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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2000
Commission File Number: 0-29583
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LOUDEYE TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 91-1908833
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
Times Square Building 414 Olive Way, Suite 500, Seattle, WA 98101
(Address of principal executive offices) (Zip Code)
206-832-4000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 Par Value Per Share
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of 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. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $30,326,000 as of February 23, 2001, based upon
the closing sale price on the Nasdaq National Market reported for such date.
Shares of Common Stock held by each officer and director and by each person
who owns 5% or more of the outstanding Common Stock have been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common 37,048,685
(Class) (Outstanding at February 23, 2001)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement relating to the registrant's
2001 Annual Meeting of Shareholders to be held on May 17, 2001 are
incorporated by reference into Part III of this Report.
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LOUDEYE TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
Page
Number
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PART I
ITEM 1 BUSINESS..................................................... 1
ITEM 2 PROPERTIES................................................... 14
ITEM 3 LEGAL PROCEEDINGS............................................ 14
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 14
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS..................................................... 15
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA......................... 16
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS AND RISK FACTORS.................. 17
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK... 35
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................. 36
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................... 57
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........... 57
ITEM 11 EXECUTIVE COMPENSATION....................................... 57
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................. 57
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............... 57
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.................................................... 58
EXHIBIT INDEX......................................................... 58-60
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PART I
ITEM I BUSINESS
Forward Looking Statements
Except for the historical information contained in this Annual Report on
Form 10-K, the matters discussed herein, including management's discussion and
analysis of financial condition and results of operations in Item 7 of Part II
hereof, are "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, including, without limitation, statements
regarding regulatory approvals, operating results and capital requirements,
that are subject to certain risks and uncertainties that could cause the
actual results to differ materially from those projected. In some cases, you
can identify forward-looking statements by terminology such as may, will,
should, expect, plan, anticipate, believe, estimate, predict, potential or
continue, the negative of terms like these or other comparable terminology.
These statements are only predictions. Actual events or results may differ
materially. Factors that could cause actual results to differ materially
include, but are not limited to, uncertainties related to the early stage of
the Company and its research and development programs; uncertainties related
to the effectiveness of the Company's technology and the development of its
products and services; dependence on and management of existing and future
corporate relationships; dependence on licensed content and technology;
dependence on proprietary technology and uncertainty of patent protection;
management of growth; history of operating losses; future capital needs and
uncertainty of additional funding; dependence on key personnel; intense
competition; existing government regulations and changes in, or the failure to
comply with, government regulations, and other risks detailed below, including
those in Item 7 of Part II "Risk Factors," the Risk Factors set forth in our
registration statement on Form S-1 as amended for the initial public offering
of our common stock as filed with the Securities and Exchange Commission and
declared effective on March 15, 2000 and those included from time to time in
the Company's other reports with the Securities Exchange Commission and press
releases, copies of which are available from the Company upon request. All
forward-looking statements included in this document are based on information
available to us on the date hereof, and the Company assumes no obligation to
update any forward-looking statements contained herein. We caution investors
that our business and financial performance are subject to substantial risks
and uncertainties.
Overview
We are a leading provider of digital media infrastructure services and
applications that create a complete solution for the media, entertainment and
corporate markets. Our digital media services and applications encompass an
end-to-end solution for customers that includes:
. media preservation and restoration, through our VidiPax subsidiary;
. media and metadata capture and digital archive management;
. encoding, or the transformation of audio and video content into
streaming media or digital download formats;
. distribution through a variety of methods including encoded file
delivery, hosted subscription services and syndication; and
. consulting services.
Our solutions simplify and accelerate the process of delivering audio and
video content on the Internet and other digital distribution platforms. Our
proprietary systems and technology enable scalable and cost effective
archival, retrieval and processing of large inventories of digital media. Our
services and applications are built upon a robust production and delivery
infrastructure. The benefits of our services and applications include:
. an end-to-end solution to reduce complexity for customers and cost-
effectively enable a wide range of digital media strategies;
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. significant capacity to process and manage large volume projects in a
rapid time frame;
. a highly flexible and extensible platform to enable tailored customer
solutions; and
. strategic relationships with selected major media companies and content
owners.
In 2000, we delivered over 7.4 million encoded audio files and 680,000
encoded video minutes to customers. We served over 220 customers in 2000
including AtomFilms (acquired by shockwave.com), Audible, Inc., CinemaNow, The
Coca-Cola Company, Digital Club Network, Disney Enterprises, Inc., EMusic.com
Inc., Ford Motor Company, IFILM, Kanakaris Communications, Inc.,
LicenseMusic.com, Inc., Microsoft Corporation, musicbank, Next Audio Inc.,
Universal Music Group, Valley Media Inc., and XM Satellite Radio, Inc.
Our objective is to be the leading digital media infrastructure provider of
comprehensive digital media solutions. We seek to achieve this objective
through the following key strategies:
. developing and marketing an end-to-end suite of products and services;
. leveraging existing management, production and delivery systems to
support new products and services;
. establishing relationships and obtaining content license agreements from
content owners;
. expanding into selected international markets; and
. selectively pursuing strategic acquisitions to strengthen our market
position, expand our proprietary technology and accelerate our product
strategy.
During 2000 the demand for digital music grew rapidly, and we believe it
will continue to grow. To address the opportunity in the digital music
segment, we intend to focus our efforts on developing and marketing an end-to-
end suite of digital music services and applications that leverage our
advanced digital media infrastructure systems and software applications. This
will enable media and music companies to deliver legitimate digital music
offerings to this growing audience. To support these initiatives, we intend to
continue executing our strategy to develop relationships with copyright owners
in the music industry, including major music companies, independent record
labels, artists and publishers, to enable them, and their authorized
licensees, to distribute digital music to their audiences on a legitimate
basis. To this end, in 2000 we announced content licensing agreements with
Universal Music Group, Warner Music Group and BMG Entertainment.
Loudeye Technologies, Inc. was founded as a Washington limited liability
company in 1997 and was incorporated in Delaware in 1998. Our headquarters are
in Seattle, Washington, and we have facilities in New York, New York, London,
England, and Santa Monica, California.
Industry Background
Traditional Media
The management of large inventories of audio and video content and the
ability to leverage distribution channels are constant challenges to companies
in a wide variety of global industries, including music and video
entertainment, corporate communications and advertising. With the millions of
hours of existing audio and video content and the thousands of hours of new
audio and video content created each day, media owners have become more
aggressive in exploring new ways to reach audiences and distribute their
content.
The technologies and standards that form the basis of traditional media and
distribution, however, are not compatible with the infrastructure supporting
the Internet and other advanced digital distribution platforms. For example,
audio and video content from compact discs, tapes and film, cannot be played
to a global Internet audience without significant manipulation, processing and
new technology. In order to further expand their markets and leverage the
value of their content over new digital distribution platforms, while
protecting, tracking, controlling and administering intellectual property
rights around their content, content owners need to find new
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methods that transfer the consistent formats and delivery methods of
traditional media into the multi-faceted and changing technologies of the new
digital distribution methods.
The Emergence of Digital Media
We believe the continued development of digital media technologies and
improved access to broadband connections will increase the quality and
reliability of digital media delivery and increase the demand for audio and
video content on the Internet and other digital distribution platforms.
. Internet usage and access speeds are increasing. The potential audience
for digital media continues to grow. According to Nielsen/NetRatings, as
of December 2000, more than 158 million people in the United States had
access to the Internet. In addition, average Internet access speeds in
the home continue to increase. Nielsen/NetRatings estimates home users
in the United States with 56Kbps or greater Internet access speeds
reached approximately 69.6 million at the end of 2000, or 71% of the
total number of home users. This is a 95% increase over the
approximately 35.6 million home users in the United States that
Nielsen/NetRatings estimates had 56Kbps or greater access at the end of
1999. Nielsen/NetRatings estimates broadband Internet access in U.S.
homes increased in 2000 by 148%, to a total of approximately 11.7
million U.S. home users in 2000 compared to approximately 4.7 million in
1999.
. Digital media players have high levels of penetration on home PCs in the
United States. Technology that enables the consumption of digital media
using personal computers and other connected devices was widely adopted
by users in the United States in 2000. For example, Media Metrix
estimates that as of September 2000 media player applications are
installed on approximately 99 percent of home personal computers in the
United States, enabling the consumption of streaming and downloadable
digital audio and video content. In addition, media player technology is
being widely utilized by such users. According to Media Metrix, in
November 2000, approximately 47 percent of home computer users in the
United States used a media player, and approximately 40 percent used a
streaming media player.
. The online music industry is a large and growing market. The market for
online media is large and growing. For example, Jupiter Research
estimates the domestic online music market in 2000, which includes the
domestic sale of CDs online as well as digital distribution of music,
equaled approximately $800 million. Jupiter Research estimates that the
domestic online music market will increase to approximately $5.4 billion
in 2005, with sales of digitally distributed music, including the sale
of digital downloads and music subscriptions services, representing
approximately 28% of the market in 2005.
Challenges to the Growth of Digital Media
Before companies can deliver traditional media over the Internet and new
digital distribution platforms, they must overcome several limitations of the
current Internet infrastructure. Digital media distribution over the Internet
is a highly fragmented process with a variety of evolving and competing
digital media formats. For example, there are a wide and growing number of
download technologies such as AAC, AVI, QuickTime and MPEG 1--n that are used
to transfer and play files from personal computers. Digital content is also
delivered in streaming formats developed by Microsoft, RealNetworks, Apple and
others, that must support a number of speeds, or bit rates. In most cases,
these formats are incompatible with one another and technology developers are
dedicated to the preservation of their own proprietary format. In order to
maximize their addressable audience and take full advantage of the compelling
experience that digital distribution of media can provide, distributors of
audio and video content must be able to distribute their content in a manner
optimized for each of these variables and must be able to respond as the
underlying technologies evolve.
Companies must internally develop the ability to deliver, or hire outside
firms to migrate, their existing and newly created audio and video content
onto the Internet and other digital platforms. The core competencies required
to complete this migration process include the following areas:
. Media Preservation and Restoration. Industry sources estimate there are
millions of hours of archived video and audio content worldwide,
representing content categories such as entertainment, news, sporting
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events, corporate communications, historical archives, etc. Much of this
video and audio content resides in enormous, discrete library archives
that were originally recorded and archived in a wide variety of
traditional and sometimes obscure magnetic media formats, all of which
degrade over time. The content owner must eventually either restore the
content on newer media formats or risk it degrading completely and losing
it forever. Recently, some of these archive and content owners have
recognized the need to both restore their media assets and adapt them for
use under the new distribution channels and business models now available
on the Internet. The process of restoring the content in parallel with
managing and encoding the files for Web distribution is complex.
. Media and Metadata Capture. Capturing digital media involves the
conversion of content from traditional analog formats to digital formats
while maintaining the original quality. Once captured, the high quality,
uncompressed digital content can be archived or used to create
compressed, encoded files that are ready for digital distribution.
The process of managing digital media is made more complex due to a range
of processes necessary to support the creation of metadata files.
Metadata, or data and information about the original content, is
especially important as companies attempt to sell and distribute content
over the Internet. Metadata provides descriptive data to the consumer such
as, in the case of music titles, artist information, track level data,
title name, cover art and additional information that can be used to
consummate commerce transactions or establish marketing relationships
associated with the music, such as an online CD sale or an email marketing
campaign. In addition, metadata is critical in facilitating the
administration of tracking and reporting required in many licensing
arrangements with copyright holders.
. Encoding. To transmit digital media over the Internet and other advanced
digital distribution networks, the uncompressed digitized content needs
to be encoded into compressed, Internet-compatible digital formats.
Encoding large volumes of content in an efficient manner is a complex
process that requires highly scalable production technology. In
addition, it is at the encoding stage that metadata is at times merged
with the encoded file from a centralized database. This adds to the
complexity of the encoding process. Since the Internet is still at a
formative stage of development, the various encoding formats and
technologies continue to conflict and evolve. As a result, content
owners many times desire to create multiple copies of their digital
content in multiple formats, to support their distribution strategies.
Additionally, the encoding process for a particular item or entire
libraries may need to be repeated over time to keep pace with the
introduction of new formats and the changing preferences of online
users, adding to the complexity.
. Distribution. Scalable and reliable methods to deliver electronic media
must be integrated with data management and encoding systems to manage
the data flow process effectively.
It is often difficult and costly for content owners and media companies to
develop and manage all of these core competencies themselves. They often do
not have the internal resources or time to develop the expertise necessary to
address these problems without disrupting their core business activities.
Also, there are many providers of applications or narrowly defined services
and technologies that fail to meet all of the challenges associated with
capturing, managing and distributing digital media, leaving a previously
unfulfilled demand in the Internet media infrastructure market. As a result,
we believe that content owners and media companies are increasingly seeking a
comprehensive, technology-agnostic, outsourced solution for enabling
traditional audio and video content on the Internet.
Moreover, apart from technical challenges, companies who seek to distribute
digital media over the Internet are often faced with challenges in obtaining
copyright licenses from a variety of rights holders. For example, these
copyrights often address differing activities related to the delivery of
digital media, such as reproduction and performance, which may require
separate licensing arrangements. In addition, these copyrights may be held by
different parties, such as publishers, artists and record labels. The effort
to obtain the necessary rights by such third parties is often significant, and
frequently disrupts, delays or prevents the launch of a wide range of digital
media business models.
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The Loudeye Solution
Loudeye is a leading provider of digital media infrastructure services and
applications that create a broad solution for the media, entertainment and
corporate markets. Our solution helps our customers reduce the barriers
impeding the management and delivery of digital audio and video content. Our
solution is based on a proprietary architecture comprised of an advanced
digital archival and production system and robust delivery infrastructure that
can scale to meet the encoding and distribution demands of large-volume and
complex digital media content libraries. The primary elements of our solution
include Digital Media Services and Digital Media Applications. By providing
this broad range of products and services, we enable the production, management
and distribution of our customers' digital media content over the Internet and
other digital distribution platforms.
Our solutions offer customers the following key benefits:
. End-to-end solution reduces complexity for customers and enables a wide
range of digital media strategies. Our end-to-end solution addresses a
series of highly complex steps required to deploy a wide range of
digital media strategies. Our services and applications provide a
comprehensive solution ranging from the restoration, capture, storage,
encoding, and delivery of audio and video content through a single
outsourced solution provider. As a result, customers receive quality and
reliable service at less expense than an internal solution without the
need to purchase capital equipment, develop system expertise, train
personnel or manage evolving technology platforms.
. Significant capacity provides time to market advantages. Our proprietary
archival and production systems are scalable resulting in significant
capacity to manage and process high volumes of digital media. We have
developed proprietary products and services based upon an automated and
distributed architecture of encoding, conversion and media enhancement
systems so that we can process high volumes of digital media while
simultaneously monitoring and enhancing its quality. We have invested
significant resources to provide the physical and technical capability
to manage large scale encoding projects in the rapid time frame that our
customers require to deploy their strategies quickly and capitalize upon
rapidly changing market opportunities. We believe we are the leader in
this area, delivering over 7.4 million encoded audio files and 680,000
encoded video minutes of digital content to customers in 2000.
. High degree of flexibility enables tailored customer solutions. Because
owners and distributors of content require flexibility in the ability to
distribute media in a variety of competing streaming and digital
download formats, we maintain platform neutrality among the expanding
number of digital media technologies. We also support third party
digital rights management technologies and content indexing solutions
and have developed close relationships and expertise related to a wide
range of industry leading hosting providers. In addition, we can offer
consulting and integration services to develop tailored solutions for
unique or highly complex digital media implementations.
. Strategic relationships facilitate legitimate digital media
strategies. From our inception we have positioned our products and
services as the enabling infrastructure to support content owners in the
legitimate distribution of digital media over the Internet and new
digital distribution platforms. At times, obtaining the requisite
licenses can prove challenging to customers, as they must often obtain
copyright licenses from a variety of rights holders. For example, these
copyrights often address differing activities related to the delivery of
digital media, such as reproduction and performance, which may require
separate licensing arrangements. In addition, these copyrights may be
held by different parties, such as publishers, artists and record
labels. We have developed relationships and signed content licensing
agreements with three of the major music companies, Universal Music,
Warner Music Group, and BMG Entertainment and have developed working
relationships with other music companies.
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Company Strategy
Our objective is to be the leading digital media infrastructure provider of
comprehensive digital media solutions. We seek to achieve this objective
through the following key strategies:
Developing and marketing an end-to-end suite of products and services. We
intend to expand upon our strengths in digital media services and applications
by continuing to develop and market an end-to-end suite of managed and
subscription services. Given the rapidly changing requirements of this evolving
industry, there are advantages in building complete systems that are optimized
for large scale archive management, high quality and high volume output, and
robust serving and delivery of hosted digital content. We believe that as the
volume of content requiring these processes continues to increase, media
companies and content owners that currently manage, encode and host their media
in-house will see a significant economic advantage to outsourcing to us for a
full-suite of managed and subscription services. This strategy allows us to
become the single, outsourced solution for digital media infrastructure
solutions for our target customers. We have invested significantly in our
research and development efforts and to build our intellectual property focused
on these digital media solutions.
Leveraging existing management, production and delivery systems to support
new products and services. As an early leader in the high-end, outsourced
encoding market, we have been able to develop strong relationships with
influential customers and manage the first step in the migration of audio and
video content onto the Internet. We plan to leverage our core infrastructure
and expertise in high quality and high capacity digital media systems into
applications and subscription services that address a variety of end-to-end
solutions for those customers. An example of these applications and services
include our Loudeye(TM) Media Subscription Services for Music Samples, an end-
to-end hosted content offering for the online music market. We believe that by
building and managing an applications platform for digital media, we can deploy
solutions that address the complete cycle of capture, management and
distribution more efficiently and cost effectively than our customers or
competitors.
Establishing relationships and obtaining content license agreements from
content owners. We have developed relationships and signed content licensing
agreements with three of the major music companies, Universal Music, Warner
Music Group and BMG Entertainment and have developed working relationships with
other music companies. We will continue to seek to obtain necessary content
licensing agreements to facilitate the delivery of other music from additional
music companies and publishers. In addition, we will seek to further develop
our relationships with all of the major music companies in order to support
their digital music strategy deployments and service their digital music
infrastructure requirements.
Expanding into selected international markets. We believe that we are well
positioned to leverage our current technology to provide digital media
solutions to major media and entertainment companies. We have relationships
with global media companies that have digital media initiatives in Europe. Our
European sales office is based in London and we plan to selectively expand into
additional international markets to capitalize upon the opportunity for
providing digital media solutions to international media and entertainment
companies.
Selectively pursuing strategic acquisitions to strengthen our market
position, expand our proprietary technology and accelerate our product
strategy. We will continue to selectively pursue strategic acquisitions to
strengthen our market position, expand our proprietary technology and
accelerate our product strategy. In addition, we continuously look for
components and technologies to augment our solutions through partnering with
industry leaders outside of our core area of expertise.
Products and Services
Our products and services are divided into two categories, Digital Media
Services and Digital Media Applications. These encompass an end-to-end solution
for customers that includes:
. media restoration, through our VidiPax subsidiary;
. media and metadata capture and digital archive management;
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. encoding, or the transformation of audio and video content into
streaming media or digital download formats;
. distribution through a variety of methods including encoded file
delivery, hosted subscription services and syndication; and
. consulting services.
Digital Media Services
Our digital media services provide a complete suite of services for customers
through project-specific and ongoing contracts. We support restoration,
capture, archival, management, encoding and delivery of audio and video content
and provide other value-added services for deployment of digital media
strategies. Typical digital media service projects can involve conversion of
tens of thousands of music titles or thousands of hours of video content into
encoded content of multiple formats and bit rates. Once content has been
encoded, we can provide watermarking, encryption and other digital rights
management technologies to our customers to protect and manage their content. A
file created from the source materials containing specified database and
attribute data relating to a particular piece of content can then be linked to
that content as part of the overall encoding process. We also provide project
analysis, as well as consulting, integration and custom application
development.
Our Digital Media Services include:
Media Preservation and Restoration. Our VidiPax subsidiary, based in New
York, is a leading independent provider of video and audio restoration,
preservation and migration services. VidiPax provides industry leading
technical expertise in the restoration of older or damaged archives of
traditional media. VidiPax's highly specialized media services are offered from
a comprehensive magnetic tape restoration facility, which features rare and
one-of-a-kind equipment to address a wide range of audio or video formats,
current or obsolete, that require restoration and repair. Some examples of
these media formats include 35mm and 16mm film, 2" quad high band and low band,
2" Helical, 1" Types A, B and C, Digital Betacam, Betacam SP,VHS / SVHS, 8mm /
Hi8, Betamax / SuperBeta, among many others. VidiPax's customers include
leading broadcast networks, production studios, Fortune 100 corporations, major
libraries, museums and universities. By offering media preservation and
restoration capabilities, we provide our customers with support for more
formats of source content and a significantly greater ability to prepare older
and poor quality and damaged originals prior to the capture and encoding
process.
Media Capture and Archive. We can capture our customers' content from
virtually all commercially available input formats. Customers deliver their
source content to us through a variety of means including satellite transfer,
source tapes, compact discs and electronic file transfer. The capture process
covers a broad spectrum of media formats and can be automated or managed as a
manual system depending on volume and complexity of the project. Also, to
significantly increase the speed of the capture process, additional capture
stations can be inserted into the production system architecture and
immediately begin capturing files. Once captured and digitized in uncompressed
format, content can be stored on our advanced digital media archive system for
later uses.
Metadata Collection and Analysis. We offer customers the ability to record
and utilize a wide array of metadata relating to the captured content, such as
artist, title, style, universal product code, album and track data and other
data that a particular customer may find useful for their particular content.
These metadata files enable customers to leverage their traditional content
over the Internet by allowing them to track and manage their digital media
content more efficiently. We perform custom metadata capture projects on a
selective basis for customers.
Encoding and Delivery Services. We have developed proprietary processes that
allow us to encode audio and video content across several streaming media and
download formats simultaneously, including support for multiple codecs from
third party developers such as Microsoft, RealNetworks, Apple, AT&T, and
others. This
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format flexibility enables customers to distribute their content to a wide
audience and support a variety of digital media strategies. Given that these
formats and platforms continue to evolve, the benefits of our multiple platform
approach remain applicable as new technologies emerge. We encode customer
content in a parallel, rather than serial, process allowing us to rapidly and
cost-effectively deliver encoded content to customers.
The production system is highly automated. Using proprietary management
software the system generates a queue that recognizes the location and order of
the files to be encoded. To encode a file, the software locates available
computing resources on the distributed computing network and requests that the
resource perform the encoding work. The software monitors the encoding
operation and reports results to the control database. The capture file and
metadata are automatically encoded into all of the streaming formats and bit
rates specified by the production system job management software and database.
If required, the encoded files can be automatically watermarked and indexed
during the encoding operation. The resulting encoded files are checked for
quality and then delivered to the customer as a collection of files or
automatically routed to our partner hosting services for direct delivery as a
hosted stream, over the Internet.
This encoding architecture creates an automated and highly scalable system.
As capacity demands grow, additional computing resources can be added with
little or no configuration effort, allowing us to rapidly respond to increased
encoding demands.
Third Party Technology Support and Rights Management. By integrating
technologies and third party solutions, we provide services to our customers
who want to secure their digital assets with certification and authentication
systems that help to prevent unauthorized copying and distribution of content
or piracy. We also provide customers with other types of rights management
solutions, including the ability to protect their digital content by utilizing
watermarking applications from third party vendors. Through this technology,
information can be embedded within digital audio or video without degrading the
quality, providing copyright and intellectual property protection.
Consulting Services. Our consulting services group helps customers create and
integrate digital media technologies and applications into key business
processes in order to increase the overall effectiveness, productivity and
profitability of the organization. Our consulting services group specializes in
enterprise-wide Internet application development for digital media initiatives.
The team has a broad range of cross-platform technical expertise specific to
the streaming media industry including Web development tools and systems,
database application programming interfaces, or APIs, and streaming server
formats and integration layers. Specific areas of expertise include: project
requirements and implementation analysis, system design and deployment, digital
media and information security, legacy system integration, database design and
development, hosting and storage management, and streaming server integration
and implementation.
Digital Media Applications
Our Loudeye(TM) Media Subscription Services platform allows content to be
packaged and converted into a variety of streaming media formats via our
encoding services and hosted in a central media repository. The hosted
applications are based upon an extensible, flexible platform, allowing us to
provide customers with a range of current and future subscriptions services.
Loudeye(TM) Media Subscription Services are deployed on an application
services provider, or ASP, basis whereby the software runs on equipment managed
and monitored by us. Our customers have flexibility and options to choose their
individual level of customization or integration.
Loudeye(TM) Media Subscription Services for Music Samples. Based upon Loudeye
Media Subscription Services platform, we will offer a complete hosted end-to-
end solution, delivering high quality music samples to customers in the online
music business. Our music samples are streaming files containing selected
portions or "samples" of a full music track. For all musical genres except
classical and jazz the music samples are generally 30 seconds in duration. For
classical and jazz music tracks the music samples are typically 60 seconds in
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duration. Music samples are used by customers for many purposes, including
increasing online music sales, user traffic and customer retention. Should the
announced acquisition of DiscoverMusic close as planned in the first quarter of
2001, we will integrate Loudeye Media Subscription Services with
DiscoverMusic's music sampling service.
In addition to hosting the music samples, our subscription solution includes
metadata associated with the music samples. For example, this may include front
cover art scans of the music title from which the song has been captured.
We are currently offering selected customers a free Beta Program for this
service, which includes a sample of 200 CD titles chosen from our catalog that
will, when complete, include more than 2 million songs from approximately
150,000 CDs available at commercial launch. The Beta Program was launched in
December 2000. The titles used in the Beta Program are from the major music
companies with which we have content licensing agreements. Formats supported in
the Beta Program include Microsoft Windows Media and RealAudio formats at
multiple bit rates. The Beta Program allows for internal testing of the service
in a non-commercial environment.
DiscoverMusic Acquisition. On January 31, 2000, we announced a definitive
agreement to acquire privately-held DiscoverMusic. DiscoverMusic, based in
Seattle, Washington, is the largest provider of song samples, and a leading
provider of music metadata and album cover art to online music retailers.
DiscoverMusic provides services to most of the major online music retailers,
such as Amazon.com, BMG Direct, barnesandnoble.com, CDnow and Tower Records,
under exclusive and generally long-term contracts. We believe that
DiscoverMusic's offerings, combined with our Media Subscription Services
platform, will accelerate our subscriptions services offering.
In 2000, DiscoverMusic served over 500 million song samples to over 80 online
music customers. DiscoverMusic hosts one of the world's largest databases of
song samples, including more than 2.5 million samples from approximately
190,000 CDs, and a recently announced video sampling service for movie trailers
in both Windows Media and RealAudio formats.
Upon completion of the acquisition of DiscoverMusic, we would discontinue our
Beta Program and seek to migrate customers for that Beta Program to the
DiscoverMusic samples offering.
Loudeye(TM) Media Syndicator. In September 2000 we released the commercial
version of Loudeye Media Syndicator, a platform independent, Java-based
application that enables businesses to create subscriptions, business rules,
encrypt and syndicate streaming media content over the Internet as part of our
end-to-end solution; customers can use our digital media services to capture,
manage and encode their digital content themselves, and then use the Loudeye
Media Syndicator application to securely distribute the content while managing
and enforcing rights and business rules related to the use of the content.
Loudeye Media Syndicator supports Microsoft WindowsMedia and RealNetworks
streaming audio and video formats. The application enables the content owner or
their authorized licensees to create business rules that govern how content is
priced and how it is used: by number of plays, time period, geographic location
or pay-per-view. The integrated, online catalog provides secure, reliable e-
commerce transactions in real time, and automated delivery and tracking of
streaming media content from the content owner's library to its customers, the
affiliates who have been approved to use the content in their site. Content is
encrypted and securely delivered to the affiliate at the time of purchase,
enabling protection of the content owner's content throughout the process. The
application manages reporting of sales and usage of the content at the
affiliates web site through a detailed reporting function.
We intend to extend the functionality of the Loudeye Media Syndicator
application into future versions of our Loudeye(TM) Media Subscription Services
platform, to enable customers of those services to have the control, tracking
and commerce functionality that Loudeye Media Syndicator provides.
9
Research and Development
We are focused on improving our digital media services and subscription
services through research and development. We believe that a strong emphasis on
automation and product development are essential to our strategy of continuing
to enhance and expand our capabilities.
Since inception, we have focused our efforts on building efficient, scalable
and quality-based capture, archival, management and encoding processes through
hardware and software integration and development. Software built to optimize
encoding, combined with our expertise learned through our automated encoding
process, has provided a platform upon which we build digital media products and
services.
Our team of developers, quality assurance engineers and program managers were
recruited from top Internet and streaming media companies. Our team has
significant experience in Java development, database development and Internet
software development. In addition, we have recruited senior management with
significant experience in the area of Internet development, streaming media and
networking.
Our core team of developers is focused in the following areas:
. digital media services, which focuses on automated capture, archive and
encoding;
. media management which focuses on building a core component layer for
streaming media online applications; and
. media subscription, distribution and syndication, which focuses on
building our subscription, distribution and business rules applications.
Most of our technology is developed internally. We also purchase and license
technology and intellectual property rights.
Our research and development expenses were $6.8 million, $1.2 million and
$204,000 in 2000, 1999, and 1998 respectively. As of February 1, 2001,
approximately 54 employees were engaged in ongoing engineering and production
development work for our services, solutions and applications.
Operations and Technology
Our production operation encompasses both an efficient, highly automated
process, optimized to produce high volumes of audio and video encoding as well
as a flexible process for complex requirements. The production personnel are
organized into functional teams which include project management, quality
control, logistics operations, data measurement, audio capture and encoding,
video capture and encoding, and production systems engineering support.
The production system is a combination of hardware and software, developed by
our research and development organization and consists of advanced digital
archive technology, proprietary file management systems, customized user
interfaces and a highly distributed encoding system. It is designed to automate
the time consuming, error prone steps inherent in a complex management and
encoding operation, and to scale for larger volume demands with minimal
configuration of additional capture and encoding machines.
Our Media Subscription Services offerings and other distribution offerings
are supported by our advanced and highly scalable infrastructure. We connect
our hosting facility and partner Internet service providers, or ISPs, in order
to provide customers with a high performance network connecting multiple
Internet backbones for Internet data transmission across over many geographic
locations, known as points of presence, or POPs. This system creates fewer
points of failure than a single network and can be monitored for network
bottlenecks or outages so the content can be re-routed and distributed to
additional resources. Customers using our subscription services receive the
benefit of redundant and high-quality Internet distribution without having to
manage or aggregate multiple relationships.
10
Sales and Marketing
Our sales and marketing group seeks to build long-term relationships with our
customers through a variety of methods including implementation of an
integrated marketing campaign that consists of direct and indirect sales and
marketing efforts, including reseller and co-marketing relationships, trade
show and conference participation, our Web site, and a monthly newsletter.
We maintain an active role in developing industry standards and initiatives
that help to mature and grow the streaming media industry. We are a founding
and active member of Secure Digital Music Initiative, or SDMI, which includes
the Recording Industry Association of America, or RIAA, and its members and is
working to create a specification for the secure digital delivery and sale of
music and help in the exposure and credibility that help to advance growth.
As of, February 1, 2001 we had 25 people in our sales and marketing
organization, substantially all of which were located in the United States. The
direct sales force primarily focuses its efforts on the large corporate
customers.
Customers
We serve customers in the media, entertainment and corporate markets. We
served over 220 customers in 2000 including AtomFilms (acquired by
shockwave.com), Audible, Inc., CinemaNow, The Coca-Cola Company, Digital Club
Network, Disney Enterprises, Inc., EMusic.com Inc., Ford Motor Company, IFILM,
Kanakaris Communications, Inc., LicenseMusic.com, Inc., Microsoft Corporation,
musicbank, NextAudio Inc., Universal Music Group, Valley Media Inc., and XM
Satellite Radio, Inc. In 2000, musicbank and Microsoft accounted for 21% and
10% of our revenues, respectively. In 1999, Kanakaris and Microsoft accounted
for 13% and 11% of our revenues, respectively.
Industry Alliances and Content Licensing Agreements
In 2000, we established and maintained a number of important relationships
that expand our end-to-end solution, provide licenses from major content owners
and strengthen our technology development.
We began executing on our music content licensing strategy by entering into
music content licenses with Universal Music Group, Warner Music Group and BMG
Entertainment enabling us to store, deliver or stream encoded music and related
contents to companies authorized to use the content. We also maintain alliance
agreements for digital media hosting and distribution with content delivery
networks including Akamai Technologies, Inc. and Digital Island.
Competition
We face competition from in-house encoding services by potential customers,
other vendors that directly address the outsourced encoding services market and
companies that directly address the digital media applications market. We
compete on the basis of service quality, ability to handle a wide range of
input and output formats, capacity of our production facilities, turnaround
time, and price and breadth of products and services offered, which include
encoding, hosting, consulting and applications.
In-House Competition. Our most significant competition has been from
potential customers who choose to invest in the resources and equipment to
digitally manage and encode their media themselves on an in-house basis. In-
house service is expected to remain a significant competitor to our services,
although we believe that as the volume of content requiring management and
optimized encoding continues to increase, companies that currently manage and
encode their media in-house will see a significant economic advantage to
outsourcing to a third-party expert for our services and applications.
11
Digital Media Services Competition. There are approximately ten identified
primary companies who are providing some level of outsourced digital media
services today. We also anticipate that as the market for outsourced digital
media services continues to develop, we could see competition from video post-
production houses and other traditional media services companies.
Digital Media Applications Competition. There are approximately ten
identified primary companies that are developing digital media applications
that will potentially compete with our applications and subscription services.
DiscoverMusic is a competitor in music samples, however on January 31, 2001 we
announced an agreement to acquire DiscoverMusic. In addition, as we continue to
develop media subscription applications, we may over time begin to compete with
some of our historical customers and partners who could also develop and market
business-to-business subscription offerings.
We may not compete successfully against current or future competitors, many
of which have substantially more capital, longer operating histories, greater
brand recognition, larger customer bases and significantly greater financial,
technical and marketing resources than we do. These competitors may also engage
in more extensive development of their technologies, adopt more aggressive
pricing policies and establish more comprehensive marketing and advertising
campaigns than we can. Our competitors may develop products and service
offerings that are more sophisticated than our own. For these or other reasons,
our competitors' products and services may achieve greater acceptance in the
marketplace than our own, limiting our ability to gain market share and
customer loyalty and to generate sufficient revenues to achieve a profitable
level of operations.
Proprietary Rights and Intellectual Property
We rely primarily on a combination of copyrights, trademarks, trade secret
laws and contractual obligations with employees and third parties to protect
our proprietary rights. We do not yet have any issued patents, but we have
filed six U.S. patent applications and four international patent applications
that claim priority to six previously filed provisional applications. Despite
our efforts to protect our proprietary rights, unauthorized parties may copy
aspects of our products and obtain and use information that we regard as
proprietary. In addition, other parties may breach confidentiality agreements
or other protective contracts we have entered into and we may not be able to
enforce our rights in the event of these breaches. Furthermore, we expect that
we will increase our international operations in the future and the laws of
many foreign countries do not protect our intellectual property rights to the
same extent as the laws of the United States.
The streaming media, digital media and software industry is characterized by
the existence of a large number of patents and frequent litigation based on
allegations of patent infringement and the violation of other intellectual
property rights. As discussed above, at times obtaining the requisite licenses
can be difficult for customers, as they must obtain copyright licenses from a
variety of rights holders to grant rights to distinct activities related to the
delivery of digital media, such as reproduction and performance, which require
separate licensing arrangements. In addition, these copyrights may be held by
different parties, such as publishers, artists and record labels. The music
industry in the United States also is generally regarded as extremely litigious
in nature compared to other industries. As a result, in the future we may be
engaged in litigation with others in the music industry, including those
entities with whom we have ongoing content license arrangements. Although we
attempt to avoid infringing known proprietary rights of third parties in our
product development efforts, we expect that we may be subject to legal
proceedings and claims for alleged infringement by us or our licensees of third
party proprietary rights, such as patents, trademarks or copyrights, by us or
our licensees from time to time in the ordinary course of business. Any claims
relating to the infringement of third party proprietary rights, even if not
meritorious, could result in costly litigation, divert management's attention
and resources or require us to enter into royalty or license agreements which
are not advantageous to us. In addition, parties making these claims may be
able to obtain an injunction, which could prevent us from providing our
products or services in the United States or abroad. Any of these results could
harm our business. We may increasingly be subject to infringement claims if the
number of products and competitors in our industry grow and the functionalities
of products overlap.
12
Governmental Regulation
We are not currently subject to direct regulation by any governmental agency
other than laws and regulations generally applicable to businesses, although
certain U.S. export controls and import controls of other countries, including
controls on the use of encryption technologies, may apply to our products. Few
existing laws or regulations specifically apply to the Internet. However, it is
likely that a number of laws and regulations may be adopted in the United
States and other countries with respect to the Internet. These laws may relate
to areas such as content issues (such as obscenity, indecency and defamation),
encryption concerns, including export contents, copyright and other
intellectual property rights, caching of content by server products, electronic
authentication or "digital signatures," personal privacy, advertising,
taxation, electronic commerce liability, email, network and information
security and the convergence of traditional communication services with
Internet communications, including the future availability of broadband
transmission capability. Other countries and political organizations are likely
to impose or favor more and different regulation than that which has been
proposed in the United States, thus furthering the complexity of regulation.
The adoption of such laws or regulations, and uncertainties associated with
their validity and enforcement, may affect our ability to provide our products
and services and increase the costs associated with our products and services,
and may affect the growth of the Internet. These laws or regulations may
therefore harm our business.
We do not know with certainty how existing laws governing issues such as
property ownership, copyright and other intellectual property issues, taxation,
illegal or obscene content, retransmission of media and personal privacy and
data protection apply to the Internet or to the distribution of music over the
Internet. The vast majority of such laws were adopted before the advent of the
Internet and related technologies and do not address the unique issues
associated with the Internet and related technologies. Most of the laws that
relate to the Internet have not yet been interpreted. Changes to or the
interpretation of these laws could:
. limit the growth of the Internet;
. create uncertainty in the marketplace that could reduce demand for our
products and services;
. increase our cost of doing business;
. expose us to significant liabilities associated with content distributed
or accessed through our products or services; or
. lead to increased product and applications development costs, or
otherwise harm our business.
Specifically with respect to one aspect of copyright law, on October 28,
1998, the Digital Millennium Copyright Act (or "DMCA") was enacted. The DMCA
includes statutory licenses for the performance of sound recordings and for the
making of recordings to facilitate transmissions. Under these statutory
licenses, depending on our future business activities, we and our customers may
be required to pay licensing fees for digital sound recordings we deliver or
our customers provide on their web site and through retransmissions of radio
broadcasts and/or other audio content. The DMCA does not specify the rate and
terms of such licenses, which will be determined either through voluntary
inter-industry negotiations or arbitration. Moreover, with respect to digital
publishing, sound recording and other music licenses not directly covered by
the DMCA, various parties interested in distribution of digital music plan to
engage in a proceeding before a tribunal of the United States Copyright Office
along with the Recording Industry Association of America during 2001 to
determine what, if any, licensee fees should be paid to various rights holders.
Depending on the rates and terms adopted for the statutory licenses, our
business could be harmed both by increasing our own cost of doing business, and
by increasing the cost of doing business for our customers.
Employees
As of February 1, 2001, we had a total of 229 permanent employees, of which
54 were in research and development, 38 were in engineering and information
technology support, 25 were in sales and marketing, 73 were in production, 13
were in professional services and 26 were in finance and administration. Our
success is
13
highly dependent on our ability to attract and retain qualified employees.
Competition for employees is intense in the technology and software industry.
To date, we believe we have been successful in our efforts to recruit qualified
employees, but there is no assurance that we will continue to be as successful
in the future. None of our employees are subject to a collective bargaining
agreement. We consider our relations with our employees to be good.
ITEM 2 PROPERTIES
We are headquartered in Seattle, Washington where we lease 46,755 square feet
under a lease that expires on May 31, 2005. In addition, we have two other
Seattle, Washington locations: a 6,000 square foot facility under a lease that
expires on September 1, 2003, and a 12,697 square foot space under a lease that
expires November 15, 2004. We lease an additional facility in New York, New
York of approximately 12,200 square feet under a lease that expires May 14,
2005. We lease a location in Santa Monica, California of approximately 4,632
square feet under a lease that expires January 1, 2005. We also have a 4,050
square foot facility in London, England under a lease that expires on December
21, 2003.
ITEM 3 LEGAL PROCEEDINGS
We are currently not subject to any material legal proceedings.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been traded on the Nasdaq National Market under the
symbol "LOUD" since our initial public offering in March 2000. There is
currently only a limited trading market for the shares of our common stock and
accordingly there is no assurance that any quantity of the common stock could
be sold at or near reported trading prices.
The following table sets forth for the periods indicated the high and low
closing prices for our common stock. These quotations represent prices between
dealers and do not include retail markups, markdowns or commissions and may
not necessarily represent actual transactions.
High Low
------- -------
Year Ended December 31, 2000:
First Quarter 2000 commencing on March 15, 2000............ $44.563 $31.875
Second Quarter 2000........................................ 32.563 12.938
Third Quarter 2000......................................... 19.125 6.813
Fourth Quarter 2000........................................ 6.688 1.188
We have not paid any cash dividends to date and do not intend to pay any
cash dividends in the foreseeable future.
As of February 21, 2001, there were approximately 476 holders of record of
our common stock. Most shares of our common stock are held by brokers and
other institutions on behalf of shareholders.
Recent Sales of Unregistered Securities
(a) Recent Sales of Unregistered Securities
On March 15, 2000, concurrent with the closing of our initial public
offering, we sold to Akamai Technologies, Inc., 336,022 shares of our
unregistered common stock at $14.88 per share, which generated cash
proceeds of $5.0 million.
Pursuant to the acquisition of VidiPax, Inc. on June 14, 2000, the
Company issued a total of 75,871 shares of Loudeye Common Stock to the sole
stockholder of VidiPax, Inc., James Lindner, and to two providers of
professional services to the sole stockholder.
In August 2000, as consideration for a business alliance, Loudeye issued
warrants to a corporation to purchase an aggregate of 75,000 common shares
in connection with a commercial agreement.
In October 2000, as consideration for a business alliance, Loudeye issued
warrants to a corporation to purchase an aggregate of 50,000 common shares
in connection with a commercial agreement.
Each of the above issuances were deemed to be exempt from registration
under the Securities Act in reliance upon Section 4(2) thereof as
transactions by an issuer not involving any public offering.
(b) Use of Proceeds from Sales of Registered Securities
The net proceeds of our initial public offering and the concurrent sale
of shares to Akamai Technologies, Inc., both of which closed on March 15,
2000 as well as the exercise of the underwriters' over-allotment option on
April 14, 2000, totaled $80.4 million. As of December 31, 2000, we have
used approximately $39.8 million of those proceeds for working capital and
general corporate purposes, including increased spending on sales and
marketing, customer support, research and development, expansion of our
operational and administrative infrastructure, and the purchase of capital
equipment and businesses. We expect to use the remaining proceeds of the
offering for similar purposes. In addition, we may use a portion of the net
proceeds to acquire or invest in complementary businesses, technologies,
product lines or products. Pending these uses, we intend to invest the net
proceeds in short-term, interest-bearing, investment grade securities with
original maturities of less than one year.
15
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our financial statements and the notes thereto included
elsewhere in this Form 10-K. The statement of operations data set forth below
for the period from August, 1997 (inception) to December 31, 2000 and the
selected balance sheet data as of December 31, 2000 have been derived from our
audited financial statements included elsewhere in this Form 10-K, which have
been audited by Arthur Andersen LLP, Independent Public Accountants. The
historical results are not necessarily indicative of results to be expected
for any future period. Amounts are presented in thousands except for shares
outstanding and per share amounts.
Year Ended December 31, Period from
--------------------------------- Aug. 12, 1997
2000 1999 1998 to Dec. 31, 1997
---------- ---------- --------- ----------------
Revenues .................. $ 11,537 $ 2,645 $ 286 $ 10
Cost of revenues .......... 12,388 2,870 504 17
---------- ---------- --------- --------
Gross margin .......... (851) (225) (218) (7)
Operating expenses
Research and development
........................ 6,784 1,248 204 12
Sales and marketing ..... 14,621 3,982 588 39
General and
administrative ......... 8,079 3,612 674 37
Amortization of
intangibles and other
long-term assets........ 7,693 302 -- --
Stock-based compensation
........................ 5,409 1,554 -- --
---------- ---------- --------- --------
Total operating
expenses ............. 42,586 10,698 1,466 88
Special charges (1) ....... 947 -- -- --
---------- ---------- --------- --------
Operating loss ............ (44,384) (10,923) (1,684) (95)
Other income (expense), net
.......................... 4,860 21 34 --
---------- ---------- --------- --------
Net loss .................. $ (39,524) $ (10,902) $ (1,650) $ (95)
Beneficial conversion
feature (2) .............. -- (14,121) -- --
---------- ---------- --------- --------
Net loss to common
shareholders ............. $ (39,524) $ (25,023) $ (1,650) $ (95)
========== ========== ========= ========
Basic and diluted net loss
per share................. $ (1.33) $ (4.62) $ (0.41) n/a
========== ========== ========= ========
Weighted average shares
outstanding used to
compute basic and diluted
net loss per share (3).... 29,773,886 5,410,507 4,039,444 n/a
========== ========== ========= ========
Basic and diluted pro forma
net loss per share........ $ (1.16) $ (1.50) $ (0.17) n/a
========== ========== ========= ========
Weighted average shares
outstanding used to
compute basic and diluted
pro forma net loss per
share (3)................. 34,103,551 16,659,800 9,585,049 n/a
========== ========== ========= ========
December 31,
-----------------------
2000 1999 1998
-------- ------- ------
Balance Sheet Data
Cash, cash equivalents and short-term investments...... $ 94,989 $49,803 $1,442
Working capital........................................ 90,018 44,032 759
Total assets........................................... 132,676 76,775 2,940
Long-term obligations, less current portion............ 7,324 1,963 900
Total stockholders' equity............................. 116,068 67,489 1,242
- --------
(1) See Note 4 of Notes to Consolidated Financial Statements.
(2) See Note 11 of Notes to Consolidated Financial Statements.
(3) See Note 5 of Notes to Consolidated Financial Statements for an
explanation of the determination of the number of weighted average shares
used to compute pro forma net loss per share amounts.
16
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We are a leading provider of Internet media infrastructure services and
applications for the media, entertainment and corporate markets that enable
our customers to use digital media content on the Internet and other digital
distribution platforms. We provide our customers with outsourced and end-to-
end solutions that include encoding services, management, publication and
distribution of rich media and hosting services. Substantially all of our
revenues to date have been generated by sales of digital media services.
Digital media services revenues consist primarily of encoding services to
convert audio and video content into Internet media formats, media
restoration, preservation and migration services, which are services provided
by our VidiPax subsidiary to restore and upgrade old or damaged archives of
traditional media, as well as other services related to the deployment of
media over the Internet. We charge our customers on either a time and
materials basis or a fixed fee basis that depends on a variety of factors,
such as volume and type of content provided and number and type of output
formats requested. We recognize digital media services revenues as the service
is provided and we have no further involvement. Standard payment terms with
customers require payment within 30 days of the invoice date. Our ongoing
digital media applications strategy consists primarily of the Loudeye(TM)
Media Subscription Services applications.
We have sustained losses on a quarterly and annual basis since inception and
we expect to sustain losses for the foreseeable future as we expand our
operations and production facilities. As of December 31, 2000, we had an
accumulated deficit of $66.2 million. Operating losses resulted from
significant costs incurred in the development and sale of our products and
services as well as significant non-cash charges related to stock-based
compensation and amortization of intangibles and other assets. We expect our
operating expenses to increase on an annual basis in all functional areas as
we execute our business plan.
Company-wide employment has grown to 229 permanent employees at February 1,
2001. We anticipate that operating expenses, as well as planned capital
expenditures, debt repayments and the DiscoverMusic acquisition, if completed,
will constitute a material use of our cash resources in 2001. We expect to
incur additional losses and continued negative cash flow from operations in
the future. We cannot assure you that we will achieve or sustain
profitability.
Our limited operating history makes the prediction of future operating
results difficult. In view of our limited operating history and the early and
rapidly evolving nature of our business, we believe that interim and annual
period-to-period comparisons of our operating results are not meaningful and
should not be relied upon as an indication of future performance. Our business
prospects must be considered in light of the risks and uncertainties often
encountered by early-stage companies in the Internet-related products and
services market. We may not be successful in addressing these risks and
uncertainties. We have experienced significant percentage growth in revenues
in recent periods; however, we do not believe that prior growth rates or
possibly even sequential quarterly growth are sustainable or indicative of
future growth rates (see "Forward-Looking Statements"). It is possible that in
some future quarter our operating results may fall below our expectations as
well as those of securities analysts and investors. In this event, the trading
price of our common stock may fall significantly.
Results of Operations
Year Ended December 31, 2000 compared to 1999
Revenues. Revenues totaled $11.5 million and $2.6 million for 2000 and 1999,
respectively. The increase was due primarily to significant large-scale orders
from our digital media audio customers, the benefit of our previously
announced acquisition of VidiPax, revenues related to our consulting services
group, the initial sales of our Loudeye Media Syndicator application, and
certain contractual revenues associated with forfeited deposits and
contractually guaranteed minimum revenues, and the recognition of deferred
revenue upon satisfaction of certain terms or the removal of our continuing
obligation under such contracts. We do not have any components
17
within operations that qualify as a separate segment, but have included
additional detail to provide insight into our operations and revenues.
We earned approximately $3.9 million in revenue from the performance of the
four largest audio digital media services projects in 2000, as compared with
approximately $400,000 for the four largest such projects in 1999. The
increase in large audio projects was primarily driven by trends driving the
demand for music online, the rapid expansion of companies and business models
focused on addressing that demand, as well as the build-out of our capacity in
late 1999 and early 2000 to be able to handle consumer volumes. We expect this
trend of significant revenue concentration among large audio customers to
continue in 2001, however the timing of any revenue realized will depend upon
issues surrounding the rights of our customers to use copyrighted music and
the ultimate survival of varied business models.
To a lesser degree, the increase was due also to video related revenues,
including those from VidiPax (which began to be included into our consolidated
results subsequent to the acquisition in June 2000). Video encoding projects
are expected to continue to trend down and the VidiPax revenues are expected
to increase modestly on a sequential basis in 2001.
In addition, our consulting services contributed to the increase in
revenues, substantially all of which occurred in the second and third quarters
of 2000. The decreasing consulting services revenue trend in late 2000 is
directly related to the slowing of the development of the market for digital
video media offerings of our customers. We expect that as more traditional
companies begin to utilize streaming media solutions, consulting revenues
could increase compared to the results in the fourth quarter of 2000. There
was no consulting revenue in 1999.
Digital media applications revenues included sales or licenses of our
Loudeye Media Syndicator application during 2000. We had no software
applications ready for sale in 1999, and accordingly had no revenues. Our
applications strategy for the future is geared toward the rapidly expanding
music industry and our Loudeye Media Subscription Services offerings.
Additionally, other application-related contractual revenues were recognized
in 2000 when contractual obligations and any uncertainties related to
performance were resolved. Such arrangements have revenue guarantees based
upon either our performance or the end of the particular contractual period.
We do not foresee recognizing significant amounts of such revenue in 2001.
Cost of Revenues. Cost of revenues increased to $12.4 million in 2000 from
$2.9 million in 1999. Cost of revenues includes the cost of production and
consulting, personnel and an allocated portion of facilities and equipment and
other supporting functions related to the delivery of digital media services
and applications. Stock-based compensation charges of $456,000 and $202,000
for the years ended December 31, 2000 and 1999, respectively are attributable
to employees included in cost of revenues and are presented in the separate
operating expense line item within the statements of operations. Cost of
revenues as a percent of revenues remained relatively constant from year to
year. This consistent margin was primarily due to the significant increase in
the amount of fixed expenses within cost of revenues. The increase in
depreciation and amortization expense was consistent with increased capital
expenditures, which totaled $15.8 million in 2000. The increase in
depreciation and amortization expense was significantly offset by the lower
costs associated with higher margin services, contracts and applications, as
well as increased efficiencies and utilization of employees and facilities. We
expect margins on traditional service offerings to remain fairly constant into
2001 and expect future margins to improve as product mix changes towards
Loudeye Media Subscription Services and offerings based upon our digital media
archive system.
Operating Expenses. Total operating expenses were $42.6 million and $10.7
million in the years ended December 31, 2000 and 1999, respectively. Without
the effect of $5.4 million of stock-based compensation charges and $7.7
million in amortization of intangible and other long-term assets, operating
expenses for the year ended December 31, 2000 would have been $29.5 million,
an increase of $20.7 million over the comparable amount in the same period in
1999.
Research and Development Expenses. Research and development expenses totaled
$6.8 million and $1.2 million in the years ended December 31, 2000 and 1999,
respectively. Research and development expenses
18
consist of salaries and consulting fees paid to support technology
development, costs of technology acquired from third parties to incorporate
into applications and other proprietary technology currently under
development. Costs of developing Loudeye Media Subscription Services, the
digital media archive and production system and Loudeye Media Syndicator for
sale or license to third parties and continued work on enhancing our
proprietary automated encoding processes comprised a significant portion of
research and development expenses. Stock-based compensation charges of
approximately $283,000 and $126,000 for the years ended December 31, 2000 and
1999, respectively, are attributable to employees categorized within research
and development and are presented in the separate operating expense line item
in the statements of operations.
To date we have capitalized approximately $1.3 million in software
development costs. Through December 31, 2000, $119,000 of these capitalized
amounts had been amortized into expense. All other research and development
costs have been expensed as incurred. We believe that continued investment in
research and development is critical to attaining our strategic objectives
and, as a result, expect research and development expenses to continue at
approximately the same or higher rate in the future compared to those incurred
in 2000.
Sales and Marketing Expenses. Sales and marketing expenses totaled $14.6
million and $4.0 million in the years ended December 31, 2000 and 1999,
respectively. Sales and marketing expenses consist primarily of salaries,
commissions, co-marketing expenses, trade show expenses, product branding
costs, advertising and cost of marketing collateral. The increase in sales and
marketing expenses was primarily due to an increase in the direct sales force
in 2000, commissions paid on the increased sales over the same period in 1999,
marketing related to the launch of our Loudeye Media Subscription Services and
Loudeye Media Syndicator application, expanded advertising and trade-show
related expenses as well as costs associated with negotiating rights
agreements with recording companies. Stock-based compensation charges of
approximately $749,000 and $333,000 for the years ended December 31, 2000 and
1999, respectively, are attributable to employees categorized within sales and
marketing and are presented in the separate operating expense line item in the
statements of operations.
General and Administrative Expenses. General and administrative expenses
totaled $8.1 million and $3.6 million in the years ended December 31, 2000 and
1999, respectively. General and administrative expenses consist primarily of
unallocated rent, facilities and information technology charges, salaries,
allowances for uncollectible accounts legal expenses for general corporate
purposes and investor relations costs associated with being a public company.
The increase was primarily due to new facilities opened during late 1999 and
the first quarter of 2000 and the significant increase in employees in the
finance, information technology, legal, investor relations and executive areas
required to support a larger organization, and increased public company
reporting obligations. We believe that as operations continue to increase in
size and scope, general and administrative expenses will continue to increase
although at a significantly lower percentage than in past periods. Stock-based
compensation charges totaling $3.9 million and $893,000 for the years ended
December 31, 2000 and 1999, respectively, are attributable to employees
categorized within general and administrative and are presented in the
separate operating expense line item in the statements of operations.
Amortization of Intangibles and Other Long-term Assets. Amortization of
intangibles and other long-term assets totaled $7.7 million and $302,000 in
the years ended December 31, 2000 and 1999, respectively, and includes
amortization of the goodwill and identified intangible assets related to past
acquisitions, amortization related to the fair value of warrants granted to
certain partners and the discount on the sale of common stock to Akamai
Technologies, Inc. in early 2000. The increase was primarily due to the timing
of the Alive.com acquisition in December 1999 and VidiPax in June 2000. We
expect that such charges will increase as the result of the pending
acquisition of DiscoverMusic in the first quarter of 2001.
Stock-Based Compensation. Stock-based compensation totaled $5.4 million and
$1.6 million in the years ended December 31, 2000 and 1999, respectively, and
consisted of $4.5 million in amortization of deferred stock compensation,
through December 31, 2000, related to stock options previously granted below
deemed fair market value, $1.3 million in compensation expense related to the
variable accounting treatment and the subsequent termination in the third
quarter of 2000 of our consultant options, a charge of $400,000 related to the
acceleration of options and $820,000 in credits related to the reversal of
previously amortized deferred stock compensation
19
due to option cancellations. In the fourth quarter of 2000, we accelerated the
vesting of approximately 660,000 options which resulted in a charge of
approximately $400,000 to stock-based compensation. There was $1.6 million in
stock-based compensation charges during the year ended December 31, 1999,
composed of $982,000 in amortization of deferred stock compensation and
$572,000 of compensation expense related to marking certain consultant options
to fair value.
Additionally, in the fourth quarter of 2000, we allowed employees to sell
back to the Company shares related to previously exercised unvested options at
the same price at which they were originally exercised. This opportunity was
made available to all employees. The 171,000 shares related to previously
exercised and unvested options were then retired without replacement of the
original option. We accounted for these transactions under APB 25 and FIN44 as
those pronouncements pertain to immature shares, and accordingly the amounts
paid were recognized as compensation expense although they were not
significant in total.
Special Charges. In January 2001, we announced a cost-savings initiative
which resulted in a $947,000 special charge being incurred in 2000, and an
anticipated similar charge of approximately $750,000 in the first quarter of
2001. Consistent with the overall market trends, we have experienced
decreasing demand for video services. Accordingly, in December 2000 our board
of directors approved a plan to close our Santa Monica, California facility
and reduce video production which resulted in an impairment in the value of
our video encoding equipment as well as existing tenant improvements at our
Santa Monica facility which was closed in the first quarter of 2001. This
combined non-cash impairment charge of $637,000 was included as a component of
operating loss in the special charge line item within the financial
statements. The fourth quarter of 2000 charge also included $300,000 related
to employee termination payments of which approximately $200,000 were paid in
the first quarter of 2001. The remaining amounts of the 2000 employee
termination costs will be paid in cash throughout 2001. As of December 31,
2000, approximately $300,000 was included within accrued expenses related to
the special charge.
Interest Income. Interest income, representing earnings on our cash, cash
equivalents and short-term investments, totaled $5.8 million and $204,000 in
the years ended December 31, 2000 and 1999, respectively. The increased income
was due primarily to interest earned on our significantly higher cash and
investment balances in 2000. We expect that our interest income will decrease
in the future as our cash balances decrease to fund our operating, investing
and financing activities.
Interest Expense and Other. Interest expense and other consists of interest
expense related to our debt instruments as well as amortization of financing
charges related to our debt instruments. This totaled $907,000 and $183,000 in
the years ended December 31, 2000 and 1999, respectively. The increase was due
primarily to interest on increased levels of borrowings incurred to finance
fixed asset expenditures.
Year Ended December 31, 1999 compared to 1998
Revenues. Revenues totaled $2.6 million and $286,000 for the years ended
December 31, 1999 and 1998, respectively. The increase was due primarily to an
increase in the number and average size of sales of our digital media services
generated by a larger sales force in the 1999 period and, to a lesser extent,
higher prices in the 1999 period.
Cost of Revenues. Cost of revenues totaled $2.9 million and $504,000 in 1999
and 1998, respectively. The increase was due primarily to increased sales
volumes. Cost of revenues includes cost of personnel expenses and the
allocated portion of facilities and equipment. Stock-based compensation
charges of $202,000 in 1999 are attributable to employees categorized within
production (cost of revenues) and are presented in a separate line item within
the statements of operations.
Operating Expenses. Operating expenses totaled $10.7 million and $1.5
million in 1999 and 1998, respectively. Without the effect of $1.6 million of
stock-based compensation charges and $302,000 in amortization of intangible
assets, operating expenses for the 1999 period would have been $8.8 million,
an increase of $7.3 million over 1998.
20
Research and Development Expenses. Research and development expenses totaled
$1.2 million and $204,000 in 1999 and 1998, respectively. The increase was due
primarily to increases in development personnel, travel and consulting
expenses. Stock-based compensation charges of $126,000 in 1999 were
attributable to employees categorized within research and development and are
presented in a separate line item within the statements of operations.
Sales and Marketing Expenses. Sales and marketing expenses totaled $4.0
million and $588,000 in 1999 and 1998, respectively. The increases were due in
large part to growth in sales personnel and commissions and costs related to
our branding and marketing campaigns. Stock-based compensation charges of
$333,000 in 1999 are attributable to employees categorized within sales and
marketing and are presented in a separate line item within the statements of
operations.
General and Administrative Expenses. General and administrative expenses
totaled $3.6 million and $674,000 in 1999 and 1998, respectively. The increase
was primarily due to the additional facilities opened during 1999 and the
increase in headcount in the finance, information technology, executive and
administration areas plus recruiting and relocation expenses. Stock-based
compensation charges of $893,000 in 1999 are attributable to employees
categorized within general and administrative and are presented in a separate
line item within the statements of operations.
Amortization of Intangibles, and Other Long-term Assets. Amortization of
intangibles, and other long-term assets totaled $302,000 in 1999 and includes
amortization of the goodwill and identified intangible assets recorded as part
of the Alive.com acquisition, which took place on December 14, 1999. There
were no intangible assets as of December 31, 1998, and accordingly, there were
no related amortization charges in 1998.
Stock-based Compensation. Stock-based compensation expense of $1.6 million
in 1999 consists of $982,000 in amortization of deferred stock compensation
related to stock options granted below fair market value prior to December 31,
1999 and $572,000 in expense related to marking options granted to consultants
to fair market value as of December 31, 1999. There was no stock-based
compensation expense in 1998.
Interest Income. Interest income, representing earnings on our cash, cash
equivalents and short-term investments, totaled $204,000 and $54,000 in the
years ended December 31, 1999 and 1998, respectively. The increase was due
primarily to interest earned on our significantly higher cash and investment
balances in 1999 compared to 1998.
Interest Expense and Other. Interest expense and other totaled $183,000 and
$20,000 in the years ended December 31, 1999 and 1998, respectively. The
increase was due primarily to interest on borrowings to finance equipment
purchases during 1999.
Liquidity and Capital Resources
As of December 31, 2000, we had approximately $95.0 million of cash, cash
equivalents and short-term investments.
Net cash used in operating activities was $25.4 million and $4.9 million in
the years ended December 31, 2000 and 1999, respectively. For 2000, cash used
in operating activities resulted primarily from a net loss of $39.5 million, a
decrease of approximately $3.8 million in accounts payable and an increase in
trade accounts receivable of $2.1 million, partially offset by non-cash
charges totaling $18.6 million related to stock-based compensation,
depreciation and amortization, and the non-cash component of the special
charge. Cash used in operating activities in 1999 was due primarily to a net
loss of $10.9 million, partially offset by an increase in accounts payable of
$4.2 million and non-cash stock-based compensation, depreciation and
amortization charges totaling $2.8 million.
Net cash used in investing activities was $61.6 million and $5.0 million for
the years ended December 31, 2000 and 1999, respectively. This was primarily
related to purchases of short-term investments, equipment, cash paid for the
acquisition of Vidipax in June of 2000 and capitalized software development
costs.
21
Net cash provided by financing activities was $89.4 million and $57.7
million for the years ended December 31, 2000 and 1999, respectively. The cash
provided by financing activities in 2000 primarily resulted from the net
proceeds of our initial public offering, and the concurrent sale of common
shares to a strategic investor. On March 15, 2000, we closed our initial
public offering of 4,500,000 shares of common stock at $16.00 per share, for
proceeds of $67.0 million. On April 14, 2000, the underwriters for the IPO
exercised their over-allotment option and purchased an additional 675,000
shares at $16.00 per share, for proceeds of $10.0 million. Concurrent with the
initial public offering, we sold 336,022 shares of common stock at a price of
$14.88 per share to Akamai for net proceeds of $5.0 million. The combined net
proceeds from these transactions, less offering costs of $1.6 million, totaled
$80.4 million. An additional $10.2 million in proceeds were generated from
borrowing on our credit facilities. Net cash provided by financing activities
for the year ended December 31, 1999 totaled $57.7 million and consisted
primarily of proceeds from the sales of convertible preferred stock of $55.0
million and $3.1 million in proceeds from long-term debt.
As of December 31, 2000, our principal commitments consisted of obligations
outstanding under operating leases and credit facilities with our banks. We
have notes payable totaling $528,000 under our original equipment line of
credit with Imperial Bank. Borrowings from Imperial Bank under the equipment
line of credit bear interest at Imperial's prime rate (9.50% at December 31,
2000), and are secured by assets financed under the agreement. Interest and
principal on the Imperial Bank note is payable monthly, and the principal is
due on August 30, 2002. The average interest rate paid on our borrowings under
the Imperial Bank facility was 9.24% and 7.99% for the years ended December
31, 2000 and 1999, respectively.
In June 2000, we amended our loan agreement with Imperial Bank to add an
additional credit facility that permits revolving borrowings and standby
letters of credit aggregating up to $2.0 million. Additionally, the amended
facility provides for a term loan of up to $10.0 million for the purchase of
capital equipment. The $2.0 million credit line bears interest at Imperial
Bank's prime rate (9.50% at December 31, 2000), with principal and interest
due in June 2001. There were no borrowings outstanding under the amended
credit line at December 31, 2000 although as of February 2001, it is being
used to back up a stand-by letter of credit. The $10.0 million equipment
facility bears interest payable monthly during each draw period at Imperial's
prime rates plus 0.75% (10.25% at December 31, 2000) followed by 36 equal
monthly payments of principal plus interest payable through May 2004.
Borrowings under this facility are secured by any assets financed under the
agreement. At December 31, 2000, $9.6 million was outstanding under the
amended credit facility with Imperial Bank. The average interest rate paid on
our borrowings under the Imperial Bank equipment facility was 10.25% for the
year ended December 31, 2000.
At December 31, 2000, we also have notes payable totaling $1.7 million under
our equipment loan facility with Dominion Venture Finance LLC. The notes
payable to Dominion bear interest at rates ranging from 8.57% to 9.65%, and
are secured by assets financed under the agreement. Interest is payable
monthly, and the principal is due in February 2003. A fee equal to 15% of the
principal balance is due with the final payment of each advance. That
additional fee is accrued on a monthly basis and is included in accrued
liabilities and interest expense over the term of the loan.
We have certain financial commitments under existing agreements that will
require significant uses of our cash resources. We entered into a strategic
partnership agreement that commits us to purchase at least $625,000 in
services in 2001. Additionally, pursuant to the acquisition of VidiPax in June
2000, additional consideration will be paid to the employees and former
shareholder based upon predetermined results in the first year subsequent to
acquisition. These payments can be made in a combination of cash and stock in
a manner to be determined solely by the Company. The value given under this
arrangement is expected to range from $600,000 to $3.4 million.
In January 2001, we announced a cost-savings initiative which resulted in a
$947,000 special charge being recognized in 2000; a similar charge totaling
approximately $750,000 will be recorded in the first quarter of 2001. The
December 2000 charge included approximately $300,000 related to employee
termination payments, of which approximately $200,000 were paid in the first
quarter of 2001. The 2001 charge relates primarily to payments for
terminations announced in January 2001 and paid in cash during the first
quarter of 2001.
22
Additionally, we expect to close the acquisition of DiscoverMusic in the
first quarter of 2001. That acquisition will require approximately $4.0
million in cash, net of acquired cash, and the remainder of the purchase price
will be paid with 3.7 million shares of our common stock.
Since our inception, our operating expenses have significantly increased. We
currently anticipate that such expenses will continue to be a material use of
our cash resources. We expect that capital expenditures, excluding
acquisitions, will total approximately $6.0 million in 2001.
We believe that our existing cash, cash equivalents, short-term investments,
the amounts available under our debt facilities will be sufficient to fund our
operations and meet our working capital and capital expenditure requirements
during 2001 and 2002. Thereafter, if we cannot fund operating and other
expenses, working capital and capital expenditure requirements from our
operations, we may find it necessary to obtain additional equity or debt
financing, sell assets or reduce spending plans. In the event additional
equity or debt financing is required, we may not be able to raise it on
acceptable terms or at all.
Recent Accounting Pronouncements
In December 1999, the staff of the Securities and Exchange Commission
released Staff Accounting Bulletin, or SAB, No. 101, "Revenue Recognition" (as
amended in 2000 by SAB 101A and SAB 101B), to provide guidance on the
recognition, presentation, and disclosure of revenues in financial statements.
We believe that our revenue recognition practices are currently in conformity
with the guidelines in SAB101 as amended, and therefore this announcement will
have no impact on our financial statements.
In March 2000, the Financial Accounting Standards Board, or FASB, released
FASB Interpretation No. 44, "Accounting for Certain Transactions involving
Stock Compensation, an interpretation of APB Opinion No. 25," (FIN 44) which
provides clarification of Opinion 25 for certain issues such as the
determination of who is an employee, the criteria for determining whether a
plan qualifies as a non-compensatory plan, the accounting consequence of
various modifications to the terms of a previously fixed stock option or
award, and the accounting for an exchange of stock compensation awards in a
business combination. We believe that our practices are in conformity with
this guidance, and therefore FIN 44 had no impact on our financial statements.
In March 2000, the Emerging Issues Task Force of the FASB, or EITF, issued
EITF 00-2, "Accounting for the Costs of Developing a Website." This issue
addresses how an entity should account for costs incurred to develop a
website. To date, we have not capitalized any such costs and believe that our
historical and current practices are in conformity with EITF 00-2 and
therefore, this release had no impact on our financial statements.
In March 2000, the EITF issued EITF 00-3, Application of AICPA SOP 97-2 to
"Arrangements that Include the Right to Use Software Stored on Another
Entity's Hardware." This issue addresses situations where entities license
software applications to a third party and also host those applications. This
pronouncement did not have a material impact on our financial statements.
In July 2000, the EITF issued EITF 00-10, "Accounting for Shipping and
Handling Fees and Costs". This issue requires that all amounts billed to a
customer in a sale transaction related to shipping and handling to be
classified as revenue. EITF 00-10 is required to be implemented during the
quarter ending December 31, 2000, with reclassification of all prior periods
presented. The impact of the implementation of this consensus did not have a
material impact on our financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning
after June 15, 2000. SFAS 133 requires that all derivatives be recognized in
the balance sheet at their fair market value, and the corresponding derivative
gains
23
or losses be either reported in the statement of operations or as a component
of other comprehensive income depending on the type of hedge relationship that
exists with respect to such derivative. The adoption of SFAS 133 is not
expected to have an effect on our financial statements as we have no
derivatives.
In September 2000, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS 140).
SFAS 140 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities and is
effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring after March 31, 2001. The adoption of SFAS 140 is not
expected to have a material impact on our financial statements.
RISK FACTORS
We have a limited operating history, making it difficult for you to evaluate
our business and your investment
Loudeye was formed as a limited liability company in August 1997 and
incorporated in March 1998. We therefore have a very limited operating history
upon which an investor may evaluate our operations and future prospects.
Because of our limited operating history, we have limited insight into trends
that may emerge and affect our business. In addition, the revenue and income
potential of our business and market are unproven. Because of the recent
emergence of the Internet media infrastructure industry, our executives have
limited experience in this industry. As a young company, we face risks and
uncertainties relating to our ability to implement our business plan
successfully, particularly due to the relatively early stage of the streaming
media industry. Our potential for future profitability must be considered in
light of the risks, uncertainties, expenses and difficulties frequently
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets, such as the Internet media
infrastructure industry, using new and unproven business models.
Because we expect to continue to incur net losses, we may not be able to
implement our business strategy and the price of our stock may decline
We have incurred net losses from operations of $57.0 million during the
period August 12, 1997 (inception) through December 31, 2000. Given the level
of our planned operating and capital expenditures, we expect to continue to
incur losses and negative cash flows for the foreseeable future. To achieve
profitability, we must, among other things:
. Achieve customer adoption and acceptance of our products and services;
. Successfully scale our current operations;
. Introduce new digital media services and applications;
. Implement and execute our business and marketing strategies;
. Address media copyright issues without negatively impacting our
business;
. Develop and enhance our brand;
. Adapt to meet changes in the marketplace;
. Respond to competitive developments in the Internet media infrastructure
industry;
. Continue to attract, integrate, retain and motivate qualified personnel;
and
. Upgrade and enhance our technologies to accommodate expanded digital
media service and application offerings.
24
We might not be successful in achieving any or all of these objectives.
Failure to achieve any or all of these objectives could have a serious adverse
impact on our business, results of operations and financial position. Even if
we ultimately do achieve profitability, we may not be able to sustain or
increase profitability on a quarterly or annual basis. Additionally, we will
likely increase our operating expenses in the future as we attempt to expand
our digital media service and application offerings; obtain, administer, and
renew financially reasonable music content license agreements with the various
third parties in the fragmented music recording and publishing industries;
grow our customer base; enhance our brand image; improve our technology
infrastructure; and open new offices. We expect the number of our employees
may grow. These higher operating costs will likely increase our quarterly net
losses for the foreseeable future. Accordingly, our ability to operate our
business and implement our business strategy may be hampered and the value of
our stock may decline.
Our quarterly financial results are subject to fluctuations that may make it
difficult to forecast our future performance and could cause our stock price
to decline
Our quarterly operating results have fluctuated in the past, and we expect
our revenues and operating results to vary significantly from quarter to
quarter due to a number of factors, including:
. Variability in demand for our digital media services and applications;
. Profitability and viability of existing and emerging businesses focused
on distribution of digital media content over the Internet;
. Market acceptance of new digital media services and applications offered
by us and our competitors;
. Ability of our customers to procure necessary intellectual property
rights in the digital media content they intend to utilize in their
businesses;
. Introduction or enhancement of digital media services and applications
offered by us and our competitors;
. Willingness of our customers to enter into digital media and
applications services agreements for digital media in light of the
economic and legal uncertainties related to their business models;
. The mix of distribution channels through which our products and services
are licensed and sold;
. Changes in the growth rate of Internet usage and adoption of broadband
access;
. Variability in average order size or product mix;
. Changes in our pricing policies or the pricing policies of our
competitors;
. Technical difficulties with respect to the use of our products;
. Governmental regulations affecting use of the Internet, including
regulations concerning intellectual property rights and security
measures;
. The amount and timing of operating costs and capital expenditures
related to expansion of our business operations and infrastructure;
. General economic conditions such as fluctuating interest rates and
inflation; and
. Economic conditions specifically related to the Internet such as
fluctuations in the costs of Internet access, hardware and software.
Our limited operating history and new and unproven business model further
contribute to the difficulty of making meaningful quarterly comparisons. We
expect our operating expenses to increase in absolute dollars on an annual
basis. Our current and future levels of operating expenses and capital
expenditures are based largely on our growth plans and estimates of expected
future revenues. These expenditure levels are, to a large extent, fixed in the
short term. Thus, we may not be able to adjust spending in a timely manner to
compensate for any shortfall in revenues and any significant shortfall in
revenues relative to planned expenditures could have an immediate adverse
effect on our business and results of operations. If our operating results
fall below our expectations as well as those of securities analysts and
investors in some future periods, our stock price will likely decline.
25
Historically, we have priced our digital media services based on the
customer's projected service volumes. We generally offer our digital media
services through volume purchase orders with prices determined by customers
committing to specific service volumes and schedules and paying nonrefundable
deposits. We attempt to secure these commitments from customers to enable us
to schedule time in our production facilities, to staff our operations
efficiently and to forecast revenues and cost of revenues. If our customers
are not willing to do business with us on these terms or if they do not
fulfill their commitments under volume purchase orders, our ability to
forecast revenues will be adversely affected and could contribute to increased
fluctuation in our quarterly results, which could seriously harm our business.
Although we have recently achieved significant percentage increases in our
quarterly revenues, we believe future quarters may not show similar percentage
revenue increases and may show declining revenue (see "Forward-Looking
Statements").
We depend on the development and rate of adoption of digital media and the
delay or failure of this development would seriously harm our business
We depend on the development and rate of adoption of digital media and the
delay or failure of this development would seriously harm our business. The
development of commercial applications for digital media content is in its
very early stages. If the Internet does not develop as an effective medium for
the distribution of digital media content to consumers or if businesses
predicated on the distribution of digital media content are not profitable or
are unable to raise necessary operating capital, then we will not succeed in
executing our business plan. Many factors could inhibit the growth of
electronic commerce in general and the distribution of digital media content
in particular, including concerns about the profitability of Internet-based
businesses, uncertainty about intellectual property rights associated with
music and other digital media, bandwidth constraints, piracy and privacy.
Our success depends on users having access to the necessary hardware,
software and bandwidth, or data transmission capability, to receive high
quality digital media over the Internet. Congestion over the Internet and data
loss may interrupt audio and video streams, resulting in unsatisfying user
experiences. In order to receive digital media adequately, users generally
must have multimedia personal computers with certain minimum microprocessor
requirements and data transmission capacities, as well as streaming media
software. The success of digital media over the Internet depends on the
continued rollout of broadband access to consumers on an affordable basis.
Users typically download digital media software and install it on their
personal computers. This installation may require technical expertise that
some users do not possess. Furthermore, some information systems managers
block reception of digital media over corporate intranets because of bandwidth
constraints. Widespread adoption of digital media technology depends on
overcoming these obstacles, identifying viable revenue models for digital
media-based businesses, improving audio and video quality and educating
customers and users in the use of digital media technology. If digital media
technology fails to overcome these obstacles, our business could be seriously
harmed.
Copyright infringement may decrease the demand for our products and services
The music industry in particular has recently been the focus of heightened
concern with respect to copyright infringement and other misappropriation
claims, and the outcome of developing legal standards in that industry is
expected to impact music, video and other content being distributed over the
Internet. If, as a result, potential customers forego distributing traditional
media content over the Internet, demand for our digital media applications and
services could be reduced which would harm our business.
Commercial failure of Internet-based businesses could reduce demand for our
digital media services and applications
The substantial proportion of customers for our digital media services and
applications have been Internet-based businesses and we expect that in the
future, a majority of our customers will be these types of businesses.
26
Our business prospects and revenues would be harmed by the commercial failure
or diminished commercial prospects of these or like customers. In addition, if
such customers have difficulty raising additional capital to fund their
operations, our business prospects and revenues would be harmed.
We may be liable or alleged to be liable to third parties for music, software,
and other content that we encode, distribute, or make available on our site
We may be liable or alleged to be liable to third parties for the content
that we encode, distribute or make available on our site:
. If the content or the performance of our services violates third party
copyright, trademark, or other intellectual property rights;
. If our customers violate the intellectual property rights of others by
providing content to us or by having us perform digital media services;
or
. If content that we encode or otherwise handle for our customers is
deemed obscene, indecent, or defamatory.
In addition, we face the risk that our customers might not have all
necessary ownership or license rights in the content for us to perform our
encoding services. Any alleged liability could harm our business by damaging
our reputation, requiring us to incur legal costs in defense, exposing us to
awards of damages and costs and diverting management's attention which could
have an adverse effect on our business, results of operations and financial
condition. Our customers for encoding services generally agree to hold us
harmless from claims arising from their failure to have the right to encode
the content given to us for that purpose. However, customers may contest this
responsibility or not have sufficient resource