<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ___________ to _______________.
COMMISSION FILE NUMBER: 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)
1740 Broadway, 23/rd/ floor, New York, NY 10019
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code (212) 265-8818
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to the filing
requirements for the past 90 days. Yes [X] No [ ]
As of August 11, 2000, 33,140,421 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 JUNE 30, 2000
TABLE OF CONTENTS
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Page
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PART I - FINANCIAL INFORMATION
Item 1 Condensed Financial Statements
Condensed Balance Sheets
June 30, 2000 (unaudited) and December 31, 1999....................................... 2
Condensed Statements of Operations (unaudited)
Three and six month periods ended June 30, 2000 and 1999.............................. 3
Condensed Statements of Cash Flows (unaudited)
Six month periods ended June 30, 2000 and 1999........................................ 4
Notes to the Condensed Financial Statements (unaudited)............................... 5
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations............................................ 8
Item 3 Quantitative and Qualitative Disclosures
About Market Risk........................................................................ 15
PART II - OTHER INFORMATION
Item 1 Legal Proceedings........................................................................ 16
Item 2 Changes in Securities and Use Of Proceeds................................................ 17
Item 3 Defaults Upon Senior Securities.......................................................... 17
Item 4 Submission of Matters to a Vote of Securities Holders.................................... 17
Item 5 Other Information........................................................................ 17
Item 6 Exhibits and Reports On Form 8-K......................................................... 18
Signatures............................................................................... 19
</TABLE>
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Musicmaker.com, Inc
ITEM 1 - CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------------ ------------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents........................................... $ 35,694,199 $ 58,290,808
Accounts receivable................................................. 1,553,185 528,958
Prepaid expenses and other current assets........................... 5,978,331 1,459,923
----------------- -----------------
Total current assets............................................ 43,225,715 60,279,689
Property and equipment, net.............................................. 5,165,730 2,447,728
Investments.............................................................. --- 750,000
Intangibles, net......................................................... 87,657,134 98,363,455
Related party accounts receivable........................................ 84,780 81,519
Other assets............................................................. 4,306,059 3,477,829
----------------- -----------------
Total assets.................................................... $ 140,439,418 $ 165,400,220
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................... $ 841,027 $ 1,706,778
Accrued expenses.................................................... 1,575,263 2,109,385
Deferred revenues................................................... 1,910,031 125,000
Current portion of long-term obligations............................ 42,857 42,857
Other current liabilities........................................... 65,727 ---
----------------- -----------------
Total current liabilities....................................... 4,434,905 3,984,020
Long-term obligations.................................................... 128,572 171,429
Other long-term liabilities.............................................. 64,812 ---
Stockholders' equity:
Common stock, $0.01 par value, 100,000,000
shares authorized; 33,140,421 and 32,993,503
shares issued and outstanding.................................. 331,404 329,934
Additional paid-in capital......................................... 194,231,166 193,945,928
Warrants........................................................... 779,059 779,059
Accumulated deficit................................................ (59,530,500) (33,810,150)
----------------- -----------------
Total stockholders' equity...................................... 135,811,129 161,244,771
----------------- -----------------
Total liabilities and stockholders' equity...................... $ 140,439,418 $ 165,400,220
================= =================
</TABLE>
The accompanying notes are an integral part of these condensed statements
2
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Musicmaker.com, Inc.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
------------------------------------ -------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 1,219,209 $ 47,671 $ 4,305,289 $ 67,831
Cost of sales
Product.......................... 446,164 11,838 1,728,842 16,302
Content.......................... 1,127,467 155,029 2,104,666 613,848
------------------------------------ -------------------------------------
Gross margin........................ (354,422) (119,196) 471,781 (562,319)
Operating expenses:
Sales and marketing.............. 5,293,544 875,679 8,854,923 1,135,529
Operating and development........ 563,930 398,384 1,305,153 651,639
General and administrative....... 2,031,927 591,628 4,657,678 1,258,489
Depreciation and amortization.... 5,836,645 1,581,259 11,528,171 1,739,028
Loss on investment............... 1,200,000 --- 1,200,000 ---
------------------------------------ -------------------------------------
14,926,046 3,446,950 27,545,925 4,784,685
------------------------------------ -------------------------------------
Loss from operations................ (15,280,468) (3,566,146) (27,074,144) (5,347,004)
Other income (expense):
Interest income.................. 631,577 11,385 1,353,794 27,924
Interest expense................. --- (38,514) --- (78,920)
------------------------------------ -------------------------------------
631,577 (27,129) 1,353,794 (50,996)
------------------------------------ -------------------------------------
Net loss............................ (14,648,891) (3,593,275) (25,720,350) (5,398,000)
Accretion for Series A
preferred stock warrants......... --- (41,106) --- (82,212)
------------------------------------ -------------------------------------
Net loss available to common
stockholders..................... $ (14,648,891) $ (3,634,381) $ (25,720,350) $ (5,480,212)
==================================== =====================================
Basic and diluted, net loss per
common share (Note 3).......... $ (0.44) $ (0.34) $ (0.78) $ (0.63)
==================================== =====================================
Weighted average shares
outstanding.................... 33,140,421 10,605,305 33,093,705 8,695,412
==================================== =====================================
</TABLE>
The accompanying notes are an integral part of these condensed statements
3
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Musicmaker.com, Inc.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six months ended
June 30,
2000 1999
------------------ ------------------
<S> <C> <C>
Operating activities
Net loss.............................................................. $ (25,720,350) $ (5,398,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation....................................................... 478,906 114,000
Amortization....................................................... 11,049,265 1,625,028
Loss on investment................................................. 750,000 ---
Services received in exchange for stock and warrants............... (244,349) 669,240
Changes in operating assets and liabilities:
Accounts receivable............................................. (1,024,227) (35,177)
Prepaid expenses and other current assets....................... (4,521,669) (202,590)
Capitalized IPO fees............................................ -- (1,156,502)
Other assets.................................................... (828,230) --
Accounts payable................................................ (865,750) 1,369,619
Accrued expenses................................................ (534,122) (181,752)
Deferred revenues............................................... 1,785,031 --
Other current liabilities....................................... 65,727 1,250,131
Long-term obligations........................................... (42,857) (42,857)
Other long-term liabilities..................................... 64,812 ---
------------------ ------------------
Net cash used in operating activities....................... (19,587,813) (1,988,860)
------------------ ------------------
Investing activities
Purchases of property and equipment................................... (3,196,909) (438,513)
------------------ ------------------
Net cash used in investing activities....................... (3,196,909) (438,513)
------------------ ------------------
Financing activities
Proceeds from issuance of convertible notes payable................... -- 1,487,500
Payment of fees on convertible notes payable.......................... -- (173,875)
Issuance of common stock.............................................. 188,113 1,116,363
------------------ ------------------
Net cash provided by financing activities................... 188,113 2,429,988
------------------ ------------------
Net (decrease) increase in cash and cash equivalents.................. (22,596,609) 2,615
Cash and cash equivalents at beginning of period...................... 58,290,808 972,954
------------------ ------------------
Cash and cash equivalents at end of period............................ $ 35,694,199 $ 975,569
================== ==================
Non-cash activities
Common stock issued for licensing agreements.......................... $ 50,000 $ 86,625,610
================== ==================
Issuance of warrants.................................................. $ 292,944 $ --
================== ==================
Payment on account receivable with common stock....................... $ 450,000 $ --
================== ==================
</TABLE>
The accompanying notes are an integral part of these condensed statements
4
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Musicmaker.com, Inc.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. - The Company and Certain Significant Accounting Policies
The Company
Musicmaker.com, Inc., a Delaware corporation, (the "Company") is a provider of
customized music CD compilations and music digital downloads. The Company sells
its products primarily over the Internet, as well as providing custom CDs
through marketing partners, strategic alliances and direct mail-order
promotions. Customers can also download songs from the Company's online library
directly to their personal computers. The Company has an office located in
Virginia for production and fulfillment of its music products and its corporate
headquarters are located in New York.
Basis of Presentation
The financial statements as of June 30, 2000 and 1999 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, 1999 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, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000. These financial statements should be read in conjunction with
the financial statements and the notes thereto, included in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999. Certain prior
period balances have been reclassified to conform to the current period
presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash and Cash Equivalents
For the purposes of the 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.
Another source of revenue to the Company is derived from contracts for the
integration of music content into customers' media properties. These development
fees are recognized as revenue once the related activities have been performed
and the music is available in the customer's media format. The Company
recognized $248,594 of such revenue for the six months ended June 30, 2000.
Advertising sales on banner contracts and interfaces and links to other websites
are recognized ratably over the period in which the advertisement and/or link is
displayed, provided that no significant obligations remain at the end of the
period and collection of the resulting receivable is probable. During 2000, the
Company has not earned advertising revenue.
Deferred revenue is recorded upon receipt of cash in advance from customers. The
Company recognizes revenue at the time merchandise is shipped to customers and
all obligations of the Company have been fulfilled. All of the deferred revenue
recorded to date is related to a significant revenue contract.
Cost of Sales
In accordance with Statement of Financial Accounting Standards No. 50,
"Financial Reporting in the Record and Music Industry," royalty advances and
minimum guarantees to music labels are recorded as an asset if the past
performance and current popularity of the music to which the advance relates
provide a sound basis for estimating the probable future recoupment of such
advances. Advances are then expensed as subsequent royalties are earned. Any
portion of advances that subsequently appear not to be fully recoverable from
future royalties are charged to expense during the period in which the loss
becomes evident.
The Company has included in cost of sales royalty advances that were paid upon
signing of certain initial royalty agreements with independent music labels, due
to management's expectations of minimal revenues expected during the one-year
period following the signing of the contracts. Additionally, the Company
includes in cost of sales royalty expenses incurred based on usage per music
track. Royalty charges resulted in costs of sales, related to music content, of
$1,127,467 and $155,029 for the three months ended June 30, 2000 and 1999,
respectively, and $2,104,666 and $613,848 for the six months ended June 30, 2000
and 1999, respectively. The Company is required to make additional advances upon
the anniversaries of the signing of certain contracts. During the first quarter
of 2000, the Company capitalized $4,000,000 of advance royalty payments made to
music labels that management believes will generate significant future revenues.
Of the $4,000,000 paid, $135,000 and $230,939 of royalty expense was amortized
based on the revenue generated from these labels in the first and second
quarters of 2000, respectively.
Note 2. - Platinum Entertainment, Inc. Investment
On October 1, 1999, the Company entered into a marketing agreement with Platinum
Entertainment, Inc. ("Platinum") under which Platinum purchased prominent
advertising and
6
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promotion positioning in Musicmaker's Christmas and Holiday music promotions for
the fourth quarter of 1999. In exchange for the marketing services rendered,
Platinum agreed to pay the Company $500,000 in cash or common stock of Platinum,
which form of payment was to be determined in Platinum's sole discretion.
Accordingly, on February 1, 2000, Platinum issued 166,667 shares of its
unregistered common stock, par value $.001 per share, to Musicmaker.com. The
Company discounted the value of the stock received given that it is not
registered, and recorded advertising sales and an account receivable of $450,000
at December 31, 1999. Upon receipt of the stock in February 2000, the Company
credited the $450,000 receivable and recorded an additional investment of
$450,000 in Platinum.
As a result of a decline in Platinum's stock price during the three months ended
June 30, 2000 and the fact that Platinum has been delisted by the Nasdaq Stock
Market, the Company has determined its investment in Platinum of $1,200,000 to
have only minimal value and wrote off its investment to expense in the month
ended June 30, 2000. This amount consisted of 111,457 and 166,667 unregistered
shares of Platinum stock issued to the Company on September 30, 1998 and
February 1, 2000, respectively.
Note 3. - Net Loss Per Share
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
------------------------------------ -------------------------------------
<S> <C> <C> <C> <C>
Numerator:
Net loss $(14,648,891) $(3,593,275) $(25,720,350) $(5,398,000)
Less: accretion of Series A
preferred stock warrants --- (41,106) --- (82,212)
------------------------------------ -------------------------------------
Net loss available to common
shareholders $(14,648,891) $(3,634,381) $(25,720,350) $(5,480,212)
==================================== =====================================
Denominator:
Weighted-average shares
outstanding 33,140,421 10,605,305 33,093,705 8,695,412
==================================== =====================================
Basic and diluted net loss per
common share $ (0.44) $ (0.34) $ (0.78) $ (0.63)
==================================== =====================================
</TABLE>
7
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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
quarterly report constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 including statements
concerning advance royalty payments and potential future revenues, its
expectations concerning the potential for access to tracks from EMI and Zomba,
its belief 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, its expectations for sales promotions, expectations
concerning gains or losses associated with transactions involving foreign
currencies and statements concerning the Company's release from future
obligations under an agreement with AOL. 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
and/or concern, among other things, the Company's limited operating history, the
Company's expected increase in future operating expenses, the effect of
litigation in which the Company is involved including securities class actions,
uncertainty concerning a dispute with Magix Entertainment over Musicmaker.com's
domain name, uncertainty concerning its license agreements with EMI, Zomba music
and other companies, general economic and business conditions with respect to
the Internet and online commerce, uncertainties with respect to accounting
estimates and assumptions, changes in government regulations, competition and
the ability of the Company to implement its business strategy discussed in the
Company's Annual Report on Form 10-K dated December 31, 1999, Musicmaker.com's
ability to predict trends and preferences in the changing music industry, the
amount and effectiveness of marketing and strategic relationships,
Musicmaker.com's ability to obtain music rights and to obtain such rights to
music that is in demand by music consumers, particularly that class of music
consumers who use the Internet, potential legal obstacles to obtaining rights to
music titles including restrictive contractual provisions in contracts between
artists and record companies from whom we obtain content, difficulty obtaining
and/or inability to obtain rights to music by top selling artists, the fact that
our competitors, current and future, including some of the record labels
themselves, have launched competing internet services, the availability of less
expensive or free music at other internet sites such as napster.com, the ability
of our equipment, facilities and staff in the future to produce CDs in a timely,
cost effective fashion, as well as the risks set forth in the Company's
Registration Statement filed on Form S-1 dated as of July 7, 1999 as filed with
the Securities and Exchange Commission and the Company's Annual Report on Form
10-K dated December 31, 1999 and risk factors listed from time to time in
subsequent filings.
We currently have exclusive rights under two five-year worldwide license
agreements, one with EMI and the second with Zomba, to include in online sales
of our custom CDs the content that EMI and Zomba elect to make available. Both
EMI and Zomba have provided content to us under the agreement. However, these
agreements do not obligate EMI or Zomba to grant us any content at all. In
addition, our use of content provided by EMI and Zomba may be severely limited
and restricted by EMI and Zomba in the future. EMI and Zomba can also revoke or
terminate any rights to music content previously granted. Our exclusive rights
under the license agreement automatically become non-exclusive upon the
occurrence of triggering events contained in our agreements. The agreements do
not limit or prevent EMI or Zomba or any of its affiliates from offering
directly to the public custom CDs manufactured by them, independent of
Musicmaker.com, nor does it obligate EMI or Zomba to grant us any music for
digital downloading over the Internet.
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
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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
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 Group,
plc., ("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 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 CD compilation.
Custom compilation consists of custom CDs and digitally downloaded music sold
directly to customers over the Internet and through advertising direct mail
campaigns directly from the Company's website. The Company also mass-produces
custom-made CDs to corporate businesses looking to fulfill mass promotions. 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 are required to manage the associated risks of
accounts receivable, expansion and collection. 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 also earns revenues from the sale of advertisements. The
advertising product consists of banner advertisements that appear on pages
within Musicmaker.com's web site. Hypertext links are embedded in each banner
advertisement or button to provide the user with instant access to the
advertiser's web site, to obtain additional information, or to purchase products
and services.
Another source of revenue to the Company is derived from contracts for the
integration of music content into customers' media properties. These fees are
recognized as revenue once the related activities have been performed and the
music is available in the customer's media format.
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
9
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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
its 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 and Zomba license agreements 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
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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 Six months ended
June 30, June 30,
----------------------------------------------------------
2000 1999 2000 1999
----------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales - product 36.6 24.8 40.2 24.0
Cost of sales - content 92.5 325.2 48.9 905.0
-----------------------------------------------------------
Gross margin -29.1 -250.0 10.9 -829.0
----------------------------------------------------------
Operating expenses:
Sales and marketing 434.2 1,836.9 205.7 1,674.1
Operating and development 46.3 835.7 30.3 960.7
General and administrative 166.6 1,241.1 108.2 1,855.3
Loss on investment 98.4 --- 27.9 ---
Depreciation and amortization 478.7 3,317.0 267.7 2,563.7
----------------------------------------------------------
1,224.2 7,230.7 639.8 7,053.8
----------------------------------------------------------
Loss from operations -1,253.3 -7,480.7 -628.9 -7,882.8
Other income (expense):
Interest income 51.81 23.9 31.44 41.2
Interest expense 0 -80.8 0 -116.3
----------------------------------------------------------
51.81 -56.9 31.44 -75.2
----------------------------------------------------------
Net loss -1,201.5% -7,537.7% -597.46% -7,958.0%
Accretion for Series A
preferred stock warrants --- -86.2 --- -121.2
----------------------------------------------------------
Net loss available to common stockholders -1,201.5% -7,623.9% -597.46% -8,079.2%
==========================================================
</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 to $1,219,209 and $4,305,289 for the three and six
months ended June 30, 2000, respectively, compared to $47,671 and $67,831 for
the three and six months ended June 30, 1999, respectively. The growth of net
sales is primarily attributable to two sources. Revenue from the sales of custom
CDs and digital downloads sold directly to customers from the Company's website
rose significantly in the first and second quarters of 2000. The continued
expansion of our music library and involvement with Columbia House, Microsoft
and other strategic partners, which provided heavier Internet traffic and access
to additional customer bases contributed to the growth in sales. The second area
of revenue growth came from the large volume sales derived from contracts with
corporate businesses looking to fulfill mass promotions. In the second quarter
of 2000 the Company recorded revenue from the fulfillment of promotional sales
of just over $98,070 or 8% of total revenue as compared to $2,060,203 or 67% in
the first quarter of 2000. The decline in revenue from promotional sales is
attributed to the wind-down of a major
11
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promotion with Pizza Hut and CDNOW during the second quarter. The Company
anticipates other sales promotions to be realized over the remainder of 2000.
Cost of Sales. Cost of sales principally consists of content acquisition
costs, production and shipping costs, and credit card receipt processing costs.
Production costs include CDs, 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 $1,406,764 or 843% to $1,573,631 and $3,203,358 or 508%
to $3,833,508 for the three and six months ended June 30, 2000, respectively,
compared to $166,867 and $630,150 for the three and six months ended June 30,
1999, respectively. Cost of sales related to content consists of royalty
advances that were paid upon signing of royalty agreements with independent
music labels and royalty charges that were assessed on a per music track usage
basis of $1,127,467 and $2,104,666 for the three and six months ended June 30,
2000, respectively, compared to $155,029 and $613,848 for the three and six
months ended June 30, 1999, respectively. Due to the significant increase in
revenue, the cost of sales as a percentage of net sales decreased to 129.1% and
89.1% for the three and six months ended June 30, 2000 compared to 350% and 929%
for the three and six months ended June 30, 1999.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of advertising and promotional expenditures, consulting costs, and
payroll and related expenses. Sales and marketing expenses increased $4,417,865
or 505% to $5,293,544 and $7,719,394 or 680% to $8,854,923 for the three and six
months ended June 30, 2000, respectively, compared to $875,679 and $1,135,529
for the three and six months ended June 30, 1999, respectively. The increase is
primarily attributable to increased advertising expenses in connection with the
America Online agreement, Columbia House print promotions, other online
promotions, and third party advertising services.
In May 2000, the Company and America Online, Inc. ("AOL") mutually agreed to end
the interactive agreement entered into on September 15, 1999. The Company took a
non-cash charge of $1,472,000 against sales and marketing expenses for the
quarter ended June 30, 2000. This non-cash charge attributed to an increase in
sales and marketing expenses of 33% and 19% for the three and six months ended
June 30, 2000, respectively. As a result of the termination, the Company is
released from its future obligation to pay AOL the remaining $13.5 million of
the original $18 million agreement. The $13.5 million obligation was to have
been paid in $1.5 million quarterly payments through September 30, 2002.
Sales and marketing expenses are expected to continue to increase as the Company
promotes its expanding music library utilizing the promotions referred to above.
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 sales and
marketing expenses will continue to represent a decreasing percentage of net
sales, the Company is not able to predict whether this will occur. No assurance
can be given that the Company will sustain increased net sales or that sales and
marketing expenses will not increase as a percentage of net sales.
Operating and Development Expenses. Operating and development expenses
increased $165,546 or 42% to $563,930 and $653,514 or 100% to $1,305,153,
respectively, for
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the three and six months ended June 30, 2000 compared to $398,384 and $651,639,
for the three and six months ended June 30, 1999, respectively. A significant
component of the increase is attributed to the increased staffing in customer
service, website maintenance, and product fulfillment. Other increases were a
result of spending on costs related to enhancing the features and functionality
of the Company's website and computer systems.
General and Administrative Expenses. 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 general
and corporate expenses. Also included in general and administrative expenses are
expenses associated with the issuance of warrants to various consultants.
General and administrative expenses increased $1,440,299 or 243% to $2,031,927
and $3,399,189 or 270% to $4,657,678, respectively, for the three and six months
ended June 30, 2000, compared to $591,628 and $1,258,489 for the three and six
months ended June 30, 1999, 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, costs for
temporary help and professional fees. Rent, equipment expenses, and office
expenses also increased as a result of the expansion.
Depreciation and Amortization. Depreciation expense increased to $309,155
and $478,906 for the three and six months ended June 30, 2000, respectively,
compared to $60,000 and $114,000 for the three and six months ended June 30,
1999, respectively. Depreciation has increased as a result of the purchases of
equipment and leasehold improvements due to the new office facility.
Amortization expense increased to $5,527,490 and $11,049,265 for the three and
six months ended June 30, 2000, respectively, compared to $1,521,259 and
$1,625,028 for the three and six months ended June 30, 1999, respectively. The
increase in amortization of intangibles was due primarily to the amortization of
the license fees associated with EMI, Zomba, TVT and Platinum.
Loss on Investment. As a result of a decline in Platinum's stock price
during the three months ended June 30, 2000 and the fact that Platinum was
delisted by the Nasdaq Stock Market, the Company has determined its investment
in Platinum of $1,200,000 to have only minimal value and wrote off its
investment to expense in the month ended June 30, 2000. This amount consisted of
111,457 and 166,667 unregistered shares of Platinum stock issued to the Company
on September 30, 1998 and February 1, 2000, respectively.
Interest Income/Expense. Interest income was $631,577 and $1,353,794,
respectively, for the three and six months ended June 30, 2000 compared to
$11,385 and $27,924, respectively, for the three and six months ended June 30,
1999. The increase in interest income is due to the higher levels of invested
funds. There was no interest expense for the three and six months ended June 30,
2000, compared to $38,514 and $78,920 for the three and six months ended June
30, 1999. The decrease in interest expense during 2000 is due to the retirement
of notes paid from the proceeds of the IPO in July 1999.
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 in
the third quarter of 1999. Upon conversion of the Series A
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preferred stock into common stock in the third quarter of 1999, the remaining
discount of $641,106 on the Series A preferred stock was recorded as accretion.
The accretion for the three and six months ended June 30, 1999 was $41,106 and
$82,212, 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 $19,587,813 for the six months
ended June 30, 2000, compared to $1,988,860 for the six months ended June 30,
1999. The net loss of $25,720,350 for the current year was reduced by non-cash
charges of $12,483,822 including depreciation and amortization of $11,528,171,
primarily in connection with the EMI license, and $1,200,000 loss due to the
decline in the Platinum investment. The combined increases to prepaid expenses
and other current assets, and other assets of $4,521,669 are primarily due to
cash outlays for the acquisition of music licenses. Increases to accounts
receivable used $1,024,227 while increased deferred revenues provided
$1,785,031. A net decrease to accounts payable and accrued expenses used
$1,399,872.
The higher sales volume during the first and second quarters of the current
year resulted in an increase in the level of accounts receivable at June 30,
2000. As of June 30, 2000, more than 90% of total net receivables outstanding is
from one significant customer. The Company granted extended payment terms to
this customer in May 2000, and to date, the customer is current on its payments
under the extended terms. Management believes that the allowance for doubtful
accounts of $75,000 at June 30, 2000 is adequate.
Cash used in investing activities was $3,196,909 for the six months ended
June 30, 2000 and $438,513 for the six months ended June 30, 1999. In the
current year, cash used in investing activities was for the purchase of computer
equipment and software, leasehold improvements, furniture and other office
equipment as the Company expanded its production facility and administrative
offices in support of its growing operations.
Net cash provided by financing activities was $188,113 for the six months
ended June 30, 2000 and $2,429,988 for the six months ended June 30, 1999. The
issuance of common stock upon the exercise of stock options accounted for all of
the cash provided by financing activities for the six months ended June 30,
2000. Net cash provided by financing activities, for the six months ended June
30, 1999 was 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.
In February 2000, the Company executed a license agreement with Metal Blade
Records. In exchange for the rights under such agreement, the Company issued
8,230 shares of its common stock valued at $50,000, estimating the fair value of
the Company's common stock at $6.08 per share. The Company is amortizing the
intangible asset on a straight-line basis over the five-year life of the
agreement.
In January 2000, the Company issued a warrant exercisable for 58,824 shares
of our common stock to Cheap Trick Unlimited, in exchange for and in connection
with Cheap Trick's execution of a license agreement, granting Musicmaker.com
access to certain sound recordings
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for inclusion in its Custom CD compilation service for a period of five years.
The warrant is exercisable for a period of five years at $5.95 per share, based
upon the average closing price of our common stock on the Nasdaq National Market
for the five days prior to the execution of the Cheap Trick license agreement.
The license fee of $292,944 will be amortized as a non-cash charge of
approximately $58,589 in each year over the next five years, the term of the
license. In addition, the Company will make royalty payments to Cheap Trick for
sales of custom CDs that include Cheap Trick's content.
In February 2000, the Company issued warrants exercisable for up to 150,000
shares of our common stock to each of two consultants, in exchange for and in
connection with their execution of consulting agreements, under which they have
agreed to perform certain services in connection with obtaining rights and
access to additional sound recordings, obtaining marketing opportunities and
obtaining webcasting and other broadcast opportunities on behalf of
Musicmaker.com. The warrants are exercisable for a three-year period at $5.06
per share, based upon the average closing price of our common stock on the
Nasdaq National Market for the five days prior to execution. Fifty percent of
the shares purchasable under the warrants vest on the first anniversary of the
grant, and the remaining shares vest on the second anniversary of the date of
the grant.
At June 30, 2000, the Company had $35,694,199 in cash and cash equivalents
compared to $975,569 for June 30, 1999. 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.
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 2000, it does not expect that any related gains or losses will
be significant. The Company has not engaged in foreign currency hedging to date.
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PART II
OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
--------------------------
On or about February 25, 2000, certain current or former stockholders of
the Company commenced a securities class action lawsuit in the United States
District Court for the Central District of California (the "Action") against
Musicmaker and certain of its directors and officers. Five nearly identical,
additional actions (together with the Action, the "Actions") were subsequently
filed in the Central District of California. On June 5, 2000 the Court ordered
that the six original Actions be consolidated into one case, and on June 14,
2000 four lead plaintiffs and lead counsel were appointed to manage the Actions.
Pursuant to the Court's consolidation order the lead plaintiffs filed a
consolidated amended complaint on June 30, 2000 (the "Complaint"). The
Complaint is a class action complaint which purports to be brought on behalf of
all public investors who purchased our common stock between July 7, 1999 and
November 15, 1999, including investors purchasing in our initial public offering
as well as those purchasing in the open market. Named as defendants in some or
all of the Actions are Musicmaker.com, Inc., The EMI Group, EMI Recorded Music,
EMI Recorded Music North America, Robert P. Bernardi, Devarajan S. Puthukarai,
Irwin H. Steinberg, Mark A. Fowler, Jay A. Samit, Jonathan A. B. Smith and John
A. Skolas.
The Complaint alleges, among other things, that plaintiff and members of
the punitive class were damaged when they acquired our common stock, as a result
of alleged material omissions and misstatements in certain press releases, SEC
filings and oral statements as well as in certain third party articles,
television programs and analyst reports that allegedly caused our stock price to
be inflated. The complaints in the Action allege violations of some or all of
the following statutory provisions: Sections 11, 12(a)(2), and 15 of the
Securities Act of 1933 and Sections 10(b), 20(a) and 20A of the Securities
Exchange Act of 1934. Plaintiffs seek compensatory damages and/or rescission
against defendants, as well as attorneys' costs and fees. The Complaint does not
state the amount of damages which plaintiffs are seeking.
The Company believes the allegations of the Actions are without merit and
intends to defend them vigorously. However, these lawsuits could materially and
adversely affect the Company's financial condition and results of operations
based on a number of factors including legal expenses, diversion of management
from normal company matters, and payout of a judgment or settlement.
In 1998, we received notice from Magix Entertainment Products GmbH, a
German company claiming ownership of the trademark MUSICMAKER and seeking to
obtain from us the domain name MUSICMAKER.COM. We reached what we view as a
definitive settlement of Magix's claim in a written settlement agreement in
1998. In late 1999, however, Magix renewed its demand for the domain name
MUSICMAKER.COM, which we believe to be in violation of our settlement agreement.
In December 1999, we filed suit against Magix in federal court in New York. The
case is captioned Musicmaker.com, Inc., v. Magix Entertainment Products GmbH,
No. 99 Civ. 11577 (BSJ)(S.D.N.Y.), and we have asked the court, among other
things, to declare that we own the trademark MUSICMAKER and the domain name
MUSICMAKER.COM and that we are entitled to use them in connection with our
business. Magix has filed counterclaims alleging, among other things, that we
infringe its trademark rights. The case is pending, and no decisions have been
rendered in the litigation. Though we currently believe that we will be
successful in the litigation, there remains a risk that if we are unsuccessful
we may lose the right to use the trademark MUSICMAKER and the domain name
MUSICMAKER.COM. Loss of these rights could detrimentally and materially affect
the financial condition and results of operations of the Company. In addition,
this lawsuit could materially and adversely affect the Company's financial
condition and results of operations based on a number of additional factors
including legal expenses, diversion of management from normal company matters,
and payout of a judgment or settlement.
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ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
--------------------------------------------------
On July 7, 1999, the Company consummated an initial public offering of its
common stock, $0.01 par value. The registration statement on Form S-1 (333-
72685) relating to such offering was declared effective on July 6, 1999 by the
Securities and Exchange Commission. 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 June 30, 2000 is as follows:
Purchase and installation of machinery and equipment $ 5,128,982
Repayment of indebtedness 1,592,505
Online and traditional advertising 8,046,974
Strategic alliances 5,542,331
The remainder of the offering proceeds have been either allocated for working
capital purposes or have or have been invested in money market accounts.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
----------------------------------------
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
--------------------------------------------------------------
None.
ITEM 5 - OTHER INFORMATION
--------------------------
Termination of Marketing Agreement
On May 12, 2000, the Company and America Online, Inc. ("AOL") mutually agreed to
terminate the Interactive Marketing Agreement for $18 million dated September
15, 1999. As a result of the termination, the Company is released from its
obligation to pay AOL the remaining $13.5 million of the original $18 million
agreement. The $13.5 million obligation was to have been paid in $1.5 million
quarterly payments through September 30, 2002. The marketing agreement was
initially established for AOL 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 AOL products and services.
Loss on Investment
During the second quarter, the Company wrote-off to expense its $1,200,000
investment in Platinum Entertainment, Inc. ("Platinum") based on the decline in
value of its stock price and delisting by the Nasdaq Stock Market, during the
aforementioned period. This amount consisted of 111,457 and 166,667 unregistered
shares of Platinum stock issued to the Company on September 30, 1998 and
February 1, 2000, respectively.
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ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
-----------------------------------------
A. Exhibits required by Item 601 of Regulation S-X:
Exhibit 27: Financial Data Schedule.
B. Reports on Form 8-K:
None.
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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/ Devarajan S. Puthukarai
-------------------------------------------
Devarajan S. Puthukarai
Chief Executive Officer, President
Chief Operating Officer
/s/ Mark A. Fowler
------------------------------------------
Mark A. Fowler, CPA
Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
Date: August 11, 2000
19
