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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934. FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
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 001-13469
MEDIABAY, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Florida 65-0429858
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(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
2 Ridgedale Avenue
Cedar Knolls, NJ 07927
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
973-539-9528
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to Section 12(b) of the Act: None Securities
registered pursuant to Section 12(g) of the Act:
Common Stock
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(TITLE OF CLASS)
Indicate by check mark whether the Registrant: (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filling requirements for
the past 90 days. Yes [ ] No |X|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained in this form, and will not be contained, to
the best of 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. [ ]
Indicate by check mark whether the Registrant Fis an accelerated filer as
defined in Rule 12b-2 of the Securities Exchange Act of 1934. Yes [ ] No |X|
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of June 30, 2003 (the last business day of the Registrant's
most recently completed second fiscal quarter) was approximately $6,964,684.
As of April 12, 2004, there were 18,463,624 shares of the Registrant's Common
Stock outstanding.
Documents Incorporated by Reference:
None
MEDIABAY, INC.
Form 10-K
Table of Contents
ITEM I 1
Item 1. Business 1
Item 2. Properties 16
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
PART II 17
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 17
Item 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 42
Item 8. Financial Statements and Supplementary Data 42
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure 42
Item 9A. Controls and Procedures 42
PART III 43
Item 10. Directors and Executive Officers of the Registrant 43
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 50
Item 13. Certain Relationships and Related Transactions 52
Item 14. Principal Accountant Fees and Services 55
PART IV 56
Item 15. Exhibits, Financial Statements Schedules,
and Reports on Form 8-K 56
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-K and in the documents incorporated by
reference in this Form 10-K constitute "forward-looking" statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All statements
other than statements of historical facts included in this Report, including,
without limitation, statements regarding our future financial position, business
strategy, budgets, projected costs and plans and objectives of our management
for future operations are forward-looking statements. In addition,
forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe," or "continue" or the negative thereof or
variations thereon or similar terminology. Although we believe that the
expectations reflected in such forward-looking statements are reasonable, we
cannot assure you that such expectations will prove to be correct. These forward
looking statements involve certain known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any results, performances or achievements expressed
or implied by such forward-looking statements. Important factors that could
cause actual results to differ materially from our expectations, include,
without limitation, our history of losses; our ability to obtain additional
financing, meet stock repurchase obligations, anticipate and respond to changing
customer preferences, license and produce desirable content, protect our
databases and other intellectual property from unauthorized access, pay our
trade creditor and collect receivables; dependence on third-party providers,
suppliers and distribution channels; competition; the costs and success of our
marketing strategies, product returns and member attrition. Undue reference
should not be placed on these forward-looking statements, which speak only as of
the date hereof. We undertake no obligation to update any forward-looking
statements.
INTRODUCTION
MediaBay, Inc. is a media, marketing and publishing company specializing in
spoken audio content, whose industry-leading businesses include direct response
and interactive marketing, retail product distribution, media publishing and
broadcasting. Our operations are comprised of four subsidiaries -- Audio Book
Club, Inc. ("ABC"), a leading club for audiobooks, Radio Spirits, Inc. ("RSI" or
"Radio Spirits"), a leading seller of classic radio programs, MediaBay.com, Inc.
our digital audio download service, and RadioClassics, Inc. ("RCI" or
RadioClassics"), a leading distributor of classic radio content across multiple
broadcast platforms including Sirius; XM Satellite and traditional broadcast
radio. Our content libraries include over 60,000 classic radio programs, 3,500
film and television programs and thousands of audiobooks, much of which are
proprietary.
We distribute our products to our customer database of approximately 3.0 million
names and 1.0 million e-mail addresses, in over 7,000 retail outlets and on the
Internet through streaming and downloadable audio.
Audio Book Club is a membership-based club with exclusive licenses from
publishers to distribute audiobooks in a club format. This business is modeled
after traditional book-of-the month clubs and its member database has grown from
approximately 64,000 in 1995 to approximately 2.5 million as of December 31,
2003, through organic growth and acquisitions. Radio Spirits, which we believe,
is the world's largest seller of old-time radio shows, sells on audiocassettes
and compact discs through retail, direct mail and online channels. Our radio
library consists of thousands of famous old-time radio shows, many of which it
licenses exclusively. Products are sold in over 7,000 leading retail outlets, as
well as directly to consumers through its catalogue and World's Greatest
Old-Time Radio continuity program.
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We report financial results on the basis of four reportable segments; corporate,
Audio Book Club, Radio Spirits and MediaBay.com. A fifth division,
RadioClassics, is aggregated with Radio Spirits for financial reporting
purposes. Except for corporate, each segment serves a unique market segment
within the spoken word audio industry. Our four divisions serving the spoken
word audio industry are as follows:
Audio Book Club
We believe that Audio Book Club, which is modeled after the traditional
"Book-of-the-Month Club" format, is the largest membership-based audiobook club.
The club's total member file, which includes active and inactive members, has
grown significantly from approximately 64,000 names at December 31, 1995 to
approximately 2.5 million names at December 31, 2003.
Audio Book Club members can enroll in the club through the mail by responding to
direct mail advertisements, and online through the club's web site at
www.audiobookclub.com. We have established relationships with substantially all
of the major audiobook publishers, including Random House Audio Publishing
Group, Simon & Schuster Audio, Harper Audio and Time Warner Audio Books. As a
club operator, we license a recording or a group of recordings from the
publisher for sale in a club format, frequently on an exclusive basis, on a
royalty or per copy basis. We then subcontract the manufacturing, including
duplication and printing, to a third party, resulting in lower costs and higher
product margins than traditional catalog, Internet or retailer sellers of
audiobooks. The Audio Book Club accounted for approximately 72% of revenues in
2003.
Radio Spirits
We believe Radio Spirits is the world's largest seller of old-time radio shows,
which it sells on audiocassettes and compact discs through retail, direct mail
and online channels. Radio Spirits has a database of names of more than 400,000
catalog customers and prospects and sells its products in over 7,000 retail
outlets, including such well-known national chains as Sam's Club, Target, Barnes
& Noble, Borders, Cracker Barrel Old Country Stores and online retailers such as
Amazon.com. Radio Spirits' products can also be purchased online at
www.radiospirits.com. The Radio Spirits content library consists of more than
60,000 classic radio shows licensed on a primarily exclusive basis. Radio
Spirits' library of classic radio shows includes episodes from the following
notable series: The Shadow, The Jack Benny Program, The Bob Hope Show, Superman,
Suspense and many others including famous stars such as Clark Gable, Cary Grant,
Humphrey Bogart, Jimmy Stewart, Lucille Ball, Frank Sinatra, Judy Garland, Orson
Welles and Bing Crosby. Radio Spirits also offers its old-time radio programs in
a continuity format, a marketing program that automatically sends selections to
a customer once an initial order is placed. Radio Spirits accounted for
approximately 28% of MediaBay's revenue in 2003.
MediaBay.com
MediaBay.com provides the infrastructure and support for all of our web sites
including www.audiobookclub.com, www.radiospirits.com, www.RadioClassics.com and
www.MediaBayDownloads.com. MediaBay.com powers our digital audio download
service located at www.MediaBayDownloads.com which offers many of our classic
radio programs for purchase either via a secure digital download subscription
service or on a pay per download basis, in either case, with desktop and mobile
playback capabilities on iPods and other MP3 players. With the increasing
popularity of these portable music players, in particular the iPod, we believe
this division is poised for growth.
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RadioClassics Division
RadioClassics was created to distribute our proprietary old-time radio content
across multiple distribution platforms including traditional radio, cable
television, satellite television (DBS), satellite radio and the Internet.
RadioClassics currently distributes a national "classic" radio program, "When
Radio Was" heard, based on Arbitron data, on more than 235 radio stations by
nearly 3 million listeners weekly and can also be heard on dedicated channels on
both the Sirius Satellite Radio and XM Satellite Radio services, with combined
subscribers in excess of 1.5 million.
STRATEGY
Our strategy consists of the following three-pronged approach: 1) Increase the
number of distribution channels of our products; 2) Increase the number of
products we distribute through those channels, and 3) Increase the amount of
products each customer buys, namely by increasing the "quality" of customer as
well as extending the "customer life" through various initiatives (i.e.
initiating customer retention strategies). Our ability to implement and execute
our strategy is dependent on a number of factors, including our ability to
obtain necessary financing. We believe that this strategy, if executed properly,
will enable us to utilize the following assets to increase the sales of our
existing products as well as develop new products, leveraging our direct
marketing and wholesale distribution channels:
o OUR PROPRIETARY LICENSES AND CONTENT- A proprietary content library,
consisting of more than 50,000 hours of spoken audio content, the
majority of which is acquired under license from the rightsholders.
o OUR CUSTOMER DATABASES- A customer database, which includes
approximately 3.0 million, spoken audio buyers who have purchased
via our catalogs and/or direct mail marketing, as well as a total
database of more than 1.0 million targeted e-mail addresses.
o OUR WHOLESALE DISTRIBUTION SYSTEM- A wholesale distribution system
that distributes our old-time radio products in over 7,000 retail
locations including Costco, Target, Sam's Club, Barnes & Noble,
Borders, Amazon.com, and Cracker Barrel Old Country Stores.
o OUR INTERNET DISTRIBUTION PLATFORM- Web sites, which offer
memberships in our Audio Book Club and which sell both our old-time
radio shows and audiobooks to Audio book Club members.. Our web
sites also serve streams of classic radio content on a monthly basis
to web site visitors at radiospirits.com and MediaBay.com.
o OVER 230 STATION SYNDICATED RADIO NETWORK- Direct response
advertising time to promote and cross-sell our products and products
from third parties.
o OUR DIRECT MARKETING AND PRODUCT DEVELOPMENT KNOWLEDGE AND
EXPERIENCE- Over 40 years experience among top management of
marketing products directly to consumers as well as developing new
product ideas.
Additional Distribution Channels
We are seeking new distribution channels. In addition to current retail outlets,
which include Target, Barnes & Noble and Borders, we are attempting to
distribute our classic radio products through drug, gift and specialty stores as
well as additional specialty catalogs. In addition, we are attempting to
distribute our old-time radio products to truck stops, airport kiosks and other
stores that specialize in product sales to travelers.
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We believe that the emergence of the Internet as an increasingly accepted media
distribution channel, as demonstrated by the recent success of the iPod and
other audio devices and the continuing growth in consumer demand for content in
a variety of formats, has resulted in significant opportunities for us to
further use the Internet as a distribution channel. To capitalize on the growing
popularity of digital audio players such as MP3 players and iPods, we intend to
expand our Internet presence and digital content delivery capabilities.
New Product Lines and Products Under Development
We expect to develop new products internally, through licensing and other
arrangements and through strategic acquisitions of direct marketing and consumer
goods companies. We have been repackaging our existing old-time radio content
and promoting it through celebrity sponsorship. Examples of these products
include a collection of baseball players' appearances on old-time radio shows
and other old-time radio baseball themed programs to be hosted by Yogi Berra and
a comedy collection of old-time radio shows to be hosted by Jackie Mason.
In addition, we recently obtained the exclusive rights to publish, duplicate,
distribute and sell selected seminars by the Learning Annex, an adult continuing
education school offering classes in areas such as personal improvement,
healing, spiritual growth, media, and business. The 10-year agreement gives us
the right to sell Learning Annex seminars in all wholesale and retail audio-book
channels, while paying the Learning Annex a royalty on each unit sold.
To capitalize on the growing popularity of digital audio players such as MP3
players and iPods, we make a portion of our old-time radio content available for
download over the Internet. For $19.95 a month, we offer subscribers the ability
to download a selection of our old-time radio programs. We have also introduced
a stream-only plan of old-time radio programs for $4.95 a month, and are
evaluating product and pricing for delivery using this medium.
Increasing Customer Quality, Customer Satisfaction and "Lifetime" of Customer We
employ data mining techniques in order to analyze various segments of our
current customer database, as well as every new customer that joins the Audio
Book Club. We have the ability to determine not only customer acquisition costs,
but also what segments of customers are most profitable, and which customers are
actually unprofitable and should be removed from the program. We use these tools
to try to be more responsive, and relevant to our customers, impacting how much
they purchase, and how long they remain with the Audio Book Club. We are also
testing various pricing strategies and offers to determine elasticity of pricing
and promotions.
BUSINESS DIVISIONS
Audio Book Club
We believe that Audio Book Club is the largest membership-based audiobook club.
Our total member file, which includes active and inactive members, has grown
significantly from approximately 64,000 names at December 31, 1995 to
approximately 2.5 million names at December 31, 2003.
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Our Audio Book Club is modeled after the "Book-of-the-Month Club." Audio Book
Club members can enroll in the club through the mail by responding to direct
mail advertisements, online through our web site or by calling us. We typically
offer new members four audiobooks at an introductory price of $.99 or less. By
enrolling, the member typically commits to purchase a minimum number of
additional audiobooks, typically one or two, at Audio Book Club's regular
prices, which generally range from $10.00 to $40.00 per audiobook. Our members
continue to receive member mailings and typically purchase audiobooks beyond
their minimum purchase commitment.
We engage in list rental programs to maximize the revenue generation potential
of these programs. As Audio Book Club's membership base and Radio Spirits'
catalog customer base continue to grow, we anticipate that our customer and
member lists will continue to be attractive to non-competitive direct marketers
as a source of potential customers.
Marketing
Since our inception, we have engaged in an aggressive marketing program to
expand our Audio Book Club member base. We devote significant efforts to
developing various marketing strategies in a concerted effort to increase
revenue and reduce marketing costs. We continually analyze the results of our
marketing activities in an effort to maximize sales, extend membership life
cycles, and efficiently target our marketing efforts to increase response rates
to our advertisements and reduce our per-member acquisition costs.
We have historically acquired new Audio Book Club members primarily through
direct mailings of member solicitation packages, acquisitions, Internet
advertising, and to a lesser extent from advertisements in magazines, newspapers
and other publications, package insert and telemarketing programs. We seek to
attract a financially sound and responsible membership base and target these
types of persons in our direct mail, Internet and other advertising efforts.
Based on our extensive knowledge and expertise, we select lists of names and
mine for membership candidates that exhibit characteristics of persons who are
likely to join Audio Book Club, purchase sufficient quantities of audiobooks to
be a profitable source of sales and remain long-term members. We analyze our
existing mailing lists and our promotional campaigns to target membership lists,
which are more likely to yield higher response rates. We have gained substantial
knowledge relating to the use of third-party mailing lists and believe we can
target potential members efficiently and cost effectively by using third-party
mailing lists.
Our Internet marketing program focuses on acquiring Audio Book Club members
through advertising agreements with other web sites that require payment only
when we enroll a bona fide member in Audio Book Club. This cost-per-acquisition
arrangement results in substantially lower marketing costs and direct control
over the cost of acquiring members.
Member Retention and Recurring Revenue
We encourage Audio Book Club members to purchase more than their minimum
purchase commitment by offering members selected promotions, spot discounts and
other incentives based on the volume of their purchases. Audio Book Club members
receive one mailing approximately every three weeks. Audio Book Club mailings
typically include a multi-page catalog which offers hundreds of titles,
including a featured selection (which is usually one of the most popular titles
at the time of mailing); alternate selections, which are best selling and other
current popular titles; and backlist selections, which are long-standing titles
that have continuously sold well.
In order to encourage members to maintain their relationship with Audio Book
Club and to maximize the long-term value of members, we seek to provide
friendly, efficient, and personalized service. Our goal is to simplify the order
process and to make members comfortable shopping via the Internet and by mail
order. Audio Book Club's membership club format makes it easy for members to
receive the featured selection without having to take any action. Under the
membership club reply system, the member receives the featured selection unless
he or she replies by the date specified on the order form by returning the order
form, calling us with a reply or replying online via our Internet web site with
a decision not to receive such selection. Members can also use any of these
methods to order additional selections from each catalog.
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We maintain a database of information on each name in our member file, including
number and genre of titles ordered, payment history and the marketing campaign
from which the member joined. We also maintain a lifetime value analysis of each
mailing list we use and each promotional campaign we undertake.
Supply and Production
We have established relationships with substantially all of the major audiobook
publishers, including Random House Audio Publishing Group, Simon & Schuster
Audio, Harper Audio and Time Warner Audio Books for the supply of audiobooks. As
a club operator, we license a recording or a group of recordings from the
publisher for sale in a club format on a royalty or per copy basis and
subcontract the manufacturing, including duplicating and printing to a third
party.
Our licensing agreements, many of which are exclusive, have one-to-three-year
terms, require us to pay an advance against future royalties upon signing the
license, permit us to sell audiobooks in our inventory at the expiration of the
term during a sell-off period and prohibit us from selling an audiobook prior to
the publisher's release date for each audiobook. Substantially all of the
license agreements permit us to make our own arrangements for the packaging,
printing and cassette and CD duplication of audiobooks. Substantially all of our
license agreements permit us to produce and sell audiobook titles in cassette
and compact disc form.
Fulfillment and Customer Service
Bookspan, formerly Doubleday Direct, currently provides order processing and
data processing services, warehousing and distribution services for our Audio
Book Club members. Bookspan's services include accepting member orders,
implementing our credit policies, inventory tracking, billing, invoicing, cash
collections and cash application and generating periodic reports, such as
reports of sales activity, accounts receivable aging, customer profile and
marketing effectiveness. Bookspan also provides us with raw data from which we
generate our own marketing and accounting reports using our in-house management
information systems department. Bookspan also packs and ships the order, using
the invoice as a packing list, to the club member.
Members are billed for their purchases at the time their orders are shipped and
are required to make payment promptly. We generally allow members in good
standing to order up to fifty dollars of products on credit, which may be
increased if the member maintains a good credit history with us. We monitor each
member's account to determine if the member has made excessive returns.
Radio Spirits
In December 1998, we completed a series of acquisitions and combined the
acquired businesses to form our Radio Spirits and RadioClassics divisions. Radio
Spirits and RadioClassics produce, syndicate, sell and license popular "classic"
and old-time radio and programs, including vintage comedy, mystery, detective,
adventure and suspense programs recorded during the "Golden Age of Radio"
typically described as the 1930's through the 1950's.
RSI Content
RSI has exclusive rights to a substantial portion of its library of popular
old-time radio and classic video programs, including vintage comedy, mystery,
detective, adventure and suspense programs. RSI's library consists of over
60,000 radio programs, most of which are licensed on an exclusive basis,
including:
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o H.G. Wells' "War of the Worlds" broadcast;
o hit series, such as The Shadow, The Lone Ranger, Superman, Tarzan,
Sherlock Holmes, The Life of Riley and Lights Out;
o recordings of stars, such as Bob Hope, Lucille Ball, Frank Sinatra
and Jack Benny; and
o recordings of comedy teams, such as Abbott and Costello, Burns and
Allen, and Martin and Lewis.
RSI leverages the content of its old-time radio and classic video library by
entering into marketing and co-branding arrangements, which provides RSI a means
to repackage these programs. RSI offers the following collections, among others:
o "The Greatest Old-Time Radio Shows of the 20th Century - selected by
Walter Cronkite" - a collection of Mr. Cronkite's favorite old-time
radio programs. RSI has entered into a license agreement to use Mr.
Cronkite's name and likeness. This collection includes some of
radio's most memorable programs, a spoken foreword by Mr. Cronkite
and a companion informational booklet.
o "The Smithsonian Collections" - a collection of old-time radio
programs branded under this name. RSI has entered into an agreement
with the Smithsonian Institution to produce a series of recordings
of nostalgic radio programs to be sold through all major bookstore
chains carrying audio programs. Each Smithsonian collection features
a foreword by a recognized celebrity from radio's golden age such as
George Burns, Jerry Lewis and Ray Bradbury.
Marketing
RSI markets its library of old-time radio and video programs through direct
marketing, Internet, and on a wholesale basis through retail channels. RSI's
marketing efforts are aimed at the direct marketing channel of distribution, via
internally developed catalogs, as well as through retail and online channels of
distribution.
Direct Mail
RSI produces several catalogs per year and mails them to its customer list and
selected third-party mailing lists three times per year. RSI maintains a total
file of over 400,000 names of customers and prospects. This list includes all
customers to which RSI's radio and video programs or catalogs have been mailed.
RSI engages in list rental programs to maximize the revenue generation potential
of its customer list.
Wholesale
RSI has developed wholesale distribution through several large, national book
retailers, including Barnes & Noble, Borders, and Waldenbooks; gift stores such
as Cracker Barrel Old Country Stores; and mass retailers like Costco, Sam's
Club, and Target, as well as on the Internet at Amazon.com. RSI markets its
old-time radio and classic video programs to wholesale customers through its
in-house sales personnel, independent sales representatives and through
third-party distributors. RSI also engages in cooperative advertising to induce
retailers to purchase its products.
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Broadcast
RSI advertises its products on "When Radio Was," our nationally syndicated
old-time radio broadcast, which is broadcasted weekly on over 210 radio
stations. Our old-time radio shows can also be heard on dedicated channels on
both the Sirius Satellite Radio and XM Satellite Radio services.
Internet
RSI sells its old-time radio programs in cassette and compact disc directly to
consumers through its web site, radiospirits.com. Radiospirits.com offers
visitors the opportunity to listen to free programs in streaming audio while
they are prompted to buy our programs. Consumers may also download old-time
radio content from the Internet at radiospirits.com. This service enables the
secure delivery of old-time radio content over the Internet for playback on
personal computers and portable playback devices.
Supply and Production
RSI has exclusive licensing rights to a substantial majority of its old-time
radio library. These rights have been principally acquired from the original
rightsholders (actors, directors, writers, producers or others) or their
estates. Engineers in our New Jersey facility use digital sound equipment to
improve the sound quality of RSI's old-time radio programs. RSI then contracts
with third-party manufacturers to duplicate and manufacture the old-time radio
cassettes and compact discs, which it sells.
Fulfillment and Customer Service
RSI uses a third-party fulfillment center to process and fill orders. RSI only
accepts credit card orders or advance payments from consumers and requires
wholesale customers to generally pay invoices within 60 to 90 days. RSI
maintains a toll-free customer service telephone hotline for these customers and
can also be contacted by mail and e-mail. RSI's policy is to accept returns of
damaged products sold on a retail basis. RSI accepts returns of unsold products
sold on a wholesale basis.
MediaBay.com
MediaBay.com provides the infrastructure and support for all of our web sites
including www.audiobookclub.com, www.radiospirits.com and
www.mediabaydownloads.com. MediaBay.com powers our digital audio download
service located at www.mediabaydownloads.com which offers many of our classic
radio programs and audiobooks for purchase either via a secure digital download
subscription service or on a pay per download basis, in either case, with
desktop and mobile playback capabilities.
RadioClassics
Our RadioClassics subsidiary produces and syndicates a one-hour version of "When
Radio Was" which is hosted by Stan Freberg and broadcast five nights each week.
In addition we also produce and syndicate a two-hour version of "When Radio Was"
which is broadcast one time each week and a one-hour weekend version, which is
broadcast once each week. These three programs are broadcast on more than 235
radio stations in the United States. Our library of old-time radio programs
provides the content and the basis for these programs.
Our current syndicated radio shows provide an excellent forum to introduce our
old-time radio programs to existing and potential new listeners. The syndication
agreements also provide us with several minutes per hour for our own advertising
and promotional use. We use this advertising and promotional forum as a means to
develop broader name recognition for Radio Spirits, to advertise third party
products and services and to sell and cross-promote old-time radio and other
MediaBay products. Our old-time radio content can also be heard on dedicated
channels on both the Sirius Satellite Radio and XM Satellite Radio services.
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AUDIOBOOK INDUSTRY
First introduced to the mass market in 1985, audiobooks are literary works or
other printed materials read by the author, a celebrity actor, or an ensemble of
readers or actors. Audiobooks are recorded primarily on audiocassette and, to a
lesser extent, on compact disc. Most best selling hardcover books printed today
are released simultaneously as audiobooks. Audiobooks are unabridged or author
approved abridgements of the original works converted to an audio. Today there
are over 70,000 audiobook titles in existence spanning every genre, including
non-fiction, fiction, self-improvement, mystery, fantasy, business, science
fiction, biography, romance, religion, motivational and children's, among
others. Audiobooks cover new releases as well as many of the literary classics.
COMPETITION
We compete for discretionary consumer spending with other mail order clubs and
catalogs and other direct marketers and traditional and on-line retailers that
offer products with similar entertainment value as audiobooks and old-time radio
programs, such as music on cassettes and compact discs, printed books, videos,
and laser and digital video discs. Many of these competitors are
well-established companies, which have greater financial resources.
Through consolidation and the exclusivity of the licenses with publishers to
sell their audiobooks in a club format, we believe we are largest business,
which sells audiobooks in a club format. Furthermore, as was similarly
accomplished with the formation of the Radio Spirits and RadioClassics, we
believe we are the largest producer, marketer and seller of old-time radio
programs. However, the audiobook and mail order industries are intensely
competitive. We compete with all other outlets through which audiobooks and
other spoken word content are offered, including larger retailers such as Barnes
& Noble and Amazon.com.
INTELLECTUAL PROPERTY
We have several United States registered trademarks and service marks for
slogans and designs used in our advertisements, member mailings and member
solicitation packages, including the Audio Book Club logo "MediaBay," "Radio
Spirits", "MediaBay.com," "audiobookclub.com" and the MediaBay logos. We believe
that our trademarks and service marks have significant value and are important
to our marketing. We also own or license the rights to substantially all of our
radio programs in our content library.
We rely on trade secrets and proprietary know-how and employ various methods to
protect our ideas, concepts and membership database. In addition, we typically
obtain confidentiality agreements with our executive officers, employees, list
managers and appropriate consultants and service suppliers.
EMPLOYEES
As of April 12, 2004, we had 37 full-time employees. Of these employees, 4
served in corporate management; 18 served in operational positions at our Audio
Book Club operations; 7 served in operational positions at our MediaBay.com and
information systems operations and 8 served in operational positions at our
old-time radio operations. We believe our employee relations to be good. None of
our employees are covered by a collective bargaining agreement.
9
RISK FACTORS
Risks Relating to Our Financial Condition
We have a history of losses, are not currently profitable, and expect to incur
losses in the future. Since our inception, we have incurred significant losses.
As of December 31, 2003, we had incurred an accumulated deficit of $102 million.
Losses are continuing and are expected to continue. We may not be able to
achieve and sustain profitable operations.
Our auditors expressed doubt about our ability to continue as a going concern in
their audit report for the fiscal year ended December 31, 2003. Our auditors
have included an explanatory paragraph in their audit opinion with respect to
our consolidated financial statements at December 31, 2003. The paragraph states
that our recurring losses from operations and our inability to meet our debt
obligations as they come due in 2004 raise substantial doubt about our ability
to continue as a going concern. Furthermore, the factors leading to and the
existence of the explanatory paragraph may adversely affect our relationships
with suppliers and other creditors and customers and may adversely affect our
ability to obtain additional financing.
The terms of our debt impose restrictions on our business.
As of December 31, 2003 we had approximately $2.9 million of debt outstanding
under our revolving line of credit and approximately $15.1 million principal
amount of debt outstanding and related accrued interest under promissory notes.
Our revolving line of credit restricts our ability to raise financing for
working capital purposes because it requires us to use any proceeds from equity
or debt financings, with limited exceptions, to repay amounts outstanding under
the credit agreement. In addition to limiting our ability to incur additional
indebtedness, our existing indebtedness under our revolving line of credit
limits or prohibits us from, among other things:
o merging into or consolidating with another corporation;
o selling all or substantially all of our assets;
o declaring or paying cash dividends; or
o materially changing the nature of our business.
We have to make substantial payments on our debt during 2004 and may not have
the funds to do so. Our line of credit matures on September 30, 2004, an
additional $10.8 million is due upon demand of the holders of notes which may be
made at various times during 2004 following the repayment of the line of credit
and an additional $4.3 million under promissory notes is due in the fourth
quarter of 2004. We are required to make monthly payments of principal on the
line of credit of $106,666 through August 2004 We might not have sufficient
funds to repay the debt, or be able to obtain other financing to replace the
debt or obtain an extension of its maturity. In addition, if an event of default
occurs under the promissory notes or senior credit facility, the indebtedness
would become due and payable. In such an event, it is unlikely that we will have
the funds necessary to repay all of the indebtedness.
Our obligations to repurchase shares of our common stock will divert available
cash from use in operation; and we may not have the funds available to meet our
obligations. We granted the seller in an acquisition the right to sell back to
us shares of our common stock that we issued in connection with the acquisition.
Unless our common stock satisfies specific price targets, these rights could
require us to purchase up to 75,000 shares of our common stock at a cost to us
of $1.1 million as follows: (i) 25,000 shares at a cost to us of $350,000 and
(ii) 50,000 shares at a cost to us of $750,000 commencing December 31, 2005. The
repurchase obligations expire based on the stock reaching the repurchase price
for a period of 10 consecutive trading days. We have asserted that the price
targets were maintained and that the obligation has expired. The seller has
disputed this assertion and asserts the right to put 25,000 shares at a price of
$14.00 per share beginning on December 31, 2003 and 50,000 shares at a price of
$15.00 per share beginning on December 31, 2005. The seller has demanded the
repurchase of the 25,000 shares for $350,000. At this time, the status of these
discussions is open and we do not know what the outcome will be. We may not have
the funds to meet these obligations to repurchase stock, which could result in
the holder of these rights commencing lawsuits to enforce his rights. Even if we
have the funds available to meet these obligations, such payments will adversely
affect our cash flow and divert cash from use in operations.
10
Risks Relating to our Operations
If we do not have sufficient funds to market to attract new members and
customers, our customer and revenue bases will continue to erode. Because we
significantly reduced our market expenditures for new members, our club
membership and revenues declined significantly. Sales for the year ended
December 31, 2003 decreased $9.1 million or 20% to $36.6 million as compared to
$45.7 million for the year ended December 31, 2002. Audio Book Club sales
decreased by $8.0 million to $26.4 million for the year ended December 31, 2003
from $34.4 million for the year ended December 31, 2002, principally due to a
decrease in club membership as a result of a reduction in our advertising
expenditures for new members. For the year ended December 31, 2003, we spent
$2.1 million to attract new Audio Book Club members, a reduction of $6.2
million, or 74.7%, from the amount spent to attract new members of $8.3 million
during the year ended December 31, 2002, principally due to the lack of
necessary funds. If we do not have the funds available to spend to acquire new
members to offset member attrition and/or expand our existing membership and
customer bases, our revenue will continue to decline, which will continue to
negatively impact our performance and could ultimately impair our ability to
continue as a going concern.
Our products are sold in a niche market that may have limited future growth
potential. Although the market for audiobooks has expanded in recent years, the
markets for our products are niche markets. Consumer interest in audiobooks and
old-time radio may decline in the future, and growth trends in these markets may
stagnate or decline. A decline in the popularity of audiobooks and old-time
radio would limit our future growth potential and negatively impact our future
operating results.
We may be unable to anticipate changes in consumer preference for our products
and may lose sales opportunities. Our success depends largely on our ability to
anticipate and respond to a variety of changes in the audiobook and old-time
radio industries. These changes include economic factors affecting discretionary
consumer spending, modifications in consumer demographics and the availability
of other forms of entertainment. The audiobook and old-time radio markets are
characterized by changing consumer preferences, which could affect our ability
to:
o plan for catalog offerings;
o introduce new titles;
o anticipate order lead time;
o accurately assess inventory requirements; and
o develop new product delivery methods.
11
Although we evaluate many factors and attempt to anticipate the popularity and
life cycle of audiobook titles, the ultimate level of demand for specific titles
is subject to a high level of uncertainty. Sales of audiobook titles typically
decline rapidly after the first few months following release. If sales of
specific titles decline more rapidly than we expect, we could be left with
excess inventory, which we might be forced to sell at reduced prices. If we fail
to anticipate and respond to factors affecting the audiobook industry in a
timely manner, we could lose significant amounts of capital or potential sales
opportunities.
We may experience system interruptions, which affect access to our web sites and
our ability to sell products over the Internet. Our future revenue depends, in
part, on the number of web site visitors who join as Audio Book Club members and
who make online purchases. The satisfactory performance, reliability and
availability of our web sites, transaction-processing systems and network
infrastructure are critical to our ability to attract and retain visitors at our
web sites. If we experience system interruptions that prevent customers and
potential customers from accessing our web sites, consumer perception of our
on-line business could be adversely affected, and we could lose sales
opportunities and visitor traffic.
We may not be able to license or produce desirable spoken word content, which
could reduce our revenues. We could lose sales opportunities if we are unable to
continue to obtain the rights to additional audiobook libraries or selected
audiobook titles. Some of our license agreements expire over the next several
months unless they are renewed. We may not be able to renew existing license and
supply arrangements for audiobook publishers' libraries or enter into additional
arrangements for the supply of new audiobook titles.
If our third-party providers fail to perform their services properly, our
business and results of operations could be adversely affected. Third-party
providers conduct all of our Audio Book Club and a majority of our Radio Spirits
customer service operations, process orders and collect payments for us. If
these providers fail to perform their services properly, Audio Book Club members
and Radio Spirits' customers could develop negative perceptions of our business,
collections of receivables could be delayed, our operations might not function
efficiently, our expenses may increase and our revenue may decline.
If our marketing strategies to acquire new members are not successful, we will
not acquire as many members as we anticipate or acquire members whose
performance is unprofitable, which would inhibit our sales growth or increase
our costs.
If our direct mail and other marketing strategies are not successful, our per
member acquisition costs may increase and we may acquire fewer new members than
anticipated or the members we do acquire may not purchase as many products as we
anticipate, return products at a higher rate than we expect or fail to pay for
their purchases. As a result, our operating results would be negatively impacted
and our sales growth would be inhibited.
The public may become less receptive to unsolicited direct mail campaigns. The
success of our direct mail campaigns is dependent on many factors including the
public's acceptance of direct mail solicitations. Negative public reception of
direct mail solicitations will result in lower customer acquisitions rates and
higher customer acquisition costs and will negatively impact operating results
and sales growth.
12
Increased member attrition could negatively impact our future revenues and
operating results.
As is typical with membership clubs, we experience significant member attrition.
Our audiobook club lost more active members than new members that joined in
2003. Increases in membership attrition above the rates we anticipate could
materially reduce our future revenues. We incur significant up front
expenditures in connection with acquiring new members. A member may not honor
his or her commitment, or we may choose to terminate a specific membership for
several reasons, including failure to pay for purchases, excessive returns or
cancelled orders. As a result, we may not be able to fully recoup our costs
associated with acquiring new members. In addition, once a member has satisfied
his or her initial commitment to purchase additional audiobooks at regular
prices, the member has no further commitment to make purchases.
New laws addressing the sending of e-mails may limit our ability to market or
subject us to penalties.
New laws recently enacted to limit "spam" e-mails may impact our ability to
conduct e-mail campaigns. While we attempt to only use "opt-in" e-mail addresses
and to work with third parties whose lists consist of "opt-in" e-mails, the law
may limit the number of third parties whose lists we can use or significantly
reduce the number of e-mails within these lists. Limitations on our ability to
continue the use of e-mail marketing campaigns could adversely affect our
ability to attract new audiobook club members and increase our cost to acquire
new members.
The closing of retail stores, which carry our products could negatively impact
our wholesale sales of these products.
Bankruptcy filings by major retailers may limit the number of outlets for our
old-time radio products. With fewer chains and stores available as distribution
outlets, competition for shelf space will increase and our ability to sell our
products could be impacted negatively. Moreover, our wholesale sales could be
negatively impacted if any of our significant retail customers were to close a
significant number of their locations or otherwise discontinue selling our
products.
If third parties obtain unauthorized access to our member and customer databases
and other proprietary information, we would lose the competitive advantage they
provide.
We believe that our member file and customer lists are valuable proprietary
resources, and we have expended significant amounts of capital in acquiring
these names. Our member and customer lists, trade secrets, trademarks and other
proprietary information have limited protection. Third parties may copy or
obtain unauthorized access to our member and customer databases and other
proprietary know-how, trade secrets, ideas and concepts.
Competitors could also independently develop or otherwise obtain access to our
proprietary information. In addition, we rent our lists for one-time use only to
third parties that do not compete with us. This practice subjects us to the risk
that these third parties may use our lists for unauthorized purposes, including
selling them to our competitors. Our confidentiality agreements with our
executive officers, employees, list managers and appropriate consultants and
service suppliers may not adequately protect our trade secrets. If our lists or
other proprietary information were to become generally available, we would lose
a significant competitive advantage.
If we are unable to pay our accounts payable in a timely manner, our suppliers
and service providers may refuse to supply us with products or provide services
to us.
At December 31, 2003, we owed approximately $8.2 million to trade and other
creditors. Approximately $6.1 million of these accounts payable were more than
60 days past due. If we do not make satisfactory payments to our vendors, they
may refuse to continue to provide us with products or services on credit, which
could interrupt our supply of products or services.
13
Higher than anticipated product return rates could reduce our future operating
results.
We experienced product return rates of approximately 24%, 26%, and 32% during
the years ended December 31, 2001, 2002 and 2003, respectively. If members and
customers return products to us in the future at higher rates than in the past
or than we currently anticipate, our net sales would be reduced and our
operating results would be adversely affected. A return rate in excess of our
allowance for returns would result in a charge to earnings to write off the
related receivables and would reduce our assets.
If we are unable to collect our receivables in a timely manner or attract paying
members, it may negatively impact our cash flow and our operating results.
We experienced bad debt rates of approximately 6.1%, 6.2%, and 10.8% during the
years ended December 31, 2001, 2002 and 2003, respectively. We are subject to
the risks associated with selling products on credit, including delays in
collection or uncollectibility of accounts receivable. If we experience
significant delays in collection or uncollectibility of accounts receivable, our
liquidity and working capital position could suffer and we could be required to
increase our allowance for doubtful accounts, which would increase our expenses
and reduce our assets.
Increases in costs of postage could negatively impact our operating results.
We distribute millions of mailings each year, and postage is a significant
expense in the operation of our business. We do not pass on the costs of member
mailings and member solicitation packages. Even small increases in the cost of
postage, multiplied by the millions of mailings we conduct, would result in
increased expenses and would negatively impact our operating results.
We face significant competition from a wide variety of sources for the sale of
our products.
We may not be able to compete effectively because of the significant competition
in our markets from many competitors, many of whom are better financed and have
greater resources and from other competing products, which provide similar
entertainment value. We compete with other web sites, retail outlets and
catalogs, which offer similar entertainment products or content, including
digital download of spoken word content. New competitors, including large
companies, may elect to enter the markets for audiobooks and spoken word
content. We also compete for discretionary consumer spending with mail order
clubs and catalogs, other direct marketers and retailers that offer products
with similar entertainment value as audiobooks and old-time radio and classic
video programs, such as music on cassettes and compact discs, printed books,
videos, and laser and digital video discs. Many of these competitors are
well-established companies, which have greater financial resources that enable
them to better withstand substantial price competition or downturns in the
market for spoken word content.
Risks Relating to Our Capital Structure
The Herrick family exerts significant influence over shareholder matters.
Norton Herrick, Howard Herrick, a director of MediaBay, their family members and
affiliates own approximately 24% of our outstanding common stock and all of our
outstanding Series A convertible preferred stock, and therefore, have the right
to cast approximately 40% of the voting power of our capital stock. They also
own principal amount of $7.1 million of convertible debt and warrants and
options, which in the aggregate are convertible or exercisable into
approximately 19.2 million shares of our common stock at prices ranging from
$0.56 per share to $4.00 per share, which if converted and exercised, would give
them the right to vote, in total, approximately 63% of the voting power of our
capital stock. As significant shareholders, they exert significant influence
over matters, which require shareholder vote, including the election of
directors, amendments to our Articles of Incorporation or approval of the
dissolution, merger, or sale of MediaBay, our subsidiaries or substantially all
of our assets. In addition, consent of the holders of the Series A convertible
preferred stock is required for certain actions, including a merger or other
business combination, certain assets sales, the creation, authorization or
increase of any series of shares of capital stock convertible into common stock,
incurrence of indebtedness and declaration or payment of dividends on capital
stock. Ownership of the convertible debt restricts our ability to take other
corporate actions, including the incurrence of additional debt, without the
holders' consent. This concentration of ownership and control by the Herrick
family could delay or prevent a change in our control or other action, even when
a change in control or other action might be in the best interests of other
shareholders.
14
Our ability to use our net operating losses will be limited in future periods,
which could increase our tax liability. Under Section 382 of the Internal
Revenue Code of 1986, utilization of prior net operating losses is limited after
an ownership change, as defined in Section 382, to an annual amount equal to the
value of the corporation's outstanding stock immediately before the date of the
ownership change multiplied by the long-term tax exempt rate. In the event we
achieve profitable operations, any significant limitation on the utilization of
net operating losses would have the effect of increasing our tax liability and
reducing after tax net income and available cash reserves. We are unable to
determine the availability of net operating losses since this availability is
dependent upon profitable operations, which we have not achieved in prior
periods.
Our stock price has been and could continue to be extremely volatile. The market
price of our common stock has been subject to significant fluctuations since our
initial public offering in October 1997. The securities markets have
experienced, and are likely to experience in the future, significant price and
volume fluctuations, which could adversely affect the market price of our common
stock without regard to our operating performance. In addition, the trading
price of our common stock could be subject to significant fluctuations in
response to:
o our ability to maintain listing of our common stock on NASDAQ;
o actual or anticipated variations in our quarterly operating results;
o announcements by us or other industry participants,
o factors affecting the market for spoken word content;
o changes in national or regional economic conditions;
o changes in securities analysts' estimates for us, our competitors'
or our industry or our failure to meet such analysts' expectations;
and
o general market conditions.
A large number of shares of our common stock could be sold in the market in the
near future, which could depress our stock price.
As of April 12, 2004, we have outstanding approximately 18.5 million shares of
common stock. In addition, a substantial portion of our shares are currently
freely trading without restriction under the Securities Act of 1933, having been
registered for resale or held by their holders for over 2 years and are eligible
for sale under Rule 144(k). At April 12, 2004 there were outstanding options and
warrants to purchase and debt convertible into approximately 29,535,000 shares
of our common stock at an average exercise or conversion price of approximately
$1.56 per share. A substantial portion of these shares has been registered for
resale. To the extent any of our warrants or options are exercised, your
percentage ownership will be diluted and our stock price could be further
adversely affected. Moreover, as the underlying shares are sold, the market
price could drop significantly if the holders of these restricted shares sell
them or if the market perceives that the holders intend to sell these shares.
15
ITEM 2. PROPERTIES
We lease approximately 12,000 square feet of office space in Cedar Knolls, New
Jersey pursuant to a sixty-six month lease agreement dated April 18, 2003. We
entered into two ten-year leases on 7,000 square feet of office and warehouse
space in Bethel, Connecticut and 3,000 square feet of warehouse space in Sandy
Hook, Connecticut, respectively. Lease payments and mandatory capital
improvement payments, starting in 2004, are $4,000 per year and $2,000 per year
on the Bethel and Sandy Hook properties, respectively. We currently sub-lease
the office and warehouse space in Bethel.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any lawsuit or proceeding, which we believe is likely to
have a material adverse effect on us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An Annual Meeting of Shareholders was held on August 11, 2003 at which time Mr.
Richard Berman, Mr. Howard Herrick and Mr. Carl Wolf were reappointed to serve
as a Class III directors until the Annual Meeting of Shareholders of the Company
to be held in 2006. Shareholder voting for these directors was as follows:
Director Votes For Votes Withheld
- -------- --------- --------------
Richard J. Berman 13,850,641 244,254
Howard Herrick 13,739,541 355,354
Carl T. Wolf 13,848,141 246,754
The following directors serve as directors for the term indicated opposite their
respective names:
Director Class Expiration of Term
- -------- ----- ------------------
Paul D. Ehrlich I 2004
Joseph R. Rosetti I 2004
Jeffrey Dittus II 2005
Mark P. Hershhorn II 2005
Richard J. Berman III 2006
Howard Herrick III 2006
Carl T. Wolf III 2006
In addition, at the annual meeting, the shareholders approved a proposal to
authorize us to issue our common stock upon conversion of certain convertible
shares of the Series B Convertible Preferred Shares (the "Series B Stock")
issued to certain of our officers and directors by a vote of 8,418,809 votes
for, 352,599 votes against, 10,460 votes abstaining and 5,313,027 broker
non-votes.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
MediaBay's common stock has been quoted on the Nasdaq National Market under the
symbol "MBAY" since November 15, 1999. The following table shows the high and
low sales prices of our common stock as reported by the Nasdaq National Market.
HIGH LOW
---- ---
FISCAL YEAR ENDED DECEMBER 31, 2002
First Quarter 3.50 .59
Second Quarter 6.04 3.20
Third Quarter 4.90 .77
Fourth Quarter 1.63 .77
FISCAL YEAR ENDED DECEMBER 31, 2003
First Quarter 1.27 .77
Second Quarter 1.11 .64
Third Quarter 1.10 .60
Fourth Quarter 1.65 .80
FISCAL YEAR ENDED DECEMBER 31, 2004
First Quarter 1.59 .52
On April 12, 2004 the last reported sale price of our common stock on the Nasdaq
National Market was $.68 per share. As of April 12, 2004, there were
approximately 144 record owners of our common stock. We believe that there are
more than 400 beneficial owners of our common stock.
DIVIDEND POLICY
We have never declared or paid and do not anticipate declaring or paying any
dividends on our common stock in the near future. The terms of our debt
agreements prohibit us from declaring or paying any dividends or distributions
on our common stock. Any future determination as to the declaration and payment
of dividends will be at the discretion of our Board of Directors and will depend
on then existing conditions, including our financial condition, results of
operations, capital requirements, business factors and other factors as our
Board of Directors deems relevant.
SALES OF SECURITIES AND USE OF PROCEEDS
During the three months ended December 31, 2003, we issued options under our
2001 and 1999 Stock Incentive Plans to purchase a total of 1,259,925 shares of
our common stock to officers, directors and consultants. We relied on the
exemptions provided by Section 4(2) of the Securities Act of 1933 in connection
with such issuances.
ITEM 6. SELECTED FINANCIAL DATA
As a result of the following factors, including capitalization of direct
response advertising costs, recording of the goodwill write-off, the strategic
charges and the income tax benefit, as well as fluctuations in operating results
depending on the timing, magnitude and success of Audio Book Club new member
advertising campaigns, comparisons of our historical operating results from year
to year may not be meaningful.
17
During the fourth quarter of 2000, we reviewed long-lived assets and certain
related identifiable intangibles, including goodwill, for impairment. As a
result, in the fourth quarter of 2000, we determined that the goodwill
associated with certain acquired businesses was impaired and recorded an
impairment charge of $38.2 million.
In the third quarter of 2001, we began to implement a series of actions and
decisions designed to improve gross profit margin, refine our marketing efforts
and reduce general and administrative costs. In connection with the movement of
the fulfillment of old-time radio products to a third party provider, in the
first quarter of 2002, we closed our old-time radio operations in Schaumburg,
Illinois and now run all of our operations, except for fulfillment, from our
corporate headquarters located in Cedar Knolls, New Jersey. In the third quarter
of 2001, as a result of the actions and decisions made after our aforementioned
review of our operations, we recorded $11.3 million of strategic charges. In
addition to these strategic charges, we recorded a charge of $2.0 million to
write-off the entire carrying amount of our cost method investment in an
unrelated entity.
As a result of the series of strategic initiatives described above, our
operations had improved. Although realization of net deferred tax assets is not
assured, we determined that it is more likely than not that a portion of our
deferred tax asset relating to temporary differences between the tax bases of
assets or liabilities and their reported amounts in the financial statements
will be realized in future periods. Accordingly, in 2001, we reduced the
valuation allowance for deferred tax assets in the amount of $17.2 million and
recorded an income tax benefit. In 2003, the deferred tax asset was reduced by
approximately $1.5 million for amounts, which the Company was unable to
determine would be recoverable in future periods.
In the fourth quarter of 2003, we evaluated the performance of Audio Passages,
an Audio Book Club marketing program tailored to listeners with an interest in
Christian product and determined based on past performance and expected future
performance that we should terminate the Audio Passages marketing program. In
connection with the termination of the Audio Passages marketing program, we took
a strategic charge for the establishment of a reserve for obsolescence of Audio
Passages inventory of $0.3 million and an assets write-down for previously
capitalized advertising, which are not recoverable in the amount of $0.5
million.
In 2003, the employment of two senior executives who had employment agreements
was terminated and the decision was made to terminate the employment agreement
of another senior executive. A consulting agreement was also terminated. We
settled these employment agreements and consulting agreement for total
consideration of $.5 million payable through May 2005.
18
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
(THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net sales $ 46,227 $ 44,426 $ 41,805 $ 45,744 $ 36,617
Cost of sales 23,687 23,044 19,783 20,651 17,479
Cost of sales - write-downs - - 2,261 - -
Advertising and promotion 8,118 11,023 11,922 10,156 9,988
Advertising and promotion - write-downs - - 3,971 - -
Bad debt expense 2,536 2,821 3,940
General and administrative 10,762 14,406 8,947 8,347 6,816
Asset write-downs and strategic charges - - 7,044 - 749
Severance and other termination costs - - - - 544
Depreciation and amortization 6,812 7,984 5,156 1,314 328
Non-cash write-down of intangibles - - - 1,224 -
Non-cash write-down of goodwill - 38,226 - - -
------------ ------------ ------------ ------------ -------------
Operating (loss) income (3,152) (50,257) (19,815) 1,231 (3,227)
Interest income (expense), net (6,271) (2,940) (2,790) (2,974) (1,925)
------------ ------------ ------------ ------------ -------------
Loss before income tax benefit (expense)
and extraordinary item (9,423) (53,197) (22,605) (1,743) (5,152)
Income tax benefit (expense) - - 17,200 (550) (1,471)
------------ ------------ ------------ ------------ -------------
Loss before extraordinary item (9,423) (53,197) (5,405) (2,293) (6,623)
Extraordinary gain (loss) on early extinguishment of debt 999 (2,152) - - -
------------ ------------ ------------ ------------ -------------
Net loss (8,424) (55,349) (5,405) (2,293) (6,623)
Dividends on preferred stock - - - 217 246
------------ ------------ ------------ ------------ -------------
Net loss applicable to common shares $ (8,424) $ (55,349) $ (5,405) $ (2,510) $ (6,869)
============ ============ ============ ============ =============
Basic and diluted loss per share:
Basic and diluted loss before extraordinary item ($1.15) ($4.18) ($0.39) ($0.18) ($0.49)
============ ============ ============ ============ =============
Basic and diluted loss applicable to common shares ($1.03) ($4.35) ($0.39) ($0.18) ($0.49)
============ ============ ============ ============ =============
Basic and diluted weighted average number of
shares outstanding 8,205 12,718 13,862 14,086 14,098
============ ============ ============ ============ =============
AS OF DECEMBER 31,
---------------------------------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
(THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET DATA:
Working capital (deficit) $ 1,599 $ 313 $ (4,167) $ (4,336) (20,165)
Total assets 93,973 49,932 44,452 48,619 36,893
Current liabilities 20,275 17,103 15,491 18,984 29,194
Long-term debt (less current portion) 36,134 15,340 15,849 14,680 -
Common stock subject to contingent put rights 4,283 4,550 4,550 4,550 750
Stockholders' equity 33,281 12,939 8,562 10,405 6,949
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS INTRODUCTION We are a seller of spoken audio and nostalgia
products, including audiobooks and old-time radio shows, through direct
response, retail and Internet channels. Our content and products are sold in
multiple formats, including physical (cassette and compact disc) and secure
digital download formats.
We report financial results on the basis of four business segments; Corporate,
Audio Book Club, Radio Spirits and MediaBay.com. A fifth division,
RadioClassics, is aggregated with Radio Spirits for financial reporting
purposes. Except for corporate, each segment serves a unique market segment
within the spoken word audio industry. In 2003, our Audio Book Club segment had
net sales of approximately $26.4 million, our Radio Spirits segment had net
sales of approximately $10.2 million, our MediaBay.com segment had sales of
approximately $0.1 million and we had eliminating inter-segment sales of $0.1
million.
19
We derive our principal revenue through sales of audiobooks, classic radio shows
and other spoken word audio products directly to consumers principally through
direct mail. We also sell classic radio shows to retailers either directly or
through distributors. We derive additional revenue through rental of our
proprietary database of names and addresses to non-competing third parties
through list rental brokers. We also derive a small amount of revenue from
advertisers who advertise on our nationally syndicated classic radio shows.
Our business is dependent on attracting and retaining members in Audio Book
Club. We continually monitor the cost to acquire new members, their buying
behavior and the attrition rate of members. Any changes to these metrics could
have a significant impact on our business.
Historically, we have funded our cash requirements through sales of equity and
debt securities and borrowings from financial institutions and our principal
shareholders. During 2003, we did not have sufficient cash to undertake
marketing activities to the extent of historical levels. As a result, our member
and customer bases eroded and our revenues declined significantly. We currently
do not have sufficient funds to market to attract new members and customers to
maintain our member and customer bases. We will require additional financing to
conduct sufficient marketing activities to maintain and rebuild our member and
customer bases. If we do not obtain the funds necessary to increase our
advertising to acquire new members to offset member attrition and/or expand our
existing membership and customer bases, our revenue will continue to decline,
which will continue to negatively impact our performance and could ultimately
impair our ability to continue as a going concern.
We also have significant outstanding indebtedness and face substantial debt
repayment obligations in the short-term. Our line of credit, of $1.4 million as
of April 12, 2004, is due September 30, 2004, an additional $10.8 million is due
upon demand of the holders of notes which may be made at various times during
2004 following the repayment of the line of credit and an additional $4.3
million under promissory notes is due in the fourth quarter of 2004. We
currently do not have sufficient funds to repay our debt as it will become due
and are actively seeking to obtain other financing to replace the debt or obtain
an extension of the maturities.
We have implemented a series of initiatives to increase cash flow. While these
initiatives and the significant reduction in marketing expenses increased cash
provided by operating activities in 2003, we cannot sustain our operations
without increasing marketing expenses. We require additional financing to repay
debt, as described above, and to fund the maintenance of our operations, working
capital or other related uses.
The preparation of financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosures of contingent assets and liabilities. We
record reductions to our revenues for future returns and record an estimate of
future bad debts arising from current sales in general and administrative
expenses. These allowances are based upon historical experience and evaluation
of current trends. If the financial condition of our customers, including either
individual consumers or retail chains, were to deteriorate or if the payment
behavior were to change, resulting in either their inability or refusal to make
payment to us, additional allowances would be required. We capitalize direct
response marketing costs for the acquisition of new members and amortize these
costs over the period of probable future benefits. In order to determine the
amount of advertising to be capitalized and the manner and period over which the
advertising should be amortized, we prepare estimates of probable future
revenues arising from the direct-response advertising in excess of future costs
to be incurred in realizing those revenues. We record an estimate of our
anticipated bad debt expense based on our historical experience.
20
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which temporary timing
differences become deductible. Although realization of net deferred tax assets
is not assured, management has determined that it is more likely than not that a
portion of our deferred tax asset relating to temporary differences between the
tax bases of assets or liabilities and their reported amounts in the financial
statements will be realized in future periods. In 2003, the deferred tax asset
was reduced by approximately $1.5 million for amounts, which we were unable to
determine would be recoverable in future periods.
We completed our annual impairment test of goodwill as of October 31, 2003 in
connection with the annual budgeting and planning process, which did not result
in an impairment loss. However, if conditions or circumstances were to change
resulting in a deterioration of our Radio Spirits business, a future impairment
of goodwill could be necessary.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
are based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of financial statements requires us to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosures of contingent assets and liabilities. On
an on-going basis we evaluate our estimates including those related to product
returns, bad debts, the carrying value and net realizable value of inventories,
the recoverability of advances to publishers and other rightsholders, the future
revenue associated with deferred advertising and promotion costs, investments,
fixed assets, the valuation allowance provided to reduce our deferred tax assets
and valuation of goodwill and other intangibles.
The Securities and Exchange Commission ("SEC") defines "critical accounting
policies" as those that require application of management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain and may change in
subsequent periods.
Our significant accounting policies are described in Note 3 to the Notes to
Consolidated Financial Statements. Not all of these significant accounting
policies require management to make difficult, subjective or complex judgments
or estimates. However the following policies are considered to be critical
within the SEC definition:
Revenue Recognition
We derive our principal revenue through sales of audiobooks, classic radio shows
and other spoken word audio products directly to consumers principally through
direct mail. We also sell classic radio shows to retailers either directly or
through distributors. We derive additional revenue through rental of our
proprietary database of names and addresses to non-competing third parties
through list rental brokers. We also derive a small amount of revenue from
advertisers included in our nationally syndicated classic radio shows. We
recognize sales to consumers, retailers and distributors upon shipment of
merchandise. List rental revenue is recognized on notification by the list
brokers of rental by a third party when the lists are rented. We recognize
advertising revenue upon notification of the airing of the advertisement by the
media buying company representing us. Allowances for future returns are based
upon historical experience and evaluation of current trends. The historical
return rates for ABC members have been consistent for the past year and our
estimate is based on a detailed historical examination of trends. Based on the
current performance and historical trends, we do not expect significant changes
in the estimate of returns for ABC members. The estimate of returns for
wholesale sales of our old-time radio products is based on a detailed review of
each significant customer, depending on the amount of products sold to a
particular customer in a specific periods, the overall return rate for wholesale
sales could vary.
21
We record reductions to our revenue for future returns and record an estimate of
future bad debts arising from current sales in general and administrative
expenses. These allowances are based upon historical experience and evaluation
of current trends. If members and customers return products to us in the future
at higher rates than in the past or than we currently anticipate, our net sales
would be reduced and our operating results would be adversely affected. In
November 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)", which addresses the income statement
classification of certain credits, allowances, adjustments, and payments given
to customers for the services or benefits provided. We adopted EITF No. 01-9
effective January 1, 2002, and, as such, have classified the cost of these sales
incentives as a reduction of sales. The effect on sales of applying EITF No.
01-9 in 2002 and 2003 was $118,000 and $60,000, respectively.
Deferred Member Acquisition Costs
We are required to capitalize direct response marketing costs for the
acquisition of new members in accordance with AICPA Statement of Position 93-7
"Reporting on Advertising Costs" and amortize these costs over the period of
probable future benefits. In order to determine the amount of advertising to be
capitalized and the manner and period over which the advertising should be
amortized, we prepare estimates of probable future revenues arising from the
direct-response advertising in excess of future costs to be incurred in
realizing those revenues. If future revenue does not meet our estimates or if
members buying patterns were to shift, adjustments to the amount and manner of
amortization would be required. At December 31, 2003 we had deferred member
acquisition costs of $3.2 million, which is being amortized over eighteen and
thirty month periods. We have tracked customer-buying behavior and believe that
the estimates we have used to amortize ABC advertising have been consistent and
we do not expect to see significant changes. In the fourth quarter of 2003, we
adjusted the amortization period for advertising to attract customers to our
World's Greatest Old-Time Radio continuity program and have revised the estimate
period for amortization of these advertising costs down to 18 months, which
resulted in and increase in advertising expenses for the year ended December 31,
2003 of $409,000.
Accounts Receivable Valuation
We record an estimate of our anticipated bad debt expense and return rates based
on our historical experience. If the financial condition of our customers,
including either individual consumers or retail chains, were to deteriorate, or
if the payment or buying behavior were to change, resulting in either their
inability or refusal to make payment to us, additional allowances would be
required. For example, a one percent increase in returns as a percentage of
gross sales for the year ended 2003, assuming a constant gross profit percentage
and all other expenses unchanged, would have resulted in a decrease in net sales
of $536,000 and a increase in net loss available to common shares of $279,000. A
one percent increase in bad debt expenses as a percentage of net sales, assuming
all other expenses were unchanged, would have resulted in an increase in bad
debt expenses and a corresponding increase in net loss available to common
shares of $366,000. Our estimate of bad debt expenses in 2003 was adjusted
upward due to the poor paying performance of ABC members attracted through
Internet offers, which did not require an upfront payment and members of Audio
Passages, our audiobook club with predominantly Christian content whose members
also demonstrated poor paying performance. Our Internet advertising currently
requires payment with a credit card of the initial order and will continue to
require a credit card until we develop better credit screening methods. We have
discontinued the Audio Passages marketing program.
22
Income Taxes
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which temporary timing
differences become deductible. Although realization of net deferred tax assets
is not assured, we have determined that it is more likely than not that a
portion of our deferred tax asset relating to temporary differences between the
tax bases of assets or liabilities and their reported amounts in the financial
statements will be realized in future periods. We determine the utilization of
deferred tax assets in the future based on our current year projections of
future periods. . In 2003, the deferred tax asset was reduced by approximately
$1.5 million for amounts, which we were unable to determine would be recoverable
in future periods.
At December 31, 2003, we have a remaining net deferred tax asset in the amount
of $14.8 million. Should we determine we would be able to realize deferred tax
assets in the future in excess of the net recorded amount, an adjustment to our
deferred tax asset would increase income in the period such determination is
made. Likewise, should we determine that we will not be able to realize all or
part of our net deferred tax asset in the future, an adjustment to the deferred
tax asset would be recorded as an increase to the valuation allowance, resulting
in a deferred tax expense charged against income in the period such
determination is made.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired in business combinations accounted for using the purchase method
of accounting. In July 2001, the Financial Accounting Standards Board issued
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 requires that
an intangible asset that is acquired shall be initially recognized and measured
based on its fair value. The statement also provides that goodwill should not be
amortized, but shall be tested for impairment annually, or more frequently if
circumstances indicate potential impairment, through a comparison of fair value
to its carrying amount. At December 31, 2003, we had $9.7 million of goodwill,
all of which relates to our Radio Spirits operations. We completed our annual
impairment test as of October 31, 2003 in connection with the annual budgeting
and planning process, which did not result in an impairment loss. However, if
conditions or circumstances were to change resulting in a deterioration of our
Radio Spirits business, a future impairment of goodwill could be necessary.
23
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, historical operating
data as a percentage of net sales.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2001 2002 2003
------------------- ------------------- -------------------
Sales........................................................ 100% 100% 100%
=================== =================== ===================
Cost of sales................................................ 47 45 48
Cost of sales - write-downs.................................. 5 -- --
Advertising and promotion.................................... 29 22 27
Advertising and promotion - write-downs...................... 10 -- --
Bad debt expense 6 6 11
General and administrative expense........................... 21 18 19
Severance and other termination costs -- -- 1
Asset write-downs and strategic charges...................... 17 -- 2
Depreciation and amortization expense........................ 12 3 1
Non-cash write-down of intangibles........................... -- 3 --
Interest expense, net........................................ 7 7 5
Income tax expense (benefit)................................. (41) 1 4
Net (loss)................................................... (13) (5) (18)
Dividends on preferred stock................................. -- -- 1
Net (loss) applicable to common shares....................... (13) (5) (19)
Year ended December 31, 2003 compared to year ended December 31, 2002
- ---------------------------------------------------------------------
Net Sales
($000'S)
CHANGE FROM
2002 2003 2002 TO 2003 % CHANGE
---- ---- ------------ --------
AUDIO BOOK CLUB $34,343 $ 26,380 $ (7,963) (23.2)%
----------------------------------------------------------------------
RADIO SPIRITS
Catalog 4,507 4,210 (297) (6.6)%
Wholesale 5,594 3,048 (2,546) (45.5)%
Continuity 1,085 2,841 1,756 161.8%
----------------------------------------------------------------------
11,186 10,099 (1,087) (9.7)%
----------------------------------------------------------------------
MEDIABAY.COM 215 138 (77) (35.8)%
----------------------------------------------------------------------
$45,744 $ 36,617 $ (9,127) (20.0)%
======================================================================
Audio Book Club sales decreased principally due to a decrease in club membership
as a result of a reduction in our advertising expenditures for new members. For
the year ended December 31, 2003, the Audio Book Club spent $2.1 million to
attract new members, a reduction of $6.2 million, or 74.7%, from the amount
spent to attract new members of $8.3 million during the year ended December 31,
2002. Audio Book Club attracted approximately 134,000 new members in the year
ended December 31, 2003 as compared to approximately 290,000 new members in the
year ended December 31, 2002.
24
The decrease in Radio Spirits catalog sales is principally attributable to
reduced catalog mailings. We spent $81,000, or 7.8% less in advertising during
the year ended December 31, 2003 as compared to the spending during the year
ended December 31, 2002. Wholesale sales of old-time radio products decreased
principally due to reduced sales to three major customers in 2003 and higher
returns from our major customers. Sales of our The World's Greatest Old-Time
Radio continuity program increased for the year ended December 31, 2003, as
compared to the year ended December 31, 2002, principally due to the inclusion
of a full year of sales in 2003. The World's Greatest Old-Time Radio continuity
program was introduced in the third quarter of 2002.
Cost of Sales
$ (000's) 2002 2003
---------------------------- -----------------------------
AS A % AS A % FROM 2002 TO 20003
$ OF NET SALES $ OF NET SALES CHANGE % CHANGE
------------- ------------ -------------- ------------ ------ --------
AUDIO BOOK CLUB $14,821 43.2% $ 12,107 45.9% $ (2,714) (18.3)%
------------------------------ -------------------------------- -----------------------------------
RADIO SPIRITS
Catalog 1,874 41.6% 2,015 47.9% 141 7.5%
Wholesale 3,072 54.9% 2,057 67.5% (1,015) (33.0)%
Continuity 884 81.5% 1,295 45.6% 411 46.5%
------------------------------ -------------------------------- -----------------------------------
5,830 52.1% 5,369 53.1% (463) (7.9)%
------------------------------ -------------------------------- -----------------------------------
MEDIABAY.COM - 5 5
------------------------------ -------------------------------- -----------------------------------
$20,651 45.1% $ 17,479 47.7% $ (3,172) (15.4)%
============================== ================================ ===================================
The principal reason for the decline in cost of sales at Audio Book Club was a
reduction in net sales of 23.2% as described above. Cost of sales as a
percentage of net sales at Audio Book Club for the year ended December 31, 2003
was 45.9%, compared to 43.2% for 2002. The increase in cost of sales as a
percentage of net sales is principally due to increased costs relating to higher
return rates in 2003, an increase in the reserve for obsolescence in 2003, in
part related to the termination of Audio Passages, our Christian audiobook club,
and higher average royalty rates since fewer books were sold in new member
offerings, which have lower royalty rates, partially offset by a reduced number
of heavily discounted books sold to new members due to a lower number of new
members added in 2003 as compared to 2002.
As a percentage of net sales, cost of sales at Radio Spirits increased to 53.1%
for the year ended December 31, 2003 from 52.1% for the year ended December 31,
2002. Cost of catalog sales increased as a percentage of net sales to 47.9% for
the year ended December 31, 2003 as compared to 41.6% for the year ended
December 31, 2002 principally due to sales of discounted items both in the Radio
Spirits catalog and through a campaign on radio stations. The cost of wholesale
sales as percentage of net revenue increased to 67.5% as compared to 54.9% for
the year ended December 31, 2002 principally due to the sales of slower moving
items at heavily discounted prices in remainder sales and costs associated with
higher returns. The cost of World's Greatest Old-Time Radio continuity sales as
a percentage of net income decreased 45.6% from 81.5%. The continuity program
commenced in August 2002 and the majority of sales in 2002 were of heavily
discounted introductory merchandise designed to attract new buyers.
25
Advertising and promotion
FROM 2002 TO 2003
2002 2003 CHANGE % CHANGE
---- ---- ------ --------
($000'S)
AUDIO BOOK CLUB
New Member $ 8,269 $ 2,092 $ (6,177) (74.7)%
Current Member 2,310 1,993 (317) (13.7)%
------------------------------------------------------------
10,579 4,085 (6,494) (61.4)%
------------------------------------------------------------
RADIO SPIRITS
Catalog 1,070 964 (106) (9.9)%
Wholesale 151 74 (77) (51.0)%
Continuity 885 775 (110) (12.4)%
------------------------------------------------------------
2,106 1,813 (293) (13.9)%
------------------------------------------------------------
NEW PROJECTS - 339 339
----------------------------------------------
TOTAL SPENDING 12,685 6,237 (6,448) (50.8)%
AMOUNT CAPITALIZED (8,099) (2,410)
AMOUNT AMORTIZED 5,571 6,161
-------------------------------
ADVERTISING AND PROMOTION EXPENSE $ 10,157 $ 9,988
===============================
Although advertising and promotion expenses were relatively consistent, actual
advertising expenditures in the year ended December 31, 2003 were $6.2 million,
a decrease of $6.4 million or 50.8% over the amount spent during the year ended
December 31, 2002 of $12.7 million.
As the chart below indicates, we attempted to grow our Audio Book Club very
aggressively in 2002. We spent $8.3 million to attract new members to our Audio
Book Club in 2002.
[BAR CHART OMITTED]
26
The largest increases in 2002 as compared to 2001 were in attracting members
through the Internet to our Audio Book Club in offers which required no
immediate payment to join the club or purchase the initial books ("Bill Me
Members") and in attracting member to Audio Passages, an audiobook club with
products intended for a Christian audience. The cost to acquire these customers
was lower than our traditional direct mail campaigns to acquire Audio Book Club
members, however the performance of both the members attracted through the
Internet and the Audio Passages members was much worse than our traditional
Audio Book Club members. Because we spent a substantial amount of money to
acquire these members and their performances were worse than we anticipated, we
did not have much funds for advertising in 2003 and accordingly our advertising
and promotion activities were dramatically reduced in 2003. A large portion of
advertising expenditures in 2002 was capitalized and a substantial portion of
that advertising was expensed in 2003. As the chart indicates our new member
recruitment was significantly reduced in 2003. In 2004, we have done a small
amount of marketing for new ABC members on an Internet offer requiring credit
card payment. While the initial response was encouraging we continue to monitor
the buying and payment behavior of these customers and currently do not have
sufficient funds to conduct any additional marketing.
Bad Debt Expense
2002 2003
----------------------------------------------------
$ (000's) AS A % AS A % FROM 2002 TO 2003
$ OF NET SALES $ OF NET SALES CHANGE % CHANGE
---------- ------------ --------- ----------- ------ --------
AUDIO BOOK CLUB $2,735 8.0% $ 3,404 12.9% $ 669 24.5%
------------------------------------------------------------------------------
RADIO SPIRITS
Catalog -- -- -- -- - --
Wholesale 15 0.3% 15 0.5% - --
Continuity 71 6.5% 521 18.3% 450 633.8%
---------------------------------------------------- ------------------------
86 1.5% 536 5.3% 450 523.3%
---------------------------------------------------- ------------------------
MEDIABAY.COM -- -- -- -- -- --
---------------------------------------------------- ------------------------
$2,821 13.7% $ 3,940 10.8% $1,119 39.7%
==================================================== ========================
Bad debt expense at Audio Book Club increased by $.7 million to $3.4 million, or
12.9%of sales. The principal reason for the increase in bad debt expense at
Audio Book Club was the attraction of over 96,000 members through the Internet,
most of which were Bill Me Members. The bad debt rates for the initial
discounted offer to these Bill Me Internet Members often exceeded 50% and the
bad debt rate for shipments subsequent to payment for the initial offer exceeded
the historical bad debt rate of the Audio Book Club acquired through direct
mail. We stopped offering Bill Me offers on the Internet in the second quarter
of 2003 and are testing alternatives methods to attract members either through
an offer requiring immediate payment of the initial offer with a credit card or
much more extensive initial screening methods.
The bad debt expense of World's Greatest Old-Time Radio continuity members for
the year ended December 31, 2003 increased by $.4 million to $.5 million from
$.1 million for the year ended December 31, 2002. As a percentage of net sales,
bad debt for the year ended December 31, 2003 were 18.3% as compared to 6.5% for
the year ended December 31, 2002. The program commenced in 2002, and as the
program matured in 2003, and customer-paying behavior became more evident, the
allowance for bad debts and the corresponding bad debt rate increased.
27
General and Administrative
$ (000's) 2002 2003
-----------------------------------------------
AS A % AS A % FROM 2002 TO 2003
$ OF NET SALES $ OF NET SALES CHANGE % CHANGE
------ ------------ ----- ------------ ------ --------
AUDIO BOOK CLUB $ 2,842 8.3% $ 2,626 10.0% $ (216) (7.6)%
RADIO SPIRITS 1,617 14.5% 1,163 11.5% (454) (28.1)%
MEDIABAY.COM 654 614 (40) (6.1)%
CORPORATE
3,234 2,412 (822) (25.4)%
-----------------------------------------------------------------------
$ 8,347 18.2% $ 6,815 18.6% $ (1,532) (18.4)%
=======================================================================
General and administrative expenses at Audio Book Club declined principally due
to reductions in payroll due to reduced staff. General and administrative
expenses at Radio Spirits for the year ended December 31, 2003 declined
principally due to reductions in payroll due to reduced staff and commissions to
outside sales personnel due to lower wholesale sales, lower consulting costs
principally due to the termination of a consulting agreement entered in to 2001
with the previous president of Radio Spirits following his resignation and
settlement of all outstanding amounts with a former joint venture partner
responsible for syndication of our old-time radio shows on broadcast radio. Our
corporate general and administrative expenses for the year ended December 31,
2003 declined principally due to reductions in public and investor relations,
travel and legal fees partially offset by higher insurance costs.
Asset write-downs and strategic charges
(000's)
2002 2003
-------- --------
ASSET WRITE-DOWNS AND STRATEGIC CHARGES $ -- $749
======== ========
In the fourth quarter of 2003, we evaluated the performance of Audio Passages,
an Audio Book Club marketing program tailored to listeners with an interest in
Christian product and determined based on past performance and expected future
performance that we should terminate the Audio Passages marketing program. In
connection with the termination of the Audio Passages marketing program, we took
a strategic charge for the establishment of a reserve for obsolescence of Audio
Passages inventory of $0.3 million and an assets write-down for previously
capitalized advertising, which are not recoverable in the amount of $0.5
million.
Termination costs
(000's)
2002 2003
-------------- ---------------
TERMINATION COSTS $ -- $544
============== ===============
In 2003, the employment of two senior executives who had employment agreements
was terminated and the decision was made to terminate the employment agreement
of another senior executive. A consulting agreement was also terminated. We
agreed to make aggregate settlement payments under the employment agreements and
consulting agreement for total consideration of $.5 million payable through May
2005.
28
Depreciation and Amortization
$ (000's) 2002 2003
-----------------------------------------------
AS A % AS A % FROM 2002 TO 2003
$ OF NET SALES $ OF NET SALES CHANGE % CHANGE
------ ------------ ----- ------------ ------ --------
DEPRECIATION
AUDIO BOOK CLUB $ 124 0.4% $ 104 0.4% $ (20) (16.1)%
RADIO SPIRITS 97 0.9% 42 0.4% (55) (56.7)%
AMORTIZATION
CORPORATE 1,093 182 (911) (83.3)%
----------------- ------------------ --------------------
$ 1,314 2.9% $ 328 0.9% $ (986) -75.0%
================= ================== ====================
The decrease in amortization expenses is principally attributable to the
reduction of the carrying amounts of our intangible assets made in the fourth
quarter of 2002. Specifically, we made a strategic decision to no longer compete
in the DVD market and accordingly wrote off the value of certain video and DVD
rights we had acquired in the amount of $90,000. We also made the strategic
decision in the fourth quarter of 2002 to discontinue future mailings to the
Columbia House lists of members of other clubs. Accordingly, in the fourth
quarter of 2002, we wrote off the unamortized value of the Columbia House
mailing agreement of $986,000.
Interest Expense
FROM 2002 TO 2003
2002 2003 CHANGE % CHANGE
---- ---- ------ --------
$ (000'S)
INTEREST PAID $ 766 $ 384 $ (382) (49.9)%
INTEREST ACCRUED 118 74 (44) (37.3)%
INTEREST INCLUDED IN DEBT 637 907 270 42.4%
AMORTIZATION OF DEFERRED FINANCING COSTS AND
ORIGINAL ISSUE DISCOUNT 1,453 560 (893) (61.5)%
TOTAL INTEREST EXPENSE ----------- ---------- ---------- ----------
$ 2,974 $ 1,925 $ (1,049) (35.3)%
=========== ========== ========== ==========
The reduction in interest expense is principally due to a reduction in the
amortization of deferred financing costs and original issue discount of $0.9
million based on the original terms of the debt to which the costs and discount
related.
Net loss before income taxes for the year ended December 31, 2003 was $5.2
million as compared to a net loss before income taxes for the year ended
December 31, 2002 of $1.7 million.
Income Tax Expense
FROM 2002 TO 2003
2002 2003 CHANGE % CHANGE
---- ---- ------ --------
$ (000'S)
INCOME TAX EXPENSE $ 550 $ 1,471 $ 921 167.5%
====== ========= ======= ========
During the years ended December 31, 2003 and 2002, we utilized $1,471,000 and
$550,000, respectively, of the $17.2 million deferred tax asset recorded in
2001. Accordingly, we recorded income tax expense of $1,471,000 and $550,000 for
the years ended December 31, 2003 and 2002, respectively.
29
Preferred Stock Dividends
FROM 2002 TO 2003
2002 2003 CHANGE % CHANGE
---- ---- ------ --------
$ (000'S)
DIVIDENDS ACCRUED ON SERIES A PREFERRED STOCK 217 228 11 5.1%
DIVIDENDS ACCRUED ON SERIES B PREFERRED STOCK - 18 18
------ ----- ------ ------
TOTAL DIVIDENDS ACCRUED ON PREFERRED STOCK $ 217 $ 246 $ 29 13.4%
====== ===== ====== ======
For the year ended December 31, 2003, we accrued preferred stock dividends of
$0.2 million on the outstanding 25,000 shares of Series A Preferred stock, which
were issued in January 2002 and $18,000 for dividends for Series B Preferred
Stock issued May 2003.
Loss Applicable to Common Stockholders
FROM 2002 TO 2003
2002 2003 CHANGE % CHANGE
---- ---- ------ --------
$ (000'S)
LOSS APPLICABLE TO COMMON STOCKHOLDERS $ 2,510 $ 6,869 $ 4,359 173.7%
======== ======== ======= ======
Principally because of lower sales due in large part to reduced spending on new
member advertising at Audio Book Club and lower wholesale sales at Radio
Spirits, our net loss applicable to common shares increased $4.4 million to $6.9
million, or $.49 per diluted share as compared to a net loss applicable to
common shares for the year ended December 31, 2002 of $2.5 million, or $.18 per
diluted share of common stock.
Year ended December 31, 2002 compared with year ended December 31, 2001
Sales for the year ended December 31, 2002 increased $3.9 million or 9.4% to
$45.7 as compared to $41.8 million for the year ended December 31, 2001. Audio
Book Club increased sales by $2.5 million, principally due to an increase in
club membership as a result of our marketing efforts to grow the business. For
the year ended December 31, 2002, the Audio Book Club attracted approximately
294,000 members as compared to approximately 211,000 members who joined the
Audio Book Club during the year ended December 31, 2001. The increase in Radio
Spirits sales, of $1.3 million, is principally attributable to sales of the
World's Greatest Old-Time Radio continuity program, a marketing program
introduced in 2002, which is similar to our Audio Book Club and offers old-time
radio products.
Cost of sales for the year ended December 31, 2002 was $20.7 million. Cost of
sales for the year ended December 31, 2001 was $22.0 million, of which $2.3
million represented a charge for the write-down of inventory in the third
quarter of 2001. Gross profit as a percentage of net sales for the year ended
December 31, 2002 was 55.0%, compared to 47.3% for 2001. Excluding the
write-down of inventory in the third quarter of 2001, gross profit as a
percentage of net sales was 52.7% for the year ended December 31, 2001. The
increase in gross profit is principally due to reduced product costs at both
Audio Book Club and Radio Spirits. The reduction in product costs is due to
better buying, combined purchasing at both Audio Book Club and Radio Spirits and
revisions in the mix of products and packaging at both Audio Book Club and Radio
Spirits.
Advertising and promotion expenses for the year ended December 31, 2002 were
$10.2 million. Advertising and promotion expenses for the year ended December
31, 2001 were $15.9 million of which, $4.0 million represented write-downs to
deferred member acquisition costs. The decrease in reported advertising costs is
principally due to lower expenditures relating to Audio Book Club new member
acquisitions in 2002 as compared to 2001 and the write-down of deferred member
acquisition costs in the third quarter of 2001 which resulted in lower
amortization of new member acquisition costs in 2002 and thus lower reported
advertising expense in 2002.
30
General and administrative expenses decreased $.3 million, or 2.7%, to $11.2
million for the year ended December 31, 2002 from $11.5 million for the prior
comparable period. General and administrative expense decreases are principally
attributable to reductions at Radio Spirits partially offset by an increase in
bad debt expenses. Bad debt expenses increased $.3 million attendant with an
increase in net sales at Audio Book Club. Bad debt expense as a percentage of
net sales was 6.2% for the year ended December 31, 2002 as compared to 6.1% for
the year ended December 31, 2001. In February 2002, we moved our Radio Spirits
operation from Schaumburg, Illinois to our corporate and Audio Book Club offices
in Cedar Knolls, New Jersey. In addition to giving us greater control over the
operations, general and administrative expenses, other than bad debt expense,
for our Radio Spirits division for the year ended December 31, 2002 declined by
$.9 million as compared to the year ended December 31, 2001. At Radio Spirits,
for the year ended December 31, 2002, we reduced payroll and related costs by
$.5 million, office expenses by $.1 million, telephone expenses by .2 million
and legal fees by $.1 million as compared to the year ended December 31, 2001.
Depreciation and amortization expenses decreased $3.9 million to $1.3 million
for the year ended December 31, 2002 from $5.2 million for the year ended
December 31, 2001. The decrease is principally attributable to the adoption of
SFAS No. 142 "Goodwill and Other Intangible Assets" in 2002 and, to a lesser
extent, certain intangible assets were fully amortized in 2001. SFAS No. 142
requires that an intangible asset that is acquired shall be initially recognized
and measured based on our fair value. The statement also provides that goodwill
should not be amortized, but shall be tested for impairment annually, or more
frequently if circumstances indicate potential impairment, through a comparison
of fair value to our carrying amount. Existing goodwill continued to be
amortized through the year ended December 31, 2001 at which time amortization
ceased. The amount of goodwill amortized during the year ended December 31, 2001
was $.5 million. Based on our review for goodwill impairment in 2002, the
Company did not recognize any goodwill impairment in 2002 in accordance with
SFAS No. 142.
During the fourth quarter of 2002, the Company reviewed the carrying amounts of
our intangible assets and determined, based on decisions made in the fourth
quarter of 2002, that the value of certain intangible assets could no longer be
supported by anticipated future operations. Specifically, the Company made a
strategic decision to no longer compete in the DVD market and accordingly wrote
off the value of certain video and DVD rights it had acquired in the amount of
$90,000. We also made the strategic decision in the fourth quarter of 2002 to
discontinue future mailings to the Columbia House lists of members of other
clubs. Accordingly, in the fourth quarter of 2002, the Company wrote off the
unamortized value of the Columbia House mailing agreement of $986,000.
Interest expense for the year ended December 31, 2002 was $3.0 million for the
year ended December 31, 2002 and $2.8 million for the year ended December 31,
2001. Included in interest expense is the amortization of debt discount
resulting from the issuance of warrants and beneficial conversion features
related to certain of our financings. The amount amortized was $.7 million and
$.6 million for the years ended December 31, 2002 and 2001, respectively.
Net loss before income taxes for the year ended December 31, 2002 was $1.7
million as compared to a net loss before income taxes for the year ended
December 31, 2001 of $22.6 million.
31
As a result of the series of strategic initiatives described above, our
operations had improved. Although realization of net deferred tax assets is not
assured, we determined in 2001, based on our improved operations, that it is
more likely than not that a portion of our deferred tax asset relating to
temporary differences between the tax bases of assets or liabilities and their
reported amounts in the financial statements will be realized in future periods.
Accordingly we reduced the valuation allowance for deferred tax assets in the
amount of $17.2 million and recorded an income tax benefit.
During then year ended December 31, 2002, we utilized $550,000 of the $17.2
million deferred tax asset recorded in 2001. Accordingly, we recorded an income
tax expense of $550,000.
We accrued preferred stock dividends of $0.2 million on the outstanding 25,000
shares of Series A Preferred stock, which were issued in January 2002.
Net loss applicable to common shares for the year ended December 31, 2002 was
$2.5 million, or $.18 per diluted share of common stock as compared to a net
loss of $5.4 million, or $0.39 per diluted share of common stock for the year
ended December 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our cash requirements through sales of our equity
and debt securities and borrowings from financial institutions and our principal
shareholders. During 2003, we did not have sufficient cash to undertake
marketing activities to the extent of historical levels. For the year ended
December 31, 2003, we spent $2.1 million to attract new Audio Book Club members,
a reduction of $6.2 million, or 74.7%, from the amount spent to attract new
members of $8.3 million during the year ended December 31, 2002, principally due
to the lack of necessary funds. As a result, our member and customer bases
eroded and our revenues declined significantly. We currently do not have
sufficient funds to market to attract new members and customers to maintain our
member and customer bases and have conducted only minimal tests of new Internet
marketing initiatives in 2004. We will require additional financing to conduct
sufficient marketing activities to maintain and rebuild our member and customer
bases. If we do not obtain the funds necessary to increase our advertising to
acquire new members to offset member attrition and/or expand our existing
membership and customer bases, our revenue will continue to decline, which will
continue to negatively impact our performance and could ultimately impair our
ability to continue as a going concern.
Our revolving line of credit matures on September 30, 2004, an additional $10.8
million is due upon demand of the holders of notes which may be made at various
times during 2004 following the repayment of the line of credit and an
additional $4.3 million under promissory notes is due in the fourth quarter of
2004. We are required to make monthly payments of principal on the line of
credit of $106,666 in February through August 2004 We currently do not have
sufficient funds to repay our debt as it becomes due and are actively seeking to
obtain other financing to replace the debt or obtain an extension of the
maturities. If we do not have the necessary extensions or replacement
financings, we will be in default on our indebtedness.
Operating Activities
We have implemented a series of initiatives to increase cash flow. While these
initiatives and the significant reduction in marketing expenses increased cash
provided by operating activities in 2003, we cannot sustain our operations
without increasing marketing expenses. We require additional financing to repay
debt and to fund the maintenance of operations, working capital or other related
uses. Without additional capital, we do not have the funds to meet our
short-term needs. We are currently exploring a number of alternatives, including
raising additional debt or equity, refinancing or extending our existing debt
and selling certain assets to fund our long and short-term needs.
32
For the year ended December 31, 2003, our cash increased by $.3 million, as we
had cash provided by operating activities of $1.6 million and we had cash used
in investing activities of $.3 million and in financing activities of $1.0
million.
During 2003, we generated cash from operations of $1.6 million, including the
repayment of accounts payable and accrued expenses of $5.4 million. This
increase in cash from operations was due to principally to our reducing new
member marketing dramatically in 2003 as compared to 2002.
Net cash provided by operating activities principally consisted of our net loss
applicable to common shares of $6.9 million, decreased by depreciation and
amortization expenses of $.3 million, amortization of deferred financing costs
and debt discount of $.6 million, non-current accrued interest and dividends
payable $1.2 million, write-offs of assets related to a terminated marketing
program of $.7 million, income tax expense of $1.5 million, stock related
non-cash compensation of $.1 million; decreases in accounts receivable,
inventory, royalty advances and prepaid expenses and other current assets of
$4.2 million, $.9 million, $.2 million and $.3 million, respectively and a net
reduction in deferred member acquisition costs of $3.8 million. Net cash
provided by operations was reduced by reductions in accounts payable and accrued
expenses of $5.4 million.
The decrease in accounts receivable is principally due to reduced sales at both
our Audio Book Club and our wholesale Radio Spirits sales. We also have reserved
bad debts based on our experience in 2003, which was much higher than in
previous years, due to the significant increase in 2002 of ABC members recruited
in Bill Me offers from the internet and Audio Passages members. We have
discontinued Internet Bill Me offers until we have tested new credit screening
methods and have discontinued our Audio Passages audiobook club. We believe that
these steps will assist us in reducing our bad debt rate. The reduction in
inventory is a result of lower sales, which require less inventory and the
aggressive sale of slower moving items old-time radio products at heavily
discounted prices in remainder sales. We have also provided a reserve for
obsolescence for our Audio Passages product because of our discontinuing the
operation. The decrease in royalty advances is principally due to increased
royalty expenses, since we sold less new member units, the audiobooks we sold
were at higher royalty rates and we also reserved $.4 million for advances we do
not expect to recover principally due to lower sales at Audio Book Club due to
fewer members. The decrease in prepaid expenses was principally the result of
not mailing a direct mail campaign to acquire new members in our Audio Book Club
in December 2003 or January 2004. The decrease net deferred member acquisition
costs is directly related to the substantial reduction in new member
advertising. We used substantially all of the cash generated from operations to
reduce accounts payable resulting in a decrease in accounts payable and accrued
expenses of $5.4 million during the year ended December 31, 2003.
Investing Activities
Cash used in investing activities was for the acquisition of fixed assets of
$0.1 million, principally computer equipment, and remaining payments of $0.25
million to Great American Audio for the 2002 acquisition of certain of Great
American Audio assets including the license to The Shadow programs.
Financing Activities
During the year ended December 31, 2003, we repaid $1.6 million under our senior
credit facility and the maturity of the senior credit facility was extended to
September 30, 2004, subject to monthly principals payments of $106,667 through
August 2004.
33
On May 7, 2003, we sold 3,350 shares of a newly created Series B Stock with a
liquidation preference of $100 per share for $335,000. Of the total sold, 1,400
shares ($140,000) were purchased by Carl Wolf, Chairman and a director of
MediaBay, and 200 shares ($20,000) were purchased by John Levy, Executive Vice
President and Chief Financial Officer of MediaBay. The holders of shares of
Series B Stock are entitled to receive dividends at the rate of $9.00 per share,
payable quarterly, in arrears, in cash on each March 31, June 30, September 30
and December 31; provided that payment will accrue until we are permitted to
make such payment in cash under the Credit Agreement.
The Series B Stock is convertible into shares of common stock at a conversion
rate equal to a fraction, (i) the numerator of which is equal to the number of
Series B Stock times $100 plus accrued and unpaid dividends though the date of
conversion and (ii) the denominator is the $0.77.
In the event of a liquidation, dissolution or winding up of MediaBay, the
holders of Series B Stock shall be entitled to receive out of the assets of
MediaBay, a sum in cash equal to $100.00 per share before any amounts are paid
to the holders of MediaBay common stock and on a pari passu with the holders of
the Series A Preferred Stock. The holders of Series B Stock shall have no voting
rights, except as required by law and except that the vote or consent of the
holders of a majority of the outstanding shares of Series B Stock, voting
separately as a class, will be required for any amendment, alteration or repeal
of the terms of the Series B Stock that adversely effects the rights,
preferences or privileges of the Series B Stock.
On June 16, 2003, ABC entered into a settlement agreement with respect to a
lawsuit in which ABC was the plaintiff and arising out of an acquisition made by
ABC. Pursuant to the settlement agreement, ABC received $350,000 in cash, the
return for cancellation of 325,000 shares of MediaBay common stock issued in
connection with the acquisition and the termination of put rights granted to the
seller in the acquisition with respect to 230,000 of the shares (put rights with
respect to the remaining 95,000 shares had previously terminated). The
termination of the puts rights terminated a $3.45 million future contingent
obligation of MediaBay and results in a corresponding increase in stockholders'
equity.
The calculation of the settlement of litigation is as follows:
Termination of contingent put rights $3,450,000
Return for cancellation of 325,000 shares of common stock 247,000
Legal and other costs incurred in connection with the
litigation, net of cash received of $350 690,000
----------
Net settlement of litigation recorded in Contributed Capital $3,007,000
==========
On October 1, 2003, we completed a $1,065,000 financing consisting of the notes
due October 1, 2004. The notes bear interest at 18%, provide for accrual of
interest to maturity and have no prepayment penalty. In connection with the
issuance of the notes, we issued to the investors, five year warrants to
purchase 266,250 shares of our common stock at an exercise price of $0.80. We
have also agreed to issue the investors warrants to purchase an additional
266,250 shares of MediaBay common stock on April 1, 2004, if the notes have not
been repaid. Carl Wolf, and Huntingdon, Inc., a company wholly owned by Norton
Herrick, each purchased a $100,000 note in the offering. In connection with the
financing, Norton Herrick and Huntingdon agreed with the holders of the notes,
that upon the occurrence and continuance of an event of default under the notes,
to the extent Mr. Herrick or Huntingdon received any payment on account of the
secured indebtedness of our company held by them, they would remit such amounts
to the holders of the notes an a pro rata basis until the notes are paid in
full.
34
On January 29, 2004, we issued $4,000,000 aggregate principal amount of
promissory notes (the "2004 Notes") and warrants to purchase 2,352,946 shares of
common stock (the "Investor Warrants") to 13 institutional and accredited
investors. The 2004 Notes are due on the earlier of (i) April 30, 2005, (ii)
such date on or after July 1, 2004 at such time as all of the our indebtedness
under our existing credit facility is either repaid or refinanced or (iii) the
consummation by us of a merger, combination or sale of all or substantially all
of our assets or the purchase by a single entity, person or group of affiliated
entities or persons of 50% of our voting stock. The 2004 Notes bear interest at
the rate of 6%, increase to 9% on April 28, 2004 and 18% on July 27, 2004. In
connection with this offering, Norton Herrick and Huntingdon entered into a
letter agreement with the purchasers of the 2004 Notes pursuant to which they
granted to the holders of the 2004 Notes in the event of an Event of Default (as
defined in the 2004 Notes) the rights to receive payment under certain secured
indebtedness owed by us to Norton Herrick and Huntingdon and to exercise their
rights under security agreements securing such secured indebtedness. Pursuant to
the letter agreement, Norton Herrick and Huntingdon also executed Powers of
Attorney in favor of a representative of the 2004 Note holders pursuant to which
such representative may, following an Event of Default, take actions necessary
to enforce the 2004 Note holders rights under the letter agreement, including
enforcing Norton Herrick's and Huntingdon's rights under the security
agreements. In consideration for Huntingdon's consent to the financing and
agreements to upon receipt of shareholders' approval we reduced the conversion
price of $1,150,000 principal amount of convertible promissory notes held by
Huntingdon from $2.00 to $1.27 and $500,000 principal amount of convertible
promissory notes held by Huntingdon from $1.82 to $1.27.
On April 12, 2004, the principal amount of the 2004 Notes, automatically
converted into 5,333,333 shares of our common stock at the rate of one share of
common stock at $0.75. In addition, accrued interest accrued interest in the
amount of approximately $49,000 converted into 64,877 shares of our common
stock.
In connection with the offering, we issued to Rockwood, Inc. ("Rockwood"), the
placement agent, and a broker warrants to purchase an aggregate of 245,000
shares of Common Stock (the "Initial Agent Warrants"), and agreed to issue to
Rockwood, if and only if we obtain shareholder approval, warrants to purchase an
additional 500,884 shares of Common Stock (the "Additional Agent Warrants" and,
together with the Initial Agent Warrants, the "Agent Warrants") as partial
consideration for Rockwood's services as placement agent. The Investor Warrants
and Rockwood Warrants are exercisable until January 28, 2009 at an exercise
price of $1.28 per share. The Additional Agent Warrants will become exercisable
upon, and only if, our shareholders approve the Proposal.
35
Indebtedness
Following is a summary of our indebtedness to our creditors:
Credit Facility
As of April 12, 2004, we had approximately $1,386,667 of indebtedness
outstanding under the Amended and Restated Credit Agreement dated as of October
3, 2002, as amended, by and among MediaBay and Radio Spirits, Inc. and Audio
Book Club, Inc., wholly-owned subsidiaries of the MediaBay, as co-borrowers, and
ING (U.S.) Capital LLC, as administrative agent, and the other lenders named
therein (the "Credit Agreement"). The maturity date of the Credit Agreement is
September 30, 2004; provided however, that we are required to make monthly
payments of principal of $106,667 through August 2004. The maturity of the
Credit Agreement automatically extends to March 31, 2005 if the notes held by
ABC Investment LLC and the holders of the notes issued in October 2003 extend
the maturity of their notes by April 15, 2004 to June 30, 2005. We are not
permitted to make any additional borrowings under the Credit Agreement. The
interest rate on the credit facility is equal to the prime rate plus 2 1/2%. We
granted the lenders under the Credit Agreement a security interest in
substantially all of our assets and the assets of our subsidiaries and pledged
the stock of our subsidiaries.
We are required to maintain minimum EBITDA, as defined below, of $7,000,000 for
the period beginning on January 1, 2001 and ending prior to March 31, 2004.
Under the Credit Agreement, "EBITDA" means, for any period, the sum of (i) net
income, (ii) interest expense, (iii) income tax expense, (iv) depreciation
expense, (v) extraordinary and nonrecurring losses and (vi) amortization
expense, less extraordinary and nonrecurring gains (in each case, determined in
accordance with generally accepted accounting principles) plus adjustments for
(x) the pro forma effect of any Permitted Acquisition (as defined in the Credit
Agreement) and (y) non-cash stock compensation; provided that EBITDA shall be
adjusted for the effect of treating our advertising expense and new member
acquisition costs as expensed as incurred. We were in compliance with this
covenant at December 31, 2003.
In addition to limiting our ability to incur additional indebtedness, the Credit
Agreement prohibits us from, among other things:
o merging into or consolidating with another entity;
o selling all or substantially all of our assets;
o declaring or paying cash dividends;
o raising additional financing, with certain exceptions, without
repaying a portion of the debt and
o materially changing the nature of our business.
We are currently seeking to refinance or extend this debt. Historically, we have
been able to extend the maturity of this debt.
Notes Held by Norton Herrick
Norton Herrick holds a $1,984,250 principal amount Convertible Senior
Subordinated Promissory Note due September 30, 2007, except that the holder has
the right to demand repayment of the unpaid principal balance of, and interest
on, the note at any time on or after the later of (i) December 31, 2004 and (ii)
the date on which we have repaid all of our obligations under the Credit
Agreement. This note is the remaining portion held by Norton Herrick of a $15
million subordinated note entered into between Norton Herrick and MediaBay on
December 31, 1998.
36
Interest on this note accrues at the rate of 11% per annum and is payable on a
monthly basis, at the holder's option, in cash or common stock; provided,
however, that cash interest accrues until 10 days after we have paid all of our
obligations under the Credit Agreement. This note is convertible into shares of
common stock at the rate of $.56 per share, subject to adjustment for below
conversion price issuances. This note is secured by a second lien on the assets
of Radio Spirits.
We are prohibited from incurring additional indebtedness (with exceptions),
selling all or substantially all of our assets and materially changing the
nature of our business without the prior written consent of the holder of this
note. While Mr. Herrick has, in the past, provided his consent to our incurring
additional indebtedness, he is not required to do so, and the requirement that
he provide his consent could be a significant impediment in our ability to raise
additional financing.
Notes held by Huntingdon Corporation
Huntingdon Corporation, a company wholly owned by Norton Herrick, holds the
following promissory notes:
o $2,500,000 principal amount Convertible Senior Promissory Note (the
"$2,500,000 Note") entered into on May 14, 2001;
o $800,000 principal amount Convertible Senior Subordinated Promissory
Note (the "$800,000 Note") entered into on May 14, 2001;
o $500,000 principal amount Convertible Senior Promissory Note (the
"$500,000 Note") entered into on February 22, 2002;
o $1,000,000 principal amount Convertible Senior Promissory Note (the
"$1,000,000 Note") entered into on October 3, 2002;
o $150,000 principal amount Convertible Senior Promissory Note (the
"$150,000 Note") entered into on October 10, 2002; and
o $350,000 principal amount Convertible Senior Promissory Note (the
"$350,000 Note") entered into on November 15, 2002.
Each of the notes held by Huntingdon are due September 30, 2007, provided that
the holder has the right, at any time on or after the date on which the Company
has repaid all of our obligations under the Credit Agreement, to demand
repayment of the unpaid principal balance of and interest on the note; provided,
however that, with respect to the $800,000 Note, such demand can not be made
until the ninetieth day after we have repaid all of our obligations under the
Credit Agreement.
Each of the $2,500,000 Note and $500,000 Note bears interest at an annual rate
equal to the prime rate plus 2%, the $800,000 Note bears interest at the rate of
12% per annum and each of the $1,000,000 Note, $150,000 Note and $350,000 Note
bears interest at an annual rate equal to the prime rate plus 2 1/2%. Interest
is payable under each note monthly, in arrears, in cash, or at the holder's
option, in lieu of cash, in shares of common stock or in kind, provided,
however, that cash interest accrues until 10 days after we have paid all of our
obligations under the Credit Agreement. Interest accrues on unpaid interest
under each note (since October 3, 2002 in the case of the $2,500,000 Note, the
$500,000 Note and the $800,000 Note) at the respective interest rate of such
note.
37
The $2,500,000 Note, and the $800,000 Note are convertible into shares of common
stock at the rate of $.56 per share, subject to adjustment for below conversion
price issuances of securities. The $500,000 Note is convertible at $2.00. Each
of the $1,000,000 Note and the $150,000 Note is convertible into shares of
common stock at the rate of $1.82 per share, and the $350,000 Note is
convertible into shares of common stock at the rate of $1.25 per share. We
agreed as consideration for Norton Herrick and Huntingdon consenting to the
January 2004 financing and granting certain rights to investors in the January
2004 financings as discussed above, we would seek shareholder approval to reduce
the conversion rate of $1,000,000 Note, the $150,000 Note and the $500,000 Note
to $1.27. Our Board has determined to recommend to our shareholders to approve
the foregoing and intends to submit a proposal for shareholder approval at our
2004 annual meeting of shareholders.
All of the notes held by Huntingdon are secured by a lien pari passu to the
senior credit facility on substantially all of our assets and certain of our
subsidiaries' assets, other than inventory, receivables and cash.
We are prohibited from incurring indebtedness (with exceptions), selling all or
substantially all of our assets and materially changing the nature of our
business without the prior written consent of the holder of the notes. While
Huntingdon has, in the past, provided its consent to our incurring additional
indebtedness, it is not required to do so, and the requirement that it provide
its consent could be a significant impediment in our ability to raise additional
financing.
Note held by N. Herrick Irrevocable ABC Trust (the "Trust")
The Trust holds a $500,000 principal amount 9% Convertible Senior Subordinated
Promissory Note due September 30, 2007, except that the holder may demand
repayment of the unpaid principal balance and interest on the note, commencing
December 31, 2004, if we have repaid all of our obligations under the Credit
Agreement.
This note is convertible into shares of common stock at the rate of $.56 per
share, subject to adjustment for below conversion price issuances of securities.
This note bears interest at the rate of 9% per annum. Interest is payable
monthly, in arrears, in cash or, at the holder's option, shares of common stock;
provided, however, that cash interest accrues until 10 days after we have repaid
our obligations under the Credit Agreement. After October 3, 2002, interest
accrues on unpaid interest at the interest rate of the note.
We are prohibited from incurring additional indebtedness (with exceptions),
selling all or substantially all of our assets and materially changing the
nature of our business without the prior written consent of the holder of this
note. While the Trust has, in the past, provided its consent to our incurring
additional indebtedness, the requirement that it provide its consent could be a
significant impediment in our ability to raise additional financing.
Note held by ABC Investment LLC
ABC Investment LLC is a third party, which holds a $3.2 million principal amount
Senior Subordinated Promissory Note due December 31, 2004. This note is
convertible into shares of common stock at the rate of $3.12 per share, subject
to adjustment for below conversion price issuances of securities. This note
bears interest at the rate of 9% per annum, quarterly, in arrears. We are
prohibited from incurring additional indebtedness (with exceptions), selling all
or substantially all of our assets and materially changing the nature of our
business without the prior written consent of the holder of this note.
38
October 2003 Notes
On October 1, 2003, we issued $1,065,000 principal amount of notes due October
1, 2004. The notes bear interest at the rate of 18%, provide for accrual of
interest to maturity and have no prepayment penalty. We also agreed to issue the
investors warrants to purchase an additional 266,250 shares of MediaBay common
stock on April 1, 2004, if the notes have not been repaid. The notes are due on
October 1, 2004, however, if we raise more than $5.0 million in financing prior
to the maturity date of the notes, the maturity date of the notes is
accelerated. Purchasers of notes included Carl Wolf and a company wholly owned
by Norton Herrick.
January 2004 Notes
On January 29, 2004, we issued $4,000,000 aggregate principal amount of notes
are described above.
Commitments
$(000,s)
Payments Due by Period
---------------------------------------------------------------------------------------
Contractual Obligations Less than 1-3 3-5 More Than
Total 1 Year Years Years 5 Years
----------- ----------- ----------- ----------- -----------
Debt Obligations $ 17,770 $ 17,770 $ -- $ -- $ --
Capital Lease Obligations 71 53 18 -- --
Operating Lease Obligations 964 163 385 406 10
Purchase Obligations 1,487 459 575 453
Other Long Term Liabilities
Reflected on the Registrant's
Balance Sheet Under GAAP 1,331 551 780 -- --
----------- ----------- ----------- ----------- -----------
Total $ 21,623 $ 18,996 $ 1,758 $ 859 $ 10
=========== =========== =========== =========== ===========
Consulting Agreement
Effective December 31, 2003, we agreed with Norton Herrick to terminate a
two-year consulting agreement with XNH Consulting Services, Inc. ("XNH"), a
company wholly-owned by Norton Herrick. In connection with the termination, we
agreed to pay XNH a fee of $7,500 per month for 16 months commencing on January
1, 2004 and to provide Mr. Herrick with health insurance and other benefits
applicable to our officers to the extent such benefits may be provided under our
benefit plans. The termination agreement provides that the indemnification
agreement with Mr. Herrick entered into on November 15, 2002 pursuant to which,
we agreed to indemnify Mr. Herrick to the maximum extent permitted by the
corporate laws of the State of Florida or, if more favorable, our Articles of
Incorporation and By-Laws in effect at the time the agreement was executed,
against all claims (as defined in the agreement) arising from or out of or
related to Mr. Herrick's services as an officer, director, employee, consultant
or agent of ours or any subsidiary or in any other capacity shall remain in full
force and effect and to also indemnify XNH on the same basis. In connection with
the termination agreement, Herrick and XNH agreed to extend the non-competition
and nondisclosure covenants of the XNH consulting agreement until December 31,
2006.
Employment Agreements
We have commitments pursuant to employment agreements with our officers. Our
minimum aggregate commitments under such employment agreements are approximately
$0.5 million, $0.4 million and $80,000 during 2004, 2005 and 2006, respectively.
39
Termination and Severance Agreements
Our minimum aggregate commitments under settlement payments under employment
agreements and a consulting agreement are $201,000 in 2004 and $30,000 in 2005.
Licensing Agreements
We have numerous licensing agreements for both audiobooks and old-time radio
shows with terms generally ranging from one to five years, which require the
Company to pay, in some instances, non-refundable advances upon signing
agreements, to be applied against future royalties. Our minimum aggregate
commitments under existing licensing agreements are $459,000, $347,000 and
$228,000 during 2004, 2005 and 2006, respectively.
Obligations to Seller in an Acquisition
In connection with an acquisition made in December 1998, we agreed to repurchase
certain shares issued to the seller at various prices ranging from $7.00 to
$15.00. The repurchase obligation would expire based on the stock reaching the
repurchase price for a period of 10 consecutive trading days. We have asserted
that the price targets were maintained and that the obligation has expired. The
seller has disputed this assertion and asserts that the right to put 25,000
shares at a price of $14.00 per share beginning on December 31, 2003 and 50,000
shares at a price of $15.00 per share beginning on December 31, 2005. The seller
has demanded the repurchase of the 25,000 shares for $350,000.
Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," which is effective for fiscal years beginning after May 15, 2002,
with earlier application encouraged. Under SFAS 145, gains and losses from
extinguishment of debt will no longer be aggregated and classified as an
extraordinary item, net of related income tax effect, on the statement of
earnings. The adoption of SFAS 145 had no impact on our financial position or
results of operations.
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs
Associated with Exit or Disposal Activities," which is effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. SFAS 146 requires recognition of a liability for the
costs associated with an exit or disposal activity when the liability is
incurred, as opposed to when the entity commits to an exit plan as required
under EITF Issue No. 94-3. SFAS 146 will primarily impact the timing of the
recognition of costs associated with any future exit or disposal activities. The
adoption of SFAS 146 had no impact on our financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation", which amends SFAS No. 123 to provide alternative methods of
transaction for an entity that voluntarily changes to the fair value method of
accounting for stock based compensation. It also amends the disclosure
provisions of SFAS No. 123 to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect to
stock based employee compensation. Finally, SFAS No. 148 amends APB Opinion No.
28, "Interim Financial Reporting", to require disclosure of those effects in
interim financial statements. SFAS No. 148 is effective for fiscal years ended
after December 15, 2002, but early adoption is permitted. Accordingly, we have
adopted the applicable disclosure requirements of this Statement within this
report. The adoption of SFAS No. 148 did not have a significant impact on our
financial disclosures.
40
In November 2002, the FASB issued interpretation No. ("FIN") 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which requires that guarantees within the
scope of FIN 45 issued or amended after December 31, 2002, a liability for the
fair value of the obligation undertaken in issuing the guarantee, be recognized
at the inception of the guarantee. The effective date for this FIN 45 is for
fiscal years ending after December 15, 2002. The adoption of FIN 45 had no
impact on our financial position or results of operations.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities," which is effective for interim periods beginning after December 15,
2003. This interpretation changes the method of determining whether certain
entities should be included in our consolidated financial statements. An entity
is subject to FIN 46 and is called a variable interest entity ("VIE") if it has
(1) equity that is insufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, or (2)
equity investors that cannot make significant decisions about the entity's
operations or that do not absorb the expected losses or receive the expected
returns of the entity. All other entities are evaluated for consolidation under
SFAS No. 94, "Consolidation of All Majority-Owned Subsidiaries." A VIE is
consolidated by its primary beneficiary, which is the party involved with the
VIE that has a majority of the expected losses or a majority of the expected
residual returns or both. We are currently evaluating FIN 46 and believe that it
will have no impact on our financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 33 on
Derivative Instruments and Hedging Activities", which amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities that fall within the
scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 149 amends SFAS No. 133 regarding implementation issues
raised in relation to the application of the definition of a derivative. The
amendments set forth in SFAS No. 149 require that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. The adoption of
SFAS No. 149 did not have a material impact on our financial position or results
of operations.
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
provides guidance on classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. We reclassified
certain items to debt as a result of the SFAS 150.
Net Operating Losses
Our federal net operating loss carryforwards expire beginning in 2018. Under
Section 382 of the Internal Revenue Code of 1986, utilization of prior net
operating losses is limited after an ownership change, as defined in Section
382, to an annual amount equal to the value of the corporation's outstanding
stock immediately before the date of the ownership change multiplied by the
long-term tax exempt rate. The additional equity financing we obtained in 2000
may result in an ownership change and, thus, may limit our use of our prior net
operating losses. In the event we achieve profitable operations, any significant
limitation on the utilization of net operating losses would have the effect of
increasing our tax liability and reducing net income and available cash
reserves. We are unable to determine the availability of net operating losses
since this availability is dependent upon profitable operations, which we have
not achieved in prior periods. We have provided a full valuation allowance for
our net operating loss carryforwards.
41
Audit Committee Approval of Non-Audit Services
In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as
added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for
disclosing any non-audit services approved by our Audit Committee (the
"Committee") to be performed by Amper, Politziner & Mattia ("APM"), our external
auditor. Non-audit services are defined as services other than those provided in
connection with an audit or a review of our financial statement. During the year
ended December 31, 2003, we did not engage APM for any non-audit services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk for the impact of interest rate changes. As a
matter of policy, we do not enter into derivative transactions for hedging,
trading or speculative purposes.
Our exposure to market risk for changes in interest rates relate to our
long-term debt. As of December 31, 2003, interest on $3.0 million of our debt is
payable at the rate of the prime rate plus 2.0% and interest on $3.0 million of
our long-term debt is payable at the rate of the prime rate plus 2.5%. If the
prime rate were to increase, our interest expense would increase, however a
hypothetical 10% increase in interest rates, from approximately 6% to 6.6%,
would not have had a material impact on our fair values, cash flows or earnings
for either 2003 or 2002. All of our other debt is at fixed rates of interest.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements appear in a separate section of this report following
Part IV.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, an evaluation was carried
out under the supervision and with the participation of our management,
including the Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), of the effectiveness of our disclosure controls and procedures. Based
on that evaluation, the CEO and CFO have concluded that our disclosure controls
and procedures are effective at the reasonable assurance level to timely alert
them of information required to be disclosed by us in reports that we file or
submit under the Securities Exchange Act of 1934. During the quarter ended
December 31, 2003 there were no changes in our internal controls over financial
reporting that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
42
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors, executive officers and other key employees of our company
are as follows:
NAME AGE POSITION
Carl T. Wolf 60 Chairman and Director
Jeffrey Dittus 37 Chief Executive Officer and Director
Howard Herrick 39 Executive Vice President and Director
John F. Levy 48 Executive Vice President and Chief Financial Officer
Robert Toro 39 Senior Vice President of Finance
Richard J. Berman 61 Director
Paul D. Ehrlich 59 Director
Mark P. Hershhorn 54 Director
Joseph R. Rosetti 70 Director
Carl T. Wolf, 60, as of May 2003 is our Chairman. Mr. Wolf has been a director
of MediaBay since March 1998. Mr. Wolf is the managing partner of the Lakota
Holdings LLC. Mr. Wolf was formerly Chairman of the Board, President and Chief
Executive Officer of Alpine Lace Brands, Inc. Mr. Wolf founded Alpine Lace and
predecessors and had been the Chief Executive Officer of each of them since the
inception of Alpine Lace in 1983. Mr. Wolf became a director of Alpine Lace
shortly after its incorporation in February 1986.
Jeffrey Dittus, 37, as of January 2004, is our Chief Executive Officer. From
December 2001 to January 2004, Mr. Dittus was founder and managing director of
Kauri Capital LLC, a boutique merchant bank. From September 1999 to November
2001, Mr. Dittus was co-founder and Chief Executive Officer of IT Capital
Limited, a publicly listed venture capital firm on the Australian and New
Zealand stock exchanges. From November 1998 to November 1999, Mr. Dittus was
Vice President Investments for Mellon Ventures; a captive private equity
partnership of Mellon Bank. From November 1995 to November 1998, Mr. Dittus was
Vice-President Corporate Development and Managing Director - New
Zealand/Australia for National Media Corporation, a large direct response
television marketer.
Howard Herrick, 39, is our co-founder and has been our Executive Vice President,
and a director since our inception. Since 1988, Mr. Herrick has been an officer
of The Herrick Company, Inc. Mr. Herrick is also an officer of the corporate
general partners of numerous limited partnerships, which acquire, finance,
market, manage and lease office, industrial, motel and retail properties; and
which acquire, operate, manage, redevelop and sell residential rental
properties.
John F. Levy, 48, joined us in November 1997 and has served as our Executive
Vice President and Chief Financial Officer since January 1998. Prior to joining
us, Mr. Levy had previously served as Chief Financial Officer of both public and
private entertainment and consumer goods companies. Mr. Levy is a Certified
Public Accountant with nine years experience with the national public accounting
firms of Ernst & Young, Laventhol & Horwath and Grant Thornton.
Robert Toro, 39, has been our Senior Vice President of Finance since July 1999,
Chief Financial Officer of our Audio Book Club division since November 2001 and
an employee since April 1999. Before joining us, Mr. Toro was Senior Vice
President of AM Cosmetics Co. and had previously served in senior financial
positions in both public and private entertainment and publishing companies.
From 1992 through early 1997, Mr. Toro served in various senior financial
positions with Marvel Entertainment Group, Inc., a publicly traded youth
entertainment company. Mr. Toro is a Certified Public Accountant with six years
of experience with the national public accounting firm of Arthur Andersen where
he was employed immediately prior to joining Marvel Entertainment Group.
43
Richard J. Berman, 61, became a director in June 2003. Mr. Berman has over 30
years of experience in venture capital and mergers and acquisitions. He is
currently a Director of International Microcomputer Software, Inc. a publicly
traded software company, the Internet Commerce Corporation, a publicly traded
Internet supply chain company, NexMed, a publicly traded life sciences company,
GVI Security Solutions, Inc., a provider of video surveillance solutions to the
retail, business-to-business, professional, and homeland security market
segments and is currently Chairman of the KnowledgeCube Group, a venture capital
firm, and Candidate Resources Inc., a leading manager of human resource
websites. Mr. Berman started and managed the mergers and acquisitions and
private equity groups of Bankers Trust as Senior Vice President. Mr. Berman has
also invested in and managed over 20 companies, including as Chairman of
Prestolite Battery, Inc., Boston Proper, Inc. and Internet Commerce Corporation.
Mr. Berman received his B.S. and M.B. A. in Finance from New York University, a
J.D. from Boston College Law School and a degree in International Law from Hague
Academy of International Law.
Paul D. Ehrlich, 59, has been a director since May 2001. Mr. Ehrlich is a
Certified Public Accountant and tax and financial consultant. Since August 2000,
Mr. Ehrlich has been a Partner with Edwards & Topple, LLP as well as President
of Paul D. Ehrlich, CPA, P.C., a tax and financial consulting corporation. From
1981 to August 1, 2000, Mr. Ehrlich was a shareholder, tax specialist and
director of Personal Financial Services of Feldman Sherb & Co., P.C. Mr. Ehrlich
has served on the Boards of Directors of several companies and is a member of
the American Institute of Certified Public Accountants, the New York State
Society of Certified Public Accountants (appointed committee member), and the
International Association for Financial Planning.
Mark P. Hershhorn, 54, has been a director since February 2003. Mr. Hershhorn is
currently President and CEO of CKS & Associates and CEO for Midwest Real Estate
Investment LLC, real estate development firms specializing in renovation and
rehabilitation of apartment buildings in urban areas. Mr. Hershhorn was formerly
President, CEO and a Director of National Media Corporation, a publicly held
transactional television marketing company. Prior to National Media Corporation,
Mr. Hershhorn served as Senior Vice President of Food Operations and Joint
Ventures for NutriSystems, Inc. Mr. Hershhorn also served as Chief Financial
Officer, Treasurer, Vice President and Director of The Franklin Mint, a global
direct marketing company operating in ten countries. Mr. Hershhorn is a member
of the Graduate Executive Board of the Wharton Graduate Division of the
University of Pennsylvania and an active participant in the Wharton School
Mentoring program. He is also Vice Chairman of the Board of Overseas and
Executive Committee of the Rutgers University Foundation, a member of the
Rutgers University Board of Trustees, Chairman of the Executive Committee of
Rutgers University Scarlet R Club, Chairperson of the Rutgers University Annual
Fund, a member of the Dean's Advisory Council for Rutgers College and a member
of Rutgers University President's Council.
Joseph R. Rosetti, 70, has been a director of MediaBay since December 2002. Mr.
Rosetti has been President of SafirRosetti, an investigative and security firm
owned by Omnicom Group, Inc since December 2001. Prior to forming SafirRosetti,
Joseph R. Rosetti was the Vice Chairman of Kroll Associates. As Vice Chairman,
he had responsibility for Corporate Security/Crisis Management, which provides
industry and professional organizations with preventive measures to combat
corporate and financial crimes. From 1971 to 1987 he had worldwide
responsibility at IBM for security programs in physical security,
investigations, personnel security, trade secret protection, information asset
security, real and movable and financial asset security and Department of
Defense Security. Mr. Rosetti was a member of the U.S. National Chamber of
Commerce Crime Reduction Panel and was Staff Director for the Conference of the
National Commission on Criminal Justice Standards and Goals, a member of the
private Security Task Force to the National Advisory Committee on Criminal
Justice Standards and Goals and Chairman of the American Management
Association's Council on Crimes against Business. Prior to joining IBM, Mr.
Rosetti was the Northeast Director for the Law Enforcement Assistance
Administration of the U.S. Department of Justice and a Special Agent, Group
Supervisor, and Special Assistant to the Assistant Commissioner for Compliance
in the Intelligence Division, U.S. Treasury Department. Mr. Rosetti is also a
director of GVI Security Solutions, Inc., a provider of video surveillance
solutions to the retail, business-to-business, professional, and homeland
security market segments.
44
Our Board of Directors is classified into three classes, each with a term of
three years, with only one class of directors standing for election by the
shareholders in any year. Paul Ehrlich and Joseph Rosetti are Class I directors
and will stand for re-election at the 2004 annual meeting of shareholders.
Jeffrey Dittus and Mark Hershhorn are Class II directors and stand for
re-election at the 2005 annual meeting of shareholders. Richard Berman, Howard
Herrick and Carl Wolf are Class III directors and stand for re-election at the
2006 annual meeting of shareholders. Our executive officers serve at the
direction of the Board and until their successors are duly elected and
qualified.
COMPLIANCE WITH SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPANIES
Section 16(a) of the Exchange Act requires our officers, directors, and persons
who own more than 10% of a registered class of our equity securities, to file
reports of ownership and changes in ownership with the Securities and Exchange
Commission. Officers, directors, and greater than 10% shareholders are required
by Securities and Exchange Commission regulations to furnish us with copies of
all forms that they file pursuant to Section 16(a).
Based solely upon our review of the copies of such forms that we received, we
believe that, during the year ended December 31, 2003, all filing requirements
applicable to our officers, directors, and greater than 10% shareholders were
complied with, except that Richard Berman, Carl Wolf, Stephen McLaughlin, Robert
Toro and Norton Herrick each filed a Form 4 related to one transaction late.
AUDIT COMMITTEE
We have established an Audit Committee of the Board of Directors, which
currently consists of Messrs. Ehrlich, Hershhorn and Rosetti, each of whom is an
"independent" director as defined under the rules of the National Association of
Securities Dealers, Inc. Mr. Ehrlich serves as Chairman. The Board has
determined that Messrs. Ehrlich, Hershhorn and Rosetti qualify as "financial
experts" under federal securities laws.
CODE OF ETHICS
In March 2004, we adopted a written code of ethics that applies to our principal
executive officer, principal financial officer, principal accounting officer
other executive officers and persons performing similar functions. We will
provide a copy of our code of ethics without charge upon written request
addressed to MediaBay, Inc., 2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927,
Attention: Investor Relations. We will disclose any amendment or waiver of this
code on a Current Report on Form 8-K.
45
ITEM 11. EXECUTIVE COMPENSATION
The following table discloses, for the periods indicated, compensation paid to
our Chief Executive Officer and each of the four most highly compensated
executive officers (the "Named Executives").
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION SECURITIES UNDERLYING
-------------------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS/SAR'S (#) COMPENSATION
---- -------- ----- ----------------- ------------
Ronald Celmer 2003 $ 85,608 $ -- 1,500,000 $ --
Former Chief Executive Officer (1)
Hakan Lindskog 2003 230,091 25,000 -- $131,250
Former Chief Executive Officer (2) 2002 317,187 45,000 200,000 --
2001 264,063 50,000 175,000 --
John F. Levy 2003 190,000 35,705 60,241 --
Executive Vice President and Chief 2002 181,414 17,500 50,000 --
Financial Officer 2001 180,000 17,500 -- --
Steven M. McLaughlin 2003 140,417 10,000 40,000 41,250
Former Executive Vice President and 2002 188,684 -- 10,000 --
Chief Technology Officer (3) 2001 178,750 -- -- --
Robert Toro 2003 185,000 5,223 216,145 --
Senior Vice President Finance 2002 176,752 18,500 -- --
2001 159,087 17,500 50,000 --
HOWARD HERRICK 2003 175,000 12,500 117,000 --
Executive Vice President 2002 154,167 15,000 100,000 --
2001 150,000 30,000 100,000 --
Carl T. Wolf 2003 135,000 -- 585,000 --
Chairman (4) 2002 15,688 -- 645,000 --
2001 -- -- 35,000 --
(1) Ronald Celmer was employed as Chief Executive Officer of MediaBay,
Inc. from August 15, 2003 through January 5, 2004. In connection
with the termination of his employment, we paid severance of $56,250
in six semi-monthly payments commencing January 15, 2004.
(2) Hakan Lindskog was employed as Chief Executive Officer of MediaBay,
Inc. from January 1, 2003 through August 13, 2003. In connection
with the termination of his employment, we agreed to pay severance
of $145,833 in semi-monthly payments from August 15, 2003 through
January 15, 2004.
(3) Stephen McLaughlin resigned as Executive Vice President and Chief
Technology Officer of MediaBay, Inc. on September 15, 2003. In
connection with the termination of his employment, we agreed to pay
severance of $146,667 in semi-monthly payments commencing September
30, 2003 and ending October 15, 2004.
46
(4) Carl Wolf became Co-Chairman on November 15, 2002 and was named
Chairman on May 1, 2003.
The following table discloses options granted during the fiscal year ended
December 31, 2003 to the Named Executives:
Option/SAR Grants in Fiscal Year Ending December 31, 2003:
POTENTIAL
NUMBER OF % OF TOTAL REALIZABLE VALUE
SHARES OPTIONS AT ASSUMED ANNUAL RATES OF
UNDERLYING GRANTED TO EXERCISE STOCK PRICE APPRECIATION
OPTIONS EMPLOYEES IN PRICE EXPIRATION FOR OPTION TERM
NAME GRANTED FISCAL YEAR ($/SHARE) DATE 5% ($) 10% ($)
---- -------- ------------ --------- ---------- ------- --------
Ronald Celmer (1) 250,000 8% $0.80 02/10/2009 $48,556 $121,297
Ronald Celmer (1) 250,000 8% 0.80 08/10/2009 54,618 136,597
Ronald Celmer (1) 250,000 8% 1.00 02/10/2010 10,984 103,426
Ronald Celmer (1) 250,000 8% 1.00 08/10/2010 17,349 120,256
Ronald Celmer (1) 250,000 8% 1.25 02/10/2011 -- 76,269
Ronald Celmer (1) 250,000 8% 1.25 08/10/2011 -- 94,782
Hakan Lindskog -- -- -- -- -- --
John F. Levy 60,241 2% 0.85 09/15/2008 14,147 31,261
Howard Herrick 39,000 1% 1.39 12/01/2009 18,800 42,787
Howard Herrick 39,000 1% 1.39 12/01/2009 22,450 52,486
Howard Herrick 39,000 1% 1.39 12/01/2009 26,283 63,156
Steven M. McLaughlin (2) 20,000 1% 1.50 02/15/2009 -- 5,077
Steven M. McLaughlin (2) 20,000 1% 1.50 02/15/2010 -- 8,585
Steven M. McLaughlin (2) 10,000 -- 1.00 02/15/2005 -- --
Steven M. McLaughlin (2) 40,000 1% 1.50 02/15/2005 -- --
Robert Toro 36,145 1% 0.85 09/15/2008 6,182 15,846
Robert Toro 60,000 2% 1.02 11/14/2009 14,381 38,716
Robert Toro 60,000 2% 1.02 11/14/2009 18,160 48,708
Robert Toro 60,000 2% 1.02 11/14/2009 22,128 59,698
Carl Wolf 285,000 9% 0.73 08/11/2003 51,158 111,786
Carl Wolf 300,000 9% 1.36 12/4/2008 112,723 249,088
47
(1) Mr. Celmer's options were cancelled January 4, 2004.
(2) Mr. McLaughlin resigned September 15, 2003. The 40,000 options scheduled
to expire on 02/15/2009 and 02/15/2010 expired on 12/15 /2003, 90 days
after his resignation.
The following table sets forth information concerning the number of options
owned by the Named Executives and the value of any in-the-money unexercised
options as of December 31, 2003. No options were exercised by any of these
executives during fiscal 2003.
Aggregated Option Exercises And Fiscal Year-End Option Values
NUMBER OF SECURITIES UNDERLYING
UNEXERCISED OPTIONS AT VALUE OF UNEXERCISED IN-THE-MONEY
NAME DECEMBER 31, 2003 OPTIONS AT DECEMBER 31, 2003
----------------- ----------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
Ronald Celmer (1) -- 1,500,000 $ -- $ --
Hakan Lindskog -- -- -- --
Steven McLaughlin 58,000 -- 8,100 --
John F. Levy (2) 150,241 -- 16,760 --
Howard Herrick (3) 600,000 117,000 66,000 --
Robert Toro 131,145 205,000 14,036 19,400
Carl T. Wolf (4) 1,022,500 285,000 108,950 --
(1) Mr. Celmer's options were cancelled January 4, 2004.
(2) 10,000 of Mr. Levy's options expired on January 1, 2004.
(3) 50,000 of Mr. Herrick's options expired on February 9, 2004.
(4) 7,500 of Mr. Wolf's options expired on March 18, 2004.
The year-end values for unexercised in-the-money options represent the positive
difference between the exercise price of such options and the fiscal year-end
market value of the common stock. An option is "in-the-money" if the fiscal
year-end fair market value of the common stock exceeds the option exercise
price. The closing sale price of our common stock on December 31, 2003 was
$1.10.
DIRECTOR COMPENSATION
For the year ended December 31, 2003, for serving as an independent director,
Mr. Hershhorn received $10,000 and Mr. Ehrlich received cash compensation of
$7,500. During the year ended December 31, 2003, Mr. Berman received options to
purchase 125,000 shares of our common stock; Mr. Ehrlich received options to
purchase 70,0000 shares of our common stock; Mr. Hershhorn received options to
purchase 90,000 shares of our common stock and Mr. Rosetti received options to
purchase 50,000 shares of our common stock. Prior to his resignation from our
Board of Directors, during the year ended December 31, 2003, the health
insurance premiums of Michael Herrick and his family and automobile leasing
payments for Mr. Herrick's automobile were paid by us totaling $20,222 and
received $200,000 as compensation under a consulting agreement. We have agreed
to continue to pay the health insurance premiums for Mr. Herrick and his family
and automobile leasing payments until September 2004.
For the year ending December 31, 2004, Mr. Ehrlich is expected to receive
$10,000 and Mr. Hershhorn - $10,000. We are currently formulating our plans with
respect to the grant of stock-based compensation to non-employee directors for
the year ending December 31, 2004.
48
EMPLOYMENT AGREEMENTS
On January 29, 2004,we entered into a 27-month employment agreement with Jeffrey
Dittus. The agreement provides for a base annual salary of $225,000 per year,
which will increase to a base salary of $250,000 per year if we consummate a
minimum of $10 million in financing by June 30, 2004, of which the financing
completed in January 2004 accounted for $4.0 million. Pursuant to the agreement,
we granted to Mr. Dittus options to purchase 1.5 million shares of our common
stock, which have exercise prices and vest as follows:
Options to Purchase Exercise Price Vesting Date
250,000 shares $0.99 04/30/2004
250,000 shares $0.99 07/30/2004
250,000 shares $1.55 01/30/2005
250,000 shares $1.55 07/30/2005
250,000 shares $1.86 01/30/2006
250,000 shares $1.86 04/30/2006
We entered into a two-year employment agreement with Carl T. Wolf on November
15, 2002. The agreement provides for a base salary of $135,000 during the first
year of the agreement. Mr. Wolf's employment under the agreement automatically
terminates on November 14, 2004, unless prior to such date, at least 75% of our
Board of Directors vote affirmatively to continue Mr. Wolf's employment. Under
the terms of the agreement, Mr. Wolf is required to devote at least 20 hours per
week to our business and activities. Pursuant to the agreement, Mr. Wolf was
granted options to purchase 570,000 shares of our common stock. Of the total
options granted, options with respect to 285,000 shares have an exercise price
of $1.25 and vested on November 15, 2003 and options with respect to 285,000
shares have an exercise price of $3.25 and vest on November 15, 2004. In the
event of termination of employment under circumstances described in the
employment agreement, including as a result of a change in control, we will be
required to provide severance pay equal to the lesser of Mr. Wolf's base salary
for the unexpired period of his employment under the agreement or one year's
base salary.
We entered into a 38-month employment agreement with Howard Herrick dated
October 30, 2002. The agreement provides for an annual base salary of $175,000
in the first year of the agreement and four percent increases in each succeeding
year. Mr. Herrick's agreement also provides for a minimum annual bonus of
$30,000, however for the year ended December 31, 2003, in order to conserve
cash, we paid Mr. Herrick $12,000 and granted Mr. Herrick options to purchase
117,000 in partial payment of his bonus. Pursuant to the agreement, we granted
to Mr. Herrick options to purchase 100,000 shares of common stock with an
exercise price of $1.00, which immediately vested. In the event of termination
of employment under circumstances described in the employment agreement,
including as a result of a change in control, we will be required to provide
severance pay equal to the greater of $525,000 or three times total compensation
received by Mr. Herrick during the twelve months prior to termination.
STOCK PLANS
Our 1997 Stock Option Plan provides for the grant of stock options to purchase
up to 2,000,000 shares. As of April 12, 2004, options to purchase an aggregate
of 335,500 shares of our common stock have been granted under the 1997 plan.
49
Our 1999 Stock Option Plan provides for the grant of stock options to purchase
2,500,000 shares. As of April 12, 2004, options to purchase an aggregate of
1,918,631 shares of our common stock have been granted under the 1999 plan.
Our 2000 Stock Incentive Plan provides for the grant of any or all of the
following types of awards: (1) stock options, which may be either incentive
stock options or non-qualified stock options, (2) restricted stock, (3) deferred
stock and (4) other stock-based awards. A total of 3,500,000 shares of common
stock have been reserved for distribution pursuant to the 2000 plan. As of April
12, 2004, options to purchase an aggregate of 2,464,750 shares of our common
stock have been granted under the 2000 plan.
Our 2001 Stock Incentive Plan provides for the grant of any or all of the
following types of awards: (1) stock options, which may be either incentive
stock options or non-qualified stock options, (2) restricted stock, (3) deferred
stock and (4) other stock-based awards. A total of 3,500,000 shares of common
stock have been reserved for distribution pursuant to the 2001 plan. As of April
12, 2004, options to purchase an aggregate of 3,092,000 shares of our common
stock have been granted under the 2001 plan.
As of April 12, 2004, of the options granted under our plans, options to
purchase 4,503,386 shares of our common stock have been granted to our officers
and directors as follows: Carl T. Wolf 1,300,500 shares; Jeffrey Dittus -
1,500,000 shares; Howard Herrick - 667,000 shares; John F. Levy - 310,241
shares; Robert Toro - 336,145 shares; Richard J. Berman - 125,000; Paul D.
Ehrlich - 85,000; Shares; Mark P. Hershhorn -- 90,000 shares; Joseph R. Rosetti
- - 90,000 shares.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table details information regarding our existing equity
compensation plans as of December 31, 2003:
I
Number of securities
(a) remaining available
Number of securities (b) for future issuance
to be issued upon Weighted-average exercise under equity compensation
exercise of outstanding price of outstanding options, plans (excluding securities
PLAN CATEGORY options, warrants and rights warrants and rights reflected in column (a))
- ------------------------- ---------------------------- ---------------------------- --------------------------
Equity compensation plans
approved by security holders.......... 7,810,881 $ 2.92 3,689,119
Equity compensation plans
not approved by security holders...... 1,291,690 4.29 --
Total.................................. 9,102,571 $ 3.11 3,689,119
Note 1: See Note 10 and Note 11 to the Consolidated Financial Statements for a
further description of these plans.
The following table sets forth information regarding the beneficial ownership of
common stock, based on information provided by the persons named below in
publicly available filings, as of April 12, 2004:
o each of MediaBay's directors and executive officers;
o all directors and executive officers of MediaBay as a group; and
o each person who is known by MediaBay to beneficially own more than
five percent of our outstanding shares of common stock.
50
Unless otherwise indicated, the address of each beneficial owner is care of
MediaBay, Inc., 2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927. Unless
otherwise indicated, we believe that all persons named in the following table
have sole voting and investment power with respect to all shares of common stock
that they beneficially own.
For purposes of this table, a person is deemed to be the beneficial owner of the
securities if that person has the right to acquire such securities within 60
days of April 12, 2004 upon the exercise of options, warrants or other
convertible securities. In determining the percentage ownership of the persons
in the table above, we assumed in each case that the person exercised and
converted all options, warrants or convertible securities which are currently
held by that person and which are exercisable within such 60 day period, but
that options, warrants or other convertible securities held by all other persons
were not exercised or converted.
Name and Address of NUMBER OF SHARES PERCENTAGE OF SHARES
Beneficial Owner BENEFICIALLY OWNED BENEFICIALLY OWNED
- ----------------- ------------------ --------------------
Norton Herrick 21,104,776(1) 58.1%
Howard Herrick 9,476,782(2) 38.7
Carl T. Wolf 1,443,908(3) 7.3
Michael Herrick 1,237,484(4) 6.5
ABC Investments, L.L.C 1,025,641(5) 5.3
Jeffrey Dittus 250,000(6) 1.3
John F. Levy 177,215(7) *
Robert Toro 156,145(8) *
Paul D. Ehrlich 60,000(9) *
Richard J. Berman 55,000(10) *
Joseph R. Rosetti 45,000(11) *
Mark P. Hershhorn 45,000(12) *
--------------- ------
All directors and executive
officers as a group (9 persons) 11,709,050 44.4%
--------------- =======
* Less than 1%
(1) Represents (a) 290,070 shares of common stock held by Norton Herrick, (b)
1,500,000 shares of common stock issuable upon exercise of options, (c)
427,500 shares of common stock issuable upon exercise of warrants held by
Huntingdon Corporation ("Huntingdon"), (d) 3,543,303 shares of common
stock issuable upon conversion of convertible promissory notes held by
Huntingdon and (e) 7,022,581 shares of common stock issuable upon
conversion of convertible notes held by Huntingdon, (f) 2,964,180 shares
of common stock held by N. Herrick Irrevocable ABC Trust (the "Trust"),
(g) 892,857 shares of common stock issuable upon conversion of a
convertible promissory note held by the Trust and (h) 4,464,285 shares of
common stock issuable upon conversion of 25,000 shares of Series A Stock
held by the Trust. Mr. Herrick is the sole stockholder of Huntingdon and
has sole voting and dispositive power over the securities held by
Huntingdon. Norton Herrick is the beneficiary of the Trust and has shared
dispositive power over the securities held by the Trust. See "Certain
Relationships and Related Transactions."
51
(2) Represents (a) 2,964,180 shares held by the Trust, (b) 488,460 shares of
common stock held by Howard Herrick, (c) 667,000 shares of common stock
issuable upon exercise of options, (d) 892,857 shares of common stock
issuable upon conversion of convertible promissory notes held by the Trust
and (e) 4,464,285 shares of common stock issuable upon conversion of
25,000 shares of Series A Stock held by the Trust. Howard Herrick is the
sole trustee of the Trust. Howard Herrick has sole voting and shared
dispositive power over the securities held by the Trust.
(3) Represents 247,090 shares of common stock, 1,015,000 shares of common
stock issuable upon exercise of options and 181,818 shares of common stock
issuable upon conversion of Series B Stock. Does not include options to
purchase 285,000 shares of common stock issuable upon exercise of options.
(4) Represents 587,484 shares and 650,000 shares of common stock issuable upon
exercise of options.
(5) Represents shares of common stock issuable upon conversion of a
convertible note.
(6) Represents 250,000 shares of common stock issuable upon exercise of
options. Does not include 1,250,000 shares of common stock issuable upon
exercise of options.
(7) Represents 1,000 shares of common stock, 160,241 shares of common stock
issuable upon exercise of options and 25,974 shares of common stock
issuable upon conversion of Series B Stock. Does not include options to
purchase 150,000 shares of common stock.
(8) Represents shares of common stock issuable upon exercise of options. Does
not include 180,000 shares of common stock issuable upon exercise of
options.
(9) Represents shares of common stock issuable upon exercise of options. Does
not include 25,000 shares of common stock issuable upon exercise of
options.
(10) Represents shares of common stock issuable upon exercise of options. Does
not include 60,000 shares of common stock issuable upon exercise of
options.
(11) Represents 25,000 shares of common stock and 45,000 shares of common stock
issuable upon exercise of options. Does not include 45,000 shares of
common stock issuable upon exercise of options.
(12) Represents shares of common stock issuable upon exercise of options. Does
not include 45,000 shares of common stock issuable upon exercise of
options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Companies wholly owned by Norton Herrick, a principal shareholder, have in the
past provided accounting, administrative, legal and general office services to
us at cost since our inception. Companies wholly owned by Norton Herrick have
also assisted us in obtaining insurance coverage without remuneration. We paid
or accrued to these entities $88,000, $430,000 and $292,000 for these services
during the years ended December 31, 2001, 2002 and 2003, respectively. In
addition, a company wholly owned by Norton Herrick provided us with access to a
corporate airplane during 2001 and 2002. We generally paid the fuel, fees and
other costs related to our use of the airplane directly to the service
providers. For use of this airplane, we paid rental fees of approximately
$14,000 in each of 2001 and 2002 to Mr. Herrick's affiliate. As of December 31,
2003 we owed to Mr. Herrick and his affiliates $895,000 for reimbursement of
such expenses and services.
52
On May 1, 2003, we entered into a two-year consulting agreement with XNH
Consulting Services, Inc. ("XNH"), a company wholly-owned by Norton Herrick. The
agreement provided, among other things that XNH will provide consulting and
advisory services to us and that XNH will be under the direct supervision of the
our Board of Directors. For its services, we agreed to pay XNH a fee of $8,000
per month and to provide Mr. Herrick with health insurance and other benefits
applicable to our officers to the extent such benefits may be provided under our
benefit plans. The consulting agreement provided that the indemnification
agreement with Mr. Herrick entered into on November 15, 2002 pursuant to which,
we agreed to indemnify Mr. Herrick to the maximum extent permitted by the
corporate laws of the State of Florida or, if more favorable, our Articles of
Incorporation and By-Laws in effect at the time the agreement was executed,
against all claims (as defined in the agreement) arising from or out of or
related to Mr. Herrick's services as an officer, director, employee, consultant
or agent of ours or any subsidiary or in any other capacity shall remain in full
force and effect and to also indemnify XNH on the same basis. Mr. Herrick
resigned as our Chairman effective May 1, 2003 and Mr. Herrick and we terminated
the employment agreement signed as of November 2, 2002 on May 1, 2003.
Effective December 31, 2003, we agreed with Norton Herrick to terminate the
two-year consulting agreement with XNH, we agreed to pay XNH a fee of $7,500 per
month for 16 months commencing on January 1, 2004 and to provide Mr. Herrick
with health insurance and other benefits applicable to our officers to the
extent such benefits may be provided under our benefit plans. The termination
agreement provides that the indemnification agreement with Mr. Herrick entered
into on November 15, 2002 shall remain in full force and effect and to also
indemnify XNH on the same basis. In connection with the termination agreement,
the non-competition and nondisclosure covenants of the XNH consulting agreement
were extended until December 31, 2006.
On May 7, 2003, we sold 3,350 shares of a newly created Series B Stock with a
liquidation preference of $100 per share for $335,000. Of the total sold, 1,400
shares ($140,000), were purchased by Carl Wolf, Chairman and a director of
MediaBay, and 200 shares ($20,000) were purchased by John Levy, our Executive
Vice President and Chief Financial Officer of the Company. The holders of shares
of Series B Convertible Preferred Stock will receive dividends at the rate of
$9.00 per share, payable quarterly, in arrears, in cash on each March 31, June
30, September 30 and December 31; provided that payment will accrue until we are
permitted to make such payment in cash under our Credit Agreement.
The Series B Stock is convertible into shares of common stock at a conversion
rate equal to a fraction, (i) the numerator of which is equal to the number of
Series B Stock times $100 plus accrued and unpaid dividends though the date of
conversion and (ii) the denominator is $0.77, the average price of our stock on
May 6, 2003.
In the event of a liquidation, dissolution or winding up of MediaBay, the
holders of Series B Stock shall be entitled to receive out of our assets, a sum
in cash equal to $100.00 per share before any amounts are paid to the holders of
our common stock and on a pari passu basis with the holders of the Series A
Convertible Preferred Stock. The holders of Series B Stock shall have no voting
rights, except as required by law and except that the vote or consent of the
holders of a majority of the outstanding shares of Series B Stock, voting
separately as a class, will be required for any amendment, alteration or repeal
of the terms of the Series B Stock that adversely effects the rights,
preferences or privileges of the Series B Stock.
53
On July 31, 2003, Norton Herrick exercised options to purchase 300,000 shares of
our common stock at an exercise price of $.50 per share pursuant to an Option
Agreement dated November 23, 2001. The options were exercised on a "cash-less"
basis and the closing stock price on July 31, 2003 was $.78. Accordingly, we
issued to Mr. Herrick a certificate for 107,692 shares of our common stock.
During the three months ended September 30, 2003, Norton Herrick provided a
$100,000 guarantee to a vendor. We subsequently paid the vendor and the
guarantee expired. Mr. Herrick received no compensation and did not profit from
the transaction.
During the three months ended September 30, 2003, Norton Herrick also loaned the
Company $100,000. The loan was subsequently converted into an investment by
Huntingdon Corporation, a company wholly owned by Mr. Herrick, in the $1,065,000
bridge financing completed on October 1, 2003. Carl Wolf, our Chairman, also
purchased a $100,000 note in this financing. In consideration, we issued to each
of Huntingdon and Mr. Wolf a $100,000 principal amount note due October 1, 2004.
The notes are identical to all other notes issued in the financing and bear
interest at the rate of 18% per annum, payable at maturity. In connection with
the issuance of the notes, we agreed, subject to receipt of shareholder
approval, to issue to each of Huntingdon and Mr. Wolf warrants to purchase
25,000 shares of common stock at an exercise price of $.80 and agreed to issue
to each of them warrants to purchase an additional 25,000 shares of common stock
if the notes are not repaid on April 1, 2004 at an exercise price per share
equal to the closing sale price of our common stock on March 31, 2004.
We entered into an agreement with Norton Herrick dated November 7, 2003 (the
"November Agreement") whereby Mr. Herrick agreed to pay amounts owed to us under
Section 16(b) of the Securities Exchange Act of 1934 as a result of various
transactions which are attributable to Mr. Herrick occurring within less than
six months of each other that involved our securities. Mr. Herrick agreed to pay
us the sum of $1,742,149, (the "Payment") by delivering to us for cancellation
within ten (10) days of the date of the November Agreement, shares of our common
stock and/or warrants to purchase shares of common stock with an aggregate value
equal to the Payment. Under the November Agreement, the value of each share of
common stock delivered under the Agreement is equal to the last sale price of
our common stock on the trading day immediately prior to the date on which the
shares of common stock were delivered (the "Market Price"). The value of any
warrant delivered under the November Agreement is equal to the Market Price of
the underlying shares less the exercise price of the warrant. Mr. Herrick
delivered the shares of common stock and warrants pursuant to the November
Agreement on Monday, November 17, 2003, with the value of the securities based
on the Market Price on November 14, 2003 of $.94 per share of common stock. As
part of the Payment, Mr. Herrick returned to us 1,095,372 shares of our common
stock. Based on the Market Price, the aggregate value of these shares is
$1,029,650. Also, as part of the Payment, Mr. Herrick deposited warrants to
purchase 1,875,000 shares of our common stock. Based on the Market Price ($.94)
less the exercise price of the warrants ($.56), the aggregate value of these
warrants was $712,500. Of the 1,875,000 warrants deposited, 1,650,000 became
exercisable May 14, 2001 and 225,000 became exercisable February 22, 2002.
In 2003 and 2002, Norton Herrick advanced $360,000 and $372,000, respectively,
to certain of our vendors and professional firms as payment of amounts owed to
them. As we made payments to these vendors, the vendors repaid the amounts
advanced to them by Mr. Herrick. Mr. Herrick received no interest or other
compensation for advancing the monies. As of April 12, 2004, none of the
advances were outstanding.
54
On January 29, 2004, we issued $4,000,000 aggregate principal amount of
promissory notes (the "2004 Notes") and warrants to purchase 2,352,946 shares of
common stock to 13 institutional and accredited investors. In connection with
this offering, Norton Herrick and Huntingdon entered into a letter agreement
with the purchasers of the 2004 Notes pursuant to which they granted to the
holders of the 2004 Notes in the event of an Event of Default (as defined in the
2004 Notes) the rights to receive payment under certain secured indebtedness
owed by us to Norton Herrick and Huntingdon and to exercise their rights under
security agreements securing such secured indebtedness. Pursuant to the letter
agreement, Norton Herrick and Huntingdon also executed Powers-of-Attorney in
favor of a representative of the 2004 Note holders pursuant to which such
representative may, following an Event of Default, take actions necessary to
enforce the 2004 Note holders rights under the letter agreement, including
enforcing Norton Herrick's and Huntingdon's rights under the security
agreements. In consideration for Huntingdon's consent to the Financing and
execution of the letter agreement upon receipt of shareholders' approval, we
agreed to reduce the conversion price of $1,150,000 principal amount of
convertible promissory notes held by Huntingdon from $2.00 to $1.27 and $500,000
principal amount of convertible promissory notes held by Huntingdon from $1.82
to $1.27.
ITEM 14. PRINCIPAL ACCOUNTANTS' FEES AND SERVICES
On June 24, 2003, MediaBay, Inc. (the "Company") dismissed Deloitte & Touche LLP
("D&T"), our former independent certified public accountants. During neither of
the past two years ended December 31, 2002 did the reports by D&T on the
financial statements of the Company contain an adverse opinion or a disclaimer
of opinion, or was qualified or modified as to uncertainty, audit scope, or
accounting principles. The decision to dismiss D&T as the Company's independent
certified public accountants was made by the Audit Committee of the Board of
Directors of the Company. During the Company's two most recent fiscal years and
subsequent period up to June 24, 2003, there were no disagreements with the
former accountant on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements if not
resolved to their satisfaction would have caused them to make reference in
connection with their opinion to the subject matter of the disagreement. On June
24, 2003, the Company engaged Amper, Politziner & Mattia, P.C. to serve as the
Company's independent certified public accountants.
The following table presents fees charged for professional fees charged for
professional audit services for the audit of the Company's financial statements
for the years ended December 31, 2003 by Amper Politziner & Mattia, P.C. and
2002 by D&T. No fees were paid for non-audit related services.
2003 2002
-------- --------
Audit Fees (1) $103,000 $338,000
Audit-Related Fees (2) -- 34,000
Tax Fees (3) -- --
All Other Fees (4) 13,000 --
-------- --------
Total $116,000 $372,000
(1) The aggregate fees billed for each year for professional services rendered
by our principal accountant for the audit of our financial statements and
review of financial statements included in our Form 10-Q.
(2) Fees billed for assurance and related services by our principal accountant
for accounting research, issues relating to prior years' financial
statements and the filing of a registration statement on Form S-3 not
reported above.
(3) There were no fees billed by our principal accountant for professional
services rendered for compliance, tax advice and tax planning.
55
(4) D&T billed $13,000 for review of financial statements included in our Form
10-Q for the three months ended March 31, 2003 prior to their dismissal.
No other fees were billed by our principal accountant other than the fees
disclosed above.
Pre-approval Policies and Procedures
Consistent with the Securities and Exchange Commission requirements regarding
auditor independence, our Audit Committee has adopted a policy to pre-approve
all audit and permissible non-audit services provided by our principal
accountant. Under the policy, the Audit Committee must approve non-audit
services prior to the commencement of the specified service. Our principal
accountants have verified, and will verify annually, to our Audit Committee that
have not performed, and will not perform any prohibited non-audit service.
PART IV
Item 15. Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) Exhibits
3.1 Restated Articles of Incorporation of the Registrant. (1)
3.2 Articles of Amendment to Articles of Incorporation. (5)
3.3 Articles of Amendment to Articles of Incorporation. (6)
3.4 Articles of Amendment to Articles of Incorporation of the Registrant filed
with the Department of State of the State of Florida on January 18, 2002.
(11)
3.5 Articles of Amendment to Articles of Incorporation of the Registrant filed
with the Department of State of the State of Florida on May 7, 2003. (15)
3.6 Amended and Restated By-Laws of the Registrant. (14)
10.1 Employment Agreement between the Registrant and Carl Wolf. (14)
10.2 Employment Agreement between the Registrant and Howard Herrick. (13)
10.3 Put Agreement, dated as of December 11, 1998, by and between the
Registrant and Premier Electronic Laboratories, Inc. (3)
10.4 $3,200,000 Principal Amount 9% Convertible Senior Subordinated Promissory
Note of the Registrant to ABC Investment, L.L.C. due December 31, 2004.
(12)
10.5 Modification Letter, dated December 31, 1998, among Norton Herrick, the
Registrant and Fleet National Bank (3)
10.6 Security Agreement, dated as of December 31, 1998, by and among the
Registrant, Classic Radio Holding Corp. and Classic Radio Acquisition
Corp. and Norton Herrick. (3)
10.7 1997 Stock Option Plan (1)
10.8 1999 Stock Incentive Plan (4)
10.9 2000 Stock Incentive Plan (7)
10.10 2001 Stock Incentive Plan (10)
56
10.11 Amended and Restated Credit Agreement dated as of April 30, 2001 (the
"Credit Agreement"), among Registrant Audio Book Club, Inc. ("ABC"), Radio
Spirits, Inc. ("RSI") and ING (U.S.) Capital LLC ("ING"). (9)
10.12 Form of Amended and Restated Security Agreement, dated as of April 30,
2001 among Registrant, RSI, ABC, VideoYesteryear, Inc. ("VYI"),
MediaBay.com, Inc. ("MBCI"), audiobookclub.com ("ABCC"), ABC-COA
Acquisition Corp. (abc-coa"), MediaBay Services, Inc. ("MSI"), ABC
Investment Corp. ("AIC"), MediaBay Publishing, Inc. ("MPI"), Radio
Classics, Inc. ("RCI") and ING. (9)
10.13 Form of Amended and Restated Intellectual Property Security Agreement,
dated as of April 30, 2001 among Registrant, RSI, ABC, VYI, MBCI, ABCC,
ABC-COA, MSI, AIC, MPI, RCI and ING. (9)
10.14 $1,984,250 principal amount 9% convertible senior subordinated promissory
note of Registrant issued to Norton Herrick due December 31, 2004. (9)
10.15 $500,000 principal amount 9% convertible senior subordinated promissory
note of Registrant issued to N Herrick Irrevocable ABC Trust due December
31, 2004. (12)
10.16 $2,500,000 principal amount convertible senior promissory note of
Registrant issued to Huntingdon Corporation ("Huntingdon") due September
30, 2002. (9)
10.17 $800,000 principal amount 12% convertible senior subordinated promissory
note of Registrant issued to Huntingdon due December 31, 2002. (9)
10.18 Form of Security Agreement dated as of April 30, 2001 between Registrant,
the subsidiaries of Registrant set forth on Schedule 2 annexed thereto and
Huntingdon. (9)
10.19 $500,000 principal amount convertible senior promissory note of Registrant
issued to Huntingdon due June 30, 2003. (12)
10.20 Consulting Agreement, dated as of October 18, 2002 and effective as of
January 1, 2003 between MEH Consulting Services, Inc. (the "Consultant")
and the Registrant. (13)
10.21 Amendment No. 2 to the Credit Agreement dated as of October 3, 2002. (11)
10.22 Loan Agreement dated October 3, 2002 between Huntingdon and the
Registrant, as amended. (14)
10.23 Agreement dated October 3, 2002 between Norton Herrick and the Registrant,
among other things, amending the $1,984,250 principal amount note. (14)
10.24 Agreement dated October 3, 2002 between Evan Herrick and the Registrant,
among other things, amending a $500,000 principal amount note. (14)
10.25 Letter Agreement between the Registrant and Norton Herrick entered into in
November 2002. (14)
10.26 Indemnification Agreement dated as of November 15, 2002 between the
Registrant, MEH Consulting Services. Inc. and Michael Herrick. (14)
10.27 Indemnification Agreement dated as of November 15, 2002 between the
Registrant and Norton Herrick. (14)
10.28 Amendment No. 3 to the Credit Agreement dated April 9, 2003. (14)
57
10.29 Amendment No. 4 to Credit Agreement dated April 28, 2003 (15)
10.30 Consulting and Termination Agreement dated as of May 1, 2003 between XNH
Consulting Services, Inc., Norton Herrick and the Registrant (15)
10.31 Letter from Deloitte & Touche LLP dated June 25, 2003 (16)
10.32 Amendment No. 5 to Credit Agreement dated September 12, 2003.
10.33 Amendment No. 6 to Credit Agreement dated September 23, 2003.
10.34 Settlement Agreement with Norton Herrick dated November 7, 2003.
10.35 Amendment No. 7 to Credit Agreement dated January 29, 2004.
10.36 Employment Agreement between the Registrant and Jeffrey Dittus dated
January 28, 2004.
10.37 Agreement dated January 29, 2004 between the Registrant, Norton Herrick
and Huntingdon Corporation.
10.38 Agreement dated January 29, 2004 among the Registrant, Norton Herrick,
Huntingdon Corporation and the Lenders listed on Schedule A thereto.
10.39 Termination Agreement dated as of March 8, 2004 among XNH Consulting
Services, Inc., the Registrant and Norton Herrick.
21.1 Subsidiaries of the Company.
23.1 Consent of Amper Politziner & Mattia, P.C.
23.2 Consent of Deloitte & Touche LLP.
31.1 Chief Executive Officer Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Jeffrey Dittus, Chief Executive Officer of MediaBay,
Inc., pursuant to 18 U.S.C Section 1350, as Adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of John Levy, Executive Vice President and Chief Financial
Officer of MediaBay, Inc., pursuant to 18 U.S.C Section 1350, as Adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2001
________________________________________________________________________________
(1) Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-30665) effective October
22, 1997.
(2) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for reportable event dated December 14, 1998.
(3) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
(4) Incorporated by reference to the applicable exhibit contained in our Proxy
Statement dated February 23, 1999.
(5) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended June 30,
1999.
58
(6) Incorporated by reference to the applicable exhibit contained in our
Registration Statement on Form SB-2 (file no. 333-95793) effective March
14, 2000.
(7) Incorporated by reference to the applicable exhibit contained in our Proxy
Statement dated May 23, 2000.
(8) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-KSB for the year ended December 31, 2000.
(9) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-QSB for the quarterly period ended March 31,
2001.
(10) Incorporated by reference to the applicable exhibit contained in our proxy
statement dated September 21, 2001.
(11) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for reportable event dated January 18, 2002.
(12) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-KSB for the year ended December 31, 2001.
(13) Incorporated by reference to the applicable exhibit contained in the
Quarterly Report on Form 10-Q for the quarterly period ended September 30,
2002.
(14) Incorporated by reference to the applicable exhibit contained in our
Annual Report on Form 10-K for the year ended December 31, 2002.
(15) Incorporated by reference to the applicable exhibit contained in our
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
2003.
(16) Incorporated by reference to the applicable exhibit contained in our
Current Report on Form 8-K for the reportable event dated June 24, 2003.
(b) Financial Statement Schedule
Schedule -I - Valuation and Qualifying Accounts and Reserve
(c) Reports on Form 8-K filed during the quarter ended December 31, 2002.
None.
59
MEDIABAY, INC.
FORM 10-K
ITEM 8
INDEX TO FINANCIAL STATEMENTS
Independent Auditors' Report...........................................................................................F-2
Independent Auditors' Report...........................................................................................F-3
Consolidated Balance Sheets as of December 31, 2003 and 2002...........................................................F-4
Consolidated Statements of Operations for the years ended December 31, 2003,
2002, and 2001.........................................................................................................F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001.......................................................................................F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2003,
2002, and 2001.........................................................................................................F-7
Notes to Consolidated Financial Statements.............................................................................F-8
Schedule II-Valuation and Qualifying Accounts and Reserves.............................................................S-1
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Media Bay, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Media Bay Inc.
and Subsidiaries as of December 31, 2003, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the year
ended December 31, 2003. Our audit also included the financial statement
schedule listed in the Index at page S-1 as of December 31, 2003 and for the
year then ended. These financial statements and schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audit.
We conducted our audit 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 consolidated
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
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Media Bay Inc. and
Subsidiaries at December 31, 2003, and the consolidated results of their
operations and their cash flows for year ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, the related financial statement schedule as of December
31, 2003 and for year then ended, when considered in relation to the
consolidated basic financial statements taken as a whole, presents fairly in all
material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has a working capital deficiency, which raise substantial doubt about its
ability to continue as a going concern. Management's plans regarding those
matters also are described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of the uncertainty.
/s/ Amper, Politziner & Mattia
Edison, New Jersey
March 19, 2004, except for Note 21 which is as of April 12, 2004
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of MediaBay, Inc.:
We have audited the accompanying consolidated balance sheets of MediaBay, Inc.
and subsidiaries (the "Company") as of December 31, 2002, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the two years in the period ended December 31, 2002. Our audits also
included the financial statement schedule as of December 31, 2002, and for each
of the two years then ended listed in the index at Item 15(a)(2). These
financial statements and the financial statement schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on the
financial statements and the financial statement schedule 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, such consolidated financial statements present fairly, in all
material respects, the financial position of MediaBay, Inc. and subsidiaries at
December 31, 2002, and the results of their operations and their cash flows for
each of the two years in the period ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
As discussed in Note 3 to the consolidated financial statements, effective
January 1, 2002, the Company changed its method of accounting for goodwill and
intangible assets upon adoption of Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets".
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
April 15, 2003
F-3
MEDIABAY, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31,
2003 2002
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents ............................................................ $ 683 $ 397
Accounts receivable, net of allowances for sales returns and doubtful accounts of
$4,446 and $5,325 at December 31, 2003 and 2002, respectively ..................... 3,264 7,460
Inventory ............................................................................ 4,063 5,244
Prepaid expenses and other current assets ............................................ 215 503
----------- -----------
Royalty advances ..................................................................... 804 1,044
Total current assets ............................................................. 9,029 14,648
Fixed assets, net ........................................................................ 227 358
Deferred member acquisition costs ........................................................ 3,172 7,396
Deferred income taxes .................................................................... 14,753 16,224
Other intangibles ........................................................................ 54 122
Goodwill ................................................................................. 9,658 9,871
----------- -----------
$ 36,893 $ 48,619
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ................................................ $ 10,268 $ 16,050
Accounts payable, related parties .................................................... ___826 566
Common stock subject to contingent put rights, current portion ....................... 350 --
Short-term debt, net of original issue discount of $274 at December 31, 2003 ......... 7,107 2,368
Related party short-term debt, net of original
issue discount of $142 at December 31, 2003.......................................... 10,643 --
----------- -----------
Total current liabilities ........................................................ 29,194 18,984
----------- -----------
Long-term debt, .......................................................................... -- 5,520
----------- -----------
Related party long-term debt, net of original issue discount of $567 at December 31, 2002 -- 9,160
----------- -----------
Common stock subject to contingent put rights ............................................ 750 4,550
----------- -----------
Commitments and Contingencies ............................................................ -- --
Preferred stock, no par value, authorized 5,000,000 shares; 25,000 shares of
Series A issued and outstanding at December 31, 2003 and December 31, 2002
and 3,350 shares and no shares of Series B at December 31, 2003 and
December 31, 2002, respectively ...................................................... 2,828 2,500
Common stock; no par value, authorized 150,000,000 shares; issued and outstanding
13,057,414 and 14,341,376 at December 31, 2003 and 2002, respectively ................ 94,567 94,800
Contributed capital ...................................................................... 11,569 8,251
Accumulated deficit ...................................................................... (102,015) (95,146)
----------- -----------
Total common stockholders' equity ........................................................ 6,949 10,405
----------- -----------
$ 36,893 $ 48,619
============ ===========
See accompanying notes to consolidated financial statements.
F-4
MEDIABAY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
2003 2002 2001
-------- -------- --------
Sales, net of returns, discounts and allowances of $16,960, $16,195 $ 36,617 $ 45,744 $ 41,805
and $13,099 for the years ended December 31, 2003, 2002 and
2001, respectively
Cost of sales ..................................................... 17,479 20,651 19,783
Cost of sales - write-downs ....................................... -- -- 2,261
Advertising and promotion ......................................... 9,988 10,156 11,922
Advertising and promotion write-downs ............................. -- -- 3,971
Bad debt .......................................................... 3,940 2,821 2,536
General and administrative ........................................ 6,816 8,347 8,947
Severance and other termination costs ............................. 544 -- --
Asset write-downs and strategic charges ........................... 749 -- 7,044
Depreciation and amortization ..................................... 328 1,314 5,156
Non-cash write-down of intangibles ................................ -- 1,224 --
-------- -------- --------
Operating (loss) income ..................................... (3,227) 1,231 (19,815)
Interest expense .................................................. 1,925 2,974 2,790
-------- -------- --------
Loss before income tax (expense) benefit .................... (5,152) (1,743) (22,605)
Income tax (expense) benefit ...................................... (1,471) (550) 17,200
-------- -------- --------
Net loss .................................................... (6,623) (2,293) (5,405)
Dividends on preferred stock ...................................... 246 217 --
-------- -------- --------
Net loss applicable to common shares ........................ $ (6,869) $ (2,510) $ (5,405)
======== ======== ========
Basic and diluted loss per share:
Basic and diluted loss per share............................. $ (.49) $ (.18) $ (.39)
======== ======== ========
See accompanying notes to consolidated financial statements.
F-5
MEDIABAY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(AMOUNTS IN THOUSANDS)
Series A Series B
Preferred Series A Preferred Series B
stock - Preferred stock - Preferred
number of stock no number of stock no
---------- --------- ---------- ---------
shares par value shares par value
------ --------- ------ ---------
Balance at January 1, 2001..................................... -- $ -- $ -- $ --
Warrants granted for financing and consulting services...... -- -- -- --
Beneficial conversion feature of debt issued................ -- -- -- --
Net loss applicable to common shares........................ -- -- -- --
Balance at December 31, 2001................................... -- -- -- --
Conversion of convertible debt to preferred stock........... 25 2,500 -- --
Conversion of convertible notes............................. -- -- -- --
Options and warrants granted for consulting................. -- -- -- --
Exercise of options and warrants............................ -- -- -- --
Cancellation of warrants issued............................. -- -- -- --
Stock issued to consultants................................. -- -- -- --
Stock tendered as payment for exercise of options........... -- -- -- --
Stock and warrants issued in acquisition of patent.......... -- -- -- --
Loss applicable to common shares............................ -- -- -- --
Balance at December 31, 2002................................... 25 2,500 -- --
Issuance of Series B Preferred Stock........................ -- -- 3,350 328
Warrants granted in consideration for non-compete
agreements.................................................. -- -- -- --
Exercise of options......................................... -- -- -- --
Stock issued to consultants................................. -- -- -- --
Options issued to consultants............................... -- -- -- --
Columbia House settlement................................... -- -- -- --
Stock tendered as payment of settlement..................... -- -- -- --
Warrants issued in connection with financing................ -- -- -- --
Options issued to Directors................................. -- -- -- --
Loss applicable to common shares............................ -- -- -- --
----- ------- ------- -------
Balance at December 31, 2003 25 $ 2,500 3,350 $ 328
===== ======= ======== =======
Common
stock Common
number of stock - no Contributed Accumulated
---------- ----------- ------------ -----------
shares par value capital deficit
------ --------- ------- -------
Balance at January 1, 2001..................................... 13,862 93,468 6,702 $(87,231)
Warrants granted for financing and consulting services...... -- -- 333 --
Beneficial conversion feature of debt issued................ -- -- 695 --
Net loss applicable to common shares........................ -- -- -- (5,405)
Balance at December 31, 2001................................... 13,862 93,468 7,730 (92,636)
Conversion of convertible debt to preferred stock........... -- -- -- --
Conversion of convertible notes............................. 200 1,000 (49) --
Options and warrants granted for consulting................. -- -- 659 --
Exercise of options and warrants............................ 221 207 -- --
Cancellation of warrants issued............................. -- (125) --
Stock issued to consultants................................. 19 50 -- --
Stock tendered as payment for exercise of options........... (61) -- -- --
Stock and warrants issued in acquisition of patent.......... 100 75 36 --
Loss applicable to common shares............................ -- -- -- (2,510)
Balance at December 31, 2002................................... 14,341 94,800 8,251 (95,146)
Issuance of Series B Preferred Stock........................ -- -- -- --
Warrants granted in consideration for non-compete
agreements.................................................. 23 --
Exercise of options......................................... 107 -- -- --
Stock issued to consultants................................. 29 14 -- --
Options issued to consultants............................... -- -- 26 --
Columbia House settlement................................... (325) (247) 3,020 --
Stock tendered as payment of settlement..................... (1,095) -- -- --
Warrants issued in connection with financing................ -- -- 176 --
Options issued to Directors................................. -- -- 73 --
Loss applicable to common shares............................ -- -- -- (6,869)
------- -------- ------- ---------
Balance at December 31, 2003 13,057 $ 94,567 $11,569 $(102,015)
======= ======== ======= =========
See accompanying notes to consolidated financial statements.
F-6
MEDIABAY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
2003 2002 2001
------------- ------------- -------------
Cash flows from operating activities:
Net loss applicable to common shares................................. $(6,869) $(2,510) $(5,405)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of deferred member acquisition costs................ 6,161 5,571 7,489
Non-current accrued interest and dividends payable............... 1,155 456 --
Amortization of deferred financing costs and original issue
discount......................................................... 561 1,453 1,011
Depreciation and amortization.................................... 328 1,314 5,156
Non-cash compensation expense.................................... 118 -- --
Asset write-downs and strategic charges.......................... 749 -- 13,276
Income tax expense (benefit)..................................... 1,471 550 (17,200)
Changes in asset and liability accounts, net of acquisitions and
asset write-downs and strategic charges:
Decrease (increase) in accounts receivable, net................ 4,195 (2,643) 321
Decrease (increase) in inventory............................... 896 (1,123) 365
Decrease (increase) in prepaid expenses and other current
assets....................................................... 300 1,106 (558)
Decrease (increase) in royalty advances........................ 240 (261) 590
Increase in deferred member acquisition costs.................. (2,410) (8,099) (3,748)
(Decrease) increase in accounts payable and accrued expenses... (5,346) 3,981 (3,360)
------------- ------------- -------------
Net cash provided by (used in) operating activities........... 1,549 1,019 (2,063)
------------- ------------- -------------
Cash flows from investing activities:
Purchase of fixed assets........................................... (16) (111) (188)
Additions to intangible assets..................................... (102) -- (110)
Cash paid in acquisitions.......................................... (148) (1,000) --
------------- ------------- -------------
Net cash used in investing activities......................... (266) (1,111) (298)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of notes payable - related parties.......... -- 2,000 2,800
Proceeds from issuance of debt 1,065 -- --
Repayment of long-term debt........................................ (1,615) (1,640) (400)
Increase in deferred financing costs............................... (99) (149) (473)
Payments made in connection with litigation settlement recorded in
contributed capital, net of cash received.......................... (676) -- --
Proceeds from exercise of stock options............................ -- 214 --
Proceeds from sale of preferred stock, net of costs................ 328 -- --
------------- ------------- -------------
Net cash (used in) provided by financing activities........... (997) 425 1,927
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents................. 286 333 (434)
Cash and cash equivalents at beginning of year....................... 397 64 498
------------- ------------- -------------
Cash and cash equivalents at end of year............................. $ 683 $ 397 $ 64
============= ============= =============
See accompanying notes to consolidated financial statements.
F-7
MEDIABAY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE D
(1) LIQUIDITY AND CASH FLOW
Historically, MediaBay, Inc. (the "Company"), has funded its cash requirements
through sales of equity and debt securities and borrowings from financial
institutions and principal shareholders. The Company's line of credit is due
September 30, 2004, an additional $10.8 million is due upon demand of the
holders of notes which may be made at various times following the repayment of
the line of credit and an additional $4.3 million under promissory notes is due
in the fourth quarter of 2004. The Company currently does not have sufficient
funds to repay the debt and is actively seeking to obtain other financing to
replace the debt or obtain an extension of its maturity.
The Company currently does not have sufficient funds to market to attract new
members and customers, and its customer and revenue bases have eroded and will
continue to erode. If the Company does not have the funds available to spend to
acquire new members to offset member attrition and/or expand its existing
membership and customer bases, revenue will continue to decline, which will
continue to negatively impact performance and could ultimately impair the
Company's ability to continue as a going concern.
The Company has implemented a series of initiatives to increase cash flow. While
these initiatives and the significant reduction in marketing expenses increased
cash provided by operating activities in 2003, the Company cannot sustain its
operations without increasing marketing expenses. The Company anticipates
requiring additional financing to repay debt and to fund the expansion of
operations, acquisitions, working capital or other related.
(2) ORGANIZATION
The Company is a Florida corporation, was formed on August 16, 1993. MediaBay,
Inc. is a seller of spoken audio products, including audiobooks and old-time
radio shows, through direct response, retail and Internet channels. The Company
markets audiobooks primarily through its Audio Book Club. Its old-time radio
programs are marketed through direct-mail catalogs, over the Internet at
radiospirits.com and, on a wholesale basis, to major retailers.
(3) SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany accounts have been
eliminated.
Cash and Cash Equivalents
Securities with maturities of three months or less when purchased are considered
to be cash equivalents.
Fair Value of Financial Instruments
The carrying amount of cash, accounts receivable, accounts payable and accrued
expenses approximates fair value due to the short maturity of those instruments.
S-1
The fair value of long-term debt is estimated based on the interest rates
currently available for borrowings with similar terms and maturities. The
carrying value of the Company's long-term debt approximates fair value.
Inventory
Inventory, consisting primarily of audiocassettes and compact discs held for
resale, is valued at the lower of cost (weighted average cost method) or market.
Prepaid Expenses
Prepaid expenses consist principally of deposits and other amounts being
expensed over the period of benefit. All current prepaid expenses will be
expensed over a period no greater than the next twelve months.
Fixed Assets, Net
Fixed assets, consisting primarily of furniture, leasehold improvements,
computer equipment, and third-party web site development costs, are recorded at
cost. Depreciation and amortization, which includes the amortization of
equipment under capital leases, is provided by the straight-line method over the
estimated useful life of three years (the lease term) for computer equipment and
five years (the lease term) for sound equipment under capital leases, five years
for equipment, seven years for furniture and fixtures, five years for leasehold
improvements, and two years for Internet web site development costs. Ongoing
maintenance and other recurring charges are expensed as incurred.
Other Intangibles, Net
Intangible assets, principally consisting of customer lists, license agreements,
and mailing and non-compete agreements acquired in the Company's acquisitions,
are being amortized over their estimated useful life, which range from three to
seven years, on a straight-line basis.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired in business combinations accounted for using the purchase method
of accounting. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets", the Company ceased
amortization of goodwill as of January 1, 2002. The Company completed the
transitional impairment test as of January 1, 2002, which did not result in an
impairment loss and performed its annual impairment tests as of October 31, 2003
and 2002, which did not result in an impairment loss. Prior to January 1, 2002,
goodwill was amortized over the estimated period of benefit not to exceed 20
years.
Revenue Recognition
The Company derives its principal revenue through sales of audiobooks, classic
radio shows and other spoken word audio products directly to consumers
principally through direct mail. The Company also sells classic radio shows to
retailers either directly or through distributors. The Company derives
additional revenue through rental of its proprietary database of names and
addresses to non-competing third parties through list rental brokers. The
Company also derives a small amount of revenue from advertisers included in its
nationally syndicated classic radio shows. The Company recognizes sales to
consumers, retailers and distributors upon shipment of merchandise. List rental
revenue is recognized on notification by the list brokers of rental by a third
party when the lists are rented. The Company recognizes advertising revenue upon
notification of the airing of the advertisement by the media buying company
representing the Company. Allowances for future returns are based upon
historical experience and evaluation of current trends.
2
Shipping and Handling Revenue and Costs
Amounts paid to the Company for shipping and handling by customers is included
in sales. Amounts the Company incurs for shipping and handling costs are
included in cost of sales. The Company recognizes shipping and handling revenue
upon shipment of merchandise. Shipping and handling expenses are recognized on a
monthly basis from invoices from the third party fulfillment houses, which
provide the services.
Cost of Sales
Cost of sales includes the following:
o Product costs (including free audiobooks in the initial enrollment offer
to prospective members)
o Royalties to publishers and rightsholders
o Fulfillment costs, including shipping and handling
o Customer service
o Direct response billing, collection and accounts receivable management
Cooperative Advertising and Related Selling Expenses
In November 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)", which addresses the income statement
classification of certain credits, allowances, adjustments, and payments given
to customers for the services or benefits provided. The Company adopted EITF No.
01-9 effective January 1, 2002, and, as such, has classified the cost of these
sales incentives as a reduction of net sales. The effect on net sales of
applying EITF No. 01-9 in 2003 and 2002 was $60 and $118, respectively.
Bad Debt Expense
The Company records an estimate of its anticipated bad debt expense based on
historical experience.
General and Administrative Costs
General and administrative costs include the following:
o Payroll and related items
o Commissions
o Insurance
o Office expenses
o Telephone and postage
o Public and investor relations
o Dues and subscriptions
o Rent and utilities
o Travel and entertainment
o Bank charges
o Professional fees, principally legal and auditing fees
o Consulting
Stock-Based Compensation
The Company accounts for its stock-based compensation plans using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". Accordingly, no stock-based employee
compensation cost has been recognized in the financial statements as all options
granted under the Company's stock option plan, had an exercise price at least
equal to the market value of the underlying common stock on the date of grant.
The pro forma information below is based on provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure", issued in
December 2002.
S-3
YEAR ENDED DECEMBER 31,
2003 2002 2001
------------------ ------------------- -------------------
Net loss applicable to common shares, as reported ($6,869) ($2,510) ($5,405)
Add: Stock-based employee compensation expense included in
reported net income applicable to common shares, net of
related tax effects -- -- --
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related
tax effects (1,486) (1,245) (163)
------------------ ------------------- -------------------
Pro forma net loss applicable to common shares ($8,355) ($3,755) ($5,568)
================== =================== ===================
Net loss per share:
Basic and diluted-as reported ($0.49) ($0.18) ($0.39)
================== =================== ===================
Basic and diluted-pro forma ($0.60) ($0.27) ($0.40)
================== =================== ===================
Income Taxes
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which temporary timing
differences become deductible. Although realization of net deferred tax assets
is not assured, management has determined that it is more likely than not that a
portion of the Company's deferred tax asset relating to temporary differences
between the tax bases of assets or liabilities and their reported amounts in the
financial statements will be realized in future periods. The Company determines
the utilization of deferred tax assets in the future based on current year
projections by management.
At December 31, 2003, the Company had a remaining net deferred tax asset in the
amount of $14.8 million. Should management determine it would be able to realize
deferred tax assets in the future in excess of the net recorded amount, an
adjustment to its deferred tax asset would increase income in the period such
determination is made. Likewise, should management determine that it will not be
able to realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be recorded as an increase to the
valuation allowance, resulting in a deferred tax expense charged against income
in the period such determination is made.
S-4
Deferred Member Acquisition Costs
Promotional costs directed at current members are expensed on the date the
promotional materials are mailed. The cost of any premiums, gifts or the
discounted audiobooks in the promotional offer to new members is expensed as
incurred. The Company accounts for direct response advertising for the
acquisition of new members in accordance with AICPA Statement of Position 93-7,
"Reporting on Advertising Costs" ("SOP 93-7"). SOP 93-7 states that the cost of
direct response advertising (a) whose primary purpose is to elicit sales to
customers who could be shown to have responded specifically to the advertising
and (b) that results in probable future benefits should be reported as assets
net of accumulated amortization. Accordingly, the Company has capitalized direct
response advertising costs and amortizes these costs over the period of future
benefit (the average member life), which has been determined to be generally 30
months. The costs are being amortized on accelerated basis consistent with the
recognition of related revenue. In the fourth quarter of 2003, the Company
adjusted the amortization period for advertising to attract customers to its
World's Greatest Old-Time Radio continuity program and revised the estimate
period for amortization of these advertising costs down to 18 months, which
resulted in an increase in advertising expenses for the year ended December 31,
2003 of $409.
Royalties
The Company is liable for royalties to licensors based upon revenue earned from
the respective licensed product. The Company pays certain of its publishers and
other rightsholders advances for rights to products. Royalties earned on the
sale of the products are payable only in excess of the amount of the advance.
Advances, which have not been recovered through earned royalties, are recorded
as an asset. Advances not expected to be recovered through royalties on sales
are charged to royalty expense.
Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from these estimates.
On an ongoing basis, management reviews its estimates based on current available
information. Changes in facts and circumstances may result in revised estimate.
(3) ASSET WRITE-DOWNS AND STRATEGIC CHARGES
In the fourth quarter of 2003, the Company evaluated the performance of Audio
Passages, an Audio Book Club marketing program tailored to listeners with an
interest in Christian product and determined based on past performance and
expected future performance that it should terminate the Audio Passages
marketing program. In connection with the termination of the Audio Passages
marketing program, the Company took a strategic charge for the establishment of
a reserve for obsolescence of Audio Passages inventory of $285 and an assets
write-down for previously capitalized advertising, which will no longer recover
of $464.
In the third quarter of 2001, the Company began to implement a series of actions
and decisions designed to improve gross profit margin, refine its marketing
efforts and reduce general and administrative costs. Specifically, the Company
reduced the number of items offered for sale at both its Radio Spirits and Audio
Book Club subsidiaries, has moved fulfillment of its old-time radio products to
a third party fulfillment provider, limited its investment and marketing efforts
in downloadable audio and refined its marketing of old-time radio products and
its marketing efforts to existing Audio Book Club members. In connection with
the movement of the fulfillment of old-time radio products to a third party
provider, the Company closed its old-time radio operations in Schaumburg,
Illinois in February 2002 and runs all of its operations from its corporate
headquarters located in Cedar Knolls, New Jersey. The Company has also reviewed
its general and administrative costs and has eliminated certain activities
unrelated to its old-time radio and Audio Book Club operations.
S-5
As a result of these decisions in the third quarter of 2001, the Company
recorded $11,276 of strategic charges. These charges include the following:
o $2,261 of inventory written down to net realizable value due to a
reduction in the number of stock keeping units (SKU's);
o $2,389 of write-downs to deferred member acquisition costs at Audio Book
Club related to new member acquisition campaigns that have been determined
to be no longer profitable and recoverable through future operations based
upon historical performance and future projections;
o $1,885 of write-downs to royalty advances paid to audiobook publishers and
other license holders primarily associated with inventory titles that will
no longer be carried and sold to members;
o $1,582 of write-downs to deferred member acquisition costs at Radio
Spirits related to old-time radio new customer acquisition campaigns that
have been determined to be no longer profitable and recoverable through
future operations based upon historical performance and future
projections;
o a write-down of $683 of customer lists acquired in the Columbia House
Audiobook Club purchase due to the inability to recover this asset through
future operations;
o $635 of fixed assets of the Old-Time Radio operations written down to net
realizable value due to the closing of the Schaumburg, Illinois facility;
o $464 of write-downs of royalty advances paid for downloadable licensing
rights that are no longer recoverable due to the strategic decisions made;
o $357 of write-downs of prepaid assets,
o $297 of write-offs to receivables
o $192 of net write-offs of capitalized website development costs related to
downloadable audio all of which are no longer recoverable due to the
strategic changes in the business; and
o $531 accrued for lease termination costs in connection with the closing of
the Schaumburg, Illinois facility.
o Of these charges, $2,261 related to inventory write-downs has been
recorded to costs of -ales - write-downs, $3,971 has been recorded to
advertising and promotion - write-downs and the remaining $5,044 has been
recorded to asset write-downs and strategic charges.
In addition to these strategic charges, in 2001, the Company recorded a charge
of $2,000 to write-off the entire carrying amount of its cost method investment
in I-Jam. This charge has been recorded to asset write-downs and strategic
charges. The Company has determined that an other than temporary decline in the
value of this investment has occurred in 2001 triggered by a strategic change in
the direction of the investee as a result of continued losses and operating
deficiencies, along with projected future losses.
S-6
(4) FIXED ASSETS
Fixed Assets consist of the following as of December 31,:
2003 2002
--------- ---------
Capital leases, equipment and related software...........................$ 825 $ 813
Furniture and fixtures................................................... 82 80
Leasehold improvements................................................... 74 73
Web site development costs............................................... 57 57
--------- ---------
Total.................................................................... 1,038 1,023
Accumulated depreciation................................................. (811) (665)
--------- ---------
$ 227 $ 358
========= =========
Depreciation expense for the years ended December 31, 2003, 2002 and 2001 was
$146, $221 and $601, respectively.
(5) ASSET ACQUISITIONS
On March 1, 2002, the Company acquired inventory, licensing agreements and
certain other assets, used by Great American Audio in connection with its
old-time radio business, including the exclusive license to "The Shadow" radio
programs. The Company expended $379 in cash at closing, including fees and
expenses. Additional payments of nine monthly installments of $74 commenced on
June 15, 2002. Other costs related to the asset purchase were $39. The
allocation of asset value was as follows:
Other assets $ 5
Net Inventory 60
Royalty Advances (The Shadow) 10
Goodwill 1,009
-------------
Total $1,084
=============
(6) GOODWILL AND OTHER INTANGIBLES
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The Company adopted
SFAS 142 on January 1, 2002. SFAS 142 changed the accounting for goodwill and
indefinite-lived intangible assets from an amortization method to an
impairment-only approach. Goodwill and indefinite-lived intangible assets are
tested for impairment annually or when certain triggering events require such
tests and are written down, with a resulting charge to operations, only in the
period in which the recorded value of goodwill and indefinite-lived intangible
assets is more than their fair value.
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets", the
Company ceased amortization of goodwill as of January 1, 2002. The following
table presents annual results of the Company on a comparable basis:
FOR THE YEAR ENDED DECEMBER 31,
2003 2002 2001
-------- -------- --------
NET INCOME (LOSS):
Reported net loss applicable to common shares $ (6,869) $ (2,510) $ (5,405)
Goodwill amortization --- --- 509
-------- -------- --------
Adjusted net loss $ (6,869) $ (2,510) $ (4,896)
======== ======== ========
BASIC AND DILUTED LOSS PER COMMON SHARE:
Reported basic and diluted loss per common share $ (.49) $ (.18) $ (.39)
Goodwill amortization --- --- .04
-------- -------- -------
Adjusted basic and diluted loss per common share $ (.49) $ (.18) $ (.35)
======== ======== =======
S-7
SFAS 142 requires the Company to perform an evaluation of whether goodwill is
impaired as of January 1, 2002, the effective date of the statement for the
Company. The Company completed the transitional impairment test as of January 1,
2002, and its annual impairment tests as of October 31, 2003 and 2002, none of
which resulted in an impairment loss. Any future impairment losses incurred will
be reported in operating results.
The following is a reconciliation of changes in the carrying amounts of goodwill
for the Radio Spirits reportable segment for each of 2003 and 2002:
2003 2002
Balance at January 1, $ 9,871 $ 8,649
Goodwill acquired during the year -- 1,222
Finalization of GAA asset purchase allocation (213) --
--------- --------
Ending Balance $ 9,658 $ 9,871
========= ========
During the fourth quarter of 2002, the Company reviewed the carrying amounts of
its intangible assets and determined, based on decisions made in the fourth
quarter of 2002, that the value of certain intangible assets could no longer be
supported by anticipated future operations. Specifically, the Company made a
strategic decision to no longer compete in the DVD market and accordingly wrote
off the value of certain video and DVD rights it had acquired in the amount of
$90. The Company also made the strategic decision in the fourth quarter of 2002
to discontinue future mailings to the Columbia House lists of members of other
clubs, which could not support the remaining carrying value of the Columbia
House mailing agreement. Accordingly, in the fourth quarter of 2002, the Company
wrote off the remaining value of the Columbia House mailing agreement of $986.
Amortization of intangible assets was $181, $1,093 and $4,027 for the years
ended December 31, 2003, 2002 and 2001, respectively. The Company estimates
intangible amortization expenses of $54 in 2004.
The following table presents details of other intangibles at December 31, 2003
and December 31, 2002:
DECEMBER 31,2003 DECEMBER 31, 2002
----------------------------------- ----------------------------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION NET COST AMORTIZATION NET
-------- -------- -------- -------- -------- --------
Mailing Agreements $ 592 $ 592 $ -- $ 592 $ 524 $ 68
Customer Lists 4,380 4,380 -- 4,380 4,380 --
Non-Compete Agreements 313 264 49 200 151 49
Other 5 -- 5 5 -- 5
-------- -------- -------- -------- -------- --------
Total Other Intangibles $ 5,290 $ 5,236 $ 54 $ 5,177 $ 5,055 $ 122
======== ========= ======== ======== ======== ========
(7) DEBT
AS OF DECEMBER 31, 2003 2002
------------- -------------
Credit agreement, senior secured bank debt................................. $ 2,925 $ 4,540
Note to Seller of GAA assets............................................... -- 148
Subordinated debt.......................................................... 3,200 3,200
October 2004 Notes and related accrued interest, net of original issue
discount................................................................... 982 --
Related party notes and related accrued interest, net of original issue
discount................................................................... 10,643 9,160
------------- -------------
17,750 17,048
Less: current maturities................................................... (17,750) (2,368)
------------- -------------
$ -- $14,680
============= =============
8
Senior Credit Facility
Since November 1999, the Company has not been permitted to make any additional
borrowings under the Credit Agreement. The interest rate on the credit facility
is equal to the prime rate p1/2 2 1/2%. The weighted average interest rate for
the years ended December 31, 2003 and 2002 was 6.44% and 6.76%, respectively.
In January and February 2004, the Company made principal payments of $1,538 and
the balance of Senior Credit Facility as of April 12, 2004 is $1,387. The
maturity date of the Senior Credit Facility was extended to September 30, 2004;
provided however, that the Company is required to make monthly payments of
principal of $107 through August 2004.
The Company was in compliance with its debt covenants at December 31, 2003.
Subordinated Debt
In August 2002, ABC Investment LLC, a third party holder of subordinated debt
converted principal amount of $1,000 into 200,000 shares of the Company's common
stock. At December 31, 2003, the principal amount of the subordinated debt held
by ABC Investment LLC is $3,200. The note is currently convertible into shares
of common stock at the rate of $3.04 per share, subject to adjustment for below
conversion price issuances of securities. The note bears interest at the rate of
9% per annum, quarterly, in arrears. The note is due December 31, 2004. The
Company is prohibited from incurring additional indebtedness (with exceptions),
selling all or substantially all of its assets and materially changing the
nature of its business without the prior written consent of the holder of this
note.
October 2003 Notes
On October 1, 2003, the Company issued $1,065 principal amount of notes due
October 1, 2004. The notes bear interest at the rate of 18%, provide for accrual
of interest to maturity and have no prepayment penalty. In connection with the
issuance of the notes, the Company issued to the investors, five year warrants
to purchase 266,250 shares of MediaBay common stock at an exercise price of
$0.80, the closing price of the stock on September 30, 2003. The Company agreed
to issue the investors warrants to purchase an additional 266,250 shares of
MediaBay common stock on April 1, 2004, if the notes have not been repaid. The
notes are due on October 1, 2004, however, if the Company raises more than
$5,000 million in financing prior to the maturity date of the notes, the
maturity date of the notes is accelerated. Carl Wolf and a company wholly owned
by Norton Herrick each purchased $100 principal amount of the notes.
Related Party Debt
NH Irrevocable ABC Trust
The Trust holds a $500 principal amount 9% Convertible Senior Subordinated
Promissory Note due September 30, 2007, except that the holder may demand
repayment of the unpaid principal balance and interest on the note, commencing
December 31, 2004, if the Company has repaid all of its obligations under the
Senior Credit Agreement.
S-9
This note is convertible into shares of common stock at the rate of $.56 per
share, subject to adjustment for below conversion price issuances of securities.
This note bears interest at the rate of 9% per annum. Interest is payable
monthly, in arrears, in cash or, at the holder's option, shares of common stock;
provided, however, that cash interest accrues until 10 days after the Company
has repaid its obligations under the Senior Credit Agreement.
The Company is prohibited from incurring additional indebtedness (with
exceptions), selling all or substantially all of its assets and materially
changing the nature of its business without the prior written consent of the
holder of this note.
Norton Herrick
Norton Herrick holds a $1,984 principal amount Convertible Senior Subordinated
Promissory Note due September 30, 2007, except that the holder has the right to
demand repayment of the unpaid principal balance of, and interest on, the note
at any time on or after the later of (i) December 31, 2004 and (ii) the date on
which the Company has repaid all of our obligations under the Credit Agreement.
Interest on this note accrues at the rate of 11% per annum and is payable on a
monthly basis, at the holder's option, in cash or common stock; provided,
however, that cash interest accrues until 10 days after the Company has paid all
of our obligations under the Credit Agreement. This note is convertible into
shares of common stock at the rate of $.56 per share, subject to adjustment for
below conversion price issuances. This note is secured by a second lien on the
assets of Radio Spirits.
The Company is prohibited from incurring additional indebtedness (with
exceptions), selling all or substantially all of its assets and materially
changing the nature of its business without the prior written consent of the
holder of this note.
Huntingdon Corporation
Huntingdon Corporation, a company wholly owned by Norton Herrick, holds the
following promissory notes:
o $2,500 principal amount Convertible Senior Promissory Note (the
"$2,500 Note") entered into on May 14, 2001;
o $800 principal amount Convertible Senior Subordinated Promissory
Note (the "$800 Note") entered into on May 14, 2001;
o $500 principal amount Convertible Senior Promissory Note (the "$500
Note") entered into on February 22, 2002;
o $1,000 principal amount Convertible Senior Promissory Note (the
"$1,000 Note") entered into on October 3, 2002;
o $150 principal amount Convertible Senior Promissory Note (the "$150
Note") entered into on October 10, 2002; and
o $350 principal amount Convertible Senior Promissory Note (the "$350
Note") entered into on November 15, 2002.
Each of the notes held by Huntingdon are due September 30, 2007, provided that
the holder has the right, at any time on or after the date on which the Company
has repaid all of our obligations under the Credit Agreement, to demand
repayment of the unpaid principal balance of and interest on the note; provided,
however that, with respect to the $800 Note, such demand can not be made until
the (90th) day after the Company has repaid all of our obligations under the
Credit Agreement.
10
Each of the $2,500 Note and $500 Note bears interest at an annual rate equal to
the prime rate plus 2%, the $800 Note bears interest at the rate of 12% per
annum and each of the $1,000 Note, $150 Note and $350 Note bears interest at an
annual rate equal to the prime rate plus 2 1/2%. Interest is payable under each
note monthly, in arrears, in cash, or at the holder's option, in lieu of cash,
in shares of common stock or in kind, provided, however, that cash interest
accrues until 10 days after the Company has paid all of our obligations under
the Credit Agreement. Interest accrues on unpaid interest under each note (since
October 3, 2002 in the case of the $2,500 Note, the $500 Note and the $800 Note)
at the respective interest rate of such note.
The $2,500 Note, and the $800 Note are convertible into shares of common stock
at the rate of $.56 per share, subject to adjustment for below conversion price
issuances of securities. The $500 Note is convertible at $2.00. Each of the
$1,000 Note and the $150 Note is convertible into shares of common stock at the
rate of $1.82 per share, and the $350 Note is convertible into shares of common
stock at the rate of $1.25 per share. The Company agreed as consideration for
Norton Herrick and Huntingdon consenting to a January 2004 financing and
granting certain rights to investors in the January 2004 financing that the
Company would seek shareholder approval to reduce the conversion rate of $1,000
note, the $150 note and the $500 note to $1.27. The Company's Board of Directors
has determined to recommend to its shareholders to approve the foregoing and
intends to submit a proposal for shareholder approval at its 2004 annual meeting
of shareholders.
All of the notes held by Huntingdon are secured by a lien on a pari passu basis
to the senior credit facility on substantially all of the assets of the Company
and our subsidiaries, other than inventory, receivables and cash of the Company
and our subsidiaries.
The Company is prohibited from incurring indebtedness (with exceptions), selling
all or substantially all of its assets and materially changing the nature of its
business without the prior written consent of the holder of the notes.
The Company has recorded original debt discount of $131 relating to the $1,000
Note, the $150 Note and the $350 Note representing the value of the Notes
ascribed to warrants granted in the financings. The Company has determined
because the conversion price was significantly higher than the market price on
the dates of grant, that there was no beneficial conversion feature.
The future minimum loan payments are as follows:
Year Ending December 31,
2004................................................. $ 18,024
---------
Total maturities, including debt discount of $274.... $ 18,024
=========
(9) COMMITMENTS AND CONTINGENCIES
Rent expense for the years ended December 31, 2003, 2002 and 2001 amounted to
$180, $291 and $272, respectively.
Operating Leases
The Company leases approximately 12,000 square feet of office space in Cedar
Knolls, New Jersey pursuant to a sixty-six month lease agreement dated April 18,
2003. The Company entered into two ten-year leases on 7,000 square feet of
office and warehouse space in Bethel, Connecticut and 3,000 square feet of
warehouse space in Sandy Hook, Connecticut, respectively. Lease payments and
mandatory capital improvement payments, starting in 2004, are $4,000 per year
and $2,000 per year on the Bethel and Sandy Hook properties, respectively.
S-11
Minimum annual lease commitments including capital improvement payments under
all non-cancelable operating leases are as follows:
Year ending December 31,
2004............................................... $ 163
2005............................................... 191
2006............................................... 194
2007............................................... 203
2008............................................... 203
Thereafter......................................... 10
Total lease commitments............................ ------
$ 964
======
Capitalized Leases
Payments under capitalized lease obligations are $53 and $18 for the years
ending December 31, 2004, 2005 and 2006, respectively.
During the year ended December 31, 2003, the Company had two capital leases.
Lease payments under these agreement were $53, $53 and $40 in 2003, 2002 and
2001, respectively. The amount of equipment capitalized under the leases and
included in fixed assets is $330 and net of depreciation the fixed asset balance
is $94 and $156 at December 31, 2003 and 2002, respectively. The obligations
under the leases included in accounts payable and accrued expenses on the
consolidated balance sheets at December 31, 2003 and 2002 were $71 and $112,
respectively.
Minimum annual lease commitments under capital leases are as follows:
2004.................................................. $ 53
2005.................................................. 18
-----
Total capital lease commitments....................... $ 71
=====
Employment Agreements
The Company has commitments pursuant to employment agreements with certain of
its officers. The Company's minimum aggregate commitments under such employment
agreements are approximately $538, $446 and $75 during 2004, 2005 and 2006,
respectively.
Termination and Severance Agreements
Our minimum aggregate commitments under settlement payments under terminated
employment agreements and a terminated consulting agreement are $201,000 in 2004
and $30,000 in 2005.
Licensing Agreements
The Company has numerous licensing agreements for both audiobooks and old-time
radio shows with terms generally ranging from one to five years, which require
the Company to pay, in some instances, non-refundable advances upon signing
agreements, against future royalties. The Company is required to pay royalties
based on net sales. Royalty expenses were $2,524, $3,243 and $3,199 for 2003,
2002 and 2001, respectively. Minimum advances required to be paid under existing
agreements for the next five years are as follows:
2004 $ 459
2005 347
2006 228
2007 354
2008 85
2009 14
------
Total $1,487
======
S-12
Litigation
The Company is not a defendant in any litigation. In the normal course of
business, the Company is subject to threats of litigation. The Company does not
believe that the potential impact of any threatened litigation, if ultimately
litigated, will have a material adverse effect on the Company.
(10) STOCK OPTION AND STOCK INCENTIVE PLANS
In June 1997, the Company adopted the 1997 Stock Option Plan, pursuant to which
the Company's Board of Directors may grant stock options to key employees of the
Company. In June 1998, the Company amended the 1997 Stock Option Plan to
authorize the grant of up to 2,000,000 shares of authorized but unissued common
stock.
In March 1999, the Company's stockholders approved an amendment to the Company's
Articles of Incorporation adopting the Company's 1999 Stock Incentive Plan. The
1999 Stock Incentive Plan provides for grants of awards of stock options,
restricted stock, deferred stock or other stock based awards. A total of
2,500,000 shares of common stock have been reserved for issuance pursuant to the
plan.
In June 2000, the Company's shareholders adopted the Company's 2000 Stock
Incentive Plan, which provides for grants of awards of stock options, restricted
stock, deferred stock or other stock based awards. A total of 3,500,000 shares
of common stock have been reserved for issuance pursuant to the plan.
In October 2001, the Company's shareholders adopted the Company's 2001 Stock
Incentive Plan, which provides for grants of awards of stock options, restricted
stock, deferred stock or other stock based awards. A total of 3,500,000 shares
of common stock have been reserved for issuance pursuant to the plan.
Options under the Company's option plans expire at various times between 2003
and 2011. In accordance with the plans, options generally have terms of 5 to 10
years and vest from grant date to three years.
Stock option activity under the plans is as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
---------- ----------
Outstanding at January 1, 2001 6,653,100 $ 6.52
Granted 898,000 1.23
Exercised -- --
Canceled and expired (1,561,750) 9.01
---------- ----------
Outstanding at December 31, 2001 5,989,350 5.06
Granted 1,205,000 2.27
Exercised (151,000) .51
Canceled and expired (748,750) 6.95
---------- ----------
Outstanding at December 31, 2002 6,294,600 4.39
Granted 3,593,781 1.05
Exercised (300,000) .50
Canceled and expired (1,777,500) 4.73
---------- ----------
Outstanding at December 31. 2003 7,810,881 $2.92
========== ==========
S-13
Norton Herrick exercised options to purchase 300,000 shares of the Company's
common stock under an option granted to him on November 23, 2001.
The per share weighted-average fair value of stock options granted during the
years ended December 31, 2002, 2001 and 2000 is as follows using an accepted
option-pricing model with the following assumptions and no dividend yield. The
shares were granted as follows:
NO. OF EXERCISE ASSUMED RISK-FREE FAIR VALUE
SHARES PRICE VOLATILITY INTEREST RATE PER SHARE
DATE
2001 GRANTS:
First Quarter -- $-- -- -- $ --
Second Quarter 84,000 2.07 165% 4.81% 0.12
Third Quarter 6,000 2.00 165% 4.63% 0.14
Fourth Quarter 808,000 1.14 165% 4.85% 0.19
----------
Total 898,000
==========
2002 GRANTS:
First Quarter 250,000 2.70 159% 4.42% $1.25
Second Quarter -- -- -- -- --
Third Quarter 40,000 4.44 159% 3.46% 3.31
Fourth Quarter 915,000 2.06 159% 3.08% 0.87
-----------
1,205,000
===========
2003 GRANTS:
First Quarter 40,000 $1.50 165% 4.85% $.90
Second Quarter -- -- -- -- --
Third Quarter 2,173,856 .97 165% 4.85% 0.29
Fourth Quarter 1,379,925 1.17 97% 4.00% 0.67
-----------
Total 3,593,781
===========
The following table summarizes information for options outstanding and
exercisable at December 31, 2003:
OPTIONS EXERCISABLE
OPTIONS OUTSTANDING WEIGHTED -------------------------------------
WEIGHTED AVERAGE AVERAGE WEIGHTED AVERAGE
RANGE OF PRICES NUMBER REMAINING LIFE IN YEARS EXERCISE PRICE NUMBER EXERCISE PRICE
---------------- ---------------------------------------------- ---------------------------------- -------------------------
$0.50-1.00 2,059,856 5.35 $ 0.86 580,856 $ 0.82
$1.01-3.00 2,330,425 5.98 1.27 637,500 1.44
$3.01-5.00 2,723,000 5.56 3.91 2,409,000 3.98
$5.01-14.88 697,600 4.50 10.69 672,850 10.84
---------------- ---------------------------------------------- ---------------------------------- ------------------------
$0.50 -14.88 7,810,881 5.54 $ 2.92 4,300,206 $ 4.25
================ ============================================== ================================== ========================
S-14
At December 31, 2003, there were 1,664,500 additional shares available for grant
under the 1997 Plan, 581,369 additional shares available for grant under the
1999 Plan, 1,035,250 additional shares available for grant under the 2000 Plan
and 408,000 available for grant under the 2001 Plan. There was no compensation
expense recorded in connection with these plans in each of the years ended
December 31, 2003, 2002, and 2001.
(11) WARRANTS AND NON-PLAN OPTIONS
The Company granted non-plan options and warrants to purchase a total of 456,250
shares of the Company's common stock, 381,250 of which vested in 2003, to
consultants and advisors. During the year ended December 31, 2003, warrants to
purchase 1,875,000 of the Company's common stock were canceled and warrants to
purchase 1,808,649 shares of the Company's common stock expired.
The following table summarizes information for warrants and non-plan options
outstanding and exercisable at December 31, 2002:
OPTIONS EXERCISABLE
OPTIONS OUTSTANDING WEIGHTED -------------------------------------
WEIGHTED AVERAGE AVERAGE WEIGHTED AVERAGE
RANGE OF PRICES NUMBER REMAINING LIFE IN YEARS EXERCISE PRICE NUMBER EXERCISE PRICE
---------------- ---------------------------------------------- ---------------------------------- -------------------------
$0.10-1.00 374,250 3.90 $ 0.84 249,250 $ 0.79
$1.01-3.00 517,500 7.98 1.86 517,500 1.86
$3.01-14.20 399,940 2.27 10.68 349,940 11.49
--------------- ------------------ -------------------------- ---------------- ---------------- -----------------------
$0.50-14.20 1,291,690 5.03 $ 4.29 1,116,690 $ 4.64
================ ============================================== ================================== ========================
(12) LITIGATION SETTLEMENT
In December 1998 the Company acquired certain assets from a third party. The
parties also entered into certain other agreements including a mailing agreement
and a non-compete agreement. As consideration for the assets acquired and the
related transactions, including the mailing agreement and the non-compete
agreement, the third party received cash consideration of $30,750 and an
aggregate of 325,000 shares of the Company's common stock"(the "shares") and
warrants to purchase an additional 100,000 shares of the Company's common stock.
The parties also entered into a Registration and Shareholder Rights Agreement
pursuant to which, the Company granted the third party the right under certain
circumstances, commencing December 31, 2004, to require the Company to purchase
from the third party the Shares at a price of $15.00 per Share.
In 2001, the Company commenced litigation alleging, among other things, that the
Company was fraudulently induced to purchase certain of the assets. On June 16,
2003, Audio Book Club, Inc. ("ABC"), a wholly owned subsidiary of MediaBay
entered into a settlement agreement with respect to the lawsuit. Pursuant to the
settlement agreement, ABC received $350 in cash, the return for cancellation of
325,000 shares of MediaBay common stock issued in connection with the
acquisition and the termination of put rights granted to the seller in the
acquisition with respect to 230,000 of the shares (put rights with respect to
the remaining 95,000 shares had previously terminated). The termination of the
put rights terminated a $3,450 future contingent obligation of MediaBay and
results in a corresponding increase in stockholders' equity.
The calculation of the settlement of litigation recorded in Contributed Capital
is as follows:
Termination of contingent put rights $3,450
Return for cancellation of 325,000 shares of common stock 247
Cash received 350
---------
Total received in settlement of litigation 4,047
Legal and other costs incurred in connection with the litigation 1,027
---------
Settlement of litigation recorded in Contributed Capital $3,020
=========
S-15
(13) COMMON STOCK SUBJECT TO CONTINGENT PUT RIGHTS
In connection with an acquisition made in December 1998, the Company agreed to
repurchase certain shares issued to the seller at various prices ranging from
$7.00 to $15.00. The repurchase obligation would expire based on the stock
reaching the repurchase price for a period of 10 consecutive trading days. The
Company has asserted that the price targets were maintained and that the
obligation has expired. The seller has disputed this assertion and asserts that
the right to put 25,000 shares at a price of $14.00 per share beginning on
December 31, 2003 and 50,000 shares at a price of $15.00 per share beginning on
December 31, 2005. The seller has demanded the repurchase of the 25,000 shares
for $350,000.
(14) EQUITY
Series B Convertible Preferred Stock
On May 7, 2003, the Company sold 3,350 shares of a newly created Series B
Convertible Preferred Stock (the "Series B Stock") with a liquidation preference
of $100 per share for $335. Of the total sold, 1,400 shares ($140) were
purchased by Carl Wolf, Chairman and a director of the Company, and 200 shares
($20) were purchased by John Levy, Executive Vice President and Chief Financial
Officer of the Company. The holders of shares of Series B Convertible Preferred
Stock will receive dividends at the rate of $9.00 per share, payable quarterly,
in arrears, in cash on each March 31, June 30, September 30 and December 31;
provided that payment will accrue until the Company is permitted to make such
payment in cash under its Agreement with its senior lender.
The Series B Stock is convertible into shares of Common Stock into MediaBay
Common Stock at a conversion rate equal to a fraction, (i) the numerator of
which is equal to the number of Series B Stock times $100 plus accrued and
unpaid dividends though the date of conversion and (ii) the denominator is
$0.77, the average price of the Company's stock on May 6, 2003.
In the event of a liquidation, dissolution or winding up of the Company, the
holders of Series B Stock shall be entitled to receive out of the assets of the
Company, a sum in cash equal to $100.00 per share before any amounts are paid to
the holders of the Company common stock and on a pari passu with the holders of
the Series A Convertible Preferred Stock. The holders of Series B Stock shall
have no voting rights, except as required by law and except that the vote or
consent of the holders of a majority of the outstanding shares of Series B
Stock, voting separately as a class, will be required for any amendment,
alteration or repeal of the terms of the Series B Stock that adversely effects
the rights, preferences or privileges of the Series B Stock.
Warrants Granted in Consideration for Non-Compete Agreements The Company also
issued non-plan warrants to purchase 90,000 shares of its common stock to a
former employee and consultant at prices ranging from $1.50 to $3.00 per share
as part of non-competition agreements. The value of the warrants of $23 was
computed using an acceptable valuation model and is being amortized over the
lives of the agreements.
S-16
Exercise of Options
On July 31, 2003, Norton Herrick exercised options to purchase 300,000 shares of
MediaBay common stock at an exercise price of $.50 per share pursuant to an
Option Agreement dated November 23, 2001. The options were exercised on a
"cash-less" basis and the closing stock price on July 31, 2003 was $.78.
Accordingly, the Company issued to Mr. Herrick a certificate for 107,692 shares
of MediaBay common stock.
Stock Issued to Consultants
During the year ended December 31, 2003, the Company issued 29,000 shares of
common stock to a consultant as partial consideration for organizational
management advisory services. The shares were valued at market on the dates of
the grants and an expense ($14) for the value of the shares is included in
general and administrative expenses.
Options Issued to Consultants
The Company issued 60,000 options under the Company's stock option plans and
150,000 non-plan warrants to advisors and consultants during the year ended
December 31, 2003 of which the 60,000 options and 75,000 warrants vested in
2003. The options and the vested warrants were valued at $26 using an accepted
valuation method and have been included in general and administrative expenses.
Stock and Options Tendered as Payment of Settlement
The Company entered into an agreement with Norton Herrick dated November 7, 2003
(the "November Agreement") whereby Mr. Herrick agreed to pay amounts owed to the
Company under Section 16(b) of the Securities Exchange Act of 1934 as a result
of various transactions which are attributable to Mr. Herrick occurring within
less than six months of each other that involved our securities. Mr. Herrick
agreed to pay the Company the sum of $1,742, (the "Payment") by delivering to
the Company for cancellation within ten (10) days of the date of the November
Agreement, shares of our common stock and/or warrants to purchase shares of
common stock of the Issuer with an aggregate value equal to the Payment. Under
the November Agreement, the value of each share of common stock delivered under
the Agreement is equal to the last sale price of our common stock on the trading
day immediately prior to the date on which the shares of common stock were
delivered (the "Market Price"). The value of any warrant delivered under the
November Agreement is equal to the Market Price of the underlying shares less
the exercise price of the warrant. Mr. Herrick delivered the shares of common
stock and warrants pursuant to the November Agreement on Monday, November 17,
2003, with the value of the securities based on the Market Price on November 14,
2003 of $.94 per share of common stock. As part of the Payment, Mr. Herrick
returned to the Company 1,095,372 shares of our common stock. Based on the
Market Price, the aggregate value of these shares is $1,030. Also, as part of
the Payment, Mr. Herrick deposited warrants to purchase 1,875,000 shares of our
common stock. Based on the Market Price ($.94) less the exercise price of the
warrants ($.56), the aggregate value of these warrants was $712. Of the
1,875,000 warrants deposited, 1,650,000 became exercisable May 14, 2001 and
225,000 became exercisable February 22, 2002.
Warrants Issued in Connection with Financing
In connection with the issuance of the $1,065 principal amount of notes due
October 1, 2004, described in Note 7, the Company issued to the investors, five
year warrants to purchase 266,250 shares of MediaBay common stock at an exercise
price of $0.80, the closing price of the stock on September 30, 2003. The
warrants were valued at $176, using an acceptable valuation method and the value
of the warrants is being amortized over the term of the notes. Carl Wolf and a
company wholly owned by Norton Herrick each purchased $100 principal amount of
the notes and each received 25,000 warrants.
S-17
Options Issued to Directors
During the year ended December 31, 2003, the Company issued options to purchase
335,000 shares of its common stock to its non-employee directors. Of the options
issued, 130,000 vested during 2003. The Company valued the vested options at $73
using an acceptable valuation method and recorded an expense for that amount in
general and administrative expenses.
Dividends
The terms of the Company's debt agreements prohibit the Company from declaring
or paying any dividends or distributions on the Company's common stock.
(14) INCOME TAXES
The Company's income tax provision for the years ended December 31, 2003, 2002
and 2001 includes a Federal deferred tax expense of $1,471, a Federal deferred
tax expense of $550 and a Federal deferred tax benefit of $17,200, respectively.
Income tax expense (benefit) for the years ended December 31, 2003, 2002 and
2001 differed from the amount computed by applying the U.S. Federal income tax
rate of 34% and the state income tax rate of 7% to the pre-tax loss as a result
of the following:
2003 2002 2001
----------------- ----------------- ----------------
Computed tax benefit $ (446) $ (797) $ (9,268)
Increase (decrease) in valuation allowance for
Federal and State deferred tax assets 1,917 1,347 (7,932)
----------------- ----------------- ----------------
Income tax expenses (benefit) $ 1,471 $ 550 $ (17,200)
================= ================= ================
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which those temporary timing
differences become deductible. Although realization of net deferred tax assets
is not assured, management has determined that it is more likely than not that a
portion of the Company's deferred tax asset relating to temporary differences
between the tax bases of assets or liabilities and their reported amounts in the
financial statements will be realized in future periods. Accordingly, in 2001,
the Company reduced the valuation allowance for deferred tax assets in the
amount of $17,200 and recorded an income tax benefit. In 2003, the deferred tax
asset was reduced by approximately $1,471 for amounts, which the Company was
unable to determine would be recoverable in future periods.
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets are as follows:
Deferred tax assets:
2003 2002
------------ ------------
Federal and state net operating loss carry-forwards $ 22,362 $ 22,224
Loss in I-Jam, LLC 85 85
Accounts receivable, principally due to allowance for doubtful accounts and
reserve for returns 1,408 1,668
Inventory, principally due to reserve for obsolescence 584 475
Fixed assets/Intangibles 13,984 13,725
Beneficial conversion feature 156 (42)
------------ -----------
Total net deferred tax assets 38,579 38,135
Less valuation allowance (23,826) (21,911)
------------ -----------
Net deferred tax assets $ 14,753 $ 16,224
============ ===========
S-18
The Company has approximately $54,660 of net operating loss carry-forwards,
which may be used to offset possible future earnings, if any, in computing
future income tax liabilities. The net operating losses will expire between
December 31, 2018 and December 31, 2023 for federal income tax purposes. For
state purposes, the net operating losses will expire at varying times between
2006 and 2013, as the Company is subject to corporate income tax in several
states. Under Section 382 of the Internal Revenue Code of 1986, utilization of
prior net operating losses is limited after an ownership change, as defined in
Section 382, to an annual amount equal to the value of the corporation's
outstanding stock immediately before the date of the ownership change multiplied
by the long-term tax exempt rate. The equity financing the Company obtained in
2000 and 2004 may result in an ownership change and, thus, may limit the use of
prior net operating losses.
(15) NET LOSS PER SHARE OF COMMON STOCK
Basic net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding during the applicable reporting
periods. The computation of diluted net loss per share is similar to the
computation of basic loss per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued.
Basic and diluted loss per share were computed using the weighted average number
of shares outstanding for the years ended December 31, 2003, 2002 and 2001 of
14,098, 14,086 and 13,862, respectively.
Common equivalent shares of 16,969 including 15,909 relating to convertible
subordinated debt and convertible preferred stock were not included in the
calculation of fully diluted shares because they were anti-dilutive. Interest
expense and dividends on the convertible subordinated debt and convertible
preferred stock that were not added back to net loss were $1,150 for the year
ended December 31, 2003.
Common equivalent shares of 17,916 including 15,913 relating to convertible
subordinated debt and convertible preferred stock were not included in the
calculation of fully diluted shares because they were anti-dilutive. Interest
expense and dividends on the convertible subordinated debt and convertible
preferred stock that were not added back to net loss were $1,134 for the year
ended December 31, 2002.
Common equivalent shares totaling 11,787, including 11,520 shares associated
with the conversion of $12,484 of convertible debt and the related reduction in
interest expense for the twelve-month period ended December 31, 2001 of $1,070,
were not included in the computation of diluted loss per share for the year
ended December 31, 2001 because they would have been anti-dilutive.
(16) SUPPLEMENTAL CASH FLOW INFORMATION
No cash has been expended for income taxes for the years ended December 31,
2003, 2002 and 2001. Cash expended for interest was $537, $766 and $1,095 for
the years ended December 31, 2003, 2002 and 2001, respectively.
The Company had the following non-cash activities for the years ended December
31, 2003, 2002, and 2001:
2003 2002 2001
-------- -------- --------
E-Data patent rights acquisition....................................... $ -- $ 75 $ --
Conversions of subordinated notes into common shares................... __ 1,000 __
Conversion of notes into preferred shares.............................. __ 2,500 --
Stock tendered as payment for exercise of options...................... 150 75 --
Settlement of litigation............................................... 3,697 -- --
S-19
(17) RELATED PARTY TRANSACTIONS
Companies wholly owned by Norton Herrick, a principal shareholder, have in the
past provided accounting, administrative, legal and general office services to
the Company at cost since its inception. Companies wholly owned by Norton
Herrick have also assisted the Company in obtaining insurance coverage without
remuneration. The Company paid or accrued to these entities $88, $430 and $292
for these services during the years ended December 31, 2001, 2002 and 2003,
respectively. In addition, a company wholly owned by Norton Herrick provided the
Company access to a corporate airplane during 2001 and 2002. The Company
generally paid the fuel, fees and other costs related to its use of the airplane
directly to the service providers. For use of this airplane, the Company paid
rental fees of approximately $14 in each of 2001 and 2002 to Mr. Herrick's
affiliate. As of December 31, 2003 the Company owed to Mr. Herrick and his
affiliates $895 for reimbursement of such expenses and services.
On May 1, 2003, the Company entered into a two-year consulting agreement with
XNH Consulting Services, Inc. ("XNH"), a company wholly-owned by Norton Herrick.
The agreement provides, among other things that XNH will provide consulting and
advisory services to the Company and that XNH will be under the direct
supervision of the Company's Board of Directors. For its services, the Company
agreed to pay XNH a fee of $8 per month and to provide Mr. Herrick with health
insurance and other benefits applicable to its officers to the extent such
benefits may be provided under the Company's benefit plans. The consulting
agreement provides that the indemnification agreement with Mr. Herrick entered
into on November 15, 2002 pursuant to which, the Company agreed to indemnify Mr.
Herrick to the maximum extent permitted by the corporate laws of the State of
Florida or, if more favorable, the Company's Articles of Incorporation and
By-Laws in effect at the time the agreement was executed, against all claims (as
defined in the agreement) arising from or out of or related to Mr. Herrick's
services as an officer, director, employee, consultant or agent of the Company
or any subsidiary or in any other capacity shall remain in full force and effect
and to also indemnify XNH on the same basis. Mr. Herrick resigned as the
Company's Chairman effective May 1, 2003 and the Company and Mr. Herrick
terminated the employment agreement signed as of November 2, 2002 on May 1,
2003.
Effective December 31, 2003, the Company agreed with Norton Herrick to the
consulting agreement with XNH. In connection with the termination, the Company
agreed to pay XNH a fee of $7.5 per month for 16 months commencing on January 1,
2004 and to provide Mr. Herrick with health insurance and other benefits
applicable to our officers to the extent such benefits may be provided under our
benefit plans. The termination agreement provides that the indemnification
agreement with Mr. Herrick shall remain in full force and effect and to also
indemnify XNH on the same basis. In connection with the termination agreement
Herrick and XNH agreed that the non-competition and nondisclosure covenants of
the XNH consulting agreement were extended to survive until December 31, 2006.
On May 7, 2003, the Company sold 3,350 shares of a newly created Series B
Convertible Preferred Stock (the "Series B Stock") with a liquidation preference
of $100 per share for $335. Of the total sold, 1,400 shares ($140), were
purchased by Carl Wolf, Chairman and a director of the Company, and 200 shares
($20) were purchased by John Levy, Executive Vice President and Chief Financial
Officer of the Company. The holders of shares of Series B Convertible Preferred
Stock will receive dividends at the rate of $9.00 per share, payable quarterly,
in arrears, in cash on each March 31, June 30, September 30 and December 31;
provided that payment will accrue until the Company is permitted to make such
payment in cash under its Credit Agreement with its senior lender.
S-20
The Series B Stock is convertible into shares of Common Stock into MediaBay
Common Stock at a conversion rate equal to a fraction, (i) the numerator of
which is equal to the number of Series B Stock times $100 plus accrued and
unpaid dividends though the date of conversion and (ii) the denominator is
$0.77, the average price of our stock on May 6, 2003.
In the event of a liquidation, dissolution or winding up of the Company, the
holders of Series B Stock shall be entitled to receive out of our assets, a sum
in cash equal to $100 per share before any amounts are paid to the holders of
our common stock and on a pari passu basis with the holders of the Series A
Convertible Preferred Stock. The holders of Series B Stock shall have no voting
rights, except as required by law and except that the vote or consent of the
holders of a majority of the outstanding shares of Series B Stock, voting
separately as a class, will be required for any amendment, alteration or repeal
of the terms of the Series B Stock that adversely effects the rights,
preferences or privileges of the Series B Stock.
On July 31, 2003, Norton Herrick exercised options to purchase 300,000 shares of
MediaBay common stock at an exercise price of $.50 per share pursuant to an
Option Agreement dated November 23, 2001. The options were exercised on a
"cash-less" basis and the closing stock price on July 31, 2003 was $.78.
Accordingly, the Company issued to Mr. Herrick a certificate for 107,692 shares
of MediaBay common stock.
During the three months ended September 30, 2003, Norton Herrick provided a $100
guarantee to a vendor. The Company subsequently paid the vendor and the
guarantee expired. Mr. Herrick received no compensation and did not profit from
the transaction.
During the three months ended September 30, 2003, Mr. Herrick also loaned the
Company $100, the loan was subsequently converted into an investment by
Huntingdon Corporation, a company wholly-owned by Mr. Herrick, in the $1,065
bridge financing completed on October 1, 2003. Carl Wolf, our Chairman, also
purchased a $100 note in this financing. In consideration, the Company issued to
each of Huntingdon and Mr. Wolf a $100 principal amount note due October 1,
2004. The notes are identical to all other notes issued in the financing and
bear interest at the rate of 18% per annum, payable at maturity. In connection
with the issuance of the notes, the Company agreed, subject to receipt of
shareholder approval, to issue to each of Huntingdon and Mr. Wolf warrants to
purchase 25,000 shares of common stock at an exercise price of $.80 and agreed
to issue to each of them warrants to purchase an additional 25,000 shares of
common stock if the notes are not repaid on April 1, 2004 at an exercise price
per share equal to the closing sale price of our common stock on March 31, 2004.
The Company entered into an agreement with Norton Herrick dated November 7, 2003
(the "November Agreement") whereby Mr. Herrick agreed to pay amounts owed to the
Company under Section 16(b) of the Securities Exchange Act of 1934 as a result
of various transactions which are attributable to Mr. Herrick occurring within
less than six months of each other that involved our securities. Mr. Herrick
agreed to pay the Company the sum of $1,742, (the "Payment") by delivering to
the Company for cancellation within ten (10) days of the date of the November
Agreement, shares of our common stock and/or warrants to purchase shares of
common stock of the Issuer with an aggregate value equal to the Payment. Under
the November Agreement, the value of each share of common stock delivered under
the Agreement is equal to the last sale price of our common stock on the trading
day immediately prior to the date on which the shares of common stock were
delivered (the "Market Price"). The value of any warrant delivered under the
November Agreement is equal to the Market Price of the underlying shares less
the exercise price of the warrant. Mr. Herrick delivered the shares of common
stock and warrants pursuant to the November Agreement on Monday, November 17,
2003, with the value of the securities based on the Market Price on November 14,
2003 of $.94 per share of common stock. As part of the Payment, Mr. Herrick
returned to the Company 1,095,372 shares of our common stock. Based on the
Market Price, the aggregate value of these shares is $1,030. Also, as part of
the Payment, Mr. Herrick deposited warrants to purchase 1,875,000 shares of our
common stock. Based on the Market Price ($.94) less the exercise price of the
warrants ($.56), the aggregate value of these warrants was $712. Of the
1,875,000 warrants deposited, 1,650,000 became exercisable May 14, 2001 and
225,000 became exercisable February 22, 2002.
S-21
On January 29, 2004, the Company issued $4,000 aggregate principal amount of
promissory notes (the "2004 Notes") and warrants to purchase 2,352,946 shares of
common stock (the "Investor Warrants") to 13 institutional and accredited
investors (the "Offering"). The 2004 Notes are due on the earlier of (i) April
30, 2005, (ii) such date on or after July 1, 2004 at such time as all of the our
indebtedness under our existing credit facility is either repaid or refinanced
or (iii) the consummation by the Company of a merger, combination or sale of all
or substantially all of our assets or the purchase by a single entity, person or
group of affiliated entities or persons of 50% of our voting stock. The 2004
Notes bear interest at the rate of 6%, increase to 9% on April 28, 2004 and 18%
on July 27, 2004. In connection with this offering, Norton Herrick and
Huntingdon entered into a letter agreement with the purchasers of the 2004 Notes
pursuant to which they granted to the holders of the 2004 Notes in the event of
an Event of Default (as defined in the 2004 Notes) the rights to receive payment
under certain secured indebtedness owed by the Company to Norton Herrick and
Huntingdon and to exercise their rights under security agreements securing such
secured indebtedness. Pursuant to the letter agreement, Norton Herrick and
Huntingdon also executed Powers of Attorney in favor of a representative of the
2004 Note holders pursuant to which such representative may, following an Event
of Default, take actions necessary to enforce the 2004 Note holders rights under
the Letter Agreement, including enforcing Norton Herrick's and Huntingdon's
rights under the security agreements. In consideration for Huntingdon's consent
to the Financing and agreements to upon receipt of Shareholders' Approval , the
Company reduced the conversion price of $1,150 principal amount of convertible
promissory notes held by Huntingdon from $2.00 to $1.27 and $500 principal
amount of convertible promissory notes held by Huntingdon from $1.82 to $1.27.
In 2003 and 2002, Norton Herrick advanced $360 and $372, respectively, to
certain of our vendors and professional firms as payment of amounts owed to
them. As the Company made payments to these vendors, the vendors repaid the
amounts advanced to them by Mr. Herrick. Mr. Herrick received no interest or
other compensation for advancing the monies. As of April 12, 2004, none of the
advances were outstanding.
(18) RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," which is effective for fiscal years beginning after May 15, 2002,
with earlier application encouraged. Under SFAS 145, gains and losses from
extinguishment of debt will no longer be aggregated and classified as an
extraordinary item, net of related income tax effect, on the statement of
earnings. The adoption of SFAS 145 had no impact on the Company's financial
position or results of operations.
S-22
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs
Associated with Exit or Disposal Activities," which is effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. SFAS 146 requires recognition of a liability for the
costs associated with an exit or disposal activity when the liability is
incurred, as opposed to when the entity commits to an exit plan as required
under EITF Issue No. 94-3. SFAS 146 will primarily impact the timing of the
recognition of costs associated with any future exit or disposal activities. The
adoption of SFAS 146 had no impact on its financial position or results of
operations.
In November 2002, the FASB issued interpretation No. ("FIN") 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which requires that guarantees within the
scope of FIN 45 issued or amended after December 31, 2002, a liability for the
fair value of the obligation undertaken in issuing the guarantee, be recognized
at the inception of the guarantee. The effective date for this FIN 45 is for
fiscal years ending after December 15, 2002. The adoption of FIN 45 had no
impact on its financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based
Compensation", which amends SFAS No. 123 to provide alternative methods of
transaction for an entity that voluntarily changes to the fair value method of
accounting for stock based compensation. It also amends the disclosure
provisions of SFAS No. 123 to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect to
stock based employee compensation. Finally, SFAS No. 148 amends APB Opinion No.
28, "Interim Financial Reporting", to require disclosure of those effects in
interim financial statements. SFAS No. 148 is effective for fiscal years ended
after December 15, 2002, but early adoption is permitted. Accordingly, the
Company has adopted the applicable disclosure requirements of this Statement
within this report. The adoption of SFAS No. 148 did not have a significant
impact on the Company's financial disclosures.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities," which is effective for interim periods beginning after December 15,
2003. This interpretation changes the method of determining whether certain
entities should be included in the Company's consolidated financial statements.
An entity is subject to FIN 46 and is called a variable interest entity ("VIE")
if it has (1) equity that is insufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
or (2) equity investors that cannot make significant decisions about the
entity's operations or that do not absorb the expected losses or receive the
expected returns of the entity. All other entities are evaluated for
consolidation under SFAS No. 94, "Consolidation of All Majority-Owned
Subsidiaries." A VIE is consolidated by its primary beneficiary, which is the
party involved with the VIE that has a majority of the expected losses or a
majority of the expected residual returns or both. The Company currently
evaluating FIN 46 and believes that it will have no impact on its financial
position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 33 on
Derivative Instruments and Hedging Activities", which amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities that fall within the
scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 149 amends SFAS No. 133 regarding implementation issues
raised in relation to the application of the definition of a derivative. The
amendments set forth in SFAS No. 149 require that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. The adoption of
SFAS No. 149 did not have a material impact on the Company's financial position
or results of operations.
S-23
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
provides guidance on classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. The Company
reclassified certain items to debt as a result of the SFAS 150.
(19) SEGMENT REPORTING
For 2003, 2002 and 2001, the Company has divided its operations into four
reportable segments: Corporate, Audio Book Club ("ABC") a membership-based club
selling audiobooks in direct mail and on the Internet; Radio Spirits ("RSI")
which produces, sells, licenses and syndicates old-time radio programs and
MediaBay.com a media portal offering spoken word audio content in secure digital
download formats. Segment operating income is total segment revenue reduced by
operating expenses identifiable with that business segment. Corporate includes
general corporate administrative costs, professional fees and interest expenses.
The Company evaluates performance and allocates resources among its three
operating segments based on operating income and opportunities for growth. The
Company evaluates performance and allocates resources among its three operating
segments based on operating income and opportunities for growth. RadioClassics,
which was created to distribute the Company's proprietary old-time radio content
across multiple distribution platforms including traditional radio, cable
television, satellite television (DBS), satellite radio and the Internet, is
aggregated with RSI for segment reporting purposes. Inter-segment sales are
recorded at prevailing sales prices.
The accounting policies of the reportable segments are the same as those
described in Note 3. Inter-segment sales are recorded at prevailing sales
prices.
YEAR ENDED DECEMBER 31, 2003
CORPORATE ABC RSI MBAY.COM INTER-SEG. TOTAL
--------- -------- -------- -------- ---------- -------
Sales $ -- $ 26,379 $ 10,247 $ 138 $ (147) $ 36,617
(Loss) profit before asset write-downs and
strategic charges, severance and other termination
costs, non-cash write-down of intangibles,
depreciation, amortization interest expense, income
tax expense and dividends on preferred stock (2,407) 455 846 (481) (19) (1,606)
Depreciation and amortization 180 106 42 -- -- 328
Asset write-downs and strategic charges 749 -- -- -- -- 749
Severance and other termination costs 544 -- -- -- -- 544
Interest expense 1,913 -- 12 -- -- 1,925
Income tax (expense) (1,200) (271) -- -- (1,471)
Dividends on preferred stock 246 -- -- -- -- 246
Net (loss) income applicable to common shares (6,039) (851) 521 (481) (19) (6,869)
Total assets 24,312 14,613 38,925
Purchase of fixed assets -- 14 2 -- -- 16
YEAR ENDED DECEMBER 31, 2002
CORPORATE ABC RSI MBAY.COM INTER-SEG. TOTAL
--------- -------- -------- -------- ---------- -------
Sales $ 34,342 $ 11,348 $ 215 $ (161) $ 45,744
(Loss) profit before non-cash write-down of
intangibles, depreciation, amortization interest
expense, income tax expense and dividends on
preferred stock (3,233) 5,281 2,141 (436) 16 3,769
Depreciation and amortization -- 1,217 97 -- -- 1,314
Interest expense 2,903 -- 71 -- -- 2,974
Non-cash write-down of intangibles 1,134 90 1,224
Income tax (expense) (449) (101) (550)
Dividends on preferred stock 217 -- -- -- -- 217
Net (loss) income applicable to common shares (6,353) 2,481 1,782 (436) 16 (2,510)
Total assets -- 31,225 17,454 -- (60) 48,619
Purchase of fixed assets -- 100 11 -- -- 111
S-24
YEAR ENDED DECEMBER 31, 2001
CORPORATE ABC RSI MBAY.COM INTER-SEG. TOTAL
--------- -------- -------- -------- ---------- -------
Sales $ -- $ 31,793 $ 10,021 $ 249 $ (258) $ 41,805
(Loss) profit before asset write-downs and
strategic charges, depreciation, amortization,
interest expense and income tax benefit (2,239) 2,058 15 (1,225) 8 (1,383)
Asset write-downs and strategic charges 2,000 6,031 4,342 903 -- 13,276
Depreciation and amortization -- 3,942 910 304 -- 5,156
Interest expense 2,779 -- 11 -- -- 2,790
Income tax benefit -- 14,035 3,165 -- -- 17,200
Net (loss) income applicable to common shares (7,018) 6,120 (2,083) (2,432) 8 (5,405)
Total assets -- 27,740 16,785 3 (76) 44,452
Purchase of fixed assets -- 58 130 -- -- 188
--------- -------- -------- -------- ---------- -------
(20) QUARTERLY OPERATING DATA (UNAUDITED)
The following table presents selected unaudited operating data of the Company
for each quarter in the three year period ended December 31, 2003.
YEAR ENDED
DECEMBER 31, 2003 1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
Sales $ 10,697 $ 9,407 $ 9,572 $ 6,941
Cost of sales 5,234 4,124 4,252 3,869
Net (loss) income applicable to common shares (1,537) (228) 285 (5,389) (***)
Basic and diluted income (loss) per share:
Basic earnings (loss) per common share $ (.11) $ (.02) $ .02 $ (.38)
Diluted earnings (loss) per common share $ (.11) $ (.02) $ .02 $ (.38)
YEAR ENDED
DECEMBER 31, 2002 1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
Sales $ 9,480 $ 11,977 $ 11,267 $ 13,020
Cost of sales 4,289 5,194 5,241 5,927
Net (loss) applicable to common shares (759) 338 (187) (1,902) (****)
Basic and diluted income (loss) per share:
Basic earnings (loss) per common share $(0.05) $ 0.02 $ (.01) $ (.13)
Diluted earnings (loss) per common share $(0.05) $ 0.02 $ (.01) $ (.13)
YEAR ENDED
DECEMBER 31, 2001 1ST 2ND 3RD 4TH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
Sales $9,601 $ 10,915 $ 9,879 $ 11,410
Cost of sales 3,816 5,455 5,285 5,227
Cost of sales - write-downs -- -- 2,261 --
Net income (loss) 10,591 (*) (2,151) (16,955) (**) 3,110
Basic and diluted income (loss) per share:
Basic earnings (loss) per common share $ 0.77 (*) $(0.16) $(1.22) (**) $ 0.23 (*****)
Diluted earnings (loss) per common share $ 0.58 (*) $(0.16) $(1.22) (**) $ 0.11 (*****)
S-25
(*) Includes a reduction in the valuation allowance for deferred tax assets in
the amount of $13,000.
(**) Includes asset write-downs and strategic charges in addition to cost of
sales write-downs of $11,015.
(***) Includes asset write-downs and strategic charges of the Company's
Audio Passages audiobook club of $749 and severance and other termination
costs of $544, relating to the termination of three senior executives
with employment agreements and termination of a consulting agreement and
income tax expense of $1,417 related to utilization of deferred tax
assets.
(****) Includes write-down of intangible assets of $1.2 million and income
tax expense of $550 related to utilization of deferred tax asset.
(*****) Includes a reduction in the valuation allowance for deferred tax assets
in the amount of $4,200.
(21) SUBSEQUENT EVENTS
From January 1, 2004 to April 12,2004 the Company issued options to purchase
1,650,000 shares of its common stock to certain directors, employees and
consultants to the Company under its 2001 Stock Option plan. The Company also
cancelled options to purchase 1,774,500 shares of its common stock.
On January 29, 2004, the Company issued $4,000 aggregate principal amount of
promissory notes (the "Notes") and warrants to purchase 2,352,946 shares of
common stock (the "Investor Warrants") to 13 institutional and accredited
investors (the "Offering"). The notes are due on the earlier of (i) April 30,
2005, (ii) such date on or after July 1, 2004 at such time as all of the
Company's indebtedness under its existing credit facility is either repaid or
refinanced or (iii) the consummation by the Company of a merger, combination or
sale of all or substantially all of the Company's assets or the purchase by a
single entity, person or group of affiliated entities or persons of 50% of the
Company's voting stock. The notes bear interest at the rate of 6%, increase to
9% on April 28, 2004 and 18% on July 27, 2004. In connection with the Offering,
Norton Herrick and Huntingdon entered into a letter agreement (the "Letter
Agreement") with the purchasers of Notes in the Offering pursuant to which they
granted to the holders of the Notes in the event of an Event of Default (as
defined in the Notes) the rights to receive payment under certain secured
indebtedness owed by the Company to Norton Herrick and Huntingdon and to
exercise their rights under security agreements securing such secured
indebtedness. Pursuant to the Letter Agreement, Norton Herrick and Huntingdon
also executed Powers of Attorney in favor of a representative of the Note
holders pursuant to which such representative may, following an Event of
Default, take actions necessary to enforce the Note holders rights under the
Letter Agreement, including enforcing Norton Herrick's and Huntingdon's rights
under the security agreements. In consideration for Huntingdon's consent to the
Financing and agreements, upon receipt of Shareholders' Approval, the Company
will reduce the conversion price of the Huntingdon Notes to $1.28.
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In accordance with the Notes, the principal amount of the notes automatically
converted into common Stock at the rate of one share of common stock at $0.75,
or approximately 5,333,333 shares, on receipt of Shareholder approval, which was
received on April 12, 2004. In addition accrued interest in the amount $49 also
converted into common stock at $0.75 per share, or 64,877 shares.
In connection with the Offering, the Company issued to Rockwood, Inc.
("Rockwood"), the placement agent, and a broker warrants to purchase an
aggregate of 245,000 shares of common stock and also issued to Rockwood warrants
to purchase an additional 500,884 shares of Common Stock on April 12, 2004 as
partial consideration for Rockwood's services as placement agent. All warrants
issued are exercisable until January 28, 2009 at an exercise price of $1.28 per
share.
The following pro forma balance sheet reflects the effects of the receipt of the
$4,000 million debt, less offering fees and expenses of $531, and the subsequent
conversion of the subordinated debt to common stock on stockholder approval, as
if the transactions had occurred on December 31, 2003:
MEDIABAY, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
PRO FORMA TO REFLECT RECEIPT OF $4,000 CONVERTIBLE NOTES OFFERING
AND SUBSEQUENT CONVERSION OF SUCH NOTES TO EQUITY.
HISTORICAL PRO FORMA PRO FORMA
DECEMBER 31, ADJUSTMENTS DECEMBER 31,
2003 DR (CR) NOTES 2003
---------- ---------- ----- ----------
ASSETS
Current Assets:
Cash and cash equivalents $ 683 $ 3,469 (1) $ 2,902
$ (1,250) (2)
Accounts receivable, net 3,264 - 3,264
Inventory 4,063 - 4,063
Prepaid expenses and other current assets 215 - 215
Royalty advances 804 - 804
---------- ---------- ----------
Total current assets 9,029 2,219 11,248
Fixed assets, net 227 - 227
Deferred member acquisition costs 3,172 - 3,172
Deferred income taxes 14,753 - 14,753
Other intangibles 54 - 54
Goodwill 9,658 - 9,658
---------- ---------- ----------
$ 36,893 $ 2,219 $ 39,112
========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 10,268 $ - $ 10,268
Accounts payable, related parties 826 - 826
Common stock subject to
contingent put rights, current portion 350 - 350
Short-term debt 7,107 1,250 (2) 5,857
Related party short-term debt 10,643 - 10,643
---------- ---------- ----------
Total current liabilities 29,194 1,250 27,944
Common stock subject to contingent put rights 750 - 750
---------- ---------- ----------
-
Commitments and Contingencies - - -
-
Preferred stock 2,828 2,828
Common stock 94,567 (3,469) (1) 98,036
Contributed capital 11,569 (1,164) (3) 16,724
(3,991) (4)
(3,188) (4)
Accumulated deficit (102,015) 1,164 (3) (107,170)
3,991 (4)
---------- ---------- ----------
Total common stockholders' equity 6,949 (3,469) 10,418
---------- ---------- ----------
$ 36,893 $ (2,219) $ 39,112
========== ========== ==========
NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 2003:
(1) To record receipt of $4,000 convertible notes, less offering fees and
expenses of $531, and conversion of such notes to common stock on approval
by stockholders which was recived on April 12, 2004.
(2) To record principal payment to senior lender made on receipt of funds from
the convertible notes offering.
(3) To record value of warrants issued to investors and agents in the
convertible notes offering and subsequent expense.
(4) To record value of beneficial conversion feature in the convertible notes
offering and subsequent expense.
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SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
BALANCE WRITE-OFFS
BEGINNING OF AMOUNTS CHARGED AMOUNTS AGAINST BALANCE END
PERIOD TO NET INCOME ACQUIRED RESERVES OF PERIOD
---------------- ------------------ ------------ ---------------- --------------
Allowances for sales returns and doubtful accounts:
Year Ended December 31, 2003 $ 5,325 $ 20,900 -- $ 21,779 $ 4,446
Year Ended December 31, 2002 4,539 18,793 -- 18,007 5,325
Year Ended December 31, 2001 4,516 15,496 -- 15,473 4,539
Valuation allowance for Federal and State deferred tax assets
Year Ended December 31, 2003 21,911 1,471 -- 446 23,826
Year Ended December 31, 2002 20,563 550 -- 798 21,911
Year Ended December 31, 2001 37,763 (17,200) -- -- 20,563
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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.
MEDIABAY, INC.
BY: /S/ JOHN F. LEVY
-------------------------------------
JOHN F. LEVY,
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
Pursuant to the requirements of the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Carl T. Wolf Chairman and Director April 12, 2004
- ------------------------------
CARL WOLF
/s/ Jeffrey Dittus Chief Executive Officer April 12, 2004
- ------------------------------ (Principal Executive Officer)
JEFFREY DITTUS
/s/ Howard Herrick Director and Executive Vice President April 12, 2004
- ------------------------------
HOWARD HERRICK
/s/ John F. Levy Executive Vice President and Chief Financial Officer April 12, 2004
- ------------------------------ (Principal Financial and Accounting Officer)
JOHN F. LEVY
/s/ Richard Berman Director April 12, 2004
- ------------------------------
RICHARD BERMAN
/s/ Paul Ehrlich Director April 12, 2004
- ------------------------------
PAUL EHRLICH
/s/ Mark Hershhorn Director April 12, 2004
- ------------------------------
MARK HERSHHORN
/s/ Joseph Rosetti Director April 12, 2004
- ------------------------------
JOSEPH ROSETTI
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