<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 September 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)
<TABLE>
<S> <C>
Delaware 54-1811721
-------- ----------
(State or Other Jurisdiction of Incorporation) (I.R.S. Employer Identification No.)
1831 Wiehle Avenue, Suite 128, Reston, VA 20190
- ------------------------------------------ -----
(Address of Principal Executive Office) (Zip Code)
</TABLE>
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 [X] No [_]
As of November 8, 1999, 32,993,503 shares of the issuer's common stock, par
value $0.01 per share, were outstanding.
<PAGE>
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Item 1 Financial Statements
Consolidated Balance Sheets
September 30, 1999 (unaudited) and December 31, 1998.......... 2
Consolidated Statements of Operations (unaudited)
Three and nine month periods ended September 30, 1999
and 1998...................................................... 3
Consolidated Statements of Cash Flows (unaudited)
Nine month periods ended September 30,1999 and 1998........... 4
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations................. 9
Item 3 Quantitative and Qualitative Disclosures
About Market Risk............................................. 16
PART II - OTHER INFORMATION
Item 1 Legal Proceedings............................................. 17
Item 2 Changes in Securities and Use Of Proceeds..................... 17
Item 3 Defaults Upon Senior Securities............................... 18
Item 4 Submission of Matters to a Vote of Securities Holders......... 18
Item 5 Other Information............................................. 18
Item 6 Exhibits and Reports On Form 8-K.............................. 18
Signatures.................................................... 19
</TABLE>
1
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musicmaker.com, Inc.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
ASSETS (unaudited)
---------------- ---------------
Current assets:
<S> <C> <C>
Cash and cash equivalents....................................... $ 67,670,833 $ 972,954
Accounts receivable............................................. 91,543 17,510
Related party accounts receivable............................... 81,519 81,519
Prepaid expenses and other current assets....................... 915,863 25,395
--------------- ---------------
Total current assets.......................................... 68,759,758 1,097,378
Property and equipment, net....................................... 854,847 360,709
Investments....................................................... 750,000 750,000
Intangibles, net.................................................. 103,918,487 967,395
Other assets...................................................... 1,391,815 58,481
--------------- ---------------
Total assets.................................................. $ 175,674,907 $ 3,233,963
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable................................................ $ 522,832 $ 455,095
Accrued expenses................................................ 1,104,593 261,974
Accrued compensation payable to related parties................. 289,598 625,219
Current portion of long-term obligations........................ 42,857 42,857
--------------- ---------------
Total current liabilities..................................... 1,959,880 1,385,145
Long-term obligations............................................. 171,429 214,286
Convertible notes payable......................................... -- 512,500
Commitments.......................................................
Mandatory redeemable convertible preferred stock,
$0.01 par value 5,959,509 shares authorized:
Series A convertible preferred stock, 0 and 1,059,089
shares designated, issued and outstanding................... -- 1,026,682
Series B convertible preferred stock, 2,017,317
shares designated, 0 and 849,640 issued and outstanding..... -- 1,750,100
Stockholders' equity (deficit):
Common stock, $0.01 par value, 100,000,000
shares authorized; 32,993,503 and 6,309,493
shares issued and outstanding................................ 329,934 63,095
Additional paid-in capital..................................... 193,151,257 4,739,658
Warrants....................................................... 779,059 779,059
Accumulated deficit............................................ (20,716,652) (7,236,562)
Total stockholders' equity (deficit).......................... 173,543,598 (1,654,750)
--------------- ---------------
Total liabilities and stockholders' equity (deficit).......... $ 175,674,907 $ 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 Nine months ended
September 30, September 30,
--------------------------- --------------------------
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales $ 189,091 $ 12,035 $ 256,921 $ 45,150
Cost of sales
Product........................ 43,283 1,804 59,584 19,776
Content........................ 725,068 80,679 1,338,916 405,822
----------- ----------- ------------ ------------
Gross profit.................... (579,260) (70,448) (1,141,579) (380,448)
----------- ----------- ------------ ------------
Operating expenses:
Sales and marketing............ 1,574,731 116,312 2,710,258 787,614
Operating and development...... 414,501 182,789 1,066,140 598,585
General and administrative..... 1,387,154 694,253 2,785,915 1,375,897
Amortization................... 4,709,613 -- 6,308,370 --
----------- ----------- ------------ ------------
8,085,999 993,354 12,870,683 2,762,096
----------- ----------- ------------ ------------
Loss from operations............ (8,665,259) (1,063,802) (14,012,262) (3,142,544)
Other income (expense):
Interest income................ 702,280 6,630 730,204 14,382
Interest expense............... (240,252) -- (319,173) --
----------- ----------- ------------ ------------
462,028 6,630 411,031 14,382
----------- ----------- ------------ ------------
Net loss........................ (8,203,231) (1,057,172) (13,601,231) (3,128,162)
Accretion for Series A
preferred stock warrants....... (641,106) (41,918) (723,318) (76,133)
----------- ----------- ------------ ------------
Net loss available to common
stockholders................... $(8,844,337) $(1,099,090) $(14,324,549) $(3,204,295)
=========== =========== ============ ============
Basic and diluted, net loss per
common share (Note 4)......... $ (0.29) $ (0.23) $ (0.89) $ (0.67)
=========== =========== ============ ============
Weighted average shares
outstanding................... 30,987,815 4,808,616 16,142,522 4,796,445
=========== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of these statements
3
<PAGE>
musicmaker.com, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months ended
September 30,
----------------------------
1999 1998
------ ------
Operating activities
<S> <C> <C>
Net loss......................................................... $ (13,601,231) $ (3,128,162)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation................................................... 174,000 89,779
Amortization................................................... 6,308,371 --
Services received in exchange for stock and warrants........... 679,597 398,263
Changes in operating assets and liabilities:
Accounts receivable.......................................... (74,034) (57,209)
Prepaid expenses and other current assets.................... (223,802) (114,015)
Other assets................................................. -- (63,891)
Intangibles.................................................. 221,977 --
Accounts payable............................................. 67,737 56,609
Accrued expenses............................................. 842,619 174,200
Accrued compensation payable to related parties.............. (335,622) (148,541)
Long-term obligation......................................... (42,857) 214,286
------------- -------------
Net cash used in operating activities...................... (5,983,245) (2,578,681)
------------- -------------
Investing activities
Purchases of property and equipment.............................. (668,137) (318,249)
------------- -------------
Net cash used in investing activities...................... (668,137) (318,249)
------------- -------------
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......................................... 72,035,636 220,576
------------- -------------
Net cash provided by financing activities.................. 73,349,261 1,754,392
------------- -------------
Net increase (decrease) in cash and cash equivalents............. 66,697,879 (1,142,538)
Cash and cash equivalents at beginning of period................. 972,954 1,401,982
------------- -------------
Cash and cash equivalents at end of period....................... $ 67,670,833 $ 259,444
------------- -------------
Non-cash activities
Common stock issued for licensing agreements..................... $ 109,306,860 $ --
============= =============
Conversion of notes payable and preferred stock to common stock $ 5,500,100 --
============= =============
Loan fees on converted notes payable............................. $ 221,977
============= =============
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
<PAGE>
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 its mail-order promotions with
marketing partners, allow customers to order custom compiled music CDs.
Customers can also digitally download songs from the Company's online music
library directly to their personal computers.
Basis of Presentation
The financial statements as of September 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 September 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.
Cash and Cash Equivalents
For the purposes of the consolidated statements 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.
5
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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.
Advertising Expense
Advertising costs are included in sales and marketing expenses and are charged
to expense as incurred. Such costs were $1,131,576 and $1,308,529 for the three
and nine-month periods ended September 30, 1999, respectively. For the three
and nine-month periods ended September 30, 1998 advertising costs were $6,253
and $308,461, respectively.
Initial Public Offering
On July 7, 1999 the Company consummated an initial public offering of its common
stock. The Company sold 5,327,803 shares of its common stock, $0.01 par value,
at an initial public offering price of $14.00 per share. After deducting the
underwriters' discounts and commissions and other offering expenses, the net
proceeds to the Company were approximately $66,300,000. On August 3, 1999, the
underwriters exercised their overallotment option for the purchase of an
additional 360,000 shares of Common Stock. After deducting underwriters'
discounts and other offering expenses, the net proceeds from the over-allotment
to the Company were approximately $4,600,000.
Note 2. -- Convertible Notes Payable and Long-term Obligations
In October 1998, the Company initiated an offering for approximately $2,000,000
in aggregate principle 8% convertible secured subordinate promissory notes which
were mandatorily converted into 968,252 shares of the Company's common stock
upon the closing of the initial public offering (See Note 3). The conversion
price was $2.06 per share of common stock.
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 was paid in full at September 30, 1999.
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 from the
proceeds of the initial public offering (See note 3).
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.
6
<PAGE>
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 shares. 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 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.
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 $66,300,000. On August 3, 1999, the underwriters exercised their
overallotment option for the purchase of an additional 360,000 shares of common
stock. After deducting underwriters' discounts and other offering expenses, the
net proceeds from the over-allotment to the Company were approximately
$4,600,000.
On August 16, 1999, Boston Financial exercised its warrant to purchase 14,524
shares of the Company's common stock, par valve $0.01 at a price of $2.065 per
share. Proceeds from this exercise to the Company totaled $30,000.
On August 23, 1999, the Company issued 1,937,008 shares of its common stock, par
value $0.01, with a market value of $20,000,000 upon issuance, to Zomba Record
Holdings B.V. ("Zomba"). Zomba is the direct or indirect parent entity of a
number of licensor entities with which the Company entered into license
agreements granting rights to use certain music content for a five-year term.
On August 24, 1999, the Company issued 275,000 shares of its common stock, par
value $0.01, with a market value of $4,064,500 upon issuance, to TeeVee Toons,
Inc. in exchange for a five-year license agreement granting the Company certain
rights as licensee to TeeVee Toons library of master recordings.
7
<PAGE>
On September 17, 1999, the Company entered into an interactive marketing
agreement with America Online, Inc. ("AOL"). This agreement provides for
America Online to promote and distribute an interactive co-branded website and
the Company's products and services on certain portions of the AOL Network and
in connection with certain America Online products and services. In connection
with this agreement, the Company issued 134,454 shares of its common stock, par
value $0.01, with a market value of $2,000,000 upon issuance, and agreed to pay
an initial marketing fee of $3,000,000 which was subsequently paid on October
17,1999. Quarterly payments by the Company of $1,500,000 are due for the
remainder of the contract (through the quarter ending September 30, 2002).
America Online also is entitled to receive certain proportionate payments in
connection with the Company's sales through the co-branded website.
Note 4. - Net Loss Per Share
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------------- -----------------------------
1999 1998 1999 1998
------- ------- -------- -------
Numerator:
<S> <C> <C> <C> <C>
Net loss $(8,203,231) $(1,057,172) $(13,601,231) $(3,182,162)
Less:
accretion of Series A preferred stock warrants (641,106) (41,918) (723,318) (76,133)
------------ ------------ ------------ -----------
Net loss available to common shareholders $(8,844,337) $(1,099,090) $(14,324,549) $(3,204,295)
============ ============ ============ ===========
Denominator:
Weighted-average shares outstanding 30,987,815 4,808,616 16,142,522 4,796,445
============ ============ ============ ===========
Basic and diluted net loss per common share $ (0.29) $ (0.23) $ (0.89) $ (0.67)
============ ============ ============ ===========
</TABLE>
8
<PAGE>
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, Inc. ("EMI"). 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.
In September 1999, the Company entered into an interactive marketing agreement
with America Online, Inc. ("AOL") under which AOL has agreed to promote and
distribute the Company's services and products to its user base. The parties
have also agreed to establish and
9
<PAGE>
share net profits generated under a co-branded interactive website through which
AOL users can purchase the Company's custom CDs and digital downloads. In
exchange for the Company's rights hereunder, 134,454 shares of common stock were
issued to AOL. In addition, the Company made an initial $3,000,000 marketing
payment to AOL and agreed to make additional quarterly payments of $1,500,000
for marketing efforts through September 30, 2002.
The Company's net sales are primarily derived from the sale of custom CDs
offered over the Internet and through advertising direct mail campaigns and the
sale of individual songs downloaded directly from the Company's website. Net
sales are net of sales discounts and include shipping and handling charges.
Customer accounts are settled by directly charging a customer's credit card or
by offering credit to pre-qualified customers through the Company's agreement
with Columbia House, and receiving cash and money orders in connection
therewith. 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.
10
<PAGE>
Results of Operations
The following table sets forth, for the periods presented, certain data
derived from our unaudited statements of operations as percentages of net sales.
The operating results in any period are not necessarily indicative of the
results that may be expected for any future period.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
---------------------- ---------------------
1999 1998 1999 1998
------- -------- ------- -------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales-product 22.9 15.0 23.2 43.8
Cost of sales-content 383.4 670.4 521.1 898.8
---------- ---------- ---------- ----------
Gross profit -306.3 -585.4 -444.3 -842.6
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing 832.8 966.4 1054.9 1744.4
Operating and development 219.2 1518.8 415.0 1325.8
General and administrative 733.6 5768.6 1084.3 3047.4
Amortization 2490.7 -- 2455.4 --
---------- ---------- ---------- ----------
4276.2 8253.9 5009.6 6117.6
---------- ---------- ---------- ----------
Loss from operations -4582.6 -8839.2 -5453.9 -6960.2
Other income (expense):
Interest income 371.4 55.1 284.2 31.9
Interest expense -127.1 -- -124.2 --
---------- ---------- ---------- ----------
244.3 55.1 160.0 31.9
---------- ---------- ---------- ----------
Net loss -4338.2 -8784.1 -5293.9 -6928.4%
Accretion for Series A
preferred stock warrants -339.0 -348.3 -281.5 -168.6
---------- ---------- ---------- ----------
Net loss available to common stockholders -4677.3% -9132.4% -5575.5% -7097.0%
========== ========== ========== ==========
</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 1,471% and 469%, to $189,091 and $256,921,
respectively, for the three and nine months ended September 30, 1999 compared to
$12,035 and $45,150 for the three and nine months ended September 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 continued 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 832% and 229% to $768,351 and $1,398,500, respectively,
for the three and nine months ended September 30, 1999 compared to $82,483 and
$425,598 for the three and
11
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nine months ended September 30, 1998, respectively. Cost of sales consist
primarily of royalty advances that were paid upon signing of royalty agreements
with independent music labels of $725,068 and $1,338,916 for the three and nine
months ended September 30, 1999 respectively, compared to $80,679 and $405,822
for the three and nine months ended September 30, 1998, respectively.
Operating and Development Expenses. Operating and development expenses
increased 127% and 78% to $414,501 and $1,066,140, respectively, for the three
and nine months ended September 30, 1999 compared to $182,789 and $598,585 for
the three and nine months ended September 30, 1998, respectively. 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, consulting costs, and payroll and
related expenses. The Company expenses all advertising costs as incurred.
Sales and marketing expenses increased 1,254% and 244% to $1,574,731 and
$2,710,258, respectively, for the three and nine months ended September 30,
1999, compared to $116,312 and $787,614 for the three and nine months ended
September 30, 1998, respectively. The increase is primarily attributable to
increased advertising expenses in connection with the Columbia House print
promotion, online promotions, and third party advertising services. Sales and
marketing expenses are expected to continue to increase as the Company promotes
its expanding music library utilizing the promotions referred to above as well
as radio advertising. 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 given 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 and Amortization Expense. General and
administrative expenses consist primarily of legal and professional fees,
payroll costs and related expenses for 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. Excluding amortization, general and administrative expenses
increased 100% and 103% to $1,387,154 and $2,785,915, respectively, for the
three and nine months ended September 30, 1999, compared to $694,253 and
$1,379,857 for the three and nine months ended September 30, 1998, respectively.
The increase in general and administrative expenses was primarily due to an
increase in personnel to support the Company's expanding operations. As a
result, salaries and wages, benefits, and other employee related costs increased
as well as recruiting and payments to temporary personnel agencies. Rent,
equipment expenses, and office expenses also increased as a result of the
expansion. Amortization expense increased to $4,709,613 and $6,308,370 for the
three and nine months ended September 30, 1999 respectively, compared to none
for the three
12
<PAGE>
and nine months ended September 30, 1998. The increase in amortization of
intangibles was due primarily to the amortization of the license fees with EMI
and Zomba.
Interest Expense/Income. Interest income was $702,280 and $730,204,
respectively, for the three and nine months ended September 30, 1999 compared to
$6,630 and $14,382, respectively, for the three and nine months ended September
30, 1998. The increase in interest income is due to the higher level of
invested funds available as a result of the Company's IPO. Interest expense for
the three and nine months ended September 30, 1999 was $240,252 and $319,173,
respectively, compared to no interest expense for the three and nine months
ended September 30, 1998. The interest expense for the three and nine months
ended September 30, 1999 is attributable to the interest associated with the
Company's outstanding convertible notes that were converted to common stock upon
consummation of the Company's IPO in the third quarter of the current year.
Accretion of Preferred Stock Warrants. Upon completion of the IPO, all
outstanding shares of Series A, Series B and Series C convertible preferred
stock were converted into 1,908,729 shares of common stock and all outstanding
convertible notes payable were converted into 968,252 shares of common stock.
Upon conversion of the Series A preferred stock into common stock, the remaining
discount of $641,106 on the Series A preferred stock was recorded as accretion.
Accretion recorded for the nine-month period ending September 30, 1999 was
$730,204. The accretion for the three and nine month periods ended September
30, 1998 was $41,918 and $76,133, respectively. The accretion did not affect
the Company's cash flows. The Series B and Series C preferred stock warrants
converted into common stock warrants upon completion of the IPO.
Liquidity and Capital Resources
Net cash used in operating activities was $5,983,245 for the nine months ended
September 30, 1999 compared to $2,578,681 for the nine months ended September
30, 1998. The net loss of $13,601,31 for the current year was offset
significantly by non-cash charges of $7,383,945 including depreciation and
amortization of $6,482,371, primarily in connection with the EMI license.
Increases in accounts payable and accrued expenses were offset by increased
receivables and prepaid expenses and a decrease in deferred compensation.
Cash used in investing activities was $668,137 for the nine months ended
September 30, 1999 and $318,249 for the nine months ended September 30, 1998.
In both periods the cash used in investing activities was 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 $73,349,261 for the nine months
ended September 30, 1999 compared to $1,754,392 for the nine months ended
September 30, 1998. Net cash provided by financing activities for the nine
months ended September 30, 1999 was primarily through the issuance of common
stock through an initial public offering for $79,629,242, net of underwriters'
fees and commissions and expenses of $8,739,970. Net cash provided by financing
activities for the nine months ended September 30, 1998 was primarily through
the issuance of convertible preferred stock for $1,533,816. Proceeds from the
issuance of common stock were $220,576 for the nine months ended September 30,
1998.
13
<PAGE>
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, all of which were exercised in August, 1999. 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 the 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 and excluding
previously leased equipment. The line has financial covenants, including
minimum net worth and liquidity ratios. At September 30, 1999, no balance was
outstanding under this line of credit.
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 in
connection with the negotiation. 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
an estimated fair market value of our common stock, as determined by the
Company's Board of Directors, to be $5.71 per share in exchange for a five-year
license which provides us with exclusive rights to use the content EMI makes
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.
On July 1, 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 IPO.
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 IPO.
14
<PAGE>
At September 30, 1999, the Company had $67,670,830 in cash and cash
equivalents compared to $972,954 for September 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.''
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, the Company
established a year 2000 internal project team comprised of all functional
disciplines. This project team is managing 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 examining 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. Historical and estimated costs of remediation to this point
have not been material; 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
15
<PAGE>
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.
At the current time, the Company's Year 2000 readiness plan anticipates that
all systems and applications will be Year 2000 compliant. This assessment is
based on the year 2000 project team's analysis to date and detailed findings at
its Reston, Virginia corporate and operations headquarters. There can be no
assurance, however, of complete compliance based on the status to date. It is
unlikely that any single system will have an adverse effect on the Company as a
whole. Contingency plans will involve the procurement of standardized
commercial off-the-shelf replacement modules for internal applications and
business functions as well as replacing non-compliant third party software with
software that is year 2000 compliant. At present there are no indications that
contingency plans will be necessary or that there will be revenue disruptions,
however, there can be no assurances that this will necessarily be the case.
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 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 1 - LEGAL PROCEEDINGS
- --------------------------
None.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------
On July 7, 1999, the Company consummated an initial public offering of its
common stock, $.01 par value, (the "Common Stock"). The registration statement
on Form S-1 (333-72685) relating to this offering was declared effective on July
6, 1999 by the Securities and Exchange Commission. Ferris, Baker Watts,
Incorporated was the managing underwriter of the Offering. On July 12, 1999,
the company, a selling stockholder participating in the offering and the
underwriters held a closing for the sale of 8,400,000 shares at an offering
price of $14.00 per share, allocated between the Company and the selling
stockholder as noted below. On August 6, 1999 the underwriters exercised their
overallotment option for the purchase of an additional 360,000 shares of common
stock to be sold solely by the Company at $14.00 per share. The number of
shares registered, the aggregate price of the offering amount registered, the
amount sold and the aggregate offering price of the amount sold by the Company
and a selling shareholder of the Company in the Offering were as follows:
<TABLE>
<CAPTION>
Shares Aggregate Price Amount Aggregate Price
Registered Registered Sold Sold
---------------- ----------------- -------------- ----------------
<S> <C> <C> <C> <C>
The Company 6,587,803 $92,229,242 5,687,803 $79,629,242
The Selling Shareholders 3,072,197 43,010,758 3,072,197 43,010,758
</TABLE>
The Company incurred the following expenses with respect to the offering
through August 6, 1999, none which were direct or indirect payments to
directors, officers, general partners of the Company or their associates or to
persons owning 10% or more of any class of equity securities of the Company or
to affiliates of the Company:
<TABLE>
<CAPTION>
Underwriting Discounts Underwriters' Other Total
and Commissions Expenses Expenses Expenses
- -------------------------- --------------- ----------------- ----------------
<S> <C> <C> <C>
$6,825,447 0 $1,914,523 $8,739,970
</TABLE>
The net offering proceeds to the Company after deducting the foregoing
discounts, commissions, fees and expenses were $70,889,272. An estimate of how
these proceeds have been applied by the Company during the period July 7, 1999
through September 30, 1999 is as follows:
<TABLE>
<S> <C>
Purchase and installation of machinery and equipment 229,624
Repayment of indebtedness 1,592,505
Online and Traditional Advertising 1,131,575
Strategic Alliances 725,068
</TABLE>
The remainder of the offering proceeds have been either allocated for working
capital purposes or have or have been invested in money market accounts.
17
<PAGE>
ITEM 3 -- DEFAULTS UPON SENIOR SECURITIES
- -----------------------------------------
None.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
- ---------------------------------------------------------------
None.
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. On November 1,
1999 this agreement was terminated.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
A. Exhibits required by Item 601 of Regulation S-B:
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: November 12, 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 SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 67,670,833
<SECURITIES> 0
<RECEIVABLES> 91,543
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 68,759,758
<PP&E> 1,220,826
<DEPRECIATION> 365,979
<TOTAL-ASSETS> 175,674,907
<CURRENT-LIABILITIES> 1,959,880
<BONDS> 0
0
0
<COMMON> 329,934
<OTHER-SE> 173,213,664
<TOTAL-LIABILITY-AND-EQUITY> 175,674,907
<SALES> 256,921
<TOTAL-REVENUES> 256,921
<CGS> 1,398,500
<TOTAL-COSTS> 1,398,500
<OTHER-EXPENSES> 12,870,683
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 319,173
<INCOME-PRETAX> (14,324,549)
<INCOME-TAX> 0
<INCOME-CONTINUING> (14,324,549)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,324,549)
<EPS-BASIC> (0.89)
<EPS-DILUTED> (0.89)
</TABLE>
