<PAGE>

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C.   20549

                           ------------------------

                                   FORM 10-Q

           Quarterly Report Pursuant To Section 13 or 15(d) of the
                        Securities Exchange Act Of 1934

                               December 31, 2000

                          Commission File No. 0-24671

                                EMUSIC.COM INC.
       (Exact Name of small business issuer as specified in its charter)

            Delaware                                     94-3290594
  (State or other jurisdiction                        (I.R.S. Employer
of incorporation or organization)                 Identification Number)

      1991 Broadway, 2/nd/ Floor                           94063
       Redwood City, California                         (Zip Code)
(Address of principal executive offices)

      Registrant's telephone number, including area code:  (650) 216-0200

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                      Yes   X                     No _____
                          -----

Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date:


        Common Stock, $0.001 Par Value              43,218,000 shares
                    (Class)                  (Outstanding at January 31, 2000)
<PAGE>

                                EMUSIC.COM INC.
                                   FORM 10-Q
                                     INDEX

<TABLE>
<CAPTION>
                                                                                                 Page
                                                                                                 ----
<S>                                                                                              <C>
PART I - FINANCIAL INFORMATION

Item 1.   Condensed Consolidated Financial Statements

          Condensed Consolidated Balance Sheets - December 31, 2000 and June 30, 2000..........     3

          Condensed Consolidated Statements of Operations - three and six months ended
            December 31, 2000 and 1999.........................................................     4

          Condensed Consolidated Statements of Cash Flows - six months ended
            December 31, 2000 and 1999.........................................................     5

          Notes to Financial Statements........................................................     6

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of
            Operations.........................................................................     9

Item 3.   Quantitative and Qualitative Disclosures About Market Risk...........................    25

PART II - OTHER INFORMATION

Item 2.   Changes in Securities and Use of Proceeds............................................    26

Item 6.   Exhibits and Reports on Form 8-K.....................................................

Signatures.....................................................................................    27
</TABLE>

                                       2
<PAGE>

--------------------------------------------------------------------------------
PART I:  FINANCIAL INFORMATION
ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

                                EMUSIC.COM INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                              December 31, 2000            June 30, 2000
                                                                              -----------------            -------------
<S>                                                                           <C>                          <C>
Assets
Current Assets:
   Cash and cash equivalents......................................                 $   3,042                  $  14,591
   Short-term investments.........................................                    12,768                     19,669
   Accounts receivable, net.......................................                     3,090                      2,488
   Notes receivable...............................................                         -                      5,676
   Prepaid expenses and other assets..............................                     3,104                      4,039
                                                                                   ---------                  ---------
       Total current assets.......................................                    22,004                     46,463

Property and equipment, net                                                            3,858                      4,706
Advanced royalties, music catalogs and investments, net...........                     7,583                     26,234
Intangible assets, net............................................                     9,000                    175,334
Notes receivable and other assets.................................                     3,667                        523
                                                                                   ---------                  ---------

           Total assets...........................................                 $  46,112                  $ 253,260
                                                                                   =========                  =========

Liabilities and Stockholders' Equity
Current Liabilities:
   Accounts payable...............................................                 $   2,071                  $   4,130
   Accrued liabilities............................................                     4,159                      3,540
   Accrued compensation and related benefits......................                     1,522                      2,352
   Deferred revenue...............................................                     3,082                      1,151
                                                                                   ---------                  ---------
       Total current liabilities..................................                    10,834                     11,173

   Capital lease, net of current portion..........................                       143                        245
                                                                                   ---------                  ---------

           Total liabilities......................................                    10,977                     11,418
                                                                                   ---------                  ---------

Stockholders' Equity:
   Capital stock and additional paid-in capital...................                   369,050                    367,406
   Accumulated deficit............................................                  (333,915)                  (125,564)
                                                                                   ---------                  ---------
           Total stockholders' equity.............................                    35,135                    241,842
                                                                                   ---------                  ---------
               Total liabilities and stockholders' equity.........                 $  46,112                  $ 253,260
                                                                                   =========                  =========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       3
<PAGE>

                                EMUSIC.COM INC.
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                     (in thousands, except per share data)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                            Three months        Three months       Six months           Six months
                                                               ended               ended              ended               ended
                                                            December 31,        December 31,        December 31,        December 31,
                                                               2000                1999                2000                1999
                                                            -----------         -----------         -----------         -----------
<S>                                                         <C>                 <C>                 <C>                 <C>
Revenues:
  Music revenues......................................         $   1,667            $    229           $   3,173          $     283
  Advertising revenues................................             3,010                 194               6,140                320
                                                               ---------            --------           ---------          ---------
     Total revenues...................................             4,677                 423               9,313                603
Cost of revenues......................................             1,838                 147               3,683                172
                                                               ---------            --------           ---------          ---------
Gross profit..........................................             2,839                 276               5,630                431
                                                               ---------            --------           ---------          ---------
Operating expenses:
  Product development, excluding stock compensation...             3,977               2,935               8,208              4,986
  Stock compensation..................................               169               2,955                 347              6,915
                                                               ---------            --------           ---------          ---------
     Total product development........................             4,146               5,890               8,555             11,901
  Selling and marketing...............................             5,550               5,637              10,547             10,408
  General and administrative..........................             2,310               1,078               4,296              1,890
  Amortization of intangible assets...................             9,104               2,877              18,244              5,160
  Impairment and other charges........................           173,061                   -             173,061                  -
                                                               ---------            --------           ---------          ---------
     Total operating expenses.........................           194,171              15,482             214,703             29,359

Operating loss........................................          (191,332)            (15,206)           (209,073)           (28,928)
Interest and other income, net........................               307                 948                 722              1,154
                                                               ---------            --------           ---------          ---------
Net loss..............................................          (191,025)            (14,258)           (208,351)           (27,774)
                                                               ---------            --------           ---------          ---------
Accretion of preferred stock..........................                 -                   -                   -               (224)
Dividend on preferred stock...........................                 -                   -                   -               (493)
                                                               ---------            --------           ---------          ---------
Net loss applicable to common shares..................         $(191,025)           $(14,258)          $(208,351)         $ (28,491)
                                                               =========            ========           =========          =========
Net loss per common share-basic and diluted...........         $   (4.65)           $  (0.47)          $   (5.10)          $  (1.31)
                                                               =========            ========           =========          =========
Weighted average common shares outstanding -
 basic and diluted....................................            41,099              30,586              40,850             21,822
                                                               =========           =========            ========          =========
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                       4
<PAGE>

                                EMUSIC.COM INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                                                 Six months ended   Six months ended
                                                                                                    December 31,       December 31,
                                                                                                        2000               1999
                                                                                                        ----               ----
<S>                                                                                              <C>                <C>
Cash flows from operating activities:
  Net loss......................................................................................       $(208,351)          $(27,774)
  Adjustments to reconcile net loss to net cash
    (used in) provided by operating activities:
    Depreciation................................................................................           1,853                480
    Amortization................................................................................          18,244              5,160
    Stock compensation..........................................................................             347              6,915
    Advanced royalties earned...................................................................             432                100
    Impairment and other charges................................................................         172,651                  -
    Changes in assets and liabilities, net of effects of acquisition:
       Accounts receivable......................................................................            (602)              (610)
       Prepaid expenses and other assets........................................................           1,026            (10,722)
       Accounts payable.........................................................................          (2,059)               170
       Accrued liabilities......................................................................             391             (1,346)
       Accrued compensation and related benefits................................................            (830)               197
       Deferred revenue.........................................................................           1,931                221
                                                                                                       ---------           --------
          Net cash used in operating activities.................................................         (14,967)           (27,209)
                                                                                                       ---------           --------
Cash flows from investing activities:
    Purchases of short-term investments.........................................................          (2,052)                 -
    Maturities of short-term investments........................................................           8,953                  -
    Notes receivable............................................................................             (55)                 -
    Advanced royalties, music catalogs and investments..........................................          (2,736)            (9,429)
    Acquisitions, net of cash acquired..........................................................               -                505
    Purchase of property and equipment..........................................................            (655)            (2,131)
                                                                                                       ---------           --------
          Net cash (used in) provided by investing activities...................................           3,455            (11,055)
                                                                                                       ---------           --------
Cash flows from financing activities:
    Proceeds from issuance of common stock......................................................               -             84,220
    Issuance costs related to offering..........................................................               -             (1,137)
    Proceeds from the sale of stock to employees................................................              38                  -
    Proceeds from exercise of stock options and warrants........................................              27                472
    Payment of dividends on Series B Preferred Stock............................................               -             (1,061)
    Payment on capital lease....................................................................            (102)                 -
                                                                                                       ---------           --------
          Net cash (used in) provided by financing activities...................................             (37)            82,494
                                                                                                       ---------           --------
Net increase (decrease) in cash and cash equivalents............................................         (11,549)            44,230
Cash and cash equivalents at beginning of period................................................          14,591             19,002
                                                                                                       ---------           --------
Cash and cash equivalents at end of period......................................................       $   3,042           $ 63,232
                                                                                                       =========           ========
Supplemental disclosure of non-cash transactions:
  Accretion of preferred stock to redemption value..............................................       $       -           $    224
  Conversion of preferred stock into common stock...............................................       $       -           $ 32,206
  Issuance of Common Stock in conjunction with acquisitions.....................................       $       -           $ 36,849
  Issuance of warrants for licensed music content...............................................       $      44           $    985
  Issuance of common stock for assets...........................................................       $     350           $      -
  Issuance of common stock for acquired music catalog...........................................       $   1,100           $      -
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                       5
<PAGE>

        NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1--The Company and Summary of Significant Accounting Policies

The Company

EMusic.com Inc. ("EMusic" or the "Company") sells downloadable music over the
Internet and operates a network of music-oriented Web sites, including
RollingStone.com, EMusic.com and other sites that generates revenue from the
sale of advertising. The Company also generates revenue from the licensing of
its acquired music catalogs. EMusic, a Delaware corporation, is based in Redwood
City, California, with regional offices in New York, Los Angeles and Chicago.


Basis of Presentation

These consolidated financial statements contemplate the realization of assets
and the satisfaction of liabilities in the normal course of business. The
Company has incurred losses in each fiscal year since inception as a result of
incurring costs to establish its business, which were significantly in excess of
revenues. The Company has also used its cash resources to make substantial
investments in music content for its websites.

Management plans to reverse its history of losses and negative cash flows by
increasing revenues while controlling costs. If the Company is unable to
generate adequate cash flows from operations, the Company may need to seek
additional sources of capital. There can be no assurance that the Company will
be able to obtain such funding, if necessary, on acceptable terms or at all.

In the opinion of management, the unaudited consolidated condensed financial
statements included herein have been prepared on a basis consistent with prior
periods reported consolidated financial statements and include all material
adjustments, consisting of normal recurring adjustments, necessary to fairly
present the information set forth therein.

All significant inter-company balances and transactions have been eliminated.

Certain information and footnote disclosures normally included in the financial
statements have been condensed or omitted pursuant to rules and regulations of
the Securities and Exchange Commission ("SEC"), although we believe that the
disclosures in the unaudited interim financial statements are adequate to ensure
that the information presented is not misleading. The results of operations for
the interim reporting periods presented herein are not necessarily indicative of
any future operating results.

The financial information as of June 30, 2000 is derived from our Annual Report
on Form 10-K for the Fiscal Year Ended June 30, 2000 as filed with the SEC. The
interim financial statements presented herein should be read in conjunction with
the financial statements and the notes thereto included in the Form 10-K.

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
reported amounts of revenues and expenses during the reported period. Actual
results could differ materially from those estimates.


                                       6
<PAGE>

Net Loss per Common Share

The weighted average shares used to compute basic net loss per share include
outstanding shares of Common Stock from the date of issuance, and exclude shares
of Common Stock subject to our right of repurchase. The calculation of diluted
net loss per share for all periods presented excludes shares of Common Stock
issuable upon exercise of employee stock options and outstanding warrants, as
their effect would be antidilutive. Therefore, the weighted average number of
shares used in the calculation of basic and dilutive net loss per Common share
is the same. The following table summarizes the computation of basic and diluted
net loss per share (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                        Three months         Three months          Six months          Six months
                                                            ended                ended               ended               ended
                                                         December 31,         December 31,         December 31,       December 31,
                                                            2000                 1999                2000                1999
                                                     ------------------   ------------------   -----------------   -----------------
<S>                                                  <C>                  <C>                  <C>                 <C>
Net loss...........................................         $(191,025)            $(14,258)          $(208,351)           $(27,774)
Accretion of preferred stock to redemption value...                 -                    -                   -                (224)
Dividend on Series B preferred stock...............                 -                    -                   -                (493)
                                                            ---------             --------           ---------            --------
Net loss applicable to common shares...............         $(191,025)            $(14,258)          $(208,351)           $(28,491)
                                                            ---------             --------           ---------            --------
Net loss per common share - basic and diluted......         $   (4.65)            $  (0.47)          $   (5.10)           $  (1.31)
                                                            ---------             --------           ---------            --------
Weighted average common shares outstanding -
 basic and diluted.................................            41,099               30,586              40,850              21,822
                                                            ---------             --------           ---------            --------
Antidilutive securities:
   Options to purchase common stock................            11,775                7,877              11,775               7,877
   Common stock subject to repurchase..............             2,071                3,891               2,071               3,891
   Warrants........................................             7,509                4,543               7,509               4,543
                                                            ---------             --------           ---------            --------

                                                               21,355               16,311              21,355              16,311
                                                            ---------             --------           ---------            --------
</TABLE>


Comprehensive Net Loss

There are no differences between our net loss as reported for any of the periods
reported herein and our comprehensive loss, as defined by Statement of Financial
Accounting Standards No. 130, for each of these respective periods.


Segment information

During all periods presented, the Company operated in a single business segment,
an online music network of websites (including EMusic.com, RollingStone.com and
other sites) that sells downloadable music and advertising. All long-lived
assets and all revenues were located or generated in the United States of
America.


Concentrations

One customer accounted for more than 10% of total revenues for the three months
ended December 31, 2000 and two customers accounted for more than 10% of total
revenue for the six months ended December 31, 2000. No customer accounted for
more than 10% of revenues for the three months or six months ended December 31,
1999.

                                       7
<PAGE>

Web site development costs

Costs incurred in the design, creation and maintenance of content, graphics and
user interface of the Company's Web site are expensed as incurred in accordance
with SOP 98-1, and Emerging Issues Task Force ("EITF") 00-02 "Accounting for Web
Site Development Costs."

Costs incurred in the development of application and infrastructure of the
Company's web site are capitalized and amortized over their useful life, which
is estimated to be 2 years.


Recent accounting pronouncements

The Company adopted Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS 137 and
SFAS 138.  SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments as well as other
hedging activities, and was effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000.  The Company's adoption of this
pronouncement did not have a material impact on the Company's financial position
and results of operations.

In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements." In
addition the SEC released, in October 2000 interpretative guidance on SAB 101 in
the form of frequently asked questions and responses thereto. SAB 101 and the
frequently asked questions and responses provide guidance for revenue
recognition under certain circumstances. The Company is currently evaluating the
impact of SAB 101 on its financial statements and related disclosures, but does
not expect that such impact, if any, will be material. The accounting and
disclosures prescribed by SAB 101 will be effective for the Company's fiscal
fourth quarter ending June 30, 2001.

In March 2000, the FASB issued FASB Interpretation No. 44 (FIN 44), "Accounting
for Certain Transactions Involving Stock Compensation, an interpretation of APB
Opinion No. 25" ("Interpretation"). The Interpretation is intended to clarify
certain problems that have arisen in practice since the issuance of APB 25. The
Interpretation provides guidance, some of which is a significant departure from
current practice.  The Interpretation generally provides for prospective
application for grants or modifications to existing stock options or awards made
after June 30, 2000.  However, for certain transactions the guidance is
effective after December 15, 1998 and January 12, 2000. The adoption of this
pronouncement did not have an effect on the current or historical financial
statements, but may impact the Company's future accounting regarding stock
option transactions.

At the September and November, 2000 EITF meetings, the EITF reached a consensus
on EITF 00-19, "Determination of Whether Share Settlement Is within the Control
of the Issuer for Purposes of Applying Issue No. 96-13". This EITF provides
guidance on the accounting for derivative financial instruments indexed to, and
potentially settled in, a company's own stock. Generally, EITF 00-19 requires
all warrants and equity derivative contracts issued which could require or force
cash settlement by the issuer to be classified as an asset or liability and not
permanent equity. EITF 00-19 also requires other significant additional
requirements in order to achieve equity classification. EITF 00-19 is effective
for all new contracts and contract modifications entered into after September
20, 2000.   Contracts that were entered into prior to or on September 20, 2000,
would not be required to follow EITF 00-19 unless they remain outstanding at
June 30, 2001. The Company does not expect the adoption of EITF No. 00-19 to
have a material impact on its financial position or results of operations.



Impairment and other charges

Impairment and other charges for the quarter ended December 31, 2000 consist of
the following:

   Impairment of goodwill and intangibles. ................    $148,349
   Impairment and write-down of music-related assets.......      20,806

                                       8
<PAGE>

   Uncollectible notes receivable...........................      2,496
   Settlement of contract dispute. .........................      1,410
                                                               --------
                                                               $173,061
                                                               ========

As a result of the downturn in the online music and advertising markets during
the quarter ended December 31, 2000, as well as the decline in the market
capitalization of companies in this sector, the Company assessed the
recoverability of its long-lived assets in accordance with SFAS 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." The Company compared the carrying value of its recorded fixed assets,
goodwill and intangible assets to the estimated future undiscounted operating
cash flows identified with these assets.  Where the carrying value of such
assets exceeded the undiscounted cash flows a non-cash write-down of goodwill
and intangibles equivalent to the extent that the carrying value of the long-
lived assets exceeded the related estimated discounted cash flows was recorded.
This impairment charge was recorded firstly as a reduction in the carrying value
of goodwill and then as a reduction in the carrying value of other intangibles.

The Company evaluated the recoverability of its advance royalties and music
catalog assets in accordance with SFAS 50, "Financial Reporting in the Record
and Music Industry," as well as assessed its cost method investments in other
music companies for potential impairment.  The write-down of advanced royalties
was determined based on the extent that estimated future royalties to be earned
by each label for the remaining life of the respective digital rights agreement
exceeded the net unearned advance and unamortized warrant balance at December
31, 2000.

The write-down of music catalogs was determined based on the amount that the
carrying value exceeded the estimated sale price for the physical rights and the
future estimated digital revenues associated with the digital rights of these
catalogs.  The Company's investments in private music companies were written
down if the carrying value of the investment was not justified by the ability of
the investee company to sustain an earnings capacity to ensure recoverability of
the Company's investment.

During 2000, the Company loaned a total of $5,500,000 to two independent music
labels from which the Company licenses music content.  Both labels are
delinquent in repaying the principal and interest payments due.  Based on the
financial condition of these labels, management does not believe that the total
outstanding balance of $5,526,000 to be fully recoverable, and accordingly a
valuation reserve of $2,496,000 was recorded at December 31, 2000.

In January 2001, the Company settled a contract dispute with a music label.  As
part of the settlement the Company returned its common stock investment in the
label, which had a carrying value of $1,000,000 at December 31, 2000.  In
addition the Company paid a cash settlement of $410,000, which was accrued at
December 31, 2000 and paid in January 2001.

The nonrecurring impairment charges are based on estimates and, therefore, are
subject to risks and uncertainties related to the Company's ability to generate
cash flows from operations and to collect amounts due from business partners.

On January 12, 2001, the Company announced a corporate restructuring, which
included the reduction of the Company's work force by 66 employees, or
approximately 36%, as well as other cost reduction measures. The Company expects
to record a charge of approximately $1,000,000 in the quarter ending March 31,
2000, primarily related to severance and employee costs associated with this
restructuring.

--------------------------------------------------------------------------------
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------

We are the owner and operator of one of the leading online music networks,
providing music fans with extensive music content, news and information and
community features.  Our network of websites is ranked among the top five music
information websites as measured by unique visitors in January 2001.  EMusic.com
is a website for sampling and purchasing music in the mp3 format, and via the
Internet, customers can link to our website from approximately 17,000 other
affiliate websites.  Through direct relationships with leading artists and
exclusive licensing agreements with over 700 independent record labels,
EMusic.com offers an expanding collection of over 150,000 tracks for purchase,
the

                                       9
<PAGE>

largest collection of digital music content from recognized artists currently
available for legal distribution in mp3 format over the Internet. In July 2000,
we launched EMusic Unlimited, a subscription program that allows customers to
download an unlimited amount of music from the EMusic catalog in exchange for a
flat, monthly fee. We also offer customers the opportunity to purchase
individual tracks and albums, generally priced at 99 cents to download a single
song and $8.99 to download an entire album. RollingStone.com is the Internet's
premier authority on music and popular culture. The website leverages Rolling
Stone magazine's unrivaled deep archives, including more than 7,500 artist
profiles, an extensive collection of exclusive photos and interviews, more than
30 years of magazine covers and over 1,600 on-demand videos.

In addition to historical statements, this Quarterly Report on Form 10-Q
contains forward-looking statements that are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
stated or implied. Forward-looking statements include those that use the words
"expects," "estimates," "will," "may," "anticipates," "believes" or similar
expressions. These forward-looking statements reflect management's opinions only
as of the date hereof, and we assume no obligation to update this information.
Risks and uncertainties include, but are not limited to, those discussed below
and in the section entitled "Factors That May Affect Our Results." Other risks
and uncertainties are disclosed in our prior SEC filings.

The following discussion should be read in conjunction with our Condensed
Consolidated Financial Statements and Notes thereto, included elsewhere in this
report.


RESULTS OF OPERATIONS


Since incorporation, we have incurred significant costs to acquire our catalog
of downloadable music and to develop the Internet websites through which we
conduct our business. We may experience significant fluctuations in operating
results in future periods due to a variety of factors, including, but not
limited to, market acceptance of the Internet as a medium for consumers to
obtain downloadable sound recordings, timing issues associated with revenue
recognition on larger corporate transactions, our ability to create, license,
and deliver compelling music-related content, our ability to obtain additional
financing in a timely manner and on terms favorable to us, our ability to
successfully integrate prospective asset or company acquisitions into our
existing business operations, the level of traffic on our websites, intense
competition from other providers of music-related content over the Internet, the
entrance of established music and/or software companies into the on-line music
industry, delays or errors in our ability to effect electronic commerce
transactions, our ability to upgrade and develop our systems and infrastructure
in a timely and effective manner, technical difficulties, system downtime or
Internet brownouts, our ability to attract customers at a steady rate and
maintain customer satisfaction, seasonality of the recorded music industry,
seasonality of advertising sales, the amount and timing of operating costs and
capital expenditures relating to expansion of our business, operations and
infrastructure and the implementation of marketing programs, key agreements and
strategic alliances, the number of recorded music releases introduced during the
period, the level of returns experienced by us and general economic conditions
and economic conditions specific to the Internet, on-line commerce and the
recorded music industry.



Revenues

Revenues are derived from the sale and licensing of downloadable music and from
advertising services provided to other companies.  Substantially all of our
revenues are related directly to the Internet.  Net revenues increased to
$4,677,000 for the quarter ended December 31, 2000, from $423,000 for the
quarter ended December 31, 1999.  Net revenues for the six months ended December
31, 2000 and 1999, were $9,313,000 and $603,000, respectively.  The increase in
revenue was primarily attributable to the increasing sales of downloadable music
including corporate sales and to increasing advertising sales following the
completion of our acquisition of Tunes.com in February 2000.  Revenues for the
quarter ended December 31, 2000, increased 65% from the combined revenues of
EMusic and Tunes.com of $2,833,000 for the quarter ended December 31, 1999.

Music revenues for the quarter ended December 31, 2000, include $1,323,000 from
the sale of downloadable music and

                                       10
<PAGE>

$344,000 from the licensing of portions of our music catalogs for use by other
music companies. Downloadable music revenues include the sale of individual
tracks and albums in downloadable mp3 files as well as revenue derived from the
EMusic Unlimited subscription service that allows customers to download an
unlimited amount of music from the EMusic catalog in exchange for a flat,
monthly fee. A substantial portion of the downloadable music revenues for the
quarter was derived from a corporate subscription agreement with Hewlett
Packard, which began in July 2000 and continues through March 31, 2001. The
revenue from this agreement is principally recognized in the quarter ended
December 31, 2000, and will continue into the quarter ending March 31, 2001.
Music revenues for the quarter ended December 31, 1999, include $222,000 from
the sale of downloadable music and $7,000 from music licensing. Our ability to
sell downloadable music and grow the EMusic Unlimited subscription service
continues to be adversely affected by the ability of potential customers to
obtain our music for free through Napster, and to a lesser extent other
websites. Until or unless Napster ceases to operate in its current model, our
downloadable music revenue growth will continue to be adversely affected.

Advertising revenues increased to $3,010,000 for the quarter ended December 31,
2000, from $194,000 ($2,604,000 including both EMusic and Tunes.com) for the
quarter ended December 31, 1999.  Advertising revenues are generated from the
sale of integrated marketing campaigns, banner advertisements and sponsorships
on our network of websites, especially RollingStone.com. The growth in
advertising revenue was benefited by the traffic growth on RollingStone.com
partially offset by declining prices for banner advertisements and the general
softening of the on-line advertising market in the last six months.
Advertising revenues include barter revenue, which represents an exchange of
advertising space on our websites for reciprocal advertising space on the
websites or other media of third parties.  Advertising revenue from barter
transactions is recognized based on the fair value of the advertising
surrendered in the transaction.  Such fair value is determined based on our
historical practice of receiving cash, or other consideration that is readily
convertible to cash, for similar advertising from buyers unrelated to the
counter-party in the barter transaction. The cost of the advertising space we
receive from the third party is recorded as advertising expense. For the
quarters ended December 31, 2000 and 1999, approximately 13 percent and 17
percent, respectively, of our total revenues were derived from barter
agreements.

Cost of Revenues

Cost of revenues is principally composed of license fees paid to the owners of
Rolling Stone magazine and of royalties paid to the owners of copyrighted songs
sold to customers as downloadable files.  Other costs of revenues include the
cost of acquiring or creating editorial content, the cost to deliver advertising
on our websites, and credit card processing fees on the sale of digital music.
Cost of revenues for the quarters ended December 31, 2000 and 1999, were
$1,838,000 and $147,000, respectively. Gross margins as a percentage of sales
for the quarters ended December 31, 2000 and 1999, were 62% and 65%,
respectively. Cost of revenues for the six months ended December 31, 2000 and
1999, were $3,683,000 and $172,000, respectively. Gross margins as a percentage
of sales for the six months ended December 31, 2000 and 1999 were 60% and 71%,
respectively.  Gross margins decreased principally as a result of the increased
license fees related to advertising revenues on the Rollingstone.com site.

Because gross margins from advertising and sponsorship are higher than
downloadable music, future gross margins may fluctuate depending on the relative
proportion of advertising and downloadable music revenues.  Although we expect
that sales and gross profits related to downloadable music will increase in
future periods, gross margins related to the EMusic Unlimited program may
continue to be lower than those we have historically experienced with our
individual album and track sales. Because the EMusic Unlimited program has only
recently been introduced and the number of songs downloaded by our subscribers
significantly impacts the gross margin on subscription sales, we do not yet have
enough data to predict the extent to which the downloads per subscriber may
effect these margins in the future.

Product Development Expenses

Product development activities are those related to acquiring the rights to
musical works and information and to building the systems necessary to deliver
music and information to customers.  Product development activities include
website design and maintenance, audio production, graphic design, content
acquisition and artist development. Product development expenses include
salaries, rent, depreciation, telecommunications charges, stock compensation and
certain non-recoverable advances to artists. Exclusive of stock compensation
expenses, product development expenses for the quarters ended December 31, 2000
and 1999 were $3,977,000 and $2,935,000, respectively. Exclusive of stock
compensation expenses, product development expenses for the six months ended
December 31, 2000 and 1999 were

                                       11
<PAGE>

$8,208,000 and $4,986,000, respectively. The increase reflects our increased
development efforts, particularly in graphic design and development of the
infrastructure required to deliver downloadable music from our Internet website
as well as the acquisition of music content and increased headcount following
the acquisition of Tunes.com in February 2000.

Stock compensation expenses represent the cost of common stock options and
warrants granted to consultants in exchange for their help in acquiring the
rights to musical works.  For accounting purposes, the cost of the options
granted to non-employees and warrants is calculated using the Black-Scholes
Model.  These stock options and warrants give the recipient the right to
purchase shares of our common stock from us in the future at a specified price.
The price specified is generally equal to the market price of our common stock
on the date the instrument was issued to the consultant. Stock compensation
expenses were $169,000 and $2,955,000 in the quarters ended December 31, 2000
and 1999, respectively. Stock compensation expenses were $347,000 and $6,915,000
in the six months ended December 31, 2000 and 1999, respectively.

Selling and Marketing Expenses

Selling and marketing consists principally of activities designed to promote our
EMusic.com and RollingStone.com websites, to attract new customers and traffic
to our websites and to sell advertisements and downloadable music to corporate
customers. Selling and marketing expenses were $5,550,000 and $5,637,000 for the
quarters ended December 31, 2000 and 1999, respectively. Selling and marketing
expenses were $10,547,000 and $10,408,000 for the six months ended December 31,
2000 and 1999, respectively. Selling and marketing expenses were generally flat
for the comparable periods due to the increase in headcount and marketing
expense following the acquisition of Tunes.com in February 2000 offset by the
decrease in offline advertising to promote the EMusic brand.


General and Administrative Expenses

General and administrative expenses consist primarily of executive management,
finance, legal, administrative and related overhead costs, such as rent, and
insurance. General and administrative expenses were $2,310,000 and $1,078,000
for the quarters ended December 31, 2000 and 1999, respectively. General and
administrative expenses were $4,296,000 and $1,890,000 for the six months ended
December 31, 2000 and 1999, respectively. General and administrative expenses
increased principally as a result of additional insurance and professional fees
and headcount required to manage our growing operations as a public company and
as a result of the acquisition of Tunes.com.

Amortization of Intangible Assets

Amortization of intangible assets for the quarters ended December 31, 2000 and
1999 were $9,104,000 and $2,877,000, respectively. Amortization of intangible
assets for the six months ended December 31, 2000 and 1999 were $18,244,000 and
$5,160,000, respectively.

As described in "Impairment and Other Charges" below, an impairment write-down
of goodwill and intangibles totaling $148,349,000 was recorded at December 31,
2000.  Accordingly, amortization expense on the remaining carrying value of the
RollingStone.com tradename of $9,000,000 will now approximate $225,000 per
quarter until the remaining balance is fully amortized.

Impairment and Other Charges

Impairment and other charges for the quarter ended December 31, 2000 consist of
the following:

   Write-down of goodwill and intangibles. .................   $148,349
   Impairment and write-down of music-related assets........     20,806
   Uncollectible notes receivable...........................      2,496
   Settlement of contract dispute. .........................      1,410
                                                               --------
                                                               $173,061
                                                               ========

                                       12
<PAGE>

As a result of the downturn in the online music and advertising markets during
the quarter ended December 31, 2000, as well as the decline in the market
capitalization of companies in this sector, we assessed the recoverability of
its long-lived assets in accordance with SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." We
compared the carrying value of its recorded fixed assets, goodwill and
intangible assets to the estimated future undiscounted operating cash flows
identified with these assets.  Where the carrying value of such assets exceeded
the undiscounted cash flows a non-cash write-down of goodwill and intangibles
equivalent to the extent that the carrying value of the long-lived assets
exceeded the related estimated discounted cash flows was recorded.  This
impairment charge was recorded firstly as a reduction in the carrying value of
goodwill and then as a reduction in the carrying value of other intangibles.

We evaluated the recoverability of our advance royalties and music catalog
assets in accordance with SFAS 50, "Financial Reporting in the Record and Music
Industry," as well as assessed our cost method investments in other music
companies for potential impairment.  The write-down of advanced royalties was
determined based on the extent that estimated future royalties to be earned by
each label for the remaining life of the respective digital rights agreement
exceeded the net unearned advance and unamortized warrant balance at December
31, 2000.

The write-down of music catalogs was determined based on the amount that the
carrying value exceeded the estimated sale price for the physical rights and the
future estimated digital revenues associated with the digital rights of these
catalogs.  Our investments in private music companies were written down if the
carrying value of the investment was not justified by the ability of the
investee company to sustain an earnings capacity to ensure recoverability of our
investment.

During 2000, we loaned a total of $5,500,000 to two independent music labels
from which we license music content.  Both labels are delinquent in repaying the
principal and interest payments due.  Based on the financial condition of these
labels, management does not believe that the total outstanding balance of
$5,526,000 to be fully recoverable, and accordingly a valuation reserve of
$2,496,000 was recorded at December 31, 2000.

In January 2001, we settled a contract dispute with a music label.  As part of
the settlement we returned our common stock investment in the label, which had a
carrying value of $1,000,000 at December 31, 2000.  In addition we paid a cash
settlement of $410,000, which was accrued at December 31, 2000 and paid in
January 2001.

The nonrecurring impairment charges are based on estimates and, therefore, are
subject to risks and uncertainties related to our ability to generate cash flows
from operations and to collect amounts due from business partners.

On January 12, 2001, we announced a corporate restructuring, which included the
reduction of our work force by 66 employees, or approximately 36%, as well as
other cost reduction measures. We expect to record a charge of approximately
$1,000,000 in the quarter ending March 31, 2000, primarily related to severance
and employee costs associated with this restructuring.

There were no similar charges in prior periods.


Liquidity and Capital Resources

At December 31, 2000, we had cash, cash equivalents and short-term investments
totaling $15,810,000. Net cash of $14,967,000 was used for operating activities
during the six months ended December 31, 2000, principally as a result of net
losses of $208,351,000 generated during the six months and the decrease of
accounts payable of $2,059,000, offset by non-cash expenses, including
amortization of $18,248,000, stock compensation of $347,000, impairment and
other charges of $172,651,000 and depreciation of $1,853,000. We expect to incur
negative cash flows from operations during the current fiscal year, as the
market continues to develop.  In January 2000, we announced that we had taken
cost-reduction actions that we believe will result in aggregate cost savings of
more than $16 million over the next four quarters.

Net cash provided by investing activities totaled $3,455,000 for the six months
ended December 31, 2000, resulting from net maturities of short-term investments
of $6,901,000, offset by $2,736,000 spent for royalty advances and $655,000 for
capital equipment and software purchases.

                                       13
<PAGE>

Net cash used in financing activities totaled $37,000 for the six months ended
December 31, 2000, as we paid $102,000 on a capital lease, offset by proceeds of
$65,000 received from the exercise of stock options and execution of the
Employee Stock Purchase Plan.

Under an agreement with Rolling Stone LLC we are required to purchase $1,100,000
of advertising and other services annually in Rolling Stone magazine until
February 2011 and to pay Rolling Stone an annual license fee of $1,250,000,
which increases to $1,500,000 in 2006.

In April 1999, we entered into a five-year lease agreement for new office space.
Under the terms of the agreement, we will make minimum monthly lease payments of
approximately $67,000 for a period of 60 months, which began in April 1999. This
monthly amount includes certain maintenance costs associated with the leased
space, and is subject to annual increases based on the Consumer Price Index.

We have incurred significant losses from operations during each fiscal year
since inception and have been dependent upon raising money from issuances of our
preferred stock and common stock in order to fund these losses and our
investment in content and other assets needed to establish our business.

We currently plan to increase our revenues to a level that will finance expected
expenditures and result in at least neutral cash flows from operations. However
until we reach this stage we will continue to use our current cash and cash
equivalent and short-term investment balances to meet the shortfall. We also
plan to raise additional financing where necessary. There can be no assurance
that, in the event we require additional financing that such financing will be
available on terms, which are acceptable to us or at all.

In the event that we are unable to increase revenue levels or financing is
unavailable to us management has developed alternative plans, which will entail
the reduction of expenses to levels that could be financed by revenues
generated. Such reductions in expenditures may include actions similar or
greater in scope to the cost-reduction exercises undertaken in January 2001.
There can be no assurance that the exercise undertaken in January or any further
cost cutting exercises will be successful in completely eliminating the
difference between expenditures and revenues or that such actions would not have
a harmful effect on our business and results of operations.

Although we believe that our existing resources will be sufficient to fund our
operating activities, capital expenditures and other obligations through the
next 12 months, in the event of unanticipated liabilities or additional working
capital requirements, we may need to raise additional funds.   Additional
financing may not be available on terms favorable to us, or at all. If
additional funds are required and not available or are not available on
acceptable terms, we may need to curtail certain of our plans or discontinue
certain of our operations. If we raise additional funds by issuing equity or
convertible debt securities, the percentage ownership of our then existing
stockholders will be reduced, and these securities may have rights, preferences
or privileges senior to those of our stockholders.

                                       14
<PAGE>

FACTORS THAT MAY AFFECT OUR RESULTS

Investing in our Common Stock involves a high degree of risk. You should
carefully consider the following factors and other information contained in this
Form 10-Q and the other filings, which we make with the SEC from time to time
before deciding to invest in our stock.

Any of the following risks, if they actually occur, could materially and
adversely affect our business, financial condition or results of operations. In
such event, the trading price of our common stock could decline, and
stockholders could lose all or part of their investments.

We have a new and unproven business model and it may not generate sufficient
revenue for our business to survive or be successful.

Our model for conducting business and generating revenues is new and unproven
and if it fails to develop as we plan, our business may not succeed. Our
business model depends upon our ability to generate revenue streams from
multiple sources primarily through our websites, including:

   .  online sales of downloadable music;

   .  website advertising and sponsorship fees from third parties; and

   .  licensing of musical recordings for use by others.

It is uncertain whether a music-based website such as EMusic.com, that relies on
attracting people to purchase and download music, mostly from lesser-known
artists, can generate sufficient revenues to survive. This business model may
not succeed or it may not be sustainable as our business grows.

We are substantially dependent upon our EMusic Unlimited subscription service,
which allows users to download substantially all of the music for sale at
EMusic.com for a fixed monthly fee. If our subscription service is not accepted
by users, our ability to increase our revenues will be adversely affected.
Likewise, if users download greater numbers of albums or tracks than we
currently expect, our operating results would be adversely affected.

In order for our business to be successful, we must not only develop services
that directly generate revenue, but also provide content and services that
attract consumers to our websites on a regular basis. We will need to develop
new offerings as consumer preferences change and new competitors emerge. We may
not be able to provide consumers with an acceptable blend of products, services,
and informational and community offerings that will attract consumers to our
websites on a regular basis. We provide many of our products and services
without charge, and we may not be able to generate sufficient revenue to pay for
these products and services. Accordingly, we cannot be certain that our business
model will be successful or that we will sustain revenue growth or be
profitable.

We are competing in a new market that may not develop sufficiently to support
our business.

The market for online music promotion and distribution is new and rapidly
evolving. As a result, demand and market acceptance for our products and
services are subject to a high degree of uncertainty and risk. In the early
stages of this market, we are attempting to capitalize on a talent pool of
artists underserved by the traditional recording industry. Consumers may not
continue to be interested in listening to, or purchasing music from, these
artists. If this new market fails to develop, develops more slowly than expected
or becomes saturated with competitors, or our products and services do not
achieve or sustain market acceptance, we may not generate sufficient revenues to
become profitable.

The future popularity of downloadable music will depend on consumer acceptance
of downloading music generally. We believe that consumer acceptance is, in part,
dependent on the availability of music from major record labels and portable
devices to store and play this music. Although the major labels have announced
plans to make music available for download, to date they have only announced the
availability of limited portions of their catalogs at prices, which are
substantially higher than the prices which we have been charging for
downloadable music. These actions may slow the overall consumer acceptance of
downloadable music and adversely impact our ability to increase our revenues.
Likewise, to the extent that new devices are not available at affordable prices,
or consumer acceptance or distribution of

                                       15
<PAGE>

these portable devices is delayed, our potential market, and thus our ability to
increase our revenues, may be reduced.

We have a limited operating history that makes an evaluation of our business
difficult.

Our limited operating history makes it difficult to evaluate our current
business and prospects. As a result of our limited operating history, we do not
have meaningful historical financial data upon which to forecast quarterly
revenues and results of operations. Before investing in us, you should evaluate
the risks, expenses and problems frequently encountered by companies such as
ours that are in the early stages of development.

We have incurred substantial losses to date and we expect net losses in the
future.

From inception through December 31, 2000, we had accumulated net losses of
approximately $300.6 million. We expect substantial net losses for the
foreseeable future and although we believe that we have a plan which can lead to
positive cash flow from operations, there can be no assurance that our plan can
be achieved. We believe it is critical to our long-term success that we continue
to develop "EMusic" and "RollingStone.com" brand awareness and loyalty through
marketing and promotion, expand our artist and consumer networks, develop our
online content and expand our other services. We have recently reduced our
operating expenses. If we determine that we need to increase operating expenses
in order to achieve our goals, we will need to generate significant additional
revenues to achieve profitability. As a result, we may never achieve
profitability and, if we do achieve profitability in any period, we may not be
able to sustain or increase profitability.

Our revenues are adversely impacted by the availability of our music for free
through Napster, and to a lesser extent other websites.  Until or unless Napster
ceases to operate in its current model, our downloadable music revenue growth
will continue to be adversely affected.

We have limited cash resources and may need to obtain additional funds to
execute our business plan.  If we are unable to obtain such funds, we will not
be able to expand our business as planned or may need to curtail or discontinue
certain operations.

As of December 31, 2000, we had approximately $16 million in cash, cash
equivalents and short-term investments. Although we believe that our existing
resources will be sufficient to fund our operating activities, capital
expenditures and other obligations through the next 12 months, in the event of
unanticipated liabilities or additional working capital requirements, we may
need to raise additional funds. Additional financing may not be available on
terms favorable to us, or at all. If additional funds are required and not
available or are not available on acceptable terms, we may need to curtail
certain of our plans or discontinue certain of our operations. If we raise
additional funds by issuing equity or convertible debt securities, the
percentage ownership of our then existing stockholders will be reduced, and
these securities may have rights, preferences or privileges senior to those of
our stockholders.

Our stock price has been and may continue to be volatile and may be subject to
de-listing.

Our Common Stock is currently traded on the Nasdaq National Market under the
ticker symbol "EMUS." Our shares may be de-listed from the Nasdaq National
Market if the minimum closing bid price per share is less than $1.00 for a
period of 30 consecutive days and such requirement is not remedied within the 90
day period thereafter. As of January 4, 2001, our stock had failed to meet this
requirement for the initial thirty day period. If our stock were de-listed from
the Nasdaq National Market there would likely be a substantial reduction in the
liquidity of any investment in our common stock. De-listing could also reduce
the ability of holders of our common stock to purchase or sell shares as quickly
and as inexpensively as they have done historically. This lack of liquidity also
makes it more difficult for us to raise capital in the future.

There can be no assurance that an active trading market will be sustained in the
future. In addition to fluctuations in our operating results, the following
factors could cause the price of our securities to be volatile:

   .  development of the downloadable music market;

   .  technological innovations;

                                       16
<PAGE>

   .  legal development with respect to copyright law and downloadable music;

   .  new products;

   .  acquisitions or strategic alliances entered into by us or our competitors;

   .  failure to meet securities analysts' expectations;

   .  government regulatory action;

   .  patent or proprietary rights developments; and

   .  market conditions for Internet and technology stocks in general.



Our quarterly revenues and operating results are subject to fluctuation, which
may result in volatility or a decline in the price of our stock.

We believe that period-to-period comparisons of our operating results are not
meaningful and should not be relied upon as indicators of future performance.
Our quarterly operating results are likely to fluctuate significantly in the
future as a result of a variety of factors, many of which are outside of our
control, including:

   .  the demand for downloadable music content and Internet advertising;

   .  the application of revenue recognition policies to large contracts under
   generally accepted accounting principles;

   .  the addition or loss of advertisers;

   .  the level of traffic on our Internet sites;

   .  amount and timing of capital expenditures and other costs relating to the
   expansion of our operations;

   .  the introduction of new sites and services by us or our competitors;

   .  seasonal trends in Internet use, purchases of downloadable music, and
   advertising placements;

   .  price competition or pricing changes in the industry;

   .  technical difficulties or system downtime; and

   .  general economic conditions, and economic conditions specific to the
   Internet and Internet media.


In addition, while our revenues may vary significantly, a portion of our
expenses are fixed. As a result, any decrease in revenues will not be
accompanied by a decrease in our fixed operating expenses and our operating
results will suffer. Our quarterly results may also be significantly impacted by
the accounting treatment of acquisitions, financing transactions or other
matters. Because of these and other factors it is likely that our operating
results will fall below expectations in some future quarter and the trading
price of our stock may drop.

We depend significantly upon our relationship with the publisher and owner of
Rolling Stone magazine, for editorial content, access to the archives of Rolling
Stone and our use of the brand name "Rolling Stone," as well as for press
coverage, business and marketing opportunities, strategic relationships and
potential acquisitions.  If we are unable to continue this relationship and to
utilize the Rolling Stone brand name and content on our websites, or if the
Rolling

                                       17
<PAGE>

Stone content or brand name is made accessible to our competitors, we may
generate less traffic, which would reduce our revenue. In addition, if Rolling
Stone is not able to continue to obtain license rights for online distribution
of its magazine content from third-party contributors, we would not be able to
make this content available on our Web sites which could reduce the number of
visitors to our websites. Our agreement with Rolling Stone will terminate in
2011 unless we have a market capitalization of at least $2 billion at that time,
in which case it will terminate in 2016. The agreement may be terminated earlier
if we fail to comply with our obligations under the agreement.

Under our agreement with Rolling Stone, we obtained the right to use the
"Rolling Stone," "RollingStone Online" and "RollingStone.com" trademarks and
their derivatives in connection with the Internet and the right to use the
RollingStone.com domain name. If our agreement terminates, we will not be
entitled to use these trademarks or the RollingStone.com domain. The loss of our
right to use the Rolling Stone trademarks, domain or content would damage our
reputation and severely limit our ability to generate advertising, e- commerce
and other revenue.

Shares eligible for future sale in the open market may depress our stock price.

As of December 31, 2000, there were approximately 43 million shares of common
stock outstanding, substantially all of which were tradable without registration
under the Securities Act or pursuant to currently effective registration
statements or exemptions from registration requirements.

If our brand names are not accepted, our ability to attract content and
customers to our website will be harmed.

We believe that establishing and maintaining the EMusic and RollingStone.com
brands is a critical aspect of our efforts to attract and expand our Internet
audience and acquire new content and that the importance of brand recognition
will increase due to the growing number of Internet sites and the relatively low
barriers to entry in providing Internet content. We intend to incur significant
expenses in our brand building efforts. If these efforts do not generate
increased revenues our operating results will suffer. If we are unable to
provide high quality content or otherwise fail to promote and maintain our
brand, our business will be harmed.

If we are unable to maintain or expand our contracts for music content, or if
the content we license does not sell, our popularity and business may suffer.

We believe that a primary draw to our EMusic.com website is the ability to
access music from known artists and independent record labels. Currently, we
have exclusive multi-year contracts for much of our music library. However, if
we are unable to sign contracts for new content, or if we are unable to extend
the terms of existing contracts as they expire, our website may fail to attract
new, or retain existing, customers which would harm our business.

For much of the content we license, we pay advances against future royalties,
which will be owed on the sale of the content. If the content we license does
not sell in sufficient quantities, we may not be able to recover all or part of
the advances we have paid and our business could be harmed.

We rely on third parties for the hosting of our websites and if these hosting
services become unavailable, our customers will not be able to access our
websites.

We currently rely on third parties, which host our EMusic.com and
RollingStone.com websites. We currently do not maintain redundant websites. If
for any reason our current website hosting services become unavailable or if our
hosting service experiences technical problems, customers will not be able to
access our websites until these services are restored or until we are able to
make arrangements with an alternate provider.

If we fail to adequately manage our growth, we may not be successful as we may
miss market opportunities.

If our revenues grow rapidly, we will also need to expand the scope of our
operations and the number of our employees rapidly. In particular, we will need
to hire additional engineering, sales, marketing, content acquisition and
administrative personnel. Additionally, we may complete additional acquisitions,
which could increase our employee headcount and business activity substantially.
Any such rapid growth would place significant stress on our technology,
operations, management and employee base. Any failure to successfully address
such issues would harm our business.

                                       18
<PAGE>

Our technology systems must be expanded and enhanced for our business to grow.

In order to support a growing business, we will need to continue to enhance and
expand the technology infrastructure, which supports our business. As our
business continues to grow, we will need to add additional servers and other
hardware and software systems as well as additional sites for website hosting.
If we fail to successfully implement these new and enhanced systems, our
operations could be disrupted, we may become less competitive, our revenues
could be reduced and we may need to incur additional costs to address these
issues.

We may have difficulty executing acquisitions and integrating the acquired
companies into our business.

Our business strategy includes entering into strategic alliances and acquiring
complementary businesses, technologies, content or products.  During the last
two fiscal years, we completed the acquisitions of Creative Fulfillment, Inc.,
IUMA, Cductive and Tunes.com. These and any other future acquisitions involve
risks commonly encountered in acquisitions of companies, including:

   .  exposure to unknown liabilities of acquired companies;

   .  incurring acquisition costs and expenses in excess of what we anticipated;

   .  the occurrence of fluctuations in our quarterly and annual operating
      results due to the costs and expenses of acquiring and integrating new
      businesses or technologies;

   .  experiencing difficulties and expenses in assimilating the operations and
      personnel of the acquired businesses;

   .  disruption of our ongoing business and diversion of our management's time
      and attention;

   .  a possible inability to integrate successfully or to complete the
      development and application of acquired technology and a possible failure
      to achieve the anticipated financial, operating, and strategic benefits
      from these acquisitions;

   .  experiencing difficulties in establishing and maintaining uniform
      standards, controls, procedures, and policies;

   .  impairment of our relationships with key employees and customers of
      acquired businesses or the loss of these key employees and customers as a
      result of changes in management and ownership of the acquired businesses.

In addition, our stockholders may be diluted if the consideration for future
acquisitions consists of equity securities. We may not overcome these risks or
any other problems encountered in connection with acquisitions. If we are
unsuccessful in doing so, our business could be harmed.

We expect competition to increase significantly in the future and we may not be
able to compete successfully.

The market for the online promotion and distribution of music and music-related
products and services is new, highly competitive and rapidly changing. The
number of websites on the Internet competing for the attention and spending of
consumers, users and advertisers has increased, and we expect it to continue to
increase, because there are few barriers to entry to Internet commerce. In
addition, the competition for advertising revenues, both on Internet websites
and in more traditional media, is intense. Currently, there are more than one
hundred music retailing websites on the Internet. We face competitive pressures
from numerous actual and potential competitors.

All of the major record label companies have announced initiatives with respect
to the sale of downloadable music.  To date we have announced agreements
pursuant to which we will sell music from the Universal Music Group, EMI and
BMG.  If we are unable to obtain licenses to sell or otherwise distribute
content from all or most of the major record label companies, our ability to
increase our sales will be limited to our ability to obtain licenses from the
independent record label segment of the music market, which has historically
represented approximately 20% of the total music market. To the extent that
other companies are able to obtain rights to content from major record labels,
such companies may have a significant competitive advantage over us.

                                       19
<PAGE>

Competition is likely to increase significantly as new companies enter the
market and current competitors expand their services. Many of our current and
potential competitors in the Internet and music entertainment businesses may
have substantial competitive advantages relative to us, including:

   .  longer operating histories;

   .  significantly greater financial, technical and marketing resources;

   .  greater brand name recognition;

   .  larger existing customer bases; and

   .  more popular content or artists.

These competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements and devote greater resources
to the development, promotion, and sale of their products or services than we
can. Websites maintained by our existing and potential competitors may be
perceived by consumers, artists, talent management companies and other music-
related vendors or advertisers as being superior to ours. In addition, we may
not be able to maintain or increase our website traffic levels, purchase
inquiries and number of click-throughs on our online advertisement. Further, our
competitors may experience greater growth in these areas than we do. Increased
competition could result in advertising price reduction, reduced margins or loss
of market share, any of which could harm our business.


Our business is dependent on the continued development and maintenance of the
internet and the availability of increased bandwidth to consumers.

The success of our business will depend largely on the development and
maintenance of the Internet infrastructure. This includes maintenance of a
reliable network with the necessary speed, data capacity and security, as well
as timely development of complementary products such as high-speed modems, for
providing reliable Internet access and services. Because global commerce on the
Internet and the online exchange of information is new and evolving, we cannot
predict whether the Internet will prove to be a viable commercial marketplace in
the long term.

The success of our business will rely on the continued improvement of the
Internet as a convenient means of consumer interaction and commerce, as well as
an efficient medium for the delivery and distribution of music. Our business
will depend on the ability of our artists and consumers to continue to upload
and download mp3 and other music file formats, as well as to conduct commercial
transactions with us, without significant delays or aggravation that may be
associated with decreased availability of Internet bandwidth and slower access
to our websites. Our penetration of a broader consumer market will depend, in
part, on continued proliferation of high speed Internet access. Even compressed
in mp3 format, a typical three-minute song file can occupy more than three
megabytes of storage space. This file could take approximately seven minutes to
download over a conventional 56 kbps modem compared to less than one minute over
an xDSL or cable modem.

The Internet has experienced, and is likely to continue to experience,
significant growth in the numbers of users and amount of traffic. As the
Internet continues to experience increased numbers of users, increased frequency
of use and increased bandwidth requirements, the Internet infrastructure may be
unable to support the demands placed on it. In addition, increases in users or
bandwidth requirements may harm the performance of the Internet. The Internet
has experienced a variety of outages and other delays as a result of damage to
portions of its infrastructure, and it could face outages and delays in the
future. This might include outages and delays resulting from denial of service
problems such as those experienced by some major Internet sites. These outages
and delays could reduce the level of Internet usage as well as the level of
traffic, and could result in the Internet becoming an inconvenient or
uneconomical source of music and music-related products and services. The
infrastructure and complementary products or services necessary to make the
Internet a viable commercial marketplace for the long term may not be developed
successfully or in a timely manner. Even if these products or services are
developed, the Internet may not become a viable commercial marketplace for the
products or services that we offer.

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We must maintain and establish strategic alliances to increase our customer base
and enhance our business.

In an attempt to increase our customer base and traffic on our websites, build
brand recognition, attract paid advertising and enhance content, distribution
and commerce opportunities, we have entered into agreements with various media,
hardware device and Internet-related companies such as America Online,
RealNetworks, and Microsoft. Our failure to maintain or renew our existing
strategic alliances or to establish and capitalize on new strategic alliances
could harm our business. Our future success depends to a significant extent upon
the success of such alliances. Moreover, we are substantially dependent on our
ability to advertise on other Internet sites and the willingness of the owners
of other sites to direct users to our Internet sites through hypertext links. We
may not achieve the strategic objectives of these alliances, and parties to
strategic alliance agreements with us may not perform their obligations as
agreed upon. Such agreements also may not be specifically enforceable by us. In
addition, some of our strategic alliances are short term in nature and may be
terminated by either party on short notice. The termination or impairment of
these strategic alliances could reduce our ability to attract new customers.

Our success depends on our retention of key personnel.

Our performance is substantially dependent on the services of Gene Hoffman, Jr.,
our chief executive officer, as well as on our ability to recruit, retain and
motivate other officers and key employees. Competition for qualified personnel
is intense and there are a limited number of persons with knowledge of and
experience in the Internet and music entertainment industries. The loss of the
services of any of our officers or senior managers could harm our business.

We may not be able to hire and retain a sufficient number of qualified employees
to grow our business as planned.

Our future success will depend on our ability to attract, train, retain and
motivate other highly skilled technical, managerial, marketing and customer
support personnel. Competition for these personnel is intense, especially for
engineers, web designers and advertising sales personnel, and we may be unable
to successfully attract sufficiently qualified personnel. A large percentage of
our employees have joined us within the last 12 months and if revenues grow
rapidly, our rate of hiring will need to continue. To manage the expected growth
of our operations, we will need to integrate these employees into our business.
Our inability to hire, integrate and retain qualified personnel in sufficient
numbers may reduce the quality of our programs, products and services, and could
harm our business. In addition, companies in the Internet and music industries
whose employees accept positions with competitive companies frequently claim
that their competitors have engaged in unfair hiring practices. We may be
subject to claims in the future as we seek to hire qualified personnel and those
claims may result in material litigation. Even if unsuccessful, these claims
could harm our business by damaging our reputation, requiring us to incur legal
costs and diverting management's attention away from our business.

Security concerns regarding credit card or other confidential information
transmitted over the web could limit our growth and subject us to liability.

A significant barrier to e-commerce and communications over the Internet has
been the need for secure transmission of confidential information over public
networks. Internet usage may not increase at the rate we expect unless some of
these concerns are adequately addressed and found acceptable by the market.
Internet usage could also decline if any well-publicized compromise of security
occurred. We may incur significant costs to protect against the threat of
security breaches or to alleviate problems caused by such breaches. Protections
against security breaches may not be available at a reasonable price or at all.
If a third party were able to circumvent our security measures and
misappropriate our users' personal information, it may cause interruptions to
our retail website operation, damage our reputation or subject us to claims by
users. Any compromise of confidential data during transmission over the Internet
may harm our business.

Any failure of our internal security measures could cause us to lose customers
and subject us to liability.

Our business is dependent on maintaining a database of confidential user
information, including credit card numbers. If the security measures that we use
to protect personal information are ineffective, we may lose customers and our
business would be harmed. We rely on security and authentication technology
licensed from third parties. With this

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<PAGE>

technology, we perform real-time credit card authorization and verification. We
cannot predict whether new technological developments could allow these security
measures to be circumvented.

In addition, our software, databases and servers may be vulnerable to computer
viruses, physical or electronic break-ins and similar disruptions. We may need
to spend significant resources to protect against security breaches or to
alleviate problems caused by any breaches and we may not be able to prevent all
security breaches.

Our intellectual property protection may be inadequate, and any loss or
reduction in intellectual property protection may harm our business.

Our intellectual property includes our trademarks and copyrights, proprietary
software, and other proprietary rights. We believe that our intellectual
property is important to our success and our competitive position, and we try to
protect it. However, our efforts to protect our intellectual property could be
inadequate. Use of the "EMusic" name by others could dilute our brand identity
and confuse the market. In addition, our ability to conduct our business may be
harmed if others claim we violate their intellectual property rights. For
example, Sightsound.com, Inc. has asserted that many online music providers,
including us, violate patent rights that it allegedly owns covering the sale of
music over the Internet through digital downloads. If successful, these claims,
or similar claims by others, could seriously harm our business by forcing us to
cease using intellectual property that we depend on to operate our business.
Even if unsuccessful, these claims could harm our business by damaging our
reputation, requiring us to incur legal costs and diverting management's
attention away from our business.

Government regulation may require us to change the way we do business.

Laws and regulations directly applicable to Internet communications, commerce
and advertising are becoming more prevalent. The United States Congress has
enacted Internet laws regarding children's privacy, copyrights and taxation.
Such legislation could dampen the growth in use of the Internet generally and
decrease the acceptance of the Internet as a communications, commercial and
advertising medium. Although our transmissions originate in California and New
Jersey, the governments of other states or foreign countries might attempt to
regulate our transmissions or levy sales or other taxes relating to our
activities. The European Union has enacted its own privacy regulations that may
result in limits on the collection and use of certain user information. The laws
governing the Internet, however, remain largely unsettled, even in areas where
there has been some legislative action. It may take years to determine whether
and how existing laws such as those governing intellectual property, privacy,
libel and taxation apply to the Internet and Internet advertising. In addition,
the growth and development of the market for Internet commerce may prompt calls
for more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on companies conducting business over
the Internet. Furthermore, the Federal Trade Commission has recently
investigated the disclosure of personal identifying information obtained from
individuals by Internet companies. Evolving areas of law that are relevant to
our business include privacy law, proposed encryption laws, content regulation
and sales and use tax. For example, changes in copyright law could require us to
change the manner in which we conduct business or increase our costs of doing
business. In addition, currently pending litigation involving copyright
infringement claims brought against MP3.com and Napster may result in decisions,
which have a significant impact on our business. If the unlicensed distribution
of music is held to be lawful, our ability to sell music could be materially
harmed. Because of this rapidly evolving and uncertain regulatory environment,
we cannot predict how these laws and regulations might affect our business. In
addition, these uncertainties make it difficult to ensure compliance with the
laws and regulations governing the Internet. These laws and regulations could
harm us by subjecting us to liability or forcing us to change how we do
business. In the event the Federal Trade Commission or other governmental
authorities adopt or modify laws or regulations applicable to our business,
including those relating to the Internet and copyright matters, our business
could be harmed.

We may have liability for content on our website and liability for other
materials, which we distribute.

We may be liable to third parties for content on our website and any other
materials we distribute if:

   .  the music, text, graphics or other content on our website violates their
      copyright, trademark, or other intellectual property rights;

   .  our artists or labels violate their contractual obligations to others by
      providing content on our website; or

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<PAGE>

   .  content we distribute is deemed obscene, defamatory or excessively
      violent.

We may also be subject to these types of liability for content that is
accessible from our websites through links to other websites.

Although we believe that we have valid licenses for the music that we sell,
other artists or labels may challenge whether the party granting us the license
had the right to do so.  Even if we are entitled to indemnification, defending
any such claim could be costly and damage our reputation and adversely affect
revenues if we must remove content from our site completely or temporarily.

Liability or alleged liability for content or other materials could harm our
business by damaging our reputation, requiring us to incur legal costs in
defense, exposing us to significant awards of damages, fines and costs and could
divert management's attention away from our business. In particular, in addition
to civil damages, liability for violations of copyright law currently can result
in penalties of up to $10,000 per occurrence.

Imposition of sales and other taxes on e-commerce transactions may impair our
ability to derive financial benefits from e-commerce.

Except for sales of tangible merchandise into certain states, we do not collect
sales or other taxes on sales of our products through our websites. Although the
Internet Tax Freedom Act precludes, for a period of three years ending October
2001, the imposition of state and local taxes that discriminate against or
single out the Internet, it does not currently impact existing taxes. However,
one or more states may seek to impose sales tax collection obligations on out-
of-state companies such as us, which engage in or facilitate online commerce. A
number of proposals have been made at the state and local level that would
impose additional taxes on the sale of goods and services through the Internet.
Such proposals, if adopted, could substantially impair the growth of electronic
commerce and could adversely affect our opportunity to derive financial benefit
from electronic commerce. Moreover, if any state or foreign country were to
successfully assert that we should collect sales or other taxes on the exchange
of merchandise on its system, it could affect our cost of doing business.

Legislation limiting the ability of states to impose taxes on Internet based
transactions has been proposed in the U.S. Congress. We cannot assure you that
this legislation will ultimately become law or that the tax moratorium in the
final version of this legislation will be ongoing. Failure to enact or renew
this legislation, if enacted, could allow various states to impose taxes on
Internet-based commerce, which could harm our business.

We may have difficulty expanding into international markets, which could limit
the growth of our business.

Our future growth and success will depend in part on our ability to generate
international sales. There can be no assurance, however, that we will be
successful in generating international sales of our products. Sales to customers
in certain international countries may be subject to a number of risks,
including: currency exchange rate risk; the risks that agreements may be
difficult or impossible to enforce and receivables difficult to collect through
an international country's legal system; foreign customers may have longer
payment cycles; or foreign countries could impose withholding taxes or otherwise
tax our foreign income, impose tariffs, embargoes, or exchange controls, or
adopt other restrictions on foreign trade. In addition, the laws of certain
countries do not protect our offerings and intellectual property rights to the
same extent as the laws of the United States. If we fail to compete successfully
or to expand the distribution of our offerings in international markets the
growth of our business could be limited.

Development of new standards for the electronic delivery of music may threaten
our business.

We currently rely on mp3 technology as a delivery method for the digital
distribution of music. Mp3 is an open standard adopted by the Moving Picture
Experts Group for the compression of audio files. We do not own or control mp3
technology and are dependent upon a license to obtain rights to certain patents
relating to the technology. The onset of competing industry standards for the
electronic delivery of music could significantly affect the way we operate our
business as well as the public's perception of EMusic as a company. For example,
in December 1998, the major recording studios announced a plan to develop a
universal standard for the electronic delivery of music, called the Secured
Digital Music Initiative. If new standards are developed and adopted by
consumers, we may not be able to

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<PAGE>

obtain a license to such technology on favorable terms or at all and our
business could be harmed. Even if new standards are not developed, delays with
respect to proposed standards, such as those, which have occurred with respect
to SDMI, can cause confusion in the marketplace, slow the development of the
market for downloadable music and otherwise harm our business.

Mp3 technology is controversial within certain segments of the traditional music
industry and we may face continued opposition to our use of mp3, which may slow
market development and harm our business.

Certain segments of the traditional music industry have not embraced the
development of the mp3 format to deliver music, in part because users of mp3
technology can download and distribute unauthorized or "pirated" copies of
copyrighted recorded music over the Internet. We believe that our success is
largely dependent upon the ease with which customers can download and play
music. We may face opposition from a number of different music industry sources
including record companies and studios, the Recording Industry Association of
America and certain artists. The adoption of competing standards may slow the
development of the market for downloadable music or result in increased costs of
doing business, which could harm our business.

Our executive officers and directors control approximately 16% of our Common
Stock and have power to influence significant corporate matters, which may
delay, deter or prevent transactions that could benefit our stockholders.

Executive officers and directors, in the aggregate, beneficially own
approximately 16% of our outstanding Common Stock. These stockholders are able
to significantly influence all matters requiring approval by our stockholders,
including the election of directors and the approval of significant corporate
transactions. This concentration of ownership may also have the effect of
delaying, deterring or preventing a change in control of EMusic and may make
some transactions more difficult or impossible without the support of these
stockholders.

Anti-takeover provisions in our charter documents could negatively impact our
stockholders.

Our Board of Directors has the authority to issue up to 20,000,000 shares of
Preferred Stock without need for stockholder approval. The board may also
determine the economic and voting rights, of this Preferred Stock. The holders
of our Common Stock could be adversely affected by the issuance of Preferred
Stock. Issuance of Preferred Stock could impede or prevent transactions that
would cause a change in control of our company. This might discourage bids for
our Common Stock as a premium over the market price of our Common Stock and
adversely affect the trading price of our Common Stock. We have no current plans
to issue shares of Preferred Stock. In addition, other provisions in our charter
documents could make it more difficult for a third party to acquire us, even if
doing so would be beneficial to our stockholders.

Our data warehousing and web server systems are vulnerable to limitations on
power availability, natural disasters, failure of third-party services and other
unexpected problems.

Since our data warehousing, web server and network facilities for EMusic.com are
all located in California, we are potentially subject to the power shortages
recently experienced in California.  In addition, an earthquake or other natural
disaster could affect all of our facilities simultaneously. An unexpected event
such as a power or telecommunications failure, fire, flood or earthquake at our
on-site data warehousing facility or at our Internet service providers'
facilities could cause the loss of critical data and prevent us from offering
our services to artists and consumers. Our business interruption insurance may
not adequately compensate us for losses that may occur. In addition, we rely on
third parties to securely store our archived data, house our web server and
network systems, and connect us to the Internet. A failure by any of these third
parties to provide these services satisfactorily could harm our business.

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<PAGE>

--------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
--------------------------------------------------------------------------------

Quantitative and Qualitative Disclosures About Market Risk

We have considered the provisions of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." We had no
holdings of derivative financial or commodity instruments at December 31, 2000.

However, we are exposed to financial market risks, including changes in interest
rates. All of our revenue and capital spending is transacted in U.S. dollars.
Our investments portfolio comprises amounts invested in short term cash deposits
and therefore we believe that the fair value of our investment portfolio or
related income would not be significantly impacted by increases or decreases in
interest rates due mainly to the short-term nature of our investment portfolio.
However, a sharp increase in interest rates could have a material adverse effect
on the fair value of our investment portfolio. Conversely, sharp declines in
interest rates could seriously harm interest earnings of our investment
portfolio.


Interest Rate Risk

We do not hold derivative or speculative financial instruments and substantially
all cash and cash equivalent balances are invested in money market accounts with
floating interest rates, therefore we are not subject to significant interest
rate risk.


Currency Exchange Rate Risk

During the period from inception through December 31, 2000, all of our revenues
and expenses have been denominated in U.S. dollars. As a result, we have not
incurred any realized or unrealized currency exchange rate gains or losses. We
do not expect to incur any significant gains and losses during the next twelve
months. We have not engaged in foreign currency hedging activities to date.

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--------------------------------------------------------------------------------
PART II - OTHER INFORMATION
--------------------------------------------------------------------------------

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS


During the quarter, we granted warrants for the purchase of 36,050 shares to
advisors and in conjunction with the acquisition of musical content during
quarter.  All of such warrants were granted to accredited investors pursuant to
Regulation D.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

None

(b) Reports on Form 8-K

None

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--------------------------------------------------------------------------------
SIGNATURES
--------------------------------------------------------------------------------

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


Date: February 14, 2000            EMusic.com Inc.

                                        /s/ Emily Rupp
                                        ------------------------
                                        Emily Rupp,
                                        Vice President and
                                        Chief Financial Officer

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