10-Q 1 v72734e10-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 MARCH 31, 2001 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 IDENTIFICATION NUMBER) INCORPORATION OR ORGANIZATION) 2700 PENNSYLVANIA AVENUE SANTA MONICA, CALIFORNIA 90404 (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, 13,531,057 SHARES OUTSTANDING AS OF APRIL 30, 2001. ========================================================================= 2 LAUNCH MEDIA, INC. TABLE OF CONTENTS

3 LAUNCH MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)

The accompanying notes are an integral part of these consolidated financial statements. 4 LAUNCH MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (unaudited, in thousand except per share data)

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

The accompanying notes are an integral part of these consolidated financial statements. 6 LAUNCH MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share data) 1. NATURE OF OPERATIONS: Launch Media, Inc. was incorporated in Delaware in February 1994 and is a digital media company dedicated to creating the premier Internet music site, www.launch.com, by providing music fans the broadest array of music and music-related content. Launch Media, Inc. and its subsidiaries are collectively referred to as the "Company" or "Launch". The Company currently 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. Launch also creates and manages multi-city concert series that showcase new and emerging artists that generate additional integrated sponsorships. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis of Presentation and Management's Plans The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring losses from operations that raise substantial doubt about its ability to continue as a going concern. Management's plans include (i) substantially reducing operating and overhead costs and accelerating our move to profitability by increasing our net revenues through increasing the Launch audience and increasing advertising revenue per advertiser, (ii) raising additional funds through public or private debt or equity placement, (iii) licensing our content and technology, and/or (iv) merging with a strategic partner. There can be no assurance that the Company will be successful in these plans. Moreover, the financial statements do not include any adjustments that might result from the outcome of this uncertainty. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Principles of Consolidation The consolidated financial statements include the accounts of Launch Media, Inc. and its wholly owned subsidiaries. All inter-company accounts and transactions have been eliminated in the consolidated financial statements. 7 Revenue Recognition The Company's revenues have been derived primarily from the sale of advertising and sponsorships and syndicating content to radio stations and other Internet sites. 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 in the period in which the advertisement is displayed, provided that no significant Launch obligations remain. Content licensing revenue includes revenue resulting from Launch obtaining 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. Revenue from syndication of Launch content is recognized ratably over the contract term, which is typically one year. 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 for advertising space on other Web sites or other advertising media. 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 Launch 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 Launch media properties. Cash and Cash Equivalents The Company considers all highly liquid investments with an initial maturity of three months or less to be cash equivalents. The Company maintains its cash accounts in various financial institutions and, at times, these deposits may be in excess of the federally insured limit. Marketable Securities The Company invests excess cash in commercial paper, corporate notes and bonds, U.S. Government securities and money market funds. The investments are stated at cost, as it is the intent of the Company to hold these securities until maturity. Investments in corporate notes and bonds, and U.S. Government securities are stated at amortized cost, which approximates fair market value. The Company has also made investments in equity securities and are classified as available-for-sale. Available for sale securities are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity. Realized gains and losses and declines in value judged to be other than temporary on available for sale securities are included in other income. The cost basis for realized gains and losses on available for sale securities is determined on a specific identification basis. 8 Property and Equipment Property and equipment are stated at cost. Depreciation is being applied on the straight-line method over five years. Leasehold improvements and equipment under capital leases are amortized over the shorter of the estimated useful life or the life of the lease. Maintenance and repairs are charged to expense as incurred while renewals and improvements are capitalized. Intangible and other Long-termed Assets The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances result in the carrying amount of the assets exceeding the sum of the expected future undiscounted cash flows associated with such assets. The measurement of the impairment losses to be recognized is based on the difference between the fair values and the carrying amounts of the assets. Fair Value of Financial Instruments The Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and capital lease obligations are carried at cost, which approximates their fair market value because of the short-term maturity of these instruments. The carrying amount of the long-term capital lease obligations is also assumed to approximate fair value. Web Site The Company capitalizes the costs incurred to build web site infrastructure and applications. Cost incurred for subsequent updates and operations are expensed as incurred. Concentration of Credit Risk and Major Customers The Company sells sponsorships and advertising to major advertising agencies representing their clients and directly to large, well established, companies. The Company's customers are concentrated in the United States of America. The Company performs ongoing credit evaluations of its customers' financial condition and generally does not require collateral. Estimated credit losses and returns have been provided for in the financial statements and, to date, have generally been within management's expectations; however, for the three months ended March 31, 2001, the Company increased the allowance for doubtful accounts by $1.2 million which is primarily as a result of certain of the Company's customers filing for bankruptcy. Advertising Advertising costs are expensed as incurred. Income Taxes The Company accounts for income taxes under Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. 9 Stock Based Compensation The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure requirements of SFAS No. 123, "Accounting for Stock Based Compensation." Under APB No. 25, compensation cost, if any, is recognized over the respective vesting period based on the difference, if any, on the date of grant, between the fair value of the Company's common stock and the grant price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force 96-18. During the three months ended March 31, 2001, the Company accelerated the vesting of certain options, which were granted between March 12, 1998 and November 4, 1998 and as a result recorded a one-time non-cash charge of $306. 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 the conversion of the Mandatory Redeemable Convertible Preferred Stock (using the if-converted method) and 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. Diluted net loss per share for the three months ended March 31, 2000 and 2001, does not include the effect of options and warrants to purchase 2,566 and 3,357 shares of common stock, respectively, as the effect of their inclusion is anti-dilutive during each period. Reclassifications Certain reclassifications have been made to the 2000 amounts to conform to the 2001 presentation. These reclassifications did not change the previously reported net loss or the total assets of the Company. 3. BARTER REVENUE Revenues and expenses recognized from barter transactions were approximately $430 and $1.3 million for the three months ended March 31, 2000 and 2001, respectively. 4. RELATED PARTY TRANSACTIONS Notes Receivable Notes receivable consist of loans to officers and other key employees. These loans are due on demand and bear interest at 8% per annum. During the three months ended March 31, 2001, officers and employees made cash payments of $234 and surrendered 901 shares of the Company's common stock. The shares surrendered have been accounted for as treasury stock with a cost of approximately $1.6 million. Subsequent to March 31, 2001, officers and an employee made additional cash payments on these notes receivable in the amount of $462. 10 5. SUBSEQUENT EVENTS During the second quarter of 2001, the Company initiated a plan designed to improve gross margins, decrease sales and marketing, content and product development and general and administrative expenses and position the Company to generate positive cash flow. This plan, together with the consolidation of facilities and the discontinuation of the Company's European expansion plans, are part of the Company's continued strategic plan to focus on growing the Company's core media brand and related revenue base and lowering operating costs to generate positive cash flow. The plan should be completed during the three months ending June 30, 2001 and will result in a cash charge for severance of approximately $300, accruals for facility leases of approximately $1.5 million and non-cash write-down of approximately $10 million of intangible assets from discontinued product lines, leasehold improvements related to vacated space and development and closure costs relating to our European operation. Convertible Debt Financing: On May 14, 2001, the Company signed a non-binding term sheet providing for $5 million in a secured convertible note financing. The Company expects to sign a definitive agreement by May 24, 2001; however, no definitive assurances can be given that this financing transaction will close or that the Company will receive the proceeds. 11 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, web casts 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. OVERVIEW Launch is a media company that offers a compelling online music discovery experience for consumers and provides a valuable marketing platform for record labels, artists, advertisers and merchants. We create engaging music content focused on both new and established artists, spanning almost all musical genres. We currently deliver our content on the Internet at www.launch.com and on the monthly Launch on CD-ROM. As broadband access to the Internet achieves greater consumer acceptance and enables us to add our richest audio and video content to launch.com, we intend to phase out delivery of Launch on CD-ROM. Launch has incurred significant net losses and negative cash flows from operations since its inception, and as of March 31, 2001, had an accumulated deficit of approximately $129.8 million. Launch intends to continue to make significant financial investments in marketing and promotions, content development, technology and infrastructure development. As a result, we believe that we may incur operating losses and negative cash flows from operations during the next year. To date, Launch's revenues have been derived primarily from the sale of advertising, including online and offline sponsorships and content licensing. Launch derives revenue from advertising sales against the total audience viewing content on both launch.com and Launch on CD-ROM. Launch expects that future growth, if any, in advertising revenue will largely depend upon increasing the launch.com audience. Advertising revenues for sponsorships across the Launch media properties are recognized ratably over the sponsorship term, which are typically one to twelve months. Sponsorships on offline tour promotions which, to date have not been significant, are recognized ratably over the tour schedule. 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. Content licensing primarily relates to the Launch Radio Networks' content syndication. Launch obtains on-air radio advertising inventory in exchange for music and entertainment news content. Launch sells this inventory for cash and recognizes revenue when the radio stations broadcast the advertisement. Other content licensing revenues includes online and content syndication. 12 Advertising revenues also include barter revenues, which represent an exchange by Launch of advertising space 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 Launch 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 Launch media properties. We have made business acquisitions in order to build our audience, provide music-specific content, generate additional online traffic, increase registered members and establish additional sources of revenue. These acquisitions have resulted in a variety of non-cash charges that will affect our operating results over the next several fiscal periods. Convertible Debt Financing: On May 14, 2001, the Company signed a non-binding term sheet providing for $5 million in a secured convertible note financing. The Company expects to sign a definitive agreement by May 24, 2001; however, no definitive assurances can be given that this financing transaction will close or that the Company will receive the proceeds. RESULTS OF OPERATIONS Net Revenues Net revenues decreased 40.2% from $6.4 million for the three months ended March 31, 2000 to $3.8 million for the three months ended March 31, 2001. The decrease in net revenues was attributable to an overall softness in the advertising market. Advertising Revenues. Advertising revenues decreased 38.6% from $4.4 million, or 68.1% of total net revenues for the three months ended March 31, 2000, to $2.7 million, or 69.9% of total net revenues for the three months ended March 31, 2001. The decrease in advertising revenue can be attributed to industry wide softness in advertising in particular to the Internet. Launch expects advertising revenue to continue to represent a significant portion of its total net revenues for the foreseeable future. Content Licensing. Content licensing revenues decreased 43.6% from $2.1 million, or 31.9% of total net revenues for the three months ended March 31, 2000, to $1.2 million, or 30.1% of total net revenues for the three months ended March 31, 2001. 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. Content licensing revenues from LRN depend on both the number of music and music related spots we are able to create and on the radio markets demand for news and information. The decline in revenue was a result of the soft radio advertising market during the three months ended March 31, 2001. Operating Expenses Cost of Revenues. Cost of revenues consist primarily of CD-ROM manufacturing, packaging and distribution costs, Online Music Group ("OMG") inventory costs, content licensing, site-hosting, bandwidth and online advertisement serving costs. Cost of revenue decreased 16.6% from $1.6 million, or 25.4% of total net revenues for the three months ended March 31, 2000, to $1.4 million or 35.4% of total net revenues for the three months ended March 31, 2001. The decrease in cost of revenues can be attributed to a decrease in OMG costs and a decrease in CD-ROM manufacturing costs. During the three months ended March 31, 2001, the OMG program was phased out, and we manufactured fewer issues of the Launch on CD-ROM than the prior year. We expect the cost of revenues remain relatively constant as a percentage of net revenues. Warped Tour. On August 31, 2000, the Company purchased the Warped Tour, which is a popular summer concert series where musicians, athletes and fans interact and participate in daylong events. Operating costs of the tour consist of service fees, transportation, talent and production costs. The costs incurred for the three months ended March 31, 2001 of $112 represents tour service fees, which are recognized pro rata over the life of the service contracts. The tour operates during the summer months and the costs will increase significantly during the 13 second and third calendar quarters, which will be offset by ticket and other revenues generated from the Warped Tour. Sales and Marketing Expenses. Sales and marketing expenses consist primarily of customer acquisition and marketing costs, promotional costs and the cost of the direct marketing and advertising sales force. Sales and marketing expenses decreased 32.6% from $6.6 million, or 102.0% of total net revenues for the three months ended March 31, 2000 to $4.4 million, or 114.9% of total net revenues for the three months ended March 31, 2001. The decrease in sales and marketing expenses is attributed to reduced advertising spending, lower subscription costs of the Launch on CD-ROM and reduced outside marketing fees on the Launch Radio Networks syndication business. We expect sales and marketing expenses to decrease as a percentage of total net revenues as we leverage existing distribution agreements to increase the audience on launch.com. Content and Product Development Expenses. Content and product development expenses consist of editorial, which includes video production and editorial writers, art production and software, technology and Web development costs. Content and product development expenses decreased 22.6% from $5.2 million, or 80.8% of total net revenues for the three months ended March 31, 2000 to $4.0 million, or 104.6% of total net revenues for the three months ended March 31, 2001. Content and product development expenses decreased due to decreased payroll and production costs associated with producing content. We believe that significant investments in content and product development are required to remain competitive and to retain our registered users. However, while we expect that content and product development expenses will remain relatively constant, we do expect them to decrease as a percentage of total net revenues. General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related costs for general corporate functions, including finance and accounting, human resources, legal, facilities, investor relations, and fees for professional services. General and administrative expenses increased 53.5% from $2.1 million, or 33.0% of total net revenues for the three months ended March 31, 2000, to $3.3 million, or 84.7% of total net revenues for the three months ended March 31, 2001. The increase in general and administrative expenses is primarily attributed to a net $1.2 million charge to bad debt expense during the three months ended March 31, 2001. We anticipate that general and administrative expenses will continue to remain relatively constant, but decrease as a percentage of total net revenue. Depreciation and Amortization Depreciation and amortization was $4.9 million for the three months ended March 31, 2000 as compared to $4.0 million for the three months ended March 31, 2001. Launch's depreciation and amortization expenses primarily consisted of amortization of excess purchase prices over net tangible assets acquired arising from its acquisitions. Also included in depreciation and amortization are costs associated with purchases of equipment and facility enhancements. Interest Income, Net Interest income, net consists of interest earned on cash, cash equivalents, notes receivable and marketable securities, offset by interest expense on borrowings under capital leases. Net interest income decreased from $1.2 million for the three months ended March 31, 2000 to $87 for the three months ended March 31, 2001. The decrease in net interest income is a result of the decrease in the average amount of short-term investments. Income Taxes Launch's income taxes consist of minimum state franchise taxes. At December 31, 2000 Launch had approximately $101.6 million and $47.8 million of federal and state net operating loss carryforwards, respectively, available to offset future taxable income. Launch's federal and state net operating loss carryforwards expire beginning in 2009 and 2001, respectively. Due to the change in Launch's ownership interests in connection with the IPO and prior private placements, 14 future utilization of the net operating loss carryforwards may be subject to certain annual limitations. Unearned Compensation In connection with the grant of stock options to employees in 1998, Launch recorded unearned compensation of $1.4 million representing the difference between the deemed value of Launch's common stock for accounting purposes and the exercise price of such options at the date of grant. Such amount, net of amortization, is presented as a reduction of stockholders' equity and amortized over the four-year vesting period of the options. Amortization of unearned compensation was $76 and $306 for the three months ended March 31, 2000 and 2001, respectively. During the three months ended March 31, 2001, the Company accelerated the vesting of certain options, which were granted between March 12, 1998 and November 4, 1998 and as a result the unearned compensation as of March 31, 2001 was fully amortized. 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. Net cash used in operating activities increased 53% from $7.4 million for the three months ended March 31, 2000, to $11.4 million for same period in 2001. The increase in net cash used in operating activities is substantially attributable to the costs associated with the growth of Launch's media business and decline in revenue during the three months ended March 31, 2001. Net cash provided by investing activities was $11.1 million for the three months ended March 31, 2001, as compared to $10.2 million for three months ended March 31, 2000. The increase in net cash provided by investing activities resulted primarily from the net maturities of debt securities in 2001, of which the majority was used to fund the Company's operating activities, rather than reinvested in additional securities. Investments of cash are predominantly invested in instruments that are highly liquid, are high quality investment grade, and have maturities of less than one year with the intent to make such funds readily available for operating purposes. Net cash used in financing activities increased slightly to $445,000 for the three months ended March 31, 2001, from $131,000 for the three months ended March 31, 2000. The increase is due to an increase in payments under capital leases. Launch has capital lease lines of credit for $5.0 million collateralized by equipment purchased under the lines, bearing interest in the range of prime rate to 15% per annum, and requiring monthly interest and principal payments. The Company's net borrowings under these lines of credit were approximately $2.9 million and $3.9 million as of March 31, 2000 and 2001, respectively. As of March 31, 2001, Launch had approximately $3.6 million in cash, cash equivalents and marketable securities. This cash is not sufficient to meet the Company's capital needs through June 30, 2001. Management's plans include (i) substantially reducing operating and overhead costs and accelerating our move to profitability by increasing our net revenues through increasing the Launch audience and increasing advertising revenue per advertiser, (ii) raising additional funds through public or private debt or equity placement, (iii) licensing our content and technology, and/or (iv) merging with a strategic partner. Launch has signed a non-binding term sheet providing for $5 million in a secured convertible note financing. We expect to sign a definitive agreement within ten days of May 14, 2001; however no definitive assurances can be given that this financing transaction will close or that the Company will receive the proceeds. There can be no assurance that Launch will be successful in these plans. Moreover, the financial statements do not include any adjustments that might result from the outcome of this uncertainty. 15 SEASONALITY Launch believes that advertising sales in traditional media generally are lower in the first and third quarters of each year 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 foregoing factors could have a material adverse affect on the Company's business, financial conditions, results of operations and cash flows. RISK FACTORS This Form 10-Q contains forward-looking statements relating to future events or our future financial performance. You are cautioned that such events are only predictions and that actual events or results may differ materially. In evaluating such statements, you should specifically consider the various factors identified in this form 10-Q, including those discussed below, which could cause actual events or results to differ materially from those indicated by the forward-looking statements. You should consider carefully the following risk factors and all other information contained in this report before purchasing our common stock. Investing in our common stock involves a high degree of risk. Additional risks and uncertainties that are not yet identified or that we currently think are immaterial may also materially adversely affect our business and financial condition in the future. Any of the following risks could materially adversely affect our business, operating results and financial condition and could result in a complete loss of your investment. 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. AS A RESULT OF OUR ANTICIPATED LOSSES AND OUR CASH POSITION, OUR INDEPENDENT ACCOUNTANTS QUALIFIED THEIR OPINION ON OUR FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2000 TO NOTE THAT THERE IS SUBSTANTIAL DOUBT REGARDING OUR ABILITY TO CONTINUE AS A GOING CONCERN. As of March 31, 2001, our accumulated deficit was $129.8 million. We have not achieved profitability and expect to incur operating losses during the remainder of 2001 as well. Our existing financial resources may not be adequate to fund our operations over the next twelve months unless we obtain additional financing or significantly increase our revenues or reduce our expenses. We cannot assure you that we will be able to obtain such financing, increase our revenues or reduce our expenses to the extent required to continue operations without significantly curtailing our business activities. Further, even if we are successful in addressing our capital needs, such actions may adversely impact stockholder value. 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. 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 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 16 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: o fund our ongoing operations; o fund more rapid expansion; o develop new or enhance existing services or products; o fund distribution relationships; o respond to competitive pressures; or o 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. OUR 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 that may cause our revenues and operating results to fluctuate include the following: o our ability to attract and retain advertisers; o 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; o the timing and uncertainty of sales cycles; o mix of online advertisements sold; o seasonal declines in advertising sales, which typically occur in the first and third calendar quarters, which will be partially be offset with the increased revenues from The Warped Tour in the third quarter; o the level of Web and online services usage; o our ability to successfully integrate operations and technologies from acquisitions or other business combinations; o technical difficulties or system downtime affecting the Internet generally or the operation of launch.com; and o 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 17 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 2000 and for the three months ended March 31, 2001 advertising sales accounted for 67.5% and 69.9% of our net revenues, respectively. 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: o conduct successful selling and marketing efforts aimed at advertisers; o increase the size of the launch.com audience; o increase the amount of revenues per advertisement; o aggregate our target demographic group of 12 to 34 year old active music consumers, and, in particular, the Generation Y segment of this group; o increase awareness of the Launch brand among advertisers; o target advertisements to appropriate segments of our audience; o make Launch available through evolving broadband distribution channels; and o 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: o continue to offer compelling music content; o encourage our users to become part of our community; 18 o conduct effective marketing campaigns to acquire new members; o develop new and maintain existing distribution relationships with other Web sites; o update and enhance the features of launch.com; o increase awareness of the Launch brand; o make Launch available through broadband distribution channels as they achieve widespread consumer acceptance; and o 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 nine 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: o advertisers' budgetary constraints; o internal acceptance reviews by advertisers and their agencies; o the timing of completion of advertisements by advertisers; and o the possibility of cancellation or delay of projects by advertisers or sponsors. 19 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. 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: o quality of our editorial staff; o technical expertise of our production staff; o access to recording artists; and o 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 a formal license because we do not believe that such a license is 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 formal 20 licenses for such content. Such 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 digital 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. 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 in each period. 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: 21 o 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; o online services or and Web sites targeted at music consumers, such as mp3.com, Artistdirect, MTVi, emusic.com and musicmaker.com; o Web retrieval and other Web "portal" companies, such as Excite@Home, Inc., Infoseek Corporation, Lycos, Inc. and Yahoo, Inc.; and o 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 advantages, including the following: o larger audiences; o larger technical, production and editorial staffs; o greater name recognition; o better access to content; o more established Internet presence; o larger advertiser bases; and o 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 two of our executive officers, and we do not anticipate that other executive officers or key personnel will enter into employment agreements. 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 22 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. 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 6.4 million unique visitors in March 2001 to Launch.com. 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 23 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. 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. 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: o issue equity securities that would dilute current stockholders' percentage ownership in us; o incur substantial debt; or o 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: o difficulties in the assimilation of acquired operations, technologies or products; o diversion of management's attention from other business concerns; 24 o risks of entering markets in which we have no or limited experience; and o 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 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 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 25 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 Alchemy's facilities in Los Angeles, California. In addition, we utilize the audio and video streaming services of iBEAM Broadcasting and Akamai. iBEAM Broadcasting and Akamai have proprietary networks 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 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. 26 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, 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 change 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 March 31, 2001. 27 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, Launch may be involved in litigation relating to claims arising out of its operations. On January 31, 2001, WB Stellar Acquisitions, LLC commenced an action against the Company in the Supreme Court of the State of New York seeking rent and damages of $793,000 with respect to a lease for commercial space that expired on July 31, 2000. The Company intends to defend the action vigorously believing that it has meritorious defenses. As the Company is unable to predict the outcome of this action, no expense has been recorded for the possible adverse resolution of this action. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS "Not applicable." ITEM 3. DEFAULTS UPON SENIOR SECURITIES "Not applicable." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS "Not applicable." ITEM 5. OTHER INFORMATION "Not applicable." ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: "Not applicable." (b) Reports on Form 8-K "Not applicable." 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 May 14, 2001 --------------- LAUNCH MEDIA, INC. (Registrant) /s/ JEFFREY M. MICKEAL -------------------------------------------- Jeffrey M. Mickeal Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)

LAUNCH MEDIA INC 10-Q