<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 : June 30, 1999
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: 0-23753
CDnow, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2979814
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation of organization)
1005 Virginia Drive, Fort Washington, PA 19034
(Address of principal executive offices and Zip Code)
(215) 619-9900
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal
year, if changed since last report)
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 registrant's classes of
common stock as of August 9, 1999: 30,266,710 shares of common stock, no par
value
<PAGE> 2
CDnow, Inc.
INDEX
Part I - Financial Information
Item 1. Financial Statements Page
Unaudited Consolidated Balance Sheets as of June 30, 1999 and
December 31, 1998..............................................................3
Unaudited Consolidated Statements of Operations for the three and six months
ended June 30, 1999 and 1998...................................................4
Unaudited Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 1998.........................................................5
Notes to Unaudited Consolidated Financial Statements...........................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........18
Part II - Other Information
ITEM 1. Legal Proceedings...........................................19
ITEM 2. Changes in Securities and Use of Proceeds...................20
ITEM 3. Defaults Upon Senior Securities.............................20
ITEM 4. Submission of Matters to a Vote of Security Holders.........20
ITEM 5. Other Information...........................................20
ITEM 6. Exhibits and Reports on Form 8-K............................20
Signatures ..............................................................21
<PAGE> 3
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CDNOW, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
----------------- -----------------
ASSETS
------
<C> <S> <S>
CURRENT ASSETS:
Cash and cash equivalents $ 41,928,290 $ 49,041,370
Accounts receivable (net of reserves of $738,807 and $299,991) 4,126,885 839,672
Prepaid expenses and other 9,991,392 8,322,889
----------------- -----------------
Total current assets 56,046,567 58,203,931
----------------- -----------------
Property and equipment, net 16,451,332 6,643,995
Goodwill and other intangibles, net 85,897,634 833,735
Other assets 2,062,782 3,361,982
----------------- -----------------
$160,458,315 $ 69,043,643
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of long term debt $ 1,316,860 $ 822,043
Accounts payable 19,844,678 10,306,323
Accrued merger costs 4,801,119 --
Accrued expenses and other current liabilities 16,570,593 4,667,395
----------------- -----------------
Total current liabilities 42,533,250 15,795,761
----------------- -----------------
Long term debt 1,992,417 1,750,892
Common stock subject to put rights 2,999,995 --
Deferred rent liabilities 873,954 358,053
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY:
Preferred Stock, no par value, 50,000,000 and 20,000,000
shares authorized, no shares issued and outstanding
Common stock, no par value, 200,000,000 and 50,000,000
shares authorized, 30,149,867 and 17,842,975 issued
and outstanding 204,250,328 102,137,536
Additional paid-in capital 13,853,623 4,325,817
Deferred compensation (110,676) (216,913)
Accumulated deficit (105,934,576) (55,107,503)
----------------- -----------------
Total stockholders' equity 112,058,699 51,138,937
----------------- -----------------
$160,458,315 $ 69,043,643
================= =================
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 4
CDNOW, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net sales $ 34,616,244 $ 11,610,141 $ 57,459,113 $ 21,624,030
Cost of sales 28,000,743 9,290,241 45,984,318 17,568,588
------------- ------------- ------------- -------------
Gross profit 6,615,501 2,319,900 11,474,795 4,055,442
Operating expenses:
Operating and development 5,827,207 1,684,665 9,553,389 2,765,714
Sales and marketing 21,680,005 9,293,703 39,731,187 18,355,629
General and administrative 3,362,400 855,074 4,733,756 1,705,359
Amortization of goodwill and other intangibles 8,144,055 28,800 9,481,681 28,800
------------- ------------- ------------- -------------
Total operating expenses 39,013,667 11,862,242 63,500,013 22,855,502
Operating loss (32,398,166) (9,542,342) (52,025,218) (18,800,060)
------------- ------------- ------------- -------------
Interest and other income 766,131 722,012 1,394,253 1,228,051
Interest expense (88,242) (48,400) (192,862) (494,914)
------------- ------------- ------------- -------------
Net loss (31,720,277) (8,868,730) (50,823,827) (18,066,923)
------------- ------------- ------------- -------------
Accretion of preferred stock to redemption value -- -- -- (115,542)
Net loss applicable to common shareholders $(31,720,277) $ (8,868,730) $(50,823,827) $(18,182,465)
============= ============= ============= =============
Basic and diluted loss per common share:
Net loss per common share $ (1.06) $ (0.55) $ (2.04) $ (1.29)
============= ============= ============= =============
Weighted average number of shares outstanding 30,038,908 16,074,787 24,960,940 14,044,939
============= ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 5
CDNOW, INC AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------------
1999 1998
-------------- --------------
<C> <S> <S>
Operating Activities:
Net loss $ (50,823,827) $ (18,066,923)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 12,124,299 750,610
Common Stock options issued to non-employees 31,979 --
Increase in operating assets and liabilities:
Accounts receivable (1,785,111) 2,661
Prepaid expenses and other 5,193,536 (1,597,421)
Accounts payable 4,496,676 (5,549,024)
Accrued expenses (735,214) 902,594
Deferred revenue 225,385 (105,266)
Deferred rent liability 515,901 89,166
-------------- --------------
Net cash used in operating activities (30,756,376) (23,573,603)
-------------- --------------
Investing Activities:
Sales and maturities of short-term investments -- 1,003,045
Purchases of property and equipment (1,633,771) (1,637,206)
Net cash acquired in (used in) acquisition 25,266,787 (423,694)
-------------- --------------
Net cash provided by (used in) investing activities 23,633,016 (1,057,855)
============== ==============
Financing Activities:
Payments on term loans payable (29,310) (25,139)
Repayment of Series A Notes and warrants -- (5,777,500)
Repayment of advances due to related parties -- (3,261)
Payments on capitalized lease obligations (481,712) (176,476)
Proceeds from warrants exercised 102,352 59,890
Proceeds from options exercised 418,950 80,706
Proceeds from issuance of Common stock, net -- 67,077,862
-------------- --------------
Net cash provided by financing activities 10,280 61,236,082
-------------- --------------
Increase (decrease) in cash and cash equivalents (7,113,080) 36,604,624
Cash and cash equivalents, beginning of period 49,041,370 10,686,001
-------------- --------------
Cash and cash equivalents, end of period $ 41,928,290 $ 47,290,625
============== ==============
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 6
CDNOW, INC AND SUBSIDIARIES.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements are presented in
accordance with the requirements for Form 10-Q and do not include all the
disclosures required by generally accepted accounting principles for complete
financial statements. Reference should be made to the Form 10-K as of and for
the year ended December 31, 1998 for CDnow, Inc. and its subsidiaries (the
"Company") for additional disclosures including a summary of the Company's
accounting policies.
In the opinion of management, the consolidated financial statements contain all
adjustments, consisting of normal recurring adjustments, necessary to present
fairly the consolidated financial position of the Company for the periods
presented. The interim operating results of the Company may not be indicative of
operating results for the full year or for any other interim period due to
seasonality and other factors.
NOTE 2 -- THE COMPANY
The Company is one of the leading electronic commerce retailers of pre-recorded
music, including compact discs ("CDs"), and other entertainment-related
products. The Company is also a source of entertainment-related content and a
focal point of an Internet community for the exchange of entertainment-related
news and information. The Company's revenues are derived from the sale of
pre-recorded music, other entertainment-related products and advertising on the
Company's cdnow.com site. The Company contracts with outside vendors for
fulfillment services to deliver its products to customers.
Since inception (February 12, 1994), the Company has incurred significant
losses, and as of June 30, 1999 had accumulated losses of $105.9 million. For
the six months ended June 30, 1999 and the year ended December 31, 1998, the
Company's net losses were $50.8 million and $43.9 million, respectively. The
Company intends to continue investing heavily in marketing and promotion,
Internet site development and technology, and development of its administrative
organization. As a result, the Company believes it will continue to incur
substantial operating losses for the foreseeable future. Because the Company has
relatively low product gross margins, achieving profitability given planned
spending levels depends upon the Company's ability to generate and sustain
substantially increased revenue and gross margins. There can be no assurance
that the Company will be able to generate sufficient revenues or gross margins
to achieve or sustain profitability in the future.
On October 22, 1998, CDnow and N2K Inc., a Delaware corporation, entered into an
Agreement and Plan of Merger (the "Merger Agreement"). The parties created a new
public company, initially named CDnow/N2K, Inc. ("CDnow/N2K"). The Merger
Agreement provided for the merger (the "Merger") of wholly-owned subsidiaries of
CDnow/N2K into each of CDnow and N2K. CDnow and N2K survived the Merger and
became wholly-owned subsidiaries of CDnow/N2K. In the Merger, each outstanding
share of common stock of CDnow was converted into one share of CDnow/N2K and
each outstanding share of common stock of N2K was converted into .83 shares of
CDnow/N2K. As a result, the shareholders of CDnow owned approximately 60% of the
combined company and the stockholders of N2K owned approximately 40% of the
combined company as of the date the Merger was completed on March 17, 1999. Also
on the Merger completion date, CDnow/N2K was renamed CDnow, Inc.
On July 13, 1999, the Company announced the execution of a definitive agreement
with Sony Corporation of America and Time Warner Inc. to merge with Columbia
House, the leading club-based direct marketer of music and videos, which is
owned equally by Sony Corporation and Time Warner Inc. The agreement provides
<PAGE> 7
for the formation of a new public company to be owned 37 percent each by Sony
and Time Warner. CDnow's existing stockholders will own the remaining 26
percent. Consummation of the merger is subject to various conditions, including,
but not limited to, approval by the shareholders of the Company. The Company
expects the merger to be completed during the fourth quarter of 1999.
NOTE 3 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All inter-company
balances and transactions have been eliminated in consolidation.
Reclassifications. The consolidated financial statements for prior periods have
been reclassified to conform with the current period's presentation.
Management's Use of Estimates. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Net Loss Per Common Share. The Company has presented net loss per share amounts
for the three and six month periods ended June 30, 1999 and 1998 pursuant to
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings per
Share" and the Securities and Exchange Commission Staff Accounting Bulletin No.
98.
Basic and diluted loss per share was computed by dividing net loss applicable to
common shareholders by the weighted average number of shares of Common stock
outstanding during the three and six months ended June 30, 1999 and 1998.
Diluted loss per share is the same amount as basic earnings per share because
the impact on loss per share using the treasury stock method is anti-dilutive
due to the Company's losses.
Cash and Cash Equivalents. For the purposes of the consolidated balance sheet
and statement of cash flows, the Company considers investment instruments with
an original maturity of three months or less to be cash equivalents. Cash
equivalents are comprised of investments in money market funds, government
mortgage backed bonds and highly rated corporate securities.
Common Stock Subject to Put Rights. America Online, Inc. ("AOL") and N2K Inc.
("N2K"), a predecessor-in-interest to and, as of the merger of CDnow and N2K,
which occurred on March 17, 1999, a wholly-owned subsidiary of CDnow, entered
into an agreement, pursuant to which AOL agreed to purchase from N2K at its
initial public offering price per share of $19.00 (less underwriting discounts
and commissions) an aggregate amount of approximately $3.0 million or 169,779
shares of N2K's Common stock (the "AOL Purchase"). Subsequent to the Merger, the
price per share converted to $22.89 and the number of shares converted to
140,916 shares of CDnow common stock. N2K granted AOL certain shelf and other
registration rights with respect to the shares purchased by AOL in the AOL
Purchase, including the right to require N2K to register such shares for resale,
to have such registration statement declared effective on or before April 16,
1998 and to maintain the effectiveness of such registration statement for a
period of two years from the consummation of the AOL Purchase. As N2K had not
caused such registration statement to be declared effective by April 16, 1998,
AOL has the right to require the Company, as a successor-in-interest to N2K, to
repurchase such shares for cash at a price equal to the greater of the original
purchase price or the then-current fair market value. Accordingly, the value of
these shares is not included in Stockholders' equity. The fair market value of
the Company's common stock as of August 4, 1999 was $16.25 per common share. As
of August 4, 1999, these shares had not been registered and AOL had not
exercised its put right. The Common stock subject to put rights on the Company's
consolidated balance sheets will be accreted to its fair market value based upon
the price of the Company's stock at each reporting date. The fair market value
will be recorded as a charge to retained earnings at each reporting date and
will reduce earnings available to Common shareholders. As of August 4, 1999,
there was no charge as the market value of the Company's common stock is below
$22.89 per Common share.
<PAGE> 8
Revenue Recognition. Net sales, which consist primarily of pre-recorded music
sold via the Internet, include shipping and handling charged to customers and
are recognized when the products are shipped. The Company records a reserve for
estimated returns, which is based on historical return rates. Revenues for sales
of advertising on the Company's cdnow.com site are recognized as advertising is
run.
Operating and Development Expense. Operating and development expense consists
primarily of payroll and related expenses for store management, design,
development and network operations personnel, systems and telecommunications
infrastructure and royalties paid by the Company on product sales in return for
licensing of ratings, reviews, sound samples and other information.
Sales and Marketing Expense. Sales and marketing expense consists primarily of
expenses related to advertising, promotion and marketing agreements as well as
payroll and related expenses for personnel engaged in marketing, selling and
customer service activities and credit card processing fees. Advertising costs
are included in sales and marketing expenses and are charged to expense as
incurred. Advertising costs were approximately $14.6 million and $28.0 million
for the three and six months ended June 30, 1999 compared to approximately $6.7
million and $14.0 million for the three and six months ended June 30, 1998,
respectively.
NOTE 4 -- COMMITMENTS AND CONTINGENCIES
Payments Under Marketing Agreements. Under the Company's current marketing
agreements, the Company is required to pay aggregate minimum fixed fees of $20.1
million, $18.9 million, and $7.4 million during the remaining six months of 1999
and the years ending December 31, 2000 and 2001, respectively.
The Company expects to amortize the costs associated with its marketing
agreements over the contract terms, with the amortization method primarily based
on the rate of delivery of certain guarantees (impressions, click-throughs or
customers) to be received during the contract term.
General. Many of the Company's marketing agreements, including, but not limited
to, the AOL, Yahoo!, Excite, Netscape, MTV/VH1 and Rolling Stone Network
agreements, contain provisions which may require additional payments to be made
by the Company based on factors such as click-throughs and new customers
generated. To date, the amount of such payments has not been material. Such
payments are expensed as incurred. The Company will continue to evaluate the
realizability of assets recorded, and if necessary, write down the assets to
their net realizable value.
NOTE 5 -- ACQUISITION
On March 17, 1999, the Company completed its merger with N2K by acquiring 100%
of N2K's capital stock for 12,159,249 shares of the Company's common stock
valued at approximately $101,834,000 and warrants and options to purchase
1,713,644 shares of the Company's common stock valued at approximately
$9,281,000. CDnow was the acquiring entity for accounting purposes. The
acquisition has been accounted for under the purchase method of accounting,
whereby the purchase price has been allocated to the assets purchased and the
liabilities assumed based on their fair market values at the date of
acquisition. The excess of the purchase price over the net assets acquired was
recorded as goodwill and other intangibles. The following table indicates the
preliminary allocation of excess purchase price and expected amortization
periods:
<TABLE>
<CAPTION>
Intangible Assets: Assigned Value Amortization Period
- ------------------------------------ -------------- -------------------
<S> <C> <C>
Web site technology $ 4,000,000 2 years
Strategic alliances/customers 19,000,000 3 years
Assembled workforce 2,200,000 3 years
Goodwill 69,345,579 3 years
--------------
Total goodwill and other intangibles $ 94,545,579
</TABLE>
<PAGE> 9
Amortization of goodwill and other intangibles related to the acquisition of N2K
and superSonic Boom, Inc., which was acquired in May 1998, were approximately
$8.1 million and $9.5 million for the three and six months ended June 30, 1999,
respectively. Amortization of goodwill and other intangibles was $28,800 for the
three and six months ended June 30, 1998 and only related to the acquisition of
superSonic Boom, Inc. Accumulated amortization as of June 30, 1999 and December
31, 1998 was approximately $9.7 million and $203,000, respectively. In addition,
the balance of accrued merger costs relating to the acquisition of N2K was
approximately $4.8 million as of June 30, 1999 and include investment banking
fees and severance-related costs.
If the N2K acquisition had occurred on January 1, 1998, pro forma revenue, net
loss and loss per common share would have been as set forth in the following
table for the three and six months ended June 30, 1999 and 1998, respectively:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
(Pro forma) (Pro forma)
------------------------------- -------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenue $ 34,616,244 $ 20,675,018 $ 70,943,492 $ 37,016,870
Net loss $ (31,720,277) $ (33,356,952) $ (69,961,539) $ (64,414,693)
Loss per common share $ (1.06) $ (1.18) $ (2.33) $ (2.46)
</TABLE>
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations and other sections of this Quarterly Report contain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. These forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from
historical and anticipated results or other expectations expressed in the
Company's forward-looking statements. Such forward-looking statements may be
identified by the use of certain forward-looking terminology, such as "may,"
will," "expect," "anticipate", "intend," "estimate," "believe," "goal," or
"continue" or comparable terminology that involves risks or uncertainties.
Actual future results and trends may differ materially from historical and
anticipated results, which may occur as a result of a variety of factors
including, but not limited to, those set forth under the "Overview" and
"Liquidity and Capital Resources" sub-sections included in the Management's
Discussion and Analysis of Financial Condition and Results of Operations section
of this document and in the "Risk Factors" section of the Company's Definitive
Proxy Statement on Form 14A (File No. 000-23753), which was filed with the
Securities and Exchange Commission ("SEC") on February 17, 1999. Particular
attention should be paid to the cautionary statements involving the Company's
limited operating history, the unpredictability of its future revenues, the
unpredictable and evolving nature of its key markets, the intensely competitive
online commerce and entertainment environments, the Company's dependence on its
marketing agreements and key suppliers and distributors, and the risks
associated with capacity constraints, systems development, relationships with
artists and the management of growth. Except as required by law, the Company
undertakes no obligation to update any forward-looking statement, whether as a
result of new information, future events or otherwise. Readers should carefully
review the factors set forth in other reports or documents that the Company
files from time-to-time with the SEC and matters generally affecting online
commerce and online sale of entertainment-related products, including, but not
limited to, music retailing.
RECENT DEVELOPMENTS
Acquisition of N2K Inc. On October 22, 1998, CDnow and N2K Inc., a Delaware
corporation, entered into an Agreement and Plan of Merger (the "Merger
Agreement"). The parties created a new public company, initially named CDnow/N2K
Inc. ("CDnow/N2K"). The Merger Agreement provided for the merger (the "Merger")
of wholly-owned subsidiaries of CDnow/N2K into each of CDnow and N2K. CDnow and
N2K survived the Merger and became wholly-owned subsidiaries of CDnow/N2K. In
the Merger, each outstanding share of common stock of CDnow was converted into
one share of CDnow/N2K and each outstanding share of common stock of N2K was
converted into .83 shares of CDnow/N2K. As a result, the shareholders of CDnow
owned approximately 60% of the combined company and the stockholders of N2K
owned approximately 40% of the combined company as of the date the Merger was
completed on March 17, 1999. Also on the Merger completion date, CDnow/N2K was
renamed CDnow, Inc.
Columbia House Merger. On July 13, 1999, the Company announced the execution of
a definitive agreement with Sony Corporation of America and Time Warner Inc. to
combine the businesses of the Company and Columbia House, the leading club-based
direct marketer of music and videos, which is owned equally by Sony Corporation
and Time Warner Inc. The agreement provides for the formation of a new public
company to be owned 37 percent each by Sony and Time Warner. CDnow's existing
stockholders will own the remaining 26 percent. Consummation of the merger is
subject to various conditions, including, but not limited to, approval by the
shareholders of the Company. The Company expects the merger to be completed
during the fourth quarter of 1999.
OVERVIEW
The Company is one of the leading electronic commerce retailers of pre-recorded
music, including CDs, and other entertainment-related products. The Company is
also a source of entertainment-related content and a focal point of an Internet
community for the exchange of entertainment-related news and information. Its
early entry into the online music retailing industry has helped the Company gain
a well-recognized brand and a large customer base. The Company strives to
combine the advantages of online commerce with superior customer focus in order
to be the authoritative source for the online purchase of music including,
<PAGE> 11
without limitation, CDs, and other entertainment-related products. The Company's
online store, cdnow.com, offers broad selection, informative content,
easy-to-use navigation and search capabilities, a high level of customer
service, competitive pricing and personalized merchandising and recommendations.
Due to the Company's retail focus, revenues are primarily derived from the sale
of pre-recorded music and related products, drawing from its comprehensive
selection of approximately 500,000 items. The Company also sells advertising
space and sponsorships on its site to companies interested in promoting their
own goods and services to the Company's customer base and the large number of
visitors to the Company's web site.
The Company has grown rapidly since its inception in 1994. Approximately 2.4
million customers have made purchases from either CDnow or from Music Boulevard,
the Internet music retail store operated previously by N2K (which, as of May 17,
1999 was consolidated into the cdnow.com online store), since their inception
through June 30, 1999, of whom approximately 755,000 made their initial purchase
during the six months ended June 30, 1999. The Company's net sales grew to $34.6
million during the three months ended June 30, 1999, compared to $11.6 million
during the three months ended June 30, 1998. The Company's net sales increased
to $57.5 million during the six months ended June 30, 1999, compared to $21.6
million during the six months ended June 30, 1998. In addition to the sales
generated from the traffic of Music Boulevard customers as a result of the
acquisition of N2K, and the rapid acquisition of new customers, the Company has
also generated significant customer loyalty. Repeat customers accounted for
approximately 63% of net sales during the six months ended June 30, 1999, up
from approximately 54% during the six months ended June 30, 1998.
The Company believes that the key factors affecting its long-term financial
success include its ability to obtain new customers at reasonable costs, retain
customers and encourage repeat purchases. The Company seeks to expand its
customer base through multiple marketing channels, which include (i) pursuing an
aggressive marketing campaign using a combination of online and traditional
marketing, (ii) establishing marketing agreements with major Internet content
and service providers, (iii) entering into linking arrangements with other
Internet sites as part of its Cosmic Credit and C2 affiliate website programs
and (iv) using direct marketing techniques to target new and existing customers
with personalized communications. The Company periodically enters into marketing
agreements with various Internet portals and online content providers. The
Company presently has marketing agreements in place with, among others, AOL,
Yahoo!, Excite, MTV/VH1 and Rolling Stone Network.
Since its inception, the Company has incurred significant net losses and, as of
June 30, 1999, had accumulated losses of $105.9 million. As it seeks to expand
aggressively, the Company believes that its operating expenses will continue at
a high level as a result of the financial commitments related to the development
of marketing channels, future marketing agreements, and improvements to its
Internet site and other capital expenditures. The Company expects that it will
continue to incur losses and generate negative cash flow from operations for the
foreseeable future as it continues to develop its business. Since the Company
has relatively low product gross margins, the ability of the Company to generate
and enhance profitability depends upon its ability to substantially increase its
net sales. To the extent that significantly higher net sales do not result from
the Company's marketing efforts, the Company will be materially adversely
affected. There can be no assurance that the Company will be able to generate
sufficient revenues from the sale of pre-recorded music, including CDs, and
other entertainment-related products to achieve or maintain profitability on a
quarterly or annual basis.
RESULTS OF OPERATIONS
Three Months Ended June 30, 1999, Compared to the
Three Months Ended June 30,1998
-------------------------------------------------
Net Sales. Net sales reflect the sale of pre-recorded music and other
entertainment-related products, net of estimated returns and include outbound
shipping and handling charges. The sale of advertising on the Company's
cdnow.com site is also included in net sales. For the three months ended June
30, 1999, net sales were $34.6 million, representing an increase of 198% over
the corresponding period in 1998. Net sales for the three month period ended
June 30, 1999, include the Company's sales to Music Boulevard customers as a
result of the acquisition of N2K. The increase in sales is also attributable to
continued growth of the Company's customer base, increased sales from repeat
customers and increased advertising revenue. International sales represented 20%
of net sales
<PAGE> 12
for the three months ended June 30, 1999, compared to 22% for the corresponding
period in 1998. The decrease in international sales as a percentage of net sales
is due to a proportionally larger increase in domestic sales from Music
Boulevard customers as a result of the acquisition of N2K.
For the three months ended June 30, 1999, the Company added approximately
332,000 new customers, bringing the total number of customers who have made
purchases at either CDnow or Music Boulevard since inception to approximately
2.4 million as of June 30, 1999. Repeat customer purchases represented
approximately 66% of net sales for the three months ended June 30, 1999 compared
to 57% for the three months ended June 30, 1998. During the quarter the Company
focused on implementing the fusion of the CDnow and Music Boulevard online
stores into a single integrated site and on migrating existing Music Boulevard
customers to the new CDnow online store. As a result, the Company primarily
targeted its marketing efforts at existing customers, rather than new customer
acquisition. In addition, the Company's second-quarter revenues were affected by
delays in transitioning certain links from a large marketing partner to the new
CDnow online store and by delays in fulfilling CDnow customer orders as a result
of a warehouse relocation by a major supplier.
Cost of Sales. Cost of sales consists primarily of the cost of merchandise sold
to customers, including product fulfillment and outbound shipping and handling
charges. Cost of sales was $28.0 million for the three months ended June 30,
1999, compared to $9.3 million for the corresponding period in 1998. The
Company's gross margin decreased to 19.1% for the three months ended June 30,
1999, compared to 20.0% for the corresponding period in 1998. The decrease in
gross margin percentage was primarily due to the overall price decline as a
result of the synchronization of CDnow and N2K's price lists effective April 1,
1999; and an extended storewide sale beginning May 17, 1999 to promote the
re-launch of the Company's website (cdnow.com). This impact was partially offset
by the positive effect of advertising revenue, which has a higher margin than
product sales.
During the quarter ended September 30, 1998, the Company determined to include
credit card processing fees ("Credit Card Fees") in sales and marketing expenses
rather than in cost of sales, as was previously the case. This change was made
based on management's determination that including Credit Card Fees in sales and
marketing expense was more consistent with the treatment of such expenses by
retailers generally. The financial information in this Form 10-Q related to the
Company's results of operations for the three months ended June 30, 1998, have
been restated to reflect this change. Credit Card Fees were approximately
$843,000 and $310,000 during the three months ended June 30, 1999 and 1998,
respectively. If Credit Card Fees were included in cost of sales, gross profit
margins would have been 16.7% and 17.3%, during the three months ended June 30,
1999 and 1998, respectively.
Operating and Development Expense. Operating and development expense consists
primarily of payroll and related expenses for store management, design,
development and network operations personnel, systems and telecommunications
infrastructure, and royalties paid by the Company on product sales in return for
licensing of ratings, reviews, sound samples and other information. Store
development costs are charged to expense as incurred. Operating and development
expense was $5.8 million for the three months ended June 30, 1999 compared to
$1.7 million for the corresponding period in 1998. As a percentage of net sales,
operating and development expense was 16.8% for the three months ended June 30,
1999 compared to 14.5% for the three months ended June 30, 1998. The increase in
both dollars and percentage terms is attributable to costs associated with
supporting increased traffic and sales volume in the CDnow store, including the
costs associated with operating two separate websites from March 18, 1999
through May 17, 1999 following the acquisition of N2K. The increase is also
attributable to increased staffing and associated costs related to enhancing the
features and functionality of the Company's Internet site and
transaction-processing systems, as well as increased investments in store
content, systems and telecommunications infrastructure to support the increased
transaction volume in the CDnow store.
Sales and Marketing Expense. Sales and marketing expense consists primarily of
expenses related to marketing agreements, advertising and promotion, as well as
payroll and related expenses for personnel engaged in marketing, selling and
customer service activities. Sales and marketing expense was $21.7 million for
the three months ended June 30, 1999, compared to $9.3 million for the three
months ended June 30, 1998. The increase in absolute dollars was primarily
attributable to increased costs associated with the Company's marketing
agreements, including marketing agreements assumed by CDnow as a result of the
acquisition of N2K and marketing agreements entered into during or after the
second quarter of 1998. The increase is also due to increased advertising and
<PAGE> 13
promotional expenditures, increased staffing and related costs in connection
with the implementation of its marketing strategy and customer service
activities necessary to support its increased customer base, and increased
credit card processing fees related to the growth of revenues. As a percentage
of net sales, sales and marketing expense decreased to 62.6% for the three
months ended June 30, 1999, compared to 80.0% for the three months ended June
30, 1998. The decrease as a percentage of sales is primarily attributable to the
increased percentage of the Company's sales from repeat customer purchases,
which are relatively less expensive than the cost of acquiring new customers.
The Company expects the dollar amount of sales and marketing expense to continue
to increase in future periods. The Company is hopeful that its net sales will
increase in future periods and that its sales and marketing expense will
represent a decreasing percentage of net sales. However, no assurance can be
given that the Company will achieve increased net sales or that sales and
marketing expense will decrease as a percentage of net sales.
General and Administrative Expense. General and administrative expense consists
of payroll and related expenses for executive, accounting and administrative
personnel, insurance, professional fees and other general and corporate
expenses. General and administrative expense was $3.4 million for the three
months ended June 30, 1999 compared to $0.9 million for the three months ended
June 30, 1998. As a percentage of net sales, general and administrative expense
increased to 9.7% for the three months ended June 30, 1999 from 7.4% for the
three months ended June 30, 1998. The increase in general and administrative
expense, in both dollars and percentage terms, was primarily due to the hiring
of additional personnel to support the overall growth of the Company and the
acquisition of N2K. The increase is also attributable to increased professional
fees and the inclusion of merger-related expenses of approximately $720,000
incurred in connection with the Company's July 12, 1999 definitive agreement to
merge with Columbia House.
Amortization of Goodwill and Other Intangibles. Amortization of goodwill and
other intangibles related to the acquisition of N2K and superSonic Boom, Inc.
was $8.1 million for the three months ended June 30, 1999, compared to $28,800
for the three months ended June 30, 1998.
Net Loss Applicable to Common Shareholders. The Company's net loss applicable to
common shareholders was $31.7 million for the three months ended June 30, 1999,
compared to $8.9 million for the three months ended June 30, 1998.
Six Months Ended June 30, 1999, Compared to the
Six Months Ended June 30, 1998
-----------------------------------------------
Net Sales. Net sales were $57.5 million for the six months ended June 30, 1999,
representing an increase of 166% over the corresponding period in 1998. Net
sales for the six month period ended June 30, 1999, include the Company's sales
to Music Boulevard customers as a result of the acquisition of N2K as of March
17, 1999. The increase in sales is also attributable to continued growth of the
Company's customer base, increased sales from repeat customers and increased
advertising revenue. For the six months ended June 30, 1999, the Company added
approximately 755,000 new customers, bringing the total number of customers who
have made purchases at either CDnow or Music Boulevard since inception to
approximately 2.4 million as of June 30, 1999. Repeat customer purchases
represented approximately 63% of net sales for the six months ended June 30,
1999, compared to 54% for the six months ended June 30, 1998. International
sales represented 20% of net sales for the six months ended June 30, 1999
compared to 22% for the corresponding period in 1998. The decrease in
international sales as a percentage of net sales is due to a proportionally
larger increase in domestic sales resulting from the inclusion of sales to Music
Boulevard customers as a result of the acquisition of N2K.
Cost of Sales. Cost of sales were $46.0 million for the six months ended June
30, 1999 compared to $17.6 million for the corresponding period in 1998. The
Company's gross profit margin increased to 20.0% for the six months ended June
30, 1999, compared to 18.8% for the corresponding period in 1998. The increase
in gross margin was primarily attributable to an increase in revenues from the
sale of advertising on the CDnow site, which has a higher margin than product
sales.
<PAGE> 14
During the quarter ended September 30, 1998, the Company determined to include
credit card processing fees ("Credit Card Fees") in sales and marketing expenses
rather than in cost of sales, as was previously the case. This change was made
based on management's determination that including Credit Card Fees in sales and
marketing expense was more consistent with the treatment of such expenses by
retailers generally. The financial information in this Form 10-Q related to the
Company's results of operations for the six months ended June 30, 1998, has been
restated to reflect this change. Credit Card Fees were approximately $1,287,000
and $586,000, during the six months ended June 30, 1999 and 1998, respectively.
If Credit Card Fees were included in cost of sales, gross profit margins would
have been 17.7% and 16.0%, during the six months ended June 30, 1999 and 1998,
respectively.
Operating and Development Expense. Operating and development expense was $9.6
million for the six months ended June 30, 1999, compared to $2.8 million for the
corresponding period in 1998. As a percentage of net sales, operating and
development expense was 16.6% for the six months ended June 30, 1999, compared
to 12.8% for the six months ended June 30, 1998. The increase in dollar and
percentage terms is attributable to costs associated with supporting increased
traffic and sales volume in the CDnow online store, including the costs
associated with operating both the CDnow and Music Boulevard websites from March
18, 1999, following the acquisition of N2K, through May 17, 1999. The increase
is also due to increased staffing and associated costs related to enhancing the
features and functionality of the Company's Internet site and
transaction-processing systems, as well as increased investments in store
content, systems and telecommunications infrastructure to support the increased
transaction volume in the CDnow store.
Sales and Marketing Expense. Sales and marketing expense was $39.7 million for
the six months ended June 30, 1999, compared to $18.4 million for the six months
ended June 30, 1998. As a percentage of net sales, sales and marketing expense
decreased to 69.1% for the six months ended June 30, 1999 compared to 84.9% for
the six months ended June 30, 1998. The increase in absolute dollars was
primarily attributable to increased costs associated with the Company's
marketing agreements, including those assumed by CDnow as a result of the
acquisition of N2K and those entered into during or after the second quarter of
1998. The increase is also due to increased advertising and promotional
expenditures including costs associated with the 1999 Grammy Awards telecast in
February 1999, which were higher than the comparable costs for the 1998 Grammy
Awards telecast. In addition, the Company incurred increased staffing and
related costs in connection with the implementation of its marketing strategy
and customer service activities necessary to support its increased customer
base, and increased credit card processing fees related to the growth of
revenues. The decrease as a percentage of sales is primarily attributable to the
increased percentage of the Company's sales from repeat customer purchases,
which are relatively less expensive than the cost of acquiring new customers.
The Company expects the dollar amount of sales and marketing expense to continue
to increase in future periods. The Company is hopeful that its net sales will
increase in future periods and that its sales and marketing expense will
represent a decreasing percentage of net sales. However, no assurance can be
given that the Company will achieve increased net sales or that sales and
marketing expense will decrease as a percentage of net sales.
General and Administrative Expense. General and administrative expense was $4.7
million for the six months ended June 30, 1999 compared to $1.7 million for the
six months ended June 30, 1998. As a percentage of net sales, general and
administrative expense increased to 8.2% for the six months ended June 30, 1999
from 7.9% for the six months ended June 30, 1998. The increase in general and
administrative expense, in both dollars and percentage terms, was primarily due
to the hiring of additional personnel to support the overall growth of the
Company, which was largely due to the acquisition of N2K. The increase is also
attributable to increased professional fees and the inclusion of merger-related
expenses of approximately $720,000 incurred in connection with the Company's
July 12, 1999 definitive agreement to merge with Columbia House.
Amortization of Goodwill and Other Intangibles. Amortization of goodwill and
other intangibles related to the acquisition of N2K and superSonic Boom, Inc.
was $9.5 million for the six months ended June 30, 1999 compared to $28,800 for
the six months ended June 30, 1998.
Net Loss Applicable to Common Shareholders. The Company's net loss applicable to
common shareholders was $50.8 for the six months ended June 30, 1999 compared to
$18.2 million for the six months ended June 30, 1998.
<PAGE> 15
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1999, the Company's cash and cash equivalents were $41.9 million
compared to $49.0 million at December 31, 1998. In February 1998, the Company
consummated its initial public offering by selling an aggregate of 4,561,250
shares of Common Stock and raising net proceeds of approximately $67.0 million.
In July 1998, the Company consummated a second public offering by selling an
aggregate of 1,250,000 shares of Common Stock and raising net proceeds of
approximately $21.5 million. Prior to February 1998, the Company primarily
financed its operations through private sales of capital stock (which, through
December 31, 1997, totaled $10.5 million, including $9.3 million raised in July
and August of 1997), the private sale of $5.8 million of Series A Notes in
November 1997, internally-generated cash flows, advances from related parties
and certain other short-term loans.
Net cash used in operating activities of $30.8 million for the six months ended
June 30, 1999 was primarily attributable to a net loss of $50.8 million and an
increase of $1.8 million in accounts receivable as a result of increased
revenues. These uses of cash were partially offset by a $12.1 million non-cash
charge for depreciation and amortization, a $5.2 million decrease in prepaid
expenses and other assets primarily due to the expense of prepaid marketing
agreements, and a $3.7 million increase in accounts payable and accrued
expenses, due to an increase in accrued merchandise costs. The changes in
working capital exclude the impact of the acquisition of the assets acquired and
liabilities assumed of N2K as of the merger date, March 17, 1999. For the six
months ended June 30, 1998, cash used in operating activities of $23.6 million
resulted primarily from a net loss of $18.1 million, a decrease of $4.6 million
in accounts payable and accrued expenses, and an increase of $1.6 million in
prepaid expenses, partially offset by depreciation and amortization of $751,000.
Net cash provided by investing activities was $23.6 million for the six months
ended June 30, 1999, which consisted of $25.3 million in net cash acquired from
the acquisition of N2K, partially offset by purchases of equipment of $1.6
million. Net cash used for investing activities was $1.1 million for the six
months ended June 30, 1998 and consisted of purchases of equipment of $1.6
million and $424,000 of cash used in the purchase of superSonicBoom, Inc.,
partially offset by the sale of short term investments of $1.0 million.
Net cash provided by financing activities was $10,000 for the six months ended
June 30, 1999, and consisted of proceeds from warrants and options exercised of
$520,000, partially offset by payments on capital leases and term loans of
$510,000. Net cash provided by financing activities was $61.2 million for the
six months ended June 30, 1998, and consisted of net proceeds of approximately
$67.1 million from the Company's initial public offering, partially offset by
the retirement of $5.8 million of the Company's Series A Notes.
The Company is required to pay aggregate minimum fixed fees under the Company's
marketing agreements of $20.1 million, $18.9 million and $7.4 million during the
remaining six months of 1999 and the years ended December 31, 2000 and 2001,
respectively. The Company also has minimum lease obligations associated with
leased office space and capital financing arrangements.
The Company expects to fund its future payment obligations under its marketing
agreements from its cash and cash equivalents and from cash generated from
future operations and financing activities. As of June 30, 1999, the Company had
$41.9 million of cash and cash equivalents. As of that date, the Company's
principal commitments consisted of obligations under its marketing agreements as
well as obligations outstanding under capital and operating leases. Although the
Company has no material commitments for capital expenditures, it anticipates
substantial increases in its capital expenditures and lease commitments
consistent with anticipated growth in operations, infrastructure and personnel.
In conjunction with the Company's execution of a definitive agreement on April
12, 1999 with Sony Corporation of America and Time Warner Inc. to combine the
businesses of the Company and Columbia House, the Company received a commitment
from Sony Music Entertainment Inc. and Time Warner Inc. to provide the Company
with up to $30 million in working capital financing, if needed based on certain
<PAGE> 16
working capital minimums, drawable on or after December 15, 1999 to assist the
Company in meeting its working capital requirements until the closing of the
merger, which is expected to be completed in the fourth quarter of 1999. The
Company believes that its current cash and cash equivalents are sufficient to
meet payment obligations until December 15, 1999.
FACTORS AFFECTING THE COMPANY'S BUSINESS AND PROSPECTS
The Company expects to experience significant fluctuations in its future
quarterly operating results due to a variety of factors, many of which are
outside the Company's control. Factors that may affect the Company's quarterly
operating results include (i) its ability to retain existing customers, attract
new customers and maintain customer satisfaction, (ii) the introduction of new
or enhanced Web pages, services, products and marketing agreements by the
Company and its competitors, (iii) price competition or higher wholesale prices,
(iv) the level of use of the Internet and consumer acceptance of the Internet
for the purchase of the Company's products, (v) seasonal fluctuations in sales
of the Company's products, (vi) its ability to upgrade and develop its systems
and infrastructure and attract qualified personnel, (vii) technical
difficulties, system downtime or Internet brownouts, (viii) the amount and
timing of operating costs and capital expenditures relating to expansion of the
Company's business, operations and infrastructure, (ix) the timing of Company
promotions and sales programs, (x) the level of merchandise returns experienced
by the Company, (xi) government regulation and (xii) general economic conditions
and economic conditions specific to the Internet, the online sale of products
and the entertainment industry. These and other factors are included in the
"Risk Factors" section of the Company's Definitive Proxy Statement on Form 14A
(File No. 000-23753), which was filed with the SEC on February 17, 1999.
The Company expects that it will experience seasonality in its business,
reflecting a combination of seasonal fluctuations in Internet usage and
traditional retail seasonality patterns affecting sales of recorded music and
other entertainment-related products. Sales in the traditional retail music
industry are significantly higher in the fourth calendar quarter of each year
than in the preceding three-quarters. However, to date, the Company's limited
operating history and rapid growth make it difficult to ascertain the effects of
seasonality on its business, especially with regard to products other than the
sale of music CDs. The Company believes that period-to-period comparisons of the
Company's historical results are not necessarily meaningful and should not be
relied upon as an indication of future results.
Risks Associated with the Year 2000. The Year 2000 issue is the result of
computer programs being written using two digits rather than four to define the
applicable year. In other words, date-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000. This could result in
system failures or miscalculations causing disruptions of operations, including,
among others, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company does not believe that it has material exposure to the Year 2000
issue with respect to its own information technology since its existing systems
correctly define the year 2000. The Company's non-information technology
systems, which include, but are not limited to, systems such as security,
heating, ventilating and air conditioning systems and facsimile machines are not
considered by the Company to be date sensitive to the Year 2000 and, therefore,
do not raise Year 2000 issues.
The Company is currently conducting an analysis to determine the extent to which
its major suppliers' systems (insofar as they relate to the Company's business),
including, but not limited to, the systems of credit card processors,
telecommunications providers, product distributors and companies with whom the
Company has strategic alliances, are subject to the Year 2000 issue. The Company
is currently unable to predict the extent to which the Year 2000 issue will
affect its suppliers, or the extent to which it would be vulnerable to the
suppliers' failure to remediate any Year 2000 issues on a timely basis. The
failure of a major supplier subject to the Year 2000 to convert its systems on a
timely basis or a conversion that is incompatible with the Company's systems
could have a material adverse effect on the Company. In addition, most of the
purchases from the Company's store are made with credit cards via the Internet
<PAGE> 17
and the Company's operations may be materially adversely affected to the extent
its customers are unable to use their credit cards or access the Internet due to
the Year 2000 issues that are not rectified by their credit card vendors or by
those organizations responsible for maintaining and providing access to the
Internet.
The Company estimates that, as of June 30, 1999, the cost of remediating its
internal systems has been approximately $100,000, and it estimates that it will
spend an additional $150,000 during the remainder of 1999. The Company is
funding this effort through normal working capital.
The Company intends to actively work with and encourage its suppliers to
minimize the risks of business disruptions resulting from Year 2000 issues and
develop contingency plans where necessary. Such plans may include, but are not
limited to, using alternative suppliers and establishing contingent supply
arrangements. The Company expects to have such plans in place during the fourth
quarter of 1999.
<PAGE> 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY RISK
Currently, all of the Company's revenues and expenses are denominated in United
States dollars. Therefore, the only current exposure to foreign currency risk
relates to international sales. For the three months ended June 30, 1999, and
the year ended December 31, 1998, international sales accounted for
approximately 20% and 21% of net sales, respectively. To the extent that the
value of the United States dollar increases relative to foreign currencies, it
may be more costly for international customers to make purchases. Therefore,
changes in exchange rates may impact the amount of the Company's international
sales.
INTEREST RATE RISK
The Company's exposure to market risk as a result of changes in interest rates
relates primarily to its investment portfolio. The Company invests in
instruments that meet high credit quality standards, as specified in its
investment policy. This policy also limits the amount of credit exposure to any
one issue, issuer and type of investment.
As of June 30, 1999, all of the Company's funds were cash equivalents. Due to
the average maturity and conservative nature of its investment portfolio, a
sudden change in interest rates would not have a material effect on the value of
the portfolio. Management estimates that had the average yield of the Company's
investments decreased by 100 basis points, the Company's interest income for the
six months ended June 30, 1999 would have decreased by approximately $300,000.
This estimate assumes that the decrease occurred on the first day of 1999 and
reduced the yield of each investment instrument by 100 basis points. The impact
on the Company's future interest income from future changes in investment yields
will depend largely on the gross amount of the Company's investments, see the
"Liquidity and Capital Resources" section of this report.
<PAGE> 19
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
N2K (a wholly-owned subsidiary of the Company) and its directors are defendants
in a consolidated purported class action in the U.S. District Court for the
Southern District of New York entitled In re N2K Inc. Securities Litigation
(Docket No. 98 CIV 3304 (HB)) (the "Consolidated Action"). The Consolidated
Action consolidates two purported class actions, entitled Kuhn v. N2K Inc. et
al. (Docket No. 98 CIV 4360 (HB)) and Bender v. Rosen et al. (Docket No. 98 CIV
3304 (HB)) that were previously discussed in N2K's Quarterly Reports on Form
10-Q for the quarterly periods ended September 30, 1998, June 30, 1998 and March
31, 1998, respectively. The Consolidated Action is a purported class action on
behalf of Common stockholders and seeks to recover unspecified damages and other
relief, as well as recovery of costs and expenses, stemming from alleged
violations of the Securities Act of 1933, as amended, in connection with the
public offering of the shares of N2K's Common stock in April 1998. The
Consolidated Action alleges that, among other things, the defendants failed to
disclose N2K's first quarter financial results in the registration statement for
the April 1998 public offering. The Company, as a successor-in-interest to N2K,
believes that the claims in the Consolidated Action are without merit and is
vigorously defending the action. The defendants moved to dismiss the complaint
on August 31, 1998 for failure to state a claim and/or for failure to plead
fraud with the requisite particularity. On May 21, 1999, Judge Baer dismissed
the plaintiff's complaint with prejudice. On June 22, 1999 plaintiffs filed a
Notice of Appeal in the U.S. Court of Appeals for the Second Circuit.
On or about November 4, 1998, an action entitled Ticketmaster Ticketing Co. v.
N2K Inc. (Docket No. BC200194) was filed against N2K in California Superior
Court for the County of Los Angeles. The Ticketmaster action alleges that N2K
breached a marketing and advertising contract dated April 23, 1998 between
Ticketmaster and N2K, which N2K terminated effective October 31, 1998, based on
alleged breaches of the agreement by Ticketmaster as well as other tortious
conduct. Ticketmaster seeks damages in an amount not less than $8,000,000, plus
pre- and post-judgment interest, as well as fees and costs. The Company, as a
successor-in-interest to N2K, believes that it has substantial defenses to the
claim asserted, intends to defend the action vigorously and has filed a
cross-compliant for affirmative relief.
On or about November 12, 1998, an action entitled Metallica v. N2K Inc. et al.
(Docket No. 98-9122 GHK (ANx)) was filed in the United States District Court for
the Central District of California against N2K, Metro Independent Records,
Richard Driscoll, Dutch East India Trading, and ten unnamed persons or entities.
The Metallica action alleges that N2K and the other defendants have infringed
copyrights and trademarks owned by Metallica and the other plaintiff, Creeping
Death Music, and have violated California state law by manufacturing,
distributing, advertising and selling a compact disc entitled "Metallica, Bay
Area Thrashers, The Early Years." Plaintiffs seek, inter alia, injunctive relief
including, but not limited to, an order requiring defendants to cease their
alleged copyright and trademark infringements, damages, including but not
limited to treble plaintiffs' damages and defendants' profits attributable to
the alleged infringements, other damages and injunctive relief, as well as fees
and costs. On June 8, 1999 the Company and plaintiffs entered into a
confidential Settlement Agreement and Mutual Release for an undisclosed amount,
which amount is not material to the Company.
N2K and seventeen other entities have been named as defendants in a civil action
entitled Interactive Gift Express v. Compuserve, Inc., et al. (Docket 95 CV 6871
(BSJ)), which is pending in the U.S. District Court for the Southern District of
New York. N2K has also been named as defendant in a civil action entitled Parsec
Sight/Sound, Inc. v. N2K Inc. (Docket 98 CV 0118), which is pending in the U.S.
District Court for the Western District of Pennsylvania. The plaintiffs in each
of these actions allege infringement of certain intellectual property rights,
and each seeks treble damages and costs in an unspecified amount, as well as
other declaratory and injunctive relief. In the Interactive Gift action, the
court has issued a preliminary ruling favorable to defendants. Plaintiffs have
stated that they will consent to entry of judgment against them in order to
<PAGE> 20
speed their appeal of the court's ruling. In the Parsec action, the Company has
answered the complaint and discovery is ongoing. The Company, as a
successor-in-interest to N2K, believes that the claims against it in each action
are without merit and intends to vigorously defend against each of them.
Moreover, the Company believes that these lawsuits, even if adversely
determined, will not have a material adverse effect on the Company's business,
financial condition or results of operations.
From time to time, the Company is involved in litigation incidental to its
business. In the opinion of management, no litigation to which the Company is
currently a party is likely to have a material adverse effect on the Company's
results of operations, financial condition or liquidity, if decided adversely to
the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
27.1 Financial Data Schedule.
B. Reports on Form 8-K
Form Item # Description Filing Date
-------- ------ ------------------------------------ -------------
Form 8-K 5,7 Report of the execution of an July 12, 1999
Agreement of Merger and
Contribution by and among CDnow,
Inc., Time Warner Inc. and Sony
Corporation of America to combine
the businesses of CDnow and Columbia
House
<PAGE> 21
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.
CDnow, Inc.
Date: August 27, 1999 /s/ Jason Olim
-----------------------------------
Jason Olim
President & Chief Executive Officer
/s/ Joel Sussman
-----------------------------------
Joel Sussman
Vice President, Treasurer and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> APR-1-1999
<PERIOD-END> JUN-30-1999
<CASH> 41,928,290
<SECURITIES> 0
<RECEIVABLES> 4,865,692
<ALLOWANCES> 738,807
<INVENTORY> 366,214
<CURRENT-ASSETS> 56,046,567
<PP&E> 26,531,195
<DEPRECIATION> 10,079,863
<TOTAL-ASSETS> 160,458,315
<CURRENT-LIABILITIES> 42,533,250
<BONDS> 0
0
0
<COMMON> 204,250,328
<OTHER-SE> (92,191,629)
<TOTAL-LIABILITY-AND-EQUITY> 160,458,315
<SALES> 34,616,244
<TOTAL-REVENUES> 34,616,244
<CGS> 28,000,743
<TOTAL-COSTS> 28,000,743
<OTHER-EXPENSES> 39,013,667
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 88,242
<INCOME-PRETAX> (31,720,277)
<INCOME-TAX> 0
<INCOME-CONTINUING> (31,720,277)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (31,720,277)
<EPS-BASIC> (1.06)
<EPS-DILUTED> (1.06)
</TABLE>
