<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
___________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________________
TO _____________________.
Commission File Number 000-25977
___________
LIQUID AUDIO, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0421089
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2221 Broadway, Redwood City, CA 94063
----------------------------------------- ----------------------------
(Address of principal executive offices) (Zip Code)
(650) 549-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) had been subject to such filing
requirements for the past 90 days. X Yes _____________No
---------
As of October 31, 2000, there were 22,395,388 shares of registrant's Common
Stock outstanding.
<PAGE>
LIQUID AUDIO, INC.
INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION............................................................................................. 3
ITEM 1. FINANCIAL STATEMENTS............................................................................................ 3
Condensed Consolidated Balance Sheet as of September 30, 2000 and December 31, 1999
Condensed Consolidated Statement of Operations for the three months ended September 30, 2000 and
1999, and for the nine months ended September 30, 2000 and 1999
Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2000 and
1999
Notes To Condensed Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................................................................... 10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................................................... 28
PART II. OTHER INFORMATION................................................................................................. 29
ITEM 1. LEGAL PROCEEDINGS............................................................................................... 29
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS....................................................................... 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................................................ 30
SIGNATURES................................................................................................................. 31
INDEX TO EXHIBITS FOR FORM 10-Q............................................................................................ 32
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LIQUID AUDIO, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(unaudited) (audited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................................................. $ 80,508 $ 138,692
Short-term investments................................................................ 53,097 19,157
Accounts receivable, net.............................................................. 900 316
Receivables from related parties...................................................... 1,928 435
Other current assets.................................................................. 2,192 638
----------- ----------
Total current assets............................................................... 138,625 159,238
----------- ----------
Investment in related party............................................................. 1,331 1,959
Property and equipment, net............................................................. 8,394 4,857
Other assets............................................................................ 224 220
----------- ----------
Total assets..................................................................... $ 148,574 $ 166,274
=========== ==========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable...................................................................... $ 2,884 $ 1,952
Accrued expenses and other current liabilities........................................ 4,064 2,901
Deferred revenue...................................................................... 1,521 1,572
Capital lease obligations, current portion............................................ 131 194
Equipment loan, current portion....................................................... 589 589
----------- ----------
Total current liabilities.......................................................... 9,189 7,208
----------- ----------
Capital lease obligations, non-current portion.......................................... 78 149
Equipment loan, non-current portion..................................................... 291 731
Note payable to related party........................................................... 419 441
----------- ----------
Total liabilities................................................................ 9,977 8,529
----------- ----------
Stockholders' equity:
Common stock.......................................................................... 22 22
Additional paid-in capital............................................................ 202,415 198,973
Unearned compensation................................................................. (458) (1,097)
Accumulated deficit................................................................... (63,359) (40,225)
Accumulated other comprehensive income................................................ (23) 72
----------- ----------
Total stockholders' equity....................................................... 138,597 157,745
----------- ----------
Total liabilities and stockholders' equity....................................... $ 148,574 $ 166,274
=========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE>
LIQUID AUDIO, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share amount; unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- ----------------------------------
2000 1999 2000 1999
------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Net revenues:
License................................................ $ 174 $ 476 $ 1,017 $ 1,129
Services............................................... 727 177 2,343 367
Business development (related party)................... 2,454 1,132 6,444 1,565
----------- ----------- ------------ ------------
Total net revenues............................... 3,355 1,785 9,804 3,061
----------- ----------- ------------ ------------
Cost of net revenues:
License................................................ 64 58 160 156
Services............................................... 720 324 2,090 649
Business development (related party)................... 7 66 75 68
----------- ----------- ------------ ------------
Total cost of net revenues....................... 791 448 2,325 873
----------- ----------- ------------ ------------
Gross profit............................................ 2,564 1,337 7,479 2,188
Operating expenses:
Sales and marketing.................................... 4,694 2,533 12,439 6,449
Research and development............................... 6,088 3,449 16,850 7,710
General and administrative............................. 2,055 741 5,373 1,741
Strategic marketing--equity instruments................ 550 826 1,625 2,190
Stock compensation expense............................. 103 330 368 1,119
----------- ----------- ------------ ------------
Total operating expenses......................... 13,490 7,879 36,655 19,209
----------- ----------- ------------ ------------
Loss from operations.................................... (10,926) (6,542) (29,176) (17,021)
Other income, net....................................... 2,209 722 6,670 986
Minority interest in loss of related party.............. (175) -- (628) --
----------- ----------- ------------ ------------
Net loss............................................... $ (8,892) $ (5,820) $ (23,134) $ (16,035)
=========== =========== ============ ============
Net loss per share:
Basic and diluted...................................... $ (0.40) $ (0.35) $ (1.05) $ (2.07)
=========== =========== ============ ============
Weighted average shares................................ 22,304 16,821 22,033 7,755
=========== =========== ============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE>
LIQUID AUDIO, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands; unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
----------------------------------------------
2000 1999
------------------- -------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................ $ (23,134) $ (16,035)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization........................................ 2,333 646
Amortization of unearned compensation................................ 368 1,119
Allowance for doubtful accounts...................................... 155 33
Equity investment losses............................................. 628 378
Strategic marketing-equity instruments............................... 1,625 2,190
Common stock issued for legal settlement............................. 354 --
Other................................................................ (22) 49
Changes in assets and liabilities:
Accounts receivable................................................ (739) 160
Receivables from related parties................................... (1,493) (327)
Other assets....................................................... (672) (650)
Accounts payable................................................... 932 1,375
Accrued expenses and other current liabilities..................... 1,286 1,429
Deferred revenue................................................... (51) 14
--------------- -------------------
Net cash used in operating activities.............................. (18,430) (9,619)
--------------- -------------------
Cash flows from investing activities:
Acquisition of property and equipment................................... (5,870) (3,422)
Sales/(purchases) of short-term investments, net........................ (34,035) (4,602)
--------------- -------------------
Net cash used in investing activities.............................. (39,905) (8,024)
--------------- -------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of repurchases.............. 725 66,013
Payments made under capital leases...................................... (134) (148)
Proceeds from equipment loan............................................ -- 846
Payments made under equipment loan...................................... (440) (298)
--------------- -------------------
Net cash provided by financing activities.......................... 151 66,413
--------------- -------------------
Net decrease in cash and cash equivalents................................. (58,184) 48,770
Cash and cash equivalents at beginning of period.......................... 138,692 14,143
--------------- -------------------
Cash and cash equivalents at end of period................................ $ 80,508 $ 62,913
=============== ===================
Supplemental disclosures:
Cash paid for interest.................................................. $ 122 $ 138
Non-cash investing and financing activities:
Acquisition of property and equipment through capital leases............ $ -- $ 37
Issuance of common stock for services rendered.......................... 1,181 1,100
Issuance of warrants in connection with a strategic marketing
agreements........................................................... 1,307 1,090
Issuance of common stock upon exercise of warrant....................... 107 --
Issuance of common stock for intellectual property...................... 16 --
Equity investment with note payable..................................... -- 378
</TABLE>
See accompanyong notes to condensed consolidated financial statements
5
<PAGE>
LIQUID AUDIO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION:
The Company
Liquid Audio, Inc. (the "Company") was incorporated in California in January
1996 and reincorporated in Delaware in April 1999, and in July 2000 established
a wholly-owned subsidiary, Liquid Audio Europe PLC, in the United Kingdom, with
the goal of becoming the premier provider of software applications and services
that enable the secure delivery and sale of digital music over the Internet. To
this end, the Company has developed an end-to-end solution for promoting and
distributing music over the Internet. The Company's solutions enable the secure
distribution of high quality music files while providing consumers with the
ability to access, preview and purchase that music via the Internet.
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included.
Principles of consolidation
The financial statements include the accounts of the Company and its subsidiary.
Significant intercompany transactions and balances have been eliminated.
Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes a
new model for accounting for derivatives and hedging activities and supercedes
and amends a number of existing accounting standards. SFAS No. 133 requires that
all derivatives be reported on the balance sheet at their fair market value and
the corresponding derivative gains or losses be either reported in the statement
of operations or as a deferred item depending on the type of hedge relationship
that exists with respect to any derivatives. In July 1999, the FASB issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133." SFAS No. 137 deferred
the effective date until fiscal years commencing after June 15, 2000. In June
2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities". SFAS No. 138 amends certain terms
and conditions of SFAS No. 133. The Company will adopt SFAS No. 133 and 138 in
its quarter ending March 31, 2001. The Company does not believe that the
pronouncement will have a material impact on its financial position or results
of operations as currently conducted.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin 101, "Revenue Recognition" ("SAB 101"). SAB 101 outlines the
basic criteria that must be met to recognize revenue and provides guidance for
presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with the SEC. In June 2000, the SEC
issued SAB 101B to defer the effective date of implementation of SAB 101 until
the fourth quarter of fiscal 2000. The Company believes that adopting SAB 101
will not have a material impact on the its financial position or results of
operations.
Reclassifications
Certain reclassifications have been made to the prior periods' consolidated
financial statements to conform to the current period presentation. The
reclassifications had no effect on net loss, stockholders' equity or cash flows.
6
<PAGE>
LIQUID AUDIO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 2 - BALANCE SHEET COMPONENTS (IN THOUSANDS):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Accounts receivable, net:
Accounts receivable............................... $ 1,164 $ 468
Less: Allowance for doubtful accounts............. (264) (152)
------------- ------------
$ 900 $ 316
============= ============
</TABLE>
Write-offs against the allowance for doubtful accounts were $7,000 and
$129,000 for the three months ended September 30, 2000 and the year ended
December 31, 1999, respectively
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Property and equipment:
Computer equipment and purchased software......... $ 11,120 $ 5,614
Furniture and fixtures............................ 812 544
Leasehold improvements............................ 544 448
------------- ------------
12,476 6,606
Less: accumulated depreciation and amortization.. (4,082) (1,749)
------------- ------------
$ 8,394 $ 4,857
============= ============
</TABLE>
Property and equipment includes $784,000 of equipment under capital leases at
September 30, 2000 and December 31, 1999. Accumulated depreciation and
amortization for equipment under capital leases was $712,000 and $581,000 at
September 30, 2000 and December 31, 1999, respectively.
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Accrued expenses and other current liabilities:
Compensation and benefits.......................... $ 2,337 $ 1,305
Consulting and professional services............... 731 418
Accrued marketing expenses......................... 46 282
Other.............................................. 950 896
------------- ------------
$ 4,064 $ 2,901
============= ============
</TABLE>
NOTE 3 - RELATED PARTIES:
In April 1998, the Company signed an agreement with a strategic partner to
establish a Japanese corporation, Liquid Audio Japan ("LAJ"). LAJ is the
exclusive reseller and distributor of the Company's software products in Japan.
The Company owns 6.92% of the outstanding common stock of LAJ and is accounting
for its investment in LAJ using the equity method of accounting. In December
1998, the company signed an agreement with another strategic partner to
establish a Korean corporation, Liquid Audio Korea ("LAK"), to develop a local
business to enable the digital delivery of music to customers in Korea using the
Company's technology and products. The Company owns 40% of the outstanding
common stock of LAK and is accounting for its investment in LAK using the equity
method of accounting. In June 2000, the Company signed an agreement with a
strategic partner to establish a British Virgin Islands corporation, Liquid
Audio Greater China ("LAGC"). LAGC will be the exclusive reseller of the
Company's products in Taiwan and Hong Kong and will work to develop business
services that enable the digital delivery of music in the local markets. The
Company will own 40% of the outstanding common stock of LAGC and will account
for its investment in LAGC using the equity method of accounting. In September
2000, the Company signed an agreement with a strategic partner to establish a
Singaporean corporation, Liquid
7
<PAGE>
Audio South East Asia ("LASE"). LASE will be the exclusive reseller of the
Company's products in Singapore, Thailand, Malaysia, Indonesia, Philippines,
Australia and New Zealand and will work to develop business services that enable
the digital delivery of music in the local markets. The Company will own 30% of
the outstanding common stock of LASE and will account for its investment in LASE
using the equity method of accounting.
Business development revenues are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Business development revenues:
Consulting and other services.......... $ 426 $ 910 $ 1,131 $ 1,243
License fees and other................. 2,028 222 5,313 322
---------- ---------- ---------- ----------
$ 2,454 $ 1,132 $ 6,444 $ 1,565
========== ========== ========== ==========
</TABLE>
At September 30, 2000, fees received in advance of recognition as business
development revenues were $987,000. This amount is classified as deferred
revenue on the balance sheet.
NOTE 4 - NET LOSS PER SHARE:
Basic and diluted net loss per share is computed by dividing the net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding during the period. The calculation of diluted net
loss per share excludes potential common shares if the effect is anti-dilutive.
Potential common shares consist of unvested restricted common stock, incremental
common shares issuable upon the exercise of stock options and common shares
issuable upon the exercise of common stock warrants.
The following table sets forth the computation of basic and diluted net loss
per share for the periods indicated (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator:
Net loss................................... $ (8,892) $ (5,820) $ (23,134) $ (16,035)
========== ========== ========== ==========
Denominator:
Weighted average shares.................... 22,355 17,396 22,127 8,469
Weighted average unvested common shares
subject to repurchase..................... (51) (575) (94) (714)
---------- ---------- ---------- ----------
Denominator for basic and diluted
calculation............................ 22,304 16,821 22,033 7,755
========== ========== ========== ==========
Net loss per share:
Basic and diluted.......................... $ (0.40) $ (0.35) $ (1.05) $ (2.07)
========== ========== ========== ==========
</TABLE>
The following table sets forth potential shares of common stock that are not
included in the diluted net loss per share calculation above because to do so
would be anti-dilutive for the periods indicated (in thousands):
8
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average effect of common stock
equivalents:
Common stock options................... 2,505 1,321 2,027 1,144
Common stock warrants.................. 558 517 580 240
</TABLE>
NOTE 5 - STRATEGIC MARKETING -- EQUITY AGREEMENTS:
In June 1999, the Company signed an Advertising Agreement with Amazon.com,
Inc. ("Amazon.com") to collaborate on event-based advertising using the
Company's digital delivery services. In connection with this agreement, the
Company issued a fully vested warrant to purchase approximately 254,000 shares
of common stock to Amazon.com. The warrant has been valued at approximately $2.0
million and was being recognized ratably over the one-year term of the
agreement, which ended in June 2000. Under the Advertising Agreement with
Amazon.com, an additional warrant to purchase approximately 127,000 shares of
common stock was to be granted to Amazon.com and was to vest over a 12-month
period, if and when the Company signed a definitive agreement with Amazon.com
during a specific period of time to utilize the Company's technology for a
specific business program. Amazon.com elected not to utilize the Company's
technology for the specific business program, and accordingly the warrant was
not granted.
In August 1999, the Company signed a Digital Audio Co-Marketing and
Distribution Agreement with Yahoo! to promote the distribution of digital music
on its web site. In connection with this agreement, the Company granted Yahoo!
three warrants totaling 250,000 shares of common stock. The first warrant for
83,334 shares vested immediately and was valued at $903,000 and is being
recognized ratably over the one-year term of the agreement. The second warrant
for 83,333 shares vested in August 2000, and was being remeasured each quarter
until a commitment for performance has been reached or the warrant vested, based
on the fair market value at the end of each period. At August 21, 2000, this
warrant is valued at $312,000, which was being recognized ratably over the one-
year term of the agreement. The third warrant for 83,333 shares vests in August
2001, and is being remeasured each quarter until the warrant vests, based on the
fair market value at the end of each period. At September 30, 2000, this warrant
is valued at $214,000, which is being recognized ratably over one year. For the
three months ended September 30, 2000, $131,000, $100,000 and $23,000 were
recognized as strategic marketing-equity instruments expense for the first,
second and third warrants, respectively.
In July 2000, the Company signed an agreement with Virgin Holdings, Inc.
("Virgin"), an affiliate of EMI Recorded Music, to distribute music over the
Internet utilizing the Company's technology. Pursuant to this agreement, the
Company issued and delivered 150,000 shares of common stock to Virgin. These
shares were valued at $1.2 million and is being recognized ratably over the one-
year term of the agreement. As a result, $295,000 was recognized as strategic
marketing-equity instruments expense for the three months ended September 30,
2000.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis contains forward-looking
statements within the meaning of Federal securities laws. You can identify these
statements because they use forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," "continue," "believe," "intend," or other
similar words. These words, however, are not the exclusive means by which you
can identify these statements. You can also identify forward-looking statements
because they discuss future expectations, contain projections of results of
operations or of financial conditions, characterize future events or
circumstances or state other forward-looking information. We have based all
forward-looking statements included in Management's Discussion and Analysis on
information currently available to us, and we assume no obligation to update any
such forward-looking statements. Although we believe that the expectations
reflected in such forward-looking statements are based on reasonable
assumptions, actual results could differ materially from those projected in the
forward-looking statements. Potential risks and uncertainty include, among
others, those set forth under the caption "Additional Factors Affecting Future
Results" included in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and in the "Company Risk Factors" section
of our 1999 Form 10-K.
While we believe that the discussion and analysis in this report is adequate
for a fair presentation of the information, we recommend that you read this
discussion and analysis with "Management's Discussion and Analysis" included in
our 1999 Form 10-K.
Overview
--------
We are a leading provider of software products and services that enable
artists, record companies and retailers to create, syndicate and sell music
digitally over the Internet. Our products and services are based on an open
technical architecture that is designed to support a variety of digital music
formats. From our inception in January 1996 through early 1997, we devoted
substantially all of our efforts to product development, raising capital and
recruiting personnel. We first generated revenues in the first quarter of 1997
through the licensing of our Liquifier Pro, Liquid Server and Liquid Player
software products. In November 1997, we introduced a subscription-based hosting
service for digital recorded music utilizing our technology. In July 1998, to
enhance consumer access to the music we were hosting, we launched the Liquid
Music Network (LMN), a syndicated network that currently links over 1,000
affiliated music-related and music retailer websites.
In early 1999, we began to place greater emphasis on developing and marketing
our digital music delivery services. Since that time, we have invested
significant resources to increase our distribution reach by expanding the LMN,
building our syndicated music catalog available for sale, actively participating
in standards initiatives and establishing our international presence. We also
have established international initiatives within the Pacific Rim to lay the
groundwork for offering digital music download services to consumers in these
markets. As a provider of digital music delivery services, we expect our
revenue sources to expand beyond software license sales to include sales of
digital recorded music and hosting service fees. Revenues from digital music
sales and transaction fees from our music delivery services represented less
than 1%, 4% and 5% of total net revenues in 1998, 1999 and the first nine months
of 2000, respectively. Our Liquid Music Network began offering syndicated music
through music retailer websites in the third quarter of 1999.
To date, we have derived our revenues principally from the licensing of
software products, digital distribution services and software license fees
associated with business development contracts. We license our software products
to record companies, artists and websites. Software license revenues, net of a
provision for estimated sales returns, are recognized upon shipment of the
product to the customer. We generate services revenues from maintenance fees
related to our licensed software products and hosting fees from record companies
and artists. We defer and recognize maintenance and hosting fees as service
revenue ratably over the life of the related contract, which is typically one
year. We intend to increase our services revenues by significantly expanding our
hosting and music delivery services. Revenue derived from hosting services
include subscription fees from artists for encoding and storing music files, e-
commerce services and transaction reporting. Services revenue also includes
transaction fees from sales of digital recorded music through our LMN website
affiliates and fees from music retailers and websites related to the Liquid Muze
Previews service for sample music clips. Business development revenues primarily
consist of software license fees from agreements with strategic related partners
that are developing international businesses based on our music delivery
technologies. We recognize the fees as they are earned; the specific timing of
this recognition
10
<PAGE>
depends on the terms and conditions of the particular contractual arrangements.
We bear full credit risk with respect to substantially all sales.
We expense all research and development as incurred. Development costs
incurred in the period from achievement of technological feasibility, which we
define as the establishment of a working model, until the general availability
of this software to customers, have been short, and therefore software
development costs qualifying for capitalization have been insignificant.
Accordingly, we have not capitalized any software development costs to date.
We have a limited operating history upon which investors may evaluate our
business and prospects. Since inception we have incurred significant losses, and
as of September 30, 2000 we had an accumulated deficit of approximately $63.4
million. We intend to continue to expend significant financial and management
resources on the development of additional products and services, sales and
marketing, improved technology and expanded operations. As a result, we expect
to incur additional losses and continued negative cash flow from operations
through at least 2002. Our revenues may not increase or even continue at their
current levels or we may not achieve or maintain profitability or generate cash
from operations in future periods. Our prospects must be considered in light of
the risks, expenses and difficulties frequently encountered by companies in
their early stages of development, particularly companies in new and rapidly
evolving markets such as the digital delivery of recorded music. We may not be
successful in addressing these risks, and our failure to do so would harm our
business.
11
<PAGE>
Results of Operations
---------------------
The following table sets forth, for the periods presented, certain data
derived from our unaudited condensed statement of operations as a percentage of
total net revenues. The operating results in any period are not necessarily
indicative of the results that may be expected for any future period.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ---------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net revenues:
License........................................................... 5% 27% 10% 37%
Services.......................................................... 22 10 24 12
Business development (related party).............................. 73 63 66 51
------- ------- ------- -------
Total net revenues.............................................. 100 100 100 100
------- ------- ------- -------
Cost of net revenues:
License........................................................... 2 3 2 5
Services.......................................................... 22 18 21 21
Business development (related party).............................. -- 4 1 2
------- ------- ------- -------
Total cost of net revenues...................................... 24 25 24 28
------- ------- ------- -------
Gross profit........................................................ 76 75 76 72
------- ------- ------- -------
Operating expenses:
Sales and marketing............................................... 140 142 127 211
Research and development.......................................... 182 193 172 252
General and administrative........................................ 61 42 55 57
Strategic marketing-equity instruments............................ 16 46 16 72
Stock compensation expense........................................ 3 18 4 36
------- ------- ------- -------
Total operating expenses........................................ 402 441 374 628
------- ------- ------- -------
Loss from operations................................................ (326) (366) (298) (556)
Other income, net................................................... 66 40 68 32
Minority interest in loss of related party.......................... (5) -- (6) --
------- ------- ------- -------
Net loss............................................................ (265)% (326)% (236)% (524)%
======= ======= ======= =======
</TABLE>
Three Months Ended September 30, 2000 and 1999
Total Net Revenues
Total net revenues increased 88% to $3.4 million for the three months ended
September 30, 2000 from $1.8 million in the comparable period of 1999.
License. License revenues decreased 63% to $174,000 for the three months
ended September 30, 2000 from $476,000 in the comparable period of 1999. This
decrease is due to Liquid Player license fees received under an agreement with a
customer that ended on December 31, 1999. Under this agreement we received total
fees of $1.5 million over a 14-month period. These fees were recognized as
license revenue over the license period, which ended December 31, 1999.
Additionally, due to our shift in marketing emphasis from software licensing to
the delivery of digital music services, revenues from licensing of our Liquifier
Pro and Liquid Server software decreased in the 2000 period from the 1999
period.
Services. Services revenues increased 311% to $727,000 for the three months
ended September 30, 2000 from $177,000 in the comparable period of 1999. This
increase was due to new revenues from encoding services, promotion and
advertising services, Liquid Muze Previews service, kiosk-related equipment
sales and an increase in music sales and hosting revenues in the 2000 period.
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<PAGE>
Business Development (Related Party). Business development revenues
increased 117% to $2.5 million for the three months ended September 30, 2000
from $1.1 million in the comparable period of 1999. The increase was due to
software licensing and related maintenance revenues recognized under software
license contracts with Liquid Audio Japan, Liquid Audio Greater China and a new
strategic related partner, Liquid Audio South East Asia.
In the three months ended September 30, 2000, approximately 73% of total
net revenues came from sales to three customers. In the comparable period of
1999, approximately 85% of total net revenues came from sales to three
customers. The following table sets forth customers comprising 10% or more of
our total net revenues for each of the periods indicated:
Three Months Ended
September 30,
------------------------
Customer 2000 1999
-------- --------- --------
A.............................................. 38% --
B.............................................. 25 --
C.............................................. 10 --
D.............................................. -- 42%
E.............................................. -- 22
F.............................................. -- 21
International revenues represented approximately 73% and 65% of total net
revenues for the three months ended September 30, 2000 and 1999, respectively.
Total Cost of Net Revenues
Our gross profit increased to approximately 76% of total net revenues for
the three months ended September 30, 2000 from approximately 75% of total net
revenues in the comparable period of 1999. Total cost of net revenues increased
77% to $791,000 in the 2000 period from $448,000 in the 1999 period.
License. Cost of license revenues primarily consists of royalties paid to
third-party technology vendors and costs of documentation, duplication and
packaging. Cost of license revenues was $64,000 for the three months ended
September 30, 2000 and $58,000 in the comparable period of 1999, an increase of
10%. Cost of license revenues increased due to the addition of technology
licenses in 2000 and product mix differences.
Services. Cost of services revenues primarily consists of compensation for
customer service, encoding and professional services personnel, kiosk-related
equipment and an allocation of our occupancy costs and other overhead
attributable to our services revenues. Cost of services revenues increased 122%
to $720,000 for the three months ended September 30, 2000 from $324,000 in the
comparable period of 1999. The increase in cost of services revenues was due
primarily to the addition of encoding, customer service and professional
services personnel and the cost of kiosk-related equipment.
Business Development (Related Party). Cost of business development revenues
primarily consists of kiosk-related equipment and royalties paid to third-party
technology vendors. Cost of business development revenues were $7,000 for the
three months ended September 30, 2000 and $66,000 for the comparable period of
1999.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation for our sales, marketing and business development personnel,
compensation for customer service and professional services personnel
attributable to sales and marketing activities, advertising, trade show and
other promotional costs, design and creation expenses for marketing literature
and our website and an allocation of our occupancy costs and other overhead.
Sales and marketing expenses increased 85% to $4.7 million for the three months
ended September 30, 2000 from $2.5 million in the comparable period of 1999.
This increase was primarily due to increases in the number of sales and
marketing personnel, advertising and promotional programs. We expect that sales
and marketing expenses will increase both in absolute dollars and as a
percentage
13
<PAGE>
of total net revenues in future periods due to expanded efforts to market and
promote our products and services both domestically and internationally.
Research and Development. Research and development expenses consist
primarily of compensation for our research and development, network operations
and product management personnel, payments to outside contractors and, to a
lesser extent, depreciation on equipment used for research and development and
an allocation of our occupancy costs and other overhead. Research and
development expenses increased 77% to $6.1 million for the three months ended
September 30, 2000 from $3.4 million in the comparable period of 1999. This
increase was primarily due to increases in the number of personnel and outside
contractors needed to enhance our existing software products, develop and
enhance our online services, develop new products and services and build our
external network and computer data center infrastructure. We expect that
research and development expenses will increase in absolute dollars in future
periods due to expanded investments in the development of enhanced and new
products and online services.
General and Administrative. General and administrative expenses consist
primarily of compensation for personnel and payments to outside contractors for
general corporate functions, including finance, information systems, human
resources, facilities, legal and general management, fees for professional
services, bad debt expense and an allocation of our occupancy costs and other
overhead. General and administrative expenses increased 177% to $2.1 million for
the three months ended September 30, 2000 from $741,000 in the comparable period
of 1999. This increase was primarily due to legal fees related to patent
infringement claims against us (see Part II, Item 1 "Legal Proceedings") and
increases in the number of personnel and outside contractors needed to support
the growth of our business and professional fees. We expect that general and
administrative expenses will increase in absolute dollars as we hire additional
personnel, incur additional expenses relating to the anticipated growth of our
business, such as costs associated with increased infrastructure and our public
company status and incur legal expenses for patent infringement claims.
Strategic Marketing-Equity Instruments. Strategic-marketing-equity
instruments expense consists of expenses associated with the value of common
stock and warrants issued to partners as part of our strategic marketing
agreements. Common stock expense is based on the fair value of the stock at the
time it was issued. Warrant expense is based on the estimated fair value of the
warrants based on the Black-Scholes option pricing model and the provisions of
EITF 96-18. Strategic marketing-equity instruments expense was $550,000 for the
three months ended September 30, 2000 and $826,000 in the comparable period of
1999. In June 1999, we signed an Advertising Agreement with Amazon.com to
collaborate on event-based advertising using our digital delivery services. In
connection with this agreement, we issued a fully vested warrant to purchase
approximately 254,000 shares of common stock to Amazon.com. The warrant has been
valued at approximately $2.0 million and was being recognized ratably over the
one-year term of the agreement, which ended in June 2000. Under the Advertising
Agreement with Amazon.com, an additional warrant to purchase approximately
127,000 shares of common stock was to be granted to Amazon.com and was to vest
over a 12-month period, if and when we sign a definitive agreement with
Amazon.com during a specific period of time to utilize our technology for a
specific business program. Amazon.com elected not to utilize the Company's
technology for the specific business program, and accordingly the warrant was
not granted. In August 1999, we signed a Digital Audio Co-Marketing and
Distribution Agreement with Yahoo! to promote the distribution of digital music
on its web site. In connection with this agreement, we granted Yahoo! three
warrants totaling 250,000 shares of common stock. The first warrant for 83,334
shares vested immediately and was valued at $903,000 and is being recognized
ratably over the one-year term of the agreement. The second warrant for 83,333
shares vested in August 2000, and was being remeasured each quarter until a
commitment for performance has been reached or the warrant vested, based on the
fair market value at the end of each period. At August 21, 2000, this warrant is
valued at $312,000, which was being recognized ratably over the one-year term of
the agreement. The third warrant for 83,333 shares vests in August 2001, and is
being remeasured each quarter until the warrant vests, based on the fair market
value at the end of each period. At September 30, 2000, this warrant is valued
at $214,000, which is being recognized ratably over one year. For the three
months ended September 30, 2000, $131,000, $100,000 and $23,000 were recognized
as strategic marketing-equity instruments expense for the first, second and
third warrants, respectively. In July 2000, the Company signed an agreement with
Virgin Holdings, Inc., an affiliate of EMI Recorded Music, to distribute music
over the Internet utilizing the Company's technology. Pursuant to this
agreement, the Company issued and delivered 150,000 shares of common stock to
Virgin. These shares were valued at $1.2 million and is being recognized ratably
over the one-year term of the agreement. As a result, $295,000 was recognized as
strategic marketing-equity instruments expense for the three months ended
September 30, 2000.
14
<PAGE>
Stock Compensation Expense. Stock compensation expense relates to stock-
based employee compensation arrangements. The total unearned compensation
recorded by us from inception to September 30, 2000 was $4.0 million. We
recognized $103,000 and $330,000 of stock compensation expense for the three
months ended September 30, 2000 and 1999, respectively. We expect quarterly
amortization related to those options to be approximately $107,000 for the
fourth quarter of 2000, between $84,000 and $44,000 per quarter during 2001 and
annual amortization to be $81,000 during 2002. These future compensation charges
would be reduced if any employee terminates employment prior to the expiration
of the employee's option vesting period.
Other Income, Net. Interest income consists of earnings on our cash, cash
equivalents and short-term investments. Interest expense consists of expenses
related to our financing obligations, which include borrowings under equipment
loans, short-term loans and capital lease obligations. Other income, net
increased to $2.2 million for the three months ended September 30, 2000 from
$722,000 in the comparable period of 1999. This increase was primarily due to
interest received on higher average cash and cash equivalent balances resulting
from proceeds of the initial and follow-on public offerings of our common stock
in July 1999 and December 1999, respectively.
Minority Interest in Loss of Related Party. Minority interest in loss of
related party consist of our share of losses from our investment in a related
party using the equity method of accounting under a 3-month lag. Minority
interest in loss of related party was $175,000 and $0 for the three months ended
September 30, 2000 and 1999, respectively. The expense in the 2000 period
represents our share of the loss of Liquid Audio Japan.
Nine Months Ended September 30, 2000 and 1999
Total Net Revenues
Total net revenues increased 220% to $9.8 million for the nine months ended
September 30, 2000 from $3.1 million in the comparable period of 1999.
License. License revenues decreased 10% to $1.0 million for the nine months
ended September 30, 2000 from $1.1 million in the comparable period of 1999. The
decrease is partially due to Liquid Player license fees as described above.
Additionally, due to our shift in marketing emphasis from software licensing to
the delivery of digital music services, revenues from licensing of our Liquifier
Pro and Liquid Server software decreased in the 2000 period from the 1999
period. These decreases were partially offset by revenues from kiosk software
and technology licenses.
Services. Services revenues increased 538% to $2.3 million for the nine
months ended September 30, 2000 from $367,000 in the comparable period of 1999.
This increase was due to new revenues from encoding services, kiosk-related
equipment sales, Liquid Muze Previews service and promotion and advertising
services and an increase in hosting revenues and music sales in the 2000 period.
Business Development (Related Party). Business development revenues
increased 312% to $6.4 million for the nine months ended September 30, 2000 from
$1.6 million in the comparable period of 1999. The increase was due to software
licensing and related maintenance revenues recognized under software license
contracts with Liquid Audio Japan, Liquid Audio Greater China, Liquid Audio
Korea and Liquid Audio South East Asia.
In the nine months ended September 30, 2000, approximately 54% of total net
revenues came from sales to two customers. In the comparable period of 1999,
approximately 79% of total net revenues came from sales to three customers. The
following table sets forth customers comprising 10% or more of our total net
revenues for each of the periods indicated:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------
Customer 2000 1999
-------- --------- ---------
<S> <C> <C>
A................................................ 41% --
B................................................ 132 --
C................................................ -- 36%
D................................................ -- 31
E................................................ -- 12
</TABLE>
15
<PAGE>
International revenues represented approximately 71% and 52% of total net
revenues for the nine months ended September 30, 2000 and 1999, respectively.
Total Cost of Net Revenues
Our gross profit increased to approximately 76% of total net revenues for
the nine months ended September 30, 2000 from approximately 72% of total net
revenues in the comparable period of 1999. Total cost of net revenues increased
166% to $2.3 million in the 2000 period from $873,000 in the 1999 period.
License. Cost of license revenues was $160,000 for the nine months ended
September 30, 2000 and $156,000 in the comparable period of 1999, an increase of
3%. Cost of license revenues remained flat due to product mix differences.
Services. Cost of services revenues increased 222% to $2.1 million for the
nine months ended September 30, 2000 from $649,000 in the comparable period of
1999. The increase in cost of services revenues was due primarily to the
addition of encoding, customer service and professional services personnel and
the cost of kiosk-related equipment.
Business Development (Related Party). Cost of business development revenues
were $75,000 for the nine months ended September 30, 2000 and $68,000 for the
comparable period of 1999.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased 93% to $12.4
million for the nine months ended September 30, 2000 from $6.4 million in the
comparable period of 1999. This increase was primarily due to increases in the
number of sales and marketing personnel, advertising and promotional programs.
The 1999 period includes a $378,000 impairment loss on our investment in Liquid
Audio Japan.
Research and Development. Research and development expenses increased 119%
to $16.9 million for the nine months ended September 30, 2000 from $7.7 million
in the comparable period of 1999. This increase was primarily due to increases
in the number of personnel and outside contractors needed to enhance our
existing software products, develop and enhance our online services, develop new
products and services and build our external network and computer data center
infrastructure.
General and Administrative. General and administrative expenses increased
209% to $5.4 million for the nine months ended September 30, 2000 from $1.7
million in the comparable period of 1999. This increase was primarily due to
increases in the number of personnel and outside contractors needed to support
the growth of our business and professional fees and legal fees related to
patent infringement claims against us (see Part II, Item 1 "Legal Proceedings").
The 2000 period includes an one-time non-cash charge of $354,000 related to the
issuance of common stock in the settlement of the lawsuit with Arne Frager and
Rose G. Frager (see Part II, Item 1 "Legal Proceedings").
Strategic Marketing-Equity Instruments. Strategic marketing-equity
instruments expense was $1.6 million for the nine months ended September 30,
2000 and $2.2 million in the comparable period of 1999.
Stock Compensation Expense. We recognized $368,000 and $1.1 million of
stock compensation expense for the nine months ended September 30, 2000 and
1999, respectively. In addition to the expense related to the agreements
discussed above, the 1999 period includes $1.1 million that relates to 100,000
shares of common stock issued to Virgin in exchange for the right to create
digitally encoded copies of EMI sound recordings using the Liquid Audio and
Genuine mp3 formats, and $95,000 relates to fully vested warrants issued to
other record companies as part of our content and distribution agreements with
them.
Other Income, Net. Other income, net increased to $6.7 million for the nine
months ended September 30, 2000 from $986,000 in the comparable period of 1999.
This increase was primarily due to interest received on higher average cash and
16
<PAGE>
cash equivalent balances resulting from proceeds of the initial and follow-on
public offerings of our common stock in July 1999 and December 1999,
respectively.
Minority Interest in Loss of Related Party. Minority interest in loss of
related party was $628,000 and $0 for the nine months ended September 30, 2000
and 1999, respectively.
Liquidity and Capital Resources
-------------------------------
Since inception, we have financed our operations primarily through the
initial and follow-on public offerings of common stock, private placements of
our preferred stock, equipment financing, lines of credit and short-term loans.
As of June 30, 2000, we had raised $65.9 million and $93.7 million through our
initial and follow-on public offerings of common stock, respectively, and $29.8
million through the sale of our preferred stock. At September 30, 2000, we had
approximately $133.6 million of cash, cash equivalents and short-term
investments.
Net cash used in operating activities was $18.4 million and $9.6 million
for the nine months ended September 30, 2000 and 1999, respectively. Net cash
used for operating activities in each of these periods was primarily the result
of net losses before non-cash charges, which include strategic marketing-equity
instruments expense, stock compensation expense and equity investment losses in
Liquid Audio Japan, offset by increases in receivables from related parties,
accounts payable and accrued expenses and other current liabilities, and an
increase in the 2000 period of accounts receivable.
Net cash used in investing activities was $39.9 million and $8.0 million
for the nine months ended September 30, 2000 and 1999, respectively. Net cash
used in investing activities in each of these periods was related to net
purchases of short-term investments and the acquisition of property and
equipment in both periods.
Net cash provided by financing activities was $151,000 and $66.4 million
for the nine months ended September 30, 2000 and 1999, respectively. The net
cash provided by financing activities in the 2000 period was provided
principally by the issuance of common stock under the employee stock purchase
plan, offset by payments made under an equipment loan and capital leases. The
net cash provided by financing activities for the 1999 period was due primarily
to the proceeds from our initial public offering of common stock.
We had a bank equipment loan facility that provided for advances of up to
$3.0 million through November 1999. Borrowings under the equipment loan facility
are repayable in monthly installments over three years and bear interest at the
bank's prime interest rate plus 0.25%. Borrowings are secured by the related
equipment and other assets. Under the equipment loan facility, we had borrowed
amounts totaling $1.8 million through September 30, 2000. We also have lease
financing agreements that provide for the lease of computers and office
equipment of up to $1.0 million. As of September 30, 2000, we had borrowed
$737,000 under the lease financing agreements. Our other significant commitments
consist of obligations under non-cancelable operating leases, which totaled $2.7
million as of September 30, 2000 and are payable in monthly installments through
2005 and a note payable to related party in the amount of $419,000 that was
issued in the three months ended March 31, 1999. The note payable to related
party is repayable in Japanese yen and bears interest at 0.5% above a Japanese
bank's prime rate. The principal is due on December 31, 2003, with quarterly
interest payments.
Although we have no material commitments for capital expenditures or
strategic investments, we anticipate an increase in the rate of capital
expenditures consistent with our anticipated growth in operations,
infrastructure and personnel. We anticipate that we will continue to add
computer hardware resources, deploy additional computer data centers worldwide
and expand our primary office facility during the next 12 months. We may also
use cash to acquire or license technology, products or businesses related to our
current business. In addition, we anticipate that we will continue to experience
significant growth in our operating expenses for the foreseeable future and that
our operating expenses will be a material use of our cash resources.
We believe that existing cash and cash equivalents and financing available
under lease agreements will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for the foreseeable future, although we
may seek to raise additional capital during that period. The sale of additional
equity or convertible debt securities could result in additional dilution to our
stockholders. There can be no assurance that financing will be available in
amounts or on terms acceptable to us, if at all.
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<PAGE>
Market Risk
-----------
At September 30, 2000, we had an investment portfolio of money market
funds, commercial securities and U.S. Government bonds including those
classified as short-term investments of $53.1 million. We had a related party
loan at September 30, 2000 of $419,000, which was denominated in Japanese yen
and bore interest at 0.5% above a Japanese bank's prime rate. These instruments,
like all fixed income instruments, are subject to interest rate risk. The fixed
income portfolio will fall in value and the strategic related partner note
payable interest would increase if there were an increase in interest rates. If
market interest rates were to increase immediately and uniformly by 10% from
levels as of December 31, 1999, the decline of the fair value of the fixed
income portfolio and strategic related partner note payable would not be
material.
18
<PAGE>
Additional Factors Affecting Future Results
-------------------------------------------
Our limited operating history in the new market of digital delivery of music
over the Internet increases the possibility that the value of your investment
will decline
We incorporated in January 1996. We did not start generating revenues until
the first quarter of 1997. In early 1999, we began to place greater emphasis on
developing and marketing our digital music delivery services. Accordingly, we
are still in the early stages of development and have only a limited operating
history upon which you can evaluate our business. You should evaluate our
chances of financial and operational success in light of the risks,
uncertainties, expenses, delays and difficulties associated with starting a new
business, many of which may be beyond our control.
Fluctuations in our quarterly revenues and operating results might lead to
reduced prices for our stock
Our quarterly results of operation have varied in the past, and you should
not rely on quarter-to-quarter comparisons of our results of operations as an
indication of our future performance. In some future periods, our results of
operations are likely to be below the expectations of public market analysts and
investors. In this event, the price of our common stock would likely decline.
Factors that have caused our results to fluctuate in the past and that are
likely to affect us in the future including the following:
. competition for consumers from traditional retailers as well as
providers of online music services;
. the announcement and introduction of new products and services by us
and our competitors;
. our ability to increase the number of websites that will use our
platform for digital music delivery;
. the timing of our partners' introduction of new products and services
for digital music sales; and
. variability and length of the sales cycle associated with our product
and service offerings.
In addition, other factors may also affect us, including:
. market adoption and growth of sales of digitally downloaded recorded
music over the Internet;
. our ability to attract significant numbers of music recordings to be
syndicated in our format;
. our ability to provide reliable and scalable service, including our
ability to avoid potential system failures;
. market acceptance of new and enhanced versions of our products and
services; and
. the price and mix of products and services we offer.
Some of these factors are within our control and others are outside of our
control.
We have a history of losses, we expect losses to continue and we might not
achieve or maintain profitability
Our accumulated deficit as of September 30, 2000 was approximately $63.4
million. We had net losses of approximately $8.5 million in 1998, $24.2 million
in 1999 and $23.1 million in the first nine months of 2000. Given the level of
our planned operating and capital expenditures, we expect to continue to incur
losses and negative cash flows through at least 2002. Even if we ultimately do
achieve profitability, we may not be able to sustain or increase profitability
on a quarterly or annual basis. If our revenues grow more slowly than we
anticipate, or if our operating expenses exceed our expectations and cannot be
adjusted accordingly, our business will be harmed.
If we do not increase the number of websites that use our platform, our business
will not grow
In order to grow our business, we need to increase the number of websites,
including websites operated by music retailers, that use our technology and our
syndicated content to digitally deliver recorded music. To increase the number
of websites, we must do the following:
19
<PAGE>
. offer competitive products and services that meet industry standards;
. attract more music content;
. make it easy and cost-effective for music-related websites to sell
digital music;
. develop relationships with online retailers, music websites, online
communities, broadband providers and Internet broadcasters; and
. develop relationships with international music websites, retailers and
broadband providers.
Any failure to achieve one or more of these objectives would harm our
business. We may not be successful in achieving any of these objectives.
We also intend to increase our expenditures on marketing the Liquid Audio
brand because we believe brand awareness will be critical to increasing our
affiliates and end-user awareness. Our increased marketing expenses may not
result in an increase of our brand awareness. Similarly, we may not achieve
increased revenues even if we are successful in increasing our brand awareness.
If we do not increase our revenues as a result of our branding and other
marketing efforts or if we otherwise fail to promote our brand successfully, our
business would be harmed.
If artists and record labels are not satisfied that they can securely digitally
deliver their music over the Internet, we might not have sufficient content to
attract consumers
Our success depends on our ability to aggregate a sufficient amount and
variety of digital recorded music for syndication. In particular, until a
significant number of artists and their record labels adopt a strategy of
digitally delivering music over the Internet, the growth of our business might
be limited. We currently do not create our own content; rather, we rely on
record companies and artists for digital recorded music to be syndicated using
our format. We believe record companies will remain reluctant to distribute
their recorded music digitally unless they are satisfied with the commercial
feasibility of digital distribution and that the digital delivery of their music
over the Internet will not result in the unauthorized copying and distribution
of that music. If record companies do not believe that recorded music can be
securely delivered over the Internet in a commercially feasible way, they will
not allow the digital distribution of their recorded music and we might not have
sufficient content to attract consumers. If we cannot offer a sufficient amount
and variety of digital recorded music for syndication, our business might be
harmed.
Our business might be harmed if challenges against intellectual property laws by
new digital music delivery technologies are successful
New music sharing technologies allowing users to locate and download copies
of digital music stored on the hard drives of other users without payment have
been introduced into the market. Because some digital recorded music formats,
such as mp3, do not contain mechanisms for tracking the source of ownership of
digital recordings, users are able to download copies of copyrighted recorded
music over the Internet without being required to compensate the owners of these
copyrights. These downloads are a significant concern to record companies and
artists. The Recording Industry Association of America has filed a suit seeking
a permanent injunction against the use of these file-sharing technologies for
exchange of copyrighted works. Several recording artists have also taken action
against companies providing music sharing technology. If the injunction is
denied, and it is determined that this file sharing technology is non-
infringing, record companies and artists may limit their use of the Internet to
sell and distribute their copyrighted materials. Even if the technology is
determined to be infringing, it may be difficult to prevent this type of file
sharing because of the non-centralized character of these technologies. As long
as free shared copies are available, legally or illegally, consumers may choose
not to pay for downloads from retail and other music delivery sites in our
Liquid Music Network, which could harm our business.
New competitors could enter the industry with alternative business models,
which, if successful, could harm our business
New companies may enter our market with alternative business models. For
example, companies may provide free music downloading from a website, earning
revenues on an advertising or subscription basis. This model could be more
20
<PAGE>
attractive to consumers. If we are unable to compete with such companies or
adapt our business model, products or services to a more consumer favorable
model, our business could be harmed.
Due to the many factors that influence market acceptance, consumers might not
accept our platform
Our success will depend on growth in consumer acceptance of our platform as
a method for digital delivery of recorded music over the Internet. Factors that
might influence market acceptance of our platform include the following, over
which we have little or no control:
. the availability of sufficient bandwidth on the Internet to enable
consumers to download digital recorded music rapidly and easily;
. the willingness of consumers to invest in computer technology that
facilitates the downloading of digital music;
. the cost of time-based Internet access;
. the number and variety of digital recordings available for purchase
through our system relative to those available through other online
digital delivery companies, digital music websites or through
traditional physical delivery of recordings;
. the availability of portable devices to which digital recorded music
can be transferred;
. the fidelity and quality of the sound of the digital recorded music;
and
. the level of consumer comfort with the process of downloading and
paying for digital music over the Internet, including ease of use and
lack of concern about transaction security.
The market for digital delivery of music over the Internet is highly
competitive, and if we cannot compete effectively, our ability to generate
meaningful revenues would suffer dramatically
Competition among companies in the business of digital delivery of music
over the Internet is intense. If we do not compete effectively or if we
experience pricing pressures, reduced margins or loss of market share resulting
from increased competition, our business might be harmed.
Competition is likely to increase as new companies enter the market and
current competitors expand their products and services. Many of these potential
competitors are likely to enjoy substantial competitive advantages, including
the following:
. larger audiences;
. larger technical, production and editorial staffs;
. greater brand recognition;
. access to more recorded music content;
. a more established Internet presence;
. a larger advertiser base; and
. substantially greater financial, marketing, technical and other
resources.
If standards for the secure digital delivery of recorded music are not adopted,
the piracy concerns of record companies and artists might not be satisfied, and
they might not use our platform for digital delivery of their music
Because other digital recorded music formats, such as mp3, do not contain
mechanisms for tracking the source or ownership of digital recordings, users are
able to download and distribute unauthorized or "pirated" copies of copyrighted
recorded music over the Internet. This piracy is a significant concern to record
companies and artists, and is the reason many record companies and artists are
reluctant to digitally deliver their recorded music over the Internet. The
Secure Digital Music Initiative (SDMI) is a committee formed by the Recording
Industry Association of America (RIAA) to propose a standard
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<PAGE>
format for the secure digital delivery and use of recorded music. If a standard
format is not adopted, however, pirated copies of recorded music will continue
to be available on the Internet, and record companies and artists might not
permit the digital delivery of their music. Additionally, as long as pirated
recordings are available, many consumers will choose free pirated recordings
rather than paying for legitimate recordings. Accordingly, if a standard format
for the secure digital delivery of music is not adopted, our business might be
harmed.
We have designed our current products to be adaptable to different music
industry and technology standards. Numerous standards in the marketplace,
however, could cause confusion as to whether our products and services are
compatible. If a competitor were to establish the dominant industry standard,
our business would be harmed.
If our platform does not provide sufficient rights reporting information, record
companies and artists are unlikely to digitally deliver their recorded music
using our platform
Record companies and artists must be able to track the number of times
their recorded music is downloaded so that they can make appropriate payments to
music rights organizations, such as the American Society of Composers, Authors
and Publishers, Broadcast Music Incorporated and SESAC, Inc. If our products and
services do not accurately or completely provide this rights reporting
information, record companies and artists might not use our platform to
digitally deliver their recorded music, and our business might be harmed.
Our business might be harmed if we fail to price our products and services
appropriately
The price of Internet products and services is subject to rapid and
frequent change. We may be forced for competitive or technical reasons to reduce
or eliminate prices for certain of our products or services. If this happens,
our business might be harmed.
If our relationships with our international partners terminate, our revenues
might decline
We derive a portion of our revenues from business development fees
generated from relationships with our international partners, Liquid Audio
Korea, Liquid Audio Japan and Liquid Audio Greater China. These relationships
vary in size and scope. If one of these relationships, or any other relationship
that accounts for a significant portion of our revenues in a given period, does
not generate a similar amount of revenue, or any, in subsequent periods, then
our business could be harmed. As a consequence, our revenues are not recurring
from period-to-period, which might result in unpredictability of our revenues.
Our revenues would be negatively affected by the loss of a significant customer
We have derived, and we believe that we will continue to derive, a
substantial portion of our net revenues from a limited number of customers and
projects. Our ten largest customers for the four quarters of 1999 and the first
three quarters of 2000 represented approximately 80%, 97%, 93%, 82%, 90%, 86%
and 90%, respectively, of our total net revenues. The loss of Liquid Audio
Japan, Liquid Audio Korea, Liquid Audio Greater China, Liquid Audio South East
Asia or any other significant customer or any significant reduction of total net
revenues generated by these or other significant customers, without an increase
in revenues from other sources, would harm our business. The volume of products
or services we sell to specific customers is likely to vary year to year, and a
major customer in one year may not use our services in a subsequent year. A
customer's decision not to use our services in a subsequent year might harm our
business.
We might not be able to scale our technology infrastructure to meet demand for
our products and services
Our success will depend on our ability to scale our technology
infrastructure to meet the demand for our products and services. Adding this new
capacity will be expensive, and we might not be able to do so successfully. In
addition, we might not be able to protect our new or existing data centers from
unexpected events as we scale our systems. To the extent that we do not address
any capacity constraints effectively, our business would be harmed.
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We might not be successful in our attempts to keep up with rapid technological
change and evolving industry standards
The markets for our products and services are characterized by rapidly
changing technology, evolving industry standards, changes in customer needs,
emerging competition, and frequent new product and service introductions. Our
future success will depend, in part, on our ability to:
. use leading technologies effectively;
. continue to develop our strategic and technical expertise;
. enhance our current products and services;
. develop new products and services that meet changing customer needs;
. advertise and market our products and services; and
. influence and respond to emerging industry standards and other
technological changes.
This must be accomplished in a timely and cost-effective manner. We may not
be successful in effectively using new technologies, developing new products or
services or enhancing our existing products or services on a timely basis. These
new technologies or enhancements may not achieve market acceptance. Our pursuit
of necessary technological advances may require substantial time and expense.
Finally, we may not succeed in adapting our services to new technologies as they
emerge.
Companies might not develop or consumers might not adopt devices that will play
digitally downloaded music
We believe that the market for digital recorded music delivered over the
Internet will not develop significantly until consumers are able to enjoy this
music other than solely through the use of a personal computer. Several consumer
electronics companies have introduced or announced plans to introduce devices
that will allow digital music delivered over the Internet to be played away from
the personal computer. If companies fail to introduce additional devices,
consumers do not adopt these devices or our products and services are
incompatible with these devices, our business would be harmed. In addition,
digital music can be transferred to a compact disc, but that transfer requires a
compact disc recorder (CD-R). Many desktop computer manufacturers offer CD-Rs in
their computers. If companies do not continue to offer CD-Rs in their computers,
consumers do not adopt CD-Rs or our products and services are incompatible with
CD-Rs, our business might be harmed.
We might not be successful in the development and introduction of new products
and services
We depend in part on our ability to develop new or enhanced products and
services in a timely manner and to provide new products and services that
achieve rapid and broad market acceptance. We may fail to identify new product
and service opportunities successfully and develop and bring to market new
products and services in a timely manner. In addition, product innovations may
not achieve the market penetration or price stability necessary for
profitability.
As the online medium continues to evolve, we plan to leverage our
technology by developing complementary products and services as additional
sources of revenue. Accordingly, we may change our business model to take
advantage of new business opportunities, including business areas in which we do
not have extensive experience. For example, we recently focused on, and will
continue to devote significant resources to, the development of digital music
delivery services, as well as our software licensing business. If we fail to
develop these or other businesses successfully, our business would be harmed.
We might experience delays in the development of new products and services
We must continue to innovate and develop new versions of our software to
remain competitive in the market for digital delivery of recorded music
solutions. Our software products and services development efforts are inherently
difficult to manage and keep on schedule. Our failure to manage and keep those
development projects on schedule might harm our business.
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Our products and services might contain errors
We offer complex products and services. They may contain undetected errors
when first introduced or when new versions are released. If we market products
and services that have errors or that do not function properly, then we may
experience negative publicity, loss of or delay in market acceptance, or claims
against us by customers, any of which might harm our business.
We might have liability for the content of the recorded music that we digitally
deliver
Because we digitally deliver recorded music to third parties, we might be
sued for negligence, copyright or trademark infringement or other reasons. These
types of claims have been brought, sometimes successfully, against providers of
online products and services in the past. Others could also sue us for the
content that is accessible from our website through links to other websites.
These claims might include, among others, claims that by hosting, directly or
indirectly, the websites of third parties, we are liable for copyright or
trademark infringement or other wrongful actions by these third parties through
these websites. Our insurance may not adequately protect us against these types
of claims and, even if these claims do not result in liability, we could incur
significant costs in investigating and defending against these claims.
We have taken steps to prevent these claims. For example, we have
arrangements with companies that use our hosting services that will allow us to
delete potentially infringing or misappropriating materials quickly and
securely. We also have put into place indemnification agreements with music
content providers, where practicable. Under the Digital Millenium Copyright Act
of 1999, Internet service providers are insulated from several types of these
claims, upon compliance with the requirement that they appoint an agent to
receive claims relating to their service, and we have appointed an agent.
Several of our customers have had limited operating histories, are unprofitable
and might have difficulty meeting their payment obligations to us
Several of our significant customers, including our international partners
Liquid Audio Japan, Liquid Audio Korea, Liquid Audio Greater China and Liquid
Audio South East Asia, have had limited operating histories and have not
achieved profitability. We believe that this will be true of other customers in
the future. You should evaluate the ability of these companies to meet their
payment obligations to us in light of the risks, expenses and difficulties
encountered by companies with limited operating histories. If one or more of our
customers were unable to pay for our services in the future, or paid more slowly
than we anticipate, our business might be harmed. As of September 30, 2000, 20%
and 16% of accounts receivable and receivables from related parties,
respectively, or $228,000 and $304,000, respectively, were more than 30 days
past due. We have provided adequate reserves for past due amounts.
System failures or delays might harm our business
Our operations depend on our ability to protect our computer systems
against damage from fire, water, power loss, telecommunications failures,
computer viruses, vandalism and other malicious acts, and similar unexpected
adverse events. Interruptions or slowdowns in our services have resulted from
the failure of our telecommunications providers to supply the necessary data
communications capacity in the time frame we required, as well as from
deliberate acts. Despite precautions we have taken, unanticipated problems
affecting our systems could in the future cause temporary interruptions or
delays in the services we provide. Our customers might become dissatisfied by
any system failure or delay that interrupts our ability to provide service to
them or slows our response time. Sustained or repeated system failures or delays
would affect our reputation, which would harm our business. Slow response time
or system failures could also result from straining the capacity of our software
or hardware due to an increase in the volume of products and services delivered
through our servers. While we carry business interruption insurance, it might
not be sufficient to cover any serious or prolonged emergencies, and our
business might be harmed.
We might be unable to license or acquire technology
We rely on certain technologies that we license or acquire from third
parties, including Dolby Laboratories Licensing Corporation, Fraunhofer
Institut, RSA Data Security, Inc. and Thomson Consumer Electronics Sales GmbH.
These technologies are integrated with our internally-developed software and
used in our products, to perform key functions and to
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enhance the value of our platform. These third-party licenses or acquisitions
may not continue to be available to us on commercially reasonable terms or at
all. Any inability to acquire such licenses or software on commercially
reasonable terms might harm our business.
Our future success depends on our key personnel
Our future success depends to a significant extent on the continued service
of our key technical, sales and senior management personnel and their ability to
execute our growth strategy. The loss of the services of any of our senior level
management, or certain other key employees, could harm our business. Our future
performance will depend, in part, on the ability of our executive officers to
work together effectively. Our executive officers may not be successful in
carrying out their duties or running our company. Any dissent among executive
officers could impair our ability to make strategic decisions quickly in a
rapidly changing market.
Our future success also depends on our ability to attract, retain and
motivate highly skilled employees. Competition for employees in our industry is
intense. Although we provide compensation packages that include incentive stock
options, cash incentives and other employee benefits, we may be unable to retain
our key employees or to attract, assimilate and retain other highly qualified
employees in the future. We have from time to time in the past experienced, and
we expect to continue to experience in the future, difficulty in hiring and
retaining highly skilled employees with appropriate qualifications.
Our management and internal systems might be inadequate to handle the potential
growth of our personnel
To manage future growth, our management must continue to improve our
operational and financial systems and expand, train, retain and manage our
employee base. Our management may not be able to manage our growth effectively.
If our systems, procedures and controls are inadequate to support our
operations, our expansion would be halted and we could lose our opportunity to
gain significant market share. Any inability to manage growth effectively may
harm our business.
We depend on proprietary rights to develop and protect our technology
Our success and ability to compete substantially depends on our internally
developed technologies and trademarks, which we protect through a combination of
patent, copyright, trade secret and trademark laws. Patent applications or
trademark registrations may not be approved. Even if they are approved, our
patents or trademarks may be successfully challenged by others or invalidated.
If our trademark registrations are not approved because third parties own these
trademarks, our use of these trademarks would be restricted unless we enter into
arrangements with the third-party owners, which might not be possible on
commercially reasonable terms or at all.
The primary forms of intellectual property protection for our products and
services internationally are patents and copyrights. Patent protection
throughout the world is generally established on a country-by-country basis. To
date, we have not applied for any patents outside the United States. We may do
so in the future. Copyrights throughout the world are protected by several
international treaties, including the Berne Convention for the Protection of
Literary and Artistic Works. Despite these international laws, the level of
practical protection for intellectual property varies among countries. In
particular, United States government officials have criticized countries such as
China and Brazil for inadequate intellectual property protection. If our
intellectual property is infringed in any country without a high level of
intellectual property protection, our business could be harmed.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally control access to
and distribution of our technologies, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights from
unauthorized use or disclosure, parties may attempt to disclose, obtain or use
our solutions or technologies. The steps we have taken may not prevent
misappropriation of our solutions or technologies, particularly in foreign
countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States.
We have licensed, and we may license in the future, certain proprietary
rights to third parties. While we attempt to ensure that the quality of our
brand is maintained by our business partners, they may take actions that could
impair the value of
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our proprietary rights or our reputation. In addition, these business partners
may not take the same steps we have taken to prevent misappropriation of our
solutions or technologies.
We face and might face intellectual property infringement claims that might be
costly to resolve
From time to time, we receive letters from corporations and other entities
suggesting that we review patents to which they claim rights or claiming that we
infringe their patent rights. Such claims may result in our being involved in
litigation. Although we do not believe we infringe the proprietary rights of any
party, we cannot assure you that parties will not assert additional claims in
the future or that any claims will not be successful. We could incur substantial
costs and diversion of management resources to defend any claims relating to
proprietary rights, which could harm our business. In addition, we are obligated
under certain agreements to indemnify the other party for claims that we
infringe on the proprietary rights of third parties. If we are required to
indemnify parties under these agreements, our business could be harmed. If
someone asserts a claim against us relating to proprietary technology or
information, we might seek licenses to this intellectual property. We might not
be able to obtain licenses on commercially reasonable terms, or at all. The
failure to obtain the necessary licenses or other rights might harm our
business.
Difficulties presented by international economic, political, legal, accounting
and business factors could harm our business in international markets
A key component of our strategy is to expand into international markets.
The following risks are inherent in doing business on an international level and
we have little or no control over them:
. unexpected changes in regulatory requirements;
. export restrictions;
. export controls relating to encryption technology;
. longer payment cycles;
. problems in collecting accounts receivable;
. political and economic instability; and
. potentially adverse tax consequences.
In addition, other factors that may also affect us and over which we have
some control include the following:
. difficulties in staffing and managing international operations;
. differences in music rights reporting structures; and
. seasonal reductions in business activity.
We have entered into individual agreements in Japan, Korea, Greater China
and South East Asia, and we may enter into similar arrangements in the future in
other countries. One or more of the factors listed above may harm our present or
future international operations and, consequently, our business.
We might need additional capital in the future and additional financing might
not be available
We currently anticipate that our available cash resources and financing
available under existing lease agreements will be sufficient to meet our
anticipated working capital and capital expenditure requirements for the
foreseeable future. However, we may need to raise additional funds through
public or private debt or equity financing in order to:
. take advantage of opportunities, including more rapid international
expansion or acquisitions of complementary businesses or technologies;
. develop new products or services; or
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. respond to competitive pressures.
Any additional financing we may need may not be available on terms
favorable to us, or at all. If adequate funds are not available or are not
available on acceptable terms, we might not be able to take advantage of
unanticipated opportunities, develop new products or services, or otherwise
respond to unanticipated competitive pressures, and our business could be
harmed. Our forecast of the period of time through which our financial resources
will be adequate to support our operations is a forward-looking statement that
involves risks and uncertainties, and actual results could vary materially as a
result of a number of factors, including those set forth in this "Additional
Factors Affecting Future Results" section.
Internet security concerns could hinder e-commerce
A significant barrier to e-commerce and communications over the Internet
has been the need for secure transmission of confidential information. Internet
usage may not increase at the rate we expect unless some of those concerns are
adequately addressed and found acceptable by the market. Internet usage could
also decline if any well-publicized compromise of security occurs. We may incur
significant costs to protect against the threat of security breaches or to
alleviate problems caused by these breaches. Protections may not be available at
a reasonable price or at all. If a third person were able to misappropriate a
user's personal information, users could bring claims against us.
Imposition of sales and other taxes on e-commerce transactions might hinder e-
commerce
We do not collect sales and other taxes when we sell our products and
services over the Internet. States or local governments may seek to impose sales
tax collection obligations on out-of-state companies, such as ours, which engage
in or facilitate e-commerce. A number of proposals have been made at the state
and local level that would impose additional taxes on the sale of products and
services through the Internet. These proposals, if adopted, could substantially
impair the growth of e-commerce and could reduce our opportunity to derive
profits from e-commerce. Moreover, if any state or local government or foreign
country were to successfully assert that we should collect sales or other taxes
on the exchange of products and services on our system, our business might be
harmed.
In 1998, Congress passed the Internet Freedom Act, which imposes a three-
year moratorium on state and local taxes on Internet-based transactions. We
cannot assure you that this moratorium will be extended. Failure to renew this
moratorium would allow various states to impose taxes on e-commerce, which might
harm our business.
Demand for our products and services might decrease if growth in the use of the
Internet declines
Our future success substantially depends upon the continued growth in the
use of the Internet. The number of users on the Internet may not increase and
commerce over the Internet may not become more accepted and widespread for a
number of reasons, including the following, over which we have little or no
control:
. actual or perceived lack of security of information, such as
credit card numbers;
. lack of access and ease of use;
. inconsistent quality of service and lack of availability of cost-
effective, high speed service;
. possible outages due to damage to the Internet;
. excessive governmental regulation; and
. uncertainty regarding intellectual property rights.
If the necessary infrastructure, products, services or facilities are not
developed, or if the Internet does not become a viable commercial medium, our
business would be harmed.
Government regulation of the Internet might harm our business
The applicability to the Internet of existing laws governing issues such as
property ownership, libel and personal privacy is uncertain. In addition,
governmental authorities may seek to further regulate the Internet with respect
to issues such
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as user privacy, pornography, acceptable content, e-commerce, taxation, and the
pricing, characteristics and quality of products and services. Finally, the
global nature of the Internet could subject us to the laws of a foreign
jurisdiction in an unpredictable manner. Any new legislation regulating the
Internet could inhibit the growth of the Internet and decrease the acceptance of
the Internet as a communications and commercial medium, which might harm our
business.
In addition, the growing use of the Internet has burdened the existing
telecommunications infrastructure and has caused interruptions in telephone
service. Telephone carriers have petitioned the government to regulate the
Internet and impose usage fees on Internet service providers. Any regulations of
this type could increase the costs of using the Internet and impede its growth,
which could in turn decrease the demand for our services or otherwise harm our
business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk" in Part I, Item 2, Management's Discussion and Analysis
of Financial Condition and Results of Operations.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In May 1999, John Hempe filed a complaint against us, our president,
Gerald W. Kearby, our chief technical officer, Philip R. Wiser, and other
defendants not employed by us, in the San Mateo Superior Court (case number
409032). The defendants not employed by us have been dismissed. The complaint
alleges, among other things, discrimination under the provisions of the
California Fair Employment and Housing Act, breach of contract and breach of
covenant of good faith and fair dealing, in connection with his termination, and
seeks unspecified damages. While we believed the suit was without merit, we
reached an out of court settlement with the plaintiff whereby we paid $17,500 to
Mr. Hempe in May 2000.
On or about April 7, 2000, Sightsound, Inc. filed an Amended Complaint
against one of our customers in the United States District Court for the Eastern
District of Pennsylvania (Pittsburgh). The suit alleges that our customer
infringes one or more claims of three patents ((United States Patent Nos.
5,191,573; 5,675,734 and 5,996,440). Damages have not been specified. Liquid
Audio has entered into an Agreement with our customer whereby we have agreed to
assume control of the defense and pay the defense costs, while reserving our
rights as to our indemnification obligations. The customer filed an Answer to
the Amended Complaint on April 27, denying the material allegations of the
complaint, and asserting counterclaims for declaratory judgment of
noninfringement and patent invalidity. A trial date has currently been set for
September 14, 2001 in the matter. There can be no assurance regarding the
outcome of the litigation. If there is a finding of infringement, we may be
required to indemnify our customer as to the full amount of the damages.
On March 31, 2000, Intouch Group, Inc. ("Intouch") filed a lawsuit against
us in the Northern District of California alleging patent infringement. On
April 26, 2000, Intouch filed an amended complaint, which was served on us
shortly thereafter. The Complaint names us and Amazon.com International, Inc.,
Listen.com, Inc., Entertaindom LLC, Discovermusic.com, Inc. and Muze, Inc. It
alleges that we infringe, or induce infringement of, the claims of U.S. Patent
Nos. 5,237,157 and 5,963,916 by operating a website and/or a kiosk that allows
interactive previewing of pre-recorded music. The Complaint seeks unspecified
damages and injunctive relief. On May 30, 2000, we filed our answer to Intouch's
first amended complaint. The action is still in the early stages, and no trial
date has yet been set. We believe that we have meritorious defenses to Intouch's
claims and we intend to vigorously defend against such claims. However, we
cannot assure you that we will be successful in defending these lawsuits. If
there is a finding of infringement, we might be required to pay substantial
damages to Intouch and could be enjoined from selling any of our products or
services that are held to infringe Intouch's patents unless and until we are
able to negotiate a license from them.
On August 14, 2000, a former employee filed a charge of discrimination with
the California Department of Fair Employment and Housing (DFEH) against us, and
several of our employees and former employees. The charge alleges sexual
harassment and unlawful retaliation. We believe, after consultation with
counsel, that these claims are without merit, and we intend to defend ourselves
vigorously. However, should a lawsuit be filed and decided adversely to us, we
may have to pay damages.
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From time to time we receive letters from corporations or other business
entities notifying us of alleged infringement of patents held by them or
suggesting that we review patents to which they claim rights. These corporations
or entities often indicate a willingness to discuss licenses to their patent
rights.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The effective date of our first registration statement, filed on Form S-1
under the Securities Act of 1933 (No. 333-82521) relating to our initial public
offering of common stock, was July 8, 1999. A total of 4,800,000 shares of
common stock were sold at a price of $15.00 per share to an underwriting
syndicate led by Lehman Brothers Inc., BancBoston Robertson Stephens Inc. and
U.S. Bancorp Piper Jaffray Inc. Offering proceeds, net of aggregate expenses of
approximately $6.1 million, were approximately $65.9 million.
The effective date of our second registration statement, filed on Form S-1
under the Securities Act of 1933 (No. 333-91541) relating to our follow-on
public offering of common stock, was December 14, 1999. A total of 2,946,076
shares of Common Stock were sold at a price of $33.63 per share to an
underwriting syndicate led by Lehman Brothers, BancBoston Robertson Stephens
Inc., U.S. Bancorp Piper Jaffray, Dain Rauscher Wessells and Fidelity Capital
Markets. An additional 503,924 shares of Common stock were sold on behalf of
selling stockholders as part of the same offering. Offering proceeds to us, net
of aggregate expenses of approximately $5.4 million, were approximately $93.7
million. Offering proceeds to selling shareholders, net of expenses of
approximately $847,000, were approximately $16.1 million.
In July 2000, we issued 150,000 shares to a major record label in
connection with a letter agreement for distributing music over the Internet
using our technology.
From the time of receipt through September 30, 2000, our proceeds were
applied toward general corporate purposes, including the purchase of temporary
investments consisting of cash, cash equivalents and short-term investments,
working capital and capital expenditures, enhancing research and development and
attracting key personnel.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed with this report as indicated below:
10.51 Letter Agreement with Virgin Holdings, Inc., an affiliate of EMI Recorded
Music, dated July 10, 2000
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
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LIQUID AUDIO, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATE: November 10, 2000 LIQUID AUDIO, INC.
/s/ Gerald W. Kearby
-----------------------------------------------
GERALD W. KEARBY
President, Chief Executive Officer and Director
/s/ Lyman Yip
-----------------------------------------------
LYMAN YIP
Controller
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LIQUID AUDIO, INC.
INDEX TO EXHIBITS FOR FORM 10-Q
FOR QUARTER ENDED SEPTEMBER 30, 2000
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
10.51 Letter Agreement with Virgin Holdings, Inc., an affiliate of
EMI Recorded Music, dated July 10, 2000
27.1 Financial Data Schedule
