SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended December 31, 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 001-13469
MEDIABAY, INC.
(Exact Name of Registrant as Specified in Its Charter)
Florida 65-0429858
(State or other jurisdiction (IRS employer
of incorporation or organization) identification no.)
2 Ridgedale Avenue
Cedar Knolls, NJ 07927
(Address of principal executive offices) (Zip Code)
973-539-9528
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(Title of Class)
Check whether the Registrant: (1) filed all reports required to be filed by
Section 13, or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filling requirements for the past 90
days. Yes [X] No [_]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-K contained in this form, and no disclosure will be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of March 25, 2002 was approximately $30,846,493. As of March
25, 2002, there were 13,875,602 shares of the issuer's Common Stock outstanding.
Documents Incorporated by Reference:
None
MEDIABAY, INC.
Form 10-K
Table of Contents
PART I
Item 1. Description of Business 1
Item 2. Description of Property 15
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 16
Item: 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 28
Item 8. Financial Statements and Supplementary Data 28
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 28
PART III
Item 10. Directors and Executive Officers 29
Item 11. Executive Compensation 32
Item 12. Security Ownership of Certain Beneficial Owners
and Management 35
Item 13. Certain Relationships and Related Transactions 37
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 40
PART I
Item 1. Description of Business.
Forward-looking Statements
Certain statements in this Form 10-K and in the documents incorporated by
reference in this Form 10-K constitute "forward-looking" statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All statements
other than statements of historical facts included in this Report, including,
without limitation, statements regarding our future financial position, business
strategy, budgets, projected costs and plans and objectives of our management
for future operations are forward-looking statements. In addition,
forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe," or "continue" or the negative thereof or
variations thereon or similar terminology. Although we believe that the
expectations reflected in such forward-looking statements are reasonable, we
cannot assure you that such expectations will prove to be correct. These forward
looking statements involve certain known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any results, performances or achievements express
or implied by such forward-looking statements. Important factors that could
cause actual results to differ materially from our expectations, include,
without limitation, our history of losses, our ability to meet stock repurchase
obligations, anticipate and respond to changing customer preferences, license
and produce desirable content, protect our databases and other intellectual
property from unauthorized access, pay our trade creditors and collect
receivables and successfully implement our acquisition strategy, dependence on
third-party providers, suppliers and distribution channels; competition; the
costs and success of our marketing strategies, product returns and member
attrition. Undue reference should not be placed on these forward-looking
statements, which speak only as of the date hereof. We undertake no obligation
to update any forward-looking statements.
Introduction
MediaBay, Inc. is a leading seller of spoken audio and nostalgia products,
including audiobooks and old-time radio shows, through direct response, retail
and Internet channels. Our content and products are sold in multiple formats,
including physical (cassette and compact disc) and secure digital download
formats.
Our content library consists of more than 50,000 hours of spoken audio
content including audiobooks, old-time radio shows and other unique spoken word
content. The majority of our content is acquired under license from the rights
holders enabling us to manufacture the product giving us significantly better
product margins than other companies.
Our customer base includes over 2.6 million spoken audio buyers who have
purchased via catalogs and direct mail marketing. We also currently have an
additional 2.2 million e-mail addresses of spoken audio buyers and enthusiasts
online. Our old-time radio products are sold in over 7,000 retail locations
including Costco, Target, Sam's Club, Barnes & Noble, Borders, Amazon.com, and
Cracker Barrel Old Country Stores.
Our web sites receive more than 2 million unique monthly web site visitors
and are among the most heavily trafficked bookselling web sites on the Internet.
We serve more than 400,000 classic radio and nostalgia video streams of our
content on a monthly basis to web site visitors at RadioSpirits.com and
MediaBay.com.
In November 2001, our intellectual property rights related to the radio and
video programs in our content library were appraised at $40.6 million by a
reputable independent appraisal firm and, in January 2002 our Audio Book Club
and Radio Spirits membership and customer lists were appraised at $24.0 million
by the same independent appraisal firm.
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Business Divisions
We report financial results on the basis of four business segments;
Corporate, Audio Book Club ("ABC"), Radio Spirits ("Radio Spirits" or "RSI") and
MediaBay.com. A fifth division, Radio Classics, is aggregated with Radio Spirits
for financial reporting purposes. Except for corporate, each segment serves a
unique market segment within the spoken word audio industry. The four segments
serving the spoken word audio industry are as follows:
o Audio Book Club ("ABC") - the largest membership-based club of its
kind with approximately 2 million members; marketed via direct mail
and the Internet at www.audiobookclub.com. Audio Book Club is the
largest audiobook club; having acquired Doubleday's Audiobooks Direct
and the Columbia House Audiobook Club.
o Radio Spirits ("Radio Spirits" or "RSI")- old-time radio and classic
video programs marketed to over 600,000 RSI catalog buyers through
direct mail catalogs and, on a wholesale basis, to more than 7,000
major retailers, including Costco, Target, Sam's Club, Barnes & Noble,
Borders, Amazon.com, Cracker Barrel Old Country Stores and the
Internet at www.radiospirits.com.
o MediaBay.com - our content-rich media portal located at
www.MediaBay.com offers our extensive library of premium spoken word
audio content in secure digital download formats.
o Radio Classics ("RCI")- the distribution of our three national
"classic" radio programs which are collectively heard on more than 500
traditional radio stations in more than 350 markets by over 3 million
listeners weekly. We plan to distribute our old-time radio programming
across multiple digital distribution platforms including digital cable
television, satellite television (DBS), satellite radio and the
Internet. We are currently in discussions with numerous companies in
this space regarding the carriage of our programming on their
satellite and cable systems.
Audio Book Club
We believe that we are a leading seller of audiobooks in the world through
our Audio Book Club, the largest membership-based club of its kind. Our total
member file, which includes active and inactive members, has grown significantly
from approximately 64,000 names at December 31, 1995 to approximately 2.0
million names at December 31, 2001.
In December 1998 and June 1999, MediaBay acquired its only two competitors
in the club segment of the audiobook market: The Columbia House Audiobook Club
from Time Warner and Sony and Doubleday's Audiobooks Direct club from
Bertelsmann.
Our Audio Book Club is modeled after the "Book-of-the-Month Club". Audio
Book Club members can enroll in the club through the mail by responding to
direct mail advertisements, online through our web site or by calling us. We
typically offer new members four audiobooks at an introductory price of $.99 or
less. By enrolling, the member typically commits to purchase a minimum number of
additional audiobooks, typically two or four, at Audio Book Club's regular
prices, which generally range from $10.00 to $35.00 per audiobook. Our members
continue to receive member mailings and typically purchase audiobooks beyond
their minimum purchase commitment.
We emphasize the timely introduction of new audiobook titles to our
catalogs and attempt to offer a balance between various genres and between
unabridged and abridged audiobooks, cassettes and compact discs to satisfy
differing member preferences.
We have created our first such specialty club for audiobooks based on
consumer preferences which we have identified from our extensive database of
member information. This first specialty club, Audio Passages, a Christian
Audiobook Club, was launched in the second quarter of 2000. We are exploring the
possibility of launching additional specialty clubs, featuring a specific
interest, such as self-help, religion, mystery and Spanish language audiobooks.
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We engage in list rental programs to maximize the revenue generation
potential of these programs. As Audio Book Club's membership base and Radio
Spirits' catalog customer base continue to grow, we anticipate that our customer
and member lists will continue to be attractive to non-competitive direct
marketers as a source of potential customers.
Audiobookclub.com
Audiobookclub.com provides visitors the opportunity to become members of
our Audio Book Club and provides our members with the ability to order online,
audiobooks offered through our catalog. Audiobookclub.com has acquired
approximately 275,000 members online, including 58,000 members in 2001, and
19,000 members online in January and February of 2002. We have significantly
reduced our cost to acquire a member online dramatically in 2001 as a result of
our revised marketing strategy. The cost to acquire a member in December 2001
was approximately $12 as compared to over $50 in January of 2000.
Audiobookclub.com currently receives over 1.6 million unique visitors per month
and is one of the most heavily trafficked bookselling web sites on the Internet.
Marketing
Since our inception, we have engaged in an aggressive marketing program to
expand our Audio Book Club member base. We devote significant efforts to
developing various marketing strategies in a concerted effort to increase
revenue and reduce marketing costs. We continually analyze the results of our
marketing activities in an effort to maximize sales, extend membership life
cycles, and efficiently target our marketing efforts to increase response rates
to our advertisements and reduce our per-member acquisition costs.
We have historically acquired new Audio Book Club members primarily through
direct mailings of member solicitation packages, acquisitions, Internet
advertising, and to a lesser extent from advertisements in magazines, newspapers
and other publications, package insert and telemarketing programs. We seek to
attract a financially sound and responsible membership base and target these
types of persons in our direct mail, Internet and other advertising efforts.
We select lists of names of membership candidates based on the extensive
knowledge and experience we have gained which we believe are characteristic of
persons who are likely to join Audio Book Club, purchase sufficient quantities
of audiobooks to be a profitable source of sales for us and remain long-term
members. We analyze our existing mailing lists and our promotional campaigns to
target membership lists, which are more likely to yield higher response rates.
We have gained substantial knowledge relating to the use of third-party mailing
lists and believe we can target potential members efficiently and cost
effectively by using third-party mailing lists.
Our Internet marketing program focuses on acquiring Audio Book Club members
through advertising agreements with other web sites that require payment only
when we enroll a bona fide member in Audio Book Club. This cost -per
- -acquisition or "CPA" arrangement results in substantially lower marketing costs
and direct control over the cost of acquiring members. These agreements have
resulted in a cost to acquire new members on the Internet, which is
approximately 50% lower than our offline cost. Unlike traditional web retailers,
our members have a purchase obligation associated with their membership and
there is a strong likelihood that they will remain members and repeat buyers for
a sustained period.
We also use push-marketing programs consisting of targeted e-mail campaigns
to our existing e-mail address database of over 2.2 million e-mail addresses.
Member Retention and Recurring Revenue
We encourage Audio Book Club members to purchase more than their minimum
purchase commitment by offering members discount pricing on their featured
selection audiobook and other incentives based on the volume of their purchases.
Audio Book Club members receive one mailing approximately every three weeks.
Audio Book Club mailings typically include a multi-page catalog
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which offers hundreds of titles, including a featured selection, which is
usually one of the most popular titles at the time of mailing; alternate
selections, which are best selling and other current popular titles; and
backlist selections, which are long-standing titles that have continuously sold
well. Each member mailing also includes an order form and a
"Member-Get-a-Member" form.
In order to encourage members to maintain their relationship with Audio
Book Club and to maximize the long-term value of members, we seek to provide
friendly, efficient, and personalized service. Our goal is to simplify the order
process and to make members comfortable shopping via the Internet and by mail
order. Audio Book Club's membership club format makes it easy for members to
receive the featured selection without having to take any action. Under the
membership club reply system, the member receives the featured selection unless
he or she replies by the date specified on the order form by returning the order
form, calling us with a reply, faxing a reply to us or replying online via our
Internet web site with a decision not to receive such selection. Members can
also use any of these methods to order additional selections from each catalog.
We maintain a database of information on each name in our member file,
including number and genre of titles ordered, payment history and the marketing
campaign from which the member joined. We also maintain a lifetime value
analysis of each mailing list we use and each promotional campaign we undertake.
Supply and Production
We have established relationships with substantially all of the major
audiobook publishers, including Random House Audio Publishing Group, Simon &
Schuster Audio, Harper Audio and Time Warner Audio Books for the supply of
audiobooks. As a membership club, our Audio Book Club enjoys a cost of goods
advantage over traditional audiobook retailers. Retailers and other online
booksellers purchase audiobooks from the finished inventory of either a
publisher or a third-party distributor. As a club operator, we license a
recording or group of recordings from the publisher for sale in a club format on
a royalty or per copy basis and subcontract the manufacturing, including
duplicating and printing to a third party. As a result of the improved economies
of scale achieved from our acquisitions of Columbia House's Audiobook Club and
Doubleday Direct's Audiobooks Direct club, we have achieved significant cost
savings in the production of audiobooks.
Our licensing agreements, many of which are exclusive, have one to
three-year terms, require us to pay an advance against future royalties upon
signing the license, permit us to sell audiobooks in our inventory at the
expiration of the term during a sell-off period and prohibit us from selling an
audiobook prior to the publisher's release date for each audiobook.
Substantially all of the license agreements permit us to make our own
arrangements for the packaging, printing and cassette duplication of audiobooks.
Substantially all of our license agreements permit us to produce and sell
audiobook titles in cassette and compact disc form. Some of our license
agreements grant us digital rights to the titles as well.
Fulfillment and Customer Service
Bookspan, formerly Doubleday Direct, currently provides order processing
and data processing services, warehousing and distribution services for our
Audio Book Club members. Bookspan's services include accepting member orders,
implementing our credit policies, inventory tracking, billing, invoicing, cash
collections and cash application and generating periodic reports, such as
reports of sales activity, accounts receivable aging, customer profile and
marketing effectiveness. Bookspan also provides us with raw data from which we
generate our own marketing and accounting reports using our in-house management
information systems department. Bookspan also packs and ships the order, using
the invoice as a packing list, to the club member.
For our Audio Book Club members, we offer fast ordering options, including
placing orders online through our web site and calling us with an order. Orders
are sent fourth-class mail and are typically delivered 10 to 14 days following
our receipt of orders. For an additional fee, members can
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receive faster delivery of an order either by priority delivery, which takes
three to five days, or by overnight delivery.
Members are billed for their purchases at the time their orders are shipped
and are required to make payment promptly. We generally allow members in good
standing to order up to fifty dollars of products on credit, which may be
increased if the member maintains a good credit history with us.
Our policy is to accept returns of damaged audiobooks. In order to maintain
favorable customer relations, we generally also accept prompt returns of
unopened audiobooks. We monitor each member's account to determine if the member
has made excessive returns. Our policy is to either terminate a membership or
change member status to positive option, if the member makes three to five
consecutive returns of either audiobooks ordered or of featured selections
received because the member did not return the reply card on time.
We have implemented a number of initiatives, which have reduced the returns
from our Audio Book Club members. We have substantially reduced the number of
SKUs (Stock Keeping Units) in our inventory, resulting in fewer back orders on
items ordered and less delay in fulfilling orders. We have also extended the
period of time between when a catalog is mailed and when we ship the featured
selection, allowing members additional time to decline the featured selection if
they choose.
Radio Spirits
History
RSI was formed in December 1998 by our acquisition of three businesses:
o Radio Spirits, Inc., a company which specialized in syndicating,
selling and licensing old-time radio programs. In connection with the
Radio Spirits, Inc. acquisition, we also acquired the assets of
Buffalo Productions, Inc. relating to its business of duplicating
pre-recorded compact discs.
o The assets used by Metacom, Inc. for its Adventures in Cassettes
business of producing, marketing and selling old-time radio programs.
o The assets used by Premier Electronic Laboratories, Inc. relating to
its business of producing, marketing and selling old-time radio and
classic video programs. Following the closing of these acquisitions,
these businesses were combined to form RSI.
RSI Content
RSI has exclusive rights to a substantial portion of its library of popular
old-time radio and classic video programs, including vintage comedy, mystery,
detective, adventure and suspense programs. In November 2001, the intellectual
property rights related to RSI's old-time radio library of programs were
appraised at $30.6 million by an accredited independent third party appraisal
firm well respected in the financial community. RSI's library consists of over
60,000 radio programs, most of which are licensed on an exclusive basis,
including:
o H.G. Wells' "War of the Worlds" broadcast;
o hit series, such as The Lone Ranger, Superman, Tarzan, Sherlock
Holmes, The Life of Riley and Lights Out;
o recordings of stars, such as Humphrey Bogart, Lucille Ball, Frank
Sinatra and Jack Benny; and
o recordings of comedy teams, such as Abbott and Costello, Burns and
Allen, and Martin and Lewis.
RSI leverages the content of its old-time radio and classic video library
by entering into marketing and co-branding arrangements, which provides RSI a
means to repackage these programs. RSI offers the following collections, among
others:
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o "TheGreatest Old-time Radio Shows of the 20th Century - selected by
Walter Cronkite" - a collection of Mr. Cronkite's favorite old-time
radio programs. RSI has entered into a license agreement to use Mr.
Cronkite's name and likeness. This collection includes some of radio's
most memorable programs, a spoken foreword by Mr. Cronkite and a
companion informational booklet.
o "The Smithsonian Collection" - a collection of old-time radio programs
branded under this name. RSI has entered into an agreement with the
Smithsonian Institution to produce a series of recordings of nostalgic
radio programs to be sold through all major bookstore chains carrying
audio programs. Each Smithsonian collection features a foreword by a
recognized celebrity from radio's golden age such as George Burns,
Jerry Lewis and Ray Bradbury.
o "AMC's Audio Movies to Go" - a collection of old-time radio
adaptations of classic movies branded under this name featuring film
stars such as Humphrey Bogart, Jimmy Stewart, John Wayne and Betty
Davis. RSI entered into an exclusive agreement with American Movie
Classics in October 1999. This product line is being sold in retail
chains carrying audio and video programs, in RSI's product catalogs
and on RSI's web site.
o "The Sixty Greatest Old-time Radio Christmas Shows Selected by Andy
Williams" featuring classic Christmas episodes of old-time radios most
popular shows. RSI has entered into a license agreement to use Mr.
Williams' name and likeness. This collection includes many of radio's
most memorable Christmas programs, a spoken foreword by Mr. Williams
and a companion informational booklet.
o "The 60 Greatest Old-time Radio Science-Fiction Programs as Selected
by Ray Bradbury" which includes many radio's most famous science
fiction broadcasts. The collection will contain a 64-page booklet,
audio and written forewords by Mr. Bradbury and feature "The War of
the Worlds" and "Donovan's Brain" both starring Orson Welles, classic
episodes of "X Minus One," "Dimension X," and "Suspense" as well as
several works written for radio by Mr. Bradbury.
o "America at War" which includes 27 of the greatest radio shows which
aired during World War II. Included in the compilation are
performances by Jack Benny, Jimmy Stewart, Frank Sinatra, John Wayne,
Clark Gable, Bette Davis, Orson Welles and more. The compilation
includes Norman Corwin's "We Hold These Truths," which aired eight
days after the attack on Pearl Harbor, "On a Note of Triumph"
commemorating our victory over Germany and "Fourteen August" broadcast
upon victory over Japan. "America at War" also includes speeches given
by Franklin D. Roosevelt, General Douglas MacArthur and Winston
Churchill.
Marketing
RSI markets its library of old-time radio and video programs through direct
marketing, Internet, and retail channels. RSI's marketing efforts are aimed at
the direct marketing channel of distribution, via internally developed catalogs,
as well as through retail and online channels of distribution. RSI produces
several catalogs per year and mails them to its customer list and selected
third-party mailing lists three times per year. RSI has developed wholesale
distribution through several large, national book retailers, including Barnes &
Noble, Borders, and Waldenbooks; gift stores such as Discovery Stores and
Cracker Barrel Old Country Stores and mass retailers like Costco, Sam's Club,
and Target as well as on the Internet at Amazon.com. RSI also sells its products
through its web site at Radiospirits.com.
Direct Mail
RSI maintains a list of over 600,000 names of customers of radio and video
programs through RSI's catalogs and other channels. This list includes all
customers to which RSI's radio and video programs or catalogs have been mailed.
RSI engages in list rental programs to maximize the revenue generation potential
of its customer list. RSI's catalogs offer cassettes and compact discs from its
old-time radio library and videos from its classic video library and RSI's line
of DVDs, which combine classic radio and classic television programs on a single
DVD.
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Broadcast
RSI advertises its products on RadioClassics' nationally syndicated
old-time radio broadcast, which reaches an audience of 3 million listeners of
old-time radio programs weekly on over 500 radio stations.
Internet
RSI also sells its old-time radio and classic video programs in cassette,
compact disc and DVD to retail customers through its web site, Radiospirits.com.
Radiospirits.com is an innovative content and e-commerce web site, offering
visitors a single location for the largest selection of old-time radio content
and products in digital download and physical formats (cassette, CD and DVD).
Consumers may download old-time radio content from the Internet at both
Radiospirits.com and MediaBay.com. This service enables the secure delivery of
old-time radio content over the Internet for playback on personal computers and
portable playback devices. Radiospirits.com provides visitors with a searchable
database to preview and purchase titles from RSI's old-time radio program
library. This site offers free full-length programs in streaming audio and
digital download formats, information on the programs, celebrities and talent of
the Golden Age of Radio, contests and trivia information.
Wholesale
RSI also sells its radio programs on a wholesale basis through major
retailers and online retailers, including Costco, Target, Sam's Club, Barnes &
Noble, Borders, Amazon.com and Cracker Barrel Old Country Stores. RSI's products
are currently sold in approximately 7,000 retail locations.
RSI markets its old-time radio and classic video programs to wholesale
customers through its in-house sales personnel, independent sales
representatives and through third-party distributors. RSI also engages in
cooperative advertising to induce retailers to purchase its products.
Supply and Production
RSI has exclusive licensing rights to a substantial majority of its
old-time radio library. These rights have been principally acquired from the
original rights holders (actors, directors, writers, producers or others) or
their estates. Engineers in our New Jersey facility use digital sound equipment
to improve the sound quality of RSI's old-time radio programs. RSI then
contracts with third-party manufacturers to duplicate and manufacture the
old-time radio cassettes and CDs, which it sells. Because RSI's old-time radio
content is acquired under license from the rights holders, which give the
ability to manufacture the programs, RSI enjoys a cost of goods advantage,
resulting in favorable product margins. RSI uses third parties to manufacture
most of its videos.
RSI has encoded over 10,000 programs from its old-time radio content
library and currently provides digital download delivery of many of these
programs and products, and is continuing to encode additional programs for
digital download delivery.
Fulfillment and Customer Service
RSI uses a third-party fulfillment center to process and fill orders. RSI
only accepts credit card orders or advance payments from consumers and requires
wholesale customers to generally pay invoices within 60 to 90 days. RSI
maintains a toll-free customer service telephone hotline for these customers and
can also be contacted by mail and e-mail. RSI's policy is to accept returns of
damaged products sold on a retail basis. RSI accepts returns of unsold products
sold on a wholesale basis.
Video Library
RSI also has an extensive library of over 3,500 video programs, including
an extensive collection of foreign and silent films, as well as classic films
from the 1930s through the 1970s. These programs include films starring Jack
Nicholson, John Wayne, James Stewart, Frank Sinatra, Bruce Lee, Orsen Welles,
Roy Rogers and Jack Palance. In November 2001, the source materials relating to
RSI's video library were valued at $10.0 million by an accredited independent
third party appraisal firm well respected in the financial community.
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DVDs
In the spring of 2001, RSI introduced a new line of DVDs, which combines
three classic television favorites with three old-time radio shows of the same
series. Because of RSI's old-time radio licenses, RSI is able to combine the
classic television programs with the radio shows that inspired them.
MediaBay.com
MediaBay.com is an innovative content and e-commerce web site offering our
2.6 million customers, 2.2 million email addresses and approximately 1.6 million
unique web site monthly visitors a single location for digital downloads of
premium spoken word content. Portions of these downloads are provided as free
samples, however, the majority of the content is offered for sale either on a
per download basis or as part of a monthly subscription. Our objective is to
position MediaBay.com as a leading digital download provider of premium spoken
word audio content.
RadioClassics
Our RadioClassics subsidiary intends to syndicate our old-time radio
library across multiple distribution platforms including traditional radio,
digital cable television, satellite television (DBS), satellite radio and the
Internet. We produce and syndicate three national "classic" radio programs:
"When Radio Was" hosted by Stan Freberg, "Radio Movie Classics" hosted by
Jeffrey Lyons, and "Radio Super Heroes." These three programs are collectively
heard on more than 500 radio stations in more than 350 markets including one of
the nation's largest radio stations, KNX1070 Los Angeles, by over 3 million
listeners weekly. Our library of old-time radio programs provides the content
and the basis for these programs.
Our current syndicated radio shows provide an excellent forum to introduce
our old-time radio programs to existing and potential new listeners. The
syndication agreements also provide us with an average of 1 to 2 minutes per
hour for our own advertising and promotional use. We use this advertising and
promotional forum as a means to develop broader name recognition for Radio
Spirits and additional sales of old-time radio products from existing and first
time buyers as well. Our success with our traditional radio syndication programs
provides a natural extension for the syndication of our content on a 24/7 basis
via numerous other distribution platforms through our RadioClassics subsidiary.
RadioClassics is currently in discussions with leading cable television,
satellite radio and satellite television companies to establish distribution
capabilities for Radio Spirit's old-time radio content.
Industry Overview
Audiobooks
The market for audiobooks in 2000, according to the Audio Publishers
Association, grew from an estimated $250 million in 1989 to approximately $2.5
billion in 2000.
In May 2001, the Audio Publishers Association released the results of a new
consumer study on audiobook listener profiles, usage and buying trends. Listed
below is an overview of some of their findings:
o The average audiobook listener earns 25% more than non-listeners, has
a higher level of education and is more likely to hold a professional
and managerial position than a non-listener.
o In 2001, 22.5% of American households listened to audiobooks.
o Audiobook users are demographically similar to print book users in
gender, age and income, but audiobook users have larger households.
o The use of CDs for audiobooks has increased dramatically in the past
two years. In fact, the average number of hours per week audiobooks
are listened to on CD is currently almost equal to the use of
audiobooks on cassettes.
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o Cars, particularly among commuters, are still the dominant place that
consumers listen to audiobooks. Each week, audiobooks are listened to
an average of 4.4 hours in the car, 3.6 hours at home, 2 hours at work
and 2 hours while exercising.
o Multi-tasking continues to be the primary benefit recognized by
consumers of audiobooks, especially by those who are driving long
distances, traveling, or commuting. Other advantages are entertainment
and information.
Old-time Radio
Old-time radio programs include radio dramas, mysteries, detective stories,
comedies, westerns, science fiction and adventure stories that originally aired
from the 1930s to the 1960s. Radio's creative forces fired the imagination of
listeners with drama, comedy, music and even re-enactments of popular movies.
The medium's writers, producers and talent laid the foundation for the advent of
television. Many of Radio's shows and stars made the transition to early
television.
Today "old-time" radio programming is still a very popular listening
option. Arbitron research has consistently shown that our nationally syndicated
old-time radio shows rank first in New York, Los Angeles, Chicago, Salt Lake
City and Milwaukee in the period when they aired.
Digital Downloads
The Internet has emerged as a significant global communications medium
giving millions of people the ability to access and share large amounts of
information and to experience entertainment offerings. Through the Internet,
people can quickly receive various forms of information and entertainment, from
traditional types of publishing such as text to the newer technologies like
streaming and downloadable audio.
In the past, the audio environment available to Internet users restricted
consumers to listening directly from their PCs or through players that allowed
short lengths of audio content. Consumer electronics and computer manufacturers
have been addressing this constraint by developing mobile devices that are
capable of storing more audio content for consumers to play. According to
Forrester Research, the installed base of Internet-connected digital audio
players reached one million units in 1999 and is estimated to be 34 million
units by 2003. We believe this increase in digital audio players will directly
translate into increased demand for premium spoken word content to be heard on
these players.
We believe that wireless telephone and wireless applications protocol
("WAP") technology is the ideal match for hand-held digital audio players. The
combination of wireless freedom and digital transmission will, in the future,
allow a consumer to download from a library of audio recordings and bypass the
anchored desktop PC. Forrester predicts that carmakers will install personal
audio recorders. By placing hard drives in cars and partnering with technology
companies, vehicle manufacturers will be able to provide commuters a solution
for on-demand audio.
Competition
We compete with other web sites, which offer similar entertainment products
or content, including digital download, of spoken word content. We also compete
for discretionary consumer spending with mail order clubs and catalogs, other
direct marketers and retailers that offer products with similar entertainment
value as audiobooks and old-time radio and classic video programs, such as music
on cassettes and compact discs, printed books, videos, and laser and digital
video discs. Many of these competitors are well-established companies, which
have greater financial resources.
9
The audiobook and mail order industries are intensely competitive. We
compete with all other outlets through which audiobooks and other spoken word
content are offered, including:
o bookstores;
o audiobook stores which rent or sell only audiobooks;
o mail order companies that offer audiobooks for rental and sale through
catalogs; and
o retail establishments such as convenience stores, video rental stores
and wholesale clubs.
Intellectual Property
We have a United States registered trademark for the Audio Book Club logo
and have several pending United States trademark and service mark registrations,
including "MediaBay," "Radio Spirits", "MediaBay.com," "audiobookclub.com" and
the MediaBay logos. We have applied for several additional service marks
relating to slogans and designs used in our advertisements, member mailings and
member solicitation packages. We believe that our trademarks and service marks
have significant value and are important to our marketing. We also own or
license the rights to the radio and video programs in our content library.
We rely on trade secrets and proprietary know-how and employ various
methods to protect our ideas, concepts and membership database. In addition, we
typically obtain confidentiality agreements with our executive officers,
employees, list managers and appropriate consultants and service suppliers.
Employees
As of March 25, 2002, we had 48 full-time employees. Of these employees, 5
served in corporate management; 27 served in operational positions at our Audio
Book Club operations; 1 served in management and 4 served in operational
positions at our MediaBay.com operations and 11 served in operational positions
at our old-time radio and classic video operations. We believe our employee
relations to be good. None of our employees are covered by a collective
bargaining agreement.
Risk Factors
Risks Related to Our Operations
Our products are sold in a niche market that is still evolving and may have
limited future growth potential.
We believe that the market for audiobooks and old-time radio and classic
video programs has expanded rapidly in recent years. However, consumer interest
in audiobooks and old-time radio and classic video programs may decline in the
future, and growth trends in these markets may stagnate or decline. The sale of
audiobooks through mail order clubs and over the Internet are emerging retail
concepts, and audiobooks are still evolving as a niche market. As is typically
the case in an evolving industry, the ultimate level of demand and market
acceptance for our products is subject to a high degree of uncertainty. A
decline in the popularity of audiobooks and old-time radio and classic video
programs would limit our future growth potential and negatively impact our
future operating results.
We may be unable to anticipate changes in consumer preference for our products
and may lose sales opportunities.
Our success depends largely on our ability to anticipate and respond to a
variety of changes in the audiobook, old-time radio and classic video
industries. These changes include economic factors affecting discretionary
consumer spending, modifications in consumer demographics and the availability
of other forms of entertainment. The audiobook, old-time radio and classic video
markets are characterized by changing consumer preferences, which could affect
our ability to:
o plan for catalog offerings;
o introduce new titles;
o anticipate order lead time;
10
o accurately assess inventory requirements; and
o develop new product delivery methods.
Although we evaluate many factors and attempt to anticipate the popularity
and life cycle of audiobook titles, the ultimate level of demand for specific
titles is subject to a high level of uncertainty. Sales of audiobook titles
typically decline rapidly after the first few months following release. If sales
of specific titles decline more rapidly than we expect, we could be left with
excess inventory, which we might be forced to sell at reduced prices. If we fail
to anticipate and respond to factors affecting the audiobook industry in a
timely manner, we could lose significant amounts of capital or potential sales
opportunities.
We may experience system interruptions, which affect access to our web sites and
our ability to sell products over the Internet.
Our future revenues may depend in part on the number of web site visitors
who join as Audio Book Club members and who make online purchases. The
satisfactory performance, reliability and availability of our web sites,
transaction-processing systems and network infrastructure are critical to our
ability to attract and retain visitors at our web sites. If we experience system
interruptions that prevent customers and potential customers from accessing our
web sites, consumer perception of our on-line business could be adversely
affected, and we could lose sales opportunities and visitor traffic.
We may not be able to license or produce desirable spoken word content, which
could reduce our revenues.
We could lose sales opportunities if we are unable to continue to obtain
the rights to additional audiobook libraries or selected audiobook titles. Many
of our license agreements with audiobook publishers are one to three years in
length, and some of our agreements will expire over the next several months
unless they are renewed. We may not be able to renew existing license and supply
arrangements for audiobook publishers' libraries or enter into additional
arrangements for the supply of new audiobook titles.
If our third-party providers fail to perform their services properly, our
business and results of operations could be adversely affected.
Third-party providers conduct a substantial portion of our customer service
operations, process orders and collect payments for us. If these providers fail
to perform their services properly, Audio Book Club members and Radio Spirits
customers could develop negative perceptions of our business, collections of
receivables could be delayed and our operations might not function efficiently.
If our marketing strategies to acquire new members are not successful, our costs
would increase, and we will not acquire as many members as we anticipate, which
would inhibit our sales growth.
If our direct mail and other marketing strategies are not successful, our
per member acquisition costs may increase and we may acquire fewer new members
than anticipated. As a result, our operating results would be negatively
impacted and our sales growth would be inhibited.
The public may become less receptive to unsolicited direct mail campaigns.
The success of our direct mail campaigns is dependent on many factors
including the public's acceptance of direct mail solicitations. Events in the
Fall of 2001, including individuals contracting Anthrax through unsolicited
mail, could alter the public's acceptance of direct mail. Negative public
reception of direct mail solicitations will result in lower customer acquisition
rates, higher customer acquisition costs and will negatively impact operating
results and sales growth.
Increased member attrition could negatively impact our future revenues and
operating results.
Increases in membership attrition above the rates we anticipate could
materially reduce our future revenues. We incur significant up front
expenditures in connection with acquiring new members. A member may not honor
his or her commitment, or we may choose to terminate a specific membership
11
for several reasons, including failure to pay for purchases, excessive returns
or cancelled orders. As a result, we may not be able to fully recoup our costs
associated with acquiring new members. In addition, once a member has satisfied
his or her initial commitment to purchase additional audiobooks at regular
prices, the member has no further commitment to make purchases.
The closing of retail stores, which carry our products, could negatively impact
our wholesale sales of these products.
If the recent trend of bankruptcy filings by major retailers continues, the
number of outlets for our old-time radio product will become limited. With fewer
chains and stores available as distribution outlets, competition for shelf space
will increase and our ability to sell our products could be impacted negatively.
Moreover, our wholesale sales could be negatively impacted if any of our
significant retail customers were to close a significant number of their
locations or otherwise discontinue selling our products.
If third parties obtain unauthorized access to our member and customer databases
and other proprietary information, we would lose the competitive advantage they
provide.
We believe that our Audio Book Club member file and customer lists are
valuable proprietary resources, and we have expended significant amounts of
capital in acquiring these names. Our member and customer lists, trade secrets,
trademarks and other proprietary information have limited protection. Third
parties may copy or obtain unauthorized access to our member and customer
databases and other proprietary know-how, trade secrets, ideas and concepts.
Competitors could also independently develop or otherwise obtain access to
certain of our proprietary information. In addition, we rent our lists for
one-time use only to third parties that do not compete with us. This practice
subjects us to the risk that these third parties may use our lists for
unauthorized purposes, including selling them to our competitors. Our
confidentiality agreements with our executive officers, employees, list managers
and appropriate consultants and service suppliers may not adequately protect our
trade secrets. If our lists or other proprietary information were to become
generally available, we might lose a competitive advantage.
If we are unable to pay our accounts payable in a timely manner, our suppliers
and service providers may refuse to supply us with products or provide services
to us.
At December 31, 2001, we owed approximately $13.9 million to trade and
other creditors. Approximately $2.8 million of these accounts payable were more
than 60 days past due. If we do not make satisfactory payments to our vendors
they may refuse to continue to provide us products or services on credit, which
could interrupt our supply of products or services.
Higher than anticipated product return rates could reduce our future operating
results.
We experienced a product return rate of approximately 26% during the year
ended December 31, 2000 and a return rate of approximately 24% during the year
ended December 31, 2001. If members and customers return products to us in the
future at higher rates than in the past or than we currently anticipate, our net
sales would be reduced and our operating results would be adversely affected.
If we are unable to collect our receivables in a timely manner, it may
negatively impact our cash flow and our operating results.
We are subject to the risks associated with selling products on credit,
including delays in collection or uncollectibility of accounts receivable. If we
experience significant delays in collection or uncollectibility of accounts
receivable, our liquidity and working capital position could suffer and we could
be required to increase our allowance for doubtful accounts, which would
increase our expenses.
12
Increases in costs of postage could negatively impact our operating results.
We distribute millions of mailings each year, and postage is a significant
expense in the operation of our business. We do not pass on the costs of member
mailings and member solicitation packages. Unanticipated increases in the cost
of postage multiplied by the millions of mailings we conduct would result in
increased expenses and would negatively impact our operating results.
We face significant competition from a wide variety of sources for the sale of
our products.
We compete with other web sites which offer similar entertainment products
or content, including digital download of spoken word content. New competitors,
including large companies, may elect to enter the markets for audiobooks and
spoken word content. We also compete for discretionary consumer spending with
mail order clubs and catalogs, other direct marketers and retailers that offer
products with similar entertainment value as audiobooks and old-time radio and
classic video programs, such as music on cassettes and compact discs, printed
books, videos, and laser and digital video discs. Many of these competitors are
well-established companies, which have greater financial resources that enable
them to better withstand substantial price competition or downturns in the
market for spoken word content.
The audiobook and mail order industries are intensely competitive. We
compete with all other outlets through which audiobooks and other spoken word
content are offered, including:
o bookstores;
o audiobook stores which rent or sell only audiobooks;
o mail order companies that offer audiobooks for rental and sale through
catalogs; and
o retail establishments such as convenience stores, video rental stores
and wholesale clubs.
The market for digital download of spoken word content is uncertain, and we may
not be able to participate in this market effectively or at all.
Digital download of spoken word content from the Internet is a relatively
new method of distribution and its growth and market acceptance is uncertain.
Purchasing spoken word content over the Internet in digital download format
involves adjustments in general consumer purchasing patterns, and consumers may
not be willing to purchase spoken word content in digital download format. If we
invest significant amounts of money and effort in developing digital download
products, which do not achieve widespread popularity, or if the market for
digital download of spoken word content does not evolve as we anticipate, we may
not be able to recover our investment.
The loss or unavailability of our key personnel could have a material adverse
effect on our business.
Our success depends largely on the efforts of Norton Herrick, our Chairman,
Michael Herrick, our Chief Executive Officer, and Hakan Lindskog, our President
and Chief Operating Officer. Norton Herrick is actively involved in the
management and operation of several businesses and is required to devote only as
much time to our business and affairs as he deems necessary to perform his
duties. Norton Herrick may experience a conflict in the allocation of his time
among his various business ventures. The loss of the service of any of these
officers or of other key personnel could have a material adverse effect on our
business. We do not maintain key-man insurance on the lives of these officers or
any other key personnel.
Our announced strategy of pursuing acquisitions could negatively impact our
operating results.
While we have announced a strategy, which includes growing by acquisition,
as of March 25, 2002, we have not completed a major acquisition since June 1999.
The legal and professional costs associated with pursuing acquisitions as well
as the time commitment of senior management could have a negative impact on our
operating results. There can be no assurance that we will realize the perceived
benefits of an acquisition.
13
Risks Related to Our Financial Condition
We have a history of losses, are not currently profitable and may incur future
losses.
Since our inception, we have incurred significant losses. We had losses of
$6.7 million during the year ended December 31, 1999; $54.6 million during the
year ended December 31, 2000 and $4.8 million for the year ended December 31,
2001. As of December 31, 2001, we had an accumulated deficit of $89.7 million.
We may not be able to meet our obligations to repurchase shares of our common
stock in the future.
We granted sellers in our acquisitions the right to sell back to us shares
of our common stock that we issued to them. Unless our common stock satisfies
specific price targets and/or trading volume requirements, these rights could
require us to purchase up to 305,000 shares in the future at a cost to us of
approximately $4.6 million. We may not have sufficient funds to meet these
obligations to repurchase stock in the future.
Risks Related to Our Capital Structure
The Herrick family exerts significant influence over shareholder matters.
As of December 31, 2001, Norton Herrick, Michael Herrick and Howard Herrick
and their affiliates own approximately 32.7% of our outstanding common stock. As
significant shareholders and directors, they are generally able to direct our
affairs and exert significant influence over matters, which require director or
shareholder vote, including the election of directors, amendments to our
Articles of Incorporation or approval of the dissolution, merger, or sale of
MediaBay, our subsidiaries or substantially all of our assets. This
concentration of ownership by the Herrick family could delay or prevent a change
in our control, even when a change in control might be in the best interests of
other shareholders.
The terms of our debt impose restrictions on our business.
As of December 31, 2001, we had approximately $6.2 million of debt
outstanding under our revolving line of credit and $12.5 million principal
amount of debt outstanding under convertible promissory notes. Our line of
credit restricts our ability to raise financing for working capital purposes
because it requires us to use any proceeds from equity or debt financings, with
limited exceptions, to repay amounts outstanding under the credit agreement. In
addition to limiting our ability to incur additional indebtedness, our existing
indebtedness under our revolving line of credit limits or prohibits us from,
among other things:
o merging into or consolidating with another corporation;
o selling all or substantially all of our assets;
o declaring or paying cash dividends; or
o materially changing the nature of our business.
We may have to make substantial payments on our debt and may not have the funds
to do so.
We are required to make an additional $1.3 million in principal payments on
our bank debt in 2002 and the balance of our bank debt, in the amount of $4.6
million is due January 15, 2003. We also have $2.5 million and $800,000 due to
a company wholly owned by our Chairmain in January 2003 and April 2003. We
believe the $3.3 million will be extended if required. We might not have
sufficient funds to repay the debt or obtain other financing to replace the debt
or obtain an extension of its maturity.
In addition, if an event of default occurs under the convertible promissory
notes or senior credit facility, the indebtedness could become due and payable.
Our ability to use our net operating losses may be limited in future periods,
which could increase our tax liability.
Under Section 382 of the Internal Revenue Code of 1986, utilization of
prior net operating losses is limited after an ownership change, as defined in
Section 382, to an annual amount equal to the value of the corporation's
outstanding stock immediately before the date of the ownership change multiplied
by the long-term tax exempt rate. The additional equity financing we obtained in
connection with recent financings has resulted in an ownership change and, thus,
may limit our use of prior net operating losses. In the event we achieve
profitable operations, any significant limitation on the utilization of net
operating losses would have the effect of increasing our tax liability and
reducing after tax net income
14
and available cash reserves. We are unable to determine the availability of net
operating losses since this availability is dependent upon profitable
operations, which we have not achieved in prior periods.
Our stock price has been and could continue to be extremely volatile.
The market price of our common stock has been subject to significant
fluctuations since our initial public offering in October 1997. The securities
markets have experienced, and are likely to experience in the future,
significant price and volume fluctuations, which could adversely affect the
market price of our common stock without regard to our operating performance. In
addition, the trading price of our common stock could be subject to significant
fluctuations in response to:
o our ability to maintain listing of our common stock on NASDAQ;
o actual or anticipated variations in our quarterly operating results;
o announcements by us or other industry participants;
o factors affecting the market for spoken word content;
o changes in national or regional economic conditions;
o changes in securities analysts' estimates for us, our competitors' or
our industry or our failure to meet such analysts' expectations; and
o general market conditions.
Substantially all of our restricted shares of common stock are currently
eligible for sale and could be sold in the market in the near future, which
could depress our stock price.
As of December 31, 2001, we have outstanding approximately 13.9 million
shares of common stock. Substantially all of our shares are currently freely
trading without restriction under the Securities Act of 1933, having been
registered for resale or held by their holders for over two years and are
eligible for sale under Rule 144(e). There are currently outstanding options and
warrants and other convertible securities to purchase an amount of shares
substantial to the public float. Substantially all of these shares have been
registered for resale. To the extent they are exercised or converted, your
percentage ownership will be further diluted and our stock price could be
further adversely affected. Moreover, as the underlying shares are sold, the
market price could drop significantly if the holders of these restricted shares
sell them or if the market perceives that the holders intend to sell these
shares.
Item 2. Description of Property.
We lease approximately 12,000 square feet of office space in Cedar Knolls,
New Jersey pursuant to a lease agreement that expires in August 2003 at a
monthly rate of $16,000. We have the option to renew the lease for an additional
three-year period.
We lease 8,000 and 8,400 square feet in Schaumburg, Illinois pursuant to
two lease agreements which both expire in December 2005, subject to a three-year
renewal option. Monthly rent for the first lease is $5,000. These spaces contain
both office and warehouse space, which was used by RSI until the first quarter
of 2002. Monthly rent for the second lease is $4,000 base rent and $2,000 per
month related to lessor's leasehold improvements. We are currently negotiating
the sublease for one of the spaces and have begun seeking tenants to sub-lease
the other space from us, but as of March 25, 2002, we have not subleased this
space.
The Company entered into two ten-year leases on 7,000 square feet of office
and warehouse space in Bethel, Connecticut and 3,000 square feet of warehouse
space in Sandy Hook, Connecticut, respectively. Lease payments and mandatory
capital improvement payments, starting in 2004, are $4,000 per year and $2,000
per year on the Bethel and Sandy Hook properties, respectively.
Item 3. Legal Proceedings
We are not a party to any lawsuit or proceeding, which we believe is likely
to have a material adverse effect on us.
15
Item 4. Submission of Matters to a Vote of Security Holders.
An Annual Meeting of Shareholders was held on October 22, 2001, at which
time Mr. Norton Herrick was reappointed to serve as a Class I director and Mr.
Paul Ehrlich was appointed to serve as a Class I director, in each case, until
the Annual Meeting of Shareholders of the Company to be held in 2004.
Shareholder voting for these directors was as follows:
Director Votes For Votes Withheld
-------- --------- --------------
Norton Herrick 11,000,730 286,843
Paul Ehrlich 11,000,730 286,843
The following directors continue to serve as directors for the term
indicated opposite their respective names:
Director Class Expiration of Term
-------- ----- ------------------
Michael Herrick II 2002
Roy Abrams II 2002
Howard Herrick III 2003
Carl Wolf III 2003
In addition, at the meeting, the Company's shareholders adopted and
approved the Company's 2001 Stock Incentive Plan by a vote of 5,864,820 for
450,176 against and 41,113 abstaining.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
MediaBay's common stock has been quoted in the Nasdaq National Market under
the symbol "MBAY" since November 15, 1999. The following table shows the high
and low sales prices of our common stock as reported by the Nasdaq National
Market.
High Low
---- ---
Fiscal Year Ended December 31, 2000
First Quarter 16.875 6.625
Second Quarter 7.625 2.938
Third Quarter 3.125 1.406
Fourth Quarter 3.813 .563
Fiscal Year Ended December 31, 2001
First Quarter 1.625 .531
Second Quarter 1.05 .50
Third Quarter 1.06 .56
Fourth Quarter .99 .43
Fiscal Year Ended December 31, 2002
First Quarter (through March 25, 2002) 3.44 .59
On March 25, 2002 the last reported sale price of our common stock on the
Nasdaq National Market was $3.30 per share. As of March 25, 2002, there were
approximately 110 record owners of our common stock. We believe that there are
more than 400 beneficial owners of our common stock.
Dividend Policy
We have never declared or paid and do not anticipate declaring or paying
any dividends on our common stock in the near future. The terms of our debt
agreements prohibit us from declaring or paying any dividends or distributions
on our common stock. Any future determination as to the declaration and payment
of dividends will be at the discretion of our Board of Directors and will depend
on then existing conditions, including our financial condition, results of
operations, capital requirements, business factors and other factors as our
Board of Directors deems relevant.
16
Sales of Securities and Use of Proceeds
In October 2001, we issued warrants to purchase a total of 800,000 shares
of common stock, which cannot vest until November 30, 2002, pursuant to a
consulting agreement. The exercise prices of the warrants are as follows:
160,000 have an exercise price of $1.00 per share; 160,000 have an exercise
price of $2.00 per share; 160,000 have an exercise price of $3.00 per share;
160,000 have an exercise price of $4.00 per share; 160,000 have an exercise
price of $5.00 per share. During the three months ended December 31, 2001, we
issued options under our 2000 Stock Incentive Plan to purchase a total of
808,000 shares of our common stock to officers, directors and employees. We
relied on the exemptions provided by Section 4(2) of the Securities Act of 1933
in connection with such issuances.
Item 6. Selected Financial Data
The selected financial data set forth below should be read in conjunction
with the financial statements and related notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
other financial information appearing elsewhere in this Form 10-K. The selected
financial data set forth below as of December 31, 2001 and 2000 and for the
years ended December 31, 1999, 2000 and 2001, are derived from, and are
qualified by reference to, our audited financial statements included elsewhere
in this Form 10-K. The selected financial data set forth below as of December
31, 1997, 1998 and 1999, and for the years ended December 31, 1997 and 1998 are
derived from our audited financial statements not included in this Form 10-K.
The balance sheet and statement of operations data for the year ended
December 31, 1999 gives effect to the purchase of Doubleday Direct's Audiobooks
Direct club on June 15, 1999. Additionally, the balance sheet and statement of
operations data for the year ended December 31, 1998 gives effect to the
following transactions:
o The acquisition of Radio Spirits, Inc., the assets of an affiliated
company, Buffalo Productions, Inc., and a 50% interest in a joint
venture owned by the sole shareholder of Radio Spirits on December 14,
1998.
o The acquisition of substantially all of the assets used by Metacom,
Inc. in connection with its Adventures in Cassettes business on
December 14, 1998.
o The acquisition of substantially all of the assets used by Premier
Electronics Laboratories, Inc. in connection with its old-time radio
and classic video businesses on December 14, 1998.
o The acquisition of substantially all of the assets of Columbia House's
Audiobook Club on December 31, 1998.
Beginning in January 1999, the Company was required to capitalize direct
response marketing costs for the acquisition of new members in accordance with
AICPA Statement of Position 93-7 "Reporting on Advertising Costs" and amortizes
these costs over the period of future benefit. Since 1999 was the first year we
capitalized new member acquisitions costs, we capitalized a very large portion
of direct response advertising expenditures.
Beginning in July 2000, we conducted a review of our operations, including
product offerings, marketing methods and fulfillment. In the third quarter of
2001, we began to implement a series of actions and decisions designed to
improve gross profit margin, refine our marketing efforts and reduce general and
administrative costs. In connection with the movement of the fulfillment of
old-time radio products to a third party provider, in the first quarter of 2002,
we closed our old-time radio operations in Schaumburg, Illinois and now run all
of our operations, except for fulfillment, from our corporate headquarters
located in Cedar Knolls, New Jersey. In the third quarter of 2001, as a result
of the actions and decisions made after our aforementioned review of our
operations, we recorded $11.3 million of strategic charges. In addition to these
strategic charges, we recorded a charge of $2.0 million to write-off the entire
carrying amount of our cost method investment in I-Jam.
17
During the fourth quarter of 2000, the Company reviewed long-lived assets
and certain related identifiable intangibles, including goodwill, for
impairment. As a result, in the fourth quarter of 2000, the Company determined
that the goodwill associated with certain acquired businesses was impaired and
recorded an impairment charge of $38.2 million.
As a result of the series of strategic initiatives described above, our
operations have improved. Although realization of net deferred tax assets is not
assured, we have determined, based on our improved operations, that it is more
likely than not that a portion of our deferred tax asset relating to temporary
differences between the tax bases of assets or liabilities and their reported
amounts in the financial statements will be realized in future periods.
Accordingly, in 2001, we reduced the valuation allowance for deferred tax assets
in the amount of $17.2 million and recorded an income tax benefit.
As a result of the capitalization of direct response advertising costs,
recording of the goodwill write-off, the strategic charges and the income tax
benefit, as well as fluctuations in operating results depending on the timing,
magnitude and success of Audio Book Club new member advertising campaigns,
comparisons of our historical operating results from year to year may not be
meaningful.
Years Ended December 31,
--------------------------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
(thousands, except per share data)
Statement of Operations Data:
Sales $ 15,119 $ 22,242 $ 62,805 $ 59,881 $ 54,904
Returns, discounts and allowances 5,041 7,348 16,578 15,455 13,099
-------- -------- -------- -------- --------
Net sales 10,078 14,894 46,227 44,426 41,805
Cost of sales 5,495 9,452 23,687 23,044 19,783
Cost of sales - write-downs -- -- -- -- 2,261
Advertising and promotion 6,843 8,910 8,118 11,023 11,922
Advertising and promotion - write-downs -- -- -- -- 3,971
General and administrative 2,217 3,330 9,799 13,964 11,483
Asset write-downs and strategic charges -- -- -- -- 7,044
Depreciation and amortization 8 367 6,812 7,984 5,156
Non-cash write-down of goodwill -- -- -- 38,226 --
-------- -------- -------- -------- --------
Operating loss (4,485) (7,165) (2,189) (49,815) (19,815)
Interest (expense) income, net (436) 180 (4,518) (2,681) (2,235)
-------- -------- -------- -------- --------
Loss before income tax benefit and
extraordinary item (4,921) (6,985) (6,707) (52,496) (22,050)
Income tax benefit -- -- -- -- 17,200
-------- -------- -------- -------- --------
Loss before extraordinary item (4,921) (6,985) (6,707) (52,496) (4,850)
Extraordinary loss on early extinguishment
of debt -- -- -- (2,152)
-------- -------- -------- -------- --------
Net loss $ (4,921) $ (6,985) $ (6,707) $(54,648) $ (4,850)
======== ======== ======== ======== ========
Basic and diluted net loss per share
before extraordinary item $ (1.29) $ (1.13) $ (0.82) $ (4.13) $ (0.35)
======== ======== ======== ======== ========
Basic and diluted net loss per share $ (1.29) $ (1.13) $ (0.82) $ (4.30) $ (0.35)
======== ======== ======== ======== ========
Weighted average number of shares
outstanding 3,820 6,188 8,205 12,718 13,862
======== ======== ======== ======== ========
Balance Sheet Data:
Working capital (deficit) $ 9,645 $ 6,571 $ 5,967 $ 7,833 $ (3)
Total assets 12,770 64,339 93,973 49,932 45,003
Current liabilities 3,017 8,231 20,275 17,103 15,491
Long-term debt -- 40,000 37,383 15,864 17,064
Common stock subject to contingent put rights -- 8,284 4,283 4,550 4,550
Stockholders' equity 9,753 7,824 32,032 12,415 7,898
18
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Introduction
Beginning in July 2000, we conducted a review of our operations, including
product offerings, marketing methods and pricing. In the third quarter of 2001,
we began to implement a series of actions and decisions designed to improve
gross profit margin, refine our marketing efforts and reduce general and
administrative costs. Specifically, we (i) reduced the number of items offered
for sale at both its Radio Spirits and Audio Book Club subsidiaries, (ii) moved
fulfillment of our old-time radio products to a third party fulfillment
provider, (iii) limited our investment and marketing efforts in downloadable
audio due to lack of customer acceptance at this time, and the limited number
and high price point of digital audio download players currently produced and
(iv) refined our marketing of old-time radio products and our marketing efforts
to existing Audio Book Club members. In connection with the movement of the
fulfillment of old-time radio products to a third party provider, in the first
quarter of 2002, we closed our old-time radio operations in Schaumburg, Illinois
and now run all of our operations, except for fulfillment, from our corporate
headquarters located in Cedar Knolls, New Jersey. In the third quarter of 2001,
as a result of the actions and decisions made after our aforementioned review of
our operations, we recorded $11.3 million of write-downs and strategic charges.
In addition to these strategic charges, we recorded a charge of $2.0 million to
write-off the entire carrying amount of our cost method investment in I-Jam.
During the fourth quarter of 2000, we reviewed long-lived assets and
certain related identifiable intangibles, including goodwill, for impairment in
accordance with Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of" ("FASB 121") due to a change in facts and circumstances. We determined that
the revised estimates of cash flows from certain of our acquired operations
would no longer be sufficient to recover the carrying value of goodwill
associated with these businesses. As a result, in the fourth quarter of 2000, we
determined that the goodwill associated with these businesses was impaired and
recorded an impairment charge of $38.2 million. The impairment charge was
measured as the difference between the carrying value of the goodwill and its
fair value, which was based upon discounted cash flows.
As a result of the series of strategic initiatives, described above, our
operations have improved. Although realization of net deferred tax assets is not
assured, we have determined, based on our improved operations, that it is more
likely than not that a portion of our deferred tax asset relating to temporary
differences between the tax bases of assets or liabilities and their reported
amounts in the financial statements will be realized in future periods.
Accordingly, in 2001 we reduced the valuation allowance for deferred tax assets
in the amount of $17.2 million and recorded an income tax benefit.
As a result of the recording of the goodwill write-off, the strategic
charges and the income tax benefit, as well as fluctuations in operating results
depending on the timing, magnitude and success of Audio Book Club new member
advertising campaigns, comparisons of our historical operating results from year
to year may not be meaningful.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosures of contingent assets and
liabilities. On an on-going basis we evaluate our estimates including those
related to product returns, bad debts, the carrying value and net realizable
value of inventories, the recoverability of advances to publishers and other
rightsholders, the future revenue associated with deferred advertising and
promotion costs, investments, fixed assets, the valuation allowance provided to
reduce our deferred tax assets and valuation of goodwill and other intangibles.
19
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o We record reductions to our revenue for future returns and record an
estimate of future bad debts arising from current sales. These
allowances are based upon historical experience and evaluation of
current trends. If members and customers return products to us in the
future at higher rates than in the past or than we currently
anticipate, our net sales would be reduced and our operating results
would be adversely affected. Also, if the financial condition of our
customers, including both individual consumers or retail chains, were
to deteriorate, resulting in their inability to make payment to us,
additional allowances would be required.
o We are required to capitalize direct response marketing costs for the
acquisition of new members in accordance with AICPA Statement of
Position 93-7 "Reporting on Advertising Costs" and amortize these
costs over the period of probable future benefits. In order to
determine the amount of advertising to be capitalized and the manner
and period over which the advertising should be amortized, we prepare
estimates of probable future revenues arising from the direct-response
advertising in excess of future costs to be incurred in realizing
those revenues. If future revenue does not meet our estimates or if
members buying patterns were to shift, adjustments to the amount and
manner of amortization would be required. Actual amounts incurred for
advertising and promotion, net of settlements with certain vendors
principally for unprofitable Internet marketing campaigns, for the
year ended December 31, 2001 were $8.2 million. The difference between
the amount expended of $8.2 million for the year ended December 31,
2001 and the amount recorded as advertising and promotion expense, of
$11.9 million, for the year ended December 31, 2001 is due to
amortization of previously capitalized direct response advertising.
o The ultimate realization of deferred tax assets is dependent on the
generation of future taxable income during the periods in which
temporary timing differences become deductible. As a result of a
series of strategic initiatives, our operations have improved.
Although realization of net deferred tax assets is not assured,
management has determined, based on the Company's improved operations,
that it is more likely than not that a portion of our deferred tax
asset relating to temporary differences between the tax bases of
assets or liabilities and their reported amounts in the financial
statements will be realized in future periods. Should we determine we
would be able to realize deferred tax assets in the future in excess
of the net recorded amount, an adjustment to our deferred tax asset
would increase income in the period such determination is made.
Likewise, should we determine that we will not be able to realize all
or part of our net deferred tax asset in the future, an adjustment to
the deferred tax asset would be charged to income in the period such
determination is made.
o Goodwill represents the excess of the purchase price over the fair
value of net assets acquired in business combinations accounted for
using the purchase method of accounting. In July 2001, the Financial
Accounting Standards Board issued SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 142 requires that an intangible asset
that is acquired shall be initially recognized and measured based on
its fair value. The statement also provides that goodwill should not
be amortized, but shall be tested for impairment annually, or more
frequently if circumstances indicate potential impairment, through a
comparison of fair value to its carrying amount. At December 31, 2001,
we had unamortized goodwill in the amount of $8.6, which is subject to
the transition provisions of SFAS No. 142. We do not believe the
transitional impairment provisions of this statement will have any
impact on our financial statements
20
Overview
We are a leading seller of spoken audio and nostalgia products, including
audiobooks and old-time radio shows, through direct response, retail and
Internet channels. Our content and products are sold in multiple formats,
including physical (cassette and compact disc) and secure digital download
formats.
We report financial results on the basis of four business segments;
Corporate, Audio Book Club ("ABC"), Radio Spirits ("Radio Spirits" or "RSI") and
MediaBay.com. A fifth division, Radio Classics, is aggregated with Radio Spirits
for financial reporting purposes. Except for corporate, each segment serves a
unique market segment within the spoken word audio industry. In 2001, our Audio
Book Club segment had net sales of approximately $31.8 million, our Radio
Spirits segment had net sales of approximately $10.0, our MediaBay.com segment
had sales of approximately $0.25 million and we had inter-segment sales of $0.26
million.
Our content library consists of more than 50,000 hours of spoken audio
content including audiobooks, old-time radio shows and other unique spoken word
content. The majority of our content is acquired under license from the rights
holders enabling us to manufacture the product giving us significantly better
product margins than other companies.
Our customer base includes over 2.6 million spoken audio buyers who have
purchased via catalogs and direct mail marketing. We also currently have an
additional 2.2 million e-mail addresses of spoken audio buyers and enthusiasts
online. Our old-time radio products are sold in over 7,000 retail locations,
including Costco, Target, Sam's Club, Barnes & Noble, Borders, Cracker Barrel
Old Country Stores and Amazon.com.
Our web sites receive more than 2 million unique monthly web site visitors
and are among the most heavily trafficked bookselling web sites on the Internet.
We serve more than 400,000 classic radio and nostalgia video streams of our
content on a monthly basis to web site visitors at RadioSpirits.com and
MediaBay.com.
Our marketing programs have consisted primarily of direct mail, media
advertising and marketing on the Internet. We capitalize direct response
marketing costs for the acquisition of new members in accordance with AICPA
Statement of Position 93-7 "Reporting on Advertising Costs" and amortize these
costs over the period of future benefit, based on our historical experience.
Results of Operations
The following table sets forth, for the periods indicated, historical
operating data as a percentage of net sales.
Year Ended
December 31,
1999 2000 2001
---- ---- ----
Net sales............................................. 100% 100% 100%
==== ==== ====
Cost of sales......................................... 51 52 47
Cost of sales - write-downs........................... -- -- 5
Advertising and promotion............................. 18 25 29
Advertising and promotion - write-downs............... -- -- 10
General and administrative expense.................... 21 31 28
Asset write-downs and strategic charges............... -- -- 17
Depreciation and amortization expense................. 15 18 12
Non-cash write-down of goodwill....................... -- 86 --
Interest income (expense), net........................ (10) (6) (5)
Income tax benefit.................................... -- -- 41
Extraordinary loss on early extinguishment of debt.... -- (5) --
Net loss.............................................. (15) (123) (12)
21
Year ended December 31, 2001 compared with year ended December 31, 2000
Gross sales decreased $5.0 million, or 8.3%, to $54.9 million for the year
ended December 31, 2001 from $59.9 million for the year ended December 31, 2000.
The decrease in gross sales is primarily attributable to more focused marketing
at Audio Book Club to concentrate on more profitable new members and
non-recurring I-Jam marketing revenue we recorded in 2000. In addition, in the
beginning of 2001, we revised the logic used in determining customer product
shipments, which resulted in lower gross sales but also lower return rates.
Returns, discounts and allowances declined $2.4 million, or 15.2%, to $13.1
million for the year ended December 31, 2001 from $15.5 million for the year
ended December 31, 2000. Returns, discounts and allowances as a percentage of
gross sales were 23.9% in 2001 as compared to 25.8% of gross sales for the prior
comparable period due to aforementioned revisions in the logic used in
determining customer shipments.
Principally as a result of lower gross sales, partially offset by lower
return rates, net sales for the year ended December 31, 2001 decreased $2.6
million, or 5.9%, to $41.8 million from $44.4 million.
Cost of sales for the year ended December 31, 2001 was $22.0 million, of
which $2.3 million represented a charge for the write-down of inventory in the
third quarter of 2001. Excluding the write-down, cost of sales for the year
ended December 31, 2001 decreased $3.3 million, or 14.2%, to $19.8 million for
the year ended December 31, 2001 from $23.0 million for the year ended December
31, 2000. The decrease in cost of sales as a percentage of net sales, is
principally due to revisions in the merchandising of our products, including
increases in our selling prices and selection of products, which contribute
greater gross profit. As a result, gross profit as a percentage of net sales,
excluding the write-down, increased to 52.7% for the year ended December 31,
2001 from 48.1% for the year ended December 31, 2000.
Advertising and promotion expenses for the year ended December 31, 2001 was
$15.9 million of which, $4.0 million represented write-downs to deferred member
acquisition costs as described below. Excluding the write-downs, advertising and
promotion expenses increased $0.9 million or 8.2%, to $11.9 million for the year
ended December 31, 2001 compared to $11.0 million for the year ended December
31, 2000. Actual amounts incurred for advertising and promotion, net of
settlements with certain vendors principally for unprofitable Internet marketing
campaigns, for the year ended December 31, 2001 were $8.2 million, a decrease of
$6.1 million, from the amount incurred in the year ended December 31, 2000 of
$14.3 million. The difference between the amount expended and the amount
recorded as expense is due to amortization of previously capitalized direct
response advertising costs.
General and administrative expenses decreased $2.5 million, or 17.8%, to
$11.5 million for the year ended December 31, 2001 from $14.0 million for the
prior comparable period. General and administrative expense decreases are
principally attributable to decreases in bad debt expenses commensurate with the
reduction in net sales, payroll and related costs due to previously announced
staff reductions, office expenses, telephone costs related to a reduction in
"800" service calls, travel costs, public relations costs and consulting
services principally relating to Internet maintenance and development. We also
benefited from settlements with certain vendors in 2001.
As a result of the actions and decisions made after our aforementioned
review of our operations, we recorded $11.3 million of strategic charges in
2001. These charges include the following:
o $2.2 million of inventory written down to net realizable value due to
a reduction in the number of stock keeping units (SKU's);
o $2.4 million of write-downs to deferred member acquisition costs at
Audio Book Club related to new member acquisition campaigns that have
been determined to be no longer profitable and recoverable through
future operations based upon historical performance and future
projections;
o $1.9 million of write-downs to royalty advances paid to audiobook
publishers and other license holders primarily associated with
inventory titles that will no longer be carried and sold to members;
22
o $1.6 million of write-downs to deferred member acquisition costs at
Radio Spirits related to old-time radio new customer acquisition
campaigns that have been determined to be no longer profitable and
recoverable through future operations based upon historical
performance and future projections;
o a write-down of $0.7 million of customer lists acquired in the
Columbia House Audiobook Club purchase due to the inability to recover
this asset through future operations;
o $0.6 million of fixed assets of the old-time radio operations written
down to net realizable value due to the closing of the Schaumburg,
Illinois facility;
o $0.5 million of write-downs of royalty advances paid for downloadable
licensing rights that are no longer recoverable due to the strategic
decisions made;
o $0.4 million of write-downs of prepaid assets,
o $0.3 million of write-offs to receivables that are deemed
uncollectible,
o $0.2 million of net write-offs of capitalized website development
costs related to downloadable audio all of which are no longer
recoverable due to the strategic changes in the business; and
o $0.5 million accrued for lease termination costs in connection with
the closing of the Schaumburg, Illinois facility.
Of these charges, $2.3 million related to inventory write-downs has been
recorded to costs of sales - strategic charges, $4.0 million has been recorded
to advertising and promotion - write-downs and the remaining $5.0 million has
been recorded to asset write-downs and strategic charges.
In addition to these strategic charges, we have recorded a charge of $2.0
million to write-off the entire carrying amount of our cost method investment in
I-Jam. This charge has been recorded to asset write-downs and strategic charges.
We have determined that an other than temporary decline in the value of this
investment has occurred, triggered by a strategic change in the direction of the
investee as a result of continued losses and operating deficiencies, along with
projected future losses.
Depreciation and amortization expenses decreased $2.8 million to $5.2
million for the year ended December 31, 2001 from $8.0 million for the year
ended December 31, 2000. The decrease is principally attributable to the
write-down of goodwill taken in the fourth quarter of 2000.During the fourth
quarter of 2000, we reviewed long-lived assets and certain related identifiable
intangibles, including goodwill, for impairment in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("FASB 121") due
to a change in facts and circumstances. In the fourth quarter of 2000, we made a
strategic decision to reduce spending on marketing to customers acquired in the
acquisitions of the Columbia House Audiobook Club, Doubleday Direct's Audiobooks
Direct and Adventures in Cassettes in order to focus its resources on more
profitable revenue sources. In addition, we sold the remaining inventory
acquired in its acquisition of Adventures in Cassettes and do not expect to
derive any future revenues associated with this business. Consequently, we
determined that the revised estimates of cash flows from such operations would
no longer be sufficient to recover the carrying value of goodwill associated
with these businesses. As a result, in the fourth quarter of 2000, we determined
that the goodwill associated with these businesses was impaired and recorded an
impairment charge of $38.2 million. The impairment charge was measured as the
difference between the carrying value of the goodwill and its fair value, which
was based upon discounted cash flows.
Net interest expense for the year ended December 31, 2001 decreased $0.5
million to $2.2 million as compared to net interest expense of $2.7 million for
the year ended December 31, 2000. The reduction in interest expense is due to a
lower average outstanding principal balance on our debt, as well as lower
interest rates on the portion of our debt, which has adjustable interest rates.
Net loss before income tax benefit for the year ended December 31, 2001 was
$22.1 million as compared to a net loss before income taxes and an extraordinary
item in 2000 of $52.5 million for the year ended December 31, 2000.
23
As a result of the series of strategic initiatives described above, our
operations have improved. Although realization of net deferred tax assets is not
assured, we have determined, based on our improved operations, that it is more
likely than not that a portion of our deferred tax asset relating to temporary
differences between the tax bases of assets or liabilities and their reported
amounts in the financial statements will be realized in future periods.
Accordingly we reduced the valuation allowance for deferred tax assets in the
amount of $17.2 million and recorded an income tax benefit.
In April 2000, we repaid $20.3 million of our bank debt out of the net
proceeds from our follow-on primary offering. Accordingly, the Company recorded
an extraordinary loss of $2.2 million relating to the write-off of deferred
financing fees incurred in connection with such debt.
Due, in part, to the reduction in the valuation allowance for deferred tax
assets offset by the strategic charges enumerated above, we had a net loss of
$4.9 million, or $0.35 per share of common stock for the year ended December 31,
2001, as compared to a net loss of $54.6 million or $4.30 per share of common
stock for the year ended December 31, 2000.
Year ended December 31, 2000 compared with year ended December 31, 1999
Gross sales decreased $2.9 million, or 4.7%, to $59.9 million for the year
ended December 31, 2000 from $62.8 million for the year ended December 31, 1999.
The decrease in gross sales was primarily attributable to a slowdown in the
aggressive marketing at both Audio Book Club and Radio Spirits. In addition, we
revised the logic used in determining customer product shipments, which resulted
in lower gross sales but also lower return rates. We also instituted a policy of
offering higher discounts, which resulted in lower dollar sales. This policy was
subsequently eliminated. Returns, discounts and allowances declined $1.1
million, or 6.8%, to $15.5 million for the year ended December 31, 2000 from
$16.6 million for the year ended December 31, 1999. Returns, discounts and
allowances as a percentage of gross sales were 25.8% in 2000 as compared to
26.4% of gross sales for the prior comparable period. The decrease in returns is
due to aforementioned revisions in the logic used in determining customer
shipments, as well as lower gross sales.
Principally as a result of lower gross sales, partially offset by lower
return rates, net sales for the year ended December 31, 2000 decreased $1.8
million, or 3.9%, to $44.4 million from $46.2 million.
Cost of sales decreased $0.6 million, or 2.7%, to $23.0 million for the
year ended December 31, 2000 from $23.7 million for the year ended December 31,
1999. Gross profit decreased $1.2 million, or 5.1%, to $21.4 million for the
year ended December 31, 2000 from $22.5 million for the year ended December 31,
1999. Gross profit as a percentage of net sales was 48.1% as compared to 48.8%
in the prior comparable period. In 2000, we offered an "everyday low pricing"
discount structure to Audio Book Club members via both the catalog and at
Audiobookclub.com. Beginning in January 2001, we eliminated this discount
structure.
Advertising and promotion expenses increased $2.9 million or 35.8%, to
$11.0 million for the year ended December 31, 2000 compared to $8.1 million for
the year ended December 31, 1999. Actual amounts expended for advertising and
promotion in the year ended December 31, 2000 were $14.3 million, a decrease of
$3.1 million from the amount expended in the year ended December 31, 1999 of
$17.4 million. The difference between the amount expended and the amount
recorded as expense is due to the capitalization of direct response advertising.
Beginning in January 1999, the Company was required to capitalize direct
response marketing costs for the acquisition of new members in accordance with
AICPA Statement of Position 93-7 "Reporting on Advertising Costs" and amortize
these costs over the period of future benefit. Since 1999 was the first year we
capitalized new member acquisitions costs, we capitalized a very large portion
of direct response advertising expenditures.
24
General and administrative expenses increased $4.2 million, or 42.5%, to
$14.0 million for the year ended December 31, 2000 from $9.8 million for the
prior comparable period. General and administrative expense increases are
principally attributable to increased personnel and related costs including
costs of bringing RSI fulfillment in-house, investor and public relation
expenses and consulting expenses, including outside Internet development and
maintenance expenses.
Depreciation and amortization expenses increased $1.2 million to $8.0
million for the year ended December 31, 2000 from $6.8 million for the year
ended December 31, 1999. The increase is principally due to amortization of
goodwill and other intangible assets in connection with our acquisition of
Doubleday Direct's Audiobooks Direct.
Net interest expense for the year ended December 31, 2000 decreased $1.8
million to $2.7 million as compared to net interest expense of $4.5 million for
the year ended December 31,1999. The Company has reduced its debt by $24.8
million since December 31, 1999.
Loss before extraordinary item for the year ended December 31, 2000 was
$52.5 million or $4.13 per share as compared to a net loss of $6.7 million or
$.82 per share for the year ended December 31, 1999.
In April 2000, we repaid $20.3 million of our bank debt out of the net
proceeds from our follow-on primary offering. Accordingly, the Company recorded
an extraordinary loss of $2.2 million relating to the write-off of deferred
financing fees incurred in connection with such debt.
Primarily due to the write-off of goodwill of $38.2 million, net loss for
the year ended December 31, 2000 was $54.6 million or $4.30 per share of common
stock as compared to a net loss of $6.7 million or $.82 per share of common
stock for the year ended December 31, 1999.
Liquidity and Capital Resources
Historically, we have funded our cash requirements through sales of our
equity and debt securities and borrowings from financial institutions and our
principal shareholders. We have implemented a series of initiatives to increase
cash flow. While these initiatives have successfully reduced cash used in
operations in 2001, there can be no assurance that we will not require
additional financing to repay debt, fund the expansion of operations,
acquisitions, working capital or other related uses. The asset write-downs and
strategic charges taken in 2001 are not expected to impact future cash flows
except for $0.5 million of accrued lease termination costs in connection with
the closing of the Schaumburg, Illinois facility, assuming the facility is not
sub-leased.
We are required under our the loan agreement for our bank debt to make
payments on our debt, in 2002, as follows:
o A payment of $300,000 was made in March 2002.
o Payments of $200,000 are due May 31 and June 30,2002.
o Monthly payments of $150,000 are due at the end of each month
beginning in July 2002 and ending December 31, 2002.
We anticipate making the payments from cash flow generated from operations.
We also have notes to Huntingdon Corporation ("Huntingdon"), a company
wholly owned by our Chairman, Norton Herrick of $2.5 million and $800,000. These
notes mature on January 15, 2003 and April 15, 2003, respectively.
For the year ended December 31, 2001, our cash decreased by $0.4 million,
as we used net cash of $2.1 million and $0.3 million for operating and investing
activities, respectively, and had cash provided by financing activities of $1.9
million. Net cash used in operations principally consisted of the net loss of
$4.9 million, including a $17.2 million reduction in the valuation allowance for
deferred tax assets, an increase in prepaid expenses of $0.6 and a decrease in
accounts payable and accrued expenses of $3.4 million. Net cash used in
operations was partially offset by asset write-downs and strategic charges of
$13.3 million, depreciation and amortization expenses included in net loss of
$5.2 million, a decrease in accounts receivable of $0.3 million, a decrease in
inventories of $0.3 million, a decrease in royalty advances of $0.6 million and
a net decrease in deferred member acquisition costs of $3.7 million.
25
The increase in prepaid expenses is principally the result of advertising
costs incurred in December 2001 for an Audio Book Club direct mail campaign,
which mailed in January 2002. The decrease in accounts payable is principally
due to payments made to vendors as our cash flow improved and settlement
agreements we entered into with certain vendors. The decrease in accounts
receivable was primarily attributable to lower net sales and to the collection
of retail receivables, net of returns, at our old-time radio business. The
decrease in inventories is principally due to a reduction in the number of
titles offered for sale. The decrease in deferred member acquisition cost is
principally due to settlements with direct response vendors, principally on the
Internet, and reductions in the size of our direct response advertising
campaigns resulting in better response rates.
Cash used in investing activities was for the acquisition of fixed assets;
principally for kiosks to be placed at certain retail stores and computer
equipment, and the acquisition of certain rights relating to our video products.
On May 14, 2001, we issued a $2.5 million secured senior convertible note
to Huntingdon Corporation ("Huntingdon"), a company wholly owned by our
chairman, Norton Herrick. In addition, we issued a $0.8 million secured senior
subordinated convertible note to Huntingdon for advances previously received
including an advance of $0.3 million received in February 2001. For a further
description of these transactions, see Note 7 of the Notes to Consolidated
Financial Statements presented elsewhere in this Form 10-K.
On May 14, 2001, we modified a $2.0 million senior subordinated convertible
note held by Norton Herrick. We also modified a $3.0 million senior subordinated
convertible note held by Evan Herrick, Norton Herrick's son. For a further
description of these transactions, see Note 7 of the Notes to Consolidated
Financial Statements presented elsewhere in this Form 10-K.
In September 2001 and December 2001, in accordance with our revised loan
agreement, we made principal payments on our revolving credit facility of $0.1
million and $0.3 million, respectively. At December 31, 2001, the amount we may
borrow under the revolving loan agreement was $6.2 million, the amount
outstanding under the revolving loan agreement. In March 2002, we made an
additional $0.3 million loan payment, as of March 25, 2002 the amount we may
borrow under the revolving loan agreement was $5.9 million, which was the amount
outstanding under the revolving loan agreement.
On January 18, 2002, Evan Herrick, a principal shareholder of the
Registrant, exchanged $2.5 million principal amount of a $3.0 million principal
amount convertible note of MediaBay, Inc. in exchange for 25,000 shares of
Series A Preferred Stock of MediaBay, having a liquidation preference of $2.5
million. The preferred share dividend rate of 9% ($9.00 per share) is the same
as the interest rate of the note, and is payable in additional preferred shares,
shares of common stock of MediaBay or cash, at the holder's option, provided
that if the holder elects to receive payment in cash, the payment will accrue
until MediaBay is permitted to make the payment under its existing credit
facility.
On February 22, 2002, Huntingdon purchased a $0.5 million principal amount
convertible senior promissory note due June 30, 2003. The note is convertible
into shares of Common Stock at the rate of $0.56 of principal and/or interest
per share. This note was issued in consideration of a $0.5 million loan made to
the Company by Huntingdon.
On April 1, 2002, Huntingdon extended the maturity date of (1) the $2.5
million secured senior convertible note to January 15, 2003 and (ii) the $0.8
million secured senior subordinated convertible note to April 15, 2003 for no
additonal consideration.
As partial consideration for the loan and pursuant to an agreement dated
April 30, 2001, the Company granted to Huntingdon warrants to purchase 250,000
of Common Stock at an exercise price of $0.56 per share. The warrants are
exercisable until May 14, 2011.
26
Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires that all business combinations be accounted for
under the purchase method. The statement further requires separate recognition
of intangible assets that meet one of two criteria. The statement applies to all
business combinations initiated after June 30, 2001.
SFAS No. 142 requires that an intangible asset that is acquired shall be
initially recognized and measured based on its fair value. The statement also
provides that goodwill should not be amortized, but shall be tested for
impairment annually, or more frequently if circumstances indicate potential
impairment, through a comparison of fair value to its carrying amount. Existing
goodwill continued to be amortized through the remainder of fi