-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PSK6LkQuq6KEpw5DnTac0c9shGqDKDDV7Xjegi92EpiltQP/0Dy5Ak4nzGaL9N5A Kjk93qpKDhVEBA23TQwWLQ== 0000928385-99-000480.txt : 19990222 0000928385-99-000480.hdr.sgml : 19990222 ACCESSION NUMBER: 0000928385-99-000480 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 11 FILED AS OF DATE: 19990219 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MUSICMAKER COM INC CENTRAL INDEX KEY: 0001079786 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 541811721 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-72685 FILM NUMBER: 99546208 BUSINESS ADDRESS: STREET 1: 1831 WIEHLE AVENUE STREET 2: SUITE 128 CITY: RESTON STATE: VA ZIP: 20190 BUSINESS PHONE: 7039044110 MAIL ADDRESS: STREET 1: 1831 WIEHLE AVENUE STREET 2: SUITE 128 CITY: RESTON STATE: VA ZIP: 20190 S-1 1 FORM S-1 As filed with the Securities and Exchange Commission on February 19, 1999 Registration No. 333- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 --------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- MUSICMAKER.COM, INC. (Exact Name of Registrant as Specified in its Charter) Delaware 5961 54-1811721 (State or Other (Primary Standard (I.R.S. Employer Jurisdiction of Industrial Identification No.) Incorporation or Classification Code Organization) Number) --------------- 1831 Wiehle Avenue Suite 128 Reston, Virginia 20190 (703) 904-4110 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) --------------- Robert P. Bernardi Co-Chief Executive Officer musicmaker.com, Inc. 1831 Wiehle Avenue Suite 128 Reston, Virginia 20190 (703) 904-4110 (Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service) --------------- Copies to: John L. Sullivan, III Andrew J. Sherman Andrea S. Kaufman David J. Kaufman Erik J. Lichter Alan J. Schaeffer Venable, Baetjer and Howard, LLP Katten Muchin & Zavis 2010 Corporate Ridge 1025 Thomas Jefferson St., N.W. Suite 400 Suite 700 McLean, VA 22102 Washington, DC 20007 (703) 760-1600 (202) 625-3790 --------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement is effective. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] --------------- CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Proposed Maximum Title of Each Class of Aggregate Amount of Securities to be Offering Registration Registered Price(2) Fee - ------------------------------------------------------------------ Common Stock, par value $0.01 per share $30,000,000 $8,340 - ------------------------------------------------------------------
- ------------------------------------------------------------------------------- (1) Includes shares of common stock which may be purchased by the underwriters to cover over-allotments, if any. (2) Estimated solely for purposes of determining the registration fee pursuant to Rule 457 under the Securities Act of 1933, as amended. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Subject to completion: dated February 19, 1999. PROSPECTUS musicmaker.com, Inc. [logo] shares of common stock $ per share initial public offering price This is our initial public offering. Prior to this initial public offering, there has been no public market for our common stock. We expect our initial public offering price to be between $ and $ per share. We have filed an application for our common stock to be quoted on the Nasdaq National Market under the symbol "MMKR." Offering Information
Per share Total Initial public offering price................................... Underwriting discounts/commissions.............................. Estimated offering expenses..................................... Net offering proceeds to musicmaker.com, Inc....................
We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase a maximum of additional shares to cover over-allotments. Because the underwriters may chose not to exercise their over-allotment option, the calculations in the table above do not account for such exercise. --------------- Investing in our common stock involves certain risks. See "Risk Factors" section beginning on page 5 of this prospectus. --------------- Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Ferris, Baker Watts Fahnestock & Co. Inc. Incorporated MUSICMAKER(TM), MUSIC CONNECTION(TM), MUSICMAGIC(TM) and CD KIT(TM) are trademarks of musicmaker.com, Inc. Musicmaker.com, Inc. has applied for federal trademark registration for each of the marks above. All other trademarks or service marks appearing in this prospectus are the property of their respective holders. [Picture of musicmaker.com website and custom CDs and descriptive language to be filed by amendment.] Prospectus Summary You should read this summary together with the more detailed information and financial statements and related notes thereto appearing elsewhere in this prospectus, including the information under "Risk Factors." Unless otherwise indicated, all information reflects: a one-for-3.85 reverse stock split effected on , 1999; the automatic conversion of all outstanding shares of preferred stock and all outstanding convertible notes into shares of our common stock; and the automatic conversion of all outstanding preferred stock warrants into common stock warrants upon completion of this offering. Musicmaker.com is a leading e-commerce provider of customized music CD compilations over the Internet. Our customers can search our extensive online music library and sample and select songs to make their own customized compilation CDs. Our music library currently contains over 150,000 licensed song titles. Our custom CDs can be further personalized by including selected graphics or consumer provided text. Our custom CDs have sound quality equivalent to pre-recorded CDs available at retail stores and are sold at competitive prices. We manufacture and ship our custom CDs from our state-of- the-art production facility generally within 24 hours of order. Our proprietary technology (patent application allowed) can digitally store approximately five million songs, provides advanced search/retrieval capabilities and automates the high speed production of our custom CDs. Customers can also download music from our music library using either Secure-MP3, a copyright-protected format, or a Liquid Audio, Inc. format. We currently have music content agreements with over 85 independent record labels and seek to sign content agreements with additional record labels. We believe that our proprietary customization process provides substantial benefits by allowing the customer to purchase only those songs that he chooses and by providing the record label with an additional source of revenue for songs in its back catalog. Musicmaker.com has amassed a library of music in multiple genres including significant catalogs of jazz, blues and classical music. Artists in our music library include: . Creedence Clearwater . The Beach Boys . Ziggy Marley Revival . Miles Davis . Johnny Cash . Jerry Lee Lewis . John Coltrane . Dionne Warwick . Little Richard . The Yardbirds with . Muddy Waters . Frank Zappa Eric Clapton . The Blues Brothers . Taylor Dayne . Blondie . The Kinks . The Ramones . Kansas . The Band We believe that the multimedia features available through the interactive environment of the Internet make it an ideal medium for promoting, marketing and selling our custom CDs and digitally downloaded music. Musicmaker.com believes that the following trends provide an environment favorable to industry and consumer acceptance of our custom CDs and digital downloads: . Growth in sales of CD singles. . Growth of the Internet as a viable retail medium. . Increasing affluence of the over 30 generation. . Continued prominence of classic rock albums. . Record label desire to diversify distribution methods while protecting intellectual property rights. 1 We sell our custom CDs through our website as well as the websites of other prominent music retailers, including Platinum Entertainment, Inc., Trans World Entertainment Corporation and N2K Inc. (musicboulevard.com). Additionally, we have a marketing alliance with The Columbia House Company, a leading record and video club, jointly owned by Sony Music Entertainment, Inc. and Time Warner Inc. This alliance currently allows us to exclusively market our custom CDs to Columbia House's 15 million members, including those without Internet access, through Columbia House's websites and direct marketing campaigns. Musicmaker.com has recently entered into a similar marketing alliance with Audio Book Club, Inc., a direct marketer of audio books through the Internet and club member catalogs, and intends to seek additional alliances with music and non-music retailers. Our management team has significant experience in both the music and technology industries. Our officers and directors include the former Chairman and Chief Executive Officer of PolyGram Records, Inc. and President of Mercury Records Corporation, the former President of Warner Music Media and RCA Direct Marketing, Inc./BMG Direct Marketing, Inc., as well as the co-founder of PictureTel Corporation. We seek to be the leading provider of custom CDs and digitally downloaded music on the Internet. The core elements of our strategy include: . Offer a new way to buy licensed, customized music. . Offer most extensive selection of music for custom compilation and digital downloading. . Increase website traffic through industry alliances and multiple hyperlinks. . Create strong brand awareness. . Establish genre-specific user communities. . Capitalize on cross-selling opportunities. . Leverage technologies for additional formats. . Expand international presence. Musicmaker.com, Inc. is a Delaware corporation incorporated on April 23, 1996. Our principal executive office is located at 1831 Wiehle Avenue, Suite 128, Reston, Virginia 20190, and our telephone number is (703) 904-4110. Our World Wide Web site is www.musicmaker.com. The information on our website is not incorporated by reference into this prospectus. 2 The Offering Common stock offered by musicmaker.com............... Common stock outstanding after this offering(1)............. Use of proceeds............... . Pay advances to record labels in connection with acquiring additional music content. . Expand advertising, marketing and promotional efforts with existing and future strategic marketing partners. . Maintain and upgrade technological systems. . Fund working capital and general corporate purposes. See "Use of Proceeds." Proposed Nasdaq National Market symbol................ "MMKR"
- -------- (1) Does not include: . shares of common stock underlying outstanding warrants issued to Ferris, Baker Watts, Incorporated and Fahnestock & Co. Inc., as representatives of the underwriters, or 595,855 shares of common stock underlying outstanding common stock warrants, or 247,039 additional shares reserved for issuance pursuant to our stock option plan. Includes: . 532,182 shares of common stock underlying stock options outstanding as of the date of this prospectus pursuant to our stock option plan and 728,725 shares of common stock underlying warrants issued upon conversion of the outstanding preferred warrants. See "Management--Stock Option Plan." 3 Summary Financial Data The following table summarizes our financial data. You should read this information together with our consolidated financial statements and notes thereto appearing elsewhere in this prospectus. Consolidated Statement of Operations Data:
Period from April 23, 1996 (inception) to Year ended December 31, December 31, ------------------------ 1996 1997 1998 -------------- ----------- ----------- Net sales............................ $ 8,355 $ 13,432 $ 74,028 Cost of sales........................ 2,590 2,955 46,821 --------- ----------- ----------- Gross profit......................... 5,765 10,477 27,207 Total operating expenses............. 370,410 2,060,677 4,699,789 --------- ----------- ----------- Loss from operations................. (364,645) (2,050,200) (4,672,582) Net interest (expense) income........ (2,667) (33,957) 17,815 --------- ----------- ----------- Net loss............................. $(367,312) $(2,084,157) $(4,654,767) ========= =========== =========== Pro forma basic and diluted net loss per share (1)(2): $ (1.73) =========== Pro forma weighted average shares outstanding (1)(2): 2,863,521 ===========
At December 31, 1998 ----------------------------------------- Pro Forma Actual Pro Forma (1) As Adjusted (3) ---------- ------------- --------------- Consolidated Balance Sheet Data: Cash and cash equivalents........... $ 972,954 $2,286,579 $ Working capital .................... (287,767) 1,025,858 Total assets........................ 3,233,963 4,435,193 Debt, long-term portion............. 726,786 214,286 Convertible preferred stock......... 3,434,700 -- Total stockholders' (deficit) equity ................................... (2,312,668) 2,835,762
- -------- (1) Pro forma to give effect to: . A one-for-3.85 reverse stock split to be effected, on , 1999. . The automatic conversion, upon the completion of the offering, of all outstanding shares of preferred stock into 819,199 shares of common stock. . The automatic conversion of all outstanding convertible notes into 415,584 shares of common stock ($512,500 of convertible notes outstanding at December 31, 1998 and $1,487,500 of convertible notes issued in January 1999). . The write-off of all capitalized loan fees related to the convertible notes ($112,395 capitalized at December 31, 1998 and $173,875 capitalized in January 1999). (2) Computed on the basis described in Note 9 of the notes to the consolidated financial statements. (3) Adjusted to give effect to reflect the sale of shares of common stock offered hereby at an assumed initial public offering price of $ per share (the midpoint of the range) and the application of the net proceeds of this offering. See "Use of Proceeds" and "Capitalization." 4 RISK FACTORS You should carefully consider the following risks, in addition to the other information contained in this prospectus, before making any investment decision. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties, not presently known to us, or currently considered immaterial by our management, may also materially affect our future business, financial condition and results of operations. As a result of any of the risks we encounter, our business, financial condition and results of operations could be materially adversely affected. In addition, any such adverse effect could cause the trading price of our common stock to decline and you may correspondingly lose all or some portion of your investment in us. We have a limited operating history, have incurred losses and may continue to realize losses. We also have an accumulated deficit that may continue to increase. We began commercial operations in November 1997. Accordingly, we have a limited operating history and we face all of the risks and uncertainties encountered by early stage companies in new, unproven and rapidly evolving markets. Among other things, our business will require: . Expanding the content available in our online music library. . Increasing awareness of the musicmaker.com brand. . Increasing our customer base. . Attracting and retaining talented management, technical, marketing and sales personnel. If we are unable to achieve any of these goals, or other requirements for the successful growth of an early stage Internet commerce company, our business, financial condition and results of operations may be materially adversely affected. We have had net losses in each period since we began operations. We anticipate that such losses may continue for the foreseeable future as our operating expenses continue to increase. We reported a net loss of $4,654,767 and $2,084,157 for the years ended December 31, 1998 and 1997, respectively. As of December 31, 1998, we had an accumulated deficit of $7,106,236. There can be no assurance that we will ever achieve profitable operations or generate significant revenue with our current products and strategy. See "Summary Financial Data," the consolidated financial statements appearing elsewhere in this prospectus and "Management's Discussion and Analysis of Financial Condition and Results of Operations." We do not have a license agreement with any major record label and currently rely solely on independent record labels for our music content. In order to build our music library, we must negotiate and enter into license agreements with record labels. We rely upon our license agreements with over 85 record labels, all of which are typically smaller, independent labels. In order to achieve significant commercial success, we believe we need to enter into a license agreement with at least one of the five major record labels. Together, the five major record labels below accounted for approximately 80% of the music sold in 1997: . BMG Entertainment . EMI . Universal Music Group . Sony Music Entertainment . Warner Music We may not be able to negotiate additional agreements and obtain additional licenses on favorable terms, if at all. Our inability to secure licenses for additional song titles or to obtain commercially popular music titles in a 5 timely fashion may have a material adverse effect upon our business, financial condition and results of operations. In addition, we may encounter difficulty in making the minimum payments required under our existing and any future license agreements with record labels. Our failure to make such minimum payments could have material adverse effects on our relationships with record labels, including, but not limited to, cancellation of our license agreements. Any difficulties in obtaining, or maintaining rights to music content could materially affect our business, financial condition and results of operations. See "Business--Music Content." We need to develop the musicmaker.com brand. Our future success and growth significantly depend upon our promotion and favorable consumer perception of the musicmaker.com brand. Increased recognition and awareness of the musicmaker.com brand will largely depend upon our advertising and promotional efforts, our strategic marketing alliances, and our continued provision of a high quality product and high level of customer service. There can be no assurance that these efforts will result in increased brand recognition or if such increased brand recognition is obtained, that we will experience a corresponding increase in the sale of our custom CDs. See "Business--musicmaker.com Strategy." Our business depends on continued growth of online commerce. Purchasing products and services over the Internet is a new and emerging market. Our future revenues and profits are substantially dependent upon widespread consumer acceptance and use of the Internet and other online services as a medium for commerce. Rapid growth of the use of the Internet and other online services is a recent phenomenon. This growth may not continue. A sufficiently broad base of consumers may not adopt, or continue to use, the Internet as a medium of commerce. Demand for and market acceptance of recently introduced products and services over the Internet are subject to a high level of uncertainty, and there are few proven products and services. For us to grow, consumers who have historically used traditional means of commerce will instead need to purchase products and services online, and as a result the custom CD market may not be viable without the growth of Internet commerce. We depend upon maintenance and continued improvement of the Internet's infrastructure. The Internet has experienced, and is expected to continue to experience, significant growth in the number of users and amount of traffic. Our success will depend upon the development and maintenance of the Internet's infrastructure to cope with this increased traffic. This will require a reliable network backbone with the necessary speed, data capacity and security, and the timely development of complementary products, such as high- speed modems, to provide reliable Internet access and services. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure and could face such outages and delays in the future. Outages and delays are likely to affect the level of Internet usage, the level of traffic on our website and the number of purchases on our website. In addition, the Internet could lose its viability as a mode of commerce due to delays in the development or adoption of new standards to handle increased levels of activity or due to increased government regulation. The adoption of such new standards or government regulation may also require us to incur substantial compliance costs. Our business model is novel and unproven. Musicmaker.com is based on a novel and unproven business model. It is impossible to predict the degree to which consumers will use the musicmaker.com service and the level of consumer acceptance for our custom CDs. It is also difficult to anticipate the level of acceptance of our distribution model by additional record labels, specifically major record labels. We will be successful only if consumers and record labels respond favorably to our business model and our custom CDs and digitally downloaded music. 6 Factors influencing consumers' acceptance of our custom CDs and digitally downloaded music include: . Our ability to consistently provide high quality custom CDs and digitally downloaded music at competitive prices. . Our maintenance of a user-friendly ordering process and a high level of customer service. . Consumers' desire to conduct online commerce, specifically their demand for custom CDs. Factors influencing record labels' acceptance of our business model include: . The belief that sales of custom CDs and digitally downloaded music will enable record labels to gain market exposure for artists and titles in their back catalogs and generate incremental revenue without disrupting existing distribution channels or retail pricing structures. . The belief that musicmaker.com will be able to assist in the protection of record label's intellectual property rights. Should we encounter difficulty with any of the factors above, or other factors associated with consumer or record label acceptance of our business model, it is possible that we will not achieve profitability. See "Business-- musicmaker.com Strategy." The online music industry is extremely competitive. The market for online commerce is extremely competitive and we believe such competition will continue to grow and intensify. Our most visible custom compilation competitors currently include Custom Revolutions, Inc., CDuctive, and amplified.com. Although our primary focus is on sales of custom, rather than pre-recorded music CDs, we may ultimately compete with existing online websites that provide sales of pre-recorded music on the Internet. Such online competitors may include N2K, CDnow, Inc., Amazon.com, Inc., barnesandnoble.com inc., Columbia House and BMG Music Service. We do not believe that any of these competitors currently offer customized music compilations to their customers. However, CDnow purchased SuperSonic Boom, a custom compilation provider, in June 1998. We also face significant competition in the growing market to provide digitally downloaded music, specifically for music files in MP3 format. Digitally downloaded music can currently be found on the websites of existing online music retailers, artists and record labels as well as catalogs of songs provided by internet portals such as Lycos. We expect the competition to provide MP3 files to intensify with further entry by additional record labels, artists and portals, including those with greater resources and music content than musicmaker.com. Recently, the five major record labels announced that they have joined with IBM to conduct a market trial of a digital distribution system, providing over 1,000 albums to cable subscribers in the San Diego area. We expect additional market trials and alliances by technology and music industry participants to continue as the music industry attempts to integrate emerging technology into its existing distribution methods. See "Risk Factors--Our industry may encounter changes in music distribution methods." Our ability to effectively compete in the online music industry will depend upon, among other things: . Our ability to expand the list of song titles available from our online music library. . Our continued promotion of the musicmaker.com website and brand. . Our maintenance and improvement of the technical systems upon which our operations rely. . Our ability to attract and retain experienced management, technical, marketing and sales personnel. . Our ability to provide a high quality, easy to use mechanism by which users can customize and purchase music at a reasonable price. Our failure in connection with any of the factors above, would materially adversely affect our ability to compete. 7 In addition to competition encountered on the Internet, we face competition from traditional music retail chains and megastores, mass merchandisers, consumer electronics stores, music clubs, and a number of small custom compilation start-up companies. We could also face competition from record companies, multimedia companies and entertainment companies that seek to offer recorded music either directly to the public or through strategic ventures and partnerships. Many of our current and potential competitors in the Internet commerce and music businesses have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and larger existing customer bases than musicmaker.com. For example, should record labels decide to compete with us by offering their own custom CDs over the Internet or by making their music available for digital downloads, we would be at a significant disadvantage from a music library selection standpoint. We expect that such competitors may be able to respond more quickly to new or emerging technological change, competitive pressures and changes in customer demand. As a result of their advantages, our competitors may be able to limit or curtail our ability to successfully compete in the industry. The competitive pressures that we encounter in the industry could materially adversely affect our business, financial condition and operating results. See "Business--Competition." We are significantly dependent upon certain existing and future marketing alliances. We believe that future marketing of our custom CDs is heavily dependant upon existing strategic marketing alliances. We anticipate that our ability to distribute print advertisements, promote the musicmaker.com brand name and ultimately sell custom CDs would be materially adversely affected by contractual difficulties associated with, or the termination of, our existing marketing alliances. We especially rely upon our current marketing alliance with Columbia House. Columbia House may terminate our alliance upon not less than thirty days notice if Mr. Puthukarai ceases to be musicmaker.com's President and Chief Operating Officer and Columbia House deems his replacement incompatible with their interest, or Columbia House determines after the first six musicmaker.com promotional mailings to its members that its financial returns do not justify continuing the relationship. Columbia House may choose to enter into non-exclusive marketing agreements with our competitors if they offer a significant repertoire of music unavailable through musicmaker.com. Our alliance with N2K is subject to renegotiation as a result of its proposed merger with CDNow, which acquired a custom compilation provider in June 1998. Our future success and development of the musicmaker.com brand name is also heavily dependant upon our ability to enter into additional marketing alliances and hyperlink arrangements with music and entertainment companies, Internet service providers, and Internet search engines. There is no assurance that we will be able to develop future strategic alliances on terms favorable to us, if at all. Our inability to enter into such alliances in the future could materially adversely affect the promotion of our musicmaker.com brand and our custom CDs. See "Business--Marketing." Growth of musicmaker.com may challenge our business operations. Since beginning commercial operations in November 1997, we have rapidly expanded our operations. While we anticipate continued expansion of our operations for the foreseeable future, such growth may place considerable strain on our existing resources and technology, as well as our management, technical, marketing and sales personnel. In order to adequately manage our growth, it will be necessary to continue to implement our strategy and to assess and upgrade the systems and resources which support our operations. If we are unable to manage our growth effectively, our business, financial condition and results of operations may be materially adversely affected. See "Business--musicmaker.com Strategy." We may encounter security risks associated with business on the Internet. We are potentially vulnerable to computer break-ins, "hackers," credit fraud, viruses and other similar disruptive problems caused by our customers or unauthorized third parties. These disruptions could result in interruption, delay or possible cessation of service to our customers. Unauthorized activity on our network or website could also result in potential misappropriation of proprietary information or customer data. Such misappropriation could cause us to incur significant litigation expense to assert our proprietary rights or defend possible claims of misuse of, or failure to secure, consumers' personal information. 8 Consumers currently use their credit cards to make online purchases. We rely on licensed encryption and authentication technology to secure transmission of confidential information, including credit card numbers. It is possible that advances in computer capabilities and technology could result in a compromise or breach of the technology we use to protect customer transaction data. Such security concerns of our business, and the online industry generally may deter customers and potential customers from using the Internet as a means of commerce. Security breaches could also expose us to potential liability to customers, record labels and others and could inhibit the growth of the Internet as a merchandising medium. Our industry may encounter changes in music distribution methods. New digital distribution channels for music could radically alter the established order of artists, publishers, distributors, retailers and media companies that use current music distribution methods. Early adopters are currently performing market trials with high quality, open format MP3 downloaded music files--some posted legally by artists or record labels on their own websites, others posted illegally on sites that have pirated intellectual property owned by the major and independent labels. A portable device, the Rio, that plays MP3 downloaded music files recently became available to consumers. In February 1999, the five major record companies announced that they would conduct a market trial to test selling music as digital information transmitted over the Internet. The test, which uses IBM software, will allow approximately 1,000 cable subscribers in San Diego to download music from a library of 1,000 album titles and several hundred song titles provided by the major record labels. The market trial is viewed by many as the first step taken by the major record companies to consider the sale of digital music online. A task force of recording companies, software programmers and consumer electronics makers, called the Secure Digital Music Initiative, is attempting to develop standards by which songs available in digital format can be disseminated without infringing upon copyright or other intellectual property rights. We have made a business decision to provide licensed music content over the Internet by licensing content from labels in a traditional manner to ensure compliance with existing copyright laws. The acceptance and integration of any of these new methods of music distribution, without sufficient protection of intellectual property or industry uniformity, could materially adversely affect our business, financial condition and results of operations. Increased availability of high bandwidth capacity could further alter existing distribution methods. We may not be able to keep up with technological advancements. The market for providing custom CDs and digitally downloaded music on the Internet, and for Internet commerce generally, is characterized by rapid change, evolving industry standards and the frequent introduction of new technological products and services. The introduction of new technology, products, services or standards may prove to be too difficult, costly or simply impossible to integrate into our existing systems. Such innovations could render our existing or any future products and services obsolete. Our ability to remain competitive will also depend heavily upon our ability to maintain and upgrade our technology products and services. Any difficulty keeping pace with technological advancements could hurt growth of our business, retention of our customers and may materially adversely affect our business, financial condition and results of operations. Risk of our system failure. Our business heavily depends upon our ability to maintain our computer and telecommunications equipment in effective working order. The scalability features of our storage and fabrication systems have not been tested in actual operations and may not be able to handle a large increase in customer demand or a significant increase in our online music library. The strain associated with increased demands upon our systems may result in reduced quality of our customer service and products or potential system failure. Any interruption, damage to, or failure of our systems could have a material adverse effect on our business, financial condition and results of operations. Substantially all of our computer and telecommunications operations are located at our facility in Reston, Virginia. We currently do not maintain a redundant website or co-hosting arrangement nor do we have an off-site back-up of our music library. In the event of a catastrophic loss at our Reston facility resulting in damage to, or destruction of, our computer and telecommunications systems, we would have a material interruption in our business operations. 9 We depend upon intellectual property rights and risk having such rights infringed. We consider our trademarks, trade secrets and similar intellectual property to be a valuable part of our business. To protect such intellectual property rights, we rely upon copyright, trademark, patent and trade secret laws, as well as confidentiality agreements with our employees and consultants. There can be no assurance that our use of such contracts and the application of existing law will provide sufficient protection from misappropriation or infringement of our intellectual property rights. It is possible that others will develop and patent technologies that are similar or superior to that of musicmaker.com. It is also possible that third parties will obtain and use our content or technology without authorization. Musicmaker.com's year 2000 risks. The year 2000 issue is the result of computer programs written using year identifiers consisting of two digits, rather than four. Use of two digits to identify years may cause certain systems to recognize a date using "00" as the year 1900, rather than the year 2000. The year 2000 issue could result in system failures, or miscalculations causing disruption to the operations of many businesses. We have not verified that the companies doing business with us are year 2000 compliant. Significant uncertainty exists concerning the potential costs and effects associated with any year 2000 compliance. Any year 2000 compliance problem of musicmaker.com, our current and any future strategic marketing partners, our vendors or our users could have a material adverse effect on our business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 System Costs." We may be exposed to liability for content retrieved from our website. Our exposure to liability from providing content on the Internet is currently uncertain. Due to third party use of information and musical content downloaded from our website, we may be subject to claims for defamation, negligence, copyright, trademark or patent infringement or other theories based on the nature and content of such materials. Our exposure to such liability, particularly for claims not covered by insurance, or in excess of any insurance coverage, could have a material adverse effect on our business, financial condition and results of operations. We depend upon the services of key personnel. Our future success depends heavily upon the continued service and industry relationships of our key senior management personnel, including, but not limited to: . Robert P. Bernardi, our Chairman of the Board of Directors and Co-Chief Executive Officer. . Devarajan S. Puthukarai, our President, Co-Chief Executive Officer and Chief Operating Officer. . Irwin H. Steinberg, our Vice Chairman of the Board of Directors and a consultant to musicmaker.com. Any departure by key senior management personnel may have a material adverse effect upon our business, financial condition and results of operations. See "Risk Factors--We are significantly dependent upon certain existing marketing alliances," "Business--Marketing" and "Management." We depend upon hiring and retaining qualified employees. Our current and future operations significantly depend upon our ability to attract, retain and motivate highly qualified, managerial, technical, marketing and sales personnel. Competition for such personnel is intense, particularly in the Northern Virginia employment market. There can be no assurance that we will be able to retain our existing employees or attract, retain and motivate highly qualified personnel in the future. Such personnel difficulties could impair growth of our business, promotion of our musicmaker.com brand and products, and materially adversely affect our business, financial condition and results of operations. 10 Regulation of Internet domain names is uncertain. We currently hold the Internet domain name "musicmaker.com." Domain names generally are regulated by Internet regulatory bodies. The regulation of domain names in the United States and in foreign countries is subject to change. Regulatory bodies could establish additional top level domains, appoint additional domain name registrars or modify the requirements for holding domain names. As a result, we may not acquire or maintain the musicmaker.com domain name in all of the countries in which we conduct or expect to conduct business. The relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that infringe or otherwise decrease the value of our trademarks and other proprietary rights. Our industry may be subject to increased government regulation. As commerce conducted on the Internet continues to evolve, federal, state or foreign agencies may adopt regulations or impose new taxes intended to cover our business operations. Such efforts may seek to regulate areas including user privacy, pricing, content and consumer protection standards for our products and services. Compliance with such regulations could hinder our growth or prove to be prohibitively expensive. It is also possible that the introduction of such regulations could expose companies involved in Internet commerce, or the provision of content over the Internet, to significant liability. If enacted, such government regulation could materially adversely affect the viability of Internet commerce, generally, as well as our business, financial condition and results of operations. Certain existing investors own a large percentage of musicmaker.com's voting securities. Following the completion of this offering, our executive officers, directors and their affiliated entities together will beneficially own approximately of our outstanding shares of common stock ( if the underwriters' overallotment option is exercised in full). As a result, these stockholders will exercise significant control over all matters requiring stockholder consent. Matters typically submitted to our stockholders for a vote include the election of our directors, mergers or consolidations, and any sale of all, or substantially all of our assets. The concentrated holdings of the stockholders noted above may result in delay or deterrence of possible changes in our control, which may reduce the market price of our common stock. See "Principal Stockholders." We may encounter risks associated with international expansion. We intend to expand our business into international markets. In the event that we conduct any such expansion, we will encounter many of the risks associated with international business expansion, generally. Such risks include, but are not limited to, language barriers, changes in currency exchange rates, political and economic instability, difficulties with regulatory compliance and difficulties with enforcing contracts and other legal obligations. See "Business--musicmaker.com Strategy." Shares eligible for future sale. We will have shares of common stock outstanding after this offering. The common stock sold in this offering will be freely tradable except for any shares purchased by "affiliates" as that term is defined in Rule 144, promulgated under the Securities Act of 1933, as amended. Our common stock sold prior to the offering and certain other securities sold prior to the offering, including securities automatically converting into common stock upon completion of this offering are "restricted securities" as that term is defined in Rule 144. In addition the following securities are outstanding and, upon exercise of certain purchase rights and issuance of common stock therefor unless registered, may only be sold pursuant to Rule 144 or an exemption from registration. . Under our stock option plan, options to purchase 532,182 shares of common stock are issued and outstanding and upon exercise, the underlying common stock may be freely traded subject to certain limitations imposed by Rule 701 of the Securities Act. An additional 247,039 shares of common stock are reserved for issuance under our stock option plan. 11 . 595,855 common stock warrants outstanding, 728,725 common stock warrants to be issued upon conversion of the outstanding preferred warrants and common stock warrants to be issued to the representatives in connection with this offering. The holders of the warrants may sell shares of common stock acquired upon exercise no earlier than six months from the date of issuance, pursuant to, and as limited by, Rule 144. Stockholders holding approximately or % of our outstanding common stock have agreed not to offer, pledge, sell, contract to sell, grant any option for the sale of, or otherwise dispose of, directly or indirectly, any musicmaker.com securities currently held without prior written consent of Ferris, Baker Watts, Incorporated for a period of 180 days. Further sales of common stock under Rule 144 or otherwise, and the introduction of such shares into the public market could materially adversely affect the market price of our common stock. See "Shares Eligible for Future Sale." Our management will have broad discretion in applying the net proceeds of this offering. Assuming an initial offering price of $ and after deducting underwriting discounts and commissions and other expenses of the offering, we will receive net proceeds of $ . We have not yet determined the specific dollar amount of net proceeds to be allocated to any of the possible uses indicated in "Use of Proceeds." Accordingly, our management will have broad discretion in applying the net proceeds of the offering. See "Use of Proceeds." Investors purchasing common stock in this offering will experience immediate and substantial dilution. The initial public offering price is expected to be substantially higher than the pro forma net tangible book value per share of the outstanding common stock immediately after this offering. Accordingly, if you purchase common stock in this offering, you will incur immediate dilution of approximately $ , or % in the pro forma net tangible book value per share of common stock from the price you pay for the common stock. To the extent that outstanding options and warrants are exercised or additional securities are issued, there will be further dilution to the investors in this offering. See "Dilution" and "Shares Eligible for Future Sale." Tax uncertainties of our business. It is possible that the current tax moratorium limiting the ability of state and local governments to impose taxes on Internet based transactions could fail to be renewed prior to October 2001. Failure to renew this legislation would allow states to impose new taxes on Internet based commerce. Should states impose a requirement that online vendors collect taxes for all products shipped to each state, collection of such sales tax could create additional administrative burdens on our operations and slow the growth of Internet commerce. The imposition of such taxes could materially adversely affect our ability to become profitable in the future. There has not been a public market for our common stock and its market price is likely to fluctuate. Prior to this offering there has been no public market for our common stock. We have applied to list our common stock on the Nasdaq National Market under the symbol "MMKR." There can be no assurance, however, that an active trading market will develop, or, if developed, that such a market will be maintained. The market price of our common stock is likely to be volatile. As a result, you may not be able to resell your shares at or above the initial public offering price and could lose all or some portion of your investment. This volatility may result from factors including: . Variations in our quarterly operating results. . Increase or decrease in orders placed for our products. . Changes in estimates prepared by analysts for musicmaker.com or online commerce generally. . Any announcement of technological innovations. . The introduction of new competitors or changes in customer preferences. . The general condition of companies engaged in Internet commerce. . Other events or factors affecting the market for our common stock and the stock market generally. 12 The stock market and Internet stocks specifically have experienced significant price and volume fluctuations that have affected the market price of common stock for many companies engaged in industries similar to musicmaker.com. The factors above could materially adversely affect the market price of our common stock. We may have fluctuations in our quarterly results. We expect to experience significant fluctuations in our future quarterly operating results caused by a variety of factors, many of which are outside of our control. Factors affecting our quarterly results may include: . Any announcement, or introduction of new or enhanced websites, products, services and strategic alliances by us, our alliance partners or our competitors. . Any changes to our current product offering, increases or decreases in our song library or that of our competitors. . Seasonality of music purchases. . Level of customer satisfaction, including our ability to retain existing customers and attract new customers. . Price competition or changes in our current licensing arrangements. . Increases or decreases in the use of the Internet, generally, and consumer acceptance of the Internet for retail commerce purposes. . Our ability to upgrade or respond to technological advances in a timely and cost effective manner with minimal disruption to our operations. . Technical difficulties, system downtime or Internet disruptions. . General economic conditions and conditions specific to Internet commerce and the music industry. As a result of these and other factors, period-to-period comparisons of our results of operations may not be meaningful and should not be relied upon as an indication of our future performance. As a result of any of the factors above, our operating results could be below expectations of investors and market analysts, and the market price of our common stock could be adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Anti-takeover effects of our Charter and Bylaws. Our Charter and Bylaws contain provisions that could discourage potential acquisition proposals and might delay or prevent a change in control of musicmaker.com. These provisions could make musicmaker.com less attractive to potential acquirers. These provisions could also result in our stockholders being denied a premium for, or receiving less for, their shares than they otherwise might have been able to obtain in a takeover attempt. See "Description of Securities." Our stockholders may have difficulty in recovering monetary damages from directors. Our Charter contains a provision which eliminates personal liability of our directors for monetary damages to be paid to us and our stockholders for breach of certain fiduciary duties. As a result of this provision, our stockholders may be unable to recover monetary damages against our directors for their actions that constitute a breach of certain fiduciary duties, negligence or gross negligence. Inclusion of this provision in our Charter may also reduce the likelihood of derivative litigation against our directors and may discourage lawsuits against our directors for breach of their duty of care even though such claims might have been successful and benefited stockholders. See "Description of Securities." 13 We may require additional capital or financing in the future. We anticipate that the proceeds of this offering, cash on hand, cash equivalents and commercial credit facilities will be adequate to meet our working capital needs for at least the next 12 months. Beyond that period, we may need to raise additional funds. We cannot be certain that we will be able to obtain such funds on favorable terms, if at all. If we decide to raise such funds by issuing additional equity securities, purchasers in this offering may experience additional dilution. Issuance of additional equity securities may also involve granting preferences or privileges ranking senior to those purchasers in this offering. If we cannot obtain sufficient funds, we may not be able to grow our operations, take advantage of future business opportunities or respond to technological developments or competitive pressures. See "Dilution," and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." We do not intend to pay dividends. We have never paid dividends on our common stock. We do not intend to pay dividends and purchasers should not expect to receive dividends on our common stock for the foreseeable future. See "Dividend Policy" and "Description of Securities." Warning regarding our use of forward-looking statements. This prospectus contains forward-looking statements. Such statements relate to possible future events, our future performance and our future operations. In some cases, you can identify forward-looking statements by our use of words such as "may," "will," "should," "anticipates," "believes," "expects," "plans," "future," "intends," and other similar expressions. These forward- looking statements are only our predictions. Our actual results could and likely will differ materially from these forward-looking statements for many reasons, including the risks described below and appearing elsewhere in this prospectus. 14 USE OF PROCEEDS Assuming an initial offering price of and after deducting underwriting discounts and commissions and other expenses of this offering, we will receive net proceeds of from the sale of shares of our common stock in this offering. We intend to use the net proceeds of this offering to pay advances in connection with acquiring additional music content from record labels. We also anticipate using net proceeds to expand our advertising, marketing and promotional efforts with our existing and future strategic marketing partners. Net proceeds may be used to support promotional inserts in direct mailings to Columbia House and Audio Book Club members, website advertising and seasonal product promotions. We intend to use net proceeds to maintain, back-up, and upgrade the technological systems which support our operations. Although we do not have any current plans to acquire any businesses, we may use a portion of the net proceeds of the offering for such purposes. We have not yet determined the amount of net proceeds to specifically allocate to each of the foregoing purposes. As a result, management will have significant discretion in the application of such proceeds. Allocation of net proceeds is further subject to future events including general economic conditions, changes in musicmaker.com's strategy and response to competitive pressures and consumer preferences associated with the music industry and Internet commerce. Pending use, we will invest the net proceeds of this offering in bank certificates of deposit and other fully insured investment grade interest bearing securities. See "Business--musicmaker.com Strategy" and "Risk Factors--Our management will have broad discretion in applying the net proceeds of this offering." 15 CAPITALIZATION The following table sets forth our capitalization as of December 31, 1998: . On an actual basis. . On a pro forma basis to reflect: . A one-for-3.85 reverse stock split to be effected on , 1999. . The automatic conversion, upon the completion of the offering, of all outstanding shares of preferred stock into 819,199 shares of common stock. . The automatic conversion of all outstanding convertible notes into 415,584 shares of common stock ($512,500 of convertible notes outstanding at December 31, 1998 and $1,487,500 of convertible notes issued in January 1999) and the issuance of 252,104 shares of common stock after December 31, 1998. . On a pro forma as adjusted basis, to reflect the receipt by musicmaker.com of the estimated net proceeds from the offering. The information below assumes an initial public offering price of $ as reduced for underwriting discounts, commissions and expenses incurred in connection with the offering.
As of December 31, 1998 ------------------------------------- Pro Forma Actual Pro Forma As Adjusted ----------- ----------- ----------- Current portion of long-term obligation.. $ 42,857 $ 42,857 =========== =========== ==== Convertible notes and long-term obligation.............................. $ 726,786 $ 214,286 Series A preferred stock................. 1,750,000 -- Series B preferred stock................. 1,684,700 -- Stockholders' (deficit) equity: Common stock, $0.01 par value; 5,194,805 shares authorized; 2,707,954 shares issued and outstanding on an actual basis; 3,942,737 shares issued and outstanding on a pro forma basis and shares issued and outstanding on a pro forma as adjusted basis...... 27,080 39,427 Additional paid-in capital............. 4,766,488 10,188,841 Accumulated deficit.................... (7,106,236) (7,392,506) ----------- ----------- ---- Total stockholders' (deficit) equity .... (2,312,668) 2,835,762 ----------- ----------- ---- Total capitalization..................... $ 1,848,818 $ 3,050,048 =========== =========== ====
16 DILUTION The difference between the initial public offering price per share of common stock and the as adjusted pro forma net tangible book value per share of common stock after this offering constitutes the dilution to investors purchasing common stock in this offering. Net tangible book value per share is determined by dividing musicmaker.com's net tangible book value (total assets less total liabilities) by the number of outstanding shares of common stock. At December 31, 1998, our net tangible book value was $ or $ per share of common stock. After giving effect to the sale of the common stock offered hereby, assuming an initial public offering price of $ and after deducting the estimated underwriting discounts, commissions and offering expenses, our net tangible book value as of December 31, 1998, would have been $ or $ per share. This represents an immediate increase in net tangible book value of $ per share to the existing holders of common stock and an immediate dilution to investors purchasing in this offering of $ per share. The following table illustrates the per share dilution to investors purchasing in this offering: Assumed initial public offering price per share.......................... Net tangible book value before offering................................ Pro forma increase attributable to new investors....................... Net tangible book value after offering................................. Pro forma dilution to investors purchasing in offering...................
The following table summarizes as of December 31, 1998, on the pro forma basis described above, the number of shares of capital stock purchased from musicmaker.com, the total consideration paid to musicmaker.com and the average price per share paid by existing stockholders and by investors purchasing shares of common stock in this offering at an assumed initial public offering price of $ , before deducting the estimated underwriting discount and commissions and estimated offering expenses:
Shares Purchased Total Consideration Average ------------------- ---------------------- Price Number Percent Amount Percent Per Share -------- -------- ---------- ---------- --------- Existing stockholders... % $ % $ New investors........... $ -------- -------- ---------- --------- ---- Total................. 100% $ 100% ======== ======== ========== ========= ====
The table above excludes the following: . 595,855 common stock warrants issued and outstanding, 728,725 common stock warrants to be issued upon conversion of the oustanding preferred stock warrants, and common stock warrants to be issued to the representatives in connection with this offering; and . 532,182 options issued as of January 31, 1999 under our stock option plan. To the extent that any of these options or warrants are exercised, there would be further dilution to investors purchasing in the offering. See "Capitalization," "Management--Stock Option Plan" and Notes 5 and 9 of the notes to the consolidated financial statements. DIVIDEND POLICY We have never declared or paid any cash dividends on our capital stock and we do not anticipate paying cash dividends in the foreseeable future. The payment of cash dividends, if any, in the future will be at the sole discretion of the Board of Directors. 17 SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the consolidated financial statements and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this prospectus. The consolidated statement of operations data for the period from April 23, 1996 (inception) to December 31, 1996 and the years ended December 31, 1997 and 1998, and the consolidated balance sheet data at December 31, 1997 and 1998 are derived from the consolidated financial statements of musicmaker.com that have been audited by our independent auditors, and are included elsewhere in this prospectus. Consolidated Statement of Operations Data:
Year ended December 31, ------------------------ Period from April 23, 1996 (inception) to December 31, 1996 1997 1998 ----------------- ----------- ----------- Net sales......................... $ 8,355 $ 13,432 $ 74,028 Cost of sales..................... 2,590 2,955 46,821 --------- ----------- ----------- Gross profit...................... 5,765 10,477 27,207 Operating expenses: Sales and marketing............. -- 7,780 929,661 Operating and development....... 64,029 692,041 1,435,690 General and administrative...... 306,381 1,360,856 2,334,438 --------- ----------- ----------- Total operating expenses.......... 370,410 2,060,677 4,699,789 --------- ----------- ----------- Loss from operations.............. (364,645) (2,050,200) (4,672,582) Net interest (expense) income..... (2,667) (33,957) 17,815 --------- ----------- ----------- Net loss.......................... $(367,312) $(2,084,157) $(4,654,767) ========= =========== =========== Basic and diluted net loss per share(2)......................... $ (0.44) $ (1.20) $ (2.13) ========= =========== =========== Weighted average shares outstanding(2)................... 830,076 1,734,328 2,186,488 ========= =========== =========== Pro forma basic and diluted net loss per share(1)(2): $ (1.73) =========== Pro forma weighted average shares outstanding(1)(2): 2,863,521 ===========
Consolidated Balance Sheet Data:
At December 31, 1998 --------------------------------------- Pro Forma Actual Pro Forma(1) As Adjusted(3) ---------- ------------ -------------- Cash and cash equivalents.............. $ 972,954 $2,286,579 $ Working capital........................ (287,767) 1,025,858 Total assets........................... 3,233,963 4,435,193 Debt, long-term portion................ 726,786 214,286 Convertible preferred stock............ 3,434,700 -- Total stockholders' (deficit) equity... (2,312,668) 2,835,762
- -------- (1) Pro forma to give effect to: . A one-for-3.85 reverse stock split to be effected on , 1999. . The automatic conversion, upon the completion of the offering, of all shares of outstanding preferred stock into 819,199 shares of common stock. . The automatic conversion of all outstanding convertible notes into 415,584 shares of common stock ($512,500 of convertible notes outstanding at December 31, 1998 and $1,487,500 of convertible notes issued in January 1999). . The write-off of all capitalized loan fees related to the convertible notes ($112,395 capitalized at December 31, 1998 and $173,875 capitalized in January 1999). (2) Computed on the basis described in Note 9 of the notes to the consolidated financial statements. (3) Adjusted to give effect to reflect the sale of shares of common stock offered hereby at an assumed initial public offering price of $ per share and the application of the net proceeds therefrom. See "Use of Proceeds" and "Capitalization." 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of musicmaker.com should be read in conjunction with the consolidated financial statements and the related notes thereto and other financial information included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Musicmaker.com's actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those factors set forth under "Risk Factors" and appearing elsewhere in this prospectus. Overview Musicmaker.com is a leading e-commerce provider of customized music CD compilations over the Internet. Our customers can search our extensive online music library and sample and select songs to make their own customized compilation CDs. Our music library currently contains over 150,000 licensed song titles. Our custom CDs can be further personalized by including selected graphics or consumer provided text. Our custom CDs have sound quality equivalent to pre-recorded CDs available at retail stores and are sold at competitive prices. We manufacture and ship our custom CDs from our state-of- the-art production facility generally within 24 hours of order. Our proprietary technology (patent application allowed) can digitally store approximately five million songs, provides advanced search/retrieval capabilities and automates the high speed production of our custom CDs. Customers can also download music from our music library using either Secure-MP3, a copyright-protected format, or a Liquid Audio format. We currently have music content agreements with over 85 independent record labels and seek to sign content agreements with additional record labels. We believe that our proprietary customization process provides substantial benefits by allowing the customer to purchase only those songs that he chooses and by providing the record label with an additional source of revenue for songs in its back catalog. Musicmaker.com has amassed a library of music in multiple genres including significant catalogs of jazz, blues and classical music. Artists in our music library include:
. Creedence Clearwater Revival . The Beach Boys . Ziggy Marley . Jerry Lee Lewis . Miles Davis . Johnny Cash . Little Richard . John Coltrane . Dionne Warwick . Frank Zappa . The Yardbirds with . Muddy Waters Eric Clapton . Taylor Dayne . Blondie . The Blues Brothers . The Ramones . Kansas . The Kinks . The Band Musicmaker.com was incorporated in April 1996 ("Inception"). On July 31, 1996, musicmaker.com acquired the technology to produce its custom CDs. See "Certain Transactions." During the remainder of 1996 and through the year ended December 31, 1997, musicmaker.com's operating activities consisted of recruiting personnel, developing the technological infrastructure necessary to create custom CDs on the Internet, building an operating infrastructure and establishing relationships with record labels and vendors. Musicmaker.com launched its website in October 1997 and shipped its first custom CD in November 1997. In 1998, musicmaker.com established several strategic alliances with leading online and offline music marketers. See "Business--Marketing." Since commercial operations primarily began in the fourth quarter of 1997, musicmaker.com has sold over 5,000 custom CDs. Through July 1998, all of musicmaker.com's net sales had been derived from the sale of custom CDs through its own website and print promotions. In August 1998, musicmaker.com began selling its custom CDs through a marketing alliance with N2K. In October 1998, musicmaker.com began selling its custom CDs through marketing alliances with Platinum and Columbia House. See "Business--Marketing." Net sales are primarily derived from custom CDs offered over the Internet and through advertising campaigns and individual songs downloaded directly from musicmaker.com's website. Net sales are net of sales 19 discounts, and include shipping and handling charges. Customer accounts are settled by directly charging a customer's credit card. Net sales are recognized upon shipment of the CD from musicmaker.com's production site in Reston, Virginia. For digitally downloaded songs, net sales are recognized upon execution of the order. Cost of sales principally consist of content costs, production and shipping costs, and credit card receipt processing costs. Content costs will include royalty payments based on actual sales. Production costs include jewel cases, CD trays and CD inserts. Musicmaker.com expects that its cost of sales will increase significantly as it enters into additional licensing agreements to further expand and develop its music library. Sales and marketing expenses consist primarily of advertising and promotional expenditures, including payroll and related expenses. Musicmaker.com expenses all advertising costs as incurred. Musicmaker.com expects sales and marketing expenses to increase significantly as it endeavors to increase its customer base, drive traffic to its website and enhance brand name awareness. Operating and development expenses are expensed as incurred and consist primarily of initial royalty payments and content development costs. To establish its music library, musicmaker.com made advance royalty payments pursuant to licensing agreements with certain record labels. These payments have been classified as operating and development expenses due to management's belief that minimal net sales will be generated during the one year period following the payment of these advances. Musicmaker.com is required to make additional annual advance payments for up to two years. Should these initial arrangements generate significant revenues, future advances will be classified as cost of sales. With respect to future licensing arrangements, musicmaker.com intends to pay royalties based on actual sales which would be included in cost of sales. Musicmaker.com expects that in the future, operating and development costs will consist primarily of payroll and related expenses for website and system development as well as expenses associated with website hosting and Internet operations. Musicmaker.com's operating and development expenses have increased significantly since Inception, and are expected to continue to increase with our growth. General and administrative expenses consist primarily of legal and professional fees, payroll costs and related expenses for officers and administrative personnel, as well as other expenses associated with corporate functions. Musicmaker.com has an extremely limited operating history upon which to base an evaluation of its business and prospects. Musicmaker.com has yet to achieve significant net sales and its ability to generate significant net sales in the future is uncertain. Further, in view of the rapidly evolving nature of musicmaker.com's business and its very limited operating history, musicmaker.com has little experience forecasting net sales. Therefore, musicmaker.com believes that period-to-period comparisons of our financial results are not necessarily meaningful and you should not rely upon them as an indication of future performance. To date, musicmaker.com has incurred substantial costs to create, introduce and enhance its services, to acquire content, to build brand awareness and to grow its business. As a result, musicmaker.com has incurred operating losses since Inception. In addition, musicmaker.com expects significantly increased operating expenses in connection with an increase in the size of its staff, expansion of its marketing efforts, and an increase in its research and development efforts to assist in musicmaker.com's planned growth. To the extent that increases in operating expenses precede or are not followed by increased net sales, musicmaker.com's business, financial condition and results of operations will be materially adversely affected. See "Risk Factors--We have a limited operating history, have incurred losses and may continue to realize losses. We also have an accumulated deficit that may continue to increase." Musicmaker.com's business and prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early years, particularly companies in new and rapidly evolving markets such as electronic commerce. See "Risk Factors--We depend on continued growth of online commerce" and "We depend on maintenance and continued improvement of the Internet's infrastructure." In addition, musicmaker.com's net sales depend substantially upon the level of activity on its website and the success of its Columbia House print promotions. Although musicmaker.com has experienced growth in its operations, there can be no assurance that musicmaker.com's net sales will continue at its current level or rate of growth. 20 Results of Operations Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 Net Sales. Net sales for the year ended December 31, 1998 were $74,028 compared to $13,432 for the year ended December 31, 1997. The generation of net sales resulted from development of our customer base, expansion of our music library and the formation of strategic alliances with Columbia House, N2K and Platinum which provided Internet traffic and access to additional customer bases. Cost of Sales. Cost of sales for the year ended December 31, 1998 were $46,821 compared to $2,955 for the year ended December 31, 1997. For the period ended December 31, 1998 content costs accounted for $10,258 or 22% of cost of sales and production costs accounted for $32,086 or 69% of cost of sales. Postage and mailing and credit card costs accounted for $2,383 and $2,095, respectively for the year ended December 31, 1998, or a combined 9% of cost of sales. Cost of sales for the year ended December 31, 1997 consisted entirely of production costs of $2,955. Operating and Development Expenses. Operating and development expenses were $1,435,690 for the year ended December 31, 1998 compared to $692,041 for the year ended December 31, 1997. This increase was primarily attributable to expenses associated with obtaining content as well as enhancing the features and functionality of our website and related systems. Sales and Marketing Expenses. Sales and marketing expenses were $929,661 for the year ended December 31, 1998 compared to $7,780 in the year ended December 31, 1997. Sales and marketing expense for the year ended December 31, 1998 consisted primarily of print advertising, expenditures incurred in the development of our strategic alliances and increases in sales and marketing personnel. General and Administrative Expenses. General and administrative expenses were $2,334,438 for the year ended December 31, 1998 from $1,360,856 for the year ended December 31, 1997. This increase was primarily due to increases in the number of personnel and corporate facility expenses necessary to support the growth of our business and operations. Interest Expense/Income. Interest income for the year ended December 31, 1998 was $17,815 compared to interest expense of $33,957 for the year ended December 31, 1997. The 1997 interest expense was attributable to convertible notes which were converted to common stock in June 1997. Musicmaker.com did not have any interest expense associated with debt during the year ended December 31, 1998. Year Ended December 31, 1997 Compared to Inception Period from April 23, 1996 to December 31, 1996 Net Sales. Net sales were $13,432 for the year ended December 31, 1997 compared to $8,355 for the period from Inception through December 31, 1996 (the "Inception Period"). Net sales in the Inception Period consisted of certain product sales from musicmaker.com's subsidiary which was dissolved in early 1999. The increase in net sales was principally due to growth in musicmaker.com's customer base and expansion of its music library. Cost of Sales. Cost of sales were $2,955 for the year ended December 31, 1997 compared to $2,590 for the Inception Period. Operating and Development Expenses. Operating and development expenses were $692,041 for the year ended December 31, 1997 compared to $64,029 for the Inception Period. This increase was primarily attributable to costs incurred to obtain content and to enhance the features and functionality of musicmaker.com's website and related systems. Sales and Marketing Expenses. Sales and marketing expenses were $7,780 for the year ended December 31, 1997. There were no sales and marketing expenses for the Inception Period. 21 General and Administrative Expenses. General and administrative expenses were $1,360,856 for the year ended December 31, 1997 compared to $306,381 for the Inception Period. This increase was primarily due to increases in the number of personnel and corporate facility expenses necessary to support the growth of musicmaker.com's business and operations. Liquidity and Capital Resources Net cash used in operating activities totaled $3,519,777 for the year ended December 31, 1998 as compared net cash used in operating activities of $1,101,275 for the year ended December 31, 1997. Net cash used in operating activities for the year ended December 31, 1998 was primarily attributable to the net loss of $4,654,767 offset by accrued compensation to related parties of $30,665, an increase in accounts payable and accrued expenses of $297,250, and an increase in long-term obligations of $257,143. Net cash used in operating activities for the year ended December 31, 1997 was primarily attributable to the net loss of $2,084,157, offset by an increase to accrued compensation payable to related parties of $543,634, the issuance of stock and warrants for services for $150,500, and an increase in accounts payable and accrued expenses of $207,776. Cash used in investing activities was $217,961 and $299,755 for the years ended December 31, 1998 and 1997, respectively. The increase from the year ended December 31, 1997 to December 31, 1998 included the purchase of computer equipment and software for $177,954, the purchase of leasehold improvements of $36,823 and furniture and other office equipment of $3,184. Net cash provided by financing activities was $3,308,710 and $2,390,940 for the year ended December 31, 1998 and December 31, 1997, respectively. Net cash provided by financing activities, for the year ended December 31, 1998 was through the issuance of outstanding preferred stock for $1,568,033 and the issuance of common stock for $1,344,302. The net cash provided by financing activities for this period also included the net proceeds from the issuance of convertible notes of $396,375. Net cash provided by financing activities, for the year ended December 31, 1997, was primarily through the issuance of outstanding preferred stock for $1,700,000, issuance of common stock for $440,940 and proceeds from the issuance of convertible notes of $250,000. On January 8, 1999, musicmaker.com signed a lease line agreement which provides leasing for computer and related equipment as well as CD fabrication equipment up to $200,000 between the signing of the agreement and June 8, 1999. Any equipment leased under this agreement will have a 24 month lease term, and at the end of the lease term musicmaker.com will either be obligated to buy the equipment at 10% of the original equipment cost or extend the lease term for an additional 24 months. Borrowings under this lease line agreement require payments due in advance with a monthly rental factor of .0498 for months one through 24. The actual monthly rental will be determined by multiplying the cost of the equipment by the applicable monthly rental factor, plus any monthly maintenance charges. We will provide the lessor with a first security interest in the equipment leased under this agreement for the duration of the term of the lease. Musicmaker.com also signed the first lease under this agreement which will have a monthly rental payment of $8,261. As part of the lease line agreement, musicmaker.com issued a warrant to purchase 6,234 shares of its common stock at $4.81 per share which expires on January 8, 2009. On February 12, 1999, musicmaker.com signed a commitment letter with a financial institution for a credit facility of up to $250,000 in a revolving line of credit for equipment and software purchases and general working capital and up to $100,000 in a cash secured letter of credit. Borrowings under this line of credit bear interest at Imperial Bank's prime rate of interest plus 2%. The line of credit is secured by a blanket security interest on all of our assets including general intangibles excluding previously leased equipment. The line also has certain financial covenants, including minimum net worth and liquidity ratios. At February 15, 1999, we did not have any outstanding balances under this line of credit. Interest on any balance outstanding is payable monthly with principal and all accrued interest due six months from the date of the loan. In the event that equipment and software purchases under the line are termed out, equal payments of principal and interest will be due monthly for 24 months, starting on the first month following the initial six month maturity. If the term of the credit facility is extended, Imperial Bank will have the right to purchase warrants equal to 4% of the commitment amount. 22 Musicmaker.com anticipates that it will have negative cash flows for the foreseeable future. It is estimated that musicmaker.com will need to provide for items such as computer storage, production equipment, distribution equipment, hardware and software for computer systems, and furniture and fixtures. Musicmaker.com expects to fund its purchase of such capital equipment with its working capital, which will include the proceeds from this offering. As of December 31, 1998, musicmaker.com had approximately $973,000 in cash and cash equivalents. Musicmaker.com believes that the net proceeds from its prior financings, this offering, and cash flows from operations, will be adequate to satisfy its operations, working capital and capital expenditure requirements for at least the next 12 months, although musicmaker.com may seek to raise additional capital during that period. There can be no assurance that such financing will be available on acceptable terms, if at all, or that such financing will not dilute shares held by musicmaker.com's stockholders. See "Risk Factors--We may require additional capital or financing in the future." Year 2000 System Costs Computer systems, software packages and microprocessor dependent equipment may cease to function or generate erroneous data when the year 2000 arrives. The problem affects those systems or products that are programmed to accept a two-digit code in date code fields. To correctly identify the year 2000, a four-digit date code field will be required to be what is commonly termed "year 2000 compliant." Musicmaker.com may realize exposure and risk if the systems it relies upon to conduct day-to-day operations are not year 2000 compliant. The potential areas of exposure include electronic data exchange systems operated by third parties with whom musicmaker.com transacts business, certain products purchased from third parties and computers, software, telephone systems and other equipment used internally. To minimize the potential adverse effects of the year 2000 problem, musicmaker.com established an internal project team comprised of all functional disciplines. This project team has begun a three- phase process of identifying internal systems (both information and non- information technology systems) that are not year 2000 compliant, determining their significance in the effective operation of musicmaker.com, and developing plans to resolve the issues where necessary. Musicmaker.com has been communicating with its suppliers and others with whom it does business to coordinate year 2000 readiness. The responses received by musicmaker.com to date indicate that steps are currently being taken to address this concern. However, if such third parties are not able to make all systems year 2000 compliant, there could be a material adverse impact on musicmaker.com. After initial review of musicmaker.com's principal transaction processing software through which nearly all of musicmaker.com's business is transacted, management has determined musicmaker.com to be year 2000 compliant and, as such, does not anticipate any material adverse operational issues to arise. Musicmaker.com plans to complete the year 2000 compliance assessment by the end of the first quarter 1999 and implement corrective solutions before the end of the third quarter 1999. Based on current estimates, management expects that musicmaker.com's future costs in connection with its year 2000 compliance project will not exceed $10,000; however, future anticipated costs are difficult to estimate with any certainty and may differ materially from those currently projected based on the results of phase one of musicmaker.com's year 2000 project. The anticipated costs associated with musicmaker.com's year 2000 compliance program do not include time and costs that may be incurred as a result of any potential failure of third parties to become year 2000 compliant or costs to implement musicmaker.com's future contingency plans. Musicmaker.com has not yet developed a contingency plan in the event that any non-compliant critical systems are not remedied by January 1, 2000, nor has it formulated a timetable to create such contingency plan. Upon completion of our review, if systems material to musicmaker.com's operations have not been made year 2000 compliant in a timely manner, the year 2000 issue could have a material adverse effect on musicmaker.com's business, financial condition and results of operations. 23 BUSINESS Overview Musicmaker.com is a leading e-commerce provider of customized music CD compilations over the Internet. Our customers can search our extensive online music library and sample and select songs to make their own customized compilation CDs. Our music library currently contains over 150,000 licensed song titles. Our custom CDs can be further personalized by including selected graphics or consumer provided text. Our custom CDs have sound quality equivalent to pre-recorded CDs available at retail stores and are sold at competitive prices. We manufacture and ship our custom CDs from our state-of- the-art production facility generally within 24 hours of order. Our proprietary technology (patent application allowed) can digitally store approximately five million songs, provides advanced search/retrieval capabilities and automates the high speed production of our custom CDs. Customers can also download music from our music library using either Secure-MP3, a copyright-protected format, or a Liquid Audio, format. We currently have music content agreements with over 85 independent record labels and seek to sign content agreements with additional record labels. We believe that our proprietary customization process provides substantial benefits by allowing the customer to purchase only those songs that he chooses and by providing the record label with an additional source of revenue for songs in its back catalog. Musicmaker.com has amassed a library of music in multiple genres including significant catalogs of jazz, blues and classical music. Artists in our music library include: . Creedence Clearwater Revival . The Beach Boys . Ziggy Marley . Miles Davis . Johnny Cash . Jerry Lee Lewis . John Coltrane . Dionne Warwick . Little Richard . The Yardbirds with Eric Clapton . Muddy Waters . Frank Zappa . Blondie . The Blues . Taylor Dayne Brothers . Kansas . The Kinks . The Ramones . The Band Industry Background Historically, the music industry has benefited from advances in technology, such as the introduction of the CD in 1983. During the last ten years much of the industry's growth resulted from consumers replacing existing record or tape music collections with CDs. According to the Record Industry Association of America, nine of the top ten selling albums were produced before 1982 and include such established artists as The Eagles, Pink Floyd, Billy Joel, Fleetwood Mac, Led Zeppelin, The Beatles, Boston and AC/DC. According to the Record Industry Association of America, domestic music sales grew from $6.2 billion in 1988 to $13.7 billion in 1998. Of the $13.7 billion in total sales, full length CDs continue to account for the greatest dollar and unit volume, such sales increased by approximately 13% from 1997 to 1998. Musicmaker.com believes that substantial growth opportunities exist for sales of music over the Internet. According to Jupiter Communications, LLC, total online sales of pre-recorded music are projected to increase from $37.0 million in 1997 to $1.4 billion in 2002. Musicmaker.com believes that while the Internet provides an additional, price competitive distribution channel for pre-recorded music, the potential exists to use the Internet as a value-added method of distribution. Internet based retailers have certain other advantages over traditional retail channels. Musicmaker.com estimates that music retail stores generally stock between 10,000 and 39,000 of the available 200,000 CDs and tend to carry a greater percentage of hit releases, often at the expense of differing music genres and back titles from the libraries of record labels. Additionally, online retailers are open 24 hours and Internet users and their purchases can be tracked to provide demographic information for use in direct marketing or other targeted programs. We believe that the demographic profile of consumers of recorded music has aged along with the general population. According to the Record Industry Association of America, domestic purchases of recorded music by 24 those age 30 and over have increased from approximately 32% of the U.S. sales in 1988 to approximately 48% of sales, or approximately $5.9 billion, in 1997. We believe that the Internet represents an attractive retail and promotion medium for customers in this age group as they are less "hits-driven" than younger age groups, typically can afford to buy more titles at one time, often own PCs and generally have credit cards, which are usually used to make electronic payments. Despite the fact that those age 30 and over represent the largest segment of the United States population and have the highest level of disposable income, this group currently spends the smallest percentage of its disposable income on music purchases. We attribute this phenomenon to the allocation of most retail shelf space and promotional budgets to new releases, which are typically targeted at younger audiences. We believe that a significant opportunity exists in remarketing older titles to the 30 and over age group. We believe that this group will be attracted to the flexibility of our custom CDs. One of the latest technological innovations in the music industry has centered on digital distribution, the downloading of compressed music files over the Internet to a PC. Such music files can be stored to a PC or on a CD using a read/write CD-ROM drive. Recently, MP3, a non-streaming compression technology, has proliferated over the Internet, allowing users to freely distribute songs, without making royalty payments to the music label or to the artist holding the rights to such music. Certain factors, including bandwidth constraints, a limited selection of music, difficulties with industry acceptance, the required purchase of a specialized MP3 player and the lack of portability associated with downloaded music, have limited the growth of MP3 to date. Nevertheless, MP3's ability to freely copy and transfer music and the potential subsequent loss of revenue is of substantial concern to the music industry. In February 1999, the five major record companies announced that they would conduct a market trial to test selling music as digital information transmitted over the Internet. The test, which utilizes IBM software, will allow approximately 1,000 cable subscribers in San Diego to download music from a library of 1,000 album titles and several hundred song titles provided by the major record labels. The market trial is viewed by many as the first step taken by the major record companies to consider the sale of digital music online. Musicmaker.com believes that the following trends provide an environment favorable to industry and consumer acceptance of our custom CDs: . Growth in sales of CD singles. . Growth of the Internet as a viable retail medium. . Increasing affluence of the over 30 generation. . Continued prominence of classic rock albums. . Record label desire to diversify distribution methods while protecting intellectual property rights. MUSICMAKER.COM STRATEGY We seek to be the leading provider of custom CDs and digitally downloaded music on the Internet. The core elements of our strategy include: Offer a new way to buy licensed, customized music. Through our proprietary technology, we offer consumers a new method for customizing, digitally downloading and purchasing music over the Internet. Unlike many online retailers, we do not use the Internet simply to distribute products that can be purchased elsewhere. Rather, our website and proprietary production technology provide the ability to create a novel product--the custom CD--that could not previously be mass marketed. We have implemented new technology for digital downloading to help protect the intellectual property rights of record labels. Offer most extensive selection of music for custom CD compilation and digital downloading. We intend to offer consumers the most extensive collection of music available for use in custom CDs and digital downloading. We have entered into exclusive and non-exclusive license agreements with more than 85 music labels and currently have a music library of more than 150,000 songs. We intend to significantly expand our existing music catalog through the development of content relationships with additional record labels, including major labels. Increase website traffic through industry alliances and multiple hyperlinks. We seek to establish strategic alliances with global music and media companies to attract additional users to the musicmaker.com website. We 25 are currently the exclusive provider or a featured retailer of custom CDs for Columbia House, N2K, Platinum, Audio Book Club and Trans World. We intend to continue to expand the number and depth of our marketing alliances and affiliate programs to drive traffic and increase the number of third party hyperlinks to musicmaker.com. Create strong brand awareness. We currently promote our brands through online and traditional media, special event driven promotions and artist- specific offerings. We intend to enhance brand awareness of our website by advertising and co-marketing as well as through strategic relationships whereby other websites designate musicmaker.com as their online music retailer for custom CDs. Establish genre-specific user communities. By collecting information about our customers, we are able to target demographic user groups, thereby providing advertisers and sponsors with access to highly defined audiences. This segmentation will enable advertisers and sponsors to customize their messages through banner advertisements, event and program sponsorships and music recording promotions. We intend to provide our advertisers and sponsors with quantitative feedback on the effectiveness of their programs. Capitalize on cross-selling opportunities. We intend to generate additional revenue by drawing users to our website and providing hyperlinks to music related merchandise sites offering posters, clothing and books. We intend to generate cross-selling opportunities by establishing hyperlinks between artist and fan club websites, placing posts in music related news groups and securing reviews and event notices in appropriate online directories. Leverage technologies for additional formats. We intend to provide additional products to consumers which may include custom music on mini-disc, custom music videos on DVD, audio books on CD and software on CD-ROM. By leveraging our existing technology to a variety of formats, we believe that we will effectively increase the content and marketability of our products. Expand international presence. We intend to capitalize on the global nature of music and the Internet by building an international user base. We intend to create local language versions of, and culture specific music content for, musicmaker.com. We also intend to expand our international presence through localized websites in countries with a demand for international music. Music Content We have licensed music from record labels to expand and diversify our online music library. We have focused primarily on independent record labels, which represent approximately 20% of the $40 billion recorded music industry, and have entered into content licenses with over 85 independent record labels. Our music collection currently contains more than 150,000 tracks licensed from independent record labels including:
. The All Blacks B.V. . Nimbus Communications International (Roadrunner) Limited . Platinum Entertainment, Inc. . Alligator Records . Prestige Records, Ltd. . Brunswick Record Corp. . Reachout International Records, . Cakewalk LLC (32 Records Inc. (ROIR) Jazz) . Rounder Records Corp. . Del-Fi Records . Storyville Records . Fantasy Records, Inc. . Sun Entertainment Corporation . HNH International Limited (Naxos) . Surrey House Music . Koch International L.P. . VelVel Records LLC . Lightyear Entertainment, L.P. . Viceroy Entertainment Group . Minnesota Mining and Manufacturing Company (3M) Our music library contains significant catalogs of blues, jazz, classical, rock (including heavy metal and punk), country, rhythm and blues, pop, gospel and oldies. Set forth below is a sampling of the artists contained in our music library, organized by music genre, for which we have licensed at least ten songs. 26 Sample Artists by Music Genre Blues .Marcia Ball Jazz . Louis Armstrong .Elvin Bishop . Chet Baker .Blues Brothers and Friends . Count Basie .Roy Buchanan . Dave Brubeck .Otis Clay . John Coltrane .Albert Collins . Miles Davis .Buddy Guy . Bill Evans .John Lee Hooker . Stan Getz .Lightnin' Hopkins . Dizzy Gillespie .Elmore James . Billie Holiday .Albert King . Charles Mingus .Brownie Mc Ghee . Thelonious Monk .Roomful of Blues . Charlie Parker .Memphis Slim . Cole Porter .Muddy Waters . Art Tatum .Junior Wells .Johnny Winter Rock .Atlanta Rhythm Section Country .Bellamy Brothers .The Band .Johnny Cash .Big Star .Roy Clark .Savoy Brown .Patsy Cline .Creedence Clearwater Revival .The Gatlin Brothers .The Guess Who .Crystal Gayle .Kansas .Merle Haggard .The Kinks .Ronnie McDowell .Alvin Lee .Roger Miller .Alan Parsons .Juice Newton .Paul Rodgers .Billy Joe Royal .The Troggs .Conway Twitty .Bill Wyman .The Yardbirds with Eric Clapton .Frank Zappa Metal . Annihilator Soul/R & B . Barbara Acklin . Biohazard . Booker T. & The MG's . Crimson Glory . Cameo . Deicide . Gene Chandler . King Diamond . The Chi-lites . Life of Agony . George Clinton . Machine Head . Dramatics . Motorhead . The Gap Band . Obituary . Isaac Hayes . Sepultura . Etta James . Type O Negative . The Persuasions . Jackie Wilson 27 Sample Artists by Music Genre (Continued) Rock 'n . Jerry Lee Lewis Pop .The Beach Boys Roll . Carl Lee Perkins .Peter Cetera . Ritchie Valens .Roger Daltrey .Taylor Dayne .The Foundations .KC & The Sunshine Band .The Vogues .Dionne Warwick Reggae .Black Uhuru Alternative .Circle Jerks .Dennis Brown .The Fleshtones .Culture .In The Nursery .Marcia Griffiths .The Legendary Pink Dots .The Heptones .Marine Girls .Gregory Isaacs .The Moon Seven Times .The Paragons .Plastic Noise Experience .Lee "Scratch" Perry .Television .Yellowman Folk . The Burns Sisters Bluegrass .Bela Fleck . Ramblin' Jack Elliott .The Bluegrass Album Band . John Fahey .J.D. Crowe & The New . David Grisman South . Peter Keane .The Freight Hoppers . Leo Kottke .John Hartford . John McCutcheon .The Johnson Mountain Boys . Tom Paxton .The Nashville Bluegrass . Tony Rice Band . Dave Van Ronk .Doc Watson . Cheryl Wheeler Punk .The Buzzcocks Easy Listening .Ronnie Aldrich .The Dickies .Arthur Ferrante .The Dictators .Nick Ingman Orchestra .UK Subs .Intimate Broadway .Peter Nero . The Royal Philharmonic Orchestra . Pat Valentino Techno . Chosen Few . Fear Factory . Front Line Assembly . Intermix . Technohead We intend to significantly expand and diversify our existing music catalog through the development of content relationships with additional record labels. 28 Downloading of Music on the Internet Customers can also download songs from our music library directly to their PCs. As of January 1999, approximately five million MP3 players have been downloaded by consumers, indicating that MP3 is rapidly becoming a favorable method of obtaining music files over the internet. Music files in an MP3 format can be downloaded in approximately 10 minutes using a 56K modem. To date, MP3 music files may be easily copied and transferred. We provide Liquid Audio and Secure-MP3, two secure downloading formats to protect the copyrights of the record label and the recording artist. We license Liquid Audio, a downloading format that prevents the transference of downloaded music to other PCs. In addition, we have developed a new, secure MP3 format called Secure-MP3. Secure-MP3 incorporates a watermarking technology licensed from Aris Technologies. Our system embeds a permanent watermark into each MP3 music file downloaded from our library, allowing the music file to be tracked by us or by industry copyright protection agencies. During a Secure-MP3 or Liquid Audio download, an on-screen display notifies the consumers that they are receiving a copyrighted file and provides the name of the licensing record label. Both the Secure-MP3 and Liquid Audio formats require downloading a software player to decrypt and play downloaded music files. Marketing Our marketing strategy is designed to build brand awareness, attract repeat users and direct traffic to our website through hyperlinks with strategic partner websites. We use a combination of advertising and promotion, both traditional and online, to accomplish these objectives. Marketing Alliances To promote our custom CDs and establish musicmaker.com as the premier brand for custom CDs, we have entered into marketing alliances with major music marketing companies including Columbia House, N2K, Platinum and Trans World. We have recently entered into a marketing alliance with Audio Book Club and intend to seek additional alliances with music and non-music retailers. These strategic alliances are intended to drive traffic to our website, increase the number of websites where our custom CDs can be purchased, and co-promote our products through direct mail campaigns. Through marketing alliances, musicmaker.com seeks to be the exclusive custom CD provider featured on a partner's website or in other promotional materials or activities. We believe that such alliances provide access to a targeted customer base, such as customers who purchase music or music related merchandise online. The Columbia House Company Alliance. We are currently the exclusive marketer and featured retailer of custom CDs for Columbia House, a leading record and video club, jointly owned by Sony Music Entertainment, Inc. and Time Warner Inc. We provide our custom CD compilation services to Columbia House's 15 million club members through website and direct mail promotions. Columbia House displays and promotes musicmaker.com's custom CDs on ColumbiaHouse.com, its club website and TotalE.com, its non-club website that offers music, videos, DVDs, computer software and other related merchandise to the general public. Columbia House also provides a hyperlink directly to a co- branded musicmaker.com and Columbia House website. We will also market our custom CDs through a series of print promotion campaigns in conjunction with the Columbia House's direct mail program. Through these direct promotion campaigns, we can market our products to all of Columbia House's members, including those without Internet access. Musicmaker.com can include promotional inserts in at least six Columbia House direct mailings per year. The inserts will promote both the co-branded and musicmaker.com websites and allow club members to purchase custom CDs using a mail-in form. 29 Our marketing alliance with Columbia House expires in September 2001. Under this alliance, we may not sell custom CDs through any other music club without prior consent of Columbia House. Additionally, we have exclusive rights to offer our custom CDs to Columbia House's members unless and until one of our competitors offers a significant repertoire of music content unavailable through musicmaker.com. Columbia House and musicmaker.com share the profits net of certain expenses from custom CD sales originating from Columbia House members and from users referred from their websites. The allocation of net profits is calculated based upon the terms of the musicmaker.com license agreement covering each of the selected song titles. If during the term of the Columbia House alliance, Sony or Warner exclusively allow Columbia House club members to create custom CDs using music from their libraries, Columbia House is required to use musicmaker.com as its custom CD provider. Columbia House may terminate our alliance upon not less than thirty days notice if Mr. Puthukarai ceases to be musicmaker.com's President and Chief Operating Officer and Columbia House deems his replacement incompatible with their interest, or Columbia House determines after the first six musicmaker.com promotional mailings to its members that its financial returns do not justify continuing the relationship. We anticipate mailing our first promotional insert to Columbia House members in the second quarter of 1999. Columbia House received 129,870 warrants for common stock exercisable at $4.62 per share prior to September 1, 2001 as part of this marketing alliance. Platinum Entertainment, Inc. Alliance. We are the exclusive marketer of custom CDs and digitally downloaded music for Platinum, the largest independent music label in the United States with artists such as Peter Cetera, Roger Daltry, Crystal Gayle and Dionne Warwick. Platinum displays and promotes our custom CDs on their PlatinumCD.com website which has a direct hyperlink to musicmaker.com. Musicmaker.com also has exclusive license rights to Platinum's entire music catalog of approximately 13,000 songs. We have a marketing alliance and license agreement with Platinum that expires in September 2003. We currently have exclusive rights to Platinum's music content and to offer custom CDs on Platinum's website. After the first two years of our alliance, however, Platinum may elect to provide its library on a non-exclusive basis to other custom compilation providers. Net profits from the sale of custom CDs under the alliance are allocated based upon the song titles selected, from which website customer orders originate and the exclusivity of the alliance. Under this alliance, we may not use music content licensed from Platinum for sale of custom CDs through an automated kiosk. Under our marketing and music content alliance with Platinum we intend to offer approximately 13,000 songs and 1,300 albums in MP3 format beginning in the second quarter of 1999. Audio Book Club, Inc. Alliance. We have an exclusive marketing alliance with Audio Book Club, a provider of direct to consumer marketing of audio books with over 1.3 million audio users and buyers. Under this arrangement, musicmaker.com will be the exclusive provider of custom CDs through the AudioBookClub.com and BooksAloud.com websites and through print promotions in direct mailings to members. Our marketing alliance with Audio Book Club expires in January 2002, with three-year renewals to be negotiated with terms no less favorable than the current arrangement. Under this alliance, musicmaker.com will promote its custom CDs: . On Audio Book Club's websites. . By participating in at least six direct mailings to club members per year. . By sponsoring annual Valentine's Day and Christmas promotions. Net profits of sales to Audio Book Club members will be allocated based upon the license arrangements covering the songs selected. Audio Book Club may terminate the marketing alliance upon 30 days' notice after the first six months of the relationship. 30 Trans World Entertainment Corporation Alliance. We have a non-exclusive marketing alliance with Trans World, one of the largest music retailers in the United States operating approximately 520 specialty retail music and video stores including approximately 320 mall locations under the names Record Town, Saturday Matinee, and F.Y.E., and approximately 200 freestanding stores under the names Coconuts Music and Movies, Planet Music, Strawberries and Waxie Maxie's. Under this alliance, musicmaker.com and Trans World will establish a co-branded, co-promoted marketing campaign to sell our custom CDs over the Internet through Trans World's TWEC.com website. Our marketing alliance with Trans World is for a one-year term, renewable from year to year, and begins upon activation of the link between musicmaker.com and TWEC.com. This alliance requires musicmaker.com to accept any music content owned or licensed and offered by Trans World for inclusion in custom CDs. Musicmaker.com and Trans World will divide the gross revenues received from orders under the alliance based upon the license arrangement covering the content included on custom CDs. N2K Inc. Alliance. Musicmaker.com markets its custom CDs with N2K, a major Internet retailer of music CDs. Musicmaker.com and N2K establish co-branded websites through which N2K customers can purchase our custom CDs from select genres and artist or occasion--specific music libraries. In 1998, the first two joint promotions, featuring Miles Davis and Christmas music compilations, were launched. Musicmaker.com has agreed to offer N2K the right of first negotiation, except with respect to Columbia House, for any genre, artist or occasion- specific promotions. Musicmaker.com and N2K allocate proceeds from the sale of promotional custom CDs based upon the website from which the order originates and the shipping option chosen by the customer. The terms of our relationship with N2K are subject to continued renewal and renegotiation as a result of a merger between N2K and CDnow. Affiliate Program We intend to position our website as part of an interconnected online music network through our affiliate program. This program will allow customers who visit affiliate websites to hyperlink to musicmaker.com through banner ads and other prominent displays. Musicmaker.com will allocate a portion of revenue from sales of custom CDs to the referring affiliate. Merchandising and Consumer Programs Insider's Club. Our Insider's Club membership program awards members a free song(s) on custom CDs after a specified number of purchases. This club allows us to collect user demographics, foster repeat purchases, and attempt to capture a greater portion of a member's purchases of custom CDs and digitally downloaded music. Consumers joining the Insider's Club submit personal and credit profiles to eliminate time and effort required for the collection of billing and shipping information. Special Promotional Sales. We intend to produce and license custom CDs to marketers for use as promotional items. We will have specialized sales personnel who will target large companies for custom-made, promotional CD products. Targeted Consumer Marketing. We collect information on website visitors and customers such as point of origin, advertisement banner clicks, destination after leaving the musicmaker.com website, genres searched, previous purchases and geographic location. Additional customer specific marketing data is obtained through the musicmaker.com Insider's Club. This information is used to develop advertising strategies and marketing campaigns and serves as the basis for our one-to-one marketing efforts. We intend to deploy push-marketing programs consisting of targeted e-mails, which may include discount coupons and information regarding new releases and special sales and promotions. We have also developed a Music Advisor program based on "intelligent agent" software licensed from Net Perceptions, Inc. that compares consumers' interests based upon past purchases and other activities and provides personalized recommendations. Musicmaker.com believes that such personalized measures are important in building and maintaining customer loyalty and in positioning musicmaker.com as a preferred source of custom CDs and digitally downloaded music. 31 Pricing We price our custom CDs to be competitive with pre-recorded CDs sold in retail locations. A five song custom CD is priced at $9.95 with each additional song priced at $1.00, plus an additional charge for shipping and handling. Songs digitally downloaded to a consumer's PC are priced at $1.00 per song. Electronic Kiosks We intend to offer our custom CDs through stand-alone, touch screen, user- friendly kiosks placed in strategic locations in 1999. We intend to place these kiosks in retail music stores, university bookstores, national movie theater chains, major book chains, convenience stores, computer store chains, video chains, and other places frequented by potential music purchasers. With the musicmaker.com proprietary kiosk system, a consumer can select up to 20 songs from a library of music stored locally in the kiosk. The custom CD is fabricated on a proprietary recording system housed within the kiosk and delivered automatically to the consumer within approximately five minutes of placing the order. We believe that the presence of these kiosks in strategic locations will further promote musicmaker.com as the premier brand for custom CDs. Technology Our technology enables us to rapidly manufacture and ship custom CDs that are equivalent in sound quality to pre-recorded CDs. This process technology consists of a distributed storage and high speed CD fabrication system running across a high speed fiber local area network managed and controlled by proprietary software we developed. We store and maintain our digital library of music titles in uncompressed (wav) format on storage arrays of hard drives. Each array consists of up to eight 36 gigabytes magnetic hard disk drives that holds approximately 288 gigabytes of digital information, or approximately 10,000 songs. Music data is typically received in digital format on pre-recorded CDs or DAT. Certain older titles are converted to DAT from analog format prior to being transferred to the arrays for permanent digital storage. The array architecture is scalable and additional arrays can be added to accommodate an increase in our online music library. Using this method, our configuration can manage up to terabytes of musical data (or millions of songs of storage capability). We believe that the array configuration is a cost- effective storage method as it can scale to store additional data as necessary; provide search and retrieval functions up to 100 times faster; and provide a more reliable search, retrieval, and delivery capability than alternative systems including CD jukeboxes and optical jukeboxes. Such alternative systems do not scale as easily or effectively and also contain fragile moving parts. Our arrays are complemented by a magnetic tape backup system, and each array can be re-recorded in approximately 15 minutes. Database Management Our system uses a software program to manage the vast amount of digital music and customer information stored in the arrays. This program enables the system to: . Scan the stored musical data by artist, title, music genre or key word. . Retrieve the music from the arrays. . Deliver the information to the fabrication units that produce the custom CDs. The software runs on our workstations' PCs that are linked to several magnetic storage arrays. These PCs run in parallel on our high speed network. As a result, any PC on the system can find musical information contained in any array. The database is maintained on a Sun Microsystems, Inc. server and UNIX operating system. The workstations and PCs that run our web, storage, and news audio servers are built to our specifications. CD Fabrication Our CD fabrication units automatically write musical information to a CD as well as print song titles, artist names, graphics, pictures and other personalized information on the CD. Based on an average CD selection of ten songs, the custom CD can be produced in five minutes, or eight times as fast as manual fabrication. Musical information is received by the fabrication unit, sits in a queue and is assigned a consumer order number so that a customer can check on the status of their order online. A single CD fabrication unit is capable of producing up 32 to 1,500 CDs in a 24 hour period. The present capacity of our three fabrication units is approximately 4,500 CDs per 24 hour period. Our production system is scalable and can grow to support production of tens of thousands of CDs per day (or millions of CDs per year). The scalable feature of the fabrication units does not involve any modification to our software. Fault Tolerance Our storage and production architecture uses redundant servers and a tape storage system for backup, to minimize downtime due to system outages or maintenance needs. The largest single point of failure in our storage system is a single magnetic disk or 36 gigabytes (or approximately 1,000 songs), a relatively small portion of our music library. Our architecture provides a back-up system that allows continuous operation through redundant servers in the event of occasional component failure. Even in the event of a complete failure of an array, the system can redeposit the data digitally on the arrays using high speed backup at a rate of approximately 4,000 songs per hour. musicmaker.com Website. Musicmaker.com's website is easy to use, graphical in design and allows custom music selection of titles from our music library. The website has a built-in full-text search engine to allow customers to search by artist, title, genre and keyword to find and display appropriate songs or artists. Furthermore, each song has a 30-second Real Audio sample track which customers can listen to prior to making a song selection. The web site's personalization capabilities offer the option of printing a 40-character message on the CD surface itself, on the tray card and on the sides (spines) of the jewel box. Musicmaker.com also provides the capability for the customer to select an occasion-specific graphic (e.g., birthday cake, rose, diploma, etc.) to be printed on the CD surface, or upload a digital picture or graphic to the server for printing in color on the CD surface. Digital Downloading of Music over the Internet Customers can also download songs from our music library directly to their PCs. As of January 1999, approximately 5.0 million MP3 players have been downloaded by consumers, indicating that MP3 is rapidly becoming a favorable method of obtaining music files over the internet. Music files in an MP3 format can be downloaded in approximately 10 minutes using a 56K modem. To date, MP3 music files may be easily copied and transferred. We provide Liquid Audio and Secure-MP3, two secure downloading formats to protect the copyrights of the record label and the recording artist. We license Liquid Audio, a downloading format that prevents the transference of downloaded music to other PCs. In addition, we have developed a new, secure MP3 format called Secure-MP3. Secure-MP3 incorporates a watermarking technology licensed from Aris Technologies. Our system embeds a permanent watermark into each MP3 music file downloaded from our library, allowing the music file to be tracked by us or by industry copyright protection agencies. During a Secure-MP3 or Liquid Audio download, an on-screen display notifies the consumers that they are receiving a copyrighted file and provides the name of the licensing record label. Both the Secure-MP3 and Liquid Audio formats require downloading a software player to decrypt and play downloaded music files. Quality Assurance and Customer Service We believe that high levels of consumer service and support are critical to retaining and expanding our user base. After a CD is manufactured, it is loaded into our testing facilities where the music is sampled by computer to assure quality. The system also monitors the production process real time during fabrication, and performs error checking throughout. Custom CDs are then shipped within 24 hours of order. Our representatives respond to inquiries regarding our products and register consumers' credit card information over the phone. We believe that these representatives are a valuable source of consumer feedback which we use to improve our services. Customer service will be assisted by automated e-mails which notify consumers about the status of their orders. Competition The market for providing music (either pre-recorded CDs or custom CDs) on the Internet is highly competitive and rapidly changing. Since the Internet's commercialization in the early 1990's, the number of 33 websites on the Internet competing for consumers' attention and spending has proliferated. With no substantial barriers to entry, we expect that competition will continue to intensify. Currently, there are more than 100 music retailing websites on the Internet, most of which sell pre-recorded music CDs which can be purchased in most retail music stores. In addition to intense competition from Internet music retailers, we also face competition from traditional retail stores, including chains and megastores, mass merchandisers, consumer electronics stores and music clubs. The most visible custom compilation competitors include Custom Revolutions, Inc., CDuctive, and amplified.com. Additionally, the major record labels, often with resources greater than musicmaker.com's, may decide to enter the custom CD business directly and would as a result be potential competitors. We also face significant and increasing competition in the growing market to provide digitally downloaded music, specifically for music files in MP3 format. Competition to provide digitally downloaded music can currently be found on the websites of existing online music retailers such as MP3.com and GoodNoise Corporation, websites established by recording artists and websites of record labels. Catalogs of songs available in MP3 format are also provided by internet portals such as Lycos. We expect the competition to provide MP3 files to intensify with further entry by additional record labels, artists and portals, including those with greater resources and music content than musicmaker.com. Recently, the five major record labels announced that they have joined with IBM to conduct a market trial of a digital distribution system, providing over 1,000 albums to cable subscribers in the San Diego area. We expect additional market trials and alliances by technology and music industry participants to continue as the music industry attempts to integrate emerging technology into its existing distribution methods. See "Risk Factors--Our industry may encounter changes in music distribution methods" and "Risk Factors--The online music industry is extremely competitive." We believe that our primary competitive advantages in providing music entertainment products and services via the Internet are: . Brand recognition. . High quality custom CDs. . Ease of use of our customization . Availability and high level of process. consumer support. . Competitive price of our custom . Technical expertise and CDs. experience. . Large online library of music . Music industry relationships available for custom CDs and and experience. digital downloading. . Scalable, cost-effective technology. Our success in this market will depend heavily upon our ability to provide high quality, entertaining content, along with cutting-edge technology and value-added Internet services. Other factors that will affect our success include our continued ability to attract experienced marketing, sales and management talent. Many of our current and potential competitors in the Internet and music entertainment businesses have longer operating histories, significantly greater financial and marketing resources, greater name recognition and larger existing consumer bases than musicmaker.com. These competitors may be able to respond more quickly to new or emerging technologies and changes in consumer requirements and to devote greater resources to the development, promotion and sale of their products or services than musicmaker.com. There can be no assurance that we will be able to compete successfully against current or future competitors. Given the large growth potential of this marketplace, we believe that competitors will enter the marketplace. We believe, however, that we have a significant first mover advantage. We have established preliminary music and marketing alliances with significant music marketing companies and maintain a strong foundation of technological and music industry expertise. We believe that we will succeed in building a high level of brand awareness to establish dominance prior to the market entrance of a significant competitor. See "Risk Factors--The online music industry is extremely competitive." EMPLOYEES We believe that our employees and their knowledge and capabilities are a major asset of musicmaker.com. We have been successful in attracting and retaining employees skilled in our core business competencies and intend to continue to employ highly skilled personnel. 34 As of January 31, 1999, we employed 15 full-time employees and consultants. We believe that our relations with our employees are good. None of our employees are covered by collective bargaining agreements. There is significant competition for employees with the managerial, technical, marketing and sales skills required to operate our business. Our success will depend in part upon our ability to attract, retain, train and motivate highly skilled employees. See "Risk Factors--We depend upon hiring and retaining qualified employees." Intellectual Property and Proprietary Rights We rely on a combination of patent, copyright, trademark and trade secret laws, as well as contractual restrictions to protect our technology. It is our policy to require that those persons with access to our proprietary technology and information enter into confidentiality agreements with us upon the commencement of their employment, consulting or other contractual relationships. We seek to protect our storage and fabrication system under patents and our brand names under trademarks as noted below. Except as noted below, we presently have no other patents, trademarks or patent/trademark applications pending. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or duplicate aspects of our production system or to obtain and use information that we regard as proprietary. Policing unauthorized use of our intellectual property is difficult, and there can be no assurance that our efforts to protect our proprietary rights will be adequate or that our competition will not independently develop and patent similar or superior technology. In addition, the laws of some foreign countries may not provide protection of our proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that third parties will not claim infringement by us with respect to others' current or future patent or proprietary rights. We expect that Internet music content providers will be increasingly subject to infringement claims as the number of issued Internet related and business model patents and music delivery websites increases and the functionality of music delivery systems based upon new technologies trend toward a similar appearance. Defending against any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into additional royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, and could have a material adverse effect upon our business, results of operations, and financial condition. Patents. We have been issued a notice of allowance for a patent application by the U.S. PTO for a system for and method of producing custom CDs, which resulting patent will expire in 2016. We own two related U.S. patent applications currently pending in the U.S. PTO. We also own a pending international counterpart patent application corresponding to the subject matter of these U.S. patent applications. In addition, we have filed three U.S. patent applications relating to kiosk technology and CD jewel cases. Trademarks. We own a number of trademarks based on our use of those marks in commerce, and have applied to the U.S. PTO to federally register such marks as well as others based on our intent to use them. We use the marks MUSIC CONNECTIONTM and MUSICMAKERTM, in commerce, and have applied to register each of these trademarks with the U.S. PTO. We have also filed two additional trademark applications for CD KITTM and MUSICMAGICTM based on our intent to use such marks. See "Risk Factors--We depend upon intellectual property rights and risk having such rights infringed." Property Our headquarters occupy approximately 4,500 square feet of general office space. The monthly rent for this space is approximately $8,000. Our current lease is set to expire in June 2005. We believe that our current leasehold facilities are adequate for our intended use for the foreseeable future. Legal Proceedings We are not currently a party to any pending lawsuits, nor do we know of any potential claims which, in the aggregate, could have a material adverse effect on our business, financial condition or results of operations. Certain aspects of our business and potential changes with regard to government regulation of Internet commerce may, however, increase our risk of liability. See "Risk Factors." 35 MANAGEMENT The following table sets forth certain information regarding our executive officers and directors:
Name Age Position ---- --- -------- Robert P. Bernardi....... 46 Chairman of the Board of Directors and Co-Chief Executive Officer Devarajan S. Puthukarai.. 55 Director, President, Co-Chief Executive Officer and Chief Operating Officer Irwin H. Steinberg....... 78 Director, Vice Chairman of the Board of Directors William Crowley.......... 44 Vice President of Marketing and Sales Mark A. Fowler........... 38 Chief Financial Officer and Director of Finance and Administration Edward J. Mathias........ 54 Director
Executive Officers and Directors Robert P. Bernardi. Mr. Bernardi is musicmaker.com's founder, Chairman of the Board of Directors and Co-Chief Executive Officer. Mr. Bernardi has served as a director since Inception. From 1990 to 1996, Mr. Bernardi was a co- founder, Chairman of the Board of Directors and Chief Executive Officer of TREEV, Inc. (formerly Network Imaging Corporation), a publicly-held software company for which he continues to serve as a director. From 1988 to 1990, Mr. Bernardi was an independent consultant in the document imaging and telecommunications fields. From 1987 to 1988, Mr. Bernardi was a co-founder, President and Chief Executive Officer of TranSwitch Corporation, a publicly- held company that designed high-speed telecommunications chips. From March 1984 to December 1987, Mr. Bernardi was Chairman of the Board of Directors and Chief Executive Officer of Spectrum Digital Corporation, a publicly-held telecommunications equipment manufacturing company. From 1984 to 1987, Mr. Bernardi was a co-founder and director of PictureTel Corporation, a publicly- held manufacturer of full-motion video conferencing systems. Prior to 1984, Mr. Bernardi held various executive management positions with MCI Communications Corporation, Mobil Corporation, Booz, Allen & Hamilton, Inc. and The MITRE Corporation. Mr. Bernardi earned a Bachelor of Science degree in Physics and a Master of Science degree in Business and Economics from the State University of New York at Stonybrook. Devarajan S. Puthukarai. Mr. Puthukarai is musicmaker.com's President, Co- Chief Executive Officer and Chief Operating Officer and has served as director since April 1997. From 1991 to April 1997, Mr. Puthukarai was President of Warner Music Media, a division of Warner Music Enterprises, a Time Warner Inc. company engaged in the business of promoting new and upcoming artists. From 1984 to 1990, Mr. Puthukarai was President of RCA Direct Marketing Inc./BMG Direct Marketing Inc., launching the country's first CD music club and building the world's largest classical music club. Mr. Puthukarai earned his Bachelor of Science and Bachelor of Law degrees from Madras University in India. Mr. Puthukarai earned a Master of Business Administration degree from the Indian Institute of Management, a Harvard/Ford Foundation school in Ahemadabad, India. Irwin H. Steinberg. Mr. Steinberg has been a musicmaker.com director and Vice Chairman of the Board of Directors since January 1997. Mr. Steinberg also serves as a consultant to musicmaker.com. From 1982 to the present, Mr. Steinberg has been President of IHS Corporation, a consulting firm specializing in the music industry. From 1975 to 1982, Mr. Steinberg was Chairman and Chief Executive Officer of PolyGram Records, Inc. Mr. Steinberg was co-founder of Mercury Records Corporation. From 1946 to 1975, Mr. Steinberg was employed with Mercury Records Corporation where he progressed from Chief Financial Officer to Executive Vice President to President, which later position he held from 1968-1975. While employed by PolyGram Records, Inc. and Mercury Records Corporation, Mr. Steinberg was a member of the RIAA. Mr. Steinberg currently serves as an adjunct Professor at Columbia College of the Arts, in Chicago, where he teaches graduate courses in music business. Mr. Steinberg holds a Bachelors degree from the University of Chicago Business School and a Masters degree from the California State University at Domingo Hills. 36 William Crowley. Mr. Crowley has served as musicmaker.com's Vice President of Marketing and Sales since August 1996. From 1995 to 1996, Mr. Crowley was a Vice President at Warner Music Enterprises where he was responsible for advertising, creative services and circulation marketing for its sampling programs and roster of music magazines. From 1993 to 1995, Mr. Crowley was Vice President at PolyGram Group Distribution, Inc. where he was responsible for direct development of both music products and new channels of distribution for PolyGram labels. From 1990 to 1993, Mr. Crowley was the Director of Marketing and Product Development at Time Life Music where he was responsible for new product and business activities for popular and classical music products. From 1981 to 1990, Mr. Crowley was Director of Artists Repertoire and Merchandising at BMG Direct Marketing, Inc. where he was responsible for product selection and development, and merchandising and market research for BMG music clubs. Mr. Crowley earned a Masters degree in Business Administration from New York University and a Bachelors degree in Political Science and Economics from Northwestern University. Mark Fowler. Mr. Fowler has served as musicmaker.com's Chief Financial Officer since January 1999 and as its Director of Finance and Administration since April 1998. From 1995 to 1998, Mr. Fowler was the Controller at BioReliance Corporation, a publicly-held international contract research organization. From 1994 to 1995, Mr. Fowler was the Controller at Fusion Lighting, Inc., an international research and development company. From 1991 to 1994, Mr. Fowler was the Controller at Excalibur Technologies Corporation, a publicly-held software development firm. Prior to 1991, Mr. Fowler held several positions, including a consultant position with Booz, Allen & Hamilton, Inc. Mr. Fowler is a certified public accountant in the State of Virginia. He earned a Bachelor of Science degree in Finance from Radford University and is currently enrolled at the Johns Hopkins University pursuing a Masters degree in Business Administration. Edward J. Mathias. Mr. Mathias has served as a musicmaker.com director since December 1996. Mr. Mathias is a Managing Director and assisted in founding The Carlyle Group L.P., a Washington, D.C.-based merchant bank. Mr. Mathias is also a special limited partner in Trident Capital, a partnership focusing on business and information service companies. Mr. Mathias currently serves as a director for Sirrom Capital Corporation, U.S. Office Products Company, Inc., Condor Technology Solutions, Inc. and U.S.A. Floral Products, Inc., each a publicly-held company. In addition, Mr. Mathias sits on a number of advisory committees for private equity partnerships. From 1971 to 1993, Mr. Mathias held various positions with T. Rowe Price Associates, Inc., an investment management organization, most recently as a Managing Director. Mr. Mathias has served on T. Rowe Price's Board of Directors and was a member of its Management Committee for over ten years. Mr. Mathias holds a Masters degree in Business Administration from Harvard Business School and a Bachelors degree from the University of Pennsylvania. Musicmaker.com intends to appoint an additional independent director prior to the consummation of this offering. Classified Board of Directors and Executive Officers Upon effectiveness of our registration statement, of which this prospectus is a part, our Board of Directors will be divided into three classes of directors, designated Class A, Class B and Class C directors, serving staggered three year terms. With respect to the present Board (consisting of five members), the term of the Class A director, , will expire at the 2000 annual meeting of stockholders, the terms of the Class B directors, Mr. Mathias and Mr. Steinberg, will expire at the 2001 annual meeting of stockholders and the terms of the Class C directors, Mr. Bernardi and Mr. Puthukarai, will expire at the 2002 annual meeting of stockholders. One additional independent director will be designated prior to the completion of this offering in order to fill the vacancy presently existing on the Board of Directors. Directors will be elected at annual meetings of stockholders to serve a three year term and until their respective successors are duly elected and qualify, or until their earlier resignation, removal from office, or death. The remaining directors may fill any vacancy on the Board of Directors for an unexpired term. Executive officers are appointed by and serve at the discretion of the Board of Directors. 37 Committees of the Board of Directors and Compensation The Board of Directors has designated an Audit Committee of the Board of Directors, currently consisting of and Mr. Mathias. The Audit Committee is responsible for reviewing, along with our independent public accountants, the scope of our accounting audits, as well as our corporate accounting practices and policies. The Audit Committee shall also review our accounting and financial controls, and be available to our independent public accountants for any necessary consultation. The Board of Directors has also designated a Compensation Committee of the Board of Directors, currently consisting of Mr. Bernardi, Mr. Mathias and . The Compensation Committee shall review the performance of our management and recommend and approve the compensation of and the issuance of stock options to certain executive officers and employees pursuant to our stock option plan. Musicmaker.com directors currently do not receive a fee for their service on the Board of Directors or any committee thereof. Directors receive reimbursement to cover their reasonable expenses incurred in attending such meetings. Directors are eligible to receive stock options under musicmaker.com's stock option plan. Pursuant to the terms of his consulting agreement, Mr. Steinberg, musicmaker.com's Vice Chairman of the Board, receives compensation of $1,200 per meeting of the Board of Directors or any committee. Compensation Interlocks and Insider Participation The current members of the Compensation Committee are Mr. Bernardi, Mr. Mathias and . Accordingly, to date, the Compensation Committee, including directors who are or were executive officers of musicmaker.com, has made all determinations concerning compensation of musicmaker.com's executive officers. During his term on the Compensation Committee, Mr. Bernardi has agreed not to participate in decisions regarding his own compensation. The Board of Directors has provided for the reconfiguration of the Compensation Committee which, upon completion of this offering, will be composed of two non-employee directors of musicmaker.com. See "--Committees of the Board of Directors and Compensation" and "--Stock Option Plan." Executive Compensation The following table sets forth all compensation awarded to, earned by, or paid for services rendered to musicmaker.com in all capacities during the fiscal year ended December 31, 1998, by musicmaker.com's chief executive officer and other executive officers whose salary and bonus for fiscal year 1998 exceeded $100,000 (the "Named Executive Officers"). Summary Compensation Table
Long-Term Compensation Awards ------------------- Annual Compensation Number of Shares -------------------- Underlying Name and Principal Position Salary ($) Bonus ($) Options (#) --------------------------- ---------- --------- ------------------- Robert P. Bernardi..................... $175,000 -- 129,870 Chairman of the Board of Directors and Co-Chief Executive Officer Devarajan S. Puthukarai................ $250,000 $100,000 129,870 President, Co-Chief Executive Officer and Chief Operating Officer
38 The following table sets forth information regarding the grant of options to purchase musicmaker.com's common stock to each of the Named Executive Officers during the fiscal year ended December 31, 1998. Option Grants in 1998
Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Individual Grants Term (1) --------------------------------------------- --------------------------- Number of Percentage of Securities Total Options Underlying Granted to Exercise Options Employees in Price Expiration Name Granted Fiscal 1998 Per Share Date 5% 10% ---- ---------- ------------- --------- ---------- ------------- ------------- Robert P. Bernardi...... 83,117 23.7% $5.29 2003 $ 1,960,000 $ 3,960,000 46,753 13.3 4.81 2008 1,125,000 2,250,000 Devarajan S. Puthukarai............. 83,117 23.7 5.29 2003 1,960,000 3,960,000 46,753 13.3% $4.81 2008 $ 1,125,000 $ 2,250,000
- -------- (1) Potential Realizable Value assumes that the common stock appreciates at the indicated annual rate (compounded annually) from the grant date until the expiration of the option term and is calculated based on the requirements promulgated by the Securities and Exchange Commission. Potential Realizable Value does not represent musicmaker.com's estimate of future stock price growth. The following table sets forth certain information regarding the number and value of securities underlying options held by each of the Named Executive Officers at the end of fiscal 1998. No options were exercised by any of the Named Executive Officers during 1998. Aggregate Option Exercises and Year-End Option Values
Number of Securities Underlying Unexercised Options at December 31, 1998 -------------------------------- Name Exercisable Unexercisable ---- ------------- --------------- Robert P. Bernardi........................... 20,780 109,090 Devarajan S. Puthukarai...................... 20,780 109,090
Employment Agreements and Consulting Agreements Mr. Bernardi and Mr. Puthukarai each have employment agreements with initial terms through December 7, 2002. These agreements require that each commit substantially all of his time and effort to furthering musicmaker.com's interests and restrict competition with musicmaker.com during the term of the agreement and for one year following termination. Under the employment agreements, Mr. Bernardi and Mr. Puthukarai receive base salaries of $175,000 and $250,000 per annum, respectively. Each is eligible for payment of bonuses and stock options as determined by the Compensation Committee of the Board of Directors. Mr. Puthukarai is guaranteed a minimum annual bonus of $100,000. Upon termination by musicmaker.com without cause, or termination by Mr. Bernardi or Mr. Puthukarai upon certain non-compliance by musicmaker.com, their respective employment agreements provide for payment of all accrued salary, benefits and bonus plus a sum equal to the salary, benefits and bonus that would have been received if the initial or any renewal term had been completed, discounted by three percent. Each agreement is automatically renewable on a year-to-year basis following expiration of the initial term, and any renewal term unless certain notice of non-renewal is given by either party. Should musicmaker.com decide not to renew their respective agreements, Mr. Bernardi and Mr. 39 Puthukarai shall be entitled to a severance payment equal to one year's salary and benefits, as in effect prior to termination. Under a consulting agreement between musicmaker.com and IHS Corporation, Mr. Steinberg is required to provide consulting services to musicmaker.com for not less than fifteen days in any given month. Mr. Steinberg seeks to obtain, on musicmaker.com's behalf, additional license agreements and content relationships with record labels in an effort to expand musicmaker.com's music library. The Steinberg Consulting Agreement is non-exclusive; however, Mr. Steinberg is restricted from providing consulting services to any of musicmaker.com's competitors. For his services, Mr. Steinberg is paid a minimum monthly payment of $9,000. Mr. Steinberg also receives compensation of $1,200 per day in connection with his attendance at meetings of musicmaker.com's Board of Directors or any committee thereof. Key Man Insurance Musicmaker.com has applied for key man insurance covering Mr. Bernardi and Mr. Puthukarai. Stock Option Plan Musicmaker.com has adopted a stock option plan for the purpose of promoting our long-term growth and profitability by (i) providing key people with incentives to improve stockholder value and contribute to the growth and financial success of musicmaker.com, and (ii) enabling musicmaker.com to attract, retain and reward talented and skilled persons for positions of substantial responsibility. Musicmaker.com has used stock options as a significant component of compensation for our officers and key employees. The stock option plan provides for the award to eligible participants, including employees, officers, directors and consultants, of stock options (including non-qualified options and incentive stock options pursuant to Section 422 of the Internal Revenue Code) and stock appreciation rights (including free standing, tandem and limited stock appreciation rights). Under the stock option plan 779,221 shares of common stock are reserved for issuance, representing % of the shares of common stock expected to be outstanding immediately subsequent to this offering. As of the date of this prospectus, options to purchase a total of 532,182 shares of common stock were outstanding, at exercise prices ranging from $0.385 to $5.29 per share. No options have been exercised and no stock appreciation rights have been granted to date. Subsequent to this offering, the stock option plan will be administered by the Compensation Committee of the Board of Directors, which will include at least two "disinterested persons," for purposes of Rule 16b-3 under the Exchange Act, and "outside directors," within the meaning of Section 162(m) of the Internal Revenue Code. The Compensation Committee will select the participants and establish the terms and conditions of each option or other rights granted under the stock option plan, including the exercise price, the number of shares subject to options or other equity rights and the time at which such options become exercisable. See "--Committees of the Board of Directors and Compensation." The exercise price of all "incentive stock options" within the meaning of Section 422 of the Internal Revenue Code, granted under the stock option plan must be at least equal to 100% of the fair market value of the option shares on the date of grant. The term of any incentive stock option granted under the stock option plan may not exceed ten years. Where the eligible stock option plan participant owns over 10% of the total combined voting power of all classes of stock of musicmaker.com, however, the exercise price must be at least equal to 110% of the fair market value of the option shares on the date of grant and the term cannot exceed five years. To the extent required to comply with Rule 16b-3 under the Exchange Act, if applicable, and in any event in the case of an incentive stock option or stock appreciation right granted with respect to an incentive stock option, no award granted under the stock option plan shall be transferable by a grantee otherwise than by will or by the laws of descent and distribution. Other terms and conditions of each award are set forth in the grant agreement governing that award and determined by the Compensation Committee. 40 Indemnification of Directors and Officers Musicmaker.com's Charter and Bylaws provide that it shall indemnify all of its directors and officers to the full extent permitted by the Delaware General Corporation Law (the "DGCL"). Under such provisions, any director or officer who, in his or her capacity as such, is made or threatened to be made a party to any suit or proceeding, may be indemnified if the Board determines such director or officer acted in good faith and in a manner such director reasonably believed to be in, or not opposed to, the best interests of musicmaker.com. The Charter, Bylaws, and the DGCL further provide that such indemnification is not exclusive of any other rights to which such individuals may be entitled under our Charter, Bylaws, any agreement, any vote of stockholders or disinterested directors, or otherwise. Musicmaker.com has the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee, or agent of musicmaker.com, or is or was serving at the request of musicmaker.com as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, or other enterprise, against any expense, liability, or loss incurred by such person in any such capacity or arising out of his status as such, whether or not musicmaker.com would have the power to indemnify such person against such liability under the DGCL. 41 CERTAIN TRANSACTIONS In July 1996, we sold 551,948 shares of common stock to Mr. Bernardi, our founder, Chairman of the Board of Directors and Co-Chief Executive Officer, for nominal cash consideration in connection with musicmaker.com's formation. In July 1996, we acquired CD Kit, S.A. in exchange for 649,351 shares of common stock, payable to the stockholders of CD Kit, S.A. In exchange we received 8,000 shares of CD Kit, SA, all of its outstanding capital stock. In connection with the acquisition of CD Kit, S.A., Bruno Costa-Marini and Jean Francois Dockes, each a former stockholder of CD Kit, S.A., became the beneficial owners of 285,714 and 188,312 of such shares of our common stock, respectively. Between December 1996 and May 1997, musicmaker.com sold 12% convertible notes to accredited investors for $650,000. The notes were convertible into our common stock at $6.74 per share. Of these investors, Mr. Bernardi and Mr. Mathias, one of our directors, participated in the offering, purchasing notes and paying an aggregate consideration of $50,000 and $150,000, respectively. These purchases were on the same terms as those applying to non-affiliated investors participating in the convertible notes offering. In connection with a June 1997 private placement of securities, we converted the principal and all accrued interest under the terms of the outstanding convertible notes at a price of $3.85 per share, rather than $6.74 a share as stated in the original offering. In connection with the conversion of the notes and the private placement of our common stock, Mr. Bernardi and Mr. Mathias received 13,815 and 41,446 shares of our common stock, respectively. The conversion of the notes belonging to Mr. Bernardi and Mr. Mathias was conducted on the same terms as that provided to non-affiliated investors participating in the conversion. In addition to the common stock received upon the conversion above, Mr. Bernardi purchased an additional 6,494 shares of common stock in the June 1997 private placement at $3.85 per share. In October 1997, we issued 194,805 common stock warrants to Mr. Puthukarai, musicmaker.com's President, Co-Chief Executive Officer and Chief Operating Officer, as part of his compensation and in exchange for services previously rendered to musicmaker.com. The warrants have an exercise price of $3.85 per share and expire on October 15, 2007. In December 1997, musicmaker.com issued and sold 375,701 shares of our Series A outstanding preferred stock, par value $.01, to Rho Management Trust I, a venture capital firm. Mr. Bernardi and Mr. Puthukarai also purchased 51,948 and 12,987 shares of our Series A outstanding preferred stock, respectively. The shares were purchased at a price of $3.85 per share. Additionally, 715,622, 98,949 and 24,737 Series B outstanding preferred warrants were issued to Rho, Mr. Bernardi and Mr. Puthukarai, respectively. The Series B outstanding preferred warrants expire on December 8, 2002 and are exercisable for Series B outstanding preferred stock, par value $.01 per share, at an exercise price of $4.62 per share. We also issued 188,103, 26,009 and 6,502 Series C outstanding preferred warrants to Rho, Mr. Bernardi and Mr. Puthukarai, respectively. The Series C outstanding preferred warrants expire on December 8, 2001 and are exercisable for Series C outstanding preferred stock, par value $.01 per share, at an exercise price of $5.78 per share. Musicmaker.com received $1,696,450 in aggregate consideration from the investors above in connection with this round of venture financing. In March and June, 1998, holders of the Series B outstanding preferred warrants exercised 364,654 warrants which were converted to Series B outstanding preferred stock at $4.62 per share. Of the 364,654 warrants exercised, Mr. Bernardi and Mr. Puthukarai received 41,229 and 10,307 shares of Series B outstanding preferred stock, respectively. Mr. Bernardi and Mr. Puthukarai received the shares above in exchange for their relinquishment of $133,334 in accrued salary and $33,333 in accrued bonus, respectively. Rho received an additional 305,903 shares of Series B outstanding preferred stock, in connection with the exercise of the warrants. In January 1998, 72,727 common stock warrants, with an exercise price of $3.85 per share, were issued to Mr. Steinberg, musicmaker.com's Vice Chairman of the Board of Directors, for consulting services related to 42 obtaining license agreements with record labels on behalf of musicmaker.com. These warrants expire January 15, 2008. In August 1998, musicmaker.com issued 25,974 common stock warrants to four members of Mr. Steinberg's family as record holders. The warrants were granted as compensation for consulting services rendered to musicmaker.com by Mr. Steinberg and he is the beneficial owner of such warrants. The warrants are convertible by the holders into common stock at an exercise price of $4.62 per share and expire on August 15, 2008. In September 1998, we issued 259,741 shares of our common stock to Platinum at a value of $1,650,000. In exchange for shares of our common stock and pursuant to the terms of a stock exchange agreement, dated September 30, 1998, and each of a licensing agreement and a marketing agreement of even date therewith, we entered into a strategic marketing and content alliance under which we market and sell our custom CDs on Platinum's website and have a license to use their song library. We also received 111,457 shares of Platinum's common stock, having an aggregate value of $750,000. In November 1998, an additional 83,116 shares of our common stock were issued to Platinum in connection with, and as payment under, the stock exchange agreement noted above. See "Business--Marketing." In December 1998, we loaned $81,519 to Mr. Puthukarai all of which was outstanding at December 31, 1998, and all of which is currently outstanding. The loan is to be repaid without interest and upon demand under a note held by musicmaker.com. The funds were loaned for payment of federal and state income taxes. We believe that the above-described transactions are as fair to musicmaker.com as could have been obtained with unaffiliated parties. We intend that all future transactions with officers, directors or principal stockholders of musicmaker.com will be approved or ratified by a majority of the Board of Directors, including a majority of the disinterested, independent directors. We intend that such future transactions will be on terms no less favorable to musicmaker.com than could be obtained from unaffiliated third parties. 43 PRINCIPAL STOCKHOLDERS The following table sets forth certain information regarding shares of our common stock beneficially owned as of January 31, 1999, and as adjusted to reflect the offering by (i) each person or group known to musicmaker.com, that beneficially owns more than five percent of our outstanding common stock; (ii) musicmaker.com's directors and Named Executive Officers, and (iii) all of musicmaker.com's executive officers and directors as a group. Beneficial ownership is calculated in accordance with Rule 13d-3(d) under the Securities Exchange Act of 1934. Shares of common stock subject to options and warrants that are currently exercisable or are exercisable within 60 days of January 31, 1999, are deemed outstanding with respect to the person holding such options but are not deemed outstanding for purposes of computing the percentage ownership of any other person. Unless otherwise indicated, each person possesses sole voting and investment power with respect to the shares identified as beneficially owned. Except as otherwise indicated in the table, the address of the stockholders listed below is that of musicmaker.com's principal executive office. See "Risk Factors--Certain existing investors own a large percentage of our voting securities" and "Certain Transactions."
Shares Beneficially Shares Beneficially Owned Owned After the Name and Address Prior to the Offering (1) Offering ---------------- -------------------------------- -------------------------- Number Percent Number Percent --------------- ------------- ------------ ---------- Rho Management Trust I.. 1,207,864(2) 25.6% 1,207,864 767 Fifth Avenue New York, NY 10053 Robert P. Bernardi...... 920,220(3) 21.0% 920,220 Devarajan S. Puthukarai............. 448,679(4) 10.0% 448,679 Platinum Entertainment, Inc.................... 342,857 8.2% 342,857 2001 Butterfield Rd. Suite 1400 Downers Grove, IL 60515 Bruno Costa-Marini...... 294,372(5) 7.0% 294,372(5) Abdulla Mohammed Al- Romaizan............... 259,740(6) 6.1% 259,740(6) P.O. Box 768 Riyadh 11421 Kingdom of Saudi Arabia Irwin H. Steinberg...... 150,649(7) 3.5% 150,649(7) Edward J. Mathias....... 67,420 1.6% 67,420 All executive officers and directors as a group (6 persons)...... 1,645,410(8) 34.3% 1,645,410(8)
- -------- (1) Shares beneficially owned prior to the offering are as adjusted to reflect and include the automatic conversion of (i) all outstanding preferred stock and outstanding preferred warrants into common stock and common stock warrants, respectively, and (ii) all outstanding convertible notes into common stock, upon completion of the offering. (2) Includes: (i) 375,701 shares of Series A and 305,903 shares of Series B outstanding preferred stock to be converted into 375,701 and 305,903 shares of common stock, respectively, and (ii) 338,156 Series B and 188,104 Series C outstanding preferred warrants to be converted into 338,156 and 188,104 common stock warrants, respectively, upon the completion of this offering. Rho Management Partners L.P., a Delaware limited partnership may be deemed the beneficial owner of shares registered in the name of Rho Management Trust I, pursuant to an investment advisory relationship by which Rho Management Partners L.P. exercises sole voting and investment control over such shares and warrants. (3) Includes (i) 51,948 shares of Series A and 41,229 shares of Series B outstanding preferred stock to be converted into 51,948 and 41,229 shares of common stock, respectively, and (ii) 117,089 Series B and 26,009 Series C outstanding preferred warrants to be converted into 117,089 and 26,009 common stock 44 warrants, respectively, upon the completion of this offering, and (iii) 64,935 vested options for common stock with exercise prices ranging from $4.81 to $5.29 per share. (4) Includes (i) 194,805 common stock warrants with an exercise price of $3.85 per share, (ii) 12,987 shares of Series A and 10,307 shares of Series B outstanding preferred stock to be automatically converted into 12,987 and 10,307 shares of common stock, respectively, and (iii) 29,272 Series B and 6,502 Series C outstanding preferred warrants to be converted into 29,272 and 6,502 common stock warrants, respectively, upon the completion of this offering, and (iv) 64,935 vested options for common stock with exercise prices ranging from $4.81 to $5.29 per share. (5) Includes 8,658 vested options for common stock with an exercise price of $3.85 per share. (6) Includes 51,948 common stock warrants with an exercise price of $4.81 per share. (7) Includes 98,701 common stock warrants with exercise prices ranging from $3.85 to $4.62 per share. (8) Includes: (i) 64,935 shares of Series A and 51,536 shares of Series B outstanding preferred stock, to be converted into 64,935 and 51,536 shares of common stock, respectively, and (ii) 146,362 Series B and 32,511 Series C outstanding preferred warrants to be converted into 146,362 and 32,511 common stock warrants, respectively, upon completion of this offering. Also includes 293,506 outstanding common stock warrants and 136,364 vested options for common stock. 45 DESCRIPTION OF SECURITIES General Pursuant to our Charter, musicmaker.com is authorized to issue up to 15,584,415 shares of common stock, par value $.01 and 1,547,924 shares of preferred stock, par value $.01 per share. Prior to this offering, 2,960,058 shares of common stock were issued and outstanding and an additional 3,091,546 were reserved for issuance pursuant to outstanding options, warrants and conversion features of other securities issued. As of January 31, 1999, there were approximately 100 holders of our common stock (after giving effect to the conversion of all outstanding outstanding preferred stock and convertible notes upon consummation of this offering). The following description of our capital stock is a summary and is qualified in its entirety by the provisions of our Charter, Bylaws and applicable law. These documents have been filed as exhibits to the registration statement, of which this prospectus forms a part. Reverse Stock Split Musicmaker.com's Board of Directors and stockholders have approved a reverse stock split by which each issued and outstanding share of our common stock will be reclassified in a one-for-3.85 reverse split to be effected on , 1999. The reverse stock split similarly affected the holders of our outstanding options and warrants for common stock, and the conversion features of the holders of our outstanding preferred stock, outstanding preferred warrants, and convertible notes. Common Stock The holders of common stock are entitled to one vote per share on all matters submitted to a vote of the stockholders. Holders of common stock are entitled to share in any and all dividends that our Board of Directors, in its discretion, declares from funds legally available therefor. In the event of any liquidation or dissolution of musicmaker.com, the holders of common stock are entitled to participate in and share pro rata in the assets available for distribution to stockholders. Any such distribution would be subsequent to payment of our liabilities and may be subject to any preferential rights of any preferred stock or other senior security then outstanding. The holders of common stock have no cumulative voting, preemptive or other subscription rights, and there are no conversion rights or redemption or sinking fund provisions with respect to the common stock. All outstanding shares of common stock are, and the shares of common stock offered hereby upon issuance and sale will be, fully paid and non-assessable. The rights, preferences and privileges of the holders of common stock are subject to, and may be adversely affected by, the rights of the holders of any shares of preferred stock or senior securities which musicmaker.com may designate in the future. Preferred Stock Pursuant to musicmaker.com's Charter, our Board of Directors may, without further action by stockholders, from time to time, issue one or more series of preferred stock. Blank check preferred stock may be issued with such rights, preferences, privileges and limitations as the Board of Directors may determine and as permitted by the DGCL, including: . The number of shares constituting the series and the distinctive designation of the series of preferred stock. . The dividend rate on such preferred stock, the dates of payment and whether such dividends shall be cumulative. . The extent of voting rights, if any, to be granted to holders of any series of preferred stock. . Other rights, privileges and preferences, including conversion into common stock, redemption by the holder or musicmaker.com and priority upon liquidation, dissolution or winding up of musicmaker.com. 46 Registration Rights Holders of our outstanding preferred stock and outstanding preferred warrants, including Mr. Bernardi, Mr. Puthukarai, Rho, and an additional investor, have been granted certain demand registration rights. These demand registration rights may require musicmaker.com to file, on not more than two occasions, a registration statement under the Securities Act covering all, or a portion of their common stock issued or issuable, upon the automatic conversion of the outstanding preferred stock and outstanding preferred warrants upon consummation of this offering. In connection with the issuance to Columbia House of a warrant for 129,870 shares of common stock, musicmaker.com granted certain registration rights permitting the holders to require that musicmaker.com, on not more than two occasions, file a registration statement under the Securities Act covering all, or a portion of the common stock issued or issuable pursuant to the warrant. Under the terms of his consulting agreement with musicmaker.com, Mr. Steinberg, musicmaker.com's Vice Chairman of the Board of Directors, was granted registration rights equivalent to those received by Mr. Bernardi. In addition, each of the holders indicated above, the noteholders and Boston Financial & Equity Corporation, a lessor of certain equipment, have certain "piggyback" registration rights. If musicmaker.com proposes to register any of its common stock under the Securities Act (other than pursuant to this offering or in connection with the registration of securities issuable under an employee benefit plan or a registered exchange offer) holders of "piggyback" rights may require that musicmaker.com include all or a portion of their common stock, issued or issuable pursuant to certain exercise rights, in such registration. In connection with any such offering, the managing underwriter thereof, shall have certain rights to limit the number of securities held by persons with "piggyback" registration rights to be included in such registration. All expenses incurred in connection with the registration rights above will be borne by musicmaker.com. The underwriters have requested that all holders of registration rights forego any request for registration for a period of 180 days following the date of effectiveness of this prospectus. Delaware General Corporation Law and certain provisions in our Charter Our Charter provides that musicmaker.com shall indemnify its currently acting and former directors and officers against any and all liabilities and expenses incurred in connection with their services in such capacities to the maximum extent permitted by the DGCL. Our Charter similarly requires musicmaker.com to advance expenses to our officers and directors entitled to indemnification to the maximum extent permitted by the DGCL. Advancement of expenses to directors and officers is conditioned upon receipt of an undertaking by such director or officer to repay the amount of any advancement if it shall ultimately be determined that such person is not entitled to be indemnified by musicmaker.com. The terms and conditions of such advancement are to be determined by musicmaker.com's Board of Directors. Insofar as indemnification for liabilities under the Securities Act may be permitted to our directors and officers, musicmaker.com has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy, as expressed in the Securities Act, and is therefore unenforceable. Our Charter provides that our directors shall not be personally liable to musicmaker.com or our stockholders for monetary damages to fullest extent permitted by the DGCL. Section 102(b)(7) of the DGCL currently permits elimination of a director's personal liability to a corporation and its stockholders except for liability: . For any breach of the director's duty of loyalty to the corporation or its stockholders. . For acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law. . Under Section 174 of the DGCL for unlawful dividends, distributions or unlawful stock repurchases or redemptions. . For any transaction from which the director derives an improper personal benefit. Under our Charter and the DGCL, our directors will be protected from monetary damages for other negligent acts on their part. Stockholders and musicmaker.com seeking redress against directors may bring an action for equitable remedies such as an injunction or rescission based upon a director's breach of fiduciary 47 duties, even where monetary remedies are unavailable. Any amendment to the DGCL that increases or decreases the protection from monetary damages afforded directors in Delaware shall be automatically incorporated into our Charter. Charter provisions that could delay or prevent a change in control Upon effectiveness of our registration statement, of which this prospectus is a part, our Board of Directors will be divided into three separate classes, with only one class, or roughly one-third of the Board of Directors, standing for election in any given year. This "staggered" structure of the Board of Directors may have the effect of delaying the ability of stockholders to change the composition of the Board of Directors and possibly delaying or preventing a corresponding change in control of musicmaker.com. Musicmaker.com's Charter also contains a provision which enables the Board of Directors to issue preferred stock without the approval of stockholders. The Board of Directors may fix the rights, preferences, privileges and limitations of such securities at its discretion. The provision grants to the Board of Directors the right to issue what is often called "blank check" preferred stock. The provision may be used to permit the Board of Directors to institute a rights plan, or "poison pill" by which the Board of Directors issues preferred stock or grants rights to acquire preferred stock, often with voting rights, to certain holders of common stock. The effect of such preferred stock grants may be to deter possible takeovers or acquisitions, making such a transaction prohibitively expensive for potential acquirers. Issuance of such preferred stock could discourage potential bids for musicmaker.com, deny stockholders a potential premium on their shares and may make a change in control of musicmaker.com more difficult. See "Risk Factors-- Anti-takeover effects of our Charter and Bylaws." 48 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this offering, we will have outstanding shares of common stock. Of these shares, the shares of common stock sold in this offering (assuming no exercise of the Underwriter's over-allotment option) will be freely tradable in the public market without restrictions under the Securities Act, except that any shares purchased by affiliates of musicmaker.com, as defined in Rule 144 under the Securities Act, may only be sold in compliance with the applicable provisions of Rule 144 discussed below. In general, under Rule 144, a person (or persons whose shares are aggregated) who has beneficially owned "restricted securities" for at least one year, including a person who may be deemed an affiliate of musicmaker.com, is entitled to sell within any three-month period the number of shares of common stock that does not exceed the greater of (i) one percent of the then outstanding shares of common stock of musicmaker.com or (ii) the average weekly trading volume of common stock on the Nasdaq National Market during the four calendar weeks preceding the date on which notice of the sale is filed with the Securities and Exchange Commission. Sales under Rule 144 are subject to certain restrictions relating to manner of sale, notice and the availability of current public information about musicmaker.com. Generally, a person who is not an affiliate of musicmaker.com and who has satisfied a two- year holding period will be able to sell without any volume limitations. As of January 31, 1999, the one-year holding period had expired with respect to 2,056,006 shares of common stock. As of January 31, 1999, the two-year holding period had expired with respect to 1,327,273 shares of common stock. Shares of outstanding preferred stock, including all outstanding preferred warrants, shall be automatically converted into shares of common stock and common stock warrants, respectively, upon completion of this offering. As a result of this automatic conversion, 819,199 shares of restricted common stock shall be issued to the former holders of the outstanding preferred stock and 728,725 warrants for common stock shall be issued in exchange for the outstanding preferred warrants. Outstanding convertible notes shall automatically convert into 415,584 shares of common stock upon completion of this offering. Stockholders holding approximately of our outstanding common stock and outstanding options and warrants for common stock, are expected to agree not to offer, pledge, sell, contract to sell, grant any option for the sale of, or otherwise dispose of, directly or indirectly, any securities of musicmaker.com they currently hold without prior written consent of the representatives for a period of 180 days following the date of the final prospectus. Upon completion of this offering, we will sell to the representatives, for nominal consideration, warrants entitling the representatives to purchase an aggregate of shares of common stock at an initial exercise price equal to 110% of the initial public offering price. The representatives' warrants will be exercisable for a period of four years commencing one year after the effective date of the registration statement of which this prospectus is a part. Subject to the limitations of Rule 144, the holders of the representatives' warrants may sell shares of common stock acquired by exercise of the warrant one year from the date of exercise thereof without registration. See "Underwriting." Prior to this offering, there has been no market for our common stock. No predictions can be made as to the effect, if any, that sales of shares of common stock under Rule 144 will have on the market price of our common stock. Sales in the public market of such common stock under Rule 144 could adversely affect the market price of our common stock or the ability of musicmaker.com to raise funds through a public offering of its equity securities. See "Risk Factors--Shares eligible for future sale." 49 UNDERWRITING Subject to the terms and conditions of an underwriting agreement, the underwriters named below, for whom Ferris, Baker Watts, Incorporated and Fahnestock & Co., Inc. are acting as the representatives, have severally agreed to purchase from us, and we have agreed to sell to the underwriters, the respective number of shares of common stock set forth opposite each underwriters named below:
Number Underwriters of Shares ------------ --------- Ferris, Baker Watts, Incorporated................................. Fahnestock & Co. Inc.............................................. --- Total........................................................... ===
The underwriting agreement provides that the obligations of the several underwriters thereunder are subject to approval of certain legal matters by their counsel and to various other conditions. The nature of the underwriter's obligation is such that they are committed to purchase and pay for all shares of common stock if any are purchased. The underwriters propose to offer the shares of common stock directly to the public at the initial public offering price set forth on the cover page of this prospectus and to certain securities dealers at such price less a concession not in excess of $ per share. The underwriters may allow, and such selected dealers may re-allow, a concession not in excess of $ per share to certain brokers and dealers. After this offering, the price to the public, concession, allowance and re-allowance may be changed by the representatives. The representatives have informed us that the underwriters do not intend to confirm sales to any account over which they exercise discretionary authority. We have granted the underwriters an option exercisable during the 30-day period after the date of this prospectus, to purchase up to additional shares of common stock at the initial public offering price solely to cover over-allotments, if any. To the extent that the underwriters exercise this option, each of the underwriters will be committed, subject to certain conditions, to purchase such additional shares of common stock in approximately the same proportions as set forth in the above table. The offering of common stock is made for delivery when, as and if accepted by the underwriters and subject to prior sale to withdrawal, cancellation or modification of the offer without notice. The underwriters reserve the right to reject any order for the purchase of common stock. We have agreed to issue warrants to the representatives to purchase up to shares of common stock, at an exercise price per share equal to 110% of the initial public offering price per share. The representatives' warrants are exercisable for a period of four years, commencing one year from the effective date of the registration statement of which this prospectus is a part. The representatives' warrants will not be sold, offered for sale, transferred, assigned or hypothecated for a period of one year from the effective date of the registration statement other than to officers, employees or partners of the respective representatives and members of the selling group and their officers and partners. The holders of the representatives' warrants will have no voting, dividend or other stockholders' rights until the representatives' warrants are exercised. We have granted the representatives certain demand and piggyback registration rights related to the representatives' warrants, which are applicable during the period that the representatives' warrants are exercisable. We also have agreed to pay the underwriters a nonaccountable expense allowance of 1% of the gross proceeds of this offering. We have agreed to enter into a financial advisory agreement with GunnAllen Financial, Inc. whereby we will pay GunnAllen an advisor fee of $125,000 upon the completion of the offering. 50 We have agreed not to issue, and all of our officers and directors, and all security holders of musicmaker.com are expected to agree not to offer, pledge, sell, contract to sell, or otherwise transfer or dispose of directly or indirectly any shares of our capital stock or other equity securities of musicmaker.com for a period of 180 days after the date of this prospectus without the prior written consent of Ferris, Baker Watts, Incorporated. In addition, those officers, directors and each security holder of musicmaker.com to whom we granted certain registration rights in connection with the issuance of shares of our common stock or other equity securities of musicmaker.com are expected to agree not to make any demand for, exercise any right, or file (or participate in the filing of) a registration statement with respect to the registration of any shares of common stock or any securities convertible into or exercisable or exchangeable for common stock for a period of 180 days after the date of this prospectus without the prior written consent of Ferris, Baker Watts, Incorporated. We have agreed to indemnify the underwriters against certain liabilities under the Securities Act of 1933, as amended, or to contribute to payments the underwriters may be required to make in respect thereof. Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price for our common stock was determined by negotiation among musicmaker.com and the Representatives. Among the factors considered in determining the public offering price were: . The preliminary demand for our common stock. . The history of and the prospects for musicmaker.com. . The condition of the industry and markets in which we compete. . An assessment of our management. . Our past earnings and the trend and future prospects of such earnings. . The present state of our business operations and development. . The general conditions of the securities market at the time of the offering; and the market prices of publicly traded common stocks of comparable companies in related industries in recent periods. There can be no assurance that an active trading market will develop for our common stock or that our common stock will trade in the public market subsequent to this offering at or above the initial public offering price. The initial public offering price set forth on the cover page of this prospectus should not be considered an indication of the actual value of our common stock. Such price is subject to change as a result of market conditions and other factors. We cannot assure you that our common stock can be resold at or above the initial public offering price. In order to facilitate this offering, certain persons participating in the offering may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock during and after the offering in accordance with Regulation M under the Securities Exchange Act of 1934, as amended. Specifically, the underwriters may over-allot or otherwise create a short position in the common stock for their own account by selling more shares of common stock than have been sold to them by us. The underwriters may elect to cover any such short position by purchasing shares of common stock in the open market or by exercising the over-allotment option granted to the underwriters. In addition, the underwriters may stabilize or maintain the price of the common stock by bidding for or purchasing shares of common stock in the open market and may impose penalty bids, under which selling concessions allowed to syndicate members or other broker-dealers participating in the offering are reclaimed if shares of common stock previously distributed in the offering are repurchased in connection with stabilization transactions or otherwise. The effect of these transactions and use of penalty bids may be to stabilize or maintain the market price at a level above that which might otherwise prevail in the open market. The imposition of a penalty bid may also affect the price of the common stock to the extent that it discourages resales. No representation is made as to the magnitude or effect of any such stabilization or other transactions. Such transactions may be effected on the Nasdaq National Market or otherwise and, if continued, may be discontinued at any time. 51 TRANSFER AGENT, ESCROW AGENT AND REGISTRAR The transfer agent, escrow agent and registrar for the common stock is . LEGAL MATTERS The legality of the securities offered hereby has been passed upon for musicmaker.com by its counsel, Venable, Baetjer and Howard, LLP of McLean, Virginia. Certain legal matters will be passed upon for the underwriters by its counsel Katten Muchin & Zavis, Washington, D.C. Certain matters in connection with United States patents and trademarks and international patents will be passed upon for musicmaker.com by Darby & Darby, P.C. of New York, New York. EXPERTS The consolidated financial statements of musicmaker.com, Inc. (formerly The Music Connection Corporation) at December 31, 1998 and 1997, and for the years ended December 31, 1998 and 1997 and for the period from April 23, 1996 (inception) through December 31, 1996, appearing in this prospectus and registration statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. Certain matters dealing with patents and trademarks set forth in "Risk Factors--We depend upon intellectual property rights and risk having such rights infringed" and "Business--Intellectual Property and Proprietary Rights" have been included in this prospectus in reliance upon the written opinion of Darby & Darby, P.C. of New York, New York, as experts in such matters. See "Legal Matters." ADDITIONAL INFORMATION Musicmaker.com has filed with the SEC a registration statement on Form S-1 under the Securities Act with respect to the shares of common stock offered by this prospectus. This prospectus does not contain all of the information set forth in the registration statement, certain parts of which are omitted in accordance with the rules and regulations of the SEC. For further information with respect to musicmaker.com and this offering, reference is made to the registration statement, including the exhibits filed therewith, copies of which may be obtained at prescribed rates from the SEC at the public reference facilities maintained by the SEC at Judiciary Plaza Building, 450 Fifth Street, NW, Washington, D.C. 20549 and at the SEC's regional offices located at Seven World Trade Center, Suite 1300, New York, NY 10048 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, IL 60661. Descriptions contained in this prospectus as to the contents of any contract or other documents filed as an exhibit to the registration statement are not necessarily complete and each such description is qualified by reference to such contract or document. The SEC maintains a website on the Internet that will contain all future reports, proxy and information statements and other information that musicmaker.com is required to file electronically with the SEC. The address of the SEC's website is http://www.sec.gov. This prospectus includes statistical data regarding Internet usage and the advertising industry which were obtained from industry publications, including reports generated by Jupiter Communications and the Record Industry Association of America. These industry publications generally indicate that they have obtained information from sources believed to be reliable, but do not guarantee the accuracy and completeness of such information. While we believe those industry publications to be reliable, we have not independently verified such data. We also have not sought, in certain circumstances, the consent of these organizations to refer to their reports in this prospectus. 52 musicmaker.com, Inc. (formerly The Music Connection Corporation) INDEX TO FINANCIAL STATEMENTS Report of Independent Auditors.............................................. F-2 Consolidated Balance Sheets................................................. F-3 Consolidated Statements of Operations....................................... F-4 Consolidated Statements of Stockholders' Deficit............................ F-5 Consolidated Statements of Cash Flows....................................... F-6 Notes to Consolidated Financial Statements.................................. F-7
F-1 REPORT OF INDEPENDENT AUDITORS Board of Directors musicmaker.com, Inc. (formerly The Music Connection Corporation) We have audited the accompanying consolidated balance sheets of musicmaker.com, Inc. (formerly The Music Connection Corporation) as of December 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' deficit, and cash flows for the period from April 23, 1996 (inception) through December 31, 1996 and for the years ended December 31, 1997 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of musicmaker.com, Inc. (formerly The Music Connection Corporation) at December 31, 1997 and 1998, and the consolidated results of its operations and its cash flows for the period from April 23, 1996 (inception) through December 31, 1996, and for the years ended December 31, 1997 and 1998, in conformity with generally accepted accounting principles. Ernst & Young LLP Vienna, Virginia February 5, 1999, except Note 11, as to which the date is , 1999 - ------------------------------------------------------------------------------- The foregoing report is in the form that will be signed upon the completion of the restatement of the capital accounts for the reverse stock split as described in Note 11 to the financial statements. /s/ Ernst & Young LLP Vienna, Virginia February 18, 1999 F-2 musicmaker.com, Inc. (formerly The Music Connection Corporation) CONSOLIDATED BALANCE SHEETS
December 31, Pro Forma ------------------------ December 31, 1997 1998 1998 (Note 10) ----------- ----------- -------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents.......... $ 1,401,982 $ 972,954 $ 2,286,579 Accounts receivable................ 12,750 17,510 17,510 Related party account receivable (Note 8).......................... -- 81,519 81,519 Prepaid expenses and other current assets............................ 17,503 25,395 25,395 ----------- ----------- ----------- Total current assets............. 1,432,235 1,097,378 2,411,003 Property and equipment, net (Note 2).................................. 297,140 360,709 360,709 Investments (Note 1)................. -- 750,000 750,000 Intangibles, net (Note 3)............ -- 967,395 855,000 Other assets......................... -- 58,481 58,481 ----------- ----------- ----------- Total assets..................... $ 1,729,375 $ 3,233,963 $ 4,435,193 =========== =========== =========== LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY Current liabilities: Accounts payable................... $ 328,450 $ 455,095 $ 455,095 Accrued expenses................... 91,369 261,974 261,974 Accrued compensation payable to related parties (Note 8).......... 761,221 625,219 625,219 Current portion of long-term obligation (Note 4)............... -- 42,857 42,857 ----------- ----------- ----------- Total current liabilities........ 1,181,040 1,385,145 1,385,145 Long-term obligation (Note 4)........ -- 214,286 214,286 Convertible notes payable (Note 4)... -- 512,500 -- Commitments (Note 7) Convertible preferred stock, $0.01 par value, 1,547,924 shares authorized (Note 5): Series A convertible preferred stock, 454,545 shares designated; 454,545 shares issued and outstanding....................... 1,750,000 1,750,000 -- Series B convertible preferred stock, 865,801 shares designated; 0 and 364,654 shares issued and outstanding....................... -- 1,684,700 -- Series C convertible preferred stock, 227,578 shares designated; no shares issued and outstanding.. -- -- -- Series A convertible preferred stock subscribed.................. (50,000) -- -- Stockholders' (deficit) equity(Note 5): Common stock, $0.01 par value, 5,194,805 shares authorized; 2,056,006, 2,707,954 shares issued and outstanding, respectively (3,942,737 pro forma shares)...... 20,560 27,080 39,427 Additional paid-in capital......... 1,279,244 4,766,488 10,188,841 Accumulated deficit................ (2,451,469) (7,106,236) (7,392,506) ----------- ----------- ----------- Total stockholders' (deficit) equity.......................... (1,151,665) (2,312,668) 2,835,762 ----------- ----------- ----------- Total liabilities and stockholders' (deficit) equity.. $ 1,729,375 $ 3,233,963 $ 4,435,193 =========== =========== ===========
See accompanying notes. F-3 musicmaker.com, Inc. (formerly The Music Connection Corporation) CONSOLIDATED STATEMENTS OF OPERATIONS
Period from Pro Forma April 23, 1996 Year ended (inception) to Year ended December 31, December 31, December 31, ------------------------ 1998 1996 1997 1998 (Note 10) -------------- ----------- ----------- ------------ (unaudited) Net sales............... $ 8,355 $ 13,432 $ 74,028 $ 74,028 Cost of sales........... (2,590) (2,955) (46,821) (46,821) --------- ----------- ----------- ----------- Gross profit............ 5,765 10,477 27,207 27,207 Operating expenses: Sales and marketing... -- 7,780 929,661 929,661 Operating and development.......... 64,029 692,041 1,435,690 1,435,690 General and administrative....... 306,381 1,360,856 2,334,438 2,620,708 --------- ----------- ----------- ----------- 370,410 2,060,677 4,699,789 4,986,059 --------- ----------- ----------- ----------- Loss from operations.... (364,645) (2,050,200) (4,672,582) (4,958,852) Other income (expense): Interest income....... -- -- 17,815 17,815 Interest expense...... (2,667) (33,957) -- -- --------- ----------- ----------- ----------- (2,667) (33,957) 17,815 17,815 --------- ----------- ----------- ----------- Net loss................ $(367,312) $(2,084,157) $(4,654,767) $(4,941,037) ========= =========== =========== =========== Basic and diluted net loss per share (Note 9)..................... $ (0.44) $ (1.20) $ (2.13) $ (1.73) ========= =========== =========== =========== Weighted average shares outstanding............ 830,076 1,734,328 2,186,488 2,863,521 ========= =========== =========== ===========
See accompanying notes. F-4 musicmaker.com, Inc. (formerly The Music Connection Corporation) CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
Common Stock Additional ----------------- Paid-In Accumulated Shares Amount Capital Deficit Total --------- ------- ---------- ----------- ----------- Issuance of common stock.................. 1,327,273 $13,273 $ 8,467 $ -- $ 21,740 Net loss............... -- -- -- (367,312) (367,312) --------- ------- ---------- ----------- ----------- Balance at December 31, 1996................... 1,327,273 13,273 8,467 (367,312) (345,572) Issuance of common stock.................. 524,415 5,244 435,696 -- 440,940 Issuance of common stock and warrants for services to non- employees.............. 25,974 260 150,240 -- 150,500 Conversion of notes payable................ 178,344 1,783 684,841 -- 686,624 Net loss............... -- -- -- (2,084,157) (2,084,157) --------- ------- ---------- ----------- ----------- Balance at December 31, 1997................... 2,056,006 20,560 1,279,244 (2,451,469) (1,151,665) Issuance of common stock.................. 651,948 6,520 2,987,782 -- 2,994,302 Issuance of warrants and options to non- employees............. -- -- 499,462 -- 499,462 Net loss............... -- -- -- (4,654,767) (4,654,767) --------- ------- ---------- ----------- ----------- Balance at December 31, 1998................... 2,707,954 $27,080 $4,766,488 $(7,106,236) $(2,312,668) ========= ======= ========== =========== ===========
See accompanying notes. F-5 musicmaker.com, Inc. (formerly The Music Connection Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS
Period from April 23, 1996 (inception) to Year ended December 31, December 31, ------------------------ 1996 1997 1998 -------------- ----------- ----------- Operating activities Net loss............................ $(367,312) $(2,084,157) $(4,654,767) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization...... 7,700 29,887 203,122 Conversion of accrued interest to common stock...................... -- 36,624 -- Services received in exchange for stock and warrants................ -- 150,500 499,462 Changes in operating assets and liabilities: Accounts receivable.............. (38,387) 25,637 (4,760) Related party account receivable...................... -- -- (81,519) Prepaid expenses and other current assets.................. (8,994) (8,509) (7,892) Other assets..................... -- -- (58,481) Accounts payable................. 166,018 162,432 126,645 Accrued expenses................. 46,025 45,344 170,605 Accrued compensation payable to related parties................. 217,587 543,634 30,665 Long-term obligation............. 2,667 (2,667) 257,143 --------- ----------- ----------- Net cash provided by (used in) operating activities.......... 25,304 (1,101,275) (3,519,777) Investing activities Purchases of property and equipment........................... (34,972) (299,755) (217,961) --------- ----------- ----------- Net cash used in investing activities.................... (34,972) (299,755) (217,961) Financing activities Proceeds from issuance of convertible notes payable........... 400,000 250,000 512,500 Payment of fees on convertible notes payable............................. -- -- (116,125) Issuance of convertible preferred stock............................... -- 1,700,000 1,568,033 Issuance of common stock............ 21,740 440,940 1,344,302 --------- ----------- ----------- Net cash provided by financing activities.................... 421,740 2,390,940 3,308,710 --------- ----------- ----------- Net increase (decrease) in cash and cash equivalents.................... 412,072 989,910 (429,028) Cash and cash equivalents at beginning of period................. -- 412,072 1,401,982 --------- ----------- ----------- Cash and cash equivalents at end of period.............................. $ 412,072 $ 1,401,982 $ 972,954 ========= =========== =========== Non-cash investing and financing activities Issuance of common stock............ $ 18,230 $ -- $ -- ========= =========== =========== Conversion of notes payable to common stock (Note 4)............... $ -- $ 686,624 $ -- ========= =========== =========== Common stock issued for licensing agreement (Note 5).................. $ -- $ -- $ 1,650,000 ========= =========== =========== Conversion of accrued compensation to preferred stock (Note 5)......... $ -- $ -- $ 166,667 ========= =========== ===========
See accompanying notes. F-6 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998 1. Summary of Significant Accounting Policies The Company Musicmaker.com, Inc. (formerly The Music Connection Corporation) (the "Company") was incorporated in Delaware on April 23, 1996. The Company is an e-commerce provider of customized music CD compilations on the Internet. The Company's website, "www.musicmaker.com," as well as mail-order promotions, allow customers to order custom compiled music CDs. Customers can also digitally download songs from the Company's online library directly to their personal computers. Since inception, management has been primarily involved in recruiting personnel, developing the technological infrastructure necessary to create custom CDs on the Internet, building an operating infrastructure and establishing relationships with record labels and vendors. The Company continues to rely on outside sources of capital to develop and exploit its products and markets. In February 1999, the Company plans to file a registration statement with the Securities and Exchange Commission relating to the initial public offering (the "IPO") of the Company's common stock. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, CD Kit, as of December 31, 1996 and 1997. As of December 31, 1998, CD Kit was inactive with no remaining assets or liabilities. All significant inter-company transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue Recognition Net sales are recognized at the time merchandise is shipped to customers for custom CDs and upon execution of orders for digitally downloaded songs. Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Investments In connection with exclusive music license, stock exchange and marketing agreements signed with Platinum Entertainment, Inc. ("Platinum") on September 30, 1998, the Company received 111,457 shares of unregistered common stock of Platinum (see Note 5). The Company's investment in these equity securities was recorded at the fair market value on the date of the transaction and is accounted for using the cost method. F-7 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Royalty Advances and Operating and Development Costs In accordance with Statement of Financial Accounting Standards No. 50, "Financial Reporting in the Record and Music Industry," royalty advances and minimum guarantees to music labels are recorded as an asset if the past performance and current popularity of the music to which the advance relates provide a sound basis for estimating the probable future recoupment of such advances. Advances are then expensed as subsequent royalties are earned. Any portion of advances that subsequently appear not to be fully recoverable from future royalties are charged to expense during the period in which the loss becomes evident. Operating and development costs relating to the Company's proprietary custom CD compilation software technology are expensed as incurred. Operating and development costs also include recoupable but not returnable advances and network and website costs. The Company has expensed as operating and development costs royalty advances that were paid upon signing of certain initial royalty agreements with independent music labels, due to management's expectations of minimal revenues expected during the one year period following the signing of the contracts. These charges resulted in increases to operating and development costs of approximately $447,500 and $614,000 for the years ended December 31, 1997 and 1998, respectively. The Company is required to make additional advances upon the anniversaries of the signing of these initial contracts. The Company will capitalize these future advances and then amortize the expense to match the revenues. Once significant revenues have been generated, the Company will classify these costs as costs of sales. Advertising Costs The Company expenses all advertising costs as incurred. The Company incurred $0, $7,800 and $328,959 in advertising costs for the period from April 23, 1996 (inception) to December 31, 1996, and the years ended December 31, 1997 and 1998, respectively. Fair Value of Financial Instruments The Company considers the recorded costs of its financial assets and liabilities, which consist primarily of cash, accounts receivable, investments, accounts payable and related party payables, to approximate the fair value of the respective assets and liabilities. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Financial Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Net Loss Per Share The Company has adopted Financial Accounting Standards Board Statement No. 128, "Earnings Per Share," ("SFAS 128") which established new standards for computing and presenting net income per share information. Basic net loss per share was determined by dividing net loss by the weighted average number of common shares outstanding during each period. Diluted net loss per share excludes common equivalent shares, F-8 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) unexercised stock options and warrants as the computation would be anti- dilutive. A reconciliation of the net loss available for common shareholders and the number of shares used in computing basic and diluted net loss per share is in Note 9. Basic and diluted loss per share is also computed pursuant to SEC Staff Accounting Bulletin No. 98 ("SAB 98"). SAB 98 requires that all equity instruments issued at nominal prices, prior to the effective date of an initial public offering, be included in the calculation of basic and diluted loss per share as if they were outstanding for all periods presented. To date, the Company has not had any nominal issuances or grants at nominal prices. Stock-Based Compensation Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation" ("SFAS 123"), allows companies to account for stock-based compensation either under the new provisions of SFAS 123 or under the provisions of Accounting Principles Bulletin No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), but requires pro forma disclosure in the footnotes to the financial statements as if the measurement provisions of SFAS 123 had been adopted. The Company has elected to account for its stock-based compensation in accordance with the provisions of APB 25 (see Note 5). Reclassifications Certain amounts in the 1996 and 1997 financial statements have been reclassified to conform with the presentation of the 1998 financial statements. Recent Pronouncements In 1998, the Company adopted FASB Statement No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and displaying comprehensive income and its components in financial statements. The adoption of SFAS 130 did not have any effect on the Company's financial statements as the Company does not have any elements of comprehensive income. In 1998, the Company adopted FASB Statement No. 131, "Disclosure About Segments of an Enterprise and Related Information," which establishes standards for disclosures about products, geographies and major customers. The Company's implementation of this standard does not have any effect on its financial statements. The Accounting Standards Executive Committee (AcSEC) recently issued SOP 98- 5, "Reporting on the Costs of Start-up Activities." SOP 98-5 is effective for fiscal years beginning after December 15, 1998 and requires the costs of start-up activities, including organization costs, to be expensed as incurred. The Company has elected early adoption of SOP 98-5. However, the early adoption of the new rules does not have a material effect on the Company's financial position or results from operations. 2. Property and Equipment Property and equipment are stated at historical cost and are depreciated using the straight-line method over the shorter of the asset's estimated useful life or the lease term, ranging from three to seven years. Depreciation and amortization expense was $7,700, $29,887 and $154,392 for the period from April 23, 1996 (inception) through December 31, 1996, and the years ended December 31, 1997 and 1998, respectively. F-9 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Property and equipment consist of the following:
December 31, ------------------- 1997 1998 -------- --------- Computer equipment and software......................... $328,166 $ 506,120 Leasehold improvements.................................. -- 36,823 Furniture and equipment................................. 6,561 9,745 -------- --------- 334,727 552,688 Less accumulated depreciation and amortization.......... (37,587) (191,979) -------- --------- $297,140 $ 360,709 ======== =========
3. Intangibles In connection with the exclusive music license, stock exchange and marketing agreements signed with Platinum, the Company recorded an intangible asset for licensing fees of $900,000 (see Note 5). The asset is the difference in fair market values of musicmaker.com's common stock issued to Platinum and the Platinum common stock issued to the Company. The Company is amortizing the intangible on a straight-line basis over the five year period of the license agreement. The carrying value of the intangible asset will be reviewed if the facts and circumstances suggest impairment. If such a review indicates that the carrying value will not be recoverable as determined based on undiscounted cash flows over the remaining amortization period, the Company will reduce the carrying value by the estimated shortfall of cash flows. In connection with the private placement of convertible notes payable, the Company recorded loan fees of $116,125 (see Note 4). The Company is amortizing this intangible through December 31, 2000, the maturity date of the convertible notes payable. Intangible assets consist of the following:
December 31, ------------------- 1997 1998 -------- ---------- Licensing fees.......................................... $ -- $ 900,000 Loan fees............................................... -- 116,125 ------- ---------- -- 1,016,125 Less accumulated amortization........................... -- (48,730) ------- ---------- $ -- $ 967,395 ======= ==========
4. Convertible Notes Payable and Long-term Obligations In December 1996, the Company received $400,000 and issued 12% convertible notes to certain investors (including the founding stockholders and a director of the Company). The Company had the right, at its option, between the date of issuance and June 15, 1997, to convert all of the principal and accrued interest owed to note holders into shares of the Company's common stock. In 1997, the Company issued two additional convertible notes totaling $250,000 with the same terms. In June 1997, the Company converted the principal amount of $650,000 of convertible notes payable plus the accrued interest of $36,624 into 178,344 shares of common stock. In October 1998, the Company initiated an offering for 8% convertible secured subordinate promissory notes which are convertible at any time at the election of the holder and are mandatorily convertible upon the F-10 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) closing of an initial public offering with gross proceeds of $5,000,000 or more or upon certain mergers and consolidations of the Company. The conversion price is $4.81 per share of common stock, subject to certain adjustments. The convertible notes payable are secured by a lien on the assets of the Company pursuant to a security agreement and the principal and accrued interest are due on December 31, 2000. As of December 31, 1998, the Company had convertible notes payable of $512,500 and had recorded loan fees of $116,125 (see Note 3). On July 1, 1998, the Company entered into a mutual coexistence agreement with Music Maker Relief Foundation, Inc. ("Music Maker Relief Foundation"), an unaffiliated not-for-profit corporation that owns the trademark MUSICMAKER and the Internet domain name MUSICMAKER.ORG. In consideration of avoiding any possible conflict regarding names, marks, goods and services, the Company agreed to pay $300,000 to Music Maker Relief Foundation. The Company paid $42,857 upon signing of the agreement and has a remaining obligation of $257,143 ($42,857 on April 15th of each of the years 1999 through and including 2004). The Company expensed $300,000 upon signing of the agreement. 5. Common Stock and Convertible Preferred Stock Common Stock and Warrants On July 3, 1996, the two founders of the Company purchased a total of 649,351 shares of common stock for $2,500. In July 1996, 649,351 shares of common stock were issued to the former stockholders of CD Kit, S.A., giving them a 50% interest in the then issued and outstanding common stock of the Company. Two outside investors purchased 2,597 and 25,974 shares of common stock in October and December of 1996, respectively. In 1997, 524,416 shares of common stock were issued to both outside investors and the founding stockholders at prices ranging from $0.04 per share to $3.85 per share. The Company also issued 25,974 shares of common stock for services to consultants valued at $50,500. Additionally, the Company issued 25,974 warrants to purchase common stock at an exercise price of $3.85 per share to a consultant for services related to signing royalty agreements with record labels and valued at $100,000. The Company recorded $150,500 of expense related to the issuance of these shares of common stock and warrants to consultants for services. The Company also issued 194,805 warrants to purchase common stock at an exercise price of $3.85 per share to a stockholder and officer of the Company for services related to signing royalty agreements with record labels. All of these warrants expire on October 15, 2007. In 1998, the Company issued a total of 309,091 shares of common stock at $4.81 per share to seven investors for a total of $1,487,500. The Company paid a finders fee of $143,198 related to this private placement and is obligated to issue 46,764 warrants in 1999 related to the completion of the private placement (see Note 11). The Company also issued warrants to purchase 51,948 shares of common stock at an exercise price of $4.81 per share to one of the investors and recorded an expense of $88,000 for the value of the warrants. On June 12, 1998, the Company signed an agreement with Columbia House with a three year term beginning September 1, 1998, under which the Company will offer custom CDs for sale to Columbia House's customers through Columbia House's websites and promotional inserts in Columbia House's mailings. The Company will design and supply promotional material to Columbia House, manufacture the custom CDs and process all orders (shipping, billing and collecting) and will pay a share of the net profits derived from the sale of CDs to Columbia House's customers to Columbia House. In connection with this agreement, the Company issued 129,870 warrants to purchase common stock at an exercise price of $4.62 per share to Columbia House and recorded an expense of $160,000 for the value of the warrants. These warrants expire on September 1, 2001. F-11 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In January 1998, a stockholder and officer of the Company returned 72,727 stock options to the Company in exchange for warrants to purchase 72,727 shares of common stock with an exercise price of $3.85 per share and valued at $148,400. These warrants expire on January 15, 2008. This individual is also the beneficial owner of warrants for 25,974 shares of common stock granted to members of his family as compensation for his consulting services in August 1998 with an exercise price of $4.62 per share valued at $64,000. The Company recorded an expense of $212,400 related to the issuance of these warrants. These warrants expire on August 15, 2008. In connection with the exclusive music license, stock exchange and marketing agreements signed with Platinum, the Company issued 342,857 shares of common stock to Platinum (valued at $1,650,000) and Platinum issued 111,457 shares of its unregistered common stock to the Company (having an aggregate value of $750,000). The Company recorded the difference in the fair market values of the two stocks as licensing fees (see Note 3). Convertible Preferred Stock and Warrants On December 8, 1997, the Company sold 389,610 shares of the Company's Series A preferred stock at $3.85 per share. Additionally, 64,935 shares of the Company's Series A preferred stock were purchased by two existing stockholders at $3.85 per share. The Company did not receive payment for 12,987 shares of the Series A preferred stock until 1998 and has therefore shown a reduction to the preferred stock on the accompanying December 31, 1997 balance sheet. The Company also issued 865,801 warrants to purchase Series B preferred stock at a price of $4.62 per share, and 227,578 warrants to purchase Series C preferred stock at a price of $5.78 per share. The warrants to purchase Series B preferred stock are exercisable, in whole or in part, at any time commencing on the date of grant through the fifth anniversary thereof. The warrants to purchase Series C preferred stock are exercisable, in whole or in part, at any time commencing on the date of grant through the fourth anniversary thereof. Each holder of preferred stock is entitled to vote on all matters as if their shares of preferred stock were converted to voting common stock. All outstanding shares of preferred stock have an automatic conversion feature upon the consummation of a firm commitment underwritten public offering of at least $15 million with a valuation of the Company greater than $50 million immediately prior to the initial public offering, or upon an affirmative vote of the holders of at least 50.1% of the outstanding shares of preferred stock to complete such a conversion. The conversion ratio is initially on a one-for- one basis for all series of preferred stock; however, the conversion price of each series shall be subject to adjustment for certain diluting issues as described in the Company's Restated Certificate of Incorporation. The preferred stock is redeemable at the election of at least 50.1% of the preferred stock holders in two equal installments, if notice is provided to the Company on or before October 8, 2002. The redemption price would be $3.85 per share, $4.62 per share and $5.78 per share plus a further amount per share equal to any declared and unpaid dividends for Series A, Series B and Series C preferred stock, respectively. The first installment would be on or about December 8, 2002, and the second installment would be on or about December 8, 2003, subject to the Company having funds legally available. If sufficient funds are not legally available for redeeming the preferred stock at either of the installment dates, the Company will have to apply the available funds to redeem the preferred stock on a ratable basis and then redeem the remaining shares as soon as practicable after the Company has the funds legally available. F-12 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In the event of either a voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of the preferred stock shall be entitled to receive, prior and in preference to any distribution of any assets of the Company to holders of the common stock, $3.85 per share plus declared and unpaid dividends on Series A preferred stock, $4.62 per share plus declared and unpaid dividends on Series B preferred stock and $5.78 per share plus declared and unpaid dividends on Series C preferred stock. On March 16, 1998, an investor exercised 89,453 warrants to purchase Series B preferred stock at a price of $4.62 per share for $413,272 in cash. Two officers of the Company were required to exercise 15,461 warrants to purchase Series B preferred stock at the same price. On June 30, 1998, two investors exercised 223,665 warrants to purchase Series B preferred stock at a price of $4.62 per share for $1,033,333 in cash. Two officers of the Company were required to exercise 36,075 warrants to purchase Series B preferred stock at the same price. The exercise of the 36,075 warrants was offset by a reduction to accrued liabilities for consulting services. Stock Option Plan The 1996 Stock Option Plan (the "Plan") was adopted by the Board of Directors and approved by the stockholders in 1996. The purpose of the Plan is to promote the long-term growth and profitability of the Company by providing key people with incentives to contribute to the growth and financial success of the Company. The aggregate number of shares of common stock for which options may be granted under the Plan shall not exceed 779,221 shares (see Note 11). Additional information with respect to stock option activity is summarized as follows:
Year ended December 31, ---------------------------------- 1997 1998 ---------------- ----------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price ------- -------- ------- -------- Outstanding at beginning of year.......... 19,480 $0.39 215,298 $3.54 Options granted........................... 195,818 $3.85 389,611 $4.88 Options exercised......................... -- $ -- -- $ -- Options canceled or expired............... -- $ -- (72,727) $3.85 ------- ----- ------- ----- Outstanding at end of year................ 215,298 $3.54 532,182 $4.48 ======= ===== ======= ===== Exercisable at end of year................ 19,480 $0.39 126,312 $3.79 ======= ===== ======= =====
The options outstanding at December 31, 1998 range in price from $0.39 per share to $5.29 per share and have a weighted average remaining contractual life of 7.6 years. The Company applies APB 25 in accounting for its stock option plan and, accordingly, recognizes compensation expense for the difference between the fair value of the underlying common stock and the grant price of the option at the date of grant. The effect of applying SFAS 123's fair value method to the Company's stock-based awards results in net losses of $372,951, $2,093,571 and $4,872,452 in 1996, 1997 and 1998, respectively, with a net loss per share of $0.45, $1.21 and $2.23, respectively. The weighted average fair value of the options granted in 1997, used as a basis for the above pro forma disclosures, was estimated as $1.69 as of the date of grant using a minimum value method option pricing model. The weighted average fair value of the options granted during 1998 was estimated as $1.95 as of the date of grant using the Black- Scholes option- F-13 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) pricing model with the following assumptions: dividend yield 0%, volatility of 25%, risk-free interest rate of 6.5% and expected lives of 5 or 10 years. The effect of applying SFAS 123 on 1997 and 1998 pro forma net loss as stated above is not necessarily representative of the effects on reported net income for future years due to, among other things, the vesting period of the stock options and the fair value of additional stock options in future years. Warrants The following table summarizes all common and preferred stock warrant activity:
Year ended December 31, ----------------------- 1997 1998 ----------- ----------- Outstanding at beginning of year..................... -- 1,314,158 Warrants issued...................................... 1,314,158 280,519 Warrants exercised................................... -- 364,654 ----------- ----------- Outstanding at end of year........................... 1,314,158 1,230,023 =========== ===========
The weighted average fair value of the warrants granted during 1998 was estimated as $1.66 using the Black-Scholes option-pricing model with the following assumptions: dividend yield 0%, volatility of 25%, risk-free interest rate of 6.5% and expected lives ranging from 3.5 to 10 years. 6. Income Taxes At December 31, 1998, the Company had net operating loss carry-forwards of approximately $4,260,000. The timing and manner in which the operating loss carry-forwards may be utilized in any year will be limited to the Company's ability to generate future earnings and by limitations imposed due to change in ownership. Current net operating loss carry-forwards will expire in the year 2018. As the Company has not generated earnings and no assurance can be made of future earnings, a valuation allowance in the amount of the deferred tax assets has been recorded. The change in the valuation allowance was $1,748,542. There was no current or deferred provision for income taxes for the period from April 23, 1996 (inception) through December 31, 1996 or the years ended December 31, 1997 or 1998. Net deferred tax assets consist of:
December 31, ---------------------- 1997 1998 --------- ----------- Deferred tax assets: Start up expenses................................. $ 555,944 $ 460,108 Deferred compensation............................. 287,365 237,583 Warrants.......................................... 57,189 227,795 Trademark expense................................. -- 114,000 Net operating loss carry-forward.................. 10,985 1,620,539 --------- ----------- Deferred tax assets before valuation allowance.... 911,483 2,660,025 Less valuation allowance............................ (911,483) (2,660,025) --------- ----------- Net deferred tax assets............................. $ -- $ -- ========= ===========
The Company has not paid any income taxes since inception. F-14 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The provision for income taxes differed from the amount computed by applying the U.S. federal statutory rate to the loss before income taxes due to the effects of the following:
Period from April 23, 1996 (inception) to Year ended December 31, December 31, ------------------------ 1996 1997 1998 -------------- ----------- ------------ Expected tax benefit at federal statutory tax rate.............. $(124,886) $ (708,613) $ (1,582,621) Future state benefit, net of federal benefit................. (16,305) (79,801) (186,191) Nondeductible expenses and other........................... (12,943) 31,065 20,270 Increase in valuation allowance.. 154,134 757,349 1,748,542 --------- ---------- ------------ $ -- $ -- $ -- ========= ========== ============
7. Commitments Royalty Agreements The Company has signed contracts with record labels for non-exclusive rights to manufacture, advertise, market, promote, distribute and sell custom CDs and digitally downloaded songs over the Internet. The agreements contain a master use royalty rate of 15% of the selling price less any sales, excise or similar taxes. If the Company enters into a more favorable royalty rate with another licensor, the majority of these contracts contain clauses allowing the licensor to also receive the more favorable royalty terms. As discussed in Note 1, the majority of the contracts require advances upon the anniversary dates of the signing of the contracts. The more recent agreements provide for the Company to pay advances based on actual royalties earned by the label in the previous year, as opposed to a fixed amount. Fixed royalty commitments on contracts entered into as of December 31, 1998 are as follows:
Year ended December 31, ----------------------- 1999.............................................................. $527,500 2000.............................................................. 183,333 -------- $710,833 ========
Operating Leases The Company leases its office facility, certain computer equipment and office furniture under operating lease agreements that were entered into during 1998. Operating lease expense for the period from April 23, 1996 (inception) to December 31, 1996, and the years ended December 31, 1997 and 1998 was $1,800, $21,000, and $110,000, respectively. Financial Consulting Agreement In connection with the Company's planned IPO, the Company signed an agreement on December 23, 1998 obligating it to pay $125,000 at the closing of the IPO. F-15 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Future minimum lease payments as of December 31, 1998 are as follows:
Year ended December 31, ----------------------- 1999.............................................................. $188,912 2000.............................................................. 164,656 2001.............................................................. 115,297 2002.............................................................. 118,584 Thereafter........................................................ 299,618 -------- $887,067 ========
8. Related Party Transactions Accrued compensation of $756,221 and $625,219 as of December 31, 1997 and 1998, respectively, are amounts due to stockholders for consulting services rendered to the Company. Additionally, in December 1998, the Company advanced a stockholder and officer $81,519 against his 1999 bonus. 9. Net Loss Per Share The following table sets forth the computation of basic and diluted net loss per share:
Period from April 23, 1996 Year ended Year ended Pro Forma (inception to December December Year ended December 31, 31, 31, December 31, 1996 1997 1998 1998 -------------- ----------- ----------- ------------ (Unaudited) Numerator: Net loss.............. $(367,312) $(2,084,157) $(4,654,767) $(4,941,037) ========= =========== =========== =========== Denominator: Denominator for basic net loss per share-- weighted average shares............... 830,076 1,734,328 2,186,488 2,863,521 Effect of dilutive securities: Preferred stock....... -- -- -- -- Stock options......... -- -- -- -- Warrants.............. -- -- -- -- --------- ----------- ----------- ----------- Dilutive potential common shares.......... -- -- -- -- Denominator for diluted net loss per share-- adjusted weighted average shares......... 830,076 1,734,328 2,186,488 2,863,521 ========= =========== =========== =========== Basic net loss per share.................. $ (0.44) $ (1.20) $ (2.13) $ (1.73) ========= =========== =========== =========== Diluted net loss per share.................. $ (0.44) $ (1.20) $ (2.13) $ (1.73) ========= =========== =========== ===========
F-16 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following equity instruments were not included in the diluted net loss per share calculation because their effect would be anti-dilutive:
Period from April 23, 1996 Pro Forma (inception) to Year ended Year ended Year ended December 31, December 31, December 31, December 31, 1996 1997 1998 1998 -------------- ------------ ------------ ------------ (Unaudited) Preferred stock: Series A.............. -- 454,545 454,545 -- Series B.............. -- -- 364,654 -- Preferred stock warrants: Series B.............. -- 865,801 501,147 -- Series C.............. -- 227,578 227,578 -- Stock options........... 19,480 215,298 532,182 532,182 Warrants................ -- 220,779 501,298 1,230,023
10. Pro Forma Financial Information (unaudited) The financial statements include pro forma information as of December 31, 1998 to give effect to (i) the one-for-3.85 reverse stock split to be effected prior to the completion of the IPO, (ii) the automatic conversion, upon the completion of the IPO, of all outstanding shares of convertible preferred stock into 819,199 shares of common stock, (iii) the automatic conversion of all outstanding convertible notes payable into 415,584 shares of common stock ($512,500 of convertible notes payable outstanding at December 31, 1998 and $1,487,500 of convertible notes payable issued in January 1999), and (iv) the write-off of all capitalized loan fees related to the convertible notes payable ($112,395 capitalized at December 31, 1998 and $173,875 capitalized in January 1999). 11. Subsequent Events On November 20, 1998, the Board of Directors approved an increase in the aggregate number of shares of common stock for which options may be granted under the Stock Option Plan to be 779,221 shares, subject to the approval of the stockholders. The stockholders approved the authorized shares increase in February 1999. The stockholders also authorized the Company's Amended and Restated Certificate of Incorporation in February 1999, which increased the total number of authorized shares of common stock to 15,584,416 shares. In January 1999, the Company completed its private placement of convertible notes payable and received an additional $1,487,500. In connection with the convertible notes payable issued in January, the Company recorded loan fees of $173,875 and issued a warrant to purchase 41,558 shares of common stock at an exercise price of $4.81, which expires on January 11, 2004. In January 1999, the Company completed its common stock private placement and issued an additional 252,104 shares of common stock at $4.81 per share for a total of $1,213,250 in cash. The Company paid a commission of approximately $97,000 related to this private placement and issued a warrant to purchase 46,764 shares of common stock with an exercise price of $4.81, which expires on January 14, 2004. F-17 musicmaker.com, Inc. (formerly The Music Connection Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) On January 8, 1999, the Company signed a lease line agreement which provides leasing for computer and related equipment as well as CD fabrication equipment up to $200,000 between the signing of the agreement and June 8, 1999. Any equipment leased under this agreement will have a 24 month lease term, and at the end of the lease term the Company will either be obligated to buy the equipment at 10% of the original equipment cost or extend the lease term for an additional 24 months. The Company also signed the first lease under this agreement which will have a monthly rental payment of $8,261. As part of the lease line agreement, the Company issued a warrant to purchase 6,234 shares of its common stock at $4.81 per share which expires on January 8, 2009. On February 12, 1999, the Company signed a commitment letter with a financial institution for a credit facility of up to $250,000 in a revolving line of credit for equipment and software purchases and general working capital and up to $100,000 in a cash secured letter of credit. The credit facility matures six months from the date of the loan unless $5,000,000 in new equity has been raised prior to maturity. In that case, the portion of the credit facility used for equipment and software purchases will be termed-out for 24 months. If the term of the credit facility is extended, the financial institution will have the right to purchase warrants equal to 4% of the commitment amount. In February 1999, the Board of Directors authorized management of the Company to file a Registration Statement with the Securities and Exchange Commission permitting the Company to sell its common stock in the IPO. On , 1999, the Board of Directors approved a one-for-3.85 reverse stock split of the Company's common stock, which will become effective on . All references in the accompanying financial statements to the number of shares of common stock and per-share amounts have been restated to reflect the split. Additionally, all references in the accompanying financial statements to the number of shares of preferred stock and per-share amounts have been restated to reflect the split in accordance with the Company's Restated Articles of Incorporation. Immediately upon completion of the IPO, all outstanding shares of Series A, Series B and Series C convertible preferred stock will convert into 819,199 shares of common stock and all outstanding convertible notes payable will convert into 415,584 shares of common stock. F-18 Part II Information Not Required in Prospectus Item 13. Other Expenses of Issuance and Distribution. We estimate that our expenses to be paid in connection with the offering (other than underwriting discounts, commissions and reasonable expense allowances) will be as follows: SEC registration fee........................................... $ 8,340 NASD filing fee................................................ $ 3,500 Nasdaq National Market listing fee............................. $75,625 Printing and engraving expenses................................ $ * Accounting fees and expenses................................... $ * Legal fees and expenses........................................ $ * Miscellaneous.................................................. $ * ------- Total.................................................... $ * =======
- -------- * To be filed by amendment. Item 14. Indemnification of Directors and Officers. Musicmaker.com is organized under the laws of the State of Delaware. Musicmaker.com's Charter and Bylaws provide that musicmaker.com shall indemnify and advance expenses to its directors, officers, employees and agents, and all persons who at any time served as directors, officers, employees or agents of musicmaker.com, to the fullest extent permitted, and in the manner provided under the laws of the State of Delaware. The DGCL provides that a Delaware corporation has the power generally to indemnify its directors, officers, employees and other agents serving, or who have served, musicmaker.com (each, a "Corporate Agent") against expenses and liabilities (including amounts paid in settlement) in connection with any proceeding involving such person by reason of his being a Corporate Agent, other than a proceeding by or in the right of the corporation, if such person acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal proceeding, such person had no reasonable cause to believe his conduct was unlawful. In the case of an action brought by or in the right of the corporation, indemnification of a Corporate Agent is permitted if such person acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation; however, no indemnification is permitted in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation, unless and only to the extent that the Court of Chancery or the court in which such proceeding was brought shall determine upon application that despite the adjudication of liability, but in view of all the circumstances of the case, such person is fairly and reasonably entitled to such indemnification. To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in the defense of such proceeding, whether or not by or in the right of the corporation, or in the defense of any claim, issue or matter therein, the corporation is required to indemnify such person for expenses in connection therewith. Expenses incurred by a Corporate Agent in connection with a proceeding may, under certain circumstances, be paid by the corporation in advance of the final disposition of the proceeding as the corporation deems appropriate. Musicmaker.com's Charter permits the advancement of expenses by musicmaker.com to officers or directors defending a qualified civil or criminal action upon receipt of an undertaking by such director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to indemnification. The terms and conditions of such advancement are to be determined by musicmaker.com's Board of Directors. II-1 The power to indemnify and advance the expenses under the DGCL does not exclude other rights to which a Corporate Agent may be entitled to under the certificate of incorporation, by laws, agreement, vote of stockholders or disinterested directors or otherwise. Pursuant to Delaware law and musicmaker.com's Charter, a director, officer, employee or agent of musicmaker.com that is successful on the merits or otherwise in defense of any action, suit or proceeding, or in defense of any claim, issue or matter therein, may require musicmaker.com to provide indemnification for expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith. Unless ordered by a relevant court, indemnification for qualified persons shall be authorized on behalf of musicmaker.com by: (i) a majority of a quorum of the Board of Directors, if a quorum consisting of the directors not party to such action suit or proceeding can be obtained; or (ii) by independent legal counsel in a written opinion, if a quorum of (i) above is not obtainable or if such disinterested quorum so directs; or (iii) stockholder approval. Under the DGCL and musicmaker.com's Charter, musicmaker.com is permitted to purchase and maintain insurance on behalf of Corporate Agents of musicmaker.com or persons serving at the request of musicmaker.com as Corporate Agents of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him or her and incurred by him or her in such capacity or arising out of his or her status as such, whether or not musicmaker.com would have had the power to indemnify such person. The purpose of these provisions is to assist musicmaker.com in retaining qualified individuals to serve as officers, directors or other Corporate Agents by limiting their exposure to personal liability for serving as such. Item 15. Recent Sales of Unregistered Securities. During the past three years, the following securities were issued by musicmaker.com without registration under the Securities Act: In July 1996, in connection with its formation, musicmaker.com issued and sold 551,948 and 97,403 shares of common stock to Mr. Bernardi, musicmaker.com's founder, Chairman of the Board of Directors and Co-Chief Executive Officer, and an accredited investor, respectively, for nominal consideration. In July 1996, musicmaker.com issued 649,351 shares of common stock to seven foreign stockholders in connection with the acquisition of all of the outstanding securities of CD Kit, S.A. Between December 1996 and May 1997, musicmaker.com issued and sold 12% convertible notes to eight accredited investors for $650,000. The notes were convertible into common stock. Between October 1996 and May 1997, musicmaker.com issued and sold 353,247 shares of common stock to various accredited investors for total aggregate consideration of approximately $13,510. In May 1997, 12,987 shares of common stock were issued in exchange for, and as compensation for services rendered to musicmaker.com. Between July 1997 and November 1997, musicmaker.com issued and sold 167,273 shares of common stock to investors for total aggregate consideration of $303,440. In July 1997, 12,987 shares of common stock were issued to a consultant in exchange for, and as compensation for services rendered to musicmaker.com. In July 1997, the outstanding notes issued between December 1996 and May 1997 were converted to 178,344 shares of common stock at a conversion price of $3.85 per share. Also, five note holders including one of our officers invested $25,000 each and each received 6,494 shares. In October 1997, musicmaker.com issued 194,805 common stock warrants to Mr. Puthukarai, musicmaker.com's President, Co-Chief Executive Officer and Chief Operating Officer and a warrant for 25,974 II-2 shares of common stock to another investor. The warrants are exercisable by the holders into common stock at an exercise price of $3.85 per share. In December 1997, musicmaker.com issued and sold 454,545 shares of Series A preferred stock to Rho, Mr. Bernardi and Mr. Puthukarai, and another investor at a price of $3.85 per share. Additionally, musicmaker.com issued 865,801 Series B and 227,578 Series C preferred warrants to the persons above. The Series B preferred warrants are exercisable into Series B preferred stock at an exercise price of $4.62 per share and the Series C preferred warrants are exercisable into Series C preferred stock at an exercise price of $5.78 per share. Musicmaker.com's outstanding preferred stock and outstanding preferred warrants shall automatically convert into common stock, and warrants therefor, upon completion of the offering. Effective February 18, 1999, musicmaker.com's stockholders approved and adopted an amendment to our stock option plan which authorized musicmaker.com to grant options to purchase up to 779,221 shares of common stock. As of January 31, 1999, 532,182 options for shares of common stock were granted and outstanding. No shares of common stock have been issued pursuant to the exercise of options under the stock option plan. The exercise price of the options for musicmaker.com's common stock ranges from $0.385 to $5.29 per share. In January 1998, 72,727 common stock warrants, with an exercise price of $3.85 per share, were issued to Mr. Steinberg, musicmaker.com's Vice Chairman of the Board of Directors, for consulting services related to obtaining license agreements with record labels on behalf of musicmaker.com. These warrants expire January 15, 2008. In August 1998, musicmaker.com issued 25,974 common stock warrants to four members of Mr. Steinberg's family as record holders. The warrants were granted as compensation for consulting services rendered to musicmaker.com by Mr. Steinberg. The warrants are convertible by the holders into common stock at an exercise price of $4.62 per share and expire on August 15, 2008. In June 1998, musicmaker.com issued a warrant for 129,870 shares of common stock to Columbia House in connection with entering into a marketing alliance. The warrant is convertible by the holder into common stock at an exercise price of $4.62 per share. In September 1998, musicmaker.com issued 259,740 shares of common stock to Platinum at a value of $1,650,000 in connection with a marketing agreement, licensing arrangement and a stock exchange agreement under which musicmaker.com purchased 111,457 shares of common stock of Platinum. In November 1998, an additional 83,117 shares of common stock were issued pursuant to the terms of the stock exchange agreement above. Between September 1998 and January 1999, musicmaker.com issued shares of its common stock in a private placement to accredited investors at $4.81 per share. Musicmaker.com used the financial advisory services of Ryan, Lee & Company, Incorporated, on a best efforts basis, which received a 7% commission and warrants for 46,764 shares of our common stock exercisable at $4.81 per share as compensation for their assistance in the private placement. Musicmaker.com received consideration in connection with this private placement of approximately 701,494. The offering closed on January 14, 1999. Between November 1998 and January 1999, musicmaker.com issued an aggregate value of $2,000,000 8% convertible notes to accredited investors. The convertible notes were issued at a cost of $25,000 per note and each note is convertible into 5,195 shares of musicmaker.com's common stock at $4.81 per share. Musicmaker.com received consideration in connection with the above sale of convertible notes of approximately $1,800,000. Musicmaker.com utilized the services of GunnAllen Financial, Inc., on a best efforts basis, which received a 10% discount and commission for their assistance in the sale above, and 41,558 warrants for our common stock with an exercise price of $4.81 per share. The offering of convertible notes above closed on January 11, 1999. II-3 All the above transactions were exempt from registration pursuant to Sections 3(b), 4(2) or 4(6) of the Securities Act. Item 16. Exhibits. The following exhibits are filed as part of this registration statement:
Page Exhibit No. Description No. ----------- ----------- ---- 1.1 Form of Underwriting Agreement between musicmaker.com and Ferris, Baker Watts, Incorporated and Fahnestock & Co., Inc. as Representatives.* 3.1 Restated Certificate of Incorporation.* 3.2 Bylaws.* 4.1 Form of Common Stock Certificate.* 4.2 Representatives' Warrant Agreement.* 5.1 Opinion of Venable, Baetjer and Howard, LLP regarding legality.* 5.2 Opinion of Darby & Darby, P.C.* 10.1 Amended and Restated Employment Agreement between the Company and Robert P. Bernardi, as amended, dated February 12, 1999. 10.2 Amended and Restated Employment Agreement between the Company and Devarajan S. Puthukarai, as amended, dated February 12, 1999. 10.3 Consulting Agreement dated January 23, 1997, between the Company and Irwin H. Steinberg, as amended on January 1, 1998, and by letters to the Company dated August 28, 1998 and August 31, 1998. 10.4 Letter Agreement dated June 12, 1998, between the Company and The Columbia House Company. 10.5 The Company's Amended Stock Option Plan.* 10.6 Marketing Agreement dated September 30, 1998, between Platinum Entertainment, Inc. and the Company. 10.7 Memorandum of Understanding between the Company and Audio Book Club, Inc. dated January 18, 1999. 10.8 Office/Warehouse/Showroom Lease dated January 15, 1998 between the Company and Century Properties Fund XX. 10.9 Form of Lock-up Agreement.* 10.10 Letter Agreement dated February 12, 1999 between the Company and Imperial Bank.* 10.11 Master Equipment Lease dated January 8, 1999 between the Company and Boston Financial & Equity Corporation.* 23.1 Consent of Ernst & Young LLP, independent auditors. 23.2 Consent of Venable, Baetjer and Howard, LLP (included in Exhibit 5.1).* 23.3 Consent of Darby & Darby, P.C. 24 Power of Attorney. 27 Financial Data Schedule.
- -------- * To be filed by amendment. Item 17. Undertakings. (a) The undersigned musicmaker.com hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement; (i) To include any prospectus required by Section 10(a)(3) of the Securities Act; II-4 (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement). Notwithstanding the forgoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in "Calculation of Registration Fee" table in the effective registration statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) The undersigned Registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. (c) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (d) The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized in Reston, Virginia, on the 17th day of February 1999. MUSICMAKER.COM, INC. /s/ Robert P. Bernardi By__________________________________: Robert P. Bernardi President and Co-Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Robert P. Bernardi and Devarajan S. Puthukarai and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this registration statement, or any related registration statement that is to be effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. II-6 Pursuant to the requirements of the Securities Act, this registration statement has been signed by the following persons in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Robert P. Bernardi Chairman and Co-Chief February 17, 1999 ______________________________________ Executive Officer Robert P. Bernardi (Principal Executive Officer) /s/ Mark A. Fowler Director of Finance and February 17, 1999 ______________________________________ Administration and Chief Mark A. Fowler Financial Officer (Principal Financial and Accounting Officer) /s/ Irwin H. Steinberg Vice Chairman February 8, 1999 ______________________________________ Irwin H. Steinberg /s/ Devarajan S. Puthukarai Co-Chief Executive February 6, 1999 ______________________________________ Officer, President, Chief Devarajan S. Puthukarai Operating Officer and Director /s/ Edward J. Mathias Director February 17, 1999 ______________________________________
Edward J. Mathias II-7 EXHIBIT INDEX
Page Exhibit No. Description No. ----------- ----------- ---- 1.1 Form of Underwriting Agreement between musicmaker.com and Ferris, Baker Watts, Incorporated and Fahnestock & Co., Inc. as Representatives.* 3.1 Restated Certificate of Incorporation.* 3.2 Bylaws.* 4.1 Form of Common Stock Certificate.* 4.2 Representatives' Warrant Agreement.* 5.1 Opinion of Venable, Baetjer and Howard, LLP regarding legality.* 5.2 Opinion of Darby & Darby, P.C.* 10.1 Amended and Restated Employment Agreement between the Company and Robert P. Bernardi, as amended, dated February 12, 1999. 10.2 Amended and Restated Employment Agreement between the Company and Devarajan S. Puthukarai, as amended, dated February 12, 1999. 10.3 Consulting Agreement dated January 23, 1997, between the Company and Irwin H. Steinberg, as amended on January 1, 1998, and by letters to the Company dated August 28, 1998 and August 31, 1998. 10.4 Letter Agreement dated June 12, 1998, between the Company and The Columbia House Company. 10.5 The Company's Amended Stock Option Plan.* 10.6 Marketing Agreement dated September 30, 1998, between Platinum Entertainment, Inc. and the Company. 10.7 Memorandum of Understanding between the Company and Audio Book Club, Inc. dated January 18, 1999. 10.8 Office/Warehouse/Showroom Lease dated January 15, 1998 between the Company and Century Properties Fund XX. 10.9 Form of Lock-up Agreement.* 10.10 Letter Agreement dated February 12, 1999 between the Company and Imperial Bank.* 10.11 Master Equipment Lease dated January 8, 1999 between the Company and Boston Financial & Equity Corporation.* 23.1 Consent of Ernst & Young LLP, independent auditors. 23.2 Consent of Venable, Baetjer and Howard, LLP (included in Exhibit 5.1).* 23.3 Consent of Darby & Darby, P.C. 24 Power of Attorney (Contained on the signature page). 27 Financial Data Schedule.
- -------- * To be filed by amendment. EX-10.1 2 EXHIBIT 10.1 Exhibit 10.1 AMENDMENT TO THE ROBERT P. BERNARDI AMENDED AND RESTATED EMPLOYMENT AGREEMENT OF DECEMBER 8, 1997 This Amendment is made and entered into as of this 12th day of February, 1999, by and between The Music Connection Corporation, a Delaware corporation (the "Company") and Robert P. Bernardi (the "Employee") (the "Agreement"). WHEREAS, the Company and the Employee are parties to that certain Amended and Restated Employment Agreement of December 8, 1997 (the "Employment Agreement"); and WHEREAS, the Company and the Employee desire to amend that certain Employment Agreement. NOW, THEREFORE, in consideration of the foregoing, the mutual covenants and agreements contained herein and other good and valuable consideration, the receipt and sufficiency of which are acknowledged by each of the parties hereto, such parties, intending to be legally bound, covenant and agree as follows: 1. Amendment. The Employment Agreement is amended so as to provide that --------- the Employee's employment, as defined in Section 1 of the Employment Agreement, be for the term of five (5) years, and that the Employee's term, as defined in Section 2 of the Employment Agreement, be extended to continue through and including December 7, 2002. 2. Authorizing Actions. Each party agrees promptly to do all things and -------------------- take all actions as may be necessary or desirable to authorize and facilitate the performance of this Agreement. 3. Counterparts. This Agreement may be executed in counterparts, each of ------------- which when so executed and delivered shall constitute an original, but all of such counterparts taken together shall constitute one and the same instrument. 4 Entire Agreement. This Agreement together with the Employment ----------------- Agreement represents the entire understanding of the parties pertaining to the subject matter hereof and supersedes any and all prior agreements, negotiations and discussions, whether written or oral, between the parties with respect to the subject matter hereof. 5. Governing Law. The validity of this Agreement, its interpretation and -------------- construction shall be governed by the laws of the Commonwealth of Virginia, without regard to principles of conflict of laws. 6. Amendment. This Agreement may modified only by a written instrument --------- signed by each of the parties hereto. 7. Recitals. The Recitals to this Agreement are incorporated herein and -------- made a part hereof. IN WITNESS WHEREOF, the parties hereto have executed this Agreement, or have caused this Agreement to be executed by their duly authorized representatives as of the date first above written. THE MUSIC CONNECTION CORPORATION By: /s/ Raju Puthukarai ----------------------------- Raju Puthukarai President EMPLOYEE By: /s/ Robert P. Bernardi ----------------------------- Robert P. Bernardi 2 Robert P. Bernardi Amended and Restated Employment Agreement AGREEMENT by and between The Music Connection Corporation, a Delaware corporation (herein called the "Company") and Robert P. Bernardi (herein called the "Employee"). WITNESSETH: The parties entered into an Employment Agreement, dated March 20, 1997, which the parties now desire to amend and restate in its entirety as follows: For and in consideration of the mutual promises and covenants herein contained, the parties hereto mutually agree as follows: Section 1. Employment. The Company hereby employs the Employee for the term of two (2) years and upon the terms and conditions hereinafter set forth, the Employee hereby accepts such employment and agrees to perform services for the Company, as provided in this Agreement. Section 2. Term. The Employee's employment hereunder shall be for a term commencing on December 8, 1997 and continuing through and including December 7, 1999, renewable automatically from year to year thereafter unless either the Company or the Employee provides the other with written notice of non-renewal at least 90 days prior to the expiration of the initial term or of any renewal term. Section 3. Duties; Control and Direction by Board of Directors. Section 3(a). Duties. Employee shall be employed on a full time basis to serve as Chairman and Chief Executive Officer of the Company. As such, the Employee (i) shall assist the Company in the development of all phases of the Company's operating activities and (ii) shall perform such other appropriate executive duties as from time to time may be assigned to him by the Board of Directors of the Company. The Company intend to maintain an office in the Northern Virginia metropolitan area out of which the Employee shall work. Unless the Employee otherwise consents, the Employee shall not be required to work out of any office outside of the Northern Virginia metropolitan area. Section 3(b). Rules and Regulations. The Employee shall comply with all Company rules and regulations applicable to the executive employees of the Company or to its employees generally and with all Company policies established by the Board of Directors. Section 4. Extent of Services. During the term of this Agreement, the Employee shall devote substantially all of his time and his best efforts to the business of the Company and the furthering of its interests and to the discharge of his duties, functions and responsibilities hereunder. Section 5. Compensation. As compensation during the term of the Employee's employment hereunder, the Company shall pay to the Employee, and the Employee shall accept, a salary at the rate of $175,000 per annum, or at such higher rate as the Compensation Committee of the Board of Directors (the "Compensation Committee"), after periodic review, at its option and in its sole discretion, may fix. Any future compensation, including bonuses and stock options, if any, shall be determined by the Compensation Committee in its sole discretion, and will to the extent granted, be based on milestones and performance. Section 6. Fringe Benefits. The Company agrees to maintain a $1,000,000 term life insurance policy on the life of the Employee to the extent insurable. Such policy shall be owned by the Company and the Employee, and the Employee shall designate the beneficiary or beneficiaries under the policy. Furthermore, the Employee shall have the right to participate, on the same terms and subject to the same conditions, limitations, restrictions and requirements as the executive employees of the Company in such medical, health, insurance, pension, profit sharing, stock option and other plans, if any, as the Company may from time to time provide for the benefit of its employees and in which executive employees of the Company are eligible to participate. Section 7. Expenses. The Employee is authorized to incur reasonable expenses in performing services for and in promoting the business of the Company, including expenses for business entertainment and travel. The Company shall promptly reimburse the Employee for such expenses provided that the Employee presents an itemized statement of the same together with such supporting vouchers as the Company may from time to time require and are normally available. Section 8. Proprietary Information Agreement. On or prior to the date hereof, the Employee shall have executed and delivered to the Company a Proprietary Information Agreement in the form annexed hereto as Exhibit A. Section 9. Insurance. The Employee agrees to submit to the usual and customary medical examinations and otherwise cooperate with the Company in its procurement of such insurance policies on the Employee's life as the Company may desire. If at any time in the Employee's lifetime the Employee ceases to be employed by the Company, then the Company shall promptly, if requested by the Employee and subject to the applicable regulations of the insurance company or companies concerned, transfer, assign and deliver to the Employee, upon payment of the then cash surrender value thereof, if any, any and all insurance policies on the life of the Employee then held and/or owned by the Company. Premiums shall be adjusted to the date of such transfer, assignment and delivery. Section 10. Participation in Competing Business. During the period beginning on the date of this Agreement and ending one year following the expiration of the term of this Agreement (the "Non-Competition Period"), Employee shall not without the prior written consent of the Company: (i) call upon any customer or business prospect of the Company for the purpose of soliciting or selling similar services in competition with the Company's business (for the purposes of this section, the term "customer" shall mean any past or present customer with whom the Company is -2- conducting business or has conducted business within the immediately preceding one-year period, the term "business prospect" shall mean any past or present business prospect with respect to the Company's business which the Company is soliciting or has actively solicited within the immediately preceding one-year period and the term "Company's business" shall mean the online custom compilation of music; (ii) call upon any employee of the Company for the purpose or with the intent of enticing the employee away or out of the employ of the Company for any reason whatsoever; and (iii) be the owner of more than five (5%) of the outstanding capital stock of any U.S. publicly traded corporation, or an officer, director or employee of any corporation which is engaged in the Company's business within the United States. Section 11. Termination of the Agreement and of the Employee's Employment Hereunder. Section 11(a). Termination for Cause by the Company. The Company shall have the right to terminate this Agreement and Employee's employment hereunder at any time for cause (as defined in Section 18 hereunder) upon written notice of such termination specifying the reasons therefor. In the event of such termination for cause, the Employee shall be entitled to receive accrued salary and benefits as of the date of termination. Section 11(b). Termination Without Cause by the Company or for Good Reason by the Employee. In the event that: (1) the Company terminates this Agreement and the Employee's employment hereunder without cause, that is, for any reason other than "cause" (as defined in Section 18 hereof), death or incapacity; or (2) the Employee terminates this Agreement for "Good Reason" (as defined in Section 18 hereof); then, in either such case: the Employee shall receive from the Company as of the effective time of such termination: (i) all Employee's accrued salary and bonuses and the Employee's accrued benefits through the date of such termination; and (ii) a sum equal in the aggregate to the full amount, discounted by three percent (3%), of (a) the salary which the Employee would have received and the benefits which the Employee would have received, at the average rate or rates in effect during the six-month period immediately prior to termination and (b) the annual bonus or bonuses which the Employee would have received, at the rate of the Employee's annual bonus for the last full fiscal year of the Company ending prior to termination, had, with respect to both (a) and (b), the Employee's employment under this Agreement continued for the full initial term or renewal term thereof, as the case may be, as provided in Section 2 hereof. For purposes of the immediately preceding sentence, the remaining full initial term or the remaining renewal term, as the case may be, shall not be less than 12 months. The Employee shall not be required to mitigate the amount of any payments provided for in this Section 11(b) by seeking other employment or otherwise, and any such employment, if obtained, shall not be deemed to mitigate such amount nor shall Employee be obligated to resell to the Company any shares of the Company's stock the Employee may own. -3- Section 12. Termination by Reason of Death or Incapacity of the Employee. Section 12(a). This Agreement will terminate upon the Employee's death. Section 12(b). Incapacity: (i) In the event Employee, during the term of employment, shall fail substantially to perform his duties hereunder for a period of six (6) consecutive months because of illness or other incapacity, he shall, upon the furnishing by a physician (acceptable to both Company and Employee or his family) of a written statement that Employee is totally incapacitated or that it would be unsafe or unwise for serious health reasons for Employee to perform his duties hereunder, be deemed to be totally incapacitated. In the event a physician cannot be located who is acceptable to both parties, each shall select a physician who shall together select a third, whose decision shall be final. In the event of a dispute or inability to select a third, a physician shall be selected by the American Arbitration Association, and such physician's decision shall be final. (ii) If Employee shall be deemed totally incapacitated as set forth above, the Company, unless this Agreement shall have earlier terminated, may at its option, by giving the Employee written notice of its intention to do so, terminate Employee's employment hereunder effective as of the end of the calendar month in which such notice is given, and the Company shall pay the Employee prior to the effective time of such termination a sum equal in the aggregate to an additional twelve (12) months' base salary, less any amounts the Employee receives through disability policies maintained by the Company. (iii) In the event Employee shall not have been deemed totally incapacitated as provided above, but shall have failed as a result of temporary incapacitation to perform his duties hereunder for an aggregate of more than twelve (12) months in any period of twenty- four (24) consecutive months, the Company may at its option, by giving the Employee written notice of its intention to do so, terminate Employee's employment hereunder effective as of the end of the calendar month in which such notice is given, and the Company shall pay the Employee prior to the effective time of such termination a sum equal in the aggregate to an additional twelve (12) months' base salary, less any amounts the Employee receives through disability policies maintained by the Company. Section 13. Severance. In the event that the Company elects not to renew the Employee's contract as specified in Section 2 of this Agreement, then the Employee shall be entitled to receive from the Company at the effective time of such termination a one year severance equal to the Employee's base salary and benefits in effect immediately prior to termination. -4- Section 14. Effect of Termination. The provisions of Sections 5 and 7 (as to amounts owing prior to termination), 8, 10, 11, 12 and 15 through 22 shall survive the termination of this Agreement. Section 15. Medical Examination. The Employee shall be required to have a medical examination annually by a physician acceptable to the Company and at the Company's cost, the results of which shall be submitted to the Company. Section 16. Waiver of Breach. Forbearance by a party to require performance of any provision hereof shall not constitute or be deemed a waiver by such party of such provision or of the right thereafter to enforce the same, and no waiver by a party of any breach or default hereunder shall constitute or be deemed a waiver of any subsequent breach or default, whether of the same or similar nature or of any other nature, or a waiver of the provision or provisions breached or with respect to which such default occurred. Section 17. Notices. All notices and other communications required or permitted hereunder shall be in writing and may be personally delivered, deposited in the United States mail (first class postage prepaid, return receipt requested), sent by nationally recognized overnight courier service, transmitted by telecopier or telex, or sent by a private messenger or carrier which issues delivery receipts, addressed to the party for whom they are intended at the following addresses: Address for the Company: President The Music Connection Corporation 250 Exchange Place, Suite A Herndon, Virginia 20170 Address for the Employee: 10607 Creamcup Lane Great Falls, Virginia 22066 Such notices and other communications shall be deemed effective upon receipt. The above addresses may be changed by notice given pursuant to this Section 17. Section 18. Definitions. As used in this Agreement: Person. The term "person" shall mean and include any individual, partnership, firm, corporation, trust, unincorporated organization, or joint venture. Cause. The term "cause" for termination by the Company of this Agreement and of Employee's employment shall mean (i) such act or omission to act, or series of acts or omissions to act, or course of conduct of the Employee that would constitute willful or criminal misconduct or (ii) Employee's breach of Sections 4, 8, or 10 under the Agreement. -5- Good Reason. The term "Good Reason" for termination by the Employee of this Agreement and of Employee's employment hereunder shall mean a failure by the Company to comply with any material provision of this Agreement where such noncompliance has not been cured by the Company within thirty (30) days after the giving of written notice thereof by the Employee to the Company. Section 19. Severability. The invalidity or unenforceability of any provision of this Agreement shall not invalidate or render unenforceable any other provisions of this Agreement. Section 20. Binding Effect. The rights and obligations of the Company and the Employee under this Agreement shall inure to the benefit of and be binding upon them and their respective successors and assigns. This Agreement shall be binding upon the Employee and, except that the Employee may not delegate his obligations hereunder, shall inure to the benefit of the Employee and his heirs, executors and administrators. Section 21. Governing Law. This Agreement shall be governed by, and construed under and in accordance with, the laws of the Commonwealth of Virginia. Section 22. Entire Agreement. This instrument embodies the entire agreement and understanding by and between the parties hereto and supersedes all prior agreements (written or oral), arrangements and discussions between the parties, with respect to the subject matter hereof. This Agreement may not be changed, modified or amended in whole or in part except by a writing signed by all the parties. No waiver of any party's rights hereunder shall be effective or binding unless such waiver shall be in writing and signed by the party against whom such waiver is sought to be enforced. Section 23. Prior Agreement. This Agreement shall supersede in its entirety a prior Employment Agreement in effect between the Company and Mr. Bernardi which was signed effective March 20, 1997 which Agreement is null and void and of no further force or effect. Notwithstanding the foregoing, the Company acknowledges that it continues to owe Employee for certain accrued salary and bonus payments for the period commencing July 1, 1996 and ending December 8, 1997. -6- IN WITNESS WHEREOF, the parties have executed this Agreement as of this 8th day of December, 1997 The Music Connection Corporation By: /s/ Raju Puthukarai ------------------------------ Raju Puthukarai President Employee: By: /s/ Robert P. Bernardi ------------------------------ Robert P. Bernardi -7- EX-10.2 3 EXHIBIT 10.2 Exhibit 10.2 AMENDMENT TO THE DEVARAJAN S. PUTHUKARAI AMENDED AND RESTATED EMPLOYMENT AGREEMENT OF DECEMBER 8, 1997 This Amendment is made and entered into as of this 12th day of February, 1999, by and between The Music Connection Corporation, a Delaware corporation (the "Company") and Devarajan S. Puthukarai (the "Employee") (the "Agreement"). WHEREAS, the Company and the Employee are parties to that certain Amended and Restated Employment Agreement of December 8, 1997 (the "Employment Agreement"); and WHEREAS, the Company and the Employee desire to amend that certain Employment Agreement. NOW, THEREFORE, in consideration of the foregoing, the mutual covenants and agreements contained herein and other good and valuable consideration, the receipt and sufficiency of which are acknowledged by each of the parties hereto, such parties, intending to be legally bound, covenant and agree as follows: 1. Amendment. The Employment Agreement is amended so as to provide that ---------- the Employee's duties, as defined in Section 3(a) of the Employment Agreement, shall include employment on a full time basis to serve as President, Co-Chief Executive Officer and Chief Operating Officer of the Company. 2. Authorizing Actions. Each party agrees promptly to do all things and -------------------- take all actions as may be necessary or desirable to authorize and facilitate the performance of this Agreement. 3. Counterparts. This Agreement may be executed in counterparts, each of ------------- which when so executed and delivered shall constitute an original, but all of such counterparts taken together shall constitute one and the same instrument. 4 Entire Agreement. This Agreement together with the Employment ----------------- Agreement represents the entire understanding of the parties pertaining to the subject matter hereof and supersedes any and all prior agreements, negotiations and discussions, whether written or oral, between the parties with respect to the subject matter hereof. 5. Governing Law. The validity of this Agreement, its interpretation and -------------- construction shall be governed by the laws of the Commonwealth of Virginia, without regard to principles of conflict of laws. 6. Amendment. This Agreement may modified only by a written instrument --------- signed by each of the parties hereto. 7. Recitals. The Recitals to this Agreement are incorporated herein and -------- made a part hereof. IN WITNESS WHEREOF, the parties hereto have executed this Agreement, or have caused this Agreement to be executed by their duly authorized representatives as of the date first above written. THE MUSIC CONNECTION CORPORATION By: /s/ Robert P. Bernardi ------------------------------------ Robert P. Bernardi Chairman and Chief Executive Officer EMPLOYEE By: /s/ Raju Puthukarai ------------------------------------- Raju Puthukarai 2 Devarajan S. Puthukarai Amended and Restated Employment Agreement AGREEMENT by and between The Music Connection Corporation, a Delaware corporation (herein called the "Company") and Devarajan S. Puthukarai (herein called the "Employee"). WITNESSETH: The parties entered into Employment Agreements, dated April 14, 1997, which the parties now desire to amend and restate in its entirety as follows: For and in consideration of the mutual promises and covenants herein contained, the parties hereto mutually agree as follows: Section 1. Employment. The Company hereby employs the Employee for the term of five (5) years and upon the terms and conditions hereinafter set forth the Employee hereby accepts such employment and agrees to perform services for the Company, as provided in this Agreement. In the event that Rho Management exercises all of its Series B Warrants (other than those that may be assigned to Employee and/or Robert Bernardi), then the Employee agrees that the term of employment shall be three (3) years from the date hereof. Section 2. Term. Subject to the second sentence of Section 1, the Employee's employment hereunder shall be for a term commencing on December 8, 1997 and continuing through and including December 7, 2002, renewable automatically from year to year thereafter unless either the Company or the Employee provides the other with written notice of non-renewal at least 90 days prior to the expiration of the initial term or of any renewal term. Section 3. Duties; Control and Direction by Board of Directors. Section 3(a). Duties. Employee shall be employed on a full time basis to serve as President and Chief Operating Officer of the Company. As such, the Employee (i) shall assist the Company in the development of all phases of the Company's operating activities and (ii) shall perform such other appropriate executive duties as from time to time may be assigned to him by the Board of Directors of the Company. The Company intends to maintain an office in New York City out of which the Employee shall work. In the event that the Company does not maintain an office in New York City, the Employee shall work out of his home. Unless the Employee otherwise consents, the Employee shall not be required to work out of any office outside of the New York metropolitan area. Section 3(b). Rules and Regulations. The Employee shall comply with all Company rules and regulations applicable to the executive employees of the Company or to its employees generally and with all Company policies established by the Board of Directors. Section 4. Extent of Services. During the term of this Agreement, the Employee shall devote substantially all of his time and his best efforts to the business of the Company and the furthering of its interests and to the discharge of his duties, functions and responsibilities hereunder. Section 5. Compensation. As compensation during the term of the Employee's employment hereunder, the Company shall pay to the Employee, and the Employee shall accept, a salary at the rate of $250,000 per annum, or at such higher rate as the Compensation Committee of the Board of Directors (the "Compensation Committee"), after periodic review, at its option and in its sole discretion, may fix. The Employee will also receive an annual bonus based on the performance of the Employee. Such bonus will be determined annually by the Compensation Committee, but shall not be less than $100,000 to be paid pro-rata on a quarterly basis. Section 6. Fringe Benefits. The Company agrees to maintain a $1,000,000 term life insurance policy on the life of the Employee. Such policy shall be owned by the Company and the Employee, and the Employee shall designate the beneficiary or beneficiaries under the policy. Furthermore, the Employee shall have the right to participate, on the same terms and subject to the same conditions, limitations, restrictions and requirements as the executive employees of the Company in such medical, health, insurance, pension, profit sharing, stock option and other plans, if any, as the Company may from time to time provide for the benefit of its employees and in which executive employees of the Company are eligible to participate. Section 7. Expenses. The Employee is authorized to incur reasonable expenses in performing services for and in promoting the business of the Company, including expenses for business entertainment and travel. The Company shall promptly reimburse the Employee for such expenses provided that the Employee presents an itemized statement of the same together with such supporting vouchers as the Company may from time to time require and are normally available. Section 8. Proprietary Information Agreement. On or prior to the date hereof the Employee shall have executed and delivered to the Company a Proprietary Information Agreement in the form annexed hereto as Exhibit A. Section 9. Insurance. The Employee agrees to submit to the usual and customary medical examinations and otherwise cooperate with the Company in its procurement of such insurance policies on the Employee's life as the Company may desire. If at any time in the Employee's lifetime the Employee ceases to be employed by the Company, then the Company shall promptly, if requested by the Employee and subject to the applicable regulations of the insurance company or companies concerned, transfer, assign and deliver to the Employee, upon payment of the then cash surrender value thereof, if any, any and all insurance policies on the life of the Employee then held and/or owned by the Company. Premiums shall be adjusted to the date of such transfer, assignment and delivery. -2- Section 10. Participation in Competing Business. During the period beginning on the date of this Agreement and ending one year following the expiration of the term of this Agreement (the "Non-Competition Period"), Employee shall not without the prior written consent of the Company: (i) call upon any customer or business prospect of the Company for the purpose of soliciting or selling similar services in competition with the Company's business (for the purposes of this section, the term "customer" shall mean any past or present customer with whom the Company is conducting business or has conducted business within the immediately preceding one-year period, the term "business prospect" shall mean any past or present business prospect with respect to the Company's business which the Company is soliciting or has actively solicited within the immediately preceding one-year period and the term "Company's business" shall mean the online custom compilation of music; (ii) call upon any employee of the Company for the purpose or with the intent of enticing the employee away or out of the employ of the Company for any reason whatsoever; and (iii) be the owner of more than five (5%) of the outstanding capital stock of any U.S. publicly traded corporation, or an officer, director or employee of any corporation which is engaged in the Company's business within the United States. Section 11. Termination of the Agreement and of the Employee's Employment Hereunder. Section 11(a). Termination for Cause by the Company. The Company shall have the right to terminate this Agreement and Employee's employment hereunder at any time for cause (as defined in Section 18 hereunder) upon written notice of such termination specifying the reasons therefor. In the event of such termination for cause, the Employee shall be entitled to receive accrued salary and minimum guaranteed bonus as of the date of termination. Section 11(b). Termination Without Cause by the Company or for Good Reason by the Employee. In the event that: (1) the Company terminates this Agreement and the Employee's employment hereunder without cause, that is, for any reason other than "cause" (as defined in Section 18 hereof), death or incapacity; or (2) the Employee terminates this Agreement for "Good Reason" (as defined in Section 18 hereof); then, in either such case: the Employee shall receive from the Company as of the effective time of such termination: (i) all Employee's accrued salary and bonuses and the Employee's accrued benefits through the date of such termination; and (ii) a sum equal in the aggregate to the full amount, discounted by three percent (3%) of (a) the salary which the Employee would have received and the benefits which the Employee would have received, at the average rate or rates in effect during the six-month period immediately prior to termination, and (b) the annual bonus which the Employee would have received, at the rate of the minimum guaranteed bonus, as provided in Section 5 hereof. With respect to both (a) and (b), the Employee's employment under this Agreement continued for the full initial term or renewal term thereof, as the case may be, as provided in Section 2 hereof. For purposes of the immediately preceding sentence, the remaining full initial term or the remaining renewal term, as provided in Section 2 hereof, shall -3- not be less than 12 months. The Employee shall not be required to mitigate the amount of any payments provided for in this Section 11(b) by seeking other employment or otherwise, and any such employment, if obtained, shall not be deemed to mitigate such amount nor shall Employee be obligated to resell to the Company any shares of the Company's stock the Employee may own. Section 12. Termination by Reason of Death or Incapacity of the Employee. Section 12(a). This Agreement will terminate upon the Employee's death. Section 12(b). Incapacity: (i) In the event Employee, during the term of employment, shall fail substantially to perform his duties hereunder for a period of six (6) consecutive months because of illness or other incapacity, he shall, upon the furnishing by a physician (acceptable to both Company and Employee or his family) of a written statement that Employee is totally incapacitated or that it would be unsafe or unwise for serious health reasons for Employee to perform his duties hereunder, be deemed to be totally incapacitated. In the event a physician cannot be located who is acceptable to both parties, each shall select a physician who shall together select a third, whose decision shall be final. In the event of a dispute or inability to select a third, a physician shall be selected by the American Arbitration Association, and such physician's decision shall be final. (ii) If Employee shall be deemed totally incapacitated as set forth above, the Company, unless this Agreement shall have earlier terminated, may at its option, by giving the Employee written notice of its intention to do so, terminate Employee's employment hereunder effective as of the end of the calendar month in which such notice is given, and the Company shall pay the Employee prior to the effective time of such termination a sum equal in the aggregate to an additional twelve (12) months' base salary, less any amounts the Employee receives through disability policies maintained by the Company. (iii) In the event Employee shall not have been deemed totally incapacitated as provided above, but shall have failed as a result of temporary incapacitation to perform his duties hereunder for an aggregate of more than twelve (12) months in any period of twenty- four (24) consecutive months, the Company may at its option, by giving the Employee written notice of its intention to do so, terminate Employee's employment hereunder effective as of the end of the calendar month in which such notice is given, and the Company shall pay the Employee prior to the effective time of such termination a sum equal in the aggregate to an additional twelve (12) months' base salary, less any amounts the Employee receives through disability policies maintained by the Company. -4- Section 13. Severance. In the event that the Company elects not to renew the Employee's contract as specified in Section 2 of this Agreement, then the Employee shall be entitled to receive from the Company at the effective time of such termination a one year severance equal to the Employee's base salary and benefits in effect immediately prior to termination. Section 14. Effect of Termination. The provisions of Sections 5 and 7 (as to amounts owing prior to termination), 8, 10, 11, 12 and 15 through 22 shall survive the termination of this Agreement. Section 15. Medical Examination. The Employee shall be required to have a medical examination annually by a physician acceptable to the Company and at the Company's cost the results of which shall be submitted to the Company. Section 16. Waiver of Breach. Forbearance by a party to require performance of any provision hereof shall not constitute or be deemed a waiver by such party of such provision or of the right thereafter to enforce the same, and no waiver by a party of any breach or default hereunder shall constitute or be deemed a waiver of any subsequent breach or default, whether of the same or similar nature or of any other nature, or a waiver of the provision or provisions breached or with respect to which such default occurred. Section 17. Notices. All notices and other communications required or permitted hereunder shall be in writing and may be personally delivered, deposited in the United States mail (first class postage prepaid, return receipt requested), sent by nationally recognized overnight courier service, transmitted by telecopier or telex, or sent by a private messenger or carrier which issues delivery receipts, addressed to the party for whom they are intended at the following addresses: Address for the Company: Chairman The Music Connection Corporation 250 Exchange Place, Suite A Herndon, Virginia 20170 Address for the Employee: 36 Stoney Brook Rd Holmdel, New Jersey 07733 Such notices and other communications shall be deemed effective upon receipt. The above addresses may be changed by notice given pursuant to this Section 17. Section 18. Definitions. As used in this Agreement: Person. The term "person" shall mean and include any individual, partnership, firm, corporation, trust, unincorporated organization, or joint venture. -5- Cause. The term "cause" for termination by the Company of this Agreement and of Employee's employment shall mean (i) such act or omission to act, or series of acts or omissions to act, or course of conduct of the Employee that would constitute willful or criminal misconduct or (ii) Employee's breach of Sections 4, 8 or 10 under the Agreement. Good Reason. The term "Good Reason" for termination by the Employee of this Agreement and of Employee's employment hereunder shall mean a failure by the Company to comply with any material provision of this Agreement where such noncompliance has not been cured by the Company within thirty (30) days after the giving of written notice thereof by the Employee to the Company. Section 19. Severability. The invalidity or unenforceability of any provision of this Agreement shall not invalidate or render unenforceable any other provisions of this Agreement. Section 20. Binding Effect. The rights and obligations of the Company and the Employee under this Agreement shall inure to the benefit of and be binding upon them and their respective successors and assigns. This Agreement shall be binding upon the Employee and except that the Employee may not delegate his obligations hereunder, shall inure to the benefit of the Employee and his heirs, executors and administrators. Section 21. Governing Law. This Agreement shall be governed by, and construed under and in accordance with, the laws of the Commonwealth of Virginia. Section 22. Entire Agreement. This instrument embodies the entire agreement and understanding by and between the parties hereto and supersedes all prior agreements (written or oral), arrangements and discussions between the parties, with respect to the subject matter hereof. This Agreement may not be changed, modified or amended in whole or in part except by a writing signed by all the parties. No waiver of any party's rights hereunder shall be effective or binding unless such waiver shall be in writing and signed by the party against whom such waiver is sought to be enforced. Section 23. Prior Agreement. This Agreement shall supersede in its entirety a prior Employment Agreement in effect between the Company and Mr. Puthukarai which was signed effective April 14, 1997 which Agreement is null and void and of no further force or effect. Notwithstanding the foregoing, the Company acknowledges that it continues to owe Employee for certain accrued salary and bonus payments for the period commencing April 14, 1997 and ending December 8, 1997. -6- IN WITNESS WHEREOF, the parties have executed this Agreement as of this 8th day of December, 1997. The Music Connection Corporation By: /s/ Robert Bernardi --------------------------------- Robert Bernardi Chairman and CEO Employee: By: /s/ Raju Puthukarai --------------------------------- Raju Puthukarai -7- EX-10.3 4 EXHIBIT 10.3 Exhibit 10.3 THE MUSIC CONNECTION CORPORATION 1430 SPRING HILL ROAD SUITE 200 MCLEAN, VIRGINIA 22102 (703) 821-3966 FAX (703) 790-0370 January 23, 1997 Mr. Irwin H. Steinberg IHS Corporation One Lincoln Plaza, Apt. 33D New York, NY 10023 Dear Mr. Steinberg: On behalf of the MUSIC CONNECTION CORPORATION (TMC), I am pleased to offer you a position as Vice Chairman of the Board of Directors of TMC, and a two year consulting contract with IHS Corporation in accordance with the terms of this letter. Beginning with your acceptance of this offer, you agree to serve as Vice Chairman of the Board of Directors and consultant to TMC with the primary responsibility for obtaining agreements from major record companies to furnish their music repertoire to TMC for its newly launched custom music CD service called "Music Maker". Your services will be non-exclusive to us except that you will not consult with any competitor of the Company engaged in providing a custom music CD service on the Web. For your services as a consultant, you will earn a fee at the rate of $1,200 per day or part thereof actually spent performing services for TMC. TMC will guarantee you a minimum of 5 days compensation per calendar month, prorated for any partial month. The minimum guarantee of $6000 per month will be paid on the 1st of each month and for days in excess of the minimum, the fee will be paid upon billing. In addition to the foregoing fees, TMC will reimburse you for reasonable expenses incurred by you in performing the consulting services. Said reimbursement will be made currently upon submission by you of invoices supported by such receipts or other supporting documentation as TMC may reasonably request. The first $6,000.00 payment to be paid on 2/1/97. 1 Upon your acceptance of this agreement, you will be immediately entitled to purchase, upon payment of $1,000, a total of 100,000 shares of common stock of TMC representing approximately 2 percent equity interest in TMC. The stock will be issued directly to Irwin Steinberg. This 2 percent interest (100,000 shares of common stock) is based upon the present capitalization of TMC and will be subject to the same dilution as all other present interests in TMC in connection with any future private or public offering. It is mutually understood that TMC is now preparing to raise $5-10 million dollars through a public or private offering of stock. If you should leave the service of TMC (whether as a consultant or Vice Chairman) within the first year following your purchase of said TMC shares, then you shall be obligated to resell all of said shares to TMC at the same price you paid for them. During the second year, one-half of your shares will be subject to this restriction. After two years, this restriction will lapse as to all shares. Your right to purchase TMC shares and your resale obligations with respect thereto shall apply to the equivalent equity interest in TMC resulting from any merger, consolidation, reorganization, stock split, stock dividend, liquidating distribution, or other change in the capitalization. Any piggy back rights or other special registration rights granted to the other founders of TMC will also be granted to you. As a bonus incentive to obtain repertoire from major music labels, TMC is prepared to issue you 25,000 stock options at fair market price at the time of grant for each major label for which you successfully complete an agreement for mutually agreeable (based on quality and quantity of recognizable hit tunes) music repertoire and issue you 10,000 stock options for each independent label you successfully complete an agreement. In lieu of the bonus stock options, at your choice, you may receive a bonus of $ 25,000 and $ 10,000 respectively for each major and/or independent label which you complete an agreement for music repertoire. The stock options will be issued pursuant to TMC's employee stock option plan which is based on 3 year vesting. In addition to your consulting agreement, you agree to become Vice Chairman of the Board of Directors of TMC. You will be expected to attend a minimum of 4 Board meetings per year and you will be entitled to receive $ 1,200 per day plus reasonable expenses. It is planned that Board meetings will be held in either New York or Washington DC (McLean, Va.). It is planned that TMC will obtain Director and Officer (D&O) insurance for the directors and officers of TMC. If these terms are acceptable to you, please countersign this letter and return it to me, and this will constitute a contract between us. 2 Very Truly Yours, The Music Connection Corporation By /s/ Robert P. Bernardi --------------------------------- Robert P. Bernardi Chairman & CEO Accepted: By /s/ Irwin H. Steinberg ----------------------------- Irwin H. Steinberg, President IHS Corporation Date: 1/28/97 -------------------------- 3 AMENDMENT TO AGREEMENT OF JANUARY 23, 1997 This AMENDMENT, dated January 1, 1998, amends the existing Agreement dated January 23, 1997, between THE MUSIC CONNECTION and IRWIN H. STEINBERG, doing business as (dba) THE I.H.S. CORP. as follows: 1. As of January 1, 1998, compensation by THE MUSIC CONNECTION to IRWIN H. STEINBERG, dba THE I.H.S. CORP. is to be $9,000.00 per month rather than the previously agreed-upon amount of $6,000 per month. 2. As of January 1, 1998, IRWIN H. STEINBERG, dba THE I.H.S. CORP. is to provide to THE MUSIC CONNECTION fifteen (15) days of service per month rather than the previously agreed-upon five (5) days per month. 3. This Amendment extends the relationship between IRWIN H. STEINBERG, dba THE I.H.S. CORP. and THE MUSIC CONNECTION from the previously agreed-upon termination date of January 23, 1999, to a new termination date of January 23, 2000. ACKNOWLEDGED AND ACCEPTED: ACKNOWLEDGED AND ACCEPTED: /s/ Robert Bernardi /s/ Irwin H. Steinberg - ------------------------------- ------------------------------ Robert Bernardi, Chairman Irwin H. Steinberg, dba THE MUSIC CONNECTION THE I.H.S. CORP. Irwin Hugh Steinberg Dominique Moyse Steinberg One Lincoln Plaza New York, NY 10023 (212) 874-7325 August 28, 1998 Mr. Robert Bernardi, Chairman The Music Connection 1831 Wiehle Avenue Reston, Virginia 20190 Dear Bob: I am awaiting the 280,000 warrants which will replace my 280,000 ISO's. Thus, this letter confirms that (1) the part of my contract with The Music Connection that relates to stock incentives for each license achieved will cease with the issuance of an additional 100,000 warrants and (2) an addendum to that agreement will be forwarded to you bearing my signature. Given below are the names and warrant amounts for the above-described additional warrants due under my contract, as agreed, totalling 100,000. Please issue them as follows: Issue to: # Warrants Address - --------- ---------- ------- Dominique M. Steinberg 25,000 One Lincoln Plaza New York, NY 10023 (212) 874-7325 Beth Steinberg Wickham 25,000 65191 Highland Bend, Or 97701 (541) 385-5947 Mark L. Steinberg 25,000 1508 Sunnyside Chicago, Il 60657 (773) 561-9495 Steven J. Steinberg 25,000 943 S. Masselin Los Angeles, Ca 90036 (213) 933-3426 Sincerely, /s/ Irwin H. Steinberg - ---------------------------- Irwin H. Steinberg IHS/dhm Irwin Hugh Steinberg Dominique Moyse Steinberg One Lincoln Plaza New York, NY 10023 (212) 874-7325 August 31, 1998 Mr. Robert Bernardi, Chairman The Music Connection 1831 Wiehle Avenue, Suite 128 Reston, Virginia 20190 Dear Bob: You have received my fax of 8/28/98 (a copy of which follows this fax, pertaining to my agreement of 1/23/97 as amended on 1/1/98. With the action taken re the 280,000 ISO's and the additional 100,000 warrants to be issued as described in that fax of 8/28/98, so much of the above-noted agreement that pertains to the issuance of incentive options is hereby cancelled. Would you please acknowledge this by returning a signed copy of this letter to me. Sincerely, /s/ Irwin H. Steinberg Irwin H. Steinberg IHD/dhm ACKNOWLEDGED: --------------------------------- ROBERT BERNARDI, CHAIRMAN THE MUSIC CONNECTION Dated: --------------------------- EX-10.4 5 EXHIBIT 10.4 Exhibit 10.4 [LETTERHEAD OF COLUMBIA HOUSE APPEARS HERE] June 12, 1998 The Music Connection Corporation 250 Exchange Place, Suite A Herndon, Virginia 20170 Ladies and Gentlemen: The following, when signed by you and by us, will constitute our agreement with you: 1. (a) "Custom CD's", below, means compact disc compilations of music sound recordings produced on a custom basis for individual consumers, each consisting of selections requested separately by the customer concerned. (b) During the Term of this agreement (defined below), you will offer Custom CD's for sale to our customers, through our Columbia House and Total E websites (the "CHC Websites") and through promotional inserts in our mailings. All sound recordings which you are authorized to distribute in Custom CD's (currently, about 40,000 titles) will be available for selection by our customers for Custom CD's under this agreement. All references below to sales to our customers will include sales to prospective customers resulting from our mailings to them and sales by you to customers accessing your websites from the CHC websites. (c) We will not authorize any other supplier of Custom CD's to offer them through the CHC Websites or our mailings during the Term of this agreement, except a supplier offering a significant repertoire of sound recordings which you do not make available to our customers under this agreement. (d) You will not authorize any other music club operation to offer, sell or distribute Custom CD's during the Term of this agreement without our consent. If we consent to such an arrangement the profits derived from your distributions through that club operation will be shared equally by you and us, in accordance with a formula to be agreed upon in that event. -1- 2. (a) You will do the following: (1) Design and implement an interface and links between the CHC Websites and your websites offering Custom CD's (the "TMC Websites"), for the purpose of providing our customers with access to the TMC Websites in order to select and order Custom CD's, and to enable them to return to the CHC Websites. Your design and implementation of the interface and links will be subject to our prior written approval; (2) Design, produce and supply us with promotional materials offering Custom CD's to our customers, for insertion in our mailings. The inserts will be subject to our prior written approval; (3) Manufacture the Custom CD's to be sold to our customers, conforming to the same quality standards as the units of the highest quality which you distribute to other customers; (4) Process all orders for our customers for Custom CD's including every aspect of each transaction, including but not limited to receipt, credit card authorization processing, fulfillment, billing, collection of payments, tracking, transaction security, and all customer service functions. (b) You will obtain all licenses or other authorizations and make all royalty and other payments required in connection with the Custom CD's distributed under this agreement, including authorizations from and payments to owners of copyright in the sound recordings and musical compositions reproduced in them; (c) You will perform your obligations under this agreement in consultation with our Chairman or his designees. All sales to our customers under this agreement will be conducted as transactions between the customers and you, and we will not be a party to them. (d) You will not make any use of names or addresses of our customers or other information about them which you acquire in the course of your activities under this agreement, except for the limited purpose of servicing their orders as required by section 2(a)(4). Without limiting the generality of the preceding sentence, all such customer data will constitute "Confidential Information" for the purposes of paragraph 8. -2- 3. (a) We will display your "Musicmaker" icon on the CHC Websites as a link to the TMC Websites, and will include promotional inserts supplied by you in mailings to our customers and prospective customers, at our election, at least six (6) times per year during the Term. You will reimburse us for our actual expenses incurred directly in doing so (not including any indirect costs or allocations of overhead), promptly upon our request. (b) If the Sony Music or Warner Music organization authorizes us to use its sound recordings in Custom CD's on an exclusive basis, we will make those recordings available to you for use in the Custom CD's to be offered to our customers under this agreement, to the extent to which those authorizations permit us to do so, and you will make them available for selection by our customers. You will index, digitize and store those recordings in your database and supply us with copies of those digitizations in accordance with our requests. 4. (a) The term of this agreement (the "Term") will be the three (3) year period beginning September 1, 1998. (b) If we so request during the last 90 days of the Term, you will negotiate with us in good faith regarding renewal of this agreement. (c) We may terminate the Term in our discretion, upon not less than thirty (30) days' notice to you, if: (1) We determine, at any time after we have completed the first six (6) promotional mailings offering Custom CD's under this agreement, that our financial returns under it do not justify its continuance, in our discretion; or (2) if Devarajan S. Puthukarai ceases to function as your President and Chief Operating Officer (but we will not terminate for this reason if his successor is appointed in a timely manner and we deem him/her compatible with our interest in the project contemplated by this agreement, in our discretion. 5. Net Profits. You will pay us a share of your Net Profits derived from ------------ the sale of Custom CD's to our customers, in accordance with this paragraph 5. -3- (a) Definition. "Net Profits", in this agreement, means all ----------- revenues derived by you in connection with sales of Custom CD's to our customers (including shipping and handling charges but excluding transactional taxes), less only the following amounts: (1) Your actual expenses incurred directly in performing the functions referred to in subparagraph 2(a) (not including any indirect costs or allocations of overhead); (2) the royalties and any other payments referred to in subparagraph 2(b); (3) reimbursements for our expenses actually paid to us under subparagraph 3(a); and (4) your actual expenses incurred directly in indexing, digitizing and storing Sony and Warner recordings under subparagraph 3(b), and in establishing a separate TMC Website for the purpose of offering them to our customers only (not including any indirect costs or allocations of overhead). (b) Net Profit Share Calculation. The amount of our participation in Net ----------------------------- profits will be determined as follows: (1) "Selection", below, means each designation of a sound recording by our customers for inclusion in Custom CD's they order. (For example: if a single recording is designated for inclusion on each of four Custom CD's, those designations will be treated as four Selections.) (2) You will determine the aggregate number of Selections included in each of the following categories: (i) Any recordings you use under licenses entered into in the future, requiring you to pay the licensors concerned at least fifty percent (50%) of your profits from the use of the recordings on Custom CD's ("Co- Ventured Recordings", below); (ii) the Sony and Warner recordings we make available to you under subparagraph 3(b) ("Sony/Warner Recordings"); and (iii) all other recordings ("Other Recordings"). -4- (3) The total amount of the Net Profits concerned will be allocated to three separate funds, in proportion to the allocation of Selections to the categories listed in section 5(b)(2). (For example: if 90% of the Selections used in Custom CD's sold to CHC Customers are Other Recordings, 90% of the Net Profits concerned will be allocated to the Other Recordings fund.) (4) You will pay us the following percentages of the Net Profits allocated to those funds: (i) Twenty-five percent (25%) of the Co-Ventured Sound Recordings fund; (ii) sixty-five percent (65%) of the Sony/Warner Recordings fund; and (iii) fifty percent (50%) of the Other Recordings fund. (c) Initial Mailings - Minimum Payments. ------------------------------------ (1) You will make separate computations of the Net Profits due us from sales of Custom CD's resulting from each of the first six (6) mailings to our customers under this agreement. Each of those computations will include only revenues derived and expenses incurred solely in connection with the mailing concerned (for example, those computations will not reflect any deductions for website interface and link expenses referred to in section 2(a)(l) or expenses for digitizing Sony/Warner recordings under subparagraph 3(b).) (2) If the amount of our Net Profit participation computed under section 5(c)(l) in connection with any of those six initial mailings is less than the amount we would charge a third party for a "ride-along" insertion in a comparable promotional mailing (or the amount fixed by our rate card then in effect if there is no comparable mailing during the time period concerned), you will pay us the difference promptly upon our request. If you fail to make any such payment we will have the right to terminate the Term of this agreement upon five (5) days' notice, without limiting our other rights. (d) Your revenues derived from sales of Custom CD's to our customers will be segregated and will not be commingled with your other funds, but will held in trust in a separate account or accounts designated as Columbia House trust accounts until disbursed in the following order of priority: -5- (1) To us, in payment of any expense reimbursements due us under subparagraph 3(a) and not previously paid to us. (2) To you, to the extent of the direct expenses deductible in computing Net Profits under subparagraph 5(a). (3) In ratable shares paid simultaneously as follows: (i) To us in payment of our participation in Net Profits under this paragraph 5; and (ii) to you as your property to the extent of the balance of those Net Profits. (e) You will compute and pay all amounts due us, accompanied by accounting statements reflecting sales, expenses, and Net Profits, within sixty (60) days after the end of each calendar quarter for the preceding calendar quarter. Each of us will furnish the other with documentation of all expenses deducted in computing Net Profits or to be reimbursed. (f) We may, at our expense, examine your books and records relating to the sales of Custom CD's and the computation of Net Profits under this agreement, during your regular business hours and at the place where you regularly keep them, for the purpose of verifying the accuracy of the statements furnished to us under subparagraph 5(e). You will keep an accurate and auditable account of your sales, expenses and payments, and Net Profits under this agreement and will retain all records concerning those sales, expenses and payments, and Net Profits. 7. As additional consideration for our execution of this agreement, you are entering into a Warrant Agreement with us granting us warrants to purchase shares of your capital stock on the terms prescribed in the Warrant Agreement. 8. (a) "Confidential Information", below, means: (1) All information regarding either party or its business, acquired by the other party in connection with this agreement or any activities conducted under it; and (2) the terms of this agreement. (b) Neither party will disclose to any other person any Confidential Information of the other party, except to its employees and advisors with a need to know it -6- in the course of their duties or for the purposes of performing the obligations of the party concerned under this agreement. "Confidential Information" shall not include information already lawfully known to or independently developed by the receiving party, disclosed in published materials, generally known to the public, lawfully obtained from any third party, or required to be disclosed by law. If any such disclosure may be required by law, the party from whom it is sought will notify the other party promptly and will cooperate with the latter as it reasonably requests to oppose the requirement. The parties acknowledge that money damages would not constitute adequate compensation for a breach of this paragraph; either party will be entitled to injunctive relief to restrain any such threatened breach in addition to any other relief to which it may be entitled. 9. You will at all times indemnify and hold us harmless from and against any and all claims, damages, liabilities, cost and expenses, including legal expenses and reasonable counsel fees, arising out of any violation of law or the rights of any person by reason of anything contained in the Custom CD's sold to our customers or their packaging, advertising, or marketing, or otherwise arising out of or related to your activities under this agreement. 10. All notices under this agreement will be in writing and given by courier or other personal delivery or registered or certified mail at the appropriate address indicated above or at a substitute address designated by notice by the party concerned. Each notice to us will be addressed for the attention of our Senior Vice President, Electronic Media, and a copy of each notice sent to us will be sent simultaneously to our Senior Vice President and General Counsel. Notices shall be deemed given when delivered to the courier, personally delivered, or mailed, except that a notice of change of address will be effective only from the date of its receipt. 11. The parties are independent contractors. Neither party will be authorized or purport to act as an agent of the other, or to make any commitments on behalf of the other. 12. Neither party will mention the other in advertising or promotional literature, or issue or authorize any publicity about the other party or the subject matter of -7- this agreement, without the prior written approval of the other party in each instance. 13. (a) This agreement contains the entire understanding of the parties relating to its subject matter and cannot be changed orally. A waiver of any provision of this agreement in any instance will not be deemed to waive it for the future. (b) THIS AGREEMENT HAS BEEN ENTERED INTO IN THE STATE OF NEW YORK, AND ITS VALIDITY, INTERPRETATION AND LEGAL EFFECT WILL BE GOVERNED BY THE LAWS OF THAT STATE APPLICABLE TO CONTRACTS ENTERED INTO AND ENTIRELY PERFORMED THERE. THE NEW YORK COURTS (STATE AND FEDERAL), ONLY, WILL HAVE JURISDICTION OF ANY CONTROVERSIES REGARDING THIS AGREEMENT; ANY ACTION OR OTHER PROCEEDING WHICH INVOLVES SUCH A CONTROVERSY WILL BE BROUGHT IN THOSE COURTS, IN NEW YORK COUNTY, AND NOT ELSEWHERE. ANY PROCESS IN ANY SUCH ACTION OR PROCEEDING MAY, AMONG OTHER METHODS, BE SERVED BY DELIVERING IT OR MAILING IT, BY REGISTERED OR CERTIFIED MAIL, DIRECTED TO THE APPLICABLE ADDRESS ABOVE OR SUCH OTHER ADDRESS AS THE PARTY CONCERNED MAY DESIGNATE PURSUANT TO PARAGRAPH 16. ANY SUCH DELIVERY OR MAIL SERVICE WILL HAVE THE SAME EFFECT AS PERSONAL SERVICE WITHIN THE STATE OF NEW YORK. (c) The invalidity or unenforceability of any provision of this agreement shall in no way affect the validity or enforceability of any other provision of this agreement. (d) Neither party shall be entitled to recover damages or to terminate the Term by reason of any breach of this agreement by the other party, unless the latter party has failed to remedy the breach concerned within twenty- one (21) days after notice. Very truly yours, THE COLUMBIA HOUSE COMPANY By: /s/ The Columbia House Company ------------------------------- Sr. V.P. AGREED: THE MUSIC CONNECTION CORPORATION By: /s/ Devarajan Puthukarai --------------------------------- President & COO -8- EX-10.6 6 EXHIBIT 10.6 Exhibit 10.6 MARKETING AGREEMENT ------------------- AGREEMENT made this 30th day of September, 1998 between THE MUSIC CONNECTION CORPORATION for its "Music Maker" custom music CD compilation service, having an office at 1831 Wiehe Avenue, Suite 128, Reston, Virginia 20190 (herein called "Music") and Platinum Entertainment, Inc., 2001 Butterfield Road - Suite 1400, Downers Grove, IL 60515 (herein called "Platinum"). Music and Platinum desire to engage in certain joint marketing activities in connection with the exploitation of sound recordings owned or controlled by Platinum by means of custom compilation compact discs produced by Music and the electronic transmission by Music of audio files featuring such sound recordings by means of the Internet to personal computers for individual use. The parties hereby agree as follows: 1. Definitions. ----------- (a) "Custom CDs" shall mean compilation compact discs produced on a custom basis for individual consumers, each consisting of Selections requested separately by the customer concerned, from which sounds, without visual images, can be perceived, reproduced or otherwise communicated, and shall include the object in which sounds are so fixed. (b) "Audio File" shall mean a Master in the form of a digitized computer file capable of being transmitted electronically from Music's Site (as hereinafter defined) as separately requested on a custom basis to a personal computer for playback or reproduction on a CD-R. (c) "Masters" shall mean the sound recordings of individual musical compositions that comprise the entire repertoire of sound recordings that are owned or controlled by Platinum or its subsidiaries, and with respect to which Platinum presently has the right to license to Music during the Term the rights to manufacture, advertise, market, distribute, and sell Custom CDs embodying such basic source material coupled with sound recordings from other sources. "Masters" shall also mean all other sound recordings, which Platinum acquires or clears licensing rights with respect to after the commencement of and during the Term. (d) "Territory" shall mean the world. (e) "Platinum's Identity" shall mean Platinum's tradenames, trademarks, trade dress, and other elements of Platinum's trade identity, in the approved form and style to be furnished by Platinum. (f) "Selection" shall mean an individual sound recording as designated by Music to its customers, whether sold for inclusion on a Custom CD or as an Audio File. Musicmaker -w- Platinum September 30, 1998 2. Business Arrangements --------------------- (a) During the term of this Agreement, Music will offer Custom CDs, featuring Masters and Audio Files, for sale to its customers from its Internet computer service presently known as MUSICMAKER, having the URL of http://www.musicmaker.com (the "Music Site"). (b) Music and Platinum will design and implement an interface and links between the Music Site and Platinum's Internet computer service having the URL of http://www.platinumcd.com (the "Platinum Site") for the purpose of providing visitors to the Platinum Site access to the Music Site in order to select and order Custom CDs and Audio Files, and to enable them to return to the Platinum Site. The design and implementation of the interface and links will be mutually approved by Music and Platinum. (c) Music will manufacture Custom CDs and transmit Audio Files sold to customers accessing the Music Site from the Platinum Site ("Platinum Customers"), conforming to the same quality standards as the units or music files of the highest quality that Music distributes to other customers. Music will also process all orders for Custom CDs and Audio Files placed by Platinum Customers, including every aspect of each transaction, including, but not limited to, receipt, credit card authorization processing, fulfillment, billing, collection of payments, tracking, transaction security, and all customer service functions. Music will also obtain all licenses or other authorization and make all royalty and other payments required in connection with the Custom CDs and Audio Files distributed under this Agreement, including authorizations from and payments to owners of copyright in the sound recordings and musical compositions reproduced in them. All sales to Platinum Customers under this Agreement will be conducted as transactions between the Platinum Customers and Music, and Platinum shall not be a party to them. Music will not make any use of names or addresses of Platinum Customers or other information about them that Music acquires in the course of its activities under this Agreement, except for the limited purpose of servicing their orders as required hereunder. Music agrees that all information concerning customers of Music who purchase Selections embodying Masters, whether compiled in Custom CDs or as Audio Files, shall be available to Platinum at its request without cost to Platinum for use by Platinum at its election, subject only to any restrictions imposed on information concerning customer orders obtained from Columbia House in existence as of the date of this Agreement. (d) Platinum will display Music's MUSICMAKER icon on the Platinum Site as a link to the Music Site, and will otherwise promote the availability of Custom CDs and Audio Files from the 2 Musicmaker -w- Platinum September 30, 1998 Music Site by means mutually agreeable to Music and Platinum. Music will display Platinum's icon on the Music Site as a link to the Platinum Site. During the period the Masters are licensed by Platinum to Music on an exclusive basis, Platinum will not authorize any other supplier of Custom CDs to offer them through the Platinum Site. (e) During the term of this Agreement, Platinum agrees to properly maintain the Platinum Site and all links to the Music Site, and Music agrees to properly maintain the Music Site and all links to the Platinum Site, so as to fulfill the purposes and intent of this Agreement. 3. Term of Agreement ----------------- (a) The initial term of the Agreement shall mean a period of five (5) years commencing on the date hereof (the "Initial Term"). The parties hereto agree that the Initial Term of the Agreement shall be automatically extended for additional consecutive periods of one (1) year each unless either party elects to terminate the Agreement, which election may be exercised by either party by written notice to the other of its election to do so delivered at any time prior to the expiration of the Initial Term or any option term. (b) Notwithstanding the foregoing, the term of this Agreement shall be co-terminous with the term of the Licensing Agreement between Platinum and Music dated as of September 30, 1998 (the "Licensing Agreement") and shall terminate automatically and without further notice upon the date of the termination of the Licensing Agreement. (c) No breach of this Agreement by either party shall be deemed material unless the party claiming a breach serves written notice thereof on the other party, specifying the nature thereof, and the party receiving notice fails to cure such breach, if any, within thirty (30) days after receipt thereof. 4. Payments to Platinum -------------------- Music will pay to Platinum a share of its proceeds derived from the sale of Custom CDs and Audio Files in accordance with this Paragraph 4. (a) Music shall pay the following amounts of Net Profits to Platinum: (i) Music shall pay to Platinum fifty percent (50%) of the Net Profits ("Exclusive Base Net Profit Share") realized 3 Musicmaker -w- Platinum September 30, 1998 from all orders received by Music from all customers other than those customers identified in Paragraph 4(a) (iii) for Selections embodying Masters licensed to Music by Platinum on an exclusive basis. (ii) Music shall pay to Platinum twenty percent (20%) of the Net Profits ("Nonexclusive Base Net Profit Share") realized from all orders received by Music from all customers other than those customers identified in Paragraph 4(a)(iii) for Selections embodying Masters licensed to Music by Platinum on a non-exclusive basis. (iii) Music shall pay to Platinum sixty six and two-thirds percent (66 2/3%) of the Exclusive Base Net Profit Share or Nonexclusive Base Net Profit Share, as applicable, for all Net Profits realized from all orders received by Music for Selections embodying Masters from customers electronically linked or referred to Music under a profit-sharing joint marketing agreement with Columbia House, N2K, or other profit-sharing joint marketing partner of Music receiving equivalent consideration from Music as that received by Columbia House or N2K (individually and collectively "Marketing Partner"), and from all orders generated through print or direct mail promotions by such Marketing Partners to their customers. (b) "Net Profits", for purposes of this Agreement, shall mean all revenue derived by Music in connection with the sale of Masters on Custom CDs or as Audio Files (excluding shipping and handling charges and transactional taxes), less only the following: (i) royalty obligations to parties other than Music for master use fees and mechanical licenses; (ii) a $.10 per Master charge for orders originating from print advertising and direct mail; and (iii) the proportionate cost of (A) the actual per unit manufacturing cost of a Custom CD, including the disc, jewel case, tray card, cover insert, and thermal printing on the disc, tray card, and cover insert ("Manufacturing Costs"), and (B) Music's out-of-pocket costs associated with on-line hosting of the Music Site, management of the Music Site, and on-line storage of files ("Site Costs"). The amount of Manufacturing Costs and Site Costs charged to determine Net Profits shall be determined by multiplying the total of all such costs for the applicable accounting period by a fraction, the numerator of which shall be the number of Selections embodying Masters sold during the applicable accounting period and the denominator of which shall be the total number of Selections sold during the applicable 4 Musicmaker -w- Platinum September 30, 1998 accounting period; provided, however, that (A) in no event shall the total costs described above in Paragraphs 4 (b) (i), (ii), and (iii) for a Custom CD for purposes of determining Net Profits exceed the amount of $4.00; and (B) in no event shall Music's indirect costs or general overhead, or the amount of profits payable to any third party, be included in the calculation of Net Profits. (c) Music shall pay to Platinum twenty percent (20%) of all proceeds net of shipping and handling fees realized by Music from all orders for Selections embodying sound recordings other than Masters from customers electronically linked or referred to Music by Platinum or any affiliate of Platinum. 5. Statements ---------- During the Term, Music shall quarterly compute all amounts due pursuant to Paragraphs 4(a) and 4(c) hereunder, and send a separate statement thereof for each to Platinum within thirty (30) days following the end of each calendar quarter period. With respect to the amounts due pursuant to Paragraph 4 (a), each statement shall show the number of units of Selections embodying Masters (on a Master-by-Master basis) sold, the price at which each Selection was sold, and all costs applied to determine Net Profits, identified by category and amount. Together with each such statement, Music shall supply Platinum with copies of all invoices supporting all costs applied to determine Net Profits. With respect to the amounts due pursuant to Paragraph 4(c), each statement shall show the number of units of Selections sold and the price at which each Selection was sold. Each statement prepared pursuant to Paragraphs 4(a) and 4(c) shall be accompanied with the payments shown to be due thereon. Music may establish reasonable reserves for unpaid or returned records. Such reserves shall become payable by the payment date of the accounting period immediately following the accounting period in which such reserves were established. Music shall keep an accurate and auditable account of its sales, expenses, payments, and Net Sales under this Agreement, and will retain all records concerning those sales, expenses, payments, and Net Sales for the period of Platinum's right to audit such records. Platinum shall have the right, upon thirty (30) days prior notice in writing, to audit and copy Music's books and records pertaining to Music's statements hereunder and the computation of Net Profits and other payments payable to Platinum once each calendar year during the Term and once within three (3) years of the end of the Term. Any such audit may be conducted only once with respect to any particular statement, shall be made during regular business hours where Music's books and records are regularly maintained, and shall be conducted on 5 Musicmaker -w- Platinum September 30, 1998 Platinum's behalf at its expense by a Certified Public Accountant familiar with record industry accounting practices. Any payment not made when due shall bear simple interest at an annual rate equivalent to the Prime Rate of interest reported from time to time by the Wall Street Journal, plus Two Percent (2%), for the period commencing when the payment should have originally been made to Platinum and ending on the date of payment in full. All royalty statements and accounts shall be binding upon Platinum unless Platinum specifically objects to such statement or accounts in writing within thirty-six (36) months from the date rendered. Platinum will be foreclosed from maintaining any action with respect to any statement or accounting unless such action is commenced against Music in a court of competent jurisdiction within forty-eight (48) months after such statement or account is rendered. 6. Force Majeure ------------- In the event that Music's manufacture and sale of Custom CDs is interrupted for any cause beyond the reasonable control of the Music, such as war, fire, earthquake, strike, civil commotion, or acts of any government, then Music, at its option, may extend the Term for a period equal to the length of the interruption, not, however, to exceed six (6) months. 7. General Warranties and Representations -------------------------------------- (a) Platinum warrants and represents it has the right to enter this Agreement and to perform all of the obligations to be performed by it hereunder. (b) Music warrants and represents it has the right to enter this agreement and to perform all of the obligations to be performed by it hereunder. 8. Indemnities ----------- (a) Platinum indemnifies and agrees to hold Music harmless from and against any damages awarded in any judgment entered against Music, together with the reasonable costs, expenses, and reasonable counsel fees of Music, by reason of any breach of the warranties above set forth by Platinum or by reason of any claim or claims made by any person or persons arising from the act or ommission of Platinum with respect to the manufacture, promotion, distribution, advertising, and sale of Records hereunder or any failure of Platinum to perform its obligations hereunder (except to the extent such damages resulted from Platinum's reliance upon information supplied by Music). Music shall promptly notify Platinum in writing of any such claim or litigation. Platinum may, 6 Musicmaker -w- Platinum September 30, 1998 at its option, assume the handling, settlement, or defense of any such claim or litigation, in which event the obligation of Platinum shall be limited to holding Music harmless from and against any final judgment paid on account thereof or any settlement effected by Platinum. (b) Music indemnifies and agrees to hold Platinum harmless from and against any damages awarded in any judgment entered against Platinum, together with the reasonable costs, expenses, and reasonable counsel fees of Platinum, by reason of any breach of the warranties above set forth by Music or by reason of any claim or claims made by any person or persons arising from the act or ommission of Music with respect to the manufacture, promotion, distribution, advertising, and sale of Records hereunder or any failure of Music to perform its obligations hereunder (except to the extent such damages resulted from Music's reliance upon information supplied by Platinum). Platinum shall promptly notify Music in writing of any such claim or litigation. Music may, at its option, assume the handling, settlement, or defense of any such claim or litigation, in which event the obligation of Music shall be limited to holding Platinum harmless from and against any final judgment paid on account thereof or any settlement effected by Music. 9. Notices ------- All notices required to be given to a party hereto must be sent to the address for the party first mentioned herein or to such new address, if changed, as described below, in order to be effective. All payments and statements will be sent to Platinum at Platinum's address mentioned herein. Each party may change its respective address hereunder by notice in writing to the other. All notices shall be served by depositing them addressed as aforesaid, postage prepaid, in the mail, by delivering them by facsimile (with confirmation of receipt) or by delivering them, charges prepaid. Any notices served by mail shall be certified or registered with return receipt requested. The date of mailing of any such notice, the date of delivery thereof, or the date of sending by facsimile of any such notice shall constitute the date of service. 10. Assignment ---------- This Agreement is personal to the parties and may not be assigned without the consent of the other party, except that Music and Platinum may assign this Agreement, in whole or in part, to its parent, to any subsidiary corporations of such party, to any affiliated company, or to any company by which it is acquired, and such rights may be assigned by an assignee thereof to a similar 7 Musicmaker -w- Platinum September 30, 1998 assignee, provided that such assignment shall not release or alter any liability, undertaking, or obligation of either party hereunder. This Agreement and all rights and obligations hereunder shall be binding upon the successors, assigns, and legal representatives of both parties. 11. Merger ------ This Agreement sets forth the entire Agreement between the parties as to the subject matter hereof, and neither party shall be bound by any amendment or modification hereto except as may be set forth subsequent to the date hereof in writing signed by a properly authorized representative of both parties. 12. Governing Law & Jurisdiction ---------------------------- This Agreement shall be governed by and be construed in accordance with the internal law of the State of Illinois. 13. Confidentiality --------------- The terms and conditions hereof are confidential to the parties hereto. The parties may disclose this Agreement to their employees, officers, directors, attorneys, and accountants, all of whom shall be bound by the aforesaid confidentiality requirement. The parties may also disclose this Agreement if so required by a governmental agency or by a court of competent jurisdiction. IN WITNESS WHEREOF, the undersigned have executed this agreement as of the date set forth above. THE MUSIC CONNECTION CORPORATION By: /s/ Robert Bernardi ------------------------------------------ An Authorized Signer PLATINUM ENTERTAINMENT, INC. By: /s/ Platinum Entertainment, Inc. ------------------------------------------ An Authorized Signer Federal ID No. 36-38032328 ------------------------------ 8 EX-10.7 7 EXHIBIT 10.7 Exhibit 10.7 MEMORANDUM OF UNDERSTANDING --------------------------- Agreement dated 1/18/99 by and between The Music Connection Corporation, 1831 Wiehle Avenue, Suite 128, Reston, Virginia 20190. A De1aware corporation organized under the laws of United States of America (herein called TMC) and Audio Book Club Inc., an organization involved in the direct to consumer marketing of Audio Books, with offices at 20 Community Place, Morristown, New Jersey 07960 (herein called ABC) to enter into an exclusive marketing arrangement to promote and market TMC's Custom CD's and Digital Downloading products to ABC's customers through ABC's websites and print insert promotions in the catalog mailed to its customers under the following terms and conditions: 1) PRODUCTS: All music and music related video repertoire under license, with --------- rights cleared by repertoire owners available for promotion to ABC's customers for TMC's Custom CD's, Digital Downloading, Digital Video Disc and Digital Audio Disc products. 2) TERRITORY: Worldwide on ABC's websites subject to TMC's licensing rights ---------- and USA for insert promotions in ABC's customer catalogs. 3) EXCLUSIVITY: ABC will not authorize any other supplier to offer any ------------ products covered under this agreement as specified in paragraph 1 above through ABC's websites or through any print promotion mailings to its customers during the Term of this agreement. 4) TERMS: The term of this agreement (the Term) will be the three (3) year ------ period beginning January 20, 1999 with automatic three (3) year renewal terms thereafter under terms no less favorable than the terms herein. Both parties agree to negotiate in good faith during the last 90 days of the initial Term or any Renewal Term for the continuation of this agreement. ABC may terminate this Agreement with 30 days written notice at anytime alter six (6) months from the date of this Agreement. 5) ADVERTISING AND PROMOTION: ABC will display TMC's "musicmaker" icon on its -------------------------- websites as a link to TMC's websites, and will include inserts supplied by TMC in mailings to its customers at least six (6) times per year during the Term. ABC, in addition to the ongoing link to TMC's websites, agrees to feature two (2) special event oriented promotions per year during the Term (a) Christmas promotion and (b) Valentine Day promotion or other on its websites. TMC will supply and up front the costs of printing and inserting the inserts for inclusion in the six (6) mailings per year to ABC customers and ABC agrees that it will not charge TMC any rental fees or insertion fees for these insert promotions. 6) NET PROFIT FORMULA: For purposes of calculation of the Net Profits to be ------------------- shared by TMC and ABC on all orders from ABC customers, the formula will be as follows: Net Revenue received from the sale of a Custom CD or Digital Download of a given single music recording excluding any shipping and handling charges and transactional taxes, less direct out of pocket costs incurred for 1) manufacturing costs including the CD-R, the jewel case, the jay cards, thermal printing on the CD-R, printing of the jay cards 2) direct labor costs in picking and packing 3) direct customer service charges incurred servicing ABC customers 4) credit card fees 5) all third party royalty obligations including royalty due to the artists, the record labels, music publisher copyright fees and any other royalties due to the holders of rights to the music sound recording 6) the printing costs of the inserts included in the mailings to ABC customers 7) the software licensing fee for digital downloading. TMC agrees that all costs will be direct out of pocket costs and will be substantiated and will not include any indirect costs or allocation of overhead. 7) PROFIT SHARING: TMC and ABC will share the Net Profits as follows on two --------------- distinct repertoire groups as follows: (a) on "Co-Ventured Recordings", where TMC has agreements with owners of music content to share 50% of the profits in addition to the royalty, ABC will receive twenty-five percent (25%) of the Net Profits from all orders from ABC customers and (b) on all "Other Recordings", where TMC has regular licensing agreements with owners of music content, ABC will receive fifty percent (50%) of the Net Profits from all orders from ABC customers. 8) ACCOUNTING: TMC will compute and pay all amounts due ABC, accompanied by ----------- accounting statement reflecting sales, expenses, and Net Profits, within thirty (30) days after the end of each calendar month for the preceding calendar month. TMC will provide separate accounting for orders received from ABC's websites and from its insert promotional mailings to its customers. 9) CONFIDENTIAL INFORMATION: Neither party will use for it's own purposes or ------------------------- disclose to any other person any confidential information of the other party including the names and addresses of any of its customers except to its employees with a need to know it in the course of their duties or for the purpose of performing the obligations of the party concerned under this agreement. 10) INDEPENDENT CONTRACTORS: The parties are independent contractors. Neither ------------------------ party will be authorized or purport to act as an agent of the other, or to make any commitments on behalf of the other. 11) GOVERNING LAWS: This agreement has been entered into in the State of --------------- Virginia, and its validity, interpretation and legal effect will be governed by the laws of that state. This agreement contains the entire understanding of the parties relating to its subject matter and cannot be changed orally. Very truly yours, THE MUSIC CONNECTION CORPORATION By: /s/ Devarajan Puthukarai ----------------------------- Title: President -------------------------- Date: 1/18/99 -------------------------- AGREED: AUDIO BOOK CLUB INC. By: /s/ Audio Book Club Inc. ----------------------------- Title: Co-CEO -------------------------- Date: 1/19/99 -------------------------- EX-10.8 8 EXHIBIT 10.8 Exhibit 10.8 OFFICE/WAREHOUSE/SHOWROOM LEASE BASIC LEASE INFORMATION - -------------------------------------------------------------------------------- Date of Lease: January 15, 1998 Landlord: Century Properties Fund XX Tenant: The Music Connection Corporation Name and Location of Building: Linpro Park I [Paragraph 1(a)] 1831 Wiehle Avenue Reston, Virginia Net Rentable Area of Premises: 4,523 sq. ft. [Paragraph 1(b)] Base Year or Estimated Operating Expenses Calendar Year 1998 (Circle one): [Paragraph 1(c) or 1(d)2] Tenant's percentage Share: 6.0153% [Paragraph 1(i)] Net Rentable Area of Building: 75,191 sq. ft. [Paragraph 1(i)] Term Commencement: April 1, 1998 [Paragraph 3] Term Expiration: February 28, 2005 [Paragraph 3] Minimum Rent:* $22.50 per sq. ft. [Paragraph 4(a)] (See Addendum One) Date of First CPI Rental Adjustment: N/A [Paragraph 4(b)] Permitted Use: General Office Use [Paragraph 9] Security Deposit: $8,480.63 Security Deposit [Paragraph 31] $8,480.63 Advance Rent Deposit ---------- for First Month's Rent $16,961.26 Total Cash Deposit ========== $50,000.00 Letter of Credit (See Addendum One) Tenant's Address for Notices: See Addendum One [Paragraph 36] Landlord's Address for Notices: See Addendum One [Paragraph 36] Exhibits: Exhibit A - Legal Description of Building Exhibit B - Floor Plan of Premises Exhibit C - Rules and Regulations Exhibit D - Guaranty Additional Provisions: See Addendum One [Paragraph 45] **[Usufruct] [Paragraph 46] *Plus applicable sales taxes (for use in Florida and Arizona only) **For use in Georgia only. - -------------------------------------------------------------------------------- The provisions of the Lease identified above in brackets are those provisions where reference to particular Base Lease Information appear. Each reference to an item of Basic Lease Information, wherever it may appear in the Lease, shall incorporate the applicable Basic Lease Information set forth above. In the event of any conflict between any Basic Lease Information and the Lease, the latter shall control. TENANT LANDLORD By: /s/ Robert Bernardi CENTURY PROPERTIES FUND XX, ------------------------------ a California limited partnership owner of Linpro Park I By: ------------------------------ By: Metric Management, Inc., a Delaware Corporation, * its agent - --------------------------------- Witness By: /s/ Richard A. Faber ------------------------------ Richard A. Faber * Vice President - --------------------------------- Witness * --------------------------------- Witness Acknowledgment** * --------------------------------- Seal*** Witness Ateam/Linpro/basic4.doc *For use in Florida only **For use in Washington, Arizona and North and South Carolina. ***For use in Georgia only. TABLE OF CONTENTS Page 1. Definitions ........................................................... 1 2. Premises .............................................................. 2 3. Term .................................................................. 2 4. Rent .................................................................. 2 5, Taxes and Assessments ................................................. 3 6. Operating Expenses .................................................... 3 7. Estimated Payments .................................................... 3 8. Common Areas .......................................................... 4 9. Use ................................................................... 4 10. Utilities ............................................................. 5 11. Alterations, Fixtures, and Improvements ............................... 5 12. Liens ................................................................. 5 13. Repair and Maintenance of Premises .................................... 5 14. Damage and Destruction ................................................ 6 15. Indemnification ....................................................... 6 16. Insurance ............................................................. 6 17. Condemnation .......................................................... 7 18. Compliance with Legal Requirements .................................... 8 19. Assignment and Subletting ............................................. 8 20. Rules and Regulations ................................................. 8 21. Landlord's Access ..................................................... 8 22. Default ............................................................... 8 23. Landlord's Right to Cure Default ...................................... 10 24. Attorney's Fees ....................................................... 10 25. Subordination ......................................................... 10 26. No Merger ............................................................. 11 27. Sale by Landlord ...................................................... 11 28. Estoppel Certificate .................................................. 11 29. Holdover Tenancy ...................................................... 11 30. Parking ............................................................... 11 31. Security Deposit ...................................................... 11 32. No Partnership ........................................................ 11 33. Recording ............................................................. 11 34. Modification and Financing Conditions ................................. 11 35. Waiver ................................................................ 12 36. Notices and Consents .................................................. 12 37. Complete Agreement .................................................... 12 38. Corporate Authority ................................................... 12 39. Limits to Tenant's Remedy ............................................. 12 40. Brokers ............................................................... 12 41. No Light and Air Easement ............................................. 12 42. Miscellaneous ......................................................... 12 43. Signs ................................................................. 12 44. Surrender of Premises ................................................. 13 45. Additional Provisions ................................................. 13 *[46 Usufruct19] */For use in Georgia only. OFFICE/WAREHOUSE/SHOWROOM LEASE THIS LEASE, DATED January 15, 1998, for purposes of reference only, is made and entered into by and between Century Properties Fund XX ("Landlord") and The Music Connection Corporation ("Tenant"). WITNESSETH: Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord the premises described in paragraph 1 (b) below for the term and subject to the terms, covenants, agreements and conditions hereinafter set forth, to each and all of which Landlord and Tenant hereby mutually agree. 1. Definitions. Unless the context otherwise specified or requires, the following terms shall have the meanings herein specified: (a) The term "Building" shall mean the parcel of real property described on Exhibit A attached hereto, situated in the location and commonly known by the name specified in the Basic Lease Information, which name the Landlord may change at any time, and all other improvements on or appurtenances to such parcel. (b) The term "premises" shall mean that portion of a floor of the Building outlined in red on the diagrams attached hereto as Exhibit B. The premises contain the net rentable area specified in the Basic Lease Information. (c) The term "Base Year" shall mean the calendar year specified in the Basic Lease Information as the Base Year. (d) The term Base Operating Expenses shall mean (i) The operating expenses paid or incurred by Landlord in the Base Year as specified in the Basic Lease Information or (ii) the amount per square foot specified in the Basic Lease Information as "Estimated Operating Expenses," which shall be an estimate of current year expenses. In the event of any conflict regarding Base Operating Expenses, the Base Year shall prevail. (e) The term "Operating Expense" shall mean all costs paid or incurred in connection with the operation, maintenance and repair of the Building (excluding those expenses which are the responsibility of Tenant pursuant to paragraphs 6,10,13 and 16 hereof) including without limitation, all costs and expenses paid or incurred with respect to the following: operating, cleaning, sweeping, restriping, repairing and resurfacing the parking lot and driveway areas; maintenance and replanting and landscaping; maintenance, repair and replacement of landscape sprinkler systems, parking bumpers, directional signs and other signs and markets, fire protection systems, lights and light standards (including bulb replacement), drainage systems and utility systems (including heating, ventilation and air-conditioning of the Building, including any common area); janitorial services; operation and maintenance of Building signs, including depreciation on such signs if purchased and rent for such signs if leased; depreciation on all equipment purchased for the purpose of operating and/or maintaining the common area, or rent for such equipment if leased, and maintenance and repair of such equipment; rental of space outside the boundaries of the Building, if needed, for use as storage and/or maintenance of equipment, supplied, props and other items used in connection with the common area; cleaning, maintenance and repair of all sidewalks, including those situated on the perimeter of and outside the boundaries of the Building (but nothing herein contained shall be construed as obligating Landlord to clean, maintain or repair any areas of improvements outside the Building boundaries); operation, maintenance and repair of any public address system, music system. and security and alarm systems, including depreciation on such systems if purchased and rent for such systems if leased; the reasonable cost of personnel to implement such services and to regulate and administer employee parking and to police and provide security for the common area and for the buildings in the Building, including all social security and other contribution, and including workmen's compensation insurance costs paid or incurred with respect to such personnel; all premiums for public liability and property damage insurance (including, without limitation, extended and broad form coverage, risks, mudslide, land subsidence, volcanic eruption, flood and earthquake), workmen's compensations, and rental loss insurance (notwithstanding anything contained in this Lease to the contrary). Tenant's pro rata share of insurance premiums shall be in the same proportion as the rentable area of the premises bears to the total occupied rentable area of all space in all the buildings which are covered by the insurance policies herein described); fees to any property manager (including Landlord if Landlord performs property management services); the cost of compliance with all state, federal or local governmental regulations affecting the Building, including without limitation, any cleanup, removal, remedial or restoration work required by any federal, state or local governmental agency or political subdivision because of Hazardous Material (defined in paragraph 9 below) present in or about any part of the Building, including without limitation, the soil or ground water under the Building; any assessment or other charges imposed by any governmental agency including, but not limited to, assessments or other charges related to federal or state environmental protection regulations; all Property Taxes (as defined in subparagraph (h) below) and personal property taxes on all land, improvements and personal property comprising the common area and all costs and expenses incurred by Landlord in attempts to obtain reductions in taxes or assessments affecting the common area (the allocation of such taxes, assessments, costs and expenses between land constituting the common area and land under tenant leased premises to be made on a straight area prorations, and the allocation of such taxes, assessments, costs and expenses, between improvements constituting common area improvements and improvements constituting non-common area improvements to be based upon the respective original construction costs of such improvements); depreciation on mechanical equipment; or rental of such equipment if leased, and maintenance and repair of such equipment, costs of electricity, water and other utilities used with respect to the operation and maintenance of the common area; garbage and refuse removal; audit expenses; reasonable legal expenses incurred in contesting real property tax assessments and in connection with attempts to control trespassing, picketing, demonstrations, gatherings or assemblies, vandalism, thefts and any other interferences with use of the common area by persons not authorized to use the common area. (f) The term "common area" shall refer to all areas, spaces, equipment, special services, improvements, and facilities in or near the Building provided by Landlord for the common or joint use and benefit of the occupants of the Building, their officers, agents, employees, servants, customers and invitees, including but not limited to, all parking areas, access roads, streets, driveways, entrances, exits, sidewalks, courts, loading docks, 1 package pick-up stations, ramps, corridors, halls, stairs, retaining walls and landscaped areas. (g) The term "Lease Year" shall mean each twelve month period during the term hereof ending on December 31, provided that the first Lease Year shall commence upon the commencement of the term hereof and shall end of the next succeeding December 31, and the last Lease year shall end upon the expiration of the term hereof. (h) The term "Property Taxes" shall mean any form of real or personal property taxes, assessments, special assessments, fees, charges, levies, penalties, service payments in lieu of taxes, excises, assessments and charges for transit, housing or any other purpose, impositions or taxes of every kind and nature whatsoever, assessed or levied or imposed by any authority having the direct or indirect power to tax including, without limitation, any city, county, state, or federal government, or any improvement or assessment district of any kind or nature whatsoever, whether or not consented to or joined in by Landlord against the Building or any legal or equitable interest of Landlord therein or any personal property of Landlord used in the operation thereof, whether now or hereafter imposed, whether or not now customary or in the contemplation of the parties on the date of this Lease, excepting only taxes measured by the net income of Landlord from all sources; provided that Property taxes shall not include any taxes, assessments or other charges payable by Tenant pursuant to paragraph 5 below. (i) The term "Tenant's percentage share" shall mean the percentage figure specified in the Basic Lease Information. Landlord and Tenant acknowledge the Tenant's percentage share has been obtained by dividing the rentable area of the premises as specified in the Basic Lease Information, by the total occupied rentable area of the existing rental space in the Building as specified in the Basic Lease Information and multiplying such quotient by 100. In the event either the rentable area of the premises or the total occupied rentable area of the Building is changed, Tenant's percentage share shall be appropriately adjusted, and as to the calendar year in which such change occurs, Tenant's percentage share shall be determined as of the last day of the calendar quarter. 2. Premises. (a) Tenant hereby acknowledges that the premises shall be delivered in an "as is" condition and that Landlord, except as may be expressly agreed by Landlord in writing, has no obligation to alter, repair, renovate, or render fit for Tenant's occupancy, any part of the premises. Landlord reserves to itself the use of the roof, exterior walls and the area beneath the premises, together with the right to install, maintain, use, repair and replace plumbing, telephone facilities, equipment, machinery, connections, pipes, ducts, conduits, and wires leading through the premises and serving other parts of the Building in a manner and in locations which will not unreasonably interfere with Tenant's use. (b) In the event Landlord determines to permit early occupancy of the premises and, therefore, informs Tenant in writing that the premises are ready for occupancy prior to the date set forth in the Basic Lease Information for the commencement of the term of the Lease, Tenant shall have the right to take early occupancy of the premises on such date as Landlord and Tenant shall agree in writing, and notwithstanding the provisions of paragraph 3 below, the term of the Lease shall commence upon such occupancy. (c) The occupancy by Tenant of the premises shall constitute an acknowledgment by Tenant that the premises are then in good, sanitary and tenantable condition and repair. 3. Term. The term of this Lease shall commence and, unless sooner terminated, shall end on the dates respectively specified in the Basic Lease Information. If Landlord for any reason cannot deliver possession of the premises to Tenant by the date specified for term commencement, this Lease shall not be void or voidable nor shall landlord be liable to Tenant for any damage resulting therefrom, but in that event, provided that the delay is not occasioned by the act or omission of Tenant, rental shall be waived for the period between the commencement of such term and the date when possession is delivered. Provided, however, if Landlord has not delivered the premises to Tenant within six months of the Term Commencement, this Lease shall be deemed null and void without liability to either party, so long as such failure is not due to a delay caused by the act or omission of Tenant. 4. Rent. Tenant shall pay to Landlord as rental for the use and occupancy of the premises, at the times and in the manner hereinafter provided, the following sums of money: (a) Tenant shall pay to Landlord [applicable sales taxes and]* minimum rent in the amount specified in the Basic Lease Information per year, payable in equal monthly installments in advance on the commencement of the term hereof and on or before the first day of each and every successive calendar month during the term hereof. If the term commences on other than the first day of a calendar month, the first payment of rent shall be appropriately prorated on the basis of a 30-day month. (b) Effective as of the first day of each Lease Year following the first Lease year, the minimum rent set forth in the Basic Lease Information shall be adjusted upward in direct proportion to any increase in the Consumer Price Index measured from the month in which this Lease is dated to the month immediately preceding the Lease Year for which the adjustment is to be made. As used herein, the term "Consumer Price Index" shall mean the Consumer Price Index for All Urban Consumers, all items, U.S. City Average (1967 equals 100), published by the Bureau of Labor Statistics of the United States Department of Labor. In the event that the Bureau of Labor Statistics should cease to publish said Consumer Price Index, Landlord shall have the exclusive right to choose and apply any similar authoritative Consumer Price Index published by any other branch or department of the U.S. Government. In any event, the base used by the new Consumer Price Index shall be approximately reconciled to the 1967 equals 100 base Consumer Price Index. In the event the Consumer Price Index for the month preceding any Lease Year is not available on the commencement date of such Lease Year, Tenant shall continue to pay the minimum rent than in effect until such time as such Consumer Price Index is available; Tenant shall pay to Landlord the full amount of any difference between the minimum rental paid during such interim period and the actual adjusted minimum rental at the time of the next monthly rental payment following notice from Landlord of the adjustment of minimum rental. */For use in Florida and Arizona only. 2 (c) Tenant shall pay, as additional rent, all sums of money required to be paid to Landlord pursuant to paragraphs 5, 6, 7, 10, 13 and 16 below, and all other sums of money or charges required to be paid by Tenant hereunder in addition to minimum rental, whether or not the same are designated "additional rent". If such amounts or charges are not paid at the time provided in this Lease, they shall nevertheless be collectible as additional rent with the next installment of minimum rental thereafter falling due, but nothing herein contained shall be deemed to suspend or delay the payment of any amount of money or charge at the time the same becomes due and payable hereunder, or limit any other remedy of Landlord. All amounts of money payable by Tenant to Landlord under this Lease, if not paid when due, shall bear interest from the due date until paid at the rate of the greater of 15% per annum or the prime rate publicly announced by the Bank of America, N.T. & S.A. at its main office in San Francisco, California, but not to exceed the maximum rate of interest permitted by law ("Default Interest"). All payments due from Tenant to Landlord hereunder shall be made to Landlord without deduction or offset in lawful money of the United States of America at Landlord's address for notices hereunder, or to such other person at such other place as Landlord may from time to time designate in writing to Tenant. (d) Tenant hereby acknowledges that late payment by Tenant to Landlord of rent and other sums due hereunder after the expiration of any applicable grace period will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any mortgage or trust deed covering the premises. Accordingly, if any installment of rent or any other sums due from Tenant shall not be received by Landlord when due, Tenant shall pay to Landlord a late charge equal to 6% of such overdue amount, provided that if such payment is not received by Landlord within 10 days after the due date such late charge shall be 10% of the overdue amount. The parties hereby agree that such last charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of late payment by Tenant. Acceptance of such late charge by Landlord shall in no event constitute a waiver of Tenant's default with respect to such overdue amount, affect Tenant's obligation to pay interest on the overdue amount as provided above, or prevent Landlord from exercising any of the other rights and remedies available to Landlord hereunder or at law. 5. Taxes and Assessments. In addition to the monthly rental and other charges to be paid by Tenant hereunder, Tenant shall reimburse Landlord upon demand for any and all taxes, assessments, levies, fees charges and impositions whatsoever levied or imposed or assessed by any authority having the direct or indirect power to tax including, without limitation, any city, county, state or federal government or any improvement or other assessment district, whether or not consented to or joined in by Landlord, payable by Landlord (other than income taxes, measured by the net income of Landlord from all sources), whether or not now customary or within the contemplation of the parties hereto on the date of this Lease: (a) upon, measured by or reasonable attributable to the cost or value of Tenant's equipment, furniture, fixtures and other personal property located in the premises or by the cost or value of any leasehold improvements made in or to the premises by or for Tenant, other than building standard tenant improvements made by Landlord, regardless of whether title to such improvements shall be in Tenant or Landlord; (b) upon or measured by the rental payable hereunder including. without limitation, any gross income tax or excise tax levied by any city, county, state, federal or other governmental body with respect to the receipt of such rental; (c) upon or with respect to the possession, leasing, operation, management, maintenance, improvement, alteration, repair, use or occupancy by Tenant of the premises or portion thereof; (d) upon this transaction or any document to which Tenant is a party creating or transferring an interest or an estate in the premises. In the event that it shall not be lawful for Tenant so to reimburse Landlord, the monthly rental payable to Landlord under this Lease shall be revised to net Landlord the same net rental after such Imposition as would have been payable to Landlord prior to such Imposition. 6. Operating Expenses. Tenant shall, during the entire term hereof, pay to Landlord Tenant's percentage share of the amount by which all Operating Expenses paid or incurred by Landlord in any Calendar Year exceed Base Operating Expenses, if Base Year used or actual expenses in a calendar year if estimated Operating Expense used. The amount of all sums payable hereunder shall be paid by Tenant to Landlord in the manner set forth in paragraph 7 below. 7. Estimated Payments. Unless otherwise expressly designated herein, all monetary amounts payable by Tenant to Landlord pursuant to this Lease shall be payable as follows: (a) During December of each Calendar Year or as soon thereafter as practicable, Landlord shall give Tenant Notice of its estimate of amounts payable hereunder for the ensuing Calendar Year. On or before the first day of each month during the ensuing Calendar Year, Tenant shall pay to Landlord 1/12 of such estimated amounts, provided that if such notice is not given in December, Tenant shall continue to pay on the basis of the prior year's estimate until the month such notice is given. If at any time or times it appears to Landlord that the amounts payable for the current Calendar Year will vary from its estimate by more than 5%, Landlord shall, by notice to Tenant, revise its estimate for such year, in which case subsequent payments by Tenant for such year shall be based upon such revised estimate. (b) Within 90 days after the close of each Calendar Year or as soon after such 90-day period as practicable, Landlord shall deliver to Tenant a statement of amounts payable for such Calendar Year. If on the basis of such statement Tenant owes an amount that is less than the estimated payments for such Calendar Year previously made by Tenant and Tenant is not in default hereunder, Tenant shall receive a credit in the amount of such excess against the next installments due under paragraphs 6 and 7 hereof. If on the basis of such statement, Tenant owes an amount that is more than the estimated payments for such Calendar Year previously made by Tenant, Tenant shall pay the deficiency to Landlord within thirty (30) days after delivery of the statement (c) If this Lease shall terminate on other than the last day of a calendar year, the adjustment in rent applicable to the Calendar Year in which such termination shall occur shall be prorated on the basis which the number of days from the commencement of such Calendar Year to and including such expiration date bears to 365. If the adjustment in rent is not determined until after the termination of this Lease, any excess amounts due Tenant or deficiency amounts due Landlord shall be paid in cash within 30 days after delivery of the 3 statement setting forth such adjustment determination. (d) Notwithstanding the foregoing, if, at any time, Landlord incurs for any item actual costs or expenses which are reimbursable in whole or in part by Tenant pursuant to this Lease and such costs or expenses are in excess of the estimated amount budgeted for such item and otherwise payable by Tenant, then, upon written demand from Landlord accompanied by a statement of such costs of expenses, Tenant shall immediately pay to Landlord the full amount of any excess reimbursable costs or expenses. 8. Use and Maintenance of Common Area. (a) The use and occupation by Tenant of the premises shall include a right to the use in common with others entitled thereto of the common areas and other facilities as may be designated from time to time by Landlord, subject, however, to the terms and condition of this Lease. All common areas and facilities not within the premises, which Tenant may be permitted to use and occupy pursuant to this paragraph, are to be used and occupied under a revocable license, and if the amount of such areas be diminished, Landlord shall not be subject to any liability nor shall Tenant be entitled to any compensation or diminution or abatement of rent, nor shall such diminution of such areas be deemed constructive or actual eviction. (b) Landlord shall at all times dining the term of this Lease have the following rights with respect to the common area: (1) Landlord shall have the right from time to time to make changes in common area, except that Landlord shall not make any materially detrimental change in the parking ratio or in the nature of the parking facilities concerning that portion of the common area which is reasonably and customarily used by Tenant's customers. (2) Landlord shall have the right to establish and from time to time change, alter, amend and to enforce against Tenant and other users of the common areas, such reasonable rules and regulations (including the exclusion of employees' parking therefrom) as may be deemed necessary or advisable for the proper and efficient operation and maintenance of the common area. (3) Landlord shall have the sole and exclusive control of the common area, and may at any time and from time to time exclude and restrain any person from use or occupancy thereof, excepting however, bona fide customers, patrons and service suppliers of Tenant, and other tenants of Landlord who make use of the common area in accordance with the rules and regulations established by Landlord from time to time with respect thereof. Nothing herein shall limit the rights of Landlord at any time to remove any authorized persons from the common area or to restrain the use of any of said area by unauthorized persons. (4) Landlord shall have the right to post temporary or permanent signs and to temporarily close any portion or all of the common area from time to time and to such extent as Landlord reasonably deems necessary to prevent a dedication or other prescriptive right therein in favor of the public or any group or individual and to prevent the accrual of any such right, and Landlord shall have the right by temporary closure or other reasonable means to discourage or prevent the use of the common area by persons other than those expressly authorized hereby. (5) Landlord shall have the right to designate specific areas from time to time, either in the Building or reasonably close thereto, for the parking of vehicles of the employees of Tenant. If a vehicle of Tenant or its officers, agents or employees is at any time parked in a part of the Building other than the designated area, Landlord shall have the right to have the vehicle towed and to collect towing and storage charges as a condition of releasing such vehicle to its owner. 9. Use. (a) The premises shall be used solely for the permitted use as described in the Basic Lease Information and no other. Tenant shall not use or permit the premises to be used for any other purpose without Landlord's prior written consent. Landlord and Tenant hereby further acknowledge that the identity of Tenant, the specific character of Tenant's business and anticipated use of the premises and the relationship between such use and other uses within the Building has been material consideration to Landlord's entry into this Lease. Any material change in the character of Tenant's business or use shall constitute a default under this Lease. (b) Tenant shall not do or permit to be done in, on or about the premises, nor bring or keep or permit to be brought or kept therein, anything which is prohibited by or will in any way conflict with any law, statute, ordinance or governmental rule or regulation now in force or which may hereafter be enacted or promulgated, or which is prohibited by the standard form of fire insurance policy or will in any way increase the existing rate of or affect any fire or other insurance upon the Building, or cause a cancellation of any insurance policy covering the Building or any part thereof of any of its contents. Tenant shall not do or permit anything to be done in or about the premises which will in any way obstruct or interfere with the rights of other tenants of the Building or injure or annoy them, or use or allow the premises to be used for any improper, immoral, unlawful or objectionable purpose. Nor shall Tenant cause, maintain or permit any nuisance in or about or commit or suffer to be committed any waste in or upon the premises. (c) Tenant shall not cause or permit any Hazardous Material to be brought upon, kept or used in or about the premises or the Building. If Tenant breaches the obligations stated in the preceding sentence, or if the presence of Hazardous Material on the premises or the Building caused or permitted by Tenant results in contamination of the premises or the Building then Tenant shall indemnify, defend and hold Landlord harmless for, from and against any and all claims, judgments, damages, penalties, fines, costs, liabilities or losses (including without limitation, diminution in value of the Building, damages for the loss or restriction on use of rentable or usable space or of any amenity of the Building, damages arising from any adverse impact on marketing of space in the Building, and sums paid in settlement of claims, reasonable attorneys' fees, consultant fees and expert fees) which arise during or after the Lease Term as a result of such contamination. This indemnification of Landlord by Tenant includes, without limitation, costs incurred in connection with any investigation of site conditions or any clean-up, remedial, removal or restoration work required by any federal state or local governmental agency or political subdivision because of Hazardous Material present in or about any part of the Building including, without limitation, the soil or ground water under the Building. As used herein, the term "Hazardous Material" means any hazardous or toxic substance, material or waste which is or becomes regulated by any federal, state or other local governmental authority including, without limitation, any material or substance which is designated as a "hazardous substance" pursuant to Section 311 of 4 the Federal Water Pollution Control Act (33 U.S.C. Subsection 1317), defined as "hazardous waste" pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, (42 U.S.C. 6901 et seq.), or defined as a "hazardous waste" pursuant to Section 1010 of the comprehensive Environmental Response, Compensation and Liability Act, (42 U.S.C. Subsection et seq.). 10. Utilities. Tenant shall pay all initial utility deposits and fees, and all monthly service charges for water, electricity, sewage, gas, telephone and any other utility services furnished to the premises and the improvements thereon during the entire term of this Lease. In the event any such services are not separately metered or billed to Tenant but rather are billed to and paid by Landlord, Tenant shall pay to Landlord its pro rata share of the cost of such services, as determined by Landlord, together with its pro rata share of the cost of making such determination. Landlord shall not be liable for any reason for any loss or damage resulting from an interruption of any of the above services. 11. Alteration, Fixtures and Improvements. (a) Tenant shall not make or suffer to be made any alterations, additions, or improvements to or of the premises or any part thereof, or attach any fixture or equipment thereto, without first obtaining Landlord's written consent Any alterations, additions or improvements to the premises consented to by Landlord shall be made by Tenant at Tenant's sole cost and expense according to plans and specifications approved by Landlord. Landlord may require, at its option, that Tenant provide Landlord at Tenant's sole cost and expense, payment and performance bonds in an amount equal to twice the estimated cost of any contemplated alternations, fixtures, and improvements, to insure Landlord against any liability for mechanic's or materialmen's liens and to insure the completion of such work. All alternations, additions, fixtures and improvements, whether temporary or permanent in character, made in or upon the premises either by Tenant or Landlord (other than furnishings, trade fixtures and equipment installed by Tenant), shall be Landlord's property and, at the end of the term hereof, shall remain on the premises without compensation to Tenant; provided that, if Landlord so requests, Tenant shall remove all such alterations, fixtures and improvements from the premises and return the premises to the condition in which they were delivered to Tenant. Upon such removal Tenant shall immediately and fully repair any damage to the premises occasioned by the removal. (b) Landlord may perform or cause to be performed, substantial renovation and remodeling to the exterior and interior of the Building and Landlord reserves the right to enter the premises in connection therewith. Landlord shall reasonably attempt to minimize any interruption of Tenant's business caused by such renovation and remodeling. 12. Liens. Tenant shall keep the premises and the Building free from any liens arising out of any work performed, material furnished or obligations incurred by Tenant. In the event that Tenant shall not, within 10 days following the imposition of any such lien, cause the same to be released of record, Landlord shall have in addition to all other remedies provided herein and by law, the right but not the obligation to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such liens. All sums incurred by it in connection therewith including, without limitation, any attorneys' fees, court costs, and expenses of litigation, together with Default Interest thereon, shall be payable to Landlord by Tenant on demand. Nothing in this Lease shall be construed in any was as constituting the consent or request of the Landlord, expressed or imposed, by inference or otherwise to any contractor, subcontractor, laborer, or materialmen, for the performance of any labor, or the furnishing of any material for any specific improvement, alteration and repair of or to the premises or as giving Tenant the right, power or authority, to contract for or permit the rendering of any service or the furnishing of any material that would give rise to the filing of any mechanic's liens against the premises. Landlord shall have the right to post and keep posted on the premises any notices that may be provided by law or which Landlord may deem to be proper for the protection of Landlord, the premises and the Building from such liens, and Tenant shall give Landlord at least 5 days' prior notice of date of commencement of any construction on the premises in order to permit the posting of such notices. 13. Repairs and Maintenance. (a) Tenant shall at all times during the term of this Lease keep and maintain at its own cost and expense, in good order, condition and repair the entire premises (including without limitation, all improvements, fixtures and equipment thereon) making all repairs and replacements interior and exterior, above or below ground, and ordinary or extraordinary; provided, however, that if the premises are only a portion of a building which contains other leasable space, then Landlord shall keep in good order, condition and repair the foundations and exterior walls (excluding the interior of all walls and the exterior and interior of all doors, plate glass, display and other windows, and excluding interior ceiling) of the premises, except for any damage thereto caused by any act, negligence or omission of Tenant or Tenant's employees, agents, contractors or customers, except for reasonable wear and tear and except for any structural alterations or improvements required by any governmental agency by reason of Tenant's use and occupancy of the premises. Tenant shall reimburse Landlord for Tenant's pro rata share of the costs which Landlord incurs in performing its foregoing repair and maintenance obligations with respect to all of the building within the Building which Landlord is obligated to repair and maintain. Tenant's pro rata share shall be in the same proportion as the rentable area of the premises bears to the total occupied rentable area of all of the buildings in the Building which Landlord is obligated to repair and maintain. Reimbursement by Tenant to Landlord for its share of such costs shall be made in the manner set forth in paragraphs 6 and 7 hereof. It is an express condition precedent to all obligations of Landlord to repair that Tenant shall have notified Landlord in writing of the need for such repair. If Landlord shall fail to commence the making of repairs as it is obligated to do by the terms hereof within thirty (30) days after such notice and the failure to repair has materially interfered with Tenant's use of the premises, Tenant's sole right and remedy for such failure on the part of the Landlord shall be to cause such repairs to be made and to charge Landlord the reasonable cost therefor; provided that, if the repair to be performed by Landlord is of an emergency type and if Landlord after receiving notice from Tenant of such emergency fails to commence repair of same as soon as reasonably possible, Tenant may do at Landlord's cost without waiting thirty (30) days. (b) Tenant's obligation to keep and maintain the premises in good order, condition and repair shall 5 include, without limiting the generality of Tenant's obligation, all plumbing and sewage facilities in the premises, floors (including floor coverings), doors, locks and closing devices, window casements and frames, glass and plate glass, grilles, all electrical facilities and equipment, HVAC system and equipment, all other appliances and equipment of every kind and nature, and all landscaping upon, within or attached to the premises. In addition, Tenant shall at its sole cost and expense install or construct any improvements, equipment, or fixtures required by any governmental authority or agency as a consequence of Tenant's use and occupancy of the premises. Tenant shall replace any damaged plate glass within forty-eight (48) hours of the occurrence of such damage. (c) Landlord shall assign to Tenant, and Tenant shall have the benefit of, any guarantee or warranty to which Landlord is entitled under any purchase, construction or installation contract relating to a component of the premises which Tenant is obligated to repair and maintain. Tenant shall have the right to call upon the contractor to make such adjustments, replacements, or repairs which are required to be made by the contractor under such contract. (d) Landlord may at Landlord's option employ and pay a firm satisfactory to Landlord, engaged in the business of maintaining systems, to perform periodic inspections of the HVAC systems serving the premises and to perform any necessary work, maintenance or repair thereon, provided said rates are competitive. In such event, Tenant shall reimburse Landlord for all sums paid by Landlord in connection therewith, such reimbursement to be made in the manner set forth in paragraph 6 and 7 above. (e) Upon the expiration or termination of this Lease, Tenant shall surrender the premises to Landlord in good order, condition and state of repair, ordinary wear and tear excepted. Tenant hereby waives the right to make repairs at Landlord's expense under the provisions of any laws permitting repairs by a tenant at the expense of a landlord to the extent allowed by law; Landlord and Tenant have by this Lease made specific provision for such repairs and have expressly defined their respective obligations. 14. Damage and Destruction. (a) If the premises of the portion of the Building necessary for Tenant's occupancy should be damaged or destroyed during the term hereof by any casualty insurance under standard fire and extended coverage insurance policies, Landlord shall (except as hereafter provided) repair or rebuild the premises to substantially the condition in which the premises were immediately prior to such destruction. (b) Landlord's obligation under this paragraph shall in no event exceed the lesser of (1) with respect to the premises, the scope of building standard improvements installed by Landlord in the original construction of the premises, or (2) the extent of proceeds received by Landlord of any insurance policy maintained by Landlord pursuant to paragraph 16(b) below, unless Landlord nevertheless elects to repair or rebuild the premises. (c) The minimum rent shall be abated proportionately during any period in which, by reason of any damage or destruction not occasioned by the negligence or willful misconduct of Tenant or Tenant's employees or invitees, there is a substantial interference with the operation of the business of Tenant. Such abatement shall be proportional to the measure of business in the premises which Tenant may be required to discontinue. The abatement shall continue for the period commencing with such destruction or damage and ending with the completion by Landlord of such work, repair or reconstruction as Landlord is obligated to do. (d) Notwithstanding the foregoing, if the premises, or the portion of the Building necessary for Tenant's occupancy should be damaged or destroyed (1) to the extent of 10% or more of the then replacement value of either, (2) in the last 3 years of the term hereof, (3) by a cause of casualty other than those covered by fire and extended coverage insurance, or (4) to the extent that it would take, in Landlord's opinion, in excess of ninety (90) days to complete the requisite repairs, then Landlord may either terminate this Lease or elect to repair or restore said damage or destruction, in which event Landlord shall repair or rebuild the same as provided in subparagraph (a) above. If such damage or destruction occurs and this Lease is not so terminated by Landlord, this Lease shall remain in full force and effect The parties hereby waive the provisions of any law that would dictate automatic termination or grant either party an option to terminate in the event of damage or destruction. Landlord's election to terminate Landlord's obligation under this paragraph shall be exercised by written notice to Tenant given within sixty (60) days following the damage or destruction. Such notice shall set forth the effective date of the termination of this Lease. (e) Upon the completion of any such work of repair or restoration by Landlord, Tenant shall forthwith repair and restore all other parts of the premises including without limitation, non-building standard leasehold improvements and all trade fixtures, equipment, furnishings, signs and other improvements originally installed by Tenant, subject to the requirements of paragraph 11(a) above. (f) Tenant agrees during any period of reconstruction or repair of the premises to continue the operation of its business in the leased premises to the extent reasonably practicable from the standpoint of good business. 15. Indemnification. Landlord shall not be liable to Tenant and Tenant hereby waives all claims against Landlord for any injury to or death of any person or damage to or destruction of property in or about the premises of the Building by or from any cause whatsoever, including, without limitation, acts of other tenants or other third parties, gas fire, oil, electricity or leakage of any character from the roof, walls, basement or other portion of the premises or the Building. Tenant shall hold Landlord and any ground landlord harmless for, from and against and defend Landlord against any and all claims, liability, damage or loss, and for, from and against all costs and expenses, including reasonable attorneys' fees, arising out of any injury to or death of any person or damage to or destruction of any property, from any cause whatsoever (except any cause resulting solely from the gross negligence or willful act of Landlord, its authorized agents or employees) occurring in or about the premises or the Building and, if occurring on or about any portion of the common areas or elsewhere in or about the Building, when such injury or damage shall be caused in whole or in part by the act, neglect, default or omission of any duty by Tenant, its agents, employees or invitees or otherwise by any conduct or transactions of any of said persons in or about or concerning the premises, including any failure of Tenant to observe or perform any of its obligations hereunder. The provisions of this paragraph 15 shall survive the termination of this Lease with respect to any damage, injury or death occurring prior to such termination. 16. Insurance. (a) Tenant shall procure and maintain in full force and effect during the entire term hereof, at its own 6 expense and in companies acceptable to Landlord, the following policies of insurance: (1) Comprehensive liability insurance, including property damage, insuring Landlord and Tenant (and any mortgagee, ground landlord or other person or persons having an insurable interest in the Building, as Landlord may designate hereinafter called "additional designated insured") from and against all claims, demands, actions or liability for injury to or death of any persons, and for damage to property arising from or related to the use of occupancy of the premises or the operation of Tenant's business. No deductible shall be carried under this coverage without the prior written consent of Landlord. Such policy shall contain, but not be limited to; coverage for premises and operations, products and completed operations, blanket contractual, personal injury, operations, ownership, maintenance and use of owned, non-owned, or hired automobiles, bodily injury and property damage. The policy shall have limits in amounts not less than one million dollars ($1,000,000.00) per person and per occurrence. This insurance shall carry a contractual coverage endorsement specifically insuring the performance by Tenant of its indemnity agreement contained in paragraph 15 above. If in the opinion of Landlord's insurance advisor, based on a substantial increase in recovered liability claims, the aforesaid amounts of coverage are no longer adequate, then such coverage shall be proportionately increased. (2) Worker's Compensation Insurance and Employer's Liability Insurance shall have a minimum coverage of one million dollars ($1,000,000.00) per person and per occurrence. (3) Fire Insurance with standard extended coverage of "all risk" endorsement including, without limitation, vandalism and malicious mischief, to the extent of 90% of the replacement value of all furnishings, trade fixtures, leasehold improvements, equipment, merchandise and other personal property and leasehold improvements from time to time situated in, on or upon the premises. As long as this Lease is in effect, the proceeds from any such insurance shall be held in trust to be used only for the repair or replacement of the improvements, fixtures and other property so insured. (b) Landlord may elect to procure and maintain liability insurance and insurance covering fire and such other risks of direct or indirect loss or damage as it deems appropriate, including extended and broad form coverage risks, mudslide, land subsidence, volcanic eruption, flood and earthquake, on leasehold improvements in the Building. Tenant shall reimburse Landlord for the costs of all such insurance as part of Operating Expenses reimbursable pursuant to paragraph (6). Any insurance coverage herein provided shall be for the benefit of Landlord, Tenant and any additional designated insured, as their interests may appear. Tenant shall not adjust losses or execute proofs of loss under such policies without Landlord's prior written approval. (c) Should this Lease be cancelled pursuant to the provisions of paragraph 14 above by reason of damage or destruction and Tenant is thus relieved of its obligation to restore or rebuild the improvements on the premises, any insurance proceeds for damage to the premises, including all fixtures and leasehold improvements thereon, shall belong to Landlord, free and clear of any claims by Tenant. (d) All policies of insurance described in this paragraph 16 of which Tenant is to procure and maintain, shall be issued by good, responsible companies, reasonably acceptable to Landlord and any additional designated insureds within ten (10) days after delivery of possession of the premises to Tenant and thereafter within thirty (30) days prior to the termination or expiration of the term of each existing policy. All public liability and property damage policies shall contain the following provisions: (1) Landlord, and any additional designated insureds although named as insured, shall nevertheless be entitled to recovery under said policies for any loss occasioned to them, their servants, agents and employees by reason of the negligence of Tenant, its officers, agents or employees; (2) the company writing such policy shall agree to give Landlord and any additional designated insured not less than thirty (30) days' notice in writing prior to any cancellation, reduction or modification of such insurance; and (3) at the election of Landlord's mortgagee, the proceeds of any insurance shall be paid to a trustee or depository designated by Landlord's mortgagee. All public liability, property damage and other casualty policies shall be written as primary policies, not entitled to contribution from, nor contributing with, any coverage which Landlord may carry. (e) Notwithstanding anything to the contrary within this paragraph. Tenant's obligations to carry the insurance provided for herein may be brought within the coverage of a so-called blanket policy or policies of insurance carried and maintained by Tenant; provided, however, that (1) Landlord and such other persons shall be named as additional insureds thereunder as their interest may appear; (2) the coverage afforded to Landlord and such other persons will not be reduced or diminished by reason of the use of such blanket policy of insurance; and (3) all other requirements set forth herein are otherwise satisfied. (f) If Tenant should fail either to acquire the insurance required pursuant to this paragraph 16 and to pay the premiums therefor or to deliver required certificates or policies, Landlord may in addition to any other rights and remedies available to Landlord, acquire such insurance and pay the requisite premiums therefor, which premiums shall be payable by Tenant to Landlord immediately upon demand. (g) Landlord and Tenant hereby waive any rights each may have against the other for loss or damage to its property, or property in which it may have an interest, where such loss is caused by a peril of the type generally covered by fire insurance with extended coverage or arising from any cause which the claiming party was obligated to insure against under this Lease, and each party on behalf of its insurer waives any right of subrogation that the insurer might otherwise have against the other party. The parties agree to cause their respective insurance companies insuring the premises or insuring their property on or in the premises to execute a waiver of any such rights of subrogation. 17. Condemnation. (a) The term "total taking" means the taking of the fee title or Landlord's master leasehold estate to so much of the premises or a portion of the Building necessary for Tenant's occupancy by right of eminent domain or other authority of law, or a voluntary transfer under the threat of the exercise thereof, that the premises are not suitable for Tenant's intended use. The term "partial taking" means the taking of only a portion of the premises or the Building which does not constitute a total taking as above defined. (b) If during the term hereof there shall be a total taking, then this Lease, and the leasehold estate of Tenant in and to the premises, shall cease and terminate as of the date possession is taken. As used in this paragraph the phrase "date possession is taken" means the date of taking actual physical possession thereof by the condemning authority of such earlier date as the condemning authority gives notice that it shall be deemed to have taken possession. (c) If during the term hereof there shall be a partial taking of the premises, this Lease shall terminate 7 as to the portion of the premises taken on the date on which actual possession of the portion of the premises is taken pursuant to the eminent domain proceedings and this Lease shall continue in full force and effect as the remainder of the premises. The minimum rent payable by Tenant for the balance of the term shall be abated in the ratio that the net rentable area of the premises taken bears to the net rentable area of the premises immediately prior to such taking, and Landlord shall make all necessary repairs or alterations to make the remaining premises a complete architectural unit. (d) All compensation and damages awarded for the taking of the premises, any portion thereof, or the whole or any portion of the common areas or Building shall, except as otherwise herein provided belong to and be the sole property of Landlord, and Tenant shall not have any claim or be entitled to any award for diminution in value of its rights hereunder or for the value of any unexpired term of this Lease; provided, however, that Tenant shall be entitled to make its own claim for, and receive separate award that may be made for Tenant's loss of business or for the taking of or injury to Tenant's improvements, or on account of any cost or loss Tenant may sustain the removal of Tenant's trade fixtures, equipment, and furnishing, or as a result of any alterations, modifications or repairs which may be reasonably required by Tenant in order to place the remaining portion of the premises not so condemned in a suitable condition for the continuance of Tenant's occupancy. The Tenant's award pursuant to this subparagraph shall not reduce Landlord's award. (e) If this Lease is terminated pursuant to the provisions of this paragraph 17, then all rentals and other charges payable by Tenant to Landlord hereunder shall be paid up to the date upon which possession shall be taken by the condemning agency and any rentals and other charges paid in advance and allocable to the period after the date possession is taken, shall be repaid to Tenant by Landlord, and the parties shall thereupon be released from all further liability hereunder. 18. Compliance With Legal Requirements. Tenant shall at its sole cost and expense promptly comply with all laws, statutes, ordinances and governmental rules, regulations or requirements now in force or which may hereafter be in force, with the requirements of any board of fire underwriters or other similar body now or hereafter constituted, with any direction or occupancy certificate issued pursuant to any law by any public officer or officers, as well as the provisions of all recorded documents affecting the premises, as they relate to or affect the condition, use or occupancy of the premises, excluding requirements of structural changes not related to or affected by improvements made by or for Tenant or Tenant's use of the premises. 19. Assignment and Subletting. Tenant shall not assign this Lease, or any interest herein, and shall not sublet the said premises, or any part thereof or any right or privilege appurtenant thereto, or suffer any other person (the agents, servants, business visitors and customers of Tenant excepted) to occupy or use the premises or any part thereof without the written consent of Landlord provided, however, that Landlord's consent thereto shall not be unreasonably withheld; and a consent to one assignment, subletting, occupation or use by any other person shall not be deemed to be a consent to any subsequent assignment, subletting, occupation, or use by another person. Any such assignment or subletting without such consent shall be void and shall at the option of Landlord, terminate this Lease. This Lease shall not, nor shall any interest herein, be assignable as to the interest of Tenant by operation of law, without the written consent of Landlord. 20. Rules and Regulations. Tenant shall faithfully observe and comply with the rules and regulations attached to this Lease as Exhibit C and, after notice thereof, all reasonable modifications thereof and additions thereto from time to time promulgated in writing by Landlord. Landlord shall not be responsible to Tenant for the nonperformance by any other tenant or occupant of the Building of any of such rules and regulations. 21. Landlord's Access. Landlord may enter the premises at reasonable hours to (1) inspect the same; (2) exhibit the same to prospective purchasers, mortgagees or tenants; (3) determine whether Tenant is complying with all its obligations hereunder; (4) supply any service to be provided by Landlord to Tenant hereunder, (5) post notices of non-responsibility; (6) post `To Lease' signs of reasonable size upon the premises during the last 90 days of the term hereof; and (7) make repairs required of Landlord under the terms hereof or repairs to any adjoining space or utility service or make repairs, alterations or additions to the premises or any other portion of the Building, provided, however, that all such work shall be done as promptly as reasonably possible and so as to cause as little interference to Tenant as reasonably possible and that any repairs, alterations, or additions to the premises shall, when completed, not materially and adversely affect Tenant's use of the premises. Tenant hereby waives any claim for damages for any injury or inconvenience to or interference with Tenant's business and any loss of occupancy or quiet enjoyment of the premises. Landlord shall have the right to use any and all means which Landlord may deem proper to open such doors in an emergency in order to obtain entry to the premises. Any entry to the premises obtained by Landlord by any means, or otherwise, shall not under any circumstances be construed or deemed to be a forcible or unlawful entry into or a detainer of the premises or an eviction, actual or constructive, of Tenant from the premises, or any portion thereof. 22. Default If: (1) Tenant shall fail to pay any rent or other sum payable hereunder for a period of five (5) days after the same is due; (2) Tenant shall fail to observe, keep or perform any of the other terms, covenants, agreements or conditions contained herein or in the rules and regulations to be observed or performed by Tenant and such default continues for a period of thirty (30) days after notice by Landlord or beyond the time reasonably necessary for cure if such default is of a nature to require in excess of thirty (30) days to remedy; (3) Tenant shall become bankrupt or insolvent or make a transfer in fraud of creditors, or make an assignment for the benefit of creditors, or take or have taken against Tenant any proceedings of any kind under any provision of the Federal Bankruptcy Act or under any other insolvency, bankruptcy or reorganization act or, in the event any such proceedings are involuntary, such involuntary proceedings are not dismissed within sixty (60) days thereafter; (4) a receiver is appointed for a substantial part of the assets of Tenant; (5) Tenant shall vacate or abandon the premises; or (6) this Lease or any interest of Tenant hereunder shall be levied upon by any attachment or execution, then any such event shall constitute an event of default by Tenant. Upon the occurrence of any event of default by Tenant hereunder, Landlord may, at its option and without any further notice or demand, in additions to any other rights and remedies given hereunder or by law do any of the following: (a) Landlord shall have the right, so long as such default continues to give notice of termination to 8 Tenant. On the date specified in such notice (which shall not be less than three (3) days after the giving of such notice) this Lease shall terminate. (b) In the event of any such termination of this Lease, Landlord may then or at any time thereafter, re-enter the premises and remove therefrom all persons and property and again repossess and enjoy the premises, without prejudice to any other remedies that Landlord may have by reason of Tenant's default or of such termination. (c) The amount of damages which Landlord may recover in event of such termination shall include, without limitation, (1) the amount at the time of award of (A) unpaid rental earned and other sums owed by Tenant to Landlord hereunder, as of the time of termination, together with interest thereon as provided in this Lease, (B) the amount by which the unpaid rent which would have been earned during the period from termination until the award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided (computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent), (2) all legal expenses and other related costs incurred by Landlord following Tenant's default including reasonable attorneys' fees incurred in collecting any amount owed hereunder, (3) all costs incurred by Landlord in restoring the premises to good order and condition, or in remodeling, renovating or otherwise preparing the premises for reletting, and (4) all costs (including, without limitation, any brokerage commissions) incurred by Landlord in reletting the premises. For the purpose of determining the unpaid rent in the event of a termination of this Lease, the monthly rent reserved in this Lease shall be deemed to be the sum of (1) the minimum rent and (2) the Operating Expense charge and any other amounts last payable by Tenant pursuant to paragraphs 5, 6, 7, 10, 13 and 16 above. (d) Following the termination of this Lease or Tenant's right to possession hereunder (or upon Tenant's failure to remove its personal property from the premises after the expiration of the term of this Lease), Landlord may remove any and all personal property located in the premises and place such property in a public or private warehouse or elsewhere at the sole cost and expense of Tenant; such warehouser shall have all rights and remedies provided by law against Tenant as the owner of such property. In addition, in the event that Tenant shall not immediately pay the cost of storage of such property after the same has been stored for a period of thirty (30) days or more, Landlord may sell any or all thereof at a public or private sale in such manner and at such times and places as Landlord in its sole discretion may deem proper, without notice to or demand upon Tenant. Tenant waives all claims for damages that may be caused by Landlord's removing or storing or selling the property as herein provided, and Tenant shall indemnify and hold Landlord free and harmless for, from and against any and all losses, costs and damages, including without limitation all costs of court and attorneys' fees of Landlord occasioned thereby. Tenant hereby irrevocably appoints Landlord as Tenant's attorney-in-fact with the rights and powers necessary in order to effectuate the provisions of this subparagraph (d). Such appointment shall be deemed coupled with an interest. (e) Landlord shall have the right to cause a receiver to be appointed in any action against Tenant to take possession of the premises and to collect the rents or profits derived therefrom. The appointment of such receiver shall not constitute an election on the part of Landlord to terminate this Lease unless notice of such intention is given to Tenant. (f) Even though Tenant has breached this Lease and/or abandoned the premises, this Lease shall continue in effect for so long as Landlord does not terminate this Lease, the Landlord may enforce all its rights and remedies under this Lease, including the right to recover the rental in periodic actions as it becomes due under this Lease. In such event, Landlord may re-enter the premises and remove all persons and property if the premises have not been vacated, using any available summary proceeding, without such re-entry or removal being deemed a termination or acceptance of surrender of this Lease. Landlord may then elect to relet the premises for the account of Tenant for a period which may extend beyond the term hereof, and upon such other terms as Landlord may reasonably deem appropriate. Tenant shall reimburse Landlord upon demand for all costs incurred by Landlord in connection with such reletting, including, without limitation, necessary restoration, renovation, or improvement costs, reasonable attorneys' fees and brokerage commissions. The proceeds of such reletting shall be applied first to any sums then due and payable Landlord from Tenant, including the reimbursement described above. The balance, if any, shall be applied to the payment of future rent as it becomes due hereunder. (g) Tenant hereby grants to Landlord a continuing personal property lien and security interest in (1) all fixtures, furnishings and equipment now owned or hereafter acquired by Tenant that are located in the premises and used in connection with the operation of Tenant's business in the premises and all proceeds from the sale or other disposition of such fixtures, furnishings and equipment, and (2) Tenant's interest under any lease of such fixtures, furnishings and equipment (hereinafter collectively referred to as the "Collateral"), as security for the full and faithful performance by Tenant of all of its obligations under the Lease. This lien and security interest are given in addition to Landlord's statutory lien, if any, and shall be cumulative thereto. Tenant hereby waives any exemption laws, to the extent permitted by law. As to the fixtures, furnishings and equipment that constitute part of the Collateral, Tenant shall keep the Collateral in good condition and repair and shall not remove the Collateral from the premises, provided that so long as Tenant is not in default under the Lease, Tenant shall have the right to discard or dispose of, in the ordinary course of its business in the premises, items of the Collateral which become broken, inoperable, obsolete or useless to the operation of Tenant's business in the premises, and provided further that Tenant shall replace all items of the Collateral necessary to keep the premises fully fixturized, furnished and equipped. As to any equipment lease that constitutes part of the Collateral, Tenant shall perform the terms thereof and not permit the same to be modified, amended or terminated without Landlord's prior written consent. If Landlord so elects, a breach of the foregoing covenants shall constitute an event of default under this Lease. Upon the occurrence of an event of default under the Lease, Landlord shall have all of the rights and remedies provided for by law in respect to this security interest. Tenant hereby waives all right to require Landlord to proceed against Tenant or any other person, firm or corporation, to apply any Collateral it may hold at any time or to apply any Collateral in any order, or to pursue any other remedy whatsoever which it may possess. Tenant hereby authorizes and empowers Landlord to exercise its right and remedies under this paragraph without taking any action against any other person, firm or corporation and without proceeding against or applying any Collateral held by it or for its benefit, in its sole discretion. At Landlord's request, concurrently with the execution of the Lease at anytime thereafter, Landlord and Tenant shall execute and file appropriate Financing Statement covering the Collateral. Tenant shall execute 9 and deliver to Landlord any further documents which it may reasonably request in order to perfect the security interest created hereby. [(h) Landlord may change door locks if Tenant is delinquent in paying rent, provided Landlord posts notices as required by law. If Tenant abandons the premises, Landlord may permanently change the locks and Tenant shall not be entitled to a key or re-entry. No other notice requirements or lockout rights shall apply and Tenant Waiver any and all duties and/or liabilities imposed on Landlord by Section 92.008, TX. Prop. Code.]* 23. Landlord's Right to Cure Default. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be at its sole cost and expense and without any abatement of rent. If Tenant shall fail to pay any sum of money, other than rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder and such failure shall have become an event of default under paragraph 22 above, Landlord may, but shall not be obligated to so, and without waiving or releasing Tenant from any obligations of Tenant, make any such payment or perform any such other act on Tenant's part to be made or performed as in this Lease provided. All sums so paid by Landlord and all necessary incidental costs shall be deemed additional rent hereunder and shall be payable to Landlord on demand together with Default Interest from the date of expenditure by Landlord until repaid. 24. Attorneys' Fees. If as a result of any breach or default in the performance of any of the provisions of this Lease or in order to enforce its rights hereunder, Landlord uses the services of an attorney in a nonjudicial action, at trial, or upon an appeal, to secure compliance with such provisions or recover damages therefor, to exercise such rights, or to terminate this Lease or evict Tenant, Tenant shall reimburse Landlord upon demand for any and all reasonable attorneys' fees and expenses so incurred by Landlord. If Tenant shall be the prevailing party in any legal action brought by Landlord against Tenant, Tenant shall be entitled to recover for the fees of its attorneys in such amount as the court may adjudge reasonable. Tenant, to the extent permitted by law, does hereby waive any further right to attorneys' fees provided by applicable state or federal law. 25. Subordination. (a) This Lease shall be subject and subordinated at all times to all ground or underlying leases which may hereafter by executed affecting the Building, and the lien of all mortgages and deeds of trust in any amount or amounts whatsoever now or hereafter placed on or against the Building or on or against Landlord's interest or estate therein or on or against all such ground or underlying leases, all without the necessity of having further instruments executed on the part of Tenant to effectuate such subordination. Notwithstanding the foregoing (1) in the event of termination for any reason whatsoever of any ground or underlying lease hereafter executed, this Lease shall not be barred, terminated, cut off or foreclosed nor shall the rights and possession of Tenant hereunder be disturbed if Tenant shall not then be in default in the payment of rental or other sums or be otherwise in default under the terms of this Lease, and Tenant shall attorn to the Landlord of any such ground or underlying Lease, or, if requested, enter into a new lease for the balance of the original or extended term hereof then remaining upon the same terms and provisions as are in this Lease contain; (2) in the event of a foreclosure of any such mortgage or deed of trust hereafter executed or of any other action or proceeding for the enforcement thereof, or of any sale thereunder, this Lease will not be barred, terminated, cut off or foreclosed nor will the rights and possession of Tenant thereunder be disturbed if Tenant shall not then be in default in the payment of rental or other sums or be otherwise in default under the terms of this Lease, and Tenant shall attorn to the purchaser at such foreclosure, sale or other action or proceeding; and (3) Tenant agrees to execute and deliver upon demand such further instruments evidencing such subordination of this Lease, ground or underlying leases, and to the lien of any such mortgages or deeds of trust as may reasonably be required by Landlord. Tenant's covenants to subordinate this Lease to ground or underlying leases, and mortgages or deeds of trust hereafter executed is conditioned upon each such senior instrument containing the commitments specified in the preceding clauses (1) and (2); and (4) Tenant further waives the provisions of any statue or rule of law, now or hereafter in effect, which may give or purport to give Tenant any right or election to terminate or otherwise adversely affect the Lease and the obligations of Tenant hereunder in the event of such foreclosure or sale. (b) Tenant shall mail by certified or registered post, return receipt requested, or personally deliver to any landlord under a ground lease or mortgage lender a duplicate copy of any and all notices in writing which Tenant may from time to time give to or serve upon Landlord pursuant to the provisions of this Lease, and such copy shall be mailed or delivered at, or as near as possible to, the same time such notices are given or served by Tenant. No notice by Tenant to Landlord hereunder shall be deemed to have been given unless and until a copy thereof shall have been so mailed or delivered to any ground lease landlord or mortgage lender. Upon the execution of any ground lease or mortgage, Tenant shall be informed in writing of the vesting of the interest evidenced by the ground lease or mortgage. (c) Should any event of default by Landlord under this Lease occur, any ground lease landlord or mortgage lender shall have thirty (30) days after receipt of written notice from Tenant setting forth the nature of such event of default within to remedy the default; provided that in the case of a default which cannot with due diligence be cured with such 30-day period, the ground lease landlord or mortgage lender shall have the additional time reasonably necessary to accomplish the cure, provided that (i) it has commenced the curing within such thirty (30) days and (ii) thereafter diligently prosecutes the cure to completion. If the default is such that the possession of the premises may be reasonably necessary to remedy the default, any ground lease landlord or mortgage lender shall have a reasonable additional time after the expiration of such 30-day period within which to remedy such default, provided that (i) it shall have fully cured any default in the payment of any monetary obligations of Landlord under this Lease within such thirty (30) day period and shall continue to pay currently such monetary obligations as and when the same are due and (ii) it shall have acquired Landlord's estate or commenced foreclosure or other appropriate proceedings within such period, or prior thereto, and is diligently prosecuting any such proceedings. */For use in Texas only. 10 26. No Merger. The voluntary or other surrender of this Lease by Tenant, or a mutual cancellation thereof, shall not work a merger, and shall, at the option of Landlord, terminate all or any existing subleases or subtenancies, or may, at the option of Landlord, operate as an assignment to it of any or all such subleases or subtenancies. 27. Sale by Landlord. In the event the original Landlord hereunder, or any successor owner of the Building shall sell or convey the Buildings, all liabilities and obligations on the part of the original Landlord, or such successor owner, under this Lease accruing thereafter shall terminate, and thereupon all such liabilities and obligations shall be binding upon the new owner. Tenant agrees to attorn to such new owner. 28. Estoppel Certificate. At any time from time, but on not less than ten (10) days prior notice by Landlord, Tenant will execute, acknowledge and deliver to Landlord, promptly upon request, a certificate certifying (a) that this Lease is unmodified and in full force and effect (or, if there have been modifications, that this Lease is in full force and effect as modified, and stating the date and nature of each such modification), (b) the date, if any, to which rental and other sums payable hereunder have been paid, (c) that no notice has been received by Tenant of any default which has not been cured, except as to defaults specified in said certificates, and (d) such other matters as may be reasonably requested by Landlord. Tenant hereby appoints Landlord as Tenant's attorney-in-fact to execute, acknowledge and deliver such certificate if Tenant shall fail to do so within the above-prescribed time period. Any such certificate may be relied upon by any prospective purchaser, mortgagee or beneficiary under any deed of trust of the Building. 29. Holdover Tenancy. If, without objection by Landlord, Tenant holds possession of the premises after expiration of the term of this Lease, Tenant shall become a tenant from month to month upon all of the terms specified in this Lease as applicable immediately prior to expiration of such term except that minimum rent will be 150% of that applicable immediately prior to expiration of such term. Each party shall give the other notice of its intention to terminate such tenancy at least one month prior to the date of such termination. 30. Parking. (a) Any parking areas appurtenant or within the Building, or designated thereof, shall be available for the use of tenants of the Building, and, to the extent designated by Landlord, the employees, agents, customers and invitees of said tenants, subject to the rules, regulations, charges and rates as set forth by the Landlord from time to time; provided, however, that Landlord may restrict to certain portions of the parking areas, parking for Tenant or other tenants of the Building and their employees and agents, and may designate other areas to be used only by customers and invitees of tenants of the Building. Notwithstanding anything herein contained, Landlord reserves the right from time to time to make reasonable changes in, additions to, and deletions from parking areas as now or hereafter constituted. (b) Landlord, or its agents, shall have the right to cause to be removed any cars, trucks, trailers, or other motorized or nonmotorized vehicles of tenants, its employees, agents, guests or invitees that are parked in violation hereof or in violation of regulations of the Building, without liability of any kind to Landlord, its agents or employees, and Tenant agrees to hold and defend it against any and all claims, losses, or damages and demands asserted or arising in respect to or in connection with the removal of any such vehicles as aforesaid. 31. Security Deposit. Tenant has deposited with Landlord the sum specified in the Basic Lease Information (the "deposit"). The deposit shall be held by Landlord as security for the faithful performance by Tenant of all of the provisions of this Lease to be performed or observed by Tenant. If Tenant fails to pay rent or other charges due hereunder, or otherwise defaults with respect to any provision of this Lease, Landlord may use, apply or retain all or any portion of the deposit for the payment of any rent or other charge in default or for the payment of any other sum to which Landlord may become obligated by reason of Tenant's default, or to compensate Landlord for any loss or damage which Landlord may suffer thereby. If Landlord so uses or applies all or any portion of the deposit, Tenant shall within ten (10) days after demand therefore deposit cash with Landlord in an amount sufficient to restore the deposit to the full amount thereof. Tenant's failure to so do shall be a material breach of this Lease. Landlord shall not be required to keep the deposit separate from its general accounts. If Tenant performs all of Tenant's obligations hereunder, the deposit, or so much thereof as has not theretofore been applied by Landlord, shall be returned, without payment of interest or other increment for its use, to Tenant (or at Landlord's option, to the last assignee, if any, of Tenant's interest hereunder) at the expiration or earlier termination of the term hereof, and after Tenant has vacated the premises; provided that Landlord may retain such security deposit as security for the payment of any adjustment in rent following an expiration or by reason of Tenant's default, or to compensate Landlord for any loss or damage which Landlord may suffer thereby. Landlord may retain such security deposit as security for the payment of any adjustment in rent following an expiration or termination pursuant to paragraph 7 (c) above and shall, upon termination of such adjustment, apply the retained security deposit against any deficiency due Landlord and return the balance, if any, to Tenant. No trust relationship is created herein between Landlord and Tenant with respect to the deposit. Such security deposit shall not be considered an advance payment of rental or a measure of Landlord's damages in cash of default by Tenant. 32. No Partnership. It is expressly understood that Landlord does not, in any way or for any purpose, become a partner of Tenant in the conduct of its business, or otherwise, or joint venturer or a member of a joint enterprise with Tenant. 33. Recording. Tenant shall not record this Lease without the prior written consent of Landlord. 34. Modification and Financing Conditions. Landlord has obtained financing and may seek to obtain further financing for the Building, portions thereof, and the operation thereof, secured by mortgages or deeds of trust encumbering the Building. Landlord may also elect to enter into a ground lease of the Building. If any mortgage lender should require, as a condition of such financing, or pursuant to rights of approval set forth in the mortgage 11 or deed of trust encumbering the Building, or if any ground lessee should require, as a condition of such ground lease pursuant to rights of approval set forth therein, any modification of the terms or conditions of this Lease, Tenant agrees to execute such modification or amendment, provided that such modification or amendment (1) shall not increase the rental or Tenant's share of any costs in addition to minimum rent, (b) shall not materially interfere with Tenant's use or occupancy, and (c) if requested by a mortgage lender with a lien on the Building or a ground lessee pursuant to a ground lease effective as of the date hereof, shall have been requested prior to thirty (30) days after the date hereof. If Tenant should refuse to execute any modifications so required within ten (10) days after receipt of same, Landlord shall have the right by notice to Tenant to cancel this Lease, and upon such cancellation Landlord shall refund any unearned rental or security deposit, and neither party shall have any liability thereafter accruing under this Lease except as provided in paragraph 15 above. 35. Waiver. The waiver by Landlord of any term, covenant, agreement or condition herein contained shall not be deemed to be a waiver of any other then existing or subsequent breach of the same or any other term, covenant, agreement or condition herein contained. Nor shall any custom or practice which may develop between the parties in the administration of the terms hereof be construed to waive or to lessen the right of the Landlord to insist upon the performance by Tenant in strict accordance with such term. The subsequent acceptance of rent or any other sum of money or other performance hereunder by Landlord shall not be deemed to be a waiver of any preceding breach by Tenant of any term, covenant, agreement or condition of this Lease, other than the failure of Tenant to pay the particular rent or other sum so accepted, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such rent or other sum or performance. 36. Notices and Consents. All notices, demands, consents or approvals which may be given by either party to the other hereunder shall be in writing and shall be deemed to have been fully given when deposited in the United States mail, registered or certified, return receipt requested, postage prepaid, and addressed as follows: to Tenant at the address specified in the Basic Lease Information, or to such other place as Tenant may from time to time designate in a notice to Landlord at the address specified in the Basic Lease Information, or to such place as Landlord may from time to time designate in a notice to Tenant; or, in the case of Tenant, delivered to Tenant at the premises. Tenant hereby appoints as its agent to receive the service of all dispossessory or distraint proceedings and notices thereunder and person or persons in charge of or occupying the premises at the time, and, if no person shall be in charge of or occupying the same, then such service may be made by attaching the same on the main entrance of the premises. 37. Complete Agreement. There are no oral agreements between Landlord and Tenant affecting this Lease and this Lease supersedes and cancels any and all previous negotiations, arrangements, brochures, agreements, understandings, if any between Landlord and Tenant or displayed by Landlord to Tenant with respect to the subject matter of this Lease or the Building. There are no representations between Landlord and Tenant other than those contained in this Lease and all reliance with respect to any representations is solely upon the representation contained herein. This Lease may not be amended or modified in any respect whatsoever except by an instrument in writing signed by Landlord and Tenant. 38. Corporate Authority. If Tenant signs as a corporation, each of the persons executing this Lease on behalf of the Tenant does hereby covenant and warrant that Tenant is a duly authorized and existing corporation, that Tenant is qualified to do business in the state in which the Building is situated, that the corporation has full right and authority to enter into this Lease, and that each person signing on behalf of the corporation is authorized to do so. 39. Limits to Tenant's Remedy. If Landlord should default in the performance of its obligations hereunder, it is understood and agreed that any claims by Tenant against Landlord shall be limited in recourse to Landlord's interest in the Building. Tenant expressly waives any and all rights otherwise to proceed on a recourse basis against Landlord, the individual partners or Landlord, or the officers, directors and shareholders of any corporate partner of Landlord. 40. Brokers. Tenant warrants that it has had no dealing with any real estate broker or agents in connection with the location or negotiation of this Lease other than any broker or agent identified in paragraph 45 below. 41. No Light and Air Easement. No diminution or shutting off of light, air, or view by any structure which may be erected on lands adjacent to or in the vicinity of the Building shall in any way affect this Lease or impose any liability on Landlord. 42. Miscellaneous. The words "Landlord" and "Tenant" as used herein shall include the plural as well as the singular. If there be more than one Tenant, the obligations hereunder imposed upon Tenant shall be joint and several. Time is of the essence of this Lease and each and all of its provisions. Submission of this instrument for examination or signature by Tenant does not constitute a reservation of or option for lease, and it is not effective as a lease or otherwise until execution and delivery by both Landlord and Tenant. The terms, covenants, agreements and conditions herein contained shall, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators and assigns of the parties hereto. If any provisions of this Lease shall be determined to be illegal or unenforceable, such determination shall not affect any other provisions of this Lease and all such other provisions shall remain in full force and effect. Landlord and Tenant agree that each party and its counsel have reviewed this Lease and that the normal rule of construction to the effect that ambiguities are to be resolved against the drafting party is not appropriate and shall not be employed in the interpretation of this Lease. This Lease shall be governed by and construed pursuant to the laws of the state in which the Building is situated. 43. Signs. (a) Tenant shall purchase and erect one sign on the front of the premises not later than the date Tenant opens for business or within thirty (30) days of date of commencement of the Lease, whichever is sooner. Such 12 sign shall be subject to Landlord's approval including, without limitation, location, size and design. It is Tenant's responsibility to maintain, repair and replace said sign as required by Landlord during the tenure of this Lease. Upon termination of this Lease said sign shall immediately become the property of the Landlord, and by execution of this Lease, Tenant assigns all ownership of said sign to Landlord upon said termination. (b) Tenant shall keep the display windows and signs of the premises well lighted until 12:00 midnight each night or such shorter period as may be prescribed by any applicable policies or regulations adopted by any utility or governmental agency, and shall maintain adequate night lights thereafter. (c) Without the prior written consent of Landlord, Tenant shall not place or permit to be placed (1) any sign, advertising material or lettering upon the exterior of the premises or (2) any sign, advertising material or lettering upon the exterior or interior surface of any door or show window or at any point inside the premises from which the same may be visible from outside the premises. Upon request of Landlord, Tenant shall immediately remove any sign, advertising material or lettering which Tenant has placed or permitted to be placed in, on or about the premises contrary to the provisions of the preceding sentence, and if Tenant fails so to do, Landlord may enter upon the premises to remove the same at Tenant's expense. Tenant shall comply with such regulations as may from time to time be promulgated by Landlord governing signs, advertising material or lettering of all tenants in the retail area, provided that Tenant shall not be required to change any sign or lettering that was in compliance with applicable regulations at the time it was installed or placed in, on or adjacent to the premises. 44. Surrender of Premises. At the termination of this Lease, or any renewal term thereof, Tenant shall surrender the premises in the same condition (subject to the removals herein required) as the premises were on the date the Tenant opened the premises for business with the public, reasonable wear and tear expected, and shall surrender all keys for the premises to Landlord at the place then fixed for the payment of rent and shall inform Landlord of all combinations on locks, safes, and vaults, if any, in the premises. Tenant, during the last thirty (30) days of such term, shall remove all its trade fixtures, and to the extent required by Landlord by written notice, any other installations, alterations or improvements provided for in paragraph 11 hereof, before surrendering the premises as aforesaid and shall repair any damage to the premises caused thereby. Tenant's obligation to observe or perform any covenant of this Lease shall survive the expiration or other termination of the Lease Term. 45. Additional Provisions. See Addendum One. *** [46. Usufruct. This contract and Lease shall create the relationship of landlord and tenant between Landlord and Tenant; no estate shall pass out of Landlord and Tenant has only a usufruct which is not subject to levy and sale.] 13 IN WITNESS HEREOF, Landlord and Tenant have caused this instrument to be duly executed, sealed and delivered on the date set forth below. TENANT LANDLORD By /s/ Robert Bernardi CENTURY PERTIES FUND XX, ---------------------------------- a California limited partnership owner of Linpro Park I - ------------------------------------ By By: Metric Management, Inc., ---------------------------------- a Delaware Corporation, its agent - ------------------------------------ Date of Execution Date of Execution By Tenant: /s/ Robert Bernardi By Landlord: /s/ Richard A. Faber -------------------------- ------------------------ Richard A. Faber Vice President * /s/ Witness * - --------------------------- ------------------------------------- Witness Witness * * - --------------------------- ------------------------------------- Witness Witness Acknowledgment Attached** Seal*** *For use in Florida only. **For use in Washington, Arizona and North and South Carolina. ***For use in Georgia only. 14 EXHIBIT A Legal Description of Building All that tract of land situated in the County of Fairfax, Virginia, and more particularly described as follows: Parcel 1-B, being part of Block 1, Section 911, RESTON, containing 4.41172 acres as the same appears duly dedicated platted and resubdivided in Deed Book 5644, page 764, among the land records of Fairfax County, Virginia. TOGETHER WITH Sanitary Sewer Easement across a portion of Block 3, Section 911, RESTON, recorded in Deed Book 5626, page 1350 among the aforesaid land records. AND FURTHER TOGETHER WITH 10' Sanitary Sewer Easement recorded in Book 2870, page 526, and shown on plat recorded in Deed Book 4775, page 139, among the aforesaid land records. AND TOGETHER WITH AND SUBJECT TO Easements contained in Declaration of Covenants and Cross-Easement Agreement recorded in Deed Book 5821, page 4, among the aforesaid land records. Private/Team/Ateam/linpro/exhbt-A.doc EXHIBIT B --------- Rentable Floor Suite Square Feet - ----- ----- ----------- 1st 105 4,523 EXHIBIT B [GRAPHIC APPEARS HERE] LINPRO PARK I DONNALLY, LEDERER, VUJCIC, L.L.C. - -------------------------------------------------------------------------------- PROJECTS\STUDLEY\LINPRO\BASEBLDG 9401 KEY WEST AVE. ROCKVILLE MD 20860 SCA1E: 1:30 DVC BY: RLM 9/23/97 PH. (301) 590--9666, FAX (301) 590--2671 7. In the case of invasion, mob, riot, public excitement, or other circumstances rendering such action advisable in Landlord's opinion, Landlord reserves the right to prevent access to the Building during the continuance of the same by such an action as Landlord deems appropriate, including closing entrances to the Building. 8. The toilet rooms, toilets, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. The expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by the Tenant who, or whose employees or invitees, shall have caused it. 9. Except with prior consent of Landlord, no Tenant shall sell, or permit the sale in the premises or use or permit the use of any common area for the sale of newspapers, magazines, periodicals, theatre tickets or any other goods, merchandise or service. Tenant shall not carry on, or permit or allow any employee or other person to carry on the business of stenography, typewriting, or any similar business in or from the premises for the service or accommodation of occupants of any other portion of the Building, nor shall the premises of any Tenant be used for manufacturing of any kind, or any business or activity other than that specifically provided for in such Tenant's lease. 10. Tenant shall not use any advertising media which may be heard outside of the premises, and Tenant shall not place or permit the placement of any radio or television, or other communications antenna, loudspeaker, sound amplifier, phonograph, searchlight, flashing light or other device of any nature on the roof or outside of the boundaries of the premises (except for Tenant's approved identification sign or signs) or at any place where the same may be seen or heard outside of the premises. l1. All loading and unloading of merchandise, supplies, material, garbage and refuse shall be made only through such entryways and elevators and at such times as Landlord shall designate. In its use of the loading areas the Tenant shall not obstruct or permit the obstruction of said loading area and at no time shall park or allow its officers, agents or employees to park vehicles therein except for loading area and at no time shall park or allow its officers, agents or employees to park vehicles therein except for loading and unloading. 12. Landlord shall have the right, exercisable without notice and without liability to any Tenant, to change the name and street address of the Building. l3. The freight elevator shall be available for use by all Tenants in the Building, subject to such reasonable scheduling as Landlord in its discretion shall deem appropriate. The persons employed to move such equipment in or out of the Building must be acceptable to Landlord. Landlord shall have the right to prescribe the weight, size and position of all equipment, materials, furniture or other property brought into the Building. Heavy objects shall, if considered necessary by Landlord, stand on wood strips of such thickness as is necessary to properly distribute the weight. Landlord will not be responsible for loss of or damage to any such property from any cause, and all damage done to the Building by moving or maintaining such property shall be repaired at the expense of the Tenant. 14. The directory of the Building will be provided for the display of the name and location of Tenants and a reasonable number of the principal officers, partners and employees of Tenants, and Landlord reserves the right to exclude any other names therefrom. Any additional name which Tenant shall desire to place upon said bulletin board must first be approved by Landlord, and, if so approved, a charge will be made therefor. 15. No curtains, draperies, blinds, shutters, shades, screens or other coverings, hangings or decorations shall be attached to, hung or placed in, or used in connection with any window of the Building without the prior written consent of Landlord. In any event, with the prior written consent of Landlord, such items shall be installed on the office side of Landlord's standard window covering and shall in no way be visible from the exterior of the Building. 16. No Tenant shall obtain for use in the premises, ice, drinking water, food beverage, towel or other similar services, except at such reasonable hours and under such reasonable regulations as may be fixed by Landlord. 17. Each Tenant shall see that the doors of its premises are closed, locked and that all water faucets, water apparatus and utilities are shut off before Tenant or Tenant's employees leave the premises, so as to prevent waste or damage, and for any default or carelessness in this regard Tenant shall be liable for, and shall indemnify Landlord against and hold Landlord harmless for, from and against all injuries sustained by other Tenants or occupants of the Building or Landlord. On multiple-tenancy floors, all Tenants shall keep the doors to the Building corridors closed at all times except for ingress or egress. 18. No Tenant shall use any portion of the common area for any purpose when the premises of such Tenant are not open for business or conducting work in preparation therefor. 19. The requirements of the Tenants will be attended to only upon application by telephone or in person at the office of the Building. Employees of Landlord shall not perform any work or do anything outside of their regular duties unless under special instructions from Landlord. 20. Landlord may waive any one or more of these Rules and Regulations for the benefit of any particular Tenant or Tenants, but no such waiver by Landlord shall be construed as a waiver of such Rules and Regulations in favor of any other Tenant or Tenants, nor prevent Landlord from thereafter enforcing any such Rules and Regulations against any or all of the Tenants of the Building. 21. These Rules and Regulations are in addition to and shall not be construed to in any way modify, alter or amend, in whole or in part, the terms, covenants, agreements and conditions of any Lease of premises in the Building. 22. Landlord reserves the right to make such other and reasonable rules and regulations as in its judgment may from time to time be needed for the safety, care and cleanliness of the Building, and for the preservation of good order therein. ADDENDUM ONE ------------ This Addendum is attached to and made a part of the Lease by and between Century Property Fund XX (Landlord) and The Music Connection Corporation and sets forth additional terms agreed upon by the parties. In the event of any conflict between any provisions of this Addendum and any provisions of the Lease and Exhibits thereto, the provisions of this Addendum shall control. Except as otherwise modified herein, all terms and provisions of this Lease shall remain in full force and effect. 1) RENT ---- A) The Minimum Rent hereinafter referred to as "Base Rental" shall be increased annually by 3% above the preceding year's Base Rental commencing with the first anniversary of the Lease. This annual increase shall be known as the "Base Rental Adjustment." Period Base Rental ------ ----------- Year One $22.50 psf Year Two $23.18 psf Year Three $23.87 psf Year Four $24.59 psf Year Five $25.32 psf Year Six $26.08 psf Year Seven $26.87 psf B) Current Rent shall be defined as the current monthly rent equal to the sum of the current monthly Base Rental plus the current monthly charge for Excess Operating Expenses. 2) OPERATING EXPENSES ------------------ A) Base Year shall be defined as calendar year 1998 which commences the 1st of January and ends on the 31st of December. B) Tenant's prorata share of Operating Expenses that exceed Base Operating Expenses shall be known as "Excess Operating Expenses". C) In the event the Building is less than 90% occupied during the Base Year, Base Operating Expenses shall be grossed up to reflect 95% occupancy. In addition, Property Taxes shall reflect a fully improved and fully assessed Building for purposes of calculating Base Year Property Taxes in determining the Base Operating Expenses. D) (i) Section 1(e) of the Lease shall be modified to include all utility costs paid or incurred in connection with the operation, maintenance and repair of the Building. Such utilities shall include but not be limited to electric, gas, water, sewer, waste disposal and other reasonable utility costs. (ii) Section 1(e) shall be further modified to include other reasonable and customary costs paid or incurred in connection with the operation, maintenance and repair of the Building provided they do not conflict with any Operating Expense exclusions provided for in the Lease or Addendum. 3) OPERATING EXPENSES EXCLUSIONS ----------------------------- A) Operating Expenses shall be defined so as to exclude the following: (i) Any ground lease rental; (ii) Capital expenditures required by Landlord's failure to comply with laws enacted on or before the Building receives a Temporary Certificate of Occupancy; (iii) Costs incurred by Landlord with respect to goods and services (including utilities sold and supplied to tenants and occupants of the Building) to the extent that Landlord is entitled to reimbursement for such costs; (iv) Costs incurred by Landlord for the repair of damage to or defects in the Building or the Development to the extent that Landlord is reimbursed by insurance proceeds or by warranties; (v) Costs, including permit, license and inspections costs, incurred with respect to the installation or repair of tenant improvements made for other tenants in the Building or the Development or incurred in renovating or otherwise improving, decorating, painting or redecorating vacant space for tenants or other occupants of the Building or the Development; (vi) Depreciation and amortization, except on materials, tools, supplies and vendor-type equipment purchased by Landlord to enable Landlord to supply services Landlord might otherwise contract for with a third party where such depreciation and amortization would otherwise have been included in the charge for such third party's services, all as determined in accordance with generally accepted accounting principles, consistently applied, and when depreciation or amortization is permitted or required, the item shall be amortized over its reasonably anticipated useful life; (vii) Leasing commissions, attorneys' fees, and other costs and expenses incurred in connection with negotiations or disputes with present or prospective tenants or other occupants of the Building or the Development; (viii) Costs incurred by Landlord for alterations which are considered capital improvements and replacement under generally accepted accounting principles, consistently applied, except as provided in (vi) above or (xxi) below; (ix) Costs of a capital nature; except as provided in (vi) above or (xxi) below, including, without limitation, capital improvements, capital repairs, capital equipment and capital tools, all as determined in accordance with generally accepted accounting principles, consistently applied; (x) Expenses in connection with services or other benefits which are not offered to Tenant or for which Tenant is charged directly but which are provided to another tenant or occupant; (xi) Costs incurred by Landlord due to the violation by Landlord or any tenants of the terms and conditions of any lease or due to the gross negligence or willful misconduct of Landlord or Landlord's agents, employees or representatives or of independent contractors; (xii) Overhead and profit increments paid to Landlord or to subsidiaries or affiliates of Landlord for services in the Building or the Development to the extent the same exceeds the costs of such services rendered by unaffiliated third parties on a competitive basis; (xiii) Interest points and fees on debt or amortization on any mortgage or mortgages encumbering the Building or the Development; (xiv) Subject to (xii) above and to the management and administrative fee for the Building and supervision fee for the Common Areas described in the lease, Landlord's (or any of its partners') general corporate overhead and general and administrative expenses; (xv) Any compensation paid to floor parking attendants in the parking facilities or persons in commercial concessions operated by Landlord in the Building or in the parking facilities; (xvi) Subject to (xxi), rentals and other related expenses incurred in leasing air conditioning systems, elevators or other equipment ordinarily considered to be of a capital nature, except equipment not affixed to the Building which is used in providing janitorial or similar services; (xvii) All items and services for which Tenant or any other tenant reimburses Landlord or which Landlord provides selectively to one or more tenants (other than Tenant) without reimbursement; (xviii) Advertising and promotional expenditures; (xix) Electric power costs or other utilities for which any tenant directly contracts with the local public service company; (xx) Services provided and costs incurred in connection with restriping (other than repairs and maintenance) any of the parking facilities or in connection with providing tandem parking; (xxi) a) Costs for capital improvements made to reduce Operating Expenses above the amount reasonably anticipated to be saved as the result of such capital improvement; i.e., except as otherwise provided herein, costs for capital items may be passed through as an Operating Expenses cost only to the extent such items are, in the reasonable discretion of Landlord, anticipated to reduce Operating Expenses, and such costs will be adjusted as the reduction in specific Operating Expenses are known so that costs for that capital improvement will be included as an Operating Expense each year only to the extent of actual savings each year; b) Costs for capital improvements required by governmental authority for compliance with any applicable laws, regulations, rules or orders which become effective subsequent to the execution date of this Lease; c) All capital improvement costs shall be amortized over their useful life as reasonably determined by Landlord in accordance with customary property management practice and the amortization shall include interest at the greater of 10% per annum or the prime rate published in the Wall Street Journal at the time the capital improvement is made; (xxii) Tax penalties incurred as a result of Landlord's negligence or inability or unwillingness to make payments when due, it being agreed that all assessments which are not specifically charged to Tenant because of what Tenant has done, which can be paid by Landlord in installments shall be paid by Landlord in the maximum number of installments permitted by law and charged as Operating Expenses only in the year in which the assessment installment is actually paid; (xxiii) Taxes and assessments directly attributable to the above standard tenant improvements of other tenants or taxes and assessments attributable to the property of other tenants whether or not such taxes or assessments are separately paid by such tenants; (xxiv) Costs of construction and maintenance of exterior or monument signage identifying and belonging to any tenant(s) of the Building. Monument signage for the project which includes tenant identification is an allowable operating cost; (xxv) Costs of replacing or retrofitting the HVAC system to comply with current laws that regulate or prohibit the use or release of chloroflourocarbons (CFC's) or hydrocarbons (HCFC's); and (xxvi) Any other items expressly excluded from Operating Expenses pursuant to the provisions of this Lease. 4) TAXES ----- A) Notwithstanding any provision of this paragraph expressed or implied to the contrary, "real property taxes" shall not include Landlord's federal or state income, franchise, inheritance or estate taxes or any taxes excluded from Operating Expenses pursuant to Section 3 of this Addendum. 5) SQUARE FOOTAGE -------------- A) The Premises contain 4,523 square feet of rentable area as defined in the Lease and Exhibit B thereto. All references to square footage in the Lease, Exhibits and Addendums attached thereto shall be rentable square feet unless otherwise specifically noted. 6) IMPROVEMENTS ------------ A) Landlord shall deliver the Premises in "as is" condition and provide Tenant with a renovation allowance equal to $15.00 per square foot. Tenant shall be responsible for all renovation costs including but not limited to demising partition, demolition, construction, permits, architectural and MEP fees. Tenant may use up to $2.00 per square foot out of its allowance for "non improvement costs" including those associated with data, phone and security systems. Landlord shall have the right to review and approve Tenant's final space plan. Landlord shall perform the renovations contained in Tenant's final space plan and Tenant shall reimburse Landlord for any and all costs associated therewith in excess of the renovation allowance. Tenant shall reimburse Landlord for such excess renovation cost under the following schedule: 50% advance deposit prior to commencing renovations and the 50% remaining balance shall be due upon the earlier of 1) substantial completion of the renovations or 2) occupancy of the premises by Tenant. Any work performed by Tenant shall be completed in a lien free manner in accordance with paragraph 12 of the Lease. 7) OPTION TO RENEW --------------- A) So long as Tenant is not in default under this Lease, either at the time of exercise or at the time the extended term commences, Tenant will have the option to extend the initial seven (7) year term of this Lease for an additional period of five (5) years (the "Option Period") on the same terms, covenants, and conditions of this Lease, except that the monthly rent during the option period will be determined pursuant to paragraph (B). Tenant will exercise its option by giving Landlord written notice ("Option Notice") at least nine (9) months prior to the expiration of the initial term of this Lease. B) The Current Rent for the Option Period will be determined as follows: (i) Landlord and Tenant will have fifteen (15) days after Landlord receives the Option Notice within which to agree on the then-fair market rental value of the premises, as defined in paragraph (B)(iii), and rental increases to the monthly rent for the Option Period. If Landlord and Tenant agree on the Current Rent for the Option Period within fifteen (15) days, they will amend this Lease by stating the initial monthly rent and rental increases for the Option Period. (ii) If Landlord and Tenant are unable to agree on the Current Rent for the Option Period within fifteen (15) days, then, the Current Rent for the Option Period will be the then-fair market rental value of the premises as determined in accordance with paragraph(B)(iv) and the periodic rental increases will be consistent with the current market standards for rent increases at that time, in amounts and at frequencies determined by the appraisers pursuant to paragraph (B)(iv). (iii) The "then-fair market rental value of the premises" means what a landlord under no compulsion to lease the premises and a tenant under no compulsion to lease the premises would determine as rents (including monthly rental and rental increases) for the Option Period as of the commencement of the Option Period, taking into consideration the uses permitted under this Lease, the quality, size, design and location of the premises, and the rent for comparable buildings located in the vicinity of Reston, Virginia. In addition, prevailing market concessions then being offered in Reston for comparable buildings shall also be taken into account. The then-fair market rental value of the premises and the rental increases in the monthly rent for the Option Period will not be less than 105% of the previous lease year's Base Rental. (iv) Within seven (7) days after the expiration of the fifteen (15) day period set forth in paragraph (B)(ii), Landlord and Tenant will each appoint a real estate appraiser with at lease five (5) years' full-time commercial appraisal experience in the area in which the premises are located to appraise the then-fair market rental value of the premises. If either Landlord or Tenant does not appoint an appraiser within ten (10) days after the other has given notice of the name of its appraiser, the single appraiser appointed will be the sole appraiser and will set the then-fair market rental value of the premises. If two (2) appraisers are appointed pursuant to this paragraph, they will meet promptly and attempt to set the then-fair market rental value of the premises. If they are unable to agree within thirty (30) days after the second appraiser has been appointed, they will attempt to elect a third appraiser meeting the qualifications stated in this paragraph within ten (10) days after the last day the two (2) appraisers are given to set the then-fair market rental value of the premises. If they are unable to agree on the third appraiser, either Landlord or Tenant, by giving ten (10) days' prior notice to the other, can apply to the then-presiding judge of the Fairfax County Court for the selection of a third appraiser who meets the qualifications stated in this paragraph. Landlord and Tenant will bear one-half (1/2) of the cost of appointing the third appraiser and of paying the third appraiser's fee. The third appraiser, however selected, must be a person who has not previously acted in any capacity for either Landlord or Tenant. Within thirty (30) days after the selection of the third appraiser, a majority of the appraisers will set the then-fair market rental value of the premises. If a majority of the appraisers are unable to set the then-fair market rental value of the premises within thirty (30) days after the selection of the third appraiser, the three (3) appraisals will be averaged and the average will be the then-fair market rental value of the premises. 8) SUPPLEMENTAL HVAC ----------------- A) All supplemental HVAC units for Tenant's premises shall be separately metered and the cost of the meter installation and all utility charges the sole responsibility of the Tenant. B) Landlord shall supply (existing extra) HVAC unit to be used by tenant for computer room at no additional charge. 9) SERVICES -------- A) Landlord shall maintain the public and common areas of the Building, including lobbies, stairs, elevators, corridors, restrooms, windows, mechanical, plumbing and electrical systems and the structure itself, in reasonably good order and condition except for damage occasioned by the act of Tenant or Tenant's invitees, which damage shall be repaired by Landlord at Tenant's expense. Landlord shall furnish the Premises with (1) electricity for lighting and the operation of office machines, (2) heat and air conditioning to the extent reasonably required for comfortable occupancy by Tenant in its use of the Premises during regular building hours (except holidays), or such shorter period as may be prescribed by any applicable policies or regulations adopted by any utility or governmental agency, [(3) elevator service], (4) initial lighting installation (for building standard lights), (5) restroom supplies, (6) window washing with reasonable frequency, (7) janitorial service five nights per week (except labor holidays) furnished in the manner that such service is customarily furnished in comparable office buildings in the locale of the Building. Landlord shall not be in default hereunder or be liable for any damages directly or indirectly resulting from, nor shall the rental herein reserved be abated by reason of (i) the installation, use or interruption of use of any equipment in connection with the furnishing of any of the foregoing services, (ii) failure to furnish or delay in furnishing any such services when such failure or delay is caused by accident or any condition beyond the reasonable control of Landlord or by the making of necessary repairs or improvements to the Premises or to the Building, or (iii) the limitation, curtailment, rationing or restrictions on use of water, electricity, gas or any other form of energy serving the Premises or the Page 5 of 9 Building, subject to Paragraph 10 of the Lease and Section 8(c) of this Addendum. Landlord shall use reasonable efforts diligently to remedy any interruption in the furnishing of such services. Whenever heat generating machines or lighting equipment other than building standard lights are used in the Premises by Tenant which affect the temperature otherwise maintained by the air conditioning system, Landlord shall have the right to install supplementary air conditioning facilities in the Premises or otherwise modify the ventilating and air conditioning system serving the Premises, and the cost of such facilities and modifications shall be borne by Tenant. Tenant shall also pay as additional rent the cost of providing all heating or cooling energy to the Premises in excess of that required for normal office use or during hours requested by Tenant when heat or air conditioning is not otherwise furnished by Landlord. If Tenant installs lighting requiring power in excess of that required for normal office use in the Building or if Tenant installs equipment requiring power in excess of that required for normal desk-top office equipment or normal copying equipment, Tenant shall pay for the cost of such excess power as additional rent, together with the cost of installing any additional risers or other facilities that may be necessary to furnish such excess power to the Premises. Landlord at the commencement of this Lease shall equip the standard electrical fixtures of the Premises with light globes and fluorescent tubes and ballasts, as the case may be; replacement thereof shall be Tenant's responsibility and cost, and if Tenant shall request Landlord to replace same, then the cost shall be paid by Tenant to Landlord. B) Regular building hours are 7:30 a.m. to 6:00 p.m. Monday through Friday and Saturday 8:00 a.m. to 12:00 p.m. (Noon) exclusive of building holidays which for purposes of this Lease are: . New Years Day . Martin Luther King Day . George Washington Day . Memorial Day . Independence Day . Labor Day . Columbus Day . Veterans Day . Thanksgiving Day . Christmas Day C) In the event Landlord shall be unable to supply power, water or HVAC services for seven (7) consecutive days, Landlord shall abate Tenant's rent until such services are restored. D) In the event the HVAC system is insufficient to meet reasonable standards for comparable properties in Reston, Virginia, the cost of any HVAC modifications or additions shall be borne by Landlord. E) Tenant shall have access to the Premises 24 hours daily during the term of the Lease. 10) INDEMNIFICATION --------------- A) Landlord shall hold Tenant harmless for, from and against and defend Tenant against any and all claims, liability, damage or loss, and for, from and against all costs and expenses, including reasonable attorneys' fees, arising out of any injury to or death of any person or damage to or destruction of any property, from any cause whatsoever occurring in or about the common areas or a portion of the Building not occupied by Tenant, except when such injury or damage shall be caused in whole or in part by the act, neglect, default or omission of any duty by Tenant, its agents, employees or invitees or otherwise by any conduct or transactions of any said persons in or about or concerning the common areas or portions of the Building not occupied by Tenant 11) PARKING ------- A) Tenant shall have the right to park 5.0 automobiles per 1,000 square feet leased on the surface parking area free of charge during the term of this Lease. Notwithstanding anything contained herein to the contrary, the parking area will be impacted by VDOT during the widening of Wiehle Avenue which Tenant acknowledges is beyond Landlord's control and shall not constitute a Landlord default or interruption in services due to the activities associated with the road work. Landlord will use commercially reasonable efforts to alleviate problems in the event of material parking problems caused by VDOT. Page 6 of 9 12) HOLDOVER -------- A) The holdover rental pursuant to Section 29 of the Lease shall be as follows: . Holdover with Landlord's consent will be 150% of the Current Rent (subject to continuing escalations) up to a maximum of three months. Holdover thereafter shall be 200% of the Current Rent (subject to continuing escalations). . Holdover without Landlord's consent will be 200% of the Current Rent (subject to continuing escalations). 13) ASSIGNMENT AND SUBLETTING ------------------------- A) Tenant shall have the right to fully assign or sublease all or any part of the Premises, or allow any other person or entity to occupy or use all or any part of the Premises, subject only to obtaining Landlord's prior written consent regarding the Subtenant, which consent will not be unreasonably withheld or delayed. Approval or consent shall not be required for a sublet or assignment to any related entity or affiliate or successor of Tenant. Any assignment, encumbrance or sublease without Landlord's prior written consent shall be void and shall constitute a default. No consent to any assignment, encumbrance or sublease shall constitute a waiver of the provisions of this Section with respect to any subsequent assignment, encumbrance or sublease. Landlord shall have the right to require any assignee or subtenant which is not a Tenant related entity or affiliate, to establish a reasonable Security Deposit prior to Landlord consent. Tenant shall be and remain liable and responsible for payment and performance of all obligations under the Lease pursuant to any permitted assignment or sublease. B) If for any proposed assignment or sublease approved by Landlord, Tenant receives rent or other consideration, either initially or over the term of the assignment or sublease, in excess of the rent called for hereunder, or, in case of the sublease of a portion of the Premises, in excess of such rent fairly allocable to such portion, after appropriate adjustments to assure that all other payments called for hereunder are taken into account, Tenant shall pay to Landlord as additional rent hereunder fifty percent (50%) of the profit or other consideration received by Tenant promptly after its receipt, unless such subtenant or assignee is a Tenant related entity or affiliate in which case Tenant may keep one-hundred percent (100%) of the profit payments received by Tenant. Profits shall be defined as sublet revenue less sublet expenses which shall include by way of example and not be limited to: rental abatement, operating expenses, construction/renovation costs, architectural and design fees, legal and accounting fees, brokerage commissions, marketing and advertising costs, moving allowances, cash allowances, and other reasonable and customary expenses. C) Occupancy of all or part of the Premises by parent, subsidiary, or affiliated companies of Tenant shall not be deemed an assignment or subletting. Regarding this paragraph (c) and any change in Tenant's controlling interest as stated herein as of the date of this Lease, Tenant shall provide Landlord with financial or other reasonable information requested by Landlord, regarding any such change in Tenant's interest. Landlord's consent regarding any change in Tenant's controlling interest shall not be unreasonably withheld or delayed. Provided Tenant is not in default, Landlord shall not have the ability to recapture any subleased space during the initial or any extended term of the Lease. 14) REPAIRS AND MAINTENANCE ----------------------- A) Notwithstanding the provisions of Section 13 of the Lease, Landlord shall repair and maintain the structural portions of the Building, including but not limited to the roof, the basic plumbing, air conditioning, heating and electrical systems, installed and furnished by Landlord, unless such maintenance and repairs are caused in part or in whole by the act, neglect, fault or omission of any duty by Tenant, its agents, servants, employees or invitees, in which case Tenant shall pay to Landlord the reasonable cost of such maintenance and repairs. Landlord shall not be liable for any failure to make any such repairs or to perform any maintenance unless such failures shall persist for an unreasonable time, considering all factors, including the availability of material, utilities and labor, after written notice of the need of such repairs or maintenance is given to Landlord by Tenant. There shall be no abatement of rent and no liability of Landlord by reason of any injury to interference with Tenant's business arising from the making or failure to make any repairs, alterations or improvements in or to any portion of the Building or the Premises or in or to fixtures, appurtenances, and equipment therein, except where such injury is a result of Landlord's negligence. Landlord shall be responsible for the cost of damage, repairs or maintenance directly resulting from the negligence or willful misconduct of the Landlord, its authorized agents or employees. Page 7 of 9 B) Except for maintenance and repairs caused by Tenant as described in Paragraph (A) above, Tenant's responsibilities under the repairs and maintenance provisions of this Lease shall be limited to those improvements constructed specifically for Tenant and shall not include building mechanical, plumbing or electrical systems unless such systems were constructed as a part of Tenant's improvements (for example, supplemental HVAC). 15) SIGNAGE ------- A) Tenant shall have the right to install its sign or logo on 50% of the area contained on a single standard sign panel located on each of the project's exterior monument signs. The signage text or logo color shall be consistent with existing standard project signage and Landlord shall have sole and absolute discretion regarding the approval of any and all signage. B) Paragraphs (a) and (b) of Section 43 in the Lease are hereby deleted. 16) BROKERAGE AND AGENCY DISCLOSURE ------------------------------- A) In this transaction, Julien J. Studley, Inc. represents the Landlord. The Landlord shall be responsible for all brokerage fees associated with this transaction. Landlord and Tenant hereby acknowledge that the above agency disclosures were made at the beginning of the transaction process and the parties hereby consent to the above. B) Tenant and Landlord each represent and warrant that they have not dealt with any real estate brokers, agents or finders other than Julien J. Studley, Inc. and The Trammell Crow Company. Each party hereby agrees to indemnify the other from liability arising from any breach of such representation and warranty including costs of reasonable attorneys fees in connection therewith. 17) USE --- A) Landlord represents that it is unaware of any "Hazardous Materials" on the site or in the building. In addition, Landlord represents and warrants that the air in the Demised Premises and the Common Areas are free and shall remain free, during the term of this Lease, of any concentrations of asbestos or radon that violate any Federal, State Local laws or present a health hazard to Tenant's employees or customers. Landlord shall promptly cure any such asbestos or radon hazard. Tenant has the duty to notify Landlord of any hazardous materials that Tenant or Tenant's employee's become aware of so that Landlord may initiate appropriate action. 18) ADDRESSES FOR NOTICE -------------------- Tenant's address for notices: (Prior to occupancy) (After occupancy) THE MUSIC CONNECTION CORP. THE MUSIC CONNECTION CORP. 250 Exchange Place 1831 Wiehle Avenue Suite A Suite 105 Herndon, VA 20170 Reston, VA 20190 Landlord's address for notices: Metric Property Management 1100 Circle 75 Parkway Suite 710 Atlanta, GA 30339 Attn: Regional Vice President 19) SECURITY DEPOSIT/LETTER OF CREDIT --------------------------------- In addition to the cash security deposit equal to one month's rent, Tenant shall provide Landlord with an irrevocable Letter of Credit in the amount of $50,000 within five (5) days of execution of this Lease. The Letter of Credit shall be in a form acceptable to Landlord and from a national or large regional financial institution approved by Landlord in its sole but reasonable discretion. The Letter of Credit can be removed upon three (3) years of Tenant faithfully meeting its lease obligations without any events of default occurring. The Letter of Credit shall be treated as an additional security deposit under the terms and conditions contained in Section 31 of the Lease. Page 8 of 9 TENANT THE MUSIC CONNECTION CORPORATION BY: /s/ Robert Bernardi ------------------------------ NAME: ---------------------------- TITLE: --------------------------- DATE: ---------------------------- WITNESS: ------------------------- LANDLORD CENTURY PROPERTIES FUND XX, a California limited partnership owner of Linpro Park I By: Metric Management, Inc., a Delaware Corporation, its agent By: /s/ Richard A. Faber 1/27/98 ----------------------------------- Richard A. Faber Vice President Page 9 of 9 AMENDMENT TWO ------------- This Amendment Two is attached to and made a part of the Lease by and between Century Properties Fund XX (Landlord) and The Music Connection Corporation and sets forth additional terms agreed upon by the parties. In the event of any conflict between any provisions of this Amendment Two and any provisions of the Lease (including Addendum One, Amendment One and Exhibits thereto), the provisions of this Amendment Two shall control. Except as otherwise modified herein, all terms and provisions of the Lease shall remain in full force and effect. 1) TERM COMMENCEMENT/RENT COMMENCEMENT/EXPIRATION ---------------------------------------------- The Term Commencement Date is June 26, 1998, which represents the Tenant move-in date. The Term Expiration Date shall be June 30, 2005. Rent shall commence and be payable effective June 26, 1998. The prorated rent due for June is one thousand four hundred thirteen and 44/100 ($1,413.44). TENANT THE MUSIC CONNECTION CORPORATION BY: /s/ Robert Bernardi ----------------------------------- NAME: Robert P. Bernardi --------------------------------- TITLE: Chairman/CEO -------------------------------- DATE: 7/27/98 --------------------------------- WITNESS: /s/ witness ------------------------------ LANDLORD CENTURY PROPERTIES FUND XX, a California limited partnership Owner of Linpro Park One By: Metric Management, Inc., a Delaware Corporation, Agent For Owner By: ----------------------------------- Tim Brock, Regional Vice President 1) TERM COMMENCEMENT AND EXPIRATION -------------------------------- The Lease is scheduled to commence on April 1, 1998. However, the Premises might not be ready for occupancy by that date. Provided that Tenant has diligently pursued all tasks required to complete the renovation improvements and has not caused any delays by its actions or failure to act, Landlord will consider adjusting the Term Commencement Date to reflect the actual completion date. The Lease term shall run for seven (7) years from the actual Term Commencement Date through the Term Expiration Date. The actual Term Commencement Date will documented in an estoppel certificate which shall be completed shortly after occupancy. In the event the Term Commencement Date commences on a date other than the first of the month, the Term Expiration Date shell be seven (7) years starting from the first full month following the Term Commencement Date. 2) SECURITY DEPOSIT/LETTER OF CREDIT --------------------------------- In lieu of the Letter of Credit Tenant is required to provide as described in Addendum One, Tenant shall have the option to provide Landlord with an additional cash security deposit in the amount of $50,000 Landlord shall place the supplemental security deposit in an interest bearing account (certificate of deposit or money market at Landlord's discretion). This supplemental security deposit plus accrued interest shall be returned upon three (3) years of Tenant faithfully meeting its lease obligations without any events of default occurring. The Letter of Credit and/or the supplemental security deposit shall be treated as an additional security deposit under the terms and conditions contained in Section 31 of the Lease. TENANT THE MUSIC CONNECTION CORPORATION BY: /s/ Robert Bernardi ----------------------------------- NAME: Robert P. Bernardi --------------------------------- TITLE: Chairman/CEO -------------------------------- DATE: March 20, 1998 --------------------------------- WITNESS: /s/ witness ------------------------------ LANDLORD CENTURY PROPERTIES FUND XX, a California limited partnership By: Metric Management, Inc., a Delaware Corporation, as Attorney-In-Fact By: /s/ Richard A. Faber ----------------------------------- Richard A. Faber Vice President EX-23.1 9 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "EXPERTS" and to the use of our report dated February 5, 1999 (except for Note 11, as to which the date is , 1999) in the Registration Statement (Form S-1 No. 33-00000) and the related Prospectus of musicmaker.com, Inc. (formerly The Music Connection Corporation) dated February 19, 1999. Ernst & Young LLP Vienna, Virginia , 1999 - ------------------------------------------------------------------------------- The foregoing consent is in the form that will be signed upon the completion of the restatement of the capital accounts for the reverse stock split as described in Note 11 to the financial statements. /s/ Ernst & Young LLP Vienna, Virginia February 19, 1999 EX-23.3 10 EXHIBIT 23.3 EXHIBIT 23.3 Consent of Darby & Darby P.C. ----------------------------- We consent to the reference to our firm under the captions "Risk Factors--We Depend Upon Intellectual Property Rights and Risk Having Such Rights Infringed" and "Business--Intellectual Property and Proprietary Rights" in the Registration Statement (Form S-1, No. ________________) and the related Prospectus of musicmaker.com, Inc. (formerly the Music Connection Corporation), dated February 19, 1999. /s/ Darby & Darby P.C. New York, New York February 19, 1999 EX-27 11 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AUDITED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 972,954 0 99,029 0 0 1,097,378 552,688 (191,979) 3,233,963 1,385,145 0 3,434,700 0 27,080 (2,339,748) 3,233,963 74,028 74,028 46,821 46,821 4,699,789 0 0 (4,654,767) 0 0 0 0 0 (4,654,767) (2.13) (2.13)
-----END PRIVACY-ENHANCED MESSAGE-----