<PAGE>
As filed with the Securities and Exchange Commission on December 22, 1999
Registration No. 333-88969
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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EMUSIC.COM INC.
(Exact name of registrant as specified in its charter)
Delaware 3652 94-3290594
State(or jurisdiction of (Primary Standard (I.R.S. Employer
incorporation or Industrial Identification No.)
organization) Classification Code
Number)
1991 Broadway, 2nd Floor
Redwood City, California 94063
(650) 216-0200
(Address and telephone number of principal executive offices)
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Gene Hoffman, Jr.
President and Chief Executive Officer
EMusic.com Inc.
1991 Broadway, 2nd Floor
Redwood City, California 94063
(650) 216-0200
(Name, address and telephone number of agent for service)
Copies to:
Andrew Zeif, Esq.
Craig Malina, Esq.
Gray Cary Ware & Freidenrich LLP
400 Hamilton Avenue
Palo Alto, California 94301-1825
(650) 833-2000
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
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If any of the securities being registered on this form are being offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
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CALCULATION OF REGISTRATION FEE
<TABLE>
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<CAPTION>
Proposed
Proposed Maximum
Maximum Aggregate
Title of Each Class of Amount to be Offering Price Offering Amount of
Securities to be Registered Registered Per Share(1) Price(1) Registration Fee
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<S> <C> <C> <C> <C>
Common Stock ($0.001 par 13,434,102
value)......................... shares(2) $15.75 $211,320,107 $58,718.22(3)
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</TABLE>
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(1) Estimated solely for the purpose of computing the registration fee pursuant
to Rule 457(c) of the Securities Act and based on the average of the
closing bid and asked prices reported on the Nasdaq National Market on
October 6, 1999 except for 150,000 additional shares included in Amendment
No. 1 which were not registered in the initial filing which is based on
$13.97, the average of the closing bid and asked price or reported on the
Nasdaq National Market on December 17, 1999.
(2) Represents shares of common stock (i) issued in connection with the
conversion of shares of our Series B Preferred Stock; (ii) issuable upon
exercise of outstanding common stock purchase warrants; (iii) issued in
connection with certain acquisitions, a share exchange transaction and
other transactions.
(3) $58,165 of which had been previously paid.
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
Subject to Completion, Dated December 22, 1999
The information contained in this prospectus is not complete and may be
changed. These securities may not be sold until the registration statement
filed with the Securities and Exchange Commission is effective. This
prospectus is not an offer to sell these securities and it is not soliciting
an offer to buy these securities in any state where the offer or sale is not
permitted.
The Resale of
13,434,102 Shares
[LOGO OF EMUSIC.COM INC.]
Common Stock
The selling price will be determined by market factors at the time of their
resale
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This prospectus relates to the resale by the selling stockholders of up to
13,434,102 shares of common stock. The selling stockholders may sell the stock
from time to time at the prevailing market price or in negotiated
transactions. Of the shares offered:
. up to 11,737,000 shares are presently outstanding and were issued upon
the conversion of the Company's Series B Preferred Stock,
. up to 1,255,367 shares are presently outstanding and were issued in
connection with the acquisition of Creative Fulfillment, Inc. and the
purchase of certain assets of Nordic Entertainment Worldwide, Inc. and
certain related partnerships;
. up to 260,000 shares are issuable upon the exercise of common stock
purchase warrants and
. up to 181,735 shares issued in connection with a share exchange
transaction in connection with the acquisition by the Company of its
predecessor corporation and various other transactions.
Of the shares covered by this prospectus, approximately 13,226,000 shares are
subject to lock-up agreements or other restrictions which precludes the resale
of such shares for 90 days following our September 24, 1999 underwritten
public offering. We will receive no proceeds from the sale of the shares by
the selling stockholders. However, we have received proceeds from the sale of
shares currently outstanding and, if exercised, will receive proceeds equal to
the exercise price of the common stock purchase warrants.
Our common stock is listed on the Nasdaq National Market under the symbol
"EMUS." On December 20, 1999, the last reported sale price of the common stock
on the Nasdaq National Market was $12.56 per share.
Investing in our common stock involves risks. See "Risk Factors" beginning on
page 8.
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
The date of this prospectus is December , 1999.
<PAGE>
Table Of Contents
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 4
Risk Factors............................................................. 8
Selling Stockholders..................................................... 19
Plan of Distribution..................................................... 28
Use of Proceeds.......................................................... 30
Dividend Policy.......................................................... 30
Capitalization........................................................... 31
Selected Financial Data.................................................. 32
Management Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 33
Business................................................................. 41
Management............................................................... 52
Certain Transactions and Relationships................................... 59
Principal Stockholders................................................... 60
Description of Capital Stock............................................. 62
Shares Eligible for Future Sale.......................................... 66
Price Range of Common Stock.............................................. 67
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.............................................................. 67
Legal Matters............................................................ 68
Experts.................................................................. 68
Where You Can Find More Information About Us............................. 68
Index to Financial Statements............................................ F-1
</TABLE>
-------------------------
Prior to June 1999, we operated under the name GoodNoise Corporation. Our
executive offices are located at 1991 Broadway, 2nd Floor, Redwood City,
California 94063, and our telephone number is (650) 216-0200. Our website can
be found at EMusic.com. Our website does not constitute part of this
prospectus.
"EMusic" is a registered trademark of EMusic.com Inc. and the EMusic logo is a
trademark of EMusic.com Inc. All other trademarks or tradenames referred to in
this prospectus are the property of their respective owners.
As used in this prospectus, the terms "we," "us," "our," "the Company" and
"EMusic" mean EMusic.com Inc. and the term "common stock" means our common
stock, par value $0.001 per share.
3
<PAGE>
Prospectus Summary
This summary highlights information contained in other parts of this
prospectus. Because it is a summary, it does not contain all of the information
that you should consider before investing in our common stock. You should read
the entire prospectus carefully, including "Risk Factors" and the financial
statements and related notes, before making an investment decision.
Our Company
EMusic.com Inc. is a leading provider of downloadable music over the Internet.
Through our website at EMusic.com, we offer a compelling selection of music
from which our customers may discover, sample, and purchase popular recordings
for immediate digital delivery and enjoyment. The recordings available for
download at EMusic.com are provided through our relationships with a growing
roster of recording artists and independent record labels. We currently have
exclusive, multi-year, digital download licenses from over 500 record labels
and over 2,500 recording artists, including selected titles from such well
known artists as Bush, Phish, They Might Be Giants, B.B. King and Ella
Fitzgerald. We currently have over 50,000 titles available for download on our
EMusic.com website. In addition, our IUMA subsidiary offers our customers
access to over 7,500 unsigned artists. We believe this represents one of the
largest digital music content archives currently licensed for distribution over
the Internet.
Our website enables artists and labels to easily access a global customer base
while providing them with an integrated means of distributing, promoting and
tracking the sales of their recorded music. Recordings are currently offered
for sale on EMusic.com and partners' websites in the "mp3" format, the most
widely-recognized compression standard for the download of musical recordings.
We believe that our combination of selection, convenience, varied content,
improved distribution and tracking capabilities creates a compelling music
purchasing experience for consumers as well as an attractive distribution
alternative for artists and independent record labels.
The emergence of the Internet as a global communications standard, the growth
of high-speed internet access, the development of audio compression techniques,
such as mp3, and the proliferation of hardware and software that enables the
management and playback of downloadable music is currently driving rapid growth
in the sector. Forrester Research estimates that total online music revenues in
the United States are expected to grow from $89.0 million in 1998 to $7.8
billion in 2003. Of this amount, Forrester further estimates that $1.1 billion
will represent sales of downloadable music in 2003.
We operate a website that allows consumers to quickly and conveniently purchase
music and download it immediately, at a lower price than most traditional CDs.
We believe that the limitations associated with the traditional music industry
present us with an opportunity to redefine the music distribution hierarchy and
enable artists and independent labels to access consumer markets at a level
currently only available to the major labels, while protecting the artists'
financial interests and providing consumers with numerous advantages in price,
convenience and music information.
Our solution provides the following benefits:
. Benefits to the Consumer. Consumer benefits include convenience, lower
prices, large selection and music information. Downloadable music can be
purchased online and used immediately, and can be more easily managed,
carried and customized than music on physical media. When using the
Internet as the distribution channel, there are none of the costs
associated with distributing physical media, and as a result, music can
be purchased at a lower cost than traditional CDs.
. Benefits to Artists and Independent Labels. Benefits to artists and
independent labels include powerful distribution capability, greater
understanding of fan base, significant new media exposure
4
<PAGE>
and an infrastructure to support the payment of royalties. Our solution
offers global distribution to artists and independent labels, with
higher margins stemming from lower distribution costs. By tracking the
behavior of fans on our web site, we are able to offer artists and
labels insight into who is buying their music, allowing them to focus
their creative and promotional efforts.
Our goal is to become the leading provider of compelling, downloadable music
directly to consumers over the Internet. Key elements of our strategy include:
. Continue to acquire compelling content through agreements with
independent record labels, owners and distributors of recording
catalogs and artists;
. Create strong brand awareness through offline and online marketing,
site development and referral fee arrangements;
. Leverage strategic relationships to build brand and acquire content;
. Improve website functionality with the addition of chat rooms, music
hubs, more content, more advanced search capabilities and dynamic
personalization;
. Leverage pricing and infrastructure to become a trusted distribution
channel by designing our technology and structuring our pricing to
dissuade piracy and track all appropriate royalty payments;
. Continue to promote development of the downloadable music market by
supporting organizations dedicated to the proliferation of
downloadable music and by providing consumers with a positive
purchase experience; and
. Continue to develop and enhance Internet Underground Music Archive by
making it easier to access and post songs and information which will
allow us to establish early relationships with potential music
content providers.
We are a development stage company and have experienced net losses since
inception in January 1998. We intend to aggressively invest to implement our
strategy, and expect to continue to incur net losses for the forseeable future.
5
<PAGE>
The Offering
Common stock offered by the selling
stockholders ......................... 13,434,102 shares; Includes an
indeterminate number of shares of
common stock that may become issuable
to prevent dilution resulting from
stock splits, stock dividends and
conversion price or exercise price
adjustments, which are included
pursuant to Rule 416 promulgated under
the Securities Act of 1933.
Common stock currently outstanding ... As of the date of this prospectus, we
have approximately 36,500,000 shares of
common stock issued and outstanding.
Use of proceeds....................... We will not receive any proceeds from
the resale of the shares of common
stock by the selling shareholders. We
will receive proceeds from the payment
of the exercise price of the common
stock purchase warrants if any are
exercised for cash.
Nasdaq National Market symbol......... EMUS
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These share numbers are based on shares outstanding as of September 30, 1999,
including approximately 2,100,000 shares issued in connection with our
acquisition of Group K Inc. d/b/a Cductive in December 1999 and exclude:
. 6,620,365 shares of common stock issuable upon exercise of outstanding
options at an average exercise price of $7.93;
. 2,711,976 shares of common stock issuable upon exercise of outstanding
warrants at an average exercise price of $14.09; and
. 4,163,650 shares of common stock issuable upon exercise of options that
may be granted under our stock option plans.
. up to 10,600,000 shares of common stock which may be issued in connection
with the proposed acquisition of Tunes.com Inc.
. 470,661 shares of common stock issuable upon exercise of outstanding
options and warrants assumed through the acquisition of Cductive at an
average exercise price of $5.95.
6
<PAGE>
Summary Consolidated Financial Data
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Three months Three months January 8, 1998
January 8, 1998 January 8, 1998 ended ended (inception) to
(inception) to Year ended (inception) to September 30, September 30, September 30,
June 30, 1998 June 30, 1999 June 30, 1999 1998 1999 1999
--------------- ------------- --------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues..................... -- $ 92 $ 92 $ 12 $ 180 $ 272
---------- ---------- ---------- ---------- ---------- ----------
Gross profit................. -- 65 65 12 155 220
---------- ---------- ---------- ---------- ---------- ----------
Operating loss............... $ (1,180) $ (15,462) $ (16,642) $ (852) $ (13,722) $ (30,364)
========== ========== ========== ========== ========== ==========
Net loss..................... $ (1,180) $ (15,140) $ (16,320) $ (849) $ (13,519) $ (29,839)
========== ========== ========== ========== ========== ==========
Net loss applicable to common
shares...................... $ (1,180) $ (47,677) $ (48,857) $ (849) $ (14,236) $ (63,093)
========== ========== ========== ========== ========== ==========
Net loss per common share--
basic and diluted........... $ (0.12) $ (3.52) $ (4.87) $ (0.06) $ (1.09) $ (5.03)
========== ========== ========== ========== ========== ==========
Weighted average common
shares outstanding--basic
and diluted................. 10,234,055 13,563,606 10,027,231 14,591,336 13,057,809 12,542,537
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended
----------------------------------------------------------------
June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30,
1998 1998 1998 1999 1999 1999
-------- --------- -------- --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Quarterly Statement of Operations Data:
Net revenue............................ -- $ 12 $ 8 $ 21 $ 51 $ 180
Gross profit........................... -- 12 4 12 37 155
Net loss............................... (1,091) (849) (1,125) (2,289) (10,877) (13,519)
Net loss applicable to common shares... $(1,091) $(849) $(1,294) $(33,914) $(11,620) $(14,236)
<CAPTION>
June 30, September 30,
1999 1999
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<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.................................................... $ 19,002 $ 78,904
Working capital.............................................................. 16,593 84,877
Total assets................................................................. 54,221 125,165
Redeemable convertible preferred stock....................................... 32,550 --
Total stockholders' equity................................................... 18,987 121,439
</TABLE>
7
<PAGE>
Risk Factors
Investing in our common stock involves a high degree of risk. You should
carefully consider the following factors and other information contained in
this prospectus before deciding to invest in our stock.
Any of the following risks, if they actually occur, could materially and
adversely affect our business, financial condition or results of operations. In
such an event, the trading price of our common stock could decline, and you
could lose all or part of your investment.
We have a new and unproven business model and it may not generate sufficient
revenue for our business to survive or be successful.
Our model for conducting business and generating revenues is new and unproven
and if it fails to develop as we plan, our business may not succeed. Our
business model depends upon our ability to generate revenue streams from
multiple sources through our website, including:
. online sales of downloadable music;
. website advertising fees from third parties;
. licensing of musical recordings for use by others; and
. online sales of music-related merchandise.
It is uncertain whether a music-based website such as ours, that relies on
attracting people to purchase and download music, mostly from lesser-known
artists, can generate sufficient revenues to survive. This business model may
not succeed or it may not be sustainable as our business grows.
In order for our business to be successful, we must not only develop services
that directly generate revenue, but also provide content and services that
attract consumers to our website frequently. We will need to develop new
offerings as consumer preferences change and new competitors emerge. We may not
be able to provide consumers with an acceptable blend of products, services,
and informational and community offerings that will attract consumers to our
website frequently. We provide many of our products and services without
charge, and we may not be able to generate sufficient revenue to pay for these
products and services. Accordingly, we are not certain that our business model
will be successful or that we can sustain revenue growth or be profitable.
We are competing in a new market that may not develop sufficiently to support
our business.
The market for online music promotion and distribution is new and rapidly
evolving. As a result, demand and market acceptance for our products and
services are subject to a high degree of uncertainty and risk. We are
attempting to capitalize on a talent pool of artists underserved by the
traditional recording industry. Consumers may not continue to be interested in
listening to, or purchasing music from, these artists. If this new market fails
to develop, develops more slowly than expected or becomes saturated with
competitors, or our products and services do not achieve or sustain market
acceptance, we may not generate sufficient revenues to become profitable.
The future popularity of downloadable music will depend on consumer acceptance
of downloading music generally. We believe that consumer acceptance is, in
part, dependent on the availability of portable devices to store and play this
music. To the extent that devices are not available at affordable prices, or
consumer acceptance or distribution of these portable devices is delayed, our
potential market, and thus our ability to increase our revenues, may be
reduced.
8
<PAGE>
We have a limited operating history that makes an evaluation of our business
difficult.
We were incorporated in January 1998. During 1998, our operating activities
consisted largely of developing the infrastructure necessary to download music
on the Internet. Our limited operating history makes it difficult to evaluate
our current business and prospects. As a result of our limited operating
history, we do not have meaningful historical financial data upon which to
forecast quarterly revenues and results of operations. Before investing in us,
you should evaluate the risks, expenses and problems frequently encountered by
companies such as ours that are in the early stages of development.
We have incurred substantial losses to date and we expect net losses in the
future.
From inception through September 30, 1999, we had a deficit accumulated during
the development stage of approximately $63.1 million. We expect substantial net
losses and negative cash flow for the foreseeable future. We believe it is
critical to our long-term success that we continue to develop "EMusic" brand
awareness and loyalty through marketing and promotion, expand our artist and
consumer networks, develop our online content and expand our other services. We
expect that our operating expenses will increase significantly during the next
several years, especially in sales and marketing. With increased expenses, we
will need to generate significant additional revenues to achieve profitability.
As a result, we may never achieve profitability and, if we do achieve
profitability in any period, we may not be able to sustain or increase
profitability.
Our quarterly revenues and operating results are subject to fluctuation which
may result in volatility or a decline in the price of our stock.
We believe that period-to-period comparisons of our operating results are not
meaningful and should not be relied upon as indicators of future performance.
Our quarterly operating results are likely to fluctuate significantly in the
future as a result of a variety of factors, many of which are outside of our
control, including:
. the demand for downloadable music content and Internet advertising;
. the addition or loss of advertisers;
. the level of traffic on our Internet sites;
. the amount and timing of capital expenditures and other costs relating to
the expansion of our operations;
. the introduction of new sites and services by us or our competitors;
. seasonal trends in Internet use, purchases of downloadable music, and
advertising placements;
. price competition or pricing changes in the industry;
. technical difficulties or system downtime; and
. general economic conditions, and economic conditions specific to the
Internet and Internet media.
In addition, while our revenues may vary significantly, a portion of our
expenses are fixed. As a result, any decrease in revenues will not be
accompanied by a decrease in our fixed operating expenses and our operating
results will suffer. Our quarterly results may also be significantly impacted
by the accounting treatment of acquisitions, financing transactions or other
matters. Particularly at our early stage of development, such accounting
treatment can have a material impact on the results for any quarter. Because of
these and other factors it is likely that our operating results will fall below
expectations in some future quarter and the trading price of our stock may
drop.
Shares eligible for future sale in the open market may depress our stock price.
As of December 20, 1999, there were approximately 36,500,000 shares of common
stock outstanding, of which approximately 10,000,000 were tradable without
restriction under the Securities Act and approximately
9
<PAGE>
11,000,000 were tradable under Rule 144. Upon the effectiveness of this
registration statement, approximately 34,000,000 shares of our outstanding
stock will be tradable, including shares tradable under Rule 144.
Our stock price has been and may continue to be volatile.
Our common stock is currently traded on the Nasdaq National Market under the
ticker symbol "EMUS." There can be no assurance that an active trading market
will be sustained in the future. In addition to fluctuations in our operating
results, the following factors could cause the price of our securities to be
volatile:
. development of the downloadable music market;
. technological innovations;
. new products;
. acquisitions or strategic alliances entered into by us or our
competitors;
. failure to meet securities analysts' expectations;
. government regulatory action;
. patent or proprietary rights developments; and
. market conditions for internet and technology stocks in general.
If our brand name is not accepted, our ability to attract content and customers
to our website will be harmed.
During the quarter ended June 30, 1999, we began to operate under the name
EMusic.com Inc. and launched a marketing campaign to establish the brand name
"EMusic." We believe that establishing and maintaining the EMusic brand is a
critical aspect of our efforts to attract and expand our Internet audience and
acquire new content and that the importance of brand recognition will increase
due to the growing number of Internet sites and the relatively low barriers to
entry in providing Internet content. We intend to incur significant expenses in
our brand building efforts. If these efforts do not generate increased revenues
our operating results will suffer. If we are unable to provide high quality
content or otherwise fail to promote and maintain our brand, our business will
be harmed.
If we are unable to maintain or expand our contracts for music content, or if
the content we license does not sell, our popularity and business may suffer.
We believe that a primary draw to our website is the ability to access music
from known artists and independent record labels. Currently, we have exclusive
multi-year contracts for much of our music library. However, if we are unable
to sign contracts for new content, or if we are unable to extend the terms of
existing contracts as they expire, our website may fail to attract new, or
retain existing, customers which would harm our business.
For much of the content we license, we pay advances against future royalties
which will be owed on sale of the content. If the content we license does not
sell in sufficient quantities, we may not be able to recover all or part of the
advances we have paid and our business could be harmed.
We rely on a third party for the hosting of our website and if this hosting
service becomes unavailable, our customers will not be able to access our
website.
We currently rely on a third party which hosts our website at a single location
in Sunnyvale, California. We currently do not maintain a redundant website. If
for any reason our current website hosting services become unavailable or if
our hosting service experiences technical problems, customers will not be able
to access our website until these services are restored or until we are able to
make arrangements with an alternate provider.
10
<PAGE>
If we fail to adequately manage our growth, we may not be successful as we may
miss market opportunities.
We expect the scope of our operations and the number of our employees to grow
rapidly. In particular, we intend to hire additional engineering, sales,
marketing, content acquisition and administrative personnel. Additionally,
acquisitions could increase our employee headcount and business activity. We
expect our rapid growth to continue to place significant stress on our
technology, operations, management and employee base. Any failure to
successfully address the needs of our growing enterprise would harm our
business.
Our technology systems must be expanded and enhanced for our business to grow.
In order to support a growing business, we will need to continue to enhance and
expand the technology infrastructure which supports our business. We have
recently converted our central database to a new database based upon technology
licensed from Oracle Corporation and we expect to implement a new accounting
system in the first half of calendar year 2000. As our business continues to
grow, we will need to add additional servers and other hardware and software
systems as well as additional sites for website hosting. If we fail to
successfully implement these new and enhanced systems, our operations could be
disrupted, we may become less competitive, our revenues could be reduced and we
may need to incur additional costs to address these issues.
We may have difficulty executing acquisitions and integrating the acquired
companies into our business.
Our business strategy includes entering into strategic alliances and acquiring
complementary businesses, technologies, content or products. In January 1999,
we completed the acquisition of Creative Fulfillment, Inc., in June 1999, we
completed the acquisition of Internet Underground Music Archive and in December
1999, we completed the acquisition of Group K Inc. d/b/a Cductive. In November
1999, we entered into an agreement to acquire Tunes.com Inc. The closing of the
Tunes.com transaction is subject to customary closing conditions. These and any
other future acquisitions involve risks commonly encountered in acquisitions of
companies, including:
. exposure to unknown liabilities of acquired companies;
. incurring acquisition costs and expenses in excess of what we
anticipated;
. the occurrence of fluctuations in our quarterly and annual operating
results due to the costs and expenses of acquiring and integrating new
businesses or technologies;
. experiencing difficulties and expenses in assimilating the operations and
personnel of the acquired businesses;
. disruption of our ongoing business and diversion of our management's time
and attention;
. a possible inability to integrate successfully or to complete the
development and application of acquired technology and a possible failure
to achieve the anticipated financial, operating, and strategic benefits
from these acquisitions;
. experiencing difficulties in establishing and maintaining uniform
standards, controls, procedures, and policies;
. impairment of our relationships with key employees and customers of
acquired businesses or the loss of these key employees and customers as a
result of changes in management and ownership of the acquired businesses;
and
. acquisitions using the purchase method of accounting, which may result in
goodwill, creating amortization charges in future periods.
In addition, our shareholders may be diluted if the consideration for future
acquisitions consists of equity securities. We may not overcome these risks or
any other problems encountered in connection with acquisitions. If we are
unsuccessful in doing so, our business could be harmed.
11
<PAGE>
We expect competition to increase significantly in the future and we may not be
able to compete successfully.
The market for the online promotion and distribution of music and music-related
products and services is new, highly competitive and rapidly changing. The
number of websites on the Internet competing for the attention and spending of
consumers, users and advertisers has increased, and we expect it to continue to
increase, because there are few barriers to entry to Internet commerce. In
addition, the competition for advertising revenues, both on Internet websites
and in more traditional media, is intense. Currently, there are more than one
hundred music retailing websites on the Internet. We face competitive pressures
from numerous actual and potential competitors.
Certain companies have agreed to work together to offer music over the
Internet, and we may face increased competitive pressures as a result. For
example, it was recently announced that Time Warner and Sony's Columbia House
unit will merge with CDNow. In May 1999, Microsoft Corporation and Sony
Corporation announced an agreement to pursue a number of cooperative
activities. Sony has announced that it will make its music content downloadable
from the Internet using Microsoft's multimedia software. In addition, Universal
Music Group and BMG Entertainment have announced a joint venture to form an
online music store.
Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Many of our current and
potential competitors in the Internet and music entertainment businesses may
have substantial competitive advantages relative to us, including:
. longer operating histories;
. significantly greater financial, technical and marketing resources;
. greater brand name recognition;
. larger existing customer bases; and
. more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to the development, promotion, and sale of their products or services than we
can. Websites maintained by our existing and potential competitors may be
perceived by consumers, artists, talent management companies and other music-
related vendors or advertisers as being superior to ours. In addition, we may
not be able to maintain or increase our website traffic levels, purchase
inquiries and number of click-throughs on our online advertisement. Further,
our competitors may experience greater growth in these areas than we do.
Increased competition could result in advertising price reduction, reduced
margins or loss of market share, any of which could harm our business.
We may need to obtain additional funds to execute our business plan and if we
are unable to obtain such funds, we will not be able to expand our business as
planned.
We believe that our existing capital resources will be sufficient to fund our
planned level of operating activities, capital expenditures and other
obligations through the next 12 months. However, we may need to raise
additional funds in order to:
. finance unanticipated working capital requirements, including additional
working capital required as a result of acquisitions;
. develop or enhance existing services or products;
. fund distribution relationships;
. advertise to build global brand recognition;
. respond to competitive pressures; or
. acquire complementary businesses, technologies, content or products.
12
<PAGE>
Additional financing 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,
our ability to fund our expansion, take advantage of unanticipated
opportunities, develop or enhance services or products or otherwise respond to
competitive pressures would be significantly limited. If we raise additional
funds by issuing equity or convertible debt securities, the percentage
ownership of our then existing stockholders will be reduced, and these
securities may have rights, preferences or privileges senior to those of our
stockholders.
Our business is dependent on the continued development and maintenance of the
Internet and the availability of increased bandwidth to consumers.
The success of our business will depend largely on the development and
maintenance of the Internet infrastructure. This includes maintenance of a
reliable network with the necessary speed, data capacity and security, as well
as timely development of complementary products such as high speed modems, for
providing reliable Internet access and services. Because global commerce on the
Internet and the online exchange of information is new and evolving, we cannot
predict whether the Internet will prove to be a viable commercial marketplace
in the long term.
The success of our business will rely on the continued improvement of the
Internet as a convenient means of consumer interaction and commerce, as well as
an efficient medium for the delivery and distribution of music. Our business
will depend on the ability of our artists and consumers to continue to upload
and download mp3 and other music file formats, as well as to conduct commercial
transactions with us, without significant delays or aggravation that may be
associated with decreased availability of Internet bandwidth and slower access
to our website. Our penetration of a broader consumer market will depend, in
part, on continued proliferation of high speed Internet access. Even compressed
in mp3 format, a typical three minute song file can occupy more than three
megabytes of storage space. This file could take approximately seven minutes to
download over a conventional 56 kbps modem compared to less than one minute
over an xDSL or cable modem.
The Internet has experienced, and is likely to continue to experience,
significant growth in the numbers of users and amount of traffic. As the
Internet continues to experience increased numbers of users, increased
frequency of use and increased bandwidth requirements, the Internet
infrastructure may be unable to support the demands placed on it. In addition,
increases in users or bandwidth requirements may harm the performance of the
Internet. The Internet has experienced a variety of outages and other delays as
a result of damage to portions of its infrastructure, and it could face outages
and delays in the future. This might include outages and delays resulting from
the "year 2000" problem. These outages and delays could reduce the level of
Internet usage as well as the level of traffic, and could result in the
Internet becoming an inconvenient or uneconomical source of music and music-
related products and services. The infrastructure and complementary products or
services necessary to make the Internet a viable commercial marketplace for the
long term may not be developed successfully or in a timely manner. Even if
these products or services are developed, the Internet may not become a viable
commercial marketplace for the products or services that we offer.
We must maintain and establish strategic alliances to increase our customer
base and enhance our business.
In an attempt to increase our customer base and traffic on our website, build
brand recognition, attract paid advertising and enhance content, distribution
and commerce opportunities, we have entered into agreements with various media,
hardware device and Internet-related companies such as: America OnLine, Yahoo!,
Creative Labs and RealNetworks. Our failure to maintain or renew our existing
strategic alliances or to establish and capitalize on new strategic alliances
could harm our business. Our future success depends to a significant extent
upon the success of such alliances. Moreover, we are substantially dependent on
our ability to advertise on other Internet sites and the willingness of the
owners of other sites to direct users to our Internet sites through hypertext
links. We may not achieve the strategic objectives of these alliances, and
parties to strategic alliance agreements with us may not perform their
obligations as agreed upon. Such agreements also
13
<PAGE>
may not be specifically enforceable by us. In addition, some of our strategic
alliances are short term in nature and may be terminated by either party on
short notice. The termination or impairment of these strategic alliances could
reduce our ability to attract new customers.
Our success depends on our retention of key personnel.
Our performance is substantially dependent on the services of Robert H. Kohn,
our chairman, and Gene Hoffman, Jr., our chief executive officer, as well as on
our ability to recruit, retain and motivate other officers and key employees.
Competition for qualified personnel is intense and there are a limited number
of persons with knowledge of and experience in the Internet and music
entertainment industries. The loss of the services of any of our officers or
senior managers could harm our business.
We may not be able to hire and retain a sufficient number of qualified
employees to grow our business as planned.
Our future success will depend on our ability to attract, train, retain and
motivate other highly skilled technical, managerial, marketing and customer
support personnel. Competition for these personnel is intense, especially for
engineers, web designers and advertising sales personnel, and we may be unable
to successfully attract sufficiently qualified personnel. A large percentage of
our employees have joined us in 1999 and we expect that our rate of hiring will
continue at a very rapid pace. To manage the expected growth of our operations,
we will need to integrate these employees into our business. Our inability to
hire, integrate and retain qualified personnel in sufficient numbers may reduce
the quality of our programs, products and services, and could harm our
business. In addition, companies in the Internet and music industries whose
employees accept positions with competitive companies frequently claim that
their competitors have engaged in unfair hiring practices. We may be subject to
claims in the future as we seek to hire qualified personnel and those claims
may result in material litigation involving EMusic. Even if unsuccessful, these
claims could harm our business by damaging our reputation, requiring us to
incur legal costs and diverting management's attention away from our business.
Security concerns regarding credit card or other confidential information
transmitted over the web could limit our growth and subject us to liability.
A significant barrier to e-commerce and communications over the Internet has
been the need for secure transmission of confidential information over public
networks. Internet usage may not increase at the rate we expect unless some of
these concerns are adequately addressed and found acceptable by the market.
Internet usage could also decline if any well publicized compromise of security
occurred. We may incur significant costs to protect against the threat of
security breaches or to alleviate problems caused by such breaches. Protections
against security breaches may not be available at a reasonable price or at all.
If a third party were able to circumvent our security measures and
misappropriate our users' personal information, it may cause interruptions to
our retail website operation, damage our reputation or subject us to claims by
users. Any compromise of confidential data during transmission over the
Internet may harm our business.
Any failure of our internal security measures could cause us to lose customers
and subject us to liability.
Our business is dependent on maintaining a database of confidential user
information, including credit card numbers. If the security measures that we
use to protect personal information are ineffective, we may lose customers and
our business would be harmed. We rely on security and authentication technology
licensed from third parties. With this technology, we perform real-time credit
card authorization and verification. We cannot predict whether new
technological developments could allow these security measures to be
circumvented. In addition, our software, databases and servers may be
vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions. We may need to spend significant resources to protect against
security breaches or to alleviate problems caused by any breaches and we may
not be able to prevent all security breaches.
14
<PAGE>
Our intellectual property protection may be inadequate, and any loss or
reduction in intellectual property protection may harm our business.
Our intellectual property includes our trademarks and copyrights, proprietary
software, and other proprietary rights. We believe that our intellectual
property is important to our success and our competitive position, and we try
to protect it. However, our efforts to protect our intellectual property could
be inadequate. Use of the "EMusic" name by others could dilute our brand
identity and confuse the market. In addition, our ability to conduct our
business may be harmed if others claim we violate their intellectual property
rights. For example, Sightsound.com, Inc. and intouch group Inc. have asserted
that many online music providers, including EMusic, violate patent rights that
they allegedly owns covering the sale of music over the Internet through
digital downloads. If successful, these claims, or similar claims by others,
could seriously harm our business by forcing us to cease using intellectual
property that we depend on to operate our business. Even if unsuccessful, these
claims could harm our business by damaging our reputation, requiring us to
incur legal costs and diverting management's attention away from our business.
Government regulation may require us to change the way we do business.
Laws and regulations directly applicable to Internet communications, commerce
and advertising are becoming more prevalent. The United States Congress has
enacted Internet laws regarding children's privacy, copyrights and taxation.
Such legislation could dampen the growth in use of the Internet generally and
decrease the acceptance of the Internet as a communications, commercial and
advertising medium. Although our transmissions originate in California, the
governments of other states or foreign countries might attempt to regulate our
transmissions or levy sales or other taxes relating to our activities. The
European Union recently enacted its own privacy regulations that may result in
limits on the collection and use of certain user information. The laws
governing the Internet, however, remain largely unsettled, even in areas where
there has been some legislative action. It may take years to determine whether
and how existing laws such as those governing intellectual property, privacy,
libel and taxation apply to the Internet and Internet advertising. In addition,
the growth and development of the market for Internet commerce may prompt calls
for more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on companies conducting business
over the Internet. Furthermore, the Federal Trade Commission has recently
investigated the disclosure of personal identifying information obtained from
individuals by Internet companies. Evolving areas of law that are relevant to
our business include privacy law, proposed encryption laws, content regulation
and sales and use tax. For example, changes in copyright law could require us
to change the manner in which we conduct business or increase our costs of
doing business. Because of this rapidly evolving and uncertain regulatory
environment, we cannot predict how these laws and regulations might affect our
business. In addition, these uncertainties make it difficult to ensure
compliance with the laws and regulations governing the Internet. These laws and
regulations could harm us by subjecting us to liability or forcing us to change
how we do business. In the event the Federal Trade Commission or other
governmental authorities adopt or modify laws or regulations applicable to our
business, including those relating to the Internet and copyright matters, our
business could be harmed.
We may have liability for content on our website and liability for other
materials which we distribute.
We may be liable to third parties for content on our website and any other
materials we distribute if:
. the music, text, graphics or other content on our website violates their
copyright, trademark, or other intellectual property rights;
. our artists or labels violate their contractual obligations to others by
providing content on our website; or
. content we distribute is deemed obscene, defamatory or excessively
violent.
We may also be subject to these types of liability for content that is
accessible from our website through links to other websites.
15
<PAGE>
Liability or alleged liability for content or other materials could harm our
business by damaging our reputation, requiring us to incur legal costs in
defense, exposing us to significant awards of damages, fines and costs and
could divert management's attention away from our business. In particular, in
addition to civil damages, liability for violations of copyright law currently
can result in penalties of up to $10,000 per occurrence.
Imposition of sales and other taxes on e-commerce transactions may impair our
ability to derive financial benefits from e-commerce.
Except for sales of tangible merchandise into certain states, we do not collect
sales or other taxes on sales of our products through our websites. Although
the Internet Tax Freedom Act precludes, for a period of three years ending
October 2001, the imposition of state and local taxes that discriminate against
or single out the Internet, it does not currently impact existing taxes.
However, one or more states may seek to impose sales tax collection obligations
on out-of-state companies such as us, which engage in or facilitate online
commerce. A number of proposals have been made at the state and local level
that would impose additional taxes on the sale of goods and services through
the Internet. Such proposals, if adopted, could substantially impair the growth
of electronic commerce and could adversely affect our opportunity to derive
financial benefit from electronic commerce. Moreover, if any state or foreign
country were to successfully assert that we should collect sales or other taxes
on the exchange of merchandise on its system, it could affect our cost of doing
business.
We may have difficulty expanding into international markets which could limit
the growth of our business.
Our future growth and success will depend in part on our ability to generate
international sales. There can be no assurance, however, that we will be
successful in generating international sales of our products. Sales to
customers in certain international countries may be subject to a number of
risks, including: currency exchange rate risk; the risks that agreements may be
difficult or impossible to enforce and receivables difficult to collect through
an international country's legal system; foreign customers may have longer
payment cycles; or foreign countries could impose withholding taxes or
otherwise tax our foreign income, impose tariffs, embargoes, or exchange
controls, or adopt other restrictions on foreign trade. In addition, the laws
of certain countries do not protect our offerings and intellectual property
rights to the same extent as the laws of the United States. If we fail to
compete successfully or to expand the distribution of our offerings in
international markets the growth of our business could be limited.
Development of new standards for the electronic delivery of music may threaten
our business.
We currently rely on mp3 technology as a delivery method for the digital
distribution of music. Mp3 is an open standard adopted by the Moving Picture
Experts Group for the compression of audio files. We do not own or control mp3
technology and are dependent upon a license to obtain rights to certain patents
relating to the technology. The onset of competing industry standards for the
electronic delivery of music could significantly affect the way we operate our
business as well as the public's perception of EMusic as a company. For
example, in December 1998, the major recording studios announced a plan to
develop a universal standard for the electronic delivery of music, called the
Secured Digital Music Initiative. If new standards are developed and adopted by
consumers, we may not be able to obtain a license to such technology on
favorable terms or at all and our business could be harmed. Even if new
standards are not developed, delays with respect to proposed standards, such as
those which have occured with respect to SDMI, can cause confusion in the
marketplace, slow the development of the market for downloadable music and
otherwise harm our business.
16
<PAGE>
Mp3 technology is controversial within certain segments of the traditional
music industry and we may face continued opposition to our use of mp3 which may
slow market development and harm our business.
Certain segments of the traditional music industry have not embraced the
development of the mp3 format to deliver music, in part because users of mp3
technology can download and distribute unauthorized or "pirated" copies of
copyrighted recorded music over the Internet. We believe that our success is
largely dependent upon the ease with which customers can download and play
music. We may face opposition from a number of different music industry sources
including record companies and studios, the Recording Industry Association of
America and certain artists. The adoption of competing standards may slow the
development of the market for downloadable music or result in increased costs
of doing business which could harm our business.
If we, or third parties on which we rely, fail to achieve year 2000 compliance,
our business could be harmed.
We may discover year 2000 compliance problems in our systems that will require
substantial revision. We have not conducted a formal year 2000 audit and have
relied only on our internal assessments of our year 2000 needs. If we
unexpectedly experience failures related to the year 2000 problem or if we fail
to fix or replace any affected systems on a timely basis, our business could be
harmed. In addition, governmental agencies, utility companies, Internet access
companies, third-party service providers and others outside of our control, as
well as the general infrastructure of the Internet, may not be year 2000
compliant. Failure of third parties or of the general Internet infrastructure
to be year 2000 compliant could prevent us from publishing our content,
generating sales or collecting revenue, decrease the use of the Internet or
prevent users from accessing our websites for a substantial period of time
which could harm our business. For more information on our state of readiness,
costs and rights associated with year 2000 issues, see "Management Discussion
and Analysis of Financial Condition and Results of Operation--Year 2000
Readiness."
Our executive officers and directors control approximately 19% of our common
stock and have power to influence significant corporate matters, which may
delay, deter or prevent transactions that could benefit our stockholders.
Executive officers and directors, in the aggregate, beneficially own
approximately 19% of our outstanding common stock. These stockholders are able
to significantly influence all matters requiring approval by our stockholders,
including the election of directors and the approval of significant corporate
transactions. This concentration of ownership may also have the effect of
delaying, deterring or preventing a change in control of EMusic and may make
some transactions more difficult or impossible without the support of these
stockholders.
Anti-takeover provisions in our charter documents could negatively impact our
stockholders.
Our Board of Directors has the authority to issue up to 20,000,000 shares of
preferred stock without need for stockholder approval. The board may also
determine the economic and voting rights, of this preferred stock. The holders
of our common stock could be adversely affected by the issuance of preferred
stock. Issuance of preferred stock could impede or prevent transactions that
would cause a change in control of our company. This might discourage bids for
our common stock as a premium over the market price of our common stock and
adversely affect the trading price of our common stock. We have no current
plans to issue shares of preferred stock. In addition, other provisions in our
charter documents could make it more difficult for a third party to acquire us,
even if doing so would be beneficial to our stockholders.
Our data warehousing and web server systems are vulnerable to natural
disasters, failure of third-party services and other unexpected problems.
Since our data warehousing, web server and network facilities are all located
in California, an earthquake or other natural disaster could affect all of our
facilities simultaneously. An unexpected event such as a power or
17
<PAGE>
telecommunications failure, fire, flood or earthquake at our on-site data
warehousing facility or at our Internet service providers' facilities could
cause the loss of critical data and prevent us from offering our services to
artists and consumers. Our business interruption insurance may not adequately
compensate us for losses that may occur. In addition, we rely on third parties
to securely store our archived data, house our web server and network systems,
and connect us to the Internet. A failure by any of these third parties to
provide these services satisfactorily could harm our business.
You should not rely on forward-looking statements in this prospectus.
This prospectus contains forward-looking statements that involve risks and
uncertainties. These statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology including, "could," "may," "will," "should," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "potential" or "continue;" the
negative of these terms or other comparable terminology. These statements are
only predictions. Actual events or results may differ materially. In evaluating
these statements, you should specifically consider various factors, including
the risks described above and in other parts of this prospectus. These factors
may cause our actual results to differ materially from any forward-looking
statement. Although we believe that the expectations reflected in the forward-
looking statements are reasonable, we cannot guarantee future results, levels
of activity, performance or achievements. We are under no duty to update any of
the forward-looking statements after the date of this prospectus to conform
them to actual results or to changes in our expectations.
18
<PAGE>
Selling Stockholders
The following table sets forth certain information with respect to the selling
stockholders as of December 20, 1999. Except as set forth below, none of the
selling shareholders currently is an affiliate of ours, and none of them has
had a material relationship with us during the past three years.
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Citiventure 96
Partnership, L.P. 1,627,100(/2/) 1,627,100 0 --
c/o Invesco Private
Capital
Attn: Mark Radovanovich,
CFO
1166 Avenue of the
Americas, 27th Floor
New York, NY 10036
Chancellor Private
Capital Offshore
Partners II, L.P. 624,000(/2/) 624,000 0 --
c/o Invesco Private
Capital
Attn: Mark Radovanovich,
CFO
1166 Avenue of the
Americas, 27th Floor
New York, NY 10036
Chancellor Private
Capital Offshore
Partners I, C.V. 58,300(/2/) 58,300 0 --
c/o Invesco Private
Capital
Attn: Mark Radovanovich,
CFO
1166 Avenue of the
Americas, 27th Floor
New York, NY 10036
Chancellor Private
Capital Offshore
Partners III, L.P. 379,000(/2/) 379,000 0 --
c/o Invesco Private
Capital
Attn: Mark Radovanovich,
CFO
1166 Avenue of the
Americas, 27th Floor
New York, NY 10036
VantagePoint
Communication Partners,
L.P. 1,111,100(/2/) 1,111,100 0 --
c/o VantagePoint Venture
Partners
Attn: James D. Marver
1001 Bayhill Drive,
Suite 140
San Bruno, CA 94066
VantagePoint Venture
Partners 1996 555,500(/2/) 555,500 0 --
c/o VantagePoint Venture
Partners
Attn: James D. Marver
1001 Bayhill Drive,
Suite 140
San Bruno, CA 94066
VantagePoint Venture
Advisors, LLC 16,600(/2/) 16,600 0 --
c/o VantagePoint Venture
Partners
Attn: James D. Marver
1002 Bayhill Drive,
Suite 140
San Bruno, CA 94066
Seligman Communications
and Information
Fund, Inc. 1,000,000(/2/) 1,000,000 0 --
c/o J. & W. Seligman &
Co., Inc.
Attn: Storm Boswiek
100 Park Avenue, 7th
Floor
New York, NY 10017
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
CTI Limited 999,900(/2/) 999,900 0 --
c/o Creative Technology
Ltd.
31 International
Business Park, Creative
Resource
Singapore 609921
Phillips-Smith
Speciality Retail Group
III, L.P. 833,300(/2/) 833,300 0 --
c/o Phillips-Smith
Speciality Retail Group
Attn: G. Michael Machens
5080 Spectrum Drive,
Suite 805 West
Addison, TX 75001
idealab! Capital
Partners I-B, L.P. 697,500(/2/) 697,500 0 --
c/o idealab! Capital
Management I, LLC
Attn: William S. Elkus
130 W. Union Street
Pasadena, CA 91103
idealab! Capital
Partners I-A, L.P. 136,500(/2/) 136,500 0 --
c/o idealab! Capital
Management I, LLC
Attn: William S. Elkus
130 W. Union Street
Pasadena, CA 91103
Drake & Co. for the
account of 645,000(/2/) 645,000 0 --
Citiventure Private
Participations III
c/o Invesco Private
Capital
Attn: Mark Radovanovich,
CFO
1166 Avenue of the
Americas, 27th Floor
New York, NY 10036
Weiss, Peck & Greer
Venture Associates IV,
L.L.C. 490,300(/2/) 490,300 0 --
c/o Weiss, Peck & Greer
LLC
Attn: Melissa Alves
555 California Street,
Suite 3130
San Francisco, CA 94104
WPG Enterprise Fund III,
L.L.C. 428,800(/2/) 428,800 0 --
c/o Weiss, Peck & Greer
LLC
Attn: Melissa Alves
555 California Street,
Suite 3130
San Francisco, CA 94104
WPG Information Sciences
Entrepreneur Fund, L.P. 19,000(/2/) 19,000 0 --
c/o Weiss, Peck & Greer
LLC
Attn: Melissa Alves
555 California Street,
Suite 3130
San Francisco, CA 94104
WPG Venture Associates
IV Cayman, L.P. 61,900(/2/) 61,900 0 --
c/o BankAmerica Trust &
Banking Corporation
(Cayman) Limited
Attn: Sarah Holbrook
P.O. Box 1092,
BankAmerica House, Fort
Street
George Town, Grand
Cayman, Cayman Islands,
British West Indies
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Abacus L.P. 10,000(/2/) 10,000 0 --
c/o TriNet Real Estate
Trust
Attn: Robert W. Holman
Jr.
One Embarcadero Center,
33rd Floor
San Francisco, CA 94111
Amcito Partners, L.P. 16,600(/2/) 16,600 0 --
Attn: William Brian
Little
630 Fifth Ave., Suite
2620
New York, NY 10111
Bank Sal Oppenheim jr &
cie (Schweiz) AG 250,000(/2/) 250,000 0 --
Attn: Marko Bianchi
Uraniastrasse 28, CH -
8022
Zurich, Switzerland
Tor Braham 46,600(/2/) 11,600 35,000 *
10 Cordova Court
Portola Valley, CA 94028
Jorge A. del Calvo and
Gerine Ongkeko 8,300(/2/) 8,300 0 --
329 Walsh Road
Atherton, CA 94027
James Chapman 146,712(/2/) 46,600 100,112 *
3435 Clay Street, #3
San Francisco, CA 94118
Catherine Filippini 3,300(/2/) 3,300 0 --
63 Indian Hill Road
Winnetka, IL 60093
Fisher Capital Ltd. 162,100(/2/)(/8/) 162,100 0 --
c/o Citadel Investment
Group, L.L.C.
225 West Washington
Street, 9th Floor
Chicago, IL 60606
Attn: Daniel Hopkins
Craig Foley 33,300(/2/) 33,300 0 --
7 Locust Lane
Bronxville, NY 10708
GCWF Investment Partners 8,300(/2/) 8,300 0 --
Attn: Greg Gallo
400 Hamilton Avenue
Palo Alto, CA 94301-1825
Roger B. Hackett 8,300(/2/) 8,300 0 --
c/o Go Video, Inc.
7835 East McClaine Drive
Scottsdale, AZ 85260-
6949
John E. Kelley 3,300(/2/) 3,300 0 --
c/o Edgewood Management
Company
675 Third Avenue
New York, NY 10017
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Richard Lawson 3,300(/2/) 3,300 0 --
1770 Broadway Street -
Apt. 202
San Francisco, CA 94109
Greg Little 16,600(/2/) 16,600 0 --
163 Carl Street
San Francisco, CA 94117
Reid Payne 8,300(/2/) 8,300 0 --
c/o ABN AMRO
199 Bishopsgate
London EC2 M3TY
United Kingdom
PM&S Venture Fund II,
LLC 16,600(/2/) 16,600 0 --
c/o Pillsbury Madison &
Sutro LLP
Attn: Michael J.
Halloran
235 Montgomery Street
San Francisco, CA 94104
Promethean Service
Company, LLC 84,000(/2/) 84,000 0 --
c/o Promethean
Attn: James F. O'Brien,
Jr.
750 Lexington Avenue,
22nd Floor
New York, NY 10022
Bryan Rutberg 3,300(/2/) 3,300 0 --
1625 Pacific Avenue -
Apt. 401
San Francisco, CA 94115
Baird Ryan 8,300(/2/) 8,300 0 --
c/o Edgewood Management
Co.
350 Park Avenue, 18th
Floor
New York, NY 10022
Sofinnova Venture
Partners IV, L.P. 333,300(/2/) 333,300 0 --
Attn: Natalie Auber, CFO
140 Geary Street, 10th
Floor
San Francisco, CA 94108
Edward Straube 6,600(/2/) 6,600 0 --
67 Murray Avenue
Larkspur, CA 94939
Jason Strober 3,300(/2/) 3,300 0 --
c/o VantagePoint Venture
Partners
1001 Bayhill Drive,
Suite 140
San Bruno, CA 94066
Wingate Capital Ltd. 87,200(/2/)(/8/) 87,200 0 --
c/o Citadel Investment
Group, L.L.C.
225 West Washington
Street, 9th Floor
Chicago, IL 60606
Attn: Daniel Hopkins
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Stanton D. Wong 5,000(/2/) 5,000 0 --
c/o Pillsbury Madison &
Sutro LLP
235 Montgomery Street
San Francisco, CA 94104
Carm Adimando 20,300(/2/) 20,300 0 --
47 Cherry Gate Lane
Trumbull, CT 06611
Jose J. Cofino 20,400(/2/) 20,400 0 --
2735 Nicols Canyon Rd.
Los Angeles, CA 90046
Deborah A. Coleman 40,600(/2/) 40,600 0 --
c/o Smart Forest
Ventures
317 SW Alder, Suite 900
Portland, OR 97204
Sheldon Derezin 20,400(/2/) 20,400 0 --
6409 Ridge Manor Ave.
San Diego, CA 92120
Elrod Lawing &
Sharpless, P.A.,
Employees Profit 40,800(/2/) 40,800 0 --
Sharing Plan & Trust
Joseph Elrod, Trustee
2900 St. Regis Road
P.O. Box 13566
Greensboro, NC 27415-
3566
Lawrence Gerbrandt 5,500(/2/) 5,500 0 --
3880 Via Mar Monte
Carmel, CA 93923
Laura Greenstein 5,100(/2/) 5,100 0 --
c/o Martin Greenstein
55 South Market Street,
Ste. 1630
San Jose, CA 95113
James H. Gregg 40,800(/2/) 40,800 0 --
580 Viejo Road
Carmel, CA 93932
Kenneth Hess 20,400(/2/) 20,400 0 --
P.O. Box 5038
Carmel, CA 93921
Chase Bank Custodian,
IRA fbo Jay C. Huffard 20,400(/2/) 20,400 0 --
Attn: Brenda Jackson AVP
One Chase Manhattan
Plaza
New York, NY 10081
Brian Kahn 10,200(/2/) 10,200 0 --
1071 N. Hillcrest Dr.
Beverly Hills, CA 90210
Dennis Levett 8,100(/2/) 8,100 0 --
c/o Strutz-Levett
Investment & Holding
Co.
502 Waverley Street
Palo Alto, CA 94302
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Spencer Leyton 65,118(/2/) 4,000 61,118 *
1689 Calypso Drive
Aptos, CA 95003
Richard Lipson 10,200(/2/) 10,200 0 --
c/o Rainbow Leather,
Inc.
14-15 112th St.
College Point, NY 11256
Raymond L. Ocampo Jr. or
Sandra O. Ocampo 20,400(/2/) 20,400 0 --
Trustees of the Ocampo
Family Trust UTA Dated
May 30, 1996
Attn: Raymond L. Ocampo,
Jr.
500 Roehampton Rd.
Hillsborough, CA 94010
peermusic III, Ltd. 61,400(/2/) 61,400 0 --
3220 Blume Drive, Suite
290
Richmond, CA 94806
Rand International
Corporation 102,300(/2/) 102,300 0 --
Attn: Shawkat Raslan
770 Lexington Ave., 16th
Floor
New York, NY 10021-8110
Sensory Sciences 102,000(/2/) 102,000 0 --
c/o Go Video
Attn: Douglas Klein, CFO
7835 East McLain Drive
Scottsdale, AZ 85260-
1732
Judith Stevens 5,100(/2/) 5,100 0 --
c/o Martin Greenstein
55 South Market Street,
Ste. 1630
San Jose, CA 95113
Seymour Svirsky 20,300(/2/) 20,300 0 --
44 Penn Blvd.
Scarsdale, NY 10583
Carl Tiedemann 40,700(/2/) 40,700 0 --
c/o Private Financial
Services Corp.
Attn: Stephanie Christie
535 Madison Ave., 35th
Floor
New York, NY 10022
Tiedemann Investment
Group 20,300(/2/) 20,300 0 --
c/o Private Financial
Services Corp.
Attn: Stephanie Christie
535 Madison Ave., 35th
Floor
New York, NY 10022
Samuel S. Trust 20,400(/2/) 20,400 0 --
P.O. Box 22274
Carmel, CA 92921
Neil & Lydia Weiss 10,200(/2/) 10,200 0 --
511 San Felicia Way
Los Altos, CA 94022
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Norbert R. Wirsching 20,300(/2/) 20,300 0 --
303 E. 57th St. Apt. 22L
New York, NY 10022-2947
Chambers Wong (Hong
Kong) 20,300(/2/) 20,300 0 --
c/o Jasper Ace Limited
Flat A, 9-F Tower 1,
Regent on the Park
9 Kennedy Rd, Hong Kong
HFTP Investment LLC 304,800(/3/) 304,800 0 --
c/o Promethean
Investment Group,
L.L.C.
Attn: James F. O'Brien,
Jr.
40 West 57th Street,
Suite 1520
New York, NY 10019
Mark S. Chasan 658,058(/1/) 538,058 120,000 --
21414 Arcos Dr.
Woodland Hills, CA 91364
Dan Barrett 645(/1/) 645 0 --
c/o Nordic Entertainment
2512 Jefferson St.
Napa, CA 94558
Scott Bergevin 461(/1/) 461 0 --
c/o Nordic Entertainment
2512 Jefferson St.
Napa, CA 94558
Fred and Rosalyn Chasan 36,896(/1/) 36,896 0 --
13633 Pasco De La Huerta
Poway, CA 92064
Griffith Emery 153(/1/) 153 0 --
156 7th St.
Del Mar, CA 92014
Trent George 13,836(/1/) 13,836 0 --
6398 Flamingo Drive
Buena Park, CA 90620
Get Travel Corporation 2,950(/1/) 2,950 0 --
3355 Vincent Road
Pleasant Hill, CA 94523
Goff Johnson LLP 6,301(/1/) 6,301 0 --
c/o Wayne Johnson
1800 Avenue of the
Stars, Suite 1000
Los Angeles, CA 90067
Lochelle Harrison 368(/1/) 368 0 --
1012 Charlson Way
Napa, CA 94558
Marilyn Jarrells 1,752(/1/) 1,752 0 --
1716 Caton Avenue, #35
Brooklyn, NY 11226
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
Maximum Number
Beneficial of Shares of Shares Percentage
Ownership of Common Stock Owned Owned
Common Stock as Offered for after after
Name and Addresses of December 20, 1999 Sale Offering Offering
- ------------------ -------------------- -------------- -------- ----------
<S> <C> <C> <C> <C>
Phil Jones 461(/1/) 461 0 --
145 Northridge Lane
Woodside, CA 94062
Jamie Riggs 276(/1/) 276 0 --
c/o Nordic Entertainment
2512 Jefferson Street
Napa, CA 94558
Skunk New Media 2,767(/1/) 2,767 0 --
1437 Seventh Street,
Suite 300
Santa Monica, CA 90401
David Walton 922(/1/) 922 0 --
499 Albacete Drive
Vacaville, CA 95688
Ralph Whitmore 1,844(/1/) 1,844 0 --
222 N. Sepulveda Blvd.,
Suite 150
El Segundo, CA 90245
Curt Zirzow 645(/1/) 645 0 --
c/o Nordic Entertainment
2512 Jefferson Street
Napa, CA 94558
Roger B. Goff 2,661 2,661 0 --
c/o Wayne R. Johnson,
Esq.
1800 Avenue of the
Stars, Suite 1000
Los Angeles, CA 90067
Wayne R. Johnson 3,991 3,991 0 --
1800 Avenue of the
Stars, Suite 1000
Los Angeles, CA 90067
Kent Kiefer 645,188(/1/)(/4/) 645,188 0 --
c/o Nordic Entertainment
2512 Jefferson Street
Napa, CA 94558
Gene Hoffman, Sr. 118,000(/5/) 118,000 0 --
13232 Idlewild Road
Matthews, NC 28105
Concord Records 63,735(/6/) 63,735 0 --
2450-A Stanwell Drive
Concord, CA 94520
Silicon Valley Bank 10,000(/7/) 10,000 0 --
3003 Tarman Drive
Santa Clara, CA 95054
Imperium Capital Inc. 150,000(/7/) 150,000 0 --
1626 Pinecrest Drive
West Vancouver, BC V75
3H3
Canada
</TABLE>
- ------------------
* Represents less than 1%
26
<PAGE>
(1) Represents shares issued in connection with an acquisition or purchase of
assets.
(2) Represents shares issued upon the conversion of our Series B preferred
stock.
(3) Represents 100,000 shares to be issued upon exercise of outstanding common
stock purchase warrants and 204,800 shares issued upon the conversion of
our Series B preferred stock.
(4) Approximately 526,829 of such shares are beneficially owned by partners of
various partnerships for which Mr. Kiefer is the general partner. Mr.
Kiefer disclaims beneficial ownership except to the extent of his pecuniary
interest.
(5) Represents shares issued in connection with the acquisition by the Company
of its predecessor corporation.
(6) Represents shares issued in connection with a share exchange transaction.
(7) Represents shares issuable upon the exercise of common stock purchase
warrants.
(8) Citadel Limited Partnership is the trading manager of each of Wingate
Capital Ltd. and Fisher Capital Ltd. (the "Citadel Entities") and
consequently has voting control and investment discretion over securities
held by the Citadel Entities. Kenneth C. Griffin indirectly controls
Citadel Limited Partnership. The ownership for each of the Citadel Entities
does not include the ownership information for the other Citadel Entity.
Citadel Limited Partnership, Kenneth C. Griffin, and each of the Citadel
Entities each disclaims beneficial ownership of the securities held by the
other Citadel Entities.
Tor Braham, a selling stockholder, is also a member of our Board of Directors.
Ralph Peer, II, a member of our Board of Directors and a selling stockholder,
is affiliated with peermusic III, Ltd., also a selling stockholder.
Spencer Leyton and Jim Chapman, both selling stockholders, are currently
officers of EMusic.
27
<PAGE>
Plan of Distribution
We will not receive any proceeds from the sale of the common stock through this
prospectus. We will receive proceeds from the payment of the exercise price of
the common stock purchase warrants if any are exercised for cash. We have
agreed to pay the expenses of registration of the common stock offered hereby,
including legal and accounting fees, but excluding underwriter's discounts and
commissions, if any.
The offered shares may be sold from time to time at
. negotiated prices,
. fixed prices which may be changed,
. market prices prevailing at the time of sale or
. prices related to prevailing market prices.
The selling stockholders may effect such transactions
. in privately negotiated sales in the over-the-counter market or any
exchange on which the securities are listed,
. by selling the shares to or through broker-dealers, including block
trades in which brokers or dealers will attempt to sell the shares as
agent but may position and resell the block as principal, and
. in one or more underwritten offerings on a firm commitment or best effort
basis.
Sales of selling stockholders' shares may also be made pursuant to Rule 144
under the Securities Act, where applicable.
To the extent required under the Securities Act, the following information will
be set forth in an accompanying prospectus supplement
. the aggregate amount of selling shareholders' shares being offered and
the terms of the offering,
. the names of any such agents, brokers, dealers, transferees or
underwriters and
. any applicable fee or commission with respect to a particular offer.
Each selling stockholder will be responsible for paying compensation owed by it
to any underwriters, dealers, brokers or agents participating in the
distribution of its shares, regardless of whether such compensation is in the
form of underwriting discounts, concessions, commission or fees. This
compensation might be in excess of customary commissions. The aggregate
proceeds to a selling stockholder from the sale of its shares offered by this
prospectus will be the purchase price of such shares less any discounts or
commissions.
If selling stockholders pledge, hypothecate or grant a security interest in
some or all of the shares, then the pledgees, secured parties or persons to
whom such securities have been hypothecated shall, upon foreclosure in the
event of default, be deemed to be selling stockholders under this prospectus.
Similarly, if the selling stockholders transfer, pledge, donate or assign
shares to lenders or others, then each of such persons will be deemed to be a
selling stockholder for purposes of this prospectus. The number of shares
beneficially owned by the selling stockholders will decrease if and when a
selling stockholder transfers, pledges, donates or assigns shares. The plan of
distribution for selling stockholders' shares sold by this prospectus will
otherwise remain
28
<PAGE>
unchanged, except that the transferees, pledgees, donees or other successors
will be selling shareholders under this prospectus. There is, however, no
assurance that any selling stockholder will sell any or all of the shares
described in this prospectus, and any selling stockholder may transfer, devise
or gift such securities by other means not described in this prospectus.
A selling stockholder may also use this prospectus in the following ways:
. to sell short, from time to time, shares of our common stock and, in such
instances, this prospectus may be delivered in connection with such short
sales and the shares offered hereby may be used to cover such short
sales,
. to enter into hedging transactions with broker-dealers, and the broker-
dealers may engage in short sales of the shares in the course of holding
the positions they assume with such selling stockholder, including,
without limitation, in connection with distribution of the shares by such
broker-dealers,
. to enter into option or other transactions with broker-dealers that
involve the delivery of the shares to the broker-dealers, who may then
resell or otherwise transfer such shares, and
. to loan or pledge the shares to a broker-dealer and the broker-dealer may
sell the shares as loaned or upon a default may sell or otherwise
transfer the pledge shares.
The selling stockholders, any underwriter, any broker-dealer or any agent that
participates with the selling stockholders in the distribution of the shares
may be deemed to be "underwriter" within the meaning of the Securities Act. As
a result thereof, any discounts, commissions or concessions received by them
and any profit on the resales of the shares purchased by them may be deemed to
be underwriting commissions under the Securities Act.
To comply with securities laws of certain states, if applicable, the shares
will be sold in such jurisdictions only through registered or licensed brokers
or dealers. In addition, in certain states the shares may not be sold unless
they have been registered or qualified for sale in the applicable state or an
exemption from the registration or qualification requirement is available.
Pursuant to a registration rights agreement entered into in connection with our
Series B preferred stock financing, we have agreed to keep the registration
statement of which this prospectus is a part continuously effective until the
earlier of the date that all of the shares issued upon the conversion of the
Series B preferred stock or exercise of the warrants have been resold or until
three years from the effectiveness of the registration statement of which this
prospectus is a part. In this regard, we are required to supplement and/or
amend the registration statement of which this prospectus is a part if more
shares than are registered for resale hereby are issued upon exercise of the
warrants or to supplement or change the list of selling stockholders hereunder.
29
<PAGE>
Use Of Proceeds
We will not receive any of the proceeds from the sale of shares of common stock
by the selling stockholders. If any warrants are exercised by selling
stockholders for cash, we will receive proceeds equal to the exercise price of
the warrants. We will use the net proceeds received upon the exercise of any
warrants for general corporate purposes, including working capital.
Dividend Policy
We have never declared or paid any cash dividends on our common stock. We
anticipate that we will retain earnings to support operations and to finance
the growth and development of our business. Therefore, we do not expect to pay
cash dividends on our common stock in the foreseeable future.
30
<PAGE>
Capitalization
The following table shows the capitalization of EMusic on September 30, 1999.
<TABLE>
<CAPTION>
September 30,
1999
-------------
(in
thousands,
except share
and per share
data)
<S> <C>
Redeemable convertible preferred stock:
Undesignated, $0.01 par value; 380,000 shares authorized; no
shares issued and
outstanding .................................................. --
Stockholders' equity:
Common stock, $0.01 par value; 200,000,000 shares authorized;
16,804,237 shares issued and outstanding, actual; 28,561,237
shares issued and outstanding, pro forma; and 33,561,237
shares issued and outstanding................................. 34
Additional paid-in capital..................................... 184,498
Accumulated deficit............................................ (63,093)
--------
Total stockholders' equity.................................... 121,439
--------
Total capitalization......................................... $121,439
========
</TABLE>
- ------------------
The number of outstanding shares in the preceeding table excludes 2,712,000
shares of common stock issuable upon the exercise of outstanding warrants with
a weighted average exercise price of $13.86 per share, 6,620,365 shares of
common stock issuable upon the exercise of outstanding stock options with a
weighted average exercise price of $7.12 per share, 4,163,650 shares of common
stock reserved for future issuance under our stock option plans and
approximately 2,100,000 shares issued in connection with our acquisition of
Cductive in December 1999.
31
<PAGE>
Selected Financial Data
This section presents our selected historical financial data. You should read
carefully the financial statements included in this prospectus, including the
notes to the financial statements. The selected data in this section is not
intended to replace the financial statements.
The statement of operations data for the year ended June 30, 1999 and periods
from our inception on January 8, 1998 to June 30, 1998 and 1999, and the
balance sheet data at June 30, 1998 and 1999, are derived from our audited
financial statements, which are included elsewhere in this prospectus.
Historical results are not necessarily indicative of future results. The pro
forma balance sheet data as of June 30, 1999 and September 30, 1999 gives
effect to our underwritten public offering and the use of the net proceeds from
such offering, the conversion of our Series B preferred stock and the payment
of accrued dividends amounting to $569,000 and $1,062,000, respectively. We
have paid no cash dividends on our common stock.
<TABLE>
<CAPTION>
January 8, January 8, January 8,
1998 1998 1998
(inception) (inception) Three months Three months (inception)
to Year ended to ended ended to
June 30, June 30, June 30, September 30, September 30, September 30,
1998 1999 1999 1998 1999 1999
----------- ---------- ---------- ------------- ------------- -------------
Statement of Operation
Data:
<S> <C> <C> <C> <C> <C> <C>
Revenues................ $ -- $ 92 $ 92 $ 12 $ 180 $ 272
Cost of revenues........ -- 27 27 -- 25 52
---------- ---------- ---------- ---------- ---------- ----------
Gross loss.............. -- 65 65 12 155 220
Operating expenses:
Product development.... 961 11,690 12,651 667 6,011 18,662
Selling and
marketing............. -- 556 556 -- 4,771 5,327
General and
administrative........ 219 1,599 1,818 197 812 2,630
Amortization of trade
names................. -- 1,682 1,682 -- 2,283 3,965
---------- ---------- ---------- ---------- ---------- ----------
Total operating
expenses............ 1,180 15,527 16,707 864 13,877 30,584
---------- ---------- ---------- ---------- ---------- ----------
Operating loss.......... $ (1,180) $ (15,140) $ (16,642) $ (852) $ (13,722) $ (30,364)
Interest income, net.... -- 322 322 3 203 525
---------- ---------- ---------- ---------- ---------- ----------
Net loss................ $ (1,180) $ (15,140) $ (16,320) $ (849) $ (13,519) $ (29,839)
---------- ---------- ---------- ---------- ---------- ----------
Accretion of Series A
and B preferred to
redemption value....... -- (247) (247) -- (224) (471)
Beneficial conversion
charge, Series A and B
preferred stock........ -- (31,721) (31,721) -- -- (31,721)
Dividend on Series B
preferred stock........ -- (569) (569) -- (493) (1,062)
---------- ---------- ---------- ---------- ---------- ----------
Net loss applicable to
common shares.......... $ (1,180) $ (47,677) $ (48,857) $ (849) $ (14,236) $ (63,093)
========== ========== ========== ========== ========== ==========
Net loss per common
share--basic and
diluted................ $ (0.12) $ (3.52) $ (4.87) $ (0.06) $ (1.09) $ (5.03)
========== ========== ========== ========== ========== ==========
Weighted average common
shares outstanding--
basic and diluted...... 10,234,055 13,563,606 10,027,231 14,591,336 13,057,809 12,542,537
========== ========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
June 30, June 30, September 30,
1998 1999 1999
-------- -------- -------------
Balance Sheet Data:
<S> <C> <C> <C>
Cash and cash equivalents....................... $510 $19,002 $78,904
Working capital................................. 396 16,593 84,877
Total assets.................................... 582 54,221 125,165
Redeemable convertible preferred stock.......... -- 32,550 --
Total stockholders' equity...................... 447 18,987 121,439
</TABLE>
32
<PAGE>
Management Discussion and Analysis of
Financial Condition and Results of Operations
You should read this discussion together with the financial statements and
other financial information included in this prospectus. This discussion
contains forward-looking statements that involve risks and uncertainties. Our
actual results may differ materially from those indicated in these forward-
looking statements.
Results of Operations
We were incorporated on January 8, 1998 and are a development stage company.
Through September 30, 1999, we incurred costs to organize and develop an
Internet website to conduct our business. We began selling musical recordings
over the Internet in July 1998 and began our first significant selling and
marketing initiatives in the quarter ended June 30, 1999. We may experience
significant fluctuations in operating results in future periods due to a
variety of factors, including:
. the demand for downloadable music content and Internet advertising;
. the addition or loss of advertisers;
. the level of traffic on our Internet sites;
. the amount and timing of capital expenditures and other costs relating to
the expansion of our operations;
. the introduction of new sites and services by us or our competitors;
. seasonal trends in Internet use, purchases of downloadable music and
advertising placements;
. price competition or pricing changes in the industry;
. technical difficulties or system downtime; and
. general economic conditions and economic conditions specific to the
Internet.
33
<PAGE>
The following table shows for the periods presented the dollar amounts of
selected line items from our unaudited statements of operations. Because the
revenues are limited, expenses stated as a percentage of revenue are not
meaningful.
<TABLE>
<CAPTION>
June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30,
1998 1998 1998 1999 1999 1999
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Revenues................ $ -- $ 12 $ 8 $ 21 $ 51 $ 180
Cost of revenues........ -- -- 4 9 14 25
---------- ---------- ---------- ---------- ---------- ----------
Gross profit............ -- 12 4 12 37 155
Operating expenses:
Product development.... 919 667 925 1,654 8,444 6,011
Selling and marketing.. -- -- -- -- 556 4,771
General and
administrative........ 172 197 205 314 883 812
Amortization of trade
names................. -- -- -- 334 1,348 2,283
---------- ---------- ---------- ---------- ---------- ----------
Total operating
expenses............. 1,091 864 1,130 2,302 11,231 13,877
---------- ---------- ---------- ---------- ---------- ----------
Loss from operations.... (1,091) (852) (1,126) (2,290) (11,194) (13,722)
Interest income, net.... -- 3 1 1 317 203
---------- ---------- ---------- ---------- ---------- ----------
Net loss................ $ (1,091) $ (849) $ (1,125) $ (2,289) $ (10,877) $ (13,519)
Accretion of Series A
preferred stock to
redemption value....... -- -- (25) -- -- --
Beneficial conversion
charge, Series A
preferred stock........ -- -- (144) -- -- --
Accretion of B preferred
stock to redemption
value.................. -- -- -- (8) (214) (224)
Beneficial conversion
charge, Series B
preferred stock........ -- -- -- (31,577) -- --
Dividend on Series B
preferred stock........ -- -- -- (40) (529) (493)
---------- ---------- ---------- ---------- ---------- ----------
Net loss applicable to
common Stockholders.... $ (1,091) $ (849) $ (1,294) $ (33,914) $ (11,620) $ (14,236)
========== ========== ========== ========== ========== ==========
Net loss per common
share, basic and
diluted................ $ (0.08) $ (0.06) $ (0.09) $ (2.31) $ (1.02) $ (1.09)
========== ========== ========== ========== ========== ==========
Weighted average common
shares outstanding,
basic and diluted...... 12,847,724 14,591,336 14,581,212 14,674,372 11,437,948 13,057,809
========== ========== ========== ========== ========== ==========
</TABLE>
34
<PAGE>
The following discussion includes a comparison of the period from January 8,
1998 (inception) through June 30, 1998 and the year ended June 30, 1999:
Net Revenues
We are a development stage company. We earned no revenue from inception through
June 30, 1998. For the year ended June 30, 1999, our revenues totaled $92,000.
Our revenues to date have been comprised of advertising and sales of physical
merchandise and downloadable music recordings. In the future, we expect sales
of merchandise to be limited.
Cost of Revenues
Cost of revenues for the year ended June 30, 1999 include the cost of
merchandise sold, credit card processing fees, royalties and other costs
related to downloadable music revenues. Costs related to physical merchandise
exceeded related revenues during this period. We believe that the sale of
physical merchandise will become an increasingly smaller portion of our future
sales. As sales of physical merchandise become a lower portion of our revenues,
we expect that our gross margins will improve.
Product Development Expenses
We began our development efforts in February 1998. Product development expenses
principally consist of:
. website development, including software engineering, audio production and
graphic design;
. telecommunications charges;
. salaries, rent, depreciation and other expenses related to building our
music distribution business; and
. amortization of music content.
Product development expenses were $11,690,000 for the year ended June 30, 1999,
compared to $961,000 for the year ended June 30, 1998. They were $12,651,000
from inception through June 30, 1999. These changes reflect the increase in our
product development efforts, particularly in software engineering, graphic
design and development of the infrastructure required to deliver downloadable
music to customers.
Included in the amount above is an expense relating to the fair value of fully-
vested options to advisors to purchase up to 666,000 shares of common stock at
exercise prices ranging from $5.75 to $13.625 per share. We also issued
warrants to individuals operating in the music industry to purchase up to
1,388,300 common shares at exercise prices ranging from $7.10 to $13.625 per
share. All of these options and warrants were issued at the closing market
price on the date of issue. Using the Black Scholes model, we estimated the
total fair value of these options to be $2,379,000 and the warrants to be
$5,682,000. We charged the combined total of $8,061,000 to product development
expense in 1999. During the period January 8, 1998 (inception) to June 30, 1999
we recorded $752,000 in respect of the fair value of 280,000 options granted to
advisors.
Although we can not predict the timing or amounts, we expect to continue to
issue options and warrants to advisors in the future and to record significant
charges as a result.
Selling and Marketing Expenses
We incurred no significant selling and marketing costs from inception through
March 31, 1999. Commencing with the launch of our EMusic brand in the quarter
ended June 30, 1999, we began an extensive selling and marketing campaign. As a
result, selling and marketing expenses for the quarter and year ended June 30,
1999 were $556,000. We also expect to enter into various strategic alliances,
begin other targeted advertising and direct promotion campaigns, attend trade
shows and begin other activities to attract new customers. As a result, we
expect to incur significant sales and marketing expenses in future periods.
35
<PAGE>
General and Administrative Expenses
General and administrative expenses consist primarily of executive management,
finance, legal, administrative and related overhead costs, such as rent,
insurance, and depreciation. We have incurred costs of $1,818,000 from
inception through June 30, 1999, related to general and administrative
expenses. Of these costs, $1,599,000 was incurred in the year ended June 30,
1999. In April 1999, we moved our headquarters to new facilities located in
Redwood City, California, resulting in an increase in rent and facilities
related expenses of approximately $200,000 per quarter. We expect general and
administrative expenses to continue to increase as we expand our staff and
incur additional costs related to the growth of our business.
The following discussion includes a comparison of the three months ended
September 30, 1998 and 1999:
Net Revenues
Revenues for the quarters ended September 30, 1999 and 1998 were $180,000 and
$12,000, respectively. Revenues increased in the quarter ended September 30,
1999 primarily as a result of the growth in customer base, the increase in
customer purchases and the increase in advertising revenues made possible by
the increase in customer traffic on our websites.
Cost of Revenues
Cost of revenues consist of credit card processing fees, and royalties and
related fees on downloadable music sales. Cost of revenues for the quarters
ended September 30, 1999 were $25. There were no similar costs during the
quarter ended September 30, 1998. Gross margins due to increased advertising
revenues, for which we incurred no cost of revenues.
Product Development Expenses
Product development expenses include the cost of engineering our websites and
the cost of acquiring the rights to the music available for sale on our EMusic
website. These costs consist principally of stock compensation charges and
other expenses including salaries, contractor fees, rent and depreciation.
Stock compensation charges were $3,960,000 and $97,000 during quarters ended
September 30, 1999 and 1998, respectively. These charges represent the cost of
fully-vested stock warrants and stock options granted to advisors. All of these
warrants and options were issued at the closing price on the date of issue, and
the total value of the warrants and options were determined by using the Black
Scholes model.
Other product development expenses for the quarters ended September 30, 1999
and 1998 were $2,051,000 and $570,000, respectively, reflecting an increase in
our product development efforts, particularly in software engineering, graphic
design, and development of the infrastructure and "e-commerce" required to
deliver downloadable music from our Internet website.
We currently plan to continue aggregating a compelling repertoire of musical
recordings available for customer downloads, and continue to develop the
software necessary to manage such downloads, and expect product development
expenses will increase in future periods.
Selling and Marketing Expenses
Selling and marketing expenses consist of advertising and promotion activities,
including television, radio and magazine ads, and salaries and other costs
related to selling music on our EMusic and IUMA websites. These
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expenses for the quarters ended September 30, 1999, were $4,771,000. There were
no similar selling and marketing expenses during the quarter ended September
30, 1998. The increase in selling and marketing expenses reflects the launch of
an extensive marketing campaign to establish the brand name "EMusic".
Advertising and promotion costs were approximately $4 million in the quarter
ended September 30, 1999. There were no similar costs in the prior quarters.
General and Administrative Expenses
General and administrative expenses consist primarily of executive management,
finance, legal, administrative and related overhead costs, such as rent,
insurance, and depreciation. These expenses for the quarters ended September
30, 1999 and 1998, were $812,000 and $197,000, respectively. We expect general
and administrative expenses to increase as we expand our staff and incur
additional costs related to the growth of our business.
Amortization of Trade Names
During 1999, we purchased the "EMusic" and "IUMA" trade names for a combined
total of $26,362,000 in cash and stock. We began amortizing these costs over
three-year lives, resulting in an amortization expense of $1,682,000 in the
year ended June 30, 1999 and $2,283,000 in the three months ended September 30,
1999. Future amortization related to these trade names will be:
<TABLE>
<CAPTION>
Year ending Amortization
June 30, Expense
----------- ------------
<S> <C>
2000 $6,849,000
2001 9,132,000
2002 6,416,000
</TABLE>
Liquidity and Capital Resources
We had a cash balance of $19,002,000 at June 30, 1999. For the period from
inception through June 30, 1999, net cash of $5,297,000 was used for operating
activities consisting of net losses of $16,320,000, substantially offset by:
. non-cash expense of $3,131,000 associated with stock and stock options
granted to advisors;
. non-cash expense of $5,682,000 associated with warrants granted to
advisors; and
. non-cash expense of $1,682,000 associated with amortization of trade
names.
As of September 30, 1999, we had a cash balance of $78,904,000. For the three
months ended September 30, 1999, net cash of $15,644,000 was used in operating
activities consisting of net losses of $13,519,000, substantially offset by:
. non-cash expense of $1,273,000 associated with stock and stock options
granted to advisors;
. non-cash expense of $2,687,000 associated with warrants granted to
advisors; and
. non-cash expense of $2,283,000 associated with amortization of trade
names.
Additionally, we purchased approximately $1,128,000 and $1,113,000 in capital
equipment from inception through June 30, 1999 and for the three months ended
September 30, 1999, respectively. We expect to incur negative cash flow from
operations for the foreseeable future, as we continue to develop our business.
In October 1998, we raised proceeds of approximately $500,000 through the sale
of 500 shares of Series A preferred stock and warrants to purchase 100,000
shares of the our common stock. The Series A shares were subsequently converted
into shares of Series B preferred stock.
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During the period from December 1998 through March 1999, we received loans in
the form of convertible notes payable totaling $1,743,000. The notes, which
bore interest at 10% per annum and were to mature on March 31, 1999,
represented bridge loans in advance of the Series B preferred stock financing.
All outstanding principal and accrued interest due under these notes converted
into an aggregate of 7,109 shares of Series B preferred stock upon the closing
of the Series B financing.
On March 23, 1999, we completed a private placement of approximately 117,570
shares of Series B convertible preferred stock, which includes the conversion
of outstanding convertible notes and Series A shares into Series B shares.
Total proceeds, including proceeds from the convertible notes, were
$31,577,000, net of issuance costs of approximately $2,724,000, of which
approximately $100,000 remained in accrued liabilities at June 30, 1999. The
Series B preferred stock was convertible at anytime at the option of the
holders into 11,757,000 shares of our common stock. As a result of the
beneficial conversion feature given to the holders of the Series B preferred
stock, we recorded a charge, limited to the net proceeds received, in the
quarter ended March 31, 1999.
In April 1999, we entered into a five-year lease agreement for new office
space. Under the terms of the agreement, we will make minimum monthly lease
payments of approximately $67,000 for a period of 60 months beginning in April
1999. This monthly amount includes certain maintenance costs associated with
the leased space, and is subject to annual increases based on the Consumer
Price Index.
On September 24, 1999 we completed a public offering of 5,270,000 shares of
common stock resulting in proceeds of $79,682,000, net of issuance costs of
approximately $1,109,000, of which $1,069,000 remained in accrued liabilities
at September 30, 1999.
We believe that our existing capital resources will be sufficient to fund our
current level of operating activities, capital expenditures and other
obligations through the next 12 months. However, if during that period or
thereafter we are not successful in generating sufficient liquidity from
operations or in raising sufficient capital resources, on terms acceptable to
us, this could have a material adverse effect on our business, results of
operations liquidity and financial condition.
Year 2000 Readiness
Many currently installed computer systems are not capable of distinguishing
21st century dates from 20th century dates or have been programmed with default
dates ending in 99, the common two-digit reference for 1999. As a result, as we
transition from the 20th century to the 21st century, computer systems and
software used by many companies and organizations in a wide variety of
industries will produce erroneous results or fail unless they have been
modified or upgraded to process date information correctly. Significant
uncertainty exists concerning the scope and magnitude of problems associated
with the year 2000 issue.
State of Readiness. Although we have not conducted a formal audit internally or
by any third party, the software used in our internal systems has either been
developed by us or has been purchased in the last twelve months. As a result,
we believe our internal systems are year 2000 compliant.
Costs. To date, we have not incurred any material costs directly associated
with our year 2000 compliance efforts, except for compensation expenses
associated with our salaried employees who have devoted some of their time to
our year 2000 assessment. We do not expect the total cost of year 2000 problems
to be material to our business. Despite our current assessment, we may not
identify and correct all significant year 2000 problems on a timely basis. Year
2000 compliance efforts may involve significant time and expense and
unremediated problems could substantially harm our business.
Risks. We are not currently aware of any year 2000 readiness problems relating
to our internally-developed proprietary systems that would substantially harm
our business. We may discover year 2000 readiness problems in these systems
that will require substantial revision. In addition, third-party software,
hardware or services incorporated into our material systems may need to be
revised or replaced, all of which could be
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time-consuming and expensive. Our failure to fix or replace our internally
developed proprietary software or third-party software, hardware or services on
a timely basis could result in lost revenues, increased operating costs, the
loss of customers and other business interruptions, any of which could
substantially harm our business. Moreover, our failure to adequately address
year 2000 readiness issues in our internally developed proprietary software
could result in claims of mismanagement, misrepresentation or breach of
contract and related litigation, which could be costly and time-consuming to
defend. In addition, governmental agencies, utility companies, Internet access
companies, third-party service providers and others outside of our control may
not be year 2000 ready. The failure by these entities to be year 2000 ready
could result in a systemic failure beyond our control, such as a prolonged
Internet, telecommunications or electrical failure, which could also prevent us
from delivering our services to our customers, decrease the use of the Internet
or prevent users from accessing websites.
In particular, we rely on Card Service International for credit card
processing. Although Card Service International have publically represented
that their systems are year 2000 compliant, we have not yet received any
written assurance from them as to their readiness for year 2000 issues. Because
we have not received written assurance, we have assumed that Card Service may
not be ready for the year 2000 before January 1, 2000, and that their credit
card processing could fail at that time. Based on this assumption, we believe
such failure would be the most reasonably likely worst case year 2000 scenario.
If the Card Service services fail, we would seek to complete credit card
transaction manually using temporary staff. If Card Service were unable to
restore service promptly, we believe switching to another financial institution
for automated credit card processing would require approximately 15 days.
Contingency Plan. As discussed above, we are engaged in an ongoing year 2000
assessment.
Quantitative and Qualitative Disclosures About Market Risk
We have considered the provisions of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and
Qualitative Information about Market Risk Inherent in Derivative Financial
Instruments, Other Financial Instruments and Derivative Commodity Instruments."
We had no holdings of derivative financial or commodity instruments at
September 30, 1999. However, we are exposed to financial market risks,
including changes in interest rates. All of our revenue and capital spending is
transacted in U.S. dollars. Our investments portfolio comprises amounts
invested in short term cash deposits and therefore we believe that the fair
value of our investment portfolio or related income would not be significantly
impacted by increases or decreases in interest rates due mainly to the short-
term nature of our investment portfolio. However, a sharp increase in interest
rates could have a material adverse effect on the fair value of our investment
portfolio. Conversely, sharp declines in interest rates could seriously harm
interest earnings of our investment portfolio.
The table below presents principal amounts by expected maturity (in U.S.
dollars) and related weighted average interest rates by year of maturity for
our investment portfolio as at September 30, 1999.
<TABLE>
<CAPTION>
Due within
one year Thereafter Total
---------- ---------- -----------
<S> <C> <C> <C>
Cash..................................... 78,904,000 $ -- $78,904,000
Weighted Average Interest Rate......... 5.18% --
Total Portfolio.......................... 78,904,000 $ -- $78,904,000
========== ==== ===========
</TABLE>
Recent Accounting Pronouncements
In March 1998, the Accounting Standards Executive Committee issued Statement of
Position No. 98-1 or SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," which
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provides guidance on accounting for the cost of computer software developed or
obtained for internal use. SOP 98-1 is effective for financial statements for
fiscal years beginning after December 15, 1998. We are currently evaluating the
impact of SOP 98-1 on our financial statements and related disclosures.
In April 1998, the Accounting Standards Executive Committee issued Statement of
Position 98-5, or SOP 98-5, "Reporting on the Costs of Start-Up Activities."
This standard requires companies to expense the costs of start-up activities
and organization costs as incurred. In general, SOP 98-5 is effective for
fiscal years beginning after December 15, 1998. We believe the adoption of SOP
98-5 will not have a material impact on our results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, or SFAS 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS 133 establishes new standards of
accounting and reporting for derivative instruments and hedging activities.
SFAS 133 requires that all derivatives be recognized at fair value in the
statement of financial position, and that the corresponding gains or losses be
reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that
exists. SFAS 133 will be effective for fiscal years beginning after June 15,
2000. We do not currently hold derivative instruments or engage in hedging
activities.
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Business
Overview
EMusic.com Inc. is a leading provider of downloadable music over the Internet.
Through our website at EMusic.com, we offer a compelling selection of music
from which our customers may discover, sample, and purchase popular recordings
for immediate digital delivery and enjoyment. The recordings available for
download at EMusic.com are provided through our relationships with a growing
roster of recording artists and independent record labels. We currently have
exclusive, multi-year, digital download licenses from over 500 record labels
and over 2,500 recording artists, including selected titles from such well
known artists as Bush, Phish, They Might Be Giants, B.B. King and Ella
Fitzgerald. We currently have over 50,000 titles available for download on our
EMusic.com website. In addition, our IUMA subsidiary offers our customers
access to over 7,500 unsigned artists. We believe this represents one of the
largest digital music content archives currently licensed for distribution over
the Internet.
Our website enables these artists and labels to easily access a global customer
base, while providing them with an integrated means of distributing, promoting
and tracking the sales of their recorded music. Recordings are currently
offered for sale on EMusic.com and partners' websites in the "mp3" format, the
most widely-recognized compression standard for the download of musical
recordings. We believe that our combination of selection, convenience, varied
content, improved distribution and tracking capabilities creates a compelling
music purchasing experience for consumers as well as an attractive distribution
alternative for artists and independent record labels.
Industry Background
Recorded Music Industry
According to a report by Market Tracking International, worldwide retail sales
in the music industry were $39.7 billion in 1997 and are expected to grow to
$46.9 billion by 2004. The music industry can be divided into two kinds of
record companies or "labels"-- the "major" record labels and the "independent"
record labels. According to Billboard, the five major record labels and their
affiliates currently account for approximately 79% of all recorded music sales
worldwide. These companies are BMG Entertainment, EMI Music, Sony Music
Entertainment, Universal Music Group and Warner Music Group. These companies
have substantial investments in the distribution infrastructure which supports
the manufacturing, distribution and retailing of records and compact discs and
through which the substantial majority of current recorded music sales take
place. Historically, the major record labels have been reluctant to participate
in any alternative distribution model which would restructure the current music
distribution hierarchy due to their investment in the current physical
distribution infrastructure and their relationship with the retail channel.
Thousands of independent record labels account for most of the remaining
recorded music sales. In contrast to the major record labels, independent
record labels generally do not have substantial existing CD and record
distribution investments and, as a result, physical distribution can be more
difficult and costly to arrange. Independent record labels also typically have
less capital available. Without the established distribution networks,
independent record labels often pay higher royalties to artists to secure
publishing and distribution rights.
Development of the Downloadable Music Industry
The Internet has emerged as a global platform that allows millions of people to
share information, communicate and conduct business. International Data
Corporation estimates that the number of Internet users worldwide who make
purchases over the Internet will grow from approximately 31 million users in
1998 to more than 183 million in 2003, representing 36% of all Internet users.
The Internet presents a significant opportunity for the rapid and cost-
effective distribution, promotion and sale of recorded music. Downloading music
files is also facilitated by the increased use of high-speed connections to the
Internet, such as digital cable modems, ISDN and digital subscriber lines.
According to Forrester Research, the number of subscribers using cable, xDSL or
ISDN modems is projected to reach 22 million by 2003.
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Forrester estimates that total online music revenues in the United States are
expected to grow from $89.0 million in 1998 to $7.8 billion in 2003. Of this
amount, Forrester further estimates that $1.1 billion will represent sales of
downloadable music in 2003. According to Market Tracking International, music
sold through the Internet will account for 8% or approximately $4.0 billion of
the $46.9 billion worth of music expected to be sold worldwide in 2004.
In addition to the development of the Internet, we believe that other
technological advances will drive rapid growth of the market for downloadable
music, including the adoption of open standards-based Internet audio, the
introduction of new hardware and improved digital compression technology. Prior
to the introduction of new digital compression technologies, it was impractical
to transmit high quality audio using the Internet because recordings in digital
format can be very large. Advances in compression techniques, however, have
greatly reduced the size of digitally stored recordings. For example, if not
compressed, a three minute song can occupy more than thirty megabytes of
storage. In contrast, the mp3 open standard can compress music files to one-
tenth their original size while maintaining their audio integrity at near-CD
quality levels. Mp3 playback software is currently available on most operating
environments such as Microsoft Windows 95/98, Windows NT and MacOS, most major
versions of UNIX and other operating environments for Internet enabled devices.
In addition, free copies of mp3 playback software like RealNetworks'
RealJukebox and America Online's WinAmp are widely available on the Internet.
Forrester estimates that there are already over 50 million mp3-capable users
today.
In recent years, consumers have increasingly used their computers to play and
store music. Dataquest estimates that in 1998, 50% of U.S. households had
multimedia PCs with a sound card, speakers and either a CD-ROM or DVD-ROM
drive. Consumers can now play CDs on their computers with the ease and fidelity
formerly associated only with high-end stereo systems. Consumer electronics
companies and technology companies have capitalized on the growing popularity
of digital music by introducing portable music devices. The Rio, introduced in
November 1998 by Diamond Multimedia Systems has already sold over 300,000
units. Other manufacturers, including Sony, Creative Labs, Sensory Sciences,
RCA/Thomson, Samsung, Toshiba and LG Electronics have released, or have
announced plans to release, portable digital music players which support mp3
files. In addition, other manufacturers have produced, or have announced plans
to produce, other devices for playing and storing mp3 recordings, including the
Empeg Car (a removable audio system capable of holding over 5,000 titles),
Clarion's AutoPC (an auto mp3 audio player) and Lydstrom's Songbank (a home
stereo component that stores and supports mp3 files). PC manufacturers such as
Dell Computer, Hewlett-Packard and Gateway have also begun to introduce
computer systems which include special features for using with digital music
such as high fidelity speaker systems, digital music players and rewritable CD
recorders.
Our Opportunity
We believe that a number of inefficiencies in the current structure of the
music industry leave three underserved constituencies: consumers, independent
record labels and artists.
Consumers pay higher prices than necessary for music in order for record labels
to recoup the high costs associated with distribution of music on a physical
media through traditional channels. In addition, the current dependence on
physical media limits consumer convenience by forcing them to purchase music at
retail outlets or through catalogs or Internet sites that use mail-order.
Further, physical media is less portable and harder to customize than
downloadable music. Increasingly, we believe that these shortcomings will drive
consumers to the solution of purchasing downloadable music direct from the
Internet.
We believe consumer adoption of downloadable music creates an excellent
opportunity for independent record labels to supplement or replace their
physical distribution networks with electronic channels. Currently, many
independent record labels rely on the distribution infrastructure of major
record labels to distribute their offerings. They are subject to constraints of
these physical channels, such as higher distribution costs driving lower
margins, limited shelf space and subordination to the offerings of the major
record labels, as well as more limited promotional capabilities. While the
promise of an electronic distribution infrastructure is compelling, most
independent record labels lack the resources and expertise to create a viable
proprietary
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electronic distribution channel. We believe that these independent record
labels will seek to partner with established providers of downloadable music to
leverage their branding, site traffic and technology.
By supporting independent record labels, we believe downloadable music creates
a compelling solution for artists. In return for access to the powerful
distribution and promotion capabilities of the major record labels, major label
artists are generally required to lock themselves into long-term contracts that
can reduce their royalty rates, limit their creative control and limit their
ability to promote and sell their music online. Artists who work with an
independent record label tend to enjoy less restrictive contracts, but must
face risks associated with an independent record label's less effective
distribution and promotion capabilities. Additionally, physical channels
require costly promotional efforts, making it difficult for some artists to
promote their offerings to a large audience. We believe that the cost and
contractual constraints of the major record labels and the limitations of
independent record labels using traditional distribution channels will
encourage many artists, including some major artists, to offer their music in
downloadable format, either on their own or through an independent record label
with electronic distribution capability.
Creating an infrastructure to handle royalty payments for downloadable music is
difficult, and the lack of this infrastructure has slowed acceptance of the
downloadable music distribution channel by artists, labels and songwriters.
Rights in the music industry focus on two levels; the underlying song and the
sound recording. The purchase of one song usually requires at least two
separate royalty payments, one to the songwriter and one to the performer. We
believe that the ability to accurately track and make royalty payments to the
correct parties is crucial to the proliferation of the downloadable music
distribution channel as a viable alternative to their physical counterparts.
The EMusic Solution
We are a leading provider of downloadable music. Our website allows consumers
to quickly and conveniently purchase music online at a lower price than most
traditional music CDs. Our website also allows consumers to download and listen
to music immediately. We believe that the limitations associated with the
traditional music industry present us with an opportunity to redefine the music
distribution hierarchy and enable artists and independent labels to access
consumer markets at a level currently only available to the major labels, while
protecting the artists' financial interests and providing consumers with
numerous advantages in price, convenience and music information.
We believe that our solution provides the following benefits:
Benefits to Consumers
Convenience. Through our website, consumers can download music at any time, 24
hours a day, seven days a week. Consumers can register to make purchases from
our site in a few easy steps, and can purchase titles on multiple visits to our
site without having to re-enter personal and credit card information. Consumers
can search our site using various easy to use indices and generally have the
flexibility to make purchases song by song or by album. When they make their
purchase, consumers can download and listen to their music immediately, or they
can wait until a more convenient time to download their purchased titles. Once
downloaded, digital technology allows the consumer to organize their purchased
titles into play lists. Play lists allow users to organize and play their
titles in any order they desire. Consumers can easily copy music to their
laptops or digital music devices for greater portability, without having to
carry physical media with them. In addition, digital music devices have no
moving parts and, as a result, do not skip and can be used in situations where
traditional music CDs are not optimal, such as running or mountain biking.
Lower Prices. Our ability to deliver music electronically eliminates the
extensive infrastructure required by the traditional music industry to
distribute physical media. This greatly reduces our costs and allows us to
offer our music at a significantly lower price to consumers.
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Compelling Music Selection. We currently have exclusive, multi-year, digital
download licenses from over 500 record labels and over 2,500 recording artists,
including selected titles from such well known artists as Bush, Phish, They
Might Be Giants, B.B. King and Ella Fitzgerald. We currently have over 50,000
titles available for download on our EMusic.com website. In addition, our IUMA
subsidiary offers our customers access to over 7,500 unsigned artists. We
believe this represents one of the largest digital music content archives
currently licensed for distribution over the Internet. Furthermore, our
downloadable music infrastructure allows us to carry hard-to-find, out-of-
production or international titles that are not commercially viable to produce
or stock in a physical format.
Varied Information and Content. Visitors to our website can access music news,
as well as links to concert information, sites for free mp3 software downloads
and other information on downloadable music. We provide our consumers with the
opportunity to sample titles before purchasing them. This enables them to
explore new music without cost and may result in them purchasing additional or
lesser-known titles. In addition, we are beginning to offer other services to
our customer base, including online concerts, organizing online chat sessions
with their favorite artists and "undiscovered" talent, and other initiatives
that we believe will offer a more direct connection between artists and
consumers.
Benefits to Artists and Independent Labels
Powerful Distribution Capabilities. Our website provides a powerful
distribution solution to artists and independent labels by allowing them access
to a broad range of music listeners. Because we are not dependent on physical
media, we can provide artists and independent record labels with much lower
distribution costs, creating higher margins for labels and allowing independent
record labels to pay artists higher royalties and publishing rates. In
addition, our distribution capabilities can allow artists to directly
distribute their offerings to the public, such as a new They Might Be Giants
mp3-only album which was released exclusively on our website.
Greater Understanding of Fan Base. By tracking the behavior and purchasing
patterns of users on our website, we are able to provide artists and
independent labels a level of feedback that was previously unavailable through
traditional music distribution channels. Artists and independent labels may use
our data to evaluate which songs receive the most interest, the location on the
Internet where they receive the best reception and how their music compares to
other music in the same genre or in other genres. Artists and labels may use
this information to target specific regions, increase the focus of promotional
efforts and provide a means to better connect with their fan base.
Significant New Media Exposure. The Internet is emerging as an important
promotional tool for artists and independent labels. In addition to the global
distribution of their music, we are currently beginning initiatives that will
enable us to offer artists significant exposure to their fan bases. This
includes concerts broadcast online, chat rooms featuring artists and fans, and
other exposure on our website. This relatively inexpensive promotion on a
global basis is a significant benefit to artists and independent labels.
Protection of Financial Interests. We believe that by closely tracking royalty
payments, and pricing our music low enough to discourage piracy, we provide a
valuable, trusted solution to artists and labels that will enable us to become
the preferred distribution channel for downloadable music. We have established
a proprietary database of artists, songwriters and labels that allows us to
seamlessly track and generate royalty payments to the appropriate parties. We
are currently licensed by the Harry Fox Agency, ASCAP, BMI and SESAC;
organizations dedicated to protecting the rights of, and collecting royalties
due to, artists and songwriters.
EMusic Business Strategy
Our objective is to become the leading provider of compelling, downloadable
music directly to consumers over the Internet. Our strategy is to leverage our
first-to-market advantage together with our established music industry
relationships as we take advantage of the growing market for the digital
distribution of music. The following are key elements of our strategy:
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Continue to Acquire Compelling and Varied Content. We will continue to increase
the number of musical selections available on our website in order to build our
global consumer base and increase the number of online music purchases. We are
pursuing a "best of breed" content acquisition strategy, focused on acquiring
exclusive rights to title libraries from leading independent record labels in
each well known music genre. We intend to continue to aggressively pursue the
acquisition of music content from, among others, independent record labels,
owners and distributors of recording catalogs, and established recording
artists.
Create Strong Brand Awareness. Building brand awareness of EMusic is
fundamental to expanding our global Internet user base and our ability to
attract providers of music content. We promote our brand through traditional
media, event sponsorships, online media and other marketing activities as well
as leveraging strategic relationships within the industry. We intend to enhance
brand awareness of our website by providing original and proprietary content,
aggressively expanding our online and offline marketing activities, enabling
consumers to purchase music and related merchandise, and establishing strategic
and referral fee relationships whereby other websites engage us as an online
music retail source and content provider.
Leverage Strategic Partnerships and Industry Relationships. We believe that our
strategic relationships with distribution and technology companies and our
strong relationships with media and music companies will help attract users,
significantly increase brand awareness of our website and help us to add new
content. We will seek to develop additional relationships with online music
retailers, Internet portal site companies and content providers. In addition,
we plan to establish retail relationships with other online distributors to
share commissions for sales generated from such websites.
Continue to Enhance Our Website. We intend to devote substantial resources to
improving the quality of our consumer users' experience on our website.
Features we intend to incorporate into future versions of our website include:
chat-rooms, music hubs, additional music-related content, more advanced search
capabilities and dynamic site personalization. We believe that a user-friendly
website with compelling and varied content will be a key differentiator of the
EMusic brand.
Become a Trusted Distribution Channel to the Music Industry. We intend to
further develop our technology infrastructure to be readily scaleable to
support our rapidly growing sales of online music, including the calculation of
royalty payments, while maintaining the speed and reliability of our site.
Furthermore, we intend to maintain low pricing to provide an attractive legal
alternative to piracy among the general public. We believe that providing a
reliable, trusted technology and payment infrastructure will position us more
favorably with record labels and artists as the premiere provider of
downloadable music.
Continue to Promote Development of Downloadable Music Market. We believe that
the development of the downloadable music market will be enhanced by educating
consumers about the benefits of downloadable music and by improving the
processes through which consumers purchase music online and use downloadable
music. We currently are active members of the Digital Media Association and
Electronic Frontier Foundation, organizations dedicated to, among other
matters, improving the ease of consumer acquisition and use of downloadable
music. We intend to continue to participate in programs which promote customer
and market awareness about downloadable music as well as industry groups which
are setting open standards for delivery. We intend to refine and simplify the
downloadable music purchasing experience through the continued development of
our website, which is designed to encourage purchases and repeat visits,
demonstrating to record labels and artists the value of the downloadable music
market.
Continue to Develop and Enhance IUMA. We believe that Internet Underground
Music Archive which allows unsigned artists to post music and related
information for access by the general public online, represents a competitive
advantage. IUMA promotes the development of the online music community and
allows us to establish early relationships with potential future music content
providers. We intend to continue to expand and improve IUMA so as to make it
easier for artists to participate and for consumers to access, search and
preview the content on the site.
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Content Acquisition
We have acquired, and intend to continue to aggressively seek, download rights
to master recordings owned by independent record labels and other owners and
distributors of significant recording catalogs. These exclusive, multi-year
license agreements typically include all existing and future recordings created
during the term of the agreement. Initially, we have focused on partnering with
independent record labels and established recording artists. We are actively
identifying and targeting independent record labels spanning every well known
music genre, including, hip hop, rap, jazz, classical, country, blues, heavy
metal and alternative rock.
We have adopted a "best of breed" approach with respect to acquiring
downloadable music licenses. In many distinctly defined genres of music, we
have successfully acquired the exclusive multi-year, digital download rights to
the market sales leaders, and are aggressively continuing those efforts in each
new genre of music we add to our expanding online catalog. The following is a
sampling of labels with which we have signed exclusive content deals with genre
market leaders:
. Epitaph Records, one of the largest selling and most distinct brand names
in punk rock and alternative music, represents top Billboard artists such
as The Offspring, Tom Waits and Pennywise.
. King Biscuit Flower Hour, which is currently aired on 180 radio stations,
is the longest running syndicated live concert radio show. Their catalog
features live recordings from such artists as The Who, David Crosby, Iggy
Pop, Elton John and Rod Stewart.
. Crunch Music Ltd., one of the United Kingdom's premier sources for
independent UK music in the mp3 format, whose content focuses on dance,
techno and hip-hop.
. Jetset Records and spinART Records, which are recognized in numerous
college magazines as the dominant music providers in the college music
niche.
. DRG Records, which owns the largest Broadway show recording library,
including numerous Grammy and Tony Award winners.
. Rykodisc, one of the largest independent recording catalogs, which
represents artists such as Elvis Costello, Frank Zappa and Robert Cray.
. Quicksilver Records, which features live recordings from The Monterey
Jazz Festival and the Palo Alto Jazz catalog.
We have also entered into contracts giving us the exclusive right to allow our
customers to download music from a variety of recognizable, brand name artists.
Included in the content catalog are recordings from Phish, Bush, Goo Goo Dolls,
James Brown, Frank Zappa, Louis Armstrong, Ella Fitzgerald, Judy Garland,
Shirley Bassey, Kool Keith, Kansas, Foghat and thousands of others.
In June 1999, we purchased the Jewel-Paula-Ronn catalog of master recordings
with such Blues and R&B artists as B.B. King, John Lee Hooker, Aretha Franklin
and Lightnin' Hopkins and in November 1999, we purchased the master recording
catalog of Xanadu Records, including such jazz artists as Dexter Gordon and
Jimmy Raney. When we acquire masters, we will seek to work with label partners
to exploit the physical distribution rights while also selling the music in
downloadable form on our website. In December 1999, we acquired Group K Inc.
d/b/a Cductive, which has content license agreements with over 350 labels, most
in the dance/electronic, alternative rock and hip-hop genres.
Strategic Partnerships
Distribution and Marketing Partnerships
We are aggressively pursuing a variety of partnerships aimed at building a
channel of distribution for our downloadable music and music-related products
and services across the Internet. To accomplish this, we are
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developing strategic relationships and alliances with high-traffic Internet
sites to feature our brand and exclusive content and in some cases offer our
content for sale.
. We have entered into an agreement with Amercia Online pursuant to which
our content is to be made available to customers of AOL's ICQ, Spinner
and WinAmp interactive properties.
. We have also entered into an agreement with Yahoo! pursuant to which our
content is to be made available to users of the Yahoo! Digital Service
for downloadable music.
. We also have advertising and marketing agreement with Real Network, CNET,
Listen.com and CMJ Online, among others.
In addition, we are also working with our label partners to offer them a
solution for selling our catalog directly from their websites. These label
partners can choose to sell only their own music, or the entire EMusic catalog
on EMusic created co-branded websites. In December 1999, we launched a grass
roots affiliate program designed to make it easy for any website to become an
affiliate and sell the EMusic catalog from their websites.
Hardware/Software/OEM Partnerships
We are building relationships with various manufacturers of computers and
consumer electronics devices, as well as software and book publishers to create
additional visibility as a source for downloadable music. As part of our
overall customer acquisition strategy, we are typically providing sample
titles, promotional coupons and other content to improve our partners' offering
to the music consumer and to continue to promote the downloadable music market.
. We have established relationships with digital audio device manufacturers
such as Creative Labs (Nomad), Diamond Multimedia (Rio) and Sensory
Sciences (Rave). As part of these arrangements we provide purchasers of
the devices with sample recordings with the installation software.
. As an additional way to attract customers, promote downloadable music and
distribute our label partners' music effectively, we plan to introduce
certain marketing initiatives and alliances with OEM computer suppliers,
sound card, high fidelity speaker and computer peripheral suppliers and
wireless product manufacturers. For example, we have an agreement with
Hewlett-Packard pursuant to which sample recordings are to be provided
with each of H-P's Pavilion branded computers.
Industry Relationships
The reporting of information relating to the sales and performance of music is
a legally required and complex aspect of the worldwide music industry. To
facilitate our compliance with these requirements, we have focused on building
strong relationships and alliances with the following organizations:
. We have a licensing agreement with the Harry Fox Agency, or HFA, a
wholly-owned licensing subsidiary of the National Music Publishers'
Association. We will submit regular reports to HFA, account for each song
purchased and pay the appropriate statutory payments to HFA for
distribution to copyright owners. This agreement helps ensure that
songwriters and music publishers will receive royalty payments for music
distributed electronically.
. We have entered into agreements with ASCAP, BMI and SESAC, the major
rights reporting organizations in the United States. Under each of these
agreements, we pay music performance royalties to the copyright holders
or performers.
. We have an agreement with peermusic, one of the world's largest private
music publishing companies. Pursuant to this agreement, peermusic
provides music publishing administration services to us. We will share
peermusic income derived from music publishing rights acquired by us. We
have also licensed certain recordings from the peermusic catalog.
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IUMA--Internet Underground Music Archive
In June 1999, we completed the acquisition of IUMA. IUMA was founded in 1993
and pioneered the delivery of music on the Internet. The IUMA website
(iuma.com) features more than 7,500 artists on individual websites with unique
URLs (bandname.iuma.com). IUMA artist websites enable audio sampling in mp3 and
RealAudio formats, and offer options for the sales of physical products and
downloadable music. IUMA artist websites also feature other content, including
artist biographies, cover art, lyrics, photos and tour dates. IUMA has received
worldwide media attention, including articles in Rolling Stone, Newsweek, USA
Today and the Financial Times, as well as spots on MTV and CNN.
The following are key elements of our strategy with respect to IUMA:
Enhance Content and Build Traffic. We believe that by increasing IUMA's brand
recognition in the unsigned artist community through aggressive marketing
efforts, IUMA can become a premier Internet destination for unsigned artists
and fans of those artists.
Leverage the IUMA Platform to Develop New Artists. We believe that by creating
an efficient environment for unsigned artists and fans to interact, the IUMA
website will allow promising artists to surface more quickly. These artists
will then be exposed to our label partners. We believe that by facilitating the
process of signing unsigned artists, we will be promoting a new generation of
artists with a greater appreciation of the value of digital downloading of
music. Consequently, this will encourage the growth of the market as well as
position EMusic to obtain additional downloadable music rights.
Sales and Marketing
Our sales and marketing objective is to sell downloadable music and music-
related products and services through EMusic.com and other websites, build
brand awareness, attract new visitors and convert them to loyal customers. To
accomplish this objective, our marketing strategy includes an aggressive
advertising campaign, high visibility promotions and sponsorships, strategic
public relations, a focused interactive marketing campaign, distribution
partnerships and broad loyalty programs.
The following are key elements to our sales and marketing strategy:
Enhance the EMusic.com Website. The focus of the website is to make the
consumer's experience finding, purchasing and downloading music as simple as
possible. We are regularly adding new elements designed to improve content,
navigability and the overall buying process.
Corporate Branding Campaign. We have recently launched an aggressive corporate
branding campaign. The campaign is initially targeted at early adopters, music
enthusiasts, record labels and the Internet business community. We have
designed a comprehensive media campaign, including network and cable TV ads,
billboards and print media. The campaign is also designed to attract new users
to the EMusic.com website and encourage trial download and purchases. Using the
tag line, "The Way To Download," the campaign features a mix of media vehicles
designed to reach our target audience.
Sponsorships and Promotions. We intend to sponsor highly-visible events
including concert tours, conferences and trade shows. We also plan to offer
creative promotions on EMusic.com and other websites designed to encourage
consumers to establish an account and purchase tracks.
Other elements of our sales and marketing initiatives include the introduction
of loyalty programs, such as rebates and incentives, online advertising to our
target demographic, genre specific marketing initiatives and the introduction
of co-marketing agreements with labels.
We also sell advertising on our website. This advertising is generally related
to our music offerings either by the product or music oriented nature of their
promotion. We currently use the Doubleclick Dart program to manage, track and
report our advertising sales to our advertising customers.
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Operations
Our integrated systems, services and tools provide functionality in the
following areas:
Digital Asset Management. The continued development of a database management
system that indexes, retrieves and manipulates our growing multimedia content
is central to our digital asset management system. This scalable system allows
us to, among other things, track user preferences to enable effective marketing
programs and maintain an efficient royalty accounting program. Our system
utilizes Oracle database technology running on Sun Microsystems' Enterprise
equipment and Linux webservers.
Ordering and Fulfillment. Our website includes an ordering system that is
designed to be easy-to-use and that facilitates convenient purchasing of
downloadable music. In order to maintain high customer satisfaction, we place
an emphasis on website and download reliability. At any time during a visit to
our website, a customer is able to click a "buy now" button to immediately
place a song or album in their personal "shopping cart." The customer can then
continue to shop on our website and add additional items if desired. New
customers are prompted to register with us at the time of purchase and to enter
their email addresses and passwords. Customers then securely submit their
credit card information online to purchase the music. The customers' email
addresses and passwords are used to identify them in the future, eliminating
the need to resubmit credit card and billing information for subsequent orders.
Audio Encoding and Delivery. We use a variety of audio compression technologies
for our audio samples and downloads, tailoring them to specific applications.
We currently use the mp3 format for digital distribution of our downloadable
music. In light of current user patterns, we use RealNetworks' popular
RealAudio format for delivering real-time streaming 30-second audio previews
and feature-length web broadcasts. Mp3 is also used for real-time preview
samples. We are exploring other download formats and plan to adjust the format
of our content to stay current with industry trends and customer preferences.
We may need to obtain a third party license to use a newly adopted format.
Infrastructure. Our hardware and software are built upon a distributed
transaction processing model which allows software to be distributed among
multiple parallel servers. Web servers are deployed in large numbers on
inexpensive Intel platforms, managed by Cisco load-balancing technology, and
served by Solaris database servers. Our servers are currently based in a co-
location facility in Sunnyvale, California. Our architecture allows us to scale
by either adding new servers or increasing the capacity of existing servers
while maintaining both user performance and cost per transaction. The system's
template technology and modular database design allows the addition or
replacement of server-based applications such as multimedia formats and
delivery systems, and search and retrieval engines. This architecture also
enables low-cost, rapid deployment of additional websites that integrate with
our existing sites.
Competition
The market for the online promotion and distribution of music and music-related
products and services is new, highly competitive and rapidly changing. The
number of websites on the Internet competing for the attention and spending of
consumers and advertisers has increased, and we expect it to continue to
increase, because there are few barriers to entry to Internet commerce. In
addition, the competition for advertising revenues, both on Internet websites
and in more traditional media, is intense. Currently, there are more than one
hundred music retailing websites on the Internet. We face competitive pressures
from numerous actual and potential competitors, including:
. providers selling online music content from signed artists such as
MusicMaker.com, CDNow Inc., and various private companies;
. providers of music news and community such as Launch Media, Inc., MTVi,
Tunes.com and various private companies;
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. companies offering mp3 or other audio compression formats, such as those
of AT&T Corp., IBM Corporation, Liquid Audio, Inc., Microsoft Corporation
and RealNetworks, Inc. Certain of these companies also offer customers
the ability to download music from their websites;
. online destination sites with greater resources than us such as online
music retailers like Amazon.com, Inc. and online "portals" like America
Online, Excite and Yahoo!; and
. traditional music industry companies, including BMG Entertainment, a unit
of Bertelsmann AG, EMI Music, a unit of EMI Group plc, Sony Music
Entertainment, a unit of Sony Corporation, Warner Music Group, a unit of
Time Warner Inc., and Universal Music Group, a unit of the Seagram
Company Ltd. Certain of these companies have recently entered the online
commercial community and are currently backing the SDMI security format.
In many cases, companies with which we have certain joint marketing or other
arrangements may be or may become direct competitors as well.
Certain companies have agreed to work together to offer music over the
Internet, and we may face increased competitive pressures as a result. For
example, in the summer of 1999, it was announced that Time Warner and Sony's
Columbia House unit will merge with CDNow. In May 1999, Microsoft Corporation
and Sony Corporation announced an agreement to pursue a number of cooperative
activities. Sony has announced that it will make its music content downloadable
from the Internet using Microsoft's multimedia software. In addition, Universal
Music Group and BMG Entertainment have announced a joint venture to form an
online music store.
We believe that we compete primarily on the bases of:
. the quality and variety of our digital content, including access to known
artists;
. the price of the downloaded content;
. the ease of use and consumer acceptance of the compression system;
. the ability to effectively promote brand equity; and
. the ease of use and speed of our website.
Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Many of our current and
potential competitors in the Internet and music entertainment businesses may
have substantial competitive advantages to us, including:
. longer operating histories;
. significantly greater financial, technical and marketing resources;
. greater brand name recognition;
. larger existing customer bases; and
. more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and to devote greater
resources to the development, promotion, and sale of their products or services
than we can. Websites maintained by our existing and potential competitors may
be perceived by consumers, artists, talent management companies and other
music-related vendors or advertisers as being superior to ours. In addition, we
may not be able to maintain or increase our website traffic levels, purchase
inquiries and number of click-throughs on our online advertisements. Further,
our competitors may experience greater growth in these areas than we do.
Increased competition could result in advertising price reduction, reduced
margins or loss of market share, any of which could harm our business.
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Intellectual Property
Our success and ability to compete are substantially dependent on our
internally developed technology. We pursue the registration of our trademarks
in the United States and internationally. We currently hold a registered
trademark from the United States Patent & Trademark Office for "EMusic." While
we rely on trademark, service mark, copyright and trade secrets laws and
restrictions in the United States and other jurisdictions, together with
contractual restrictions, to protect our proprietary rights, such trademark,
service mark, copyright and trade secret protection may not be available in
every jurisdiction in which we distribute or make available our musical content
and technology through the Internet. Although we believe that the use of
material on our websites is protected under current provisions of copyright
law, legal rights to certain aspects of Internet content and commerce are not
clearly settled. We may not be able to maintain rights to information,
including webcasting of popular sound recordings, downloadable music samples,
and artist, entertainment and other information. The failure to be able to
offer such information would harm our business.
While we have generally entered into confidentiality or license agreements with
our employees, consultants, and corporate partners in order to limit access to
and distribution and disclosure of our proprietary information, we cannot
assure you that the steps we have taken will adequately protect or prevent
misappropriation of our proprietary rights, particularly in foreign countries
where laws or law enforcement practices may not protect our proprietary rights
as fully as in the United States. Despite our efforts, unauthorized parties may
attempt to copy or otherwise obtain and use our products and technology.
Policing unauthorized use is difficult.
There are no pending lawsuits against us regarding infringement of any existing
patents or other intellectual property rights or any material notices that we
are infringing the intellectual property rights of others. However, there can
be no assurance that such infringement claims will not be asserted by third
parties in the future. Any such claims could result in litigation subjecting us
to significant liability for damages, or in invalidation of our proprietary
rights. Any such claims, with or without merit, could be time consuming to
defend, result in costly litigation, divert management attention and resources,
or require us to enter into royalty or licensing agreements.
Employees
As of November 30, 1999, we had 88 full-time employees, including 24 in selling
and marketing, 50 in engineering and product development and 22 in finance and
operations. Our future success depends, in significant part, upon the continued
service of our key technical, editorial, product development, and senior
management personnel and on our ability to attract and retain highly qualified
technical and management personnel, for whom competition is intense. None of
our employees are represented by a collective bargaining unit, and we have
never experienced a work stoppage. Our relations with our employees are good.
Legal Proceedings
From time to time, we may be involved in litigation relating to claims arising
out of our operations. We are not currently engaged in any legal proceedings
that, individually or in the aggregate, we expect would have a material adverse
effect on our business.
Facilities
Our corporate headquarters are located in approximately 20,000 square feet in
Redwood City, California occupied under a lease expiring in April 2004. We
believe that our existing facilities will be adequate for the foreseeable
future, and that suitable additional facilities will be available in the future
as needed on commercially reasonable terms.
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Management
Executive Officers, Directors and Key Employees
Our current executive officers and directors as well as certain members of our
senior management, and their ages and positions as of December 20, 1999 are as
follows:
<TABLE>
<CAPTION>
Name Age Position(s)
- ---- --- -----------
<S> <C> <C>
Robert H. Kohn *...... 42 Chairman and Secretary
Gene Hoffman, Jr. *... 24 President, Chief Executive Officer, and Director
Joseph H. Howell *.... 47 Executive Vice President and Chief Financial Officer
Peter M. Astiz *...... 41 Executive Vice President and General Counsel
James R. Chapman *.... 32 Executive Vice President, Corporate Strategy
Gary Culpepper........ 50 Executive Vice President, Business Affairs
Spencer Leyton........ 51 Senior Vice President, Sales
Brian Brinkerhoff..... 36 Vice President, Content Acquisition
Steve Grady........... 33 Vice President, Marketing
Peter Harter.......... 31 Vice President, Global Public Policy and Standards
Marv Su............... 36 Vice President, Interactive Marketing
Brett A. Thomas....... 29 Vice President, Technology
Tor Braham............ 42 Director
Ralph Peer, II........ 55 Director
Ed Rosenblatt......... 64 Director
</TABLE>
- ------------------
*Executive Officer
Robert H. Kohn, a co-founder of EMusic, has been Chairman of the Board and
Secretary since January 1998. From October 1996 to December 1997, Mr. Kohn was
Vice President, Business Development and General Counsel of Pretty Good
Privacy, Inc., a developer and marketer of Internet encryption and security
software. From March 1987 to September 1996, he was Senior Vice President of
Corporate Affairs, Secretary, and General Counsel of Borland International,
Inc., a software company. Mr. Kohn also served as chief legal counsel for
Ashton-Tate Corporation. Prior to Ashton-Tate, he was an attorney at the
Beverly Hills law offices of Rudin & Richman, an entertainment law firm whose
clients included Frank Sinatra, Liza Minelli, Cher and Warner Brothers Music.
He was also Associate Editor of the Entertainment Law Reporter, for which he
continues to serve as a member of the Advisory Board. A member of the
California Bar Association, Mr. Kohn co-authored Kohn On Music Licensing, a
treatise on music industry law for lawyers, music publishers, and songwriters.
He graduated from Loyola Law School, Los Angeles and received a Bachelor of
Arts degree in Business Administration from California State University at
Northridge. Mr. Kohn is also an adjunct professor of law at Monterey College of
Law, where he teaches Corporate Law.
Gene Hoffman, Jr., a co-founder of EMusic, has been President, Chief Executive
Officer, and a Director since January 1998. From November 1996 to December
1997, Mr. Hoffman was Director of Business Development and Director of
Interactive Marketing of Pretty Good Privacy. From October 1995 to November
1996, he was founder, director and Executive Vice President of PrivNet, Inc.,
an Internet privacy software company. From August 1993 to October 1995, Mr.
Hoffman was a student at the University of North Carolina, Chapel Hill.
Joseph H. Howell joined EMusic in April 1998 as Executive Vice President and
Chief Financial Officer. From January 1995 to April 1998, Mr. Howell was Senior
Vice President and Chief Financial Officer of Merix Corporation, a manufacturer
of multilayer printed circuit boards. From May 1988 to January 1995, Mr. Howell
served as Vice President and Controller of Borland. He also served as Borland's
acting Chief Financial Officer in 1994. Mr. Howell received a Bachelor of Arts
degree in Political Science from the University of Michigan and a Masters of
Science in Accounting from Eastern Michigan University.
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Peter M. Astiz joined EMusic in July 1999 as Executive Vice President and
General Counsel. From October 1996 to July 1999, Mr. Astiz was a partner of
Gray Cary Ware & Freidenrich LLP, a law firm. From July 1989 until October
1996, Mr. Astiz was a partner of the law firm of Baker & McKenzie. Mr. Astiz
received a Bachelor of Science degree in Business Administration from the
University of California in 1979 and a J.D. from the University of San
Francisco.
James R. Chapman joined EMusic in April 1999 as Executive Vice President,
Corporate Strategy. From April 1997 to April 1999, Mr. Chapman was Director of
the Global Private Capital Group at Warburg Dillon Read LLC (formerly UBS
Securities LLC), a major investment bank. Prior to joining UBS Securities, from
July 1995 to April 1997 Mr. Chapman was President and Founder of Ashley Capital
Management, a private equity and advisory firm focused on principal investments
in emerging growth companies located in the Pacific Northwest and Rocky
Mountain States. From September 1994 to July 1995, Mr. Chapman was a partner of
Jacobson Partners, a boutique merchant bank focused on middle market buyouts
and direct equity investments. From May 1990 to September 1994, Mr. Chapman
also worked as an associate in the technology and healthcare investment banking
groups of Oppenheimer & Co. and PaineWebber Incorporated. Mr. Chapman received
a Bachelor of Arts degree in Economics from Middlebury College.
Gary Culpepper joined EMusic in April 1998 as Executive Vice President,
Business Affairs. From May 1995 to March 1998, Mr. Culpepper was in private law
practice, specializing in music and entertainment transactions for recording
artists, producers, and songwriters. From April 1994 to April 1995, Mr.
Culpepper was Senior Counsel for Sony Pictures/Columbia/TriStar Home Video. Mr.
Culpepper previously served as Vice President, Business Affairs/Music for
Paramount Pictures Corporation, where he was responsible for the negotiation,
structuring, and administration of all music-related rights for all film and
soundtrack licensing agreements, budget planning, and financial analysis for
all music-related deal-making activities. Prior to that, Mr. Culpepper was
Director, Business Affairs for Capitol Records, Inc. He was also Senior Counsel
for Casablanca Records & Filmworks, Assistant General Counsel for ABC Records,
Inc., and Manager, A&R Administration for A&M Records. He is a member of the
California Bar Association, graduated cum laude from University of California,
Los Angeles, and received his law degree from Southwestern University.
Spencer Leyton joined EMusic in April 1999 as Vice President, Corporate
Development, M&A and was appointed Senior Vice President, Sales, in August
1999. From 1997 until April 1999, Mr. Leyton worked as an independent business
consultant. From 1995 through 1996, Mr. Leyton served as Vice President,
Mergers & Acquisitions for Sybase, Inc., a software company. From 1989 through
1994, Mr. Leyton served as Senior Vice President, Business Development for
Borland. Mr. Leyton received a Bachelors of Arts degree in geography from
California State University, Hayward.
Brian Brinkerhoff joined EMusic in November 1998 as Vice President, Content
Acquisition. From January 1995 to November 1998, Mr. Brinkerhoff was Head of
Creative Music Publishing at the Walt Disney Company, a multinational
entertainment company. From January 1992 to December 1994, he was a principal
of Vis-a-Vis Entertainment Company, a music publishing company. From May 1989
to December 1991, Mr. Brinkerhoff was Product Manager, Kodak Interactive
Systems, a developer and marketer of personal computer software. Mr.
Brinkerhoff received a Bachelors of Arts degree in Economics from the
University of California at Davis.
Steve Grady joined EMusic in June 1998 as Vice President, Corporate
Communications and was promoted to Vice President, Marketing in January 1999.
From July 1997 to May 1998, Mr. Grady was Director, Corporate Communications
for Borland, where he was responsible for public relations and investor
relations. From July 1996 to July 1997, he was Director, Marketing
Communications for Infoseek Corporation. From 1992 to June 1995, he served as
Director, Corporate Communications for Borland. Prior to Borland, Mr. Grady
served in a variety of corporate communications and marketing positions with
Ashton-Tate, TeraData, and Lotus Development. Mr. Grady received a Masters
degree in Communications Studies from Emerson College and a Bachelor of Arts
degree in Public Communications from Ashland University.
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Peter Harter joined EMusic in March 1999 as Vice President, Global Public
Policy and Standards. From November 1995 through March 1999, Mr. Harter was
Global Public Policy Counsel for Netscape Communications Corp. From June 1994
through November 1995, Mr. Harter was Executive Director and General Counsel
for the National Public Telecomputing Network (NPTN) in Cleveland, Ohio. Mr.
Harter was a founder of the Internet Law and Policy Forum (ILPF), an ad-hoc
body of over twenty companies from around the world focused on developing open
draft legal standards for a variety of Internet law and policy matters.
Mr. Harter received a Bachelor of Arts degree in Rhetoric & Government from
Lehigh University and a J.D. from Villanova Law School.
Marv Su joined EMusic as Vice President, Interactive Marketing in February
1999. From January 1998 through January 1999, Mr. Su served as director of
Small Business Internet Marketing and Community at Intuit, Inc., a software
company. From February 1996 through December 1997, Mr. Su served as Senior
Director of Advertising Operations at Infoseek. From August 1991 through
February 1996, Mr. Su held various management and marketing positions at Apple
Computer. He received a Bachelor of Science in Electrical Engineering from
Stanford University and a Master of Science in Management from the M.I.T. Sloan
School of Management.
Brett A. Thomas joined EMusic in April 1998 as Vice President, Technology. From
November 1996 to January 1998, Mr. Thomas was Principal Engineer for Pretty
Good Privacy, where he was responsible for the design and implementation of PGP
4.5 and 5.0 for Win32, PGP for Unix and its key server software. Previously,
Mr. Thomas was a senior engineer for NCR, where he developed their check
processing software. Prior to NCR, he wrote automated document processing
programs for MCI, internal management software for an insurance company, and
inventory control systems under contract to IBM. Since 1994, Mr. Thomas has
been involved in the Linux software community, maintaining websites operating
on Linux platform and making several modifications to the source code of the
core of the Linux operating system.
Tor Braham, a Director since May 1999, is Managing Director and Head of the
Technology Mergers & Acquisitions Department for Warburg Dillon Read. From
February 1984 until November 1997, Mr. Braham was a partner of the law firm of
Wilson Sonsini Goodrich & Rosati. Mr. Braham received a Bachelor of Science
degree in English from Columbia University and a J.D. from the New York
University Law School.
Ralph Peer, II, a Director since June 1998, is Chairman and Chief Executive
Officer of peermusic, a global network of music publishing and production
companies. In addition, Mr. Peer is Vice President and Director of the National
Music Publishers' Association (U.S.A.) and the Harry Fox Agency. He is a
lifetime director and past president of the Country Music Association and a
publisher/director of ASCAP. Mr. Peer is also a director of Fox Agency
International (Singapore) and a consultant to the board of the Mechanical
Copyright Protection Society, U.K. He is a past president and a current
director of the International Confederation of Music Publishers and in 1997 was
elected "President d'Honneur" of the Confederation.
Ed Rosenblatt, became a Director in 1999. From 1994 until his retirement in
1999, Mr. Rosenblatt served as Chairman of Geffen Records. Mr. Rosenblatt
helped found Geffen Records in 1980, and served as its President and Chief
Operating Officer until 1994. Prior to Geffen Records, Mr. Rosenblatt served as
Senior Vice President of sales and promotion for Warner Brothers Records. Mr.
Rosenblatt received a degree in Applied Arts from Brooklyn College.
Board of Directors
The terms of the board of directors are divided into three classes: Class I,
whose term will expire at the annual meeting of stockholders to be held in
2002; Class II, whose term will expire at the annual meeting of stockholders to
be held in 2000; and Class III, whose term will expire at the annual meeting of
stockholders to be held in 2001. The Class I directors are Robert Kohn and Tor
Braham, the Class II directors are Gene Hoffman, Jr. and Ed Rosenblatt, and the
Class III director is Ralph Peer. At each annual meeting of stockholders, the
successors to directors whose term expires will be elected to serve a term of
three years. This classification of directors may have the effect of delaying
or preventing changes in our control. Our board of
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<PAGE>
directors consists of five members. Our amended and restated bylaws provide
that the authorized number of directors may be changed by resolution of the
board of directors.
Executive officers are elected by the board of directors annually. There are no
family relationships among any of our directors, officers or key executives.
Board Committees
We have established an Audit Committee and a Compensation Committee. The Audit
Committee, which currently consists of Messrs. Braham, Peer and Rosenblatt,
reviews our internal accounting procedures and consults with and reviews the
services provided by our independent auditors. The Compensation Committee,
which currently consists of Messrs. Braham, Peer and Rosenblatt, reviews and
recommends to the Board of Directors the compensation and benefits of our
executive officers, establishes and reviews general policies relating to our
compensation and benefits and administers our stock plans.
Director Compensation
Directors do not receive cash compensation for their services as directors or
members of committees of the board of directors, but are reimbursed for
reasonable expenses incurred in attending meetings of the board. In May 1998,
we granted Mr. Peer a fully-vested, nonqualified stock option to purchase
100,000 shares of our common stock at an exercise price of $5.00 per share. In
June 1999, we granted Messrs. Braham and Rosenblatt fully-vested, nonqualified
stock options to purchase 35,000 and 100,000 shares of our common stock,
respectively, at an exercise price of $13.63 per share.
Compensation Committee Interlocks and Insider Participation
None of our executive officers has served as a member of a compensation
committee or board of directors of any other entity which has an executive
officer serving as a member of the board of directors.
Change of Control Arrangements and Employment Agreements
Pursuant to agreements with Messrs. Kohn and Hoffman, upon any acquisition of
EMusic or if their employment is terminated other than for cause, the
repurchase right in favor of EMusic which applies to certain unvested shares
owned by them will terminate. Pursuant to agreements with Messrs. Howell, Astiz
and Chapman, upon any acquisition of EMusic, all unvested stock options held by
each will become vested in full. Further each executive officer is entitled to
twelve months severance in the event their employment is terminated other than
for cause.
Executive Compensation
Summary Compensation Information
The following table sets forth information concerning the compensation we paid
for services rendered during the fiscal years ended June 30, 1998 and 1999 by
our Chief Executive Officer:
Summary Compensation Table
<TABLE>
<CAPTION>
Long Term
Compensation
Annual Compensation Awards
-------------------------- ---------------------
Name and Other Annual Securities Underlying
Principal Position Year Salary Bonus Compensation Options
------------------ ---- ------- ----- ------------ ---------------------
<S> <C> <C> <C> <C> <C>
Gene Hoffman, Jr., Presi-
dent and Chief 1999 $82,291 -- -- 250,000
Executive Officer....... 1998 31,250 -- -- --
</TABLE>
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<PAGE>
The stock option granted to Mr. Hoffman vests ratably over a four year term. No
other executive officer received a total salary and bonus during fiscal year
1998 or 1999 in excess of $100,000.
Option Grants
The following table provides information regarding stock option grants made
during fiscal 1999 to Mr. Hoffman. Options may terminate before their
expiration date upon the termination of optionee's status as an employee or
upon the optionee's death or disability.
Option Grants in Fiscal Year 1999
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of
Number of % of Total Stock Price
Securities Options Appreciation for
Underlying Granted to Exercise Option Term(2)
Options Employees in Price Per Expiration ---------------------
Name Granted Fiscal 1999(a)(1) Share Date 5% 10%
---- ---------- ----------------- --------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Gene Hoffman, Jr. ...... 250,000 5.9% $13.63 6/10/09 $ 941,429 $ 2,080,312
</TABLE>
- ------------------
(1) Based on an aggregate of 4,216,000 shares subject to options granted in
fiscal 1999.
(2) Potential realizable values are net of exercise price, but before taxes
associated with exercise. Amounts represent hypothetical gains that could
be achieved for the options if exercised at the end of the option term. The
assumed 5% and 10% rates of stock price appreciation are provided in
accordance with rules of the SEC and do not represent our estimate or
projection of the future common stock price.
Option Exercises and Year-End Holdings
There were no option exercises by Mr. Hoffman during fiscal 1999. The following
table sets forth information concerning unexercised options held as of June 30,
1999 by Mr. Hoffman.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying In-the-Money
Unexercised Options at
Options at 6/30/99 6/30/99
----------------------- ----------------------
Name Vested Unvested Vested Unvested
---- --------- ------------ ----------------------
<S> <C> <C> <C> <C>
Gene Hoffman, Jr................. -- 250,000 -- $ 1,750,000
</TABLE>
We have not awarded stock appreciation rights to any employee of ours and we do
not have any multi-year incentive plans.
Stock Plans
1998 Stock Option Plan. Our 1998 stock option plan was approved by the board of
directors in March 1998 and was subsequently approved by our stockholders. The
1998 option plan provides for the grant to employees of incentive stock options
within the meaning of section 422 of the Internal Revenue Code of 1986, as
amended, and for grants of nonstatutory stock options to employees, non-
employee directors and consultants. Because non-employee directors are eligible
to receive grants under the 1998 option plan, we have not adopted a separate
plan which provides for the formula grant of stock options to non-employee
directors.
The 1998 option plan is administered by the board of directors or a committee
thereof. Subject to the provisions of the 1998 option plan, the board or
committee has the authority to select the persons to whom options are granted
and determine the terms of each option, including:
. the number of shares of common stock covered by the option;
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<PAGE>
. when the option becomes exercisable;
. the per share option exercise price, which in the case of incentive stock
options must be at least equal to the fair market value of a share of
common stock on the grant date (or 110% of such fair market value for
incentive stock options granted to 10% shareholders), and, in the case of
nonstatutory stock options, must be at least 85% of the fair market value
of a share of common stock on the grant date; and
. the duration of the option (which may not exceed ten years, or, with
respect to incentive stock options granted to 10% shareholders, five
years).
Generally, options granted under the 1998 option plan become exercisable as the
underlying shares vest. Options granted under the 1998 option plan generally
vest over four years, although the board or committee may specify a different
vesting schedule for a particular grant. Options granted under the 1998 option
plan are non-transferable other than by will or the laws of descent and
distribution.
In the event of a change in control of EMusic, the acquiring or successor
corporation may assume or substitute for the outstanding options granted under
the 1998 option plan. The outstanding options will terminate to the extent that
such options are neither exercised nor assumed or substituted for by the
acquiring or successor corporation.
As of September 30, 1999, six million shares are reserved for issuance under
the 1998 option plan, 195,985 shares have been issued upon the exercise of
options, options to purchase of a total of 2,796,165 shares at a weighted
average exercise price of $3.95 per share were outstanding and 3,007,850 shares
were available for future option grants.
1998 Nonstatutory Stock Option Plan. Our 1998 nonstatutory stock option plan
was approved by the board of directors in December 1998. The nonstatutory plan
provides for the grant of nonstatutory stock options to employees (who are not
officers or directors) and consultants.
The nonstatutory plan is administered by the board of directors or a committee
thereof. Subject to the provisions of the nonstatutory plan, the board or
committee has the authority to select the persons to whom options are granted
and determine the terms of each option, including:
. the number of shares of common stock covered by the option;
. when the option becomes exercisable;
. the per share option exercise price, which must be at least equal to 85% of
the fair market value of a share of common stock on the grant date; and
. the duration of the option (which may not exceed ten years).
Generally, options granted under the nonstatutory plan become exercisable as
the underlying shares vest. Options granted under the nonstatutory plan
generally vest over four years, although the board or committee may specify a
different vesting schedule for a particular grant. Options granted under the
nonstatutory plan are non-transferable other than by will or the laws of
descent and distribution.
In the event of a change in control of EMusic, the acquiring or successor
corporation may assume or substitute for the outstanding options granted under
the nonstatutory plan. The outstanding options will terminate to the extent
that such options are neither exercised nor assumed or substituted for by the
acquiring or successor corporation.
As of September 30, 1999, five million shares are reserved for issuance under
the nonstatutory plan, 20,000 shares have been issued upon the exercise of
options, options to purchase of a total of 3,827,200 shares at a weighted
average exercise price of $10.85 per share were outstanding and 1,155,800
shares were available for future option grants.
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<PAGE>
1999 Employee Stock Purchase Plan. A total of 250,000 shares of common stock
have been reserved for issuance under our 1999 employee stock purchase plan,
none of which have been issued as of the effective date of this offering. The
purchase plan, which is intended to qualify under section 423 of the Internal
Revenue Code, is administered by the board or by a committee thereof. Our
employees (including our officers and employee directors) and those of any of
our subsidiaries designated by the board for participation in the purchase plan
are eligible to participate in the purchase plan if they are customarily
employed for more than 20 hours per week and more than five months per year.
The purchase plan will be implemented by sequential offerings of approximately
six months duration. We have not yet determined when the first offering period
will commence. Shares will be purchased on the last day of each offering
period. The board may change the dates or duration of one or more offerings,
but no offering may exceed 27 months. The purchase plan permits eligible
employees to purchase common stock through payroll deductions at a price no
less than 85% of the lower of the fair market value of the common stock on (a)
the first day of the offering, or (b) the purchase date. Participants generally
may not purchase more than 1,000 shares in a six-month offering period or stock
having a value (measured at the beginning of the offering) greater than $25,000
in any calendar year. In the event of certain changes in control of EMusic, the
board may accelerate the purchase date of the then current offering period to a
date prior to the change in control unless the acquiring or successor
corporation assumes or replaces the purchase rights outstanding under the
purchase plan.
Limitation of Liability and Indemnification
Section 145 of the Delaware General Corporation Law permits indemnification of
officers, directors and other corporate agents under certain circumstances and
subject to certain limitations. Our amended and restated certificate of
incorporation and bylaws provide that we shall indemnify our directors,
officers, employees and agents to the full extent permitted by Delaware General
Corporation Law, including in circumstances in which indemnification is
otherwise discretionary under Delaware law. In addition, we intend to enter
into separate indemnification agreements with our directors and officers which
would require us, among other things, to indemnify them against certain
liabilities which may arise by reason of their status or service (other than
liabilities arising from willful misconduct of a culpable nature). We also
intend to continue to maintain director and officer liability insurance, if
available on reasonable terms. These indemnification provisions and the
indemnification agreements may be sufficiently broad to permit indemnification
of our officers and directors for liabilities (including reimbursement of
expenses incurred) arising under the Securities Act.
At present, there is no pending litigation or proceeding involving any of our
directors, officers, employees or other agents in which indemnification is
being sought nor are we aware of any threatened litigation that may result in a
claim for indemnification by any of our directors, officers, employees or other
agents.
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<PAGE>
Certain Transactions and Relationships
We were formed on January 8, 1998 as a Delaware corporation under the name
GoodNoise Corporation. In February 1998, we issued 3,100,000 shares of common
stock to each of Robert Kohn, our chairman of the board, and Gene Hoffman, Jr.,
our chief executive officer and a member of our board, and 900,000 shares of
common stock to Gary Culpepper, our executive vice president of business
affairs. All such shares were issued at $0.001 per share. Of the shares issued
to Mr. Culpepper, approximately 600,000 shares were subject to repurchase
pursuant to a restricted stock purchase agreement. As of September 30, 1999,
the restricted stock purchase agreement provides us with the right to
repurchase approximately 262,000 of these shares at a nominal price subject to
ratable vesting over three years ending February 2001.
In February 1998, we entered into an agreement to borrow $10,000 from Mr. Kohn
and $50,000 from peermusic, and entity controlled by Ralph Peer, II, one of our
directors, through the issuance of promissory notes bearing interest at 10.0%
per annum, due in December 1998. On May 1, 1998, these notes were converted
into an aggregate of 150,000 shares of common stock at $0.40 per share.
On May 11, 1998, GoodNoise Corporation, a Florida corporation, formerly
Atlantis Ventures Corporation entered into an Agreement and Plan of
Reorganization pursuant to which it acquired GoodNoise Corporation, a Delaware
corporation. In connection with such acquisition, the Florida corporation
exchanged 11,015,300 shares of its common stock for all outstanding stock of
the Delaware corporation and assumed all outstanding options of the Delaware
corporation for the purchase of an additional 2,032,550 shares of the Florida
corporation's common stock. Following such transaction, the directors and
officers of the Delaware corporation became the directors and officers of the
Florida corporation. Of the shares issued as part of such transaction,
8,555,000 shares were issued to such directors and officers. The shareholders
of the Florida corporation prior to the Merger had no affiliation with the
Delaware corporation and following the Merger ceased to be affiliates of the
Florida corporation.
On March 23, 1999, we sold shares of Series B preferred stock through Warburg
Dillon Read LLC, a placement agent. Mr. Tor Braham was a managing director of
Warburg Dillon Read LLC at this time. Mr. Braham subsequently became a member
of our board of directors on May 5, 1999. Of the 117,570 shares of Series B
preferred stock sold on March 23, 1999, we sold 614 shares to peermusic III,
Ltd. which is affiliated with Ralph Peer, II, a member of our board of
directors. We also sold 33,334 and 16,832 shares of our Series B preferred
stock to affiliates of Invesco Private Capital and VantagePoint Venture
Partners, respectively. As a result, Invesco Private Capital and VantagePoint
are deemed to own over five percent of our outstanding common stock.
Also in connection with the sale of our Series B preferred stock, on March 23,
1999 we entered into a shareholders' agreement with Mr. Kohn and Mr. Hoffman,
as well as the purchasers of the Series B preferred stock. This agreement
provides, among other things, that the shares of our common stock owned by
Messrs. Kohn and Hoffman be held subject to a right of repurchase in favor of
EMusic. As of September 30, 1999, 2,335,916 and 2,010,598 shares of our common
stock owned by Messrs. Kohn and Hoffman, respectively, were subject to this
right of repurchase. This amount decreases by 72,726 and 62,598 shares monthly,
respectively, until March of 2002, when the right of repurchase expires.
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<PAGE>
Principal Stockholders
The following table sets forth the beneficial ownership of our voting stock,
including optioned shares, as of September 30, 1999 by:
. each person or entity who is known by us to beneficially own more than 5%
of our outstanding common stock;
. each of our directors and executive officers; and
. all executive officers and directors as a group.
Unless otherwise indicated, the address for each of the named individuals is
c/o EMusic.com Inc., 1991 Broadway, 2nd Floor, Redwood City, California 94063.
Except as otherwise indicated, and subject to applicable community property
laws, the persons named in the table have sole voting and investment power with
respect to all shares of common stock held by them.
Applicable percentage ownership in the table is based on shares of common stock
outstanding as of September 30, 1999. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission. Shares of
common stock subject to options that are presently exercisable or exercisable
within sixty (60) days of September 30, 1999 are deemed outstanding for the
purpose of computing the percentage ownership of the person or entity holding
such options, but are not treated as outstanding for the purpose of computing
the percentage ownership of any other person or entity. To the extent that any
shares are issued upon exercise of options, warrants or other rights to acquire
our capital stock that are presently outstanding or granted in the future or
reserved for future issuance under our stock plans, there will be further
dilution to new public investors. The number of shares of common stock
beneficially owned includes shares which are being registered for resale
pursuant to this registration statement.
<TABLE>
<CAPTION>
Number of
Shares of
Common Stock
Beneficially
Beneficial Owner Owned Percent(1)
- ---------------- ------------ ----------
<S> <C> <C>
5% Stockholders
Citiventure 96 Partnership, L.P.
c/o Invesco Private Capital
1166 Avenue of the Americas, Suite 2700
New York, NY 10036 (2)................................. 3,333,400 9.7%
VantagePoint Venture Partners
1001 Bayhill Drive, Suite 140
San Bruno, CA 94066 (3)................................ 1,686,500 4.9%
Directors and Executive Officers
Robert H. Kohn.......................................... 2,881,700 8.4%
Gene Hoffman, Jr. ...................................... 3,202,000 9.3%
Joseph H. Howell (4).................................... 178,624 *
Peter M. Astiz.......................................... 216,000 *
James R. Chapman (5).................................... 79,941 *
Tor Braham (6).......................................... 46,600 *
Ralph Peer, II (7)...................................... 308,900 *
Ed Rosenblatt (8)....................................... 100,000 *
Executive officers and directors as a group
(8 persons) (9)........................................ 7,013,765 20.5%
</TABLE>
- ------------------
* Less than 1%
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<PAGE>
(1) Percentage of beneficial ownership excludes up to 6,162,957 shares issuable
upon exercise of outstanding stock options and warrants.
(2) Represents shares owned by Invesco related partnerships as follows: 58,300
shares owned by Chancellor Private Capital Offshore Partners I, C.V.;
624,000 shares owned by Chancellor Private Capital Offshore Partners II,
L.P.; 379,000 shares owned by Chancellor Private Capital III, L.P.;
1,627,100 shares owned by Citiventure 96 Partnership, L.P.; and 645,000
shares owned by Drake & Co. for the account of Citiventure Private
Participations III.
(3) Represents shares owned by VantagePoint related partnerships as follows:
3,300 shares owned by Jason Strober; 1,111,100 shares owned by VantagePoint
Communications Partners, L.P.; 16,600 shares owned by VantagePoint Venture
Advisors, LLC; and 555,500 shares owned by VantagePoint Venture Partners
1996.
(4) Includes 142,624 shares issuable upon exercise of outstanding options.
(5) Includes 50,007 shares issuable upon exercise of outstanding options.
(6) Includes 35,000 shares issuable upon exercise of outstanding options.
(7) Includes 100,000 shares issuable upon exercise of outstanding options.
Includes 61,400 shares of common stock held by peermusic III, Ltd. which
were issued in connection with the conversion of shares of Series B
preferred stock. Mr. Peer disclaims beneficial ownership of the shares held
by peermusic III, Ltd. except to the extent of his pecuniary interest
therein.
(8) Represents shares issuable upon exercise of outstanding options.
(9) Includes 460,408 shares issuable upon exercise of outstanding options.
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Description of Capital Stock
Our authorized capital stock consists of 200,000,000 shares of common stock,
par value $0.001 per share, and 20,000,000 shares of preferred stock, par value
$0.001 per share.
This summary does not purport to be complete and is subject to, and qualified
in its entirety by, the provisions of our amended and restated certificate of
incorporation where such rights are set forth in full, and the provisions of
applicable law.
Common Stock
As of September 30, 1999, there were approximately 34,000,000 shares of common
stock outstanding held of record by approximately 200 shareholders. The holders
of common stock are entitled to one vote for each share held of record on all
matters submitted to a vote of the holders of common stock. Subject to
preferences applicable to any then outstanding preferred stock, holders of
common stock are entitled to receive ratably such dividends as may be declared
by the board of directors out of funds legally available therefor. In the event
of a liquidation, dissolution, or winding up of EMusic, the holders of common
stock are entitled to share ratably in all assets remaining after payment of
our liabilities and the liquidation preference of any preferred stock. Holders
of common stock have no preemptive or subscription rights, and there are no
redemption or conversion rights with respect to such shares. All outstanding
shares of common stock are fully paid and non-assessable.
Preferred Stock
Our board of directors has the authority to issue preferred stock in one or
more series and to fix the number of shares constituting any such series and
the preferences, limitations and relative rights, including dividend rights,
dividend rate, voting rights, terms of redemption, redemption price or prices,
conversion rights and liquidation preferences of the shares constituting any
series, without any further vote or action by our stockholders. The issuance of
preferred stock by our board of directors could adversely affect the rights of
holders of common stock.
The potential issuance of preferred stock may have the effect of delaying or
preventing a change in control of EMusic, may discourage bids for our common
stock at a premium over the market price of the common stock and may adversely
affect the market price of, and the voting and other rights of the holders of,
common stock. Immediately after this offering there will be no shares of
preferred stock outstanding, and we have no current plans to issue shares of
preferred stock.
Warrants
As of September 30, 1999, we had outstanding warrants to purchase an aggregate
of approximately 2,712,000 shares of our common stock. Warrants for 100,000
shares expire in October 2003 and have an exercise price equal to $7.10. The
exercise price of these warrants is subject to certain adjustments upon future
issuances of common stock or rights to acquire common stock at a price less
than the applicable exercise price. The warrants for the remaining shares have
an average exercise price of $14.12 and expire by September 2001. The exercise
price of all warrants is subject to customary adjustments on stock splits,
stock dividends, any merger or acquisition involving EMusic and similar
transactions, such as to permit the holders of warrants to receive upon
exercise of the warrants that which they would have received had they exercised
the warrants immediately prior to any such transaction.
Registration Rights of Certain Holders
In connection with the sale of shares of our Series B preferred stock, on March
23, 1999 we entered into an agreement with the holders of shares of our Series
B preferred stock and the holder of a warrant to purchase 100,000 shares of our
common stock to register the shares of our common stock into which these
securities are
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convertible or exercisable. In accordance with this agreement, we have included
these shares as part of this registration statement. In connection with our
acquisition of Cductive, we have agreed to file a registration statement
covering resale of the shares issued within six months of the closing of such
acquisition.
Anti-Takeover, Limited Liability and Indemnification Provisions
Effect of Delaware Anti-takeover Statute. We are subject to Section 203 of the
Delaware General Corporation Law, as amended, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years following the date that such
stockholder became an interested stockholder, unless:
. prior to such date, the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
. upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned (1) by persons who are
directors and also officers and (2) by employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer; or
. on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by the
interested stockholder.
Section 203 defines business combinations to include:
. any merger or consolidation involving the corporation and any interested
stockholder;
. any sale, transfer, pledge or other disposition of 10% or more of the
assets of the corporation involving the interested stockholder;
. any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the interested
stockholder;
. any transaction involving the corporation that has the effect of
increasing the proportionate share of the stock of any class or series of
the corporation beneficially owned by the interested stockholder; or
. the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
In general, Section 203 defines an interested stockholder as any entity or
person beneficially owning 15% or more or the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
Certificate of Incorporation and Bylaw Provisions. Our amended and restated
certificate of incorporation and amended and restated bylaws include provisions
that may have the effect of discouraging, delaying or preventing a change in
control of EMusic or an unsolicited acquisition proposal that a stockholder
might consider favorable, including a proposal that might result in the payment
of a premium over the market price for the shares held by stockholders. These
provisions are summarized in the following paragraphs.
Classified Board of Directors. Our amended and restated certificate of
incorporation and amended and restated bylaws provide for our board to be
divided into three classes of directors serving staggered, three-year terms.
The classification of the board has the effect of requiring at least two annual
stockholder meetings, instead of one, to replace a majority of the members of
the board of directors.
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Supermajority Voting. Our amended and restated certificate of incorporation
requires the approval of the holders of at least 66 2/3% of our combined voting
power to effect certain amendments to the amended and restated certificate of
incorporation with respect to the bylaws, directors, stockholder meetings and
indemnification, or to effect any business combination (as defined in Section
203) relating to us. Our amended and restated bylaws may be amended by either a
majority of the board of directors, or the holders of a majority of our voting
stock, provided that certain amendments approved by stockholders require the
approval of at least 66 2/3% of our combined voting power.
Authorized but Unissued or Undesignated Capital Stock. Our authorized capital
stock consists of 200,000,000 shares of common stock and 20,000,000 shares of
preferred stock. As of September 30, 1999, no preferred stock has been
designated. As of September 30, 1999, we had outstanding approximately
34,000,000 shares of common stock. The authorized but unissued (and in the case
of preferred stock, undesignated) stock may be issued by the board of directors
in one or more transactions. In this regard, our amended and restated
certificate of incorporation grants the board of directors broad power to
establish the rights and preferences of authorized and unissued preferred
stock. The issuance of shares of preferred stock pursuant to the board of
director's authority described above could decrease the amount of earnings and
assets available for distribution to holders of common stock and adversely
affect the rights and powers, including voting rights, of such holders and may
have the effect of delaying, deferring or preventing a change in control of
EMusic. The board of directors does not currently intend to seek stockholder
approval prior to any issuance of preferred stock, unless otherwise required by
law or the rules of any exchange on which our securities are then traded.
Special Meetings of Stockholders. Our amended and restated bylaws provide that
special meetings of stockholders of EMusic may be called only by the board of
directors, or by the chairman of our board of directors or our president.
No Stockholder Action by Written Consent. Our amended and restated certificate
of incorporation and amended and restated bylaws provide that an action
required or permitted to be taken at any annual or special meeting of the
stockholders of EMusic may only be taken at a duly called annual or special
meeting of stockholders. This provision prevents stockholders from initiating
or effecting any action by written consent.
Notice Procedures. Our amended and restated bylaws establish advance notice
procedures with regard to all stockholder proposals to be brought before
meetings of stockholders of EMusic, including proposals relating to the
nomination of candidates for election as directors, the removal of directors
and amendments to our amended and restated certificate of incorporation or
amended and restated bylaws. These procedures provide that notice of such
stockholder proposals must be timely given in writing to the secretary of
EMusic prior to the meeting. Generally, to be timely, notice must be received
by our secretary not less than 120 days prior to the meeting. The notice must
contain certain information specified in the amended and restated bylaws.
Limitation of Director Liability. Our amended and restated certificate of
incorporation limits the liability of our directors (in their capacity as
directors but not in their capacity as officers) to us or our stockholders to
the fullest extent permitted by Delaware law. Specifically, directors will not
be personally liable for monetary damages for breach of a director's fiduciary
duty as a director, except for liability:
. for any breach of the director's duty of loyalty to us or our
stockholders;
. for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. under Section 174 of the Delaware General Corporation Law, which relates
to unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
. for any transaction from which the director derived an improper personal
benefit.
Indemnification Arrangements. Our amended and restated bylaws provide that our
directors and officers shall be indemnified and provide for the advancement to
them of expenses in connection with actual or threatened
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<PAGE>
proceedings and claims arising out of their status as such to the fullest
extent permitted by the Delaware General Corporation Law. We intend to enter
into indemnification agreements with each of our directors and executives
officers that will provide them with rights to indemnification and expense
advancement to the fullest extent permitted under the Delaware General
Corporation Law.
Transfer Agent
The transfer agent and registrar for our common stock is Interwest Transfer
Company, Inc. Its address is 1981 East 4800 South, Suite 100, Salt Lake City,
Utah 84117, and its telephone number at this location is (801) 272-9294.
65
<PAGE>
Shares Eligible for Future Sale
As of December 20, 1999, we had outstanding approximately 36,500,000 shares of
common stock. Of these shares, 5,750,000 shares sold in our underwritten public
offering are freely tradable without restrictions or further registration under
the Securities Act unless such shares are purchased by "affiliates" of EMusic,
as that term is defined under Rule 144 under the Securities Act. Shares
purchased by affiliates are subject to certain limitations and restrictions as
described below.
Sales of Restricted Shares
The remaining approximately 31,000,000 shares of common stock held by existing
stockholders were issued and sold by us in reliance upon exemptions from the
registration requirements of the Securities Act. Approximately 13,112,000 of
such shares will be freely tradable upon the effectiveness of the registration
statement to which this prospectus is a part except to the extent that such
shares are held by affiliates of EMusic. Of the remaining shares, approximately
4,045,000 are freely tradeable, approximately 10,729,000 shares are eligible
for resale pursuant to, and subject to the requirements of Rule 144.
In general, under Rule 144 as currently in effect, a person who has
beneficially owned shares for at least one year is entitled to sell within any
three-month period, a number of shares that does not exceed the greater of:
. 1% of the number of shares of common stock then outstanding, which equals
approximately 365,000 shares; or
. the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale.
Sales under Rule 144 are also subject to certain other requirements regarding
the manner of sale, notice filing and the availability of current public
information about us.
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an affiliate, is
entitled to sell such shares without complying with the manner of sale, notice
filing, volume limitation or notice provisions of Rule 144. Therefore, unless
otherwise restricted, "Rule 144(k) shares" may be sold without restriction.
Options
As of September 30, 1999, there were a total of approximately 6,623,000 shares
of common stock subject to outstanding options under our stock option plans,
approximately 2,439,000 of which were vested. All shares issuable upon exercise
of options granted under our stock option plans as well as shares issuable
under our 1999 employee stock purchase plan are generally available for resale
in the public market.
Warrants
As of September 30, 1999, approximately 2,712,000 shares of our common stock
were subject to outstanding warrants. Of such shares, 110,000 are subject to
the registration statement to which this prospectus is a part. We have no
contractual obligation to file a registration statement with respect to the
other shares issuable upon exercise of the warrants. If we do not file such a
registration statement, such shares will begin to be eligible for resale under
Rule 144 if such warrants are exercised on a "net exercise" basis beginning in
June 2000.
66
<PAGE>
Lock-up Agreements
Our officers, directors and some other stockholders, holding in total
approximately 8,893,000 of our outstanding shares, have agreed with CIBC World
Markets Corp. not to sell or otherwise dispose of any of their shares for a
period of 90 days after September 24, 1999. Other stockholders holding in total
approximately 12,100,000 of our outstanding shares are subject to agreements
with us which require that they not, directly or indirectly, offer, sell,
pledge or otherwise dispose of any of their shares for the same 90-day period.
CIBC World Markets Corp., however, may in its sole discretion and at any time,
without notice, release all or any portion of the shares subject to these
agreements.
Price Range of Common Stock
Our common stock is traded on the Nasdaq National Market under the symbol
"EMUS." Prices reported represent prices between dealers, do not include
markups, markdowns or commissions and do not necessarily represent actual
transactions. The market for our shares has been sporadic and at times very
limited.
The following table sets forth the high and low bid quotations for the common
stock for the fiscal years ending June 30, 1999 and 2000 and the portion of the
fiscal year ended June 30, 1998 for which our common stock was traded.
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
Fiscal Year Ended June 30, 1998
Fourth Quarter (after May 12, 1998)......................... $ 6.50 $ 5.00
Fiscal Year Ended June 30, 1999
First Quarter............................................... $ 8.00 $ 5.88
Second Quarter.............................................. 7.50 5.00
Third Quarter............................................... 23.88 7.00
Fourth Quarter.............................................. 29.13 13.63
Fiscal Year Ending June 30, 2000
First Quarter .............................................. $26.19 $11.56
Second Quarter (through December 20, 1999).................. 17.88 9.94
</TABLE>
On December 20, 1999, the last sale price reported on the Nasdaq National
Market for our common stock was $12.56 per share.
Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure
In June 1998, EMusic retained PricewaterhouseCoopers LLP as EMusic's
independent accountants and dismissed Barry L. Friedman P.C., Atlantis Ventures
Corporation's former accountants. The decision to change independent
accountants was ratified by our board of directors. During the two most recent
fiscal years audited by Barry Friedman through June 29, 1998, there were no
disagreements with Barry Friedman regarding any matters with respect to
accounting principles or practices, financial statement disclosure or audit
scope or procedure, which disagreements, if not resolved to the satisfaction of
the former accountants, would have caused Barry Friedman to make reference to
the subject matter of the disagreement in connection with this report. The
former accountants reports for the years and periods audited by them are not
part of our financial statements included in this prospectus. Such reports did
not contain an adverse opinion or disclaimer of opinion or qualifications or
modifications as to uncertainty, audit scope or accounting principles. Prior to
retaining PricewaterhouseCoopers LLP, we did not consult with
PricewaterhouseCoopers LLP regarding the application of accounting principles
or the type of audit opinion that might be rendered on our financial
statements.
67
<PAGE>
Legal Matters
The validity of the shares of common stock offered hereby will be passed upon
for us by Gray Cary Ware & Freidenrich LLP, Palo Alto, California. As of the
date of this prospectus, an investment partnership of Gray Cary Ware &
Freidenrich owned an aggregate of 8,300 shares of common stock. This investment
partnership is also a selling stockholder.
Experts
The financial statements of EMusic.com Inc. as of June 30, 1999 and for the
period January 8, 1998 (Inception) to June 30, 1998, the year ended June 30,
1999 and the period January 8, 1998 (Inception) to June 30, 1999, the financial
statements of Creative Fulfillment, Inc. as of December 31, 1998 and for each
of the two years in the period ended December 31, 1998 and the financial
statements of Internet Underground Music Archive Inc. as of July 31, 1998 and
for each of the two years in the period ended July 31, 1998 included in this
prospectus, have been so included in reliance on the reports of
PricewaterhouseCoopers LLP, independent accountants, given upon the authority
of said firm as experts in auditing and accounting.
Ernst & Young LLP, independent auditors, have audited the consolidated
financial statements and related financial statement schedule of Tunes.com as
of December 31, 1997 and 1998 and for the years then ended and for the period
from July 2, 1996, inception, to December 31, 1996, and the financial
statements of Tunes Network, Inc. as of December 31, 1996 and 1997 and for the
years then ended as set forth in their reports. We have included these
financial statements in the prospectus and elsewhere in the registration
statement in reliance upon Ernst & Young LLP's reports, given on their
authority as experts in accounting and auditing.
Richard A. Eisner & Company, LLP, independent auditors, have audited the
financial statements of Group K Inc. as of December 31, 1997 and 1998, for the
year ended December 31, 1998, the period from June 16, 1997 (Inception) through
December 31, 1997 and the period from June 16, 1997 (Inception) through
December 31, 1998. We have included these financial statements in the
prospectus and elsewhere in the registration statement in reliance upon Richard
A. Eisner & Company, LLP's reports, given on their authority as experts in
accounting and auditing.
Where You Can Find More Information About Us
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act with respect to the shares of common stock registered hereby.
This prospectus, which constitutes a part of the registration statement, does
not contain all of the information set forth in our registration statement and
the exhibits filed therewith. For further information with respect to EMusic
and the common stock, reference is made to the registration statement and the
exhibits filed therewith. Statements contained in this prospectus regarding the
contents of any agreement or any other document to which reference is made are
not necessarily complete, and, in each instance, reference is made to the copy
of such agreement or other document filed as an exhibit to the registration
statement, each such statement being qualified in all respects by such
reference.
You may read and copy any document we file at the SEC's public reference rooms
in Washington, D.C., New York, New York and Chicago, Illinois. Please call the
SEC at 1-800-SEC-0330 for further information about the public reference rooms.
Our SEC filings are also available to the public from the SEC's website at
http://www.sec.gov.
Since September 20, 1998, we have been subject to the information and periodic
reporting requirements of the Securities Exchange Act of 1934, and, in
accordance therewith, file periodic reports, proxy statements and other
information with the SEC. Such periodic reports, proxy statements and other
information will be available for inspection and copying at the SEC's public
reference rooms and the SEC's website, which is described above.
68
<PAGE>
Index to Financial Statements
Index to Financial Statements--EMusic.com
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... F-3
Consolidated Balance Sheets............................................... F-4
Consolidated Statements of Operations..................................... F-5
Consolidated Statements of Stockholders' Equity........................... F-6
Consolidated Statements of Cash Flows..................................... F-7
Notes To Consolidated Financial Statements................................ F-8
Index to Pro Forma Financial Statements
<CAPTION>
Page
----
<S> <C>
Unaudited Pro Forma Condensed Combining Balance Sheet Data................ F-23
Unaudited Pro Forma Condensed Combining Statement of Operations Data...... F-25
Notes to Unaudited Pro Forma Condensed Combining Financial Data........... F-27
Index to Financial Statements--Creative Fulfillment, Inc.
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... F-30
Balance Sheets............................................................ F-31
Statements of Operations.................................................. F-32
Statements of Stockholders' Equity (Deficit).............................. F-33
Statements of Cash Flows.................................................. F-34
Notes To Financial Statements............................................. F-35
Index to Financial Statements--IUMA
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... F-39
Balance Sheets............................................................ F-40
Statements of Operations.................................................. F-41
Statements of Stockholders' Deficit....................................... F-42
Statements of Cash Flows.................................................. F-43
Notes To Financial Statements............................................. F-44
Index to Financial Statements--Cductive
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................... F-49
Balance Sheets............................................................ F-50
Statements of Operations.................................................. F-51
Statements of Shareholders' Equity (Deficit).............................. F-52
Statements of Cash Flows.................................................. F-53
Notes to Financial Statements............................................. F-54
</TABLE>
F-1
<PAGE>
Index to Financial Statements--Tunes.com
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors............................................. F-62
Consolidated Balance Sheets................................................ F-63
Consolidated Statements of Operations...................................... F-64
Consolidated Statements of Stockholders' Equity (Deficit).................. F-65
Consolidated Statements of Cash Flows...................................... F-66
Notes to Consolidated Financial Statements................................. F-67
Index to Financial Statements--Tunes Network, Inc.
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors............................................. F-78
Balance Sheets............................................................. F-79
Statements of Operations................................................... F-80
Statements of Stockholders' Equity (Deficit)............................... F-81
Statements of Cash Flows................................................... F-82
Notes to Financial Statements.............................................. F-83
</TABLE>
F-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
EMusic.com Inc. (formerly GoodNoise Corporation)
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of
EMusic.com Inc. (formerly GoodNoise Corporation) (a development stage
enterprise) and its subsidiaries at June 30, 1998 and 1999, and the results of
their operations and cash flows for the period January 8, 1998 (Inception) to
June 30, 1998, the year ended June 30, 1999 and the period January 8, 1998
(Inception) to June 30, 1999 in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards, which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
July 26, 1999
F-3
<PAGE>
EMusic.com Inc.
(formerly GOODNOISE CORPORATION)
(a Development Stage Enterprise)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, June 30, September 30,
1998 1999 1999
---------- -------- -------------
(unaudited)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash...................................... $ 510 $19,002 $ 78,904
Accounts receivable....................... -- 51 168
Prepaid expenses and other assets......... 21 224 9,531
---------- ------- --------
Total current assets.................... 531 19,277 88,603
Property and equipment, net................. 34 1,076 1,989
Music content, net.......................... -- 8,758 11,746
Trade names, net............................ -- 24,680 22,397
Other assets................................ 17 430 430
---------- ------- --------
Total assets............................ $ 582 $54,221 $125,165
========== ======= ========
LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS'
EQUITY
Current Liabilities:
Accounts payable.......................... 67,041 637 406
Accrued liabilities....................... 51,177 1,679 1,828
Dividends payable on preferred stock...... -- -- 1,062
Accrued compensation and related
benefits................................. 16,982 368 430
---------- ------- --------
Total current liabilities............... 135,200 2,684 3,726
---------- ------- --------
Commitments Note 8
Redeemable Convertible Preferred Series B
Stock...................................... -- 31,981 --
Dividends payable on preferred stock........ -- 569 --
Stockholders' Equity:
Preferred Stock, $0.01 par value.......... -- -- --
Common Stock, $0.01 par value............. 147,153 17 34
Additional paid-in capital................ 1,485,611 67,827 184,498
Notes receivable from employees........... (6,000) -- --
Deficit accumulated during the development
stage.................................... (1,180,104) (48,857) (63,093)
---------- ------- --------
Total stockholders' equity.............. 446,660 18,987 121,439
---------- ------- --------
Total liabilities, redeemable
convertible preferred stock and
stockholders' equity................. $ 581,860 $54,221 $125,165
========== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
EMusic.com Inc.
(formerly GOODNOISE CORPORATION)
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Three months Three months January 8, 1998
January 8, 1998 January 8, 1998 ended ended (Inception) to
(Inception) to Year ended (Inception) to September 30, September 30, September 30,
June 30, 1998 June 30, 1999 June 30, 1999 1998 1999 1999
--------------- ------------- --------------- ------------- ------------- ---------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Revenues................ $ -- $ 92 $ 92 $ 12 $ 180 $ 272
Cost of revenues........ -- 27 27 -- 25 52
---------- ---------- ---------- ---------- ---------- ----------
Gross loss.............. -- 65 65 12 155 220
Operating expenses:
Product development.... 961 11,690 12,651 667 6,011 18,662
Selling and
marketing............. -- 556 556 -- 4,771 5,327
General and
administrative........ 219 1,599 1,818 197 812 2,630
Amortization of trade
names................. -- 1,682 1,682 -- 2,283 3,965
---------- ---------- ---------- ---------- ---------- ----------
Total operating
expenses............ 1,180 15,527 16,707 864 13,877 30,584
---------- ---------- ---------- ---------- ---------- ----------
Operating loss.......... (1,180) (15,462) (16,642) (852) (13,722) (30,364)
Interest income, net.... -- 322 322 3 203 525
---------- ---------- ---------- ---------- ---------- ----------
Net loss................ $ (1,180) $ (15,140) $ (16,320) $ (849) $ (13,519) $ (29,839)
---------- ---------- ---------- ---------- ---------- ----------
Accretion of Series A
and B preferred to
redemption value....... -- (247) (247) -- (224) (471)
Beneficial conversion
charge, Series A and B
preferred stock........ -- (31,721) (31,721) -- -- (31,721)
Dividend on Series B
preferred stock........ -- (569) (569) -- (493) (1,062)
---------- ---------- ---------- ---------- ---------- ----------
Net loss applicable to
common shares.......... $ (1,180) $ (47,677) $ (48,857) $ (849) $ (14,236) $ (63,093)
========== ========== ========== ========== ========== ==========
Net loss per common
share--basic and
diluted................ $ (0.12) $ (3.52) $ (4.87) $ (0.06) $ (1.09) $ (5.03)
========== ========== ========== ========== ========== ==========
Weighted average common
shares outstanding--
basic and diluted...... 10,234,055 13,563,606 10,027,231 14,591,336 13,057,809 12,542,537
========== ========== ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
Emusic.com Inc.
(formerly GOODNOISE CORPORATION)
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Deficit
Note Accumulated
Receivable During the Total
Number of Common Additional From Development Stockholders'
Shares Stock Paid Capital Employee Stage Equity
---------- ------ ------------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock
at inception of the
company................ 8,378,000 $ 8 $ (8) $ -- $ -- $ --
Issuance of common stock
on March 30, 1998...... 1,191,800 1 9 (10) -- --
Issuance of common stock
in exchange for
services on March 30,
1998................... 672,600 1 5 -- -- 6
Issuance of common stock
in exchange for
services on April 12,
1998................... 271,400 -- 7 -- -- 7
Conversion of notes
payable into common
stock on May 1, 1998... 501,500 1 169 -- -- 170
Payment on note
receivable............. -- -- -- 4 -- 4
Issuance of shares in
connection with
merger................. 3,700,000 4 684 -- -- 688
Issuance of options to
advisors............... -- -- 752 -- -- 752
Net loss for the period
from January 8, 1998
(inception) through
June 30, 1998.......... -- -- -- -- (1,180) (1,180)
---------- --- -------- ---- -------- --------
BALANCE, June 30, 1998.. 14,715,300 15 1,618 (6) (1,180) 447
Issuance of common stock
for acquisition of
Creative Fulfillment,
Inc.................... 630,179 1 5,557 -- -- 5,558
Issuance of common stock
related to Nordic
Entertainment
transaction............ 665,188 1 11,083 -- -- 11,084
Issuance of common stock
for acquisition of
IUMA, Inc.............. 448,000 -- 7,771 -- -- 7,771
Issuance of warrants in
conjunction with the
purchase of music
content ............... -- -- 1,327 -- -- 1,327
Issuance of warrants
with Series A preferred
stock.................. -- -- 343 -- -- 343
Accretion of Series A
preferred stock to
redemption value....... -- -- -- -- (25) (25)
Beneficial conversion
charge, Series A
preferred stock........ -- -- 144 -- (144) --
Accretion of Series B
preferred stock to
redemption value....... -- -- -- -- (222) (222)
Beneficial conversion
charge, Series B
preferred stock........ -- -- 31,577 -- (31,577) --
Dividends on Series B
preferred stock........ -- -- -- -- (569) (569)
Exercise of warrants to
purchase common stock.. 300,000 -- 300 -- -- 300
Exercise of options to
purchase common stock.. 45,400 -- 1 -- -- 1
Payment on note
receivable from
employee............... -- -- -- 6 -- 6
Issuance of common stock
for services........... 170 -- -- -- --
Issuance of options to
advisors............... -- -- 2,379 -- -- 2,379
Issuance of warrants for
product development.... -- -- 5,682 -- -- 5,682
Issuance of common stock
options in exchange for
assets................. -- -- 45 -- -- 45
Net loss for the year
ended June 30, 1999.... -- -- -- -- (15,140) (15,140)
---------- --- -------- ---- -------- --------
BALANCE, June 30, 1999.. 16,804,237 17 67,827 -- (48,857) 18,987
Issuance of common stock
through offering....... 5,270,000 5 79,677 -- -- 79,682
Issuance costs
associated with public
offering............... -- -- (1,136) -- -- (1,136)
Accretion of Series B
preferred stock to
redemption value....... -- -- -- -- (224) (224)
Dividends on Series B
preferred stock........ -- -- -- -- (493) (493)
Exercise of options to
purchase common stock.. 170,585 -- 5 -- -- 5
Conversion of Series B
preferred stock into
common stock........... 11,757,000 12 32,194 -- -- 32,206
Issuance of options to
advisors............... -- -- 1,273 -- -- 1,273
Issuance of warrants for
product development.... -- -- 4,658 -- -- 4,658
Net loss for the three
months ended September
30, 1999............... -- -- -- -- (13,519) (13,519)
---------- --- -------- ---- -------- --------
BALANCE, September 30,
1999 (unaudited)....... 34,001,822 $34 $184,498 $ -- $(63,093) $121,439
========== === ======== ==== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
Emusic.com Inc.
(formerly GOODNOISE CORPORATION)
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Three months
January 8, 1998 January 8, 1998 ended January 8, 1998
(Inception) to Year ended (Inception) to Three months ended September 30, (Inception) to
June 30, 1998 June 30, 1999 June 30, 1999 September 30, 1998 1999 September 30, 1999
--------------- ------------- --------------- ------------------ ------------- ------------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss.............. $(1,180) $(15,140) $(16,320) $(849) $(13,519) $(29,839)
Adjustments to
reconcile net loss to
net cash used in
operating activities:
Depreciation.......... 3 93 96 5 200 296
Amortization of trade
names................ -- 1,682 1,682 -- 2,283 3,965
Loan interest
converted into Series
B preferred stock.... -- 34 34 -- -- 34
Amortization of music
content.............. -- 2 2 -- -- 2
Issuance of common
stock for services... 13 -- 13 -- -- 13
Fair value of warrants
issued for product
development.......... -- 5,682 5,682 -- 2,687 8,369
Fair value of options
issued to advisors... 752 2,379 3,131 96 1,273 4,404
Changes in assets and
liabilities, net of
effects of merger:
Accounts receivable.. -- (51) (51) (12) (117) (168)
Prepaid expenses and
other assets........ (38) (616) (654) (47) (7,336) (7,990)
Accounts payable..... 67 149 216 93 (231) (15)
Accrued liabilities.. 51 652 703 -- (946) (243)
Accrued payroll and
related benefits.... 17 152 169 (2) 62 231
------- -------- -------- ----- -------- --------
Net cash used in
operating
activities......... (315) (4,982) (5,297) (716) (15,644) (20,941)
------- -------- -------- ----- -------- --------
Cash flows from
investing activities:
Purchase of trade
names................ -- (468) (468) -- -- (468)
Purchase of music
content.............. -- (7,317) (7,317) -- (2,988) (10,305)
Purchase of property
and equipment........ (37) (1,091) (1,128) (21) (1,113) (2,241)
------- -------- -------- ----- -------- --------
Net cash used in
investing
activities......... (37) (8,876) (8,913) (21) (4,101) (13,014)
Cash flows from
financing activities:
Proceeds from issuance
of common stock
through public
offering............. -- -- -- -- 79,682 79,682
Issuance costs
associated with
public offering...... -- -- -- -- (40) (40)
Proceeds from issuance
of common stock...... -- 301 301 300 -- 301
Common stock issued in
connection with
merger............... 688 -- 688 -- -- 688
Proceeds from issuance
of Series A Preferred
Stock and warrants... -- 500 500 -- -- 500
Proceeds from issuance
of Series B Preferred
Stock................ -- 29,800 29,800 -- -- 29,800
Proceeds from issuance
of convertible
notes................ 170 1,743 1,913 -- -- 1,913
Exercise of stock
options.............. -- -- -- -- 5 5
Proceeds from
repayment of employee
notes receivable..... 4 6 10 -- -- 10
------- -------- -------- ----- -------- --------
Net cash provided by
financing
activities......... 862 32,350 33,212 300 79,647 112,859
------- -------- -------- ----- -------- --------
Net increase (decrease)
in cash............... 510 18,492 19,002 (437) 59,902 78,904
Cash at beginning of
period................ -- 510 -- 510 19,002 --
------- -------- -------- ----- -------- --------
Cash at end of period.. $ 510 $ 19,002 $ 19,002 $ 73 $ 78,904 $ 78,904
======= ======== ======== ===== ======== ========
Supplemental disclosure
of non-cash
transactions:
Conversion of notes
payable into common
stock................ $ 170 $ -- $ 170 $ -- $ -- $ 170
Issuance of common
stock for notes
receivable........... 10 -- 10 -- -- 10
Accretion of Series A
preferred stock to
redemption value...... -- 25 25 -- -- 25
Beneficial conversion
charge, Series A
preferred stock....... -- 144 144 -- -- 144
Conversion of notes
payable and interest
to Series B preferred
stock................ -- 1,777 1,777 -- -- 1,777
Accretion of Series B
preferred stock to
redemption value..... -- 222 222 -- 224 446
Beneficial conversion
charge, Series B
preferred stock...... -- 31,577 31,577 -- -- 31,577
Conversion of Series A
preferred stock into
series B preferred
stock................ -- 182 182 -- -- 182
Issuance of common
stock options for
assets............... -- 44 44 -- -- 44
Issuance of warrants
for music content.... -- 1,327 1,327 -- -- 1,327
Issuance of common
stock in conjunction
with acquisitions.... -- 13,329 13,329 -- -- 13,329
Issuance of common
stock to Nordic...... -- 11,084 11,084 -- -- 11,084
Accrued dividend
payable on Series B
preferred stock...... -- 569 569 -- 493 1,062
Conversion of Series B
preferred stock into
common stock......... -- -- -- -- 32,206 32,206
Accrual for amount due
on content license... $ -- $ 116 $ 116 $ -- $ -- $ 116
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of September 30, 1999 and/or for three months ended September
30, 1999 and 1998 is unaudited)
Note 1--The Company and Summary of Significant Accounting Policies
The Company, its Recapitalization and Liquidity
Emusic.com Inc (formerly GoodNoise Corporation), (the "Company"), a Delaware
corporation, was incorporated on January 8, 1998 to develop and market a
repertoire of musical recordings offered for sale to consumers by direct file
transfer, or "downloading," over the Internet. Since its inception, the Company
has been in the development stage devoting its efforts primarily to organizing
itself as a public reporting entity, recruiting management and technical staff,
developing its product, acquiring operating assets and raising capital. The
Company operates within one industry segment.
On May 11, 1998, Atlantis Ventures Corporation ("Atlantis"), a Florida
Corporation, acquired 9,335,000 shares of Common Stock of the Company
representing its then outstanding common stock in exchange for 11,015,300
shares of Atlantis. Prior to the merger, Atlantis had 3,700,000 shares issued
and outstanding. For accounting purposes, this transaction was presented as a
recapitalization of the Company. Atlantis was a publicly traded company that
was organized in August 1989 and had no revenues or operations prior to the
merger with the Company. As of May 11, 1998, Atlantis had cash balances of
$690,000, liabilities of $2,000 and an accumulated deficit of $2,000. Following
the recapitalization, Atlantis changed its name to GoodNoise Corporation.
On July 22, 1999, the Company changed its name to Emusic.com Inc. and
recapitalized as a Delaware corporation. The accompanying financial statements
reflect all share amounts after giving effect to these recapitalizations.
Principles of Consolidation
These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries from the dates of acquisition. All significant
intercompany-balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Risks and Uncertainties
The Company is in the development stage and is subject to various risks,
including the need for additional financing, dependence on key personnel and
the establishment of its operations as a viable business model. Furthermore,
the Company is subject to the risks and uncertainties associated with Internet
commerce. In addition the Company has made substantial investments in music
content for its website. To date the Company does not have sufficient operating
history to determine whether it can fully recover the cost of such investments.
Fair Value of Financial Instruments
The carrying value of the Company's financial instruments, including cash,
accounts receivable and accounts payable, approximate their fair value due to
their relatively short maturities.
F-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Music Content and Advance Royalty Payments
In accordance with Statement of Financial Accounting Standards No. 50,
"Financial Reporting in the Record and Music Industry," royalty advances and
minimum guarantees to acquire music content are recorded as an asset. Advances
are then expensed as subsequent royalties are earned. Any portion of advances
that subsequently appear not to be fully recoverable from future royalties are
subjected to an impairment reserve and charged to expense during the period in
which the loss becomes evident.
Advances to artists are recorded as an asset if past performance and current
popularity of the artist to which the advance is made provide a sound basis for
estimating the probable future recoupment of such advances.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, generally
two to three years, or the lease term of the respective assets.
Revenue Recognition
Advertising revenues are derived principally from short-term advertising
agreements. These revenues are generally recognized ratably over the term of
the agreements, provided the Company has no significant remaining obligations
and collection of the resulting receivable is probable.
Revenue from music downloads and physical merchandise are recognized in the
period in which the download or shipment occurs. Revenues from music downloads
and physical merchandise have not been significant to date.
Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of APB No. 25 "Accounting for Stock Issued to
Employees," and complies with disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). The Company accounts
for stock issued to non-employees in accordance with the provisions of SFAS
123.
Income Taxes
Income taxes are accounted for using an asset and liability method which
requires the recognition of deferred tax assets and liabilities for the future
tax consequences of events that have been recognized in the Company's financial
statements or tax returns. The measurement of current and deferred tax assets
and liabilities are based on provisions of the enacted tax law; the effects of
future changes in tax laws or rates are not anticipated. The measurement of
deferred tax assets is reduced, if necessary, by the amount of any tax benefits
that, based on available evidence, are not expected to be realized.
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Net Loss per Common Share
The weighted average shares used to compute basic net loss per share include
outstanding shares of common stock from the date of issuance, and exclude
shares of common stock subject to repurchase by the Company. The calculation of
diluted net loss per share for all periods presented excludes shares of common
stock issuable upon exercise of employee stock options and common stock
issuable upon the conversion of Series B preferred stock, as their effect would
be antidilutive. Therefore, the weighted average number of shares used in the
calculation of basic and dilutive net loss per common share is the same. The
following table summarizes the computation of basic and diluted net loss per
share (in thousands, except share and per share data):
<TABLE>
<CAPTION>
Three months Three months January 8, 1998
January 8, 1998 January 8, 1998 ended ended (Inception) to
(Inception) to Year ended (Inception) to September 30, September 30, September 30,
June 30, 1998 June 30, 1999 June 30, 1999 1998 1999 1999
--------------- ------------- --------------- ------------- ------------- ---------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net loss................ $ (1,180) $ (15,140) $ (16,320) $ (849) $ (13,519) $ (29,839)
---------- ---------- ---------- ---------- ---------- ----------
Accretion of Series A
and B preferred to
redemption value....... -- (247) (247) -- (224) (471)
Beneficial conversion
charge, Series A and B
preferred stock........ -- (31,721) (31,721) -- -- (31,721)
Dividend on Series B
preferred stock........ -- (569) (569) -- (493) (1,062)
---------- ---------- ---------- ---------- ---------- ----------
Net loss applicable to
common shares.......... $ (1,180) $ (47,677) $ (48,857) $ (849) $ (14,236) $ (63,093)
========== ========== ========== ========== ========== ==========
Net loss per common
share--basic and
diluted................ $ (0.12) $ (3.52) $ (4.87) $ (0.06) $ (1.09) $ (5.03)
========== ========== ========== ========== ========== ==========
Weighted average common
shares outstanding--
basic and diluted...... 10,234,055 13,563,606 10,027,231 14,591,336 13,057,809 12,542,537
========== ========== ========== ========== ========== ==========
Options to purchase
common stock.......... 908,297 2,183,091 1,710,861 2,347,150 6,460,558 2,052,984
Common stock subject to
repurchase............ 508,056 1,596,492 1,257,344 483,473 4,549,500 1,662,800
Series B Preferred
Stock................. -- 3,167,858 2,271,771 -- 10,022,859 3,617,538
Warrants............... -- 35,267 21,471 -- 2,232,388 465,557
---------- ---------- ---------- ---------- ---------- ----------
1,416,353 6,982,708 5,261,447 2,830,623 23,265,305 7,798,879
========== ========== ========== ========== ========== ==========
</TABLE>
Comprehensive Net Loss
There are no differences between the Company's net loss as reported for any of
the periods reported herein and the Company's comprehensive loss, as defined by
Statement of Financial Accounting Standards No. 130, for each of these
respective periods.
Segment information
Effective for the year ended June 30, 1999, the Company has adopted the
provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131"). SFAS 131 establishes annual and interim
reporting standards for an enterprise's operating segments and related
disclosures about its products, services, geographic areas and major customers.
During all periods presented, the Company operated in a single business
segment, marketing a repertoire of musical recordings offered for sale to
consumers by direct file transfer, or "downloading," over the Internet. Through
September 30, 1999, foreign operations have not been significant.
F-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original or
remaining maturities of three months or less at the date of purchase to be cash
equivalents. Cash and cash equivalents are deposited with two major banks in
the United States. Deposits in these banks may exceed the amount of insurance
provided on such deposits. The Company has not experienced any losses on its
deposits of its cash and cash equivalents.
Reclassifications
Certain previously reported amounts have been reclassified to conform to the
current financial statement presentation format included herein.
Recent Accounting Pronouncements
In March 1998 the Accounting Standards Executive Committee issued Statement of
Position No. 98-1, or SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use", which provides guidance on accounting
for the cost of computer software developed or obtained for internal use. SOP
98-1 is effective for the fiscal years beginning after December 15, 1998. The
Company is currently evaluating the impact of SOP 98-1 on its financial
statements and related disclosures.
In April 1998, the Accounting Standards Executive Committee issued Statement of
Position No. 98-5, or SOP 98-5, "Reporting on the Costs of Start-Up
Activities." This standard requires companies to expense the costs of start-up
activities and organization costs as incurred. In general, SOP 98-5 is
effective for fiscal years beginning after December 15, 1998. The Company
believes the adoption of SOP 98-5 will not have a material impact on its
results of operations.
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, or SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities" SFAS 133 requires that all derivatives be
recognized at fair value in the statement of financial position, and that the
corresponding gains or losses be reported either in the statement of operations
or as a component of comprehensive income, depending on the type of hedging
relationship that exists. SFAS 133 will be effective for fiscal years beginning
after June 15, 2000. The Company does not currently hold derivative instruments
or engage in hedging activities.
Note 2--Acquisitions
On January 31, 1999, the Company completed the acquisition of Creative
Fulfillment, Inc. ("Creative Fulfillment") for a combination of cash and stock,
at which time Creative Fulfillment became a wholly owned subsidiary of the
Company. The results of Creative Fulfillment have been included in the
Consolidated Results of Operations since the date of acquisition. The total
purchase price of $6,030,000 consisted of 630,179 shares of the Company's
common stock valued at $5,557,000, cash consideration of $313,000 net
liabilities assumed of $11,000 and other acquisition related expenses of
approximately $150,000. Substantially all of the purchase price has been
allocated, based on an independent appraisal to the domain name and trademark
"EMusic" which the Company is amortizing over its estimated life of three years
using the straight-line method.
On June 18, 1999, the Company completed the acquisition of Internet Underground
Music Archive, Inc. ("IUMA") for a combination of cash and stock, at which time
IUMA became a wholly owned subsidiary of the Company. The results of IUMA have
been included in the Consolidated Statement of Operations since the date of
acquisition. The total purchase price of $8,990,000 consisted of 448,000 shares
of the Company's common stock valued at $7,771,000, net liabilities assumed of
$1,119,000 and professional fees of approximately $100,000. The acquisition has
been accounted for using the purchase method of accounting and,
F-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
based on a preliminary review, the Company has allocated substantially all of
the purchase price to the tradename "IUMA". The Company has engaged an
independent valuations consultant to perform a review of the Company's
preliminary allocation of the purchase price. Any adjustments arising as a
result of their review will be recorded upon its completion. The Company is
amortizing this intangible asset over its estimated life of three years using
the straight-line method.
Summarized below are the unaudited pro-forma results of the Company as though
Creative Fulfillment and IUMA had been acquired on January 8, 1998 (Inception).
Adjustments have been made for the estimated increases in amortization relating
to the intangible assets acquired and other immaterial pro forma adjustments
(in thousands except per share amounts).
<TABLE>
<CAPTION>
January 8, 1998 Year
(Inception) to ended
June 30, June, 30
1998 1999
--------------- --------
<S> <C> <C>
Revenue.............................................. $ 182 $ 444
Net loss............................................. (4,594) (19,964)
Net loss per common share, basic and diluted......... $ (0.41) $ (3.66)
</TABLE>
The above amounts are based upon certain assumptions and estimates which the
Company believes are reasonable. The pro forma financial information presented
above is not necessarily indicative of either the results of operations that
would have occurred had the acquisition taken place on January 8, 1998
(Inception) or of future results of operations of the combined companies.
Note 3--Music Content, net
Music content and advanced royalty balances are comprised of payments for the
following (in thousands):
<TABLE>
<CAPTION>
June 30, June 30,
1998 1999
-------- --------
<S> <C> <C>
Acquired sound recordings..................................... $-- $2,343
Digital distribution rights................................... -- 6,417
--- ------
-- 8,760
Earned royalty................................................ -- (2)
--- ------
$-- $8,758
=== ======
</TABLE>
On June 30, 1999 the Company purchased certain music master sound recordings,
copyrights and trademarks, including the full physical and electronic download
distribution rights and other intangible assets related to certain record
labels. The total purchase price of $2,343,000 consisted of the fair value of
warrants to purchase 35,000 shares of the Company's common stock at a price of
$13.63 per share, estimated as $143,000 using the Black-Scholes model, and cash
of $2,200,000.
The Company has acquired rights to distribute other musical recordings over the
Internet for periods generally ranging from three to five years for a total
consideration of $6,356,000, consisting of advances paid on future royalties of
$5,117,000 in cash and warrants to purchase up to 229,500 shares of common
stock exercisable at prices ranging from $13.63 to $18.00 with a fair value,
estimated using the Black-Scholes model, of $1,184,000. In addition an amount
of $116,000 due under the terms of one contract remained outstanding at
June 30, 1999. This amount is included in accrued liabilities.
F-12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Note 4--Property and Equipment
Property and equipment balances comprise the following (in thousands):
<TABLE>
<CAPTION>
June 30, June 30,
1998 1999
-------- --------
<S> <C> <C>
Computer equipment............................................ $27 $ 495
Software...................................................... 5 81
Furniture and fixtures........................................ 5 584
--- ------
37 1,160
Less: Accumulated depreciation................................ (3) (84)
--- ------
$34 $1,076
=== ======
</TABLE>
Note 5--Trade Names
Trade names consist of the following (in thousands):
<TABLE>
<CAPTION>
June June
30, 30,
1998 1999
------ -------
<S> <C> <C>
EMusic trade and domain name:
From Creative Fullfillment acquisition (see note 2)........... $ -- $ 6,018
Purchased from Nordic Entertainment........................... -- 11,354
------ -------
Total......................................................... -- 17,372
IUMA trade and domain name (see note 2)......................... -- 8,990
Less: Accumulated amortization.................................. -- (1,682)
------ -------
$ -- $24,680
====== =======
</TABLE>
On April 27, 1999 the Company completed a purchase of the rights related to the
EMusic domain name and certain digital music distribution rights from Nordic
Entertainment Worldwide, Inc. and affiliated entities ("Nordic"). Nordic
continued as a stand-alone business following this transaction. The total
purchase price of $11,459,000 consisted of 665,188 shares of the Company's
common stock valued at $11,084,000, and cash consideration of $375,000. The
total purchase price was allocated to the EMusic domain name and music
distribution rights in the amounts of $11,354,000 and $205,000, respectively.
The trade name is being amortized over its estimated useful life of three years
on a straight-line basis.
Note 6--Notes Payable
During the period from December 1998 through March 1999, the Company obtained
loans in the form of convertible notes payable totaling $1,743,000. The notes,
which bore interest at 10% per annum and were due to mature on March 31, 1999,
represented bridge loans in advance of the Series B Preferred Stock financing.
All outstanding principal and accrued interest of $34,000 due under these notes
converted into 7,109 shares of Series B preferred stock upon the closing of the
sale of such stock on March 23, 1999 (See Note 7).
F-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Note 7--Mandatorily Redeemable Convertible Preferred Stock
Mandatorily redeemable convertible preferred stock at June 30, 1999 was
comprised of the following:
<TABLE>
<CAPTION>
Shares
---------------------- Liquidation
Authorized Outstanding Amount
---------- ----------- -----------
<S> <C> <C> <C>
Series B..................................... 120,000 117,570 $35,271,000
Undesignated................................. 380,000 -- --
------- ------- -----------
500,000 117,570 $35,271,000
======= ======= ===========
</TABLE>
Series A
On October 28, 1998, the Company raised proceeds of $500,000 through the sale
of 500 shares of Series A mandatorily redeemable preferred stock ("Series A ")
and warrants to purchase 100,000 shares of the Company's common stock to an
accredited investor. The Series A shares were convertible into shares of the
Company's common stock based on a conversion formula and contained certain
redemption provisions. The Company recorded a charge to deficit accumulated
during the development stage in the amount of $144,000 arising from the "in-
the-money" conversion feature attached to the Series A shares. In conjunction
with the Company's Series B financing discussed below, all 500 shares of Series
A were converted into 2,048 shares of Series B redeemable convertible preferred
stock.
The warrants, which remain outstanding at June 30, 1999, have a term of four
years with an initial exercise price of $7.10 per share and have been recorded
at fair value, estimated using the Black Scholes Model, as additional paid in
capital of $343,000.
Series B
On March 23, 1999 ("Issuance Date"), the Company completed a private placement
of 117,570 shares of Series B Convertible Preferred Stock ("Series B"), which
includes the conversion of outstanding convertible notes and Series A shares
into Series B Shares. Total proceeds, including proceeds from the convertible
notes were $31,577,000 net of issuance costs of approximately $2,724,000.
Under the terms of the Series B Purchase Agreement, each share of Series B is
convertible into 100 shares of the Company's common stock. The conversion
factor of 100 is determined by dividing the redemption value of $300 per Series
B by the conversion price per common share of $3.00.
During the year ended June 30, 1999, the Company has recorded a charge to
accumulated deficit for the "in-the-money" conversion feature attached to the
Series B stock. The amount of this charge is limited to the aggregate amount of
the net proceeds received of $31.6 million. The remaining difference between
the Series B carrying value and its redemption value, resulting from issuance
costs associated with the transaction, will be accreted through March 2004, the
earliest redemption date, using the effective interest rate method, as a charge
to deficit accumulated during the development stage. Charges related to this
accretion for the year ended June 30, 1999 and the three months ended September
30, 1999 were $222,000 and $224,000 (unaudited), respectively.
On September 24, 1999, the Company completed an underwritten public offering.
In connection with this offering the 117,570 shares of Series B were
automatically converted to 11,757,000 shares of common stock. In conjunction
with this conversion, we recorded an addition to common stock of $12,000 and an
increase to additional paid in capital of $32,194,000. As of September 30,
1999, dividends on the Series B shares of $1,062,000 (unaudited) were
reclassified to accrued liabilities.
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
The key terms of the Series B Preferred Stock Purchase Agreement include:
Voting Rights. The holders of the Series B are entitled to a number of votes
equal to the number of shares of Common Stock issuable upon conversion of the
Series B. The holders of the Series B are also entitled to elect one member of
the Board of Directors.
Liquidation Preference. Upon any liquidation, dissolution or winding up of the
affairs of the Company, the holder of each Series B Share shall be entitled to
be paid $300 per share (the "Series B Preference Amount"). If the assets of the
Company upon such event are insufficient to make such payment in full, then the
holders of Series B shares shall be entitled to pro rata distribution of all
the assets of the Company. After payment in full of the liquidation preference
to the holders of Series B shares, such holders are entitled to no further
distributions.
Dividends. The Series B stockholders are entitled to cumulative dividends at an
annual rate of 6% of the Series B Preference Amount. The payment of such
amounts may be deferred until the Company completes an initial underwritten
public offering, is sold, or until March 31, 2004. During the year ended June
30, 1999 and the three months ended September 30, 1999, the Company recorded
charges of approximately $569,000 and $493,000 (unaudited), respectively, for a
total of $1,062,000 (unaudited) to deficit accumulated during the development
stage, representing the accrued dividends on the Series B.
Conversion. Each Series B is initially convertible into 100 shares of Common
Stock at the election of the holder thereof. All Series B are subject to
conversion on the closing of an underwritten public offering with gross
proceeds of $25 million or more at a per share price of $6 or more or the
approval of the holders of 67% of the Series B.
Adjustments to Conversion Rate. The Conversion Rate is subject to proportional
adjustment upon any stock split, stock dividend or other similar change to the
capital stock of the Company and certain other adjustments upon future
issuances of common stock or rights to acquire Common Stock at a price less
than $3 per share.
Redemption. In the event of certain defaults by the Company or if the Series B
have not been converted after five years, the holders of the Series B have the
right to require the Company to redeem the Series B.
Registration Rights. The Company is obligated to promptly (and in any event
within 120 days of the first sale of the Series B) file a registration
statement with the Securities and Exchange Commission to cover the resale of
the Company's common stock issuable upon the conversion of the Series B shares.
The Company has received a waiver from the holders of Series B extending this
date until the earlier of 10 days after the closing of the Company's follow on
offering (see Note 10) or September 30, 1999.
Fundamental Changes. Certain corporate actions, as more fully defined in the
Company's restated articles of incorporation, require the approval of the
holders of 67% of the series B preferred shares.
Note 8--Commitments:
The Company leases office space under a non-cancelable operating lease that
expires in March 2004. The monthly rent amount includes certain maintenance
costs associated with the leased space, and is subject to annual increases
based on the Consumer Price Index. In addition, the Company has a lease for its
former offices under which it is committed to pay monthly rentals of $4,000
until March 31, 2001. The Company has entered into a subleasing agreement for
these premises for which it receives monthly payments of $4,000 until March 31,
2001. The Company is exposed to credit risk as the sublease does not relieve it
of it's obligation under the original lease.
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Rent expense, net of sublease income, was $13,000, $231,000, $244,000 and
$276,000 (unaudited) for the period from January 8, 1998 (Inception) to June
30, 1998, the year ended June 30, 1999, the period from January 8, 1998
(Inception) to June 30, 1999 and the three months ended September 30, 1999,
respectively.
Future minimum lease payments under these leases, net of sublease income, are
as follows (in thousands):
<TABLE>
<CAPTION>
Year Ending June 30,
<S> <C>
2000.................................................................. $ 804
2001.................................................................. 804
2002.................................................................. 804
2003.................................................................. 804
2004.................................................................. 603
------
$3,819
======
</TABLE>
Note 9--Stockholders' Equity
Restricted Common Stock
A total of 8,378,000 shares of common stock were issued to the Company's
founders, of which 1,062,000 were issued subject to a restricted stock purchase
agreement with one of the founders. The agreement provides the Company with the
right to repurchase 590,000 of these shares at $0.01 per share subject to
ratable vesting over three years. As of June 30, 1999 and September 30, 1999,
total shares of 311,389 and 262,222 (unaudited), respectively, were subject to
repurchase by the Company under this agreement. In March 1999, pursuant to the
stockholders' agreement entered into in conjunction with the Series B preferred
stock issuance (Note 6), an additional 4,897,650 shares of the common stock
originally issued to the Company's two other founders, were designated as newly
restricted shares, subject to repurchase by the Company at $0.01 per share. The
shares vest ratably over three years from the date of the Series B preferred
stock issuance. As of June 30, 1999 and September 30, 1999, 4,465,679 and
4,059,708 (unaudited), respectively, of these shares remained subject to
repurchase by the Company.
Stock Option Plans
On March 30, 1998, the Company adopted the 1998 Stock Option Plan and on
December 31, 1998 the Company adopted the 1998 Non-Statutory Stock Option Plan
(the "Plans") that provides for the granting of either incentive or
nonqualified stock options to purchase shares of the Company's common stock,
and for stock-based awards to officers, directors key employees of the Company
and to non-employee consultants. Options granted to employees generally vest
ratably over a period of three or four years, and expire ten years from the
date of grant. On June 30, 1999 and September 30, 1999, there were total shares
of 1,656,850 and 4,163,650 (unaudited), respectively, of common stock available
for grant under the Plans.
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Option activity under the Plans is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Number of Exercise Price Per
Shares Price Share
--------- ------------- ---------
<S> <C> <C> <C>
Granted................................... 2,437,550 $ 0.01-$5.00 $ 0.85
---------
Balance at June 30, 1998.................... 2,437,550 $ 0.85
Granted................................... 4,216,000 $ 5.75-$13.63 $10.76
Exercised................................. (45,400) $ 0.03 $ 0.03
Canceled.................................. (310,400) $ 11.00 $11.00
---------
Balance at June 30, 1999.................... 6,297,750 $ 7.12
Granted................................... 537,800 $14.38-$15.00 $14.29
Exercised................................. (170,585) $ 0.03 $ 0.03
Cancelled................................. (44,600) $ 5.75-$13.63 $12.15
---------
Balance at September 30, 1999 (unaudited)... 6,620,365 $ 7.93
=========
</TABLE>
The following table summarizes information with respect to stock options
outstanding at June 30, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------- ---------------------
Weighted-
Number Average Weighted- Number Weighted-
Outstanding Remaining Average Exercisable Average
Range of at June 30, Contractual Exercise at June 30, Exercise
Exercise Prices 1999 Life Years Price 1999 Price
--------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 0.01-$0.03 1,951,750 8.79 $ 0.03 906,184 $ 0.03
5.00-6.75 1,145,000 9.28 5.04 569,613 5.42
7.19-8.38 625,000 9.54 7.47 85,000 7.26
11.00-13.63 2,576,000 9.89 13.11 191,000 13.55
--------- ---------
6,297,750 9.40 7.12 1,751,797 3.60
========= =========
</TABLE>
Fair Value Disclosures
The aggregate fair value and weighted average fair value per share of options
granted to employees and advisors was $1,121,000 and $0.46 and $21,786,000 and
$5.17 in the period from January 8, 1998 (Inception) through June 30, 1998 and
the year ended June 30, 1999, respectively. In the year ended June 30, 1999,
$2,379,000 of the aggregate amount was recorded as Product Development expense
in the Consolidated Statement of Operations representing the estimated fair
value of 666,000 issued to various Company advisors which vested upon issuance.
In the period January 8, 1998 (Inception) through June 30, 1998, $752,000 of
the aggregate amount, representing the estimated fair value 280,000 options
issued to Company advisors, was recorded in the Consolidated Statement of
Operations.
F-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
The fair value of each option grant is estimated on the date of grant using the
Black Scholes Option Pricing Model with the following assumptions:
<TABLE>
<CAPTION>
January 8, 1998 Year
(Inception) Ended
through June
June 30, 30,
1998 1999
--------------- -------
<S> <C> <C>
Expected volatility.................................. 55% 46%
Risk-free interest................................... 5.73% 6.0%
Expected life........................................ 5 years 5 years
Expected dividend yield.............................. 0% 0%
</TABLE>
Pro forma stock compensation
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Had compensation cost been determined based on
the fair value at the grant date for the awards in 1998 and 1999 consistent
with the provisions of SFAS No. 123, the Company's net loss for 1998 and 1999,
respectively, would have been as follows (in thousands except per share data):
<TABLE>
<CAPTION>
January 8, 1998
(Inception) Year
through Ended
June 30, June 30,
1998 1999
--------------- --------
<S> <C> <C>
Net loss applicable to common shares - as report-
ed.............................................. $(1,180) $(47,677)
Net loss applicable to common shares - pro
forma........................................... $(1,458) $(49,009)
Net loss per common share basic and diluted - as
reported........................................ $ (0.12) $ (3.52)
Net loss per common share basic and diluted - pro
forma........................................... $ (0.14) $ (3.61)
</TABLE>
Such pro forma disclosures may not be representative of future compensation
cost because options vest over several years and additional grants are made
each year.
Warrants
Warrants to purchase 300,000 shares of the Company's common stock were
exercised on August 10, 1998 for cash proceeds of $300,000. Warrants to
purchase 100,000 shares of the Company's common stock at $7.31 per share, which
expire on October 28, 2002, remained outstanding at June 30, 1999 and September
30, 1999 (Unaudited).
In conjunction with the acquisition of music content on June 30, 1999 (Note 2),
the Company issued warrants to purchase 35,000 shares of the Company's common
stock at a price of $13.63 per share. The warrants, which expire on June 10,
2001, were valued at $143,000 and were recorded as an addition to paid in
capital. These warrants remained outstanding at June 30, 1999 and September 30,
1999 (Unaudited).
During the year ended June 30, 1999, the Company issued warrants for the
purchase of 1,388,300 common shares in exchange for product development
activities by various individuals operating in the music industry. The warrants
were issued with exercise prices ranging from $7.10 to $13.625 and have two-
year terms. The fair value of these warrants, estimated using the Black-Scholes
Model, of $5,682,000 has been recorded as a charge to Product Development
expense in the Consolidated Statement of Operations. All these warrants
remained outstanding as of June 30, 1999 and September 30, 1999 (Unaudited).
F-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
In connection with agreements to license digitally downloadable rights from
various record labels the Company issued warrants to purchase up to 229,500
shares of common stock at exercise prices ranging between $13.63 and $18.00.
These warrants remained outstanding as of June 30, 1999 and September 30, 1999
(Unaudited).
During the three months ended September 30, 1999, the Company issued warrants
for the purchase of 612,000 (Unaudited) common shares in exchange for product
development activities by various individuals operating in the music industry.
The warrants were issued with exercise prices ranging from $13.625 to $18.00
and have two-year terms. The fair value of these warrants, estimated using the
Black-Scholes Model, of $2,687,000 (Unaudited) has been recorded as a charge to
Product Development expense in the Consolidated Statement of Operations. All
the warrants remained outstanding as of September 30, 1999.
During the three months ended September 30, 1999 and pursuant to a marketing
agreement, the Company issued warrants for the purchase of 549,000 (Unaudited)
common shares at exercise prices of $20.19 with two-year terms. The fair value
of these warrants, estimated using the Black-Scholes Model, of $1,971,000
(Unaudited) has been recorded as prepaid marketing expense and is being
amortized over the term of the agreement. During the three months ended
September 30, 1999, $286,000 (Unaudited) of the above balance was amortized to
Marketing expense in the Consolidated Statement of Operations. All these
warrants remained outstanding as of September 30, 1999.
Note 10--Income Taxes
At June 30, 1999, the Company had approximately $10 million of federal and $10
million state Net Operating Loss carryforwards available to offset future
taxable income which will expire in varying amounts beginning in 2018 and 2006,
respectively. Under the Tax Reform Act of 1986, the amounts of and benefits
from Net Operating Loss carryforwards may be impaired or limited in certain
circumstances. Events which cause limitations in the amount of Net Operating
Losses that the company may utilize in any one year include, but are not
limited to, a cumulative change in ownership.
Deferred Taxes are composed of the following (in thousands):
<TABLE>
<CAPTION>
June 30
------------
1998 1999
---- ------
<S> <C> <C>
Deferred tax assets:
Net Operating Losses....................................... $400 $4,120
Accruals and reserves...................................... -- 80
Depreciation and amortization.............................. -- 200
---- ------
400 4,400
Less Valuation Allowance: (398) --
---- ------
2 4,400
Deferred tax liabilities:
Non-deductible intangible assets........................... -- (4,400)
Depreciation and amortization.............................. (2) --
---- ------
Total asset/(liability).................................... $ -- $ --
==== ======
</TABLE>
The acquisitions of IUMA and Creative Fulfillment were structured as tax-free
exchanges of stock, therefore, the differences between the recognized fair
values of acquired net assets and their historical tax bases are not deductible
for tax purposes. A deferred tax liability has been recognized for the
differences between assigned fair values of intangibles for book purposes and
the tax bases of such assets. The Company has recognized deferred tax assets to
the extent of deferred tax liabilities.
F-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of September 30, 1999 and/or for
three months ended September 30, 1999 and 1998 is unaudited)
Note 11--Subsequent Events
Investment in Crunch Music Ltd
On July 6, 1999 the Company invested approximately $833,000 in Crunch Music
Ltd. ("Crunch"), in exchange for a 19.5% ownership interest and a seat on the
Crunch board of directors. Crunch is a company incorporated in England and
Wales which operates a website selling downloadable music in the mp3 format
from independent British dance labels. Under a separate distribution agreement,
the Company and Crunch agreed to distribute each others musical content in
their respective territories.
Approval of Name Change
On July 16, 1999, the stockholders approved a proposal to amend the Company's
Restated Articles of Incorporation in order to change its name from GoodNoise
Corporation to EMusic.com Inc. and to recapitalize as a Delaware corporation.
In connection with these changes, the par value of the Company's common shares
changed from $0.01 per share to $0.001 per share. The accompanying financial
statements reflect all share amounts after giving effect to this
recapitalization.
Approval of Increase in Number of Shares for Stock Option Plans.
On July 16, 1999, the stockholders approved an increase in the number of shares
available for issuance under the Plans from 8 million to 11 million shares.
Approval of Employee Stock Purchase Plan
On July 16, 1999 the stockholders approved the 1999 Stock Purchase Plan Under
the terms of the plan, eligible employees may purchase shares of common stock
at a discount through payroll deductions. A total of 250,000 shares of common
stock were reserved for issuance under the plan.
Increase in authorized capital
On July 16, 1999 the stockholders approved an increase in the authorized number
of preferred shares to 20,000,000.
Intention to Sell Additional Shares
On July 23, 1999 the Company filed a registration statement with the Securities
and Exchange Commission relating to an offering of up to 5.5 million shares of
common stock. Of the shares offered, it is expected that 5.0 million shares
will be sold by the Company and that up to 500,000 shares will be sold by
certain selling stockholders.
Note 12--Subsequent Events (unaudited)
On September 24, 1999, the Company completed an underwritten public offering.
In connection with this offering, the Company sold 5,270,000 shares of common
stock raising $79,682,400 in proceeds net of underwriting discounts.
F-20
<PAGE>
Unaudited Pro Forma Condensed Combining Financial Information
The following Unaudited Pro Forma Combined Condensed Financial Statements
give effect to proposed business combination between EMusic.com Inc. (the
"Company"), and Tunes.com Inc. ("Tunes.com"). The Pro Forma Combined Condensed
Financial Statements are based on the historical financial statements and the
notes thereto of the Company included in the Annual Report on Form 10-K for the
fiscal year ended June 30, 1999 and the Quarterly Report on Form 10-Q for the
quarter ended September 30, 1999, the historical financial statements and notes
thereto of Group K, Inc. ("Cductive") included on the Form 8K/A filed with the
Securities and Exchange Commission on December 21, 1999 and the historical
financial statements and the notes thereto of Tunes.com included herein.
On January 31, 1999, EMusic completed the acquisition of Creative
Fulfillment, Inc. ("Creative Fulfillment"). EMusic issued 630,000 shares of its
common stock and provided cash consideration of $313,000 for all of the
outstanding stock of Creative Fulfillment. EMusic accounted for the transaction
as a purchase business combination. Accordingly, Creative Fulfillment's results
of operations are included in EMusic's historical results of operations for the
period beginning from the date of consummation of the acquisition.
On June 18, 1999, EMusic completed the acquisition of Internet Underground
Music Archive, Inc. ("IUMA"). EMusic issued 448,000 shares of its common stock
and accounted for the transaction as a purchase business combination.
Accordingly, IUMA's results of operations are included in EMusic's historical
results of operations for the period beginning from the date of consummation of
the IUMA acquisition.
On December 10, 1999, EMusic completed the acquisition of Cductive. EMusic
issued 2,136,000 shares of its common stock and, in addition, assumed all of
Cductives then outstanding common stock options and warrants. Total
consideration amounted to approximately $36.8 million.
The Unaudited Pro Forma Combined Condensed Balance Sheet combines the
Company's September 30, 1999 balance sheet with Tunes.com's and Cductive's
balance sheets dated September 30, 1999, giving effect to the Mergers with
Tunes.com and Cductive as if they had occurred on September 30, 1999.
The Unaudited Pro Forma Combined Condensed Statement of Operations for the
three months ended September 30, 1999 gives effect to each merger as if they
had occurred on July 1, 1999 and combine the Company's historical condensed
statement of operations for the three months ended September 30, 1999 and the
condensed consolidated statement of operations of Cductive and Tunes.com for
the three months ended September 30, 1999.
The Unaudited Pro Forma Combined Condensed Statement of Operations for the
twelve months ended June 30, 1999 gives effect to each of the above mergers as
if they had occurred on July 1, 1998. The Unaudited Pro Forma Combined
Statement of Operations combines EMusic's statement of operations for the
twelve months ended June 30, 1999 with
. the condensed consolidated statement of operations of Tunes.com and
Cductive for the twelve months ended June 30, 1999;
. the condensed statement of operations of Creative Fulfillment for the
six months ended January 31, 1999; and
. the condensed statement of operations of IUMA for the nine months ended
April 30, 1999.
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the operating results or financial
position that would have occurred if each Merger had been consummated at the
beginning of the periods presented, nor is it necessarily indicative of future
operating results or financial position. The unaudited Pro Forma Combined
Condensed Financial Statements do not incorporate any benefits from cost
savings or synergy of operations of the combined company.
F-21
<PAGE>
The Company expects to incur direct transaction costs of approximately
$3,800,000 associated with the Merger that will be included in the purchase
price allocated to acquired net assets. There can be no assurance that the
Company will not incur additional charges in subsequent quarters to reflect
costs associated with the Merger or that management will be successful in its
efforts to integrate the operations of the two companies.
These Unaudited Pro Forma Combined Condensed Financial Statements should be
read in conjunction with the historical financial statements and the related
notes thereto of the Company included in the Form 10-K and Form 10-Q filed with
the Securities and Exchange Commission, and the financial statements and the
notes thereto of the Company included herein.
F-22
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING BALANCE SHEET DATA
(In thousands)
<TABLE>
<CAPTION>
EMusic.com Cductive Pro Forma
------------- ------------- -----------------------
September 30, September 30,
1999 1999 Adjustments Combined
------------- ------------- ------------ --------
(see note 5)
<S> <C> <C> <C> <C>
Assets
Current Assets:
Cash..................... $ 78,904 $ 888 $ -- $ 79,792
Accounts receivable...... 168 -- -- 168
Prepaid expenses and
other assets............ 9,531 17 -- 9,548
-------- ------- ------- --------
Total current assets... 88,603 905 -- 89,508
-------- ------- ------- --------
Property and equipment,
net....................... 1,989 219 2,208
Music content, net......... 11,746 239 11,985
Trade names, net........... 22,397 -- 35,867 (J) 58,264
Other intangible assets,
net....................... -- -- --
Other assets............... 430 73 -- 503
-------- ------- ------- --------
Total assets........... $125,165 $ 1,436 $35,867 $162,468
-------- ------- ------- --------
Liabilities and
Stockholders' Equity
Current Liabilities:
Accounts payable......... $ 406 $ 272 $ -- $ 678
Accrued liabilities...... 1,829 28 100 (J) 1,957
Accrued payroll and
related benefits........ 430 -- -- 430
Deferred revenue......... -- -- -- --
Dividends payable on
preferred stock......... 1,061 92 -- 1,153
Current portion of long
term debt............... -- 69 -- 69
-------- ------- ------- --------
Total current
liabilities........... 3,726 461 100 4,287
-------- ------- ------- --------
Long term debt............. -- 60 -- 60
Redeemable convertible
preferred stock........... -- 1,217 (1,217)(K) --
-------- ------- ------- --------
Total Liabilities.......... 3,726 1,738 (1,117) 4,347
-------- ------- ------- --------
Stockholders' Equity
(Deficit):
Preferred Stock.......... -- -- -- --
Common Stock............. 34 3 (3)(K) 2,170
2,136 (J)
Additional paid-in 184,498 2,008 (2,008)(K) 219,044
capital................. 34,546 (J)
Common stock to be issued.. -- -- -- --
Deficit accumulated
during the development
stage................... (63,093) (2,313) 2,313 (K) (63,093)
-------- ------- ------- --------
Total stockholders'
equity................ 121,439 (302) 36,984 158,121
-------- ------- ------- --------
Total liabilities and
stockholders' equity.. $125,165 $ 1,436 $35,867 $162,468
======== ======= ======= ========
</TABLE>
See accompanying notes.
F-23
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING BALANCE SHEET DATA--(Continued)
(In thousands)
<TABLE>
<CAPTION>
Tunes.com Pro Forma
------------- -----------------------
September 30,
1999 Adjustments Combined
------------- ----------- --------
(see Note 5)
<S> <C> <C> <C>
Assets
Current Assets:
Cash................................... $ 7,528 $ -- $ 87,320
Accounts receivable.................... 882 -- 1,050
Prepaid expenses and other assets...... 2,777 -- 12,325
-------- -------- --------
Total current assets................. 11,187 -- 100,695
-------- -------- --------
Property and equipment, net.............. 1,593 -- 3,801
Music content, net....................... -- -- 11,985
Trade names, net......................... 1,423 137,933 (L) $197,620
Other intangible assets, net............. 2,044 (2,044)(L) --
Other assets............................. 52 -- 555
-------- -------- --------
Total assets......................... $ 16,299 $135,889 $314,656
-------- -------- --------
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable....................... $ 1,327 -- 2,005
Accrued liabilities.................... 1,783 3,893 (L) 7,633
Accrued payroll and related benefits... 537 -- 967
Deferred revenue....................... 96 -- 96
Dividends payable on preferred stock... -- -- 1,153
Current portion of long term debt...... -- -- 69
-------- -------- --------
Total current liabilities............ 3,743 3,893 11,923
-------- -------- --------
Long term debt........................... 82 -- 142
Deferred tax liability................... -- 9,435 (L) 9,435
Redeemable convertible preferred stock... 43,135 (43,135)(M) --
-------- -------- --------
Total liabilities........................ 46,960 (29,807) 21,500
-------- -------- --------
Stockholders' Equity (Deficit):
Preferred Stock
Common Stock........................... 15 (15)(M) 2,176
6 (L)
Additional paid-in capital............. 10,673 (10,673)(M) 354,073
135,029 (L)
Common stock to be issued................ 55 (55)(M) --
Deficit accumulated during the
development stage..................... (41,404) 41,404 (M) (63,093)
-------- -------- --------
Total stockholders' equity........... (30,661) 165,696 293,156
-------- -------- --------
Total liabilities and stockholders'
equity.............................. $(16,299) $135,889 $314,656
======== ======== ========
</TABLE>
See accompanying notes.
F-24
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING STATEMENT OF OPERATIONS DATA
(In thousands except per share amounts)
<TABLE>
<CAPTION>
EMusic.com Cductive Pro Forma
------------- ------------- ----------------------
Three Months Three Months
Ended Ended
September 30, September 30,
1999 1999 Adjustments Combined
------------- ------------- ----------- --------
(see note
5)
<S> <C> <C> <C> <C>
Revenues................... $ 180 $ 22 $ -- $ 202
Cost of revenues........... 25 32 -- 57
-------- ------ ------- --------
Gross profit (loss)....... 155 (10) -- 145
-------- ------ ------- --------
Operating expenses:
Product development....... 6,011 226 -- 6,237
Selling and marketing..... 4,771 111 -- 4,882
General and
administrative........... 812 531 -- 1,343
Amortization of trade
names.................... 2,283 -- $ 2,989 (B) 5,272
-------- ------ ------- --------
Total operating expenses.. 13,877 868 2,989 17,734
-------- ------ ------- --------
Operating loss............. (13,722) (878) (2,989) (17,589)
Interest and other income
(expense), net............ 203 (6) -- 197
-------- ------ ------- --------
Net income (loss).......... $(13,519) $ (884) $(2,989) $(17,392)
Accretion of Series B
Preferred to redemption
value..................... (224) -- -- (224)
Dividend on Series B
Preferred Stock........... (493) -- -- (493)
-------- ------ ------- --------
Net loss applicable to
common stockholders....... $(14,236) $ (884) $2,989 $(18,109)
======== ====== ======= ========
Net loss per share, basic
and diluted............... $ (1.09) $ (1.19)
======== ========
Weighted average common
shares outstanding, basic
and diluted............... 13,058 2,136 (A) 15,194
======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
Tunes.com Pro Forma
------------- ----------------------
Three Months
Ended
September 30,
1999 Adjustments Combined
------------- ----------- --------
<S> <C> <C> <C>
Revenues................................. $ 1,305 $ -- $ 1,507
Cost of revenues......................... 1,106 (340)(E) 823
------- ------- --------
Gross profit (loss)..................... 199 -- 684
------- ------- --------
Operating expenses:
Product development..................... 1,006 340 (E) 7,583
Selling and marketing................... 4,343 -- 9,225
General and administrative.............. 1,135 -- 2,478
Amortization of trade names............. 681 8,789 (D) 14,742
------- ------- --------
Total operating expenses................ 7,165 9,129 34,028
------- ------- --------
Operating loss........................... (6,966) (8,789) (33,344)
Interest and other income (expense),
net..................................... 126 -- 323
------- ------- --------
Net income (loss)........................ $(6,840) $(8,789) $(33,021)
Accretion of Series B Preferred to
redemption value........................ -- -- (224)
Dividend on Series B Preferred Stock..... -- -- (493)
------- ------- --------
Net loss applicable to common
stockholders............................ $ 6,840 $(8,789) $(33,738)
======= ======= ========
Net loss per share, basic and diluted.... $ (1.60)
========
Weighted average common shares
outstanding, basic and diluted.......... -- 5,892 (C) 21,086
======= ======= ========
</TABLE>
See accompanying notes.
F-25
<PAGE>
UNAUDITED PROFORMA CONDENSED COMBINING STATEMENT OF OPERATIONS DATA--
(Continued)
(In thousands except per share amounts)
<TABLE>
<CAPTION>
EMusic.com
------------- Creative IUMA Cductive.com
Twelve Months Fulfillment Nine Twelve
Ended Six Months Ended Months Ended Months Ended
June 30, 1999 January 31, 1999 April 30, 1999 June 30, 1999
------------- ---------------- -------------- -------------
<S> <C> <C> <C> <C>
Revenues................ $ 92 $103 $ 299 $ 105
Cost of revenues........ 27 32 -- 108
-------- ---- ------- -------
Gross profit (loss).... 65 71 299 (3)
-------- ---- ------- -------
Operating expenses:
Product development.... 11,690 57 255 496
Selling and marketing.. 556 -- -- 183
General and
administrative........ 1,599 13 1,120 551
Amortization of trade
names................. 1,682 -- -- --
-------- ---- ------- -------
Total operating
expenses.............. 15,527 70 1,375 1,230
-------- ---- ------- -------
Operating loss.......... (15,462) 1 (1,076) (1,233)
Interest and other
income (expense), net.. 322 -- -- (14)
-------- ---- ------- -------
Net income (loss)....... $(15,140) $ 1 $(1,076) $(1,247)
Accretion of Series A
Preferred to redemption
value.................. (25) -- -- --
Beneficial conversion
charge, Series A
Preferred Stock........ (144) -- -- --
Accretion of Series B
Preferred to redemption
value.................. (222) -- -- --
Beneficial conversion
charge, Series B
Preferred Stock........ (31,577) -- -- --
Dividend on Series B
Preferred Stock........ (569) -- -- --
-------- ---- ------- -------
Net loss applicable to
common stockholders.... $(47,677) $ 1 $ 1,076 (1,247)
======== ==== ======= =======
Net loss per share,
basic and diluted...... $ (3.52)
========
Weighted average common
shares outstanding,
basic and diluted...... 13,564
========
</TABLE>
<TABLE>
<CAPTION>
Tunes.com
Twelve Months
Ended
June 30, 1999 Adjustments Combined
------------- ----------- ---------
(see Note 5)
<S> <C> <C> <C>
Revenues................................ $ 3,351 $ (50)(G) $ 3,900
Cost of revenues........................ 4,008 (1,271)(H) 2,904
-------- -------- ---------
Gross profit (loss).................... (657) 1,221 6,804
-------- -------- ---------
Operating expenses:
Product development.................... 9,600 1,233 (H) 23,331
Selling and marketing.................. 6,055 -- 6,794
General and administrative............. 3,754 -- 7,037
Amortization of trade names............ 2,836 50,849 (I) 55,367
-------- -------- ---------
Total operating expenses............... 22,245 52,082 92,529
-------- -------- ---------
Operating loss.......................... (22,902) (50,861) (85,725)
Interest and other income (expense),
net.................................... 280 -- 588
-------- -------- ---------
Net income (loss)....................... $(22,622) $(50,861) $ (85,137)
Accretion of Series A Preferred to
redemption value....................... -- -- (25)
Beneficial conversion charge, Series A
Preferred Stock........................ -- -- (144)
Accretion of Series B Preferred to
redemption value....................... -- -- (222)
Beneficial conversion charge, Series B
Preferred Stock........................ -- -- (31,577)
Dividend on Series B Preferred Stock.... -- -- (569)
-------- -------- ---------
Net loss applicable to common
stockholders.......................... (22,622) (50,861) $(117,674)
======== ======== ---------
Net loss per share, basic and diluted... $ (5.26)
=========
Weighted average common shares
outstanding, basic and diluted......... -- 8,806 (F) 22,370
======== ======== =========
</TABLE>
See accompanying notes
F-26
<PAGE>
NOTES TO UNAUDITED PROFORMA CONDENSED COMBINING FINANCIAL DATA
1. The preliminary allocation of the purchase price among the indentifiable
tangible and intangible assets was based on a preliminary assessment of the
fair market value of those assets. The Company is amortizing the intangible
assets over their estimated useful life of three and ten years using the
straight line method. For the purposes of the unaudited proforma condensed
combining financial data we allocated 30% of intangible assets obtained through
the acquisition of Tunes.com to Rollingstone.com, to be amortized over ten
years. Rollingstone.com is a trade name that Tunes.com acquired pursuant to an
agreement that has a life of ten years but contains provisions for a five year
extension based on certain contingencies. The Company has engaged an
independent valuations consultant to perform an allocation of the purchase
price based on generally accepted valuation techniques. To the extent the
purchase price is allocated to Rollingstone.com or a longer life is determined,
the adjustment will be made to the amortization which could be material in
amount. Any adjustments arising as a result of the valuation work will be
recorded upon its completion.
2. Below is a table of the estimated acquisition cost, estimated purchase
price allocation and estimated amortization of intangible assets of Tunes.com
and Cductive as of September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
September 30, 1999: Tunes.com Cductive
------------------- --------- --------
<S> <C> <C>
Estimated acquisition price:
Value of securities issued............................... $135,035 $36,682
Acquisition costs........................................ 3,893 100
-------- -------
Total acquisition costs................................ 138,928 36,782
Deferred tax liability................................... 9,435 --
-------- -------
Total.................................................. 148,363 36,782
======== =======
Estimated purchase price allocation:
Tangible net assets acquired............................. $ 9,007 $ 915
Goodwill and other intangibles........................... 139,356 35,867
-------- -------
Total.................................................. 148,363 36,782
======== =======
Estimated amortization (based on composite amortization
period of approximately four years)
Annual..................................................... $ 35,156 $11,956
======== =======
</TABLE>
The tangible net assets of Tunes.com and Cductive include cash, accounts
receivable, other current assets and property and equipment net of liabilities.
Liabilities include accounts payable and other accrued liabilities.
3. The unaudited pro forma combined loss per share is based on the weighted
average number of common and common equivalent shares of EMusic, 630,000 shares
issued to Creative Fulfillment, 448,000 shares issued to IUMA, 2,136,000 shares
issued to Cductive and 5,892,000 shares to be issued to Tunes.com for the three
month period ended September 30, 1999 and the year ended June 30, 1999. The
dilutive effect of stock options has been excluded since the unaudited pro
forma condensed statement of operations results in a net loss for the three-
months ended September 30, 1999 and the year ended June 30, 1999.
The pro-forma combined basic and diluted loss per share information was
determined as follows for the three-months ended September 30, 1999 (in
thousands):
<TABLE>
<S> <C>
EMusic shares used for net loss per share calculation............... 13,058
EMusic shares issued for the acquisition of Cductive................ 2,136
EMusic shares issued for the acquisition of Tunes.com............... 5,892
------
Pro forma combined EMusic shares used for loss per share
calculation........................................................ 21,086
======
</TABLE>
F-27
<PAGE>
The pro forma combined basic and diluted loss per share information was
determined as follows for the year ended June 30, 1999 (in thousands):
<TABLE>
<S> <C>
EMusic shares used for net loss per share calculation............... 13,564
Adjustment to give full period effect of EMusic shares issued for
Creative Fulfillment............................................... 367
Adjustment to give full period effect of EMusic shares issued for
acquisition of IUMA................................................ 411
EMusic shares issued for the acquisition of Cductive................ 2,136
EMusic shares issued for the acquisition of Tunes.com............... 5,892
------
Pro forma combined EMusic shares used for loss per share
calculation........................................................ 22,370
======
</TABLE>
4. These unaudited pro forma combined condensed financial statements reflect
the issuance of 5,891,712 shares of EMusic common stock in exchange for all of
the outstanding shares of common stock of Tunes.com as of September 30, 1999.
The following table details the pro forma share issuance in connection with
the acquisition as of September 30, 1999 (in thousands):
<TABLE>
<S> <C>
Number of shares of EMusic common stock issued for Cductive net
tangible assets.................................................... 2,136
Number of shares of EMusic common stock issued for Tunes.com net
tangible assets.................................................... 5,892
Number of shares of EMusic common stock outstanding as of September
30, 1999........................................................... 34,002
------
Number of shares of EMusic common stock outstanding after the
completion of acquisition.......................................... 42,030
======
</TABLE>
5. The following pro forma adjustments are reflected in the unaudited pro
forma condensed combining financial information and are required to allocate
the preliminary purchase price and acquisition costs to the net assets acquired
from Creative Fulfillment, IUMA, Cductive and Tunes.com based on their fair
value:
Adjustments reflecting the acquisition of Cductive and Tunes.com for the
three months ended September 30, 1999:
(A) Reflects the issuance of 2,136,000 shares of Common Stock in exchange
for all outstanding common shares of Cductive.
(B) Reflects the amortization of intangible assets associated with the
purchase of Cductive as if the acquisition was completed as of the
beginning of each period presented. Amortization is over the estimated
useful lives of the assets acquired of three years. Any adjustments
arising as a result of the completion of valuation work to be performed
by the independent valuation consultant, may have a material effect on
the amortization for the period reported.
(C) Reflects the issuance of 5,892,000 shares of Common Stock in exchange
for all the outstanding common stock of Tunes.com.
(D) Reflects the amortization of intangible assets associated with the
purchase of Tunes.com as if the acquisition was completed as of the
beginning of each period presented. Amortization is over the estimated
useful lives of the assets acquired. Any adjustments arising as a
result of the completion of valuation work to be performed by the
independent valuation consultant, may have a material effect on the
amortization for the period reported.
(E) Reflects the adjustment to Tunes.com to conform expense classifications
for reporting with respect to the allocation of expense to cost of
revenues versus product development.
F-28
<PAGE>
Adjustments reflecting the acquisition of Creative Fulfillment, IUMA,
Cductive and Tunes.com for the twelve months ended June 30, 1999:
(F) Reflects the issuance of 367,000 shares for Creative Fulfillment,
411,000 shares for IUMA, 2,136,000 shares for Cductive and 5,892,000
shares for Tunes.com.
(G) Reflects the elimination of inter-company development consulting
revenue paid by EMusic.com to Creative Fulfillment.
(H) Reflects the adjustment to Tunes.com to conform expense classifications
for reporting and the elimination of expense related to inter-company
development consulting revenue paid by EMusic.com to Creative
Fulfillment.
(I) Reflects the amortization of intangible assets associated with the
purchase of Creative Fulfillment, IUMA, Cductive and Tunes.com as if
the acquisition was completed as of July 1, 1998. Amortization for
Cductive and Tunes.com is over the estimated useful lives of the assets
acquired. Any adjustments arising as a result of the completion of
valuation work to be performed by the independent valuations
consultant, may have a material effect on the amortization for the
period reported.
Adjustments reflecting the acquisition of Cductive and Tunes.com on September
30, 1999:
(J) Reflects the allocation of the Cductive purchase price of approximately
$36,782,000, which consisted of the issuance of 2,136,000 shares of
Common Stock valued at $14.85 per share, assumption of fully-vested
warrants and options for 471,000 shares of Common Stock, net assets
assumed of approximately $915,000 and direct acquisition related
expenses of $100,000.
(K) Reflects the elimination of Cductive's equity accounts.
(L) Reflects the allocation of the Tunes.com purchase price of
approximately $138,928,000, which consisted of the issuance of
5,892,000 shares of Common Stock valued at $14.29 per share, assumption
of fully-vested warrants and options for 4,708,000 shares of Common
Stock, net assets assumed of approximately $9,007,000 and direct
acquisition related expenses of $3,893,000.
(M) Reflects the elimination of Tunes.com's equity accounts.
F-29
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Boards of Directors and Shareholders
Creative Fulfillment, Inc. (d.b.a. "Emusic")
(a Development Stage Enterprise)
In our opinion, the accompanying balance sheet and the related statements of
operations, of changes in shareholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of Creative
Fulfillment, Inc. (d.b.a. "Emusic") (a development stage enterprise) at October
31, 1998, and the results of its operations and its cash flows for the years
ended October 31, 1997 and 1998 and for the period from March 14, 1995
(inception) through October 31, 1998 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
March 31, 1999
F-30
<PAGE>
CREATIVE FULFILLMENT, INC. (d.b.a. "EMUSIC")
(a Development Stage Enterprise)
BALANCE SHEETS
<TABLE>
<CAPTION>
October 31, January 31,
1998 1999
----------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 1,770 $ 13,852
Accounts receivable................................... -- 3,062
--------- ---------
Total current assets................................. 1,770 16,914
Property and equipment, net............................ 9,664 6,774
--------- ---------
Total assets........................................ $ 11,434 $ 23,688
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Commitments (Note 4)
Current liabilities:
Accounts payable and accrued liabilities.............. $ 18,402 $ 9,443
Related party liabilities (Notes 3 & 7)............... 7,066 13,286
--------- ---------
Total current liabilities............................ 25,468 22,729
--------- ---------
Shareholders' equity:
Common stock, no par value; 25,000,000 shares
authorized, 17,079,965 shares issued and
outstanding.......................................... 186,133 186,133
Deficit accumulated during the development stage...... (200,167) (185,174)
--------- ---------
Total shareholders' equity (deficit)................. (14,034) 959
--------- ---------
Total liabilities and shareholders' equity.......... $ 11,434 $ 23,688
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-31
<PAGE>
CREATIVE FULFILLMENT, INC. (d.b.a. "EMUSIC")
(a Development Stage Enterprise)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended March 14, 1995 Three Months Ended March 14, 1995
October 31, (Inception) to January 31, (Inception) to
------------------ October 31, ----------------------- January 31,
1997 1998 1998 1998 1999 1999
-------- -------- -------------- ----------- ----------- --------------
(Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Music revenues......... $272,253 $117,993 $685,481 $38,431 $10,092 $ 695,573
Advertising revenues... 191 39,560 39,751 -- 10,296 50,047
Other revenues......... 118 37,083 37,201 -- 50,000 87,201
-------- -------- --------- ------- ------- ---------
Total revenues........ 272,562 194,636 762,433 38,431 70,388 832,821
Cost of revenues:
Cost of music
revenues.............. 244,307 113,753 625,605 35,011 11,747 637,352
Cost of other
revenues.............. -- 17,730 17,730 -- -- 17,730
-------- -------- --------- ------- ------- ---------
Total cost of
revenues............. 244,307 131,483 643,335 35,011 11,747 655,082
-------- -------- --------- ------- ------- ---------
Gross profit............ 28,255 63,153 119,098 3,420 58,641 177,739
-------- -------- --------- ------- ------- ---------
Operating expenses:
Product development.... 48,371 76,859 158,851 4,089 40,349 199,200
Sales, general and
administrative........ 21,052 68,333 156,132 2,323 3,299 159,431
-------- -------- --------- ------- ------- ---------
Total operating
expenses............. 69,423 145,192 314,983 6,412 43,648 358,631
-------- -------- --------- ------- ------- ---------
Income (loss) from
operations............. (41,168) (82,039) (195,885) (2,992) 14,993 (180,892)
Interest and other
expense, net........... (1,731) (951) (4,282) (1,057) -- (4,282)
-------- -------- --------- ------- ------- ---------
Net income (loss)....... $(42,899) $(82,990) $(200,167) $(4,049) $14,993 $(185,174)
======== ======== ========= ======= ======= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-32
<PAGE>
CREATIVE FULFILLMENT, INC. (d.b.a. "EMUSIC")
(a Development Stage Enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Deficit
Accumulated Total
Common Stock During the Shareholders'
------------------- Development Equity
Shares Amount Stage (Deficit)
---------- -------- ----------- -------------
<S> <C> <C> <C> <C>
Issuance of Common Stock to
Founders for services.......... 13,500,000 $ 15,000 $ -- $ 15,000
Net loss........................ (29,104) (29,104)
---------- -------- --------- --------
Balance at October 31, 1995..... 13,500,000 15,000 (29,104) (14,104)
Issuance of Common Stock to
Founder in exchange for fixed
assets......................... 2,000,000 20,000 -- 20,000
Issuance of Common Stock in
exchange for advertising
services....................... 96,665 4,833 -- 4,833
Issuance of Common Stock in
exchange for cancellation of
note payable................... 1,000,000 50,000 -- 50,000
Net loss........................ -- -- (45,174) (45,174)
---------- -------- --------- --------
Balance at October 31, 1996..... 16,596,665 89,833 (74,278) 15,555
Sale of Common Stock for Cash... 47,500 9,500 -- 9,500
Issuance of Common Stock for
Services....................... 125,000 24,640 -- 24,640
Net loss........................ -- -- (42,899) (42,899)
---------- -------- --------- --------
Balance at October 31, 1997..... 16,769,165 123,973 (117,177) 6,796
Issuance of Common Stock for
Services....................... 310,800 62,160 -- 62,160
Net loss........................ -- -- (82,990) (82,990)
---------- -------- --------- --------
Balance at October 31, 1998..... 17,079,965 186,133 (200,167) (14,034)
Net income (unaudited).......... -- -- 14,993 14,993
---------- -------- --------- --------
Balance at January 31, 1999
(unaudited).................... 17,079,965 $186,133 $(185,174) $ 959
========== ======== ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-33
<PAGE>
CREATIVE FULFILLMENT, INC. (d.b.a. "EMUSIC")
(a Development Stage Enterprise)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended March 14, 1995 Three Months Ended March 14, 1995
October 31, (Inception) to January 31, (Inception) to
------------------ October 31, ----------------------- January 31,
1997 1998 1998 1998 1999 1999
-------- -------- -------------- ----------- ----------- --------------
(Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net income (loss)....... $(42,899) $(82,990) $(200,167) $(4,049) $14,993 $(185,174)
Adjustments to reconcile
net income (loss) to
net cash used in
operating activities:
Depreciation........... 12,277 12,856 30,453 3,221 2,890 33,343
Issuance of common
stock in exchange for
services.............. 24,640 62,160 106,633 -- -- 106,633
Changes in operating
assets and
liabilities:
Accounts receivable.... -- -- -- -- (3,062) (3,062)
Accounts payable and
accrued liabilities... 5,180 1,617 25,468 (4,251) (15,239) 10,229
-------- -------- --------- ------- ------- ---------
Net cash used by
operating activities... (802) (6,357) (37,613) (5,079) (418) (38,031)
-------- -------- --------- ------- ------- ---------
Cash flows from
investing activities:
Acquisition of property
and equipment.......... (2,623) (1,464) (20,117) -- -- (20,117)
-------- -------- --------- ------- ------- ---------
Net cash provided by
investing activities... (2,623) (1,464) (20,117) -- -- (20,117)
-------- -------- --------- ------- ------- ---------
Cash flows from
financing activities:
Proceeds from issuance
of note................ -- -- 50,000 -- 12,500 62,500
Net proceeds from
issuance of common
stock.................. 9,500 -- 9,500 -- -- 9,500
-------- -------- --------- ------- ------- ---------
Net cash provided by
financing activities... 9,500 -- 59,500 -- 12,500 72,000
-------- -------- --------- ------- ------- ---------
Net increase/(decrease)
in cash................ 6,075 (7,821) 1,770 (5,079) 12,082 13,852
Cash at beginning of
period................. 3,516 9,591 -- 9,591 1,770 --
-------- -------- --------- ------- ------- ---------
Cash at end of period... $ 9,591 $ 1,770 $ 1,770 $ 4,512 $13,852 $ 13,852
-------- -------- --------- ------- ------- ---------
Supplemental disclosures
of cash flow
information:
Issuance of Common Stock
in exchange for fixed
assets................. $ -- $ -- $ 20,000 $ -- $ -- $ 20,000
Conversion of notes
payable to Common
Stock.................. $ -- $ -- $ 50,000 $ -- $ -- $ 50,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-34
<PAGE>
Creative Fulfillment, Inc. (d.b.a. "Emusic")
(a Development Stage Enterprise)
Notes to Financial Statements
1. Nature of Business and Significant Accounting Policies
Organization and Business
Creative Fulfillment, Inc. ("Creative" or the "Company"), a California
corporation, was incorporated on March 14, 1995 to develop an Internet web site
to sell musical recordings on CD's, the fulfillment and shipping of which is
performed by a third party. Since its inception, the Company has been in the
development stage devoting its efforts primarily to developing its web site,
acquiring operating assets and raising capital. The Company operates within one
business segment, operates only in the United States, and sells primarily to
customers in the United States.
Significant Accounting Policies
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates.
Unaudited Interim Results
The accompanying interim financial statements as of January 31, 1999 and for
the three months ended January 31, 1998 and 1999 are unaudited. The unaudited
interim financial statements have been prepared on the same basis as the annual
financial statements and, in the opinion of management, reflect all
adjustments, which include only normal recurring adjustments, necessary to
present fairly the Company's financial position, results of operations and its
cash flows as of January 31, 1999 and for the three months ended January 31,
1998 and 1999. The financial data and other information disclosed in these
notes to financial statements related to these periods are unaudited. The
results for the three months ended January 31, 1999 are not necessarily
indicative of the results to be expected for the year ending October 31, 1999.
Revenue Recognition
Music revenues are generally recognized in the period in which the shipment
occurs. A provision is made for returns based on historical return levels
experienced by the Company. All music sales are paid for by credit card.
Advertising revenues are derived principally from short-term advertising
agreements. These revenues are generally recognized ratably over the term of
the agreements, provided that the Company has no significant remaining
obligations and collection of the resulting receivable is probable.
Other revenue consists primarily of consulting revenue, which is generally
recognized ratably over the term of the agreements, provided that the Company
has no significant remaining obligations and collection of the resulting
receivable is probable.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentration of credit risk consist primarily of cash and accounts receivable.
Cash balances are maintained with a major financial institution and have been
maintained below federally insured limits. No individual customers represented
greater than 10% of sales in fiscal 1997 or 1998. In the three months ended
January 31, 1999 (unaudited), one customer accounted for 71% of total revenues.
See also Note 3 below.
F-35
<PAGE>
Creative Fulfillment, Inc. (d.b.a. "Emusic")
(a Development Stage Enterprise)
Notes to Financial Statements--(Continued)
Cash Equivalents and Fair Value of Financial Instruments
The Company considers all highly liquid, low risk debt instruments with a
maturity of three months or less from the date of purchase to be cash
equivalents. The carrying value of the Company's financial instruments,
including cash, accounts receivable and accounts payable, approximate their
fair value due to their relatively short maturities.
Property and Equipment
Property and equipment is stated at historical cost. Depreciation is computed
using the straight-line method over estimated useful lives, generally three
years.
Comprehensive Income or Loss
There are no differences between the Company's net income or loss for the years
ended October 31, 1997 and 1998, for the period from March 14, 1995 (inception)
to October 31, 1998, the three months ended January 31, 1999 (unaudited) and
the period from March 14, 1995 (inception) to January 31, 1999 (unaudited) and
the Company's comprehensive income or loss for each of these periods.
Product Development Costs
Product development costs include expenses incurred by the Company to develop,
enhance, manage, monitor and operate the Company's Web site. Product
development costs are expensed as incurred.
Income Taxes
Income taxes are accounted for using an asset and liability method which
requires the recognition of deferred tax assets and liabilities for the future
tax consequences of events that have been recognized in the Company's financial
statements or tax returns. The measurement of current and deferred tax assets
and liabilities are based on provisions of the enacted tax law; the effects of
future changes in tax laws or rates are not anticipated. The measurement of
deferred tax assets is reduced, if necessary, by the amount of any tax benefits
that, based on available evidence, are not expected to be realized.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
SOP No. 98-1, "Software for Internal Use," which provides guidance on
accounting for the cost of computer software developed or obtained for internal
use. SOP No. 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company does not expect that the
adoption of SOP No. 98-1 will have a material impact on its financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 requires that an entity
recognize all derivatives as either assets or liabilities and measure those
instruments at fair value. It also provides guidance for accounting for changes
in the fair value of a derivative (i.e. gains and losses). SFAS 133 is
effective for all fiscal years beginning after June 15, 1999. The Company does
not expect that the adoption of SFAS 133 will have a material effect on its
financial statements.
F-36
<PAGE>
Creative Fulfillment, Inc. (d.b.a. "Emusic")
(a Development Stage Enterprise)
Notes to Financial Statements--(Continued)
2. Property and Equipment
<TABLE>
<CAPTION>
October 31, January 31,
1998 1999
----------- -----------
(Unaudited)
<S> <C> <C>
Computer and office equipment........................ $ 40,117 $ 40,117
Less accumulated depreciation........................ (30,453) (33,343)
-------- --------
$ 9,664 $ 6,774
======== ========
</TABLE>
3. Related Party Transactions
The Company has incurred $18,000 and $19,000 in development expenses during
fiscal 1998 and the period from March 14, 1995 (inception) to October 31, 1998,
and incurred $31,010 (unaudited) and $43,510 in development expenses in the
period from March 14, 1995 (inception) to January 31, 1999 with Mango
Enterprises. Mango Enterprises is owned by the Founder and holder of 79% of the
outstanding Common Stock of Emusic.
The Company has incurred $3,927 in expenses during the period from March 14,
1995 (inception) to October 31, 1998 with WebCentral. There have been no
transactions with WebCentral since October 1998. WebCentral is owned by the
Founder and holder of 79% of the outstanding Common Stock of Emusic.
At October 31, 1998 and January 31, 1999, the Company owed $7,066 and $786
(unaudited) to the Founder of the Company for short-term advances made. Such
advances are not evidenced by a note, and are generally repaid within three
months or less.
See Note 7 below for additional related party transactions subsequent to
October 31, 1998.
4. Commitments
The Company does not have any equipment or facilities lease commitments as of
October 31, 1998 or January 31, 1999 (unaudited). Rent paid during fiscal 1997,
1998 and the three months ended January 31, 1999 (unaudited) was insignificant.
5. Income Taxes
There is no provision for income taxes for the period from March 14, 1995
(inception) through January 31, 1999 as the Company incurred a net loss. The
Company's deferred tax assets at October 31, 1998 principally relate to its net
operating loss and approximate $175,000. Due to uncertainty surrounding
recoverability, a full valuation allowance has been established against this
amount.
Utilization of the net operating losses and tax credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
provisions of the Internal Revenue Code of 1986. The annual limitation may
result in the expiration of net operating losses and credits before full
utilization.
6. Common Stock
The Company's is authorized to issue 25,000,000 shares of Common Stock, of
which 17,079,965 shares were issued and outstanding as of October 31, 1998 and
January 31, 1999 (unaudited). Of the total shares issued and outstanding,
17,032,465 shares were issued for other than cash proceeds. The value of such
shares was based on sales of similar instruments for cash, or the value of the
goods or services received, whichever was more readily determinable.
F-37
<PAGE>
Creative Fulfillment, Inc. (d.b.a. "Emusic")
(a Development Stage Enterprise)
Notes to Financial Statements--(Continued)
7. Subsequent Events
Merger
On January 25, 1999, EMusic.com Inc. (formerly GoodNoise Corporation)
("EMusic") acquired all of the Company's outstanding shares of Common Stock, at
which time the Company became a wholly owned subsidiary of EMusic.
Related Party Loan and Consulting Revenues
In January 1999, EMusic loaned Creative $12,500, which was repaid to EMusic in
February 1999. In addition, during the three months ended January 31, 1999,
EMusic paid consulting fees totaling $50,000, which were recorded as revenue by
Creative.
F-38
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders
Internet Underground Music Archive ("IUMA")
In our opinion, the accompanying balance sheet and the related statements of
operations, of changes in shareholders' deficit and of cash flows present
fairly, in all material respects, the financial position of Internet
Underground Music Archive ("IUMA") at July 31, 1998 and the results of its
operations and its cash flows for the years ended July 31, 1998 and 1997 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for the
opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
July 21, 1999
F-39
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE INC. ("IUMA")
BALANCE SHEETS
<TABLE>
<CAPTION>
July 31, April 30,
1998 1999
--------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 1,684 $ 33,537
Accounts receivable................................... 40,204 21,797
Prepaid expenses...................................... 592 2,293
--------- -----------
Total current assets................................ 42,480 57,627
Property and equipment, net............................. 33,468 41,613
Intangible assets, net.................................. 15,921 12,884
Other assets............................................ 1,700 64,570
--------- -----------
Total assets........................................ $ 93,569 $ 176,694
========= ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable...................................... $ 87,356 $ 391,471
Accrued payroll and related benefits.................. -- 203,027
Current portion of notes payable...................... 51,468 183,638
--------- -----------
Total current liabilities........................... 138,824 778,136
--------- -----------
Notes payable, less current portion..................... 131,145 309,550
--------- -----------
Total liabilities....................................... 269,969 1,087,686
--------- -----------
Commitments (Note 4)
Shareholders' equity (deficit):
Common stock, no par value; 30,000,000 shares
authorized, 3,351,750 and 4,432,480 shares issued and
outstanding.......................................... 554,810 1,105,168
Notes receivable from shareholders.................... -- (8,655)
Deferred compensation................................. (328,527) (528,971)
Accumulated deficit................................... (402,683) (1,478,534)
--------- -----------
Total shareholders' equity (deficit)................ (176,400) (910,992)
--------- -----------
Total liabilities and shareholders' equity
(deficit)......................................... $ 93,569 $ 176,694
========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-40
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE INC. ("IUMA")
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended July Nine Months Ended
31, April 30,
-------------------- -----------------------
1997 1998 1998 1999
--------- --------- ----------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Website hosting............... $ 55,799 $ 137,200 $ 53,061 $ 136,958
Advertising................... 162,447 79,326 55,327 64,140
Other......................... 213,814 7,821 6,872 97,572
--------- --------- --------- -----------
Total revenues............... 432,060 224,347 115,260 298,670
Operating expenses:
Product development........... 50,524 99,616 88,793 123,657
Selling, general and
administrative............... 345,346 340,493 221,576 1,119,994
Amortization of deferred
compensation................. 4,158 13,662 12,492 130,870
--------- --------- --------- -----------
Total operating expenses..... 400,028 453,771 322,861 1,374,521
--------- --------- --------- -----------
Income (loss) from operations.. 32,032 (229,424) (207,601) (1,075,851)
Interest and other expense,
net........................... -- (1,011) -- --
--------- --------- --------- -----------
Income (loss) before income
taxes......................... 32,032 (230,435) (207,601) (1,075,851)
Income tax benefit (expense)... (10,542) 10,542 10,542 --
--------- --------- --------- -----------
Net income (loss).............. $ 21,490 $(219,893) $(197,059) $(1,075,851)
========= ========= ========= ===========
Net income (loss) per common
share-basic................... $ 0.01 $ (0.07) $ (0.06) $ (0.28)
========= ========= ========= ===========
Net income (loss) per common
share-diluted................. $ 0.01 $ (0.07) $ (0.06) $ (0.28)
========= ========= ========= ===========
Weighted average common shares
outstanding-basic ............ 3,270,000 3,310,875 3,297,250 3,829,615
========= ========= ========= ===========
Weighted average common shares
outstanding-diluted........... 3,636,601 3,310,875 3,297,250 3,829,615
========= ========= ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-41
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE INC. ("IUMA")
STATEMENT OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Notes due Total
from Deferred Accumulated Shareholders'
Shares Amount Shareholders Compensation Deficit Deficit
--------- ---------- ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at July 31,
1996................... 3,270,000 $ 163,500 $ -- $ -- $ (204,280) $ (40,780)
Unearned stock-based
compensation.......... 17,333 -- (17,333) -- --
Amortization of stock-
based compensation.... -- -- -- 4,158 -- 4,158
Net income............. -- -- -- -- 21,490 21,490
--------- ---------- ------- --------- ----------- -----------
Balance at July 31,
1997................... 3,270,000 180,833 -- (13,175) (182,790) (15,132)
Issuance of common
stock for services.... 81,750 44,963 -- -- -- 44,963
Unearned stock-based
compensation.......... 329,014 -- (329,014) -- --
Amortization of stock-
based compensation.... -- -- -- 13,662 -- 13,662
Net loss............... -- -- -- -- (219,893) (219,893)
--------- ---------- ------- --------- ----------- -----------
Balance at July 31,
1998................... 3,351,750 554,810 -- (328,527) (402,683) (176,400)
Exercise of stock
options............... 955,730 9,557 (8,655) -- 902
Issuance of common
stock for services.... 125,000 209,487 -- -- -- 209,487
Unearned stock-based
compensation.......... -- 331,314 -- (331,314) -- --
Amortization of stock-
based compensation.... -- -- -- 130,870 -- 130,870
Net income
(unaudited)........... -- -- -- -- (1,075,851) (1,075,851)
--------- ---------- ------- --------- ----------- -----------
Balance at April 30,
1999 (unaudited)....... 4,432,480 $1,105,168 $(8,655) $(528,971) $(1,478,534) $ (910,992)
========= ========== ======= ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-42
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE INC. ("IUMA")
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended July Nine Months Ended
31, April 30,
------------------- -----------------------
1997 1998 1998 1999
-------- --------- ----------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss)............... $ 21,490 $(219,893) $(197,059) $(1,075,851)
Adjustments to reconcile net
income (loss) to net cash used
in operating activities:
Depreciation and
amortization................. 6,341 14,481 13,128 14,892
Amortization of deferred
compensation................. 4,158 13,662 12,492 130,870
Issuance of common stock for
services..................... -- 44,963 44,963 209,487
Changes in operating assets
and liabilities:
Accounts receivable......... (52,372) 27,277 40,459 18,407
Other assets................ -- (94) (2,230) (4,571)
Prepaid expenses relating to
acquisition................ -- -- -- (60,000)
Accounts payable and accrued
liabilities................ 39,922 (3,834) (15,702) 507,142
-------- --------- --------- -----------
Net cash provided (used) by
operating activities........... 19,539 (123,438) (103,949) (259,624)
-------- --------- --------- -----------
Cash flows used in investing
activities:
Acquisition of property and
equipment...................... (19,349) (18,077) (12,955) (20,000)
Cash paid for intangibles....... -- (11,756) -- --
-------- --------- --------- -----------
Net cash used in investing
activities..................... (19,349) (29,833) (12,955) (20,000)
-------- --------- --------- -----------
Cash flows from financing
activities:
Proceeds from issuance of
notes.......................... 4,100 149,342 131,145 315,100
Principal payments on notes..... -- -- -- (4,525)
Proceeds from issuance of common
stock.......................... -- -- -- 902
-------- --------- --------- -----------
Net cash provided by financing
activities..................... 4,100 149,342 131,145 311,477
-------- --------- --------- -----------
Net increase/(decrease) in
cash........................... 4,290 (3,929) 14,241 31,853
Cash at beginning of period..... 1,323 5,613 5,613 1,684
-------- --------- --------- -----------
Cash at end of period........... $ 5,613 $ 1,684 $ 19,854 $ 33,537
======== ========= ========= ===========
Supplemental disclosures of cash
flow information:
Cash paid during the year for:
Interest...................... $ -- $ 1,011 $ -- $ 758
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-43
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE, INC. ("IUMA")
NOTES TO THE FINANCIAL STATEMENTS
1. Nature of Business and Significant Accounting Policies
Organization and Business
Internet Underground Music Archive Inc. ("IUMA" or the "Company"), a California
corporation, was incorporated on July 1, 1995 to promote, distribute and sell
music from unsigned and independent musicians. The Company operates within one
business segment, operates only in the United States, and sells primarily to
customers in the United States.
Significant Accounting Policies
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates.
Unaudited Interim Results
The accompanying interim financial statements as of April 30, 1999 and for the
nine months ended April 30, 1998 and 1999 are unaudited. The unaudited interim
financial statements have been prepared on the same basis as the annual
financial statements and, in the opinion of management, reflect all
adjustments, which include only normal recurring adjustments, necessary to
present fairly the Company's financial position, results of operations and its
cash flows as of April 30, 1999 and for the nine months ended April 30, 1998
and 1999. The results for the nine months ended April 30, 1999 are not
necessarily indicative of the results to be expected for the year ending July
31, 1999.
Revenue Recognition
Website hosting and related service revenues are generally recognized ratably
over the term of the agreements, provided that the Company has no significant
remaining obligations and collection of the resulting receivable is probable.
Advertising revenues are derived principally from short-term advertising
agreements. These revenues are generally recognized ratably over the term of
the agreements, provided that the Company has no significant remaining
obligations and collection of the resulting receivable is probable.
Other revenue consists primarily of consulting revenue and commissions on music
sales. Consulting revenue is recognized ratably over the term of the
agreements. Commissions on music sales are derived from fulfillment of compact
disc sales on behalf of artists listed on the IUMA websites, and are recognized
upon shipment of the related product.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant
concentration of credit risk consist primarily of cash and accounts receivable.
Cash balances are maintained with a major financial institution and have been
maintained below federally insured limits. For the fiscal years ending July 31,
1997 and 1998 there were two different sets of customers, which accounted for
76% and 72% of revenues, respectively. Three customers accounted for 91% of
revenues for the nine months ending 4/30/99.
F-44
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE, INC. ("IUMA")
NOTES TO THE FINANCIAL STATEMENTS
Cash Equivalents and Fair Value of Financial Instruments
The Company considers all highly liquid, low risk debt instruments with a
maturity of three months or less from the date of purchase to be cash
equivalents. The carrying value of the Company's financial instruments,
including cash, accounts receivable and accounts payable, approximate their
fair value due to their relatively short-term maturities.
Property and Equipment
Property and equipment is stated at historical cost. Depreciation is computed
using the straight-line method over estimated useful lives, generally three
years.
Net Income or Loss per Common Share
Basic earnings per share is computed by dividing net income or loss available
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted net income per common share is computed
giving effect to all dilutive options in issuance.
Comprehensive Income or Loss
There are no differences between the Company's net income or loss for the years
ended July 31, 1997 and 1998 and for the nine months ended April 30, 1999
(unaudited) and the Company's comprehensive income or loss for the same
periods.
Product Development Costs
Product development costs include expenses incurred by the Company to develop,
enhance, manage, monitor and operate the Company's Web site. Product
development costs are expensed as incurred.
Income Taxes
Income taxes are accounted for using the asset and liability method, which
requires the recognition of deferred tax assets and liabilities for the future
tax consequences of events that have been recognized in the Company's financial
statements or tax returns. The measurement of current and deferred tax assets
and liabilities are based on provisions of the enacted tax law; the effects of
future changes in tax laws or rates are not anticipated. The measurement of
deferred tax assets is reduced, if necessary, by the amount of any tax benefits
that, based on available evidence, are not expected to be realized.
Stock-based compensation
The Company accounts for stock-based awards/options to employees using the
intrinsic value method and has adopted the disclosure only provisions of
Financial Accounting Standard No. 123.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
SOP No. 98-1, "Software for Internal Use," which provides guidance on
accounting for the cost of computer software developed or obtained for internal
use. SOP No. 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. The Company does not expect that the
adoption of SOP No. 98-1 will have a material impact on its financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 requires that entities recognize
all derivatives as either assets or liabilities and measure those instruments
at fair value. It also provides guidance for accounting for changes in the fair
value of a derivative (i.e. gains and losses). SFAS 133 is effective for all
fiscal years beginning after June 15, 2000. The Company does not expect that
the adoption of SFAS 133 will have a material effect on its financial
statements.
F-45
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE, INC. ("IUMA")
NOTES TO THE FINANCIAL STATEMENTS
2. Property and Equipment
<TABLE>
<CAPTION>
July 31, April 30,
1998 1999
-------- -----------
(unaudited)
<S> <C> <C>
Computer and office equipment.......................... $48,601 $59,874
Less accumulated depreciation.......................... (15,133) (18,261)
------- -------
$33,468 $41,613
======= =======
</TABLE>
Book value for assets under capital lease at July 31, 1998 and April 30, 1999
totaled approximately $5,000 and $4,000, respectively.
Depreciation expense for the periods ended July 31, 1997, July 31, 1998 and
April 30, 1999 totaled approximately $5,000, $12,000 and $12,000, respectively.
The Company incurred rental expense of $17,000, $18,000, and $14,000 for the
years ended July 31, 1997 and July 31, 1998 and for the nine months ended,
respectively.
3. Related Party Transactions
Shares of Common Stock were issued to several employees in exchange for
promissory notes. As of April 30, 1999, none of these promissory notes have
been paid in full.
The Company had the following related party transactions during the periods
presented.
. On July 12, 1996 the Company entered into an agreement with two
shareholders, under which it borrowed approximately $33,000. Under the
terms of the agreement and in return for consulting services provided,
the shareholders received stock equivalent to 18% of the outstanding
capital of the Company. The note was interest free and is payable upon
receipt by the Company of additional financing in excess of $250,000. As
of July 31, 1998 and April 30, 1999 (unaudited), the total amount
borrowed remained outstanding.
. Pursuant to an agreement dated October 23, 1998 one shareholder loaned
the Company $5,000 at 5% per annum. The loan was unsecured and payable
when the Company received additional financing.
. Two shareholders are due approximately $27,000, pursuant to a consulting
agreement dated February 5, 1997.
. During the year ended July 31, 1998 a shareholder advanced the Company
approximately $12,000 repayable at $100 per month, interest at 5.73% per
annum. As of July 31, 1998 and April 30, 1999 (unaudited), the total
amount borrowed remained outstanding.
4. Commitments
IUMA entered into a capital lease for equipment during the year ended July 31,
1998 and will have payments due of approximately $2,000 for each of the years
ended July 31, 1999, 2000 and 2001.
As of July 31, 1998, the Company had operating leases for equipment with
commitments of approximately 13,000, $13,000, 8,000 and 1000 for the years
ended July 31, 1999, 2000, 2001 and 2002, respectively.
As of July 31, 1998 the Company had a rental lease with minimum monthly
payments of approximately $1,000 for a total commitment of approximately
$12,000 for the year ended July 31, 1999.
F-46
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE, INC. ("IUMA")
NOTES TO THE FINANCIAL STATEMENTS
5. Income Taxes
The Company's deferred tax assets of approximately $79,000 at July 31, 1998
principally relate to its net operating loss. A full valuation allowance has
been established because of the uncertainty of realization.
Utilization of the net operating losses and tax credit carryforwards may be
subject to a substantial annual limitation due to ownership changes. The annual
limitation may result in the expiration of net operating losses and credits
before full utilization.
6. Preferred Stock
The Company was authorized to issue 20,000,000 shares of Preferred Stock, of
which none were issued or outstanding at July 31, 1998 and April 30, 1999
7. Common Stock
The Company was authorized to issue 30,000,000 shares of Common Stock, of which
3,351,750 and 4,307,480 shares were issued and outstanding at July 31, 1998 and
April 30, 1999 (unaudited), respectively. The value of such shares was
determined based upon the value of the shares issued, as determined by cash
proceeds to the company on sales of similar instruments, or the value of the
goods or services received, whichever was more readily determinable.
8. Stock Options
Option activity
Option activity during the year ended July 31, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
Average
Weighted
Exercise
Shares Price
------- --------
<S> <C> <C>
Balance, July 31, 1996..................................... -- $--
Options granted........................................... 389,326 .01
-------
Balance, July 31, 1997..................................... 389,326 .01
Options granted........................................... 325,557 .01
-------
Balance, July 31, 1998..................................... 714,883 .01
=======
</TABLE>
At July 31, 1998, all outstanding options were exercisable of which 506,486
shares, at a weighted average exercise price of $0.01, are subject to the
Company's right of repurchase upon exercise.
Pro forma stock compensation
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Had compensation cost been determined based on
the minimum value at the grant date for the awards in 1997 and 1998 consistent
with the provisions of SFAS No. 123, the Company's net loss for 1997 and 1998,
respectively, would have been as follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
1997 1998
------- ---------
<S> <C> <C>
Net income (loss) attributable to common stock
holders--as reported................................. $21,490 $(219,893)
Net income (loss) attributable to common
stockholders--pro forma.............................. $17,214 $(233,892)
Net income (loss) per common share--basic and diluted
as reported.......................................... $ (0.01) $ (0.07)
Net income (loss) per common share--basic and diluted
pro forma............................................ $ (0.01) $ (0.06)
</TABLE>
F-47
<PAGE>
INTERNET UNDERGROUND MUSIC ARCHIVE, INC. ("IUMA")
NOTES TO THE FINANCIAL STATEMENTS
Such pro forma disclosures may not be representative of future compensation
cost because options vest over several years and additional grants are made
each year.
The minimum value of each option grant is estimated on the date of grant using
a type of Black-Scholes option-pricing model with the following assumptions
used for grants:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Weighted average risk-free interest rate......................... 6.49% 5.47%
Expected life (from vesting date)................................ 5 5
Expected dividends............................................... -- --
</TABLE>
Based on the above assumptions, the aggregate fair value and weighted average
fair value per share of options granted in 1997 and 1998 were $18,501 and
$0.048 and $329,665 and $1.013, respectively. All options were granted with
exercise prices below the estimated market value at the date of grant.
The options outstanding (all of which are exercisable) by exercise price at
July 31, 1998 are as follows:
Options Outstanding
<TABLE>
<CAPTION>
Weighted
Average
Remaining
Contractual
Exercise Number Life
Prices Outstanding (years)
-------- ----------- -----------
<S> <C> <C>
$0.01 714,883 8.79
</TABLE>
Deferred stock compensation
During the years ended July 31, 1997 and 1998, the Company issued options to
certain employees with exercise prices below the deemed fair market value of
the Company's common stock at the date of grant. In addition, the Company
allowed such options to be exercised in advance of full vesting, subject to
repurchase rights with respect to unvested shares. In accordance with the
requirements of APB 25, the Company has recorded deferred compensation for the
difference between the exercise price of the stock options and the fair market
value of the Company's stock at the date of grant. Deferred compensation is
being amortized over the vesting periods. At July 31, 1998, the Company
recorded deferred compensation of $328,527 (net of cancellations), of which
$4,158 and $13,662 had been amortized to expense during the years ended July
31, 1997 and 1998.
9. Subsequent Events
Leases
During October 1999 the Company entered into a second rental lease with minimum
monthly payments of approximately $1,000. This lease was cancelled in May 1999.
In addition, during July 1999 the original rental lease was also cancelled.
Merger
On June 30, 1999, EMusic.com Inc. (formerly GoodNoise Corporation) acquired all
of the Company's outstanding shares of Common Stock, at which time the Company
became a wholly owned subsidiary of EMusic.com Inc.
F-48
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Group K Inc.
New York, New York
We have audited the accompanying balance sheets of Group K Inc. (a development
stage company) (Note L[1]) as of December 31, 1998 and 1997 and the related
statements of operations, stockholders' equity and cash flows for the period
from June 16, 1997 (inception) through December 31, 1998, the year ended
December 31, 1998 and the period June 16, 1997 (inception) through December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements enumerated above present fairly, in
all material respects, the financial position of Group K Inc. (Note L[1]) as of
December 31, 1998 and 1997, and the results of its operations and its cash
flows for the period from June 16, 1997 (inception) through December 31, 1998,
the year ended December 31, 1998 and the period June 16, 1997 (inception)
through December 31, 1997 in conformity with generally accepted accounting
principles.
Richard A. Eisner & Company, LLP
New York, New York
November 19, 1999
F-49
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
--------------------- September 30,
1998 1997 1999
----------- -------- -------------
(unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ 849,000 $ 36,000 $ 888,000
Subscription receivable (collected in
1999).................................. 283,000 -- --
Prepaid and other current assets........ 25,000 21,000 256,000
----------- -------- ----------
Total current assets.................. 1,157,000 57,000 1,144,000
Property and equipment, net............... 169,000 45,000 219,000
Other assets.............................. 42,000 -- 73,000
----------- -------- ----------
$ 1,368,000 $102,000 $1,436,000
=========== ======== ==========
LIABILITIES
Current liabilities:
Accounts payable and accrued expenses... $ 75,000 $ 2,000 $ 300,000
Loans payable........................... -- 50,000 --
Current portion of capital lease
obligations.............................. 60,000 9,000 69,000
Dividends payable--preferred stock........ 38,000 -- 92,000
----------- -------- ----------
Total current liabilities............. 173,000 61,000 461,000
Capital lease obligations, less current
portion.................................. 92,000 29,000 60,000
----------- -------- ----------
265,000 90,000 521,000
----------- -------- ----------
Redeemable Preferred Stock (liquidation
preference $1,500,000)................... -- -- 1,217,000
----------- -------- ----------
Commitments and contingency
STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
Preferred stock--$.10 par value; 2,000,000
shares authorized;
Series B issued and outstanding 269,933
shares (liquidation preference
$810,000).............................. 27,000 -- --
Common stock--$.001 par value; 18,500,000
shares authorized;
3,154,002, 2,499,999 and 3,440,602 shares
issued and outstanding,
respectively............................. 3,000 2,000 3,000
Additional paid-in capital................ 1,766,000 58,000 2,008,000
Deficit accumulated during the development
stage.................................... (693,000) (48,000) (2,313,000)
----------- -------- ----------
1,103,000 12,000 (302,000)
----------- -------- ----------
$1,368,000 $102,000 $1,436,000
=========== ======== ==========
</TABLE>
See notes to financial statements
F-50
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
June 16, June 16,
1997 1997 June 16, 1997
(Inception) Year (Inception) Nine months ended (Inception)
Through Ended Through September 30, Through
December 31, December 31, December 31, ----------------------- September 30,
1998 1998 1997 1999 1998 1999
------------ ------------ ------------ ----------- ---------- -------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net sales............... $ 61,000 $ 60,000 $ 1,000 $ 80,000 $ 31,000 $ 141,000
Cost of sales........... 55,000 55,000 109,000 21,000 164,000
--------- --------- -------- ----------- --------- -----------
Gross profit (loss)..... 6,000 5,000 1,000 (29,000) 10,000 (23,000)
Expenses:
Selling, general and
administrative
expenses (excluding
equity
compensation)........ (570,000) (506,000) (64,000) (1,577,000) (285,000) (2,147,000)
Noncash compensation
charge............... (150,000) (150,000) -- (11,000) -- 161,000
Interest expense...... (13,000) (12,000) (1,000) (16,000) (6,000) (29,000)
Interest income......... 6,000 6,000 13,000 4,000 19,000
Other income............ 28,000 12,000 16,000 -- 12,000 28,000
--------- --------- -------- ----------- --------- -----------
Net loss................ $(693,000) $(645,000) $(48,000) $(1,620,000) $(265,000) $(2,313,000)
========= ========= ======== =========== ========= ===========
</TABLE>
See notes to financial statements
F-51
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
STATEMENTS OF STOCKHOLDERS' EQUITY (Capital Deficiency)
<TABLE>
<CAPTION>
Deficit
Accumulated
Preferred Stock Common Stock Additional During the Total Stockholders'
------------------ ---------------- Paid-in Development Equity
Shares Amount Shares Amount Capital Stage (Capital Deficiency)
-------- -------- --------- ------ ---------- ----------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock
at inception of the
Company................ 2,499,999 $2,000 $ 58,000 $ 60,000
Net loss................ $ (48,000) (48,000)
-------- -------- --------- ------ ---------- ----------- -----------
Balance--December 31,
1997................... 2,499,999 2,000 58,000 (48,000) 12,000
Conversion of loans
payable into Series A
convertible preferred
stock at $0.90 per
share in April 1998.... 66,670 $ 7,000 53,000 60,000
Issuance of Series A
convertible preferred
stock at $1.00 per
share in April 1998.... 504,000 50,000 454,000 504,000
Issuance of Series B
convertible preferred
stock at $3.00 per
share in December
1998................... 269,933 27,000 783,000 810,000
Issuance of common stock
and 213,000 warrants in
December 1998.......... 83,333 250,000 250,000
Conversion of Series A
preferred stock into
common stock in
December 1998.......... (570,670) (57,000) 570,670 1,000 56,000 0
Value of options
granted................ 150,000 150,000
Dividends declared in
December 1998.......... (38,000) (38,000)
Net loss................ (645,000) (645,000)
-------- -------- --------- ------ ---------- ----------- -----------
Balance--December 31,
1998................... 269,933 $ 27,000 3,154,002 $3,000 $1,766,000 $ (693,000) $ 1,103,000
======== ======== ========= ====== ========== =========== ===========
Conversion of Series B
preferred stock into
common stock in August
1999................... (269,933) (27,000) 269,933 27,000
Issuance of common stock
through preferred stock
financing.............. 16,667 75,000 75,000
Issuance of common stock
warrants through
preferred stock
financing.............. 188,000 188,000
Accretion of Series C
preferred stock to
redemption value....... (5,000) (5,000)
Dividends declared in
August 1999............ (54,000) (54,000)
Value of options granted
to investors........... 11,000 11,000
Net loss................ (1,620,000) (1,620,000)
-------- -------- --------- ------ ---------- ----------- -----------
Balance--September 30,
1999 (unaudited)....... -- $ -- 3,440,602 $3,000 $2,008,000 $(2,313,000) $ (302,000)
======== ======== ========= ====== ========== =========== ===========
</TABLE>
See notes to financial statements
F-52
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------
June 16,
June 16, 1997 1997 June 16, 1997
(Inception) (Inception) (Inception)
Through Year Ended Through Through
December 31, December 31, December 31, September 30,
1998 1998 1997 1999 1999 1998
------------- ------------ ------------ ------------- ----------- ----------
(Unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss................ $ (693,000) $ (645,000) $(48,000) $(2,313,000) $(1,620,000) $ (265,000)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Depreciation and
amortization........... 46,000 42,000 4,000 111,000 65,000 24,000
Compensation expense
attributable to
options................ 150,000 150,000 161,000 11,000
Changes in:
Other assets............ (67,000) (46,000) (21,000) (329,000) (262,000) (30,000)
Accounts payable and
accrued expenses....... 75,000 73,000 2,000 300,000 225,000 9,000
---------- ---------- -------- ----------- ----------- ----------
Net cash used in
operating activities... (489,000) (426,000) (63,000) (2,070,000) (1,581,000) (262,000)
---------- ---------- -------- ----------- ----------- ----------
Cash flows from
investing activities:
Additions to property
and equipment.......... (34,000) (24,000) (10,000) (122,000) (88,000) (46,000)
---------- ---------- -------- ----------- ----------- ----------
Cash flows from
financing activities:
Payment of capital lease
obligations............ (29,000) (28,000) (1,000) (79,000) (50,000) (15,000)
Loans payable........... 60,000 10,000 50,000 60,000 10,000
Proceeds from sale of
stock and warrants..... 1,341,000 1,281,000 60,000 3,099,000 1,758,000 504,000
---------- ---------- -------- ----------- ----------- ----------
Net cash provided by
financing activities... 1,372,000 1,263,000 109,000 3,080,000 1,708,000 499,000
---------- ---------- -------- ----------- ----------- ----------
Net increase in cash and
cash equivalents....... 849,000 813,000 36,000 888,000 39,000 191,000
Cash and cash
equivalents at
beginning of period.... 36,000 849,000 36,000
---------- ---------- -------- ----------- ----------- ----------
Cash and cash
equivalents at end of
period................. $ 849,000 $ 849,000 $ 36,000 $ 888,000 $ 888,000 $ 227,000
========== ========== ======== =========== =========== ==========
Cash paid for:
Interest................ $ 12,000 $ 11,000 $ 1,000 $ 28,000 $ 16,000 $ 6,000
Taxes................... $ 1,000 $ 1,000 $ 5,000 $ 4,000 $ 1,000
Supplemental disclosures
of noncash financing
activities:
Equipment purchased
under capital leases... $ 181,000 $ 142,000 $ 39,000 $ 208,000 $ 27,000 $ 74,000
Dividends declared not
yet paid............... $ 38,000 $ 38,000 $ 92,000 $ 54,000
Conversion of loans into
preferred stock........ $ 60,000 $ 60,000 $ 60,000 $ $ 60,000
</TABLE>
See notes to financial statements
F-53
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
Note A--The Company
Group K Inc. (the "Company") (Note L[1]) incorporated on June 16, 1997 in the
State of New York and is doing business as CDuctive. The Company is an online
aggregator and distributor of independent label music. The Company offers its
catalog in digital download and custom CD compilation formats from its web site
www.cductive.com. The Company also provides distribution and e-commerce
services to a number of online partners. In May 1999, the Company expanded into
direct digital downloads with the launch of its MP3 digital download web site.
Since its inception the Company has been in the development stage devoting its
efforts primarily to organizing itself, recruiting management and technical
staff, developing its business, acquiring operating assets and raising capital.
Note B--Significant Accounting Policies
[1]Cash and cash equivalents:
For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three
months or less to be cash equivalents.
[2]Property and equipment:
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful life of three years.
[3]Revenue recognition:
The Company generates revenues from custom compact disc sales through
affiliated partners and direct sales or from the Company's web site. Sales
are recognized when compact disc are shipped or when music is downloaded.
[4]Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from these
estimates.
[5]Stock-based compensation:
The Company has elected to follow the intrinsic value method set forth in
Accounting Principles Board Opinion 25, "Accounting for Stock Issued to
Employees" in accounting for its stock option incentive plan. As such,
compensation expense would be recorded on the date of grant if the current
market price of the underlying stock exceeded the exercise price of the
option.
F-54
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
[6]Unaudited interim financial statements:
The financial information presented as of September 30, 1999 and for the
nine month periods ended September 30, 1999 and 1998 is unaudited, but in
the opinion of management contains all adjustments (consisting only of
normally recurring adjustments) necessary for a fair presentation of such
financial information. Results of operations for interim periods are not
necessarily indicative of those to be achieved for full fiscal years.
Note C--Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentration of
credit risk consist of cash and cash equivalents. At December 31, 1998, the
Company held its cash and cash equivalents at one bank primarily in money
market accounts.
Note D--Property and Equipment
Property and equipment consists of:
<TABLE>
<CAPTION>
December 31,
---------------- September 30,
1998 1997 1999
-------- ------- -------------
(unaudited)
<S> <C> <C> <C>
Computer hardware.......................... $201,000 $49,000 $314,000
Furniture.................................. 1,000 1,000
Leasehold improvements..................... 13,000 15,000
-------- ------- --------
215,000 49,000 330,000
Less accumulated depreciation.............. 46,000 4,000 111,000
-------- ------- --------
$169,000 $45,000 $219,000
======== ======= ========
</TABLE>
Depreciation and amortization expense for the period June 16, 1997 (inception)
through December 31, 1997 was $4,000 and for the year ended December 31, 1998
it was $42,000 and for the nine months ended September 30, 1999 and 1998 was
$65,000 and $24,000, respectively.
Assets under capital leases with a net book value of approximately $127,000 and
$118,000 are included in property and equipment at December 31, 1998 and
September 30, 1999, respectively.
Note E--Income Taxes
The Company files its United States income tax returns on the cash basis of
accounting. Deferred taxes represent the expected future tax consequences of
the differences between (i) the carrying amounts of the assets and liabilities
(principally accounts payable and accrued expenses which are stated for
financial reporting purposes on the accrual basis) and (ii) their income tax
basis.
At December 31, 1998, the Company had available net operating loss
carryforwards of approximately $414,000 to reduce future taxable income. The
net operating loss carryforwards expire in 2018.
F-55
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
At December 31, 1998 and 1997, the Company had deferred tax assets of
approximately $296,000 and $18,000, respectively, representing the benefits of
its net operating loss carryforwards and certain expenses not currently
deductible for tax purposes. The Company has not recorded a benefit for such
items because realization of the benefit is uncertain and therefore a valuation
allowance has been fully provided against the deferred tax assets.
The difference between the statutory federal rate of 34% and the Company's
effective tax rate of 0% is due to an increase in valuation allowance of
$278,000 and $18,000 in 1998 and 1997.
Note F--Commitments
[1]Capital leases:
Certain equipment and computer software were acquired pursuant to capital
leases expiring through 2002. Future minimum lease payments are as follows:
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
1999.............................................................. $72,000
2000.............................................................. 62,000
2001.............................................................. 37,000
2002.............................................................. 1,000
-------
Total minimum lease payments...................................... 172,000
Less deferred interest............................................ (20,000)
-------
Present value of net minimum lease payments....................... 152,000
Current portion................................................... 60,000
-------
Noncurrent portion................................................ $92,000
=======
</TABLE>
The noncurrent portion of such leases is due as follows:
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
2000............................................................. $56,000
2001............................................................. 35,000
2002............................................................. 1,000
-------
Noncurrent portion............................................... $92,000
=======
</TABLE>
Certain of these leases are collateralized by personal guarantees and
securities of the Company's principal stockholders.
F-56
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
[2]Leases of office premises:
Office space is leased through the year 2002 at the following minimum
annual rentals.
<TABLE>
<CAPTION>
Year Ending December 31,
------------------------
<S> <C>
1999............................................................ $ 81,000
2000............................................................ 109,000
2001............................................................ 91,000
2002............................................................ 46,000
--------
$327,000
========
</TABLE>
Rent expense was approximately $13,000 and $21,000 for the period from June
16, 1997 (inception) through December 31, 1997 and for the year ended
December 31, 1998, respectively and for the nine
Note F--Commitments (continued)
months ended September 30, 1999 and 1998 was $51,000 and $14,000,
respectively. The 1997 expense represents payments to three directors of
the Company who provided office space during the initial stages (June
through December 1997).
[3]Royalty and licensing agreements:
The Company has entered into various license agreements which provide for
the payment of royalties at various percentages of the selling price of
each title sold. These royalty fees are accrued by the Company on a
quarterly basis. Certain of these agreements included a provision for the
Company to make nonrefundable advances. Royalty fees incurred under these
agreements are first applied to the advance. Once the advance is
liquidated, the Company pays fees as incurred.
In addition, these agreements require the payment of mechanical royalties,
$0.07 per track, to be paid to the party that has publishing rights to the
title.
[4]Employment agreements:
Effective January 1, 1999, the Company entered into employment and
consulting agreements with several employees. The agreements continue at
the will of the Company, are not for a specific period and provide for
various levels of annual compensation. Certain of the employment agreements
have guarantees upon termination. The Company issued 4,667 shares of common
stock valued at approximately $14,000 to one stockholder in connection with
a signing bonus offered at time of employment with the Company.
Note G--Related Party Transactions
Other income includes consulting fees received for services provided by a
director of the Company to his previous employer. See Notes F, I and L for
additional related party transactions.
F-57
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
Note H--Stockholders' Equity
[1]Series A preferred stock:
The Company issued 504,000 shares of Series A perpetual convertible
preferred stock, par value $.10, in April 1998 at $1.00 per share. In
addition, loans of $60,000 were converted into 66,670 Series A convertible
preferred stock. These shares automatically converted to common stock in
December 1998 when the Company issued shares of Series B convertible
preferred stock. Immediately prior to the automatic conversion, a 10%
dividend was declared on Series A convertible preferred stock.
[2]Series B preferred stock:
The Company issued 269,933 shares of Series B perpetual convertible
preferred stock, par value $.10, in December 1998. The proceeds of this
offering amounted to $810,000. The shares are automatically
Note H--Stockholders' Equity (continued)
convertible into common stock at the option of the holder or by the
corporation on the completion of an equity financing as defined. Series B
shares are entitled to one vote per share, have a liquidated preference of
$3.00 per share and entitled to a dividend of 10% per annum. In August
1999, the Series B preferred stock automatically converted into common
stock upon the issuance of Series C preferred stock (see Note L[2]). In
addition, a dividend of $.20 per share was declared to the holders of
Series B preferred stock on August 18, 1999.
Note I--Warrants
In December 1998, in connection with the sale of 83,333 shares of common stock
at $2.97 per share the Company sold 213,000 redeemable warrants to an investor
for $2,130. The warrants are exerciseable into common stock at a price of $3.00
per share through December 2008.
During 1999, 145,918 warrants were issued (see Note L[2]).
Note J--Stock Options
In December 1998, the Board of Directors approved, subject to stockholders'
approval, a stock option plan under which options to acquire up to 700,000
shares of common stock may be granted to employees and select board members.
Options generally vest in eight quarterly installments commencing three months
from the date of grant or as otherwise determined by the board. The exercise
price for each option granted may not be less than 100% of the fair market
value of the stock on the grant date or such other amount as determined by the
board from time to time. No option granted under the plan may be exercised in
whole or in part more than ten years after its grant date. The plan is to be
administered by the board or a committee appointed by the board, comprised of
not less than one member of the board. The shareholders ratified the plan at
the annual meeting on August 31, 1999.
F-58
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
Stock option activity under the plan including options granted to employees
outside the plan is summarized as follows:
<TABLE>
<CAPTION>
June 16, 1997
(Inception)
Year Ended Through Nine months
December 31, December 31, ended September
1998 1997 30, 1999
---------------- --------------- ----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------ -------- ------- --------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of period........ 27,000 $1.00 165,533 $1.30
Granted..................... 138,533 1.36 27,000 $1.00 259,764 $3.04
------- ------ -------
Options outstanding at end
of period.................. 165,533 1.30 27,000 1.00 425,297 $1.30
======= ====== =======
Options exercisable at end
of period.................. 102,250 1.02 0 254,495
======= ====== =======
</TABLE>
Note J--Stock Options (continued)
At December 31, 1998 and September 30, 1999, there were 605,217 and 355,153
options, respectively, for the purchase of shares available for future grants
under the plan.
In December 1998, the Company issued options to three stockholders to purchase
25,000 shares of stock each at an exercise price of $2.00 below fair value at
date of grant. As a result, a noncash compensation charge of $150,000 was
recorded in 1998.
The following table presents information relating to stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------- -------------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Exercise Exercise Life in Exercise
Price Shares Price Years Shares Price
-------- ------- -------- --------- ------- --------
<S> <C> <C> <C> <C> <C>
$1.00 135,750 $1.00 9.62 100,583 $1.00
2.00 10,000 2.00 9.67 1,667 2.00
3.00 19,783 3.00 10.00
------- ----- ----- ------- -----
165,533 1.30 9.67 102,250 1.02
======= ===== ===== ======= =====
</TABLE>
F-59
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
The fair value of options at date of grant was estimated using the Black-
Scholes option pricing model utilizing the following assumptions:
<TABLE>
<CAPTION>
June 16, 1997
(Inception)
Year Ended Through
December 31, December 31,
1998 1997
-------------- -------------
<S> <C> <C>
Risk-free interest rates...................... 4.64% to 5.61% 5.71%
Expected option life in years................. 5 5
Expected stock price volatility............... 40% 40%
Expected dividend yield....................... 0% 0%
</TABLE>
Had the Company elected to recognize compensation cost based on the fair value
of the options at the date of grant as prescribed by SFAS No. 123, the
Company's net loss would have been as presented in the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
June 16,
1997 June 16, 1997
(Inception) (Inception)
Through Year Ended Through
December December 31, December 31,
31, 1998 1998 1997
----------- ------------ -------------
<S> <C> <C> <C>
Net loss:
As reported....................... $(693,000) $(645,000) $(48,000)
Pro forma......................... (698,000) (650,000) (48,000)
Weighted average fair value of
options granted.................... .52 .53 .44
</TABLE>
Note K--Contingency
The Company has received cease and desist letters regarding the sale of certain
songs recorded by a musical group. Such letters were sent on behalf of the
group and the record label, asserting that two record labels do not hold the
rights to the music licensed to the Company. The Company has signed agreements
with the record labels which indemnify the Company from the accusations being
levied against the Company in the aforementioned letters. However, one of the
record labels is attempting to repudiate its agreement with the Company
claiming lack of authority of its signator. The Company is currently attempting
to resolve the matter with the parties involved, however, should it become
necessary, the Company will vigorously defend its rights.
Note L--Subsequent Events
[1]Sale of company:
In November 1999, the Company entered into an agreement with EMusic.com,
Inc. ("EMusic") whereby EMusic would acquire the Company for stock. The
agreement provides for shares of the Company to be exchanged for the right
to receive an equivalent value of EMusic stock at a predetermined exchange
ratio. At the closing of this agreement, the separate corporate existence
of the Company would cease.
F-60
<PAGE>
GROUP K INC.
(A Development Stage Company)
(Note L[1])
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1998 and 1997
(Unaudited with respect to the data as of September 30, 1999 and for the nine-
month periods ended September 30, 1999 and 1998)
[2]Series C convertible preferred stock:
From August to November 1999, the Company sold an aggregate of 477,005
shares of Series C convertible preferred stock for aggregate proceeds of
$2,146,550. In conjunction therewith, the Company issued warrants to
purchase 119,251 shares of common stock, exercisable at a price of $5.40
per share from August through November 2009.
The Series C convertible preferred stock is convertible into common stock
on a one for one basis and is entitled to one vote per share. Such shares
have preferential liquidation rights of $4.50 per share. This series of
shares may be converted at the option of the holder in its entirety at any
time after issuance, unless otherwise subject to mandatory conversion by
the Company. The preferred stock automatically convert into common stock
upon the completion of an initial public offering as defined. The shares
have no dividend rights. The shares are redeemable at $4.50 per share upon
the earlier of a change in control as defined or their fifth anniversary
date and have a liquidation preference of $4.50 per share. In connection
with this series of preferred stock, the Company paid the placement agent
$25,000 and issued 16,667 shares of common stock and warrants to purchase
26,667 shares of common stock at an exercise price of $5.40.
At September 30, 1999 the Company valued the warrants and common stock
issued in connection with the Series C at a fair value of $263,000.
Accordingly, the preferred stock has been recorded at its fair value
including the value of the common stock, warrants and expenses related to
the preferred stock offering as a preferred stock discount, which is to be
accreted against the preferred stock until the fifth anniversary date.
Note L--Subsequent Events (continued)
[3]Stock options:
In January 1999, the Company granted stock options under the plan to
purchase 40,000 shares of common stock at an exercise price of $3.00 per
share to a director of the Company.
In February 1999, the Company granted stock options to purchase 4,667
shares of common stock at an exercise price of $3.60 per share to an
employee as a signing bonus under the plan.
In July 1999, the Company granted the three founding stockholders 14,000
options each to purchase shares of common stock in consideration for
guaranties of 1999 capital leases. The Company also issued each of the
founding stockholders 13,167 options to purchase shares of common stock as
deferred compensation from December 1, 1998 to June 30, 1999. Both grants
were at an exercise price of $3.00.
The Company granted an additional 196,496 stock options authorized under
the Company's stock option plan during 1999.
At various times during 1999, the Company granted options outside of the
plan to purchase 13,866 shares of common stock at exercise prices ranging
from $3.60 to $4.50 to fourteen various music labels in connection with the
licensing of electronic download rights.
F-61
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Tunes.com Inc.
We have audited the accompanying consolidated balance sheets of Tunes.com
Inc. as of December 31, 1997 and 1998 and the related consolidated statements
of operations, stockholders' equity (deficit), and cash flows for the period
from July 2, 1996 (inception) to December 31, 1996 and the years ended December
31, 1997 and 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Tunes.com Inc. at
December 31, 1997 and 1998, and the consolidated results of its operations and
its cash flows for the years ended December 31, 1997 and 1998 and for the
period from July 2, 1996 (inception) to December 31, 1996, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
January 26, 1999
F-62
<PAGE>
TUNES.COM INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------- Sept. 30,
1997 1998 1999
----------- ------------ ------------
(Unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents........... $ 2,674,236 $ 4,251,082 $ 7,527,896
Accounts receivable, net of
allowance of $17,000 in 1998 and
$12,000 in 1999.................... 130,016 368,720 881,462
Prepaid expenses and other current
assets............................. 88,156 374,195 2,527,387
Restricted investment............... 1,000,000 1,000,000 250,000
----------- ------------ ------------
Total current assets.............. 3,892,408 5,993,997 11,186,745
Equipment and leasehold improvements.. 840,430 1,712,802 2,379,327
Less: Accumulated depreciation........ (131,185) (498,636) (786,371)
----------- ------------ ------------
709,245 1,214,166 1,592,956
Restricted investment, less current
portion.............................. 1,000,000 -- --
Goodwill, net......................... -- 3,488,570 1,744,280
Other intangibles, net................ -- 682,498 299,990
License agreement, net................ -- -- 1,423,077
Other................................. -- 33,941 51,587
----------- ------------ ------------
Total assets...................... $ 5,601,653 $ 11,413,172 $ 16,298,635
=========== ============ ============
Liabilities and Stockholders' Deficit
Liabilities:
Accounts payable.................... $ 186,084 $ 743,344 $ 1,327,267
Accrued compensation................ 34,690 410,331 536,958
Acquisition liability............... -- 404,000 --
Deferred revenue.................... 110,831 541,246 95,969
Other accrued expenses and current
liabilities........................ 181,895 655,271 1,783,008
----------- ------------ ------------
Total current liabilities......... 513,500 2,754,192 3,743,202
Long-term obligations................. -- 160,507 82,182
Redeemable convertible preferred
stock................................ 8,430,108 22,116,439 43,134,794
Stockholders' deficit:
Common stock, par value $0.01;
11,500,000 shares authorized;
issued and outstanding: 1,469,782
in 1999, 1,340,530 in 1998 and
1,150,530 in 1997.................. 11,505 13,405 14,698
Additional paid-in capital.......... 748,195 4,174,029 10,672,790
Common stock to be issued........... -- 1,055,420 55,420
Accumulated deficit................. (4,101,655) (18,860,820) (41,404,451)
----------- ------------ ------------
Total stockholders' deficit....... (3,341,955) (13,617,966) (30,661,543)
----------- ------------ ------------
Total liabilities and
stockholders' deficit............ $ 5,601,653 $ 11,413,172 $ 16,298,635
=========== ============ ============
</TABLE>
See accompanying notes.
F-63
<PAGE>
TUNES.COM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
July 2, 1996
(inception) Nine Months Ended
to Year Ended December 31 September 30
December 31, ------------------------- -------------------------
1996 1997 1998 1998 1999
------------ ----------- ------------ ----------- ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Revenue:
Advertising........... $ -- $ 283,807 $ 970,189 $ 502,439 $ 2,456,151
Other................. -- 280,887 1,514,466 1,212,793 846,876
--------- ----------- ------------ ----------- ------------
Total revenue....... -- 564,694 2,484,655 1,715,232 3,303,027
Cost of revenue......... -- 1,267,521 4,045,056 2,863,312 3,108,355
--------- ----------- ------------ ----------- ------------
Gross margin (deficit).. -- (702,827) (1,560,401) (1,148,080) 194,672
Operating expenses:
Operations and
development.......... 32,003 458,381 1,880,480 1,058,809 2,778,321
Sales and marketing... 36,769 1,064,502 4,034,115 2,282,191 7,486,287
General and
administrative....... 152,859 1,244,676 2,836,678 1,935,134 2,990,253
Depreciation and
amortization......... 2,319 156,529 1,777,931 961,020 2,555,504
Stock compensation.... -- 9,700 1,527,734 413,373 4,526,844
--------- ----------- ------------ ----------- ------------
Total operating
expenses........... 223,950 2,933,788 12,056,938 6,650,527 20,337,211
--------- ----------- ------------ ----------- ------------
Loss from operations.... (223,950) (3,636,615) (13,617,339) (7,798,607) (20,142,539)
Other income (expense):
Interest income....... 7,353 99,540 432,566 340,276 284,277
Interest expense...... -- -- (9,438) (5,121) (76,812)
Other income
(expense)............ -- 15,040 4,568 4,568 (35,451)
--------- ----------- ------------ ----------- ------------
Net loss................ (216,597) (3,522,035) (13,189,643) (7,458,884) (19,970,525)
Accretion of redeemable
convertible preferred
stock.................. -- (363,023) (1,569,522) -- (2,573,106)
--------- ----------- ------------ ----------- ------------
Net loss attributable to
common stockholders.... $(216,597) $(3,885,058) $(14,759,165) $(7,458,884) $(22,543,631)
========= =========== ============ =========== ============
</TABLE>
See accompanying notes.
F-64
<PAGE>
TUNES.COM INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Members' Units Common Stock Additional
------------------- ------------------- Common Stock Paid-in Accumulated
Units Amount Shares Par Value To Be Issued Capital Deficit Total
-------- --------- --------- --------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Initial capitalization,
July 2, 1996........... 115,053 $ 750,000 -- $ -- $ -- $ -- $ -- $ 750,000
Net loss for the period
from July 2, 1996
to December 31, 1996... -- -- -- -- -- -- (216,597) (216,597)
-------- --------- --------- ------- ---------- ----------- ------------ ------------
Balance at December 31,
1996................... 115,053 750,000 -- -- -- -- (216,597) 533,403
Conversion of Members'
units to shares of
common stock........... (115,053) (750,000) 1,150,530 11,505 -- 738,495 -- --
Stock compensation
expense................ -- -- -- -- -- 9,700 -- 9,700
Accretion of redeemable
convertible preferred
stock.................. -- -- -- -- -- -- (363,023) (363,023)
Net loss................ -- -- -- -- -- -- (3,522,035) (3,522,035)
-------- --------- --------- ------- ---------- ----------- ------------ ------------
Balance at December 31,
1997................... -- -- 1,150,530 11,505 -- 748,195 (4,101,655) (3,341,955)
Common stock to be
issued................. -- -- -- -- 2,955,420 -- -- 2,955,420
Common stock issued in
connection with
acquisition............ -- -- 190,000 1,900 (1,900,000) 1,898,100 -- --
Stock compensation
expense................ -- -- -- -- -- 1,527,734 -- 1,527,734
Accretion of redeemable
convertible preferred
stock.................. -- -- -- -- -- -- (1,569,522) (1,569,522)
Net loss................ -- -- -- -- -- -- (13,189,643) (13,189,643)
-------- --------- --------- ------- ---------- ----------- ------------ ------------
Balance at December 31,
1998................... -- -- 1,340,530 13,405 1,055,420 4,174,029 (18,860,820) (13,617,966)
Issuance of warrants
(unaudited)............ -- -- -- -- -- 713,011 -- 713,011
Stock compensation
expense (unaudited).... -- -- -- -- -- 4,526,845 -- 4,526,845
Accretion of redeemable
convertible preferred
stock (unaudited)...... -- -- -- -- -- -- (2,573,106) (2,573,106)
Exercise of stock
options and warrants
(unaudited)............ -- -- 29,252 293 -- 259,905 -- 260,198
Common stock issued in
connection with
acquisition
(unaudited)............ -- -- 100,000 1,000 (1,000,000) 999,000 -- --
Net loss (unaudited).... -- -- -- -- -- -- (19,970,525) (19,970,525)
-------- --------- --------- ------- ---------- ----------- ------------ ------------
Balance at September 30,
1999 (unaudited)....... -- $ -- 1,469,782 $14,698 $ 55,420 $10,672,790 $(41,404,451) $(30,661,543)
======== ========= ========= ======= ========== =========== ============ ============
</TABLE>
See accompanying notes.
F-65
<PAGE>
TUNES.COM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
July 2, 1996
(inception) Nine Months Ended
to Year Ended December 31, September 30,
December 31, ------------------------- -------------------------
1996 1997 1998 1998 1999
------------ ----------- ------------ ----------- ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES
Net loss................ $(216,597) $(3,522,035) $(13,189,643) $(7,458,884) $(19,970,525)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Depreciation and
amortization.......... 2,319 156,529 1,777,931 961,020 2,632,427
Stock compensation
expense............... -- 9,700 1,527,734 413,373 4,526,845
Other noncash items.... -- (82,500) 100,000 100,000 37,785
Changes in operating
assets and
liabilities, excluding
effects from
acquisitions:
Accounts receivable.... -- (130,016) (234,864) (384,805) (512,742)
Prepaid expenses and
other current assets.. (17,458) (70,698) (292,486) (266,848) (870,580)
Accounts payable....... 49,980 136,104 172,035 252,383 583,923
Accrued compensation... 4,827 29,863 58,520 192,573 126,627
Deferred revenue....... -- 110,831 430,415 558,398 (445,277)
Other accrued expenses
and current
liabilities........... 45,856 136,039 353,598 150,942 676,377
--------- ----------- ------------ ----------- ------------
Net cash used in
operating activities... (131,073) (3,226,183) (9,296,760) (5,481,848) (13,215,140)
CASH FLOWS FROM
INVESTING ACTIVITIES
Purchase of equipment
and leasehold
improvements........... (29,857) (708,073) (584,761) (506,322) (845,281)
Payment of license fee.. -- -- -- -- (1,500,000)
Decrease (increase) in
restricted investment.. -- (2,000,000) 1,000,000 750,000 750,000
Acquisitions, net of
cash acquired (Note
4)..................... (27,663) -- (507,783) (507,783) (404,000)
--------- ----------- ------------ ----------- ------------
Net cash used in
investing activities... (57,520) (2,708,073) (92,544) (264,105) (1,999,281)
CASH FLOWS FROM
FINANCING ACTIVITIES
Proceeds from notes
payable................ -- 500,000 -- -- 3,995,000
Payments on notes
payable and capital
leases................. -- -- (1,150,659) (10,436) (126,704)
Proceeds from issuance
of members' units...... 750,000 -- -- -- --
Proceeds from issuance
of preferred stock, net
of issue costs......... -- 7,547,085 12,116,809 12,116,809 15,103,000
Proceeds from exercise
of stock options and
warrants............... -- -- -- -- 260,198
Payment of deferred
financing costs........ -- -- -- -- (740,259)
--------- ----------- ------------ ----------- ------------
Net cash provided by
financing activities... 750,000 8,047,085 10,966,150 12,106,373 18,491,235
--------- ----------- ------------ ----------- ------------
Net increase in cash and
cash equivalents....... 561,407 2,112,829 1,576,846 6,360,420 3,276,814
Cash and cash
equivalents, beginning
of period.............. -- 561,407 2,674,236 2,674,236 4,251,082
--------- ----------- ------------ ----------- ------------
Cash and cash
equivalents, end of
period................. $ 561,407 $ 2,674,236 $ 4,251,082 $ 9,034,656 $ 7,527,896
--------- ----------- ------------ ----------- ------------
SUPPLEMENTAL NONCASH
INVESTING AND FINANCING
ACTIVITIES
Common stock issued or
to be issued in
acquisition............ $ -- $ -- $ 2,955,420 $ 2,955,420 $ --
Liabilities assumed in
acquisition............ $ -- $ -- $ 1,940,000 $ 1,940,000 $ --
Notes payable exchanged
for shares of preferred
stock.................. $ -- $ 500,000 $ -- $ -- $ 3,995,000
Capital leases for
computer equipment..... $ -- $ -- $ 182,993 $ 42,506 $ --
</TABLE>
See accompanying notes.
F-66
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to the nine-month periods ended
September 30, 1998 and 1999 is unaudited)
1. NATURE OF OPERATIONS
Tunes.com Inc. (the Company) is an Internet-based music media, marketing, and
promotion company that provides interactive music content, live and archived
music performances and interviews, current news and information, audio and
video samples and other programming, as well as the opportunity for music fans
worldwide to purchase music-related merchandise directly through the
www.tunes.com, www.rollingstone.com, www.thesource.com, www.downbeatjazz.com
and www.jamtv.com Web sites, and radio and Internet content affiliates.
Effective February 26, 1999, the Company changed its name from JAMtv
Corporation to Tunes.com Inc.
2. BASIS OF PRESENTATION
The financial statements of the Company as of September 30, 1999 and for the
nine-month periods ended September 30, 1998 and 1999 contain all adjustments
and accruals (consisting of normal recurring adjustments) which, in the opinion
of management, are necessary for a fair presentation of the financial position
and operating results of the interim periods presented.
As detailed in Note 6, on June 2, 1997, holders of members' units in Digital
Entertainment Network, L.L.C. (DEN), a limited liability company, exchanged
such units for shares of common stock of the Company, a newly formed Delaware
corporation. All of the assets and liabilities of DEN were transferred to the
Company at book value and DEN was dissolved. The accompanying financial
statements reflect the operations of DEN for the period prior to June 2, 1997,
and the Company thereafter.
3. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts and transactions
of the Company and its wholly owned subsidiaries. All significant intercompany
transactions and balances are eliminated.
Cash and Cash Equivalents
Cash and cash equivalents include cash which is unrestricted as to use and
highly liquid investments having a maturity of three months or less at the time
of purchase.
Restricted Investment
The restricted investment represents the future license payments held in
escrow pursuant to a third-party agreement (see Note 9).
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost. Depreciation is
calculated on the straight-line method over the estimated useful lives of the
assets, generally three to five years. Assets under capital leases are
amortized using the straight-line method over the shorter of the estimated
useful lives or the remaining lease terms, generally three years.
F-67
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Intangible Assets
Intangible assets represent the excess of cost over the fair market value of
tangible net assets acquired and primarily consist of purchased technology and
goodwill related to the acquisition of Tunes Network, Inc. (Tunes Network--see
Note 4). Intangible assets are amortized on a straight-line basis over the
useful lives of the assets, currently two years. If there are indicators such
assets may be impaired, the Company assesses recoverability from future
operations using undiscounted cash flows of the related business as a measure.
Under this approach, the carrying value of the intangible would be reduced to
fair value if the Company's best estimate for expected undiscounted future cash
flows of the related business would be less than the carrying amount of the
intangible over its remaining amortization period.
Intangible assets consisted of the following at December 31, 1998:
<TABLE>
<S> <C>
Goodwill........................................................ $ 4,651,430
Developed technology............................................ 800,000
Assembled work force............................................ 110,000
-----------
5,561,430
Less: Accumulated amortization.................................. (1,390,362)
-----------
$ 4,171,068
===========
</TABLE>
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
Revenue Recognition
Advertising Revenue
Advertising revenue is derived from the sale of banner advertisements and
sponsorships on the Company's Web sites as well as integrated marketing
campaigns sold by the Company and the Company's share of revenue on co-branded
Web sites of affiliates under certain agreements. Advertising revenue is
recognized in the period the advertisement is displayed or campaign is run,
provided no significant Company obligations remain and collection of the
resulting receivable is probable. Company obligations typically include
guarantees of a minimum number of advertising impressions delivered or times
that any advertisement is viewed by users of the Company's Web sites. To the
extent minimum guaranteed impressions are not met, the Company defers
recognition of the corresponding revenues until guaranteed levels are achieved.
The Company also recognizes advertising revenue as a result of barter
transactions with certain other internet-related companies. Such revenue is
recognized based on the fair value of the consideration received or provided,
whichever is more determinable. This primarily consists of advertising
displayed on other companies' Web sites in exchange for advertising on the
Company's Web site. Barter revenue and the corresponding expense is recognized
in the period the advertising is displayed. Advertising revenue from barter
transactions during 1997 and 1998 was $174,000 and $156,800, respectively. In
the nine months ended September 30, 1999 the Company recorded barter revenue of
$672,000.
F-68
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Other Revenue
Other revenue is derived from content licensing, commerce and product
development. Content license fee revenue is recognized over the period of the
license agreement under which the Company delivers its content. Commerce
revenue from the sale of CDs and other music-related merchandise is recognized
when the products are shipped to customers, net of allowances for returns.
Product development revenue is derived from the development of content for
interactive CDs under third-party contracts and the development of other Web
based services. Product development revenue is generally recognized when the
product is delivered, except for services provided under longer-term contracts
where the revenue is recognized on a percentage-of-completion basis over the
life of the project. Two customers accounted for 52% of total revenue in 1998
and three customers accounted for 68% of total revenue in 1997.
Fair Value of Financial Instruments
All financial instruments are held for purposes other than trading. The
carrying amount of cash and cash equivalents, accounts receivable, accounts
payable and accruals are a reasonable estimate of their fair value due to the
short-term nature of these instruments. The estimated fair value of long-term
obligations at December 31, 1997 and 1998 was approximately equal to the
carrying amounts at those dates.
Advertising Costs
The Company expenses advertising and promotion costs when the advertising and
promotion occurs. Advertising and promotion expense for 1996, 1997, and 1998,
was $6,020, $460,132, and $2,454,366 respectively.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation," established a fair value method of
accounting for stock-based compensation. As permitted by SFAS No. 123, the
Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25), and related
Interpretations in accounting for its employee stock options. No compensation
expense is recognized under APB 25 if the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
measurement date. As required by SFAS No. 123, the Company discloses the pro
forma effect of the fair value method on operations in Note 7 to the financial
statements. Stock options and warrants held by non-employees are accounted for
under the fair value method of accounting.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-1, "Accounting for Costs of Computer Software
Developed or Obtained for Internal Use," which provides guidance on accounting
for the costs of computer software developed or obtained for internal use. SOP
No. 98-1 is effective for financial statements for fiscal years beginning after
December 15, 1998. The Company has adopted the provisions of SOP 98-1 during
the nine months ended September 30, 1999 with no material effect.
4. ACQUISITIONS
Effective July 1, 1998, the Company acquired all of the capital stock of
Tunes Network. The purchase consideration, including direct costs of
acquisition of $315,000, was $5,815,000, consisting of 295,542 shares of common
stock with a fair value of $10 per share, approximately $1,940,000 of assumed
liabilities, and
F-69
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$604,000 in cash of which $404,000 was paid subsequent to December 31, 1998. At
September 30, 1999, 5,542 shares of common stock have not been issued; such
shares will be issued in 1999. In addition up to an additional 100,000 shares
of common stock may be issuable based upon reaching minimum equity market
capitalization thresholds soon after the completion of an initial public
offering by the Company. The current fair value of these contingent shares will
be recorded as additional goodwill when the contingency is resolved and the
shares become issuable and will be amortized over the remaining estimated
useful life of the goodwill.
The acquisition was accounted for as a purchase and, accordingly, the results
of operations have been included in the consolidated financial statements from
July 1, 1998, the effective date of the acquisition.
Based on unaudited data, the following table presents selected financial
information for the Company on a pro forma basis, assuming Tunes Network had
been consolidated since January 1, 1997:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
1997 1998
----------- ------------
<S> <C> <C>
Revenue........................................... $ 863,810 $ 2,725,641
Net loss.......................................... (8,029,869) (15,587,790)
</TABLE>
The pro forma results are not necessarily indicative of future operations or
the actual results that would have occurred had the acquisition been made as of
January 1, 1997.
The purchase consideration was allocated to the acquired assets and assumed
liabilities based on fair values as follows:
<TABLE>
<S> <C>
Cash............................................................ $ 7,217
Accounts receivable and other assets............................ 21,616
Equipment....................................................... 124,737
Developed technology............................................ 800,000
In-process research and development............................. 100,000
Assembled work force............................................ 110,000
Goodwill........................................................ 4,651,430
-----------
5,815,000
Less: Liabilities assumed....................................... (1,940,000)
-----------
Cash and common stock purchase consideration.................... $ 3,875,000
===========
</TABLE>
The acquired in-process research and development includes the value of
products in the development stage not considered to have reached technological
feasibility. In accordance with applicable accounting rules, the acquired in-
process research and development was expensed in the third quarter of 1998. The
capitalized intangible assets acquired in the acquisition of Tunes Network
including developed technology, assembled work force, and goodwill are being
amortized on a straight-line basis over the estimated useful life of two years.
In November 1997, the Company formed a wholly owned subsidiary, JAMtv
Interactive Services Corporation (JIS) and acquired certain assets from
Imagination Pilots Entertainment Inc. (IPEI) and assumed certain IPEI
liabilities (see Note 12).
F-70
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consisted of the following:
<TABLE>
<CAPTION>
December 31,
---------------------
1997 1998
--------- ----------
<S> <C> <C>
Computer equipment.................................... $ 394,500 $1,014,741
Software.............................................. 341,187 379,828
Furniture and equipment............................... 69,001 233,148
Leasehold improvements................................ 18,500 61,202
Other................................................. 17,242 23,883
--------- ----------
840,430 1,712,802
Less: Accumulated depreciation........................ (131,185) (498,636)
--------- ----------
Net equipment and leasehold improvements.............. $ 709,245 $1,214,166
========= ==========
</TABLE>
Depreciation expense was approximately $2,319, $156,529 and $387,569, for the
period from July 2, 1996 (inception) to December 31, 1996, and for the years
ended December 31, 1997 and 1998, respectively.
6. CAPITALIZATION
At September 30, 1999, the authorized capital stock of the Company consisted
of 11,500,000 shares of common stock, $.01 par value per share, and 7,000,000
shares of preferred stock, $.01 par value per share. The Company is prohibited
from declaring or paying dividends for as long as there remains any outstanding
shares of preferred stock.
Reorganization
On July 2, 1996, DEN was initially capitalized through the issuance of
115,053 Members' units for total proceeds of $750,000. In early 1997, the
Company adopted a Unit Option Plan and an aggregate of 28,760 options to
purchase Member units were granted at an option price of $10 per unit. In March
1997, the Company received $500,000 in bridge financing in the form of notes
payable from various investors.
On June 2, 1997, DEN was reorganized (Reorganization) into the Company,
whereby all of the Members of DEN received 10 shares of the Company's common
stock for each unit of DEN. Concurrent with the Reorganization, the $500,000
bridge financing notes payable were exchanged for 166,666 shares of Series A-I
preferred stock and each option granted under the Unit Option Plan was
exchanged for 10 stock options under the Company's 1997 Stock Option Plan.
Preferred Stock
The Company's preferred stock is convertible at any time into common stock on
a 1-for-1 basis, subject to certain anti-dilution adjustments, and has the same
voting rights as common stock. On June 3, 2007, or the first date thereafter
that redemption is permitted under Delaware law, the Company is required to
redeem all of the outstanding shares of the preferred stock at the following
amounts: Series A-I (1,666,666 shares) at $6.00 per share; Series A-II (200,000
shares) at $10.00 per share; Series A-III (150,000 shares) at $20.00 per share;
Series A-IV (76,165 shares) at $20.00 per share; Series B (472,000 shares) at
$10.00 per share; Series C (533,334 shares) at $15.00 per share; and Series D
(666,136 shares) at $20.00 per share and Series E shares (1,955,661 shares) at
$20.00 per share. All shares of the preferred stock automatically convert into
shares of common stock in the event of a public offering of common stock, which
generates gross proceeds of at least
F-71
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$30,000,000 with a price per share of at least $20.00. The aggregate redemption
amount is approximately $81,679,000.
In May 1999, the Company issued 76,165 shares of Series A-IV and 1,955,661
shares of Series E redeemable convertible preferred stock for aggregate
consideration of $20,318,260, including $3,995,000 of notes payable and related
accrued interest of $60,260.
The carrying amount of the preferred stock is being increased by periodic
accretions to adjust the amount recorded in the balance sheet to the mandatory
redemption amount at the redemption date.
In March and April 1999, the Company issued convertible promissory notes in
the amount of $3,995,000. The notes payable bear interest at 8% per annum and
were due March 2001. The notes payable automatically converted to 405,526
shares of preferred stock upon the May 1999 issuance of preferred stock.
Warrants
In connection with a third-party agreement (the Agreement--see Note 9), the
Company issued a warrant to purchase the Company's common stock at an exercise
price of $3.00 per share, the estimated fair value of the Company's common
stock at the date of the Agreement. The number of shares subject to the warrant
increases in the event of the occurrence of certain dilution criteria, as
defined in the Agreement. At December 31, 1997 and 1998 and September 30, 1999,
a warrant to purchase 419,224, 715,221 and 1,021,904 shares of the Company's
common stock was outstanding. The estimated fair value of the warrant, as
calculated using the Black-Scholes method at each date of issuance, totaled
$2,290,099 at December 31, 1998 and $4,847,385 at September 30, 1999, and is
being amortized over the initial three-year term of the Agreement or earlier as
the warrant becomes exercisable. During 1997 and 1998, $9,700 and $615,124 was
included in stock compensation expense in the Company's statement of
operations, respectively. The warrant may be exercised at any time on or after
certain triggering events, including an initial public offering by the Company
or the closing of a private round of equity financing at a minimum amount as
defined in the Agreement, or upon the occurrence of certain change of control
events. As a result of the May 1999 issuance of redeemable convertible
preferred stock, the warrants became fully exercisable and the remaining fair
value of the warrant ($4,207,457) was recorded as stock compensation expense in
May 1999.
On January 1, 1999, in connection with an affiliation agreement, the Company
issued a warrant to purchase up to 75,000 shares of common stock at an exercise
price of $10.00 per share. As a result of the May 1999 issuance of redeemable
convertible preferred stock, the warrant became fully exercisable. The
estimated fair value at the date of issuance of $292,500, as calculated using
the Black-Scholes method, was recorded as stock compensation expense in
connection with this warrant during the nine months ended September 30, 1999.
On November 12, 1999, this warrant was terminated in connection with the
termination of the affiliate agreement.
In connection with the convertible promissory notes issued in 1999, warrants
to purchase 39,950 shares of common stock at an exercise price of $10.00 per
share were issued. These warrants expire upon the earlier of an initial public
offering or March 2001. The estimated fair value of the warrants, as calculated
using the present value method, is $230,000 and has been recorded in 1999 as a
reduction to the carrying value of the notes payable and an increase to
additional paid-in capital.
In May 1999, in connection with the issuance of the redeemable convertible
preferred stock, a warrant to purchase 81,315 shares of common stock at an
exercise price of $10.00 per share was issued. The estimated fair value of the
warrant, as calculated using the Black-Scholes method at the date of issuance,
was $483,011
F-72
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and was recorded as a reduction to the redeemable convertible preferred stock
and an increase to additional paid-in capital. The warrant is exercisable until
May 2004.
In applying the Black-Scholes method, the Company has used an expected
dividend yield of zero, a risk-free interest rate of 5% and a volatility factor
of 66%. The lives used to value each of the warrants was based on the term of
each warrant as described above.
7. STOCK OPTION PLAN
Under the Company's 1997 Stock Option Plan (the 1997 Plan), 1,550,000 shares
of common stock are authorized for granting of options to employees, directors
and consultants of the Company as determined by the Compensation Committee of
the Board of Directors.
At December 31, 1998, 224,220 shares were available for future grants.
Options granted generally vest over four years. All options expire 10 years
from date of grant. Vesting generally accelerates upon the Company's initial
public offering or a change in control.
The following table summarizes activity under the 1997 Plan during the years
ended December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
------- --------- --------- ---------
<S> <C> <C> <C> <C>
Outstanding, beginning of year...... -- $ -- 863,660 $2.64
Granted............................. 863,660 $2.64 480,020 $7.31
Canceled............................ -- $ -- (17,900) $6.25
------- ---------
Outstanding, end of year............ 863,660 $2.64 1,325,780 $4.28
======= =========
Exercisable, end of year............ 390,780 $1.53 819,063 $3.19
======= =========
</TABLE>
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1998:
<TABLE>
<CAPTION>
Weighted-
Average
Remaining
Exercise Number Contractual Number
Price Outstanding Life (years) Exercisable
-------- ----------- ------------ -----------
<S> <C> <C> <C>
$ 1.00 287,600 8.4 287,600
3.00 445,410 8.5 252,673
5.00 277,000 8.9 208,790
7.50 197,420 9.2 70,000
10.00 118,350 9.8 --
--------- -------
1,325,780 8.8 819,063
========= =======
</TABLE>
For the nine months ended September 30, 1999, 252,420 options were granted
under the 1997 Plan.
Pursuant to a severance agreement at December 31, 1998, 45,730 stock options
were transferred to a company controlled by a former employee and are accounted
for under the fair value method.
F-73
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has elected to follow APB 25 and related Interpretations in
accounting for its employee stock options. During 1998 compensation expense of
$912,610 for the accelerated vesting of stock options held by terminated
employees was included in stock compensation expense. Had the provisions of
SFAS 123 been used in accounting for employee stock options (calculated using
the minimum value method for nonpublic companies), pro forma net loss
attributable to common stockholders and pro forma net loss per common share
(basic and dilutive) would have been approximately $4,132,000 and $3.58 and
$14,339,000 and $12.12 for the years ended December 31, 1997 and 1998,
respectively.
The weighted-average fair value of options granted during 1997 and 1998 is
estimated at $.61 and $1.66, respectively. The pro forma 1997 and 1998 net loss
impact and the weighted-average fair value of options granted during 1997 and
1998 was estimated using the minimum value option pricing model with a risk-
free interest rate of 6%, an expected life of 4.5 years (5 years in 1997), and
assuming no dividends.
In February 1999 the Company adopted the 1999 Stock Option Plan (the 1999
Plan). The number of shares of common stock subject to the 1999 Plan is
1,300,000 shares. As of September 30, 1999 there were 430,150 options
outstanding under the 1999 Plan. In 1999 all options were granted with an
exercise price of $10.00, the estimated fair value of the Company's common
stock on each date of grant.
8. RETIREMENT PLAN
Effective June 1, 1998, the Company established a defined contribution plan
that includes an employee 401(k) contribution provision covering substantially
all employees. The plan permits eligible employees to make voluntary
contributions on a pretax basis up to a certain limit. The Company does not
currently make contributions to the plan.
9. COMMITMENTS
Operating Leases
The Company leases certain office facilities and equipment under various
operating leases. The future minimum lease payments under noncancelable
operating leases having an initial term longer than one year at December 31,
1998, are as follows:
<TABLE>
<S> <C>
1999................................................................ $281,233
2000................................................................ 223,582
2001................................................................ 227,131
2002................................................................ 96,035
2003................................................................ --
Thereafter.......................................................... --
--------
$827,981
========
</TABLE>
Rent expense for the period July 2, 1996 (inception) to December 31, 1996 and
the years ended December 31, 1997 and 1998, was approximately $5,000, $121,469,
and $245,904, respectively.
License Agreement
In 1997, the Company entered into an agreement with a third party (the
Agreement) pursuant to which the Company was granted certain rights with
respect to brand name, trademarks, URL, historical, current and future content,
advertising and promotion services, and other services. Under the terms of the
Agreement, the
F-74
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company granted warrants (see Note 6) and is required to pay an annual license
fee of $1,000,000 (paid quarterly in equal installments) for a period of three
years. Upon a first and second renewal term as defined in the Agreement, the
Company would have to pay an annual license fee of $1,250,000 and $1,500,000,
respectively. In addition to the license fee, the Company was also required to
pay a $1,500,000 Trigger License Fee as a result of the May 1999 issuance of
redeemable convertible preferred stock.
The rights granted to the Company under the terms of the Agreement extend for
an additional five years upon the successful completion of either a public or
private offering of the Company's securities (trigger events) in which the
amount raised is no less than $15,000,000. The Agreement extends for a further
period of five years based on the Company or its acquirer having publicly
traded securities with a market capitalization of no less than $150,000,000.
The ultimate number of shares issued pursuant to the warrant (see Note 6) will
be determined by: (a) the extent of intervening equity financings prior to
either of the trigger events, and (b) the mutual further agreement of the
parties.
Other
The Company has entered into various Web site tenancy agreements that provide
for the Company to make payments of at least $1,500,000 during 1999, of which
$1,200,000 has been paid through September 30, 1999.
10. CAPITAL LEASES
Total office and computer equipment under capital leases was $240,193, less
accumulated amortization of $36,731, at December 31, 1998. Amortization is
included with depreciation expense. Future minimum lease payments for the
assets under capital leases are as follows:
<TABLE>
<S> <C>
1999............................................................... $115,806
2000............................................................... 96,999
2001............................................................... 63,455
2002............................................................... 13,379
2003............................................................... 4,445
Thereafter......................................................... --
--------
Total minimum lease payments....................................... 294,084
Less: Amount representing interest................................. (39,912)
--------
Present value of net minimum lease payments........................ $254,172
Current portion, included in other accrued expenses................ (93,665)
--------
Long-term obligations at December 31, 1998......................... $160,507
========
</TABLE>
11. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A valuation allowance
has been provided for the net deferred tax asset because of uncertainty
regarding the Company's ability to generate taxable income prior to the
expiration of the carryforward period.
F-75
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Significant components of the Company's deferred income tax assets and
liabilities are as follows at December 31:
<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................... $ 5,734,927 $ 941,300
Stock compensation expense......................... 539,853 --
Research and development credit carryforward....... 80,000 --
Accrued compensation............................... 28,863 8,000
Other.............................................. 38,740 45,700
----------- ---------
Gross deferred tax assets.......................... 6,422,383 995,000
Deferred tax liability:
Intangible amortization............................ (266,174) --
----------- ---------
Net deferred tax assets............................ 6,156,209 995,000
----------- ---------
Less: Valuation allowance.......................... (6,156,209) (995,000)
----------- ---------
$ -- $ --
=========== =========
</TABLE>
The valuation allowance for net deferred tax assets increased $5,161,209 as a
result of the net changes in temporary differences including a $529,554
increase related to the acquisition of Tunes Network.
At December 31, 1998, the Company had net operating loss carryforwards
totaling approximately $14,705,000, which expire beginning in 2011. Based on
the Internal Revenue Code regulations relating to changes in the ownership of
the Company, utilization of the net operating loss carryforwards may be subject
to annual limitations. Because the Company operated as a limited liabilty
company until June 2, 1997, no income taxes were provided for as of December
31, 1996.
12. RELATED PARTY TRANSACTIONS
The Company incurred various operating expenses through JAM Productions Ltd.
(JPL). The Company reimbursed JPL for these expenses, which totaled
approximately $24,000, $90,000, and $75,000 in 1996, 1997 and 1998,
respectively. A stockholder of JPL was the Company's Chairman of the Board
through January 1999.
The Company leases office space from an entity in which the Company's chief
executive officer has an ownership interest. The monthly lease payments are
approximately $18,000 and increase approximately 3% per year.
Prior to 1998, the Company was charged for various services by Imagination
Pilots Entertainment Inc. (IPEI), whose majority stockholder is the Company's
chief executive officer. These services included rent of office facilities, use
of personnel, and other various operating activities. Expenses related to these
services were approximately $75,000 and $95,000 in 1996 and 1997, respectively.
During 1997, the Company purchased certain assets, primarily computer and
other equipment, software, certain intellectual property, and the rights to a
contract for the development of CD-ROM titles, from IPEI and Imagination
Pilots, Inc. (IPI), whose majority stockholder is the Company's chief executive
officer, and
F-76
<PAGE>
TUNES.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
assumed certain IPEI and IPI liabilities, for a total cash purchase price of
$370,000. The purchase price was allocated as follows:
<TABLE>
<S> <C>
Computer and other equipment and software.......................... $309,000
In process research and development................................ 95,000
--------
404,000
Less: Liabilities assumed.......................................... (34,000)
--------
Cash............................................................... $370,000
========
</TABLE>
13. SUBSEQUENT EVENTS
In June 1999, the Company filed a registration statement on Form S-1 with the
Securities and Exchange Commission with respect to a proposed initial public
offering. In August 1999, the Company postponed its initial public offering due
to adverse market conditions, and approximately $1,300,000 in related costs
were charged to general and administrative expenses in October 1999.
In November 1999, the Company entered into a lease facility that allows for
borrowings of up to $1.0 million for equipment purchases made on or prior to
July 31, 2000. Borrowings made under this lease facility are payable over a 36-
month term. At November 30, 1999, the Company had outstanding borrowings of
approximately $400,000 under this facility.
In connection with the amendment of a third-party license agreement (see Note
9), the Company issued a warrant to purchase 2,652,717 shares of the Company's
common stock at an exercise price of $3.00 per share in December 1999.
In November 1999, the Company entered into a merger agreement with EMusic.com
Inc. Under the terms of the agreement, each share of the Company's capital
stock outstanding as of the effective date of the merger will be converted into
that number of shares of the EMusic common stock equal to 10,600,000 divided by
the number of shares of the Company's capital stock outstanding on a fully-
diluted basis as of the effective date of the merger. EMusic.com Inc. will also
assume all outstanding options and warrants to purchase shares of the Company's
capital stock. The merger, subject to shareholder approval, is expected to
close in the first quarter of 2000.
F-77
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Tunes Network, Inc.
We have audited the accompanying balance sheets of Tunes Network, Inc. as of
December 31, 1996 and 1997, and the related statements of operations,
stockholders' equity (deficit) and cash flows for each of the years then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Tunes Network, Inc. at
December 31, 1996 and 1997, and the results of its operations and its cash
flows for each of the years then ended, in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
June 22, 1998
F-78
<PAGE>
TUNES NETWORK, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------- June 30,
1996 1997 1998
--------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash.................................... $ -- $ -- $ 7,217
Accounts receivable..................... 791 13,852 3,841
Advances to shareholders................ 10,220 -- --
Prepaids and other current assets....... 12,474 -- 922
--------- ----------- -----------
Total current assets...................... 23,485 13,852 11,980
Property and equipment, net............... 186,240 172,365 124,737
Other assets.............................. 5,243 13,615 16,853
--------- ----------- -----------
Total assets.............................. $ 214,968 $ 199,832 $ 153,570
========= =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Bank overdraft.......................... $ 9,305 $ 3,309 $ --
Accounts payable........................ 169,639 251,177 371,799
Accrued compensation.................... 222,383 536,557 317,121
Other accrued expenses.................. 6,586 119,969 129,158
Payables to officers.................... 97,816 271,376 275,146
Current obligations under capital
leases................................. 23,701 40,984 44,123
Current obligations under revolving line
of credit with a related party......... -- 185,000 185,000
Convertible note payable to a related
party.................................. -- 50,000 505,000
Notes payable to related parties........ -- 33,465 33,465
Note payable............................ -- 15,000 31,726
Advances from Tunes.com................. -- -- 260,366
--------- ----------- -----------
Total current liabilities................. 529,430 1,506,837 2,152,904
Obligations under capital leases, net of
current portion.......................... 91,895 78,803 63,005
Obligations under revolving line of credit
with a related party..................... 135,000 -- --
Notes payable to related parties, net of
current portion.......................... 11,490 -- --
Bridge financing.......................... -- 465,000 --
Commitments
Stockholders' equity (deficit):
Common stock, no par value; 10,000,000
shares authorized; 1,884,000, 5,940,500
and 7,875,955 shares issued and
outstanding at December 31, 1996 and
1997 and June 30, 1998, respectively... 21,861 351,019 1,147,277
Accumulated deficit..................... (574,708) (2,201,827) (3,209,616)
--------- ----------- -----------
Total stockholders' equity (deficit)...... (552,847) (1,850,808) (2,062,339)
--------- ----------- -----------
Total liabilities and stockholders' equity
(deficit)................................ $ 214,968 $ 199,832 $ 153,570
========= =========== ===========
</TABLE>
See accompanying notes
F-79
<PAGE>
TUNES NETWORK, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended Six months
December 31, ended
---------------------- June 30,
1996 1997 1998
--------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
Revenue................................... $ 62,693 $ 299,116 $ 240,986
Cost of revenue........................... 12,048 247,798 229,122
--------- ----------- -----------
50,645 51,318 11,864
Operating expenses:
Operating and development............... 267,257 737,873 440,208
Sales and marketing..................... 203,336 344,155 2,878
General and administrative.............. 190,966 597,033 499,894
--------- ----------- -----------
661,559 1,679,061 942,980
--------- ----------- -----------
Loss from operations...................... (610,914) (1,627,743) (931,116)
Other income, net......................... -- 10,000 (3,591)
Interest expense.......................... (21,137) (41,661) (73,082)
--------- ----------- -----------
Loss from continuing operations........... (632,051) (1,659,404) (1,007,789)
Income from discontinued operations
(income from operations -- $213,773 and
$5,464 in 1996 and 1997, respectively;
income from disposal--$26,821 in 1997)... 213,773 32,285 --
--------- ----------- -----------
Net loss.................................. $(418,278) $(1,627,119) $(1,007,789)
========= =========== ===========
</TABLE>
See accompanying notes
F-80
<PAGE>
TUNES NETWORK, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Total
Common stock shareholders
-------------------- Accumulated equity
Shares Amount deficit (deficit)
--------- ---------- ----------- ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995.... 1,771,000 $ 18,788 $ (156,430) $ (137,642)
Issuance of common stock to
employees and third parties
in exchange for services..... 113,000 3,073 -- 3,073
Net loss...................... -- -- (418,278) (418,278)
--------- ---------- ----------- -----------
Balance at December 31, 1996.... 1,884,000 21,861 (574,708) (552,847)
Issuance of common stock to
employees and third parties
in exchange for services..... 4,056,500 329,158 -- 329,158
Net loss...................... -- -- (1,627,119) (1,627,119)
--------- ---------- ----------- -----------
Balance at December 31, 1997.... 5,940,500 351,019 (2,201,827) (1,850,808)
Issuance of common stock to
employees and third parties in
exchange for services
(unaudited).................... 989,713 433,810 -- 433,810
Exercise of stock options
(unaudited).................... 660,092 237,448 -- 237,448
Conversion of notes payable to
common stock (unaudited)....... 285,650 125,000 125,000
Net loss (unaudited)............ -- -- (1,007,789) (1,007,789)
--------- ---------- ----------- -----------
Balance at June 30, 1998
(unaudited).................... 7,875,955 $1,147,277 $(3,209,616) $(2,062,339)
========= ========== =========== ===========
</TABLE>
See accompanying notes
F-81
<PAGE>
TUNES NETWORK, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December
31, Six months
---------------------- ended June
1996 1997 30, 1998
--------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.................................. $(418,278) $(1,627,119) $(1,007,789)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization........... 60,826 105,868 57,736
Common stock issued to employees and
third parties in exchange for
services............................... 3,073 329,158 433,810
Stock compensation expense.............. -- -- 203,628
Changes in operating assets and
liabilities:
Accounts receivable................... (791) (13,061) 10,011
Advances to shareholders.............. (10,220) 10,220 --
Prepaids and other current assets..... (8,536) 12,474 (922)
Other assets.......................... (9,586) (8,372) (3,238)
Accounts payable...................... 106,074 81,538 120,622
Accrued compensation.................. 139,472 314,174 (219,436)
Other accrued expenses................ 2,322 113,383 9,189
--------- ----------- -----------
Net cash used in operating activities..... (135,644) (681,737) (396,389)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment........ (28,650) (66,014) (10,108)
--------- ----------- -----------
Net cash used in investing activities..... (28,650) (66,014) (10,108)
CASH FLOWS FROM FINANCING ACTIVITIES
Bank overdraft............................ 7,985 (5,996) (3,309)
Proceeds from payables to officers........ 145,385 316,700 3,770
Repayment of payables to officers......... (47,569) (143,140) --
Proceeds from revolving line of credit
with a related party..................... 135,000 50,000 --
Proceeds from convertible note payable to
a related party.......................... -- 50,000 115,000
Proceeds from notes payable to related
parties.................................. -- 25,000 --
Repayment of notes payable to related
parties.................................. (7,260) (3,025) 16,726
Proceeds from notes payable............... -- 15,000 --
Proceeds from bridge financing............ -- 465,000 --
Repayment of lease obligations............ (69,247) (21,788) (12,659)
Proceeds from exercise of stock options... -- -- 33,820
Advances from Tunes.com................... -- -- 260,366
--------- ----------- -----------
Net cash provided by financing
activities............................... 164,294 747,751 413,714
--------- ----------- -----------
Net increase in cash and cash
equivalents.............................. -- -- 7,217
Cash and cash equivalents at beginning of
period................................... -- -- --
--------- ----------- -----------
Cash and cash equivalents at end of
period................................... $ -- $ -- $ 7,217
========= =========== ===========
SUPPLEMENTAL DISCLOSURE:
Cash paid for interest.................. $ 15,735 $ 24,571 $ 15,813
========= =========== ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Purchase of property and equipment under
capital lease obligations.............. $ 112,934 $ 25,979 $ --
========= =========== ===========
Notes payable converted to shares of
common stock........................... $ -- $ -- $ 125,000
========= =========== ===========
</TABLE>
See accompanying notes
F-82
<PAGE>
TUNES NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS
(Information with respect to the six-month period ended June 30, 1998
is unaudited)
1. NATURE OF BUSINESS
Tunes Network, Inc. (the "Company"), a California corporation, formerly Surf
Communications, Inc., was incorporated on April 19, 1994 as a provider of
Internet access services. In 1996, the Company expanded its strategy to include
music entertainment. The Company is currently a developer of music-related Web
site technology and content and an online retailer of CDs. The Company
contracts with outside warehouses for fulfillment services to deliver products
to customers and, therefore, the Company maintains no inventories. The Company
sells its products and services primarily to customers in the United States.
In December 1997, the Company discontinued its Internet access services
business and sold this business. The operations of the Internet access services
business have been accounted for as a discontinued operation.
2. BASIS OF PRESENTATION
The financial statements of the Company as of June 30, 1998 and for the six-
month period ended June 30, 1998 contain all adjustments and accruals
(consisting of normal recurring adjustments) which, in the opinion of
management, are necessary for a fair presentation of the financial position and
operating results of the interim period presented.
3. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amount of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated on the
straight-line method over the estimated useful lives of the assets, generally
three years. Assets under capital leases are amortized using the straight-line
method over the shorter of the estimated useful lives or the remaining lease
terms, generally three years.
REVENUE RECOGNITION
Revenue from CD sales, which consists primarily of recorded music sold via the
Internet, includes outbound shipping and handling charges and are recognized
when the products are shipped. Allowances for credit losses and for estimated
returns are recorded upon recognition of revenue. Actual credit losses and
returns have been insignificant to date. Revenue from services, including music
encoding, and Web site development services is recognized after the services
have been performed and collection of the related receivable is considered
probable.
Revenue from one customer accounted for 80% of revenues for the year ended
December 31, 1996. Revenue from a different customer accounted for 27% of
revenues for the year ended December 31, 1997.
The Company does not perform credit evaluations and does not require collateral
from customers.
F-83
<PAGE>
TUNES NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
(Information with respect to the six-month period ended June 30, 1998
is unaudited)
Operating and Development
Costs to develop the Company's products are expensed as incurred in accordance
with Statement of Financial Accounting Standards No. 2, "Accounting for
Research and Development Costs," which established accounting and reporting
standards for research and development costs.
Operating and development expenses consist principally of payroll and related
expenses for development, editorial, and network operations personnel and
consultants and expenses for systems and telecommunications infrastructure.
Internally Developed Systems and Software
The costs to develop internal systems and software, primarily payroll and
related expenses for development and design of software, are charged to expense
as incurred.
Dependence on Suppliers
The Company's primary provider of order fulfillment for recorded music titles
is Valley Record Distributors ("Valley"). The Company has no fulfillment
operation or facility of its own and, accordingly, is dependent upon
maintaining its existing relationship with Valley or establishing a new
fulfillment relationship with one of the few other fulfillment operations.
There can be no assurance that the Company will maintain its relationship with
Valley beyond the term of its existing two-year agreement, which expires in
September 1998, or that it will be able to find an alternative, comparable
vendor capable of providing fulfillment services on terms satisfactory to the
Company, should its relationship with Valley terminate. Valley accounted for
79% of the cost of sales for the years ended 1996 and 1997. The Company has the
right to offset accounts receivable from and accounts payable to Valley. As a
result, the accounts receivable were used to reduce the accounts payable in the
accompanying balance sheet.
4. DISCONTINUED OPERATION
In September 1997, the Company decided to discontinue the Internet access
services line of business and sold that line of business in December 1997 for
$25,000. Income on disposal included the $25,000 cash proceeds and operating
income from September 1997 through December 1997 of $1,821. Revenues from the
Internet access services line of business were $450,000 and $156,618 in 1996
and 1997, respectively. No assets or liabilities were sold as a result of this
disposition. The results of operations of the Internet access services line of
business is shown as a discontinued operation for all periods presented.
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31,
------------------
1996 1997
-------- --------
<S> <C> <C>
Computer software and equipment........................ $241,278 $324,172
Furniture and fixtures................................. 8,915 18,014
-------- --------
250,193 342,186
Less accumulated depreciation and amortization......... (63,953) (169,821)
-------- --------
Property and equipment, net............................ $186,240 $172,365
======== ========
</TABLE>
F-84
<PAGE>
TUNES NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
(Information with respect to the six-month period ended June 30, 1998
is unaudited)
Total property and equipment under capital leases was $186,877 and $212,856,
less accumulated amortization of $42,268 and $98,616, at December 31, 1996 and
1997, respectively.
6. DEBT
Payables to Officers
Payables to officers represent amounts loaned to the Company by officers for
purposes of sustaining the Company's operations. Payables for $61,664 and
$218,474 at December 31, 1996 and 1997, respectively, bear interest at 15% per
annum. The remaining payables do not bear interest. Payables are repaid as
Company funds are available.
Revolving Line of Credit
In April 1996, the Company entered into a $50,000 revolving line-of-credit
agreement (the "Agreement") with an officer of the Company. This line of credit
was increased to $135,000 in October 1996, $185,000 in January 1997 and
$200,000 in May 1997. The Agreement bears interest at 10.14% and 9.89% at
December 31, 1996 and 1997, respectively, per annum. Interest is payable
monthly. The Agreement expires on June 20, 1998, at which time all outstanding
interest and principal under the Agreement will become due and payable.
Additionally, should the Company receive funding or achieve a significant
income event before June 20, 1998, the balance outstanding under this Agreement
shall become due and payable. Borrowings outstanding under the Agreement are
collateralized by substantially all of the Company's assets not otherwise
encumbered and are personally guaranteed by an officer of the Company.
Convertible Note Payable to a Related Party
In November 1997, the Company entered into an agreement with an investor, who
is an advisory board member of the Company, under which it borrowed $50,000
issued under a convertible promissory note, with interest at 12% per annum.
Under the terms of the agreement, principal and interest are due and payable on
the earlier of 12 months from the date of the agreement, or, in the event of a
default, amounts are declared due and payable by the investor, unless such
amounts are automatically converted into equity securities of the Company
pursuant to the terms of the agreement.
The note will convert into equity upon the closing of the next equity
financing, completed before September 30, 1998, in which the Company receives
aggregate offering proceeds valued by the Company at more than $250,000. At
such time, the investor shall receive, in full satisfaction of amounts owing
under the note, a number of equity securities equal to the quotient of the
amount of the loan divided by 72.5% of the price per equity security paid by
participants in the next equity financing. The investor will be entitled to all
rights granted to participants in the next equity financing.
Additionally, upon the closing of the next equity financing, the investor shall
receive an option to purchase a certain number of shares of common stock of the
Company based on the pre-money valuation of the next equity financing. In no
event shall the number of shares of common stock under the option be less than
50,000. The option will be fully vested upon the closing of the next equity
financing.
In the event of any liquidation, dissolution or winding up of the Company,
prior and in preference to any distribution of any of the assets of the Company
to any investor or to the holders of any equity security, the investors will be
entitled to, at the investors' election, either a repayment of all amounts due
under the loan, or
F-85
<PAGE>
TUNES NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(Information with respect to the six-month period ended June 30, 1998
is unaudited)
to convert the principal amount into the most senior equity securities then
authorized by the Articles of Incorporation of the Company at a price per share
that would cause the Company to be valued at $3,500,000.
Notes Payable to Related Parties
In December 1995, the Company entered into a promissory note (the "Note") for
$18,750 with the father of an officer of the Company. The Note bears interest
at 10% per annum. Interest and principal are due monthly in equal monthly
payments of $605 commencing on January 1, 1996. The balance of this Note,
including accrued interest, shall be due and payable in full on or before
December 1, 1998. Borrowings outstanding under the Note are collateralized by
substantially all of the Company's assets not otherwise encumbered (see Note
11).
In December 1997, the Company entered into a promissory note (the "Note") for
$25,000 with an investor. The Note bears interest at 6% per annum. Interest and
principal are due on or before May 22, 1998 (see Note 11).
Notes Payable
In November 1997, the Company entered into a promissory note (the "Note") for
$15,000 with a lender. The Note bears interest at the prime rate plus 2% (10.5%
at December 31, 1997) per annum. Interest and principal are due and payable on
the earlier of the date on which the lender shall purchase all or substantially
all of the assets of the borrower or January 30, 1998 (see Note 11).
Bridge Financing
In 1997, the Company entered into bridge financing agreements with certain
investors under which it borrowed $465,000. Under the terms of the agreements,
upon the closing of the next equity financing as defined in the agreements, in
which the Company receives aggregate offering proceeds valued by the Company at
more than $1,000,000, the investors shall receive a number of equity securities
equal to the quotient of the amount of the funds delivered by the investors
divided by 50% of the price per equity security paid by participants in the
next equity financing. The investors will be entitled to all rights granted to
participants in the next equity financing.
In March 1998, the Company entered into bridge financing agreements with
certain investors under which it borrowed $115,000 issued under convertible
promissory notes, with interest at 6% per annum (see Note 11).
7. LEASE COMMITMENTS
If the investors have not received equity securities pursuant to this agreement
before the closing of a corporate sale transaction, as defined in the
agreement, the investors shall receive from the Company the most senior equity
securities then authorized by the Articles of Incorporation of the Company
valued at an amount equal to 200% of the amount of the funds delivered by the
investors.
The Company leases certain office facilities under noncancelable operating
leases. The Company leases equipment under capital leases. Interest rates on
capital leases range from 12% to 21%.
F-86
<PAGE>
TUNES NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS-(Continued)
(Information with respect to the six-month period ended June 30, 1998
is unaudited)
Future minimum lease payments under capital leases and noncancelable operating
leases with initial terms of one year or more at December 31, 1997, are as
follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
-------- ---------
<S> <C> <C>
1998...................................................... $53,565 $28,200
1999...................................................... 52,481 --
2000...................................................... 34,416 --
2001...................................................... 1,284 --
-------- -------
Total minimum lease payments.............................. 141,746 $28,200
=======
Less amount representing interest......................... 21,959
--------
Present value of net minimum lease payments............... 119,787
Less current portion...................................... 40,984
--------
$ 78,803
========
</TABLE>
Rent expense for the years ended December 31, 1996 and 1997 was $22,953 and
$56,468, respectively.
8. STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock
Common stock represents the deemed fair value of services contributed to the
Company by employees and third parties in 1996 and 1997. In November 1997, all
employee stockholders of the Company entered into restricted common stock
purchase agreements under which all common shares granted to such employee
stockholders through October 1997 were vested 25% on October 20, 1997 and vest
1/48 per month thereafter. Additionally, such shares will vest immediately upon
the sale of substantially all of the Company's assets. At December 31, 1997,
5,336,407 common shares were vested.
9. INCOME TAXES
The Company uses the liability method to account for income taxes as required
by Financial Accounting Standards Board Statement No. 109, "Accounting for
Income Taxes." Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities. Deferred tax assets and liabilities are measured using
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
Significant components of the Company's deferred tax assets are as follows (in
thousands):
<TABLE>
<CAPTION>
December 31,
--------------
1996 1997
------ ------
<S> <C> <C>
Net operating loss carryforwards........................... $ 94 $530
Research and development credit carryforwards.............. -- 80
Accrued compensation....................................... -- 215
------ ------
Total deferred tax assets.................................. 94 825
Valuation allowance........................................ (94) (825)
------ ------
Net deferred tax assets.................................... $ -- $ --
====== ======
</TABLE>
F-87
<PAGE>
TUNES NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(Information with respect to the six-month period ended June 30, 1998
is unaudited)
The valuation allowance increased by $94,000 and $731,000 in the years ended
1996 and 1997, respectively.
At December 31, 1997, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $1,300,000 which expire in the tax
years 2011 through 2012. The Company has federal tax credit carryforwards of
approximately $50,000 which expire in the year 2012.
Because of the "change in ownership" provisions of the Internal Revenue Code of
1986, a portion of the Company's net operating loss carryforwards and tax
credit carryforwards may be subject to an annual limitation regarding their
utilization against taxable income in future periods. As a result of the annual
limitation, a portion of these carryforwards may expire before ultimately
becoming available to reduce future income tax liabilities.
10. DISPUTE SETTLEMENT
In March 1998, a former consultant of the Company filed a suit against the
Company. In May 1998, the Company entered into a settlement agreement with the
former consultant. In connection with this settlement, the former consultant
received $31,989 for wages earned during employment with the Company from
January 1998 to March 1998, and an option, effective upon the time of the
acquisition of the Company by JAMtv, to purchase 445,834 shares of common stock
of the Company at $.10 per share which was, as required under the terms of the
agreement, automatically exercised in full upon the effective time of the
acquisition (see Note 11).
11. SUBSEQUENT EVENT
Effective July 1, 1998, substantially all of the Company's business was merged
with and into Tunes Acquisition Corp., a wholly owned subsidiary of Tunes.com
Inc, formerly JAMtv Corporation. In connection with this merger, all
outstanding debt was assumed by Tunes.com Inc. and repaid in 1998.
12. RISKS ASSOCIATED WITH THE YEAR 2000 (UNAUDITED)
Although the Company is not aware of any material operational issues or costs
associated with preparing its internal systems for the year 2000, there can be
no assurance that the Company will not experience serious unanticipated
negative consequences and/or material costs caused by undetected errors or
defects in the technology used in its internal systems, which include third-
party software and hardware technology.
F-88
<PAGE>
[LOGO OF eMUSIC APPEARS HERE]
<PAGE>
- --------------------------------------------------------------------------------
[LOGO OF EMUSIC.COM INC.]
13,434,102 Shares
Common Stock
-----------------
PROSPECTUS
-----------------
December , 1999
- --------------------------------------------------------------------------------
You should rely only on the information contained in this prospectus. No
dealer, salesperson or other person is authorized to give information that is
not contained in this prospectus. This prospectus is not an offer to sell nor
is it seeking an offer to buy these securities in any jurisdiction where the
offer or sale is not permitted. The information contained in this prospectus is
correct only as of the date of this prospectus, regardless of the time of the
delivery of this prospectus or any sale of these securities.
<PAGE>
Part II
Information Not Required in Prospectus
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses, other than underwriting
discounts and commissions, to be paid by the Registrant in connection with this
offering. All amounts shown are estimates except for the SEC registration fee.
<TABLE>
<S> <C>
SEC registration fee................................................... $ 553
Nasdaq National Market additional listing fee.......................... 2,000
Printing expenses...................................................... 5,000
Legal fees and expenses................................................ 20,000
Accounting fees and expenses........................................... 10,000
Transfer Agent and Registrar fees...................................... 1,000
Miscellaneous expenses................................................. 1,000
-------
Total................................................................ $39,553
=======
</TABLE>
Item 14. Indemnification of Officers and Directors
Section 145 of the Delaware General Corporation Law permits indemnification of
officers, directors and other corporate agents under certain circumstances and
subject to certain limitations. The Registrant's Amended and Restated
Certificate of Incorporation and Bylaws provide that the Registrant shall
indemnify its directors, officers, employees and agents to the full extent
permitted by Delaware General Corporation Law, including in circumstances in
which indemnification is otherwise discretionary under Delaware law. In
addition, the Registrant has entered into separate indemnification agreements
(Exhibit 10.1) with its directors and officers which would require the
Registrant, among other things, to indemnify them against certain liabilities
which may arise by reason of their status or service (other than liabilities
arising from willful misconduct of a culpable nature). The Registrant also
intends to continue to maintain director and officer liability insurance, if
available on reasonable terms. These indemnification provisions and the
indemnification agreements may be sufficiently broad to permit indemnification
of the Registrant's officers and directors for liabilities (including
reimbursement of expenses incurred) arising under the Securities Act.
Item 15. Recent Sales of Unregistered Securities
On May 6, 1998, we issued 2,500,000 shares of our common stock and warrants to
purchase a total of 500,000 shares of our common stock at an exercise price of
$1.00 per share to accredited investors in exchange for $500,000.00 in reliance
on Rule 504 of Regulation D promulgated under the Securities Act. Warrants to
purchase 200,000 shares of common stock were exercised at the time of their
issuance.
On May 11, 1998, we acquired all of the outstanding shares of GoodNoise
Corporation, a Delaware corporation, in exchange for 11,015,300 shares of our
common stock in reliance on Section 4(2) of the Securities Act. On the same
date, we assumed options to purchase 1,722,500 shares of the Delaware
corporation's common stock, which were automatically converted into options to
purchase 2,032,550 shares of our common stock at a weighted average exercise
price of approximately $0.03 per share.
On July 29, 1998, we issued 170 shares of our common stock to a consultant in
exchange for consulting services in reliance on Section 4(2) of the Securities
Act.
II-1
<PAGE>
On August 10, 1998, investors exercised warrants to purchase 300,000 shares of
our common stock in exchange for $300,000. These warrants had been issued as a
part of the private placement which occurred on May 6, 1998.
On October 28, 1998, we issued 500 shares of our Series A Preferred Stock and a
warrant to purchase 100,000 shares of our common stock at an exercise price of
$7.91 to an investor in reliance on Regulation D.
On December 16, 1998, we issued 10,000 shares of our common stock to an
employee upon exercise of an employee stock option in reliance on Rule 701.
On February 24, 1999, we acquired all of the outstanding shares of Creative
Fulfillment, Inc. in exchange for 630,179 shares of our common stock in
reliance on Section 4(2) of the Securities Act.
On March 23, 1999, we issued 117,570 shares of our Series B Preferred Stock to
accredited investors in exchange for $32,523,900.00 in cash, cancellation of
debt of $1,777,250 and conversion of the outstanding shares of our Series A
Preferred Stock in reliance on Rule 506 of Regulation D promulgated under the
Securities Act.
On April 27, 1999, we issued 665,188 shares of our common stock in
consideration of the acquisition of certain music rights in reliance on Section
4(2) of the Securities Act.
On June 11, 1999, we issued 448,000 shares of our common stock in exchange for
all of the outstanding shares of Internet Underground Music Archive, Inc. in
reliance on Section 4(2) of the Securities Act.
On June 10, 1999 we granted warrants for the purchase of 1,607,800 shares
solely to accredited investors in reliance on Regulation D.
From May 11, 1998 through September 20, 1998, we granted options to purchase
435,000 shares of our common stock at a weighted average exercise price of
approximately $5.07 per share. These options were granted to our employees and
consultants in exchange for services rendered in transactions exempt from
registration under the Securities Act under Rule 701. From September 21, 1998
through July 15, 1999, we granted options to purchase 4,186,000 shares of our
common stock at a weighted average purchase price of approximately $7.078 per
share. These options were granted to our employees and consultants in exchange
for services rendered in transaction exempt from registration under the
Securities Act under Section 4(2) thereof.
In December 1999, we issued approximately 2,100,000 shares in connection with
our acquisition of Cductive. Such issuance was made in reliance on Regulation
D.
There were no underwriters employed in connection with any of the above
transactions.
II-2
<PAGE>
Item 16. Exhibits and Financial Statement Schedules
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
2.1(a) Agreement and Plan of Reorganization by and among GoodNoise
Corporation, Atlantis Ventures Corp., GN Acquisition Corp and certain
other parties dated as of May 11, 1998
2.2(a) Agreement and Plan of Reorganization by and among GoodNoise
Corporation, Creative Fulfillment, Inc., GN Acquisition Corp and
certain other parties dated as of October 8, 1998
2.3(c) Agreement and Plan of Reorganization by and among GoodNoise
Corporation, GNA Corporation, Internet Underground Music Archive, Inc.
and certain shareholders of Internet Underground Music Archive, Inc.
dated as of May 16, 1999
2.4(b) Agreement and Plan of Merger by and between EMusic.com Inc., a Florida
corporation, and EMusic.com Inc., a Delaware corporation, dated as of
July 21, 1999
2.5(d) Agreement and Plan of Reorganization by and among EMusic.com Inc., GNA
Corporation, Group K Inc., d.b.a. Cductive and the principal
shareholders of Cductive, dated as of November 15, 1999.
2.6(e) Agreement and Plan of Reorganization dated as of November 29, 1999,
among EMusic.com Inc., GNB Corporation and Tunes.com Inc.
3.1(c) Amended and Restated Certificate of Incorporation
3.2(c) Amended and Restated Bylaws
5.1* Opinion of Gray Cary Ware & Freidenrich LLP
10.1(c) Form of Indemnity Agreement
10.2(a) Stock Purchase Agreement dated as of March 30, 1998 with Gary
Culpepper
10.3(a) 1998 Stock Option Plan
10.4(c) 1998 Nonstatutory Stock Option Plan
10.5(c) 1999 Employee Stock Purchase Plan
10.6(c) Form of Amendment to Investor Rights Agreement dated July 19, 1999
21(c) Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Gray Cary Ware & Freidenrich LLP (included in Exhibit 5.1)
23.3 Consent of Ernst & Young LLP
23.4 Consent of Richard A. Eisner & Company LLP
24.1* Power of Attorney
27.1* Financial Data Schedule
</TABLE>
- ------------------
(a) Previously filed as an exhibit to the Registrant's Form 10-SB/A dated
December 24, 1998.
(b) Previously filed as an exhibit to the Registrant's Form 8-K dated July 23,
1999.
(c) Previously filed as an exhibit to the Registrant's Form S-1 (Registration
Statement No. 333-83685).
(d) Previously filed as an exhibit to the Registrant's Form 8-K dated November
15, 1999.
(e) Previously filed as an exhibit to the Registrant's From 8-K dated November
29, 1999.
* Previously filed.
Item 17. Undertakings
The Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933 (the "Securities Act");
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the
II-3
<PAGE>
form of prospectus filed with the Commission pursuant to Rule 424(b)
if, in the aggregate, the changes in volume and price represent no more
than a 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective
registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement;
provided, however, that paragraphs (a)(1)(i) and (a)(1)(ii) do not
apply if the information required to be included in a post-effective
amendment by those paragraphs is contained in periodic reports filed by
the Registrant pursuant to Section 13 or Section 15(d) of the
Securities Exchange Act of 1934 that are incorporated by reference in
the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to
be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the
termination of the offering.
Insofar as indemnification by the Registrant for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Registrant pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission, such indemnification is against public policy as expressed in the
Securities Act, and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer, or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by EMusic pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at the time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
Signatures
In accordance with the requirements of the Securities Act of 1933, EMusic
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-1 and has duly caused this Amendment No. 1 to
the registration statement on Form S-1 to be signed on its behalf by the
undersigned, in the City of Redwood City, State of California, on the 22nd day
of December, 1999.
EMUSIC.COM INC.
/s/ Peter M. Astiz
By: _________________________________
Peter M. Astiz
Executive Vice President
Pursuant to the requirements of the Securities Act, this Registration Statement
has been signed by the following persons in the capacities and on the dates
indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
* Chairman of the Board and December 22, 1999
______________________________________ Assistant Secretary
Robert H. Kohn
* President, Chief Executive December 22, 1999
______________________________________ Officer and Director
Gene Hoffman, Jr. (Principal Executive
Officer)
* Executive Vice President December 22, 1999
______________________________________ and Chief Financial
Joseph H. Howell Officer (Principal
Financial and Accounting
Officer)
* Director December 22, 1999
______________________________________
Ralph Peer, II
* Director December 22, 1999
______________________________________
Tor Braham
* Director December 22, 1999
______________________________________
Ed Rosenblatt
/s/ Peter M. Astiz
*By: _________________________________
Peter M. Astiz
Attorney-in-Fact
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
2.1(a) Agreement and Plan of Reorganization by and among GoodNoise
Corporation, Atlantis Ventures Corp., GN Acquisition Corp and certain
other parties dated as of May 11, 1998
2.2(a) Agreement and Plan of Reorganization by and among GoodNoise
Corporation, Creative Fulfillment, Inc., GN Acquisition Corp and
certain other parties dated as of October 8, 1998
2.3(c) Agreement and Plan of Reorganization by and among GoodNoise
Corporation, GNA Corporation, Internet Underground Music Archive, Inc.
and certain shareholders of Internet Underground Music Archive, Inc.
dated as of May 16, 1999
2.4(b) Agreement and Plan of Merger by and between EMusic.com Inc., a Florida
corporation, and EMusic.com Inc., a Delaware corporation, dated as of
July 21, 1999
2.5(d) Agreement and Plan of Reorganization by and among EMusic.com Inc., GNA
Corporation, Group K Inc., d.b.a. Cductive and the principal
shareholders of Cductive, dated as of November 15, 1999.
2.6(e) Agreement and Plan of Reorganization dated as of November 29, 1999,
among EMusic.com Inc., GNB Corporation and Tunes.com Inc.
3.1(c) Amended and Restated Certificate of Incorporation
3.2(c) Amended and Restated Bylaws
5.1* Opinion of Gray Cary Ware & Freidenrich LLP
10.1(c) Form of Indemnity Agreement
10.2(a) Stock Purchase Agreement dated as of March 30, 1998 with Gary
Culpepper
10.3(a) 1998 Stock Option Plan
10.4(c) 1998 Nonstatutory Stock Option Plan
10.5(c) 1999 Employee Stock Purchase Plan
10.6(c) Form of Amendment to Investor Rights Agreement dated July 19, 1999
21(c) Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Gray Cary Ware & Freidenrich LLP (included in Exhibit 5.1)
23.3 Consent of Ernst & Young LLP
23.4 Consent of Richard A. Eisner & Company LLP
24.1* Power of Attorney
27.1* Financial Data Schedule
</TABLE>
- ------------------
(a) Previously filed as an exhibit to the Registrant's Form 10-SB/A dated
December 24, 1998.
(b) Previously filed as an exhibit to the Registrant's Form 8-K dated July 23,
1999.
(c) Previously filed as an exhibit to the Registrant's Form S-1 (Registration
Statement No. 333-83685).
(d) Previously filed as an exhibit to the Registrant's Form 8-K dated November
15, 1999.
(e) Previously filed as an exhibit to the Registrant's Form 8-K dated November
29, 1999.
* Previously filed.
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this Registration Statement on Form S-1 of
our report dated July 26, 1999 relating to the financial statements of
EMusic.com Inc. (formerly Goodnoise Corporation), our report dated March 31,
1999 relating to the financial statements of Creative Fulfilment Inc., and our
report dated July 21, 1999 relating to the financial statements of Internet
Underground Music Archive Inc. ("IUMA") which appear in such Registration
Statement. We also consent to the reference to us under the heading "Experts"
in such Registration Statement.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
San Jose, California
December 21, 1999
<PAGE>
EXHIBIT 23.3
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our report dated January 26, 1999, with respect to the consolidated
financial statements of Tunes.com, Inc. and to the use of our report dated June
22, 1998, with respect to the financial statements of Tunes Network, Inc.
included in Amendment No.1 to the Registration Statement (Form S-1 No. 333-
88969) and related Prospectus of EMusic.com, Inc. for the registration of
13,434,102 shares of its common stock.
/s/ Ernst & Young LLP
Chicago, Illinois
December 21, 1999
<PAGE>
EXHIBIT 23.4
INDEPENDENT AUDITORS' CONSENT
We consent to the inclusion in the Registration Statement of EMusic.com Inc. on
Amendment No. 1 of Form S-1 of our report dated November 19, 1999, on our
audits of the financial statements of Group K Inc. as of December 31, 1998 and
1997 and for the period June 16, 1997 (inception) through December 31, 1998,
the year ended December 31, 1998 and the period June 16, 1997 (inception)
through December 31, 1997 and to the reference to our firm under the caption
"Experts".
/s/ Richard A. Eisner & Company, LLP
New York, New York
December 20, 1999
