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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------
FORM 10-Q
Quarterly Report Pursuant To Section 13 or 15(d) of
the Securities Exchange Act Of 1934
September 30, 2000
Commission File No. 0-24671
EMUSIC.COM INC.
(Exact Name of small business issuer as specified in its charter)
Delaware 94-3290594
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1991 Broadway, 2nd Floor 94063
Redwood City, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 216-0200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date:
Common Stock, $0.001 Par Value 43,145,000 shares
(Class) (Outstanding at October 31, 2000)
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EMUSIC.COM INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C> <C>
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2000 and June 30, 2000........ 3
Condensed Consolidated Statements of Operations - three months ended
September 30, 2000 and 1999....................................................... 4
Condensed Consolidated Statements of Cash Flows - three months ended
September 30, 2000 and 1999....................................................... 5
Notes to Financial Statements....................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 24
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds........................................... 25
Item 6. Exhibits and Reports on Form 8-K.................................................... 25
Signatures.................................................................................... 26
</TABLE>
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PART I: FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
EMUSIC.COM INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
September 30, 2000 June 30, 2000
------------------- --------------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents......... $ 5,036 $ 14,591
Short-term investments............ 17,903 19,669
Accounts receivable, net.......... 4,954 2,488
Note receivable................... - 5,676
Prepaid expenses and
other assets.................... 4,090 4,039
--------- ---------
Total current assets 31,983 46,463
Property and equipment, net............ 4,557 4,706
Advanced royalties, music
catalogs and investments, net........ 29,136 26,234
Intangible assets, net................. 166,342 175,334
Notes receivable and other assets...... 6,247 523
--------- ---------
Total assets........................... $ 238,265 $ 253,260
========= =========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable.................. $ 2,839 $ 4,130
Accrued liabilities............... 3,762 3,540
Accrued compensation and
related benefits................ 2,290 2,352
Deferred revenue.................. 3,086 1,151
--------- ---------
Total current liabilities.... 11,977 11,173
Capital lease, net of current
portion......................... 200 245
--------- ---------
Total liabilities 12,177 11,418
--------- ---------
Stockholders' Equity:
Capital stock and additional
paid-in capital................. 368,978 367,406
Accumulated deficit............... (142,890) (125,564)
--------- ---------
Total stockholders' equity... 226,088 241,842
--------- ---------
Total liabilities
and stockholders' $ 238,265 $ 253,260
equity ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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EMUSIC.COM INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Three months ended
September 30, 2000 September 30, 1999
<S> <C> <C>
Revenues............................... $ 4,636 $ 180
Cost of revenues....................... 1,845 25
-------- --------
Gross profit........................... 2,791 155
-------- --------
Operating expenses:
Product development, excluding stock
compensation.................... 4,231 2,051
Stock compensation................ 178 3,960
-------- --------
Total product development.... 4,409 6,011
Selling and marketing............. 4,997 4,771
General and administrative........ 1,986 812
Amortization of intangible assets. 9,140 2,283
-------- --------
Total operating expenses..... 20,532 13,877
Operating loss......................... (17,741) (13,722)
Interest and other income, net......... 415 203
-------- --------
Net loss............................... (17,326) (13,519)
-------- --------
Accretion of preferred stock........... - (224)
Dividend on preferred stock............ - (493)
-------- --------
Net loss applicable to common shares... $(17,326) $(14,236)
======== ========
Net loss per common share-basic
and diluted.......................... $(0.43) $(1.09)
======== ========
Weighted average common shares
outstanding - basic and diluted....... 40,600 13,058
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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EMUSIC.COM INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<S> <C> <C>
Three months ended Three months ended
September 30, September 30,
2000 1999
------------------ ------------------
Cash flows from operating activities:
Net loss............................ $(17,326) $(13,519)
Adjustments to reconcile net loss to
net cash (used in) provided by used
in operating activities:
Depreciation........................ 886 200
Amortization........................ 9,140 2,283
Stock compensation.................. 178 3,960
Changes in assets and liabilities,
net of effects of acquisition:
Accounts receivable............... (2,466) (117)
Prepaid expenses and other assets. (47) (7,336)
Accounts payable.................. (1,291) (231)
Accrued liabilities............... 222 (946)
Accrued compensation and related
benefits........................ (62) 62
Deferred revenue 1,935 -
--------- ----------
Net cash (used in) provided by
operating activities (8,831) (15,644)
--------- ----------
Cash flows from investing activities:
Purchases of short-term
investments....................... (1,999) -
Maturities of short-term
investments....................... 3,765 -
Note receivable..................... (52) -
Advanced royalties.................. (2,011) (2,988)
Purchase of property
and equipment..................... (387) (1,113)
--------- ----------
Net cash (used in) provided
by used in investing
activities.................... (684) (4,101)
--------- ----------
Cash flows from financing activities:
Proceeds from issuance of
common stock...................... - 79,682
Issuance costs related
to offering....................... - (40)
Proceeds from exercise of
stock options and warrants........ 5 5
Payment on capital lease............ (45) -
--------- -----------
Net cash (used in) provided by
used in financing activities.. (40) 79,647
--------- -----------
Net decrease in cash and cash
equivalents......................... (9,555) 59,902
Cash at beginning of period 14,591 19,002
--------- ----------
Cash at end of period.................... $ 5,036 $ 78,904
============ ============
Supplemental disclosure of non-cash
transactions:
Accretion of preferred stock to
redemption value.................. $ - $ 224
Accrued dividend payable on
preferred stock................... $ - $ 493
Conversion of preferred stock into
common stock...................... $ - $ 32,206
Issuance of warrants for licensed
music content..................... $ 93 $ -
Issuance of common stock for
assets............................ $ 350 $ -
Issuance of common stock for licensed
music content..................... $ 32 $ -
Issuance of common stock for acquired
music catalog..................... $ 1,100 $ -
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1--The Company and Summary of Significant Accounting Policies
The Company
EMusic.com Inc. ("EMusic" or the "Company") sells downloadable music over the
Internet and operates a network of music-oriented Web sites, including
RollingStone.com, EMusic.com, DownBeatJazz.com and IUMA.com that generates
revenue from the sale of advertising. The Company also generates revenue from
the licensing of its acquired music catalogs. A Delaware corporation formerly
known as GoodNoise Corporation, EMusic was incorporated on January 8, 1998 and
is based in Redwood City, California, with regional offices in New York, Los
Angeles and Chicago.
Basis of Presentation
These consolidated financial statements contemplate the realization of assets
and the satisfaction of liabilities in the normal course of business. The
Company has incurred losses in each fiscal year since inception as a result of
incurring costs to establish its business, which were significantly in excess of
revenues. The Company has also used its cash resources to make substantial
investments in music content for its websites.
Management's plans to reverse its the recent trendhistory of losses and negative
cash flows by increasing are to increase revenues while controlling costs. If
the Company is unable to generate adequate cash flows from operations, the
Company may need to seek additional sources of capital. There can be no
assurance that the Company will be able to obtain such funding, if necessary, on
acceptable terms or at all.
In the opinion of management, the unaudited consolidated condensed financial
statements included herein have been prepared on a basis consistent with prior
periods reported consolidated financial statements and include all material
adjustments, consisting of normal recurring adjustments, necessary to fairly
present the information set forth therein.
All significant inter-company balances and transactions have been eliminated.
Certain information and footnote disclosures normally included in the financial
statements have been condensed or omitted pursuant to rules and regulations of
the Securities and Exchange Commission ("SEC"), although we believe that the
disclosures in the unaudited interim financial statements are adequate to ensure
that the information presented is not misleading. The results of operations for
the interim reporting periods presented herein are not necessarily indicative of
any future operating results.
The financial information as of June 30, 2000 is derived from our Annual Report
on Form 10-K for the Fiscal Year Ended June 30, 2000 as filed with the SEC. The
interim financial statements presented herein should be read in conjunction with
the financial statements and the notes thereto included in the Form 10-K.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported amounts in the financial statements and accompanying
notesof assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and reported amounts of
revenues and expenses during the reported period. Actual results could differ
materially from those estimates.
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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 our right of repurchase. 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 upon the conversion of
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 per share data):
<TABLE>
<CAPTION>
Three months ended Three months ended
September 30, 2000 September 30, 1999
------------------ ------------------
<S> <C> <C>
Net loss................................. $ (17,236) $ (13,519)
Accretion of preferred stock to
redemption value....................... - (224)
Dividend on Series B preferred stock..... - (493)
----------- ---------
Net loss applicable to common shares..... $ (17,236) $ (14,236)
----------- ---------
Net loss per common share - basic and
diluted................................ $ (0.43) $ (1.09)
----------- ---------
Weighted average common shares
outstanding - basic and diluted........ 40,600 13,058
----------- ----------
Antidilutive securities:
Options to purchase common stock....... 10,672 6,645
Common stock subject to repurchase..... 2,526 4,347
Warrants............................... 6,416 3,305
----------- ----------
19,614 14,297
----------- ----------
</TABLE>
Comprehensive Net Loss
There are no differences between our net loss as reported for any of the periods
reported herein and our comprehensive loss, as defined by Statement of Financial
Accounting Standards No. 130, for each of these respective periods.
Segment information
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," which 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, an online music
network of websites (including EMusic.com, RollingStone.com, IUMA.com and
DownbeatJazz.com) that sells downloadable music and advertising. All long-lived
assets and all revenues were located or generated in the United States of
America.
Capitalization of web development costs
Costs incurred in the design, creation and maintenance of content, graphics and
user interface of the Company's Web site are expensed as incurred in accordance
with SOP 98-1, and Emerging Issues Task Force ("EITF") 00-02 "accounting for Web
Site Development Costs."
Costs incurred in the development of application and infrastructure of the
Company's web site are capitalized and
7
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amortized over their useful life, which is estimated to be 2 years.
Recent Accounting Pronouncement
The Company adopted Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS 137 and
SFAS 138. SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments as well as other
hedging activities, and was effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000. The Company's adoption of this
pronouncement did not have a material impact on the Company's financial position
and results of operations.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements." In
addition the SEC released, in October 2000 interpretative guidance on SAB 101 in
the form of frequently asked questions and responses thereto. SAB 101 and the
frequently asked questions and responses provide guidance for revenue
recognition under certain circumstances. The Company is currently evaluating the
impact of SAB 101 on its financial statements and related disclosures, but does
not expect that such impact, if any, will be material. The accounting and
disclosures prescribed by SAB 101 will be effective for our fiscal year ending
June 30, 2001.
In March 2000, the FASB issued FASB Interpretation No. 44 (FIN44), "Accounting
for Certain Transactions Involving Stock Compensation, an interpretation of APB
Opinion No. 25" ("Interpretation"). The Interpretation is intended to clarify
certain problems that have arisen in practice since the issuance of APB 25. The
Interpretation provides guidance, some of which is a significant departure from
current practice. The Interpretation generally provides for prospective
application for grants or modifications to existing stock options or awards made
after June 30, 2000. However, for certain transactions the guidance is
effective after December 15, 1998 and January 12, 2000. The adoption of this
pronouncement did not have an effect on the current or historical financial
statements, but may impact our future accounting regarding stock option
transactions.
8
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--------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
We are the owner and operator of one of the leading online music networks,
providing music fans with extensive music content, news and information and
community features. Our network of websites is ranked among the top five music
informationcontent websites as measured by unique visitors in Julyne 2000.
EMusic.com is a website for sampling and purchasing music in the mp3 format.
Through direct relationships with leading artists and exclusive licensing
agreements with over 600 independent record labels, EMusic.com offers an
expanding collection of over 130,000 tracks for purchase, the largest collection
of digital music content from recognized artists currently available for legal
distribution in mp3 format over the Internet. RollingStone.com is the
Internet's premier authority on music and popular culture. The website
leverages Rolling Stone magazine's unrivaled deep archives, including more than
7,000 artist profiles, an extensive collection of exclusive photos and
interviews, more than 30 years of magazine covers and over 1,000 on-demand
videos. We also operate additional websites including IUMA.com, Tunes.com and
Downbeatjazz.com.
In addition to historical statements, this Quarterly Report on Form 10-Q
contains forward-looking statements that are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
stated or implied. Forward-looking statements include those that use the words
"expects," "estimates," "will," "may," "anticipates," "believes" or similar
expressions. These forward-looking statements reflect management's opinions only
as of the date hereof, and we assume no obligation to update this information.
Risks and uncertainties include, but are not limited to, those discussed below
and in the section entitled "Factors That May Affect Our Results." Other risks
and uncertainties are disclosed in our prior SEC filings.
The following discussion should be read in conjunction with our Condensed
Consolidated Financial Statements and Notes thereto, included elsewhere in this
report.
RESULTS OF OPERATIONS
Since incorporation, we have incurred significant costs to acquire our catalog
of downloadable music and to develop the Internet websites through which we
conduct our business. We began selling musical recordings over the Internet in
July 1998, and have since sold more than 3.0 million songs for download over the
Internet. We may experience significant fluctuations in operating results in
future periods due to a variety of factors, including, but not limited to,
market acceptance of the Internet as a medium for consumers to obtain
downloadable sound recordings, timing issues associated with revenue recognition
on larger corporate transactions, our ability to create, license, and deliver
compelling music-related content, our ability to obtain additional financing in
a timely manner and on terms favorable to us, our ability to successfully
integrate prospective asset or company acquisitions into our existing business
operations, the level of traffic on our websites, intense competition from other
providers of music-related content over the Internet, the entrance of
established music and/or software companies into the on-line music industry,
delays or errors in our ability to effect electronic commerce transactions, our
ability to upgrade and develop our systems and infrastructure in a timely and
effective manner, technical difficulties, system downtime or Internet brownouts,
our ability to attract customers at a steady rate and maintain customer
satisfaction, seasonality of the recorded music industry, seasonality of
advertising sales, the amount and timing of operating costs and capital
expenditures relating to expansion of our business, operations and
infrastructure and the implementation of marketing programs, key agreements and
strategic alliances, the number of recorded music releases introduced during the
period, the level of returns experienced by us and general economic conditions
and economic conditions specific to the Internet, on-line commerce and the
recorded music industry.
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Revenues
Revenues are derived from the sale and licensing of downloadable music and from
advertising services provided to other companies. Substantially all of our
revenues are related directly to the Internet. Net revenues increased to
$4,636,000 for the quarter ended September 30, 2000 from $180,000 for the
quarter ended September 30, 1999. The revenue increase was primarily
attributable to the increasing sales of downloadable music and to increasing
advertising sales following the completion of our acquisition of Tunes.com in
February 2000.
We have acquired and control the exclusive legal rights to the largest catalog
of music available for purchase as downloadable mp3 files. At September 30,
2000, we offered approximately 130,000 songs from over 7,000 professional
artists and over 600 record labels for sale and download over the Internet. Via
the Internet, customers browse, purchase and download these files from
EMusic.com, and can link to our website from approximately 11,000 other
affiliate websites. Music revenues for the quarter ended September 30, 2000
include $1,365,000 from the sale of downloadable music and $141,000 from the
licensing of portions of our music catalogs for use by other music companies. A
substantial portion of the music revenues was derived from large corporate
purchases. Music revenues totaled $54,000 for the quarter ended September 30,
1999.
In July 2000, we launched EMusic Unlimited, a subscription program that allows
customers to download an unlimited amount of music from the EMusic catalog in
exchange for a flat, monthly fee. We also offer customers the opportunity to
purchase individual tracks and albums, generally priced at 99 cents to download
a single song and $8.99 to download an entire album. In June 2000, we announced
that Hewlett-Packard agreed to purchase a minimum of approximately $3 million of
EMusic Unlimited subscriptions to be bundled with CD-Writer products between
July 1, 2000 and March 31, 2001. This revenue principally will be recognized
during the quarters ending December 31, 2000 and March 31, 2001. Our ability to
sell downloadable music continues to be adversely affected by the ability of
potential customers to obtain our music for free through Napster, and to a
lesser extent other websites. Until or unless Napster ceases to operate in its
current model, our downloadable music revenue growth will continue to be
adversely affected.
We generate advertising revenues from the sale of integrated marketing
campaigns, banner advertisements and sponsorships on our network of websites,
especially RollingStone.com. Advertising revenues are derived principally from
short-term agreements and are generally recognized ratably over the term of the
agreements, provided that we have no significant remaining obligations and our
collection of the resulting receivable is probable. Our obligations typically
include guarantees of a minimum number of advertising impressions delivered or
times that the advertisement is viewed on our websites. Some of our top
advertising customers include American Express, Best Buy, COMPAQ, ESPN, Sears,
Universal and Wendy's.
Advertising revenues include barter revenue, which represents an exchange of
advertising space on our websites for reciprocal advertising space on the
websites or other media of third parties. Advertising revenues for the quarter
ended September 30, 2000 were $3,130,000, compared to $126,000 for the quarter
ended September 30, 1999. Advertising revenue principally increased as a result
of pageviews on Rollingstone.com, following our acquisition of Tunes.com in
February 2000. Advertising revenue from barter transactions is recognized based
on the fair value of the advertising surrendered in the transaction. Such fair
value is determined based on our historical practice of receiving cash, or other
consideration that is readily convertible to cash, for similar advertising from
buyers unrelated to the counter-party in the barter transaction. The cost of the
advertising space we receive from the third party is recorded as advertising
expense. For the quarter ended September 30, 2000, approximately 16 percent of
our revenues were derived from barter agreements. No barter revenue was recorded
in the quarter ended September 30, 1999.
Cost of Revenues
Cost of revenues is principally comprised of license fees paid to the owners of
Rolling Stone magazine and of royalties paid to the owners of copyrighted songs
sold to customers as downloadable files. Other costs of revenues include the
cost of acquiring or creating editorial content, the cost to deliver advertising
on our websites, and credit card processing fees. Cost of revenues for the
quarter ended September 30, 2000 and 1999 were $1,845,000 and $25,000,
respectively. Gross margins as a percentage of sales for the quarter ended
September 30, 2000 and 1999 were 60% and 86%, respectively. Gross margins
decreased principally as a result of the increased license fees related to
advertising revenue on the Rollingstone.com site.
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Because gross margins from advertising and sponsorship are higher than
downloadable music, future gross margins may fluctuate depending on the relative
proportion of advertising and downloadable music revenues. Although we expect
that sales and gross profits related to downloadable music will increase in
future periods, gross margins related to the EMusic Unlimited program may be
lower than those we have historically experienced with our individual album and
track sales. Because the EMusic Unlimited program has only recently been
introduced and the number of songs downloaded by our subscribers significantly
impacts the gross margin on subscription sales, we do not yet have enough data
to predict the extent to which these margins may be lower.
Product Development Expenses
Product development activities are those related to acquiring the rights to
musical works and information and to building the systems necessary to deliver
music and information to customers. Product development activities include
website design and maintenance, audio production, graphic design, content
acquisition and artist development. Product development expenses include
salaries, rent, depreciation, telecommunications charges, stock compensation and
certain non-recoverable advances to artists. Exclusive of stock compensation
expenses, product development expenses for the quarters ended September 30, 2000
and 1999 were $4,231,000 and $2,051,000, respectively. This reflects our
increased development efforts, particularly in graphic design and development of
the infrastructure required to deliver downloadable music from our Internet
website as well as the acquisition of music content.
Stock compensation expenses represent the cost of common stock options and
warrants granted to consultants in exchange for their help in acquiring the
rights to musical works. For accounting purposes, the cost of the options
granted to non-employees and warrants is calculated using the Black-Scholes
Model. These stock options and warrants give the recipient the right to
purchase shares of our common stock from us in the future at a specified price.
The price specified is generally equal to the market price of our common stock
on the date the instrument was issued to the consultant. Stock compensation
expenses were $178,000 and $3,960,000 in the quarters ended September 30, 2000
and 1999, respectively.
Selling and Marketing Expenses
Selling and marketing consists principally of activities designed to promote our
EMusic.com and RollingStone.com websites, to attract new customers and traffic
to our websites and to sell advertisements and downloadable music to corporate
customers. Selling and marketing expenses were $4,997,000 and $4,771,000 for the
quarters ended September 30, 2000 and 1999, respectively. The increase in
selling and marketing expenses during fiscal year 2000 reflects the increase in
headcount and marketing expense following the acquisition of Tunes.com in
February 2000.
General and Administrative Expenses
General and administrative expenses consist primarily of executive management,
finance, legal, administrative and related overhead costs, such as rent, and
insurance. General and administrative expenses for the quarters ended September
30, 2000 and 1999 were $1,986,000 and $812,000, respectively. General and
administrative expenses increased principally as a result of additional
insurance and professional fees and headcount required to manage our growing
operations as a public company and as a result of the acquisition of Tunes.com.
Amortization of Intangible Assets
Amortization of intangible assets for the quarters ended September 30, 2000 and
1999 were $9,140,000 and $2,283,000, respectively. During 1999, we acquired the
"EMusic," "IUMA" and certain other trade names for a combined total of
$26,362,000 in cash and stock. We began amortizing these costs over a three-year
period, resulting in an amortization expense of $2,283,000 per quarter.
On December 13, 1999, we acquired Cductive.com and began amortizing the goodwill
and intangible assets associated with this purchase of $35,869,000, over a
three-year period, resulting in an amortization expense of $2,989,000 per
quarter. On February 15, 2000, we acquired Tunes.com and began amortizing the
goodwill and trade name totaling $134,652,000 over a ten-year period and the
other intangible assets of $1,418,000 associated with this purchase over a one-
year period, resulting in an amortization expense of $3,721,000 per quarter.
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Liquidity and Capital Resources
At September 30, 2000, we had cash, cash equivalents and short-term investments
totaling $22,939,000. Net cash of $8,831,000 was used for operating activities
during the quarter ended September 30, 2000, principally as a result of net
losses of $17,326,000 generated during the quarter and the decrease of accounts
payable of $1,291,000, offset by non-cash expenses, including amortization of
intangible assets of $9,140,000 and depreciation of $886,000. We expect to incur
negative cash flow from operations during current fiscal year, as the market
continues to develop and we expand our operations. However, in June 2000, we
announced that we had taken cost-reduction actions that we believe will result
in aggregate cost savings of more than $15 million over the 12 months ending in
June 2001.
Net cash used for investing activities totaled $684,000 for the quarter
ended September 30, 2000 as we spent $2,011,000 for royalty advances and
$387,000 on capital equipment and software, partially offset by net maturities
of short-term investments of $1,766,000.
Net cash used in financing activities totaled $40,000 for the quarter ended
September 30, 2000, as we paid $45,000 on a capital lease.
Under an agreement with Rolling Stone LLC we are required to purchase $1,100,000
of advertising and other services annually in Rolling Stone magazine until
February 2011 and to pay Rolling Stone an annual license fee of $1,000,000,
which increases to $1,250,000 in 2001 and $1,500,000 in 2006.
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, which began 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.
We have incurred significant losses from operations during each fiscal year
since inception and have been dependent upon raising money from issuances of our
preferred stock and common stock in order to fund these losses and our
investment in content and other assets needed to establish our business.
We currently plan to increase our revenues to a level that will finance expected
expenditures and result in at least neutral cash flows from operations. However
until we reach this stage we will continue to use our current cash and cash
equivalent and short-term investment balances to meet the shortfall. We also
plan to raise additional financing where necessary. There can be no assurance
that, in the event we require additional financing that such financing will be
available on terms, which are acceptable to us or at all.
In the event that we are unable to increase revenue levels or financing is
unavailable to us management has developed alternative plans which will entail
the reduction of expenses to levels that could be financed by revenues
generated. Such reductions in expenditures may include actions similar or
greater in scope to the cost-reduction exercises undertaken in June 2000. There
can be no assurance that the exercise undertaken in June or any further cost
cutting exercises will be successful in completely eliminating the difference
between expenditures and revenues or that such actions would not have a harmful
effect on our business and results of operations.
Based on our current plans we believe that the current balances of our cash and
cash equivalents and short-term investments will be sufficient to meet our cash
requirements for at least the next twelve months.
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FACTORS THAT MAY AFFECT OUR RESULTS
Investing in our Common Stock involves a high degree of risk. You should
carefully consider the following factors and other information contained in this
Form 10-Q and the other filings which we make with the SEC from time to time
before deciding to invest in our stock.
Any of the following risks, if they actually occur, could materially and
adversely affect our business, financial condition or results of operations. In
such event, the trading price of our common stock could decline, and
stockholders could lose all or part of their investments.
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 primarily through our websites, including:
. online sales of downloadable music;
. website advertising and sponsorship fees from third parties; and
. licensing of musical recordings for use by others.
It is uncertain whether a music-based website such as EMusic.com, 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.
We are substantially dependent upon our recently introduced EMusic Unlimited
subscription service which allows users to download substantially all of the
music for sale at EMusic.com for a fixed monthly fee. If our subscription
service is not accepted by users, our ability to increase our revenues will be
adversely affected. Likewise, if users download greater numbers of albums or
tracks than we currently expect, our operating results would be adversely
affected.
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 websites on a regular basis. 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
websites on a regular basis. 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 cannot be certain that our business
model will be successful or that we will 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. In the early
stages of this market, 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 music from major record labels and portable
devices to store and play this music. Although the major labels have announced
plans to make music available for download, to date they have only announced the
availability of limited portions of their catalogs at prices which are
substantially higher than the prices which we have been charging for
downloadable music. These actions may slow the overall consumer acceptance of
downloadable music and adversely impact our ability to increase our revenues.
Likewise, to the extent that new devices are not available at affordable prices,
or consumer acceptance or distribution of
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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 and 1999, our operating
activities consisted largely of developing the infrastructure necessary to
download music on the Internet and obtaining exclusive digital rights to sell
music. We acquired Tunes.com Inc., the original operator of RollingStone.com, in
early 2000. Our limited operating history makes it difficult to evaluate our
current business and prospects. As a result of our limited operating history, we
do not have meaningful historical financial data upon which to forecast
quarterly revenues and results of operations. Before investing in us, you should
evaluate the risks, expenses and problems frequently encountered by companies
such as ours that are in the early stages of development.
We have incurred substantial losses to date and we expect net losses in the
future.
From inception through September 30, 2000, we had accumulated net losses of
$109.6 million. We expect substantial net losses for the foreseeable future and
although we believe that we have a plan which can lead to positive cash flow
from operations, there can be no assurance that our plan can be achieved. We
believe it is critical to our long-term success that we continue to develop
"EMusic" and "RollingStone.com" brand awareness and loyalty through marketing
and promotion, expand our artist and consumer networks, develop our online
content and expand our other services. We have recently reduced our operating
expenses. If we determine that we need to increase operating expenses in order
to achieve our goals, we will need to generate significant additional revenues
to achieve profitability. As a result, we may never achieve profitability and,
if we do achieve profitability in any period, we may not be able to sustain or
increase profitability.
Our revenues are adversely impacted by the availability of our music for free
through Napster, and to a lesser extent other websites. Until or unless Napster
ceases to operate in its current model, our downloadable music revenue growth
will continue to be adversely affected.
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 application of revenue recognition policies to large contracts
under generally accepted accounting principles;
. 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.
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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. 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.
We depend significantly upon our relationship with the publisher and owner of
Rolling Stone magazine, for editorial content, access to the archives of Rolling
Stone and our use of the brand name "Rolling Stone," as well as for press
coverage, business and marketing opportunities, strategic relationships and
potential acquisitions. If we are unable to continue this relationship and to
utilize the Rolling Stone brand name and content on our websites, or if the
Rolling Stone content or brand name is made accessible to our competitors, we
may generate less traffic, which would reduce our revenue. In addition, if
Rolling Stone is not able to continue to obtain license rights for online
distribution of its magazine content from third-party contributors, we would not
be able to make this content available on our Web sites which could reduce the
number of visitors to our websites. Our agreement with Rolling Stone will
terminate in 2011 unless we have a market capitalization of at least $2 billion
at that time, in which case it will terminate in 2016. The agreement may be
terminated earlier if we fail to comply with our obligations under the
agreement.
Under our agreement with Rolling Stone, we obtained the right to use the
"Rolling Stone," "RollingStone Online" and "RollingStone.com" trademarks and
their derivatives in connection with the Internet and the right to use the
RollingStone.com domain name. If our agreement terminates, we will not be
entitled to use these trademarks or the RollingStone.com domain. The loss of our
right to use the Rolling Stone trademarks, domain or content would damage our
reputation and severely limit our ability to generate advertising, e- commerce
and other revenue.
Shares eligible for future sale in the open market may depress our stock price.
As of September 30, 2000, there were approximately 43,000,000 shares of common
stock outstanding, substantially all of which were tradable without registration
under the Securities Act or pursuant to currently effective registration
statements or exemptions from registration requirements.
Our stock price has been and may continue to be volatile.
Our Common Stock is currently traded on the Nasdaq National Market under the
ticker symbol "EMUS." There can be no assurance that an active trading market
will be sustained in the future. In addition to fluctuations in our operating
results, the following factors could cause the price of our securities to be
volatile:
. development of the downloadable music market;
. technological innovations;
. legal development with respect to copyright law and downloadable
music;
. new products;
. acquisitions or strategic alliances entered into by us or our
competitors;
. failure to meet securities analysts' expectations;
. government regulatory action;
. patent or proprietary rights developments; and
. market conditions for Internet and technology stocks in general.
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Our shares may be delisted from the Nasdaq National Market if the minimum
closing bid price per share is less than $1.00 for a period of 30 consecutive
days. If our stock were delisted from the Nasdaq National Market there would
likely be a substantial reduction in the liquidity of any investment in our
common stock. Delisting could also reduce the ability of holders of our common
stock to purchase or sell shares as quickly and as inexpensively as they have
done historically. This lack of liquidity also makes it more difficult for us to
raise capital in the future.
If our brand names are not accepted, our ability to attract content and
customers to our website will be harmed.
We believe that establishing and maintaining the EMusic and RollingStone.com
brands 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 EMusic.com 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 the 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 third parties for the hosting of our websites and if these hosting
services become unavailable, our customers will not be able to access our
websites.
We currently rely on third parties, which host our EMusic.com and
RollingStone.com websites. We currently do not maintain redundant websites. 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 websites 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.
If our revenues grow rapidly, we will also need to expand the scope of our
operations and the number of our employees rapidly. In particular, we will need
to hire additional engineering, sales, marketing, content acquisition and
administrative personnel. Additionally, we may complete additional acquisitions
which could increase our employee headcount and business activity substantially.
Any such rapid growth would place significant stress on our technology,
operations, management and employee base. Any failure to successfully address
such issues would harm our business.
Our technology systems must be expanded and enhanced for our business to grow.
In order to support a growing business, we will need to continue to enhance and
expand the technology infrastructure, which supports our business. We have
recently converted our central database for EMusic.com to a new database based
upon technology licensed from Oracle Corporation and implemented a new
accounting system. As our business continues to grow, we will need to add
additional servers and other hardware and software systems as well as additional
sites for website hosting. If we fail to successfully implement these new and
enhanced systems, our operations could be disrupted, we may become less
competitive, our revenues could be reduced and we may need to incur additional
costs to address these issues.
We may have difficulty executing acquisitions and integrating the acquired
companies into our business.
Our business strategy includes entering into strategic alliances and acquiring
complementary businesses, technologies,
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content or products. During the last two fiscal years, we completed the
acquisitions of Creative Fulfillment, Inc., IUMA, Cductive and Tunes.com. 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.
In addition, our stockholders 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.
All of the major record label companies have announced initiatives with respect
to the sale of downloadable music. To date we have announced agreements
pursuant to which we will sell music from the Universal Music Group, EMI and
BMG. If we are unable to obtain licenses to sell or otherwise distribute
content from all or most of the major record label companies, our ability to
increase our sales will be limited to our ability to obtain licenses from the
independent record label segment of the music market, which has historically
represented approximately 20% of the total music market. To the extent that
other companies are able to obtain rights to content from major record labels,
such companies may have a significant competitive advantage over us.
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;
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. larger existing customer bases; and
. more popular content or artists.
These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to the development, promotion, and sale of their products or services than we
can. Websites maintained by our existing and potential competitors may be
perceived by consumers, artists, talent management companies and other music-
related vendors or advertisers as being superior to ours. In addition, we may
not be able to maintain or increase our website traffic levels, purchase
inquiries and number of click-throughs on our online advertisement. Further, our
competitors may experience greater growth in these areas than we do. Increased
competition could result in advertising price reduction, reduced margins or loss
of market share, any of which could harm our business.
We may need to obtain additional funds to execute our business plan and if we
are unable to obtain such funds, we will not be able to expand our business as
planned.
We believe that our existing capital will be sufficient to fund our planned
level of operating activities, capital expenditures and other obligations
through the next 12 months. However, unless we raise additional capital, we may
need to reduce the scope of certain activities. In addition, 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 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 websites. 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
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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 denial of service
problems such as those experienced by some major Internet sites. 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 websites, build
brand recognition, attract paid advertising and enhance content, distribution
and commerce opportunities, we have entered into agreements with various media,
hardware device and Internet-related companies such as America Online,
RealNetworks, and Microsoft. 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 Gene Hoffman, Jr.,
our chief executive officer, as well as on our ability to recruit, retain and
motivate other officers and key employees. Competition for qualified personnel
is intense and there are a limited number of persons with knowledge of and
experience in the Internet and music entertainment industries. The loss of the
services of any of our officers or senior managers could harm our business.
We may not be able to hire and retain a sufficient number of qualified employees
to grow our business as planned.
Our future success will depend on our ability to attract, train, retain and
motivate other highly skilled technical, managerial, marketing and customer
support personnel. Competition for these personnel is intense, especially for
engineers, web designers and advertising sales personnel, and we may be unable
to successfully attract sufficiently qualified personnel. A large percentage of
our employees have joined us within the last 12 months and if revenues grow
rapidly, our rate of hiring will need to continue. 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. 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
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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 us, violate patent rights that it allegedly owns covering the sale of
music over the Internet through digital downloads. If successful, these claims,
or similar claims by others, could seriously harm our business by forcing us to
cease using intellectual property that we depend on to operate our business.
Even if 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 and New
Jersey, 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 has 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. In addition, currently pending litigation involving copyright
infringement claims brought against MP3.com and Napster may result in decisions
which have a significant impact on our business. If the unlicensed distribution
of music is held to be lawful, our ability to sell music could be materially
harmed. Because of this rapidly evolving and uncertain regulatory environment,
we cannot predict how these laws and regulations might
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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 websites through links to other websites.
Although we believe that we have valid licenses for the music that we sell,
other artists or labels may challenge whether the party granting us the license
had the right to do so. Even if we are entitled to indemnification, defending
any such claim could be costly and damage our reputation and adversely affect
revenues if we must remove content from our site completely or temporarily.
Liability or alleged liability for content or other materials could harm our
business by damaging our reputation, requiring us to incur legal costs in
defense, exposing us to significant awards of damages, fines and costs and could
divert management's attention away from our business. In particular, in addition
to civil damages, liability for violations of copyright law currently can result
in penalties of up to $10,000 per occurrence.
Imposition of sales and other taxes on e-commerce transactions may impair our
ability to derive financial benefits from e-commerce.
Except for sales of tangible merchandise into certain states, we do not collect
sales or other taxes on sales of our products through our websites. Although the
Internet Tax Freedom Act precludes, for a period of three years ending October
2001, the imposition of state and local taxes that discriminate against or
single out the Internet, it does not currently impact existing taxes. However,
one or more states may seek to impose sales tax collection obligations on out-
of-state companies such as us, which engage in or facilitate online commerce. A
number of proposals have been made at the state and local level that would
impose additional taxes on the sale of goods and services through the Internet.
Such proposals, if adopted, could substantially impair the growth of electronic
commerce and could adversely affect our opportunity to derive financial benefit
from electronic commerce. Moreover, if any state or foreign country were to
successfully assert that we should collect sales or other taxes on the exchange
of merchandise on its system, it could affect our cost of doing business.
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
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withholding taxes or otherwise tax our foreign income, impose tariffs,
embargoes, or exchange controls, or adopt other restrictions on foreign trade.
In addition, the laws of certain countries do not protect our offerings and
intellectual property rights to the same extent as the laws of the United
States. If we fail to compete successfully or to expand the distribution of our
offerings in international markets the growth of our business could be limited.
Development of new standards for the electronic delivery of music may threaten
our business.
We currently rely on mp3 technology as a delivery method for the digital
distribution of music. Mp3 is an open standard adopted by the Moving Picture
Experts Group for the compression of audio files. We do not own or control mp3
technology and are dependent upon a license to obtain rights to certain patents
relating to the technology. The onset of competing industry standards for the
electronic delivery of music could significantly affect the way we operate our
business as well as the public's perception of EMusic as a company. For example,
in December 1998, the major recording studios announced a plan to develop a
universal standard for the electronic delivery of music, called the Secured
Digital Music Initiative. If new standards are developed and adopted by
consumers, we may not be able to obtain a license to such technology on
favorable terms or at all and our business could be harmed. Even if new
standards are not developed, delays with respect to proposed standards, such as
those which have occurred with respect to SDMI, can cause confusion in the
marketplace, slow the development of the market for downloadable music and
otherwise harm our business.
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.
Our executive officers and directors control approximately 16% of our Common
Stock and have power to influence significant corporate matters, which may
delay, deter or prevent transactions that could benefit our stockholders.
Executive officers and directors, in the aggregate, beneficially own
approximately 19% of our outstanding Common Stock. These stockholders are able
to significantly influence all matters requiring approval by our stockholders,
including the election of directors and the approval of significant corporate
transactions. This concentration of ownership may also have the effect of
delaying, deterring or preventing a change in control of EMusic and may make
some transactions more difficult or impossible without the support of these
stockholders.
Anti-takeover provisions in our charter documents could negatively impact our
stockholders.
Our Board of Directors has the authority to issue up to 20,000,000 shares of
Preferred Stock without need for stockholder approval. The board may also
determine the economic and voting rights, of this Preferred Stock. The holders
of our Common Stock could be adversely affected by the issuance of Preferred
Stock. Issuance of Preferred Stock could impede or prevent transactions that
would cause a change in control of our company. This might discourage bids for
our Common Stock as a premium over the market price of our Common Stock and
adversely affect the trading price of our Common Stock. We have no current plans
to issue shares of Preferred Stock. In addition, other provisions in our charter
documents could make it more difficult for a third party to acquire us, even if
doing so would be beneficial to our stockholders.
Our data warehousing and web server systems are vulnerable to natural disasters,
failure of third-party services and other unexpected problems.
Since our data warehousing, web server and network facilities for EMusic.com are
all located in California, an earthquake or other natural disaster could affect
all of our facilities simultaneously. An unexpected event such as a
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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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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Quantitative and Qualitative Disclosures About Market Risk
We have considered the provisions of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." We had no
holdings of derivative financial or commodity instruments at September 30, 2000.
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.
Interest Rate Risk
We do not hold derivative or speculative financial instruments and substantially
all cash and cash equivalent balances are invested in money market accounts with
floating interest rates, therefore we are not subject to significant interest
rate risk.
Currency Exchange Rate Risk
During the period from inception through September 30, 2000, all of our revenues
and expenses have been denominated in U.S. dollars. As a result, we have not
incurred any realized or unrealized currency exchange rate gains or losses. We
do not expect to incur any significant gains and losses during the next twelve
months. We have not engaged in foreign currency hedging activities to date.
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PART II - OTHER INFORMATION
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter, we granted warrants for the purchase of 112,000 shares to
advisors and in conjunction with the acquisition of musical content during
quarter. All of such warrants were granted to accredited investors pursuant to
Regulation D.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
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SIGNATURES
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2000 EMusic.com Inc.
/s/ Joseph Howell
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Joseph Howell,
Executive Vice President and
Chief Financial Officer
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