<PAGE> 1
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 SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
------ ------
COMMISSION FILE NUMBER 000-30063
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 September 30, 2000:
37,728,502 shares.
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page
---------------------------- ----
<S> <C>
ITEM 1. BALANCE SHEETS AT SEPTEMBER 30, 2000 (UNAUDITED) AND DECEMBER
31, 1999 ....................................................... 1
STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 2000 (UNAUDITED) AND 1999 (UNAUDITED)............. 2
STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER
30, 2000 (UNAUDITED) AND 1999 (UNAUDITED)....................... 3
NOTES TO FINANCIAL STATEMENTS................................... 4-11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................... 12-37
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ..... 38
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................... 39
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS....................... 39
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................. 40
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 40
ITEM 5. OTHER INFORMATION............................................... 40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 40
A. EXHIBITS.................................................... 40
B. REPORTS ON FORM 8-K......................................... 40
SIGNATURES............................................................... 41
</TABLE>
In this Report, "ARTISTdirect," the "Company," "we," "us" and "our"
collectively refer to ARTISTdirect, Inc.
i
<PAGE> 3
PART I FINANCIAL INFORMATION
ARTISTDIRECT, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 53,465 $ 69,119
Cash held for clients 210 770
Short term investments 43,765 --
Accounts receivable, net 2,455 1,001
Prepaid expenses and other current assets 5,898 6,795
--------- ---------
Total current assets 105,793 77,685
Property and equipment, net 8,785 3,343
Goodwill and intangibles, net 16,026 13,415
Other assets, net 2,425 4,157
--------- ---------
$ 133,029 $ 98,600
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Cash held for clients $ 210 $ 770
Accounts payable 1,656 3,709
Accrued expenses 7,404 4,698
Notes payable 172 741
Deferred revenue 18 37
--------- ---------
Total current liabilities 9,460 9,955
Long term liabilities 1,387 683
--------- ---------
Total liabilities 10,847 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 $10,242 and $9,206 in 2000 and 1999, respectively 10,242 9,206
--------- ---------
Total redeemable securities 10,242 111,707
--------- ---------
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 37,728,502 and 14,088,674 shares
in 2000 and 1999, respectively 378 141
Additional paid-in-capital
204,339 36,688
Unearned compensation (26,914) (36,976)
Accumulated deficit (65,863) (23,598)
--------- ---------
Total stockholders' equity (deficit) 111,940 (23,745)
--------- ---------
$ 133,029 $ 98,600
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE> 4
ARTISTDIRECT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- -------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenue:
Online product sales $ 3,265 $ 1,331 $ 7,874 $ 3,501
Advertising and other 1,246 777 5,016 1,666
Agency commissions 1,051 371 2,523 662
Record label -- 273 244 605
------------ ------------ ------------ ------------
Total net revenue 5,562 2,752 15,657 6,434
Cost of revenue:
Direct cost of product sales 2,813 1,165 7,051 3,114
Other cost of revenue 2,405 1,212 6,167 2,161
Stock-based compensation 1,678 330 6,150 381
------------ ------------ ------------ ------------
Total cost of revenue 6,896 2,707 19,368 5,656
Gross profit (loss) (1,334) 45 (3,711) 778
Operating expenses:
Product development 1,271 397 2,757 1,028
Sales and marketing 7,749 2,901 19,542 5,438
General and administrative 4,774 2,385 12,832 5,622
Amortization of stock-based compensation 1,725 19,625 3,116 21,542
Depreciation and amortization 1,684 841 4,315 1,554
------------ ------------ ------------ ------------
Loss from operations (18,537) (26,104) (46,273) (34,406)
Income from equity investment -- -- 15 33
Interest income, net 1,462 90 3,993 167
------------ ------------ ------------ ------------
Net loss $ (17,075) $ (26,014) $ (42,265) $ (34,206)
Dividends on redeemable securities (154) 523 1,302 952
Beneficial conversion feature on redeemable
preferred stock -- -- 24,375 --
------------ ------------ ------------ ------------
Net loss attributable to common shareholders $ (16,621) $ (26,537) $ (67,942) $ (35,158)
============ ============ ============ ============
Basic and diluted loss per share $ (0.45) N/A $ (2.29) N/A
============ ============ ============ ============
Weighted average common shares outstanding 37,355,556 N/A 29,665,415 N/A
============ ============ ============ ============
Pro forma loss per share $ (0.45) $ (1.26) $ (1.95) $ (1.83)
============ ============ ============ ============
Pro forma weighted average common shares
outstanding 37,355,556 20,745,745 34,263,920 18,665,230
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 5
ARTISTDIRECT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(42,265) $(34,206)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 4,315 1,554
Income from equity investment (15) (33)
Allowance for doubtful accounts and sales returns 478 51
Amortization of unearned compensation 9,266 21,923
Changes in assets and liabilities:
Accounts receivable (1,932) (878)
Prepaid expenses and other current assets 958 (1,096)
Other assets 1,997 (1,339)
Accounts payable, accrued expenses and other liabilities 436 3,936
Deferred revenue (35) 118
-------- --------
Net cash used in operating activities (26,797) (9,970)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (6,378) (2,287)
Purchase of short term investments, net of maturities (43,765) --
Investments in trademarks (120) (37)
Investment in joint venture (250) (30)
Distribution of earnings from equity investment -- 33
Cash paid for acquisitions (2,015) (237)
-------- --------
Net cash used in investing activities (52,528) (2,558)
-------- --------
Cash flows from financing activities:
Payment of preferred dividend -- (96)
Payment of notes to shareholders (741) --
Payment of Series C redeemable preferred stock offering costs (4,800) --
Proceeds from exercise of stock options 1,553 --
Proceeds from issuance of preferred securities 15,224 15,000
Proceeds from initial public offering, net of offering costs paid 52,435 --
-------- --------
Net cash provided by financing activities 63,671 14,904
-------- --------
Net (decrease) increase in cash and cash equivalents
(15,654) 2,376
Cash and cash equivalents at beginning of period 69,119 1,940
-------- --------
Cash and cash equivalents at end of period $ 53,465 $ 4,316
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 6
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 $52.4 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. 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
4
<PAGE> 7
present fairly the financial position of the Company at September 30, 2000 and
results of its operations and cash flows for the three and nine months ended
September 30, 1999 and 2000. The results for the three and nine months ended
September 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
and 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 and
sponsorships, both online and offline, under short-term contracts. To date, the
duration of the Company's advertising and sponsorship commitments has generally
averaged from one to three months. 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. Online advertising revenue is generally recognized as the
impressions are served during 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 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 September 30,
2000. Revenue generated from sponsorships is recognized ratably over the terms
of the sponsorship agreements.
The Company entered into several contracts with advertisers whereby the parties
exchanged online and offline advertising. This revenue was recognized as trade
and barter. Trade and barter is valued based upon similar cash transactions
which have been entered into within six months of the respective trade and
barter agreement. Trade and barter revenue was $167,000 and $234,000 for the
three and nine months ended September 30, 2000, respectively. Trade and barter
revenue was $38,000 and $61,000 for the three and nine months ended September
30, 1999, respectively.
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.
5
<PAGE> 8
Cost of Revenue
Direct cost of product sales consists of amounts payable to artists, which
includes the cost of merchandise sold and share of net proceeds, and online
commerce transaction costs, including 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 artists and payroll and related expenses for
staff involved in Web site maintenance, content programming and the ARTISTdirect
talent 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 that
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 nine months ended September 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 a currently contemplated 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.
6
<PAGE> 9
The pro forma loss for the nine months ended September 30, 2000 and 1999 is
calculated as follows:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
2000 1999
-------- --------
(in thousands)
<S> <C> <C>
Net loss attributable to common shareholders $(68,016) $(35,120)
Addback: Accrued dividends on Series A & B redeemable preferred stock 963 914
-------- --------
Pro forma loss $(67,053) $(34,206)
======== ========
</TABLE>
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. 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.
7
<PAGE> 10
NOTE 4 - SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENT OF CASH FLOWS
Significant non-cash investing and financing activities are reflected in the
following table:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
2000 1999
------- --------
(in thousands)
<S> <C> <C>
Cash paid for acquisitions:
Fair value of net assets acquired $ 5,025 $ 2,463
Net liabilities assumed (203) (185)
Common stock issued (2,807) (2,168)
------- --------
Cash paid for acquisitions $ 2,015 $ 110
======= ========
Issuance of common securities for minority
interest in affiliated companies
Issuance of common securities $ -- $ 13,922
Acquisitions costs - cash paid -- 127
Net assets acquired -- (938)
------- --------
Goodwill $ -- $ 13,111
======= ========
Accrual of dividends on redeemable preferred
securities $ 1,302 $ 952
======= ========
</TABLE>
NOTE 5 - 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 that was filed with the SEC on July 18,
2000, as subsequently amended, the Company has issued shares or options to
purchase shares to employees, artists and advisors. The issuance of certain of
these shares or options did not fully comply with certain requirements under the
Securities Act, or available exemptions thereunder, 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, the Company will offer to repurchase from these persons
all shares issued directly to such persons or pursuant to option exercises by
such 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 7% 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 September 30, 2000, the out-of-pocket cost to the Company
would be approximately $2.2 million, plus interest.
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<PAGE> 11
In addition, the Company 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 7% from the date the options were granted.
Based on the number of options outstanding as of September 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 the Company in repurchasing such
options would be approximately $7.4 million, plus interest.
NOTE 6 - 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 nine months ended September 30, 2000 was $1.0 million and $3.5 million,
respectively. There was no compensation expense for the three and nine months
ended September 30, 1999.
The Artist Stock Option Plan and the Artist and Artist Advisor Stock Option Plan
have reserved 4,000,000 and 1,850,000 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 nine months ended September 30,
2000 related to such option grants was $2.3 million and $8.1 million,
respectively, of which $1.6 million and $6.0 million, respectively, was included
in cost of revenue and $700,000 and $2.1 million, respectively, was included in
operating expenses. Compensation expense was $4.8 million and $5.0 million for
the three and nine months ended September 30, 1999, respectively, of which
$264,000 and $279,000, respectively, was included in cost of revenue and $4.5
million and $4.7 million, respectively, was included in operating costs.
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 $14.2 million and $16.0 million
for the three and nine months ended September 30, 1999, respectively.
Warrants
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<PAGE> 12
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 and
$196,000 for the three and nine months ended September 30, 2000, respectively.
The Company recorded compensation expense reflected in cost of revenue of
$65,000 and $102,000 for the three and nine months ended September 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 $1.1875 as of September 30, 2000,
the Company recorded a credit to stock based compensation of $56,000 for the
three months ended September 30, 2000. The Company recorded compensation expense
of $42,000 for the nine months ended September 30, 2000.
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 $33,000 for the three and nine months ended September 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 nine months ended September 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.
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<PAGE> 13
NOTE 7 - MERGER TRANSACTION
In August 2000, ARTISTdirect acquired all of the outstanding capital stock of
Mjuce.com, Inc., a company involved in the development and distribution of the
secure digital distribution of MP3-formatted music. The Company issued 900,000
of its common shares and common share equivalents in exchange for all of the
outstanding equity of Mjuice.com, Inc. The total purchase consideration for
Mjuice.com was approximately $5.0 million, which includes cash paid of $2.0
million. The acquisition was accounted for as a purchase, with goodwill being
amortized over a period of five years. Amortization expense was $169,000 for the
three and nine months ended September 30, 2000.
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<PAGE> 14
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 general uncertainties related to amount spent on online
advertising, ARTISTdirect's ability to attract new artists and retain existing
artists, competition in its industry, including from Web sites offering free
music, ability to enter into new strategic relationships and leverage existing
strategic relationships, ability to increase revenue from online product sales,
advertising and other revenue streams, and to generate revenue from digital
distribution, ability to increase visits to ARTISTdirect's network of sites,
ability to offer compelling content, ability to fulfill online music and
merchandise orders in a timely manner, ability to build brand recognition, and
ability to protect and/or obtain intellectual property rights. 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, our Form
10-Q filed on August 14, 2000 with the SEC and similar discussions in our
registration statement on Form S-1 declared effective by the SEC on August 14,
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 September 30, 2000, ARTISTdirect featured 126 unique,
artist-owned ARTISTchannels, and had signed agreements to launch channels with
an additional 9 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
ARTISTdirect Superstore, an online store that offers a broad selection of music
CD's and merchandise. We also operate a music talent agency, the
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ARTISTdirect Agency, and prior to June 30, 2000, managed a traditional record
label, Kneeling Elephant Records.
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, we 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
was 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 was 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 to decrease as a percentage of our total revenue in the future.
In August 2000, we acquired all of the outstanding capital stock of
Mjuce.com, Inc. The total purchase consideration for Mjuice.com was
approximately $5.0 million. The acquisition was accounted for as a purchase. The
purchase price has been largely allocated to goodwill, which is being amortized
over five years.
We have incurred cumulative net losses of $106.9 million from inception to
September 30, 2000, of which approximately $45.1 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
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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.
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. Trade
and barter revenue represented 3% and 2% of our revenue for the three and nine
months ended September 30, 2000, respectively, and less than 1% for the year
ended December 31, 1999.
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:
- 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 nine months ended September 30, 2000 and the year
ended December 31, 1999, online product sales revenue constituted
approximately 59%, 50% and 51%, respectively, of our total net
revenue for those periods.
- 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 generally recognized as the
impressions are served during 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. 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
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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 nine months ended September 30, 2000 and the year
ended December 31, 1999, advertising revenue constituted
approximately 22%, 32% and 28%, respectively, of our total net
revenue for those periods.
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 nine months ended
September 30, 2000 and the year ended December 31, 1999, commission revenue
constituted approximately 19%, 16% 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 nine months ended September 30, 2000, Pringles, a
division of Procter & Gamble, accounted for 24% and 13%, respectively, and
Universal Music Group accounted for 24% and 11%, respectively, of the Company's
advertising revenue.
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 artists,
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 September 30, 2000, we recorded non-cash
compensation expense of approximately $1.7 million and $6.2 million for the
three and nine months ended September 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
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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.
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 $37.2
million of stock-based compensation expense for the period from inception
through September 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 $1.7 million and
$3.1 million during the three and nine months ended September 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. The Company is currently anticipating
initiating the rescission offer (see note 5 to condensed financial statements)
during the forth quarter of 2000. To the extent that employees holding options,
subject to the rescission offer, accept the offer the Company will record
compensation expense for such payments, which could be significant.
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, Mjuice 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
value 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 to date has been
estimated to be $20.6 million and is 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.
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RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
NET REVENUE
Net revenue increased to $5.6 million for the three months ended September
30, 2000 from $2.8 million for the three months ended September 30, 1999, which
represented an increase of 102%. Net revenue for the nine months ended September
30, 2000 increased to $15.7 million from $6.4 million for the nine months ended
September 30, 1999, which represented an increase of 143%. 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 September 30,
2000, increased 145% to $3.3 million from $1.3 million for the three months
ended September 30, 1999, primarily as a result of an increase in the number of
ARTISTchannels that were operated. Online product sales revenue for the nine
months ended September 30, 2000, increased 125% to $7.9 million from $3.5
million for the nine months ended September 30, 1999, primarily as a result of
an increase in the number of ARTISTchannels that were operated.
Advertising and other revenue increased $470,000, or 60%, to $1.2 million
for the three months ended September 30, 2000, from $777,000 for the three
months ended September 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 $3.3
million, or 201%, to $5.0 million for the nine months ended September 30, 2000,
from $1.7 million for the nine months ended September 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 $371,000
for the three months ended September 30, 1999 to $1.1 million for the three
months ended September 30, 2000, which represented an increase of 183%, due
primarily to increased touring activity of the agency's artists. Commission
revenue from the ARTISTdirect Agency increased from $662,000 for the nine months
ended September 30, 1999 to $2.5 million for the nine months ended September 30,
2000, which represented an increase of 281%, 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 $2.8 million for the three months ended September 30, 2000 from $1.2 million
for the three months ended September 30, 1999, which represented an increase of
142%. This $1.6 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 $7.1 million for
the nine months ended September 30, 2000 from $3.1 for the nine months ended
September 30, 1999, which represented an increase of 126%. This $4.0 million
increase corresponded with the increase in
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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 $2.4 million for
the three months ended September 30, 2000, from $1.2 million for the three
months ended September 30, 1999, which represented an increase of 98%. This $1.2
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 $6.2 million for the nine months ended September 30, 2000,
from $2.2 for the nine months ended September 30, 1999, which represented an
increase of 185%. This $4.0 million increase was primarily due to increases in
Web site hosting and maintenance costs.
Stock-based compensation. For the three months ended September 30, 2000 we
recorded non-cash stock-based compensation charges of $1.7 million compared to
$330,000 for the three months ended September 30, 1999. For the nine months
ended September 30, 2000 we recorded non-cash stock-based compensation charges
of $6.2 million compared to $381,000 for the nine months ended September 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 with the operation of their stores and is amortized over
the life of the associated contract periods. Our overall gross profit margin
decreased to negative 24% in the third quarter of 2000 from 2% in the third
quarter of 1999 primarily due to the non-cash stock-based compensation expenses
recognized in 2000. Gross profit excluding stock-based compensation and
amortization of vendor prepaid was 8% and 17% for the third quarter of 2000 and
1999, respectively.
OPERATING EXPENSE
Product Development. Product development expense increased to $1.3 million
for the three months ended September 30, 2000, from $400,000 for the three
months ended September 30, 1999, which represented an increase of 220%. 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 $2.8 million for the nine
months ended September 30, 2000, from $1.0 million for the nine months ended
September 30, 1999, which represented an increase of 168%. 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 $7.7 million
for the three months ended September 30, 2000, from $2.9 million for the three
months ended September 30, 1999, which represented an increase of 167%. 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 $19.5
million for the nine months ended September 30, 2000 from $5.4 million for the
nine months ended September 30, 1999, which represented an increase of 259%. The
increase was primarily attributable to a significant increase in our online
advertising expenditures, as well as increased
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offline advertising. We expect the growth rate of sales and marketing expenses
to decrease in future periods.
General and Administrative. General and administrative expense increased
to $4.8 million for the three months ended September 30, 2000 from $2.4 million
for the three months ended September 30, 1999, which represented an increase of
100%. This increase was primarily attributable to increases in personnel and
related expenses and outside professional services expenses. General and
administrative expense increased to $12.8 million for the nine months ended
September 30, 2000 from $5.6 million for the nine months ended September 30,
1999, which represented an increase of 128%. This increase was primarily
attributable to increases in personnel and related expenses, facilities and
outside professional services expenses. We expect the growth rate of general and
administrative expense to decrease as we seek to operate more efficiently.
Amortization of Stock-based Compensation. We recorded stock-based
compensation expense of $1.7 million for the three months ended September 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 $19.6 million, primarily in connection
with stock issuances to employees, directors and professional firms. We recorded
stock-based compensation expense of $3.1 million for the nine months ended
September 30, 2000 in connection with stock issuances to employees, directors,
professional firms, artists and advisors for promotional services, which
represented a decrease of 86% for the comparable period in 1999. Stock-based
compensation for the comparable period in 1999 was $21.5 million, primarily in
connection with stock issuances to employees, directors and professional firms.
The expense during the period reflected a credit to stock-based compensation for
grants 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 $1.7 million for the three months ended September 30, 2000 from
approximately $841,000 for the three months ended September 30, 1999, which
represented an increase of 100%. This increase was primarily attributable to the
amortization of the goodwill associated with the acquisition of iMusic and
Mjuice 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 $4.3 million for the nine
months ended September 30, 2000 from approximately $1.6 million for the nine
months ended September 30, 1999, which represented an increase of 178%. This
increase was primarily attributable to the amortization of the goodwill
associated with the acquisition of iMusic, Mjuice 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
September 30, 2000 from $90,000 for the three months ended September 30, 1999,
and to $4.0 million for the nine months
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ended September 30, 2000 from $167,000 for the nine months ended September 30,
1999, which represented increases of 1,524% and 2,291%. The increases are due to
interest earned on higher cash balances resulting from the proceeds we received
from our initial public offering in March 2000 and the Series C redeemable
preferred shares issued in December 1999 and January 2000.
NET LOSS
Net loss decreased to $17.1 million for the three months ended September
30, 2000, compared to $26.0 million for the three months ended September 30,
1999, which represented an decrease of 34%. The decrease in the net loss is
primarily attributable to a $17.9 million decrease in the amortization of
stock-based compensation and $1.4 million increase in net interest income
partially offset by a $1.4 million decrease in gross profit, a $4.8 million
increase in sales and marketing expense, a $2.4 million increase in general and
administrative expense, and an $800,000 increase in depreciation and
amortization expense. Net loss increased to $42.3 million for the nine months
ended September 30, 2000, compared to $34.2 million for the nine months ended
September 30, 1999, which represented an increase of 24%. The increase in the
net loss is primarily attributable to a $4.5 million decrease in gross profit
due to stock-based compensation related to artist store agreements, a $14.1
million increase in sales and marketing expense, a $7.2 million increase in
general and administrative expense and a $2.8 million increase in depreciation
and amortization expense, partially offset by a $18.4 million decrease in the
amortization of stock-based compensation and a $3.8 million increase in interest
income.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2000, we completed our initial public offering and raised net
proceeds of approximately $52.4 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 September 30, 2000, we had $53.5 million of cash and cash equivalents,
excluding cash held for clients, and held $43.8 million in short-term
investments.
Net cash used in operating activities was $26.8 million for the nine
months ended September 30, 2000, and $10.0 million for the nine months ended
September 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 $52.5 million for the nine
months ended September 30, 2000, and $2.6 million for the nine months ended
September 30, 1999. Net cash used in investing activities for the nine months
ended September 30, 2000 consisted of purchases of fixed assets of $6.4 million,
primarily computer equipment to support the ARTISTdirect
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Network and leasehold improvements to our corporate offices, the purchase of
short-term investments of $43.7 million and $2.0 relating to the purchase of
Mjuice.
Net cash provided by financing activities was $63.7 million for the nine
months ended September 30, 2000 and $14.9 million for the nine months ended
September 30, 1999. Net cash provided by financing activities for the nine
months ended September 30, 2000 was principally attributable to the proceeds of
our initial public offering in March 2000 in which we raised approximately $52.4
million, net of underwriters' discounts and expenses, and $10.4 million raised
from the sale of Series C preferred stock in January 2000, net of offering
costs.
The Company currently expects to complete a rescission offer with respect
to certain options and shares issued pursuant to its stock option plans during
the fourth quarter of 2000. Assuming that all options and shares subject to the
rescission offer are tendered to the Company as of December 31, 2000, the
maximum cash exposure would be approximately $9.6 million, plus interest.
As of September 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, content development
and technology and infrastructure development.
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, acquired iMusic in February 1999 and
acquired Mjuice.com, Inc. in August 2000. 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:
- online sales of music and related merchandise;
- sales of advertising and sponsorships;
- marketing our database of consumer information and preferences; and
- 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 $106.9 million as of September 30, 2000. For
the three months ended September 30, 2000 and the year ended December 31, 1999,
we incurred net losses of approximately $17.1 million and $57.8 million,
respectively, which represented approximately 307% 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, 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 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:
- respond to and anticipate fluctuations in the demand for, and
pricing of, online advertising;
- conduct successful selling and marketing efforts aimed at
advertisers;
- increase the size of our audience and the amount of time that our
audience spends on our Web sites;
- increase our direct advertising sales force and build up our
international marketing team;
- increase the amount of revenue per advertisement;
- aggregate our target demographic group of 12 to 34 year-old active
music consumers;
- offer advertisers the means to effectively target their
advertisements to our audience;
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- accurately measure the size and demographic characteristics of our
audience;
- maintain key advertising relationships; and
- compete for advertisers with Internet and traditional media
companies.
Our failure to achieve one or more of these objectives could impair our
ability to increase advertising revenue, which could adversely affect our
business. 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. In particular, the growth of online advertising has recently decreased,
which has adversely affected revenue from online advertising.
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.
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. For example, we believe that the recent growth of online
advertising revenue has been less than was generally expected. 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.
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:
- inability to recruit new artists and increase the number of
ARTISTchannels;
- the loss of popularity of artists for whom we operate
ARTISTchannels;
- increased competition to maintain existing relationships with
artists;
- non-renewals of our current agreements with artists; and
- 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.
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The artists own the domain names for their ARTISTchannels and some of the
intellectual 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:
- reduced access to content controlled by record labels, music
publishers and artists;
- diminished technical expertise and creativity of our production
staff; and
- 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 and may
spend significant amounts 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
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they do, any increased revenue may not offset the expenses we 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:
- longer operating histories;
- significantly greater financial, technical and marketing resources;
- greater brand name recognition;
- larger existing customer bases; and
- 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 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
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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 September 30, 2000, and the year ended December 31, 1999, virtually
all of our orders for music and related merchandise were fulfilled by Alliance.
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 September 30, 2000, and year ended December 31, 1999, we
purchased approximately 96%, of the dollar volume of our compact discs from
Alliance, and we obtained approximately 21% and 27%, respectively, of the dollar
volume of our other music-related merchandise from Giant Merchandising and
approximately 5% 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 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
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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 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.
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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.
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
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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 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. We have 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 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
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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 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
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may 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 IS
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.
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 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
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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 issues 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.
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 of 1933, as amended, or any
other
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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 7% 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 September 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 $2.2 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 7% from the date the options were granted.
Based on the number of options outstanding as of September 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 $7.4 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. Similar 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 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 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.
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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.
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,
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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 has 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.
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
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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 operations in states outside California and Florida
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 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.
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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
September 30, 2000, following the 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 by an employee, the Company issued an aggregate of 9,921
shares of Common Stock for an aggregate purchase price of approximately $15,002.
In August 2000, the Company issued 900,000 shares of its Common
Stock to shareholders of Mjuice.com, Inc. in connection with the closing of its
acquisition of Mjuice.com, Inc. The shares were issued pursuant to the exemption
provided in Section 3(a)(10) of the Securities Act.
(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.
<TABLE>
<S> <C>
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 403,709
----------
Total $3,365,000
==========
</TABLE>
After deducting the underwriting discounts and commissions and the
estimated Offering expenses described above, the Company received net proceeds
from the Offering of approximately $52.4 million. As of September 30, 2000, the
Company had not used any of the
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net proceeds from the Offering and had used its existing cash balances to fund
the general operations 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
On November 7, 2000, we amended our advertising and promotion
agreement with Yahoo!. The agreement, as amended, will now terminate as of
December 31, 2000. In connection with the amendment, Yahoo! will deliver
certain page views containing our banners on various Yahoo! properties. Under
the amendment, we have no additional payment obligations to Yahoo!.
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) Reports on Form 8-K.
Current Report on Form 8-K dated May 15, 2000
(Announcement of adjustment to calculation of pro forma
net loss per share).
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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: November 14, 2000
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EXHIBIT INDEX
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
42
