Microsoft Word 10.0.2627;1
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to ________
Commission file number 1-13469
MediaBay, Inc.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Florida 65-0429858
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employment
Incorporation or Organization) Identification No.)
2 Ridgedale Avenue, Cedar Knolls, New Jersey 07927
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone number, Including Area Code: (973) 539-9528
--------------
Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirement for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer as defined
in Rule 12b-2 of the Securities Exchange Act of 1934. Yes [ ] No |X|
As of November 12, 2004, there were 22,298,624 shares of the Registrant's Common
Stock outstanding.
MEDIABAY, INC.
QUARTER ENDED SEPTEMBER 30, 2004
FORM 10-Q
Index
Page
PART I: Financial Information
Item 1: Financial Statements (unaudited)
Condensed Consolidated Balance Sheets at September 30, 2004
and December 31, 2003, (unaudited) 3
Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 2004 and 2003, (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2004 and 2003, (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations. 18
Item 3: Quantitative and Qualitative Disclosures of Market Risk 37
Item 4. Controls and Procedures 37
Part II: Other Information
Item 2: Changes in Securities and Use of Proceeds 38
Item 6: Exhibits 38
Signatures 39
2
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
MEDIABAY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
-------------- -------------
Assets
Current Assets:
Cash and cash equivalents............................................................... $ 1,746 $ 683
Accounts receivable, net of allowances for sales returns and doubtful accounts of $2,851
and $4,446 at September 30, 2004 and December 31, 2003, respectively................. 1,287 3,264
Inventory............................................................................... 3,001 4,063
Prepaid expenses and other current assets............................................... 158 215
Royalty advances........................................................................ 494 804
------------ -----------
Total current assets................................................................ 6,686 9,029
Fixed assets, net........................................................................... 209 227
Deferred member acquisition costs........................................................... 1,309 3,172
Deferred income taxes....................................................................... 14,753 14,753
Other intangibles........................................................................... 52 54
Goodwill.................................................................................... 9,658 9,658
------------ -----------
$ 32,667 $ 36,893
------------ -----------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses................................................... $ 5,033 $ 10,268
Accounts payable, related party......................................................... 436 826
Common stock subject to contingent put rights, current portion.......................... -- 350
Short-term debt, net of original issue discount of $55 and $274 at September 30, 2004 and
December 31, 2003, respectively...................................................... 229 7,107
Related party short-term debt, net of original issue discount of $142
at December 31, 2003................................................................. -- 10,643
------------ -----------
Total current liabilities.......................................................... 5,698 29,194
------------ -----------
Long-term debt, net of original issue discount of $1,131 at September 30, 2004.............. 10,500 --
Related party long-term debt................................................................ 7,386 --
Common stock subject to contingent put rights............................................... -- 750
------------ -----------
Total liabilities.................................................................. 23,584 29,944
------------ -----------
Commitments and Contingencies -- --
Preferred stock, no par value, authorized 5,000,000 shares; 25,000 shares of
Series A and 3,350 shares of Series B issued and outstanding at September
30, 2004 and December 31, 2003 and 43,527 and no shares of Series C issued
and outstanding at September 30, 2004
and December 31, 2003, respectively..................................................... 7,181 2,828
Common stock; no par value, authorized 150,000,000 shares; issued and outstanding 18,463,624
and 13,057,414 at September 30, 2004 and December 31, 2003, respectively................ 98,543 94,567
Contributed capital......................................................................... 17,436 11,569
Accumulated deficit......................................................................... (114,077) (102,015)
------------ -----------
Total stockholders' equity.................................................................. 9,083 6,949
------------ -----------
$ 32,667 $ 36,893
============ ===========
See accompanying notes to condensed consolidated financial statements.
3
MEDIABAY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
--------------- -------------- -------------- --------------
Sales, net of returns, discounts and allowances of $983 and
$4,753, and $4,286 and $14,174 for the three and nine
months ended September 30, 2004 and 2003, respectively $ 3,849 $ 9,572 $ 14,334 $ 29,677
Cost of sales 1,875 4,252 6,672 13,611
Cost of sales - strategic charges 2,100 -- 2,100 --
Advertising and promotion 1,131 2,069 3,758 7,528
Bad debt 203 931 823 2,734
General and administrative 1,356 1,613 4,208 5,491
Depreciation and amortization 28 65 116 263
--------------- -------------- -------------- --------------
Operating (loss) income (2,844) 642 (3,343) 50
Interest expense, net of interest income 741 295 8,340 1,347
--------------- -------------- -------------- --------------
(Loss) income before income taxes (3,585) 347 (11,691) (1,297)
Income tax expense -- -- -- --
--------------- -------------- -------------- --------------
Net (loss) income (3,585) 347 (11,691) (1,297)
Dividends on preferred stock 199 62 378 183
--------------- -------------- -------------- --------------
Net (loss) income applicable to common shares (3,784) $ 285 (12,061) $ (1,480)
=============== ============== ============== ==============
Basic and diluted (loss) income per share:
Basic(loss) income per common share $ (.21) $ .02 $ (.73) $ (.10)
=============== ============== ============== ==============
Diluted (loss) income per common share $ (.21) $ .02 $ (.73) $ (.10)
=============== ============== ============== ==============
See accompanying notes to condensed consolidated financial statements.
4
MEDIABAY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2004 2003
---------- ----------
Cash flows from operating activities:
Net loss applicable to common shares $ (12,061) $ (1,480)
Adjustments to reconcile net loss to net cash (used in) provided by
operating activities:
Depreciation and amortization 116 263
Non-cash beneficial conversion 4,381
Cost of sales - strategic charges 2,100 --
Amortization of deferred member acquisition costs 2,203 4,525
Loss on extinguishment of debt 1,532 --
Non-current accrued interest and dividends 1,090 818
Amortization of deferred financing costs and debt discount 1,060 379
Non-cash stock compensation 82 --
Changes in asset and liability accounts, net of acquisitions and asset
write-downs and strategic charges:
Decrease in accounts receivable, net 1,977 1,389
Decrease in inventory 62 468
(Increase) decrease in prepaid expenses (40) 78
Increase in royalty advances (790) (26)
Increase in deferred member acquisition costs (339) (2,383)
Decrease in accounts payable and accrued expenses (5,655) (2,381)
---------- ----------
Net cash (used in) provided by operating activities (4,282) 1,650
---------- ----------
Cash flows from investing activities:
Acquisition of fixed assets (77) (15)
Assets acquired, net of cash -- (148)
Acquisition of intangible assets (20) (102)
---------- ----------
Net cash used in investing activities (97) (265)
---------- ----------
Cash flows from financing activities:
Proceeds from exercise of stock options and warrants 1 --
Net proceeds from issuance of long-term debt 13,500 --
Payment of long-term debt (5,987) (1,390)
Increase in deferred financing costs (2,071) (40)
Proceeds from issuance of Preferred Stock -- 348
Payments made in connection with litigation settlement
recorded in contributed capital, net of cash received -- (690)
Cash received from bridge loan investors -- 965
---------- ----------
Net cash provided by (used in) financing activities 5,442 (807)
---------- ----------
Net increase in cash and cash equivalents 1,063 578
Cash and cash equivalents at beginning of period 683 397
---------- ----------
Cash and cash equivalents at end of period $ 1,746 $ 975
========== ==========
See accompanying notes to condensed consolidated financial statements.
5
MEDIABAY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
1) ORGANIZATION
MediaBay, Inc. ("MediaBay" or the "Company"), a Florida corporation,
was formed on August 16, 1993. MediaBay, Inc. is a marketer of spoken audio
products, including audiobooks and old-time radio shows, through direct
response, retail and Internet channels. The Company markets audiobooks primarily
through its Audio Book Club. Its old-time radio programs are marketed through
direct-mail catalogs, over the Internet at RadioSpirits.com and, on a wholesale
basis, to major retailers.
(2) SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The interim unaudited condensed consolidated financial statements
should be read in conjunction with the Company's audited consolidated financial
statements contained in its Annual Report on Form 10-K. The preparation of
financial statements in accordance with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from these estimates. On an
ongoing basis management reviews its estimates based on current available
information. Changes in facts and circumstances may result in revised estimates.
In the opinion of management, the interim unaudited financial statements include
all material adjustments, all of which are of a normal recurring nature,
necessary to present fairly the Company's financial position, results of
operations and cash flows for the periods presented. The results for any interim
period are not necessarily indicative of results for the entire year or any
other interim period.
Revenue Recognition
The Company derives its principal revenue through sales of audiobooks,
classic radio shows and other spoken word audio products directly to consumers
principally through direct mail. The Company also sells classic radio shows to
retailers either directly or through distributors. The Company derives
additional revenue through rental of its proprietary database of names and
addresses to non-competing third parties through list rental brokers. The
Company also derives a small amount of revenue from advertisers included in its
nationally syndicated classic radio shows. The Company recognizes sales to
consumers, retailers and distributors upon shipment of merchandise. List rental
revenue is recognized on notification by the list brokers of rental by a third
party when the lists are rented. The Company recognizes advertising revenue upon
notification of the airing of the advertisement by the media buying company
representing the Company. Allowances for future returns are based upon
historical experience and evaluation of current trends.
Shipping and Handling Revenue and Costs
Amounts paid to the Company for shipping and handling by customers is
included in sales. Amounts the Company incurs for shipping and handling costs
are included in cost of sales. The Company recognizes shipping and handling
revenue upon shipment of merchandise. Shipping and handling expenses are
recognized on a monthly basis from invoices from the third party fulfillment
houses, which provide the services.
6
Cost of Sales
Cost of sales includes the following:
o Product costs (including heavily discounted audiobooks and
old-time radio programs in the initial enrollment offer to
prospective members and customers)
o Royalties to publishers and rightsholders
o Fulfillment costs, including shipping and handling
o Customer service
o Direct response billing, collection and accounts receivable
management.
Cooperative Advertising and Related Selling Expenses
The Company classifies the cost of certain credits, allowances,
adjustments and payments given to customers for the services or benefits
provided as a reduction of net sales.
Stock-Based Compensation
The Company accounts for employee stock options in accordance with
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees." In October 1995, SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") was issued. SFAS 123, which prescribes the
recognition of compensation expense based on the fair value of options on the
grant date, allows companies to continue applying APB 25 if certain pro forma
disclosures are made assuming a hypothetical fair value method application. Had
compensation expense for the Company's stock options been recognized on the fair
value on the grant date under SFAS 123, the Company's net loss and net loss per
share for the three and nine months ended September 30, 2004 and 2003 would have
been as follows:
Three Months Ended Nine Months
September 30, Ended September 30,
------------------ --------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net (loss) income applicable to common shares,
as reported $(3,784) $ 285 $ (12,061) $ (1,480)
Add: Stock-based employee compensation expense included in
reported net loss applicable to common shares, net of
related tax effects -- -- -- --
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects (206) (601) (1,828) (637)
--------- -------- ----------- ---------
Pro forma net (loss) income applicable to common shares $(3,990) $ (316) $ (13,889) $ (2,117)
========= ======== =========== ==========
Net (loss) income per share:
Basic and diluted - as reported $ (.21) $ .02 $ (.73) $ (.10)
========= ======== =========== ==========
Basic and diluted - pro forma $ (.22) $ (.02) $ (.85) $ (.15)
========= ======== =========== ==========
No dividend yield and the following assumptions were used in the pro
forma calculation of compensation expense:
RISK-FREE FAIR VALUE PER
DATE NO. OF SHARES EXERCISE PRICE VOLATILITY INTEREST RATE SHARE
---- ------------- -------------- ---------- ------------- -----
First Nine Months 2004 3,607,500 $0.92 97% 4.00% $0.51
First Nine Months 2003 2,213,856 $0.97 165% 4.85% $0.29
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
basis and operating loss and tax credit carryforwards. A valuation allowance is
provided when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
7
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the period that includes the enactment date.
Deferred Member Acquisition Costs
Promotional costs directed at current members are expensed on the date
the promotional materials are mailed. The cost of any premiums, gifts or the
discounted audiobooks or radio programs in the promotional offer to new members
is expensed as incurred. The Company accounts for direct response advertising
for the acquisition of new members in accordance with AICPA Statement of
Position 93-7, "Reporting on Advertising Costs" ("SOP 93-7"). SOP 93-7 states
that the cost of direct response advertising (a) whose primary purpose is to
elicit sales to customers who could be shown to have responded specifically to
the advertising and (b) that results in probable future benefits should be
reported as assets net of accumulated amortization. Accordingly, the Company has
capitalized direct response advertising costs and amortizes these costs over the
period of future benefit, which has been determined to be generally 30 months
for Audio Book Club advertising costs and 18 months for World's Greatest
Old-Time Radio continuity program. The costs are being amortized on accelerated
basis consistent with the recognition of related revenue.
Royalties
The Company is liable for royalties to licensors based upon revenue
earned from the respective licensed product. The Company pays certain of its
publishers and other rightsholders advances for rights to products. Royalties
earned on the sale of the products are payable only in excess of the amount of
the advance. Advances, which have not been recovered through earned royalties,
are recorded as an asset. Advances not expected to be recovered through
royalties on sales are charged to royalty expense.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
(3) GOODWILL AND OTHER INTANGIBLES
Goodwill and indefinite-lived intangible assets are tested for
impairment annually or when certain triggering events require such tests and are
written down, with a resulting charge to operations, only in the period in which
the recorded value of goodwill and indefinite-lived intangible assets is more
than their fair value.
The Company amortizes other intangible assets over their estimated
useful lives over periods from three to seven years. Other intangible assets
primarily relate to mailing and non-compete agreements, customer lists, and
license agreements associated with the Company's Audio Book Club and Radio
Spirits divisions. Amortization expense for other intangible assets was $2 and
$30 for the three months ended September 30, 2004 and 2003, respectively and $30
and $151 for the nine months ended September 30, 2004 and 2003, respectively.
The Company estimates intangible amortization expenses of the following:
Three months ended December 31, 2004 $ 2
Year ended 2005 8
Year ended 2006 8
Year ended 2007 8
Year ended 2008 1
--------------------
Total $ 27
====================
8
The following table presents details of Other Intangibles at September
30, 2004 and December 31, 2003:
September 30, 2004 December 31, 2003
----------------------------------------- ------------------------------------------
Accumulated Accumulated
Cost Amortization Net Cost Amortization Net
------- ------------ --- ---- ------------ ---
Mailing Agreements $ 592 $ 592 $ -- $ 592 $ 592 $ --
Customer Lists 4,380 4,380 -- 4,380 4,380 --
Non-Compete Agreements 313 286 27 313 264 49
Other 25 -- 25 5 -- 5
------- ------------ ----- ------- ------------ -----
Total Other Intangibles $ 5,310 $ 5,258 $ 52 $ 5,290 $ 5,236 $ 54
======= =========== ===== ======= ============ =====
Goodwill of $9,658 as of September 30, 2004 and December 31, 2003 is
attributable to the Company's Radio Spirits business. The Company completed its
annual impairment tests as of October 31, 2003, which did not result in an
impairment loss.
(4) DEBT
As of
September 30, December 31,
2004 2003
------------- ------------
Credit agreement, senior secured bank debt, $ -- $ 2,925
Credit agreement, senior secured debt,
net of original issue discount 8,453 --
Subordinated debt 1,600 3,200
Premier debt, net of original issue discount 676 --
October 2003 Notes and related accrued interest,
net of original issue discount -- 982
Related party notes and related accrued interest,
net of original issue discount 7,386 10,643
------------- ------------
Total Debt 18,115 17,750
Less: Current Portion (229) (17,750)
------------- ------------
Long-Term Debt $ 17,886 $ --
============= ============
New Credit Agreement and Related Transactions
On April 28, 2004, MediaBay entered into a new credit agreement ("New
Credit Agreement") by and among MediaBay and certain of its subsidiaries, the
guarantors signatory thereto, Zohar CDO 2003-1, Limited ("Zohar") as lender, and
Zohar, as agent, pursuant to which MediaBay and certain of its subsidiaries
initially borrowed $9,500. The initial term of the New Credit Agreement is one
year and it is extendable, at MediaBay's sole option, for two additional
one-year terms upon issuance of additional notes of $600 for the first
additional year and $300 for the second additional year, provided there is no
event of default. The loan bears interest at the rate of LIBOR plus 10%. In the
first year of the loan, a fee of $900 has been added to the principal balance,
which will be reflected as debt discount and will be accreted to interest
expense over the next twelve months. The New Credit Agreement contains certain
positive and negative covenants, including, beginning with the quarter ending
September 30, 2004, the maintenance of certain minimum levels of EBITDA, as
defined in the New Credit Agreement.
MediaBay used a portion of the $8,600 of funds received under the New
Credit Agreement to satisfy all of its outstanding obligations under (i)
promissory notes that it issued in October 2003 in the aggregate principal
amount of $1,065, and (ii) its prior Credit Agreement, which had an outstanding
principal balance of approximately $1,386. The Company has included in interest
expense a loss on early extinguishment of debt of $73 related to unamortized
original issue discount relating to promissory notes that it issued in October
2003 and a loss on early extinguishment of debt of $116 related to unamortized
debt discount relating to the prior Credit Agreement.
9
The Principal Shareholder and an affiliate of the principal
shareholder, which held a $500 principal amount note and 25,000 shares of Series
A Convertible Preferred Stock, consented to the New Credit Agreement and the
other transactions described above and entered into a subordination agreement
with Zohar. The New Credit Agreement required the aggregate amount of principal
and interest owed by MediaBay to the Principal Shareholder and the affiliate of
the Principal Shareholder be reduced to $6,800 ("Permissible Debt") by June 1,
2004, and that the Permissible Debt be further reduced by up to an additional
$1,800 if MediaBay does not raise at least $2,000 in additional equity in the
two years after the execution of the New Credit Agreement.
On April 28, 2004, to reduce its debt to $6,800, the Principal
Shareholder and his affiliate agreed, subject to, and automatically upon, the
receipt of a fairness opinion from an independent investment banking firm, to
exchange the principal of their $500 Note, $1,000 Note, $150 Note and $350 Note,
plus accrued and unpaid interest owed to the Principal Shareholder aggregating
$1,833 and accrued and unpaid dividends owed to the Principal Shareholder
aggregating $519 into an aggregate of 43,527 shares of Series C Preferred Stock
convertible into (i) an aggregate of 5,580,384 shares of Common Stock at an
effective conversion price of $0.78, and (ii) warrants to purchase an aggregate
of 11,160,768 shares of Common Stock. The Warrants are exercisable until April
28, 2014 at an exercise price of $0.53. The Series C Preferred Stock has a
liquidation preference of $100 per share. On May 25, 2004, a fairness opinion
was received from an independent investment banking firm, and, pursuant to the
agreements described above, the exchange of debt for units occurred. The
transactions described above resulted in a charge to earnings for debt
inducement pursuant to SFAS 84 estimated at $391.
The remaining promissory notes held by the Principal Shareholders and
its affiliate are guaranteed by certain subsidiaries of the Company and secured
by a lien on the assets of the Company and certain subsidiaries of the Company.
If the amount of the Permissible Debt is required to be reduced due to
MediaBay's failure to raise the requisite additional equity, such reduction will
automatically occur by the exchange of Permissible Debt for additional shares of
Series C Preferred Stock in an aggregate liquidation preference equal to the
amount of debt exchanged and warrants to purchase a number of shares of common
stock equal to two times the number of shares of preferred stock issuable upon
conversion of the Series C Preferred Stock.
New ABC Note
Also on April 28, 2004, MediaBay repaid $1,600 principal amount of the
$3,200 principal amount convertible note issued to ABC Investment, L.L.C.
MediaBay issued a new $1,600 note (the "New ABC Note") for the remaining
principal amount. The New ABC Note extends the maturity date from December 31,
2004 to July 29, 2007. In exchange for extending the maturity date, the
conversion price of the New ABC Note was reduced to $0.50. The closing sale
price of MediaBay's Common Stock on the closing date was $0.48.
Premier Debt
MediaBay has also entered into a settlement agreement, dated as of
April 1, 2004, with Premier Electronic Laboratories, Inc. ("Premier"). Pursuant
to the settlement, among other things, MediaBay is paying Premier $950 in
exchange for Premier waiving its right to put its shares of Common Stock to
MediaBay pursuant to a Put Agreement dated December 11, 1998. MediaBay's
obligation under the Put Agreement was reduced by $150 in exchange for
relinquishing certain leases for real property. MediaBay paid $14 on closing and
is paying the remaining balance over six years in monthly payments starting at
$7 in July 2004 and increasing to $19 from May 2007 through April 2010.
10
(5) STOCKHOLDERS' EQUITY AND STOCK OPTIONS AND WARRANTS
Stock Options and Warrants
From January 1, 2004 to September 30, 2004, the Company issued options
to purchase 4,657,500 shares of its common stock to certain officers, employees,
directors and consultants to the Company under its stock option plans. The
Company also cancelled options to purchase 1,500,000 shares of its common stock
and options to purchase 828,000 shares of its common stock expired.
In addition, the Company issued warrants to purchase 3,098,830 of its
common stock in connection with the January 2004 Convertible Debt described
immediately below, and warrants to purchase 11,160,768 shares of its common
stock to the Principal Shareholder and his affiliate in connection with the debt
reduction required by the April 2004 Senior Debt as described in Note 4 above.
The Company also issued non-plan warrants to purchase 216, 250 shares of its
common stock to holders of the $1,065 principal amount of promissory notes that
it issued in October 2003 in the aggregate principal amount of $1,065 ("October
2003 Note"), as previously agreed to under the terms the October 2003 Note. The
Company also cancelled non-plan warrants to purchase 339,940 shares of its
common stock. Non-plan options to purchase 8,000 shares of our common stock at
$.10 were exercised during the nine months ended September 30, 2004.
January 2004 Convertible Debt
On January 29, 2004, the Company issued $4,000 aggregate principal
amount of promissory notes (the "January 2004 Notes") and warrants to purchase
2,352,946 shares of common stock (the "Investor Warrants") to institutional and
accredited investors (the "Offering"). The notes were due on the earlier of (i)
April 30, 2005, (ii) such date on or after July 1, 2004 at such time as all of
the Company's indebtedness under its existing credit facility is either repaid
or refinanced or (iii) the consummation by the Company of a merger, combination
or sale of all or substantially all of the Company's assets or the purchase by a
single entity, person or group of affiliated entities or persons of 50% of the
Company's voting stock. The January 2004 Notes bore interest at the rate of 6%,
increasing to 9% on April 28, 2004 and 18% on July 27, 2004. On receipt of
shareholder approval, which was received on April 12, 2004, in accordance with
the terms of the January 2004 Notes, the principal amount of the notes
automatically converted into MediaBay common stock at the rate of one share of
common stock at $0.75, or approximately 5,333,333 shares. In addition accrued
interest in the amount $49 also converted into common stock at $0.75 per share,
or 64,877 shares.
In connection with the Offering, the Company issued to the placement
agent and a broker warrants to purchase an aggregate of 245,000 shares of common
stock and also issued to the placement agent warrants to purchase an additional
500,884 shares of Common Stock on April 12, 2004 as partial consideration for
its services as placement agent. All warrants issued are exercisable until
January 28, 2009 at an exercise price of $1.28 per share.
The Company accounted for the issuance of the January 2004 debt and its
subsequent conversion in accordance with Emerging Issues task Force No. 00-27,
"Application of Issue No. 95-5 to Certain Convertible Instruments". Accordingly,
the Company recorded an expense of $3,991 as beneficial conversion expenses
at the date of the conversion. The Company also recorded in interest expense a
loss on early extinguishment of debt for the unamortized debt discount relating
to the expenses incurred in the transaction and the relative fair value of the
warrants issued in the transaction totaling $1,343.
In connection with the Offering, the Principal Shareholder and an
affiliate of the Principal Shareholder entered into a letter agreement (the
"Letter Agreement") with the purchasers of January 2004 Notes in the Offering
pursuant to which the Principal Shareholder granted to the holders of the Notes
in the event of an Event of Default (as defined in the Notes) the rights to
receive payment under certain secured indebtedness owed by the Company to the
Principal Shareholder and to exercise their rights under security agreements
securing such secured indebtedness. Pursuant to the Letter Agreement, the
Principal Shareholder also executed Powers of Attorney in favor of a
representative of the January 2004 Note holders pursuant to which such
representative may, following an Event of Default, take actions necessary to
enforce the Note holders rights under the Letter Agreement, including enforcing
the Principal Shareholder's rights under the security agreements.
11
(6) COST OF SALES - STRATEGIC CHARGES
The Company has conducted a review of its operations including product
offerings, marketing methods and fulfillment. The Company is committed to
digitizing and encoding its library of spoken word content that includes
audiobooks and famous Old Time Radio shows, including The Shadow, Amos and Andy,
Jack Benny, Dragnet, Gunsmoke and more. By making its content available to the
digital customer, it believes it can expand the market for its audio content and
may be able to significantly reduce the cost of delivery. The Company believes
this distribution strategy could lead to increased revenues and potentially put
the Company on a track to profitability.
In October 2004 the Company and Microsoft announced that they are
working together to offer a wide range of audiobook titles via download to the
millions of MSN(R) users in the United States. Among the audiobook titles we
will exclusively offer on the MSN Music service are those from the nation's
largest audiobook publishers. MSN attracts more than 350 million unique users
worldwide per month. With localized versions available globally in 39 markets
and 20 languages, MSN is a world leader in delivering Web services to consumers
and online advertising opportunities to businesses worldwide.
In October 2004 the Company also announced that it had signed a
multi-year agreement with Celebrity Newsletter LLC to develop television
personality and syndicated talk show host, Larry King's, On-line Audiobook and
Entertainment Club. The Company intends to design The Larry King Audiobook Club
to meet, what it believes, are its customers' needs for an easy to use online
retail experience. The Company is working to give its members more choice,
better customer service, and great prices for repeat buyers.
The Company believes that many of its key operating metrics may be
improved by its transition from a predominantly mail order business to an
Internet based business. The Company hopes to reduce its return rates, lower its
bad debt rates and reduce printing and fulfillment costs.
As a result of these third quarter decisions, the Company has recorded
$2,100 of strategic charges for the three months ended September 30, 2004. These
charges include: $1,000 of inventory written down to net realizable value due to
a reduction in Audio Book Club members and the Company's new focus on delivering
spoken word products via downloads and $1,100 of write-downs to royalty advances
paid to audiobook publishers and other license holders, which the Company does
not believe will be recoverable due to its new focus on delivering spoken word
products via downloads.
(7) INTEREST EXPENSES
The following table presents details of interest expense for the three
and nine months ended September 30, 2004 and 2003 as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
------ ------ ------- -------
Interest Accrued or Paid:
Credit agreement, senior secured bank debt, $ -- $ 55 $ 42 $ 192
Credit agreement 274 -- 459 --
January 2004 Notes -- -- 49 --
Subordinated debt 37 83 158 231
October 2003 Notes -- -- 63 --
Forgiveness of interest to trade creditors -- (192) 2 (90)
Related party notes 166 218 602 635
----- ------ ------ ------
Total interest accrued or paid 477 164 1,375 968
----- ------ ------ ------
Amortization of Debt Discount:
Credit agreement, senior secured bank debt (12) 25 25 60
Credit agreement 266 -- 371 --
January 2004 Notes -- -- 442 --
Premier debt 15 -- 20 --
October 2003 Notes -- -- 59 --
Related party notes -- 106 142 319
----- ------ ------ ------
Total amortization of debt discount 269 131 1,059 379
----- ------ ------ ------
Loss on Early Extinguishment of Debt:
Loss on early extinguishment of January 2004 Notes -- -- 1,343 --
Loss on early extinguishment of senior secured bank debt -- -- 116 --
Loss on early extinguishment of October 2003 Notes -- -- 73 --
Total loss on early extinguishment of debt -- -- 1,532 --
Beneficial conversion expense of January 2004 Notes -- -- 3,991 --
Expense of inducement to convert, related party notes -- -- 391 --
----- ------ ------ ------
Total loss on early extinguishment of debt -- -- 4,382 --
----- ------ ------ ------
Interest expense 746 295 8,348 --
Less: Interest income 5 -- 8 --
----- ------ ------ ------
Net Interest expense $ 741 $ 295 $8,340 $1,347
===== ====== ====== ======
(8) NET INCOME (LOSS) PER SHARE OF COMMON STOCK
Basic income (loss) earnings per share was computed using the weighted
average number of common shares outstanding for the three and nine months ended
September 30, 2004 of 18,463,624 and 16,432,589, respectively and for the three
and nine months ended September 30, 2003 of 14,128,179 and 14,269,529,
respectively.
For the three months ended September 30, 2004 common equivalent shares
which were not included in the computation of diluted loss per share because
they would have been anti-dilutive were 25,021 common equivalent shares, as
calculated under the treasury stock method and 24,008,750 common equivalent
shares relating to convertible subordinated debt and preferred stock calculated
under the "if-converted method". Interest expense and dividends on the
convertible subordinated debt and convertible preferred stock added back to net
income applicable to common stockholders would have been $368 for the three
months ended September 30, 2004.
For the nine months ended September 30, 2004 common equivalent shares
which were not included in the computation of diluted loss per share because
they would have been anti-dilutive were 876,933 common equivalent shares, as
calculated under the treasury stock method and 19,542,673 common equivalent
shares relating to convertible subordinated debt and convertible preferred stock
calculated under the "if-converted method". Interest expense and dividends on
the convertible subordinated debt and convertible preferred stock added back to
net income applicable to common stockholders would have been $984 for the nine
months ended September 30, 2004.
Differences in the weighted average number of common shares outstanding
for purposes of computing diluted earnings per share for the three months ended
September 30, 2003 were due to the inclusion of 591,000 common equivalent
shares, as calculated under the treasury stock method and 17,087,000 common
equivalent shares relating to convertible subordinated debt calculated under the
"if-converted method". Interest expense and dividends on the convertible
subordinated debt and convertible preferred stock added back to net income was
$359 for the three months ended September 30, 2003. .
For the nine months ended September 30, 2003 common equivalent shares
which were not included in the computation of diluted loss per share because
they would have been anti-dilutive were 694,000 common equivalent shares, as
calculated under the treasury stock method and 16,884,000 common equivalent
shares relating to convertible subordinated debt and convertible preferred stock
calculated under the "if-converted method". Interest expense and dividends on
the convertible subordinated debt and convertible preferred stock added back to
net income applicable to common stockholders would have been $1,034 for the nine
months ended September 30, 2003.
13
(9) SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest expense was $852 and $412 for the nine months
ended September 30, 2004 and 2003, respectively.
On receipt of shareholder approval, which was received on April 12,
2004, the principal amount of $4,000 of the January 2004 Notes, as described in
Note 5 above, automatically converted into MediaBay common stock at the rate of
one share of common stock at $0.75, or approximately 5,333,333 shares. In
addition accrued interest in the amount $49 also converted into common stock at
$0.75 per share, or 64,877 shares.
During the nine months ended September 30, 2003, the Company issued
13,333 shares of the Company's common stock to consultants under consulting
agreements. The shares have been valued at $10 and are being amortized to
expense over the period of benefit.
(10) SEGMENT REPORTING
For 2004 and 2003, the Company has divided its operations into four
reportable segments: Corporate, Audio Book Club ("ABC") a membership-based club
selling audiobooks in direct mail and on the Internet; Radio Spirits ("RSI")
which produces, sells, licenses and syndicates old-time radio programs; and
MediaBay.com a media portal offering spoken word audio content in secure digital
download formats. Segment operating income is total segment revenue reduced by
operating expenses identifiable with that business segment. Corporate includes
general corporate administrative costs, professional fees, interest expenses and
amortization of acquisition related costs. The Company evaluates performance and
allocates resources among its three operating segments based on operating income
and opportunities for growth. The Company did not expend any funds or receive
any income in the nine months ended September 30, 2004 and 2003 from its newest
subsidiary RadioClassics, which is aggregated with RSI for segment reporting
purposes. Inter-segment sales are recorded at prevailing sales prices.
THREE MONTHS ENDED SEPTEMBER 30, 2004
Corporate ABC RSI Mbay.com Inter-segment Total
--------------------------------------------------------------------------
Sales, net of returns, discounts and allowances $ -- $ 2,654 $ 1,154 $ 52 $ (11) $ 3,849
Profit (loss) before depreciation and amortization,
interest and dividends (353) (2,103) (270) (99) 9 (2,816)
Depreciation and amortization 2 17 9 -- -- 28
Interest expense 740 -- 1 -- -- 741
Dividends on preferred stock 199 -- -- -- -- 199
Net (loss) income applicable to common shares (1,294) (2,120) (280) (99) 9 (3,784)
Total assets -- 19,096 13,623 10 (62) 32,667
Acquisition of fixed assets -- 10 -- -- -- 10
THREE MONTHS ENDED SEPTEMBER 30, 2003
Corporate ABC RSI Mbay.com Inter-segment Total
--------------------------------------------------------------------------
Sales, net of returns, discounts and allowances $ -- $ 6,493 $ 3,071 $ 42 $ (34) $ 9,572
Profit (loss) before depreciation and amortization,
interest and dividends (532) 541 813 (118) 3 707
Depreciation and amortization 30 25 10 -- -- 65
Interest expense 292 -- 3 -- -- 295
Dividends on preferred stock 62 -- -- -- -- 62
Net (loss) income applicable to common shares (916) 516 800 (118) 3 285
Total assets -- 28,397 16,441 3 (68) 44,773
Acquisition of fixed assets -- -- -- -- -- --
14
Nine Months Ended September 30, 2004
Corporate ABC RSI Mbay.com Inter-segment Total
--------------------------------------------------------------------------
Sales, net of returns, discounts and allowances $ -- $ 9,719 $4,514 $ 158 $ (57) $14,334
Profit (loss) before depreciation and amortization,
interest and dividends (1,194) (2,229) 501 (315) 10 (3,227)
Depreciation and amortization 22 66 28 -- -- 116
Interest expense 8,337 -- 3 -- -- 8,340
Dividends on preferred 378 -- -- -- -- 378
stock
Net (loss) income applicable to common shares (9,931) (2,295) 470 (315) 10 (12,061)
Total assets -- 19,096 13,623 10 (62) 32,667
Acquisition of fixed assets -- 68 9 -- -- 77
Nine Months Ended September 30, 2003
Corporate ABC RSI Mbay.com Inter-segment Total
--------------------------------------------------------------------------
Sales, net of returns, discounts and allowances $ -- $ 21,873 $ 7,781 $ 94 $ (71) $ 29,677
Profit (loss) before depreciation and amortization,
interest and dividends (1,802) 1,351 1,172 (415) 7 313
Depreciation and amortization 151 79 33 -- -- 263
Interest expense 1,337 -- 10 -- -- 1,347
Dividends on preferred 183 -- -- -- -- 183
stock
Net (loss) income applicable to common shares (3,473) 1,272 1,129 (415) 7 (1,480)
Total assets -- 28,397 16,441 3 (68) 44,773
Acquisition of fixed assets -- 13 2 -- -- 15
(11) RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock
Based Compensation", which amends SFAS No. 123 to provide alternative methods of
transaction for an entity that voluntarily changes to the fair value method of
accounting for stock based compensation. It also amends the disclosure
provisions of SFAS No. 123 to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect to
stock based employee compensation. Finally, SFAS No. 148 amends APB Opinion No.
28, "Interim Financial Reporting", to require disclosure of those effects in
interim financial statements. SFAS No. 148 is effective for fiscal years ended
after December 15, 2002, but early adoption is permitted. Accordingly, the
Company has adopted the applicable disclosure requirements of this Statement
within this report. The adoption of SFAS No. 148 did not have a significant
impact on the Company's financial disclosures.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities," which is effective for interim periods beginning after
December 15, 2003. This interpretation changes the method of determining whether
certain entities should be included in the Company's consolidated financial
statements. An entity is subject to FIN 46 and is called a variable interest
entity ("VIE") if it has (1) equity that is insufficient to permit the entity to
finance its activities without additional subordinated financial support from
other parties, or (2) equity investors that cannot make significant decisions
about the entity's operations or that do not absorb the expected losses or
receive the expected returns of the entity. All other entities are evaluated for
consolidation under SFAS No. 94, "Consolidation of All Majority-Owned
Subsidiaries." A VIE is consolidated by its primary beneficiary, which is the
party involved with the VIE that has a majority of the expected losses or a
majority of the expected residual returns or both. The Company has evaluated FIN
46 and it had no impact on its financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 33
on Derivative Instruments and Hedging Activities", which amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities that fall within the
scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 149 amends SFAS No. 133 regarding implementation issues
raised in relation to the application of the definition of a derivative. The
amendments set forth in SFAS No. 149 require that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. The adoption of
15
SFAS No. 149 did not have a material impact on the Company's financial position
or results of operations.
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
150 provides guidance on classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. The Company
reclassified certain items to debt as a result of the SFAS 150.
(12) SUBSEQUENT EVENTS
Stock Options
From October 1, 2004 to November 12, 2004, the Company issued options
to purchase 925,000 shares of MediaBay common stock to directors, employees and
consultants.
Sale of Equity
On October 11, 2004, the Company entered into a Securities Purchase
Agreement pursuant to which it issued to the purchasers thereunder an aggregate
of 1,800,000 shares (the "Shares") of the Company's common stock, no par value
per share (the "Common Stock"), and warrants to purchase 400,000 shares of
Common Stock (the "Warrants"). The purchasers paid an aggregate purchase price
of $900 for the Shares and Warrants. Each Warrant is exercisable to purchase one
share of the Company's Common Stock at an exercise price of $0.83 per share
during the five (5)-year period commencing on October 11, 2004.
Conversion of Debt
In October 2004, the holder of a $1,600 convertible note ("ABC Note")
converted $1,000 principal amount of the ABC Note, such that the holder received
600,000 and 1,400,000 shares of the Company's Common Stock, respectively, on
October 6, 2004 and October 7, 2004. Following the conversion, the principal
amount of the ABC Note was reduced to $600.
Licensing Agreement
In the fourth quarter of 2004, the Company issued to Celebrity
Newsletter LLC ("CNL") 25,000 shares of common stock pursuant to a multi-year
agreement to develop television personality and syndicated talk show host, Larry
King's on-line audiobook and entertainment club.
Amendment to New Credit Agreement
In November 2004, the New Credit Agreement was amended to amend the
definition of Adjusted EBITDA to exclude the $2.1 million of Cost of Sales -
Strategic Charges discussed above and to allow the Company to retain the entire
$900,000 received in the Sale of Equity discussed below.
Pro Forma Balance Sheet
The following pro forma balance sheet reflects the effects of the
following:
o The issuance of an aggregate of 1,800,000 shares of the Company's
common stock for $900,000,
o The conversion rights of $1,000 principal amount of the ABC Note into
2,000,000 shares of Common Stock and
o The issuance to CNL of 25,000 shares of Common Stock.
16
Condensed Pro Forma Balance Sheet
Pro Forma
September 30, Pro Forma September 30,
2004 Adjustments Notes 2004
Assets
Current Assets:
Cash and cash equivalents $ 1,746 $ 900 1 $ 2,646
Accounts receivable, net 1,287 1,287
Inventory 3,001 3,001
Prepaid expenses and other current
assets 158 158
Royalty advances 494 494
---------- -------- ------------
Total current assets 6,686 900 9,686
Fixed assets, net 209 209
Deferred member acquisition costs 1,309 1,309
Deferred income taxes 14,753 14,753
Other intangibles 52 16 2 68
Goodwill 9,658 9,658
---------- -------- ------------
$ 32,667 $ 916 $ 33,583
========== ======== ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $ 5,033 5,469
Accounts payable, related parties 436 436
Short-term debt, net 229 229
---------- ------------
Total current liabilities 5,698 5,698
Long-term debt, net 10,500 (1,000) 3 9,500
Related party long-term debt, net 7,386 7,386
---------- -------- ------------
Total liabilities 23,584 (1,000) 22,584
---------- -------- ------------
Preferred stock 7,181 7,181
Common stock 98,543 900 1 100,443
1,000 3
Contributed capital 17,436 16 2 17,452
Accumulated deficit (114,077) (114,077)
---------- -------- ------------
Total stockholders' equity 9,083 1,916 10,999
---------- -------- ------------
$ 32,667 $ 916 $ 33,583
========== ======== ============
Notes:
1. To reflect the issuance of an aggregate of 1,800,000 shares of the
Company's common stock for $900,000.
2. To reflect the issuance to CNL 25,000 unregistered shares MediaBay's
common stock.
3. To reflect the partial exercise of conversion rights under the ABC Note
(the "Exercises"), such that the holder received 600,000 and 1,400,000
shares of the Company's Common Stock.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-Q constitute "forward-looking"
statements within the meaning of the Private Securities Litigation Reform Act of
1995. All statements other than statements of historical facts included in this
Report, including, without limitation, statements regarding our future financial
position, business strategy, budgets, projected costs and plans and objectives
of our management for future operations are forward-looking statements. In
addition, forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe," or "continue" or the negative thereof or
variations thereon or similar terminology. Although we believe that the
expectations reflected in such forward looking statements are reasonable, we
cannot assure you that such expectations will prove to be correct. These forward
looking statements involve certain known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any results, performances or achievements expressed
or implied by such forward-looking statements. Important factors that could
cause actual results to differ materially from our expectations, include,
without limitation, our history of losses; the success of our new digital media
distribution strategy and new Larry King initiatives, our ability to anticipate
and respond to changing customer preferences, license and produce desirable
content, protect our databases and other intellectual property from unauthorized
access, collect receivables; dependence on third-party providers, suppliers and
distribution channels; competition; the costs and success of our marketing
strategies; product returns; member attrition and other risks detailed in our
Annual Report on Form 10-K for the year ended December 31, 2003. Undue reference
should not be placed on these forward-looking statements, which speak only as of
the date hereof. We undertake no obligation to update any forward-looking
statements.
INTRODUCTION
We are a seller of spoken audio and nostalgia products, including
audiobooks and old-time radio shows, through direct response, retail and
Internet channels. Our content and products are sold in multiple formats,
including physical (cassette and compact disc) and secure digital download
formats.
We are digitizing and encoding our library of spoken word content that
includes audiobooks and famous Old Time Radio shows, including The Shadow, Amos
and Andy, Jack Benny, Dragnet, Gunsmoke and more. By making our content
available to the digital customer, we believe we can expand the market for our
audio content and we may be able to significantly reduce the cost of delivery.
We believe this distribution strategy could lead to increased revenues and
potentially put the Company on a track to profitability.
In October 2004, the Company and Microsoft announced that we are
working together to offer a wide range of audiobook titles via download to the
millions of MSN(R) users in the United States. Among the audiobook titles we
will exclusively offer on the MSN Music service (http://www.music.msn.com) are
those from many of the nation's largest audiobook publishers.
This new relationship complements the already extensive MSN Music
service catalog, which provides music fans with an easy, comprehensive service
for discovering and downloading legal digital music. MSN Music offers simple
sign-up, no-hassle purchasing and superior sound quality, either through a Web
browser or the new Microsoft(R) Windows Media(R) Player 10. We believe that MSN
will provide us with access to the growing number of audiobook listeners who are
using the Internet more and more to access their entertainment and information
needs, as well as attract new listeners who are unfamiliar with the format. We
believe that the growth of the MSN Music Service will be driven by the launch of
approximately 70 new portable media devices with Microsoft's digital rights
management software.
18
MSN attracts more than 350 million unique users worldwide per month.
With localized versions available globally in 39 markets and 20 languages, MSN
is a world leader in delivering Web services to consumers and online advertising
opportunities to businesses worldwide.
In October 2004, we also announced that we had signed a multi-year
agreement to with Celebrity Newsletter LLC to develop television personality and
syndicated talk show host, Larry King's, On-line Audiobook and Entertainment
Club. We intend to design The Larry King Audiobook Club to meet, what we
believe, are our customers' needs for an easy to use online retail experience.
We are working to give our members more choice, better customer service, and
great prices for repeat buyers. In addition, we plan to offer a variety of
exclusive audio content and entertainment to our members as an added benefit of
membership.
We believe that many of our key operating metrics may be improved by
our transition from a predominantly mail order business to an Internet based
business. We hope to reduce our return rates, lower our bad debt rates and
reduce our printing and fulfillment costs.
We report financial results on the basis of four business segments:
Corporate, Audio Book Club, Radio Spirits and MediaBay.com. A fifth division,
RadioClassics, is aggregated with Radio Spirits for financial reporting
purposes. Except for corporate, each segment serves a unique market segment
within the spoken word audio industry.
We derive our principal revenue through sales of audiobooks, classic
radio shows and other spoken word audio products directly to consumers
principally through direct mail. We also sell classic radio shows to retailers
either directly or through distributors. We derive additional revenue through
rental of our proprietary database of names and addresses to non-competing third
parties through list rental brokers. We also derive a small amount of revenue
from advertisers who advertise on our nationally syndicated classic radio shows.
The preparation of financial statements requires us to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosures of contingent assets and liabilities. We
record reductions to our revenues for future returns and record an estimate of
future bad debts arising from current sales in general and administrative
expenses. These allowances are based upon historical experience and evaluation
of current trends. If the financial condition of our customers, including either
individual consumers or retail chains, were to deteriorate or if the payment
behavior were to change, resulting in either their inability or refusal to make
payment to us, additional allowances would be required. We capitalize direct
response marketing costs for the acquisition of new members and amortize these
costs over the period of probable future benefits. In order to determine the
amount of advertising to be capitalized and the manner and period over which the
advertising should be amortized, we prepare estimates of probable future
revenues arising from the direct-response advertising in excess of future costs
to be incurred in realizing those revenues. We record an estimate of our
anticipated bad debt expense based on our historical experience.
The ultimate realization of deferred tax assets is dependent on the
generation of future taxable income during the periods in which temporary timing
differences become deductible. Although realization of net deferred tax assets
is not assured, management has determined that it is more likely than not that a
portion of our deferred tax asset relating to temporary differences between the
tax bases of assets or liabilities and their reported amounts in the financial
statements will be realized in future periods.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities. On an on-going basis we evaluate our estimates including those
related to product returns, bad debts, the carrying value and net realizable
value of inventories, the recoverability of advances to publishers and other
19
rightsholders, the future revenue associated with deferred advertising and
promotion costs, investments, fixed assets, the valuation allowance provided to
reduce our deferred tax assets and valuation of goodwill and other intangibles.
The Securities and Exchange Commission ("SEC") defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods.
Our significant accounting policies are described in Note 2 to the
Notes to Consolidated Financial Statements. Not all of these significant
accounting policies require management to make difficult, subjective or complex
judgments or estimates. However the following policies are considered to be
critical within the SEC definition:
Revenue Recognition
We derive our principal revenue through sales of audiobooks, classic
radio shows and other spoken word audio products directly to consumers
principally through direct mail. We also sell classic radio shows to retailers
either directly or through distributors. We derive additional revenue through
rental of our proprietary database of names and addresses to non-competing third
parties through list rental brokers. We also derive a small amount of revenue
from advertisers included in our nationally syndicated classic radio shows. We
recognize sales to consumers, retailers and distributors upon shipment of
merchandise. List rental revenue is recognized on notification by the list
brokers of rental by a third party when the lists are rented. We recognize
advertising revenue upon notification of the airing of the advertisement by the
media buying company representing us. Allowances for future returns are based
upon historical experience and evaluation of current trends. The historical
return rates for ABC members have been consistent for the past year and our
estimate is based on a detailed historical examination of trends. Based on the
current performance and historical trends, we do not expect significant changes
in the estimate of returns for ABC members. The estimate of returns for
wholesale sales of our old-time radio products is based on a detailed review of
each significant customer, depending on the amount of products sold to a
particular customer in a specific periods, the overall return rate for wholesale
sales could vary.
We record reductions to our revenue for future returns and record an
estimate of future bad debts arising from current sales in general and
administrative expenses. These allowances are based upon historical experience
and evaluation of current trends. If members and customers return products to us
in the future at higher rates than in the past or than we currently anticipate,
our net sales would be reduced and our operating results would be adversely
affected. In November 2001, the Emerging Issues Task Force ("EITF") issued EITF
No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor's Products)", which addresses the income
statement classification of certain credits, allowances, adjustments, and
payments given to customers for the services or benefits provided. We adopted
EITF No. 01-9 effective January 1, 2002, and, as such, have classified the cost
of these sales incentives as a reduction of sales.
Deferred Member Acquisition Costs
We are required to capitalize direct response marketing costs for the
acquisition of new members in accordance with AICPA Statement of Position 93-7
"Reporting on Advertising Costs" and amortize these costs over the period of
probable future benefits. In order to determine the amount of advertising to be
capitalized and the manner and period over which the advertising should be
amortized, we prepare estimates of probable future revenues arising from the
direct-response advertising in excess of future costs to be incurred in
realizing those revenues. If future revenue does not meet our estimates or if
members buying patterns were to shift, adjustments to the amount and manner of
amortization would be required.
Accounts Receivable Valuation
We record an estimate of our anticipated bad debt expense and return
rates based on our historical experience. If the financial condition of our
customers, including either individual consumers or retail chains, were to
20
deteriorate, or if the payment or buying behavior were to change, resulting in
either their inability or refusal to make payment to us, additional allowances
would be required.
Income Taxes
The ultimate realization of deferred tax assets is dependent on the
generation of future taxable income during the periods in which temporary timing
differences become deductible. Although realization of net deferred tax assets
is not assured, we have determined that it is more likely than not that a
portion of our deferred tax asset relating to temporary differences between the
tax bases of assets or liabilities and their reported amounts in the financial
statements will be realized in future periods. We determine the utilization of
deferred tax assets in the future based on our current year projections of
future periods.
At September 30, 2004, we have a remaining net deferred tax asset in
the amount of $14.8 million. Should we determine we would be able to realize
deferred tax assets in the future in excess of the net recorded amount, an
adjustment to our deferred tax asset would increase income in the period such
determination is made. Likewise, should we determine that we will not be able to
realize all or part of our net deferred tax asset in the future, an adjustment
to the deferred tax asset would be recorded as an increase to the valuation
allowance, resulting in a deferred tax expense charged against income in the
period such determination is made.
Goodwill
Goodwill represents the excess of the purchase price over the fair
value of net assets acquired in business combinations accounted for using the
purchase method of accounting. In July 2001, the Financial Accounting Standards
Board issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142
requires that an intangible asset that is acquired shall be initially recognized
and measured based on its fair value. The statement also provides that goodwill
should not be amortized, but shall be tested for impairment annually, or more
frequently if circumstances indicate potential impairment, through a comparison
of fair value to its carrying amount. At September 30, 2004, we had $9.7 million
of goodwill, all of which related to our Radio Spirits operations. If conditions
or circumstances were to change resulting in a deterioration of our Radio
Spirits business, a future impairment of goodwill could be necessary.
Inventory
Inventory, consisting primarily of audiocassettes and compact discs
held for resale, is valued at the lower of cost (weighted average cost method)
or market. We record an estimate for inventory obsolescence based on future
sales projections. These sales projections are based on estimates of future
marketing expenditures and the anticipated success of future marketing efforts.
If the Company does not invest in marketing or if sales estimates are not met
for the other reasons, the estimate of inventory obsolescence would need to be
increased which would result in a lower reported inventory value.
Royalty Advances
We are liable for royalties to licensors based upon revenue earned from
the respective licensed product. We pay certain of its publishers and other
rightsholders advances for rights to products. Royalties earned on the sale of
the products are payable only in excess of the amount of the advance. Advances,
which have not been recovered through earned royalties, are recorded as an
asset. The estimate of future advances to be recovered is based on an estimate
of future sales. Advances not expected to be recovered through royalties on
sales are charged to royalty expense. If the Company does not invest in
marketing or if sales estimates are not met for the other reasons, the royalty
expense would be understated and the value of the royalty advance we reported
would require reduction.
21
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, historical operating
data as a percentage of net sales.
Three Months Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
---------------- ---------------- ------------ ----------------
Sales....................................... 100% 100% 100.0% 100.0%
Cost of sales............................... 48.7 44.4 46.5 45.9
Cost of sales - strategic charges........... 54.6 -- 14.7 --
Advertising and promotion................... 29.4 21.6 26.2 25.4
Bad debt expense 5.3 9.7 5.7 9.2
General and administrative expense.......... 35.2 16.9 29.4 18.5
Depreciation and amortization expense....... 0.7 0.7 0.8 0.9
Interest expense, net....................... 19.3 3.1 58.2 4.5
Income tax expense (benefit)................ -- -- -- --
---------------- ---------------- ------------ ----------------
Net (loss).................................. (93.1) 3.6 (81.6) (4.4)
Dividends on preferred stock................ 5.2 0.6 2.6 0.6
================ ================ ============ ================
Net (loss) applicable to common shares...... (98.3)% 3.0% (84.2)% (5.0)%
================ ================ ============ ================
RESULTS OF OPERATIONS
Three months ended September 30, 2004 compared to three months ended
September 30, 2003:
NET SALES
(In thousands) CHANGE FROM
2003 2004 2003 TO 2004 % CHANGE
---- ---- ------------ --------
AUDIO BOOK CLUB $6,493 $2,654 $(3,839) (59.1) %
----------------------------------------------------------------------
RADIO SPIRITS
Catalog 916 515 (401) (43.8)
Wholesale 1,327 287 (1,040) (78.4)
Continuity 794 341 (453) (57.1)
----------------------------------------------------------------------
3,037 1,143 (1,894) (62.4)
----------------------------------------------------------------------
MediaBay.com 42 52 10 23.8
----------------------------------------------------------------------
$9,572 $3,849 $(5,723) (59.8) %
======================================================================
Audio Book Club sales decreased principally due to a decrease in club
membership as a result of a substantial reduction in our advertising
expenditures for new members. For the three months ended September 30, 2004, the
Audio Book Club spent $110,000 to attract new members, a reduction of $381,000,
or 77.6%, from the amount spent to attract new members of $491,000 during the
three months ended September 30, 2003. Audio Book Club attracted approximately
4,540 new members in the three months ended September 30, 2004 as compared to
approximately 24,558 members in the three months ended September 30, 2003. The
reduction of advertising spending compared to historical levels occurred
throughout the year ended December 31, 2003 and the first nine months of 2004.
For the year ended December 31, 2003, advertising expenditures to attract new
members were down 74.7%, from the amount spent to attract new members during the
year ended December 31, 2002. Audio Book Club attracted approximately 134,000
new members in the year ended December 31, 2003 as compared to approximately
290,000 new members in the year ended December 31, 2002.
The decrease in Radio Spirits catalog sales of $401,000, or 43.8%, is
principally attributable to lower sales from catalogs mailed in the third
22
quarter of 2004 due to less new product introduced into the catalogs during the
quarter and the timing of shipments from the catalog mailed in September 2004.
The Company has begun to develop more new product offerings and is beginning to
offer other nostalgia products in the catalogs beginning in September 2004.
Wholesale sales of old-time radio products decreased principally due to lower
orders from mass merchants and other retailers and the timing of 2004 holiday
sales.
Sales of our World's Greatest Old-Time Radio continuity program
decreased for the three months ended September 30, 2004, as compared to the
three months ended September 30, 2003, principally due to the reduction in our
advertising expenditures for new members. For the three months ended September
30, 2004, we did not spend any money to attract new continuity customers,
compared to $60,000 spent to attract new customers during the three months ended
September 30, 2003.
Cost of Sales
(In thousands) 2003 2004
------------------------------ --------------------------------
As a % As a % From 2003 to 20004
$ of Net Sales $ of Net Sales Change % Change
------------ ------------ ------ --------
Audio Book Club $ 2,796 43.1% $ 1,275 48.0% $ (1,521) (54.4)%
Radio Spirits
Catalog 411 44.9% 242 47.0% (169) (41.1)%
Wholesale 761 57.3% 229 79.8% (532) (69.9)%
Continuity 284 35.8% 129 37.8% (155) (54.6)%
------------------------------ -------------------------------- -----------------------------------
Total Radio Spirits 1,456 47.9% 600 52.5% (856) (58.8)%
------------------------------ -------------------------------- -----------------------------------
MediaBay.com -- -- -- -- -- --
------------------------------
Cost of Sales - Before
Strategic Charges 4,252 44.4% 1,875 48.7% 2,377 (55.9)%
------------------------------ -------------------------------- -----------------------------------
Cost of Sales -
Strategic Charges -- -- 2,100 54.6% 2,100 --
------------------------------ -------------------------------- -----------------------------------
$ 4,252 44.4% $ 3,975 103.3% $ (277) (6.5)%
============================== ================================ ===================================
The principal reason for the decline in cost of sales at Audio Book
Club was a reduction in sales of 59.1% as described above. Cost of sales as a
percentage of sales at Audio Book Club for the three months ended September 30,
2004 was 48.0%, compared to 43.1% for 2003. The increase in cost of sales as a
percentage of sales is principally due to an increase in product costs as a
percentage of sales since smaller active membership required us to purchase
finished goods from publishers rather than the licensing and manufacture of
product due to lower sales and our inability to meet manufacturing minimums and
recoup advances to publishers, higher sales of unabridged and CD titles with
higher costs, higher manufacturing costs due to lower volumes and the offering
of more discounted titles in our catalogs in an effort to increase sales.
The principal reason for the decline in cost of sales at Radio Spirits
was a reduction in sales of 62.4% as described above. As a percentage of sales,
cost of sales at Radio Spirits increased to 52.5% for the three months ended
September 30, 2004 from 47.9% for the three months ended September 30, 2003.
Cost of catalog sales increased as a percentage of sales to 47.0% for the three
months ended September 30, 2004 as compared to 44.9% for the three months ended
September 30, 2003 principally due to more sales of discounted items. The cost
of wholesale sales as percentage of sales increased to 79.8% for the three
months ended September 30, 2004 as compared to 57.3% for the three months ended
September 30, 2003 principally due to sales to discounters of discontinued items
in the third quarter of 2004.
The Company has conducted a review of its operations including product
offerings, marketing methods and fulfillment. The Company is committed to
digitizing and encoding its library of spoken word content and making its
23
content available to the digital customer as described in the introduction to
this Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Also as described in this Item 2, the Company announced that it had
signed a multi-year agreement with Celebrity Newsletter LLC to develop
television personality and syndicated talk show host, Larry King's, On-line
Audiobook and Entertainment Club. The Company intends to design The Larry King
Audiobook Club to meet, what it believes, are its customers' needs for an easy
to use online retail experience.
As a result of these third quarter decisions, the Company has recorded
$2,100 of strategic charges for the three months ended September 30, 2004. These
charges include: $1,000 of inventory written down to net realizable value due to
a reduction in Audio Book Club members and the Company's new focus on delivering
spoken word products via downloads and $1,100 of write-downs to royalty advances
paid to audiobook publishers and other license holders, which the Company does
not believe will be recoverable due to its new focus on delivering spoken word
products via downloads.
Advertising and Promotion
From 2003 to 2004
2003 2004 Change % Change
---- ---- ------ --------
(In thousands)
Audio Book Club
New Member $ 492 $ 110 $(382) (77.6)%
Current Member 393 251 (142) (36.1)%
--------------------------------------------------------
Total Audio Book Club 885 361 (524)
--------------------------------------------------------
Radio Spirits
Catalog 198 203 5 2.5%
Wholesale (7) 8 15 --
Continuity 60 -- (60) --
--------------------------------------------------------
Total Radio Spirits 251 211 (40) (15.9)%
--------------------------------------------------------
New Projects 36 47 11 30.6%
--------------------------------------------------------
Total Spending 1,172 619 (553) (47.1)%
Amount Capitalized (498) (96) (402) (80.7)%
Amount Amortized 1,395 608 (787) (56.4)%
--------------------------------------------------------
Advertising and Promotion Expense $2,069 $1,131 $(938) (45.3)%
--------------------------------------------------------
Advertising and promotion expenses decreased $938,000 to $1.1 million
for the three months ended September 30, 2004 as compared to $2.1 million in the
prior comparable period. Actual advertising expenditures for the three months
ended September 30, 2004 decreased $552,000 to $619,000 from $1.2 million during
the three months ended September 30, 2003. The decrease was due to a minimal
amount of new member marketing for Audio Book Club new members due to cash
constraints and decreased advertising to existing members due to the reduction
in Audio Book Club membership because of normal attrition with no marketing to
replace leaving members. Radio Spirits continuity advertising was reduced due to
cash constraints.
24
Bad Debt Expense
2003 2004 From 2003 to2004
------------------------ ------------------------- ----------------------
(In thousands) As a % As a %
$ of Net Sales $ of Net Sales Change % Change
----- ------------ ------ ------------ ------ -----------
Audio Book Club $ 835 12.9 % $ 180 6.8 % (655) (78.4)%
----- ------------ ------ ------------ ------ -----------
Radio Spirits
Catalog -- -- -- -- -- --
Wholesale 4 0.2% 4 0.5% -- --
Continuity 92 8.7% 19 5.6% (73) (79.3)%
----- ------------ ------ ------------ ------ -----------
96 23 (73) (46.0)%
MediaBay.com -- -- -- -- -- --
----- --------------- ------------ ---------------- $(728) (78.2)%
$ 931 9.7% $ 203 5.3%
===== =============== ============ ================ ====== ===========
The principal reason for the decline in bad debt expense at Audio Book
Club was a reduction in net sales of 59.1% as described above. Bad debt expense
as a percentage of net sales at Audio Book Club for the three months ended
September 30, 2004 was 6.8%, compared to 12.9% for the three months ended
September 30, 2003. The decrease in bad debt expense as a percentage of net
sales is principally due to a reduced number of new members, who typically have
higher bad debt expense, since a lower number of new members were added in the
three months ended September 30, 2004 as compared to the three months ended
September 30, 2003.
General and Administrative
2003 2004 From 2003 to2004
------------------------ ------------------------- ----------------------
(In thousands) As a % As a %
$ of Net Sales $ of Net Sales Change % Change
------ ------------ ------ ------------ ------ ---------
Audio Book Club $ 619 9.8% $ 555 20.9% (64) (10.5)%
Radio Spirits 302 25.5% 298 25.8% (4) (1.3)%
MediaBay.com 160 381.0% 151 290.4% (9) (5.6)%
Corporate 532 -- 352 -- (180) (33.8)%
------ ------------ ------- ------------ ------ ---------
$1,613 16.8% $ 1,356 35.2% (257) (16.0)%
====== ============ ======= ============ ======= =========
The decrease in general and administrative expenses for the three
months ended September 30, 2004 as compared to the three months ended September
30, 2003 is principally due to a reduction in personnel, as a result of a
restructuring, which occurred in September 2003 and reductions in insurance
costs.
25
Depreciation and Amortization
2003 2004
-------------- --------------
(In thousands)
Depreciation
Audio Book Club $ 25 $17
Radio Spirits 10 9
Total depreciation 35 26
Amortization
Corporate 30 2
-------------- --------------
Total depreciation and amortization $65 $28
============== ==============
The decrease in depreciation and amortization expenses for the three
months ended September 30, 2004 as compared to the three months ended September
30, 2003 is principally attributable to reductions in the amortization of
intangibles, which had been fully amortized or written off during the year ended
December 31, 2003.
Interest Expense
2003 2004 Change
---- ---- ------
(In thousands)
Total interest paid, net $ 128 $ 312 $ 184
Accrued interest paid this period 73 -- (73)
------ ----- -----
Current interest paid 55 312 257
Interest accrued (109) -- 109
Interest included in debt 218 165 (53)
Amortization of deferred financing costs and
original issue discount 131 269 138
------ ----- -----
Total interest expense 295 746 451
Interest income -- (5) (5)
------ ----- -----
Total interest expense, net $ 295 $ 741 $ 446
====== ===== =====
The increase in interest expenses is principally due to increased debt
and higher interest costs and amortization of debt discount relating to the
financing transactions in the first nine months of 2004 as described in the
Liquidity and Capital Resources section of this Item 2: Management's Discussion
and Analysis of Financial Condition and Results of Operations.
PREFERRED STOCK DIVIDENDS
2003 2004
---- ----
(In thousands)
Dividends accrued on Series A Preferred Stock $ 57 $ 57
Dividends accrued on Series B Preferred Stock 5 8
Dividends accrued on Series C Preferred Stock -- 134
Total dividends accrued on preferred stock ------- -------
$ 62 $199
The increase in preferred stock dividends for the three months ended
September 30, 2004 as compared to the three months ended September 30, 2003 is
due to the accrual of dividends for Series B Preferred Stock issued May 2003 and
accrual of dividends on the Series C Preferred Stock issued in May 2004. Our
Principal Shareholder agreed to exchange the principal of certain notes, plus
accrued and unpaid interest owed to the Principal Shareholder aggregating $3.8
million and accrued and unpaid dividends owed to the Principal Shareholder
aggregating $519,000 into an aggregate of 43,527 shares of Series C Preferred
Stock convertible into (i) an aggregate of 5,580,384 shares of Common Stock at
an effective conversion price of $0.78, and (ii) warrants to purchase an
26
aggregate of 11,160,768 shares of Common Stock. The Series C Preferred Stock
accrues dividends at the rate of 9% per annum.
Income (Loss) Applicable to Common Stockholders
From 2002 to 2003
2003 2004 Change % Change
---- ---- ------ --------
(In thousands)
Income (Loss) applicable to common stockholders $285 $(3,784) $(4,069) --
Principally due to reduced sales and higher interest costs, partially
offset by lower advertising, bad debt and general and administrative expenses,
our net loss applicable to common shares for the three months ended September
30, 2004 increased $4.1 million to $3.8 million, or $.21 per diluted share as
compared to a net income applicable to common shares for the three months ended
September 30, 2003 of $285,000, or $.02 per diluted share of common stock.
Nine months ended September 30, 2004 compared to nine months ended
September 30, 2003:
Net Sales
($000's) Change from
2003 2004 2003 to 2004 % Change
---- ---- ------------ --------
Audio Book Club $ 21,874 $ 9,719 $ (12,155) (55.6)%
----------------------------------------------------------------------
Radio Spirits
Catalog 3,101 2,125 (976) (31.5)%
Wholesale 2,228 1,270 (958) (43.0)%
Continuity 2,380 1,062 (1,318) (55.4)%
----------------------------------------------------------------------
7,709 4,457 (3,252) (42.2)%
----------------------------------------------------------------------
MediaBay.com 94 158 64 68.1%
----------------------------------------------------------------------
$ 29,677 $ 14,334 $ (15,343) (51.7)%
======================================================================
Audio Book Club sales decreased principally due to a decrease in club
membership as a result of a substantial reduction in our advertising
expenditures for new members. For the nine months ended September 30, 2004, the
Audio Book Club spent $382,000 to attract new members, a reduction of $1.7
million, or 81.7%, from the amount spent to attract new members of $2.1 million
during the nine months ended September 30, 2003. Audio Book Club attracted
approximately 17,600 new members in the nine months ended September 30, 2004 as
compared to approximately 129,400 new members in the nine months ended September
30, 2003. The lack of advertising spending also occurred throughout the year
ended December 31, 2003. For the year ended December 31, 2003, the Audio Book
Club spent $2.1 million to attract new members, a reduction of $6.2 million, or
74.7%, from $8.3 million spent to attract new members during the year ended
December 31, 2002. Audio Book Club attracted approximately 134,000 new members
in the year ended December 31, 2003 as compared to approximately 290,000 new
members in the year ended December 31, 2002.
The decrease in Radio Spirits catalog sales of $976,000, or 31.5%, is
principally attributable to lower sales from catalogs mailed in 2004 due to
reduced discounting in attempt to improve margins and a reduction in new product
offerings in the catalog mailings. Based on the performance of these catalogs we
have revised our mailings beginning in September 2004 to include more discounted
products and have increased the number of new product offerings, including other
nostalgia products. Wholesale sales of old-time radio products decreased
principally due to lower sales to mass marketers and other retailers and the
timing of holiday orders. Sales of our World's Greatest Old-Time Radio
continuity program decreased for the nine months ended September 30, 2004, as
compared to the nine months ended September 30, 2003, principally due lower
membership because we reduced advertising expenditures for new members. For the
nine months ended September 30, 2004, we spent $6,000 to attract new continuity
27
customers; a reduction of $735,000, or 99.2% less, from the amount spent to
attract new customers of $741,000 during the nine months ended September 30,
2003.
Cost of Sales
(In thousands) 2003 2004
------------------------------ --------------------------------
As a % As a % From 2003 to 20004
$ of Net Sales $ of Net Sales Change % Change
------- ------------ ------- ------------ ------ --------
Audio Book Club $ 9,621 44.0% $4,500 46.3% $ (5,121) (53.2)%
Radio Spirits
Catalog 1,473 47.5% 921 43.4% (552) (37.4)%
Wholesale 1,427 64.0% 834 65.7% (593) (41.6)%
Continuity 1,086 45.6% 416 39.2% (670) (61.7)%
-------- ------------ ------- ------------ --------- --------
Total Radio Spirits 3,986 51.7% 2,171 48.7% (1,815) (45.5)%
-------- ------------ ------- ------------ --------- --------
MediaBay.com 4 4.3% 1 0.6% (3) (75.0)%
-------- ------------ ------- ------------ --------- --------
Cost of Sales Before
Strategic Charges 13,611 45.9% 6,672 46.5% (6,939) (51.0)%
-------- ------------ ------- ------------ --------- --------
Cost of Sales -
Strategic Charges -- -- 2,100 14.7% 2,100 --
-------- ------------ ------- ------------ --------- --------
$ 13,611 45.9% $8,772 61.2% $ (4,839) (35.6)%
======== ============ ======= =========== ======== ========
The principal reason for the decline in cost of sales at Audio Book
Club was a reduction in sales of 55.6% as described above. Cost of sales as a
percentage of sales at Audio Book Club for the nine months ended September 30,
2004 was 46.3%, compared to 44.0% for 2003. The increase in cost of sales as a
percentage of sales is principally due to an increase in product costs as a
percentage of sales since smaller active membership required us to purchase
finished goods from publishers rather than the licensing and manufacture of
product due to lower sales and our inability to meet manufacturing minimums and
recoup advances to publishers, higher sales of unabridged and CD titles with
higher costs, higher manufacturing costs due to lower volumes and the offering
of more discounted titles in our catalogs in an effort to increase sales.
The principal reason for the decline in cost of sales at Radio Spirits
was a reduction in sales of 42.2% as described above. As a percentage of sales,
cost of sales at Radio Spirits decreased to 48.7% for the nine months ended
September 30, 2004 from 51.7% for the nine months ended September 30, 2003. Cost
of catalog sales as a percentage of sales decreased principally due to fewer
sales of discounted items. The cost of wholesale sales as percentage of sales
for the nine months ended September 30, 2004 increased principally due to sales
to discounters of discontinued products in the quarter ended September 30, 2004.
The cost of World's Greatest Old-Time Radio continuity sales as a percentage of
sales decreased because the continuity sales for the nine months ended September
30, 2003 included heavily discounted introductory merchandise designed to
attract new buyers. Since we did very little new customer marketing in the nine
months ended September 30, 2004, very little of the product sales were of
heavily discounted products.
The Company has conducted a review of its operations including product
offerings, marketing methods and fulfillment. The Company is committed to
digitizing and encoding its library of spoken word content and making its
content available to the digital customer as described in the introduction to
this Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Also as described in this Item 2, the Company announced that it had
signed a multi-year agreement with Celebrity Newsletter LLC to develop
television personality and syndicated talk show host, Larry King's, On-line
Audiobook and Entertainment Club. The Company intends to design The Larry King
28
Audiobook Club to meet, what it believes, are its customers' needs for an easy
to use online retail experience.
As a result of these third quarter decisions, the Company has recorded
$2,100 of strategic charges for the three months ended September 30, 2004. These
charges include: $1,000 of inventory written down to net realizable value due to
a reduction in Audio Book Club members and the Company's new focus on delivering
spoken word products via downloads and $1,100 of write-downs to royalty advances
paid to audiobook publishers and other license holders, which the Company does
not believe will be recoverable due to its new focus on delivering spoken word
products via downloads.
Advertising and Promotion
(In thousands) From 2003 to 2004
-----------------
2003 2004 Change % Change
---- ---- ------ --------
Audio Book Club
New Member $ 2,082 $ 382 $ (1,700) (81.7)%
Current Member 1,507 885 (622) (41.3)%
-------------------------------------------------------
Total Audio Book Club 3,589 1,267 (2,322) (64.7)%
-------------------------------------------------------
Radio Spirits
Catalog 696 543 (153) (22.0)%
Wholesale 29 19 (10) (34.5)%
Continuity 741 6 (735) (99.2)%
-------------------------------------------------------
Total Radio Spirits 1,466 568 (898) (61.3)%
-------------------------------------------------------
New Projects 340 61 (279) (82.1)%
-------------------------------------------------------
Total Spending 5,395 1,896 (3,499) (64.9)%
Amount Capitalized (2,393) (341) (2,052) (85.8)%
Amount Amortized 4,526 2,203 (2,323) (51.3)%
-------------------------------------------------------
Advertising and Promotion Expense $7,528 $ 3,758 $ (3,770) (50.1)%
=======================================================
Advertising and promotion expenses decreased $3.8 million to $3.8
million for the nine months ended September 30, 2004 as compared to $7.6 million
in the prior comparable period. Actual advertising expenditures for the nine
months ended September 30, 2004 decreased $3.5 million to $1.9 million from $5.4
million during the nine months ended September 30, 2003. The decrease was due to
a minimal amount of new member marketing for Audio Book Club new members,
reduced spending on the World's Greatest Old-Time Radio continuity and reduced
spending on new projects all due to cash constraints and restrictions placed on
us by our new senior debt covenants and the reduction in Audio Book Club
membership due to normal attrition with no marketing to replace leaving members.
29
Bad Debt Expense
2003 2004 From 2003 to2004
------------------------ ------------------------- ------------------------
(In thousands) As a % As a %
$ of Net Sales $ of Net Sales Change % Change
------ ------------ ------ ------------ ---------- --------
Audio Book Club $2,528 11.6% $ 731 7.5% $(1,797) (71.1)%
------ ------------ ------ ------------ ---------- --------
Radio Spirits
Catalog -- --
Wholesale 11 0.5% 11 0.9% -- --
Continuity 195 8.2% 81 7.6% (114) (58.5)%
------ ------------ ------ ------------ ---------- --------
206 92
------ ------------ ------ ------------ ---------- --------
MediaBay.com -- -- -- -- -- --
------ ------------ ------ ------------ ---------- --------
$2,734 9.2% $ 823 5.7% $(1,911) (69.9)%
====== ============ ====== ============ ========== ========
The principal reason for the decline in bad debt expense at Audio Book
Club was a reduction in net sales of 55.6% as described above. Bad debt expense
as a percentage of net sales at Audio Book Club for the nine months ended
September 30, 2004 was 7.5%, compared to 11.6% for the nine months ended
September 30, 2003. The decrease in bad debt expense as a percentage of net
sales is principally due to a reduced number of new members, who typically have
higher bad debt expense, since a lower number of new members were added in the
nine months ended September 30, 2004 as compared to the nine months ended
September 30, 2003.
General and Administrative
2003 2004 From 2003 to2004
----------------------- ------------------------- ------------------------
(In thousands) As a % As a %
$ of Net Sales $ of Net Sales Change % Change
----------- --------------- ------------ ---------------- -------- -----------
Audio Book Club $2,184 10.0% 1,829 18.8% (355) (16.3)%
Radio Spirits 1,001 13.0% 712 16.0% (289) (28.9)%
MediaBay.com 504 536.2% 473 299.4% (31) (6.2)%
Corporate 1,802 1,194 (608) (33.7)%
----------- --------------- ------------ ---------------- -------- -----------
$5,491 18.5% $4,208 29.4% (1,283) (23.4)%
=========== =============== ============ ================ ======== ===========
The decrease in general and administrative expenses for the nine months
ended September 30, 2004 as compared to the nine months ended September 30, 2003
at Audio Book Club is principally due to a reduction in personnel, as a result
of a restructuring, which occurred in September 2003 and lower insurance costs.
The decrease in general and administrative expenses for the nine months ended
September 30, 2004 as compared to the nine months ended September 30, 2003 at
Radio Spirits is principally due to a reduction in personnel, as a result of a
restructuring, which occurred in September 2003, and lower insurance costs. The
reduction in corporate general and administrative expenses for the nine months
ended September 30, 2004 as compared to the nine months ended September 30, 2003
is principally due to a reduction in personnel, as a result of a restructuring,
a reduction in accounting fees due principally to a change in our auditors and
reduction in legal expenses partially offset by higher investor relations
expenses.
30
Depreciation and Amortization
2003 2004
-------------- --------------
(In thousands)
Depreciation
Audio Book Club $ 79 $ 67
Radio Spirits 33 28
-------------- --------------
Total depreciation 112 95
Amortization
Corporate 151 21
-------------- --------------
Total depreciation and amortization $ 263 $ 116
============== ==============
The decrease in depreciation and amortization expenses for the nine
months ended September 30, 2004 as compared to the nine months ended September
30, 2003 is principally attributable to reductions in the amortization of
intangibles, which had been fully amortized or written off during the year ended
December 31, 2003.
Interest Expense
2003 2004 Change
---- ---- ------
(In thousands)
Total interest paid $ 422 $ 852 $ 430
Accrued interest paid this period 74 74 --
--------- --------- ---------
Current interest paid 348 778 430
Interest accrued (14) -- 14
Interest included in debt 634 602 (32)
Amortization of deferred financing costs and
original issue discount 379 1,058 679
Loss on early extinguishment of debt -- 1,532 1,532
Beneficial conversion expenses of January 2004 Notes
-- 3,991 3,991
Expense of inducement to convert, related party debt
-- 390 390
Total interest expense 1,347 8,351 7,004
Interest income -- (11) (11)
--------- --------- ---------
$ 1,347 $ 8,340 $ 6,993
========= ========= =========
The increase in interest expenses is principally due to the recognition
of expenses relating to our financing transactions in the first nine months of
2004 as described in the Liquidity and Capital Resources section of this Item 2:
Management's Discussion and Analysis of Financial Condition and Results of
Operations. These items which total $5.9 million include a loss on early
extinguishment of debt of $1.5 million; beneficial conversion expenses of
January 2004 Notes of $4.0 million and the expense of inducement to convert,
related party debt of $390,000.
Preferred Stock Dividends
2003 2004
---- ----
(In thousands)
Dividends accrued on Series A Preferred Stock $ 171 $ 171
Dividends accrued on Series B Preferred Stock 12 23
Dividends accrued on Series C Preferred Stock -- 184
---------- ----------
Total dividends accrued on preferred stock $ 183 $ 378
========== =========
31
The increase in preferred stock dividends for the nine months ended
September 30, 2004 as compared to the nine months ended September 30, 2003 is
due to the accrual of dividends for Series B Preferred Stock issued May 2003 and
accrual of dividends on the Series C Preferred Stock issued in May 2004. Our
Principal Shareholder agreed to exchange the principal of certain notes, plus
accrued and unpaid interest owed to the Principal Shareholder aggregating $3.8
million and accrued and unpaid dividends owed to the Principal Shareholder
aggregating $519,000 into an aggregate of 43,527 shares of Series C Preferred
Stock convertible into (i) an aggregate of 5,580,384 shares of Common Stock at
an effective conversion price of $0.78, and (ii) warrants to purchase an
aggregate of 11,160,768 shares of Common Stock. The Series C Preferred Stock
accrues dividends at the rate of 9% per annum.
Loss Applicable to Common Stockholders
From 2002 to 2003
2003 2004 Change % Change
---- ---- ------ --------
(In thousands)
Loss applicable to common stockholders $ 1,480 $ 12,061 $ 10,581 714.9%
========== ========== ========== ======
Principally due to the increase in interest expenses relating to the
recognition of expenses of our financing transactions in the first nine months
of 2004 which total $6.0 million, a reduction in gross profit due to lower sales
as described above and strategic charges of $2.1 million as described above,
partially offset by lower advertising expenses and general and administrative
expenses, our net loss applicable to common shares for the nine months ended
September 30, 2004 increased $10.6 million to $12.1 million, or $.73 per diluted
share as compared to a net loss applicable to common shares for the nine months
ended September 30, 2003 of $1.5 million, or $.10 per diluted share of common
stock.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our cash requirements through sales of
equity and debt securities and borrowings from financial institutions and our
principal shareholders. During 2003 and the first nine months of 2004, we did
not have sufficient cash to undertake marketing activities to the extent of
historical levels. As a result, our member and customer bases eroded and our
revenues declined significantly. Although our cash position as of September 30,
2004 improved considerably, we require additional financing to conduct
sufficient marketing activities to execute our new digital strategy and the new
Larry King initiatives. If we do not obtain the funds necessary to increase our
advertising to acquire new members to expand our existing membership and
customer bases, our revenue will continue to decline, which will continue to
negatively impact our performance.
For the nine months ended September 30, 2004, cash increased by $1.0
million, as we had net cash used in operating activities of $4.3 million, used
net cash of $97,000 in investing activities and had cash provided by investing
activities of $5.4 million.
FINANCING ACTIVITIES:
The following is a summary of our financing activities in the first
nine months of 2004:
January 2004 Convertible Debt
On January 29, 2004, we issued $4.0 million aggregate principal amount
of promissory notes (the "Notes") and warrants to purchase 2,352,946 shares of
common stock (the "Investor Warrants") to institutional and accredited investors
(the "Offering"). The notes were due on the earlier of (i) April 30, 2005, (ii)
such date on or after July 1, 2004 at such time as all of our indebtedness under
our existing credit facility is either repaid or refinanced or (iii) our
consummation of a merger, combination or sale of all or substantially all of our
assets or the purchase by a single entity, person or group of affiliated
entities or persons of 50% of the our voting stock. The notes bore interest at
the rate of 6%, increasing to 9% on April 28, 2004 and 18% on July 27, 2004. On
receipt of shareholder approval, which was received on April 12, 2004, in
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accordance with the terms of the Notes, the principal amount of the notes
automatically converted into common stock at the rate of one share of common
stock at $0.75, or approximately 5,333,333 shares. In addition, accrued interest
in the amount $49,000 also converted into common stock at $0.75 per share, or
64,877 shares.
In connection with the Offering, we issued to the placement agent and a
broker warrants to purchase an aggregate of 245,000 shares of common stock and
also issued to the placement agent warrants to purchase an additional 500,884
shares of common stock on April 12, 2004 as partial consideration for the
placement agent's services. All warrants issued are exercisable until January
28, 2009 at an exercise price of $1.28 per share.
We used a portion of the proceeds of the offering to repay $1,250,000
of principal due on our prior credit Agreement with ING (U.S.) Capital, L.L.C.
and Patriarch Partners, L.L.C. (the "ING Credit Agreement") and to reduce our
accounts payable.
New Credit Agreement and Related Financing Transactions
On April 28, 2004, we entered into a new credit agreement ("New Credit
Agreement") by and among MediaBay and certain of its subsidiaries, the
guarantors signatory thereto, Zohar CDO 2003-1, Limited ("Zohar") as lender, and
Zohar, as agent, pursuant to which we and certain of our subsidiaries initially
borrowed $9.5 million. The initial term of the New Credit Agreement is one year
and it is extendable, at our sole option, for two additional one-year terms upon
issuance of additional notes of $600,000 for the first additional year and
$300,000 for the second additional year, provided there is no event of default.
The loan bears interest at the rate of LIBOR plus 10%. In the first year of the
loan, a fee of $900,000 has been added to the principal balance, which will be
reflected as debt discount and will be accreted to interest expense over the
next twelve months. We used a portion of the $8.6 million of funds received
under the New Credit Agreement to satisfy all of its outstanding obligations
under (i) promissory notes that it issued in October 2003 in the aggregate
principal amount of $1.0 million plus accrued interest of $.2 million, (ii) the
ING Credit Agreement, which had an outstanding principal balance of
approximately $1.4 million and a partial payment of $1.6 million of the
convertible note issued to ABC Investment, L.L.C. as described below.
Norton Herrick ("Herrick"), a principal shareholder of the Company,
Huntingdon Corporation ("Huntingdon"), a company wholly-owned by Herrick, and N.
Herrick Irrevocable ABC Trust (the "Trust"), of which Herrick is the
beneficiary, and Howard Herrick, a principal shareholder of the Company, is the
trustee, consented to the New Credit Agreement and the other transactions
described above and entered into a subordination agreement with Zohar. The New
Credit Agreement required the aggregate amount of principal and interest owed by
MediaBay to Herrick, Huntingdon and the Trust be reduced to $6,800,000
("Permissible Debt") by June 1, 2004, and that the Permissible Debt be further
reduced by up to an additional $1,800,000 if MediaBay does not raise at least
$2,000,000 in additional equity in each of the next two years.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004 Herrick
exchanged accrued and unpaid interest and dividends (including accrued and
unpaid interest distributed by the Trust to Herrick) owed to Herrick aggregating
$1,181,419 into (i) 11,814 shares of Series C Preferred Stock with a liquidation
preference of $100 per share convertible into an aggregate of 1,514,615 shares
of Common Stock at an effective conversion price of $0.78, and (ii) warrants to
purchase 3,029,230 shares of Common Stock. The warrants are exercisable until
April 28, 2014 at an exercise price of $0.53.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004
Huntingdon exchanged the principal of the $500,000 principal amount note,
$1,000,000 principal amount note, $150,000 principal amount note and $350,000
principal amount note held by Huntingdon, plus accrued and unpaid interest owed
to Huntingdon aggregating $1,171,278 into (i) 31,713 shares of Series C
Preferred Stock convertible into an aggregate of 4,065,768 shares of Common
Stock at an effective conversion price of $0.78, and (ii) warrants to purchase
an aggregate of 8,131,538 shares of Common Stock. The warrants are exercisable
until April 28, 2014 at an exercise price of $0.53. If the amount of the
Permissible Debt is required to be reduced due to MediaBay's failure to raise
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the requisite additional equity, such reduction will automatically occur by the
exchange of Permissible Debt held by Huntingdon for additional shares of Series
C Preferred Stock in an aggregate liquidation preference equal to the amount of
debt exchanged and warrants to purchase a number of shares of common stock equal
to two times the number of shares of preferred stock issuable upon conversion of
the Series C Preferred Stock.
Herrick and Huntingdon agreed not to demand repayment of their debt
until the earlier of (i) the repayment of the New Credit Agreement or (ii) June
28, 2007.
The remaining promissory notes held by Herrick, Huntingdon and the
Trust are guaranteed by certain subsidiaries of the Company and secured by a
lien on the assets of the Company and certain subsidiaries of the Company.
In November 2004, the New Credit Agreement was amended to amend the
definition of Adjusted EBITDA to exclude the $2.1 million of Cost of Sales -
Strategic Charges discussed above and to allow us to retain the entire $900,000
received in the October Sale of Equity discussed below.
New ABC Note
Also on April 28, 2004, we repaid $1.6 million principal amount of the
$3.2 million principal amount convertible note issued to ABC Investment, L.L.C.
We issued a new $1.6 million note (the "New ABC Note") for the remaining
principal amount. The New ABC Note extends the maturity date from December 31,
2004 to July 29, 2007. In exchange for extending the maturity date, the
conversion price of the New ABC Note was reduced to $0.50. The closing sale
price of our common stock on the closing date was $0.48. In October 2004, ABC
Investment, L.L.C., converted $1.0 million principal amount of the New ABC Note
into 2.0 million shares of Common Stock.
Settlement of Put Obligations
We also entered into a settlement agreement with Premier Electronic
Laboratories, Inc. ("Premier") dated April 1, 2004. Pursuant to the settlement,
among other things, we agreed to pay Premier $950,000 in exchange for Premier
waiving its right to put its shares of Common Stock to MediaBay pursuant to a
Put Agreement dated December 11, 1990. MediaBay's obligation under the Put
Agreement was reduced by $150,000 in exchange for relinquishing certain leases
for real property. MediaBay paid $14,000 on closing and is paying the remaining
balance over six years in monthly payments starting at $7,000 in July 2004 and
increasing to $19,000 from May 2007 through April 2010.
October Sale of Equity
On October 11, 2004, the Company entered into a Securities Purchase
Agreement pursuant to which it issued to the purchasers thereunder an aggregate
of 1,800,000 shares (the "Shares") of the Company's common stock, no par value
per share (the "Common Stock"), and warrants to purchase 400,000 shares of
Common Stock (the "Warrants"). The purchasers paid an aggregate purchase price
of $900 for the Shares and Warrants. Each Warrant is exercisable to purchase one
share of the Company's Common Stock at an exercise price of $0.83 per share
during the five (5)-year period commencing on October 11, 2004.
OPERATING ACTIVITY
Net cash used in operating activities principally consisted of the net
loss of $12.1 million, increases in prepaid expenses and royalty advances of
$40,000 and $790,000, respectively, and a decrease in accounts payable and
accrued expenses of $5.7 million, partially offset by non-cash beneficial
conversion charges of $4.4 million, non-cash strategic charges relating to the
write-down of inventory and advances to publishers, as described above, of $2.1
million, loss on extinguishment of debt of $1.5 million, depreciation and
amortization expenses of $116,000, amortization of deferred financing costs and
original issue discount of $1.1 million, non-current accrued interest and
dividends payable of $1.1 million, non-cash stock compensation of $82,000
decreases in accounts receivable of $2.0 million and inventory of $62,000 and a
net reduction in deferred member acquisition costs of $1.9 million.
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The decrease in accounts receivable was primarily attributable to a
reduction in sales as described above. The net decrease in deferred member
acquisition cost is due the lack of funds to conduct new member and customer
acquisition activities. The increase in royalty advances is principally due to a
decline in sales and a reduction in new member acquisition activities at Audio
Book Club, which results in lower royalty expense and less utilization of the
advances, as well as the timing and payment of advances. During the nine months
ended September 30, 2004, we reduced accounts payable and accrued expenses by
$5.7 million, the majority of which were over 90 days past due.
Net cash used in investing activities consists of acquisition of fixed
assets of $77,000, principally computer equipment.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock
Based Compensation", which amends SFAS No. 123 to provide alternative methods of
transaction for an entity that voluntarily changes to the fair value method of
accounting for stock based compensation. It also amends the disclosure
provisions of SFAS No. 123 to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect to
stock based employee compensation. Finally, SFAS No. 148 amends APB Opinion No.
28, "Interim Financial Reporting", to require disclosure of those effects in
interim financial statements. SFAS No. 148 is effective for fiscal years ended
after December 15, 2002, but early adoption is permitted. Accordingly, we have
adopted the applicable disclosure requirements of this Statement within this
report. The adoption of SFAS No. 148 did not have a significant impact on our
financial disclosures.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities," which is effective for interim periods beginning after
December 15, 2003. This interpretation changes the method of determining whether
certain entities should be included in our consolidated financial statements. An
entity is subject to FIN 46 and is called a variable interest entity ("VIE") if
it has (1) equity that is insufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
or (2) equity investors that cannot make significant decisions about the
entity's operations or that do not absorb the expected losses or receive the
expected returns of the entity. All other entities are evaluated for
consolidation under SFAS No. 94, "Consolidation of All Majority-Owned
Subsidiaries." A VIE is consolidated by its primary beneficiary, which is the
party involved with the VIE that has a majority of the expected losses or a
majority of the expected residual returns or both. We are currently evaluating
FIN 46 and believe that it will have no impact on its financial position or
results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 33
on Derivative Instruments and Hedging Activities", which amends and clarifies
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities that fall within the
scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 149 amends SFAS No. 133 regarding implementation issues
raised in relation to the application of the definition of a derivative. The
amendments set forth in SFAS No. 149 require that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. The adoption of
SFAS No. 149 did not have a material impact on our financial position or results
of operations.
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
150 provides guidance on classification and measurement of certain financial
instruments with characteristics of both liabilities and equity. We reclassified
certain items to debt as a result of the SFAS 150.
35
CERTAIN TRANSACTIONS
In addition, to the financing transactions described above under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources", in connection with the Offering
described above, Norton Herrick and Huntingdon Corporation ("Huntingdon"), of
which Norton Herrick is the sole shareholder, entered into a letter agreement
(the "Letter Agreement") with the purchasers of Notes in the Offering pursuant
to which they granted to the holders of the Notes in the event of an Event of
Default (as defined in the Notes) the rights to receive payment under certain
secured indebtedness owed by us to Norton Herrick and Huntingdon and to exercise
their rights under security agreements securing such secured indebtedness.
Pursuant to the Letter Agreement, Norton Herrick and Huntingdon also executed
Powers of Attorney in favor of a representative of the Noteholders pursuant to
which such representative may, following an Event of Default, take actions
necessary to enforce the Note holders rights under the Letter Agreement,
including enforcing Norton Herrick's and Huntingdon's rights under the security
agreements. The January 2004 Notes were converted into common stock on April 12,
2004.
On April 28, 2004, we entered into a new credit agreement. Norton
Herrick, Huntingdon and N. Herrick Irrevocable ABC Trust (the "Trust"), of which
Norton Herrick is the beneficiary, consented to the new credit agreement and the
other transactions described above and entered into a subordination agreement
with Zohar. The new credit agreement required the aggregate amount of principal
and interest owed by MediaBay to Herrick, Huntingdon and the Trust be reduced to
$6.8 million ("Permissible Debt") by June 1, 2004, and that the Permissible Debt
be further reduced by up to an additional $1.8 million if we do not raise at
least $2.0 million in additional equity in the two calendar years following the
execution of the new credit agreement. As of November 12, 2004, the Company has
raised $900,000 of additional equity.
Pursuant to an agreement dated April 28, 2004, on May 25, 2004, Norton
Herrick exchanged accrued and unpaid interest and dividends (including accrued
and unpaid interest distributed by the Trust to Herrick) owed to Herrick
aggregating $1,181,419 into (i) 11,814 shares of Series C Convertible Preferred
Stock with a liquidation preference of $100 per share convertible into an
aggregate of 1,514,615 shares of Common Stock at an effective conversion price
of $0.78, and (ii) warrants to purchase 3,029,230 shares of Common Stock. The
warrants are exercisable until April 28, 2014 at an exercise price of $0.53.
Pursuant to an agreement dated April; 28, 2004, on May 25, 2004,
Huntingdon exchanged the principal of the $500,000 principal amount note,
$1,000,000 principal amount note, $150,000 principal amount note and $350,000
principal amount note held by Huntingdon, plus accrued and unpaid interest owed
to Huntingdon aggregating $1,171,278 into (i) 31,713 shares of Series C
Convertible Preferred Stock convertible into an aggregate of 4,065,768 shares of
Common Stock at an effective conversion price of $0.78, and (ii) warrants to
purchase an aggregate of 8,131,538 shares of Common Stock. The warrants are
exercisable until April 28, 2014 at an exercise price of $0.53. If the amount of
the Permissible Debt is required to be reduced due to the Company's failure to
raise the requisite additional equity, such reduction will automatically occur
by the exchange of Permissible Debt held by Huntingdon for additional shares of
Series C Convertible Preferred Stock in an aggregate liquidation preference
equal to the amount of debt exchanged and warrants to purchase a number of
shares of Common Stock equal to two times the number of shares of Common Stock
issuable upon conversion of the Series C Convertible Preferred Stock.
Herrick and Huntingdon agreed not to demand repayment of their debt
until the earlier of (i) the repayment of the New Credit Agreement or (ii) June
28, 2007.
The remaining promissory notes held by Herrick, Huntingdon and the
Trust are guaranteed by certain of our subsidiaries and secured by a lien on our
assets and certain of our subsidiaries of the Company.
In connection with Norton Herrick and Huntingdon consenting to the New
Credit Agreement, we agreed to pay to Herrick accounts payable and accrued
expenses due to him as of March 31, 2004 in the amount of approximately
$672,000. Such amounts are being paid to him at the rate of $40,500 per month.
XNH Consulting Services, Inc. ("XNH"), a company wholly-owned by Norton Herrick,
and the Company also modified a termination agreement, in which we had agreed
36
among other things to pay XNH a fee of $7,500 per month for 16 months commencing
on January 1, 2004 and Herrick agreed to provide consulting services at his sole
discretion. The modification eliminated our obligation to make the monthly
payments and our ability to request consulting services from XNH. All other
terms of the termination agreement were unchanged.
On April 28, 2004, the Company repaid $1.6 million principal amount of
the $3.2 million principal amount convertible note issued to ABC Investments,
L.L.C., a principal shareholder of the Company. We issued a new $1.6 million
note (the "New ABC Note") for the remaining principal amount. The New ABC Note
extends the maturity date from December 31, 2004 to July 29, 2007. In exchange
for extending the maturity date, the conversion price of the New ABC Note was
reduced to $0.50. The closing sale price of our common stock on the closing date
was $0.48. During October 2004, ABC Investments, L.L.C. converted $1,000,000
principal amount of the New ABC into shares of Common Stock pursuant to the
terms of the note.
QUARTERLY FLUCTUATIONS
Our operating results vary from period to period as a result of
purchasing patterns of members, the timing, costs, magnitude and success of
direct mail campaigns and Internet initiatives and other new member recruitment
advertising, member attrition, the timing and popularity of new audiobook
releases and product returns.
The timing of new member enrollment varies depending on the timing,
magnitude and success of new member advertising, particularly Internet
advertising and direct mail campaigns. We believe that a significant portion of
our sales of old-time radio and classic video programs are gift purchases by
consumers. Therefore, we tend to experience increased sales of these products in
the fourth quarter in anticipation of the holiday season and the second quarter
in anticipation of Fathers' Day.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
We are exposed to market risk for the impact of interest rate changes.
Historically, we have not entered into derivative transactions for hedging,
trading or speculative purposes.
The Company's exposure to market risk for changes in interest rates
relates to its variable rate debt. The Company has total debt outstanding, not
including debt discount, as of November 12, 2004 of $18.4 million, of which $6.5
million is at fixed rates, $9.4 million bears interest at LIBOR plus 10% and
$2.5 million bears interest at prime plus 2.5%. If the prime rate or LIBOR were
to increase the Company's interest expense would increase, however a
hypothetical 10% change in interest rates would not have had a material impact
on its fair values, cash flows, or earnings for the three and nine months ended
September 30, 2004.
Item 4. Controls and Procedures
As of the end of the period covered by this report, an evaluation was
carried out under the supervision and with the participation of our management,
including the Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO"), of the effectiveness of our disclosure controls and procedures. Based
on that evaluation, the CEO and CFO have concluded that our disclosure controls
and procedures are effective at the reasonable assurance level to timely alert
them of information required to be disclosed by us in reports that we file or
submit under the Securities Exchange Act of 1934. During the nine months ended
September 30, 2004 there were no changes in our internal controls over financial
reporting that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
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PART II - OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS (DOLLARS IN THOUSANDS, EXCEPT
PER SHARE DATA)
During the three months ended September 30, 2004, we issued plan
options to purchase 907,500 shares of its common stock our officers, employees,
directors and consultants. The options have exercise prices ranging from $0.33
to $0.39 vest at various times and have a five-year exercise period. These
securities were issued pursuant to an exemption from the registration
requirements offered by Section 3(a)(9) of the Securities Act of 1933. Also
during the three months ended September 30, 2004, options to purchase 39,000
shares of Common Stock expired.
ITEM 6: EXHIBITS
10.1 Employment Agreement between the Registrant and Joseph R. Rosetti
10.2 Employment Agreement between the Registrant and John F. Levy
10.3 Consent and Amendment No. 1 dated November 12, 2004, to the Credit
Agreement dated as of April 28, 2004
31.1 Chief Executive Officer Certification Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of Jeffrey Dittus, Chief Executive Officer of
MediaBay, Inc., pursuant to 18 U.S.C Section 1350, as Adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of John Levy, Vice Chairman and Chief
Financial Officer of MediaBay, Inc., pursuant to 18 U.S.C Section
1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 20
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, MediaBay, Inc. has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
MediaBay, Inc.
Dated: November 15, 2004 By: /s/ Jeffrey Dittus
-------------------------------
Jeffrey Dittus
Chief Executive Officer
Dated November 15, 2004 By: /s/ John F. Levy
-------------------------------
John F. Levy
Vice Chairman and Chief Financial Officer
(principal accounting and financial officer)
39