<PAGE> 1
This filing is made pursuant
to Rule 424(b)(4) under
the Securities Act of
1933 in connection with
Registration No. 333-87547
PROSPECTUS
5,000,000 Shares
[ARTISTDIRECT LOGO]
COMMON STOCK
-------------------------
ARTISTDIRECT, INC. IS OFFERING 5,000,000 SHARES OF ITS COMMON STOCK. THIS IS OUR
INITIAL PUBLIC OFFERING AND NO PUBLIC MARKET CURRENTLY EXISTS FOR OUR SHARES.
-------------------------
OUR COMMON STOCK HAS BEEN APPROVED FOR QUOTATION ON THE NASDAQ NATIONAL MARKET
UNDER THE SYMBOL "ARTD."
-------------------------
INVESTING IN THE COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 9.
-------------------------
PRICE $12 A SHARE
-------------------------
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS ARTISTDIRECT
----------- ------------- ------------
<S> <C> <C> <C>
Per Share....................................... $12.00 $.84 $11.16
Total........................................... $60,000,000 $4,200,000 $55,800,000
</TABLE>
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities, or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
ARTISTdirect has granted the underwriters the right to purchase up to an
additional 750,000 shares of common stock to cover over-allotments. Morgan
Stanley & Co. Incorporated expects to deliver the shares to purchasers on March
31, 2000.
-------------------------
MORGAN STANLEY DEAN WITTER
BEAR, STEARNS & CO. INC.
DEUTSCHE BANC ALEX. BROWN
March 27, 2000
<PAGE> 2
INSIDE FRONT COVER
THE OUTSIDE GATEFOLD PAGE INCLUDES:
A four-by-four grid with a total of 16 rectangles, each depicting a picture of
an artist or band. The bottom row of rectangles have the ARTISTdirect logo
superimposed across them.
TWO PAGE INSIDE GATEFOLD INCLUDES:
The ARTISTdirect network logo across the top center.
In the upper left corner is a screen shot of the ARTISTdirect.com home page
with the following four lines of text immediately below the screen shot:
Overview of the ARTISTdirect Network
ARTISTdirect Network Navigator
Featured Programs
Search Capabilities
Immediately above the screen shot is the text: ARTISTDIRECT.COM
In the lower left corner is a screen shot of the iMusic.com home page with the
following five lines of text immediately below the screen shot:
Music Community Hub
Message Boards
Chat Sessions
Classifieds
Local Music Connection
Immediately above the screen shot is the text: IMUSIC.COM
In the upper right corner is a screen shot of the Downloads Direct home page
with the following four lines of text immediately below the screen shot:
Digital Downloads
High Profile Artists
Downloads by Genec
Music from Unsigned Artists
Immediately above the screen shot is the text: DOWNLOADS DIRECT
In the lower right corner is a screen shot of the ARTISTdirect Superstore home
page with the following five lines of text along the lower left side of the
screen shot:
200,000 CD Titles
Featured Artists
Weekly Specials
Artist Merchandise
Music by Genre
Immediately above the screen shot is the text: ARTISTDIRECT SUPERSTORE
In the left center are screen shots of the home pages of five ARTISTdirect
channels with the following four lines of text immediately below the screen
shots:
Official Artist Stores
Exclusive Merchandise
Exclusive Content
Contests and Ticket Giveaways
Immediately above the screen shot is the text: ARTIST CHANNELS.
In the right center is a screen shot of the UBL.com home page with the
following four lines of text immediately below the screen shot:
Comprehensive Music Resource
Search 95,000 Artists
Music News
Concert Information
Featured Artists
All the screen shots and text are superimposed on a backdrop that depicts the
names of artists.
<PAGE> 3
INSIDE BACK COVER
The following text is superimposed on a backdrop of a four-by-four grid
consisting of sixteen rectangles, each depicting the picture of an artist or
band:
Across the top center the following text appears: REPRESENTATIVE ARTIST CHANNELS
There are three columns of text. The left column consists of the following
artist names:
Aerosmith Black Crowes CSNY
Tori Amos blink-182 Cypress Hill
B-52s Bone Thugs 'N' Harmony Def Leppard
Backstreet Boys Cher Eminem
Beastie Boys Coal Chamber Eve 6
Beck Collective Soul Everclear
George Benson Chris Cornell Fastball
Bjork Counting Crows Bryan Ferry
Black Sabbath David Crosby Filter
Clint Black
The center column consists of the following artist names:
Foo Fighters Kenny Loggins Mike Ness
Vince Gill Aimee Mann Stevie Nicks
Godsmack Marilyn Manson No Doubt
Incubus Matchbox 20 The Offspring
Indigo Girls Megadeth Ozzy Osbourne
Chris Isaak Metallica Pantera
Kenny G Mighty Mighty Bosstones Patty Loveless
BB King Monster Magnet Pearl Jam
Korn Mandy Moore Tom Petty
Limp Bizkit
The right column consists of the following artist names:
Powerman 5000 Stabbing Westward System of a Down
Primus Static X Pam Tillis
Rage Against The Machine Steps Toto
Rancid Stone Temple Pilots Tina Turner
Red Hot Chili Peppers Sugar Ray The Who
Brian Setzer Sublime/Long Beach Dub Robbie Williams
Severdust All Stars Dwight Yoakam
Slaye Matthew Sweet Rob Zombie
Soul Coughing ZZ Top
<PAGE> 4
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................. 4
Risk Factors........................ 9
Special Note Regarding
Forward-Looking Statements........ 25
Use of Proceeds..................... 26
Dividend Policy..................... 26
Capitalization...................... 27
Dilution............................ 29
Unaudited Pro Forma Consolidated
Financial Data.................... 30
Selected Consolidated Financial
Data.............................. 33
Management's Discussion and Analysis
of Financial Condition and Results
of Operations..................... 34
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Business............................ 45
Management.......................... 65
Related Party Transactions.......... 77
Principal Stockholders.............. 85
Description of Capital Stock........ 89
Rescission Offer.................... 92
Shares Eligible for Future Sale..... 93
Underwriters........................ 96
Legal Matters....................... 98
Experts............................. 98
Where You Can Find Information...... 99
Index to Consolidated Financial
Statements........................ F-1
</TABLE>
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of the common stock.
UNTIL APRIL 21, 2000, 25 DAYS AFTER COMMENCEMENT OF THE OFFERING, ALL
DEALERS THAT BUY, SELL OR TRADE THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS REQUIREMENT IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
3
<PAGE> 5
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our financial statements and the notes to those financial
statements appearing elsewhere in this prospectus.
ARTISTDIRECT
We are an online music company that connects artists directly with their
fans worldwide. Through our online ARTISTdirect Network, we provide music
entertainment by offering multi-media content, community around shared music
interests and sales of music and related merchandise. During January 2000, users
visited more than 60 million pages in our ARTISTdirect Network.
Our ARTISTdirect Network is an integrated network of Web sites consisting
of:
- ARTISTchannels -- customized, artist-owned Web sites that provide one
destination for artist-specific music, merchandise and content. We build,
operate and maintain these sites on behalf of our artists. Artists
control the programming and products offered on their ARTISTchannels and
share in the revenue that they generate. As of December 31, 1999,
ARTISTdirect featured 79 unique, artist-owned ARTISTchannels, and had
signed agreements to launch channels with an additional 26 artists. A
selection of artists with ARTISTchannels includes:
<TABLE>
<S> <C> <C>
Aerosmith Chris Cornell Metallica
Backstreet Boys Cypress Hill Ozzy Osbourne
Beastie Boys Def Leppard Tom Petty
Beck Kenny G Red Hot Chili Peppers
Clint Black Korn Robbie Williams
Cher Limp Bizkit The Who
</TABLE>
- The Ultimate Band List or the UBL -- a comprehensive online music search
engine with information on more than 95,000 artists across numerous
musical genres and links to thousands of music Web sites. The UBL
features news, concert information, biographies, album reviews, contests,
promotions, music samples and downloads;
- iMusic -- a popular online music community with chats, message boards and
fan clubs. Through hosted chats and fan conferences on iMusic, fans can
interact directly with their favorite artists;
- The ARTISTdirect Superstore -- a retail site offering over 200,000 music
titles and merchandise from over 220 artists; and
- DOWNLOADSdirect -- a feature which enables users to download music from
the ARTISTdirect Network and to upload their music and other information.
We also operate a music talent agency, the ARTISTdirect Agency, and manage
a traditional record label, Kneeling Elephant Records. Consequently, we are able
to provide artists with a full range of traditional and online services. Marc
Geiger, our Chief Executive Officer, Don Muller, our President of the
ARTISTdirect Agency and Kneeling Elephant Records, Steve Rennie, our President
of the UBL and Nick Turner, our Vice President, ARTISTchannels, have 18, 14, 20
and 20 years of experience, respectively, in the music industry.
4
<PAGE> 6
Music is one of the most popular forms of entertainment worldwide and a
multi-billion dollar industry. In 1998, worldwide sales of recorded music were
$38.7 billion, according to the International Federation of the Phonographic
Industry. Sales of concert tickets, advertising and merchandise related to music
events and individual artists also generate substantial revenue. The Internet is
emerging as an important new medium for music, in part because it enables fans
to communicate with their favorite artists and purchase music and related
merchandise directly from them. Jupiter Communications projects that online
sales of recorded music in the United States will grow from $327 million in 1999
to approximately $2.6 billion in 2003.
To take advantage of these opportunities, we have entered into strategic
relationships with six leading music and media companies, including Universal
Music Group, BMG Entertainment, Sony Music Entertainment, Time Warner Inc., an
affiliate of Cisneros Television Group, and Yahoo!. These companies invested an
aggregate of $97.5 million cash in ARTISTdirect in connection with these
strategic relationships and include four of the five major music companies, who
together accounted for 74.6% of U.S. music albums shipped in the year ended
December 31, 1999.
We have generated substantially all of our revenue from online sales of
compact discs and other artist-related merchandise, online advertising and
sponsorships, royalties on record sales and talent agency commissions. Our
revenue was $4.6 million for 1998 and $10.3 million for the year ended December
31, 1999. Although traffic to our sites and our revenue have increased, we
incurred a net loss for the year ended December 31, 1999 of approximately $57.8
million, and our accumulated losses of ARTISTdirect, Inc. and its predecessors
as of December 31, 1999 were approximately $64.6 million, of which approximately
$35.9 million represented stock-based compensation. While we believe that we can
increase our revenue and diversify our revenue opportunities, we expect to
continue to incur net losses and negative cash flows for the foreseeable future.
We also expect to continue to face strong competition in our industry from the
growing number of online music companies, traditional music retailers, "portals"
and record labels. Such competition could adversely affect our future operating
results.
We seek to be the leading online music company. To accomplish our
objective, we plan to:
- aggressively add ARTISTchannels;
- rapidly build consumer awareness of our brands;
- add features and content to our ARTISTdirect Network;
- package and exploit our diverse assets and services; and
- develop new revenue streams.
ARTISTdirect, Inc. was incorporated in Delaware in July 1999. ARTISTdirect,
LLC, our predecessor, was organized as a California limited liability company in
August 1996. Our principal executive offices are located at 17835 Ventura
Boulevard, Suite 310, Encino, California 91316, and our telephone number is
(818) 758-8700. Our World Wide Web address is www.artistdirect.com. The
information on our Web site is not a part of this prospectus.
We use the following registered service marks and domain names of
ARTISTdirect in this prospectus: ARTISTdirect(SM), UBL(SM), iMusic(SM),
www.artistdirect.com, www.ubl.com, www.imusic.com and www.downloadsdirect.com.
All other trade names and trademarks appearing in this prospectus are the
property of their respective holders.
5
<PAGE> 7
THE OFFERING
Common stock offered................ 5,000,000 shares
Common stock to be outstanding after
the offering........................ 36,373,185 shares
Over-allotment option............... 750,000 shares
Use of proceeds..................... We intend to use approximately $30
million of the proceeds for advertising
and promotion of our brands,
approximately $10 million for content
production and Web site development,
approximately $741,000 to repay
existing indebtedness, and the
remainder for other general corporate
purposes, including for working capital
and potential obligations to fund a
rescission offer. See "Use of Proceeds"
on page 26 for more information on our
use of the proceeds from this offering.
Proposed Nasdaq National Market
symbol.............................. ARTD
- -------------------------
Unless otherwise indicated, all information in this prospectus:
- reflects the one-for-four reverse split of our common stock effected on
March 21, 2000;
- reflects outstanding shares as of December 31, 1999, after giving effect
to the issuance of 1,094,917 shares of Series C preferred stock in
January 2000;
- gives effect to the conversion of all outstanding shares of preferred
stock into shares of common stock effective upon the closing of this
offering; all outstanding shares of Series C preferred stock, including
the 1,094,917 shares issued in January 2000, will convert into 10,156,252
shares of common stock upon the consummation of this offering, based on
the initial offering price of $12.00 per share;
- assumes no exercise of the underwriters' over-allotment option;
- excludes shares of our common stock issuable pursuant to options and
warrants outstanding as of December 31, 1999;
- excludes up to 900,000 shares of common stock to be issued to acquire
Mjuice.com, Inc.;
- excludes approximately 80,200 shares of common stock to be issued as
accrued but unpaid dividends on preferred stock after December 31, 1999;
and
- excludes up to 62,500 shares of common stock issuable pursuant to a
warrant issued in March 2000.
6
<PAGE> 8
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following pro forma basic and diluted net loss per share and the
weighted average shares outstanding used in computing pro forma basic and
diluted net loss per share give effect to the following events as if such events
occurred on January 1, 1998 or at original issuance date, if later:
- the exchange transaction and issuance of ARTISTdirect, LLC Series B
preferred units as more fully discussed on page 78;
- the one-for-four reverse split of our common stock effected on March 21,
2000; and
- the conversion of all outstanding shares of preferred stock into shares
of common stock upon the closing of this offering at a ratio of one
preferred share for one common share; provided that shares of Series C
preferred stock are convertible at a ratio of one preferred share for
approximately 1.4508 common shares based on the initial public offering
price of $12.00 per share.
<TABLE>
<CAPTION>
PERIOD FROM
AUGUST 8, 1996 YEAR ENDED DECEMBER 31,
(INCEPTION) TO ----------------------------
DECEMBER 31, 1996 1997 1998 1999
----------------- ------ ------ ----------
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue................................ $ -- $1,888 $4,582 $ 10,274
Gross profit............................... -- 1,280 2,067 34
Operating expense.......................... 28 1,737 8,416 58,169
Loss from operations....................... 28 457 6,349 58,135
Net loss................................... 28 460 6,318 57,804
Pro forma basic and diluted net loss per
share.................................... $ (2.96)
Weighted average shares outstanding used in
computing pro forma basic and diluted net
loss per share........................... 19,502,437
</TABLE>
The "pro forma as adjusted" column below reflects our capitalization as of
December 31, 1999 with adjustments to give effect to:
- the events listed above related to the pro forma basic and diluted net
loss per share;
- the issuance of 1,094,917 shares of Series C preferred stock in January
2000;
- the termination of the put option described in a "Related Party
Transactions -- Transaction with Scott Blum" on page 81, which will occur
upon the closing of this offering; and
- the issuance and sale of 5,000,000 shares of our common stock at the
initial public offering price of $12.00 per share and the application of
the net proceeds from the offering, after deducting the underwriting
discounts, commissions and estimated offering expenses, as set forth
under "Use of Proceeds" on page 26.
7
<PAGE> 9
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
-------------------------
PRO FORMA
ACTUAL AS ADJUSTED
----------- -----------
(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 69,119 $138,476
Working capital............................................. 67,730 137,087
Goodwill and intangibles, net............................... 13,415 13,415
Total assets................................................ 98,600 167,957
Total redeemable securities................................. 111,707 6,854
Total members' and stockholders' equity (deficit)........... (23,745) 150,465
</TABLE>
8
<PAGE> 10
RISK FACTORS
You should carefully consider the risks described below, together with all
of the other information included in this prospectus before making an investment
decision. If any of the following risks actually occurs, our business, financial
condition or operating results could be materially and adversely affected. In
such case, the trading price of our common stock could decline, and you may lose
part or all of your investment.
RISKS RELATED TO OUR BUSINESS
IT IS DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS BECAUSE WE HAVE A
LIMITED OPERATING HISTORY.
We were formed in August 1996. We acquired the UBL in July 1997, launched
our first ARTISTchannel in September 1997 and acquired iMusic in February 1999.
We have been operating all of these sites as an integrated network since July
1999. Our limited operating history, particularly as an integrated network of
Web sites, makes it difficult to evaluate our current business and prospects or
to accurately predict our future revenue or results of operations. Our revenue
and income potential are unproven, and our business model is constantly
evolving. Because the Internet is constantly changing, we may need to modify our
business model to adapt to these changes. Before investing, you should evaluate
the risks, uncertainties, expenses and difficulties frequently encountered by
companies in early stages of development, particularly companies in new and
rapidly evolving Internet industry segments.
OUR BUSINESS MODEL IS NEW AND UNPROVEN, AND WE MAY NOT BE ABLE TO GENERATE
SUFFICIENT REVENUE TO OPERATE OUR BUSINESS SUCCESSFULLY.
Our model for conducting business and generating revenue is new and
unproven. Our success will depend primarily on our ability to generate revenue
from multiple sources through the ARTISTdirect Network, including:
- 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.
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 $64.6 million as of December 31, 1999. For
the year ended December 31, 1999, we incurred a net loss of approximately $57.8
million, which represented approximately 560% of our revenue for that period. We
expect our operating losses and negative cash flow to continue for the
foreseeable
9
<PAGE> 11
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. We estimate that, for the year
2000, we will increase our sales and marketing expenses by approximately $20
million, increase our content development expenses by approximately $5 million
and increase our technology and infrastructure development expenses by
approximately $5 million. With increased expenses, we will need to generate
significant additional revenue to achieve profitability. Consequently, it is
possible that we may never achieve profitability, and even if we do achieve
profitability, we may not sustain or increase profitability on a quarterly or
annual basis in the future. If we do not achieve or sustain profitability in the
future, then we will be unable to continue our operations.
OUR OPERATING RESULTS MAY PROVE UNPREDICTABLE.
Our operating results are likely to fluctuate significantly in the future
due to a variety of factors, many of which are outside of our control. Because
our operating results are volatile and difficult to predict, in some future
quarters our operating results may fall below the expectations of securities
analysts and investors. In this event, the trading price of our common stock may
fall significantly.
IF WE DO NOT GENERATE INCREASED REVENUE FROM ONLINE PRODUCT SALES, OUR
GROWTH WILL BE LIMITED AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.
If we do not generate increased revenue from sales of online products, our
growth will be limited and our business will be adversely affected. To generate
significant online product revenue, we will have to offer music and related
merchandise that appeal to a large number of online consumers. We also will have
to continue to create online communities that are conducive to electronic
commerce, build or license a sufficiently robust and scalable electronic
commerce platform and increase our order fulfillment capability. Since our
target market includes Internet users below the age of 18, and these users have
limited access to credit cards, our ability to capture online product revenue
from this group may be limited. If we are not successful in meeting these
challenges, our growth will be limited and our business will be adversely
affected.
IF WE DO NOT INCREASE ADVERTISING REVENUE, OUR BUSINESS WILL BE ADVERSELY
AFFECTED.
If we do not increase advertising revenue, our business will be adversely
affected. Increasing our advertising revenue depends upon many factors,
including our ability to:
- 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;
- accurately measure the size and demographic characteristics of our
audience;
- maintain key advertising relationships; and
- compete for advertisers with Internet and traditional media companies.
10
<PAGE> 12
In addition to the above factors, general economic conditions, as well as
economic conditions specific to online advertising, electronic commerce and the
music industry, could affect our ability to increase our advertising revenue.
Our failure to achieve one or more of these objectives could impair our ability
to increase advertising revenue, which could adversely affect our business.
WE DEPEND UPON ARTISTS TO ATTRACT ADVERTISERS AND GENERATE ELECTRONIC
COMMERCE REVENUE.
We believe that our future success depends on our ability to maintain our
existing artist agreements and to secure additional agreements with artists. Our
business would be adversely affected by any of the following:
- 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. 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. Of the 100 ARTISTchannel contracts we
had as of December 31, 1999, none will expire in 2000 and 12 will expire in
2001. In addition, as of December 31, 1999, we did not have signed contracts for
five of the 79 ARTISTchannels that we operate.
As of December 31, 1999, we had granted options to purchase an aggregate of
2,476,561 shares of our common stock to 100 of our artists. These options
provide artists with an additional incentive to actively promote the
ARTISTchannels and the ARTISTdirect Network. Following this offering, 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
11
<PAGE> 13
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. We intend
to spend approximately $30 million during 2000 on our offline and online
advertising and promotional efforts to increase brand awareness, traffic and
revenue. Our marketing activities may, however, not result in increased revenue
and, even if they do, any increased revenue may not offset the expenses we 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, 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.
12
<PAGE> 14
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 in reduced advertising rates and margins and loss of market share,
any of which could harm our business. For additional information regarding
competition, see "Business -- Competition" on page 59.
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 year
ended December 31, 1999, approximately 99.2% of the dollar volume of our orders
for music and related merchandise were fulfilled by Alliance. In July 1997,
Alliance filed for protection from its creditors under Chapter 11 of the U.S.
Bankruptcy Code. Alliance has since emerged from Chapter 11 and is under new
ownership. Our agreement with Alliance covers fulfillment services for sales
under the ARTISTdirect Superstore, but does not cover fulfillment services for
our ARTISTchannels. Although Alliance has been fulfilling orders for music and
related merchandise from the ARTISTchannels on the same terms as orders from the
ARTISTdirect Superstore, Alliance may terminate the ARTISTchannel arrangement at
any time.
We purchase almost all of our compact discs from Alliance and a substantial
majority of our other music-related merchandise from two other vendors, Giant
Merchandising and Winterland Concessions Company. During the year ended December
31, 1999, we purchased approximately 96.0% of the dollar volume of our compact
discs from Alliance, and we obtained approximately 26.9% of the dollar volume of
our other music-related merchandise from Giant Merchandising and approximately
17.0% 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
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
13
<PAGE> 15
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 IMPLEMENT OUR NEW ACCOUNTING AND FINANCIAL
REPORTING SYSTEMS, OUR BUSINESS WOULD BE SERIOUSLY HARMED.
We are currently implementing a comprehensive enterprise resource planning
system based on SAP software provided to us by Pandesic, LLC, a joint venture
between Intel and SAP. If we fail to successfully implement and integrate this
system with our existing systems, or if we are not able to expand this system to
accommodate our growth, we may not have adequate, accurate or timely financial
information. Our failure to have adequate, accurate or timely financial
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 and American Digital Network. 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.
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,
14
<PAGE> 16
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. We expect we will need to hire between
50 and 75 additional personnel in all areas during 2000. 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 appropriate opportunities, we intend to
actively pursue these acquisitions and/or investments. We may not, however,
realize the anticipated benefits of any acquisition or investment. If we buy a
company, we could have difficulty in assimilating that company's other
personnel, technology, operations or products into our operations. In addition,
the key personnel of the acquired company may decide not to work for us. These
difficulties could disrupt our ongoing business, distract our management and
employees and increase our expenses. Acquisitions or business combinations could
also cause us to issue equity securities that would dilute your percentage
ownership in us, incur debt or assume contingent liabilities and take large
immediate or future write-offs or charges, including amortization of goodwill or
compensation expense. Each of these results could materially and adversely
affect our business and adversely affect the price of our common stock.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR
COMPETITIVE POSITION COULD BE HARMED OR WE COULD BE REQUIRED TO INCUR
EXPENSES TO ENFORCE OUR RIGHTS.
We rely upon common-law trademark rights that arise from our commercial use
of the ARTISTdirect, ARTISTdirect Agency, UBL, Ultimate Band List, iMusic and
Kneeling Elephant Records brand names, and the respective associated domain
names, and the ARTISTdirect logo. We seek to protect our trademarks, copyrights
and other proprietary rights by registration and other means, but these actions
may be inadequate. ARTISTdirect has trademark applications pending in several
jurisdictions, but our registrations may not be accepted or may be preempted by
third parties and/or we may not be able to register our trademarks in all
jurisdictions in which we intend to do business. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to and distribution of our
proprietary information.
15
<PAGE> 17
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 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,
16
<PAGE> 18
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 could be unable to prevent third parties from acquiring or using
domain names that infringe or otherwise decrease the value of our brand name,
trademarks and other proprietary rights.
IF OUR ONLINE SECURITY MEASURES FAIL, WE COULD LOSE VISITORS TO OUR SITES
AND COULD BE SUBJECT TO CLAIMS FOR DAMAGE FROM OUR USERS, CONTENT
PROVIDERS, ADVERTISERS AND MERCHANTS.
Our relationships with consumers would be adversely affected and we may be
subject to claims for damage if the security measures that we use to protect
their personal information, especially credit card numbers, are ineffective. We
rely on security and authentication technology that we license from third
parties to perform real-time credit card authorization and verification with our
bank. We cannot predict whether events or developments will result in a
compromise or breach of the technology we use to protect a customer's personal
information.
Our infrastructure is vulnerable to unauthorized access, physical or
electronic computer break-ins, computer viruses and other disruptive problems.
Internet service providers have experienced, and may continue to experience,
interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees and others. Anyone who is able to
circumvent our security measures could misappropriate proprietary information or
cause interruptions in our operations. Security breaches relating to our
activities or the activities of third-party contractors that involve the storage
and transmission of proprietary information could damage our reputation and our
relationships with our content providers, advertisers and merchants. We also
could be liable to our content providers, advertisers and merchants for the
damages caused by such breaches or we could incur substantial costs as a result
of defending claims for those damages. We may need to expend significant capital
and other resources to protect against such security breaches or to address
problems caused by such breaches. Our security measures may not prevent
disruptions or security breaches.
WE MAY BE SUBJECT TO LIABILITY IF PRIVATE INFORMATION PROVIDED BY OUR USERS
WERE MISUSED.
Our privacy policy discloses how we use individually identifiable
information that we collect. This policy is displayed and accessible throughout
the ARTISTdirect Network. Despite this policy, however, if third persons were
able to penetrate our network security or otherwise misappropriate our users'
personal information or credit card information, we could be subject to
liability. We could also be subject to liability for claims for unauthorized
purchases with credit card information, impersonation or other similar fraud
claims, or other misuses of personal information, such as for unauthorized
marketing purposes. These claims could result in costly and time-consuming
litigation.
17
<PAGE> 19
CHANGES IN LAWS OR REGULATIONS MAY ADVERSELY AFFECT OUR ABILITY TO COLLECT
DEMOGRAPHIC AND PERSONAL INFORMATION FROM USERS AND COULD AFFECT OUR
ABILITY TO ATTRACT ADVERTISERS.
Legislatures and government agencies have adopted and are considering
adopting laws and regulations regarding the collection and use of personal
information obtained from individuals when accessing Web sites. For example,
Congress recently enacted the Children's Online Privacy Protection Act, which
restricts the ability of Internet companies to collect information from children
under the age of 13 without their parents' consent. In addition, the Federal
Trade Commission and state and local authorities have been investigating
Internet companies regarding their use of personal information. Our privacy
programs may not conform with laws or regulations that are adopted. In addition,
these legislative and regulatory initiatives may adversely affect our ability to
collect demographic and personal information from users, which could have an
adverse effect on our ability to provide advertisers with demographic
information.
The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. The directive could impose restrictions
that are more stringent than current Internet privacy standards in the United
States. If this directive were applied to us, it could prevent us from
collecting data from users in European Union member countries or subject us to
liability for use of information in contravention of the directive. Other
countries have adopted or may adopt similar legislation. We could incur
additional expenses if new regulations regarding the use of personal information
are introduced or if government authorities choose to investigate our privacy
practices. See "Business -- Governmental Regulation" on page 60 for more
information on governmental regulation issues applicable to our business.
WE MAY BE ADVERSELY IMPACTED IF THE SOFTWARE, COMPUTER TECHNOLOGY AND OTHER
SYSTEMS WE USE ARE NOT YEAR 2000 COMPLIANT.
The risks posed by Year 2000 issues could adversely affect our business in
a number of ways. Although we believe that our internal systems and technology
are Year 2000 compliant and have not experienced any Year 2000 issues to date,
we currently do not have, and do not plan to develop, a contingency plan to
address any problems caused by Year 2000 issues. Software and hardware from
third parties that have been integrated into our systems may need to be updated
or replaced, which may be time consuming and expensive. We rely on a number of
third parties to support and operate our Web sites. In addition, our
distribution providers and suppliers, including our accounting services
provider, depend on their own information technology systems and on the systems
of their vendors.
Failures or interruptions of our systems or those of third parties because
of Year 2000 problems could seriously damage our business and our relationships
with our content, distribution and technology providers, advertisers and users.
Failures, interruptions or other service problems due to Year 2000 could result
in lost revenue, increased operating costs and loss of significant user traffic.
Governmental agencies, public utilities, Internet service providers and others
that we rely on or that our customers rely on and which we do not control may
not be Year 2000 compliant. This could result in systemic failures beyond our
control, such as a prolonged Internet, telecommunications or electrical failure,
and prevent us from providing our content or reduce user traffic.
WE HAVE A CONTINGENT LIABILITY OF UP TO $33.0 MILLION AS A RESULT OF A
RESCISSION OFFER WE INTEND TO MAKE DUE TO OUR ISSUANCES OF SECURITIES IN
VIOLATION OF SECURITIES LAWS.
As of the date of this prospectus, 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
18
<PAGE> 20
the requirements of Rule 701 under the Securities Act, or any other available
exemptions from the registration requirements of Section 5 of the Securities
Act, and may not have qualified for any exemption from qualification under
California securities laws either.
Beginning approximately 180 days after the date of this prospectus, 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
registration statement, at the purchase or exercise price paid for these shares,
plus interest at the rate of 10% per year from the date of issuance until the
rescission offer expires. To comply with California securities law, we will also
offer to repurchase all unexercised options issued to such persons at 20% of the
option exercise price multiplied by the number of shares subject to such
options, plus interest at the rate of 10% per year 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 on the number of shares and options issued as of February 29, 2000,
we could be required to pay up to approximately $19.8 million plus the total
amount of interest on that amount as described above based on the number of
shares which have already been issued or which may be issued pursuant to vested
unexercised options before the rescission offer period expires and the number of
outstanding options which will not be exercisable throughout the rescission
offer period. We currently expect to use a portion of the net proceeds of this
offering to fund any requested repayment. The Securities Act does not expressly
provide that a rescission offer will terminate a purchaser's right to rescind a
sale of stock, which was not registered under the Securities Act as required.
Accordingly, should any offerees reject the rescission offer, we may continue to
be contingently liable under the Securities Act for the purchase price of their
shares and options which were not issued in compliance with the Securities Act
or California securities laws. In this case, based on the number of shares and
options issued as of February 29, 2000, we could be liable for a total amount of
up to $33.0 million plus interest.
As of the date of this prospectus, 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.
RISKS RELATED TO OUR INDUSTRY
WE MAY BE SUED FOR CONTENT AVAILABLE OR POSTED ON OUR WEB SITES OR PRODUCTS
SOLD THROUGH OUR WEB SITES.
We may be liable to third parties for content published on our Web sites
and other Web sites where our syndicated content appears if the music, artwork,
text or other content available violates their copyright, trademark or other
intellectual property rights or if the available content is defamatory, obscene
or pornographic. Those types of claims have been brought, sometimes
successfully, against Web site operators in the past. We also may be liable for
content uploaded or posted by our users on our Web sites, such as digitally
distributed music files, postings on our message boards, chat room discussions
and copyrightable works. In addition, we could have liability to some of our
content licensors for claims made against them for content available on our Web
sites. We also could be exposed to these types of claims for the content that
may be accessed from our Web sites or via links to other Web sites or for
products sold through our Web site. While we have resolved all of these types of
claims made against us in the past, we may not be able to do so in the future.
We intend to implement measures to reduce exposure to these 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
19
<PAGE> 21
and damages. Our insurance may not adequately protect us against these types of
claims or the costs of their defense or payment of damages.
THE EFFECTIVENESS OF THE INTERNET FOR ADVERTISING IS UNPROVEN, WHICH MAY
DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON OUR SITES.
Our future depends in part on an increase in the use of the Internet and
other forms of digital media for advertising. The Internet advertising market is
new and rapidly evolving, and we cannot yet gauge the effectiveness of
advertising on the Internet as compared to traditional media. As a result,
demand for Internet advertising is uncertain. Many advertisers have little or no
experience using the Internet for advertising purposes. The adoption of Internet
advertising, particularly by companies that have historically relied upon
traditional media for advertising, requires the acceptance of a new way of
conducting business, exchanging information and advertising products and
services. Such customers may find advertising on the Internet to be undesirable
or less effective than traditional advertising media for promoting their
products and services. If the Internet advertising market fails to fully develop
or develops more slowly than we expect, our business could be adversely
affected. In addition, the market for advertising on other forms of digital
media, such as broadband distribution, is even less developed than Internet
advertising, and if that market does not develop, our growth may be limited.
IF CURRENT STANDARDS TO MEASURE THE EFFECTIVENESS OF ADVERTISING ON THE
INTERNET DO NOT DEVELOP, OUR ABILITY TO ATTRACT AND RETAIN ADVERTISERS
COULD BE ADVERSELY IMPACTED.
There are currently few, well established standards to measure the
effectiveness of advertising on the Internet and other digital media, and the
absence of these standards could adversely impact our ability to attract and
retain advertisers. Currently available software programs that track Internet
usage and other tracking methodologies are rapidly evolving, but such standard
measurements may never develop. In addition, the development of such software or
other methodologies may not keep pace with our information needs, particularly
to support the growing needs of our internal business requirements and
advertising clients.
SOFTWARE PROGRAMS THAT PREVENT OR LIMIT THE DELIVERY OF ADVERTISING MAY
SERIOUSLY DAMAGE OUR ABILITY TO ATTRACT AND RETAIN ADVERTISERS.
A number of "filter" software programs have been developed which limit or
prevent advertising from being delivered to an Internet user's computer. This
software could adversely affect the commercial viability of Internet
advertising. These programs attempt to blank out, or block, banner and other
advertisements. To date, such programs have not had a material adverse impact on
our ability to attract and retain advertisers or caused us to fail to meet the
terms of our advertising agreements. These programs may, however, have these
effects on us in the future. Widespread adoption of this type of software would
seriously damage our ability to attract and retain advertisers.
WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF
GOVERNMENT REGULATION INCREASES.
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. Laws and regulations may be adopted
in the future, however, that address issues such as user privacy, pricing,
taxation, content, copyrights, distribution, security, and the quality of
products and services. For example, the Telecommunications Act sought to
prohibit transmitting certain types of information and content over the Web.
Several telecommunications companies have petitioned the Federal Communications
Commission to regulate Internet service providers and online services providers
in a manner similar to long distance telephone carriers and to impose access
fees on these companies.
20
<PAGE> 22
Any imposition of access fees could increase the cost of transmitting data over
the Internet. In addition, the growth and development of the market for online
commerce may lead to more stringent consumer protection laws, both in the United
States and abroad, that may impose additional burdens on us. The United States
Congress recently enacted Internet laws regarding children's privacy,
copyrights, taxation and the transmission of sexually explicit material. The law
of the Internet, however, remains largely unsettled, even in areas where there
has been some legislative action. Moreover, it may take years to determine the
extent to which existing laws relating to issues such as property ownership,
libel and personal privacy are applicable to the Web. Any new, or modifications
to existing, laws or regulations relating to the Web could adversely affect our
business.
Prohibition and restriction of Internet content and commerce could reduce
or slow Internet use, decrease the acceptance of the Internet as a
communications and commercial medium and expose us to liability. Any of these
outcomes could have a material adverse effect on our business, results of
operations and financial condition. The growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws,
both in the United States and abroad, that may impose additional burdens on
companies conducting business over the Internet.
THE INTERNET IS SUBJECT TO RAPID CHANGES, WHICH COULD RESULT IN SIGNIFICANT
ADDITIONAL COSTS.
The market for Internet products and services is characterized by rapid
change, evolving industry standards and frequent introductions of new
technological developments. These new standards and developments could make our
existing or future products or services obsolete. Keeping pace with the
introduction of new standards and technological developments could result in
significant additional costs or prove difficult or impossible for us. The
failure to keep pace with these changes and to continue to enhance and improve
the responsiveness, functionality and features of our Web sites could harm our
ability to attract and retain users. Among other things, we will need to license
or develop leading technologies, enhance our existing services and develop new
services and technologies that address the varied needs of our users.
OUR NET SALES COULD BE ADVERSELY AFFECTED IF WE BECOME SUBJECT TO SALES AND
OTHER TAXES.
If one or more states or any foreign country successfully asserts that we
should collect sales or other taxes on the sale of our products, our net sales
and results of operations could be harmed. We do not currently collect sales or
other similar taxes for physical shipments of goods into states other than
California and Florida. However, one or more states may seek to impose sales tax
collection obligations on companies, such as ARTISTdirect, which engage in or
facilitate online commerce. A number of proposals have been made at the state
and local level that would impose additional taxes on the sale of goods and
services through the Internet. Such proposals, if adopted, could substantially
impair the growth of electronic commerce and could adversely affect our
opportunity to derive financial benefit from electronic commerce. Moreover, if
any state or foreign country were to successfully assert that we should collect
sales or other taxes on the exchange of merchandise on its system, our results
of operations could be adversely affected. In addition, any new operations in
states outside California could subject our shipments in such states to state
sales taxes under current or future laws.
Legislation limiting the ability of the states to impose taxes on
Internet-based transactions has been enacted by Congress. However, this
legislation, known as the Internet Tax Freedom Act, imposes only a moratorium
ending on October 21, 2001 on state and local taxes on electronic commerce where
such taxes are discriminatory and on Internet access unless such taxes were
generally imposed and actually enforced before October 1, 1998. Failure to renew
this legislation would allow various states to impose taxes on Internet-based
commerce.
21
<PAGE> 23
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.
RISKS RELATED TO THE OFFERING
AFTER THIS OFFERING, OUR EXECUTIVE OFFICERS, DIRECTORS AND MAJOR
STOCKHOLDERS WILL BENEFICIALLY OWN APPROXIMATELY 62.1% OF OUR OUTSTANDING
COMMON STOCK AND CONSEQUENTLY WILL BE ABLE TO EXERCISE SIGNIFICANT CONTROL
OVER ARTISTDIRECT.
After this offering, executive officers, directors and holders of 5% or
more of the outstanding ARTISTdirect common stock together will beneficially own
approximately 62.1% of our outstanding common stock. These stockholders would be
able to significantly influence all matters requiring approval by our
stockholders, including the election of directors and the approval of
significant corporate transactions. This concentration of ownership may also
have the effect of delaying, deterring or preventing a change in control of
ARTISTdirect and may make some transactions more difficult or impossible to
complete without the support of these stockholders.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY, AND THIS
COULD PREVENT CHANGES IN OUR MANAGEMENT.
Upon the closing of this offering, we will be subject to the Delaware
anti-takeover laws regulating corporate takeovers. These anti-takeover laws
prevent a Delaware corporation from engaging in a business combination involving
a merger or sale of more than 10% of its assets with any stockholder, including
all affiliates and associates of the stockholder, who owns 15% or more of the
corporation's
22
<PAGE> 24
outstanding voting stock, for three years following the date that the
stockholder acquired 15% or more of the corporation's stock unless:
- the board of directors approved the transaction where the stockholder
acquired 15% or more of the corporation's stock;
- after the transaction where the stockholder acquired 15% or more of the
corporation's stock, the stockholder owned at least 85% of the
corporation's outstanding voting stock, excluding shares owned by
directors, officers and employee stock plans in which employee
participants do not have the right to determine confidentially whether
shares held under the plan will be tendered in a tender or exchange
offer; or
- on or after this date, the merger or sale is approved by the board of
directors and the holders of at least two-thirds of the outstanding
voting stock that is not owned by the stockholder.
A Delaware corporation may opt out of the Delaware anti-takeover laws if
its certificate of incorporation or bylaws so provide. We have not opted out of
the provisions of the anti-takeover laws. As such, these laws prohibit or delay
mergers or other takeovers or changes of control of ARTISTdirect and may
discourage attempts by other companies to acquire us.
Before the consummation of this offering, we intend to amend and restate
our certificate of incorporation and our bylaws to include a number of
provisions that may delay, deter or impede hostile takeovers or changes of
control or management. These provisions include:
- our board is classified into three classes of directors as nearly equal
in size as possible with staggered three year-terms;
- the authority of our board to issue up to five million shares of
preferred stock and to determine the price, rights, preferences and
privileges of these shares, without stockholder approval;
- all stockholder actions must be effected at a duly called meeting of
stockholders and not by written consent;
- special meetings of the stockholders may be called only by the Chairman
of the Board, the Chief Executive Officer or the Board; and
- the elimination of cumulative voting.
Our certificate of incorporation and bylaws provide that we will indemnify
officers and directors against losses that may incur in investigations and legal
proceedings resulting from their services to us, which may include services in
connection with takeover defense measures. These provisions may have the effect
of preventing changes in our management.
OUR COMMON STOCK PRICE MAY BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INDIVIDUAL STOCKHOLDERS.
The market prices of stock for Internet and technology companies,
particularly following an initial public offering, frequently reach levels that
bear no relationship to the past or present operating performance of such
companies. Such market prices may not be sustainable and may be subject to wide
variations. If our common stock trades to such levels following this offering,
it may thereafter experience a material decline.
23
<PAGE> 25
YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION AND PAY A HIGHER
PRICE THAN EXISTING STOCKHOLDERS.
The initial public offering price of our common stock in this offering is
substantially higher than the book value per share of the outstanding common
stock immediately after this offering. If you purchase common stock in this
offering, you will experience immediate dilution of approximately $8.23 in the
book value per share of the common stock, based on the initial public offering
price of $12.00 per share. In addition, if outstanding options and warrants to
purchase shares of common stock are exercised, investors in this offering could
experience further dilution. Existing stockholders paid an average price of
$3.79 per share. Please see "Dilution" on page 29 for more information regarding
the dilution you will experience.
WE MAY NOT BE ABLE TO SECURE ADDITIONAL FINANCING TO MEET OUR FUTURE
CAPITAL NEEDS.
We currently anticipate that our available cash resources, without the
proceeds from this offering, will be sufficient to meet our anticipated needs
for working capital and capital expenditures for the next twelve months.
However, if our available cash, the proceeds from this offering and cash flows
from operations are insufficient to meet our anticipated needs for working
capital and capital expenditures, we will need to raise additional funds to
continue our operations, promote our brands, develop new or enhanced services,
respond to competitive pressures or make acquisitions. In particular, we intend
to spend approximately $30 million for advertising and promoting our brands and
network of web sites and approximately $10 million for content production and
Web site development. We may be unable to obtain any required additional
financing on terms favorable to us, if at all. If adequate funds are not
available on acceptable terms, we may be unable to fund our expansion,
successfully promote our brands, develop or enhance services, respond to
competitive pressures or take advantage of acquisition opportunities, any of
which could have a material adverse effect on our business. If we raise
additional funds through the issuance of equity securities, our stockholders may
experience dilution of their ownership interest, and the newly-issued securities
may have rights superior to those of the common stock. If we raise additional
funds by issuing debt, we may be subject to limitations on our operations,
including limitations on the payment of dividends.
SUBSTANTIAL SALES OF OUR COMMON STOCK COULD CAUSE OUR STOCK PRICE TO FALL.
If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants, in the
public market following this offering, the market price of our common stock
could fall. Such sales also might make it more difficult for us to sell equity
or equity-related securities in the future at a time and price that we deem
appropriate. Upon completion of this offering, we will have outstanding
36,373,185 shares of common stock, assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options after December 31,
1999. Of these shares, the 5,000,000 shares sold in this offering are freely
tradable. This leaves 31,373,185 remaining shares, 21,216,933 of which will be
eligible for sale in the public market 180 days after the date of this
prospectus. Our directors, officers and existing stockholders have entered into
"lock-up" agreements with respect to approximately 31,273,185 of our shares.
These lock-up agreements restrict the resale of the shares of our stock;
however, the underwriters may waive the restriction on resale on a case-by-case
basis. If they waive this restriction, more shares will be eligible for sale in
the public market at an earlier date.
24
<PAGE> 26
The following table sets forth the number of shares of common stock
available for sale in the public market based on shares outstanding as of
December 31, 1999:
<TABLE>
<CAPTION>
APPROXIMATE
NUMBER OF
SHARES
ELIGIBLE FOR
DATE FUTURE SALE COMMENT
---- ------------ -------
<S> <C> <C>
Date of this prospectus........ 5,000,000 Shares sold in this offering
181 days after the date of this
prospectus................... 21,216,933 Underwriters' lock-up period
ends. These shares are eligible
for sale under Rule 144 or 701.
271 days after the date of this
prospectus................... 10,156,252 Additional shares eligible for
sale under Rule 144, assuming
that the shares of common stock
issued upon the automatic
conversion of Series C
preferred stock issued in
December 1999 and January 2000
are eligible.
</TABLE>
SALES OF STOCK TO EMPLOYEES, ARTISTS AND KEY INDIVIDUALS WILL REDUCE YOUR
OWNERSHIP PERCENTAGE.
We seek to attract and retain officers, directors, employees, artists and
other key individuals, in part by offering them stock options and other rights
to purchase shares of common stock. As of December 31, 1999, we had outstanding
options to purchase 6,890,549 shares of our common stock and had reserved a
total of an additional 3,432,784 shares for future grants under our three option
plans. The exercise of stock options will reduce your percentage ownership in
ARTISTdirect.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance, or achievements expressed or implied
by such forward-looking statements. Such factors include, among other things,
those listed under "Risk Factors" and elsewhere in this prospectus.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "could," "expects," "plans," "intends,"
"anticipates," "believes," "estimates," "predicts," "potential" or "continue" or
the negative of such terms or other comparable terminology.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements. You should not place undue reliance on
these forward-looking statements.
25
<PAGE> 27
USE OF PROCEEDS
We estimate that our net proceeds from the sale of 5,000,000 shares of
common stock in this offering will be approximately $54.1 million after
deducting estimated underwriting discounts and commissions and estimated
offering expenses. If the underwriters exercise their over-allotment option in
full, we estimate that our net proceeds will be $62.5 million. We currently
anticipate that our available cash resources combined with the net proceeds from
this offering will be sufficient to meet our anticipated needs for working
capital and capital expenditures for at least eighteen months following the date
of this prospectus.
We plan to use the net proceeds for the following purposes:
- approximately $30 million for advertising and promoting our brands and
network of Web sites to increase consumer traffic;
- approximately $10 million for content production and Web site
development, in particular to develop and launch additional ARTIST
channels;
- approximately $741,000 to repay notes issued to several stockholders in
satisfaction of our obligation to make distributions triggered by the
merger of ARTISTdirect, LLC into ARTISTdirect, Inc. See "Related Party
Transactions -- Debt to Executive Officers and Director" on page 80 for
more information on these notes; and
- general corporate purposes, including working capital.
The portion available following application to the first three items above
may be used to fund the repurchase of our shares tendered in connection with our
rescission offer with respect to shares of, or options to purchase, our common
stock issued to our employees and our artists and their managers and advisors.
The amount required for the repurchase may be up to $19.8 million plus interest,
based on the number of options and shares issued as of February 29, 2000. See
"Rescission Offer" on page 92 for more information on the rescission offer. A
portion of the net proceeds may also be used for possible acquisitions of
complimentary businesses, technologies, product lines or content. We intend to
invest the net proceeds in short-term interest-bearing, investment grade
securities until we use them.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. Our
predecessor, ARTISTdirect, LLC, made cash distributions to its members,
principally to pay taxes. We currently intend to retain all available funds and
any future earnings for use in the operation and expansion of our business, and
we do not expect to pay any cash dividends in the foreseeable future.
26
<PAGE> 28
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999:
- on an actual basis;
- on pro forma basis to reflect:
- the issuance of 1,094,917 shares of Series C preferred stock in
January 2000;
- the filing of an amended and restated certificate of incorporation to
provide for authorized capital stock of 150 million shares of common
stock and five million shares of undesignated preferred stock;
- a one-for-four reverse stock split of our common stock effected on
March 21, 2000;
- the termination of the put option described in "Related Party
Transactions -- Transactions with Scott Blum" on page 81, which will
occur upon the closing of this offering; and
- the automatic conversion of all shares of outstanding preferred stock
into shares of common stock upon the closing of this offering at a
ratio of one preferred share for one common share; provided that the
shares of Series C preferred stock are convertible at a ratio of one
preferred share for approximately 1.4508 common shares, based on the
initial public offering price of $12.00 per share;
- on a pro forma as adjusted basis to reflect the pro forma adjustments and
the issuance and sale of 5,000,000 shares of common stock at the initial
public offering price of $12.00 per share and the application of the net
proceeds from the offering, after deducting the underwriting discounts,
commissions and estimated offering expenses, as set forth in "Use of
Proceeds" on page 26.
None of the columns set forth below reflects the following:
- the 1,244,394 shares of common stock issuable upon exercise of warrants,
of which 529,303 were exercisable as of December 31, 1999 with a weighted
average exercise price of $7.18 per share;
- the 6,890,549 shares subject to outstanding options under our stock
option plans as of December 31, 1999, with a weighted average exercise
price of $3.67 per share;
- approximately 80,200 shares of common stock to be issued as accrued but
unpaid dividends on preferred stock subsequent to December 31, 1999;
- the issuance of up to 900,000 shares of common stock to be issued to
acquire Mjuice.com, Inc.;
- the issuance of up to 62,500 shares of common stock issuable upon the
exercise of a warrant issued in March 2000; and
- the effect of any shares or options repurchased in the rescission offer
that we intend to make after the closing of this offering, as described
in more detail on page 92 under "Rescission Offer".
27
<PAGE> 29
The table below should be read in conjunction with our financial statements
and the notes to those financial statements, which are included elsewhere in
this prospectus:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
-----------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- -------------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents(1)...................... $ 69,119 $ 84,343 $138,476
======== ======== ========
Notes payable..................................... 741 741 741
Redeemable securities:
Series A redeemable preferred
securities -- issued and outstanding:
3,207,815 shares actual; none pro forma and
pro forma as adjusted........................ $ 4,963 -- --
Series B redeemable preferred
securities -- issued and outstanding:
3,750,000 shares actual; none pro forma and
pro forma as adjusted........................ 15,350 -- --
Series C redeemable preferred
securities -- issued 7,000,291 shares; none
outstanding actual, pro forma and pro forma
as adjusted(1)............................... 82,188
Redeemable common securities -- issued and
outstanding: 597,110 shares actual; 426,667
pro forma and pro forma as adjusted(2)....... 9,206 6,854 6,854
-------- -------- --------
Total redeemable securities.................. 111,707 6,854 6,854
-------- -------- --------
Stockholders' equity:
Preferred stock, $0.01 par value, no shares
authorized or issued on actual basis;
5,000,000 shares authorized, no shares issued
on a pro forma and pro forma as adjusted
basis;....................................... -- -- --
Common stock, $.01 par value, no shares
authorized or issued on actual basis;
150,000,000 shares authorized; 31,373,185
shares issued on a pro forma basis(1); and
36,373,185 shares issued on a pro forma as
adjusted basis............................... 141 314 364
Additional paid in capital...................... 36,688 156,592 210,675
Unearned compensation............................. (36,976) (36,976) (36,976)
Accumulated deficit............................... (23,598) (23,598) (23,598)
-------- -------- --------
Total members' and stockholders' equity
(deficit).................................. (23,745) 96,332 150,465
-------- -------- --------
Total capitalization.................... $ 87,962 $103,186 $157,319
======== ======== ========
</TABLE>
- ------------------------
(1) Reflects the issuance of 1,094,917 shares of Series C preferred stock in
January 2000 for $15.25 million, and the conversion of all outstanding
shares of Series C preferred stock into 10,156,252 shares of common stock
upon the consummation of this offering, based on the initial public offering
price of $12.00 per share.
(2) The redeemable common securities are 170,443 common securities that were
subject to a put option and 426,667 shares of common stock issued pursuant
to the exercise of stock options as of December 31, 1999. The put option was
granted to the holder in connection with our acquisition of iMusic. The
holder has informed us that he does not intend to exercise this option.
Accordingly, he will retain ownership of these securities, and the put
option will expire on the closing of this offering. In addition redeemable
common securities includes options and securities subject to a rescission
offer. The outstanding shares issued pursuant to the exercise of stock
options are subject to a rescission offer.
28
<PAGE> 30
DILUTION
Our pro forma net tangible book value as of December 31, 1999 was
approximately $82.9 million or $2.64 per share. Pro forma net tangible book
value per share is determined by dividing our pro forma tangible net worth
(total tangible assets minus total liabilities) by the pro forma total number of
shares of common stock outstanding; the pro forma adjustments give effect to:
- the issuance of 1,094,917 shares of Series C preferred stock in January
2000;
- the one-for-four reverse stock split effected on March 21, 2000; and
- the automatic conversion of all shares of outstanding preferred stock
into shares of common stock upon the closing of this offering at a ratio
of one preferred share for one common share; provided that outstanding
shares of Series C preferred stock will convert into 10,156,252 shares of
common stock based on the initial offering price of $12.00 per share.
Assuming the sale of the 5,000,000 shares of common stock offered by us at
the initial public offering price of $12.00 per share, and after deducting the
underwriting discounts, commissions and estimated offering expenses, our pro
forma net tangible book value as of December 31, 1999 would have been
approximately $137.1 million, or $3.77 per share of common stock. This
represents an immediate increase in pro forma net tangible book value of $1.13
per share to existing stockholders and an immediate dilution of $8.23 per share
to new investors purchasing shares at the initial public offering price. The
following table illustrates this dilution per share:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $12.00
Pro forma net tangible book value per share as of December
31, 1999............................................... $2.64
Increase in pro forma net tangible book value per share
attributable to new investors.......................... 1.13
-----
Pro forma net tangible book value per share after the
offering.................................................. 3.77
------
Dilution per share to new investors......................... $ 8.23
======
</TABLE>
The following table summarizes on a pro forma basis, after giving effect to
the January 2000 Series C preferred stock issuance, as of December 31, 1999, the
number of shares of common stock purchased from us by existing stockholders and
new investors, the total consideration paid to us and the average price per
share paid after giving effect to the offering. The calculation is based on the
initial public offering price of $12.00 per share, before deducting estimated
underwriting discounts, commissions and offering expenses.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------ -------------------------- PRICE PER
NUMBER PERCENTAGE AMOUNT PERCENTAGE SHARE
---------- ---------- ------------ ---------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 31,373,185 86.3% $118,833,000 66.4% $ 3.79
New investors.............. 5,000,000 13.7 60,000,000 33.6 12.00
---------- ----- ------------ -----
Total............ 36,373,185 100.0% $178,833,000 100.0%
========== ===== ============ =====
</TABLE>
The foregoing table excludes 10,323,333 shares of common stock reserved for
issuance under our stock option plans as of December 31, 1999, of which
6,890,549 were subject to outstanding options as of December 31, 1999 at a
weighted average exercise price of $3.67 per share, shares issued after December
31, 1999 upon exercise of outstanding options, and 1,244,394 shares of common
stock issuable upon exercise of warrants outstanding as of December 31, 1999 at
a weighted average exercise price of $6.44 per share.
29
<PAGE> 31
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA
The following unaudited pro forma consolidated financial data has been
derived by applying pro forma adjustments to the historical financial statements
of ARTISTdirect and its subsidiaries for the period indicated. The historical
financial statements of ARTISTdirect represent the operations of ARTISTdirect,
LLC for the period from January 1, 1999 to October 5, 1999 (which was the period
before the conversion to a C corporation), and ARTISTdirect, Inc. from October
6, 1999 to December 31, 1999 (which was the period after the conversion to a C
corporation). The adjustments are described in accompanying notes.
The unaudited pro forma consolidated statement of operations for the year
ended December 31, 1999 gives effect to:
- our acquisition of the 80% interest of iMusic we did not own; and
- our acquisition of the interests in The Ultimate Band List, LLC we did
not own.
as if each occurred at the beginning of the period.
The unaudited pro forma consolidated statement of operations is not
necessarily indicative of the operating results that would have been achieved
had the transactions been in effect as of the beginning of the period presented
and should not be construed as being representative of future operating results.
The historical financial statements of ARTISTdirect and its subsidiaries,
are included elsewhere in this prospectus and the unaudited pro forma
consolidated financial data presented herein should be read in conjunction with
those financial statements and related notes.
30
<PAGE> 32
ARTISTDIRECT, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
----------------------------------------------
ARTISTDIRECT
AND SUBSIDIARIES
ACTUAL(a) ADJUSTMENTS PRO FORMA
---------------- ----------- -----------
<S> <C> <C> <C>
Net revenue
Online product sales........................ $ 5,282 $ -- $ 5,282
Advertising and other....................... 2,910 63(d) 2,973
Agency commissions.......................... 1,304 -- 1,304
Record label................................ 778 -- 778
----------- ------- -----------
Total net revenue................... 10,274 63(d) 10,337
Cost of revenue............................... 10,240 20(d) 10,260
----------- ------- -----------
Gross profit........................ 34 43 77
Operating expense:
Product development......................... 1,815 -- 1,815
Sales and marketing......................... 13,222 2(d) 13,224
General and administrative.................. 10,319 52(d) 10,371
Amortization of stock-based compensation.... 30,304 -- 30,304
Depreciation and amortization............... 2,509 1,160(c) 3,669
----------- ------- -----------
Loss from operations................ (58,135) (1,171) (59,306)
Income from equity investment................. 50 -- 50
Interest income, net................ 281 -- 281
----------- ------- -----------
Loss before provision for income
tax.............................. (57,804) (1,171) (58,975)
Provision for income tax(b)................... -- -- --
----------- ------- -----------
Net income (loss)................... $ (57,804) $(1,171) $ (58,975)
=========== ======= ===========
Basic and diluted net loss per share for
period from October 6, 1999 to December 31,
1999........................................ $ (1.66)
Weighted average shares outstanding used in
computing basic and diluted net loss per
share for period from October 6, 1999 to
December 31, 1999........................... 14,177,463
Pro forma basic and diluted net loss per
share....................................... $ (2.96) $ (3.02)
Weighted average shares outstanding used in
computing pro forma basic and diluted net
loss per share.............................. 19,502,437 19,523,743(e)
=========== ===========
</TABLE>
31
<PAGE> 33
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(a) Includes the operations of ARTISTdirect, Inc. (for the period from October
6, 1999 through December 31, 1999), ARTISTdirect, LLC, its predecessor
entity (for the period from January 1, 1999 through October 5, 1999) and the
following subsidiaries: ARTISTdirect Agency, LLC, Kneeling Elephant Records,
LLC, The Ultimate Band List, LLC, ARTISTdirect New Media, LLC, and iMusic,
Inc. For The Ultimate Band List, LLC, all of the entity's losses have been
allocated to the majority interest due to its funding of the operations. The
results of iMusic, Inc. are included from the date of acquisition of the
remaining 80% interest that we did not already own.
(b) On October 6, 1999, ARTISTdirect, LLC was merged into ARTISTdirect, Inc. The
transaction was a merger of entities under common control and, accordingly,
it has been accounted for on the historical cost basis. Before the merger,
we operated as a limited liability company and did not incur federal and
state income taxes. Federal and state income taxes attributable to income
during such periods were incurred and paid directly by the members. The
Company is now taxed as a corporation. No impact of the merger is reflected
on the statement of operations since we have incurred operating losses to
date, and we have recorded a full valuation allowance for the deferred tax
asset. The valuation allowance is based on management's consideration of
historical and projected future taxable income.
(c) In February 1999, The Ultimate Band List, LLC acquired the remaining 80% of
iMusic, Inc. that it did not already own. iMusic, Inc. operates a Web site
that provides music-related content. The acquisition was accounted for using
the purchase method of accounting and, accordingly, the purchase price has
been allocated to the tangible and intangible assets acquired and
liabilities assumed on the basis of their respective fair values on the
acquisition date. The total purchase price of $2.5 million consisted of a 2%
redeemable interest in The Ultimate Band List, LLC with an estimated fair
value of $2.2 million, a cash payment of $110,000, and the assumption of
approximately $180,000 in liabilities, resulting in excess purchase price
over net tangible assets acquired of $2.4 million. In May 1999,
ARTISTdirect, LLC acquired the interests of the minority unit holders of The
Ultimate Band List, LLC, which included the redeemable interest issued in
connection with the iMusic acquisition, in exchange for common interests in
ARTISTdirect, LLC. The acquisition of the minority interests was accounted
for using the purchase method of accounting. The fair value of the
consideration given was $13.9 million, which resulted in excess purchase
price over net tangible assets acquired of $13.1 million. The adjustments
reflect the additional amortization expense for total goodwill resulting
from the iMusic acquisition and purchase of the interests of The Ultimate
Band List, LLC that ARTISTdirect, LLC did not own, using a five year
estimated useful life for the applicable period. The acquisitions were
structured as tax free exchanges of securities; therefore, the differences
between the recognized fair values of acquired assets, including intangible
assets, and their historical tax bases are not deductible for tax purposes.
(d) The adjustments reflect the inclusion of the operations of iMusic, Inc. from
January 1, 1999 through the date of the acquisition.
(e) Reflects the pro forma weighted average common stock and common stock
equivalent shares outstanding and resulting in basic and diluted net loss
per share giving effect to:
- increase in outstanding shares resulting from inclusion of redeemable
common shares issued in connection with the iMusic acquisition, assuming
such shares are not redeemed and common shares issued in the acquisition
of the UBL minority interest as if such shares were outstanding from
January 1, 1999;
- automatic conversion of our redeemable preferred stock into common stock
upon the consummation of this offering;
- the one-for-four reverse stock split effected on March 21, 2000 as though
it had occurred on January 1, 1999; and
- the issuance of common stock as accrued dividends on redeemable preferred
stock.
32
<PAGE> 34
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below for the period
from August 8, 1996 (inception) to December 31, 1996, for the years ended
December 31, 1997, 1998, 1999 and as of December 31, 1996, 1997, 1998, and 1999
are derived from our audited financial statements.
You should read the financial data presented below together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and the related notes included in this
prospectus.
<TABLE>
<CAPTION>
PERIOD FROM
AUGUST 8, 1996
(INCEPTION) TO YEAR ENDED DECEMBER 31,
DECEMBER 31, -----------------------------
1996 1997 1998 1999
-------------- ------ ------- ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenue:
Online product sales........................... $ -- $ 269 $ 1,548 $ 5,282
Advertising and other.......................... -- 95 552 2,910
Agency commissions............................. -- 974 1,917 1,304
Record label................................... -- 550 565 778
---- ------ ------- ----------
Total net revenue........................... -- 1,888 4,582 10,274
Cost of revenue.................................. -- 608 2,515 10,240
---- ------ ------- ----------
Gross profit................................ -- 1,280 2,067 34
Operating expense:
Product development............................ -- 78 589 1,815
Sales and marketing............................ 10 196 1,395 13,222
General and administrative..................... 13 1,442 2,545 10,319
Stock-based compensation(1).................... -- -- 3,828 30,304
Depreciation and amortization.................. 5 21 59 2,509
---- ------ ------- ----------
Loss from operations........................ 28 457 6,349 58,135
Income from equity investment.................... -- -- 2 50
Interest income (expense), net................... -- (3) 29 281
---- ------ ------- ----------
Net loss.................................... $ 28 $ 460 $ 6,318 $ 57,804
==== ====== ======= ==========
Pro forma basic and diluted net loss per share... $ (2.96)
==========
Weighted average shares used in computing pro
forma basic and diluted net loss per
share(2)....................................... 19,502,437
==========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------------------
1996 1997 1998 1999
-------------- ------ ------- ----------
<S> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents........................ $ 80 $ 167 $ 1,940 $ 69,119
Working capital.................................. (20) (526) 1,079 67,730
Goodwill and intangibles, net.................... -- 16 45 13,415
Total assets..................................... 173 314 3,412 98,600
Total redeemable securities...................... -- -- 5,135 111,707
Total members' and stockholders' equity
(deficit)...................................... 72 (412) (3,436) (23,745)
</TABLE>
- -------------------------
(1) Stock-based compensation is comprised of sales and marketing expense of $0
and $8,551 in 1998 and 1999, respectively, and general and administrative
expense of $3,828 and $21,753 in 1998 and 1999, respectively.
(2) See Note 3 to notes to consolidated financial statements for an explanation
of the determination of the number of shares and share equivalents used in
computing pro forma per share amounts.
33
<PAGE> 35
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated financial statements and the notes to those financial statements
included elsewhere in this prospectus. The following discussion contains
forward-looking statements that involve risks and uncertainties. The statements
are based on current expectations and actual results could differ materially
from those discussed herein. Factors that could cause or contribute to the
differences are discussed in "Risk Factors" and elsewhere in this prospectus.
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 December 31, 1999, ARTISTdirect featured 79 unique, artist-owned
ARTISTchannels, and had signed agreements to launch channels with an additional
26 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 and DOWNLOADSdirect, a feature that allows users to
download music and upload music and other information to the ARTISTdirect
Network. We also operate a music talent agency, the ARTISTdirect Agency, and
manage a traditional record label, Kneeling Elephant Records.
ARTISTdirect was organized as a California limited liability company in
August 1996 and conducts operations through a group of affiliated limited
liability companies. From inception through December 1996, our primary
activities consisted of developing our business model, recruiting and training
employees and developing our infrastructure. During 1997, our operations
consisted primarily of the ARTISTdirect Agency and the Kneeling Elephant Records
label. In July 1997, we formed a joint venture to own a controlling interest in
UBL, LLC.
In September 1997, we launched our first ARTISTchannel. In June 1998, we
expanded content offerings on the UBL and added an online retail store now known
as the ARTISTdirect Superstore. Also in June 1998, we launched our second
ARTISTchannel and, by the end of 1998, we had nine ARTISTchannels in operation.
In February 1999, ARTISTdirect acquired all of the outstanding capital
stock of iMusic, Inc. The purchase consideration for iMusic was approximately
$2.5 million, including $110,000 in cash, a redeemable put option valued at
approximately $2.2 million and the assumption of approximately $180,000 in
liabilities. The acquisition was accounted for as a purchase. The purchase price
has been largely allocated to goodwill, which will be amortized over five years.
In May 1999, we engaged in an exchange transaction in which all membership
interests in UBL, LLC that we did not own were exchanged for membership
interests in ARTISTdirect, LLC. The value of the consideration given was
approximately $13.9 million and the transaction was accounted for as a purchase.
The purchase price has been largely allocated to goodwill, which will be
amortized over five years.
In July 1999, we officially launched the ARTISTdirect Network, integrating
the UBL and iMusic Web sites with our ARTISTchannels. Since 1997, our revenue
mix has shifted from primarily agency commissions and record label revenue to
electronic commerce revenue and online advertising, and we expect this trend to
continue, particularly with respect to record label revenue, which we expect to
continue decreasing as a percentage of our total revenue in the future.
ARTISTdirect has incurred cumulative net losses of $64.6 million from
inception to December 31, 1999 of which approximately $35.9 million represented
stock-based compensation expense. We expect our net
34
<PAGE> 36
losses to increase and to continue for the foreseeable future. We plan to expend
significant resources developing our ARTISTdirect Network, building our brands,
increasing our traffic, expanding our operations, enhancing and acquiring
content, and improving our technology infrastructure. We have a limited
operating history on which to base an evaluation of our business and prospects.
Our prospects must be considered in light of the risks, expenses, and
difficulties encountered by companies in their early stage of development,
particularly companies in new and rapidly evolving markets, such as electronic
commerce. See "Risk Factors" beginning on page 9 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 income during such periods were incurred and paid directly by
the members. Accordingly, no discussion of income taxes is included in "Results
of Operations" beginning on page 37. 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.
REVENUE
We generate revenue from three sources: the ARTISTdirect Network, the
ARTISTdirect Agency, and Kneeling Elephant Records. Substantially all of our
revenue is generated in cash. Less than 1% of our revenue for the year ended
December 31, 1999 was barter revenue.
Revenue from the ARTISTdirect Network, including the ARTISTchannels, the
UBL, iMusic, DOWNLOADSdirect and the ARTISTdirect Superstore, consists primarily
of online product sales and advertising revenue as described below:
- Online product sales revenue 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 year ended December 31, 1999, online product sales
revenue constituted approximately 51.4% of our total net revenue for that
period.
- Advertising revenue consists primarily of sales of banner advertisements
and sponsorships. In sales of banner advertisements, we principally earn
revenue based on the number of impressions or times an advertisement
appears on pages viewed within our Web sites. Our banner advertising
commitments generally range from one to three months. Banner advertising
revenue is recognized ratably over the period in which the advertising is
displayed, provided no significant obligations remain and collection of
the receivable is probable. We typically guarantee a minimum number of
impressions to the advertiser. To the extent that minimum guaranteed page
deliveries are not met, we defer recognition of the corresponding revenue
until the guaranteed impressions are delivered. We also sell to
advertisers sponsorship of a Web page or event for a specified period of
time. We recognize sponsorship revenue over the period in which the
sponsored page or event is displayed. To the extent that committed
obligations under sponsorship agreements are not met, revenue recognition
is deferred until the obligations are met. For the year ended December
31, 1999, advertising revenue constituted approximately 28.3% of our
total net revenue for that period.
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
35
<PAGE> 37
time of the event. 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.
Revenue from Kneeling Elephant Records is generated from overhead advances
and from royalties earned on albums sold by artists signed to the label. We
recognize royalties at the time the releases are shipped to the retailer.
Reserves are established for possible returns.
COST OF REVENUE
Cost of revenue consists primarily of the product cost of music and
music-related merchandise, credit card fees, fulfillment and shipping costs,
payments to our artists for their share of net proceeds, Web site maintenance
expenses, content acquisition costs, 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 December 31, 1999, we recorded non-cash
compensation expense of approximately $1.8 million for the year ended December
31, 1999. We expect to grant additional equity instruments in the future related
to ARTISTchannels. Due to these equity grants, we expect to record substantial
non-cash compensation expense into the foreseeable future.
OPERATING EXPENSE
Product Development. Product development expense consists primarily of
expenses required to design and develop our Web sites and underlying technology
infrastructure. These expenses primarily include payments to third-party service
vendors and personnel costs.
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 $34.1
million of stock-based compensation expense for the period from inception
through December 31, 1999 in connection with equity granted to employees,
directors, professional firms and artists during this period. We expect to grant
additional options for promotional services in the future. We recorded
amortization of stock-based compensation expense of $30.3 million during the
year ended December 31, 1999. We also anticipate granting additional equity
securities in the future to employees, directors and artists.
Depreciation and Amortization. Depreciation and amortization expense
consists of the depreciation of fixed assets and the amortization of acquired
intangible assets. The acquisitions of iMusic and the minority interest of the
UBL were accounted for using the purchase method of accounting and, accordingly,
the purchase prices have been allocated to the tangible and intangible assets
acquired and liabilities assumed on the basis of their fair values on the
acquisition dates. Substantially all of the
36
<PAGE> 38
purchase price of these transactions is attributable to the acquired intangible
assets. As a result, the aggregate excess purchase price over the net tangible
assets has been estimated to be $15.5 million and will be 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
interest expense consists of interest associated with short-term borrowings.
RESULTS OF OPERATIONS
Operations in 1996 were limited and consisted primarily of start-up
operations of ARTISTdirect. Accordingly, we believe that year-to-year
comparisons between 1996 against 1997 are not meaningful.
FISCAL YEARS ENDED DECEMBER 31, 1999 AND 1998
NET REVENUE
Net revenue increased to $10.3 million in the year ended December 31, 1999
from $4.6 million in the same period of 1998. The increase was primarily due to
an increase in online product sales revenue to $5.3 million from $1.5 million,
reflecting additional ARTISTchannels plus contributions from the ARTISTdirect
Superstore. Advertising and other revenue also increased to $2.9 million from
$552,000, reflecting an increase in the page views generated by our Web sites
plus a significant increase in sales of sponsorships. Commission revenue from
the ARTISTdirect Agency decreased from $1.9 million to $1.3 million, due
primarily to a decrease in the touring activity of the agency's artists.
COST OF REVENUE
Direct cost of product revenue increased to $5.1 million in the year ended
December 31, 1999 from $1.5 million for the same period of 1998. This $3.6
million increase corresponded with the increase in online product sales revenue
and was primarily attributable to a related $2.4 million increase in royalties
payable to artists and $1.1 million increase in transaction costs. Other cost of
revenue increased to $5.1 million in 1999 from $1.0 million in 1998. This $4.1
million increase was primarily due to a $2.0 million increase in Web site
hosting and maintenance costs and $1.8 million of non-cash expense for the
amortization of warrants issued to vendors and options issued to artists and
their advisors related to our rights to operate ARTISTchannels. In total, in
1999 we recorded non-cash compensation charges of $15.5 million and such amount
will be amortized to cost of revenue over the life of the contract periods
associated with the warrants and options. Our overall gross profit margin
decreased to 0.3% of net revenue for the year ended December 31, 1999 from 45%
of net revenue for the year ended December 31, 1998, due to a higher proportion
of online product sales revenue, which has lower gross margin than our other
sources of revenue, and the increased costs detailed above.
OPERATING EXPENSE
Product Development. Product development expense increased to $1.8 million
for the year ended December 31, 1999 from $589,000 for the same period in 1998.
This increase was primarily attributable to fees paid to third party service
vendors relating to the development of the new ARTISTdirect Network Web site,
which launched in July 1999.
Sales and Marketing. Sales and marketing expense increased to $13.2 million
for the year ended December 31, 1999 from $1.4 million for the same period in
1998. The increase was primarily
37
<PAGE> 39
attributable to a significant increase in online and offline advertising,
promotion and sponsorship. In addition, personnel and related expenses increased
as we added to our advertising sales and marketing staffs. We intend to continue
to pursue an aggressive branding and marketing campaign and, therefore, expect
sales and marketing expenses to increase significantly in future periods.
General and Administrative. General and administrative expense increased to
$10.3 million for the year ended December 31, 1999 from $2.5 million for the
year ended December 31, 1998. This increase was primarily attributable to a $3.0
million increase in personnel and related expenses and a $2.0 million increase
in outside professional services expenses. We expect general and administrative
expense to increase as we expand our staff to support our growth strategy and
incur the higher costs of operating as a public company.
Amortization of Stock-based Compensation. We recorded a total of $30.3
million of stock-based compensation expense for the year ended December 31, 1999
in connection with stock issuances to employees, directors, professional firms
and artists for promotional services which are being treated as variable stock
compensation. Stock-based compensation for the comparable period in 1998 was
$3.8 million, primarily in connection with stock issuances to employees,
directors and professional firms.
Depreciation and Amortization. Depreciation and amortization expense
increased to $2.5 million for the year ended December 31, 1999 from
approximately $59,000 in the same period of 1998. This increase was primarily
attributable to the amortization of the goodwill associated with the acquisition
of iMusic and the minority interest in the UBL.
NET LOSS
Net loss increased to $57.8 million in the year ended December 31, 1999
compared to $6.3 million in the year ended December 31, 1998. The increase in
the net loss can be primarily attributed to a $26.5 million increase in the
amortization of stock-based compensation, $11.8 million increase in sales and
marketing expense, $7.8 million increase in general and administrative expense,
$2.5 million increase in depreciation and amortization expense and $2.0 million
decrease in gross profit due to increased expenditures for Web site hosting,
maintenance and content compared with the prior year.
FISCAL YEARS ENDED DECEMBER 31, 1998 AND 1997
NET REVENUE
Net revenue increased to $4.6 million for the fiscal year ended December
31, 1998 from $1.9 million for the fiscal year ended December 31, 1997. The
increase was primarily attributable to a $1.3 million increase in online product
sales revenue and a $943,000 increase in ARTISTdirect Agency commission revenue.
The increase in online product sales revenue resulted primarily from the June
1998 introduction of the ARTISTdirect Superstore and the addition of ten
ARTISTchannels during 1998. The increase in ARTISTdirect Agency commission
revenue reflects a significant increase in touring activity by major artists
represented by the agency.
COST OF REVENUE
Cost of revenue increased to $2.5 million for the fiscal year ended
December 31, 1998 from $608,000 for the fiscal year ended December 31, 1997.
This increase corresponded with the increase in online product sales revenue and
was primarily attributable to higher direct costs of merchandise sold,
additional Web site maintenance expenses and an increase in personnel and
related expenses. Our gross profit margin decreased to 45% of net revenue for
the fiscal year ended December 31, 1998 from 68% of
38
<PAGE> 40
net revenue for the fiscal year ended December 31, 1997. The margin decline
primarily reflects an increase in online product sales revenue, which has a
lower gross margin than other sources of revenues.
OPERATING EXPENSE
Product Development. Product development expense increased to $589,000 for
the fiscal year ended December 31, 1998 from $78,000 for fiscal year ended
December 31, 1997. The $511,000 increase was primarily attributable to increased
staffing and fees paid to third-party vendors for development costs related to
the expanded content offerings on the UBL and new ARTISTchannels.
Sales and Marketing. Sales and marketing expense increased to $1.4 million
for the fiscal year ended December 31, 1998 from $196,000 for the fiscal year
ended December 31, 1997. This $1.2 million increase was primarily attributable
to the expansion of our online and offline advertising, as well as to increased
personnel and related expenses required to implement our marketing strategy.
General and Administrative. General and administrative expense increased to
$2.5 million for the fiscal year ended December 31, 1998 from $1.4 million for
the fiscal year ended December 31, 1997. This $1.1 million increase was
primarily attributable to increased personnel and related expenses associated
with the hiring of additional personnel and increased professional services
expenses.
Amortization of Stock-based Compensation. Amortization of stock-based
compensation expense was $3.8 million for the fiscal year ended December 31,
1998. There was no stock-based compensation expense in the fiscal year ended
December 31, 1997.
Depreciation and Amortization. Depreciation and amortization expense
increased to $59,000 for the fiscal year ended December 31, 1998 from $21,000 in
the same period of 1997. This increase is primarily attributable to the
amortization associated with fixed asset purchases during 1998.
NET LOSS
Net loss increased to $6.3 million for the fiscal year ended December 31,
1998 from $460,000 for the fiscal year ended December 31, 1997. The increase in
the net loss can be primarily attributed to the $3.8 million amortization of
stock-based compensation expense in 1998 as well as the $.5 million increase in
product development, $1.2 million increase in sales and marketing, and $1.1
million increase in general and administrative expense compared with the prior
year.
SEGMENT OPERATIONS
ARTISTdirect provides music entertainment products and services through the
following three reportable segments:
- ARTISTdirect Network -- music-related Web site operations;
- Talent Agency -- artist booking operations; and
- Record Label -- record label operations.
39
<PAGE> 41
The factors for determining reportable segments were based on service and
products. Each segment is responsible for executing a segment-specific business
strategy. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. ARTISTdirect
evaluates performance based on profit or loss from operations before income
taxes. The following table summarizes the net revenue, cost of revenue, gross
profit, operating expense, and operating income (loss) by segment for the years
ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997 1998 1999
----- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
ARTISTDIRECT NETWORK
Net revenue:
Online product sales................................. $ 269 $ 1,548 $ 5,282
Advertising and other................................ 95 552 2,910
----- ------- --------
Total net revenue.................................. 364 2,100 8,192
Cost of revenue:
Direct cost of product sales......................... 262 1,505 5,091
Other cost of revenues............................... 172 735 4,488
----- ------- --------
Total cost of revenue.............................. 434 2,240 9,579
----- ------- --------
Gross profit (loss)..................................... (70) (140) (1,387)
Operating expense....................................... 670 5,116 56,513
----- ------- --------
Loss from operations.................................... (740) (5,256) (57,900)
----- ------- --------
TALENT AGENCY
Net revenue............................................. $ 974 $ 1,917 $ 1,304
Cost of revenue......................................... 174 259 432
----- ------- --------
Gross profit............................................ 800 1,658 872
Operating expense....................................... 603 2,287 850
----- ------- --------
Income (loss) from operations........................... 197 (629) 22
----- ------- --------
RECORD LABEL
Net revenue............................................. $ 550 $ 565 $ 778
Cost of revenue......................................... -- 16 229
----- ------- --------
Gross profit............................................ 550 549 549
Operating expense....................................... 464 1,013 806
----- ------- --------
Income (loss) from operations........................... 86 (464) (257)
----- ------- --------
TOTAL LOSS FROM OPERATIONS................................ $(457) $(6,349) $(58,135)
===== ======= ========
</TABLE>
Segment income (loss) from operations excludes interest income, interest
expense, and provision for income tax.
40
<PAGE> 42
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly results of operations
for the six most recent quarters ended December 31, 1999. This unaudited
quarterly information has been derived from our unaudited financial statements
and, in our opinion, includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the information for
the periods covered. The quarterly data should be read in conjunction with our
financial statements and related notes. The operating results for any quarter
are not necessarily indicative of the operating results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
----------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 1999 1999 1999 1999
------------- ------------ --------- -------- ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net revenue:
Online product sales........ $ 444 $ 744 $ 1,016 $ 1,154 $ 1,331 $ 1,781
Advertising and other....... 128 218 381 508 777 1,244
Agency commissions.......... 1,338 135 130 161 371 642
Record label................ 138 137 171 161 273 173
------- ------- ------- ------- -------- --------
Total net revenue.... 2,048 1,234 1,698 1,984 2,752 3,840
Cost of revenue............... 677 1,241 1,296 1,653 2,707 4,584
------- ------- ------- ------- -------- --------
Gross profit
(loss)............. 1,371 (7) 402 331 45 (744)
Operating expense:
Product development......... 99 253 191 440 397 787
Sales and marketing......... 419 603 777 1,760 2,901 7,784
General and
administrative............ 590 747 1,308 1,929 2,385 4,697
Amortization of stock-based
compensation.............. 1,090 1,450 802 1,115 19,625 8,762
Depreciation and
amortization.............. 17 17 88 625 841 955
------- ------- ------- ------- -------- --------
Loss from
operations......... (844) (3,077) (2,764) (5,538) (26,104) (23,729)
Income from equity
investment.................. -- 2 33 -- -- 17
Interest income (expense),
net......................... (1) 45 12 65 90 114
------- ------- ------- ------- -------- --------
Net loss............. $ (845) $(3,030) $(2,719) $(5,473) $(26,014) $(23,598)
======= ======= ======= ======= ======== ========
</TABLE>
Our quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future due to a variety of factors, many of which
are outside of our control. We believe that quarter-to-quarter comparisons of
our operating results are not a good indication of our future performance.
LIQUIDITY AND CAPITAL RESOURCES
From our inception in August 1996 through July 1998, we financed our
operations and growth entirely from internally generated cash flow and capital
contributions from founders. Since July 1998, we have raised $117.4 million
through private sales of preferred securities, including the sale of an
aggregate of $97.5 million of Series C preferred stock in December 1999 and
January 2000.
Net cash used in operating activities was $26.0 million for the year ended
December 31, 1999, and $2.3 million for the fiscal year ended December 31, 1998.
Net cash used in operating activities for each of these periods primarily
consisted of net losses, partially offset by increases in accounts payable and
accrued expenses. Net cash provided by operating activities was $312,000 for the
fiscal year ended December 31, 1997.
Net cash used in investing activities was $4.4 million for the year ended
December 31, 1999, and $514,000 and $101,000 for the fiscal years ended December
31, 1998 and 1997, respectively. Net cash
41
<PAGE> 43
used in investing activities for each of these periods consisted of purchases of
fixed assets, primarily computer equipment and systems, totaling $3.5 million
for the year ended December 31, 1999 and $141,000 for the year ended December
31, 1998.
Net cash provided by financing activities was $97.6 million for the year
ended December 31, 1999, and $4.6 million for the fiscal year ended December 31,
1998. Net cash provided by financing activities during each of these periods
primarily consisted of cash proceeds from the following issuances of preferred
securities:
- 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.
- In May 1999, we issued 3,750,000 shares of Series B preferred securities
in exchange for an aggregate purchase price of $15.0 million.
In December 1999, we issued an aggregate of 5,905,374 shares of Series C
preferred shares for a total purchase price of $82.25 million. In addition, in
January 2000 we issued 1,094,917 shares of Series C preferred stock for $15.25
million. All of the Series C preferred shares will be automatically converted
into 10,156,252 shares of common stock upon the closing of this offering based
upon the initial offering price of $12.00.
As of December 31, 1999, we had $69.1 million of cash and cash equivalents,
excluding cash held for clients. As of that date, our principal commitments
consisted of obligations outstanding under operating leases and employment
contracts. In November 1999, we reinstated two lines of credit totalling $5.0
million with Republic Bank California N.A. Interest on amounts outstanding under
these credit facilities accrues at the bank's base rate plus 1% per annum and is
payable monthly. The amounts outstanding under these credit facilities are
personally guaranteed by several of our officers and directors and are due on
demand. No amounts are currently outstanding under the credit facilities.
Although we have no material commitments for capital expenditures, we
anticipate a substantial increase in our capital expenditures and lease
commitments in connection with anticipated growth in operations and
infrastructure. Furthermore, we will need to spend significant amounts for sales
and marketing, advertising and promoting our brands, content development and
technology and infrastructure development. We will need to expend funds to add
personnel in all areas.
We currently anticipate that our available cash resources, without the
proceeds from this offering, will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures for the next 12 months. In
addition, we currently anticipate that the net proceeds from this offering,
together with our current cash, cash equivalents, short-term investments and
credit facilities, will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for at least the next 18 months.
Although we do not currently have any specific material capital commitments
beyond such 18-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 are 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.
42
<PAGE> 44
YEAR 2000
Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
recent change in the century. If not corrected, many computer software
applications could fail or create erroneous results, at or beyond the Year 2000.
We use software, computer technology and other services internally developed and
provided by third-party vendors that may fail due to the Year 2000 phenomenon.
For example, we depend on third parties to process our customers' credit card
payments, host our servers, maintain our network, deliver orders to customers,
and provide fulfillment and accounting services.
We have completed the process of reviewing the Year 2000 compliance of our
internal software and performing any necessary remediation. This review included
testing to determine how our systems will function at and beyond the Year 2000
and updating our software where required for Year 2000 compliance. Substantially
all of the systems for the operation of our Web site have been developed within
the last three years. These systems include the software used to provide our Web
sites' search, customer interaction, and transaction processing and distribution
functions, as well as monitoring and back-up capabilities. Based upon our work
to date, the fact that most of our systems were recently developed, and the fact
that we have not experienced any Year 2000 issues to date, we believe that our
internal software is Year 2000 compliant. We have not, and do not, expect to
incur any material remediation expenses to update our internal systems.
We have completed our assessment of the Year 2000 readiness of our
third-party supplied software, computer technology and other services, which
include software for use in our accounting, database and security systems. This
assessment included an audit of their software as well as performing necessary
remediation. The failure of such software or systems to be Year 2000 compliant
could have a material adverse impact on our corporate accounting functions and
the operation of our Web site. As part of the assessment of the Year 2000
compliance of these systems, we sought assurances from these vendors that their
software, computer technology and other services are year 2000 compliant. We
have received written assurances from our software vendors regarding the Year
2000 compliance of their software. We have also received written assurances from
most of our third party service providers, stating that they planned to become
Year 2000 compliant before December 31, 1999. To date, our expenses associated
with this assessment have not been material and we do not expect to incur any
material remediation expenses in connection with our third-party supplied
software and computer systems. The failure of our software and computer systems
and of our third-party suppliers to be Year 2000 complaint would have a material
adverse effect on us.
The Year 2000 readiness of the general infrastructure necessary to support
our operations is more difficult to assess. For instance, we depend on the
integrity and stability of the Internet to provide our services. We also depend
on the Year 2000 compliance of the computer systems and financial services used
by consumers. Thus, the infrastructure necessary to support our operations
consists of a network of computers and telecommunications systems located
throughout the world and operated by numerous unrelated entities and
individuals, none of which has the ability to control or manage the potential
Year 2000 issues that may impact the entire infrastructure. Our ability to
assess the reliability of this infrastructure is limited and relies solely on
generally available news reports, surveys and comparable industry data. Based on
these sources, we believe most entities and individuals that rely significantly
on the Internet are carefully reviewing and attempting to remediate issues
relating to Year 2000 compliance, but it is not possible to predict whether
these efforts will be successful in reducing or eliminating the potential
negative impact of Year 2000 issues. A significant disruption in the ability of
consumers to reliably access the Internet or portions of it or to use their
credit cards would have an adverse effect on demand for our services and would
have a material adverse effect on us.
43
<PAGE> 45
To date, we have not experienced any Year 2000 issues. We do not have, and
do not plan to develop, a contingency plan to address situations that may result
if we or our vendors are unable to achieve Year 2000 compliance. The cost of
developing and implementing such a plan, if necessary, could be material. Any
failure of our material systems, our vendors' material systems or the Internet
to be Year 2000 compliant could have material adverse consequences for us. Such
consequences could include difficulties in operating our Web site effectively,
taking product orders, making product deliveries or conducting other fundamental
parts of our business.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 130, "Reporting
Comprehensive Income," in June 1997. SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income includes all changes in
members' equity, except those arising from transactions with members, and
includes net income and net unrealized gains or losses on securities. There is
no impact on our financial statements as a result of the implementation of SFAS
No. 130.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Software for Internal Use," which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. SOP No. 98-1 is effective for financial statements
for fiscal years beginning after December 15, 1998. The adoption of SOP 98-1 did
not have a material impact on the financial statements.
In April, 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities and
organization costs to be expensed as incurred. We are required to adopt SOP 98-5
for the year ended December 31, 1999. The adoption of SOP 98-5 is not expected
to have a material impact on our consolidated financial statements.
The Financial Accounting Standards Board recently issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000 (as amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective date of FASB Statement No.
133"). SFAS 133 establishes accounting and reporting standards for derivative
instruments and hedging activities by requiring that all derivative instruments
be reported as assets or liabilities and measured at their fair values. Under
SFAS 133, changes in the fair values of derivative instruments are recognized
immediately in earnings unless those instruments qualify as hedges of the (1)
fair values of existing assets, liabilities, or firm commitments, (2)
variability of cash flows of forecasted transactions, or (3) foreign currency
exposures on net investments in foreign operations. We are required to adopt
SFAS No. 133 for the quarter ended September 30, 2000. The adoption of SFAS No.
133 is not expected to have a material impact on our consolidated financial
statements.
44
<PAGE> 46
BUSINESS
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 December 31, 1999, ARTISTdirect featured 79 unique, artist-owned
ARTISTchannels, and had signed agreements to launch channels with an additional
26 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 and DOWNLOADSdirect, a feature which allows users to
download music and upload music and other information to the ARTISTdirect
Network. During January 2000, users viewed more than 60 million pages in our
ARTISTdirect Network.
- ARTISTchannels -- customized Web sites that we build, operate and
maintain on behalf of each of our artists, directly linking artists and
fans. These sites provide artists with a unique opportunity to control
the programming, promotion and distribution of a broad range of their
products and services. Artists share in revenue generated by their
ARTISTchannel. These sites also provide consumers with a single
destination to access a large selection of artist-specific music,
merchandise and content. A selection of artists with ARTISTchannels
includes:
<TABLE>
<S> <C> <C>
Aerosmith Chris Cornell Metallica
Backstreet Boys Cypress Hill Ozzy Osbourne
Beastie Boys Def Leppard Tom Petty
Beck Kenny G Red Hot Chili Peppers
Clint Black Korn Robbie Williams
Cher Limp Bizkit The Who
</TABLE>
- The Ultimate Band List -- a comprehensive online music search engine and
resource for music information. The UBL provides information on more than
95,000 artists across numerous musical genres, featuring news, concert
information, artist biographies, album reviews, contests, promotions,
music samples and downloads. The UBL also offers links to thousands of
other Web sites in the online music community;
- iMusic -- a highly trafficked music-oriented online community providing
chats, message boards and fan clubs relating to specific artists and
general music topics. iMusic allows fans to communicate with others
around the world to share interests and commentary about their favorite
music and artists. iMusic also serves as a platform for fans to interact
directly with their favorite artists through hosted chats and fan
conferences that we organize periodically;
- The ARTISTdirect Superstore -- a retail site offering over 200,000 music
titles and a wide selection of artist merchandise. The ARTISTdirect
Superstore complements the ARTISTchannels by offering music and
merchandise from a wider range of artists; and
- DOWNLOADSdirect -- a feature which enables users to download music from
the ARTISTdirect Network. Users can also upload their music and other
information to the ARTISTdirect Network, making such content available to
other users.
We also operate a music talent agency, the ARTISTdirect Agency and manage a
traditional record label, Kneeling Elephant Records, which, when combined with
the ARTISTdirect Network, allow us to provide a full range of traditional and
online services to artists. Marc Geiger, our Chief Executive Officer, Don
Muller, our President of ARTISTdirect Agency and Kneeling Elephant Records,
Steve Rennie, our
45
<PAGE> 47
President of the UBL and Nick Turner, our Vice President, ARTISTchannels, have
18, 14, 20 and 20 years of experience, respectively, in the music industry. We
believe that our management team's extensive music industry experience and its
understanding of the needs of artists and music consumers provide us with a
distinct advantage in pursuing opportunities arising from the convergence of the
music industry and the Internet.
STRATEGIC RELATIONSHIPS
In November and December 1999, we entered into strategic relationships with
four of the five major music companies: Universal Music Group, Inc., BMG
Entertainment, Sony Music, and Time Warner Inc. We also entered into strategic
relationships with an affiliate of Cisneros Television Group, a leading pay
television content provider in Latin America, and Yahoo!, a leading global
Internet company. These companies invested an aggregate of $97.5 million cash in
ARTISTdirect in connection with these strategic relationships and represent four
of the five major music companies, who together accounted for 74.6% of U.S.
music albums shipped in the year ended December 31, 1999.
UNIVERSAL MUSIC GROUP
Our agreement with Universal Music Group has a term of three years and
provides us with the right to use, on a non-exclusive basis, content related to
Universal's artists as this material is generally made available to other
companies. This material may include music and music-related content such as new
releases, music videos, music audio samples, cybercasts, photographs, album
covers, concert film clips, biographical information, promotional merchandise
and similar materials. Universal will also, from time to time, provide to us the
right to license special content such as exclusive or semi-exclusive cybercasts
and chats with Universal's artists. The fee for this content will be negotiated
on a case-by-case basis. We are required to purchase a minimum of $1.0 million
of content each year, and an aggregate of $4.0 million of content over the term
of the agreement from Universal pursuant to the agreement. We will provide
Universal with marketing support, including advertising, marketing services,
data, data analyses and other promotional services on terms to be negotiated.
Universal is required to purchase a minimum of $1.0 million marketing support
each year, and an aggregate of $4.0 million of marketing support over the term
of the agreement from us. Universal also invested $30.0 million in connection
with this strategic relationship.
BMG ENTERTAINMENT
Our agreement with BMG Entertainment has a term of three years and provides
us with the right to use, on a non-exclusive basis, content related to BMG's
artists as this material is generally made available to other online music
companies. This material may include music and music-related content such as new
releases, electronic press kits, music audio samples, cybercasts, photographs,
album covers, concert film clips, biographical information, promotional
merchandise and similar materials. BMG will also make available to us special
content such as exclusive or semi-exclusive cybercasts, chats with BMG artists
and digital downloads. The fee for this content will be negotiated on a
case-by-case basis. BMG will have the right to designate a specified number of
its artists' Web sites to be integrated into the UBL search engine and to
designate a specified number of its artists to be featured on our Web site. We
will also provide BMG with marketing support, including advertising, marketing
services, data, data analyses and other promotional services on terms to be
negotiated. In addition, we will work with BMG to create a series of links
between our Web sites and BMG's Web sites. BMG also invested $15.0 million in
connection with this strategic relationship.
46
<PAGE> 48
SONY MUSIC ENTERTAINMENT
Our agreement with Sony Music Entertainment has a term of two years and
provides us with a limited license to use audio and video excerpts and front
album cover artwork owned by Sony. Sony will consider reasonable requests from
us regarding promotions involving Sony artists that have an ARTISTchannel with
us. We are required to provide, on each of our Web sites that contains a
recording by, or video of, a Sony artist, an active link to the artist's Web
site or to the ARTISTchannel for that particular artist. We are also required to
provide Sony with usage and sales information related to Sony recordings. Sony
also invested $15.0 million in connection with this strategic relationship.
TIME WARNER AND MAVERICK RECORDING COMPANY
We entered into two-year Webcasting, video license, audio sample and
marketing agreements with both Time Warner and Maverick Recording Company. The
Webcasting agreements provide us with a limited non-exclusive license to
transmit their sound recordings and display associated album cover art, in each
case, subject to specified conditions. We will pay a transmission fee for each
transmission. The video license agreements provide us with a limited
non-exclusive license to use Time Warner's and Maverick's videos on a revenue
sharing and per-use basis. The audio sample agreements provide us with
non-exclusive licenses to use audio samples of up to 30 seconds in length for
promotional purposes. The marketing agreements require Time Warner and Maverick
to make the UBL their preferred non-commerce music search engine on their Web
sites, and we are required to prominently feature their artist sites and
advertisements in connection with search results from the UBL pertaining to
their respective artists. Time Warner also invested $14.0 million and Maverick
invested $1.0 million in connection with this strategic relationship.
CISNEROS TELEVISION GROUP
We have agreed to establish a 50/50 joint venture with affiliates of
Cisneros Television Group to develop an Internet music portal featuring content
and e-commerce opportunities targeted to Spanish and Portuguese speaking
audiences in Latin America and the United States. We will provide technical
expertise and content valued at $55.0 million and an affiliate of Cisneros
Television Group will provide content and advertising and promotional support
valued at $55.0 million. In particular, we are obligated to contribute licenses
to our proprietary software, provide technical assistance, sign a specified
number of artists to operate their Web sites for the joint venture and to
contribute or obtain content with respect to a specified number of artists. An
affiliate of Cisneros Television Group is required to provide access to its
media distribution channels, advertising, and licenses to some of its
programming.
The initial term of the venture is for fifty years and may be extended for
additional ten-year periods. Each of us may also be required to make up to an
aggregate of $20.0 million in capital contributions from time to time on a
pro-rata basis. An affiliate of Cisneros Television Group will receive an
aggregate fee of approximately $510,000 for providing management and back-office
services for the first two years of the agreement. Data generated by the joint
venture will be licensed to both us and an affiliate of Cisneros Television
Group for a fee and content created or acquired by the joint venture will be
licensed to both us and an affiliate of Cisneros Television Group on a
royalty-free basis. After the thirtieth month of the agreement, an affiliate of
Cisneros Television Group will have the right to cause a roll-up of the joint
venture so that the affiliate's equity interests in the joint venture are
exchanged for our common stock on a fair market value basis. The shares of our
common stock that Cisneros Television Group's affiliate receives in the roll-up
will be subject to the registration rights agreement discussed on page 81. An
affiliate of Cisneros Television Group invested $20.0 million in ARTISTdirect in
connection with this strategic relationship.
47
<PAGE> 49
YAHOO!
We have a two-year advertising and promotion agreement with Yahoo!,
pursuant to which we will purchase media placement on Yahoo! and be one of the
two premier music merchants featured on certain pages in Yahoo!'s music site.
Yahoo! is required to deliver a minimum number of impressions, or page views,
throughout its music and other selected sites, and will deliver a minimum number
of targeted e-mail messages to its users containing our promotional offers. In
exchange for these services, we will pay Yahoo! a slotting fee of $19.8 million,
$1.0 million of which will be paid in the form of in-kind co-marketing
opportunities. To date, we have paid $7.4 million of the cash portion of the
slotting fee, $5.5 million of which was paid as of December 31, 1999 and $1.9
million of which was paid in March 2000. The remaining $11.4 million of the cash
portion of the slotting fee is due in 6 quarterly payments of $1.9 million,
beginning June 15, 2000. In addition, we entered into a two-year agreement to
participate in Yahoo!'s Remote Merchant Integration Program. This agreement
allows us to market our music and merchandise offerings through Yahoo!'s
Shopping pages pursuant to a revenue-sharing arrangement with Yahoo! We also
issued Yahoo! a warrant to purchase shares of our common stock. See "Description
of Capital Stock -- Warrants" on page 92 for more information on this warrant.
DISTRIBUTION AND CONTENT RELATIONSHIPS
GO NETWORK
In December 1999, we entered into an eighteen-month co-marketing agreement
with ABC News Internet Ventures, an affiliate of The Walt Disney Company. Under
the agreement, we provide distribution on the ARTISTdirect Network of selected
content developed by Wall of Sound, a music-oriented web site owned and operated
by ABC News Internet Ventures, and selected content developed by us is
distributed in the music area of the GO Network (http://wallofsound.go.com).
Each party's selected content may contain links back to its Web site. Over the
term of the agreement, should one party receive traffic from the other party's
site significantly in excess of the traffic it directs to the other party's
site, the agreement provides for the delivery of advertising inventory to
compensate for the shortfall.
CHUMCITY INTERNATIONAL
In November 1999, we entered into a strategic alliance agreement and a
three-year programming license agreement with CHUMcity International Ltd., a
member of the CHUM group. The strategic alliance agreement contemplates that the
parties will collectively produce a series of music events which they will
jointly own and exploit. Under the programming license agreement, we are allowed
access to CHUM's music library for exploitation over the Internet. This license
is not exclusive and is subject to limitations imposed by CHUM's existing
obligations to third parties. We will pay CHUM a fixed license fee over the term
of the programming license agreement.
INDUSTRY BACKGROUND
THE MUSIC INDUSTRY
Music is one of the most popular forms of entertainment worldwide and a
multi-billion dollar consumer industry. According to the International
Federation of the Phonographic Industry, worldwide sales of recorded music were
$38.7 billion in 1998, 34% of which were in the United States. Concert tours
also generate significant revenue for the music industry. Pollstar estimates
that the total gross ticket sales for major concerts in North America were
approximately $1.3 billion in 1998. In addition, the music industry generates
substantial advertising, sponsorship, promotional and merchandise revenue
related to music events and individual artists.
The music industry identifies artists and develops, promotes and
distributes their content. The high cost associated with development, promotion
and distribution has led artists to rely on third parties such as record labels,
merchandisers and tour promoters. Consequently, artists have had limited ability
to
48
<PAGE> 50
control how they are marketed to consumers, to identify and communicate directly
with their fans and to maximize their economic participation in all available
revenue streams.
The experience of the typical music consumer has been fragmented and
inefficient. Music consumers have had to search a variety of media to find music
news and information and have had to purchase compact discs, tickets and
merchandise through different retail channels. Goods, such as apparel and other
artist merchandise, have been difficult to find and frequently available only at
concerts or selected retail outlets. For music fans, opportunities to interact
with their favorite artists and fellow enthusiasts have been limited.
THE INTERNET OPPORTUNITY
The Internet has emerged as a platform that allows millions of people
worldwide to deliver and receive information rapidly, create virtual communities
around shared interests and engage in electronic commerce. This has made the
Internet an important new medium for music, dramatically altering the way
consumers search for, discover, listen to and purchase music. The Internet
offers:
- efficient reach to a worldwide audience;
- convenient access to a vast offering of musical content and services;
- ongoing flexibility to tailor products and services to consumer interests
and market dynamics;
- digital distribution of music;
- consumer personalization of the music experience; and
- timely collection of customer preferences and demographics for targeted
advertising and promotion.
Artists have begun to view the Internet as a platform to gain greater
control over the programming, promotion and distribution of their music and
related merchandise and to communicate directly with their fans. Consumers have
adopted the Internet to locate music information, share interests and discover
and buy music. According to Jupiter Communications, online sales of recorded
music in the United States are projected to grow from $327 million in 1999,
representing 2.3% of online music sales, to approximately $2.6 billion in 2003,
representing 14.0% of online music sales. Forrester Research estimates that
approximately 50 million individuals will be capable of downloading and playing
digital music by the end of 1999, and by 2003, downloading will add $1.1 billion
to the U.S. music industry. Forrester also estimates that 56% of consumers want
to communicate with artists directly, and 31% would pay for non-music products
from their favorite artists.
According to the United States Census Bureau, this group of consumers, aged
10 through 34, comprised approximately 95 million individuals in the United
States, and according to the Recording Industry Association of America,
purchased 60% of the music sold in the United States in 1998. Not surprisingly,
the music industry has historically focused its promotional and marketing
efforts on this group. According to International Data Corporation,
approximately 58% of the 35 million home Internet users at the end of 1998 were
from essentially the same demographic group, aged 12 through 34. According to
the Internet Advertising Bureau, advertisers on the Internet spent $2.3 billion
during the 12 months ended March 30, 1999.
We believe that the features of the Internet and the common demographics of
music consumers and Internet users present an opportunity to reshape the music
industry. Artists now have the opportunity to exert greater control over the
programming, promotion and distribution of their music and consumers can now
search for, discover and purchase music and related merchandise and content at a
single destination.
49
<PAGE> 51
OUR SOLUTION
BENEFITS TO ARTISTS
By providing artists with a platform to develop their presence on the Web,
we enable artists to assume more creative control over their image, promote
their music in innovative ways, interact with their fans, extend their reach and
participate in incremental revenue streams. Our benefits to artists include:
Artist-controlled Online Media Channel. We offer artists an online media
presence, the ARTISTchannels, to create, present, promote and distribute their
content. The ARTISTchannels include auto-publishing tools, content management
features, and capabilities for advertising and direct marketing and electronic
commerce. Our technology enables us to quickly launch customized Web sites for
our artists. Artists actively collaborate on the design, content and other
features of their ARTISTchannels. With continuing advances in broadband
technology and standards for digital music distribution, we believe the
ARTISTchannels will emerge as the artists' preferred platform for the full range
of their content, commerce and community activities on the Internet.
Closer Relationships with Fans. The ARTISTchannels promote greater fan
affinity and loyalty by directly linking artists and fans. Artists can use the
ARTISTchannels to provide content and products to fans, including artist news,
concert information, music and video programming, exclusive chats, ticket
giveaways and fan club activities. Artists can also solicit the views of fans on
new music, live performances and music videos. A better understanding of their
fans enables artists to develop relevant content for their ARTISTchannels,
promote their music more effectively and create new revenue opportunities.
Access to Traffic from the ARTISTdirect Network. We attract, aggregate and
retain consumers within the ARTISTdirect Network through our compelling content
and commerce offerings, thereby providing our artists the opportunity to tap
into an active community of millions of music fans. The ARTISTchannels can be
accessed directly or through the ARTISTdirect Network, allowing artists the
opportunity not only to reach their existing audience, but to broaden their fan
base as well. As a heavily trafficked music destination on the Internet, we
aggregate global consumer traffic, collect targeted fan information and generate
incremental revenue from electronic commerce and advertising for the shared
benefit of the artist and ARTISTdirect.
New Revenue Opportunities. We provide artists with a number of incremental
revenue opportunities, including from music and related merchandise sales and
auctions, advertising and direct marketing. Our sites significantly increase
consumers' access to artist merchandise previously available only at concert
venues or selected retail locations. We also assist artists in developing
original merchandise items for sale through their sites. We believe that our
revenue-sharing with artists provides incentives for them to actively promote
their ARTISTchannels and the ARTISTdirect Network.
Direct Marketing Opportunities. We encourage fans to provide identifying
information that allows the artists to develop consumer databases through their
ARTISTchannels. Artists use this database information to communicate important
news, upcoming music releases, live appearances or online events that are
targeted to a particular fan base. Data may be also used to develop
artist-approved targeted advertising and marketing opportunities. Artists have
access to detailed information about how many people visited their sites,
listened to or downloaded their music and purchased compact discs. We maintain
each artist database and share any revenue generated through its use with the
artist.
New Platform for Digital Distribution. The Internet represents an important
new platform for digital music distribution. As the music industry develops
standards for secure digital distribution, we are implementing the
infrastructure and systems for digital distribution through the ARTISTdirect
Network. We currently allow free digital downloads of promotional music and a
variety of streaming audio services
50
<PAGE> 52
through the DOWNLOADSdirect area of the ARTISTdirect Network. We have entered
into a definitive agreement to acquire Mjuice.com, a Web site offering secure
mp3 downloads, some of which are available free and some on a pay basis. We
intend to provide artists with a broad array of opportunities to generate
revenue from digital music distribution, including pay-per-download,
subscription services and advertising or sponsor-supported services.
BENEFITS TO CONSUMERS
Our ARTISTdirect Network offers a comprehensive one-stop destination for
the music consumer. Our benefits to consumers include:
Direct Connection to Artists. Our ARTISTchannels provide a unique fan
experience. Consumers have access to content specifically created or endorsed by
their favorite artists, as well as official artist news and concert information,
music, merchandise, special promotions and other benefits. Special promotions
have included opportunities to meet artists, concert ticket giveaways, trips to
live concerts, online fan conferences with artists, exclusive music downloads
and exclusive videos. Consumers can interact with artists and offer direct
feedback on new releases, concert performances and videos.
Comprehensive Music Resource. The ARTISTdirect Network includes the UBL, a
comprehensive destination for searching, discovering and enjoying music content.
The UBL is an online search engine and database of more than 95,000 artists
covering a wide variety of musical genres, organized links to other Internet
music resources, news, concert information, artist biographies, album reviews,
contests and promotions, music samples and downloads. The UBL is designed to
encourage user participation by allowing users to create entries in the artist
database and links from the UBL to music sites elsewhere on the Internet. The
UBL also includes tools to allow artists to upload content, including
biographies, pictures and music for the benefit of their fans.
Rich Community Features. Our iMusic community site provides chats, message
boards, fan clubs and personalization tools relating to both specific artists
and more general music topics. Our site enables fans around the world to share
interests and commentary about their favorite music and artists and facilitates
their discovery of new music. iMusic also serves as a platform for fans to
interact directly with their favorite artists through hosted chats and fan
conferences.
Comprehensive Shopping Destination. The ARTISTdirect Network brings
together many of the disparate elements of the music shopping experience. Music
consumers can purchase and pre-order a full range of recorded music and shop for
artist-related merchandise, including some items available only through
ARTISTdirect. In addition, our content, downloadable music, weekly specials and
auctions enhance the consumer experience. The UBL and iMusic provide relevant
information to help consumers make purchasing decisions.
Access to Online Digital Distribution. We currently allow free digital
downloads of promotional music and provide users with a variety of streaming
audio services through the DOWNLOADSdirect area of the ARTISTdirect Network,
including some content that is available only through ARTISTdirect. As digital
distribution becomes commercially viable, we plan to offer consumers many ways
to acquire and experience music, including subscription services,
pay-per-download and advertising or sponsor-supported services.
51
<PAGE> 53
BUSINESS STRATEGY
Our objective is to be the leading provider of music entertainment,
information, community and electronic commerce on the Internet. Our strategy is
to:
Add ARTISTchannels Aggressively. We intend to aggressively add
ARTISTchannels by continuing to market the benefits of our unique ARTISTchannel
model to high-profile artists. We intend to add artists from U.S. and
international markets and a variety of music genres. We are currently in
discussions with more than 35 additional artists whose popularity makes them
excellent candidates for ARTISTchannels. We believe that our ARTISTchannel
model, current roster of prominent artists and experienced, artist-oriented
management team will enable us to attract additional artists to expand the
ARTISTdirect Network.
Build Brand Awareness Rapidly. We intend to establish ARTISTdirect as the
leading brand for online music entertainment. We have achieved our current brand
recognition with aggregate advertising expenditures of approximately $8.2
million through December 31, 1999. We intend to increase our marketing
expenditures through a television, radio, print and online advertising campaign
that features a number of our high-profile artists promoting and endorsing the
ARTISTdirect Network. We will continue to encourage our artists to use their
album releases, concert tours and personal appearances to promote their
ARTISTchannels. Through the ARTISTdirect Agency, we intend to create
ARTISTdirect-branded concerts and concert tours that will include both media and
venue promotion.
Enhance Our Users' Experience. We intend to add features and content to the
ARTISTdirect Network to enhance our users' experience. We plan to help our users
discover new music by providing personalization tools, targeted recommendations,
digital downloads and streaming audio and video. For example, we have expanded
our digital download area and will seek to provide exclusive downloads from
well-known artists. The technologies we will use to add features and content to
the ARTISTdirect Network will be based on commercial packages provided by
third-party suppliers. We plan to integrate these packages by using the
provider's service department, outside consultants and our internal staff,
depending on the application.
Exploit Our Unique Assets. We intend to exploit our uniquely integrated
assets, broad reach and experienced, artist-oriented management team to
differentiate ourselves from companies with less comprehensive offerings. For
example, we aim to:
- offer selected artists a range of services, including live performance
booking through our talent agency; development, marketing and promotion
through our record label; and online programming, promotion and
distribution through both an ARTISTchannel and the ARTISTdirect
Superstore;
- cross-promote specific ARTISTchannels to the audiences of the UBL and
iMusic, as well as to the audiences of other ARTISTchannels;
- develop branded live events and tours sponsored by advertisers and
merchants; and
- enable advertisers and merchants to deliver their messages to the
audience of the entire ARTISTdirect Network or to targeted audiences
within the ARTISTdirect Network.
Pursue Additional Revenue Streams. We intend to increase revenue from
existing sources and add new revenue streams. New revenue opportunities include:
- digital distribution of music: As the music industry develops standards
for secure digital distribution, we plan to provide consumers with a
variety of products and services that will generate revenue from sales of
digital music and subscription fees;
52
<PAGE> 54
- database marketing: We plan to derive revenue from our growing databases
of consumer information and preferences. Our databases enable us to
create affinity groups and frequent buyer programs, promote existing
artists more effectively, and assist advertisers and merchants in
targeting specific audiences;
- international markets: We will pursue opportunities to obtain and
distribute localized ARTISTdirect content and merchandise in
international markets; and
- ancillary network opportunities: Our network will allow us to pursue a
variety of incremental revenue, for example, by offering a tiered menu of
subscription services and syndicated content for use both online and
offline.
ARTISTDIRECT BUSINESS UNITS
ARTISTDIRECT NETWORK
The ARTISTdirect Network is comprised of the ARTISTchannels, the UBL,
iMusic, DOWNLOADSdirect and the ARTISTdirect Superstore.
ARTISTchannels. Our ARTISTchannels are designed to strengthen the
relationship between artists and their fans and to provide a wide range of
content, including news, tour information, music samples and special offers,
community, including artist-hosted chats, fan clubs and message boards, and
products, including music, merchandise and collectibles. These Web sites are
individually designed for, and owned by, the artists and are produced and
operated by ARTISTdirect. Each ARTISTchannel contains an official online store
where consumers can shop directly from the artist. These stores benefit the
artist by making both their music and merchandise available to fans 24 hours a
day, resulting in incremental sales. For fans, a large selection of
artist-specific music and merchandise is readily available in one place,
combined with content and community features.
The ARTISTchannels are typically operated under a contractual arrangement
with the artist, under which ARTISTdirect undertakes to design, host and
regularly update the ARTISTchannel, to promote the ARTISTchannel via the
ARTISTdirect Network, and to provide a complete electronic commerce solution
that includes order and credit card transaction processing, inventory management
and warehousing, order fulfillment, and online and toll-free telephone customer
service. The artist agreements further provide that the artists share in the
various types of revenue generated by their sites, including from sales of music
and other products, as well as from advertising. The ARTISTchannels are
accessible directly using their specific Web site addresses, or through the
ARTISTdirect home page or the UBL. Many artists take an active role in promoting
their ARTISTchannels, displaying their Web site addresses in album packaging, in
advertising, on merchandise and in fan club communications.
As broadband technology continues to advance, we expect artists to use
their ARTISTchannels as platforms for a broader array of programming, including
music videos, live video chats, fan conferences, Webcasts and access to archives
of pre-recorded content. We also expect artists to use the databases we are
building on their behalf to market new music and merchandise directly to fans
and offer those fans benefits for loyalty and active purchasing.
53
<PAGE> 55
Our current roster of ARTISTchannels includes:
Aerosmith
www.aerosmithdirect.com
Tori Amos
www.toriamosdirect.com
B-52s
www.theb52sdirect.com
Backstreet Boys
www.bsbdirect.com
Beastie Boys
www.grandroyaldirect.com
Beck
www.beckdirect.com
George Benson
www.georgebensondirect.com
Bjork
www.bjorkdirect.com
Black Sabbath
www.blacksabbathdirect.com
Clint Black
www.clintblackdirect.com
Sheryl Crow
www.sherylcrow.com
Black Crowes
www.blackcrowesdirect.com
blink-182
www.loserkids.com
Bone Thugs 'N' Harmony
www.bonethugsdirect.com
Cher
www.cherdirect.com
Coal Chamber
www.coalchamberdirect.com
Collective Soul
www.collectivesouldirect.com
Chris Cornell
www.chriscornelldirect.com
Counting Crows
www.countingcrowsdirect.com
David Crosby
www.crosbycprdirect.com
CSNY
www.csnydirect.com
Cypress Hill
www.cypresshilldirect.com
Def Leppard
www.deflepparddirect.com
Dr. Dre
www.drdredirect.com
Eminem
www.eminemdirect.com
Eve 6
www.eve6direct.com
Everclear
www.evercleardirect.com
Fastball
www.fastballdirect.com
Bryan Ferry
www.bryanferrydirect.com
Filter
www.filterdirect.net
Foo Fighters
www.foofightersdirect.com
Vince Gill
www.vincegilldirect.com
Godsmack
www.godsmackdirect.net
Incubus
www.incubusdirect.com
Indigo Girls
www.indigogirlsdirect.com
Chris Isaak
www.chrisisaakdirect.com
Kenny G
www.kennygdirect.com
BB King
www.bbkingdirect.com
Korn
www.korndirect.com
Lenny Kravitz
www.lennykravitzdirect.com
Limp Bizkit
www.limpbizkitdirect.com
Kenny Loggins
www.kennylogginsdirect.com
Aimee Mann
www.aimeemanndirect.com
Marilyn Manson
www.marilynmansondirect.com
Matchbox 20
www.matchbox20direct.com
Megadeth
www.megadethdirect.com
Metallica
www.metallicadirect.com
Mighty Mighty Bosstones
www.bosstonesdirect.com
Monster Magnet
www.monstermagnetdirect.com
Mandy Moore
www.mandymooredirect.com
Mike Ness
www.mikenessdirect.com
*NSYNC
www.nsyncdirect.com
Stevie Nicks
www.stevienicksdirect.com
No Doubt
www.nodoubtdirect.com
The Offspring
www.offspringdirect.com
Ozzy Osbourne
www.ozzydirect.com
Pantera
www.panteradirect.com
Patty Loveless
www.pattylovelessdirect.com
Pearl Jam
www.pearljamdirect.com
Tom Petty
www.tompettydirect.com
Powerman 5000
www.pm5kdirect.com
Primus
www.clubbastardo.com
Rage Against The Machine
www.ratmdirect.com
Rancid
www.ranciddirect.com
Red Hot Chili Peppers
www.chilipeppersdirect.com
Brian Setzer
www.briansetzerdirect.com
54
<PAGE> 56
Sevendust
www.sevendustdirect.com
Slayer
www.slayerdirect.com
Soul Coughing
www.soulcoughingdirect.com
Stabbing Westward
www.stabbingwestwarddirect.com
Static X
www.staticxdirect.com
Steps
www.stepsofficial.com
Stone Temple Pilots
www.stpdirect.com
Sugar Ray
www.sugarraydirect.com
Sublime/Long Beach
Dub All Stars
www.sublimedirect.com
Matthew Sweet
www.matthewsweetdirect.com
System of a Down
www.soaddirect.com
Pam Tillis
www.pamtillisdirect.com
Toto
www.toto99direct.com
Tina Turner
www.tinaturnerdirect.com
The Who
www.thewhodirect.com
Robbie Williams
www.robbiewilliamsdirect.com
Dwight Yoakam
www.dwightyoakam.net
Rob Zombie
www.robzombiedirect.com
ZZ Top
www.zztopdirect.com
In addition to the ARTISTchannels already launched, we have agreements in
place for the launch of additional ARTISTchannels for artists such as:
<TABLE>
<S> <C> <C>
Jeff Beck Galactic Diana Ross
Frank Black Guns N' Roses Silverchair
Danielle Brisebois Tony Iommi Sonic Youth
DJ Shadow Janet Jackson James Taylor
DMX Madonna Too $hort
eVe Barry Manilow Wallflowers
Perry Farrell Remy Zero Neil Young
</TABLE>
Based on our recent experience, we generally launch new ARTIST channels
within 3 to 4 months after an agreement has been signed.
The UBL. The UBL is a music-specific Internet search engine. The UBL serves
as a comprehensive resource for music information relating to specific artists,
various genres and a wide range of events. The UBL combines content generated by
our staff with third-party content either licensed for use on our Web site or
accessible using edited links to other Web sites. Users have ready access to
artist profiles, music downloads, tour information, contests, Internet radio,
Webcasts and other content. The UBL allows users to add or update their own
information about their favorite artists. We believe that this process, together
with links to other music content sites, has made the UBL one of the most
comprehensive databases of bands available on the Web. The UBL currently
contains information regarding more than 95,000 artists and contains links to
thousands of other music-related sites.
iMusic. We believe iMusic is one of the most active music-specific
community sites on the Internet. iMusic offers message boards, text chats, video
chats, fan conferences and other opportunities for fans to interact with each
other and with artists. We plan to introduce e-mail and personal home page
services through iMusic in the near future. We also plan to host a regular
series of artist chats and conferences, providing users with the opportunity to
interact and communicate with their favorite artists.
DOWNLOADSdirect. In October 1999, we added an area within the ARTISTdirect
Network devoted to music downloads. We provide users with a selection of free
downloads chosen by the editorial staff of the UBL. Some of these downloads are
made available to us on an exclusive basis from artists. In addition, we enable
users to upload their music, biography and picture, and then we make this
content available to other users. We plan to expand this area to include a
larger number of downloads and to allow for downloads on a pay or subscription
basis. We have entered into a definitive agreement to
55
<PAGE> 57
acquire Mjuice, a Web site offering secure mp3 downloads, some of which are
available free and some on a pay basis.
ARTISTdirect Superstore. The ARTISTdirect Superstore is a retail center for
leading brands and artists, offering recorded music and related merchandise. The
ARTISTdirect Superstore offers more than 200,000 music titles and merchandise
for a broad range of artists, including those with an ARTISTchannel who want to
reach a broader audience of music consumers.
ARTISTDIRECT AGENCY
The ARTISTdirect Agency is a music talent agency that procures live
performance and concert touring appearance engagements, and seeks advertising
and sponsorship opportunities, for a roster of high-profile artists. In
connection with our agency activities, we have conceived, developed, managed and
promoted integrated series of live concert tours and festivals, including the
Sno-Core Tour, a punk rock winter snowboard lifestyle tour. We believe that our
agency services enhance the relationships we have with many of our artists for
whom we also host ARTISTchannels. These services also enable us to identify
potential sponsorship opportunities for the advertisers with whom we have
relationships. We typically receive 10% of the net revenue generated from
agency-provided services. For the year ended December 31, 1999, we derived 13%
of our revenue from commissions generated by the ARTISTdirect Agency. Currently,
the ARTISTdirect Agency roster includes over 70 acts, including:
<TABLE>
<S> <C> <C>
Alice in Chains Everclear Rage Against the Machine
Beastie Boys Foo Fighters Red Hot Chili Peppers
Beck Hovercraft Elliott Smith
Ben Folds Five Ben Lee Sonic Youth
Frank Black The London Suede Sunny Day Real Estate
Blues Traveler Marcy Playground The The
Catherine Wheel Pearl Jam Paul Westerberg
Chris Cornell Primus
</TABLE>
KNEELING ELEPHANT RECORDS
Kneeling Elephant Records is an independent record label managed by
ARTISTdirect pursuant to a label agreement with RCA Records. RCA provides all
funding for the label and owns the rights to all sound recordings made under
artist agreements during the initial three year term of the label agreement. The
initial term was recently extended to March 21, 2000. During the initial term,
RCA provides overhead advances, funding for artist advances and recording costs
and marketing resources for a minimum of three artists per year. Kneeling
Elephant finds new talent and negotiates contracts, including royalties,
advances and artist development, and works with RCA's marketing, promotion,
publicity and sales force to develop a marketing strategy for each album.
Manufacturing, packaging and distribution are handled by RCA's affiliated
worldwide distribution network. Kneeling Elephant participates on a royalty
basis in the proceeds of the albums recorded during the initial term. At the end
of the initial term, unless terminated by RCA, this royalty arrangement will
convert to a three-year 50/50 joint venture with respect to all product created
after the initial term. Each party will continue to be responsible generally for
the same functions under the joint venture arrangement, including RCA continuing
to be responsible for funding. If RCA terminates the label agreement at the end
of the initial term the artists signed to the label will remain with RCA. If we
desire to continue with the record label business, we will be responsible for
funding the label's future operations unless we can enter into an arrangement
with another record company.
Kneeling Elephant has signed seven bands to date: Fly/Longslide, Gloritone,
Snakefarm, The Innocence Mission, Lea Krueger, Zen Mafia and Wan Santo Condo. We
have begun to use the ARTISTdirect Network to market some Kneeling Elephant
artists directly to electronic consumers.
56
<PAGE> 58
For the year ended December 31, 1999, we derived 8% of our revenue from our
Kneeling Elephant Records label. We do not expect that revenue from our Kneeling
Elephant Records label will be material in the future and expect that revenue
from this operation will continue to decrease as a percentage of our total
revenue.
INFRASTRUCTURE AND OPERATIONS
TECHNOLOGY
Our infrastructure is designed to be integrated, scalable, reliable and
secure. The software that we use supports the acquisition, management and
publication of content on our Web sites.
Our Web sites and servers for content, applications, database and
electronic commerce are currently hosted at AT&T CerfNet and American Digital
Network in San Diego, California and at Digex, Inc. in Cupertino, California,
under either co-location or managed server agreements. Some of our digital
content is hosted by InterVU in San Diego, California. Our operations depend on
these companies' ability to protect their systems against fire, power loss,
telecommunications failure, break-ins and other events. These companies provide
comprehensive facilities management services, including human and technical
monitoring of all production servers 24 hours per day, seven days per week. All
Web sites, servers, and systems are monitored continuously. Backups are
performed daily. Weekly backups are stored at a remote location.
We are currently implementing a comprehensive enterprise resource planning
system based on SAP software provided to us by Pandesic, LLC, a joint venture
between Intel and SAP. This system is an integrated production, electronic
commerce and management information solution that we expect will provide us with
significant benefits over the systems we currently use. In particular, the
system will include materials management, sales and distribution, finance and
control features. We have transitioned all of our ARTISTchannel stores to the
Pandesic system and plan to fully transition our remaining systems to the
Pandesic system by mid-2000.
ORDER PROCESSING AND FULFILLMENT
Our Web sites include an ordering system that is designed to facilitate
convenient online purchasing of pre-recorded music and merchandise. Customers
can add items to their "shopping cart" while surfing our Web sites. At any time
they can securely "checkout", at which time they need to register (if they are
new customers), or enter a username and password to retrieve previously saved
billing, shipping and credit card information. We verify orders submitted for
credit card payment for fraud detection and sufficient funds before we release
them for fulfillment. We also accept alternative modes of payment, such as
checks and money orders. Credit card numbers are encrypted, and all customer,
commerce and transactional data are stored in secure databases protected by
firewalls. The transmission of information over the Internet uses Secure Socket
Layer security technology verified by VeriSign.
Alliance Entertainment. In August 1998, we entered into a five-year
agreement with Alliance Entertainment Corp. to be our primary supplier of music
and music-related information for our ARTISTdirect Superstore. Alliance owns the
All Music Guide, a comprehensive source of artist and album information that is
supplied to our users primarily through its integration into the UBL. Alliance
fulfills compact discs ordered by our customers and we pay Alliance the
wholesale cost plus a fulfillment fee. In addition, Alliance has provided
warehouse space for our music-related merchandise that allows the consolidated
shipping of customer orders for both music and merchandise. We have integrated
our order processing system with Alliance's information systems to assist in
fulfillment tracking, inventory management and customer service.
57
<PAGE> 59
We maintain very low levels of inventory. Almost all of the music titles
available for sale on our Web sites are purchased by us from inventory held by
Alliance. Similarly, almost all of the music-related merchandise available for
sale is the inventory of the artist. We take physical title to the product at
the time of shipment and have ultimate credit and collection risk.
Giant and Winterland. We entered into a four-year agreement with Giant
Merchandising in April 1999 and a three-year agreement with Winterland
Concessions Company in June 1999 to supply merchandise on a wholesale basis for
both our ARTISTchannels and the ARTISTdirect Superstore. Together, Giant and
Winterland represent more than 115 artists, including 35 of those with whom we
have agreements for ARTISTchannels. We believe that our inventory management and
distribution strategy allows us to offer extensive selection while avoiding the
high fixed costs and capital requirements associated with owning and warehousing
product inventory as well as the operational effort integral to shipping and
delivery.
We depend on Alliance, Giant and Winterland for timely shipment of products
purchased through our Web sites. Alliance currently provides fulfillment
services for our ARTISTchannels pursuant to an oral agreement that Alliance may
terminate at any time. If we are unable to renew our agreements with these
suppliers when they expire, on favorable terms or at all, or if Alliance ceases
to provide fulfillment services for our ARTISTchannels, our business could be
adversely affected.
CUSTOMER SERVICE
We have established an in-house customer service operation currently
operating five days per week from 6 a.m. to 11 p.m. Pacific time to respond to
customer inquiries, orders and other requests made by phone, fax, e-mail and
regular mail. As of December 31, 1999, we employed 25 full-time employees in
customer service operations.
SALES AND MARKETING
ADVERTISING SALES
We sell advertising and sponsorships to a variety of advertisers seeking to
reach one or more of the distinct demographic audiences viewing content in the
ARTISTdirect Network. This advertising may take the form of banner ads or
sponsorship of specific content areas. Because the ARTISTdirect Network is
comprised of a large number of distinct Web sites, advertisers may choose a
broad run-of-network campaign or one that is highly targeted based upon the
demographics of a particular section within a single site or a grouping of
sites. Placement and pricing are negotiated based upon the size of the target
audience and the duration and intensity of the campaign desired by the
advertiser. Our strategy is to expand the number of advertisers using the
ARTISTdirect Network and increase the number of product and service categories
represented by these advertisers.
We derive a significant portion of our revenue from the sale of
advertising. In 1998 and 1999, advertising represented 11% and 26% of revenue,
respectively. In 1999, Intel Corporation accounted for 25% of the Company's
advertising revenues but no other single advertiser represented more than 5% in
1999 or 1998. As of December 31, 1999, we employed a direct sales force of 12
people in Los Angeles and New York and intend to expand this staff.
58
<PAGE> 60
Following is a sample of advertisers on the ARTISTdirect Network during
1999. This list provides a cross-section of different industries represented by
our advertisers:
<TABLE>
<S> <C> <C>
Atlantic Records Dreamworks Microsoft
Butterfinger Epic Records Milky Way
Coca Cola Gateway OnNow.com
Columbia Records Honda Second Spin
Discover Card Intel Talk City
</TABLE>
The above advertisers purchased between $10,000 and $106,000 of advertising
in 1999, other than Intel, which purchased $637,500 of advertising.
MARKETING AND PROMOTION
We use a number of methods to create awareness of the ARTISTdirect Network
and drive traffic to our Web sites. We have focused much of our online
advertising on specific artists, contests, promotions and other events designed
to attract interest to our sites. We have also used print and radio advertising
to create brand awareness for ARTISTdirect and to promote special events taking
place on the ARTISTdirect Network. In addition, we participate in the
sponsorship of live music and other industry events that provide prominent
visibility for either ARTISTdirect or the UBL and maintain an aggressive public
relations program generating press coverage and speaking engagements for our
senior executives.
We also use e-mail direct marketing to communicate with registered users of
the ARTISTdirect Network. Campaigns have included direct notification of special
merchandise offers, live artist chats, music downloads and non-scheduled live
performances. As we continue to build our user databases, we expect to expand
the use of e-mail direct marketing to facilitate user retention and create
loyalty and affinity programs.
COMPETITION
The market for the online promotion and distribution of music and
music-related products and services is new, highly competitive and rapidly
changing. The number of Web sites competing for the attention and spending of
consumers and advertisers has increased, and we expect it to continue to
increase, because there are few barriers to entry to Internet commerce. In
addition, the competition for advertising revenue, both on Web sites and in more
traditional media, is intense. We believe that there are more than 150 music
retailing Web sites. We compete as follows:
- for music consumers, advertisers and, to a lesser extent, artist
relationships, with providers of music information, community and content
such as MTVi, Launch Media, mp3.com, EMusic, CheckOut.com and various
other companies;
- with major online music retailers such as Amazon.com and CDnow in selling
music and merchandise;
- for music consumers and advertisers with online "portals" which have
music-oriented sites, including America Online and Yahoo!;
- for music consumers and artist relationships with traditional music
industry companies, including BMG Entertainment, a unit of Bertelsmann
AG, EMI Music, a unit of EMI Group, Sony Music Entertainment, a unit of
Sony Corporation, Warner Music Group, a unit of Time Warner Inc., and
Universal Music Group, a unit of the Seagram Company. Some of these
companies have recently established online presences to promote and
distribute the music and tours of their respective artists;
59
<PAGE> 61
- for music consumers and advertisers with publishers and distributors of
traditional media, such as television, radio and print, including MTV,
CMT, Rolling Stone and Spin and their Internet affiliates; and
- with traditional retailers targeting music consumers, including Tower
Records and Virgin Megastore and their Internet affiliates, in selling
music and merchandise.
Some of our competitors have agreed to work together to offer music over
the Internet, and we may face increased competitive pressures as a result. For
example, Universal Music Group and BMG Entertainment recently formed a joint
venture to operate an online music store.
We believe that we compete primarily on the bases of:
- the popularity, quality and variety of our ARTISTchannels, including our
ability to attract well-known artists;
- the breadth and quality of the UBL database and the community features of
iMusic;
- the variety, availability and price of music-related merchandise on our
sites;
- the ease of use and consumer acceptance of the ARTISTdirect Network; and
- the ability to effectively promote our brands.
Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Many of our current and
potential competitors in the Internet and music entertainment businesses may
have substantial competitive advantages 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 to devote greater
resources to the development, promotion and sale of 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, we may
not be able to maintain or increase our Web site traffic levels, purchase
inquiries and number of click-throughs on our online advertisements. Further,
our competitors may experience greater growth in these areas than we do.
Increased competition could result in advertising price reduction, reduced
margins or loss of market share, any of which could harm our business.
GOVERNMENTAL REGULATION
The laws and regulations that govern our business change rapidly. Although
our operations are currently based in California, the United States government
and the governments of other states and foreign countries have attempted to
regulate activities on the Internet. The following are some of the evolving
areas of law that are relevant to our business:
CONTENT REGULATION
Federal, state and foreign governments have adopted and proposed laws
governing the content of material transmitted over the Internet. These include
laws relating to obscenity, indecency, libel and
60
<PAGE> 62
defamation. We could be liable if content delivered by us or placed on our Web
sites violates these regulations.
PRIVACY LAW
Current and proposed federal, state and foreign privacy regulations and
other laws restricting the collection, use and disclosure of personal
information could limit our ability to use the information in our databases to
generate revenues. In late 1998, the Children's Online Privacy Protection Act,
or COPPA, was enacted, mandating that measures be taken to safeguard minors
under the age of 13. The FTC promulgated regulations implementing COPPA on
October 21, 1999 which will become effective on April 21, 2000. The principal
COPPA requirement is that individually identifiable information about minors
under the age of 13 not be collected, used or displayed without first obtaining
informed parental consent that is verifiable in light of present technology. The
FTC final regulations create a "sliding scale" of permissible methods for
obtaining such consent. Consent for internal use of the individually
identifiable information of children under the age of 13 can be obtained through
e-mail plus an additional safeguard, such as confirming consent with a delayed
e-mail, telephone call, or letter. Obtaining verifiable consent from a child's
parent to share that child's information with a third party or enable the child
to publicly distribute the information by, for example, allowing unrestricted
access to a chat room or message board is significantly more burdensome.
The FTC has required that parental consent for such higher risk activities
be verified by more secure methods than e-mail, such as a credit card in
connection with a transaction, print-and-sign forms, toll-free numbers staffed
by trained operators, or digital signatures. Complying with the new requirements
will be costly and will likely dissuade some percentage of our customers. While
we plan to be fully compliant with the FTC requirements by the time they become
effective, our efforts may not be successful. In addition, if implementing a
system to adequately verify parental consent is too expensive, we may not be
able to provide our services to children under the age of 13, which may
adversely affect our business. Requiring parental consent from children under
the age of 13 may drive them to use different Internet sites for their music
needs, which may adversely affect our business. If our methods of obtaining
parental consent are inadequate, we may face litigation with the FTC or
individuals, which would adversely affect our business.
SALES TAX
The tax treatment of goods sold over the Internet is currently unsettled.
We collect sales taxes for goods shipped to California and Florida. A number of
proposals have been made at the state and local level that would impose
additional taxes on the sale of goods 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. Recently, though, the Internet Tax Freedom Act was signed into law,
placing a three-year moratorium on new state and local taxes on Internet
commerce. However, the tax moratorium may not continue. Failure to renew this
legislation would allow various states to impose taxes on Internet-based
commerce, which could adversely affect our business.
ONLINE CONTESTS AND SWEEPSTAKES
We conduct online promotional contests and sweepstakes. No purchase is
necessary to participate. Our official rules, with all material terms,
conditions of eligibility, dates of participation, methods of entry and
limitations, if any, along with the odds and prize offerings, are posted on our
Web sites. In order to comply with New York and Florida state law, our prizes
are limited in value to less than $5,000, or we comply with those states'
registration and bonding requirements. While we attempt to comply with the law
of all fifty state jurisdictions, we may not be uniformly successful, and
foreign jurisdictions may
61
<PAGE> 63
attempt to regulate or ban our promotional contests. In that event, we could
lose an effective tool for increasing and keeping visitors to our Web site, and
our business could be adversely affected.
INTELLECTUAL PROPERTY
OUR PROPRIETARY RIGHTS
Copyrighted material that we develop, as well as our service marks and
domain names relating to the ARTISTdirect, UBL or iMusic brands and other
proprietary rights are important to our business prospects. We seek to protect
our common-law trademarks through federal registration, but these actions may be
inadequate. Where consultants develop copyrighted content for us, our general
policy is to use written agreements prior to content creation to obtain
ownership of that content. In addition, we principally rely upon trademark,
copyright, trade secret and contract law to protect our proprietary rights. We
generally enter into confidentiality agreements, "work-made-for-hire" contracts
and intellectual property licenses with our employees, consultants and corporate
partners, respectively, as part of our efforts to control access to and
distribution of our technologies, content and other proprietary information.
Despite our efforts to protect our proprietary rights from unauthorized use
or disclosure, parties may attempt to disclose or use our customer lists, Web
site content, service marks, domain names or confidential commercial data. The
steps that 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 at all, or 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 costly and distracting litigation to enforce our rights.
OUR WEB SITES FEATURE CONTENT THAT IS COPYRIGHTED BY MULTIPLE THIRD-PARTIES
A copyright gives the owner divisible rights, including those of
performance, reproduction and distribution. The music featured by us is
typically comprised of copyrighted works owned, controlled or administered by
multiple third parties, including record labels, artists, songwriters, music
publishers and performance rights and licensing organizations such as The Harry
Fox Agency, Broadcast Music Inc. and the American Society of Composers, Authors
and Publishers. Each song often has multiple copyright owners, who control
rights which may include performance, reproduction and distribution rights in
the "musical composition" comprised of the lyrics and music, as well as with the
"sound recording" of the artist's interpretation of the "musical composition."
In the case of music videos, there are separate copyrights to the visual
content. We, or our artists, may have different licensing arrangements with some
or all of these parties to perform, reproduce and distribute works depending
upon how the song or music video is used by us.
Our Web sites, depending upon the specific musical work, may offer audio
streaming of part or all of an entire song or "webcasting," or the downloading
of an entire song in MP3 or other compressed audio formats. Full-length
streaming only occurs in special instances after obtaining an oral license from
the record label or band manager for the "sound recording." In that case, an
ASCAP or BMI blanket music license is also obtained by us or by our artists for
rights to perform the associated underlying "musical composition." Where we
offer full-length downloads of songs in MP3 or other compressed audio formats,
we seek to obtain the rights to transmit, reproduce and perform the "sound
recording" in writing from the person or entity owning or controlling copyrights
in such "sound recording." With respect to rights in the
62
<PAGE> 64
"musical compositions" embodied in such "sound recordings" offered for download,
ARTISTdirect seeks to clear rights in musical composition in one of the
following three ways:
- a license agreement with the publisher, writer or other owner of such
copyright in the "musical composition";
- a waiver of any fees or royalties that would otherwise be required for
such use; or
- a representation and warranty from the owner of the copyrights in the
"sound recording" that no mechanical royalties are owed to any third
parties.
In the event that the foregoing steps are insufficient to clear rights, or
we otherwise fail to obtain rights, we could be exposed to claims of copyright
infringement, with attendant disruption to our operations and liability
including potential statutory or actual damages and loss of profits attributable
to infringement, plus payment of attorneys' fees and entry of an injunction.
There are other situations, such as a limited 30-second sample of a song
that is "streamed," where we use content without a license because we do not
believe that one is required. However, the laws in this area are uncertain, and
we may be forced to obtain such licenses or may be prevented from third party
content use, and may further be liable to pay actual or statutory damages,
profits attributable to any alleged infringement, as well as attorneys' fees.
Our licensing arrangements for third-party content vary from formal contracts to
informal agreements based on the promotional nature of the content. In some
cases we pay a fee to the licensor for use of the "sound recording," "musical
composition" or music video and in other cases the use is free. We also use
other third-party content, including photographs, artist names, likenesses and
concert reviews. While it is our general policy to obtain a written release or
license for such use, in many instances we rely only upon an oral license for
such use. We rely upon our positive working relationships with copyright owners
to obtain licenses on favorable terms. Any changes in the nature or terms of
these arrangements, including any requirement that we pay significant fees for
the use of the content, could have a negative impact on the availability of
content or our business.
LINKING AND FRAMING OF THIRD-PARTY WEB SITES
We link to and "frame" third-party Web sites of our artists without express
written permission to do so. Those practices are controversial, and have, in
instances not involving us, resulted in litigation. Various claims, including
trademark and copyright infringement, unfair competition, and commercial
misappropriation, as well as infringement of the right of publicity may be
asserted against us as a result. The law regarding linking and framing remains
unsettled; it is uncertain as to how existing laws, especially trademark and
copyright law, will be applied by the judiciary to the Internet. Also, Congress
is increasingly active in passing new laws related to the Internet, and there is
uncertainty as to the impact of future potential laws, especially those
involving domain names, databases and privacy.
DEFAMATION OR CONTRIBUTORY INFRINGEMENT
Our Web sites feature live "chat," or interactive on line discussion groups
made up of our customers. We do not censor such comments in advance and it is
possible that a customer could use our Web sites as a forum to make false,
misleading or disparaging remarks about others. Such on-line comments could lead
to claims for defamation or infringement. Separately, our Web sites allow
consumers to use our personal Web publishing tools to post samples of their
works. Such postings could be misused to post unlicensed copyrighted content of
others. We have obtained limited safe-harbor protection under the
recently-enacted Digital Millennium Copyright Act against liability for
infringing material of which we do not have control and knowledge.
63
<PAGE> 65
EMPLOYEES
As of December 31, 1999, we had 174 full-time employees. None of our
employees is represented by a labor union. We have not experienced any work
stoppages and consider our employee relations to be good.
FACILITIES
Our principal corporate offices are located in Encino, California where we
lease approximately 11,400 square feet under leases that expire in 2000 and
2002. In addition, we currently lease approximately 8,200 square feet in
Woodland Hills, California under a sublease which expires in May 2000 and have
leased approximately 1,400 square feet for our New York sales office under a
lease that expires in November 2002. We also lease approximately 2,200 square
feet in Seattle, Washington under a lease that expires in January 2002. To
accommodate our growth, we recently leased approximately 64,000 square feet in
Los Angeles for our principal corporate offices under a lease that expires in
2010. We expect that this additional space will accommodate our needs for the
foreseeable future.
LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims
arising out of our ordinary course of business. We are not presently involved in
any material legal proceedings.
64
<PAGE> 66
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth specific information regarding our
directors, executive officers and other key employees as of December 31, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
---- --- -----------
<S> <C> <C>
Marc P. Geiger........................... 37 Chairman of the Board and Chief Executive
Officer
Donald P. Muller......................... 39 President, ARTISTdirect Agency and
Kneeling Elephant Records and Director
Keith K. Yokomoto........................ 37 President, Chief Operating Officer and
Director
Stephen P. Rennie........................ 44 President, The Ultimate Band List
James B. Carroll......................... 44 Executive Vice President, Chief Financial
Officer, and Secretary
Scott M. Blum............................ 32 President, iMusic and Vice President,
Research & Development, ARTISTdirect
Richard B. Colbert....................... 43 Vice President, Sales and Business
Development
Pascal O. Desmarets...................... 38 Vice President, Information Technology
and Operations
Thomas F. Fuelling....................... 37 Vice President, Finance
Robert A. Morse.......................... 37 Vice President, Business Administration
and Treasurer
Jeffrey P. Rea........................... 41 Vice President, Marketing
Nicholas J. Turner....................... 40 Vice President, ARTISTchannels
Carlos E. Cisneros(1).................... 34 Director
Clifford H. Friedman..................... 40 Director
Dara Khosrowshahi(2)..................... 30 Director
Stephen M. Krupa......................... 35 Director
Allen D. Lenard.......................... 57 Director
Rick Rubin............................... 36 Director
</TABLE>
- ---------------
(1) Appointed in January 2000.
(2) Appointed in March 2000.
EXECUTIVE OFFICERS AND DIRECTORS
Marc P. Geiger is a co-founder of ARTISTdirect and has served as Chief
Executive Officer since our inception and as our Chairman of the Board since
July 1998. From January 1992 to December 1996, Mr. Geiger was the Senior Vice
President of Marketing, A&R and New Media at American Recordings, Inc. From 1984
to 1991, Mr. Geiger worked as a talent agent for Regency Artists, that was later
acquired by the William Morris Agency. In 1990, Mr. Geiger co-founded the
Lollapalooza concert tour.
Donald P. Muller is a co-founder of ARTISTdirect and has served as the
President of both ARTISTdirect Agency and Kneeling Elephant Records since July
1999 and as a director of ARTISTdirect since July 1998. From January 1997 to
June 1999, Mr. Muller was a co-Chief Executive Officer of ARTISTdirect, LLC.
From October 1992 to December 1996, Mr. Muller was a talent agent overseeing
William Morris Agency's Contemporary Music Worldwide division. From 1986 to
September 1992, Mr. Muller was a club agent at International Creative
Management. Mr. Muller received his B.A.
65
<PAGE> 67
in Communications from the University of Iowa. In 1990, Mr. Muller co-founded
the Lollapalooza concert tour.
Keith K. Yokomoto is a co-founder of ARTISTdirect and has served as our
President since July 1999, as our Chief Operating Officer since January 1997,
and as a director since July 1998. From September 1985 to January 1997, Mr.
Yokomoto was a manager of new ventures and business development and a project
engineer at Hughes Electronics. Mr. Yokomoto received his B.S. in Mechanical
Engineering from the University of California at San Diego and his M.B.A. from
the University of Southern California.
Stephen P. Rennie has served as the President of the Ultimate Band List
since April 1998. From October 1994 to April 1998, Mr. Rennie was Senior Vice
President and General Manager, West Coast at Epic Records. From 1990 to 1994,
Mr. Rennie was in artist management. From 1984 to 1990, Mr. Rennie was a Senior
Vice President for Avalon Attractions.
James B. Carroll has served as our Executive Vice President and Chief
Financial Officer since May 1999. Mr. Carroll has served as our Secretary since
July 1999. From November 1994 to May 1999, Mr. Carroll was a Managing Director
in the Media & Entertainment Group at Bear, Stearns & Co. Inc., where he served
as an investment banker to companies primarily in broadcasting and new media.
From January 1989 to August 1994, Mr. Carroll was a Managing Director at Smith
Barney Inc., where he co-founded the Media & Communications Group and served on
the Investment Banking Management Committee. Mr. Carroll received his B.A. in
Psychology from Claremont McKenna College and his M.B.A. from Harvard Business
School.
Carlos E. Cisneros has served as a director since January 2000. In October
1996, Mr. Cisneros founded and became Chief Executive Officer of the Cisneros
Television Group, a member of Ibero-American Media Partners, II, Ltd. In January
1998, Mr. Cisneros was named Vice-Chairman of Ibero-American Media Partners, II,
Ltd., an investment fund jointly owned by the Cisneros Group of Companies and
Hicks, Muse, Tate & Furst Incorporated. From June 1993 to October 1996, Mr.
Cisneros was Vice-President of New Business Development at Venevision
International. Mr. Cisneros serves on the board as a representative of
Meadowlane Enterprises, Ltd., an affiliate of Cisneros Television Group. Mr.
Cisneros also serves on the boards of El Sitio, Inc., OneSoft Corporation and
Playboy TV International, LLC. Mr. Cisneros received his B.A. in Political
Science from American University in Washington, D.C.
Clifford H. Friedman has served as a director since July 1998. Mr. Friedman
is a Senior Managing Director at Bear, Stearns & Co. Inc. where he manages
venture capital funds, including Constellation Venture Capital, L.P. Mr.
Friedman serves on the board as a representative of Constellation. From January
1996 to August 1997, Mr. Friedman served as a Senior Vice President of Universal
Studios. From January 1995 to January 1996 Mr. Friedman was a Vice President of
Corporate Development at NBC. Mr. Friedman received his B.S. in Electrical
Engineering and Computer Science and his M.S. in Electrophysics from Polytechnic
University. Mr. Friedman received his M.B.A. from Adelphi University.
Dara Khosrowshahi has served as a director since March 2000. Since October
1999, Mr. Khosrowshahi has been President of USANetworks Interactive, a division
of USAi. From February 1998 to October 1999, Mr. Khosrowshahi was the Vice
President of Strategic Planning for USAi and USANi LLC. From 1991 to 1998, he
was at Allen & Company Incorporated, an investment bank, where he was a Vice
President from 1995 to 1996 and a director from 1996 to 1998. Mr. Khosrowshahi
also serves as a director of Ticketmaster Online-CitySearch, Inc., HRN and
several private companies. Mr. Khosrowshahi received his B.S. in Bioelectrical
Engineering from Brown University.
Stephen M. Krupa has served as a director since May 1999. Mr. Krupa is a
founding member and Managing Director of Psilos Group Managers, LLC, a private
venture capital fund focused on the digital media, information technology and
health care sectors. Mr. Krupa serves on the board as a representative
66
<PAGE> 68
of Chase Capital Partners. Mr. Krupa is currently a director of several private
Internet companies. From February 1995 to July 1998, Mr. Krupa held various
positions at Wasserstein Perella & Co., most recently as a Vice President where
he specialized in mergers and acquisitions advisory work. Mr. Krupa received his
B.S. in Mechanical Engineering from the University of South Florida and his
M.B.A. from the Wharton School of the University of Pennsylvania.
Allen D. Lenard has served as a director since July 1998. Mr. Lenard is
Managing Partner of Lenard & Gonzalez LLP, a transactional entertainment law
firm. Mr. Lenard received his B.A. in Business Administration from the
University of Wisconsin, Madison and his J.D. from the University of California
at Los Angeles School of Law.
Rick Rubin has served as a director since May 1999. Mr. Rubin is founder
and President of American Recordings, Inc. He has produced various artists,
including Black Crowes, Johnny Cash, Red Hot Chili Peppers and Tom Petty and
numerous Grammy Award winning albums, including the 1998 Country Album of the
Year -- "Unchained" by Johnny Cash. In 1984, Mr. Rubin was a founder of the Def
Jam label, where he signed or produced such artists as LL Cool J, Beastie Boys
and Public Enemy. Mr. Rubin received his B.F.A. in Philosophy, Film and
Television from New York University.
Our executive officers serve at the discretion of the Board of Directors.
There are no family relationships among any of our directors or executive
officers.
OTHER KEY EMPLOYEES
Scott M. Blum has served as President of iMusic since June 1995 and our
Vice President, Research and Development, since February 1999. From May 1993 to
June 1995, Mr. Blum was Executive Producer at Starwave, a CD-ROM and Internet
game development company, where he led the development of Peter Gabriel's "Eve"
CD-ROM project.
Richard B. Colbert has served as our Vice President of Sales and Business
Development since September 1999. From October 1998 to September 1999, Mr.
Colbert served as President of Northern NOMA Corp., providing consulting
services to internet and broadcasting companies. From 1983 to 1998, Mr. Colbert
was President of IntelliVentures, Inc., a producer and distributor of special
interest video programming. From 1989 to 1993, Mr. Colbert was Senior Executive
Vice President of ITC Domestic Television, a distributor of first-run television
programming.
Pascal O. Desmarets has served as our Vice President, Information
Technology and Operations since February 1999. From February 1997 to February
1999, Mr. Desmarets held various management positions in the engineering group
at Optum Software. Mr. Desmarets received his B.S. in Industrial Engineering and
Management from the Catholic University of Louvain, Belgium and his M.B.A. from
the University of Southern California.
Thomas F. Fuelling has served as our Vice President, Finance since October
1999. From April 1998 to September 1999, Mr. Fuelling was Vice President,
Finance and CFO of Sega GameWorks, LLC. From December 1995 to March 1998, Mr.
Fuelling was Executive Vice President, Finance and CFO of Village Roadshow
Pictures. From March 1994 to November 1995, Mr. Fuelling was Vice President and
Controller of The Samuel Goldwyn Company. From 1984 to 1994, Mr. Fuelling was a
certified public accountant with Price Waterhouse LLP in its Entertainment
practice unit. Mr. Fuelling received his B.S. in Business Administration from
the University of Southern California and his Master of Management from
Northwestern University.
Robert A. Morse has served as our Vice President, Business Administration
and Treasurer since May 1999. Mr. Morse served as our Chief Financial Officer
from March 1998 to May 1999. From October 1994 to March 1998, Mr. Morse was Vice
President and Chief Financial Officer of Pacific Bell Interactive Media. From
1989 to 1994, Mr. Morse served in a variety of corporate financial and strategic
roles for the Times Mirror Company. From 1985 to 1989, Mr. Morse was a certified
public accountant
67
<PAGE> 69
with Arthur Andersen. Mr. Morse received his B.A. in Economics from the
University of California at Los Angeles and his M.B.A. from the University of
Southern California.
Jeffrey P. Rea has served as our Vice President of Marketing since October
1999. From October 1998 to July 1999, Mr. Rea consulted as acting head of
marketing for Avanti Corporation. From March 1997 to October 1998, he was Vice
President of Sales and Marketing for Aramark Corporation's publishing
distribution operation. Between 1992 and 1996, Mr. Rea served in international
marketing and product development roles with Whirlpool Corporation. From 1989 to
1993, Mr. Rea served as Brand Director, Miller Lite and Director, New Business
Development for Miller Brewing Company. From 1983 to 1989, Mr. Rea served in a
variety of marketing and business analysis roles at Frito-Lay, Inc. Mr. Rea
received his B.A. in Business Administration from Washington State University
and his Master of Management from Northwestern University.
Nicholas J. Turner has served as our Vice President, ARTISTchannels, since
March 1999. From June 1996 to February 1999, Mr. Turner was Vice President, West
Coast for N2K's Music Boulevard, and from June 1994 to June 1996, Mr. Turner
founded and operated Rocktropolis. Music Boulevard and Rocktropolis are online
music entertainment companies. Before founding Rocktropolis, Mr. Turner was an
associate of artist manager Miles Copeland, working in various capacities with
recording artists.
BOARD COMPOSITION
Each of our directors was appointed to the Board of Directors pursuant to
the stockholders agreement described on page 81. Although the provisions of the
stockholders agreement regarding appointment of directors will terminate upon
the closing of the offering, our existing directors, officers and 5%
stockholders will hold approximately 74.6% of our outstanding voting stock
immediately after the offering. As a result, they will be able to re-elect these
directors. Carlos Cisneros is affiliated with Cisneros Television Group, Inc.,
which will beneficially own approximately 5.7% of our common stock after this
offering and Clifford Friedman is affiliated with Constellation Venture Capital,
L.P., which will beneficially own approximately 7.5% of our common stock after
this offering.
Upon the closing of this offering, our Board of Directors will be divided
into three classes designated as Class I, Class II and Class III, and our
directors will be assigned to each class by the Board of Directors. The Class I
directors will be Keith Yokomoto, Carlos Cisneros and Rick Rubin; the Class II
directors will be Donald Muller, Allen Lenard and Stephen Krupa; and the Class
III directors will be Marc Geiger and Clifford Friedman. At the first annual
meeting of stockholders following the closing of this offering, the term of
office of the Class I directors will expire, and Class I directors will be
elected for a full term of three years. At the second annual meeting of
stockholders following the closing of this offering, the term of office of the
Class II directors will expire, and Class II directors will be elected for a
full term of three years. At the third annual meeting of stockholders following
the closing of this offering, the term of office of the Class III directors will
expire, and Class III directors will be elected for a full term of three years.
At each succeeding annual meeting of stockholders, directors will be elected for
a full term of three years to succeed the directors of the class whose terms
expire at such annual meeting.
BOARD COMMITTEES
The Board of Directors has established a Compensation Committee and an
Audit Committee. The Compensation Committee reviews and recommends to the Board
of Directors the compensation and benefits of all our officers and establishes
and reviews general policies relating to compensation and benefits of our
employees. The members of the Compensation Committee are Messrs. Friedman, Krupa
and Lenard. The Audit Committee reviews our internal accounting procedures and
consults with and reviews the services provided by our independent accountants.
The members of our Audit Committee are Messrs. Friedman, Khosrowshahi and Krupa.
68
<PAGE> 70
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of our Compensation Committee of the Board of Directors are
currently Messrs. Friedman, Krupa and Lenard, none of whom has ever been an
officer or employee of ARTISTdirect. Before establishing the Compensation
Committee in September 1999, the Board of Directors as a whole performed the
functions delegated to the Compensation Committee. None of our executive
officers serves as a member of the board of directors or compensation committee
of any entity that has one or more executive officers who serve on our board or
compensation committee.
DIRECTOR COMPENSATION
Our directors do not currently receive any cash compensation from us for
their service as members of the Board of Directors, although they are reimbursed
for travel and lodging expenses in connection with attendance at Board and
Committee meetings. Our directors are eligible to participate in the 1999
Employee Stock Option Plan.
EXECUTIVE COMPENSATION
The following table sets forth information concerning compensation earned
in the fiscal year ended December 31, 1999 for our Chief Executive Officer for
that year and for our four other most highly compensated executive officers
whose compensation, as defined by the Securities and Exchange Commission,
exceeded $100,000. These people are referred to as the "named executive
officers." The information in the table includes salaries, bonuses granted and
other miscellaneous compensation.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ACCRUAL (EARNED) BASIS ------------
----------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS COMPENSATION
--------------------------- ---- -------- -------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Marc P. Geiger................. 1999 $150,000 $100,000 $4,715 -- --
Chairman and Chief Executive
Officer
Donald P. Muller............... 1999 150,000 100,000 4,508 -- --
President, ARTISTdirect
Agency
and
Kneeling Elephant Records
Keith K. Yokomoto.............. 1999 150,000 50,000 6,011 -- --
President, Chief Operating
Officer and Director
Stephen P. Rennie.............. 1999 137,500 37,500 -- -- --
President, UBL
James B. Carroll............... 1999 81,250 29,167 -- -- --
Vice President and Chief
Financial Officer
</TABLE>
69
<PAGE> 71
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information with respect to stock options
granted to James Carroll, our chief financial officer, in 1999, including the
potential realizable value over the seven year term of the options, based on
assumed rates of stock appreciation of 5% and 10%, compounded annually. These
assumed rates of appreciation comply with the rules of the Commission and do not
represent our estimate of future stock price. Actual gains, if any, on stock
option exercises will be dependent on the future performance of our common
stock. No other options were granted to any of our other named executive
officers in 1999.
<TABLE>
<CAPTION>
OPTION GRANTS IN 1999
-------------------------------------------------- POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED ANNUAL
NUMBER OF TOTAL RATES OF STOCK PRICE
SECURITIES OPTIONS EXERCISE APPRECIATION FOR
UNDERLYING GRANTED TO PRICE OPTION TERM($)
OPTIONS EMPLOYEES IN PER-SHARE EXPIRATION ------------------------
NAME GRANTED(#) 1999(%) ($) DATE 5% 10%
- ---- ---------- ------------ --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
James B. Carroll..... 459,184 13.3% $3.60 5/25/06 $6,100,354 $9,084,774
</TABLE>
The potential realizable value is calculated based on the seven year term
of the option at its time of grant. It is calculated based on the assumption
that the initial public offering price of $12.00 per share appreciates at the
indicated annual rate compounded annually for the entire term of the option and
that the option is exercised and sold on the last day of its term for the
appreciated stock price. Actual gains, if any, on stock option exercises are
dependent on the future performance of the common stock and overall stock market
conditions. The amounts reflected in the table may not necessarily be achieved.
In addition, in March 2000, we granted Mr. Carroll an option to purchase 226,084
shares of our common stock at an exercise price equal to the initial offering
price of the common stock offered in this offering. Upon the closing of this
offering, we will also grant Keith Yokomoto and Steve Rennie options to purchase
our common stock. Please see "Related Party Transactions -- Options and Stock
Issued to James Carroll" on page 80 and "Related Party
Transactions -- Equity-Related Transactions Between Officers and Directors" on
page 83 for more information on the option grants to Messrs. Carroll, Yokomoto
and Rennie.
YEAR-END OPTION VALUES
The following table sets forth the number of shares of common stock
underlying the unexercised options held by James Carroll, our chief financial
officer, at the end of 1999. No other named executive officer held options at
the end of 1999. No options were exercised during 1999.
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
SECURITIES UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS AT OPTIONS AT
DECEMBER 31, 1999 DECEMBER 31, 1999
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
James B. Carroll...................... 86,097 373,087 $723,215 $3,133,931
</TABLE>
There was no public trading market for our common stock as of December 31,
1999. Accordingly, these values have been calculated on the basis of the initial
public offering price of $12.00 per share, less the applicable exercise price
per share, multiplied by the number of shares underlying such options.
70
<PAGE> 72
BENEFIT PLANS
STOCK OPTION PLANS.
Introduction. We maintain the following three separate stock option plans:
- The 1999 Employee Stock Option Plan under which we have reserved
6,500,000 shares of our common stock for issuance to our employees,
non-employee members of our board of directors and consultants. This
share reserve includes an increase of 1,250,000 shares which was approved
by our board and our stockholders in March 2000. This share reserve will
also automatically increase on the first trading day in January each
calendar year, beginning 2001, by an amount equal to two percent (2%) of
the total number of shares of our common stock outstanding on the last
trading day of December in the prior calendar year, but in no event will
this annual increase exceed 875,000 shares. As of December 31, 1999,
options for 3,745,780 shares of our common stock were outstanding under
this plan, 58,750 options had been exercised, and 1,445,470 shares
remained available for future option grant;
- The 1999 Artist Stock Option Plan under which we have reserved an
additional 4,000,000 shares of our common stock for issuance to artists
for whom we maintain ARTISTchannels. This share reserve will
automatically increase on the first trading day in January each calendar
year, beginning 2001, by an amount equal to two percent (2%) of the total
number of shares of our common stock outstanding on the last trading day
of December in the prior calendar year, but in no event will this annual
increase exceed 875,000 shares. As of December 31, 1999, options for
2,146,144 shares of our common stock were outstanding under this plan,
117,916 options had been exercised, and 1,735,939 shares remained
available for future option grant; and
- The 1999 Artist and Artist Advisor Stock Option Plan under which we have
reserved 1,550,000 shares of our common stock for issuance to artists for
whom we maintain ARTISTchannels and their agents, business managers,
attorneys and other advisors. This share reserve includes an increase of
300,000 shares which was approved by our board and our stockholders in
March 2000. This share reserve will also automatically increase on the
first trading day in January each calendar year, beginning 2001, by an
amount equal to one percent (1%) of the total number of shares of our
common stock outstanding on the last trading day of December in the prior
calendar year, but in no event will this annual increase exceed 375,000
shares. As of December 31, 1999, options for 998,625 shares of our common
stock were outstanding under this plan, no options had been exercised,
and 251,375 shares remained available for future option grant.
Administration. Each plan is administered by our compensation committee.
This committee will determine which eligible persons are to receive option
grants under the plan, the time or times when the grants are to be made, the
number of shares subject to each grant, the exercise price in effect for each
option, the status of any granted option as either an incentive stock option or
a nonstatutory stock option under the federal tax laws, the vesting schedule to
be in effect for the option grant and the maximum term for which any granted
option is to remain outstanding. No option may have a term in excess of 10
years.
Plan Features. The terms and provisions governing the option grants made
under each of our three plans are substantially the same and may be summarized
as follows:
- The exercise price for any options granted under the plans may be paid in
cash or in shares of our common stock valued at fair market value on the
exercise date. The option may also be exercised through a same-day sale
program pursuant to which the purchased shares are immediately sold
through a designated broker and a portion of the sale proceeds delivered
to us in payment of the option exercise price;
71
<PAGE> 73
- The compensation committee will have the authority to cancel outstanding
options under the plans in return for the grant of new options for the
same or different number of option shares with an exercise price per
share based upon the fair market value of our common stock on the new
grant date;
- Each optionee will have a limited period of time following the
termination of service with us in which to exercise his or her
outstanding options for any shares for which those options are
exercisable at the time of such termination; and
- The compensation committee may structure one or more option grants so
that those options may be assigned during the optionee's lifetime to one
or more family members or to a trust established for such family members.
Upon the optionee's death while holding one or more options under the
plans, those options will be transferred in accordance with the
optionee's will or the laws of inheritance.
Change in Control. Effective upon the execution of the underwriting
agreement for this offering, each of the plans will be amended to include the
following change in control provisions that may result in the accelerated
vesting of outstanding option grants:
- If we are acquired by merger, sale of more than 50% or more of our
outstanding voting securities or sale of substantially all of our assets,
each option grant that is not to be assumed by the successor corporation
or otherwise continued in effect will immediately vest and become
exercisable for all the option shares;
- The compensation committee will have complete discretion to grant one or
more options that will vest and become exercisable for all the option
shares if those options are assumed in the acquisition or otherwise
continued in effect, but the optionee's service with us or the acquiring
entity is subsequently terminated within a designated period (not to
exceed 18 months) following such acquisition; and
- Options currently outstanding under all three of our option plans
immediately vest if we are acquired by merger or asset sale and the
options are not assumed by the acquiring entity.
Additional Provisions. The board may amend or modify any or all of the
three plans at any time, subject to any required stockholder approval. Each of
the plans will terminate no later than October 13, 2009.
1999 EMPLOYEE STOCK PURCHASE PLAN.
Introduction. Our 1999 Employee Stock Purchase Plan was adopted by the
board on October 13, 1999 and approved by the stockholders in October 1999. The
plan will become effective immediately upon the signing of the underwriting
agreement for this offering. The plan is designed to allow our eligible
employees and the eligible employees of our participating subsidiaries to
purchase shares of common stock at semi-annual intervals with accumulated
payroll deductions.
Share Reserve. 500,000 shares of our common stock will initially be
reserved for issuance. The reserve will automatically increase on the first
trading day in January each calendar year, beginning 2000, by an amount equal to
one percent (1%) of the total number of outstanding shares of our common stock
on the last trading day in December in the prior calendar year. In no event will
any such annual increase exceed 1,000,000 shares.
Offering Periods. The plan will have a series of successive offering
periods, each with a maximum duration of 24 months. The initial offering period
will start on the date the underwriting agreement for this offering is signed
and will end on the last business day in April 2002. The next offering period
will start on the first business day in May 2002, and subsequent offering
periods will be set by our compensation committee.
72
<PAGE> 74
Eligible Employees. Individuals scheduled to work more than 20 hours per
week for more than 5 calendar months per year may join an offering period on the
start date or any semi-annual entry date within that period. Semi-annual entry
dates will occur on the first business day of May and November each year.
Individuals who become eligible employees after the start date of an offering
period may join the plan on any subsequent semi-annual entry date within that
offering period.
Payroll Deductions. A participant may contribute up to 15% of his or her
total cash earnings through payroll deductions, and the accumulated deductions
will be applied to the purchase of shares on each semi-annual purchase date. The
purchase price per share will be equal to 85% of the fair market value per share
on the participant's entry date into the offering period or, if lower, 85% of
the fair market value per share on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of April and October each
year. However, a participant may not purchase more than 750 shares on any
purchase date, and not more than 250,000 shares may be purchased in total by all
participants on any purchase date. Our compensation committee will have the
authority to change these limitations for any subsequent offering period.
Change in Control. Should we be acquired by merger or sale of substantially
all of our assets or more than fifty percent of our voting securities, then all
outstanding purchase rights will automatically be exercised immediately before
the effective date of the acquisition. The purchase price will be equal to 85%
of the market value per share on the participant's entry date into the offering
period in which an acquisition occurs or, if lower, 85% of the fair market value
per share immediately before the acquisition.
Plan Provisions. The following provisions will also be in effect under the
plans:
- The plan will terminate no later than the last business day of October
2009.
- The board may at any time amend, suspend or discontinue the plan.
However, amendments may require stockholder approval.
EMPLOYMENT AGREEMENTS
We have entered into employment agreements with our named executive
officers. The compensation and dates of employment under the employment
agreements are as follows:
Marc Geiger
In July 1998, we entered into an employment agreement with Marc Geiger, our
Chairman and Chief Executive Officer which provides for the following:
- Mr. Geiger is paid an annual salary of $150,000 and a guaranteed annual
bonus of $100,000.
- The initial term of his employment expires July 27, 2001, with automatic
extensions for successive one-year periods.
- The agreement provides for the payment of salary and a guaranteed bonus
for twelve months after the date of termination if the termination was
other than:
(1) due to a disability,
(2) for "cause," such as the commission of a felony, material dishonesty
against ARTISTdirect, or gross negligence in the performance of
duties,
(3) due to Mr. Geiger's death, or
(4) if he terminates his employment for "good reason," such as an
adverse change of duties, a reassignment of location, or a material
breach of our obligations to him.
73
<PAGE> 75
- If Mr. Geiger's employment is terminated for cause or disability, or he
resigns for other than good reasons, he is prohibited, for a period of
the later of one year after the early termination of his employment, or
the expiration of the term of his employment agreement, from competing
with ARTISTdirect or attempting to hire any ARTISTdirect employee.
Donald Muller
In July 1998, we entered into an employment agreement with Donald Muller,
the President of ARTISTdirect Agency and Kneeling Elephant Records, and one of
our directors, which provides for the following:
- Mr. Muller is paid an annual salary of $150,000 and a guaranteed annual
bonus of $100,000.
- The initial term of the agreement expires July 27, 2001, with automatic
extensions for successive one-year periods.
- The agreement provides for the payment of salary and a guaranteed bonus
for twelve months after the date of termination if the termination was
other than:
(1) due to a disability,
(2) for "cause," such as the commission of a felony, material
dishonesty against ARTISTdirect, or gross negligence in the performance of
duties,
(3) due to Mr. Muller's death, or
(4) if he terminates his employment for "good reason," such as an
adverse change of duties, a reassignment of location, or a material breach
of our obligations to him.
- If Mr. Muller's employment is terminated for cause or disability or
resigns for other than good reasons, he is prohibited, for a period of
the later of one year after the early termination of his employment, or
the expiration of the term of his employment agreement, from competing
with ARTISTdirect or attempting to hire any ARTISTdirect employee.
Keith Yokomoto
In January 1998, we entered into an employment agreement with Keith
Yokomoto, our President and Chief Operating Officer, which provides for the
following:
- Mr. Yokomoto was paid an annual salary of $100,000 for the first five
months of the agreement and $150,000 thereafter, with a guaranteed bonus
of $50,000 the second year and $100,000 for each year thereafter.
- The initial term of the agreement expires December 31, 2000, and
ARTISTdirect has an option to extend the term for two additional one-year
periods.
- The agreement provides for the payment of his salary and a guaranteed
bonus for the lesser of:
(1) twelve months after the date of termination, or
(2) until the end of the agreement, if he is terminated other than due
to a disability, for "cause," such as the commission of a felony,
material dishonesty against ARTISTdirect, or gross negligence in the
performance of duties, or upon his death.
Mr. Yokomoto also signed a separate agreement concurrently with his
employment agreement which prohibits him from competing with ARTISTdirect or
attempting to hire any ARTISTdirect employee for the later of one year after
termination of employment, or the expiration of the then-current period of the
term of the agreement.
74
<PAGE> 76
James Carroll
In May 1999, we entered into an employment agreement with James Carroll,
our Chief Financial Officer, which provides for the following:
- Mr. Carroll is paid an annual salary of $150,000 and a guaranteed annual
bonus of $50,000.
- The initial term of the agreement expires May 23, 2001, and ARTISTdirect
has an option to extend the term for one additional year.
- The employment agreement provides that if Mr. Carroll's employment is
terminated other than due to a disability, death or for "cause," such as
the commission of a felony, material dishonesty against ARTISTdirect, or
gross negligence in the performance of duties, he will be paid his base
salary for the lesser of:
(1) six months after the date of termination, or
(2) the remainder of the agreement.
- If Mr. Carroll is terminated for cause, he is prohibited from competing
with ARTISTdirect until the date the agreement would otherwise have
expired. Mr. Carroll is also prohibited from attempting to hire any
ARTISTdirect employee for one year following the later of:
(1) the date the agreement expires, or
(2) the actual date of termination.
In addition, please see "-- Options and Stock Issued to James Carroll" on
page 80 for information on stock and options issued to Mr. Carroll in connection
with his employment.
Steve Rennie
In April 1998, UBL, LLC entered into an employment agreement with Steve
Rennie, President of the Ultimate Band List, which provides for the following:
- Mr. Rennie is paid an annual salary of $100,000 for the first year and
$150,000 for the second and third years, with a guaranteed bonus of
$50,000 the second year and $100,000 the third year.
- The initial term of the agreement expires March 31, 2001.
- If Mr. Rennie's employment is terminated other than due to disability,
death, or for cause, such as the commission of a felony, material
dishonesty against ARTISTdirect, or gross negligence in the performance
of duties, Mr. Rennie's employment agreement provides for the payment of
his salary and a guaranteed bonus for the lesser of:
(1) twelve months after the date of termination, or
(2) the remaining period of the term.
In June 1998, Mr. Rennie also entered into a separate agreement which
prohibits him from competing with UBL, LLC until March 31, 2001, or, in the
event Mr. Rennie is terminated other than for cause, the date of Mr. Rennie's
termination. The agreement also prohibits him from soliciting any customer of
ARTISTdirect or attempting to hire any ARTISTdirect employee until March 31,
2002.
75
<PAGE> 77
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit indemnification for
liabilities, including reimbursement for expenses incurred, arising under the
Securities Act. This indemnification may, however, be unenforceable as against
public policy.
As permitted by Delaware law, our amended and restated certificate of
incorporation, which will become effective upon the closing of this offering,
includes a provision that eliminates the personal liability of its directors for
monetary damages for breach of fiduciary duty as a director, except for
liability:
- for any breach of the director's duty of loyalty to us or our
stockholders;
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
- under Section 174 of the Delaware law regarding unlawful dividends and
stock purchases; or
- for any transaction from which the director derived an improper personal
benefit.
As permitted by Delaware law, our amended and restated certificate of
incorporation and our amended and restated bylaws, which will become effective
upon the closing of this offering, provide that:
- we are required to indemnify our directors and officers to the fullest
extent permitted by Delaware law, so long as such person acted in good
faith and in a manner the person reasonably believed to be in or not
opposed to the best interests of ARTISTdirect, and with respect to any
criminal action or proceeding, had no reasonable cause to believe the
person's conduct was unlawful;
- we are permitted to indemnify our other employees to the extent that we
indemnify our officers and directors, unless otherwise required by law,
our amended and restated certificate of incorporation, our amended and
restated bylaws or other agreements;
- we are required to advance expenses to our directors and officers
incurred in connection with a legal proceeding to the fullest extent
permitted by Delaware law, subject to very limited exceptions; and
- the rights conferred in our amended and restated bylaws are not
exclusive.
Before the closing of this offering, we intend to enter into indemnity
agreements with each of our current directors and officers to give such
directors and officers additional contractual assurances regarding the scope of
the indemnification set forth in our amended and restated certificate of
incorporation and our amended and restated bylaws and to provide additional
procedural protections. At present, there is no pending litigation or proceeding
involving any of our directors, officers or employees regarding which
indemnification is sought, nor are we aware of any threatened litigation that
may result in claims for indemnification.
We have obtained directors' and officers' liability insurance.
76
<PAGE> 78
RELATED PARTY TRANSACTIONS
ISSUANCES OF INTERESTS IN PREDECESSOR
INITIAL ISSUANCES
In September 1996, Marc Geiger and Don Muller formed ARTISTdirect, LLC, our
predecessor, and each acquired 17,461,365 common units of its membership
interest. All information with respect to units of ARTISTdirect, LLC in this
section gives effect to a 35 to 1 forward unit split that occurred in May 1999
and does not give effect to the one-for-four reverse stock split of ARTISTdirect
effected on March 21, 2000.
In 1998, as partial compensation for services rendered and to be rendered,
ARTISTdirect, LLC issued common units to Keith Yokomoto, our President and Chief
Operating Officer, Steve Rennie, President of the UBL, Robert Morse, our Vice
President and Treasurer and L&G Associates One. These common units entitled the
holders to share in the profits and losses of ARTISTdirect, LLC but limited the
holders' share of the capital of ARTISTdirect, LLC to increases in its fair
value after the issuance of the units. The value of the capital at the time of
these issuances remained the property of Messrs. Geiger and Muller. In January
1998, Mr. Yokomoto and L&G Associates One received 4,014,107 and 1,204,232
common units, respectively. Allen Lenard, one of our directors, is Managing
Partner of L&G Associates One and is also Managing Partner of Lenard & Gonzalez
LLP, one of our outside law firms. In June 1998, Messrs. Rennie and Morse
received 1,605,643 and 401,411 common units, respectively. In connection with
these issuances, Messrs. Geiger and Muller agreed that the percentages
represented by these common units would not be diluted for the first $5 million
in capital contributions made to ARTISTdirect, LLC by outside investors. To
effect this anti-dilution protection, Messrs. Geiger and Muller periodically
contributed common units to ARTISTdirect, LLC and ARTISTdirect, LLC issued the
same total number of common units to Messrs. Yokomoto, Rennie, Morse and L&G
Associates One for no additional consideration.
In July 1998, Messrs. Geiger and Muller contributed their interests in MGE,
LLC, another company they wholly-owned, to ARTISTdirect Holdings, L.L.C., a
newly-formed Delaware limited liability company, and then contributed their
interests in ARTISTdirect Holdings, L.L.C. to ARTISTdirect, LLC in exchange for
additional common units. As a result, ARTISTdirect Holdings, L.L.C. became a
wholly-owned subsidiary of ARTISTdirect, LLC.
In July 1997, ARTISTdirect New Media, LLC, one of our subsidiaries or ADNM,
and American Recordings, Inc., or ARI, which was wholly-owned by Rick Rubin, one
of our directors, formed UBL, LLC. ARI contributed all of the assets used in
connection with the operation of the UBL Web site to UBL, LLC in exchange for a
membership interest in UBL, LLC. Since its inception, ADNM has been 99% owned by
ARTISTdirect LLC and 1% owned by an entity owned by the members of ARTISTdirect,
LLC. From UBL, LLC's inception in June 1997 until May 1999, when ADNM exchanged
its interest in UBL, LLC for interests in ARTISTdirect LLC, ADNM owned
approximately 49% of the membership interests in UBL, LLC, and controlled and
funded the operations of the UBL Web site.
77
<PAGE> 79
ISSUANCES OF ARTISTDIRECT, LLC SERIES A PREFERRED UNITS
Between July 1998 and December 1998, ARTISTdirect, LLC sold a total of
9,458,340 of its Series A preferred units at a purchase price of approximately
$0.31 per unit to the following purchasers:
<TABLE>
<CAPTION>
AGGREGATE VALUE OF
SERIES A PURCHASE UNDERLYING
PURCHASER PREFERRED UNITS PRICE COMMON STOCK(1)
--------- --------------- ---------- ---------------
<S> <C> <C> <C>
Constellation Venture Capital, L.P............. 5,850,520 $1,800,000 $17,551,560
Psilos Group Partners, L.P..................... 1,950,172 600,000 5,850,516
DreamMedia Internet Ventures, LLC.............. 1,462,632 450,000 4,387,896
Carl Kawabe.................................... 195,016 60,000 585,048
</TABLE>
- -------------------------
(1) Based on the initial offering price of $12.00 per share.
In January 1999, ARTISTdirect, LLC redeemed 780,068 of its Series A
preferred units from Psilos Group Partners, L.P. for a purchase price of
$240,080 and re-issued those units to CCP/Psilos ARTISTdirect, LLC for the same
price. Mr. Friedman, one of our directors, is the General Partner of
Constellation Venture Capital, L.P. and Mr. Krupa, one of our directors, is the
Managing Director of Psilos Group Managers, L.P.
ISSUANCES OF UBL, LLC UNITS
Between July 1998 and December 1998, UBL, LLC, sold an aggregate of
1,940,000 of its Series A preferred units, and 1,940,000 of its Series B
preferred units, at a purchase price of $1.00 per unit to the following
purchasers:
<TABLE>
<CAPTION>
AGGREGATE VALUE OF
SERIES A SERIES B PURCHASE UNDERLYING
PURCHASER PREFERRED UNITS PREFERRED UNITS PRICE COMMON STOCK
--------- --------------- --------------- ---------- ------------
<S> <C> <C> <C> <C>
Constellation Venture Capital,
L.P............................... 1,200,000 -- $1,200,000 $6,259,027
Psilos Group Partners, L.P.......... 400,000 -- 400,000 2,086,342
DreamMedia Internet Ventures, LLC... 300,000 -- 300,000 1,564,757
Carl Kawabe......................... 40,000 -- 40,000 208,634
ADNM................................ -- 1,940,000 1,940,000 5,820,000
</TABLE>
- -------------------------
(1) Based on the initial offering price of $12.00 per share.
In January 1999, UBL, LLC redeemed 160,000 of its Series A preferred units
from Psilos Group Partners, L.P. for a purchase price of $160,000 and re-issued
those units to CCP/Psilos UBL, LLC for the same price.
In February 1999, UBL, LLC issued 392,134 of its common units to Scott
Blum, President of iMusic and our Vice President, Research and Development, in
consideration of his contribution of 540,000 shares of common stock of iMusic,
Inc. All information with respect to units of UBL, LLC in this section gives
effect to a 1,000-for-1 unit split that occurred in April 1999.
EXCHANGE TRANSACTION AND ISSUANCE OF ARTISTDIRECT, LLC SERIES B PREFERRED
UNITS
In May 1999, we completed an exchange transaction in which the holders of
common and/or Series A preferred units of UBL, LLC, other than ADNM exchanged a
total of 8,042,134 UBL, LLC common units and 1,940,000 UBL, LLC preferred units
for a total of 13,982,207 common units and 3,372,920 Series A preferred units of
ARTISTdirect, LLC. At the same time, ADNM distributed units in UBL, LLC to
ARTISTdirect, LLC and to ARTISTdirect Holdings LLC, so that after giving effect
to
78
<PAGE> 80
the exchange and distribution transactions, UBL, LLC was 99% owned by
ARTISTdirect, LLC and 1% owned by ARTISTdirect Holdings LLC. In connection with
this transaction, Messrs. Geiger and Muller contributed 491,467 and 995,819
common units, respectively, to the capital of ARTISTdirect, LLC. These units
were then reissued to Mr. Rubin.
In May 1999, ARTISTdirect, LLC also sold an aggregate of 15,000,000 of its
Series B preferred units at a purchase price of $1.00 per unit to the following
purchasers:
<TABLE>
<CAPTION>
SERIES B AGGREGATE VALUE OF
PREFERRED PURCHASE UNDERLYING
PURCHASER UNITS PRICE COMMON STOCK(1)
--------- --------- ---------- ---------------
<S> <C> <C> <C>
Chase Capital Partners............................ 4,800,000 $4,800,000 $14,400,000
CCP/Psilos ARTISTdirect, LLC...................... 922,509 922,509 2,767,527
Flatiron Fund..................................... 200,000 200,000 600,000
Bowman Capital Management LLC..................... 4,000,000 4,000,000 12,000,000
Constellation Venture Capital, L.P................ 2,500,000 2,500,000 7,500,000
Psilos Group Partners, L.P........................ 1,383,764 1,383,764 4,151,292
Cassandra/ARTISTdirect Partners, LLC.............. 1,000,000 1,000,000 3,000,000
Toronto Dominion Investments, Inc................. 193,727 193,727 581,181
</TABLE>
- -------------------------
(1) Based on the initial offering price of $12.00 per share.
In connection with this financing, the holders of Series A preferred units
in ARTISTdirect, LLC received 354,526 common units in ARTISTdirect, LLC and
$85,000 in exchange for accrued and unpaid preferred returns.
The preferred and common units of ARTISTdirect, LLC were exchanged for
preferred and common stock in connection with the merger of ARTISTdirect, LLC
into ARTISTdirect, Inc. on October 6, 1999. All shares of preferred stock will
convert into shares of common stock on a one-for-one basis upon the closing of
this offering. In addition, approximately 50,000 shares of common stock will be
issued as accrued but unpaid dividends on the preferred stock. See the notes to
the beneficial ownership table in "Principal Stockholders" on page 85 for
information relating to the beneficial ownership of such shares.
ISSUANCES OF ARTISTDIRECT, INC. SERIES C PREFERRED STOCK
Between December 1999 and January 2000, ARTISTdirect, Inc. sold an
aggregate of 7,000,291 of its Series C preferred stock at a purchase price of
$13.928 per share to the following purchasers:
<TABLE>
<CAPTION>
SHARES OF
SERIES C AGGREGATE VALUE OF
PREFERRED PURCHASE UNDERLYING
PURCHASER STOCK PRICE COMMON STOCK(1)
--------- --------- ----------- ---------------
<S> <C> <C> <C>
Universal Music Group, Inc....................... 2,153,935 $30,000,000 $37,500,000
Cisneros Television Group(2)..................... 1,435,957 20,000,000 25,000,000
Sony Music, a Group of Sony Music Entertainment
Inc............................................ 1,076,968 15,000,000 18,750,000
BMG Music d/b/a BMG Entertainment................ 1,076,968 15,000,000 18,750,000
Time Warner Inc.(3).............................. 1,005,170 14,000,000 17,500,000
Yahoo! Inc....................................... 179,495 2,500,000 3,125,000
Maverick Recording Company....................... 71,798 1,000,000 1,250,000
</TABLE>
- -------------------------
(1) Based on the initial offering price of $12.00 per share.
(2) Shares are actually held by Meadowlane Enterprises Ltd., an affiliate of
Cisneros Television Group.
(3) Shares are actually held by Art-Dir Holdings Inc., an affiliate of Time
Warner Inc.
79
<PAGE> 81
Mr. Cisneros, one of our directors, is the Chairman and Chief Executive
Officer of the Cisneros Television Group. Universal Music Group, Inc. has the
right to appoint a director pursuant to the stockholders agreement described on
page 81. The actual number of shares into which each share of Series C preferred
stock will convert is equal to the ratio determined by dividing $13.928 by 80%
of the initial offering price. Based on the initial offering price of $12.00 per
share, each share of Series C preferred stock will convert into approximately
1.4508 shares of our common stock.
STRATEGIC AGREEMENTS WITH SERIES C PREFERRED STOCK INVESTORS
Each of our Series C preferred stock investors entered into strategic
agreements with us in connection with its purchase of Series C preferred stock.
See "Business -- Strategic Relationships" on page 46 for more information on
these agreements. Of these investors, Universal Music Group, Inc. and Cisneros
Television Group will each continue to beneficially own more than 5% of our
common stock after this offering, based on the initial offering price of $12.00
per share.
OPTIONS AND STOCK ISSUED TO JAMES CARROLL
In May 1999, the board granted James Carroll, our Chief Financial Officer,
two options to purchase a total of 459,184 shares of common stock at an exercise
price of $3.60 per share. One-fourth of the 344,388 shares subject to the first
option became exercisable immediately, and the remaining option shares become
exercisable in three equal annual installments from the date of the grant. All
of these remaining option shares become immediately exercisable if a change of
control occurs.
At the time Mr. Carroll's second option was granted, the option was
initially not exercisable and became exercisable as follows:
- One-half of the 114,796 shares underlying Mr. Carroll's second option
would become exercisable upon the completion of an offering.
- The remaining shares underlying this option would become exercisable if
the closing price of our common stock on any two or more trading days
exceeds 150% of the initial offering price during the one month period
following the closing of this offering. The remaining shares would also
become exercisable immediately upon a change of control which occurs
before May 24, 2002, provided that the valuation of ARTISTdirect at the
change of control equaled or exceeded $300 million. In February 2000, we
accelerated the exercisability of this option so that it immediately
became exercisable for all 114,796 of the shares subject to the option.
On September 23, 1999, James Carroll purchased 83,333 shares of common
stock from Don Muller and 27,778 shares of common stock from Keith Yokomoto for
$300,000 and $100,000, respectively.
On March 6, 2000, the board approved an option grant to Mr. Carroll which
became effective on March 27, 2000, the time the initial public offering price
for this offering was determined. The option grant will be for 226,084 shares,
will have an exercise price equal to the initial public offering price of $12.00
per share and will become exercisable with respect to one-third of the option
shares on each anniversary of the effectiveness of the option grant.
DEBT TO EXECUTIVE OFFICERS AND DIRECTOR
In satisfaction of our obligations to make distributions triggered by the
merger of ARTISTdirect, LLC into ARTISTdirect, Inc., we issued a note in the
principal amount of $275,000 to each of Messrs. Geiger and Muller and a note in
the principal amount of $190,714 to Mr. Rubin. Each of these notes bears
interest at a rate of 5.98% per annum and will become due and payable upon the
closing of this offering.
80
<PAGE> 82
DEFERRED COMPENSATION AGREEMENT
In April 1998, we entered into a deferred compensation agreement with Keith
Yokomoto, our President and Chief Operating Officer. The agreement grants Mr.
Yokomoto deferred compensation of up to $200,000, depending on the value of our
company as of the payment date. The compensation is due on the earlier to occur
of:
- Mr. Yokomoto's sale of all of his shares of our common stock;
- the occurrence of specific capital events, including the sale of
substantially all of our assets and receipt of insurance proceeds from
the occurrence of an extraordinary event; or
- April 1, 2005.
Messrs. Geiger and Muller are obligated to contribute to ARTISTdirect the
amounts necessary to fund this obligation. We have recorded the $200,000
obligation as an expense for 1998.
TRANSACTIONS WITH SCOTT BLUM
In connection with UBL, LLC's acquisition of iMusic, we granted Scott Blum,
President of iMusic, and our Vice President, Research and Development, an option
to have all of his shares of our common stock redeemed for a redemption price of
up to $2.8 million. The redemption option is triggered by the occurrence of
specified events, including this offering. Mr. Blum has notified us that he has
decided not to exercise his option. Accordingly, it will terminate on the
closing of this offering. If Mr. Blum had exercised his option we would have
been required to pay a total of $200,000 in bonuses to employees of iMusic
designated by Mr. Blum.
In addition, UBL, LLC entered into a contingent loan agreement with Scott
Blum to make loans to pay federal and state tax liabilities that he may incur as
a result of (a) the liquidation of iMusic or a taxable disposition or other
transfer of iMusic common stock or (b) a distribution of property by UBL, LLC to
Mr. Blum not involving sufficient cash or marketable securities for him to pay
the resulting tax liability, in either case. Any advances to Mr. Blum under the
contingent loan agreement will bear interest at the then lowest permissible rate
under the Internal Revenue Code and be secured by a pledge of a portion of Mr.
Blum's shares of our common stock.
Between 1996 and 1998, Mr. Blum periodically advanced iMusic funds for
various expenses. The largest amount outstanding at any one time during this
period was $66,000. During this period, iMusic leased its principal executive
office from Mr. Blum, for which Mr. Blum received annual rental payments of
$13,500.
REGISTRATION RIGHTS AGREEMENT
We have entered into a registration rights agreement with Rick Rubin, one
of our directors, Marc Geiger, our Chairman of the Board and Chief Executive
Officer, Donald Muller, President of ARTISTdirect Agency and Kneeling Elephant
Records and one of our directors, and the holders of our Series A, Series B and
Series C preferred stock. The registration rights agreement provides these
stockholders with rights to require us to register their stock with the
Securities and Exchange Commission. The holders of these rights have waived them
as to this offering. The other registration rights will survive this offering
and will terminate no later than ten years after the closing date of this
offering.
STOCKHOLDERS AGREEMENT
We have entered into a stockholders agreement with a number of our
stockholders with respect to their rights, restrictions and obligations as
stockholders. These stockholders include several of our officers and directors
and their affiliates, including Marc Geiger, Donald Muller, Keith Yokomoto, L&G
81
<PAGE> 83
Associates One, Steve Rennie, James Carroll, Robert Morse, Constellation Venture
Capital, L.P., Psilos Group Partners, L.P., Rick Rubin, Scott Blum, Chase
Venture Capital Associates, L.P., Universal Music Group, Inc., Meadowlane
Enterprises, Ltd., Sony Music, Art-Dir Holdings Inc., Maverick Recording
Company, BMG Music and Yahoo!. Although most of the provisions of this agreement
will terminate upon the consummation of this offering, the following provisions
will remain in effect:
- Private Transfer. If Messrs. Geiger or Muller, or any of their
transferees, proposes to transfer five percent or more of our outstanding
capital stock in a single private transaction or series of private transactions,
each of the parties to the stockholders agreement will be allowed to participate
in the transaction;
- Mandatory redemption of Elson's Common Stock. William Elson has notified
us that he intends to exercise the option he received in connection with the
settlement agreement described in "-- Settlement Agreement" on page 84. When Mr.
Elson exercises this option, we will be required to automatically redeem an
amount of shares from each of Messrs. Geiger and Muller equal to 50% of the
number of shares of Common Stock issued to Elson pursuant to the option. The
price per share payable to Messrs. Geiger and Muller shall be equal to the price
per share paid by Mr. Elson; and
- Errors and omissions insurance. We are required to obtain and maintain an
errors and omissions insurance policy covering our officers and directors with a
stated policy limit of no less than $5,000,000. Rick Rubin, one of our
directors, Constellation Ventures (BVI), Inc., CCP/Psilos ARTISTdirect, LLC,
Chase Venture Capital Associates, L.P. Flatiron Fund 1998/99, LLC, Universal
Music Group, Inc., Meadowlane Enterprises, Ltd., Sony Music, Art-Dir Holdings
Inc., Maverick Recording Company, BMG Music and Yahoo! shall be additional named
insureds on the policy as long as such coverage is reasonably available.
PERSONAL GUARANTEES BY EXECUTIVE OFFICERS AND DIRECTORS
In February 1999, Marc Geiger, our Chairman of the Board and Chief
Executive Officer, and Donald Muller, President of ARTISTdirect Agency and
Kneeling Elephant Records and one of our directors, personally guaranteed
obligations by us under our $750,000 credit facility with Republic Bank
California, N.A., and obligations by UBL under the $1,250,000 credit facility
with Republic Bank. In November 1999, the $1,250,000 credit facility was
increased to $4,250,000 and James Carroll, our Chief Financial Officer, was
added as one of the personal guarantors on both this facility and the $750,000
facility. Rick Rubin, one of our directors, also personally guaranteed the
obligations by UBL under the $4,250,000 credit facility. As of the date of this
prospectus, no amounts were outstanding under the credit facilities.
In connection with the personal guarantees by Messrs. Geiger and Muller for
the $750,000 line of credit, ARTISTdirect, LLC, ARTISTdirect Holdings, L.L.C.,
ARTISTdirect Agency, LLC, ARTISTdirect New Media, LLC, Kneeling Elephant
Records, Keith Yokomoto, our President, Chief Operating Officer and one of our
directors, L&G Associates One, Stephen P. Rennie, President of The Ultimate Band
List, Robert A. Morse, our Vice President of Business Administration and
Treasurer, Constellation Venture Capital, L.P., Constellation Ventures (BVI),
Inc., Psilos Group Partners, L.P., DreamMedia Internet Ventures, LLC, Carl
Kawabe and CCP/Psilos ARTISTdirect, LLC, each agreed to reimburse Messrs. Geiger
and Muller on demand for any payment they make pursuant to the guarantees.
Additionally, Messrs. Geiger and Muller each agreed to pay the other's
proportionate share of their obligation if either one of them does not receive
the full amount of reimbursement described above.
In connection with the personal guarantees by Messrs. Geiger, Muller,
Carroll and Rubin for the $4,250,000 line of credit, ARTISTdirect, LLC,
ARTISTdirect Holdings, L.L.C., ARTISTdirect Agency, LLC, ARTISTdirect New Media,
LLC, Kneeling Elephant Records, American Recordings, Inc., Constellation Venture
Capital, L.P., Constellation Ventures (BVI), Inc., Psilos Group Partners, L.P.
DreamMedia Internet Ventures, LLC, Carl Kawabe and CCP/Psilos ARTISTdirect, LLC,
each agreed to
82
<PAGE> 84
reimburse Messrs. Geiger, Muller, Carroll and Rubin on demand for any payment
they make pursuant to the guarantees. Additionally, Messrs. Geiger, Muller,
Carroll and Rubin each agreed to pay each other's proportionate share of their
obligation if any one of them does not receive the full amount of reimbursement
described above. Rick Rubin, one of our directors, is President of American
Recordings, Inc.
EQUITY-RELATED TRANSACTIONS BETWEEN OFFICERS AND DIRECTORS
In March 2000, Marc Geiger, Donald Muller and Rick Rubin agreed to enter
into a series of transactions which will effectively transfer to Keith Yokomoto,
Steve Rennie and L&G Associates One the economic benefit of the increase in
value over $13.928 per share with respect to an aggregate of 1,234,386 shares of
our common stock, referred to below as the "Transferred Shares". The purpose of
these transactions was to provide additional equity-based incentives to Messrs.
Yokomoto and Rennie and to provide both equity-based incentives and compensation
for past services to L&G Associates One.
To effect these transactions, Rick Rubin contributed 411,462 shares of his
common stock to ARTISTdirect Investors, LLC in exchange for membership interests
in that entity. ARTISTdirect Investors, LLC is the entity through which Messrs.
Geiger, Muller, Yokomoto, Rennie, and L&G Associates One currently hold their
shares. ARTISTdirect Investors, LLC then granted additional membership interests
to Messrs. Yokomoto and Rennie and L&G Associates One in a transaction that only
diluted the membership interests of Messrs. Geiger, Muller and Rubin. These
additional membership interests, which we refer to as the "Additional
Interests", do not entitle Messrs. Yokomoto or Rennie or L&G Associates One to
any share of the current capital value of ARTISTdirect Investors, LLC. Instead,
the Additional Interests entitle Messrs. Yokomoto and Rennie and L&G Associates
One to any increase in the value of 696,831, 238,913 and 298,642 shares,
respectively, of our common stock held by ARTISTdirect Investors, LLC over
$13.928 per share. Any increase in value will be determined based upon the
closing price of our common stock on the third day of trading, which we refer to
below as the "Closing Price".
Upon closing of this offering, ARTISTdirect Investors, LLC will distribute
the shares of common stock it holds to its members and then dissolve. The number
of shares distributed to each member will be determined based upon the Closing
Price. If the Closing Price does not exceed $13.928, Messrs. Yokomoto and Rennie
and L&G Associates One will not receive any additional shares of common stock
from ARTISTdirect Investors, LLC as a result of its issuance of the Additional
Interests.
In addition to any shares of common stock that they receive from
ARTISTdirect Investors, LLC, upon the closing of this offering, the Company will
issue each of Messrs. Yokomoto and Rennie and L&G Associates One an option to
purchase shares of the Company's common stock. These options will have an
exercise price equal to the Closing Price. The options of Messrs. Yokomoto and
Rennie and L&G Associate One will entitle them to purchase a number of shares
equal to the difference between 696,831, 238,913 and 298,642 and the number of
shares, if any, that ARTISTdirect Investors, LLC distributes to them in respect
of the additional interests. These options have seven year terms. The options to
be granted to Messrs. Yokomoto and Rennie will be granted under our 1999
Employee Stock Plan and will be exercisable at any time following the one year
anniversary of their grant, unless the applicable optionee terminates his
employment prior to that date. In this event, that optionee's option will
terminate. The options granted to Messrs. Yokomoto and Rennie also become
immediately exercisable upon a change of control, or if the optionee dies,
becomes disabled or is terminated by us without cause. The option to be granted
to L&G Associates One will be granted under our 1999 Artist and Artist Advisor
Plan and will be immediately exercisable in full.
Each of Messrs. Rubin, Geiger and Muller have agreed that, upon exercise of
any of these options, they will sell to us, and we will redeem from them, the
same number of aggregate shares that we are required to issue in connection with
the exercise of the option. The price that we will pay Messrs. Rubin, Geiger and
Muller for their shares will be equal to the exercise price that we receive from
the optionee.
83
<PAGE> 85
Each of Messrs. Rubin, Geiger and Muller is obligated to sell us one third of
the number of shares issued by us upon the exercise. To effect this agreement,
Messrs. Rubin, Geiger and Muller have irrevocably authorized us to hold in
escrow share certificates representing the maximum number of shares of common
stock that may be acquired upon exercise of these options.
RETURN OF CAPITAL
In August 1997 and August 1998, we paid a total of $100,000 to Marc Geiger,
our Chairman of the Board and Chief Executive Officer, as a return of capital
that Mr. Geiger previously contributed to us.
PAYMENTS TO LEGAL COUNSEL
In 1998 and 1999, we paid Lenard & Gonzalez LLP $350,000 and $1,010,000,
respectively, for legal services provided to us. Allen Lenard, one of our
directors, is Managing Partner of Lenard & Gonzalez LLP.
SETTLEMENT AGREEMENT
We entered into a settlement agreement with William Elson in connection
with the termination of his employment as our Chief Operating Officer in October
1997. Pursuant to this agreement, Mr. Elson received a severance payment of
$175,000 and an option to purchase the lesser of 100,000 shares of our common
stock, or 2.5% of the common stock issued in this offering at an exercise price
that will be set at the completion of this offering pursuant to the agreement.
Mr. Elson has notified us that he will exercise this option. Messrs. Geiger and
Muller will each contribute half the shares of common stock to be issued to Mr.
Elson upon exercise of his option, in exchange for which we will pay Messrs.
Geiger and Muller the consideration we receive from Mr. Elson for the exercise
of the option. In addition, Mr. Elson loaned us $100,000 in 1996, which we
repaid in 1997.
84
<PAGE> 86
PRINCIPAL STOCKHOLDERS
Except as indicated in footnote (1), the following table sets forth
information with respect to beneficial ownership of our common stock as of
December 31, 1999 and as adjusted to reflect the sale of common stock in this
offering for:
- each person or entity known by us to beneficially own more than 5% of our
outstanding shares of common stock;
- each of our directors;
- each of the named executive officers; and
- all of our directors and executive officers as a group.
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER OF SHARES SHARES BENEFICIALLY
BENEFICIALLY OWNED(1) OWNED
------------------------ ----------------------
BEFORE AFTER BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER OFFERING OFFERING(2) OFFERING OFFERING(2)
------------------------------------ ---------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Entities affiliated with Constellation Venture
Capital, L.P.(3)................................. 2,728,907 2,728,907 8.7% 7.5%
575 Lexington Avenue
New York, New York 10022
Entities affiliated with Chase Capital
Partners(4)...................................... 1,512,238 1,512,238 4.8 4.2
380 Madison Avenue, 12th Floor
New York, New York 10017
Universal Music Group, Inc.(5)..................... 3,125,000 3,125,000 10.0 8.6
10 Universal City Plaza
Universal City, California 91608
Entity affiliated with Cisneros Television Group,
Inc.(6).......................................... 2,083,334 2,083,334 6.6 5.7
404 Washington Avenue
Miami Beach, Florida 33139
BMG Music d/b/a BMG Entertainment(7)............... 1,562,500 1,562,500 5.0 4.3
1540 Broadway
New York, New York 10036
Sony Music, a Group of Sony Music
Entertainment(7)................................. 1,562,500 1,562,500 5.0 4.3
550 Madison Avenue
New York, New York 10022
Marc P. Geiger(8)(9)............................... 3,335,820 3,388,767 10.6 9.3
Donald P. Muller(8)(9)............................. 3,252,486 3,304,107 10.4 9.1
Keith K. Yokomoto(8)(10)........................... 1,955,324 1,926,462 6.2 5.3
Stephen P. Rennie(8)............................... 504,352 453,350 1.6 1.2
James B. Carroll(8)(11)............................ 312,004 312,418 1.0 0.9
Rick Rubin(8)...................................... 3,620,219 3,620,219 11.5 10.0
c/o Alan S. Halfon & Company
9595 Wilshire Boulevard, Suite 505
Beverly Hills, CA 90212
Clifford H. Friedman(3)............................ 2,728,907 2,728,907 8.7 7.5
Carlos E. Cisneros(6).............................. 2,083,334 2,083,334 6.6 5.7
Dara Khosrowshahi.................................. -- -- -- --
Stephen Krupa(12).................................. 1,288,577 1,288,577 4.1 3.5
Allen D. Lenard(8)(13)............................. 378,264 664,536 1.2 1.8
1900 Avenue of the Stars
Twenty-Fifth Floor
Los Angeles, California 90067
All directors and executive officers as a group (11
persons)(14)..................................... 19,459,287 19,472,035 62.0 53.5
</TABLE>
85
<PAGE> 87
- -------------------------
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power
with respect to the securities. Common stock subject to options or warrants
that are currently exercisable or exercisable within 60 days of December
31, 1999 are deemed to be outstanding and to be beneficially owned by the
person holding such options or warrants for the purpose of computing the
percentage ownership of such person but are not treated as outstanding for
the purpose of computing the percentage ownership of any other person.
Unless otherwise indicated, the address for each of the individuals listed
in the table is care of ARTISTdirect, Inc., 17835 Ventura Boulevard, Suite
310, Encino, California. Unless otherwise indicated by footnote, the
persons named in the table have sole voting and sole investment power with
respect to all shares of common stock shown as beneficially owned by them,
subject to applicable community property laws. Percentage of beneficial
ownership before the offering is based on 31,373,185 shares of common stock
outstanding as of December 31, 1999, after giving effect to the issuance of
1,094,917 shares of Series C preferred stock issued in January 2000, and
the conversion of all outstanding shares of the preferred stock. Percentage
of beneficial ownership after the offering is based on 36,373,185 shares of
common stock issued and outstanding after completion of this offering.
These numbers assume the conversion of each share of Series C preferred
stock into approximately 1.4508 shares of common stock, based on the
initial public offering price of $12.00. In addition, these numbers do not
reflect the issuance of an aggregate of approximately 80,200 shares of
common stock as accrued dividends on preferred stock, based on the initial
offering price of $12.00 per share.
(2) Assumes no exercise of the underwriters' over-allotment option.
(3) Includes (a) 1,967,546 shares held by Constellation Venture Capital, L.P.;
and (b) 759,361 shares held by Constellation Ventures (BVI), Inc. Mr.
Friedman is President and Chief Executive Officer of Constellation Ventures
(BVI), Inc. and managing member of Constellation Ventures Management, LLC,
the general partners of Constellation Venture Capital, L.P. As such, Mr.
Friedman may be deemed to exercise voting and investment power over such
shares. Mr. Friedman disclaims beneficial ownership of such shares, except
to the extent of his proportionate interest therein. The number does not
include (a) 515,803 shares held by DreamMedia Internet Ventures, LLC and
(b) 68,347 shares held by Carl Kawabe. DreamMedia and Mr. Kawabe entered
into a voting agreement pursuant to which Mr. Friedman is entitled to vote
their shares of our common stock. The agreement automatically terminates
upon this offering; therefore, after the offering, Mr. Friedman will no
longer have any voting or dispositive power with respect to such shares.
(4) Includes 1,251,507 shares held by Chase Venture Capital Associates, L.P.
and 260,731 shares held by Cassandra/ARTISTdirect Partners, LLC. Chase
Capital Partners is General Partner of Chase Venture Capital Associates,
L.P. which is the managing member of Cassandra/ARTISTdirect Partners, LLC.
As such, Chase Capital Partners is deemed to exercise voting and investment
power over such shares.
(5) Includes 1,059,018 shares of Series C preferred stock issued in December
1999 and 1,094,917 shares of Series C preferred stock issued in January
2000, all of which will be automatically converted into an aggregate of
3,125,000 shares of common stock upon the consummation of this offering,
based on the initial public offering price of $12.00.
(6) Includes 1,435,957 shares of Series C preferred stock held by Meadowlane
Enterprises Ltd., which will be converted into 2,083,334 shares of common
stock upon the consummation of this offering, based on the initial offering
price of $12.00 per share. An affiliate of Cisneros Television Group owns
all of the equity and voting interests in Meadowlane Enterprises Ltd. and
as such, Cisneros Television Group may be deemed to beneficially own such
shares. Mr. Cisneros is the Chairman
86
<PAGE> 88
and Chief Executive Officer of Cisneros Television Group and may be deemed
to exercise voting and investment power over such shares. Mr. Cisneros
disclaims beneficial ownership of such shares.
(7) Includes 1,076,968 shares of Series C preferred stock which will be
automatically converted into 1,562,500 shares of common stock upon the
consummation of this offering, based on the initial offering price of
$12.00 per share.
(8) Includes shares of common stock which are held by ARTISTdirect Investors,
LLC for the benefit of the stockholder. In connection with the merger of
ARTISTdirect, LLC into ARTISTdirect, Inc., Messrs. Geiger, Muller,
Yokomoto, Rennie, Morse and Carroll and L&G Associates One formed
ARTISTdirect Investors, LLC to hold their shares of our common stock. Upon
the closing of this offering, ARTISTdirect Investors, LLC will distribute
the shares of common stock held by it to the stockholders and will be
dissolved. ARTISTdirect Investors, LLC's operating agreement provides each
of its members voting rights with respect to a specific number of shares of
our common stock held by ARTISTdirect Investors, LLC. The number of shares
which each member is entitled to vote is different from the number of
shares each member will receive after the dissolution of ARTISTdirect
Investors, LLC. The actual number of shares of our common stock held by
ARTISTdirect Investors, LLC that each stockholder will receive upon
dissolution and is currently entitled to vote, is as follows:
<TABLE>
<CAPTION>
SHARES ENTITLED ADJUSTMENT OF SHARES TOTAL SHARES
STOCKHOLDER/MEMBER TO VOTE UPON DISTRIBUTION UPON DISTRIBUTION
------------------ ---------------- -------------------- -----------------
<S> <C> <C> <C>
Rick Rubin..................... 411,462 -- 411,462
Marc P. Geiger................. 3,335,820 52,947 3,388,767
Donald P. Muller............... 3,252,486 51,621 3,304,107
Keith K. Yokomoto.............. 1,955,324 (28,862) 1,926,462
James B. Carroll............... 111,111 414 111,525
Stephen P. Rennie.............. 504,352 (51,002) 453,350
Robert A. Morse................ 126,088 (12,748) 113,340
L&G Associates One............. 378,264 (12,370) 365,894
</TABLE>
After the dissolution of ARTISTdirect Investors, LLC, which will occur upon
the consummation of this offering, each stockholder will have sole voting
and dispositive power over an adjusted number of shares that will be
determined based on the closing bid price of the stock on the trading day
immediately prior to the consummation of this offering. The number of
shares set forth under "Total Shares Upon Distribution" for each of Keith
Yokomoto, Stephen Rennie and L&G Associates One above does not reflect the
options that will be issued to these stockholders upon the dissolution of
ARTISTdirect Investors, LLC. The number of shares underlying these options
will be 696,831 for Mr. Yokomoto, 238,913 for Mr. Rennie, and 298,642 for
L&G Associates One, in each case, based on an assumed closing bid price
equal to the initial offering price of $12.00 per share. The option for L&G
Associates One is immediately exercisable and is reflected in beneficial
ownership after the offering. In addition, the number of shares set forth
under "Total Shares Upon Distribution" for each of Marc Geiger, Donald
Muller and Rick Rubin have not been adjusted to reflect the potential
redemption of up to 411,462 shares from each of these stockholders upon the
exercise of the options to Keith Yokomoto, Stephen Rennie and L&G
Associates One. Please see "Related Party Transactions -- Equity-Related
Transactions Between Officers and Directors" on page 83 for more
information on the transactions between the members of ARTISTdirect
Investors LLC.
(9) Does not reflect the effect of the transfer of the 100,000 shares of common
stock that will be contributed by Marc Geiger and Don Muller to William
Elson upon the closing of this offering.
87
<PAGE> 89
Each of Messrs. Geiger and Muller will contribute half of these shares.
Please see "Related Party Transactions -- Settlement Agreement" on page 84
for more information on this transaction.
(10) Includes (a) 361,111 shares held by Keith Yokomoto as trustee of the Geiger
Children's Trust and (b) 361,111 shares held by Keith Yokomoto as trustee
of the Muller Children's Trust. Mr. Yokomoto will have sole voting and
dispositive power over these shares upon the consummation of this offering.
Mr. Yokomoto disclaims beneficial ownership of these shares.
(11) Includes (a) the shares set forth in note (8), (b) 200,893 shares subject
to options which are exercisable within 60 days of December 31, 1999.
(12) Includes (a) 775,519 shares held by Psilos Group Partners, L.P.; (b)
440,325 shares held by CCP/Psilos ARTISTdirect, LLC; and (c) 72,733 shares
held by CCP/Psilos UBL, LLC. Mr. Krupa is managing director of Psilos Group
Managers, LLC and a member of Psilos Group Investors, LLC. Psilos Group
Investors, LLC is the managing member of both CCP/Psilos ARTISTdirect, LLC
and CCP/Psilos UBL, LLC and is the general partner of Psilos Group
Partners, L.P. As such, Mr. Krupa may be deemed to exercise voting and
investment power over such shares. Mr. Krupa disclaims beneficial ownership
of such shares, except to the extent of his proportionate interest therein.
(13) Represents all of the shares held by L&G Associates One. Mr. Lenard is
General Partner of Lenard Holdings, L.P., which is the Managing Partner of
L&G Associates One, and as such, may be deemed to exercise voting and
investment power over such shares. He disclaims beneficial ownership of the
shares held by this entity except to the extent of his proportionate
interest therein.
(14) Includes the information set forth in notes 3, 6, and 8-13 above.
88
<PAGE> 90
DESCRIPTION OF CAPITAL STOCK
GENERAL
Immediately following the closing of this offering, our authorized capital
stock will consist of 150 million shares of common stock, $.01 par value per
share, and 5 million shares of preferred stock, $.01 par value per share. Upon
completion of this offering, based on the number of shares, options and warrants
outstanding as of December 31, 1999, there will be 36,373,185 outstanding shares
of common stock, outstanding options to purchase 6,890,549 shares of common
stock and outstanding warrants to purchase 1,244,394 shares of common stock.
This number reflects the conversion of each share of Series C preferred stock
into approximately 1.4508 shares of common stock, based on the initial public
offering price of $12.00.
COMMON STOCK
As of December 31, 1999, there were 31,373,185 shares of common stock
outstanding and held of record by 44 stockholders, assuming conversion of all
shares of preferred stock into common stock and including the issuance of
1,094,917 shares of Series C preferred stock in January 2000. Based on the
number of shares outstanding as of that date and giving effect to the issuance
of the 5,000,000 shares of common stock offered by us hereby, there will be
36,373,185 shares of common stock outstanding, assuming no exercise of the
underwriters' over-allotment option, upon the closing of the offering.
Holders of the common stock are entitled to one vote for each share held on
all matters submitted to a vote of the stockholders. Holders of common stock are
entitled to receive ratably any dividends that may be declared by the Board of
Directors out of legally available funds, subject to any preferential dividend
rights of any outstanding preferred stock. Upon our liquidation, dissolution or
winding up, the holders of common stock are entitled to receive ratably our net
assets available after the payment of all debts and other liabilities and
subject to the prior rights of any outstanding preferred stock. Holders of
common stock have no preemptive, subscription, redemption or conversion rights.
The outstanding shares of common stock are, and the shares offered by us in this
offering will be upon receipt of payment for such shares, fully paid and
nonassessable. The rights, preferences and privileges of holders of common stock
are subject to, and may be adversely affected by, the rights of holders of
shares of any series of preferred stock which we may designate and issue in the
future without further stockholder approval. Upon the closing of the offering,
there will be no shares of preferred stock outstanding.
PREFERRED STOCK
Upon the closing of this offering, all outstanding shares of our Series A,
Series B and Series C preferred stock will convert into shares of common stock.
Thereafter, the board of directors will be authorized without further
stockholder approval to issue from time to time up to an aggregate of 5 million
shares of preferred stock in one or more series and to fix or alter the
designations, preferences, rights, qualifications, limitations or restrictions
of the shares of each series, including the dividend rights, dividend rates,
conversion rights, voting rights, term of redemption including sinking fund
provisions, redemption price or prices, liquidation preferences and the number
of shares constituting any series or designations of such series without further
vote or action by the stockholders. The issuance of preferred stock may have the
effect of delaying, deferring or preventing a change in control of our
management without further action by the stockholders and may adversely affect
the voting and other rights of the holders of common stock. The issuance of
preferred stock with voting and conversion rights may adversely affect the
voting power of the holders of common stock, including the loss of voting
control to others. We have no present plans to issue any shares of preferred
stock.
89
<PAGE> 91
ANTI-TAKEOVER PROVISIONS
DELAWARE LAW
Upon closing of this offering, we will be subject to the provisions of
Section 203 of the Delaware General Corporation Law regulating corporate
takeovers. Section 203 prevents Delaware corporations, including those that are
listed on the Nasdaq National Market, from engaging in a "business combination"
involving a merger or sale of more than 10% of the corporation's assets, with
any "interested stockholder," that is, a stockholder who owns 15% or more of the
corporation's outstanding voting stock, as well as affiliates and associates of
any such person, for three years following the date that such stockholder became
an "interested stockholder" unless:
- the transaction that resulted in the stockholder becoming an "interested
stockholder" was approved by the board of directors prior to the date the
"interested stockholder" attained such status;
- upon consummation of the transaction that resulted in the stockholder
becoming an "interested stockholder," the "interested stockholder" owned
at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced, excluding those shares owned by (i)
persons who are directors as well as officers and (ii) employee stock
plans in which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be tendered
in a tender or exchange offer; or
- on or subsequent to such date, the "business combination" is approved by
the board of directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of at least two-thirds of the
outstanding voting stock that is not owned by the "interested
stockholder."
A Delaware corporation may "opt out" of Section 203 with an express
provision in its original certificate of incorporation or an express provision
in its certificate of incorporation or bylaws resulting from a stockholders'
amendment approved by at least a majority of the outstanding voting shares. We
have not "opted out" of the provisions of the Anti-Takeover Law. This statute
could prohibit or delay mergers or other takeover or change-of-control attempts
with respect to ARTISTdirect and, accordingly, may discourage attempts to
acquire us.
CHARTER AND BYLAW PROVISIONS
There are provisions in our amended and restated certificate of
incorporation and our amended and restated bylaws, which will become effective
upon the closing of this offering, that may make it more difficult to acquire
control of ARTISTdirect by various means. These provisions could deprive the
stockholders of opportunities to realize a premium on the shares of common stock
owned by them. In addition, these provisions may adversely affect the prevailing
market price of the stock. These provisions are intended to:
- enhance the likelihood of continuity and stability in the composition of
the board and in the policies formulated by the board;
- discourage the types of transactions which may involve an actual or
threatened change in control of ARTISTdirect;
- discourage tactics that may be used in proxy fights;
- encourage persons seeking to acquire control of ARTISTdirect to consult
first with the board of directors to negotiate the terms of any proposed
business combination or offer; and
- reduce our vulnerability to an unsolicited proposal for a takeover that
does not contemplate the acquisition of all outstanding shares of
ARTISTdirect or that is otherwise unfair to our stockholders.
90
<PAGE> 92
Classified Board of Directors; Removal; Filling Vacancies and
Amendment. The certificate and bylaws provide that upon the closing of this
offering the board shall be divided into three classes of directors serving
staggered, three-year terms. The classification of the board has the effect of
requiring at least two annual stockholder meetings, instead of one, to replace a
majority of members of the board. Subject to the rights of the holders of any
outstanding series of preferred stock, the certificate authorizes only the board
to fill vacancies, including newly created directorships. Accordingly, this
provision could prevent a stockholder from obtaining majority representation on
the board by enlarging the board of directors and filling the new directorships
with its own nominees. The certificate also provides that directors may be
removed by stockholders only for cause and only by the affirmative vote of
holders of two-thirds of the outstanding shares of voting stock.
Stockholder Action; Special Meeting of Stockholders. The certificate
provides that stockholders may not take action by written consent, but may only
take action at duly called annual or special meetings of stockholders. The
certificate further provides that special meetings of our stockholders may be
called only by the chairman of the board of directors or a majority of the board
of directors. This limitation on the right of stockholders to call a special
meeting could make it more difficult for stockholders to initiate actions that
are opposed by the board of directors. These actions could include the removal
of an incumbent director or the election of a stockholder nominee as a director.
They could also include the implementation of a rule requiring stockholder
ratification of specific defensive strategies that have been adopted by the
board of directors with respect to unsolicited takeover bids. In addition, the
limited ability of the stockholders to call a special meeting of stockholders
may make it more difficult to change the existing board and management.
Advance Notice Requirements for Stockholder Proposals and Director
Nominations. The bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for election
as directors at an annual meeting of stockholders, must provide timely notice
thereof in writing. To be timely, a stockholder's notice must be delivered to or
mailed and received at our principal executive offices not less than 120 days
prior to the date of our annual meeting. The bylaws also specify requirements as
to the form and content of a stockholder's notice. These provisions may preclude
stockholders from bringing matters before an annual meeting of stockholders or
from making nominations for directors at an annual meeting of stockholders.
Authorized but Unissued Shares. The authorized but unissued shares of
common stock and preferred stock are available for future issuance without
stockholder approval. These additional shares may be utilized for a variety of
corporate purposes, including future public offerings to raise additional
capital, corporate acquisitions and employee benefit plans. The existence of
authorized but unissued shares of common stock and preferred stock could render
more difficult or discourage an attempt to obtain control of us by means of a
proxy contest, tender offer, merger or otherwise.
Supermajority Vote to Amend Charter and Bylaws. The Delaware General
Corporation Law provides generally that the affirmative vote of a majority of
the shares entitled to vote on any matter is required to amend a corporation's
certificate of incorporation or bylaws, unless a corporation's certificate of
incorporation or bylaws, as the case may be, requires a greater percentage. Our
amended and restated certificate of incorporation imposes a 66 2/3% vote
requirement in connection with business combination transactions and the
amendment of some provisions of our certificate of incorporation and bylaws,
including those provisions relating to the classified board of directors, action
by written consent, the ability of stockholders to call special meetings and the
ability of stockholders to bring business before an annual meeting or to
nominate directors. Following the completion of this offering, our present
directors and executive officers and their respective affiliates will
beneficially own approximately 53.5% of our common stock. This gives them veto
power with respect to any stockholder action or approval requiring either a
two-thirds vote or a simple majority.
91
<PAGE> 93
REGISTRATION RIGHTS
We have provided purchasers of our Series A, Series B and Series C
preferred stock and Rick Rubin, one of our directors, with rights to require us
to register their securities under the Securities Act of 1933, as amended.
Please see "Related Party Transactions -- Registration Rights Agreement" on page
81 for more information on these rights.
WARRANTS
As of December 31, 1999, Giant Merchandising and Winterland Concessions
held outstanding warrants to purchase 562,500 and 342,640 shares of our common
stock, respectively, at a price of $4.00 per share, and Yahoo! held a warrant to
purchase 169,627 shares of our common stock at a price of $13.928 per share, and
169,627 shares of our common stock at a price of $12.00 per share.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for our common stock will be ChaseMellon
Shareholder Services.
LISTING
Application has been made for listing the common stock on the Nasdaq
National Market under the trading symbol "ARTD."
RESCISSION OFFER
As of the date of this prospectus, we have issued shares or options to
purchase shares of our common stock to our employees and to artists and their
managers and advisors. Due to the nature of the persons who received these
shares and options in addition to our employees and the total number of shares
and options issued to them and our employees, the issuance of these shares and
options did not comply with the requirements of Rule 701 under the Securities
Act, or any other available exemptions from the registration requirements of
Section 5 of the Securities Act, and may not have qualified for any exemption
from qualification under California securities laws either. Beginning
approximately 180 days after the date of this prospectus, 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 registration statement, at
the purchase or exercise price paid for these shares, plus interest at the rate
of 10% per year from the date of issuance until the rescission offer expires. To
comply with California securities law, we will also offer to repurchase all
unexercised options issued to such persons at 20% of the option exercise price
multiplied by the number of shares subject to such options, plus interest at the
rate of 10% per year 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 on the number of shares and options issued as of February 29, 2000,
we could be required to pay up to approximately $19.8 million plus the total
amount of interest on that amount as described above based on the number of
shares which have been already issued or which may be issued pursuant to vested
unexercised options before the rescission offer period expires and the number of
outstanding options which will not be exercisable throughout the rescission
offer period. We currently expect to use a portion of the net proceeds of this
offering to fund any requested repayment. In addition, we will keep the
rescission offer registration statement, or another form of registration
statement available to us, in effect to cover the issuance of all shares
issuable upon exercise of the options until the last expiration date of all of
the options or until all of the options have been exercised, whichever occurs
first. Offerees who do not accept the rescission offer and persons who exercise
such options while the registration statement is in effect, will, for purposes
of applicable federal and state securities laws, be deemed to hold registered
shares, and those shares will be freely tradeable on the public market as of the
effective date of each
92
<PAGE> 94
registration statement covering such shares. Some of these shares are subject to
contractual vesting restrictions, to which the holders have previously agreed.
The Securities Act does not expressly provide that a rescission offer will
terminate a purchaser's right to rescind a sale of stock, which was not
registered under the Securities Act as required. Accordingly, should any
offerees reject the rescission offer, we may continue to be contingently liable
under the Securities Act for the purchase price of their shares and options
which were not issued in compliance with the Securities Act or California
Securities laws. In this case, based on the number of shares and options issued
as of February 29, 2000, we could be liable for a total amount of up to $33.0
million plus interest.
SHARES ELIGIBLE FOR FUTURE SALE
Before this offering, there has been no market for our common stock, and a
significant public market for our common stock may not develop or be sustained
after this offering. Future sales of substantial amounts of common stock,
including shares issued upon exercise of outstanding options and warrants, in
the public market after this offering could adversely affect market prices
prevailing from time to time and could impair our ability to raise capital
through the sale of our equity securities. Sales of substantial amounts of our
common stock in the public market could adversely affect the prevailing market
price and our ability to raise equity capital in the future.
Upon completion of this offering, we will have outstanding 36,373,189
shares of common stock and 37,123,189 shares if the underwriters exercise their
over-allotment option in full, assuming no exercise of outstanding warrants and
options. Of these shares, 5,000,000 shares, plus an additional 750,000 shares if
the underwriters exercise their over-allotment option in full, of common stock
sold in this offering will be freely tradable without restriction or further
registration under the Securities Act unless purchased by our affiliates. Based
on shares outstanding as of December 31, 1999, the remaining shares will become
eligible for public sale as follows:
<TABLE>
<CAPTION>
APPROXIMATE
NUMBER OF
SHARES
ELIGIBLE FOR
DATE FUTURE SALE COMMENT
---- ------------ -------
<S> <C> <C>
Date of this prospectus........ 5,000,000 Shares sold in this offering
181 days after the date of this
prospectus................... 21,216,933 Underwriters' lock-up period
ends. These shares are eligible
for sale under Rule 144 or 701.
271 days after the date of this
prospectus................... 10,156,252 Additional shares eligible for
sale under Rule 144, assuming
that the shares of common stock
issued upon the automatic
conversion of Series C
preferred stock issued in
December 1999 and January 2000
are eligible.
</TABLE>
LOCK-UP AGREEMENTS
A total of approximately 31,273,185 shares held by our directors, executive
officers and our existing stockholders are subject to "lock-up" agreements
generally providing that, these stockholders will not (1) offer, pledge, sell,
contract to sell, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase, lend, file
a registration statement, or
93
<PAGE> 95
otherwise transfer or dispose of, directly or indirectly, any shares of common
stock or any securities convertible into or exercisable or exchangeable for
common stock or (2) enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences of ownership of
the common stock or such other securities, in cash or otherwise, for a period of
180 days following the date of the final prospectus for this offering without
the prior written consent of Morgan Stanley & Co. Incorporated. The restrictions
described in this paragraph do not apply to:
- the sale of shares to the underwriters;
- the issuance by us of shares of common stock upon the exercise of an
option or a warrant or the conversion of a security outstanding on the
date of this prospectus of which the underwriters have been advising in
writing;
- transactions by any person other than us relating to shares of common
stock or other securities acquired in open market transactions after the
completion of the offering of the shares; or
- transfers by gift or distributions by a partnership to its partners, so
long as, in any such instance, such transferee executes a lock-up
agreement with terms identical to those described in this paragraph.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person or persons whose shares are aggregated,
who has beneficially owned restricted shares for at least one year, including
the holding period of any prior owner except an affiliate, would be entitled to
sell within any three-month period a number of shares that does not exceed the
greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 372,955 shares immediately after this offering, or;
- the average weekly trading volume of the common stock during the four
calendar weeks preceding the filing of a Form 144 with respect to such
sale. Sales under Rule 144 also are subject to manner of sale provisions
and notice requirements and to the availability of current public
information about us. Under Rule 144(k), a person who is not deemed to
have been an affiliate of ARTISTdirect at any time during the three
months preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years, including the holding period
of any prior owner except an affiliate, is entitled to sell such shares
without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
RULE 701
Rule 701 permits resales of shares in reliance upon Rule 144 but without
compliance with some of the restrictions, including the holding period
requirement, of Rule 144. Any employee, officer or director of, or consultant
to, ARTISTdirect who purchased his or her shares pursuant to a written
compensatory plan or contract may be entitled to rely on the resale provisions
of Rule 701. Rule 701 permits affiliates to sell their Rule 701 shares under
Rule 144 without complying with the holding period requirements of Rule 144.
Rule 701 further provides that non-affiliates may sell such shares in reliance
on Rule 144 without having to comply with the holding period, public
information, volume limitation or notice provisions of Rule 144. All holders of
Rule 701 shares are required to wait until 90 days after the date of this
prospectus before selling such shares.
Following the closing of this offering, we intend to file a registration
statement on Form S-8 under the Securities Act covering shares of common stock
subject to outstanding options under our 1999 Employee Stock Option Plan and
nonstatutory stock option agreements which are outside of these plans. Based on
the number of outstanding shares and shares subject to outstanding options as of
December 31,
94
<PAGE> 96
1999, the registration statement would cover approximately 7,317,216 shares.
Such registration statement will automatically become effective upon filing.
Accordingly, subject to the exercise of such options, shares registered under
such registration statement will be available for sale in the open market
immediately after the 180-day lock-up period expires.
REGISTRATION RIGHTS
In addition, some of our stockholders have registration rights with respect
to approximately 20,528,481 shares of common stock. Registration of these
securities under the Securities Act would result in those shares becoming freely
tradeable without restriction under the Securities Act. See "Related Party
Transactions -- Registration Rights Agreement" on page 81 for more information
on these rights.
95
<PAGE> 97
UNDERWRITERS
Under the terms and subject to the conditions contained in the underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc. and Deutsche
Bank Securities Inc. are acting as representatives, have severally agreed to
purchase, and we have agreed to sell to them, severally, the respective number
of shares of common stock indicated below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
---- ---------
<S> <C>
Morgan Stanley & Co. Incorporated........................... 2,162,500
Bear, Stearns & Co. Inc. ................................... 1,081,250
Deutsche Bank Securities Inc. .............................. 1,081,250
Banc of America Securities LLC.............................. 75,000
Dain Rauscher Wessels....................................... 75,000
A Division of Dain Rauscher
E*Offering Corp. ........................................... 75,000
First Union Securities, Inc. ............................... 75,000
FleetBoston Robertson Stephens Inc. ........................ 75,000
Edward D. Jones & Co., L.P. ................................ 75,000
Raymond James & Associates Inc. ............................ 75,000
U.S. Bancorp Piper Jaffray Inc. ............................ 75,000
Thomas Weisel Partners LLC ................................. 75,000
---------
Total............................................. 5,000,000
=========
</TABLE>
The underwriters are offering the shares of common stock subject to their
acceptance of the shares from us and subject to prior sale. The underwriting
agreement provides that the obligations of the several underwriters to pay for
and accept delivery of the shares of common stock offered by this prospectus are
subject to the approval of legal matters by their counsel and to other
conditions. The underwriters are obligated to take and pay for all of the shares
of common stock offered by this prospectus if any such shares are taken.
However, the underwriters are not required to take or pay for the share covered
by the underwriters' over-allotment option described below.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the initial public offering price listed on the
cover page of this prospectus and part to other dealers at a price that
represents a concession not in excess of $.50 a share under the public offering
price. After the initial offering of the shares of common stock, the offering
price and other selling terms may from time to time be varied by the
representatives.
The following table summarizes the per share and total underwriting
discounts and commissions we will pay to the underwriters.
<TABLE>
<CAPTION>
WITHOUT WITH
OVER-ALLOTMENT OVER-ALLOTMENT
-------------- --------------
<S> <C> <C>
Per Share.......................................... $.84 $.84
Total.................................... $4,200,000 $4,830,000
</TABLE>
ARTISTdirect estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $1.67 million. In
addition, shares of our common stock that Morgan Stanley & Co. Incorporated will
receive for providing financial advisory services to us in connection with our
acquisition of Mjuice.com, Inc. have been deemed underwriting compensation
received in connection with this offering by the National Association of
Securities Dealers, Inc.
96
<PAGE> 98
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to an aggregate of 750,000
additional shares of common stock at the initial public offering price listed on
the cover page of this prospectus, less underwriting discounts and commissions.
The underwriters may exercise this option solely for the purpose of covering
overallotments, if any, made in connection with the offering of the shares of
common stock offered by this prospectus. To the extent this option is exercised,
each underwriter may become obligated to purchase about the same percentage of
the additional shares of common stock as the number listed next to the
underwriter's name in the preceding table bears to the total number of shares of
common stock listed next to the names of all underwriters in the preceding
table.
The underwriters have informed ARTISTdirect that they do not intend sales
to discretionary accounts to exceed five percent of the total number of shares
of common stock offered by them.
ARTISTdirect has applied for quotation of its common stock on the Nasdaq
National Market under the symbol "ARTD."
Each of ARTISTdirect and the holders of approximately 31,273,185 shares of
ARTISTdirect common stock has agreed that, without the prior written consent of
Morgan Stanley & Co. Incorporated on behalf of the underwriters, it will not,
during the period ending 180 days after the date of this prospectus:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend or otherwise transfer or dispose of
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock; or
- enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the
common stock.
whether any transaction described above is to be settled by delivery of common
stock or such other securities, in cash or otherwise. The restrictions described
in this paragraph do not apply to:
- the sale of shares to the underwriters;
- the issuance by ARTISTdirect of shares of common stock upon the exercise
of an option or a warrant or the conversion of a security outstanding on
the date of this prospectus of which the underwriters have been advised
in writing; or
- transactions by any person other than ARTISTdirect relating to shares of
common stock or other securities acquired in open market transactions
after the completion of the offering of the shares.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock for
their own account. In addition, to cover over-allotments or to stabilize the
price of the common stock, the underwriters may bid for, and purchase, shares of
common stock in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
common stock in the offering, if the syndicate repurchases previously
distributed common stock in transactions to cover syndicate short positions, in
stabilization transactions or otherwise. Any of these activities may stabilize
or maintain the market price of the common stock above independent market
levels. The underwriters are not required to engage in these activities, and may
end any of these activities at any time.
ARTISTdirect and the underwriters have agreed to indemnify each other
against a number of liabilities, including liabilities under the Securities Act.
97
<PAGE> 99
DIRECTED SHARE PROGRAM
At the request of ARTISTdirect, Morgan Stanley & Co. Incorporated reserved
for sale, at the initial offering price, up to 866,667 shares offered in this
prospectus for directors, officers, employees, and business associates of
ARTISTdirect as well as their family members. The number of shares of common
stock available for sale to the general public will be reduced to the extent
such persons purchase such reserved shares. Any reserved shares which are not so
purchased will be offered by the underwriters to the general public on the same
basis as the other shares offered in this prospectus.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for the common
stock. The initial public offering price will be determined by negotiations
between ARTISTdirect and the representatives of the underwriters. The principal
factors to be considered in determining the initial public offering price will
be the future prospects of ARTISTdirect and its industry in general, sales,
earnings and other financial and operating information of ARTISTdirect in recent
periods, and the price-earnings ratios, price-sales ratios, market prices of
securities and other financial and operating information of companies engaged in
activities similar to those of ARTISTdirect. The estimated initial public
offering price range set forth on the cover page of this preliminary prospectus
is subject to change as a result of market conditions and other factors.
Morgan Stanley & Co. Incorporated and Bear, Stearns & Co. Inc. also acted
as placement agents in connection with our private offering of Series C
preferred stock in December 1999 and January 2000, for which they will receive
customary fees for performing such services. In addition, Morgan Stanley & Co.
Incorporated has provided other financial advisory services to us in connection
with our acquisition of Mjuice.com, Inc. for which Morgan Stanley & Co.
Incorporated will receive $500,000 in shares of our common stock at the initial
offering price, or 41,667 shares, based on the initial public offering price of
$12.00 per share. These securities have been deemed underwriting compensation by
the National Association of Securities Dealers, Inc. and shall not be sold,
transferred, assigned, pledged or hypothecated for one year from the effective
date of this offering.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for
ARTISTdirect by Brobeck, Phleger & Harrison LLP, Irvine, California. As of
December 31, 1999, Brobeck, Phleger & Harrison LLP and a number of individuals
affiliated with Brobeck, Phleger & Harrison LLP beneficially own a total of
7,500 shares of our common stock. Certain legal matters in connection with this
offering will be passed upon for the underwriters by O'Melveny & Myers LLP, Los
Angeles, California.
EXPERTS
The financial statements of ARTISTdirect, Inc. (and its predecessor company
ARTISTdirect, LLC) and subsidiaries as of December 31, 1998 and 1999, and for
each of the years in the three year period ended December 31, 1999, and the
financial statements of iMusic, Inc., as of December 31, 1997 and 1998 and the
years ended December 31, 1997 and 1998, have been included herein and in the
registration statement in reliance upon the reports of KPMG LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
98
<PAGE> 100
WHERE YOU CAN FIND INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 with respect to the shares of common stock offered by this
prospectus. This prospectus, which constitutes a part of the registration
statement, does not contain all of the information set forth in the registration
statement or the exhibits and schedules which are part of the registration
statement. For further information with respect to us and our common stock, see
the registration statement and the exhibits thereto. Statements contained in
this prospectus regarding the contents of any contract or any other document to
which reference is made are not necessarily complete, and, in each instance
where a copy of such contract or other document has been filed as an exhibit to
the registration statement, reference is made to the copy so filed, each such
statement being qualified in all respects by such reference. Any document we
file may be read and copied at the Public Reference Room of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. The public may
obtain information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330. Our filings with the Commission are also available
to the public from the Commission's Web site (http://www.sec.gov).
Upon completion of this offering, we will become subject to the information
and periodic reporting requirements of the Securities Exchange Act and,
accordingly, will file periodic reports, proxy statements and other information
with the Commission. Such periodic reports, proxy statements and other
information will be available for inspection and copying at the Commission's
public reference rooms, and the Web site of the Commission referred to above.
Our principal executive offices are located at 17835 Ventura Boulevard,
Suite 310, Encino, California 91316, and our telephone number is (818) 758-8700.
Our fiscal year ends on December 31. We maintain a worldwide web site at
http://www.artistdirect.com. The reference to our worldwide Web address does not
constitute incorporation by reference of the information contained at this site.
99
<PAGE> 101
ARTISTDIRECT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ARTISTdirect, Inc. and Subsidiaries Consolidated Financial
Statements
Independent Auditors' Report.............................. F-2
Consolidated Balance Sheets............................... F-3
Consolidated Statements of Operations..................... F-4
Consolidated Statements of Changes in Members' and
Stockholders' Equity (Deficit)......................... F-5
Consolidated Statements of Cash Flows..................... F-6
Notes to Consolidated Financial Statements................ F-7
iMusic, Inc. Financial Statements
Independent Auditors' Report.............................. F-28
Balance Sheets............................................ F-29
Statements of Operations.................................. F-30
Statements of Stockholders' Equity (Deficit).............. F-31
Statements of Cash Flows.................................. F-32
Notes to Financial Statements............................. F-33
</TABLE>
F-1
<PAGE> 102
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
ARTISTdirect, Inc.
We have audited the accompanying consolidated balance sheets of
ARTISTdirect, Inc. (and its predecessor company ARTISTdirect, LLC) and
subsidiaries (the Company) as of December 31, 1998 and 1999 and the related
consolidated statements of operations, changes in members' and stockholders'
equity (deficit) and cash flows for each of the years in the three year period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of ARTISTdirect, Inc. and
subsidiaries as of December 31, 1998 and 1999 and the results of its operations
and its cash flows for each of the years in the three year period ended December
31, 1999, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Los Angeles, CA
February 23, 2000, except as to note 2
which is as of March 21, 2000
F-2
<PAGE> 103
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA
REDEEMABLE
SECURITIES AND
STOCKHOLDERS'
DECEMBER 31, EQUITY AT
------------------ DECEMBER 31,
1998 1999 1999
------- -------- --------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,940 $ 69,119
Cash held for clients..................................... -- 770
Accounts receivable, net.................................. 460 1,001
Prepaid expenses and other current assets................. 392 6,795
------- --------
Total current assets.................................... 2,792 77,685
Property and equipment, net................................. 175 3,343
Investments................................................. 373 70
Goodwill and intangibles, net............................... 45 13,415
Other assets, net........................................... 27 4,087
------- --------
$ 3,412 $ 98,600
======= ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Cash held for clients..................................... $ -- $ 770
Accounts payable.......................................... 507 3,709
Accrued expenses.......................................... 761 4,698
Due to employees.......................................... 288 --
Notes payable............................................. -- 741
Deferred revenue.......................................... 157 37
------- --------
Total current liabilities............................... 1,713 9,955
Long term liabilities..................................... -- 683
------- -------- ---------
Total liabilities....................................... 1,713 10,638
Redeemable securities:
Series A redeemable preferred stock, $.01 par value.
Authorized, issued and outstanding 3,207,815 shares in
1998 and 1999. Liquidation preference and redemption
value of $5,021 and $4,963 in 1998 and 1999,
respectively............................................ 5,021 4,963 --
Series B redeemable preferred stock, $.01 par value.
Authorized 3,750,000 shares, 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 $114 and $9,206 in 1998 and 1999,
respectively............................................ 114 9,206 9,854
------- -------- ---------
Total redeemable securities............................. 5,135 111,707 9,854
------- -------- ---------
Member's and stockholders' equity:
Common stock, $.01 par value. Authorized 50,000,000
shares; issued and outstanding 14,088,674 shares in
1999.................................................... -- 141 271
Additional paid-in-capital................................ -- 36,688 138,411
Members' interest......................................... 3,872 -- --
Unearned compensation..................................... (502) (36,976) (36,976)
Accumulated (deficit)..................................... (6,806) (23,598) (23,598)
------- -------- ---------
Total members' and stockholders' equity
(deficit)............................................ (3,436) (23,745) $ 78,108
------- -------- =========
$ 3,412 $ 98,600
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 104
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1998 1999
------ ------- ----------
<S> <C> <C> <C>
Net revenue:
Online product sales................................... $ 269 $ 1,548 $ 5,282
Advertising and other.................................. 95 552 2,910
Agency commissions..................................... 974 1,917 1,304
Record label........................................... 550 565 778
------ ------- ----------
Total net revenue................................... 1,888 4,582 10,274
Cost of revenue:
Direct cost of product sales........................... 262 1,505 5,091
Other cost of revenues................................. 346 1,010 3,380
Stock-based compensation............................... -- -- 1,769
------ ------- ----------
Total cost of revenue............................... 608 2,515 10,240
Gross profit........................................ 1,280 2,067 34
Operating expense:
Product development.................................... 78 589 1,815
Sales and marketing.................................... 196 1,395 13,222
General and administrative............................. 1,442 2,545 10,319
Stock-based compensation(1)............................ -- 3,828 30,304
Depreciation and amortization.......................... 21 59 2,509
------ ------- ----------
Loss from operations................................ (457) (6,349) (58,135)
Income from equity investment.......................... -- 2 50
Interest income (expense), net......................... (3) 29 281
------ ------- ----------
Net loss............................................ $ (460) $(6,318) $ (57,804)
====== ======= ==========
Basic and diluted net loss per share for period from
October 6, 1999 to December 31, 1999................... $ (1.66)
Weighted average shares outstanding used in calculating
net loss per share basic and diluted net loss per share
for period from October 6, 1999 to December 31, 1999... 14,177,463
Pro forma basic and diluted net loss per share:.......... $ (2.96)
====== ==========
Pro forma weighted average shares basic and diluted.... 19,502,437
</TABLE>
- ---------------
(1) Stock-based compensation is comprised of sales and marketing expense of $0
and $8,551, in 1998 and 1999, respectively and general and administrative
expense of $3,828 and $21,753 in 1998 and 1999, respectively.
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 105
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' AND STOCKHOLDERS' EQUITY
(DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
-------------------- PAID IN MEMBERS' UNEARNED ACCUMULATED TOTAL
SHARES AMOUNT CAPITAL INTEREST COMPENSATION DEFICIT EQUITY
---------- ------- ---------- -------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996........... $ -- $ -- $ 100 $ -- $ (28) $ 72
Distribution of members' interest.... -- -- (24) -- -- (24)
Net loss............................. -- -- -- -- (460) (460)
---------- ---- ------- -------- -------- -------- --------
Balance at December 31, 1997........... -- -- 76 -- (488) (412)
Distribution of members' interest.... -- -- (249) -- -- (249)
Profit interests..................... -- -- 4,330 (4,330) -- --
Amortization of unearned
compensation....................... -- -- -- 3,828 -- 3,828
Accrual of dividends to preferred
members............................ -- -- (171) -- -- (171)
Securities subject to rescission..... -- -- (114) -- -- (114)
Net loss............................. -- -- -- -- (6,318) (6,318)
---------- ---- ------- -------- -------- -------- --------
Balance at December 31, 1998........... -- -- 3,872 (502) (6,806) (3,436)
Issuance of securities............... -- -- 13,859 -- -- 13,859
Issuance of options/warrants......... -- -- 51,202 (51,202) -- --
Profit interests..................... -- -- 16,470 (16,470) -- --
Amortization of unearned
compensation....................... -- -- -- 31,198 -- 31,198
Payment of preferred dividend by
LLC................................ -- -- (85) -- -- (85)
Conversion of preferred return to
common securities as an LLC........ -- -- 355 -- -- 355
Accrual of dividends to preferred
members............................ -- -- (1,414) -- -- (1,414)
Accretion of redeemable stock........ -- -- (184) -- -- (184)
Conversion to C corporation.......... 13,699,006 137 42,926 (84,075) -- 41,012 --
Payment of preferred dividend by C --
corporation........................ -- (191) -- -- -- (191)
Exercise of stock option............. 176,666 2 669 -- -- -- 671
Conversion of preferred return to 213,002
common stock as a C corporation.... 2 765 -- -- -- 767
Securities subject to rescission..... -- (6,740) -- -- -- (6,740)
Notes issued to shareholders......... -- (741) -- -- -- (741)
Net loss............................. -- -- -- -- (57,804) (57,804)
---------- ---- ------- -------- -------- -------- --------
Balance at December 31, 1999........... 14,088,674 $141 $36,688 $ -- $(36,976) $(23,598) $(23,745)
========== ==== ======= ======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 106
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss................................................ $(460) $(6,318) $(57,804)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization........................ 21 59 2,509
Income from equity investment........................ -- (2) (50)
Allowance for doubtful accounts and sales returns.... 5 89 29
Write-off of investment.............................. -- -- 250
Amortization of unearned compensation................ -- 3,828 32,073
Changes in assets and liabilities:
Accounts receivable................................ (18) (536) (571)
Prepaid expenses and other current assets.......... (2) (391) (6,628)
Other assets....................................... 59 (49) (2,054)
Accounts payable and accrued expenses.............. 507 1,049 6,384
Deferred revenue................................... 200 (43) (120)
----- ------- --------
Net cash provided by (used in) operating
activities.................................... 312 (2,314) (25,982)
----- ------- --------
Cash flows from investing activities:
Purchases of property and equipment..................... (101) (141) (3,513)
Purchase of programming rights.......................... -- -- (675)
Cash paid for acquisitions.............................. -- -- (237)
Investments............................................. -- (373) (30)
Distribution of earnings from equity investment......... -- -- 33
----- ------- --------
Net cash used in investing activities........... (101) (514) (4,422)
----- ------- --------
Cash flows from financing activities:
Repayment of borrowings................................. (100) -- --
Payment of preferred dividend........................... -- -- (276)
Distribution of members' interest....................... (24) (249) --
Proceeds from exercise of stock options................. -- -- 671
Proceeds from issuance of preferred securities.......... -- 4,850 97,188
----- ------- --------
Net cash (used in) provided by financing
activities.................................... (124) 4,601 97,583
----- ------- --------
Net increase in cash and cash equivalents....... 87 1,773 67,179
Cash and cash equivalents at beginning of period.......... 80 167 1,940
----- ------- --------
Cash and cash equivalents at end of period................ $ 167 $ 1,940 $ 69,119
===== ======= ========
Supplemental disclosure of cash flow information -- cash
paid during the period for interest..................... $ 4 $ 50 $ 11
===== ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 107
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
ORGANIZATION
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. ARTISTdirect, LLC had a 99% ownership
interest in ARTISTdirect Agency LLC, Kneeling Elephant Records, LLC and
ARTISTdirect NewMedia, LLC ("affiliated companies") and has consolidated their
results since inception. In February 1999, Ultimate Band List, LLC ("UBL")
acquired the remaining 80% of iMusic, Inc., a Washington corporation, that it
did not already own. On May 18, 1999, ARTISTdirect, LLC entered into an
agreement with UBL and the affiliated companies whereby units in ARTISTdirect,
LLC were exchanged for the membership interests of UBL and the affiliated
companies. The acquisition of the minority interests in UBL was accounted for
under purchase accounting.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the consolidated accounts of
the Company and its subsidiaries in which it has controlling interests in the
form of voting and operating control. All significant intercompany accounts and
transactions have been eliminated for all periods presented. UBL generated
losses on its operations for all periods prior to the Company's purchase of the
minority interest in UBL. Due to the full funding of those 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.
LIQUIDITY
The Company has relied on various equity financings to fund its operations
in the past. The Company believes that its available cash resources, without the
proceeds from this offering, will be sufficient to meet its anticipated cash
needs for working capital and capital expenditures for the next 12 months.
2. CAPITAL REORGANIZATION AND REVERSE STOCK SPLIT
The common units and redeemable preferred units outstanding immediately
prior to the Capital Reorganization were converted into common stock and
redeemable preferred stock of the C corporation. Each common and preferred unit
converted into one share of common and preferred stock, respectively.
On March 21, 2000, the Company effected a 1 for 4 reverse stock split (the
"Reverse Stock Split"). The outstanding common securities, redeemable
securities, options and warrants have been retroactively adjusted to reflect the
Reverse Stock Split. All discussion of equity amounts in the following footnotes
reflect the effect of the Capital Reorganization and Reverse Stock Split.
3. SIGNIFICANT ACCOUNTING POLICIES
CASH HELD FOR CLIENTS
Cash held for clients consists of funds held on behalf of the Company's
clients for musical performances. The cash is restricted for payment to the
clients, and there is a corresponding amount due to clients.
F-7
<PAGE> 108
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DEPRECIATION
Depreciation is provided using the straight-line method over the following
estimated useful lives:
<TABLE>
<S> <C>
Computer equipment and software................ 3 years
Furniture and fixtures......................... 7 years
</TABLE>
REVENUE RECOGNITION
Online product sales, which consists primarily of the gross amount of sales
revenue paid by the customer for recorded music and merchandise sold via the
Internet, includes shipping fees and is recognized when the products are
shipped. The Company obtains merchandise from merchandisers and manufacturers,
music from a third party distributor, contracts for warehousing and fulfillment,
processes customer orders and provides customer service. The Company takes title
to all products sold and bears the risk of loss for collections and non-delivery
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 direct cost of product sales.
The Company generates revenue from the sale of on-line advertisements under
short-term contracts. To date, the duration of the Company's advertising
commitments has generally averaged from one to three months. Online advertising
revenue is generally recognized ratably in the period in which the advertisement
is displayed, provided that no significant obligations of the Company remain and
collection of the resulting receivable is probable. The Company's obligations
typically include the guarantee of a minimum number of "impressions" or times
that an advertisement appears in pages viewed by the users of the Company's
online properties. The Company records a reserve for contracts in which the
guarantee of a minimum number of impressions is not expected to be met. There
were no such instances as of December 31, 1997, 1998 and 1999.
Revenue generated from sponsorships is recognized evenly over the terms of
the sponsorship agreements.
Agency commission revenue is recognized in accordance with the terms of the
representation agreements between the Company and its clients. Revenue is
generally recorded upon payment for the performance of services or delivery of
materials created by the artists represented.
Overhead advances on the record label are recognized as revenue evenly over
the period covered by the advances. Royalties earned on albums sold by artists
signed to the record label are recognized as revenue at the time the releases
are shipped to the retailer. Reserves are established for possible returns.
COST OF REVENUE
Direct cost of product sales consists of amounts payable to artists, which
includes the cost of merchandise sold and a 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 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
F-8
<PAGE> 109
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
over the period benefited. Non-cash stock-based compensation charges are
recognized over the period of the related agreements.
INVENTORIES
Inventories, included in prepaid expenses and other current assets, consist
of music-related merchandise and amounts advanced for inventory on behalf of
artists and are stated at the net realizable value. Cost is determined using the
first-in, first-out method.
INCOME TAXES
Prior to the Capital Reorganization, the Company was treated as a limited
liability company for federal and state income tax reporting purposes whereby
income (or losses) of the Company was reported in the individual income tax
returns of the Company's members. After the Capital Reorganization, the Company
began accounting for income taxes under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under the asset and
liability method of SFAS No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
PRODUCT DEVELOPMENT COSTS
Product development costs consist primarily of third-party development
costs and payroll and related expenses for in-house Web site development costs
incurred in the start-up and production of the Company's content and services.
ADVERTISING COSTS
Advertising costs are expensed as incurred and totaled $24,000, $461,000
and $7.7 million during the years ended December 31, 1997, 1998 and 1999,
respectively.
INTANGIBLE ASSETS
Goodwill and other intangible assets resulting from the acquisitions of
minority interests in the UBL and iMusic, Inc. are amortized on a straight-line
basis over five years, the estimated period of benefit.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically reviews the carrying amounts of long-lived assets
to determine whether current events or circumstances warrant adjustments to such
carrying amounts. An impairment adjustment is necessary in the event the net
book value of such long-lived assets exceeds the future undiscounted cash flows
attributable to such assets. In such an event, the loss is measured by the
amount that the carrying value of such assets exceeds their fair value.
Considerable management judgment is necessary to estimate the fair value of
assets; accordingly, actual results could vary significantly from such
estimates.
F-9
<PAGE> 110
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONCENTRATION OF CREDIT RISK AND SUPPLIER RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments and trade
accounts receivable. The Company places its cash investments in high credit
quality instruments. Cash balances at certain financial institutions may exceed
the FDIC insurance limits. The Company performs ongoing credit evaluations of
its customers but does not require collateral. Exposure to losses on receivables
is principally dependent on each customer's financial condition. The Company
monitors its exposure to credit losses and maintains allowances for anticipated
losses.
The Company purchases a large percentage of its music-related merchandise
inventory from three suppliers. The Company is subject to risk in the event that
any of the suppliers is unable to fulfill customer orders.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments, which include cash, cash
held for clients, accounts receivable, accounts payable and accrued expenses and
amounts due to employees, approximate fair value because of the short maturity
of these instruments.
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, etc.) 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. Prior to the Capital
Reorganization on October 6, 1999 (see Note 2), the Company was organized as a
limited liability company and had not issued common stock. Accordingly, no
historical loss per share information is included in the attached financial
statements.
PRO FORMA NET LOSS PER SHARE
The pro forma net loss per share for the year ended December 31, 1999 is
computed using the weighted average number of common shares outstanding giving
pro forma effect to the Reverse Stock Split of the Company, the dividend from
the rescission offer, and the automatic conversion of the redeemable preferred
securities into shares of the Company's common stock effective upon the closing
of the Company's initial public offering as if such events occurred on January
1, 1999, or at original issuance date, if later. In addition, the pro forma net
loss does not include an adjustment for the change in tax status due to the
Capital Reorganization as there was no pro forma effect on income tax expense.
Pro forma diluted loss per share excludes 7.6 million of securities (after
giving effect to the Reverse Stock Split) as of December 31, 1999, since the
impact would be anti-dilutive.
F-10
<PAGE> 111
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table is a reconciliation of the shares and net loss amounts
used in the pro forma net loss per share calculation:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1999
------------
<S> <C>
Actual shares at beginning of the period.................... 16,568,192
Pro forma weighted average shares issued during the
period.................................................... 2,934,245
----------
Pro forma basic and diluted weighted average shares at the
end of the period......................................... 19,502,437
==========
</TABLE>
PRO FORMA REDEEMABLE STOCK AND STOCKHOLDERS' EQUITY
Effective upon the closing of this offering, the outstanding shares of
Series A, Series B and Series C Redeemable Preferred Stock will automatically
convert into approximately 3,207,815, 3,750,000 and 5,905,374 shares,
respectively, of common stock (after giving effect to the Reverse Stock Split).
The pro forma effects of these transactions have been reflected in the
accompanying Pro Forma Stockholders' Equity at December 31, 1999.
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
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 non-employees in accordance with SFAS No. 123, 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 130, "Reporting
Comprehensive Income," in June 1997. SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income includes all changes in
members' equity (except those arising from transactions with members) and
includes net income and net unrealized gains (losses) on securities. There is no
impact on the Company's financial statements as a result of the implementation
of SFAS No. 130.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use,"
which provides guidance on accounting for the cost of computer software
developed or obtained for internal use. SOP No. 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998. The adoption of
SOP 98-1 did not have a material impact on the financial statements.
In April, 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities and
organization costs to be expensed as incurred. The Company is required to adopt
F-11
<PAGE> 112
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SOP 98-5 for the year ended December 31, 1999. The adoption of SOP 98-5 is not
expected to have a material impact on the Company's consolidated financial
statements.
The Financial Accounting Standards Board recently issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000 (as amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective date of FASB Statement No.
133"). SFAS 133 establishes accounting and reporting standards for derivative
instruments and hedging activities by requiring that all derivative instruments
be reported as assets or liabilities and measured at their fair values. Under
SFAS 133, changes in the fair values of derivative instruments are recognized
immediately in earnings unless those instruments qualify as hedges of the (1)
fair values of existing assets, liabilities, or firm commitments, (2)
variability of cash flows of forecasted transactions, or (3) foreign currency
exposures on net investments in foreign operations. The adoption of SFAS No. 133
is not expected to have a material impact on the Company's consolidated
financial statements.
4. SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
Significant non-cash investing and financing activities are reflected in
the following table:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
---------------
1998 1999
---- -------
(IN THOUSANDS)
<S> <C> <C>
Cash paid for acquisitions:
Fair value of net assets acquired......................... $ -- $ 2,463
Net liabilities assumed................................... -- (185)
Common units issued....................................... -- (2,168)
---- -------
Cash paid for acquisitions........................... $ -- $ 110
==== =======
Issuance of common securities for minority interests in
affiliated companies:
Issuance of common securities............................. $ -- $13,922
Acquisition costs -- cash paid............................ 127
Net assets acquired....................................... -- (938)
---- -------
Goodwill............................................. $ -- $13,111
==== =======
Accrual of dividends on redeemable preferred securities..... $171 $ 1,414
Securities subject to potential rescission offer............ $114 $ 6,740
Accretion on redeemable stock............................... $ -- $ 184
Issuance of options/warrants................................ $ -- $51,202
Appreciation of profit interests............................ $ -- $16,470
Conversion of preferred return to common securities......... $ -- $ 1,122
Issuance of shares to officer............................... $ -- $ 875
Notes issued to shareholders................................ $ -- $ 741
</TABLE>
F-12
<PAGE> 113
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1998 1999
---- ------
(IN THOUSANDS)
<S> <C> <C>
Computer equipment and software............................. $220 $3,559
Furniture and fixtures...................................... 33 207
---- ------
253 3,766
Less accumulated depreciation............................... (78) (423)
---- ------
Property and equipment, net................................. $175 $3,343
==== ======
</TABLE>
6. ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURN RESERVE
A summary of the activity of the allowance for doubtful accounts for the
periods indicated is reflected in the following table:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
---------------
1998 1999
----- ------
(IN THOUSANDS)
<S> <C> <C>
Balance, beginning of period................................ $ -- $ 81
Provision for doubtful accounts............................. 115 385
Amounts charged off......................................... (34) (377)
---- -----
Balance, end of period...................................... $ 81 $ 89
==== =====
</TABLE>
A summary of the activity of the reserve for sales returns for the periods
indicated is reflected in the following table:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
---------------
1998 1999
----- ------
(IN THOUSANDS)
<S> <C> <C>
Balance, beginning of period................................ $ 5 $ 13
Provision for sales returns................................. 16 180
Amounts charged off......................................... (8) (159)
--- -----
Balance, end of period...................................... $13 $ 34
=== =====
</TABLE>
F-13
<PAGE> 114
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1998 1999
---- ------
(IN THOUSANDS)
<S> <C> <C>
Accrued payroll and related........................... $105 $1,470
Accrued advertising costs............................. 88 873
Accrued cost of sales................................. 359 865
Accrued professional fees............................. 143 333
Programming rights.................................... -- 682
Other accrued expenses................................ 66 475
---- ------
Total accrued expenses........................... $761 $4,698
==== ======
</TABLE>
8. INVESTMENTS
Investments are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1998 1999
---- ------
(IN THOUSANDS)
<S> <C> <C>
American Digital Network.............................. $250 --
iMusic, Inc........................................... 100 --
SnoCore, LLC.......................................... 23 70
---- ------
Total investments................................... $373 $ 70
==== ======
</TABLE>
In 1998 the Company acquired a 1.7% ownership in American Digital Networks
("ADN") and accounted for this investment under the cost method. During 1999,
the Company fully reserved its investment in ADN to reflect its estimated net
realizable value.
As of December 31, 1998, the Company had an approximate 20% ownership in
iMusic, Inc. The majority owner in iMusic, Inc. had a 76% voting interest. As
the Company was not able to exert significant influence in the management of
iMusic, Inc., the investment was accounted for under the cost method. In
February 1999, the Company acquired all of the outstanding capital stock of
iMusic, Inc. that it did not already own.
As of December 31, 1998 and December 31, 1999, the Company has a 30% and
45%, respectively, ownership in SnoCore, LLC, and accounts for the investment
under the equity method. The Company recorded income of $2,000 and $50,000 for
this investment for the years ended December 31, 1998 and 1999, respectively.
The Company received a $33,000 distribution of income from the investee during
the year ended December 31, 1999.
In December 1999, the Company entered into a joint venture with Cisneros
Television Group. The venture will be owned and funded equally by both parties,
and will be accounted for under the equity method. Neither party made capital
contributions during the year ended December 31, 1999.
F-14
<PAGE> 115
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LINE OF CREDIT
In 1997, the Company obtained a $250,000 line of credit with a financial
institution. The line was increased to $500,000 during 1998, to $2.0 million in
February 1999 and to $5.0 million in November 1999. The line of credit is
guaranteed by certain officers and stockholders of the Company and bears
interest, which is payable monthly, at a base rate as defined in the lending
agreement plus 1%. There was no balance outstanding on the line of credit as of
December 31, 1998 and the line of credit was terminated at the Company's option
in September 1999 and reinstated in October 1999. As of December 31, 1999, there
was no balance outstanding on the line of credit.
10. ACQUISITIONS
In February 1999, the Company acquired the remaining 80% of iMusic, Inc.
that it did not own. The consideration paid for the acquisition included
$110,000 in cash, redeemable common units of UBL equal to 2% of its membership
interests and the assumption of approximately $180,000 of liabilities. The value
of the redeemable common units given was approximately $2.2 million. The
acquisition has been accounted for as a purchase and the operations of iMusic,
Inc. have been included from the date of acquisition. The Company recorded
goodwill of approximately $2.4 million as a result of this acquisition, which is
being amortized over a five year period.
In May 1999 the Company acquired the 40.29% minority interest in the UBL in
exchange for common interests in ARTISTdirect, LLC. The value of the
consideration given was approximately $13.9 million, which was based on the
value of the equity given, using the pricing of third party equity contributed
at or around the time of the purchase transaction; the transaction has been
accounted for as a purchase. Due to the full funding of the losses of UBL by the
Company and its members prior to the purchase of the minority interest, none of
the losses generated by UBL during the periods presented have been allocated to
the minority holders. The Company recorded goodwill of approximately $13.1
million as a result of this acquisition, which is being amortized over a five
year period.
The pro forma results of operations assuming the above transactions had
occurred at the beginning of the period as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1999
---------------
(IN THOUSANDS)
<S> <C>
Revenues.................................................. $10,337
-------
Net loss.................................................. $58,975
-------
</TABLE>
F-15
<PAGE> 116
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES
Income taxes for the period from October 6, 1999 (the date of conversion to
a C corporation) to December 31, 1999 differs from the amount computed using the
federal income tax rate of 34% as a result of the following (amounts in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1999
------------
<S> <C>
Computed expected tax benefit.............................. $(8,259)
State and local income taxes, net of federal income tax
benefit.................................................. (977)
FAS 109 implementation..................................... (9,227)
Goodwill amortization...................................... 271
Other...................................................... 27
Increase in valuation allowance............................ 18,165
-------
Total tax benefit................................ $ --
=======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and (liabilities) at December 31, 1999 are
presented below:
<TABLE>
<S> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $ 4,520
Amortization of stock based compensation.................. 14,296
Other..................................................... 576
--------
Total deferred tax assets................................... 19,392
Less -- valuation allowance................................. (18,165)
--------
Net deferred assets......................................... 1,227
--------
Deferred tax liability -- state income taxes................ (1,227)
--------
Net deferred tax assets........................... $ --
========
</TABLE>
At December 31, 1999, the Company had net operating loss carryforwards
totaling approximately $11.5 million for Federal income tax purposes expiring in
2019 and California state net operating loss carryforwards of $5.7 million
expiring in 2004. Due to the uncertainty surrounding the realization of the
benefits of its tax attributes, including net operating loss carryforwards in
future tax returns, the Company has recorded a valuation allowance against its
deferred tax assets as of December 31, 1999 of $18.2 million.
In assessing the potential realization of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will be realized. The ultimate realization of deferred tax
assets is dependent upon the Company attaining future taxable income during the
periods in which those temporary differences become deductible. In addition, the
utilization of net operating loss carryforwards may be limited due to
restrictions imposed under applicable Federal and state laws due to a change in
ownership.
12. SIGNIFICANT CONTRACTS
The Company entered into a settlement agreement with an employee in
connection with the termination of his employment in October 1997. Pursuant to
this agreement, the employee received a
F-16
<PAGE> 117
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
severance payment of $175,000, to be paid out in eight quarterly installments.
The amount due under this severance arrangement was $175,000 and $88,000 as of
December 31, 1997 and 1998, respectively. The amount was paid in full as of
December 31, 1999. Additionally, this individual loaned the Company $100,000 in
1996, the entire amount of which was repaid in 1997. As part of the settlement
agreement, the individual received an option to purchase the lesser of 100,000
securities or 2.5% of the shares offered to the public upon an initial public
offering at an exercise price that will be set at the completion of the initial
public offering pursuant to the provision defined in the settlement agreement.
The excess of the fair value of the shares at the date of grant over the
consideration paid will be recorded as compensation expense. The employee has
communicated to the Company that he intends to exercise the purchase option.
In 1998 the Company entered into an employment agreement with an officer of
the Company under which deferred compensation of up to $200,000 was granted. The
value of the deferred compensation was determined based on the value of the
Company as of the payment date. The Company has accrued $200,000 in deferred
compensation.
The Company has an investment in American Digital Network (ADN), and also
entered into a software development agreement with ADN in 1997. The Company paid
ADN $250,000 for development of the software, and received a payment of $250,000
from ADN for the license to use the software. These transactions have been
netted together in the financial statements.
For the years ended December 31, 1998 and 1999, the Company incurred legal
expenses of approximately $450,000 and $1,101,000, respectively, for legal
services provided by Lenard & Gonzalez LLP. Allen Lenard, one of the Company's
directors, is Managing Partner of Lenard & Gonzalez LLP.
Kneeling Elephant Records, LLC, a subsidiary of the Company, entered into
an agreement with RCA in January 1997. Kneeling Elephant is a record label
managed by the Company. Under the agreement, RCA provides all funding to the
Company for the label and owns the rights to all sound recordings made under
artist agreements during the initial three year term of the agreement. RCA has
an option to terminate its agreement with Kneeling Elephant after three years,
at which point, the assets and properties of Kneeling Elephant shall be divided
based on the terms of the agreement. The maximum term of the agreement is six
years. Under the agreement, RCA provided funding of $300,000 in January 1997,
which has been recognized ratably over the minimum three year operating term.
Additionally, RCA has provided annual funding of $450,000 to the Company for the
operation of Kneeling Elephant under the terms of the agreement. RCA shall
provide additional funding based on the occurrence of certain events in the
future. The profits and losses of Kneeling Elephant shall be divided based on
the terms and conditions of the agreement. The ownership structure is also
subject to change based on the achievement of certain financial guidelines. The
amounts due from RCA as of December 31, 1997, 1998 and 1999 are $1,000, $4,000,
and $1,000, respectively.
In April 1999, the Company entered into an agreement with a merchandiser
for a term of four years. In exchange for merchandise fulfillment services, the
Company granted the merchandiser warrants to purchase 131,250 shares of common
stock (after giving effect to the Reverse Stock Split) upon the signing of the
agreement. Additional warrants to purchase common stock may be earned by the
merchandiser based on the achievement of various sales levels.
In June 1999, the Company entered into an agreement with a merchandiser for
a three-year term. In exchange for merchandise fulfillment services over the
term of the agreement, the Company paid a deposit of $1.0 million which is being
amortized over the term of the agreement, and granted the merchandiser warrants
to purchase 228,426 shares of common stock (after giving effect to the Reverse
F-17
<PAGE> 118
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock Split) upon the signing of the agreement. Additional warrants to purchase
common stock may be earned by the merchandiser based on the achievement of
various sales levels.
In November 1999, the Company entered into three year programming license
agreement with CHUMcity International. The Company is amortizing the license
cost over the contractual license period.
In December 1999, the Company entered into an eighteen month marketing
agreement with ABC News Internet Ventures. The agreement provides for the
exchange and distribution of content by both parties. As the values of the
content and services being provided by both parties is not readily determinable,
the content and services provided and received by the Company will be recorded
at their cost basis to the Company, which is zero.
In connection with the issuance of Series C Preferred shares, the Company
entered into strategic relationships with four record labels. Under the terms of
these agreements, the Company has the right to purchase certain content related
to each of the respective companies' artists on terms generally made available
to other online music companies. The cost associated with the acquisition of
such content will be expensed as it is acquired and broadcast online.
In December 1999, the Company entered into a two-year advertising and
promotion agreement with Yahoo! pursuant to which the Company will purchase
media placement on Yahoo! in return for certain promotional considerations. The
Company will record the expense related to the amounts paid to Yahoo! for
advertising and promotion services over the term of the agreement as services or
promotions are received. Also in connection with the agreement, the Company
issued Yahoo! warrants to purchase 339,254 shares of common stock (after giving
effect to the Reverse Stock Split). The exercise price for 169,627 of the
warrants is $13.93, and the exercise price for the remaining warrants shall be
the IPO price. The expense related to the warrants will also be amortized over
the term of the agreement.
13. REDEEMABLE SECURITIES
From July through December 1998, the Company issued redeemable preferred
units for proceeds of $4.9 million. These preferred units were converted into
12.8 million Series A ARTISTdirect, LLC redeemable preferred securities pursuant
to the Exchange Transaction, and were converted into 3,207,815 shares of Series
A Redeemable Preferred Stock (Series A Preferred) pursuant to the Capital
Reorganization and Reverse Stock Split. The Series A Preferred shares carry a
10% cumulative annual dividend, and may be converted into common shares at any
time by the holder. Upon conversion, the shareholders shall receive a cash
payment of 25% of the accrued unpaid dividends through the date of the Capital
Reorganization. The number of common shares into which the preferred shares may
be converted is calculated as the initial capital contribution divided by the
current conversion price. The current conversion price is $1.51 per preferred
share (after giving effect to the Capital Reorganization and Reverse Stock
Split). The conversion price shall be updated periodically based on the fair
value of the Company. All Series A Preferred shares shall be automatically
converted to common shares upon an initial public offering or the conversion of
95% of the shares initially issued. The shareholders have the right to redeem
the Series A Preferred shares upon a management vacancy by one of the founders
of the Company prior to July 28, 2003, or at any time after July 28, 2003. The
Series A Preferred shares have liquidation preference over all other classes of
shares except for the Series B Preferred shares. The liquidation preference and
redemption value of the Series A Preferred shares was approximately $5.0 million
as of December 31, 1998 and 1999.
F-18
<PAGE> 119
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On February 17, 1999, the Company issued 170,443 redeemable common shares
(Redeemable Stock) (after giving effect to the Reverse Stock Split) for the
purchase of the remaining 80% of iMusic, Inc. The holder of the Redeemable Stock
shall have the right to redeem the Redeemable Stock upon the earlier of an
initial public offering or February 17, 2002. The redemption value shall be $2.8
million. Upon redemption, the Company is also required to pay a total of
$200,000 in bonuses to employees of iMusic, Inc. as designated by the holder.
The holder has communicated to the Company that he will not exercise the
redemption right and will retain the common shares. The Redeemable Stock was
initially recorded at its fair value which shall be accreted to the redemption
value through February 2002. The Redeemable Stock has liquidation preference
over the common shares. The accreted value, which is also the liquidation
preference and redemption value, of the Redeemable Stock was approximately $2.4
million as of December 31, 1999.
On May 18, 1999, the Company issued 3,750,000 Series B redeemable preferred
shares (Series B Preferred) (after giving effect to the Reverse Stock Split) for
proceeds of $15 million. The Series B Preferred shares have the same redemption
terms as the Series A Preferred shares, and have a current conversion price of
$4.00 per share. The Series B Preferred shares have liquidation preference over
all other classes of shares. The liquidation preference and redemption value of
the Series B Preferred shares was $15.4 million as of December 31, 1999.
In December 1999, the Company issued 5,905,374 Series C redeemable
preferred shares (Series C Preferred) (after giving effect to the Reverse Stock
Split) for proceeds of $82.2 million and in January 2000, the Company issued an
additional 1,094,917 Series C Preferred shares for proceeds of $15.2 million.
The total sum of $97.5 million was raised through the sale of shares to six
music and media companies which included Universal Music Group, BMG
Entertainment, Sony Music Entertainment, Time Warner Inc, an affiliate of
Cisneros Television Group and Yahoo! The Series C Preferred shares have the same
redemption terms as the Series A and Series B Preferred shares and had an
initial conversion price of $13.928 per share. The liquidation preference and
redemption value as of December 31, 1999 was $82.3 million.
Included in Redeemable Common Securities are amounts related to options and
securities subject to a potential rescission offer. The rescission offer will
include an offer to repurchase shares issued directly to certain individuals or
purchased pursuant to option exercises at the exercise price, plus interest at
an annual rate of 10% from the date of issuance. To comply with California
Securities law, the Company will also offer to repurchase all unexercised
options issued to such persons at 20% of the option exercise price multiplied by
the number of shares subject to such options, plus interest at an annual rate of
10% per year from the date of issuance. The amounts due under the potential
rescission offer aggregated $114,000 and $6.9 million as of December 31, 1998
and 1999, respectively, including interest. Under the terms of the rescission
offer, the Company could be required to repurchase all underlying shares and
options that may be exercisable within 180 days of the date of the prospectus
for the initial public offering. The potential rescission offer based on the
repurchase of all shares underlying options outstanding as of December 31, 1999
that may be exercisable within 180 days of the date of the prospectus for the
initial public offering is approximately $17.5 million plus interest. The
potential rescission offer based on the repurchase of all shares underlying
options outstanding as of December 31, 1999 is approximately $27.0 million plus
interest.
F-19
<PAGE> 120
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. MEMBERS' EQUITY
MEMBER DISTRIBUTIONS
The Company made distributions to members of $24,000, $249,000 and $741,000
in 1997, 1998 and 1999, respectively.
COMMON UNIT INTERESTS
During 1998, the Company issued common units to certain executive employees
and its outside legal counsel in connection with services rendered and to be
rendered. In January 1998, Keith Yokomoto and L&G Associates One, an affiliate
of Lenard & Gonzalez LLP, one of the Company's outside legal counsel, received
interests of 10.1% and 3.03%, respectively. In June 1998, Steve Rennie and
Robert Morse received interests of 4.04% and 1.01%, respectively. The units
provide for the holder to share in the profits and losses of the entity
consistent with the rights and limitations of the other equity holders. The
units represent a common unit but limit the holder to share in the capital of
the Company only to the extent of increases in the fair value of the Company
subsequent to the issuance of the units. The value of the common units at the
time of their issuance, which represents existing capital, will remain the
property of the founders. The common units issued to employees under these
agreements have been accounted for as stock appreciation rights. The common
units issued to outside legal counsel were valued at estimated fair value as
determined by the Company. Accordingly the value of these rights are adjusted
upon changes in the fair value of the Company. The Company has estimated the
fair value of the Company for the periods presented based primarily on third
party equity financing. The Company has recorded compensation expense of $3.8
million and $16.3 million for the years ended December 31, 1998 and 1999,
respectively, related to the employee and legal counsel common units. There is
no provision for the Company to settle common units in cash or by issuance of
additional equity securities.
WARRANTS
In May and June 1999, the Company issued 359,676 warrants to purchase
common stock (after giving effect to the Reverse Stock Split) to two vendors
from whom it purchases merchandise ("merchandisers"). The value of the warrants
is $864,000, of which $168,000 has been recognized as expense for the year ended
December 31, 1999. The value of the warrants has been recorded as unearned
compensation in the statement of changes in members' and stockholders' equity,
and will be amortized as cost of revenues over the term of the related
merchandising agreements. Additionally, the merchandisers may earn up to 545,464
of additional warrants based on certain performance levels as specified in the
merchandising agreements.
In December 1999, the Company issued 339,254 warrants to purchase common
stock in connection with an advertising and promotion agreement. The value of
the warrants is $2.0 million, of which $19,000 has been recorded as expense for
the year ended December 31, 1999. The value of the warrants will be amortized
over the term of the related agreement.
PREFERRED DIVIDENDS
On May 18, 1999, the Company paid to the Series A redeemable preferred
securities holders the accrued dividends to that date of $355,000 in the form of
88,632 common shares (after giving effect to the Reverse Stock Split), as well
as a cash payment of $85,000.
F-20
<PAGE> 121
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On October 6, 1999, the Company paid to the Series A and B redeemable
preferred stockholders the accrued dividends to that date of $767,000 in the
form of 213,002 shares of common stock (after giving effect to the Reverse Stock
Split), as well as a cash payment of $191,000.
PURCHASE OF SHARES BY OFFICER
In September 1999, the Company's Chief Financial Officer purchased 111,111
shares of common securities from certain officer stockholders at a purchase
price of $3.60 per share. The difference between the purchase price and the fair
value of the securities as of the date of the transaction has been reflected as
stock-based compensation. The amount of stock-based compensation aggregated
$875,000. The Company determined the fair value of the securities based on the
continued growth of the Company's operations and recent equity transactions with
third parties.
15. OPTIONS
In July 1998, the Company implemented the 1998 Unit Option Plan (which was
subsequently amended and replaced by the 1999 Employee Stock Option Plan), which
reserved 5,250,000 shares (after giving effect to the Reverse Stock Split) of
our common stock for issuance to employees, non-employee members of our board of
directors and consultants. This share reserve will automatically increase on the
first trading day in January each calendar year, beginning 2001, by an amount
equal to two percent (2%) of the total number of shares of our common stock
outstanding on the last trading day of December in the prior calendar year, but
in no event will this annual increase exceed 875,000 shares. No option may have
a term in excess of 10 years. The options issued during 1998 and 1999 vest
within three years. As of December 31, 1999, 1,445,470 shares remained available
for future option grant.
The Company accounts for its employee stock option plan in accordance with
the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. As such,
compensation expense would be recorded on the date of grant only if the current
market price of the underlying stock exceeded the exercise price.
Summary stock option activity for 1999 Stock Option Plan during the years
ended December 31, 1998 and 1999 is as follows (after giving effect to the
Reverse Stock Split):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- ----------------
<S> <C> <C>
Outstanding options at December 31, 1997........ -- $ --
Granted....................................... 356,718 1.52
Exercised..................................... -- --
Canceled...................................... -- --
--------- -----
Outstanding options at December 31, 1998........ 356,718 1.52
Granted....................................... 3,449,062 3.60
Exercised..................................... (58,750) 3.40
Canceled...................................... (1,250) 3.60
--------- -----
Outstanding options at December 31, 1999........ 3,745,780 $3.41
========= =====
</TABLE>
F-21
<PAGE> 122
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During the year ended December 31, 1999 the Company issued 7,500 options to
consultants, resulting in a weighted average fair value per option of $10.21,
and a total value of $77,000. The Company recorded this amount as stock based
compensation for the year ended December 31, 1999.
If the Company had elected to recognize compensation cost based on the fair
value at the date of grant, consistent with the method as prescribed by SFAS No.
123, net loss for the years ended December 31, 1998 and 1999 would have changed
to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Net loss:
As reported................................ $6,318 $57,804
Pro forma.................................. 6,334 $58,254
====== =======
</TABLE>
The fair value of options granted during 1998 and 1999 was determined using
a minimum value pricing model with the following assumptions: risk-free interest
rate of 6.0% and an expected life of five years. The weighted average fair
values of the options on the date of grant were $.32 per share and $5.56 per
share for the options granted in 1998 and 1999, respectively.
The following table summarizes information regarding options outstanding
and options exerciseable at December 31, 1999 (after giving effect to the
Reverse Stock Split):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICE OF SHARES LIFE PRICE OF SHARES PRICE
- ----------- --------- ----------- -------- ------------ --------
<C> <C> <S> <C> <C> <C>
$ 1.24 256,746 8.60 years $1.24 158,497 $1.24
2.30 94,972 8.60 2.32 58,534 2.32
3.60 3,394,062 9.62 3.60 204,683 3.60
- ----------- --------- ---------- ----- --------- -----
$1.24-$3.60 3,745,780 9.52 years $3.41 421,713 $2.54
=========== ========= ========== ===== ========= =====
</TABLE>
In June 1999 and as amended in October 1999, the Company adopted the 1999
Artist and Artist Advisor Stock Option Plan (the Advisor Plan). The Plan has
reserved 1,250,000 shares (after giving effect to the Reverse Stock Split) of
common stock for issuance to artists for whom the Company maintains
ARTISTchannels and their agents, business managers, attorneys and other
advisors. This share reserve will automatically increase on the first trading
day in January each calendar year, beginning 2001, by an amount equal to one
percent (1%) of the total number of shares of our common stock outstanding on
the last trading day of December in the prior calendar year, but in no event
will this annual increase exceed 375,000 shares. As of December 31, 1999,
251,375 shares remained available for future option grants. The options expire
seven years from the date of grant. Vesting generally varies between one to
three years, as specifically stated in each advisor's option agreement.
F-22
<PAGE> 123
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summary stock option activity for the Advisor Plan options during the year
ended December 31, 1999 is as follows (after giving effect to the Reverse Stock
Split):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-----------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- ---------
<S> <C> <C>
Outstanding Options at
December 31, 1998............................... -- --
Granted...................................... 1,036,125 $3.92
Exercised.................................... (37,500) 3.60
Canceled..................................... -- --
--------- -----
Outstanding Options at
December 31, 1999............................... 998,625 $3.93
========= =====
</TABLE>
The weighted average fair value of options granted under the Advisor Plan
was $9.34 per option, resulting in a total value for options granted of $9.7
million, which has been recorded as unearned compensation in the statement of
charges in members' and stockholders' equity, and will be amortized over the
term of the advisor's option agreement. Compensation expense recognized during
the year ended December 31, 1999 was $6.0 million, and is recorded in cost of
revenue or operating expense based on the services provided by the advisor. The
weighted average remaining contractual life of the advisor options granted
during the year ended December 31, 1999 is 6.7 years, and there are 774,313
options exercisable as of December 31, 1999.
In June 1999 and as amended in October 1999, the Company adopted the 1999
Artist Stock Plan (the Artist Option Plan), which has reserved 4,000,000 shares
(after giving effect to the Reverse Stock Split) of common stock for issuance to
artists for whom the Company maintains ARTISTchannels. This share reserve will
automatically increase on the first trading day in January each calendar year,
beginning 2001, by an amount equal to two percent (2%) of the total number of
shares of our common stock outstanding on the last trading day of December in
the prior calendar year, but in no event will this annual increase exceed
875,000 shares. As of December 31, 1999, 1,735,939 shares remained available for
future option grants. The options expire seven years from the date of grant.
Vesting generally varies between one to three years, as specifically stated in
each artist's option agreement.
Summary stock option activity for the Artist Option Plan during the year
ended December 31, 1999 is as follows (after giving effect to the Reverse Stock
Split):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
<S> <C> <C>
Outstanding Options at
December 31, 1998................................ -- --
Granted....................................... 2,476,561 $3.97
Exercised..................................... (330,417) 3.74
Canceled...................................... -- --
--------- -----
Outstanding Options at
December 31, 1999................................ 2,146,144 $4.00
========= =====
</TABLE>
F-23
<PAGE> 124
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The weighted average fair value of the options granted under the Artist
Option Plan was $8.33 per option, resulting in a total value for options granted
of $20.6 million, which has been recorded as unearned compensation in the
statement of changes in members' and stockholders' equity, and will be amortized
over the service period of the related artist agreements. Compensation expense
recognized during the year ended December 31, 1999 was $6.4 million, and is
recorded in cost of revenue or operating expense based on the services provided
by the artist.
The weighted average remaining contractual life of the artist options
granted during the year ended December 31, 1999 is 6.7 years, and 1,114,250 of
these options were exerciseable as of December 31, 1999.
The estimated fair values of the options granted under the Advisor Plan and
the Artist Option Plan was determined using the Black-Scholes model. The key
assumptions used in the model for the purpose of the calculation were: a risk
free rate of 6.0%, a volatility factor of 81%, no expected dividends and an
expected life of seven years.
In October 1999, the Company adopted the 1999 Employee Stock Purchase Plan,
which has reserved 500,000 shares of common stock for issuance under this plan.
Terms of the plan permit eligible employees to purchase common stock through
payroll deduction of up to 15% of each employee's compensation. The accumulated
deductions will be applied to the purchase on shares on each semi-annual
purchase date at a purchase price per share equal to 85% of the fair market
value per share on the participant's entry date into the offering period or the
semi-annual purchase date, whichever is lower. Pursuant to the provisions of APB
No. 25, shares issued to employees under this plan are considered
noncompensatory.
16. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
Future minimum lease payments under operating leases for facilities and
certain equipment, including leases entered into subsequent to December 31,
1999, are as follows as of the years ended December 31:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
2000.............................................. $ 1,163
2001.............................................. 1,659
2002.............................................. 1,837
2003.............................................. 1,756
2004.............................................. 1,746
Thereafter........................................ 10,251
-------
Total........................................... $18,412
=======
</TABLE>
Rent expense under operating leases for the years ended December 31, 1997,
1998 and 1999 for the Company was $58,000, $109,000, and $341,000, respectively.
F-24
<PAGE> 125
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EMPLOYMENT CONTRACTS
Future payments under employment contracts entered into through December
31, 1999 are as follows for the years ended December 31:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
2000.............................................. $2,396
2001.............................................. 1,334
2002.............................................. 25
------
Total........................................... $3,755
======
</TABLE>
LITIGATION
The Company is subject to various pending and threatened legal actions,
which arise in the normal course of business. The Company's management believes
that the impact of such litigation will not have a material adverse impact on
its financial position or results of operations.
17. REPORTABLE SEGMENTS
The Company provides integrated music entertainment products and services
through three reportable segments. The three reportable segments are
music-related Web site operations ("ARTISTdirect Network"), musical artist
booking operations ("Talent Agency") and record label operations ("Record
Label"). ARTISTdirect Network generates revenue primarily from the sale of
recorded music and music-related merchandise and from the sale of advertising on
our Web sites. The Talent Agency generates revenue from commissions based on the
income received by agency clients for live performances. The Record Label
generates revenue from advances under an agreement with RCA and from royalties
on sales of recorded music. The factors for determining reportable segments were
based on service and products. Each segment is responsible for executing a
unique marketing and business strategy. The accounting policies of the segments
are the same as those described in the summary of significant accounting
policies. The Company evaluates performance based on profit or loss from
operations before income taxes. The following table summarizes the revenue,
operating income and depreciation and amortization by segment for the years
ended December 31, 1997, 1998 and 1999.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1998 1999
------ ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net Revenue:
ARTISTdirect Network............................ $ 364 $ 2,100 $ 8,192
Talent Agency................................... 974 1,917 1,304
Record Label.................................... 550 565 778
------ ------- --------
1,888 4,582 10,274
Income (Loss) from Operations:
ARTISTdirect Network............................ (740) (5,256) (57,900)
Talent Agency................................... 197 (629) 22
Record Label.................................... 86 (464) (257)
------ ------- --------
(457) (6,349) (58,135)
------ ------- --------
Interest income (expense), net.................... (3) 29 281
Income from equity investment..................... -- 2 50
------ ------- --------
Net Loss.......................................... $ (460) $(6,318) $(57,804)
====== ======= ========
</TABLE>
F-25
<PAGE> 126
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1998 1999
------ ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Depreciation and amortization:
ARTISTdirect Network............................ $ 4 $ 38 $ 2,504
Talent Agency................................... 11 18 5
Record Label.................................... 6 3 --
------ ------- --------
$ 21 $ 59 $ 2,509
====== ======= ========
</TABLE>
The following tables summarize the capital expenditures for the years ended
December 31, 1997, 1998, and 1999 and assets as of December 31, 1998 and 1999.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998 1999
----- ------ -------
(IN THOUSANDS)
<S> <C> <C> <C>
Capital expenditures:
ARTISTdirect Network............................... $ 23 $ 123 $ 3,498
Talent Agency...................................... 57 15 9
Record Label....................................... 21 3 6
----- ------ -------
$ 101 $ 141 $ 3,513
===== ====== =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1998 1999
------ -------
<S> <C> <C>
Assets:
Corporate................................................ $ 403 $78,406
ARTISTdirect Network..................................... 2,932 17,571
Talent Agency............................................ 68 2,547
Record Label............................................. 9 76
------ -------
$3,412 $98,600
====== =======
</TABLE>
Assets by segment are those assets used in the Company operations in each
segment. Corporate assets are principally made up of cash and cash equivalents,
prepaid expenses, computer equipment and other assets.
18. SUBSEQUENT EVENTS
In January 2000, the Company signed a definitive merger agreement with
Mjuice.com, Inc., a company involved in the development and distribution of the
secure digital distribution of MP3-formatted music. The Company plans to issue
up to $15.0 million of its shares in exchange for all of the outstanding equity
of Mjuice.com, Inc. The acquisition is to be accounted for as a purchase, with
substantially all of the purchase price being attributed to goodwill that will
be amortized over a five-year period. The acquisition is expected to close
shortly following the Company's initial public offering.
In March 2000, Marc Geiger, Donald Muller and Rick Rubin agreed to enter
into a series of transactions which will effectively transfer to Keith Yokomoto,
Steve Rennie and L&G Associates One the economic benefit ("Appreciation Rights")
of the difference between the closing price on the third day of trading after
the initial public offering and $13.93 per share, for the number of shares as
specified in the terms of the related agreement. Such increase in value shall be
transferred in the form of shares of common stock of the Company. Additionally,
the Company will issue to these parties options to purchase
F-26
<PAGE> 127
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
common stock at an exercise price equal to the closing price on the third day of
trading after the initial public offering. The Company will record as expense
the appreciation in the price per share of the common stock over $13.93 for
Messrs. Yokomoto and Rennie. As the options granted to Messrs. Yokomoto and
Rennie will have an exercise price equal to the fair value on the date of grant,
the Company will not record compensation for the options granted to these
individuals. The Company will record as expense the fair value of the
appreciation rights and stock options granted to L&G Associates One as
determined on the respective grant dates.
F-27
<PAGE> 128
INDEPENDENT AUDITORS' REPORT
To The Board of Directors
iMusic, Inc.:
We have audited the accompanying balance sheets of iMusic, Inc. (the
"Company") as of December 31, 1997 and 1998 and the related statements of
operations, shareholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of iMusic, Inc. as of December
31, 1997 and 1998 and the results of its operations and its cash flows for the
years then ended in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Los Angeles, CA
May 26, 1999
F-28
<PAGE> 129
IMUSIC, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1997 1998
----- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 2 $116
Accounts receivable....................................... 5 65
----- ----
Total current assets................................... 7 181
----- ----
Property and equipment, at cost:
Computer equipment........................................ -- 7
Less accumulated depreciation............................. -- (1)
----- ----
-- 6
----- ----
Total assets........................................... $ 7 $187
===== ====
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 11 $ 15
Accrued payroll taxes..................................... 12 27
Due to related party...................................... 52 66
Note payable.............................................. 5 --
----- ----
Total current liabilities.............................. 80 108
Line of credit.............................................. 7 6
----- ----
Total liabilities...................................... 87 114
----- ----
Shareholders' equity (deficit):
Series A convertible preferred stock, $.01 par value.
Authorized 200,000 shares; issued and outstanding
161,364 as of December 31, 1998. Liquidation value of
$100 as of December 31, 1998........................... -- 2
Common stock, $.01 par value. Authorized 1,000,000 shares;
issued and outstanding 545,455 shares as of December
31, 1997 and 1998...................................... 5 5
Additional paid-in capital................................ 15 113
Accumulated deficit....................................... (100) (47)
----- ----
Total shareholders' equity (deficit)................... (80) 73
----- ----
Total liabilities and shareholders' equity............. $ 7 $187
===== ====
</TABLE>
See accompanying notes to financial statements.
F-29
<PAGE> 130
IMUSIC, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
1997 1998
---- ----
<S> <C> <C>
Revenue, net................................................ $ 51 $260
Cost of revenue............................................. 52 115
---- ----
Gross profit.............................................. (1) 145
Operating expenses:
Sales and marketing....................................... 5 33
General and administrative................................ 39 57
---- ----
(Loss) income from operations............................. (45) 55
Interest expense, net....................................... 1 2
---- ----
Net (loss) income......................................... $(46) $ 53
==== ====
</TABLE>
See accompanying notes to financial statements.
F-30
<PAGE> 131
IMUSIC, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
SERIES A
PREFERRED STOCK COMMON STOCK TOTAL
---------------- ---------------- ADDITIONAL ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT PAID-IN-CAPITAL DEFICIT EQUITY (DEFICIT)
------- ------ ------- ------ --------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1996....................... -- $-- 545,455 $ 5 $ 15 $ (54) $(34)
Net loss..................... -- -- -- -- -- (46) (46)
------- --- ------- --- ---- ----- ----
Balance at December 31,
1997....................... -- -- 545,455 5 15 (100) (80)
Net income................... -- -- -- -- -- 53 53
Issuance of preferred
stock...................... 161,364 2 -- -- 98 -- 100
------- --- ------- --- ---- ----- ----
Balance at December 31,
1998....................... 161,364 $ 2 545,455 $ 5 $113 $ (47) $ 73
======= === ======= === ==== ===== ====
</TABLE>
See accompanying notes to financial statements.
F-31
<PAGE> 132
IMUSIC, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
1997 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income......................................... $(46) $ 53
---- ----
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation........................................... -- 1
Changes in assets and liabilities:
Accounts receivable.................................. 31 (60)
Accounts payable and accrued expenses................ (2) 19
---- ----
Net cash (used in) provided by operating
activities...................................... (17) 13
---- ----
Cash flows from investing activities -- purchase of
equipment................................................. -- (7)
---- ----
Cash flows from financing activities:
Change in due to related party............................ 13 14
Proceeds from (payment on) note payable................... 5 (5)
Payments on line of credit................................ (1) (1)
Issuance of preferred stock............................... -- 100
---- ----
Net cash provided by financing activities......... 17 108
---- ----
Net increase in cash and cash equivalents......... -- 114
Cash and cash equivalents at beginning of year.............. 2 2
---- ----
Cash and cash equivalents at end of year.................... $ 2 $116
==== ====
Supplemental disclosure of cash flow information -- cash
paid during the year for interest......................... $ 1 $ 2
==== ====
</TABLE>
See accompanying notes to financial statements.
F-32
<PAGE> 133
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
iMusic, Inc. (the "Company") was incorporated as a Washington corporation
in October 1995. The Company operates an Internet Web site that provides
music-related content such as chats, message boards, news, music information and
live performances.
2. SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash equivalents consist of temporary investments in short-term securities
with an original maturity date of three months or less.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is provided using
the straight-line method over a useful life of three years.
REVENUE RECOGNITION
The Company generates revenue from the sale of advertisements under
short-term contracts. To date, the duration of the Company's advertising
commitments has generally averaged from one to three months. Advertising revenue
is generally recognized ratably in the period in which the advertisement is
displayed, provided that no significant obligations of the Company remains and
collection of the resulting receivable is probable. The Company's obligations
typically include the guarantee of a minimum number of "impressions" or times
that an advertisement appears in pages viewed by the users of the Company's
online properties. The Company records a reserve for contracts in which the
guarantee of a minimum number of impressions is not expected to be met. There
were no such instances as of December 31, 1997 and 1998.
The Company also generates revenue from a "link" to the Web site of a third
party. Revenue is based on merchandise purchased on the third-party's Web site
by customers utilizing the "link" on the Company's Web site.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on historical experience and
management's evaluation of outstanding accounts receivable at the balance sheet
date. There was no allowance as of December 31, 1997 and 1998.
PRODUCT DEVELOPMENT EXPENSE
Product development expense consists primarily of third-party Internet
development costs and payroll and related expenses for in-house Web site
development costs incurred in the start-up and production of the Company's
content and services.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under the
asset and liability method of SFAS No. 109, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their
F-33
<PAGE> 134
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under SFAS
No. 109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically reviews the carrying amounts of long-lived assets
to determine whether current events or circumstances warrant adjustments to such
carrying amounts. An impairment adjustment is necessary in the event the net
book value of such long-lived assets exceeds the future undiscounted cash flows
attributable to such assets. In such an event, the loss is measured by the
amount that the carrying value of such assets exceeds their fair value.
Considerable management judgment is necessary to estimate the fair value of
assets, accordingly, actual results could vary significantly from such
estimates.
CONCENTRATION OF CREDIT RISK AND REVENUES FROM A SINGLE CUSTOMER
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments and trade
accounts receivable. The Company places its cash investments in high-credit
quality instruments and, by policy, limits the amount of credit exposure to any
one financial institution. Certain financial instruments potentially subject the
Company to credit risk. The Company performs ongoing credit evaluations of its
customers but does not require collateral. Exposure to losses on receivables is
principally dependent on each customer's financial condition. The Company
monitors its exposure for credit losses and maintains allowances for anticipated
losses.
During the years ended December 31, 1997 and 1998, the Company derived
revenues from a single customer that comprised 50% and 65% of total revenues,
respectively.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments, which include cash, accounts
receivable, accounts payable and accrued expenses, lines of credit and due to
related party, approximate fair value because of the short maturity of these
instruments.
USE OF 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued SFAS No. 130, "Reporting
Comprehensive Income," in June 1997. SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income includes all changes in
shareholders' equity (except those arising from transactions with members) and
includes net income and net unrealized gains (losses) on securities. There is no
impact on the Company's financial statements as a result of the implementation
of SFAS No. 130.
F-34
<PAGE> 135
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information." SFAS No.
131 requires the use of the "management approach" for segment reporting, which
is based on the way the chief operating decision maker organizes segments within
a company for making operating decisions and assessing performance. The adoption
of this statement did not have a material impact on the Company's financial
statement.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use,"
which provides guidance on accounting for the cost of computer software
developed or obtained for internal use. SOP No. 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998. The adoption of
SOP 98-1 did not have a material impact on the financial statements.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities." The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up activities and
organization costs to be expensed as incurred. The Company is required to adopt
SOP 98-5 for the year ended December 31, 1999. The adoption of SOP 98-5 is not
expected to have a material impact on the Company's consolidated financial
statements.
The Financial Accounting Standards Board recently issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for all fiscal years beginning after September 15, 1999. SFAS 133
establishes accounting and reporting standards for derivative instruments and
hedging activities by requiring that all derivative instruments be reported as
assets or liabilities and measured at their fair values. Under SFAS 133, changes
in the fair values of derivative instruments are recognized immediately in
earnings unless those instruments qualify as hedges of the (1) fair values of
existing assets, liabilities, or firm commitments, (2) variability of cash flows
of forecasted transactions, or (3) foreign currency exposures on net investments
in foreign operations. As of December 31, 1997 and 1998, the Company has not
entered into any derivative contracts nor does it hold any derivative financial
instruments. Therefore, SFAS 133 does not have a material impact on the
Company's consolidated results of operations, financial position, or cash flows.
3. LINE OF CREDIT
In 1996, the Company obtained a $10,000 line of credit with a financial
institution which is guaranteed by the majority shareholder of the Company. The
credit line bears interest, which is payable monthly, at an index rate plus 1%
(10.25% and 10% at December 31, 1997 and 1998, respectively). The balance
outstanding on the line of credit as of December 31, 1997 and 1998 was $7,000
and $6,000, respectively. The unused balance under the line of credit as of
December 31, 1997 and 1998 was $3,000 and $4,000, respectively.
4. NOTE PAYABLE
In 1997, the Company issued a note payable in the amount of $5,000 that
bore interest at 10% and was repaid in 1998.
5. RELATED PARTY TRANSACTIONS
A shareholder of the Company has paid expenses on behalf of the Company
during 1996, 1997 and 1998. Additionally, the Company rents office space from
this shareholder. The facility is on a month-to-month lease, and the monthly
rent approximates a fair market rate. Lease payments for the facility for
F-35
<PAGE> 136
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
each of the years ended 1997 and 1998 were $14,000. The amount due to the
shareholder as of December 31, 1997 and 1998 as a result of these transactions
was $52,000 and $66,000, respectively.
6. SHAREHOLDERS' EQUITY
In August 1998, the Company issued 161,364 shares of Series A convertible
preferred stock for proceeds of $100,000. The preferred shareholder may convert
the preferred shares into common shares at a ratio based on the issue price per
share plus any accrued and unpaid dividends. The preferred shares shall be
automatically converted to common shares upon an initial public offering or at
such time when 80% of the shares initially issued have been converted to common
shares. The liquidation value of the preferred shares shall be the initial issue
price plus any accrued and unpaid dividends. The preferred shareholder shall
have voting rights as if the preferred shares had been converted to common
shares.
7. INCOME TAXES
There was no income tax provision for the years ended December 31, 1997 and
1998. Income tax expense (benefit) differs from the amount computed by applying
the federal statutory tax rate of 34% to income before income taxes as shown
below. There is no corporate tax in the state of Washington.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------
1997 1998
---- ----
(IN THOUSANDS)
<S> <C> <C>
Computed "expected" income tax expense (benefit)....... $(15) $ 18
Change in valuation allowance.......................... 15 (18)
---- ----
Income taxes......................................... $ -- $ --
==== ====
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets as of December 31, 1997 and 1998 are presented
below:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1997 1998
---- ----
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards..................... $ 29 $ 28
Temporary differences -- accounts receivable and
accounts payable.................................. 1 (17)
Valuation allowance.................................. (30) (11)
---- ----
Net deferred tax assets........................... $ -- $ --
==== ====
</TABLE>
The Company has federal net operating loss carryforwards of $82,000 and
$84,000 as of December 31, 1997 and 1998, respectively, that begin to expire in
2003.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that the deferred tax assets will be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences become deductible. Management considers historical and projected
future taxable income in making this assessment. Management has provided for a
full valuation allowance.
F-36
<PAGE> 137
IMUSIC, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES
In February 1999, the Company entered into a lease agreement for its
facilities. Future minimum lease payments under this operating lease are as
follows for the years ended December 31:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
1999.............................................. $24
2000.............................................. 26
2001.............................................. 26
2002.............................................. 2
---
$78
===
</TABLE>
9. SUBSEQUENT EVENTS
In February 1999, ARTISTdirect, which previously had a 20% ownership in the
Company, acquired all of the remaining outstanding capital stock of the Company.
The purchase consideration for the Company was approximately $2.5 million,
including $110,000 in cash, a redeemable put option valued at approximately $2.2
million and the assumption of approximately $185,000 in liabilities. The
acquisition was accounted for as a purchase. The purchase price has been largely
allocated to goodwill, which will be amortized over five years.
F-37
<PAGE> 138
[ARTISTDIRECT LOGO]
