ROXIO INC - 10-Q Quarterly Report

June 30,
2004

March 31,
2004

Navarre Corporation

Gem Distribution

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

As of August 1, 2004, there were 34,670,913 shares of the Registrant’s Common Stock outstanding, par value $0.001.

In addition to historical information, this Quarterly Report on Form 10-Q (“Quarterly Report”) 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. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words. All statements in this Quarterly Report regarding our future strategy, future operations, projected financial position, estimated future revenues, projected costs, future prospects, and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements. You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this Quarterly Report was filed with the Securities and Exchange Commission (“SEC”). We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such difference might be significant and materially adverse to our stockholders. Many important factors that could cause such a difference are described in this Quarterly Report under the caption “Risk Factors” which you should review carefully. Please consider our forward-looking statements in light of those risks as you read this Quarterly Report.

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

The unaudited condensed consolidated financial statements have been prepared by Roxio, Inc., a Delaware company (“Roxio”), pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, Roxio believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes included in Roxio’s annual report on Form 10-K for the year ended March 31, 2004.

The condensed consolidated financial statements reflect all adjustments, which include only normal, recurring adjustments, that are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full year.

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

Certain reclassifications have been made to prior year balances in order to conform to the current period presentation, namely the separate presentation of online music revenues and restructuring charges on the statements of operations, the reclassification of certain amortization expenses to cost of revenues, and the reclassification of certain accrued professional fees from accounts payable to accrued liabilities on the balance sheets. These reclassifications do not have an effect on Roxio’s consolidated financial condition, results of operation or cash flows.

At June 30, 2004, Roxio has $735,000 of restricted cash. The restricted cash serves as collateral for irrevocable standby letter of credit that provides financial assurance that Roxio will fulfill its obligation to one of its lessors. The cash is held in custody by the issuing bank and is restricted as to withdrawal or use. Unless renewed, the restriction will lapse within twelve months.

Roxio accounts for stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and complies with the disclosure provisions of Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and with the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, Amendment of SFAS No. 123.” Under APB No. 25, compensation expense is recognized based on the difference, if any, on the measurement date between the fair value of Roxio’s common stock and the amount an employee must pay to acquire the common stock. The compensation expense is recognized over the periods the employee performs the related services, generally the vesting period of four years.

Roxio accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires that such equity instruments are recorded at their fair value on the measurement date, which is typically the date of grant. No non-employee compensation expense has been recognized in Roxio’s Condensed Consolidated Statement of Operations.

The following table illustrates the effect on net loss and earnings per share if Roxio had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share amounts):

Roxio uses the straight-line method to amortize its SFAS No. 123 pro forma stock –based compensation expense over the vesting period, which is generally four years, of stock options, and over the applicable purchase period, which ranges from six months to two years, for employee stock purchase plan (“ESPP”) purchase rights.

Pro forma information regarding net loss and net loss per share is required by SFAS No. 123. This information is required to be determined as if Roxio had accounted for its employee stock options and ESPP under the fair value method of SFAS No. 123, as amended by SFAS No. 148.

The fair value of stock option and ESPP stock purchase rights was estimated on the date of grant using the Black-Scholes model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. Roxio uses historical volatility rates for this calculation. Because Roxio’s employee stock options and ESPP purchase rights have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing option-pricing models do not necessarily provide a reliable single measure of the fair value of our options and purchase rights. Under the Black-Scholes option-pricing model, the weighted average fair value of stock options at date of grant was $3.17 and $4.18 per share for options granted during the three months ended June 30, 2004 and 2003, respectively. The weighted average fair value of purchase rights under ESPP was $2.85 and $3.09 per share during the three months ended June 30, 2004 and 2003, respectively.

The following table sets forth the weighted-average assumptions used to calculate the fair value of the stock options and ESPP stock purchase rights:

In May 2003, Roxio acquired substantially all of the ownership of Napster, LLC, provider of an online music service formerly known as Pressplay. Napster, LLC was not affiliated with Napster, Inc. Pressplay served as the foundation for Roxio’s online music service which was launched on October 29, 2003 under the Napster brand. Pressplay’s results of operations were included in Roxio’s financial statements from the date of acquisition. In consideration of the acquisition, Roxio paid $12.5 million in cash, issued 3.9 million shares of Roxio’s common stock valued at $23.5 million and obligated itself to pay up to $12.4 million in contingent payments based on Roxio’s future cash flows from the Napster business. The common stock issued was valued in accordance with the provisions of Emerging Issues Task Force (“EITF”) No. 99-12, “Determination of the Measurement Date for the Market Price of Acquiror Securities Issued in a Purchase Business Combination” using the average of the market values of Roxio’s common stock for five days prior to the date of the consummation of the acquisition. Roxio incurred approximately $1.8 million in professional fees, including legal, valuation and accounting fees related to the acquisition, which were included as part of the purchase price of the transaction.

Roxio accounted for the acquisition of Napster, LLC using the purchase method of accounting. The results of operations and the estimated assets acquired and liabilities assumed have been included in Roxio’s financial statements from the date of acquisition. The allocation of the purchase price to the tangible and identifiable intangible assets acquired is summarized below. Management determined the allocation and estimate of fair value with the assistance of a third party independent appraiser.

The identifiable intangible asset was amortized on a straight line basis over its estimated useful life of one year. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is not amortized but is tested annually for impairment.

The following unaudited pro forma results of operations are calculated as if Pressplay had been acquired at the beginning of the period presented (in thousands, except per share amounts):

In April 2003, Roxio sold its GoBack product line and related tangible and intangible assets to Symantec. Cash consideration of $10.2 million was received at the date of the sale with a further $2.8 million held in escrow. This escrow was subject to claims for certain potential contingencies and was paid to Roxio after the one-year anniversary date of the close of the transaction. A total of $1.1 million of the escrow amount was recognized as consideration at the time of the transaction. The remainder was recognized in April 2004, the one-year anniversary date of the close of the transaction after satisfaction of the conditions specified in the purchase agreement. Roxio recorded a total gain of $12.3 million from the sale of the GoBack product line, including $1.7 million recognized in the quarter ended June 30, 2004.

At June 30, 2004 and March 31, 2004, the estimated fair value of Roxio’s short-term investments approximated their carrying value. There were $351,000 and $276,000 of net unrealized losses at June 30, 2004 and March 31, 2004, respectively. Approximately $30.1 million and $27.2 of the short-term investments mature in less than one year as of June 30, 2004 and March 31, 2004, respectively. The remaining short-term investments generally have effective maturity dates between one and two years.

Prepaid marketing expense consists of amounts paid to strategic marketing partners for future marketing services. $5.0 million of the balance at June 30, 2004 relates to stock issued to Best Buy Enterprise Services, Inc. during June 2004 as described in Note 11. The recoverability of this balance is subject to regular review by management.

Content advances are advances paid to third-party content providers as part of an agreement to make digital content available to Roxio. These advances are being expensed as content fees become due in accordance with the terms of the related agreements, generally based on usage. Advances that are not expected to be recovered by the end of their contractual terms are expensed if they are not refundable. The recoverability of these balances is subject to regular review by management.

In August 2002, Roxio made a strategic investment of $3.0 million in YesVideo, a company specializing primarily in video-to-DVD conversion services. Roxio owns approximately 11% of YesVideo, does not have significant influence over YesVideo’s operating and financial policies, and is not represented at YesVideo’s board of directors. As a result, the investment is accounted for using the cost method of accounting.

The gross carrying amounts and accumulated amortization of identifiable intangible assets are as follows for the periods presented (in thousands):

Identifiable intangible assets are generally amortized over three years. Amortization of identifiable intangible assets was $1.3 million and $1.2 million for the quarters ended June 30, 2004 and 2003, respectively.

The estimated remaining amortization expense for identifiable intangible assets is as follows (in thousands):

In accordance with SFAS 142, “Goodwill and Other Intangible Assets,” Roxio annually evaluates the carrying value of goodwill and adjusts the carrying value if the asset’s value has been impaired. In addition, Roxio periodically evaluates if there are any events or circumstances that would require an impairment assessment of the carrying value of the goodwill between each annual impairment assessment. Roxio completed its most recent annual goodwill impairment review as of March 31, 2004 and concluded that goodwill was not impaired. Since March 31, 2004 there have been no events or circumstances that would require an updated impairment assessment.

The following table summarizes Roxio’s total restructuring accrual as of March 31, 2004 and the activity during the quarter ended June 30, 2004 (in thousands):

The $294,000 reclassification of costs in the table above relates to future lease payments for facilities assigned to Roxio when it acquired MGI Software in January 2002. These costs were included in other costs at March 31, 2004.

Roxio has an agreement with a bank to provide a $17.0 million revolving line of credit, collateralized by substantially all of its assets. The line of credit bears interest at a variable rate of prime plus 0.50% per annum and expires in March 2006. The line of credit contains a material adverse conditions clause and certain covenants that require Roxio to maintain certain financial ratios. The covenants require at the end of each month and throughout the term of the agreement (i) a minimum tangible net worth of $10.0 million, (ii) a ratio of unrestricted cash, cash equivalents and short-term investments, plus 50% of net accounts receivable, less sales returns reserves, to total borrowings under the line of credit of not less than 2.00 to 1.00. At June 30, 2004, Roxio was in compliance with all covenants and had drawn down $15.0 million under the line of credit.

Roxio recognizes revenues in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition in Financial Statements,” American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 97-2 (“SOP 97-2”), “Software Revenue Recognition” and Emerging Issues Task Force (“EITF”) 01-09, “Accounting for Consideration Given by a Vendor to a Customer” including subsequent interpretations.

Online music revenue is comprised of revenues from online subscriptions, individual music downloads, delivery of associated hardware and licenses of merchandising rights. Subscription and download fees are paid by customers in advance either via credit card or redemption of pre-paid cards, gift certificates or promotional codes.

Online music subscription revenue is recognized as the subscribed services are made available to the end user. Revenues from sales of individual songs or albums by download are recognized at the time the music is delivered, digitally, to the end user. Revenues from shipments of hardware are recognized when the hardware is shipped to the customer, provided that all revenue recognition criteria are met. Revenues from licensees of Napster merchandising rights are recognized upon receipt of royalty reports from the licensee.

Revenues from pre-paid cards, gift certificates or promotional codes are deferred and recognized upon delivery of products or services obtained through redemption of the cards, gift certificates or promotions. Credit card fees are recognized as a cost of revenues in the period that the associated billing is earned.

On arrangements with multiple deliverables, revenue is recognized upon the delivery of the separate elements provided the elements can be divided into separate units in accordance with EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” Consideration from multiple element arrangements is allocated among the separate units based on their relative fair values, provided the elements have value on a stand alone basis, there is objective and reliable evidence of fair value, the arrangement does not include a general right of return relative to the delivered item and delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the vendor. In the event that there is no objective and reliable evidence of fair value for the delivered elements, the revenue recognized upon delivery is the total arrangement consideration less the fair value of the undelivered items. The maximum revenue recognized on a delivered element is limited to the amount that is not contingent upon the delivery of additional items.

cost Roxio would incur to procure the same goods or services from a non-customer third party. To the extent the goods or services cannot be separated, the total consideration is recorded as a reduction of revenues. Consideration paid to customers under these arrangements that exceed the separately identifiable value of the goods or services provided would be reflected as a reduction of the customer’s revenue.

Direct costs of online music content delivered to customers through subscriptions or downloads are expensed to cost of revenues as incurred.

Roxio sells its consumer software products through original equipment manufacturers (“OEMs”) and retail channels via distributors and direct to end users.

For software product sales to OEMs, revenues are recognized based on reported product shipments from OEMs to their customers provided that all fees are fixed or determinable, evidence of an arrangement exists and collectibility is probable. For arrangements in which all elements are not delivered at the point of reported product shipment, revenues associated with the undelivered element are deferred and amortized over the fulfillment period.

For software product sales to distributors, revenues are recognized upon product shipment to the distributors or receipt of the products by the distributor, depending on the shipping terms, provided that all fees are fixed or determinable, evidence of an arrangement exists and collectibility is probable. Roxio’s distributor arrangements provide distributors with certain product rotation rights. Additionally, Roxio permits its distributors to return products in certain circumstances, generally during periods of product transition. Roxio utilizes mail-in rebates (“MIRs”) as a marketing tool to promote its products and acquire new end users. Estimated redemption of MIRs is recorded as a direct reduction to revenues and is accrued at the date the related revenues are recognized. Estimates are based upon historical redemption rates and current market factors.

For direct software product sales to end users, revenues are recognized upon shipment by Roxio to the end users provided all appropriate revenue recognition criteria have been met. End users additionally have the right to return their product within 30 days of the purchase. Roxio establishes allowances for expected product returns in accordance with SFAS No. 48, “Revenue Recognition When Right of Return Exists” and SAB 104. These allowances are recorded as a direct reduction of revenues and as an accrued liability.

Revenues from licenses of technology are recognized in accordance with SAB 104 upon delivery of the licensees, provided that all fees are fixed or determinable, evidence of an arrangement exists and collectability is probable.

Costs related to post-contract customer support (“PCS”) are accrued at the date the related revenues are recognized. PCS obligations relate to telephone support, and minor bug fixes and updates are downloadable from our website. As no separate charge is made for the PCS and the PCS is available for a period of less than one year, Roxio does not ascribe any value to the PCS or defer any portion of revenues for it. If PCS services become a more significant portion of Roxio’s costs or Roxio makes it available for more than one year, Roxio may be required to assign a portion of its revenues to PCS and recognizes those revenues over the period of the PCS services.

SFAS No. 130, “Reporting Comprehensive Income,” requires the disclosure of comprehensive income to reflect changes in equity that result from transactions and economic events from non-owner sources. Other comprehensive income for the periods presented represents foreign currency translation items associated with Roxio’s operations in the Europe, Japan and Canada. No tax effect has been provided on the foreign currency translation items for any period shown, as the undistributed earnings of Roxio’s foreign investments will continue to be reinvested. The tax effect of the unrealized loss on marketable securities was immaterial for the quarters ended June 30, 2004 and 2003, respectively.

The components of comprehensive loss, net of tax, are as follows (in thousands):

The components of accumulated other comprehensive income, net of tax, are as follows (in thousands):

On June 17, 2004, Roxio entered into a Common Stock Purchase Agreement with Best Buy Enterprise Services, Inc. (“Best Buy”). Under the terms of a related multi-year agreement, Best Buy Stores, L.P., an affiliate of Best Buy will promote Napster as its leading digital music service through comprehensive in-store marketing activities as well as extensive broadcast, print and online advertising. Best Buy will also market a co-branded version of Napster which will be made available to customers via retail locations and online through Bestbuy.com. In connection with the transaction, Best Buy will receive Roxio stock with a value of up to $10 million over the term of the agreement and Napster will engage with Best Buy in jointly funded marketing activities. On June 17, 2004, Roxio issued approximately 1.1 million shares of common stock valued at $5.0 million to Best Buy at a cash purchase price of $0.01 per share. The difference between the fair value of the shares and the cash purchased price was recorded as prepaid marketing expenses upon issuance of the shares in June 2004.

Changes in the common stock and additional paid-in-capital are as follows (in thousands):

Adjustment to additional paid-in-capital was a result of adjustment of stock issuance costs related to the common stock issuances during fiscal 2004.

Effective with its acquisition of Napster, LLC, formerly known as Pressplay, on May 19, 2003, Roxio operates its business in two reportable segments or divisions: the consumer software division and the online music distribution division. Prior to this acquisition, Roxio did not have an online music distribution business.

The determination that Roxio operates in two reportable segments was primarily based on how the chief operating decision maker (“CODM”) views and evaluates Roxio’s operations. Roxio’s Chief Executive Officer has been identified as the CODM as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Roxio organizes its divisions, which equate to reportable segments, by evaluating criteria such as economic characteristics, the nature of products and services, the nature of the production process, and the type of customers.

Roxio’s online music distribution division provides an online music subscription service that allows consumers to stream, download and burn a wide variety of digital music.

Roxio’s consumer software division designs, develops and markets application software products which allow customers to create, manage and move their rich digital media.

Roxio’s CODM evaluates the performance of these divisions based on net revenues and operating income (loss) before income taxes, interest income, interest expenses, gain on divestitures, and other income, excluding the effects of nonrecurring charges and the amortization of identifiable intangible assets related to acquisitions. Operating results also include the allocation of certain corporate expenses based on usage. There are no sales transactions between the segments. Restructuring charges, amortization of identifiable intangible assets and stock-based compensation charges are not included in management’s evaluation of performance by the operating divisions as they are primarily organizational in nature.

The following table presents financial information for the two reportable segments (in thousands):

The following table presents net revenues by country based on the location of customers (in thousands):

The following table presents long-lived assets, excluding goodwill and identifiable intangible assets, by country based on the location of the assets (in thousands):

The following individual customers accounted for a significant portion of our net revenues:

The following individual customers accounted for a significant portion of our net accounts receivable:

Roxio and MGI Software Corp. (“MGI Software”) have been notified by a number of companies that certain of their respective software products may infringe patents owned by those companies. Roxio is investigating the nature of these claims and the extent to which royalties may be owed by it and by MGI Software to these entities. In addition, Roxio and MGI Software have been notified by a number of their respective original equipment manufacturers (“OEMs”) customers that the OEMs have been approached by certain of these companies regarding possible patent infringement related to certain Roxio and MGI Software software products that they bundle with their respective computer products. Roxio estimates that at the low end of the range, there may not be any additional payments required to settle the pending MGI Software related-claims. The upper end of the range cannot be reasonably estimated at this time. Roxio accrued $2.4 million for possible litigation settlements as part of the purchase price allocation of MGI Software. Because no amount in the range is more likely than any other to be the actual amount of any settlement, and because there have been no specific triggering events related to these possible claims, Roxio has not adjusted the original provision. The amount, if any, necessary to settle patent claims related to Roxio’s products cannot be determined at this time.

Roxio and Pressplay have been notified by a number of companies that the Pressplay and Napster online music distribution services may infringe patents owned by those companies. Roxio is investigating the nature of these claims and the extent to which royalties may be owed by it and by Napster, LLC to these entities. The amount of money, if any, necessary to settle these claims cannot be determined at this time.

On April 23, 2002, Electronics for Imaging and Massachusetts Institute of Technology filed action against 214 companies in the Eastern District of Texas, Case No. 501 CV 344, alleging patent infringement. Roxio and MGI Software are named as defendants in that action, along with some of their customers. The patent at issue in the case has expired, and Roxio intends to continue to defend the action. Because the case is at an early stage, the outcome cannot be predicted with any certainty.

On December 12, 2003, Optima Technology Corporation filed a lawsuit against us in U.S. District Court for the Central District of California, Case No. 03-1776-JVS-ANx alleging infringement of certain of their patents by our Easy CD Creator line of products. Optima is seeking unspecified damages and injunctive relief. We believe the claims are without merit and intend to defend ourselves vigorously. On February 20, 2004, we filed a countersuit against Optima Technology Corporation alleging infringement of certain of our patents by their CD-R Access Pro product. We are seeking unspecified damages and injunctive relief. Because the case is at an early stage, the outcome cannot be predicted with any certainty.

Roxio is a party to other litigation matters and claims that are normal in the course of its operations, and, while the results of such litigation and claims cannot be predicted with certainty, Roxio believes that the final outcome of such matters will not have a material adverse impact on its business, financial position, cash flows or results of operations.

On March 31, 2004, the Financial Accounting Standard Board (“FASB”) issued a proposed Statement, “Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95,” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based compensation transactions using Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally would require that such transactions be accounted for using a fair-value-based method and recognized as expenses in our consolidated statement of income. The proposed standard would require that the modified prospective method be used, which requires that the fair value of new awards granted from the beginning of the year of adoption, plus unvested awards at the date of adoption, be expensed over the vesting period. In addition, the proposed statement encourages companies to use the “binomial” approach to value stock options, which differs from the Black-Scholes option pricing model that we currently use. The recommended effective date of the proposed standard for public companies is for fiscal years beginning after

December 15, 2004. Roxio has not completed its assessment of the impact of the proposed standard on its financial condition, results of operations or cash flow.

On August 9, 2004 Roxio signed a definitive agreement to sell substantially all the assets and liabilities of its Consumer Software Division, including all the assets and liabilities of certain international subsidiaries, to Sonic Solutions (“Sonic”). Sonic has agreed to pay a total of $70 million in cash and $10 million in stock consideration, and to assume certain working capital liabilities and long term leases. The disposition will be accounted for as a discontinued operation in accordance with FASB 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

The following discussion should be read in conjunction with the financial statements and notes thereto included elsewhere in this quarterly report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed below, in “Risk Factors” and elsewhere in this quarterly report.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:

Roxio is a leading provider of digital media software and services for the consumer market. We have pioneered the development of consumer software products and services that allow our customers to create, acquire, manage and move rich digital media. Through our Napster service, users can legally stream, download and copy, or “burn” a wide variety of digital music. The software division provides software that enables individuals to record digital content onto CDs and DVDs and we offer photo and video editing products. Taken together, these products enable customers to access, archive, create, customize and share digital materials in formats compatible with the growing number of digital entertainment devices such as personal computers (PCs), CD and DVD players, and compressed audio players.

Effective with our acquisition of Napster, LLC (f/k/a Pressplay) on May 19, 2003, we operate our business in two segments or divisions, the consumer software division and the online music distribution division. To date, we have derived the majority of our revenues from sales of consumer software products.

We derive consumer software revenues primarily through distributors and direct sales to end users through our Website and toll-free number. Distributors resell our products to retailers of computer software products. We also sell our software products to OEMs such as PC manufacturers and CD- and DVD-recordable drive manufacturers and integrators. Generally, OEMs bundle a standard (not fully featured) version of our software together with their products pursuant to licensing agreements with us.

Historically our revenues originated primarily through OEM’s, however the OEM distribution channels have become increasingly competitive over time, resulting in increasing price pressure and lower revenue. To maintain growth, we have broadened our distribution through retail channels and direct sales through our Roxio web store.

Our consumer software products have earned numerous product recognition awards due to our innovative technology and feature sets, which give us a competitive advantage. We intend to continue to invest in product development to improve our technology, expand the breadth of our product offering and maintain compatibility with technology standards. In the future, if technology standards or the digital entertainment devices with which we are compatible change, our revenues could be adversely impacted.

We expect that the consumer software space will remain competitive, but that revenues will grow incrementally as we launch new products. In the future, if we lose access to our various OEM and retail distribution channels, our revenues could be adversely impacted. Additionally, if our competitors develop more advanced technology, we could lose our competitive advantage.

The consumer software business is seasonal with lows in the summer and highs in the fall and winter due to the holidays and consumer winter spending. Management expects that revenues in the quarter ending September 30, 2004 will be lower than the prior three quarters due to this seasonality.

Our online music division derives its primary revenues from online subscriptions and individual music downloads, via our Napster service. This service offers subscribers on-demand access to a wide variety of music that can be streamed or downloaded as well as the ability to purchase individual tracks or albums on an a-la-carte basis. Subscription and download fees are paid by customers in advance either via credit card or redemption of pre-paid cards, gift certificates or partner promotional codes. This division also periodically licenses merchandising rights and resells hardware that our end users may utilize to store and replay their digital music content.

The online music division was launched under the Napster brand in the United States in October 2003. Prior to this launch we had online music revenue from the acquisition of a business, Napster, LLC, formerly known as Pressplay. During May 2004 the online music division expanded its service to be available in both the United Kingdom and Canada.

We sell our online music services directly to end users through our Napster.com website, but also leverage retail distribution channels to promote and bundle the Napster services with other products they sell. If we lost access to our retail distribution partners, our revenues could be adversely impacted.

The market for online music is rapidly growing and we expect our online music business to continue to grow as the industry expands. This market is highly competitive and we expect competition to continue to increase in the future as the market expands. However, we believe that our unique technology positions us ahead of many of our competitors. We plan to drive increased demand and stay ahead of our competition by adding additional features and functionality to expand the portability of our Napster service and to improve our customers online music experience in the future.

Our overall strategy for both divisions is to expand our offerings for both products and services to allow for even easier management of and access to rich digital entertainment and personal media, including music, photos and video, and to continue global expansion.

During fiscal year 2004, we undertook a number of restructurings, particularly workforce reductions and real estate consolidations, to react to market conditions, reducing expenses through strong cost cutting measures and consolidating operations. These activities included the sale of our GoBack product line to Symantec in a transaction accounted for as a sale of assets. As a result of these restructurings, we have significantly reduced costs, and the consumer software division is now profitable and cash flow positive. The online music division continues to operate at a loss and net cash burn due to our significant investments to expand the service capabilities and ensure world-wide growth.

In May 2003, Roxio acquired substantially all of the ownership of Napster, LLC (formerly known as Pressplay), a provider of an online music service. Napster, LLC was not affiliated with Napster, Inc. Pressplay

served as the foundation for Roxio’s online music service which was launched on October 29, 2003 under the Napster brand. In consideration of the acquisition, Roxio exchanged $12.5 million in cash, issued 3.9 million shares of Roxio’s common stock valued at $23.5 million and obligated itself to pay up to $12.4 million in contingent payments based on Roxio’s future cash flows from the Napster business. Roxio incurred approximately $1.8 million in professional fees, including legal, valuation and accounting fees related to the acquisition, which were included as part of the purchase price of the transaction. This acquisition was accounted for as a purchase and Napster, LLC’s (f/k/a Pressplay) results of operations are included in our financial statements from the date of acquisition. Prior to the launch of the Napster branded online music services in October 2003, online music revenues were minimal.

In April 2003, Roxio sold its GoBack product line and related tangible and intangible assets to Symantec. Cash consideration of $10.2 million was due at the date of the sale with a further $2.8 million held in escrow. This escrow was subject to claims for certain potential contingencies and was paid to Roxio after the one-year anniversary date of the close of the transaction. A total of $1.1 million of the escrow amount was recognized as consideration at the time of the transaction. The remainder was recognized in April 2004, the one-year anniversary date of the close of the transaction after satisfaction of the conditions specified in the purchase agreement. Roxio recorded a total gain of $12.3 million from the sale of the GoBack product line, including $1.7 million recognized in the quarter ended June 30, 2004.

On June 17, 2004, Roxio entered into a Common Stock Purchase Agreement with Best Buy Enterprise Services, Inc. (“Best Buy”). Under the terms of a related multi-year agreement, Best Buy’s affiliates, Best Buy Stores, L.P., will promote Napster as its leading digital music service through comprehensive in-store marketing activities as well as extensive broadcast, print and online advertising. Best Buy Stores, L.P. will also market a co-branded version of Napster which will be made available to customers via retail and online through Bestbuy.com. In connection with the transaction, Best Buy will receive Roxio stock with a value of up to $10 million over the term of the agreement and Napster will engage with Best Buy Shares, L.P. in jointly funded marketing activities. On June 17, 2004, Roxio issued approximately 1.1 million shares of common stock valued at $5.0 million to Best Buy at a cash purchase price of $0.01 per share. The difference between the fair value of the shares and the cash purchase price was recorded as prepaid marketing expenses upon issuance of the shares in June 2004.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to: sales returns and allowances, bad debt allowances, provisions for excess and obsolete inventory, warranty reserves, intangible assets, restructure provisions and deferred income taxes. Actual results could differ from these estimates. Certain of our critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the Financial Statements.

These critical accounting policies and the effect that changes in management’s estimates could have on our consolidated financial statements are further described below.

We recognize up front advance payments for digital content and marketing fees in Prepaids and Other Current Assets. Prepaid Content Advances are expensed as content fees and become due in accordance with the terms of the related agreements, generally based on usage. Marketing Fees are expensed as we receive separately identifiable marketing services from our strategic marketing partners. Advances that are not recovered by the end of their contractual terms may be non-refundable. The recoverability of these balances is subject to regular review by management considering expected future content fees and marketing services. The estimates of expected future benefits include judgments about growth in demand for our products, performance by our strategic partners and fair values for the related services. Changes in these estimates could require us to write down the carrying value of these advances and could materially impact our financial position and results of operations.

Roxio recognizes revenues in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition in Financial Statements,” and American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 97-2 (“SOP 97-2”), “Software Revenue Recognition” including subsequent interpretations.

On arrangements with multiple deliverables, revenue is recognized upon the delivery of the separate units in accordance with EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” Consideration from multiple element arrangements is allocated among the separate elements based on their relative fair values. In the event that there is no objective and reliable evidence of fair value, the revenue recognized upon delivery is the total arrangement consideration less the fair value of the undelivered items. The maximum revenue recognized on a delivered element is limited to the amount that is not contingent upon the delivery of additional items. Management applies significant judgment in establishing the fair value of multiple elements within revenue arrangements. Estimates of fair value represent our best estimate, but changes in circumstances relating to the products and services sold in these arrangements may result in one-time revenue charges as future elements of the arrangements are delivered.

Roxio has arrangements with certain customers whereby the customer provides goods or services to Roxio. Our revenue and the charges for the goods or services provided by a customer are accounted for in accordance with EITF 01-09. The costs of separately identifiable goods or services received by Roxio from a customer are valued at the cost Roxio would incur to procure the same goods or services from a non-customer third party. To the extent the goods or services cannot be separated, the total consideration is recorded as a reduction of revenues. Consideration paid to customers under these arrangements that exceed the separately identifiable value of the goods or services provided would be reflected as a reduction of the customer’s revenue. Management exercises significant judgment in determining the fair value of separately identified goods or services. Estimates of fair value represent our best estimate, but changes in circumstances relating to the products and services sold in these arrangements may result in one-time expense or revenue charges.

For software product sales to distributors, revenues are recognized upon product shipment to the distributors or receipt of the products by the distributor, depending on the shipping terms, provided that all fees are fixed or determinable, evidence of an arrangement exists and collectibility is probable. Roxio’s distributor arrangements provide distributors with certain product rotation rights. Additionally, Roxio permits its distributors to return products in certain circumstances, generally during periods of product transition. End users additionally have the right to return their product within 30 days of the purchase. Roxio establishes allowances for expected product returns in accordance with SFAS No. 48, “Revenue Recognition When Right of Return Exists” and SAB 104. These allowances are recorded as a direct reduction of revenues and as an accrued liability.

For direct software product sales to end users, revenues are recognized upon shipment by Roxio to the end users provided all appropriate revenue recognition criteria have been met. Roxio utilizes mail-in rebates (“MIRs”) as a marketing tool to promote its products and acquire new end users. Estimated redemption of MIRs is recorded as a direct reduction to revenues and is accrued at the date the related revenues are recognized. Estimates are based upon historical redemption rates and current market factors.

Management applies significant judgment and relies on historical experience in establishing these allowances. If future return or “MIR” patterns differ from past patterns, due to reduced demand for our product or other factors beyond our control, we may be required to increase these allowances in the future and may be required to reduce future revenues. If at any point in the future we become unable to estimate returns reliably, we could be required to defer recognizing revenues until the distributor notifies us that the product has been sold to an end user.

Costs related to post-contract customer support (“PCS”) are accrued at the date the related revenues are recognized. PCS obligations relate to telephone support, and minor bug fixes and updates that are downloadable from our website. As no separate charge is made for the PCS and the PCS is available for a period of less than one year, Roxio does not ascribe any value to the PCS or defer any portion of revenues for it. If PCS services become a more significant portion of Roxio’s costs or Roxio makes it available for more than one year, Roxio may be required to assign a portion of its revenues to PCS and recognize those revenues over the period of the PCS services.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review the adequacy of our accounts receivable allowance after considering the size of the accounts receivable balance, each customer’s expected ability to pay and our collection history with each customer. We review significant invoices that are past due to determine if an allowance is appropriate based on the risk category using the factors described above. Generally, our customer payment terms do not exceed 45 days. In addition, our allowance is calculated by applying to all unpaid invoices a percentage based on the age category and an analysis of our historical experience of bad debts. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable, including changes in general economic conditions, may result in a requirement for additional allowances in the future.

Our long-lived assets consist primarily of goodwill and identifiable intangible assets, property and equipment, an investment in a private company and advances of content fees for our online music business. We review long-lived assets for impairment in accordance with SFAS No. 144 “Accounting for Impairment or Disposal of Long-Lived Assets” whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Such events or circumstances include, but are not limited to, significant changes in general economic conditions, a significant decrease in the fair value of the underlying business, difficulty or delays in integrating an acquired business or a significant change in the operations of our business.

Management applies significant judgment when determining whether events or changes in circumstances indicate that a long lived asset may not be realizable and makes significant estimates while assessing the recoverability if an impairment evaluation is deemed necessary. These estimates included judgments about growth in demand for our products, sustainability of gross margins and our ability to integrate acquired companies and achieve economies of scale. Changes in these estimates could require us to write down the carrying value of our long-lived assets and could materially impact our financial position and results of operations.

We record restructure provisions in accordance with SFAS No. 146, “Accounting for Exit Costs Associated with Exit or Disposal Activities” (“SFAS 146”). In order to determine our restructuring liability, SFAS 146 requires us to make a number of assumptions. These assumptions include estimated sublease income over the remaining lease period, estimated term of subleases, estimated utility and real estate broker fees, as well as estimated discount rates for use in calculating the present value of our liability. We develop these assumptions based on our understanding of the current real estate market as well as current market interest rates. The assumptions used are our management’s best estimate at the time of the accrual, and adjustments are made on a periodic basis if better information is obtained.

Roxio’s estimates of the excess facilities charge may vary significantly depending, in part, on factors, such as our success in negotiating with our lessor, the time periods required to locate and contract suitable subleases and the market rates at the time of such subleases, which may be out of our control. Adjustments to the facilities accrual will be made if further consolidations are required or if actual lease exit costs or sublease income differ from amounts currently expected. Such adjustments could materially impact our financial position and results of operations.

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $19.1 million as of June 30, 2004, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of net operating losses and accrued liabilities and other provisions, not currently deductible for tax purposes. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations.

Our fiscal year ends on March 31. Unless otherwise stated, all years and dates refer to our fiscal year.

The financial information presented in this quarterly report is not necessarily indicative of our financial position, results of operations or cash flows in the future.

The following table sets forth, as a percentage of total revenue, certain consolidated statements of operations data for the periods indicated. These operating results are not necessarily indicative of the results for any future period.

The following table sets forth, for the periods indicated, our consumer software and online music revenues as a percentage of net revenues:

Retail revenues consist of sales to distributors and direct sales to end-users. Retail revenues increased 8% to $18.3 million for the quarter ended June 30, 2004 from $16.9 million for the comparable quarter in the prior year. This increase was primarily due to sales of products that were previously reserved. Gross revenue was flat quarter over quarter, while offsetting returns & allowances decreased $1.4 million, resulting in a net $1.4 million revenue increase. Gross revenue remained flat due to the benefit of new product releases, offset by seasonality, lower volume sales and intense price competition during the quarter ended June 30, 2004. Returns and allowances decreased because we maintained fewer inventories in the channel requiring fewer reserves for returns.

OEM revenues decreased 42% to $3.8 million for the quarter ended June 30, 2004 from $6.5 million for the comparable quarter in the prior year. The decrease was primarily due to lower per-unit royalty rates and a decrease in the number of units shipped by Dell Computer Corporation, one of our significant customers. Beginning in October 2003 Dell Computer Corporation stopped bundling our CD and DVD-recording technology with their consumer desktops, and now only bundles our CD and DVD-recording technology on their commercial desktops. Previously Dell had bundled our CD and DVD-recording technology on both their consumer and commercial desktops. Revenues from this customer declined by $3.5 million in the quarter ended June 30, 2004 compared to the same quarter in the prior year. The unit decrease from Dell was partially offset by the addition of new OEM agreements.

In the future, we anticipate that OEM software revenues will continue to decline in total, and on a per-unit basis, as a result of increased price competition, and that retail and direct revenues will grow incrementally as we launch new products.

We began to generate online music revenues with the acquisition of Napster, LLC in May 2003. Revenues increased approximately 900% to $7.9 million in the quarter ended June 30, 2004 from $781,000 in the quarter ended June 30, 2003 due to the US launch of the Napster service in October 2003 and the subsequent UK and Canadian launches in May 2004. We had no license or product revenue in the same quarter of the prior year.

We anticipate that net revenues from our online music distribution division will continue to increase in the future as a result of continued marketing activities and initiatives to drive customer growth and international expansion, and as the overall online music market expands.

The following table sets forth, for the periods indicated, our revenues per geographic area:

Revenues in geographies outside of North America comprise 26% of our total revenues and increased 5% to $7.8 million for the quarter ended June 30, 2004 from $7.4 million (or 27% of our total revenues) for the comparable quarter in the prior year. The increase in revenues outside North America was primarily due to product launches, higher OEM and Retail sales. We anticipate that in the future international revenues will not fluctuate significantly as a percentage of our total sales.

Gross margin on consumer software is the percentage of profit from net revenues after deducting cost of revenues, which includes costs related to the physical goods shipped, third party licensed intellectual property, freight, warranty, end user technical support, scrap, royalties and amortization of purchased technology. Our gross margin from OEM revenues is generally significantly higher than our gross margin from retail revenues primarily due to lower product costs and to a lesser extent due to a different level of product support effort associated with OEM sales compared to retail sales. For sales of our products through OEMs, the OEMs are responsible for the first

level of product support and we only provide a second level of support to the OEM. Our technical support costs as a percentage of our revenues have declined as a result of the consolidation of these services into our Canadian facility during fiscal 2004 as well as changes in the levels of support currently provided to end users.

Gross margin for the consumer software division increased to 76% for the quarter ended June 30, 2004 from 68% for the comparable quarter in the prior year. The eight percentage points increase was primarily a result of the positive impact of: (1) cost control measures of approximately four percentage point, (2) lower technical support costs of approximately one percentage point, (3) reduced royalties of approximately one percentage point, and (4) better inventory management of approximately two percentage points.

In the future we anticipate that margin levels may fluctuate based on seasonality and price competition.

Gross margin on online music is the percentage of profit from net revenues after deducting the cost of royalties to content providers, end user technical support, costs associated with physical goods shipped, depreciation of infrastructure assets related to the delivery of our on-line services and any other direct costs of the net revenues.

Gross margin for the online music division decreased slightly to 18% for the quarter ended June 30, 2004 from 19% for the comparable quarter in the prior year. The decrease in the margin was primarily a result of promotions during the quarter, which had lower margins than ongoing content revenues. During the quarter ended June 30, 2004 the online music division offered two hardware promotions that involved deep discounts, as well as free initial subscription periods, both of which drove down overall division gross margins. Considering only the margins on content distribution, our gross margins as a percentage of revenues were flat.

We expect online music gross margins to remain low near term as we do promotions to drive expansion. We expect gross margins to improve long term as we grow in the various geographies and as promotional efforts become a smaller percentage of our overall revenues.

We classify operating expenses as research and development, sales and marketing and general and administrative. Each category includes related expenses for salaries, employee benefits, incentive compensation, travel, telephone, communications, rent and allocated facilities and professional fees. Our sales and marketing expenses include additional expenditures specific to the marketing group, such as public relations and advertising, trade shows, and marketing collateral materials and expenditures specific to the sales group, such as commissions. In addition, we include restructuring charges, certain amortization of identifiable intangible assets and stock-based compensation charges associated with individuals in operating expense departments as operating expenses.

The following table sets forth, for the periods indicated, our operating costs (in thousands and as a percentage of net revenues):

Research and development expenses consist primarily of salary, benefits and contractors’ fees for our development and other costs associated with the enhancements of existing products and development of new products.

Research and development expenses decreased $456,000 or 7% to $6.5 million for the quarter ended June 30, 2004 from $6.9 million for the comparable quarter in the prior year. This $456,000 decrease was the result of a $2.0 million reduction in research and development for the consumer software division offset by a $1.6 million increase in research and development for the online music division, which had virtually no research and development expense in the quarter ended June 20, 2003. The $2.0 million decrease in the consumer software division was a result of cost reductions due to our fiscal 2004 restructuring efforts.

Research and development headcount decreased to 173 at June 30, 2004 from 224 at June 30, 2003. We anticipate that research and development expenses will increase in the future as we continue to invest in online music features and services.

Sales and marketing expenses consist primarily of salary, commissions and benefits for sales and marketing personnel and costs associated with advertising and promotions.

Sales and marketing expenses increased $983,000 or 10% to $10.4 million for the quarter ended June 30, 2004 from $9.4 million for the comparable quarter in the prior year. This increase was primarily due to increased marketing activities related to online music. Consumer software sales and marketing expenses decreased $2.0 million in the quarter ended June 30, 2004 compared to the same quarter of the prior year, while online music sales and marketing expenses increased $2.7 million. Overall sales and marketing headcount decreased to 72 at June 30, 2004 from 97 at June 30, 2003.

We expect sales and marketing expenses to increase in the future as a result of continued marketing activities and initiatives and planned expansion of the online music business.

General and administrative expenses consist primarily of salary and benefit costs for executive and administrative personnel, professional services and other general corporate activities.

General and administrative expenses decreased $416,000, or 8% to $4.9 million for the quarter ended June 30, 2004 from $5.3 million for the comparable quarter in the prior year. This decrease was primarily a result of cost reductions due to our restructuring efforts of $1.4 million, partially offset by a $900,000 increase in headcount and other related expenses for the online music division.

General and administrative headcount decreased to 66 at June 30, 2004 from 85 at June 30, 2003. We believe that general and administrative expenses will remain flat going forward.

During the quarter ended June 30, 2004, we signed subleases to sublet previously vacated facilities for which we had provisions at March 31, 2004. The $153,000 restructure benefit in the quarter ended June 30, 2004 includes the benefit of $316,000 as a result of signing subleases at rates more favorable than originally anticipated, offset by professional service fees of $163,000 incurred during the period related to the restructuring of the European entities.

Amortization of identifiable intangible assets, before reclassification of purchased technologies amortization to cost of revenues, was $1.3 million for the quarter ended June 30, 2004 compared to $1.2 million for the comparable quarter in the prior year. This increase was primarily due to fluctuations in foreign currency exchange rates. Amortization of identifiable intangible assets is anticipated to be $3.2 million and $1.4 million for the nine months ending March 31, 2005 and for the year ending March 31, 2006, respectively.

Stock-based compensation charges relate to the amortization of costs associated with stock options issued to employees and the commitment of Roxio stock options to Adaptec employees who became Roxio employees.

Stock based compensation charges decreased $137,000, or 26% to $382,000 for the quarter ended June 30, 2004 from $519,000 for the comparable quarter in the prior year. This decrease was primarily due to lower headcount that resulted in $193,000 lower amortization, partially offset by additional $56,000 amortization expense related to stock options granted to our chief executive officer on September 18, 2003. We believe that stock-based compensation charges will decline in future periods. A substantial portion of the deferred charges will be fully amortized in the second quarter of fiscal 2005.

In April 2003, Roxio sold its GoBack product line and related tangible and intangible assets to Symantec. Cash consideration of $10.2 million was received at the date of the sale with a further $2.8 million held in escrow. This escrow was subject to claims for certain potential contingencies and was paid to Roxio at the one-year anniversary date of the close of the transaction. A total of $1.1 million of the escrow amount was recognized as consideration at the time of the transaction. The remainder was recognized in April 2004, the one-year anniversary date of the close of the transaction after satisfaction of the conditions specified in the purchase agreement. Roxio recorded a total gain of $12.3 million from the sale of the GoBack product line, including $1.7 million recognized in the quarter ended June 30, 2004.

Other income, net, consists primarily of interest income on our cash equivalents and short-term investments, interest expense, realized gain (loss) on foreign transactions, and other miscellaneous income.

Interest income increased $69,000, or 30% to $292,000 for the quarter ended June 30, 2004 from $225,000 for the comparable quarter in the prior year. This increase was primarily due to increased short-term investments. Short-term investments balance was $43.4 million at June 30, 2004 compared to $16.7 million at June 30, 2003.

Interest expense increased $127,000, or 208% to $188,000 for the quarter ended June 30, 2004 from $61,000 for the comparable quarter in the prior year. This increase was primarily due to interest on the cash borrowings through our revolving line of credit.

In the quarter ended June 30, 2004, we realized gains on foreign transactions of $66,000, compared to realized losses of $88,000 for the comparable quarter of the prior year. This change was due to fluctuations in foreign currency exchange rates.

We have recorded a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. In the event that deferred tax assets would be realizable in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Therefore for the three months ended June 30, 2004, our tax provision consists solely of foreign income taxes. We have a mix of tax rates across the various jurisdictions in which we do business, and this estimate does not take into account any future benefit from loss carry forwards, which we may realize once we again achieve profitability and begin generating taxable income. Consolidated income tax provisions were accrued at $185,000 for the three month period ended June 30, 2004.

Roxio ended the first quarter of fiscal 2005 with $63.4 million in cash, cash equivalents, restricted cash and short-term investments, consisting principally of commercial paper, corporate bonds, U.S. government securities and money market funds, a decrease of $3.7 million as compared to fiscal 2004 year end. Our primary ongoing source of cash is receipts from revenues. This quarter we had a one time proceed from the divestiture of the GoBack software in 2004. The primary uses of cash are payroll (salaries and related benefits), general operating expenses (marketing, travel and office rent), payments for the production of our products including royalties payable to content providers, and purchases of property and equipment. Our working capital was $40.1 million at June 30, 2004.

Net cash used in operating activities was $6.0 million for the quarter ended June 30, 2004, primarily due to a net loss of $2.6 million, net non-cash related expenses of $2.9 million, a decrease in accrued liabilities of $2.5 million, and an increase in prepaid expenses and other current assets of $4.0 million. The decrease in accrued liabilities was primarily due to payments of employee severance accrued at March 31, 2004 and a decrease in sales reserve resulted from claims received in the quarter ended June 30, 2004 related to item price protection and end-of-life reserved at March 31, 2004. The increase in prepaid and other current assets is primarily due to marketing advances paid to strategic partners.

Net cash used in operating activities was $6.2 million for the quarter ended June 30, 2003, primarily due to a net loss of $370,000 (which included a gain on the sale of our GoBack product line of $10.6 million), net non-cash related expenses of $5.6 million, a decrease in accounts payable of $4.6 million and a decrease in income taxes payable of $1.1 million. The decrease in accounts payable was primarily due to decreased spending and faster payments to our customers during the first quarter of fiscal 2005. The decrease in income tax payable was primarily due to cash paid for income taxes of $1.3 million during the quarter ended June 30, 2003. These decreases were partially offset by a decrease in accounts receivable of $4.1 million and an increase in deferred revenues of $1.8 million. The decrease in accounts receivable was primarily due to our improved collections during the first quarter of fiscal 2005. In the quarter ended June 30, 2003, net cash used in operating activities was $4.6 million for the software division and $1.6 million for the online music distribution division.

Roxio expects to continue to use cash for operations as cash provided by the software division does not fully fund the investments we are making in the online music division.

Net cash used in investing activities was $11.3 million for the quarter ended June 30, 2004, primarily as a result of $33.6 million used to purchase short-term investments, slightly offset by proceeds of $2.8 million received from final installment from the sale of our GoBack product line and $18.6 million from the sales and maturities of our marketable securities.

Net cash used in investing activities was $4.5 million for the quarter ended June 30, 2003, primarily as a result of $1.1 million used to purchase capital equipment, primarily for the online music distribution division, $2.8 million used to purchase short-term investments, $13.5 million used to acquire Napster, LLC, formerly known as Pressplay.

The outflows of cash were offset by proceeds of $10.2 million received from the sale of our GoBack product line and $2.7 million from the sales and maturities of our marketable securities.

We expect investment activities to continue to provide funds as we release short term investments to pay for the investments in the online music division.

Net cash used in financing activities was $64,000 for the quarter ended June 30, 2004, primarily as a result of $174,000 of principal cash payments made on our capital lease obligations, slightly offset by $109,000 of net proceeds from the exercise of stock options and the employee stock purchase plan.

Net cash provided by financing activities was $20.5 million for the quarter ended June 30, 2003, primarily as a result of $20.6 million of net proceeds from the issuance of common stock through our first private equity financing in June 2003. The inflows of cash were partially offset by $154,000 of principal cash payments made on our capital lease obligations.

In March 2004, Roxio entered into an agreement with a U.S. bank to provide a $15.0 million revolving line of credit, collateralized by substantially all of its assets. During June 2004, Roxio amended the line of credit agreement to increase the available funding to $17.0 million. The line of credit bears interest at a variable rate of prime plus 0.5% per annum and expires in March 2006. The line of credit contains a material adverse conditions clause and certain covenants that require Roxio to maintain certain financial ratios. The covenants require at the end of each month and throughout the term of the agreement (i) a minimum tangible net worth of $10.0 million, (ii) a ratio of unrestricted cash, cash equivalents and short-term investments, plus 50% of net accounts receivable, less sales returns reserves, to total borrowings under the line of credit of not less than 2.00 to 1.00. At June 30, 2004, Roxio was in compliance with all covenants and had drawn down $15.0 million under the line of credit.

We believe that the liquidity provided by existing cash, cash equivalents, restricted cash, short-term investments, and expected cash generated from operations will provide sufficient capital to meet our requirements for at least the next 12 months. The consumer software division currently operates at a profit and generates positive cash flows. The online music division operates and will continue to operate in the near term at a loss and incurs net cash burn due to significant investments to expand the service capabilities and ensure worldwide growth.

Generally, payment terms from our customers do not exceed 45 days, while our liabilities with vendors are due from zero to 30 days following the invoice date. Payments of receivables by our customers to us are not contingent upon resale and we have not experienced payment delays due to product disputes.

We have never held derivative financial instruments. We do not currently hold any variable interest rate debt other than our revolving line of credit. Accordingly, we have not been exposed to near-term adverse changes in interest rates or other market prices. We may, however, experience such adverse changes if we incur debt or hold derivative financial instruments in the future.

On March 31, 2004, the FASB issued a proposed Statement, “Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95,” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based compensation transactions using Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally would require that such transactions be accounted for using a fair-value-based method and recognized as expenses in our consolidated statement of income. The proposed standard would require that the modified prospective method be used, which requires that the fair value of new awards granted from the beginning of the year of adoption, plus unvested awards at the date of adoption, be expensed over the vesting period. In addition, the proposed statement encourages companies to use the “binomial” approach to value stock options, which differs from the Black-Scholes option pricing model that we currently use. The recommended effective date of the proposed standard for public companies is for fiscal years beginning after December 15, 2004. We have not completed our assessment of the impact of the proposed standard on our financial condition, results of operations or cash flows.

You should carefully consider the risks described below and the other information in this annual report. Our business, financial condition or operating results could be seriously harmed if any of these risks materialize. The trading price of our common stock may also decline due to the occurrence of any of these risks.

Fluctuations in our quarterly operating results may cause our stock price to decline.

Our quarterly operating results may fluctuate from quarter to quarter. We cannot reliably predict future revenue and margin trends and such trends may cause us to adjust our operations. Other factors that could affect our quarterly operating results include:

We depend on key personnel who do not, or may not continue to work for us.

Our success substantially depends on the continued employment of certain executive officers and key employees, particularly Christopher Gorog, Nand Gangwani, Thomas Shea, Brad Duea and Laura Goldberg. The loss of the services of these or other key officers, employees or third parties could harm our business. If any of these individuals were to leave our company, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor obtains the necessary training and experience.

If we fail to manage expansion effectively, we may not be able to successfully manage our business, which could cause us to fail to meet our customer demand or to attract new customers, which would adversely affect our revenue.

Our ability to successfully offer our products and implement our business plan in a rapidly evolving market requires an effective planning and management process. We plan to continue to increase the scope of our operations domestically and internationally. In addition, we plan to continue to hire a significant number of employees this year for our online music distribution service. This anticipated growth in future operations will place a significant strain on our management resources.

In the future we plan to continue to develop and improve our financial and managerial controls, reporting systems and procedures. In addition, we plan to continue to expand, train and manage our work force worldwide.

We may need to make additional future acquisitions to remain competitive. The process of identifying, acquiring and integrating future acquisitions may constrain valuable management resources, and our failure to effectively integrate future acquisitions may result in the loss of key employees and the dilution of stockholder value and have an adverse effect on our operating results.

We have completed several acquisitions and expect to continue to pursue strategic acquisitions in the future. Completing any potential future acquisitions could cause significant diversions of management time and resources. Financing for future acquisitions may not be available on favorable terms, or 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 have not entered into any agreements or understanding regarding any future acquisitions and 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 annual testing for impairment. 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 significantly diluted. 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.

Acquisition-related costs can cause significant fluctuation in our net income.

Previous acquisitions have resulted in significant expenses, including amortization of purchased technology, charges for in-process research and development and amortization of acquired identifiable intangible assets, which are reflected in operating expenses. Total amortization of acquired intangible and purchased technology assets was $1.3 million in the three months ended June 30, 2004. Additional acquisitions and any additional impairment of the value of purchased assets could have a significant negative impact on future operating results.

A significant portion of our revenues is derived from international revenues. Economic, political, regulatory and other risks associated with international revenues and operations could have an adverse effect on our revenues.

Because we sell our products worldwide, our business is subject to risks associated with doing business internationally. International net revenues accounted for approximately 37% of our net revenues for each of the quarters ended June 30, 2004 and 2003. We anticipate that revenues from international operations will continue to

represent a substantial portion of our total net revenues especially as we expand our Napster service abroad. Accordingly, our future revenues could decrease based on a variety of factors, including:

To grow our business, we must be able to hire and retain sufficient qualified technical, sales, marketing and administrative personnel.

Our future success depends in part on our ability to attract and retain engineering, sales, marketing, finance and customer support personnel. If we fail to retain and hire a sufficient number of these employees, we will not be able to maintain and expand our business. We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business objectives.

Our inability to protect our proprietary rights, and the costs of failing to do so, could harm our business. Our success and ability to compete partly depend on the superiority, uniqueness or value of our technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology. These efforts also may not prevent the development and design by others of products or technologies similar to, competitive with or superior to those we develop. Any of these results could reduce the value of our intellectual property. We may be forced to litigate to enforce or defend our intellectual property rights and to protect our trade secrets. Any such litigation could be very costly and could distract our management from focusing on operating our business.

We may be subject to intellectual property infringement claims, which are costly to defend and could limit our ability to use certain technologies in the future.

Many of our current and potential competitors dedicate substantially greater resources to protection and enforcement of their intellectual property rights, especially patents, than we do. Many parties are actively developing streaming media and digital distribution-related technologies, e-commerce and other Web-related technologies, as well as a variety of online business methods and models. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, disputes regarding the ownership of these technologies and rights associated with streaming media, digital distribution and online businesses are likely to arise in the future and may be very costly. In addition to existing patents and intellectual property rights, we anticipate that additional third-party patents related to our products and services will be issued in the future. If a blocking patent has been issued or is issued in the future, we would need to either obtain a license or design around the patent. We may not be able to obtain such a license on acceptable terms, if at all, or design around the patent, which could harm our business.

Companies in the technology and content-related industries have frequently resorted to litigation regarding intellectual property rights. We may be forced to litigate to determine the validity and scope of other parties’ proprietary rights. Any such litigation could be very costly and could distract our management from focusing on operating our business. In addition, we believe these industries are experiencing an increased level of litigation to determine the applicability of current laws to, and impact of new technologies on, the use and distribution of content over the Internet and through new devices, especially in the music industry, and as we develop products and services that provide or enable the provision of content, in such ways, our litigation risk may increase. The existence and/or outcome of such litigation could harm our business.

From time to time we receive claims and inquiries from third parties alleging that our internally developed technology, or technology we license from third parties, may infringe the other third parties’ proprietary rights, especially patents. In December 2003, Optima Technology filed a lawsuit against us in U.S. District Court for the Central District of California alleging patent infringement of certain of its patents by our Easy CD Creator line of products. We believe the claims are without merit and intend to defend ourselves vigorously. In addition, Napster has been notified by several companies that its services may infringe their respective patents. Napster also receives from time to time notices from artists, record labels and other asserted content right holders identifying music content that they believe is being made available via Napster’s services without proper authorization. Napster generally removes the allegedly infringing music content from its service. MGI Software, which we acquired in January 2002, has been notified by a number of companies that certain of MGI Software’s software products may infringe patents owned by these companies. MGI Software also has been notified by a number of its OEM customers that they have been approached by one of these companies regarding possible patent infringement related to certain MGI Software software products that they bundle with their respective computer products. Third parties have also asserted and most likely will continue to assert claims against us alleging infringement of copyrights, trademark rights, or other proprietary rights, or alleging unfair competition or violations of privacy rights. We could be required to spend significant amounts of time and money to defend ourselves against such claims. If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products and services while we re-engineer them or seek licenses to necessary technology, which might not be available on reasonable terms, or at all. We could also be subject to claims for indemnification resulting from infringement claims made against our customers and strategic partners, which could increase our defense costs and potential damages. Any of these events could require us to change our business practices and could harm our business.

Our business is directly affected by the level of consumer spending. One of the primary factors that affect consumer spending is the general state of the local economies in which we operate. Lower levels of consumer spending in regions in which we have significant operations could have a negative impact on our business, financial condition or results of operations.

We may need additional capital, and we cannot be sure that additional financing will be available.

Although we currently anticipate that our available funds and expected cash flows from operations will be sufficient to meet our cash needs for at least the next twelve months, we may require additional financing. Our ability to obtain financing will depend, among other things, on our development efforts, business plans, operating performance and condition of the capital markets at the time we seek financing. We expect to spend significant amounts of cash in connection with the recent launch of our Napster service and expect to experience operating losses from such service in at least the short term. We cannot assure you that additional financing will be available to us on favorable terms when required, or at all. If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution.

Another significant terrorist attack could have a negative impact on our business.

A significant terrorist attack on U.S. soil or U.S.-based business interests abroad could cause a significant decline in demand for our products and disrupt our business. An attack could generally trigger a significant economic downturn, which could affect the consumer electronics and software industry as a whole. Further, an attack could disrupt our manufacturing and worldwide distribution of our products. Any terrorist attack could cause a significant decrease in our revenues.

If we repatriate cash from our foreign subsidiaries, we will incur additional income taxes that could negatively impact our results of operations and financial position.

A portion of our cash and cash equivalents are held by one or more of our foreign subsidiaries. If we need additional cash to acquire assets or technology or to support our operations in the United States, we may be required to repatriate some of our cash from these foreign subsidiaries to the United States. We are likely to incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position. Recently, we began a corporate restructuring to close certain of our overseas operations. We cannot assure you that

such restructuring efforts will not result in additional tax liability as cash is repatriated to the United States in connection with such restructuring.

Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace.

Technology companies like ours have a history of using broad based employee stock option programs to hire, incentivise and retain our workforce in a competitive marketplace. Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) allows companies the choice of either using a fair value method of accounting for options, which would result in expense recognition for all options granted, or using an intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, “ Accounting for Stock Issued to Employees” (APB 25), with pro forma disclosure of the impact on net income (loss) of using the fair value option expense recognition method. We have elected to apply APB 25 and accordingly we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.

During March 2004 the FASB issued a proposed Statement, “Share-Based Payment, an Amendment of FASB Statements No. 123 and 95”. The proposed statement eliminates the treatment for share-based transactions using APB 25 and generally would require share-based payments to employees be accounted for using a fair-value-based method and recognized as expenses in our statements of operations. The proposed standard would require the modified prospective method be used, which would require that the fair value of new awards granted from the beginning of the year of adoption, plus unvested awards at the date of adoption, be expensed over the vesting term. In addition, the proposed statement encourages companies to use the “binomial” approach to value stock options, as opposed to the Black-Scholes option pricing model that we currently use for the fair value of our options under SFAS 123 disclosure provisions. The effective date the proposed standard is recommending is for fiscal years beginning after December 15, 2004. Should this proposed statement be finalized, it will have a significant impact on our consolidated statement of operations as we will be required to expense the fair value of our stock options rather than disclosing the impact on our consolidated result of operations within our footnotes in accordance with the disclosure provisions of SFAS 123 (see Note 1 of the Notes to Consolidated Financial Statements). This will result in lower reported earnings per share which could negatively impact our future stock price. In addition, should the proposal be finalized, this could impact our ability to utilize broad based employee stock plans to reward employees and could result in a competitive disadvantage to us in the employee marketplace.

We are subject to risks associated with governmental regulation and legal uncertainties.

Few existing laws or regulations specifically apply to the Internet, other than laws and regulations generally applicable to businesses. Certain U.S. export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. Many laws and regulations, however, are pending and may be adopted in the United States, individual states, and local jurisdictions and other countries with respect to the Internet. These laws may relate to many areas that impact our business, including content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, digital rights management, encryption, caching of content by server products, personal privacy, taxation, e-mail, sweepstakes, promotions, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability and wireless networks. These types of regulations are likely to differ between countries and other political and geographic divisions. Other countries and political organizations are likely to impose or favor more and/or different regulations than that which has been proposed in the United States, thus furthering the complexity of regulation. The United States, for example, has recently enacted an e-mail marketing law that, among other things, permits consumers to choose not to receive unsolicited e-mail from specified senders and subjects violators to certain civil penalties. As we have in the past utilized, and will likely continue in the future to utilize e-mail marketing, such laws will affect our future marketing efforts and, although we intend to comply with such laws, any inadvertent violation of such laws could subject us to penalties. In addition, state and local governments may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for and costs associated with our products and services and may affect the growth of the Internet. Such laws or regulations may harm our business. Our products and services may also become subject to investigation and regulation of foreign data protection and e-commerce authorities, including those in the European Union. Such activities could result in additional product and distribution costs for us in order to comply with such regulations.

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

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

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

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

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

Our disclosure controls and procedures and internal controls over financial reporting may not prevent all errors and intentional misrepresentations. Any system of internal control can only provide reasonable assurance that all control objectives are met. Some of the potential risks involved could include but are not limited to management judgments, simple errors or mistakes, willful misconduct regarding controls or misinterpretation. There is no guarantee that existing controls will prevent or detect all material issues or be effective in future conditions, which could materially and adversely impact our financial results in the future.

Risks Relating to the Proposed Sale of Our Consumer Software Products Division

If we fail to complete the sale of our Consumer Software Products Division, our business may be harmed.

We plan to sell all of the assets related to our Consumer Software Products Division to Sonic Solutions. We cannot assure you that the sale of our Consumer Software Products Division will be completed. As a result of our announcement of the sale of our Consumer Software Products Division, we may be unable to enter into material additional agreements with respect to our Consumer Software Products Division. The failure to maintain existing business relationships or enter into new ones could adversely affect our business, results of operations and financial condition if the sale is not completed.

Selling our Consumer Software Products Division will constitute a sale of substantially all of our historical operating assets.

To date, our Consumer Software Products Division has accounted for the majority of our revenues. Upon consummation of the sale of our Consumer Software Products Division, all of our revenues will be generated by our Online Music Distribution Division. As described below in Risks Related to Our Online Music Services Business, we have limited experience in the Online Music Distribution Division and cannot assure you that we will be successful in operating and growing such business. If we are not successful in operating and growing our Online Music Distribution Division, our business, results of operations and financial condition will be adversely affected.

We will require the approval of our stockholders and certain regulatory and other approvals and consents in order to complete the sale of our Consumer Software Products Division and we may not be able to obtain such approvals and consents.

Under Delaware Law, the sale of the Consumer Software Products Division is deemed the sale of substantially all of our assets, requiring the approval of the majority of our stockholders. We plan to solicit stockholder approval at our upcoming annual meeting of stockholders. Because the sale of the Consumer Software Products Division will constitute a significant change in our business strategy, some of our stockholders may choose to vote against the transaction, which could make it impossible to obtain majority stockholder approval and to close the sale of our Consumer Software Products Division to Sonic Solutions.

Additionally, the sale of the Consumer Software Products Division is subject to the reporting and waiting period requirements of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and may be subject to our receipt of approval by certain state and foreign regulatory bodies. Further, the sale of the Consumer Software Products Division is subject to our obtaining consents of various third parties. We cannot assure you that we will be able to obtain these approvals or consents in a timely manner or at all. Because the asset purchase agreement contains a deadline for the closing of the transaction and because these approvals and consents are necessary conditions to the closing of the transaction, a substantial delay in obtaining any of these approvals or consents, or failure to obtain any such approval or consent may make it impossible to complete the sale of our Consumer Software Products Division.

If we are unable to complete the sale of our Consumer Software Products Division, we may, under certain circumstances be liable to Sonic Solutions for termination fees and expenses.

If we and Sonic Solutions are unable to close this acquisition, the terms of the asset purchase agreement provide that, under certain circumstances, we may be liable to Sonic Solutions for a termination fee and certain expenses, which may have a material adverse effect on our business, results of operations and financial condition. The circumstances under which we would be liable to Sonic Solutions for a termination fee and expenses include termination of the asset purchase agreement:

The purchase price for our Consumer Software Products Division is subject to adjustment, and we may receive less proceeds than we expect.

Under the asset purchase agreement, the purchase price will be reduced by the amount the net tangible working capital (as defined in the asset purchase agreement) of the Consumer Software Products Division as of the closing date is less than the net tangible working capital of the Consumer Software Products Division as of March 31, 2004. In addition, the purchase price is subject to additional adjustments based on certain reserves and channel inventory levels. To the extent the purchase price is reduced, we will have less cash available to operate the Online Music Distribution Division. If we are required to seek additional financing, such financing may not be available on acceptable terms, if at all.

Under the asset purchase agreement, we have retained various liabilities relating to the Consumer Software Products Division and have agreed to indemnify Sonic Solutions for any breach of our representations and warranties contained in the asset purchase agreement and for other matters, including all liabilities retained by us under that agreement. For example, an indemnification claim by Sonic Solutions might result if we breach or default on any of our representations about the assets comprising our Consumer Software Products Division. If any claim is made by Sonic Solutions, we may be required to expend significant cash resources in defense and settlement of the claim, which may adversely affect our business, results of operations and financial condition.

Management could spend or invest the proceeds from the sale of our Consumer Software Products Division in ways with which our stockholders may not agree.

Our management could spend or invest the proceeds from the sale of our Consumer Software Products Division in ways with which our stockholders may not agree. We currently intend to invest the proceeds from the sale of our Consumer Software Products Division into our Online Music Distribution Division. The investment of these proceeds may not yield a favorable return. Furthermore, because our Online Music Distribution Division is evolving, in the future we may discover new opportunities that are more attractive. As a result, we may commit resources to these alternative market opportunities. If we change our business focus, we may face risks that are different from the risks currently associated with our Online Music Distribution Division.

Our Digital Media Suite software accounts for the majority of our revenues. If demand for this software declines, our sales could be significantly reduced and our operating results may be adversely affected.

Historically, the majority of our operating revenues have come from sales of our Digital Media Suite software. We expect that this product will continue to account for a significant portion of our software license revenues for the foreseeable future. Any factors adversely affecting the pricing of, or demand for or market acceptance of our recording software products, such as competition or technological change, would materially adversely affect our business and operating results. Our future operating results depend on the continued market acceptance of our Digital Media Suite software, including future enhancements. If our Digital Media Suite product fails to successfully integrate the applications or if consumers do not see enough value in these improvements, our revenues will suffer and our business will be harmed. Competition, technological change or other factors could decrease demand for these products or make these products obsolete.

If new technologies or formats replace the CD and DVD as the preferred method of consumers to store digital content, such as portable digital audio players or removable storage devices, sales of our Digital Media Suite and recording software products could be seriously harmed. Additionally, if new consumer appliance technologies replace the PC as the preferred means of personalizing and managing digital content, our business could be seriously harmed.

If we fail to compete effectively in the DVD video-authoring software category, sales of our Digital Media Suite software products may be adversely affected.

We released the latest version of our Digital Media Suite (Roxio Easy Media Creator 7) in February 2004. This software includes DVD video-authoring technology. Because this technology is relatively new and rapidly evolving, our success in this market segment will depend upon our ability to continue to develop and advance this technology to keep pace with competition and customer demand. Because this functionality is prominently featured in our CD and DVD recording software products, if our DVD video authoring technology does not compete effectively in the marketplace, sales of our Digital Media Suite software products may be adversely affected and our business may be adversely affected.

If CD recording does not remain the primary technology for recording and managing digital content, our sales of recording software may decline significantly and our business may be adversely affected.

Sales of our recording software depend in large part on the continued viability of CD recording as the primary technology used to record and manage digital content. If DVD recorders surpass CD recorders as the primary technology used to record and manage digital content and our DVD recording solutions are not as popular as those of our competitors, then sales of our recording software may decline significantly.

We expect the success of our consumer software products will depend on the sale of upgrades to our CD/DVD recording software products. If we fail to sell upgrades to such products effectively, our business may be adversely affected.

Historically, we have derived a significant portion of our revenues from sales of our recording software products to OEMs of PCs and CD and DVD recorders. Recently, competition in our own market and diminishing margins that PC and drive manufacturers have been experiencing have contributed to a reduction in the prices we can charge PC and drive manufacturers to include our software in their product offerings. If this trend continues as anticipated, we expect that revenues derived from the sale of our CD and DVD recording software products to PC and drive manufacturers in total and as a percentage of net revenues will decline significantly. As such, our future success will depend in part on our ability to sell software upgrades directly to end users and through retail. Although we are developing marketing strategies to increase our sales of software upgrades, we cannot assure you that any marketing strategies we develop will be successful in increasing our upgrade rate or that users will be content with the version of software that is included in their PC, CD or DVD recorder purchase.

If our products do not operate effectively with the hardware of our customers, our revenues will be adversely affected.

We must design our digital content editing and burning products to operate effectively with a variety of hardware and software products, including CD and DVD recorders, PCs, digital still cameras, digital video recorders, printers, scanners, digital audio players and operating system software. We depend on significant cooperation with manufacturers of these products to achieve our design objectives and to produce products that operate successfully. If our software is not interoperable with the hardware that our customers purchase and use, demand for our software will decrease and our business will be harmed.

A significant portion of our revenues currently comes from a small number of distributors and OEMs, and any decrease in revenues from these or other distributors or OEMs could adversely affect our operating results.

One of our distributors, Navarre Corporation, accounted for 10% of net revenues for the quarter ended June 30, 2004, as compared to 18% for the same quarter of the prior year. A second distributor, Ingram Micro, accounted for 16% of net revenues for the quarter ended June 30, 2004, compared to 15% for the same quarter of the prior year.

We rely on distributors and retailers to sell our products, and disruptions to these channels would adversely affect our ability to generate revenues from the sale of our products.

If our distributors attempt to reduce their levels of inventory or if they do not maintain sufficient levels to meet customer demand, our sales could be negatively impacted. If we reduce the prices of our products to our distributors, we may have to compensate them for the difference between the higher price they paid to buy their inventory and the new lower prices. In addition, we are exposed to the risk of product returns from distributors through their exercise of contractual return rights.

If direct sales to customers through our own online channels increase, our distributors and retailers may suffer decreased sales as a consequence. These changes may cause our distributors to cease distribution or seek more favorable terms, which could seriously harm our business.

Our distributors, and the retailers who sell our software to the public, also sell products offered by our competitors. If our competitors offer our distributors or retailers more favorable terms, those distributors or retailers may de-emphasize or decline to carry our products. In the future, we may not be able to retain or attract a sufficient number of qualified distributors or retailers. Further, distributors or retailers may not recommend, or continue to recommend, our products.

A disruption of our online delivery or transaction processing system could have a negative impact on revenues.

We expect that direct sales will account for an increasing portion of our overall sales particularly due to competitive pressures in the OEM markets. A reduction in the performance, reliability and availability of our online software delivery or transaction processing system will harm our ability to market and distribute our products and services to our users, as well as our reputation and ability to attract and retain users and customers.

Our failure to maintain or expand our relationships with OEMs could cause demand for our products to decline.

Historically, we have derived a significant percentage of our revenues from sales of our products to OEMs, such as PC, digital still camera, digital video camera and drive manufacturers and integrators. These OEMs typically license and include a standard version of our software with their hardware. As a result, these relationships also serve an important role in distributing our software to the end user and positioning the market for upgrades to our more full featured software products. These OEMs may decline to include our software with their hardware for a number of reasons, including if our competitors offer these OEMs more favorable terms, if our competitors are able to take advantage of their existing relationships with these OEMs, or if these OEMs decide not to bundle any software with their products. The loss of any of our relationships with OEMs could harm our operating results. One OEM customer, Dell Computer Corporation, accounted for 4% of net revenues for the quarter ended June 30, 2004, as compared to 16% for the quarter of the prior year. Beginning in October 2003, Dell Computer Corporation, now only bundles our CD and DVD-recording technology with their commercial desktop sales. As a result, revenues from this customer have significantly declined.

Because sales to OEM manufacturers in particular provide a significant means of distributing our software to end users, and because sales to OEM manufacturers account for a significant portion of our revenues, a downturn or competitive pricing pressures in the PC, CD and DVD recorder, or digital still and video camera industries could cause our revenues to decline.

Sales of our Digital Media Suite depend in large part on the continued growth of the installed base of PCs, CD and DVD recorders, digital still cameras and digital video cameras. While these installed bases are growing, we cannot assure you that this growth will continue. Consumers may choose to purchase new PCs that do not include CD or DVD recorders, or existing PC owners may not purchase CD or DVD recorders as a stand-alone product in the numbers that are expected if an alternative technology emerges or if the demand for moving, managing and storing digital content is less than expected. Consumers may reject digital photography or find the new digital still and video cameras too complicated to work or too expensive to purchase. Growth in the installed base of these products may also be limited due to shortages in components required to manufacture them or other supply constraints. If the demand for these products decreases, our sales to OEM manufacturers will likely decline. If we are unable to sell our products to OEM manufacturers in the amount and on the terms that we have negotiated with our current OEM customers, our revenues may decline.

The PC, CD and DVD recorder, or digital still and video camera industries are highly competitive, and we expect this competition to increase significantly. In particular, we expect pricing pressures in these markets to continue. To the extent that OEM manufacturers are pressured through competition to reduce the prices of their products, they may be less likely to purchase our software products on terms as favorable as we have negotiated with our current OEM customers, if at all.

If we are unable to compete effectively with existing or new competitors to our software business, including if these competitors offer OEMs better terms than we do, we could experience price reductions, fewer customer orders, reduced margins or loss of market share.

We compete in providing solutions for editing, moving, managing and protecting digital content. The markets for providing products and services offering these solutions are highly competitive, and we expect competition to increase in the future. Key competitors for sales of our CD and DVD recording software include Ahead, BHA, Sonic Solutions, and Pinnacle Systems. Key competitors for our digital photo and video editing software include Microsoft, Adobe, Pinnacle Systems, Ulead, Intervideo and Arcsoft. Additionally, Microsoft and Apple have included CD recording software and video editing software in their respective operating systems and Apple has included DVD recording software in its operating system.

Many of our competitors or potential competitors have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements and may be able to leverage their customer bases and adopt aggressive pricing policies to gain market share. They may also devote greater resources to the development, promotion and sale of their products than we do. In addition, some of our software competitors or potential competitors have existing relationships with hardware manufacturers, integrators or retailers that currently carry our products. If our competitors are able to exploit these existing relationships to expand into our product areas, our business could be harmed.

If we fail to release our products as scheduled, it would adversely affect our revenue and the growth of our business.

We may fail to introduce or deliver new product offerings, or new versions of existing products, on a timely basis or at all. If new versions of existing products or potential new products are delayed, we could experience a delay or loss of revenues and customer dissatisfaction. Customers may delay purchases of our current software products in anticipation of future releases. If customers defer material orders of our current software products in anticipation of new releases or new product introductions, our business would be seriously harmed.

Our software could be susceptible to errors or defects that could result in lost revenues, liability or delayed or limited market acceptance.

Complex software products often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. We have in the past discovered, and may in the future discover, software errors in our new releases after their introduction. Despite internal testing and testing by current and potential customers, our

current and future products may contain serious defects or errors. Any such defects or errors would likely result in lost revenues, liability or a delay in market acceptance of these products.

Our online music services initiatives have a limited operating history and a history of losses and may not be successful.

On May 19, 2003 we acquired substantially all of the ownership interest of Napster, LLC (f/k/a Pressplay). We used the Pressplay-branded service as a technology platform to roll-out our online music services division in October 2003. The business models, technologies and market for online music services are new and unproven. Prior to our acquisition of Napster, LLC, consumer adoption and usage of the Pressplay-branded service had not been significant. You should consider the online music distribution business and prospects in light of the risks, expenses and difficulties encountered by companies in their early stage of development. Napster has experienced significant net losses since its inception and, given the significant operating and capital expenditures associated with our business plan, we expect to incur net losses for at least the next twelve months and may experience net losses thereafter. No assurance can be made that our Napster division will ever contribute net income to our statement of operations. If our Napster division is not successful, our business and business prospects could be harmed. Napster, LLC (f/k/a Pressplay) has incurred cumulative losses of approximately $52.6 million from inception (April 2001) through May 19, 2003. Napster has incurred cumulative losses of approximately $46.7 million from May 20, 2003 through June 30, 2004.

The success of our online music service depends upon our ability to add new subscribers.

We cannot assure you that we will be able to attract new subscribers to the Napster service or that existing subscribers will continue to subscribe. Existing subscribers may cancel their subscriptions to the Napster service for many reasons, including cost, availability of content, or a perception that they do not use the services sufficiently or that the service does not provide enough value relative to our competition. If we do not continue to increase the total number of subscribers each quarter, our operating results will be adversely impacted.

Our online music service has lower margins than our traditional software business.

Costs of our online music service as a percentage of the revenue generated by that service are higher than those of our historical software licensing business. The cost of third party content, in particular, is a substantial portion of revenues we receive from subscribers and end users and is unlikely to decrease significantly over time as a percentage of revenue. We expect this trend will continue to negatively impact our overall gross margins as our online music service increases as a percentage of our total revenue, which may affect our ability to regain profitability.

We cannot provide assurances that the usage of the Napster brand will increase revenues.

Customers may not associate the Napster brand with a paid service model. If the Napster brand fails to attract new customers, our revenues and business will suffer, and we may need to incur additional marketing expenditures to compensate for such failure.

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

Our paid online music services face competition from traditional retail music distributors such as Tower Records as well as online retailers such as Amazon.com. These retailers may include regional and national mall-based music chains, international chains, deep-discount retailers, mass merchandisers, consumer electronics outlets, mail order, record clubs, independent operators and online physical retail music distributors, some of which have greater financial and other resources than we do. To the extent that consumers choose to purchase media in non-electronic formats, it may reduce our sales, reduce our gross margins, increase our operating expenses and decrease our profit margins in specific markets.

Our online music services competitors include Listen.com, the provider of the Rhapsody service and a subsidiary of RealNetworks, Inc., Apple Computer’s iTunes Music Store, MusicMatch, Sony Connect, Walmart.com and online music services powered by MusicNet such as AOL Music and Virgin. We anticipate competition for online music distribution service revenue from a wide range of companies, including broadband

Internet service providers such as Yahoo! and MSN. Internationally we currently compete with OD2 and Puretracks as well as with a number of the other competitors described above.

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

Many of our competitors have significantly more resources than we do, and some of our competitors may be able to leverage their experience in providing online music distribution services or similar services to their customers in other businesses. Some of these competitors offer other goods and services and may be willing and able to offer music services at a lower price than we can in order to promote the sale of these goods and services. We or our competitors may be able to secure limited exclusive rights to content from time to time. If our competitors secure significant exclusive content, it could harm the ability of our online music services to compete effectively in the marketplace.

Online music distribution services in general are new and rapidly evolving and may not prove to be a profitable or even viable business model.

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

We rely on content provided by third parties, which may not be available to us on commercially reasonable terms or at all.

We rely on third-party content providers to offer music online content that can be delivered to users of our service. These third party providers include music publishers and music labels. Rights to provide this content to our customers, particularly publishing rights, are difficult to obtain and require significant time and expense. In some cases, we pay substantial fees to obtain this third party content. In order to provide a compelling service, we must be able to continue to license a wide variety of music content to our customers with attractive usage rules such as CD recording, output to digital audio devices, portable subscription rights and other rights. In addition, if we do not have sufficient breadth and depth of the titles necessary to satisfy increased demand arising from growth in our subscriber base, our subscriber satisfaction may be affected adversely. We cannot guarantee that we will be able to secure licenses to music content or that such licenses will be available on commercially reasonable terms. Recently, we have begun to offer the Napster service outside of the United States. The expansion of the service abroad requires that additional publishing and sound recording licenses be obtained for music currently offered in the United States as well as for music that is available only in foreign markets. We cannot assure you that we will be able to obtain such licenses on favorable terms or at all. Failure to obtain these licenses will harm our business in existing and potential foreign markets and our revenues.

Under copyright law, we may be required to pay licensing fees for digital sound recordings we deliver in original and archived programming in our Napster service. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory licenses where voluntary negotiations are unsuccessful, by arbitration proceedings known as CARP proceedings which are subject to approval by the United States Copyright Office. Past CARP proceedings have resulted in proposed rates for statutory webcasting that were significantly in excess of rates requested by webcasters. CARP proceedings relating to music subscription and non-subscription services offering music programming that qualify for various licenses under U.S. copyright law are pending. We cannot predict the outcome of these negotiations or CARP proceedings and may elect instead to attempt to directly license music content for our subscription and/or non-subscription services, either alone or in concert with other affected companies. Such licenses may only apply to music performed in the United States, and the availability of corresponding licenses for international performances

is unclear. Therefore, our ability to find rights holders and negotiate appropriate licenses is uncertain. Many of our systems may be affected by these rates, which may negatively impact our revenues. There are other negotiations and CARP proceedings in process which will set rates for subscription music services and services that deliver digital downloads of music, and the outcome of these negotiations and CARP proceedings will also likely affect our business in ways that we cannot predict. Voluntarily negotiated rates for mechanical licenses with respect to streaming and conditional digital downloads with the Harry Fox Agency and National Music Publishers Association have not been agreed to, and we are currently operating under a standstill agreement until such time as such rates are negotiated. No agreement has been reached with performing rights societies such as ASCAP or BMI regarding whether digital downloads constitute public performances of copyrighted works that would trigger payment of public performance royalties. Depending on the rates and terms adopted for these voluntary and/or statutory licenses, our business could be harmed by increasing our own cost of doing business, as well as by increasing the cost of doing business for our customers. We anticipate future CARP proceedings relating to music subscription delivery services, which may also adversely affect the online distribution of music.

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

We must provide digital rights management solutions and other security mechanisms in our online music distribution services in order to address concerns of content providers and artists, and we cannot be certain that we can develop, license or acquire such solutions, or that content licensors or consumers will accept them. Content providers may be unwilling to continue to support portable subscription services. Consumers may be unwilling to accept the use of digital rights management technologies that limit their use of content, especially with large amounts of free content readily available.

Third-party providers of digital rights management software, such as Microsoft, may be unwilling to continue to provide such software to us upon reasonable or any terms. If we are unable to acquire these solutions on reasonable or any terms, or if customers are unwilling to accept these solutions, our business and prospects could be harmed.

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

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

Our success depends on our music service’s interoperability with our customer’s music playback hardware.

In order for our Napster service to be successful we must design our service to interoperate effectively with a variety of hardware products, including home stereos, car stereos, portable digital audio players, and PCs. We depend on significant cooperation with manufacturers of these products and with software manufacturers that create the operating systems for such hardware devices to achieve our design objectives and to offer a service that is attractive to our customers. Our software is currently not compatible with the iPod music player. If we cannot successfully design our service to interoperate with the music playback devices that our customers own, our business will be harmed.

The success of the Napster service will depend on our ability to develop leading edge media and digital distribution products and services. Our business and operating results will be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues or gross profits to offset our development and operating costs. We may not timely and successfully identify, develop and market new product and service opportunities. We may not be able to add new content such as video, spoken word or other content as quickly or as efficiently as our competitors or at all. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability. Competitive or technological developments may require us to make substantial, unanticipated investments in new products and technologies, and we may not have sufficient resources to make these investments.

Because the markets for our products and services are changing rapidly, we must develop new offerings quickly. Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements. Our products also may contain undetected errors that could cause increased development costs, loss of revenues, adverse publicity, reduced market acceptance of our products or services or lawsuits by customers.

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

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

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

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

We believe that increased Internet use and especially the increased use of media over the Internet may depend on the availability of greater bandwidth or data transmission speeds (also known as broadband transmission). If broadband technologies do not become widely available or widely adopted, our online music distribution services may not achieve broad market acceptance and our business and prospects could be harmed. To date, we believe that broadband technologies have been adopted at a slower rate than expected, which we believe has slowed the level of use of media over the Internet and may harm our business and prospects if the rate of adoption does not increase.

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

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

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

Online commerce and communications depend on the ability to transmit confidential information and licensed intellectual property securely over private and public networks. Any compromise of our ability to transmit such information and data securely or reliably, and any costs associated with preventing or eliminating such problems, could harm our business. Online transmissions are subject to a number of security and stability risks, including:

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

The market price of our common stock could be subject to significant fluctuations. Among the factors that could affect our stock price are:

The stock markets in general and the markets for technology stocks in particular, have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. In particular, we cannot assure you that you will be able to resell your shares at any particular price, or at all.

Shares eligible for sale in the future could negatively affect our stock price.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock or the perception that these sales could occur. This might also make it more difficult for us to raise funds through the issuance of securities. As of August 1, 2004, we had outstanding 34,670,913 shares of common stock of which 33,555,522 shares are freely tradable and 1,099,626 shares are currently in the process of being registered on Form S-3. The remaining 15,765 shares of common stock outstanding are “restricted securities” as defined in Rule 144 held by our “affiliates” (as those terms are defined in Rule 144 under the Securities Act). These restricted securities may be sold in the future pursuant to registration statements filed with the SEC or without registration under the Securities Act to the extent permitted by Rule 144 or other exemptions under the Securities Act. Pursuant to the terms of a common stock purchase agreement with Best Buy Enterprise Services, up to an additional 3,925,374 shares may be sold in separate closings on July 17, 2005 and December 17, 2005.

As of August 1, 2004, there was an aggregate of 5,899,229 shares of common stock issuable upon exercise of outstanding stock options and warrants, including 5,799,229 shares issuable upon exercise of options outstanding under our option plans, and 100,000 shares of common stock issuable upon exercise of an outstanding warrant issued to the trustee in the Napster bankruptcy in connection with our acquisition of the Napster assets. We may register additional shares in the future in connection with acquisitions, compensation or otherwise. We have not entered into any agreements or understanding regarding any future acquisitions and cannot ensure that we will be able to identify or complete any acquisition in the future.

Provisions in our agreements, charter documents, stockholder rights plan and Delaware law may delay or prevent acquisition of us, which could decrease the value of your shares.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions include a classified board of directors and limitations on actions by our stockholders by written consent. In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. In addition, we have adopted a stockholder rights plan that makes it more difficult for a third party to acquire us without the approval of our board of directors. Although we believe these provisions provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders.

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. We maintain our cash, cash equivalents and short-term investments with high quality financial institutions and, as part of our cash management process, we perform periodic evaluations of the relative credit standing of these financial institutions. Amounts deposited with these institutions may exceed federal depository insurance limits. In addition, the portfolio of investments conforms to our policy regarding concentration of investments, maximum maturity and quality of investment.

Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline in value. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, corporate bonds, U.S. agencies securities, asset-backed securities and money market funds. In general, money market funds are not subject to interest rate risk because the interest paid on these funds fluctuates with the prevailing interest rate. All of our short-term investments mature in less than two years.

The following table presents the amounts of our short-term investments that are subject to market risk by range of expected maturity and weighted-average interest rates as of June 30, 2004. Our cash equivalents are invested in money market funds, commercial paper and municipal securities, which are not included in the table because those funds are not subject to interest rate risk due to their short maturities.

We do not currently hold any derivative instruments and do not engage in hedging activities. We have available to us a $17 million revolving line of credit. Currently, there is $15.0 million outstanding under the line of credit, which bears interest at a variable rate of prime plus 0.50% per annum and expires in March 2006. We do not hold any

other variable interest rate debt. Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of trade accounts receivable and accounts payable.

We develop our software in the United States, Canada and Europe, and sell it in North America, Europe, the Pacific Rim and Asia. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. For our foreign subsidiaries whose functional currency is the local currency, we translate assets and liabilities to U.S. dollars using period-end exchange rates and translate revenues and expenses using average exchange rates during the period. Exchange gains and losses arising from translation of foreign entity financial statements are included as a component of other comprehensive income and have not been significant for all periods presented.

For foreign subsidiaries, certain assets and liabilities are re-measured at the period end or historical rates as appropriate. Revenues and expenses are re-measured at the average rate during the period. Currency translation gains and losses are recognized in current operations.

We sell our consumer software products primarily to original equipment manufacturers and distributors throughout the world, resulting in sales denominated in U.S. dollars, Euro, and Japanese yen. We sell our online music products primarily to consumers in the United States, the United Kingdom, and Canada, resulting in sales denominated in U.S. dollars, United Kingdom pounds, and Canadian dollars. Cash and cash equivalents are predominantly denominated in U.S. dollars.

An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures (as defined by Exchange Act Rules 13a-15(e) or 15d-15(e)) as of June 30, 2004. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of June 30, 2004, as required by Exchange Act Rules 13a-15(b) and 15d-15(b).

Roxio and MGI Software Corp. (“MGI Software”) have been notified by a number of companies that certain of their respective software products may infringe patents owned by those companies. Roxio is investigating the nature of these claims and the extent to which royalties may be owed by it and by MGI Software to these entities. In addition, Roxio and MGI Software have been notified by a number of their respective original equipment manufacturers (“OEMs”) customers that the OEMs have been approached by certain of these companies set forth above regarding possible patent infringement related to certain Roxio and MGI Software software products that they bundle with their respective computer products. Roxio estimates that at the low end of the range, there may not be any additional payments required to settle the pending MGI Software related-claims. The upper end of the range cannot be reasonably estimated at this time. Roxio accrued $2.4 million for possible litigation settlements as part of the purchase price allocation of MGI Software. Because no amount in the range is more likely than any other to be the actual amount of any settlement, and because there have been no specific triggering events related to these possible claims, Roxio has not adjusted the original provision. The amount, if any, necessary to settle patent claims related to Roxio’s products cannot be determined at this time.

On June 17, 2004, Roxio entered into a Common Stock Purchase Agreement with Best Buy Enterprise Services, Inc. (“Best Buy”). Under the terms of a multi-year agreement, Best Buy’s affiliate, Best Buy Stores, L.P., will promote Napster as its leading digital music service through comprehensive in-store marketing activities as well as extensive broadcast, print and online advertising. Best Buy Stores, L.P. will also market a co-branded version of Napster which will be made available to customers online through Bestbuy.com. In connection with the transaction, Best Buy will receive Roxio stock with a value of up to $10.0 million over the term of the agreement and Napster will engage with Best Buy Stores, L.P. in jointly funded marketing activities. On June 17, 2004, Roxio issued approximately 1.1 million shares of common stock with a value of $5.0 million to Best Buy at a cash purchase price of $0.01 per share. The issuance of these securities were exempt from registration under the Securities Act, by virtue of Regulation D and Section 4(2) of the Securities Act, on the basis that the transaction did not involve any public offering.

There were no matters submitted to a vote of security holders during the quarter ended June 30, 2004.

The exhibits listed on the Exhibit Index (following the Signatures section of this report) are included, or incorporated by reference, in this Quarterly Report.

We filed a Current Report on Form 8-K on June 25, 2004 under Items 5 and 7, regarding the Common Stock Purchase Agreement dated June 17, 2004 with Best Buy Enterprise Services, Inc., pursuant to which Best Buy purchased $5.0 million of Roxio’s common stock on June 17, 2004 and will purchase up to an additional $5.0 million in two closings over the next eighteen months. The Common Stock Purchase Agreement was entered into in connection with a Strategic Marketing Agreement between Roxio and Best Buy Stores, L.P., an affiliate of Best Buy.

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

ROXIO, INC.

(Registrant)




By:		/s/ WM. CHRISTOPHER GOROG
		Wm. Christopher Gorog Chief Executive Officer (Principal Executive Officer)




By:		/s/ NAND GANGWANI
		Nand Gangwani Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)


Delaware		77-0551214
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)


PART I.	Financial Information	Page Number

Item 1	Financial Statements (unaudited)

	Condensed Consolidated Balance Sheets as of June 30, 2004 and March 31, 2004	4

	Condensed Consolidated Statements of Operations for the three-month periods ended June 30, 2004 and 2003	5

	Condensed Consolidated Statements of Cash Flows for the three-month periods ended June 30, 2004 and 2003	6

	Notes to Condensed Consolidated Financial Statements	8

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3	Quantitative and Qualitative Disclosures about Market Risk	50

Item 4	Controls and Procedures	51

PART II.	Other Information

Item 1	Legal Proceedings	52

Item 2	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	53

Item 3	Defaults Upon Senior Securities	53

Item 4	Submission of Matters to a Vote of Security Holders	53

Item 5	Other Information	53

Item 6	Exhibits and Reports on Form 8-K	53

Signatures		54

Index to Exhibits		55

Exhibit 10.1

Exhibit 31.1

Exhibit 31.2

Exhibit 32.1


	June 30, 2004			March 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	19,283		$	36,911
Restricted cash		735			1,735
Short-term investments		43,395			28,490
Accounts receivable, net of allowance for doubtful accounts of $905 at June 30, 2004 and $991 at March 31, 2004		15,566			16,279
Prepaid expenses and other current assets		15,230			7,480
Deferred income taxes		146			150

Total current assets		94,355			91,045
Long-term investment		3,000			3,000
Property and equipment, net		9,063			9,933
Goodwill		91,623			91,723
Identifiable intangible assets, net		4,565			5,899
Other assets		1,180			1,748

Total assets	$	203,786		$	203,348

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,895		$	6,085
Income taxes payable		2,803			2,841
Accrued liabilities		27,403			30,627
Deferred revenues		2,707			1,545
Current portion of long-term debt		15,491			15,420

Total current liabilities		54,299			56,518
Long term liabilities:
Deferred revenues		85			85
Long-term capital lease obligations		155			68
Other long term liabilities		2,268			2,296

Total liabilities		56,807			58,967

Stockholders’ equity:
Preferred stock, $0.001 par value; Authorized: 10,000 shares; Issued and outstanding: none at June 30, 2004 and at March 31, 2004		—			—
Common stock, $0.001 par value; Authorized: 100,000 shares; Issued and outstanding: 34,671 shares at June 30, 2004 and 33,543 shares at March 31, 2004		35			34
Additional paid-in capital		200,737			195,503
Deferred stock-based compensation		(1,034	)		(1,386	)
Accumulated deficit		(57,728	)		(55,088	)
Accumulated other comprehensive income		4,969			5,318

Total stockholders’ equity		146,979			144,381

Total liabilities and stockholders’ equity	$	203,786		$	203,348


	Three Months Ended June 30,
	2004			2003
Net revenues :
Consumer software	$	22,048		$	23,395
Online music		7,867			781

Total net revenues		29,915			24,176
Cost of revenues :
Consumer software (1)		4,625			6,986
Online music		6,416			620
Amortization of purchased technologies		696			587

Total cost of revenues		11,737			8,193

Gross profit		18,178			15,983

Operating expenses:
Research and development (2)		6,478			6,934
Sales and marketing (3)		10,390			9,407
General and administrative (4)		4,861			5,277
Restructuring charges		(153	)		1,536
Amortization of intangible assets		576			617
Stock-based compensation charges		382			519

Total operating expenses		22,534			24,290

Loss from operations		(4,356	)		(8,307	)
Gain on sale of GoBack product line		1,682			10,592
Other income, net		219			67

Income (loss) before provision for income taxes		(2,455	)		2,352
Provision for income taxes		185			2,722

Net loss	$	(2,640	)	$	(370	)

Net loss per share:
Basic and Diluted	$	(0.08	)	$	(0.02	)

Weighted average shares used in computing net loss per share
Basic and Diluted		33,726			21,864


	Three Months Ended June 30,
	2004			2003
Cash flows from operating activities:
Net loss	$	(2,640	)	$	(370	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,552			2,347
Stock-based compensation charges		382			519
Bad debt expense (benefit)		(81	)		38
Loss on retirement of property and equipment		—			320
Gain on sale of GoBack product line		(1,682	)		(10,592	)
Deferred income taxes		—			2,372
Change in operating assets and liabilities, net of effects of acquisition of Napster, LLC and sale of GoBack product line:
Accounts receivable		829			4,063
Prepaid expenses and other current assets		(3,993	)		543
Other long term assets		661			(228	)
Accounts payable		(700	)		(4,583	)
Income taxes payable		35			(1,052	)
Accrued liabilities		(2,512	)		(1,729	)
Deferred revenues		1,247			1,827
Other liabilities		(113	)		295

Net cash used in operating activities		(6,015	)		(6,230	)


Cash flows from investing activities:
Purchases of property and equipment, net		(81	)		(1,113	)
Proceeds from sale of GoBack product line		2,760			10,250
Purchases of other intangible assets		—			(63	)
Purchases of short-term investments		(33,601	)		(2,792	)
Proceeds from sale of short-term investments		12,812			350
Maturities of short-term investments		5,809			2,390
Transfer from restricted cash account		1,000			—
Acquisition of Napster, LLC, net of cash acquired		—			(13,473	)

Net cash used in investing activities		(11,301	)		(4,451	)


Cash flows from financing activities:
Principal payment of capital lease obligations		(174	)		(154	)
Issuance of common stock under employee stock plan		109			—
Issuance of common stock		1			20,613

Net cash provided by (used in) financing activities		(64	)		20,459

Effect of exchange rates on cash		(248	)		(2	)

Change in cash and cash equivalents :		(17,628	)		9,776
Cash and cash equivalents at beginning of period		36,911			36,820

Cash and cash equivalents at end of period	$	19,283		$	46,596


	Three Months Ended June 30,
	2004			2003
Net loss, as reported	$	(2,640	)	$	(370	)
Add:
Unearned stock-based compensation expense included in reported net loss		382			519
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(2,301	)		(2,732	)

Pro forma net loss	$	(4,559	)	$	(2,583	)

Net loss per share:
Basic and diluted—as reported	$	(0.08	)	$	(0.02	)
Basic and diluted—pro forma	$	(0.14	)	$	(0.12	)


	(in thousands)
Calculation of purchase price:
Value of stock consideration	$	23,487
Cash consideration		12,500
Acquisition costs		1,821

Total costs	$	37,808

Allocation of purchase price:
Current assets	$	3,067
Property and equipment		4,144
Other assets		1,096
Identifiable intangible assets—Trademark		300
Goodwill		34,658

Total assets acquired		43,265
Current liabilities		(5,457	)

Net assets acquired	$	37,808


	Three Months Ended June 30, 2003
Net revenues	$	24,970
Net loss	$	(3,896	)
Basic and diluted net loss per share	$	(0.19	)
Weighted average shares used in computing net loss per share		21,036


	June 30, 2004 Fair Value		March 31, 2004 Fair Value
Commercial paper	$	15,895	$	16,256
Corporate securities		16,076		5,067
Municipal securities		8,918		6,654
U.S. agencies securities		2,506		513

Total short-term investments	$	43,395	$	28,490


	June 30, 2004				March 31, 2004
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
	(Including Effects of Foreign Currency Exchange)
Identifiable intangible assets:
Patents	$	5,627	$	5,457	$	5,627	$	5,426
Covenant not to compete		6,010		6,010		6,010		6,010
Purchased technology		11,289		9,736		11,158		8,915
OEM relationships		1,186		1,186		1,186		1,186
Trademark		8,196		5,354		8,116		4,661
Capitalized website development costs		1,823		1,823		1,823		1,823

	$	34,131	$	29,566	$	33,920	$	28,021

Net book value			$	4,565			$	5,899


Fiscal Year Ending March 31,
2005 (9 months)	$	3,216
2006		1,349

Total	$	4,565


	For the Quarter Ended June 30, 2004			For the Year Ended March 31, 2004
Balance at beginning of fiscal year	$	91,723		$	55,247
Goodwill resulting from the acquisition of Napster, LLC, formerly known as Pressplay		51			34,709
Effect of foreign currency exchange		(151	)		1,767

Balance at end of period	$	91,623		$	91,723


	Lease Termination Costs			Severance and Other Benefits			Other Costs			Total
Total provision at March 31, 2004	$	3,240		$	1,233		$	841		$	5,314
Adjustment to provision		(316	)		—						(316	)
Additional provision		—			52			111			163
Reclassification of costs		294						(294	)		—
Cash payments		(280	)		(1,235	)		(242	)		(1,757	)
Non cash items		33			—			—			33

Total provision at June 30, 2004	$	2,971		$	50		$	416		$	3,437

Short term portion of provision	$	1,309		$	50		$	416		$	1,775

Long term portion of provision	$	1,662		$	—		$	—		$	1,662


	June 30, 2004		March 31, 2004
Revolving credit agreement	$	15,000	$	15,000
Obligations under capital leases with interest rates ranging from 4.83% to 12.00%		491		420

Current portion of long-term debt	$	15,491	$	15,420


	June 30, 2004			March 31, 2004
Cumulative translation adjustment	$	5,320		$	5,594
Net unrealized loss on short-term investments		(351	)		(276	)

Accumulated other comprehensive income	$	4,969		$	5,318


	Common Stock			Additional Paid-in Capital
	Shares	Amount		Additional Paid-in Capital
Balance at March 31, 2004	33,543	$	34	$	195,503
Issuance of common stock under employee stock plan	28		—		109
Issuance of common stock in connection with Best Buy agreement	1,100		1		4,909
Adjustment to additional paid-in capital	—		—		186
Stock-based compensation	—		—		30

Balance at June 30, 2004	34,671	$	35	$	200,737


	June 30, 2004		March 31, 2004
United States	$	11,682	$	12,969
Canada		879		964
Other countries		682		748

	$	13,243	$	14,681


	As a Percentage of Net Revenues For the Three Months Ended June 30,
	2004		2003
Net revenues	100	%	100	%
Cost of revenues	39		34

Gross margin	61		66

Operating expenses:
Research and development	22		29
Sales and marketing	35		39
General and administrative	16		22
Restructuring charges	(1	)	6
Amortization of intangible assets	2		2
Stock-based compensation charges	2		2

Total operating expenses	76		100


Loss from operations	(15	)	(34	)
Gain on sale of GoBack product line	6		44
Other income, net	1		—


Income (loss) before provision for income taxes	(8	)	10
Provision for income taxes	1		12


Net loss	(9	%)	(2	%)


	For the Three Months Ended June 30,				As a Percentage of Net Revenues For the Three Months Ended June 30,
	2004		2003		2004		2003
	(in thousands)
Consumer software revenues:
Retail	$	18,273	$	16,920	61	%	70	%
OEM		3,775		6,475	13	%	27	%

		22,048		23,395	74	%	97	%
Online music revenues :
Content		6,708		781	22	%	3	%
Product and licenses		1,159		—	4	%	—

		7,867		781	26	%	3	%

Total net revenues	$	29,915	$	24,176	100	%	100	%


	Gross Margin For the Three Months Ended June 30,						As a Percentage of Comparable Revenues For the Three Months Ended June 30,
	2004			2003			2004		2003
	(in thousands)
Consumer software :
Retail	$	13,867		$	10,085		76	%	60	%
OEM		3,556			6,324		94	%	98	%
Amortization of purchased technology		(665	)		(572	)	—		—

Total consumer software margin		16,758			15,837		76	%	68	%
Online music :
Content		1,392			161		21	%	21	%
Product and license		59			—		5	%	—
Amortization of purchased technology		(31	)		(15	)	—		—

Total online music margin		1,420			146		18	%	19	%

Total blended gross margin	$	18,178		$	15,983		61	%	66	%


	For the Three Months Ended June 30,					As a Percentage of Net Revenues For the Three Months Ended June 30,
	2004			2003		2004		2003
Research and development	$	6,478		$	6,934	22	%	29	%
Sales and marketing		10,390			9,407	34	%	39	%
General and administrative		4,861			5,277	16	%	22	%
Restructuring charges		(153	)		1,536	(1	%)	6	%
Amortization of intangible assets		576			617	2	%	2	%
Stock-based compensation charges		382			519	1	%	2	%

	$	22,534		$	24,290	74	%	100	%


	Maturing in
	Less than One Year			More than One Year			Total		Estimated Fair Value
	(Dollars in thousands)
Short-term investments	$	30,128		$	13,267		$	43,395	$	43,395
Weighted-average interest rate		1.94	%		4.94	%


Exhibit Number		Description of Exhibit

2.1		Asset Purchase Agreement between the Registrant and Napster, Inc., Napster Music Company, Inc., and Napster Mobile Company, Inc., dated November 15, 2002. (1)

2.2		Purchase Agreement among the Registrant, UMG Duet Holdings, Inc., a Delaware corporation, and SMEI Duet Holdings, Inc., a Delaware corporation, dated May 19, 2003. (2)

2.3		Asset Purchase Agreement dated April 17, 2003 by and between Registrant, Roxio CI Ltd., Wildfile, Inc. Symantec Ltd. and Symantec Corporation (3)

3.1		Amended and Restated Certificate of Incorporation of the Registrant (4)

3.2		Amended and Restated Bylaws of the Registrant (5)

3.3		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of the Registrant (6)

4.1		Form of Common Stock certificate of the Registrant (5)

4.2		Registration Rights Agreement dated May 17, 2001 between the Registrant and Virgin Holdings, Inc. (7)

4.3		Preferred Stock Rights Agreement, dated as of May 18, 2001, between the Registrant and Mellon Investor Services, LLC, including the Certificate of Designation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively (6)

4.4		Warrant Agreement between the Registrant and Napster, Inc. dated November 27, 2002 (1)

4.5		Form of Purchase Agreement dated as of June 18, 2003 by and between the Registrant and certain Purchasers set forth on the signature page thereto (8)

4.6		Amended and Restated LLC Operating Agreement of Napster, LLC dated May 19, 2003 by and between the Registrant, UMG Duet Holdings, Inc. and SMEI Duet Holdings, Inc. (5)

4.7		Form of Purchase Agreement dated as of January 13, 2004 by and between the Registrant and certain Purchasers set forth on the signature page thereto (9)

4.8		Registration Rights Agreement dated June 17, 2004 between the Registrant and Best Buy Enterprise Services Inc. (10)

4.9		Common Stock Purchase Agreement between the Registrant and Best Buy Enterprise Services Inc. dated June 17, 2004 (10)

10.1		The Loan Modification Agreement dated June 8, 2004 to the Loan and Security Agreement dated March 25, 2004 between the Registrant and Silicon Valley Bank

31.1		Certification of Chief Executive Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification pursuant to 18 U.S.C. Section 1350, required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002