NEW YORK (03/30/2000) - You know you're in trouble when your accountant says you're running out of cash. That's the predicament CDnow finds itself in now that Arthur Andersen, the firm's independent public accountant, has revealed that the retailer has just enough cash to operate through Sept. 30, 2000.
Beyond that, it's anybody's guess.
CDnow "has suffered recurring losses from operations, has a working capital deficiency and significant payments due in 2000 related to marketing agreements that raises substantial doubt about its ability to continue as a going concern," the accounting firm wrote in a Jan. 28 letter to CDnow's management.
The eye-opening disclosure came to light when the company filed its annual report with the Securities and Exchange Commission on Tuesday evening.
CDnow included the Andersen letter in its annual report. In midday trading, the stock, which has been on a progressive slide for more than 18 months, was in a tailspin. The stock had fallen nearly 25 percent to $3.81 a share. The company's CEO, Jason Olim, could not be reached for comment. CDnow reports that it has $40 million in cash and assets at its disposal. But the math does not favor the Fort Washington, Penn.-based retailer. Its quarterly burn rate - the rate at which the firm is spending cash - hovers at about $15 million, meaning that its reserve will run out in roughly six months.
In a belt-tightening move, the company announced on March 20 that it would trim operating expenses. But it's clear that the company needs to find a partner or risk bankruptcy, a rarity among Net firms. To that end, the company announced last week that it has retained the services of Allen & Co. to explore strategic options and new sources of funding. CDnow's problem, according to Goldman Sachs analyst Anthony Noto, is that its industry doesn't lend itself to a category killer.
The music-retailing industry is relatively small, constituting roughly $12 billion in the U.S. Moreover, music is available everywhere - from corner record stores to neighborhood supermarkets. Such stiff competition leads to rampant discounting. Retailers such as Wal-Mart and Amazon.com "sometimes sell CDs at a loss ... because they can get [customers] to come and buy other items," Noto says.
The latest hint of trouble started last week when Barron's published a report stating that CDnow had less than a month's worth of cash remaining. The company issued a press release refuting the story, citing an infusion that had pushed its reserves to $40 million. CDnow began as an online retail pioneer. Launched in 1994 by twentysomething twin brothers Jason and Matthew Olim, the company took an early lead in the now-crowded field of selling CDs and music merchandise on the Web.
The firm rode its early momentum to a February 1998 IPO. Amazon entered the fray later that year, however, and quickly became top dog. To keep up, CDnow merged with its next-closest rival, N2K, in a deal completed in March 1999, but that union failed to unseat Amazon. Last July, CDnow announced that it would merge with Columbia House, the unit - jointly owned by Time Warner and Sony - which popularized offers of multiple CDs for a penny.
The companies scuttled that merger last month. However, in a charitable termination agreement, Time Warner and Sony agreed to commit $51 million to the flagging online retailer. At the time, CDnow announced that the amount would go toward debts and operating expenses. Unless a white knight shows up to fund it - or buy it - the company has the resources to run through the summer.
Christmas is doubtful. Get ready for a glut of Santana CDs.