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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO ______________.
Commission file number 000-30063
ARTISTDIRECT, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 95-4644384
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or organization) Identification No.)
5670 WILSHIRE BOULEVARD, SUITE 200, LOS ANGELES, CALIFORNIA 90036
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (323) 634-4000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [X] No [ ]
Indicate by check mark whether the disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [ ]
Based on the closing sale price of March 15, 2001, the aggregate market
value of the approximately 21.1 million shares of voting stock of the registrant
held by nonaffiliates of the registrant on such date was approximately $16.5
million. For purposes of such calculation, only executive officers, board
members and beneficial owners of more than 10% of the Company's outstanding
Common Stock are deemed to be affiliates.
As of March 15, 2001, there were 37,796,081 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders currently expected to be held on May 16, 2001, as filed with the
Securities Exchange Commission pursuant to the Securities Exchange Act of 1934,
as amended, are incorporated by reference in Part III of this Report.
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ARTISTDIRECT INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business......................................................... 3
Item 2. Properties....................................................... 25
Item 3. Legal Proceedings................................................ 25
Item 4. Submission of Matters to a Vote of Security Holders.............. 25
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.............................................. 25
Item 6. Selected Financial Data.......................................... 26
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 26
Item 7a. Quantitative and Qualitative Disclosures About Market Risk....... 33
Item 8. Financial Statements and Supplementary Data...................... 33
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................... 33
PART III
Item 10. Directors and Executive Officers of the Registrant............... 34
Item 11. Executive Compensation........................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and Management... 34
Item 13. Certain Relationships and Related Transactions................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 34
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This report contains forward-looking statements which include, but are not
limited to, statements concerning projected revenues, expenses, gross profit and
income, the need for additional capital, and the success of pending litigation.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, management's beliefs, and certain
assumptions made by us. Words such as "anticipates," "expects," "intends,"
"plans," "believes," "seeks," "estimates," "may," "will" and variations of these
words or similar expressions are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and assumptions that are difficult to predict. Therefore, our actual results
could differ materially and adversely from those expressed in any
forward-looking statements as a result of various factors. The section entitled
"Risk Factors" set forth at the end of Part I, Item 1 of this report, the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Part II, Item 7 of this report and similar discussions in our
other filings with the Securities and Exchange Commission ("SEC") discuss some
of the important risk factors that may affect our business, results of
operations and financial condition. You should carefully consider those risks in
addition to the other information in this report and in our other filings with
the SEC before deciding to invest in our company or to maintain or increase your
investment. We undertake no obligation to revise or update publicly any
forward-looking statements for any reason.
PART I
PART 1. 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. 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 Digital Music, a feature which allows users to
download music, both free and paid, stream promotional tracks and listen to
Internet radio stations.
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.
The Ultimate Band List -- a comprehensive online music search engine and
resource for music information. The UBL provides information on more than
100,000 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 a wide selection of
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;
Digital Music -- a feature which enables users to download music, both free
and paid, stream promotional tracks and listen to Internet radio stations. Users
also have access to a variety of audio tools to locate, organize and manage a
digital music collection; and
ARTISTtv -- a site for broadband programming on the ARTISTdirect Network.
We also operate a music talent agency, the ARTISTdirect Agency. Prior to
June 30, 2000, we also managed a traditional record label, Kneeling Elephant
Records. Marc Geiger, our Chief Executive Officer, Don Muller, our President of
ARTISTdirect Agency, and Nick Turner, our Vice President, ARTISTchannels, have
18, 14 and 20 years of experience, respectively, in the music
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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.
INDUSTRY BACKGROUND
THE MUSIC INDUSTRY
Music is one of the most popular forms of entertainment worldwide and a
multi-billion dollar consumer industry. Concert tours also generate significant
revenue for the music industry. 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 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. 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.
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:
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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 can 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 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
infrastructure and systems for digital distribution through the ARTISTdirect
Network. We currently allow both free and paid digital downloads of music and a
variety of streaming audio services through the Digital Music area of the
ARTISTdirect Network. 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 100,000
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
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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 wide 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 Digital Music 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.
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:
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:
- record label: We plan to establish new record label operations that
will allow us to participate with artists on the production and sale
of music both online and offline. The planned record label may take
the form of a joint venture and may involve third-party financing.
- 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;
- 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.
Add ARTISTchannels. We intend to 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 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. We intend to establish ARTISTdirect as the
leading brand for online music entertainment. We intend to use both online and
offline marketing channels to reach consumers and promote the ARTISTdirect brand
name. In addition, 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.
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ARTISTDIRECT BUSINESS UNITS
ARTISTDIRECT NETWORK
The ARTISTdirect Network is comprised of the ARTISTchannels, the UBL,
iMusic, Digital Music, the ARTISTdirect Superstore and ARTISTtv.
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.
Based on our recent experience, we generally launch new ARTISTchannels
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
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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 100,000 artists and contains links to
thousands of other music-related sites.
iMusic. iMusic offers message boards, text chats, video chats, fan
conferences and other opportunities for fans to interact with each other and
with artists. We host a regular series of artist chats and conferences,
providing users with the opportunity to interact and communicate with their
favorite artists. We plan to introduce e-mail and personal home page services
through iMusic in the near future.
Digital Music. In October 1999, we added an area within the ARTISTdirect
Network devoted to music downloads, originally called DOWNLOADSdirect. We
provide users with a selection of downloads both free and paid, chosen by our
editorial staff. Some of these downloads are made available to us on an
exclusive basis from artists. In addition, users can stream promotional tracks,
listen to Internet radio stations and have access to a variety of audio tools to
locate, organize and manage a digital music collection.
ARTISTdirect Superstore. The ARTISTdirect Superstore is a retail center
for leading brands and artists, offering recorded music and related merchandise.
The ARTISTdirect Superstore offers a wide selection of 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.
ARTISTtv. In September 1999, we added ARTISTtv to the ARTISTdirect
Network. ARTISTtv is a site for broadband programming on the ARTISTdirect
Network, offering artist-related video material.
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, 2000, we derived
approximately 14% of our revenue from commissions generated by the ARTISTdirect
Agency. For the year ended December 31, 1999, we derived approximately 13% of
our revenue from commissions generated by the ARTISTdirect Agency.
KNEELING ELEPHANT RECORDS
Prior to June 30, 2000, ARTISTdirect managed Kneeling Elephant Records,
an independent record label, pursuant to a label agreement with RCA Records. RCA
provided all funding for the label and owned the rights to all sound recordings
made under artist agreements during the initial three year term of the label
agreement. During the term of the agreement, RCA provided overhead advances,
funding for artist advances and recording costs and marketing resources for a
minimum of three artists per year. Kneeling Elephant found new talent and
negotiated contracts, including royalties, advances and artist development, and
worked with RCA's marketing, promotion, publicity and sales force to develop a
marketing strategy for each album. Manufacturing, packaging and distribution
were handled by RCA's affiliated worldwide distribution network. Kneeling
Elephant participated on a royalty basis in the proceeds of the albums recorded
during the term. The label agreement terminated in June 2000 and the artists
signed to the label remained with RCA upon the label agreement termination. We
are currently evaluating a plan to continue with the record label business, in
which case, we will be responsible for signing new artists and funding the
label's future operations unless we are able to enter into a third party funding
arrangement, such as we had with RCA.
For the year ended December 31, 2000, we derived approximately 1% of our
revenue from our Kneeling Elephant Records label. For the year ended December
31, 1999, we derived 8% of our revenue from our Kneeling Elephant Records label.
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BUSINESS 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 AOL-Time Warner. We also entered into a strategic
relationship with an affiliate of Cisneros Television Group, a leading pay
television content provider in Latin America. These relationships generally
provide for the licensing of content by ARTISTdirect, cooperative marketing and
other related features and have a term of two to three years.
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.
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 are paying CHUM a fixed license fee over the
term of the programming license agreement.
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 Level(3) Communications in Los
Angeles, California, and at Digex, Inc. in Cupertino, California, under either
co-location or managed server agreements. Some of our digital content is hosted
by Akamai 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.
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.
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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. We entered into a four-year agreement with Giant Merchandising in
April 1999 to supply merchandise on a wholesale basis for both our
ARTISTchannels and the ARTISTdirect Superstore. 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, SMI Promotional Apparel and several other
vendors 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 8 a.m. to 5 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, 2000, we employed 23 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. For the years ended December 31, 1999 and 2000, advertising
represented 28% and 29% of revenue, respectively. Intel Corporation accounted
for 25% of our advertising revenues for the year ended December 31, 1999.
Pringles, a division of Procter & Gamble, accounted for 11% and Universal Music
Group accounted for 16% of our advertising revenue for the year ended December
31, 2000, respectively. No other advertiser accounted for more than 10% of our
advertising revenue in the years ended December 31, 1999 and 2000. As of
December 31, 2000, we employed a direct sales force of 13 people in Los Angeles,
New York and Chicago.
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 a public relations
program to generate 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.
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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 100 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, 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 AOL-Time Warner,
and Universal Music Group, a subsidiary of Vivendi Universal. Some of
these companies have recently established online presences to promote
and distribute the music and tours of their respective artists;
- 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 have formed a joint venture
to operate getmusic.com, an online music site combining programming and
e-commerce.
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.
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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 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 became 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
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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 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 "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.
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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.
EMPLOYEES
As of December 31, 2000, we had 211 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.
RISK FACTORS
You should carefully consider the risks described below, together with
all of the other information included in this Annual Report on Form 10-K. 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, acquired iMusic in February
1999 and acquired Mjuice.com, Inc. in August 2000. We have been operating all of
these sites as an integrated network since July 1999 or acquisition date, if
later. 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.
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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 $123.9 million as of December 31,
2000. For the years ended December 31, 1999 and 2000, we incurred net losses of
approximately $57.8 million and $59.3 million, respectively, which represented
approximately 563% and 274%, respectively, of our revenue for those periods. We
expect our operating losses and negative cash flow to continue for at least the
new future. 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 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 13 to 34 year-old active
music consumers;
- offer advertisers the means to effectively target their advertisements
to our audience;
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- accurately measure the size and demographic characteristics of our
audience;
- maintain key advertising relationships; and compete for advertisers
with Internet and traditional media companies.
Our failure to achieve one or more of these objectives could impair our
ability to increase advertising revenue, which could adversely affect our
business. In addition to the above factors, general economic conditions, as well
as economic conditions specific to online advertising, electronic commerce and
the music industry, could affect our ability to increase our advertising
revenue. In particular, the growth of online advertising has recently declined,
which has had, and in the future may continue to have, a significant adverse
effect on our revenue from online advertising.
IF WE DO NOT GENERATE INCREASED REVENUE FROM ONLINE PRODUCT SALES, OUR
GROWTH WILL BE LIMITED AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.
If we do not generate increased revenue from sales of online products,
our growth will be limited and our business will be adversely affected. To
generate significant online product revenue, we will have to offer music and
related merchandise that appeal to a large number of online consumers. We also
will have to continue to create online communities that are conducive to
electronic commerce, maintain a sufficiently robust and scalable electronic
commerce platform and increase our order fulfillment capability. Since our
target market includes Internet users below the age of 18, and these users have
limited access to credit cards, our ability to capture online product revenue
from this group may be limited. If we are not successful in meeting these
challenges, our growth will be limited and our business will be adversely
affected.
THE EFFECTIVENESS OF THE INTERNET FOR ADVERTISING IS UNPROVEN, WHICH MAY
DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON OUR SITES.
Our future depends in part on an increase in the use of the Internet and
other forms of digital media for advertising. The Internet advertising market is
new and rapidly evolving, and we cannot yet gauge the effectiveness of
advertising on the Internet as compared to traditional media. As a result,
demand for Internet advertising is uncertain. Many advertisers have little or no
experience using the Internet for advertising purposes. The adoption of Internet
advertising, particularly by companies that have historically relied upon
traditional media for advertising, requires the acceptance of a new way of
conducting business, exchanging information and advertising products and
services. Such customers may find advertising on the Internet to be undesirable
or less effective than traditional advertising media for promoting their
products and services. For example, we believe that the recent growth of online
advertising revenue has been less than was generally expected. If the Internet
advertising market fails to fully develop or develops more slowly than we
expect, our business could be adversely affected. In addition, the market for
advertising on other forms of digital media, such as broadband distribution, is
even less developed than Internet advertising, and if that market does not
develop, our growth may be limited.
WE DEPEND UPON ARTISTS TO ATTRACT ADVERTISERS AND GENERATE ELECTRONIC
COMMERCE REVENUE.
We believe that our future success depends in part 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.
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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 112 ARTISTchannel contracts we
had as of December 31, 2000, 9 will expire in 2001, 66 will expire in 2002 and
37 will expire in 2003. In addition, as of December 31, 2000, we did not have
signed contracts for 23 of the 125 ARTISTchannels that we operate.
In the past, we have offered our artists options to purchase our common
stock. Options were intended to provide artists with an additional incentive to
actively promote the ARTISTchannels and the ARTISTdirect Network. We may not be
able to offer artists options or other equity incentives on terms as attractive
to artists as what we have offered previously. If we cannot provide adequate
incentives, our efforts to sign new artists may be impaired. If we cannot
maintain our current relationships with artists or sign agreements with new
artists, our user base would likely diminish and our ability to generate
revenues from electronic commerce and advertising would be seriously harmed.
WE MAY NOT BE ABLE TO DEVELOP OR OBTAIN SUFFICIENTLY COMPELLING CONTENT
TO ATTRACT AND RETAIN OUR TARGET AUDIENCE.
For our business to be successful, we must provide content and services
that attract consumers who will purchase music and related merchandise online.
We may not be able to provide consumers with an acceptable mix of products,
services, information and community to attract them to our Web sites frequently
or to encourage them to remain on our Web sites for an extended period of time.
If our audience determines that our content does not reflect its tastes, then
our audience size could decrease or the demographic characteristics of our
audience could change and we may be unable to react to those changes effectively
or in a timely manner. Any of these results would adversely affect our ability
to attract advertisers and sell music and other related merchandise. Our ability
to provide compelling content could be impaired by any of the following:
- reduced access to content controlled by record labels, music
publishers and artists;
- diminished technical expertise and creativity of our production staff;
and
- inability to anticipate and capitalize on trends in music.
IF WE DO NOT BUILD AND MAINTAIN STRONG BRANDS, WE MAY NOT BE ABLE TO
ATTRACT A SUFFICIENT NUMBER OF USERS TO OUR WEB SITES.
To attract users we must develop a brand identity for ARTISTdirect and
increase public awareness of the ARTISTchannels, the UBL and iMusic and may
spend significant amounts on our offline and online advertising and promotional
efforts to increase brand awareness, traffic and revenue. Our marketing
activities may, however, not result in increased revenue and, even if 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 100 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.
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We face competitive pressures from numerous actual and potential
competitors. Our competitors include MP3.com, Launch Media, Amazon.com, CDnow,
MTVi, major Internet portals and traditional music companies. Competition is
likely to increase significantly as new companies enter the market and current
competitors expand their services. Some of our competitors have announced
agreements to work together to offer music over the Internet, and we may face
increased competitive pressures as a result. Many of our current and potential
competitors in the Internet and music entertainment businesses may have
substantial competitive advantages relative to us, including:
- longer operating histories;
- significantly greater financial, technical and marketing resources;
- greater brand name recognition;
- larger existing customer bases; and
- more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to develop, promote and sell their products or services than we can. Web sites
maintained by our existing and potential competitors may be perceived by
consumers, artists, talent management companies and other music-related vendors
or advertisers as being superior to ours. In addition, increased competition
could result in reduced advertising rates and margins and loss of market share,
any of which could harm our business.
WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS FOR MUSIC MERCHANDISE,
FULFILLMENT AND DISTRIBUTION; IF WE CANNOT SECURE ALTERNATE SUPPLIERS, OUR
BUSINESS MAY BE HARMED.
We rely to a large extent on timely distribution by third parties. We
currently rely substantially on one vendor, Alliance Entertainment, to fulfill
and distribute our orders for music and related merchandise. During the years
ended December 31, 2000 and 1999, virtually all of our orders for music and
related merchandise were fulfilled by Alliance. Our agreement with Alliance
covers fulfillment services for sales under the ARTISTdirect Superstore, but
does not cover fulfillment services for our ARTISTchannels. Although Alliance
has been fulfilling orders for music and related merchandise from the
ARTISTchannels on the same terms as orders from the ARTISTdirect Superstore,
Alliance may terminate the ARTISTchannel arrangement at any time.
We purchase almost all of our compact discs from Alliance and a
substantial portion of our other music-related merchandise from Giant
Merchandising, SMI Promotional Apparel and several other vendors. During the
year ended December 31, 2000, we purchased approximately 92.7% of the dollar
volume of our compact discs from Alliance, and we obtained approximately 26.3%
of the dollar volume of our other music-related merchandise from Giant
Merchandising and approximately 11.9% from SMI Promotional Apparel. Our business
could be significantly disrupted if Alliance, Giant or SMI Promotional Apparel
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 SMI Promotional Apparel 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 past, both we and
Alliance have occasionally 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 brand and our
results of operations.
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OUR BUSINESS IS SUBJECT TO SEASONALITY, WHICH COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.
We have experienced and expect to continue to experience seasonal
fluctuations in our online sales. These seasonal patterns will cause quarterly
fluctuations in our operating results. In particular, a disproportionate amount
of our online sales have been realized during the fourth calendar quarter and
during the summer months, traditionally when artists go on tour. Due to our
limited operating history, it is difficult to predict the seasonal pattern of
our online sales and the impact of such seasonality on our business and
operating results. Our seasonal online sales patterns may become more
pronounced, strain our personnel, warehousing, and order shipment activities and
cause our operating results to be significantly less than expected for any given
period. This would likely cause our stock price to fall.
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 Digex and Level(3) Communications. We have periodically
experienced service interruptions caused by temporary problems in our own
systems or software or in the systems or software of these third parties. While
we are implementing procedures to improve the reliability of our systems, these
interruptions may continue to occur from time to time.
In addition, under our agreement with Digex it is not liable to us for
any damage or loss it may cause to our business, and we may be unable to seek
reimbursement from it for losses that it causes. 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, we must improve
and effectively utilize our existing operational, management, marketing and
financial systems and successfully recruit, hire, train and manage personnel and
maintain close coordination among our technical, finance, marketing, sales and
production staffs. In addition, we may also need to increase the capacity of our
software, hardware and telecommunications systems on short notice. We also will
need to manage an increasing number of complex relationships with users,
strategic partners, advertisers and other third parties. Our failure to manage
growth could disrupt our operations and ultimately prevent us from generating
the revenue we expect.
THE LOSS OF KEY PERSONNEL, INCLUDING MARC GEIGER, DONALD MULLER OR KEITH
YOKOMOTO, COULD ADVERSELY AFFECT OUR BUSINESS BECAUSE THESE INDIVIDUALS ARE
IMPORTANT TO OUR CONTINUED GROWTH.
Our future success depends to a significant extent on the continued
services of our senior management, particularly Marc Geiger, Donald Muller and
Keith Yokomoto. The loss of any of these individuals would likely have an
adverse effect on our business. Competition for personnel throughout our
industry is intense and we may be unable to retain these key employees or
attract, integrate or retain other highly qualified employees in the future. We
have in the past experienced, and we expect to continue to experience,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications. If we do not succeed in attracting new personnel or retaining
and motivating our current personnel, our business could be adversely affected.
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IF WE DO NOT REALIZE THE ANTICIPATED BENEFITS OF POTENTIAL FUTURE
ACQUISITIONS, OUR BUSINESS COULD BE SERIOUSLY HARMED AND OUR STOCK PRICE COULD
FALL.
We regularly evaluate, in the ordinary course of business, potential
acquisitions of, or investments in, complementary businesses, products and
technologies. If we are presented with appropriate opportunities, we intend to
actively pursue these acquisitions and/or investments. We may not, however,
realize the anticipated benefits of any acquisition or investment. If we buy a
company, we could have difficulty in assimilating that company's personnel,
technology, operations or products into our operations. In addition, the key
personnel of the acquired company may decide not to work for us. These
difficulties could disrupt our ongoing business, distract our management and
employees and increase our expenses. Acquisitions or business combinations could
also cause us to issue equity securities that would dilute your percentage
ownership in us, incur debt or assume contingent liabilities and take large
immediate or future write-offs or charges, including amortization of goodwill or
compensation expense. Each of these results could materially and adversely
affect our business and adversely affect the price of our common stock.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR
COMPETITIVE POSITION COULD BE HARMED OR WE COULD BE REQUIRED TO INCUR EXPENSES
TO ENFORCE OUR RIGHTS.
We rely upon common-law trademark rights that arise from our commercial
use of the ARTISTdirect, ARTISTdirect Agency, UBL, Ultimate Band List, iMusic
and Kneeling Elephant Records brand names, and the respective associated domain
names, and the ARTISTdirect logo. We seek to protect our trademarks, copyrights
and other proprietary rights by registration and other means, but these actions
may be inadequate. We have trademark applications pending in several
jurisdictions, but our registrations may not be accepted or may be preempted by
third parties and/or we may not be able to register our trademarks in all
jurisdictions in which we intend to do business. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to and distribution of our
proprietary information.
The steps we have taken may not prevent misappropriation of our
proprietary rights, particularly in foreign countries where laws or law
enforcement practices may not protect our proprietary rights as fully as in the
United States. If third parties were to use or otherwise misappropriate our
copyrighted materials, trademarks or other proprietary rights without our
consent or approval, our competitive position could be harmed, or we could
become involved in litigation to enforce our rights. In addition, policing
unauthorized use of our content, trademarks and other proprietary rights could
be very expensive, difficult or impossible, particularly given the global nature
of the Internet.
OUR ACCESS TO COPYRIGHTED CONTENT DEPENDS UPON THE WILLINGNESS OF
CONTENT OWNERS TO MAKE THEIR CONTENT AVAILABLE.
The music content available on the ARTISTdirect Network is typically
comprised of copyrighted works owned or controlled by multiple third parties.
Most of the content on ARTISTchannels is either owned or licensed by the artist.
On other parts of the ARTISTdirect Network, depending on the nature of the
content and how we use the music content, we typically license such rights from
publishers, record labels, performing rights societies or artists. We frequently
either do not have written contracts or have short-term contracts with copyright
owners, and, accordingly, our access to copyrighted content depends upon the
willingness of such parties to continue to make their content available. If the
fees for music content increase 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
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infringement against us and we are unable to develop non-infringing technology
or license the infringed or similar technology or content on a timely basis, it
could harm our business.
In addition, we rely on third parties to provide services enabling our
online product sales transactions, including credit card processing, order
fulfillment and shipping. We could become subject to infringement actions by
third parties based upon our use of intellectual property provided by our
third-party providers. It is also possible that we could become subject to
infringement actions based upon the content licensed from third parties. Any
such claims or disputes could subject us to costly litigation and the diversion
of our financial resources and technical and management personnel. Further, if
our efforts to enforce our intellectual property rights are unsuccessful or if
claims by third parties against ARTISTdirect, the UBL and iMusic are successful,
we may be required to change our trademarks, alter or remove content, pay
financial damages, or alter our business practices. These changes of trademarks,
alteration of content, payment of financial damages or alteration of practices
may adversely affect our business.
WE MAY BE UNABLE TO ACQUIRE NECESSARY WEB DOMAIN NAMES.
We may be unable to acquire or maintain Web domain names relating to our
brand or to specific ARTISTchannels in the United States and other countries in
which we may conduct business. We currently hold various relevant domain names,
including the "artistdirect.com," "ubl.com," "imusic.com" and
"downloadsdirect.com" domain names. The acquisition and maintenance of domain
names generally is regulated by governmental agencies and their designees and is
subject to change. The relationship between regulations governing domain names
and laws protecting trademarks and similar proprietary rights is unclear.
Therefore, we 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.
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
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children under the age of 13 without their parents' consent. In addition, the
Federal Trade Commission and state and local authorities have been investigating
Internet companies regarding their use of personal information. Our privacy
programs may not conform with laws or regulations that are adopted. In addition,
these legislative and regulatory initiatives may adversely affect our ability to
collect demographic and personal information from users, which could have an
adverse effect on our ability to provide advertisers with demographic
information.
The European Union has adopted a directive that imposes restrictions on
the collection and use of personal data. The directive could impose restrictions
that are more stringent than current Internet privacy standards in the United
States. If this directive were applied to us, it could prevent us from
collecting data from users in European Union member countries or subject us to
liability for use of information in contravention of the directive. Other
countries have adopted or may adopt similar legislation. We could incur
additional expenses if new regulations regarding the use of personal information
are introduced or if government authorities choose to investigate our privacy
practices.
WE HAVE A CONTINGENT LIABILITY AS THE RESULT OF A RESCISSION OFFER WE
INTEND TO MAKE DUE TO OUR ISSUANCES OF SECURITIES IN VIOLATION OF SECURITIES
LAWS.
We have issued shares or options to purchase shares of our common stock
to our employees and to artists and their managers and advisors. Due to the
nature of the persons who received these shares and options in addition to our
employees and the total number of shares and options issued to them and our
employees, the issuance of these shares and options did not comply with the
requirements of Rule 701 under the Securities Act of 1933, as amended, or any
other available exemptions from the registration requirements of Section 5 of
the Securities Act, and may not have qualified for any exemption from
qualification under California securities laws either.
As a result, we plan 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 to these persons pursuant to
option exercises by these persons before the expiration of the rescission offer
for an amount equal to the purchase or exercise price paid for these issued
shares, plus interest at the rate of 7% 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 upon the number of options exercised through December 31, 2000, and
assuming that all such issued shares are tendered in the rescission offer, the
out-of-pocket cost to us would be approximately $2.2 million, plus interest.
In addition, we will also offer to repurchase all unexercised options
issued to these persons at 20% of the option exercise price times the number of
option shares, plus interest at the rate of 7% per year from the date the
options were granted. Based on the number of options outstanding as of December
31, 2000, and assuming that none of these options are exercised prior to the end
of the rescission offer, and, further, that all such options are tendered in the
rescission offer, the cost to us in repurchasing such options would be
approximately $7.8 million, plus interest.
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 December 31, 2000, and assuming that all options are exercised, we could
be liable for a total amount of up to $41.1 million plus interest. However, in
such case we would receive a total amount of up to $38.9 million in proceeds
from the exercise of options, which could be used to offset our liability. As of
the date of this report, we are not aware of any claims for rescission against
us. If we are required to repurchase all of the shares subject to the rescission
offer or if we incur any other liability with respect to rescission claims, our
operating results and liquidity during the period in which such repurchase or
liability 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. Similar claims have been brought, sometimes successfully,
against Web site operators in the past. We also may be liable for content
uploaded or posted by our users on our Web
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sites, such as digitally distributed music files, postings on our message
boards, chat room discussions and copyrightable works. In addition, we could
have liability to some of our content licensors for claims made against them for
content available on our Web sites. We also could be exposed to these types of
claims for content that may be accessed from our Web sites or via links to other
Web sites or for products sold through our Web site. While we have resolved all
of these types of claims made against us in the past, we may not be able to do
so in the future. We intend to implement measures to reduce exposure to these
types of claims, but such measures may not be successful and may require us to
expend significant resources. Any litigation as a result of defending these
types of claims could result in substantial costs and damages. Our insurance may
not adequately protect us against these types of claims or the costs of their
defense or payment of damages.
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. Several telecommunications companies have petitioned the
Federal Communications Commission to regulate Internet service providers and
online services providers in a manner similar to long distance telephone
carriers and to impose access fees on these companies. Any imposition of access
fees could increase the cost of transmitting data over the Internet. In
addition, the growth and development of the market for online commerce may lead
to more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on us. The United States Congress has
enacted Internet laws regarding children's privacy, copyrights, taxation and the
transmission of sexually explicit material. The law of the Internet, however,
remains largely unsettled, even in areas where there has been some legislative
action. Moreover, it may take years to determine the extent to which existing
laws relating to issues such as property ownership, libel and personal privacy
are applicable to the Web. Any new, or modifications to existing, laws or
regulations relating to the Web could adversely affect our business.
Prohibition and restriction of Internet content and commerce could
reduce or slow Internet use, decrease the acceptance of the Internet as a
communications and commercial medium and expose us to liability. Any of these
outcomes could have a material adverse effect on our business, results of
operations and financial condition. The growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws,
both in the United States and abroad, that may impose additional burdens on
companies conducting business over the Internet.
THE INTERNET IS SUBJECT TO RAPID CHANGES, WHICH COULD RESULT IN
SIGNIFICANT ADDITIONAL COSTS.
The market for Internet products and services is characterized by rapid
change, evolving industry standards and frequent introductions of new
technological developments. These new standards and developments could make our
existing or future products or services obsolete. Keeping pace with the
introduction of new standards and technological developments could result in
significant additional costs or prove difficult or impossible for us. The
failure to keep pace with these changes and to continue to enhance and improve
the responsiveness, functionality and features of our Web sites could harm our
ability to attract and retain
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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
operations in states outside California and Florida could subject our shipments
in such states to state sales taxes under current or future laws.
Legislation limiting the ability of the states to impose taxes on
Internet-based transactions has been enacted by Congress. However, this
legislation, known as the Internet Tax Freedom Act, imposes only a moratorium
ending on October 21, 2001 on state and local taxes on electronic commerce where
such taxes are discriminatory and on Internet access unless such taxes were
generally imposed and actually enforced before October 1, 1998. Failure to renew
this legislation would allow various states to impose taxes on Internet-based
commerce.
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT AND MAINTENANCE OF THE
INTERNET AND THE AVAILABILITY OF INCREASED BANDWIDTH TO CONSUMERS.
The success of our business will rely on the continued improvement of
the Internet as a convenient means of consumer interaction and commerce, as well
as an efficient medium for the delivery and distribution of music. Our business
will depend on the ability of our artists and consumers to conduct commercial
transactions with us, as well as to continue to upload and download music files,
without significant delays or aggravation that may be associated with decreased
availability of Internet bandwidth and access to our Web site. This will depend
upon the maintenance of a reliable network with the necessary speed, data
capacity and security, as well as timely development of complementary products,
such as high speed modems, for providing reliable Internet access and services.
The failure of the Internet to achieve these goals will reduce our ability to
generate significant revenue.
Our penetration of a broader consumer market will depend, in part, on
continued proliferation of high speed Internet access. The Internet has
experienced, and is likely to continue to experience, significant growth in the
numbers of users and amount of traffic. As the Internet continues to experience
increased numbers of users, increased frequency of use and increased bandwidth
requirements, the Internet infrastructure may be unable to support the demands
placed on it. In addition, increased users or bandwidth requirements may harm
the performance of the Internet.
The Internet has experienced a variety of outages and other delays and
it could face outages and delays in the future. These outages and delays could
reduce the level of Internet usage as well as the level of traffic, and could
result in the Internet becoming an inconvenient or uneconomical source of music
and related products and merchandise which would cause our revenue to decrease.
The infrastructure and complementary products or services necessary to make the
Internet a viable commercial marketplace for the long term may not be developed
successfully or in a timely manner. Even if these products or services are
developed, the Internet may not become a viable commercial marketplace for the
products or services that we offer.
OUR STOCK MAY BE DELISTED FROM THE NASDAQ EXCHANGE.
We have received notice from Nasdaq that our shares of common stock will
be delisted from the NASDAQ National Market and have received a hearing date of
April 12, 2001 with Nasdaq regarding its decision to delist our shares. While we
believe our common stock will continue to be listed on the NASDAQ National
Market during the pendency of such hearing process, we cannot assure you that
our shares will not be delisted after the conclusion of the hearing process.
Such delisting or a prolonged decline in the price of our stock may reduce the
liquidity of our stock and adversely impact our ability to execute our business
plan. If our shares are delisted from the NASDAQ National Market, we expect that
our shares will trade on the OTC Bulletin Board.
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ITEM 2. PROPERTIES
Our principal corporate offices are located in Los Angeles, California
where we lease approximately 64,000 square feet under a lease that expires in
2010. In addition, we currently lease approximately 1,400 square feet for our
New York sales office under a lease that expires in November 2002 and lease
approximately 3,500 square feet for our San Francisco office under a lease that
expires in May 2002. We expect that our current space will accommodate our needs
for the foreseeable future.
ITEM 3. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
ARTISTDIRECT's common stock is listed for quotation on the Nasdaq
National Market under the symbol "ARTD." The following table sets forth, for the
periods indicated, the high and low closing sale prices for our common stock as
reported by Nasdaq since our initial public offering which was completed in
March 2000:
2000 HIGH LOW
---- ---- ---
Second Quarter................................................. $8.25 $2.75
Third Quarter.................................................. 3.875 1.125
Fourth Quarter................................................. 1.50 0.3438
On March 15, 2001, the closing sale price for our common stock as reported by
Nasdaq was $0.7812.
HOLDERS
As of March 15, 2001, there were 130 holders of record of our common stock.
DIVIDENDS
We have never paid any cash dividends on our common stock and we have no current
plans to do so.
SALES OF UNREGISTERED SECURITIES
None.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to ARTISTDIRECT's
consolidated statements of operations for the years ended and consolidated
balance sheets as of December 31, 2000, 1999, 1998, 1997 and 1996 are derived
from the audited Consolidated Financial Statements of the company. The following
information should be read in conjunction with the Consolidated Financial
Statements of the company and the related notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Annual Report on Form 10-K.
TABLE OF SELECTED FINANCIAL DATA FISCAL YEAR ENDED DECEMBER 31
--------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1996 1997 1998 1999 2000
---- ------ ------ ------- --------
Net Sales or Operating Revenues ..... $ -- $1,888 $4,582 $ 10,274 $ 21,676
Loss from continuing operations ..... 28 460 6,318 57,804 59,308
Loss from continuing operations
per common share .................. -- -- -- 1.71(1) 2.68
Total Assets ........................ 173 314 3,412 98,600 118,505
Long term obligations and redeemable
preferred stock (including long
term debt, capital leases, and
redeemable preferred stock as
defined in Rule 5-02.28 of
Reg S-X) ........................ -- -- 5,135 112,390 12,308
(1) The loss from continuing operations per common share is for the period from
October 1, 1999 through December 31, 1999. The Company was merged into a
C corporation on October 6, 1999. Consequently, there is no loss per share
before that date as the Company was an LLC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following discussion should be read in conjunction with our
consolidated financial statements and the notes to those financial statements
included elsewhere in this Annual Report on Form 10-K. 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 Annual
Report on Form 10-K.
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, 2000, ARTISTdirect featured 125 unique,
artist-owned ARTISTchannels, and had signed agreements to launch channels with
an additional 11 artists. The ARTISTdirect Network also features the UBL, a
music search engine on the Web, iMusic, a popular online community where fans
exchange music interests and commentary and Digital Music, a feature that allows
users to download music, both free and paid, stream promotional tracks and
listen to Internet radio stations on the ARTISTdirect Network. We also operate a
music talent agency, the ARTISTdirect Agency. Prior to June 30, 2000, we also
managed a traditional record label, Kneeling Elephant Records, which we no
longer operate.
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 is being amortized over five
years.
In May 1999, we engaged in an exchange transaction in which all
membership interests in UBL, LLC that we did not own were exchanged for
membership interests in ARTISTdirect, LLC. The value of the consideration given
was approximately $13.9 million and the transaction was accounted for as a
purchase. The purchase price has been largely allocated to goodwill, which is
being amortized over five years.
In July 1999, we officially launched the ARTISTdirect Network,
integrating the UBL and iMusic Web sites with our ARTISTchannels. Since 1997,
our revenue mix has shifted from primarily agency commissions and record label
revenue to electronic commerce revenue and online advertising; however, given
the recent industry-wide decrease in amounts spent on online advertising, we do
not know if this trend will continue.
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In August 2000, ARTISTdirect acquired all of the outstanding capital
stock of Mjuice.com, Inc. The total purchase consideration for Mjuice.com was
approximately $5.1 million. The acquisition was accounted for as a purchase. The
purchase price has been largely allocated to goodwill, which is being amortized
over five years.
ARTISTdirect has incurred cumulative net losses of $123.9 million from
inception to December 31, 2000 of which approximately $48.5 million represented
stock-based compensation expense. While we expect our net losses to decrease in
the future, we do not expect to become profitable in the near future, and cannot
assure you that we will ever achieve profitability. 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 14 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 29. 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 the ARTISTdirect Network, the ARTISTdirect
Agency, and, prior to June 30, 2000, also generated revenue from Kneeling
Elephant Records. Substantially all of our revenue is generated in cash. Trade
and barter revenue represented approximately 1% of our revenue for the year
ended December 31, 2000 and less than 1% for the year ended December 31, 1999.
Revenue from the ARTISTdirect Network consists primarily of online
product sales and advertising revenue as described below:
- Revenue from online product sales includes the sale of music and
related merchandise, such as apparel, collectibles and accessories,
through our ARTISTchannels and the ARTISTdirect Superstore. We
recognize the gross amount of product sales and shipping revenue upon
shipment of the item and record appropriate reserves for product
returns. We have experienced seasonality with respect to our online
product sales. In particular, our online product sales in December
have, on average, been higher than in other months. We believe that
this trend may continue for the foreseeable future. For the years
ended December 31, 2000 and 1999, online product sales revenue
constituted approximately 56% and 51%, respectively, of our total net
revenue for those periods.
- Advertising revenue consists primarily of sales of banner
advertisements and sponsorships. In sales of banner advertisements, we
principally earn revenue based on the number of impressions or times
an advertisement appears on pages viewed within our Web sites. Our
banner advertising commitments generally range from one to three
months. Banner advertising revenue is generally recognized as the
impressions are served during the period in which the advertisement is
displayed, provided that no significant obligations of ARTISTdirect
remain and collection of the resulting receivable is probable. We
typically guarantee a minimum number of impressions to the advertiser.
To the extent that minimum guaranteed page deliveries are not met, we
defer recognition of the corresponding revenue until the guaranteed
impressions are delivered. We also sell to advertisers sponsorships 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 years ended December 31, 2000
and 1999, advertising revenue constituted approximately 29% and 28%,
respectively, of our total net revenue for those periods.
Revenue from the ARTISTdirect Agency consists primarily of commissions
generated on tour and event bookings of artists represented by the agency.
Agency commission revenue is recognized at the time the artist gets paid. Agency
commission revenue fluctuates depending on touring schedules of major artists
represented by the agency. Touring schedules are subject to
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seasonality, with summer typically being a more active period. For the years
ended December 31, 2000 and 1999, commission revenue constituted approximately
14% and 13%, respectively, of our total net revenue for those periods.
Prior to June 30, 2000, revenue from Kneeling Elephant Records was
generated from overhead advances and from royalties earned on albums sold by
artists signed to the label. We recognized royalties at the time the releases
were shipped to the retailer. Reserves were established for possible returns.
During the year ended December 31, 2000, Pringles, a division of Procter
& Gamble, accounted for 11% and Universal Music Group accounted for 16% of the
Company's advertising revenue.
During the fourth quarter of 2000 and the first quarter of 2001, we laid
off 105 employees. We expect this to help us decrease our net loss and conserve
our cash resources given prevailing market conditions.
We have received notice from Nasdaq that our shares of common stock will
be delisted from the NASDAQ National Market and have received a hearing date of
April 12, 2001 with Nasdaq regarding its decision to delist our shares. While we
believe our common stock will continue to be listed on the NASDAQ National
Market during the pendency of such hearing process, we cannot assure you that
our shares will not be delisted after the conclusion of the hearing process.
Such delisting or a prolonged decline in the price of our stock may reduce the
liquidity of our stock and adversely impact our ability to execute our business
plan.
COST OF REVENUE
Cost of revenue consists primarily of amounts payable to artists, which
includes the cost of merchandise sold and share of net proceeds, online
transaction costs, including credit card fees, fulfillment charges and shipping
costs, Web site hosting and maintenance costs, online content and programming
costs, online advertising serving costs, record royalties payable to artists,
payroll and related expenses for staff involved in Web site maintenance, content
programming and the ARTISTdirect Agency, and amortization of non-cash
compensation expense related to vendor warrants and ARTISTchannel stock options
granted to artists and their advisors in connection with opening their
ARTISTchannels. Artist royalties are based on electronic commerce and
advertising revenue generated from their ARTISTchannels. Web site maintenance
costs include personnel-related costs, software consulting costs, Internet
hosting charges, and networking costs.
In connection with the amortization of vendor warrants and ARTISTchannel
stock options granted through December 31, 2000, we recorded non-cash
compensation expense of approximately $7.5 million for the year ended December
31, 2000 and approximately $1.8 million for the year ended December 31, 1999. We
may 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
Web Site Development. Web site 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 $39.2
million of stock-based compensation expense for the period from inception
through December 31, 2000 in connection with equity granted to employees,
directors, professional firms, artists and advisors during this period. We
recorded amortization of stock-based compensation expense of $5.1 million and
$30.3 million during the years ended December 31, 2000 and 1999. We anticipate
granting additional equity securities in the future to employees, directors and
artists.
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The Company is currently anticipating initiating a rescission offer
during the second quarter of 2001 with respect to options and shares of its
common stock issued prior to its initial public offering. To the extent that
employees holding options, subject to the rescission offer, accept the offer,
the Company will record compensation expense for such payments, which could be
significant. The amount of expense recorded for the repurchase of unexercised
stock options from employees shall be the sum of the intrinsic value at the
original measurement date (less any expense related to the intrinsic value
recorded up to the acceptance of the rescission offer) and the amount of cash
paid to the holder that exceeds the lesser of the intrinsic value at the
original measurement date or immediately prior to settlement. The amount of
expense that shall be recorded for the repurchase of unexercised non-employee
options shall be the difference between the amount paid for each option and the
fair value of the options on the date the repurchase offer is accepted. The fair
value of the options shall be determined using the Black-Scholes option pricing
model over the remaining expected life of the options. Any unamortized expense
at the time of repurchase related to the initial grant of the options to the
non-employees shall continue to be amortized over the remaining service period
related to the original option grants. The Company shall also record as expense
for the repurchase of shares issued pursuant to the exercise of options the
difference between the cash paid for the repurchase of the shares and the fair
value of the shares on the date the repurchase is accepted. The amount of
expense will vary depending on the number of individuals that accept the
rescission offer and the Company's stock price on the date any rescission is
consummated.
Depreciation and Amortization. Depreciation and amortization expense
consists of the depreciation of fixed assets and the amortization of acquired
intangible assets. The acquisitions of iMusic, Mjuice and the minority interest
of the UBL were accounted for using the purchase method of accounting and,
accordingly, the purchase prices have been allocated to the tangible and
intangible assets acquired and liabilities assumed on the basis of their fair
value on the acquisition dates. Substantially all of the purchase price of these
transactions is attributable to the acquired intangible assets. As a result, the
aggregate excess purchase price over the net tangible assets to date has been
estimated to be $20.6 million and is being amortized over five years, the
expected estimated useful life of these assets. These non-cash charges will
significantly affect our reported operating results over the next several years.
INTEREST INCOME AND EXPENSE
Interest income consists of earnings on our cash and cash equivalents
and short-term investments, and interest expense consists of interest associated
with short-term borrowings.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000 AND 1999
NET REVENUE
Net revenue for the year ended December 31, 2000 increased to $21.7
million from $10.3 million for the year ended December 31, 1999, which
represented an increase of 111%. The increase was due to increases in online
product sales revenues, advertising revenue and agency commission revenue.
Online product sales revenue for the year ended December 31, 2000,
increased 130% to $12.2 million from $5.3 million for the year ended December
31, 1999, primarily as a result of an increase in the number of ARTISTchannels
that were operated.
Advertising and other revenue increased $3.4 million, or 117%, to $6.3
million for the year ended December 31, 2000, from $2.9 million for the year
ended December 31, 1999, primarily as a result of an increase in the number of
advertisers, increased page views generated by our Web sites plus a significant
increase in the number of advertisers, primarily in sales of non-impression
based sponsorships.
Commission revenue from the ARTISTdirect Agency increased from $1.3
million for the year ended December 31, 1999 to $2.9 million for the year ended
December 31, 2000, which represented an increase of 126%, due primarily to
increased touring activity of the agency's artists.
COST OF REVENUE
Direct cost of product revenue. Direct cost of product revenue increased
to $10.4 million for the year ended December 31, 2000 from $5.1 for the year
ended December 31, 1999, which represented an increase of 104%. This $5.3
million increase
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corresponded with the increase in online product sales revenue and was primarily
attributable to a $3.7 million increase in product and royalty costs payable to
our vendors and artists and a $1.6 million increase in transaction costs.
Other cost of revenue. Other cost of revenue increased to $8.6 million
for the year ended December 31, 2000, from $3.4 million for the year ended
December 31, 1999, which represented an increase of 155%. This $5.2 million
increase was primarily due to increases in Web site hosting and maintenance
costs.
Stock-based compensation. For the year ended December 31, 2000, we
recorded non-cash stock-based compensation charges of $7.5 million compared to
$1.8 million for the year ended December 31, 1999. The stock-based compensation
expense relates primarily to the amortization of the estimated value of the
options, using the Black-Scholes method, given to artists in connection with the
operation of their stores and is amortized over the life of the associated
contract periods. As of December 31, 2000, $11.1 million of unearned
compensation remains to be amortized. Of this amount, $6.2 million will be
recorded as stock-based compensation expense in 2001, $4.8 million in 2002 and
$196,000 in 2003.
OPERATING EXPENSE
Web Site Development. Web site development expense increased to $5.4
million for the year ended December 31, 2000, from $1.8 million for the year
ended December 31, 1999, which represented an increase of 196%. This increase
was primarily attributable to increased fees paid to third party service vendors
relating to the continued development of our Web site, as well as an increase in
the development costs of programming.
Sales and Marketing. Sales and marketing expense increased to $25.6
million for the year ended December 31, 2000 from $13.2 million for the year
ended December 31, 1999, which represented an increase of 94%. The increase was
primarily attributable to a significant increase in our online advertising
expenditures, as well as increased offline advertising. We expect the growth
rate of sales and marketing expenses to decrease in future periods.
General and Administrative. General and administrative expense increased
to $17.9 million for the year ended December 31, 2000 from $10.3 million for the
year ended December 31, 1999, which represented an increase of 73%. This
increase was primarily attributable to increases in personnel and related
expenses, facilities and outside professional services expenses. We expect the
growth rate of general and administrative expense to decrease as we seek to
operate more efficiently.
Amortization of Stock-based Compensation. We recorded stock-based
compensation expense of $5.1 million for the year ended December 31, 2000 in
connection with stock issuances to employees, directors, professional firms,
artists and advisors for promotional services, which represented a decrease of
83% for the comparable period in 1999. Stock-based compensation for the
comparable period in 1999 was $30.3 million, primarily in connection with stock
issuances to employees, directors and professional firms. The expense during the
year ended December 31, 2000 reflected a credit to stock-based compensation of
$6.6 million related to stock appreciation rights granted to certain executives
of the Company as a result of a reduction in the valuation of the Company's
underlying common stock as compared with December 31, 1999. This credit was
offset by $11.7 million of amortization of stock-based compensation expense
related to options granted to employees, professional firms, artists and
advisors.
Depreciation and Amortization. Depreciation and amortization expense
increased to $6.2 million for the year ended December 31, 2000 from
approximately $2.5 million for the year ended December 31, 1999, which
represented an increase of 149%. This increase was primarily attributable to the
amortization of the goodwill associated with the acquisition of iMusic, Mjuice
and the minority interest in the UBL, as well as an increase in depreciation of
fixed assets and amortization of leasehold improvements.
INTEREST INCOME AND EXPENSE
Interest income increased to $6.0 million for the year ended December
31, 2000 from $281,000 for the year ended December 31, 1999, which represented
an increase of 2,024%. The increase is due to interest earned on higher cash
balances resulting from the proceeds we received from our initial public
offering in March 2000 and the Series C redeemable preferred shares issued in
December 1999 and January 2000.
NET LOSS
Net loss increased to $59.3 million for the year ended December 31,
2000, compared to $57.8 million for the year ended December 31, 1999, which
represented an increase of 3%. The increase in the net loss is primarily
attributable to a $4.9 million
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decrease in gross profit due to stock-based compensation related to artist store
agreements, a $12.4 million increase in sales and marketing expense, a $7.6
million increase in general and administrative expense and a $3.7 million
increase in depreciation and amortization expense, partially offset by a $25.2
million decrease in the amortization of stock-based compensation and a $5.7
million increase in interest income.
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, which represented an increase
of approximately 124%. 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, which
represented an increase of approximately 425%, 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, which represented a decrease of approximately 32%,
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, which
represented an increase of 240%. 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, which represented an increase of 410%. 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
Web Site Development. Web site development expense increased to $1.8
million for the year ended December 31, 1999 from $589,000 for the same period
in 1998, which represented an increase of approximately 208%. 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, which represented an increase of approximately 846%. The
increase was primarily 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.
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, which represented an increase of 305%. 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.
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 and advisors for promotional services which were being treated as
variable stock compensation, which represented an increase of approximately 692%
for the comparable period in 1998. 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, which represented an increase
of approximately
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4,153%. 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, which represented
an increase of approximately 817%. 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.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2000, we completed our IPO and raised net proceeds of
approximately $52.4 million through the sale of 5,000,000 common shares. In
addition, we raised an aggregate of $97.5 million of gross proceeds through the
sale of 7,000,291 shares of Series C preferred stock in December 1999 and
January 2000. In May 1999, we issued 3,750,0000 shares of Series B preferred
securities in exchange for an aggregate purchase price of $15.0 million. Between
July 1998 and December 1998, we issued 3,207,815 shares of Series A preferred
securities in exchange for an aggregate purchase price of $4.9 million. Prior to
July 1998, we financed our operations and growth entirely from internally
generated cash flow and capital contributions from founders. As of December 31,
2000, we had $51.4 million of cash and cash equivalents, excluding cash held for
clients, and held $36.4 million in short-term investments. In February 2001, we
commenced a partial self-tender offer for up to 2,000,000 of our outstanding
shares at a price per share not less than $1.25 and not greater than $1.50.
Assuming that we purchase all 2,000,000 shares at the maximum purchase price of
$1.50, we expect our out-of-pocket costs, including expenses associated with the
tender offer, to be approximately $3.2 million, which we expect to fund from
our existing cash and cash equivalents. We currently expect the tender offer to
be consummated in the second quarter of 2001.
Net cash used in operating activities was $35.1 million for the year
ended December 31, 2000, and $26.0 million and $2.3 million for the years ended
December 31, 1999 and 1998, respectively. Net cash used in operating activities
for each of these periods primarily consisted of net losses partially offset by
non-cash items such as stock-based compensation and depreciation and
amortization.
Net cash used in investing activities was $46.3 million for the year
ended December 31, 2000, which consisted of purchases of fixed assets of $7.5
million, primarily computer equipment to support the ARTISTdirect Network,
leasehold improvements to our corporate offices, the purchase of short-term
investments of $36.4 million, and $2.0 million relating to the purchase of
Mjuice.com, Inc. Net cash used was $4.4 million and $514,000 for the years ended
December 31, 1999 and 1998, respectively, and consisted primarily of fixed asset
purchases.
Net cash provided by financing activities was $63.7 million for the year
ended December 31, 2000 which was principally attributable to the proceeds of
our initial public offering in March 2000 in which we raised approximately $52.4
million, net of underwriters' discounts and offering costs, and $10.4 million
raised from the sale of Series C preferred stock in January 2000, net of
offering costs.
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 approximately $82.3
million.
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As of December 31, 2000 our principal commitments consisted of
obligations outstanding under operating leases and employment contracts.
We currently anticipate that our available cash resources will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months. There can be no assurance,
however, that the underlying assumed levels of revenues and expenses will prove
to be accurate. Although we do not currently have any specific material capital
commitments beyond such 12-month period, if we are unsuccessful in generating
sufficient cash flow from operations, we may need to raise additional funds in
future periods through public or private financings, or other arrangements to
fund our operations and potential acquisitions. If any additional financing is
needed, we might not be able to raise capital on reasonable terms or at all.
Failure to raise capital when needed could seriously harm our business and
operating results. If additional funds were raised through the issuance of
equity securities, the percentage of ownership of our stockholders would be
reduced. Furthermore, these equity securities might have rights, preferences or
privileges senior to our common stock. We currently do not have any plans for
future equity offerings.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board recently issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended by
SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities --
Deferral of the Effective date of FASB Statement No. 133" and SFAS 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities."
These pronouncements become effective January 1, 2001 and establish 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 year ended December
31, 2000. The adoption of these pronouncements will not have an impact on our
consolidated financial statements.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") 101, Revenue Recognition in Financial
Statements. SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements of all public registrants. Any
change in the Company's revenue recognition policy resulting from the
implementation of SAB 101 would be reported as a change in accounting principle.
In June 2000, the SEC issued SAB 101B which delayed the implementation date of
SAB 101 until the fourth fiscal quarter of fiscal years beginning after December
15, 1999. The adoption of SAB 101 did not have an impact on our consolidated
financial statements.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market rate risk for changes in interest rates is
related primarily to our investment portfolio. We have not used derivative
financial instruments in our investment portfolio. Our short term investments
are comprised of U.S. government obligations and public corporate debt
securities. Interest rate fluctuations impact the carrying value of the
portfolio. We do not believe that the future market risks related to the above
securities will have material adverse impact on our financial position, results
of operations or liquidity.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and schedule, as listed under Item
14, appear in a separate section of this Annual Report on Form 10-K beginning on
page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
33
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The sections titled "Executive Officers of the Company," "Directors and
Nominees" and "Compliance with Section 16(a) of the Exchange Act" appearing in
the Company's Proxy Statement for the 2001 Annual Meeting of Stockholders is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section titled "Executive Compensation and Related Information" appearing in
the Company's Proxy Statement for the 2001 Annual Meeting of Stockholders is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section titled "Principal Stockholders" appearing in the Company's Proxy
Statement for the 2001 Annual Meeting of Stockholders is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section titled "Certain Transactions" appearing in the Company's Proxy
Statement for the 2001 Annual Meeting of Stockholders is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1). FINANCIAL STATEMENTS
ARTISTDIRECT's financial statements appear in a separate section of this
Annual Report on Form 10-K beginning on the pages referenced below:
PAGE
----
ARTISTdirect, Inc. and Subsidiaries Consolidated Financial
Statements................................................ F-1
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
(2) FINANCIAL STATEMENT SCHEDULE
ARTISTDIRECT's financial statement schedule appears in a separate
section of this Annual Report on Form 10-K on the pages referenced below. All
other schedules have been omitted as they are not applicable, not required or
the information is included in the consolidated financial statements or the
notes thereto.
34
35
(3) EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1* Amended and Restated Certificate of Incorporation of the Registrant.
3.2* Amended and Restated Bylaws of the Registrant.
4.1* See Exhibits 3.1 and 3.2 for provisions of the Registrant's Certificate of Incorporation and Bylaws
determining the rights of holders of the Registrant's common stock. See Exhibit 10.8 for the rights of
holders of registration rights.
4.2* Specimen common stock certificate.
10.1+* Agreement dated as of November 15, 1996, between the RCA Records Label and the Registrant.
10.2* Digex Services and Products Agreement, dated August 8, 1999, between Digex, Inc. and the Registrant.
10.3+* BMI Music Performance Agreement for the UBL, dated October 9, 1998.
10.4+* AT&T Dedicated Hosting Service Agreement, dated April 16, 1999, between AT&T and the Registrant.
10.5* Settlement Agreement and Mutual General Release, dated as of October 23, 1997, between William Elson, on
the one hand, and the Registrant, MGE, LLC, Marc Geiger and Donald Muller, on the other hand.
10.6+* Database, On-Line Internet Retail Store and Consumer Direct Fulfillment Services Agreement, dated as of
August 15, 1998, between AEC One Stop Group, Inc. and the UBL, as amended.
10.7* Securities Purchase Agreement, dated July 28, 1998, among the Registrant, the UBL, Constellation Venture
Capital, L.P. and Constellation Ventures (BVI), Inc.
10.8* Third Amended and Restated Registration Rights Agreement, dated as of November 12, 1999, among the
Registrant and the other parties who are signatories thereto, as amended.
10.9* UBL Exchange, Contribution and Distribution Agreement, dated May 18, 1999.
10.10* Exchange Agreement, dated February 17, 1999, by and among the UBL, Scott Blum and Eric Benjamin.
10.11* Contingent Loan Agreement, dated February 17, 1999, by and between the UBL and Scott Blum.
10.12* Letter Agreement, dated February 17, 1999, between the UBL and Scott Blum regarding bonuses to cover
interest obligations under the Contingent Loan Agreement.
10.13* Issuance, Noncompetition and Nonsolicitation Agreement, dated as of January 1, 1996, between the
Registrant and Keith Yokomoto.
10.14* Issuance Agreement, dated as of January 1, 1998, between the Registrant, Marc Geiger, Donald Muller, and
L&G Associates One.
10.15* Issuance, Noncompetition and Nonsolicitation Agreement, dated as of June 30, 1998, between the Registrant
and Steve Rennie.
10.16* Deferred Compensation Agreement, dated as of April 1, 1998, by and between Keith Yokomoto and the
Registrant dated July 1, 1998.
10.17* Employment Agreement, dated as of January 1, 1998, between Keith Yokomoto and the Registrant.
10.18* Employment Agreement, dated as of April 1, 1998, between Steve Rennie and the UBL.
10.19* Employment Agreement, dated as of July 28, 1998, between Marc Geiger and the Registrant.
35
36
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.20* Employment Agreement, dated as of July 28, 1998, between Don Muller and the Registrant.
10.21* 1999 Employee Stock Purchase Plan.
10.22* 1999 Employee Stock Option Plan.
10.23* 1999 Artist and Artist Advisor Stock Option Plan.
10.24* 1999 Artist Stock Option Plan.
10.25+* Agreement to license Pandesic E-business Solution Service between Pandesic LLC, AD and UBL.
10.26+* ADNM Merchandiser Agreement, dated as of April 1, 1999, between Giant Merchandising and ARTISTdirect New Media, LLC.
10.27+* ADNM Merchandiser Agreement, dated as of June 7, 1999, between Winterland Concessions Company and
ARTISTdirect New Media, LLC.
10.28+* UBL Merchandiser Agreement, dated as of April 1, 1999, between Giant Merchandising and ARTISTdirect New Media, LLC.
10.29* Form of Directors Indemnification Agreement.
10.30* Form of Officers Indemnification Agreement.
10.31* Audio Sample License Agreement dated as of December 20, 1999 between the Company and Maverick Recording Company.
10.32+* Internet Video License Agreement dated as of December 20, 1999 between the Company and Maverick Recording Company.
10.33+* Webcasting Transmission License Agreement dated as of December 20, 1999 between the Company and Maverick
Recording Company.
10.34+* Strategic Marketing Agreement dated as of December 20, 1999 between the Company and Maverick Recording Company.
10.35+* Audio Sample License Agreement dated as of December 20, 1999 between the Company and Warner Music Group Inc.
10.36+* Internet Video License Agreement dated as of December 20, 1999 between the Company and Warner Music Group Inc.
36
37
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.37+* Webcasting Transmission License Agreement dated as of December 20, 1999 between the Company and Warner
Music Group Inc.
10.38+* Strategic Marketing Agreement dated as of December 20, 1999 between the Company and Warner Music Group Inc.
10.39* Strategic Marketing Agreement dated as of December 6, 1999 between the Company and Universal Music Group, Inc.
10.40+* ARTISTdirect -- Cisneros Television Group Memorandum of Understanding dated as of November 15, 1999
between the Company and Lakeport Overseas Ltd.
10.41+* Strategic Licensing Agreement dated as of December 6, 1999 between the Company and Sony Music.
10.42* Strategic Marketing Agreement dated as of December 20, 1999 between the Company and BMG Music.
10.43+* Advertising and Promotion Agreement dated as of December 24, 1999 between the Company and Yahoo! Inc.
10.44* Yahoo! Remote Merchant Integration (RMI) Program Agreement dated as of December 24, 1999 between the
Company and Yahoo! Inc.
10.45* Form of Series C Preferred Stock Purchase Agreement.
10.46* Warrant dated December 24, 1999, issued to Yahoo!
10.47* 5670 Wilshire Boulevard Office Lease, as amended.
21.1** Subsidiaries of ARTISTdirect, Inc.
23.1 Consent of KPMG LLP with respect to ARTISTdirect, LLC and subsidiaries.
- -------------------------
* Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 (Registration Number 333-87547)
initially filed on September 22, 1999, as amended by Amendment No.'s 1-7
thereto.
** Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 (Registration Number 333-41630)
initially filed on July 18, 2000.
+ Confidential treatment has been requested for certain confidential portions
of this exhibit pursuant to Rule 406 under the Securities Act. In
accordance with Rule 406, these confidential portions have been omitted
from this exhibit and filed separately with the Commission.
(b) EXHIBITS ON FORM 8-K
No Current Reports on Form 8-K were filed during the quarter ended
December 31, 2000.
37
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
ARTISTDIRECT, INC.
Date: April 2, 2001 By: /s/ MARC P. GEIGER
---------------------------------
Marc P. Geiger
Chief Executive Officer and
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ MARC P. GEIGER Chief Executive Officer and Chairman April 2, 2001
- --------------------------------- of the Board (Principal Executive
Marc P. Geiger Officer)
/s/ DONALD P. MULLER President, ARTISTdirect Agency and April 2, 2001
- --------------------------------- Kneeling Elephant Records and
Donald P. Muller Director
/s/ KEITH YOKOMOTO Chief Operating Officer April 2, 2001
- ---------------------------------
Keith Yokomoto
/s/ JAMES B. CARROLL Executive Vice President and Chief April 2, 2001
- --------------------------------- Financial Officer (Principal
James B. Carroll Financial and Accounting Officer)
/s/ ALLEN D. LENARD Director April 2, 2001
- --------------------------------
Allen D. Lenard
/s/ CLIFFORD H. FRIEDMAN Director April 2, 2001
- --------------------------------
Clifford H. Friedman
/s/ RICK RUBIN Director April 2, 2001
- --------------------------------
Rick Rubin
/s/ DARA KHOSROWSHAHI Director April 2, 2001
- --------------------------------
Dara Khosrowshahi
/s/ BENJAMIN MOODY Director April 2, 2001
- --------------------------------
Benjamin Moody
38
39
ARTISTDIRECT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
ARTISTdirect, Inc. and Subsidiaries Consolidated Financial
Statements................................................ F-1
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
F-1
40
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, 1999 and 2000 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, 2000. 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 auditing standards generally
accepted in the United States of America. 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, 1999 and 2000 and the results of their
operations and their cash flows for each of the years in the three year period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America.
/s/ KPMG LLP
Los Angeles, CA
February 19, 2001
F-2
41
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31,
--------------------
1999 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 69,119 $ 51,457
Cash held for clients..................................... 770 743
Short term investments.................................... -- 36,368
Accounts receivable, net.................................. 1,001 948
Prepaid expenses and other current assets................. 6,795 3,218
-------- --------
Total current assets.................................... 77,685 92,734
Property and equipment, net................................. 3,343 9,057
Investments in affiliated companies......................... 70 85
Goodwill and intangibles, net............................... 13,415 15,018
Other assets, net........................................... 4,087 1,611
-------- --------
$ 98,600 $118,505
======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Cash held for clients..................................... $ 770 $ 743
Accounts payable.......................................... 3,709 2,257
Accrued expenses.......................................... 4,698 5,186
Loans and notes payable................................... 741 178
Deferred revenue.......................................... 37 34
-------- --------
Total current liabilities............................... 9,955 8,398
Long term liabilities..................................... 683 1,530
-------- --------
Total liabilities....................................... 10,638 9,928
Redeemable securities:
Series A redeemable preferred stock, $.01 par value.
Authorized, issued and outstanding 3,207,815 shares in
1999. Liquidation preference and redemption value of
$4,963 in 1999.......................................... 4,963 --
Series B redeemable preferred stock, $.01 par value.
Authorized 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 $9,206 and $10,778 in 1999 and 2000,
respectively............................................ 9,206 10,778
-------- --------
Total redeemable securities............................. 111,707 10,778
-------- --------
Members' and stockholders' equity (deficit):
Common stock, $.01 par value. Authorized 150,000,000
shares; issued and outstanding 14,088,674 and 37,796,081
shares in 1999 and 2000................................. 141 379
Additional paid-in-capital................................ 36,688 200,690
Unearned compensation..................................... (36,976) (20,364)
Accumulated deficit....................................... (23,598) (82,906)
-------- --------
Total members' and stockholders' equity (deficit)....... (23,745) 97,799
-------- --------
$ 98,600 $118,505
======== ========
See accompanying notes to consolidated financial statements.
F-3
42
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1999 2000
------- ---------- ----------
Net revenue:
Online product sales................................... $ 1,548 $ 5,282 $ 12,160
Advertising and other.................................. 552 2,910 6,326
Agency commissions..................................... 1,917 1,304 2,946
Record label........................................... 565 778 244
------- ---------- ----------
Total net revenue................................... 4,582 10,274 21,676
Cost of revenue:
Direct cost of product sales........................... 1,505 5,091 10,381
Other cost of revenues................................. 1,010 3,380 8,616
Stock-based compensation............................... -- 1,769 7,545
------- ---------- ----------
Total cost of revenue............................... 2,515 10,240 26,542
Gross profit (loss)................................. 2,067 34 (4,866)
Operating expense:
Website development costs.............................. 589 1,815 5,364
Sales and marketing.................................... 1,398 13,222 25,623
General and administrative............................. 2,545 10,319 17,874
Stock-based compensation............................... 3,828 30,304 5,067
Depreciation and amortization.......................... 59 2,509 6,248
------- ---------- ----------
Loss from operations................................ (6,349) (58,135) (65,042)
Income/(loss) from equity investments.................. 2 50 (235)
Interest income (expense), net......................... 29 281 5,969
------- ---------- ----------
Net loss before taxes............................... (6,318) (57,804) (59,308)
Income taxes............................................. -- -- --
------- ---------- ----------
Net loss............................................ $(6,318) $ (57,804) $ (59,308)
=======
Interest on rescission offer............................. 237 532
Dividends on redeemable preferred securities............. 1,414 963
Beneficial conversion feature on redeemable preferred
stock.................................................. -- 24,375
---------- ----------
Net loss attributable to common shareholders............. $ (59,455) $ (85,178)
========== ==========
Basic and diluted net loss per share for period from
October 6, 1999 to December 31, 1999 and for the year
ended December 31, 2000................................ $ (1.71) $ (2.68)
Weighted average shares outstanding used in calculating
basic and diluted net loss per share for period from
October 6, 1999 to December 31, 1999 and for the year
ended December 31, 2000................................ 14,177,463 31,751,258
See accompanying notes to consolidated financial statements.
F-4
43
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS' AND STOCKHOLDERS' EQUITY
(DEFICIT)
(IN THOUSANDS)
COMMON STOCK ADDITIONAL TOTAL
-------------------- PAID IN MEMBERS' UNEARNED ACCUMULATED EQUITY/
SHARES AMOUNT CAPITAL INTEREST COMPENSATION DEFICIT (DEFICIT)
---------- ------- ---------- -------- ------------ ----------- ---------
Balance at December 31, 1997............... -- $ -- $ -- $ 76 $ -- $ (488) $ (412)
Distribution of members' interest........ -- -- -- (249) -- -- (249)
Variable equity interests................ -- -- -- 4,330 (4,330) -- --
Amortization of unearned compensation.... -- -- -- -- 3,828 -- 3,828
Accrual of dividends to preferred
members................................ -- -- -- (171) -- -- (171)
Accrual for securities subject to
rescission offer....................... -- -- -- (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) -- --
Variable equity 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 common
stock as a C corporation............... 213,002 2 765 -- -- -- 767
Accrual for securities subject to
rescission offer....................... -- (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)
Issuance of securities upon initial
public offering, net of offering
costs.................................. 5,000,000 50 52,385 -- -- -- 52,435
Issuance of securities for acquisition... 866,034 9 2,850 -- -- -- 2,859
Issuance of securities for employee stock
purchase plan.......................... 67,578 1 39 -- -- -- 40
Series C redeemable preferred stock
offering costs......................... -- -- (4,800) -- -- -- (4,800)
Issuance/cancellation of
options/warrants....................... -- -- (1,372) -- 1,372 -- --
Exercise of stock options................ 409,069 4 1,549 -- -- -- 1,553
Amortization of unearned compensation.... -- -- -- -- 15,240 -- 15,240
Variable equity interests................ -- -- (6,645) -- -- -- (6,645)
Issuance of stock appreciation
rights/options......................... -- -- 2,992 -- -- -- 2,992
Issuance of stock for settlement
agreement.............................. -- -- 1,025 -- -- -- 1,025
Accrual of dividends to preferred
shareholders........................... -- -- (963) -- -- -- (963)
Conversion of redeemable preferred shares
to common shares....................... 17,194,283 172 118,516 -- -- -- 118,688
Conversion of redeemable common shares to
common shares.......................... 170,443 2 2,350 -- -- -- 2,352
Accrual for securities subject to
rescission offer....................... -- -- (3,924) -- -- -- (3,924)
Net loss................................. -- -- -- -- -- (59,308) (59,308)
---------- ---- -------- -------- -------- -------- --------
Balance at December 31, 2000............... 37,796,081 $379 $200,690 $ -- $(20,364) $(82,906) $ 97,799
========== ==== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
F-5
44
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
-------- -------- --------
Cash flows from operating activities:
Net loss.................................................. $ (6,318) $(57,804) $(59,308)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization........................... 59 2,509 6,248
(Income)/loss from equity investment.................... (2) (50) 235
Allowance for doubtful accounts and sales returns....... 89 29 341
Write-off of investment................................. -- 250 --
Amortization of unearned compensation................... 3,828 32,073 12,612
Changes in assets and liabilities:
Accounts receivable................................... (536) (571) (288)
Prepaid expenses and other current assets............. (391) (6,628) 3,638
Other assets.......................................... (49) (2,054) 2,476
Accounts payable, accrued expenses and other
liabilities.......................................... 1,049 6,384 (1,032)
Deferred revenue...................................... (43) (120) (19)
-------- -------- --------
Net cash used in operating activities.............. (2,314) (25,982) (35,097)
-------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment....................... (141) (3,513) (7,523)
Purchase of short term investments, net of maturities..... -- -- (36,368)
Purchase of programming rights............................ -- (675) --
Cash paid for acquisitions................................ -- (237) (2,015)
Investments in affiliated companies....................... (373) (30) (250)
Investments in trademarks................................. -- -- (120)
Distribution of earnings from equity investment........... -- 33 --
-------- -------- --------
Net cash used in investing activities.............. (514) (4,422) (46,276)
-------- -------- --------
Cash flows from financing activities:
Payment of preferred dividend............................. -- (276) --
Distribution of members' interest......................... (249) -- --
Payment of notes to shareholders.......................... -- -- (741)
Proceeds from issuance of securities for employee stock
purchase plan........................................... -- -- 40
Proceeds from exercise of stock options................... -- 671 1,553
Proceeds from issuance of preferred securities............ 4,850 97,188 15,224
Payment of Series C redeemable preferred stock offering
costs................................................... -- -- (4,800)
Proceeds from initial public offering, net of offering
costs paid.............................................. -- -- 52,435
-------- -------- --------
Net cash provided by financing activities.......... 4,601 97,583 63,711
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents...................................... 1,773 67,179 (17,662)
Cash and cash equivalents at beginning of period............ 167 1,940 69,119
-------- -------- --------
Cash and cash equivalents at end of period.................. $ 1,940 $ 69,119 $ 51,457
======== ======== ========
Supplemental disclosure of cash flow information -- cash
paid during the period for interest....................... $ 50 $ 11 $ 43
======== ======== ========
See accompanying notes to consolidated financial statements.
F-6
45
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 (Exchange Transaction). The acquisition of the minority interest 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.
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 EQUIVALENTS
Cash equivalents consist of investments, which are readily convertible into
cash and have maturities of three months or less at the time of purchase.
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
46
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SHORT TERM INVESTMENTS
The Company's investments are classified as held-to-maturity as the Company
has the intent and ability to hold the securities to maturity. The securities
are stated at amortized cost, adjusted for amortization of premiums and
accretion discounts to maturity. The Company invests exclusively in fixed income
securities with maturities of one year or less at the time of purchase.
DEPRECIATION
Depreciation is provided using the straight-line method over the following
estimated useful lives:
Computer equipment and software............... 3 years
Furniture and fixtures........................ 7 years
Leasehold improvements........................ Lesser of estimated
useful life or life of
lease (10 years)
REVENUE RECOGNITION
Online product sales, which consist primarily of the gross amount of sales
revenue paid by the customer for recorded music and merchandise sold via the
Internet, include shipping fees and are recognized when the products are
shipped. The Company obtains merchandise from merchandisers and manufacturers,
music from a third party distributor, contracts for warehousing and fulfillment,
processes customer orders and provides customer service. The Company takes title
to all products sold and bears the risk of loss for collections and 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 advertisements and
sponsorships, both online and offline, under short-term contracts. To date, the
duration of the Company's advertising and sponsorship commitments has generally
averaged from one to three months. The Company's online obligations typically
include the guarantee of a minimum number of "impressions" or times that an
advertisement appears in pages viewed by the users of the Company's online
properties. Online advertising revenue is generally recognized as the
impressions are served during the period in which the advertisement is
displayed, provided that no significant obligations of the Company remain and
collection of the resulting receivable is probable. The Company records a
reserve for contracts in which the guarantee of a minimum number of impressions
are not expected to be met. There were no such instances as of December 31,
1998, 1999 and 2000. Revenue generated from offline advertising and sponsorships
is recognized ratably over the terms of the sponsorship agreements.
The Company entered into several contracts with advertisers whereby the
parties exchanged online and offline advertising. This revenue was recognized as
trade and barter. Trade and barter is valued based upon similar cash
transactions, which have been entered into within six months prior to the
respective trade and barter agreement. Trade and barter revenue was $0, $98,000
and $309,000 for years ended December 31, 1998, 1999 and 2000, respectively.
Agency commission revenue is recognized in accordance with the terms of the
representation agreements between the Company and its clients. Revenue is
generally recorded upon payment for the performance of services or delivery of
materials created by the artists represented.
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
F-8
47
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 in the
period incurred. 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 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.
WEBSITE DEVELOPMENT COSTS
Website 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.
These costs are expensed as incurred. The implementation of Emerging Issues
Task Force No. 00-02 "Accounting for Website Development Costs," effective
July 1, 2000, has not had a material impact on the consolidated financial
statements.
ADVERTISING COSTS
Advertising costs are expensed as incurred and totaled $461,000, $7.7
million and $14.7 million during the years ended December 31, 1998, 1999 and
2000, respectively.
F-9
48
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
INTANGIBLE ASSETS
Intangible assets consist almost entirely of goodwill resulting from the
excess of the purchase price over the net assets acquired from the acquisition
of a minority interest in the UBL, and the acquisitions of iMusic, Inc. and
Mjuice.com, Inc. Intangible assets 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.
CONCENTRATION OF CREDIT RISK AND SUPPLIER RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, short term
investments and trade accounts receivable. The Company places its cash and short
term 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 five 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, short term investments, accounts receivable, accounts payable
and accrued expenses and amounts due to employees, approximate fair value
because of the short maturity of these instruments.
INVESTMENTS IN AFFILIATED COMPANIES
Investments in affiliated companies in which the Company's voting interest
is 20% to 50%, or in which the Company is able to exert significant influence in
instances where the voting interest is less than 20%, are accounted for under
the equity method of accounting. Under this method, the investment, originally
recorded at cost, is adjusted to recognize the Company's share of the net
earnings or losses of the affiliates as they occur rather than as dividends or
other distributions received. The Company's share of losses is generally limited
to the extent of the Company's investment in, advances to and commitments for
the investee.
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).
F-10
49
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Dividends to preferred shareholders and interest on the
rescission offer balance are added to the net loss in determining the net loss
attributable to common shareholders. 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 for periods
prior to October 6, 1999.
Included in net loss attributable to common shareholders for the year ended
December 31, 2000 is the effect of the beneficial conversion feature of the
Series C redeemable preferred stock which converted into common shares as of
March 31, 2000 in connection with the initial public offering. The value of the
beneficial conversion feature was calculated based on the $2.40 per share
difference between the initial public offering price of $12.00 and the effective
conversion price of $9.60 multiplied by the 10,156,252 shares of common stock
issued to the Series C shareholders.
The diluted loss per share excludes 7.6 million and 9.8 million securities
(after giving effect to the Reverse Stock Split) as of December 31, 1999 and
2000, respectively, since the impact would be anti-dilutive.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation in accordance
with the provisions of Accounting Principles Board ("APB") Opinion No. 25 and
FASB Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions
Involving Stock Compensation," 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 and EITF
96-18, "Accounting for Equity Investments that are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services",
which addresses the measurement date and recognition approach for such
transactions.
The Company recognizes compensation expense related to variable awards in
accordance with FIN 28. For fixed awards, the Company recognizes expense over
the vesting period or the period of service.
Stock-based compensation is comprised of sales and marketing expense of $0,
$8,551 and $2,209 for the years ended December 31, 1998, 1999 and 2000,
respectively, and general and administrative expense of $3,828, $21,753 and
$2,858 for the years ended December 31, 1998, 1999 and 2000, respectively.
COMPREHENSIVE LOSS
The Company has no significant components of other comprehensive income,
and accordingly, the comprehensive loss is the same as net loss for all periods.
F-11
50
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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")
and SFAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which becomes effective January 1, 2001. These pronouncements
establish 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 these pronouncements will not have an
impact on the consolidated financial statements of the Company.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") 101, Revenue Recognition in Financial
Statements. SAB 101 provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements of all public registrants. Any
change in the Company's revenue recognition policy resulting from the
implementation of SAB 101 would be reported as a change in accounting principle.
In June 2000, the SEC issued SAB 101B which delayed the implementation date of
SAB 101 until the fourth fiscal quarter of fiscal years beginning after December
15, 1999. The adoption of SAB 101 did not have an impact on the Company's
consolidated financial statements.
F-12
51
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
Significant non-cash investing and financing activities are reflected in
the following table:
YEAR ENDED DECEMBER 31,
---------------------------
1998 1999 2000
---- ------- --------
(IN THOUSANDS)
Cash paid for acquisitions:
Fair value of net assets acquired........................ $ -- $ 2,463 $ 5,077
Net liabilities assumed.................................. -- (185) (203)
Common units/stock issued................................ -- (2,168) (2,859)
---- ------- --------
Cash paid for acquisitions.......................... $ -- $ 110 $ 2,015
==== ======= ========
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 $ 963
Securities subject to potential rescission offer........... $114 $ 6,740 $ 3,924
Accretion on redeemable stock.............................. $ -- $ 184 $ --
Issuance/cancellation of options/warrants.................. $ -- $51,202 $ 1,372
Appreciation (depreciation) of variable equity interests... $ -- $16,470 $ (6,645)
Conversion of preferred return to common securities........ $ -- $ 1,122 $ --
Issuance of shares to officer.............................. $ -- $ 875 $ --
Notes issued to shareholders............................... $ -- $ 741 $ --
Conversion of redeemable common stock to common stock...... $ -- $ -- $ 2,352
Issuance of stock appreciation rights/options.............. $ -- $ -- $ 2,992
Conversion of redeemable preferred stock and accrued
dividends to common shares............................... $ -- $ -- $118,688
5. SHORT TERM INVESTMENTS
The Company's short-term investments consist of the following
held-to-maturity securities:
DECEMBER 31, 2000
--------------------
FAIR
MARKET AMORTIZED
VALUE COST
------- ---------
(IN THOUSANDS)
U.S. corporate and bank debt............. $30,361 $30,362
U.S. government and agencies............. 4,001 4,002
International corporate and bank debt.... 2,003 2,004
------- -------
Total investments................. $36,365 $36,368
======= =======
All held-to-maturity securities mature within one year.
F-13
52
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and consist of the following:
DECEMBER 31,
-------------------
1999 2000
------ -------
(IN THOUSANDS)
Computer equipment and software............................ $3,559 $ 7,845
Furniture and fixtures..................................... 207 1,747
Leasehold improvements..................................... -- 2,542
------ -------
3,766 12,134
Less accumulated depreciation.............................. (423) (3,077)
------ -------
Property and equipment, net................................ $3,343 $ 9,057
====== =======
7. 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:
YEAR ENDED
DECEMBER 31,
--------------
1999 2000
----- -----
(IN THOUSANDS)
Balance, beginning of period................................ $ 81 $ 89
Provision for doubtful accounts............................. 385 653
Amounts charged off......................................... (377) (353)
----- -----
Balance, end of period...................................... $ 89 $ 389
===== =====
A summary of the activity of the reserve for sales returns for the periods
indicated is reflected in the following table:
YEAR ENDED
DECEMBER 31,
--------------
1999 2000
----- -----
(IN THOUSANDS)
Balance, beginning of period................................ $ 13 $ 34
Provision for sales returns................................. 180 244
Amounts charged off......................................... (159) (203)
----- -----
Balance, end of period...................................... $ 34 $ 75
===== =====
F-14
53
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
DECEMBER 31,
----------------
1999 2000
------ ------
(IN THOUSANDS)
Accrued cost of sales....................................... $ 865 $1,924
Accrued payroll and related................................. 1,470 1,391
Programming rights.......................................... 682 682
Accrued professional fees................................... 333 317
Accrued advertising costs................................... 873 170
Other accrued expenses...................................... 475 702
------ ------
Total accrued expenses................................. $4,698 $5,186
====== ======
9. INVESTMENTS IN AFFILIATED COMPANIES
As of December 31, 1999 and 2000, the Company had a 45% ownership in
SnoCore, LLC, and accounts for the investment under the equity method. The
Company recorded income of $50,000 and $15,000 for this investment for the years
ended December 31, 1999 and 2000, respectively. The Company received a $33,000
distribution of income from the investee during the year ended December 31,
1999.
During the year ended December 31, 2000, the Company entered into a joint
venture, ARTISTdirect Latin America, LLC in which the Company holds a 50%
ownership interest. The Company accounts for the investment under the equity
method. The Company made an initial investment of $250,000 during the year ended
December 31, 2000. The Company recorded its share of losses of $250,000 for this
investment for the year ended December 31, 2000.
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.
F-15
54
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. 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%. 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. In March 2000, the line of
credit expired.
11. 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.
In August 2000, ARTISTdirect acquired all of the outstanding capital stock
of Mjuice.com, Inc., a company involved in the development and distribution of
the secure digital distribution of MP3-formatted music. The Company issued
900,000 of its common shares and common share equivalents in exchange for all
the outstanding equity of Mjuice.com, Inc. The total purchase consideration for
Mjuice.com was approximately $5.1 million, which includes cash paid of
approximately $2.0 million. The acquisition was accounted for as a purchase,
with $5.0 million being recorded as goodwill, which is being amortized over a
period of five years.
The pro forma results of operations assuming the above transactions had
occurred at the beginning of the following periods are as follows:
YEAR ENDED DECEMBER 31,
------------------------
1999 2000
-------- ------------
(IN THOUSANDS)
Revenues......................................... $10,337 $ 21,676
------- -----------
Net loss......................................... $62,470 $ 62,165
------- -----------
Pro forma loss per share......................... $ 2.73
-----------
Pro forma weighted average shares................ 32,273,251
===========
F-16
55
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The accumulated amortization related to the above intangible assets was
$2.1 million and $5.7 million as of December 31, 1999 and 2000, respectively.
12. INCOME TAXES
Income taxes for the period from October 6, 1999 (the date of conversion to
a C corporation) to December 31, 1999 and for the year ended December 31, 2000
differs from the amount computed using the Federal income tax rate of 35% as a
result of the following (amounts in thousands):
PERIOD FROM
OCTOBER 6,
1999 TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1999 2000
------------ ------------
Computed expected tax benefit............................... $ (8,259) $(20,758)
State and local income taxes, net of federal income tax
benefit................................................... (977) (3,200)
FAS 109 implementation...................................... (9,227) --
Goodwill amortization....................................... 271 1,240
Other....................................................... 27 (303)
Increase in valuation allowance............................. 18,165 23,021
-------- --------
Total tax benefit................................. $ -- $ --
======== ========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and (liabilities) at December 31, 1999 and
2000 are presented below:
PERIOD FROM
OCTOBER 6,
1999 TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1999 2000
------------ ------------
Deferred tax assets:
Net operating loss carryforwards.......................... $ 4,520 $ 23,165
Amortization of stock based compensation.................. 14,296 19,817
Other..................................................... 576 1,331
-------- --------
Total deferred tax assets................................... 19,392 44,313
Less -- valuation allowance................................. (18,165) (41,186)
-------- --------
Net deferred assets......................................... 1,227 3,127
-------- --------
Deferred tax liability -- state income taxes................ (1,227) (3,127)
-------- --------
Net deferred tax assets........................... $ -- $ --
======== ========
At December 31, 2000, the Company had net operating loss carryforwards
totaling approximately $52.8 million for Federal income tax purposes expiring
beginning in 2019 and California state net operating loss carryforwards of $52.8
million expiring beginning in 2007. 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 and 2000 of
$18.2 million and $41.2 million, respectively.
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,
Internal Revenue Code Section 382 substantially restricts the ability of a
Corporation to utilize existing net operating losses in the event of an
"ownership change." Therefore, the Company's net operating losses for Federal
income tax purposes may be limited due to changes in ownership.
F-17
56
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. 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 severance payment of $175,000, to be
paid out in eight quarterly installments. The amount due under this severance
arrangement was $88,000 as of December 31, 1998. The amount was paid in full in
1999. 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 employee exercised the purchase option of
100,000 shares. The Company recorded compensation expense of $1,025,000 for the
year ended December 31, 2000, which represented the difference between the fair
value of the common stock and the amount paid.
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.
For the years ended December 31, 1998, 1999 and 2000, the Company incurred
legal expenses of approximately $450,000, $1,101,000 and $464,000, 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 was a record label
managed by the Company. Under the agreement, RCA provided 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 had
an option to terminate its agreement with Kneeling Elephant after three years,
at which point, the assets and properties of Kneeling Elephant would be divided
based on the terms of the agreement. Under the agreement, RCA provided funding
of $300,000 in January 1997, which was recognized ratably over the minimum three
year operating term. Additionally, RCA has provided annual funding of $450,000,
paid on a quarterly basis, to the Company for the operation of Kneeling Elephant
under the terms of the agreement. The original agreement with RCA was extended
through June 30, 2000, at which point it was terminated.
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 certain sales levels, none of which
have been reached to date.
F-18
57
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
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
certain sales levels, none of which have been reached to date. In January 2001,
the merchandiser filed for bankruptcy protection under Chapter 11.
In November 1999, the Company entered into a 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 are being 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 an advertising and promotion
agreement with Yahoo! pursuant to which the Company purchases media placement on
Yahoo! in return for certain promotional considerations. The Company is
recording 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. On November 7, 2000, the Company amended this agreement such that it
has been terminated as of December 31, 2000. Yahoo! will deliver certain
additional page views containing the Company's banners on various Yahoo!
properties through June 30, 2001. Under the amendment, the Company has no
additional payment obligations to Yahoo!. In connection with the original
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 is $12.00. The expense related to the warrants is being
amortized through June 30, 2001 (see discussion of fair value under "Warrants"
in note 15).
The Company entered into an agreement with a landlord for office space for
a term of ten years. In connection with the agreement, the Company issued
warrants to purchase 62,500 shares of common stock at $13.93 per share. The
expense related to the warrants is being amortized over the term of the
agreement.
14. 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 carried a
10%
F-19
58
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
cumulative annual dividend. The liquidation preference and redemption value of
the Series A Preferred shares was approximately $5.0 million as of December 31,
1999. The Series A Preferred shares and accrued dividend were converted to
common shares upon the closing of the initial public offering.
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
had the right to redeem the Redeemable Stock upon the earlier of an initial
public offering or February 17, 2002 at a redemption value of $2.8 million. The
holder chose not to redeem the shares. The accreted value of $2.4 million was
included in redeemable common securities in the balance sheet as of December 31,
1999 and was converted to common shares upon the completion of the initial
public offering in March 2000.
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 had the same redemption
terms as the Series A Preferred shares, and had an original conversion price of
$4.00 per share. The Series B Preferred shares had 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. The
Series B Preferred shares and accrued dividends were converted to common shares
upon the closing of the initial public offering in March 2000.
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 had 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. The Series C
Preferred shares were converted to 10,156,252 common shares upon the closing of
the initial public offering. The conversion rate was 1.45 common shares for each
Series C Preferred share based on the offering price and pursuant to the Series
C shareholder agreement.
Included in redeemable common securities are amounts related to options and
securities subject to a potential rescission offer. The Company issued shares or
options to purchase shares to employees, artists and advisors. The issuance of
these shares or options did not fully comply with certain requirements under the
Securities Act, or available exemptions there under, and as a result the Company
intends to make a rescission offer to all these persons pursuant to a
registration statement to be filed under the Securities Act and pursuant to
California securities law.
In the rescission offer, the Company will offer to repurchase from these
persons all shares issued directly to these persons or pursuant to option
exercises by these persons before the expiration of the rescission offer for an
amount equal to the purchase or exercise price paid for the shares, plus
interest at the rate of 7% from the date of issuance until the rescission offer
expires. The rescission offer will expire approximately 30 days after the
effectiveness of the rescission offer registration statement. Based upon the
number of options exercised through December 31, 2000, the out-of-pocket cost to
the Company would be approximately $2.2 million, plus interest.
F-20
59
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In addition, the Company will also offer to repurchase all unexercised
options to these persons at 20% of the option exercise price times the number of
option shares, plus interest at the rate of 7% from the date the options were
granted. Based on the number of options outstanding as of December 31, 2000, and
assuming that none of these options are exercised prior to the end of the
rescission offer, the out-of-pocket cost to the Company in repurchasing such
options would be approximately $7.8 million, plus interest.
The Company has accrued $114,000, $6.7 million and $3.9 million related to
the rescission offer for the years ended December 31, 1998, 1999 and 2000. Of
the $10.8 million accrued as of December 31, 2000, $7.8 million represents the
accrual for options issued during the period that are subject to the rescission
offer, $2.2 million represents amounts due as a result of the exercise of
options and $769,000 represents accrued interest.
15. MEMBERS' EQUITY
MEMBER DISTRIBUTIONS
The Company made distributions to members of $249,000 and $741,000 in 1998
and 1999, respectively.
VARIABLE EQUITY INTERESTS
During 1998, the Company issued common units, which were converted to
common shares upon the conversion of the Company to a C Corporation in October
1999, to certain executive employees and its outside legal counsel in connection
with services rendered and to be rendered. In January 1998, Keith Yokomoto and
L&G Associates One, an affiliate of Lenard and 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 provided for the holder to share in the
capital of the Company to the extent of increases in the fair value of the
Company subsequent to the issuance of the units (Appreciation Rights). The
Appreciation Rights issued to employees have been accounted for as stock
appreciation rights. The Appreciation Rights issued to the outside legal counsel
were valued at the estimated fair value as determined by the Company and
expensed immediately as they related to past services. Accordingly, the value of
the Appreciation Rights has been adjusted based on changes in the fair value of
the Company. The Company has estimated the fair value based on third party
equity transactions and ultimately on the trading price of the Company's common
shares upon the completion of the initial public offering. The Appreciation
Rights were settled upon the closing of the initial public offering on March 31,
2000. The Company has recognized as stock based compensation expense $3.8
million and $16.3 million for the years ended December 31, 1998 and 1999,
respectively. The Company recorded a credit to stock based compensation in the
amount of $6.6 million for the year ended December 31, 2000 as a result of the
decline in the value of the Company's common shares from December 31, 1999 to
March 31, 2000, the date on which the Appreciation Rights were settled.
WARRANTS
In May and June 1999, the Company issued warrants to purchase 359,676
shares of common stock (after giving effect to the Reverse Stock Split) at $4.00
per share to two vendors from whom it purchases merchandise ("merchandisers").
The value of the warrants was $864,000, of which $168,000 and $262,000 has been
recognized as expense for the years ended December 31, 1999 and 2000,
respectively. The value of the warrants is being amortized as cost of revenues
over the term of
F-21
60
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the related merchandising agreements. All of the warrants are exercisable as of
December 31, 2000 and none have been exercised. Additionally, the merchandisers
may earn up to 545,464 of additional warrants based on certain performance
levels as specified in the merchandising agreements, none of which have been
reached as of December 31, 2000.
In December 1999, the Company issued warrants to purchase 339,254 shares of
common stock in connection with an advertising and promotion agreement. The
warrants vest in December 2001. The value of the warrants upon issuance was $2.0
million, of which $19,000 was recorded as expense for the year ended December
31, 1999. These warrants are being accounted for as variable instruments under
EITF 96-18. Due to the decrease in fair value of the Company's common stock, the
value of the warrants was reduced to $92,000 as of December 31, 2000. The
related expense for the year ended December 31, 2000 was $28,000. The value of
the warrants is being amortized through June 30, 2001.
In January 2000, the Company issued warrants to purchase 62,500 shares of
common stock in connection with an office lease. The warrants were exerciseable
upon grant, and none have been exercised as of December 31, 2000. The warrants
were valued at $568,000, of which $47,000 has been recorded as expense for the
year ended December 31, 2000. The value of the warrants is being amortized over
the term of the related lease.
In August 2000, the Company issued warrants to purchase 13,059 shares of
common stock to various consultants in connection with the acquisition of
Mjuice.com, Inc. These warrants were valued at $34,000 and were accounted for as
part of the purchase price. The warrants have exercise prices ranging from $0.19
to $6.35 per share, and all of the warrants were exerciseable as of December 31,
2000.
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.
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.
Upon the conversion of the Series A, B and C Preferred shares to common
shares, accrued dividends of $963,000 were converted into 80,216 common shares.
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 for the year ended December 31, 1999. 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.
F-22
61
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EQUITY TRANSFER
In March 2000, the founders of the Company entered into a series of
transactions whereby two employees and an outside legal counsel would receive
the appreciation on the Company's common stock above $13.93 per share through
the third day of trading after the initial public offering. Additionally, the
two employees and outside legal counsel received stock options on the third day
of trading after the initial public offering with an exercise price of $13.93.
There was no expense charge for the appreciation rights and stock options
granted to the two employees, as the stock price was below $13.93 per share on
the third day of trading and the exercise price on the stock options was greater
than the fair value of the Company's common stock on the date of grant. The fair
value of the appreciation rights and stock options granted to the outside legal
counsel was $2,029,000 and was recorded as expense for the year ended December
31, 2000, as the grants related to past services.
16. 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
has reserved 6,500,000 shares (after giving effect to the Reverse Stock Split)
of the Company's common stock for issuance to employees, non-employee members of
the 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,
1999 and 2000 vest within three years. As of December 31, 2000, 746,401 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," Interpretation No. 44, and other 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.
F-23
62
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summary stock option activity for 1999 Employee Stock Option Plan during
the years ended December 31, 1998, 1999 and 2000 is as follows (after giving
effect to the Reverse Stock Split):
OPTIONS OUTSTANDING
----------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- --------
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
Granted........................................ 3,197,088 8.16
Exercised...................................... (31,809) 1.37
Canceled....................................... (1,248,019) 4.62
---------- -----
Outstanding options at December 31, 2000......... 5,663,040 $5.84
========== =====
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.
In February 2000, the Company accelerated the vesting of 114,796 stock
options granted to an executive of the Company. The resulting compensation
expense of $964,000, which represented the difference between the fair value of
the Company's common stock on the date of modification and the exercise price,
was recorded during the year ended December 31, 2000.
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, 1999 and 2000 would have
changed to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31,
----------------------------
1998 1999 2000
------ ------- -------
(IN THOUSANDS)
Net loss:
As reported...................................... $6,318 $57,804 $59,308
Pro forma........................................ $6,334 $58,254 $64,678
====== ======= =======
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 fair value of options
granted during the year ended December 31, 2000 was determined using a
Black-Scholes model with the following assumptions: risk free rate of 6.38%, a
volatility factor of 100%, no expected dividends and an expected life of five
years. The weighted
F-24
63
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
average fair values of the options on the date of grant were $.32 per share,
$5.56 per share and $5.83 for the options granted in 1998, 1999 and 2000,
respectively.
The following table summarizes information regarding options outstanding
and options exerciseable at December 31, 2000 (after giving effect to the
Reverse Stock Split):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OF SHARES LIFE PRICE OF SHARES PRICE
- -------------- --------- ----------- -------- --------- --------
$ 0.75 80,000 6.89 years $ 0.75 -- $ 0.75
1.24 208,168 4.58 1.24 203,051 1.24
2.00 32,500 6.76 2.00 -- 2.00
2.32 87,691 4.58 2.32 85,560 2.32
2.50 45,000 6.76 2.50 -- 2.50
3.00 545,000 6.76 3.00 -- 3.00
3.60 2,610,239 5.60 3.60 1,591,049 3.60
4.00 642,625 6.42 4.00 10,972 4.00
12.00 469,823 6.15 12.00 135,137 12.00
13.93 935,744 6.25 13.93 -- 13.93
14.00 6,250 6.07 14.00 -- 14.00
- -------------- --------- ---------- ------ --------- ------
$0.75 - $14.00 5,663,040 5.94 years $ 5.84 2,025,769 $ 4.28
============== ========= ========== ====== ========= ======
In June 1999 and as amended in October 1999 and March 2000 the Company
adopted the 1999 Artist and Artist Advisor Stock Option Plan (the Advisor Plan).
The Advisor Plan has reserved 1,850,000 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, 2000,
521,170 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. In
January 2000, the vesting of certain options was accelerated such that these
options grants vested immediately.
F-25
64
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summary stock option activity for the Advisor Plan options during the years
ended December 31, 1999 and 2000 is as follows (after giving effect to the
Reverse Stock Split):
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding Options at
December 31, 1998............................... -- --
Granted...................................... 999,563 $ 3.92
Exercised.................................... -- --
Canceled..................................... -- --
--------- ------
Outstanding Options at
December 31, 1999............................... 999,563 3.92
Granted...................................... 333,017 13.93
Exercised.................................... (135,469) 4.00
Canceled..................................... (3,750) 4.00
--------- ------
Outstanding Options at
December 31, 2000............................... 1,193,361 $ 6.70
========= ======
The weighted average fair value of options granted under the Advisor Plan
was $9.34 and $6.65 per option, resulting in a total value for options granted
of $9.7 million and $2.1 million for the years ended December 31, 1999 and 2000,
respectively. Of the $2.1 million in option fair value in 2000, $1.8 million was
expensed immediately, as it related to past services. Consequently, $9.7 million
and $300,000 for 1999 and 2000, respectively, of total value for options granted
has been recorded as unearned compensation in the statement of changes in
members' and stockholders' equity (deficit) and is being amortized over the term
of the artists' and advisors' option agreement.
The following table summarizes information regarding options outstanding
and options exercisable at December 31, 2000 (after giving effect to the Reverse
Stock Split):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICE OF SHARES LIFE PRICE OF SHARES PRICE
- -------------- --------- --------- -------- --------- --------
$ 3.60 189,375 5.78 $ 3.60 189,375 $ 3.60
4.00 670,969 5.73 4.00 633,719 4.00
13.93 333,017 6.23 13.93 308,017 13.93
- -------------- --------- ---- ------ --------- ------
$3.60 - $13.93 1,193,361 5.88 $ 6.70 1,131,111 $ 6.64
============== ========= ==== ====== ========= ======
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
F-26
65
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
year, but in no event will this annual increase exceed 875,000 shares. As of
December 31, 2000, 1,416,564 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. In January 2000, the vesting of certain options was accelerated such
that these options vested immediately.
Summary stock option activity for the Artist Option Plan during the years
ended December 31, 1999 and 2000 is as follows (after giving effect to the
Reverse Stock Split):
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding Options at
December 31, 1998............................... -- --
Granted...................................... 2,264,061 $ 4.00
Exercised.................................... (117,916) 4.00
Canceled..................................... -- --
--------- ------
Outstanding Options at
December 31, 1999............................... 2,146,145 4.00
Granted...................................... 469,375 $13.41
Exercised.................................... (241,770) 4.00
Canceled..................................... (150,000) 4.00
--------- ------
Outstanding Options at
December 31, 2000............................... 2,223,750 $ 5.99
========= ======
The weighted average fair value of the options granted under the Artist
Option Plan was $8.33 and $9.97 per option, resulting in a total value for
options granted of $20.6 million and $4.7 million for the years ended December
31, 1999 and 2000, respectively, which has been recorded as unearned
compensation in the statement of changes in members' and stockholders' equity,
and is being amortized over the service period of the related artist agreements.
The following table summarizes information regarding options outstanding
and options exercisable at December 31, 2000 (after giving effect to the Reverse
Stock Split):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICE OF SHARES LIFE PRICE OF SHARES PRICE
- -------------- --------- --------- -------- --------- --------
$ 4.00 1,754,375 5.68 $ 4.00 888,037 $ 4.00
12.00 125,000 6.22 12.00 125,000 12.00
13.93 344,375 6.18 13.93 106,979 13.93
- -------------- --------- ---- ------ --------- ------
$4.00 - $13.93 2,223,750 5.79 $ 5.99 1,120,016 $ 5.84
============== ========= ==== ====== ========= ======
Total compensation expense related to the Advisor Plan and the Artist
Option Plan was $12.4 million and $10.2 million for the years ended December 31,
1999 and 2000 respectively, of
F-27
66
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
which $1.6 million and $7.3 million, respectively, was included in cost of
revenue, and $10.8 million and $2.9 million, respectively, was included in
operating expenses.
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 80%, no expected dividends and an
expected life of seven years for options granted in 1999; and a risk free rate
of 6.4%, a volatility factor ranging from 80% to 150%, no expected dividends and
an expected life of seven years for options granted in 2000.
For the year ended December 31, 1999, the addition to unearned compensation
of $67.7 million was comprised of the issuance of options under the Artist
Option Plan and Advisor Plan with a fair value of $30.3 million; the issuance of
compensatory options granted under the 1999 Employee Stock Option Plan with a
fair value of $17.9 million; options granted to non-employees under the 1999
Employee Stock Option Plan with a fair value of $77,000; warrants granted to
suppliers with a fair value of $864,000; warrants granted for advertising
services with a fair value of $2.0 million; and an increase in the value of the
variable equity interests of $16.5 million.
For the year ended December 31, 2000, the decrease to unearned compensation
of $1.4 million was comprised of additions of $5.7 million, which were offset by
reductions of $7.1 million. The additions were a result of the grant of options
under the Artist Option Plan and Advisor Plan with a fair value of $4.9 million;
warrants granted to the landlord with a fair value of $568,000; and the issuance
of compensatory options under the 1999 Employee Stock Option Plan with a fair
value of $210,000. The reductions were a result of the cancellation of options
under the Artist Option Plan and Advisor Plan with an unamortized balance of
$1.3 million on the cancellation date; a decrease in the value of the
unamortized portion of the variable equity interest of $600,000; a decrease in
the value of warrants accounted for as variable instruments of $1.9 million; and
the cancellation of unvested compensatory employee options with a remaining
unamortized value of $3.3 million as a result of terminations in 2000.
In October 1999, the Company adopted the 1999 Employee Stock Purchase Plan,
which initially reserved 500,000 shares of common stock for issuance under this
plan. This share reserve automatically increases 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 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 250,000 shares. 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. As of December 31, 2000, 67,578 shares were issued
under this plan for total proceeds of $40,000.
In connection with the acquisition of Mjuice.com, Inc. in August 2000, the
Company assumed the Audio Explosion, Inc. 1998 Stock Option Plan and the
Mjuice.com, Inc. 1999 Stock Option Plan. Options granted to employees,
consultants and directors under these plans were converted into options to
purchase shares of the Company's common stock. Options currently outstanding
vest over periods of up to 48 months from their grant date. Each option shall
terminate 10 years after the date of grant. The value of the options issued by
the Company was included as part of the purchase price.
Summary stock option activity for the Audio Explosion and Mjuice.com Stock
Option Plans during the year ended December 31, 2000 is as follows:
OPTIONS OUTSTANDING
---------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Outstanding options at December 31, 1999.......... -- $ --
Granted......................................... 20,907 2.94
Exercised....................................... -- --
Canceled........................................ (1,071) 5.24
------ -----
Outstanding options at December 31, 2000.......... 19,836 $2.81
====== =====
F-28
67
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information regarding options outstanding
and options exercisable at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICE OF SHARES LIFE PRICE OF SHARES PRICE
- -------------- --------- --------- -------- --------- --------
$1.87 9,182 8.13 $1.87 4,782 $1.87
3.18 9,155 8.66 3.18 7,314 3.18
6.35 1,499 9.07 6.35 464 6.35
- ------------- ------ ---- ----- ------ -----
$1.87 - $6.35 19,836 8.45 $2.81 12,560 $2.80
============= ====== ==== ===== ====== =====
17. 401(K) PLAN
In February 1999 and as amended in January 2000, the Company adopted the
Cash or Deferred Profit Sharing Plan and Trust under Section 401(k) of the
Internal Revenue Code (the 401(k) Plan). Under the 401(k) Plan, participating
employees may defer a percentage (not to exceed 15%) of their eligible pretax
earnings up to the Internal Revenue Service's annual contribution limit. All
employees of the Company age 21 years or older who complete three months of
service are eligible to participate in the 401(k) Plan. The Company does not
match participants' contributions to the 401(k) Plan. Accordingly, there is no
expense for the years ended December 31, 1999 and 2000.
18. 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,
2000, are as follows as of the years ended December 31:
(IN THOUSANDS)
2001.............................................. $ 1,730
2002.............................................. 1,878
2003.............................................. 1,756
2004.............................................. 1,746
Thereafter........................................ 10,251
-------
Total........................................... $17,361
=======
Rent expense under operating leases for the years ended December 31, 1998,
1999 and 2000 for the Company was $109,000, $341,000 and $1,735,000,
respectively.
F-29
68
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EMPLOYMENT CONTRACTS
Future payments under employment contracts are as follows for the years
ended December 31:
(IN THOUSANDS)
2001.............................................. $1,293
2002.............................................. 25
------
Total........................................... $1,318
======
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.
19. 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
generated revenue from advances under an agreement with RCA, which was
terminated in June 2000, 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, 1998,
1999 and 2000.
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- -------- --------
(IN THOUSANDS)
Net Revenue:
ARTISTdirect Network........................... $ 2,100 $ 8,192 $ 18,486
Talent Agency.................................. 1,917 1,304 2,946
Record Label................................... 565 778 244
------- -------- --------
4,582 10,274 21,676
Income (Loss) from Operations:
ARTISTdirect Network........................... (5,256) (57,900) (66,971)
Talent Agency.................................. (629) 22 2,191
Record Label................................... (464) (257) (262)
------- -------- --------
(6,349) (58,135) (65,042)
------- -------- --------
Interest income (expense), net................... 29 281 5,969
Income/(loss) from equity investment............. 2 50 (235)
------- -------- --------
Net Loss......................................... $(6,318) $(57,804) $(59,308)
======= ======== ========
F-30
69
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1999 2000
------- -------- --------
(IN THOUSANDS)
Depreciation and amortization:
ARTISTdirect Network........................... $ 38 $ 2,504 $ 6,237
Talent Agency.................................. 18 5 9
Record Label................................... 3 -- 2
------- -------- --------
$ 59 $ 2,509 $ 6,248
======= ======== ========
The following tables summarize the capital expenditures for the years ended
December 31, 1998, 1999 and 2000 and assets as of December 31, 1998, 1999 and
2000.
YEAR ENDED DECEMBER 31,
------------------------
1998 1999 2000
---- ------ ------
(IN THOUSANDS)
Capital expenditures:
ARTISTdirect Network.............................. $123 $3,498 $7,523
Talent Agency..................................... 15 9 --
Record Label...................................... 3 6 --
---- ------ ------
$141 $3,513 $7,523
==== ====== ======
DECEMBER 31,
----------------------------------
1998 1999 2000
------ ------- -------------
Assets:
Corporate.................................. $ 403 $78,406 $100,708
ARTISTdirect Network....................... 2,932 17,571 17,054
Talent Agency.............................. 68 2,547 743
Record Label............................... 9 76 --
------ ------- --------
$3,412 $98,600 $118,505
====== ======= ========
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,
short term investments, prepaid expenses, computer equipment, leasehold
improvements and other assets.
F-31
70
ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly results of operations
for the eight most recent quarters ended December 31, 2000. This unaudited
quarterly information has been derived from the Company's unaudited financial
statements and, in the Company's opinion, includes all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
information for the periods covered. The operating results for any quarter are
not necessarily indicative of the operating results for any future period.
QUARTER ENDED
--------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1999 1999 1999 1999 2000 2000
--------- -------- ------------- ------------ --------- --------
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
Net revenue.................... $ 1,698 $ 1,984 $ 2,752 $ 3,840 $ 4,497 $ 5,598
Gross profit (loss)............ 402 331 45 (744) (1,850) (527)
Net loss....................... (2,719) (5,473) (26,014) (23,598) (11,187) (14,003)
Net loss attributed to common
shareholders................. (2,840) (5,770) (26,548) (24,297) (36,747) (14,274)
Basic and diluted loss per
share........................ $ -- $ -- $ -- $ (1.71) $ (2.45) $ (0.39)
QUARTER ENDED
----------------------------
SEPTEMBER 30, DECEMBER 31,
2000 2000
------------- ------------
(IN THOUSANDS)
Net revenue.................... $ 5,562 $ 6,019
Gross profit (loss)............ (1,334) (1,155)
Net loss....................... (17,075) (17,043)
Net loss attributed to common
shareholders................. (16,921) (17,236)
Basic and diluted loss per
share........................ $ (0.45) $ (0.46)
21. SUBSEQUENT EVENTS
In February 2001, the Company authorized the repurchase of up to 2.0
million shares of the Company's outstanding shares of common stock. The
repurchase will be made through a "Dutch Auction" style self-tender offer, at an
expected offering range of between $1.25 and $1.50 per share, subject to market
conditions prior to commencement of the tender offer. If the number of shares
tendered is greater than the number sought, the Company will select the tendered
price within the range that allows the Company to repurchase the entire 2.0
million shares at the lowest aggregate price, with purchases to be made on a
pro-rata basis for stockholders tendering at or below the purchase price.
F-32
71
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1* Amended and Restated Certificate of Incorporation of the Registrant.
3.2* Amended and Restated Bylaws of the Registrant.
4.1* See Exhibits 3.1 and 3.2 for provisions of the Registrant's Certificate of Incorporation and Bylaws
determining the rights of holders of the Registrant's common stock. See Exhibit 10.8 for the rights of
holders of registration rights.
4.2* Specimen common stock certificate.
10.1+* Agreement dated as of November 15, 1996, between the RCA Records Label and the Registrant.
10.2* Digex Services and Products Agreement, dated August 8, 1999, between Digex, Inc. and the Registrant.
10.3+* BMI Music Performance Agreement for the UBL, dated October 9, 1998.
10.4+* AT&T Dedicated Hosting Service Agreement, dated April 16, 1999, between AT&T and the Registrant.
10.5* Settlement Agreement and Mutual General Release, dated as of October 23, 1997, between William Elson, on
the one hand, and the Registrant, MGE, LLC, Marc Geiger and Donald Muller, on the other hand.
10.6+* Database, On-Line Internet Retail Store and Consumer Direct Fulfillment Services Agreement, dated as of
August 15, 1998, between AEC One Stop Group, Inc. and the UBL, as amended.
10.7* Securities Purchase Agreement, dated July 28, 1998, among the Registrant, the UBL, Constellation Venture
Capital, L.P. and Constellation Ventures (BVI), Inc.
10.8* Third Amended and Restated Registration Rights Agreement, dated as of November 12, 1999, among the
Registrant and the other parties who are signatories thereto, as amended.
10.9* UBL Exchange, Contribution and Distribution Agreement, dated May 18, 1999.
10.10* Exchange Agreement, dated February 17, 1999, by and among the UBL, Scott Blum and Eric Benjamin.
10.11* Contingent Loan Agreement, dated February 17, 1999, by and between the UBL and Scott Blum.
10.12* Letter Agreement, dated February 17, 1999, between the UBL and Scott Blum regarding bonuses to cover
interest obligations under the Contingent Loan Agreement.
10.13* Issuance, Noncompetition and Nonsolicitation Agreement, dated as of January 1, 1996, between the
Registrant and Keith Yokomoto.
10.14* Issuance Agreement, dated as of January 1, 1998, between the Registrant, Marc Geiger, Donald Muller, and
L&G Associates One.
10.15* Issuance, Noncompetition and Nonsolicitation Agreement, dated as of June 30, 1998, between the Registrant
and Steve Rennie.
10.16* Deferred Compensation Agreement, dated as of April 1, 1998, by and between Keith Yokomoto and the
Registrant dated July 1, 1998.
10.17* Employment Agreement, dated as of January 1, 1998, between Keith Yokomoto and the Registrant.
10.18* Employment Agreement, dated as of April 1, 1998, between Steve Rennie and the UBL.
10.19* Employment Agreement, dated as of July 28, 1998, between Marc Geiger and the Registrant.
72
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.20* Employment Agreement, dated as of July 28, 1998, between Don Muller and the Registrant.
10.21* 1999 Employee Stock Purchase Plan.
10.22* 1999 Employee Stock Option Plan.
10.23* 1999 Artist and Artist Advisor Stock Option Plan.
10.24* 1999 Artist Stock Option Plan.
10.25+* Agreement to license Pandesic E-business Solution Service between Pandesic LLC, AD and UBL.
10.26+* ADNM Merchandiser Agreement, dated as of April 1, 1999, between Giant Merchandising and ARTISTdirect New Media, LLC.
10.27+* ADNM Merchandiser Agreement, dated as of June 7, 1999, between Winterland Concessions Company and
ARTISTdirect New Media, LLC.
10.28+* UBL Merchandiser Agreement, dated as of April 1, 1999, between Giant Merchandising and ARTISTdirect New Media, LLC.
10.29* Form of Directors Indemnification Agreement.
10.30* Form of Officers Indemnification Agreement.
10.31* Audio Sample License Agreement dated as of December 20, 1999 between the Company and Maverick Recording Company.
10.32+* Internet Video License Agreement dated as of December 20, 1999 between the Company and Maverick Recording Company.
10.33+* Webcasting Transmission License Agreement dated as of December 20, 1999 between the Company and Maverick
Recording Company.
10.34+* Strategic Marketing Agreement dated as of December 20, 1999 between the Company and Maverick Recording Company.
10.35+* Audio Sample License Agreement dated as of December 20, 1999 between the Company and Warner Music Group Inc.
10.36+* Internet Video License Agreement dated as of December 20, 1999 between the Company and Warner Music Group Inc.
73
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.37+* Webcasting Transmission License Agreement dated as of December 20, 1999 between the Company and Warner
Music Group Inc.
10.38+* Strategic Marketing Agreement dated as of December 20, 1999 between the Company and Warner Music Group Inc.
10.39* Strategic Marketing Agreement dated as of December 6, 1999 between the Company and Universal Music Group, Inc.
10.40+* ARTISTdirect -- Cisneros Television Group Memorandum of Understanding dated as of November 15, 1999
between the Company and Lakeport Overseas Ltd.
10.41+* Strategic Licensing Agreement dated as of December 6, 1999 between the Company and Sony Music.
10.42* Strategic Marketing Agreement dated as of December 20, 1999 between the Company and BMG Music.
10.43+* Advertising and Promotion Agreement dated as of December 24, 1999 between the Company and Yahoo! Inc.
10.44* Yahoo! Remote Merchant Integration (RMI) Program Agreement dated as of December 24, 1999 between the
Company and Yahoo! Inc.
10.45* Form of Series C Preferred Stock Purchase Agreement.
10.46* Warrant dated December 24, 1999, issued to Yahoo!
10.47* 5670 Wilshire Boulevard Office Lease, as amended.
21.1** Subsidiaries of ARTISTdirect, Inc.
23.1 Consent of KPMG LLP with respect to ARTISTdirect, LLC and subsidiaries.
- -------------------------
* Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 (Registration Number 333-87547)
initially filed on September 22, 1999, as amended by Amendment No.'s 1-7
thereto.
** Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 (Registration Number 333-41630)
initially filed on July 18, 2000.
+ Confidential treatment has been requested for certain confidential portions
of this exhibit pursuant to Rule 406 under the Securities Act. In
accordance with Rule 406, these confidential portions have been omitted
from this exhibit and filed separately with the Commission.