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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2003

or

For the transition period from      to

Commission File Number: 0-29583

Loudeye Corp.

1130 Rainier Avenue South, Seattle, WA 98144
(Address of principal executive offices) (Zip Code)

206-832-4000
(Registrant’s telephone number, including area code)

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

Yes   x    No  o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes  No X

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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Loudeye Corp.

Form 10-Q Quarterly Report
For the Quarter Ended June 30, 2003

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PART I – FINANCIAL INFORMATION

ITEM I                      FINANCIAL STATEMENTS

LOUDEYE CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands)

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

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LOUDEYE CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)

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

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LOUDEYE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

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

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LOUDEYE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)

1. ORGANIZATION, RISKS, and GOING CONCERN

The Company

     Loudeye Corp. (the Company) provides the business infrastructure and services for managing, promoting, and distributing digital content for the entertainment and corporate markets. The Company is headquartered in Seattle, Washington with offices in New York, NY, Hollywood, CA, and Washington D.C., and conducts business in two business segments, digital media services and media restoration services.

Risks

     The Company is subject to a number of risks similar to other companies in a comparable stage of development, including, but not limited to, reliance on key personnel, successful marketing of its services in an emerging market, competition from other companies with greater technical, financial, management and marketing resources, successful development of new services, successful integration of acquired businesses and technology, the enhancement of existing services, and the ability to secure adequate financing to support future operations.

Going Concern

     The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred losses since inception, has an accumulated deficit of $188.8 million at June 30, 2003, has experienced negative cash flows from operations since inception and the expansion and development of the Company’s business may require additional capital. These matters raise substantial doubt about the Company’s ability to continue as a going concern.

     Management has restructured the Company’s operations, reduced its work force, renegotiated leases, and taken other actions to limit the Company’s expenditures. However, there can be no assurance that the Company’s cash balances will be sufficient to sustain its operations until profitable operations and positive cash flows are achieved. Consequently, the Company may require additional capital to fund its operations. There can be no assurance that capital will be available to the Company on acceptable terms, or at all.

     If the Company fails to generate positive cash flows or fails to obtain additional capital when required, the Company could continue to modify, delay or abandon some or all of the Company’s business and expansion plans. The accompanying consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty.

Basis of Consolidation

     The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Unaudited Interim Financial Data

     The interim consolidated financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 15, 2003. The financial information included herein reflects all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the three and six months ended June 30, 2003 and 2002 are not necessarily indicative of the results to be expected for the full years.

Use of Estimates

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     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and that affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. The recoverability of long-lived assets, which include property and equipment ($2.3 million) and intangible assets ($344,000), is a sensitive accounting estimate for which changes could result in additional charges in the near term. Additional impairment analyses could be required in a number of circumstances, including if the Company’s plans for the assets change, if operating results decline further, or if the price of the Company’s stock declines.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents

     Cash and cash equivalents consist of demand deposits and money market accounts maintained with financial institutions and certain other investment grade instruments. The Company considers all cash deposits and highly liquid investments with an original maturity at the date of acquisition of three months or less to be cash equivalents.

Short Term Investments

     The Company has invested amounts in investment-grade government obligations, institutional money market funds and other obligations with FDIC insured U.S. banks. Short-term investments are generally held to maturity and are accounted for as available for sale. These securities all mature within one year and reported amounts approximate fair value due to the relatively short maturities of these investments.

Restricted Cash and Investments

     The Company has $1.2 million of restricted cash and investments which are utilized as collateral for certain irrevocable standby letters of credit. These securities all mature within one year and reported amounts approximate fair value due to the relatively short maturities of these investments.

Impairment of Long-lived Assets

     The Company assesses the recoverability of long-lived assets whenever events or changes in business circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss is recognized when the sum of the expected undiscounted future net cash flows over the remaining useful life is less than the carrying amount of the asset.

Stock Based Compensation

     The Company accounts for stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issues to Employees,” (APB 25), as interpreted by Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB 25” (FIN 44), and related interpretations. Under APB 25, compensation expense is based on the difference between the exercise price of employee stock options granted and the fair value of the Company’s common stock at the date of grant. Deferred compensation, if any, is amortized over the vesting period of the related options, which is generally three to four and one-half years.

     Equity instruments issued to non-employees are accounted for in accordance with the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (FAS 123) and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Investments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services” (EITF 96-18), and related interpretations.

     Stock compensation was $195,000 for the quarter ended June 30, 2003, consisting of the amortization of deferred stock compensation of $44,000, stock issued to former employees as severance and termination benefits of $30,000 and options with an estimated fair value, accounted for under FAS 123, of $121,000 granted to a member of the Company’s board of directors for consulting services, and approximately $102,000 for the quarter ended June 30, 2002, consisting of the amortization of deferred stock compensation.

     Stock compensation was $238,000 for the six months ended June 30, 2003, consisting of the amortization of deferred stock compensation of $87,000, stock issued to former employees as severance and termination benefits of $30,000, and options with an estimated fair value, accounted for under FAS 123, of $121,000 granted to a member of the Company’s board of directors for

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consulting services, and a credit of approximately $554,000 for the quarter ended June 30, 2002, consisting primarily of the reversal of expense related to accelerated amortization for options that were cancelled.

     The Company records stock-based compensation charges as a separate component of operating expenses. These amounts can be allocated to the other expense categories in the accompanying consolidated statements of operations as follows (in thousands):

     The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation (in thousands):

     To determine compensation expense under FAS 123, the Company used the following assumptions:

Reclassifications

     Certain information reported in previous periods has been reclassified to conform to the current period presentation.

3. SPECIAL CHARGES

     The Company has recorded Special Charges related to corporate restructurings, facilities consolidations and the impairment of assets in accordance with its long-lived asset policy (see Note 2). The following table summarizes such charges recorded in the consolidated statements of operations (in thousands):

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Six Months Ended June 30, 2003

On February 4, 2003, the Company’s Chairman and Chief Executive Officer, John T. Baker, resigned and the Company engaged Regent Pacific Management Corporation to provide management services to the Company. On March 7, 2003, Regent Pacific resigned from the engagement and Jeffrey M. Cavins was elected President and Chief Executive Officer. These events are described more fully in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. During and subsequent to Regent Pacific’s engagement, the Company undertook a strategic and operational analysis of its business and product lines. This analysis resulted in the development of a new strategic and operational plan, under which the Company will restructure itself to focus on its core competencies in digital media services and on core strategic customers and markets for its enterprise communications services. A revised corporate forecast was developed in connection with this plan. The revised forecast also considered that the Company had learned that revenue from a significant customer in its Media Restoration Services segment would be less than originally anticipated. Utilizing the revised forecast, the Company performed a reassessment of the carrying value of all of its assets, both tangible and intangible. The revised forecast demonstrated that certain tangible and intangible assets and goodwill related to its media restoration services and enterprise communications services businesses were impaired, as the projected undiscounted discernible cash flows did not exceed the carrying value of the assets over their estimated useful lives. The fair values of each of these assets were estimated using primarily a discounted cash flow method. The estimated fair values of each of the assets were then compared to their carrying values to measure the impairments. As a result of this analysis, the Company recorded impairment charges for goodwill, intangible assets, and property and equipment related to its enterprise communication services and media restoration services businesses of $5.3 million, $685,000, and $601,000, respectively.

In addition to the impairment charges above, the Company recorded severance and termination benefits of $204,000 associated with a reduction in force announced on March 14, 2003 of approximately 35% of its consolidated staffing. In addition, the Company recorded $297,000 of severance and termination benefits with respect to certain changes in senior management in the first quarter of 2003. The Company incurred costs of approximately $465,000 related to the termination or renegotiation of certain facilities leases in connection with its facilities consolidation. The other restructuring charges of $878,000 represent fees and costs paid to Regent Pacific Management Corporation with respect to interim management services provided to the Company in connection with its management and operational restructuring.

In March 2003, the Company reduced by approximately half the space it occupies for its principal operating facility on Rainier Avenue, Seattle, Washington from a base rent of approximately $108,000 per month with a term expiring on November 30, 2005 to a base rent of approximately $33,000 per month for the remainder of the term which was shortened to June 30, 2003. The Company exercised its option to extend the term for a 3-month period at a base rent of $100,000 and pre-paid utility expenses of $60,000, and has the option of extending the term for an additional 3-month period, under the same terms. As consideration for the reduction of space and lease term, the Company allowed its landlord to retain its security deposit in the amount of $218,500 and made cash payments of $276,000.

In April, 2003, the Company entered into a lease termination agreement with the landlord of its unoccupied facility on Fourth Avenue, Seattle, Washington. Under the terms of the agreement, the Company paid a lease termination fee of $200,000. As a result, all of the Company’s obligations under the lease were terminated effective April 30, 2003. In accordance with EITF 94-3 the lease termination fee was included in accrued special charges at December 31, 2002. The Company had been paying approximately $29,000 per month under this lease.

In May, 2003, the Company entered into a lease termination agreement with the landlord of its unoccupied facility in Ardsley, New York. Under the terms of the agreement, the Company paid a lease termination fee of approximately $114,000 which included its

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security deposit of $29,000. As a result, all of the Company’s obligations under the lease were terminated effective May 19, 2003. In accordance with EITF 94-3, the lease termination fee was included in accrued special charges at December 31, 2002. The Company had been paying approximately $19,000 per month under this lease.

Six Months Ended June 30, 2002

The Company recorded special charges totaling $748,000 and $1.1 million in the three and six months ended June 30, 2002, respectively. These special charges were for severance and related termination benefits.

The following table summarizes the activity in accrued special charges during the six months ended June 30, 2003 (in thousands):

4. NET LOSS PER SHARE

Basic earnings per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net loss by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of shares of common stock issuable upon the exercise of stock options and warrants (using the treasury stock method); common equivalent shares are excluded from the calculation if their effect is antidilutive. The Company has excluded the following numbers of shares using this method (in thousands):

The Company had 603 and 1,812 shares outstanding that were subject to repurchase at June 30, 2003 and 2002, respectively. The impact of these unvested but exercised options has been removed from the calculation of weighted average shares outstanding for purposes of determining basic and diluted net loss per share.

The following table presents a reconciliation of shares used to calculate basic and diluted earnings per share (in thousands):

5. LINE OF CREDIT

In June, 2003, the Company entered into a revolving credit facility (the “2003 Revolving Facility”) with a bank under which it may borrow up to $2.5 million based on a certain percentage of eligible accounts receivable. The 2003 Revolving Facility expires in June, 2004 and is collateralized by substantially all of the Company’s assets. The initial advance was for $2.5 million on June 30, 2003 and bears interest at the greater of the prime rate plus 1.5% (5.5% at June 30, 2003) or 5%. Subsequent borrowings bear interest at the greater of the prime rate plus 1.75% (5.75% at June 30, 2003) or 5.75%. The Company also issued a warrant to the lender to purchase 45,700 shares of its common stock at $0.89 per share. The warrant expires on June 27, 2010. In addition, the Company is required to establish a lockbox account with the lender to which all payments from customers will be deposited. The lender will apply such deposits to the outstanding borrowings and transfer any excess funds to the Company’s operating bank account. Fees for the lockbox arrangement are 0.35% of the average daily outstanding principal balance. On June 30, 2003, outstanding borrowings under the 2003

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Revolving Facility were $2.5 million. The Company repaid the balance in full in July, 2003. The Company intends to utilize borrowings under the 2003 Revolving Facility for working capital and general corporate purposes.

6. SEGMENT INFORMATION

The Company operates in two business segments, Digital Media Services and Media Restoration Services. The following information summarizes the Company’s segments (in thousands):

During the three and six months ended June 30, 2003 and 2002, the Company had sales to certain significant customers, as a percentage of revenues, as follows:

Revenue from Customer A was derived primarily from the Media Restoration Services segment and revenue from Customer B was derived primarily from the Digital Media Services segment.

7. CONTINGENCIES

Between July 26, 2001 and August 30, 2001, four substantially similar class action complaints were filed in the Untied States District Court for the Southern District of New York against the Company and certain of its former officers and directors, as well as against certain underwriters who handled its March 15, 2000 initial public offering of common stock. The various complaints were purportedly filed on behalf of a class of persons who purchased the Company’s common stock during the time period beginning on March 15, 2000 and ending on December 6, 2000. The complaints together allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, primarily based on the allegation that there was undisclosed compensation received by the Company’s underwriters in connection with its initial public offering and the allegation that the underwriters entered into undisclosed arrangements with some investors that were designed to distort and/or inflate the market price for the Company’s common stock in the aftermarket following the initial public offering. These actions have all been consolidated before the same judge for pretrial purposes. No specific amount of damages has been claimed. The individual defendants and the Company have demanded to be indemnified by the underwriter defendants pursuant to the underwriting agreement entered into at the time of the initial public offering. Presently, all claims against the former officers have been withdrawn without prejudice. The Company, along with the many other issuer defendants, moved to dismiss the claims in the complaint. By decision dated February 19, 2003 the court denied the Company’s motion. The Company has approved a settlement proposal made by the plaintiffs. As a result, all of plaintiffs’ claims against the

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Company will be dismissed with prejudice. The settlement proposal has yet to be approved by the other defendants and an estimate of the likelihood or range of possible loss for this matter cannot be made at this time.

     On or about January 8, 2003 a company known as Dominion Venture Finance, L.L.C. commenced an action against the Company and “John Doe” defendants in the Superior Court of the State of California, County of San Francisco. In its complaint, plaintiff alleged that pursuant to a loan and security agreement and a master lease agreement (the “Agreements”) (the liabilities for which agreement, plaintiff alleged, were acquired by the Company when the Company merged with an entity known as DiscoverMusic.com, Inc.) the Company failed to make certain required payments to plaintiff. On August 5, 2003, the Company agreed to settle all claims under the suit for a cash payment of approximately $228,000, which represented the outstanding principal and interest under the Agreements.

     On February 3, 2003, the Company entered into an agreement (“Agreement”) with Regent Pacific Management Corporation (“Regent Pacific”) pursuant to which Regent Pacific would provide management services to the Company. The Agreement was for a term of 26 weeks with an option to renegotiate certain terms of the Agreement after 13 weeks, and was terminable by either party under certain circumstances. Under the Agreement, the Company paid certain fees to Regent Pacific. In addition, Regent Pacific was to receive stock options to purchase up to 4,000,000 shares of the Company’s common stock based on Regent Pacific’s length of service. These options were to be granted at various times throughout their engagement at exercise prices based on the closing market price on each grant date. On March 7, 2003, Regent Pacific resigned from the engagement. On July 25, 2003, Regent Pacific filed suit against the Company for breach of the Agreement. In this complaint, Regent Pacific is seeking unspecified damages and specific performance of the Company’s alleged obligation to grant the stock options due them under the contract. The Company believes that it has meritorious defenses to the claims made in the suit, intends to defend vigorously this suit, and intends to bring certain counterclaims against Regent Pacific. An estimate of the range of possible loss for this matter can not be made at this time.

     In April 2003, the landlord of one of the Company’s unoccupied facilities filed suit against the Company for breach of its lease and is seeking an unspecified amount of damages. The Company believes that it has meritorious defenses to the claims made in the suit and intends to vigorously defend this suit and may also bring certain counterclaims against the landlord. An estimate of the range of possible losses for this matter can not be made at this time.

     The Company becomes involved from time to time in various other claims and lawsuits incidental to the ordinary course of its operations, including such matters as contract and lease disputes and complaints alleging employment discrimination. The Company believes that the outcome of any such pending claims or proceedings individually or in the aggregate, will not have a material adverse effect upon its business or financial condition, cash flows, or results of operations.

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

Forward-Looking Statements

     The following discussion of our financial condition and results of operations 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, and are made under the safe harbor provisions thereof. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of terms like these or other comparable terminology. These forward-looking statements are only predictions and actual events or results may differ materially from those projected. Specific factors that could cause actual results to differ materially from those projected include, but are not limited to, uncertainties related to our early stage; uncertainties related to the effectiveness of our technology and development of our products and services; dependence on and management of existing and future corporate relationships; dependence on licensed content and technology; dependence on proprietary technology and uncertainty of patent protection; management of growth; history of operating losses; future capital needs and uncertainty of additional funding; dependence on key personnel; competition; existing governmental regulations and changes in, or the failure to comply with, government regulations, and other risks detailed below, including the Risk Factors set for the below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and those included from time to time in the Company’s other reports filed with the SEC and press releases, copies of which are available from the Company upon request. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to publicly release any revisions of the forward-looking statements contained herein to reflect events or circumstances after the date hereof. Readers are cautioned not to place undue reliance on these forward-looking statements, as our business and financial performance are subject to substantial risks and uncertainties.

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Results of Operations

Three Months Ended June 30, 2003 and 2002

     Revenues. Revenues totaled $2.9 million and $3.2 for the second quarter of 2003 and 2002, respectively.

Revenue from our digital media services segment increased slightly in the second quarter of 2003 to $2.5 million from $2.4 million in the second quarter of 2002. This increase is due primarily to an increase in the volume of encoding and other fulfillment services in the second quarter of 2003 compared to the prior year, offset partially by decreases in webcasting services.

Media restoration revenues totaled $404,000 in the second quarter of 2003 compared to $865,000 in the second quarter of 2002. This decrease was primarily the result of decreased customer spending on discretionary projects due to current economic conditions.

     Cost of Revenues. Cost of revenues decreased to $1.7 million for the second quarter of 2003 from $3.6 million for the second quarter of 2002. Cost of revenues include the cost of production, including personnel, an allocated portion of facilities and equipment, and other supporting functions related to the delivery of digital media services and applications and media restoration services. Excluding depreciation, cost of revenues decreased to $1.4 million for the second quarter of 2003 from $2.8 million for the second quarter of 2002. This decrease is due primarily to cost reduction initiatives implemented in the second half of 2002 and the first quarter of 2003. Accordingly, we anticipate that cost of revenues for the second half of 2003 will continue to be lower than 2002.

Depreciation included in cost of revenues decreased to approximately $240,000 in the second quarter of 2003 from $812,000 in the second quarter of 2002. This decrease is due primarily to impairment charges recorded in the fourth quarter of 2002 and the first quarter of 2003 for certain assets of our digital media services and media restoration services segments. These charges decreased the cost basis of the assets, resulting in lower depreciation charges.

     Research and Development. Research and development expenses totaled $392,000 and $974,000 in the second quarter of 2003 and 2002, respectively. This decrease is due primarily to the reduction in the number of development personnel as a result of the corporate restructurings. Research and development expenses include labor and other related costs of the continued support of our digital media offerings, the recently announced Quick Clips media player application, and enhanced webcasting offerings, including the recently announced Loudeye Express and the development of internal operational solutions necessary to fully integrate previous acquisitions.

We believe that continued investment in research and development is critical to attaining our strategic objectives. However, due to our operational restructurings and a sharper focus on opportunities which we believe will result in near term results, development headcount was significantly reduced in 2003 as compared to 2002 and, as a result, research and development expenses declined in 2003 as compared to 2002. We expect research and development expenses to remain relatively stable in the foreseeable future. Accordingly, research and development expenses for the remainder of 2003 should continue to be lower than 2002.

     Sales and Marketing. Sales and marketing expenses totaled $835,000 and $2.2 million in the second quarter of 2003 and 2002, respectively. Sales and marketing expenses consist primarily of salaries, commissions, product branding costs, advertising, trade show expenses, and cost of marketing collateral. The decrease in sales and marketing expenses was primarily due to the decreased personnel subsequent to our reductions in force in the second half of 2002 and first quarter of 2003, as well as a lower level of marketing activity in 2003. Accordingly, we anticipate that sales and marketing expenses for the second half of 2003 will continue to be lower than 2002.

     General and Administrative. General and administrative expenses decreased to $1.7 million for the second quarter of 2003 from $2.8 million for the second quarter of 2002. This decrease was due primarily to the decrease in personnel subsequent to our reductions in force in the second half of 2002 and first quarter of 2003 and related cost reduction initiatives. Accordingly, we anticipate that general and administrative expenses for the second half of 2003 will continue to be lower than 2002. General and administrative expenses consist primarily of rent, facilities and information technology charges, salaries, legal expenses, investor relations costs, and other costs associated with being a public company.

     Amortization of Intangible and Other Assets. Amortization of intangibles and other assets totaled $260,000 and $713,000 for the second quarter of 2003 and 2002, respectively, and includes amortization of identified intangible assets related to past acquisitions. The decrease was due primarily to the impairment charges recorded in the fourth quarter of 2002 and first quarter of 2003, which resulted in lower amortization charges during the second quarter of 2003.

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     Stock-Based Compensation. Stock-based compensation charges for the second quarter 2003 were $195,000, consisting of the amortization of deferred stock compensation of $44,000, stock granted to former employees for severance and termination benefits of $30,000, and options granted to a member of our board of directors for consulting services for $121,000. For the second quarter of 2002, stock compensation was $102,000, consisting primarily of the amortization of deferred stock compensation. The balance of deferred stock compensation was $44,000 at June 30, 2003 and will be fully amortized in the third quarter of 2003.

     Special Charges. We recorded special charges in the second quarter of 2002 associated with a reduction in force in June of 2002 of approximately 37% of consolidated staffing. The special charge of $1.1 million was for severance and related termination benefits. There were no such charges in the second quarter of 2003.

     Interest Income. Interest income totaled $101,000 and $309,000 in the second quarter of 2003 and 2002, respectively. The decrease was due primarily to the lower average cash and investment balances in 2003 resulting from the voluntary repayment of our credit facility in the third quarter of 2002, utilization of cash to fund operations, and lower interest rates in 2003. We expect that our interest income will decrease in the future as our cash and investment balances are used to fund our operations.

     Interest Expense. Interest expense consists of interest expense related to our debt instruments, including capital lease obligations. Interest expense totaled $48,000 and $235,000 in the second quarter of 2003 and 2002, respectively. The decrease was due primarily to lower average debt balances in 2003 due to the voluntary repayment of our credit facility in the third quarter of 2002 and lower interest rates in 2003.

     Other Income. Other income for the second quarter of 2003 consisted of gains on sales of excess equipment. There were no such transactions in the second quarter of 2002.

Six Months Ended June 30, 2003 and 2002

     Revenues. Revenues totaled $6.2 million $6.5 million for the first six months of 2003 and 2002, respectively.

We recorded approximately $5.2 million of revenue from our digital media services segment in the first six months of 2003 compared to $4.9 million in the first six months of 2002. This increase is due primarily to an increase in the volume of encoding and other fulfillment services in the first half of 2003 compared to the prior year, offset partially by decreases in webcasting services.

Media restoration revenues totaled $1.1 million in the first six months of 2003 compared to $1.6 million in the first six months of 2002. This decrease was primarily the result of decreased spending by our customers on discretionary projects due to current economic conditions.

     Cost of Revenues. Cost of revenues decreased to $1.7 million for the first six months of 2003 from $3.6 million for the first six months of 2002. Cost of revenues include the cost of production including personnel, an allocated portion of facilities and equipment and other supporting functions related to the delivery of digital media services and applications, and media restoration services. Excluding depreciation, cost of revenues decreased to $3.8 million for the first six months of 2003 from $5.2 million for the first six months of 2002. This decrease is due primarily to cost reduction initiatives implemented in the second half of 2002 and the first quarter of 2003. Accordingly, we anticipate that cost of revenues for the second half of 2003 will continue to be lower than 2002.

Depreciation included in cost of revenues decreased to approximately $456,000 in the first six of 2003 from $1.6 million in the first six months of 2002. This decrease is due primarily to impairment charges recorded in the fourth quarter of 2002 and first quarter of 2003 for certain assets of our Digital Media Services and Media Restoration Services segments. These charges decreased the cost basis of the assets, resulting in lower depreciation charges.

     Research and Development. Research and development expenses totaled $969,000 and $2.3 million in the first six months of 2003 and 2002, respectively. This decrease is due primarily to the reduction in the number of development personnel as a result of the corporate restructurings. Research and development expenses include labor and other related costs of the continued support of our digital media offerings, the recently announced Quick Clips media player application, enhanced webcasting offerings, including the recently announced Loudeye Express, and the development of internal operational solutions necessary to fully integrate previous acquisitions.

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We believe that continued investment in research and development is critical to attaining our strategic objectives. However, due to our operational restructurings and a sharper focus on opportunities which we believe will result in near term results, development headcount was reduced significantly in 2003 as compared to 2002 and, as a result, research and development expenses declined in 2003 as compared to 2002. We expect research and development expenses to remain relatively stable in the foreseeable future. Accordingly, research and development expenses for the remainder of 2003 should continue to be lower than 2002.

     Sales and Marketing. Sales and marketing expenses totaled $2.4 million and $4.5 million in the first six months of 2003 and 2002, respectively. Sales and marketing expenses consist primarily of salaries, commissions, product branding costs, advertising, trade show expenses, and cost of marketing collateral. The decrease in sales and marketing expenses was primarily due to the decreased personnel subsequent to our reductions in force in the second quarter of 2002 and first quarter of 2003, as well as a lower level of marketing activity in 2003. Accordingly, we anticipate that sales and marketing expenses for the second half of 2003 will continue to be lower than 2002.

     General and Administrative. General and administrative expenses decreased to $4.5 million for the first six months of 2003 from $6.2 million for the first six months of 2002. This decrease was due primarily to the decrease in personnel subsequent to our reductions in force in the second half of 2002 and first quarter of 2003, and related cost reduction initiatives. Accordingly, we anticipate that general and administrative expenses for the second half of 2003 will continue to be lower than 2002. General and administrative expenses consist primarily of rent, facilities and information technology charges, salaries, legal expenses, investor relations costs, and other costs associated with being a public company.

     Amortization of Intangible and Other Assets. Amortization of intangible and other assets totaled $786,000 and $1.4 million for the first six months of 2003 and 2002, respectively, and includes amortization of identified intangible assets related to past acquisitions. The decrease was due primarily to the impairment charges recorded in the fourth quarter of 2002 and first quarter of 2003, which resulted in lower amortization charges during the first six months of 2003.

     Stock-Based Compensation. Stock-based compensation charges for 2003 consisted of the amortization of deferred stock compensation, stock granted to former employees, and options granted to a member of our board of directors for consulting services. For the first six months of 2002, stock compensation was a credit of $554,000, resulting from reversals of previously recorded deferred stock compensation associated with the terminated employees in connection with our restructuring initiatives, offset partially by the amortization of deferred stock compensation. The balance of deferred stock compensation was $44,000 at June 30, 2003 and will be fully amortized in the third quarter of 2003.

     Special Charges. We have recorded special charges related to corporate restructurings, facilities consolidations and the impairment of assets in accordance with our long-lived asset policy. Following is a summary of special charges for the six months ended June 30, 2003 and 2002:

Six Months Ended June 30, 2003

On February 4, 2003, our Chairman and Chief Executive Officer, John T. Baker, resigned and we engaged Regent Pacific Management Corporation to provide management services. On March 7, 2003, Regent Pacific resigned from the engagement and Jeffrey M. Cavins was elected President and Chief Executive Officer. These events are described more fully in our Annual Report on Form 10-K for the year ended December 31, 2002. During and subsequent to Regent Pacific’s engagement, we undertook a strategic and operational analysis of our business and product lines. This analysis resulted in the development of a new strategic and operational plan, under which we restructured our business to focus on our core competencies in digital media services and on core strategic customers and markets for our enterprise communications services. We developed a revised corporate forecast in connection with this plan. The revised forecast also considered that we had learned that revenue from a significant customer in our Media Restoration Services segment would be less than originally anticipated. Utilizing the revised forecast, we performed a reassessment of the carrying value of all of our assets, both tangible and intangible. The revised forecast demonstrated that certain tangible and intangible assets and goodwill related to our media restoration services and enterprise communications services businesses were impaired, as the projected undiscounted discernible cash flows did not exceed the carrying value of the assets over their estimated useful lives. The fair values of each of these assets were estimated using primarily a discounted cash flow method. The estimated fair values of each of the assets were then compared to their carrying values to measure the impairments. As a result of this analysis, we recorded impairment charges for goodwill, intangible assets, and property and equipment related to our enterprise communication services and media restoration services businesses of $5.3 million, $685,000, and $601,000, respectively.

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In addition to the impairments above, we recorded severance and termination benefits of $204,000 associated with a reduction in force announced on March 14, 2003 of approximately 35% of our consolidated staffing. In addition, we recorded $297,000 of severance and termination benefits with respect to certain changes in senior management in the first quarter of 2003. We incurred costs of approximately $465,000 related to the termination or renegotiation of certain facilities leases in connection with our ongoing facilities consolidation. The other restructuring charges of $878,000 represent fees and costs paid to Regent Pacific Management Corporation with respect to interim management services provided to us in connection with our management and operational restructuring.

	We will continue to review the carrying value of our long-lived assets for impairments. Future adverse developments in our business could result in additional impairments.

The following table summarizes the activity in accrued special charges during the six months ended June 30, 2003 (in thousands):