<PAGE>
UNITED STATES
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 September 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, 23rd 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 November 6, 2000, 3,314,042 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, 2000
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1 Condensed Financial Statements Page
----
Condensed Balance Sheets
September 30, 2000 (unaudited) and December 31, 1999.......... 2
Condensed Statements of Operations (unaudited)
Three and nine month periods ended September 30, 2000 and 1999 3
Condensed Statements of Cash Flows (unaudited)
Nine month periods ended September 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................. 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..................... 18
Item 3 Defaults Upon Senior Securities............................... 19
Item 4 Submission of Matters to a Vote of Securities Holders......... 19
Item 5 Other Information............................................. 19
Item 6 Exhibits and Reports On Form 8-K.............................. 20
Signatures.................................................... 21
<PAGE>
Musicmaker.com, Inc.
ITEM 1 - CONDENSED FINANCIAL STATEMENTS CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
----------------------------------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents....................................... $ 32,015,438 $ 58,290,808
Accounts receivable............................................. 523,976 528,958
Inventory....................................................... 1,564,195 12,015
Prepaid expenses and other current assets....................... 1,617,767 1,447,908
----------------------------------------
Total current assets.......................................... 35,721,376 60,279,689
Property and equipment, net....................................... 5,653,340 2,447,728
Investments....................................................... --- 750,000
Intangibles, net.................................................. 82,129,644 98,363,455
Related party accounts receivable................................. 86,410 81,519
Other assets...................................................... 1,451,582 3,477,829
----------------------------------------
Total assets.................................................. $125,042,352 $165,400,220
========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 806,509 $ 1,706,778
Accrued expenses................................................ 3,829,385 2,109,385
Deferred revenues............................................... 3,316,638 125,000
Current portion of long-term obligations........................ 48,787 42,857
Other current liabilities....................................... 75,442 ---
----------------------------------------
Total current liabilities..................................... 8,076,761 3,984,020
Long-term obligations............................................. 145,867 171,429
Other long-term liabilities....................................... 102,708 ---
Stockholders' equity:
Common stock, $0.01 par value, 10,000,000 shares authorized;
3,314,042 and 3,299,350 shares issued and outstanding........ 33,140 32,994
Additional paid-in capital..................................... 194,418,419 194,242,868
Warrants....................................................... 779,059 779,059
Accumulated deficit............................................ (78,513,602) (33,810,150)
----------------------------------------
Total stockholders' equity.................................... 116,717,016 161,244,771
----------------------------------------
Total liabilities and stockholders' equity.................... $125,042,352 $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 Nine months ended
September 30, September 30,
2000 1999 2000 1999
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 845,190 $ 189,091 $ 5,150,478 $ 256,921
Cost of sales
Product......................... 362,140 43,283 2,090,984 59,584
Content......................... 5,907,611 725,068 8,012,278 1,338,916
-----------------------------------------------------------------------
Gross margin...................... (5,424,561) (579,260) (4,952,784) (1,141,579)
Operating expenses:
Sales and marketing............. 4,955,720 1,574,731 13,810,644 2,710,258
Operating and development....... 519,399 414,501 1,825,036 1,066,140
General and administrative...... 1,885,657 1,327,154 6,542,854 2,611,914
Depreciation and amortization... 5,934,851 4,769,613 17,463,022 6,482,371
Reorganization.................. 774,573 --- 774,573 ---
Loss on investment.............. --- --- 1,200,000 ---
-----------------------------------------------------------------------
14,070,200 8,085,999 41,616,129 12,870,683
-----------------------------------------------------------------------
Loss from operations.............. (19,494,761) (8,665,259) (46,568,913) (14,012,262)
Other income (expense):
Interest income................. 511,665 702,280 1,865,461 730,204
Interest expense................ --- (240,252) --- (319,173)
-----------------------------------------------------------------------
511,665 462,028 1,865,461 411,031
-----------------------------------------------------------------------
Net loss.......................... (18,983,096) (8,203,231) (44,703,452) (13,601,231)
Accretion for Series A
preferred stock warrants......... --- (641,106) --- (723,318)
-----------------------------------------------------------------------
Net loss available to common
stockholders..................... $(18,983,096) $(8,844,337) $(44,703,452) $(14,324,549)
=======================================================================
Basic and diluted, net loss per
common share (Note 5)............ $(5.73) $(2.85) $(13.50) $(8.87)
=======================================================================
Weighted average shares
outstanding...................... 3,314,042 3,098,782 3,310,939 1,614,252
=======================================================================
</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>
Nine months ended
September 30,
2000 1999
--------------- ---------------
<S> <C> <C>
Operating activities
Net loss........................................................ $(44,703,452) $(13,601,231)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation.................................................. 886,267 174,000
Amortization.................................................. 16,576,755 6,308,371
Loss on investment............................................ 750,000 ---
Services received in exchange for stock and warrants.......... (355,361) 679,597
Changes in operating assets and liabilities:
Accounts receivable......................................... 4,982 (74,034)
Prepaid expenses and other current assets................... (1,726,930) (223,802)
Other assets................................................ 2,026,247 221,977
Accounts payable............................................ (900,269) 67,737
Accrued expenses............................................ 1,720,000 506,997
Deferred revenues........................................... 3,191,638 ---
Other current liabilities................................... 81,372 ---
Long-term obligations....................................... (25,562) (42,857)
Other long-term liabilities................................. 102,708 ---
--------------- ---------------
Net cash used in operating activities..................... (22,371,605) (5,983,245)
--------------- ---------------
Investing activities
Purchases of property and equipment............................ (4,091,878) (668,137)
--------------- ---------------
Net cash used in investing activities..................... (4,091,878) (668,137)
--------------- ---------------
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 72,035,636
--------------- ---------------
Net cash provided by financing activities................. 188,113 73,349,261
--------------- ---------------
Net (decrease) increase in cash and cash equivalents........... (26,275,370) 66,697,879
Cash and cash equivalents at beginning of period............... 58,290,808 972,954
--------------- ---------------
Cash and cash equivalents at end of period..................... $ 32,015,438 $ 67,670,833
=============== ===============
Non-cash activities
Common stock issued for licensing agreements................... $ 50,000 $109,306,860
=============== ===============
Issuance of warrants........................................... $ 292,944 $ ---
=============== ===============
Payment on account receivable with common stock................ $ 450,000 $ ---
=============== ===============
Conversion of notes payable and preferred stock to common stock $ --- $ 5,500,100
=============== ===============
Loan fees on converted notespayable............................ $ --- $ 221,977
=============== ===============
</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 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 September 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 September 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
<PAGE>
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.
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.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101").
Effective October 1, 2000, SAB 101 summarizes certain areas of the Staff's views
in applying generally accepted accounting principles to revenue recognition in
financial statements. We believe that our current revenue recognition
principles comply with SAB 101.
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 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 $5,907,611 and $725,068 for the three months ended September 30,
2000 and 1999, respectively, and $8,012,278 and $1,338,916 for the nine months
ended September 30, 2000 and 1999, respectively. Additionally, the Company
includes in cost of sales royalty advances paid upon signing of certain initial
royalty agreements, that management determines will generate minimal future
revenues. The Company is required to make additional advances upon the
anniversaries of the signing of certain contracts.
During the quarter ended September 30, 2000, the Company recognized
approximately $5,600,000 of expense for certain royalty advances not expected to
be earned. Included in the expense is a $1,000,000 non-cash charge for future
payments scheduled, per the contract terms, to be paid in November 2000 and
February 2001. The Company has established an accrual for these payments.
6
<PAGE>
Note 2. - One for Ten Reverse Stock Split
On August 28, 2000, the Company's Board of Directors and a majority of the
stockholders authorized a one for ten reverse stock split of the Company's $0.01
par value common stock. As a result of the split, which became effective on
November 3, 2000, 33,140,421 shares of existing common stock were exchanged for
3,314,042 shares of new common stock, thus additional paid-in capital was
increased by $298,263 and common stock was decreased accordingly. All
references in the accompanying financial statements to the number of common
shares and per-share amounts for 2000 and 1999 have been restated to reflect the
stock split.
Note 3. - Infrastructure Reorganization
On September 28, 2000, the Company announced an infrastructure reorganization
that reduced full-time staff levels by 30% or 27 individuals. The $774,573
reorganization charge consisted of severance packages for the involuntarily
terminated employees. Employee terminations occurred within the marketing,
engineering, and fulfillment departments. The reorganization charge also
includes the severance agreement for Robert Bernardi who resigned as Chairman of
the Board on September 9, 2000. The Company did not dispose of any assets or
discontinue any products as a result of the reorganization.
Note 4. - Platinum Entertainment, Inc. Investment
During the second quarter of 2000, the Company expensed 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.
7
<PAGE>
Note 5. - Net Loss Per Share
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Numerator:
Net loss $(18,983,096) $ (8,203,231) $(44,703,452) $(13,601,231)
Less: Accretion of Series A
preferred stock warrants --- (641,106) --- (723,318)
------------ ------------ ------------ ------------
Net loss available to
common shareholders $(18,983,096) $ (8,844,337) $(44,703,452) $(14,324,549)
============ ============ ============ ============
Denominator:
Weighted-average shares
outstanding 3,314,042 3,098,782 3,310,939 1,614,252
============ ============ ============ ============
Basic and diluted net
loss per common share $ (5.73) $ (2.85) $ (13.50) $ (8.87)
============ ============ ============ ============
</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 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
expectation that it can reduce cash outflow significantly as a result of the
recent reorganization or through other expense reduction measures, its
expectations for sales promotions, expectations concerning gains or losses
associated with transactions involving foreign currencies, statements concerning
the Company's release from future obligations under an agreement with America
Online, Inc. ("AOL"), expected cost savings from the reduction in full-time
staff, and the reverse stock split discussed herein which became effective on
November 3, 2000, it's expectation that with the effectiveness of the reverse
stock split, stock outstanding will be approximately 3,314,000 common shares,
the intent and ability of the reverse stock split to maximize stockholder value
and bring the number of shares outstanding and the share price to a level more
consistent with companies of Musicmaker's size, and whether the reverse stock
split and other efforts to comply with the listing requirements of the Nasdaq
National Market system will permit the Company to be in compliance with those
requirements. 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 history of
operating losses, the Company's expected decrease in future operating expenses,
the effect of litigation in which the Company is involved including securities
class actions and alleged copyright infringement, 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, the inherent volatility and unpredictability of the stock market
generally, the effect of the reverse stock split on the stock price of the
Company's common stock, 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
9
<PAGE>
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 their respective agreements.
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 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. 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 the Company's 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 global record company. In
connection with our license agreement with EMI, we will amortize approximately
$17,300,000 in each of the next four 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 and direct mail
campaigns. The Company also mass-produces custom-made CDs to corporate
businesses looking to fulfill mass promotions. Net
10
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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 customers and subsequently receiving cash, checks or money
orders in connection therewith. Accordingly, we are required to manage the
associated risks of accounts receivable, expansion and collection.
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 to generate significant net sales in the
future is uncertain. Further, in view of the rapidly evolving nature of the
Company's business, current reports by the media involving the music industry in
the United States 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. The Company expects to realize decreased operating expenses
beginning in the fourth quarter of 2000 as a result of the infrastructure
reorganization announced during the end of the third quarter of 2000. The
Company believes that cost savings will be realized as the staff size has
decreased by approximately 30%. Should operating expenses increase and 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.
11
<PAGE>
Results of Operations
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 $845,190 and $5,150,478 for the three and nine
months ended September 30, 2000, respectively, compared to $189,091 and $256,921
for the three and nine months ended September 30, 1999, respectively. The
growth of net sales is primarily attributable to two sources. The first area of
revenue growth is related to the sales of custom CDs and digital downloads sold
directly to customers, from the Company's website and print and direct marketing
efforts. These sales increased significantly in the first and second quarters
of 2000 and increased 54% in the third quarter 2000 as compared to the same
period in 1999. The continued expansion of our music library and involvement
with Columbia House, Microsoft and other strategic partners, which has provided
heavier Internet traffic and access to additional customer bases, contributed to
the growth in sales. The second area of revenue growth is attributed to the
large volume of sales derived from contracts with corporate businesses looking
to fulfill mass promotions. In the third quarter of 2000, the Company recorded
revenue from the fulfillment of promotional sales of $553,000 or 65% of total
revenue as compared sales of just over $98,070 or 8% of total revenue in the
second quarter of 2000, and to $2,060,203 or 67% of total revenue in the first
quarter of 2000. The Company currently has $3,316,638 of deferred revenues
associated with sales promotions that will be realized, under the guidance of
SAB 101, upon completion of the terms of the respective contracts.
Cost of Sales Cost of sales principally consists of content acquisition
costs, production and shipping costs, and credit card receipt processing costs.
Content acquisition costs include 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. Production costs include CDs,
jewel cases, CD trays and CD inserts. Cost of sales-product increased $318,857
or 737% to $362,140 and $2,031,400 or 3,410% to $2,090,984 for the three and
nine months ended September 30, 2000, respectively, compared to $43,283 and
$59,584 for the three and nine months ended September 30, 1999, respectively.
The increase in cost of sales-product was attributed to increased sales for the
three and nine months ended September 30, 2000 as compared to the same periods
in 1999. Cost of sales-content increased $5,182,543 or 715% to $5,907,611 and
$6,673,362 or 499% to $8,012,278 for the three and nine months ended September
30, 2000, respectively, compared to $725,068 and $1,338,916 for the three and
nine months ended September 30, 1999, respectively. The increase in cost of
sales-content was due to the Company determining in the third quarter of 2000
that the existing prepaid royalty agreements were impaired assets due to the
significant decline in per music track usage and management's determination that
the Company will not derive significant future economic benefit from the content
under these agreements. Therefore, the Company expensed approximately
$5,600,000 of the remaining unamortized agreements, inclusive of future
commitments of $1,000,000. The Company expects to pay the $1,000,000 in two
installments, November 2000 and February 2001, as stated in each of the
respective contracts. This charge contributed to approximately $5,600,000 or
84% of the increase within cost of sales-content for the nine months ended
September 30, 2000 as compared to the nine months ended September 30, 1999.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily
of advertising and promotional expenditures, consulting costs, payroll and
related expenses. Sales and marketing expenses increased $3,380,989 or 215% to
$4,955,720 and $11,100,386 or 410%
12
<PAGE>
to $13,810,644 for the three and nine months ended September 30, 2000,
respectively, compared to $1,574,731 and $2,710,258 for the three and nine
months ended September 30, 1999, respectively. The increase is primarily
attributable to increased advertising expenses in connection with Columbia House
direct mail promotions, upscale magazine print promotions, the America Online
agreement (a non-cash charge in second quarter 2000 only), concert tour
sponsorship, and third party advertising services.
Sales and marketing expenses are expected to decrease in light of the
reorganization and the reduction of full-time staff within the marketing
department. However, as the Company promotes its expanding music library
utilizing the promotions referred to above, sales and marketing expenses may
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 $104,898 or 26% to $519,399 and $758,896 or 72% to $1,825,036,
respectively, for the three and nine months ended September 30, 2000 compared to
$414,501 and $1,066,140, for the three and nine months ended September 30, 1999,
respectively. A significant component of the increase over the same period
during the third quarter 1999 is attributed to increased staffing in customer
service, website maintenance, and the use of temporary help in product
fulfillment. The Company anticipates decreases in these costs due to a
reduction in staff within the aforementioned areas. Other increases were a
result of spending on costs related to enhancing the features and functionality
of the Company's website and computer systems over the nine month period.
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. General and administrative expenses increased $558,503
or 42% to $1,885,657 and $3,930,940 or 150% to $6,542,854, respectively, for the
three and nine months ended September 30, 2000, compared to $1,327,154 and
$2,611,914 for the three and nine months ended September 30, 1999, respectively.
The increase in general and administrative expenses from the prior year was
primarily due to an increase in personnel to support the Company's operations.
As a result, salaries and wages, benefits such as insurance, bonuses, and other
employee related costs increased as well as recruiting and costs for temporary
help. The Company anticipates decreases in these costs due to a reduction in
staff levels in these areas. Professional fees also increased over the same
period during the prior year due to investor relations, public relations, and
attorneys' fees related to the defense of the stockholder class action lawsuit.
Rent, facility expenses (such as communication data lines, telephone, and
certain equipment leases), and general office expenses also increased as a
result of the Virginia office expansion.
Depreciation and Amortization. Depreciation expense increased to $407,361
and $886,267 for the three and nine months ended September 30, 2000,
respectively, compared to $60,000 and $174,000 for the three and nine months
ended September 30, 1999, respectively. Depreciation has increased as a result
of the acquisition of new equipment to increase our production capacity and
leasehold improvements for the new office and production facility. Amortization
expense
13
<PAGE>
increased to $5,527,490 and $16,576,755 for the three and nine months ended
September 30, 2000, respectively, compared to $4,709,613 and $6,308,371 for the
three and nine months ended September 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, three of which were acquired
mid third quarter 1999.
Infrastructure Reorganization. On September 28, 2000, the Company announced
an infrastructure reorganization that resulted in a 30% decrease of full-time
staff or 27 individuals. The employee reductions occurred within the marketing,
engineering, and fulfillment departments. The Company initiated the
reorganization as an attempt to reduce the cash outflow. The reorganization
resulted in a charge of $774,573 that consisted principally of severance
payments for outplaced employees, including Robert Bernardi who resigned from
the position of Chairman of the Board on September 9, 2000. The Company expects
to begin realizing future cost savings beginning in the first quarter 2001.
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 $511,665 and $1,865,461,
respectively, for the three and nine months ended September 30, 2000 compared to
$702,280 and $730,204, respectively, for the three and nine months ended
September 30, 1999. The interest income is a reflection of the current levels
of invested funds. There was no interest expense for the three and nine months
ended September 30, 2000, compared to $240,252 and $319,173 for the three and
nine months ended September 30, 1999. The decrease in interest expense during
2000 is due to the retirement of notes paid from the proceeds of the Company's
initial public offering in July 1999.
Accretion of Preferred Stock Warrants. Upon completion of the initial public
offering, 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
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 nine months ended September 30, 1999 was
$641,106 and $723,318, 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 initial public offering.
14
<PAGE>
Liquidity and Capital Resources
Net cash used in operating activities was $22,371,605 for the nine months
ended September 30, 2000, compared to $5,983,245 for the nine months ended
September 30, 1999. The net loss of $44,703,452 for the current nine month
period was reduced by non-cash charges of $18,307,660 including depreciation and
amortization of $17,463,022, 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
$1,726,930 are primarily due to cash outlays for the acquisition of music
licenses. Decreases to accounts receivable provided $4,982 and increased
deferred revenues provided $3,191,638. A net increase to accounts payable and
accrued expenses provided $819,731.
Cash used in investing activities was $4,091,878 for the nine months ended
September 30, 2000 and $668,137 for the nine months ended September 30, 1999.
In the current year, cash used in investing activities was for the purchase of
computer equipment and software, leasehold improvements, vehicle, furniture and
other office equipment as the Company expanded its production facility and
administrative offices in support of its operations.
Net cash provided by financing activities was $188,113 for the nine months
ended September 30, 2000 and $73,349,261 for the nine months ended September 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 nine months ended
September 30, 2000. Net cash provided by financing activities, for the nine
months ended September 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 in the
Company's initial public offering July 7, 1999 for $79,629,242, net of fees of
$8,739,970.
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 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
15
<PAGE>
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 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 September 30, 2000, the Company had $32,015,438 in cash and cash
equivalents compared to $67,670,833 at September 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.
16
<PAGE>
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.
On September 27, 2000, the Company filed a motion to dismiss the Complaint.
The hearing on that motion is currently scheduled for January 2001.
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 excess of
available insurance.
On or about August 22, 2000, TeeVee Toons, Inc., ("TVT"), TVT Music, Inc.,
TVT Catalog Enterprises, LLC and Wax Trax Records, Inc., (collectively
"Plaintiffs") filed a lawsuit in the United States District Court for the
Southern District of New York (the "Complaint"). On August 23, 2000, Plaintiffs
filed an order to show cause for expedited discovery and for a preliminary
injunction.
The Complaint alleges, inter alia, that Musicmaker.com, Inc. committed
copyright infringement by copying Plaintiffs' sound recordings and musical
compositions and offering them for download on the Internet in a substandard,
low quality, non-secure format without TVT's approval. Plaintiffs also allege
that Musicmaker.com, Inc. committed copyright infringement by copying the
musical compositions owned by TVT Music, Inc. without obtaining a mechanical
license to do so. Musicmaker.com, Inc. filed an answer, affirmative defenses
denying all of the allegations in Plaintiff's Complaint. Musicmaker.com, Inc.
also filed a counterclaim for declaratory judgment seeking a determination that
TVT and its affiliated companies had a contractual obligation to deliver the
appropriate mechanical licenses pursuant to by the contract between the parties
dated August 23, 1999 (the "License Agreement").
On November 1, 2000, the parties entered into a tentative settlement
agreement. A definitive settlement has not yet been reached.
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
17
<PAGE>
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.
ITEM 2- CHANGES IN SECURITIES AND USE OF PROCEEDS
-------------------------------------------------
On September 14, 2000, the Company announced a one for ten reverse stock split
of the Company's $0.01 par value existing common stock which became effective on
November 3, 2000. The Company initiated the one for ten reverse stock split in
an effort to increase its stock price above the $1.00 minimum bid price which is
the minimum bid price for continued listing on the Nasdaq National Market. The
Company believed that The Nasdaq Stock Market, Inc. ("NASDAQ") would remove the
Company from the listing on the National Market if the stock did not trade above
the Nasdaq National Market minimum bid price. The Company believes that the
reverse stock split should positively affect the trading price per share of the
new common stock, however, the Company cannot make any assurances that the
listing price for the Nasdaq National Market will be met in the future.
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 September 30, 2000 is as follows:
<TABLE>
<S> <C>
Purchase and installation of machinery and equipment $6,023,951
Repayment of indebtedness 1,592,505
Online and traditional advertising 9,707,942
Strategic alliances 5,542,331
</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.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
----------------------------------------
None.
18
<PAGE>
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
--------------------------------------------------------------
On September 12, 2000, the Company held its Annual Meeting of Stockholders. At
the meeting, the stockholders elected John A. Skolas as a Class A director (with
26,894,621 affirmative votes, zero votes against, and 1,042,269 votes withheld).
The stockholders also approved an amendment to the Company's Amended and
Restated Stock Option plan (with 16,690,444 shares voting for, 1,612,175
against, and 38,427 abstaining). The stockholders also ratified the appointment
of Ernst & Young LLP as the independent accountants for the Company for the year
ending December 31, 2000 (with 26,930,706 shares voting for, 988,317 against,
and 17,867 abstaining).
On September 13, 2000, holders of 17,761,106 shares of common stock of the
Company approved a one for ten reverse stock split of the Company's common
stock.
ITEM 5 - OTHER INFORMATION
--------------------------
Infrastructure Reorganization
On September 28, 2000 the Company announced a reorganization that resulted in a
30% reduction in full-time staff. This reorganization is targeted to enable the
Company to reduce its annual cash outflow.
Resignation of Larry Lieberman as President of Global Marketing
On September 26, 2000, Larry Lieberman resigned as President of Global
Marketing, effective October 26, 2000. Mr. Lieberman's resignation was on
amicable terms.
One for Ten Reverse Stock Split
On September 14, 2000, the Company announced a one for ten reverse stock split
of the Company's $0.01 par value existing common stock and filed Schedule PRE
14C with the Securities and Exchange Commission. On September 27, 2000, the
Company filed form DEF 14C with the SEC. On October 13, 2000, the Company's
transfer agent notified stockholders of the approved one for ten reverse stock
split, which became effective on November 3, 2000. The Company initiated the
one for ten reverse stock split in an effort to increase its stock price above
the $1.00 minimum bid price. The existing common stock had been trading below
$1.00 per share, which is the minimum bid price for continued listing on The
Nasdaq National Market, Inc. (the "National Market"). The Company believed that
The Nasdaq Stock Market, Inc. ("NASDAQ") would remove the Company from the
listing on the National Market if the stock did not trade above the NASDAQ
minimum bid price. The Company believes that the Reverse Split should
positively affect the trading price per share of the new common stock, however,
the Company cannot make any assurances that the listing price for the National
Market will be met in the future.
Resignation of Robert Bernardi From the Board of Directors
Effective September 9, 2000, Robert Bernardi resigned as Chairman of the Board
of Directors. Devarajan Puthukarai, President and CEO of the Company will
assume the responsibilities of Chairman of the Board. Mr. Bernardi's
resignation from the Company was on amicable terms.
19
<PAGE>
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.
20
<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/ 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: November 13, 2000
21
