10-Q 1 e10-q.txt FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 000-25723 LAUNCH MEDIA, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4465753 (STATE OR JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 2700 PENNSYLVANIA AVENUE SANTA MONICA, CALIFORNIA 940404 (Address of principal executive offices) TELEPHONE: (310) 526-4300 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, PAR VALUE OF $0.001 PER SHARE, 13,561,790 SHARES OUTSTANDING AS OF JULY 31, 2000. ================================================================================ 2 LAUNCH MEDIA, INC. AND SUBSIDIARIES TABLE OF CONTENTS

3 LAUNCH MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements. 1 4 LAUNCH MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

The accompanying notes are an integral part of these consolidated financial statements. 2 5 LAUNCH MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements. 3 6 LAUNCH MEDIA, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL Launch Media, Inc. and subsidiaries ("the Company") was incorporated in Delaware in February 1994 and is a digital media company focused on creating the premier Internet destination for discovering new music. The Company operates in one reportable industry segment. Leveraging the inherent advantages of digital media, the Company offers a compelling music discovery experience from new and established artists for consumers and provides a valuable marketing platform for record labels, artists, advertisers and merchants. The music content is delivered on the Internet at www.launch.com and on Launch on CD-ROM. Both launch.com and Launch on CD-ROM are advertiser supported and include original content that takes advantage of the personal computer's interactive multimedia technology. On April 23, 1999 the Company effected an initial public offering ("IPO") of 3,500,000 shares of its common stock at a price of $22 per share. On May 19, 1999, the underwriters exercised their over-allotment option to purchase an additional 510,000 shares of common stock. The net proceeds to the Company, after deducting underwriting discounts and commissions and offering expenses, were approximately $80.9 million. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Launch Media, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. UNAUDITED INTERIM FINANCIAL INFORMATION The unaudited interim consolidated financial statements of the Company for the three and six months ended June 30, 1999 and 2000, included herein have been prepared in accordance with the instructions for Form 10-Q under the Securities Exchange Act of 1934, as amended, and Article 10 of Regulation S-X under the Securities Act of 1933, as amended. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at June 30, 2000, and the results of its operations and its cash flows for the three and six months ended June 30, 1999 and 2000. The results for the three and six months ended June 30, 2000 are not necessarily indicative of the expected results for the full fiscal year or any future period. BASIS OF PRESENTATION These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included in the Annual Report on Form 10-K, filed with the Securities and Exchange Commission ("SEC"). USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an 4 7 ongoing basis, management reviews its estimates based on currently available information. Changes in facts and circumstances may result in revised estimates. REVENUE RECOGNITION The Company's revenues have been derived primarily from the sale of advertising, content licensing, transaction fees and annual subscriptions relating to Launch on CD-ROM. Revenues for sponsorships across the Launch media properties are recognized ratably over the sponsorship term which ranges from one to twelve months. Revenues from advertisements for Launch on CD-ROM are recognized upon the release date of the issue in which the advertisement appears. With respect to launch.com, revenues from advertisements are recognized ratably over the period in which the advertisement is displayed, provided that no significant Launch obligations remain. Content licensing revenue includes revenue resulting from Launch's business to business content licensing. Launch obtains on-air radio advertising in exchange for music news content. Launch sells this inventory to other web sites for cash and recognizes revenue when the radio stations broadcast the advertisement. In addition, revenue from syndication of Launch content is recognized ratably over the contract term which is typically one year. Advance payments for Launch on CD-ROM subscriptions are deferred and recognized over the term of the related subscription, typically 12 months. Advance payments for sponsorships are deferred and recognized over the term of the sponsorship. Advertising revenues also include barter revenues, which represent an exchange by Launch of advertising space on the Company's media properties for advertising space on other Web sites. Revenues and expenses from barter transactions are recorded at the lower of estimated fair value of the advertisements received or delivered based on advertising rates currently in effect. Barter revenues are recognized when the advertisements are run on the Company's media properties. Barter expenses are recognized when Launch's advertisements are run on the reciprocal Web sites or other advertising medium, which is typically in the same period as when the advertisements are run on the Company's media properties. Revenues and expenses recognized from barter transactions were approximately $270,000 and $504,000 for the three months ended June 30, 1999 and 2000, respectively, or 14.6% and 10.0% of advertising and transaction fees, respectively, and were approximately $478,000 and $834,000 for the six months ended June 30 1999 and 2000, respectively, or 18.6% and 9.5% of advertising, respectively. RECENT ACCOUNTING PRONOUNCEMENTS On June 26, 2000, the SEC staff issued SAB 101B to provide registrants with additional time to implement guidance contained in SAB 101, Revenue Recognition in Financial Statements. SAB 101B delays the implementation date of SAB 101 until no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. Management is evaluating the impact this statement may have on the company's financial statements. In March 2000, the Financial Accounting Standards Board issued Interpretation No.44 ("FIN No.44"), "Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25." FIN No.44 will be effective July 1, 2000. This interpretation provides guidance for applying APB Opinion No.25, "Accounting for Stock issued to Employees." Management does not believe that the adoption of FIN No.44 will have a significant impact on the Company's consolidated financial position, results of operations or cash flows. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement, which is effective for the year beginning January 1, 2001, establishes accounting and reporting standards for derivative instruments and for hedging activities. SAFS No. 133 was amended by SFAS No. 138 in June 2000. SFAS No. 133 requires a company to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. 5 8 COMPUTATION OF NET LOSS PER SHARE In accordance with SFAS No. 128, "Computation of Earnings Per Share", basic earnings per share is computed using the weighted average number of shares outstanding during the period and diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of the incremental common shares issuable upon exercise of outstanding stock options and warrants, using the treasury stock method. Common equivalent shares are excluded from the calculation if their effect is anti-dilutive. Pursuant to SEC Staff Accounting Bulletin No. 98, common stock and convertible preferred stock issued for nominal consideration, prior to the anticipated effective date of an IPO, are required to be included in the calculation of basic and diluted net loss per share as if they were outstanding for all periods presented. To date, the Company has not had any issuances or grants for nominal consideration. Diluted net loss per share for the three months ended June 30, 2000, does not include the effect of options and warrants to purchase 1,627,176 and 946,496 shares of common stock, respectively. 3. RELATED PARTY TRANSACTIONS In April 1999, the Company and another corporate shareholder entered into a sponsorship and content license agreement and a music video license agreement upon the closing of the IPO. Advertising revenues for the three and six months ended June 30, 2000 were approximately $409,000 and $827,000, respectively. This revenue is included in advertising and transaction fees in the consolidated statement of operations. On June 19, 2000, Launch entered into a definitive agreement to acquire The Warped Tour, a summer concert series. The transaction is expected to close prior to September 30, 2000. 4. INCOME TAXES The Company's income tax provision consists of minimum state franchise taxes. 5. CAPITAL LEASE LINE OF CREDIT AND FINANCING FACILITY The Company has a revolving capital lease line of credit for $2.0 million. At June 30, 2000, $1.7 million was outstanding under this line of credit. This facility bears interest at the bank's prime rate (9.5% at June 30, 2000). The leased assets collateralize any borrowings under this line of credit. The Company has an additional line of credit for $3.0 million to finance capital expenditures. The line of credit accrues interest at 15% per annum and requires monthly interest and principal payments. At June 30, 2000, $1.6 million was outstanding under this line. The acquired assets collateralize any borrowings under this facility. 6 9 6. PRO FORMA RESULTS Pro forma results of operations for the three and six months ended June 30, 1999, presented by combining the results of operations of the Company's acquisitions of SW Networks Inc. (April 1999) and Musicvideos.com (February 1999) with the results of operations of the Company were as follows.

7 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company has included in this filing certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 concerning the Company's business, operations and financial condition. The words or phrases "can be", "expects", "may affect", "may depend", "believes", "estimates", "projects", and similar words and phrases are intended to identify such forward-looking statements. Such forward-looking statements are subject to various known and unknown risks and uncertainties, and the Company cautions you that any forward-looking information provided by or on behalf of the Company is not a guarantee of future performance. Actual results could differ materially from those anticipated in such forward-looking statements due to a number of factors, some of which are beyond the Company's control, in addition to those discussed in the Company's other public filings, press releases and statements by the Company's management, including (i) the volatile and competitive nature of the Internet and music industries, (ii) changes in domestic and foreign economic and market conditions, (iii) the effect of federal, state and foreign regulation on the Company's business, and (iv) the effect of any future acquisitions. All such forward-looking statements are current only as of the date on which such statements were made. The Company does not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events. The Company's fiscal year ends on December 31 of each calendar year. RECENT EVENTS On June 19, 2000, Launch entered into a definitive purchase agreement to acquire The Warped Tour, the popular summer concert series where musicians, athletes and fans interact and participate in day-long events. The acquisition is expected to close prior to September 30, 2000. The Warped Tour blends a section of great music from chart-topping and emerging artists with the skate/surf culture and extreme sports. The acquisition will allow Launch to deliver additional unique integrated sponsorship opportunities to its customers. Additionally, the tour will afford Launch the opportunity of supplementing its existing marketing efforts, as well as serve as a vehicle that will generate additional content. Launch will maintain an on-site presence at the concerts and simultaneously take on the responsibility of promoting, marketing and selling sponsorships for the tour by leveraging key online and offline partnerships. The Tour's web site, warpedtour.com, will become one of Launch's online media properties. Launch will leverage its database of 4.3 million registered members to both promote the tour and drive ticket sales. We believe that this acquisition will bring synergies to the Company's online efforts while strengthening our offline presence. 8 11 OVERVIEW Launch is a digital media company focused on music, leveraging the inherent advantages of digital media to offer consumers a compelling music discovery experience while providing record labels, artists, advertisers and merchants a valuable marketing platform. Our content is delivered on the Internet at www.launch.com and on the monthly Launch on CD-ROM. As of June 30, 2000, launch.com had approximately 4.3 million registered members, and Launch on CD-ROM had approximately 265,000 subscribers. Doubleclick, Inc. our third party ad server, reported that in June of 2000 there were approximately 3.7 million unique visitors to launch.com. Launch has incurred significant net losses and negative cash flows from operations since its inception, and as of June 30, 2000, had an accumulated deficit of approximately $89.2 million. Launch intends to continue to make significant financial investments in marketing and promotion, content development and technology and infrastructure development. As a result, Launch believes that it will incur operating losses and negative cash flows from operations for the foreseeable future, and that such cumulative losses and cumulative negative cash flows will increase for at least the next year. To date, Launch's revenues have been derived primarily from the sale of advertising, sponsorships, and content licensing. Revenues for sponsorships across the Launch media properties are recognized ratably over the sponsorship term, which is typically one month. Revenues from advertisements for Launch on CD-ROM are recognized upon the release date of the issue in which the advertisement appears. With respect to launch.com, revenues from advertisements are recognized ratably in the period in which the advertisement is displayed, provided that no significant Launch obligations remain. With respect to the majority of Launch's business to business content licensing, Launch obtains on-air radio advertising inventory in exchange for music news content. Launch sells this inventory for cash and recognizes revenue when the radio stations broadcast the advertisement. We derive subscription revenues from annual subscription fees for Launch on CD-ROM. Advance payments for Launch on CD-ROM subscriptions are recorded as deferred revenue and recognized as revenue ratably over the term of the subscription. Advertising revenues also include barter revenues, which represent an exchange by Launch of advertising space on the Company's media properties for advertising space on other Web sites. Revenues and expenses from barter transactions are recorded at the lower of estimated fair value of the advertisements received or delivered based on advertising rates currently in effect. Barter revenues are recognized when the advertisements are run on the Company's media properties. Barter expenses are recognized when Launch's advertisements are run on the reciprocal Web sites or other advertising medium, which is typically in the same period as when the advertisements are run on the Company's media properties. We have entered into various license arrangements, strategic alliances and business acquisitions in order to increase our music-specific content, generate additional online traffic, increase subscriptions and memberships and establish additional sources of revenue. Our business acquisitions, arrangements and alliances have resulted in a variety of non-cash charges that will affect our operating results over the next several fiscal periods. RESULTS OF OPERATIONS Net Revenues: Net revenues increased 125% from $3.5 million for the three months ended June 30, 1999 to $7.8 million for the three months ended June 30, 2000. Net revenues increased 201.4% from $4.7 million for the six months ended June 30, 1999 to $14.3 million for the six months ended June 30, 2000. The increase in net revenues was attributable primarily to an increase in advertising and transaction fees and content licensing revenues. 9 12 Advertising And Transaction Fees. Advertising and transaction fees increased 173% from $1.9 million or 53.2% of net revenues, for the three months ended June 30, 1999 to $5.1 million, or 64.7% of net revenues, for the three months ended June 30, 2000. Advertising and transaction fees increased 242.3% from $2.6 million or 54.2% of net revenues for the six months ended June 30, 1999 to $8.8 million or 61.5% of net revenues for the six months ended June 30, 2000. Advertising revenues increased primarily as a result of an increased number of new advertisers and sponsors on the Company's media properties. During 1999 and the six months ended June 30, 2000, Launch continued to expand its advertising sales force, in particular focusing its sales efforts on sponsorships or advertisements that covered all of Launch's media properties. In addition, the inventory of impressions available on our web site increased as registered and unique users on launch.com increased. Launch expects advertising and transaction revenue will continue to represent a significant portion of our net revenues for the foreseeable future. Included in advertising revenues are revenues recognized from barter transactions of $270,000, or 14.6% of advertising revenues, for the three months ended June 30, 1999 and $504,000 or 10.0% of advertising revenues, for the three months of 2000. Revenues recognized from barter transactions were $478,000 or 18.6% of advertising revenues for the six months ended June 30, 1999 and $834,000 or 9.5% of advertising revenues for the six months ended June 30, 2000. Content Licensing. Content licensing revenues increased 63.7% from $1.4 million or 38.8% of net revenues for the three months ended June 30,1999 to $2.2 million, or 28.3% of net revenues for the three months ended June 30, 2000. Content licensing revenues increased 224.9% from $1.4 million or 28.5% of net revenues for the six months ended June 30, 1999 to $4.4 million or 30.8% of net revenues for the six months ended June 30, 2000. Content licensing revenue is primarily generated from Launch Radio Networks (LRN) by providing news and information to radio stations in exchange for advertising radio spots. These radio spots are sold through a third-party advertising agency and recognized as revenue when the radio station broadcasts the advertisement. While LRN revenue comprises the majority of our content licensing, we expect LRN revenues to decrease as a percentage of total content licensing as we continue to expand our content syndication. Subscriptions and Other Revenues. Subscriptions and other revenues increased 95.0% from $280,000, or 8.0% of total net revenues for the three months ended June 30, 1999 to $547,000, or 7.0% of total net revenues for the three months ended June 30, 2000. Subscriptions and other revenues increased 34.5% from $817,000 or 17.3% of net revenues for the six months ended June 30, 1999 to $1.1 million or 7.7% of net revenues for the six months ended June 30, 2000. Operating Expenses Cost of Revenues. Cost of revenues consists primarily of Online Music Group (OMG) inventory purchases, Launch on CD-ROM manufacturing and packaging costs and related subscription distribution costs. Cost of revenues increased 58.9% from $827,000, or 23.8% of net revenues, during the three months ended June 30, 1999 to $1.3 million, or 16.8% of net revenues, during the three months ended June 30, 2000. Cost of revenues increased 65.6% from $1.5 million or 31.3% of net revenues for the six months ended June 30, 1999 to $2.4 million or 17.2% of net revenues for the six months ended June 30, 2000. The increase in cost of revenues during the three and six months ended June 30, 2000 was primarily the result of banner inventory costs relating to OMG. We expect cost of revenue as a percentage of net revenues to decrease as Launch on CD-ROM is phased out. Sales and Marketing Expenses. Sales and marketing expenses consist primarily of advertising and marketing costs, promotional costs, customer acquisition costs, commissions paid to a media representative firm, radio affiliate sales and advertising sales force expenses. Sales and marketing expenses increased 39.1% from $5.7 million, or 164.3% of net revenues, during the three months ended June 30, 1999 to $8.0 million, or 101.8% of net revenues, during the three months ended June 30, 2000. Sales and marketing expenses increased 80.8% from $8.6 million or 180.8% of net revenues for the six months ended June 30, 1999 to $15.5 million or 108.5% of net revenues for the six months ended June 30, 2000. The increase in sales and marketing expenses occurred primarily due to the cost of acquiring new registered users on launch.com including distribution agreements and promotions, advertising for Launch on other websites, the hiring of additional sales 10 13 and marketing personnel, and increased marketing to promote the Launch brand. We expect sales and marketing expenses to increase in absolute dollars as we pursue our marketing campaigns to increase the audience on launch.com and hire additional sales and marketing personnel. Content and Product Development Expenses. Content and product development expenses consist primarily of editorial expenses, which includes video production and editorial writers, art production, hosting and bandwidth, software and content licenses, and Web development costs. Content and product development expenses increased 77.6% from $2.6 million, or 75.7% of net revenues, during the three months ended June 30, 1999 to $4.7 million, or 59.9% of net revenues, during the three months ended June 30, 2000. Content and product development expenses increased 137.3% from $4.0 million or 83.6% of net revenues for the six months ended June 30, 1999 to $9.4 million or 65.8% of net revenues for the six months ended June 30, 2000. Content and product development expenses increased in the three and six months ended June 30, 2000 due to costs of further developing and enhancing the launch.com Web site, including consulting costs, software license costs and additions to personnel. We believe that significant investments in product development are required to remain competitive. Therefore, we expect that product development expenses will continue to increase in absolute dollars for the foreseeable future and our content costs to remain relatively flat. General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related costs for general corporate functions, including finance, legal, human resources and accounting. Also included are facilities costs and fees for professional services. General and administrative expenses increased 134.4% from $1.0 million, or 29.3% of net revenues, during the three months ended June 30, 1999 to $2.4 million, or 30.6% of net revenues, during the three months ended June 30, 2000. General and administrative expenses increased 182.8% from $1.6 million or 34.3% of net revenues for the six months ended June 30, 1999 to $4.6 million or 32.1% of net revenues for the six months ended June 30, 2000. The absolute dollar increase in general and administrative expenses in the three and six months ending June 30, 2000 was primarily attributable to salary and related expenses for additional personnel and increases in facilities costs. Launch believes our infrastructure to be primarily in place. However, we anticipate increases relating to expanding facilities and additional costs related to being a public company, including costs related to investor relations programs and professional service fees. Depreciation and Amortization. Depreciation and amortization was $4.2 million during the three months ended June 30, 2000 and primarily consisted of $3,374,000 of amortization of excess purchase price over tangible net assets acquired arising from its acquisitions and $822,000 of depreciation. Depreciation and amortization was $8.2 million for the six months ended June 30, 2000. Interest Income And Other, Net. Interest income and other, net, consists of interest earned on cash and cash equivalents and short-term investments, offset by interest expense on borrowings and net gains or losses from the sale of securities held for sale. Net interest income and other was $265,000 during the three months ended June 30, 1999 compared which increased to $484,000 during the three months ended June 30, 2000 as a result of investing net proceeds from the Company's IPO. Net interest income and other was $285,000 for the six months ended 1999, compared to $1.7 million for the six months ended June 30, 2000. LIQUIDITY AND CAPITAL RESOURCES Since its inception, Launch has financed its operations primarily through a public issuance of common stock, private placements of preferred stock and, to a lesser extent, from the revenues generated by operations. As of June 30, 2000, Launch had approximately $40.0 million in cash, cash equivalents, and short term investments. Net cash used in operating activities increased to $15.9 million for the six months ended June 30, 2000 from $7.6 million for the six months ended June 30, 1999. The increase in net cash used in operating activities is substantially attributable to the increased net loss, excluding non-cash charges. 11 14 Net cash provided by investing activities was $18.8 million for the six months ended June 30, 2000, as compared to net cash used by investing activities of $75.4 million for the six months ended June 30, 1999. The increase in net cash provided by investing activities resulted primarily from the sale of securities purchased during the first and second quarter of 2000 as a result of investing the cash raised in our IPO. This cash is invested predominantly in high quality investment grade debt securities with maturities of less than one year. Net cash used by financing activities was $12,000 for the six months ended June 30, 2000, compared to $82.4 million provided by financing activities for the six months ended June 30, 1999. The net cash provided by financing activities during the six months ended June 30, 1999 was attributable to the IPO. We have a revolving capital lease line of credit for $2.0 million. At June 30, 2000, $1.7 million was outstanding under this line of credit. This facility bears interest at the bank's prime rate (9.5% at June 30, 2000). The leased assets collateralize any borrowings under this line of credit. In addition, we have $1.6 million outstanding under an additional capital expenditure line of credit as of June 30, 2000. This line of credit accrues interest at 15% per annum and requires monthly interest and principal payments. Any acquired assets collateralize borrowings under this facility. We have experienced a substantial increase in our capital expenditures and operating lease arrangements since inception, which is consistent with the growth in our operations and staffing, and anticipate that this will continue for the foreseeable future. Additionally, Launch will continue to evaluate possible investments in businesses, products and technologies, and plans to expand its sales and customer acquisition programs and conduct brand promotions. Launch currently expects that the net proceeds from its IPO, together with its existing lines of credit and available funds, will be sufficient to meet its anticipated needs for working capital and capital expenditures for at least the next 12 months. There can be no assurance, however, that the underlying assumed levels of revenues and expenses will prove to be accurate. Launch may seek additional funding through public or private financings or other arrangements prior to such time. Adequate funds may not be available when needed or may not be available on terms favorable to Launch. If additional funds are raised through the issuance of equity securities, dilution to existing stockholders may result. If funding is insufficient at any time in the future, Launch may be unable to develop or enhance its products or services, take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on Launch's business, financial condition and results of operations. SEASONALITY OF BUSINESS AND QUARTERLY RESULTS The Company believes that advertising sales in traditional media are generally lower in the first and third calendar quarters of each year than in respective preceding quarters and that advertising expenditures fluctuate significantly with economic cycles. Depending on the extent to which the Internet is accepted as an advertising medium, seasonality and cyclicality in the level of internet advertising expenditures could become more pronounced. The forgoing factor could have a material adverse effect on the Company's business, results of operations and financial condition. 12 15 RISKS THAT MAY AFFECT RESULTS WE HAVE A LIMITED OPERATING HISTORY THAT MAKES AN EVALUATION OF OUR BUSINESS DIFFICULT We incorporated in February 1994 and published the first issue of Launch on CD-ROM in May 1995. We first made launch.com available over the Internet in October 1997. Because we have a limited operating history, you must consider the risks and difficulties frequently encountered by early-stage companies such as Launch in new and rapidly evolving markets, including the market for advertising on the Internet and other digital media. Prior to 1999, Launch on CD-ROM had accounted for the majority of Launch's audience. Accordingly, Launch had derived its revenues principally from advertising sales against the Launch on CD-ROM audience and, to a lesser extent, from subscriptions for Launch on CD-ROM. Future growth in our business will depend substantially upon our ability to increase the size of the launch.com audience, to increase advertising sales against that audience and to meet the challenges described in the risk factors below. WE HAVE A HISTORY OF LOSSES AND BECAUSE WE ANTICIPATE THAT OUR OPERATING EXPENSES WILL GROW MORE QUICKLY THAN OUR REVENUES, AT LEAST IN THE SHORT TERM, WE EXPECT INCREASED LOSSES We incurred net losses of $6.7 million in 1997, $13.4 million in 1998 and $37.5 million in 1999 and $24.1 million for the six months ended June 30, 2000. As of June 30, 2000, our accumulated deficit was $89.2 million. We have not achieved profitability and expect to incur operating losses for the foreseeable future. We expect these operating losses to increase for at least the next year. We will need to generate significant revenues to achieve and maintain profitability, and we cannot assure you that we will be able to do so. Even if we do achieve profitability, we cannot assure you that we can sustain or increase profitability on a quarterly or an annual basis in the future. If our revenues grow more slowly than we anticipate or if our operating expenses exceed our expectations, our financial performance will likely be adversely affected. See "Selected Financial Data" for more detailed information regarding our historical operating results. OUR QUARTERLY OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR STOCK PRICE TO FLUCTUATE Our future revenues and operating results are likely to vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control. Accordingly, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of future performance. It is possible that in some future periods our operating results will be below the expectations of public market analysts and investors. In this event, the price of our common stock will likely decline. Factors which may cause our revenues and operating results to fluctuate include the following: - our ability to attract and retain advertisers; - our ability to increase the registered membership of launch.com and the new web sites, services or products introduced by us or by our competitors; - the timing and uncertainty of sales cycles; - mix of online advertisements sold; - seasonal declines in advertising sales, which typically occur in the first and third calendar quarters; - the level of Web and online services usage; - our ability to successfully integrate operations and technologies from acquisitions or other business combinations; - technical difficulties or system downtime affecting the Internet generally or the operation of launch.com; and 13 16 - general economic conditions, as well as economic conditions specific to digital media and the music industry. To attract and retain a larger audience, we plan to increase our expenditures for sales and marketing, content development, and technology and infrastructure development. Many of these expenditures are planned or committed in advance in anticipation of future revenues. Because advertising orders are typically short term and subject to cancellation without penalty until shortly before the advertisement runs, our quarterly operating results are difficult to forecast. If our revenues in a particular quarter are lower than we anticipate, we may be unable to reduce spending in that quarter. As a result, any shortfall in revenues would likely adversely affect our quarterly operating results. BECAUSE WE DEPEND PRINCIPALLY UPON ADVERTISING REVENUES, IF WE DO NOT INCREASE ADVERTISING SALES, OUR BUSINESS MAY NOT GROW OR SURVIVE Our revenues for the foreseeable future will depend substantially on sales of advertising. In 1999 advertising sales accounted for 53.9% of our net revenues, and for the three months ended June 30, 2000 they accounted for 64.7%. If we do not increase advertising revenues, our business may not grow or survive. Increasing our advertising revenues depends upon many factors, including our ability to do the following: - conduct successful selling and marketing efforts aimed at advertisers; - increase the size of the launch.com audience; - increase the amount of revenues per advertisement; - aggregate our target demographic group of 12 to 34 year old active music consumers, and, in particular, the Generation Y segment of this group; - increase awareness of the Launch brand among advertisers; - target advertisements to appropriate segments of our audience; - make Launch available through evolving broadband distribution channels; and - accurately measure the size and demographic characteristics of our audience. Our failure to achieve one or more of these objectives could adversely affect our business. Advertising revenues are difficult to forecast, especially because the market for advertising on digital media has emerged relatively recently. We have historically entered into barter transactions with advertisers that we do not believe would pay cash for such advertisements. We expect to substantially reduce both the dollar volume and frequency of such transactions in future periods. In each quarterly period, we derive a significant portion of our revenues from sales of advertising to a limited number of customers. Accordingly, the loss of a key advertising relationship or the cancellation or deferral of even a limited number of orders could adversely affect our quarterly performance. IF WE FAIL TO INCREASE THE SIZE OF OUR AUDIENCE, WE MAY NOT BE ABLE TO ATTRACT ADVERTISERS OR STRATEGIC PARTNERS Increasing the size of our audience is critical to selling advertising and to increasing our revenues. If we cannot increase the size of our audience, then we may be unable to attract new or retain existing advertisers. In addition, we may be at a relative disadvantage to other digital media companies with larger audiences that may be able to leverage their audiences to access more advertisers and significant strategic alliances. To attract and retain our audience, we must do the following: 14 17 - continue to offer compelling music content; - encourage our users to become part of our community; - conduct effective marketing campaigns to acquire new members; - develop new and maintain existing distribution relationships with other Web sites; - update and enhance the features of launch.com; - increase awareness of the Launch brand; - make Launch available through broadband distribution channels as they achieve widespread consumer acceptance; and - offer targeted, relevant products and services. Our failure to achieve one or more of these objectives could adversely affect our business, and we cannot assure you that we will be successful in these efforts. A significant element of our strategy is to build a loyal community of registered members on launch.com because we believe community features help retain actively engaged users. The concept of developing such a community on the Web is unproven, and if it is not successful, then it may be more difficult to increase the size of our audience. We also depend on establishing and maintaining distribution relationships with high-traffic Web sites to increase our audience. There is intense competition for placements on these sites, and we may not be able to enter into such relationships on commercially reasonable terms or at all. Even if we enter into distribution relationships with these Web sites, they themselves may not attract significant numbers of users. Therefore, launch.com may not obtain additional users from these relationships. Moreover, we have paid in the past, and may pay in the future, significant fees to establish these relationships. We also intend to increase our financial expenditures on marketing the Launch brand because we believe brand awareness will be critical to increasing our audience, especially because there are few barriers to entry for Internet businesses. If we do not increase our revenues as a result of our branding and other marketing efforts or if we otherwise fail to promote our brand successfully, our business could be adversely affected. SALES CYCLES VARY FOR ADVERTISING AND MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE Our dependence on advertising subjects us to additional risks because the sales cycles for these sales vary significantly. The time between the date of initial contact with a potential advertiser or sponsor and receipt of a purchase order from the advertiser may range from as little as six weeks to up to nine months. During these sales cycles, we may expend substantial funds and management resources but not obtain advertising revenues. Therefore, if these sales are delayed or do not otherwise occur, our operating results for a particular period may be adversely affected. Advertising sales are subject to delays over which we have little or no control, including the following: - advertisers' budgetary constraints; - internal acceptance reviews by advertisers and their agencies; - the timing of completion of advertisements by advertisers; and - the possibility of cancellation or delay of projects by advertisers or sponsors. 15 18 FAILURE TO CONTINUE TO DEVELOP COMPELLING CONTENT THAT ATTRACTS OUR TARGET AUDIENCE COULD CAUSE OUR AUDIENCE SIZE TO DECREASE OR CHANGE THE DEMOGRAPHICS OF OUR AUDIENCE Our future success depends on our ability to continue to develop content that is interesting and engaging to our target audience. If our audience determines that our content does not reflect its tastes, then our audience size could decrease or the demographic characteristics of our audience could change. Either of these results would adversely affect our ability to attract advertisers. Our ability to develop compelling content depends on several factors, including the following: - quality of our editorial staff; - technical expertise of our production staff; - access to recording artists; and - access to content controlled by record labels, publishers and artists. Further, consumer tastes change, particularly those of Generation Y, and we maybe unable to react to those changes effectively or in a timely manner. LIMITATIONS ON THE AVAILABILITY OR INCREASES IN THE PRICE OF MUSIC CONTENT DEVELOPED BY THIRD PARTIES COULD ADVERSELY AFFECT OUR BUSINESS Because much of our content, including recording artist interviews, audio and video performances and music, are provided to us by record labels and artists at minimal or no charge, we depend on our good relations with record labels and artists to offer compelling content. We cannot assure you that they will continue to make their content available to us on reasonable terms or at all. If record labels, music publishers or artists charge significant fees for their content or discontinue their relationships with us, then our content offering could be adversely affected. A significant portion of the music content available on Launch is licensed from publishers, record labels and artists. We frequently either do not have written contracts or have short-term contracts with copyright owners, and, accordingly, our access to copyrighted content depends upon the willingness of such parties to continue to make their content available. Further, the parties who license material to us may face increasing costs to develop or acquire that material as a result of evolving laws regarding intellectual property, and these licensors may pass any such additional costs on to us. If the fees for music content increase substantially or if significant music content becomes unavailable, our ability to offer music content could be materially limited. We currently use certain content without first obtaining a license because we believe that a license is not required under existing law. However, this area of law remains uncertain and may not be resolved for a number of years. When this area of law is resolved, we may be required to obtain licenses for such content. Licenses may not be available on reasonable terms, if at all. Any limit on our content offering could adversely affect our business. WE NEED NEW DISTRIBUTION TECHNOLOGIES TO INCREASE ACCESSIBILITY OF OR OUR CONTENT, AND FAILURE OF SUCH TECHNOLOGIES TO ACHIEVE CONSUMER ACCEPTANCE COULD LIMIT OUR GROWTH To experience the full extent of our high-quality audio and full-motion video content, consumers must access such content either from a CD-ROM, DVD-ROM or over a high-bandwidth connection, such as cable or direct subscriber line modem or satellite data broadcast. If such broadband distribution networks do not achieve widespread consumer acceptance, we may be unable to effectively distribute our audio and video content in its most compelling format. We cannot assure you that broadband distribution networks will ever achieve consumer acceptance, and if they do not, our growth may be limited. 16 19 WE DEPEND ON A LIMITED NUMBER OF ADVERTISERS, AND THE LOSS OF A NUMBER OF THESE ADVERTISERS COULD ADVERSELY AFFECT OUR OPERATING RESULTS Historically, a limited number of advertisers have accounted for a significant percentage of our revenues. We anticipate that our results of operations in any given period will continue to depend to a significant extent upon revenues from a small number of advertisers. In addition, particularly because few advertisers are contractually obligated to purchase any advertising in the future, we anticipate that the mix of advertisers in each fiscal period will continue to vary. In order to increase our revenues, we will need to attract additional significant advertisers on an ongoing basis. Our failure to sell a sufficient number of advertisements or to engage a sufficient number of advertisers during a particular period could adversely affect our results of operations. WE MUST MAINTAIN AND ESTABLISH STRATEGIC ALLIANCES TO INCREASE OUR AUDIENCE AND ENHANCE OUR BUSINESS In an attempt to increase audience, build brand recognition and enhance content, distribution and commerce opportunities, we have entered into strategic alliances with various media and Internet-related companies such as Sony Music, Inc., America Online, Inc., Microsoft Corporation and Intel Corporation. Our failure to maintain or renew our existing strategic alliances or to establish and capitalize on new strategic alliances could have an adverse affect on our business. Our future success depends to a significant extent upon the success of such alliances. Occasionally, we enter into agreements with strategic partners that may prohibit us from entering into similar arrangements with competitors of our strategic partners. Such exclusivity provisions may limit our ability to enter into favorable arrangements with complementary businesses and thereby limit our growth. We cannot assure you that we will achieve the strategic objectives of these alliances, that any party to a strategic alliance agreement with Launch will perform its obligations as agreed upon or that such agreements will be specifically enforceable by Launch. In addition, some of our strategic alliances are short term in nature and may be terminated by either party on short notice. COMPETITION FROM TRADITIONAL AND ONLINE MEDIA AND OTHER COMPANIES FOCUSED ON MUSIC COULD REDUCE OUR ADVERTISING SALES OR MARKET SHARE Competition among media companies seeking to attract the active music consumer is intense. Increased competition could result in advertising price reduction, reduced margins or loss of market share, any of which could adversely affect our business. Traditional media companies, such as television broadcasters, magazine publishers and radio stations, are constantly refining their content and strategies to increase their audiences and advertising revenues. Further, the number of Web sites competing for the attention and spending of members, users and advertisers has increased, and we expect it to continue to increase, particularly because there are so few barriers to entry on the Web. We compete for members, users and advertisers with the following types of companies: - publishers and distributors of traditional media, such as television, radio and print, including MTV, Clear Channel, CMT, Rolling Stone and Spin, and their Internet affiliates; - online services or and Web sites targeted at music consumers, such as mp3.com, Artistdirect, MTVi, emusic.com and musicmaker.com; - Web retrieval and other Web "portal" companies, such as Excite@Home, Inc., Infoseek Corporation, Lycos, Inc. and Yahoo, Inc.; and - online music retailers, such as CDNow, Inc. and Amazon.com, Inc. Because we compete for advertisers with traditional advertising media, our business could be adversely affected if advertisers do not view digital media as effective for advertising. Competition is likely to increase significantly as new companies enter the market and current competitors expand their services. Many of these potential competitors are likely to enjoy substantial competitive 17 20 advantages, including the following: - larger audiences; - larger technical, production and editorial staffs; - greater name recognition; - better access to content; - more established Internet presence; - larger advertiser bases; and - substantially greater financial, marketing, technical and other resources. If we do not compete effectively or if we experience any pricing pressures, reduced margins or loss of market share resulting from increased competition, our business could be adversely affected. THE LOSS OF OUR CHIEF EXECUTIVE OFFICER, OUR PRESIDENT OR OTHER KEY PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS BECAUSE THESE OFFICERS ARE IMPORTANT TO OUR CONTINUED GROWTH Our future success depends to a significant extent on the continued services of our senior management and other key personnel, and particularly David B. Goldberg, Launch's chief executive officer, and Robert D. Roback, Launch's president. The loss of either of these individuals or certain other key employees would likely have an adverse effect on our business. We have an employment agreement with only one of our executive officers, and we do not anticipate that other executive officers or key personnel will enter into employment agreements. We expect that we will need to hire additional personnel in all areas during 2000. Competition for personnel throughout our industry is intense. We may be unable to retain our current key employees or attract, integrate or retain other highly qualified employees in the future. We have in the past experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. If we do not succeed in attracting new personnel or retaining and motivating our current personnel, our business could be adversely affected. GROWTH IN OUR OPERATIONS, PARTICULARLY OUR SALES, MARKETING, FINANCIAL AND ADMINISTRATIVE ORGANIZATIONS, IS PLACING A STRAIN ON OUR RESOURCES, AND FAILURE TO MANAGE GROWTH EFFECTIVELY COULD HARM OUR BUSINESS We have experienced and are currently experiencing a period of significant growth in our operations. This growth has placed, and our anticipated future growth in our operations will continue to place, a significant strain on our resources. As part of this growth, we will have to implement new operational systems and procedures and controls to expand, train and manage our employee base and to maintain close coordination among our technical, accounting, finance, marketing, sales and production staffs. We will also need to continue to attract, retain and integrate personnel in all aspects of our operations. To the extent we acquire new businesses, we will also need to integrate new operations, technologies and personnel. Failure to manage our growth effectively could adversely affect our business. ACCEPTANCE AND EFFECTIVENESS OF DIGITAL MEDIA FOR ADVERTISING ARE UNPROVEN, WHICH MAY DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON LAUNCH Our future is highly dependent on an increase in the use of the Internet and other forms of digital media for advertising. If the Internet advertising market fails to develop or develops more slowly than we expect, then our business could be adversely affected. Moreover, the market for advertising on other forms of digital media, such as broadband distribution, is even less developed than Internet advertising, and if that market does not develop, then our growth may be limited. 18 21 The Internet advertising market is new and rapidly evolving, and we cannot yet gauge the effectiveness of advertising on the Internet as compared to traditional media. As a result, demand for Internet advertising is uncertain. Many advertisers have little or no experience using the Internet for advertising purposes. The adoption of Internet advertising, particularly by companies that have historically relied upon traditional media for advertising, requires the acceptance of a new way of conducting business, exchanging information and advertising products and services. Such customers may find advertising on the Internet to be undesirable or less effective for promoting their products and services relative to traditional advertising media. Different pricing models are used to sell Internet advertising. It is difficult to predict which, if any, will emerge as the industry standard. This uncertainty makes it difficult to project our future advertising rates and revenues. Any failure to adapt to pricing models that develop or respond to competitive pressures could adversely affect our advertising revenues. Moreover, "filter" software programs that limit or prevent advertising from being delivered to an Internet user's computer are available. Widespread adoption of this software could adversely affect the commercial viability of Internet advertising. TRACKING AND MEASUREMENT STANDARDS FOR ADVERTISING ARE EVOLVING AND CREATE UNCERTAINTY ABOUT THE VIABILITY OF OUR BUSINESS MODEL There are currently no standards for the measurement of the effectiveness of advertising on the Internet and other digital media, and the industry may need to develop standard measurements. The absence or insufficiency of these standards could adversely impact our ability to attract and retain advertisers. We cannot assure you that such standard measurements will develop. In addition, currently available software programs that track Internet usage and other tracking methodologies are rapidly evolving. We cannot assure you that the development of such software or other methodologies will keep pace with our information needs, particularly to support the growing needs of our internal business requirements and advertising clients. For instance, DoubleClick, Inc., our third party ad server, reported that there were 8.0 million unique visitors in June 2000 to Launch.com properties. Our advertisers may rely on this data or other similar data to determine whether to advertise on Launch, and adverse data from this or other sources in any particular period may cause advertisers not to advertise on Launch. It is important to our advertisers that we accurately measure the demographics of our user base and the delivery of advertisements on our Web site. We depend on third parties to provide certain of these measurement services. If they are unable to provide these services in the future, we would need to perform them ourselves or obtain them from another provider, if available. This could cause us to incur additional costs or cause interruptions in our business during the time we are replacing these services. Companies may choose to not advertise on Launch or may pay less for advertising if they do not perceive our measurements or measurements made by third parties to be reliable. WE MAY HAVE LIABILITY FOR NEGLIGENCE, DEFAMATION OR OTHER MATTERS FOR CONTENT POSTED ON LAUNCH.COM OR TO CONSUMERS FOR PRODUCTS SOLD THROUGH LAUNCH.COM Because users of our Web site may distribute our content to others, third parties might sue us for defamation, negligence, copyright or trademark infringement or other matters. These types of claims have been brought, sometimes successfully, against online services in the past. Others could also sue us for the content that is accessible from our Web sites through links to other Web sites or through content and materials that may be posted by launch.com members. Such claims might include, among others, that by directly or indirectly hosting the personal Web sites of third parties, we are liable for copyright or trademark infringement or other wrongful actions by such third parties through such Web sites. It is also possible that if any third-party content information provided on launch.com contains errors, third parties could make claims against us for losses incurred in reliance on such information. 19 22 We may also enter into agreements that entitle us to receive a share of revenue from the purchase of goods and services through direct links from our Web sites to their Web sites. Such arrangements may subject us to additional claims, including potential liabilities to consumers of such products and services, based on the access we provide to such products or services, even if we do not provide such products or services ourselves. While our agreements with these parties may provide that we will be indemnified against such liabilities, such indemnification, if available, may not be adequate. Our insurance may not adequately protect us against these types of claims and, even if such claims do not result in liability, we could incur significant costs in investigating and defending against such claims. WE EXPECT TO MAKE ACQUISITIONS THAT MAY DILUTE OUR STOCKHOLDERS' INTERESTS IN LAUNCH OR RESULT IN AMORTIZATION OF SIGNIFICANT AMOUNTS OF INTANGIBLE ASSETS As part of our business strategy, we expect to review acquisition prospects that would complement our current content offerings, increase our market share or otherwise offer growth opportunities. Such acquisitions could cause our operating results or the price of our common stock to decline. To date, we have had limited experience in these types of transactions. We may acquire businesses, products or technologies in the future. Because business acquisitions typically involve significant amounts of intangible assets, future operating results may be adversely affected by amortization of intangible assets acquired. In the event of such future acquisitions or business combinations, we could do the following: - issue equity securities that would dilute current stockholders' percentage ownership in us; - incur substantial debt; or - assume contingent liabilities. WE MAY BE UNABLE TO EFFECTIVELY INTEGRATE BUSINESSES WE ACQUIRE IN THE FUTURE, AND ANY SUCH FAILURE COULD DIMINISH THE VALUE OF AN ACQUIRED BUSINESS OR CAUSE DISRUPTIONS IN OUR ONGOING OPERATIONS Acquisitions and business combinations entail numerous operational risks, including the following: - difficulties in the assimilation of acquired operations, technologies or products; - diversion of management's attention from other business concerns; - risks of entering markets in which we have no or limited experience; and - potential loss of key employees of acquired organizations. We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and our failure to do so could damage our business. We may not be able to effectively integrate the operations of acquired businesses with our ongoing operations. Such failure could harm our business by diverting management and other resources. Further, the personnel of acquired businesses may elect not to continue with Launch after completion of any acquisition, which could diminish the value of any acquisition. In that regard, we cannot assure you that the personnel of acquired businesses will continue as employees of Launch. WE MAY NEED ADDITIONAL FINANCING TO ACHIEVE OUR BUSINESS OBJECTIVES, AND SUCH FINANCING MAY NOT BE AVAILABLE BECAUSE OF THE CONDITION OF OUR BUSINESS OR THE UNCERTAIN NATURE OF THE FINANCIAL MARKETS We currently anticipate that our available cash resources, combined with the net proceeds from our IPO, will be sufficient to meet our anticipated 20 23 working capital and capital expenditure requirements for at least the 12 months following the date of this Report on Form 10-Q. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our then-current stockholders will be reduced, and such securities may have rights, preferences or privileges senior to those of such stockholders. We cannot assure you that additional financing will 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. This limitation could adversely affect our business. We may need to raise additional funds in order to do the following: - fund more rapid expansion; - develop new or enhance existing services or products; - fund distribution relationships; - respond to competitive pressures; or - acquire complementary products, businesses or technologies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for a discussion of our working capital and capital expenditures. IF THE USE OF DIGITAL MEDIA, INCLUDING THE INTERNET, DOES NOT CONTINUE TO GROW, OUR MARKET MAY NOT DEVELOP ADEQUATELY Our market is new and rapidly evolving. If usage of digital media, and in particular the Internet, does not continue to grow, our business will be adversely affected. A number of factors may inhibit such usage, including, but not limited to the following: - inadequate network infrastructure; - security concerns; - inconsistent quality of service; and - limited availability of cost-effective, high-speed access. Even if digital media usage grows, the infrastructure necessary for such growth may not be able to support the demands placed on it by this growth, and its performance and reliability may decline. In addition, Web sites have experienced interruptions in their service as a result of outages and other delays occurring throughout the Internet network infrastructure. If these outages or delays frequently occur in the future, digital media and, in particular, Internet usage, as well as the usage of launch.com, could grow more slowly than we expect or even decline. WE NEED TO ADAPT TO RAPID TECHNOLOGICAL CHANGE IN SOFTWARE AND DISTRIBUTION SYSTEMS TO REMAIN COMPETITIVE Our market is characterized by rapidly changing technologies, frequent new product and service introductions and evolving industry standards. The recent growth of digital media, and in particular, the Internet, and intense competition in our industry exacerbate these market characteristics. To achieve our goals, we need to effectively integrate the various software programs and tools required to enhance and improve our product offerings and manage our business. Our future success will depend on our ability to adapt to rapidly changing technologies by continually improving the performance features and reliability of our products and services. We may experience difficulties that could delay or prevent the successful development, introduction or marketing of 21 24 new products and services. In addition, new enhancements must meet the requirements of our current and prospective users and must achieve significant market acceptance. We could also incur substantial costs if we need to modify our service or infrastructures or adapt our technology to respond to these changes. GOVERNMENTAL REGULATION OF THE WEB RELATED TO COMMUNICATION, COMMERCE, SALES TAX AND OTHER ISSUES MAY LIMIT THE GROWTH OF OUR BUSINESS AND DECREASE OUR MARKET OPPORTUNITY There are currently few laws or regulations that specifically regulate communications or commerce on the Web. Laws and regulations may be adopted in the future, however, that address issues such as user privacy, pricing, and the characteristics and quality of products and services. For example, the Telecommunications Act sought to prohibit transmitting certain types of information and content over the Web. Several telecommunications companies have petitioned the Federal Communications Commission to regulate Internet service providers and online services providers in a manner similar to long distance telephone carriers and to impose access fees on these companies. Any imposition of access fees could increase the cost of transmitting data over the Internet. Moreover, it may take years to determine the extent to which existing laws relating to issues such as property ownership, libel and personal privacy are applicable to the Web. Any new laws or regulations relating to the Web could adversely affect our business. Launch generally does not collect sales or other taxes in respect of goods sold to users on launch.com. However, one or more states may seek to impose sales tax collection obligations on out-of-state companies, such as Launch, 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 Launch should collect sales or other taxes on the exchange of merchandise on its system, our results of operations could be adversely affected. 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, once enacted, could allow various states to impose taxes on Internet-based commerce, which could adversely affect our business. WE RELY ON THIRD PARTIES FOR OUR WEB SITE HOSTING FACILITIES AND INTERNET CONNECTIVITY. IF THESE SYSTEMS FAIL, THEY COULD DISRUPT OR DELAY USER TRAFFIC, WHICH COULD IMPAIR OUR BUSINESS Substantially all of our launch.com communications and computer hardware are located at PSINet's facilities in Marina del Rey, California. PSINet provides Web site hosting services. In addition, we utilize the audio and video streaming services of iBEAM Broadcasting. iBEAM Broadcasting has a proprietary network which delivers streaming audio and video over the Internet. Fire, floods, earthquakes, power loss, telecommunications failures, break-ins and similar events could damage these systems and cause interruptions in our services. Computer viruses, electronic break-ins or other similar disruptive problems could result in reductions or termination of our services by our customers or otherwise adversely affect our Web site. Our business could be adversely affected if our systems were affected by any of these occurrences. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures or interruptions in our systems. We do not presently have any backup systems or a formal disaster recovery plan. Our Web site must be able to accommodate a high volume of traffic and deliver frequently updated information. Our Web site has experienced in the past and may in the future experience slower response times or decreased traffic for a variety of reasons. In addition, our users depend on Internet service providers, online service providers and other Web site operators for access to our Web site. Many of them have experienced significant outages in the past, and 22 25 could experience outages, delays and other difficulties due to system failures unrelated to our systems. Moreover, the Internet network infrastructure may not be able to support continued growth. Any of these problems could adversely affect our business. BECAUSE OUR USERS PROVIDE US WITH PRIVATE INFORMATION, WE MAY BE SUBJECT TO LIABILITY IF THIS INFORMATION WERE MISUSED Our privacy policy provides that we will not willfully disclose any individually identifiable information about any user to a third party without the user's consent unless required by law. This policy is displayed to users of our personalized services when they initially register and is easily accessible on launch.com. Despite this policy, however, if third persons were able to penetrate our network security or otherwise misappropriate our users' personal information or credit card information, we could be subject to liability. We also rely on a third-party provider for our e-commerce services. If we experience service problems with our e-commerce transactions, we could also be subject to liability. This liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims. It could also include claims for other misuses of personal information, such as for unauthorized marketing purposes. These claims could result in litigation. In addition, the Federal Trade Commission, the European Union and certain state and local authorities have been investigating certain Internet companies regarding their use of personal information. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if these authorities choose to investigate our privacy practices. Like most Web sites, we typically place certain information commonly referred to as cookies on a user's hard drive without the user's knowledge or consent. We use cookies for a variety of reasons, including enabling us to limit the frequency with which a user is shown a particular advertisement. Certain currently available Internet browsers allow users to modify their browser settings to remove cookies at anytime or to prevent cookies from being stored on their hard drives. In addition, some Internet commentators, privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies. Any reduction or limitation in the use of cookies could limit the effectiveness of this technology. SECURITY CONCERNS REGARDING CREDIT CARD OR OTHER CONFIDENTIAL INFORMATION TRANSMITTED OVER THE WEB COULD LIMIT OUR GROWTH A significant barrier to e-commerce and communications over the Internet has been the need for secure transmission of confidential information. Internet usage may not increase at the rate we expect unless some of 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. Any such protections may not be available at a reasonable price or at all. If a third party were able to misappropriate our users' personal information, users could sue us or bring claims against us. WE MAY EXPEND SIGNIFICANT RESOURCES TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR TO DEFEND CLAIMS OF INFRINGEMENT BY THIRD PARTIES, AND IF WE ARE NOT SUCCESSFUL WE MAY LOSE RIGHTS TO USE SIGNIFICANT MATERIAL OR BE REQUIRED TO PAY SIGNIFICANT FEES Copyrighted material that Launch develops internally, as well as trademarks relating to the Launch brand and other proprietary rights, are important to our success and our competitive position. We seek to protect our copyrights, trademarks and other proprietary rights, but these actions may be inadequate. Launch has trademark applications pending in several jurisdictions, but we cannot guarantee that we will be able to register our trademarks in all jurisdictions in which we intend to do business. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to and distribution of our proprietary information. We cannot assure you that the steps we have taken will prevent misappropriation of our proprietary rights, 23 26 particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States. If third parties were to use or otherwise misappropriate our copyrighted materials, trademarks or other proprietary rights without our consent or approval, our competitive position could be harmed, or we could become involved in litigation to enforce our rights. In addition, we rely on a third party to provide services enabling our e-commerce transactions. We could become subject to infringement actions by third parties based upon our use of intellectual property provided by our third-party provider. There is no provision for indemnification of Launch by the third-party provider. It is also possible that we could become subject to infringement actions based upon the content licensed from third parties. Any such claims or disputes could subject us to costly litigation and the diversion of our financial resources and technical and management personnel. Further, if our efforts to enforce our intellectual property rights are unsuccessful or if claims by third parties against Launch are successful, we may be required to change our trademarks, alter the content and pay financial damages. We cannot assure you that such changes of trademarks, alteration of content or payment of financial damages will not adversely affect our business. ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We maintain investment portfolio holdings of various issuers, types and maturities whose values are dependent upon short-term interest rates. We generally classify these securities as available for sale, and consequently record them on the balance sheet at fair value with unrealized gains and losses being recorded as a separate part of stockholders' equity. We do not currently hedge these interest rate exposures. Given Launch's current profile of interest rate exposures and the maturities of its investment holdings, we believe that an unfavorable change in interest rates would not have a significant negative impact on our investment portfolio or statement of operations through December 31, 2000. 24 27 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS "Not applicable." ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS The net proceeds to the Company from the sale of the 4,010,000 shares of Common Stock in the Company's initial public offering (Registration Statement No. 333-72433 and No. 333-76871), effective April 22, 1999, including the underwriter's exercise of their over-allotment option on May 18, 1999, were approximately $81,000,000 after deducting underwriting discounts and commissions and other offering expenses. Our use of proceeds through June 30, 2000 conformed to the intended use of proceeds described in our prospectus relating to the IPO. From the date of the IPO through June 30, 2000, Launch has spent $33.6 million of the net proceeds on sales and marketing, $18.2 million of the net proceeds on content and product development expenses, $8.1 million on general and administrative expenses, $6.3 million on capital expenditures and $1.5 million on acquisitions. The balance of the net proceeds of the IPO have been invested in investment grade, interest bearing securities. ITEM 3. DEFAULTS UPON SENIOR SECURITIES "Not applicable." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS a. To elect six directors to hold office until the next Annual Meeting of Stockholders and until their successors are duly elected and qualified. The final tabulation of votes was as follows: 4,461,192 votes for and 6,204 votes abstained. b. To approve amendments to our 1998 Stock Option Plan to (i) increase the number of shares reserved for issuance under our 1998 Stock Option Plan from 2,000,000 shares to 3,200,000 shares of common stock and (ii) limit to 250,000 the maximum number of shares for which options may be granted to any employee in any fiscal year. The results were as follows: 1,203,865 shares voted for, 491,944 voted against and 16,445 abstained. c. To approve an amendment to our 1998 Stock Option Plan to provide that the number of shares issuable under our 1998 Stock Option Plan is automatically increased on the first day of each of our fiscal years beginning on and after January 1, 2001 by (i) 3% of the number of shares of our common stock issued and outstanding on the last day of the preceding fiscal year or (ii) such lesser number of shares as determined by the Board of Directors or a committee of the Board. The results were as follows: 1,064,474 voted for, 631,857 voted against and 15,923 abstained. d. To ratify the appointment of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending December 31, 2000. The results were as follows: 4,454,052 voted for, 3,439 voted against and 9,905 abstained. ITEM 5. OTHER INFORMATION "Not applicable." ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: (27) Financial Data Schedule 25 28 (b) Reports on Form 8-K No reports were filed on form 8-K during the quarter for which this report is filed. 26 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated August 11, 2000 ------------------- LAUNCH MEDIA, INC. (Registrant) /s/ JEFFREY M. MICKEAL -------------------------------------------- Jeffrey M. Mickeal Chief Financial Officer and Secretary (Principal Financial and Accounting Officer) 27

LAUNCH MEDIA INC 10-Q