This report on Form 10-K (this "Report") contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. Persons considering purchasing or selling shares of our common stock are cautioned that our actual results will differ (and may differ significantly) from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include those factors discussed herein under "Factors that May Affect Future Results" beginning on page 10 and elsewhere in this Report. The reader is also encouraged to review our other filings with the Securities and Exchange Commission describing other factors that may affect our future results.

VitalStream Holdings, Inc. provides products and services that allow companies to broadcast video, audio and other related digital media over the Internet. Specifically, we provide content delivery network services such as streaming, hosting, and related products and services that allow clients to outsource their digital broadcasting needs. Streaming is an efficient method of broadcasting video, audio and other media over the Internet. Hosting is the business of storing and serving computer files for Web sites, and providing a high-speed connection to the Internet. We offer hosting services that are accompanied by extensive support services, which we collectively refer to as managed services. We provide streaming, hosting, and other related services to companies in a variety of industries; however, we focus our marketing efforts toward media and entertainment companies, advertising agencies, radio stations, Internet gaming companies, companies needing online training or webcasting, a nd other businesses that create and have a need to electronically distribute their digital media.

We believe that as a result of recent advances in streaming technology and anticipated growth in the number of people using broadband Internet connections, the Internet will become a widely used medium for distributing and receiving audio and video content. Consumer applications for streaming include movies and movie trailers, music samples, interactive television, news clips, online video games, pay-per-view music, theater, sports and other events. Business applications center on communications to customers, employees, and partners over the Internet or through the use of Intranets, including employee training, sales calls, delivery of rich media advertising messages, product launches, press and other video conferencing and presentations.

VitalStream is uniquely positioned as a rich media integrator Internet content delivery network, which according to Giga Research in a February 2004 report, "is the third segment of Internet content delivery networks (others being IP-transport Internet content delivery networks and Middleware Internet content delivery networks respectively), pioneered by VitalStream, addressing a concern frequently cited by companies regarding deploying streaming media solutions on the Internet: It is comparatively difficult to manage the whole production and deployment process because it involves a number of departments inside the corporation as well as the Internet content delivery network provider. VitalStream offers a service that brings together all of the hardware, software and services necessary to enable customers to deliver rich media content solutions in an integrated fashion."

Numerous companies use the Internet to broadcast content to a geographically dispersed audience. These companies need sophisticated Internet digital media delivery solutions. The conversion of audio and video content into a streaming media format that can be distributed electronically is a technologically and artistically complex process. Selecting the equipment, the software and the distribution model appropriate for certain streaming applications requires technical expertise that most content owners do not have. In addition, constructing and maintaining the server network infrastructure and the broadband connectivity to the Internet on a stand-alone basis is costly and may distract the content owner from its core business. Our business is to provide these customers with an end-to-end solution.

Many businesses could use our streaming, managed services and hosting products and services. The market for content delivery services, and specifically streaming, is growing rapidly, and numerous companies are using streaming technology for everything from in-house training, online rich media advertising to international product demonstrations and worldwide distribution of movie trailers and branded products.

Although the potential market for our services is broad, we currently focus our marketing efforts on industries for which industry analysts anticipate growth in the use of the content delivery services we provide. These industries include the following:

According to July 2003 research conducted by Arbitron/Edison Media Research, from January 2000 to early 2003, an average of 8% of all Americans watched some form of Internet video in the past month. By July 2003, the monthly Internet video audience grew to 12% of all Americans. Movie trailers and music videos were the most watched types of online video programming. According to a February 2004 report published by Accustream Research, total video streams viewed in 2003 were 7.87 billion. Of the video streams, music videos captured 33% viewing share, followed by news at 28% and sports at 17%.

Rich media advertising is online advertising technologically enhanced with movement, sound or video. Traditional print and television advertising is expensive and targets broad demographic groups. Online advertising can be more cost effective and has the ability to narrowly target an audience or have a broad reach. Unlike print and television advertising, rich media can deliver instant, detailed feedback, ranging from how many seconds PC users spent viewing an ad, what they clicked to next and how many unique visitors viewed the ad. Rich media also can provide a call to action, getting users to submit demographic data in real time, by completing a form, or making an online purchase.

As more companies incorporate online advertising into their media plans, advertising agencies will need to offer a complete solution to their clients. Agencies will need a reliable content delivery network partner to stream the rich media ads over the Internet. VitalStream can provide the necessary products and services to help advertising agencies broadcast the rich media ads they create to their clients' audience.

In December 2003 The Interactive Advertising Bureau (IAB) and PricewaterhouseCoopers (PwC) stated that Internet advertising totaled an estimated $1.745 billion in the third quarter of 2003, the highest total revenues reported since Q3 2001 ($1.773 billion). A study by eMarketer estimated that US online advertising will reach $8.6 billion in 2005 and $9.9 billion in 2007.

According to a report from Jupiter Research in September 2003, rich media specifically, will account for 11 percent of online ad spending in 2004, with streaming making up 4 percent. In 2005, rich media is projected to represent 15 percent of online ad spending, with streaming making up 6 percent.

DoubleClick reported in February 2004, rich media as a percent of all Internet ads served accounted for nearly 40% in Q4 2003, up 60% from Q4 2002 and confirmed that rich media continues to display stronger conversion rates than non-rich media. It also generates higher rates of post-impression activity per impression (1.11% vs. .54% for non-rich media) and post impression sales per those activities of 2.30% vs. 1.47%.

Radio stations use streaming technology to expand the reach of their broadcast. By streaming their programming over the Internet, they make it available to a wider audience. This allows stations to provide sponsors and advertisers access to demographics unreachable by conventional broadcast signals. In addition, musicians, record companies and online music retailers use streaming technology to permit potential customers to listen to short samples of their music prior to purchasing a song or CD.

The use of the Internet for radio listening and other music streaming appears to be growing. According to research as of July 2003 reported by Arbitron/Edison Media Research, four in ten Americans have listened to Internet radio, and listening to radio stations online has increased 500% in five years. In 1998, only 6% of Americans had ever listened to online rebroadcasts of over-the-air radio programs. As of July 2003, 33% have listened to online rebroadcasts of radio programs.

Other types of music streaming include the use of paid online music services, which usually feature streamed music samples. According to comScore Media Metrix this form of music is growing, while the use of peer-to-peer file share is decreasing. For example, in November 2003, 3.2 million Americans visited Napster.com, which re-launched as a paid online music service in late October 2003. Apple's iTunes, which expanded to serve Windows-based PC users in mid-October 2003, drew 2.7 million such visitors in November 2003. By contrast, comScore found that usage of each of the four peer-to-peer file applications sampled - KaZaa, WinMX, BearShare and Grokster, all decreased in visitors in November 2003 versus November 2002.

Internet gaming companies develop or sell various types of video games. Using streaming technology, players of online video games can interact with other players over the Internet and download new scenes and levels. Gaming over the Internet is becoming increasing popular and gaming companies are putting significant resources into developing and selling Internet games.

According to a Juniper Networks report published in December 2003, over 145 million people in American play interactive games on a regular basis. Projections for the online gaming community generally forecast positive growth, but vary as to the rate of growth. Analysis from a January 2003 Jupiter Research report estimates that online PC game subscriptions were $600.7 million in 2003, and projects that subscriptions will grow to more than $1.513 billion by 2006.

Educational institutions include universities, community colleges, and other educational organizations. Most of these institutions are equipped with broadband connections and have Internet savvy students. By using streaming technology, these institutions can broadcast prerecorded audio and video or broadcast live lectures, allowing students to take courses at their convenience.

Companies are increasingly using electronic communications to operate faster and more efficiently. Companies can reduce travel costs by using streaming technology to hold meetings and to deliver internal communications. Additional uses of streaming in the business include online advertising, online trade shows, press conferences, employee training and product demonstrations.

We focus on providing customized products and services allowing companies to tailor the way they encode, broadcast, manage, and track the content they are delivering over the Internet. Our key products and services are as follows:

A customer using MediaConsole can request a number of additional features without needing to contact our customer service representatives. This automation allows us to minimize personnel costs. Customers typically commit to a monthly fee for streaming services, based on the volume and complexity of their specific solution. Customers using both our streaming and our hosting services can use MediaConsole to perform Web site management tasks such as traffic reporting, e-mail account setup, e-mail forwarding, and Web-based e-mail access.

This new way of delivering video on demand is fast, easy and reliable, giving our customers the opportunity to utilize their existing Macromedia Flash environment, streamlining their workflow. FVSS offers sophisticated tracking and reporting capabilities and permits the user is able to upload files to our streaming network without having to set up and maintain video servers. With the VitalStream high-performance network, built-in load balancing insures the clients' videos will scale to accommodate the heaviest traffic. Additionally, the geographically dispersed deployment and full redundancy insures the video streams will always be available.

Hosting is the storing and serving of computer files for Internet delivery. We provide server hardware, bandwidth and continuous system administration, including server and network monitoring, reporting, ongoing maintenance, security and backup. We charge a fixed monthly fee for standard hosting services.

Our hosting customers provide and manage their application software on our network. We provide and maintain the server hardware, operating system, rack space, power and bandwidth. We also offer the following optional services for an additional fee:

We control customers' access via password, set the operating parameters of their server, and perform upgrades to their hardware and operating system software configuration as required by the customer or security protocol. This allows our customers to focus on developing their content while we provide the appropriate hardware, operating systems and technical expertise to manage the overall solution. We deliver our services using the Linux and the Microsoft Windows Server 2000 and 2003 platforms.

Colocation is the business of providing secure space and an Internet connection for customers to maintain their own servers and other related equipment. We provide limited colocation services to customers wanting to run their servers in one of our data centers in order to take advantage of our network infrastructure. Colocation customers choose to purchase or rent their server and switching hardware from us or from a supplier. Colocation customers monitor and control their own servers. We provide rack or cabinet space, telco-grade connections to the Internet, an IP address, network cabling, a power source, reporting and other related services. For an additional fee, we also offer our colocation customers the following services:

By providing colocation services, we can leverage economies of scale, allowing us to offer a high quality of service for a reasonable fee.

Our network incorporates high-performance equipment, robust connections to multiple tier-1 providers and geographic diversity. The network is comprised of multiple data centers containing distributed server clusters.

We have two data centers: one in Los Angeles, California, and one in Irvine, California. We also colocate servers at a secure data center in Ashburn, Virginia.

Our Los Angeles data center is near Hollywood, California, in a 16,000 square foot space, originally built for a bank. Our security and environmental systems in Los Angeles include multi-layer identity control procedures, armed security staff and closed circuit video surveillance systems. Power at the Los Angeles facility is supplied by multiple 34,800-volt lines with a capacity of 31,000 amps, and four 750 KVA, 4,000 amp, UPS backup power modules that prevent power interruptions. For long-term power backup, the Los Angeles facility has five emergency generators with the capacity to generate a total of 5,650 KW, enough power to supply a city of 20,000 people. The Los Angeles facility has five centrifugal chillers with a total capacity of 4,000 tons that supply chilled water to an HVAC system.

Our Irvine data center also features a climate-controlled segregated data room with static-free flooring that is monitored through an automated system 24 hours a day, seven days a week. Additional features include an industrial and dedicated air conditioning system, segregated internal-use and customer-use networks (each protected with its own redundant set of firewalls), an FM200 waterless fire suppression system (water is also used in the event of a major fire), fingerprint-based security access control systems protecting the entire facility, security cameras that log all access attempts, and proactive anti-hacker "network sniffing" security devices. Regular backups, including periodic off-site storage, are standard for web hosting and managed server clients, as are the routine, timely installation of security and operating system patches and service packs. In the event of a power failure, an enterprise-level uninterruptible power supply keeps the power running continuously. Addition ally, we have a diesel generator available that can supply up to approximately forty hours of runtime, before refueling.

Both data centers maintain multiple connections to multiple tier-1 backbone providers. This multi-homed network helps minimize exposure at congested peers. Our close proximity to other backbone providers ensures that we can quickly add bandwidth when needed. Our network infrastructure uses hardware from leading brands such as Cisco Systems, Extreme Networks, Nortel Networks, RouteScience and IBM. Distributed clustering technology for streaming and hosting services allows us to scale the network based on customer demand.

Our network is protected by advanced security systems. We use firewalls, proxies, and private networking to protect critical systems from intruders. We actively monitor our network for security vulnerabilities and malicious activity and employ a staff of security experts to respond to security-related incidents. And we provide various encryption services to our customers helping them protect their content on our network.

Our most important marketing tool is our reputation and commitment to providing reliable state-of-the art services. In 2003, readers of Streaming Magazine, a monthly publication covering the business of digital media and interactive broadcasting, selected our content delivery network as the best content delivery network in the industry. VitalStream's platform supports the industry-leading streaming formats, including Macromedia Flash MX, Microsoft Windows Media, Apple QuickTime, and Real Networks' Real Video and Real Audio and provides our customers with all of the features they need to generate revenues from, and control, the distribution of their media content. In addition, we are committed to continuing to provide industry-leading technology, as illustrated by our MediaConsole platform. We believe that the quality, reliability and flexibility of our services have been, and will continue to be, the strongest marketing tool for our company.

We use various traditional and nontraditional methods to market our products and services, including co-marketing which may include bundling our software and services with third-party software, working with resellers, online marketing, speaking and exhibiting at tradeshows and conferences and using targeted print advertising.

Co-marketing involves cross-promotion of our products and services with our partners. In 2002, we entered into a co-marketing arrangement with Microsoft. We agreed to support and promote Microsoft's Windows Media 9 software in exchange for Microsoft agreeing to promote our products through its Windows Media Web site. In September 2003, we entered into a co-marketing arrangement with Macromedia. We agreed to support and promote Macromedia's Flash Communication Server MX software through the Flash Video Streaming Service in exchange for Macromedia agreeing to promote our services through its sales force and its Web site.

We also market our products through resellers. We have reseller relationships with production companies, advertising agencies, Web designers and technology companies in our industry. We offer discounted setup and pricing based on volume. Resellers can also private label MediaConsole and can receive e-mail referrals of visitors to the reseller-oriented pages of our Web site. We also have a lead referral program in which we give customer referrals to our resellers, as in the case of customers needing Web design or interactive advertising services. This reciprocal lead referral program helps build our relationships with the resellers and increase the mindshare with the customers that we refer.

We engage in various forms of Internet, or online marketing. We advertise with online banner ads and use pay-per-click search engine marketing. We also maintain a comprehensive and heavily-visited Web site with information about our products and services, and use it to give working examples of the potential of streaming media. Visitors to the Web site can view electronic literature, request additional information or special offers, select products and services and place orders.

We also engage in print advertising and other forms of marketing. We periodically advertise in industry print publications. We measure the responses received by each publication and adjust the distribution of our print advertising accordingly. We also use various other forms of marketing, including exhibiting and speaking at tradeshows and conferences, publicity through press releases and media outreach programs, industry and analyst briefings and press tours.

The market for streaming services is competitive. The content delivery sector is growing rapidly, and competitors are continually introducing new products and services. We are considered a rich media integrator Internet content delivery network and are not limited by our technology products and services. Because we are able to offer a complete solution, we face different competitors for different products and services. We compete against well-capitalized streaming companies as well as small under-capitalized hosting companies. We also compete for customers who support their streaming and encoding in-house.

We compete on price, the reliability and quality of our network, service offering, and customer support. We believe that our pricing is generally comparable to the pricing of our competitors that offer streaming and managed hosting services.

Prior to signing a contract with a content delivery provider, the customer needs to be assured the provider will be reliable, credible and have longevity. In the past, we have lost potential customers to larger competitors with stronger balance sheets and longer operating histories. We believe we can increase our market share if we can significantly improve our balance sheet in the coming year.

Our key competitors are Akamai, Loudeye and Speedera. These competitors, and certain other competitors, have longer operating histories, more customers, greater financial strength and recognized brands in the industry. These competitors may be able to attract customers more easily because of their superior financial resources and awareness in the market. These larger competitors can also devote substantially more resources to business development and may adopt more aggressive pricing policies.

We have a policy of entering into confidentiality, work for hire, and non-disclosure agreements with our employees and some of our vendors and customers. We also have a policy of not allowing customers to access our software source code. These agreements and policy protect our intellectual property, but we cannot assure that these agreements or the other steps we have taken to protect our intellectual property will be sufficient to prevent theft or adverse infringement claims. We cannot prevent piracy of our software, methods and features, and we cannot determine the extent to which our software, methods and features are being pirated. Further, the laws of some foreign countries do not protect our proprietary rights as well as the laws of the United States.

We spent $337,510 during 2003, $271,604 during 2002, and $274,232 during 2001 on company-sponsored research and development. To date, none of our research has been sponsored by customers.

We have one client that represents approximately 18% of our revenue. This client has been a customer since the SiteStream merger in March 2001 and was a SiteStream client for approximately one year prior. The loss of this customer would not likely have a material adverse affect on our operating results. No other customer represents more than 10% of revenue as of December 31, 2003.

As of March 15, 2004, we had a total of 43 employees, of which 27 were in sales and marketing, 5 in research and development, and 11 in general and administrative. None of our employees are represented by a collective bargaining agreement, and we have not experienced any work stoppage. We consider our relationship with our employees to be good.

The employment of our Chief Financial Officer, Kevin Herzog, was terminated as of March 24, 2004 for personal reasons. The certifications appearing in Exhibits 31.2 and 32.2 of this Report have been signed by Philip N. Kaplan, Chief Operating Officer and acting Principal Financial Officer, and the certification appearing as Exhibit 31.3 has been signed by Patrick Deane, Vice President of Finance and acting Principal Accounting Officer. We are actively conducting a search for a new Chief Financial Officer.

VitalStream Holdings, Inc. was incorporated in 1986 in the state of Nevada. Our principal executive offices are located at One Jenner, Suite 100, Irvine, California 92618. Our telephone number is (949) 743-2000.

Prior to 1999, VitalStream Holdings, Inc., formerly named Sensar Corporation and Larsen-Davis Corporation, designed, developed, manufactured and marketed analytical scientific instruments. In 1999, after experiencing losses for several years, we sold substantially all of our assets associated to our scientific instruments business. On April 23, 2002, VitalStream Holdings, Inc. merged with VitalStream, Inc., and VitalStream, Inc. became a wholly-owned subsidiary (the "VitalStream Merger") of VitalStream Holdings, Inc. and its business became our core business.

In January 2003, another VitalStream Holdings, Inc. wholly-owned subsidiary, VitalStream Broadcasting Corporation entered into an Amended and Restated Asset Purchase Agreement with Epoch Networks, Inc. and Epoch Hosting, Inc. ("Epoch") pursuant to which VitalStream Broadcasting Corporation acquired Epoch's hosting and colocation contracts, related computer equipment, software and licenses, a leasehold interest in a Los Angeles data center, and a certificate of deposit for $300,000, which serves as collateral on the leaseholder interest. As consideration for those assets, we paid to Epoch Hosting $200,000 in cash and issued 3,848,760 shares of common stock to Epoch.

Today, through VitalStream, Inc., we offer global integrated content delivery services enabling businesses to broadcast their digital media and communications to worldwide audiences via the Internet. We provide complete solutions including audio and video streaming, live event broadcasting, media asset management, integrated web hosting and services that seamlessly integrate with today's leading streaming media technologies. Through VitalStream Broadcasting Corporation, we offer hosting and colocation services to the customers we acquired from Epoch Hosting and Epoch Networks.

Our cash reserves as of January 31, 2004 were $867,850, and our monthly cash expenses presently exceed the cash we generate from operations. Any projection of positive cash flow from operations in the future would be based on our expectation that our revenue and collections will continue to grow at a faster rate than our expenses and that we will incur no significant unbudgeted expenses. Our revenue may not continue to grow. We may experience problems collecting our accounts receivable, or our incremental costs associated with adding customers may exceed associated revenue. We may also experience significant unbudgeted expenses, including litigation, acquisition and financing transaction expenses, which could lead to monthly expenses and significant one-time expenses in excess of our budgeted expenses. In addition, because of non-cash expenses such as depreciation and amortization, even if we reach positive cash flow from operations, we may not have reached financial statement profita bility. Achieving financial statement profitability would require additional growth in our revenue in such an amount that the additional gross profit from those additional revenues would be sufficient to cover the non-cash expenses. If we continue to experience negative cash flow for more than an additional few months, we may need to raise additional capital in order to continue our operations. In addition, our business plan contemplates growth through acquisition and similar transactions. In connection with any significant acquisition, financing or other transaction, we would need to raise additional capital. Additional capital may not be available on favorable terms or at all.

Our business plan contemplates continued expansion of our operations in the foreseeable future. Because we presently experience negative cash flow from operations, if we are to continue our operations and grow as contemplated, of which there can be no assurance, we will need to seek additional financing.

If we fail to raise sufficient capital to expand as planned, we may be required to delay or abandon some of our future expansion or planned expenditures or to discontinue some of our operations, which would have a material adverse effect on our operations, financial condition and competitive position.

We have experienced net losses in each quarter since inception, with net losses of approximately $7 million from inception through December 31, 2003. We have not projected a net profit for the 2004 fiscal year and are uncertain when, or if, we will experience net income from operations. Even if we do experience net income in one or more calendar quarters in the future, subsequent developments in our industry, customer base, business or cost structure or expenses associated with significant litigation or a significant transaction may cause us to again experience net losses. We may never become profitable.

The market for Internet broadcasting and streaming services is evolving, and we cannot be certain that a viable market for our services will emerge or be sustainable. Factors that may inhibit the development of a viable market for Internet broadcasting services include:

If the market for Internet broadcasting services does not continue to develop, or develops more slowly than expected, our business, results of operations and financial condition will be seriously harmed.

We have pledged substantially all of our assets to secure repayment of the Factoring and Security Agreement dated June 30, 2003 we entered into with Alliance Bank. In addition, in order to be able to grant a security interest to Alliance Bank, we were required under the restrictive covenants related to promissory notes issued to Dolphin Communications Fund II, L.P. and Dolphin Parallel Fund II (Netherlands) L.P. (collectively, "Dolphin") to enter into a security agreement with Dolphin granting Dolphin a security interest in substantially all of our assets other than our accounts receivable in order to secure the promissory notes. These security agreements afford Alliance Bank and Dolphin rights and remedies that are commonly provided a secured creditor. If we default under our Factoring and Security Agreement or the promissory notes issued to Dolphin, the secured parties may, subject to laws restricting the remedies of creditors, immediately seize and dispose of all pledged assets.

In order to successfully implement our business strategy, we must establish and achieve substantial growth in our customer base through sales, business acquisitions or a combination thereof. If achieved, significant growth would place significant demands on our management and systems of financial and internal controls, and will almost certainly require an increase in the capacity, efficiency and accuracy of our billing and customer support systems. Moreover, significant growth would require an increase in the number of our personnel, particularly within sales and marketing, customer service and technical support. The market for such personnel remains highly competitive, and we may not be able to attract and retain the qualified personnel required by our business strategy. If successful in attracting new customers, we may outgrow our present facilities and/or network capacity, placing additional strains on our human resources in trying to locate, manage and staff multiple locations and to scale our network.

Through its holdings of common stock and shares of 2003 Series A Preferred Stock ("Series A Preferred Stock"), Dolphin presently controls over 6,284,725 votes in connection with the election of directors and other matters, constituting 17.7% of the voting power of our company. In addition, if Dolphin exercised all warrants it holds and converted all promissory notes and shares of Series A Preferred Stock it holds or controls, Dolphin's aggregate beneficial ownership would increase to approximately 13,094,525 votes in connection with the election of directors and other matters, constituting 30.9% of the voting power of our company following such conversions or exercises. As a result of its stock holdings, Dolphin may be able to block, or extract concessions or special benefits in connection with, various transactions, including any future merger or asset sale transactions.

In addition, the promissory notes issued to Dolphin and the shares of Series A Preferred Stock held by Dolphin and others contain restrictive covenants prohibiting us from taking certain actions without the consent of the holders of a majority of the shares of common stock issuable upon conversion of the promissory notes and Series A Preferred Stock. Dolphin controls a majority of such shares and, as a result, we may not, without the consent of Dolphin,

Dolphin may use these restrictive covenants to block, or extract concessions or special benefits in connection with, various transactions, including, with certain exceptions, any future debt, preferred stock, merger, or asset sale transactions.

Our current and future competitors in Internet streaming may include other digital content delivery providers, Internet broadcast network specialty providers and alternative access providers such as various cable television companies, direct broadcast satellite, DSL, wireless communications providers and other established media companies. Our current and future competitors in hosting and colocation may include other Internet hosting, colocation and access businesses, including such major providers as Cable & Wireless and Qwest, and essentially any other participant in the Internet industry.

Many of these competitors have a longer operating history and greater market presence, brand recognition, engineering and marketing capabilities, and financial, technological and personnel resources than we do. Competitors with an extended operating history, a strong financial position and an established reputation have an inherent marketing advantage because of the reluctance of many potential customers to entrust key operations to a company that may be perceived as unproven or unstable. In addition, our competitors may be able to use their extensive resources:

If we are unable to compete effectively in our various markets, or if competitive pressures place downward pressure on the prices at which we offer our services, our business, financial condition and results of operations may suffer.

Our services are subject to system failure and security risks.

Our operations are dependent upon our ability to protect our network infrastructure against interruptions, damages and other events that may adversely affect our ability to provide services to our customers (on a short-term or long-term basis) and may lead to lawsuits and contingent liabilities. Despite the implementation of precautions, the core of our network infrastructure is vulnerable to various potential problems, including the following:

The occurrence of any natural disaster, power outage, unauthorized access, computer virus, equipment failure or other disruptive problem could have a material adverse affect on our business, financial condition and results of operations.

We are dependent upon key personnel who may leave at any time and may be unable to attract qualified personnel in the future.

We are highly dependent upon the efforts of our senior management team, the loss of any of whom could impede our growth and ability to execute our business strategy. To the extent our principal managers are parties to employment agreements, such agreements are terminable at will. Although our principal managers have significant equity interests or options to purchase equity interests in the company, such options to purchase equity interests are substantially vested, and the shares held by our President and our Chief Operating Officer are not subject to vesting or repurchase rights and will be retained whether or not such persons remain with the company. The loss of the services of key management personnel could have a material adverse effect on our business, financial condition and results of operations.

In addition, in order to continue to grow as planned, we will need to attract and retain qualified executive, technical and marketing personnel for whom there is intense competition in the areas of our activities. Any failure to attract or retain key executive, technical and marketing sales personnel as required could have a material adverse effect on our financial condition and results of operations.

We may be unable to keep up with evolving industry standards and changing user needs.

The market for Internet media-related services is characterized by rapidly changing technology, evolving industry standards, changing user needs and frequent new service and product introductions. Our success will depend in part on our ability to identify, obtain authorized access to and use third party-provided technologies effectively, to continue to develop our technical capabilities, to enhance our existing services and to develop new services to meet changing user needs in a timely and cost-effective manner. In addition, new industry standards have the potential to replace or provide lower-cost alternatives to our services. The adoption of such new industry standards could render our existing services obsolete and unmarketable or require reduction in the fees charged. Any failure on our part to identify, adopt and use new technologies effectively, to develop our technical capabilities, to develop new services or to enhance existing services in a timely and cost-effective manner co uld have a material adverse effect on our business, financial condition and results of operations.

We may be unable to grow if methods of high-speed Internet access are not widely deployed.

Our business is greatly enhanced by (and generally assumes adoption of) fundamental changes in the method of Internet access delivery to consumers. Currently, consumers access the Internet primarily via computers connected to public telephone networks through dial-up access or leased lines. A number of alternative methods for users to obtain high-speed access to the Internet, including cable modems, DSL, satellites and other terrestrial and wireless telecommunications technologies (usually referred to as broadband internet access), currently provided by third party suppliers are in use or are under development. We believe that these technologies need to be deployed to consumers on a large scale before the delivery of media over the Internet will be truly viable. The failure of broadband Internet access to gain rapid acceptance could have a material adverse effect on our ability to execute our business plan and consequently on our business, financial condition and results of operations. Recent financial difficulties and outright bankruptcies experienced by several high profile wholesale and consumer providers of broadband connectivity may negatively impact the growth rate and availability of broadband internet access to end users.

We are dependent upon third-party suppliers and may be unable to find alternative suppliers.

We rely on other companies to supply key components of our network infrastructure, including Internet bandwidth, which constitutes our largest direct cost of providing services, and networking equipment. Additionally, we rely on third-party development of technology to provide media-related functionality, such as streaming media formats and payment processing. We do not have long-term agreements governing the supply of many of these services or technologies, and most are available from only limited sources. We may be unable to continue to obtain such services, or licenses for needed technologies, at a commercially reasonable cost, which would adversely affect our business, financial condition and results of operations.

The services provided by telecommunications carriers are governed by regulatory policies establishing charges and terms for wireline communications. We are not a telecommunications carrier or otherwise subject to regulations governing telecommunications carriers (or the obligation to pay access charges and contribute to the universal service fund). The Federal Communications Commission (FCC) could, however, expand the reach of telecommunications regulations so as to apply to companies such as ours. In particular, the FCC could require Internet service providers like us to pay access charges or to contribute to the universal service fund when the Internet service provider provides its own transmission facilities and engages in data transport over those facilities in order to provide an information service. The resultant increase in cost could have a material adverse effect on our business, financial condition and results of operations.

As Internet commerce continues to evolve, we expect that federal, state or foreign legislatures and agencies may adopt laws and regulations affecting our business, including laws or regulations potentially imposing taxes or other fees on us or our customers, imposing reporting, tracking or other costly reporting requirements or imposing restrictions or standards related to issues such as user privacy, pricing, content and quality of products and services. Such laws and regulations may significantly increase our costs of operations, may expose us to liability or may limit the services we can offer.

We depend on our ability to develop and maintain the proprietary aspects of our technology. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, and common law copyright and trademark principles. Protection of our intellectual property is subject to the following risks:

Litigation regarding intellectual property rights is common in the Internet and software industries. We expect that Internet technologies and software products and services may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of products in different industry segments overlaps. We may from time to time encounter disputes over rights and obligations concerning intellectual property. Although we believe that our intellectual property rights are sufficient to allow us to market our services without incurring liability to third parties, third parties may bring claims of infringement against us, which may be with or without merit.

We could be required, as a result of an intellectual property dispute, to do one or more of the following:

In addition, we have agreed, and may agree in the future, to indemnify certain of our customers against claims that our software infringes upon the intellectual property rights of others. We could incur substantial costs in defending ourselves and our customers against infringement claims. In the event of a claim of infringement, we and our customers may be required to obtain one or more licenses from third parties. We, or our customers, may be unable to obtain necessary licenses from third parties at a reasonable cost, or at all. Defense of any lawsuit or failure to obtain any such required licenses could harm our business, operating results and financial condition.

Our common stock is quoted on the Nasdaq OTC Bulletin Board. The volume of trading in our common stock is small, and trading in our common stock is likely dominated by a few individuals. Because of the thinness of the market for our stock, the price of our common stock may be subject to manipulation by one or more shareholders and may increase or decrease significantly because of buying or selling by a single shareholder. In addition, the limited volume of trading limits significantly the number of shares that one can purchase or sell in a short period of time. Consequently, an investor may find it more difficult to dispose of large numbers of shares of our common stock or to obtain a fair price for our common stock in the market.

The market price of our common stock, like that of the securities of other early stage companies, may be highly volatile. Our stock price may change dramatically as the result of announcements of our quarterly results, new products or innovations by us or our competitors, significant customers contracts, significant litigation or other factors or events that would be expected to affect our business financial condition, results of operations and other factors specific to our business and future prospects. In addition, the market price for our common stock may be affected by various factors not directly related to our business, including the following:

Under our Articles of Incorporation, as amended, we are authorized to issue up to 10 million shares of preferred stock and 290 million shares of common stock without seeking shareholder approval. Our Board of Directors has the authority to create various series of preferred stock with such voting and other rights superior to those of our common stock and to issue such stock without shareholder approval. Our Board of directors also has the authority to issue the remainder of our authorized shares of common stock without shareholder approval. Any issuance of such preferred stock or common stock would dilute the ownership and voting power of existing holders of our common stock and may have a negative effect on the price of our common stock. The issuance of preferred stock without shareholder approval may also be used by management to stop or delay a change of control.

Our executive officers, directors and their affiliates beneficially own or control approximately 36.6% of the voting power of our company. In combination with entities owning 5% or more of our outstanding common shares, this group controls approximately 77.2% of the voting power of our company. As a result, if such persons act together, they have the ability to control all matters submitted to our shareholders for approval, including the election and removal of directors and the approval of any merger, consolidation or sale of all or substantially all of our assets. These shareholders may make decisions that are adverse to your interests.

We have not declared any dividends on our common stock. We intend to retain earnings, if any, to finance the operation and expansion of our business and, therefore, we do not expect to pay cash dividends on our shares of common stock in the foreseeable future. In addition, pursuant to restrictive covenants related to our preferred stock and certain promissory notes, we may not pay any dividends without the consent of Dolphin until such restrictive covenants expire.

We believe that shares of our common stock are "penny stock," resulting in increased risks to our investors and certain requirements being imposed on some brokers who execute transactions in our common stock. In general, a penny stock is an equity security that

Our common stock has a trading price below five dollars; our common stock is not trading on an exchange or NASDAQ; we have average historical revenues of less than $6 million; and we have less than $2 million dollars in net tangible assets. Accordingly, we believe that our common stock is "penny stock." At any time our common stock qualifies as a penny stock, the following requirements, among others, will generally apply:

These requirements significantly add to the burden of the broker-dealer and limit the market for penny stocks. These regulatory burdens may severely affect the liquidity and market price for our common stock.

We are subject to certain provisions of the California corporate code.

Because we are a Nevada corporation, the rights of our stockholders are generally governed by the Nevada Private Corporations Law. However, under Section 2115(a) of the California Corporations Code, we became subject to various sections of the California Corporations Code on January 1, 2004 and will continue to be subject to such conditions until such time as fewer than one-half of our outstanding voting securities (held by other than nominee holders) are held by persons located in California. Although the applicable portions of the California Corporations Code are generally consistent with governing provisions of the Nevada Private Corporations Law and our charter documents, they are not identical. We may be faced with circumstances in which applicable provisions of the Nevada Private Corporations Law or our charter documents cannot be reconciled to governing provisions of the California Corporations Code. The existence of such a conflict may adversely effect our business and operatio ns in various ways in that it may require us to withdraw from a proposed transaction, seek authorizations, interpretations, injunctions or other orders from various courts in connection with a conflict, rescind or re-execute a transaction or pay damages if our good faith attempts at reconciliation are deemed inadequate or incur additional expenses in order to attempt compliance with both governing laws.

On August 23, 2003, the Company signed a third amendment to the lease, acquiring additional space within the same building that houses its corporate headquarters. Payments for the lease total $2,260 per month through October 2004. Additionally, the Company is required to pay its pro rata share of all taxes, building maintenance costs and insurance. Annual base rental lease payments under the third amendment are as follows:

In connection with our acquisition of the hosting and colocation assets of Epoch, we assumed a sublease for 16,577 rentable square-feet in Los Angeles, California. The sublease expires on February 27, 2009. Annual base rental payments for this facility, which hosts our hosting and colocation business, are as follows:

We rent outsourced data center space on a per rack basis for an offsite data center located in Ashburn, Virginia. The contract with respect to such space expires on March 31, 2005, and our annual rent payments under such lease are approximately $67,000.

We do not own any real property. We believe that the two facilities we currently lease are sufficient for our present operations and for our projected internal growth during 2004. Although we do not have any commitments to lease additional office and data center space, we believe that additional space would be available in our existing buildings or at nearby locations if required.

As of March 15, 2004, the number of shares of our common stock outstanding was 32,263,746 held by approximately 419 holders of record. The outstanding shares do not include up to 4,039,612 shares of common stock authorized for issuance upon exercise of outstanding options granted pursuant to our stock option plans, 3,940,388 shares of our common stock reserved for the future grant of stock options under such plans, 3,075,827 shares of common stock subject to outstanding warrants to purchase common stock and approximately 9,338,450 shares of our common stock issuable upon conversion of an outstanding convertible promissory note and outstanding convertible preferred stock.

VitalStream Holdings has never declared or paid cash dividends on its common stock. We currently intend to retain any future earnings for use in our business and, therefore, do not anticipate paying any dividends on our common shares in the foreseeable future. In addition, pursuant to the terms of our outstanding convertible promissory notes and Series A Preferred Stock, VitalStream Holdings is prohibited from paying any dividends until the beneficial ownership of Dolphin is reduced to less than 10% of our outstanding common stock or all such securities are converted to common stock.

Set forth below is certain information about the number of shares of our common stock subject to options, warrants and other rights granted, or that may be granted, under our compensation plans as of December 31, 2003.

(1) Represents shares of common stock of VitalStream Holdings subject to outstanding options granted under our 2001 Stock Incentive Plan (the "Option Plan").

(2) Represents shares of common stock of VitalStream Holdings available for future grant under the Option Plan.

There were no sales of unregistered securities during the quarter ended December 31, 2003.

(1) For periods prior to April 23, 2002, the data is for VitalStream, Inc. and its wholly-owned subsidiary.

(2) The Company acquired certain assets, customers and accounts of Epoch Hosting, Inc. and Epoch Networks, Inc. effective January 1, 2003. Approximately $1,826,750 (56.9%) of the increase in net sales of the Company in 2003 compared with 2002 is attributable to this acquisition. This acquisition also accounts for similar increases in other statement of operations and financial statement data.

VitalStream, Inc. was incorporated in March 2000 in the State of Delaware. On April 23, 2002, VitalStream merged with and into a wholly-owned subsidiary of VitalStream Holdings. Because VitalStream Holdings did not have any operations immediately prior to the VitalStream merger, the business of VitalStream is now the business of VitalStream Holdings, and forward-looking statements in this Report relate to the consolidated business of VitalStream Holdings, VitalStream, and VitalStream Broadcasting (the latter comprised of the customers and assets acquired and liabilities assumed from Epoch Hosting and Epoch Networks).

Our results for the year ending 2003 reflect the integration of the customers acquired from Epoch Hosting and Epoch Networks, as well as the addition of our Los Angeles Broadcast Center, which was part of that transaction. In conjunction with the Epoch transaction, VitalStream Broadcasting contracted for certain telecommunication services that it needed in transition. The 2003 results also reflect organic customer growth. Our results for the year ending 2002 reflect organic growth of our customer base.

Revenue. Revenue consists primarily of fees for Internet broadcasting, including streaming media services, managed services, web hosting and sales of hardware. Revenues increased from $3,786,980 for the year ended December 31, 2002 to $7,000,535 for the year ended December 31, 2003, an increase of 84.9%. This increase reflects customer contracts acquired from Epoch, the addition organically of a significant number of new customers, and an increase in average per-customer service utilization within the installed base. We expect quarterly revenue growth to accelerate in 2004 as compared with the quarter-over-quarter revenue growth experienced in 2003, as we expand our sales force, ramp up channel partnerships, increase our marketing efforts and continue to focus our sales efforts towards enterprise customers. A significant portion of our revenue growth comes from service upgrades for existing clients, and we expect this to continue contributing to our revenue growth as we start 2 004 with a greater client base than we had at the beginning of 2003.

Cost of Revenue. Cost of revenue consists primarily of access charges from the local exchange carrier, Internet backbone and transport costs and depreciation of network equipment, hardware costs and license fees. Cost of revenue increased from $1,843,186 for the year ended December 31, 2002, to $3,206,877 for the year ended December 31, 2003, an increase of 74.0%. Cost of revenue as a percentage of revenue, however, decreased from 48.7% for the year ended December 31, 2002 to 45.8% for the year ended December 31, 2003. The increased cost in absolute dollars reflects the increase in bandwidth consumption, network equipment and other items necessary to support the increase in revenue between the two years. The improvement in cost of revenue as a percentage of revenue mostly reflects our lower unit cost of bandwidth, which we obtained from our suppliers as a result of our increased bandwidth purchasing volume and due to an industry-wide decrease in bandwidth prices. Th ere was also improvement due to the spreading of the relatively fixed costs of core networking equipment over a larger client base. We expect our unit cost of revenue to continue to decrease through 2004. This will occur as we achieve even greater economies of scale in our purchasing of bandwidth and networking equipment, as we are able to more efficiently distribute bandwidth amongst carriers and as we then spread these costs over an increasing customer base.

Sales and Marketing. Sales and marketing expense consists primarily of personnel costs, including salary and commissions, in addition to the costs of various marketing programs. Sales & marketing expense increased from $1,591,522 for the year ended December 31, 2002 to $1,958,232 for the year ended December 31, 2003, an increase of 23.0%. Although sales & marketing expense increased between the two periods, as a percentage of revenue it decreased from 42.0% for the year ended December 31, 2002 to 28.0% for the year ended December 31, 2003. This decrease as a percentage of revenue reflects improved marketing efficiencies obtained from targeted strategic marketing efforts, as well as improved productivity within our sales force. As a result of the Epoch acquisition, part of the increase in expense in absolute terms was attributable to the increase in customer support personnel that were added to handle Los Angeles Broadcast Center customer support. Overall, w e expect sales and marketing expense to increase incrementally in absolute terms and to continue to decrease as a percentage of revenue throughout 2004 as we expand our sales force and continue to increase sales and marketing productivity.

General and Administrative. General and administrative expense consists primarily of personnel expense, professional fees and costs to maintain and support our facilities. General and administrative expense increased from $2,326,835 for the year ended December 31, 2002 to $2,452,323 for the year ended December 31, 2003, an increase of 5.4%. General and administrative expense as a percentage of revenue however, decreased from 61.4% for the year ended December 31, 2002 to 35.0% for the year ended December 31, 2003. This decrease reflects a larger base of revenue spread out over an expense base that is primarily fixed. Overall, we expect our general and administrative expense to continue to decrease as a percentage of revenue throughout 2004 as the base of general and administrative costs remains relatively constant, while revenue continues to grow.

Net Interest Expense. Net interest expense increased from $54,165 for the year ended December 31, 2002 to $150,229 for the year ended December 31, 2003, an increase of 177.4%. The increase in net interest expense reflects interest accrued on three items, all of which started in 2003: new capital leases, an accounts receivable factoring line and the note payable to Dolphin. In 2004, we anticipate an increase in net interest expense as we continue to fund capital expenditures through lease financing. However, should we successfully raise capital in 2004, this amount may be largely offset by the interest income on the company's increased cash balances.

Net Loss. Our net loss decreased from $2,186,627 for the year ended December 31, 2002 to $1,055,310 for the year ended December 31, 2003, a decrease of 51.7%. Our net loss decreased due to our efforts to attain and manage rapid scaling, which resulted in approximately double the amount of gross profit in 2003 compared to 2002, while our operating expenses increased by only about 13% in the same period. We expect our net loss to continue to decrease throughout 2004 as our revenue base expands, general and administrative costs remain relatively constant, other personnel expense grows slower than revenue and our unit cost of service decreases or remains flat. Our business plan does however, contemplate engaging in acquisitions, financings and other transactions. If one or more of these transactions were to occur, our net loss may actually increase as a result of the uncapitalized portion of the transaction expenses that would be incurred.

Revenue. Revenue consists primarily of fees for Internet broadcasting, including streaming media services, managed services, web hosting and sales of hardware. Revenues increased from $1,521,253 for the year ended December 31, 2001, to $3,786,980 for the year ended December 31, 2002, an increase of 148.9%. This increase reflects the addition of a significant number of new clients and the increase in average per client service utilization within the installed base.

Cost of Revenue. Cost of revenue consists primarily of access charges from the local exchange carrier, Internet backbone and transport costs and depreciation of network equipment, hardware costs and license fees. Cost of revenue increased from $904,313 for the year ended December 31, 2001, to $1,843,186 for the year ended December 31, 2002. Cost of revenue as a percentage of revenue, however, decreased from 59.4% for the year ended December 31, 2001 to 48.7% for the year ended December 31, 2002. The increased cost in absolute dollars reflects the increase in bandwidth consumption, network equipment and other items necessary to support the increase in revenue between the two years. The improvement in cost of revenue as a percentage of revenue mostly reflects our lower unit cost of bandwidth, which we obtained from our suppliers as a result of our increased bandwidth purchases and due to an industry-wide decrease in bandwidth prices. There was also improvement due to the spreading of the relatively fixed costs of core networking equipment over a larger client base.

Sales and Marketing. Sales and marketing expense consists primarily of personnel costs, including salary and commissions, in addition to the costs of various marketing programs. Sales & marketing expense increased from $1,379,224 for the year ended December 31, 2001 to $1,591,522 for the year ended December 31, 2002. Although sales & marketing expense increased between the two periods, as a percentage of revenue it decreased from 90.7% for the year ended December 31, 2001 to 42.0% for the year ended December 31, 2002. This decrease as a percentage of revenue reflects improved marketing efficiencies obtained from targeted strategic marketing efforts combined with improved productivity within our sales force.

General and Administrative. General and administrative expense consists primarily of personnel expense, professional fees and costs to maintain and support our facilities. General and administrative expense increased from $1,679,404 for the year ended December 31, 2001 to $2,326,835 for the year ended December 31, 2002. The year ended December 31, 2002 includes expenses primarily related to compensation expense for additional administrative personnel necessary to support a larger revenue base and customer count. Additionally, our insurance, legal and professional fees increased incrementally. General and administrative expense as a percentage of revenue however, decreased from 110.4% for the year ended December 31, 2001 to 61.4% for the year ended December 31, 2002. This decrease reflects a larger base of revenue spread out over an expense base that is primarily fixed.

Net Loss. Our net loss decreased from $2,802,633 for the year ended December 31, 2001 to $2,186,627 for the year ended December 31, 2002. Our net loss decreased due to the approximately 215% increase in gross profit which the company generated for the year ended December 31, 2002, while our operating expenses only increased approximately 25% for the year ended December 31, 2002.

The following table discloses aggregate information about our contractual obligations including long-term debt, operating and capital lease payments, office lease payments and contractual service agreements, and the periods in which payments are due as of December 31, 2003:

(1) This represents the promissory note issued to Dolphin due January 15, 2025. See Note 4 of the Notes to Consolidated Financial Statements that appear at the end of this Report for additional information about the Dolphin note.

Our long-term debt represents $1,100,000 in convertible promissory notes issued to Dolphin on November 26, 2002 and January 15, 2003, which notes were amended and restated in September 30, 2003. The proceeds of the convertible promissory notes were used, in part, to pay the $200,000 cash portion of the purchase price under the Amended Epoch Repurchase Agreement and approximately $272,153 in related transaction expenses. The remainder of the proceeds of the convertible promissory notes have been used for capital purchase and operating expenses. The convertible promissory notes issued to Dolphin, and the shares of Series A Preferred Stock held by Dolphin and others, contain restrictive covenants prohibiting us from taking certain actions without the consent of the holders of a majority of the shares of common stock issuable upon conversion of the convertible promissory notes and Series A Preferred Stock. Dolphin controls a majority of such shares and, as a result, we may not, without the consent of Dolphin,

Our capital leases represent $694,575 spread over eight capital lease financing arrangements. The use of proceeds of these capital leases was to purchase hardware and software that we use in our daily operations. The hardware and software purchased is used in our data center operations, for supplying service to our customers and maintaining our internal network and providing the equipment needed for internal staff.

Liquidity and Capital Resources.

As of December 31, 2003, the Company had $773,143 in cash and cash equivalents. This represents an increase of $535,632 compared to December 31, 2002. Cash used during the year ended December 31, 2003 includes approximately $743,596 used in operations as well as $225,826 used in investing activities. Sources of cash for the Company during the year ended December 31, 2003 included a net amount of $1,505,054 from financing activities. Of the $1,505,054 of net cash provided by financing activities, $691,000 represents cash received from subsequent convertible promissory notes issued to Dolphin on January 15, 2003 (and subsequently amended and restated), $900,000 represents cash received from the sale of Series A Preferred Stock, $142,118 represents the proceeds from our accounts receivable factoring line and $222,380 represents cash received from the exercise of some of the outstanding stock options. The $450,434 difference between the $1,955,498 of cash received in connection with f inancing activities and the $1,505,054 of cash provided by financing activities represents payments on capital leases, payment of costs associated with the issuance of the Series A Preferred Stock and the payment of loan costs.

As of March 12, 2004, the Company has approximately $825,000 in cash and cash equivalents. We presently use more cash in our operations that we generate from operations. Accordingly, we expect to use between $100,000 and 200,000 of capital during 2004 in order to sustain our operations (which includes making payments on our capital leases). We anticipate making capital expenditures between $400,000 and $600,000 during the remainder of calendar 2004, generally for data center equipment, customer servers, improved internal systems and related software. We assume that virtually all of our capital expenditures are put on 24-36 month capital leases, and that the payment of those leases is included as part of our use of capital estimate given above.

In addition, we hope to rapidly expand our operations during 2004, and we may seek to expand our operations through additional strategic acquisitions. If we were to engage in strategic acquisitions, we would most likely seek additional financing in order to pay for the transaction costs of any mergers and/or acquisitions (e.g., legal and accounting fees, integration expense and working capital to support the acquired entity). We may also seek additional financing, in any amount between $5,000,000 and $10,000,000, in order to improve our balance sheet in order to increase our ability to attract significant customers and acquisition targets or in order to qualify for listing on the American Stock Exchange or the Nasdaq SmallCap Market.

We would most likely generate such financing through the issuance of equity securities in one or more private placements of common stock (probably with accompanying re-sale registration rights and warrants to purchase common stock) or public offerings of our common stock. We may also sell preferred stock or debt securities or enter into loan or capital leasing arrangements with one or more financial institutional investors. Any financing, especially an issuance of debt or equity securities in a public offering or large private placement, would involve significant transaction costs. We can provide no assurance that, if we determine to seek additional financing, we will be able to obtain additional financing at a reasonable cost, or at all.

As discussed above, we may seek additional financing in order to facilitate a strategic transaction, strengthen our balance sheet, facilitate an stock exchange listing or for other reasons. If we determine not to engage in any such transaction, or if financing is not available to us on acceptable terms, we expect that the cash we have on hand, together with recurring operating revenues and funds obtained through capital lease financing arrangements, will be sufficient to meet our current and future obligations until the time that the Company can sustain itself on its own internally-generated cash flow as a result of organic growth. Continuing operations without additional financing would likely require short-term limited cuts in our expense model. By making these cuts, we would be able to continue operating the business; however, such actions may slow our growth and could have a material adverse effect on future operations and financial results.