SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934. For the fiscal year ended December 31, 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 001-13469
MEDIABAY, INC.
- -------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Florida 65-0429858
- ----------------------------------------- ---------------------------------
(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
2 Ridgedale Avenue 07927
Cedar Knolls, NJ ---------------------------------
- ----------------------------------------- (Zip Code)
(Address of principal executive offices)
973-539-9528
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
----------------------------------------------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
------------
(Title of Class)
Indicate by check mark whether the Registrant: (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filling requirements for
the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained in this form, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
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|
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of June 30, 2004 (the last business day of the Registrant's
most recently completed second fiscal quarter) was approximately $6,647,500.
As of March 28, 2005, there were 35,406,151 shares of the Registrant's Common
Stock outstanding.
Documents Incorporated by Reference:
None
MEDIABAY, INC.
Form 10-K
Table of Contents
ITEM I 1
Item 1. Business 1
Item 2. Properties 17
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
PART II 18
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 18
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 44
Item 8. Financial Statements and Supplementary Data 44
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 44
Item 9A. Controls and Procedures 44
Item 9B. Other Information 44
PART III 45
Item 10. Directors and Executive Officers of the Registrant 45
Item 11. Executive Compensation 48
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 52
Item 13. Certain Relationships and Related Transactions 53
Item 14. Principal Accountant Fees and Services 57
PART IV 58
Item 15. Exhibits, Financial Statements Schedules, and Reports on Form 8-K 58
PART I
Item 1. Business
Forward-looking Statements
Certain statements in this Form 10-K and in the documents incorporated by
reference in this Form 10-K constitute "forward-looking" statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All statements
other than statements of historical facts included in this Report, including,
without limitation, statements regarding our future financial position, business
strategy, budgets, projected costs and plans and objectives of our management
for future operations are forward-looking statements. In addition,
forward-looking statements generally can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe," or "continue" or the negative thereof or
variations thereon or similar terminology. Although we believe that the
expectations reflected in such forward-looking statements are reasonable, we
cannot assure you that such expectations will prove to be correct. These forward
looking statements involve certain known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any results, performances or achievements expressed
or implied by such forward-looking statements. Important factors that could
cause actual results to differ materially from our expectations, include,
without limitation our ability to implement our new strategy and transition our
business and the risks related thereto: our history of losses and declining
revenues; our ability to license and sell new spoken word content, obtain
additional financing, anticipate and respond to changing customer preferences,
license and produce desirable content, protect our databases and other
intellectual property from unauthorized access, and collect receivables;
dependence on third-party providers, suppliers and distribution channels;
competition; the costs and success of our marketing strategies, product returns,
member attrition; and risks relating to our capital structure. Undue reference
should not be placed on these forward-looking statements, which speak only as of
the date hereof. We undertake no obligation to update any forward-looking
statements.
Introduction
We are a digital media and publishing company specializing in spoken audio
entertainment. We have over 75,000 hours of audio content, which we distribute
via mail order, our websites, some of the nation's largest retailers, and a la
carte, digital downloads and subscription services.
Today we have two principal content libraries; (1) Audiobooks: which we license
from the nation's largest publishing houses to sell on CD and cassette through
the Audio Book Club and which we intend to distribute via digital downloads on
third-party websites and a digital download service that is under development;
and (2) An archive of the history of American radio which we produce and sell on
CD and cassettes through our catalog, a mail order based continuity program,
retail outlets, and our on-line download subscription service and third-party
websites, of which one is currently operational. We broadcasts our radio
programs through a syndicated radio show on 200 commercial stations across the
United States, as well as its 24-hour Radio Classics channels on Sirius and XM
Satellite Radio.
We are transitioning our business from selling hard goods primarily via mail
order to digital distribution via wireless and Internet downloads. Our
distribution strategy is two pronged: (1) to wholesale our audio content to the
leading music services and broadband companies on a white label basis, both
domestically and internationally; and (2) to operate our own downloadable
1
content stores and subscription services which are intended to be branded via
partnerships with celebrities and corporate affiliates, each chosen specifically
to reach the targeted demographics known to be interested in its content. We
intend to use various means to market our downloadable content stores, including
working with manufacturers of digital music players, smart phones, and PDA's to
include samples of our audio content for consumers to preview when they purchase
these new devices, with the hope that that these samples will attract consumers
to our content stores.
We recently executed distribution agreements with Microsoft's MSN Music to
provide our spoken word content to the MSN audience, which has 350 million
unique monthly visitors. We have also executed a distribution agreement with
Loudeye to act as our digital sales agent in distributing our catalog to
potentially 70 music services which that company hosts and sources content for.
In addition, we expect to launch an on-demand, download and subscription service
in partnership with Larry King in 2005, and have begun to make our Classic Radio
library available for ring tone distribution.
Today, some of our largest digital content partners include Simon & Schuster,
Random House, Harper Collins, Penguin Group (USA) Audio, Hay House, Sound Room
Publishers, Oasis, Zondervan, BBC, Blackstone, and CBS Radio.
March 2005 Financing
On March 23, 2005, we received an infusion of $35 million in private equity
financing from several institutional investors. We retired all of our borrowings
and our cash reserves increased to approximately $16.5 million. Because of this
financing, we believe that we have sufficient cash to implement our new
strategy, including required marketing expenditures, for at least twelve months.
Strategy
In response to the music industry's recent success in creating a market for
legal digital downloads using digital rights management solutions that are
intended to prevent piracy of copyrighted content, we intend to become a leading
distributor for downloadable, spoken word audio entertainment. We intend to
build this new distribution channel by utilizing our nearly twelve years of
experience operating the Audio Book Club and our old-time radio business. During
those twelve years, we have serviced approximately 2.9 million customer accounts
and plan to leverage this list of audio buyers to attract new digital shoppers.
We intend to use the Windows Media Digital Rights Management (DRM) system, and
other easy to use, rights management technologies that may evolve over time.
Beginning this past Christmas season, 70 new digital devices that support the
Microsoft "PlaysforSure(TM)" digital rights management and device platform
became available for sale by many of the leading device manufacturers. Examples
of companies offering a "PlaysforSure(TM)" device include Hewlett Packard, Dell,
Creative, Rio, i-River and Samsung. Many of these devices have large file
storage capacities and make, what we believe, could be a perfect match for our
content, which is typically one half hour in length for our classic radio shows,
to an average of 6 to10 hours for an audiobook.
In addition, the rapid evolution of cell and smart phones with hard drives and
media players presents a large potential user base of digital devices for our
content, as more than 500 million new handsets are sold each year in the market
place. These portable devices, coupled with the ubiquitous installed base of
personal computers with CD burners and USB port memory discs are making digital
audio content portable and more accessible to users.
We believe the proliferation of broadband Internet service, the Microsoft
digital rights management solution, and an expanding user base of portable
devices have created an inflection point where downloads are a better way to
2
distribute audio than traditional CDs and tapes via a retail store or by mail
order. Broadband Internet and ubiquitous wireless networks means companies like
MediaBay can deliver audio files quickly and affordably. Downloads provide
consumers a more convenient way to purchase audio in real time and provides
incredible opportunity for broad choice since there are no inventory
requirements. This distribution is better for the environment and most
importantly, provides real savings for the consumer.
We have determined that future investment in our mail order, hard goods based,
Audio Book Club would not provide the returns adequate to justify future
expenditures. Accordingly, in 2004, we discontinued marketing to attract new
Audio Book Club members and are developing plans to transition current members
to new programs including encouraging existing members to begin downloading
spoken word.
Online Agreement with Microsoft
The first step in executing our new strategy is our agreements with Microsoft.
These agreements provide for us to distribute spoken word audio content,
including audiobooks from the largest publishers and our old-time radio
programs, through an exclusive distribution relationship with the new MSN Music
Service. Today, MSN has an audience of 350 million unique monthly visitors.
Microsoft has announced that the new music service will have the largest
selection of songs and audio content of any service and will be compatible with
the most number of digital devices, leveraging its industry leading windows
media player and windows digital rights management platform.
Online Agreement with Loudeye
We have also announced a multi-year agreement with Loudeye Corp., a worldwide
leader in business-to-business digital media solutions. Loudeye is working with
us to provide a solution for powering digital distribution of a wide range of
audiobooks. Under the agreement, we intend to make available our audiobook
content catalog to Loudeye for both domestic and international distribution,
subject to obtaining appropriate international rights, to new and existing
Loudeye partners. Loudeye and its OD2 services have relationships with more than
70 web storefronts and music services throughout the United States, Europe and
Australia.
Larry King Opportunity
Celebrity Interactive LLC, Larry King and MediaBay have signed an endorsement
and promotion agreement, which MediaBay intends to use to reach first time
downloaders and the large and diverse Larry King fan base to help us build a new
digital service. We intend to utilize the arrangement with Larry King to form a
Larry King audio entertainment and education service. This digital service is
being designed to allow consumers to shop and download a broad selection of
content, including but not limited to, audiobooks, classic radio programs,
educational materials, self-help titles, and current events. We anticipate that
the titles will be available for download directly to the personal computer or
other digital devices.
Open Standard Platform Technology
We have chosen to leverage the proliferation of the Windows Media DRM platform
as the de facto rights management standard for content owners to protect their
intellectual property on the Internet. According to a report from the
International Federation of the Phonographic Industry (IFPI) trade group, the
number of online music stores quadrupled to more than 230 in 2004. In the United
States, the overwhelming majority of these stores have adopted the Windows Media
3
DRM as their solution to protect content owners intellectual property and to
transfer files to digital hand held devices. This trend is certain to improve
consumer choice as it allows consumers to shop in a broad range of stores, but
maintain the flexibility to switch devices over time as functionality improves
without having to worry about media format conversion issues that closed
proprietary systems, such as Apple i-Tunes, create. On-line music stores in the
United States that use the Window's DRM system include such companies as
RealNetworks, MSN Music, Wal-Mart, Napster, Music Maker, Yahoo's Music Match,
Buy.com, Music Now, and VirginDigital. The competing storefronts, which use
proprietary DRM technologies or closed systems, are Sony, Apple and Audible.
Industry Background
A major trend over the thirty years in the United States is to work longer
hours, spend more time in the automobile commuting to and from work, and thus
have less time for leisure activities. According to Harris Interactive, since
1973, the median number of hours that people say they work has jumped from 41
hours a week to 49. Over the same period, Harris reports that people's leisure
time has dropped from 26 to 19 hours per week. Listening is a way for
individuals to consume content at times when they are unable to read, such as
when they are driving. The 2003 edition of the Veronis Suhler Stevenson
Communications Industry Forecast estimates that on average Americans spent more
than 20 hours a week listening to the radio in 2003, compared to 17.7 hours in
1998. In comparison, Veronis Suhler Stevenson estimates that book reading
declined among Americans from an average of 2.3 hours in 1998 to 2.1 hours per
week in 2003. According to the 2000 United States Census, 97 million people
drive to and from work alone, an increase of 15% from 1989. The average travel
time to work increased to 25.5 minutes each way, an increase of 7% from 1990. In
addition, more than 42 million individual drivers have a commute of at least 30
minutes or more each way.
As individuals look to use their commuting time more efficiently and manage an
increasing amount of available content, audiobooks have emerged as a
personalized "pay-to-listen" alternative to radio, because radio does not allow
listeners to control when they listen to a particular program.
According to the Audio Publishers Association 2003 Sales Survey, the U.S. market
for audiobooks on cassette and CD sold in retail stores grew to $800 million in
2001. The APA also estimated that 25 million American households listened to
audiobooks in 2002, and that in 2002 audiobooks were the "fastest growing
segment of the publishing industry".
This increasing usage of audiobooks exists despite limited types of content,
high prices and the limitations of cassette tapes and CDs. For instance, the
audiobook market based on retail sales does not include the many audiobooks and
other spoken word products sold to consumers directly or in vertical markets
such as personal improvement, training, and educational markets, nor does it
address the emerging market in personalized "time-shifted" radio programming or
timely print content such as newspapers, newsletters, magazines, and journals.
The Internet has emerged as a powerful global communications and entertainment
medium, giving millions of people the ability to access large amounts of
valuable, pay-for-access media. Jupiter Research reported that as of the end of
2003, 21.5 million households, or about one-fifth of U.S. households, were
connected to the Internet via broadband. Based on historic growth rates and
current trends around broadband availability, interest, and pricing, Jupiter
Research forecasts that by 2008, 46 million households, representing half of
online households and 40% of all U.S. households will connect via high-speed,
always-on technologies. Through the Internet, people can buy various forms of
information and entertainment, from books to music and video for usage both at
and away from the computer.
4
According to International Data Corporation (IDC), mobile access to the
Internet, instant messaging, music, and more are spurring a nearly fivefold
run-up in worldwide sales of smart handheld devices by 2004, creating a market
for those products valued at approximately $26 billion.
In December 2003, Jupiter Research published a report that predicted the demand
for MP3 players in the U.S. would grow at a rate of 50% a year through 2006.
According to Jupiter, shipments of MP3 players in the U.S. were about 3.5
million in 2003, which are almost double 2002 figures. Jupiter also predicted
that there would be more than 26 million MP3 players in use by 2006 and that
starting in 2004, the demand for players with hard drives will surpass that of
players with flash memory. The DVD player market, which we believe is a valid
comparative model, has grown from 11.4 million U.S. households in 2000 to 39.3
million in 2003 according to the Consumer Electronics Association, with an
average price of $490 in 1997 to an estimated $138 in 2003.
The market for personal digital assistants that have digital audio capabilities
had been led by Pocket PCs -- devices running on Microsoft operating systems
which are manufactured by Hewlett-Packard, Toshiba, and Dell among others.
Gartner Group has reported that sales of smartphones were significant enough in
the U.S. to slow the sales of PDAs. Research firm IDC published a report in
February 2004 estimated that smartphones showed significant growth and future
promise. In 2003, the worldwide smartphone market grew 181% year-over-year to
9.6 million units.
The key characteristic of smartphones that enable the download of spoken word
content is the inclusion of enough internal memory to store our audio content.
Since most smartphones "dock" to computers, allowing for data exchange of
contact and schedule information, spoken word can also be transferred to
smartphones via a personal computer.
We are seeking to develop relationships with cell phone companies and other high
technology providers. Wireless handheld technology is the ideal match for the
download spoken word business. The combination of wireless freedom and digital
transmission will in the future allow a consumer to download from a library of
audio recordings and bypass the anchored desktop PC. This freedom to download
wirelessly will allow unprecedented convenience for consumers.
Current Businesses
Audio Book Club is a membership-based club with licenses from publishers to
distribute audiobooks in a club format. This business is modeled after
traditional book-of-the month. Radio Spirits, which we believe, is the world's
largest seller of old-time radio shows, sells on audiocassettes and compact
discs through retail, direct mail and online channels. Our radio library
consists of thousands of famous old-time radio shows, many of which it licenses
exclusively.
Our content library consists of more than 75,000 hours of spoken audio content
including audiobooks and old-time radio shows. The majority of our content is
acquired under license from the rights holders enabling us to manufacture the
product giving us lower costs for goods sold than other companies.
Our customer base includes over 2.9 million spoken audio buyers who have
purchased via catalogs and direct mail marketing. Our old-time radio products
are sold in retail locations including Barnes & Noble, Borders, Wal-mart and
Cracker Barrel Old-Time Stores.
We report financial results on the basis of four reportable 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. Our four divisions serving the spoken
word audio industry are as follows:
5
Audio Book Club
We believe that Audio Book Club, which is modeled after the traditional
"Book-of-the-Month Club" format, is the largest membership-based audiobook club.
The club's total account file, which includes active and inactive accounts, was
approximately 2.5 million accounts at December 31, 2004.
We have determined that future investment in Audio Book Club would not provide
the returns adequate to justify future expenditures. Accordingly we have
discontinued marketing to attract new Audio Book Club members and are developing
plans to transition current members to new programs including encouraging
existing members to begin downloading spoken word. Due to the lack of new member
marketing expenditures revenue in Audio Book Club declined $14.1 million, or
53.3% to $12.3 million for the year ended December 31, 2004 from $26.4 million
for the year ended December 31, 2003 and we expect revenue derived from the
Audio Book Club to continue to decline. The Audio Book Club accounted for
approximately 64.7% of revenues in 2004.
Radio Spirits
We believe Radio Spirits is the world's largest seller of old-time radio shows,
which it sells on audiocassettes and compact discs through retail, direct mail
and online channels. Radio Spirits has a database of names of more than 400,000
catalog customers and prospects and sells its products in such well-known
national chains as Barnes & Noble, Borders, Wal-Mart, Cracker Barrel Old Country
Stores and online retailers such as Amazon.com. Radio Spirits' products can also
be purchased online at www.radiospirits.com. The Radio Spirits content library
consists of more than 65,000 hours of classic radio shows licensed on a
primarily exclusive basis. Radio Spirits' library of classic radio shows
includes episodes from the following notable series: The Shadow, The Jack Benny
Program, The Bob Hope Show, Superman, Suspense and many others including famous
stars such as Clark Gable, Cary Grant, Humphrey Bogart, Jimmy Stewart, Lucille
Ball, Frank Sinatra, Judy Garland, Orson Welles and Bing Crosby. Radio Spirits
also offers its old-time radio programs in a continuity format, a marketing
program that automatically sends selections to a customer once an initial order
is placed. Radio Spirits accounted for approximately 35.3% of MediaBay's revenue
in 2004.
MediaBay.com
MediaBay.com provides the infrastructure and support for all of our web sites
including www.audiobookclub.com, www.radiospirits.com, and
www.RadioClassics.com. It is expected that MediaBay.com will power our new
digital audio download services.
RadioClassics Division
RadioClassics was created to distribute our proprietary old-time radio content
across multiple distribution platforms including traditional radio, cable
television, satellite television (DBS), satellite radio and the Internet.
RadioClassics currently distributes a national "classic" radio program, "When
Radio Was" and can also be heard on dedicated channels on both the Sirius
Satellite Radio and XM Satellite Radio services.
Competition
We compete for discretionary consumer spending with other mail order clubs and
catalogs and other direct marketers and traditional and on-line retailers that
offer products with similar entertainment value as audiobooks and old-time radio
programs, such as music on cassettes and compact discs, printed books, videos,
and laser and digital video discs. Many of these competitors are
well-established companies, which have greater financial resources.
6
We will compete for consumers of spoken word content with other Internet-based
audio distributors, as well as with our existing, competitors, such as
distributors of audio on cassette tape or compact disc. The business of
providing content over the Internet is experiencing rapid growth and is
characterized by rapid technological changes, changes in consumer habits and
preferences, and the emergence of new and established companies. We will also
continue to compete with (i) book store chains deep-discount retailers, retail
stores, mass merchandisers, mail order catalogs, clubs, and libraries that sell,
rent, or loan audiobooks on cassette tape or compact disc, such as Borders,
Barnes & Noble, (ii) online retailers such as Amazon.com, (iii) websites that
offer streaming access to spoken audio content using tools such as the
RealPlayer or Windows Media Player, (iv) other companies offering services
similar to ours, such as Audible AudioFeast, and (v) online and Internet portal
companies such as America Online, Inc., Yahoo! Inc., and iTunes, which are
either offering or have the potential to offer audio content. Moreover Audible,
Inc., has begun to establish itself as a leader in downloadable spoken word
content distribution.
Intellectual Property
We have several United States registered trademarks and service marks for
slogans and designs used in our advertisements, member mailings and member
solicitation packages, including the Audio Book Club logo, "MediaBay," "Radio
Spirits", "MediaBay.com," "audiobookclub.com" and the MediaBay logos. We believe
that our trademarks and service marks have significant value and are important
to our marketing. We also own or license the rights to substantially all of our
radio programs in our content library.
We rely on trade secrets and proprietary know-how and employ various methods to
protect our ideas, concepts and membership database. In addition, we typically
obtain confidentiality agreements with our executive officers, employees, list
managers and appropriate consultants and service suppliers.
Employees
As of March 28, 2005 we had 35 full-time employees. Of these employees, 3 served
in corporate management; 16 served in operational positions at our Audio Book
Club operations; 9 served in operational positions at our MediaBay.com and
information systems operations and 7 served in operational positions at our
old-time radio operations. We believe our employee relations to be good. None of
our employees are covered by a collective bargaining agreement.
RISK FACTORS
Risks Relating to our Operations
We have a history of losses, are not currently profitable, and expect to incur
losses in the future. Since our inception, we have incurred significant losses.
As of December 31, 2004, we had incurred an accumulated deficit of approximately
$133 million. Losses are continuing and are expected to continue. We may not be
able to achieve and sustain profitable operations.
Our revenues have declined significantly and will continue to decline. We do not
intend to devote sufficient funds to market to attract new Audio Book Club
members and our revenue bases will continue to erode.
Because we significantly reduced our marketing expenditures for new members, our
club membership and revenues declined significantly. Sales for the year ended
December 31, 2004 decreased $17.8 million or 48.6% to $18.8 million as compared
to $36.6 million for the year ended December 31, 2003. Audio Book Club sales
decreased by $14.1 million to $12.3 million for the year ended December 31, 2004
7
from $26.4 million for the year ended December 31, 2003 principally due to a
decrease in club membership as a result of a reduction in our advertising
expenditures for new members. We do not anticipate conducting any significant
new member acquisition marketing of Audio Book Club as we have moved to a new
strategy to grow our business, as a result, our revenues will continue to
decline until such time, if ever, as we successfully implement our new
strategies.
Our products are sold in a niche market that may have limited future growth
potential.
Consumer interest in audiobooks and old-time radio may decline in the future,
and growth trends in these markets may stagnate or decline. A decline in the
popularity of audiobooks and old-time radio would limit our future growth
potential and negatively impact our future operating results.
We may be unable to anticipate changes in consumer preference for our products
and may lose sales opportunities.
Our success depends largely on our ability to anticipate and respond to a
variety of changes in the audiobook and old-time radio industries. These changes
include economic factors affecting discretionary consumer spending,
modifications in consumer demographics and the availability of other forms of
entertainment. The audiobook and old-time radio markets are characterized by
changing consumer preferences, which could affect our ability to:
o plan for product offerings;
o introduce new titles;
o anticipate order lead time;
o accurately assess inventory requirements; and
o develop new product delivery methods.
We may not be able to license or produce desirable spoken word content, which
could reduce our revenues.
We could lose sales opportunities if we are unable to continue to obtain the
rights to additional premium spoken word content. We rely on third-party content
providers to offer downloads of premium spoken word content. These third party
providers include publishers. In some cases, we may be required to pay
substantial fees to obtain this third party content. In order to provide a
compelling service, we must license a wide variety of spoken word content to our
customers with attractive usage rules such as CD recording, output to digital
audio devices, portable subscription rights and other rights. In addition, if we
do not have sufficient breadth and depth of the titles necessary to satisfy
increased demand arising from growth in our customer base, our customer
satisfaction may be affected adversely. We cannot guarantee that we will be able
to secure licenses to spoken word content or that such licenses will be
available on commercially reasonable terms. Some of our license agreements
expire over the several months unless they are renewed.
In addition, we have an agreement with a publisher under which we made periodic
payments for a series of audiobook titles. The agreement provides us to make
additional payments of approximately $700,000, some of which is past due. We do
not believe that we can profitably license the additional titles and we are
negotiating with the publisher to revise, amend or cancel the agreement.
If our third-party providers fail to perform their services properly, our
business and results of operations could be adversely affected.
Third-party providers conduct all of our Audio Book Club and a majority of our
Radio Spirits customer service operations, process orders and collect payments
8
for us. If these providers fail to perform their services properly, Audio Book
Club members and Radio Spirits' customers could develop negative perceptions of
our business, collections of receivables could be delayed, our operations might
not function efficiently, our expenses may increase and our revenue may decline.
Our fulfillment agreement with a third-party provider, which provides virtually
all of the services for our Audio Book Club, expires April 2005 and new
arrangements may be more expensive and create disruptions in service to our
Audio Book Club members.
Our fulfillment agreement with the third-party provider, which provides
virtually all of the services for our Audio Book Club expires, April 2005. While
we are negotiating to extend such agreement to continue on a month-to-month
basis, we cannot assure you that we will be able to enter into such an agreement
Moreover, we anticipate that a month-to-month agreement will result in higher
fulfillment costs. If we are required or elect to change fulfillment providers,
there may be significant disruptions to our Audio Book Club members, which could
result in decreased orders and higher returns and bad debts.
If our marketing strategies to acquire new customers are not successful our
sales will decline and our costs could increase. If our direct mail and other
marketing strategies are not successful, our per member acquisition costs may
increase and we may acquire fewer new members than anticipated or the members we
do acquire may not purchase as many products as we anticipate, return products
at a higher rate than we expect or fail to pay for their purchases. As a result,
our operating results would be negatively impacted and our sales growth would be
inhibited.
The public may become less receptive to unsolicited direct mail campaigns.
The success of our direct mail campaigns is dependent on many factors including
the public's acceptance of direct mail solicitations. Negative public reception
of direct mail solicitations will result in lower customer acquisitions rates
and higher customer acquisition costs and will negatively impact operating
results and sales growth.
New laws addressing the sending of e-mails may limit our ability to market or
subject us to penalties. New laws recently enacted to limit "spam" e-mails may
impact our ability to conduct e-mail campaigns. While we attempt to only use
"opt-in" e-mail addresses and to work with third parties whose lists consist of
"opt-in" e-mails, the law may limit the number of third parties whose lists we
can use or significantly reduce the number of e-mails within these lists.
Limitations on our ability to continue the use of e-mail marketing campaigns
could adversely affect our ability to attract new Audio Book Club members and
increase our cost to acquire new members.
The closing of retail stores, which carry our products could negatively impact
our wholesale sales of these products. Bankruptcy filings by major retailers may
limit the number of outlets for our old-time radio products. With fewer chains
and stores available as distribution outlets, competition for shelf space will
increase and our ability to sell our products could be impacted negatively.
Moreover, our wholesale sales could be negatively impacted if any of our
significant retail customers were to close a significant number of their
locations or otherwise discontinue selling our products.
If third parties obtain unauthorized access to our member and customer databases
and other proprietary information, we would lose the competitive advantage they
provide. We believe that our member file and customer lists are valuable
proprietary resources, and we have expended significant amounts of capital in
acquiring these names. Our member and customer lists, trade secrets, trademarks
and other proprietary information have limited protection. Third parties may
9
copy or obtain unauthorized access to our member and customer databases and
other proprietary know-how, trade secrets, ideas and concepts.
Competitors could also independently develop or otherwise obtain access to our
proprietary information. In addition, we rent our lists for one-time use only to
third parties that do not compete with us. This practice subjects us to the risk
that these third parties may use our lists for unauthorized purposes, including
selling them to our competitors. Our confidentiality agreements with our
executive officers, employees, list managers and appropriate consultants and
service suppliers may not adequately protect our trade secrets. If our lists or
other proprietary information were to become generally available, we would lose
a significant competitive advantage.
If we are unable to collect our receivables in a timely manner, it may
negatively impact our cash flow and our operating results. We experienced bad
debt rates of approximately 4.4% and 10.8% during the year ended December 31,
2004 and 2003, respectively. We are subject to the risks associated with selling
products on credit, including delays in collection or uncollectibility of
accounts receivable. If we experience significant delays in collection or
uncollectibility of accounts receivable, our liquidity and working capital
position could suffer and we could be required to increase our allowance for
doubtful accounts, which would increase our expenses and reduce our assets.
Increases in costs of postage could negatively impact our operating results. We
market through direct mailings to both our customers and prospective customers,
and postage is a significant expense in the operation of our business. We do not
pass on the costs of member mailings and member solicitation packages. Even
small increases in the cost of postage, multiplied by the millions of mailings
we conduct, would result in increased expenses and would negatively impact our
operating results.
We face significant competition from a wide variety of sources for the sale of
our products. We may not be able to compete effectively because of the
significant competition in our markets from many competitors, many of whom are
better financed and have greater resources and from other competing products,
which provide similar entertainment value. We compete with other web sites,
retail outlets and catalogs, which offer similar entertainment products or
content, including digital download of spoken word content. New competitors,
including large companies, may elect to enter the markets for audiobooks and
spoken word content. We also compete for discretionary consumer spending with
mail order clubs and catalogs, other direct marketers and retailers that offer
products with similar entertainment value as audiobooks and old-time radio and
classic video programs, such as music on cassettes and compact discs, printed
books, videos, and DVDs. Many of these competitors are well-established
companies, which have greater financial resources that enable them to better
withstand substantial price competition or downturns in the market for spoken
word content.
A decline in current levels of consumer spending could reduce our sales. The
level of consumer spending directly affects our business. One of the primary
factors that affect consumer spending is the general state of the local
economies in which we operate. Lower levels of consumer spending in regions in
which we have significant operations could have a negative impact on our
business, financial condition or results of operations.
We have not fully complied with the terms of all of our license agreements and
failure to do so may impair our ability to license products from some
rightsholders. As of the December 31, 2004, certain royalty payments have not
been made and there have been no requests for royalty statements or payments in
10
connection therewith. The publishers and other rightsholders have not requested
royalty statements or payments. These amounts are accrued for and reflected in
the Company's financial statements.
11
If we are unable to complete our assessment as to the adequacy of our internal
control over financial reporting when required and future year-ends as required
by Section 404 of the Sarbanes-Oxley Act of 2002, investors could lose
confidence in the reliability of our financial statements, which could result in
a decrease in the market price of our common stock.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and
Exchange Commission adopted rules requiring public companies to include a report
of management on the issuer's internal control over financial reporting in their
annual reports on Form 10-K. This report is required to contain an assessment by
management of the effectiveness of such issuer's internal controls over
financial reporting. In addition, the public accounting firm auditing a public
company's financial statements must attest to and report on management's
assessment of the effectiveness of the company's internal controls over
financial reporting. While we anticipate expending significant resources in
developing the necessary documentation and testing procedures required by
Section 404, there is a risk that we will not comply with all of the
requirements imposed by Section 404. If we fail to implement required new or
improved controls, we may be unable to comply with the requirements of SEC 404
in a timely manner. This could result in an adverse reaction in the financial
markets due to a loss of confidence in the reliability of our financial
statements, which could cause the market price of our common stock to decline
and make it more difficult for us to finance our operations.
The effectiveness of our disclosure and internal controls may be limited. Our
disclosure controls and procedures and internal controls over financial
reporting may not prevent all errors and intentional misrepresentations. Any
system of internal control can only provide reasonable assurance that all
control objectives are met. Some of the potential risks involved could include
but are not limited to management judgments, simple errors or mistakes, willful
misconduct regarding controls or misinterpretation. There is no guarantee that
existing controls will prevent or detect all material issues or be effective in
future conditions, which could materially and adversely impact our financial
results in the future.
Additional Risks Relating to Our Change in Strategy and Our Downloadable Spoken
Word Content Offerings and Online Initiatives.
Our new strategy to focus on downloadable spoken word content and our proposed
Larry King online initiatives is subject to many uncertainties and could result
in continuing losses and declining revenues until such time, if ever, it is
successfully implemented.
Historically, we have sold audiobooks through a membership club format and other
spoken word content, substantially all in hard goods format (audio cassettes and
CDs). Over the past two years, we significantly reduced our new member and
customer marketing activities. We intend to pursue a new strategy of pursuing
the opportunities to sell downloadable spoken word content and selling hard good
format content online. We have limited experience in the emerging and
competitive downloadable content distribution business and cannot assure you
that we will be successful in transiting, operating and growing our business.
Because we intend to pursue a new strategy, which focuses on downloadable spoken
word content and our proposed on-line club, we intend to phase out the Audio
Book Club and will not devote the funds necessary to acquire new members to
offset member attrition and/or expand our existing membership and customer
bases. As a result, our revenue will continue to decline, which will continue to
negatively impact our performance. We expect this trend to continue until such
time, if even, as we generate significant revenue from the sale of downloadable
12
spoken word content and attract and establish a meaningful customer base for our
online Larry King website. We do not expect to begin to offer downloadable
spoken word content until at least June 2005 or launch our proposed Larry King
website until at least June 2005. There can be no assurance that we will meet
these launch dates, or be able to successfully implement our new strategies or
that implementation will result in increased revenues or profitable operations.
The download spoken word distribution business is new and rapidly evolving and
may not prove to be a profitable or even viable business model. Download spoken
word distribution services are a relatively new business model for delivering
digital media over the Internet. It is too early to predict whether consumers
will accept, in significant numbers, online spoken word content services and
accordingly whether the services will be financially viable. If download spoken
word distribution services do not prove to be popular with consumers, or if
these services cannot sustain any such popularity, our business and prospects
would be harmed.
Our proposed Larry King on-line service may not attract new customers. We have
signed an agreement with Larry King to form an online Larry King audio
entertainment and education service, which we believe could build an income
stream to replace the current negative option audiobook club. The celebrity
spokesman and associated public relations activities are expected to lower
acquisition costs of new members. We have not completed the design and
development of our proposed Larry King web site and related strategies and
cannot assure you that we will be successful in operating and growing the web
site. If our efforts are not successful, we will not generate sufficient
revenues to offset the expected continuing declining revenues from our Audit
Book Club. Moreover, there can be no assurance that we will be able to reduce
our cost of acquiring new members and overall operating costs as compared to our
Audio Book Club.
The market for our service is uncertain and consumers may not be willing to use
the Internet to purchase spoken audio content, which could harm our business.
Downloading audio content from the Internet is a relatively new method of
distribution and its growth and market acceptance is highly uncertain. Our
success will depend in large part on more widespread consumer willingness to
purchase and download spoken audio content over the Internet. Purchasing this
content over the Internet involves changing purchasing habits, and if consumers
are not willing to purchase and download this content over the Internet, our
revenue will be limited, and our business will be materially and adversely
affected. We believe that acceptance of this method of distribution may be
subject to network capacity constraints, hardware limitations, company computer
security policies, the ability to change user habits, and the quality of the
audio content delivered.
Manufacturers of electronic devices may not manufacture, make available, or sell
a sufficient number of products suitable for our service, which would limit our
revenue growth. If manufacturers of electronic devices do not manufacture, make
available, or sell a sufficient number of electronic devices enabled with the
Windows Media Platform for downloadable spoken word content or if these players
do not achieve sufficient market acceptance our sales could be adversely
affected and our business will be materially and adversely affected. Microsoft
competes with others for relationships with manufacturers of electronic devices
with audio playback capabilities. Manufacturers of electronic devices have
experienced delays in their delivery schedule of their digital players due to
parts shortages and other factors. Although the content we intend to provide can
be played on personal computers and burned to CDs for later listening, we
believe that a key to our future success is the ability to playback this content
on hand-held electronic devices that have digital audio capabilities.
13
We must provide digital rights management solutions that are acceptable to both
content providers and consumers. We must provide digital rights management
solutions and other security mechanisms in our download spoken word distribution
services in order to address concerns of content providers and authors, and we
cannot be certain that content licensors or consumers will accept them. Content
providers may be unwilling to continue to support portable subscription
services. Consumers may be unwilling to accept the use of digital rights
management technologies that limit their use of content, especially with large
amounts of free content readily available.
Third-party providers of digital rights management software, such as Microsoft,
may be unwilling to continue to provide such software to us upon reasonable or
any terms. If we are unable to acquire these solutions on reasonable or any
terms, or if customers are unwilling to accept these solutions, our business and
prospects could be harmed.
Capacity constraints and failures, delays, or overloads could interrupt our
service and reduce the attractiveness of downloading spoken word to potential
customers. Any capacity constraints or sustained failure or delay in downloading
spoken word could reduce the attractiveness of downloading spoken word products
which could materially and adversely affect our ability to implement our new
strategy. The success of our new strategy depends on our ability to
electronically, efficiently, and with few interruptions or delays distribute
spoken audio content to potential customers. Accordingly, the performance,
reliability, and availability of our Website, our transaction processing systems
and our network infrastructure are critical to our operating results. We believe
the potential instability of the Internet could mean that periodic interruptions
to our new service could occur. These interruptions might make it difficult to
download audio content from our Website in a timely manner and jeopardize
prospective customer relationships.
We do not have a comprehensive disaster recovery plan and we have limited
back-up systems, and a disaster could severely damage our operations and could
result in loss of customers. If our computer systems are damaged or interrupted
by a disaster for an extended period of time, our business, results of
operations, and financial condition would be materially and adversely affected.
We do not have a comprehensive disaster recovery plan in effect. Our operations
depend upon our ability to maintain and protect our computer systems - all of
which are located in our headquarters and at a third party offsite hosting
facility. Although we maintain insurance against general business interruptions,
we cannot assure you that the amount of coverage will be adequate to compensate
us for our losses.
Problems associated with the Internet could discourage use of Internet-based
services and adversely affect our business. If the Internet fails to develop or
develops more slowly than we expect as a commercial medium, our business may
also grow more slowly than we anticipate or fail to grow. Our success will
depend in large part on increasing use of the Internet. There are critical
issues concerning the commercial use of the Internet which we expect to affect
the development of the market for downloadable spoken word, including:
o Secure transmission of customer credit card numbers and other
confidential information;
o Reliability and availability of Internet service providers;
o Cost of access to the Internet;
o Availability of sufficient network capacity; and
14
o Ability to download audio content consistent with computer security
measures employed by businesses.
More consumers are utilizing non-PC devices to access digital content, and we
may not be successful in gaining widespread adoption by users of such devices.
In the coming years, the number of individuals who access digital content
through devices other than a personal computer, such as personal digital
assistants, cellular telephones, television set-top devices, game consoles and
Internet appliances, is expected to increase dramatically. Manufacturers of
these types of products are increasingly investing in media-related
applications, but development of these devices is still in an experimental stage
and business models are new and unproven. If we are unable to offer downloads of
spoken word content on these alternative non-PC devices, we may fail to capture
a sufficient share of an increasingly important portion of the market for
digital media services or our costs may increase significantly.
We could be sued for content that we distribute over the Internet, which could
subject us to substantial damages. A lawsuit based on the spoken word content we
intend to distribute could be expensive and damaging to our business. As a
distributor and publisher of content over the Internet, we may be liable for
copyright, trademark infringement, unlawful duplication, negligence, defamation,
indecency, and other claims based on the nature and content of the materials
that we publish or distribute to customers. Our liability insurance may not
cover claims of these types or may not be adequate to protect us from the full
amount of the liability. If we are found liable in excess of the amount of our
insurance coverage, we could be liable for substantial damages. Our reputation
and business may suffer even if we are not liable for significant financial
damages.
Future government regulations may increase our cost of doing business on the
Internet, which could adversely affect our cost structure. Laws and regulations
applicable to the Internet, covering issues such as user privacy, pricing, and
copyrights are becoming more prevalent. The adoption or modification of laws or
regulations relating to the Internet could force us to modify our services in
ways that could adversely affect our business.
We may become subject to sales and other taxes for direct sales over the
Internet, which could affect our revenue growth. Increased tax burden could make
our service too expensive to be competitive. We do not currently collect sales
or other similar taxes for download of content. Nevertheless, one or more local,
state, or foreign jurisdictions may require that companies located in other
states collect sales taxes when engaging in online commerce in those states. If
one or more states successfully assert that we should collect sales or other
taxes on the download of spoken word content, the increased cost to our
customers could discourage them from purchasing our services, which would
materially and adversely affect our business.
We may not be able to protect our licenses or our intellectual property, which
could jeopardize our competitive position. If we fail to protect our licenses or
our intellectual property, we may be exposed to expensive litigation or risk
jeopardizing our competitive position. The steps we have taken may be inadequate
to protect our licenses or other intellectual property. We rely on a combination
of licenses, confidentiality agreements, and other contracts to establish and
protect our intellectual property rights. We may have to litigate to enforce our
15
licenses or other intellectual property rights or to determine the validity and
scope of the proprietary rights of others. This litigation could result in
substantial costs and the diversion of our management and other resources, which
would harm our business.
Other companies may claim that we infringe their copyrights or patents, which
could subject us to substantial damages. Any claim of infringement could cause
us to incur substantial costs defending against the claim, even if the claim is
invalid, and could distract our management from our business. A party making a
claim could secure a judgment that requires us to pay substantial damages. A
judgment could also include an injunction or other court order that could
prevent us from offering downloads of spoken word content. Any of these events
could have a material adverse effect on our business, operating results, and
financial condition.
The online content distribution industry is highly competitive and we cannot
assure you that we will be able to compete effectively, which would harm our
business. We will face competition in all aspects of our online business and we
cannot assure you that we will be able to compete effectively. We will compete
for consumers of spoken word content with other Internet-based audio
distributors, as well as with our existing, competitors, such as distributors of
audio on cassette tape or compact disc. The business of providing content over
the Internet is experiencing rapid growth and is characterized by rapid
technological changes, changes in consumer habits and preferences, and the
emergence of new and established companies. We will also continue to compete
with (i) book store chains deep-discount retailers, retail stores, mass
merchandisers, mail order catalogs, clubs, and libraries that sell, rent, or
loan audiobooks on cassette tape or compact disc, such as Borders, Barnes &
Noble, (ii) online retailers such as Amazon.com, (iii) websites that offer
streaming access to spoken audio content using tools such as the RealPlayer or
Windows Media Player, (iv) other companies offering services similar to ours,
such as Audible AudioFeast, iTunes, and (v) online and Internet portal companies
such as America Online, Inc., and Yahoo! Inc., and, which have the potential to
offer audio content. Moreover Audible, Inc., has begun to establish itself as a
leader in downloadable spoken word content distribution. Many of these companies
have financial, technological, promotional, and other resources that are much
greater than those available to us and could use or adapt their current
technology, or could purchase technology, to provide a service directly
competitive with our services and products.
Risks Relating to Our Capital Structure
Our ability to use our net operating losses will be limited in future periods,
which could increase our tax liability. Under Section 382 of the Internal
Revenue Code of 1986, utilization of prior net operating losses is limited after
an ownership change, as defined in Section 382, to an annual amount equal to the
value of the corporation's outstanding stock immediately before the date of the
ownership change multiplied by the long-term tax exempt rate. In the event we
achieve profitable operations, any significant limitation on the utilization of
net operating losses would have the effect of increasing our tax liability and
reducing after tax net income and available cash reserves. We are unable to
determine the availability of net operating losses since this availability is
dependent upon profitable operations, which we have not achieved in prior
periods.
Our stock price has been and could continue to be extremely volatile.
The market price of our common stock has been subject to significant
fluctuations since our initial public offering in October 1997. The securities
markets have experienced, and are likely to experience in the future,
16
significant price and volume fluctuations, which could adversely affect the
market price of our common stock without regard to our operating performance. In
addition, the trading price of our common stock could be subject to significant
fluctuations in response to:
o Timely and successful implementation of our new strategies;
o actual or anticipated variations in our quarterly operating results;
o announcements by us or other industry participants;
o factors affecting the market for spoken word content;
o changes in national or regional economic conditions;
o changes in securities analysts' estimates for us, our competitors'
or our industry or our failure to meet such analysts' expectations;
and
o general market conditions.
Our stock price may decline if we are unable to maintain our listing on Nasdaq
Our Common Stock is currently below the minimum per share requirement ($1.00)
for continued listing on the Nasdaq National Market and we have received a
letter dated March 8, 2005 from Nasdaq Stock Market, Inc. stating that we are
not in compliance with the minimum per share requirement ($1.00) for continued
listing on the exchange under Nasdaq Marketplace Rule 4310(c)(4). We have 180
days to demonstrate compliance by having our stock trade over $1.00 for a
minimum of ten consecutive trading days, or are subject to delisting by Nasdaq.
A large number of shares of our common stock could be sold in the market in the
near future, which could depress our stock price. As of March 28, 2005, we had
outstanding approximately 37.8 million shares of common stock. In addition, a
substantial portion of our shares are currently freely trading without
restriction under the Securities Act of 1933, having been registered for resale
or held by their holders for over two years and are eligible for sale under Rule
144(k). There are currently outstanding options and warrants to purchase and
convertible preferred stock convertible into an aggregate of approximately 163
million shares of our common stock. To the extent any of our warrants or options
are exercised or convertible preferred stock is converted, your percentage
ownership will be diluted and our stock price could be further adversely
affected. Moreover, as the underlying shares are sold, the market price could
drop significantly if the holders of these restricted shares sell them or if the
market perceives that the holders intend to sell these shares.
Because our board of directors consists of three classes, it may be more
difficult for a third party to acquire our company. Our by-laws divide our board
of directors into three classes, serving staggered three-year terms. The
staggered board of directors may make it more difficult for a third party to
acquire, or may discourage acquisition bids for our company.
Our outstanding preferred stock and our ability to designate additional
preferred stock could adversely effect the rights of our common stockholders.
Our Articles of Incorporation authorize our board of directors to issue up to
5,000,000 shares of "blank check" preferred stock without shareholder approval,
in one or more series and to fix the dividend rights, terms, conversion rights,
voting rights, redemption rights and terms, liquidation preferences, and any
other rights, preferences, privileges, and restrictions applicable to each new
series of preferred stock. We currently have four series of preferred stock
outstanding all of which have liquidation preferences senior to our common
17
stock. Three of these series have approval rights with respect to amendments to
our articles of incorporation which adversely affect the preferred stock,
incurrence of indebtedness, payment of dividends and distributions, redemption
of capital stock, the creation of other series of capital stock convertible into
our common stock. Moreover, two of the series of preferred stock have voting
rights, including an approval right with respect to certain corporate events,
such as, mergers and other business contribution and certain sales and transfer
of assets. The existence of our outstanding preferred stock and designation of
additional series of preferred stock in the future could, among other results,
adversely affect the voting power of the holders of common stock and, under
certain circumstances, could make it difficult for third parties to gain control
of our company, prevent or substantially delay a change in control, discourage
bids for our common stock at a premium, or otherwise adversely affect the market
price of our common stock.
Item 2. Properties
We lease approximately 12,000 square feet of office space in Cedar Knolls, New
Jersey pursuant to a sixty-six month lease agreement dated April 18, 2003.
Item 3. Legal Proceedings
We are not a party to any lawsuit or proceeding, which we believe is likely to
have a material adverse effect on us.
Item 4. Submission of Matters to a Vote of Security Holders
An Annual Meeting of Shareholders was held on December 15, 2004 at which time
Mr. Joseph Rosetti, Mr. Paul Ehrlich and Mr. Steven Yarvis were reappointed to
serve as Class I directors until the Annual Meeting of Shareholders of the
Company to be held in 2007. Shareholder voting for these directors was as
follows:
Director Votes For Votes Withheld
- -------- --------- --------------
Joseph Rosetti 25,083,772 88,465
Paul Ehrlich 25,083,572 88,665
Steven Yarvis 24,997,860 174,277
The following directors serve as directors for the term indicated opposite their
respective names:
Director Class Expiration of Term
- -------- ----- ------------------
Jeffrey Dittus II 2005
Paul D. Neuwirth II 2005
Richard Berman III 2006
John F. Levy III 2006
In addition, at the annual meeting, the shareholders approved the adoption of
the Company's 2004 Stock Incentive Plan (the "2004 Plan") providing for the
issuance of stock options to purchase, or equity awards for, up to 7,500,000
Shares of the Corporation's Common Stock by a vote of 13,468,891 for and 405,132
votes against, with 221,244 votes abstaining and 11,076,970 shares of Common
Stock not voting.
The shareholders also approved the adoption of a resolution to amend the
Company's Certificate of Incorporation to effect a combination (a "Reverse
Split") of the Company's issued and outstanding Common Stock. The motion
received, with respect to (i) Common Stock: 17,702,449 votes for and 930,263
18
votes against, with 30,570 votes abstaining, (ii) Series A Preferred Stock
1,428,571 votes for and no votes against, and (iii) with respect to Series C
Preferred Stock 5,580,384 votes for and no votes against. The Board of Directors
may abandon the proposal at any time prior to the date and time at which the
Reverse Split becomes effective if for any reason the Board of Directors deems
it advisable to abandon the proposal. The Board has elected to abandon the
proposal.
The Board also approved an amendment to the Company's Articles of Incorporation
to change the Company's name to Soundbytes Media Corporation. The motion to
amend the Company's Articles of Incorporation to change the Company's name to
Soundbytes Media Corporation received, with respect to (i) Common Stock:
18,055,734 votes for and 81,208 votes against, with 26,340 votes abstaining,
(ii) Series A Preferred Stock 1,428,571 votes for and no votes against and (iii)
with respect to Series C Preferred Stock 5,580,384 votes for and no votes
against.
PART II
Item 5. Market for Registrant's Common Equity Related Stockholder Matters and
Issuer Purchases of Equity Securities MediaBay's common stock has been quoted on
the Nasdaq National Market under the symbol "MBAY" since November 15, 1999. The
following table shows the high and low sales prices of our common stock as
reported by the Nasdaq National Market.
High Low
------------- -------------
Fiscal Year Ended December 31, 2003
First Quarter $ 1.27 $ .77
Second Quarter 1.11 .64
Third Quarter 1.10 .60
Fourth Quarter 1.65 .80
Fiscal Year Ended December 31, 2004
First Quarter 1.59 .52
Second Quarter .72 .36
Third Quarter .49 .25
Fourth Quarter 1.91 .33
On March 28, 2005 the last reported sale price of our common stock on the Nasdaq
National Market was $0.60 per share. As of March 28, 2005, there were
approximately 150 record owners of our common stock. We believe that there are
more than 400 beneficial owners of our common stock.
Dividend Policy
We have never declared or paid and do not anticipate declaring or paying any
dividends on our common stock in the near future. The terms of our debt
agreements prohibit us from declaring or paying any dividends or distributions
on our common stock. Any future determination as to the declaration and payment
of dividends will be at the discretion of our Board of Directors and will depend
on then existing conditions, including our financial condition, results of
operations, capital requirements, business factors and other factors as our
Board of Directors deems relevant.
Item 6. Selected Financial Data
As a result of the following factors, including capitalization and write-off of
direct response advertising costs, recording of goodwill write-offs, the
19
strategic charges and the income tax benefit and subsequent expense, as well as
fluctuations in operating results depending on the timing, magnitude and success
of Audio Book Club new member advertising campaigns, and the changes in our
strategy made in 2004, as discussed above, comparisons of our historical
operating results from year to year may not be meaningful. For more information,
see our financial statements for the years ended December 31, 2002, 2003 and
2004 and the notes thereto included herein.
20
Years Ended December 31,
--------------------------------------------------------
2000 2001 2002 2003 2004
-------- -------- -------- -------- --------
(thousands, except per share data)
Statement of Operations Data:
Net sales $ 44,426 $ 41,805 $ 45,744 $ 36,617 $ 18,831
Cost of sales 23,044 19,783 20,651 17,479 8,802
Cost of sales - write-downs -- 2,261 -- -- 3,745
Advertising and promotion 11,023 11,922 10,156 9,988 4,700
Advertising and promotion - write-downs -- 3,971 -- -- 846
Bad debt expense 2,583 2,536 2,821 3,940 829
General and administrative 11,823 8,947 8,347 6,816 6,043
Asset write-downs and strategic charges -- 7,044 -- 749 --
Severance and other termination costs -- -- -- 544 --
Depreciation and amortization 7,984 5,156 1,314 328 144
Non-cash write-down of intangibles -- -- 1,224 -- --
Non-cash write-down of goodwill 38,226 -- -- -- --
-------- -------- -------- -------- --------
Operating (loss) income (50,257) (19,815) 1,231 (3,227) (6,278)
Interest income (expense), net (2,940) (2,790) (2,974) (1,925) (9,082)
-------- -------- -------- -------- --------
Loss before income tax benefit (expense)
and extraordinary item (53,197) (22,605) (1,743) (5,152) (15,360)
Income tax benefit (expense) -- 17,200 (550) (1,471) (14,753)
-------- -------- -------- -------- --------
Loss before extraordinary item (53,197) (5,405) (2,293) (6,623) (30,113)
Extraordinary gain (loss) on early extinguishment of debt (2,152) -- -- -- --
-------- -------- -------- -------- --------
Net loss (55,349) (5,405) (2,293) (6,623) (30,113)
Dividends on preferred stock -- -- 217 246 574
-------- -------- -------- -------- --------
Net loss applicable to common shares $(55,349) $ (5,405) $ (2,510) $ (6,869) $(30,687)
======== ======== ======== ======== ========
Basic and diluted loss per share:
Basic and diluted loss before extraordinary item $ (4.18) $ (0.39) $ (0.18) $ (0.49) $ (1.71)
======== ======== ======== ======== ========
Basic and diluted loss applicable to common shares $ (4.35) $ (0.39) $ (0.18) $ (0.49) $ (1.71)
======== ======== ======== ======== ========
Basic and diluted weighted average number of
shares outstanding 12,718 13,862 14,086 14,098 17,976
======== ======== ======== ======== ========
21
As of December 31,
Actual Pro Forma (a)
2000 2001 2002 2003 2004 2004
-------- -------- -------- -------- -------- --------
(thousands, except per share data)
Balance Sheet Data:
Working capital (deficit) $ 313 $ (4,167) $ (4,336) $(20,165) $ 720 $ 15,705
Total assets 49,932 44,452 48,619 36,893 16,576 31,361
Current liabilities 17,103 15,491 18,984 29,194 5,905 5,705
Long-term debt (less current portion) 15,340 15,849 14,680 -- 16,853 640
Common stock subject to contingent put rights 4,550 4,550 4,550 750 -- --
Total Common Stockholders' equity (deficit) $ 12,939 $ 8,562 $ 10,405 $ 6,949 $ (6,181) $ 25,016
(a) Gives effect to (i) the sale of $35 million in Series D preferred stock and
warrants (the "Financing"), (2) repayment of $9.35 million of senior debt
facility, (iii) conversion of $5.8 million subordinated debt and $1.1 million
stated capital of preferred stock to common stock and, (iv) payment of $2.3
million in accrued interest and dividends, (v) redemption of $5.8 million of
stated capital of Series A and Series C Preferred Stock, which will occur on or
before June 1, 2005 (vi) loss on early retirement of debt of $.8 million, (vii)
payment of $3.1 million of cash fees and expenses incurred and the issuance of
warrants valued at $2.7 million to investment bankers in connection with the
Financing. See Note 19 Subsequent Events to our Financial Statements for the
year ended December 31, 2004, included herein. This information is being
provided to illustrate the significant effect of the Financing on MediaBay's
financial position.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations 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.
On March 23, 2005, we received an infusion of $35 million in private equity
financing from several institutional investors. We retired all of our borrowings
and our cash reserves increased to approximately $16.5 million. Because of this
financing, we believe that we have sufficient cash to implement our new
strategy, including for required marketing expenditures, for at least twelve
months.
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. In 2004, our Audio Book Club segment had
net sales of approximately $12.3 million, our Radio Spirits segment had net
sales of approximately $6.4 million, our MediaBay.com segment had sales of
approximately $0.2 million and we had eliminating inter-segment sales of $0.1
million.
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.
22
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 rightsholders, the future
revenue associated with deferred advertising and promotion costs, investments,
fixed assets, the valuation allowance provided to reduce our deferred tax assets
and valuation of goodwill and other intangibles.
The Securities and Exchange Commission ("SEC") defines "critical accounting
policies" as those that require application of management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain and may change in
subsequent periods.
Our significant accounting policies are described in Note 3 to the Notes to
Consolidated Financial Statements. Not all of these significant accounting
policies require management to make difficult, subjective or complex judgments
or estimates. However the following policies are considered to be critical
within the SEC definition:
Revenue Recognition
We derive our principal revenue through sales of audiobooks, classic radio shows
and other spoken word audio products directly to consumers principally through
direct mail. We also sell classic radio shows to retailers either directly or
through distributors. We derive additional revenue through rental of our
proprietary database of names and addresses to non-competing third parties
through list rental brokers. We also derive a small amount of revenue from
advertisers included in our nationally syndicated classic radio shows. We
recognize sales to consumers, retailers and distributors upon shipment of
merchandise. List rental revenue is recognized on notification by the list
brokers of rental by a third party when the lists are rented. We recognize
advertising revenue upon notification of the airing of the advertisement by the
media buying company representing us. Allowances for future returns are based
upon historical experience and evaluation of current trends. The historical
return rates for ABC members have been consistent for the past year and our
estimate is based on a detailed historical examination of trends. Based on the
current performance and historical trends, we do not expect significant changes
in the estimate of returns for ABC members. The estimate of returns for
wholesale sales of our old-time radio products is based on a detailed review of
each significant customer, depending on the amount of products sold to a
particular customer in a specific periods, the overall return rate for wholesale
sales could vary.
We record reductions to our revenue for future returns and record an estimate of
future bad debts arising from current sales in general and administrative
expenses. These allowances are based upon historical experience and evaluation
of current trends. If members and customers return products to us in the future
at higher rates than in the past or than we currently anticipate, our net sales
would be reduced and our operating results would be adversely affected. In
November 2001, the Emerging Issues Task Force ("EITF") issued EITF No. 01-9,
"Accounting for Consideration Given by a Vendor to a Customer (Including a
23
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. The effect on sales of applying EITF No.
01-9 in 2002, 2003 and 2004 was $118,000, $60,000 and $48,000 respectively.
Downloadable content revenue from the sale of individual content titles is
recognized in the period when the content is downloaded and the customer's
credit card is processed. Content revenue from the sale of content subscriptions
is recognized pro rata over the term of the subscription period. Rebates and
refunds are recorded as a reduction of revenue in the period in which the rebate
or refund is paid in accordance with Emerging Issues Task Force Issue No. 01-9,
Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products).
Accounts Receivable Valuation
We record an estimate of our anticipated bad debt expense and return rates based
on our historical experience. If the financial condition of our customers,
including either individual consumers or retail chains, were to deteriorate, or
if the payment or buying behavior were to change, resulting in either their
inability or refusal to make payment to us, additional allowances would be
required. For example, a one percent increase in returns as a percentage of
gross sales for the year ended 2004, assuming a constant gross profit percentage
and all other expenses unchanged, would have resulted in a decrease in net sales
of $242,000 and a increase in net loss available to common shares of $129,000. A
one percent increase in bad debt expenses as a percentage of net sales, assuming
all other expenses were unchanged, would have resulted in an increase in bad
debt expenses and a corresponding increase in net loss available to common
shares of $188,000.
Income Taxes
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which temporary timing
differences become deductible. We determine the utilization of deferred tax
assets in the future based on current year projections by management.
Based on a change in our strategy, which we believe will result in lower sales
and losses in the near term, but ultimately will be more profitable, we have
determined that it is not more likely than not that we will, in the foreseeable
future, be able to realize all or part of our net deferred tax asset. We have
accordingly made an adjustment to the deferred tax asset recording an increase
to the valuation allowance, resulting in a deferred tax expense charged against
income in the fourth quarter of 2004, the period when such determination was
made.
Deferred Member Acquisition Costs
Promotional costs directed at current members are expensed on the date the
promotional materials are mailed. The cost of any premiums, gifts or the
discounted audiobooks in the promotional offer to new members is expensed as
incurred. We account for direct response advertising for the acquisition of new
members in accordance with AICPA Statement of Position 93-7, "Reporting on
Advertising Costs" ("SOP 93-7"). SOP 93-7 states that the cost of direct
response advertising (a) whose primary purpose is to elicit sales to customers
who could be shown to have responded specifically to the advertising and (b)
that results in probable future benefits should be reported as assets net of
accumulated amortization Accordingly, we have capitalized direct response
advertising costs and amortized these costs over the period of future benefit
(the average member life), which has been determined to be generally 30 months.
The costs are being amortized on accelerated basis consistent with the
24
recognition of related revenue. In the fourth quarter of 2003, we adjusted the
amortization period for advertising to attract customers to its World's Greatest
Old-Time Radio continuity program and revised the estimate period for
amortization of these advertising costs down to 18 months, which resulted in an
increase in advertising expenses for the year ended December 31, 2003 of $409.
SOP 93-7 requires that the realizability of the mounts of direct-response
advertising reported as assets should be evaluated at each balance sheet date by
comparing the carrying amounts of the assets to their probable remaining future
net revenues. Based on the change in our strategy we have determined that the
future net revenue from our Audio Book Club does not support the carrying amount
of the direct-response advertising reported as assets relating to the Audio Book
Club. Accordingly, we have made an adjustment to write-off the carrying amount
of the asset in the fourth quarter for 2004 resulting in an increase in
advertising expense of $846.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired in business combinations accounted for using the purchase method
of accounting. In July 2001, the Financial Accounting Standards Board issued
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 requires that
an intangible asset that is acquired shall be initially recognized and measured
based on its fair value. The statement also provides that goodwill should not be
amortized, but shall be tested for impairment annually, or more frequently if
circumstances indicate potential impairment, through a comparison of fair value
to its carrying amount. At December 31, 2004, we had $9.7 million of goodwill,
all of which relates to our Radio Spirits operations. We completed our annual
impairment test as of January 2005, utililizing the services of an independent
third-party appraiser, which did not result in an impairment loss. However, if
conditions or circumstances were to change resulting in a deterioration of our
Radio Spirits business, a future impairment of goodwill could be necessary.
Results of Operations
The following table sets forth, for the periods indicated, historical operating
data as a percentage of net sales.
Year Ended December 31,
-----------------------------------
2002 2003 2004
--------- --------- ---------
Net sales ............................. 100% 100% 100%
========= ========= =========
Cost of sales ......................... 45 48 47
Cost of sales - write-downs ........... -- -- 20
Advertising and promotion ............. 22 27 25
Advertising and promotion - write-downs -- -- 5
Bad debt expense ...................... 6 11 4
General and administrative expense .... 18 19 32
Severance and other termination costs . -- 1 --
Asset write-downs and strategic charges -- 2 --
Depreciation and amortization expense . 3 1 1
Non-cash write-down of intangibles .... 3 -- --
Interest expense, net ................. 7 5 48
Income tax expense (benefit) .......... 1 4 78
Net (loss) ............................ (5) (18) (160)
Dividends on preferred stock .......... -- 1 3
Net (loss) applicable to common shares (5) (19) (163)
25
Year ended December 31, 2004 compared to year ended December 31, 2003
Net Sales
($000's) Change from
2003 2004 2003 to 2004 % Change
---- ---- ------------ --------
Audio Book Club $ 26,380 12,303 (14,076) (53.4)%
----------------------------------------------
Radio Spirits
Catalog 4,210 3,248 (962) (22.8)
Wholesale 3,048 1,671 (1,377) (45.2)
Continuity 2,841 1,403 (1,438) (50.6)
----------------------------------------------
10,099 6,322 (3,777) (37.4)
----------------------------------------------
MediaBay.com 138 205 67 48.7
----------------------------------------------
$ 36,617 18,831 (17,786) (48.6)%
==============================================
Audio Book Club sales decreased principally due to a decrease in club membership
as a result of a reduction in our advertising expenditures for new members. For
the year ended December 31, 2004, the Audio Book Club spent $414,000 to attract
new members, a reduction of $1.7 million, or 80.2%, from the amount spent to
attract new members of $2.1 million during the year ended December 31, 2003.
Audio Book Club attracted approximately 19,000 new members in the year ended
December 31, 2004 as compared to approximately 134,000 new members in the year
ended December 31, 2003.
The decrease in Radio Spirits catalog sales is principally attributable to lower
sales from catalogs mailed due to less new product introductions into the
catalogs and fewer new customers. Wholesale sales of old-time radio products
decreased principally due to lower orders from mass merchants and other
retailers. Sales of our The World's Greatest Old-Time Radio continuity program
decreased for the year ended December 31, 2004, as compared to the year ended
December 31, 2003, principally due to the reduction in our advertising
expenditures for new members. For the year ended December 31, 2004, we spent
$6,000 to attract new continuity customers, compared to $775,000 spent to
attract new customers during the year ended December 31, 2003.
Cost of Sales
$ (000's) 2003 2004
------------------------- ---------------------------
As a % As a % From 2003 to 20003
$ of Net Sales $ of Net Sales of Net Sales % Change
----------- ---------- ---------- ------------ ---------- --------
Audio Book Club $ 12,107 45.9% $ 5,484 44.6% (6,623) (54.7)%
------------------------------------------------------------------------------------
Radio Spirits
Catalog 47.9% 1,476 45.5 (539) (26.7)
2,015
Wholesale 67.5% 1,346 80.6 (711) (34.6)
2,057
Continuity 45.6% 495 29.7 (800) (61.8)
------------------------------------------------------------------------------------
5,367 53.1% 3,317 52.5 (2050) (38.2)
------------------------------------------------------------------------------------
MediaBay.com 5 1 0.3 (4) (80.0)
------------------------------------------------------------------------------------
$ 17,479 47.7% 8,802 46.7% (8,677) (49.6)%
====================================================================================
26
The principal reason for the decline in cost of sales at Audio Book Club was a
reduction in net sales of 53.4% as described above. Cost of sales as a
percentage of net sales at Audio Book Club for the year ended December 31, 2004
was 60.2%, compared to 45.9% for 2003. Cost of sales increased as a percentage
of sales because our smaller active membership required us to purchase finished
goods from publishers rather than licensing and manufacturing product due to
lower sales and made us unable to meet manufacturing minimums and recoup
advances to publishers, and because 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.
As a percentage of net sales, cost of sales at Radio Spirits increased to 54.1%
for the year ended December 31, 2004 from 53.1% for the year ended December 31,
2003. Cost of catalog sales decreased as a percentage of net sales to 46.3% for
the year ended December 31, 2004 as compared to 47.9% for the year ended
December 31, 2003 principally due to less discounting in the catalogs. The cost
of wholesale sales as percentage of net revenue increased to 79.3% as compared
to 67.5% for the year ended December 31, 2003 principally due to principally due
to sales to discounters of discontinued items. The cost of World's Greatest
Old-Time Radio continuity sales as a percentage of net income decreased to 37.0%
from 45.6% principally due to the smaller number of new customers in 2004 whose
initial purchase has a very high cost of goods sold.
Cost of sales - write-downs
(000's)
2003 2004
-------- --------
Cost of sales - write-downs $ -- $ 3,745
======== ========
We have conducted a review of our operations including product offerings,
marketing methods and fulfillment. We are committed to digitizing and encoding
our library of spoken word content and making our content available to the
digital customer as described in the introduction to this Item 1. Business.
As a result of decisions made in the third quarter of 2004 we have recorded $2.1
million of strategic charges for the three months ended September 30, 2004.
These charges include: $1.0 of inventory written down to net realizable value
due to a reduction in Audio Book Club members and our new focus on delivering
spoken word products via downloads and $1.1 million of write-downs to royalty
advances paid to audiobook publishers and other license holders, which we do not
believe will be recoverable due to our new focus on delivering spoken word
products via downloads.
In the fourth quarter of 2004, we decided to transition our Audio Book Club
customers to either principally a downloadable business or an Internet based
business, which will not offer a negative club option. Based on this decision,
we further reduced the value of our Audio Book Club inventory by $870,000 and
reduced the amount of publishers' advances recorded as assets by $215,000.
Also in the fourth quarter of 2004, we reviewed our product mix of offerings to
both our mail order and wholesale Radio Spirits customers. We have experienced a
significant shift in the mix between CDs and cassettes and will substantially
reduce the number of cassette offerings in the future. Accordingly, we have
written off a substantial portion of our existing cassette inventory as well as
a portion of our CD inventory relating to older products, which we will not
aggressively promote in future periods. The additional increase in the reserve
for obsolescence of the Radio Spirits inventory made in the fourth quarter of
2004 was $560,000.
27
Advertising and promotion
From 2003 to 2004
-----------------
2003 2004 Change % Change
------------ ------------ ------------ ------------
($000's)
Audio Book Club
New Member $ 2,092 $ 414 $ (1,678) (80.2)%
Current Member 1,993 994 (999) (50.1)
------------------------------------------------------------
4,085 1,408 (2,677) (65.5)
------------------------------------------------------------
Radio Spirits
Catalog 964 787 (177) (18.4)
Wholesale 74 57 (17) (22.3)
Continuity 775 6 (769) (99.2)
------------------------------------------------------------
1,813 850 (963) (53.1)
------------------------------------------------------------
New Projects 339 164 (175) (51.6)
------------------------------------------------------------
Total Spending 6,237 2,422 (3,815) (61.2)
Amount Capitalized (2,410) (354) (2,056) (85.3)
Amount Amortized 6,161 2,632 (3,529) (57.3)
------------------------------------------------------------
Advertising and Promotion Expense $ 9,988 $ 4,700 $ (5,288) (52.9)%
============================================================
Advertising and promotion decreased $5.3 million to $4.7 million or 52.9% for
the year ended December 31, 2004 from the amount spent during the year ended
December 31, 2003 of $10.0 million. Actual advertising expenditures for the year
ended December 31, 2004 decreased $3.8 million to $2.4 million from $6.2 million
during the year ended December 31, 2003. The decrease was due to a minimal
amount of new member marketing for Audio Book Club new members due to cash
constraints and our change in strategy as described above and decreased
advertising to existing members due to the reduction in Audio Book Club
membership because of normal member attrition with no marketing to replace
leaving members. Radio Spirits continuity advertising was reduced due to cash
constraints. We spent $164,000 on the new Larry King promotion in 2004.
Advertising and promotion - write-downs
(000's)
2003 2004
---------- ----------
Advertising and promotion - write-downs $ -- $ 846
========== ==========
Based on the change in our strategy , described above, we have determined that
the future net revenue from our Audio Book Club does not support the carrying
amount of the direct-response advertising reported as assets relating to the
Audio Book Club. Accordingly, we have made an adjustment to write-off the
carrying amount of the asset in the fourth quarter for 2004 resulting in an
increase in advertising expense of $846,000.
28
Bad Debt Expense
2003 2004
----------------------------------------------------
$ (000's) As a % As a % from 2002 to 2003
$ of Net Sales $ Sales Change % Change
---------- ---------- ---------- --------- ---------- ----------
Audio Book Club $ 3,404 12.9% $ 744 6.0% $ (2,660) (78.1)%
----------------------------------------------------- -------------------------
Radio Spirits
Catalog -- -- -- -- -- --
Wholesale 15 0.5% 15 0.8% -- --
Continuity 521 18.3% 70 5.2% 451 86.5%
----------------------------------------------------- -------------------------
536 5.3% 85 1.3% 451 84.1%
----------------------------------------------------- -------------------------
MediaBay.com -- -- -- -- -- --
----------------------------------------------------- -------------------------
$ 3,940 10.8% $ 829 4.4% $ 3,111 79.0%
===================================================== =========================
The principal reason for the decline in bad debt expense at Audio Book Club was
a reduction in net sales of 53.4% as described above. Bad debt expense as a
percentage of net sales at Audio Book Club for the year ended December 31, 2004
was 6.0 %, compared to 12.9% for the year ended December 31, 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 year ended December 31, 2004 as compared
to the year ended December 31, 2003.
The bad debt expense of World's Greatest Old-Time Radio continuity for the year
ended December 31, 2004 decreased by $451,000 to $70,000 from $521,000 for the
year ended December 31, 2003. As a percentage of net sales, bad debt expense for
the World's Greatest Old-Time Radio continuity for the year ended December 31,
2004 was 5.2% as compared to 18.3% for the year ended December 31, 2003. The
decrease in bad debt expense as a percentage of net sales is principally due to
a reduced number of new customers, who typically have higher bad debt expense,
since a lower number of new customers were added in the year ended December 31,
2004 as compared to the year ended December 31, 2003.
Because of the reasons stated above, our bad debt expense decreased $3.1
million, or 79.0% to $829,000 for the year ended December 31, 2004 as compared
to $3.9 million for the year ended December 31, 2003. As a percentage of net
sales, bad debt expense was 4.4 % for the year ended December 31, 2004 as
compared to 10.8% for the year ended December 31, 2003.
General and Administrative
$ (000's) 2003 2004
----------------------------------------------------
As a % As a % from 2003 to 2004
$ of Net Sales $ of net Sales Change % Change
---------- ---------- ---------- --------- ---------- ----------
Audio Book Club $ 2,626 10.0% $ 2,379 19.3% $ (247) (9.4)%
Radio Spirits 1,163 11.5% 959 15.2% (204) (17.5)
MediaBay.com 614 621 7 1.1
Corporate 2,412 2,084 (328) (13.6)
----------------------------------------------------- --------------------------
$ 6,815 18.6% $ 6,043 32.1% $ (772) (11.3)%
===================================================== ==========================
29
General and administrative expenses at Audio Book Club declined principally due
to reductions in payroll and related costs due to reduced staff. General and
administrative expenses at Radio Spirits for the year ended December 31, 2004
declined principally due to reductions in payroll due to reduced staff and
commissions to outside sales personnel due to lower wholesale sales. Our
corporate general and administrative expenses for the year ended December 31,
2004 declined principally due to lower payroll costs due to less employees and
settlement of lease and consulting obligations.
Asset write-downs and strategic charges
(000's)
2003 2004
-------- -------
Asset write-downs and strategic charges $ 749 $ --
======== =======
In the fourth quarter of 2003, we evaluated the performance of Audio Passages,
an Audio Book Club marketing program tailored to listeners with an interest in
Christian product and determined based on past performance and expected future
performance that we should terminate the Audio Passages marketing program. In
connection with the termination of the Audio Passages marketing program, we took
a strategic charge for the establishment of a reserve for obsolescence of Audio
Passages inventory of $0.3 million and an assets write-down for previously
capitalized advertising, which are not recoverable in the amount of $0.5
million.
Termination costs
(000's)
2003 2004
------- ---------
Termination costs $ 544 $ --
======= =========
In 2003, the employment of two senior executives who had employment agreements
was terminated and the decision was made to terminate the employment agreement
of another senior executive. A consulting agreement was also terminated. We
agreed to make aggregate settlement payments under the employment agreements and
consulting agreement for total consideration of $.5 million payable through May
2005.
Depreciation and Amortization
2003 2004
----------------------------------------------------
$ (000's) As a % As a % from 2003 to 2004
$ of Net Sales $ of net Sales Change % Change
---------- --------- ---------- ----------
Depreciation:
Audio Book Club $ 104 0.4% 83 0.7% $ (21) (19.9)%
Radio Spirits 42 0.4% 37 0.6 (5) (11.9)%
Amortization:
Corporate 182 -- 24 -- (158) (87.0)%
----------------------- ----------------------- -------------------------
$ 328 0.9% 144 0.8% $ (184) (75.0)%
======================= ======================= =========================
The decrease in amortization expenses is principally attributable to the
reduction of the carrying amounts of our intangible assets made in the fourth
quarter of 2003. Specifically, we made a strategic decision to no longer compete
in the DVD market and accordingly wrote off the value of certain video and DVD
rights we had acquired in the amount of $90,000. We also made the strategic
30
decision in the fourth quarter of 2003 to discontinue future mailings to the
Columbia House lists of members of other clubs. Accordingly, in the fourth
quarter of 2003, we wrote off the unamortized value of the Columbia House
mailing agreement of $986,000.
Interest Expense
From 2003 to 2004
-----------------
2003 2004 Change % Change
---- ---- ------ --------
$ (000's)
Interest paid $ 384 $ 1,045 $ 661 159.1%
Interest accrued 74 25 (49) (66.2)
Interest included in debt 907 521 (386) (42.6)
Amortization of deferred financing costs and
original issue discount 560 1,341 (781) (139.5)
Loss on early extinguishment of debt -- 1,532 1,532 --
Beneficial conversion expense -- 3,991 3,991 --
Inducement to convert -- 391 391 --
Interest converted to preferred stock -- 254 254 --
Less: Interest income -- (18) (18) --
----------------------------------------------------
Total interest expense $ 1,925 $ 9,082 $ 7,157 371.8%
====================================================
The increase in interest expenses is principally due to increased debt and
higher interest costs and amortization of debt discount relating to the 2004
financing transactions as described in the Liquidity and Capital Resources
section of this Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Net loss before income taxes for the year ended December 31, 2004 was $15.4
million as compared to a net loss before income taxes for the year ended
December 31, 2003 of $5.2 million.
Income Tax Expense
From 2003 to 2004
-----------------
2003 2004 Change % Change
---- ---- ------ --------
$ (000's)
Income Tax Expense $ 1,471 $ 14,753 $ (13,282) 902.9%
==================================================
The ultimate realization of deferred tax assets is dependent on the generation
of future taxable income during the periods in which temporary timing
differences become deductible. We determine the utilization of deferred tax
assets in the future based on current year projections by management.
Based on the change in Company strategy, described above, we have determined
that it is not more likely than not that we will, in the foreseeable future, be
able to realize all or part of our net deferred tax asset. Accordingly, we have
made an adjustment to the deferred tax asset recording an increase to the
valuation allowance, resulting in a deferred tax expense charged against income
of $14.8 million in the fourth quarter of 2004, the period when such
determination was made.
During the years ended December 31, 2003; we utilized $1,471,000, of the $17.2
million deferred tax asset recorded in 2001. Accordingly, we recorded income tax
expense of $1,471,000 for the year ended December 31, 2003.
31
Preferred Stock Dividends
From 2003 to 2004
2003 2004 Change % Change
---- ---- ---