<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
FORM 10-Q
Quarterly Report Pursuant To Section 13 Or 15(D) Of The Securities Exchange Act
Of 1934
For the quarterly period ended September 30, 1999
Commission File No. 0-24671
EMUSIC.COM INC.
(Exact Name of small business issuer as specified in its charter)
Delaware 94-3290594
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1991 Broadway, 2nd Floor
Redwood City, California 94063
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 216-0200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, $0.001 Par Value 34,001,822
(Class) (Outstanding at October 31, 1999)
<PAGE>
EMUSIC.COM INC.
FORM 10-Q
INDEX
<TABLE>
<S> <C>
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - September 30, 1999 and June 30, 1999.............. 1
Condensed Consolidated Statements of Operations - three months ended
September 30, 1999, September 30, 1998 and January 8, 1998 (Inception) to
September 30, 1999....................................................................... 2
Condensed Consolidated Statements of Cash Flows - three months ended September 30,
1999, September 30, 1998 and January 8, 1998 (Inception) to September 30, 1999........... 3
Notes to Financial Statements............................................................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 22
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................................................. 23
Item 6. Exhibits and Reports on Form 8-K.......................................................... 24
Signatures......................................................................................... 25
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
PART I: FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
EMusic.com Inc.
(a development stage enterprise)
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
September 30, 1999 June 30, 1999
------------------------- -------------------------
Assets
<S> <C> <C>
Current Assets:
Cash........................................................ $ 78,904 $ 19,002
Accounts receivable......................................... 168 51
Prepaid expenses and other assets........................... 9,531 224
------------------------- -------------------------
Total current assets..................................... 88,603 19,277
Property and equipment, net................................... 1,989 1,076
Music content, net............................................ 11,746 8,758
Trade names, net.............................................. 22,397 24,680
Other assets.................................................. 430 430
------------------------- -------------------------
Total assets........................................... $ 125,165 $ 54,221
========================= =========================
Liabilities, Redeemable Convertible Preferred Stock and
Stockholders' Equity
Current Liabilities:
Accounts payable............................................ $ 406 $ 637
Accrued liabilities......................................... 1,829 1,679
Dividends payable on preferred stock........................ 1,061 -
Accrued compensation and related benefits................... 430 368
------------------------- -------------------------
Total current liabilities................................ 3,726 2,684
------------------------- -------------------------
Redeemable Convertible Preferred Series B Stock - 31,981
Dividends payable on preferred stock - 569
Stockholders' Equity:
Preferred stock, $0.001 par value........................... - -
Common stock, $0.001 par value.............................. 34 17
Additional paid-in capital.................................. 184,498 67,827
Deficit accumulated during the development stage............ (63,093) (48,857)
------------------------- -------------------------
Total stockholders' equity................................ 121,439 18,987
------------------------- -------------------------
Total liabilities, redeemable convertible preferred
stock and stockholders' equity........................ $ 125,165 $ 54,221
========================= =========================
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
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EMUSIC.COM INC.
(a development stage enterprise)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months Three months January 8, 1998
ended ended (Inception) to
September 30, September 30, September 30,
1999 1998 1999
---- ---- ----
<S> <C> <C> <C>
Revenues................................................ $ 180 $ 12 $ 272
Cost of revenues........................................ 25 - 52
----------- ----------- -----------
Gross profit............................................ 155 12 220
----------- ----------- -----------
Operating expenses:
Product development................................... 6,011 667 18,662
Selling and marketing................................. 4,771 - 5,327
General and administrative............................ 812 197 2,630
Amortization of trade names........................... 2,283 - 3,965
----------- ----------- -----------
Total operating expenses.......................... 13,877 864 30,584
Operating loss.......................................... (13,722) (852) (30,364)
Interest and other income, net.......................... 203 3 525
----------- ----------- -----------
Net loss................................................ $ (13,519) $ (849) $ (29,839)
----------- ----------- -----------
Accretion of Series A Preferred Stock................... - - (25)
Beneficial conversion charge, Series A Preferred Stock.. - - (144)
Accretion of Series B Preferred to redemption value..... (224) - (446)
Beneficial conversion charge, Series B Preferred Stock.. - - (31,577)
Dividend on Series B Preferred Stock (Note 3)........... (493) - (1,062)
----------- ----------- -----------
Net loss applicable to common shares.................... $ (14,236) $ (849) $ (63,093)
=========== =========== ===========
Net loss per Common share-basic and diluted............. $(1.09) $(0.06) $(5.03)
=========== =========== ===========
Weighted average common shares outstanding - basic
and diluted............................................ 13,057,809 14,591,336 12,542,537
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
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EMUSIC.COM INC.
(a development stage enterprise)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three months Three months January 8, 1998
ended ended (Inception) to
September 30, September 30, September 30,
1999 1998 1999
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss....................................................... $(13,519) $ (849) $(29,839)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation.................................................... 200 5 296
Amortization of trade names..................................... 2,283 - 3,965
Loan interest converted into Series B preferred stock........... - - 34
Amortization of music content................................... - - 2
Issuance of common stock in exchange for services............... - - 13
Fair value of warrants issued to advisors....................... 2,687 - 8,369
Fair value of options issued to advisors........................ 1,273 96 4,404
Changes in assets and liabilities, net of effects of mergers:
Accounts receivable.......................................... (117) (12) (168)
Prepaid expenses and other assets............................ (7,336) (47) (7,990)
Accounts payable............................................. (231) 93 (15)
Accrued liabilities.......................................... (946) - (243)
Accrued payroll and related benefits......................... 62 (2) 231
-------- -------- --------
Net cash provided by (used in) operating activities......... (15,644) (716) (20,941)
-------- -------- --------
Cash flows from investing activities:
Purchase of trade names......................................... - - (468)
Purchase of music content....................................... (2,988) - (10,305)
Purchase of property and equipment.............................. (1,113) (21) (2,241)
-------- -------- --------
Net cash used in investing activities....................... (4,101) (21) (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.......................... - 300 301
Proceeds from issuance of common stock issued in connection
with merger.................................................... - - 688
Proceeds from repayment of employee notes receivable............ - - 10
Proceeds from issuance of convertible notes..................... - - 1,913
Proceeds from issuance Series A preferred stock and warrants.... - - 500
Proceeds from issuance Series B preferred stock................. - - 29,800
Exercise of stock options....................................... 5 - 5
-------- -------- --------
Net cash provided by financing activities................... 79,647 300 112,859
-------- -------- --------
Net increase (decrease) in cash................................... 59,902 (437) 78,904
Cash at beginning of period....................................... 19,002 510 -
-------- -------- --------
Cash at end of period............................................. $ 78,904 $ 73 $ 78,904
======== ========= ========
Supplemental disclosure of non-cash transactions:
Conversion of notes payable into common stock.................... $ - $ - $ 170
Issuance of common stock for notes receivable.................... $ - $ - $ 10
Accretion of Series A preferred stock to redemption value........ $ - $ - $ 25
Beneficial conversion charge, Series A preferred stock........... $ - $ - $ 144
Conversion of notes payable and interest to Series B preferred
stock.......................................................... $ - $ - $ 1,777
Accretion of Series B preferred stock to redemption value........ $ 224 $ - $ 446
Beneficial conversion charge, Series B preferred stock........... $ - $ - $ 31,577
Conversion of Series A preferred stock into series B preferred
stock.......................................................... $ - $ - $ 182
Issuance of common stock options for assets...................... $ - $ - $ 44
Issuance of warrants for music content........................... $ - $ - $ 1,327
Issuance of common stock in conjunction with acquisitions........ $ - $ - $ 13,329
Issuance of common stock to Nordic............................... $ - $ - $ 11,084
Accrued dividend payable on Series B preferred stock............. $ 493 $ - $ 1,062
Conversion of Series B preferred stock into common stock......... $ 32,206 $ - $ 32,206
Accrual for amount due on content license........................ $ - $ - $ 116
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1--The Company and Summary of Significant Accounting Policies
The Company
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 our inception, we have been
in the development stage devoting our efforts primarily to organizing as a
public reporting entity, recruiting management and technical staff, developing
our product, acquiring operating assets and raising capital. We operate within
one industry segment.
On July 22, 1999, we changed our 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.
Basis of Presentation
In the opinion of management, the unaudited consolidated condensed
financial statements included herein have been prepared on a basis consistent
with prior periods reported consolidated financial statements and include all
material adjustments, consisting of normal recurring adjustments, necessary to
fairly present the information set forth therein.
All significant intercompany balances and transactions have been
eliminated.
Certain information and footnote disclosures normally included in the
financial statements have been condensed or omitted pursuant to rules and
regulations of the Securities and Exchange Commission, although we believe that
the disclosures in the unaudited interim financial statements are adequate to
ensure that the information presented is not misleading. The results of
operations for the interim reporting periods presented herein are not
necessarily indicative of any future operating results.
The financial information as of June 30, 1999 is derived from our Annual
Report on Form 10-K for the Fiscal Year Ended June 30, 1999 as filed with the
Securities Exchange Commission. The interim financial statements presented
herein should be read in conjunction with the financial statements and the notes
thereto included in the Form 10-K.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ materially from those estimates.
4
<PAGE>
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 EMusic.com. The
calculation of diluted net loss per share for all periods presented excludes
shares of common stock issuable upon exercise of employee stock options.
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>
<S> <C> <C> <C>
Three months Three months January 8, 1998
ended ended (Inception) to
September 30, September 30, September 30,
1999 1998 1999
---- ---- ----
Net loss.............................................. (13,519) $ (849) $ (29,839)
----------- ----------- ------------
Accretion of Series A Preferred Stock -- -- (25)
Beneficial conversion charge, Series A Preferred Stock -- -- (144)
Accretion of Series B Preferred to redemption value (224) -- (446)
Beneficial conversion charge, Series B Preferred Stock -- -- (31,577)
Dividend on Series B Preferred Stock (Note 3)......... (493) -- (1,062)
----------- ----------- ------------
Net loss applicable to common shares.................. $ (14,236) $ (849) $ (63,093)
=========== =========== ===========
Net loss per Common share-basic and diluted........... $(1.09) $ (0.06) $(5.03)
=========== =========== ===========
Weighted average common shares outstanding............ 17,607,309 15,074,809 14,205,337
=========== =========== ===========
Common shares subject to repurchase................... (4,549,500) (483,473) (1,662,800)
=========== =========== ===========
Weighted average common shares outstanding - basic
and diluted.......................................... 13,057,809 14,591,336 12,542,537
=========== =========== ===========
</TABLE>
In addition, the weighted average warrants and options of 2,232,000 and
6,461,000, respectively, outstanding during the quarter ended September 30, 1999
were excluded from the above calculation as their effect would be antidilutive
for the purposes of the calculation of diluted earnings per share.
Comprehensive Net Loss
There are no differences between our net loss as reported for any of the
periods reported herein and our comprehensive loss, as defined by Statement of
Financial Accounting Standards No. 130, for each of these respective periods.
Reclassifications
Certain previously reported amounts have been reclassified to conform to
the current financial statement presentation format included herein.
Recent Accounting Pronouncements
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
5
<PAGE>
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.
Note 3 - Mandatorily Redeemable Convertible Preferred Stock
On March 23, 1999 ("Issuance Date"), we completed a private placement of
117,570 shares of Series B Convertible Preferred Stock ("Series B"), which
included the conversion of outstanding convertible notes and shares of Series A
Preferred Stock into Series B Shares. Total proceeds, including proceeds from
the convertible notes were $31,577,000 net of issuance costs of $2,724,000. Each
share of Series B was convertible into 100 shares of our common stock.
During the quarter ended September 30, 1999 and the period from inception
to September 30, 1999, we recorded a charge of $224,000 and $446,000,
respectively to accumulated deficit related to the accretion of the Series B
shares to the redemption value. In addition, we have recorded charges of
$493,000 and $1,062,000 to accumulated deficit related to dividends payable at a
rate of 6% per annum on the Series B shares for the quarter ended September 30,
1999 and the period from inception to September 30, 1999, respectively.
On September 24, 1999, we 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 were reclassified to
accrued liabilities.
6
<PAGE>
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
EMusic.com Inc. ("EMusic.com" or the "Company") 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 our inception, we have been in the development stage devoting
our efforts primarily to organizing as a public reporting entity, recruiting
management and technical staff, aggregating musical content, acquiring operating
assets and raising capital. We operate within one industry segment, primarily in
the United States.
In addition to historical statements, this Quarterly Report on Form 10-Q
contains certain forward-looking statements that are subject to certain risks
and uncertainties, which could cause actual results to differ materially from
those stated or implied. Forward-looking statements are those that use the words
"expects," "estimates," "will," "may," "anticipates," "believes" or similar
expressions. These forward-looking statements reflect management's opinions only
as of the date hereof, and we assume no obligation to update this information.
Risks and uncertainties include, but are not limited to, those discussed below
and in the section entitled "Factors That May Affect Our Results." Other risks
and uncertainties are disclosed in our prior SEC filings.
The following discussion should be read in conjunction with our Condensed
Consolidated Financial Statements and Notes thereto, included elsewhere in this
report.
RESULTS OF OPERATIONS
We were incorporated on January 8, 1998 and are a development stage
enterprise that has incurred costs to organize and develop an Internet website
through which we will conduct our business. We began selling musical recordings
over the Internet in July 1998. We may experience significant fluctuations in
operating results in future periods due to a variety of factors, including, but
not limited to, market acceptance of the Internet as a medium for consumers to
obtain downloadable sound recordings, our ability to create, license, and
deliver compelling music-related content, our ability to obtain additional
financing in a timely manner and on terms favorable to us, our ability to
successfully integrate prospective asset acquisitions into our existing business
operations, the level of traffic on our website, intense competition from other
providers of music-related content over the Internet, the entrance of
established music and/or software companies into the on-line music industry,
delays or errors in our ability to effect electronic commerce transactions, our
ability to upgrade and develop our systems and infrastructure in a timely and
effective manner, technical difficulties, system downtime or Internet brownouts,
our ability to attract customers at a steady rate and maintain customer
satisfaction, seasonality of the recorded music industry, seasonality of
advertising sales, Company promotions and sales programs, the amount and timing
of operating costs and capital expenditures relating to expansion of our
business, operations and infrastructure and the implementation of marketing
programs, key agreements and strategic alliances, the number of recorded music
releases introduced during the period, the level of returns experienced by us
and general economic conditions and economic conditions specific to the
Internet, on-line commerce and the recorded music industry.
This is the first quarter in which we have included the results of Internet
Underground Music Archive, Inc. ("IUMA") in our operations for the entire
period. On June 18, 1999 we completed the acquisition of IUMA for a combination
of cash and stock, at which time IUMA became a wholly owned subsidiary of
EMusic.com.
We have experienced significant growth since inception and in comparison to
the three months ended September 30, 1998. Due to the magnitude of the change,
we have provided additional analysis including the quarter ended June 30, 1999.
As a result, the following table (in thousands, except per share data) and
analysis sets forth a comparison of the three months ended September 30, 1999,
June 30, 1999 and September 30, 1998.
7
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<TABLE>
<CAPTION>
Three months Three months Three months
ended ended ended
September 30, June 30, September 30,
1999 1999 1998
---- ---- ----
<S> <C> <C> <C>
Revenue...................................................... $ 180 $ 51 $ 12
Cost of revenue.............................................. 25 14 -
----------- ----------- -----------
Gross profit................................................. 155 37 12
Gross margin................................................. 86% 73% 100%
Product development expense:
Stock compensation expense................................ 3,960 6,565 97
Other product development expense......................... 2,051 1,879 570
----------- ----------- -----------
Total product development expense............................ 6,011 8,444 667
Selling and marketing expense................................ 4,771 556 -
General and administrative expense........................... 812 883 197
Amortization of trade names.................................. 2,283 1,348 -
----------- ----------- -----------
Total operating expense...................................... 13,877 11,231 864
Operating loss............................................... (13,722) (852) (30,364)
Interest and other income.................................... 203 317 3
----------- ----------- -----------
Net loss..................................................... $ (13,519) $ (10,877) $ (849)
Accretion of Series B preferred stock to redemption value.... (224) (214) -
Dividend on Series B preferred stock......................... (493) (529) -
----------- ----------- -----------
Net loss applicable to common shares......................... $ (14,236) $ (11,620) $ (849)
=========== =========== ===========
Net loss per common share- basic and diluted................. $ (1.09) $ (1.02) $ (0.06)
=========== =========== ===========
Weighted average common shares outstanding-basic
and diluted................................................. 13,057,809 11,437,948 14,591,336
=========== =========== ===========
Proforma net loss:
Exclusive of stock compensation expense and amortization
of trade names........................................... (6,876) (2,848) (742)
=========== =========== ===========
Per common share- basic and diluted....................... (0.53) (0.25) (0.05)
=========== =========== ===========
</TABLE>
Net Revenues
We are a development stage enterprise that introduced an Internet retail
website, www.emusic.com, in April 1998 and began selling digital, downloadable
musical recordings and physical merchandise in July 1998. Net revenues are
comprised of sales of downloadable music from our EMusic site and advertising on
both our EMusic and IUMA sites. Revenues for the quarters ended September 30,
1999, June 30, 1999 and September 30, 1998 were $180,000, $51,000 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 and June 30, 1999 were $25,000 and $14,000,
respectively. There were no similar costs during the quarter ended September 30,
1998. Gross margins increased from the quarter ended June 30, 1999 to the
quarter ended September 30, 1999 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.
8
<PAGE>
Stock compensation charges were $3,960,000, $6,565,000 and $97,000 during
quarters ended September 30, 1999, June 30, 1999 and September 30, 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, June 30, 1999 and September 30, 1998 were $2,051,000, $1,879,000 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 expenses
for the quarters ended September 30, 1999 and June 30, 1999, were $4,771,000 and
$556,000, respectively. 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.
Amortization of Trade Names
During 1999, we purchased the "EMusic," "IUMA" and certain other 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
$2,283,000 per quarter through the year ending June 30, 2002.
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, June 30, 1999 and September 30, 1998, were $812,000,
$884,000 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.
Operating expenses exclusive of non-cash charges
We incurred total operating expenses exclusive of non-cash charges of
$7,434,000, $3,260,000 and $762,000 for the quarters ended September 30, 1999,
June 30, 1999 and September 30, 1998, respectively. Non-cash charges for the
quarter ended September 30, 1999 included depreciation of $200,000, stock
compensation charges of $3,960,000 and amortization of trade names of
$2,283,000. During the quarter ending June 30, 1999, non-cash charges included
depreciation of $58,000, stock compensation of $6,565,000 and amortization of
trade names of $1,348,000. During the quarter ending September 30, 1998, non-
cash charges included depreciation of $5,000, stock compensation of $97,000 and
no similar charges related to the amortization of trade names.
Interest and other income
Interest income during the quarters ended September 30, 1999, June 30, 1999
and September 30, 1998 was $203,000, $317,000 and $3,000, respectively. The
interest income during the quarter ended September 30, 1999 was primarily
related to cash proceeds from the issuance of Series B Preferred Stock of
approximately $31,577,000 net of issuance costs of approximately $2,724,000
during the quarter ended March 31, 1999.
Accretion and dividends on the Series B Preferred Stock
The difference between the Series B Preferred Stock carrying value and the
redemption value, resulting from issuance costs associated with the transaction
was accreted through the date of conversion using the effective interest rate
method. Charges to accumulated deficit from the accretion for the quarters ended
September 30, 1999 and June 30,
9
<PAGE>
1999 were $214,000 and $224,000, respectively. There were no similar charges for
the quarter ending September 30, 1998. These charges will not continue to future
periods.
The Series B Preferred Stockholders were entitled to cumulative dividends
at an annual rate of 6% of the Series B Preferred Stock Preference Amount
through the date of conversion. Charges to accumulated deficit from the
dividends for the quarters ended September 30, 1999 and June 30, 1999 were
$529,000 and $493,000, respectively. There were no similar charges for the
quarter ending September 30, 1998. These charges will not continue in future
periods.
Prepaid expenses and other assets
Prepaid expenses and other assets primarily consist of prepaid advertising
costs. These prepaid costs were $9,531,000 and $224,000 as of September 30, 1999
and June 30, 1999, respectively. The increase in these prepaid costs is as a
result of our launch of an extensive marketing campaign to establish the brand
name "EMusic." These costs will be amortized over the period in which they are
incurred.
Liquidity and Capital Resources
At September 30, 1999, we had a cash balance of $78,905,000. Net cash of
$14,518,000 was used for operating activities for the quarter ended September
30, 1999, principally as a result of net losses of $13,519,000 generated during
the period and the increase of prepaid expenses of $7,336,000, offset by non-
cash expenses of $6,443,000 associated with stock options and warrants granted
to advisors, amortization of trade names and depreciation. Purchases of capital
equipment for the quarter ended September 30, 1999 totaled $1,113,000. We expect
to incur negative cash flow from operations for the foreseeable future, as we
continue to develop our market and operations.
On March 23, 1999, we completed a private placement of 117,570 shares of
Series B Convertible Preferred Stock (the "Series B Shares"), which included the
conversion of outstanding convertible notes and Series A Shares into Series B
Shares. Total proceeds, including proceeds from the convertible notes and Series
A shares, were $31,577,000 net of issuance costs of $2,724,000.
In April 1999, we entered into a five-year lease agreement for office
space. Under the terms of the agreement, we are required to make minimum monthly
lease payments of $67,000 for a period of 60 months commencing in April of 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 for proceeds of $78,573,000, net of issuance costs of
$1,109,000, of which $1,069,000 remained in accrued liabilities at September 30,
1999.
On October 27, 1999, we issued an additional 300,000 shares of Common Stock
for net proceeds of $4,536,000 in connection with the exercise by the
underwriters of their over-allotment option.
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, based on our current assessment, we believe
our internal systems are year 2000 compliant. We are currently conducting
additional
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reviews of our internal management information and other computer systems to
identify any year 2000 problems, and have begun to communicate with the external
vendors that supply us with material software and information systems and with
our significant suppliers to determine their year 2000 readiness. We have not
completed our year 2000 investigation and overall compliance initiative.
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. However, during the months prior to the
century change, we will continue to evaluate new software and information
systems provided to us by third parties and any new infrastructure systems that
we acquire to determine whether they are year 2000 compliant. 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. We currently have no contingency plans to address the risks associated
with unremediated year 2000 problems.
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 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. We have not yet received any written assurance from Card Service 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 and website
hosting capabilities could fail at that time. Based on this assumption, we
believe such failures would be the most reasonably likely worst case year 2000
scenarios. 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 and have not yet developed any contingency plans. The responses
received from third-party vendors and service providers will be taken into
account in determining the nature and extent of any contingency plans we adopt.
Factors That May Affect Our Results
Investing in our common stock involves a high degree of risk. You should
carefully consider the following factors and other information contained in this
Form 10-Q and in our Form 10-K and other filings with the SEC before deciding to
invest in our stock.
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:
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. online sales of downloadable music;
. website advertising fees from third parties;
. licensing of musical recordings for use by others; and
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
products and 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.
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 $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.
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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;
. 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 September 30, 1999, there were approximately 34,000,000 shares of
common stock outstanding, of which approximately 10,000,000 were tradable
without restriction under the Securities Act and approximately 11,000,000 were
tradable under Rule 144. We have filed a registration statement relating to the
resale of approximately 13,000,000 shares, following the effectiveness of which,
we expect that substantially all of our remaining 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." Our stock is held by a limited number of investors and
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;
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. 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.
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.
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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.
and in June 1999, we completed the acquisition of Internet Underground
Music Archive. 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.
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
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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. For additional
information regarding competition, see "Business--Competition."
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 will be sufficient to fund our planned
level of operating activities, capital expenditures and other obligations
through the next 12 months. Further, we may need to raise additional funds in
order to:
. finance unanticipated working capital requirements;
. 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.
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.
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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 our 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 strategic
alliances with various media, hardware device and Internet-related companies
such as: Yahoo, America Online, Creative Labs, Sensory Science, RealNetworks
and Real Names. 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 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.
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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.
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. has asserted that many online
music providers, including EMusic, violate patent rights that it 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
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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.
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 January 2002, the imposition of state and local taxes that discriminate
against or single out the Internet, it does not
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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 our
system, it could affect our cost of doing business.
Legislation limiting the ability of states to impose taxes on Internet
based transactions has been proposed in the U.S. Congress. We cannot assure you
that this legislation will ultimately become law or that the tax moratorium in
the final version of this legislation will be ongoing. Failure to enact or renew
this legislation, if enacted, could allow various states to impose taxes on
Internet-based commerce, which could harm our 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,
some of the major recording studios have recently announced a plan to develop a
universal standard for the electronic delivery of music, called the Secured
Digital Music Initiative and have announced their intention to make this
delivery method available by the end of 1999. 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.
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.
20
<PAGE>
We may discover year 2000 compliance problems in our systems that will
require substantial revision. We have not conducted a year 2000 audit and have
relied only on our internal assessments of our year 2000 needs. Furthermore, we
have not developed contingency plans to respond to potential year 2000 issues.
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 20% 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 20% 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
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.
21
<PAGE>
- --------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
Interest Rate Risk
We do not hold derivative or speculative financial instruments and
substantially all cash and cash equivalent balances are invested in money market
accounts with floating interest rates, therefore we are not subject to
significant interest rate risk.
Currency Exchange Rate Risk
During the period from inception through September 30, 1999, all of our
revenues and expenses have been denominated in U.S. dollars. As a result, we
have not incurred any realized or unrealized currency exchange rate gains or
losses. We do not expect to incur any significant gains and losses during the
next twelve months. We have not engaged in foreign currency hedging activities
to date, nor do we plan to engage in such activities in the next twelve months.
22
<PAGE>
- --------------------------------------------------------------------------------
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 2. Changes in Securities and Use of Proceeds
On September 24, 1999, we completed a public offering of 5,270,000 shares
of common stock. In conjunction with this offering the Series B shares
converted into 11,757,000 shares of common stock.
On August 4, we granted warrants for the purchase of 345,000 shares at
weighted average exercise price of $14.53 related to the acquisition of
certain music rights.
On September 27, we granted warrants for the purchase of 267,000 shares
at weighted average exercise price of $15.00 related to the acquisition of
certain music rights.
The warrants noted above were granted solely to accredited investors in
reliance on Regulation D.
Use of Proceeds
During the quarter ended September 30, 1999, proceeds from the above
offering and available cash have been used to pay $40,000 in offering related
expenses, to purchase $1,113,000 in fixed assets, and to pay operating expenses,
primarily payroll and facilities related, of $14,518,000. The remainder of the
proceeds have been invested in money market accounts as of September 30, 1999.
23
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule (EDGAR only)
(b) No reports on Form 8-K were filed during the three months ended
September 30, 1999.
24
<PAGE>
- --------------------------------------------------------------------------------
SIGNATURES
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 12, 1999 EMusic.com Inc.
/s/ Joseph Howell
------------------
Joseph Howell,
Executive Vice President and
Chief Financial Officer
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM EMUSIC.COM
INC.'S ANNUAL REPORT ON FORMS 10-KSB/A FOR THE YEAR ENDED JUNE 30, 1998, AND
QUARTERLY REPORT ON FORMS 10-QSB FOR THE QUARTER ENDED SEPTEMBER 30, 1999, AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 78,904,548
<SECURITIES> 0
<RECEIVABLES> 167,851
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 88,602,908
<PP&E> 1,989,068
<DEPRECIATION> (287,772)
<TOTAL-ASSETS> 125,164,853
<CURRENT-LIABILITIES> 3,726,475
<BONDS> 0
0
0
<COMMON> 33,955
<OTHER-SE> 121,404,423
<TOTAL-LIABILITY-AND-EQUITY> 125,164,853
<SALES> 42,048
<TOTAL-REVENUES> 180,226
<CGS> 25,229
<TOTAL-COSTS> 25,229
<OTHER-EXPENSES> 13,876,647
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 202,571
<INCOME-PRETAX> (13,519,079)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,519,079)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,519,079)
<EPS-BASIC> (1.09)
<EPS-DILUTED> (1.09)
</TABLE>
