<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): November 29, 1999
________________________
EMUSIC.COM INC.
(Exact name of registrant as specified in its charter)
Delaware 0-24671 65-0207877
(State or other (Commission File Number) (I.R.S. Employer
jurisdiction of Identification Number)
incorporation or organization)
1991 Broadway, 2nd Floor 94063
Redwood City, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 216-0200
<PAGE>
This Amendment No. 1 to the Current Report on Form 8-K dated December 14,
1999 (the "Report") filed by Emusic.com Inc., a Delaware corporation (the
"Company"), is being filed in connection with the Company's acquisition of
Tunes.com Inc., a Delaware corporation ("Tunes.com"), by way of a merger of
GNB Corporation, a Delaware corporation and wholly owned subsidiary of the
Company, with and into Tunes.com (the "Merger") with Tunes.com being the
surviving corporation in the Merger, pursuant to the terms and conditions set
forth in the Agreement and Plan of Reorganization, dated as of November 29,
1999, and previously filed as Exhibit 99.1 to the Report. The Company hereby
amends Item 5 and Item 7 of the Report as set forth below to provide for
certain supplementary financial information.
Item 5. Other Events.
The following supplemental financial information relating to the Merger
is filed as part of this Report:
(a) Unaudited pro forma condensed combining financial information; and
(b) Audited financial statements of Tunes.com for the years ended
December 31, 1997 and 1998, and unaudited financial statements for
the nine months ended September 30, 1999.
Item 7. Financial Statements and Exhibits.
(a) Financial Statements of Businesses Acquired.
See Exhibit 99.3 for the audited financial statements of Tunes.com.
(b) Pro Forma Financial Information
See Exhibit 99.2 for the Unaudited Pro Forma Combined Condensed
Financial Information.
(c) Exhibits
Exhibit No. Description
----------- -----------
23.1 Consent of Ernst & Young, LLP, Independent Auditors.
99.1* Agreement and Plan of Reorganization, dated as of
November 29, 1999.
99.2 Unaudited Pro Forma Condensed Combining Financial
Information.
99.3 Audited Financial Statements of Tunes.com for the
years ended December 31, 1997 and 1998, and unaudited
Financial Statements for the nine months ended
September 30, 1999.
* Previously filed.
<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 hereunto duly authorized.
EMUSIC.COM INC.
December 22, 1999 By: /s/ Joseph Howell
----------------------------
Joseph Howell
Executive Vice President and
Chief Financial Officer
<PAGE>
Exhibit 23.1
CONSENT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement Form
S-8 No. 333-82841 and 333-86551) of EMusic.com Inc., of our report dated
January 26, 1999, with respect to the consolidated financial statements of
Tunes.com, Inc. and to the use of our report dated June 22, 1998 with respect
to the financial statements of Tunes Network, Inc, included in this Current
Report (Form 8-K) dated December 22, 1999, both filed with the Securities and
Exchange Commission.
/s/ Ernst & Young LLP
Chicago, Illinois
December 21, 1999
<PAGE>
EXHIBIT 99.2
UNAUDITED PROFORMA CONDENSED COMBINING BALANCE SHEET DATA
(In thousands)
<TABLE>
<CAPTION>
EMusic.com Cductive Pro Forma
------------- ------------- ----------------------
September 30, September 30,
1999 1999 Adjustments Combined
------------- ------------- ----------- --------
(see note 5)
<S> <C> <C> <C> <C>
Assets
Current Assets:
Cash..................... $ 78,904 $ 888 $ -- $ 79,792
Accounts receivable...... 168 -- -- 168
Prepaid expenses and
other assets............ 9,531 17 -- 9,548
-------- ------- ------- --------
Total current assets... 88,603 905 -- 89,508
-------- ------- ------- --------
Property and equipment,
net....................... 1,989 219 2,208
Music content, net......... 11,746 239 11,985
Trade names, net........... 22,397 -- 35,867 (J) 58,264
Other intangible assets,
net....................... -- -- --
Other assets............... 430 73 -- 503
-------- ------- ------- --------
Total assets........... $125,165 $ 1,436 $35,867 $162,468
-------- ------- ------- --------
Liabilities and
Stockholders' Equity
Current Liabilities:
Accounts payable......... $ 406 $ 272 $ -- $ 678
Accrued liabilities...... 1,829 28 100 (J) 1,957
Accrued payroll and
related benefits........ 430 -- -- 430
Deferred revenue......... -- -- -- --
Dividends payable on
preferred stock......... 1,061 92 -- 1,153
Current portion of long
term debt............... -- 69 -- 69
-------- ------- ------- --------
Total current
liabilities........... 3,726 461 100 4,287
-------- ------- ------- --------
Long term debt............. -- 60 -- 60
Redeemable convertible
preferred stock........... -- 1,217 (1,217)(K) --
-------- ------- ------- --------
Total Liabilities.......... 3,726 1,738 (1,117) 4,347
-------- ------- ------- --------
Stockholders' Equity
(Deficit):
Preferred Stock.......... -- -- -- --
Common Stock............. 34 3 (3)(K) 2,170
2,136 (J)
Additional paid-in 184,498 2,008 (2,008)(K) 219,044
capital................. 34,546 (J)
Common stock to be issued.. -- -- -- --
Deficit accumulated
during the development
stage................... (63,093) (2,313) 2,313 (K) (63,093)
-------- ------- ------- --------
Total stockholders'
equity................ 121,439 (302) 36,984 158,121
-------- ------- ------- --------
Total liabilities and
stockholders' equity.. $125,165 $ 1,436 $35,867 $162,468
======== ======= ======= ========
</TABLE>
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING BALANCE SHEET DATA--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Tunes.com Pro Forma
------------- -----------------------
September 30,
1999 Adjustments Combined
------------- ----------- --------
(see Note 5)
<S> <C> <C> <C>
Assets
Current Assets:
Cash................................... $ 7,528 $ -- $ 87,320
Accounts receivable.................... 882 -- 1,050
Prepaid expenses and other assets...... 2,777 -- 12,325
-------- -------- --------
Total current assets................. 11,187 -- 100,695
-------- -------- --------
Property and equipment, net.............. 1,593 -- 3,801
Music content, net....................... -- -- 11,985
Trade names, net......................... 1,423 137,933 (L) $197,620
Other intangible assets, net............. 2,044 (2,044)(L) --
Other assets............................. 52 -- 555
-------- -------- --------
Total assets......................... $ 16,299 $135,889 $314,656
-------- -------- --------
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable....................... $ 1,327 -- 2,005
Accrued liabilities.................... 1,783 3,893 (L) 7,633
Accrued payroll and related benefits... 537 -- 967
Deferred revenue....................... 96 -- 96
Dividends payable on preferred stock... -- -- 1,153
Current portion of long term debt...... -- -- 69
-------- -------- --------
Total current liabilities............ 3,743 3,893 11,923
-------- -------- --------
Long term debt........................... 82 -- 142
Deferred tax liability................... -- 9,435 (L) 9,435
Redeemable convertible preferred stock... 43,135 (43,135)(M) --
-------- -------- --------
Total liabilities........................ 46,960 (29,807) 21,500
-------- -------- --------
Stockholders' Equity (Deficit):
Preferred Stock
Common Stock........................... 15 (15)(M) 2,176
6 (L)
Additional paid-in capital............. 10,673 (10,673)(M) 354,073
135,029 (L)
Common stock to be issued................ 55 (55)(M) --
Deficit accumulated during the
development stage..................... (41,404) 41,404 (M) (63,093)
-------- -------- --------
Total stockholders' equity........... (30,661) 165,696 293,156
-------- -------- --------
Total liabilities and stockholders'
equity.............................. $(16,299) $135,889 $314,656
======== ======== ========
</TABLE>
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING STATEMENT OF OPERATIONS DATA
(In thousands except per share amounts)
<TABLE>
<CAPTION>
EMusic.com Cductive Pro Forma
------------- ------------- ----------------------
Three Months Three Months
Ended Ended
September 30, September 30,
1999 1999 Adjustments Combined
------------- ------------- ----------- --------
(see note
5)
<S> <C> <C> <C> <C>
Revenues................... $ 180 $ 22 $ -- $ 202
Cost of revenues........... 25 32 -- 57
-------- ------ ------- --------
Gross profit (loss)....... 155 (10) -- 145
-------- ------ ------- --------
Operating expenses:
Product development....... 6,011 226 -- 6,237
Selling and marketing..... 4,771 111 -- 4,882
General and
administrative........... 812 531 -- 1,343
Amortization of trade
names.................... 2,283 -- $ 2,989 (B) 5,272
-------- ------ ------- --------
Total operating expenses.. 13,877 868 2,989 17,734
-------- ------ ------- --------
Operating loss............. (13,722) (878) (2,989) (17,589)
Interest and other income
(expense), net............ 203 (6) -- 197
-------- ------ ------- --------
Net income (loss).......... $(13,519) $ (884) $(2,989) $(17,392)
Accretion of Series B
Preferred to redemption
value..................... (224) -- -- (224)
Dividend on Series B
Preferred Stock........... (493) -- -- (493)
-------- ------ ------- --------
Net loss applicable to
common stockholders....... $(14,236) $ (884) $2,989 $(18,109)
======== ====== ======= ========
Net loss per share, basic
and diluted............... $ (1.09) $ (1.19)
======== ========
Weighted average common
shares outstanding, basic
and diluted............... 13,058 2,136 (A) 15,194
======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
Tunes.com Pro Forma
------------- ----------------------
Three Months
Ended
September 30,
1999 Adjustments Combined
------------- ----------- --------
<S> <C> <C> <C>
Revenues................................. $ 1,305 $ -- $ 1,507
Cost of revenues......................... 1,106 (340)(E) 823
------- ------- --------
Gross profit (loss)..................... 199 -- 684
------- ------- --------
Operating expenses:
Product development..................... 1,006 340 (E) 7,583
Selling and marketing................... 4,343 -- 9,225
General and administrative.............. 1,135 -- 2,478
Amortization of trade names............. 681 8,789 (D) 14,742
------- ------- --------
Total operating expenses................ 7,165 9,129 34,028
------- ------- --------
Operating loss........................... (6,966) (8,789) (33,344)
Interest and other income (expense),
net..................................... 126 -- 323
------- ------- --------
Net income (loss)........................ $(6,840) $(8,789) $(33,021)
Accretion of Series B Preferred to
redemption value........................ -- -- (224)
Dividend on Series B Preferred Stock..... -- -- (493)
------- ------- --------
Net loss applicable to common
stockholders............................ $ 6,840 $(8,789) $(33,738)
======= ======= ========
Net loss per share, basic and diluted.... $ (1.60)
========
Weighted average common shares
outstanding, basic and diluted.......... -- 5,892 (C) 21,086
======= ======= ========
</TABLE>
See accompanying notes.
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING STATEMENT OF OPERATIONS DATA--(Continued)
(In thousands except per share amounts)
<TABLE>
<CAPTION>
EMusic.com
------------- Creative IUMA Cductive.com
Twelve Months Fulfillment Nine Twelve
Ended Six Months Ended Months Ended Months Ended
June 30, 1999 January 31, 1999 April 30, 1999 June 30, 1999
------------- ---------------- -------------- -------------
<S> <C> <C> <C> <C>
Revenues................ $ 92 $103 $ 299 $ 105
Cost of revenues........ 27 32 -- 108
-------- ---- ------- -------
Gross profit (loss).... 65 71 299 (3)
-------- ---- ------- -------
Operating expenses:
Product development.... 11,690 57 255 496
Selling and marketing.. 556 -- -- 183
General and
administrative........ 1,599 13 1,120 551
Amortization of trade
names................. 1,682 -- -- --
-------- ---- ------- -------
Total operating
expenses.............. 15,527 70 1,375 1,230
-------- ---- ------- -------
Operating loss.......... (15,462) 1 (1,076) (1,233)
Interest and other
income (expense), net.. 322 -- -- (14)
-------- ---- ------- -------
Net income (loss)....... $(15,140) $ 1 $(1,076) $(1,247)
Accretion of Series A
Preferred to redemption
value.................. (25) -- -- --
Beneficial conversion
charge, Series A
Preferred Stock........ (144) -- -- --
Accretion of Series B
Preferred to redemption
value.................. (222) -- -- --
Beneficial conversion
charge, Series B
Preferred Stock........ (31,577) -- -- --
Dividend on Series B
Preferred Stock........ (569) -- -- --
-------- ---- ------- -------
Net loss applicable to
common stockholders.... $(47,677) $ 1 $ 1,076 (1,247)
======== ==== ======= =======
Net loss per share,
basic and diluted...... $ (3.52)
========
Weighted average common
shares outstanding,
basic and diluted...... 13,564
========
</TABLE>
<TABLE>
<CAPTION>
Tunes.com
Twelve Months
Ended
June 30, 1999 Adjustments Combined
------------- ----------- ---------
(see Note 5)
<S> <C> <C> <C>
Revenues................................ $ 3,351 $ (50)(G) $ 3,900
Cost of revenues........................ 4,008 (1,271)(H) 2,904
-------- -------- ---------
Gross profit (loss).................... (657) 1,221 6,804
-------- -------- ---------
Operating expenses:
Product development.................... 9,600 1,233 (H) 23,331
Selling and marketing.................. 6,055 -- 6,794
General and administrative............. 3,754 -- 7,037
Amortization of trade names............ 2,836 50,849 (I) 55,367
-------- -------- ---------
Total operating expenses............... 22,245 52,082 92,529
-------- -------- ---------
Operating loss.......................... (22,902) (50,861) (85,725)
Interest and other income (expense),
net.................................... 280 -- 588
-------- -------- ---------
Net income (loss)....................... $(22,622) $(50,861) $ (85,137)
Accretion of Series A Preferred to
redemption value....................... -- -- (25)
Beneficial conversion charge, Series A
Preferred Stock........................ -- -- (144)
Accretion of Series B Preferred to
redemption value....................... -- -- (222)
Beneficial conversion charge, Series B
Preferred Stock........................ -- -- (31,577)
Dividend on Series B Preferred Stock.... -- -- (569)
-------- -------- ---------
Net loss applicable to common
stockholders.......................... (22,622) (50,861) $(117,674)
======== ======== ---------
Net loss per share, basic and diluted... $ (5.26)
=========
Weighted average common shares
outstanding, basic and diluted......... -- 8,806 (F) 22,370
======== ======== =========
</TABLE>
See accompanying notes
<PAGE>
NOTES TO UNAUDITED PROFORMA CONDENSED COMBINING FINANCIAL DATA
1. The preliminary allocation of the purchase price among the indentifiable
tangible and intangible assets was based on a preliminary assessment of the
fair market value of those assets. The Company is amortizing the intangible
assets over their estimated useful life of three and ten years using the
straight line method. For the purposes of the unaudited proforma condensed
combining financial data we allocated 30% of intangible assets obtained through
the acquisition of Tunes.com to Rollingstone.com, to be amortized over ten
years. Rollingstone.com is a trade name that Tunes.com acquired pursuant to an
agreement that has a life of ten years but contains provisions for a five year
extension based on certain contingencies. The Company has engaged an
independent valuations consultant to perform an allocation of the purchase
price based on generally accepted valuation techniques. To the extent the
purchase price is allocated to Rollingstone.com or a longer life is determined,
the adjustment will be made to the amortization which could be material in
amount. Any adjustments arising as a result of the valuation work will be
recorded upon its completion.
2. Below is a table of the estimated acquisition cost, estimated purchase
price allocation and estimated amortization of intangible assets of Tunes.com
and Cductive as of September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
September 30, 1999: Tunes.com Cductive
------------------- --------- --------
<S> <C> <C>
Estimated acquisition price:
Value of securities issued............................... $135,035 $36,682
Acquisition costs........................................ 3,893 100
-------- -------
Total acquisition costs................................ 138,928 36,782
Deferred tax liability................................... 9,435 --
-------- -------
Total.................................................. 148,363 36,782
======== =======
Estimated purchase price allocation:
Tangible net assets acquired............................. $ 9,007 $ 915
Goodwill and other intangibles........................... 139,356 35,867
-------- -------
Total.................................................. 148,363 36,782
======== =======
Estimated amortization (based on composite amortization
period of approximately four years)
Annual..................................................... $ 35,156 $11,956
======== =======
</TABLE>
The tangible net assets of Tunes.com and Cductive include cash, accounts
receivable, other current assets and property and equipment net of liabilities.
Liabilities include accounts payable and other accrued liabilities.
3. The unaudited pro forma combined loss per share is based on the weighted
average number of common and common equivalent shares of EMusic, 630,000 shares
issued to Creative Fulfillment, 448,000 shares issued to IUMA, 2,136,000 shares
issued to Cductive and 5,892,000 shares to be issued to Tunes.com for the three
month period ended September 30, 1999 and the year ended June 30, 1999. The
dilutive effect of stock options has been excluded since the unaudited pro
forma condensed statement of operations results in a net loss for the three-
months ended September 30, 1999 and the year ended June 30, 1999.
The pro-forma combined basic and diluted loss per share information was
determined as follows for the three-months ended September 30, 1999 (in
thousands):
<TABLE>
<S> <C>
EMusic shares used for net loss per share calculation............... 13,058
EMusic shares issued for the acquisition of Cductive................ 2,136
EMusic shares issued for the acquisition of Tunes.com............... 5,892
------
Pro forma combined EMusic shares used for loss per share
calculation........................................................ 21,086
======
</TABLE>
<PAGE>
The pro forma combined basic and diluted loss per share information was
determined as follows for the year ended June 30, 1999 (in thousands):
<TABLE>
<S> <C>
EMusic shares used for net loss per share calculation............... 13,564
Adjustment to give full period effect of EMusic shares issued for
Creative Fulfillment............................................... 367
Adjustment to give full period effect of EMusic shares issued for
acquisition of IUMA................................................ 411
EMusic shares issued for the acquisition of Cductive................ 2,136
EMusic shares issued for the acquisition of Tunes.com............... 5,892
------
Pro forma combined EMusic shares used for loss per share
calculation........................................................ 22,370
======
</TABLE>
4. These unaudited pro forma combined condensed financial statements reflect
the issuance of 5,891,712 shares of EMusic common stock in exchange for all of
the outstanding shares of common stock of Tunes.com as of September 30, 1999.
The following table details the pro forma share issuance in connection with
the acquisition as of September 30, 1999 (in thousands):
<TABLE>
<S> <C>
Number of shares of EMusic common stock issued for Cductive net
tangible assets.................................................... 2,136
Number of shares of EMusic common stock issued for Tunes.com net
tangible assets.................................................... 5,892
Number of shares of EMusic common stock outstanding as of September
30, 1999........................................................... 34,002
------
Number of shares of EMusic common stock outstanding after the
completion of acquisition.......................................... 42,030
======
</TABLE>
5. The following pro forma adjustments are reflected in the unaudited pro
forma condensed combining financial information and are required to allocate
the preliminary purchase price and acquisition costs to the net assets acquired
from Creative Fulfillment, IUMA, Cductive and Tunes.com based on their fair
value:
Adjustments reflecting the acquisition of Cductive and Tunes.com for the
three months ended September 30, 1999:
(A) Reflects the issuance of 2,136,000 shares of Common Stock in exchange
for all outstanding common shares of Cductive.
(B) Reflects the amortization of intangible assets associated with the
purchase of Cductive as if the acquisition was completed as of the
beginning of each period presented. Amortization is over the estimated
useful lives of the assets acquired of three years. Any adjustments
arising as a result of the completion of valuation work to be performed
by the independent valuation consultant, may have a material effect on
the amortization for the period reported.
(C) Reflects the issuance of 5,892,000 shares of Common Stock in exchange
for all the outstanding common stock of Tunes.com.
(D) Reflects the amortization of intangible assets associated with the
purchase of Tunes.com as if the acquisition was completed as of the
beginning of each period presented. Amortization is over the estimated
useful lives of the assets acquired. Any adjustments arising as a
result of the completion of valuation work to be performed by the
independent valuation consultant, may have a material effect on the
amortization for the period reported.
(E) Reflects the adjustment to Tunes.com to conform expense classifications
for reporting with respect to the allocation of expense to cost of
revenues versus product development.
<PAGE>
Adjustments reflecting the acquisition of Creative Fulfillment, IUMA,
Cductive and Tunes.com for the twelve months ended June 30, 1999:
(F) Reflects the issuance of 367,000 shares for Creative Fulfillment,
411,000 shares for IUMA, 2,136,000 shares for Cductive and 5,892,000
shares for Tunes.com.
(G) Reflects the elimination of inter-company development consulting
revenue paid by EMusic.com to Creative Fulfillment.
(H) Reflects the adjustment to Tunes.com to conform expense classifications
for reporting and the elimination of expense related to inter-company
development consulting revenue paid by EMusic.com to Creative
Fulfillment.
(I) Reflects the amortization of intangible assets associated with the
purchase of Creative Fulfillment, IUMA, Cductive and Tunes.com as if
the acquisition was completed as of July 1, 1998. Amortization for
Cductive and Tunes.com is over the estimated useful lives of the assets
acquired. Any adjustments arising as a result of the completion of
valuation work to be performed by the independent valuations
consultant, may have a material effect on the amortization for the
period reported.
Adjustments reflecting the acquisition of Cductive and Tunes.com on September
30, 1999:
(J) Reflects the allocation of the Cductive purchase price of approximately
$36,782,000, which consisted of the issuance of 2,136,000 shares of
Common Stock valued at $14.85 per share, assumption of fully-vested
warrants and options for 471,000 shares of Common Stock, net assets
assumed of approximately $915,000 and direct acquisition related
expenses of $100,000.
(K) Reflects the elimination of Cductive's equity accounts.
(L) Reflects the allocation of the Tunes.com purchase price of
approximately $138,928,000, which consisted of the issuance of
5,892,000 shares of Common Stock valued at $14.29 per share, assumption
of fully-vested warrants and options for 4,708,000 shares of Common
Stock, net assets assumed of approximately $9,007,000 and direct
acquisition related expenses of $3,893,000.
(M) Reflects the elimination of Tunes.com's equity accounts.
<PAGE>
Exhibit 99.3
TUNES.COM, INC. ("TUNES.COM")
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
REPORT OF INDEPENDENT AUDITORS.......................................................... 2
CONSOLIDATED BALANCE SHEETS............................................................. 3
CONSOLIDATED STATEMENTS OF OPERATIONS................................................... 4
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)............................... 5
CONSOLIDATED STATEMENTS OF CASH FLOWS................................................... 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.............................................. 7
</TABLE>
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Tunes.com Inc.
We have audited the accompanying consolidated balance sheets of Tunes.com
Inc. as of December 31, 1997 and 1998 and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the period from
July 2, 1996 (inception) to December 31, 1996 and the years ended December 31,
1997 and 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Tunes.com Inc.
at December 31, 1997 and 1998, and the consolidated results of its operations
and its cash flows for the years ended December 31, 1997 and 1998 and for the
period from July 2, 1996 (inception) to December 31, 1996, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
January 26, 1999
<PAGE>
TUNES.COM INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION> DECEMBER 31, SEPT. 30,
------------
1997 1998 1999
----- ---- ----
(UNAUDITED)
ASSETS
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents......................................... $ 2,674,236 $ 4,251,082 $ 7,527,896
Accounts receivable, net of allowance of $17,000 in 1998 and
$12,000 in 1999................................................. 130,016 368,720 881,462
Prepaid expenses and other current assets......................... 88,156 374,195 2,527,387
Restricted investment............................................. 1,000,000 1,000,000 250,000
----------- ------------ ------------
Total current assets.............................................. 3,892,408 5,993,997 11,186,745
Equipment and leasehold improvements.............................. 840,430 1,712,802 2,379,327
Less: Accumulated depreciation.................................... (131,185) (498,636) (786,371)
----------- ------------ ------------
709,245 1,214,166 1,592,956
Restricted investment, less current portion....................... 1,000,000 -- --
Goodwill, net..................................................... -- 3,488,570 1,744,280
Other intangibles, net............................................ -- 682,498 299,990
License agreement, net............................................ -- -- 1,423,077
Other............................................................. -- 33,941 51,587
----------- ------------ ------------
Total assets...................................................... $ 5,601,653 $ 11,413,172 $ 16,298,635
=========== ============= ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Liabilities:
Accounts payable................................................ $ 186,084 $ 743,344 $ 1,327,267
Accrued compensation............................................ 34,690 410,331 536,958
Acquisition liability........................................... -- 404,000 --
Deferred revenue................................................ 110,831 541,246 95,969
Other accrued expenses and current liabilities.................. 181,895 655,271 1,783,008
----------- ------------ ------------
Total current liabilities......................................... 513,500 2,754,192 3,743,202
Long-term obligations............................................. -- 160,507 82,182
Redeemable convertible preferred stock............................ 8,430,108 22,116,439 43,134,794
Stockholders' deficit:
Common stock, par value $0.01; 11,500,000 shares authorized;
issued and outstanding: 1,469,782 in 1999, 1,340,530 in 1998
and 1,150,530 in 1997......................................... 11,505 13,405 14,698
Additional paid-in capital...................................... 748,195 4,174,029 10,672,790
Common stock to be issued....................................... -- 1,055,420 55,420
Accumulated deficit............................................. (4,101,655) (18,860,820) (41,404,451)
----------- ------------ ------------
Total stockholders' deficit....................................... (3,341,955) (13,617,966) (30,661,543)
----------- ------------ ------------
Total liabilities and stockholders' deficit....................... $ 5,601,653 $ 11,413,172 $ 16,298,635
=========== ============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
TUNES.COM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
JULY 2, 1996
(INCEPTION) NINE MONTHS ENDED
TO DECEMBER YEAR ENDED DECEMBER 31 SEPTEMBER 30
----------------------------- ---------------------------
31,
1996 1997 1998 1998 1999
------------ ----------- ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Advertising.......................... $ -- $ 283,807 $ 970,189 $ 502,439 $ 2,456,151
Other................................ -- 280,887 1,514,466 1,212,793 846,876
------------ ----------- ------------ ----------- ------------
Total revenue.......................... -- 564,694 2,484,655 1,715,232 3,303,027
Cost of revenue........................ -- 1,267,521 4,045,056 2,863,312 3,108,355
------------ ----------- ------------ ----------- ------------
Gross margin (deficit)................. -- (702,827) (1,560,401) (1,148,080) 194,672
Operating expenses:
Operations and development........... 32,003 458,381 1,880,480 1,058,809 2,778,321
Sales and marketing.................. 36,769 1,064,502 4,034,115 2,282,191 7,486,287
General and administrative........... 152,859 1,244,676 2,836,678 1,935,134 2,990,253
Depreciation and amortization........ 2,319 156,529 1,777,931 961,020 2,555,504
Stock compensation................... -- 9,700 1,527,734 413,373 4,526,844
------------ ----------- ------------ ----------- ------------
Total operating expenses............... 223,950 2,933,788 12,056,938 6,650,527 20,337,211
------------ ----------- ------------ ----------- ------------
Loss from operations................... (223,950) (3,636,615) (13,617,339) (7,798,607) (20,142,539)
Other income (expense):
Interest income...................... 7,353 99,540 432,566 340,276 284,277
Interest expense..................... -- -- (9,438) (5,121) (76,812)
Other income (expense)............... -- 15,040 4,568 4,568 (35,451)
------------ ----------- ------------ ----------- ------------
Net loss............................... (216,597) (3,522,035) (13,189,643) (7,458,884) (19,970,525)
Accretion of redeemable convertible
preferred stock...................... -- (363,023) (1,569,522) -- (2,573,106)
------------ ----------- ------------ ----------- ------------
Net loss attributable to common
stockholders......................... $ (216,597) $(3,885,058) $(14,759,165) $(7,458,884) $(22,543,631)
============ =========== ============ =========== ============
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
TUNES.COM INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
MEMBERS' UNITS COMMON STOCK ADDITIONAL
----------------------- ---------------------- COMMON STOCK PAID-IN ACCUMULATED
UNITS AMOUNT SHARES PAR VALUE TO BE ISSUED CAPITAL DEFICIT
----------- --------- --------- ----------- -------------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial capitalization, July 2,
1996:................................ 115,053 $750,000 -- $ -- $ -- $ -- $ --
Net loss for the period from July 2,
1996 to December 31, 1996............ -- -- -- -- -- -- (216,597)
-------------- --------- ------------ --------- ------------ ---------- ------------
Balance at December 31, 1996.......... 115,053 750,000 -- -- -- -- (216,597)
Conversion of Members' units to
shares of common stock............... (115,053) (750,000) 1,150,530 11,505 -- 738,495 --
Stock compensation expense............ -- -- -- -- -- 9,700 --
Accretion of redeemable convertible
preferred stock...................... -- -- -- -- -- -- (363,023)
Net loss.............................. -- -- -- -- -- -- (3,522,035)
-------------- --------- ------------ --------- ------------ ---------- ------------
Balance at December 31, 1997.......... -- -- 1,150,530 11,505 -- 748,195 (4,101,655)
Common stock to be issued............. -- -- -- -- 2,955,420 -- --
Common stock issued in connection
with acquisition..................... -- -- 190,000 1,900 (1,900,000) 1,898,100 --
Stock compensation expense............ -- -- -- -- -- 1,527,734 --
Accretion of redeemable convertible
preferred stock...................... -- -- -- -- -- -- (1,569,522)
Net loss.............................. -- -- -- -- -- -- (13,189,643)
-------------- --------- ------------ --------- ------------ ---------- ------------
Balance at December 31, 1998.......... -- -- 1,340,530 13,405 1,055,420 4,174,029 (18,860,820)
Issuance of warrants (unaudited)...... -- -- -- -- -- 713,011 --
Stock compensation expense
(unaudited).......................... -- -- -- -- -- 4,526,845 --
Accretion of redeemable convertible
preferred stock (unaudited).......... -- -- -- -- -- -- (2,573,106)
Exercise of stock options and warrants
(unaudited).......................... -- -- 29,252 293 -- 259,905 --
Common stock issued in connection
with acquisition (unaudited)......... -- -- 100,000 1,000 (1,000,000) 999,000 --
Net loss (unaudited).................. -- -- -- -- -- -- (19,970,525)
-------------- --------- ------------ --------- ------------ ----------- ------------
Balance at September 30, 1999
(unaudited).......................... -- -- 1,469,782 $14,698 $ 55,420 $10,672,790 $(41,404,451)
============== ========= ============ ========= ============ =========== ============
TOTAL
--------------
Initial capitalization, July 2,
1996:................................ $ 750,000
Net loss for the period from July 2,
1996 to December 31, 1996............ (216,597)
-------------
Balance at December 31, 1996.......... 533,403
Conversion of Members' units to
shares of common stock............... --
Stock compensation expense............ 9,700
Accretion of redeemable convertible
preferred stock...................... (363,023)
Net loss.............................. (3,522,035)
-------------
Balance at December 31, 1997.......... (3,341,955)
Common stock to be issued............. 2,955,420
Common stock issued in connection
with acquisition..................... --
Stock compensation expense............ 1,527,734
Accretion of redeemable convertible
preferred stock...................... (1,569,522)
Net loss.............................. (13,189,643)
-------------
Balance at December 31, 1998.......... (13,617,966)
Issuance of warrants (unaudited)...... 713,011
Stock compensation expense
(unaudited).......................... 4,526,845
Accretion of redeemable convertible
preferred stock (unaudited).......... (2,573,106)
Exercise of stock options and warrants
(unaudited).......................... 260,198
Common stock issued in connection
with acquisition (unaudited)......... --
Net loss (unaudited).................. (19,970,525)
-------------
Balance at September 30, 1999
(unaudited).......................... $ (30,661,543)
=============
</TABLE>
SEE ACCOMPANYING NOTES
<PAGE>
TUNES.COM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
JULY 2, 1996 NINE MONTHS ENDED
(INCEPTION) YEAR ENDED DECEMBER 31, SEPTEMBER 30,
TO DECEMBER -------------------------- ---------------------
31, 1996 1997 1998 1998 1999
--------- ----------- ----------- ---------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss............................................. $(216,597) $(3,522,035) $(13,189,643) $ (7,458,884) $ (19,970,525)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization...................... 2,319 156,529 1,777,931 961,020 2,632,427
Stock compensation expense......................... -- 9,700 1,527,734 413,373 4,526,845
Other noncash items................................ -- (82,500) 100,000 100,000 37,785
Changes in operating assets and liabilities,
excluding effects from acquisitions:
Accounts receivable.............................. -- (130,016) (234,864) (384,805) (512,742)
Prepaid expenses and other current assets........ (17,458) (70,698) (292,486) (266,848) (870,580)
Accounts payable................................. 49,980 136,104 172,035 252,383 583,923
Accrued compensation............................. 4,827 29,863 58,520 192,573 126,627
Deferred revenue................................. -- 110,831 430,415 558,398 (445,277)
Other accrued expenses and current
liabilities.................................... 45,856 136,039 353,598 150,942 676,377
--------- ----------- ------------ -------------- ------------
Net cash used in operating activities................ (131,073) (3,226,183) (9,296,760) (5,481,848) (13,215,140)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment and leasehold
improvements........................................ (29,857) (708,073) (584,761) (506,322) (845,281)
Payment of license fee............................... -- -- -- -- (1,500,000)
Decrease (increase) in restricted investment......... -- (2,000,000) 1,000,000 750,000 750,000
Acquisitions, net of cash acquired (Note 4).......... (27,663) -- (507,783) (507,783) (404,000)
--------- ----------- ------------ -------------- -------------
Net cash used in investing activities................ (57,520) (2,708,073) (92,544) (264,105) (1,999,281)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable.......................... -- 500,000 -- -- 3,995,000
Payments on notes payable and capital leases......... -- -- (1,150,659) (10,436) (126,704)
Proceeds from issuance of members' units............. 750,000 -- -- -- --
Proceeds from issuance of preferred stock, net of
issue costs......................................... -- 7,547,085 12,116,809 12,116,809 15,103,000
Proceeds from exercise of stock options and warrants. -- -- -- -- 260,198
Payment of deferred financing costs.................. -- -- -- -- (740,259)
--------- ----------- ------------ -------------- ------------
Net cash provided by financing activities............ 750,000 8,047,085 10,966,150 12,106,373 18,491,235
--------- ----------- ------------ -------------- ------------
Net increase in cash and cash equivalents............ 561,407 2,112,829 1,576,846 6,360,420 3,276,814
Cash and cash equivalents, beginning of period....... -- 561,407 2,674,236 2,674,236 4,251,082
--------- ----------- ------------ -------------- ------------
Cash and cash equivalents, end of period............. $ 561,407 $ 2,674,236 $ 4,251,082 $ 9,034,656 $ 7,527,896
--------- ----------- ------------ -------------- ------------
SUPPLEMENTAL NONCASH INVESTING AND FINANCING
ACTIVITIES
Common stock issued or to be issued in
acquisition......................................... $ -- $ -- $ 2,955,420 $ 2,955,420 $ --
Liabilities assumed in acquisition................... $ -- $ -- $ 1,940,000 $ 1,940,000 $ --
Notes payable exchanged for shares of preferred
stock............................................... $ -- $ 500,000 $ -- $ -- $ 3,995,000
Capital leases for computer equipment................ $ -- $ -- $ 182,993 $ 42,506 $ --
</TABLE>
SEE ACCOMPANYING NOTES.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to the nine-month periods ended
September 30, 1998 and 1999 is unaudited)
1. NATURE OF OPERATIONS
Tunes.com Inc. (the Company) is an Internet-based music media, marketing,
and promotion company that provides interactive music content, live and archived
music performances and interviews, current news and information, audio and video
samples and other programming, as well as the opportunity for music fans
worldwide to purchase music-related merchandise directly through the
www.tunes.com, www.rollingstone.com, www.thesource.com, www.downbeatjazz.com and
www.jamtv.com Web sites, and radio and Internet content affiliates.
Effective February 26, 1999, the Company changed its name from JAMtv
Corporation to Tunes.com Inc.
2. BASIS OF PRESENTATION
The financial statements of the Company as of September 30, 1999 and for
the nine-month periods ended September 30, 1998 and 1999 contain all adjustments
and accruals (consisting of normal recurring adjustments) which, in the opinion
of management, are necessary for a fair presentation of the financial position
and operating results of the interim periods presented.
As detailed in Note 6, on June 2, 1997, holders of members' units in
Digital Entertainment Network, L.L.C. (DEN), a limited liability company,
exchanged such units for shares of common stock of the Company, a newly formed
Delaware corporation. All of the assets and liabilities of DEN were transferred
to the Company at book value and DEN was dissolved. The accompanying financial
statements reflect the operations of DEN for the period prior to June 2, 1997,
and the Company thereafter.
3. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and transactions
of the Company and its wholly owned subsidiaries. All significant intercompany
transactions and balances are eliminated.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash which is unrestricted as to use and
highly liquid investments having a maturity of three months or less at the time
of purchase.
RESTRICTED INVESTMENT
The restricted investment represents the future license payments held in
escrow pursuant to a third-party agreement (see Note 9).
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost. Depreciation is
calculated on the straight-line method over the estimated useful lives of the
assets, generally three to five years. Assets
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
under capital leases are amortized using the straight-line method over the
shorter of the estimated useful lives or the remaining lease terms, generally
three years.
INTANGIBLE ASSETS
Intangible assets represent the excess of cost over the fair market value
of tangible net assets acquired and primarily consist of purchased technology
and goodwill related to the acquisition of Tunes Network, Inc. (Tunes Network --
see Note 4). Intangible assets are amortized on a straight-line basis over the
useful lives of the assets, currently two years. If there are indicators such
assets may be impaired, the Company assesses recoverability from future
operations using undiscounted cash flows of the related business as a measure.
Under this approach, the carrying value of the intangible would be reduced to
fair value if the Company's best estimate for expected undiscounted future cash
flows of the related business would be less than the carrying amount of the
intangible over its remaining amortization period.
Intangible assets consisted of the following at December 31, 1998:
<TABLE>
<S> <C>
Goodwill........................................................ $ 4,651,430
Developed technology............................................ 800,000
Assembled work force............................................ 110,000
-----------
5,561,430
Less: Accumulated amortization.................................. (1,390,362)
-----------
$ 4,171,068
===========
</TABLE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
REVENUE RECOGNITION
ADVERTISING REVENUE
Advertising revenue is derived from the sale of banner advertisements and
sponsorships on the Company's Web sites as well as integrated marketing
campaigns sold by the Company and the Company's share of revenue on co-branded
Web sites of affiliates under certain agreements. Advertising revenue is
recognized in the period the advertisement is displayed or campaign is run,
provided no significant Company obligations remain and collection of the
resulting receivable is probable. Company obligations typically include
guarantees of a minimum number of advertising impressions delivered or times
that any advertisement is viewed by users of the Company's Web sites. To the
extent minimum guaranteed impressions are not met, the Company defers
recognition of the corresponding revenues until guaranteed levels are achieved.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company also recognizes advertising revenue as a result of barter
transactions with certain other internet-related companies. Such revenue is
recognized based on the fair value of the consideration received or provided,
whichever is more determinable. This primarily consists of advertising displayed
on other companies' Web sites in exchange for advertising on the Company's Web
site. Barter revenue and the corresponding expense is recognized in the period
the advertising is displayed. Advertising revenue from barter transactions
during 1997 and 1998 was $174,000 and $156,800, respectively. In the nine months
ended September 30, 1999 the Company recorded barter revenue of $672,000.
OTHER REVENUE
Other revenue is derived from content licensing, commerce and product
development. Content license fee revenue is recognized over the period of the
license agreement under which the Company delivers its content. Commerce revenue
from the sale of CDs and other music-related merchandise is recognized when the
products are shipped to customers, net of allowances for returns. Product
development revenue is derived from the development of content for interactive
CDs under third-party contracts and the development of other Web based services.
Product development revenue is generally recognized when the product is
delivered, except for services provided under longer-term contracts where the
revenue is recognized on a percentage-of-completion basis over the life of the
project. Two customers accounted for 52% of total revenue in 1998 and three
customers accounted for 68% of total revenue in 1997.
FAIR VALUE OF FINANCIAL INSTRUMENTS
All financial instruments are held for purposes other than trading. The
carrying amount of cash and cash equivalents, accounts receivable, accounts
payable and accruals are a reasonable estimate of their fair value due to the
short-term nature of these instruments. The estimated fair value of long-term
obligations at December 31, 1997 and 1998 was approximately equal to the
carrying amounts at those dates.
ADVERTISING COSTS
The Company expenses advertising and promotion costs when the advertising
and promotion occurs. Advertising and promotion expense for 1996, 1997, and
1998, was $6,020, $460,132, and $2,454,366 respectively.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation," established a fair value method of
accounting for stock-based compensation. As permitted by SFAS No. 123, the
Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25), and related Interpretations
in accounting for its employee stock options. No compensation expense is
recognized under APB 25 if the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the measurement date.
As required by SFAS No. 123, the Company discloses the pro forma effect of the
fair value method on operations in Note 7 to the financial statements. Stock
options and warrants held by non-employees are accounted for under the fair
value method of accounting.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use," which provides guidance on
accounting for the costs of computer software developed or obtained for internal
use. SOP No. 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company has adopted the provisions of SOP
98-1 during the nine months ended September 30, 1999 with no material effect.
4. ACQUISITIONS
Effective July 1, 1998, the Company acquired all of the capital stock of
Tunes Network. The purchase consideration, including direct costs of acquisition
of $315,000, was $5,815,000, consisting of 295,542 shares of common stock with a
fair value of $10 per share, approximately $1,940,000 of assumed liabilities,
and $604,000 in cash of which $404,000 was paid subsequent to December 31, 1998.
At September 30, 1999, 5,542 shares of common stock have not been issued; such
shares will be issued in 1999. In addition up to an additional 100,000 shares of
common stock may be issuable based upon reaching minimum equity market
capitalization thresholds soon after the completion of an initial public
offering by the Company. The current fair value of these contingent shares will
be recorded as additional goodwill when the contingency is resolved and the
shares become issuable and will be amortized over the remaining estimated useful
life of the goodwill.
The acquisition was accounted for as a purchase and, accordingly, the
results of operations have been included in the consolidated financial
statements from July 1, 1998, the effective date of the acquisition.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS (CONTINUED)
Based on unaudited data, the following table presents selected financial
information for the Company on a pro forma basis, assuming Tunes Network had
been consolidated since January 1, 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1998
------------ -------------
<S> <C> <C>
Revenue....................................... $ 863,810 $ 2,725,641
Net loss ..................................... (8,029,869) (15,587,790)
</TABLE>
The pro forma results are not necessarily indicative of future operations
or the actual results that would have occurred had the acquisition been made as
of January 1, 1997.
The purchase consideration was allocated to the acquired assets and assumed
liabilities based on fair values as follows:
<TABLE>
<S> <C>
Cash............................................................ $ 7,217
Accounts receivable and other assets............................ 21,616
Equipment....................................................... 124,737
Developed technology............................................ 800,000
In-process research and development............................. 100,000
Assembled work force............................................ 110,000
Goodwill........................................................ 4,651,430
-----------
5,815,000
Less: Liabilities assumed....................................... (1,940,000)
-----------
Cash and common stock purchase consideration.................... $ 3,875,000
===========
</TABLE>
The acquired in-process research and development includes the value of
products in the development stage not considered to have reached technological
feasibility. In accordance with applicable accounting rules, the acquired in-
process research and development was expensed in the third quarter of 1998. The
capitalized intangible assets acquired in the acquisition of Tunes Network
including developed technology, assembled work force, and goodwill are being
amortized on a straight-line basis over the estimated useful life of two years.
In November 1997, the Company formed a wholly owned subsidiary, JAMtv
Interactive Services Corporation (JIS) and acquired certain assets from
Imagination Pilots Entertainment Inc. (IPEI) and assumed certain IPEI
liabilities (see Note 12).
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1998
---------- ------------
<S> <C> <C>
Computer equipment........................ $ 394,500 $1,014,741
Software.................................. 341,187 379,828
Furniture and equipment................... 69,001 233,148
Leasehold improvements.................... 18,500 61,202
Other..................................... 17,242 23,883
--------- ----------
840,430 1,712,802
Less: Accumulated depreciation............ (131,185) (498,636)
--------- ----------
Net equipment and leasehold improvements.. $ 709,245 $1,214,166
========= ==========
</TABLE>
Depreciation expense was approximately $2,319, $156,529 and $387,569, for
the period from July 2, 1996 (inception) to December 31, 1996, and for the years
ended December 31, 1997 and 1998, respectively.
6. CAPITALIZATION
At September 30, 1999, the authorized capital stock of the Company
consisted of 11,500,000 shares of common stock, $.01 par value per share, and
7,000,000 shares of preferred stock, $.01 par value per share. The Company is
prohibited from declaring or paying dividends for as long as there remains any
outstanding shares of preferred stock.
REORGANIZATION
On July 2, 1996, DEN was initially capitalized through the issuance of
115,053 Members' units for total proceeds of $750,000. In early 1997, the
Company adopted a Unit Option Plan and an aggregate of 28,760 options to
purchase Member units were granted at an option price of $10 per unit. In March
1997, the Company received $500,000 in bridge financing in the form of notes
payable from various investors.
On June 2, 1997, DEN was reorganized (Reorganization) into the Company,
whereby all of the Members of DEN received 10 shares of the Company's common
stock for each unit of DEN. Concurrent with the Reorganization, the $500,000
bridge financing notes payable were exchanged for 166,666 shares of Series A-I
preferred stock and each option granted under the Unit Option Plan was exchanged
for 10 stock options under the Company's 1997 Stock Option Plan.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. CAPITALIZATION (CONTINUED)
PREFERRED STOCK
The Company's preferred stock is convertible at any time into common stock
on a 1-for-1 basis, subject to certain anti-dilution adjustments, and has the
same voting rights as common stock. On June 3, 2007, or the first date
thereafter that redemption is permitted under Delaware law, the Company is
required to redeem all of the outstanding shares of the preferred stock at the
following amounts: Series A-I (1,666,666 shares) at $6.00 per share; Series A-II
(200,000 shares) at $10.00 per share; Series A-III (150,000 shares) at $20.00
per share; Series A-IV (76,165 shares) at $20.00 per share; Series B (472,000
shares) at $10.00 per share; Series C (533,334 shares) at $15.00 per share; and
Series D (666,136 shares) at $20.00 per share and Series E shares (1,955,661
shares) at $20.00 per share. All shares of the preferred stock automatically
convert into shares of common stock in the event of a public offering of common
stock, which generates gross proceeds of at least $30,000,000 with a price per
share of at least $20.00. The aggregate redemption amount is approximately
$81,679,000.
In May 1999, the Company issued 76,165 shares of Series A-IV and 1,955,661
shares of Series E redeemable convertible preferred stock for aggregate
consideration of $20,318,260, including $3,995,000 of notes payable and related
accrued interest of $60,260.
The carrying amount of the preferred stock is being increased by periodic
accretions to adjust the amount recorded in the balance sheet to the mandatory
redemption amount at the redemption date.
In March and April 1999, the Company issued convertible promissory notes in
the amount of $3,995,000. The notes payable bear interest at 8% per annum and
were due March 2001. The notes payable automatically converted to 405,526 shares
of preferred stock upon the May 1999 issuance of preferred stock.
WARRANTS
In connection with a third-party agreement (the Agreement -- see Note 9),
the Company issued a warrant to purchase the Company's common stock at an
exercise price of $3.00 per share, the estimated fair value of the Company's
common stock at the date of the Agreement. The number of shares subject to the
warrant increases in the event of the occurrence of certain dilution criteria,
as defined in the Agreement. At December 31, 1997 and 1998 and September 30,
1999, a warrant to purchase 419,224, 715,221 and 1,021,904 shares of the
Company's common stock was outstanding. The estimated fair value of the warrant,
as calculated using the Black-Scholes method at each date of issuance, totaled
$2,290,099 at December 31, 1998 and $4,847,385 at September 30, 1999, and is
being amortized over the initial three-year term of the Agreement or earlier as
the warrant becomes exercisable. During 1997 and 1998, $9,700 and $615,124 was
included in stock compensation expense in the Company's statement of operations,
respectively. The warrant may be exercised at any time on or after certain
triggering events, including an initial public offering by the Company or the
closing of a private round of equity financing at a minimum amount as defined in
the Agreement, or upon the occurrence of certain change of control events. As a
result of the May 1999 issuance of redeemable convertible preferred stock, the
warrants became fully exercisable and the remaining fair value of the warrant
($4,207,457) was recorded as stock compensation expense in May 1999.
On January 1, 1999, in connection with an affiliation agreement, the
Company issued a warrant to purchase up to 75,000 shares of common stock at an
exercise price of $10.00 per share. As a result of the May 1999 issuance of
redeemable convertible preferred stock, the warrant became fully exercisable.
The estimated fair value at the date of issuance of $292,500, as calculated
using the Black-Scholes method, was recorded as stock compensation expense in
connection with this warrant during the nine months ended September 30, 1999. On
November 12, 1999, this warrant was terminated in connection with the
termination of the affiliate agreement.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the convertible promissory notes issued in 1999,
warrants to purchase 39,950 shares of common stock at an exercise price of
$10.00 per share were issued. These warrants expire upon the earlier of an
initial public offering or March 2001. The estimated fair value of the warrants,
as calculated using the present value method, is $230,000 and has been recorded
in 1999 as a reduction to the carrying value of the notes payable and an
increase to additional paid-in capital.
In May 1999, in connection with the issuance of the redeemable convertible
preferred stock, a warrant to purchase 81,315 shares of common stock at an
exercise price of $10.00 per share was issued. The estimated fair value of the
warrant, as calculated using the Black-Scholes method at the date of issuance,
was $483,011 and was recorded as a reduction to the redeemable convertible
preferred stock and an increase to additional paid-in capital. The warrant is
exercisable until May 2004.
In applying the Black-Scholes method, the Company has used an expected
dividend yield of zero, a risk-free interest rate of 5% and a volatility factor
of 66%. The lives used to value each of the warrants was based on the term of
each warrant as described above.
7. STOCK OPTION PLAN
Under the Company's 1997 Stock Option Plan (the 1997 Plan), 1,550,000
shares of common stock are authorized for granting of options to employees,
directors and consultants of the Company as determined by the Compensation
Committee of the Board of Directors.
At December 31, 1998, 224,220 shares were available for future grants.
Options granted generally vest over four years. All options expire 10 years from
date of grant. Vesting generally accelerates upon the Company's initial public
offering or a change in control.
The following table summarizes activity under the 1997 Plan during the
years ended December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
------- --------- --------- ---------
<S> <C> <C> <C> <C>
Outstanding, beginning of year.. -- $ -- 863,660 $ 2.64
Granted......................... 863,660 $ 2.64 480,020 $ 7.31
Canceled........................ -- $ -- (17,900) $ 6.25
------- ---------
Outstanding, end of year........ 863,660 $ 2.64 1,325,780 $ 4.28
======= =========
Exercisable, end of year........ 390,780 $ 1.53 819,063 $ 3.19
======= =========
</TABLE>
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. STOCK OPTION PLAN (CONTINUED)
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
REMAINING
NUMBER CONTRACTUAL NUMBER
EXERCISE PRICE OUTSTANDING LIFE (YEARS) EXERCISABLE
- --------------- ------------- ------------- -----------
<S> <C> <C> <C>
$ 1.00 287,600 8.4 287,600
3.00 445,410 8.5 252,673
5.00 277,000 8.9 208,790
7.50 197,420 9.2 70,000
10.00 118,350 9.8 --
--------- -------
1,325,780 8.8 819,063
========= =======
</TABLE>
For the nine months ended September 30, 1999, 252,420 options were granted
under the 1997 Plan.
Pursuant to a severance agreement at December 31, 1998, 45,730 stock
options were transferred to a company controlled by a former employee and are
accounted for under the fair value method.
The Company has elected to follow APB 25 and related Interpretations in
accounting for its employee stock options. During 1998 compensation expense of
$912,610 for the accelerated vesting of stock options held by terminated
employees was included in stock compensation expense. Had the provisions of SFAS
123 been used in accounting for employee stock options (calculated using the
minimum value method for nonpublic companies), pro forma net loss attributable
to common stockholders and pro forma net loss per common share (basic and
dilutive) would have been approximately $4,132,000 and $3.58 and $14,339,000 and
$12.12 for the years ended December 31, 1997 and 1998, respectively.
The weighted-average fair value of options granted during 1997 and 1998 is
estimated at $.61 and $1.66, respectively. The pro forma 1997 and 1998 net loss
impact and the weighted-average fair value of options granted during 1997 and
1998 was estimated using the minimum value option pricing model with a risk-free
interest rate of 6%, an expected life of 4.5 years (5 years in 1997), and
assuming no dividends.
In February 1999 the Company adopted the 1999 Stock Option Plan (the 1999
Plan). The number of shares of common stock subject to the 1999 Plan is
1,300,000 shares. As of September 30, 1999 there were 430,150 options
outstanding under the 1999 Plan. In 1999 all options were granted with an
exercise price of $10.00, the estimated fair value of the Company's common stock
on each date of grant.
8. RETIREMENT PLAN
Effective June 1, 1998, the Company established a defined contribution plan
that includes an employee 401(k) contribution provision covering substantially
all employees. The plan permits eligible employees to make voluntary
contributions on a pretax basis up to a certain limit. The Company does not
currently make contributions to the plan.
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS
OPERATING LEASES
The Company leases certain office facilities and equipment under various
operating leases. The future minimum lease payments under noncancelable
operating leases having an initial term longer than one year at December 31,
1998, are as follows:
<TABLE>
<S> <C>
1999.............................................. $ 281,233
2000.............................................. 223,582
2001.............................................. 227,131
2002.............................................. 96,035
2003.............................................. --
Thereafter........................................ --
---------
$ 827,981
=========
</TABLE>
Rent expense for the period July 2, 1996 (inception) to December 31, 1996
and the years ended December 31, 1997 and 1998, was approximately $5,000,
$121,469, and $245,904, respectively.
LICENSE AGREEMENT
In 1997, the Company entered into an agreement with a third party (the
Agreement) pursuant to which the Company was granted certain rights with respect
to brand name, trademarks, URL, historical, current and future content,
advertising and promotion services, and other services. Under the terms of the
Agreement, the Company granted warrants (see Note 6) and is required to pay an
annual license fee of $1,000,000 (paid quarterly in equal installments) for a
period of three years. Upon a first and second renewal term as defined in the
Agreement, the Company would have to pay an annual license fee of $1,250,000 and
$1,500,000, respectively. In addition to the license fee, the Company was also
required to pay a $1,500,000 Trigger License Fee as a result of the May 1999
issuance of redeemable convertible preferred stock.
The rights granted to the Company under the terms of the Agreement extend
for an additional five years upon the successful completion of either a public
or private offering of the Company's securities (trigger events) in which the
amount raised is no less than $15,000,000. The Agreement extends for a further
period of five years based on the Company or its acquirer having publicly traded
securities with a market capitalization of no less than $150,000,000. The
ultimate number of shares issued pursuant to the warrant (see Note 6) will be
determined by: (a) the extent of intervening equity financings prior to either
of the trigger events, and (b) the mutual further agreement of the parties.
OTHER
The Company has entered into various Web site tenancy agreements that
provide for the Company to make payments of at least $1,500,000 during 1999, of
which $1,200,000 has been paid through September 30, 1999.
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. CAPITAL LEASES
Total office and computer equipment under capital leases was $240,193, less
accumulated amortization of $36,731, at December 31, 1998. Amortization is
included with depreciation expense. Future minimum lease payments for the assets
<PAGE>
under capital leases are as follows:
<TABLE>
<S> <C>
1999.............................................. $ 115,806
2000.............................................. 96,999
2001.............................................. 63,455
2002.............................................. 13,379
2003.............................................. 4,445
Thereafter........................................ --
---------
Total minimum lease payments...................... 294,084
Less: Amount representing interest................ (39,912)
---------
Present value of net minimum lease payments....... $ 254,172
Current portion, included in other accrued
expenses......................................... (93,665)
---------
Long-term obligations at December 31, 1998........ $ 160,507
=========
</TABLE>
11. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A valuation allowance has
been provided for the net deferred tax asset because of uncertainty regarding
the Company's ability to generate taxable income prior to the expiration of the
carryforward period.
Significant components of the Company's deferred income tax assets and
liabilities are as follows at December 31:
<TABLE>
<CAPTION>
1998 1997
------------ ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.............. $ 5,734,927 $ 941,300
Stock compensation expense.................... 539,853 --
Research and development credit carryforward.. 80,000 --
Accrued compensation.......................... 28,863 8,000
Other......................................... 38,740 45,700
----------- ---------
Gross deferred tax assets..................... 6,422,383 995,000
Deferred tax liability:
Intangible amortization (266,174) --
----------- ---------
Net deferred tax assets......................... 6,156,209 995,000
----------- ---------
Less: Valuation allowance....................... (6,156,209) (995,000)
----------- ---------
$ -- $ --
=========== =========
</TABLE>
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
The valuation allowance for net deferred tax assets increased $5,161,209 as
a result of the net changes in temporary differences including a $529,554
increase related to the acquisition of Tunes Network.
At December 31, 1998, the Company had net operating loss carryforwards
totaling approximately $14,705,000, which expire beginning in 2011. Based on the
Internal Revenue Code regulations relating to changes in the ownership of the
Company, utilization of the net operating loss carryforwards may be subject to
annual limitations. Because the Company operated as a limited liabilty company
until June 2, 1997, no income taxes were provided for as of December 31, 1996.
12. RELATED PARTY TRANSACTIONS
The Company incurred various operating expenses through JAM Productions Ltd.
(JPL). The Company reimbursed JPL for these expenses, which totaled
approximately $24,000, $90,000, and $75,000 in 1996, 1997 and 1998,
respectively. A stockholder of JPL was the Company's Chairman of the Board
through January 1999.
The Company leases office space from an entity in which the Company's chief
executive officer has an ownership interest. The monthly lease payments are
approximately $18,000 and increase approximately 3% per year.
Prior to 1998, the Company was charged for various services by Imagination
Pilots Entertainment Inc. (IPEI), whose majority stockholder is the Company's
chief executive officer. These services included rent of office facilities, use
of personnel, and other various operating activities. Expenses related to these
services were approximately $75,000 and $95,000 in 1996 and 1997, respectively.
During 1997, the Company purchased certain assets, primarily computer and
other equipment, software, certain intellectual property, and the rights to a
contract for the development of CD-ROM titles, from IPEI and Imagination Pilots,
Inc. (IPI), whose majority stockholder is the Company's chief executive officer,
and assumed certain IPEI and IPI liabilities, for a total cash purchase price of
$370,000. The purchase price was allocated as follows:
<TABLE>
<S> <C>
Computer and other equipment and software......................... $ 309,000
In process research and development............................... 95,000
---------
404,000
Less: Liabilities assumed......................................... (34,000)
---------
Cash.............................................................. $ 370,000
=========
</TABLE>
13. SUBSEQUENT EVENTS
In June 1999, the Company filed a registration statement on Form S-1 with
the Securities and Exchange Commission with respect to a proposed initial
public offering. In August 1999, the Company postponed its initial public
offering due to adverse market conditions, and approximately $1,300,000 in
related costs were charged to general and administrative expenses in October
1999.
<PAGE>
In November 1999, the Company entered into an lease facility that allows
for borrowings of up to $1.0 million for equipment purchases made on or prior
to July 31, 2000. Borrowings made under this lease facility are payable over a
36-month term. At November 30, 1999, the Company had outstanding borrowings of
approximately of $400,000 under this facility.
In connection with the amendment of a third-party license agreement (see
Note 9), the Company issued a warrant to purchase 2,652,717 shares of the
Company's common stock at an exercise price of $3.00 per share in December
1999.
In November 1999, the Company entered into a merger agreement with
EMusic.com Inc. Under the terms of the agreement, each share of the Company's
capital stock outstanding as of the effective date of the merger will be
converted into that number of shares of the EMusic common stock equal to
10,600,000 divided by the number of shares of the Company's capital stock
outstanding on a fully-diluted basis as of the effective date of the merger.
EMusic.com Inc. will also assume all outstanding options and warrants to
purchase shares of the Company's capital stock. The merger, subject to
shareholder approval, is expected to close in the first quarter of 2000.
