UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2004

or

For the transition period from      to

Commission File Number: 0-29583

Loudeye Corp.

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

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

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

Yes  [X]   No  [   ]

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

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

Loudeye Corp.

Form 10-Q Quarterly Report
For the Quarter Ended March 31, 2004

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

ITEM I            FINANCIAL STATEMENTS

LOUDEYE CORP.

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

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LOUDEYE CORP.

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

4

LOUDEYE CORP.

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

5

LOUDEYE CORP.

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

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LOUDEYE CORP.

1.

ORGANIZATION and RISKS

The Company

     Loudeye Corp. (the “Company” or “Loudeye”) provides digital media services and media restoration services. The Company is headquartered in Seattle, Washington and to date conducts business in the United States in two business segments, digital media services and media restoration services. As discussed in Note 5, the Company transferred the assets and certain liabilities of its media restoration services business in January 2004.

Risks

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

Basis of Consolidation

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

Unaudited Interim Financial Data

     The interim consolidated financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 22, 2004. The interim financial information included herein reflects all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The unaudited results of operations for the three months ended March 31, 2004 and 2003 are not necessarily indicative of the results to be expected for the full years.

Use of Estimates

     The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

     Management’s assessments of the impairment of property and equipment, goodwill and intangible assets are sensitive accounting estimates that could result in additional impairment charges in the near term. Factors that impact these estimates include, but are not limited to, possible changes in business plans, decreases in the market price of the Company’s common stock and declining financial results.

     Management evaluates the potential loss exposure on various claims and lawsuits arising in the normal course of business. An accrual is made if the amount of a particular claim or lawsuit is probable and reasonably estimable.

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2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents

     The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of acquisition to be cash equivalents. Cash and cash equivalents consist of demand deposits and money market accounts maintained with financial institutions and certain other investment grade instruments, which at times exceed federally insured limits. The Company has not experienced any losses on its cash and cash equivalents.

Marketable Securities

     The Company has invested amounts in investment-grade government obligations, institutional money market funds and other obligations with FDIC insured U.S. banks. Marketable securities are accounted for as available for sale. Marketable securities are classified in current assets as they are considered by management as available to support current operations.

Restricted Cash and Investments

     The Company has approximately $316,000 of short-term investments which are utilized as collateral for certain irrevocable standby letters of credit. Accordingly, these investments are classified as restricted investments in the consolidated balance sheets. These securities all mature within one year and reported amounts approximate fair value due to the relatively short maturities of these investments. These investments are related to standby letters of credit required for certain lease agreements which expire through 2005. Accordingly, the restricted investments have been classified in long-term assets in the accompanying consolidated balance sheets.

Fair Value of Financial Instruments and Concentrations of Credit Risk

     Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents, marketable securities, and long-term obligations. Fair values of cash and cash equivalents approximate their carrying value due to the short period of time to maturity. Short-term investments are reported at their market value. The carrying value of the Company’s line of credit and long-term obligations approximate fair value because the interest rates of the obligations are variable.

     The Company is exposed to credit risk because it extends credit to its customers. The Company performs initial and ongoing evaluations of its customers’ financial condition and generally extends credit on open account, requiring collateral as deemed necessary.

     The Company had sales to certain significant customers, as a percentage of revenues, as follows:

     Revenues from Customer A were reported primarily in the Digital Media Services segment and revenues from Customer B were reported primarily in the Media Restoration Services segment.

Impairment of Long-lived Assets

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

Goodwill and Intangible Assets

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     The Company accounts for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (FAS 142). Under FAS 142, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to, at a minimum, annual impairment tests. The Company completes its annual impairment test as of November 30 of each year. As disclosed in Note 7, the Company has recorded goodwill and intangible assets in connection with its acquisition of Overpeer, Inc. in March 2004.

Revenue Recognition

     The Company recognizes revenue in accordance with Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” (SAB 101) as amended by Staff Accounting Bulletin No. 104 (SAB 104), and EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” The Company recognizes revenue associated with the license of software in accordance with Statement of Position 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by SOP 98-4, SOP 98-9 and related interpretations and Technical Practice Aids.

     The Company recognizes revenues from encoding services, digital music samples services, digital distribution services, Internet radio services, live and on-demand webcasting services, software licensing, content protection services, and media restoration services. The Company recognizes these revenues when persuasive evidence of an arrangement exists, the product and/or service has been delivered, the price is fixed and determinable, and collectibility is reasonably assured.

     In arrangements that include rights to multiple products and/or services, the Company allocates the total arrangement consideration among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on verifiable and objective evidence of the fair value of the undelivered elements. Multiple element arrangements may consist of implementation services, development services, encoding services, digital music samples services, digital distribution services, Internet radio services, and on-demand webcasting services. Verifiable and objective evidence is based upon the price charged when an element is sold separately.

     Under the provisions of SOP 97-2, in software arrangements that involve rights to multiple products and services, the Company allocates the total arrangement consideration among each of the deliverables using the residual method, under which revenue is allocated to the undelivered elements based on vendor-specific objective evidence of the fair value of such undelivered elements. Elements included in multiple element arrangements consist of software, intellectual property, implementation services, maintenance and consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not sold separately, the price established by management, if it is probable that the price, once established, will not change before market introduction.

     Deferred revenue arises from payments received in advance of the culmination of the earnings process. Deferred revenue expected to be realized within the next twelve months is classified as current.

     Encoding services consist of the conversion of audio and video content into digital media formats. Sales of encoding services are generally under nonrefundable time and materials or per unit contracts. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, the Company recognizes revenues as the encoding services are rendered and the Company has no continuing involvement in the goods and services delivered, which is the date the finished media is shipped to the customer.

     Digital music samples services are provided to customers using the Company’s proprietary streaming media software, tools, and processes. Music samples are streamed files containing selected portions, or samples, of a full music track and are typically 30 to 60 seconds in length. Customer billings are based on the volume of data streamed at rates agreed upon in the customer contract, subject to a nonrefundable monthly minimum fee. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, the Company recognizes revenue in the period in which the samples are delivered.

     Digital distribution services consist primarily of rights clearing services, ringtune services and the hosting of digital media content for the Company’s customers for download by the end user. Customer billings for digital distribution services are generally based on a combination of a set-up fee, a fixed montly fee and a fee per download. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, the Company recognizes revenue in the period in which the services are provided.

     Similar to the digital music samples services, Internet radio and video services are provided to customers using the Company’s proprietary media software, tools and processes. Internet radio and video services can consist of the rebroadcasting over the Internet

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of a customer’s over-the-air radio programming. Services provided may also include playlist selection and programming services for online radio channels and may include related video content, such as music videos. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, revenue from the sale of Internet radio and video services is recognized on a monthly basis as the services are provided and customers are typically billed monthly in arrears.

     Webcasting services are provided to customers using the Company’s proprietary streaming media software, tools and processes. Services for live webcast events may be sold separately or combined with on-demand webcasting services in which the Company may host an archive of the webcast event for future use on an on-demand basis. In addition, on-demand webcasting services are often sold separately without the live event component. As a result, the Company has verifiable and objective evidence of the fair value for both the live and on-demand services. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, the Company recognizes revenue for live webcasting in the period in which the webcast event occurs. Revenue for on-demand webcasting services are deferred and recognized ratably over the period in which the services are provided. Customer billings are typically based on the volume of data streamed at rates agreed upon in the customer contract or a set monthly fee.

     Content protection services consist primarily of anti-piracy, data mining, and content promotion solutions related to peer-to-peer file sharing networks. Customer billings for content protection services are generally based on a fixed monthly fee, but may also contain a volume-based component and, for content promotion services, a fee based on customer sales volume. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, the Company recognizes revenue in the period in which the services are provided.

     Media restoration services consist of services provided by our VidiPax subsidiary to restore and upgrade old or damaged archives of traditional media. Under the provisions of SAB 101, as amended by SAB 104, and EITF 00-21, the Company recognizes revenues as these services are rendered and the Company has no continuing involvement in the goods and services delivered, which generally is the date the finished media is shipped to the customer. As discussed in Note 5, the Company sold its Vidipax subsidiary on January 30, 2004 pursuant to an agreement dated October 31, 2003.

Stock-based Compensation

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

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

     Stock-based compensation for the quarter ended March 31, 2004 totaled $141,000, consisting of the amortization of deferred stock compensation of $139,000, of which $19,000 is included in cost of revenues, stock-based compensation expense of $14,000 related to options granted to a consultant, and a credit of $12,000 for variable stock compensation related to stock options that were repriced in 2001. Stock-based compensation was $42,000 for the quarter ended March 31, 2003, of which $4,000 is included in cost of revenues, consisting of the amortization of deferred stock compensation.

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

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

Reclassifications

     Certain information reported in previous periods has been reclassified to conform to the current period presentation. These reclassifications had no impact on previously reported net loss, stockholders’ equity or cash flows.

3.

SPECIAL CHARGES

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

The following table summarizes the activity in accrued special charges during the three months ended March 31, 2004 (in thousands):

     During the fourth quarter of 2002, management committed to a plan to exit certain of the Company’s leased facilities, including the Company’s unoccupied facility at 414 Olive Way, Seattle, WA. Under the provisions of EITF 94-3, the Company recorded the estimated lease termination costs in accrued special charges. As discussed in Note 9, the landlord of the Company’s unoccupied facility at 414 Olive Way, Seattle, WA filed suit against the Company in April 2003 for breach of its lease. In January 2004, the Court

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entered a judgment in favor of the plaintiff for rents due through January 2004 of $438,000, which the Company accrued in a prior period and paid in the first quarter of 2004.

     At December 31, 2003, the Company had accrued special charges under the provisions of Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (FAS 146) related to its Vidipax facility in New York, New York. The lease agreement was originally entered into in December 2002 and the Company had never occupied the facility. During 2003, the Company informed the landlord of its decision to release its rights under the lease agreement and had been in ongoing discussions with the landlord to negotiate a lease termination agreement. Accordingly, under the requirements of FAS 146, the Company had accrued $562,000 in accrued special charges through the third quarter of 2003 representing the estimated fair value of future rental payments, net of estimated sublease rentals and related costs with respect to the termination of this lease. In December 2003, the Company accrued an additional $150,000, for a total accrual of $712,000, to adjust its estimate of the fair value of the liability based on further negotiations with the landlord. In February 2004, the Company entered into a lease settlement agreement with the landlord pursuant to which the Company paid the landlord $450,000 and allowed the landlord to retain its security deposit of $212,000, for a total settlement of $662,000. The $50,000 difference between the amount recorded in accrued special charges and the final settlement amount has been reflected as a credit to special charges in the consolidated statement of operations.

     In February 2003, the Company’s Chairman and Chief Executive Officer, John T. Baker, resigned and the Company engaged Regent Pacific Management Corporation to provide management services to the Company. In March 2003, Regent Pacific resigned from the engagement and Jeffrey M. Cavins was elected President and Chief Executive Officer. These events are described more fully in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. During and subsequent to Regent Pacific’s engagement, the Company undertook a strategic and operational analysis of its business and product lines. This analysis resulted in the development of a new strategic and operational plan, under which the Company restructured itself to focus on its core competencies in digital media services and on core strategic customers and markets for its enterprise communications services. A revised corporate forecast was developed in connection with this plan. The revised forecast also considered that the Company had learned that revenue from a significant customer in its Media Restoration Services segment would be less than originally anticipated. Using the revised forecast, the Company performed a reassessment of the carrying value of all of its assets, both tangible and intangible. The revised forecast demonstrated that certain tangible and intangible assets related to its media restoration services and enterprise communications services businesses were impaired, as the projected undiscounted discernible cash flows did not exceed the carrying value of the assets over their estimated useful lives. The fair values of each of these assets were estimated using primarily a discounted cash flow method. The fair value of goodwill was estimated under the two-step process required by FAS 142. The estimated fair values of each of the assets were then compared to their carrying values to measure the impairments. As a result of this analysis, the Company recorded impairment charges for goodwill, intangible assets, and property and equipment related to its enterprise communication services and media restoration services businesses of $5.3 million, $685,000, and $601,000, respectively.

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

4.

NET LOSS PER SHARE

     Basic earnings per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net loss by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of shares of common stock issuable upon the exercise of stock options and warrants (using the treasury stock method). For all periods presented, common equivalent shares are excluded from the calculation because their effect is antidilutive as a result of the Company’s net losses. The Company has excluded the following numbers of shares using this method (in thousands):

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5.

TRANSFER OF MEDIA RESTORATION ASSETS AND LIABILITIES

     On January 30, 2004 (“Transfer Date”), the Company’s wholly-owned media restoration services subsidiary, VMRLE Co., Inc. (formerly Vidipax, Inc.), transferred substantially all of its assets and certain liabilities to a company controlled by the former general manager of VMRLE Co., Inc. pursuant to an asset purchase agreement signed on October 31, 2003 and amended on January 30, 2004. The total purchase price of $1.2 million was placed in escrow when the asset purchase agreement was signed. Based on the January 30, 2004 amendment, $900,000 of the $1.2 million purchase price was to be released from escrow upon the assignment to the purchaser of contracts with the General Services Administration of the United States (“GSA Contracts”). If the GSA Contracts were not assigned within a certain time period after the Transfer Date, the purchaser had the option to unwind the transfer and reclaim the $1.2 million held in escrow. Accordingly, consistent with the provisions of SEC Staff Accounting Bulletin Topic 5E, the assets and liabilities transferred were recorded on the consolidated balance sheet as assets and liabilities transferred under contractual arrangement at their carrying value as of the Transfer Date. As of December 31, 2003, these assets and liabilities were classified as held for sale. On May 10, 2004, (“Accounting Closing Date”), the GSA contracts were assigned to the purchaser, resulting in the subsequent release of the $900,000 from escrow to VMRLE Co., Inc. For the period from the Transfer Date to the Accounting Closing Date, VMRLE Co., Inc. continued to be the contracting party with the GSA. The media restoration services provided under the GSA contracts during that period were provided by the purchaser as agent for VMRLE Co., Inc. and the purchaser retained the profits or losses earned from such services. Because VMRLE Co., Inc. continued to be the primary obligor under the GSA contracts until their assignment, revenues and costs of revenues in the consolidated statement of operations of Loudeye reflect the revenues from services provided under the GSA contracts of $95,000 for the period from the Transfer Date through March 31, 2004. All other revenues and costs of VMRLE, Co., Inc.’s operations have been appropriately excluded from the Company’s Statement of Operations subsequent to the Transfer Date. Results from services provided under the GSA contracts from March 31, 2004 to the Accounting Closing Date will be recorded as revenues and cost of revenues in the Company’s consolidated statement of operations in the second quarter of 2004. The difference between the proceeds and the carrying value of the assets and liabilities transferred as of the Accounting Closing Date will be recorded as a gain or loss on the sale of assets and liabilities transferred in the second quarter of 2004.

     With the GSA Contract assigned to the purchaser, the remaining $300,000 of the $1.2 million held in escrow will be released upon the execution of an agreement relating to certain rights associated with certain equipment owned by a third party. If such agreement is not executed by October 31, 2004, the purchaser may reclaim the $300,000 held in escrow. Due to this uncertainty, the $300,000 will be recorded as a gain at the time the agreement is executed.

     The Company may receive up to an additional $500,000 based on the purchaser achieving certain performance targets over a period of two years from the Transfer Date. At transfer, the Company also entered into a co-marketing and reseller agreement with the purchaser pursuant to which the Company will sell, for a fee, media restoration services on behalf of the purchaser for a two-year period. The co-marketing and earn-out provisions constitute continuing involvement by the Company under FAS 144. Consequently, VMRLE Co. Inc. has not been reported as a discontinued operation.

6.

PRIVATE EQUITY FINANCING

     In February 2004, the Company sold 10,810,811 shares of common stock at $1.85 per share to a limited number of accredited investors. The gross proceeds received from the financing were $20,000,000. The Company paid a placement fee equal to 5% of the gross proceeds. The net proceeds of the offering, after commissions and expenses, will be used for working capital and general corporate purposes, including expansion of the Company’s business-to-business digital music solutions in the U.S. and internationally. The Company filed a registration statement in March 2004 covering the resale of the shares sold in the financing and has agreed to use its reasonable efforts to have the registration statement declared effective by the SEC as soon thereafter as practicable.

7.

ACQUISITION OF OVERPEER, INC.

     In March 2004, the Company completed the acquisition of Overpeer, Inc. (“Overpeer”), a privately held company based in New York. Pursuant to the Agreement and Plan of Merger and Reorganization (“Merger Agreement”), among Loudeye, Privateer Acquisition Corp., a wholly owned subsidiary of the Company, Overpeer and certain of Overpeer’s stockholders, Privateer Acquisition Corp. was merged with and into Overpeer, with Overpeer continuing as the surviving company and a wholly-owned subsidiary of the Company (the “Merger”).

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As a result of the Merger, all of the outstanding capital stock of Overpeer was exchanged for a total of 1,752,772 shares of Loudeye’s common stock. The number of shares issued in the Merger was calculated by dividing $4,000,000 by the volume weighted average closing sales price of Loudeye’s common stock on each of the thirty consecutive trading days preceding the closing of the Merger, or $2.2821 per share. 262,916 of the shares issued in the Merger will be held in escrow for one year and will be available during that time to satisfy indemnity claims under the Merger Agreement. The Company filed a registration statement in March 2004 for the resale of the securities issued to the Overpeer shareholders, which registration statement has not yet been declared effective.

     Overpeer is a provider of digital media data mining, anti-piracy and promotional solutions, which are complimentary to Loudeye’s current and planned future digital media solutions. The acquisition is intended to allow the Company to provide a more complete suite of digital media solutions to its customers.

     The Company accounted for the acquisition in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations.” In accordance with EITF Issue No. 99-12 “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination,” the fair value of the shares issued was determined to be $2.26 per share based on the closing price of the Company’s common stock on February 29, 2004, which was the date on which the number of shares issued could be determined. The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed, along with the preliminary estimated useful lives of property and equipment and intangible assets, which have been recorded in the Company’s digital media services segment (in thousands):

The purchase price allocation set forth above includes acquisition costs of $129,000 is preliminary and subject to change in future periods pending the completion of an independent valuation report.

     The following table presents the unaudited pro forma results of the Company for the three months ended March 31, 2004 and 2003 assuming the Company had acquired Overpeer at the beginning of each period (in thousands):

8.

SEGMENT INFORMATION

     The Company operates in two business segments, Digital Media Services and Media Restoration Services. As described in Note 5, the Company transferred the assets and certain liabilities of its media restoration services business on January 30, 2004. The following information summarizes the Company’s segments (in thousands):

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9.

CONTINGENCIES

     In July and August 2001, four substantially similar class action complaints were filed in the Untied States District Court for the Southern District of New York against the Company and certain of its former officers and directors, as well as against certain underwriters who handled its initial public offering of common stock in March 2000. The various complaints were filed purportedly on behalf of a class of persons who purchased the Company’s common stock during the time period beginning on March 15, 2000 and ending on December 6, 2000. The complaints together allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, primarily based on the allegation that there was undisclosed compensation received by the Company’s underwriters in connection with its initial public offering and the allegation that the underwriters entered into undisclosed arrangements with some investors that were designed to distort and/or inflate the market price for the Company’s common stock in the aftermarket following the initial public offering. These actions have all been consolidated before the same judge for pretrial purposes. No specific amount of damages has been claimed. The Company and the individual defendants have demanded to be indemnified by the underwriter defendants pursuant to the underwriting agreement entered into at the time of the initial public offering. Presently, all claims against the former officers have been withdrawn without prejudice. The Company, along with the other issuer defendants, moved to dismiss the claims in the complaint. In February 2003 the court denied the Company’s motion. A proposed settlement and release of claims against the issuer defendants was approved by the court and is scheduled to be completed in June 2004. Management does not anticipate that the Company will be required to pay any amounts under this settlement.

     In February 2003, the Company entered into an agreement with Regent Pacific Management Corporation pursuant to which Regent Pacific would provide management services. The agreement was for a term of 26 weeks, with an option to renegotiate certain terms of the agreement after 13 weeks, and was terminable by either party under certain circumstances. Under the agreement, the Company paid certain fees to Regent Pacific. In addition, Regent Pacific was to receive stock options to purchase up to 4,000,000 shares of Loudeye common stock based on Regent Pacific’s length of service. These options were to be granted at various times throughout their engagement at exercise prices based on the closing market price on each grant date. In March 2003, Regent Pacific resigned from the engagement. In July 2003, Regent Pacific filed suit against the Company in the United States District Court for the Northern District of California for breach of the agreement. In this complaint, Regent Pacific is seeking unspecified damages and specific performance of the alleged obligation to grant the stock options due to them under the contract. The Company answered the complaint in September 2003 denying all allegations and asserting counterclaims. In March 2004, the court granted the Company’s motion to transfer the case to the United States District Court for the Western District of Washington. The Company intends to defend vigorously this action and to pursue vigorously its counterclaims. The likelihood of loss is not considered probable and the amount of loss, if any, is not estimable at this time.

     In April 2003, the landlord of the Company’s unoccupied facility at 414 Olive Way, Seattle, WA filed suit against the Company in the Superior Court of Washington, King County, for breach of its lease and is seeking damages of $2.0 million. In January 2004, the court entered a judgment in favor of the plaintiff for rents due through January 2004 of $438,000, which the Company had accrued in a prior period and paid in the first quarter of 2004. The Court reserved the other issues in the suit, including mitigation, interest and attorney’s fees, for trial. The Company has appealed the judgment and management believes that the Company has meritorious defenses to the claims made in the suit and intends to defend this suit vigorously and the Company may also bring certain counterclaims against the landlord. If the Company does not prevail on its appeal or its counterclaims, the Company may be held liable for additional amounts beyond the

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amount of the judgment. As of December 31, 2003 and March 31, 2004, the Company has recorded in accrued special charges an estimate of the additional amounts the Company may ultimately be required to pay with respect to this matter.

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

     In the normal course of business, the Company indemnifies other parties, including business partners, lessors and parties to other transactions with the Company. The Company has agreed to hold the other parties harmless against losses arising from the breach of representation or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made. In addition, the Company has entered into indemnification agreements with certain of its officers and directors and the Company’s by-laws contain similar indemnification obligations to the Company’s officers and directors. It is not possible to determine the maximum potential amount under these indemnification agreements since the Company has not had any prior indemnification claim upon which to base an estimate and each claim would be based on the unique facts and circumstances of the claim and the particular provisions of each agreement.

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

Forward-Looking Statements

     The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are made under the safe harbor provisions thereof. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of terms like these or other comparable terminology. These forward-looking statements are only predictions and actual events or results may differ materially from those projected. Specific factors that could cause actual results to differ materially from those projected include, but are not limited to the Risk Factors set for the below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to publicly release any revisions of the forward-looking statements contained herein to reflect events or circumstances after the date hereof. Readers are cautioned not to place undue reliance on these forward-looking statements, as our business and financial performance are subject to substantial risks and uncertainties.

Overview

     We are an innovative business-to-business provider of services that facilitate the distribution and promotion of digital media content to media & entertainment, retail and enterprise customers. Our services enable our customers to outsource the management and distribution of audio and video digital media content over the Internet and on other digital distribution platforms. Our technical infrastructure and back-end solutions, combined with our proprietary applications, comprise an end-to-end solution, from basic digital media services, such as the hosting, storage, encoding, management and protection of media assets for content owners, to complex, fully-outsourced digital media distribution and promotional services, such as private-labeled digital music download stores and streaming Internet radio and music sample services. Our solutions reduce the complexity and cost of internal solutions, and enable our customers to provide branded digital media offerings to their users while supporting a variety of digital media technologies and consumer business models.

     The Loudeye Solution

     During the first quarter of 2004, we provided our services via two primary business segments, Digital Media Services and Media Restoration Services. As discussed in Note 5 to the consolidated financial statements, in January 2004 we transferred substantially all of the assets of our media restoration services subsidiary, Vidipax, Inc., to a company controlled by the general manager of that subsidiary. While we will have ongoing rights to co-market and resell media restoration services for two years after the sale, we anticipate media restoration services will represent a significantly smaller portion of our operations for the remainder of 2004 and beyond.

     Digital Media Services. We provide a full service business-to-business digital media solution that allows our customers to deploy, rapidly and cost effectively, their own privately branded digital media service. Our solution is the culmination of our significant investments in our systems and infrastructure. Some of the key features of our solution include:

•		Web enabled architecture;
•		Archive of 4.5 million music tracks in uncompressed, digital master format;
•		Highly scalable and reliable operations;
•		Support for multiple media players, digital media formats and codecs;
•		Support for multiple bit rates; and
•		Extensive, transferable content rights and experience working with major and independent record labels.

Although our customers may choose any combination of services we offer, our management views our solutions in three tiers of service. These tiers are summarized as follows:

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     Media Restoration Services. Our media restoration services segment has performed services to restore and migrate legacy media archives to current media formats. We recognized revenues as services were rendered and we had no continuing involvement in the goods and services delivered, which generally was the date the finished media was shipped to the customer.

Highlights of First Quarter 2004 Operating Results

     The following is a summary description of our operating results for the three months ended March 31, 2004. A more detailed discussion of our operating results is included below under the heading “Results of Operations.”

     Our first quarter of 2004 represents a continuation of the business and strategic initiatives implemented in 2003. Highlights include:

Organization:

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We expanded our management team with the hiring of Lawrence J. Madden, executive vice president and chief financial officer, and William P. Fasig, executive vice president of business development, sales and marketing.

Digital Media Solutions Initiatives:

•		We upgraded our Media Operations Center and increased its archive storage, throughput and encoding capacities.
•		We launched IndieSource, an extension of our music label program that enables companies that build a digital music business to license hundreds of thousands of non-major label, independent music tracks from around the world through a single program. We have signed several independent labels to the program, including Saregama, India’s largest music company.
•		We developed a complete solution for Universal Music Publishing Group’s SYNCHExpress.com Website.
•		We powered the first Web-enabled and wireless in-store media kiosks with enhanced features and digital media content.

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$20 million Equity Financing:

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We sold 10,810,811 shares of common stock at $1.85 per share to a limited number of accredited investors in a private placement. The net proceeds received from this financing were $18.9 million. We had cash, short-term investments and restricted investments of $34.8 million at March 31, 2004, compared to $22.3 million at December 31, 2003.

Acquisitions and Divestitures:

•		As discussed in Note 7 to the consolidated financial statements, we acquired Overpeer, Inc., a leading provider of digital media data mining, anti-piracy and promotional solutions. Following this acquisition, we made significant investments in the Overpeer service line including doubling its capacity, expanding capabilities, and adding dedicated sales staff.
•		As discussed in Note 5 to the consolidated financial statements, we sold our Vidipax subsidiary to increase our focus on digital media services.

     We believe our first quarter shows positive results deriving from these initiatives. Our first quarter 2004 revenues were $2.0 million, compared to $3.3 million in the prior year quarter. The results for the 2004 quarter include $155,000 of revenue attributable to our acquisition of Overpeer, and an increase of $157,000 in revenue from our core digital media services business. These increases were offset by a decrease in our webcasting business resulting from a restructuring in 2003 (representing $1.2 million of the decrease) and the sale of our Vidipax subsidiary in January 2004 (representing $471,000 of the decrease).

     Our first quarter gross profit as a percentage of revenues was 28%, compared to 23% in the prior year quarter, principally due to restructuring activities and other cost management initiatives.

     We reported a net loss of $2.8 million or $0.04 per share in the first quarter of 2004, compared to a net loss of $13.1 million or $0.28 per share in the prior year quarter.

Results of Operations

     Revenues. Revenues totaled $2.0 million and $3.3 million for the first quarter of 2004 and 2003 and consisted of the following (in thousands):

     Our product mix changed significantly over the course of 2003 after we restructured our management team and operations and changed our strategic direction at the end of the first quarter of 2003. We shifted marketing emphasis away from webcasting and more toward digital media services, primarily digital music solutions. Our current webcasting services are focused on customer relationships that provide higher margins. As a result, revenue from webcasting services decreased significantly for the first quarter of 2004 compared to the first quarter of 2003.

     Revenues from encoding services, samples services, and radio and hosting services generally fluctuate based on the volume of content delivered (for encoding services) and volume of content streamed (for samples and radio and hosting services). Such volume is driven primarily by our customers’ content needs and the level of activity on their websites. Consequently, a certain amount of fluctuation in these revenue sources is common.

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     Content protection services are provided by our Overpeer subsidiary which we acquired in March 2004. Accordingly, there were no revenues from such services in 2003.

     Revenues from digital distribution services consist principally of ringtunes and rights clearing services. We began providing these services following our restructuring in the first quarter of 2003, so there were limited revenues from such services in the first quarter of 2003.

     Media restoration services revenue for the first quarter of 2004 does not include a full three months of revenue due to the transfer of our media restoration business on January 30, 2004 as discussed in Note 5 to the consolidated financial statements.

     Cost of Revenues. Cost of revenues decreased to $1.4 million for the first quarter of 2004 from $2.5 million for the first quarter of 2003. Cost of revenues decreased from 77% of revenue in 2003 to 72% of revenue in 2004, and consisted of the following (in thousands):

     Cost of revenues include the cost of production, including personnel, an allocated portion of facilities and equipment, and other supporting functions related to the delivery of our digital media and media restoration services. The decrease is due primarily to cost reduction initiatives implemented in March 2003, which included reductions in our workforce and the renegotiation or termination of several facilities leases. We have begun to expand our production work force in order to meet the demands of anticipated growth and new initiatives. Accordingly, we expect cost of revenues to increase moderately over the remainder of 2004 compared to the same periods in 2003.

     Depreciation included in cost of revenues increased to approximately $292,000 in 2004 from $216,000 in 2003. This increase is due primarily to equipment purchased in the first quarter of 2004 of $1.5 million to upgrade the storage and access systems for our digital music archive. Accordingly, we expect depreciation included in cost of revenues to increase moderately in 2004 compared to 2003.

     Operating Expenses. Our operating expenses were as follows for the first quarter of 2004 and 2003 (in thousands):

     Research and Development. Research and development expenses totaled $590,000 and $577,000 for the first quarter of 2004 and 2003. Research and development expenses include labor and other related costs of the continued development and support of our digital media services. We expect research and development expense to increase moderately through the remainder of 2004 compared to the same period in 2003 as we invest in the development of our digital media service offerings, particularly our Loudeye Digital MusicStore™ and iRadio™ products, as well as our content protection services.

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     Sales and Marketing. Sales and marketing expenses totaled $635,000 and $1.5 million for the first quarters of 2004 and 2003. Sales and marketing expenses consist primarily of salaries, commissions, product branding costs, advertising, public relations costs, trade show expenses, and cost of marketing collateral. The decrease in sales and marketing expenses is due to the decreased personnel and cost reduction initiatives related to our reductions in force in the first quarter of 2003. We expect sales and marketing expenses to increase moderately through the remainder of 2004 compared to the same period in 2003 as we expand our sales force and marketing personnel to market and sell our new Tier 3 application level products and services.

     General and Administrative. General and administrative expenses decreased to $2.0 million in the first quarter of 2004 from $2.8 million in the first quarter 2003. This decrease was due to the decrease in personnel related to our reductions in force in the first quarter of 2003, and related cost reduction initiatives. General and administrative expenses consist primarily of rent, facilities and information technology charges, salaries, legal expenses, investor relations costs and other costs associated with being a public company. We anticipate that general and administrative expenses for the remainder of 2004 will increase moderately compared to the same period of 2003 as we increase our personnel and other resources to support our growth. In addition, we will incur additional professional fees in order to comply with the new requirements under the Sarbanes-Oxley Act of 2002.

     Amortization of Intangible and Other Assets. Amortization of intangible and other assets totaled $140,000 and $525,000 for the first quarters of 2004 and 2003, and includes amortization of identified intangible assets related to acquisitions. The decrease was due to the impairment charges recorded in the first quarter of 2003, which resulted in lower amortization charges starting with the second quarter of 2003. We will incur additional amortization expense in 2004 related to our acquisition of Overpeer, Inc. However, based on our intangible assets as of March 31, 2004, amortization expense for the remainder of 2004 will continue to be less than 2003.

     Stock-Based Compensation. Stock-based compensation included in operating expenses for the first quarter of 2004 totaled $122,000, consisting of the amortization of deferred stock compensation of $120,000, stock-based compensation expense of $14,000 related to options granted to a consultant, and a credit of $12,000 for variable stock compensation related to stock options that were repriced in 2001. Stock-based compensation included in operating expenses was $38,000 for the first quarter of 2003, consisting of the amortization of deferred stock compensation. The increase in amortization of deferred stock-based compensation is due to options granted to employees at below fair value in July 2003 and February 2004.

     Special Charges. We have recorded special charges related to corporate restructurings, facilities consolidations and the impairment of assets in accordance with our long-lived asset policy. Following is a summary of special charges for the first quarters of 2004 and 2003 (in thousands):

In February 2004, we entered into a lease settlement agreement with the landlord or our Vidipax facility in New York, New York, pursuant to which we paid $450,000 and allowed the landlord to retain its security deposit of $212,000, for a total settlement of $662,000. This total settlement was $50,000 less than we had recorded in accrued special charges at December 31, 2003. Accordingly, this $50,000 difference has been reflected as a credit to special charges in the consolidated statement of operations. Impairments during the first quarter of 2003 are explained in Note 3 to the consolidated financial statements.

     Investment Income. Investment income consists of interest income and realized gains and losses on sales of our investments. Investment income totaled $79,000 and $85,000 for the first quarters of 2004 and 2003. The decrease was due primarily to realized gains on sales of investments in the first quarter of 2003. For 2004, we expect interest income will increase due to higher average investment balance resulting from the proceeds received from the private equity financings completed in August 2003 and February 2004.

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     Interest Expense. Interest expense relates to our debt instruments, consisting of our line of credit, term loan and capital lease obligations. Interest expense totaled $71,000 and $50,000 for the first quarters of 2004 and 2003. The increase was due primarily to higher average debt balances in 2004 resulting from borrowings under the $3 million term loan facility that we put in place at the end of 2003.

     Other Income. Other income was $3,000 and $18,000 for the first quarters of 2004 and 2003 and consists principally of gains on sales of excess equipment.

Liquidity and Capital Resources

     As of March 31, 2004, we had approximately $34.8 million of cash, cash equivalents, marketable securities, and restricted investments. These funds reflect net proceeds of $18.9 million from our sale of common stock in a private placement in February 2004. Of these funds, $316,000 is held in investment accounts that serve as collateral for standby letters of credit for certain of our capital lease and other obligations.

     Net cash used in operating activities was $3.2 million and $3.0 million for first quarters of 2004 and 2003. For 2004, cash used in operating activities resulted primarily from a net loss of $2.8 million and payments of accrued special charges of $1.1 million, offset partially by non-cash charges for depreciation and amortization and stock-based compensation aggregating $622,000. The payment of accrued special charges relates to the settlement of our lease obligation with respect to our Vidipax facility in New York, New York and payment of a judgement related to an unoccupied facility in Seattle, Washington as described in Note 3 to the consolidated financial statements.

     Net cash used in investing activities was $6.4 million in the first quarter of 2004, consisting principally of the net purchases of short-term investments of $4.6 million to invest a portion of the proceeds from our private equity financing in February 2004 and purchases of property and equipment of $1.8 million, consisting principally of equipment to upgrade the storage and access systems for our digital music archive.

     Net cash provided by financing activities was $17.5 million for the first quarter of 2004, consisting primarily of proceeds from the private equity financing in February 2004 of $19.0 million, as described below, and proceeds from the exercise of stock options of $133,000, offset partially by principal payments on our debt and capital lease obligations of $300,000 and the repayment in full of our line of credit for $1.3 million.

Other Recent Developments

     As more fully described in Note 5 to the consolidated financial statements, in May 2004, $900,000 in proceeds from the sale of our Vidipax subsidiary were released from escrow. The remaining $300,000 held in escrow will be released upon our conveyance to the purchaser of rights we have to use certain equipment owned by a third party. If we do not convey such rights by October 31, 2004, the purchaser will have the right to reclaim the $300,000 held in escrow.

     We believe that our existing cash, cash equivalents, and short-term investments will be sufficient to fund our operations and meet our working capital and capital expenditure requirements for the next year. Since we have incurred net losses since inception, we have relied on sales of equity securities, proceeds from the exercises of stock options and warrants and borrowings under our credit facilities to fund our working capital needs. Such capital may not be available in the future if it is needed. The availability of such capital will depend on a number of factors, some of which are outside our control. These include general market conditions, conditions in the private equity and public markets, the then-current market price of our common stock, and our historical financial performance and future prospects. Our ability to raise capital could also be affected by any of the risks affecting our business discussed below under the heading “Risk Factors.”

Critical Accounting Policies and Estimates

     We have identified the most critical accounting policies and estimates used in the preparation of our financial statements by considering accounting policies and estimates that involve the most complex or subjective decisions or assessments.

     Revenue recognition. We recognize revenue in accordance with Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by Staff Accounting Bulletin No. 104, and EITF 00-21. We recognize revenue associated with the

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license of software in accordance with Statement of Position 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by SOP 98-4, SOP 98-9 and related interpretations and Technical Practice Aids.

     We recognize revenues from encoding services, digital music samples services, digital distribution services, Internet radio services, live and on-demand webcasting services, software licensing, peer-to-peer services and media restoration services. We recognize these revenues when persuasive evidence of an arrangement exists, the product and/or service has been delivered, the price is fixed and determinable, and collectibility is reasonably assured.

     In arrangements that include rights to multiple products and/or services, we allocate the total arrangement consideration among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on verifiable and objective evidence of the fair value of the undelivered elements. Multiple element arrangements may consist of implementation services, development services, encoding services, digital music samples services, digital distribution services, Internet radio services, and live and on-demand webcasting services. Verifiable objective evidence is based upon the price charged when an element is sold separately.

     Under the provisions of SOP 97-2, in software arrangements that involve rights to multiple products and services, we allocate the total arrangement consideration among each of the deliverables using the residual method, under which revenue is allocated to the undelivered elements based on vendor-specific objective evidence of the fair value of such undelivered elements. Elements included in multiple element arrangements consist of software, intellectual property, implementation services, maintenance and consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not sold separately, the price established by management, if it is probable that the price, once established, will not change before market introduction.

     Deferred revenue arises from payments received in advance of the culmination of the earnings process. Deferred revenue expected to be realized within the next twelve months is classified as current liability

     Long-lived assets. Management periodically evaluates the recoverability of our long-lived assets in accordance with SFAS No. 144. When doing so, management is required evaluate the recoverability of an asset’s (or group of assets) carrying value through estimates of undiscounted future cash flows. If the assets are deemed impaired, the assets are written down to estimated fair value. Estimates of fair value may differ from the actual amount that could be realized if we were to sell our assets.

     Management’s assessments of the impairment of property and equipment are sensitive accounting estimates that could result in additional impairment charges in the near term. Factors that impact these estimates include, but are not limited to, possible changes in business plans, market price of our common stock and declining financial results. Net long-term assets subject to impairment review in the future totaled $7.1 million at March 31, 2004. We will continue to review the carrying value of our long-lived assets and goodwill for impairments. Future adverse developments in our business may result in additional charges.

     Goodwill and Intangible Assets. We account for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (FAS 142). Under FAS 142, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to, at a minimum, annual impairment tests. The Company completes its annual impairment test as of November 30 of each year. As disclosed in Note 7, we have recorded goodwill and intangible assets in connection with our acquisition of Overpeer, Inc. in March 2004.

     Exit costs. We have followed the provisions of EITF 94-3 to record the costs associated with exit activities through December 31, 2002 and FAS 146 for exit activities after December 31, 2003. Management is required to make its best estimates of exit costs such as remaining lease obligations and/or termination fees, these estimates may be different than the actual amounts that will be paid under existing lease arrangements. Future adverse changes in our business could result in additional exit activities and charges.

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

     Income tax valuation allowance. Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the periods in which the differences are

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expected to reverse. The Company’s net deferred tax asset has been reduced by a full valuation allowance based upon management’s determination that it is more likely than not that the net deferred tax asset will not be realized.

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RISK FACTORS

     Our company has a short operating history and our industry is new and rapidly evolving, which makes it difficult to evaluate our business.

     We were formed as a limited liability company in August 1997 and incorporated in March 1998. Our limited operating history makes it difficult to evaluate us or our prospects and performance, due to our:

•		unproven ability to generate profits;
•		limited historical financial data; and
•		limited experience in addressing emerging trends that may affect our business.

     We have recently shifted our marketing emphasis to application level services, which we have only recently begun to deliver. You should consider our prospects in light of the risk, expenses and difficulties we may encounter as an early stage company in the new and rapidly evolving market segments we serve. As a result of such risks, expenses and difficulties, we may have difficulty:

•		Establishing and maintaining broad market acceptance of our products and services and converting that acceptance into direct and indirect sources of revenue;
•		Establishing and maintaining our brand name;
•		Successfully developing new products, product features and services on a timely basis and increasing the functionality and features of existing products and services;
•		Successfully responding to our current competition including, competition from emerging technologies and solutions;
•		Developing and maintaining strategic relationships to enhance the distribution, features, content and utility of our products and services; and
•		Attracting, training and retaining qualified sales, technical and customer support personnel.

     Our quarterly financial results will continue to fluctuate making it difficult to forecast our operating results.

     Our quarterly operating results have fluctuated in the past and we expect our revenues and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are beyond our control, including:

•		Market acceptance of our turn-key application level services;
•		Variability in demand for our digital media services and applications;
•		Market acceptance of digital media and components offered by us and our competitors;
•		Ability of our customers and ourselves to procure necessary intellectual property rights for digital media content;
•		Willingness of our customers to enter into longer-term volume or recurring revenue digital media and applications service agreements and purchase orders in light of the economic and legal uncertainties related to their business models;
•		Governmental regulations affecting use of the Internet, including regulations concerning intellectual property rights and security measures; or

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•

Competition from other companies entering our markets.

     Our limited operating history and unproven business model further contribute to the difficulty of making meaningful quarterly comparisons and forecasts. Our current and future levels of operating expenses and capital expenditures are based largely on our growth plans and estimates of expected future revenues. These expenditure levels are, to a large extent, fixed in the short term and our sales cycle can be lengthy. Thus, we may not be able to adjust spending or generate new revenue sources in a timely manner to compensate for any shortfall in revenues, and any significant shortfall in revenues relative to planned expenditures could have an immediate adverse effect on our business and results of operations. If our operating results fall below the expectations of securities analysts and investors in some future periods, our stock price could decline significantly.

     We may need to raise additional capital in the future, and if we are unable to secure adequate funds on terms acceptable to us, we may be unable to execute our business plan. If we raise additional capital, current stockholders may experience significant dilution.

     As of March 31, 2004, we had approximately $34.8 million in cash and cash equivalents, marketable securities, and restricted investments. In the first quarter of 2004, we completed a private placement that resulted in net proceeds of $18.9 million. We have, however, experienced net losses from operations and net losses are expected to continue into future periods. If our existing cash reserves prove insufficient to fund operating and other expenses, we may find it necessary to secure additional financing, sell assets or reduce expenditures further. In the event additional financing is required, we may not be able to obtain such financing on acceptable terms, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to pursue our business objectives. This inability could seriously harm our business, results of operations and financial condition.

     If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders will be reduced and these securities may have rights and preferences superior to those of our current stockholders. If we raise capital through debt financing, we may be forced to accept restrictions affecting our liquidity, including restrictions on our ability to incur additional indebtedness or pay dividends.

     Because we expect to continue to incur net losses, we may not be able to implement our business strategy and the price of our stock may decline.

     As of March 31, 2004, we had an accumulated deficit of $195.7 million. We have incurred net losses from inception, and we expect to continue to incur net losses in future periods.

     Accordingly, our ability to operate our business and implement our business strategy may be hampered by negative cash flows in the future, and the value of our stock may decline as a result. Our capital requirements may vary materially from those currently planned if, for example, we incur unforeseen capital expenditures, unforeseen operating expenses or make investments to maintain our competitive position. If we lack necessary capital, we may have to delay or abandon some or all of our development plans or otherwise forego market opportunities. We will need to generate significant additional revenues to be profitable in the future and we may not generate sufficient revenues to be profitable on either a quarterly or annual basis in the future.

     We might not be successful in implementing our business strategy in a cost-effective manner, if at all, and the implementation may require significant additional expenditures on our part. The capital requirements of our business strategy combined with the expectation that we will incur net losses in future periods could have a serious adverse impact on our business, results of operations and financial position. Even if we ultimately do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

     Our success is dependent on the performance and retention of our executive officers and key employees.

     Our business and operations are substantially dependent on the performance of our executive officers and key employees who have worked together for only a relatively short period of time. We do not maintain “key person” life insurance on any of our executive officers. The loss of one or several key employees could seriously harm our business. Any reorganization or reduction in the size of our employee base could harm our ability to attract and retain other valuable employees critical to the success of our business.

     We must integrate our recent acquisition of Overpeer, Inc. and we may need to make additional future acquisitions to remain competitive. The process of identifying, acquiring and integrating future acquisitions may constrain valuable management

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resources, and our failure to effectively integrate future acquisitions may result in the loss of key employees and the dilution of stockholder value and have an adverse effect on our operating results.

     We have completed a number of acquisitions during the past three fiscal years, and we expect to continue to pursue strategic acquisitions in the future. In March 2004, we completed the acquisition of Overpeer, Inc.

     Integrating the Overpeer acquisition and completing any potential future acquisitions could cause significant diversions of management time and resources. Financing for future acquisitions may not be available on favorable terms, if at all. If we identify an appropriate acquisition candidate for any of our businesses, we may not be able to negotiate the terms of the acquisition successfully, finance the acquisition or integrate the acquired business, products, technologies or employees into our existing business and operations. Future acquisitions may not be well-received by the investment community, which may cause our stock price to fall. We cannot ensure that we will be able to identify or complete any acquisition in the future.

     If we acquire businesses, new products or technologies in the future, we may be required to amortize significant amounts of identifiable intangible assets and we may record significant amounts of goodwill that will be subject to at least annual testing for impairment. For example, we recorded in our first quarter of fiscal 2003 impairments of $5.3 million, $685,000 and $601,000 to goodwill, intangible assets, and property and equipment related to our enterprise communication services and media restoration services business. A significant portion of those impairments related to assets acquired in our acquisition of TT Holding Corp. in November 2002. If we consummate one or more significant future acquisitions in which the consideration consists of stock or other securities, our existing stockholders’ ownership could be diluted significantly. If we were to proceed with one or more significant future acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash. The anticipated benefits of any acquisition may not be realized. If any of the negative events occur, our operations and financial position could be harmed.

     We face competition from “free” peer-to-peer services such as KaZaA and Morpheus, from emerging paid online music services delivered electronically, and from traditional retail music distributors.

     The online music services of our customers face significant competition from “free” peer-to-peer services, such as KaZaA, Morpheus, Grokster and a variety of other similar services that allow computer users to connect with each other and to copy many types of program files, including music and other media, from one another’s hard drives, all without securing licenses from content providers. The legal status of these “free” services is uncertain, because although some courts have found that these services violate copyright laws, other services have been found to not violate any copyright laws, particularly in the case of Grokster. Additionally, enforcement efforts against those in violation have not effectively shut down these services, and there can be no assurance that these services will ever be shut down. The ongoing presence of these “free” services substantially impairs the marketability of legitimate services, regardless of the ultimate resolution of their legal status.

     Because digital recorded music formats, such as MP3, do not always contain mechanisms for tracking the source or ownership of digital recordings, users are able to download and distribute unauthorized or “pirated” copies of copyrighted recorded music over the Internet. This piracy is a significant concern to record companies and artists, and is a primary reason many record companies and artists are reluctant to digitally deliver their recorded music over the Internet. As long as pirated recordings are available, many consumers will choose free pirated recordings rather than paying for legitimate recordings. Accordingly, if this issue is not addressed, our business might be harmed.

     Many of our competitors have substantially greater capital resources than we do.

     Many of our competitors have significantly more resources than we do, including access to content, and some of our competitors may be able to leverage their experience in providing online music distribution services or similar services to their customers in other businesses. Some of these competitors may be able to offer services at a lower price than we can. In addition, competing services may be able to obtain more or better music content or may be able to license such content on more favorable terms than we can, which could harm the ability of our online music services to compete effectively in the marketplace.

     Online music distribution services in general are new and rapidly evolving and may not prove to be viable business models.

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     Online music distribution services are a relatively new business model for delivering digital media over the Internet. It is too early to predict whether consumers will accept in significant numbers, online music services and accordingly whether the services will be financially viable. If online music distribution services do not prove to be popular with consumers, or if these services cannot sustain any such popularity, our business and prospects would be harmed.

     We must provide digital rights management solutions that are acceptable to both content providers and consumers.

     We must also provide digital rights management solutions and other security mechanisms in order to address concerns of content providers and artists, and we cannot be certain that we can develop, license or acquire such solutions, or that content licensors or consumers will accept them. Consumers may be unwilling to accept the use of digital rights management technologies that limit their use of content, especially with large amounts of free content readily available. No assurance can be given that such solutions will be available to us upon reasonable terms, if at all. If we are unable to acquire these solutions on reasonable or any terms, or if customers are unwilling to accept these solutions, our business and prospects could be harmed.

     Our business could be harmed by a lack of availability of popular content.

     Our digital media services business is affected by the release of “hit” music titles, which can create cyclical trends in sales distinctive to the music industry. It is not possible to determine the timing of these cycles or the future availability of hit titles. Hit products are important because they generate consumer interest. We depend upon the music content providers to continue to produce hit products. To the extent that new hits are not available, or not available at prices attractive to consumers, our sales and margins may be adversely affected.

     The growth of our business depends on the increased use of the Internet for communications, electronic commerce and advertising.

     The growth of our business depends on the continued growth of the Internet as a medium for media consumption, communications, electronic commerce and advertising. Our business will be harmed if Internet usage does not continue to grow, particularly as a source of media information and entertainment and as a vehicle for commerce in goods and services. Our success also depends on the efforts of third parties to develop the infrastructure and complementary products and services necessary to maintain and expand the Internet as a viable commercial medium, and identifying additional viable revenue models for digital media-based businesses. We believe that other Internet-related issues, such as security, privacy, reliability, cost, speed, ease of use and access, quality of service, and necessary increases in bandwidth availability and access on an affordable basis, remain largely unresolved and may affect the amount and type of business that is conducted over the Internet, and may adversely affect our ability to sell our products and services and ultimately impact our business results and prospects.

     If Internet usage grows, the Internet infrastructure may not be able to support the demands placed on it by such growth, specifically the demands of delivering high-quality media content. As a result, the performance and reliability of the Internet may decline. In addition, Websites have experienced interruptions in service as a result of outages, system attacks and other delays occurring throughout the Internet network infrastructure. If these outages, attacks or delays occur frequently or on a broad scale in the future, Internet usage, as well as the usage of our products, services and Websites, could grow more slowly or decline.

     If broadband technologies do not become widely available or widely adopted, our online media distribution services may not achieve broad market acceptance, and our business may be harmed.

     We believe that increased Internet use and especially the increased use of media over the Internet may depend on the availability of greater bandwidth or data transmission speeds (also known as broadband transmission). If broadband technologies do not become widely available or widely adopted, our online media distribution services may not achieve broad market acceptance and our business and prospects could be harmed. Congestion over the Internet and data loss may interrupt audio and video streams, resulting in unsatisfying user experiences. The success of digital media distribution over the Internet depends on the continued rollout of broadband access to consumers on an affordable basis. To date, we believe that broadband technologies have been adopted at a slower rate than expected, which we believe has delayed broader-based adoption of the Internet as a media distribution medium. Our business and prospects may be harmed if the rate of adoption does not increase.

     More consumers are utilizing non-PC devices to access digital content, and we may not be successful in developing versions of our products and services that will gain widespread adoption by users of such devices.

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     In the coming years, the number of individuals who access digital content through devices other than a personal computer, such as personal digital assistants, cellular telephones, television set-top devices, game consoles and Internet appliances, may increase dramatically. Manufacturers of these types of products are increasingly investing in media-related applications, but these devices are in an early stage of development and business models are new and unproven. If we are unable to offer our services on these alternative non-PC devices, we may fail to capture a sufficient share of an increasingly important portion of the market for digital media services or our costs may increase significantly.

     We depend on a limited number of customers for a majority of our revenues so the loss of, or delay in payment from, one or a small number of customers could have a significant impact on our revenues and operating results.

     A limited number of customers have accounted for a majority of our revenues and may continue to do so for the foreseeable future. During 2003 and 2002, one customer accounted for approximately 11% and 13% of our revenues and another customer accounted for 5% and 10% of our revenues. During the first quarter of 2004, one customer accounted for 11% of our revenues. We believe that a small number of customers may continue to account for a significant percentage of our revenues for the foreseeable future. Due to high revenue concentration among a limited number of customers, the cancellation, reduction or delay of a large customer order or our failure to complete or deliver a project on a timely basis during a given quarter is likely to significantly reduce revenues. In addition, if any significant customer fails to pay amounts it owes us, or does not pay those amounts on time, our revenues and operating results could suffer. If we are unsuccessful in increasing and broadening our customer base, our business could be harmed.

     Average selling prices of our products and services may decrease, which may harm our gross margins.

     The average selling prices of our products and services may be lower than expected as a result of competitive pricing pressures, promotional programs and customers who negotiate price reductions in exchange for longer term purchase commitments or otherwise. The pricing of services sold to our customers depends on the duration of the agreement, the specific requirements of the order, purchase volumes, the sales and service support and other contractual agreements. We have experienced and expect to continue to experience pricing pressure and anticipate that the average selling prices and gross margins for our products will decrease over product life cycles. We may not be successful in developing and introducing on a timely basis new products with enhanced features that can be sold at higher gross margins.

     We may be liable or alleged to be liable to third parties for music, software, and other content that we encode, distribute, or make available on to our customers.

     We may be liable or alleged to be liable to third parties for the content that we encode, distribute or make available to our customers:

•		If the content or the performance of our services violates third party copyright, trademark, or other intellectual property rights;
•		If our customers violate the intellectual property rights of others by providing content to us or by having us perform digital media services; or
•		If content that we encode or otherwise handle for our customers is deemed obscene, indecent, or defamatory.

     Any alleged liability could harm our business by damaging our reputation, requiring us to incur legal costs in defense, exposing us to awards of damages and costs and diverting management’s attention which could have an adverse effect on our business, results of operations and financial condition. Our customers for encoding services generally agree to hold us harmless from claims arising from their failure to have the right to encode the content given to us for that purpose. However, customers may contest this responsibility or not have sufficient resources to defend claims and we have limited insurance coverage for claims of this nature.

     Because we host, stream and Webcast audio and video content on or from our Website and on other Websites for customers and provide services related to digital media content, we face potential liability or alleged liability for negligence, infringement of copyright, patent, or trademark rights, defamation, indecency and other claims based on the nature and content of the materials we host. Claims of this nature have been brought, and sometimes successfully prosecuted, against content distributors. In addition, we could be exposed to liability with respect to the unauthorized duplication of content or unauthorized use of other parties’ proprietary

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technology. Any imposition of liability that is not covered by insurance or is in excess of insurance coverage or any alleged liability could harm our business.

     We cannot assure you that third parties will not claim infringement by us with respect to past, current, or future technologies. The music industry in particular has recently been the focus of infringement claims. We expect that participants in our markets will be increasingly subject to infringement claims as the number of services and competitors in our industry segment grows. In addition, these risks are difficult to quantify in light of the continuously evolving nature of laws and regulations governing the Internet. Any claim relating to proprietary rights, whether meritorious or not, could be time-consuming, result in costly litigation, cause service upgrade delays or require us to enter into royalty or licensing agreements, and we can not assure you that we will have adequate insurance coverage or that royalty or licensing agreements will be available on terms acceptable to us or at all.

     If we do not continue to add customers for our services, our revenues and business will be harmed.

     In order to achieve return on our investments in new products and services, we must continue to add new customers while minimizing the rate of loss of existing customers. If our other marketing and promotional activities fail to add new customers at a rate significantly higher than our rate of loss, our business will suffer. In addition, if the costs of such marketing and promotional activities increase in order to add new customers, our margins and operating results will suffer.

     We cannot be certain that we will be able to protect our intellectual property, and we may be found to infringe on proprietary rights of others, which could harm our business.

     Our intellectual property is important to our business, and we seek to protect our intellectual property through copyrights, trademarks, patents, trade secrets, confidentiality provisions in our customer, supplier and strategic relationship agreements, nondisclosure agreements with third parties, and invention assignment agreements with our employees and contractors. We cannot assure you that measures we take to protect our intellectual property will be successful or that third parties will not develop alternative solutions that do not infringe upon our intellectual property.

     In addition, we could be subject to intellectual property infringement claims by others. Potential customers may be deterred from distributing content over the Internet for fear of infringement claims. The music industry in particular has recently been the focus of heightened concern with respect to copyright infringement and other misappropriation claims, and the outcome of developing legal standards in that industry is expected to affect music, video and other content being distributed over the Internet. If, as a result, potential customers forego distributing traditional media content over the Internet, demand for our digital media services and applications could be reduced which would harm our business. The music industry in the U.S. is generally regarded as extremely litigious in nature compared to other industries and we could become engaged in litigation with others in the music industry. Claims against us, and any resultant litigation, should they occur in regard to any of our digital media services and applications, could subject us to significant liability for damages including treble damages for willful infringement. In addition, even if we prevail, litigation could be time-consuming and expensive to defend and could result in the diversion of our time and attention. Any claims from third parties may also result in limitations on our ability to use the intellectual property subject to these claims. Further, we plan to offer our digital media services and applications to customers worldwide including customers in foreign countries that may offer less protection for our intellectual property than the United States. Our failure to protect against misappropriation of our intellectual property, or claims that we are infringing the intellectual property of third parties could have a negative effect on our business, revenues, financial condition and results of operations.

     We rely on strategic relationships to promote our services and for access to licensed technology; if we fail to maintain or enhance these relationships, our ability to serve our customers and develop new services and applications could be harmed.

     Our ability to provide our services to users of multiple technologies and platforms depends significantly on our ability to develop and maintain our strategic relationships with key streaming media technology companies and content providers. We rely on these relationships for licensed technology and content. We also rely on relationships with major recording labels for our music content licensing strategy. Obtaining comprehensive music content licenses is challenging, as doing so may require us to obtain copyright licenses with various third parties in the fragmented music recording and publishing industries. These copyrights often address differing activities related to the delivery of digital media, including reproduction and performance, some of which may require separate licensing arrangements from various rights holders such as publishers, artists and record labels. The effort to obtain the necessary rights by such third parties is often significant, and could disrupt, delay, or prevent us from executing our business plans. Because of the large number of potential parties from which we must obtain licenses, we may never be able to obtain a sufficient number of licenses to allow us to provide services that will meet our customers’ expectations.

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     Due to the evolving nature of our industry, we will need to develop additional relationships to adapt to changing technologies and standards and to work with newly emerging companies with whom we do not have pre-existing relationships. We cannot be certain that we will be successful in developing new relationships or that our partners will view these relationships as significant to their own business or that they will continue their commitment to us in the future. If we are unable to maintain or enhance these relationships, we may have difficulty strengthening our technology development and increasing the adoption of our brand and services.

     Our business will suffer if we do not anticipate and meet specific customer requirements or respond to technological change.

     The market for digital media services is characterized by rapid technological change, frequent new product introductions and changes in customer requirements, some of which are unique or on a customer by customer basis. We may be unable to respond quickly or effectively to these developments or requirements. Our future success will depend to a substantial degree on our ability to offer services that incorporate leading technology, address the increasingly sophisticated, varied or individual needs of our current and prospective customers and respond to technological advances and emerging industry standards and practices on a timely and cost-effective basis. You should be aware that:

•		Our technology or systems may become obsolete upon the introduction of alternative technologies;
•		We may not have sufficient resources to develop or acquire new technologies or the ability to introduce new services capable of competing with future technologies or service offerings; and
•		The price of our services is likely to decline as rapidly as the cost of any competitive alternatives.

     The development of new or enhanced services through technology development activities is a complex and uncertain process that requires the accurate anticipation of technological and market trends. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new services and enhancements. In addition, our inability to effectively manage the transition from older services to newer services could cause disruptions to customer orders and harm our business and prospects.

     Our music content licenses could result in operational complexity that may divert resources or make our business more expensive to conduct.

     The large number of licenses that we need to maintain in order to expand our music-related services creates operational difficulties in connection with tracking the rights that we have acquired and the complex royalty structures under which we must pay. In addition, our licensing agreements typically allow the third party to audit our royalty tracking and payment mechanisms to ensure that we are accurately reporting and paying the royalties owed. If we are unable to accurately track the numerous parties that we must pay in connection with each delivery of digital music services and deliver the appropriate payment in a timely fashion, we may risk penalties up to and including termination of certain licenses.

     Competition may decrease our market share, revenues, and gross margins.

     We face intense and increasing competition in the digital media services market. If we do not compete effectively or if we experience reduced market share from increased competition, our business will be harmed. In addition, the more successful we are in the emerging market for digital media services, the more competitors are likely to emerge. We believe that the principal competitive factors in our market include:

•		Ability to offer a private branded solution;
•		Service functionality, quality and performance;
•		Ease of use, reliability, scalability and security of services;
•		Establishing a significant base of customers and distribution partners;

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•		Ability to introduce new services to the market in a timely manner;
•		Customer service and support;
•		Attracting third-party web developers; and
•		Pricing.

     Many of our competitors have substantially more capital, longer operating histories, greater brand recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. These competitors may also engage in more extensive development of their technologies, adopt more aggressive pricing policies and establish more comprehensive marketing and advertising campaigns than we can. Our competitors may develop products and service offerings that we do not offer or that are more sophisticated or more cost effective than our own. For these and other reasons, our competitors’ products and services may achieve greater acceptance in the marketplace than our own, limiting our ability to gain market share and customer loyalty and to generate sufficient revenues to achieve a profitable level of operations. Our failure to adequately address any of the above factors could harm our business and operating results.

     Our industry is experiencing consolidation that may intensify competition.

     The Internet and digital media services industries are undergoing substantial change that has resulted in increasing consolidation and a proliferation of strategic transactions. Many companies in these industries have failed or are being acquired by larger entities. As a result, we are increasingly competing with larger competitors which have substantially greater resources than we do. We expect this consolidation and strategic partnering to continue. Acquisitions or strategic relationships could harm us in a number of ways. For example:

•		Competitors could acquire or enter into relationships with companies with which we have strategic relationships and discontinue our relationship, resulting in the loss of distribution opportunities for our products and services or the loss of certain enhancements or value-added features to our products and services;
•		Competitors could obtain exclusive access to desirable multimedia content and prevent that content from being available in certain formats, thus impairing our content selection and our ability to attract customers;
•		Suppliers of important or emerging technologies could be acquired by a competitor or other company which could prevent us from being able to utilize such technologies in our offerings, and disadvantage our offerings relative to those of competitors;
•		A competitor could be acquired by a party with significant resources and experience that could increase the ability of the competitor to compete with our products and services; and
•		Other companies with related interests could combine to form new, formidable competition, which could preclude us from obtaining access to certain markets or content; or which could significantly change the market for our products and services.

     Any of these results could put us at a competitive disadvantage that could cause us to lose customers, revenue and market share. They could also force us to expend greater resources to meet the competitive threat, which could also harm our operating results.

     We must enhance our existing digital media services and applications, and develop and introduce new services and applications to remain competitive in that segment. Any failure to do so in a timely manner will cause our results of operations in that segment to suffer.

     The market for digital media service solutions is characterized by rapidly changing technologies and short product life cycles. These market characteristics are heightened by the emerging nature of the Internet and the continuing trend of companies from many industries to offer Internet-based applications and services. The widespread adoption of the new Internet, networking, streaming

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media, or telecommunications technologies or other technological changes could require us to incur substantial expenditures to modify or adapt our operating practices or infrastructure. Our future success will depend in large part upon our ability to:

•		Identify and respond to emerging technological trends in the market;
•		Enhance our products by adding innovative features that differentiate our digital media services and applications from those of our competitors;
•		Acquire and license leading technologies;
•		Bring digital media services and applications to market and scale our business and operations on a timely basis at competitive prices; and
•		Respond effectively to new technological changes or new product announcements by others.

     We will not be competitive unless we continually introduce new services and applications or enhancements to existing services and applications that meet evolving industry standards and customer needs. In the future, we may not be able to address effectively the compatibility and interoperability issues that arise as a result of technological changes and evolving industry standards. The technical innovations required for us to remain competitive are inherently complex, require long development schedules and are dependent in some cases on sole source suppliers. We will be required to continue to invest in research and development in order to attempt to maintain and enhance our existing technologies and products, but we may not have the funds available to do so. Even if we have sufficient funds, these investments may not serve the needs of customers or be compatible with changing technological requirements or standards. Most development expenses must be incurred before the technical feasibility or commercial viability of new or enhanced services and applications can be ascertained. Revenue from future services and applications or enhancements to services and applications may not be sufficient to recover the associated development costs.

     The technology underlying our services and applications is complex and may contain unknown defects that could harm our reputation, result in product liability or decrease market acceptance of our services and applications.

     The technology underlying our digital media services and applications is complex and includes software that is internally developed and software licensed from third parties. These software products may contain errors or defects, particularly when first introduced or when new versions or enhancements are released. We may not discover software defects that affect our current or new services and applications or enhancements until after they are sold. Furthermore, because our digital media services are designed to work in conjunction with various platforms and applications, we are susceptible to errors or defects in third-party applications that can result in a lower quality product for our customers. Because our customers depend on us for digital media management, any interruptions could:

•		Damage our reputation;
•		Cause our customers to initiate product liability suits against us;
•		Increase our product development resources;
•		Cause us to lose sales; and
•		Delay market acceptance of our digital media services and applications.

     We do not possess product liability insurance, and our errors and omissions coverage is not likely to be sufficient to cover our complete liability exposure.

     Our network is subject to security and stability risks that could harm our business and reputation and expose us to litigation or liability.

     Online commerce and communications depend on the ability to transmit confidential information and licensed intellectual property securely over private and public networks. Any compromise of our ability to transmit such information and data securely or

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reliably, and any costs associated with preventing or eliminating such problems, could harm our business. Our systems and operations are susceptible to, and could be damaged or interrupted by a number of security and stability risks, including: outages caused by fire, flood, power loss, telecommunications failure, Internet breakdown, earthquake and similar events. We do not have complete redundancy in our webcasting facilities and therefore any damage or destruction to these would significantly harm our webcasting business. Our systems are also subject to human error, security breaches, power losses, computer viruses, break-ins, “denial of service” attacks, sabotage, intentional acts of vandalism and tampering designed to disrupt our computer systems, Websites and network communications. A sudden and significant increase in traffic on our Websites could strain the capacity of the software, hardware and telecommunications systems that we deploy or use. This could lead to slower response times or system failures.

     Our operations also depend on receipt of timely feeds from our content providers, and any failure or delay in the transmission or receipt of such feeds could disrupt our operations. We also depend on Web browsers, ISPs and online service providers to provide access over the Internet to our product and service offerings. Many of these providers have experienced significant outages or interruptions in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. These types of interruptions could continue or increase in the future.

     The occurrence of any of these or similar events could damage our business, hurt our ability to distribute products and services and collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation, and expose us to litigation or liability. We may be required to expend significant capital or other resources to protect against the threat of security breaches, hacker attacks or system malfunctions or to alleviate problems caused by such breaches, attacks or failures.

     Our services are complex and are deployed in complex environments and therefore may have errors or defects that could seriously harm our business.

     Our services are highly complex and are designed to be deployed in and across numerous large complex networks. Our digital distribution activities are managed by sophisticated software and computer systems. From time to time, we have needed to correct errors and defects. In addition, we must continually develop and update these systems over time as our business and business needs grow and change, and these systems may not adequately reflect the current needs of our business. We may encounter delays in developing these systems, and the systems may contain undetected errors and defects that could cause system failures. Any system error or failure that causes interruption in availability of products or content or an increase in response time could result in a loss of potential or existing business services customers, users, advertisers or content providers. If we suffer sustained or repeated interruptions, our products, services and Websites could be less attractive to such entities or individuals and our business could be harmed.

     Our transmission capacity is not entirely in our control, as we rely in part on transmission capacity provided by third parties. Insufficient transmission capacity could result in interruptions in our services and loss of revenues.

     Significant portions of our business are dependent on providing customers with efficient and reliable services to enable customers to broadcast content to large audiences on a live or on-demand basis. Our operations are dependent in part upon transmission capacity provided by third-party telecommunications network providers. Any failure of such network providers to provide the capacity we require may result in a reduction in, or interruption of, service to our customers. If we do not have access to third-party transmission capacity, we could lose customers and if we are unable to obtain such capacity on terms commercially acceptable to us, our business and operating results could suffer.

     Our business and operations may be especially subject to the risks of earthquakes and other natural catastrophes.

     Our computer and communications infrastructure is located at a single leased facility in Seattle, Washington, an area that is at heightened risk of earthquake and volcanic events. We do not have fully redundant systems, and we may not have adequate business interruption insurance to compensate us for losses that may occur from a system outage. Despite our efforts, our network infrastructure and systems could be subject to service interruptions or damage and any resulting interruption of services could harm our business, operating results and reputation.

     Government regulation could adversely affect our business prospects.

     Few existing laws or regulations specifically apply to the Internet, other than laws and regulations generally applicable to businesses. Certain U.S. export controls and import controls of other countries, including controls on the use of encryption

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technologies, may apply to our products. Many laws and regulations, however, are pending and may be adopted in the United States, individual states and local jurisdictions and other countries with respect to the Internet. These laws may relate to many areas that impact our business, including content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, digital rights management, encryption, caching of content by server products, personal privacy, taxation, e-mail, sweepstakes, promotions, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability and wireless networks. These types of regulations are likely to differ between countries and other political and geographic divisions. Other countries and political organizations are likely to impose or favor more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. In addition, state and local governments may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for and costs associated with our products and services, and may affect the growth of the Internet. Such laws or regulations may harm our business. Our products and services may also become subject to investigation and regulation of foreign data protection and e-commerce authorities, including those in the European Union. Such activities could result in additional product and distribution costs for us in order to comply with such regulation.

     There is uncertainty regarding how existing laws governing issues such as property ownership, copyright and other intellectual property issues, digital rights management, taxation, gambling, security, illegal or obscene content, retransmission of media, and personal privacy and data protection apply to the Internet. The vast majority of such laws was adopted before the advent of the Internet and related technologies and does not address the unique issues associated with the Internet and related technologies. Most of the laws that relate to the Internet have not yet been interpreted. In addition to potential legislation from local, state and federal governments, labor guild agreements and other laws and regulations that impose fees, royalties or unanticipated payments regarding the distribution of media over the Internet may directly or indirectly affect our business. While we and our customers may be directly affected by such agreements, we are not a party to such agreements and have little ability to influence the degree such agreements favor or disfavor Internet distribution or our business models. Changes to or the interpretation of these laws and the entry into such industry agreements could:

•		Limit the growth of the Internet;
•		Create uncertainty in the marketplace that could reduce demand for our products and services;
•		Increase our cost of doing business;
•		Expose us to increased litigation risk, substantial defense costs and significant liabilities associated with content available on our Websites or distributed or accessed through our products or services, with our provision of products and services, and with the features or performance of our products and Websites;
•		Lead to increased product development costs or otherwise harm our business; or
•		Decrease the rate of growth of our user base and limit our ability to effectively communicate with and market to our user base.

     The Digital Millennium Copyright Act (DMCA) includes statutory licenses for the performance of sound recordings and for the making of recordings to facilitate transmissions. Under these statutory licenses, we and our broadcast customers may be required to pay licensing fees for digital sound recordings we deliver in original and archived programming and through retransmissions of radio broadcasts. The DMCA does not specify the rate and terms of the licenses, which are determined by arbitration proceedings, known as CARP proceedings, supervised by the United States Copyright Office. Past CARP proceedings have resulted in proposed rates for statutory webcasting that were significantly in excess of rates requested by webcasters. CARP proceedings relating to music subscription and non-subscription services offering music programming that qualify for various licenses under U.S. copyright law are pending. We cannot predict the outcome of these CARP proceedings and may elect instead to directly license music content for our subscription and/or non-subscription services, either alone or in concert with other affected companies.

     Such licenses may apply only to music performed in the United States, and the availability of corresponding licenses for international performances is unclear. Therefore, our ability to find rights holders and negotiate appropriate licenses is uncertain. Many of our customers may be affected by these rates, which may negatively affect our revenue. Several CARP proceedings are

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pending for subscription music services and services that deliver digital downloads of music, and the outcome of these CARPs will also likely affect our business in ways that we cannot predict. Depending on the rates and terms adopted for the statutory licenses, our business could be harmed both by increasing our own cost of doing business, as well as by increasing the cost of doing business for our customers. We anticipate future CARPs relating to music subscription delivery services, which may also adversely affect the online distribution of music.

     The Child Online Protection Act and the Child Online Privacy Protection Act impose civil and criminal penalties on persons distributing material harmful to minors over the Internet to persons under the age of 17, or collecting personal information from children under the age of 13. We do not knowingly distribute harmful materials to minors or collect personal information from children under the age of 13. The manner in which these Acts may be interpreted and enforced cannot be fully determined, and future legislation similar to these Acts could subject us to potential liability if we were deemed to be non-compliant with such rules and regulations, which in turn could harm our business.

     There are a large number of legislative proposals before the United States Congress and various state legislatures regarding intellectual property, digital rights management, copy protection requirements, privacy, email marketing and security issues related to our business. It is not possible to predict whether or when such legislation may be adopted, and certain proposals, if adopted, could materially and adversely affect our business through a decrease in user registration and revenue, and influence how and whether we can communicate with our customers.

     We may be subject to market risk and legal liability in connection with the data collection capabilities of our products and services.

     Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate. To provide better consumer experiences and to operate effectively, our products send information to servers. Many of the services we provide also require that a user provide certain information to us. We post an extensive privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client and server products. Any failure by us to comply with our posted privacy policy and existing or new legislation regarding privacy issues could impact the market for our products and services, subject us to litigation and harm our business.

     A class action lawsuit has been filed against us that may result in litigation that is costly to defend and the outcome of which is uncertain and may harm our business.

     We, and various underwriters for our initial public offering are defendants in a putative shareholder class action. The complaint alleges undisclosed improper underwriting practices concerning the allocation of shares for our IPO, in violation of the federal securities laws. Similar complaints have been filed concerning the IPOs of more than 300 companies, and the litigation has been coordinated in federal court for the Southern District of New York as In re Initial Public Offering Securities Litigation, 21 MC 92. A proposal has been made for the settlement and release of claims against the issuer defendants. The settlement is subject to a number of conditions, including approval of other proposed settling parties and the court. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to defend this case vigorously. In addition, because class action litigation has often been brought against companies with periods of volatility in their stock prices, we could become involved in additional litigation.

     Our stock price is volatile and may continue to be volatile in the future.

     Our common stock trades on the Nasdaq SmallCap Market. The market price of our common stock has fluctuated significantly to date. In the future, the market price of our common stock could be subject to significant fluctuations due to general market conditions and in response to quarter-to-quarter variations in:

•		Our anticipated or actual operating results;
•		Developments concerning our technologies and market offerings;
•		Technological innovations or setbacks by us or our competitors;
•		Conditions in the digital media and Internet markets;

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•		Announcements of merger or acquisition transactions; and
•		Other events or factors and general economic and market conditions.

     The stock market in recent years has experienced extreme price and volume fluctuations that have affected the market price of many technology companies, and that have often been unrelated or disproportionate to the operating performance of companies.

     Future sales of our common stock or the perception that future sales could occur, may adversely affect our common stock price.

     If a large number of shares of our common stock are sold in the open market or if there is a perception that such sales could occur, the trading price of our common stock could decline materially. In addition, the sale of these shares, or possibility of such sale, could impair our ability to raise capital through the sale of additional shares of common stock.

     In 2003, we registered 17,358,553 shares for resale by selling stockholders, representing 30.5% of our common shares then outstanding. In addition, we have filed a registration statement for resale by selling stockholder of up to 12,593,570 shares, representing 18.0% of our common stock outstanding on May 4, 2004, which registration statement has not yet been declared effective. The selling stockholders under effective registration statements will be permitted to sell their registered shares in the open market from time to time without advance notice to us or to the market and without limitations on volume.

     Sales of shares pursuant to exercisable options and warrants could also lead to subsequent sales of the shares in the public market. These sales, together with sales of shares by the selling stockholders, could depress the market price of our stock by creating an excess in supply of shares for sale. Availability of these shares for sale in the public market could also impair our ability to raise capital by selling equity securities.

     Securities analysts may not continue to cover our common stock or may issue negative reports, and this may have a negative impact on our common stock’s market price.

     There is no guarantee that securities analysts will continue to cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect our common stock’s market price. The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about our business or us. If one or more of the analysts who cover us downgrades our stock, our stock price may decline rapidly. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, recently adopted rules mandated by the Sarbanes-Oxley Act of 2002, and a global settlement reached between the SEC, other regulatory analysts and a number of investment banks in April 2003, may lead to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many investment banking firms will now be required to contract with independent financial analysts for their stock research. It may be difficult for companies with smaller market capitalizations, such as our company, to attract independent financial analysts that will cover our common stock, which could have a negative effect on our market price.

     If proposed accounting regulations that require companies to expense stock options are adopted, our earnings will decrease and our stock price may decline.

     A number of publicly-traded companies have recently announced that they will begin expensing stock option grants to employees. In addition, the Financial Accounting Standards Board (FASB) has indicated that possible rule changes requiring expensing of stock options may be adopted in the near future. Currently, we include such expenses on a pro forma basis in the notes to our annual financial statements in accordance with accounting principles generally accepted in the United States, but do not include stock option expense for employee options in our reported financial statements. If accounting standards are changed to require us to expense stock options, our reported earnings will decrease significantly and our stock price could decline.

     Some provisions of our certificate of incorporation and bylaws and of Delaware law may deter takeover attempts, which may limit the opportunity of our stockholders to sell their shares at a favorable price.

     Some of the provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders by providing them with the opportunity to sell their shares possibly at a premium over the then market price.

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     For example, our board of directors is divided into three classes. At each annual meeting of stockholders, the terms of approximately one-third of the directors will expire, and new directors will be elected to serve for three years. It will take at least two annual meetings to effect a change in control of our board of directors because a majority of the directors cannot be elected at a single meeting, which may discourage hostile takeover bids.

     In addition, our certificate of incorporation authorizes the board of directors to issue up to 5,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by our board of directors without further action by the stockholders. These terms may include voting rights including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. No shares of preferred stock are currently outstanding and we have no present plans for the issuance of any preferred stock. The issuance of any preferred stock, however, could diminish the rights of holders of our common stock, and therefore could reduce the value of our common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change in control, thereby preserving the current stockholders’ control.

     Our bylaws contain provisions that require stockholders to act only at a duly-called meeting and make it difficult for any person other than management to introduce business at a duly-called meeting by requiring such other person to follow certain notice procedures.

     Finally, we are also subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder. The preceding provisions of our certificate of incorporation and bylaws, as well as Section 203 of the Delaware General Corporation Law, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management, even if such things would be in the best interests of our stockholders.

We have not, and currently do not anticipate, paying dividends on our common stock.

     We have never paid any dividends on our common stock and do not plan to pay dividends on our common stock for the foreseeable future. We currently intend to retain future earnings, if any, to finance operations, capital expenditures and the expansion of our business.

Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Our financial results could be affected by factors such as changes in interest rates and fluctuations in the stock market. As substantially all sales are currently made in U.S. dollars, a strengthening of the dollar could make our services less competitive in foreign markets. We do not use derivative instruments to hedge our risks. Our interest income is sensitive to changes in the general level of U.S. interest rates. Based on our cash and investment balances of $34.8 million at March 31, 2004, a one percent change in interest rates would cause a change in interest income of $348,000 per year. Due to the investment grade level of our investments, we anticipate no material market risk exposure. In addition, interest on our term loan is based on the prime rate. Based on the $2.8 million balance outstanding at March 31, 2004, a one percent increase in the prime rate would increase our interest expense by $28,000 per year.

     We invest in investment-grade government obligations, institutional money market funds and other obligations with FDIC insured US banks. Our primary investment focus is to preserve capital and earn a market rate of return on our investments. We do not speculate nor invest in publicly traded equity securities and, therefore, do not believe that our capital is subject to significant market risk.

Item 4 DISCLOSURE CONTROLS AND PROCEDURES

     We maintain a set of disclosure controls and procedures designed to ensure that information required to be disclosed by us in the reports filed under the Securities Exchange Act, is recorded, processed, summarized and reported within the time periods specified by

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the SEC’s rules and forms. Disclosure controls are also designed with the objective of ensuring that this information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

     Based upon their evaluation as of the end of the period covered by this report, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be included in our periodic SEC filings is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms.

     There have been no changes in our internal controls during the period covered by this report that significantly affect our control environment.

     Limitations of Disclosure Controls and Procedures. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or internal controls over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

     See Note 9 to the consolidated unaudited financial statements for information concerning legal proceedings.

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

ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS

     In December 2003, we entered into a term loan facility with a bank. In connection with this transaction we issued a warrant to the lender to purchase 25,000 shares of our common stock at $1.75 per share. The warrant expires on December 31, 2010. The warrant was issued without registration under the Securities Act of 1933 (the “Act”) to an accredited investor in reliance on the exemption provided by Section 4(2) of the Act. An appropriate legend was placed on the warrant and will be placed on the shares issuable upon exercise of the warrant.

     In January 2004, we issued to an executive search firm a five-year warrant exercisable for 12,820 shares of common stock with an exercise price of $1.95 per share. The search firm is a sophisticated investor which had access to all material information concerning our company, and we relied on Section 4(2) of the Securities Act in issuing such warrant. An appropriate legend was placed on the warrant and will be placed on the shares issuable upon exercise of the warrant.

     In February 2004, we entered into a Securities Purchase Agreement with certain institutional investors pursuant to which the we issued and sold 10,810,811 shares of our common stock at a price of $1.85 per share. We also paid to the placement agent, Allen & Company, a placement fee of 5% of the gross proceeds. The shares were issued and sold without registration under the Securities Act of 1933 to accredited investors in reliance on the exemption provided by Regulation D, Rule 506 under the Securities Act. An appropriate legend was placed on the shares. The shares purchased are included in a registration statement on Form S-3 which has been filed but has not yet been declared effective. We have agreed to use our reasonable efforts to have the registration statement declared effective by the SEC as soon as practicable.

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     In March 2004, we completed the acquisition of Overpeer, Inc., a privately held company based in New York. In the acquisition, all of the outstanding capital stock of Overpeer was exchanged for a total of 1,752,772 shares of our common stock. The number of shares issued was calculated by dividing $4,000,000 by the volume weighted average closing sales price of one share of our common stock as quoted on the Nasdaq SmallCap Market on each of the thirty consecutive trading days preceding the closing of the acquisition, or $2.2821 per share. 262,916 of the shares issued in the acquisition were placed into an escrow account that will remain open for one year to satisfy indemnity claims we may have. The shares of common stock issued in the acquisition were offered and sold to Overpeer’s former stockholders without registration under the Securities Act of 1933 in reliance upon the exemption provided by Regulation D, Rule 506 under the Securities Act. An appropriate legend was placed on the shares. The shares purchased are included in a registration statement on Form S-3 which has been filed but has not yet been declared effective.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

     None.

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

     None.

ITEM 5: OTHER INFORMATION

     None.

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits.

2.1	(1)		Agreement and Plan of Merger and Reorganization
10.1	(2)		Form of Subscription Agreement.
10.2			Offer letter dated February 21, 2004 between William P. Fasig and Loudeye Corp., filed herewith.
10.3			Offer letter dated March 12, 2004 between Lawrence J. Madden and Loudeye Corp., filed herewith.
31.1			Certification of Jeffrey M. Cavins, President and Chief Executive Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2			Certification of Lawrence J. Madden., Executive Vice President and Chief Financial Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1			Certification of Jeffrey M. Cavins, President and Chief Executive Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2			Certification of Lawrence J. Madden., Executive Vice President and Chief Financial Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)

Reports on Form 8-K

		On January 9, 2004, we filed a Report on Form 8-K containing disclosure in Items 5 and 7.
		On February 17, 2004, we filed a Report on Form 8-K containing disclosure in Items 5 and 7.

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		On February 24, 2004, we furnished a Report on Form 8-K containing disclosure for Item 12.
		On March 5, 2004 we filed a Report on Form 8-K containing disclosure in Items 2 and 7.
		On March 11, 2004 we filed a Report on Form 8-K containing disclosure in Item 5.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, May 17, 2004.

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