ARTISTDIRECT INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q


	(Mark One)
	þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
			For the quarterly period ended June 30, 2003


	o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
			For the transition period from to

Commission file number 000-30063

ARTISTDIRECT, INC.

(Exact name of registrant as specified in its charter)


Delaware		95-4760230
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

5670 Wilshire Boulevard, Suite 200		90036
Los Angeles, California		(Zip Code)
(Address of principal executive office)

(323) 634-4000
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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 þ No o

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

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

Number of shares of Common Stock, par value $0.01 per share, outstanding as of June 30, 2003: 3,462,117 shares.

TABLE OF CONTENTS


PART I: FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS OF ARTISTDIRECT, INC.
		Consolidated Balance Sheets
		Consolidated Statements of Operations
		Consolidated Statements of Changes in Stockholders’ Equity (Deficit)
		Consolidated Statements of Cash Flows
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II: OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
		(a) Exhibits
		(b) Reports on Form 8-K
SIGNATURES
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

INDEX


		Page

PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
	CONSOLIDATED BALANCE SHEETS AT JUNE 30, 2003 (UNAUDITED) AND DECEMBER 31, 2002		1
	CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 (UNAUDITED) AND 2002 (UNAUDITED)		2
	CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT) AT JUNE 30, 2003 (UNAUDITED) AND DECEMBER 31, 2002		3
	CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 (UNAUDITED) AND 2002 (UNAUDITED)		4
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		5
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			42
ITEM 4. CONTROLS AND PROCEDURES			42
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS			43
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS			43
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			44
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			44
ITEM 5. OTHER INFORMATION			44
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K			44
	A. EXHIBITS		44
	B. REPORTS ON FORM 8-K		45
SIGNATURES			45

In this Report the words “ARTISTdirect,” the “Company,” “We,” “us” and “our” collectively refer to ARTISTdirect, Inc.

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS OF ARTISTDIRECT, INC.

ARTISTdirect, Inc. and Subsidiaries
Consolidated Balance Sheets
(amounts in thousands, except for share data)


		June 30,			December 31,
		2003			2002

		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	866		$	1,910
Restricted cash			1,705			2,157
Short term investments			2,472			6,124
Accounts receivable, net			546			426
Other prepaid expenses and current assets			294			1,220

	Total current assets		5,883			11,837
Property and equipment, net			651			3,629
Investments in affiliated companies			64			64
Other assets, net			135			395

		$	6,733		$	15,925

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable		$	495		$	493
Accrued expenses			2,187			3,018
Deferred revenue			8			144

	Total current liabilities		2,690			3,655
Liability associated with record label joint venture			12,000			7,699
Long term liabilities			1,123			1,117

	Total liabilities		15,813			12,471

Stockholders’ equity (deficit):
Common stock , $.01 par value. Authorized 15,000,000 shares; issued 3,785,019 and 3,784,644 shares in 2003 and 2002, respectively; outstanding 3,462,117 and 3,461,742 shares in 2003 and 2002, respectively			379			379
Treasury stock, 322,902 shares			(3,442	)		(3,442	)
Additional paid-in-capital			207,868			207,867
Unearned compensation			(379	)		(440	)
Accumulated deficit			(213,533	)		(200,978	)
Unrealized gain on available for sale investments			27			68

	Total stockholders’ equity (deficit)		(9,080	)		3,454

		$	6,733		$	15,925

See accompanying notes to condensed consolidated financial statements.

ARTISTdirect, Inc. and Subsidiaries
Consolidated Statements of Operations
(amounts in thousands, except for share data)


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2003			2002			2003			2002

			(Unaudited)						(Unaudited)
Net revenue:
	E-Commerce		$	855		$	1,118		$	1,666		$	2,368
	Media			624			323			758			404
	Record label			497			—			1,252			—

		Total net revenue		1,976			1,441			3,676			2,772
Cost of revenue:
	Direct cost of product sales			809			862			1,810			1,825
	Other cost of revenue			396			895			911			1,803
	Stock-based compensation			13			954			33			1,904

		Total cost of revenue		1,218			2,711			2,754			5,532
		Gross profit (loss)		758			(1,270	)		922			(2,760	)
Operating expenses:
	Website development			—			11			—			20
	Sales and marketing			307			455			1,104			1,096
	General and administrative			1,318			1,816			2,832			3,395
	Stock-based compensation			14			740			28			1,454
	Depreciation and amortization			340			709			753			1,496
	Loss from impairment of fixed assets			2,225			—			2,225			—
	Loss from impairment of goodwill			—			788			—			788

		Loss from operations		(3,446	)		(5,789	)		(6,020	)		(11,009	)
	Loss from equity investments			(2,440	)		(9,612	)		(7,050	)		(18,010	)
	Forgiveness of debt			411			—			411			—
	Interest income, net			51			200			104			495

		Loss from continuing operations before taxes		(5,424	)		(15,201	)		(12,555	)		(28,524	)
	Income taxes			—			—			—			—

		Loss from continuing operations	$	(5,424	)	$	(15,201	)	$	(12,555	)	$	(28,524	)
	Income (loss) from discontinued operations			—			(11	)		—			147

		Net loss	$	(5,424	)	$	(15,212	)	$	(12,555	)	$	(28,377	)

Basic and diluted loss per share from continuing operations			$	(1.57	)	$	(4.40	)	$	(3.63	)	$	(8.24	)
Basic and diluted income per share from discontinued operations				—			—			—			0.04

Basic and diluted loss per share			$	(1.57	)	$	(4.40	)	$	(3.63	)	$	(8.20	)

Weighted average common shares outstanding				3,461,983			3,460,948			3,461,859			3,460,774

See accompanying notes to condensed consolidated financial statements.

ARTISTdirect, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

(amounts in thousands, except for share data)


																	Unrealized
																	gain on
		Common Stock							Additional								avail.
						Treasury			Paid In		Unearned			Accumulated			for sale			Total
		Shares		Amount		Stock			Capital		Compensation			Deficit			investments			Equity

											(Unaudited)
Balance at December 31, 2002			3,461,742	$	379	$	(3,442	)	$	207,867	$	(440	)	$	(200,978	)	$	68		$	3,454
	Amortization of unearned
	compensation		—		—		—			—		61			—			—			61
	Issuance of securities for ESPP		375		—		—			1		—			—			—			1
	Unrealized loss on available
	for sale investments		—		—		—			—		—			—			(41	)		(41	)
	Net loss		—		—		—			—		—			(12,555	)		—			(12,555	)

Balance at June 30, 2003			3,462,117	$	379	$	(3,442	)	$	207,868	$	(379	)	$	(213,533	)	$	27		$	(9,080	)

See accompanying notes to condensed consolidated financial statements.

ARTISTdirect, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(amounts in thousands)


			Six Months Ended
			June 30,

			2003			2002

			(Unaudited)
Cash flows from operating activities:
	Net loss		$	(12,555	)	$	(28,377	)
	Income (loss) from discontinued operations			—			147

		Loss from continuing operations		(12,555	)		(28,524	)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
	Depreciation and amortization			753			1,496
	Loss from equity investments			7,050			18,004
	Loss from impairment of fixed assets			2,225			—
	Loss from impairment of goodwill			—			788
	Allowance for doubtful accounts and sales returns			54			(47	)
	Stock based compensation			61			3,358
Changes in assets and liabilities:
	Accounts receivable			(174	)		341
	Prepaid expenses and other current assets			926			(801	)
	Other assets			260			(1	)
	Accounts payable, accrued expenses and other liabilities			(822	)		(1,638	)
	Deferred revenue			(136	)		53

		Net cash used in continuing operations		(2,358	)		(6,971	)
		Net cash provided by discontinued operations		—			147

		Net cash used in operating activities		(2,358	)		(6,824	)

Cash flows from investing activities:
	Purchases of property and equipment			—			(17	)
	Proceeds from the sales of equipment			—			15
	Sale/maturity of short-term investments, net			3,611			4,109
	Investment in ARTISTdirect Records, LLC, net			(2,750	)		(11,250	)
	Distribution from other equity investments			—			6

		Net cash provided by (used in) investing activities		861			(7,137	)

Cash flows from financing activities:
	Decrease (increase) in restricted cash			452			(299	)
	Proceeds from employee stock purchase plan			1			5

		Net cash provided by (used in) financing activities		453			(294	)

		Net decrease in cash and cash equivalents		(1,044	)		(14,255	)
Cash and cash equivalents at beginning of period				1,910			25,766

Cash and cash equivalents at end of period			$	866		$	11,511

See accompanying notes to condensed consolidated financial statements.

ARTISTDIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – THE COMPANY

ARTISTdirect, Inc. (the “Company”) was formed on October 6, 1999 upon its merger with ARTISTdirect, LLC. This merger was only a change in the form of ownership of the Company. ARTISTdirect, LLC was organized as a California limited liability company and commenced operations on August 8, 1996.

NOTE 2 – GOING CONCERN

The Company has incurred losses and negative cash flows from operations in every fiscal period since inception and has an accumulated deficit of $254.5 million as of June 30, 2003. For the three months and six months ended June 30, 2003, the Company incurred net losses of $5.4 million and $12.6 million, respectively, and negative operating cash flows of $1.3 million and $2.4 million, respectively. Additionally, the Company has been funding substantially all of the operations of ARTISTdirect Records, LLC, its record label joint venture with Radar Records Holdings, LLC, an entity owned by the Company’s Chief Executive Officer, Ted Field. The Company’s operations to date and loans to ARTISTdirect Records, LLC have been funded by sales of its capital stock. Management expects the Company’s operating losses and the operating losses of ARTISTdirect Records, LLC to continue for the foreseeable future. The Company does not currently anticipate that available cash reserves will be sufficient to meet anticipated needs for working capital and capital expenditures over the next twelve months without additional capital. The Company is attempting to raise additional funding, but does not have any formal commitments as of the date of these financial statements. If sufficient funding is not available, then the Company may not be able to fund its own operations or the operations of ARTISTdirect Records, LLC. In such event, the Company may seek to divest all or certain of our assets or the entire company in order to raise the capital necessary to sustain business operations. Should this fail the Company may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss for stockholders. The conditions described above raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

NOTE 3 – CRITICAL ACCOUNTING POLICIES

Principles of Consolidation

The accompanying financial statements include the consolidated accounts of the Company and its subsidiaries in which it has controlling interests in the form of voting and operating control. All significant intercompany accounts and transactions have been eliminated for all periods presented.

Liability associated with investments in affiliated companies

Investments in affiliated companies in which the Company’s voting interest is greater than 20% and does not have a controlling financial interest, or in which the Company is able to exert significant influence in instances where the voting interest is less than 20%, are accounted for under the equity method of accounting. Under this method, the investment, originally recorded at cost, is adjusted to recognize the Company’s share of the net earnings or losses of the affiliates as they occur rather than as dividends or other distributions received. The Company’s share of losses is generally limited to the extent of the Company’s investment in and advances to the investee. However, the Company records losses in excess of its investment when funding commitments exist.

The Company is accounting for its investment in ARTISTdirect Records, a limited liability company that was founded with Ted Field in July 2001, on the equity method of accounting since the Company does not have voting or operational control of the investee. The Company had committed to fund 100% of the operations of ARTISTdirect Records, up to $45.0 million, and has recorded 100% of the losses attributable to that venture from inception to April 30, 2002. From May 1, 2002, the Company’s funding commitment was reduced by the sale of 5% of ARTISTdirect Records’ equity to BMG and therefore the Company has recorded only its proportionate share, on the basis of relative funding commitments, of any losses of ARTISTdirect Records since that time. As of June 30, 2003, the Company had funded ARTISTdirect Records and recorded losses totaling $45.0 million, the total of its funding commitment and initial capital contribution. As a result, it is expected that no additional equity losses in

ARTISTdirect Records will be recorded by the Company going forward. The Company has recorded a liability related to this investment as of June 30, 2003 and December 31, 2002 as the Company’s share of losses exceeded their advances as of these respective dates.

The Company records a valuation allowance on loans to ARTISTdirect Records in the period in which it appears that the loan is no longer collectible. The Company has not recorded a valuation allowance on its loans to ARTISTdirect Records as the carrying amount of the loans has been reduced to zero as a result of the Company recording its share of losses of ARTISTdirect Records as of June 30, 2003 and December 31, 2002.

Unaudited Interim Financial Information

The unaudited interim financial statements of the Company included herein have been prepared in accordance with the instructions for Form 10-Q under the Securities Exchange Act of 1934, as amended, and Article 10 of Regulation S-X under the Securities Act of 1933, as amended. 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 relating to interim financial statements.

In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at June 30, 2003 and results of its operations, stockholders’ equity (deficit) and cash flows for the six months ended June 30, 2003 and 2002. The results for the three and six months ended June 30, 2003 are not necessarily indicative of the expected results for the full year or any future period. These financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s documents filed with the Securities and Exchange Commission (“SEC”) including its Form 10-K and Registration Statements on Form S-1, and all amendments thereto.

Loss Per Common Share

The Company computes net loss per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No.128, “Earnings Per Share,” and Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 98. SFAS No.128 requires companies with complex capital structures to present basic and diluted earnings per share (“EPS”). Basic EPS is measured as the income or loss available to common shareholders divided by the weighted average outstanding common shares for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per-share basis of potential common shares (e.g., convertible securities, options, and the like) as if they had been converted at the beginning of the periods presented. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from diluted EPS. The number of potentially dilutive common share equivalents outstanding and excluded from diluted EPS because their effect is anti-dilutive as of June 30, 2003 and 2002 was approximately 780,000.

Revenue Recognition

E-commerce revenue consists primarily of the gross amount of sales revenue paid by the customer for recorded music and merchandise sold via the Internet, including shipping fees, and is recognized when the products are shipped. The Company records e-commerce revenue on a gross basis as the Company enters into the sale transactions with customers, establishes the prices of the products, chooses the suppliers of the products, assumes the risk of inventory loss and collects all amounts from the customers and assumes the credit risk. E-commerce revenue is subject to amounts due to the respective artists based on their contracts, and such expense is recorded as part of direct cost of product sales.

The Company records amounts charged to customers for shipping and handling in accordance with Emerging Issues Task Force 00-10, “Accounting for Shipping and Handling Fees and Costs.” Pursuant to EITF 00-10, the Company records amounts charged to customers for shipping and handling as revenue, and records the related costs incurred for shipping and handling to direct cost of product sales in the consolidated statements of operations. For the three months ended June 30, 2003 and 2002, the Company recorded $200,000 and $241,000, respectively, as revenue for shipping and handling fees charged to customers. For the three months ended June 30, 2003 and 2002,

the Company recorded $173,000 and $228,000, respectively, of shipping and handling costs as direct cost of product sales in the consolidated statements of operations.

Media revenue consists primarily of the sale of advertisements and sponsorships, both online and offline, under short-term contracts. To date, the duration of the Company’s advertising and sponsorship commitments has generally averaged from one to three months with certain programs lasting up to six months. The Company’s online obligations typically include the guarantee of a minimum number of “impressions” or times that an advertisement appears in pages viewed by the users of the Company’s online properties. Online advertising revenue is generally recognized as the impressions are served during the period in which the advertisement is displayed, provided that no significant obligations of the Company remain and collection of the resulting receivable is reasonably assured.

The Company recognizes revenue for sponsorship arrangements, both online and offline, over the period during which the advertising is provided, generally on a straight-line basis. If the sponsorship arrangement is for the sponsorship of a specific event, the Company recognizes revenue when event occurs. The Company recognizes revenue separately for each element of integrated entertainment marketing packages that offer advertisers a combination of off-line concert and tour sponsorships that are supported by on-line banner advertising, web page sponsorships, emails to the Company’s customers and custom content. The Company determines the fair value of each deliverable based on the fair value of the different deliverables when sold on a stand-alone basis. The Company recognizes revenue for each deliverable as the services are provided. The Company recognizes revenue for the banner impression deliverable as the banner impressions are delivered. The Company recognizes revenue for the customer emails when the emails are sent. The Company recognizes revenue for web page sponsorships on a straight-line basis over the term of the sponsorship. The Company recognizes revenue for custom content when the content is provided to the customer. The Company recognizes revenue for event sponsorships when the event has occurred.

iMusic record label revenue consists primarily of the sale of compact discs by artists signed to iMusic, the brand name used by the Company for the record label operated by its wholly owned subsidiary ARTISTdirect Digital, Inc. The Company recognizes revenues upon the shipment of compact discs from its distributors to retailers and independent wholesalers and records appropriate reserves for product returns. At the time of the shipment of the product, the following criterion under Statement of Financial Accounting Standards (SFAS) No. 48, “Revenue Recognition When Right of Return Exists,” have been met: the seller’s price to the buyer is substantially fixed or determinable at the date of sale; the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; the buyer acquiring the product for resale has economic substance apart from that provided by the seller; the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; the amount of future returns can be reasonably estimated.

The Company estimates the provision for returns on a quarterly basis by album based on the amount of time since the initial album release, the actual returns to date, the trend of sales activity (sales by the retailers and wholesalers) and the number of unsold units at retailers and wholesalers. Returns to the Company’s distributors are deemed to be returns to the Company. iMusic record label revenues recorded for the three months and six months ended June 30, 2003 are net of a provision for returns of $61,000 and $464,000, respectively.

Stock-Based Compensation

The Company accounts for stock-based employee compensation in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and FASB Interpretation No. 44 (FIN 44), “Accounting for Certain Transactions Involving Stock Compensation,” and complies with the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation.” Under APB No. 25, compensation expense is recorded based on the difference, if any, between the fair value of the Company’s stock and the exercise price on the measurement date. The Company accounts for stock issued to non-employees in accordance with SFAS No. 123, which requires entities to recognize as expense over the service period the fair value of all stock-based awards on the date of grant and EITF 96-18, “Accounting for Equity Investments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, which addresses the measurement date and recognition approach for such transactions.

Stock-based compensation included in cost of revenue represents the amortization of non-cash compensation expense related to vendor warrants and stock options granted to artists and their advisors in connection with entering into contractual commitments to operate their online commerce activities. The Company records the fair value of options and warrants granted to non-employees as compensation expense over the period of service. The Company determines the fair value of these options and warrants based on the Black-Scholes option pricing model.

Stock-based compensation included in operating expenses represents the amortization of non-cash compensation expense related to equity instruments granted to employees, directors, professional firms, artists and artist advisors. Compensation for equity grants to non-employees is recorded in the same manner as described above. The Company records stock compensation for employee option grants equal to the excess of the fair value of its common stock over the exercise price on the grant date. The Company records the compensation over the vesting period.

Pro forma information regarding net loss per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of such statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model. The assumptions used in the model and the weighted average fair value of each option granted for 2002 are as follows: risk free interest rate of 4%, volatility of 120%, dividend yield of 0% and a weighted average expected life of 5 years. There have been no option grants in 2003.

For purpose of pro forma disclosures, the estimated fair value of the options is amortized into expense over the options’ vesting period. The Company’s pro forma information follows (in thousands, except per share amount):


			Three Months Ended June 30,						Six Months Ended June 30,
			(Unaudited)						(Unaudited)

			2003			2002			2003			2002

			(in thousands, except for share data)
Net loss as reported			$	5,424		$	15,212		$	12,555		$	28,377
Add: Stock based compensation
		expense reported in net loss
		attributable to common
		shareholders		—			31			—			31
Deduct: Total stock-based compensation
		expense determined under fair
		value methods for all awards		132			225			264			412

Pro forma net loss			$	5,556		$	15,406		$	12,819		$	28,758

Net loss per share:
	Basic and diluted - as reported		$	(1.57	)	$	(4.40	)	$	(3.63	)	$	(8.20	)
	Basic and diluted - pro forma		$	(1.60	)	$	(4.45	)	$	(3.70	)	$	(8.31	)

Impairment of Long-Lived Assets

Impairment of long-lived assets is monitored on a continuing basis, and is assessed based on the undiscounted cash flows generated by the underlying assets. In the event the carrying amount of long-lived assets exceed the undiscounted future cash flows, then the carrying amount of such assets is adjusted to their fair value. There was no

impairment of long-lived assets as of December 31, 2002. In the second quarter of 2003, the Company determined that its fixed assets were impaired due to continuing losses, going concern issues, the delisting of its stock from the NASDAQ and the likelihood that the majority of these assets will be abandoned in the near future. The Company believes that these factors are indicators of impairment and the carrying amount of the fixed assets was reduced to the estimated fair value. The Company recorded a write-off of $2.25 million in the second quarter of 2003.

Estimates

In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Some of the more significant estimates are the allowances for sales returns and inventory obsolescence, reserves on artist advances, allowances for bad debt, impairment of long-lived assets and goodwill, stock based compensation and the valuation allowance on deferred tax assets. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

In November 2002, the FASB’s Emerging Issues Task Force (EITF) issued EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying EITF 00-21, separate contracts with the same entity or related parties that are entered into at or near the same time are presumed to have been negotiated as a package and should, therefore, be evaluated as a single arrangement in considering whether there are one or more units of accounting. That presumption may be overcome if there is sufficient evidence to the contrary. EITF 00-21 also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Alternatively, companies may elect to report the change in accounting as a cumulative-effect adjustment. Early application of this consensus is permitted. The adoption of this accounting pronouncement may have a significant impact on the Company’s financial statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of SFAS No. 123”. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the Notes to these Consolidated Financial Statements. The Company will implement SFAS No. 148 effective January 1, 2003 regarding disclosure requirements for condensed financial statements for interim periods. The Company’s management has determined that they will continue to account for stock-based employee compensation in accordance with APB No. 25.

In February 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”), which addresses the consolidation by business enterprises of variable interest entities, which have one or both of the following characteristics: (1) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional financial support from other parties, or (2) the equity investors lack one or more of the following essential characteristics of a controlling financial interest: (a) the direct or indirect ability to make decisions about the entity’s activities through voting or similar rights, (b) the obligation to absorb the expected losses of the entity if they occur, or (c) the right to receive the expected residual returns of the entity if they occur. FIN 46 will have a significant effect on existing practice because it requires existing variable interest entities to be consolidated if those entities do not effectively disburse risks among parties involved. In addition, FIN 46 contains detailed disclosure requirements. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. This Interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or

more years with a cumulative-effect adjustment as of the beginning of the first year restated. The adoption of this pronouncement may have a significant impact on the Company’s consolidated financial statements due to the Company’s investment in ARTISTdirect Records.

NOTE 4 – INVESTMENT IN ARTISTDIRECT RECORDS, LLC

In May 2001, the Company entered into an agreement with veteran entertainment executive Frederick W. “Ted” Field to become Chairman and Chief Executive Officer of ARTISTdirect and form a new record label, ARTISTdirect Records, LLC, in partnership with ARTISTdirect. On June 29, 2001, ARTISTdirect stockholders approved the employment of Mr. Field and the formation of the record label. ARTISTdirect Records was formed as a 50/50 co-venture between ARTISTdirect and Mr. Field, with the Company providing a significant financial commitment.

In November 2001, ARTISTdirect Records agreed in principle to enter into a preliminary North American distribution agreement and worldwide license agreement with BMG, the global music division of Bertelsmann AG. Under the terms of the agreement, BMG Distribution will distribute ARTISTdirect Records’ releases in North America, and BMG will license ARTISTdirect Records’ repertoire in territories throughout the world. In April 2002, the agreements with BMG were finalized including BMG’s purchase of 5% of the equity of ARTISTdirect Records from the Company. As part of this transaction, BMG agreed to assume $5.0 million of the Company’s funding commitment to ARTISTdirect Records. In December 2002, BMG exercised its option to extend the term of the distribution and license agreement until September 2004.

The Company initially committed to the venture a total of $50 million over five years with the Company committing to fund up to $15.0 million per year, subject to a limit of $33 million in any three year period. Any funding in excess of these amounts would require the approval of the Company’s Board of Directors. As a result of the BMG equity purchase, the Company’s funding commitment was reduced to $45 million of which it has advanced $33.0 million as of June 30, 2003.

In August 2002, the Company’s Board of Directors approved an agreement (the “Bridge Loan Agreement”) to accelerate up to $10 million of its funding commitment to ARTISTdirect Records. This funding was in addition to the $15 million that the Company was obligated to advance to ARTISTdirect Records in 2002 as part of the initial $50 million funding commitment. During 2002, the Company funded its $15 million commitment plus the additional $10 million bridge loan for total advances to the record label of $25.0 million in 2002 and $30.25 million from the inception of the record label through December 31, 2002. The $10 million of accelerated funding was credited toward the satisfaction of the Company’s overall funding commitment and funding obligation for 2003 resulting in a remaining funding commitment of $2.75 million for 2003 and $12.0 million for 2004. The Company’s commitment to fund ARTISTdirect Records is subject to a guaranty for the benefit of BMG. Should the Company fail to meet its commitment, BMG may choose to enforce the guaranty or provide substitute financing that could result in dilution of the Company’s interest in ARTISTdirect Records.

As consideration for entering into the Bridge Loan Agreement and funding the additional $10 million, the Company received an additional 20% interest in ARTISTdirect Records from Radar Records Holdings, L.L.C. (“FieldCo,” the entity through which Mr. Field owns his interest in ARTISTdirect Records) which resulted in an increase in the Company’s ownership share of ARTISTdirect Records to 65% from 45% and a decrease in Mr. Field’s ownership share to 30% from 50% (the “Ownership Transfer”). The Bridge Loan Agreement also provides that any dilution from the issuance of equity interests in ARTISTdirect Records that would have been borne solely by the Company will be borne both by FieldCo and the Company pro rata with their then respective ownership interests. Furthermore, the Bridge Loan Agreement contains a provision designed to provide the Company with a minimum compound annual rate of return of 25% based upon the realized value of the Bridge Loan Agreement and the Ownership Transfer, however, there can be no assurance that such rate of return will be realized. Consequently, the Company has not recorded any amounts related to the 25% minimum annual compounded return.

In June 2003, ARTISTdirect Records raised $900,000 of additional capital from several outside investors and $250,000 from Ted Field, CEO of the Company and ARTISTdirect Records, through the issuance of Convertible Promissory Notes (the “Bridge Notes”). The Bridge Notes accrue interest at an annual rate of 8% and shall be converted into new equity in ARTISTdirect Records when an aggregate amount of at least $3.0 million, including the $1.15 million of Bridge Notes already issued, of new financing is raised. The Bridge Notes are due in June 2005. In

addition, the holders of the Bridge Notes received warrants with a term of five years to purchase additional equity of ARTISTdirect Records at $.01 per unit equivalent to the number of units of new equity that their Bridge Notes are converted into. The relative fair value of the warrants was $575,000, which was recorded as additional paid in capital, resulting in a discount on the carrying amount of the Bridge Notes. The Bridge Notes are convertible into equity based on their face amount, which results in a beneficial conversion feature with a relative fair value of $575,000. The resulting carrying amount of the Bridge Notes is $0. The fair value of the warrants is being expensed over the term of the Bridge Notes. Since the commitment date for the beneficial conversion feature is contingent upon the completion of the financing round, the fair value of the beneficial conversion feature will be expensed upon the completion of a financing round of an aggregate amount of at least $3.0 million.

ARTISTdirect Records will require additional capital during the remainder of 2003, and therefore the Company is continuing to pursue alternatives to raise additional capital for both itself and for ARTISTdirect Records. However, there can be no assurance that additional capital can be obtained by either the Company or by ARTISTdirect Records on reasonable terms or at all. If additional funds were raised through the issuance of equity securities of either the Company or ARTISTdirect Records, the percentage ownership of the Company’s current stockholders in the Company and/or the Company’s ownership of ARTISTdirect Records would be reduced. Failure to raise additional capital could seriously harm the business of ARTISTdirect Records and impair the value of the Company’s investment in ARTISTdirect Records. In such event, ARTISTdirect Records may seek to divest all or certain of its assets or the Company may seek to divest all or a part of its ownership of ARTISTdirect Records, in order to raise the capital necessary to sustain business operations of the Company and/or ARTISTdirect Records. Should this fail, ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss of the Company’s investment in ARTISTdirect Records.

Because the Company does not have voting or operating control of ARTISTdirect Records, even with its majority ownership position, it does not consolidate the results of ARTISTdirect Records and it records its share of losses based on the equity method of accounting as loss from equity investments in its consolidated statements of operations. Prior to the completion of BMG’s purchase of a 5% interest in ARTISTdirect Records in April 2002 and BMG’s assumption of 10% of the Company’s total funding commitment, the Company had committed to fund 100% of the operations of ARTISTdirect Records and has recorded 100% of the losses attributable to that venture from the inception of ARTISTdirect Records to April 30, 2002. Since May 1, 2002, the Company has recorded only its proportionate share, on the basis of remaining relative funding commitments, of any losses of ARTISTdirect Records. The Company recognized $2.4 million and $7.1 million of equity loss for the three and six months ended June 30, 2003, respectively compared with equity losses of $9.6 million and $18.0 million for the three and six months ended June 30, 2002, respectively. During the three months ended June 30, 2003, the Company’s cumulative losses recognized since inception of ARTISTdirect Records reached $45.0 million, the amount of its reduced funding commitment plus it’s initial capital contribution. As a result, the Company ceased recording any additional equity losses beyond that amount and does not anticipate recording any additional equity losses in the future.

The Company charged ARTISTdirect Records $225,000 and $562,500 for the three and six months ended June 30, 2003, respectively, and $337,500 and $675,000, for the three and six months ended June 30, 2002, for the reimbursement of overhead costs including rent and other occupancy costs and shared personnel. These amounts are reflected as a reduction in general and administrative expense in the Company’s consolidated statements of operations.

The carrying amount of the Company’s investment in ARTISTdirect Records represents the difference between the Company’s investment and advances and the Company’s share of losses from ARTISTdirect Records. The Company records its loan advances to ARTISTdirect Records as additional equity investments. As of June 30, 2003 and December 31, 2002, the Company’s share of losses exceeded the amount of the Company’s investment and advances to those dates, resulting in a credit balance of approximately $12.0 million and $7.7 million, respectively. Therefore, the carrying amounts have been classified as a liability on the Company’s balance sheet.

The Company has no recorded investment in the loans to ARTISTdirect Records, as the carrying amount of the loans have been reduced to zero as a result of the Company recording its share of losses of ARTISTdirect Records as of June 30, 2003 and December 31, 2002. The Company does not record interest income on the loans to ARTISTdirect Records.

A roll forward of the Company’s net investment balance for the periods indicated is as follows:


	Six Months
	Ended
	June 30, 2003

	(in thousands)
Balance, beginning of period	$	(7,699	)
Investment and advances		2,750
Intercompany activity with ARTISTdirect Records, LLC		(1	)
Equity losses recorded		(7,050	)

Balance, end of period	$	(12,000	)

The income statements for ARTISTdirect Records, LLC for the three and six months ended June 30, 2003 and 2002 are as follows (amounts in thousands):

ARTISTdirect Records, LLC

Statements of Operations

(amounts in thousands)


			Three Months Ended						Six Months Ended
			June 30,						June 30,

			2003			2002			2003			2002

			(Unaudited)						(Unaudited)
Net revenue			$	217		$	959		$	1,175		$	1,801
Cost of revenue:
	Manufacturing and distribution expenses			102			297			376			578
	Advances and royalties, net			244			3,029			1,316			6,186

		Total cost of revenue		346			3,326			1,692			6,764
		Gross loss		(129	)		(2,367	)		(517	)		(4,963	)
Operating expenses:
	Sales and marketing			1,085			4,607			3,123			6,854
	General and administrative			2,345			3,994			5,485			7,545
	Depreciation			12			7			25			11
	Loss from impairment of fixed assets			100			—			100			—

		Total operating expenses		3,542			8,608			8,733			14,410
		Loss from operations		(3,671	)		(10,975	)		(9,250	)		(19,373	)
	Interest expense, net			522			292			1,141			434

		Net loss	$	(4,193	)	$	(11,267	)	$	(10,391	)	$	(19,807	)

The balance sheets for ARTISTdirect Records, LLC as of June 30, 2003 and December 31, 2002 are as follows (amounts in thousands):

ARTISTdirect Records, LLC

Balance Sheets

(amounts in thousands)


			June 30,			December 31,
			2003			2002

			(Unaudited)
Assets
Current assets:
	Cash		$	417		$	—
	Accounts receivable, net			66			18
	Inventory, net			13			85
	Prepaid expenses			19			118

		Total current assets		515			221
Property and equipment, net				106			231
Other assets, net				—			85

			$	621		$	537

Liabilities and Members’ Equity (Deficit)
Current liabilities:
	Accounts payable		$	829		$	531
	Accrued expenses			1,704			2,123
	Net liability to distributor			8,843			4,113

		Total current liabilities		11,376			6,767
Interest payable				2,420			1,276
Loan advances from related parties				37,750			35,000
Bridge notes				—			—

		Total liabilities		51,546			43,043
Members’ Equity (Deficit)				(50,925	)		(42,506	)

			$	621		$	537

NOTE 5 – BUILDING LEASE

In June 2003, the Company initiated discussions with its landlord regarding the potential termination or restructuring of its office lease that extends until April 2010. On June 24, 2003 the landlord filed suit against the Company for unlawful detainer of its premises and in July 2003 the landlord drew down the entire remaining $1.35 million letter of credit that the Company had put forth as a security deposit in conjunction with the execution of the original lease. The Company still has $350,000 of restricted cash as part of a separate letter of credit for the security of our e-commerce credit card processor. The Company and landlord are in discussions regarding a possible resolution of the dispute. However, until a resolution is reached, the Company remains obligated under its lease.

NOTE 6 – SEGMENT INFORMATION

As of June 30, 2003, the Company operated primarily through three reportable segments: E-commerce operations (“E-commerce”), Media operations (“Media”) and Record Label operations through its iMusic record label and its 65% equity interest in ARTISTdirect Records LLC, its co-venture with Ted Field. However, because the Company does not exert voting and operating control over ARTISTdirect Records, its results are not consolidated. Therefore, results shown for Record Label operations reflect only the iMusic record label.

During the second quarter of 2003, the Company decided to scale back the activity of its iMusic label in order to conserve capital and it does not expect to sign any additional artists. In addition, the Company is in negotiations with a third party to assign its rights and related future liabilities to six unreleased artists in exchange for retaining a profit interest in the projects. The Company itself does not plan to release any further iMusic releases domestically and has approximately six albums yet to release internationally through its international distributors.

Prior to December 2001, the Company also considered its talent agency business to be a segment, but the Company decided in December 2001 to exit this business and as a result it has been shown as a discontinued operation in the consolidated statements of operations. The segment data below has been restated for all periods to reflect the current segment structure.

E-commerce revenue is generated from the sale of recorded music and music-related merchandise. Media revenue is generated from the sale of advertising and sponsorships, both online and offline. Record label revenue is generated from the sale of recorded music performed by artists signed to the Company’s wholly owned iMusic record label.

The factors for determining reportable segments were based on service and products. Each segment is responsible for executing a unique marketing and business strategy. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on EBITDA (earnings or loss before interest, taxes, depreciation and amortization, including stock based compensation, and loss from impairment of goodwill). Included in EBITDA loss are direct operating expenses for the segment. The following table summarizes the revenue and EBITDA loss by segment for the three and six months ended June 30, 2003 and 2002. Corporate expenses consist of general operating expenses that are not directly related to the operations of the segments.


		Three months ended June 30,						Six months ended June 30,

		2003			2002			2003			2002

		(in thousands)						(in thousands)
Net Revenue:
	E-commerce	$	855		$	1,118		$	1,666		$	2,368
	Media		624			323			758			404
	Record Label		497			—			1,251			—

		$	1,976		$	1,441		$	3,675		$	2,772

EBITDA:
	E-commerce		103			(115	)		191			(201	)
	Media		1			(637	)		(574	)		(1,642	)
	Record Label		14			—			(478	)		—

			118			(752	)		(861	)		(1,843	)
	Corporate		(972	)		(1,846	)		(2,120	)		(3,524	)

		$	(854	)	$	(2,598	)	$	(2,981	)	$	(5,367	)


			Three months ended June 30,						Six months ended June 30,

			2003			2002			2003			2002

			(in thousands)						(in thousands)
Reconciliation of EBITDA to Net Loss:
	EBITDA per Segments		$	(854	)	$	(2,598	)	$	(2,981	)	$	(5,367	)
	Stock-based compensation			(27	)		(1,694	)		(61	)		(3,358	)
	Depreciation and amortization			(340	)		(709	)		(753	)		(1,496	)
	Loss from impairment of fixed assets			(2,225	)		—			(2,225	)		—
	Loss from impairment of goodwill			—			(788	)		—			(788	)
	Income (loss) from equity investments			(2,440	)		(9,612	)		(7,050	)		(18,010	)
	Forgiveness of debt			411			—			411			—
	Interest income, net			51			200			104			495
	Income from discontinued operations			—			(11	)		—			147

		Net loss	$	(5,424	)	$	(15,212	)	$	(12,555	)	$	(28,377	)

The following table summarizes assets as of June 30, 2003 and December 31, 2002.


		June 30,		December 31,
		2003		2002

		(in thousands)
Assets:
	Corporate	$	5,589	$	14,455
	E-commerce		460		432
	Media		383		819
	Record Label		301		219

		$	6,733	$	15,925

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

This report on Form 10-Q contains forward-looking statements based on our current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by us. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “may,” “will” or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements include, but are not limited to, statements concerning our unproven business model, increased competition in our industry, our ability to generate revenues from our record label, online product sales, advertising and other revenue streams, and our ability to increase visits to our Web site, to attract and retain artists, to adequately fund our operations and financial commitments, to offer compelling content, to fulfill on-line music and merchandise orders in a timely manner, to build brand recognition, to integrate acquisitions of technology and other businesses, to protect and/or obtain intellectual property rights, and to manage growth. Such statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. The section entitled “Risk Factors” set forth in this report on Form 10-Q and similar discussions in our other filings with the SEC, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. The information contained in this report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our Common Stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC that discuss our business in greater detail.

Overview

We are a music entertainment company that combines an online music network and a record label to provide an integrated offering for music fans, artists and marketing partners. The ARTISTdirect Network (www.artistdirect.com) is a network of Web sites offering multi-media content, music news and information, community around shared music interests, music-related commerce and digital music services. In May 2001, we entered into an agreement with veteran entertainment executive Frederick W. “Ted” Field to become our Chairman and Chief Executive Officer and form a new record label in partnership with us. On June 29, 2001, our stockholders approved the employment of Mr. Field and the formation of the record label, ARTISTdirect Records, LLC, as a 50/50 co-venture between ARTISTdirect and Mr. Field where we agreed to provide a significant financial commitment. Through our co-venture record label, we develop new musical artists and produce and distribute their recordings as an independent label utilizing both traditional channels and emerging Internet distribution channels. In addition to the formation of the record label and our financial commitment, we entered into a five-year employment agreement with Mr. Field and he joined our Board of Directors. Mr. Field also serves as the Chief Executive Officer of ARTISTdirect Records.

In November 2001, we agreed in principle to sell a 5% equity interest in ARTISTdirect Records to BMG Entertainment in connection with entering into a North American distribution agreement and a worldwide licensing agreement with BMG. In April 2002, these agreements were formally executed. As part of this transaction, BMG agreed to assume $5 million of the Company’s funding commitment to ARTISTdirect Records. The Company recorded 100% of the losses attributable to ARTISTdirect Records from inception to April 30, 2002. From May 1, 2002, the Company began recording only its proportionate share, on the basis of relative funding commitments, of the losses of ARTISTdirect Records. In the second quarter of 2003, the amount of cumulative losses recorded by the Company reached its $45 million funding commitment and therefore the Company ceased recognizing any losses in excess of that amount.

In 2002, the Company agreed to accelerate an additional $10 million of funding to ARTISTdirect Records and as part of this agreement, the Company’s ownership interest in ARTISTdirect Records increased from 45% to 65% and the ownership interest of Ted Field decreased from 50% to 30%. This additional $10 million of funding was credited toward the satisfaction of the Company’s overall funding commitment and funding obligation for 2003 resulting in a remaining funding commitment of $2.75 million for 2003 and $12.0 million for 2004. During the six months ended

June 30, 2003, the Company advanced to ARTISTdirect Records the remaining $2.75 million of its 2003 funding commitment and has advanced a total of $33.0 million as of June 30, 2003.

In 2002, our wholly owned subsidiary ARTISTdirect Digital, Inc. began operating a record label under the brand name iMusic. The concept of iMusic was to focus on the signing of established artists with a proven sales base and an ability to generally make records less expensively than developing artists. In addition, its was intended that substantially less would be spent on marketing and promotion of these releases than on those of new artists. During the second quarter of 2003, the Company decided to scale back the activity of its iMusic label in order to conserve capital and it does not expect to sign any additional artists. In addition, the Company is in negotiations with a third party to assign its rights and related future liabilities to six unreleased artists in exchange for retaining a profit interest in the projects. The Company itself does not plan to release any further iMusic releases domestically and has approximately six albums yet to release internationally through its international distributors.

Based upon our available cash resources and our anticipated requirements for working capital to continue our online operations, and meet our funding commitment to ARTISTdirect Records, we face substantial doubt about our ability to continue as a going concern. In order to address this concern, we have implemented substantial cost reductions and have also been pursuing alternatives to raise additional capital both at ARTISTdirect and ARTISTdirect Records in order to continue the operations of both entities. If sufficient funding is not available, then the Company may not be able to fund its own operations or the operations of ARTISTdirect Records, LLC. In such event, the Company may seek to divest all or certain of our assets or the entire company in order to raise the capital necessary to sustain business operations. Should this fail the Company and/or ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss for stockholders. See Liquidity and Capital Resources section for more detail.

In December 2001, we decided to exit the talent agency business because we believed that our prospects for increasing the value of this business were limited and that there were potential conflicts of interests with our new co-venture record label. As a result, we have recorded the net results of this business segment as a discontinued operation in the consolidated statement of operations for all years presented. We completed the wind down of the agency business during 2002.

The Company has significantly reduced its operating costs over the past two years including a reduction in staffing. We expect this to help us reduce our net loss going forward and conserve our cash resources given prevailing market conditions. In addition, our Chief Executive Officer has agreed to a reduction in his salary under his employment agreements with the Company and ARTISTdirect Records. We have incurred cumulative net losses of $254.5 million from inception to June 30, 2003, of which approximately $74.3 million represented stock-based compensation expense. Although we have significantly reduced our operating expenses, especially those related to our online operations, technology infrastructure and marketing, we expect our net losses to continue and to remain significant for the foreseeable future.

We are committed to advance to ARTISTdirect Records an additional $12.0 million in 2004, which exceeds our current available cash. The Company’s commitment to fund ARTISTdirect Records is subject to a guaranty for the benefit of BMG. Should the Company fail to meet its commitment, BMG may choose to enforce the guaranty or provide substitute financing that could result in dilution of the Company’s interest in ARTISTdirect Records.

We have a limited operating history on which to base an evaluation of our business and prospects. Our prospects must be considered in light of the risks, expenses, and difficulties encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets. See “Risk Factors” for a more complete description of the many risks we face. Our business is evolving rapidly, and therefore we believe that period-to-period comparisons of our operating results may not be meaningful and may not be accurate indicators of future performance.

We have identified the following as critical accounting policies: revenue recognition, impairment of long-lived assets and equity grants to employees and non-employees. See discussion of these critical accounting policies below.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the

United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to bad debts, reserves for sales returns, income taxes, long-lived assets, and contingencies and litigation. 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 assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

E-commerce revenue consist primarily of the gross amount of sales revenue paid by the customer for recorded music and merchandise sold via the Internet, including shipping fees, and is recognized when the products are shipped. We record e-commerce revenue on a gross basis as we enter into the sale transactions with customers, establishes the prices of the products, chooses the suppliers of the products, assumes the risk of inventory loss and collects all amounts from the customers and assumes the credit risk. E-commerce revenue is subject to amounts due to the respective artists based on their contracts, and such expense is recorded as part of direct cost of product sales.

We record amounts charged to customers for shipping and handling in accordance with Emerging Issues Task Force 00-10, “Accounting for Shipping and Handling Fees and Costs.” Pursuant to EITF 00-10, the Company records amounts charged to customers for shipping and handling as revenue, and records the related costs incurred for shipping and handling to direct cost of product sales in the consolidated statements of operations. For the three and six months ended June 30, 2003 and 2002, we recorded $200,000 and $402,000, and $241,000 and $494,000, respectively, as revenue for shipping and handling fees charged to customers. For the three and six months ended June 30, 2003 and 2002, we recorded $173,000 and $341,000, and $228,000 and $468,000, respectively, of shipping and handling costs as direct cost of product sales in the consolidated statements of operations.

Media revenue consists primarily of the sale of advertisements and sponsorships, both online and offline, under short-term contracts. To date, the duration of our advertising and sponsorship commitments has generally averaged from one to three months with certain programs lasting up to six months. Our online obligations typically include the guarantee of a minimum number of “impressions” or times that an advertisement appears in pages viewed by the users of our online properties. Online advertising revenue is generally recognized as the impressions are served during the period in which the advertisement is displayed, provided that no significant obligations of the Company remain and collection of the resulting receivable is reasonably assured.

We recognize revenue for sponsorship arrangements, both online and offline, over the period during which the advertising is provided, generally on a straight-line basis. If the sponsorship arrangement is for the sponsorship of a specific event, we recognize revenue when event occurs. We recognize revenue separately for each element of integrated entertainment marketing packages that offer advertisers a combination of off-line concert and tour sponsorships that are supported by on-line banner advertising, web page sponsorships, emails to the our customers and custom content. We determine the fair value of each deliverable based on the fair value of the different deliverables when sold on a stand-alone basis. We recognize revenue for each deliverable as the services are provided. We recognize revenue for the banner impression deliverable as the banner impressions are delivered. We recognize revenue for the customer emails when the emails are sent. We recognize revenue for web page sponsorships on a straight-line basis over the term of the sponsorship. We recognize revenue for the custom content when the content is provided to the customer. We recognize revenue for event sponsorships when the event has occurred.

iMusic record label revenue consists primarily of the worldwide sale of compact discs by artists signed to iMusic, the brand name used by us for the record label operated by its wholly owned subsidiary ARTISTdirect Digital, Inc. We recognize revenues upon the shipment of compact discs from its distributors to retailers and independent wholesalers and records appropriate reserves for product returns. At the time of the shipment of the product, the following criterion under Statement of Financial Accounting Standards (SFAS) No. 48, “Revenue Recognition When Right of Return Exists,” have been met: the seller’s price to the buyer is substantially fixed or determinable at the date of sale; the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; the buyer acquiring the product for resale has economic substance

apart from that provided by the seller; the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; the amount of future returns can be reasonably estimated.

We estimate the provision for returns on a quarterly basis by album based on the amount of time since the initial album release, the actual returns to date, the trend of sales activity (sales by the retailers and wholesalers) and the number of unsold units at retailers and wholesalers. Returns to our distributor are deemed to be returns to the Company. The iMusic record label revenues recorded for the three and six months ended June 30, 2003 are net of a provision for returns of $61,000 and $464,000, respectively.

Stock-Based Compensation

Stock-based compensation included in cost of revenue represents the amortization of non-cash compensation expense related to vendor warrants and stock options granted to artists and their advisors in connection with entering into contractual commitments to operate their online commerce activities. We record the fair value of options and warrants granted to non-employees as compensation expense over the period of service. We determine the fair value of these options and warrants based on the Black-Scholes option-pricing model.

Stock-based compensation included in operating expenses represents the amortization of non-cash compensation expense related to equity instruments granted to employees, directors, professional firms, artists and artist advisors. Compensation for equity grants to non-employees is recorded in the same manner as described above. We record stock compensation for employee option grants equal to the excess of the fair value of its common stock over the exercise price on the grant date. We record the compensation over the vesting period.

Impairment of Long-Lived Assets and Goodwill

We evaluate impairment of long-lived assets (which consist primarily of fixed assets) by comparing the projected future cash flows at the lowest level of discrete financial information, by its operating segments, to the carrying amount of the assets. In the event that projected future cash flows do not appear to be sufficient to recover the carrying amounts of the assets, the Company records an impairment charge to record the assets at their fair value. The fair value represents the discounted projected future cash flows.

Revenue

We currently generate revenues from three sources: E-commerce, Media and iMusic record label. All of our revenue is generated in cash. For the three and six months ended June 30, 2003 and 2002 there was no barter revenue.

E-Commerce Revenue. E-Commerce revenue includes the sale of music and related merchandise, such as apparel, collectibles and accessories, through the ARTISTdirect shopping mall of our network. We recognize the gross amount of product sales and shipping revenue upon shipment of the item and record appropriate reserves for product returns. We have experienced seasonality with respect to our online product sales. In particular, our E-Commerce sales in the fourth quarter have, on average, been higher than in other quarters. We believe that this trend may continue for the foreseeable future. E-commerce revenues have decreased over the past three years as a result of a reduction in the number of official artist stores and corresponding lower traffic to our websites. For the three and six months ended June 30, 2003, e-commerce revenue constituted approximately 43% and 45%, respectively, of our total net revenue for those periods compared with 78% and 85%, respectively, for the three and six months ended June 30, 2002.

Media Revenue. Media revenue consists primarily of sales of banner advertisements and sponsorships. In sales of banner advertisements, we principally earn revenue based on the number of impressions or times an advertisement appears on pages viewed within our Web sites. Our banner advertising commitments generally range from one to six months. Banner advertising revenue is generally recognized as the impressions are served during the period in which the advertisement is displayed, provided that no significant obligations of ARTISTdirect remain and collection of the resulting receivable is probable. We typically guarantee a minimum number of impressions to the advertiser. To the extent that minimum guaranteed page deliveries are not met, we defer recognition of the corresponding revenue until the guaranteed impressions are delivered. We also sell to advertisers sponsorship of a Web page or event for a specified period of time. We recognize sponsorship revenue over the period in which the sponsored page or event is

displayed. To the extent that committed obligations under sponsorship agreements are not met, revenue recognition is deferred until the obligations are met.

For the three and six months ended June 30, 2003, media revenue constituted approximately 32% and 21%, respectively, of our total net revenue for those periods compared with 22% and 15 %, respectively, for the three and six months ended June 30, 2002. Since most of our sponsorship and advertising contracts are short-term in nature, our advertising revenue is susceptible to significant fluctuation. In particular, our net revenue from advertising revenue has significantly decreased over the past three years. This decrease is primarily due to advertisers spending less money on banner advertising and to a lesser degree due to decreased traffic to our websites. Due to the continued weak demand for online advertising, we do not expect our advertising revenues to increase significantly in the near future. During the three and six months ended June 30, 2003, AT&T Wireless accounted for 83% and 73%, respectively of our total media revenue. No other advertiser accounted for more than 10% of our media revenue for that period.

iMusic Record Label Revenue. iMusic record label revenue consists primarily of the sale of compact discs by artists signed to the iMusic record label. The Company recognizes revenues upon the shipment of compact discs to retailers and independent wholesalers and records appropriate reserves for product returns. iMusic is the brand name used by the Company for the record label operated by its wholly owned subsidiary ARTISTdirect Digital, Inc. During the second quarter of 2003, the Company decided to scale back its iMusic operations and does not expect to release any additional albums domestically.

ARTISTdirect Records. ARTISTdirect Records generates revenue primarily from the sale of compact discs by artists signed to the record label. Because the Company is not deemed to have voting or operating control of ARTISTdirect Records, the Company accounts for this investment under the equity method of accounting as loss from equity investments in the consolidated statements of operations.

Cost of Revenue

Direct cost of product sales consists primarily of the cost of merchandise sold, the amounts payable to artists for their share of net proceeds, online transaction costs, including credit card fees, warehousing and fulfillment charges and shipping costs. Direct cost of product sales also includes manufacturing costs and distribution fees payable related to the sales of the iMusic record label.

Other cost of revenue consists primarily of online advertising serving and outside production costs, direct costs related to the organization of sponsorable activities, including payments to artists, Web site hosting and maintenance costs, online content and programming costs, customer service costs, and payroll and related expenses for staff involved in Web site maintenance and content programming.

Stock-based compensation included in cost of revenue represents the non-cash amortization of the estimated value of warrants and options, using the Black-Scholes option pricing model, granted to vendors and to artists and their advisors in connection with entering into contractual commitments to operate their online commerce activities, and is amortized over the life of the associated contract periods. We currently do not intend to grant additional equity interests in the future related to obtaining e-commerce rights from artists.

Operating Expense

Web Site Development. Web site development expense consists primarily of expenses incurred to update the content and design of our Web sites and underlying technology infrastructure. These expenses primarily include payments to third-party service vendors and personnel costs. The implementation of Emerging Issues Task Force No. 00-02, “Accounting for Website Development Costs,” effective July 1, 2000, did not have a material impact on our consolidated financial statements. During 2002, the Company curtailed investment in the development of its websites and does not expect to spend significantly in this area in the foreseeable future.

Sales and Marketing. Sales and marketing expense consists primarily of advertising, marketing and promotion expenses incurred to promote our Web sites, plus payroll and related expenses for personnel engaged in marketing and advertising sales activities. The Company has significantly reduced its sales and marketing expenses over the past three years and does not intend to spend significantly in the foreseeable future.

General and Administrative. General and administrative expense consists of payroll and related expenses for executive and administrative personnel, professional services expenses, facilities expenses, travel and other general corporate expenses.

Stock-based Compensation. Stock-based compensation included in operating expenses represents the amortization of non-cash compensation expense related to equity instruments (including compensation related to the rescission offer) granted to employees, directors, professional firms, and to artists and advisors in connection with the artists entering into contractual commitments to provide promotional services for their online commerce activities. For the three and six months ended June 30, 2003, stock-based compensation expense of approximately $14,000 and $28,000, respectively, was recognized in operating expenses compared with $740,000 and $1.5 million for the three and six months ended June 30, 2002.

We record stock compensation for employee option grants equal to the excess of the fair value of our common stock over the exercise price on the grant date. We record the compensation over the vesting period. For options and warrants granted to non-employees, we record as stock compensation the fair value of the options and warrants (using the Black-Scholes option pricing model) amortized over the related period of service. We may grant additional equity securities in the future to employees, directors, and others.

In December 2001, we completed a rescission offer to certain holders of stock options and shares of Common Stock purchased pursuant to stock options and recorded stock-based compensation expense of approximately $6.9 million. An additional $1.9 million was expensed during 2002 as the initial term of the service agreements related to the rescinded stock options continued into 2002. We did not record any compensation expense related to the shares and options of those holders who chose not to accept the rescission offer. The staff of the Securities and Exchange Commission has taken the position that a person’s federal right of rescission may survive the rescission offer. However, federal courts in the past have ruled that a person who rejects or fails to accept a rescission offer is precluded from later seeking similar relief. We believe that subsequent to the rescission offer, any rights to rescind will be contingent upon legal rulings, the outcome of which are not currently determinable. Accordingly, we will account for shares and options that were not rescinded in the rescission offer as if there is no right of rescission. In the event any rescissions occur subsequent to the expiration of the rescission offer in December 2001, we will account for those rescissions, if any, at the time those rescissions are completed.

Depreciation and Amortization. Depreciation and amortization expense consists of the depreciation of fixed assets.

Interest Income and Expense

Interest income consists of earnings on our cash and cash equivalents, and interest expense consists of interest associated with short-term borrowings and equipment lease obligations.

Results of Operations – ARTISTdirect, Inc.

Three and six months ended June 30, 2003 and 2002

Net Revenue

Three months ended June 30, 2003

Net revenue for the three months ended June 30, 2003 increased 37% to $2.0 million from $1.4 million for the three months ended June 30, 2002. The increase was primarily due to the addition of iMusic record label revenue. iMusic record label revenue was $497,000 for the three months ended June 30, 2003 and there was no activity for the three months ended June 30, 2002. E-Commerce revenue decreased 24% to $855,000 for the three months ended June 30, 2003 from $1.1 million for the three months ended June 30, 2002, primarily due to the decrease in the number of official artist stores, and a reduction in our offering of exclusive music and merchandise that drove sales in 2002. Media revenue increased 93% to $624,000 for the three months ended June 30, 2003 from $323,000 for the three months ended March 31, 2002, primarily due to the execution of an entertainment marketing program that involved online components and a tour sponsorship during the second quarter of 2003.

Six months ended June 30, 2003

Net revenue for the six months ended June 30, 2003 increased 33% to $3.7 million from $2.8 million for the six months ended June 30, 2002. The increase was primarily due to the addition of $1.2 million of iMusic record label revenue for the period compared with no activity during the first half of the prior year. E-Commerce revenue for the first half of 2003 decreased 30% to $1.7 million from $2.3 million for the six months ended June 30, 2002, primarily due to a decrease in the number of official artist stores that the Company operated in 2003. Media revenue for the first half of 2003 increased 88% to $758,000 from $404,000 for the six months ended June 30, 2002, primarily due to an increase in entertainment marketing revenue as a result of a tour sponsorship during the first six months of 2003.

Cost of Revenue

Three months ended June 30, 2003

Direct cost of product sales for the three months ended June 30, 2003 decreased 6% to $809,000 from $862,000 for the three months ended June 30, 2002. The net decrease of $53,000 is a result of an approximate $200,000 decrease in e-commerce direct costs in conjunction with a decrease in revenues offset partially by approximately $150,000 of direct costs of sales related to the iMusic record label. E-commerce direct gross margin decreased during the 2003 due to the decrease in revenues but the margin percentage remained approximately the same compared with 2002.

Other cost of revenue for the three months ended June 30, 2003 decreased 56% to $396,000 from $895,000 for the three months ended June 30, 2002. This $499,000 net decrease was primarily due to an approximate $500,000 decrease in web site hosting and maintenance costs due to a restructuring of our third party service provider agreements, and a reduction in other network indirect costs of revenue of approximately $150,000 offset by an approximately equivalent increase in entertainment marketing costs of revenue.

Stock-based compensation for the three months ended June 30, 2003 decreased 99% to $13,000 from $954,000 for the three months ended June 30, 2002. The decrease in expense is due to the termination of artist stores and the expiration of artist store agreements resulting in the full amortization of the related stock-based compensation in 2002.

Our gross profit (loss) percentage for the three months ended June 30, 2003 improved to 38% from – 88% for the three months ended June 30, 2002. The improvement in gross margin percentage is due primarily to the significant decrease in stock-based compensation and to a lesser degree to the improvement in the Media segment’s gross margin and the addition of approximately $350,000 of gross margin from the iMusic record label.

Six months ended June 30, 2003

Direct cost of product sales for the six months ended June 30, 2003 remained consistent at $1.8 million compared with the six months ended June 30, 2002. However, e-commerce direct cost of sales decreased approximately $500,000 in conjunction with a decrease in revenues and was offset by the manufacturing costs, distribution fees and mechanical royalties related to iMusic record label revenues for the period.

Other cost of revenue for the six months ended June 30, 2003 decreased 49% to $911,000 from $1.8 million for the six months ended June 30, 2002. This $892,000 net decrease was primarily due to an approximate $1.1 million decrease in web site hosting and maintenance costs due to a restructuring of our third party service provider agreements, and a reduction in other network indirect costs of revenue of approximately $150,000 offset by an increase in entertainment marketing costs of revenue of approximately $200,000 and approximately $150,000 of iMusic artist advances during the period.

Stock-based compensation for the six months ended June 30, 2003 decreased 98% to $33,000 from $1.9 million for the six months ended June 30, 2002. The decrease in expense is due to the termination of artist stores and the expiration of artist store agreements resulting in the full amortization of the related stock-based compensation in 2002.

Our gross profit (loss) percentage for the six months ended June 30, 2003 improved to 25% from – 100% for the six months ended June 30, 2002. The improvement in gross margin percentage is due primarily to the significant

decrease in stock-based compensation and to a lesser degree to the improvement in the Media segment’s gross margin and the addition of approximately $700,000 of gross margin from the iMusic record label.

Operating Expenses

Web Site Development. We incurred no web site development costs for the three months or six months ended June 30, 2003 compared to $11,000 and $20,000, respectively, for the three months and six months ended June 30, 2002. These decreases were due to a cessation of activity related to the enhancement of our Web sites.

Sales and Marketing. Sales and marketing expense for the three months ended June 30, 2003 decreased 33% to $307,000 compared to $455,000 for the three months ended June 30, 2002. The decrease was due to the termination of an online advertising agreement during the second quarter of 2003 and a reduction in payroll expense partially offset by the addition of iMusic record label marketing expenses in 2003.

Sales and marketing expense for the six months ended June 30, 2003 remained approximately the same at $1.1 million compared with the first half of 2002. However, during the first half of 2003, sales and marketing related payroll expense and online advertising expense decreased in aggregate by approximately $700,000 compared with the first half of 2002 due to the elimination of internal sales staff and outside sales consultants and termination of an online advertising agreement. This increase was offset by approximately $700,000 of marketing expenses related to iMusic record label releases.

General and Administrative. General and administrative expense for the three months ended June 30, 2003 decreased 27% to $1.3 million from $1.8 million for the three months ended June 30, 2002. This decrease was primarily attributable to a decrease in payroll and related costs as well as decreases in insurance and travel and entertainment expenses.

General and administrative expense for the six months ended June 30, 2003 decreased 17% to $2.8 million from $3.4 million for the six months ended June 30, 2002. This decrease was primarily attributable to a decrease in payroll and related costs as well as decreases in insurance, travel and entertainment expenses and legal fees.

Stock-based Compensation. Stock-based compensation for the three and six months ended June 30, 2003 was $14,000 and $28,000, respectively, compared with $740,000 and $1.5 million for the three and six months ended June 30, 2002. These decreases were primarily due to the termination of artist promotion agreements in 2002 in connection with the completion of terms and closure of artist stores resulting in full-amortization of stock-based compensation expense in 2002.

Depreciation and Amortization. Depreciation and amortization expense for the three and six months ended June 30, 2003 was $340,000 and $753,000, respectively, compared to $709,000 and $1.5 million for the three and six months ended June 30, 2002. These decreases were primarily due to the full depreciation of certain fixed assets during 2002 and the absence of any significant new fixed asset purchases.

Loss from Impairment of Fixed Assets. Loss from impairment of fixed assets for the three and six months ended June 30, 2003 was $2.2 million compared with $0 for the same periods in 2002. The increases are due to the impairment of Company’s net fixed assets that were recorded during the quarter ended June 30, 2003

Loss from Impairment of Goodwill. Loss from impairment of goodwill for the three and six months ended June 30, 2003 was $0 compared with $788,000 for the same periods in 2002. The decrease is due to the write-off of the remaining unamortized goodwill of the Company from acquisitions in previous periods during the second quarter of 2002.

Income (loss) from Equity Investments. Loss from equity investments for the three and six months ended June 30, 2003 was $2.4 million and $7.1 million, respectively, compared to $9.6 million and $18.0 million, respectively, for the three and six months ended June 30, 2002. The decreases in the loss from equity investments are due to decreases in the losses from operations of our record label venture, ARTISTdirect Records.

See additional discussion and analysis of ARTISTdirect Records in the section “Results of Operations –

ARTISTdirect Records, LLC below.

Forgiveness of Debt. Forgiveness of debt for the three and six months ended June 30, 2003 was $411,000 compared to $0 for the same periods in 2002. The forgiveness of debt in 2003 was due to an executive of the Company forgiving deferred salary amounts during the quarter ended June 30, 2003.

Interest Income and Expense.

Interest income for the three months ended June 30, 2003 decreased 75% to $51,000 from $200,000 for the three months ended June 30, 2002. The decrease was due to lower available cash balances for the relevant period as well as lower interest rates.

Interest income for the six months ended June 30, 2003 decreased 79% to $104,000 from $495,000 for the six months ended June 30, 2002. The decrease was due to lower available cash balances for the relevant period as well as lower interest rates.

Net Loss

Three months ended June 30, 2003

Net loss for the three months ended June 30, 2003 decreased $9.8 million, or 64%, to $5.4 million compared to $15.2 million for the three months ended June 30, 2002. The decrease in the net loss is primarily attributable to a $2.0 million increase in gross profit, a $7.2 million decrease in the loss from the Company’s equity investment in ARTISTdirect Records, which were partially offset by a $2.2 million increase in loss from impairment of fixed assets. In addition, the Company realized an approximate $150,000 decrease in sales & marketing expenses, $500,000 decrease in general & administrative expenses, a $1.1 million decrease in non-cash stock-based compensation and depreciation, an approximate $800,000 decrease in the loss from impairment of goodwill, and a $411,000 increase in the forgiveness of debt.

Six months ended June 30, 2003

Net loss for the six months ended June 30, 2003 decreased $15.8 million, or 56%, to $12.5 million compared to $28.4 million for the six months ended June 30, 2002. The decrease in the net loss is primarily attributable to a $3.7 million increase in gross profit, a $11.0 million decrease in the loss from the Company’s equity investment in ARTISTdirect Records, which were partially offset by a $2.2 million increase in loss from impairment of fixed assets. In addition, the Company realized an approximate $560,000 decrease in general & administrative expenses, $2.2 million decrease in non-cash stock-based compensation and depreciation , an approximate $800,000 decrease in the loss from impairment of goodwill, and a $411,000 increase in the forgiveness of debt.

Liquidity and Capital Resources – ARTISTdirect, Inc.

As of June 30, 2003, we had $866,000 of unrestricted cash and cash equivalents and held $2.5 million in short-term investments.

Net cash used in operating activities was $2.4 million for the six months ended June 30, 2003, compared with $6.8 million for the six months ended June 30, 2002. Net cash used in operating activities for each of these periods primarily consisted of net losses partially offset by non-cash items such as the loss from equity investments, loss from impairment of fixed assets, stock-based compensation, and depreciation and amortization.

Net cash provided by investing activities was $861,000 for the six months ended June 30, 2003, which resulted primarily from net sales of short-term investments of $3.6 million, offset by advances of $2.75 million to the record label venture. Net cash used in investing activities was $7.1 million for the six months ended June 30, 2002, which resulted primarily from advances of $11.25 million to the record label venture offset by net sales of short-term investments of $4.1 million.

Net cash provided by financing activities was $453,000 for the six months ended June 30, 2003, which resulted primarily from a decrease in restricted cash. Net cash used in financing activities for the six months ended June 30, 2002 was $294,000 that resulted primarily from an increase in restricted cash during that period.

As of June 30, 2003, our principal commitments consisted of our obligation to fund ARTISTdirect Records with an additional $12.0 million ($45 million commitment less $33.0 million advanced by us through June 30, 2003) and obligations outstanding under operating leases and employment contracts. Our most significant operating lease liability relates to leased office space and we are currently in discussions with our landlord about terminating our lease and settling our lease obligation.

A summary of our contractual cash obligations, excluding the record label funding commitment, as of June 30, 2003, is as follows:


				Payments Due by Period (in thousands)
				Less than		Between		Between		After
Contractual cash obligations		Total		1 year		2-3 years		4-5 years		5 years

Operating leases (1)		$	12,884	$	1,756	$	3,714	$	3,868	$	3,546
Employment contracts (2)			1,500		500		1,000		—		—

	Total contractual cash obligations (excluding record label commitments)	$	14,384	$	2,256	$	4,714	$	3,868	$	3,546

(1) The Company is currently in negotiations with its landlord about terminating its office lease. No formal agreement has yet been executed but if the Company is successful in terminating its office lease, the Company’s cash obligations under operating leases as shown above will be reduced by approximately $870,000 in 2003, $1.8 million in 2003 and 2004, $1.9 million in 2005 thru 2009, and $600,000 in 2010.

(2) During 2002, certain employment agreements were amended whereby certain executives agreed to defer all or a portion of their future salaries until the Company raised new debt or equity financing of at least $20 million. During the three months ended June 30, 2003, one of these employment agreements was further amended whereby all future salary would be reduced, even if new debt or equity financing is raised. The contractual cash obligations under employment contracts shown above reflect the current gross contractual commitments as of June 30, 2003. If amounts being deferred do not become payable, the Company’s cash obligations under employment agreements as shown above will be reduced by $125,000 during 2003, $250,000 annually during 2004 and 2005 and by $125,000 during 2006.

We currently anticipate that available cash resources, including short-term investments, will likely not be sufficient to meet anticipated needs for working capital and capital expenditures for the next twelve months without additional capital or a significant reduction of operating expenses that would likely include a shut-down, disposition of operations or divestiture of assets. Furthermore, ARTISTdirect Records will require additional capital during 2003 to continue its operations. We have implemented substantial cost reductions with the goal of improving our ability to operate as a going concern. However, there can be no assurance that these efforts will be sufficient to enable us to operate as a going concern on a sustained basis. We are also pursuing alternatives to raise additional capital in order to continue funding of ARTISTdirect and ARTISTdirect Records. There can be no assurance that additional capital can be obtained by either ARTISTdirect or by ARTISTdirect Records on reasonable terms, in a timely manner or at all. If additional funds are raised through the issuance of equity securities of either ARTISTdirect or ARTISTdirect Records, the percentage ownership of current stockholders in ARTISTdirect, and our ownership interest in ARTISTdirect Records, will be reduced. If we raise additional funds by issuing debt, we may be subject to limitations on our operations, including limitations on the payment of dividends, and any debt issued by ARTISTdirect Records may be senior to the obligations of ARTISTdirect Records to ARTISTdirect. Failure to raise additional capital could seriously harm our business and the business of ARTISTdirect Records and impair the value of our investment in ARTISTdirect Records. In such event, ARTISTdirect and/or ARTISTdirect Records may seek to divest all or certain of their assets or we may seek to divest all or a part of our ownership of ARTISTdirect Records, in order to raise the capital necessary to sustain business operations of ARTISTdirect and/or ARTISTdirect Records. Should this fail, ARTISTdirect and/or ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or

undertake liquidation, potentially resulting in a total loss for our stockholders and/or a total loss of our investment in ARTISTdirect Records.

Results of Operations – ARTISTdirect Records, LLC

The following discussion of the results of operations of ARTISTdirect Records, LLC for the three months and six months ended June 30, 2003 and 2002, is provided for additional information.

Net Revenue

Net revenue for the three and six months ended June 30, 2003 was $217,000 and $1.2 million, respectively, compared with $959,000 and $1.8 million, respectively, for the three and six months ended June 30, 2002. During the first half of 2003, ARTISTdirect Records released one album, The Blood Brothers’ Burn, Piano, Burn in March 2003 compared with two albums released during the first half of 2002, Custom’s Fast and Badly Drawn Boy’s About a Boy. In addition, during the first half of 2003, additional units were shipped for a number of the label’s 2002 releases including most prominently Smilez and Southstar’s Crash the Party. Net revenues for the six months ended June 30, 2003 and 2002, are net of return provisions of $771,000 and $436,000, respectively.

Cost of Revenue

Direct cost of product revenue includes manufacturing costs and distribution fees payable to BMG and the provision for artist advances and royalty expense. Manufacturing and distribution expenses for the three and six months ended June 30, 2003 were $102,000 and $376,000, respectively, compared with $297,000 and $578,000, respectively, for the three and six months ended June 30, 2002. The decrease in these expenses was due to the decrease in shipped albums during 2003 compared with the prior year period.

Advances and royalties include amounts paid to artists or producers signed to the label, costs paid for the recording of albums and royalties earned from the sales of such albums. Advances are typically recoupable against royalties earned by the artists or producers upon the sale of their albums. Advances and royalties, net of recoupment, for the three and six months ended June 30, 2003 were $244,000 and $1.3 million, respectively, compared with $3.0 million and $6.2 million, respectively, for the three and six months ended June 30, 2002. The decreases were due primarily to a decrease in the signing and recording activity during the first half of 2003 compared with 2002 as well as an advance payment made during the first half of 2002 to a producer.

Operating Expenses

Sales and Marketing. Sales and marketing expense represents costs of sales, marketing, promotion, publicity and video production related to ARTISTdirect Records’ albums released during the period as well as the related costs for setting up future releases. Sales and marketing expense for the three and six months ended June 30, 2003 was $1.1 million and $3.1 million, respectively, compared with $4.6 million and $6.9 million, respectively, for the three and six months ended June 30, 2002. The decrease in expenses is due to lower amounts being expended on the marketing and promotion of singles and a decrease in the first half of 2003 in the number of albums being set up for future release compared with activity during the first half of 2002.

General and Administrative. General and administrative expense represents payroll and related expenses, costs for travel & entertainment, outside legal fees and general office and communication expenses. General and administrative expense for the three months and six months ended June 30, 2003 was $2.3 million and $5.5 million, respectively, compared with $4.0 million and $7.5 million, respectively, for the three and six months ended June 30, 2002. The decreases were due primarily to decreases in payroll and related, travel & entertainment and outside legal expenses.

Loss from Impairment of Fixed Assets. Loss from impairment of fixed assets for the three and six months ended June 30, 2003 was $100,000 compared with $0 for the same periods in 2002. The increase is due to the write-off of certain of the Company’s net fixed assets that were deemed to be impaired as of June 30, 2003 due to the likelihood of future abandonment of certain leasehold improvements.

Interest Expense. Interest expense represents the accrual of interest on loan advances made to ARTISTdirect Records from ARTISTdirect, Inc. and BMG. Interest expense for the three months and six months ended June 30, 2003 was $522,000 and $1.1 million, respectively, compared to $292,000 and $434,000, respectively, for the three

and six months ended June 30, 2002. The increases are due to an increase in the total loan balances during 2003 compared with 2002.

Net Loss

Net loss was $4.2 million and $10.4 million for the three and six months ended June 30, 2003, respectively, compared with $11.3 million and $19.8 million, respectively, for the three and six months ended June 30, 2002. The decreases in net loss of $7.1 million and $9.4 million, respectively, were due to decreases in gross loss for the three and six months ended June 30 of $2.2 million and $4.4 million, respectively, and lower sales and marketing expenses of $3.5 million and $3.7 million, respectively, and lower general and administrative expenses of $1.7 million and $2.1 million, respectively.

Liquidity and Capital Resources – ARTISTdirect Records, LLC

As of June 30, 2003, ARTISTdirect Records had approximately $400,000 of cash on hand. During the six months ended June 30, 2003, ARTISTdirect made loan advances to ARTISTdirect Records of $2.75 million for a total amount of loan advances of $33.0 million since inception. In June 2003, ARTISTdirect Records received $1.15 million from several individual investors, including $250,000 from CEO Ted Field, under Convertible Promissory Notes that will convert to equity if at least $3.0 million (including the $1.15 million) of additional financing is raised. In April 2003, BMG made distribution advances to ARTISTdirect Records of $3.0 million ($5.0 million of additional advances less $2.0 million retained as an offset against prior distribution advances that had not yet been recouped) in conjunction with its North American distribution agreement and worldwide license agreement. In aggregate, BMG has made a total of $10.0 million ($12.0 million of gross advances less $2.0 million retained against unrecouped amounts) of distribution advances.

In order to continue its operations, ARTISTdirect Records will require additional capital during the remainder of 2003. We are currently pursuing alternatives to raise additional capital in order to continue operations of ARTISTdirect Records. There can be no assurance that additional capital can be obtained by the Company or ARTISTdirect Records on reasonable terms or at all. Failure to raise additional capital could seriously harm the business of ARTISTdirect Records. In such event, ARTISTdirect Records may seek to divest all or certain of its assets in order to raise the capital necessary to sustain business operations. Should this fail, ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss of our investment. If additional funds were raised through the issuance of equity securities, our percentage ownership of ARTISTdirect would be reduced.

RISK FACTORS

Before investing in our company or deciding to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the Securities and Exchange Commission. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment.

We Face Substantial Doubt About Our Ability To Continue As A Going Concern Without Further Substantial Cost Reductions And/Or Additional Financing

The report from our Independent Auditors for the year ended December 31, 2002 includes an explanatory paragraph that describes substantial doubt concerning our ability to continue as a going concern given our current available cash resources. In order to address this concern, we are implementing substantial cost reductions designed to allow us to operate as a going concern. However, there can be no assurance that these efforts will be sufficient to enable us to operate as a going concern on a sustained basis. In addition, we are pursuing alternatives to raise additional capital both at ARTISTdirect and ARTISTdirect Records in order to continue the operations of both entities. We do not have any formal commitments at this time and there can be no assurance that additional capital can be obtained either by ARTISTdirect or by ARTISTdirect Records on reasonable terms, in a timely manner or at

all. If additional funds are raised through the issuance of equity securities of either ARTISTdirect or ARTISTdirect Records, the percentage ownership of current stockholders in ARTISTdirect, and our ownership interest in ARTISTdirect Records, will be reduced. If we raise additional funds by issuing debt, we may be subject to limitations on our operations, including limitations on the payment of dividends, and any debt issued by ARTISTdirect Records may be senior to the obligations of ARTISTdirect Records to ARTISTdirect. Failure to raise additional capital could seriously harm our business and the business of ARTISTdirect Records and impair the value of our investment in ARTISTdirect Records. In such event, ARTISTdirect and/or ARTISTdirect Records may seek to divest all or certain of their assets or we may seek to divest all or a part of our ownership of ARTISTdirect Records, in order to raise the capital necessary to sustain business operations of ARTISTdirect and/or ARTISTdirect Records. Should this fail, ARTISTdirect and/or ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss for our stockholders and/or a total loss of our investment in ARTISTdirect Records.

It Is Difficult To Evaluate Our Business And Prospects Because We Have A Limited Operating History And Rapidly Evolving Business

Our limited operating history and rapidly evolving business make it difficult to evaluate our prospects or to accurately predict our future revenue or results of operations. Our revenue and income potential are unproven, and our business model is constantly and rapidly evolving. In particular, the Internet is constantly changing and we may need to modify our business model to adapt to these changes. In addition, our decision to focus a substantial portion of both our human and capital resources on our record label businesses, ARTISTdirect Records and iMusic, represents entry into a business new to us that entails significant uncertainty.

Our Business Model Is New And Unproven, And We May Not Be Able To Generate Sufficient Revenue To Operate Our Business Successfully

Our model for conducting business and generating revenue is new and unproven. Our success will depend primarily on our ability to generate revenue and income from ARTISTdirect Records and our iMusic record label and from multiple sources through the ARTISTdirect Network, including:

• online sales of music and related merchandise;

• sales of advertising and sponsorships;

• marketing our database of consumer information and preferences;

• sales of, or subscription fees for, digitally distributed music; and

• sales of music CDs by the ARTISTdirect Records and iMusic record labels.

It is uncertain whether a music-related Web site that relies on attracting people to learn about, listen to and purchase music and related merchandise can generate sufficient revenue from electronic commerce, advertising, sales of database information and sales of, or fees for, digital downloads of music, to become a viable business. We provide many of our online features without charge, and we may not be able to generate sufficient revenue to pay for these features. In addition, it may take a significant amount of time for us to develop ARTISTdirect Records with Ted Field and our iMusic record label. Accordingly, we are not certain that our business model will be successful or that we can sustain revenue growth or be profitable. If our markets develop more slowly than expected or become saturated with competitors, or our products and services do not achieve or sustain market acceptance, we may not be able to successfully operate our business.

We Have A History Of Operating Losses And Anticipate Losses And Negative Cash Flow For The Foreseeable Future

To date, we have not been profitable on an annual or quarterly basis and have incurred accumulated losses of approximately $254.5 million as of June 30, 2003. For the three and six months ended June 30, 2003, and the year ended December 31, 2002, we incurred net losses of approximately $5.4 million, $12.6 million and $48.2 million,

respectively, which represented approximately 274%, 341% and 771%, respectively, of our revenue for those periods. We expect our operating losses and negative cash flow to continue for at least the near future. We will need to generate significant additional revenue to achieve profitability. Consequently, it is possible that we may never achieve profitability, and even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis in the future. If we do not achieve or sustain profitability in the future, then we will likely be unable to continue our operations.

Our Operating Results Will Likely Be Unpredictable

Our operating results are likely to fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. Because our operating results are volatile and difficult to predict, our operating results have in the past, and in the future may, fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock may fall significantly.

Global Sales of Recorded Music Have Recently Declined and This Trend May Continue in the Future

Based on data compiled by the International Federation of the Phonographic Industry (IFPI), global sales of recorded music declined 1.3% in value and 1.2% in units from 1999 to 2000, declined 5.0% in value and 6.5% in units from 2000 to 2001, and declined 9.2% in value and 11.2% in units in the first half of 2002 compared with the first half of 2001. The IFPI attributes this decline, in part, to widespread copying and illegal Internet downloading of music. This trend of declining sales of recorded music may continue in the future and could have a detrimental impact on revenue at our iMusic and ARTISTdirect Records labels.

If We Are Not Successful In Generating Revenue From The ARTISTdirect Records Co-Venture With Ted Field, Our Business And Financial Condition May Be Materially Adversely Affected

In 2001, we decided to invest a significant amount of our resources in offline activities and in May 2001, we entered into an agreement with music and entertainment veteran, Ted Field, to develop and operate our record label co-venture, ARTISTdirect Records, and to hire Mr. Field as our Chairman of the Board and Chief Executive Officer. ARTISTdirect Records is a relatively new enterprise and faces significant challenges in developing and operating its planned business, including but not limited to the following:

• identifying and entering into recording agreements with artists for ARTISTdirect Records;

• hiring and retaining personnel for ARTISTdirect Records;

• producing and promoting new music recordings for artists signed to ARTISTdirect Records ;

• developing a recognized brand name in the music industry;

• developing distribution channels for ARTISTdirect Records;

• integrating the ARTISTdirect Records operations with our existing operations;

• obtaining the capital necessary to sustain the ARTISTdirect Records operations; and

• generating ARTISTdirect Records revenue and achieving profitability.

ARTISTdirect Records has a very limited operating history upon which to assess whether it will be able to meet all of the challenges required to successfully develop and operate its business. Accordingly, there can be no assurance that Mr. Field will be able to successfully operate ARTISTdirect Records. ARTISTdirect Records may be forced to curtail or cease operations if it is not able to obtain the capital necessary to sustain its operations, in which events the value of our investment in ARTISTdirect Records may be seriously impaired. In such event, ARTISTdirect Records may seek to divest all or certain of its assets or the Company may seek to divest all or a part of its ownership of ARTISTdirect Records, in order to raise the capital necessary to sustain business operations of the Company and/or ARTISTdirect Records. Should this fail, ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss of our investment in ARTISTdirect Records.

There May Be A Significant Conflict Of Interest As A Result Of Ted Field’s Separate Ownership Interest In ARTISTdirect Records And His Dual Roles As Chief Executive Officer Of Both ARTISTdirect Records And The Company

As of December 31, 2002, Mr. Field held options to purchase approximately 12.8% of the currently outstanding voting interests in the Company and also held 30% of the outstanding ownership interests in ARTISTdirect Records, the Company’s record label co-venture. By virtue of the difference in his ownership interests, Mr. Field would likely gain a greater personal benefit if opportunities were realized by ARTISTdirect Records rather than by the Company. Accordingly, there are potential conflicts of interest between the Company and Mr. Field. Although our employment agreement with Mr. Field precludes him from voting on behalf of the Company on matters concerning ARTISTdirect Records, Mr. Field will, by virtue of his authority as Chief Executive Officer of both the Company and ARTISTdirect Records, have substantial influence over the execution of any decisions made by the Company’s management and Board of Directors.

As a result, Mr. Field could, through his day-to-day managerial decisions, take actions that are detrimental to the Company and favorable to ARTISTdirect Records. For instance, Mr. Field could decide to sign a particular artist to the ARTISTdirect Records record label instead of the iMusic record label. In addition, Mr. Field’s concurrent service as the Chief Executive Officer of both the Company and ARTISTdirect Records could allow Mr. Field to devote more time to ARTISTdirect Records than to the Company. Under the terms of the employment agreement with each entity, Mr. Field is required to devote at least 80% of his business time exclusively to the Company and ARTISTdirect Records. However, Mr. Field is allowed to devote all of that business time exclusively to ARTISTdirect Records as long as it does not adversely affect his performance under the terms of his employment agreement with the Company. While the Company does not expect that any of the foregoing events will occur, there can be no assurance that Mr. Field will always act in the best interests of the Company and its stockholders.

We Have Committed A Substantial Amount Of Our Available Cash To The ARTISTdirect Records Co-Venture With Ted Field And, As A Result, The Amount Of Cash That We Will Have Available To Operate Our Other Businesses Has Been Substantially Reduced

The ARTISTdirect Records co-venture with Mr. Field represented a significant shift in the planned use of our cash resources. As of June 30, 2003, we had provided $33.0 million to ARTISTdirect Records and are obligated to provide an additional $12.0 million from 2004 through July 2006, which exceeds our current available cash. As of June 30, 2003, we had unrestricted cash and short-term investments totaling $3.3 million. Our commitment to fund ARTISTdirect Records is subject to a guaranty for the benefit of BMG. Should we fail to meet our commitment, BMG may choose to enforce the guaranty or provide substitute financing that could result in dilution of our interest in ARTISTdirect Records.

We currently anticipate that available cash resources, including short-term investments, may not be sufficient to meet anticipated needs for working capital and capital expenditures for at least twelve months without additional capital. Furthermore, to continue its operations ARTISTdirect Records will require additional capital in 2003 beyond that to be provided by us.

We are currently pursuing alternatives to raise additional capital in order to continue the operations of ARTISTdirect and ARTISTdirect Records. There can be no assurance that additional capital can be obtained by either ARTISTdirect or by ARTISTdirect Records on reasonable terms, in a timely manner or at all. If additional funds are raised through the issuance of equity securities of either ARTISTdirect or ARTISTdirect Records, the percentage ownership of current stockholders in ARTISTdirect and/or ARTISTdirect Records will be reduced. If we raise additional funds by issuing debt, we may be subject to limitations on our operations, including limitations on the payment of dividends, and any debt issued by ARTISTdirect Records may be senior to the obligations of ARTISTdirect Records to ARTISTdirect. Failure to raise additional capital could seriously harm or result in the cessation of the business of ARTISTdirect Records and ARTISTdirect, and impair the value of our investment in ARTISTdirect Records. Cessation of the business of ARTISTdirect Records or ARTISTdirect could result in bankruptcy or liquidation, in either case potentially resulting in a total loss for stockholders of ARTISTdirect.

See Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources for more information on our liquidity and capital resources.

Our Equity Interest In ARTISTdirect Records May Be Significantly Diluted If We Are Unable To Meet Our Financing Commitment

In the event that we fail to provide funding to ARTISTdirect Records as required under the terms of the operating agreement governing the co-venture, ARTISTdirect Records then has the right to secure substitute financing. Among other things, any advances made by us that are outstanding at the time will become subordinated to repayment of the substitute financing and we can be forced to divest certain of our equity interest in ARTISTdirect Records should the issuance of an equity interest to the substitute financier be required as a condition of the substitute financing.

We Do Not Currently Expect Online Advertising To Grow Significantly In The Near Future And As A Result, Our Business May Be Adversely Affected

If we do not increase advertising revenue, our business will be adversely affected. Increasing our advertising revenue depends upon many factors, including our ability to:

• respond to and anticipate fluctuations in the demand for, and pricing of, online advertising;

• develop and maintain key advertising relationships and compete for advertisers with Internet and traditional media companies;

• conduct successful selling and marketing efforts aimed at advertisers;

• successfully develop, sell and execute entertainment marketing solutions;

• increase the size of our audience and the amount of time that our audience spends on our Web sites;

• accurately measure the size and demographic characteristics of our audience;

• offer advertisers the means to effectively target their advertisements to our audience; and

• increase the amount of revenue per advertisement.

Our failure to achieve one or more of these objectives could impair our ability to increase advertising revenue, which could adversely affect our business. In addition to the above factors, general economic conditions, as well as economic conditions specific to online advertising, electronic commerce and the music industry, could affect our ability to increase our advertising revenue. In particular, the growth of online advertising has declined since 2000, which has had, and in the future may continue to have, a significant adverse effect on our revenue from online advertising. We do not currently expect online advertising to grow significantly in the near future. In the past, we have traditionally relied on a limited number of customers for our advertising revenue. For instance, during the three and six months ended June 30, 2003, AT&T Wireless accounted for 83% and 73%, respectively, of our total media revenue. During the year ended December 31, 2002, AT&T Wireless accounted for 14% of our total media revenue. The loss of this customer could have a significant adverse effect on our media revenue.

The Effectiveness Of The Internet For Advertising Is Unproven, Which May Discourage Some Advertisers From Advertising On Our Sites

Our future depends in part on an increase in the use of the Internet and other forms of digital media for advertising. The Internet advertising market is relatively new and rapidly evolving, and we cannot yet gauge the effectiveness of advertising on the Internet as compared to traditional media. As a result, demand for Internet advertising is uncertain. Many advertisers have little or no experience using the Internet for advertising purposes. The adoption of Internet advertising, particularly by companies that have historically relied upon traditional media for advertising, requires the acceptance of a new way of conducting business, exchanging information and advertising products and services. Such customers may find advertising on the Internet to be undesirable or less effective than traditional advertising media for promoting their products and services. In particular, online advertising revenue has significantly decreased. If the Internet advertising market fails to grow, our business could be adversely affected. In addition, the market for advertising on other forms of digital media, such as broadband distribution, is even less developed than Internet advertising, and if that market does not develop, our growth may be limited.

We Depend Upon Artists To Generate Electronic Commerce Revenue And Traffic To Our Web Sites

We believe that the future success of our online e-commerce business depends in part on our ability to maintain our existing artist relationships and to establish additional relationships with artists. During 2001, we modified the agreements with many of our artists to simplify the relationship between the artists and us. Our business would be adversely affected by any of the following:

• our inability to establish relationships with new artists and offer their music and merchandise for sale to our customers;

• the loss of popularity of artists for whom we sell music and merchandise;

• increased competition to maintain existing relationships with artists; and

• non-renewals or non-conversions of certain of our current agreements with artists.

If we are not able to provide valuable services or incentives to artists, or if we otherwise fail to maintain good relations with our artists, they may lose interest in providing content and merchandise and otherwise promoting the ARTISTdirect Network. The artists own the domain names for their Web sites and some of the intellectual property rights with respect to content developed for the Web sites. As a result, we may lose the rights to operate artists’ official online stores if our agreements with these artists terminate and are not renewed or converted. Most of our current artist contracts have a term of three years, and most of these agreements expired in 2002. Upon expiration, artists may decide not to renew these contracts on reasonable terms, if at all. We plan to negotiate new agreements with some of our existing artists and terminate existing agreements with some of our other artists. Our inability to negotiate new agreements or to terminate existing agreements may have an adverse impact on our business. In the past, we have offered our artists options to purchase our common stock. Options were intended to provide artists with an additional incentive to actively promote their Web sites and the ARTISTdirect Network. We do not currently intend to offer artists options or other equity incentives in the future and this may impair our efforts to sign new artists. If we cannot maintain our current relationships with artists or sign agreements with new artists, our user base would likely diminish and our ability to generate revenues from electronic commerce would be seriously harmed.

We May Not Be Able To Develop Or Obtain Sufficiently Compelling Content To Attract And Retain Our Target Audience

For our business to be successful, we must provide content and services that attract consumers who will purchase music and related merchandise online. We may not be able to provide consumers with an acceptable mix of products, services, information and community to attract them to our Web sites or to encourage them to remain on our Web sites for an extended period of time. If our audience determines that our content does not reflect its tastes, then our audience size could decrease or the demographic characteristics of our audience could change and we may be unable to react to those changes effectively or in a timely manner. Any of these results would adversely affect our ability to attract advertisers and sell music and other related merchandise. Our ability to provide compelling content could be impaired by any of the following:

• reduced access to content controlled by record labels, music publishers and artists;

• diminished technical expertise and creativity of our production staff; and

• inability to anticipate and capitalize on trends in music.

If We Do Not Build And Maintain Strong Brands, We May Not Be Able To Attract A Significant Number Of Users To Our Web Sites

To attract users we must develop a brand identity for ARTISTdirect and increase public awareness of the ARTISTdirect Network; however to conserve cash, we have significantly decreased the amounts we have spent and plan to spend on our offline and online advertising and promotional efforts to increase brand awareness, traffic and revenue. Accordingly, our marketing activities may not result in increased revenue and, even if they do, any increased revenue may not offset the expenses we incur in building our brands. Moreover, despite these efforts we may be unable to increase public awareness of our brands, which would have an adverse effect on our results of operations.

Our Online Store Agreements With Artists Do Not Preclude Our Artists From Selling Music And Related Merchandise On Other Web Sites

Our online store agreements with artists do not preclude them from selling merchandise and compact discs or offering music downloads on other Web sites. If we are unable to attract sufficient traffic to the ARTISTdirect Network, consumers may purchase the products that we offer on other Web sites. If we are unable to generate revenue from the sale of music and related merchandise, our results of operations will be adversely affected.

Our Market Is Highly Competitive And We May Not Be Able To Compete Successfully Against Our Current And Future Competitors

The market for the online promotion and distribution of music and related merchandise is highly competitive and rapidly changing. There are a significant number of Web sites promoting and distributing music and related merchandise that compete for the attention and spending of consumers, advertisers and users. We face competitive pressures from numerous actual and potential competitors. Our competitors include America Online, MSN, Yahoo!, Listen.com, Amazon.com, CDnow, MTV, other web sites and traditional music companies.

Competition is likely to increase significantly as new companies enter the market and current competitors expand their services. Some of our competitors have announced agreements to work together to offer music over the Internet, and we may face increased competitive pressures as a result. Many of our current and potential competitors in the Internet and music entertainment businesses may have substantial competitive advantages relative to us, including:

• longer operating histories;

• significantly greater financial, technical and marketing resources;

• greater brand name recognition;

• larger existing customer bases; and

• more popular content or artists.

These competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements and devote greater resources to develop, promote and sell their products or services than we can. Consumers, artists, talent management companies and other music-related vendors or advertisers may perceive Web sites maintained by our existing and potential competitors as being superior to ours. In addition, increased competition could result in reduced advertising rates and margins and loss of market share, any of which could harm our business.

We Depend On A Limited Number Of Suppliers For Music Merchandise, Fulfillment And Distribution and If We Cannot Secure Alternate Suppliers, Our Business May Be Harmed

We rely to a large extent on timely distribution by third parties. During 2002, we relied on two vendors, Alliance Entertainment, and Benn Co. (formerly Old Glory Boutique Distributing, Inc.) to fulfill and distribute our orders for music and related merchandise. During the both the three months ended June 30, 2003 and the year ended December 31, 2002, approximately 85% and 15%, respectively, of our total customer orders were fulfilled by Alliance and Benn Co., respectively. We purchase a significant portion of our artist-licensed merchandise from Benn Co. and most all of our compact discs from Alliance. Our contracts with Alliance and Benn Co. expire in August 2003 and April 2004, respectively. Our business could be significantly disrupted if Alliance or Benn Co. were to terminate, fail to renew or breach their agreements or suffer adverse developments that affect their ability to supply products to us. If, for any reason, Alliance, Benn Co. or other vendors are unable or unwilling to supply products to us in sufficient quantities and in a timely manner, we may not be able to secure alternative suppliers, on acceptable terms, in a timely manner or at all.

We Depend On Third Party Inventory And Financial Systems And Carrier Services

Because we rely on third parties to fulfill orders, we depend on their systems for tracking inventory and financial data. If our distributors’ systems fail or are unable to scale or adapt to changing needs, or if we cannot integrate our information systems with the systems of any new distributors, we may not have adequate, accurate or timely inventory or financial information. We also rely on third-party carriers for shipments to and from distribution facilities. We are therefore subject to the risks, including employee strikes and inclement weather, associated with our carriers’ ability to provide delivery services to meet our distribution and shipping needs. In the past, both

Alliance and we have occasionally experienced an unusually high volume of orders, which resulted in shipping delays to our customers. These delays did not have a material adverse effect, however, our failure to deliver products to our customers in a timely and accurate manner in the future could harm our reputation, our relationship with customers, the ARTISTdirect brand and our results of operations.

Our Business Is Subject To Seasonality, Which Could Adversely Affect Our Operating Results

We have experienced and expect to continue to experience seasonal fluctuations in our online sales. These seasonal patterns will cause quarterly fluctuations in our operating results. In particular, a disproportionate amount of our online sales have been realized during the fourth calendar quarter and during the summer months, traditionally when artists go on tour. Due to our limited operating history, it is difficult to predict the seasonal pattern of our online sales and the impact of such seasonality on our business and operating results. Our seasonal online sales patterns may become more pronounced, strain our personnel, warehousing, and order shipment activities and cause our operating results to be significantly less than expected for any given period. This would likely cause our stock price to fall.

Our Record Label Businesses Are Subject To Unpredictable Fluctuations, Which Could Adversely Affect Our Operating Results

We expect that the ARTISTdirect Records and iMusic record labels will experience significant fluctuations in revenue and income based, in part, on the release schedule for artists signed to the label and the subsequent sales of the released compact discs. It is inherently difficult to predict the sales for any particular compact disc and, therefore, operating results for any given period may be significantly higher or lower than another given period. To the extent that the record labels’ results are significantly lower than expected for any given period, this could adversely affect our overall operating results and would likely cause our stock price to fall. ARTISTdirect Records will require additional capital in 2003 to sustain operations. Failure to raise additional capital could seriously harm the business of ARTISTdirect Records and impair the value of the Company’s investment in ARTISTdirect Records. In such event, ARTISTdirect Records may seek to divest all or certain of its assets or the Company may seek to divest all or a part of its ownership of ARTISTdirect Records, in order to raise the capital necessary to sustain business operations of the Company and/or ARTISTdirect Records. Should this fail, ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss of the Company’s investment in ARTISTdirect Records.

We May Be Subject To System Disruptions, Which Could Reduce Our Revenue

Our ability to attract and retain artists, users, advertisers and merchants for our online network depends on the performance, reliability and availability of our Web sites and network infrastructure. Our own staff performs the maintenance and operation of substantially all of our Internet communications hardware and servers. We have periodic maintenance windows, and we experience outages from time to time caused by temporary problems in our own systems or software. While we have implemented procedures to improve the reliability of our systems, these interruptions may continue to occur from time to time. Our users also depend on third party Internet service providers and Web site operators for access to our Web sites. These entities have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures in the future which are unrelated to our systems, but which could nonetheless adversely affect our business.

Computer Viruses, Electronic Break-Ins Or Similar Disruptive Events Could Disrupt Our Online Services

Computer viruses, electronic break-ins or similar disruptive events could disrupt our online services. System disruptions could result in the unavailability or slower response times of our Web sites, which would reduce the number of advertisements delivered or commerce conducted on our Web sites and lower the quality of our users’ experience. Service disruptions could adversely affect our revenue and, if they were prolonged, would seriously harm our business and reputation. Our business interruption insurance may not be sufficient to compensate us for losses that may occur as a result of these interruptions.

If We Do Not Successfully Manage Our Operations, We May Not Be Able To Operate Our Business Effectively

Since our inception in August 1996, we have rapidly and significantly expanded and changed our operations. This process has strained, and we expect that it will continue to strain, our management, operations, systems and financial resources. In 2001 and 2002, we reduced our headcount to conserve cash and expect to further reduce headcount in the future. Accordingly, to manage our operations and personnel, we must improve and effectively utilize our existing operational, management, marketing and financial systems and maintain close coordination among our technical, finance, marketing, sales and production staffs. In addition, we may also need to increase the capacity of our software, hardware and telecommunications systems on short notice. We also will need to manage an increasing number of complex relationships with users, strategic partners, advertisers and other third parties, especially in light of certain functions being outsourced. Our failure to manage growth could disrupt our operations and ultimately prevent us from generating the revenue we expect.

The Loss Of Key Personnel, Including Ted Field Or Keith Yokomoto, Could Adversely Affect Our Business Because These Individuals Are Important To Our Continued Operation

Our future success depends to a significant extent on the continued services of our senior management, particularly Ted Field and Keith Yokomoto. The loss of either of these individuals would likely have an adverse effect on our business. During the second quarter of 2003, Marc Geiger, one of the Company’s founders and most recently Vice Chairman and President — Artist Services, resigned from the Company to pursue other opportunities but will remain a director until September 2003. The departure of Mr. Geiger may impact our business going forward. Competition for personnel throughout our industry is intense and we may be unable to retain these key employees or attract, integrate or retain other highly qualified employees in the future. We have in the past experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. If we do not succeed in attracting new personnel or retaining and motivating our current personnel, our business could be adversely affected. Recently enacted and proposed changes in corporate governance and securities laws and regulations, such as the Sarbanes-Oxley Act of 2002, could make it more difficult for us to attract and retain qualified executive officers or qualified members of our Board of Directors, particularly to serve on our audit committee.

If We Are Unable To Protect Our Intellectual Property Rights, Our Competitive Position Could Be Harmed Or We Could Be Required To Incur Expenses To Enforce Our Rights

We rely upon registered trademark rights in the United States for our commercial use of the ARTISTdirect, UBL, Ultimate Band List, and iMusic brand names and their respective associated domain names, and the ARTISTdirect logo. We seek to protect our trademarks, copyrights and other proprietary rights by registration and other means, but these actions may be inadequate. We have trademark applications pending in several jurisdictions, but our registrations may not be accepted or may be preempted by third parties and/or we may not be able to register our trademarks in all jurisdictions in which we intend to do business. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to and distribution of our proprietary information. The steps we have taken may not prevent misappropriation of our proprietary rights, particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States. If third parties were to use or otherwise misappropriate our copyrighted materials, trademarks or other proprietary rights without our consent or approval, our competitive position could be harmed, or we could become involved in litigation to enforce our rights. In addition, policing unauthorized use of our content, trademarks and other proprietary rights could be very expensive, difficult or impossible, particularly given the global nature of the Internet.

Our Access To Copyrighted Content Depends Upon The Willingness Of Content Owners To Make Their Content Available

The music content available on the ARTISTdirect Network is typically comprised of copyrighted works owned or controlled by multiple third parties. Most of the content on our artist-specific Web sites is either owned or licensed by the artist. On other parts of the ARTISTdirect Network, depending on the nature of the content and how we use the music content, we typically license such rights from publishers, record labels, performing rights societies or artists. We frequently either do not have written contracts or have short-term contracts with copyright owners, and, accordingly, our access to copyrighted content depends upon the willingness of such parties to continue to make their content available. If the fees for music content increase substantially or if significant music content becomes unavailable, our ability to offer music content could be materially limited. We have not obtained a license for some of the content offered on the ARTISTdirect Network, including links to other music-related sites and thirty-second

streamed song samples, because we believe that a license is not required under existing law. However, this area of law remains uncertain and may not be resolved for a number of years. When this area of law is resolved, we may be required to obtain licenses for such content, alter or remove the content from our Web sites and be forced to pay potentially significant financial damages for past conduct.

Intellectual Property Claims Against Us Could Be Costly And Could Result In The Loss Of Significant Rights

Third parties may assert trademark, copyright, patent and other types of infringement or unfair competition claims against us. If we are forced to defend against any such claims, whether they are with or without merit or are determined in our favor, we may face costly litigation, loss of access to, and use of, content, diversion of technical and management personnel, or product shipment delays. As a result of such a dispute, we may have to develop non-infringing technology or enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may be unavailable on terms acceptable to us, or at all. While we have resolved all such disputes in the past, we may not be able to do so in the future. If there is a successful claim of infringement against us and we are unable to develop non-infringing technology or license the infringed or similar technology or content on a timely basis, it could harm our business. In addition, we rely on third parties to provide services enabling our online product sales transactions, including credit card processing, order fulfillment, shipping and customer service. We could become subject to infringement actions by third parties based upon our use of intellectual property provided by our third-party providers. It is also possible that we could become subject to infringement actions based upon the content licensed from third parties. Any such claims or disputes could subject us to costly litigation and the diversion of our financial resources and technical and management personnel. Further, if our efforts to enforce our intellectual property rights are unsuccessful or if claims by third parties against ARTISTdirect, the UBL and iMusic are successful, we may be required to change our trademarks, alter or remove content, pay financial damages, or alter our business practices. These changes of trademarks, alteration of content, payment of financial damages or alteration of practices may adversely affect our business.

We May Be Unable To Acquire Necessary Web Domain Names

We may be unable to acquire or maintain Web domain names relating to our brand or to artist-specific Web sites in the United States and other countries in which we may conduct business. We currently hold various relevant domain names, including the “artistdirect.com,” “ubl.com,” and “imusic.com” domain names. The acquisition and maintenance of domain names generally is regulated by governmental agencies and their designees and is subject to change. The relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we could be unable to prevent third parties from acquiring or using domain names that infringe or otherwise decrease the value of our brand name, trademarks and other proprietary rights.

If Our Online Security Measures Fail, We Could Lose Visitors To Our Sites And Could Be Subject To Claims For Damage From Our Users, Content Providers, Advertisers And Merchants

Our relationships with consumers would be adversely affected and we may be subject to claims for damage if the security measures that we use to protect their personal information, especially credit card numbers, are ineffective. We rely on security and authentication technology that we license from third parties to perform real-time credit card authorization and verification with our bank. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect a customer’s personal information. Our infrastructure may be vulnerable to unauthorized access, physical or electronic computer break-ins, computer viruses and other disruptive problems. Internet service providers have experienced, and may continue to experience, interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees and others. Anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. Security breaches relating to our activities or the activities of third-party contractors that involve the storage and transmission of proprietary information could damage our reputation and our relationships with our content providers, advertisers and merchants. We also could be liable to our content providers, advertisers and merchants for the damages caused by such breaches or we could incur substantial costs as a result of defending claims for those damages. We may need to expend significant capital and other resources to protect against such security breaches or to address problems caused by such breaches. Our security measures may not prevent disruptions or security breaches.

We May Be Subject To Liability If Private Information Provided By Our Users Were Misused

Our privacy policy discloses how we use individually identifiable information that we collect. This policy is displayed and accessible throughout the ARTISTdirect Network. Despite this policy, however, if third persons were able to penetrate our network security or otherwise misappropriate our users’ personal information or credit card information, we could be subject to liability. We could also be subject to liability for claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims, or other misuses of personal information, such as for unauthorized marketing purposes. These claims could result in costly and time-consuming litigation.

Laws Or Regulations May Adversely Affect Our Ability To Collect Demographic And Personal Information From Users, Or To Display Certain Content On Our Sites, And Could Affect Our Ability To Attract Advertisers

Legislatures and government agencies have adopted and are considering adopting additional laws and regulations regarding the collection, use and disclosure of personal information obtained from individuals when accessing Web sites. For example, the Children’s Online Privacy Protection Act restricts the ability of Internet companies to collect information from children under the age of 13 without their parents’ consent. In addition, the Federal Trade Commission and state and local authorities have been investigating Internet companies regarding their use of personal information. Our privacy programs may not conform with laws or regulations that are adopted. In addition, these legislative and regulatory initiatives may adversely affect our ability to collect demographic and personal information from users, which could have an adverse effect on our ability to provide advertisers with demographic information. These initiatives may also affect our ability to conduct electronic commerce.

The European Union has adopted a directive that imposes restrictions on the collection and use of personal data. The directive imposes restrictions that are more stringent than current Internet privacy standards in the United States. If this directive were enforced against us, it could prevent us from collecting data from users in European Union member countries or subject us to liability for use of information in contravention of the directive. Other countries have adopted or may adopt similar legislation. We could incur additional expenses if new regulations regarding the use of personal information are introduced or if government authorities choose to investigate our privacy practices.

In addition, legislatures and government agencies have adopted and are considering adopting additional laws and regulations governing the content of material transmitted over the Internet. These include laws relating to obscenity, indecency, libel and defamation. For example, the Child Online Protection Act, or COPA, prohibits and imposes criminal penalties and civil liability on anyone communicating material harmful to minors through the Internet for commercial purposes, unless access to such material is blocked to minors under age 17. The Third U.S. Circuit Court of Appeals, on remand from the U.S. Supreme Court, has again upheld a preliminary injunction precluding enforcement of COPA on constitutional grounds. If the U.S. Supreme Court hears another appeal on the matter and decides to lift the injunction against COPA, and if content delivered by us or placed on our Web sites violates COPA, we could be liable. Such a result may adversely affect our ability to attract users under age 17 and, consequently, may adversely affect our ability to attract advertisers.

We May Continue To Have Contingent Liability Due To Our Issuances Of Certain Unregistered Securities

Prior to our initial public offering, we issued a number of shares and options to purchase shares of our common stock to our employees and to artists and their managers and advisors. Due to the nature of the persons who received these shares and options in addition to our employees and the total number of shares and options issued to them and our employees, the issuance of some of these shares and options did not comply with the requirements of Rule 701 under the Securities Act of 1933, as amended, or any other available exemptions from the registration requirements of Section 5 of the Securities Act, and may not have qualified for any exemption from qualification or registration under applicable state securities laws either.

As a result, in November 2001,we made a rescission offer to all these persons pursuant to a registration statement filed under the Securities Act and pursuant to applicable state securities law. In the rescission offer, we offered to repurchase from these persons all shares purchased by them pursuant to option exercises before the expiration of the rescission offer for an amount equal to the purchase or exercise price paid for these purchased shares, plus interest from the date of purchase until the expiration of the rescission offer, at the current statutory rate per year mandated by the state in which the shares were purchased, or at 7% per year if a “private placement” exemption was available in a particular state or if the shares were otherwise issued in compliance with state law (less any amounts received by those persons who had already sold their shares). We also offered to repurchase all unexercised options granted to

these persons at 20% of the option exercise price times the number of option shares, plus interest from the date the options were granted until the rescission offer expires, at the current statutory rate per year mandated by the state in which the options were granted, or at 7% per year if a “private placement” exemption was available in a particular state or if the options were otherwise granted in compliance with state law. The rescission offer was completed in December 2001 and 83,403 shares and 636,740 options were tendered in the rescission offer and the cost to us of repurchasing such shares and options was approximately $10.2 million.

The Securities Act does not expressly provide that a rescission offer will terminate a purchaser’s right to rescind a sale of stock that was not registered under the Securities Act as required. Accordingly, we may continue to be contingently liable under the Securities Act to any offerees that rejected the rescission offer. In addition, it is possible that offerees may claim that the consideration offered to them in the rescission offer was insufficient, in which case we may have additional liability.

The Delisting Of Our Common Stock From The Nasdaq Stock Market Has Resulted In Less Liquidity For Our Common Stock, Making It More Difficult For Us To Raise Financing And For You To Sell Your Shares.

In May 2003, NASDAQ notified us that we no longer complied with the stockholder’s equity, market capitalization and certain other requirements for continued listing on The NASDAQ National Market or for moving our listing to The NASDAQ Small Cap Market. Our common stock was delisted from The NASDAQ Stock Market effective May 9, 2003 and is now being traded on the Over-The-Counter Bulletin Board. As a result of being delisted from The NASDAQ Stock Market, our stockholders may find it more difficult to sell their shares of our common stock. This lack of market liquidity also may make it more difficult for us to raise additional capital in the future.

As a result of being delisted, our common stock may become subject to the “penny stock” regulations, including Rule 15g-9 under the Securities Exchange Act of 1934. That rule imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and accredited investors. For transactions covered by this rule, a broker-dealer must make a special written suitability determination for the purchaser and have received the purchaser’s written agreement to the transaction prior to sale. Consequently, if this rule were to become applicable, the ability or willingness of broker-dealers to sell our common stock, and accordingly the ability of stockholders to sell their shares of our common stock in the public market, might decline. These additional procedures could also limit our ability to raise additional capital in the future. In the event that our common stock becomes subject to the penny stock regulations, the market liquidity for the shares would be severely and adversely affected. We can provide no assurance that trading in our common stock will not be subject to these or other regulations in the future, which would negatively affect the market for our common stock.

Our Common Stock Price Has Been Volatile Which Could Result In Substantial Losses For Individual Stockholders

The market prices of Internet-related stocks, including our common stock, have been volatile and we expect that they will continue to be volatile. In particular, our common stock may be subject to significant fluctuations in response to a variety of factors, including but not limited to:

• general economic conditions;

• actual or anticipated variations in quarterly operating results;

• changes in financial estimates by securities analysts;

• failure to meet analyst predictions and projections;

• changes in market valuations of media and online e-commerce companies;

• new products or services offered by us or our competitors;

• announcements of significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors;

• additions or departures of key personnel;

• our sales of common stock or other securities in the future; and

• other events or factors, many of which are beyond our control.

In addition, the average trading volume of our common stock has been extremely low in the past As a result, our stock price may be susceptible to significant volatility on a day-to-day basis, depending on the number of shares traded on any given day Due to these factors, you may not be able to sell your stock at or above the price you paid for it, which could result in substantial losses.

We May Be Sued For Content Available Or Posted On Our Website Or Products Through Our Web Sites Or For Linking And Framing Of Third-Party Web Sites

We may be liable to third parties for content published on our Web sites and other Web sites where our syndicated content appears if the music, artwork, text or other content available violates their copyright, trademark or other intellectual property rights or if the available content is defamatory, obscene or pornographic. Similar claims have been brought, sometimes successfully, against Web site operators in the past. We also may be liable for content uploaded or posted by our users on our Web sites, such as digitally distributed music files, postings on our message boards, chat room discussions and copyrightable works. In addition, we could have liability to some of our content licensors for claims made against them for content available on our Web sites. We also could be exposed to these types of claims for content that may be accessed from our Web sites or via links to other Web sites or for products sold through our Web site. While we have resolved all of these types of claims made against us in the past, we may not be able to do so in the future. We intend to implement measures to reduce exposure to these types of claims, but such measures may not be successful and may require us to expend significant resources. Any litigation as a result of defending these types of claims could result in substantial costs and damages. Our insurance may not adequately protect us against these types of claims or the costs of their defense or payment of damages. We link to and “frame” third-party Web sites of our artists without express written permission to do so. In addition, in the past we have provided a search feature to allow users to find music residing elsewhere on the Internet. Those practices are controversial, and have, in instances not involving us, resulted in litigation. Various claims, including trademark and copyright infringement, unfair competition, and commercial misappropriation, as well as infringement of the right of publicity may be asserted against us as a result. The law regarding linking and framing remains unsettled; it is uncertain as to how existing laws, especially trademark and copyright law, will be applied by the judiciary to the Internet. Also, Congress is increasingly active in passing new laws related to the Internet, and there is uncertainty as to the impact of future potential laws, especially those involving domain names, databases and privacy.

Software Programs That Prevent Or Limit The Delivery Of Advertising May Seriously Damage Our Ability To Attract And Retain Advertisers

A number of “filter” software programs have been developed which limit or prevent advertising from being delivered to an Internet user’s computer. This software could adversely affect the commercial viability of Internet advertising. These programs attempt to blank out, or block, banner and other advertisements. To date, such programs have not had a material adverse impact on our ability to attract and retain advertisers or caused us to fail to meet the terms of our advertising agreements. These programs may, however, have these effects on us in the future. Widespread adoption of this type of software would seriously damage our ability to attract and retain advertisers.

We May Need To Change The Manner In Which We Conduct Our Business If Government Regulation Increases

There are currently few laws or regulations that specifically regulate communications or commerce on the Internet. Laws and regulations may be adopted in the future, however, that address issues such as user privacy, pricing, taxation, content, copyrights, distribution, security, and the quality of products and services. Several telecommunications companies have petitioned the Federal Communications Commission to regulate Internet service providers and online services providers in a manner similar to long distance telephone carriers and to impose access fees on these companies. Any imposition of access fees could increase the cost of transmitting data over the Internet. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on us. The United States Congress has enacted Internet laws regarding children’s privacy, copyrights, taxation and the transmission of sexually explicit material. The law of the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. Moreover, it may take years to determine the extent to which existing laws relating to issues such as property ownership, libel and personal privacy are applicable to the Web. Any new, or modifications to existing, laws or regulations relating to the Web could adversely affect our business. Prohibition and restriction of Internet content and commerce could reduce or slow Internet use, decrease the acceptance of the Internet as a

communications and commercial medium and expose us to liability. Any of these outcomes could have a material adverse effect on our business, results of operations and financial condition. The growth and development of the market for Internet commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on companies conducting business over the Internet.

The Internet Is Subject To Rapid Changes, Which Could Result In Significant Additional Costs

The market for Internet products and services is characterized by rapid change, evolving industry standards and frequent introductions of new technological developments. These new standards and developments could make our existing or future products or services obsolete. Keeping pace with the introduction of new standards and technological developments could result in significant additional costs or prove difficult or impossible for us. The failure to keep pace with these changes and to continue to enhance and improve the responsiveness, functionality and features of our Web sites could harm our ability to attract and retain users. Among other things, we will need to license or develop leading technologies, enhance our existing services and develop new services and technologies that address the varied needs of our users.

Our Net Sales Could Be Adversely Affected If We Become Subject To Sales And Other Taxes

If one or more states or any foreign country successfully asserts that we should collect sales or other taxes on our sale of products over the Internet, our net sales and results of operations could be harmed. We do not currently collect sales or other similar taxes for physical shipments of goods into states other than California and Florida. However, one or more states may seek to impose sales tax collection obligations on companies, such as ARTISTdirect, which engage in or facilitate online commerce. A number of proposals have been made at the state and local level that would impose additional taxes on the sale of goods and services through the Internet. Such proposals, if adopted, could substantially impair the growth of electronic commerce and could adversely affect our opportunity to derive financial benefit from electronic commerce. Moreover, if any state or foreign country were to successfully assert that we should collect sales or other taxes on the exchange of merchandise on its system, our results of operations could be adversely affected. In addition, any operations in states outside California and Florida could subject our shipments in such states to state sales taxes under current or future laws. Congress has enacted legislation limiting the ability of the states to impose taxes on Internet-based transactions. This legislation, known as the Internet Tax Freedom Act, imposes a moratorium ending on November 1, 2003 on state and local taxes on electronic commerce where such taxes are discriminatory and on Internet access unless such taxes were generally imposed and actually enforced before October 1, 1998. Failure to renew this legislation in the future would allow various states to impose taxes on Internet-based commerce.

Our Success Depends On The Continued Development And Maintenance Of The Internet And The Availability Of Increased Bandwidth To Consumers

The success of our business will rely on the continued improvement of the Internet as a convenient means of consumer interaction and commerce, as well as an efficient medium for the delivery and distribution of music. Our business will depend on the ability of our artists and consumers to conduct commercial transactions with us, as well as to continue to upload and download music files, without significant delays or aggravation that may be associated with decreased availability of Internet bandwidth and access to our Web site. This will depend upon the maintenance of a reliable network with the necessary speed, data capacity and security, as well as timely development of complementary products, such as high-speed modems, for providing reliable Internet access and services. The failure of the Internet to achieve these goals will reduce our ability to generate significant revenue.

Our penetration of a broader consumer market will likely depend, in part, on continued proliferation of high speed Internet access. The Internet has experienced, and is likely to continue to experience, significant growth in the numbers of users and amount of traffic. As the Internet continues to experience increased numbers of users, increased frequency of use and increased bandwidth requirements, the Internet infrastructure may be unable to support the demands placed on it. In addition, increased users or bandwidth requirements may harm the performance of the Internet. The Internet has experienced a variety of outages and other delays and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage as well as the level of traffic, and could result in the Internet becoming an inconvenient or uneconomical source of music and related products and merchandise which would cause our revenue to decrease. The infrastructure and complementary products or services necessary to make the Internet a viable commercial marketplace for the long term may not be developed successfully

or in a timely manner. Even if these products or services are developed, the Internet may not become a viable commercial marketplace for the products or services that we offer.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market rate risk for changes in interest rates is related primarily to our investment portfolio. We have not used derivative financial instruments in our investment portfolio. Our short-term investments are comprised of U.S. government obligations and public corporate debt securities. Interest rate fluctuations impact the carrying value of the portfolio. We do not believe that the future market risks related to the above securities will have a material adverse impact on our financial position, results of operations or liquidity.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

ARTISTdirect’s management, with the participation of ARTISTdirect’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of ARTISTdirect’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, ARTISTdirect’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, ARTISTdirect’s disclosure controls and procedures were effective in timely alerting them to the material information relating to ARTISTdirect (or its consolidated subsidiaries) required to be included in the reports ARTISTdirect files or submits under the Securities Exchange Act of 1934.

Changes in Internal Control over Financial Reporting

During the most recent fiscal quarter covered by this report, there has been no change in ARTISTdirect’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that has materially affected, or is reasonably likely to materially affect, ARTISTdirect’s internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On June 24, 2003, our landlord, 5670 Wilshire, L.P., filed a lawsuit for unlawful detainer against us in Los Angeles Superior Court. In the lawsuit, our landlord alleges that we are in default under our office space lease because we have not paid rent for the month of June 2003. In the lawsuit, our landlord is seeking immediate possession of the premises and monetary damages against us. We are attempting to resolve the dispute amicably. We cannot assure you that we will achieve an amicable resolution of, or a favorable outcome in, the lawsuit. From time to time, we also may be involved in litigation relating to claims arising out of our ordinary course of business.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(a) Sales of Unregistered Securities.

None

(b) Use of Proceeds from Sales of Registered Securities.

On March 31, 2000, the Company completed its initial public offering (the “Offering”) of its Common Stock, $0.01 par value. The managing underwriters in the Offering were Morgan Stanley Dean Witter, Bear, Stearns & Co. Inc. and Deutsche Banc Alex Brown (the “Underwriters”). The shares of Common Stock sold in the Offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (the “Registration Statement”) (Reg. No. 333-87547) that was declared effective by the Securities and Exchange Commission (“SEC”) on March 27, 2000. The Offering commenced on March 28, 2000. All 500,000 (after giving effect to the Company’s one-for-ten reverse stock split in July 2001) shares of Common Stock registered under the Registration Statement were sold at a price of $120.00 per share. The aggregate price of the Offering amount registered was $60,000,000. In connection with the Offering, the Company paid an aggregate of $4.2 million in underwriting discounts and commissions to the Underwriters. In addition, the following table sets forth an estimate of all expenses incurred in connection with the Offering, other than underwriting discounts and commissions. All amounts shown are estimated except for the fees payable to the SEC, National Association of Securities Dealers, Inc. (“NASD”) and NASDAQ National Market.


SEC Registration Fee		$	23,978
NASD Filing Fee			9,125
NASDAQ National Market Listing Fee			117,188
Blue Sky Fees and Expenses			—
Printing and Engraving Expenses			741,000
Legal Fees and Expenses			1,300,000
Accounting Fees and Expenses			750,000
Transfer Agent Fees			20,000
Miscellaneous			403,709

	Total Expenses	$	3,365,000

After deducting the underwriting discounts and commissions and the estimated Offering expenses described above, the Company received net proceeds from the Offering of approximately $52.4 million. From January 1, 2003 to June 30, 2003, the Company used such net proceeds for the purposes and in the approximate amounts set forth in the following table:


Advances to ARTISTdirect Records		$	2.8	million
EBITDA loss from Operations			2.6
Working Capital			(.8	)

	Total Expenditures	$	4.6	million

This use of proceeds does not represent a material change in the use of proceeds described in the prospectus of the Registration Statement, but rather clarifies the specific uses of such proceeds for general corporate purposes.

All of such expenses incurred and net proceeds used were direct or indirect payments to others. None of the Company’s expenses or net proceeds from the Offering were paid directly or indirectly to any director, officer, general partner of the Company or their associates, persons owning 10% or more of any class of equity securities of the Company, or an affiliate of the Company, except as follows. As part of the Company’s ongoing funding commitment to ARTISTdirect Records, part of the net proceeds from the Offering have been, and will continue to be, used to fund ARTISTdirect Records, which is jointly owned by the Company’s Chairman of the Board and Chief Executive Officer, Ted Field through his affiliated company, Radar Records Holdings, LLC.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

On May 9, 2003, ARTISTdirect, Inc.’s common stock was delisted from the NASDAQ Stock Market. The delisting action was taken by the NASDAQ as a result of deficiencies relating to listing standards for stockholder’s equity and market value of publicly held shares. The Company’s common stock is currently trading on the Over-the-Counter Bulletin Board (OTCBB). OTCBB securities are traded through broker/dealers acting as market makers.

During the second quarter of 2003, Marc Geiger, one of the Company’s founders and most recently Vice Chairman and President — Artist Services, resigned from the Company to pursue other opportunities in the music industry. Other Company executives have assumed Mr. Geiger’s duties. In July 2003, Jim Carroll, the Company’s Chief Financial Officer, resigned from the Company to pursue other opportunities and Tom Fuelling, the Company’s Executive Vice President, Finance and Operations, was appointed to replace him. Mr. Carroll will remain a consultant with the Company for six months.

We anticipate holding our 2003 annual meeting of stockholders during the third or fourth quarter of 2003, which would represent a delay of more than thirty days beyond the anniversary date of our 2002 annual meeting of stockholders. The deadlines for submission and acceptance of stockholder proposals that were published in our proxy statement for the 2002 annual meeting of stockholders remain as stated in our proxy statement for the 2002 annual meeting of stockholders.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits


3.1		Amended and Restated Certificate of Incorporation of the Registrant. Incorporated by reference to Exhibit 3.1 in the Registrant’s Registration Statement on Form S-1 initially filed on September 22, 1999 (Registration No. 333-87547), as amended by Amendment No.’s 1–7 thereto.

3.2		Amended and Restated Bylaws of the Registrant. Incorporated by reference to Exhibit 3.2 in the Registrant’s Registration Statement on Form S-1 initially filed on September 22, 1999 (Registration No. 333-87547), as amended by Amendment No.’s 1–7 thereto.

3.3		Certificate of Amendment of the Third Amended and Restated Certificate of Incorporation. Incorporated by reference to Exhibit 3.3 in the Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2001.

3.4		Certificate of Amendment, dated June 3, 2002, of the Third Amended and Restated Certificate of Incorporation. Incorporated by reference to Exhibit 3.4 in the Registrant’s Quarterly Report on Form 10-Q filed on August 14, 2002.


10.1		Letter Agreement, dated as of May 1, 2003, by and between ARTISTdirect, Inc. and Frederick Field to amend the Employment Agreement dated May 31, 2001 between ARTISTdirect, Inc. and Mr. Field.

10.2		Letter Agreement, dated as of May 1, 2003, by and between ARTISTdirect Records, L.L.C. and Frederick Field to amend the Employment Agreement dated May 31, 2001 between ARTISTdirect Records, L.L.C. and Mr. Field.

31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

None.

SIGNATURES

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


		ARTISTDIRECT, INC. (Registrant)

		By: /s/ THOMAS F. FUELLING Thomas F. Fuelling Executive Vice President, Chief Financial Officer and Secretary

Dated: August 14, 2003

	•		online sales of music and related merchandise;

	•		sales of advertising and sponsorships;

	•		marketing our database of consumer information and preferences;

	•		sales of, or subscription fees for, digitally distributed music; and

	•		sales of music CDs by the ARTISTdirect Records and iMusic record labels.

	•		identifying and entering into recording agreements with artists for ARTISTdirect Records;

	•		hiring and retaining personnel for ARTISTdirect Records;

	•		producing and promoting new music recordings for artists signed to ARTISTdirect Records ;

	•		developing a recognized brand name in the music industry;

	•		developing distribution channels for ARTISTdirect Records;

	•		integrating the ARTISTdirect Records operations with our existing operations;

	•		obtaining the capital necessary to sustain the ARTISTdirect Records operations; and

	•		generating ARTISTdirect Records revenue and achieving profitability.

	•		respond to and anticipate fluctuations in the demand for, and pricing of, online advertising;

	•		develop and maintain key advertising relationships and compete for advertisers with Internet and traditional media companies;

	•		conduct successful selling and marketing efforts aimed at advertisers;

	•		successfully develop, sell and execute entertainment marketing solutions;

	•		increase the size of our audience and the amount of time that our audience spends on our Web sites;

	•		accurately measure the size and demographic characteristics of our audience;

	•		offer advertisers the means to effectively target their advertisements to our audience; and

	•		increase the amount of revenue per advertisement.

	•		our inability to establish relationships with new artists and offer their music and merchandise for sale to our customers;

	•		the loss of popularity of artists for whom we sell music and merchandise;

	•		increased competition to maintain existing relationships with artists; and

	•		non-renewals or non-conversions of certain of our current agreements with artists.

	•		reduced access to content controlled by record labels, music publishers and artists;

	•		diminished technical expertise and creativity of our production staff; and

	•		inability to anticipate and capitalize on trends in music.

	•		longer operating histories;

	•		significantly greater financial, technical and marketing resources;

	•		greater brand name recognition;

	•		larger existing customer bases; and

	•		more popular content or artists.

	•		general economic conditions;

	•		actual or anticipated variations in quarterly operating results;

	•		changes in financial estimates by securities analysts;

	•		failure to meet analyst predictions and projections;

	•		changes in market valuations of media and online e-commerce companies;

	•		new products or services offered by us or our competitors;

	•		announcements of significant acquisitions, strategic partnerships, joint ventures or capital commitments by us or our competitors;

	•		additions or departures of key personnel;

	•		our sales of common stock or other securities in the future; and

	•		other events or factors, many of which are beyond our control.

	(a)		Sales of Unregistered Securities.

			None

	(b)		Use of Proceeds from Sales of Registered Securities.