on April 14, 2000 totaled $82.0 million. As of September 30,
2000, we have used approximately $26.0 million of those proceeds for
working capital and general corporate purposes, including increased
spending on sales and marketing, customer support, research and
development, expansion of our operational and administrative
infrastructure, and the purchase of capital equipment and businesses.
We expect to use the remaining proceeds of the offering for similar
purposes. In addition, we may use a portion of the net proceeds to
acquire or invest in complementary businesses, technologies, product
lines or products. However, specific amounts for any future use of
proceeds have not yet been determined and we have no current plans,
agreements or commitments with respect to any such acquisition.
Pending these uses, we intend to invest the net proceeds in short-
term, interest-bearing, investment grade securities with original
maturities of less than one year.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
None.
ITEM 5: OTHER INFORMATION
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------------------------------------------------------------------------------
Exhibit Description
------- -----------
Number
------
--------------------------------------------------------------------------------
2.1* Agreement and Plan of Reorganization dated November 19, 1999
between Loudeye Technologies, Inc. and Alive.com, Inc.
--------------------------------------------------------------------------------
3.1* Fifth Amended and Restated Certificate of Incorporation of
Loudeye Technologies, Inc.
--------------------------------------------------------------------------------
3.2* Form of Amended and Restated Certificate of Incorporation of
Loudeye.
--------------------------------------------------------------------------------
3.4* Bylaws of Loudeye Technologies, Inc.
--------------------------------------------------------------------------------
4.1* Form of Loudeye Technologies, Inc. common stock certificate.
--------------------------------------------------------------------------------
10.1* Form of Indemnification Agreement between Loudeye Technologies
and each of its officers and directors.
--------------------------------------------------------------------------------
10.2* 1998 Stock Option Plan, as amended.
--------------------------------------------------------------------------------
10.3* Alive.com, Inc. 1998 Stock Option Plan.
--------------------------------------------------------------------------------
10.4* 2000 Stock Option Plan.
--------------------------------------------------------------------------------
10.5* 2000 Director Stock Option Plan.
--------------------------------------------------------------------------------
10.6* 2000 Employee Stock Purchase Plan.
--------------------------------------------------------------------------------
10.7* Series A Preferred Stock Subscription Agreement dated March 26,
1998 between Loudeye Technologies, Inc. and Martin Tobias.
--------------------------------------------------------------------------------
10.8* Series A Preferred Stock Subscription Agreement dated March 26,
1998 between Loudeye Technologies, Inc. and Alex Tobias.
--------------------------------------------------------------------------------
10.9* Series A Preferred Stock Note Conversion Agreement dated June 5,
1998 between Loudeye Technologies, Inc. and Martin Tobias.
--------------------------------------------------------------------------------
10.10* Series B Preferred Stock Purchase Agreement dated June 5, 1998
among Loudeye Technologies, Inc. and Purchasers of Series B Preferred
Stock.
--------------------------------------------------------------------------------
10.11* Series C Preferred Stock Purchase Agreement dated April 30, 1999
among Loudeye Technologies and Purchasers of Series C Preferred Stock.
--------------------------------------------------------------------------------
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--------------------------------------------------------------------------------
10.12* Series C Preferred Stock Purchase Agreement dated August 6, 1999
among Loudeye Technologies, Inc. and Purchasers of Series C Preferred
Stock.
--------------------------------------------------------------------------------
10.13* Form of Warrant To Purchase Series C Preferred Stock dated June
22, 1999 between Loudeye Technologies, Inc. and Dominion Capital
Management, L.L.C.
--------------------------------------------------------------------------------
10.14* Series D Preferred Stock Purchase Agreement dated December 14,
1999 among Loudeye Technologies, Inc. and Purchasers of Series D
Preferred Stock.
--------------------------------------------------------------------------------
10.15* Amended and Restated Investors' Rights Agreement dated December
14, 1999 among Loudeye Technologies, Inc. and certain holders of our
preferred stock.
--------------------------------------------------------------------------------
10.16* Warrant to Purchase Common Stock dated December 17, 1999 between
Loudeye Technologies, inc. and Valley Media, Inc.
--------------------------------------------------------------------------------
10.17* Lease Agreement dated August 10, 1999 between Loudeye
Technologies, Inc.and Times Square Building LLC for offices at Times
Square Building, 414 Olive Way, Suite 300, Seattle, Washington.
--------------------------------------------------------------------------------
10.18* Lease Agreement dated September 1, 1998 between Loudeye
Technologies, Inc.and Martin Tobias for offices at 3406 E. Union
Street, Seattle, Washington.
--------------------------------------------------------------------------------
10.19* Lease Agreement dated October 28,1999 between Loudeye
Technologies, Inc.and Westlake Park Associates for offices at
Centennial Building, 1904 Fourth Avenue, Seattle, Washington.
--------------------------------------------------------------------------------
10.20* Lease Agreement dated June 7, 1999 between Loudeye Technologies,
Inc. and MSI 83 King LLC for offices at 83 King Street, Seattle,
Washington.
--------------------------------------------------------------------------------
10.21* Lease Agreement dated November 9, 1999 between Loudeye
Technologies, Inc. and Downtown Entertainment Associates, LP for
offices at 1424 Second Street, Santa Monica, California.
--------------------------------------------------------------------------------
10.22+* Encoding Services Agreement dated June 30, 1999 between Loudeye
Technologies, Inc.and Emusic.com, Inc.
--------------------------------------------------------------------------------
10.23+* Services Agreement dated December 17, 1999 between Loudeye
Technologies, Inc. and Valley Media, Inc.
--------------------------------------------------------------------------------
10.24* Imperial Bank Starter Kit Loan and Security Agreement dated
August 4, 1998 between Loudeye Technologies, Inc. and Imperial Bank.
--------------------------------------------------------------------------------
10.25* Loan and Security Agreement with Dominion Venture Finance L.L.C.
dated June 15, 1999 between Loudeye Technologies, Inc. and Dominion
Venture Finance L.C.C.
--------------------------------------------------------------------------------
10.26* Offer Letter to David Bullis dated June 23, 1999.
--------------------------------------------------------------------------------
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10.27* Offer Letter to Larry Culver dated August 2, 1999.
--------------------------------------------------------------------------------
10.28* Offer Letter to Douglas Schulze dated August 30, 1999.
--------------------------------------------------------------------------------
10.29* Offer Letter to James Van Kerkhove dated November 5, 1999.
--------------------------------------------------------------------------------
10.30* Offer Letter to David Weld dated December 2, 1999.
--------------------------------------------------------------------------------
10.31* Offer Letter to Tom Hodge dated January 17, 2000.
--------------------------------------------------------------------------------
10.32+* Agreement between Loudeye Technologies, Inc. and Microsoft
Corporation dated June 22, 1998.
--------------------------------------------------------------------------------
10.33* Common Stock Purchase Agreement between the Registrant and Akamai
Technologies, Inc. dated as of February 15, 2000.
--------------------------------------------------------------------------------
10.34+* Services Agreement between Loudeye Technologies, Inc. and Akamai
Technologies, Inc. dated as of February 15, 2000.
--------------------------------------------------------------------------------
10.35* Amended and Restated Loan and Security Agreement between Imperial
Bank and Loudeye Technologies, Inc. dated May 17, 2000.
--------------------------------------------------------------------------------
10.36* Amended and Restated Services Agreement between Valley Media,
Inc. and Loudeye Technologies, Inc. dated April 2000.
--------------------------------------------------------------------------------
10.37* Stock Purchase Agreement dated as of June 14, 2000 by and among
Loudeye Technologies, Inc., VidiPax, Inc. and James Lindner
--------------------------------------------------------------------------------
10.38* First Amendment of Office Lease Agreement dated April 3, 2000
between Times Square Building L.L.C. and Loudeye Technologies, Inc.
--------------------------------------------------------------------------------
10.39* Second Amendment of Office Lease Agreement dated May 1, 2000
between Times Square Building L.L.C. and Loudeye Technologies, Inc.
--------------------------------------------------------------------------------
10.40* Lease Agreement dated June 14, 2000 between Brown Bear Realty
Corporation and Loudeye Technologies, Inc.
--------------------------------------------------------------------------------
10.41+ Volume Purchase Order dated July 19, 2000 by and between
MusicBank and Loudeye Technologies, Inc.
--------------------------------------------------------------------------------
27.1 Financial Data Schedule
--------------------------------------------------------------------------------
+ Confidential treatment has been requested as to certain portions of this
Exhibit.
* Incorporated by reference to Loudeye Technologies, Inc.'s registration
statement on Form S-1 file number 333-93361 or previously filed statements on
Form 10-Q.
(b) Reports on Form 8(k).
None.
37
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 13, 2000.
LOUDEYE TECHNOLOGIES, INC.
By /s/ BRADLEY A. BERG
---------------------------
Bradley A. Berg
Chief Financial and Accounting Officer
38
