<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 March 31, 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)
<TABLE>
<S> <C>
Delaware 54-1811721
(State or Other Jurisdiction of Incorporation) (I.R.S. Employer Identification No.)
1740 Broadway, 23/rd/ floor, New York, NY 10019
(Address of Principal Executive Office) (Zip Code)
</TABLE>
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 April 26, 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 MARCH 31, 2000
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
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<CAPTION>
Item 1 Financial Statements Page
----
<S> <C>
Balance Sheets
March 31, 2000 (unaudited) and December 31, 1999......... 2
Statements of Operations (unaudited)
Three month periods ended March 31, 2000 and 1999........ 3
Statements of Cash Flows (unaudited)
Three month periods ended March 31, 2000 and 1999........ 4
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................................. 17
Signatures....................................................... 18
</TABLE>
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musicmaker.com, Inc
BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
ASSETS (unaudited)
------------------- -------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents....................................... $ 46,792,628 $ 58,290,808
Accounts receivable............................................. 2,032,980 528,958
Prepaid expenses and other current assets....................... 2,269,023 1,459,923
------------------- -------------------
Total current assets.......................................... 51,094,631 60,279,689
Property and equipment, net....................................... 3,871,394 2,447,728
Investments....................................................... 1,200,000 750,000
Intangibles, net.................................................. 93,184,624 98,363,455
Related party accounts receivable................................. 83,150 81,519
Other assets...................................................... 6,766,496 3,477,829
------------------- -------------------
Total assets.................................................. $ 156,200,295 $ 165,400,220
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 2,052,210 $ 1,706,778
Accrued expenses................................................ 1,233,961 2,109,385
Deferred revenues............................................... 1,936,875 125,000
Current portion of long-term obligations........................ 42,857 42,857
------------------- -------------------
Total current liabilities..................................... 5,265,903 3,984,020
Long-term obligations............................................. 171,429 171,429
Commitments and contingencies.....................................
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..................................... 194,534,104 193,945,928
Warrants....................................................... 779,059 779,059
Accumulated deficit............................................ (44,881,604) (33,810,150)
------------------- -------------------
Total stockholders' equity.................................... 150,762,963 161,244,771
------------------- -------------------
Total liabilities and stockholders' equity.................... $ 156,200,295 $ 165,400,220
=================== ===================
</TABLE>
The accompanying notes are an integral part of these statements
2
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musicmaker.com, Inc.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended March 31,
2000 1999
-------------------- --------------------
<S> <C> <C>
Net sales....................................... $ 3,086,082 $ 20,160
Cost of sales
Product........................................ 1,282,678 4,464
Content........................................ 977,199 458,819
-------------------- --------------------
Gross profit.................................... 826,205 (443,123)
-------------------- --------------------
Operating expenses:
Sales and marketing............................ 3,561,378 259,852
Operating and development...................... 741,223 253,256
General and administrative..................... 2,625,751 693,130
Depreciation and amortization.................. 5,691,526 131,499
-------------------- --------------------
12,619,878 1,337,737
-------------------- --------------------
Loss from operations............................ (11,793,673) (1,780,860)
Other income (expense):
Interest income................................ 722,401 16,539
Interest expense............................... (182) (40,406)
-------------------- --------------------
722,219 (23,867)
-------------------- --------------------
Net loss........................................ (11,071,454) (1,804,727)
Accretion for Series A preferred stock
warrants....................................... - (41,106)
-------------------- --------------------
Net loss available to common stockholders....... $(11,071,454) $(1,845,833)
==================== ====================
Basic and diluted, net loss per common share
(Note 4)....................................... $ (0.34) $ (0.27)
==================== ====================
Weighted average shares outstanding............. 33,046,988 6,805,561
==================== ====================
</TABLE>
The accompanying notes are an integral part of these statements
3
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musicmaker.com, Inc.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
March 31,
2000 1999
----------------- -----------------
<S> <C> <C>
Operating activities
Net loss......................................................... $(11,071,454) $ (1,804,727)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation................................................... 169,751 54,000
Amortization................................................... 5,521,775 77,499
Interest....................................................... -- 26,270
Services received in exchange for stock and warrants........... 58,589 169,621
Changes in operating assets and liabilities:
Accounts receivable.......................................... (1,954,022) (11,822)
Prepaid expenses and other current assets.................... (810,731) (30,818)
Capitalized IPO fees......................................... -- (338,365)
Other assets................................................. (3,288,667) --
Accounts payable............................................. 345,432 340,028
Accrued expenses............................................. (875,424) (142,882)
Deferred revenues............................................ 1,811,875 --
Accrued compensation payable to related parties.............. -- 4,996
Other liabilities............................................ -- 39,453
----------------- -----------------
Net cash used in operating activities...................... (10,092,876) (1,616,747)
----------------- -----------------
Investing activities
Purchases of property and equipment.............................. (1,593,417) (100,961)
----------------- -----------------
Net cash used in investing activities...................... (1,593,417) (100,961)
----------------- -----------------
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............. (11,498,180) 712,280
Cash and cash equivalents at beginning of period................. 58,290,808 972,954
----------------- -----------------
Cash and cash equivalents at end of period....................... $ 46,792,628 $ 1,685,234
================= =================
Non-cash activities
Common stock issued for licensing agreements..................... $ 50,000 $ --
================= =================
Issuance of warrants............................................. $ 292,944 $ --
================= =================
Payment on account receivable with common stock.................. $ 450,000 $ --
================= =================
</TABLE>
The accompanying notes are an integral part of these statements
4
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musicmaker.com, Inc.
NOTES TO FINANCIAL STATEMENTS
(unaudited)
Note 1. -- The Company and Summary of 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 March 31, 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 March 31, 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. In the first quarter
of 2000, the Company recognized $248,000 of such revenue.
Investments
On October 1, 1999, the Company entered into a marketing agreement with Platinum
Entertainment, Inc. ("Platinum") under which Platinum purchased prominent
advertising and 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.
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. These charges resulted in
increases to costs of sales of approximately $454,000 and $815,000 for the
quarters ended March 31, 2000 and 1999, respectively. The Company is required to
make additional advances upon the anniversaries of the signing of these initial
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 advanced royalties paid,
$135,000 royalty expense was amortized based on the revenue generated from these
labels in the first quarter of 2000.
6
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Note 2. -- Issuances of stock and warrants and related events
In February 2000, the Company executed a license agreement with Metal Blade
Records, a California corporation, whereby Metal Blade granted exclusive rights
to such entities sound recordings for use in Custom CD compilation services. In
exchange for the Company's 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 for the five days prior to the execution of the Cheap
Trick license agreement. The Company valued the warrant using the Black-Scholes
option pricing model and recorded an intangible asset of $292,944 to be
amortized over five years.
In February 2000, musicmaker.com issued warrants exercisable for up to 150,000
shares or 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 Nasdaq
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.
Note 3. -- Net Loss Per Share
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------------------
2000 1999
-------------------- --------------------
<S> <C> <C>
Numerator:
Net loss $(11,071,454) $(1,804,727)
Less: accretion of Series A preferred stock warrants - (41,106)
-------------------- --------------------
Net loss available to common shareholders $(11,071,454) $(1,845,833)
==================== ====================
Denominator:
Weighted-average shares outstanding 33,046,988 6,805,561
==================== ====================
Basic and diluted net loss per common share $ (0.34) $ (0.27)
==================== ====================
</TABLE>
7
<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 the Company's expectation that certain advance royalty payments made
to music labels will generate significant future revenues, its expectations
concerning the potential for access to tracks from EMI, 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, and the
Company's belief that it will not incur any future material expenditures related
to Year 2000 compliance. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company, or industry results, to be
materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the Company's limited operating history, uncertainty concerning
its license agreement with EMI Recorded Music, general economic and business
conditions with respect to the Internet and online commerce, changes in
government regulations, competition and the ability of the Company to implement
its business strategy 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, the fact that
our competitors, current and future, including some of the record labels
themselves, may launch competing internet services, the ability of or 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 a five-year worldwide license
agreement with EMI Recorded Music to include in online sales of our custom CDs
the content that EMI elects to make available. EMI has provided a significant
amount of content to us under the agreement. However, the agreement does not
obligate EMI to grant us any content at all. In addition, our use of content
provided by EMI may be severely limited and restricted by EMI in the future. EMI
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 agreement. Our
agreement does not limit or prevent EMI 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 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
8
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later become aware that it is not likely to be achieved. If the Company were to
update or correct a forward-looking statement, investors and others should not
conclude that the Company will make additional updates or corrections
thereafter.
The following discussion should be read in conjunction with the financial
statements contained in Item 1 of Part I of this Form 10-Q.
Overview
Musicmaker.com, Inc. (the "Company") was incorporated in April 1996
("Inception"). On July 31, 1996, the Company acquired the technology to
produce its custom CDs. During the remainder of 1996 and through the year ended
December 31, 1997, the Company's operating activities consisted of recruiting
personnel, developing the technological infrastructure necessary to create
custom CDs on the Internet, building an operating infrastructure and
establishing relationships with record labels and vendors. The Company launched
its website in October 1997 and shipped its first custom CD in November 1997. In
1998, the Company established several strategic alliances with leading online
and offline music marketers including Columbia House and TransWorld
Entertainment. In June 1999, the Company entered into a license agreement with
Virgin Holdings, Inc., an affiliate of EMI Recorded Music, Inc. ("EMI"). The
Company was granted a five-year exclusive worldwide license to include the music
content that EMI makes available for use in our online sales of custom CDs. The
new relationship with EMI gives the Company the potential for access to tracks
from EMI artists and the extensive music catalog of a major record company. In
connection with our license agreement with EMI, we will amortize approximately
$17,300,000 in each of the next five years.
9
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The Company's net sales are primarily derived from two sources. One source
of sales 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 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 has an extremely limited operating history upon which to base
an evaluation of its business and prospects. The Company has yet to achieve
significant net sales and its ability to generate significant net sales in the
future is uncertain. Further, in view of the rapidly evolving nature of the
Company's business and its very limited operating history, the Company has
little experience forecasting net sales. Therefore, the Company believes that
period-to-period comparisons of our financial results are not necessarily
meaningful and you should not rely upon them as an indication of future
performance.
To date, the Company has incurred substantial costs to create, introduce
and enhance its services, to acquire content, to build brand awareness and to
grow its business. As a result, the Company has incurred operating losses since
Inception. In addition, the Company expects significantly increased operating
expenses in connection with an increase in the size of its staff, expansion of
its marketing efforts, and an increase in its research and development efforts
to assist in the Company's planned growth. To the extent that increases in
operating expenses precede or are not followed by increased net sales, the
Company's business, financial condition and results of operations will be
materially adversely affected.
The Company's business and prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early years, particularly companies in new and rapidly evolving markets such as
electronic commerce. In addition, the Company's net sales depend substantially
upon the level of activity on its website, the amount and quality of content
provided under its EMI license agreement and the success of its Columbia House
print promotions. Although the Company has experienced growth in its operations,
there can be no assurance that the Company's net sales will continue at its
current level or rate of growth.
10
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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
March 31,
------------------------------
2000 1999
------------------------------
<S> <C> <C>
Net sales 100% 100%
Cost of sales - product 41 22
Cost of sales - content 32 2276
------------------------------
Gross profit 27 -2198
------------------------------
Operating expenses:
Sales and marketing 115 1289
Operating and development 24 1257
General and administrative 85 3438
Depreciation and amortization 185 652
------------------------------
409 6636
------------------------------
Loss from operations -382 -8834
Other income (expense):
Interest income 23 82
Interest expense -- -200
------------------------------
23 -118
------------------------------
Net loss -359 -8952
Accretion for Series A
preferred stock warrants -- -205
------------------------------
Net loss available to common
stockholders -359% -9157%
==============================
</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 $3,086,082 for the three months ended March 31,
2000 compared to $20,160 for the three months ended March 31, 1999. 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 quarter 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 first quarter of
2000 the Company recorded revenue from promotional sales of just over $2,000,000
or 67% of total revenue.
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
11
<PAGE>
significantly as it enters into additional licensing agreements to further
expand and develop its music library. Cost of sales increased 388% to $2,259,877
for the three months ended March 31, 2000 compared to $463,283 for the three
months ended March 31, 1999. Cost of sales largely consists of royalty advances
that were paid upon signing of royalty agreements with independent music labels
of $977,199 for the three months ended March 31, 2000 compared to $458,819 for
the three months ended March 31, 1999. Due to the significant increase in
revenue, the cost of sales as a percentage of net sales decreased to 73% for the
first quarter of 2000 compared to 2298% for the first quarter of 1999.
Operating and Development Expenses. Operating and development expenses
increased 193% to $741,223 for the three months ended March 31, 2000 compared to
$253,256 for the three months ended March 31, 1999. The increase was
attributable to increased spending on website maintenance and equipment expense,
increased staffing and associated costs related to enhancing the features and
functionality of the Company's website and computer systems. Operating and
development expenses are expected to increase in future periods as a result of
anticipated personnel additions and additional equipment and maintenance
expenses associated with the expansion of the Company's technical operations.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of advertising and promotional expenditures, consulting costs, and
payroll and related expenses. The Company expenses all advertising costs as
incurred. Sales and marketing expenses increased 1271% to $3,561,378 for the
three months ended March 31, 2000, compared to $259,852 for the three months
ended March 31, 1999. The increase is primarily attributable to increased
advertising expenses in connection with the America Online agreement, Columbia
House print promotion, other online promotions, and third party advertising
services. Sales and marketing expenses are expected to continue to increase as
the Company promotes its expanding music library utilizing the promotions
referred to above. 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 expense 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 expense will not increase as a percentage of
net sales.
General and Administrative Expenses and Amortization Expense. General and
administrative expenses consist primarily of legal and professional fees,
payroll costs and related expenses for accounting and administrative personnel,
as well as other expenses associated with corporate functions, the depreciation
of fixed assets, the amortization of intangibles and other general and corporate
expenses. Also included in general and administrative expenses are expenses
associated with the issuance of warrants to various consultants. Excluding
depreciation and amortization, general and administrative expenses increased
279% to $2,625,751 for the three months ended March 31, 2000, compared to
$693,130 for the three months ended March 31, 1999. The increase in general and
administrative expenses was primarily due to an increase in personnel to support
the Company's expanding operations. As a result, salaries and wages, benefits,
and other employee related costs increased as well as recruiting and costs for
temporary help. Rent, equipment expenses, and office expenses also increased as
a result of the expansion. Accounting and legal expenses have also increased as
a result of the Company's growth. Amortization expense increased 7025% to
$5,521,775 for the three months ended March 31, 2000, compared to $77,499 for
the three months ended March 31, 1999. The increase in
12
<PAGE>
amortization of intangibles was due primarily to the amortization of the license
fees with EMI, Zomba, TVT and Platinum.
Interest Expense/Income. Interest income increased to $722,401 for the
three months ended March 31, 2000 compared to $16,539 for the three months ended
March 31, 1999. The increase in interest income is due to the higher levels of
invested funds. Interest expense decreased 99% to $182 for the three months
ended March 31, 2000, compared to $40,406 for the three months ended March 31,
1999. The decrease in interest expense in the first quarter of 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 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. There was no accretion
recorded for the three-month period ended March 31, 2000. The accretion for the
three-month period ended March 31, 1999 was $41,106. 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 $10,092,876 for the three months
ended March 31, 2000 compared to $1,616,747 for the three months ended March 31,
1999. The net loss of $11,071,454 for the current year was reduced by non-cash
charges of $5,750,115, including depreciation and amortization of $5,691,526,
primarily in connection with the EMI license. The combined increases to prepaid
expenses and other current assets, and other assets of $4,099,398 are primarily
due to cash outlays for the acquisition of music licenses. Increases to accounts
receivable used $1,954,022 while reduced deferred revenues provided $1,811,875.
A net decrease to accounts payable and accrued expenses used $529,992.
The higher sales volume during the first quarter of the current year
resulted in an increase in the level of accounts receivable at March 31, 2000.
Management believes that the allowance for doubtful accounts of $75,000 at March
31, 2000 is adequate.
Cash used in investing activities was $1,593,417 for the three months ended
March 31, 2000 and $100,961 for the three months ended March 31, 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 three months
ended March 31, 2000 and $2,429,988 for the three months ended March 31, 1999.
The issuance of common stock upon the exercise of stock options accounted for
all of the cash provided by financing activities for the three months ended
March 31, 2000. Net cash provided by financing activities, for the three months
ended March 31, 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.
13
<PAGE>
In February 2000, the Company executed a license agreement with Metal Blade
Records, a California corporation, whereby Metal Blade granted exclusive rights
to such entities sound recordings for use in Custom CD compilation services. In
exchange for the Company's 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 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 or 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 Nasdaq
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 March 31, 2000, the Company had $46,792,628 in cash and cash equivalents
compared to $1,685,234 for March 31, 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.
14
<PAGE>
Year 2000 System Costs
For the purposes of Year 2000 compliance, the corporate MIS department has
managed the task of verifying that all of the Company's internal transaction
processing systems are date compliant. This process was initiated in order to
ensure the Company would be able to continue operations without disruption after
January 1, 2000. As of the date of this filing the Company's principal
transaction processing software through which nearly all of the Company's
business is transacted has not experienced any significant problems associated
with Year 2000 date compliance. The Company also utilizes electronic data
exchange systems operated by third parties, as well as computers, software,
telephone systems and other equipment used internally. None of these systems
have experienced any significant Year 2000 compliance problems.
Historical and estimated costs in preparation for Year 2000 compliance to
this point have not been material. Although future anticipated costs are
difficult to estimate with any certainty, the Company does not anticipate any
future material expenditures related to Year 2000 compliance.
At the current time, the Company's anticipates that all systems and
applications will remain Year 2000 compliant. There can be no assurance,
however, of complete compliance based on the status to date. It is unlikely that
any single system will have an adverse effect on the Company as a whole. If a
problem were to occur, contingency plans will involve the procurement of
standardized commercial off-the-shelf replacement modules for internal
applications and business functions as well as replacing non-compliant third
party software with software that is Year 2000 compliant. At present there are
no indications that contingency plans will be necessary or that there will be
revenue disruptions, however, there can be no assurances that future disruptions
will not occur.
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.
15
<PAGE>
PART II
OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
- ---------------------------
On February 25, 2000, certain current or former shareholders of the company
commenced a securities class action lawsuit in the United States District Court
for the Central District of California (the "Action"). Since that time, five
nearly identical, additional actions have been filed (together with the Action,
the "Actions") in the Central District of California. The Actions are 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. Slokas.
The complaints in the Actions allege that, among other things, that
plaintiff and members of the putative class were damaged when they acquired our
common stock, as a result of material omissions and misstatements in certain of
our press releases, analyst reports and our public filings with the Securities
and Exchange Commission 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 Section 10(b) of the Securities Exchange Act of 1934. Plaintiffs seek
compensatory damages and/or rescission against defendants, as well as attorneys'
costs and fees.
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 the United States District
Court for the Southern District of New York, Musicmaker.com, Inc., v. Magix
Entertainment Prods. GmbH, No.99 Civ. 11577 (BSJ)(S.D.N.Y.), vesting exclusive
jurisdiction over our domain name. The case is pending, and no decisions have
been rendered in the litigation. Though we currently believe that we remain in
compliance with the terms of our settlement agreement, there remains a risk that
should we be unsuccessful in such litigation we may lose access to and our
rights in the domain name MUSICMAKER.COM. Loss of access to and loss or our
rights in the domain name MUSICMAKER.COM 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.
16
<PAGE>
ITEM 2 -- CHANGES IN SECURITIES AND USE OF PROCEEDS
- -------------------------------------------------
On July 7, 1999, the Company consummated an initial public offering of its
common stock, $.01 par value, (the "Common Stock"). The registration statement
on Form S-1 (333-72685) relating to 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 March 31, 2000 is as follows:
<TABLE>
<S> <C>
Purchase and installation of machinery and equipment $3,525,490
Repayment of indebtedness 1,592,505
Online and traditional advertising 6,735,518
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.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
- ---------------------------------------------------------------
None.
ITEM 5 -- OTHER INFORMATION
- ---------------------------
None.
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
- ------------------------------------------
A. Exhibits required by Item 601 of Regulation S-B:
Exhibit 27: Financial Data Schedule.
B. Reports on Form 8-K:
None.
17
<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: May 12, 2000
18
<PAGE>
EXHIBIT INDEX
-------------
Exhibit 27: Financial Data Schedule.
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 46,792,628
<SECURITIES> 0
<RECEIVABLES> 2,032,980
<ALLOWANCES> 75,000
<INVENTORY> 0
<CURRENT-ASSETS> 51,094,631
<PP&E> 4,516,691
<DEPRECIATION> 645,297
<TOTAL-ASSETS> 156,200,295
<CURRENT-LIABILITIES> 5,265,903
<BONDS> 0
0
0
<COMMON> 331,404
<OTHER-SE> 150,431,559
<TOTAL-LIABILITY-AND-EQUITY> 156,200,295
<SALES> 3,086,082
<TOTAL-REVENUES> 3,086,082
<CGS> 2,259,877
<TOTAL-COSTS> 2,259,877
<OTHER-EXPENSES> 12,619,878
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 182
<INCOME-PRETAX> (11,071,454)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,071,454)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,071,454)
<EPS-BASIC> (0.34)
<EPS-DILUTED> (0.34)
</TABLE>
