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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2005
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to ________
Commission file number 1-13469
MediaBay, Inc.
- --------------------------------------------------------------------------------
(Exact name of Registrant as Specified in its Charter)
Florida 65-0429858
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employment
incorporation or organization) Identification No.)
2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (973) 539-9528
Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirement for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer as defined
in Rule 12b-2 of the Securities Exchange Act of 1934. Yes |_| No |X|
Indicate the number of shares outstanding of each of the Registrant's classes of
common equity, as of the latest practical date. As of May 13, 2005, there were
35,406,151 shares of the Registrant's Common Stock outstanding.
1
MEDIABAY, INC.
Quarter ended March 31, 2005
Form 10-Q
MEDIABAY, INC.
Index
Page
PART I: Financial Information
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at March 31, 2005 (unaudited)
and December 31, 2004...............................................3
Consolidated Statements of Operations for the
three months ended March 31, 2005 and 2004 (unaudited)...............4
Consolidated Statements of Cash Flows for the
three months ended March 31, 2005 and 2004 (unaudited)...............5
Notes to Consolidated Financial Statements (unaudited)...............6
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of
Operations..........................................................16
Item 3: Quantitative and Qualitative Disclosures of Market Risk.............28
Item 4: Controls and Procedures.............................................28
PART II: Other Information
Item 5: Other Information .................................................29
Item 6: Exhibits and Reports on Form 8-K...................................29
Signatures...................................................................30
2
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
MEDIABAY, INC.
Condensed Consolidated Balance Sheets
(Dollars in thousands)
(Unaudited)
March 31, December 31,
2005 2004
--------- ----------
Assets
Current Assets:
Cash and cash equivalents............................................................. $ 16,438 $ 3,122
Restricted cash....................................................................... 5,789 --
Accounts receivable, net of allowances for sales returns and doubtful accounts of 1,073 1,285
$2,085 and $2,708 at March 31, 2005 and December 31, 2004, respectively............
Inventory............................................................................. 1,419 1,530
Prepaid expenses and other current assets............................................. 262 199
Royalty advances...................................................................... 454 489
--------- ----------
Total current assets.............................................................. 25,435 6,625
Fixed assets, net......................................................................... 394 243
Other intangibles......................................................................... 48 50
Goodwill.................................................................................. 9,658 9,658
--------- ----------
$ 35,535 $ 16,576
========= ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses................................................. $ 5,075 $ 5,361
Accounts payable, related party....................................................... 153 315
Current portion of long-term debt..................................................... -- 200
Short-term debt, net of original issue discount of $54 at March 31, 2005 and December
31, 2004........................................................................... 30 29
--------- ----------
Total current liabilities......................................................... 5,258 5,905
--------- ----------
Long-term debt, net of original issue discount of $154 and $908 at March 31, 2005 and
December 31, 2004......................................................................... 628 9,102
Related party long-term debt including accrued interest................................... -- 7,750
--------- ----------
Total liabilities................................................................. 5,886 22,757
--------- ----------
Commitments and Contingencies -- --
Preferred stock, no par value, authorized 5,000,000 shares; 14,316 and 25,000 shares of 25,737 6,873
Series A outstanding at March 31, 2005 and December 31, 2004; respectively, 200
shares of Series B issued and outstanding at March 31, 2005 and December 31, 2004;
43,527 shares of Series C issued and outstanding at March 31, 2005 and December 31,
2004; and 35,900 and no shares of Series D issued and outstanding at March 31, 2005
and December 31, 2004.................................................................
Common stock; no par value, authorized 150,000,000 shares; issued and outstanding 107,905 101,966
35,406,151 and 24,843,980 at March 31, 2005 and December 31, 2004, respectively.......
Contributed capital....................................................................... 47,943 17,682
Accumulated deficit....................................................................... (151,936) (132,702)
--------- ----------
Total stockholders' equity (deficit)...................................................... 29,649 (6,181)
--------- ----------
$ 35,535 $ 16,576
========= ==========
See accompanying notes to consolidated financial statements.
3
MEDIABAY, INC.
Condensed Consolidated Statements of Operations
(Dollars in thousands, except per share data)
(Unaudited)
Three months ended
March 31,
2005 2004
------------ ------------
Sales, net of returns, discounts and allowances of $815 and $1,926 for the three months
ended March 31, 2005 and 2004, respectively .................................. $ 3,352 $ 5,684
Cost of sales ......................................................................... 1,796 2,570
------------ ------------
Gross profit ................................................................. 1,556 3,114
Expenses:
Advertising and promotion ......................................................... 386 1,359
Bad debt expense .................................................................. 141 398
General and administrative ........................................................ 1,433 1,560
Depreciation and amortization ..................................................... 26 47
------------ ------------
Operating loss ............................................................... (430) (250)
Interest expense, net of interest income of $13 for the three months ended
March 31, 2005 ............................................................... 597 854
Loss on early extinguishment of debt .................................................. 579 --
------------ ------------
Loss before income taxes ..................................................... (1,606) (1,104)
Income taxes .......................................................................... -- --
------------ ------------
Net loss ..................................................................... (1,606) (1,104)
Dividends on preferred stock .......................................................... 205 64
Deemed dividend for beneficial conversion feature of Series D
Preferred Stock .............................................................. 17,423 --
------------ ------------
Net loss applicable to common shares ......................................... $ (19,234) $ (1,168)
============ ============
Basic and diluted loss per common share:
Basic and diluted loss per common share .......................................... $ (.77) $ (.09)
============ ============
Weighted average common shares outstanding:
Basic and diluted Weighted average common shares outstanding ..................... 25,045,306 13,060,051
============ ============
See accompanying notes to consolidated financial statements.
4
MEDIABAY, INC.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Three months ended March 31,
2005 2004
---------- ----------
Cash flows from operating activities:
Net loss applicable to common shares ....................................... $ (19,234) $ (1,168)
Adjustments to reconcile net loss to net cash provided by operating activities:
Deemed dividend for beneficial conversion feature of Series D
Preferred Stock ........................................................ 17,423 --
Loss on early extinguishment of debt ........................................ 579 --
Depreciation and amortization ............................................... 26 47
Amortization of deferred member acquisition costs ........................... 9 855
Amortization of deferred financing costs and original issue discount ........ 196 424
Non-current accrued interest and dividends payable .......................... 306 389
Non-cash stock compensation ................................................. -- 48
Changes in asset and liability accounts, net of asset acquisition:
Decrease in accounts receivable, net ..................................... 434 1,269
Decrease (increase) in inventory ......................................... 111 (118)
Increase in prepaid expenses ............................................. (108) (137)
Decrease (increase) in royalty advances .................................. 35 (513)
Increase in deferred member acquisition costs ............................ -- (218)
(Decrease) in accounts payable and accrued expenses ...................... (634) (2,492)
---------- ----------
Net cash used in by operating activities ........................ (857) (1,614)
---------- ----------
Cash flows from investing activities:
Acquisition of fixed assets, including development of websites ............ (175) (47)
---------- ----------
Net cash used in investing activities ........................... (175) (47)
---------- ----------
Cash flows from financing activities:
Proceeds from sale of Series D Preferred stock, net of cash fees
and expenses .............................................................. 31,866 --
Proceeds from issuance of short-term debt ................................. -- 4,000
Payment of long-term debt, including accrued interest and dividends ....... (11,700) (1,538)
Increase in restricted cash ............................................... (5,789)
Increase in deferred financing costs ...................................... (29) (551)
---------- ----------
Net cash provided by financing activities ....................... 14,348 1,911
---------- ----------
Net increase in cash and cash equivalents ......................................... 13,316 250
Cash and cash equivalents at beginning of period .................................. 3,122 683
---------- ----------
Cash and cash equivalents at end of period ........................................ $ 16,438 $ 933
========== ==========
See accompanying notes to consolidated financial statements.
5
MEDIABAY, INC.
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
(Unaudited)
(1) Organization
MediaBay, Inc. ("MediaBay" or "the Company") is a Florida corporation formed on
August 16, 1993. The Company is a media, marketing and publishing company
specializing in spoken audio entertainment. Today, the Company is a leading
reseller of audiobooks on CD and cassettes from the nation's largest publishing
houses via the Audio Book Club, a mail order based, negative option book club.
MBAY is also a licensee and marketer of programs from the golden age of radio.
These titles are sold in physical formats through a catalog focused on
collectors, a mail order based continuity program, retail outlets, and an
on-line download subscription service. The Company's strategy consist of
pursuing the download opportunity through both the exclusive distribution
agreement with Microsoft and the opportunity to offer its content to other
websites; leveraging their agreement with Larry King to create opportunities
which provide lower customer acquisition costs and higher profit potential; and
exploiting their existing content and businesses.
(2) Significant Accounting Policies
Basis of Presentation
The interim unaudited condensed consolidated financial statements should be read
in conjunction with the Company's audited consolidated financial statements
contained in its Annual Report on Form 10-K. 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 estimates. In the opinion of management,
the interim unaudited financial statements include all material adjustments, all
of which are of a normal recurring nature, necessary to present fairly the
Company's financial position, results of operations and cash flows for the
periods presented. The results for any interim period are not necessarily
indicative of results for the entire year or any other interim period.
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, Cash Equivalents and Restricted Cash
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, restricted cash, accounts receivable, accounts
payable and accrued expenses approximates fair value due to the short maturity
of those instruments.
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.
6
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 twelve months from the date of the
Balance Sheet.
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.
SOP 93-7 requires that the realizability of the amounts of direct-response
advertising reported as assets should be evaluated at each balance sheet date by
comparing the carrying amounts of the assets to their probable remaining future
net revenues. At March 31, 2005, we had no direct-response advertising reported
as assets, since we have determined that probable future benefits from any
direct advertising we have incurred would not exceed the amounts expended.
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 from the date the assets are put into service for
Internet web site development costs. Ongoing maintenance and other recurring
charges are expensed as incurred.
Other Intangibles, Net
Intangible assets, principally consisting of purchased intellectual property,
which is reviewed for impairment on each reporting date, and non-compete
agreements, which are being amortized over their contractual term.
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. Goodwill is 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 is more than its fair value.
Revenue Recognition
During the three months ended March 31, 2005 and March 31, 2004, the Company
derived 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 sold classic radio shows to retailers either
directly or through distributors. The Company derived additional revenue through
rental of its proprietary database of names and addresses to non-competing third
parties through list rental brokers. The Company also derived 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.
7
Downloadable content revenue from the sale of individual content titles is
recognized in the period when the content is downloaded and the customer's
credit card is processed. Downloadable content revenue from the sale of
downloadable content subscriptions is recognized pro rata over the term of the
subscription period.
8
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 accordance with EITF No. 01-9, "Accounting for Consideration Given by a
Vendor to a Customer (Including a Reseller of the Vendor's Products)", the
Company classifies the cost of sales incentives as a reduction of net sales.
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 employee stock options in accordance with Accounting
Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees." In October 1995, SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") was issued. SFAS 123, which prescribes the
recognition of compensation expense based on the fair value of options on the
grant date, allows companies to continue applying APB 25 if certain pro forma
disclosures are made assuming a hypothetical fair value method application. Had
compensation expense for the Company's stock options been recognized on the fair
value on the grant date under SFAS 123, the Company's net loss and net loss per
share for the three months ended March 31, 2005 and 2004 would have been as
follows:
9
Three Months Ended March 31,
2005 2004
---------- ----------
Net loss applicable to common shares, as reported ..................... $ (19,234) $ (1,168)
Add: Stock-based employee compensation expense included in reported
net loss 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 ........................................ (35) (1,163)
---------- ----------
Pro forma net loss applicable to common shares ........................ $ (19,269) $ (2,331)
========== ==========
Net loss per share
Basic and diluted - as reported ....................................... $ (.77) $ (.09)
========== ==========
Basic and diluted - pro forma ......................................... $ (.77) $ (.18)
========== ==========
No dividend yield and the following assumptions were used in the pro forma
calculation of compensation expense:
Assumed Risk-free Fair Value per
Date No. of Shares Exercise Price Volatility Interest Rate Share
---- ------ ------ ---------- ------------- -----
First Quarter 2005 100,000 $.87 41% 3.35% $.35
First Quarter 2004 1,650,000 $.99-$1.86 97% 4.00% $.66-$.75
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amount of
existing assets and liabilities and their respective tax basis and operating
loss and tax credit carryforwards. A valuation allowance is provided when it is
more likely than not that some portion or all of the deferred tax assets will
not be realized. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
the period that includes the enactment date.
Royalties
The Company is liable for royalties to licensors based upon revenue earned from
the respective licensed product. The Company pays certain 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) Restricted Cash
In connection with the March 2005 sale of preferred stock and warrants (the
"Financing") described in Note 6 below, the Company agreed to redeem from Norton
Herrick, a principal shareholder of MediaBay, and his affiliate, Huntingdon
10
(collectively the "Herrick Entities"), the balance of the Series A Preferred
shares remaining after the partial conversion thereof pursuant to the terms of
the Financing and all of the Series C Preferred Shares for an amount equal to
the aggregate stated capital of such shares, or $1,432 and $4,355, respectively,
on the earlier of the effective date of the Shareholder Consent and June 1,
2005. The Company placed funds of $5,789 in escrow to be released to the Herrick
Entities, on the earlier of the effective date of the Shareholder Consent and
June 1, 2005. The funds were released on May 3, 2005
(4) Goodwill and Other Intangibles
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.
The Company amortizes other intangible assets over their estimated useful lives.
Amortization expense for other intangible assets was $2 and $13 for the three
months ended March 31, 2005 and 2004, respectively. The Company estimates
intangible amortization expenses of $8 in 2005:
The following table presents details of Other Intangibles at March 31, 2005 and
December 31, 2004:
March 31, 2005 December 31, 2004
-------------- -----------------
Cost Accumulated Net Cost Accumulated Net
--- Amortization --- ---- Amortization ---
------------ ------------
Mailing Agreements $ 592 $ 592 $ -- $ 592 $ 592 $ --
Customer Lists 4,380 4,380 -- 4,380 4,380 --
Non-Compete Agreements 313 290 23 313 288 25
Other 25 -- 25 25 -- 25
-------- -------- -------- -------- -------- --------
Total Other Intangibles $ 5,310 $ 5,262 $ 48 $ 5,310 $ 5,260 $ 50
======== ======== ======== ======== ======== ========
Goodwill of $9,658 as of March 31, 2005 and December 31, 2004 is attributable to
the Company's Radio Spirits business. The Company conducted its annual
impairment test for 2004 in January 2005, utilizing the services of an
independent appraiser, and its annual impairment tests for 2003 in October 2003,
neither of which resulted in an impairment loss. Any future impairment losses
incurred will be reported in operating results.
(5) Debt
As of
March 31, December 31,
2005 2004
---- ----
Credit agreement, senior secured debt,
net of original issue discount $ -- $ 8,661
Premier debt, net of original issue discount 658 670
Related party notes and related accrued interest,
net of original issue discount -- 7,750
Total debt 658 17,081
Less: current portion (30) (229)
Long-term debt $ 628 $ 16,852
March Transactions
On March 23, 2005, the Company completed the Financing described below.
Concurrently with the Financing, the Company repaid from the net proceeds all of
the principal and accrued and unpaid interest due on the Company's outstanding
senior notes issued on April 28, 2004, in the aggregate amount of approximately
$9,400. The Company reported a charge in the first quarter of 2005 of $579 to
reflect the write-off of unamortized financing charges related to the repayment
of this debt.
11
Also in connection with the Financing, the Company entered into an agreement
(the "Herrick Agreement") with the Herrick Entities, described below (the
"Herrick Agreement"). Pursuant to the Herrick Agreement, concurrently with the
Financing, among other actions, all $5,784 principal amount of the convertible
notes of the Company owned by the Herrick Entities were converted into an
aggregate of approximately 10.3 million shares of Common Stock, at their stated
conversion rate of $0.56 per share.
The Company also paid to Norton Herrick and Huntingdon all accrued and unpaid
interest dividends due to them in the amount $2,271.
(6) Stockholders' Equity and Stock Options and Warrants
The following table presents information regarding the Company's outstanding
preferred stock at March 31, 2005 and December 31, 2004:
As of
March 31, December 31,
2005 2004
---- ----
Series A Preferred Stock $ 1,439 $ 2,500
Series B Preferred Stock 20 20
Series C Preferred Stock 4,353 4,353
Series D Preferred Stock, total issued $35,900, net of cash fees and
expenses of $3,134; value ascribed to advisors' warrants of $1,986
and value ascribed ot investors' warrants of $10,852
19,928 --
---------- ----------
Total Preferred Stock $ 25,737 $ 6,873
========== ==========
March 2005 Sale of Preferred Stock and Warrants
On March 21, 2005, the Company agreed to issue an aggregate of (a) 35,900 shares
(the "Offering Shares") of its Series D Convertible Preferred Stock (the "Series
D Preferred") convertible into 65,272,273 shares of the Company's common stock,
(b) 32,636,364 five-year common stock purchase warrants (the "Offering
Warrants"), valued at $10,852 using an accepted valuation method and (c)
preferred warrants (the "Over-Allotment Warrants" and, together with the
Offering Shares and the Offering Warrants, the "Offering Securities")
exercisable for a limited time, for additional proceeds to the Company of
$8,975, to purchase (1) up to 8,975 additional shares of Series D Preferred (the
"Additional Shares" and, together with the Offering Shares, the "Preferred
Shares") and (2) up to 8,159,091 additional warrants identical to the Offering
Warrants (the "Additional Warrants" and, together with the Offering Warrants,
the "Warrants"), to accredited investors (the "Investors") for an aggregate
purchase price of $35,900 (the "Financing").
Immediately prior to the Financing, holders of a majority of the Company's
voting securities approved by written consent (the "Shareholder Consent") (a) an
amendment to the Articles of Incorporation of the Company, increasing the number
of authorized shares of the common stock of the Company ("Common Stock") from
150,000,000 to 300,000,000, (b) a change of control which may occur as a result
of the Financing, and (c) the Company's issuance, in connection with the
transactions contemplated by the Financing documents, of Common Stock in excess
of 19.99% of the number of shares of Common Stock outstanding immediately prior
to the Financing.
While such actions were approved by a majority of the shareholders prior to the
Financing, the Company was not permitted to effect them until it satisfied
certain information requirements to the shareholders of the Company not party to
the Shareholder Consent. As a result, the Shareholder Consent did not become
effective until May 3, 2005
The Preferred Shares have a face value of $1,000 per share ("Stated Value") and
are convertible at any time at the option of the holder into shares ("Conversion
Shares") of common stock at the rate of $0.55 per Conversion Share, subject to
certain anti-dilution adjustments, including for issuances of Common Stock for
consideration below the conversion price. The Preferred Shares are also
12
mandatorily convertible at the option of the Company, subject to its
satisfaction of certain conditions, commencing 30 days following the later date
to occur (the "Effective Date") of (a) the effective date of the Financing
Registration Statement (defined below) and (b) May 3, 2005, the effective date
of the Shareholder Consent. Under certain circumstances under the control of the
Company, the holders will also have the right to require the Company to redeem
their Preferred Shares at their Stated Value. Cumulative dividends will accrue
on the Preferred Shares on an annualized basis in an amount equal to 6% of their
Stated Value until they are converted or redeemed and will be payable quarterly
in arrears, beginning April 1, 2005, in cash or, at the Company's option,
subject to its satisfaction of certain conditions, in shares of Common Stock
("Dividend Shares") valued at 93% of the average of the daily volume weighted
average per-share price of the Common Stock for the five trading days prior to
the applicable payment date. The Preferred Shares are non-voting. Subject to
certain exceptions for accounts receivable and equipment and capital lease
financings, the Company may not incur additional indebtedness for borrowed money
or issue additional securities that are senior to or pari passu to the Preferred
Shares without the prior written consent of holders of at least 2/3rds of the
Preferred Shares then outstanding.
Each Warrant is exercisable to purchase one share of Common Stock (collectively,
the "Warrant Shares"), at an exercise price of $0.56 per share for a period of
five years commencing September 23, 2005, subject to certain anti-dilution
adjustments, including for issuances of Common Stock for consideration below the
exercise price. In addition, once exercisable, the Warrants permit cashless
exercises during any period when the Warrant Shares are not covered by an
effective resale registration statement.
The Over-Allotment Warrants are exercisable until 90 days following the
Effective Date for the purchase of Additional Shares and Additional Warrants, at
an exercise price equal to the Stated Value of the Additional Shares purchased,
with the purchase of each Additional Share including an Additional Warrant
exercisable for a number of Warrant Shares equal to 50% of the Conversion Shares
underlying such Additional Share.
As part of the Financing, the Forest Hill Entities exchanged 1.8 million shares
of Common Stock and 400,000 common stock warrants previously purchased by them
from the Company in October 2004 for $900 of the Offering Securities. The Forest
Hill Entities also purchased $1,000 of the Offering Securities. The Company has
agreed to include an additional 119,048 shares of Common Stock, as well as
50,000 shares of Common Stock underlying certain additional warrants, already
beneficially owned and retained by Forest Hill Capital, for resale in the
Financing Registration Statement.
In connection with the Financing, the Company also entered into the Herrick
Agreement pursuant to which, concurrently with the Financing:
o all $5,784 principal amount of the convertible notes of the Company
owned by the Herrick Entities (the "Herrick Notes") and 10,684 of
their shares of the Series A Convertible Preferred Stock of the
Company ("Series A Preferred") were converted into an aggregate of
approximately 12.2 million shares of Common Stock (the "Herrick
Shares"), at their stated conversion rate of $0.56 per share;
o the Company agreed to redeem the remaining 14,316 shares of Series A
Preferred held by the Herrick Entities and all 43,527 of their
shares of the Series C Convertible Preferred Stock of the Company
(collectively, the "Redemption Securities") for $5,784, the
aggregate stated capital of such shares, on the earlier of the
effective date of the Shareholder Consent (May 3, 2005) and June 1,
2005, and both the Redemption Securities and the redemption price
were placed into escrow pending such date;
o the Herrick Entities waived certain of their registration rights and
the Company agreed to include the Herrick Shares for resale in the
Financing Registration Statement, so long as such Herrick Shares are
owned by the Herrick Entities and not otherwise transferred,
including, but not limited to, in the Herrick Financing (as defined
below); and
o the Herrick Entities consented to the terms of the Financing and the
agreements entered into in connection with the Financing, as the
Company was required to obtain such consents pursuant to the terms
of the Herrick Notes, the Series A Preferred and the Series C
Preferred.
13
o Herrick and Huntingdon also entered into a voting agreement and
proxy with the Company pursuant to which they agreed not to take any
action to contradict or negate the Shareholder Consent.
o the Company entered into a registration rights agreement dated the
date hereof with Herrick and Huntingdon in which the parties are
granted "piggy-back" registration rights and, with respect to the
shares of Common Stock issuable to Herrick and Huntingdon upon
conversion of the Herrick Notes and Series A Preferred Stock,
Herrick and Huntingdon are granted the same automatic registration
rights as the Investors under the Registration Rights Agreement.
o the Company also entered into another registration rights agreement
dated March 23, 2005, with Herrick and Huntingdon in which the
parties are granted "piggy-back" registration rights and, with
respect to the shares of our common stock issuable to Herrick and
Huntingdon upon exercise of the warrants held by Herrick and
Huntingdon.
The Company received $35,000 of gross proceeds (not including the securities
exchanged by the Forest Hill Entities for $900 of the purchase price) in the
Financing. Merriman Curhan Ford & Co. ("Merriman") acted as a financial advisor
with respect to certain of the investors in the Financing for which it received
compensation from the Company of $2,625 plus a five-year warrant (the "Merriman
Warrant") to purchase 7,159,091 shares of Common Stock at an exercise price of
$0.69 per share commencing upon May 3, 2005, the effective date of the
Shareholder Consent. Merriman also received a structuring fee from the Company
with respect to the Financing in the amount of $175. In addition, the Company
issued to Satellite Strategic Finance Associates, LLC and Satellite Strategic
Finance Partners, Ltd., investors in the Financing, warrants to purchase an
aggregate of 250,000 shares of Common Stock (identical to the Warrants), and
reimbursed them $55 for expenses, for consulting services rendered by it in
connection with the Financing. The Company incurred cash fees and expenses
including fees paid to advisors of $3,134. Warrants issued to advisors were
valued at $1,986 using an accepted valuation method.
The Preferred Shares are convertible at any time at the option of the holder
into shares ("Conversion Shares") of common stock at the rate of $0.55 per
Conversion Share and each Warrant is exercisable to purchase one share of Common
Stock (collectively, the "Warrant Shares"), at an exercise price of $0.56 per
share. The market price for the Company's common stock at March 21, 2005 was
$.69. The Company recorded as dividends an amount of $17,423 to reflect the
value of the deemed dividend for beneficial conversion feature of Series D
Preferred Stock.
Stock Options and Warrants
From January 1, 2005 to March 31, 2005, the Company issued options to purchase
100,000 shares of its common stock to an employee under its 2004 Stock Incentive
Plan. The Company also cancelled options to purchase 223,430 shares of its
common stock and options to purchase 41,000 shares of its common stock expired.
The Company issued non-plan warrants to purchase 40,045,455 shares of its common
stock in connection with the Financing described above. The Company cancelled
non-plan warrants to purchase 460,000 shares of its common stock.
(7) Net Loss Per Share of Common Stock
Basic loss per share was computed using the weighted average number of common
shares outstanding for the three months ended March 31, 2005 and 2004 of
25,045,306 and 13,060,051, respectively.
For the three months ended March 31, 2005, common equivalent shares, which were
not included in the computation of diluted loss per share because they would
have been anti-dilutive were 1,407,072 common equivalent shares, as calculated
under the treasury stock method and 22,734,620 common equivalent shares relating
to convertible subordinated debt and preferred stock calculated under the
"if-converted method". Interest expense on the convertible subordinated debt
added back to net loss would have been $155 and preferred dividends added back
to net loss applicable to common shares would have been $205 for the three
months ended March 31, 2005.
14
For the three months ended March 31, 2004, common equivalent shares, which were
not included in the computation of diluted loss per share because they would
have been anti-dilutive were 289,943 common equivalent shares, as calculated
under the treasury stock method and 21,856,353 common equivalent shares relating
to convertible subordinated debt and preferred stock calculated under the
"if-converted method". Interest expense on the convertible subordinated debt
added back to net loss would have been $340 and preferred dividends added back
to net loss applicable to common shares would have been $65 for the three months
ended March 31, 2004.
(8) Supplemental Cash Flow Information
No cash has been expended for income taxes for the three months ended March 31,
2005 and 2004. Cash paid for interest expense was $2,007 and $180 for the three
months ended March 31, 2005 and 2004, respectively.
The Company had the following non-cash activities for the three months ended
March 31, 2005:
2005
----------
Conversions of subordinated notes into common stock $ 5,784
Conversion of preferred shares into common stock $ 1,063
Conversion of common shares and warrants into preferred stock and
warrants sold in the Financing $ 900
Issuance of warrants in connection with the Financing $ 12,838
(9) Segment Reporting
For the three months ended March 31, 2005 and 2004, the Company operated in four
reportable segments: Corporate; Audio Book Club ("ABC") a membership-based club
selling audiobooks via 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, interest expenses and
amortization of acquisition related costs. The Company evaluates performance and
allocates resources among its three operating segments based on operating income
and opportunities for growth. Inter-segment sales are recorded at prevailing
sales prices.
Segment Reporting
Three Months Ended March 31, 2005 Inter-
Corporate ABC RSI Mbay.com segment Total
Sales, net of returns, discounts and $ -- $ 2,240 $ 1,065 $ 47 $ -- $ 3,352
allowances
Operating (loss) profit (538) 183 45 (125) 5 (430)
Depreciation and amortization 2 15 9 -- -- 26
Interest expense, net 597 -- -- -- -- 597
Loss on early retirement of debt 579 -- -- -- -- 579
Dividends on Preferred Stock 205 -- -- -- -- 205
Deemed dividend for beneficial conversion
feature of Series D Preferred Stock 17,423 17,423
Net (loss) income applicable to common (19,342) 183 45 (125) 5 (19,234)
shares
Total assets -- 22,607 12,969 9 (50) 35,535
Acquisition of fixed assets -- 175 -- -- -- 175
Segment Reporting
Three Months Ended March 31, 2004 Inter-
Corporate ABC RSI Mbay.com segment Total
Sales, net of returns, discounts and $ -- $ 3,726 $ 1,940 52 (34) $ 5,684
allowances
Operating profit (loss) (522) (90) 482 (120) -- (250)
Depreciation and amortization 13 25 9 -- -- 47
Interest expense 853 -- 1 -- -- 854
Dividends on Preferred Stock 64 -- -- -- -- 64
Net (loss) income applicable to common (1,439) (90) 481 (120) -- (1,168)
shares
Total assets -- 22,065 13,983 -- (72) 35,976
Acquisition of fixed assets -- 38 9 -- -- 47
15
(10) Recent Accounting Pronouncements
Share-Based Payment
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment," which
is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. The compensation cost will
be measured based on the fair value of the equity or liability instruments
issued. The Statement is effective as of the beginning of the first annual
period beginning after June 15, 2005. We do not yet know the impact that any
future share-based payment transactions will have on our financial position or
results of operations.
Inventory Costs
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs." SFAS 151
amends ARB No. 43, "Inventory Pricing", to clarify the accounting for certain
costs as period expense. The Statement is effective for fiscal years beginning
after June 15, 2005; however, early adoption of this Statement is permitted. The
Company does not anticipate an impact from the adoption of this statement.
(11) Related Party Transactions
In addition to the transactions described above with the Herrick Entities and
the Forest Hill entities, as of March 31, 2005, the Company owed to Norton
Herrick, and his affiliates $153 for reimbursement of certain expenses and
services incurred in prior years. From December 31, 2004 through March 31, 2005,
the Company paid Herrick a total of $162, and has agreed to pay Herrick $41 per
month on the first of each month through and including July 2005 and $31 on
August 1, 2005.
(12) Subsequent Events
Stock Options
From April 1, 2005 to May 13, 2005 options to purchase 3,770,000 shares of
MediaBay common stock were issued to officers, directors, employees and
consultants. Options to purchase 204,000 shares of MediaBay common stock were
cancelled or expired.
16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-looking Statements
Certain statements in this Form 10-Q 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 ability to implement our new strategy and transition our
business and the risks related thereto: our history of losses and declining
revenues; our ability to license and sell new spoken word content, anticipate
and respond to changing customer preferences, license and produce desirable
content, protect our databases and other intellectual property from unauthorized
access, and collect receivables; dependence on third-party providers, suppliers
and distribution channels; competition; the costs and success of our marketing
strategies, product returns, member attrition; and risks relating to our capital
structure. 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
We are a digital media and publishing company specializing in spoken audio
entertainment. We have over 75,000 hours of audio content, which we distribute
via mail order, our websites, some of the nation's largest retailers, and a la
carte, digital downloads and subscription services.
Today we have two principal content libraries; (1) Audiobooks: which we license
from the nation's largest publishing houses to sell on CD and cassette through
the Audio Book Club and which we intend to distribute via digital downloads on
third-party websites and a digital download service that is under development;
and (2) An archive of the history of American radio which we produce and sell on
CD and cassettes through our catalog, a mail order based continuity program,
retail outlets, and our on-line download subscription service and third-party
websites, of which one is currently operational. We broadcasts our radio
programs through a syndicated radio show on 200 commercial stations across the
United States, as well as its 24-hour Radio Classics channels on Sirius and XM
Satellite Radio.
We are transitioning our business from selling hard goods primarily via mail
order to digital distribution via wireless and Internet downloads. Our
distribution strategy is two pronged: (1) to wholesale our audio content to the
leading music services and broadband companies on a white label basis, both
domestically and internationally; and (2) to operate our own downloadable
content stores and subscription services which are intended to be branded via
partnerships with celebrities and corporate affiliates, each chosen specifically
to reach the targeted demographics known to be interested in its content. We
intend to use various means to market our downloadable content stores, including
working with manufacturers of digital music players, smart phones, and PDA's to
include samples of our audio content for consumers to preview when they purchase
these new devices, with the hope that that these samples will attract consumers
to our content stores.
We recently executed distribution agreements with Microsoft's MSN Music to
provide our spoken word content to the MSN audience, which has 350 million
17
unique monthly visitors. We have also executed a distribution agreement with
Loudeye Corp., a worldwide leader in business-to-business digital media
solutions, to act as our digital sales agent in distributing our catalog to
potentially 70 music services which that company hosts and sources content for.
In addition, we expect to launch an on-demand, download and subscription service
in partnership with Larry King in 2005, and have begun to make our Classic Radio
library available for ring tone distribution.
Today, some of our largest digital content partners include Simon & Schuster,
Random House, Harper Collins, Penguin Group (USA) Audio, Hay House, Sound Room
Publishers, Oasis, Zondervan, BBC, Blackstone, and CBS Radio.
March 2005 Equity Financing
On March 23, 2005, pursuant to an agreement executed on March 21, 2005, we
received an infusion of gross cash proceeds of $35 million in private equity
financing from several institutional investors. We retired all of our borrowings
and our cash reserves increased to approximately $16.4 million. Because of this
financing, we believe that we have sufficient cash to implement our new
strategy, including required marketing expenditures, for at least twelve months.
The Preferred Shares are convertible at any time at the option of the holder
into shares ("Conversion Shares") of common stock at the rate of $0.55 per
Conversion Share and each Warrant is exercisable to purchase one share of Common
Stock (collectively, the "Warrant Shares"), at an exercise price of $0.56 per
share. The market price for our common stock at March 21, 2005 was $.69. We
recorded as a non-cash deemed dividend an amount of $17,423 to reflect the value
of the beneficial conversion feature of the Series D Preferred Stock and
increased contributed capital by $17,423. The recording of the deemed dividend
had no effect on our cash or net equity.
Strategy
In response to the music industry's recent success in creating a market for
legal digital downloads using digital rights management solutions that are
intended to prevent piracy of copyrighted content, we intend to become a leading
distributor for downloadable, spoken word audio entertainment. We intend to
build this new distribution channel by utilizing our nearly twelve years of
experience operating the Audio Book Club and our old-time radio business. During
those twelve years, we have serviced approximately 2.9 million customer accounts
and plan to leverage this list of audio buyers to attract new digital shoppers.
We intend to use the Windows Media Digital Rights Management (DRM) system, and
other easy to use, rights management technologies that may evolve over time.
Beginning this past Christmas season, 70 new digital devices that support the
Microsoft "PlaysforSure(TM)" digital rights management and device platform
became available for sale by many of the leading device manufacturers. Examples
of companies offering a "PlaysforSure(TM)" device include Hewlett Packard, Dell,
Creative, Rio, i-River and Samsung. Many of these devices have large file
storage capacities and make, what we believe, could be a perfect match for our
content, which is typically one half hour in length for our classic radio shows,
to an average of 6 to10 hours for an audiobook.
In addition, the rapid evolution of cell and smart phones with hard drives and
media players presents a large potential user base of digital devices for our
content, as more than 500 million new handsets are sold each year in the market
place. These portable devices, coupled with the ubiquitous installed base of
personal computers with CD burners and USB port memory discs are making digital
audio content portable and more accessible to users.
We believe the proliferation of broadband Internet service, the Microsoft
digital rights management solution, and an expanding user base of portable
devices have created an inflection point where downloads are a better way to
distribute audio than traditional CDs and tapes via a retail store or by mail
order. Broadband Internet and ubiquitous wireless networks means companies like
MediaBay can deliver audio files quickly and affordably. Downloads provide
consumers a more convenient way to purchase audio in real time and provides
18
incredible opportunity for broad choice since there are no inventory
requirements. This distribution is better for the environment and most
importantly, provides real savings for the consumer.
We have determined that future investment in our mail order, hard goods based,
Audio Book Club would not provide the returns adequate to justify future
expenditures. Accordingly, in 2004, we discontinued marketing to attract new
Audio Book Club members and are developing plans to transition current members
to new programs including encouraging existing members to begin downloading
spoken word.
Online Agreement with Microsoft
The first step in executing our new strategy is our agreements with Microsoft.
These agreements provide for us to distribute spoken word audio content,
including audiobooks from the largest publishers and our old-time radio
programs, through an exclusive distribution relationship with the new MSN Music
Service. Today, MSN has an audience of 350 million unique monthly visitors.
Microsoft has announced that the new music service will have the largest
selection of songs and audio content of any service and will be compatible with
the most number of digital devices, leveraging its industry leading windows
media player and windows digital rights management platform.
Online Agreement with Loudeye
We have also announced a multi-year agreement with Loudeye Corp., a worldwide
leader in business-to-business digital media solutions. Loudeye is working with
us to provide a solution for powering digital distribution of a wide range of
audiobooks. Under the agreement, we intend to make available our audiobook
content catalog to Loudeye for both domestic and international distribution,
subject to obtaining appropriate international rights, to new and existing
Loudeye partners. Loudeye and its OD2 services have relationships with more than
70 web storefronts and music services throughout the United States, Europe and
Australia.
Larry King Opportunity
Celebrity Interactive LLC, Larry King and MediaBay have signed an endorsement
and promotion agreement, which MediaBay intends to use to reach first time
downloaders and the large and diverse Larry King fan base to help us build a new
digital service. We intend to utilize the arrangement with Larry King to form a
Larry King audio entertainment and education service. This digital service is
being designed to allow consumers to shop and download a broad selection of
content, including but not limited to, audiobooks, classic radio programs,
educational materials, self-help titles, and current events. We anticipate that
the titles will be available for download directly to the personal computer or
other digital devices.
Open Standard Platform Technology
We have chosen to leverage the proliferation of the Windows Media DRM platform
as the de facto rights management standard for content owners to protect their
intellectual property on the Internet. According to a report from the
International Federation of the Phonographic Industry (IFPI) trade group, the
number of online music stores quadrupled to more than 230 in 2004. In the United
States, the overwhelming majority of these stores have adopted the Windows Media
DRM as their solution to protect content owners intellectual property and to
transfer files to digital hand held devices. This trend is certain to improve
consumer choice as it allows consumers to shop in a broad range of stores, but
maintain the flexibility to switch devices over time as functionality improves
without having to worry about media format conversion issues that closed
proprietary systems, such as Apple i-Tunes, create. On-line music stores in the
United States that use the Window's DRM system include such companies as
RealNetworks, MSN Music, Wal-Mart, Napster, Music Maker, Yahoo's Music Match,
Buy.com, Music Now, and VirginDigital. The competing storefronts, which use
proprietary DRM technologies or closed systems, are Sony, Apple and Audible.
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
19
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.
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.
Downloadable content revenue from the sale of individual content titles is
recognized in the period when the content is downloaded and the customer's
credit card is processed. Content revenue from the sale of content subscriptions
is recognized pro rata over the term of the subscription period. Rebates and
refunds are recorded as a reduction of revenue in the period in which the rebate
or refund is paid in accordance with Emerging Issues Task Force Issue No. 01-9,
Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products).
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,
20
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.
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. We determine the utilization of deferred tax
assets in the future based on current year projections by management.
Based on a change in our strategy, which we believe will result in lower sales
and losses in the near term, but ultimately will be more profitable, we have
determined that it is not more likely than not that we will, in the foreseeable
future, be able to realize all or part of our net deferred tax asset. We have
accordingly made an adjustment to the deferred tax asset recording an increase
to the valuation allowance, resulting in a deferred tax expense charged against
income in the fourth quarter of 2004, the period when such determination was
made.
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. We account 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, we have capitalized direct response
advertising costs and amortized 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.
SOP 93-7 requires that the realizability of the mounts of direct-response
advertising reported as assets should be evaluated at each balance sheet date by
comparing the carrying amounts of the assets to their probable remaining future
net revenues. Based on the change in our strategy we have determined that the
future net revenue from our Audio Book Club does not support the carrying amount
of the direct-response advertising reported as assets relating to the Audio Book
Club.
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, 2004, we had $9.7 million of goodwill,
all of which relates to our Radio Spirits operations. We completed our annual
impairment test as of January 2005, utilizing the services of an independent
third-party appraiser, 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.
Results of Operations
The following table sets forth, for the periods indicated, historical operating
data as a percentage of net sales.
Three Months Ended March 31,
2005 2004
-------- ---------
Sales ..................................................... 100% 100%
Cost of sales ............................................. 53.6 45.2
-------- ---------
Gross profit .............................................. 46.4 54.8
Advertising and promotion ................................. 11.5 23.9
Bad debt expense .......................................... 4.2 7.0
21
General and administrative expense ........................ 42.8 27.4
Depreciation and amortization expense ..................... .8 .8
Interest expense, net ..................................... 17.8 15.0
Loss on early extinguishment of debt ...................... 17.2 --
Income tax expense (benefit) .............................. -- --
-------- ---------
Net (loss) ................................................ (47.9) (19.4)
Dividends on preferred stock .............................. 6.1 1.1
Deemed dividend for beneficial conversion feature of Series
D Preferred Stock .................................... 519.8
-------- ---------
Net (loss) applicable to common shares .................... -- --
(573.8)% (20.5)%
======== =========
Results of Operations
Three months ended March 31, 2005 compared to three months ended March 31,
2004:
Net Sales
($000's) Change from
2004 2005 2004 to 2005 % Change
---- ---- ------------ --------
Audio Book Club $ 3,727 $ 2,241 $ (1,486) (39.9) %
----------------------------------------------------------------------
Radio Spirits
Catalog 923 687 (236) (25.6) %
Wholesale 569 210 (359) (62.9) %
Continuity 413 167 (246) (59.6) %
----------------------------------------------------------------------
1,905 1,064 (841) (44.1) %
----------------------------------------------------------------------
MediaBay.com 52 47 (5) (9.6) %
----------------------------------------------------------------------
$ 5,684 $ 3,352 (2,332) (41.0) %
======================================================================
Audio Book Club sales decreased principally due to a decrease in club membership
as a result of a substantial reduction in our advertising expenditures for new
members.
The decrease in Radio Spirits catalog sales of $236,000, or 25.6%, is
principally attributable to discounting of products offered in our catalogs,
which has reduced average order size and fewer customers. Wholesale sales of
old-time radio products decreased principally due to reduced sales at our major
customers. Sales of our World's Greatest Old-Time Radio continuity program
decreased for the three months ended March 31, 2005, as compared to the three
months ended March 31, 2004, principally due to a reduction of advertising for
new members in the first quarter of 2005 and reduced advertising in all of 2004,
which resulted in fewer active customers in 2005.
Cost of Sales
$ (000's) 2004 2005
------------------------------------------------------------------
As a % As a % From 2004 to 2005
$ of Net $ of Net Sales Change % Change
Sales
Audio Book Club $ 1,656 44.4% $ 1,261 56.3 % $ (395) (23.9) %
-------- -------- -------- -------- -------- --------
Radio Spirits
Catalog 387 41.9% 294 42.8 % (93) (24.0) %
Wholesale 348 61.2% 174 82.5 % (174) (50.0) %
Continuity 179 43.3% 67 40.1 % (112) (62.6) %
-------- -------- -------- -------- -------- --------
Total Radio Spirits 914 48.0% 535 50.2 % (379) (41.5) %
-------- -------- -------- -------- -------- --------
MediaBay.com -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
$ 2,570 45.2% $ 1,796 53.6 % (774) (30.1) %
======== ======== ======== ======== ======== ========
22
The principal reason for the decline in cost of sales at Audio Book Club was a
reduction in sales of 39.9% as described above. Cost of sales as a percentage of
sales at Audio Book Club for the three months ended March 31, 2005 was 56.3%,
compared to 44.4% for 2004. The increase in cost of sales as a percentage of
sales is principally due to an increase in product costs as a percentage of
sales since smaller active membership required us to purchase finished goods
from publishers rather than the licensing and manufacture of product due to
lower sales and our inability to meet manufacturing minimums and recoup advances
to publishers, higher sales of unabridged and CD titles with higher costs and
higher manufacturing costs due to lower volumes.
The principal reason for the decline in cost of sales at Radio Spirits was a
reduction in sales of 44.1% as described above. As a percentage of sales, cost
of sales at Radio Spirits increased to 50.2% for the three months ended March
31, 2005 from 48.0% for the three months ended March 31, 2004. Cost of catalog
sales increased as a percentage of sales to 42.8% for the three months ended
March 31, 2005 as compared to 41.9% for the three months ended March 31, 2004
principally due to sales of lower cost items with lower margins and increased
discounting in the catalogs. The cost of wholesale sales as percentage of sales
increased to 82.5% for the three months ended March 31, 2005 as compared to
61.2% for the three months ended March 31, 2004 principally due to a higher
portion of our cost of goods sold in 2005 were fixed costs due to lower volume.
The cost of World's Greatest Old-Time Radio continuity sales as a percentage of
sales decreased to 40.1% from 43.3%. Since we did no new customer marketing in
the three months ended March 31, 2005, very little of the product sales were of
the heavily discounted introduction products.
Advertising and Promotion
$ (000's)
From 2004 to 2005
-----------------
2004 2005 Change % Change
---------- ---------- ---------- ----------
($000's)
Audio Book Club
New Member $ 242 $ -- (242) (100.0) %
Current Member 302 193 (109) (36.1) %
---------- ---------- ---------- ----------
Total Audio Book Club 544 193 (351) (64.5) %
---------- ---------- ---------- ----------
Radio Spirits
Catalog 170 184 14 8.2 %
Wholesale 3 -- (3) (100.0) %
Continuity 5 -- (5) (100.0) %
---------- ---------- ---------- ----------
Total Radio Spirits 178 184 6 3.4 %
---------- ---------- ---------- ----------
New Projects -- -- -- --
---------- ---------- ---------- ----------
Total Spending 722 377 (345) (47.8) %
Amount Capitalized (218) -- 218 (100.0) %
Amount Amortized 855 9 (846) (98.9) %
---------- ---------- ---------- ----------
Advertising and Promotion Expense $ 1,359 $ 386 (973) (71.6) %
========== ========== ========== ==========
Advertising and promotion expenses decreased $973,000 to $386,000 for the three
months ended March 31, 2004 as compared to $1.4 million in the prior comparable
period. The decrease in advertising expense was principally due to reduced
amortization expense of advertising costs incurred in prior periods and reducing
spending on advertising in the current quarter. In the fourth quarter of 2004,
based on the change in our strategy, described above, we determined that the
future net revenue from our Audio Book Club would not support the carrying
amount of the direct-response advertising reported as assets relating to the
23
Audio Book Club. Actual advertising expenditures for the three months ended
March 31, 2005 decreased $345,000 to $377,000 from $722,000 during the three
months ended March 31, 2004. Accordingly, we wrote-off the carrying amount of
the asset in the fourth quarter for 2004 resulting in an increase in advertising
expense of $846,000 in 2004 and lower expense in 2005. The decrease in spending
was due to the lack of new member marketing for Audio Book Club new members due
to our change in strategy as described above and decreased advertising to
existing members due to the reduction in Audio Book Club membership because of
normal member attrition with no marketing to replace leaving members.
Bad Debt Expense
2004 2005
--------------------------------------------
$ (000's) From 2004 to 2005
As a % As a %
$ of Net Sales $ of Net Sales Change % Change
-------- -------- -------- -------- -------- --------
Audio Book Club $ 356 9.5% 128 5.7 % $ (228) (64.0) %
-------- -------- -------- -------- -------- --------
Radio Spirits
Catalog -- -- -- -- -- --
Wholesale 4 0.7% 4 1.9 % -- --
Continuity 38 9.2% 9 5.4 % (29) (76.3) %
-------- -------- -------- -------- -------- --------
42 2.2% 13 1.2 % (29) (69.0) %
-------- -------- -------- -------- -------- --------
MediaBay.com -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
$ 398 7.00% 141 4.2 % $ (257) (64.6) %
======== ======== ======== ======== ======== ========
The principal reason for the decline in bad debt expense at Audio Book Club was
a reduction in net sales. The decrease in bad debt expense as a percentage of
net sales is principally due to a reduced number of new members, who typically
have higher bad debt expense and a core membership in Audio Book Club, which has
demonstrated good paying behavior. The decrease in bad debt expense at the
World's Greatest Old-Time Radio continuity is due to lower sales as described
above and fewer new customers who typically have higher bad debt rates.
General and Administrative
$ (000's) 2004 2005
--------------------------------------------
As a % As a % From 2004 to 2005
$ Of Net Sales $ Of Net Sales Change % Change
-------- -------- -------- -------- -------- --------
Audio Book Club $ 669 17.9 % $ 459 20.5 % (210) (31.4) %
Radio Spirits 205 10.9 % 266 25.0 % 61 29.8 %
MediaBay.com 171 172 1 0.6 %
Corporate 515 536 21 4.1 %
-------- -------- -------- -------- -------- --------
$ 1,560 27.3 % $ 1,433 42.7 % (127) (8.1) %
======== ======== ======== ======== ======== ========
The decrease in general and administrative expenses for the three months ended
March 31, 2005 as compared to the three months ended March 31, 2004 at Audio
Book Club is principally due to a reduction in personnel and lower consulting
fees. The increase in general and administrative expenses for the three months
ended March 31, 2005 as compared to the three months ended March 31, 2004 at
Radio Spirits is principally due to an increase in personnel. The increase in
corporate general and administrative expenses for the three months ended March
31, 2005 as compared to the three months ended March 31, 2004 is principally due
to increased payroll costs and accounting fees, partially offset by lower public
and investor relations costs.
24
Depreciation and Amortization
2004 2005
---------- ----------
$ (000's)
Depreciation
Audio Book Club $ 25 $ 15
Radio Spirits 9 9
---------- ----------
Total depreciation 34 24
Amortization
Corporate 13 2
---------- ----------
Total depreciation and amortization $ 47 $ 26
========== ==========
The decrease in depreciation and amortization expenses for the three months
ended March 31, 2005 as compared to the three months ended March 31, 2004 is
principally attributable to reductions in the amortization of intangibles, which
had been fully amortized or written off during the year ended December 31, 2004
and certain equipment, which was fully depreciated in 2004.
Interest Expense
From 2004 to 2005
-----------------
2004 2005 Change % Change
---------- ---------- ---------- ----------
$ (000's)
Total interest paid $ 180 2,007 1,827 1,015.1 %
Accrued interest paid this period (74) (1,599) (1,525) 2,060.8 %
Current interest paid 106 415 309 291.5 %
Interest included in debt -- (323) (100.0)%
323
Amortization of deferred financing costs and
original issue discount 425 195 (230) (54.1)%
Interest income -- (13) (13) --
---------- ---------- ---------- ----------
Total interest expense $ 854 597 (257) (30.1)%
========== ========== ========== ==========
The decrease in interest expenses is principally due to the conversion of $11.6
million of debt into preferred stock and common stock in 2004.
Loss on Early Extinguishment of Debt
2004 2005
---- ----
$ (000's)
Loss on early extinguishment of debt $ -- $ 579
Concurrently with the Financing as described in the Liquidity and Capital
Resources section below, the Company repaid from net proceeds, all of the
principal and accrued and unpaid interest due on the Company's outstanding
senior notes issued on April 28, 2004, in the aggregate amount of approximately
$9,400. The Company reported a charge in the first quarter of 2005 of $579
reflect the write-off of unamortized financing charges related to the repayment
of this debt.
Preferred Stock Dividends
2004 2005
---------- ----------
$ (000's)
Dividends accrued on Series A Preferred Stock $ 56 $ 51
Dividends accrued on Series B Preferred Stock 8 1
Dividends accrued on Series C Preferred Stock -- 100
Dividends accrued on Series D Preferred Stock -- 53
Deemed dividend for beneficial conversion feature of
Series D Preferred Stock -- 17,423
Total dividends deemed or accrued on preferred --
stock $ 64 $ 17,628
25
The Series D Preferred Shares are convertible at any time at the option of the
holder into shares of our common stock at the rate of $0.55 per share and each
warrant is exercisable to purchase one share of our common stock at an exercise
price of $0.56 per share. The market price for our common stock at March 21,
2005 was $.69. We recorded as a non-cash deemed dividend an amount of $17,423 to
reflect the value of the beneficial conversion feature of the Series D Preferred
Stock and increased contributed capital by $17,423. The recording of the
dividend had no effect on our cash or net equity.
The increase in the accrual of preferred stock dividends for the three months
ended March 31, 2004 as compared to the three months ended March 31, 2003 is due
to the accrual of dividends for Series C Preferred Stock issued May 2004 and the
Series D Preferred Stock issued in March 2005, as described in the Liquidity and
Capital Resources section below.
Loss Applicable to Common Stockholders
$ (000's)
From 2004 to 2005
-----------------
2004 2005 Change % Change
---- ---- ------ --------
$ (000's)
Loss applicable to common stockholders $ 1,168 $19,234 $18,066 1,546.7%
======= ======= ======= =======
Principally due to the deemed dividend for beneficial conversion of Series D
Preferred Stock of $17,423, lower sales due in large part to reduced spending on
new member and customer advertising and lower wholesale sales at Radio Spirits
and a loss on early extinguishment of debt of $579, partially offset by lower
advertising and other expenses as described above, our net loss applicable to
common shares for the three months ended March 31, 2005 increased $18.0 million
to $19.2 million, or $0.77 per diluted share, as compared to a net loss
applicable to common shares for the three months ended March 31, 2004 of $1.2
million, or $.09 per diluted share of common stock, for the three months ended
March 31, 2004.
Liquidity and Capital Resources
March 2005 Equity Financing
On March 23, 2005, pursuant to an agreement executed on March 21, 2005, we
issued an aggregate of (a) 35,900 shares (the "Offering Shares") of our Series D
Convertible Preferred Stock (the "Series D Preferred") convertible into
65,272,273 of our common stock, (b) 32,636,364 five-year common stock purchase
warrants (the "Offering Warrants") and (c) preferred warrants (the
"Over-Allotment Warrants" and, together with the Offering Shares and the
Offering Warrants, the "Offering Securities") exercisable for a limited time,
for additional proceeds to us of $8.975 million, to purchase (1) up to 8,975
additional shares of Series D Preferred (the "Additional Shares" and, together
with the Offering Shares, the "Preferred Shares") and (2) up to 8,159,091
additional warrants identical to the Offering Warrants (the "Additional
Warrants" and, together with the Offering Warrants, the "Warrants"), to
accredited investors (the "Investors") for an aggregate purchase price of $35.9
million (the "Financing").
Immediately prior to the Financing, holders of a majority of our voting
securities approved by written consent (the "Shareholder Consent") (a) an
amendment to our Articles of Incorporation, increasing the number of our
authorized shares of the common stock ("Common Stock") from 150,000,000 to
300,000,000, (b) a change of control which may occur as a result of the
Financing, and (c) our issuance, in connection with the transactions
contemplated by the Financing documents, of Common Stock in excess of 19.99% of
the number of shares of Common Stock outstanding immediately prior to the
Financing.
While such actions were approved by a majority of our shareholders prior to the
financing, we ere not permitted to effect them until we satisfied certain
information requirements to our shareholders not party to the Shareholder
Consent. As a result, the Shareholder Consent did not become effective until May
3, 2005.
26
The Preferred Shares have a face value of $1,000 per share ("Stated Value") and
are convertible at any time at the option of the holder into shares ("Conversion
Shares") of common stock at the rate of $0.55 per Conversion Share, subject to
certain anti-dilution adjustments, including for issuances of Common Stock for
consideration below the conversion price. The Preferred Shares are also
mandatorily convertible at our option, subject to satisfaction of certain
conditions, commencing 30 days following the later date to occur (the "Effective
Date") of (a) the effective date of the Financing Registration Statement
(defined below) and (b) May 3, 2005, the effective date of the Shareholder
Consent. Under certain limited circumstances within our control, the holders
will also have the right to require us to redeem their Preferred Shares at their
Stated Value. Cumulative dividends will accrue on the Preferred Shares on an
annualized basis in an amount equal to 6% of their Stated Value until they are
converted or redeemed and will be payable quarterly in arrears, beginning April
1, 2005, in cash or, at our option, subject to satisfaction of certain
conditions, in shares of Common Stock ("Dividend Shares") valued at 93% of the
average of the daily volume weighted average per-share price of the Common Stock
for the five trading days prior to the applicable payment date. The Preferred
Shares are non-voting. Subject to certain exceptions for accounts receivable and
equipment and capital lease financings, we may not incur additional indebtedness
for borrowed money or issue additional securities that are senior to or pari
passu to the Preferred Shares without the prior written consent of holders of at
least two thirds of the Preferred Shares then outstanding.
Each Warrant is exercisable to purchase one share of Common Stock (collectively,
the "Warrant Shares"), at an exercise price of $0.56 per share for a period of
five years commencing September 23, 2005, subject to certain anti-dilution
adjustments, including for issuances of Common Stock for consideration below the
exercise price. In addition, once exercisable, the Warrants permit cashless
exercises during any period when the Warrant Shares are not covered by an
effective resale registration statement.
The Over-Allotment Warrants are exercisable until 90 days following the
Effective Date for the purchase of Additional Shares and Additional Warrants, at
an exercise price equal to the Stated Value of the Additional Shares purchased,
with the purchase of each Additional Share including an Additional Warrant
exercisable for a number of Warrant Shares equal to 50% of the Conversion Shares
underlying such Additional Share.
As part of the Financing, the Forest Hill Entities exchanged the 1.8 million
shares of Common Stock and 400,000 October Warrants previously purchased by them
in October 2004 for $900,000 of the Offering Securities.
In connection with the Financing, we also entered into an agreement (the
"Herrick Agreement") with Herrick and Huntingdon (collectively, the "Herrick
Entities"), pursuant to which, concurrently with the Financing:
o all $5.784 million principal amount of our convertible notes owned
by the Herrick Entities (the "Herrick Notes") and 10,684 of their
shares of our Series A Preferred Stock were converted into an
aggregate of approximately 12.2 million shares of Common Stock (the
"Herrick Shares"), at their stated conversion rate of $0.56 per
share;
o we also agreed to redeem the remaining 14,316 shares of Series A
Preferred Stock held by the Herrick Entities and all 43,527 of their
shares of our Series C Convertible Preferred Stock of the Company
(collectively, the "Redemption Securities") for $5.8 million, the
aggregate stated capital of such shares, on the earlier of the
effective date of the Shareholder Consent and June 1, 2005, and both
the Redemption Securities and the redemption price were placed into
escrow pending such date;
o the Herrick Entities waived certain of their registration rights and
we agreed to include the Herrick Shares for resale in the Financing
Registration Statement, so long as such Herrick Shares are owned by
the Herrick Entities and not otherwise transferred, including, but
not limited to, in the Herrick Financing (as defined below); and
o the Herrick Entities consented to the terms of the Financing and the
agreements entered into in connection with the Financing, as we were
required to obtain such consents pursuant to the terms of the
Herrick Notes, the Series A Preferred Stock and the Series C
Preferred Stock.
27
o Herrick and Huntingdon also entered into a voting agreement and
proxy with us pursuant to which they agreed not to take any action
to contradict or negate the Shareholder Consent.
We received $35 million of gross proceeds (not including the securities
exchanged by the Forest Hill Entities for $900,000 of the purchase price) in the
Financing. Merriman Curhan Ford & Co. ("Merriman") acted as a financial advisor
with respect to certain of the investors in the Financing for which it received
compensation from us of $2,625,000 plus a five-year warrant to purchase
7,159,091 shares of Common Stock at an exercise price of $0.69 per share, the
market price of our common stock on March 21, 2005, commencing on May 3, 2005,
the effective date of the Shareholder Consent. Merriman also received a
structuring fee from us with respect to the Financing in the amount of $175,000.
In addition, we issued to Satellite Strategic Finance Associates, LLC and
Satellite Finance Partners. Ltd., investors in the Financing, warrants to
purchase an aggregate of 250,000 shares of our common stock (identical to the
Warrants), and reimbursed them $55,000 for expenses, for consulting services
rendered by it in connection with the Financing. We also incurred additional
legal accounting and other costs of $279,000.
Concurrently with the Financing, we repaid from net Financing proceeds all of
the principal and accrued and unpaid interest due on our outstanding senior
notes issued on April 28, 2004, in the aggregate amount of approximately $9.4
million. We will report an additional charge in the first quarter of 2005 to
reflect the write-off of unamortized financing charges related to the repayment
of this debt.
We used approximately $2,271,000 of the proceeds from the Financing to pay all
accrued and unpaid interest to the Herrick Entities on convertible notes and the
Series A Preferred Stock and Series C Preferred Stock.
Activity during the three months ended March 31, 2005.
For the three months ended March 31, 2005, cash increased by $13.3
million, as we had net cash used in operating activities of $893,000, used net
cash of $175,000 in investing activities and had cash provided by investing
activities of $14.4 million. Net cash used in operating activities principally
consisted of the net loss of $19.2 million, increases in prepaid expenses of
$108,000 and a decrease in accounts payable and accrued expenses of $634,000
partially offset by the deemed dividend for beneficial conversion feature of
Series D preferred Stock of $17.2 million, the loss on early extinguishment of
debt of $579,000, depreciation and amortization expenses of $26,000,
amortization of deferred financing costs and original issue discount of
$196,000, non-current accrued interest and dividends payable of $306,000, and
decreases in accounts receivable, inventory and royalty advances of $434,000,
111,000, and $35,000.
The decreases in accounts receivable and inventory are primarily attributable
the reduction in sales as described above. The increase in prepaid expenses is
principally due to the timing of payments of prepaid insurance and other costs
and certain Radio Spirits catalog expenses.
Net cash used in investing activities consists of acquisition of fixed assets of
$175,000, principally computer equipment and the cost of the development of the
Larry King web site.
During the three months ended March 31, 2005, we received net cash proceeds of
the sale of Series D Preferred Stock of $31.9 million, as described above,
repaid all of our senior secured debt in the amount of $9.35 million, repaid
accrued interest, dividends and fees relating to the debt of $2.35 million, and
placed $5.8 million in escrow to redeem from the Herrick Entities the balance of
the Series A Preferred shares remaining after the partial conversion thereof
pursuant to the terms of the Financing and all of the Series C Preferred Shares.
The $5.8 million in escrow was released to the Herrick Entities on May 3, 2005,
the effective date of the Shareholder Consent.
Recent Accounting Pronouncements
Share-Based Payment
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment," which
is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. The compensation cost will
be measured based on the fair value of the equity or liability instruments
issued. The Statement is effective as of the beginning of the annual period
28
beginning after June 15, 2005. We do not yet know the impact that any future
share-based payment transactions will have on our financial position or results
of operations.
Inventory Costs
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs." SFAS 151
amends ARB No. 43, "Inventory Pricing", to clarify the accounting for certain
costs as period expense. The Statement is effective for fiscal years beginning
after June 15, 2005; however, early adoption of this Statement is permitted. The
Company does not anticipate an impact from the adoption of this statement.
Certain Transactions
In addition to the transactions described above with the Herrick Entities and
the Forest Hill entities, as of March 31, 2005, we owed to Norton Herrick, and
his affiliates approximately $152,900 for reimbursement of certain expenses and
services incurred in prior years. From December 31, 2004 through March 31, 2005,
we paid Herrick a total of $162,000, and have agreed to pay Herrick $40,500 per
month on the first of each month through and including July 2005 and $31,410 on
August 1, 2005.
Quarterly Fluctuations
Our operating results vary from period to period as a result of purchasing
patterns of our members and customers, member attrition, the timing and
popularity of new audiobook releases and product returns.
We believe that a significant portion of our sales of old-time radio and classic
video programs are gift purchases by consumers. Therefore, we tend to experience
increased sales of these products in the fourth quarter in anticipation of the
holiday season and the second quarter in anticipation of Fathers' Day.
Item 3: Quantitative and Qualitative Disclosures of Market Risk
The Company's has no exposure to market risk for changes in interest rates. The
Company has total debt outstanding as of May 13, 2005 of $658,000, all of which
is at fixed rates. Changes in the prime rate or LIBOR would not have an impact
on our fair values, cash flows, or earnings for the three months ended March 31,
2005.
Item 4. Controls and Procedures
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (the Act), beginning
with our Annual Report on Form 10-K for the fiscal year ending December 31,
2006, we will be required to furnish a report by our management on our internal
control over financial reporting. This report will contain, among other matters,
an assessment of the effectiveness of our internal control over financial
reporting as of the end of our fiscal year, including a statement as to whether
or not any material weakness in our internal control over financial reporting
identified by management. If we identify one or more material weaknesses in our
internal control over financial reporting, we will be unable to assert our
internal control over financial reporting is effective. This report will also
contain a statement that our independent registered pubic accountants have
issued an attestation report on management's assessment of such internal
controls and a conclusion on the operating effectiveness of those controls.
Management acknowledges its responsibility for internal controls over financial
reporting and seeks to continually improve those controls. In order to achieve
compliance with Section 404 of the Act within the prescribed period, we are
currently performing the system and process documentation and evaluation needed
to comply with Section 404, which is both costly and challenging. We believe our
process, which we began in the first quarter of 2005 and, we believe, will
continue through 2006 for documenting, evaluating and monitoring our internal
control over financial reporting is consistent with the objectives of Section
404 of the Act.
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
29
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 March
31, 2005 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.
30
Part II - Other Information
Item 5: Other Information
On May 10, 2005, MediaBay entered into a consulting and severance agreement with
John Levy, its Vice Chairman and Chief Financial Officer. Pursuant to the
agreement, Mr. Levy resigned all of his positions with the Company, including
Chief Financial Officer and director, and the Company's subsidiaries effective
as of May 17, 2005. We agreed to pay severance payments to Levy as follows: (i)
$75,000 on May 15, 2005 and (ii) $6,000 per month commencing with a payment on
May 31, 2005 and ending on April 30, 2006 (collectively "Severance Payments").
We also engaged Levy to provide to MediaBay certain consulting services,
including assistance with accounting and finance issues, transition of the
Company's financing and accounting functions and preparation of the Company's
Quarterly Report on Form 10-Q for the quarter ending June 30, 2005. We agreed to
pay Levy (in addition to the Severance Payments) $10,000 per month. In addition,
we agreed to reimburse Levy for business expenses he actually incurs in the
performance of the consulting services and continue to provide Levy with the use
of the office, cellular phone and computer Levy currently uses without charge.
Levy agreed not engage in any business activity on behalf of an entity, which is
a direct competitor of MediaBay without obtaining the prior written
authorization of MediaBay. Levy also agreed not use or to reveal to any person
or entity any trade secrets or confidential information of MediaBay or any trade
secrets or confidential information of any third parties which MediaBay is under
an obligation to keep confidential.
On May 10, 2005, we authorized payment of a $25,000 bonus to Robert Toro, our
Senior Vice President of Finance on May 16, 2005.
On May 12, 2005, effective May 17, 2005, Robert Toro was appointed Chief
Financial Officer.
Item 6: Exhibits and Reports on Form 8-K.
Exhibits
10.1 Option Agreement dated as of April 4, 2005 between the Company and
Jeffrey Dittus.
10.2 Option Agreement dated as of April 4, 2005 between the Company and
Joseph Rosetti.
10.3 Option Agreement dated as of April 4, 2005 between the Company and
Robert Toro.
10.4 Option Agreement dated as of April 4, 2005 between the Company and
Patricia Campbell.
10.5 Option Agreement dated as of April 4, 2005 between the Company and
Daniel Altobello.
10.6 Option Agreement dated as of April 4, 2005 between the Company and
Richard Berman.
10.7 Option Agreement dated as of April 4, 2005 between the Company and
Paul Neuwirth.
10.8 Option Agreement dated as of April 4, 2005 between the Company and
Stephen Yarvis.
10.9 Severance and Consulting Agreement between the Company and John
Levy.
10.10 Approval of Bonus Payable to Robert Toro.
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
32.1 32.2 Certification of John Levy, Vice Chairman 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 20
31
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, MediaBay, Inc. has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
MediaBay, Inc.
Dated: May 16, 2005 By: /s/ Jeffrey Dittus
--------------------------------------------
Jeffrey Dittus
Chief Executive Officer
Dated May 16, 2005 By: /s/ John F. Levy
-----------------------------------
John F. Levy
Chief Financial Officer
(principal accounting and financial officer)
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