MUSICMAKER COM INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

(Mark One)

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2001, or

/ / 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: 000-26585

MUSICMAKER.COM, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 54-1811721
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation)

888 SEVENTH AVENUE, NEW YORK, NY 10019
(Address of Principal Executive Office) (Zip Code)

Registrant's telephone number, including area code (212) 974-5708

Securities registered pursuant to Section 12(b) of the Securities Act: NONE.

Securities registered pursuant to Section 12(g) of the Securities Act: COMMON
STOCK, PAR VALUE $.01 PER SHARE (the "Common Stock").

Indicate by check mark whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days:
Yes /X/ No / /.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K / /.

The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $3,864,045 as of March 26, 2002, based upon the
closing price of such equity as of such date.

As of March 26, 2002, 3,313,996 shares of the issuer's Common Stock were
outstanding.

MUSICMAKER.COM, INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

TABLE OF CONTENT

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PART I

NOTE REGARDING FORWARD-LOOKING INFORMATION

The statements contained in this Annual Report that are not historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, including statements regarding the expectations, beliefs, intentions
or strategies regarding the future. Without limiting the foregoing, the words
"anticipates," "believes," "expects," "intends," "may" and "plans" and similar
expressions are intended to identify forward-looking statements. The Company
intends that all forward-looking statements be subject to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements reflect the Company's views as of the date they are
made with respect to future events, but are subject to many risks and
uncertainties, which could cause the actual results of the Company to differ
materially from any future results expressed or implied by such forward-looking
statements. These statements speak only as of the date hereof. We are under no
duty to update, and do not undertake to update, any of the of the
forward-looking statements contained in this Annual Report to conform them to
actual results or to changes in our expectations.

ITEM 1. BUSINESS.

On January 3, 2001, the Board of Directors of musicmaker.com, Inc. (as used
herein, "musicmaker", the "Company" or "we") as then constituted voted
unanimously to cease the operations of its Internet-based custom CD-marketing
business. The then-Board concluded at that time that this business no longer
represented a viable alternative to provide maximum value to the Company's
stockholders.

The present Board determined to review alternatives for the Company going
forward, which included, among other things, potential dispositions of
assets, the possibility of one or more additional cash distributions to
stockholders, and the potential continued operation of musicmaker as a public
company which might pursue other business opportunities as they arise, as
well as other possible steps intended to provide stockholder value, all
subject to the ongoing review and consideration of the Board, some of which
would require stockholder approval. On February 15, 2001, the Company
announced that the Board of Directors had approved a cash distribution in the
amount of $3.00 per share to the holders of record of Common Stock as of
March 1, 2001, the record date, pursuant to which the Company distributed
$9,941,998 to its stockholders.

Thereafter, the Board determined to seek to pursue one or more potential
acquisitions of other publicly traded or privately held companies or
significant interests in such companies, with a view to refocusing the
Company's strategic direction. While the Company continues to actively
examine certain potential acquisition transactions and believes that
attractive opportunities exist, there can be no assurance whether, when, or
on what terms the Company will complete any such acquisition.

Until the events described above, the Company was a provider of customized music
CD compilations and music digital downloads. The Company sold its products
primarily over the Internet through its website and through marketing partners,
strategic alliances and direct mail-order promotions.

In connection with the Company's cessation of its Internet-based custom
CD-marketing business, the Company sold all of the Company's remaining
furniture and equipment.

In addition, effective as of July 1, 2001, the Company relocated its
principal executive offices to 888 Seventh Avenue, 17th Floor, New York, New
York 10019, an office maintained by Barington Capital Group, L.P.
("Barington"), a limited partnership whose general partner is a corporation
of which James Mitarotonda is Chairman, President and Chief Executive
Officer. Barington and an affiliate are members, and Mr. Mitarotonda is one
of the managing members, of BCG Strategic Investors LLC, which, together with
certain affiliates, beneficially owns approximately 38% of the Company's
Common Stock. Mr. Mitarotonda is also the President and Chief Executive
Officer of the Company.

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Effective July 1, 2001, Barington has made available to the Company the services
of a Barington employee to serve as the Chief Financial Officer and Secretary of
the Company, and began providing the Company with the assistance of certain
other Barington employees and the use of office space and administrative
services provided by Barington.

SUBSEQUENT EVENTS

On February 25, 2002 the Board of Directors authorized a stock repurchase
program for up to 500,000 shares of the Company's Common Stock. Shares of Common
Stock are expected to be purchased from time to time in open market transactions
and privately negotiated transactions, subject to availability and price,
prevailing market and business conditions and regulatory compliance.

EMPLOYEES

As of December 31, 2001, the Company had no employees other than its President
and Chief Executive Officer and its Chief Financial Officer.

ITEM 2. PROPERTIES.

The Company is party to a lease regarding 31,261 square feet of space on
Parkridge Boulevard in Reston, Virginia (the "Parkridge Property"). This
facility had served as the Company's administrative offices and production
center. The term of this lease expires on December 31, 2009, with a monthly
rent ranging from approximately $71,000 during the first year of the lease to
approximately $92,000 in the final year of the term. The Company has vacated
the Parkridge Property, has suspended lease payments and is actively pursuing
a new sub-lessee. The Company has engaged the services of a real estate
consulting company to pursue alternative uses for the building. On March 12,
2002, the Company was served with a "Bill of Complaint" by the owner of the
property, Parkridge Five Associates Limited, seeking restoration of the
security deposit in the amount of $664,344, which the owner maintains has
been depleted by application to rent payments in prior months. There can be
no assurance that the Company will be able to obtain the requisite landlord
consent to assign or sub-let these premises or that any such assignment or
sub-let can be accomplished on favorable terms or at all.

Effective as of June 30, 2001, the Company closed its office located on Wiehle
Avenue in Reston, Virginia (the "Wiehle Property") and re-located its
principal executive offices to 888 Seventh Avenue, 17th Floor, New York, NY
10019. Effective June 1, 2001, the Company sub-let this property. The
sub-lessee subsequently vacated the premises and, the Company believes, is in
default under the sub-lease. Collection proceedings have commenced against
the sub-lessee. The monthly rent for the Wiehle Property space is
approximately $11,000, which the Company has been paying since the departure
of the sub-lessee. The Company is actively pursuing a new sub-lessee. There
can be no assurance that the Company will be able to obtain the requisite
landlord consent to assign or sub-let these premises or that any such
assignment or sub-let can be accomplished on favorable terms or at all.

The Company is party to a ten-year lease for 7,566 square feet of general office
space located in New York City. The monthly rent for this space is approximately
$32,000, with an 8% escalation in rent on the third anniversary and an
additional 4% escalation on the seventh anniversary. In October 1999, the
Company entered into a sub-lease surrendering possession of this office space
for five of the nine years remaining under its lease. The Company is secondarily
responsible for the payment of rent during the term of the sub-lease and
primarily responsible for such payment thereafter.

ITEM 3. LEGAL PROCEEDINGS.

On February 25, 2000, a purported securities class action complaint,
PAUL A. ROSENFELD, ET AL. V. MUSICMAKER.COM, INC., ET AL., No. 00-02018 CAS
(MANx), was filed in the United States District Court for the Central District
of California. At least four nearly identical complaints were filed shortly
after the original action was filed. On June 30, 2000, Plaintiffs filed a
consolidated and amended complaint (the "Class Action Complaint"), IN RE
MUSICMAKER.COM SEC. LITIG., No. 00-02018 CAS (MANx). Named as defendants are
musicmaker.com, Inc., EMI Group, PLC, EMI Recorded Music, EMI Recorded Music
North America, Virgin Holdings, Inc., Robert P. Bernardi,
Devarajan S. Puthukarai, Irwin H. Steinberg, Jay A. Samit, Jonathan A.B. Smith,
and John A. Skolas. The Class Action Complaint alleges that the Company violated
Sections 11 and 12(a)(2) of the Securities Act of 1933 and Section 10(b) of the

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Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder
("Rule 10b-5"), by making false and misleading statements in the Company's
filings with the SEC and in press releases concerning musicmaker's access to
recordings pursuant to certain licensing agreements during the period from
July 7, 1999, through November 15, 1999. The claims are purportedly brought on
behalf of all persons who purchased musicmaker stock during that period,
including investors who purchased stock during the Company's initial public
offering, as well as those who purchased stock thereafter. Plaintiffs seek
unspecified compensatory damages and/or rescission, as well as attorneys' fees
and costs. On September 27, 2000, the defendants filed a motion to dismiss the
Class Action Complaint. In June 2001 the court denied the motion to dismiss in
part, granted it in part, and in August 2001 denied a subsequent motion for
reconsideration with respect to the motion to dismiss. In September 2001
plaintiffs filed a Third Consolidated Amended and Supplemental Class Action
Complaint, asserting the same causes of action against the Company as were
alleged in the Class Action Complaint (the "Third Amended Complaint"). In
October 2001 the Company answered the Third Amended Complaint, denying liability
to the plaintiffs on any cause of action. In April 2001 several plaintiffs filed
a purported non-class action complaint against the same defendants named in the
Class Action Complaint (including the Company). The plaintiffs in this action
subsequently filed an amended complaint (this complaint, as amended, the "Butler
Complaint") in September 2001. The Butler Complaint alleges claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5,
as well as common law fraud and negligent misrepresentation claims relating to
the same general types of purported misrepresentations set forth in the Class
Action Complaint. However, the alleged misrepresentations set forth in the
Butler Complaint allegedly occurred during the period from November 15, 1999
through at least April of 2000. On January 21, 2002, the parties participated in
a mediation in an attempt to settle matters set forth in the Class Action
Complaint, the Third Amended Complaint and the Butler Complaint. That mediation
failed to yield a settlement. However, the parties have agreed to participate in
another mediation session on May 14, 2002. In the interim, the parties have
agreed to pursue limited non-party discovery. The Company believes the
allegations contained in the Class Action Complaint and the Butler Complaint are
without merit and intends to defend against them vigorously. However, these
lawsuits could materially and adversely affect the Company's financial condition
and results of operations based on a number of factors, including legal
expenses, diversion of management's time and attention, and payment of judgments
or settlements in excess of available insurance.

The Company has also been named as a defendant in three separate lawsuits
arising out of licensing agreements it had previously entered into with
Classicberry Limited and the Black Crowes partnership in the case of the first
lawsuit (the "Classicberry Lawsuit"), with Profile Publishing and Management
Corporation ApS in the case of the second lawsuit (the "Profile Lawsuit"), and
with Koch Entertainment LLC in the case of the third lawsuit (the "Koch
Lawsuit"). The lawsuits each seek an aggregate of approximately $250,000,
representing what the respective plaintiffs allege is the balance owed by the
Company under the agreements. The Company has asserted various counterclaims and
affirmative defenses to each of the Profile Lawsuit and the Koch Lawsuit and
intends to vigorously oppose such actions. With respect to the Classicberry
Lawsuit, in December 2001 the District Court granted the plaintiff's motion for
summary judgment and denied the Company's cross-motion. The Company has filed a
notice of appeal and is in the process of securing a bond that will stay
enforcement of the judgment.

On January 3, 2001, we paid the balance of $825,000 remaining due in settlement
of prior litigation involving TeeVee Toons, Inc. and related parties.

In 1998, we received notice from Magix Entertainment Products GmbH, a German
company ("Magix") claiming ownership of the trademark MUSICMAKER and seeking to
obtain from us the domain name MUSICMAKER.COM. We reached what we view as a
definitive settlement of Magix's claim in a written settlement agreement in
1998. In late 1999, however, Magix renewed its demand for the domain name
MUSICMAKER.COM, which we believe to be in violation of our settlement agreement.
In December 1999, we filed suit against Magix in

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federal court in New York. The case is captioned Musicmaker.com, Inc., v. Magix
Entertainment Products GmbH, No. 99 Civ. 11577 (BSJ) (S.D.N.Y.). The Company has
asked the court, among other things, to declare that we own the trademark
MUSICMAKER and the domain name MUSICMAKER.COM and that we are entitled to use
them in connection with our business. Magix has filed counterclaims alleging,
among other things, that we infringe its trademark rights.

In May of 2001, the Company settled its obligation of $171,429 to Music Maker
Relief Fund (the "Foundation") for $20,000. Pursuant to the terms of the
settlement, the Company was released from the monetary claims that the
Foundation may have had against the Company under a contract dated July 1, 1998,
between the Company and the Foundation. Under the terms of the settlement, the
Company can no longer use the trademark "musicmaker" but we can continue to use
the domain name musicmaker.com, Inc. The Company is presently considering
alternative names.

On March 12, 2002, the Company was served a "Bill of Complaint" by the owner of
Parkridge Five Associates Limited, the owner of the Parkridge Property, seeking
restoration of the security deposit in the amount of $664,344, which the owner
maintains has been depleted by application to rent payments in prior months. See
Item 2 "Properties". The Company is in discussion with the landlord as to
these premises.

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

None.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.

MARKET PRICE OF OUR COMMON STOCK.

The Company was delisted from the Nasdaq National Market as of August 27, 2001.
The Company's Common Stock subsequently became eligible for quotation and is
currently traded on the over-the-counter bulletin board ("OTC-BB").

At March 26, 2002 the Company had 3,313,996 shares of Common Stock outstanding,
held by 169 shareholders of record. This does not reflect persons or entities
that held their stock in nominee or "street" name. The following table sets
forth the high and low bid quotations per share as reported by NASDAQ and the
OTC-BB for the periods stated. The quotations set forth below, to the extent
reflective of quotations on the OTC-BB, reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not necessarily represent
actual transactions.

On March 26, 2002, the last sale price of our Common Stock on OTC-BB was $1.88
per share.

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CASH DISTRIBUTION

On February 15, 2001, the Company announced that the Board of Directors had
approved a cash distribution in the amount of $3.00 per share to the holders of
record of Common Stock as of March 1, 2001, the record date. For additional
discussion of management's policy with respect to any future distributions to
our stockholders, see "Item 1. Business" included elsewhere in this Annual
Report.

RECENT SALES OF UNREGISTERED SHARES.

None.

ITEM 6. SELECTED FINANCIAL DATA.

The following selected financial data should be read in conjunction with the
financial statements and the related notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" appearing
elsewhere in this Annual Report on Form 10-K. The statement of operations data
for the years ended December 31, 2001, 2000, and 1999 and the balance sheet data
at December 31, 2001 and 2000 are derived from the financial statements of
musicmaker that are included elsewhere in this Annual Report on Form 10-K. The
statement of operations data for the year ended December 31, 1998 and 1997 and
the balance sheet data at December 31, 1999, 1998 and 1997 are derived from the
Company's 2000 Annual Report on Form 10-K. The results of operations of prior
periods are not necessarily indicative of results that may be expected for any
other period.

STATEMENT OF OPERATIONS DATA

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

The following discussion should be read in conjunction with the financial
statements contained in Item 8 of Part IV of this Form 10-K.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000

NET SALES. Net sales include the selling price of products sold by the Company,
net of returns, as well as sales promotions and discounts. The Company's net
sales were $3,201,412 for the year ended December 31, 2001, compared to
$5,583,505 for the year ended December 31, 2000.

At December 31, 2000, the Company had $3,100,779 of deferred revenue associated
with corporate sales promotions agreements entered into with the Pepsi-Cola
Company which were to be realized, under the guidance of SAB 101, upon
completion of the terms of the respective contracts. In February 2001, the
Company fulfilled its obligation to the Pepsi-Cola Company under such contracts.
As a result, in the first quarter of 2001, the Company recognized the remaining
$3,100,779 of contracted revenue provided under such contracts, as well as
$1,871,760 of related cost of sales.

COST OF SALES. Cost of sales principally consists of content acquisition costs,
production and shipping costs, and credit card receipt processing costs. Content
acquisition costs include royalty advances that were paid upon signing of
royalty agreements with independent music labels and royalty charges that were
assessed on a per music track usage basis. Cost of sales, consisting primarily
of the costs associated with the Pepsi-Cola contract, was $1,925,333 for the
year ended December 31, 2001, as compared to $11,045,929 for the year ended
December 31, 2000.

SALES AND MARKETING EXPENSES. Sales and marketing expenses primarily include
advertising and promotional expenditures, consulting costs, payroll and related
expenses incurred during the first two quarters of the year ended December 31,
2001. Sales and marketing expenses were ($647,685) for the year ended December
31, 2001, as compared to $16,093,084 for the year ended December 31, 2000. In
January 2001, the Company had accrued a liability of $1,719,455 payable to The
Columbia House Company pursuant to a joint venture between the parties, which
was subsequently settled for $450,000. The accrued difference was reversed,
creating a credit to expense of $1,269,455.

In May 2000, the Company and AOL mutually agreed to end an agreement entered
into in September 1999. As a result of the termination, the Company was released
from its future obligation to pay AOL the remaining $13,500,000 obligation
(which was to have been repaid in $1,500,000 quarterly payments through
September 2002) and recorded a non-cash charge of $1,472,000 to sales and
marketing expenses for the quarter ended June 30, 2000.

OPERATING AND DEVELOPMENT EXPENSES. As a result of the Company's cessation of
its Internet-based custom CD-marketing business, the Company expensed $85,444
for operating and development expenses for the year ended December 31, 2001, as
compared to $2,595,802 for the year ended December 31, 2000.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$8,005,124 for the year ended December 31, 2001, compared to $10,658,425 for the
year ended December 31, 2000. General and administrative

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expenses for the year ended December 31, 2001 included $2,818,401 in accrued
rent for the Parkridge Property and $418,901 in accrued rent for the Wiehle
Property (the "Rent Accruals") and a $104,000 accrual for future payments under
certain licensing agreements. Of the total Rent Accruals, $1,827,376 was
recorded during the quarter ended December 31, 2001, based on a revision of an
estimate regarding the sublet of the Parkridge Property. The Rent Accruals are
subject to a reversal, in whole or in part, in future periods depending on
possible assignments or sub-lets of such properties, or successful negotiations
with the relevant landlords. The Company also expensed $907,253 for legal and
other professional fees during the year ended December 31, 2001 and $600,000 in
insurance premiums.

DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization was
$2,976,630 for the year ended December 31, 2001, as compared to $102,033,806 for
the year ended December 21, 2000. Depreciation expense decreased to $2,976,630
for the year ended December 31, 2001, as compared to $3,332,407 for the year
ended December 31, 2000. Depreciation decreased as a result of the sale of all
of the Company's remaining equipment and furniture during the second quarter.
The Company received gross proceeds of $435,927, less applicable expenses of
$55,389. This represented a gain of $27,898 on the written down book value of
equipment, furniture and fixtures. Amortization expense decreased to zero for
the year ended December 31, 2001, as compared to $98,706,399 for the year ended
December 31, 2000. The decrease in amortization of intangibles was due to the
full write down to amortization expense of the December 21, 2000, carrying value
of $78,444,650 of intangibles, including, but not limited to, the agreements
with EMI, Zomba and Platinum, based on the accounting criteria for reflecting
the impairment of assets established in Statement of Financial Accounting
Standards No. 121. Prior to the write down of the carrying values, the Company
recorded $20,261,748 of straight line amortization.

REORGANIZATION COSTS. On September 28, 2000, the Company announced an
infrastructure reorganization that resulted in a 30% decrease of full-time staff
or 27 individuals. The employee reductions occurred within the marketing,
engineering and fulfillment departments. The Company initiated the
reorganization as an attempt to reduce cash outflow. The reorganization resulted
in a charge of $774,573, consisting principally of severance payments for
outplaced employees, including Robert Bernardi who resigned from his position as
Chairman of the Board on September 9, 2000. On January 3, 2001, the Company
suspended its website and terminated over 80% of its workforce. Since June 30,
2001, the Company has had no employees other than its President and Chief
Executive Officer and Chief Financial Officer. During the year ended December
31, 2001, the Company incurred total reorganization costs of $2,087,745,
consisting of severance packages granted to terminated employees in varying
amounts based on length of service with the Company. The Company does not expect
to incur any significant additional reorganizational expenses.

INTEREST INCOME AND EXPENSE. Interest income was $528,116 for the year ended
December 31, 2001, as compared to $2,314,219 for the year ended December 31,
2000. The decline in interest income reflects the decline in cash balances
available for investments. This decrease is partially attributable to the
distribution by the Company on March 9, 2001, of $9,941,988 representing $3.00
per share to holders of record as of March 1, 2001.

OTHER INCOME. As part of the Company's cessation of its Internet-based custom
CD marketing business, the Company hired a professional auction firm in
February of 2001 to assist in the sale of all of the Company's remaining
furniture and equipment. As a result of the auction process, which was
substantially completed by July of 2001, the Company received gross proceeds
of $435,927 and realized other income of $27,898.

EXTRAORDINARY GAIN. In May of 2001, the Company settled its obligation of
$171,429 to Music Maker Relief Foundation for $20,000 and recorded an
extraordinary gain on the early extinguishment of debt of $151,429.

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999

NET SALES. Net sales include the selling price of products sold by the Company,
net of returns, as well as sales promotions and discounts. The Company's net
sales increased 435% to $5,583,505 for the year ended December 31, 2000 compared
to $1,043,841 for the year ended December 31, 1999. Revenue growth resulted from
the sales of custom CDs and digital downloads sold directly to customers through
the Company's website and print and direct marketing efforts. Our involvement
with Columbia House, Microsoft, and other strategic partners provided heavier
Internet traffic and access to additional customer bases which contributed to
the increase in sales. Revenue growth can also be attributed to the large volume
of sales derived from contracts with corporate business looking to fulfill

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mass promotions. During the year ended December 31, 2000, the Company recorded
revenue from the fulfillment of mass promotional sales of $2,921,548 or 52% of
total revenue.

At December 31, 2000, the Company had $3,100,779 of deferred revenue associated
with corporate sales promotions agreements entered into with the Pepsi-Cola
Company which were to be realized, under the guidance of SAB 101, upon
completion of the terms of the respective contracts. In February 2001, the
Company fulfilled its obligation to the Pepsi-Cola Company under such contracts.
As a result, in the first quarter of 2001, the Company recognized the
remaining $3,100,779 of contracted revenue provided under such contracts, offset
by $1,871,760 of cost of sales.

During the year ended December 31, 2000, the Company did not earn advertising
revenue, as compared to $450,000 during the year ended December 31, 1999. The
Company does not expect future sales of these products.

COST OF SALES. Cost of sales principally consist of content acquisition
costs, production and shipping costs, and credit card receipt processing
costs. Content acquisition costs include royalty advances that were paid upon
signing of royalty agreements with independent music labels and royalty
charges that were assessed on a per music track usage basis. Production costs
include jewel cases, CD trays and CD inserts. Cost of sales-product increased
1,458% to $2,435,774 for the year ended December 31, 2000 as compared to
$156,381 for the year ended December 31, 1999. The increase in cost of
sales-product was attributed to increased sales volume during 2000 as
compared to 1999. Cost of sales-content increased 299% to $8,610,155 for the
year ended December 31, 2000 as compared to $2,157,829 for the year ended
December 31, 1999. This increase is attributed to content contracts entered
into in 2000, including, but not limited to, content that was provided by
Deathrow Records (for, among other artists, Snoop Dogg and Tupac Shakur),
Classicberry Limited (for Jimmy Page and the Black Crowes), and Profile
Publishing (for The Who). During the third quarter of 2000, the Company
determined that certain prepaid royalty agreements were impaired assets in
accordance with applicable accounting literature. Thus, the Company expensed
approximately $5,600,000 of the remaining unamortized agreements. The
write-down constituted 87% of the increase in cost of sales-content when
compared to 1999.

SALES AND MARKETING EXPENSES. Sales and marketing expenses primarily include
advertising and promotional expenditures, consulting costs, payroll and related
expenses. Sales and marketing expenses increased 109% to $16,093,084 for the
year ended December 31, 2000 as compared to $7,682,436 for the year ended
December 31, 1999. The increase is primarily attributed to increased advertising
expenses in connection with Columbia House direct mail promotions, magazine
print promotions, concert tour sponsorship for The Who and Jimmy Page and The
Black Crowes, third party advertising services, and the AOL agreement.

In May 2000, the Company and AOL mutually agreed to end the interactive
agreement entered into in September 1999. The Company recorded a non-cash charge
of $1,472,000 to sales and marketing expenses for the quarter ended June 30,
2000. As a result of the termination, the Company was released from its future
obligation to pay AOL the remaining $13,500,000 obligation which was to have
been repaid in $1,500,000 quarterly payments through September 2002.

OPERATING AND DEVELOPMENT EXPENSES. Operating and development expenses increased
63% to $2,595,802 for the year ended December 31, 2000 as compared to $1,596,505
for the year ended December 31, 1999. A significant component of the increase
from the previous year is attributed to increased staffing in customer service,
research and development, website maintenance, and product fulfillment. The
Company anticipates decreases in these costs due to staff reductions in the
aforementioned areas and the suspension of the Company's website.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily consist of legal and professional fees, payroll costs and related
expenses for accounting and administrative personnel, and other expenses
associated with general and corporate functions. Also included in general and
administrative expenses are expenses associated with the issuance of warrants to
various consultants. For the year ended December 31, 2000 general and
administrative expenses increased 104% to $10,658,425 as compared to $5,213,998
for the year ended December 31, 1999. The increase in general and administrative
expenses is primarily attributed to increases in personnel to support the
Company's operations. As a result, salaries and wages, benefits such as
insurance, bonuses, and other employee related costs increased as well as
recruiting and costs for temporary help. Professional fees also increased

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as compared to the prior year due to investor relations, public relations, and
attorneys' fees related to the defense of the stockholder class action lawsuit.
Rent, facility expenses (such as communication data lines, telephone, and
certain equipment leases), and general office expenses also increased as a
result of the Virginia office expansion.

DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization was
$102,038,806 for the year ended December 31, 2000 as compared to $12,081,971 for
the year ended December 31, 1999. Depreciation expense increased 1,075% to
$3,332,407 for the year ended December 31, 2000 as compared to $283,566 for the
year ended December 31, 1999. Depreciation increased as a result of the
leasehold improvements for the new Virginia office and production facility and
the acquisition of new equipment to increase production capacity. Additionally,
depreciation was increased by $2,000,000 resulting from the Company recording an
impairment allowance for its technology and computer equipment (See Note 2 to
our financial statements). Amortization expense increased 737% to $98,706,399
for the year ended December 31, 2000 as compared to $11,798,405 for the year
ended December 31, 1999. The increase in amortization of intangibles was due to
the full write down to amortization expense of the December 31, 2000 carrying
value, $78,444,650, of intangibles, including, but not limited to, the
agreements with EMI, Zomba, and Platinum, based on the accounting criteria for
reflecting the impairment of assets established in Statement of Financial
Accounting Standards No. 121. Prior to the write down of the carrying values,
the Company recorded $20,261,748 of straight line amortization during the year
2000.

LOSS ON INVESTMENT. As a result of a decline in Platinum's stock price during
the three months ended June 30, 2000 and the fact that Platinum was de-listed by
the Nasdaq Stock Market, the Company has determined its investment in Platinum
of $1,200,000 to have only minimal value and wrote off its investment to expense
in the month ended June 30, 2000. This amount consisted of 111,457 and 166,667
unregistered shares of Platinum stock issued to the Company on September 30,
1998 and February 1, 2000, respectively.

INTEREST INCOME AND EXPENSE. Interest income increased 51% to $2,314,219 for the
year ended December 31, 2000 as compared to $1,535,077 for the year ended
December 31, 1999. The increase in interest income is attributed to the
investment of cash and cash equivalents for a full year in 2000 as compared to
half of a year during 1999. Interest expense decreased 99% to $1,210 for the
year ended December 31, 2000 as compared to $384,527 for the year ended
December 31, 1999. The decrease in interest expense during 2000 from 1999 is due
to the retirement of notes payable that were paid from the proceeds of the
Company's initial public offering in July 1999.

ACCRETION OF PREFERRED STOCK WARRANTS. Upon completion of the initial public
offering, all outstanding shares of Series A, Series B, and Series C convertible
preferred stock were converted into 190,872 shares of common stock and all
outstanding convertible notes payable were converted into shares of 96,825
shares of common stock in the third quarter of 1999. Upon conversion of the
Series A preferred stock into common stock in the third quarter of 1999, the
remaining discount of $641,106 on the Series A preferred stock was recorded as
accretion. The accretion recorded for the year ended December 31, 1999 was
$723,318. No accretion was recorded for the year ended December 31, 2000. The
accretion did not effect the Company's cash flows. The Series B and Series C
preferred stock warrants converted into common stock warrants upon completion of
the initial public offering.

ONE FOR TEN REVERSE STOCK SPLIT. On August 28, 2000, the Company's Board of
Directors and a majority of the stockholders authorized a one for ten reverse
stock split of the Company's $0.01 par value common stock. As a result of the
split, which became effective on November 3, 2000, 33,140,421 shares of existing
common stock were exchanged for 3,314,042 share of new common stock, thus
additional paid-in capital was increased by $298,263 and common stock was
decreased accordingly. All references in the accompanying filing on Form 10-K to
the number of common shares and per share amounts for 2000, 1999, and 1998 have
been restated to reflect the stock split.

CRITICAL ACCOUNTING POLICIES

The SEC has recently issued Financial Reporting Release No. 60, "Cautionary
Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"),
suggesting companies provide additional disclosure and commentary on those
accounting policies considered most critical. FRR 60 considers an accounting
policy to be critical if it is important to the Company's financial condition
and results, and requires significant judgment and estimates on the

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part of management in its application. Musicmaker believes the following
represent the critical accounting policies of the Company as contemplated by
FRR 60 based on our current state of operations. For a summary of all of the
Company's significant accounting policies, including the critical accounting
policies discussed below, see Note 2 to the accompanying consolidated financial
statements based on the Company's current activities.

INVESTMENTS IN AVAILABLE-FOR-SALE SECURITIES

The Company purchased marketable equity securities which it has classified, for
accounting purposes, as available-for-sale securities. Available-for-sale
securities are stated at fair value with unrealized holding gains and losses
reported as a separate component of stockholders' equity as accumulated other
comprehensive income. The fair market value of available-for-sale securities is
based on quoted market prices from nationally recognized exchanges. The Company
also assesses whether any impairment of the fair value of an available-for-sale
security below its cost basis is other than temporary and might require a write
down through earnings.

OPERATING LEASE ACCRUALS

The Company has vacated possession of its premises subject to operating
leases. We have accrued an expense representing an estimate of the net costs
that the Company expects to pay through the end of those operating leases.
The recorded value of this accrual requires an estimate of the payment terms
and duration of sub-leases for each operating lease. These estimates may
change from time to time based on our ability to sub-lease these properties
or our ability to terminate some or all of these leases prior to the end of
their respective terms. It is possible that future results of operations for
quarterly or annual periods could be materially affected by changes to the
assumptions and estimates relating to the operating lease accruals.

LEGAL CONTINGENCIES

We are involved in several legal proceedings resulting from our former
operations. A significant judgment we make, in consultation with legal counsel,
is the determination as to the likelihood that any of the legal claims filed
against us will result in a liability for the Company. We record accruals
related to the potential loss that we believe provides for the probable and
estimable losses related to legal claims. We also disclose any legal claims
filed against us that we believe to be significant. It is possible that future
results of operations for quarterly or annual periods could be materially
affected by changes in our assumptions, or the effectiveness of our settlement
or litigation strategies, related to these proceedings.

LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities was $7,819,360 for the year ended December
31, 2001. The cash used in operating activities resulted from the Company's net
loss of $10,523,737, a decrease in deferred revenue of $3,100,779, a decrease in
accounts payable of $576,560 and other charges of $256,813, offset by a decrease
in prepaid expenses and other current assets of $1,925,444, a decrease in
accounts receivable of $533,112, a decrease in related party receivables of
$88,041, an increase in accrued expenses of $1,115,302 and depreciation expense
of $2,976,630.

Cash used in activities characterized as investment activities for accounting
purposes was $1,156,369 for the year ended December 31, 2001. The cash
outlays were for the purchase of securities classified, for accounting
purposes, as available-for-sale securities. Cash provided by investing
activities represents the proceeds from the sale and retirement of a majority
of all the Company's equipment, offset by the purchase of miscellaneous
equipment previously accounted for under operating leases.

Net cash used in financing activities was $9,879,488 for the year ended December
31, 2001. The payment of a $3.00 cash distribution totaling $9,859,488 payable
to shareholders of record on March 1, 2001 accounted for substantially all of
the cash used in financing activities.

On February 25, 2002 the Board of Directors authorized a stock repurchase
program for up to 500,000 shares of the

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Company's Common Stock. Shares of Common Stock are expected to be purchased from
time to time in open market transactions and privately negotiated transactions,
subject to availability and price, prevailing market and business conditions and
regulatory compliance.

On February 27, 2002, the Company, along with certain other entities
(together with the Company, the "Reporting Entities"), was party to a joint
filing on Schedule 13D reporting the purchase of 3,485,500 shares of common
stock of Fairmarket Inc. ("Fairmarket") (NASDAQ: FAIM) (such amount
representing approximately 12.0% of Fairmarket's outstanding common stock).
Of the total amount of outstanding common stock reported as beneficially
owned by the Reporting Entities, the Company may deemed to account for
627,390 shares of such common stock (such amount representing approximately
3.0% of Fairmarket's outstanding common stock). The Reporting Entities
include, in addition to the Company, Barington Companies Equity Partners,
L.P., an affiliate of Barington, a major shareholder of the Company, and
Jewelcor Management, Inc., an entity whose Chairman and Chief Executive
Officer is Seymour Holtzman, the Chairman of the Company's Board of Directors.

At December 31, 2001, the Company had $7,596,588 in cash and cash equivalents
compared to $26,451,805 at December 31, 2000. Substantially all of the Company's
remaining cash was provided by our initial public offering of Common Stock in
1999. The Company expects to experience negative cash flows for the foreseeable
future. Based on our current level of operations, we believe that we have
sufficient cash and cash equivalents to satisfy our obligations in 2002,
although we can give no assurances in that regard. The Company believes these
obligations will primarily relate to contractual obligations on non-cancelable
operating leases, costs associated with the operation as a public company
(legal, accounting, insurance, etc.), as well as the satisfaction of any
potential legal judgments or settlements as well as the expenses associated with
any new business activities which may be undertaken by the Company.

To the extent that management of the Company moves forward on its alternative
strategies, such strategies may have a significant impact on our liquidity.

-13-

FACTORS THAT MAY AFFECT OUR BUSINESS, FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

OUR COMMON STOCK HAS BEEN DELISTED FROM THE NASDAQ AND IS CURRENTLY SUBJECT TO
"PENNY STOCK" RULES.

Since our common stock is not listed on a national securities exchange or listed
on a qualified automated quotation system, and does not qualify for any
available exceptions, it is subject to Rule 15g-9 under the Exchange Act, which
imposes additional sales practice requirements on broker-dealers that sell such
securities to persons other than established customers and "accredited
investors" (generally, individuals with a net worth in excess of $1,000,000 or
annual incomes exceeding $200,000 or $300,000 together with their spouses).

For transactions covered by Rule 15g-9, a broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to sale. For any transaction involving
a penny stock, unless exempt, the rules require delivery, prior to any
transaction in a penny stock, of a disclosure schedule prepared by the
Securities and Exchange Commission relating to the penny stock market.
Disclosure is also required to be made about sales commissions payable to both
the broker-dealer and the registered representative and current quotations for
the securities. Finally, monthly statements are required to be sent disclosing
recent price information for the penny stock held in the account and information
on the limited market in penny stock. Consequently, such Rule may affect the
ability of broker-dealers to sell the Company's securities and may affect the
ability of purchasers to sell any of the Company's securities in the secondary
market.

CONCENTRATION OF STOCK OWNERSHIP MAY DELAY OR PREVENT A CHANGE OF CONTROL.

Our directors, executive officers and principal stockholders and their
affiliates own a significant percentage of our outstanding common stock. As a
result, these stockholders may have the ability to influence the outcome of
corporate actions requiring stockholder approval. This concentration of
ownership may have the effect of delaying or preventing a change in control of
the Company.

CERTAIN ALTERNATIVES BEING CONSIDERED BY THE BOARD, IF THEY OCCUR, COULD HAVE A
SUBSTANTIALLY DILUTIVE EFFECT ON YOUR INVESTMENT.

The Company's Board of Directors has determined to seek to pursue one or more
potential acquisitions. See Item 1. "Business." Such acquisitions could involve
the issuance of additional equity in the Company or a future business
combination involving the Company. Depending on the terms of any such event, you
could experience a substantially dilutive effect on your investment.

WE FACE CONTINGENT LIABILITIES THAT MAY PROVE TO HAVE A MATERIAL ADVERSE EFFECT
ON OUR ABILITY TO MAXIMIZE SHAREHOLDER VALUE.

As disclosed in "Legal Proceedings", included elsewhere in this Annual Report,
we are subject to certain lawsuits that could result in judgments against the
Company for, or settlements resulting in, significant monetary awards. Although
the Company believes that it has meritorious defenses to such lawsuits, and
intends to defend against them vigorously, there can be no assurances that the
ultimate outcome of such lawsuits would not have a material adverse effect on
the Company and your investment.

OUR STOCKHOLDERS MAY HAVE DIFFICULTY IN RECOVERING MONETARY DAMAGES FROM
DIRECTORS.

Our Certificate of Incorporation contains a provision which eliminates personal
liability of our directors for monetary damages to be paid to us and our
stockholders for some breaches of fiduciary duties. As a result of this
provision, our stockholders may be unable to recover monetary damages against
our directors for their actions that constitute breaches of fiduciary duties,
negligence or gross negligence. Inclusion of this provision in our Certificate
of Incorporation may also reduce the likelihood of derivative litigation against
our directors and may discourage lawsuits against our directors for breach of
their duty of care even though some stockholder claims might have been
successful and benefited stockholders.

-14-

WE MIGHT BE DEEMED TO BE AN INVESTMENT COMPANY AND SUBJECTED TO RELATED
RESTRICTIONS

The regulatory scope of the federal Investment Company Act, which was enacted
principally for the purpose of regulating vehicles for pooled investments in
securities, extends generally to companies engaged primarily in the business of
investing, reinvesting, owning, holding or trading in securities. The Investment
Company Act may, however, also be deemed to be applicable to companies which do
not intend to be characterized as an investment company but which, nevertheless,
may be deemed to be within the definitional scope of certain provisions of the
Investment Company Act. We do not intend and do not consider the Company to be
an investment company and our anticipated activities going forward are expected
to involve acquiring one or more related or other businesses. To the extent
that, pending such developments, we may technically fall within the scope of
certain definitional provisions of the Investment Company Act, we would expect
to rely on exclusions of limited duration for so-called "transient investment
companies" contained in the rules under the Investment Company Act. If we were
deemed to be an investment company, our activities would be restricted,
including restrictions on the nature of our investments and the issuance or
repurchase of securities. We might also be required to register under the
Investment Company Act and file reports, or adopt corporate governance rules
including significant reporting, record keeping, voting, proxy, disclosure and
other rules and regulations. In the event we were deemed to be an investment
company, our failure to satisfy such regulatory requirements would have a
material adverse effect on us.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The majority of our sales and expenses are denominated in U.S. dollars and as a
result, foreign exchange gains and losses to date have been insignificant. While
the Company may effect some transactions in foreign currencies, it does not
expect that any related gains or losses will be significant. The Company has not
engaged in foreign currency hedging to date.

-15-

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

-16-

Report of Independent Auditors

Board of Directors and Stockholders
Musicmaker.com, Inc.

We have audited the accompanying balance sheets of Musicmaker.com, Inc. as of
December 31, 2001 and 2000, and the related statements of operations,
stockholders' (deficit) equity, and cash flows for each of the three years in
the period ended December 31, 2001. Our audit also included the financial
statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Musicmaker.com, Inc. at
December 31, 2001 and 2000, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

The accompanying financial statements and schedule have been prepared
assuming that Musicmaker.com, Inc. will continue as a going concern. As
described more fully in Note 1, on January 3, 2001, Musicmaker.com, Inc.
ceased operation of its Internet-based custom compact disc marketing business
and has no current substantive business operations. The Board of Directors
continues to review alternatives for the Company, but has not consummated any
significant transactions to date. As a result, the Company's business
prospects remain uncertain. These conditions raise substantial doubt about
the Company's ability to continue as a going concern. The financial
statements and schedule do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the
outcome of this uncertainty.

/s/ Ernst & Young LLP
McLean, Virginia
January 26, 2002

-17-

Musicmaker.com, Inc.

Balance Sheets

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.

-18-

Musicmaker.com, Inc.

Statements of Operations

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.

-19-

Musicmaker.com, Inc.

Statements of Stockholders' (Deficit) Equity

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.

-20-

Musicmaker.com, Inc.

Statements of Cash Flows

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART TO THESE FINANCIAL STATEMENTS.

-21-

1. ORGANIZATION

THE COMPANY

On January 3, 2001, the Board of Directors of musicmaker.com, Inc.
("musicmaker", the "Company") as then constituted voted unanimously to cease
the operations of its Internet-based custom CD-marketing business. The
then-Board concluded at that time that this business no longer represented a
viable alternative to provide maximum value to the Company's stockholders.

The present Board determined to review alternatives for the Company going
forward, which included, among other things, potential dispositions of
assets, the possibility of one or more additional cash distributions to
stockholders, and the potential continued operation of musicmaker as a public
company which might pursue other business opportunities as they arise, as
well as other possible steps intended to provide stockholder value, all
subject to the ongoing review and consideration of the Board, some of which
would require stockholder approval. On February 15, 2001, the Company
announced that the Board of Directors had approved a cash distribution in the
amount of $3.00 per share to the holders of record of Common Stock as of
March 1, 2001, the record date, pursuant to which the Company distributed
$9,941,998 to its stockholders.

Thereafter, the Board determined to seek to pursue one or more potential
acquisitions of other publicly traded or privately held companies or significant
interests in such companies, with a view to refocusing the Company's strategic
direction. While the Company has actively examined certain potential acquisition
transactions and believes that attractive opportunities exist, there can be no
assurance whether, when, or on what terms the Company will complete any such
acquisition.

Until the events described above, the Company was a provider of customized music
CD compilations and music digital downloads. The Company sold its products
primarily over the Internet through its website and through marketing partners,
strategic alliances and direct mail-order promotions.

In connection with the Company's cessation of its Internet-based custom
CD-marketing business, the Company hired a professional auction firm in
February 2001 to assist in the sale of all of the Company's remaining
furniture and equipment. As a result of the auction process, which was
substantially completed by July 2001, the Company received gross proceeds of
$435,927.

In addition, effective as of July 1, 2001, the Company relocated its
principal executive offices to 888 Seventh Avenue, 17th Floor, New York, New
York 10019, an office maintained by Barington Capital Group, L.P.
("Barington"), a limited partnership whose general partner is a corporation
of which James Mitarotonda is Chairman, President and Chief Executive
Officer. Barington and an affiliate are members, and Mr. Mitarotonda is one
of the managing members, of BCG Strategic Investors LLC, which, together with
certain affiliates, beneficially owns approximately 38% of the Company's
Common Stock. Mr. Mitarotonda is also the President and Chief Executive
Officer of the Company.

Effective July 1, 2001, Barington has made available to the Company the services
of a Barington employee to serve as the Chief Financial Officer and Secretary of
the Company, and began providing the Company with the assistance of certain
other Barington employees and the use of office space and administrative
services provided by Barington.

The Company's financial statements as of December 31, 2001 and for the year
then ended have been prepared on a going concern basis, which contemplates
the realization of assets and the settlement of liabilities and commitments
in the normal course of business. At December 31, 2001, the Company had
$7,596,588 in cash and cash equivalents compared to $26,451,805 at December
31, 2000. Substantially all of the Company's remaining cash was provided by
our initial public offering of Common Stock in 1999. The Company expects to
experience negative cash flows for the foreseeable future. Based on our
current level of operations, the Company believes that it has sufficient cash
and cash equivalents to satisfy our obligations in 2002, although it can give
no assurances in that regard. The Company believes these obligations will
primarily relate to contractual obligations on non-cancelable operating
leases, costs associated with the operation as a public company (legal,
accounting, insurance, etc.), as well as the satisfaction of any potential
legal judgments or settlements as well as the expenses associated with any
new business activities which may be undertaken by the Company. As noted
above, the Company continues to consider future alternatives, including the
possible acquisition of other businesses. However, the Company has not
consummated any significant transactions to date and the Company's business
prospects remain uncertain. To the extent that management of the Company
moves forward on any alternative strategy, such strategy may have an impact
on the Company's liquidity.

-22-

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

REVENUE RECOGNITION

Net sales were recognized at the time merchandise was shipped to customers for
custom CDs and upon execution of orders for digitally downloaded songs.

Deferred revenue was recorded upon receipt of cash in advance from customers.
The Company recognized revenue at the time merchandise was shipped to customers
and all obligations of the Company had been fulfilled.

Advertising sales on banner contracts and interfaces and links to other websites
were recognized ratably over the period in which the advertisement and/or link
were displayed, provided that no significant obligations remained at the end of
the period and collection of the resulting receivable was probable.

SIGNIFICANT CUSTOMERS

In February 2001, the Company fulfilled its contract with the Pepsi-Cola
Company. As a result, the Company recognized the remaining $3,100,779 of revenue
under the contract, which represented approximately 97% of the Company's total
revenue for the year ended December 31, 2001. For the year ended December 31,
2000, two customers generated 50% of the Company's total revenue.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with an original maturity
of three months or less when purchased to be cash equivalents. A portion of
the Company's cash balances are held in an account managed by Barington.
Barington and an affiliate are members of BCG Strategic Investors, which,
together with certain affiliates, beneficially owns approximately 38% of the
Company's Common Stock.

INTANGIBLE ASSETS

Prior to the Company's cessation of its Internet-based custom CD marketing
business, the Company entered into license agreements with various record
labels. The Company recorded the assets based on the fair market value of the
consideration granted and was amortizing the assets over the life of the license
agreements. At December 31, 2000, the carrying value of the intangibles was
assessed at zero and the value was written off to amortization. See Note 5.

IMPAIRMENT OF LONG-LIVED ASSETS

At each balance sheet date, management determines whether any property and
equipment or any other assets have been impaired based on the criteria
established in Statement of Financial Accounting Standards ("SFAS") No. 121,

ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO
BE DISPOSED OF.

The Company evaluates the carrying amount of long-lived assets to be held and
used, including property and equipment and intangible assets, when events and
circumstances warrant such a review. The carrying amount of a long lived
asset is considered impaired when the estimated undiscounted cash flow from
each asset is less than its carrying amount. In that event, the Company
records a loss equal to the amount by which the carrying amount exceeds the
fair market value of the long-lived asset. Assets to be disposed of are
measured at the lower of carrying amount or fair value less cost to sell. For
the year ended December 31, 2001 and 2000 the Company recorded impairment
allowances of $2,276,731 and $2,000,000, respectively. At December 31, 2001
all property and equipment had a carrying value of zero. See Note 3.

-23-

COST OF SALES

In accordance with Statement of Financial Accounting Standards No. 50,
"FINANCIAL REPORTING IN THE RECORD AND MUSIC INDUSTRY," royalty advances and
minimum guarantees to music labels were recorded as an asset if the past
performance and current popularity of the music to which the advance related
provided a sound basis for estimating the probable future recoupment of such
advances. Advances were then expensed as subsequent royalties were earned. Any
portion of advances that subsequently appeared not to be fully recoverable from
future royalties were charged to expense during the period in which the loss
became evident.

The Company includes in cost of sales royalty expenses incurred based on usage
per music track. Royalty charges resulted in cost of sales, related to music
content, of $13,647, $8,610,155, and $2,157,829 for the years ended December 31,
2001, 2000, and 1999, respectively. The Company has included in cost of sales
royalty advances that were paid upon signing of certain initial royalty
agreements with independent music labels, due to management's expectations of
minimal revenues expected during the one-year period following the signing of
the contracts. The Company may be required to make additional advances upon the
anniversaries of the signing of these initial contracts and expenses them as
incurred.

OPERATING AND DEVELOPMENT COSTS

Operating and development costs relating to the Company's proprietary custom CD
compilation software technology were expensed as incurred. The Company has
incurred research and development costs of approximately $72,000, $511,000 and
$744,000 in the years ended December 31, 2001, 2000 and 1999, respectively.
Operating and development costs also include network and non-capitalized website
costs.

ADVERTISING COSTS

The Company expenses all advertising costs as incurred. The Company incurred
approximately ($1,167,000), $7,970,000, and $4,614,000 in advertising costs for
the years ended December 31, 2001, 2000 and 1999, respectively.

INVESTMENTS

Securities classified for accounting purposes as available-for-sale securities
consist of marketable equity securities not classified as either
held-to-maturity or trading securities. Available-for-sale securities are stated
at fair value with unrealized holding gains and losses reported as a separate
component of stockholders' equity as accumulated other comprehensive income.
Dividends on marketable equity securities are recognized in income when
declared. Realized gains and losses and declines in value deemed to be
other-than-temporary are included in other income (expense.) The cost basis for
realized gains and losses is determined on the basis of the actual cost of the
securities sold.

As of December 31, 2001, the Company had available-for-sale investments with a
fair market value of $1,670,992 and a cost basis of $1,556,903. The gross
unrealized gains of $114,089 have been recorded as a separate component of other
comprehensive income.

As of December 31, 2001 the Company held the following equity positions:

Liquid Audio Inc. (NASDAQ: LQID) 626,100 shares
Clarus Corporation (NASDAQ: CLRS) 6,195 shares
Vulcan International Corp. (AMEX: VUL) 4,000 shares

All investments are held in an account managed by Barington. Barington and an
affiliate are members of BCG Strategic Investors, which, together with
certain affiliates, beneficially owns approximately 38% of the Company's
Common Stock.

-24-

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company considers the recorded costs of its financial assets and
liabilities, which consist primarily of cash and cash equivalents, accounts
receivable, investments, accounts payable and related party payables, to
approximate the fair value of the respective assets and liabilities.

INCOME TAXES

The Company accounts for income taxes in accordance with Statement of Financial
Accounting Financial Standards No. 109, "ACCOUNTING FOR INCOME TAXES"
("SFAS 109"). Under the asset and liability method of SFAS 109, deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statements carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under SFAS 109, the effect of a change in tax rates on deferred tax
assets and liabilities is recognized in income in the period that includes the
enactment date.

COMPREHENSIVE INCOME/(LOSS)

The Company separately reports net loss and comprehensive income or loss
pursuant to SFAS No. 130, "Reporting Comprehensive Income." Other comprehensive
income includes revenues, expenses, gains and losses that under generally
accepted accounting principles are recorded as an element of stockholders'
equity and are excluded from net income. The Company's comprehensive loss for
the year ended December 31, 2001 totaled $10,409,648 and is comprised of the
Company's net loss of $10,523,737, partially offset by $114,089 of unrealized
gains related to available-for-sale securities. Comprehensive loss equals net
less for all other periods presented.

NET LOSS PER SHARE

The Company has adopted Financial Accounting Standards Board Statement No. 128,
"EARNINGS PER SHARE," ("SFAS 128") which established standards for computing and
presenting net income per share information. Basic net loss per share was
determined by dividing net loss by the weighted average number of common shares
outstanding during each period. Diluted net loss per share excludes common
equivalent shares, unexercised stock options and warrants as the computation
would be anti-dilutive. A reconciliation of the net loss available for common
shareholders and the number of shares used in computing basic and diluted net
loss per share is in Note 11.

Basic and diluted net loss per share is also computed pursuant to SEC Staff
Accounting Bulletin No. 98 ("SAB 98"). SAB 98 requires that all equity
instruments issued at nominal prices, prior to the effective date of an initial
public offering, be included in the calculation of basic and diluted loss per
share as if they were outstanding for all periods presented. To date, the
Company has not had any nominal issuances or grants at nominal prices.

STOCK-BASED COMPENSATION

Statement of Financial Accounting Standards No. 123, "ACCOUNTING FOR STOCK-BASED
COMPENSATION" ("SFAS 123"), allows companies to account for stock-based
compensation either under the new provisions of SFAS 123 or under the provisions
of Accounting Principles Bulletin No. 25, "ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES" ("APB 25"), but requires pro forma disclosure in the footnotes to the
financial statements as if the measurement provisions of SFAS 123 had been
adopted. The Company has elected to account for its stock-based compensation in
accordance with the provisions of APB 25. As of December 31, 2001, the Company
did not have any equity instruments outstanding to employees.

RECLASSIFICATIONS

Certain amounts in the prior periods have been reclassified to conform with the
current period presentation.

3. PROPERTY AND EQUIPMENT

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Property and equipment are stated at historical cost and are depreciated using
the straight-line method over the shorter of the asset's estimated useful life
or the lease term, ranging from three to ten years.

At December 31, 2000, the Company reviewed its property and equipment for
impairment and determined to record an impairment allowance based on the
criteria established in SFAS No. 121. This determination was based on the fact
that the Company suspended its website, and suspended sales of custom CDs and
that digital downloads as of January 3, 2001 and the computer equipment is
technologically obsolete in certain respects. As a result, the Company recorded
an additional $2,000,000 in depreciation expense to estimate the value of the
impairment.

As of June 30, 2001, the Company had sold all of its remaining furniture and
equipment at auction for gross proceeds of $435,927 and realized a gain of
$27,898 which is included in other income. Additionally, the Company reviewed
its leasehold improvements for impairment and determined an impairment
allowance existed for the book value at June 30, 2001 as the Company was
currently vacating the space and there was no salvage value for the leasehold
improvements. As a result, the Company recorded an additional $2,276,731 in
depreciation expense. Property and equipment consist of the following:

4. INVESTMENT IN PLATINUM

In connection with exclusive music license, stock exchange and marketing
agreements signed with Platinum, on September 30, 1998, the Company received
111,457 shares of unregistered common stock of Platinum. The Company's
investment in these equity securities was recorded at the fair market value of
Platinum's stock, $750,000, on the date of the transaction.

On October 1, 1999, the Company entered into another marketing agreement with
Platinum under which Platinum purchased prominent advertising and promotion
positioning in Musicmaker's Christmas and Holiday music promotions for the
fourth quarter of 1999. The marketing services consisted principally of an
interface and link between the Musicmaker website and the Platinum website,
which site was accessed by an icon on the Musicmaker site as a link to the
Platinum site. In exchange for the marketing services rendered, Platinum agreed
to pay the Company $500,000 in cash or common stock of Platinum, which form of
payment was to be determined in Platinum's sole discretion. Accordingly, on
February 1, 2000, Platinum issued 166,667 shares of its unregistered common
stock, par value $.001 per share, to Musicmaker.com. The Company discounted the
value of the stock received given that it is not registered, and recorded
advertising sales and an account receivable of $450,000 at December 31, 1999.
Upon receipt of the shares, the Company increased its recorded investment in
Platinum by $450,000 and relieved the account receivable balance.

As a result of a decline in Platinum's stock price during the second quarter
2000, the fact that Platinum was delisted by the Nasdaq Stock Market and the
fact that Platinum declared bankruptcy in July 2000, the Company determined its
investment of $1,200,000 in Platinum to have only minimal value and wrote off
its investment to expense.

5. INTANGIBLES

In connection with the exclusive music license, stock exchange and marketing
agreements signed with Platinum in

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1998, the Company recorded an intangible asset for licensing fees of $900,000.
(See Note 6). The asset recorded was the difference in fair market values of
Musicmaker's common stock issued to Platinum and the Platinum common stock
issued to the Company. The Company was amortizing the intangible on a
straight-line basis over the five-year period of the license agreement.

In June 1999, the Company executed a license agreement with Virgin Holdings,
Inc., an affiliate of EMI Recorded Music, Inc. ("EMI") whereby EMI agreed to
make certain of its content available to the Company, in EMI's sole discretion,
in exchange for 50% of the Company's common stock, calculated on a fully diluted
basis on the effective date of the transaction. Under this agreement, the
Company made royalty payments in connection with the inclusion of music content
provided by EMI in the Company's library of content available for custom CDs. In
exchange for the Company's rights under the license agreement, the Company
issued 1,517,086 shares of common stock valued at $86,625,610, estimating the
fair value of the Company's common stock at $57.10 per share. The Company was
amortizing the intangible asset on a straight-line basis over the five-year
period of the license agreement. The Company was amortizing this license fee as
a non-cash charge of approximately $17.3 million each year.

In August 1999, the Company entered into a license agreement with Zomba Record
Holdings B.V. ("Zomba") in exchange for 193,700 shares of the Company's common
stock valued at $20 million. Zomba is the direct or indirect parent entity of a
number of licensor entities under which the license agreement grants rights to
use certain music content for a five-year term.

Additionally in August 1999, the Company entered into a five-year license
agreement with TeeVee Toons, Inc., ("TVT") in exchange for 27,500 shares of the
Company's common stock valued at $2,681,250.

In January 2000, the Company issued a warrant exercisable for 5,882 shares of
our common stock to Cheap Trick Unlimited, in exchange for and in connection
with Cheap Trick's execution of a license agreement, granting Musicmaker.com
access to certain sound recordings for a period of five years. The Company
recorded an intangible asset of $292,922 which was to be amortized over five
years, however in accordance with the criteria of SFAS No. 121, the intangible
was fully amortized at December 31, 2000.

In February 2000, the Company executed a license agreement with Metal Blade
Records. In exchange for the Company's rights under such agreement the Company
issued 823 shares of its common stock valued at $50,000. The Company recorded an
intangible of $50,000 which was to be amortized over five years, however in
accordance with the criteria of SFAS No. 121, the agreement was fully amortized
at December 31, 2000.

As of December 31, 2000, the Company reviewed the intangibles for impairment and
determined to fully write down the carrying value of such assets at December 31,
2000 based on the accounting criteria for reflecting the impairment of assets
established by SFAS No. 121. This determination was based on the fact that the
Company suspended its website and suspended sales of custom compiled CDs and
digital downloads as of January 3, 2001. As a result, the Company expensed
$78,444,650, the current values of all the agreements, to amortization expense.

Intangible assets consist of the following:

See Note 8 for discussion of equity investments issued in connection with
licensing agreements.

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6. ACCRUED EXPENSES

Accrued expenses as of December 31, 2001 and 2000 are comprised of the
following:

7. LONG-TERM OBLIGATIONS, CONVERTIBLE NOTES PAYABLE AND OTHER DEBT
ARRANGEMENTS

On July 1, 1998, the Company entered into a mutual coexistence agreement with
Music Maker Relief Foundation, Inc. ("Music Maker Relief Foundation"), a
not-for-profit corporation that owns the trademark MUSICMAKER and the Internet
domain name MUSICMAKER.ORG. In consideration of avoiding any possible conflict
regarding names, marks, goods and services, the Company agreed to pay $300,000
to Music Maker Relief Foundation prior to changing its name to Musicmaker.com,
Inc. At December 31, 2000, the Company had a remaining obligation of $171,429
($42,857 is due on April 15th of each of the years 2001 through and including
2004). The Company expensed $300,000 upon signing of the agreement.

In May of 2001, the Company settled its obligation for $20,000 and recorded an
extraordinary gain on the early extinguishment of debt of $151,429. Pursuant to
the terms of the settlement, the Company was released from all monetary claims
that the Foundation may have had against the Company.

From October 1998 through January 1999 the Company completed a private placement
offering of approximately $2,000,000 in aggregate principle 8% convertible
secured subordinate notes payable. In July 1999, upon consummation of the
initial public offering, all of the outstanding convertible notes payable were
mandatorily converted into 96,825 shares of the Company's common stock at $20.60
per share. In connection with the convertible notes payable, the Company
recorded loan fees of $290,000 and issued a warrant to purchase 9,683 shares of
common stock at an exercise price of $20.60 per share, which expires on January
11, 2004. The Company recorded an expense of $70,649 for the fair value of this
warrant.

8. COMMON STOCK AND CONVERTIBLE PREFERRED STOCK

COMMON STOCK AND WARRANTS

In 1998, the Company issued a total of 72,017 shares of common stock at $20.60
per share to seven investors for a total of $1,487,500. The Company paid a
finders fee of $143,198 related to this private placement. The Company also
issued a warrant to purchase 12,103 shares of common stock at an exercise price
of $20.60 per share to one of the investors and recorded an expense of $88,000
for the value of the warrants. This warrant expires on October 27, 2003.

In January 1998, a stockholder and officer of the Company returned 16,945 stock
options to the Company in

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exchange for a warrant to purchase 16,945 shares of common stock with an
exercise price of $16.50 per share and valued at $148,400. This warrant expires
on January 15, 2008. This individual is also the beneficial owner of warrants
for 6,051 shares of common stock granted to members of his family as
compensation for his consulting services in August 1998 with an exercise price
of $19.80 per share valued at $64,000. The Company recorded an expense of
$212,400 related to the issuance of these warrants. These warrants expire on
August 15, 2008.

In connection with the exclusive music license, stock exchange and marketing
agreements signed with Platinum on September 30, 1998, the Company issued 79,885
shares of common stock to Platinum (valued at $1,650,000) and Platinum issued
111,457 shares of its unregistered common stock to the Company (having an
aggregate value of $750,000). The Company recorded the difference in the fair
market values of the two stocks as licensing fees.

In January 1999, the Company completed its common stock private placement to
outside investors and issued 58,738 shares of common stock at $20.60 per share
for a total of $1,213,250. The Company paid a commission of approximately
$97,000 related to this private placement and issued a warrant to purchase
10,896 shares of common stock with an exercise price of $20.60 per share, which
expires on January 14, 2004.

As part of an equipment lease agreement entered into in January 1999, the
Company issued a warrant to purchase 1,452 shares of common stock at $20.60 per
share which was exercised on August 16, 1999 for $30,000. The Company recorded
an expense of $16,021 related to the issuance of this warrant.

In February 1999, the Board of Directors approved a one-for-3.85 reverse stock
split of the Company's common stock, which was effective on April 8, 1999. All
references in the accompanying financial statements to the number of shares of
common stock and per-share amounts have been restated to reflect the split.
Additionally, all references in the accompanying financial statements to the
number of shares of preferred stock and per-share amounts have been restated to
reflect the split in accordance with the Company's Amended and Restated
Certificate of Incorporation.

On April 8, 1999, the Company issued a warrant to purchase 24,207 shares of
common stock at $19.80 per share to a consultant for services rendered. The
Company recorded an expense of $464,415 related to the issuance of this warrant.

In June 1999, in connection with the license agreement signed with EMI, the
Company issued 1,517,086 shares of common stock valued at $86,625,610.

On June 8, 1999, the Board of Directors approved a 2.33-for-one stock split of
the Company's common stock, which was effective on June 14, 1999. All references
in the accompanying financial statements to the number of shares of common stock
and per-share amounts have been restated to reflect the split. Additionally, all
references in the accompanying financial statements to the number of shares of
preferred stock and per-share amounts have been restated to reflect the split in
accordance with the Company's Restated Certificate of Incorporation. Also on
June 8, 1999, the stockholders authorized the Company's Amended and Restated
Certificate of Incorporation, which increased the Company's total number of
authorized shares of common stock to 100 million shares.

On July 7, 1999, the Company consummated an initial public offering of its
common stock. The Company sold 840,000 shares of its common stock (including
307,219 shares of one of its stockholders) at a public offering price of $140.00
per share. After deducting the underwriters' discounts and other offering
expenses, the net proceeds to the Company were approximately $66,300,000. On
August 3, 1999, the underwriters exercised their overallotment option for the
purchase of an additional 36,000 shares of common stock. After deducting
underwriters' discounts and other offering expenses, the net proceeds from the
over-allotment to the Company were approximately $4,600,000.

In August 1999, the Company issued 193,700 shares of common stock valued at
$20,000,000 to Zomba, and 27,500 shares of common stock valued at $2,681,250 to
TeeVee Toons, in exchange for five-year license agreements.

On September 17, 1999, the Company entered into an interactive marketing
agreement with America Online, Inc. ("AOL"). The agreement provided for AOL to
promote and distribute an interactive co-branded website and the

-29-

Company's products and services on certain portions of the AOL Network and in
connection with certain America Online products and services. In connection with
this agreement, the Company issued 13,445 shares of common stock valued at
$2,000,000, and paid an initial marketing fee of $3,000,000. On May 12, 2000 the
Company and AOL mutually agreed to terminate the marketing agreement.

In connection with a consulting agreement signed in October 1999, the Company
issued a warrant to purchase 25,000 shares of common stock with an exercise
price of $98.10 per share. The vesting provisions of the warrant are based upon
the Company's stock price, except 5,000 of the shares purchasable under the
warrant that were exercisable upon the start of the program. The Company
recorded an expense of $222,000 based upon the fair market value of the warrant
as of December 31, 1999.

In December 1999, the Company issued two warrants, which expire in December
2001, in connection with the signing of consulting agreements. The warrants are
for a total of 12,000 shares of common stock with an exercise price of $72.50
per share and are immediately exercisable. The Company recorded an expense of
$103,215 for the fair market value of these warrants as of December 31, 1999.

In January 2000, the Company issued a warrant exercisable for 5,882 shares of
our common stock to Cheap Trick Unlimited, in exchange for and in connection
with Cheap Trick's execution of a license agreement. The warrant is exercisable
for a period of five years at $59.50 per share, based upon the average closing
price of our common stock on the Nasdaq for a period of five days prior to the
execution of the Cheap Trick license agreement. The Company valued the warrant
using the Black-Scholes option pricing model and recorded an intangible asset of
$292,922 which was fully amortized at December 31, 2000.

In February 2000, the Company issued 823 shares of its common stock valued at
$50,000, estimating the fair value of the Company's common stock at $60.80 per
share in exchange for a license agreement with Metal Blade Records.

In February 2000, Musicmaker issued warrants exercisable for up to 15,000 shares
of our common stock to each of two consultants, in exchange for and in
connection with their execution of consulting agreements, under which they
agreed to perform certain services in connection with obtaining rights and
access to additional sound recordings, obtaining marketing opportunities and
obtaining webcasting and other broadcast opportunities on behalf of the Company.
The warrants are exercisable for a three-year period at $50.60 per share, based
upon the average closing price of our common stock on Nasdaq for the five days
prior to execution. Fifty percent of the shares purchasable under the warrants
vest on the first anniversary of the grant, and the remaining shares vest on the
second anniversary of the date of the grant.

On August 28, 2000, the Company's Board of Directors and a majority of the
stockholders authorized a one for ten reverse stock split of the Company's $0.01
par value common stock, which was effective November 3, 2000. All references in
the accompanying financial statements to the number of common shares and
per-share amounts for 2000, 1999, and 1998 have been restated to reflect the
stock split. Additionally, all references in the accompanying financial
statements to the number of shares of preferred stock and per-share amounts have
been restated to reflect the split in accordance with the Company's Amended and
Restated Certificate of Incorporation.

9. CONVERTIBLE PREFERRED STOCK AND WARRANTS

Immediately upon completion of the initial public offering, all outstanding
shares of Series A, Series B, and Series C convertible preferred stock were
converted into 190,872 shares of common stock. Upon conversion of the Series A
preferred stock into common stock, the remaining discount on Series A preferred
stock was recorded as accretion and the effect on net loss available to common
stock holders was $723,318 in the year ended December 31, 1999. This accretion
had no effect on the Company's cash flows. Also, the Series B and Series C
preferred stock warrants were converted to warrants to purchase 169,793 shares
of common stock upon completion of the initial public offering.

10. STOCK OPTION PLAN

The 1996 Stock Option Plan (the "Plan") was adopted by the Board of Directors
and approved by the stockholders in

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1996. The purpose of the Plan is to promote the long-term growth and
profitability of the Company by providing key people with incentives to
contribute to the growth and financial success of the Company. The aggregate
number of shares of common stock for which options may be granted under the
Plan shall not exceed 650,000 shares as voted on by a majority of the
stockholders during the 2000 annual stockholder meeting. Additional
information with respect to stock option activity is summarized as follows:

The Company applies APB 25 in accounting for its stock option plan and,
accordingly, recognized compensation expense for the difference between the fair
value of the underlying common stock and the grant price of the option at the
date of grant. The effect on net loss and net loss per share for the year ended
December 31, 2001 was not significant. The effect of applying SFAS 123's fair
value method to the Company's stock-based awards results in net losses of
$138,936,383 and $28,280,720, in 2000 and 1999, respectively, with a net loss
per share of $41.96 and $13.86, respectively. The effect of applying SFAS 123 as
stated above is not necessarily representative of the effects on reported net
income for future years.

In 1999, the Company issued four consultants a total of 14,509 stock options
with exercise prices ranging from $20.70 to $34.30 per share and exercise terms
of one or five years. The options vest per the individual stock option
agreements over periods ranging from immediately to three years. The Company
revalued these options at each reporting period and recorded (income) expense of
($141,000) and $514,000 in 2000 and 1999, respectively, related to these stock
options. The Company calculated the expense using the Black-Scholes option
pricing model.

In 2001, the Board of Directors approved the issuance of an aggregate of 46,147
shares of Company Common Stock and stock options to board members for
services provided in their role as directors. As of December 31, 2001, such
shares of Company Common Stock and stock options had not been issued.

On January 12, 2001, the Company issued a stock appreciation right for 75,000
shares to each of James Mitarotonda and Seymour Holtzman. The stock
appreciation right provides that it may be exercised for cash in an amount
equal to the excess value, if any, by which the market value of the shares on
the date of exercise exceeds $4.563, as adjusted from time to time. The stock
appreciation right is exercisable

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immediately and expires on January 12, 2006. No compensation expense has been
recorded during the year ended December 31, 2001, as the Company's stock
price was lower than the stock appreciation right's exercise price.

11. WARRANTS

The following table summarizes all common and preferred stock warrant activity:

12. INCOME TAXES

At December 31, 2001, the Company had net operating loss carryforwards of
$121.8 million and capital loss carryforwards of $1.2 million. The timing and
manner in which the remaining operating loss carryforwards may be utilized in
any year will be limited to the Company's ability to generate future earnings
and by limitations imposed due to change in ownership. Current net operating
loss carryforwards will expire principally in the years 2019 through 2021. The
capital loss carryforward will expire in 2005. As the Company has not generated
earnings and no assurance can be made of future earnings, a valuation allowance
in the amount of the deferred tax assets has been recorded. The change in the
valuation allowance was $3,924,499. There was no current or deferred provision
for income taxes for the years ended December 31, 2001, 2000 or 1999.

The total NOL of $121.8 million has been reduced, for financial reporting
purposes, by $13.8 million which is unlikely ever to be utilized due to the
operation of the Section 382 provisions. The remainder of the NOL also likely
might effectively be obviated if certain future events were to occur that would
invoke additional Section 382 provisions. Future use of the NOLs therefore is
extremely speculative and should not be presumed absent extensive analysis of
the complex Section 382 provisions.

Net deferred tax assets consist of:

The Company has not paid any income taxes since its inception.

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The provision for income taxes differed from the amount computed by applying the
U.S. federal statutory rate to the loss before income taxes due to the effects
of the following:

13. COMMITMENTS AND CONTINGENCIES

ROYALTY AGREEMENTS

The Company has signed contracts with record labels for non-exclusive rights to
manufacture, advertise, market, promote, distribute and sell custom CDs and to
digitally download songs over the Internet. The agreements contain a master use
royalty rate of 15% of the selling price less any sales, excise or similar
taxes. If the Company enters into a more favorable royalty rate with another
licensor, the majority of these contracts contain clauses allowing the licensor
to also receive the more favorable royalty terms. As discussed in Note 1, many
of the contracts require advances upon the anniversary dates of the signing of
the contracts. Several of the royalty agreements provide for the Company to pay
advances based on actual royalties earned by the label in the previous year, as
opposed to a fixed amount.

In connection with the royalty agreement signed on October 11, 1999, the Company
advanced $500,000 to an independent record label. There is a note receivable for
this amount that was due on April 11, 2000 that earns interest at 7% per annum.
In 2000, the Company established a reserve for the entire receivable and is
currently pursuing legal action to collect the note. This receivable is included
in prepaid expenses and other current assets in the accompanying financial
statements.

Fixed commitments on contracts entered into as of December 31, 2001 totals
$260,000 and is payable in 2002.

14. OPERATING LEASES

The Company leased its office facility under operating lease agreements that
were entered into during 1999 and 1998. Operating lease expense for the years
ended December 31, 2001, 2000 and 1999 was $2,326,000, $1,540,000 and
$790,000, respectively. As of December 31, 2001, the Company has either
terminated its operating leases or stopped using the leased assets. As a
result, the Company has accrued for estimated future rent payments, net of
estimated sublease payments. As of December 31, 2001, the Company has
$2,813,705 accrued for future rent payments under operating leases. The lease
payments presented below are shown net of subleasing income.

Future minimum lease payments as of December 31, 2001 are as follows:

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2006 (net of sublease income of $210,574) 1,217,860
Thereafter 4,515,988
------------
$ 9,899,737
============

15. LITIGATION

On February 25, 2000, a purported securities class action complaint, PAUL A.
ROSENFELD, ET AL. V. MUSICMAKER.COM, INC., ET AL., No. 00-02018 CAS (MANx), was
filed in the United States District Court for the Central District of
California. At least four nearly identical complaints were filed shortly after
the original action was filed. On June 30, 2000, Plaintiffs filed a consolidated
and amended complaint (the "Class Action Complaint"), IN RE MUSICMAKER.COM SEC.
LITIG., No. 00-02018 CAS (MANx). Named as defendants are musicmaker.com, Inc.,
EMI Group, PLC, EMI Recorded Music, EMI Recorded Music North America, Virgin
Holdings, Inc., Robert P. Bernardi, Devarajan S. Puthukarai, Irwin H. Steinberg,
Jay A. Samit, Jonathan A.B. Smith, and John A. Skolas. The Class Action
Complaint alleges that the Company violated Sections 11 and 12(a)(2) of the
Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated thereunder ("Rule 10b-5"), by making false and
misleading statements in the Company's filings with the SEC and in press
releases concerning musicmaker's access to recordings pursuant to certain
licensing agreements during the period from July 7, 1999, through November 15,
1999. The claims are purportedly brought on behalf of all persons who purchased
musicmaker stock during that period, including investors who purchased stock
during the Company's initial public offering, as well as those who purchased
stock thereafter. Plaintiffs seek unspecified compensatory damages and/or
rescission, as well as attorneys' fees and costs. On September 27, 2000, the
defendants filed a motion to dismiss the Class Action Complaint. In June 2001
the court denied the motion to dismiss in part, granted it in part, and in
August 2001 denied a subsequent motion for reconsideration with respect to the
motion to dismiss. In September 2001 plaintiffs filed a Third Consolidated
Amended and Supplemental Class Action Complaint, asserting the same causes of
action against the Company as were alleged in the Class Action Complaint (the
"Third Amended Complaint"). In October 2001 the Company answered the Third
Amended Complaint, denying liability to the plaintiffs on any cause of action.
In April 2001 several plaintiffs filed a purported non-class action complaint
against the same defendants named in the Class Action Complaint (including the
Company). The plaintiffs in this action subsequently filed an amended complaint
(this complaint, as amended, the "Butler Complaint") in September 2001. The
Butler Complaint alleges claims under Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and Rule 10b-5, as well as common law fraud and negligent
misrepresentation claims relating to the same general types of purported
misrepresentations set forth in the Class Action Complaint. However, the alleged
misrepresentations set forth in the Butler Complaint allegedly occurred during
the period from November 15, 1999 through at least April of 2000. On January 21,
2002, the parties participated in a mediation in an attempt to settle matters
set forth in the Class Action Complaint, the Third Amended Complaint and the
Butler Complaint. That mediation failed to yield a settlement. However, the
parties have agreed to participate in another mediation session on May 14, 2002.
In the interim, the parties have agreed to pursue limited non-party discovery.
The Company believes the allegations contained in the Class Action Complaint and
the Butler Complaint are without merit and intends to defend against them
vigorously. However, these lawsuits could materially and adversely affect the
Company's financial condition and results of operations based on a number of
factors, including legal expenses, diversion of management's time and attention,
and payment of judgments or settlements in excess of available insurance.

The Company has also been named as a defendant in three separate lawsuits
arising out of licensing agreements it had previously entered into with
Classicberry Limited and the Black Crowes partnership in the case of the first
lawsuit (the "Classicberry Lawsuit"), with Profile Publishing and Management
Corporation ApS in the case of the second lawsuit (the "Profile Lawsuit"), and
with Koch Entertainment LLC in the case of the third lawsuit (the "Koch
Lawsuit"). The lawsuits each seek an aggregate of approximately $250,000,
representing what the respective plaintiffs allege is the balance owed by the
Company under the agreements. The Company has asserted various counterclaims and
affirmative defenses to each of the Profile Lawsuit and the Koch Lawsuit and
intends to vigorously oppose such actions. With respect to the Classicberry
Lawsuit, in December 2001 the District Court granted the plaintiff's motion for
summary judgment and denied the Company's cross-motion. The Company has filed a
notice of appeal and is in the process of securing a bond that will stay
enforcement of the judgment.

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On January 3, 2001, we paid the balance of $825,000 remaining due in settlement
of prior litigation involving TeeVee Toons, Inc. and related parties.

In 1998, we received notice from Magix Entertainment Products GmbH, a German
company ("Magix") claiming ownership of the trademark MUSICMAKER and seeking to
obtain from us the domain name MUSICMAKER.COM. We reached what we view as a
definitive settlement of Magix's claim in a written settlement agreement in
1998. In late 1999, however, Magix renewed its demand for the domain name
MUSICMAKER.COM, which we believe to be in violation of our settlement agreement.
In December 1999, we filed suit against Magix in federal court in New York. The
case is captioned Musicmaker.com, Inc., v. Magix Entertainment Products GmbH,
No. 99 Civ. 11577 (BSJ) (S.D.N.Y.). The Company has asked the court, among other
things, to declare that we own the trademark MUSICMAKER and the domain name
MUSICMAKER.COM and that we are entitled to use them in connection with our
business. Magix has filed counterclaims alleging, among other things, that we
infringe its trademark rights.

In May of 2001, the Company settled its obligation of $171,429 to Music Maker
Relief Fund (the "Foundation") for $20,000. Pursuant to the terms of the
settlement, the Company was released from the monetary claims that the
Foundation may have had against the Company under a contract dated July 1, 1998,
between the Company and the Foundation. Under the terms of the settlement, the
Company can no longer use the trademark "musicmaker" but we can continue to use
the domain name musicmaker.com, Inc. The Company is presently considering
alternative names.

On March 12, 2002, the Company was served a "Bill of Complaint" by the owner of
Parkridge Five Associates Limited, the owner of the Parkridge Property, seeking
restoration of the security deposit in the amount of $664,344, which the owner
maintains has been depleted by application to rent payments in prior months. See
Item 2 "Properties". The Company is in discussion with the landlord with
respect to these premises. See Item 2. "Properties".

The costs and other effects of pending or future litigation, legal and
administrative cases and proceedings (whether civil or criminal), settlements,
judgments and investigations, claims and changes in those matters (including
those matters described above), could have a material adverse effect on
Musicmaker's business, financial condition and operating results.

16. INFRASTRUCTURE REORGANIZATION

On September 28, 2000, the Company announced an infrastructure reorganization
that reduced full-time staff levels by 30% or 27 individuals. The $774,573
reorganization charge consisted of severance packages for the involuntarily
terminated employees. Employee terminations occurred within the marketing,
engineering, fulfillment, and administration departments. The Company did not
dispose of any assets or discontinue any products as a result of the September
2000 reorganization. All amounts related to this charge were paid as of December
31, 2000.

On January 3, 2001, the Company's Board of Directors as then constituted voted
unanimously to cease the operations of its Internet-based custom CD-marketing
business. As a result, pending the present Board's ongoing review of
alternatives for the Company going forward, the Company suspended its website,
bought out several equipment leases and terminated 44 employees which
represented 83% of the work force. Severance packages, totaling approximately
$1,714,000, were granted to these employees based on length of service with the
Company. Additionally, the Company accrued the severance costs of approximately
$374,000 related to the remaining employees. As of June 30, 2001, the Company
had no employees other than its President and Chief Executive

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Officer and Chief Financial Officer. All amounts related to this charge have
been paid as of December 31, 2001.

17. RELATED PARTY TRANSACTIONS

In December 1998, the Company advanced a stockholder and officer $81,519. The
advance was payable on or before January 1, 2003 and bears interest at 8% per
annum. The note was deducted from the officer's severance payment in January
2001.

In connection with the Company's cessation of its Internet-based custom
CD-marketing business, effective as of July 1, 2001, the Company relocated
its principal executive offices to 888 Seventh Avenue, 17th Floor, New York,
New York 10019, an office maintained by Barington Capital Group, L.P.
("Barington"), a limited partnership whose general partner is a corporation
of which James Mitarotonda is Chairman, President and Chief Executive
Officer. Barington and an affiliate are members, and Mr. Mitarotonda is one
of the managing members, of BCG Strategic Investors LLC, which, together with
certain affiliates, beneficially owns approximately 38% of the Company's
Common Stock. Mr. Mitarotonda is also the President and Chief Executive
Officer of the Company.

Effective July 1, 2001, Barington has made available to the Company the
services of a Barington employee to serve as the Chief Financial Officer and
Secretary of the Company, and began providing the Company with the assistance
of certain other Barington employees and the use of office space and
administrative services provided by Barington. In consideration of the
foregoing, the Company pays Barington a $5,000 monthly fee. In addition, the
Company pays $5,000 per month, each, to Mr. Mitarotonda and Mr. Holtzman for
services performed. For the year ended December 31, 2001, the Company
expensed $100,000 in payments to related parties, which is included in
general and administrative expenses.

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18. NET LOSS PER SHARE

The following equity instruments were not included in the diluted net loss per
share calculation because their effect would be anti-dilutive:

19. 401(k) PLAN

The Company provided a 401(k) plan (the "Plan") for all employees. Contributions
are made through voluntary employee salary reductions and discretionary matching
by the Company. The Company did not make matching contributions to the Plan on
behalf of its employees during 2001.

On February 13, 2001, the Company's Board of Directors approved the termination
of the Plan. The Plan termination was effective on April 2, 2001.

20. SHAREHOLDER DISTRIBUTION

On February 15, 2001, the Company announced that the Board of Directors had
approved a cash distribution in the amount of $3.00 per share to the holders
of record of common stock as of March 1, 2001, the record date. The
distribution totaled $9,941,988 and was paid in March 2001. The distribution
included $82,500 paid in error to a former stockholder of the Company whose
stock was not returned to the Company until after the establishment of the
record date for the distribution, which amount was subsequently returned by
the stockholder, leading the Company to record a net distribution of
$9,859,488 as a reduction of stockholder's equity.

21. SUBSEQUENT EVENTS (UNAUDITED)

On February 25, 2002 the Board of Directors authorized a stock repurchase
program for up to 500,000 shares of the Company's Common Stock. Shares of Common
Stock are expected to be purchased from time to time in open market transactions
and privately negotiated transactions, subject to availability and price,
prevailing market and business conditions and regulatory compliance.

On February 27, 2002, the Company, along with certain other entities
(together with the Company, the "Reporting Entities"), was party to a joint
filing on Schedule 13D reporting the purchase of 3,485,500 shares of common
stock of Fairmarket Inc. ("Fairmarket")(NASDAQ: FAIM)(such amount
representing approximately 12.0% of Fairmarket's outstanding common stock).
Of the total amount of outstanding common stock reported as beneficially
owned by the Reporting Entities, the Company may deemed to account for
627,390 shares of such common stock (such amount representing approximately
3.0% of Fairmarket's outstanding common stock). The Reporting Entities
include, in addition to the Company, Barington Companies Equity Partners,
L.P., an affiliate of Barington, and Jewelcor Management, Inc., an entity
whose Chairman and Chief Executive Officer is Seymour Holtzman, the Chairman
of the Company's Board of Directors. Messrs. Mitarotonda and Holtzman are
managing members, and Barington and an affiliate of Jewelcor are members, of
BCG Strategic Investors LLC, which together with certain affiliates
beneficially owns approximately 38% of the Company's Common Stock.

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Schedule II - VALUATION AND QUALIFYING ACCOUNTS

MUSICMAKER.COM, INC.

B. FOR YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

PART III.

The information, and accompanying exhibits called for by Item 10 "Directors and
Executive Officers of the Registrant," Item 11 "Executive Compensation," Item 12
"Security Ownership of Certain Beneficial Owners and Management," and Item 13
"Certain Relationships and Related Transactions" of Form 10-K is incorporated
herein by reference to the Company's definitive proxy statement for its 2002
Annual Meeting of Shareholders, which definitive proxy statement is expected to
be filed with the Commission no later than 120 days after the end of the fiscal
year to which this Annual Report relates.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)(1) Index to Financial Statements

Please see the accompanying Index to Financial Statements which appears in Item
8 on page 19 of this report. The Report of Independent Auditors, Financial
Statements and Notes to Financial Statements which are listed in the Index to
Financial Statements and which appear beginning on page 20 of this report are
included in Item 8.

(a)(2) Financial Statement Schedules

Schedules not listed have been omitted because the information required to be
set forth therein is not applicable or is included in the Financial Statements
or notes thereto.

(a)(3) Exhibits

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Please see subsection (c) below.

(b) Reports on Form 8-K

No reports on Form 8-K have been filed through December 31, 2001.

(c) Exhibits.

1.1 Form of Underwriting Agreement between Musicmaker.com, Virgin Holdings, Inc. and Ferris, Baker Watts, Incorporated,
Fahnestock & Co. Inc. and C. E. Unterberg, Towbin as Representatives.+
3.1 Form of Amended and Restated Certificate of Incorporation.+
4.1 Form of Common Stock Certificate.+
5.1 Opinion of Venable, Baetjer and Howard, LLP regarding legality.+
10.1 Amended and Restated Employment Agreement between the Company and Robert P. Bernardi dated December 8, 1997, amended on
February 12, 1999.+
10.2 Amended and Restated Employment Agreement between the Company and Devarajan S. Puthukarai dated December 8, 1997, amended
on February 12, 1999 and on May 19, 1999.+
10.3 Consulting Agreement dated January 23, 1997, between the Company and Irwin H. Steinberg, amended on January 1, 1998, and
amended by letters to the Company dated August 28, 1998 and August 31, 1998.+
10.4 Letter Agreement dated June 12, 1998, between the Company and The Columbia House Company.+
10.5 The Company's Amended Stock Option Plan.+
10.6 Marketing Agreement dated September 30, 1998, between Platinum Entertainment, Inc. and the Company.+
10.7 Memorandum of Understanding between the Company and Audio Book Club, Inc. dated January 18, 1999.+
10.8 Office/Warehouse/Showroom Lease dated January 15, 1998 between the Company and Century Properties Fund XX.+
10.9 Form of Lock-up Agreement.+
10.10.1 Loan and Security Agreement between the Company and Imperial Bank dated March 12, 1999.+
10.10.2 Standby Letter of Credit and Security Agreement dated March 9, 1999, and Addendum thereto dated March 5, 1999.+
10.11 Master Equipment Lease dated January 8, 1999 between the Company and Boston Financial & Equity Corporation.+
10.12 Agreement of Lease between 570 Lexington Company, L.P. and the Company dated February 26, 1999.+
10.13 License Agreement between the Company and Virgin Holdings, Inc. dated June 8, 1999.+
10.14 Agreement between the Company and Virgin Holdings, Inc. dated June 8, 1999.+
10.15 Stockholders' Agreement between the Company, Virgin Holdings, Inc. and the other Stockholders listed on Schedule I dated
June 8, 1999.+
10.16 Registration Rights Agreement between the Company, Virgin Holdings, Inc., Rho Management Trust I, The Columbia House
Company and the other Stockholders listed on Schedules I and II dated June 8, 1999.+
10.17 Co-Branding and Media Purchase Agreement between the Company and Spinner Networks, Inc. dated March 26, 1999.+
10.18 Note Purchase Agreement between Rho Management Trust I and the Company dated as of June 23, 1999.+
10.19 Demand Promissory Note in the aggregate principal amount of $1,000,000 issued by the Company to Rho Management Trust I
dated as of June 23, 1999.+
10.20 Office Lease (1740 Broadway, 23rd Floor, New York, NY 10019) commencing January 15, 2000#
10.21 Office Lease (10780 Parkridge Blvd., Suite 50, Reston, VA 20191) commencing January 15, 2000#
10.22 Loan agreement between the Company and Devarajan Puthukarai#
10.23 Interactive marketing agreement between the Company and American Online, Inc., dated September 15, 1999#
10.24 Stockholders Agreement dated January 12, 2001, among Musicmaker.com, Inc. and BCG Strategic Investors, LLC, Barington
Capital Group, L.P., Barington Companies Equity Partners, L.P. and Dot Com Investment Corporation.$

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23.1 Consent of Ernst & Young LLP, Independent Auditors.$$
24 Power of Attorney (Contained on the signature page).#

+ Previously filed as an exhibit to Musicmaker.com, Inc.'s registration
statement on Form S-1, as amended and incorporated herein by reference.
# Previously filed as an exhibit to Musicmaker.com, Inc.'s Form 10-K annual
report for the year ended December 31, 1999 and incorporated herein by
reference.
* Previously filed as an exhibit to Musicmaker.com, Inc.'s information
statement on Form DEF 14C on September 27, 2000 and incorporated herein by
reference.
% Previously filed as an exhibit to Musicmaker.com, Inc.'s Form 8-A12G filed on
December 29, 2000 and incorporated herein by reference.
$ Previously filed as an exhibit to Musicmaker.com, Inc.'s Form 10-K annual
report for the year ended December 31, 2000 and incorporated herein by
reference.

$$ Filed herewith.

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SIGNATURES

/s/ JAMES MITAROTONDA
----------------------------- Chief Executive Officer,
James Mitarotonda President

/s/ SEYMOUR HOLTZMAN
----------------------------- Chairman
Seymour Holtzman

/s/ IRWIN H. STEINBERG
----------------------------- Director
Irwin H. Steinberg

/s/ JOSEPH WRIGHT, JR.
----------------------------- Director
Joseph Wright, Jr.

/s/ DEVARAJAN S. PUTHUKARAI
----------------------------- Director
Devarajan S. Puthukarai

/s/ WILLIAM SCRANTON
----------------------------- Director
William Scranton

/s/ JESSE CHOPER
----------------------------- Director
Jesse Choper

/s/ MELVYN BRUNT
----------------------------- Chief Financial Officer and Secretary
Melvyn Brunt