1.         GENERAL

2.         SIGNIFICANT ACCOUNTING POLICIES

3.         LEGAL MATTERS AND CONTINGENCIES

4.         COMMON STOCK TRANSACTIONS

We are based in Irvine, California and, through our wholly-owned subsidiary VitalStream, Inc., we offer our customers a range of managed services including audio and video streaming, live event streaming, media asset management, integrated hosting services, content distribution, and vertical solutions such as digital dailies for the entertainment industry, encoding (via third-party resellers) and consulting. Through our wholly-owned subsidiary VitalStream Broadcasting Corporation, we offer hosting and colocation services to customers we acquired from Epoch Hosting and Epoch Networks. Our mix of products and services enables our customers to concentrate on the creation and marketing of their content, while outsourcing the encoding, data storage, broadcasting, hosting and related functions to VitalStream and its partners. Our business model relies upon leveraging our expertise and resources in audio and video streaming as well as our integrated hosting technology to persuade customers to utilize our Internet broadcasting services, thereby allowing our company to build a base of recurring revenues from monthly or other periodic broadcasting fees.

We believe that our company is well positioned to take advantage of the growth opportunity within the streaming media marketplace. Over the past year, our management team has made changes within the sales, marketing and operations areas of our business. Specifically, in the fourth quarter of 2003, we restructured our sales and marketing department. We recruited a senior-level Vice President of Sales, and are now focusing our sales and customer support efforts on enterprise accounts. By adopting a more solutions-oriented sales approach, we believe our marketing proposition is value-based, allowing us to sell increasingly customized solutions as opposed to off-the-shelf products. This in turn, increases overall gross margins and creates higher switching costs for customers to move to competitive services.

While improving the top-line growth rate, we have also focused on efficiency and economies of scale within our cost of service expense structure. As a result of favorably renegotiating certain material contracts, we have been able to reduce our unit cost of service starting in the first quarter of 2004. The operational efficiency gains coupled with our improved top line growth rate are expected to result in increased gross profits in 2004 as compared with 2003.

As our gross profits have increased in 2004, we have reinvested, and intend to continue to reinvest, some of those gains in the further development of our service offering. By continuing to develop our service platform with additional unique and proprietary features, we expect to be able to further differentiate ourselves from our competitors, enabling us to gain market share and advantage, and to increase our prospects for customer retention and renewals.

While the opportunities for us are increasing, they are not without risk. Our business and our industry have risks (see "Certain Factors" at the end of this Item), only some of which can be mitigated to varying degrees, and others that can only be dealt with reactively. As with any technology company, new technological advances within our industry could cause a paradigm shift in how we develop, market and service our offering. Some of these advances may be unavailable to us and we may not have a comparable or competitive technological offering. Additionally, while bandwidth and server hardware prices have been dropping over the last few years due to excess capacity and competition, this has presented both risks and opportunity for us. Although to date we have been able to manage the declining price environment to our advantage, there can be no assurance that we will continue to be able to do so in the future. In addition to technological and pricing risks, our balance sheet is another area of concern for management. While we believe that our cash on hand is sufficient to maintain the company through the point of profitability, the margin of error is not large in the event of a material adverse event. To ensure that there are sufficient resources to meet our company's needs, it is likely we will seek to raise additional equity capital in the second or third quarter of 2004.

Weighing the opportunities versus the risks, we believe the prospects are favorable for increased market capitalization for our company. The new upward trend in sales growth coupled with recently achieved operational efficiencies create an opportunity for us to become profitable, which we believe may occur by the end of 2004. As of the date of this report, our valuation multiples are lower than those of our publicly-traded competitors Akamai Technologies, Inc. and Loudeye Corporation. Because of the highly-fragmented nature of the streaming media services industry, economies of scale enable companies to be more competitive. Based on our recent experience in acquiring new accounts, we believe that the industry does not currently have a dominant leader. In view of the highly-fragmented nature of our industry, management believes that our experience in successfully integrating acquired businesses, combined with our strong operational focus on our business, positions us to potentially bec ome that market leader.

Management is basing this discussion and analysis of our financial condition and results of operations on our consolidated financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, valuation of accounts receivable, property, plant and equipment, long-lived assets, intangible assets, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptio ns or conditions.

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. These judgments and estimates affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting periods. Changes to these judgments and estimates could materially affect the Company's future results of operations and cash flows.

Revenue. Revenue consists primarily of fees for Internet broadcasting, including streaming media services, managed services, web hosting and sales of hardware and software. Revenues increased from $1,752,448 for the quarter ended March 31, 2003, to $1,991,437 for the quarter ended March 31, 2004, an increase of 13.6%. This increase in revenue is primarily attributable to the addition of new customers using Vitalstream to deliver streaming video. We expect revenue to continue to grow through 2004 as we continue to strengthen our sales force, build on our channel partnerships, increase our marketing efforts, gain greater market recognition from potential customers and release our new MediaConsole Pro technology platform. We expect strong revenue growth through 2004 from the addition of new customers and from increased services to existing customers.

Cost of Revenue. Cost of revenue consists primarily of Internet backbone and transport costs, data center rent and power costs, depreciation of network and server equipment, hardware costs and software license fees. Cost of revenue increased from $781,850 for the quarter ended March 31, 2003, to $840,226 for the quarter ended March 31, 2004. The increased cost in absolute dollars primarily reflects the increase in bandwidth consumption, in addition to increases in other costs necessary to support the increase in revenue between the two quarters. The decrease in the cost of revenue as a percentage of revenue between the two quarters, from 44.6% of revenue in the quarter ended March 31, 2003 to 42.2% of revenue for the quarter ended March 31 2004, represents economies of scale primarily in the purchase of bandwidth due to our increasing purchasing volume and an industry-wide decrease in bandwidth prices. Management expects that additional cost savings will result as we achieve even greater economies of scale in our purchasing of bandwidth, as we are able to more efficiently distribute bandwidth amongst carriers and as we then spread these costs over an increasing customer base. Management also expects the cost of revenue to decrease as a percentage of revenue as our Internet backbone and data center rent and power costs remain mostly fixed while revenue increases.

Research and Development. Research and development expense consists primarily of personnel costs to develop and maintain our product offering. Research and development expense increased $17,606, from $84,705 for the quarter ended March 31, 2003, to $102,311 for the quarter ended March 31, 2004. As a percentage of revenue, research and development increased from 4.8% for the quarter ended March 31, 2003 to 5.1% for the quarter ended March 31, 2004. This absolute dollar increase, and increase as a percentage of revenue reflects higher payroll and other costs to support our expanding product and service mix. We expect research and development expense to increase in absolute dollars and to remain relatively constant as a percentage of revenue through 2004 as we continue to develop additional technology related to our core product offering.

Sales and Marketing. Sales and marketing expense consists primarily of marketing-related personnel costs, including salary and commissions, in addition to the costs of various marketing programs. Sales and marketing expense increased from $476,236 for the quarter ended March 31, 2003 to $591,233 for the quarter ended March 31, 2004. Sales and marketing expense also increased slightly as a percentage of revenue, from 27.2% for the quarter ended March 31, 2003 to 29.7% for the quarter ended March 31, 2004. This absolute dollar increase, and increase as a percentage of revenue, reflects increased commissions due to higher bookings and additional payroll and travel costs to expand and support the sales force. We expect sales and marketing expense to increase incrementally both in absolute terms and as a percentage of revenue through at least the end of the third quarter of 2004 as we expand our sales force and invest a portion of our anticipated revenue growth into sales an d marketing.

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 $531,312 for the quarter ended March 31, 2003 to $606,547 for the quarter ended March 31, 2004. The increase in the expense during the quarter ended March 31, 2004 primarily related to costs for administrative personnel necessary to support the growth in our customer and revenue base. General and administrative expense as a percentage of revenue, however, remained relatively constant, increasing from 30.3% of revenue for the quarter ended March 31, 2003 to 30.5% for the quarter ended March 31, 2004. We expect general and administrative expense to decrease as a percentage of revenue through 2004 as the base of general and administrative costs remain relatively constant, while revenue continues to grow.

Net Interest Expense. Net interest expense increased from $23,472 for the quarter ended March 31, 2003 to $51,758 for the quarter ended March 31, 2004. The increase in net interest expense reflects increased interest payments on capital leases added after March 31, 2003 and additional interest from the use of the credit lines under our factoring agreements that we entered into in June 2003.

Net Loss. Our net loss increased from $167,374 for the quarter ended March 31, 2003 to $213,166 for the quarter ended March 31, 2004. Our net loss increased quarter over quarter due primarily to additional costs to expand our sales and marketing efforts, increased infrastructure costs to support a growing revenue base, and an increase in interest expense as described above partially offset by an increase in gross profit. We expect our net loss to decrease through 2004 as our revenue base expands, fixed costs remain relatively constant and our per unit cost of service decreases.

The following table sets forth, for the periods indicated, items included in our consolidated statements of operations, stated as a percentage of revenues:

The Company's EBITDA (earnings/loss from continuing operations, excluding interest income (expense), income taxes, depreciation and amortization), was a gain of $34,860 for the quarter ended March 31, 2004 compared with a gain of $3,017 for the quarter ended March 31, 2003. The increase in EBITDA was primarily due to increases in our revenue base partially offset by increases in our payroll and cost of service. EBITDA is not a measure used in financial statements reported in accordance with generally accepted accounting principles, does not represent funds available for discretionary use and is not intended to represent cash flow from operations as measured under generally accepted accounting principles. EBITDA should not be considered as an alternative to net loss or net cash used in operating activities. The Company's calculation of EBITDA may not be comparable to the computation of similarly titled measures of other companies.

We use EBITDA as a measure of our operating performance. In addition, we believe that EBITDA may be useful to existing and potential creditors, and to any analysts and investors that follow our performance, because it is one measure of the income generated that is available to service debt and capital leases. In addition, our ability to prepay the $1.1 million in 7% Convertible Promissory Notes issued on September 30, 2003 is contingent upon, among other things, our debt to EBITDA ratio being less than or equal to two.

Our net loss from continuing operations for the quarter ended March 31, 2004 was $213,166 and for the quarter ended March 31, 2003 was $167,374. Reconciliation of net loss from continuing operations to EBITDA is as follows:

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 March 31, 2004:

Our long-term debt represents $1,100,000 in convertible promissory notes issued to Dolphin on November 1, 2002 and January 15, 2003, which notes were amended and restated on 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 c onsent of Dolphin,

Our capital leases represent $992,830 spread over eight capital lease financing arrangements. The hardware and software obtained through these capital lease arrangements are 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.

As of March 31, 2004, the Company had $727,829 in cash and cash equivalents. This represents a decrease compared to the $773,143 in cash and cash equivalents held by the Company on December 31, 2003. Cash used during the quarter ended March 31, 2004 includes $51,984 used in operations as well as $38,090 used in investing activities. Sources of cash for the Company during the quarter ended March 31, 2004 included $44,760 primarily from the exercise of options offset by payments on capital leases.

We presently use more cash in our operations than we generate from operations. Overall, we expect to use between $100,000 and 200,000 of capital during 2004 to make payments on our capital leases and sustain our operations.

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 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, to improve our balance sheet to increase our ability to attract significant customers and acquisition targets and/or to qualify for listing on the Nasdaq SmallCap Market or the American Stock Exchange .

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 a 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 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.

In December 2002, the FASB issued SFAS no. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure", which amends SFAS No, 123, "Accounting for Stock-Based Compensation". SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and requires more prominent and more frequent disclosures in the financial statements of the effects of stock-based compensation. The provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002 and the interim disclosures provisions are effective for the current period.

If any of the adverse events described in the following factors actually occur or the Company does not accomplish necessary events or objectives described in the factors, its business, financial condition and operating results could be materially and adversely affected, the trading price of the Company's common stock could decline and shareholders could lose all or part of their investments. The risks and uncertainties described below are not the only risks the Company faces.

Our cash reserves as of March 31, 2004 were $727,829, 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 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 reach financial statement profitability. Achievin g 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 likely 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 $7.2 million from inception through March 31, 2004. Although we have indicated we may achieve a net profit for the 2004 fiscal year, we 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 16.3% 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 13,094,545 votes in connection with the election of directors and other matters, constituting 28.9% 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 Savvis and AT&T, 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 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:

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult, and while we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States.

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:

The occurrence of any of these events could result in substantial costs and diversion of resources, which could seriously harm our business, operating results and financial condition.

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.

As of April 15, 2004, our executive officers and directors beneficially owned or controlled approximately 36% of the voting power of our company. In combination with officers and directors and their affiliates, and entities owning 5% or more of our outstanding common shares, this group beneficially owned or controlled approximately 77% 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 the year after 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 operat ions 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.

We do not have any derivative instruments, commodity instruments, or other financial instruments for trading or speculative purposes, nor are we presently at risk for changes in foreign currency exchange rates.

(a) Based on the evaluation of our "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e)) required by paragraph (b) of Rules 13a-15 or 15d-15, our chief executive officer and our principal accounting officer, have concluded that, as of March 31, 2004, our disclosure controls and procedures were effective.

(b) There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

In the ordinary course of its business, the Company becomes involved in certain legal actions and claims, including lawsuits, administrative proceedings, regulatory and other matters. Substantial and sometimes unspecified damages or penalties may be sought from the Company in some matters, and some matters may remain unresolved for extended periods. While the Company may establish reserves from time to time based on its periodic assessment of the potential outcomes of pending matters, there can be no assurance that an adverse resolution of one or more such matters during any subsequent reporting period will not have a material adverse effect on the Company's results of operations for that period. However, on the basis of information furnished by counsel and others and taking into consideration the reserves, if any, established for pending matters, the Company does not believe that the resolution of currently pending matters, individually or in the aggregate, will have a materi al adverse effect on the Company's financial condition.