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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-24671
EMusic.com Inc.
(Exact name of Registrant as specified in its charter)
Delaware 94-329054
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1991 Broadway, 2nd Floor 94063
Redwood City, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 216-0200
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, $.001 par value
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $_____________ as of September 27, 1999, based upon
the closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose.
33,831,237 shares of the Registrant's Common stock, $.001 par value, were
outstanding at September 27, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
None
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EMUSI.COM INC.
FORM 10-K
INDEX
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PART I
Item 1. Business ........................................................ 3
Item 2. Properties ...................................................... 14
Item 3. Legal Proceedings ............................................... 14
Item 4. Submission of Matters to a Vote of Security holders ............. 14
PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder
Matters ......................................................... 14
Item 6. Selected Consolidated Financial Data ............................ 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................... 17
Item7A. Quantitative and Qualitative Disclosures About Market Risk ..... 32
Item 8. Financial Statements and Supplementary Data ..................... 34
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure ............................................ 34
PART III
Item 10. Directors and Executive Officers of the Registrant .............. 34
Item 11. Executive Compensation .......................................... 39
Item 12. Security Ownership of Certain Beneficial Owners and Management .. 42
Item 13. Certain Relationships and Related Transactions .................. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K . 45
SIGNATURES
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PART I
Item 1. Business.
When used in this Form 10-K, the words "expects," "anticipates," "estimates" and
similar expressions are intended to identify forward-looking statements. Such
statements, which include statements concerning the timing of the development of
the market for downloadable music, our ability to obtain content for sale as
downloadable music, and announcements and actions by our existing and future
competitors, are subject to risks and uncertainties, including those set forth
below under "Factors That May Affect Our Results," that could cause actual
results to differ materially from those projected. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions
or circumstances on which any statement is based. You should read this
discussion together with the financial statements and other financial
information included in this Form 10-K.
Overview
EMusic.com Inc. ("EMusic" or the "Company") 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 to over 300,000 titles, from over 85 record labels and over
1,300 recording artists, including selected titles from such well known artists
as The Offspring, They Might Be Giants, Iggy Pop, and Ella Fitzgerald. We
currently have over 20,000 titles available for download on our EMusic.com
website. In addition, our IUMA subsidiary offers our customers access to over
4,000 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 offered for sale
on EMusic.com 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
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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.
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 Creative Labs, Sensory Sciences, RCA/Thomson,
Samsung, Toshiba and LG Electronics have released, or have announced plans to
release, portable mp3 players. 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).
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
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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, most
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 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
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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
mp3 devices for greater portability, without having to carry physical media with
them. In addition, mp3 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.
Compelling Music Selection. We currently have exclusive, multi-year, digital
download licenses to over 300,000 titles, from over 85 record labels and over
1,300 recording artists, including selected titles from such well known artists
as The Offspring, They Might Be Giants, Iggy Pop and Ella Fitzgerald. We
currently have over 20,000 titles available for download on our EMusic.com
website. In addition, IUMA offers our customers access to over 4,000 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 format 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 the new They Might Be Giants mp3-only album
which was recently 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.
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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:
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,
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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.
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.
. Fiction Music, which features new and never before released tracks from
The Cure.
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 Frank Zappa, Louis
Armstrong, Ella Fitzgerald, Judy Garland, Shirley Bassey, Kool Keith, Kansas,
Foghat and thousands of others.
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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. 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.
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 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.
. Examples of existing marketing and advertising relationships include
Comedy Central, CNET, Centraal, E!Online, Listen.com, ZDNet and CMJ
Online.
. In May 1999, RealNetworks and EMusic announced that mp3 tracks would be
featured in RealJukebox Music Showcase and that there would be links to
our website highlighted in the RealGuide music download section.
. In July 1999, we announced a new strategic partnership and equity
investment with Crunch Music Ltd., one of the United Kingdom's premier
sources for independent UK music in the mp3 format. Under the new
relationship, the two companies will work together on marketing,
promoting and co-branding their websites, label partners and artists on
both sides of the Atlantic. Launched in March 1999, Crunch has quickly
established itself as one of the leading sites in the UK for downloading
music and plans to expand to the rest of Western Europe. The Crunch site
hosts music from leading UK independent record labels including Dorado,
Filter, Pussyfoot, Platipus, The End, Tummy Touch, Marine Parade, TCR
and Ochre. Notable artists include Echo and The Bunnymen's Will Sargant,
pka as Glide, U2 producer DJ Howie B, Jacknife Lee, Art of Trance and
Union Jack.
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. Beginning in the fall of 1999, we plan to
launch 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). In each partnership, we are featured on the
outside of the box as the premier source for downloadable music and
provide sample titles with the installation software. Beginning in mid-
1999, we will begin a marketing program with Creative Labs whereby a
discount coupon for our content will be supplied or shipped with each
product supplied by Creative Labs, including the Nomad portable mp3
player, Soundblaster sound cards and Cambridge Soundworks speaker
systems.
. In January 1999, we announced a technology and marketing alliance with
Adaptec aimed at promoting the
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growth of downloadable music sales in the popular mp3 format. Adaptec is
the developer of the market-leading CD-recording software products, Easy
CD Creator, DirectCD and Toast. Under the terms of the agreement, EMusic
and Adaptec will jointly sell and promote each other's products and
services. EMusic and Adaptec will focus on technology solutions that
allow consumers to easily purchase and download mp3 music from the
Internet and make their own music CDs.
. 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. Some of these programs
will target the "back to school" and holiday seasons.
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:
. In February 1999, we announced a licensing agreement with the Harry Fox
Agency, or HFA, a wholly-owned licensing subsidiary of the National
Music Publishers' Association. Under this agreement, HFA will grant us
the first Digital Phonorecord Delivery License for delivering songs in
the mp3 format. Accordingly, 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.
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 4,000 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
10
<PAGE>
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.
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. We are in the
process of converting our system to 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
11
<PAGE>
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 an
AboveNet Communications co-location facility in San Jose, 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 of online music content such as MP3.com, MusicMaker.com and
various private companies;
. providers of music news and community such as Launch Media, Inc.,
Tunes.com and various private companies;
. 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 CDNow 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.
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.
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<PAGE>
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.
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.
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<PAGE>
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 September 15, 1999, we had 68 full-time employees, including 36 in content
acquisition and marketing, 14 in engineering and product development, 10 in
finance and operations and 8 in other administrative functions. 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.
Item 2. Properties.
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.
Item 3. Legal Proceedings.
We are not aware of any pending legal proceedings against us that, individually
or in the aggregate, would have a material adverse effect on our business,
operating results or financial condition. We may in the future be party to
litigation arising in the course of our business, including claims that we
allegedly infringe third-party trademarks and other intellectual property
rights. Such claims, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
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
</TABLE>
14
<PAGE>
<TABLE>
<S> <C> <C>
Third Quarter...................................... 23.88 7.00
Fourth Quarter..................................... 29.13 13.63
Fiscal Year Ending June 30, 2000
First Quarter (through September 23, 1999)......... $26.19 $11.56
</TABLE>
At June 30, 1999, there were approximately 138 stockholders of record of the
Company's common stock. The Company has never declared or paid cash dividends on
its capital stock and does not anticipate paying any cash dividends in the
foreseeable future. The Company currently intends to retain future earnings for
the development of its business.
15
<PAGE>
Item 6. Selected Consolidated Financial Data.
This section presents our selected historical financial data. You should read
carefully the financial statements included in this Form 10-K, 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. We have paid no cash dividends
on our common stock.
<TABLE>
<CAPTION>
January 8, 1998 January 8, 1998
(inception) to Year ended (inception) to
June 30, 1998 June 30, 1999 June 30, 1999
---------------- -------------- ----------------
(in thousands, except share and per share data)
<S> <C> <C> <C>
Statement of Operation Data:
Revenues........................................................................ $ -- $ 92 $ 92
----------- ----------- -----------
Cost of revenues................................................................ 27 27
Gross loss...................................................................... -- 65 65
Operating expenses:.............................................................
Product development........................................................... 961 11,690 12,651
Selling and marketing......................................................... -- 556 556
General and administrative.................................................... 219 1,599 1,818
Amortization of trade names................................................... -- 1,682 1,682
----------- ----------- -----------
Total operating expenses.................................................... 1,180 15,527 16,707
----------- ----------- -----------
Operating loss.................................................................. (1,180) (15,462) (16,642)
Interest income................................................................. -- 359 359
Interest expense................................................................ -- (37) (37)
----------- ----------- -----------
Net loss........................................................................ $ (1,180) $ (15,140) $ (16,320)
----------- ----------- -----------
Accretion of Series A and B preferred to redemption value....................... -- (247) (247)
Beneficial conversion charge, Series A and B preferred stock.................... -- (31,721) (31,721)
Dividend on Series B preferred stock............................................ -- (569) (569)
----------- ----------- -----------
Net loss applicable to common shares............................................ $ (1,180) $ (47,677) $ (48,857)
=========== =========== ===========
Net loss per common share--basic and diluted.................................... $ (0.12) $ (3.52) $ (4.87)
=========== =========== ===========
Weighted average common shares outstanding--basic and diluted................... 10,234,055 13,563,606 10,027,231
=========== =========== ===========
Pro forma net loss per common share............................................. $ (0.95) $ (1.39)
=========== ===========
Weighted average common shares outstanding used in computing pro forma basic
and diluted net loss per share................................................. 16,731,464 12,299,002
========== ==========
</TABLE>
<TABLE>
<CAPTION>
June 30, 1999
June 30, 1998 June 30, 1999 Pro Forma
------------- ------------- -------------
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents....................................................... $ 510 $ 19,002 $ 18,433
Working capital................................................................. 396 16,593 16,025
Total assets.................................................................... 582 54,221 53,652
Redeemable convertible preferred stock.......................................... -- 32,550 --
Total stockholders' equity...................................................... 447 18,987 50,968
</TABLE>
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<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
When used in this discussion, the words "expects," "anticipates," "estimates"
and similar expressions are intended to identify forward-looking statements.
Such statements, which include statements concerning the timing of the
development of the market for downloadable music, our ability to obtain content
for sale as downloadable music, and announcements and actions by our existing
and future competitors, are subject to risks and uncertainties, including those
set forth below under "Factors That May Affect Our Results," that could cause
actual results to differ materially from those projected. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events, conditions
or circumstances on which any statement is based. You should read this
discussion together with the financial statements and other financial
information included in this Form 10-K.
Quarterly Results of Operations
We were incorporated on January 8, 1998 and are a development stage company.
Through June 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.
Because of our limited history, we believe that period-to-period comparisons of
our operations are not meaningful. Accordingly, we have not included comparisons
in the discussions set forth below.
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<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>
Quarter Ended
-------------------------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, March 31, June 30,
1998 1998 1998 1999 1999
----------------- ---------------- ----------------- --------------- ---------------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C> <C>
Revenues ........................... $ -- $ 12 $ 8 $ 21 $ 51
Cost of revenues ................... -- -- 4 9 14
---------------- ---------------- ----------------- --------------- ---------------
Gross profit ....................... -- 12 4 12 37
Operating expenses:
Product development ............... 919 667 925 1,654 8,444
Selling and marketing ............. -- -- -- -- 556
General and administrative ........ 172 197 205 314 883
Amortization of trade names ....... -- -- -- 334 1,348
---------------- ---------------- ----------------- --------------- ---------------
Total operating expenses ......... 1,091 864 1,130 2,302 11,231
---------------- ---------------- ----------------- --------------- ---------------
Loss from operations ............... (1,091) (852) (1,126) (2,290) (11,194
Interest income, net ............... -- 3 1 1 317
---------------- ---------------- ----------------- --------------- ---------------
Net loss ........................... $ (1,091) $ (849) $ (1,125) $ (2,289) $ 10,877
Accretion of Series A preferred stock
redemption value .................. -- -- (25) -- --
Beneficial conversion charge, Series
preferred stock ................... -- -- (144) -- --
Accretion of B preferred stock to
redemption value .................. -- -- -- (8) (214
Beneficial conversion charge, Series
preferred stock ................... -- -- -- (31,577) --
Dividend on Series B preferred stock. -- -- -- (40) (529
---------------- ---------------- ----------------- --------------- ---------------
Net loss applicable to common
Stockholders ...................... $ (1,091) $ (849) $ (1,294) $ (33,914) $ (11,620)
================ =============== ================= =============== ===============
Net loss per common share, basic and
diluted ........................... $ (0.08) $ (0.06) $ (0.09) $ (2.31) $ (1.02)
================ ================ ================= =============== ===============
Weighted average common shares
outstanding, basic and diluted .... 12,847,724 14,591,336 14,581,212 14,674,372 11,437,948
================ ================ ================= =============== ===============
</TABLE>
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.
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<PAGE>
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.
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
19
<PAGE>
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 1999. Future amortization related to these trade names will be:
<TABLE>
<CAPTION>
Year ending Amortization
June 30, Expense
------------ ------------
<S> <C> <C>
2000 $ 9,132,000
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.
Additionally, we purchased approximately $1,128,000 in capital equipment from
inception through June 30, 1999. 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.
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.
Since inception, we have experienced significant losses and negative cash flows
from operations. We believe that
20
<PAGE>
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 future periods
through public or private financings, or other sources, to fund our operations
and potential acquisitions, if any, until we achieve profitability, if ever. We
may not be able to obtain adequate or favorable financing at that time. Failure
to raise capital when needed could harm our business. If we raise additional
funds through the issuance of equity securities, the percentage of ownership of
our stockholders would be reduced. Furthermore, these equity securities might
have rights, preferences or privileges senior to our common stock.
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 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
and AboveNet Communications for website hosting. We have not yet received any
written assurance from Card Service or AboveNet as to their readiness for year
2000 issues. Because we have not received written assurance, we have assumed
that Card
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Service and AboveNet 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. If the AboveNet services fail,
we would not be able to operate our business until AboveNet restored its service
or until we were able to obtain another web hosting arrangement. We believe that
it would require approximately three days to establish a new web hosting
arrangement.
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.
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 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.
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-K 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:
. online sales of downloadable music;
. website advertising fees from third parties;
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. 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.
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 June 30, 1999, we had a deficit accumulated during the
development stage of $48.8 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 29, 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 are filing 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;
. acquisitions or strategic alliances entered into by us or our
competitors;
. failure to meet securities analysts' expectations;
. government regulatory action;
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. 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 San Jose, 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.
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 begun a conversion of 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
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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 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
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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.
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
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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 strategic alliances with
various media, hardware device and Internet-related companies such as: Creative
Labs, RealNetworks and Centraal. 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,
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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.
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
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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
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.
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.
31
<PAGE>
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 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
32
<PAGE>
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 June 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.
<TABLE>
<CAPTION>
1999 Thereafter Total
----------- -------------- ------------
<S> <C> <C> <C>
Cash........................................ $19,002,000 $ -- $ 19,002,000
Weighted Average Interest Rate............ 5.18% --
Total Portfolio............................. $19,002,000 $ -- $ 19,002,000
=========== ============== ============
</TABLE>
33
<PAGE>
Item 8. Financial Statements and Supplementary Data.
Annual Financial Statements: See Part IV, Item 14 of this Form 10-K.
Selected Quarterly Data: See Part II, Item 7 of this Form 10-K.
Item 9. 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.
PART III
Item 10. Directors and Executive Officers of the Registrant.
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 September 15, 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........................... 49 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............................. 30 Vice President, Global Public Policy and Standards
Marv Su.................................. 36 Vice President, Interactive Marketing
Brett A. Thomas.......................... 29 Vice President, Technology
Tor Braham............................... 41 Director
Ralph Peer, II........................... 54 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.
34
<PAGE>
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.
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
35
<PAGE>
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.
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
36
<PAGE>
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 1999;
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 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
37
<PAGE>
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.
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.
Section 16(a) of the Exchange Act requires the Company's
directors and executive officers, and persons who own more than
ten percent of a registered class of the Company's equity
securities ("ten percent holders"), to file reports of ownership
and changes in ownership with the SEC and the Nasdaq National
Market. Directors, executive officers, and ten percent holders
are required by SEC regulations to furnish us with copies of all
Section 16(a) forms they file.
Based solely on our review of the copies of such forms received
or written representations from certain reporting persons, we
believe that, during the year ended June 30, 1999, all filing
requirements under Section 16(a) applicable to our directors,
executive officers and ten percent holders were met except that
James Chapman failed to file a Form 3 on a timely basis when his
status was changed to that of an executive officer, Such failure
is in process of being corrected.
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Item 11. 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., President and Chief 1999 $82,291 -- -- 250,000
Executive Officer...................... 1998 31,250 --
</TABLE>
- ---------------------------------
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
Number of % of Total Annual Rates of
Securities Options Stock Price
Underlying Granted to Exercise Appreciation for
Options Employees in Price Per Expiration Option Term (2)
---------------------------
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>
</TABLE>
39
<PAGE>
<TABLE>
<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;
. 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 July 15, 1999, six million shares are reserved for issuance under the 1998
option plan, 45,400 shares have been issued upon the exercise of options,
options to purchase of a total of 2,946,750 shares at a weighted average
exercise price of $3.52 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
40
<PAGE>
. 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 July 15, 1999, five million shares are reserved for issuance under the
nonstatutory plan, no shares have been issued upon the exercise of options,
options to purchase of a total of 3,351,000 shares at a weighted average
exercise price of $10.29 per share were outstanding and 1,649,000 shares were
available for future option grants.
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 September 29, 1999. 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.
41
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth the ownership of our voting stock, including
optioned shares, 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 27, 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 27, 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.
<TABLE>
<CAPTION>
Number of Shares
of Common Stock
Beneficial Owner(1) Owned Percent(2)
------------------- ---------------- -----------
<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 (3)........................ 3,333,400 9.7%
VantagePoint Venture Partners
1001 Bayhill Drive, Suite 140
San Bruno, CA 94066 (4)....................... 1,686,500 4.9%
Directors and Executive Officers
- --------------------------------
Robert H. Kohn................................. 2,881,700 8.3%
Gene Hoffman, Jr............................... 3,202,000 9.3%
Joseph H. Howell (5)........................... 178,624 *
Peter M. Astiz................................. 216,000 *
James R. Chapman (6)........................... 79,941 *
Tor Braham (7)................................. 46,600 *
Ralph Peer, II (8)............................. 308,900 *
Ed Rosenblatt (9).............................. 100,000 *
Executive officers and directors as a group
(8 persons) (10).............................. 7,013,765 20.3%
</TABLE>
- ----------------------
* Less than 1%
(1) A person is deemed to be the beneficial owner of securities that can be
acquired by such person within 60 days upon the exercise of options.
Calculations of percentages of beneficial ownership assume the exercise by
only the respective named shareholders of all options for the purchase of
common stock held by such shareholder which are exercisable within 60 days
of July 15, 1999.
42
<PAGE>
(2) Percentage of beneficial ownership excludes shares issuable upon exercise
of outstanding stock options and warrants.
(3) 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.
(4) 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.
(5) Includes 268,624 shares issuable upon exercise of outstanding options.
(6) Includes 33,341 shares issuable upon exercise of outstanding options.
(7) Includes 35,000 shares issuable upon exercise of outstanding options.
(8) Includes 100,000 shares issuable upon exercise of outstanding options.
Includes 61,400 shares of common stock held by peermusic III, Ltd. which
are issuable upon 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.
(9) Represents shares issuable upon exercise of outstanding options.
(10) Includes 536,965 shares issuable upon exercise of outstanding options.
43
<PAGE>
Item 13. Certain Relationships and Related Transactions.
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 July 15, 1999, the
restricted stock purchase agreement provides us with the right to repurchase
approximately 311,000 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
July 15, 1999, 2,618,136 and 2,253,514 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.
44
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as a part of this Form 10-K:
(1) Financial Statements:
Index to Financial Statements
Index to Financial Statements- June 30, 1999
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Accountants.............................................................. 46
Consolidated Balance Sheets.................................................................... 47
Consolidated Statements of Operations.......................................................... 48
Consolidated Statement of Stockholders' Equity................................................. 49
Consolidated Statements of Cash Flows.......................................................... 50
Notes To Consolidated Financial Statements..................................................... 51
</TABLE>
45
<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
46
<PAGE>
EMusic.com Inc.
(formerly GOODNOISE CORPORATION)
(a Development Stage Enterprise)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Proforma
June 30, 1998 June 30, 1999 June 30, 1999
--------------- --------------
(unaudited)
(in thousands, except share and per share data)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash....................................................... $ 510 $ 19,002 $ 18,433
--------
Accounts receivable........................................ -- 51
Prepaid expenses and other assets.......................... 21 224
------- --------
Total current assets................................... 531 19,277
Property and equipment, net.................................. 34 1,076
Music content, net........................................... -- 8,758
Trade names, net............................................. -- 24,680
Other assets................................................. 17 430
Total assets............................................ $ 582 $ 54,221
======= ========
LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS'
EQUITY
Current Liabilities:
Accounts payable........................................... $ 67 $ 637
Accrued liabilities........................................ 51 1,679
Accrued compensation and related benefits.................. 17 368
------- --------
Total current liabilities............................... 135 2,684
Commitments Note 8
Redeemable Convertible Preferred Series B Stock.............. -- 32,550 --
------- -------- --------
Stockholders' Equity:
Preferred Stock, $0.001 par value; 380,000 shares
Authorized; no shares issued and outstanding............. -- -- --
Common Stock, $0.001 par value; 200,000,000 shares
Authorized; 14,715,300,16,804,237 and 28,561,237
(unaudited) pro-forma shares issued and outstanding,
respectively............................................. 15 17 29
Additional paid-in capital................................. 1,618 67,827 99,796
Note receivable from employee.............................. (6) -- --
Deficit accumulated during the development stage........... (1,180) (48,857) (48,857)
------- -------- --------
Total stockholders' equity.............................. 447 18,987 $ 50,968
Total liabilities, redeemable convertible
preferred stock and stockholders' equity........... $ 582 $ 54,221
======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
47
<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>
January 8, 1998 January 8, 1998
(Inception) to Year ended (Inception) to
June 30, 1998 June 30, 1999 June 30, 1999
------------------ --------------- -----------------
<S> <C> <C> <C>
Revenues........................................................ $ -- $ 92 $ 92
Costs of revenues............................................... -- 27 27
------------ ----------- -----------
Gross profit.................................................... -- 65 65
------------ ----------- -----------
Operating expenses:
Product development........................................... 961 11,690 12,651
Selling and marketing......................................... -- 556 556
General and administrative.................................... 219 1,599 1,818
Amortization of trade names................................... -- 1,682 1,682
----------- ----------- -----------
Total operating expenses................................... 1,180 15,527 16,707
----------- ----------- -----------
Operating loss.................................................. (1,180) (15,462) (16,642)
Interest income................................................. -- 359 359
Interest expense................................................ -- (37) (37)
------------ ----------- -----------
Net loss........................................................ $ (1,180) $ (15,140) $ 6,320)
------------ ----------- -----------
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)
Dividend on Series B Preferred Stock............................ -- (569) (569)
----------- ----------- -----------
Net loss applicable to common shares............................ $ (1,180) $ (47,677) $ (48,857)
=========== =========== ===========
Net loss per common share--basic and diluted.................... $ (0.12) $ (3.52) $ (4.87)
=========== =========== ===========
Weighted average common shares outstanding--basic and
Diluted........................................................ 10,234,055 13,563,606 10,027,231
=========== =========== ===========
Pro forma net loss per common share--basic
and diluted.................................................... $ (0.95) $ (1.39)
=========== ===========
Shares used in pro forma net loss per common share.............. 16,731,464 12,299,002
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
48
<PAGE>
Emusic.com Inc.
(formerly GOODNOISE CORPORATION)
(A Development Stage Enterprise)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Deficit
Accumulated
Note During the
Number of Common Additional Receivable ---------- Total
---------- --------- ------------ 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
========== ========= =========== ========= ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
49
<PAGE>
Emusic.com Inc.
(formerly GOODNOISE CORPORATION)
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
January 8, 1998 January 8, 1998
(Inception) to Year Ended (Inception) to
June 30, 1998 June 30, 1999 June 30, 1999
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................................................ $ (1,180) $ (15,140) $ (16,320)
Adjustments to reconcile net loss to net cash used in operating
activities (net of the effects of acquisitions):
Depreciation................................................................... 3 93 96
Amortization of trade names.................................................... -- 1,682 1,682
Loan interest converted into Series B preferred stock.......................... -- 34 34
Amortization of music content.................................................. -- 2 2
Issuance of common stock for services.......................................... 13 -- 13
Fair value of warrants issued for product development.......................... -- 5,682 5,682
Fair value of options issued to advisors....................................... 752 2,379 3,131
Changes in assets and liabilities:
Accounts receivable........................................................... -- (51) (51)
Prepaid expenses.............................................................. (21) (203) (224)
Other assets.................................................................. (17) (413) (430)
Accounts payable.............................................................. 67 149 216
Accrued liabilities........................................................... 51 652 703
Accrued payroll and related benefits.......................................... 17 152 169
Net cash used in operating activities........................................ (315) (4,982) (5,297)
------------- ------------- -------------
Cash flows from investing activities:
Purchase of trade names........................................................ -- (468) (468)
Purchase of music content...................................................... -- (7,317) (7,317)
Purchase of property and equipment............................................. (37) (1,091) (1,128)
Net cash used in investing activities........................................ (37) (8,876) (8,913)
Cash flows from financing activities:
Proceeds from issuance of common stock......................................... -- 301 301
Common stock issued in connection with merger.................................. 688 -- 688
Proceeds from issuance of Series A Preferred Stock and warrants................ -- 500 500
Proceeds from issuance of Series B Preferred Stock............................. -- 29,800 29,800
Proceeds from issuance of convertible notes.................................... 170 1,743 1,913
Proceeds from repayment of employee notes receivable........................... 4 6 10
Net cash provided by financing activities.................................... 862 32,350 33,212
Net increase in cash............................................................. 510 18,492 19,002
Cash at beginning of period...................................................... -- 510 --
Cash at end of period............................................................ $ 510 $ 19,002 $ 19,002
============= ============= =============
Supplemental disclosure of non-cash financing activities:
Conversion of notes payable into common stock................................... $ 170 $ -- $ 170
============= ============= =============
Issuance of common stock for notes receivable................................... 10 -- 10
============= ============= =============
Accretion of Series A preferred stock to redemption value....................... -- 25 25
============= ============= =============
Beneficial conversion charge Series A preferred stock........................... -- 144 144
============= ============= =============
Conversion of notes payable and interest to Series B preferred Stock............ -- 1,777 1,777
============= ============= =============
Accretion of Series B preferred stock to redemption value....................... -- 222 222
============= ============= =============
Beneficial conversion charge, Series B preferred stock.......................... -- 31,577 31,577
============= ============= =============
Conversion of Series A preferred into series B preferred stock.................. -- 182 182
============= ============= =============
Issuance of common stock options for assets..................................... -- 44 44
============= ============= =============
Issuance of warrants for music content.......................................... -- 1,327 1,327
============= ============= =============
Issuance of common stock in conjunction with acquisitions....................... -- 13,329 13,329
============= ============= =============
Issuance of common stock to Nordic.............................................. -- 11,084 11,084
============= ============= =============
</TABLE>
50
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<S> <C> <C> <C>
Accrued dividend payable on Series B preferred stock..................... -- 569 569
======= ======== ========
Accrual for amount due on content licence................................ -- 116 116
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
51
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
52
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
January 8, 1998 Year January 8, 1998
(Inception) to Ended (Inception) to
June 30, June, 30 June 30,
1998 1999 1999
---------------- ------------ ----------------
<S> <C> <C> <C>
Net loss........................................................... $ (1,180) $ (15,140) $ (16,320)
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)
Dividend on Series B preferred stock............................... -- (569) (569)
----------- ----------- -----------
Net loss applicable to common shares............................... $ (1,180) $ (47,677) $ (48,857)
----------- ----------- -----------
Net loss per common share - basic and diluted...................... $(0.12) $(3.52) $(4.87)
----------- ----------- -----------
Weighted average common shares outstanding - basic and diluted..... 10,234,055 13,563,606 10,027,231
----------- ----------- -----------
Antidilutive securities:
Options to purchase common stock................................. 908,297 2,183,091 1,710,861
Common stock subject to repurchase............................... 508,056 1,596,492 1,257,344
Series B Preferred Stock......................................... -- 3,167,858 2,271,771
Warrants......................................................... -- 35,267 21,471
----------- ----------- -----------
1,416,353 6,982,708 5,261,447
=========== =========== ===========
</TABLE>
In addition, the effects of warrants for the purchase of 1,508,000 and 100,000
shares of common stock exercisable at $13.63 and $18.00 respectively have been
excluded from the above calculation as their effect would be antidilutive for
purposes of the calculation of diluted earnings per share.
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 June 30,
1999, foreign operations have not been significant.
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.
53
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 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, 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
</TABLE>
54
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<S> <C> <C>
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 is comprised of payments for the
following as of June 30 (in thousands):
<TABLE>
<CAPTION>
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 remains outstanding at June 30, 1999. This
amount is included in accrued liabilities.
55
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 4--Property and Equipment
Property and equipment balances comprise the following as of June 30 (in
thousands):
<TABLE>
<CAPTION>
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 as of June 30 (in thousands):
<TABLE>
<CAPTION>
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).
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
56
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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,
the Company recorded a charge of approximately $569,000 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
57
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
Rent expense, net of sublease income, was $13,000, $231,000 and $244,000 for the
period from January 8, 1998 (Inception) to June 30, 1998, the year ended June
30, 1999, and the period from January 8, 1998 (Inception) to June 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, a total of 311,389 shares
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, 4,465,679 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
58
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
years from the date of grant. On June 30, 1999, there were 1,656,850 shares of
common stock available for grant under the Plans.
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--$13.625 $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
=========
</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-
Range of Outstanding Remaining Average Exercisable Average
Exercise at June 30, Contractual Exercise At June 30, 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>
59
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, $21,786,000 and
$5.17, respectively, in the period 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 options 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.
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
(Inception) Year
through Ended
June 30, June 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 reported............................ $(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, remain outstanding at June 30, 1999.
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 remain outstanding at June 30, 1999.
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
60
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 remain outstanding as of June 30,
1999.
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 remain outstanding as of June 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.................... --
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.
61
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
62
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
63
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 12--Unaudited Pro Forma Net Loss Per Common Share And Pro Forma
Stockholders Deficit
Pro forma basic net loss per common share has been computed as described in Note
1 and also gives effect to common equivalent shares from the conversion of the
Series B preferred stock, which will occur automatically on the completion of
the Company's follow-on offering (using the as-converted method) for the year
ended June 30, 1999.
A reconciliation of the numerator and denominator used in the calculation of pro
forma and diluted net loss per common share follows (in thousands except share
and per share data):
<TABLE>
<CAPTION>
January 8,
Year Ended 1998 to
June 30, June 30,
1999 1999
------------ ------------
<S> <C> <C>
Pro forma net loss per common share, basic and diluted:
Net loss attributable to common stockholders................................ $ (47,677) $ (48,857)
Accretion of Series B preferred stock to redemption value...................... 222 222
Beneficial conversion charge, Series B preferred Stock......................... 31,577 31,577
----------- -----------
Net loss....................................................................... $ (15,878) $ (17,058)
----------- -----------
Shares used in computing net loss per common share, basic and diluted.......... 13,563,606 10,027,231
Adjustments to effect the assumed conversion of the preferred stock............ 3,167,858 2,271,771
----------- -----------
Shares used in computing pro forma net loss per common share, basic and
diluted...................................................................... 16,731,464 12,299,002
=========== ===========
Pro forma net loss per common share, basic and diluted......................... $ (0.95) $ (1.39)
=========== ===========
</TABLE>
If the offering contemplated by the registration statement is consummated, all
of the Series B stock will be automatically converted into an aggregate of
11,757,000 shares of common stock and the accumulated dividend of $569,000 will
be paid in cash to the holders of Series B. Unaudited pro forma stockholders
equity as at June 30, 1999, as adjusted for the conversion of the Series B
stock, is disclosed on the Balance Sheet.
64
<PAGE>
(2) Financial Statement Schedules:
The following financial statement schedule of EMusic.com Inc. for the period
from inception, January 8, 1998 to June 30, 1998 and for the year ended June
30, 1999 is filed as part of this Report and should be read in conjunction
with the Consolidated Financial Statements of EMusic.com Inc.
<TABLE>
<CAPTION>
Reference
Page
-----------
<S> <C>
Schedule II -- Valuation and Qualifying Accounts...................................... 67
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
(3) Exhibits:
The exhibits listed below are required by Item 601 of Regulation S-K. Each
management contract or compensatory plan or arrangement required to be filed as
an exhibit to this Form 10-K has been identified.
Exhibit
Number Description of Document
- -------- -----------------------
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(b) 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
65
<PAGE>
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
3.1(b) Amended and Restated Certificate of Incorporation
3.2(b) Amended and Restated Bylaws
10.1(b) 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(b)* 1998 Nonstatutory Stock Option Plan
10.5(b)* 1999 Employee Stock Purchase Plan
10.6(b) Form of Amendment to Investor Rights Agreement dated July 19, 1999
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney (see page 67 of this Form 10-K)
27.1 Financial Data Schedule (available in EDGAR format only)
____________________
* Indicates management contract or compensatory plan or arrangement.
(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 Registration Statement on
Form S-1 (333-83685)
(c) Reports on Form 8-K:
On April 13, 1999, the Company filed an amended report on Form 8-K,
pursuant to Items 2 and 7 of such Form, which included the supplementary
consolidated financial statements of Emusic.com Inc.
On June 29, 1999, the Company filed a report on Form 8-K, pursuant to
Items 2 and 7 of such Form, regarding its acquisition of Emusic.com Inc.
66
<PAGE>
SCHEDULE II
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on September 28, 1999.
EMUSIC.COM INC.
(Registrant)
By: /s/ GENE HOFFMAN, JR.
--------------------------------------
Gene Hoffman Jr.
President
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Gene Hoffman, Joseph Howell and Peter Astiz, and
each of them, his or her true and lawful attorneys-in-fact, each with full power
of substitution, for him or her in any and all capacities, to sign any
amendments to this report on Form 10-K and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact or their substitute or substitutes may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:
<TABLE>
<S> <C>
/s/ GENE HOFFMAN, JR. /s/ ROBERT KOHN
- ---------------------------------------------------------------- ----------------------------------------------------------------
Gene Hoffman, Jr. Robert Kohn
President, Chief Executive Officer Chairman of the Board
Director September 28, 1999
September 28, 1999
/s/ JOSEPH. HOWELL /s/ RALPH PEER, II
- ---------------------------------------------------------------- ----------------------------------------------------------------
Joseph H. Howell Ralph Peer, II
Executive Vice President & Chief Financial Officer Director
(Principal Financial and Accounting Officer) September 28, 1999
September 28, 1999
/s/ TOR BRAHAM /s/ ED ROSENBLATT
- ---------------------------------------------------------------- ----------------------------------------------------------------
Tor Braham Ed Rosenblatt
Director Director
September 28, 1999 September 28, 1999
</TABLE>
67
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description of Document
- -------- -----------------------
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney (see page 67 of this Form 10-K)
27.1 Financial Data Schedule (available in EDGAR format only)
- ----------------------------------
* Indicates management contract or compensatory plan or arrangement.
(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 Registration Statement on
Form S-1 (333-83685)
68
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-82841) of EMusic.com Inc., of our report dated
July 26, 1999 relating to the financial statements which appears in this
Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
September 29, 1999
<TABLE> <S> <C>
<PAGE>
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<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 19,002,000
<SECURITIES> 0
<RECEIVABLES> 51,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 19,277,000
<PP&E> 1,076,000
<DEPRECIATION> 93,000
<TOTAL-ASSETS> 54,221,000
<CURRENT-LIABILITIES> 2,684,000
<BONDS> 0
32,550,000
0
<COMMON> 17,000
<OTHER-SE> 18,970,000
<TOTAL-LIABILITY-AND-EQUITY> 54,221,000
<SALES> 33,000
<TOTAL-REVENUES> 92,000
<CGS> 27,000
<TOTAL-COSTS> 15,527,000
<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> (37,000)
<INCOME-PRETAX> (47,677,000)
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<EXTRAORDINARY> (47,677,000)
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<EPS-BASIC> (3.52)
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