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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE THREE MONTH PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-30063
ARTISTDIRECT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4644384
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5670 WILSHIRE BOULEVARD, SUITE 200 90036
LOS ANGELES, CALIFORNIA (Zip Code)
(Address of principal executive office)
(323) 634-4000
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL DOCUMENTS AND
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 SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock outstanding as of June 30, 2000:
36,852,548 shares.
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INDEX
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PART I FINANCIAL INFORMATION Page
----
ITEM 1. BALANCE SHEETS AT JUNE 30, 2000 (UNAUDITED)
AND DECEMBER 31, 1999 ............................................ 1
STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS
ENDED JUNE 30, 2000 (UNAUDITED) AND 1999 (UNAUDITED).............. 2
STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED
JUNE 30, 2000 (UNAUDITED) AND 1999 (UNAUDITED).................... 3
NOTES TO FINANCIAL STATEMENTS...................................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................ 10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ....... 36
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................. 37
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS......................... 37
ITEM 3 DEFAULTS UPON SENIOR SECURITIES................................... 38
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............... 38
ITEM 5. OTHER INFORMATION................................................. 38
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.................................. 38
A. EXHIBITS...................................................... 38
B. REPORTS ON FORM 8-K........................................... 38
SIGNATURES................................................................. 39
In this Report, "ARTISTdirect," the "Company," "we," "us" and "our"
collectively refers to ARTISTdirect, Inc.
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PART I FINANCIAL INFORMATION
ARTISTDIRECT, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
--------- -----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 62,150 $ 69,119
Cash held for clients 643 770
Short term investments 44,091 --
Accounts receivable, net 2,551 1,001
Prepaid expenses and other current assets 7,592 6,795
--------- ---------
Total current assets 117,027 77,685
Property and equipment, net 8,400 3,343
Goodwill and intangibles, net 11,958 13,415
Other assets, net 4,269 4,157
--------- ---------
$ 141,654 $ 98,600
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Cash held for clients $ 643 $ 770
Accounts payable 1,267 3,709
Accrued expenses 5,577 4,698
Notes payable -- 741
Deferred revenue -- 37
--------- ---------
Total current liabilities 7,487 9,955
Long term liabilities 891 683
--------- ---------
Total liabilities 8,378 10,638
--------- ---------
Redeemable securities:
Series A redeemable preferred stock, $.01 par value. Authorized, issued and
outstanding 3,207,815 shares in 1999. Liquidation preference and redemption
value of $4,963 in 1999 -- 4,963
Series B redeemable preferred stock, $.01 par value. Authorized, issued and
outstanding 3,750,000 shares in 1999. Liquidation preference and redemption
value of $15,350 in 1999 -- 15,350
Series C redeemable preferred stock, $.01 par value. Authorized 8,550,000;
issued and outstanding 5,905,374 shares in 1999. Liquidation preference and
redemption value of $82,250 in 1999 -- 82,188
Redeemable common securities, $.01 par value. Authorized 10,800,000 shares
Liquidation preference and redemption value of $11,506 and $9,206 in 2000 and
1999, respectively 11,506 9,206
--------- ---------
Total redeemable securities 11,506 111,707
--------- ---------
Stockholders' equity (deficit):
Common stock, $.01 par value. Authorized 150,000,000 and 50,000,000
shares in 2000 and 1999, respectively; issued and outstanding 36,852,548 and
14,088,674 shares in 2000 and 1999, respectively 369 141
Additional paid-in-capital 201,395 36,688
Unearned compensation (31,206) (36,976)
Accumulated deficit (48,788) (23,598)
--------- ---------
Total stockholders' equity (deficit) 121,770 (23,745)
--------- ---------
$ 141,654 $ 98,600
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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ARTISTDIRECT, INC.
CONSOLIDATED STATEMENTS OF OPERATION
(AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
-------------- ------------ -------------- ------------
<S> <C> <C> <C> <C>
Net revenue:
Online product sales $ 2,580 $ 1,154 $ 4,609 $ 2,170
Advertising and other 1,973 508 3,770 889
Agency commissions 927 161 1,472 291
Record label 118 161 244 332
------------ ------------ ------------ ------------
Total net revenue 5,598 1,984 10,095 3,682
Cost of revenue:
Direct cost of product sales 2,317 1,048 4,238 1,949
Other cost of revenue 2,129 554 3,762 949
Stock-based compensation 1,679 51 4,472 51
------------ ------------ ------------ ------------
Total cost of revenue 6,125 1,653 12,472 2,949
Gross profit (loss) (527) 331 (2,377) 733
Operating expenses:
Product development 679 440 1,486 631
Sales and marketing 6,596 1,760 11,793 2,537
General and administrative 4,478 1,929 8,058 3,237
Amortization of stock-based compensation 1,757 1,115 1,391 1,917
Depreciation and amortization 1,457 625 2,631 713
------------ ------------ ------------ ------------
Loss from operations (15,494) (5,538) (27,736) (8,302)
Income from equity investment 15 -- 15 33
Interest income, net 1,476 65 2,531 77
------------ ------------ ------------ ------------
Net loss $ (14,003) $ (5,473) $ (25,190) (8,192)
Dividends on redeemable securities 271 297 1,456 418
Beneficial conversion feature on redeemable
preferred stock -- -- 24,375 --
------------ ------------ ------------ ------------
Net loss attributable to common shareholders $ (14,274) $ (5,770) $ (51,021) $ (8,610)
============ ============ ============ ============
Basic and diluted loss per share $ (0.39) N/A $ (1.97) N/A
============ ============ ============ ============
Weighted average common shares outstanding 36,852,548 N/A 25,902,230 N/A
============ ============ ============ ============
Pro forma loss per share $ (0.39) $ (0.29) $ (1.53) $ (0.46)
============ ============ ============ ============
Pro forma weighted average common shares
outstanding 36,852,548 18,594,676 32,696,302 17,735,212
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
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ARTISTDIRECT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------------
2000 1999
-------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(25,190) $ (8,192)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 2,631 713
Income from equity investment (15) (33)
Allowance for doubtful accounts and sales returns 275 (26)
Amortization of unearned compensation 5,863 1,968
Changes in assets and liabilities:
Accounts receivable (1,825) (187)
Prepaid expenses and other current assets (797) (617)
Other assets (97) (722)
Accounts payable, accrued expenses and other liabilities (1,355) 2,028
Deferred revenue (38) 82
-------- --------
Net cash used in operating activities (20,548) (4,986)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (6,111) (574)
Purchase of short term investments (44,091) --
Investments in trademarks (120) (15)
Cash paid for acquisitions -- (110)
-------- --------
Net cash used in investing activities (50,322) (699)
-------- --------
Cash flows from financing activities:
Payment of preferred dividend -- (96)
Payment of notes to stockholders 741 --
Proceeds from exercise of stock options 1,538 --
Proceeds from issuance of preferred securities 15,224 15,000
Payment of Series C redeemable preferred stock offering costs (4,750) --
Proceeds from initial public offering, net of offering costs paid 52,630 --
-------- --------
Net cash provided by financing activities 63,901 14,904
-------- --------
Net (decrease) increase in cash and cash equivalents (6,969) 9,219
Cash and cash equivalents at beginning of period 69,119 1,940
-------- --------
Cash and cash equivalents at end of period $ 62,150 $ 11,159
======== ========
Supplemental disclosure of non cash financing activities:
Accrual of dividends on redeemable preferred securities $ 1,456 $ 418
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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ARTISTDIRECT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - THE COMPANY
ARTISTdirect, Inc. (the "Company") was formed on October 6, 1999 upon its merger
with ARTISTdirect, LLC (the "Capital Reorganization"). The Capital
Reorganization was only a change in the form of ownership of the Company.
ARTISTdirect, LLC was organized as a California limited liability company and
commenced operations on August 8, 1996.
NOTE 2 - INITIAL PUBLIC OFFERING
On March 31, 2000, the Company completed an initial public offering ("IPO") of
5,000,000 shares of its common stock at a price of $12.00 per share. The net
proceeds to the Company, after deducting underwriting discounts and commissions,
and offering expenses, were approximately $52.6 million.
Upon the closing of the IPO, all of the outstanding shares of the Company's
Series A and Series B redeemable preferred stock, including accrued dividends
thereon, automatically converted into shares of common stock on a one-for-one
basis and all of the outstanding shares of the Company's Series C redeemable
preferred stock automatically converted into shares of common stock on an
approximately 1.451-for-one basis. The aggregate number of common shares issued
upon the redeemable preferred stock conversion was 17,194,283.
NOTE 3 - ACCOUNTING POLICIES
Principles of Consolidation
The accompanying financial statements include the consolidated accounts of the
Company and its subsidiaries in which it has controlling interests in the form
of voting and operating control. All significant intercompany accounts and
transactions have been eliminated for all periods presented. Due to the full
funding of losses by the Company and its members, none of the losses generated
by UBL during the periods presented have been allocated to the minority holders.
Unaudited Interim Financial Information
The unaudited interim financial statements of the Company included herein have
been prepared in accordance with the instructions for Form 10-Q under the
Securities Exchange Act of 1934, as amended, and Article 10 of Regulation S-X
under the Securities Act of 1933, as amended. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations relating to interim financial statements.
In the opinion of management, the accompanying unaudited interim consolidated
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to
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present fairly the financial position of the Company at June 30, 2000 and
results of its operations and cash flows for the three and six months ended June
30, 1999 and 2000. The results for the three and six months ended June 30, 2000
are not necessarily indicative of the expected results for the full year or any
future period. These financial statements should be read in conjunction with the
consolidated financial statements and footnotes included in the Company's
documents filed with the Securities and Exchange Commission ("SEC") including
its Registration Statements on Form S-1, and all amendments thereto.
Revenue Recognition
Online product sales, which consist primarily of the gross amount of sales
revenue paid by the customer for recorded music and merchandise sold via the
Internet, include shipping fees and are recognized when the products are
shipped. The Company obtains merchandise from merchandisers and manufacturers,
music from a third-party distributor, contracts for warehousing and fulfillment,
processes customer orders and provides customer service. The Company takes title
to all products sold and bears the risk of loss for collections and nondelivery
subject to any recourse against the shipper. Online product sales are subject to
amounts due to the respective artists based on their contracts, and such expense
is recorded as part of the direct cost of product sales.
The Company generates revenue from the sale of online advertisements under
short-term contracts. To date, the duration of the Company's advertising
commitments has generally averaged from one to three months. Online advertising
revenue is generally recognized ratably in the period in which the advertisement
is displayed, provided that no significant obligations of the Company remain and
collection of the resulting receivable is probable. The Company's obligations
typically include the guarantee of a minimum number of "impressions" or times
that an advertisement appears in pages viewed by the users of the Company's
online properties. The Company records a reserve for contracts in which the
guarantee of a minimum number of impressions are not expected to be met. There
were no such instances as of June 30, 2000 and 1999.
Revenue generated from sponsorships is recognized evenly over the terms of the
sponsorship agreements.
Agency commission revenue is recognized in accordance with the terms of the
representation agreements between the Company and its clients. Revenue is
generally recorded upon payment for the performance of services or delivery of
materials created by the artists represented.
Overhead advances on the record label are recognized as revenue evenly over the
period covered by the advances. Royalties earned on albums sold by artists
signed to the record label are recognized as revenue at the time the releases
are shipped to the retailer. Reserves are established for possible returns.
Cost of Revenue
Direct cost of product sales consists of amounts payable to artists, which
includes the costs of merchandise sold and share of net proceeds, and online
commerce transaction costs, including
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credit card fees, fulfillment charges and shipping costs. Other cost of revenue
consists primarily of Web-site hosting and maintenance costs, online content
programming costs, online advertising serving costs, record royalties payable to
artist and payroll and related expenses for staff involved in Web site
maintenance, content programming and the agency. Stock-based compensation
expense relates to non-cash charges in connection with warrants issued to
vendors and options issued to artists and their advisors for the right to
operate their stores. Amounts payable to artists and transaction costs are
recognized upon shipment. Web site-related costs are recognized immediately when
incurred. Payroll and related expenses are recognized over the period benefited.
Non-cash stock-based compensation charges are recognized over the period of the
related agreements.
Loss per Common Share
The Company computes net loss per share in accordance with SFAS No. 128,
Earnings per Share, and Securities and Exchange Commission Staff Accounting
Bulletin No. 98 (SAB 98). SFAS No. 128 requires companies with complex capital
structures to present basic and diluted EPS. Basic EPS is measured as the income
or loss available to common shareholders divided by the weighted average
outstanding common shares for the period. Diluted EPS is similar to basic EPS
but presents the dilutive effect on a per-share basis of potential common shares
(e.g., convertible securities, options, and the like) as if they had been
converted at the beginning of the periods presented. Potential common shares
that have an anti-dilutive effect (i.e., those that increase income per share or
decrease loss per share) are excluded from diluted EPS.
Included in net loss attributable to common shareholders is the effect of the
beneficial conversion feature of the Series C redeemable preferred stock which
converted into common shares as of March 31, 2000 in connection with our initial
public offering. The value of the beneficial conversion feature was calculated
based on the $2.40 per share difference between the initial public offering
price of $12.00 and the effective conversion price of $9.60 multiplied by the
10,156,252 shares of common stock issued to the Series C shareholders.
Pro Forma Net Loss per Share
The pro forma loss per share for the three and six months ended June 30, 2000
and 1999 is computed using the weighted average number of common shares
outstanding giving effect to the conversion to a C corporation, the elimination
of the dividends on the redeemable preferred securities (except for the interest
accrual on the rescission offer) and the automatic conversion of the redeemable
preferred securities into shares of the Company's common stock effective upon
the closing of the Company's initial public offering as if such events occurred
at the beginning of the periods presented, or at original issuance date, if
later. The calculation of the pro forma net loss per share includes the effect
of the beneficial conversion feature assuming the Series C preferred stock
converted at the initial public offering date at $9.60 per share pursuant to the
original terms of the Series C preferred stock.
Stock-Based Compensation
The Company accounts for stock-based employee compensation in accordance with
the provisions of Accounting Principles Board (APB) opinion No. 25 and FASB
Interpretation No.
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44 and complies with the disclosure requirements of SFAS No. 123, Accounting for
Stock-Based Compensation. Under APB No. 25, compensation expense is recorded
based on the difference, if any, between the fair value of the Company's stock
and the exercise price on the measurement date. The Company accounts for stock
issued to nonemployees in accordance with SFAS No. 123 and EITF 96-18, which
requires entities to recognize as expense over the service period the fair value
of all stock-based awards on the date of grant.
Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosures
of contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
NOTE 4 - RESCISSION OFFER
Included in Redeemable Common Securities are amounts related to options and
securities subject to a potential rescission offer. As disclosed in the
Company's S-1 Registration Statement, the Company issued shares or options to
purchase shares to employees, artists and advisors. The issuance of these shares
or options did not fully comply with certain requirements under the Securities
Act, or available exemptions there under, and as a result the Company intends to
make a rescission offer to all these persons pursuant to a registration
statement to be filed under the Securities Act and pursuant to California
securities law.
In the rescission offer, we will offer to repurchase from these persons all
shares issued directly to these persons or pursuant to option exercises by these
persons before the expiration of the rescission offer for an amount equal to the
purchase or exercise price paid for the shares, plus interest at the rate of 10%
from the date of issuance until the rescission offer expires. The rescission
offer will expire approximately 30 days after the effectiveness of the
rescission offer registration statement. Based upon the number of options
exercised through June 30, 2000, the out-of-pocket cost to us would be
approximately $3.0 million, plus interest.
In addition, we will also offer to repurchase all unexercised options to these
persons at 20% of the option exercise price times the number of option shares,
plus interest at the rate of 10% from the date the options were granted. Based
on the number of options outstanding as of June 30, 2000, and assuming that none
of these options are exercised prior to the end of the rescission offer, the
out-of-pocket cost to us in repurchasing such options would be approximately
$8.0 million, plus interest.
NOTE 5 - STOCK-BASED COMPENSATION
Stock Options
The Employee Stock Option Plan has reserved 6,500,000 shares of common stock for
issuance to employees, non-employee members of the Board of Directors and
consultants. Compensation expense related to such option grants for the three
and six months ended June 30, 2000 was $1.3
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million and $2.5 million, respectively. There was no compensation expense for
the three and six months ended June 30, 1999.
The Artist Stock Option Plan and the Artist and Artist Advisor Stock Option Plan
have reserved 4,000,000 and 1,550,000 shares, respectively, of common stock for
issuance to artists and their advisors for the ARTIST channels and promotional
services. Compensation expense for the three and six months ended June 30, 2000
related to such option grants was $2.3 million and $5.8 million, respectively,
of which $1.6 million and $4.4 million, respectively, was included in cost of
revenue and $700,000 and $1.4 million, respectively, was included in operating
expenses. Compensation expense was $163,000 for the three months ended June 30,
1999, of which $15,000 was included in cost of revenue and $148,000 was included
in operating costs. There was no compensation expense for the three months ended
March 31, 1999.
In February 2000, the Company accelerated the vesting of 114,796 stock options
granted to an executive of the Company. The resulting compensation expense of
$964,000 was recorded during the three months ended March 31, 2000.
Common Unit Interests
During 1998, the Company issued common units, which were converted to common
shares upon the conversion of the Company to a C corporation in October 1999, to
certain executive employees and its outside legal counsel in connection with
services rendered and to be rendered. The holders of these shares were entitled
to receive the amount of appreciation per share through March 31, 2000 above the
value on the date of grant. The fair value of the Company's common stock
decreased from $11.48 as of December 31, 1999 to $7.63 as of March 31, 2000,
which resulted in a decrease in the appreciation per share, and a credit to
stock based compensation expense of $6.6 million for the three months ended
March 31, 2000. The Company recorded expense of $1.0 million and $1.9 million
for the three and six months ended June 30, 2000, respectively.
Warrants
In May and June 1999, the Company issued warrants to purchase common stock to
two vendors. The fair value of the warrants is being amortized as cost of
revenues over the term of the related merchandising agreements. The Company
recorded compensation expense reflected in cost of revenue of $65,000, $131,000
and $36,000 for the three and six months ended June 30, 2000 and three months
ended June 30, 1999, respectively.
In December 1999, the Company issued warrants to purchase 339,254 shares of
common stock in connection with an advertising and promotion agreement. These
warrants are being accounted for as variable warrants. Due to the decrease in
fair value of the Company's common stock to $3.125 as of June 30, 2000, the
Company recorded a credit to stock based compensation of $64,000 for the three
months ended June 30, 2000. The Company recorded compensation expense of $98,000
for the six months ended June 30, 2000.
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The Company entered into an agreement with a landlord for office space for a
term of ten years. In connection with the agreement, the Company issued warrants
to purchase 62,500 shares of common stock. The expense related to the warrants
will be amortized over the term of the agreement. The Company recorded expense
of $14,000 and $19,000 for the three and six months ended June 30, 2000,
respectively.
Equity Transfer
In March 2000, the founders of the Company entered into a series of transactions
whereby two employees and an outside legal counsel would receive the
appreciation on the Company's common stock above $13.93 per share through the
third day of trading after the initial public offering. Additionally, the two
employees and outside legal counsel received stock options on the third day of
trading after the initial public offering with an exercise price equal to $13.93
per share. There was no expense charge for the appreciation rights and stock
options granted to the two employees. The fair value of the appreciation rights
and stock options granted to the outside legal counsel was $2,029,000, and was
recorded as expense during the six months ended June 30, 2000, as the grants
related to past services.
Stock Issuance
As part of a settlement agreement entered into in 1997 with a former employee,
the Company issued 100,000 shares of common stock to the former employee for
consideration of $175,000. The founders each contributed half of the shares of
common stock issued to the employee. The Company recorded as compensation
expense during the three months ended March 31, 2000 $1,025,000 for the excess
of the fair value of the common stock over the consideration received.
NOTE 6 - MERGER TRANSACTION
In January 2000, the Company signed a definitive merger agreement with
Mjuice.com, Inc., a company involved in the development and distribution of the
secure digital distribution of MP3-formatted music. The Company plans to issue
900,000 of its common shares in exchange for all of the outstanding equity of
Mjuice.com, Inc. The acquisition is to be accounted for as a purchase, with
substantially all of the purchase price being attributed to goodwill that will
be amortized over a five-year period. The acquisition is expected to close
during the third quarter of 2000.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report on Form 10-Q contains forward-looking statements based on our
current expectations, estimates and projections about our industry, management's
beliefs and certain assumptions made by us. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "may," "will" or similar expressions
are intended to identify forward-looking statements. In addition, any statements
that refer to expectations, projections or other characterizations of future
events or circumstances, including any underlying assumptions, are
forward-looking statements. Such statements include, but are not limited to,
statements concerning ARTISTdirect's unproven business model, increased
competition in its industry, ARTISTdirect's ability to increase revenues from
online product sales, advertising and other revenue streams, ability to increase
visits to ARTISTdirect's site, ability to attract and retain artists, ability to
offer compelling content, ability to fulfill on-line music and merchandise
orders in a timely manner, ability to build brand recognition, ability to
integrate acquisitions of technology and other businesses, ability to protect
and/or obtain intellectual property rights, and ability to manage growth. Such
statements are not guarantees of future performance and are subject to certain
risks, uncertainties and assumptions that are difficult to predict. Therefore,
our actual results could differ materially and adversely from those expressed in
any forward-looking statements as a result of various factors. The section
entitled "Factors That May Affect Future Results" set forth in this Form 10-Q
and similar discussions in our registration statement declared effective by the
SEC on March 27, 2000, discuss some of the important risk factors that may
affect our business, results of operations and financial condition. You should
carefully consider those risks, in addition to the other information in this
report and in our other filings with the SEC, before deciding to invest in our
company or to maintain or increase your investment. We undertake no obligation
to revise or update publicly any forward-looking statements for any reason. The
information contained in this Form 10-Q is not a complete description of our
business or the risks associated with an investment in our common stock. We urge
you to carefully review and consider the various disclosures made by us in this
report and in our other reports filed with the SEC that discuss our business in
greater detail.
OVERVIEW
We are an online music company that connects artists directly with their
fans worldwide. We provide music entertainment through our ARTISTdirect Network,
an integrated network of Web sites offering multi-media content, music news and
information, community around shared music interests, and music-related
commerce. As of June 30, 2000, ARTISTdirect featured 116 unique, artist-owned
ARTISTchannels, and had signed agreements to launch channels with an additional
11 artists. The ARTISTdirect Network also features the UBL, a music search
engine on the Web, iMusic, a popular online community where fans exchange music
interests and commentary, DOWNLOADSdirect, a feature that allows users to
download music and upload music and other information to the ARTISTdirect
Network, ARTISTtv, providing music-oriented video programming, and the
Superstore, offering a broad selection of music CD's and merchandise. We also
operate a music talent agency, the ARTISTdirect Agency, and prior to June 30,
2000, managed a traditional record label, Kneeling Elephant Records.
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ARTISTdirect was organized as a California limited liability company in
August 1996 and conducted operations through a group of affiliated limited
liability companies. From inception through December 1996, our primary
activities consisted of developing our business model, recruiting and training
employees and developing our infrastructure. During 1997, our operations
consisted primarily of the ARTISTdirect Agency and the Kneeling Elephant Records
label. In July 1997, we formed a joint venture to own a controlling interest in
UBL, LLC.
In September 1997, we launched our first ARTISTchannel. In June 1998, we
expanded content offerings on the UBL and added an online retail store now known
as the ARTISTdirect Superstore. Also in June 1998, we launched our second
ARTISTchannel and, by the end of 1998, we had nine ARTISTchannels in operation.
In February 1999, ARTISTdirect acquired all of the outstanding capital
stock of iMusic, Inc. The purchase consideration for iMusic was approximately
$2.5 million, including $110,000 in cash, redeemable common units in UBL valued
at approximately $2.2 million and the assumption of approximately $180,000 in
liabilities. The acquisition was accounted for as a purchase. The purchase price
has been largely allocated to goodwill, which is being amortized over five
years.
In May 1999, we engaged in an exchange transaction in which all membership
interests in UBL, LLC that we did not own were exchanged for membership
interests in ARTISTdirect, LLC. The value of the consideration given was
approximately $13.9 million and the transaction was accounted for as a purchase.
The purchase price has been largely allocated to goodwill, which is being
amortized over five years.
In July 1999, we officially launched the ARTISTdirect Network, integrating
the UBL and iMusic Web sites with our ARTISTchannels. Since 1997, our revenue
mix has shifted from primarily agency commissions and record label revenue to
electronic commerce revenue and online advertising, and we expect this trend to
continue, particularly with respect to record label revenue, which we expect to
continue decreasing as a percentage of our total revenue in the future.
ARTISTdirect has incurred cumulative net losses of $89.8 million from
inception to June 30, 2000 of which approximately $41.8 million represented
stock-based compensation expense. We expect our net losses to increase and to
continue for the foreseeable future. We plan to expend significant resources
developing our ARTISTdirect Network, building our brands, increasing our
traffic, expanding our operations, enhancing and acquiring content, and
improving our technology infrastructure. We have a limited operating history on
which to base an evaluation of our business and prospects. Our prospects must be
considered in light of the risks, expenses, and difficulties encountered by
companies in their early stage of development, particularly companies in new and
rapidly evolving markets, such as electronic commerce. See "Factors That May
Affect Future Results" for a more complete description of the many risks we
face. Our business is evolving rapidly, and therefore we believe that
period-to-period comparisons of our operating results are not meaningful and
should not be relied upon as an indication of future performance.
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On October 6, 1999, ARTISTdirect, LLC merged into ARTISTdirect, Inc. Before
that time, we operated as a group of limited liability companies and did not
incur federal and state income taxes, other than iMusic, which is a Washington
corporation that we acquired in February 1999. Federal and state income taxes
attributable to losses during such periods were incurred and paid directly by
the members. Any tax benefit attributable to losses generated before our
conversion will not be available to us. As a Delaware corporation, we are fully
subject to federal and state income taxation for periods subsequent to October
6, 1999.
REVENUE
We generate revenue from the ARTISTdirect Network, the ARTISTdirect Agency,
and, prior to June 30, 2000, also generated revenue from Kneeling Elephant
Records. Substantially all of our revenue is generated in cash. Less than 1% of
our revenue for the three and six months ended June 30, 2000 and the year ended
December 31, 1999 was barter revenue.
Revenue from the ARTISTdirect Network, including the ARTISTchannels, the
UBL, iMusic, DOWNLOADSdirect, ARTISTtv, and the ARTISTdirect Superstore,
consists primarily of online product sales and advertising revenue as described
below:
o Revenue from online product sales includes the sale of music and
related merchandise, such as apparel, collectibles and accessories,
through our ARTISTchannels and the ARTISTdirect Superstore. We
recognize the gross amount of product sales and shipping revenue upon
shipment of the item and record appropriate reserves for product
returns. We have experienced seasonality with respect to our online
product sales. In particular, our online product sales in December
have, on average, been higher than in other months. We believe that
this trend may continue for the foreseeable future. For the three and
six months ended June 30, 2000 and the year ended December 31, 1999,
online product sales revenue constituted approximately 46%, 46%
and 51%, respectively, of our total net revenue for those periods.
o Advertising revenue consists primarily of sales of banner
advertisements and sponsorships. In sales of banner advertisements, we
principally earn revenue based on the number of impressions or times
an advertisement appears on pages viewed within our Web sites. Our
banner advertising commitments generally range from one to three
months. Banner advertising revenue is recognized ratably over the
period in which the advertising is displayed, provided no significant
obligations remain and collection of the receivable is probable. We
typically guarantee a minimum number of impressions to the advertiser.
To the extent that minimum guaranteed page deliveries are not met, we
defer recognition of the corresponding revenue until the guaranteed
impressions are delivered. We also sell to advertisers sponsorship of
a Web page or event for a specified period of time. We recognize
sponsorship revenue over the period in which the sponsored page or
event is displayed. To the extent that committed obligations under
sponsorship agreements are not met, revenue recognition is deferred
until the obligations are met. For the three and six months ended June
30, 2000 and the year ended December 31, 1999, advertising revenue
constituted approximately 35%, 37% and 28%, respectively, of our
total net revenue for those periods.
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Revenue from the ARTISTdirect Agency consists primarily of commissions
generated on tour and event bookings of artists represented by the agency.
Agency commission revenue is recognized at the time the artist gets paid. Agency
commission revenue fluctuates depending on touring schedules of major artists
represented by the agency. Touring schedules are subject to seasonality, with
summer typically being a more active period. For the three and six months ended
June 30, 2000 and the year ended December 31, 1999, commission revenue
constituted approximately 17%, 15% and 13%, respectively, of our total net
revenue for those periods.
Prior to June 30, 2000, revenue from Kneeling Elephant Records was
generated from overhead advances and from royalties earned on albums sold by
artists signed to the label. We recognized royalties at the time the releases
were shipped to the retailer. Reserves were established for possible returns.
During the three and six months ended June 30, 2000, Pringles, a division
of Procter & Gamble, accounted for 19% and 10%, respectively, of the Company's
advertising revenue. No other single advertiser represented more than 10% of the
Company's advertising revenue in the three or six months ended June 30, 2000.
COST OF REVENUE
Cost of revenue consists primarily of amounts payable to artists, which
includes the cost of merchandise sold and share of net proceeds, online
transaction costs, including credit card fees, fulfillment charges and shipping
costs, Web site hosting and maintenance costs, online content and programming
costs, online advertising serving costs, record royalties payable to artist,
payroll and related expenses for staff involved in Web site maintenance, content
programming and the ARTISTdirect Agency, and amortization of non-cash
compensation expense related to vendor warrants and ARTISTchannel stock options
granted to artists and their advisors in connection with opening their
ARTISTchannels. Artist royalties are based on electronic commerce and
advertising revenue generated from their ARTISTchannels. Web site maintenance
costs include personnel-related costs, software consulting costs, Internet
hosting charges, and networking costs.
In connection with the amortization of vendor warrants and ARTISTchannel
stock options granted through June 30, 2000, we recorded non-cash compensation
expense of approximately $1.7 million and $4.5 million for the three and six
months ended June 30, 2000, respectively, and approximately $1.8 million for the
year ended December 31, 1999. We expect to grant additional equity instruments
in the future related to ARTISTchannels. Due to these equity grants, we expect
to record substantial non-cash compensation expense into the foreseeable future.
OPERATING EXPENSE
Product Development. Product development expense consists primarily of
expenses required to design and develop our Web sites and underlying technology
infrastructure. These expenses primarily include payments to third-party service
vendors and personnel costs.
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Sales and Marketing. Sales and marketing expense consists primarily of
advertising, marketing and promotion expenses incurred to promote our Web sites
and our brands, plus payroll and related expenses for personnel engaged in
advertising sales, business development, marketing and customer service
activities.
General and Administrative. General and administrative expense consists of
payroll and related expenses for executive and administrative personnel,
professional services expenses, facilities expenses, travel and other general
corporate expenses.
Amortization of Stock-based Compensation. We recorded a total of $35.6
million of stock-based compensation expense for the period from inception
through June 30, 2000 in connection with equity granted to employees, directors,
professional firms, artists and advisors during this period. We recorded
amortization of stock-based compensation expense of $1.8 million and $1.4
million during the three and six months ended June 30, 2000, respectively, and
approximately $30.3 million during the year ended December 31, 1999. We
anticipate granting additional equity securities in the future to employees,
directors and artists.
Depreciation and Amortization. Depreciation and amortization expense
consists of the depreciation of fixed assets and the amortization of acquired
intangible assets. The acquisitions of iMusic and the minority interest of the
UBL were accounted for using the purchase method of accounting and, accordingly,
the purchase prices have been allocated to the tangible and intangible assets
acquired and liabilities assumed on the basis of their fair values on the
acquisition dates. Substantially all of the purchase price of these transactions
is attributable to the acquired intangible assets. As a result, the aggregate
excess purchase price over the net tangible assets has been estimated to be
$15.5 million and are being amortized over five years, the expected estimated
average useful life of these assets. These non-cash charges will significantly
affect our reported operating results over the next several years.
INTEREST INCOME AND EXPENSE
Interest income consists of earnings on our cash and cash equivalents and
short-term investments, and interest expense consists of interest associated
with short-term borrowings.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999
NET REVENUE
Net revenue increased to $5.6 million for the three months ended June 30,
2000 from $2.0 million for the three months ended June 30, 1999, which
represented an increase of 182%. Net revenue for the six months ended June 30,
2000 increased to $10.1 million from $3.7 million for the six months ended June
30, 1999, which represented an increase of 174%. The increases were primarily
due to increases in online product sales revenues, advertising revenue and
agency commission revenue. Online product sales revenue for the three months
ended June 30, 2000, increased 124% to $2.6 million from $1.2 million for the
three months ended June 30, 1999,
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primarily as a result of an increase in the number of ARTISTchannels that were
operated. Online product sales revenue for the six months ended June 30, 2000,
increased 112% to $4.6 million from $2.2 million for the six months ended June
30, 1999, primarily as a result of an increase in the number of ARTISTchannels
that were operated. Advertising and other revenue increased $1.5 million, or
288%, to $2.0 million for the three months ended June 30, 2000 from $500,000
for the three months ended June 30, 1999, primarily as a result of increased
page views generated by our Web sites plus a significant increase in sales of
non-impression based sponsorships. Advertising and other revenue increased $2.9
million, or 324%, to $3.8 million for the six months ended June 30, 2000 from
$900,000 for the six months ended June 30, 1999, primarily as a result of
increased page views generated by our Web sites plus a significant increase in
the number of advertisers primarily in sales of non-impression based
sponsorships. Commission revenue from the ARTISTdirect Agency increased from
$160,000 for the three months ended June 30, 1999 to $930,000 for the three
months ended June 30, 2000, which represented an increase of 476%, due
primarily to increased touring activity of the agency's artists. Commission
revenue from the ARTISTdirect Agency increased from $290,000 for the six months
ended June 30, 1999 to $1.5 million for the six months ended June 30, 2000,
which represented an increase of 406%, due primarily to increased touring
activity of the agency's artists.
COST OF REVENUE
Direct cost of product revenue. Direct cost of product revenue increased to
$2.3 million for the three months ended March 31, 2000 from $1.0 for the three
months ended June 30, 1999, which represented an increase of 121%. This $1.3
million increase corresponded with the increase in online product sales revenue
and was primarily attributable to a related increase in product and royalty
costs payable to our vendors and artists and an increase in transaction costs.
Direct cost of product revenue increased to $4.2 million for the six months
ended June 30, 2000 from $1.9 for the six months ended June 30, 1999, which
represented an increase of 117%. This $2.3 million increase corresponded with
the increase in online product sales revenue and was primarily attributable to a
related increase in product and royalty costs payable to our vendors and artists
and an increase in transaction costs.
Other cost of revenue. Other cost of revenue increased to $2.1 million for
the three months ended June 30, 2000 from $500,000 for the three months ended
June 30, 1999, which represented an increase of 310%. This $1.6 million
increase was primarily due to increases in Web site hosting and maintenance
costs as well as higher payroll and related costs. Other cost of revenue
increased to $3.8 million for the six months ended June 30, 2000 from $900,000
for the six months ended June 30, 1999, which represented an increase of 312%.
This $2.9 million increase was primarily due to increases in Web site hosting
and maintenance costs.
Stock-based compensation. For the three months ended June 30, 2000 we
recorded non-cash stock-based compensation charges of $1.7 million compared to
$51,000 for the three months ended June 30, 1999. For the six months ended June
30, 2000 we recorded non-cash stock-based compensation charges of $4.5 million
compared to $51,000 for the six months ended June 30, 1999. The stock-based
compensation expense relates primarily to the amortization of the estimated
value of the options, using the Black-Scholes method, given to artists in
connection
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with the operation of their stores and is amortized over the life of the
associated contract periods. Our overall gross profit margin decreased to -9%
in the second quarter of 2000 from 17% in the second quarter of 1999 primarily
due to the non-cash stock-based compensation expenses recognized in 2000. Gross
profit excluding stock-based compensation was 21% and 19% for the second
quarter of 2000 and 1999, respectively.
OPERATING EXPENSE
Product Development. Product development expense increased to $679,000 for
the three months ended June 30, 2000 from $440,000 for the three months ended
June 30, 1999, which represented an increase of 54%. This increase was
primarily attributable to increased fees paid to third party service vendors
relating to the continued development of our Network Web site as well as an
increase in the development costs of music content and programming. Product
development expense increased to $1.5 million for the six months ended June 30,
2000 from $600,000 for the six months ended June 30, 1999, which represented an
increase of 136%. This increase was primarily attributable to increased fees
paid to third party service vendors relating to the continued development of our
Web site as well as an increase in the development costs of programming.
Sales and Marketing. Sales and marketing expense increased to $6.6 million
for the three months ended June 30, 2000 from $1.8 million for the three months
ended June 30, 1999, which represented an increase of 275%. The increase was
primarily attributable to a significant increase in our online advertising
expenditures as well as increased offline advertising and market research. In
addition, personnel and related expenses increased as we added headcount to
support our growth. Sales and marketing expense increased to $11.8 million for
the six months ended June 30, 2000 from $2.5 million for the six months ended
June 30, 1999, which represented an increase of 365%. The increase was
primarily attributable to a significant increase in our online advertising
expenditures as well as increased offline advertising. We expect sales and
marketing expenses to continue to increase in future periods as we continue to
build our brand and consumer awareness.
General and Administrative. General and administrative expense increased to
$4.5 million for the three months ended June 30, 2000 from $1.9 million for the
three months ended June 30, 1999, which represented an increase of 132%. This
increase was primarily attributable to increases in personnel and related
expenses and outside professional services expenses. General and administrative
expense increased to $8.1 million for the six months ended June 30, 2000 from
$3.2 million for the six months ended June 30, 1999, which represented an
increase of 149%. This increase was primarily attributable to increases in
personnel and related expenses, facilities and outside professional services
expenses. We expect general and administrative expense to increase as we expand
our staff to support our growth strategy and incur the higher costs of operating
as a public company.
Amortization of Stock-based Compensation. We recorded stock-based
compensation expense of $1.8 million for the three months ended June 30, 2000 in
connection with stock issuances to
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employees, directors, professional firms, artists and advisors for promotional
services. Stock-based compensation for the comparable period in 1999 was $1.1
million, primarily in connection with stock issuances to employees, directors
and professional firms, which represented a increase of 58%. We recorded
stock-based compensation expense of $1.4 million for the six months ended June
30, 2000 in connection with stock issuances to employees, directors,
professional firms, artists and advisors for promotional services. Stock-based
compensation for the comparable period in 1999 was $1.9 million, primarily in
connection with stock issuances to employees, directors and professional firms,
which represented a decrease of 27%. The expense during the period reflected a
credit to stock-based compensation granted to certain executives of the Company
as a result of a reduction in the valuation of the Company's underlying common
stock as compared with December 31, 1999. This credit was offset by the
amortization during the period of stock-based compensation expense related to
options granted to employees, artists and advisors.
Depreciation and Amortization. Depreciation and amortization expense
increased to $1.5 million for the three months ended June 30, 2000 from
approximately $600,000 for the three months ended June 30, 1999. This increase
was primarily attributable to the amortization of the goodwill associated with
the acquisition of iMusic and the minority interest in the UBL as well as an
increase in depreciation of fixed assets and amortization of leasehold
improvements. Depreciation and amortization expense increased to $2.6 million
for the six months ended June 30, 2000 from approximately $700,000 for the six
months ended June 30, 1999. This increase was primarily attributable to the
amortization of the goodwill associated with the acquisition of iMusic and the
minority interest in the UBL as well as an increase in depreciation of fixed
assets and amortization of leasehold improvements.
INTEREST INCOME AND EXPENSE
Interest income increased to $1.5 million for the three months ended June
30, 2000 from $65,000 for the three months ended June 30, 1999, and from $2.5
million for the six months ended June 30, 2000 from $80,000 for the six months
ended June 30, 1999. The increases are due to interest earned on cash balances
resulting from the proceeds we received from our initial public offering ("IPO")
in March 2000 and the Series C redeemable preferred shares issued in December
1999 and January 2000.
NET LOSS
Net loss increased to $14.0 million for the three months ended June 30,
2000, compared to $5.5 million for the three months ended June 30, 1999, which
represented an increase of 156%. The increase in the net loss is primarily
attributable to a $4.8 million increase in sales and marketing expense, a $2.6
million increase in general and administrative expense, a $600,000 increase in
the amortization of stock-based compensation, and an $800,000 increase in
depreciation and amortization expense, partially offset by a $1.4 million
increase in interest income. Net loss increased to $25.2 million for the six
months ended June 30, 2000, compared to $8.2 million for the six months ended
June 30, 1999, which represented an increase of 208%. The increase in the net
loss is primarily attributable to a $3.1 million decrease in gross profit due to
stock-based compensation related to artist store agreements, a $9.3 million
increase
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in sales and marketing expense, a $4.8 million increase in general and
administrative expense, and a $1.9 million increase in depreciation and
amortization expense, partially offset by a $2.5 million increase in interest
income.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2000, we completed our IPO and raised net proceeds of
approximately $52.6 million through the sale of 5,000,000 common shares. In
addition, we raised an aggregate of $97.5 million of gross proceeds through the
sale of 7,000,291 shares of Series C preferred stock in December 1999 and
January 2000. In May 1999, we issued 3,750,0000 shares of Series B preferred
securities in exchange for an aggregate purchase price of $15.0 million. Between
July 1998 and December 1998, we issued 3,207,815 shares of Series A preferred
securities in exchange for an aggregate purchase price of $4.9 million. Prior to
July 1998, we financed our operations and growth entirely from internally
generated cash flow and capital contributions from founders. As of June 30,
2000, we had $62.1 million of cash and cash equivalents, excluding cash held for
clients, and held $44.1 million in short-term investments.
Net cash used in operating activities was $20.5 million for the six months
ended June 30, 2000, and $5.0 million for the six months ended June 30, 1999.
Net cash used in operating activities for each of these periods primarily
consisted of net losses partially offset by non-cash items such as stock-based
compensation and depreciation and amortization in 2000.
Net cash used in investing activities was $50.3 million for the six months
ended June 30, 2000, and $700,000 for the six months ended June 30, 1999. Net
cash used in investing activities for each of these periods consisted of
purchases of fixed assets of $6.1 million, primarily computer equipment to
support the ARTISTdirect Network and leasehold improvements to our corporate
offices, and the purchase of short-term investments of $44.1 million in 2000.
Net cash provided by financing activities was $63.9 million for the six
months ended June 30, 2000 and $14.9 million for the six months ended June 30,
1999. Net cash provided by financing activities for the six months ended June
30, 2000 was principally attributable to the proceeds of our initial public
offering in March 2000 in which we raised approximately $52.6 million, net of
underwriters' discounts and expenses, and $10.5 million raised from the sale of
Series C preferred stock in January 2000, net of offering costs.
As of June 30, 2000 our principal commitments consisted of obligations
outstanding under operating leases and employment contracts. We will need to
spend significant amounts for sales and marketing, advertising and promoting our
brands, content
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development and technology and infrastructure development. We will need to
expend funds to add personnel in all areas.
We currently anticipate that our available cash resources will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. There can be no assurance,
however, that the underlying assumed levels of revenues and expenses will prove
to be accurate. Although we do not currently have any specific material capital
commitments beyond such 12-month period, if we are unsuccessful in generating
sufficient cash flow from operations, we may need to raise additional funds in
future periods through public or private financings, or other arrangements to
fund our operations and potential acquisitions. If any additional financing is
needed, we might not be able to raise capital on reasonable terms or at all.
Failure to raise capital when needed could seriously harm our business and
operating results. If additional funds were raised through the issuance of
equity securities, the percentage of ownership of our stockholders would be
reduced. Furthermore, these equity securities might have rights, preferences or
privileges senior to our common stock. We currently do not have any plans for
future equity offerings.
YEAR 2000
To date we have not experienced any known material Year 2000 problems in
our products, our internal systems or facilities, or the products, systems and
services of third parties. We will continue to monitor our mission critical
computer applications and those of our suppliers and vendors throughout the year
2000 to ensure that any latent Year 2000 matters that may arise are addressed
promptly. We did not incur material costs to identify and address specific Year
2000 compliance issues. We could however incur additional costs in addressing
any residual Year 2000 issues, which could have a material and adverse effect on
our business.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
In future periods, our business, financial condition and results of
operations may be affected by many factors, including but not limited to the
following:
IT IS DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS BECAUSE WE HAVE A LIMITED
OPERATING HISTORY.
We were formed in August 1996. We acquired the UBL in July 1997, launched
our first ARTISTchannel in September 1997 and acquired iMusic in February 1999.
We have been operating all of these sites as an integrated network since July
1999. Our limited operating history, particularly as an integrated network of
Web sites, makes it difficult to evaluate our current business and prospects or
to accurately predict our future revenue or results of operations. Our revenue
and income potential are unproven, and our business model is constantly
evolving. Because the Internet is constantly changing, we may need to modify our
business model to adapt to these changes. Before investing, you should evaluate
the risks, uncertainties, expenses and difficulties frequently encountered by
companies in early stages of development, particularly companies in new and
rapidly evolving Internet industry segments.
OUR BUSINESS MODEL IS NEW AND UNPROVEN, AND WE MAY NOT BE ABLE TO GENERATE
SUFFICIENT REVENUE TO OPERATE OUR BUSINESS SUCCESSFULLY.
Our model for conducting business and generating revenue is new and
unproven. Our success will depend primarily on our ability to generate revenue
from multiple sources through the ARTISTdirect Network, including:
o online sales of music and related merchandise;
o sales of advertising and sponsorships;
o marketing our database of consumer information and preferences; and
o sales of, or subscription fees for, digitally distributed music.
It is uncertain whether a music-related Web site that relies on attracting
people to learn about, listen to and purchase music and related merchandise can
generate sufficient revenue from electronic commerce, advertising, sales of
database information and sales of, or fees for, digital downloads of music, to
become a viable business. We provide many of our products and services without
charge, and we may not be able to generate sufficient revenue to pay for these
products and services. Accordingly, we are not certain that our business model
will be successful or that we can sustain revenue growth or be profitable. If
our markets develop more slowly than expected or become saturated with
competitors, or our products and services do not achieve or sustain market
acceptance, we may not be able to successfully operate our business.
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WE HAVE A HISTORY OF OPERATING LOSSES AND ANTICIPATE LOSSES AND NEGATIVE CASH
FLOW FOR THE FORESEEABLE FUTURE.
To date, we have not been profitable on an annual basis and have incurred
accumulated losses of approximately $89.8 million as of June 30, 2000. For the
three months ended June 30, 2000 and the year ended December 31, 1999, we
incurred net losses of approximately $14.0 million and $57.8 million,
respectively, which represented approximately 250% and 560%, respectively, of
our revenue for those periods. We expect our operating losses and negative cash
flow to continue for the foreseeable future. We anticipate that our operating
losses will increase significantly from current levels because we plan to
significantly increase our expenditures for sales and marketing, content
development, and technology and infrastructure development to enhance the
ARTISTdirect Network. With increased expenses, we will need to generate
significant additional revenue to achieve profitability. Consequently, it is
possible that we may never achieve profitability, and even if we do achieve
profitability, we may not sustain or increase profitability on a quarterly or
annual basis in the future. If we do not achieve or sustain profitability in the
future, then we will be unable to continue our operations.
OUR OPERATING RESULTS MAY PROVE UNPREDICTABLE.
Our operating results are likely to fluctuate significantly in the future
due to a variety of factors, many of which are outside of our control. Because
our operating results are volatile and difficult to predict, in some future
quarters our operating results may fall below the expectations of securities
analysts and investors. In this event, the trading price of our common stock may
fall significantly.
IF WE DO NOT GENERATE INCREASED REVENUE FROM ONLINE PRODUCT SALES, OUR GROWTH
WILL BE LIMITED AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.
If we do not generate increased revenue from sales of online products, our
growth will be limited and our business will be adversely affected. To generate
significant online product revenue, we will have to offer music and related
merchandise that appeal to a large number of online consumers. We also will have
to continue to create online communities that are conducive to electronic
commerce, build or license a sufficiently robust and scalable electronic
commerce platform and increase our order fulfillment capability. Since our
target market includes Internet users below the age of 18, and these users have
limited access to credit cards, our ability to capture online product revenue
from this group may be limited. If we are not successful in meeting these
challenges, our growth will be limited and our business will be adversely
affected.
IF WE DO NOT INCREASE ADVERTISING REVENUE, OUR BUSINESS WILL BE ADVERSELY
AFFECTED.
If we do not increase advertising revenue, our business will be adversely
affected. Increasing our advertising revenue depends upon many factors,
including our ability to:
o respond to and anticipate fluctuations in the demand for, and pricing
of, online advertising;
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o conduct successful selling and marketing efforts aimed at advertisers;
o increase the size of our audience and the amount of time that our
audience spends on our Web sites;
o increase our direct advertising sales force and build up our
international marketing team;
o increase the amount of revenue per advertisement;
o aggregate our target demographic group of 12 to 34 year-old active
music consumers;
o offer advertisers the means to effectively target their advertisements
to our audience;
o accurately measure the size and demographic characteristics of our
audience;
o maintain key advertising relationships; and
o compete for advertisers with Internet and traditional media companies.
In addition to the above factors, general economic conditions, as well as
economic conditions specific to online advertising, electronic commerce and the
music industry, could affect our ability to increase our advertising revenue.
Our failure to achieve one or more of these objectives could impair our ability
to increase advertising revenue, which could adversely affect our business.
WE DEPEND UPON ARTISTS TO ATTRACT ADVERTISERS AND GENERATE ELECTRONIC COMMERCE
REVENUE.
We believe that our future success depends on our ability to maintain our
existing artist agreements and to secure additional agreements with artists. Our
business would be adversely affected by any of the following:
o inability to recruit new artists and increase the number of
ARTISTchannels;
o the loss of popularity of artists for whom we operate ARTISTchannels;
o increased competition to maintain existing relationships with artists;
o non-renewals of our current agreements with artists; and
o poor performance or negative publicity of our artists.
If we are not able to provide valuable services or incentives to artists,
or if we otherwise fail to maintain good relations with our artists, they may
lose interest in providing content and merchandise and otherwise promoting their
ARTISTchannels or the ARTISTdirect Network. The artists own the domain names for
their ARTISTchannels and some of the intellectual
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property rights with respect to content developed for the ARTISTchannels. As a
result, we may lose the rights to operate artists' sites if our agreements with
these artists terminate and are not renewed.
Most of our current artist contracts have a term of three years. Upon
expiration, artists may not renew these contracts on reasonable terms, if at
all. If artists decide to remove their online stores from the ARTISTdirect
Network when their agreements terminate, we may be unable to recoup our costs to
develop, operate and promote the sites.
In the past, we have offered our artists options to purchase our common
stock. Options were intended to provide artists with an additional incentive to
actively promote the ARTISTchannels and the ARTISTdirect Network. We may not be
able to offer artists options or other equity incentives on terms as attractive
to artists as what we have offered previously. If we cannot provide adequate
incentives, our efforts to sign new artists may be impaired. If we cannot
maintain our current relationships with artists or sign agreements with new
artists, our user base would likely diminish and our ability to generate
revenues from electronic commerce and advertising would be seriously harmed.
WE MAY NOT BE ABLE TO DEVELOP OR OBTAIN SUFFICIENTLY COMPELLING CONTENT TO
ATTRACT AND RETAIN OUR TARGET AUDIENCE.
For our business to be successful, we must provide content and services
that attract consumers who will purchase music and related merchandise online.
We may not be able to provide consumers with an acceptable mix of products,
services, information and community to attract them to our Web sites frequently
or to encourage them to remain on our Web sites for an extended period of time.
If our audience determines that our content does not reflect its tastes, then
our audience size could decrease or the demographic characteristics of our
audience could change and we may be unable to react to those changes effectively
or in a timely manner. Any of these results would adversely affect our ability
to attract advertisers and sell music and other related merchandise. Our ability
to provide compelling content could be impaired by any of the following:
o reduced access to content controlled by record labels, music
publishers and artists;
o diminished technical expertise and creativity of our production staff;
and
o inability to anticipate and capitalize on trends in music.
IF WE DO NOT BUILD AND MAINTAIN STRONG BRANDS, WE MAY NOT BE ABLE TO ATTRACT A
SUFFICIENT NUMBER OF USERS TO OUR WEB SITES.
To attract users we must develop a brand identity for ARTISTdirect and
increase public awareness of the ARTISTchannels, the UBL and iMusic. We intend
to spend approximately $30 million during 2000 on our offline and online
advertising and promotional efforts to increase brand awareness, traffic and
revenue. Our marketing activities may, however, not result in increased revenue
and, even if they do, any increased revenue may not offset the expenses we
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incur in building our brands. Moreover, despite these efforts we may be unable
to increase public awareness of our brands, which would have an adverse effect
on our results of operations.
OUR ONLINE STORE AGREEMENTS WITH ARTISTS DO NOT PRECLUDE OUR ARTISTS FROM
SELLING MUSIC AND RELATED MERCHANDISE ON OTHER WEB SITES.
Our online store agreements with artists do not preclude them from selling
merchandise and compact discs or offering music downloads on other Web sites. If
we are unable to attract sufficient traffic to the ARTISTdirect Network,
consumers may purchase the products that we offer on other Web sites. If we are
unable to generate revenue from the sale of music and related merchandise, our
results of operations will be adversely affected.
OUR MARKET IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY
AGAINST OUR CURRENT AND FUTURE COMPETITORS.
The market for the online promotion and distribution of music and related
merchandise is highly competitive and rapidly changing. We estimate that there
are currently over 150 Web sites that promote and distribute music and related
merchandise. The number of Web sites competing for the attention and spending of
consumers, advertisers and users has increased, and we expect it to continue to
increase because there are few barriers to entry to Internet commerce.
We face competitive pressures from numerous actual and potential
competitors. Our competitors include mp3.com, Launch Media, Amazon.com, CDnow,
CheckOut.com, MTVi, major Internet portals and traditional music companies.
Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Some of our competitors
have announced agreements to work together to offer music over the Internet, and
we may face increased competitive pressures as a result. Many of our current and
potential competitors in the Internet and music entertainment businesses may
have substantial competitive advantages relative to us, including:
o longer operating histories;
o significantly greater financial, technical and marketing resources;
o greater brand name recognition;
o larger existing customer bases; and
o more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to develop, promote and sell their products or services than we can. Web sites
maintained by our existing and potential competitors
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may be perceived by consumers, artists, talent management companies and other
music-related vendors or advertisers as being superior to ours. In addition,
increased competition could result in reduced advertising rates and margins and
loss of market share, any of which could harm our business.
WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS FOR MUSIC MERCHANDISE, FULFILLMENT
AND DISTRIBUTION; IF WE CANNOT SECURE ALTERNATE SUPPLIERS, OUR BUSINESS MAY BE
HARMED.
We rely to a large extent on timely distribution by third parties. We
currently rely substantially on one vendor, Alliance Entertainment, to fulfill
and distribute our orders for music and related merchandise. During the three
months ended June 30, 2000, and the year ended December 31, 1999, virtually all
of our orders for music and related merchandise were fulfilled by Alliance. In
July 1997, Alliance filed for protection from its creditors under Chapter 11 of
the U.S. Bankruptcy Code. Alliance has since emerged from Chapter 11 and is
under new ownership. Our agreement with Alliance covers fulfillment services for
sales under the ARTISTdirect Superstore, but does not cover fulfillment services
for our ARTISTchannels. Although Alliance has been fulfilling orders for music
and related merchandise from the ARTISTchannels on the same terms as orders from
the ARTISTdirect Superstore, Alliance may terminate the ARTISTchannel
arrangement at any time.
We purchase almost all of our compact discs from Alliance and a substantial
majority of our other music-related merchandise from two other vendors, Giant
Merchandising and Winterland Concessions Company. During the three months ended
June 30, 2000, and year ended December 31, 1999, we purchased approximately 90%
and 96%, respectively, of the dollar volume of our compact discs from Alliance,
and we obtained approximately 38% and 27%, respectively, of the dollar volume of
our other music-related merchandise from Giant Merchandising and approximately
12% and 17%, respectively, from Winterland Concessions. Our business could be
significantly disrupted if Alliance, Giant or Winterland were to terminate or
breach their agreements or suffer adverse developments that affect their ability
to supply products to us. If, for any reason, Alliance, Giant or Winterland are
unable or unwilling to supply products to us in sufficient quantities and in a
timely manner, we may not be able to secure alternative suppliers, on acceptable
terms in a timely manner, or at all.
WE DEPEND ON THIRD PARTY INVENTORY AND FINANCIAL SYSTEMS AND CARRIER SERVICES.
Because we rely on third parties to fulfill orders, we depend on their
systems for tracking inventory and financial data. If our distributors' systems
fail or are unable to scale or adapt to changing needs, or if we cannot
integrate our information systems with the systems of any new distributors, we
may not have adequate, accurate or timely inventory or financial information. We
also rely on third-party carriers for shipments to and from distribution
facilities. We are therefore subject to the risks, including employee strikes
and inclement weather, associated with our carriers' ability to provide delivery
services to meet our distribution and shipping needs. In the quarter ended
December 31, 1999, both we and Alliance experienced an unusually high volume of
orders, which resulted in shipping delays to our customers. These delays did not
have a material adverse effect; however, our failure to deliver products to our
customers in a timely
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and accurate manner in the future could harm our reputation, our relationship
with customers, the ARTISTdirect and UBL brands and our results of operations.
OUR BUSINESS IS SUBJECT TO SEASONALITY, WHICH COULD ADVERSELY AFFECT OUR
OPERATING RESULTS
We have experienced and expect to continue to experience seasonal
fluctuations in our online sales. These seasonal patterns will cause quarterly
fluctuations in our operating results. In particular, a disproportionate amount
of our online sales have been realized during the fourth calendar quarter and
during the summer months, traditionally when artists go on tour. Due to our
limited operating history, it is difficult to predict the seasonal pattern of
our online sales and the impact of such seasonality on our business and
operating results. Our seasonal online sales patterns may become more
pronounced, strain our personnel, warehousing, and order shipment activities and
cause our operating results to be significantly less than expected for any given
period. This would likely cause our stock price to fall.
IF WE ARE UNABLE TO SUCCESSFULLY MIGRATE OUR E-COMMERCE SYSTEM, OUR BUSINESS
WOULD BE SERIOUSLY HARMED.
Our current e-commerce system is based on SAP software provided to us by
Pandesic, LLC, a joint venture between Intel and SAP. Pandesic recently
announced that it is winding down its business, and while it is not accepting
new business, it intends to support existing customers in their transition to a
new enterprise resource planning system. Pandesic and SAP have expressed an
intent to work with current customers, including us, to attempt a migration to
mySAP.com or another SAP-developed solution. Upon Pandesic's cessation of
operations, we also have the right to receive the source code and executables
for the e-commerce system that had been provided by Pandesic. If we fail to
successfully transition from Pandesic's services to a new e-commerce system and
integrate this system with our existing systems, or if we are not able to expand
a future system to accommodate our growth, we may not have adequate, accurate or
timely e-commerce transaction information. Our failure to have adequate,
accurate or timely e-commerce transaction information would harm our business,
which could have a material adverse effect on our results of operations.
WE MAY BE SUBJECT TO SYSTEM DISRUPTIONS, WHICH COULD REDUCE OUR REVENUE.
Our ability to attract and retain artists, users, advertisers and merchants
depends on the performance, reliability and availability of our Web sites and
network infrastructure. The maintenance and operation of substantially all of
our Internet communications hardware and servers have been outsourced to the
facilities of AT&T CerfNet, Digex, American Digital Network and Level (3)
Communications. We have periodically experienced service interruptions caused by
temporary problems in our own systems or software or in the systems or software
of these third parties. While we are implementing procedures to improve the
reliability of our systems, these interruptions may continue to occur from time
to time.
In addition, under our agreements with Digex and American Digital Network,
they are not liable to us for any damage or loss they may cause to our business,
and we may be unable to seek reimbursement from them for losses that they cause.
Our users also depend on third party
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Internet service providers and Web site operators for access to our Web sites.
These entities have experienced significant outages in the past, and could
experience outages, delays and other difficulties due to system failures in the
future which are unrelated to our systems, but which could nonetheless adversely
affect our business.
COMPUTER VIRUSES, ELECTRONIC BREAK-INS OR SIMILAR DISRUPTIVE EVENTS COULD
DISRUPT OUR SERVICES.
Computer viruses, electronic break-ins or similar disruptive events could
disrupt our services. System disruptions could result in the unavailability or
slower response times of our Web sites, which would reduce the number of
advertisements delivered or commerce conducted on our Web sites and lower the
quality of our users' experience. Service disruptions could adversely affect our
revenue and, if they were prolonged, would seriously harm our business and
reputation. Our business interruption insurance may not be sufficient to
compensate us for losses that may occur as a result of these interruptions.
IF WE DO NOT MANAGE OUR GROWTH, WE MAY NOT BE ABLE TO OPERATE OUR BUSINESS
EFFECTIVELY.
Since our inception in August 1996, we have rapidly and significantly
expanded our operations. We expect further significant expansion will be
required to address potential growth in our artist and consumer bases, the
breadth of our product and service offerings, and other opportunities. This
expansion has strained, and we expect that it will continue to strain, our
management, operations, systems and financial resources. To manage our recent
growth and any future growth of our operations and personnel, we must improve
and effectively utilize our existing operational, management, marketing and
financial systems and successfully recruit, hire, train and manage personnel and
maintain close coordination among our technical, finance, marketing, sales and
production staffs. In addition, we may also need to increase the capacity of our
software, hardware and telecommunications systems on short notice. We also will
need to manage an increasing number of complex relationships with users,
strategic partners, advertisers and other third parties. Our failure to manage
growth could disrupt our operations and ultimately prevent us from generating
the revenue we expect.
THE LOSS OF KEY PERSONNEL, INCLUDING MARC GEIGER, DONALD MULLER OR KEITH
YOKOMOTO, COULD ADVERSELY AFFECT OUR BUSINESS BECAUSE THESE INDIVIDUALS ARE
IMPORTANT TO OUR CONTINUED GROWTH.
Our future success depends to a significant extent on the continued
services of our senior management, particularly Marc Geiger, Donald Muller and
Keith Yokomoto. The loss of any of these individuals would likely have an
adverse effect on our business. Competition for personnel throughout our
industry is intense and we may be unable to retain these key employees or
attract, integrate or retain other highly qualified employees in the future. We
have in the past experienced, and we expect to continue to experience,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications. If we do not succeed in attracting new personnel or retaining
and motivating our current personnel, our business could be adversely affected.
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IF WE DO NOT REALIZE THE ANTICIPATED BENEFITS OF POTENTIAL FUTURE ACQUISITIONS,
OUR BUSINESS COULD BE SERIOUSLY HARMED AND OUR STOCK PRICE COULD FALL.
We regularly evaluate, in the ordinary course of business, potential
acquisitions of, or investments in, complementary businesses, products and
technologies. If we are presented with appropriate opportunities, we intend to
actively pursue these acquisitions and/or investments. We may not, however,
realize the anticipated benefits of any acquisition or investment. If we buy a
company, we could have difficulty in assimilating that company's other
personnel, technology, operations or products into our operations. In addition,
the key personnel of the acquired company may decide not to work for us. These
difficulties could disrupt our ongoing business, distract our management and
employees and increase our expenses. Acquisitions or business combinations could
also cause us to issue equity securities that would dilute your percentage
ownership in us, incur debt or assume contingent liabilities and take large
immediate or future write-offs or charges, including amortization of goodwill or
compensation expense. Each of these results could materially and adversely
affect our business and adversely affect the price of our common stock.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR COMPETITIVE
POSITION COULD BE HARMED OR WE COULD BE REQUIRED TO INCUR EXPENSES TO ENFORCE
OUR RIGHTS.
We rely upon common-law trademark rights that arise from our commercial use
of the ARTISTdirect, ARTISTdirect Agency, UBL, Ultimate Band List, iMusic and
Kneeling Elephant Records brand names, and the respective associated domain
names, and the ARTISTdirect logo. We seek to protect our trademarks, copyrights
and other proprietary rights by registration and other means, but these actions
may be inadequate. ARTISTdirect has trademark applications pending in several
jurisdictions, but our registrations may not be accepted or may be preempted by
third parties and/or we may not be able to register our trademarks in all
jurisdictions in which we intend to do business. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to and distribution of our
proprietary information.
The steps we have taken may not prevent misappropriation of our proprietary
rights, particularly in foreign countries where laws or law enforcement
practices may not protect our proprietary rights as fully as in the United
States. If third parties were to use or otherwise misappropriate our copyrighted
materials, trademarks or other proprietary rights without our consent or
approval, our competitive position could be harmed, or we could become involved
in litigation to enforce our rights. In addition, policing unauthorized use of
our content, trademarks and other proprietary rights could be very expensive,
difficult or impossible, particularly given the global nature of the Internet.
OUR ACCESS TO COPYRIGHTED CONTENT DEPENDS UPON THE WILLINGNESS OF CONTENT OWNERS
TO MAKE THEIR CONTENT AVAILABLE.
The music content available on the ARTISTdirect Network is typically
comprised of copyrighted works owned or controlled by multiple third parties.
Most of the content on ARTISTchannels is either owned or licensed by the artist.
On other parts of the ARTISTdirect
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Network, depending on the nature of the content and how we use the music
content, we typically license such rights from publishers, record labels,
performing rights societies or artists. We frequently either do not have written
contracts or have short-term contracts with copyright owners, and, accordingly,
our access to copyrighted content depends upon the willingness of such parties
to continue to make their content available. If the fees for music content
increase substantially or if significant music content becomes unavailable, our
ability to offer music content could be materially limited.
We have not obtained a license for some of the content offered on the
ARTISTdirect Network, including links to other music-related sites and
thirty-second streamed song samples, because we believe that a license is not
required under existing law. However, this area of law remains uncertain and may
not be resolved for a number of years. When this area of law is resolved, we may
be required to obtain licenses for such content, alter or remove the content
from our Web sites and be forced to pay potentially significant financial
damages for past conduct.
INTELLECTUAL PROPERTY CLAIMS AGAINST US COULD BE COSTLY AND COULD RESULT IN THE
LOSS OF SIGNIFICANT RIGHTS.
Third parties may assert trademark, copyright, patent and other types of
infringement or unfair competition claims against us. If we are forced to defend
against any such claims, whether they are with or without merit or are
determined in our favor, we may face costly litigation, loss of access to, and
use of, content, diversion of technical and management personnel, or product
shipment delays. As a result of such a dispute, we may have to develop
non-infringing technology or enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may be unavailable on terms
acceptable to us, or at all. While we have resolved all such disputes in the
past, we may not be able to do so in the future. If there is a successful claim
of infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology or content on a timely
basis, it could harm our business.
In addition, we rely on third parties to provide services enabling our
online product sales transactions, including credit card processing, order
fulfillment and shipping. We could become subject to infringement actions by
third parties based upon our use of intellectual property provided by our third-
party providers. It is also possible that we could become subject to
infringement actions based upon the content licensed from third parties. Any
such claims or disputes could subject us to costly litigation and the diversion
of our financial resources and technical and management personnel. Further, if
our efforts to enforce our intellectual property rights are unsuccessful or if
claims by third parties against ARTISTdirect, the UBL and iMusic are successful,
we may be required to change our trademarks, alter or remove content, pay
financial damages, or alter our business practices. These changes of trademarks,
alteration of content, payment of financial damages or alteration of practices
may adversely affect our business.
WE MAY BE UNABLE TO ACQUIRE NECESSARY WEB DOMAIN NAMES.
We may be unable to acquire or maintain Web domain names relating to our
brand or to specific ARTISTchannels in the United States and other countries in
which we may conduct
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business. We currently hold various relevant domain names, including the
"artistdirect.com," "ubl.com," "imusic.com" and "downloadsdirect.com" domain
names. The acquisition and maintenance of domain names generally is regulated by
governmental agencies and their designees and is subject to change. The
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. Therefore, we could be
unable to prevent third parties from acquiring or using domain names that
infringe or otherwise decrease the value of our brand name, trademarks and other
proprietary rights.
IF OUR ONLINE SECURITY MEASURES FAIL, WE COULD LOSE VISITORS TO OUR SITES AND
COULD BE SUBJECT TO CLAIMS FOR DAMAGE FROM OUR USERS, CONTENT PROVIDERS,
ADVERTISERS AND MERCHANTS.
Our relationships with consumers would be adversely affected and we may be
subject to claims for damage if the security measures that we use to protect
their personal information, especially credit card numbers, are ineffective. We
rely on security and authentication technology that we license from third
parties to perform real-time credit card authorization and verification with our
bank. We cannot predict whether events or developments will result in a
compromise or breach of the technology we use to protect a customer's personal
information.
Our infrastructure is vulnerable to unauthorized access, physical or
electronic computer break-ins, computer viruses and other disruptive problems.
Internet service providers have experienced, and may continue to experience,
interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees and others. Anyone who is able to
circumvent our security measures could misappropriate proprietary information or
cause interruptions in our operations. Security breaches relating to our
activities or the activities of third-party contractors that involve the storage
and transmission of proprietary information could damage our reputation and our
relationships with our content providers, advertisers and merchants. We also
could be liable to our content providers, advertisers and merchants for the
damages caused by such breaches or we could incur substantial costs as a result
of defending claims for those damages. We may need to expend significant capital
and other resources to protect against such security breaches or to address
problems caused by such breaches. Our security measures may not prevent
disruptions or security breaches.
WE MAY BE SUBJECT TO LIABILITY IF PRIVATE INFORMATION PROVIDED BY OUR USERS WERE
MISUSED.
Our privacy policy discloses how we use individually identifiable
information that we collect. This policy is displayed and accessible throughout
the ARTISTdirect Network. Despite this policy, however, if third persons were
able to penetrate our network security or otherwise misappropriate our users'
personal information or credit card information, we could be subject to
liability. We could also be subject to liability for claims for unauthorized
purchases with credit card information, impersonation or other similar fraud
claims, or other misuses of personal information, such as for unauthorized
marketing purposes. These claims could result in costly and time-consuming
litigation.
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CHANGES IN LAWS OR REGULATIONS MAY ADVERSELY AFFECT OUR ABILITY TO COLLECT
DEMOGRAPHIC AND PERSONAL INFORMATION FROM USERS AND COULD AFFECT OUR ABILITY TO
ATTRACT ADVERTISERS.
Legislatures and government agencies have adopted and are considering
adopting laws and regulations regarding the collection and use of personal
information obtained from individuals when accessing Web sites. For example,
Congress recently enacted the Children's Online Privacy Protection Act, which
restricts the ability of Internet companies to collect information from children
under the age of 13 without their parents' consent. In addition, the Federal
Trade Commission and state and local authorities have been investigating
Internet companies regarding their use of personal information. Our privacy
programs may not conform with laws or regulations that are adopted. In addition,
these legislative and regulatory initiatives may adversely affect our ability to
collect demographic and personal information from users, which could have an
adverse effect on our ability to provide advertisers with demographic
information.
The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. The directive could impose restrictions
that are more stringent than current Internet privacy standards in the United
States. If this directive were applied to us, it could prevent us from
collecting data from users in European Union member countries or subject us to
liability for use of information in contravention of the directive. Other
countries have adopted or may adopt similar legislation. We could incur
additional expenses if new regulations regarding the use of personal information
are introduced or if government authorities choose to investigate our privacy
practices.
WE MAY BE ADVERSELY IMPACTED IF THE SOFTWARE, COMPUTER TECHNOLOGY AND OTHER
SYSTEMS WE USE ARE NOT YEAR 2000 COMPLIANT.
The risks posed by Year 2000 issues could adversely affect our business in
a number of ways. Although we believe that our internal systems and technology
are Year 2000 compliant and have not experienced any Year 2000 issues to date,
we currently do not have, and do not plan to develop, a contingency plan to
address any problems caused by Year 2000 issues. Software and hardware from
third parties that have been integrated into our systems may need to be updated
or replaced, which may be time consuming and expensive. We rely on a number of
third parties to support and operate our Web sites. In addition, our
distribution providers and suppliers, including our accounting services
provider, depend on their own information technology systems and on the systems
of their vendors.
Failures or interruptions of our systems or those of third parties because
of Year 2000 problems could seriously damage our business and our relationships
with our content, distribution and technology providers, advertisers and users.
Failures, interruptions or other service problems due to Year 2000 could result
in lost revenue, increased operating costs and loss of significant user traffic.
Governmental agencies, public utilities, Internet service providers and others
that we rely on or that our customers rely on and which we do not control may
not be Year 2000 compliant. This could result in systemic failures beyond our
control, such as a prolonged Internet, telecommunications or electrical failure,
and prevent us from providing our content or reduce user traffic.
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WE HAVE A CONTINGENT LIABILITY AS A RESULT OF A RESCISSION OFFER WE INTEND TO
MAKE DUE TO OUR ISSUANCES OF SECURITIES IN VIOLATION OF SECURITIES LAWS.
We have issued shares or options to purchase shares of our common stock to
our employees and to artists and their managers and advisors. Due to the nature
of the persons who received these shares and options in addition to our
employees and the total number of shares and options issued to them and our
employees, the issuance of these shares and options did not comply with the
requirements of Rule 701 under the Securities Act, or any other available
exemptions from the registration requirements of Section 5 of the Securities
Act, and may not have qualified for any exemption from qualification under
California securities laws either.
As a result, we intend to make a rescission offer to all these persons
pursuant to a registration statement filed under the Securities Act and pursuant
to California securities law. In the rescission offer, we will offer to
repurchase from these persons all shares issued directly to these persons or
pursuant to option exercises by these persons before the expiration of the
rescission offer for an amount equal to the purchase or exercise price paid for
the shares, plus interest at the rate of 10% from the date of issuance until the
rescission offer expires. The rescission offer will expire approximately 30 days
after the effectiveness of the rescission offer registration statement. Based
upon the number of options exercised through June 30, 2000, and assuming that
all such issued shares are tendered in the rescission offer, the out-of-pocket
cost to us would be approximately $3.0 million, plus interest.
In addition, we will also offer to repurchase all unexercised options to
these persons at 20% of the option exercise price times the number of option
shares, plus interest at the rate of 10% from the date the options were granted.
Based on the number of options outstanding as of June 30, 2000, and assuming
that none of these options are exercised prior to the end of the rescission
offer, and, further, that all such options are tendered in the rescission offer,
the cost to us in repurchasing such options would be approximately $8.0 million,
plus interest.
As of the date of this report, we are not aware of any claims for
rescission against us. If we are required to repurchase all of the shares
subject to the rescission offer, our operating results and liquidity during the
period in which such repurchase occurs could be adversely affected.
WE MAY BE SUED FOR CONTENT AVAILABLE OR POSTED ON OUR WEB SITES OR PRODUCTS SOLD
THROUGH OUR WEB SITES.
We may be liable to third parties for content published on our Web sites
and other Web sites where our syndicated content appears if the music, artwork,
text or other content available violates their copyright, trademark or other
intellectual property rights or if the available content is defamatory, obscene
or pornographic. Those types of claims have been brought, sometimes
successfully, against Web site operators in the past. We also may be liable for
content uploaded or posted by our users on our Web sites, such as digitally
distributed music files, postings on our message boards, chat room discussions
and copyrightable works. In addition, we could have liability to some of our
content licensors for claims made against them for content available on our Web
sites. We also could be exposed to these types of claims for the content that
may be accessed from our Web sites or via links to other Web sites or for
products sold through our Web site. While we have resolved all of these types of
claims made against us in the past, we may not be able to do so in the future.
We intend to implement measures to reduce exposure to these
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types of claims, but such measures may not be successful and may require us to
expend significant resources. Any litigation as a result of defending these
types of claims could result in substantial costs and damages. Our insurance may
not adequately protect us against these types of claims or the costs of their
defense or payment of damages.
THE EFFECTIVENESS OF THE INTERNET FOR ADVERTISING IS UNPROVEN, WHICH MAY
DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON OUR SITES.
Our future depends in part on an increase in the use of the Internet and
other forms of digital media for advertising. The Internet advertising market is
new and rapidly evolving, and we cannot yet gauge the effectiveness of
advertising on the Internet as compared to traditional media. As a result,
demand for Internet advertising is uncertain. Many advertisers have little or no
experience using the Internet for advertising purposes. The adoption of Internet
advertising, particularly by companies that have historically relied upon
traditional media for advertising, requires the acceptance of a new way of
conducting business, exchanging information and advertising products and
services. Such customers may find advertising on the Internet to be undesirable
or less effective than traditional advertising media for promoting their
products and services. If the Internet advertising market fails to fully develop
or develops more slowly than we expect, our business could be adversely
affected. In addition, the market for advertising on other forms of digital
media, such as broadband distribution, is even less developed than Internet
advertising, and if that market does not develop, our growth may be limited.
IF CURRENT STANDARDS TO MEASURE THE EFFECTIVENESS OF ADVERTISING ON THE INTERNET
DO NOT DEVELOP, OUR ABILITY TO ATTRACT AND RETAIN ADVERTISERS COULD BE ADVERSELY
IMPACTED.
There are currently few, well established standards to measure the
effectiveness of advertising on the Internet and other digital media, and the
absence of these standards could adversely impact our ability to attract and
retain advertisers. Currently available software programs that track Internet
usage and other tracking methodologies are rapidly evolving, but such standard
measurements may never develop. In addition, the development of such software or
other methodologies may not keep pace with our information needs, particularly
to support the growing needs of our internal business requirements and
advertising clients.
SOFTWARE PROGRAMS THAT PREVENT OR LIMIT THE DELIVERY OF ADVERTISING MAY
SERIOUSLY DAMAGE OUR ABILITY TO ATTRACT AND RETAIN ADVERTISERS.
A number of "filter" software programs have been developed which limit or
prevent advertising from being delivered to an Internet user's computer. This
software could adversely affect the commercial viability of Internet
advertising. These programs attempt to blank out, or block, banner and other
advertisements. To date, such programs have not had a material adverse impact on
our ability to attract and retain advertisers or caused us to fail to meet the
terms of our advertising agreements. These programs may, however, have these
effects on us in the future. Widespread adoption of this type of software would
seriously damage our ability to attract and retain advertisers.
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WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF GOVERNMENT
REGULATION INCREASES.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. Laws and regulations may be adopted
in the future, however, that address issues such as user privacy, pricing,
taxation, content, copyrights, distribution, security, and the quality of
products and services. For example, the Telecommunications Act sought to
prohibit transmitting certain types of information and content over the Web.
Several telecommunications companies have petitioned the Federal Communications
Commission to regulate Internet service providers and online services providers
in a manner similar to long distance telephone carriers and to impose access
fees on these companies. Any imposition of access fees could increase the cost
of transmitting data over the Internet. In addition, the growth and development
of the market for online commerce may lead to more stringent consumer protection
laws, both in the United States and abroad, that may impose additional burdens
on us. The United States Congress recently enacted Internet laws regarding
children's privacy, copyrights, taxation and the transmission of sexually
explicit material. The law of the Internet, however, remains largely unsettled,
even in areas where there has been some legislative action. Moreover, it may
take years to determine the extent to which existing laws relating to issues
such as property ownership, libel and personal privacy are applicable to the
Web. Any new, or modifications to existing, laws or regulations relating to the
Web could adversely affect our business.
Prohibition and restriction of Internet content and commerce could reduce
or slow Internet use, decrease the acceptance of the Internet as a
communications and commercial medium and expose us to liability. Any of these
outcomes could have a material adverse effect on our business, results of
operations and financial condition. The growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws,
both in the United States and abroad, that may impose additional burdens on
companies conducting business over the Internet.
THE INTERNET IS SUBJECT TO RAPID CHANGES, WHICH COULD RESULT IN SIGNIFICANT
ADDITIONAL COSTS.
The market for Internet products and services is characterized by rapid
change, evolving industry standards and frequent introductions of new
technological developments. These new standards and developments could make our
existing or future products or services obsolete. Keeping pace with the
introduction of new standards and technological developments could result in
significant additional costs or prove difficult or impossible for us. The
failure to keep pace with these changes and to continue to enhance and improve
the responsiveness, functionality and features of our Web sites could harm our
ability to attract and retain users. Among other things, we will need to license
or develop leading technologies, enhance our existing services and develop new
services and technologies that address the varied needs of our users.
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OUR NET SALES COULD BE ADVERSELY AFFECTED IF WE BECOME SUBJECT TO SALES AND
OTHER TAXES.
If one or more states or any foreign country successfully asserts that we
should collect sales or other taxes on the sale of our products, our net sales
and results of operations could be harmed. We do not currently collect sales or
other similar taxes for physical shipments of goods into states other than
California and Florida. However, one or more states may seek to impose sales tax
collection obligations on companies, such as ARTISTdirect, which engage in or
facilitate online commerce. A number of proposals have been made at the state
and local level that would impose additional taxes on the sale of goods and
services through the Internet. Such proposals, if adopted, could substantially
impair the growth of electronic commerce and could adversely affect our
opportunity to derive financial benefit from electronic commerce. Moreover, if
any state or foreign country were to successfully assert that we should collect
sales or other taxes on the exchange of merchandise on its system, our results
of operations could be adversely affected. In addition, any new operations in
states outside California could subject our shipments in such states to state
sales taxes under current or future laws.
Legislation limiting the ability of the states to impose taxes on
Internet-based transactions has been enacted by Congress. However, this
legislation, known as the Internet Tax Freedom Act, imposes only a moratorium
ending on October 21, 2001 on state and local taxes on electronic commerce where
such taxes are discriminatory and on Internet access unless such taxes were
generally imposed and actually enforced before October 1, 1998. Failure to renew
this legislation would allow various states to impose taxes on Internet-based
commerce.
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT AND MAINTENANCE OF THE INTERNET
AND THE AVAILABILITY OF INCREASED BANDWIDTH TO CONSUMERS.
The success of our business will rely on the continued improvement of the
Internet as a convenient means of consumer interaction and commerce, as well as
an efficient medium for the delivery and distribution of music. Our business
will depend on the ability of our artists and consumers to conduct commercial
transactions with us, as well as to continue to upload and download music files,
without significant delays or aggravation that may be associated with decreased
availability of Internet bandwidth and access to our Web site. This will depend
upon the maintenance of a reliable network with the necessary speed, data
capacity and security, as well as timely development of complementary products,
such as high speed modems, for providing reliable Internet access and services.
The failure of the Internet to achieve these goals will reduce our ability to
generate significant revenue.
Our penetration of a broader consumer market will depend, in part, on
continued proliferation of high speed Internet access. The Internet has
experienced, and is likely to continue to experience, significant growth in the
numbers of users and amount of traffic. As the Internet continues to experience
increased numbers of users, increased frequency of use and increased bandwidth
requirements, the Internet infrastructure may be unable to support the demands
placed on it. In addition, increased users or bandwidth requirements may harm
the performance of the Internet.
The Internet has experienced a variety of outages and other delays and it
could face outages and delays in the future. These outages and delays could
reduce the level of Internet usage as well as the level of traffic, and could
result in the Internet becoming an inconvenient or
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uneconomical source of music and related products and merchandise which would
cause our revenue to decrease. The infrastructure and complementary products or
services necessary to make the Internet a viable commercial marketplace for the
long term may not be developed successfully or in a timely manner. Even if these
products or services are developed, the Internet may not become a viable
commercial marketplace for the products or services that we offer.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) SALES OF UNREGISTERED SECURITIES. During the three months ended June
30, 2000, there was no exercise of options to purchase shares of Common Stock
that had been granted under the 1999 Employee Stock Option Plan, the 1999 Artist
Stock Option Plan and/or the 1999 Artist and Artist Advisor Stock Option Plan.
The Company issued options to purchase 821,000 shares of its Common Stock at a
weighted average exercise price of $4.00 per share during this period.
(d) USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES. On March 31,
2000, the Company completed an initial public offering (the "Offering") of its
Common Stock, $.01 par value. The managing underwriters in the Offering were
Morgan Stanley Dean Witter, Bear, Stearns & Co. Inc. and Deutsche Banc Alex.
Brown (the "Underwriters"). The shares of Common Stock sold in the Offering were
registered under the Securities Act of 1933, as amended, on a Registration
Statement on Form S-1 (the "Registration Statement") (Reg. No. 333-87547) that
was declared effective by the SEC on March 27, 2000. The Offering commenced on
March 28, 2000. All 5,000,000 shares of Common Stock registered under the
Registration Statement were sold at a price of $12.00 per share. The aggregate
price of the Offering amount registered was $60,000,000. In connection with the
Offering, the Company paid an aggregate of $4.2 million in underwriting
discounts and commissions to the Underwriters. In addition, the following table
sets forth an estimate of all expenses incurred in connection with the Offering,
other than underwriting discounts and commissions. All amounts shown are
estimated except for the fees payable to the SEC, National Association of
Securities Dealers, Inc. ("NASD") and Nasdaq National Market.
SEC registration fee $ 23,978
NASD filing fee 9,125
Nasdaq National Market listing fee 117,188
Blue Sky fees and expenses --
Printing and engraving expenses 741,000
Legal fees and expenses 1,300,000
Accounting fees and expenses 750,000
Transfer Agent fees 20,000
Miscellaneous 2,38,709
----------
Total $3,200,000
==========
After deducting the underwriting discounts and commissions and the
estimated Offering expenses described above, the Company received net proceeds
from the Offering of approximately $52.6 million. As of June 30, 2000, the
Company had not used any of the net proceeds from the Offering and had used its
existing cash balances to fund the general operations
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of the Company. The Company intends to use the proceeds for general corporate
purposes as described in the prospectus for the Offering. None of the Company's
net proceeds of the Offering were paid directly or indirectly to any director,
officer, general partner of the Company or their associates, persons owning 10%
or more of any class of equity securities of the Company, or an affiliate of the
Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3. Registrant's Certificate of Incorporation and Bylaws (incorporated
by reference to Exhibits 3.1 and 3.2 to Registrant's Form S-1 No. 333-87547).
27. Financial Data Schedule
(b) None
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SIGNATURES
Pursuant to the requirements 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.
ARTISTDIRECT, INC.
(Registrant)
By: /s/ James B. Carroll
-----------------------------------------
James B. Carroll
Executive Vice President,
Chief Financial Officer and Secretary
Dated: August 14, 2000
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
27 Financial Data Schedule
