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LQ CORP INC - 10-K - 20010330 - MARKET_RISK
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 31, 2000, we had an investment portfolio of cash, money market
funds, commercial securities and U.S. Government bonds including those
classified as short-term investments, of $123.8 million. We had a related party
loan outstanding at December 31, 2000 of $393,000, which was denominated in
Japanese yen and bore interest at 2.6%. These instruments, like all fixed
income instruments, are subject to interest rate risk. The fixed income
portfolio will fall in value and the related party note payable interest would
increase if there were an increase in interest rates. If market interest rates
were to increase immediately and uniformly by 10% from levels as of December
31, 2000 and 1999, the decline of the fair value of the fixed income portfolio
and related party note payable would not be material. See notes 1 and 2 of
notes to financial statements.
35
As a global concern, we face exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could seriously harm our financial results. Substantially
all of our international sales are currently denominated in U.S. dollars. An
increase in the value of U.S. dollar relative to foreign currencies could make
our products and services more expensive and therefore, reduce the demand for
our products and services. Reduced demand for our products and services could
seriously harm our financial results. Currently, we do not hedge against any
foreign currencies and as a result, could incur unanticipated gains or losses.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Index to Financial Statements which appears on page
F-1 of this report. The Report of Independent Accountants, Financial Statements
and Notes to Financial Statements which are listed in the Index to Financial
Statements and which appear beginning on page F-2 of this report are
incorporated into this Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table presents our directors and executive officers, their
ages and the positions held by them as of December 31, 2000:
Name Age Position
-------------------------- --- -----------------------------------------------
Gerald W. Kearby.......... 53 President, Chief Executive Officer and Director
Robert G. Flynn........... 46 Senior Vice President of Business Development
and Secretary
Philip R. Wiser........... 34 Senior Vice President of Engineering, Chief
Technical Officer and Director
Richard W. Wingate........ 48 Senior Vice President of Content Development
and Label Relations
James Lynch III........... 37 Vice President of Information Technology
(resigned February 2001)
Kevin M. Malone........... 35 Vice President of Business Development, Europe
Mathieu "Charly" Prevost.. 52 Vice President of Promotions
Andrea Cook Fleming....... 34 Vice President of Corporate Marketing
Leon Rishniw.............. 35 Vice President of Engineering
Paul W. Melnychuck........ 41 Vice President of Sales and Business
Development
Ann Winblad............... 50 Director
Silvia Kessel............. 49 Director
Sanford R. Climan......... 45 Director (resigned March 2001)
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Mr. Kearby co-founded Liquid Audio in January 1996. Since January 1996, Mr.
Kearby has served as our President and Chief Executive Officer and one of our
directors. From June 1995 to December 1995, Mr. Kearby was co-founder and Chief
Executive Officer of Integrated Media Systems, a manufacturer of computer-based
professional audio equipment. From January 1989 until June 1995, Mr. Kearby
served as Vice President of Sales and Marketing at Studer Editech Corporation,
a professional audio recording equipment company. Mr. Kearby holds a B.A. in
broadcast management and audio engineering from San Francisco State University.
Mr. Flynn co-founded Liquid Audio in January 1996. Since July 1999, Mr.
Flynn has served as our Senior Vice President of Business Development and
Secretary. From January 1996 to July 1999, Mr. Flynn served as our Vice
President of Business Development and Secretary. Mr. Flynn also served as our
Chief Financial Officer from January 1996 to August 1997 and as one of our
directors from January 1996 to June 1996. From March 1987 until November 1995,
Mr. Flynn served as a general partner of Entertainment Media Venture Partners
I, L.P., an institutional venture capital fund investing in the entertainment,
media and communications technology industries. During this time, Mr. Flynn
also served on the board of directors of Integrated Media Systems. Mr. Flynn
holds a B.A. in English from Stanford University and an M.B.A. from University
of California at Los Angeles.
Mr. Wiser co-founded Liquid Audio in January 1996. Since July 1999, Mr.
Wiser has served as our Senior Vice President of Engineering and Chief
Technical Officer. From May 1996 to July 1999, Mr. Wiser served as our Vice
President of Engineering and from November 1998 to July 1999 as our Chief
Technical Officer. Since June 1996, he has also served as one of our directors.
From July 1995 to May 1996, Mr. Wiser served as a senior software engineer,
directing audio compression work at Chromatic Research, a multimedia
semiconductor device company. From October 1994 to July 1995, Mr. Wiser was a
senior software engineer and the director of digital signal processing research
for Studer Editech Corporation. From June 1994 to October 1994, Mr. Wiser was a
software engineer for Sonic Solutions, a developer of digital media tools. Mr.
Wiser holds a B.S. in electrical engineering from the University of Maryland,
College Park and an M.S. in electrical engineering from Stanford University.
Mr. Wingate has served as our Senior Vice President of Content Development
and Label Relations since November 1999 and as our Vice President of Content
Development and Label Relations since August 1998.
37
Mr. Wingate operated his own new media marketing consulting company, Wingate
Marketing, from July 1996 until June 1998. From August 1997 to June 1998, Mr.
Wingate was also a private music industry consultant. From June 1994 to July
1996, Mr. Wingate was Senior Vice President, Marketing for Arista Records
Incorporated, a music recording company. Prior to June 1994, Mr. Wingate held
several senior management positions with major music industry record labels,
including Polygram, Inc. and Columbia Records. Mr. Wingate holds a B.A. in
communications from Brown University.
Mr. Lynch served as our Vice President of Information Technology from
November 1999 to February 2001. From August 1997 to November 1999, Mr. Lynch
was Manager of Integration Services at Wells Fargo & Company, a banking
institution. From November 1996 to August 1997, Mr. Lynch was an Internet
development consultant, providing services to several companies, including
Internet service providers. Prior to November 1996, Mr. Lynch owned Business
Link Communications, a prepress company, and worked as a music journalist and
artist manager. Mr. Lynch holds a B.A. in English from Columbia University.
Mr. Malone has served as our Vice President of Sales since February 1998.
From June 1997 to February 1998, Mr. Malone was our Director, International
Sales. From May 1993 to June 1997, Mr. Malone held a variety of positions at
Silicon Graphics, Inc., a manufacturer of work stations, servers and
supercomputing systems, including Manager, Strategic Marketing, Operations
Manager, Portugal and International Business Development Manager. Mr. Malone
holds a B.S. in business administration from the University of Arizona and an
M.B.A. in international business studies from the University of South Carolina.
Mr. Prevost has served as our Vice President of Promotions since December
1998. From April 1996 to November 1998, Mr. Prevost was Vice President, Retail
at The Album Network, a media company trade journal. Prior to April 1996, Mr.
Prevost was president of his own company, the Charly Prevost Company, a
multimedia management company. Mr. Prevost has also held several senior
management positions within the music recording industry, including president
of Island Records.
Ms. Fleming has served as our Vice President of Corporate Marketing since
June 1999. From February 1999 to June 1999, Ms. Fleming was our Director of
Corporate Marketing. From December 1995 to February 1999, Ms. Fleming served as
Public Relations Director at Netscape Communications Corporation, an Internet
services provider. From June 1994 to December 1995, Ms. Fleming was a Corporate
Public Relations Manager for Microsoft Corporation, a software company. Ms.
Fleming holds a B.A. in English from Stanford University.
Mr. Rishniw has served as our Vice President of Engineering since October
1999. He was originally employed by us as a software engineer in August 1996,
became one of our Development Managers in January 1997 and Director of
Engineering in November 1998. From May 1995 until August 1996, Mr. Rishniw
served as a senior software engineer for Studer Editech, a professional audio
recording equipment company. From August 1994 until May 1995, Mr. Rishniw
served as a software engineer for Signal Stream Technology, a medical imaging
technology provider. Mr. Rishniw holds a B.S. in engineering from Melbourne
Institute of Technology.
Mr. Melnychuck has served as our Vice President of Sales and Business
Development since February 2000. From April 1998 to February 2000, Mr.
Melnychuck served as Director of Corporate Marketing and Communications at
Digidesign, a manufacturer of digital audio workstations and a division of Avid
Technology, Inc. From May 1981 to April 1998, Mr. Melnychuck held a variety of
positions at Eastman Kodak Company, an imaging company, including Senior Vice
President and General Manager of Kodak Recording Products, a division of FPC,
Inc., a Kodak Company from January 1996 to April 1998 and other sales,
marketing, product development, manufacturing and research positions in prior
years. Mr. Melnychuck holds a B.S. in chemistry, a M.S. in imaging science from
Rochester Institute of Technology and a M.S. in electrical engineering from
National Technological University.
Ms. Winblad has served as one of our directors since May 1996. Ms. Winblad
has been a general partner of Hummer Winblad Venture Partners, a venture
capital investment firm, since 1989. She is a member of the
38
board of trustees of the University of St. Thomas and is an advisor to numerous
entrepreneurial groups such as the Software Development Forum and Software
Industry Business Practices. Ms. Winblad also serves on the boards of directors
of Net Perceptions Inc., a developer and supplier of realtime recommendation
technology for the Internet, The Knot, Inc., an Internet-based wedding services
company, and several private companies. Ms. Winblad holds a B.S. in mathematics
and business administration from the College of Saint Catherine and an M.A. in
education with an economics focus from the University of St. Thomas.
Ms. Kessel has served as one of our directors since October 1998. Since
November 1995, Ms. Kessel has held several positions at Metromedia
International Group, Inc., a global communications and media company, including
Executive Vice President, Chief Financial Officer and Treasurer. From January
1993 to June 1997, Ms. Kessel was Executive Vice President and a director of
Orion Pictures Corporation, a movie production company. Since January 1994, Ms.
Kessel has served as Senior Vice President of Metromedia Company, a privately-
held partnership. Ms. Kessel has also served as President of Kluge & Company, a
privately-held company, for over five years. Ms. Kessel is currently a director
and Executive Vice President of Metromedia Fiber Network, Inc., a fiber optic
network provider, and Big City Radio, Inc., an owner and operator of radio
station combinations in New York City, Chicago and Los Angeles. Ms. Kessel
received an M.B.A. in finance from Columbia University.
Mr. Climan served as one of our directors from April 1999 to March 2001.
Since February 1999, Mr. Climan has been President of Entertainment Media
Ventures, Inc., an investment and advisory company focused on traditional and
new media. From October 1995 to May 1997, Mr. Climan was Executive Vice
President and President of Worldwide Business Development for Universal
Studios, Inc., a media production company. From June 1997 to February 1999 and
from June 1986 to September 1995, Mr. Climan was a member of the senior
management team at Creative Artists Agency, a talent and literary
representation firm. Mr. Climan also serves on the boards of directors of
Equity Marketing, Inc., a provider of custom promotional programs, and Sunterra
Corporation, a developer and operator of vacation ownership resorts. Mr. Climan
holds a B.A. in chemistry from Harvard College, an M.S. in health policy and
management from the Harvard School of Public Health and an M.B.A. from Harvard
Business School.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than 10% of a registered class
of the Company's equity securities, to file certain reports regarding ownership
of, and transactions in, the Company's securities with the Securities and
Exchange Commission (SEC) and with Nasdaq. Such officers, directors and 10%
shareholders are also required by SEC rules to furnish the Company with copies
of all Section 16(a) forms that they file.
Based solely on its review of copies of Forms 3 and 4 and amendments thereto
furnished to the Company pursuant to Rule 16(a)-(e) and Forms 5 and amendments
thereto furnished to the Company with respect to the last fiscal year, and any
written representations referred to in Item 405(b)(2)(i) of Regulation S-K
stating that no Forms 5 were applicable to the Company's officers, directors
and 10% shareholders were complied with, except a late filing of a Form 4 by
Sanford Climan, resulting in one sales transaction not being reported on time
and a late filing of a Form 3 by Paul Melnychuck, resulting in his initial
holdings not being reported on time.
Board Composition
We currently have four directors. Sanford R. Climan resigned in March 2001
and did not have any disagreements with the other directors or our management.
Our restated certificate of incorporation divides our board of directors into
three classes: Class I, whose term will expire at the annual meeting of
stockholders to be held in 2003; Class II, whose term will expire at the annual
meeting of stockholders to be held in 2001; and Class III, whose term will
expire at the annual meeting of stockholders to be held in 2002. The Class I
director position is vacant, the Class II directors are Silvia Kessel and Ann
Winblad and the Class III directors are
39
Gerald W. Kearby and Philip R. Wiser. At each annual meeting of stockholders
after the initial classification, the successors to directors whose terms have
expired will be elected to serve from the time of election and qualification
until the third annual meeting following their election. In addition, our
bylaws provide that the authorized number of directors may be changed only by
resolution of the board of directors. Any additional directorships resulting
from an increase in the number of directors will be distributed among the three
classes so that, as nearly as possible, each class will consist of one-third of
the total number of directors. This classification of the board of directors
may have the effect of delaying or preventing changes in our control or
management.
Each officer is elected by, and serves at the discretion of, the board of
directors. Each of our officers and directors, other than non-employee
directors, devotes his or her full time to our affairs. Our non-employee
directors devote the amount of time necessary to discharge their duties to us.
There are no family relationships among any of our directors, officers or key
employees.
Board Committees
The audit committee of the board of directors reviews our internal
accounting procedures and consults with and reviews the services provided by
our independent accountants. The audit committee currently consists of Silvia
Kessel and Ann Winblad. Sanford R. Climan served on the audit committee prior
to his resignation.
The compensation committee of the board of directors reviews and recommends
to the board of directors the compensation and benefits of all of our executive
officers, administers our stock and option plans and establishes and reviews
general policies relating to compensation and benefits of our employees. The
compensation committee currently consists of Ann Winblad and Silvia Kessel.
Sanford R. Climan served on the compensation committee prior to his
resignation. No interlocking relationships exist between our board of directors
or compensation committee and the board of directors or compensation committee
of any other company, nor has an interlocking relationship existed in the past.
Director Compensation
Our directors do not receive cash compensation for their service as members
of the board of directors, although they are reimbursed for certain expenses in
connection with attendance at board and committee meetings. Non-employee
directors are granted a fully vested option to purchase 30,000 shares of common
stock upon initial election and a fully vested option to purchase 10,000 shares
of common stock on each anniversary of becoming a director during their term of
service. We do not provide additional compensation for committee participation
or special assignments of the board of directors. In October 2000, we granted
Silvia Kessel, Ann Winblad and Sanford R. Climan an option to purchase 10,000
shares of common stock each.
Change of Control Arrangements
We have granted options to purchase common stock to James Lynch III. The
shares underlying the options are subject to a vesting schedule that
accelerates with respect to the lesser of 25% of the total number of shares
subject to each option or the remaining unvested shares upon certain corporate
transactions, as described in each individual option grant.
40
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2001 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2001 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information set forth in our proxy statement for the 2001 Annual Meeting of
Stockholders to be filed with the Commission within 120 days after the end of
our fiscal year ended December 31, 2000.
41
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Index to Financial Statements
Please see the accompanying Index to Financial Statements which appears on
page F-1 of this report. The Report of Independent Accountants, Financial
Statements and Notes to Financial Statements which are listed in the Index to
Financial Statements and which appear beginning on page F-2 of this report are
included in Item 8 above.
(a)(2) Schedules not listed have been omitted because the information
required to be set forth therein is not applicable or is included in the
Financial Statements or notes thereto.
(a)(3) Exhibits
Please see subsection (c) below.
(b) Reports on Form 8-K
Not applicable.
(c) Exhibits
The following exhibits are incorporated herein by reference or are filed
with this report as indicated below:
Number Description
------ -----------------------------------------------------------------------
3.1 Certificate of Incorporation as currently in effect (1)
3.2 Bylaws as currently in effect (4)
4.1 Reference is made to Exhibits 3.1 and 3.2
4.2 Form of Specimen Stock Certificate (1)
4.3 Second Amended and Restated Investor Rights Agreement dated July 31,
1998 (1)
10.1 Form of Indemnification Agreement entered into between the registrant
and each of its directors and executive officers (1)
10.2 1996 Equity Incentive Plan (1)
10.3 1999 Employee Stock Purchase Plan (1)
10.4 Licensing Agreement with SESAC dated May 21, 1998 (1)
10.5+ Software Cross License Agreement with Adaptec, Inc. dated June 12, 1998
(1)
10.6 Form of Liquid Music Network Agreement (1)
10.7+ Letter Agreement with Compaq Computer Corporation dated March 23, 1998
(1)
10.8+ LA Agreement with Real Networks, Inc. dated April 26, 1998 (1)
10.9+ Binary Software License Agreement with Precept Software, Inc. dated
September 30, 1997 (1)
10.10+ Patent License Agreement with Fraunhofer-Gesellschaft, zur Forderung
der angewandten Forschung e.V. dated August 14, 1998 (1)
10.11+ Software License Agreement with Fraunhofer-Gesellschaft, zur Forderung
der angewandten Forschung e.V. dated August 14, 1998 (1)
10.12+ OEM Master License Agreement with RSA Data Security, Inc. dated July
18, 1997 (1)
10.13+ Agreement in Principle with N2K, Inc. dated February 12, 1997 (1)
10.14+ Patent License Agreement with Dolby Laboratories Licensing Corporation,
dated May 3, 1996 (1)
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42
Number Description
------ -----------------------------------------------------------------------
10.15+ Adjustment to Patent and License Agreement with Dolby Laboratories
Licensing Corporation, dated September 18, 1997 (1)
10.16+ Source Code, Trademark and Know-How License Agreement with Dolby
Laboratories Licensing Corporation dated May 3, 1996 (1)
10.17 Founders Restricted Stock Purchase Agreement (with amendments) with
Gerald W. Kearby dated April 25, 1996 (1)
10.18 Founders Restricted Stock Purchase Agreement (with amendments) with
Philip R. Wiser dated April 25, 1996 (1)
10.19 Founders Restricted Stock Purchase Agreement (with amendments) with
Robert G. Flynn dated April 25, 1996 (1)
10.20 Master Equipment Lease No. 0044 (with amendments) with Phoenix Leasing
Incorporated dated as of October 15, 1996 (1)
10.21 Summary Plan Description of 401(K) Plan (1)
10.22 Loan and Security Agreement with Silicon Valley Bank dated April 16,
1998 (1)
10.23 Loan and Security Agreement with Silicon Valley Bank dated November 16,
1998 (1)
10.24 Lease Agreement with Master Lease, a Division of Tokai Financial
Services, dated March 3, 1998 (1)
10.25 Lease Agreement with John Anagnostou Realty and Michael J. Monte, dated
February 16, 1999, for property located at 2221 Broadway, Redwood City,
California (1)
10.26 Lease and Service Agreement with Alliance Business Centers, dated
August 17, 1998, and Office Rider dated February 1, 1999, for property
located at 599 Lexington Avenue, New York, New York (1)
10.27 Lease Agreement with New Retail Concepts Ltd., dated September 1, 1998,
for property located at 21 Bridge Square, Westport, Connecticut (1)
10.28 Commercial Lease with Jim and Jeannette Beeger, dated November 3, 1998,
for property located at 820 Winslow Street, Redwood City, California
(1)
10.29 Commercial Lease with John Anagnostou Realty, dated October 9, 1997,
for property located at 810 Winslow Street, Redwood City, California
(1)
10.30+ Software Reseller Agreement with Liquid Audio Japan, dated as of August
9, 1998 (1)
10.31+ Shareholder Agreement with Super Stage, Inc., Liquid Audio Japan, Inc.,
ITOCHU Corporation, and Hikari Tsushin, Inc., dated March 31, 1999 (1)
10.32 Loan Agreement with Super Factory, Inc., dated March 31, 1999 (1)
10.33+ Share Sale and Purchase and Option Agreement with Super Stage, Inc.,
dated March 31, 1999 (1)
10.34+ Shareholders Agreement with SKM Limited and Liquid Audio Korea Co. Ltd.
dated December 31, 1998 (1)
10.35+ Software Reseller and Services Agreement with Liquid Audio Korea Co.
Ltd. dated December 31, 1998 (1)
10.36+ Consulting Agreement with Liquid Audio Korea Co. Ltd. dated December
31, 1998 (1)
10.37 Consulting Agreement with SKM Limited dated December 31, 1998 (1)
10.38 Guaranty issued to Liquid Audio, Inc. by SKM Limited dated December 31,
1998 (1)
10.39 Software License Agreement with Intel Corporation dated May 4, 1999 (1)
10.40 Liquid Remote Inventory Fulfillment Systems(TM) Merchant Affiliate and
License Agreement with MTS, Inc., dated May 14, 1999 (1)
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43
Number Description
------ -----------------------------------------------------------------------
10.41+ OEM Agreement with Sanyo Electric Co., Ltd. dated June 2, 1999 (1)
10.42 Amazon.com/Liquid Audio Advertising Agreement, including exhibits,
dated as of June 9, 1999 (1)
10.43 Online Program Agreement with Muze, Inc., dated as of February 9, 1999
(1)
10.44 Letter Agreement By and Between Texas Instrument Incorporated, dated as
of January 29, 1999 (1)
10.45+ OEM Agreement with Toshiba Corporation, dated June 9, 1999 (1)
10.46 Stock Option Agreement with Gary J. Iwatani, dated November 10, 1997
(1)
10.47 Letter Agreement with Virgin Holdings, Inc., an affiliate of EMI
Recorded Music, dated June 16, 1999 (1)
10.48 Commercial Lease with George Anagnostou, dated August 1, 1999, for
property located at 2317 Broadway, Redwood City, California (2)
10.49+ Amended and Restated License Agreement with Liquid Audio Japan, Inc.,
dated January 1, 2000 (3)
10.50 2000 Nonstatutory Stock Option Plan (4)
10.51 Letter Agreement with Virgin Holdings, Inc., an affiliate of EMI
Recorded Music, dated July 10, 2000 (5)
11.1 Statement regarding computation of per share earnings (6)
21.1 Subsidiary of Liquid Audio, Inc.
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney (contained in the signature page to this report)
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+ confidential treatment received as to certain portions
(1) incorporated by reference to the Registration Statement on Form S-1 and all
amendments thereto, Registration No. 333-77707, filed with the Securities
and Exchange Commission on May 4, 1999 and declared effective July 8, 1999
(2) incorporated by reference to the Registration Statement on Form S-1 and all
amendments thereto, Registration No. 333-91541, filed with the Securities
and Exchange Commission on November 23, 1999 and declared effective
December 14, 1999
(3) incorporated by reference to the Form 10-Q filed with the Securities and
Exchange Commission on May 15, 2000
(4) incorporated by reference to the Form 10-Q filed with the Securities and
Exchange Commission on August 14, 2000
(5) incorporated by reference to the Form 10-Q filed with the Securities and
Exchange Commission on November 13, 2000
(6) this exhibit has been omitted because the information is shown in the
financial statements or notes thereto
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Palo Alto, State of California on March 30, 2001.
/s/ Gerald W. Kearby
By: _________________________________
Gerald W. Kearby
Chief Executive Officer
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POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints, jointly and severally, Gerald W. Kearby
and Lyman Yip, and each of them, as his or her attorney-in-fact, with full
power of substitution, for him or her in any and all capacities, to sign any
and all amendments to this report, and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming his or her signatures as they may
be signed by his or her said attorney to any and all amendments to said report.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED:
Signature Title Date
---------------------- ----------------------------------- --------------
/s/ Gerald W. Kearby President, Chief Executive Officer March 30, 2001
______________________ and Director
Gerald W. Kearby (Principal Executive Officer)
/s/ Lyman Yip Controller and Acting Chief March 30, 2001
______________________ Financial Officer
Lyman Yip (Principal Financial and
Accounting Officer)
/s/ Philip R. Wiser Senior Vice President of March 30, 2001
______________________ Engineering,
Philip R. Wiser Chief Technical Officer and
Director
/s/ Ann Winblad Director March 30, 2001
______________________
Ann Winblad
/s/ Silvia Kessel Director March 30, 2001
______________________
Silvia Kessel
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45
LIQUID AUDIO, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants.......................................... F-2
Consolidated Balance Sheets................................................ F-3
Consolidated Statement of Operations....................................... F-4
Consolidated Statement of Stockholders' Equity (Deficit)................... F-5
Consolidated Statement of Cash Flows....................................... F-6
Notes to Consolidated Financial Statements................................. F-7
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F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Liquid Audio, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and comprehensive income (loss), of
stockholders' equity (deficit) and of cash flows present fairly, in all
material respects, the financial position of Liquid Audio, Inc. ("Liquid
Audio") and its subsidiary at December 31, 2000, and 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000 in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of Liquid Audio's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
PricewaterhouseCoopers LLP
San Jose, California
February 2, 2001
F-2
LIQUID AUDIO, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
December 31,
------------------
2000 1999
-------- --------
Assets
------
Current assets:
Cash and cash equivalents...................................... $ 96,398 $138,692
Short-term investments......................................... 27,378 19,157
Accounts receivable from third parties, net.................... 725 151
Accounts receivable from related parties....................... 1,253 435
Other current assets 2,307 638
-------- --------
Total current assets.......................................... 128,061 159,073
Investment in strategic partner................................ 1,089 1,959
Property and equipment, net.................................... 8,860 4,857
Other assets................................................... 200 220
-------- --------
Total assets.............................................. $138,210 $166,109
======== ========
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable............................................... $ 3,314 $ 1,952
Accrued expenses and other current liabilities................. 3,522 2,736
Deferred revenue from third parties............................ 440 405
Deferred revenue from related parties.......................... 987 1,167
Capital lease obligations, current portion..................... 120 194
Equipment loan, current portion................................ 589 589
-------- --------
Total current liabilities..................................... 8,972 7,043
Capital lease obligations, non-current portion.................. 28 149
Equipment loan, non-current portion............................. 143 731
Note payable to related party................................... 393 441
-------- --------
Total liabilities........................................... 9,536 8,364
-------- --------
Commitments and contingencies (Note 9)
Stockholders' equity:
Common stock, $0.001 par value; 50,000,000 shares authorized;
22,541,959 and
21,875,256 shares issued and outstanding...................... 23 22
Additional paid-in capital..................................... 202,877 198,973
Unearned compensation.......................................... (333) (1,097)
Accumulated deficit............................................ (73,910) (40,225)
Accumulated other comprehensive income......................... 17 72
-------- --------
Total stockholders' equity.................................. 128,674 157,745
-------- --------
Total liabilities and stockholders' equity................ $138,210 $166,109
======== ========
|
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
LIQUID AUDIO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
Year Ended December 31,
---------------------------------
2000 1999 1998
---------- ---------- ---------
Net revenues:
License..................................... $ 1,284 $ 1,537 $ 1,235
Services.................................... 2,977 733 268
Business development (related party)........ 7,307 2,137 1,300
---------- ---------- ---------
Total net revenues....................... 11,568 4,407 2,803
---------- ---------- ---------
Cost of net revenues:
License..................................... 290 235 310
Services.................................... 2,722 1,122 242
Business development (related party)........ 75 79 2
Non-cash cost of revenues................... 28 25 36
---------- ---------- ---------
Total cost of net revenues............... 3,115 1,461 590
---------- ---------- ---------
Gross profit................................ 8,453 2,946 2,213
---------- ---------- ---------
Operating expenses:
Sales and marketing......................... 17,114 10,217 4,035
Non-cash sales and marketing................ 314 783 741
Research and development.................... 22,917 11,706 4,109
Non-cash research and development........... 80 371 210
General and administrative.................. 7,131 2,770 1,642
Non-cash general and administrative......... 13 190 254
Strategic marketing--equity instruments..... 1,935 3,130 --
---------- ---------- ---------
Total operating expenses................. 49,504 29,167 10,991
---------- ---------- ---------
Loss from operations......................... (41,051) (26,221) (8,778)
Interest income.............................. 8,809 2,271 379
Interest expense............................. (144) (193) (140)
Other income (expense), net.................. (429) (63) --
Equity in net loss of investment............. (870) -- --
---------- ---------- ---------
Net loss..................................... $ (33,685) $ (24,206) $ (8,539)
========== ========== =========
Net loss per share:
Basic and diluted........................... $ (1.52) $ (2.28) $ (3.60)
========== ========== =========
Weighted average shares..................... 22,133,403 10,615,566 2,370,564
========== ========== =========
|
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
LIQUID AUDIO, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share amounts)
Common Stock Additional Unearned Other
------------------ Paid-in Compen- Accumulated Comprehensive
Shares Amount Capital sation Deficit Income (Loss) Total
---------- ------ ---------- -------- ----------- ------------- --------
Balance at December 31,
1997................... 3,899,643 $ 4 $ 2,159 $(1,562) $ (7,480) $-- $ (6,879)
Repurchase of founders'
common stock........... (87,868) -- -- -- -- -- --
Repurchase of common
stock in connection
with unvested stock
options previously
exercised.............. (24,219) -- (2) -- -- -- (2)
Issuance of common stock
in connection with
exercise of stock
options................ 90,173 -- 6 -- -- -- 6
Issuance of common stock
in connection with a
strategic marketing
agreement.............. 38,316 -- 40 -- -- -- 40
Unearned compensation,
net of effect of
cancellations.......... -- -- 1,714 (1,714) -- -- --
Amortization of unearned
compensation........... -- -- -- 1,241 -- -- 1,241
Net loss................ -- -- -- -- (8,539) -- (8,539)
---------- --- -------- ------- -------- ---- --------
Balance at December 31,
1998................... 3,916,045 4 3,917 (2,035) (16,019) -- (14,133)
Repurchase of common
stock in connection
with unvested stock
options previously
exercised.............. (50,861) -- (3) -- -- -- (3)
Issuance of common stock
in connection with
strategic marketing
agreements............. 100,000 -- 1,100 -- -- -- 1,100
Issuance of common stock
warrants in connection
with strategic
marketing agreements... -- -- 2,030 -- -- -- 2,030
Conversion of
mandatorily redeemable
convertible preferred
stock upon initial
public offering........ 9,744,199 10 29,791 -- -- -- 29,801
Issuance of common stock
in connection with
public stock offerings,
net of offering
expenses of $1,481..... 7,750,147 8 159,592 -- -- -- 159,600
Issuance of common stock
in connection with
exercise of stock
options................ 398,581 -- 156 -- -- -- 156
Issuance of common stock
in connection with
exercise of warrants... 17,145 -- -- -- -- -- --
Unearned compensation,
net of effect of
cancellations.......... -- -- 431 (431) -- -- --
Amortization of unearned
compensation........... -- -- -- 1,369 -- -- 1,369
Gain on investment in
strategic partner...... -- -- 1,959 -- -- -- 1,959
Unrealized gain on
investments............ -- -- -- -- -- 72 --
Net loss................ -- -- -- -- (24,206) -- --
Comprehensive loss...... -- -- -- -- -- -- (24,134)
---------- --- -------- ------- -------- ---- --------
Balance at December 31,
1999................... 21,875,256 22 198,973 (1,097) (40,225) 72 157,745
Repurchase of common
stock in connection
with unvested stock
options previously
exercised.............. (18,845) -- (12) -- -- -- (12)
Issuance of common stock
for intellectual
property............... 4,072 -- 16 -- -- -- 16
Issuance of common stock
warrants in connection
with strategic
marketing agreements... -- -- 1,356 -- -- -- 1,356
Issuance of common stock
in connection with
strategic marketing
agreements............. 200,000 -- 1,376 -- -- -- 1,376
Issuance of common stock
in connection with
settlement of legal
claim.................. 30,000 -- 354 -- -- -- 354
Issuance of common stock
in connection with
employee stock purchase
plan................... 194,877 -- 934 -- -- -- 934
Issuance of common stock
in connection with
exercise of stock
options................ 230,017 1 128 -- -- -- 129
Issuance of common stock
in connection with
exercise of warrants... 26,582 -- 107 -- -- -- 107
Unearned compensation,
net of effect of
cancellations.......... -- -- (355) 355 -- -- --
Amortization of unearned
compensation........... -- -- -- 409 -- -- 409
Cumulative translation
adjustment............. -- -- -- -- -- 23 --
Unrealized loss on
investments............ -- -- -- -- -- (78) --
Net loss................ -- -- -- -- (33,685) -- --
Comprehensive loss...... -- -- -- -- -- -- (33,740)
---------- --- -------- ------- -------- ---- --------
Balance at December 31,
2000................... 22,541,959 $23 $202,877 $ (333) $(73,910) $ 17 $128,674
========== === ======== ======= ======== ==== ========
|
The accompanying notes are an integral part of these consolidated financial
statements
F-5
LIQUID AUDIO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
---------------------------
2000 1999 1998
-------- -------- -------
Cash flows from operating activities:
Net loss.......................................... $(33,685) $(24,206) $(8,539)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization.................... 3,436 1,143 451
Amortization of unearned compensation............ 409 1,369 1,241
Allowance for doubtful accounts and sales returns
reserve......................................... 315 101 263
Notes receivable write-off....................... 470 -- --
Equity in net loss of investments................ 870 378 400
Strategic marketing-equity instruments........... 1,935 3,130 --
Non-cash cost of revenue......................... 26 -- --
Issuance of common stock in connection with
settlement of a legal claim..................... 354 -- --
Other............................................ (47) 63 --
Changes in assets and liabilities:
Accounts receivable from third parties........... (889) 10 (502)
Accounts receivable from related parties......... (1,288) 180 (615)
Other assets..................................... (878) (474) (191)
Accounts payable................................. 1,362 1,150 397
Accrued expenses and other current liabilities... 909 1,918 206
Deferred revenue................................. (145) 395 1,087
-------- -------- -------
Net cash used in operating activities............ (26,846) (14,843) (5,802)
-------- -------- -------
Cash flows from investing activities:
Acquisition of property and equipment............ (7,439) (4,456) (982)
Sales/(purchases) of short-term investments,
net............................................. (8,221) (16,084) (3,001)
Equity investment................................ -- -- (400)
-------- -------- -------
Net cash used in investing activities............ (15,660) (20,540) (4,383)
-------- -------- -------
Cash flows from financing activities:
Proceeds from issuance of mandatorily redeemable
convertible preferred stock..................... -- -- 21,535
Proceeds from issuance of common stock, net of
repurchases..................................... 1,051 159,753 4
Payments made under capital leases............... (195) (221) (118)
Proceeds from equipment loan..................... -- 846 920
Payments made under equipment loan............... (588) (446) --
Payments under line of credit.................... -- -- (400)
Proceeds from short-term loan.................... -- -- 1,330
Payments on short-term loan...................... -- -- (1,330)
-------- -------- -------
Net cash provided by financing activities........ 268 159,932 21,941
-------- -------- -------
Effect of exchange rates on cash and cash
equivalents...................................... (56) -- --
-------- -------- -------
Net increase (decrease) in cash and cash
equivalents...................................... (42,294) 124,549 11,756
Cash and cash equivalents at beginning of period.. 138,692 14,143 2,387
-------- -------- -------
Cash and cash equivalents at end of period........ $ 96,398 $138,692 $14,143
======== ======== =======
Supplemental cash flow disclosures:
Cash paid for interest........................... $ 144 $ 193 $ 121
Supplemental non-cash investing and financing
activities:
Acquisition of property and equipment through
capital leases.................................. $ -- $ 37 $ 305
Issuance of warrants in connection with strategic
marketing agreements............................ 1,356 2,030 --
Issuance of common stock in connection with
strategic marketing agreements.................. 1,376 1,100 40
Issuance of common stock upon exercise of
warrant......................................... 107 -- --
Issuance of common stock for intellectual
property........................................ 16 -- --
Equity investment with note payable.............. -- 378 --
|
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company
Liquid Audio, Inc. (the "Company") was incorporated in California in January
1996 and reincorporated in Delaware in April 1999. In July 2000, the Company
established a wholly-owned subsidiary in the United Kingdom, Liquid Audio
Europe PLC, to develop sales in Europe. The Company was formed with the goal of
becoming the premier provider of software applications and services that enable
the secure delivery and sale of digital music over the Internet. The Company's
end-to-end solutions enable the secure distribution, promotion and sale of high
quality music files while providing consumers with the ability to access,
preview and purchase that music via the Internet.
In July 1999, the Company completed its initial public offering of common
stock. A total of 4,800,000 shares were sold at $15.00 per share. Net proceeds
to the Company, after deducting the underwriting discount and offering
expenses, were $65.9 million. In December 1999, the Company completed a follow-
on public offering of common stock. A total of 2,946,076 shares were sold at
$33.63 per share. Net proceeds to the Company, after deducting the underwriting
discount and offering expenses, were $93.7 million.
Reclassifications
Certain reclassifications have been made to the prior years' consolidated
financial statements to conform to current period presentation. The statement
of operations reflects reclassifications to allocate the non-cash compensation
expense related to the issuance of stock options from a single line
presentation within operating expenses to the respective amounts in cost of net
revenues, sales and marketing, research and development and general and
administrative expense.
Principles of Consolidation
The financial statements include the accounts of the Company and its
subsidiary. Significant intercompany transactions and balances have been
eliminated.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company's management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash and cash equivalents and short-term investments
All highly liquid investments with a maturity of three months or less when
purchased are considered to be cash equivalents, and those with maturities
greater than three months and less than twelve months are considered short-term
investments. Cash and cash equivalents consist of cash on deposit with banks,
money market funds and commercial securities that are stated at cost, which
approximates fair value. The Company classifies all short-term investments as
available-for-sale in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." In addition, the cost of securities sold is based upon the
specific identification method. At December 31, 2000 and 1999, amortized cost
approximated fair value and unrealized gains and losses were insignificant.
Accordingly,
F-7
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
these investments are carried at fair value at the balance sheet date, with
unrealized gains and losses recorded net of taxes in stockholders' equity. The
following schedule summarizes the estimated fair value of the Company's cash,
cash equivalents and short-term investments (in thousands):
December 31,
----------------
2000 1999
------- --------
Cash and cash equivalents:
Cash.................................................... $79,683 $ 10,237
Money market funds...................................... 265 8,613
Commercial securities................................... 16,450 119,842
------- --------
$96,398 $138,692
======= ========
Short-term investments:
Commercial securities................................... $27,378 $ 1,003
U.S. Government bonds................................... -- 18,154
------- --------
$27,378 $ 19,157
======= ========
|
All short-term investments had a contractual maturity of one year or less.
Concentration of credit risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash and cash equivalents,
short term investments and accounts receivable. Substantially all of the
Company's cash and cash equivalents are invested in a highly-liquid money
market fund and commercial securities with major financial institutions. Short
term investments are invested in government and corporate bonds. The Company
performs ongoing credit evaluations of its customers and maintains an allowance
for potential credit losses. Credit losses to date have been within
management's estimates.
The following table sets forth customers comprising 10% or more of the
Company's total net revenues for each of the periods indicated:
Year Ended December 31,
-----------------------
Customer 2000 1999 1998
-------- ------- ------- -------
A (related party)................................. -- -- 34%
B................................................. -- 31% --
C (related party)................................. -- 30% --
D (related party)................................. -- 12% --
E (related party)................................. 42% -- --
F (related party)................................. 11% -- --
|
At December 31, 2000, one customer represented 29% of gross accounts
receivable. At December 31, 1999, three customers represented 31%, 21% and 13%,
respectively, of gross accounts receivable.
Fair value of financial instruments
The Company's financial instruments, including cash and cash equivalents,
short-term investments, accounts receivable, accounts payable, capital lease
obligations, an equipment loan, a line of credit and a note payable to a
related party are carried at cost and in the case of short-term investments, at
fair value which
F-8
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
equates to market. The Company's short-term financial instruments, except for
short-term investments, approximate fair value due to their relatively short
maturities. The carrying value of the Company's long-term financial instruments
approximate fair value as the interest rates approximate current market rates
of similar debt. The Company does not hold or issue financial instruments for
trading purposes.
Property and equipment
Property and equipment, including leasehold improvements, are stated at
historical cost. Depreciation and amortization are computed using the straight-
line method over the estimated useful lives of the assets, generally three
years, or for leasehold improvements, the term of the lease, whichever is
shorter. Assets held under capital leases are amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the life
of the lease, generally three years.
Software development costs
Costs incurred in connection with the development of the Company's Internet
site and services and other software for internal use are accounted for in
accordance with Statement of Position ("SOP") No. 98-1, "Accounting for the
Cost of Computer Software Developed or Obtained for Internal Use." SOP 98-1
requires that costs incurred in the preliminary project and post implementation
stages of an internal software project be expensed as incurred and that certain
costs incurred in the application development stage of a project be
capitalized. Costs qualifying for capitalization are amortized using the
straight-line method over the expected economic life of the software, generally
three years. The Company evaluates the net realizable value of capitalized
software and website costs on an ongoing basis, relying on a number of business
and economic factors.
Long-lived assets
The Company accounts for long-lived assets under SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of," which requires the Company to review the impairment of long-lived
assets whenever events or changes in circumstances indicate that the carrying
amount of an asset might not be recoverable. When such an event occurs, the
Company estimates the future of cash flows expected to result from the use of
an asset and its eventual disposition. If the undiscounted expected future cash
flows is less than the carrying amount of the asset, an impairment loss is
recognized. To date, the Company has not recognized an impairment loss on its
long-lived assets.
Revenue recognition
Software license revenues are recognized when persuasive evidence of an
arrangement exists, delivery has occurred, no significant Company obligations
with regard to implementation or integration exist, the fee is fixed or
determinable and collection is probable as prescribed in SOP No. 97-2,
"Software Revenue Recognition." For arrangements with multiple elements, the
total fee from the arrangement is allocated among each element based upon
vendor specific objective evidence ("VSOE") of fair value. VSOE of fair value
for the service elements is based upon the standard hourly rate the Company
charges for services when such services are sold separately. VSOE of fair value
for annual maintenance is established based upon the optional stated renewal
rate. When VSOE of fair value exist for all undelivered elements, the Company
accounts for the delivered elements, primarily the license portion, based upon
the "residual method" as prescribed by SOP No. 98-9, "Modification of SOP 97-2
with Respect to Certain Transactions." The Company recognizes revenue allocated
to maintenance ratably over the contract period, which is generally twelve
months.
F-9
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Business development revenue primarily consists of license and maintenance
fees derived from contractual agreements with the Company's strategic partners.
These U.S. dollar-denominated, non-refundable fees are based upon agreements
whereby the strategic partners are contractually obligated to pay to the
Company a fixed fee for the right to license and use the Company's proprietary
technology in various countries. The total fee from business development
agreements are allocated among the various elements of the contracts based on
VSOE of fair value. The fees are recognized by the Company as earned, the
specific timing of which depends on the terms and conditions of the particular
contractual arrangements, including payment terms. When VSOE of fair value does
not exist for the undelivered elements, the total fee from the business
development arrangement is recognized ratably over the period of the contract.
The Company also generates license and service revenues from digital music
kiosk sales and hosting services. Revenue derived from hosting services include
subscription fees from artists for encoding and storing music files, e-commerce
services and transaction reporting. Music delivery services revenue include
transaction fees from sales of digital recorded music through the Company's
website affiliates and fees from music retailers and websites related to the
sample digital music clips delivery service. Revenue from kiosk sales consist
of software licenses and services revenue from equipment and kiosk-related
services. The Company bears full credit risk with respect to substantially all
sales.
Research and development costs
Costs incurred in the research and development of new products and
enhancements of existing products are charged to expense as incurred until the
technological feasibility has been established through the development of a
working model. After establishing technological feasibility, additional
development costs incurred through the date the product is available for
general release to customers would be capitalized and amortized over the
estimated product life. To date, the period between achieving technological
feasibility and general release has been short and software development costs
qualifying for capitalization has been insignificant. Accordingly, the Company
has not capitalized any development costs in all periods presented.
Advertising
Advertising costs are expensed as incurred. The following table sets forth
advertising costs for the periods indicated (in thousands):
Year Ended
December 31,
------------------
2000 1999 1998
------ ------ ----
Advertising costs......................................... $1,552 $1,659 $247
|
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and Financial Accounting
Standards Board Interpretation ("FIN") No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans," and
complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-
Based Compensation." Under APB No. 25, compensation expense is based on the
difference, if any, on the date of the grant, between the fair value of the
Company's stock and the exercise price. Stock-based compensation is amortized
in accordance with FIN 28 using a multiple option approach. SFAS No. 123
defines a "fair value" based method of accounting for an employee stock option
or similar equity instrument. The pro forma disclosure of the difference
between compensation expense included in net loss and the cost presented by the
fair value method is presented in Note 7.
F-10
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company accounts for stock issued to non-employees in accordance with
the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") No. 96-
18 "Accounting for Equity Instruments That Are Issued to Other Than Employees
for Acquiring, or in Conjunction with Selling, Goods or Services."
Foreign currency translation
The functional currency of the Company's subsidiary is its local currency.
Foreign currency assets and liabilities are translated at the current exchange
rate at each balance sheet date. Revenues and expenses are translated at
weighted average exchange rates in effect during the year. The related gains
and losses from foreign currency translation are recorded in accumulated other
comprehensive income. Realized gains and losses on foreign currency
transactions are included in other income (expense), net.
Income taxes
Income taxes are accounted for using the asset and liability approach, which
requires the recognition of taxes payable or refundable for the current year
and deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in the Company's financial statements or tax
returns. The measurement of current and deferred tax liabilities and assets are
based on provisions of the enacted tax laws; the effects of future changes in
tax laws or rates are not anticipated. The measurement of deferred tax assets
is reduced, if necessary, by the amount of any tax benefits that, based on
available evidence, are not expected to be realized.
Net loss per share
Basic and diluted net loss per share is computed by dividing the net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding during the period. The calculation of diluted net
loss per share excludes potential common shares if the effect is anti-dilutive.
Potential common shares consist of unvested restricted common stock,
incremental common shares issuable upon the exercise of stock options, shares
issuable upon conversion of the Series A, Series B and Series C mandatorily
redeemable convertible preferred stock and common shares issuable upon the
exercise of common and mandatorily redeemable convertible preferred stock
warrants.
The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except per share amounts):
Year Ended December 31,
---------------------------
2000 1999 1998
-------- -------- -------
Numerator:
Net loss..................................... $(33,685) $(24,206) $(8,539)
======== ======== =======
Denominator:
Weighted average shares...................... 22,211 11,199 3,888
Weighted average unvested common shares
subject to repurchase....................... (78) (583) (1,517)
-------- -------- -------
Denominator for basic and diluted
calculation................................. 22,133 10,616 2,371
======== ======== =======
Net loss per share:
Basic and diluted............................ $ (1.52) $ (2.28) $ (3.60)
======== ======== =======
|
F-11
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table sets forth potential shares of common stock that are not
included in the diluted net loss per share calculation above because to do so
would be anti-dilutive for the periods indicated (in thousands):
December 31,
-----------------
2000 1999 1998
----- ----- -----
Series A mandatorily redeemable convertible preferred
stock.................................................. -- 3,050 3,050
Series B mandatorily redeemable convertible preferred
stock.................................................. -- 3,187 3,187
Series C mandatorily redeemable convertible preferred
stock.................................................. -- 3,507 3,507
Mandatorily redeemable convertible preferred stock
warrants............................................... -- -- 18
Common stock options.................................... 2,830 1,520 1,067
Common stock warrants................................... 875 609 49
Unvested common stock subject to repurchase............. 17 583 1,517
|
Comprehensive income
The Company adopted SFAS No. 130, "Reporting Comprehensive Income" effective
January 1, 1998. SFAS No. 130 establishes standards for disclosure and
financial statement presentation for reporting total comprehensive income
(loss) and its individual components. Comprehensive income (loss), as defined,
includes all changes in equity during a period from non-owner sources. The
Company's comprehensive income (loss) includes net income (loss), unrealized
gains and losses on investments and foreign currency translation adjustments
and is displayed in the statement of stockholders' equity (deficit).
Segment information
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes standards for the method companies report information
about operating segments in financial statements. SFAS No. 131 focuses on the
internal organization that is used by management for making operating decisions
and assessing performance as the source of the Company's reportable segments.
SFAS No. 131 also requires disclosures about products and services, geographic
areas and major customers. The Company has determined that it operates in only
one operating segment.
International revenues are based on the country in which the customer is
located. The following is a summary of total net revenues by geographic area
(in thousands):
Year Ended
December 31,
---------------------
2000 1999 1998
------- ------ ------
Domestic............................................... $ 3,629 $2,236 $ 982
International.......................................... 7,939 2,171 1,821
------- ------ ------
$11,568 $4,407 $2,803
======= ====== ======
|
It is impractical for the Company to compute revenues by type of product and
service for the years ended December 31, 2000, 1999 and 1998.
Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 establishes a new model for accounting for derivatives and hedging
activities and supercedes and amends a number of existing accounting standards.
SFAS No. 133 requires that all derivatives be reported on the balance sheet at
their fair market value and the corresponding derivative gains or losses be
either reported in the statement of operations or as a deferred item
F-12
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
depending on the type of hedge relationship that exists with respect to any
derivatives. In July 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date
of FASB Statement No. 133." SFAS No. 137 deferred the effective date until
fiscal years commencing after June 15, 2000. In June 2000, the FASB issued SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities." SFAS No. 138 amends certain terms and conditions of SFAS No. 133.
The Company will adopt SFAS No. 133 and 138 in its quarter ending March 31,
2001. The Company does not believe that the pronouncement will have a material
impact on its financial position or results of operations as currently
conducted.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition." SAB 101 outlines
the basic criteria that must be met to recognize revenue and provides guidance
for presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with the SEC. In June 2000, the SEC
issued SAB 101B to defer the effective date of implementation of SAB 101 until
the fourth quarter of fiscal 2000. The adoption of SAB 101 did not have a
material impact on the Company's financial position or results of operations.
NOTE 2--RELATED PARTIES:
Investment in Liquid Audio Japan
In April 1998, the Company signed an agreement with a strategic partner (the
"Strategic Partner") to establish a Japanese corporation, Liquid Audio Japan
("LAJ"). LAJ is the exclusive reseller and distributor of the Company's
software products in Japan. In March 1999, the Company purchased 18% of the
issued and outstanding shares in LAJ from the Strategic Partner for $378,000.
The Company retains the option, expiring on December 31, 2003, to purchase up
to 20% of the capital of LAJ from the Strategic Partner, at the then fair
market value of LAJ's shares. The Company also has a put option whereby the
Company can require the Strategic Partner to purchase its shares in LAJ at the
then fair market value, if certain performance measures of LAJ, as defined, are
not met. The Company's purchase of shares in LAJ was funded by a loan from a
related entity of the Japanese Strategic Partner. This loan, denominated in
Japanese yen, is repayable on December 31, 2003. Interest on the loan bears
interest at 0.5% above a Japanese bank's prime rate (2.6% at December 31, 2000)
and is payable quarterly. The loan is classified in the balance sheet as a non-
current note payable to a related party and recorded at the prevailing exchange
rate at December 31, 2000.
In March 1999, the Company's investment in LAJ of $378,000 was deemed to be
impaired due to substantial doubt regarding recoverability and the significant
losses that are expected to be incurred during LAJ's initial operating periods.
The write-off of this investment was included in sales and marketing expenses.
In December 1999, LAJ completed its initial public offering in Japan, which
raised total proceeds of approximately $28.3 million and resulted in the
Company's ownership in LAJ reducing to 6.92%. The Company booked an investment
in LAJ of $1,959,000, which was recorded as additional paid in capital as
prescribed by SAB Topic No. 5, "Miscellaneous Accounting," to reflect the
increase in the Company's share of LAJ's net assets. The Company's ownership
percentage was further reduced to 6.81% during the current year due to an
increase in LAJ's total outstanding shares. The fair value of the Company's
ownership in LAJ, based on the quoted trading price, was approximately $2.6
million at December 31, 2000.
Investment in Liquid Audio Korea
In December 1998, the Company signed an agreement with another strategic
partner to establish a Korean corporation, Liquid Audio Korea Co. Ltd. ("LAK"),
to develop a local business to enable the digital delivery of music to
customers in Korea. LAK is the exclusive reseller and distributor of the
Company's software products in
F-13
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Korea, under an agreement expiring on December 31, 2003. The Company paid
$400,000 for 40% of the outstanding common stock of LAK and accounts for its
investment in LAK using the equity method of accounting. The investment of
$400,000 was recorded as an offset to the business development revenue
recognized from LAK in December 1998. The Company is not recording its share of
additional losses beyond its investment since there is no obligation on the
part of the Company to pay LAK or any other party for those losses. If LAK
generates sufficient profits to recoup its initial operating losses, the
Company will re-instate the equity method of accounting. LAK stopped making its
contractual payments as scheduled. LAK is undergoing a recapitalization through
the addition of new investment partners so that it can continue making its
payments to the Company. Until such time contractual payments are resumed, the
Company is deferring recognition of revenue from LAK. The Company additionally
wrote off its loans of $470,000 to LAK as of December 31, 2000.
Liquid Audio Greater China
In June 2000, the Company signed an agreement with a strategic partner to
establish a British Virgin Islands corporation, Liquid Audio Greater China
("LAGC"). LAGC is the exclusive reseller of the Company's products in Taiwan
and Hong Kong and will work to develop business services that enable the
digital delivery of music in those local markets. The Company owns 40% of the
outstanding common stock of LAGC and accounts for its investment in LAGC using
the equity method of accounting. LAGC stopped making its contractual payments
in late 2000 as scheduled. Until such time contractual payments are resumed,
the Company is deferring recognition of revenue from LAGC.
Liquid Audio South East Asia
In September 2000, the Company signed an agreement with a strategic partner
to establish a Singaporean corporation, Liquid Audio South East Asia ("LASE").
LASE will be the exclusive reseller of the Company's products in Singapore,
Thailand, Malaysia, Indonesia, Philippines, Australia and New Zealand and will
work to develop business services that enable the digital delivery of music in
those local markets. The Company will own 30% of the outstanding common stock
of LASE and will account for its investment in LASE using the equity method of
accounting. The strategic partner of LASE did not make its contractual payments
in late 2000 as scheduled. Until such time contractual payments are resumed,
the Company is deferring recognition of revenue from LASE.
Other transactions
Total business development revenues are summarized as follows (in
thousands):
Year Ended December
31,
--------------------
2000 1999 1998
------ ------ ------
Liquid Audio Japan and strategic partner............... $5,047 $1,105 $ 250
Liquid Audio South East Asia and strategic partner..... 1,261 -- --
Liquid Audio Greater China and strategic partner....... 705 500 --
Liquid Audio Korea and strategic partner............... 294 532 1,050
------ ------ ------
$7,307 $2,137 $1,300
====== ====== ======
|
Of the total fees earned from Liquid Audio Japan and strategic partner,
$4,880,000 and $272,000 were earned from Liquid Audio Japan and relate to
software licensing and maintenance fees in 2000 and 1999, respectively, and
$167,000 and $833,000 were earned from the strategic partner in Liquid Audio
Japan in 2000 and 1999, respectively, and relate to a non-refundable service
fee of $1,000,000 received in March 1999 and recognized ratably over the one-
year term of the service agreement. The fee of $250,000 earned from the
strategic partner in Liquid Audio Japan in 1998 relates to consulting services.
F-14
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The total fee of $1,261,000 and $705,000 earned in 2000 from Liquid Audio
South East Asia through the strategic partner and Liquid Audio Greater China,
respectively, primarily consist of software licensing and maintenance fees. The
total fee of $500,000 earned from the strategic partner in Liquid Audio Greater
China in 1999 relates to a service fee to develop a local business in Taiwan
and Hong Kong.
The total fee of $294,000 and $532,000 earned from Liquid Audio Korea in
2000 and 1999, respectively, consist primarily of software licensing and
maintenance fees. Of the $1,050,000 earned from the strategic partner in Liquid
Audio Korea in 1998, $950,000 relates to service fees earned under two separate
agreements and $100,000 relates to software licensing fees.
At December 31, 2000 and 1999, fees billed or received in advance of
recognition as business development revenues were $987,000 and $1,167,000,
respectively. These amounts are classified as deferred revenue from related
parties on the balance sheet.
NOTE 3--BALANCE SHEET COMPONENTS (in thousands):
December 31,
----------------
2000 1999
------- -------
Accounts receivable, net:
Accounts receivable..................................... $ 1,313 $ 468
Allowance for doubtful accounts and sales returns
reserve................................................ (588) (317)
------- -------
$ 725 $ 151
======= =======
The allowance for doubtful accounts and sales returns reserve increased
(decreased) by $271,000, $(28,000) and $229,000 in the years ended December 31,
2000, 1999 and 1998, respectively. Bad debt write-offs against the allowance
for doubtful accounts were $44,000, $129,000 and $34,000 in the years ended
December 31, 2000, 1999 and 1998, respectively.
December 31,
----------------
2000 1999
------- -------
Property and equipment:
Computer equipment and purchased software............... $12,190 $ 5,614
Website and software development costs.................. 399 --
Furniture and fixtures.................................. 774 544
Leasehold improvements.................................. 682 448
------- -------
14,045 6,606
Less: accumulated depreciation and amortization......... (5,185) (1,749)
------- -------
$ 8,860 $ 4,857
======= =======
Property and equipment includes $784,000 of equipment under capital leases
at December 31, 2000 and 1999. Accumulated amortization for equipment under
capital leases was $734,000 and $581,000 at December 31, 2000 and 1999,
respectively.
December 31,
----------------
2000 1999
------- -------
Accrued expenses and other current liabilities:
Compensation and benefits............................... $ 2,321 $ 1,305
Consulting and professional services.................... 475 418
Accrued marketing expenses.............................. 48 282
Other................................................... 678 731
------- -------
$ 3,522 $ 2,736
======= =======
|
F-15
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 4--BORROWINGS:
Equipment loan
Pursuant to the terms of an equipment financing agreement with a bank ("the
Bank"), the Company had a $3,000,000 line of credit ("Equipment Line") to be
used specifically to purchase computer and office equipment. The Equipment Line
expired in November 1999 through which time the Company borrowed amounts
totaling $1,766,000. Borrowings under the Equipment Line are repayable in
monthly installments of principal and interest over three years and bear
interest at the Bank's prime interest rate plus 0.25% (9.75% and 8.75% at
December 31, 2000 and 1999, respectively). Borrowings outstanding at December
31, 2000 and 1999 were $732,000 and $1,030,000, respectively. Borrowings are
secured by the related equipment and other assets of the Company.
Under the Equipment Line, the Company is required to meet certain monthly
reporting and financial covenants, including minimum operating results and
certain liquidity, leverage and debt service ratios. At December 31, 2000 and
1999, the Company was in compliance with all such covenants.
Future maturities under the Equipment Line as of December 31, 2000 are as
follows (in thousands):
Year Ending December 31,
------------------------
2001.................................................................. $589
2002.................................................................. 143
----
$732
====
|
NOTE 5--COMMON STOCK:
In April 1999, the Company's Certificate of Incorporation was amended and
restated to authorize the issuance of 50,000,000 shares of common stock at
$0.001 par value.
Following the completion of the Company's Initial Public Offering in 1999,
9,744,199 shares of mandatorily redeemable preferred stock were converted into
common stock. In addition, warrants to purchase 15,306 shares of Series B
mandatorily redeemable preferred stock and 4,544 of Series C mandatorily
redeemable preferred stock were converted into 19,850 shares of common stock
upon the Company's completion of its Initial Public Offering.
In June 1999, the Company signed an agreement with Virgin Holdings, Inc.
("Virgin"), an affiliate of EMI Recorded Music, to facilitate the production of
music for delivery over the Internet using the Company's technology. Pursuant
to this agreement, the Company issued 100,000 shares of common stock to Virgin.
These shares were valued at $1,100,000 and immediately recognized as strategic
marketing-equity instruments expense during the three months ended June 30,
1999.
In July 2000, the Company signed an agreement with Virgin to promote the
distribution of digital music over the Internet using the Company's technology.
Pursuant to this agreement, the Company issued 150,000 shares of common stock
to Virgin. These shares were valued at $1,181,000 and are being recognized as
strategic marketing-equity instruments expense ratably over the one-year term
of the agreement. As a result, $591,000 was recognized as strategic marketing-
equity instruments expense in 2000.
In December 2000, the Company signed an agreement with BMG Entertainment to
obtain the right to distribute BMG sound recordings and related artwork through
kiosks. In connection with this agreement, the Company issued 50,000 shares of
common stock to BMG. These shares were valued at $195,000 and are being
recognized as non-cash cost of net revenues ratably over the one-year term of
the agreement. As a result, $14,000 was recognized as non-cash cost of net
revenues in 2000.
F-16
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--WARRANTS:
In February 1997, the Company entered into a marketing agreement whereby the
Company and another company jointly developed and marketed a certain feature
specification of the Company's software products. Pursuant to this agreement,
the Company issued 38,316 shares of the Company's common stock and a warrant to
purchase 48,860 shares of common stock at $6.14 per share. The warrant expires
on January 1, 2001. The Company accrued $107,000 during the year ended December
31, 1997 for the estimated fair value of the warrant, based on the Black-
Scholes option pricing model.
In March and April 1999, the Company granted fully vested common stock
warrants to purchase 15,000 shares at $6.56 per share. These warrants were
valued at $95,000 using the Black-Scholes option pricing model and was
recognized as strategic marketing-equity instruments expense. The warrants
expire in April 2004.
In June 1999, the Company signed an Advertising Agreement with Amazon.com,
Inc. ("Amazon.com") to collaborate on event-based advertising using the
Company's digital delivery services. In connection with this agreement, the
Company issued a fully vested warrant to purchase approximately 254,000 shares
of common stock to Amazon.com. The warrant was valued at $2,022,000 and was
recognized as strategic marketing-equity instruments expense ratably over the
one-year term of the agreement, which ended in June 2000. As a result, $843,000
and $1,179,000 were recognized as strategic marketing equity instruments
expense in 2000 and 1999, respectively.
In August 1999, the Company signed a Digital Audio Co-Marketing and
Distribution Agreement with Yahoo! to promote the distribution of digital music
on its web site. In connection with this agreement, the Company granted Yahoo!
three warrants totaling 250,000 shares of common stock. The first warrant for
83,334 shares vested immediately. The first warrant was valued at $903,000 and
was recognized ratably over the one-year term of the agreement as strategic
marketing-equity instruments expense. The second warrant for 83,333 shares
vested in August 2000. The second warrant was initially valued at $426,000 and
was recognized ratably over the one-year period ending at the vesting date as
strategic marketing-equity instruments expense. The second warrant was revalued
at each balance sheet date through the vesting date. As a result, the original
charge of $426,000 was reduced to $312,000 based on current market data. The
third warrant for 83,333 shares will vest in August 2001. The third warrant was
initially valued at $105,000 and is recognized ratably over the one-year period
ending at the vesting date. The third warrant will be revalued at each balance
sheet date through the vesting date based on current market data. In 2000,
$577,000, $(114,000) and $38,000 were recognized as strategic marketing-equity
instruments expense for the first, second and third warrants, respectively. In
1999, $330,000 and $426,000 were recognized as strategic marketing-equity
instruments expense for the first and second warrants, respectively.
In December 2000, the Company signed an agreement with BMG Entertainment to
obtain the right to distribute BMG sound recordings and related artwork through
kiosks. In connection with this agreement, the Company granted a warrant for a
total of 233,300 shares of common stock. Of the total, 77,768 shares vest in
December 2001, and the cost will be remeasured each quarter until a commitment
for performance has been reached or the warrant vests, based on current market
data. At December 31, 2000, the 77,768 shares under this warrant was valued at
$156,000, of which $12,000 was recognized as non-cash cost of net revenues. The
unamortized portion will be remeasured at each balance sheet date through the
vesting date and amortized over the remaining vesting period. If BMG renews the
agreement after December 2001, the remaining shares will vest at 6,481 shares
per month commencing January 2002 for one year and 6,480 shares per month
commencing January 2003 for one year. Such shares will be valued at the fair
market value of the Company's common stock upon BMG renewing the agreement at
each renewal date.
F-17
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 7--EMPLOYEE BENEFIT PLANS:
401(k) Savings Plan
The Company sponsors a 401(k) defined contribution plan covering eligible
employees who elect to participate. The Company elected to contribute matching
and discretionary contributions to the plan. The company is not required to
contribute to the 401(k) plan, but in 2000 elected to match contributions up to
a maximum of $2,000 per employee, with a two year vesting schedule. As a
result, the Company contributed $177,000, which was expensed in 2000.
Stock Option Plans
In September 1996, the Board of Directors adopted the 1996 Equity Incentive
Plan (the "1996 Plan"), which initially provided for the granting of up to
1,144,000 incentive stock options and nonqualified stock options. In August
1997, October 1998 and April 1999, an additional 441,000, 88,000 and 1,600,000
shares, respectively, were authorized for grants under the 1996 Plan. Under the
1996 Plan, incentive stock options may be granted to employees of the Company
and nonqualified stock options and stock purchase rights may be granted to
consultants, employees, directors and officers of the Company. Options granted
under the 1996 Plan are for periods not to exceed ten years, and must be issued
at prices not less than 100% and 85%, for incentive and nonqualified stock
options, respectively, of the fair market value of the stock on the date of
grant as determined by the Board of Directors. Options granted under the 1996
Plan generally vest 25% after the first year and then 2.083% each month
thereafter until 100% vested. Options granted to stockholders who own greater
than 10% of the outstanding stock must be for periods not to exceed five years
and must be issued at prices not less than 110% of the estimated fair market
value of the stock on the date of grant as determined by the Board of
Directors. In April 1999, the 1996 Plan was also amended to provide for annual
increases on January 1 equal to the lesser of 1,500,000 shares, 5% of the
outstanding shares on such date or a lesser amount determined by the Board of
Directors.
In April 2000, the Board of Directors adopted the 2000 Nonstatutory Stock
Option Plan (the "2000 Plan"), which provided for the granting of up to 500,000
nonqualified stock options. Under the 2000 Plan, stock options may be granted
to employees of the Company. Options granted under the 2000 Plan are for
periods not to exceed ten years, and are issued at prices determined by the
Board of Directors or any of its committees. Options granted under the 2000
Plan vest at terms and conditions determined by the Board of Directors or any
of its committees. Options granted for the year ended December 31, 2000 vest
25% after the first year and then 2.083% each month thereafter until 100%
vested.
F-18
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes stock option activity under the plans (shares
in thousands):
Options Outstanding
------------------------
Options Weighted
Available Average Exercise
for Grant Shares Price Per Share
--------- ------ ----------------
Balance at December 31, 1997.............. 255 861 $0.130
Additional options authorized............ 88 -- --
Repurchase of common stock in connection
with unvested stock options previously
exercised............................... 24 -- --
Options granted.......................... (512) 512 1.01
Options exercised........................ -- (90) 0.067
Options canceled......................... 216 (216) 0.11
------ -----
Balance at December 31, 1998.............. 71 1,067 0.68
Additional options authorized............ 1,600 -- --
Repurchase of common stock in connection
with unvested stock options previously
exercised............................... 51 -- --
Options granted.......................... (1,044) 1,044 17.62
Options exercised........................ -- (399) 0.39
Options canceled......................... 192 (192) 2.45
------ -----
Balance at December 31, 1999.............. 870 1,520 12.17
Additional options authorized............ 1,594 -- --
Repurchase of common stock in connection
with unvested stock options previously
exercised............................... 19 -- --
Options granted.......................... (2,310) 2,310 11.53
Options exercised........................ -- (230) 0.57
Options canceled......................... 770 (770) 13.55
------ -----
Balance at December 31, 2000.............. 943 2,830 12.06
====== =====
|
The following table summarizes information concerning outstanding and
exercisable options for all stock option plans as of December 31, 2000 (shares
in thousands):
Options Vested and
Options Outstanding Exercisable
--------------------------------- --------------------
Weighted Weighted
Weighted Average Average
Average Exercise Exercise
Remaining Price Price
Number Contractual Per Number Per
Range of Exercise Prices Outstanding Life (Years) Share Outstanding Share
------------------------ ----------- ------------ -------- ----------- --------
$0.07................... 5 5.1 $ 0.07 5 $0.07
0.19.................... 49 6.8 0.19 49 0.19
0.33-0.40............... 52 7.2 0.40 52 0.40
1.50-2.00............... 106 7.5 1.78 106 1.78
2.50.................... 74 8.1 2.50 74 2.50
3.91-5.44............... 248 9.7 4.59 47 4.68
6.50-9.47............... 1,009 9.6 7.56 41 8.11
11.00-15.81............. 796 8.8 11.63 321 11.10
23.25-33.50............. 398 9.0 29.32 140 31.66
43.75................... 93 8.8 43.75 93 43.75
----- ---
2,830 928
===== ===
|
F-19
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Fair value disclosures
Pro forma information regarding net loss and net loss per share is required
by SFAS No. 123, which also requires that the information be determined as if
the Company had accounted for its employee stock options granted under the fair
value method. The fair value for these options was estimated using the Black-
Scholes option pricing model.
The Company calculated the fair value of each option grant on the date of
grant using the Black-Scholes option pricing method as prescribed by SFAS No.
123 using the following assumptions:
Year Ended December
31,
------------------------
2000 1999 1998
------- ------- ------
Risk-free rates.................................. 5.4-6.7% 5.7% 5.8%
Expected lives (in years)........................ 4.0 4.0 4.0
Dividend yield................................... 0.0% 0.0% 0.0%
Expected volatility.............................. 130% 78.0% 0.0%
Had compensation costs been determined based upon the fair value at the
grant date for awards under these plans, consistent with the methodology
prescribed under SFAS No. 123, the Company's pro forma net loss attributable to
common stockholders and pro forma basic and diluted net loss per share under
SFAS No. 123 would have been:
Year Ended December,
31
------------------------
2000 1999 1998
------- ------- ------
Pro forma net loss (in thousands)................ $43,291 $24,534 $8,579
Pro forma net loss per share..................... $ 1.96 $ 2.31 $ 3.62
The weighted average fair value of options
granted were:
Year Ended December
31,
------------------------
2000 1999 1998
------- ------- ------
Weighted average fair value of options granted
during period................................... $ 9.58 $ 17.62 $ 4.84
Unearned stock-based compensation
In connection with certain stock option grants, the Company recognized
unearned compensation which is being amortized over the vesting periods of the
related options, usually four years, using an accelerated basis. Future
compensation charges are subject to reduction for any employee who terminates
employment prior to the expiration of such employee's option vesting period.
The following table sets forth unearned compensation and the amortization of
unearned compensation (in thousands):
Year Ended December
31,
------------------------
2000 1999 1998
------- ------- ------
Unearned compensation, net of effect of
cancellation upon termination................... $ (355) $ 431 $1,714
Amortization of unearned compensation............ $ 409 $ 1,369 $1,241
|
Employee Stock Purchase Plan
In April 1999, the Board of Directors adopted the 1999 Employee Stock
Purchase Plan (the "Purchase Plan") and reserved 500,000 shares of common stock
for issuance thereunder. The Purchase Plan was
F-20
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
approved by the stockholders in June 1999. On each January 1, the aggregate
number of shares reserved for issuance under the Purchase Plan is increased by
the lesser of 750,000 shares, 3% of the outstanding shares on such date or a
lesser amount determined by the Board of Directors. The Purchase Plan became
effective on the first business day on which price quotations for the Company's
common stock were available on the Nasdaq National Market, which was July 8,
1999. Employees are eligible to participate if they are customarily employed by
the Company or any participating subsidiary for at least 20 hours per week and
more than five months in any calendar year and do not (i) immediately after
grant own stock possessing 5% or more of the total combined voting capital
stock, or (ii) possess rights to purchase stock under all of the employee stock
purchase plans at an accrual rate which exceeds $25,000 worth of stock for each
calendar year. The Purchase Plan permits participants to purchase common stock
through payroll deductions up to 15% of the participant's compensation, as
defined in the Purchase Plan, but limited to 2,500 shares per participant per
purchase period. Each offering period includes four six-month purchase periods,
and the Purchase Plan was amended in June 2000 so that purchase periods begin
on April 1 and October 1 of each year, except for the offering period which
started on the first trading day on or after the effective date of the public
offering. The price at which the common stock is purchased under the Purchase
Plan is 85% of the lesser of the fair market value at the beginning of the
offering period or at the end of the purchase period. The Purchase Plan will
terminate after a period of ten years unless terminated earlier as permitted by
the Purchase Plan.
NOTE 8--INCOME TAXES:
Deferred taxes are composed of the following (in thousands):
December 31,
------------------
2000 1999
-------- --------
Deferred tax assets (liabilities)
Net operating loss and credit carryforwards............. $ 22,419 $ 12,840
Research and development credit carryforwards........... 1,780 405
Depreciation and amortization........................... 263 42
Accruals and other liabilities.......................... 435 511
Other................................................... 2 --
-------- --------
Total deferred tax assets............................... 24,899 13,798
Less: Valuation allowance............................... (24,899) (13,798)
-------- --------
Net deferred tax assets.................................. $ -- $ --
======== ========
|
At December 31, 2000, the Company had approximately $60.0 million of federal
and $33.0 million of state net operating loss carryforwards available to offset
future taxable income. The federal and state net operating loss carryforwards
expire in varying amounts beginning in 2011 and 2004, respectively. At December
31, 2000, the Company had approximately $1.0 million of federal and $738,000 of
state research and development credit carryforwards available to offset future
taxable income, which, in the case of the federal carryforwards, expire in
varying amounts beginning in 2011. Under the Tax Reform Act of 1986, the
amounts of and benefits from net operating loss carryforwards may be impaired
or limited in certain circumstances.
The Company has incurred a loss in each period since its inception. Based on
the available objective evidence, including the Company's history of losses,
management believes it is more likely than not that the net deferred tax assets
will not be fully realizable. Accordingly, the Company has provided for a full
valuation allowance against its total deferred tax assets at December 31, 2000
and 1999. The valuation allowance increased by $11,101,000, $8,234,000 and
$2,999,000 in the years ended December 31, 2000, 1999 and 1998, respectively.
F-21
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 9--COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases its office facilities and certain equipment under
noncancelable operating lease agreements which expire at various dates through
2005. The terms of the facility lease provide for rental payments on a
graduated scale. The Company recognizes rent expense on a straight-line basis
over the lease period, and has accrued for rent expense incurred but not paid.
The lease requires that the Company pay all costs of maintenance, utilities,
insurance and taxes. Rent expense under these leases is as follows (in
thousands):
Year Ended
December 31,
----------------
2000 1999 1998
------ ---- ----
Rent expense................................................ $1,642 $643 $294
|
Future minimum lease payments under all noncancelable capital and operating
leases at December 31, 2000 are as follows (in thousands):
Capital Operating
Year Ending December 31, Leases Leases
------------------------ ------- ---------
2001....................................................... $ 137 $1,646
2002....................................................... 31 904
2003....................................................... -- 47
2004....................................................... -- 47
2005....................................................... -- 16
----- ------
Total minimum payments................................... 168 $2,660
======
Less: amount representing interest......................... (20)
-----
Present value of capital lease obligations................. 148
Less: current portion...................................... (120)
-----
Capital lease obligations, non-current portion............. $ 28
=====
|
Litigation
In February 2000, an entity notified one of the Company's customers that it
intended to add the customer as a party to a pending patent litigation in the
United States District Court for the Eastern District of Pennsylvania
(Pittsburgh). The litigation alleges infringement of unspecified claims of
three patents (United States Patent Nos. 5,191,573; 5,675,734 and 5,996,440).
Damages have not been specified. The customer has agreed to be added to the
case, subject to a revision in the trial schedule. The customer has requested
indemnification, including defense costs, from the Company, based upon the
terms of the Company's contract with them. Based on this request, the Company
is negotiating an agreement with the customer under which the Company would (i)
assume control of the defense, (ii) pay the expenses of the defense and (iii)
reserve certain rights as to indemnification. During negotiation of this
agreement the Company has agreed to assume the expense of the defense for the
customer. These expenses could be significant. There is no assurance that the
Company will enter into this agreement. If the Company does not reach an
agreement with the customer and the defense is not successful, the customer
might seek full indemnification from the Company for the damages, if any. There
can be no assurance regarding the outcome of the litigation. If there is a
finding of infringement, the Company may be required to indemnify the customer
as to the full amount of the damages. No amount has been accrued for any
potential liabilities in relation to these matters.
On March 31, 2000, Intouch Group, Inc. ("Intouch") filed a lawsuit against
the Company in the Northern District of California alleging patent
infringement. On April 26, 2000, Intouch filed an amended complaint,
F-22
LIQUID AUDIO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
which was served on the Company shortly thereafter. The complaint names the
Company and Amazon.com International, Inc., Listen.com, Inc., Entertaindom LLC,
Discovermusic.com, Inc. and Muze, Inc. It alleges that the Company infringe or
induce infringement of, the claims of United States Patent Nos. 5,237,157 and
5,963,916 by operating a website and/or a kiosk that allows interactive
previewing of portions of pre-recorded music products. The complaint seeks
unspecified damages and injunctive relief. On May 20, 2000, the Company filed
an answer to Intouch's first amended complaint. The action is currently in
discovery, and the trial date has been set for January 11, 2002. The Company
believes that it has meritorious defenses to Intouch's claims and the Company
intends to vigorously defend against such claims. However, the Company cannot
assure that it will be successful in defending these lawsuits. If there is a
finding of infringement, the Company might be required to pay substantial
damages to Intouch and could be enjoined from selling any of the Company's
products or services that are held to infringe Intouch's patents unless and
until the Company is able to negotiate a license from them. No amount has been
accrued for any potential liabilities in relation to these matters.
On August 14, 2000, a former employee filed a charge of discrimination with
the California Department of Fair Employment and Housing against the Company,
and several of the Company's employees and former employees. The charge alleges
sexual harassment and unlawful retaliation. The Company believes, after
consultation with counsel, that these claims are without merit, and the Company
intends to defend itself vigorously. However, should a lawsuit be filed and
decided adversely to the Company, the Company may have to pay damages. No
amount has been accrued for any potential liabilities in relation to these
matters.
Contingencies
From time to time, in the normal course of business, various claims are made
against the Company. In the opinion of the management, there are no pending
claims the outcome of which is expected to result in a material adverse effect
on the financial position or results of operations of the Company.
NOTE 10--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The following is a summary of the unaudited quarterly results of operations
for the periods shown (in thousands except per share data):
Three Months Ended
------------------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999 2000 2000 2000 2000
--------- -------- --------- -------- --------- -------- --------- --------
Net revenues............ $ 531 $ 745 $ 1,785 $ 1,346 $ 2,995 $ 3,454 $ 3,355 $ 1,764
Gross profit............ 323 514 1,330 779 2,453 2,463 2,562 975
Net loss................ (4,143) (6,072) (5,820) (8,171) (6,524) (7,718) (8,892) (10,551)
Net loss per share,
basic and diluted...... (1.39) (1.89) (0.35) (0.43) (0.30) (0.35) (0.40) (0.47)
Weighted average shares
used in per share
calculation............ 2,972 3,213 16,821 19,133 21,918 22,013 22,304 22,429
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F-23
EXHIBIT INDEX
Exhibit
No. Description
------- -------------------------------------
21.1 Subsidiary of Liquid Audio, Inc.
23.1 Consent of PricewaterhouseCoopers LLP
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EXHIBIT 21.1
SUBSIDIARY OF LIQUID AUDIO, INC.
Liquid Audio Europe PLC, doing business under the same name, was organized
and incorporated under the laws of the United Kingdom.
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANT
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-46874 and 333-86785) of Liquid Audio, Inc. of
our report dated February 2, 2001 relating to the financial statements of
Liquid Audio, Inc., which is incorporated in this Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
March 30, 2001
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