UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 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 þ          No o

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

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

Loudeye Corp.

Form 10-Q Quarterly Report
For the Quarter Ended June 30, 2004

TABLE OF CONTENTS

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PART I – FINANCIAL INFORMATION

     ITEM I. FINANCIAL STATEMENTS

LOUDEYE CORP.

CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share amounts)

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

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LOUDEYE CORP.

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

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

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LOUDEYE CORP.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited, in thousands)

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

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LOUDEYE CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

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

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LOUDEYE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)

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 has offices in the United States, the United Kingdom, France, Germany and Italy. The Company segregates its business in two business segments, digital media services and media restoration services. As discussed in Note 5, on June 22, 2004, the Company acquired On Demand Distribution Limited (“OD2”), a privately held digital music provider based in Europe. As discussed in Note 6, the Company completed the sale of its media restoration services business in May 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.

     Assuming the Company’s stockholders approve the issuance of additional shares to OD2 stockholders to pay future required payments, the Company believes that its existing cash, cash equivalents, and short-term investments will be sufficient to fund its operations and meet its working capital and capital expenditure requirements for the next year. If the Company’s stockholders do not approve such issuances, the Company will be required to satisfy such amounts in cash, which would likely cause a significant strain on the Company’s cash resources, the Company may need to obtain additional equity or debt financing and the Company may have difficulty pursuing its business objectives. Since the Company has incurred net losses since inception, the Company has relied on sales of equity securities, proceeds from the exercises of stock options and warrants and borrowings under its 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 the Company’s control. These include general market conditions, conditions in the private equity and public markets, the then-current market price of the Company’s common stock and the Company’s historical financial performance and future prospects.

Basis of Consolidation

     The consolidated financial statements include the accounts of the Company and its 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 and six months ended June 30, 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 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. Available for sale marketable securities are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity. Realized gains and losses are included in investment income. The cost of securities sold is based upon the specific identification method.

Restricted 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 in July 2004 and October 2005. Accordingly, the restricted investments have been classified in short-term and 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. Marketable securities 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 Microsoft Corporation were reported in the Digital Media Services segment and revenues from The Coca-Cola Company 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 5, the Company has recorded goodwill and intangible assets in connection with its acquisition of Overpeer, Inc. in March 2004 and OD2 in June 2004.

Revenue Recognition

     The Company recognizes revenue in accordance with Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements,” (SAB 101) as amended by Staff Accounting Bulletin No. 104 (SAB 104), and Emerging Issues Task Force (EITF) Issue No. 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 fixed monthly 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 of a customer’s over-the-air radio programming. Services provided may also include playlist selection and programming services for

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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 consisted 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 6, the Company completed the sale of its VidiPax business in May 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 (APB) 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 June 30, 2004 totaled $62,000, consisting of the amortization of deferred stock compensation of $68,000, of which $19,000 is included in cost of revenues, and a credit of $6,000 for variable stock compensation related to stock options that were repriced in 2001. Stock-based compensation was $195,000 for the quarter ended June 30, 2003, of which $4,000 is included in cost of revenues, consisting of the amortization of deferred stock compensation of $44,000, stock issued to former employees as severance and termination benefits of $30,000, and options with an estimated fair value, accounted for under FAS 123, of $121,000 granted to a member of the Company’s board of directors for consulting services.

     Stock-based compensation for the six months ended June 30, 2004 totaled $203,000, consisting of the amortization of deferred stock compensation of $207,000, of which $38,000 is included in cost of revenues, stock-based compensation expense of $14,000 related to options granted to a consultant, and a credit of $18,000 for variable stock compensation related to stock options that were repriced in 2001. Stock-based compensation was $238,000 for the six months ended June 30, 2003, of which $7,000 is included in cost of revenues, consisting of the amortization of deferred stock compensation of $87,000, stock issued to former employees as severance and termination benefits of $30,000, and options with an estimated fair value, accounted for under FAS 123, of $121,000 granted to a member of the Company’s board of directors for consulting services.

     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):

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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 six months ended June 30, 2004 (in thousands):

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     During the fourth quarter 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, Washington. Under the provisions of EITF 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity,” 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, Washington filed suit against the Company in April 2003 for breach of its lease. 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 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 of accrued special charges through the third quarter 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 during the first quarter 2004 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, during the first quarter 2003.

     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 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

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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):

5. ACQUISITIONS

     On Demand Distribution Limited

     On June 22, 2004, the Company commenced a tender offer to acquire 100% of the outstanding shares of On Demand Distribution Limited (“OD2”), a privately held digital music provider based in Europe. The Company acquired 93% of the shares of OD2 upon commencement of the tender offer. The Company expects to acquire the remaining 7% of OD2’s shares on the same terms by October 2004 from shareholders of OD2 that subsequently accept the offer or pursuant to compulsory sweep-along provisions provided for under English law. This acquisition supports the Company’s commitment to providing global services by broadening its reach and capabilities into key geographic regions including Europe, the second largest music market in the world, and Australia. In addition, the acquisition expands the Company’s content management and anti-piracy content protection services into Europe and will enable the Company to leverage OD2’s reach to expand its business into new markets. The unaudited consolidated statement of operations of Loudeye for the period ended June 30, 2004, includes the results of operations of OD2 for the nine days from June 22, 2004 to June 30, 2004.

     The consideration for the transaction consisted of the following elements:

	•		Loudeye issued 9,065,919 shares of its common stock on June 22, 2004, to existing OD2 shareholders and option holders, which amount includes shares issuable upon exercise of OD2 options to be assumed by Loudeye.
	•		Loudeye expects to issue up to 2,811,712 additional shares of its common stock, representing minority interest and shares to be issued to OD2 shareholders who had accepted the tender offer as of June 30, 2004, but to whom shares of common stock had not yet been issued. Minority interest includes shares that will be issued to existing OD2 shareholders and option holders, including shares issuable upon exercise of OD2 options to be assumed by Loudeye.
	•		Certain of OD2’s principal shareholders agreed to have an aggregate of 15% of the total consideration payable in the transaction held in escrow by the Company for 18 months to satisfy claims the Company may have with respect to breaches of representations, warranties and covenants, indemnification claims and working capital adjustments. As of June 22, 2004, the Company had issued and placed in escrow 2,072,369 shares of its common stock to 17 former OD2 shareholders who had tendered their shares of OD2 stock as of that date. The Company is obligated to issue and place into escrow an additional 20,131 shares of its common stock to one individual upon his tendering his outstanding shares of OD2 stock.
	•		Loudeye will pay approximately $2.8 million in cash to retire certain liabilities.
	•		Loudeye is obligated to pay an additional £7.8 million (approximately $13.5 million based on exchange rates as of June 30, 2004), excluding minority interest and the 15% additional consideration to be held in escrow (as discussed below), through November 30, 2005, to OD2’s shareholders, as follows:

	•		On November 30, 2004, approximately £1.0 million or $1.7 million;
	•		On January 31, 2005, approximately £3.8 million or $6.7 million;
	•		On May 31, 2005, approximately £1.0 million or $1.7 million; and
	•		On November 30, 2005, approximately £2.0 million or $3.4 million.

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     The escrow shares and the 15%, or approximately $2.6 million, of additional consideration described above are not recorded as liabilities and the value of the shares held in escrow and the 15% additional consideration was not included in determining the cost of acquiring OD2 as of June 30, 2004, since the resolution of the escrow shares and 15% additional consideration is still pending. Loudeye will reflect the escrow shares as outstanding and the liability relating to the 15% additional consideration as accrued and record the value of both as additional costs of acquiring OD2 upon the earlier of the expiration of the 18 month escrow period or when Loudeye believes beyond a reasonable doubt that it will not state a claim pursuant to the terms of the escrow.

     The maximum number of shares to be issued of approximately 13,950,000 constituted approximately 19.9% of Loudeye’s outstanding shares of common stock at the commencement of the tender offer.

     Certain OD2 employee option holders may elect to exercise their options and accept the offer, in which case they will receive the same consideration as other OD2 shareholders. Alternatively, Loudeye will assume the unexercised OD2 options, which will then become exercisable for Loudeye common stock based on a predetermined exchange rate.

     Based on management’s internal analysis, excluding the impact of minority interest which has not yet been recorded as noted below and the escrow shares and 15% additional consideration discussed above, the Company has preliminarily recorded $33.7 million of net assets in connection with the transaction consisting of upfront stock consideration, including the assumption of OD2 options, deferred consideration, cash obligations to retire certain liabilities, and the Company’s transaction related expenses. As of June 22, 2004, the initial purchase price can be summarized as follows (amounts in thousands):

     The accrued acquisition consideration recorded in the Company’s financial statements as of June 30, 2004, has been adjusted for the foreign currency exchange rate at June 30, 2004 and a foreign currency transaction gain of $183,000 was recorded in other income in the accompanying consolidated statement of operations for the three and six month periods ended June 30, 2004.

     Because OD2 had a deficit in net worth at acquisition, minority interest has not been reflected in the Company’s consolidated balance sheet.

     Under the terms of the offer, future cash consideration is payable in British currency (pounds), and accordingly the corresponding U.S. dollar amounts set forth above may vary with fluctuations in the prevailing exchange rate. All future payments are payable in cash or, at Loudeye’s election and if approved by stockholders representing a majority of Loudeye’s outstanding shares (excluding shares issued in connection with the transaction to the extent such shares are required to be excluded by the rules of the Nasdaq Stock Market), in shares of Loudeye common stock, the number of which will be determined based on Loudeye’s volume weighted average share price for a specified period prior to issuance. OD2 shareholders may also elect to receive promissory notes in lieu of any cash payments that Loudeye may be required to make. Loudeye has also agreed to reserve 2 million shares for stock option grants under its 2000 Stock Option Plan to employees of OD2 for future services.

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     Loudeye has agreed to file a registration statement covering the resale of the initial shares issued by it by the later of (i) August 6, 2004, (ii) 15 calendar days following the date it acquires all remaining OD2 shares, or (iii) 10 business days following receipt of certain OD2 financial statements required to be filed by Loudeye on Form 8-K. The registration statement has not yet been filed.

     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,” for purposes of estimating the value of the OD2 purchase consideration, the fair value of the Loudeye common stock to be issued for the acquisition of OD2 was determined to be $1.45 per share based on the average closing price of the Company’s common stock over the two day periods before and after June 22, 2004, the date the acquisition was announced, multiplied by the Loudeye shares issued based upon the exchange ratio set forth in the merger agreement. The fair value of options assumed is deemed to be equivalent to the value of the underlying Loudeye shares into which such options are exercisable given the nominal strike price of such options. In accordance with FAS No. 52, “Foreign Currency Translation,” and as a result of currency fluctuation between the U.S. dollar and British pound during the nine day period from June 22, 2004, to June 30, 2004, the Company recorded a $183,000 foreign currency transaction gain in other income in the accompanying consolidated statement of operations for the three and six month periods ending June 30, 2004.

     The following table summarizes as of June 22, 2004, 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, based upon management's internal analysis, which have been recorded in the Company’s digital media services segment (in thousands):

     The purchase price allocation set forth above is preliminary and subject to change in future periods pending the completion of an independent valuation report. The Company is currently in the process of finalizing its assessment of the fair value of the net assets acquired. The preliminary allocation of the purchase price to tangible and intangible assets, as well as the related amortization expense, may change materially as a result of the completion of the Company’s evaluation of the fair value of the net assets acquired.

     The weighted average amortization period of amortizable intangibles acquired is estimated to be three (3) years. The goodwill recorded is not expected to be amortizable for income tax purposes. The goodwill associated with OD2 will be included in the Company’s digital media services segment.

     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”). 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

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registration statement in March 2004 for the resale of the securities issued to the Overpeer shareholders, which registration statement was declared effective on May 26, 2004.

     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. Overpeer’s operating results have been included in the accompanying consolidated statements of operations effective beginning in March 2004. 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 and is preliminary and subject to change in future periods pending the completion of an independent valuation report.

     Pro forma financial information

     The following table presents the unaudited pro forma results of the Company for the three and six months ended June 30, 2004 and 2003 assuming the Company had acquired OD2 and Overpeer at the beginning of each period (in thousands):

6. SALE OF MEDIA RESTORATION BUSINESS

     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, 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. At March 31, 2004, these assets and liabilities were classified as net

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assets transferred under contractual arrangement. On May 17, 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. 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 totaling $213,000 for the period from the Transfer Date through the Accounting Closing Date, of which $95,000 was recorded as revenue in the first quarter 2004 and $118,000 was recorded as revenue in the second quarter 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. The difference between the $900,000 proceeds received from escrow and the carrying value of the assets and liabilities transferred as of the Accounting Closing Date is $160,000 and is recorded as a loss on the sale of net assets transferred under contractual arrangement in the second quarter 2004.

     With the GSA Contracts assigned to the purchaser, the remaining $300,000 of the $1.2 million originally 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.

7. 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 the registration statement was declared effective by the SEC on May 26, 2004.

8. SEGMENT INFORMATION

     The Company operates in two business segments, Digital Media Services and Media Restoration Services. As described in Note 6, the Company transferred the assets and certain liabilities of its media restoration services business on January 30, 2004, and completed the sale on May 17, 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. In June 2003, a proposed settlement of this litigation was structured between the plaintiffs, the issuer defendants, the issuer officers and directors named as defendants, and the issuers’ insurance companies. The proposed settlement provides that the issuer defendants and related individual defendants will be released from the litigation without any liability other than certain expenses incurred to date in connection with the litigation, the issuer defendants’ insurers will guarantee $1.0 billion in recoveries by plaintiff class members, the issuer defendants will assign certain claims against the underwriter defendants to the plaintiff class members, and the issuer defendants will have the opportunity to recover certain litigation-related expenses if the plaintiffs recover more than $5.0 billion from the underwriter defendants. The Company’s board of directors approved the proposed settlement in August 2003. On June 25, 2004, the plaintiffs filed a motion for preliminary approval of the settlement with the court, which was accompanied by a brief filed by the issuer defendants in support of the plaintiffs’ motion. The court requested that any objections to preliminary approval of the settlement be submitted by July 14, 2004, and the underwriter defendants formally objected to the settlement. The plaintiffs and issuer defendants separately filed replies to the underwriter defendants’ objections to the settlement on August 4, 2004. There can be no assurance that this proposed settlement would be approved and implemented in its current form, or at all. 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 cash 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 Superior Court of California in San Francisco County 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

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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 former facility at 414 Olive Way, Seattle, Washington 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 landlord for rents due through January 2004 of $438,000, which the Company had accrued in a prior period and paid in the first quarter 2004. The Court reserved the other issues in the suit, including mitigation, interest and attorney’s fees, for trial. The Company appealed the judgment which is now in the process of being vacated by stipulation. As part of the stipulation, the trial date has been extended to Spring 2005. Management believes that meritorious defenses to some portions of the claims made in the suit exist. The Company continues to vigorously defend this suit while exploring opportunities to reach a settlement with the plaintiff. As of December 31, 2003 and June 30, 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 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 a 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. For all agreements entered into after December 31, 2002, the fair value of potential claims has not been recorded in the Company’s financial statements because they are not material.

10.  SUBSEQUENT EVENTS

     On August 24, 2004, the Company received a notice from the Nasdaq Listing Qualifications staff indicating that the Company has failed to timely file its quarterly report on Form 10-Q for the period ended June 30, 2004, as required by Nasdaq Marketplace Rule 4310(c)(14). This delisting notification is standard procedure when a Nasdaq listed company fails to complete a required filing in a timely manner. On August 30, 2004, to ensure it remains listed until it can file this Quarterly Report and regain compliance with all applicable listing standards, Loudeye filed an appeal of the delisting notification to the NASDAQ Listings Qualifications Panel. The filing of this appeal will prevent the delisting of Loudeye’s securities until Loudeye regains compliance with all applicable listing standards through the filing of its Quarterly Report or, should that not occur, pending the Panel’s decision.

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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. Forward-looking statements include, but are not limited to, statements about our digital media products and services and commercialization goals and expectations, potential market opportunities, integration of OD2 and Overpeer, and other statements that are not historical facts. Words such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential” or “continue,” and the negative of terms like these or other comparable terminology may identify forward-looking statements, but the absence of these words does not mean that the statement is not forward-looking. 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 forth below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

     You should not unduly rely on these forward-looking statements, which speak only as of the date of this quarterly report. We undertake no obligation to publicly revise any forward-looking statement after the date of this quarterly report to reflect circumstances or events occurring after the date of this quarterly report or to conform the statement to actual results or changes in our expectations. You should, however, review the factors, risks and other information we provide in the reports we file from time to time with the SEC.

Overview

     We are an innovative business-to-business provider of services that facilitate the distribution and promotion of digital media content to media and 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.

Acquisition of OD2

     In June 2004, we acquired On Demand Distribution Limited (OD2), one of the largest digital music providers in Europe, creating what we believe is the world’s largest business-to-business focused digital media company, providing outsourced digital media solutions to many of the world’s digital media businesses. The combined company now serves more than 200 customers in 15 countries, adding European customers such as Coca Cola (UK), MSN (Pan-Europe), MTV (Pan-Europe), Virgin Megastores (UK), HMV (UK) and other retailers, Internet portals and Internet service providers, telecommunications companies and commercial radio stations throughout Europe and Australia. This acquisition supports our commitment to providing global services by broadening our reach and capabilities into key geographic regions including Europe, the second largest music market in the world, and Australia. In addition, this acquisition expands our content management and anti-piracy content protection services into Europe and will enable us to leverage OD2’s reach to expand our business into new markets. The unaudited consolidated statement of operations of Loudeye for the period ended June 30, 2004, includes the results of operations of OD2 for the nine days from June 22, 2004, to June 30, 2004. More information on the terms of the acquisition is provided below under “Liquidity and Capital Resources—Acquisition of On Demand Distribution Limited.”

The Loudeye Solution

     During the first and second quarters of 2004, we provided our services via two primary business segments, Digital Media Services and Media Restoration Services. In January 2004, we transferred substantially all of the assets of our media restoration services subsidiary, VidiPax, Inc., to a company controlled by VidiPax’s general manager. In May 2004, we completed the sale of this media restoration services business. While we will have ongoing rights to co-market and resell media restoration services for two years after

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the sale, we anticipate media restoration services will represent an insignificant portion of our revenue and 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 nearly 5.0 million music tracks in uncompressed, digital master format;
	•		Highly scalable and reliable operations;
	•		Support for multiple media players and digital media formats;
	•		Support for multiple transmission speeds, or 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:

     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 Second Quarter 2004

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

     Digital Media Solutions Initiatives:

	•		We made significant investments in the Overpeer anti-piracy content protection service offering including doubling its capacity, expanding capabilities and adding dedicated sales staff. Since the acquisition of Overpeer in March 2004, we have added additional customer contracts representing major content owners from the music, film/video, game and software industries.
	•		We have expanded 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, and Naxos, the leading independent classical music catalog.
	•		We acquired OD2, one of the largest digital music providers in Europe. This acquisition supports our commitment to providing global services by broadening our reach and capabilities into key geographic regions including Europe, the second largest music market in the world, and Australia. In addition, this acquisition expands our content management and anti-piracy content protection services into Europe and will enable us to leverage OD2’s reach to expand our business into new markets.

     Organization:

•

We expanded our management team with the hiring of Charles Grimsdale, president and managing director of our international business operations through the acquisition of OD2, and the hiring of Lee Kirby, executive vice president of professional and customer services.

     Highlights of Operating Results:

     The following is a summary description of our operating results for the three months ended June 30, 2004. A more detailed discussion of our operating results is included below under the heading “Results of Operations.”

     Our second quarter 2004 revenues were $3.1 million, compared to $2.9 million in the prior year quarter. The results for the 2004 quarter include an increase of $368,000 in revenue from our existing core digital media services business, $545,000 of revenue from anti-piracy services, and $177,000 of revenue attributable to our acquisition of OD2 on June 22, 2004. These increases were offset by a decrease in our webcasting business resulting from a restructuring in 2003 (representing $571,000 of the decrease) and the completion of the sale of our substantially all of the business of our VidiPax subsidiary in May 2004 (representing $286,000 of the decrease).

     We reported a net loss of $2.6 million or $0.04 per share in the second quarter 2004, compared to a net loss of $2.1 million or $0.04 per share in the prior year quarter. The increase in net loss primarily reflects additional research and development expense related to the Loudeye Digital MusicStore^TM product, and increased selling, general and administrative expense related to our acquisitions of Overpeer and OD2.

Results of Operations

Three Months Ended June 30, 2004 and 2003

     Revenues. Revenues totaled $3.1 million and $2.9 million for the second quarter 2004 and 2003 and consisted of the following (in thousands):

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     Our product and service 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 2003. We shifted marketing emphasis away from webcasting and more toward digital media services, primarily digital music solutions, as well as anti-piracy content protection services.

     Revenues from encoding services, samples services, and internet 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. In the second quarter there was increased demand from our customers for encoding services, primarily for the delivery of digital music, as our customers focused on launching digital music services. Our current webcasting services are focused on customer relationships that provide higher margins. As a result, revenue from webcasting services decreased significantly for the second quarter 2004 compared to the second quarter 2003.

     Revenues from digital distribution services consist principally of digital download and subscription services, primarily from our acquisition of OD2 in the second quarter, as well as existing ringtunes and rights clearing service offerings. We began providing these services following our restructuring in the first quarter 2003, but there were no revenues in the prior year quarter.

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

     Media restoration services revenue for the second quarter 2004 does not include a full three months of revenue due to the transfer of our media restoration business on January 30, 2004 and completion of sale in May 2004 as discussed in Note 6 to the consolidated financial statements. Because our media restoration subsidiary continued to be the primary obligor under certain contracts with the General Services Administration of the United States (“GSA Contracts”) until their assignment on May 17, 2004, revenues and costs of revenues in the consolidated statement of operations of Loudeye reflect the revenues from services provided under the GSA Contracts totaling $118,000 in the second quarter 2004. Media restoration services revenues in future periods are expected to be insignificant.

     Cost of Revenues. Cost of revenues increased to $1.8 million for the second quarter 2004 from $1.7 million for the second quarter 2003. Cost of revenues remained consistent at 58% of revenue in 2004 and 2003, and consisted of the following (in thousands):

     Cost of revenues includes 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. We implemented cost reduction initiatives related to our restructuring in March 2003, however, in 2004 we began to expand our digital media services production work force in order to meet the demands of anticipated growth and new initiatives. In addition, costs associated with the delivery of digital media services revenue from our acquisitions of OD2 and Overpeer contributed to the increase in digital media services cost of revenue compared to the prior year quarter. We expect cost of revenues related to our digital media services to increase over the remainder of 2004 compared to the prior year periods.

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     As discussed above, media restoration services cost of revenue for the second quarter 2004 does not include a full three months of costs due to the transfer of our media restoration business on January 30, 2004 and completion of sale in May 2004. Because our media restoration subsidiary continued to be the primary obligor under certain contracts with the GSA until their assignment on May 17, 2004, revenues and costs of revenues in the consolidated statement of operations of Loudeye reflect the revenues from services provided under the GSA Contracts, totaling $118,000 in the second quarter 2004. The cost of revenue entirely offset the associated revenue.

     Depreciation included in cost of revenues increased to approximately $365,000 in the 2004 period from $240,000 in the 2003 period. This increase is due primarily to equipment purchased in the first quarter 2004 of $1.5 million to upgrade the storage and access systems for our digital music archive, as well as additional equipment expenditures in the second quarter 2004 related to our content protection services offering. As a result of these items, as well as our acquisition of OD2, we expect depreciation included in cost of revenues to increase moderately in the remainder of 2004 compared to the prior year periods.

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

     Research and Development. Research and development expenses totaled $753,000 and $392,000 for the second 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 through the remainder of 2004 compared to the prior year periods as we invest in the development of our digital media service offerings, particularly our Loudeye Digital MusicStore™ product, as well as our content protection services, and as we complete the integration of our acquisitions of OD2 and Overpeer.

     Sales and Marketing. Sales and marketing expenses totaled $836,000 and $835,000 for the second quarter 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. Sales and marketing expenses were flat compared to the same period in 2003, reflecting cost reduction initiatives implemented in 2003, somewhat offset by increases resulting from our acquisitions of Overpeer in March 2004 and OD2 in June 2004. We expect sales and marketing expenses to increase through the remainder of 2004 compared to the prior year periods as we expand our sales force and marketing personnel to market and sell our new Tier 3 application level products and services and as we complete the integration of our acquisitions of OD2 and Overpeer.

     General and Administrative. General and administrative expenses increased to $2.2 million in the second quarter 2004 from $1.7 million in the second quarter 2003. 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. This increase was primarily the result of our acquisitions of Overpeer in March 2004 and OD2 in June 2004. We anticipate that general and administrative expenses for the remainder of 2004 will increase compared to the prior year periods as we complete the integration of our acquisitions of OD2 and Overpeer, and as we increase our personnel and other resources to support our growth. In addition, we will continue to 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 $126,000 and $260,000 for the second quarter of 2004 and 2003, and includes amortization of identified intangible assets related to acquisitions. We recorded impairment charges in the first quarter 2003 relating to our restructuring, which resulted in lower amortization charges starting with the second quarter 2003. The trend of lower quarterly amortization charges continued through the second quarter 2004. However, during the second quarter 2004 we incurred additional amortization expense related to our acquisitions of Overpeer and OD2, and expect that amortization expense for the remainder of 2004 will increase compared to the prior quarter periods.

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     Stock-Based Compensation. Stock-based compensation included in operating expenses for the second quarter 2004 totaled $43,000, consisting of the amortization of deferred stock compensation of $49,000, somewhat offset by a credit of $6,000 for variable stock compensation related to stock options that were repriced in 2001. Stock-based compensation included in operating expenses was $191,000 for the second quarter 2003, consisting of the amortization of deferred stock compensation of $40,000, stock granted to former employees of $30,000 and options granted to a member of our board of directors for consulting services of $121,000. 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.

     Investment Income. Investment income consists of interest income and realized gains and losses on sales of our investments. Investment income totaled approximately $107,000 and $101,000 for the second quarter of 2004 and 2003. The increase was due primarily to higher average investment balance resulting from the proceeds received from the private equity financings completed in August 2003 and February 2004. We expect interest income will decrease moderately for the remainder of 2004 due to lower average investment balances resulting from our utilization of cash.

     Interest Expense. Interest expense relates to our debt instruments, consisting of our line of credit, term loan and capital lease obligations. Interest expense totaled $59,000 and $48,000 for the second quarter 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 (Expense). Other income consists of foreign currency transaction gains on the accrued acquisition consideration related to our acquisition of OD2 in June 2004.

Six Months Ended June 30, 2004 and 2003

     Revenues. Revenues totaled $5.1 million and $6.2 million for the first six months 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 2003. We shifted marketing emphasis away from webcasting and more toward digital media services, primarily digital music solutions, as well as anti-piracy content protection services.

     Revenues from encoding services, samples services, and internet 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. In the second quarter there was increased demand from our customers for encoding services, primarily for the delivery of digital music, as our customers focused on launching digital music services. 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 six months of 2004 compared to the first six months of 2003.

     Revenues from digital distribution services consist principally of digital download and subscription services, primarily from our acquisition of OD2 in the second quarter, as well as existing ringtunes and rights clearing service offerings. We began providing these services following our restructuring in the first quarter 2003, but there were no revenues during the first six months of 2003.

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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 the corresponding period in 2003.

     Media restoration services revenue for the first six months of 2004 does not include a full six months of revenue due to the transfer of our media restoration business on January 30, 2004 and completion of the sale in May 2004 as discussed in Note 6 to the consolidated financial statements. Revenue in the first six months of 2004 includes $84,000 from operations in January prior to the transfer of substantially all of the business of our VidiPax subsidiary to the purchaser of our media restoration subsidiary. Because our media restoration subsidiary continued to be the primary obligor under certain contracts with the General Services Administration of the United States GSA Contracts until their assignment on May 17, 2004, revenues and costs of revenues in the consolidated statement of operations of Loudeye reflect the revenues from services provided under the GSA Contracts, totaling $213,000 in the first six months of 2004. Media restoration services revenues in future periods are expected to be insignificant.

     Cost of Revenues. Cost of revenues decreased to $3.2 million for the first six months of 2004 from $4.2 million for the first six months of 2003. Cost of revenues decreased from 68% of revenue in 2003 to 63% of revenue in 2004, and consisted of the following (in thousands):

     Cost of revenues includes 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. We implemented cost reduction initiatives related to our restructuring in March 2003, and as a result, cost of revenue in the first quarter 2004 were less than the first quarter 2003. However, in the second quarter 2004 we began to expand our digital media services production work force in order to meet the demands of anticipated growth and new initiatives. In addition, costs associated with the delivery of digital media services revenue from our acquisitions of OD2 and Overpeer contributed to an increase in digital media services cost of revenue during the second quarter 2004 compared to the prior year period. Accordingly, we expect cost of revenues related to our digital media services to increase over the remainder of 2004 compared to the prior year periods.

     Media restoration services cost of revenue for the first six months of 2004 includes $71,000 for operations in January 2004 prior to the transfer of substantially all of the business of our VidiPax subsidiary on January 30, 2004 and completion of sale in May 2004. Because our media restoration subsidiary continued to be the primary obligor under certain contracts with the GSA until their assignment on May 17, 2004, revenues and costs of revenues in the consolidated statement of operations of Loudeye reflect the revenues from services provided under the GSA Contracts totaling $213,000 in the second quarter 2004. From the January 30, 2004, date of transfer of the VidiPax assets, the cost of revenue entirely offset the associated revenue.

     Depreciation included in cost of revenues increased to approximately $657,000 in 2004 from $456,000 in 2003. This increase is due primarily to equipment purchased in the first quarter 2004 of $1.5 million to upgrade the storage and access systems for our digital music archive, as well as additional equipment expenditures in the second quarter 2004 related to our content protection services offering. As a result of these items, as well as our acquisition of OD2, we expect depreciation included in cost of revenues to increase moderately in 2004 compared to the prior year periods.

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

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     Research and Development. Research and development expenses totaled $1.3 million and $969,000 for the first six months 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 through the remainder of 2004 compared to the prior year periods as we invest in the development of our digital media service offerings, particularly our Loudeye Digital MusicStore™ product, and as we complete the integration of our acquisitions of OD2 and Overpeer.

     Sales and Marketing. Sales and marketing expenses totaled $1.5 million and $2.4 million for the first six months 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 compared to the same period in 2003 reflects cost reduction initiatives implemented in 2003, somewhat offset by increases resulting from our acquisitions of Overpeer in March of 2004 and OD2 in June of 2004. We expect sales and marketing expenses to increase through the remainder of 2004 compared to the prior year periods as we expand our sales force and marketing personnel to market and sell our new Tier 3 application level products and services and as we complete the integration of our acquisitions of OD2 and Overpeer.

     General and Administrative. General and administrative expenses decreased to $4.2 million in the first six months of 2004 from $4.5 million in the first six months of 2003. 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. This decrease was due to the decrease in personnel related to our reductions in force in the first quarter 2003, and related cost reduction initiatives. The decrease was somewhat offset by an increase in the second quarter 2004 primarily as the result of our acquisitions of Overpeer in March 2004 and OD2 in June 2004. We anticipate that general and administrative expenses for the remainder of 2004 will increase compared to the prior year periods 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 $266,000 and $786,000 for the first six months 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 2003, which resulted in lower amortization charges starting with the second quarter 2003. During the second quarter 2004 we incurred additional amortization expense related to our acquisitions of Overpeer and OD2, and expect that amortization expense for the remainder of 2004 will increase compared to the prior year periods.

     Stock-Based Compensation. Stock-based compensation included in operating expenses for the first six months of 2004 totaled $165,000, consisting of the amortization of deferred stock compensation of $169,000, stock-based compensation expense of $14,000 related to options granted to a consultant, and a credit of $18,000 for variable stock compensation related to stock options that were repriced in 2001. Stock-based compensation included in operating expenses was $231,000 for the first six months of 2003, consisting of the amortization of deferred stock compensation of $80,000, stock granted to former employees of $30,000, and options granted to a member of our board of directors for consulting services of $121,000. 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 six months of 2004 and 2003 (in thousands):

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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 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 $186,000 and $187,000 for the first six months of 2004 and 2003. We expect interest income will decrease moderately for the remainder of 2004 due to lower average investment balances resulting from our utilization of cash.

     Interest Expense. Interest expense relates to our debt instruments, consisting of our line of credit, term loan and capital lease obligations. Interest expense totaled $130,000 and $97,000 for the first six months 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 (Expense). Other income consists primarily of foreign currency transaction gains on the accrued acquisition consideration related to our acquisition of OD2 in June 2004.

Liquidity and Capital Resources

     As of June 30, 2004, we had approximately $32.5 million of cash and 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 $4.6 million for first six months of 2004. Cash used in operating activities resulted primarily from a net loss of $5.4 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 $1.2 million, collection of proceeds from the sale of our media restoration subsidiary of $900,000 and an increase in other assets and liabilities of approximately $935,000. 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 judgment 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 $11.7 million in the first six months of 2004, consisting principally of the net purchases of short-term investments of $9.3 million to invest a portion of the proceeds from our private equity financing in February 2004 and purchases of property and equipment of $2.6 million, consisting principally of equipment to upgrade the storage and access systems for our digital music archive and investments in capital equipment for our Overpeer anti-piracy service offering. In addition, $900,000 cash was used related to our acquisition of OD2.

     Net cash provided by financing activities was $17.2 million for the first six months of 2004, consisting primarily of proceeds from the private equity financing in February 2004 of $18.9 million, as described below, and proceeds from the exercise of stock options of $195,000, offset partially by principal payments on our debt and capital lease obligations of $662,000 and the repayment in full of our line of credit for $1.3 million.

Acquisition of On Demand Distribution Limited

     The discussion below includes information that is not based on accounting principals generally accepted in the United States, or GAAP. To supplement our consolidated financial statements and information below that is presented on a GAAP basis, we have included this non-GAAP “pro forma” information, including the table below indicating the allocation of the purchase price we will have paid for OD2 including minority interest and all shares and cash consideration held or to be held in escrow. Reconciliations of the non-GAAP information are included below. We believe these pro forma presentations enhance overall understanding of our expenses in acquiring OD2, in particular with respect to minority interest and the approximately 2.1 million escrow shares that we have issued and the 15%, or approximately $2.6 million, of additional consideration that we are required to pay, which are not reflected from an accounting perspective, and is used by management for that purpose. Although management believes the above non-GAAP information enhances a reader’s understanding of the OD2 acquisition, this non-GAAP information does not reflect GAAP accounting for the acquisition as of June 30, 2004. Accordingly, readers should consider this pro forma information together with the GAAP information above, rather than as an alternative to GAAP basis financial measures.

     In June 2004, we commenced a tender offer to acquire 100% of the outstanding shares of OD2, a privately held digital music provider based in Europe. We acquired 93% of the shares of OD2 upon commencement of the tender offer. As of August 17, 2004, we had acquired the remaining 7% of OD2’s shares on the same terms from the remaining shareholders of OD2.

     The consideration for the transaction consisted of the following elements:

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	•		15% of the total additional consideration that we are required to pay to the OD2 shareholders through November 30, 2005, or approximately $2.6 million (excluding minority interest), will be placed into escrow along with the escrow shares.
	•		We are obligated to pay an additional contingent consideration of up to £10.0 million (approximately $18.0 million based on exchange rates as of June 30, 2004) including minority interest, if OD2 achieves certain financial performance targets during the period through November 30, 2006.

     From a financial accounting perspective, the escrow shares and the 15%, or approximately $2.6 million, of additional consideration described above are not recorded as liabilities and the value of the shares held in escrow and the 15% additional consideration was not included in determining the cost of acquiring OD2 as of June 30, 2004, since the resolution of the escrow shares and 15% additional consideration is still pending. We will reflect the escrow shares as outstanding and the liability relating to the 15% additional consideration as accrued and record the value of both as additional costs of acquiring OD2 upon the earlier of the expiration of the 18 month escrow period or when management believes beyond a reasonable doubt that we will not state a claim pursuant to the terms of the escrow.

     The maximum number of shares to be issued of approximately 13,950,000 constituted approximately 19.9% of Loudeye’s outstanding shares of common stock at the commencement of the tender offer. Certain OD2 employee option holders may elect to exercise their options and accept the offer, in which case they will receive the same consideration as other OD2 shareholders. Alternatively, Loudeye will assume the unexercised OD2 options, which will then become exercisable for Loudeye common stock based on a predetermined exchange rate.

     Based on management’s internal analysis, excluding the impact of minority interest and the escrow shares and 15% additional consideration discussed above, we have preliminarily recorded $33.7 million of net assets in connection with the transaction consisting of upfront stock consideration, including the assumption of OD2 options, deferred consideration, cash obligations to retire certain liabilities, and our transaction related expenses. As of June 22, 2004, the initial purchase price can be summarized as follows (amounts in thousands):

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     The accrued acquisition consideration recorded in our financial statements as of June 30, 2004, has been adjusted for the foreign currency exchange rate at June 30, 2004 and therefore accrued acquisition consideration in the table above is $183,000 greater than as reflected on our balance sheet as of June 30, 2004.

In addition to the $33.5 million purchase price recorded at June 30, 2004, if

     •     we had acquired 100% of the OD2 stock at the date of purchase, resulting in no minority interest,

     •     the 2,072,369 shares of common stock held in escrow by us were treated as outstanding,

     •     the 15% of additional escrow consideration to be paid by us were treated as a liability, and

     •     net liabilities assumed of $2.8 million were reflected as an additional component of consideration,

then the acquisition price would have been approximately $44.9 million as a result of the inclusion of the fair value of the minority interest and the shares and additional consideration paid into escrow and the initial purchase consideration would be summarized as follows (amounts in thousands):

     Certain OD2 employee option holders may make an election whether to exercise their options and accept the offer, in which case they will receive the same consideration as other OD2 shareholders, or to exchange their options for similar options issued by us.

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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 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 $8.1 million at June 30, 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. We complete our 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 acquisitions of Overpeer, Inc. in March 2004 and OD2 in June 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, 2002. 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.

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     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 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.

Contractual Obligations

     The following table provides aggregated information about our contractual obligations as of June 30, 2004 (in thousands).

Off-Balance Sheet Arrangements

     In the normal course of business, we indemnify other parties, including business partners, lessors and parties to other transactions with us. We have agreed to hold the other parties harmless against losses arising from a 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, we have entered into indemnification agreements with certain of our officers and directors and our amended and restated certificate of incorporation and amended bylaws contain similar indemnification obligations to our officers and directors. For all agreements entered into after December 31, 2002, the fair value of potential claims has not been recorded in our financial statements because they are not material.

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Legal Proceedings

     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 us and certain of our former officers and directors, as well as against certain underwriters who handled our initial public offering of common stock in March 2000. The various complaints were filed purportedly on behalf of a class of persons who purchased our 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 our underwriters in connection with our 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 our 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. We 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. In June 2003, a proposed settlement of this litigation was structured between the plaintiffs, the issuer defendants, the issuer officers and directors named as defendants, and the issuers’ insurance companies. The proposed settlement provides that the issuer defendants and related individual defendants will be released from the litigation without any liability other than certain expenses incurred to date in connection with the litigation, the issuer defendants’ insurers will guarantee $1.0 billion in recoveries by plaintiff class members, the issuer defendants will assign certain claims against the underwriter defendants to the plaintiff class members, and the issuer defendants will have the opportunity to recover certain litigation-related expenses if the plaintiffs recover more than $5.0 billion from the underwriter defendants. Our board of directors approved the proposed settlement in August 2003. On June 25, 2004, the plaintiffs filed a motion for preliminary approval of the settlement with the court, which was accompanied by a brief filed by the issuer defendants in support of the plaintiffs’ motion. The court requested that any objections to preliminary approval of the settlement be submitted by July 14, 2004, and the underwriter defendants formally objected to the settlement. The plaintiffs and issuer defendants separately filed replies to the underwriter defendants’ objections to the settlement on August 4, 2004. There can be no assurance that this proposed settlement would be approved and implemented in its current form, or at all. Management does not anticipate that we will be required to pay any amounts under this settlement.

     In February 2003, we 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, we paid certain cash 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 us in the Superior Court of California in San Francisco County 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. We answered the complaint in September 2003 denying all allegations and asserting counterclaims. In March 2004, the court granted our motion to transfer the case to the United States District Court for the Western District of Washington. We intend to defend vigorously this action and to pursue vigorously our counterclaims. We do not consider the likelihood of loss is to be probable and the amount of loss, if any, is not estimable at this time

     In April 2003, the landlord of our former facility at 414 Olive Way, Seattle, Washington filed suit against us in the Superior Court of Washington, King County, for breach of our lease and seeking damages of $2.0 million. In January 2004, the court entered a judgment in favor of the landlord for rents due through January 2004 of $438,000, which we had accrued in a prior period and paid in the first quarter 2004. The Court reserved the other issues in the suit, including mitigation, interest and attorney’s fees, for trial. The Company appealed the judgment which is now in the process of being vacated by stipulation. As part of the stipulation, the trial date has been extended to Spring 2005. Management believes that meritorious defenses to some portions of the claims made in the suit exist. We continue to vigorously defend this suit while exploring opportunities to reach a settlement with the plaintiff. As of December 31, 2003 and June 30, 2004, we have recorded in accrued special charges an estimate of the additional amounts we may ultimately be required to pay with respect to this matter.

     We are involved from time to time in various other claims and lawsuits incidental to the ordinary course of our operations, including 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.

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Factors That May Affect Our Business, Future Operating Results and Financial Condition

     Risks of Our Business

     We have a history of losses on a quarterly and annual basis and we may experience greater losses from operations than we currently anticipate.

     As of June 30, 2004, we had an accumulated deficit of $198.3 million. We have incurred net losses from inception, and we expect to continue to incur net losses in future periods. If our revenues grow slower than anticipated, we may not achieve a pro forma net profit by the middle of 2005 as previously forecasted and we may continue to suffer substantial losses. 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. Even if we ultimately do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

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

     Our quarterly and annual operating results have fluctuated in the past and we expect our revenues and operating results may vary significantly from quarter to quarter and year to year 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

     •      Competition from other companies entering our markets.

     Our limited operating history, unproven business model and significant acquisitions and dispositions of businesses 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 have restructured our business and if we are unsuccessful in executing on our revised business strategy, our business, results of operations and financial condition could be seriously harmed.

     We have recently shifted our business plan to offering full-service business-to-business digital media solutions, referred to as Tier 3 services, which we have only recently begun to deliver. You should consider our prospects in executing on our revised business strategy 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 not be successful in:

     •      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;

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     •      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.

     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. 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. Our inability to execute on our strategy could result in increased expenses and decreased revenues, either or both of which could seriously harm our business, results of operations and financial condition.

     We may have to pay up to £19.6 million in additional consideration in connection with our acquisition of OD2, which can be paid with shares of our common stock only with approval of our stockholders. The number of shares we would issue in lieu of cash will vary based on the market value of our stock.

     We have agreed to pay to the former shareholders of OD2 an additional £9.6 million (approximately $17.5 million based on exchange rates as of June 22, 2004) in deferred payments, and up to £10.0 million (approximately $18.3 million based on exchange rates as of June 22, 2004) in contingent payments. All future payments described above are payable in cash or, at our election, in shares of our common stock, the number of which will be determined based on our volume weighted average share price for a specified period prior to issuance. In accordance with the rules of the Nasdaq Stock Market, approval of our stockholders (excluding shares issued in connection with the OD2 transaction) will be required prior to any election by us to satisfy these payments in shares. If our stockholders do not approve such issuances, we will be required to satisfy such amounts in cash, which would likely cause a significant strain on our cash resources, we may need to obtain additional equity or debt financing and we may have difficulty pursuing our business objectives.

     In addition, the number of shares we must issue should we elect to pay these amounts in shares will vary based upon the volume weighted average share price for a specified period prior to issuance. Because the pricing formula averages historical prices of our stock over periods of from one to six months, the formula could result in an effective value for the shares that differs from the market value at the time of issuance. In the event of a decline in our stock price, or in the event the pricing formula results in a price substantially below market price at the time of payment, our board of directors may decide to pay certain amounts in cash rather than subject our stockholders to the dilution of lower-valued stock payments. Such a decision could also cause a significant strain on our cash resources, and we may have difficulty pursuing our business objectives.

     We are subject to exchange rate risk in connection with up to £19.6 million in deferred and contingent payments payable to former OD2 shareholder, and in connection with our international operations.

     We are obligated to pay an additional £9.6 million (approximately $17.5 million based on exchange rates as of June 22, 2004) through November 30, 2005, to OD2’s shareholders, plus additional contingent consideration of up to £10.0 million (approximately $18.3 million based on exchange rates as of June 22, 2004) if OD2 achieves certain financial performance targets during the period through November 30, 2006. The payments are to be made in British pounds, and accordingly, we are exposed to risks with changes in the prevailing exchange rate. We may hedge this risk. If we do not hedge against exchange rate risk, any decrease in the value of the U.S. dollar against the British pound will cause a proportional increase in the amount of the future consideration we must pay to the former OD2 shareholders. To the extent we are required to or elect to pay these amounts in cash, the obligations could put significant strains on our cash resources. To the extent we elect to pay these amounts in shares, we could be forced to issue additional shares due to a decline in the U.S. dollar, which would cause further dilution to our stockholders.

     In addition, the results of operations of OD2 are exposed to foreign exchange rate fluctuations as the financial results of this subsidiary are translated from the local currency to U.S. dollars upon consolidation. Because of the significance of the operations of OD2 to our consolidated operations, as exchange rates vary, net sales and other operating results, when translated, may differ

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materially from our prior performance and our expectations. In addition, because of the significance of our overseas operations, we could also be significantly affected by weak economic conditions in foreign markets that could reduce demand for our products and further negatively impact the results of our operations in a material and adverse manner. As a result of these market risks, the price of our stock could decline significantly and rapidly.

     We may engage in hedging activities. As foreign currency exchange rates vary, the fluctuations in revenues and expenses may materially impact the financial statements upon consolidation. A weaker US dollar would result in an increase to revenues and expenses upon consolidation, and a stronger US dollar would result in a decrease to revenues and expenses upon consolidation.

     We must integrate our recent acquisitions of On Demand Distribution Limited And Overpeer, Inc. and we may need to make additional future acquisitions to remain competitive. The process of identifying, acquiring and integrating these and future acquisitions may have a material 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. and in June 2004 we completed the acquisition of On Demand Distribution Limited (OD2).

     Integrating the Overpeer and OD2 acquisitions and completing any potential future acquisitions could cause significant diversions of management time and resources. Our business, financial condition and results of operations could be materially adversely affected if we are unable to integrate the operations of the acquired companies or joint ventures. Our ability to integrate the operations of the acquired companies will depend, in part, on our ability to overcome or address:

     •      The difficulties of assimilating the operations and personnel of the acquired companies and the potential disruption of our ongoing business;

     •      Operational difficulties, including the need to attract and retain qualified personnel and the need to attract customers and advertisers;

     •      The difficulties of maintaining uniform standards, controls, procedures and policies;

     •      The need to incorporate successfully the acquired or shared technology or content and rights into our products and services; and

     •      The potential impairment of relationships with employees and customers as a result of any integration of new management personnel or reduction of personnel.

     In addition, completing acquisitions could require use of a significant amount of our available cash. Furthermore, 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 materially adversely affected.

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     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.

     As of June 30, 2004, we had approximately $32.5 million in cash and cash equivalents, marketable securities, and restricted investments. 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. 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.

     Our success is dependent on the performance and retention of our executive officers and key employees. In particular, we must recruit and retain personnel in our accounting function.

     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. In addition, we must recruit for positions in our accounting function in light of recent significant turnover in that department. 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.

     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.

     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.

     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.

     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;

     •      Ability to introduce new services to the market in a timely manner;

     •      Customer service and support;

     •      Attracting third-party web developers; and

     •      Pricing.

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