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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE THREE MONTH PERIOD ENDED JUNE 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
----------------------- -----------------
COMMISSION FILE NUMBER 000-30063
ARTISTDIRECT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4644384
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5670 WILSHIRE BOULEVARD, SUITE 200 90036
LOS ANGELES, CALIFORNIA (Zip Code)
(Address of principal executive office)
(323) 634-4000
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL DOCUMENTS AND
REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares of Common Stock outstanding as of June 30, 2001: 3,582,275
shares.
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INDEX
Page
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PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED BALANCE SHEETS AT JUNE 30, 2001 (UNAUDITED)
AND DECEMBER 31, 2000 ........................................... 1
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX
MONTHS ENDED JUNE 30, 2001 (UNAUDITED) AND 2000 (UNAUDITED)...... 2
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS
ENDED JUNE 30, 2001 (UNAUDITED) AND 2000 (UNAUDITED)............. 3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS....................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................ 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ...... 36
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................ 37
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................ 37
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................. 39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 39
ITEM 5. OTHER INFORMATION................................................ 40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 41
A. EXHIBITS..................................................... 41
B. REPORTS ON FORM 8-K.......................................... 41
SIGNATURES............................................................... 42
In this Report, "ARTISTdirect," the "Company," "we," "us" and "our"
collectively refers to ARTISTdirect, Inc.
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PART I FINANCIAL INFORMATION
ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
JUNE 30, DECEMBER 31,
2001 2000
--------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 58,643 $ 51,457
Cash held for clients 524 743
Marketable securities 11,125 36,368
Accounts receivable, net 548 948
Prepaid expenses and other current assets 2,507 3,218
--------- ---------
Total current assets 73,347 92,734
Property and equipment, net 8,020 9,057
Goodwill and intangibles, net 8,730 15,018
Other assets, net 145 1,696
--------- ---------
$ 90,242 $ 118,505
========= =========
LIABILITIES, REDEEMABLE SECURITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Cash held for clients $ 524 $ 743
Accounts payable 537 2,257
Accrued expenses 3,487 5,186
Loans and notes payable 191 178
Deferred revenue -- 34
--------- ---------
Total current liabilities 4,739 8,398
Long term liabilities 1,058 1,530
--------- ---------
Total liabilities 5,797 9,928
--------- ---------
Redeemable securities:
Redeemable common securities, $.01 par value
Authorized 10,800,000 shares. Liquidation
preference and redemption value of $10,993
and $10,778 in 2001 and 2000, respectively 10,993 10,778
--------- ---------
Total redeemable securities 10,993 10,778
--------- ---------
Stockholders' equity:
Common stock, $.01 par value. Authorized
15,000,000 shares in 2001 and 2000; issued
3,782,275 and 3,779,608 in 2001 and 2000,
respectively; outstanding 3,582,275 and
3,779,608 shares in 2001 and 2000, respectively 379 379
Treasury stock, 200,000 shares in 2001 (2,500) --
Additional paid-in-capital 199,948 200,690
Unearned compensation (13,437) (20,364)
Accumulated deficit (110,938) (82,906)
--------- ---------
Total stockholders' equity 74,452 97,799
--------- ---------
$ 90,242 $ 118,505
========= =========
The accompanying notes are an integral part of these financial statements.
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ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATION
(AMOUNTS IN THOUSANDS, EXCEPT FOR SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
Net revenue:
E-Commerce $ 1,688 $ 2,580 $ 4,082 $ 4,609
Media 1,051 1,973 1,785 3,770
Agency 154 927 379 1,472
Record label -- 118 -- 244
----------- ----------- ----------- -----------
Total net revenue 2,893 5,598 6,246 10,095
Cost of revenue:
Direct cost of product sales 1,306 2,317 3,419 4,238
Other cost of revenue 1,549 2,129 3,290 3,762
Stock-based compensation 1,550 1,679 3,099 4,472
----------- ----------- ----------- -----------
Total cost of revenue 4,405 6,125 9,808 12,472
Gross loss (1,512) (527) (3,562) (2,377)
Operating expenses:
Web site development 1,166 679 2,813 1,486
Sales and marketing 1,482 6,676 3,908 11,793
General and administrative 3,617 4,398 7,837 8,058
Amortization of stock-based compensation 1,607 1,757 3,290 1,391
Depreciation and amortization 1,644 1,457 3,640 2,631
Loss from impairment of goodwill -- -- 4,458 --
----------- ----------- ----------- -----------
Loss from operations (11,028) (15,494) (29,508) (27,736)
Income/(loss) from equity investments (778) 15 (723) 15
Interest income, net 856 1,476 2,199 2,531
----------- ----------- ----------- -----------
Net loss $ (10,950) $ (14,003) $ (28,032) $ (25,190)
Interest on rescission offer 173 271 337 493
Dividend on redeemable stock -- -- -- 963
Beneficial conversion feature on redeemable
preferred stock -- -- -- 24,375
----------- ----------- ----------- -----------
Net loss attributable to common shareholders $ (11,123) $ (14,274) $ (28,369) $ (51,021)
=========== =========== =========== ===========
Basic and diluted loss per share $ (3.07) $ (3.87) $ (7.67) $ (19.70)
=========== =========== =========== ===========
Weighted average common shares outstanding 3,623,154 3,685,255 3,700,949 2,590,223
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
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ARTISTDIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
----------------------
2001 2000
-------- --------
Cash flows from operating activities:
Net loss $(28,032) $(25,190)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 3,640 2,631
(Income)/loss from equity investments 723 (15)
Loss on sale of equipment 10 --
Loss from impairment of goodwill 4,458 --
Allowance for doubtful accounts and sales returns (258) 275
Amortization of unearned compensation 6,389 5,863
Changes in assets and liabilities:
Accounts receivable 658 (1,825)
Prepaid expenses and other current assets 711 (797)
Other assets 241 (97)
Accounts payable, accrued expenses and
other liabilities (2,740) (1,355)
Deferred revenue (34) (38)
-------- --------
Net cash used in operating activities (14,234) (20,548)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment, net (823) (6,111)
Proceeds from the sales of property and equipment 40 --
Proceeds from maturities of marketable securities 25,243 --
Purchase of marketable securities -- (44,091)
Investment in joint ventures (551) --
Investments in trademarks -- (120)
-------- --------
Net cash provided by (used in) investing
activities 23,909 (50,322)
-------- --------
Cash flows from financing activities:
Repurchase of common stock (2,500) --
Proceeds from employee stock purchase plan 11 --
Payment of notes to shareholders -- (741)
Payment of Series C redeemable preferred stock
offering costs -- (4,750)
Proceeds from exercise of stock options -- 1,538
Proceeds from issuance of preferred securities -- 15,224
Proceeds from initial public offering, net
of offering costs paid -- 52,630
-------- --------
Net cash (used in) provided by financing
activities (2,489) 63,901
-------- --------
Net increase (decrease) in cash and cash
equivalents 7,186 (6,969)
Cash and cash equivalents at beginning of period 51,457 69,119
-------- --------
Cash and cash equivalents at end of period $ 58,643 $ 62,150
======== ========
The accompanying notes are an integral part of these financial statements.
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ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - THE COMPANY
ARTISTdirect, Inc. (the "Company") was formed on October 6, 1999 upon its merger
with ARTISTdirect, LLC (the "Capital Reorganization"). The Capital
Reorganization was only a change in the form of ownership of the Company.
ARTISTdirect, LLC was organized as a California limited liability company and
commenced operations on August 8, 1996.
NOTE 2 - REVERSE STOCK SPLIT
On July 5, 2001, the Company declared a 1 for 10 reverse stock split (the
"Reverse Stock Split"). The outstanding common stock, redeemable common
securities, options and warrants have been retroactively adjusted to reflect the
Reverse Stock Split.
NOTE 3 - ACCOUNTING POLICIES
Principles of Consolidation
The accompanying financial statements include the consolidated accounts of the
Company and its subsidiaries in which it has controlling interests in the form
of voting and operating control. All significant intercompany accounts and
transactions have been eliminated for all periods presented.
Unaudited Interim Financial Information
The unaudited interim financial statements of the Company included herein have
been prepared in accordance with the instructions for Form 10-Q under the
Securities Exchange Act of 1934, as amended, and Article 10 of Regulation S-X
under the Securities Act of 1933, as amended. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations relating to interim financial statements.
In the opinion of management, the accompanying unaudited interim consolidated
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of the
Company at June 30, 2001 and results of its operations for the three and six
months ended June 30, 2001 and 2000 and cash flows for the six months ended June
30, 2001 and 2000. The results for the three and six months ended June 30, 2001
are not necessarily indicative of the expected results for the full year or any
future period. These financial statements should be read in conjunction with the
consolidated financial statements and footnotes included in the Company's
documents filed with the Securities and Exchange Commission ("SEC") including
its Form 10-K and Registration Statements on Form S-1, and all amendments
thereto.
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Loss Per Common Share
The Company computes net loss per share in accordance with Statement of
Financial Accounting Standards (SFAS) No.128, "Earnings Per Share," and
Securities and Exchange Commission Staff Accounting Bulletin No. 98 (SAB 98).
SFAS No.128 requires companies with complex capital structures to present basic
and diluted EPS. Basic EPS is measured as the income or loss available to common
shareholders divided by the weighted average outstanding common shares for the
period. Diluted EPS is similar to basic EPS but presents the dilutive effect on
a per-share basis of potential common shares (e.g., convertible securities,
options, and the like) as if they had been converted at the beginning of the
periods presented. Potential common shares that have an anti-dilutive effect
(i.e., those that increase income per share or decrease loss per share) are
excluded from diluted EPS. The number of potentially dilutive common share
equivalents as of June 30, 2001 and 2000 was 1,350,552 and 1,013,786,
respectively.
Included in net loss attributable to common stockholders for the six months
ended June 30, 2000 is the effect of the beneficial conversion feature of the
Series C redeemable preferred stock, which converted into common shares as of
March 31, 2000 in connection with the Company's initial public offering. The
value of the beneficial conversion feature was calculated based on the $24.00
per share difference between the initial public offering price of $120.00 and
the effective conversion price of $96.00 multiplied by the 1,015,625 shares of
common stock issued to the Series C shareholders.
Impairment of Long-Lived Assets and Goodwill
The Company has reviewed the carrying value of its long-lived assets and
goodwill for possible impairment in accordance with SFAS No. 121 "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." The Company determined that the remaining goodwill associated with the
acquisition of Mjuice was impaired due to the Company's decision to wind down
the related operation. During the three months ended March 31, 2001, the Company
recorded a loss from impairment of the goodwill from the Mjuice transaction of
$4.5 million. The Company has determined that there is sufficient basis to
support the carrying amount of goodwill associated with the acquisition of
iMusic and the minority interest in the UBL based upon the projected
undiscounted future cash flows related to the underlying assets of these
goodwill amounts. However, these assets, which are significantly impacted by
online advertising and promotions, may become impaired in the future if
advertising revenue continues to decline.
Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosures
of contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
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Recently Issued Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement No. 141,
"Business Combinations", and Statement No. 142, "Goodwill and Other Intangible
Assets". Statement 141 requires that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001 as well as all
purchase method business combinations completed after June 30, 2001. Statement
141 also specifies criteria intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121.
The Company is required to adopt the provisions of Statement 141 immediately,
except with regard to business combinations initiated prior to July 1, 2001,
which it expects to account for using the pooling-of-interests method, and
Statement 142 effective January 1, 2002. Furthermore, any goodwill and any
intangible asset determined to have an indefinite useful life that are acquired
in a purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-Statement 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.
In connection with the transitional goodwill impairment evaluation, Statement
142 will require the Company to perform an assessment of whether there is an
indication that goodwill (and equity-method goodwill) is impaired as of the date
of adoption. To accomplish this the Company must identify its reporting units
and determine the carrying value of each reporting unit by assigning the assets
and liabilities, including the existing goodwill and intangible assets, to those
reporting units as of the date of adoption. The Company will then have up to six
months from the date of adoption to determine the fair value of each reporting
unit and compare it to the reporting unit's carrying amount. To the extent a
reporting unit's carrying amount exceeds its fair value, an indication exists
that the reporting unit's goodwill may be impaired and the Company must perform
the second step of the transitional impairment test. In the second step, the
Company must compare the implied fair value of the reporting unit's goodwill,
determined by allocating the reporting unit's fair value to all of it assets
(recognized and unrecognized) and liabilities in a manner similar to a purchase
price allocation in accordance with Statement 141, to its carrying amount, both
of which would be measured as of the date of adoption. This second
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step is required to be completed as soon as possible, but no later than the end
of the year of adoption. Any transitional impairment loss will be recognized as
the cumulative effect of a change in accounting principle in the Company's
statement of earnings.
And finally, any unamortized negative goodwill (and negative equity-method
goodwill) existing at the date Statement 142 is adopted must be written off as
the cumulative effect of a change in accounting principle.
As of the date of adoption, the Company expects to have unamortized goodwill in
the amount of $7.2 million, which will be subject to the transition provisions
of Statements 141 and 142. Amortization expense related to goodwill was $3.5
million, $768,000 and $1.8 million for the year ended December 31, 2000 and the
three and six months ended June 30, 2001, respectively. Because of the extensive
effort needed to comply with adopting Statements 141 and 142, it is not
practicable to reasonably estimate the impact of adopting these Statements on
the Company's financial statements at the date of this report, including whether
any transitional impairment losses will be required to be recognized as the
cumulative effect of a change in accounting principle.
NOTE 4 - RECORD LABEL JOINT VENTURE
In June 2001, the Company entered into an agreement with veteran entertainment
executive Ted Field to become chairman and chief executive officer of
ARTISTdirect and form a new record label in partnership with ARTISTdirect. On
June 29, 2001, ARTISTdirect stockholders approved the employment of Mr. Field
and the formation of the record label. The record label is a 50/50 co-venture
between ARTISTdirect and Mr. Field, with the Company providing a significant
financial commitment. Due to the Company's commitment to fund the operations of
the joint venture, the Company shall record 100% of the losses of the joint
venture. As of June 30, 2001, the Company recorded $551,000 of losses from the
joint venture. In addition to the formation of the record label and its
financial commitment, the Company entered into a five-year employment agreement
with Mr. Field and he joined the Company's board of directors. Mr. Field also
serves as the CEO of the record label.
NOTE 5 - RESCISSION OFFER
Included in Redeemable Securities are amounts related to options and securities
subject to a potential rescission offer. As disclosed in the Company's S-1
Registration Statement filed on November 22, 2000, the Company issued shares or
options to purchase shares to employees, artists and advisors. The issuance of
these shares or options did not fully comply with certain requirements under the
Securities Act, or available exemptions there under, and as a result the Company
intends to make a rescission offer to all these persons pursuant to an effective
registration statement filed under the Securities Act and pursuant to California
securities law.
In the rescission offer, the Company will offer to repurchase from these persons
all shares issued directly to these persons or pursuant to option exercises by
these persons before the expiration of the rescission offer for an amount equal
to the purchase or exercise price paid for the shares, plus interest at the rate
of 7% from the date of issuance until the rescission offer expires. The
rescission offer will expire approximately 30 days after the effectiveness of
the rescission offer registration statement. Based upon the number of options
exercised through June 30, 2001, the out-of-pocket cost to the Company to
purchase the shares issued upon such exercised options would be approximately
$2.2 million, plus interest.
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In addition, the Company will also offer to repurchase all unexercised options
to these persons at 20% of the option exercise price times the number of option
shares, plus interest at the rate of 7% from the date the options were granted.
Based on the number of options outstanding as of June 30, 2001, and assuming
that none of these options are exercised prior to the end of the rescission
offer, the out-of-pocket cost to the Company in repurchasing such unexercised
options would be approximately $7.7 million, plus interest.
NOTE 6 - STOCK-BASED COMPENSATION
Stock Options
The Employee Stock Option Plan has reserved 725,592 shares of common stock for
issuance to employees, non-employee members of the Board of Directors and
consultants. Compensation expense related to such option grants for the three
and six months ended June 30, 2001 was $871,000 and $1.8 million, respectively.
Compensation expense related to such option grants for the three and six months
ended June 30, 2000 was $1.3 million and $2.5 million, respectively.
The Artist Stock Option Plan and the Artist and Artist Advisor Stock Option Plan
have reserved 400,000 and 185,000 shares, respectively, of common stock for
issuance to artists and their advisors for the ARTIST channels and promotional
services. Compensation expense related to such option grants was $2.2 million
and $4.4 million for the three and six months ended June 30, 2001, respectively,
of which $1.5 million and $3.0 million, respectively, was included in cost of
revenue and $700,000 and $1.4 million, respectively, was included in operating
expenses. Compensation expense for the three and six months ended June 30, 2000
related to such option grants was $2.3 million and $5.8 million, respectively,
of which $1.6 million and $4.4 million, respectively, was included in cost of
revenue and $700,000 and $1.4 million, respectively, was included in operating
expenses.
Variable Equity Interests
During 1998, the Company issued common units, which were converted to common
shares upon the conversion of the Company to a C corporation in October 1999, to
certain executive employees and its outside legal counsel in connection with
services rendered and to be rendered. The holders of these shares were entitled
to receive the amount of appreciation per share through June 30, 2000 above the
value on the date of grant. The fair value of the Company's common stock
decreased from $114.80 as of December 31, 1999 to $76.30 as of March 31, 2000,
which resulted in a decrease in the appreciation per share, and a credit to
stock based compensation expense of $6.6 million for the three months ended
March 31, 2000.
Warrants
In May and June 1999, the Company issued warrants to purchase common stock to
two vendors. The fair value of the warrants is being amortized as cost of
revenues over the term of the related merchandising agreements. The Company
recorded compensation expense reflected in cost of revenue of $65,000 and
$131,000 for both the three and six months ended June 30, 2001 and 2000,
respectively.
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In December 1999, the Company issued warrants to purchase 33,925 shares of
common stock in connection with an advertising and promotion agreement. Due to
the decrease in fair value of the Company's common stock to $6.90 as of June 30,
2001, the Company recorded a credit to stock based compensation of $3,000 for
the three months ended June 30, 2001. The Company recorded compensation expense
of $20,000 for the six months ended June 30, 2001. Due to the decrease in fair
value of the Company's common stock to $31.25 as of June 30, 2000, the Company
recorded a credit to stock based compensation of $64,000 for the three months
ended June 30, 2000. The Company recorded compensation expense of $98,000 for
the six months ended June 30, 2000.
The Company entered into an agreement with a landlord for office space for a
term of ten years. In connection with the agreement, the Company issued warrants
to purchase 6,250 shares of common stock. The expense related to the warrants is
being amortized over the term of the lease. The Company recorded expense of
$14,000 for the three months ended June 30, 2001 and 2000. The Company recorded
expense of $28,000 and $19,000 for the six months ended June 30, 2001 and 2000,
respectively
Equity Transfer
In March 2000, the founders of the Company entered into a series of transactions
whereby two employees and an outside legal counsel would receive the
appreciation on the Company's common stock above $139.30 per share through the
third day of trading after the initial public offering. Additionally, the two
employees and outside legal counsel received stock options on the third day of
trading after the initial public offering with an exercise price equal to
$139.30 per share. There was no expense charge for the appreciation rights and
stock options granted to the two employees. The fair value of the appreciation
rights and stock options granted to the outside legal counsel was $2,028,000,
and was recorded as expense in March 2000, as the grants related to past
services.
NOTE 7 - SEGMENT INFORMATION
The Company provides integrated music entertainment products and services
through five reportable segments. The five reportable segments, based upon
management's new focus in January, are ARTISTdirect Media Group ("Media"),
E-Commerce Operations Group ("E-Commerce"), Digital Music Distribution Group
("Digital Music"), Talent Agency and Live Event Group ("Agency") and Record
Label ("Record Label"). E-Commerce revenue is generated from the sale of
recorded music and music-related merchandise. Media revenue is generated
primarily from the sale of advertising and sponsorships, both online and
offline. Talent agency revenue is generated from commissions based on the income
received by agency clients for live performances. The Digital Music and the
Record Label segments currently are not generating revenue. Prior to January 1,
2001, the Company had three reportable segments: music-related Web site
operations ("ARTISTdirect Network"), musical artist booking operations
("Agency") and record label operations ("Record Label"). ARTISTdirect Network
generated revenue primarily from the sale of recorded music and music-related
merchandise and from the sale of advertising on our Web sites. The Agency
generated revenue from commissions based on the income received by agency
clients for live performances. The Record Label generated revenue from advances
under an agreement with RCA, which was terminated in June 2000, and from
royalties on sales of recorded music. The factors for determining reportable
segments were based on the distinctive services and products. Each segment is
responsible for executing a
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unique marketing and business strategy. The accounting policies of the new
classifications of segments are the same as those described in the summary of
significant accounting policies. The Company evaluates performance based on
EBITDA loss [earnings before interest, taxes, depreciation and amortization,
stock-based compensation, loss from impairment of goodwill, amortization of
vendor prepaid, interest income and income (loss) from equity investments]. The
following table summarizes the revenue and EBITDA net loss by segment for the
three and six months ended June 30, 2001 and 2000.
Three months ended Six months ended
June 30, June 30,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
(in thousands)
Net Revenue:
E-Commerce $ 1,688 $ 2,580 $ 4,082 $ 4,609
Media 1,051 1,973 1,785 3,770
Talent Agency 154 927 379 1,472
Digital Music -- -- -- --
Record Label -- 118 -- 244
-------- -------- -------- --------
2,893 5,598 6,246 10,095
EBITDA Net Income (Loss)
E-Commerce (1,995) (3,647) (4,691) (6,714)
Media (3,118) (6,870) (7,868) (11,885)
Talent Agency (541) 43 (982) (362)
Digital Music (573) -- (1,341) --
Record Label -- (43) -- (115)
-------- -------- -------- --------
$ (6,227) $(10,517) $(14,882) $(19,076)
======== ======== ======== ========
Reconciliation of EBITDA Net Loss to Net Loss:
EBITDA Net Loss Per Segments (6,227) (10,517) (14,882) (19,076)
Amortization of vendor prepaid -- (84) (139) (166)
Amortization of stock-based compensation (3,157) (3,436) (6,389) (5,863)
Depreciation and amortization (1,644) (1,457) (3,640) (2,631)
Loss from impairment of goodwill -- -- (4,458) --
Interest income (expense), net 856 1,476 2,199 2,531
Income (loss) from equity investments (778) 15 (723) 15
-------- -------- -------- --------
Net Loss $(10,950) $(14,003) $(28,032) $(25,190)
======== ======== ======== ========
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The following table summarizes assets as of June 30, 2001 and December 31, 2000.
June 30, December 31,
2001 2000
-------- ------------
(in thousands)
Assets:
Corporate $ 78,098 $ 98,857
E-Commerce 5,721 9,394
Media 5,804 9,486
Agency 619 768
Digital Music -- --
Record Label -- --
-------- --------
$ 90,242 $118,505
======== ========
Assets by segment are those assets used in the Company operations in each
segment. Corporate assets are principally made up of cash and cash equivalents,
short-term investments, prepaid expenses, computer equipment, leasehold
improvements and other assets.
NOTE 8 - TENDER OFFER AND OPEN MARKET SHARE REPURCHASE
In April 2001, the Company completed a self-tender offer in which it repurchased
200,000 shares of common stock for a total cost of $2.5 million. The repurchased
shares are reflected as treasury stock in the balance sheet as of June 30, 2001.
In May 2001, the Company authorized the purchase of up to $2 million worth of
the Company's common stock. This repurchase is separate and distinct from the
Company's self-tender offer described above. The stock repurchase program will
be implemented through purchases in the open market or in privately negotiated
transactions from time to time depending on market conditions and other factors.
The Company intends to hold the common stock repurchased as treasury stock. As
of June 30, 2001, there were no settled repurchases of common stock.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report on Form 10-Q contains forward-looking statements based on our
current expectations, estimates and projections about our industry, management's
beliefs and certain assumptions made by us. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "may," "will" or similar expressions
are intended to identify forward-looking statements. In addition, any statements
that refer to expectations, projections or other characterizations of future
events or circumstances, including any underlying assumptions, are
forward-looking statements. Such statements include, but are not limited to,
statements concerning ARTISTdirect's unproven business model, increased
competition in its industry, ARTISTdirect's ability to increase revenues from
its record label, online product sales, advertising and other revenue streams,
ability to increase visits to ARTISTdirect's site, ability to attract and retain
artists, ability to offer compelling content, ability to fulfill on-line music
and merchandise orders in a timely manner, ability to build brand recognition,
ability to integrate acquisitions of technology and other businesses, ability to
protect and/or obtain intellectual property rights, and ability to manage
growth. Such statements are not guarantees of future performance and are subject
to certain risks, uncertainties and assumptions that are difficult to predict.
Therefore, our actual results could differ materially and adversely from those
expressed in any forward-looking statements as a result of various factors. The
section entitled "Factors That May Affect Future Results" set forth in this Form
10-Q and similar discussions in our other filings with the SEC, discuss some of
the important risk factors that may affect our business, results of operations
and financial condition. You should carefully consider those risks, in addition
to the other information in this report and in our other filings with the SEC,
before deciding to invest in our company or to maintain or increase your
investment. We undertake no obligation to revise or update publicly any
forward-looking statements for any reason. The information contained in this
Form 10-Q is not a complete description of our business or the risks associated
with an investment in our common stock. We urge you to carefully review and
consider the various disclosures made by us in this report and in our other
reports filed with the SEC that discuss our business in greater detail.
OVERVIEW
We are an online music company that connects artists directly with their
fans worldwide. We provide music entertainment through our ARTISTdirect Network,
an integrated network of Web sites offering multi-media content, music news and
information, community around shared music interests, and music-related
commerce. We also operate a music talent agency, the ARTISTdirect Agency. Prior
to June 30, 2000, we also managed a traditional record label, Kneeling Elephant
Records, which we no longer operate. On June 29, 2001, ARTISTdirect stockholders
approved the formation of a new record label, ARTISTdirect Records LLC, as a
co-venture between the Company and Ted Field, the Company's Chairman and Chief
Executive Officer.
In January 2001, ARTISTdirect reorganized the company into five distinct
business groups: ARTISTdirect Media Group ("Media"), E-Commerce Operations Group
("E-Commerce"), Digital Music Distribution Group ("Digital Music"), Talent
Agency and Live Event Group ("Agency") and Record Label ("Record Label").
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In June 2001, we entered into an agreement with veteran entertainment
executive Ted Field to become chairman and chief executive officer of
ARTISTdirect and form a new record label in partnership with ARTISTdirect. On
June 29, 2001, ARTISTdirect stockholders approved the employment of Mr. Field
and the formation of the record label. The record label is a 50/50 co-venture
between ARTISTdirect and Mr. Field, with ARTISTdirect providing a significant
financial commitment. Due to our commitment to fully fund the operations of the
joint venture, we shall record 100% of the losses of the joint venture. In
addition to the formation of the record label and our financial commitment, we
entered into a five-year employment agreement with Mr. Field and he joined our
board of directors. Mr. Field also serves as the CEO of the record label.
On November 30, 2000, Nasdaq notified the Company that, because the closing
bid price of its common stock had been below $1.00 for over 30 consecutive
trading days, it would be subject to delisting. At the Company's request, the
Nasdaq Listing Qualifications Panel conducted a hearing on April 12, 2001 to
give the Company an opportunity to appeal Nasdaq's decision to delist its common
stock. On May 23, 2001, the Nasdaq Listing Qualifications Panel decided to allow
the continued listing of the Company's common stock on The Nasdaq National
Market provided that (i) the closing bid price of the Company's common stock on
Nasdaq reached a minimum of $1.00 per share on or before July 9, 2001 and
remained at or above that level for a minimum of 10 consecutive trading days (or
longer, if required by the Nasdaq Listing Qualifications Panel), and (ii) the
Company demonstrated compliance with all requirements for continued listing on
The Nasdaq National Market. On July 25, 2001, the Company received notification
from Nasdaq that the Company was in compliance with the provisions of the
exchange and would, therefore, remain listed on The Nasdaq National Market.
ARTISTdirect has incurred cumulative net losses of $152.0 million from
inception to June 30, 2001, of which approximately $54.9 million represented
stock-based compensation expense. While we have significantly reduced our
operating expenses, we expect our net losses to continue and continue to be
significant for the foreseeable future. We plan to expend significant resources
developing a new record label with Ted Field. In addition, we are still
expanding our online operations, but are significantly reducing related
expenditures going forward. We have a limited operating history on which to base
an evaluation of our business and prospects. Our prospects must be considered in
light of the risks, expenses, and difficulties encountered by companies in their
early stage of development, particularly companies in new and rapidly evolving
markets. See "Factors That May Affect Future Results" for a more complete
description of the many risks we face. Our business is evolving rapidly, and
therefore we believe that period-to-period comparisons of our operating results
are not meaningful and should not be relied upon as an indication of future
performance.
REVENUE
We currently generate revenue from three sources: E-Commerce, Media and
Agency. Prior to June 30, 2000, we generated revenue from our Record Label.
Substantially all of our revenue is generated in cash. For the three and six
months ended June 30, 2001 there was no barter revenue and approximately 1% of
our revenue for the year ended December 31, 2000 was barter revenue.
E-Commerce Revenue. E-Commerce revenue includes the sale of music and
related merchandise, such as apparel, collectibles and accessories, through the
ARTISTdirect shopping mall of our network. We recognize the gross amount of
product sales and shipping revenue upon shipment of the item and record
appropriate reserves for product returns. We have experienced
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seasonality with respect to our online product sales. In particular, our
e-commerce sales in the fourth quarter have, on average, been higher than in
other quarters. We believe that this trend may continue for the foreseeable
future. For the three and six months ended June 30, 2001 and the year ended
December 31, 2000, e-commerce revenue constituted approximately 58%, 65% and
56%, respectively, of our total net revenue for those periods.
Media Revenue. Media revenue consists primarily of sales of banner
advertisements and sponsorships. In sales of banner advertisements, we
principally earn revenue based on the number of impressions or times an
advertisement appears on pages viewed within our Web sites. Our banner
advertising commitments generally range from one to six months. Banner
advertising revenue is generally recognized as the impressions are served during
the period in which the advertisement is displayed, provided that no significant
obligations of the Company remain and collection of the resulting receivable is
probable. We typically guarantee a minimum number of impressions to the
advertiser. To the extent that minimum guaranteed page deliveries are not met,
we defer recognition of the corresponding revenue until the guaranteed
impressions are delivered. We also sell to advertisers sponsorship of a Web page
or event for a specified period of time. We recognize sponsorship revenue over
the period in which the sponsored page or event is displayed. To the extent that
committed obligations under sponsorship agreements are not met, revenue
recognition is deferred until the obligations are met. For the three and six
months ended June 30, 2001 and the year ended December 31, 2000, media revenue
constituted approximately 36%, 29% and 29%, respectively, of our total net
revenue for those periods.
During the three and six months ended June 30, 2001, Universal Music Group
accounted for 24% and 28% and Pringles, a division of Procter & Gamble,
accounted for 14% and 17% respectively, of our total media revenue. No other
advertisers accounted for more than 10% of our media revenue for those periods.
Agency Revenue. Revenue from the ARTISTdirect Agency consists primarily of
commissions generated on tour and event bookings of artists represented by the
agency. Agency revenue is recognized at the time the artist gets paid. Agency
revenue fluctuates depending on touring schedules of major artists represented
by the agency. Touring schedules are subject to seasonality, with summer
typically being a more active period. For the three and six months ended June
30, 2001 and the year ended December 31, 2000, agency revenue constituted
approximately 5%, 6% and 14%, respectively, of our total net revenue for those
periods.
Record Label. Prior to June 30, 2000, revenue from Kneeling Elephant
Records was generated from overhead advances and from royalties earned on albums
sold by artists signed to the label. We recognized royalties at the time the
releases were shipped to the retailer. Reserves were established for possible
returns.
COST OF REVENUE
Cost of revenue consists primarily of amounts payable to artists, which
includes the cost of merchandise sold and share of net proceeds, online
transaction costs, including credit card fees, fulfillment charges and shipping
costs, Web site hosting and maintenance costs, online content and programming
costs, online advertising serving costs, payroll and related expenses for staff
involved in Web site maintenance, content programming and the ARTISTdirect
Agency, and amortization of non-cash compensation expense related to vendor
warrants and stock options granted to artists and their advisors in connection
with entering into contractual commitments to
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exclusively operate their online commerce activities. Artist royalties are based
primarily on electronic commerce revenue generated from the sale of their
licensed merchandise. Web site maintenance costs include personnel-related
costs, software consulting costs, Internet hosting charges, and networking
costs.
In connection with the amortization of vendor warrants and artist stock
options granted through June 30, 2001, we recorded non-cash compensation expense
of approximately $1.6 million and $3.1 million, respectively, for the three and
six months ended June 30, 2001 and approximately $7.5 million for the year ended
December 31, 2000. We may grant additional equity instruments in the future
related to signing additional artists. These equity grants may cause us to
record substantial non-cash compensation expense in the foreseeable future.
OPERATING EXPENSE
Web Site Development. Web site development expense consists primarily of
expenses incurred to update the content and design of our Web sites and
underlying technology infrastructure. These expenses primarily include payments
to third-party service vendors and personnel costs.
Sales and Marketing. Sales and marketing expense consists primarily of
advertising, marketing and promotion expenses incurred to promote our Web sites
and our brands, plus payroll and related expenses for personnel engaged in
marketing and advertising sales activities.
General and Administrative. General and administrative expense consists of
payroll and related expenses for executive and administrative personnel,
professional services expenses, facilities expenses, travel and other general
corporate expenses.
Amortization of Stock-based Compensation. We recorded a total of $42.5
million of stock-based compensation expense for the period from inception
through June 30, 2001 in connection with equity granted to employees, directors,
professional firms, artists and artist advisors during this period. We recorded
amortization of stock-based compensation expense of approximately $1.6 million
and $3.3 million, respectively, during the three and six months ended June 30,
2001 and approximately $5.1 million during the year ended December 31, 2000. We
anticipate granting additional equity securities in the future to employees,
directors, artists and artist advisors.
We are currently anticipating initiating a rescission offer with respect to
options and shares of our common stock issued prior to our initial public
offering in March 2000. To the extent that employees holding options subject to
the rescission offer, accept the offer, we will record compensation expense for
such payments, which could be significant. The amount of expense recorded for
the repurchase of unexercised stock options from employees shall be the sum of
the intrinsic value at the original measurement date (less any expense related
to the intrinsic value recorded up to the acceptance of the rescission offer)
and the amount of cash paid to the holder that exceeds the lesser of the
intrinsic value at the original measurement date or immediately prior to
settlement. The amount of compensation that shall be recorded for the repurchase
of unexercised non-employee options shall be the difference between the amount
paid for each option and the fair value of the options on the date the
repurchase offer is accepted. This compensation amount shall be amortized over
the future period over which services will be provided. The fair value of the
options shall be determined using the Black-Scholes
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option-pricing model over the remaining expected life of the options. Any
unamortized expense at the time of repurchase related to the initial grant of
the options to the non-employees shall continue to be amortized over the
remaining service period related to the original option grants. The Company
shall also record as expense for the repurchase of shares issued pursuant to the
exercise of options the difference between the cash paid for the repurchase of
the shares and the fair value of the shares on the date the repurchase is
accepted. The amount of expense will vary depending on the number of individuals
that accept the rescission offer and the Company's stock price on the date any
rescission is consummated.
Depreciation and Amortization. Depreciation and amortization expense
consists of the depreciation of fixed assets and the amortization of acquired
intangible assets. The acquisitions of iMusic, Mjuice and the minority interest
of the UBL were accounted for using the purchase method of accounting and,
accordingly, the purchase prices have been allocated to the tangible and
intangible assets acquired and liabilities assumed on the basis of their fair
value on the acquisition dates. Substantially all of the purchase price of these
transactions is attributable to the acquired intangible assets. As a result, the
aggregate excess purchase price over the net tangible assets allocated to
goodwill was $20.6 million and is being amortized over five years, the expected
estimated average useful life of these assets. These non-cash charges will
significantly affect our reported operating results over the remainder of 2001,
and in the future periods for the portion of goodwill allocated to identifiable
intangible assets, which will continue to be amortized after December 31, 2001
INTEREST INCOME AND EXPENSE
Interest income consists of earnings on our cash and cash equivalents, and
interest expense consists of interest associated with short-term borrowings.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000
NET REVENUE
Net revenue decreased to $2.9 million for the three months ended June 30,
2001 from $5.6 million for the three months ended June 30, 2000, which
represented a decrease of 48%. Net revenue decreased to $6.2 million for the six
months ended June 30, 2001 from $10.1 million for the three months ended June
30, 2000, which represented a decrease of 38%. The decrease was due to decreases
in media, e-commerce and agency revenue. E-commerce revenue decreased 35% to
$1.7 million for the three months ended June 30, 2001 from $2.6 million for the
three months ended June 30, 2000, primarily as a result of a decrease in sales
of merchandise from the top 20 artists. There was less interest in these artists
in 2001, since they released fewer albums and toured less compared to 2000.
Media revenue decreased $922,000, or 47%, to $1.1 million for the three months
ended June 30, 2001 from $2.0 million for the three months ended June 30, 2000,
primarily as a result of a decrease in sales of impression based advertising due
to an overall soft advertising market. Commission revenue from the agency
decreased 83% from $927,000 for the three months ended June 30, 2000 to $154,000
for the three months ended June 30, 2001, due primarily to decreased touring
activity of the agency's artists. E-commerce revenue decreased 11% to $4.1
million for the six months ended June 30, 2001 from $4.6 million for the six
months ended June 30, 2000, primarily as a result of a decrease in sales from
the top 20 artists. For the six months ended June 30, 2001, media revenue
decreased $2.0 million, or 53%
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to $1.8 million from $3.8 million for the six months ended June 30, 2000,
primarily as a result of an overall soft advertising market. Commission revenue
from the agency decreased 74% from $1.5 million for the six months ended June
30, 2000 to $379,000 for the six months ended June 30, 2001, due primarily to
decreased touring activity of the agency's artists.
COST OF REVENUE
Direct cost of product revenue. Direct cost of product revenue decreased to
$1.3 million for the three months ended June 30, 2001 from $2.3 million for the
three months ended June 30, 2000, which represented a decrease of 44%. This $1.0
million decrease corresponded with the decrease in e-commerce revenue and was
primarily attributable to a related decrease in product and royalty costs
payable to our vendors and artists and a decrease in transaction costs. Direct
cost of product revenue decreased to $3.4 million for the six months ended June
30, 2001 from $4.2 million for the six months ended June 30, 2000, which
represented a decrease of 19%. This $800,000 decrease corresponded with the
decrease in online product sales revenue and was primarily attributable to a
related decrease in product and royalty costs payable to our vendors and artists
and a decrease in transaction costs.
Other cost of revenue. Other cost of revenue decreased to $1.5 million for
the three months ended June 30, 2001 from $2.1 million for the three months
ended June 30, 2000, which represented a decrease of 27%. This $580,000 decrease
was primarily due to decreases in Web site hosting and maintenance costs, as
well as network programming costs. Other cost of revenue decreased to $3.3
million for the six months ended June 30, 2001 from $3.8 million for the six
months ended June 30, 2000, which represented a decrease of 13%. This $500,000
decrease was primarily due to decreases in Web site hosting and maintenance
costs.
Stock-based compensation. For the three months ended June 30, 2001 we
recorded non-cash stock-based compensation charges of $1.7 million compared to
$1.5 million for the three months ended June 30, 2000. For the six months ended
June 30, 2001 we recorded non-cash stock-based compensation charges of $3.1
million compared to $4.5 million for the six months ended June 30, 2000. The
stock-based compensation expense relates primarily to the amortization of the
estimated value of the options, using the Black-Scholes method, given to artists
in connection with the operation of their stores and is amortized over the life
of the associated contract periods.
Our overall gross profit margin decreased to -52% in the second quarter of
2001 from -9% in the second quarter of 2000 primarily due to the significant
decrease in media and e-commerce revenue. Gross profit excluding stock-based
compensation and amortization of vendor prepaid was 1% and 22% for the three
months ended June 30, 2001 and 2000, respectively. Our overall gross profit
margin decreased to -57% in 2001 from -24% in 2000 primarily due to the
significant decrease in media and e-commerce revenue. Gross profit excluding
stock-based compensation and amortization of vendor prepaid was -5% and 22% for
the six months ended June 30, 2001 and 2000, respectively.
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OPERATING EXPENSE
Web Site Development. Web site development expense increased 72% to $1.2
million for the three months ended June 30, 2001 from $679,000 for the three
months ended June 30, 2000. This increase was primarily attributable to
maintenance costs associated with our Pandesic e-commerce system, as well as
fees paid to third party service vendors relating to maintenance on the
procurement system interface. Web site development expense increased 89% to $2.8
million for the six months ended June 30, 2001 from $1.5 million for the six
months ended June 30, 2000. This increase was primarily attributable to
maintenance costs associated with our Pandesic e-commerce system, as well as
fees paid to third party service vendors relating to maintenance on the
procurement system interface, the continued development and content updates of
our network and development costs of digital music products.
Sales and Marketing. Sales and marketing expense decreased 78% to $1.5
million for the three months ended June 30, 2001 from $6.7 million for the three
months ended June 30, 2000. The decrease was primarily attributable to reduced
spending on advertising to promote the ARTISTdirect Network. Sales and marketing
expense decreased 67% to $3.9 million for the six months ended June 30, 2001
from $11.8 million for the six months ended June 30, 2000. The decrease was
primarily attributable to reduced spending on advertising to promote the
ARTISTdirect Network.
General and Administrative. General and administrative expense decreased
18% to $3.6 million for the three months ended June 30, 2001 from $4.4 million
for the three months ended June 30, 2000. This decrease was primarily
attributable to salary and benefits savings associated with the reduction in
staff. General and administrative expense decreased 3% to $7.8 million for the
six months ended June 30, 2001 from $8.1 million for the six months ended June
30, 2000. This decrease was primarily attributable to salary and benefits
savings associated with the reduction in staff, partially offset by the related
increase in severance costs.
Amortization of Stock-based Compensation. We recorded stock-based
compensation expense of $1.6 million for the three months ended June 30, 2001 in
connection with stock issuances to employees, directors, professional firms,
artists and artist advisors for promotional services. Stock-based compensation
for the comparable period in 2000 was $1.8 million, primarily in connection with
stock issuances to employees, directors and professional firms, which
represented a decrease of 9%. We recorded stock-based compensation expense of
$3.3 million for the six months ended June 30, 2001 in connection with stock
issuances to employees, directors, professional firms, artists and artist
advisors for promotional services. Stock-based compensation for the comparable
period in 2000 was $1.4 million, primarily in connection with stock issuances to
employees, directors and professional firms, which represented an increase of
137% compared to the corresponding period in 2000. The expense for the six
months ended June 30, 2000 reflected a $6.6 million credit to stock-based
compensation granted to certain executives of the Company as a result of a
reduction in the valuation of the Company's underlying common stock as compared
with December 31, 1999. This credit was offset by $8.0 million of amortization
during the period of stock-based compensation expense related to options granted
to employees, artists and advisors and vendor warrants.
Depreciation and Amortization. Depreciation and amortization expense
increased to $1.6 million for the three months ended June 30, 2001 from $1.5
million for the three months ended June 30, 2000. This increase was primarily
attributable to an increase in depreciation of fixed assets and amortization of
leasehold improvements. Depreciation and amortization expense increased to $3.6
million for the six months ended June 30, 2001 from $2.6 million for the six
months ended June 30, 2000. This increase was primarily attributable to an
increase in depreciation of fixed assets and amortization of leasehold
improvements.
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Impairment of Goodwill. For the three months ended June 30, 2001, we did
not record any loss on impairment of goodwill. We recorded a loss on impairment
of goodwill related to the Mjuice acquisition in the amount of $4.5 million for
the six months ended June 30, 2001.
INTEREST INCOME AND EXPENSE
Interest income decreased to $856,000 for the three months ended June 30,
2001 from $1.5 million for the three months ended June 30, 2000. For the six
months ended June 30, 2001, interest income decreased to $2.2 million from $2.5
million for the six months ended June 30, 2000. The decreases are due to less
interest earned on lower available cash balances for the relevant periods.
NET LOSS
EBITDA loss decreased 41% to $6.2 million for the three months ended June
30, 2001, compared to $10.5 million for the three months ended June 30, 2000.
This decrease is attributable to a $1.7 million decrease in e-commerce loss, a
$3.8 million decrease in media loss, partially offset by a $584,000 increase in
agency loss and a $573,000 increase in digital music loss. EBITDA loss decreased
22% to $14.9 million for the six months ended June 30, 2001, compared to $19.1
million for the six months ended June 30, 2000. This decrease is attributable to
a $4.0 million decrease in e-commerce loss, a $2.0 million decrease in media
loss, partially offset by a $620,000 increase in agency loss and a $1.3 million
increase in digital music loss.
Net loss decreased 22% to $11.0 million for the three months ended June 30,
2001, compared to $14.0 million for the three months ended June 30, 2000. The
decrease in net loss is attributable a $5.2 million decrease in sales and
marketing expense, a $781,000 decrease in general and administrative expense and
a $150,000 decrease in the amortization of stock-based compensation partially
offset by a $985,000 decrease in gross profit, a $487,000 increase in web site
development, a $187,000 increase in depreciation and amortization expense, a
$793,000 increase in loss from equity investment and a $620,000 decrease in
interest income. Net loss increased to $28.0 million for the six months ended
June 30, 2001, compared to $25.2 million for the six months ended June 30, 2000,
which represented an increase of 11%. The increase in the net loss is
attributable to a $1.2 million dollar decrease in gross profit, a $1.3 million
increase in web site development, a $1.9 million increase in the amortization of
stock-based compensation, a $1.0 increase in depreciation and amortization
expense and a $4.5 million loss from impairment of goodwill, partially offset by
a $7.9 million decrease in sales and marketing expense, a $221,000 decrease in
general and administrative expense, a $738,000 increase in loss from equity
investment and a $332,000 decrease in interest income.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2000, we completed our initial public offering ("IPO") and
raised net proceeds of approximately $52.6 million through the sale of 5.0
million common shares (500,000 shares after taking into effect the 1:10 Reverse
Stock Split consummated in July 2001). In addition, we raised an aggregate of
$97.5 million of gross proceeds through the sale of our Series C Preferred stock
in December 1999 and January 2000. In May 1999, we issued shares of Series B
preferred securities in exchange for an aggregate purchase price of $15.0
million. Between July 1998 and
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December 1998, we issued shares of Series A preferred securities in exchange for
an aggregate purchase price of $4.9 million. Prior to July 1998, we financed our
operations and growth entirely from internally generated cash flow and capital
contributions from founders. As of June 30, 2001, we had $69.8 million of cash,
cash equivalents and short-term investments, excluding cash held for clients.
Net cash used in operating activities was $14.2 million for the six months
ended June 30, 2001 and $20.5 million for the six months ended June 30, 2000.
Net cash used in operating activities for each of these periods primarily
consisted of net losses partially offset by non-cash items such as stock-based
compensation, depreciation and amortization and income/(loss) from equity
investment.
Net cash provided by investing activities was $23.9 million for the six
months ended June 30, 2001 and net cash used in investing activities was $50.3
million for the six months ended June 30, 2000. Net cash provided by investing
activities for 2001 consisted primarily of proceeds from the maturity of
short-term investments, and net cash used in investing activities for 2000
consisted primarily of the purchase of short-term investments and fixed assets.
Net cash used in financing activities was $2.5 million for the six months
ended June 30, 2001, which consisted primarily of the repurchase of common stock
in our partial self-tender offer consummated in April 2001. Net cash provided by
financing activities was $63.9 million for the six months ended June 30, 2000,
which consisted primarily of the net proceeds from the sale of securities in our
initial public offering and our Series C Preferred Stock financing.
As of June 30, 2001 our principal commitments consisted of obligations
outstanding under operating leases and employment contracts. In June 2001 we
entered into an agreement with Ted Field for a co-venture record label. We are
required to provide up to $50 million of funding over the next five years to the
record label.
We currently anticipate that our available cash resources will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months, including the significant
financial commitment to the co-venture record label with Ted Field. There can be
no assurance, however, that the underlying assumed levels of revenues and
expenses will prove to be accurate. Although we do not currently have any
specific material capital commitments other than the record label beyond such
12-month period, if we are unsuccessful in generating sufficient cash flow from
operations, we may need to raise additional funds in future periods through
public or private financings, or other arrangements to fund our operations and
potential acquisitions. If any additional financing is needed, we might not be
able to raise capital on reasonable terms or at all. Failure to raise capital
when needed could seriously harm our business and operating results. If
additional funds were raised through the issuance of equity securities, the
percentage of ownership of our stockholders would be reduced. Furthermore, these
equity securities might have rights, preferences or privileges senior to our
common stock. We currently do not have any plans for future equity offerings.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
In future periods, our business, financial condition and results of
operations may be affected by many factors, including but not limited to the
following:
IT IS DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS BECAUSE WE HAVE A LIMITED
OPERATING HISTORY AND RAPIDLY EVOLVING BUSINESS.
Our limited operating history and rapidly evolving business, make it
difficult to evaluate our prospects or to accurately predict our future revenue
or results of operations. Our revenue and income potential are unproven, and our
business model is constantly and rapidly evolving. In particular, the Internet
is constantly changing and we may need to modify our business model to adapt to
these changes, including our recent decision to focus a significant amount of
resources on off-line businesses such as the record label.
OUR BUSINESS MODEL IS NEW AND UNPROVEN, AND WE MAY NOT BE ABLE TO GENERATE
SUFFICIENT REVENUE TO OPERATE OUR BUSINESS SUCCESSFULLY
Our model for conducting business and generating revenue is new and
unproven. Our success will depend primarily on our ability to generate revenue
from our offline assets and from multiple sources through the ARTISTdirect
Network, including:
o online sales of music and related merchandise;
o sales of advertising and sponsorships;
o marketing our database of consumer information and preferences;
o sales of, or subscription fees for, digitally distributed music; and
o royalties and related revenue from record label operations.
It is uncertain whether a music-related Web site that relies on attracting
people to learn about, listen to and purchase music and related merchandise can
generate sufficient revenue from electronic commerce, advertising, sales of
database information and sales of, or fees for, digital downloads of music, to
become a viable business. We provide many of our products and services without
charge, and we may not be able to generate sufficient revenue to pay for these
products and services. In addition, it may take a significant amount of time for
us to develop and operate our record label co-venture with Ted Field.
Accordingly, we are not certain that our business model will be successful or
that we can sustain revenue growth or be profitable. If our markets develop more
slowly than expected or become saturated with competitors, our products and
services do not achieve or sustain market acceptance, we may not be able to
successfully operate our business.
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WE HAVE A HISTORY OF OPERATING LOSSES AND ANTICIPATE LOSSES AND NEGATIVE CASH
FLOW FOR THE FORESEEABLE FUTURE
To date, we have not been profitable on an annual or quarterly basis and
have incurred accumulated losses of approximately $152 million as of June 30,
2001. For the three months ended June 30, 2001 and the year ended December 31,
2000, we incurred net losses of approximately $11.0 million and $59.3 million,
respectively, which represented approximately 379% and 274%, respectively, of
our revenue for those periods. We expect our operating losses and negative cash
flow to continue for at least the near future. We will need to generate
significant additional revenue to achieve profitability. Consequently, it is
possible that we may never achieve profitability, and even if we do achieve
profitability, we may not sustain or increase profitability on a quarterly or
annual basis in the future. If we do not achieve or sustain profitability in the
future, then we will be unable to continue our operations.
OUR OPERATING RESULTS WILL LIKELY BE UNPREDICTABLE
Our operating results are likely to fluctuate significantly in the future
due to a variety of factors, many of which are outside of our control. Because
our operating results are volatile and difficult to predict, in some future
quarters our operating results may fall below the expectations of securities
analysts and investors. In this event, the trading price of our common stock may
fall significantly.
IF WE ARE NOT SUCCESSFUL IN GENERATING REVENUE FROM A CO-VENTURE RECORD LABEL
WITH TED FIELD, WE MAY NOT BE ABLE TO INCREASE OUR NET REVENUES.
We have recently decided to invest a significant amount of our resources in
offline activities such as a record label. Accordingly, in April 2001, we
entered into an agreement with music and entertainment veteran, Ted Field, to
develop and operate a co-venture record label and to hire Mr. Field as our
Chairman and CEO. The co-venture record label will be a new enterprise and will
face significant challenges in developing and operating its planned business,
including but not limited to the following:
o identifying and entering into recording agreements with artists for the
record label;
o hiring new personnel for the record label;
o producing and promoting new music recordings for artists signed to the
record label;
o developing a recognized brand name in the music industry;
o developing distribution channels for the record label;
o integrating the record label's operations with our existing operations;
and
o generating record label revenue and achieving profitability.
The record label has no operating history upon which to assess whether it
will be able to meet all of the challenges required to successfully develop and
operate its business. Accordingly, there can be no assurance that Mr. Field will
be able to successfully operate the label. If the record label is not able to
develop a successful business with revenue and profits, we will not receive the
anticipated benefits of our investment in the record label and our business,
financial condition and results of operations would be materially and adversely
affected.
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WE HAVE COMMITTED A SUBSTANTIAL AMOUNT OF OUR AVAILABLE CASH TO THE RECORD LABEL
CO-VENTURE WITH TED FIELD AND, AS A RESULT, THE AMOUNT OF CASH THAT WE WILL HAVE
AVAILABLE TO OPERATE OUR OTHER BUSINESSES HAS BEEN SUBSTANTIALLY REDUCED.
The record label co-venture with Mr. Field represents a potentially
significant shift in the planned use of our cash resources. We will be required
to commit as much as $50 million to the record label over the next five years.
Subject to this overall limit, we may be required to advance as much as $15
million per year to the record label, including an initial commitment of $12
million that has been partially funded. As of June 30, 2001, we had
approximately $69.8 million in cash (including short-term investments in
marketable securities). While we currently believe this amount of cash is
adequate to fund our obligations to the record label and our existing businesses
for the foreseeable future, if the record label is not successful, or, if there
is a material delay in anticipated cash flow from the record label, there can be
no assurance that our existing cash resources will be adequate to enable us to
successfully operate our other businesses or to become cash flow positive at any
time in the foreseeable future. If this occurs, we will need to raise additional
capital to continue operating our businesses. There can be no assurance that we
will be able to raise this additional funding at all or on reasonably acceptable
terms if it is needed in the future. If we are unable to successfully raise any
necessary funding, our ability to successfully operate our business would be
materially adversely affected.
IF WE DO NOT INCREASE ADVERTISING REVENUE, OUR BUSINESS WILL BE ADVERSELY
AFFECTED
If we do not increase advertising revenue, our business will be adversely
affected. Increasing our advertising revenue depends upon many factors,
including our ability to:
o respond to and anticipate fluctuations in the demand for, and pricing
of, online advertising;
o conduct successful selling and marketing efforts aimed at advertisers;
o increase the size of our audience and the amount of time that our
audience spends on our Web sites;
o increase our direct advertising sales force and build up our
international marketing team;
o increase the amount of revenue per advertisement;
o aggregate our target demographic group of 13 to 34 year-old active music
consumers;
o offer advertisers the means to effectively target their advertisements
to our audience;
o accurately measure the size and demographic characteristics of our
audience;
o maintain key advertising relationships; and compete for advertisers with
Internet and traditional media companies.
Our failure to achieve one or more of these objectives could impair our
ability to increase advertising revenue, which could adversely affect our
business. In addition to the above factors, general economic conditions, as well
as economic conditions specific to online advertising, electronic commerce and
the music industry, could affect our ability to increase our advertising
revenue. In particular, the growth of online advertising has recently declined,
which has had, and in the future may continue to have, a significant adverse
effect on our revenue from online advertising.
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IF WE DO NOT GENERATE INCREASED REVENUE FROM ONLINE PRODUCT SALES, OUR GROWTH
WILL BE LIMITED AND OUR BUSINESS WILL BE ADVERSELY AFFECTED
If we do not generate increased revenue from sales of online products, our
growth will be limited and our business will be adversely affected. To generate
significant online product revenue, we will have to offer music and related
merchandise that appeal to a large number of online consumers. We also will have
to continue to create online communities that are conducive to electronic
commerce, maintain a sufficiently robust and scalable electronic commerce
platform and increase our order fulfillment capability. Since our target market
includes Internet users below the age of 18, and these users have limited access
to credit cards, our ability to capture online product revenue from this group
may be limited. If we are not successful in meeting these challenges, our growth
will be limited and our business will be adversely affected.
THE EFFECTIVENESS OF THE INTERNET FOR ADVERTISING IS UNPROVEN, WHICH MAY
DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON OUR SITES
Our future depends in part on an increase in the use of the Internet and
other forms of digital media for advertising. The Internet advertising market is
relatively new and rapidly evolving, and we cannot yet gauge the effectiveness
of advertising on the Internet as compared to traditional media. As a result,
demand for Internet advertising is uncertain. Many advertisers have little or no
experience using the Internet for advertising purposes. The adoption of Internet
advertising, particularly by companies that have historically relied upon
traditional media for advertising, requires the acceptance of a new way of
conducting business, exchanging information and advertising products and
services. Such customers may find advertising on the Internet to be undesirable
or less effective than traditional advertising media for promoting their
products and services. In particular, online advertising revenue has
significantly decreased. If the Internet advertising market fails to grow, our
business could be adversely affected. In addition, the market for advertising on
other forms of digital media, such as broadband distribution, is even less
developed than Internet advertising, and if that market does not develop, our
growth may be limited.
WE DEPEND UPON ARTISTS TO ATTRACT ADVERTISERS AND GENERATE ELECTRONIC COMMERCE
REVENUE
We believe that our future success depends in part on our ability to
maintain our existing artist relationships and to establish additional
relationships with artists. We recently began a process of negotiating new
agreements that generally simplify the relationship between the artists and us.
Our business would be adversely affected by any of the following:
o inability to establish relationships with new artists and offer their
music and merchandise for sale to our customers;
o the loss of popularity of artists for whom we sell music and
merchandise;
o increased competition to maintain existing relationships with artists;
o non-renewals or non-conversions of certain of our current agreements
with artists; and
o poor performance or negative publicity of our artists.
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If we are not able to provide valuable services or incentives to artists,
or if we otherwise fail to maintain good relations with our artists, they may
lose interest in providing content and merchandise and otherwise promoting the
ARTISTdirect Network. The artists own the domain names for their ARTISTchannels
and some of the intellectual property rights with respect to content developed
for the ARTISTchannels. As a result, we may lose the rights to operate artists'
sites if our agreements with these artists terminate and are not renewed or
converted.
Most of our current artist contracts have a term of three years. Upon
expiration, artists may not renew these contracts on reasonable terms, if at
all. If artists decide to remove their online stores from the ARTISTdirect
Network when their agreements terminate, we may be unable to recoup our costs to
develop, operate and promote the sites. We have recently undertaken the
negotiation of new agreements with certain of our existing artists and the
termination of existing agreements with certain other of our artists. Our
inability to negotiate new agreements or to terminate existing agreements may
have an adverse impact on our business.
In the past, we have offered our artists options to purchase our common
stock. Options were intended to provide artists with an additional incentive to
actively promote the ARTISTchannels and the ARTISTdirect Network. We may not be
able to offer artists options or other equity incentives on terms as attractive
to artists as what we have offered previously. If we cannot provide adequate
incentives, our efforts to sign new artists may be impaired. If we cannot
maintain our current relationships with artists or sign agreements with new
artists, our user base would likely diminish and our ability to generate
revenues from electronic commerce and advertising would be seriously harmed.
WE MAY NOT BE ABLE TO DEVELOP OR OBTAIN SUFFICIENTLY COMPELLING CONTENT TO
ATTRACT AND RETAIN OUR TARGET AUDIENCE
For our business to be successful, we must provide content and services
that attract consumers who will purchase music and related merchandise online.
We may not be able to provide consumers with an acceptable mix of products,
services, information and community to attract them to our Web sites frequently
or to encourage them to remain on our Web sites for an extended period of time.
If our audience determines that our content does not reflect its tastes, then
our audience size could decrease or the demographic characteristics of our
audience could change and we may be unable to react to those changes effectively
or in a timely manner. Any of these results would adversely affect our ability
to attract advertisers and sell music and other related merchandise. Our ability
to provide compelling content could be impaired by any of the following:
o reduced access to content controlled by record labels, music publishers
and artists;
o diminished technical expertise and creativity of our production staff;
and
o inability to anticipate and capitalize on trends in music.
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IF WE DO NOT BUILD AND MAINTAIN STRONG BRANDS, WE MAY NOT BE ABLE TO ATTRACT A
SUFFICIENT NUMBER OF USERS TO OUR WEB SITES
To attract users we must develop a brand identity for ARTISTdirect and
increase public awareness of the ARTISTchannels, the UBL and iMusic; however to
conserve cash, we have significantly decreased the amounts we have spent on our
offline and online advertising and promotional efforts to increase brand
awareness, traffic and revenue. Accordingly, our marketing activities may not
result in increased revenue and, even if they do, any increased revenue may not
offset the expenses we incur in building our brands. Moreover, despite these
efforts we may be unable to increase public awareness of our brands, which would
have an adverse effect on our results of operations.
OUR ONLINE STORE AGREEMENTS WITH ARTISTS DO NOT PRECLUDE OUR ARTISTS FROM
SELLING MUSIC AND RELATED MERCHANDISE ON OTHER WEB SITES
Our online store agreements with artists do not preclude them from selling
merchandise and compact discs or offering music downloads on other Web sites. If
we are unable to attract sufficient traffic to the ARTISTdirect Network,
consumers may purchase the products that we offer on other Web sites. If we are
unable to generate revenue from the sale of music and related merchandise, our
results of operations will be adversely affected.
OUR MARKET IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY
AGAINST OUR CURRENT AND FUTURE COMPETITORS
The market for the online promotion and distribution of music and related
merchandise is highly competitive and rapidly changing. We estimate that there
are currently over 100 Web sites that promote and distribute music and related
merchandise. There are a significant number of Web sites competing for the
attention and spending of consumers, advertisers and users and the number may
increase in the future.
We face competitive pressures from numerous actual and potential
competitors. Our competitors include MP3.com, Launch Media, Amazon.com, CDnow,
MTVi, major Internet portals and traditional music companies. Competition is
likely to increase significantly as new companies enter the market and current
competitors expand their services. Some of our competitors have announced
agreements to work together to offer music over the Internet, and we may face
increased competitive pressures as a result. Many of our current and potential
competitors in the Internet and music entertainment businesses may have
substantial competitive advantages relative to us, including:
o longer operating histories;
o significantly greater financial, technical and marketing resources;
o greater brand name recognition;
o larger existing customer bases; and
o more popular content or artists.
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These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to develop, promote and sell their products or services than we can. Consumers,
artists, talent management companies and other music-related vendors or
advertisers may perceive web sites maintained by our existing and potential
competitors as being superior to ours. In addition, increased competition could
result in reduced advertising rates and margins and loss of market share, any of
which could harm our business.
WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS FOR MUSIC MERCHANDISE, FULFILLMENT
AND DISTRIBUTION; IF WE CANNOT SECURE ALTERNATE SUPPLIERS, OUR BUSINESS MAY BE
HARMED
We rely to a large extent on timely distribution by third parties. We
currently rely substantially on one vendor, Alliance Entertainment, to fulfill
and distribute our orders for music and related merchandise. During the three
and six months ended June 30, 2001 and the year ended December 31, 2000,
virtually all of our orders for music and related merchandise were fulfilled by
Alliance. Our agreement with Alliance covers fulfillment services for sales
under the ARTISTdirect Superstore, but does not cover fulfillment services for
our ARTISTchannels. Although Alliance has been fulfilling orders for music and
related merchandise from the ARTISTchannels on the same terms as orders from the
ARTISTdirect Superstore, Alliance may terminate the ARTISTchannel arrangement at
any time.
We purchase almost all of our compact discs from Alliance and a substantial
portion of our other music-related merchandise from Giant Merchandising, SMI
Promotional Apparel and several other vendors. Our business could be
significantly disrupted if Alliance, Giant or SMI Promotional Apparel were to
terminate or breach their agreements or suffer adverse developments that affect
their ability to supply products to us. If, for any reason, Alliance, Giant or
SMI Promotional Apparel are unable or unwilling to supply products to us in
sufficient quantities and in a timely manner, we may not be able to secure
alternative suppliers, on acceptable terms in a timely manner, or at all.
WE DEPEND ON THIRD PARTY INVENTORY AND FINANCIAL SYSTEMS AND CARRIER SERVICES
Because we rely on third parties to fulfill orders, we depend on their
systems for tracking inventory and financial data. If our distributors' systems
fail or are unable to scale or adapt to changing needs, or if we cannot
integrate our information systems with the systems of any new distributors, we
may not have adequate, accurate or timely inventory or financial information. We
also rely on third-party carriers for shipments to and from distribution
facilities. We are therefore subject to the risks, including employee strikes
and inclement weather, associated with our carriers' ability to provide delivery
services to meet our distribution and shipping needs. In the past, both we and
Alliance have occasionally experienced an unusually high volume of orders, which
resulted in shipping delays to our customers. These delays did not have a
material adverse effect, however, our failure to deliver products to our
customers in a timely and accurate manner in the future could harm our
reputation, our relationship with customers, the ARTISTdirect brand and our
results of operations.
OUR BUSINESS IS SUBJECT TO SEASONALITY, WHICH COULD ADVERSELY AFFECT OUR
OPERATING RESULTS
We have experienced and expect to continue to experience seasonal
fluctuations in our online sales. These seasonal patterns will cause quarterly
fluctuations in our operating results. In particular, a disproportionate amount
of our online sales have been realized during the fourth
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calendar quarter and during the summer months, traditionally when artists go on
tour. Due to our limited operating history, it is difficult to predict the
seasonal pattern of our online sales and the impact of such seasonality on our
business and operating results. Our seasonal online sales patterns may become
more pronounced, strain our personnel, warehousing, and order shipment
activities and cause our operating results to be significantly less than
expected for any given period. This would likely cause our stock price to fall.
WE MAY BE SUBJECT TO SYSTEM DISRUPTIONS, WHICH COULD REDUCE OUR REVENUE
Our ability to attract and retain artists, users, advertisers and merchants
for our online network depends on the performance, reliability and availability
of our Web sites and network infrastructure. The maintenance and operation of
substantially all of our Internet communications hardware and servers have been
outsourced to CNP and its providers. We have periodic maintenance windows, and
we experience outages from to time caused by temporary problems in our own
systems or software or in the systems or software of these third parties. While
we are implementing procedures to improve the reliability of our systems, these
interruptions may continue to occur from time to time.
Our users also depend on third party Internet service providers and Web
site operators for access to our Web sites. These entities have experienced
significant outages in the past, and could experience outages, delays and other
difficulties due to system failures in the future which are unrelated to our
systems, but which could nonetheless adversely affect our business.
COMPUTER VIRUSES, ELECTRONIC BREAK-INS OR SIMILAR DISRUPTIVE EVENTS COULD
DISRUPT OUR ONLINE SERVICES
Computer viruses, electronic break-ins or similar disruptive events could
disrupt our online services. System disruptions could result in the
unavailability or slower response times of our Web sites, which would reduce the
number of advertisements delivered or commerce conducted on our Web sites and
lower the quality of our users' experience. Service disruptions could adversely
affect our revenue and, if they were prolonged, would seriously harm our
business and reputation. Our business interruption insurance may not be
sufficient to compensate us for losses that may occur as a result of these
interruptions.
IF WE DO NOT MANAGE OUR EXPANSION, WE MAY NOT BE ABLE TO OPERATE OUR BUSINESS
EFFECTIVELY
Since our inception in August 1996, we have rapidly and significantly
expanded our operations. We expect further significant expansion, particularly
as a result of the record label co-venture and other potential opportunities.
This expansion has strained, and we expect that it will continue to strain, our
management, operations, systems and financial resources. In addition, we
recently reduced our headcount to conserve cash and may further reduce
headcount. At the same time, we expect to expand staff associated with the
record label co-venture. Accordingly, to manage our operations and personnel, we
must improve and effectively utilize our existing operational, management,
marketing and financial systems and maintain close coordination among our
technical, finance, marketing, sales and production staffs. In addition, we may
also need to increase the capacity of our software, hardware and
telecommunications systems on short notice. We also will need to manage an
increasing number of complex relationships with users, strategic partners,
advertisers and other third parties, especially in light of certain functions
being outsourced. Our failure to manage growth could disrupt our operations and
ultimately prevent us from generating the revenue we expect.
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THE LOSS OF KEY PERSONNEL, INCLUDING TED FIELD, MARC GEIGER, DONALD MULLER OR
KEITH YOKOMOTO, COULD ADVERSELY AFFECT OUR BUSINESS BECAUSE THESE INDIVIDUALS
ARE IMPORTANT TO OUR CONTINUED GROWTH
Our future success depends to a significant extent on the continued
services of our senior management, particularly Ted Field, Marc Geiger, Donald
Muller and Keith Yokomoto. The loss of any of these individuals would likely
have an adverse effect on our business. Competition for personnel throughout our
industry is intense and we may be unable to retain these key employees or
attract, integrate or retain other highly qualified employees in the future. We
have in the past experienced, and we expect to continue to experience,
difficulty in hiring and retaining highly skilled employees with appropriate
qualifications. If we do not succeed in attracting new personnel or retaining
and motivating our current personnel, our business could be adversely affected.
IF WE DO NOT REALIZE THE ANTICIPATED BENEFITS OF POTENTIAL FUTURE ACQUISITIONS,
OUR BUSINESS COULD BE SERIOUSLY HARMED AND OUR STOCK PRICE COULD FALL
We regularly evaluate, in the ordinary course of business, potential
acquisitions of, or investments in, complementary businesses, products and
technologies. If we are presented with appropriate opportunities, we intend to
actively pursue these acquisitions and/or investments. We may not, however,
realize the anticipated benefits of any acquisition or investment. If we buy a
company, we could have difficulty in assimilating that company's personnel,
technology, operations or products into our operations. In addition, the key
personnel of the acquired company may decide not to work for us. These
difficulties could disrupt our ongoing business, distract our management and
employees and increase our expenses. Acquisitions or business combinations could
also cause us to issue equity securities that would dilute your percentage
ownership in us, incur debt or assume contingent liabilities and take large
immediate or future write-offs or charges, including amortization of goodwill or
compensation expense. Each of these results could materially and adversely
affect our business and adversely affect the price of our common stock.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR COMPETITIVE
POSITION COULD BE HARMED OR WE COULD BE REQUIRED TO INCUR EXPENSES TO ENFORCE
OUR RIGHTS
We rely upon common-law trademark rights that arise from our commercial use
of the ARTISTdirect, ARTISTdirect Agency, UBL, Ultimate Band List, and iMusic
brand names, and the respective associated domain names, and the ARTISTdirect
logo. We seek to protect our trademarks, copyrights and other proprietary rights
by registration and other means, but these actions may be inadequate. We have
trademark applications pending in several jurisdictions, but our registrations
may not be accepted or may be preempted by third parties and/or we may not be
able to register our trademarks in all jurisdictions in which we intend to do
business. We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally control access to
and distribution of our proprietary information.
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The steps we have taken may not prevent misappropriation of our proprietary
rights, particularly in foreign countries where laws or law enforcement
practices may not protect our proprietary rights as fully as in the United
States. If third parties were to use or otherwise misappropriate our copyrighted
materials, trademarks or other proprietary rights without our consent or
approval, our competitive position could be harmed, or we could become involved
in litigation to enforce our rights. In addition, policing unauthorized use of
our content, trademarks and other proprietary rights could be very expensive,
difficult or impossible, particularly given the global nature of the Internet.
OUR ACCESS TO COPYRIGHTED CONTENT DEPENDS UPON THE WILLINGNESS OF CONTENT OWNERS
TO MAKE THEIR CONTENT AVAILABLE
The music content available on the ARTISTdirect Network is typically
comprised of copyrighted works owned or controlled by multiple third parties.
Most of the content on ARTISTchannels is either owned or licensed by the artist.
On other parts of the ARTISTdirect Network, depending on the nature of the
content and how we use the music content, we typically license such rights from
publishers, record labels, performing rights societies or artists. We frequently
either do not have written contracts or have short-term contracts with copyright
owners, and, accordingly, our access to copyrighted content depends upon the
willingness of such parties to continue to make their content available. If the
fees for music content increase substantially or if significant music content
becomes unavailable, our ability to offer music content could be materially
limited.
We have not obtained a license for some of the content offered on the
ARTISTdirect Network, including links to other music-related sites and
thirty-second streamed song samples, because we believe that a license is not
required under existing law. However, this area of law remains uncertain and may
not be resolved for a number of years. When this area of law is resolved, we may
be required to obtain licenses for such content, alter or remove the content
from our Web sites and be forced to pay potentially significant financial
damages for past conduct.
INTELLECTUAL PROPERTY CLAIMS AGAINST US COULD BE COSTLY AND COULD RESULT IN THE
LOSS OF SIGNIFICANT RIGHTS
Third parties may assert trademark, copyright, patent and other types of
infringement or unfair competition claims against us. If we are forced to defend
against any such claims, whether they are with or without merit or are
determined in our favor, we may face costly litigation, loss of access to, and
use of, content, diversion of technical and management personnel, or product
shipment delays. As a result of such a dispute, we may have to develop
non-infringing technology or enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may be unavailable on terms
acceptable to us, or at all. While we have resolved all such disputes in the
past, we may not be able to do so in the future. If there is a successful claim
of infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology or content on a timely
basis, it could harm our business.
In addition, we rely on third parties to provide services enabling our
online product sales transactions, including credit card processing, order
fulfillment and shipping. We could become subject to infringement actions by
third parties based upon our use of intellectual property provided by our
third-party providers. It is also possible that we could become subject to
infringement actions based upon the content licensed from third parties. Any
such claims or disputes could subject us to costly litigation and the diversion
of our financial resources and technical and management personnel. Further, if
our efforts to enforce our intellectual property rights are unsuccessful or if
claims by third parties against ARTISTdirect, the UBL and iMusic
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are successful, we may be required to change our trademarks, alter or remove
content, pay financial damages, or alter our business practices. These changes
of trademarks, alteration of content, payment of financial damages or alteration
of practices may adversely affect our business.
WE MAY BE UNABLE TO ACQUIRE NECESSARY WEB DOMAIN NAMES
We may be unable to acquire or maintain Web domain names relating to our
brand or to specific ARTISTchannels in the United States and other countries in
which we may conduct business. We currently hold various relevant domain names,
including the "artistdirect.com," "ubl.com," "imusic.com" and
"downloadsdirect.com" domain names. The acquisition and maintenance of domain
names generally is regulated by governmental agencies and their designees and is
subject to change. The relationship between regulations governing domain names
and laws protecting trademarks and similar proprietary rights is unclear.
Therefore, we could be unable to prevent third parties from acquiring or using
domain names that infringe or otherwise decrease the value of our brand name,
trademarks and other proprietary rights.
IF OUR ONLINE SECURITY MEASURES FAIL, WE COULD LOSE VISITORS TO OUR SITES AND
COULD BE SUBJECT TO CLAIMS FOR DAMAGE FROM OUR USERS, CONTENT PROVIDERS,
ADVERTISERS AND MERCHANTS
Our relationships with consumers would be adversely affected and we may be
subject to claims for damage if the security measures that we use to protect
their personal information, especially credit card numbers, are ineffective. We
rely on security and authentication technology that we license from third
parties to perform real-time credit card authorization and verification with our
bank. We cannot predict whether events or developments will result in a
compromise or breach of the technology we use to protect a customer's personal
information.
Our infrastructure is vulnerable to unauthorized access, physical or
electronic computer break-ins, computer viruses and other disruptive problems.
Internet service providers have experienced, and may continue to experience,
interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees and others. Anyone who is able to
circumvent our security measures could misappropriate proprietary information or
cause interruptions in our operations. Security breaches relating to our
activities or the activities of third-party contractors that involve the storage
and transmission of proprietary information could damage our reputation and our
relationships with our content providers, advertisers and merchants. We also
could be liable to our content providers, advertisers and merchants for the
damages caused by such breaches or we could incur substantial costs as a result
of defending claims for those damages. We may need to expend significant capital
and other resources to protect against such security breaches or to address
problems caused by such breaches. Our security measures may not prevent
disruptions or security breaches.
WE MAY BE SUBJECT TO LIABILITY IF PRIVATE INFORMATION PROVIDED BY OUR USERS WERE
MISUSED
Our privacy policy discloses how we use individually identifiable
information that we collect. This policy is displayed and accessible throughout
the ARTISTdirect Network. Despite this policy, however, if third persons were
able to penetrate our network security or otherwise misappropriate our users'
personal information or credit card information, we could be subject to
liability. We could also be subject to liability for claims for unauthorized
purchases with credit card information, impersonation or other similar fraud
claims, or other misuses of personal information, such as for unauthorized
marketing purposes. These claims could result in costly and time-consuming
litigation.
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CHANGES IN LAWS OR REGULATIONS MAY ADVERSELY AFFECT OUR ABILITY TO COLLECT
DEMOGRAPHIC AND PERSONAL INFORMATION FROM USERS AND COULD AFFECT OUR ABILITY TO
ATTRACT ADVERTISERS
Legislatures and government agencies have adopted and are considering
adopting laws and regulations regarding the collection and use of personal
information obtained from individuals when accessing Web sites. For example, the
Children's Online Privacy Protection Act restricts the ability of Internet
companies to collect information from children under the age of 13 without their
parents' consent. In addition, the Federal Trade Commission and state and local
authorities have been investigating Internet companies regarding their use of
personal information. Our privacy programs may not conform with laws or
regulations that are adopted. In addition, these legislative and regulatory
initiatives may adversely affect our ability to collect demographic and personal
information from users, which could have an adverse effect on our ability to
provide advertisers with demographic information.
The European Union has adopted a directive that imposes restrictions on the
collection and use of personal data. The directive could impose restrictions
that are more stringent than current Internet privacy standards in the United
States. If this directive were applied to us, it could prevent us from
collecting data from users in European Union member countries or subject us to
liability for use of information in contravention of the directive. Other
countries have adopted or may adopt similar legislation. We could incur
additional expenses if new regulations regarding the use of personal information
are introduced or if government authorities choose to investigate our privacy
practices.
WE HAVE A CONTINGENT LIABILITY AS THE RESULT OF A RESCISSION OFFER WE INTEND TO
MAKE DUE TO OUR ISSUANCES OF SECURITIES IN VIOLATION OF SECURITIES LAWS
We have issued shares or options to purchase shares of our common stock to
our employees and to artists and their managers and advisors. Due to the nature
of the persons who received these shares and options in addition to our
employees and the total number of shares and options issued to them and our
employees, the issuance of these shares and options did not comply with the
requirements of Rule 701 under the Securities Act of 1933, as amended, or any
other available exemptions from the registration requirements of Section 5 of
the Securities Act, and may not have qualified for any exemption from
qualification under California securities laws either.
As a result, we plan to make a rescission offer, during the forth quarter
of 2001, to all these persons pursuant to a registration statement filed under
the Securities Act and pursuant to California securities law. In the rescission
offer, we will offer to repurchase from these persons all shares issued to these
persons pursuant to option exercises by these persons before the expiration of
the rescission offer for an amount equal to the purchase or exercise price paid
for these issued shares, plus interest at the rate of 7% per year from the date
of issuance until the rescission offer expires. The rescission offer will expire
approximately 30 days after the effectiveness of the rescission offer
registration statement. Based upon the number of options exercised through June
30, 2001, and assuming that all such issued shares are tendered in the
rescission offer, the out-of-pocket cost to us would be approximately $2.2
million, plus interest.
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In addition, we will also offer to repurchase all unexercised options
issued to these persons at 20% of the option exercise price times the number of
option shares, plus interest at the rate of 7% per year from the date the
options were granted. Based on the number of options outstanding as of June 30,
2001, and assuming that none of these options are exercised prior to the end of
the rescission offer, and, further, that all such options are tendered in the
rescission offer, the cost to us in repurchasing such options would be
approximately $7.7 million, plus interest.
The Securities Act does not expressly provide that a rescission offer will
terminate a purchaser's right to rescind a sale of stock, which was not
registered under the Securities Act as required. Accordingly, should any
offerees reject the rescission offer, we may continue to be contingently liable
under the Securities Act for the purchase price of their shares and options
which were not issued in compliance with the Securities Act or California
securities laws. In this case, based on the number of shares and options issued
as of June 30, 2001, and assuming that all options are exercised, we could be
liable for a total amount of up to $40.5 million plus interest. However, in such
case we would receive a total amount of up to $38.3 million in proceeds from the
exercise of options, which could be used to offset our liability. If we are
required to repurchase all of the shares subject to the rescission offer or if
we incur any other liability with respect to rescission claims, our operating
results and liquidity during the period in which such repurchase or liability
occurs could be adversely affected.
WE MAY BE SUED FOR CONTENT AVAILABLE OR POSTED ON OUR WEB SITES OR PRODUCTS SOLD
THROUGH OUR WEB SITES
We may be liable to third parties for content published on our Web sites
and other Web sites where our syndicated content appears if the music, artwork,
text or other content available violates their copyright, trademark or other
intellectual property rights or if the available content is defamatory, obscene
or pornographic. Similar claims have been brought, sometimes successfully,
against Web site operators in the past. We also may be liable for content
uploaded or posted by our users on our Web sites, such as digitally distributed
music files, postings on our message boards, chat room discussions and
copyrightable works. In addition, we could have liability to some of our content
licensors for claims made against them for content available on our Web sites.
We also could be exposed to these types of claims for content that may be
accessed from our Web sites or via links to other Web sites or for products sold
through our Web site. While we have resolved all of these types of claims made
against us in the past, we may not be able to do so in the future. We intend to
implement measures to reduce exposure to these types of claims, but such
measures may not be successful and may require us to expend significant
resources. Any litigation as a result of defending these types of claims could
result in substantial costs and damages. Our insurance may not adequately
protect us against these types of claims or the costs of their defense or
payment of damages.
SOFTWARE PROGRAMS THAT PREVENT OR LIMIT THE DELIVERY OF ADVERTISING MAY
SERIOUSLY DAMAGE OUR ABILITY TO ATTRACT AND RETAIN ADVERTISERS
A number of "filter" software programs have been developed which limit or
prevent advertising from being delivered to an Internet user's computer. This
software could adversely affect the commercial viability of Internet
advertising. These programs attempt to blank out, or block, banner and other
advertisements. To date, such programs have not had a material adverse impact on
our ability to attract and retain advertisers or caused us to fail to meet the
terms of our advertising agreements. These programs may, however, have these
effects on us in the future. Widespread adoption of this type of software would
seriously damage our ability to attract and retain advertisers.
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WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF GOVERNMENT
REGULATION INCREASES
There are currently few laws or regulations that specifically regulate
communications or commerce on the Internet. Laws and regulations may be adopted
in the future, however, that address issues such as user privacy, pricing,
taxation, content, copyrights, distribution, security, and the quality of
products and services. Several telecommunications companies have petitioned the
Federal Communications Commission to regulate Internet service providers and
online services providers in a manner similar to long distance telephone
carriers and to impose access fees on these companies. Any imposition of access
fees could increase the cost of transmitting data over the Internet. In
addition, the growth and development of the market for online commerce may lead
to more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on us. The United States Congress has
enacted Internet laws regarding children's privacy, copyrights, taxation and the
transmission of sexually explicit material. The law of the Internet, however,
remains largely unsettled, even in areas where there has been some legislative
action. Moreover, it may take years to determine the extent to which existing
laws relating to issues such as property ownership, libel and personal privacy
are applicable to the Web. Any new, or modifications to existing, laws or
regulations relating to the Web could adversely affect our business.
Prohibition and restriction of Internet content and commerce could reduce
or slow Internet use, decrease the acceptance of the Internet as a
communications and commercial medium and expose us to liability. Any of these
outcomes could have a material adverse effect on our business, results of
operations and financial condition. The growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws,
both in the United States and abroad, that may impose additional burdens on
companies conducting business over the Internet.
THE INTERNET IS SUBJECT TO RAPID CHANGES, WHICH COULD RESULT IN SIGNIFICANT
ADDITIONAL COSTS
The market for Internet products and services is characterized by rapid
change, evolving industry standards and frequent introductions of new
technological developments. These new standards and developments could make our
existing or future products or services obsolete. Keeping pace with the
introduction of new standards and technological developments could result in
significant additional costs or prove difficult or impossible for us. The
failure to keep pace with these changes and to continue to enhance and improve
the responsiveness, functionality and features of our Web sites could harm our
ability to attract and retain users. Among other things, we will need to license
or develop leading technologies, enhance our existing services and develop new
services and technologies that address the varied needs of our users.
OUR NET SALES COULD BE ADVERSELY AFFECTED IF WE BECOME SUBJECT TO SALES AND
OTHER TAXES
If one or more states or any foreign country successfully asserts that we
should collect sales or other taxes on the sale of our products, our net sales
and results of operations could be harmed. We do not currently collect sales or
other similar taxes for physical shipments of goods into
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states other than California and Florida. However, one or more states may seek
to impose sales tax collection obligations on companies, such as ARTISTdirect,
which engage in or facilitate online commerce. A number of proposals have been
made at the state and local level that would impose additional taxes on the sale
of goods and services through the Internet. Such proposals, if adopted, could
substantially impair the growth of electronic commerce and could adversely
affect our opportunity to derive financial benefit from electronic commerce.
Moreover, if any state or foreign country were to successfully assert that we
should collect sales or other taxes on the exchange of merchandise on its
system, our results of operations could be adversely affected. In addition, any
operations in states outside California and Florida could subject our shipments
in such states to state sales taxes under current or future laws.
Congress has enacted legislation limiting the ability of the states to
impose taxes on Internet-based transactions. However, this legislation, known as
the Internet Tax Freedom Act, imposes only a moratorium ending on October 21,
2001 on state and local taxes on electronic commerce where such taxes are
discriminatory and on Internet access unless such taxes were generally imposed
and actually enforced before October 1, 1998. Failure to renew this legislation
would allow various states to impose taxes on Internet-based commerce.
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT AND MAINTENANCE OF THE INTERNET
AND THE AVAILABILITY OF INCREASED BANDWIDTH TO CONSUMERS
The success of our business will rely on the continued improvement of the
Internet as a convenient means of consumer interaction and commerce, as well as
an efficient medium for the delivery and distribution of music. Our business
will depend on the ability of our artists and consumers to conduct commercial
transactions with us, as well as to continue to upload and download music files,
without significant delays or aggravation that may be associated with decreased
availability of Internet bandwidth and access to our Web site. This will depend
upon the maintenance of a reliable network with the necessary speed, data
capacity and security, as well as timely development of complementary products,
such as high-speed modems, for providing reliable Internet access and services.
The failure of the Internet to achieve these goals will reduce our ability to
generate significant revenue.
Our penetration of a broader consumer market will depend, in part, on
continued proliferation of high speed Internet access. The Internet has
experienced, and is likely to continue to experience, significant growth in the
numbers of users and amount of traffic. As the Internet continues to experience
increased numbers of users, increased frequency of use and increased bandwidth
requirements, the Internet infrastructure may be unable to support the demands
placed on it. In addition, increased users or bandwidth requirements may harm
the performance of the Internet.
The Internet has experienced a variety of outages and other delays and it
could face outages and delays in the future. These outages and delays could
reduce the level of Internet usage as well as the level of traffic, and could
result in the Internet becoming an inconvenient or uneconomical source of music
and related products and merchandise which would cause our revenue to decrease.
The infrastructure and complementary products or services necessary to make the
Internet a viable commercial marketplace for the long term may not be developed
successfully or in a timely manner. Even if these products or services are
developed, the Internet may not become a viable commercial marketplace for the
products or services that we offer.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market rate risk for changes in interest rates is related
primarily to our investment portfolio. We have not used derivative financial
instruments in our investment portfolio. Our short-term investments are
comprised of U.S. government obligations and public corporate debt securities.
Interest rate fluctuations impact the carrying value of the portfolio. We do not
believe that the future market risks related to the above securities will have
material adverse impact on our financial position, results of operations or
liquidity.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims
arising out of our ordinary course of business. We are not presently involved in
any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) SALES OF UNREGISTERED SECURITIES.
During the period covered by this report, the Company issued unregistered
securities to Frederick W. Field, our Chairman of the Board and Chief Executive
Officer, as described below:
On May 31, 2001, the Company granted Frederick W. Field three non-plan,
non-qualified stock options to purchase 444,480 shares of common stock at an
exercise price of $7.50 per share, as an inducement to serve as the Company's
Chairman of the Board and Chief Executive Officer pursuant to an Employment
Agreement dated May 31, 2001.
The right to purchase 302,370 shares of common stock (the "Base Option") is
immediately exercisable for all the option shares, but any shares purchased
under the Base Option will be subject to repurchase by the Company, at the
exercise price paid per share, to the extent those shares are unvested when Mr.
Field ceases to remain in the Company's service. Mr. Field will acquire a vested
interest in and the Company's repurchase right will lapse with respect to the
option shares in a series of 60 successive equal monthly installments upon Mr.
Field's completion of each month of service measured from June 29, 2001. The
option shares will automatically accelerate in full so that they are immediately
fully vested and exercisable upon (i) a change of control of the Company that
occurs prior to Mr. Field's cessation of service with the Company or (ii) upon
Mr. Field's cessation of service with the Company pursuant to an involuntary
termination. A change of control of the Company includes a merger,
consolidation, sale of all or substantially all of the assets and a sale of the
voting control of the Company. An involuntary termination includes (i) a
termination by the Company of Mr. Field's employment for reasons other than for
cause, (ii) a cessation of services pursuant to Mr. Field's permanent disability
or death and (iii) Mr. Field's voluntary resignation for good reason, as set
forth in the Employment Agreement. Permanent disability exists if Mr. Field
becomes unable to engage in any substantial gainful activity by reason of any
medically determinable physical or mental impairment which is expected to result
in death or has lasted or can be expected to last for a continuous period of at
least 12 months. In addition, if (i) Mr. Field terminates his employment upon
written notice in connection with the commencement of any arbitration proceeding
to determine whether or not his employment with the Label may be terminated for
cause and (ii) Mr. Field remains employed at the Label because the arbitrator
determined that the Label was not entitled to terminate Mr. Field's employment
for cause (together, such events will constitute a "Termination With
Justification"), then 50% of the then unvested option shares will automatically
accelerate so they are immediately fully vested and exercisable.
The right to purchase 75,588 shares of common stock (the "Level One
Option") will not be exercisable by Mr. Field unless one of the following events
occurs prior to June 29, 2004, in which event Mr. Field will acquire a vested
interest in and the option will become fully exercisable with respect to all of
the option shares: (i) the 30-day average closing sale price of the
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Company's common stock or the consideration paid per share in an acquisition of
the Company reaches a minimum of $35.00 per share; (ii) the Company's common
stock is re-listed on The Nasdaq National Market following a delisting; (iii) a
change of control of the Company occurs; or (iv) Mr. Field's service with the
Company ceases pursuant to an involuntary termination (each a "Level One
Triggering Event"). If no Level One Triggering Event has occurred by June 29,
2004, then the option will terminate and no option shares will vest or become
exercisable by Mr. Field.
The right to purchase 66,522 shares of common stock (the "Level Two
Option") will not be exercisable by Mr. Field unless one of the following events
occurs prior to June 29, 2004, in which event Mr. Field will acquire a vested
interest in and the option will become fully exercisable with respect to all of
the option shares: (i) the 30-day average closing sale price of the Company's
common stock or the consideration paid per share in an acquisition of the
Company reaches a minimum of $70.00 per share; (ii) the Company's common stock
is re-listed on The Nasdaq National Market following a delisting; (iii) a change
of control of the Company occurs; or (iv) Mr. Field's service with the Company
ceases pursuant to an involuntary termination (each a "Level Two Triggering
Event"). If no Level Two Triggering Event has occurred by June 29, 2004, then
the option will terminate and no option shares will vest or become exercisable
by Mr. Field.
All three stock options expire no later than May 30, 2008. All three stock
options may also terminate prior to the expiration date as follows: (i) upon the
later of the 12 month anniversary of Mr. Field's cessation of service or the
expiration of Mr. Field's initial five-year employment term with the Company if
Mr. Field's employment with the Company ceases pursuant to an involuntary
termination; (ii) upon the earlier of the 12 month anniversary of Mr. Field's
cessation of service or the expiration of Mr. Field's initial five-year
employment term with the Company if Mr. Field terminates his employment pursuant
to a Termination With Justification; (iii) upon the earlier of the 90-day
anniversary of Mr. Field's cessation of service or the expiration date of the
stock option if Mr. Field ceases to remain in the Company's service for any
reason other than an involuntary termination or a Termination With
Justification; (iv) immediately if the Company terminates Mr. Field's employment
for cause; (v) upon the earlier of the 12 month anniversary of Mr. Field's death
or the expiration date of the stock option if Mr. Field ceases to remain in the
Company's service due to his death; and (vi) upon the latter of the 12 month
anniversary of Mr. Field's cessation of service with the Company or the
expiration of Mr. Field's initial five-year employment term with the Company if
Mr. Field ceases to remain in the Company's service due to his permanent
disability, Additionally, the Level One Option and the Level Two Option will
also terminate if a Level One Triggering Event or a Level Two Triggering Event,
as applicable, has not occurred by June 29, 2004.
These stock option grants did not involve any underwriters, any
underwriting discounts or commissions, or any public offering, and the Company
believes that the stock option grants were exempt from the registration
requirements of the 1933 Act, by virtue of Section 4(2) and by virtue of the
fact that, as an executive officer of the Company, Mr. Field is an "accredited
investor" within the meaning of SEC Rule 501 of Regulation D, as presently in
effect. Mr. Field represented his intention to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof, and appropriate legends were affixed to the instruments
issued in the transaction. Mr. Field had adequate access, through his
relationship with the Company, to information about the Company. The Company
intends to register the shares of common stock issuable to Mr. Field upon
exercise of the options on a registration
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statement on Form S-8 under the 1933 Act, and to keep such registration
statement on Form S-8 effective until all of the options have been exercised in
full or have expired. Upon resale of the common stock issuable to Mr. Field upon
exercise of the options and registered under an effective registration
statement, Mr. Field will receive all of the proceeds from such sale. The
Company will not receive any of the proceeds from sales by Mr. Field.
(d) USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on June 29, 2001 to act on the
following matters:
1. To elect three directors to serve for a three-year term ending in the
year 2004 or until their successors are duly elected and qualified. The
following directors were elected at the Annual Meeting: Keith K.
Yokomoto, Frederick W. Field and Benjamin Moody. The votes cast for Mr.
Yokotmoto were 30,136,014, with 53,988 votes withheld. The votes cast
for Mr. Field were 30,148,420, with 41,582 votes withheld. The votes
cast for Mr. Moody were 30,137,006, with 52,996 votes withheld. The
following directors' terms of office continued after the Annual Meeting:
Donald P. Muller, Stephen M. Krupa, Allen D. Lenard, Marc P. Geiger,
Clifford H. Friedman and Dara Khosrowshahi.
2. To ratify the appointment of KPMG, LLP as independent accountants of the
Company for the fiscal year ending December 31, 2001. The votes cast for
and against this action were 30,162,954 and 21,101, respectively, with
5,947 votes abstaining and zero broker non-votes.
3. To approve the formation of a record label company as a co-venture
between the Company and Frederick W. Field, and related agreements with
Mr. Field. The votes cast for and against this action were 25,408,101
and 85,046, respectively, with 24,256 votes abstaining and 4,672,599
broker non-votes.
4. To approve an amendment to the Company's Certificate of Incorporation to
effect a one-for-ten reverse stock split. The votes cast for and against
this action were 30,111,118 and 64,780, respectively, with 14,104 votes
abstaining and zero broker non-votes.
Based on these voting results, all of the above matters were approved.
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ITEM 5. OTHER INFORMATION
On May 31, 2001, the Company's Board of Directors ("Board") approved the
formation of a new record label company, ARTISTdirect Records, LLC, as a
co-venture between the Company and Frederick W. Field, and related agreements
with Mr. Field to retain Mr. Field as Chairman of the Board and Chief Executive
Officer of the Company and Chief Executive Officer of ARTISTdirect Records, LLC.
In addition, the Board nominated Mr. Field to be elected as a director of the
Company.
On May 31, 2001, ARTISTdirect Recordings, Inc., a wholly-owned subsidiary
of the Company, and Radar Records Holdings, LLC, an entity wholly owned directly
or indirectly by Mr. Field, entered into definitive agreements regarding the
joint formation and operation of ARTISTdirect Records, LLC and the terms of Mr.
Field's employment. Under the terms of these agreements, ARTISTdirect
Recordings, Inc. and Radar Records Holdings, LLC will each own a 50% equity
interest in the co-venture. ARTISTdirect Recordings, Inc. will provide funding
to the co-venture in the form of a $50 million revolving credit facility
pursuant to a loan and security agreement, and Mr. Field will be responsible for
running the day-to-day operations of the co-venture. As an inducement to Mr.
Field to enter into the co-venture with the Company, the Company entered into a
five-year employment agreement with Mr. Field to serve as Chief Executive
Officer of the Company, and entered into three non-plan, non-qualified stock
option agreements with Mr. Field, as discussed more fully above in Item 2. Mr.
Field also will serve as the Chief Executive Officer of ARTISTdirect Records,
LLC pursuant to a separate five-year employment agreement. The terms of the
material agreements relating to these transactions are set forth in Appendices B
and C and Exhibits 1 through 4 attached to the Company's Definitive Proxy
Statement filed with the Securities and Exchange Commission on June 11, 2001,
and incorporated herein by this reference.
At the Company's Annual Meeting of Stockholders on June 29, 2001, the
Company's stockholders approved the formation of ARTISTdirect Records, LLC as a
co-venture between the Company and Mr. Field, and the related agreements with
Mr. Field, and elected Mr. Field as a director of the Company.
Upon Mr. Field being retained as Chairman of the Board and Chief Executive
Officer of the Company, Marc Geiger resigned his position as Chairman of the
Board and Chief Executive Officer of the Company and was appointed to the
position of Vice Chairman of the Board and President, Artist Services.
On June 29, 2001, the Company's stockholders also approved a one-for-ten
reverse split of the Company's common stock. The reverse split became effective
at the close of business on July 5, 2001, and the Company's common stock opened
trading on a post-split basis on The Nasdaq National Market on July 6, 2001.
After the reverse split, the total number of shares of the Company's common
stock outstanding is 3,582,275 (subject to reduction for fractional shares
eliminated in connection with the reverse split). The Company is paying cash in
lieu of fractional shares created by the reverse split.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Exhibit Description
- ----------- -------------------
3.1(1) Amended and Restated Certificate of Incorporation of the
Registrant.
3.2(1) Amended and Restated Bylaws of the Registrant.
3.3 Certificate of Amendment of the Third Amended and Restated
Certificate of Incorporation.
4.3(2) Registration Rights Letter Agreement dated May 31, 2001 between the
Registrant and Frederick W. Field.
10.48(3) Operating Agreement of ARTISTdirect Records, LLC dated May 31, 2001
by and among ARTISTdirect Records, LLC, ARTISTdirect Recordings,
Inc. and Radar Records Holdings, LLC.
10.49(4) Loan and Security Agreement dated May 31, 2001 by and between
ARTISTdirect Records, LLC and ARTISTdirect Recordings, Inc.
10.50(5) Employment Agreement dated May 31, 2001 by and between the
Registrant and Frederick W. Field.
10.51(6) Employment Agreement dated May 31, 2001 by and between ARTISTdirect
Records, LLC and Frederick W. Field.
10.52(7) Letter Agreement dated May 31, 2001 by and among the Registrant,
ARTISTdirect Records, LLC, ARTISTdirect Recordings, Inc., Frederick
W. Field and Radar Records Holdings, LLC.
- --------------
(1) Incorporated by reference to the same exhibit in the Registrant's
Registration Statement on Form S-1 (Registration Number 333-87547)
initially filed on September 22, 1999, as amended by Amendment Nos. 1-7
thereto.
(2) Incorporated by reference to Exhibit 3 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(3) Incorporated by reference to Appendix B filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(4) Incorporated by reference to Appendix C filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(5) Incorporated by reference to Exhibit 1 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(6) Incorporated by reference to Exhibit 2 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(7) Incorporated by reference to Exhibit 4 filed in connection with the
Registrant's Definitive Proxy Statement on June 11, 2001.
(b) None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARTISTDIRECT, INC.
(Registrant)
By: /s/ James B. Carroll
-----------------------------
James B. Carroll
Executive Vice President,
Chief Financial Officer
and Secretary
Dated: August 14, 2001
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.3 Certificate of Amendment of the Third Amended and
Restated Certificate of Incorporation.