<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------------------------
FORM 10-Q
[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 No. 000-26585
MUSICMAKER.COM, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 54-1811721
- ------------------------------ ------------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation)
1831 Wiehle Avenue, Suite 128, Reston, VA 20190
- ----------------------------------------- ------------------------------------
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code: (703) 904-4110
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [_] No [X]
As of August 20, 1999, 30,632,517 shares of the issuer's common stock, par value
$0.01 per share, were outstanding.
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TABLE OF CONTENTS
<TABLE>
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Page
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PART I............................................................................... 1
ITEM 1 FINANCIAL STATEMENTS....................................................... 1
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............................. 9
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK.......................................................... 15
PART II.............................................................................. 17
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS.................................. 17
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................ 17
ITEM 5 OTHER INFORMATION ......................................................... 17
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K........................................... 18
</TABLE>
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
- -----------------------------
The consolidated financial statements for the six months ended June 30,
1999 have not been audited but, in the opinion of management, contain all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the financial position and results of operations of the Company
as of such date and for such periods. The unaudited consolidated financial
statements should be read in conjunction with the Consolidated Financial
Statements of the Company and the Notes thereto appearing in the Company's
Registration Statement filed on Form S-1 and dated July 7, 1999 for the years
ended December 31, 1998 and 1997 and the three months ended March 31, 1999 and
1998. The results of operations for the six months ended June 30, 1999 are not
necessarily indicative of the results of operations that may be expected for the
year ending December 31, 1999 or any future periods.
1
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musicmaker.com, Inc
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
ASSETS (unaudited)
-------------------- --------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 975,569 $ 972,954
Accounts receivable 52,687 17,510
Related party accounts receivable 81,519 81,519
Prepaid expenses and other current assets 227,985 25,395
-------------------- --------------------
Total current assets 1,337,760 1,097,378
Property and equipment, net 685,222 360,709
Capitalized IPO fees 1,156,502 ---
Investments 750,000 750,000
Intangibles, net 86,141,852 967,395
Other assets 58,481 58,481
==================== ====================
Total assets $ 90,129,817 $ 3,233,963
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable $ 1,824,714 $ 455,095
Accrued expenses 70,360 261,974
Accrued compensation payable to related parties 635,213 625,219
Current portion of long-term obligations 42,857 42,857
Other current liabilities 1,250,000 ---
-------------------- --------------------
Total current liabilities 3,823,144 1,385,145
Long-term obligations 171,429 214,286
Convertible notes payable 2,000,000 512,500
Commitments
Mandatory redeemable convertible preferred stock, $0.01 par value 5,959,509
shares authorized:
Series A convertible preferred stock, 1,059,089
shares designated, issued and outstanding 1,108,894 1,026,682
Series B convertible preferred stock, 2,017,317
shares designated, 849,640 issued and outstanding 1,750,100 1,750,100
Series C convertible preferred stock, 530,256
shares designated, no shares issued and outstanding --- ---
Stockholders' equity (deficit):
Common stock, $0.01 par value, 100,000,000
shares authorized; 22,067,773 and 6,309,493
shares issued and outstanding 220,677 63,095
Additional paid-in capital 92,993,289 4,739,658
Warrants 779,059 779,059
Accumulated deficit (12,716,775) (7,236,562)
-------------------- --------------------
Total stockholders' equity (deficit) 81,276,250 (1,654,750)
-------------------- --------------------
Total liabilities and stockholders' equity (deficit) $ 90,129,817 $ 3,233,963
==================== ====================
</TABLE>
The accompanying notes are an integral part of these statements
2
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musicmaker.com, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
------------------------------ ------------------------------
<S> <C> <C> <C> <C>
Net sales $ 47,671 $ 10,699 $ 67,831 $ 33,115
Cost of sales (166,867) (110,316) (630,150) (343,115)
------------------------------ ------------------------------
Gross profit (119,196) (99,617) (562,319) (310,000)
------------------------------ ------------------------------
Operating expenses:
Sales and marketing 875,679 273,573 1,135,529 671,302
Operating and development 398,384 212,152 651,639 415,796
General and administrative 2,172,887 247,375 2,997,517 681,644
------------------------------ ------------------------------
3,446,950 733,100 4,784,685 1,768,742
------------------------------ ------------------------------
Loss from operations (3,566,146) (832,717) (5,347,004) (2,078,742)
Other income (expense):
Interest income 11,385 2,502 27,924 7,752
Interest expense (38,514) --- (78,920) ---
------------------------------ ------------------------------
(27,129) 2,502 (50,996) 7,752
------------------------------ ------------------------------
Net loss (3,593,275) (830,215) (5,398,000) (2,070,990)
Accretion of Series A
preferred stock warrants (41,106) (21,941) (82,212) (34,215)
------------------------------ ------------------------------
Net loss available to common
stockholders $ (3,634,381) $ (852,156) $(5,480,212) $(2,105,205)
============================== ==============================
Basic and diluted net loss per
common share (Note 4) $ (0.34) $ (0.18) $ (0.63) $ (0.44)
============================== ==============================
Weighted average shares
outstanding 10,605,305 4,790,460 8,695,412 4,790,460
============================== ==============================
</TABLE>
The accompanying notes are an integral part of these statements
3
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musicmaker.com, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six months ended
June 30,
1999 1998
---- ----
<S> <C> <C>
Operating activities
Net loss $ (5,398,000) $ (2,070,990)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 114,000 53,779
Amortization 1,625,028 ---
Services received in exchange for stock and
warrants 669,240 325,290
Changes in operating assets and liabilities:
Accounts receivable (35,177) ---
Prepaid expenses and other current assets (202,590) (50,723)
Capitalized IPO fees (1,156,502) ---
Other assets --- (63,891)
Accounts payable 1,369,619 (157,651)
Accrued expenses (191,615) 120,174
Accrued compensation payable to related parties 9,994 (133,555)
Other current liabilities 1,250,000 ---
Long-term obligation (42,857) ---
---------------- ---------------
Net cash used in operating activities (1,988,860) (1,977,567)
---------------- ---------------
Investing activities
Purchases of property and equipment (438,513) (197,015)
---------------- ---------------
Net cash used in investing activities (438,513) (197,015)
---------------- ---------------
Financing activities
Proceeds from issuance of convertible notes payable 1,487,500 ----
Payment of fees on convertible notes payable (173,875) ----
Issuance of convertible preferred stock ---- 1,533,816
Issuance of common stock 1,116,363 ----
---------------- ---------------
Net cash provided by financing activities 2,429,988 1,533,816
---------------- ---------------
Net increase (decrease) in cash and cash equivalents 2,615 (640,766)
Cash and cash equivalents at beginning of period 972,954 1,401,982
---------------- ---------------
Cash and cash equivalents at end of period $ 975,569 $ 761,216
---------------- ---------------
Non-cash investing and financing activities
Common stock issued for licensing agreement $ 86,625,610 $ ----
================ ===============
Conversion of accrued compensation to preferred stock $ ---- $ 166,667
================ ===============
Issuance and modification of warrants $ ---- $ 584,937
================ ===============
</TABLE>
The accompanying notes are an integral part of these statements
4
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musicmaker.com, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. - The Company and Summary of Significant Accounting Policies
The Company
Musicmaker.com, Inc. (formerly The Music Connection Corporation) (the "Company")
was incorporated in Delaware on April 23, 1996. The Company is an e-commerce
provider of customized music CD compilations on the Internet. The Company's
website, "www.musicmaker.com," as well as mail-order promotions, allow customers
to order custom compiled music CDs. Customers can also digitally download songs
from the Company's online library directly to their personal computers.
Basis of Presentation
The financial statements as of June 30, 1999 and 1998 have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC"). These statements are unaudited and, in the opinion of
management, include all adjustments (consisting of normal recurring adjustments
and accruals) necessary to present fairly the results for the periods presented.
The balance sheet at December 31, 1998 has been derived from the audited
financial statements at that date. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted pursuant to such SEC rules and
regulations. Operating results for the quarter ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. These financial statements should be read in conjunction with
the audited financial statements and the accompanying notes included in the
Company's Registration Statement on Form S-1 and the prospectus contained
therein as filed with the SEC on July 7, 1999. Certain prior period balances
have been reclassified to conform to the current period presentation.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, CD Kit. As of December 31, 1998, CD Kit
was inactive with no remaining assets or liabilities. All significant
inter-company transactions and balances have been eliminated in consolidation.
Revenue Recognition
Net sales are recognized at the time merchandise is shipped to customers for
custom CDs and upon execution of orders for digitally downloaded songs.
Note 2. -- Convertible Notes Payable and Long-term Obligations
On July 1, 1998, the Company entered into a mutual coexistence agreement with
Music Maker Relief Foundation, Inc. ("Music Maker Relief Foundation"), an
unaffiliated not-for-profit
5
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corporation that owns the trademark MUSICMAKER and the Internet domain name
MUSICMAKER.ORG. In consideration of avoiding any possible conflict regarding
names, marks, goods and services, the Company agreed to pay $300,000 to Music
Maker Relief Foundation. The Company paid $42,857 upon signing of the agreement
and has a remaining obligation of $214,286 ($42,857 on April 15th of each of the
years 1999 through and including 2004). The Company expensed $300,000 upon
signing of the agreement.
In October 1998, the Company initiated an offering for 8% convertible secured
subordinate promissory notes which are convertible at any time at the election
of the holder and are mandatorily convertible upon the closing of an initial
public offering with gross proceeds of $5,000,000 or more or upon certain
mergers and consolidations of the Company subject to certain requirements. The
conversion price is $2.06 per share of common stock, subject to certain
adjustments. The convertible notes payable are secured by a lien on the assets
of the Company pursuant to a security agreement and the principal and accrued
interest are due on December 31, 2000. As of June 30, 1999, the Company had
convertible notes payable of $2,000,000.
On February 12, 1999, the Company signed a loan and security agreement with a
financial institution for a credit facility of up to $250,000 in a revolving
line of credit ("line of credit") for equipment and software purchases and
general working capital and up to $100,000 in a cash secured letter of credit.
The credit facility matures six months from the date of the loan unless
$5,000,000 in new equity has been raised prior to maturity. In that case, the
portion of the credit facility used for equipment and software purchases will
automatically convert to a 24-month term loan. If the term of the credit
facility is extended, the financial institution will have the right to purchase
warrants equal to 4% of the commitment amount. As of June 30, 1999, $250,000
was outstanding against the line of credit and $100,000 was outstanding secured
by a certificate of deposit
On June 23, 1999, the Company issued a demand promissory note to Rho Management
Trust I for financing in the principal amount of $1,000,000 bearing interest at
12% and maturing on January 1, 2000. The promissory note states that if the
Company has not consummated an initial public offering by September 30, 1999,
the interest payable on the note increases to 14%. The Company is required to
repay the note from the proceeds of an initial public offering.
Note 3. -- Issuance of Stock and Related Events
On April 8, 1999, the Company issued a warrant to purchase 242,077 shares of
common stock at $1.98 per share to a consultant for services rendered. The
Company recorded an expense of $464,415 related to the issuance of this warrant.
On June 8, 1999, the Board of Directors approved an increase in the aggregate
number of shares of common stock for which options may be granted under the
Company's Stock Option Plan up to 4.2 million. Also on June 8, 1999, the
stockholders authorized the Company's Amended and Restated Certificate of
Incorporation, which increased the Company's total number of authorized shares
of common stock to 100 million shares.
On June 8, 1999, the Company executed a license agreement with Virgin Holdings,
Inc., an affiliate of EMI Recorded Music, Inc. ("EMI") whereby EMI agreed to
make certain of its content available to the Company, in EMI's sole discretion,
in exchange for 50% of the Company's common stock, calculated on a fully diluted
basis on the effective date of the
6
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transaction. Under this agreement, the Company will make royalty payments in
connection with the inclusion of music content provided by EMI in the Company's
library of content available for custom CDs. In exchange for the Company's
rights under the license agreement, the Company issued 15,170,860 shares of
common stock valued at $86,625,610, estimating the fair value of the Company's
common stock at $5.71 per share. The Company is amortizing the intangible asset
on a straight-line basis over the five-year period of the license agreement.
This license fee will be written off as a non-cash charge of approximately
$17,300,000 in each year over the next five years.
On June 8, 1999, the Board of Directors approved a 2.33-for-one stock split of
the Company's common stock, which was effective on June 14, 1999. All references
in the accompanying financial statements to the number of shares of common stock
and per-share amounts have been restated to reflect the split. Additionally, all
references in the accompanying financial statements to the number of shares of
preferred stock and per-share amounts have been restated to reflect the split in
accordance with the Company's Restated Articles of Incorporation.
Note 4. - Net Loss Per Share
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
------------------------------ ------------------------------
<S> <C> <C> <C> <C>
Numerator:
Net loss (3,593,275) (830,215) (5,398,000) (2,070,990)
Less: Accretion of Series A
Preferred stock warrants (41,106) (21,941) (82,212) (34,215)
------------------------------ ------------------------------
Net loss available to common
stockholders $ (3,634,381) $ (852,156) $(5,480,212) $(2,105,205)
============================== ==============================
Denominator 10,605,305 4,790,460 8,695,412 4,790,460
============================== ==============================
Basic and diluted net loss per
share $ (0.34) $ (0.18) $ (0.63) $ (0.44)
============================== ==============================
</TABLE>
Note 5. -- Subsequent Events
Initial Public Offering
On July 7, 1999, the Company consummated an initial public offering of its
common stock (the "IPO"). The Company sold 8,400,000 shares (including 3,072,197
shares of one of its stockholders) of its common stock, par value $0.01, at a
public offering price of $14.00 per share. After deducting the underwriters'
discounts and other offering expenses, the net proceeds to the Company were
approximately $66,800,000. On July 30, 1999, the underwriters exercised their
overallotment option for the purchase of an additional 360,000 shares of Common
Stock. After deducting underwriter's discounts and other offering expenses, the
net proceeds to the Company were approximately $4,600,000.
The Company intends to use the net proceeds from its initial public
offering to pay advances
7
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in connection with acquiring additional music content from record labels. The
Company also anticipates using net proceeds to expand advertising, marketing and
promotional efforts with existing and future strategic marketing partners. Net
proceeds may be used to support promotional inserts in direct mailings to
Columbia House and Audio Book Club members, website advertising and seasonal
product promotions. The Company intends to use net proceeds to maintain, back-
up, and upgrade the technological systems which support our operations. Although
the Company does not have any current plans to acquire any businesses, a portion
of the net proceeds of the offering may be used for these purposes. The Company
used a portion of the net proceeds in July 1999 to repay a 12% loan from Rho
Management Trust I in the principal amount of $1,000,000 plus interest of
$8,661. The Company has not yet determined the amount of net proceeds to
specifically allocate to each of the foregoing purposes. Pending use, the net
proceeds of this offering in bank certificates of deposit and other fully
insured investment grade interest bearing securities will be invested.
8
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
Note Regarding Forward-Looking Information
Certain statements under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
Report constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Company, or industry
results, to be materially different from any future results, performance, or
achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the Company's limited operating history, its
license agreement with EMI Recorded Music, general economic and business
conditions with respect to the Internet and online commerce, changes in
government regulations, competition and the ability of the Company to implement
its business strategy and other risks discussed in the Company's Registration
Statement on Form S-1 and the Prospectus contained therein dated July 7, 1999.
Forward-looking statements are intended to apply only at the time
they are made. Moreover, whether or not stated in connection with a forward-
looking statement, the Company undertakes no obligation to correct or update a
forward-looking statement should the Company later become aware that it is not
likely to be achieved. If the Company were to update or correct a forward-
looking statement, investors and others should not conclude that the Company
will make additional updates or corrections thereafter.
The following discussion should be read in conjunction with the
financial statements contained in Item 1 of Part I of this Form 10-Q.
Overview
Musicmaker.com, Inc. (the "Company") was incorporated in April 1996
("Inception"). On July 31, 1996, the Company acquired the technology to produce
its custom CDs. During the remainder of 1996 and through the year ended December
31, 1997, the Company's operating activities consisted of recruiting personnel,
developing the technological infrastructure necessary to create custom CDs on
the Internet, building an operating infrastructure and establishing
relationships with record labels and vendors. The Company launched its website
in October 1997 and shipped its first custom CD in November 1997. In 1998, the
Company established several strategic alliances with leading online and offline
music marketers including Columbia House and TransWorld Entertainment. In June
1999, the Company entered into a license agreement with Virgin Holdings, Inc.,
an affiliate of EMI Recorded Music. The Company was granted a five year
exclusive worldwide license to include the music content that EMI makes
available for use in our online sales of custom CDs. The new relationship with
EMI gives the Company the potential for access to tracks from EMI artists and
the extensive music catalog of a major record company. In connection with our
license agreement with EMI, we will amortize approximately $17,300,000 in each
of the next five years.
The Company's net sales are primarily derived from custom CDs offered over
the Internet and through advertising campaigns and individual songs downloaded
directly from the Company's website. Net sales are net of sales discounts and
include shipping and handling
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charges. Customer accounts are settled by directly charging a customer's credit
card or by offering credit to customers that have previous payment history with
musicmaker.com. Accordingly, we will be required to manage the associated risks
of accounts receivable, expansion and collection. To date, we have not extended
a material amount of customer credit. Net sales are recognized upon shipment of
the CD from the Company's production site in Reston, Virginia. For digitally
downloaded songs, net sales are recognized upon execution of the order.
The Company has an extremely limited operating history upon which to base
an evaluation of its business and prospects. The Company has yet to achieve
significant net sales and its ability to generate significant net sales in the
future is uncertain. Further, in view of the rapidly evolving nature of the
Company's business and its very limited operating history, the Company has
little experience forecasting net sales. Therefore, the Company believes that
period-to-period comparisons of our financial results are not necessarily
meaningful and you should not rely upon them as an indication of future
performance.
To date, the Company has incurred substantial costs to create, introduce
and enhance its services, to acquire content, to build brand awareness and to
grow its business. As a result, the Company has incurred operating losses since
Inception. In addition, the Company expects significantly increased operating
expenses in connection with an increase in the size of its staff, expansion of
its marketing efforts, and an increase in its research and development efforts
to assist in the Company's planned growth. To the extent that increases in
operating expenses precede or are not followed by increased net sales, the
Company's business, financial condition and results of operations will be
materially adversely affected.
The Company's business and prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early years, particularly companies in new and rapidly evolving markets such as
electronic commerce. In addition, the Company's net sales depend substantially
upon the level of activity on its website, the amount and quality of content
provided under its EMI license agreement and the success of its Columbia House
print promotions. Although the Company has experienced growth in its operations,
there can be no assurance that the Company's net sales will continue at its
current level or rate of growth.
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Results of Operations
The following table reflects items in the Statements of Operations as
dollar amounts and as percentages of net sales.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------------------------------- ----------------------------------------------
1999 1998 1999 1998
--------------------------------------------- ----------------------------------------------
Percentage Percentage Percentage Percentage
of Total of Total of Total of Total
Amount Revenue Amount Revenue Amount Revenue Amount Revenue
--------------------------------------------- --------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales $ 47,671 100.0% $ 10,699 100.0% $ 67,831 100.0% $ 33,115 100.0%
Cost of sales (166,867) -350.0% (110,316) -1031.1% (630,150) -929.0% (343,115) -1036.1%
------------------------------------------- --------------------------------------------
Gross profit (119,196) -250.0% (99,617) -931.1% (562,319) -829.0% (310,000) -936.1%
------------------------------------------- --------------------------------------------
Operating expenses:
Sales and marketing 875,679 1836.9% 273,573 2557.0% 1,135,529 1674.1% 671,302 2027.2%
Operating and development 398,384 835.7% 212,152 1982.9% 651,639 960.7% 415,796 1255.6%
General and administrative 2,172,887 4558.1% 247,375 2312.1% 2,997,517 4419.1% 681,644 2058.4%
------------------------------------------- --------------------------------------------
3,446,950 7230.7% 733,100 6852.0% 4,784,685 7053.8% 1,768,742 5341.2%
------------------------------------------- --------------------------------------------
Loss form operations (3,566,146) (832,717) (5,347,004) (2,078,742)
Other income (expense):
Interest income 11,385 23.9% 2,502 23.4% 27,924 41.2% 7,752 23.4%
Interest expense (38,514) -80.8% --- N/N (78,920) -116.3% --- N/N
------------------------------------------- --------------------------------------------
(27,129) -56.9% 2,502 23.4% (50,996) -75.2% 7,752 23.4%
------------------------------------------- --------------------------------------------
Net loss (3,593,275) -7537.7% (830,215) -7759.7% (5,398,000) -7958.0% (2,070,990) -6253.9%
Accretion of Series A
preferred stock warrants (41,106) -86.2% (21,941) -205.1% (82,212) -121.2% (34,215) -103.3%
------------------------------------------- --------------------------------------------
Net loss available to common
stockholders $(3,634,381) -7623.9% $(852,156) -7964.8% $(5,480,212) -8079.2% $(2,105,205) -6357.3%
=========================================== ============================================
</TABLE>
Net Sales. Net sales include the selling price of products sold by the
Company, net of returns, as well as sales promotions and discounts. The
Company's net sales increased 345.6% and 104.8%, to $47,671 and $67,831, for the
three and six months ended June 30, 1999 compared to $10,699 and $33,115 for the
three and six months ended June 30, 1998, respectively. The growth of net sales
resulted from a significant increase in the number of units sold due to further
development of our customer base, repeat purchases from the Company's existing
customers, the expansion of our music library and the implementation of our
print promotion with Columbia House and other strategic partners which provided
heavier Internet traffic and access to additional customer bases.
Cost of Sales. Cost of sales principally consist of content acquisition
costs, production and shipping costs, and credit card receipt processing costs.
Production costs include jewel cases, CD trays and CD inserts. The Company
expects that its cost of sales will increase significantly as it enters into
additional licensing agreements to further expand and develop its music library.
Cost of sales increased 51.3% and 83.7% to $166,867 and $630,150 for the three
and six months ended June 30, 1999 compared to $110,316 and $343,115 for the
three and six months ended June 30, 1998. Cost of sales consist primarily of
royalty advances that were paid upon signing of royalty agreements with
independent music labels of $155,029 and $613,848 for the three and six months
ended June 30, 1999 compared to $98,527 and $324,388 for the three and six
months
11
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ended June 30, 1998.
Operating and Development Expenses. Operating and development expenses
increased 87.8% and 56.7% to $398,384 and $651,639 for the three and six months
ended June 30, 1999 compared to $212,152 and $415,796 for the three and six
months ended June 30, 1998. The increase was attributable to increased spending
on website maintenance and equipment expense, increased staffing and associated
costs related to enhancing the features and functionality of the Company's
website and computer systems. Operating and development expenses are expected to
increase in future periods as a result of anticipated personnel additions and
additional equipment and maintenance expenses associated with the expansion of
the Company's technical operations.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of advertising and promotional expenditures, and consulting and
payroll and related expenses. The Company expenses all advertising costs as
incurred. Sales and marketing expenses increased 220.1% and 69.2% to $875,679
and $1,135,529 for the three and six months ended June 30, 1999, respectively,
compared to $273,573 and $671,302 for the three and six months ended June 30
1998, respectively. The increase is primarily attributable to consulting
expenses associated with the issuance of warrants in April 1999 for services
rendered for which the Company recorded an expense of approximately $465,000.
Sales and marketing expenses are expected to increase in the near term, due to
the commencement of advertising in connection with the Columbia House print
promotions, online promotions, and radio and third party advertising services.
The Company expects sales and marketing expenses to increase significantly as it
endeavors to increase its customer base, drive traffic to its website and
enhance brand name awareness. While the Company is hopeful that its net sales
will also increase in future periods so that its sales and marketing expense
will not continue to represent an increasing percentage of net sales, the
Company is not able to predict whether its net sales will increase by a
sufficient amount for this to occur. No assurance can be give that the Company
will achieve increased net sales or that sales and marketing expense will not
increase as a percentage of net sales.
General and Administrative Expenses. General and administrative expenses
consist primarily of legal and professional fees, payroll costs and related
expenses for officers, accounting and administrative personnel, as well as other
expenses associated with corporate functions, the amortization of intangibles
and other general and corporate expenses. Also included in general and
administrative expenses are expenses associated with the issuance of warrants to
various consultants, one of the Company's shareholders and to Columbia House.
General and administrative expenses increased 778.4% and 339.8% to $2,172,887
and $2,997,517 for the three and six months ended June 30, 1999, compared to
$247,375 and $681,644 for the three and six months ended June 30, 1998. The
increase in general and administrative expenses was primarily due to
amortization of intangibles, an increase in legal and professional fees,
increases in consulting expenses, as well as the increased administrative costs
associated with preparation of the Company's initial public offering.
Net Loss. The Company's net loss was $3,634,381 and $5,480,212 for the
three and six months ended June 30, 1999, compared to $852,156 and $2,105,205
for the three and six months ended June 30, 1998.
Interest Expense/Income. Interest income was $11,385 and $27,924 for the
three and six months ended June 30, 1999 compared to $2,502 and $7,752 for the
three and six months ended
12
<PAGE>
June 30, 1998. Interest expense for the three and six months ended June 30, 1999
was $38,514 and $78,920, respectively, compared to no interest expense for the
three and six months ended June 30, 1998. The interest expense for the three and
six months ended June 30, 1999 is attributable to the interest associated with
the outstanding convertible notes.
Liquidity and Capital Resources
Net cash used in operating activities was $1,988,860 for the six months
ended June 30, 1999 compared to $1,977,567 for the six months ended June 30,
1998. Net operating cash flows were primarily attributable to quarterly net
losses, capitalized IPO fees and an increase in accounts payable, offset by non-
cash charges for depreciation and amortization, and warrants issued in exchange
for services and an increase in other current liabilities.
Cash used in investing activities was $438,513 for the six months ended
June 30, 1999 and $197,015 for the six months ended June 30, 1998. In both
periods the cash used in investing activities was primarily for the purchase of
property and equipment, including computer equipment and software, leasehold
improvements, and furniture and other office equipment.
Net cash provided by financing activities was $2,429,988 for the six months
ended June 30, 1999 compared to $1,533,816 for the six months ended June 30,
1998. Net cash provided by financing activities, for the six months ended June
30, 1999 was primarily through the issuance of 8% convertible notes for
$1,487,500, net of fees of $173,875, and the issuance of common stock for
$1,213,250, net of fees of $96,887. Net cash provided by financing activities,
for the six months ended June 30, 1998 was primarily through the issuance of
convertible preferred stock of $1,533,816.
On January 8, 1999, the Company signed a lease line agreement which
provides leasing for computer and related equipment as well as CD fabrication
equipment up to $200,000 between the signing of the agreement and June 8, 1999.
Any equipment leased under this agreement will have a 24 month lease term, and
at the end of the lease term the Company will either be obligated to buy the
equipment at 10% of the original equipment cost or extend the lease term for an
additional 24 months. Borrowings under this lease line agreement require
payments due in advance with a monthly rental factor of .0498 for months one
through 24. The actual monthly rental will be determined by multiplying the cost
of the equipment by the applicable monthly rental factor, plus any monthly
maintenance charges. The Company will provide the lessor with a first security
interest in the equipment leased under this agreement for the duration of the
term of the lease. The Company also signed the first lease under this agreement
which will have a monthly rental payment of $8,261. As part of the lease line
agreement, the Company issued a warrant to purchase 14,524 shares of its common
stock at $2.06 per share which expires on January 8, 2009. The Company recorded
an expense of $16,021 related to the issuance of the warrant.
On February 12, 1999, the Company signed a loan and security agreement with
a financial institution for a credit facility of up to $250,000 in a revolving
line of credit for equipment and software purchases and general working capital
and up to $100,000 in a cash secured letter of credit, all of which has been
borrowed. Borrowings under this line of credit bear interest at Imperial Bank's
prime rate of interest plus 2%. The line of credit is secured by a blanket
security interest on all of our assets including general intangibles, but
excluding previously leased equipment. The line has financial covenants,
including minimum net worth and liquidity ratios. At June 30,
13
<PAGE>
1999, we have $250,000 outstanding under this line of credit. Interest on any
balance outstanding is payable monthly with principal and all accrued interest
due six months from the date of the loan. In the event that costs of equipment
and software purchased under the line are converted into a term loan, equal
payments of principal and interest will be due monthly for 24 months, starting
on the first month following the initial six month maturity. The initial six
month period runs from March 12, 1999. The credit facility will automatically
convert to a 24 month term loan after September 11, 1999, if $5,000,000 in new
equity is raised prior to that date. If the term of the credit facility is
extended, Imperial Bank will have the right to purchase warrants equal to 4% of
the commitment amount.
On April 8, 1999, the Company issued a warrant to purchase 242,077 shares
of common stock at $1.98 per share to a consultant for services rendered. The
Company recorded an expense of $464,415 related to the issuance of this warrant.
On June 8, 1999, the Company entered into a license agreement with EMI.
Under this agreement, the Company issued 15,170,860 shares of common stock
valued at our estimate of the fair market value of our common stock of $5.71 per
share in exchange for a five-year license which provides us with exclusive
rights to use the content they make available for online sales of custom CDs.
The license fee of $86,625,610 will be written off as a non-cash charge of
approximately $17,300,000 in each year over the next five years, the term of the
license. In addition, the Company will make royalty payments to EMI for sales of
custom CDs that include EMI's content.
In June 1999, the Company issued a demand promissory note to Rho Management
Trust I for financing in the principal amount of $1,000,000 bearing interest at
12% and maturing on January 1, 2000. The Company repaid the note and interest
due thereon from the proceeds of its initial public offering.
The Company anticipates that it will have negative cash flows for the
foreseeable future. It is estimated that the Company will need to provide for
items such as computer storage, production equipment, distribution equipment,
hardware and software for computer systems, and furniture and fixtures. The
Company expects to fund its purchase of necessary capital equipment with its
working capital and the proceeds from its initial public offering.
At June 30, 1999, the Company had $975,569 in cash and cash equivalents
compared to $972,954 for June 30, 1998. The Company believes that the net
proceeds from its prior financings, its initial public offering, and cash flows
from operations, will be adequate to satisfy its operations, working capital and
capital expenditure requirements for at least the next 12 months, although it
may seek to raise additional capital during that period. There can be no
assurance that additional financing will be available on acceptable terms, if at
all, or that any additional financing will not dilute shares held by
musicmaker.com's stockholders.
Year 2000 System Costs
Computer systems, software packages and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives. The
problem affects those systems or products that are programmed to accept a two-
digit code in date code fields. To correctly identify the year 2000, a four-
digit date code field will be required to be what is commonly termed "year 2000
compliant."
14
<PAGE>
The Company may realize exposure and risk if the systems it relies upon to
conduct day-to-day operations are not year 2000 compliant. The potential areas
of exposure include electronic data exchange systems operated by third parties
with whom the Company transacts business, products purchased from third parties
and computers, software, telephone systems and other equipment used internally.
To minimize the potential adverse effects of the year 2000 problem,
musicmaker.com established an internal project team comprised of all functional
disciplines. This project team has begun a three-phase process of:
. identifying our internal information and non-information technology
systems that are not year 2000 compliant,
. determining their significance in the effective operation of the
Company, and
. developing plans to resolve the issues where necessary.
The Company has been communicating with its suppliers and others with whom
it does business to coordinate year 2000 readiness. The responses received by
the Company to date indicate that steps are currently being taken to address
this concern. However, if those third parties are not able to make all systems
year 2000 compliant, there could be a material adverse impact on the Company's
operations. For example, the Company relies on credit card companies to collect
the majority of its revenues. Failure of these credit card vendors or other
third party equipment or software to properly process dates for the year 2000
and thereafter could result in unanticipated expenses or losses of revenues.
Moreover, the Company's business is heavily dependent upon the continued
successful operation of the Internet and any interruption or degradation of
Internet operations due to year 2000 problems could materially harm the
Company's business.
After initial review of the Company's principal transaction processing
software through which nearly all of the Company's business is transacted,
management does not anticipate any material adverse operational issues to arise
as a result of the year 2000. Based on current estimates, management expects
that the Company's future costs in connection with its year 2000 compliance
project will not exceed $10,000; however, future anticipated costs are difficult
to estimate with any certainty and may differ materially from those currently
projected based on the results of phase one of the Company's year 2000 project.
The anticipated costs associated with the Company's year 2000 compliance program
do not include time and costs that may be incurred as a result of any potential
failure of third parties to become year 2000 compliant or costs to implement the
Company's future contingency plans. The Company has not yet developed a
contingency plan in the event that any non-compliant critical systems are not
remedied by January 1, 2000, nor has it formulated a timetable to create a
contingency plan. Upon completion of our review, if systems material to the
Company's operations have not been made year 2000 compliant in a timely manner,
the year 2000 issue could have a material adverse effect on musicmaker.com's
business, financial condition and results of operations.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
Foreign Currency Risk
Currently the majority of the Company's sales and expenses are denominated
in U.S. dollars and as a result, foreign exchange gains and losses to date have
been insignificant. While the Company may effect some transactions in foreign
currencies during 1999, it does not expect that
15
<PAGE>
any related gains or losses will be significant. The Company has not engaged in
foreign currency hedging to date.
16
<PAGE>
PART II
OTHER INFORMATION
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
- -------------------------------------------------
On July 6, 1999 the Company's Registration Statement on Form S-1 (333-
72685) pertaining to its initial public offering of 8,400,000 shares of the
Company's common stock, par value $0.01, was declared effective by the
Securities and Exchange Commission.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
The Company submitted a written consent of the stockholders of
musicmaker.com, Inc. for approval by at least a majority of all of the
stockholders of the Company, which consent was signed by a majority of the
stockholders as of June 9, 1999. The following is a brief description of the two
matters submitted to the stockholders for their approval and the number of votes
cast for and the number of votes abstained with respect to these matters:
(a) The stockholders approved the proposed amendment to the Certificate of
Incorporation to effect a split of the Company's Common Stock and to increase
the number of authorized shares of Common Stock. All numbers below reflect the
one-for-3.85 reverse stock split effected on April 8, 1999, but do not reflect
the 2.33-for-one stock split effected on June 14, 1999:
Common and Preferred Stock voted for: 8,780,477
Common and Preferred Stock abstaining: 1,509,879
(b) The stockholders approved the increase in authorized shares available for
issuance under the Company's stock option plan. All numbers below reflect the
one-for-3.85 reverse stock split effected on April 8, 1999, but do not reflect
the 2.33-for-one stock split effected on June 14, 1999:
Common and Preferred Stock voted for: 8,780,477
Common and Preferred Stock abstaining: 1,509,879
The Company submitted the same matters to the preferred stockholders
of the Company separately by written consent of the stockholders of preferred
stock of musicmaker.com, Inc. for approval by the preferred stockholders in
accordance with a certain Securities Purchase Agreement dated December 7, 1997.
The written consent of the stockholders of preferred stock of musicmaker.com,
Inc. was signed by all of the preferred stockholders as of June 9, 1999,
resulting in 819,199 votes for the proposal and no votes abstaining. The
outstanding preferred stock automatically converted into Common Stock as of the
completion of the IPO.
ITEM 5 - OTHER INFORMATION
- --------------------------
On July 25, 1999, the Company entered into a letter of intent with
Tunes.com, Inc. to form a strategic marketing and e-commerce relationship.
Tunes.com is a Web-based provider of music and music related content through its
online network. The letter of intent provides that musicmaker.com will be the
exclusive provider of custom CD compilations to the Tunes.com
17
<PAGE>
Web sites and will have the non-exclusive right to sell music recordings which
may be downloaded from the Tunes.com Web sites. In exchange for these rights,
musicmaker.com will purchase advertising on the Tunes.com Web sites in the
amount of $1.0 million each year for a period of five years. In addition, the
Company will pay a sales commission on all sales of musicmaker.com CDs and
downloads of recorded music purchased from the Tunes.com Web sites. This
marketing agreement will have an initial term of five years. Under the letter of
intent, Tunes.com will also exchange 357,143 shares of its common stock, with an
estimated value of $5.0 million based on its assumed initial public offering
price of $14.00 per share for common stock of musicmaker.com having a value of
approximately $5.0 million. The letter of intent and this transaction are
subject to further approvals, and the negotiation and execution of definitive
agreements. The Company expects to execute these agreements and close the
private placement of common stock with Tunes.com during the third quarter of
1999. However, there is no assurance that this transaction will close.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
A. Exhibits required by Item 601 of Regulation S-K:
Exhibit 27: Financial Data Schedule.
B. Reports on Form 8-K:
None.
18
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) 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.
MUSICMAKER.COM, INC.
By: /s/ ROBERT P. BERNARDI
----------------------------------
Robert P. Bernardi
Co-Chief Executive Officer
Chairman of the Board of Directors
/s/ MARK A. FOWLER
-------------------------------
Mark A. Fowler, CPA
Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
Date: August 23, 1999
19
<PAGE>
EXHIBIT INDEX
-------------
Exhibit 27: Financial Data Schedule.
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR QUARTERLY PERIOD ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 975,569
<SECURITIES> 0
<RECEIVABLES> 52,687
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,337,760
<PP&E> 991,201
<DEPRECIATION> 305,979
<TOTAL-ASSETS> 90,129,817
<CURRENT-LIABILITIES> 3,823,144
<BONDS> 0
2,858,994
0
<COMMON> 220,677
<OTHER-SE> 81,055,573
<TOTAL-LIABILITY-AND-EQUITY> 81,276,250
<SALES> 67,831
<TOTAL-REVENUES> 67,831
<CGS> 630,150
<TOTAL-COSTS> 630,150
<OTHER-EXPENSES> 4,784,685
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 78,920
<INCOME-PRETAX> (5,480,212)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,480,212)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,480,212)
<EPS-BASIC> (0.63)
<EPS-DILUTED> (0.63)
</TABLE>
