##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549




---

FORM 10-Q



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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended June 30,
2001

Commission File Number 000-26697

MP3.com, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                |  |                                      
|--------------------------------------------------------------- |  | -------------------------------------
|                                                               
|                                                               
|                                                               
|                                                               
|Delaware                                                        |  | 33-0840026                           
|(State or other jurisdiction of
	Incorporation or organization) |  | (I.R.S. Employer
	Identification No.)
|                                                               
|4790 Eastgate Mall, San Diego, CA                               |  | 92121                                
|(Address of principal executive
	offices)                       |  | (Zip Code)                           

(858) 623-7000

(Registrants telephone number, including
area code)


N/A

(Former name, former address and former fiscal
year, if changed since last reported)


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 twelve 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 ninety days.  Yes 
x  No 
o

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

Common Stock, $0.001 per share par value,
69,890,861 shares outstanding as of July 31, 2001.

This report contains 62 pages



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---

TABLE OF CONTENTS



|                                             |                                                                                              |  |  |  |  |  |  | 
|-------------------------------------------- | -------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I -- CONSOLIDATED FINANCIAL INFORMATION
|                                             | Item 1.Consolidated Financial Statements                                                    
|                                             | Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                             | Item 3. Quantitative and Qualitative Disclosures about Market Risk                          
|PART II  OTHER INFORMATION                 
|                                             | Item 1. Legal Proceedings                                                                   
|                                             | Item 2. Changes in Securities and Uses of Proceeds                                          
|                                             | Item 4. Submission of Matters to a Vote of Security Holders                                 
|                                             | Item 6. Exhibits and Reports on Form 8-K                                                    
|SIGNATURES                                  
|EXHIBIT 2.2                                 
|EXHIBIT 3.3                                 
|EXHIBIT 10.29                               
|EXHIBIT 10.36                               
|EXHIBIT 10.37                               
|EXHIBIT 10.38                               
|EXHIBIT 10.39                               
|EXHIBIT 10.40                               



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##### Table of Contents



MP3.COM, INC.

FORM 10-Q

For the Quarter Ended June 30,
2001


INDEX

|                                             |  |                                                                                        |  |      |    | 
|-------------------------------------------- |  | -------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                             |  |                                                                                        |  | Page
|                                             |  |                                                                                        |  |     
|PART I  CONSOLIDATED FINANCIAL
	INFORMATION
|                                            
|                                            
|                                            
|                                            
|                                            
|Item  1.                                     |  | Condensed Consolidated Financial Statements                                            |  |      | 3  | 
|                                            
|                                            
|                                            
|                                            
|Item  2.                                     |  | Managements Discussion and Analysis of
	Financial Condition and Results of Operations |  |      | 15 | 
|                                            
|                                            
|                                            
|                                            
|Item  3.                                     |  | Quantitative and Qualitative Disclosures About
	Market Risk                            |  |      | 53 | 
|                                            
|                                            
|                                            
|                                            
|PART II  OTHER
	INFORMATION                
|                                            
|                                            
|                                            
|                                            
|                                            
|Item  1.                                     |  | Legal Proceedings                                                                      |  |      | 55 | 
|                                            
|                                            
|                                            
|                                            
|Item  2.                                     |  | Changes in Securities and Uses of Proceeds                                             |  |      | 59 | 
|                                            
|                                            
|                                            
|                                            
|Item  4.                                     |  | Submission of Matters to a Vote of Security
	Holders                                   |  |      | 60 | 
|                                            
|                                            
|                                            
|                                            
|Item  6.                                     |  | Exhibits and Reports on Form 8-K                                                       |  |      | 61 | 

2



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##### Table of Contents






PART I  CONSOLIDATED FINANCIAL
INFORMATION




Item 1. Consolidated Financial
Statements

MP3.COM, INC.

CONDENSED CONSOLIDATED BALANCE
SHEETS

(In thousands, except for share and per share
data)


ASSETS

|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |          |         | 
|-------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------------ | ------- |  | ------ | -------- | ------- | 
|                                                                                             |                                                                                                                                                                                                                     | June 30,                                   |        | December 31,
|                                                                                             |                                                                                                                                                                                                                     | 2001                                       |        | 2000        
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |             
|                                                                                             |                                                                                                                                                                                                                     | (Unaudited)                                |        |             
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Current assets:                                                                              |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Cash and cash equivalents                                                                                                                                                                                           |                                            | $      | 76,805       |         |  | $      | 83,858   |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Short-term investments in marketable securities                                                                                                                                                                     |                                            |        |             |         |  |        | 14,988   |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Accounts receivable, net                                                                                                                                                                                            |                                            |        | 4,053        |         |  |        | 4,409    |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Restricted cash                                                                                                                                                                                                     |                                            |        |             |         |  |        | 30,000   |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Unbilled receivables                                                                                                                                                                                                |                                            |        | 1,667        |         |  |        | 2,021    |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Prepaid expenses and other current assets                                                                                                                                                                           |                                            |        | 15,455       |         |  |        | 11,074   |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Prepaid multimedia content royalties                                                                                                                                                                                |                                            |        | 8,583        |         |  |        | 8,755    |        
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                             |                                                                                                                                                                                                                     | Total current assets                       |        |              | 106,563 |  |        |          | 155,105 | 
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Property and equipment, net of accumulated
	depreciation                                     |                                                                                                                                                                                                                     |                                            | 17,431 |              |         |  | 20,270 |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Prepaid marketing and promotions expense, net of
	accumulated amortization                   |                                                                                                                                                                                                                     |                                            | 3,444  |              |         |  | 3,579  |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Prepaid multimedia content royalties, net of
	accumulated amortization, less current portion |                                                                                                                                                                                                                     |                                            | 38,443 |              |         |  | 41,633 |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Strategic investments                                                                        |                                                                                                                                                                                                                     |                                            | 10,210 |              |         |  | 11,410 |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Other non-current assets                                                                     |                                                                                                                                                                                                                     |                                            | 5,666  |              |         |  | 6,602  |         
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                             |                                                                                                                                                                                                                     | Total assets                               |        | $            | 181,757 |  |        | $        | 238,599 | 
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY                                                        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Current liabilities:                                                                         |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Accounts payable                                                                                                                                                                                                    |                                            | $      | 3,541        |         |  | $      | 4,767    |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Accrued expenses                                                                                                                                                                                                    |                                            |        | 14,567       |         |  |        | 15,690   |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Deferred revenues                                                                                                                                                                                                   |                                            |        | 2,284        |         |  |        | 1,104    |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Reserve for litigation and copyright matters                                                                                                                                                                        |                                            |        | 41,328       |         |  |        | 42,933   |        
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                             |                                                                                                                                                                                                                     | Total current liabilities                  |        |              | 61,720  |  |        |          | 64,494  | 
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Other liabilities                                                                            |                                                                                                                                                                                                                     |                                            | 456    |              |         |  | 389    |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Stockholders equity:                                                                        |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Preferred stock, par value $0.001 per share;
	15,000,000 authorized at June 30, 2001 and
	December 31, 2000; none issued and outstanding at
	June 30, 2001 and December 31, 2000                                    |                                            |        |             |         |  |        |         |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Common stock, par value $0.001 per share;
	300,000,000 authorized at June 30, 2001 and
	December 31, 2000; 69,113,512 and 68,529,044 issued and
	outstanding at June  30, 2001 and December 31, 2000,
	respectively |                                            |        | 69           |         |  |        | 69       |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Additional paid in capital                                                                                                                                                                                          |                                            |        | 502,017      |         |  |        | 501,194  |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Common shares issuable                                                                                                                                                                                              |                                            |        | 5,391        |         |  |        |         |        
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Notes receivable from stockholders                                                                                                                                                                                  |                                            |        | (5,106       | )       |  |        | (258     | )      
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Deferred compensation                                                                                                                                                                                               |                                            |        | (2,754       | )       |  |        | (4,945   | )      
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Accumulated other comprehensive loss                                                                                                                                                                                |                                            |        | (9           | )       |  |        | (12      | )      
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Accumulated deficit                                                                                                                                                                                                 |                                            |        | (380,027     | )       |  |        | (322,332 | )      
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                             |                                                                                                                                                                                                                     | Total stockholders equity                 |        |              | 119,581 |  |        |          | 173,716 | 
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         
|                                                                                             |                                                                                                                                                                                                                     | Total liabilities and stockholders equity |        | $            | 181,757 |  |        | $        | 238,599 | 
|                                                                                             |                                                                                                                                                                                                                     |                                            |        |              |         |  |        |         

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

3



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##### Table of Contents



MP3.COM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except for share and per share
data)


(Unaudited)


|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |            |        |         | 
|----------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------- | ------------------ | ------------------------ | ---------------- | ------ | -------- | -------- | ---------- | ------ | ------- | ------- | ---------- | ------ | ------ | -------- | ---------- | ------ | ------- | 
|                                                                                          |                                                                                                                      |                    |                          |                 
|                                                                                          |                                                                                                                      | Three Months Ended |                          | Six Months Ended
|                                                                                          |                                                                                                                      |                    |                          |                 
|                                                                                          |                                                                                                                      | June 30,           |                          | June 30,         |        | June 30, |          | June 30,  
|                                                                                          |                                                                                                                      | 2001               |                          | 2000             |        | 2001     |          | 2000      
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |           
|Net revenues                                                                              |                                                                                                                      | $                  | 17,533                   |                  |        | $        | 20,178   |            |        | $       | 39,283  |            |        | $      | 37,673   |           
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Cost of revenues (excludes deferred compensation
	of $, $57, $, and $128, respectively) |                                                                                                                      |                    | 4,202                    |                  |        |          | 3,812    |            |        |         | 9,077   |            |        |        | 7,568    |           
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|                                                                                          |                                                                                                                      | Gross profit       |                          |                  | 13,331 |          |          |            | 16,366 |         |         |            | 30,206 |        |          |            | 30,105 |        
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Operating expenses:                                                                       |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Sales and marketing (excludes deferred
	compensation of $226, $419, $547, and $1,010, respectively)                  |                    |                          | 6,893            |        |          |          | 11,961     |        |         |         | 17,384     |        |        |          | 28,963     |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Engineering and product development (excludes
	deferred compensation of $249, $669, $574, and $1,474,
	respectively) |                    |                          | 5,259            |        |          |          | 6,125      |        |         |         | 10,854     |        |        |          | 11,404     |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | General and administrative (excludes deferred
	compensation of $271, $789, $596, and $3,724, respectively)           |                    |                          | 5,383            |        |          |          | 6,597      |        |         |         | 11,601     |        |        |          | 14,359     |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Charges related to class action and derivative
	lawsuits                                                             |                    |                          | 3,270            |        |          |          |           |        |         |         | 44,698     |        |        |          |           |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Costs related to acquisition activities                                                                              |                    |                          | 3,160            |        |          |          |           |        |         |         | 3,160      |        |        |          | 1,704      |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Amortization of deferred and other stock-based
	compensation                                                         |                    |                          | 746              |        |          |          | 1,934      |        |         |         | 1,717      |        |        |          | 6,336      |       
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Charge related to copyright claims                                                                                   |                    |                          |                 |        |          |          | 150,000    |        |         |         |           |        |        |          | 150,000    |       
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|                                                                                          |                                                                                                                      |                    | Total operating expenses |                  |        | 24,711   |          |            |        | 176,617 |         |            |        | 89,414 |          |            |        | 212,766 | 
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|Loss from operations                                                                      |                                                                                                                      |                    | (11,380                  | )                |        |          | (160,251 | )          |        |         | (59,208 | )          |        |        | (182,661 | )         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Interest income, net                                                                      |                                                                                                                      |                    | 1,013                    |                  |        |          | 5,016    |            |        |         | 2,713   |            |        |        | 10,794   |           
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Impairment of strategic investments                                                       |                                                                                                                      |                    | (1,200                   | )                |        |          | (21,570  | )          |        |         | (1,200  | )          |        |        | (21,670  | )         
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|Loss before minority interest                                                             |                                                                                                                      |                    | (11,567                  | )                |        |          | (176,805 | )          |        |         | (57,695 | )          |        |        | (193,537 | )         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|Minority interest in losses of an unconsolidated
	subsidiary                              |                                                                                                                      |                    |                         |                  |        |          | 263      |            |        |         |        |            |        |        | 1,668    |           
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|Net loss                                                                                  |                                                                                                                      | $                  | (11,567                  | )                |        | $        | (177,068 | )          |        | $       | (57,695 | )          |        | $      | (195,205 | )         
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|Net loss per share:                                                                       |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                          | Basic and diluted                                                                                                    |                    | $                        | (0.17            | )      |          | $        | (2.71      | )      |         | $       | (0.86      | )      |        | $        | (2.98      | )     
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           
|                                                                                          | Weighted average shares  basic and
	diluted                                                                         |                    |                          | 67,381,000       |        |          |          | 65,384,000 |        |         |         | 67,185,000 |        |        |          | 65,430,000 |       
|                                                                                          |                                                                                                                      |                    |                          |                  |        |          |          |            |        |         |         |            |        |        |          |           

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

4



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##### Table of Contents



MP3.COM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


(Unaudited)


|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |         |         |         |  
|---------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | --------------------------------- | -------- | ------ | ------- | -------- | ------- | ------- | ------- | -
|                                                                                   |                                                                                                                         |                                             
|                                                                                   |                                                                                                                         | Six Months Ended                            
|                                                                                   |                                                                                                                         |                                             
|                                                                                   |                                                                                                                         | June 30,                                     |                                   | June 30,
|                                                                                   |                                                                                                                         | 2001                                         |                                   | 2000    
|                                                                                   |                                                                                                                         |                                              |                                   |         
|Operating activities:                                                              |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Net loss                                                                           |                                                                                                                         | $                                            | (57,695                           | )        |        | $       | (195,205 | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Adjustments to reconcile net loss to cash used in
	operating activities:           |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Depreciation, amortization of goodwill and
	intangible assets, and amortization of prepaid multimedia
	royalty licenses |                                              |                                   | 8,786    |        |         |          | 2,741   |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Charge related to class action and derivative
	lawsuits (non-cash portion)                                              |                                              |                                   | 5,391    |        |         |          |        |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Amortization of deferred compensation                                                                                   |                                              |                                   | 1,716    |        |         |          | 6,336   |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Impairment of strategic investments                                                                                     |                                              |                                   | 1,200    |        |         |          | 21,670  |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Loss from the sale of fixed assets                                                                                      |                                              |                                   | 284      |        |         |          | 91      |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Charge for copyright claims                                                                                             |                                              |                                   |         |        |         |          | 150,000 |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Stock based charges associated with the
	acceleration of stock option vesting                                           |                                              |                                   |         |        |         |          | 7,195   |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Amortization of stock based marketing                                                                                   |                                              |                                   |         |        |         |          | 417     |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Changes in operating assets and liabilities:                                                                            |                                              |                                   |          |        |         |          |         |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Restricted cash                              |                                   |          | 30,000 |         |          |         |        |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Accounts receivable                          |                                   |          | 356    |         |          |         | 3,352   |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Unbilled receivables                         |                                   |          | 529    |         |          |         | (470    | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Prepaid expenses and other current assets    |                                   |          | (3,692 | )       |          |         | (1,690  | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Accounts payable                             |                                   |          | (1,226 | )       |          |         | (350    | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Accrued expenses                             |                                   |          | (1,056 | )       |          |         | 13,289  |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Reserve for litigation and copyright matters |                                   |          | (4,847 | )       |          |         | (28,518 | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |                                                                                                                         | Deferred revenue                             |                                   |          | 1,180  |         |          |         | (14,628 | )      
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                   |                                                                                                                         |                                              | Cash used in operating activities |          |        | (19,074 | )        |         |         | (35,770 | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Investing activities:                                                              |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Purchase of property and equipment                                                 |                                                                                                                         |                                              | (1,824                            | )        |        |         | (8,333   | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Maturities of short-term investments in
	marketable securities, net                |                                                                                                                         |                                              | 14,991                            |          |        |         | 104,591  |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Refund of prepaid multimedia content royalties,
	net                               |                                                                                                                         |                                              | 3,157                             |          |        |         |         |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Other assets                                                                       |                                                                                                                         |                                              | 59                                |          |        |         | (20,099  | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Purchases of strategic investments                                                 |                                                                                                                         |                                              |                                  |          |        |         | (39,737  | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Issuance of loan receivable                                                        |                                                                                                                         |                                              |                                  |          |        |         | (4,000   | )      
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Cash provided by investing activities                                              |                                                                                                                         |                                              | 16,383                            |          |        |         | 32,422   |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Financing activities:                                                              |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Proceeds from the issuance of common stock                                         |                                                                                                                         |                                              | 486                               |          |        |         | 1,084    |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Issuance of note receivable to shareholder                                         |                                                                                                                         |                                              | (4,848                            | )        |        |         |         |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Repurchase of unvested common stock                                                |                                                                                                                         |                                              |                                  |          |        |         | (2,400   | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Payments on line of credit                                                         |                                                                                                                         |                                              |                                  |          |        |         | (435     | )      
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Cash used in financing activities                                                  |                                                                                                                         |                                              | (4,362                            | )        |        |         | (1,751   | )      
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Translation adjustment                                                             |                                                                                                                         |                                              |                                  |          |        |         | 2        |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Decrease in cash and cash equivalents                                              |                                                                                                                         |                                              | (7,053                            | )        |        |         | (5,097   | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Cash and cash equivalents at beginning of period                                   |                                                                                                                         |                                              | 83,858                            |          |        |         | 193,192  |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Cash and cash equivalents at end of period                                         |                                                                                                                         | $                                            | 76,805                            |          |        | $       | 188,095  |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Supplemental disclosures of cash flow
	information:                                |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Interest paid                                                                      |                                                                                                                         | $                                            |                                  |          |        | $       | 51       |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Taxes paid                                                                         |                                                                                                                         | $                                            | 5                                 |          |        | $       |         |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Supplemental schedule of non-cash
	activities:                                     |                                                                                                                         |                                              |                                   |          |        |         |          |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Reduction in deferred compensation associated
	with stock option forfeitures       |                                                                                                                         | $                                            | 474                               |          |        | $       | 3,704    |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Unrealized gain (loss) on marketable
	securities, net                              |                                                                                                                         | $                                            | 3                                 |          |        | $       | (2,820   | )      
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Unbilled receivable related to the sale of
	equipment                              |                                                                                                                         | $                                            | 175                               |          |        | $       |         |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Other receivables in connection with stock option
	exercises                       |                                                                                                                         | $                                            | 812                               |          |        | $       |         |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        
|Stock based compensation associated with the
	acceleration of stock option vesting |                                                                                                                         | $                                            |                                  |          |        | $       | 6,400    |        
|                                                                                   |                                                                                                                         |                                              |                                   |          |        |         |          |        

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

5



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##### Table of Contents



MP3.COM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

Note 1  The Company and Summary of
Significant Accounting Policies

The Company

MP3.com, Inc. (MP3.com) has created a
unique and robust technology infrastructure designed to
facilitate the storage, management, promotion, and delivery of
digital music. As a Music Service Provider (MSP), MP3.com is
dedicated to providing consumers access to music when they want
it, where they want it, using any web-enabled device.
MP3.coms web site hosts large catalogs of digital music
available on the Internet. Dedicated to growing the digital
music space, MP3.coms products, services and initiatives
include on-demand Subscription Music Channels, Business Music
Services program, a Syndicated Radio program and its Music
InterOperating System initiative.

MP3.com shares of Common Stock are listed for
trading on the Nasdaq National Market System under the symbol
MPPP. MP3.com was incorporated in the state of
Delaware on March 17, 1998 and commenced operations on that
date. MP3.com is headquartered in San Diego, California.

Basis of Presentation

The accompanying condensed consolidated financial
statements as of June 30, 2001 and for the three and six
months ended June 30, 2001 and 2000 are unaudited and have
been prepared by MP3.com pursuant to the rules and regulations
of the Securities and Exchange Commission (SEC). The
unaudited condensed consolidated financial statements have been
prepared on the same basis as the audited consolidated financial
statements and, in the opinion of management, include all
adjustments, consisting only of normal recurring adjustments,
necessary to state fairly the financial information included, in
accordance with accounting principles generally accepted in the
United States. Certain information and footnote disclosures
normally included in consolidated financial statements prepared
in accordance with accounting principles generally accepted in
the United States have been omitted pursuant to such SEC rules
and regulations. The condensed consolidated results of
operations for the three and six months ended June 30, 2001
are not necessarily indicative of the results which may be
reported for any other interim period or for the year ending
December 31, 2001. Certain prior period amounts have been
reclassified to conform to the current period presentation.

Principles of Consolidation

The consolidated financial statements include the
accounts of MP3.com and its wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated. The equity and net income or loss attributable to
the minority stockholder interests which relate to
MP3.coms subsidiaries are shown separately in the
condensed consolidated balance sheets and condensed consolidated
statements of operations, respectively. Investments in entities
over which MP3.com can exercise significant influence, but which
are less than majority owned and not otherwise controlled by
MP3.com, are accounted for under the equity method. Under the
equity method of accounting, MP3.coms share of the
investees earnings or losses are included in condensed
consolidated statements of operations as Minority interest
in losses of an unconsolidated subsidiary. All other
investments, either in entities over which MP3.com does not have
the ability to exercise significant influence or for which there
is not a readily determinable market value, are accounted for
under the cost method of accounting. Dividends and other
distributions of earnings from investees, if any, are included
in income when declared.

Use of Estimates

The preparation of 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 consolidated financial

6



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##### Table of Contents



MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

statements and the reported amounts of revenues
and expenses during the reporting period. Examples include
provisions for returns, bad debts, valuation of privately held
strategic investments, the ultimate realizability of the prepaid
multimedia content royalties, the reserve for litigation and
copyright matters and the charge and reserve for class action
and derivative lawsuits. Actual results could differ from those
estimates.

Net Loss Per Share

MP3.com computes net loss per share following
SFAS No. 128 Earnings Per Share and SEC Staff
Accounting Bulletin No. 98 (SAB 98). Under
the provisions of SFAS No. 128, basic net loss per share is
computed by dividing the net loss available to common
stockholders for the period by the weighted average number of
common shares outstanding during the period. Diluted net loss
per share is computed by dividing the net loss for the period by
the weighted average number of common and common equivalent
shares outstanding during the period. Common equivalent shares,
composed of unvested restricted common shares, incremental
common shares issuable upon the exercise of stock options, and
common shares issuable upon the exercise of warrants for common
stock, are included in diluted net loss per share to the extent
these shares are dilutive. Common equivalent shares are not
included in the computation of dilutive net loss per share for
the three and six months ended June 30, 2001 and 2000
because the effect would be anti-dilutive.

Under the provisions of SAB 98, common shares
issued for nominal consideration, if any, would be included in
the per share calculations as if they were outstanding for all
periods presented. No common shares have been issued for nominal
consideration.

The following table sets forth the computation of
basic and diluted net loss per share as follows (in thousands,
except share and per share data):

|                                              |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |            |  
|--------------------------------------------- | ------------------------------------------------------------------------- | ------------------ | ---------- | ---------------- | - | -------- | ---------- | ---------- | - |  | ---------- | ---------- | - |  | ---------- | ---------- | -
|                                              |                                                                           |                    |            |                 
|                                              |                                                                           | Three Months Ended |            | Six Months Ended
|                                              |                                                                           |                    |            |                 
|                                              |                                                                           | June 30,           |            | June 30,         |   | June 30, |            | June 30,  
|                                              |                                                                           | 2001               |            | 2000             |   | 2001     |            | 2000      
|                                              |                                                                           |                    |            |                  |   |          |            |           
|Numerator:                                    |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           
|                                             
|                                             
|                                             
|                                             
|                                              | Net loss                                                                  |                    | $          | (11,567          | ) |          | $          | (177,068   | ) |  | $          | (57,695    | ) |  | $          | (195,205   | )
|                                              |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           
|Denominator:                                  |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average shares outstanding                                       |                    |            | 68,850,000       |   |          |            | 68,249,000 |   |  |            | 68,733,000 |   |  |            | 67,962,000 |  
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average unvested common shares subject
	to repurchase agreements |                    |            | (1,469,000       | ) |          |            | (2,865,000 | ) |  |            | (1,548,000 | ) |  |            | (2,532,000 | )
|                                              |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           
|Denominator for basic and diluted calculation |                                                                           |                    | 67,381,000 |                  |   |          | 65,384,000 |            |   |  | 67,185,000 |            |   |  | 65,430,000 |           
|                                              |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           
|Net loss per share:                           |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           
|                                             
|                                             
|                                             
|                                             
|                                              | Basic and diluted                                                         |                    | $          | (0.17            | ) |          | $          | (2.71      | ) |  | $          | (0.86      | ) |  | $          | (2.98      | )
|                                              |                                                                           |                    |            |                  |   |          |            |            |   |  |            |            |   |  |            |           

Diluted common stock equivalents include common
stock options, warrants for common stock (as if converted),
restricted stock that has not yet fully vested, and common
shares issuable in connection with MP3.coms settlement
agreement for the class action and derivative lawsuits (see
Note 2). Potentially dilutive securities totaled
approximately 5,203,000 and 5,165,000 common shares for the
three and six month periods ended June 30, 2001 and
6,785,000 and 6,452,000 common shares for the three and six
month periods ended June 30, 2000, respectively, and were
excluded from historical diluted loss per share because of their
anti-dilutive effect.

Comprehensive Income

MP3.com has adopted the provisions of SFAS
No. 130, Reporting Comprehensive Income. SFAS
No. 130 establishes standards for reporting comprehensive
income and its components in condensed consolidated financial
statements. Comprehensive income includes all changes in equity
(net assets) during a period from

7



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##### Table of Contents



MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

non-owner sources. Net loss and other
comprehensive loss, including foreign currency translation
adjustments, and unrealized gains and losses on investments
shall be reported, net of their related tax effect, to arrive at
comprehensive loss. There were no differences between
MP3.coms net loss and its total comprehensive loss for the
three and six months ended June 30, 2001 and 2000, except
for unrealized gains (losses) on investments of
approximately $2,000 and $3,000 and $2,953,000 and $(2,820,000),
respectively.

Segment Information

MP3.com has adopted the provisions of SFAS
No. 131, Disclosures about Segments of an Enterprise
and Related Information. SFAS 131 requires public
companies to report financial and descriptive information about
their reportable operating segments. MP3.com identifies its
operating segments based on how management internally evaluates
separate financial information, business activities and
management responsibility. MP3.com believes it operates in a
single business segment. Through June 30, 2001, MP3.com has
had insignificant foreign operations.

A summary of advertising and non-advertising
revenue from customers is as follows (in thousands):

|                |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 
|--------------- |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|                |  |                    |        |                 
|                |  | Three Months Ended |        | Six Months Ended
|                |  | June 30,           |        | June 30,        
|                |  |                    |        |                 
|                |  | 2001               |        | 2000             |  | 2001 |        | 2000
|                |  |                    |        |                  |  |      |        |     
|Advertising     |  | $                  | 14,998 |                  |  | $    | 16,394 |      |  | $ | 35,009 |  |  | $ | 30,977 | 
|               
|               
|               
|               
|Non-advertising |  |                    | 2,535  |                  |  |      | 3,784  |      |  |   | 4,274  |  |  |   | 6,696  | 
|                |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 
|                |  | $                  | 17,533 |                  |  | $    | 20,178 |      |  | $ | 39,283 |  |  | $ | 37,673 | 
|                |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |        | 

Note 2  Legal Proceedings

Copyright Litigation

Major Label
Lawsuits.On January 21, 2000,
ten major recording companies filed a copyright infringement
lawsuit against MP3.com, Inc. in the United States District
Court for the Southern District of New York (the Major
Label Lawsuit). The complaint alleged that MP3.com, in
connection with certain content available in its My.MP3 service,
made unauthorized copies of tens of thousands of audio CDs in
violation of the Copyright Act. On April 28, 2000, the
court granted plaintiffs motion for summary judgment and
held that MP3.com was liable for infringing plaintiffs
copyrights, and the litigation proceeded with discovery on the
issues of willfulness and damages. On May 10, 2000, MP3.com
disabled all content within the My.MP3 service except as
expressly authorized by the copyright holders.

Between June and August 2000, MP3.com entered
into settlement and license agreements with Warner Music Group,
BMG Entertainment, Sony Music, and Capitol Records, Inc. (EMI),
which together represented eight of the ten major recording
companies that filed the Major Label Lawsuit. The settlement
agreements provide for a settlement amount to be paid in cash by
MP3.com in exchange for a release from the settling plaintiffs
and their affiliated entities (as defined in the settlement
agreements) of all claims related to the lawsuit and the My.MP3
service. Most-favored-nation provisions in these
settlement agreements require additional settlement amounts to
be paid under certain circumstances.

As a result of these settlements, the Major Label
Lawsuit was limited to a dispute with UMG Recordings, Inc.,
which represented two of the original plaintiffs. A trial in the
case was held from August 28 through September 6, 2000
on the issues of willfulness and damages. After hearing
evidence, the court ruled on September 6, 2000 that MP3.com
had willfully infringed UMGs copyrights and awarded
damages to UMG in an amount of $25,000 per CD. The Court then
scheduled a period to allow MP3.com to conduct discovery
concerning the certificates of registration for which plaintiffs
sought damages. On November 16, 2000, UMG made a motion for
entry of judgment in the amount of $53,400,000 in statutory
damages, costs, and attorneys fees, which MP3.com did not
oppose. As a result, a judgment in that amount was entered.

8



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##### Table of Contents



MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

MP3.com has also entered into a license agreement
with UMG. Subject to certain affirmative obligations of MP3.com
and other terms and conditions regarding the implementation of
the My.MP3 service, MP3.com is permitted to utilize the
recordings owned by Warner Music Group, BMG Entertainment, Sony
Music, EMI, and UMG as part of the My.MP3 service. The license
agreements have terms of approximately three to ten years, and
provide for payment of a one-time fee each time a
licensors recording is added to a separate My.MP3 account.
These licenses also provide for on-going royalty payments based
on the greater of (i) a specified percentage of net
revenues generated from or in connection with the My.MP3 service
or (ii) a specified amount accrued each time a
licensors recording is streamed from My.MP3. Although
MP3.com has obtained license agreements permitting the use of
recordings from BMG Entertainment, Warner Music Group, Sony
Music, UMG, EMI, and certain other independent labels, there can
be no guarantee that MP3.com will be able to secure similar
license agreements from any other recording company.

Other Record Label
Lawsuits.Over the course of 2000 and
2001, some other entities filed lawsuits against MP3.com based
on the same set of allegations as the Major Label Lawsuit. These
include: Tee Vee Toons, Inc.; Zomba Recording Corp. (the
Zomba case); Koch Entertainment and Velvel Records
LLC (the Koch case); EMusic.com, Inc., Fuel 2000
Records, Spinart, Inc., Gig Records, Fearless Records, and
Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case).
Additionally, several independent labels have sent MP3.com
demand letters alleging similar claims.

A jury trial in the Tee Vee Toons case commenced
on March 26, 2001. Prior to trial, in reliance on the
Courts rulings in the Major Label Lawsuit, the issues of
infringement, fair use, and willfulness were adjudicated against
MP3.com. As a result, the jury trial was limited to the issue of
damages. The trial concluded on April 6, 2001. The jury
considered 145 copyright certificates and returned a verdict
which the Court tabulated as totaling $292,968. Subsequently,
two jurors contacted the Court to inform it that the verdict
decided upon by the jurors contained discrepancies. The Court
interviewed all the jurors and set a briefing schedule on the
issue of the jurys verdict. On June 19, 2001, the
Court declared a mistrial, and set a new trial date of
November 5, 2001. On June 26, 2001, MP3.com filed a
motion to certify the ruling to the Court of Appeals pursuant to
28 U.S.C. sec. 1292(b). Tee Vee Toons response papers were
filed on June 29, 2001. The Court denied the motion on
July 27, 2001.

Discovery in the Zomba case closed June 4,
2001. The final pre-trial conference is scheduled for
August 10, 2001, and the case is set for trial on
September 5, 2001. Like the Tee Vee Toons case, the trial
in the Zomba case will be limited to only the issue of damages.
The Koch case has been settled and the case is now closed. The
complaint in the EMusic case was filed on December 14,
2000. MP3.coms response to the complaint was filed on
February 8, 2001. On June 20, 2001, MP3.com and EMusic
filed a stipulation of dismissal of their claims against each
other without prejudice. The dismissal was entered by the Court
on June 21, 2001. Plaintiffs counsels motion to
withdraw as counsel to the remaining plaintiffs was granted on
July 23, 2001. On August 7, 2001, the Court will hear
MP3.coms motion to dismiss the case. The Unity case, which
purports to be brought on behalf of Unity, an independent record
company whose works were allegedly used in the My.MP3 service,
and all other similarly situated entities or individuals, was
filed on November 7, 2000. MP3.com answered the Complaint
on January 16, 2001. On April 16, 2001, the Court
entered an order denying plaintiffs motion for class
certification without prejudice to a renewal of the motion
within 45 days. Unity did not renew its motion within the
45 day deadline. Thus, the case may proceed as an
individual action only based on the Unity sound recordings
allegedly infringed by MP3.com.

Publisher Lawsuits.On March 14, 2000, two large music publishing companies,
MPL Communications, Inc. and Peer International Corporation,
with the assistance of The Harry Fox Agency, Inc.
(HFA), filed a copyright infringement lawsuit
against MP3.com in the United States District Court for the
Southern District of New York (the MPL/ Peer case).
The complaint alleged that MP3.com, in connection with its
My.MP3 service, made unauthorized copies of audio CDs containing
plaintiffs copyrighted works in violation of the Copyright
Act, and that MP3.com, in connection with the streaming of audio
content to users of the My.MP3

9



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##### Table of Contents



MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

service, continued to make unauthorized digital
phonorecords in violation of the Copyright Act. The complaint
further alleged that MP3.coms actions constituted
unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs sought damages
(including statutory damages of up to $150,000 per violation)
and injunctive relief prohibiting MP3.com from operating its
My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works.

On October 17, 2000, MP3.com, the National
Music Publishers Association, Inc., and its licensing
subsidiary, HFA, entered into a preliminary agreement to be
approved by individual HFA music publisher-principals for
settlement and use of musical compositions on the My.MP3 service
for a three year term. As a result, MPL and Peer settled the
MPL/ Peer case with MP3.com, and a stipulation of dismissal with
prejudice was subsequently signed by the parties on
December 28, 2000 and entered by the Court on
January 2, 2001.

The three-year licensing arrangement provided
that MP3.com would pay up to $30,000,000 to HFA for the benefit
of up to 25,000 music publishers and their songwriter partners,
to be allocated to two equal funds. One fund was used to pay HFA
publisher-principals for past uses of music on the My.MP3
service, in exchange for a release from HFA publisher-principals
and their affiliated entities of all claims related to those
asserted in the MPL/ Peer case and the use of their compositions
on the My.MP3 service. The other fund provides advance payments
toward royalties earned under the prospective license. The terms
of the prospective license call for a payment of one-quarter
cent each time a song is streamed on demand to a customer from
his or her My.MP3 locker, along with a one-time fee per track
added to the My.MP3 service. The preliminary agreement with HFA
was finalized on February 28, 2001. Approximately 78% of
the publisher-principals HFA represents accepted and are bound
by the settlement agreement and approximately 90% accepted and
are bound by the licensing agreement. In April 2001, HFA
refunded to MP3.com approximately $4,600,000 pursuant to the
agreement, representing approximately $3,200,000 and $1,400,000
for the proportion of HFA publisher-principals that did not
settle or license content to MP3.com, respectively.

Zomba Enterprises, Inc. has filed its own music
publishing case against MP3.com making allegations like those
set forth in the MPL/ Peer case. The case is set for trial on
September 5, 2001. In the second quarter of 2001, similar
publisher lawsuits were filed by Randy Newman, Tom Waits, and
Ann and Nancy Wilson (the Newman case) and Major Bob
Music, Inc., Rio Bravo Music, Inc., Castle Bound Music Inc.,
Dream Catcher Music, Inc., and Moon Catcher Music, Inc. (the
Major Bob case). The Newman case was filed on
May 7, 2001 in the United States District Court for the
Central District of California. MP3.com filed its answer to the
complaint on June 15, 2001. The Major Bob case was filed on
May 14, 2001. MP3.com filed its answer to the complaint on
June 28, 2001. Additionally, several other publishers, not
affiliated with HFA, have sent MP3.com demand letters alleging
similar claims. In view of the Courts rulings in the Tee
Vee Toons and Zomba cases, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be
adjudicated against MP3.com in any and all publisher cases. This
would mean that MP3.com would only be able to litigate the issue
of damages.

Artists
Class Action.On April 12,
2000, several artists filed a class action lawsuit in the United
States District Court for the Southern District of New York
against MP3.com and several major recording companies that
claimed to own copyrights in sound recordings featuring the
artists. The complaint alleged that the recording company
defendants in the Major Label Lawsuit claimed rights in
plaintiffs recordings that they did not possess. In
particular, the complaint alleged that the recording company
defendants did not possess any copyright protections with
respect to plaintiffs pre-1972 published and pre-1978
unpublished recordings, did not possess the right to digitally
transmit plaintiffs pre-1996 recordings over the Internet,
and did not possess the right to control the conversion of
plaintiffs recordings into mp3 files. The complaint
further alleged that MP3.com has used the names and likenesses
of plaintiffs without their consent or authorization and in a
deceptive manner, in violation of the federal Lanham Act, the
New York Civil Rights Law, and unspecified unfair competition
and misappropriation laws. In their prayer for relief,
plaintiffs asked to have their class action certified, to be
awarded unspecified damages and attorneys fees, to have
the defendants enjoined from

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MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

using plaintiffs names and likenesses to
promote downloading music over the Internet, and to receive
declaratory relief regarding plaintiffs rights in their
pre- and post-1972 recordings. On August 28, 2000, the
Court issued an oral ruling dismissing all claims against
MP3.com. On December 7, 2000, judgment was entered
dismissing, with prejudice, the federal claims against the
defendants. All state claims were dismissed for lack of an
independently sufficient jurisdictional basis. Plaintiffs filed
a Notice of Appeal on January 5, 2001. Briefing on the
appeal concluded June 11, 2001. Oral argument on the appeal
has not yet been scheduled but is anticipated to occur after
October 21, 2001.

Copyright Settlement Discussions; Charge to
Operations.MP3.com has pursued and
continues to actively pursue settlement discussions with the
various plaintiffs and claimants in the cases and disputes
discussed above. The decision whether to enter into settlement
and/or license agreements with each party will be based upon a
number of factors related to both the lawsuits and
MP3.coms business in general. MP3.com cannot guarantee
that it will be able to enter into any additional settlement
agreements on terms favorable to MP3.com, if at all, or that any
settlement or license agreement will prove beneficial to its
business or stockholders. During the year ended
December 31, 2000, MP3.com recorded a charge for litigation
and copyright matters of $170,000,000. The charge for litigation
and copyright matters represented its estimate of the total
costs to be incurred only in connection with the resolution of
the various litigation and copyright matters associated with the
My.MP3 service, including the lawsuits filed by major recording
companies and other parties. Copyright issues associated with
the My.MP3 service also include but are not limited to
publishing rights, non-major label content, and legal and
advisory fees. This charge did not reflect or include any
amounts paid or payable in connection with forward-looking
licenses to use music recordings or compositions in connection
with the My.MP3 service. This charge reflects managements
expectations as of the date of this filing, and is based on
currently available information as well as significant
assumptions made by management regarding the various litigation
and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the
cumulative amount reserved as a result of this charge to
$41,328,000 as of June 30, 2001. MP3.com cannot guarantee
that future events or results will conform to its expectations
or assumptions regarding the various litigation and copyright
matters. If these expectations and significant assumptions prove
to be erroneous in light of future events, the actual amounts
incurred by MP3.com to resolve all copyright matters related to
the My.MP3 service could be materially different than those
recorded as of June 30, 2001, and could far exceed the
resources and market capitalization of MP3.com.

Class Action and Derivative
Lawsuits

MP3.com and certain of its employees, officers,
and directors have been named as defendants in several lawsuits
alleging violations of the federal securities laws. The
complaints, which were filed between September 19, 2000 and
November 15, 2000 in the United States District Court for
the Southern District of California, each purport to be brought
on behalf of a class of stockholders. The complaints allege that
MP3.com and the other defendants violated the federal securities
laws by issuing materially false and misleading statements and
failing to disclose material information regarding its My.MP3
service and the litigation surrounding the service. Between
September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits
against MP3.com and certain of its employees, officers, and
directors in the Superior Court of the State of California,
County of San Diego. These complaints allege various statutory
and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud,
gross mismanagement, unjust enrichment, and waste of corporate
assets.

MP3.com and the representatives of the various
plaintiffs for both the class action lawsuits and derivative
lawsuit executed Stipulations of Settlement dated as of
March 20, 2001 (the Stipulations). Under the
terms of the Stipulations, the defendants, while continuing to
deny all liability, have paid into an escrow account $35,000,000
and agreed to issue 2.5 million shares of MP3.com common
stock which MP3.com valued at $5,391,000, in exchange for
complete dismissals and releases of all claims with prejudice.
The escrow amount

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MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

and the 2.5 million shares of common stock
will be governed by the Stipulations. The distribution of the
escrow amount and the 2.5 million shares will not occur
prior to March 31, 2002, except under certain
circumstances, including the sale or other acquisition of
MP3.com prior to the distribution of the 2.5 million shares
of common stock, in which case the stock will be treated equally
with all other outstanding shares of MP3.com common stock. In
addition, under the Stipulations, MP3.com agreed to institute
certain corporate governance enhancements. On June 29,
2001, the State Superior Court issued final approval of the
settlement of the derivative cases. The Federal District Court
entered final approval of the settlement of the class action on
July 16, 2001. As part of the settlement agreement, counsel
for the plaintiffs are to receive 27.5% of the total settlement
fund. Plaintiffs counsels portion of the
2.5 million shares was issued to plaintiffs counsel
on July 31, 2001.

Charge Related to Class Action and
Derivative Lawsuits.In light of the
settlements of the class action and derivative lawsuits, MP3.com
has recorded a charge of $41,428,000 during the three months
ended March 31, 2001. The charge includes the cash paid
into the escrow account, the value of the 2.5 million
shares of common stock to be issued, and an estimate of its
defense and legal advisory costs. While the charge of
$41,428,000 excludes any potential recovery from its insurance
carriers, MP3.com is seeking to recover from its carriers the
full amount of the settlement together with its legal expenses.
National Union has agreed to pay its policy limit of $5,000,000
towards the securities case, but such amount has not yet been
paid. Prior to receiving payment from National Union, MP3.com is
required to provide certain releases. Currently, MP3.com is
reviewing those releases. If MP3.com receives insurance
proceeds, MP3.com will record the recovery as a gain in the
statement of operations caption Charge related to class
action and derivative lawsuits.

In May 2001, in light of the pending transaction
with Vivendi Universal, MP3.com finalized its negotiations with
its lead defense counsel pursuant to the terms of the fee
agreement and agreed to pay an additional $5,000,000 in fees. As
MP3.coms lead counsel also provided various legal services
and advice to MP3.com on matters other than the shareholder
class action and derivative lawsuits, including but not limited
to the copyright matters, insurance recovery, and the pending
merger of MP3.com with Vivendi Universal, MP3.com has allocated
and charged to expense the additional fee during the three
months ended June 30, 2001 as follows: (i) $3,270,000
to charges related to class action and derivative lawsuits,
(ii) $1,402,000 to costs related to acquisition activities,
and (iii) $328,000 to reserve for litigation and copyright
matters.

IPO Allocation Cases

During May and June 2001, MP3.com and certain of
its current and former directors and officers were named
defendants in seven similar class actions pending in federal
district court in the Southern District of New York. The
complaints allege that the prospectus and registration statement
in MP3.coms initial public offering contained materially
false and misleading statements related to underwriting fees,
commissions and other economic benefits connected with the
offering, including alleged tie-in arrangements between the
underwriters and their customers. The complaints allege causes
of action under Sections 11, 12(2) and 15 of the Securities
Act of 1933, as well as Sections 10(b) and 20(a) and
Rule 10b-5 of the Securities Exchange Act of 1934. Similar
cases have been filed against a number of other companies and
their underwriters. There has been no activity in any of these
cases to date.

Other Litigation

MP3.com is also involved in other legal matters
and claims of various types, and from time to time MP3.com may
also be involved in litigation relating to claims arising out of
its operations in the normal course of business.

In particular, the music industry in the United
States is generally regarded as extremely litigious in nature
compared to other industries. As a result, in the future MP3.com
may be engaged in litigation with others in the music industry,
including those entities with whom MP3.com has ongoing license
arrangements. For

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MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

example, some of the major recording companies
that settled their portion of the Major Label Lawsuit with
MP3.com have asserted in writing that they believe the amount
paid by MP3.com to UMG in satisfaction of the Courts
judgment, together with the concurrent issuance of warrants to
UMG, triggered additional payments to them under the most
favored nations clause in their settlement agreement with
MP3.com. Although MP3.com does not believe they are entitled to
any such additional payments, there can be no assurances that
MP3.com will be successful in ultimately concluding this
particular matter in an amicable fashion, or defending any
resulting lawsuit. As a result, MP3.com may be forced to defend
one or more lawsuits on this and other issues in the future, and
in fact may be involved in a number of litigation proceedings
with the same group of related plaintiffs. MP3.com has not
recorded any charge related to any claims for additional
most favored nations payments as of June 30,
2001.

There can be no assurances that MP3.com will be
successful in ultimately defending any of these lawsuits, and
MP3.com may be required to pay license fees or substantial
damages, including statutory, punitive, or other damages that
far exceed the resources and overall market capitalization of
MP3.com, in which event MP3.com may have to significantly limit
or terminate its business operations, particularly because its
business is not yet profitable. At the rate of $25,000 per work
(which is the per CD amount of statutory damages awarded by the
court in the Major Label Lawsuit), MP3.coms aggregate
potential liability resulting from all of its copyright
litigation proceedings could exceed one billion dollars. If
successful, any one of these lawsuits could seriously harm its
business by forcing MP3.com to cease providing services to its
consumers or requiring MP3.com to pay monetary damages. Even if
unsuccessful, these lawsuits still can harm MP3.coms
business severely by damaging its reputation, requiring MP3.com
to incur legal costs, lowering its stock price and public demand
for MP3.com stock, and diverting managements attention
away from MP3.coms primary business activities in general.

Note 3  Related Party
Transaction

In April 2001, MP3.com loaned the chief executive
officer of MP3.com approximately $4,820,000. The loan is secured
by no less than 19,700,000 shares of MP3.com Common Stock held
by the officer and certain other assets, and accrues interest at
6.75%. Principal and interest are due in April 2002 or earlier
if there is a change of control of MP3.com.

Note 4  Merger

In May 2001, MP3.com entered into an Agreement
and Plan of Merger, as amended (the Merger
Agreement), with Vivendi Universal, a société
anonyme organized under the laws of France (Vivendi
Universal), and Metronome Acquisition Sub Inc., a Delaware
corporation and a wholly-owned subsidiary of Vivendi Universal
(Sub). Pursuant to the Merger Agreement, MP3.com
will be merged with and into Sub (the Merger), with
Sub continuing as the surviving corporation and as a
wholly-owned subsidiary of Vivendi Universal. At the effective
time of the Merger, each issued and outstanding share of common
stock of MP3.com will be converted into, at the option of the
holder thereof, the right to elect to receive either (i) $5
in cash, or (ii) a number of Vivendi Universal shares (in
the form of American Depositary Receipts) having a value of $5,
subject to proration. The overall percentage of shares of
MP3.com common stock that will be converted into Vivendi
Universal ordinary shares if fixed at 50% and the percentage of
shares of MP3.com common stock that will be converted into cash
is also fixed at 50%. Therefore, the elections of all holders of
MP3.com common stock may be adjusted on a pro rata basis so
that, in the aggregate, 50% of the shares are converted in to
the right to receive Vivendi Universal ordinary shares and 50%
of the shares are converted into the right to receive cash. The
Merger is expected to qualify as a reorganization under the
Internal Revenue Code of 1986, as amended. As a result, U.S.
holders of MP3.com common stock generally will not recognize any
gain or loss under U.S. federal income tax laws to the extent
they receive Vivendi Universal shares.

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MP3.COM, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)

The Board of Directors of MP3.com has unanimously
approved the Merger. Under Delaware law, approval of the Merger
requires the affirmative vote of the holders of a majority of
the outstanding shares of common stock of MP3.com. MP3.com
stockholders will vote on a proposal to adopt the merger
agreement at a Special Meeting of Stockholders to be held on
August 27, 2001. Holders of more than 50% of MP3.coms
outstanding shares as of July 23, 2001, the record date for
stockholders entitled to vote at the Special Meeting, have
agreed to vote in favor of adoption of the merger agreement. The
Merger is also subject to the expiration or early termination of
the applicable waiting period under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976 (the HSR Act), as
amended, and other customary closing conditions. Vivendi
Universal and MP3.com each filed notification reports with the
Department of Justice and Federal Trade Commission under the HSR
Act on June 12, 2001. The waiting period expired at
midnight on July 12, 2001, and thus all applicable waiting
periods under the HSR Act have been satisfied. The Merger is
anticipated to close during the third quarter of 2001.

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Item 2. Managements Discussion
and Analysis of Financial Condition and Results of
Operations

Forward-Looking Statements

This document contains forward-looking statements
within the meaning of the Safe Harbor provisions of
the Private Securities Litigation Reform Act of 1995. These
statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking
statements by terminology such as may,
will, going to, should,
could, expect, intend,
plan, anticipate, believe,
estimate, predict, potential
or continue, the negative of such terms or other
comparable terminology. These statements are only predictions
and reflect our expectations and assumptions as of the date of
this quarterly report based on currently available operating,
financial and competitive information.

Although we believe that the expectations
reflected in the forward-looking statements are reasonable, we
cannot guarantee future events or results, levels of activity,
performance or achievements, all of which may differ materially.
Moreover, neither we nor any other person assumes responsibility
for the accuracy or completeness of the forward-looking
statements. We are under no obligation to update any of the
forward-looking statements after the filing of this
Form 10-Q to conform such statements to actual results or
to changes in our expectations.

The following discussion should be read in
conjunction with our consolidated financial statements and the
related notes and the other financial information appearing
elsewhere in this Form 10-Q. Readers are also urged to
carefully review and consider the various disclosures made by us
which attempt to describe some of the factors which affect our
business and may cause such material differences, including
without limitation, the disclosures made under the captions
Managements Discussion and Analysis of Financial
Condition and Results of Operations and Risk
Factors, and the audited consolidated financial statements
and related footnotes included herein and in MP3.coms
Form 10-K for the year ended December 31, 2000 (File
No. 000-26697).

Overview

MP3.com has created a unique and robust
technology infrastructure designed to facilitate the storage,
management, promotion, and delivery of digital music. As the
Internets premier Music Service Provider (MSP), we are
dedicated to providing consumers access to music when they want
it, where they want it, using any web-enabled device. Our web
site hosts what we believe is the largest collection of digital
music available on the Internet, with more than 1,095,000 song
and audio files posted from over 165,000 digital artists and
record labels. Dedicated to growing the digital music space, our
products and services include on-demand Subscription Music
Channels, an innovative Business Music Services program, a Radio
Services program and others. Additionally, through our MSP
technology initiative and Music InterOperating System (Music
IOS), we are partnering with a variety of forward-looking
businesses to expand our digital music strategy.

We devoted much of 2000 and the first half of
2001 to enhancing and improving the MP3.com web site and its
technology infrastructure. In January 2000, we unveiled our
upgraded My.MP3 service, a unique and robust service designed to
facilitate the storage, management, promotion and delivery of
digital music, and to enable users to listen to their music when
they want, where they want by accessing any web-enabled device.
The My.MP3 service allows users to create online music lockers
where they can store, organize and manage their favorite songs
from music posted by digital artists on the MP3.com web site,
and receive personalized music services. In addition, with the
introduction of the Beam-It and Instant Listening
features of the My.MP3 service in January 2000, we began
providing consumers the ability to access, add to and manage
their existing music CD collections online without having to
encode and store tracks themselves. Under this system, once we
are able to determine that a consumer purchased a CD (through
the Instant Listening feature), or was already in possession of
a CD (through the proprietary Beam-It software), we make music
from that CD available in the consumers music locker.

We believe we have developed core competencies
and created a technology infrastructure system that will enable
us to provide a wide variety of data management and
infrastructure services to other businesses. Through our ongoing
efforts to develop, maintain and improve the MP3.com web site,
we have amassed a

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significant amount of expertise in data storage,
delivery and management; server-side security; and royalty
tracking and payment systems. We have also created a technology
infrastructure system that stores, manages, tracks and provides
statistical analyses on a real-time basis for digital data for
over 165,000 digital artists and more than 15.8 million
registered users. In June 2001, our technology infrastructure
system managed an average of over 5.4 terabytes of data
each day.


We generate revenue from advertising,
infrastructure products, merchandising products, subscription
products, music licensing products, and business music services.
For the quarters ended June 30, 2001 and 2000, 85.5% and
81.2%, respectively, of our total net revenues were from
advertising.

MP3.com was incorporated in March 1998. During
1998, our operations consisted largely of developing the
infrastructure necessary to download and stream music from the
Internet. Since the beginning of 1999, our growth has been
dramatic. The number of employees increased from eight on
December 31, 1998 to 274 on December 31, 1999 to 308
on December 31, 2000 and decreased to 294 on June 30,
2001.

In June 2001, we added over 150 artists and more
than 1,400 new song and audio files on average each day, which
is a decrease from more than 220 artists and over 1,500 new
song and audio files that were added on average each day in June
2000. During June 2001, visitors to our web site listened to or
downloaded over 55.0 million songs, which is an increase
from June 2000 when visitors listened to or downloaded over
34.0 million songs.

The Three Months Ended June 30, 2001
Compared to June 30, 2000

Results of Consolidated Operations

Net Revenues

For the three months ended June 30, 2001,
total net revenues were $17,533,000 compared to $20,178,000
during the same period a year ago, representing a decrease of
$2,645,000 or 13.1%. Total net revenues are derived from two
primary sources: advertising based products and non-advertising
based products and services. Advertising based product revenues
primarily consist of traditional web-based advertisements;
advertisements placed in e-mail campaigns and electronic
greeting cards; advertising spots on syndicated radio programs;
and sponsorships of free CD products. The duration of our
advertising commitments range from one month to over three
years. Non-advertising based products and services primarily
consist of contests and sweepstakes; online sales of Digital
Automatic Music (DAM) CDs and other music-related
merchandise; infrastructure and music licensing products;
subscriptions to various music and artist-related services; and
web-based business music services. Infrastructure and music
licensing products represent revenues derived from the licensing
of various technologies and artist content to outside third
parties. Subscription revenues consist of fees paid to access
the enhanced version of the My.MP3 service, various music
channels and premium services for artists. The business music
services program provides web-based management and delivery of
in-store music and messaging directly to businesses for a
monthly fee.

Revenues from Advertising.For the quarter ended June 30,
2001, revenues from advertising based products were $14,998,000
or 85.5% of total net revenues compared to $16,394,000 or 81.2%
of total net revenues for the same period a year ago. The
decrease in advertising based product revenues was primarily due
to a decrease in traditional web-based advertising products of
57.9% offset by an increase in e-mail and electronic greeting
card revenues of 118.4%.

Revenues from Non-Advertising Products and
Services.For the three months ended
June 30, 2001, revenues from non-advertising based products
and services were $2,535,000 or 14.5% of total net revenues
compared to $3,784,000 or 18.8% of total net revenues for the
same period a year ago. The decrease in revenues from
non-advertising based products and services was primarily due to
Montaigne Participations Et Gestion (MPG) purchasing
an increased portion of advertising related products when
compared to the second quarter of 2000 and the MP3 Summit which
is being held during the third quarter of 2001 instead of the
second quarter of 2000. These decreases are offset by the
introduction of new products such as subscriptions and business
music services which did not exist during the second quarter of
2000.

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Revenue Concentration.For the three months ended
June 30, 2001 and 2000, 85.5% and 81.2%, respectively, of
total net revenues were from advertising. Additionally, during
the three months ended June 30, 2001 and 2000, we
recognized revenue of $11,250,000 (net of certain financial
incentives of $1,000,000) or 64.2% of total net revenues and
$8,500,000 or 42.1% of total net revenues, respectively,
associated with our agreement with MPG. The significant increase
in MPG related revenues of $2,750,000 or 32.4% of total net
revenues is related to MPGs commitment to purchase
advertising, promotion, and marketing services from us through
2004. MPGs commitment to purchase advertising, promotion,
and marketing services from us during each of the remaining
calendar quarters of 2001 is $12,250,000 with the possibility to
earn financial incentives during each of these quarters of an
amount not to exceed $1,000,000. Further, MPGs quarterly
advertising commitments are scheduled to decline after December
2001, from approximately $12,250,000 during the fourth quarter
of 2001 to approximately $6,000,000 in the first quarter of
2002. For at least the remainder of this fiscal year, we expect
that a significant amount of our revenues will continue to be
derived from advertising products and our relationship with MPG.
In January 2000, MP3.com entered into an agreement with
Visitalk, which, as amended, committed to purchase an aggregate
of $12,500,000 of advertising and promotional services. During
the quarter ended June 30, 2000, MP3.com recognized revenue
of $2,038,000 or 10.1% of total net revenues related to the
Visitalk agreement. We do not anticipate recognizing any
additional revenues in the future associated with the Visitalk
agreement.

Cost of Revenues

Cost of revenues for the three months ended
June 30, 2001 were $4,202,000 or 24.0% of total net
revenues compared to $3,812,000 or 18.9% of total net revenues
during the same period a year ago, resulting in gross margins of
76.0% and 81.1%, respectively. The increase in cost of revenues
and the resulting decrease in gross margins, as a percentage of
net revenues, was primarily due to increases in the amortization
of prepaid multimedia royalty licensing arrangements with
certain major recording companies of approximately $1,757,000
offset by decreases in contest and sweepstakes costs of
approximately $890,000. Those costs associated with prepaid
multimedia royalty licensing arrangements are included in cost
of revenues at the greater of straight-line amortization or
units of measure. Currently, listening activity dictates that we
amortize the licenses on a straight-line basis; however, if
future activity increases, thereby requiring us to expense the
licenses using the units of measure method, cost of revenues
could increase accordingly. We will continue to monitor the
prepaid royalty licensing arrangements for any indication that
the assets value has been impaired. If activity does not
increase to a level that more closely approximates straight-line
amortization, this may be an indication that the value of these
prepaid royalty licenses could be impaired which could result in
a charge to earnings of a significant portion of the prepaid
royalty license value. An impairment charge could have a
material adverse effect on our financial performance during the
period it is recorded.

Additionally, we anticipate that future gross
margins will fluctuate depending on changes in our revenue mix
and the amount of MPG quarterly revenues allocated between
various advertising products, some of which have significantly
lower gross margins than other advertising products. Cost of
revenues in future periods may increase both in absolute dollars
and as a percentage of revenue as a result of the cost of
certain royalty licensing arrangements with certain major
recording companies.

Sales and Marketing

During the three months ended June 30, 2001,
sales and marketing expense was $6,893,000 or 39.3% of total net
revenues compared to $11,961,000 or 59.3% of total net revenues
during the same period a year ago. The decrease in sales and
marketing expense, in absolute dollar amounts, was primarily due
to decreases in spending on advertising, promotions and
marketing programs of approximately $1,989,000, sales and
marketing payroll and related expenses of approximately
$1,310,000, amortization of prepaid marketing expenses in
connection with our arrangements with internationally known
artists of approximately $408,000, stock based charges
associated with acceleration of stock option vesting of
approximately $331,000, and the cost of our Payback for Playback
program of approximately $275,000. The decrease in sales and
marketing costs as a percentage of revenues is primarily due to
the significant decrease in sales and marketing spending offset
by a decrease in total net revenues. Overall sales and marketing
expense may increase in the foreseeable

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future; however, sales and marketing expense as a
percentage of net revenues may fluctuate depending on the level
of future total net revenues, the timing of new marketing
programs and the addition of sales and marketing personnel.


In the future, we may enter into arrangements
with additional artists and creative talent agencies to secure
their promotional and marketing services and obtain rights to
their music. Future expenses may include costs related to
promotional events, which will be expensed to sales and
marketing in the period the event is held. Proceeds from these
events, if any, will be credited against promotional expenses
incurred. Depending upon the terms and timing of promotional
activities, substantial sales and marketing expenses may be
incurred in any quarterly or annual period.

Engineering and Product Development

During the three months ended June 30, 2001,
engineering and product development expense was $5,259,000 or
30.0% of total net revenues compared to $6,125,000 or 30.4% of
total net revenues during the same period a year ago. The
decrease in the level of engineering and product development
expense, in absolute dollar amounts, was primarily due to
decreases in payroll and related expenses of approximately
$1,095,000 and temporary labor and consultants of approximately
$224,000, offset by an increase in depreciation of approximately
$365,000. Overall engineering and product development expenses
may increase in the foreseeable future; however, engineering and
product development expenses as a percentage of total net
revenues may fluctuate depending on the level of future total
net revenues and the timing of investments in engineering and
product development and hiring.

General and Administrative

During the three months ended June 30, 2001,
general and administrative expense was $5,383,000 or 30.7% of
total net revenues compared to $6,597,000 or 32.7% of total net
revenues during the same period a year ago. The decrease in
general and administrative expense, in absolute dollar amounts,
was primarily a result of decreases in bad debt expense of
approximately $511,000; finance and administrative payroll and
related expenses of approximately $894,000; legal, accounting,
and public relations expenses of approximately $338,000;
facility-related costs of approximately $313,000; and stock
based charges associated with acceleration of stock option
vesting of approximately $258,000. These decreases were offset
by an increase in amortization of goodwill of approximately
$350,000 and legal costs related to insurance recovery of
approximately $303,000. Overall general and administrative
expenses may increase in the foreseeable future; however,
general and administrative expense as a percentage of total net
revenues may fluctuate depending on the level of future total
net revenues and the timing of additional investments in general
and administrative infrastructure.

Charges Related to Class Action and
Derivative Lawsuits

MP3.com and certain of its employees, officers,
and directors have been named as defendants in several lawsuits
alleging violations of the federal securities laws. The
complaints, which were filed between September 19, 2000 and
November 15, 2000 in the United States District Court for the
Southern District of California, each purport to be brought on
behalf of a class of stockholders. The complaints allege that
MP3.com and the other defendants violated the federal securities
laws by issuing materially false and misleading statements and
failing to disclose material information regarding its My.MP3
service and the litigation surrounding the service. Between
September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits
against MP3.com and certain of its employees, officers, and
directors in the Superior Court of the State of California,
County of San Diego. These complaints allege various statutory
and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud,
gross mismanagement, unjust enrichment, and waste of corporate
assets.

MP3.com and the representatives of the various
plaintiffs for both the class action lawsuits and derivative
lawsuit executed Stipulations of Settlement dated as of
March 20, 2001 (the Stipulations). Under the
terms of the Stipulations, the defendants, while continuing to
deny all liability, have paid into an escrow account $35,000,000

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and agreed to issue 2.5 million shares of
MP3.com common stock which MP3.com valued at $5,391,000, in
exchange for complete dismissals and releases of all claims with
prejudice. The escrow amount and the 2.5 million shares of
common stock will be governed by the Stipulations. The
distribution of the escrow amount and the 2.5 million
shares will not occur prior to March 31, 2002, except under
certain circumstances, including the sale or other acquisition
of MP3.com prior to the distribution of the 2.5 million
shares of common stock, in which case the stock will be treated
equally with all other outstanding shares of MP3.com common
stock. In addition, under the Stipulations, MP3.com agreed to
institute certain corporate governance enhancements. On
June 29, 2001, the State Superior Court issued final
approval of the settlement of the derivative cases. The Federal
District Court entered final approval of the settlement of the
class action on July 16, 2001. As part of the settlement
agreement, counsel for the plaintiffs are to receive 27.5% of
the total settlement fund. Plaintiffs counsels
portion of the 2.5 million shares was issued to
plaintiffs counsel on July 31, 2001.


In light of the settlements of the class action
and derivative lawsuits, MP3.com has recorded a charge of
$41,428,000 during the three months ended March 31, 2001.
The charge includes the cash paid into the escrow account, the
value of the 2.5 million shares of common stock to be
issued, and an estimate of its defense and legal advisory costs.
While the charge of $41,428,000 excludes any potential recovery
from its insurance carriers, MP3.com is seeking to recover from
its carriers the full amount of the settlement together with its
legal expenses. National Union has agreed to pay its policy
limit of $5,000,000 towards the securities case, but such amount
has not yet been paid. Prior to receiving payment from National
Union, MP3.com is required to provide certain releases.
Currently, MP3.com is reviewing those releases. If MP3.com
receives insurance proceeds, MP3.com will record the recovery as
a gain in the statement of operations caption Charge
related to class action and derivative lawsuits.

In May 2001, in light of the pending transaction
with Vivendi Universal, MP3.com finalized its negotiations with
its lead defense counsel pursuant to the terms of the fee
agreement and agreed to pay an additional $5,000,000 in fees. As
MP3.coms lead counsel also provided various legal services
and advice to MP3.com on matters other than the shareholder
class action and derivative lawsuits, including but not limited
to the copyright matters, insurance recovery, and the pending
merger of MP3.com with Vivendi Universal, MP3.com has allocated
and charged to expense the additional fee during the three
months ended June 30, 2001 as follows: (i) $3,270,000
to charges related to class action and derivative lawsuits,
(ii) $1,402,000 to costs related to acquisition activities,
and (iii) $328,000 to reserve for litigation and copyright
matters.

Costs Related to Acquisition
Activities

Acquisition related costs for the three months
ended June 30, 2001 were approximately $3,160,000 compared
to zero for the same period one year ago. These acquisition
related costs represent various legal, accounting and financial
advisory fees paid in connection with the proposed merger
between MP3.com and Vivendi Universal. Therefore, during the
three months ended June 30, 2001, MP3.com expensed to costs
related to acquisition activities the remainder of the unused
legal services.

Amortization of Deferred
Compensation

During the quarter ended June 30, 2001,
total deferred compensation of $746,000 was amortized to expense
compared to $1,934,000 during the quarter ended June 30, 2000.
Deferred compensation is being amortized over the vesting period
of the relevant granted stock options, which is generally four
years. The decrease in amortization is primarily a result of the
accelerated amortization method (as provided for in FASB
Interpretation No. 28) to amortize deferred compensation,
which resulted in a greater amount of amortization expense in
the earlier years of the amortization period.

Charge for Copyright Claims

Major Label
Lawsuits.On January 21, 2000,
ten major recording companies filed a copyright infringement
lawsuit against MP3.com, Inc. in the United States District
Court for the Southern District of New York (the Major
Label Lawsuit). The complaint alleged that MP3.com, in
connection with certain content available in its My.MP3 service,
made unauthorized copies of tens of thousands of audio CDs in
violation of the

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Copyright Act. On April 28, 2000, the court
granted plaintiffs motion for summary judgment and held
that MP3.com was liable for infringing plaintiffs
copyrights, and the litigation proceeded with discovery on the
issues of willfulness and damages. On May 10, 2000, MP3.com
disabled all content within the My.MP3 service except as
expressly authorized by the copyright holders.


Between June and August 2000, MP3.com entered
into settlement and license agreements with Warner Music Group,
BMG Entertainment, Sony Music, and Capitol Records, Inc. (EMI),
which together represented eight of the ten major recording
companies that filed the Major Label Lawsuit. The settlement
agreements provide for a settlement amount to be paid in cash by
MP3.com in exchange for a release from the settling plaintiffs
and their affiliated entities (as defined in the settlement
agreements) of all claims related to the lawsuit and the My.MP3
service. Most-favored-nation provisions in these
settlement agreements require additional settlement amounts to
be paid under certain circumstances.

As a result of these settlements, the Major Label
Lawsuit was limited to a dispute with UMG Recordings, Inc.,
which represented two of the original plaintiffs. A trial in the
case was held from August 28 through September 6, 2000
on the issues of willfulness and damages. After hearing
evidence, the court ruled on September 6, 2000 that MP3.com
had willfully infringed UMGs copyrights and awarded
damages to UMG in an amount of $25,000 per CD. The Court then
scheduled a period to allow MP3.com to conduct discovery
concerning the certificates of registration for which plaintiffs
sought damages. On November 16, 2000, UMG made a motion for
entry of judgment in the amount of $53,400,000 in statutory
damages, costs, and attorneys fees, which MP3.com did not
oppose. As a result, a judgment in that amount was entered.

MP3.com has also entered into a license agreement
with UMG. Subject to certain affirmative obligations of MP3.com
and other terms and conditions regarding the implementation of
the My.MP3 service, MP3.com is permitted to utilize the
recordings owned by Warner Music Group, BMG Entertainment, Sony
Music, EMI, and UMG as part of the My.MP3 service. The license
agreements have terms of approximately three to ten years, and
provide for payment of a one-time fee each time a
licensors recording is added to a separate My.MP3 account.
These licenses also provide for on-going royalty payments based
on the greater of (i) a specified percentage of net revenues
generated from or in connection with the My.MP3 service or
(ii) a specified amount accrued each time a licensors
recording is streamed from My.MP3. Although MP3.com has obtained
license agreements permitting the use of recordings from BMG
Entertainment, Warner Music Group, Sony Music, UMG, EMI, and
certain other independent labels, there can be no guarantee that
MP3.com will be able to secure similar license agreements from
any other recording company.

Other Record Label
Lawsuits.Over the course of 2000 and
2001, some other entities filed lawsuits against MP3.com based
on the same set of allegations as the Major Label Lawsuit. These
include: Tee Vee Toons, Inc.; Zomba Recording Corp. (the
Zomba case); Koch Entertainment and Velvel Records
LLC (the Koch case); EMusic.com, Inc., Fuel 2000
Records, Spinart, Inc., Gig Records, Fearless Records, and
Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case).
Additionally, several independent labels have sent MP3.com
demand letters alleging similar claims.

A jury trial in the Tee Vee Toons case commenced
on March 26, 2001. Prior to trial, in reliance on the
Courts rulings in the Major Label Lawsuit, the issues of
infringement, fair use, and willfulness were adjudicated against
MP3.com. As a result, the jury trial was limited to the issue of
damages. The trial concluded on April 6, 2001. The jury
considered 145 copyright certificates and returned a verdict
which the Court tabulated as totaling $292,968. Subsequently,
two jurors contacted the Court to inform it that the verdict
decided upon by the jurors contained discrepancies. The Court
interviewed all the jurors and set a briefing schedule on the
issue of the jurys verdict. On June 19, 2001, the
Court declared a mistrial, and set a new trial date of
November 5, 2001. On June 26, 2001, MP3.com filed a
motion to certify the ruling to the Court of Appeals pursuant to
28 U.S.C. sec. 1292(b). Tee Vee Toons response
papers were filed on June 29, 2001. The Court denied the
motion on July 27, 2001.

Discovery in the Zomba case closed June 4,
2001. The final pre-trial conference is scheduled for
August 10, 2001, and the case is set for trial on
September 5, 2001. Like the Tee Vee Toons case, the trial
in the Zomba case will be limited to only the issue of damages.
The Koch case has been settled and the case is now closed. The
complaint in the EMusic case was filed on December 14,
2000. MP3.coms response to the complaint was

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filed on February 8, 2001. On June 20,
2001, MP3.com and EMusic filed a stipulation of dismissal of
their claims against each other without prejudice. The dismissal
was entered by the Court on June 21, 2001. Plaintiffs
counsels motion to withdraw as counsel to the remaining
plaintiffs was granted on July 23, 2001. On August 7,
2001, the Court will hear MP3.coms motion to dismiss the
case. The Unity case, which purports to be brought on behalf of
Unity, an independent record company whose works were allegedly
used in the My.MP3 service, and all other similarly situated
entities or individuals, was filed on November 7, 2000.
MP3.com answered the Complaint on January 16, 2001. On
April 16, 2001, the Court entered an order denying
plaintiffs motion for class certification without
prejudice to a renewal of the motion within 45 days. Unity
did not renew its motion within the 45 day deadline. Thus,
the case may proceed as an individual action only based on the
Unity sound recordings allegedly infringed by MP3.com.


Publisher Lawsuits.On March 14, 2000, two large music publishing companies,
MPL Communications, Inc. and Peer International Corporation,
with the assistance of The Harry Fox Agency, Inc.
(HFA), filed a copyright infringement lawsuit
against MP3.com in the United States District Court for the
Southern District of New York (the MPL/ Peer case).
The complaint alleged that MP3.com, in connection with its
My.MP3 service, made unauthorized copies of audio CDs containing
plaintiffs copyrighted works in violation of the Copyright
Act, and that MP3.com, in connection with the streaming of audio
content to users of the My.MP3 service, continued to make
unauthorized digital phonorecords in violation of the Copyright
Act. The complaint further alleged that MP3.coms actions
constituted unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs sought damages
(including statutory damages of up to $150,000 per violation)
and injunctive relief prohibiting MP3.com from operating its
My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works.

On October 17, 2000, MP3.com, the National
Music Publishers Association, Inc., and its licensing
subsidiary, HFA, entered into a preliminary agreement to be
approved by individual HFA music publisher-principals for
settlement and use of musical compositions on the My.MP3 service
for a three year term. As a result, MPL and Peer settled the
MPL/ Peer case with MP3.com, and a stipulation of dismissal with
prejudice was subsequently signed by the parties on
December 28, 2000 and entered by the Court on
January 2, 2001.

The three-year licensing arrangement provided
that MP3.com would pay up to $30,000,000 to HFA for the benefit
of up to 25,000 music publishers and their songwriter partners,
to be allocated to two equal funds. One fund was used to pay HFA
publisher-principals for past uses of music on the My.MP3
service, in exchange for a release from HFA publisher-principals
and their affiliated entities of all claims related to those
asserted in the MPL/ Peer case and the use of their compositions
on the My.MP3 service. The other fund provides advance payments
toward royalties earned under the prospective license. The terms
of the prospective license call for a payment of one-quarter
cent each time a song is streamed on demand to a customer from
his or her My.MP3 locker, along with a one-time fee per track
added to the My.MP3 service. The preliminary agreement with HFA
was finalized on February 28, 2001. Approximately 78% of
the publisher-principals HFA represents accepted and are bound
by the settlement agreement and approximately 90% accepted and
are bound by the licensing agreement. In April 2001, HFA
refunded to MP3.com approximately $4,600,000 pursuant to the
agreement, representing approximately $3,200,000 and $1,400,000
for the proportion of HFA publisher-principals that did not
settle or license content to MP3.com, respectively.

Zomba Enterprises, Inc. has filed its own music
publishing case against MP3.com making allegations like those
set forth in the MPL/ Peer case. The case is set for trial on
September 5, 2001. In the second quarter of 2001, similar
publisher lawsuits were filed by Randy Newman, Tom Waits, and
Ann and Nancy Wilson (the Newman case) and Major Bob
Music, Inc., Rio Bravo Music, Inc., Castle Bound Music Inc.,
Dream Catcher Music, Inc., and Moon Catcher Music, Inc. (the
Major Bob case). The Newman case was filed on
May 7, 2001 in the United States District Court for the
Central District of California. MP3.com filed its answer to the
complaint on June 15, 2001. The Major Bob case was filed on
May 14, 2001. MP3.com filed its answer to the complaint on
June 28, 2001. Additionally, several other publishers, not
affiliated with HFA, have sent MP3.com demand letters alleging
similar claims. In view of the Courts rulings in the Tee
Vee Toons and Zomba cases, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be
adjudicated against MP3.com in any and all publisher cases. This
would mean that MP3.com would only be able to litigate the issue
of damages.

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Artists
Class Action. On
April 12, 2000, several artists filed a class action
lawsuit in the United States District Court for the Southern
District of New York against MP3.com and several major recording
companies that claimed to own copyrights in sound recordings
featuring the artists. The complaint alleged that the recording
company defendants in the Major Label Lawsuit claimed rights in
plaintiffs recordings that they did not possess. In
particular, the complaint alleged that the recording company
defendants did not possess any copyright protections with
respect to plaintiffs pre-1972 published and pre-1978
unpublished recordings, did not possess the right to digitally
transmit plaintiffs pre-1996 recordings over the Internet,
and did not possess the right to control the conversion of
plaintiffs recordings into mp3 files. The complaint
further alleged that MP3.com has used the names and likenesses
of plaintiffs without their consent or authorization and in a
deceptive manner, in violation of the federal Lanham Act, the
New York Civil Rights Law, and unspecified unfair competition
and misappropriation laws. In their prayer for relief,
plaintiffs asked to have their class action certified, to be
awarded unspecified damages and attorneys fees, to have
the defendants enjoined from using plaintiffs names and
likenesses to promote downloading music over the Internet, and
to receive declaratory relief regarding plaintiffs rights
in their pre- and post-1972 recordings. On August 28, 2000,
the Court issued an oral ruling dismissing all claims against
MP3.com. On December 7, 2000, judgment was entered
dismissing, with prejudice, the federal claims against the
defendants. All state claims were dismissed for lack of an
independently sufficient jurisdictional basis. Plaintiffs filed
a Notice of Appeal on January 5, 2001. Briefing on the
appeal concluded June 11, 2001. Oral argument on the appeal
has not yet been scheduled but is anticipated to occur after
October 21, 2001.

Copyright Settlement Discussions; Charge to
Operations. MP3.com has pursued
and continues to actively pursue settlement discussions with the
various plaintiffs and claimants in the cases and disputes
discussed above. The decision whether to enter into settlement
and/or license agreements with each party will be based upon a
number of factors related to both the lawsuits and
MP3.coms business in general. MP3.com cannot guarantee
that it will be able to enter into any additional settlement
agreements on terms favorable to MP3.com, if at all, or that any
settlement or license agreement will prove beneficial to its
business or stockholders. During the three months ended
June 30, 2000, MP3.com recorded a charge for litigation and
copyright matters of $150,000,000. The charge for litigation and
copyright matters represented its estimate of the total costs to
be incurred only in connection with the resolution of the
various litigation and copyright matters associated with the
My.MP3 service, including the lawsuits filed by major recording
companies and other parties. Copyright issues associated with
the My.MP3 service also include but are not limited to
publishing rights, non-major label content, and legal and
advisory fees. This charge did not reflect or include any
amounts paid or payable in connection with forward-looking
licenses to use music recordings or compositions in connection
with the My.MP3 service. This charge reflects managements
expectations as of the date of this filing, and is based on
currently available information as well as significant
assumptions made by management regarding the various litigation
and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the
cumulative amount reserved as a result of this charge to
$41,328,000 as of June 30, 2001. MP3.com cannot guarantee
that future events or results will conform to its expectations
or assumptions regarding the various litigation and copyright
matters. If these expectations and significant assumptions prove
to be erroneous in light of future events, the actual amounts
incurred by MP3.com to resolve all copyright matters related to
the My.MP3 service could be materially different than those
recorded as of June 30, 2001, and could far exceed the
resources and market capitalization of MP3.com.

Interest Income, Net

Interest income (net of interest expense) during
the quarter ended June 30, 2001 was $1,013,000 compared to
$5,016,000 during the same period a year ago. The decrease in
interest income was primarily due to a reduction in cash, cash
equivalents and marketable securities from $303,373,000 at
June 30, 2000 to $76,805,000 at June 30, 2001. The
decrease in cash, cash equivalents and short-term investments in
marketable securities is primarily a result of payments
associated with litigation and copyright matters, class action
and derivative lawsuits, prepayments for multimedia royalty
licensing arrangements with certain major recording companies,
purchases of property and equipment, purchases of strategic
investments, the acquisition of the remaining interest in
mp3radio.com from Cox Interactive Media, Inc. and normal
operating costs. In

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addition to the decrease in cash, cash
equivalents, and marketable securities, interest rates have
decreased significantly due to the Federal Reserves
interest rate cuts during 2001.


Impairment of Strategic Investments

During the quarter ended June 30, 2001,
MP3.com recorded a charge of $1,200,000 for the estimated
impairment of its strategic investment portfolio compared to
$21,570,000 during the same period one year ago. The impairment
is associated with a decrease in the value of certain
investments within its portfolio, which is considered other than
temporary.

Provision for Income Taxes

Due to the loss from operations for both book and
tax purposes, no provision or benefit for income taxes was
recorded for the three months ended June 30, 2001 and 2000.
Currently, we provide a valuation allowance for all future tax
benefits.

Minority Interest in Loss of an Unconsolidated
Subsidiary

Minority interest in the loss of an
unconsolidated subsidiary during the quarter ended June 30,
2001 was zero compared to $263,000 for the same period a year
ago. The decrease in minority interest in losses of an
unconsolidated subsidiary was directly related to our
acquisition of the remaining 53.5% of mp3radio.com, our former
joint venture with Cox Interactive Media, Inc. We accounted for
the acquisition under the purchase method of accounting, whereby
the excess purchase price over fair value of net assets acquired
of $4,000,000 was generally allocated to assembled work force;
URLs, trademarks and names; a radio station agreement; and
goodwill. These intangibles are amortized over 12 to
24 months using the straight-line method. The amortization
of goodwill and other intangible assets is included in general
and administrative expense.

The Six Months Ended June 30, 2001
Compared to June 30, 2000

Results of Operations

Net Revenues

For the six months ended June 30, 2001,
total net revenues were $39,283,000 compared to $37,673,000
during the same period a year ago, representing an increase of
$1,610,000 or 4.3%. Total net revenues are derived from two
primary sources: advertising based products and non-advertising
based products and services. Advertising based product revenues
primarily consist of traditional web-based advertisements;
advertisements placed in e-mail campaigns and electronic
greeting cards; advertising spots on syndicated radio programs;
and sponsorships of free CD products. The duration of our
advertising commitments range from a few days to over three
years. Non-advertising based products and services primarily
consist of contests and sweepstakes; online sales of Digital
Automatic Music (DAM) CDs and other music-related
merchandise; infrastructure and music licensing programs;
subscriptions to various music and artist-related services; and
web-based business music services. Infrastructure and music
licensing programs represent revenues derived from the licensing
of various technologies and artist content to outside third
parties. Subscription revenues consist of fees paid to access
the enhanced version of the My.MP3 service, various music
channels and premium services for artists. The business music
services program provides web-based management and delivery of
in-store music and messaging directly to businesses for a
monthly fee.

Revenues from Advertising.For the six months ended June 30,
2001, revenues from advertising based products were $35,009,000
or 89.1% of total net revenues compared to $30,977,000 or 82.2%
of total net revenues for the same period a year ago. The
increase in advertising based product revenues was primarily due
to an increase in e-mail and electronic greeting card revenues
of approximately 139.7% offset by a decrease in both traditional
web-based advertising products and in the sponsorship of free CD
products of approximately 30.0%.

Revenues from Non-Advertising Products and
Services.For the six months ended
June 30, 2001, revenues from non-advertising based products
and services were $4,274,000 or 10.9% of total net revenues
compared to

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$6,696,000 or 17.8% of total net revenues for the
same period a year ago. The decrease in revenues from
non-advertising based products and services was primarily due to
an increased portion of the Montaigne Participations Et Gestion
(MPG) purchasing an increased portion of advertising
related products during the first six months of 2001 when
compared to the same period one year ago and the MP3 Summit
which is being held during the third quarter of 2001 instead of
the second quarter of 2000. These decreases are offset by the
introduction of new products such as infrastructure and music
licensing programs, subscriptions and business music services
which did not exist during the first half of 2000.


Revenue Concentration.For the six months ended June 30,
2001 and 2000, 89.1% and 82.2%, respectively, of total net
revenues were from advertising. Additionally, during the six
months ended June 30, 2001 and 2000, we recognized revenue
of $25,709,000 (net of certain financial incentives of
$1,541,000) or 65.4% of total net revenues and $15,345,000 or
40.7% of total net revenues, respectively, associated with our
agreement with MPG. The significant increase in MPG related
revenues of $10,364,000 or 67.5% is related to MPGs
commitment to purchase advertising, promotion, and marketing
services from us through 2004. MPGs commitment to purchase
advertising, promotion, and marketing services from us during
each of the remaining calendar quarters of 2001 is $12,250,000
with the possibility to earn financial incentives during each of
these quarters of an amount not to exceed $1,000,000. Further,
MPGs quarterly advertising commitments are scheduled to
decline after December 2001, from approximately $12,250,000
during the fourth quarter of 2001 to approximately $6,000,000 in
the first quarter of 2002. For at least the remainder of this
fiscal year, we expect that a significant amount of our revenues
will continue to be derived from advertising products and our
relationship with MPG. In January 2000, MP3.com entered into an
agreement with Visitalk, which, as amended, committed to
purchase an aggregate of $12,500,000 of advertising and
promotional services. During the six months ended June 30,
2000, MP3.com recognized revenue of $5,116,000 or 13.6% of total
net revenues related to the Visitalk agreement. We do not
anticipate recognizing any additional revenues in the future
associated with the Visitalk agreement.

Cost of Revenues

Cost of revenues for the six months ended
June 30, 2001 were $9,077,000 or 23.1% of total net
revenues compared to $7,568,000 or 20.1% of total net revenues
during the same period a year ago, resulting in gross margins of
76.9% and 79.9%, respectively. The increase in cost of revenues
and resulting decrease in gross margins, as a percentage of
total net revenues, was primarily due to increases in the
amortization of prepaid multimedia royalty licensing
arrangements with certain major recording companies of
$3,712,000 and bandwidth charges of $1,013,000, offset by a
decrease in contest and sweepstakes costs of $2,570,000. Those
costs associated with prepaid multimedia royalty licensing
arrangements are included in cost of revenues at the greater of
straight-line amortization or units of measure. Currently,
listening activity dictates that we amortize the licenses on a
straight-line basis; however, if future activity increases,
thereby requiring us to expense the licenses using the units of
measure method, costs of revenues could increase accordingly. We
will continue to monitor the prepaid royalty licensing
arrangements for any indication that the assets value has
been impaired. If activity does not increase to a level that
more closely approximates straight-line amortization, this may
be an indication that the value of these prepaid royalty
licenses could be impaired which could result in a charge to
earnings of a significant portion of the prepaid royalty license
value. An impairment charge could have a material adverse effect
on our financial performance during the period it is recorded.

Additionally, we anticipate that future gross
margins will fluctuate depending on changes in our revenue mix
and the amount of MPG quarterly revenues allocated between
various advertising products, some of which have significantly
lower gross margins than other advertising products. Cost of
revenues in future periods may increase both in absolute dollars
and as a percentage of revenue related to the cost of certain
royalty licensing arrangements with certain significant music
recording companies.

Sales and Marketing

During the six months ended June 30, 2001,
sales and marketing expense was $17,384,000 or 44.3% of total
net revenues compared to $28,963,000 or 76.9% of total net
revenues during the same period a year ago. The decrease in
sales and marketing expense, in absolute dollar amounts, was
primarily due to decreases in cash

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charges related to certain employee costs and
stock based compensation associated with the acceleration of
stock option vesting of approximately $6,732,000; advertising,
promotions and marketing programs of approximately $2,802,000;
amortization of prepaid marketing expenses in connection with
our arrangements with internationally known artists of
approximately $2,235,000; and sales and marketing payroll and
related expenses of approximately $2,306,000. These decreases
were offset by an increase in the cost of our Payback for
Playback program of approximately $2,108,000. The decrease in
sales and marketing costs as a percentage of total net revenues
is primarily due to the significant decrease in total sales and
marketing expenses and, to a lesser extent, an increase in total
net revenues. Overall sales and marketing expense may continue
to increase significantly in the foreseeable future; however,
sales and marketing expense as a percentage of total net
revenues may fluctuate depending on the level of future total
net revenues and the timing of new marketing programs and the
addition of sales and marketing personnel.


In the future, we may enter into arrangements
with additional artists and creative talent agencies to secure
their promotional and marketing services and obtain rights to
their music. Future expenses may include costs related to
promotional events, which will be expensed to sales and
marketing in the period the event is held. Proceeds from these
events, if any, will be credited against promotional expenses
incurred. Depending upon the terms and timing of promotional
activities, substantial sales and marketing expenses may be
incurred in any quarterly or annual period.

Engineering and Product Development

During the six months ended June 30, 2001,
engineering and product development expense was $10,854,000 or
27.6% of total net revenues compared to $11,404,000 or 30.3% of
total net revenues during the same period a year ago. The
decrease in the level of engineering and product development
expense in absolute dollar amounts was primarily due to
decreases in payroll and related expenses of approximately
$910,000, consulting and temporary labor of approximately
$326,000, and expensed computer supplies of approximately
$302,000. These decreases were offset by an increase in
depreciation of approximately $1,048,000. The decrease in
engineering and product development expense as a percentage of
total net revenue is primarily due to the decrease in total
engineering and product development expenses and, to a lesser
extent, an increase in total net revenues. Overall engineering
and product development expenses may increase in the foreseeable
future; however, engineering and product development expenses as
a percentage of total net revenues may fluctuate depending on
the level of future total net revenues and the timing of
investments in engineering and product development and hiring.

General and Administrative

During the six months ended June 30, 2001,
general and administrative expense was $11,601,000 or 29.5% of
total net revenues compared to $14,359,000 or 38.1% of total net
revenues during the same period a year ago. The decrease in
general and administrative expense in absolute dollar amounts
was primarily a result of decreases in legal, accounting, and
public relations expenses of approximately $1,713,000; bad debt
expense of approximately $1,548,000; finance and administrative
payroll and related expenses of approximately $1,285,000; and
facility-related cost of approximately $696,000. These decreases
were offset by an increase in insurance costs of approximately
$940,000, amortization of goodwill of approximately $1,112,000,
and legal costs related to insurance recovery of approximately
$303,000. General and administrative expenses as a percentage of
total net revenues decreased primarily due to a decrease in
general and administrative expenses and, to a lesser extent, an
increase in total net revenues. Overall general and
administrative expenses may increase in the foreseeable future;
however, general and administrative expense as a percentage of
total net revenues may fluctuate depending on the level of
future total net revenues and the timing of additional
investments in general and administrative infrastructure.

Charge for Class Action and Derivative
Lawsuits

MP3.com and certain of its employees, officers,
and directors have been named as defendants in several lawsuits
alleging violations of the federal securities laws. The
complaints, which were filed between September 19, 2000 and
November 15, 2000 in the United States District Court for
the Southern District of

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California, each purport to be brought on behalf
of a class of stockholders. The complaints allege that MP3.com
and the other defendants violated the federal securities laws by
issuing materially false and misleading statements and failing
to disclose material information regarding its My.MP3 service
and the litigation surrounding the service. Between
September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits
against MP3.com and certain of its employees, officers, and
directors in the Superior Court of the State of California,
County of San Diego. These complaints allege various statutory
and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud,
gross mismanagement, unjust enrichment, and waste of corporate
assets.


MP3.com and the representatives of the various
plaintiffs for both the class action lawsuits and derivative
lawsuit executed Stipulations of Settlement dated as of
March 20, 2001 (the Stipulations). Under the
terms of the Stipulations, the defendants, while continuing to
deny all liability, have paid into an escrow account $35,000,000
and agreed to issue 2.5 million shares of MP3.com common
stock which MP3.com valued at $5,391,000, in exchange for
complete dismissals and releases of all claims with prejudice.
The escrow amount and the 2.5 million shares of common
stock will be governed by the Stipulations. The distribution of
the escrow amount and the 2.5 million shares will not occur
prior to March 31, 2002, except under certain
circumstances, including the sale or other acquisition of
MP3.com prior to the distribution of the 2.5 million shares
of common stock, in which case the stock will be treated equally
with all other outstanding shares of MP3.com common stock. In
addition, under the Stipulations, MP3.com agreed to institute
certain corporate governance enhancements. On June 29,
2001, the State Superior Court issued final approval of the
settlement of the derivative cases. The Federal District Court
entered final approval of the settlement of the class action on
July 16, 2001. As part of the settlement agreement, counsel
for the plaintiffs are to receive 27.5% of the total settlement
fund. Plaintiffs counsels portion of the
2.5 million shares was issued to plaintiffs counsel
on July 31, 2001.

In light of the settlements of the class action
and derivative lawsuits, MP3.com has recorded a charge of
$41,428,000 during the three months ended March 31, 2001.
The charge includes the cash paid into the escrow account, the
value of the 2.5 million shares of common stock to be
issued, and an estimate of its defense and legal advisory costs.
While the charge of $41,428,000 excludes any potential recovery
from its insurance carriers, MP3.com is seeking to recover from
its carriers the full amount of the settlement together with its
legal expenses. National Union has agreed to pay its policy
limit of $5,000,000 towards the securities case, but such amount
has not yet been paid. Prior to receiving payment from National
Union, MP3.com is required to provide certain releases.
Currently, MP3.com is reviewing those releases. If MP3.com
receives insurance proceeds, MP3.com will record the recovery as
a gain in the statement of operations caption Charge
related to class action and derivative lawsuits.

In May 2001, in light of the pending transaction
with Vivendi Universal, MP3.com finalized its negotiations with
its lead defense counsel pursuant to the terms of the fee
agreement and agreed to pay an additional $5,000,000 in fees. As
MP3.coms lead counsel also provided various legal services
and advice to MP3.com on matters other than the shareholder
class action and derivative lawsuits, including but not limited
to the copyright matters, insurance recovery, and the pending
merger of MP3.com with Vivendi Universal, MP3.com has allocated
and charged to expense the additional fee during the three
months ended June 30, 2001 as follows: (i) $3,270,000
to charges related to class action and derivative lawsuits,
(ii) $1,402,000 to costs related to acquisition activities,
and (iii) $328,000 to reserve for litigation and copyright
matters.

Costs Related to Acquisition
Activities

Acquisition related costs for the six months
ended June 30, 2001 were approximately $3,160,000 compared
to $1,704,000 for the same period one year ago. During the first
half of 2001, the acquisition related costs represent various
legal, accounting and financial advisory fees paid in connection
with the proposed merger between MP3.com and Vivendi Universal.
The acquisition costs for the first six months of 2000 related
to certain costs charged to expense associated with the
previously announced acquisition of TransComputing International
Corporation (TCI) d/b/a seeUthere.com, which was not
completed.

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Amortization of Deferred
Compensation

During the six months ended June 30, 2001,
total deferred compensation of $1,717,000 was amortized to
expense compared to $6,336,000 during the same period one year
ago. Deferred compensation is being amortized over the vesting
period of the relevant granted stock options, which is generally
four years. The decrease in amortization is primarily a result
of the accelerated amortization method (as provided for in FASB
Interpretation No. 28) to amortize deferred compensation,
which resulted in a greater amount of amortization expense in
the earlier years of the amortization period.

Charge for Copyright Claims

Major Label
Lawsuits.On January 21, 2000,
ten major recording companies filed a copyright infringement
lawsuit against MP3.com, Inc. in the United States District
Court for the Southern District of New York (the Major
Label Lawsuit). The complaint alleged that MP3.com, in
connection with certain content available in its My.MP3 service,
made unauthorized copies of tens of thousands of audio CDs in
violation of the Copyright Act. On April 28, 2000, the
court granted plaintiffs motion for summary judgment and
held that MP3.com was liable for infringing plaintiffs
copyrights, and the litigation proceeded with discovery on the
issues of willfulness and damages. On May 10, 2000, MP3.com
disabled all content within the My.MP3 service except as
expressly authorized by the copyright holders.

Between June and August 2000, MP3.com entered
into settlement and license agreements with Warner Music Group,
BMG Entertainment, Sony Music, and Capitol Records, Inc. (EMI),
which together represented eight of the ten major recording
companies that filed the Major Label Lawsuit. The settlement
agreements provide for a settlement amount to be paid in cash by
MP3.com in exchange for a release from the settling plaintiffs
and their affiliated entities (as defined in the settlement
agreements) of all claims related to the lawsuit and the My.MP3
service. Most-favored-nation provisions in these
settlement agreements require additional settlement amounts to
be paid under certain circumstances.

As a result of these settlements, the Major Label
Lawsuit was limited to a dispute with UMG Recordings, Inc.,
which represented two of the original plaintiffs. A trial in the
case was held from August 28 through September 6, 2000
on the issues of willfulness and damages. After hearing
evidence, the court ruled on September 6, 2000 that MP3.com
had willfully infringed UMGs copyrights and awarded
damages to UMG in an amount of $25,000 per CD. The Court then
scheduled a period to allow MP3.com to conduct discovery
concerning the certificates of registration for which plaintiffs
sought damages. On November 16, 2000, UMG made a motion for
entry of judgment in the amount of $53,400,000 in statutory
damages, costs, and attorneys fees, which MP3.com did not
oppose. As a result, a judgment in that amount was entered.

MP3.com has also entered into a license agreement
with UMG. Subject to certain affirmative obligations of MP3.com
and other terms and conditions regarding the implementation of
the My.MP3 service, MP3.com is permitted to utilize the
recordings owned by Warner Music Group, BMG Entertainment, Sony
Music, EMI, and UMG as part of the My.MP3 service. The license
agreements have terms of approximately three to ten years, and
provide for payment of a one-time fee each time a
licensors recording is added to a separate My.MP3 account.
These licenses also provide for on-going royalty payments based
on the greater of (i) a specified percentage of net
revenues generated from or in connection with the My.MP3 service
or (ii) a specified amount accrued each time a
licensors recording is streamed from My.MP3. Although
MP3.com has obtained license agreements permitting the use of
recordings from BMG Entertainment, Warner Music Group, Sony
Music, UMG, EMI, and certain other independent labels, there can
be no guarantee that MP3.com will be able to secure similar
license agreements from any other recording company.

Other Record Label
Lawsuits.Over the course of 2000 and
2001, some other entities filed lawsuits against MP3.com based
on the same set of allegations as the Major Label Lawsuit. These
include: Tee Vee Toons, Inc.; Zomba Recording Corp. (the
Zomba case); Koch Entertainment and Velvel Records
LLC (the Koch case); EMusic.com, Inc., Fuel 2000
Records, Spinart, Inc., Gig Records, Fearless Records, and
Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case).
Additionally, several independent labels have sent MP3.com
demand letters alleging similar claims.

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A jury trial in the Tee Vee Toons case commenced
on March 26, 2001. Prior to trial, in reliance on the
Courts rulings in the Major Label Lawsuit, the issues of
infringement, fair use, and willfulness were adjudicated against
MP3.com. As a result, the jury trial was limited to the issue of
damages. The trial concluded on April 6, 2001. The jury
considered 145 copyright certificates and returned a
verdict which the Court tabulated as totaling $292,968.
Subsequently, two jurors contacted the Court to inform it that
the verdict decided upon by the jurors contained discrepancies.
The Court interviewed all the jurors and set a briefing schedule
on the issue of the jurys verdict. On June 19, 2001,
the Court declared a mistrial, and set a new trial date of
November 5, 2001. On June 26, 2001, MP3.com filed a
motion to certify the ruling to the Court of Appeals pursuant to
28 U.S.C. sec. 1292(b). Tee Vee Toons response papers
were filed on June 29, 2001. The Court denied the motion on
July 27, 2001.

Discovery in the Zomba case closed June 4,
2001. The final pre-trial conference is scheduled for
August 10, 2001, and the case is set for trial on
September 5, 2001. Like the Tee Vee Toons case, the trial
in the Zomba case will be limited to only the issue of damages.
The Koch case has been settled and the case is now closed. The
complaint in the EMusic case was filed on December 14,
2000. MP3.coms response to the complaint was filed on
February 8, 2001. On June 20, 2001, MP3.com and EMusic
filed a stipulation of dismissal of their claims against each
other without prejudice. The dismissal was entered by the Court
on June 21, 2001. Plaintiffs counsels motion to
withdraw as counsel to the remaining plaintiffs was granted on
July 23, 2001. On August 7, 2001, the Court will hear
MP3.coms motion to dismiss the case. The Unity case, which
purports to be brought on behalf of Unity, an independent record
company whose works were allegedly used in the My.MP3 service,
and all other similarly situated entities or individuals, was
filed on November 7, 2000. MP3.com answered the Complaint
on January 16, 2001. On April 16, 2001, the Court
entered an order denying plaintiffs motion for class
certification without prejudice to a renewal of the motion
within 45 days. Unity did not renew its motion within the
45 day deadline. Thus, the case may proceed as an
individual action only based on the Unity sound recordings
allegedly infringed by MP3.com.

Publisher Lawsuits.On March 14, 2000, two large music publishing companies,
MPL Communications, Inc. and Peer International Corporation,
with the assistance of The Harry Fox Agency, Inc.
(HFA), filed a copyright infringement lawsuit
against MP3.com in the United States District Court for the
Southern District of New York (the MPL/ Peer case).
The complaint alleged that MP3.com, in connection with its
My.MP3 service, made unauthorized copies of audio CDs containing
plaintiffs copyrighted works in violation of the Copyright
Act, and that MP3.com, in connection with the streaming of audio
content to users of the My.MP3 service, continued to make
unauthorized digital phonorecords in violation of the Copyright
Act. The complaint further alleged that MP3.coms actions
constituted unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs sought damages
(including statutory damages of up to $150,000 per violation)
and injunctive relief prohibiting MP3.com from operating its
My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works.

On October 17, 2000, MP3.com, the National
Music Publishers Association, Inc., and its licensing
subsidiary, HFA, entered into a preliminary agreement to be
approved by individual HFA music publisher-principals for
settlement and use of musical compositions on the My.MP3 service
for a three year term. As a result, MPL and Peer settled the
MPL/ Peer case with MP3.com, and a stipulation of dismissal with
prejudice was subsequently signed by the parties on
December 28, 2000 and entered by the Court on
January 2, 2001.

The three-year licensing arrangement provided
that MP3.com would pay up to $30,000,000 to HFA for the benefit
of up to 25,000 music publishers and their songwriter partners,
to be allocated to two equal funds. One fund was used to pay HFA
publisher-principals for past uses of music on the My.MP3
service, in exchange for a release from HFA publisher-principals
and their affiliated entities of all claims related to those
asserted in the MPL/ Peer case and the use of their compositions
on the My.MP3 service. The other fund provides advance payments
toward royalties earned under the prospective license. The terms
of the prospective license call for a payment of one-quarter
cent each time a song is streamed on demand to a customer from
his or her My.MP3 locker, along with a one-time fee per track
added to the My.MP3 service. The preliminary agreement with HFA
was finalized on February 28, 2001. Approximately 78% of
the publisher-principals HFA represents accepted and are bound
by the settlement agreement and approximately 90% accepted and
are bound by the licensing agreement. In April 2001, HFA
refunded to MP3.com approximately $4,600,000

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pursuant to the agreement, representing
approximately $3,200,000 and $1,400,000 for the proportion of
HFA publisher-principals that did not settle or license content
to MP3.com, respectively.


Zomba Enterprises, Inc. has filed its own music
publishing case against MP3.com making allegations like those
set forth in the MPL/ Peer case. The case is set for trial on
September 5, 2001. In the second quarter of 2001, similar
publisher lawsuits were filed by Randy Newman, Tom Waits, and
Ann and Nancy Wilson (the Newman case) and Major Bob
Music, Inc., Rio Bravo Music, Inc., Castle Bound Music Inc.,
Dream Catcher Music, Inc., and Moon Catcher Music, Inc. (the
Major Bob case). The Newman case was filed on
May 7, 2001 in the United States District Court for the
Central District of California. MP3.com filed its answer to the
complaint on June 15, 2001. The Major Bob case was filed on
May 14, 2001. MP3.com filed its answer to the complaint on
June 28, 2001. Additionally, several other publishers, not
affiliated with HFA, have sent MP3.com demand letters alleging
similar claims. In view of the Courts rulings in the Tee
Vee Toons and Zomba cases, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be
adjudicated against MP3.com in any and all publisher cases. This
would mean that MP3.com would only be able to litigate the issue
of damages.

Artists
Class Action.On April 12,
2000, several artists filed a class action lawsuit in the United
States District Court for the Southern District of New York
against MP3.com and several major recording companies that
claimed to own copyrights in sound recordings featuring the
artists. The complaint alleged that the recording company
defendants in the Major Label Lawsuit claimed rights in
plaintiffs recordings that they did not possess. In
particular, the complaint alleged that the recording company
defendants did not possess any copyright protections with
respect to plaintiffs pre-1972 published and pre-1978
unpublished recordings, did not possess the right to digitally
transmit plaintiffs pre-1996 recordings over the Internet,
and did not possess the right to control the conversion of
plaintiffs recordings into mp3 files. The complaint
further alleged that MP3.com has used the names and likenesses
of plaintiffs without their consent or authorization and in a
deceptive manner, in violation of the federal Lanham Act, the
New York Civil Rights Law, and unspecified unfair competition
and misappropriation laws. In their prayer for relief,
plaintiffs asked to have their class action certified, to be
awarded unspecified damages and attorneys fees, to have
the defendants enjoined from using plaintiffs names and
likenesses to promote downloading music over the Internet, and
to receive declaratory relief regarding plaintiffs rights
in their pre- and post-1972 recordings. On August 28, 2000,
the Court issued an oral ruling dismissing all claims against
MP3.com. On December 7, 2000, judgment was entered
dismissing, with prejudice, the federal claims against the
defendants. All state claims were dismissed for lack of an
independently sufficient jurisdictional basis. Plaintiffs filed
a Notice of Appeal on January 5, 2001. Briefing on the
appeal concluded June 11, 2001. Oral argument on the appeal
has not yet been scheduled but is anticipated to occur after
October 21, 2001.

Copyright Settlement Discussions; Charge to
Operations.MP3.com has pursued and
continues to actively pursue settlement discussions with the
various plaintiffs and claimants in the cases and disputes
discussed above. The decision whether to enter into settlement
and/or license agreements with each party will be based upon a
number of factors related to both the lawsuits and
MP3.coms business in general. MP3.com cannot guarantee
that it will be able to enter into any additional settlement
agreements on terms favorable to MP3.com, if at all, or that any
settlement or license agreement will prove beneficial to its
business or stockholders. During the six months ended
June 30, 2000, MP3.com recorded a charge for litigation and
copyright matters of $150,000,000. The charge for litigation and
copyright matters represented its estimate of the total costs to
be incurred only in connection with the resolution of the
various litigation and copyright matters associated with the
My.MP3 service, including the lawsuits filed by major recording
companies and other parties. Copyright issues associated with
the My.MP3 service also include but are not limited to
publishing rights, non-major label content, and legal and
advisory fees. This charge did not reflect or include any
amounts paid or payable in connection with forward-looking
licenses to use music recordings or compositions in connection
with the My.MP3 service. This charge reflects managements
expectations as of the date of this filing, and is based on
currently available information as well as significant
assumptions made by management regarding the various litigation
and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the
cumulative amount reserved as a result of this charge to
$41,328,000 as of June 30, 2001. MP3.com cannot guarantee
that future events or results will

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conform to its expectations or assumptions
regarding the various litigation and copyright matters. If these
expectations and significant assumptions prove to be erroneous
in light of future events, the actual amounts incurred by
MP3.com to resolve all copyright matters related to the My.MP3
service could be materially different than those recorded as of
June 30, 2001, and could far exceed the resources and
market capitalization of MP3.com.


Interest Income, Net

Interest income (net of interest expense) during
the six months ended June 30, 2001 was $2,713,000 compared
to $10,794,000 during the same period a year ago. The decrease
in interest income was primarily due to a reduction in cash,
cash equivalents and short-term investments in marketable
securities from $303,373,000 at June 30, 2000 to
$76,805,000 at June 30, 2001. The decrease in cash, cash
equivalents and short-term investments in marketable securities
is primarily a result of payments associated with litigation and
copyright matters, class action and derivative lawsuits,
prepayments for multimedia royalty licensing arrangements with
certain major recording companies, purchases of property and
equipment, purchases of strategic investments, the acquisition
of the remaining interest in mp3radio.com from Cox Interactive
Media, Inc. and normal operating costs. In addition to the
decrease in cash, cash equivalents, and marketable securities,
interest rates have decreased significantly due to the Federal
Reserves interest rate cuts during 2001.

Impairment of Strategic Investments

During the six months ended June 30, 2001,
MP3.com recorded a reserve of $1,200,000 for the estimated
impairment of its strategic investment portfolio compared to
$21,670,000 during the same period one year ago. The impairment
is associated with a decrease in the value of certain
investments within its portfolio, which is considered other than
temporary.

Provision for Income Taxes

Due to the loss from operations for both book and
tax purposes, no provision or benefit for income taxes was
recorded for the first six months of 2001 and 2000. Currently,
we provide a valuation allowance for all future tax benefits.

Minority Interest in Loss of an Unconsolidated
Subsidiary

Minority interest in the loss of an
unconsolidated subsidiary during the six months ended
June 30, 2001 was zero compared to $1,668,000 for the same
period a year ago. The decrease in minority interest in losses
of an unconsolidated subsidiary is directly related to our
acquisition of the remaining 53.5% of mp3radio.com, our former
joint venture with Cox Interactive Media, Inc. We accounted for
the acquisition under the purchase method of accounting, whereby
the excess purchase price over fair value of net assets acquired
of $4,000,000 was generally allocated to assembled work force;
URLs, trademarks and names; a radio station agreement; and
goodwill. These intangibles are amortized over twelve to
twenty-four months using the straight-line method. The
amortization of goodwill is included in general and
administrative expense.

Liquidity and Capital Resources

Overview

To date, MP3.com has generated cash from internal
operations, proceeds from the sale of convertible preferred
stock, proceeds from its initial public offering and, to a
lesser extent, the exercise of stock options. As of
June 30, 2001, MP3.com had approximately $76,805,000 in
cash, cash equivalents and marketable securities.

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Operating Activities

Net cash used in operating activities during the
six months ended June 30, 2001 was approximately
$19,074,000, consisting primarily of the following:



| |   |                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | net loss of approximately $57,695,000;                                                                                                                                
|
| |  | depreciation of property and equipment,
	amortization of goodwill and intangible assets, and amortization
	of prepaid multimedia licenses of approximately $8,786,000;
|
| |  | a non-cash charge for class action and derivative
	lawsuits of $5,391,000;                                                                                            
|
| |  | amortization of deferred compensation of
	approximately $1,716,000;                                                                                                   
|
| |  | impairment of strategic investments of $1,200,000;                                                                                                                    
|
| |  | a decrease in restricted cash of $30,000,000;                                                                                                                         
|
| |  | a net decrease in accounts and unbilled
	receivables of approximately $885,000;                                                                                       
|
| |  | an increase in prepaid expenses and other assets
	of approximately $3,692,000;                                                                                        
|
| |  | a decrease in accounts payable of approximately
	$1,226,000;                                                                                                          
|
| |  | a net decrease in accrued expenses and accrued
	amounts for copyright claims of approximately $5,903,000; and                                                         
|
| |  | an increase in deferred revenue of approximately
	$1,180,000.                                                                                                         

The decrease in restricted cash was a result of
the expiration of the restrictions in an escrow arrangement in
February 2001. The entire principal amount of $30,000,000 became
unrestricted and freely available for general working capital
purposes in February 2001.

Investing Activities

Net cash provided by investing activities during
the six months ended June 30, 2001 was approximately
$16,383,000,consisting primarily of net maturities of
marketable securities of $14,991,000 and a net decrease in
prepaid multimedia licenses of approximately $3,157,000 reduced
by property and equipment expenditures of $1,824,000. The net
decrease in prepaid multimedia licenses is primarily associated
with a partial refund of a prepaid multimedia license with the
Harry Fox Agency.

Financing Activities

Net cash used in financing activities during the
six months ended June 30, 2001 was approximately
$4,362,000, consisting primarily of the issuance of a note
receivable to MP3.coms chief executive officer of
approximately $4,848,000 offset by proceeds from the issuances
of common stock in connection with exercises of stock options of
approximately $486,000.

Future Capital Requirements

We believe that our cash and cash equivalent
balances will be sufficient to satisfy our cash requirements for
at least the next 12 months, after taking into
consideration the payment of our reserves for litigation and
copyright matters accrued as of June 30, 2001. We intend to
invest our cash in excess of current operating requirements in
short-term, interest-bearing investment-grade securities.

To the extent our total net revenues increase in
the future, we anticipate increases in our working capital
requirements to finance higher levels of associated accounts
receivable, unbilled receivables and other assets, offset by
increases in accounts payable and other liabilities. However, we
do not expect that the increases in accounts payable and other
liabilities will offset the increases in accounts receivable,
unbilled receivables and other assets.

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We may need to raise additional capital if our
business expands more rapidly than initially planned, to satisfy
any damage awards or unanticipated settlement costs related to
our current or potential future litigation proceedings, to
finance unanticipated working capital requirements, to obtain
additional licenses in order to provide certain music services
and/or specific content to consumers, to develop new or enhance
existing services or products, to fund distribution
relationships, to respond to competitive pressures, or to
acquire complementary businesses, technologies, content or
products. If additional funds are raised through the sale of
equity or convertible debt securities, the percentage ownership
of our stockholders will be reduced, our stockholders may
experience additional dilution and these securities may have
rights, preferences or privileges senior to those of our
stockholders. There can be no assurance that additional
financing will be available at all or on terms favorable to us.
If adequate funds are not available or are not available on
acceptable terms, our ability to fund our expansion, take
advantage of unanticipated opportunities, develop or enhance
products or services or otherwise respond to competitive
pressures could be significantly limited. Our business may be
harmed by these limitations.

Financial Commitments

As of June 30, 2001, we have no material
financial commitments other than obligations under our operating
leases. We expect to continue to make investments in the
following:



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | web site computer equipment;                               
|
| |  | bandwidth and networking equipment and
	infrastructure; and
|
| |  | additional sales and marketing employees.                  

We expect to pay these expenses principally in
cash, though we may elect to enter into additional financing
arrangements or expand existing financing arrangements to pay
certain types and amounts of expenses. Additionally, we prepaid
substantial multimedia content royalties in connection with
certain litigation settlements. In the future, we may continue
to advance prepaid multimedia content royalties as we settle
certain independent music label copyright claims. Capital
requirements in any particular period will depend on the timing
of these expenditures.

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RISK FACTORS

Litigation Risk

We Have Been And Are Engaged In A Number Of
Ongoing Lawsuits. We Have Settled Some Of The Lawsuits At
Significant Expense, And These Expenses Together With Any
Monetary Damages And/ Or Settlement Expenses From Remaining
Lawsuits Could Severely Impact Our Financial Condition.
Litigation Could Also Result In The Discontinuation Or
Interruption Of Services To Our Consumers.

We are currently a named defendant in a number of
copyright lawsuits, including several individual lawsuits
brought by independent record companies and publishers, each
alleging that, among other things, portions of our My.MP3 and
related services violated their respective copyrights. See
Part II  Item 1  Legal
Proceedings. We were also involved in similar significant
litigation proceedings that either settled or were brought to
judgment in 2000 or the first half of 2001. These included a
lawsuit brought by two major publishing companies and a lawsuit
brought by ten major music recording companies (the UMG
case), each concerning copyright claims like those
described above. In the UMG case, we were found by the court to
have willfully infringed plaintiffs copyrights. Eight
plaintiffs in that case settled through various agreements and
two plaintiffs in that case proceeded through judgment. In
reliance upon the courts rulings in the UMG case, the
issues of infringement, fair use, and willfulness have been
adjudicated against us in other copyright cases still pending.
Thus, we are only able to litigate the issue of damages. At this
juncture, we are unable to determine the number of valid
copyright registration certificates that may be appropriately
subject to an award of statutory or actual damages in these
pending cases. We do not yet know, for example, whether other
plaintiffs will ultimately elect to recover statutory damages in
lieu of actual damages, nor are we able to speculate as to the
likely size of any award of statutory damages in these cases. At
the rate of $25,000 per work (which is the per CD amount of
statutory damages awarded by the court in the UMG case), our
aggregate potential liability resulting from all of our
copyright litigation proceedings could still exceed one billion
dollars.

During the year ended December 31, 2000, we
recorded a charge for litigation and copyright matters of
$170,000,000. The charge for litigation and copyright matters
represented our estimate of the total costs to be incurred only
in connection with the resolution of the various litigation and
copyright matters associated with the My.MP3 service, including
the lawsuits filed by major recording companies and other
parties. Copyright issues associated with the My.MP3 service
also include but are not limited to publishing rights, non-major
label content, and legal and advisory fees. This charge did not
reflect or include any amounts paid or payable in connection
with forward-looking licenses to use music recordings or
compositions in connection with the My.MP3 service. This charge
reflects managements expectations as of the date of this
report, and is based on currently available information as well
as significant assumptions made by management regarding the
various litigation and copyright matters. Cash payments for the
settlements and judgments discussed above and other payments
have reduced the cumulative amount reserved as a result of this
charge to $41,328,000 as of June 30, 2001. We cannot
guarantee that future events or results will conform to our
expectations or assumptions regarding the various litigation and
copyright matters. If these expectations and significant
assumptions prove to be erroneous in light of future events, the
actual amounts incurred by MP3.com to resolve all copyright
matters related to the My.MP3 service could be materially
different than those recorded as of June 30, 2001, and
could far exceed the resources and market capitalization of our
company.

In addition to the copyright litigation discussed
above, we and certain of our employees, officers and directors
have been named as defendants in several lawsuits alleging
violations of the federal securities laws. The complaints, which
were filed between September 19, 2000 and November 15,
2000 in the United States District Court for the Southern
District of California, each purport to be brought on behalf of
a class of stockholders. The complaints allege that we and the
other defendants violated the federal securities laws by issuing
materially false and misleading statements and failing to
disclose material information regarding our My.MP3 service and
the litigation surrounding the service. Also, between
September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits
against MP3.com and certain of its employees, officers and
directors in the Superior Court of the State of California,
County of San Diego. These complaints allege various statutory
and common law claims relating to the My.MP3 service. MP3.com
and the representatives of the various plaintiffs for both the
class action lawsuits and derivative

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lawsuit executed stipulations of settlement dated
as of March 20, 2001 (the Stipulations). Under
the terms of the Stipulations, the defendants, while continuing
to deny all liability, have paid into an escrow account
$35,000,000 and agreed to issue 2.5 million shares of
MP3.coms common stock which MP3.com valued at $5,391,000,
in exchange for complete dismissals and releases of all claims
with prejudice. The escrow amount and the 2.5 million
shares of common stock will be governed by the Stipulations;
however, except in certain circumstances, the distribution will
not occur prior to March 31, 2002. In addition, under the
Stipulations, MP3.com agreed to institute certain corporate
governance enhancements. On June 29, 2001, the State
Superior Court issued final approval of the settlement of the
derivative cases. The Federal District Court entered final
approval of the settlement of the class action on July 16,
2001. As part of the settlement agreement, counsel for the
plaintiffs are to receive 27.5% of the total settlement fund.
Plaintiffs counsels portion of the 2.5 million
shares was issued to plaintiffs counsel on July 31,
2001.


During May and June 2001, MP3.com and certain of
its current and former directors and officers were named
defendants in seven similar class actions pending in federal
district court in the Southern District of New York. The
complaints allege that the prospectus and registration statement
in MP3.coms initial public offering contained materially
false and misleading statements related to underwriting fees,
commissions and other economic benefits connected with the
offering, including alleged tie-in arrangements between the
underwriters and their customers. The complaints allege causes
of action under Sections 11, 12(2) and 15 of the Securities
Act of 1933, as well as Sections 10(b) and 20(a) and
Rule 10b-5 of the Securities Exchange Act of 1934. Similar
cases have been filed against a number of other companies and
their underwriters. There has been no activity in any of these
cases to date.

We are also involved in other legal matters and
claims of various types, and from time to time may also be
involved in litigation relating to claims arising out of our
operations in the normal course of business. We cannot assure
you that we will be successful in ultimately defending any of
these lawsuits, and we may be required to pay license fees or
substantial damages, including statutory, punitive or other
damages that far exceed the resources and overall market
capitalization of MP3.com, in which event we may have to
significantly limit or terminate our business operations,
particularly because our business is not yet profitable. If
successful, any one of these lawsuits could seriously harm our
business by forcing us to cease providing services to our
consumers or requiring us to pay monetary damages. Even if
unsuccessful, these lawsuits still can harm our business
severely by damaging our reputation, requiring us to incur legal
costs, lowering our stock price and public demand for our stock,
and diverting managements attention away from our primary
business activities in general.

Risks Related To MP3.coms Merger With
Vivendi Universal

MP3.coms Merger With Vivendi Universal
May Be Delayed, Or May Not Occur At All, Causing Significant,
And Perhaps Irreversible, Damage To MP3.coms Future
Business Plans And Its Stock Price.

The consummation of the Merger with Vivendi
Universal (see Part I 
Item I  Notes to Condensed Consolidated
Financial Statements  Note 4 
Merger) may be significantly delayed, or may not occur at
all, due to failure of either Vivendi Universal or us to satisfy
required closing conditions under the Merger Agreement. If the
Merger is significantly delayed or does not occur, we could
suffer significant damage to our business reputation and may not
be able to sustain our business operations as a stand-alone
entity. As a result, MP3.coms financial results and stock
price could be severely and perhaps irreversibly harmed, and we
may not be suitable for acquisition by any other potential
business partners.

If The Merger With Vivendi Universal Does Not
Occur, We May Not Be Able To Obtain Additional Capital To Fund
Our Operations When Needed.

If the Merger with Vivendi Universal does not
occur, and if our capital requirements or revenue vary
materially from our current plans or if unforeseen circumstances
occur, we may require additional financing sooner than we
anticipate. This financing may not be available on a timely
basis, in sufficient amounts or on terms acceptable to us. The
financing may also dilute existing stockholders. If we cannot
obtain adequate funds on acceptable terms, we may be unable to
fund our capital requirements, take advantage of strategic

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opportunities, respond to competitive pressures
and develop or enhance our products and services. Any of these
failures would have a material adverse effect on our business,
operations and financial condition.


Risks Related To Our Business Model

We Have A Limited Operating History That Makes
An Evaluation Of Our Business Difficult.

MP3.com, Inc. was incorporated in March 1998. Due
to our limited operating history, and due to the risks described
in this report, it is difficult to evaluate our current business
and prospects and accurately predict our future revenues or
results of operations. This uncertainty may result in one or
more future quarters where our financial results may fall below
the expectation of analysts and investors. As a result, the
trading price of our common stock may decline significantly.
Operating results may vary depending on a number of factors,
many of which are outside our control.

Our Business Model Is Not Typical Of
Traditional, More Established Business Enterprises And May Not
Generate Sufficient Revenues For Our Business To
Survive.

Our model for conducting business and generating
revenues is new and unproven and may evolve rapidly. Our
business model depends upon our ability to generate revenue
streams from multiple sources including:



| |   |                                                                
| | - | ---------------------------------------------------------------
| |  | web site advertising fees from third parties;                  
|
| |  | e-mail and electronic greeting cards;                          
|
| |  | online sales of CDs and music-related merchandise;             
|
| |  | syndicated radio advertising revenues;                         
|
| |  | business music services revenues;                              
|
| |  | subscription channel revenues;                                 
|
| |  | artist and consumer data;                                      
|
| |  | label promotional activity fees;                               
|
| |  | My.MP3 subscription revenues; and                              
|
| |  | service and licensing fees from our technology
	infrastructure.

Our historical revenue sources and our projected
revenue sources have changed as our business has evolved, and
our revenue sources may change significantly in the future.
Because our business may continue to evolve rapidly, the above
sources of revenues, including those derived from our My.MP3 and
other MSP-related services in development, may change, or
increase or decrease in importance.

It is uncertain whether a music-based web site
that relies on attracting people to learn about, listen to and
download music, mostly from lesser-known artists, or a company
that markets the technology and related services that drive the
web site, can generate sufficient revenues to survive. We cannot
assure you that our business model will succeed or will be
sustainable as our business grows. In order for our business to
be successful, we must not only develop services and products
that directly generate revenue, but also provide content and
services that attract consumers and businesses to our web site
frequently. We will need to develop new offerings as consumer
and business preferences change and new competitors emerge. We
cannot assure you that we will be able to provide consumers with
an acceptable blend of products, services, and informational and
community offerings that will attract consumers and businesses
to our web site frequently. We provide many of our products and
services without charge, and we may not be able to generate
sufficient revenue to pay for these products and services.
Moreover, for those services that we provide for a fee, we may
not generate sufficient revenue to offset the loss of
advertising revenue on those services, or to cover the cost of
the royalties that we must pay to content providers.
Accordingly, we are not certain that our business model will be
successful or that we can sustain revenue growth or be
profitable.

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We Recently Re-Introduced Our My.MP3 Service,
Which May Not Be Successful, And Which May Adversely Impact Our
Overall Business By Requiring A Substantial Investment And
Disproportionate Amount Of Attention From Our Management And
Employees. Also, Our My.MP3 Service May Not Generate Sufficient
Revenues To Offset Our Ongoing Royalty Obligations To Licensors.
In Addition, We Will Likely Need Additional Licenses To Enhance
The Attractiveness Of The My.MP3 Services To
Consumers.

In December 2000, we re-introduced the My.MP3
service and began offering the service to customers in two
versions. A limited version of the service contains advertising
and is offered for free. A premier version of My.MP3 contains
less advertising than the free service. These and our other
efforts to generate revenue from My.MP3 and other MSP services
in development may not be successful or may meet significant
consumer resistance. The development, maintenance and growth of
the My.MP3 service will continue to require substantial
resources and a substantial amount of managements time and
focus. If the revenues recognized as a result of the My.MP3
service are not sufficient to offset this investment of
resources and time, our business may be harmed substantially.

Also, in connection with the launch of our
upgraded My.MP3 service in 2000 and the subsequent litigation
proceedings involving My.MP3, we entered into several license
agreements with major recording companies covering the use of
certain master recordings in My.MP3. These license agreements
provide for payment of a one-time fee each time a
licensors recording is added to a separate My.MP3 account.
These licenses also provide for on-going royalty payments based
on the greater of (i) a specified percentage of net
revenues generated from or in connection with the My.MP3 service
or (ii) a specified amount accrued each time a
licensors recording is streamed from My.MP3. Similarly, we
entered into an agreement with the National Music
Publishers Association, Inc. and its licensing subsidiary,
The Harry Fox Agency, Inc., or HFA, covering the use of certain
musical compositions in My.MP3. The terms of this license with
HFA call for a payment of one-quarter cent each time a song is
streamed on demand to a customer from his or her My.MP3 locker,
along with a one-time fee per track added to the My.MP3 service.
Some of our master recording and musical composition licenses
required us to make advance payments toward royalties earned
under the respective license, and we may be required to make
similar payments in the future. We cannot assure you that such
advance payments will be fully recouped over the term of the
relevant licenses, if ever, nor can we assure you that we will
be able to generate revenues from the My.MP3 service in a manner
sufficient to cover our ongoing royalty obligations under our
various license agreements. If the revenues generated by the
My.MP3 service are not sufficient to offset our ongoing royalty
obligations, our business may be harmed substantially.
Accordingly, we are not certain that our business model will be
successful or that we can sustain revenue growth or be
profitable. Also, in the event we are unable to fully recoup any
advance payments made under our various license agreements, we
may be required to write-off a significant portion of the
prepaid amounts. This may result in one or more future quarters
where our financial results may fall below the expectation of
analysts and investors. As a result, the trading price of our
common stock may decline significantly.

Consumers May Not React Favorably To The
Current Configuration Of Our My.MP3 Service; We Will Need
Additional Licenses From A Large Number Of Third Parties In
Order To Enhance the Attractiveness Of The My.MP3 Service And
Deliver Some Content. We May Not Be Able To Secure A Sufficient
Number Of Licenses On Acceptable Terms In Order To Provide A
Necessary Level Of Service.

In light of our past litigation proceedings, we
have modified the My.MP3 service so that individual tracks are
made available only if they are covered by one of our master
recording and musical composition licenses. Currently,
significantly less than all of the tracks contained on any one
CD may be made available through My.MP3s Beam-It and
Instant Listening features. In order to enhance the
attractiveness of the My.MP3 service to consumers, and relatedly
increase the potential revenues to be generated by the service,
we will need to obtain additional licenses covering more content
from record companies, music publishing companies, performing
arts societies and other third parties, and allowing users
outside the current licensed territories to access restricted
content. Although we have obtained several such licenses,
including some in connection with the settlement of lawsuits as
described above, the success of the My.MP3 service may require
that we be able to obtain licenses from enough parties to be
able to offer a broad range of content. Because of the large
number of potential parties from which we must obtain a license,
we may never be able to obtain a sufficient number of licenses
to allow us to provide services that will meet our
customers expectations. The difficulty of

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obtaining negotiated license agreements with all
the various third parties in the fragmented music recording and
publishing industries continues to pose a substantial obstacle
to our efforts to provide consumers with a fully satisfactory
product. In particular, users of our My.MP3 service may decide
that we are not able to provide them with access to enough of
their music to make the service valuable, and they may choose
not to subscribe to the fee-based My.MP3 service or to use other
methods of accessing their music altogether. Even if we are able
to obtain a sufficient number of licenses, those licenses may
not be on favorable terms, and we may have to increase the
amount that we charge consumers for our services in order to
cover the costs of these licenses. Consumers may not be willing
to pay the increased costs, and may discontinue the use of our
services.


A Substantial Portion Of Our Revenues For At
Least The Next Year Will Come From MPG. If Other Significant
Sources Of Revenue Are Not Developed Or If This Relationship Is
Prematurely Terminated, Modified Substantially Or Is Not
Renewed, We May Not Have Sufficient Revenues To Sustain Our
Growth And Our Stock Price May Fall.

In July 1999, we entered into an advertising,
promotion and marketing agreement with MPG. This agreement was
amended effective September 2000. As amended, the agreement
provides for a significant scheduled decrease in advertising
commitments over the next two years, which we may not be able to
make up in revenue from other sources. For the quarter ended
June 30, 2001, 85.5% of our revenues came from sales of our
advertising, promotion and marketing services under this
agreement. We anticipate that if we do not develop significant
alternative revenue sources, a substantial portion of our
revenues for the next year will come from sales under this
agreement. Further, MPGs quarterly advertising commitments
are scheduled to decline after December 2001, from approximately
$12 million during the fourth quarter of 2001 to
approximately $6 million in the first quarter of 2002.
Moreover, after December 2002, MPGs quarterly commitments
are scheduled to sharply decrease again, to only 2% or less of
the scheduled quarterly commitment for the first quarter of 2001.

MPG is under no obligation to renew its
relationship with us after the current agreement terminates at
the end of December 2004 or to increase its advertising
commitments with us when they significantly decrease under the
agreement at the end of December 2001. If MPG does not increase
its advertising commitments with us when they significantly
decrease under the agreement at the end of December 2001 or
renew its relationship with us after termination of the current
agreement at the end of December 2004, and we do not gain
alternative revenue sources, our revenues or growth rate will
decline. In addition, if the parties agree to terminate or to
substantially modify the agreement prior to its scheduled
termination, our revenues, growth rate and stock price may drop
dramatically. We may not be able to develop enough additional
revenue to offset the loss of revenues that is scheduled to take
place under the MPG agreement, or that would result in the
absence, or the significant modification, of our agreement with
MPG. Moreover, the other revenue sources we may develop will be
sufficient to maintain our past rate of revenue growth. If any
of the aforementioned risks cause our revenues or our revenue
growth rate to be substantially reduced, we may not have
sufficient revenues to support our business, we may never become
profitable and the market price of our stock may fall.

We Face Tremendous Competition For Online
Users Of File-Sharing Applications And Web Sites.

There are a number of so-called
file-sharing applications and web sites which allow
users to swap music files online such as Napster,
Freenet, Napigator and Gnutella. Although the legality of such
applications is currently in question, these applications at
various times boasted large numbers of online users which far
exceed our current user base. The alleged popularity of these
applications and web sites may continue indefinitely whether or
not such applications and/or web sites may be deemed illegal in
certain jurisdictions. Moreover, in November 2000, Napster Inc.
entered into a partnership with Bertelsmann AG to potentially
develop a record industry-friendly version of its file-sharing
application. The success of these relationships and the
continued development and proliferation of file-sharing
applications in general may result in a decrease in the number
of people that turn to our company to obtain and listen to
music, and may harm our overall business.

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Our My.MP3 Licenses Could Result In
Operational Complexity That May Divert Resources Or Make Our
Business More Expensive To Conduct.

The large number of licenses which we have to
maintain creates operational difficulties in connection with
tracking the rights that we have acquired and the royalty
payments that we must pay. For example, we have modified the
My.MP3 service so that individual tracks are made available only
if they are covered by one of our master recording and musical
composition licenses. We are largely dependent on third party
information when determining whether a track is covered by a
license. Third parties erroneously may indicate themselves as
the appropriate rights holder with respect to a particular
track, or we may misinterpret data sent to us by our numerous
licensors. As a result, we may inadvertently activate a track in
the My.MP3 service that is not covered by one of our licenses,
and accordingly may face litigation related to that track. In
addition, our licensing agreements typically allow the third
party to audit our royalty tracking and payment mechanisms to
ensure that we are accurately reporting and paying the royalties
owed. If we are unable to accurately track the numerous parties
that we must pay in connection with each delivery of a musical
work and deliver the appropriate payment in a timely fashion, we
may risk termination of certain licenses.

We May Encounter Problems With Our Copyright
Licenses, Which May Negatively Impact Our Ability To Provide Our
Services.

We have significant licensing arrangements with
major record labels and music publishers that were only recently
entered into, and were structured in the context of litigation
settlements or judgments rather than in the pursuit of mutual
business objectives on an arms-length basis. As a result, we may
face problems trying to run our business under these agreements,
which may have terms that are less favorable to us than would
have been the case had they been negotiated outside of the
litigation context. Our ability to utilize, for example,
recordings from recording companies in the My.MP3 service could
be materially and adversely affected by current litigation and
future settlements, and also be difficulties involved with
operating under our existing settlement and licensing
arrangements. Over time, we will be forced to periodically renew
these licenses in order to continue to provide our My.MP3
service. When the current licenses expire, we may not be able to
secure renewals of these licenses on favorable terms, or at all,
and the other parties may demand greater royalties as a
condition of renewal. Also, we may encounter further disputes
with the other parties to these licenses as they are performed
because they may contain provisions that are difficult to
implement, create disagreement or are economically unattractive
when applied in the regular course of operating our business.

The United States Music Industry Is Extremely
Litigious; We May Continue To Be Engaged In Litigation Even
After All Copyright Issues Related To The My.MP3 Service Are
Resolved. Expenses Related to This Ongoing Litigation Could
Severely Impact Our Financial Condition, And Could Also Result
In The Discontinuation Or Interruption Of Services To Our
Consumers.

The music industry in the United States is
generally regarded as extremely litigious in nature compared to
other industries. As a result, in the future we may be engaged
in litigation with others in the music industry, including those
entities with whom we have ongoing license arrangements. For
example, some of the major recording companies that settled
their portion of the UMG case with us have asserted in writing
that they believe the amount paid by MP3.com to UMG in
satisfaction of the Courts judgment, together with the
concurrent issuance of warrants to UMG, triggered additional
payments to them under the most favored nations
clauses in their settlement agreement with MP3.com. Although we
do not believe they are entitled to any such additional
payments, we cannot assure you that we will be successful in
ultimately concluding this matter in an amicable fashion, or
defending any resulting lawsuit. As a result, we may be forced
to defend one or more lawsuits on this and other issues in the
future, and in fact may be involved in a number of litigation
proceedings with the same group of related plaintiffs. These
lawsuits could harm our business severely by damaging our
reputation, requiring us to incur legal costs, lowering our
stock price and public demand for our stock, and diverting
managements attention away from our primary business
activities in general. We have not recorded any charge related
to claims for additional most favored nations
payments as of June 30, 2001.

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Because Our My.MP3 Licenses Cover Limited
Geographic Regions, We May Encounter Copyright Problems Outside
The Licensed Territory, Which May Negatively Impact Our Ability
To Provide Our Services.

Our My.MP3 licenses are geographically limited in
scope and do not authorize us, by their own terms, to provide
our My.MP3 and certain other MSP-related services on a worldwide
basis. We attempt to restrict persons located outside the
licensed territories from accessing restricted content within
the My.MP3 service. However, because the Internet cannot be
constrained by any geographic limitations, we are unable to
ensure with any certainty that individuals outside the territory
will not be able to access restricted content. As a result, we
may face copyright litigation in countries outside the licensed
territories stemming from the ability of foreign users to access
restricted content with the My.MP3 service. We cannot assure you
that we would be successful in ultimately defending any of these
lawsuits, and we may be required to pay license fees or damages
as a result of any such litigation, or we may have to
significantly limit or terminate the My.MP3 service. If
successful, any one of these lawsuits could seriously harm our
business by forcing us to cease providing services to our
consumers or requiring us to pay monetary damages. Even if
unsuccessful, these lawsuits still can harm our business
severely by damaging our reputation, requiring us to incur legal
costs, lowering our stock price and public demand for our stock,
and diverting managements attention away from our primary
business activities in general.

We Are Competing In A New Market Which May Not
Develop Or Where We May Fail To Gain Market Acceptance For Our
Products And Services.

The market for online music promotion and
distribution is new and rapidly evolving. As a result, demand
and market acceptance for our products and services expose us to
a high degree of uncertainty and risk. We have historically and
are now largely attempting to capitalize on a talent pool of
artists not currently served by the traditional recording
industry. We cannot assure you that consumers will continue to
be interested in listening to or purchasing music from our
artists or that the traditional music industry will not
successfully serve these artists in the future. If this new
market fails to develop, develops more slowly than expected or
becomes saturated with competitors, or our products and services
do not achieve or sustain market acceptance, our business could
be harmed. We believe the future popularity of downloadable
digital music will depend, in part, on the availability of
portable devices to store and replay this music. In addition, we
are attempting to develop new features and services for our
consumers based on our My.MP3 and other MSP-related services to
allow consumers additional ways to access, manage and listen to
their music on any web-enabled device or application. These
efforts may not be successful and may meet significant consumer
and industry resistance. To the extent that consumer acceptance
or distribution of these portable devices and/or MSP services is
delayed or these devices or services are not available at
affordable prices, our market and thus a portion of our revenues
may not grow at a sufficient pace and our business could
ultimately be harmed.

As Currently Contemplated, The Success Of Our
Business Model Depends On Our Ability To Generate Substantially
Increased Revenues From Subscription-Based Products And Services
Such As Our Subscription Channels And My.MP3 Services.

In May 2000, our first subscription channel,
offering classical music to our consumers, was introduced. Since
then, we have also launched a childrens music channel, and
we intend to pursue the creation of additional channels. When we
re-introduced our My.MP3 service, we included a
subscription-based alternative to the free service. The creation
of these services is costly, both in terms of the cost of the
required licenses and in the labor and systems expenses we incur
to develop and maintain them. Consumers, who are accustomed to
purchasing CDs and then listening to them for free, may not be
willing to pay for such music again on a subscription basis.
Previous efforts by other companies to convince consumers to
adopt a subscription-based music delivery model have been
relatively unsuccessful when compared to traditional methods of
music distribution. If consumers resist our subscription-based
programs, we may never generate sufficient revenues from our
subscription channels or other subscription-based services to
overcome the high cost of providing such services.

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We Expect Competition To Increase
Significantly In The Future Which Could Reduce Our Revenues,
Potential Profits And Overall Market Share.

The market for the online promotion and
distribution of music and music-related products is competitive.
Barriers to entry on the Internet are relatively low, and we
expect competition to increase significantly in the future.
Although we have secured licenses from record companies and
other third parties for some of the content that we deliver,
these licenses are generally non-exclusive. Moreover, much of
our technology, including our Beam-it and Instant Listening
services, subscription channels, the business music services and
web site technology and software, are currently not protected by
patents or other protection which would prevent third parties,
including record companies and other rights holders, from
duplicating the technology and providing services identical to
ours. Although we have applied for patents with regard to a
number of these and other core technologies of our business,
none of these patents have yet been issued, nor is there any
guarantee that they will ever be issued in the future. We face
competitive pressures from numerous actual and potential
competitors, many of which have longer operating histories,
greater brand name recognition, larger consumer bases and
significantly greater financial, technical and marketing
resources than we do.

For example, Sony Music Entertainment and
Universal Music Group, two of the worlds largest music
companies, recently announced the roll-out of a new subscription
service, called Duet (d/b/a Pressplay), on the
Internet portal Yahoo!. In addition, Warner Music Group, BMG
Entertainment and EMI Recorded Music, the other three major
music companies, announced the formation of a similar service,
called MusicNet, offered through America Online and elsewhere.
Both services are expected to offer music for downloading and
streaming for a monthly fee. There is also the possibility that
one combined service would offer music from all five of these
music companies. In addition, MTVi Group, a music entertainment
company, and web site operator RioPort.com announced that they
will offer paid music downloads by song from all five major
music companies.

We cannot assure you that the web sites, software
or services offered by our existing and potential competitors
will not be perceived by consumers, artists, talent management
companies and other music-related vendors or advertisers as
being superior to ours. We also cannot assure you that we will
be able to maintain or increase our web site traffic levels,
purchase inquiries and number of click-throughs on our online
advertisements or that competitors will not experience greater
growth in these areas than we do. Increased competition could
result in advertising price reduction, reduced margins or loss
of market share, any of which could damage the long-term or
short-term prospects of our business.

Our Continued Reliance On Revenue From
Advertising May Not Provide Sufficient Financial Returns For Our
Business To Grow Or Survive. We Currently Depend On A Small
Group Of Customers For Our Advertising Revenue.

Although our business model contemplates multiple
sources of revenue, we anticipate that in the foreseeable future
we will depend substantially on revenue from advertising. During
the quarter ended June 30, 2001, revenue from advertising
accounted for 85.5% of our total net revenues, an increase of
approximately 4.3% from the comparable quarter one year ago. We
currently depend on a small group of customers for our revenue
from advertising. During the second quarter of 2001, one
customer accounted for approximately 64.2% of net revenues, and
our top ten customers accounted for approximately 78.0% of net
revenues. We expect that most of our revenues will continue to
be derived from third party advertising agreements. If any of
our significant customers were to leave us, our business could
be harmed. Similarly, our revenues may also be adversely
affected by the future insolvency of individual major customers
or multiple other customers within the volatile Internet and
technology industries. If we do not increase our revenues from
online advertising, our business may not grow or survive.
Increasing our revenues from online advertising depends largely
on our ability to:



| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | conduct successful selling and marketing efforts
	aimed at advertisers;                                                                                     
|
| |  | increase the size of the MP3.com audience by
	increasing both our artist and consumer bases;                                                                
|
| |  | increase or at least maintain the amount of
	revenues per advertisement in the face of a recent industry-wide
	decline in online advertising prices and use;

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| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | increase the size of our sales force, where
	appropriate;                    
|
| |  | target advertising to appropriate segments of our
	audience; and             
|
| |  | measure accurately the size and demographic
	characteristics of our audience.

Our failure to achieve these objectives could
reduce our revenues from online advertising and ultimately
prevent us from generating the revenues we expect.

The Market For Online Advertising Is Currently
Undergoing An Industry-Wide Decline In Prices, Usage And
Perceived Desirability Which May Cripple Our Ability To Generate
Revenue.

Standard industry-wide rates for online
advertising have declined during the past year, and many
advertising customers are using the Internet less for
advertising, as well as demanding lower rates per advertisement.
Our revenues depend heavily on online advertising and our
company may not be able to survive a sustained continuation of
this industry-wide decline in prices and the decreased
desirability of online advertising in general. There has also
been a decline in the number of viable dot-com
businesses and technology companies in general, and the private
and public equity markets on which those companies previously
relied for capital have become increasingly unreceptive. As a
result, even those companies that remain viable can be expected
to continue to spend less on advertising in the future, which
may make it increasingly difficult for us to meet existing
revenue expectations.

Many Of Our New Business Initiatives Are
Untested And May Not Be Successful. Our Syndicated Radio,
Business Music Services Or Infrastructure Licensing Initiatives
May Not Succeed Due To Technological Challenges, Intense
Competition And The Type Of Music That We Deliver.

During 2000 and the first half of 2001, we
launched several new business initiatives, which are untested
and may not be successful. We expect to launch new initiatives
in the future, such as label marketing and promotion, which will
be similarly challenging. Several of these initiatives are based
on a subscription model, which may not successfully generate
revenue. We also may not successfully extend our business to
serve personal Internet devices or new international regions.
These new initiatives require significant investment of
resources and time that could strain our resources beyond
capacity. We may never realize benefits sufficient to offset
such investment.

For example, we hope to grow our syndicated radio
and business music services divisions into significant
revenue-generating components of our business. However, our
ability to syndicate and sell content to radio businesses or
provide a comprehensive music solution to retail and other
business establishments may be significantly limited by existing
competition, which can be intense, from current content
providers in these industries. The business music industry is
currently served by competitors who have a substantially longer
track record and operating history, have established
distribution channels and production facilities, and are able to
provide music by well-known artists. These companies include
Muzak LLC, AEI Music Network, Inc., Music Choice, Play Network
Inc., and DMX Music, Inc., as well as Internet-driven
competitors such as American Music Environments, Inc. We may not
be able to compete with these companies effectively. In
addition, our ability to deliver music to business
establishments is dependent upon each location of the business
having a fast, reliable connection to the Internet. Most retail
establishments connect to the Internet through a standard
telephone line using a dial-up connection and a modem. This type
of connection may not be able to support the implementation of
our business music delivery platform in many businesses. Also,
we may encounter resistance from both radio stations and retail
business establishments to utilizing our content because we
feature content from lesser-known artists that is usually
available for free streaming or download on our web site. In
addition, most of the potential customers for our business music
services already have entered into long term contracts with
other providers that are not easily terminated. This is likely
to result in extremely long sales cycles, which may negatively
impact our ability to attract and sell our business music
services. These divisions may not be able to attract a
sufficient number of customers in order to be significant
sources of revenues, and we may never realize the revenue levels
that we have projected for this services. As a result, the
financial performance of our company may be harmed.

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Our infrastructure licensing initiative is in its
infancy, and our ability to provide a comprehensive technology
infrastructure solution to other businesses may be significantly
limited by existing competition. The business music industry is
currently served by competitors who have a substantially longer
track record and operating history and have established customer
relationships. We may not be able to compete with these
companies effectively. This initiative may not be able to
attract a sufficient number of customers in order to be a
significant source of revenues, and we may never realize revenue
from infrastructure licensing.

Record Companies With Whom We Enter Into
Marketing And Promotional Arrangements May Choose Not To Renew
Their Arrangements With Us, If Any, And We May Lose The
Promotional Value Of Being Able To Feature Their Well-Known
Artists On Our Web Site.

In December 2000, we entered into an agreement
with a major label record company to provide, among other
things, targeted promotional services in exchange for the right
to feature well-known artists on our web site. We intend to
enter into more such agreements in the future. If the record
companies decide that our services are not as valuable as an
alternative means of marketing or develop substantially
equivalent promotional abilities themselves, then they may
choose not to sign or renew such agreements, and we will lose
the additional exposure associated with being able to feature
well-known artists, consequently harming our business.

Rapid Growth In Our Operations And
Infrastructure Is Placing A Significant Strain On Our Resources,
And Failure To Manage This Growth Effectively Could Disrupt Our
Operations And Prevent Us From Generating The Revenues We
Expect.

Since our inception in March of 1998 until
recently, we have experienced extended periods of rapid
expansion in our web site traffic, personnel, facilities and
infrastructure. For example, our employees increased from eight
on December 31, 1998, to 274 on December 31, 1999, to
308 on December 31, 2000, but decreased slightly to 294 on
June 30, 2001. Further expansion may be required to address
potential growth in our artist and consumer bases, the breadth
of our product and service offerings, and other opportunities.
Our expansion has placed, and we expect it will continue to
place, a significant strain on our management, operational and
financial resources. Our failure to manage growth could disrupt
our operations and ultimately prevent us from generating the
revenues we expect.

Mp3 Technology Is Controversial Within The
Traditional Music Industry And May Face Continued Opposition,
Which May Negatively Affect The Perception Of Our Business, Lead
To Market Confusion, Alienate Advertisers And Consumers, And
Reduce Our Revenue.

The traditional music industry has not embraced
the development of the mp3 format to deliver music, in part
because users of mp3 technology can download and distribute
unauthorized or pirated copies of copyrighted
recorded music over the Internet. Although our business model
for the digital distribution of music supports more than one
audio compression format and method of delivery, and is intended
to discourage music piracy and ensure that only legitimate music
is posted on our web site, our brand identity is currently
linked to the mp3 technology and possibly with other companies
that may not use mp3 or other similar technologies in a legal or
scrupulous manner. As a result, we sometimes face and may
continue to face opposition from a number of different music
industry sources including record companies and studios, the
Recording Industry Association of America and established
artists with record contracts, due to our current brand identity
and its potentially negative associations. In addition, adverse
news or events relating to mp3 technology may lead to confusion
in the public markets regarding our company and its prospects,
alienate advertisers and consumers, reduce revenues and harm our
overall financial results. This is in part evidenced by our
current and past litigation proceedings, but additional disputes
could arise in the future.

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We May Have Difficulty Competing For Or
Executing Business Partnerships And Making Acquisitions That We
May Need To Expand Our Content And Distribution Channels, Which
Could Impair Our Overall Strategic Goals.

Our business strategy includes entering into
business partnerships and may include acquiring complementary
businesses, technologies, content or products. We may be unable
to complete suitable business partnerships and acquisitions on
commercially reasonable terms, if at all. We expect to face
competition for business partnerships and acquisition candidates
and sponsorships. This competition could impair our ability to
successfully pursue these aspects of our business strategy.
Business partnerships or acquisitions could disrupt our ongoing
business, distract our management and employees and increase our
expenses. If we acquire a company, we could face difficulties
assimilating that companys personnel, culture and
operations. In addition, the key personnel of the acquired
company may decide not to work for us. Acquisitions of
additional services or technologies also involve risks of
incompatibility and lack of integration into our existing
operations. If we finance the acquisitions by issuing equity
securities, this could dilute our existing stockholders. Any
amortization of goodwill or other assets, or other charges
resulting from the costs of acquisitions, could adversely affect
our operating results.

Without The Continued Development And
Maintenance Of The Internet And The Availability Of Increased
Bandwidth To Consumers, Our Business May Not Succeed.

Without the continued development and maintenance
of the Internet infrastructure, we could fail to meet our
overall strategic objectives and ultimately fail to generate the
web site traffic and revenues we expect. This continued
development of the Internet includes maintenance of a reliable
network with the necessary speed, data capacity and security, as
well as timely development of complementary products including
high speed modems, hand-held Internet devices or personal
digital assistants, for providing reliable Internet access
and services. The success of our business will rely on the
continued improvement of the Internet and related products and
services as a convenient means of consumer interaction and
commerce, as well as an efficient medium for the delivery and
distribution of music.

Our business will depend on the ability of our
artists and consumers to continue to upload and download mp3 and
other music files, as well as to conduct commercial transactions
with us, without significant delays or aggravation that may be
associated with decreased availability of Internet bandwidth and
access to our web site. Our penetration of a broader consumer
market will depend, in part, on continued proliferation of high
speed Internet access. Even compressed in mp3 format, a typical
three minute song file can occupy more than three megabytes of
storage space. This file could take as much as two minutes to
download over an xDSL or cable modem compared to 10 to
20 minutes over a conventional 56Kbps modem. Because the
Internet is likely to continue to experience significant growth
in the numbers of users and amount of traffic, the Internet
infrastructure may be unable to support the demands placed on
it. In addition, increased users or bandwidth requirements may
harm the performance of the Internet. The Internet has
experienced a variety of outages and other delays as a result of
damage to portions of its infrastructure, and it could face
outages and delays in the future. The infrastructure and
complementary products or services necessary to make the
Internet a viable commercial marketplace for the long term may
not be developed successfully or in a timely manner. Even if
these products or services are developed, the Internet may not
become a viable commercial marketplace for the products or
services that we offer.

Our Business Strategy Depends In Part On Our
Ability To Deliver Music To Non-PC Devices And We May Not Be
Successful In Developing A Version Of Our Service That Will
Operate On Such Devices, That Manufacturers Of Such Devices Will
Incorporate Into Their Products, And That Will Gain Widespread
Adoption By Users.

In the coming years, the number of individuals
who access the Internet through devices other than a personal
computer, such as personal digital assistants and cellular
telephones, as well as automobile, portable and component or
home-based Internet-enabled radios and television set-top
devices, is expected to increase dramatically. A key part of our
business strategy as an MSP is to deliver music digitally to as
many of these types of devices as possible. Our services are
designed to use rich graphical, audio and other resources such as

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those available on personal and laptop computers.
The lower resolution, poorer sound quality, lower functionality,
lower memory and typically slower Internet access speeds
associated with alternative devices may make the use of our
services through such devices difficult and we may be
unsuccessful in our efforts to modify our services to provide a
compelling service for users of alternative devices. As we have
limited experience to date in operating versions of our service
developed or optimized for users of alternative devices, it is
difficult to predict the problems we may encounter in doing so
and we may need to devote significant resources to the creation,
support and maintenance of such versions.


If we are unsuccessful in developing versions of
our services that can be distributed to alternative device users
or if we are unable to attract and retain a substantial number
of alternative device users to our online services, we will fail
to capture a sufficient share of an increasingly important
portion of the market for digital music delivery. Further, as
the majority of our revenues are derived through the sale of
banner and other advertising optimized for a personal computer
screen, we may not be successful at developing a viable strategy
for deriving substantial revenues from the delivery of digital
music to users through alternative devices. Any failure to
develop revenue-generating services that are adopted by a
significant number of alternative device users could limit our
growth and prevent us from becoming profitable, which could
negatively impact our stock price.

Third-Party Manufacturers Must Choose To
Develop, And Consumers Must Purchase, Alternative Music Delivery
Devices Through Which We Can Deliver Music To Consumers. If They
Do Not, We May Not Be Able To Operate As An MSP As We Have
Described, And Our Business May Fail.

Currently, substantially all of the music that we
deliver is delivered to consumers on their personal computers,
because relatively few alternative devices are available that
have the capability to receive and use digitally distributed
music. In order for our business to be successful, third parties
must design and manufacture such alternative devices, including
automobile, portable and home-based Internet radios, personal
digital assistants and mobile phones that are compatible with
the technology that we use to deliver music. We cannot guarantee
that such devices will ever become available or that they will
be purchased by consumers. If they are not manufactured and
purchased, we will not be able to operate as an MSP as we have
described in this report and elsewhere, and our revenues and
stock price may fall.

Financial Risks

Our Quarterly Revenues And Operating Results
Are Not Indicative Of Future Performance And Are Difficult To
Forecast, And Our Stock Price May Fall If Our Performance Does
Not Meet Analysts Or Investors
Expectations.

As a result of our limited operating history, we
do not have historical financial data for a significant number
of periods upon which to forecast quarterly revenues and results
of operations. We believe that period-to-period comparisons of
our operating results may not be meaningful and should not be
relied upon as indicators of future performance. In addition,
our revenue and earnings may vary substantially as a result of
seasonal Internet use and/or the business cycles of the music
industry, online advertisers and of Internet commerce in
general. Moreover, our gross margin and net losses may fluctuate
from quarter-to-quarter due to changes in our revenue mix and
the timing of expenditures in our web site and operating
expenses. However, the actual effect of these factors on the
price of our stock will be difficult to assess due to our
limited operating history. In one or more future quarters our
results of operations may fall below the expectations of
securities analysts and investors, and the trading price of our
common stock may be affected.

We Expect Net Losses In The Future And May
Never Achieve Profitability, Which May Cause Our Stock Price To
Fall.

In 2000 and during the six months ended
June 30, 2001, we had a net loss of approximately
$279.5 million and $57.7 million, respectively. We
expect substantial net losses and negative cash flow for the
foreseeable future. We believe it is critical to our long term
success that we continue to develop MP3.com brand awareness and
loyalty through marketing and promotion, expand our artist and
consumer networks, develop our online content and expand the
commercial application of our other services. Our operating
expenses may continue to

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increase significantly during the next several
years, especially in sales and marketing and product
development. We may also incur significant litigation and
settlement expenses, as we did in 2000 and in the first half of
2001, due to our pending litigation and any other lawsuits that
may arise. With increased expenses, we will need to generate
significant additional revenues to achieve profitability,
especially in light of the dramatic scheduled reduction in
revenues from our agreement with MPG, discussed elsewhere. As a
result, we may never achieve or sustain profitability and, if we
do achieve profitability in any period, we may not be able to
sustain or increase profitability on a quarterly or annual basis.


Unless We Obtain Additional Financing, We May
Not Be Able To Meet Our Strategic Business Objectives.

Our available cash and equivalents are expected
to be sufficient to meet our cash requirements for at least the
next 12 months, even taking into account certain litigation
settlement payments that may be required in connection with
claims related to our My.MP3 service to the extent we have
accrued such amounts as of June 30, 2001. However, we may
need to raise additional funds in order to:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | satisfy any damage awards or unanticipated
	settlement costs related to our current or potential future
	litigation proceedings;
|
| |  | finance unanticipated working capital
	requirements;                                                                            
|
| |  | obtain additional licenses in order to provide
	certain music services and/or specific content to consumers;                    
|
| |  | develop or enhance existing services or products;                                                                               
|
| |  | fund distribution relationships;                                                                                                
|
| |  | respond to competitive pressures; or                                                                                            
|
| |  | acquire complementary businesses, technologies,
	content or products.                                                           

We cannot assure you that additional financing
will be available on terms favorable to us, or at all. In
particular, potential investors or lenders may be deterred from
financing our company given its past, current and potential
litigation and other legal challenges, or may demand terms
unfavorable to us as conditions to investment or funding. If
adequate funds are not available or are not available on
acceptable terms, our ability to satisfy litigation awards or
settlement, obtain additional music licenses, fund possible
expansion, take advantage of unanticipated opportunities,
develop or enhance services or products or otherwise respond to
competitive pressures would be significantly limited. If we
raise additional funds by issuing equity or convertible debt
securities, the percentage ownership of our stockholders will be
reduced, and these securities may have rights, preferences or
privileges senior to those of our stockholders.

We May Be Required To Record A Charge For The
Impairment Of Certain Prepaid Multimedia Royalty Licenses, Which
Could Significantly Impact Our Financial Results.

In connection with our various multimedia content
license agreements entered into with certain major and
independent record labels, we advanced significant recoupable,
non-refundable pre-payments in order to cover future royalty
payments owed under such licenses. We cannot assure you that
such advance payments will be fully recouped over the term of
the relevant licenses and we will not receive a refund for the
amounts not recouped. If in the future, there are indications of
impaired value, we may be required to write down a significant
portion, if not all, of the impaired license. These potential
charges to operations could significantly affect one or more of
our future quarterly financial results and cause us to miss the
performance expectations of analysts and investors, thus
potentially lowering the trading price of our common stock
significantly.

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We Have Made Investments In Other Companies
From Which We May Never Be Able To Derive Income And In Relation
To Which We Have Had To And May In The Future Have To Record
Impairment Expenses, Which Will Impact Our Financial
Results.

We have made investments in and other business
arrangements with companies that have experienced financial and
operational difficulties, including bankruptcy, which could
impair the overall value and potential value of these
investments and arrangements. This could, in turn, negatively
impact our business operations, financial accounting results and
stock price. During the year ended December 31, 2000 and
six months ended June 30, 2001, we recorded expenses
related to the impairment of our strategic investments equal to
$50,736,000 and $1,200,000, respectively. We may have to record
additional impairment expenses in future quarters, and there can
be no assurance that we will ever benefit from these investments.

Our Stock Price And Trading Volume Has Been
And May Continue To Be Extremely Volatile.

The trading price of our common stock has been
and is likely to continue to be extremely volatile. Our stock
price could be subject to wide fluctuations in response to a
variety of factors, including the following:



| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | developments related to our current or future
	legal proceedings;                                                                   
|
| |  | actual or anticipated variations in quarterly
	and/or annual operating results;                                                     
|
| |  | announcements of technological innovations;                                                                                         
|
| |  | new products or services offered by us or our
	competitors;                                                                         
|
| |  | changes in financial estimates and/or ratings by
	securities analysts;                                                              
|
| |  | announcements of significant acquisitions,
	strategic partnerships, joint ventures or capital commitments by
	us or our competitors;
|
| |  | additions or departures of key personnel;                                                                                           
|
| |  | sales of common stock;                                                                                                              
|
| |  | the granting and/or exercise of warrants to
	purchase our common stock;                                                             
|
| |  | perceived and/or actual sales of our stock by
	company insiders; and                                                                
|
| |  | other events or factors, many of which are beyond
	our control.                                                                     

In addition, the stock market in general, and the
Nasdaq National Market and the stock prices of Internet-related
companies in particular, have experienced extreme price and
volume fluctuations that have often been unrelated or
disproportionate to the operating performance of such companies.
In addition, the market reaction to companies in the Internet
sector is often tied to the success of a few established
companies such as AOL-Time Warner, Inc., Yahoo! Inc., eBay Inc.
and Amazon.com, Inc., regardless of such companies
relation to a particular company, including ours. These broad
market and industry factors may materially adversely affect the
market price of our common stock, regardless of our actual
operating performance. In the past, following periods of
volatility in the market price of a companys securities,
securities class action litigation has often been instituted
against companies. Class action and derivative lawsuits have
been filed against us arising in part from the decline in our
stock price throughout 2000, as described elsewhere in these
risk factors. This litigation could result in substantial costs
and a diversion of managements attention and resources,
which could adversely affect our business, financial condition
and the market price of our common stock.

Substantial Future Sales Of Our Common Stock
In The Public Market Could Cause Our Stock Price To
Fall.

Sales of a large number of shares of our common
stock in the public market or the perception that such sales
could occur could cause the market price of our common stock to
drop. The majority of our shares are freely transferable without
restriction or registration under the Securities Act of 1933,
unless such shares are held by our affiliates, as that term is
defined in Rule 144 under the Securities Act. Once issued,
any shares registered

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on a Form S-8 registration statement, as all
of our shares subject to outstanding options are, may be freely
transferable without restriction or registration under the
Securities Act of 1933, with the exception of certain shares
held by our affiliates, as that term is defined in Rule 144
under the Securities Act. Sales of common stock by existing
stockholders in the public market, or the availability of such
shares for sale, could adversely affect the market price of the
common stock.


As of June 30, 2001, holders of up to
17,088,152 shares of our common stock, as well as holders of
warrants to purchase up to 5,400,000 shares of common stock,
have certain registration rights. If such holders, by exercising
either their registration rights or their rights under
Rule 144 or Rule 701, cause a large number of
securities to be registered and/or sold in the public market,
such sales could have an adverse effect on the market price for
our common stock. If we were to include in a company-initiated
registration shares held by such holders pursuant to the
exercise of their registration rights, such sales may have an
adverse effect on our ability to raise needed capital.
Additionally, we are required to issue 2.5 million shares
of MP3.com common stock in connection with the Stipulations, a
portion of which was issued to plaintiffs counsels on
July 31, 2001. These shares, when issued, must be freely
tradable securities without restrictions. However, if the Merger
is not consummated, the remaining shares will not be issued
until at least March 2002.

Risks Related To Sales And Marketing

Our Brand Name And Revenues Could Be Damaged
If The Music Provided By Lesser-Known Artists Fails To Meet
Consumer Expectations.

Many artists, including most widely-recognized
artists, typically sign multi-year exclusive recording contracts
that may prevent them from posting music on our web site. To
post music on our web site, these artists must typically get
permission from their record company. As a result, our access to
widely-recognized artists is limited. If the music provided by
these lesser-known and local artists fails to meet consumer
expectations, our brand name could be damaged and our business
may not generate sufficient revenues to survive.

Development Of New Standards For The
Electronic Delivery Of Music May Diminish Our Brand Identity And
Disrupt The Way We Do Business.

We currently rely on mp3 technology for both
brand identity and as a delivery method for the digital
distribution of music. We do not own or control mp3 technology.
The onset of competing industry standards for the electronic
delivery of music could significantly affect the way we operate
our business as well as the publics perception of MP3.com
as a company. For example, for almost two years, some of the
major recording studios devoted significant resources into
developing a universal standard for the electronic delivery of
music, called the Secure Digital Music Initiative, or SDMI.
Although at this time SDMI does not appear to be a viable
standard, the development of which may be abandoned entirely,
the recording companies may continue to pursue SDMI or similar
efforts in the future. In addition, a number of corporations
including Microsoft Corporation, IBM Corporation, AT&T
Corp., Liquid Audio, Inc., RealNetworks, Inc. and Sony
Corporation have launched efforts to establish proprietary audio
formats to compete with the mp3 format. Some competitive formats
offer security and features that track the number of copies made
or designate each copy with an identifiable
watermark. The mp3 technology we currently use does
not offer these features. These features are especially popular
among groups associated with the traditional music industry, and
are being promoted by some of our competitors. Widespread
industry and consumer acceptance of any of these audio formats
could significantly harm our business if we are unable to adapt
and respond to these changing standards. In addition, it has
been reported that Microsoft plans to severely limit the quality
of music that can be recorded as an mp3 file using software
built into the next version of its personal computer operating
system, Windows XP. It has also been reported that music
recorded in Microsofts Windows Media Audio format will
sound clearer than the mp3 audio format and may require less
storage space on a computer.

Although we are not tied exclusively to the use
of mp3 technology or to any other specific standard for the
digital delivery of music, if a proprietary, or closed, music
delivery format receives widespread industry and consumer
acceptance, we may be required to license additional technology
and information from third parties in order to adopt that
format. We cannot assure you that this third-party technology
and information will be

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available to us on commercially reasonable terms,
if at all. Any failure to obtain any of these technology and
information licenses or to successfully reconfigure our music
library to support these technologies could prevent us from
making our music available in the most widely accepted formats,
which could make our offerings less popular or inaccessible to
both consumers and artists and thus harm our business.


Unless We Develop A Strong Brand Identity, Our
Business May Not Continue To Grow And Our Financial Results May
Suffer.

We believe that our historical growth and brand
recognition have been largely attributable to frequent and
visible national and local media exposure as well as promotion
of our web site. The frequency or quality of this media exposure
or promotion may not continue. Widespread industry and consumer
acceptance of a music delivery platform other than the mp3
format may greatly reduce the frequency and quality of this
media exposure and promotion and, as a result, our brand
recognition. Further, negative publicity from our litigation
proceedings, or from negative perceptions in the public and
financial community of dot-com,
e-commerce or Internet content
companies, could hurt public perception of our brand and cause
consumers and artists to use other web sites or other means of
accessing and distributing their music. We believe that
continuing to strengthen our brand will be critical to achieve
widespread acceptance of our products and services. Favorable
public perception of our brand will depend largely on our
ability to continue providing users with high quality products
and services and the success of our marketing efforts. We plan
to increase our marketing expenditures to create and maintain
brand recognition. However, brand promotion activities may not
yield increased revenues and, even if they do, any increased
revenues may not offset the expenses we incur in building our
brand.

If We Do Not Transcend A Mere Association
Between Our Company And The Mp3 Format In The Minds Of
Consumers, Our Brand Identity And Financial Results Could
Suffer.

The growth of our business will also depend in
significant part on our ability to develop a brand identity that
transcends a mere association with the mp3 format. We must
pursue a brand development strategy that identifies our company
as a primary source for interesting and diverse high quality
music and artists above and beyond mp3 technology. Although
MP3.com is not tied exclusively to the use of mp3 technology or
to any other specific standard for the digital delivery of
music, failure to achieve brand recognition apart from the mp3
format could significantly affect the future viability of our
brand name and our ability to generate revenues.

If We Fail To Collect Accurate And Useful Data
About Our Consumers, Potential Advertisers May Not Advertise On
Our Web Site, Which May Result In Reduced Advertising
Revenues.

We plan to use consumer data to expand, refine
and target our marketing and sales efforts. We collect most of
our data from users who report information to us as they conduct
transactions on our web site. If a large proportion of users
impede our ability to collect data or if they falsify data, our
marketing and sales efforts would be less effective because
advertisers generally require detailed demographic data on their
target audiences. In addition, laws relating to privacy and the
use of the Internet to collect personal information, including
strict laws relating to collecting information from children,
could limit our ability to collect data and utilize our
database. Failure to collect accurate and useful data could
result in a substantial reduction in advertising revenues, which
represented approximately 81.4% of our total revenues during
2000 and approximately 85.5% for the six months ended
June 30, 2001. Because we use e-mail for direct marketing,
any legislative or consumer efforts to regulate unsolicited bulk
e-mails, commonly referred to as spam, as well as
other laws regulating the use of e-mail, could significantly
impair our sales and marketing efforts and our associated
advertising revenue.

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Risks Related To Operations

Our International Operations Involve Numerous
Risks That Could Harm Our Business.

We currently operate a small branch office in
London, England, through which we manage our European operations
and attempt to market and sell our services in several other
countries. Our artists resided in approximately 200 countries as
of June 30, 2001, and customers visit our web site from all
over the world. We have also entered into relationships with
third parties outside of the U.S., in particular Japan, to
assist with our penetration of foreign markets.

To date, we have developed four translated
versions of our web site and have limited experience selling and
marketing our products and services internationally. We believe
we need to continue to expand quickly into international markets
in order to effectively obtain and maintain market share. In
most countries, we will have to compete with local companies who
understand the local markets better than we do and who may have
established local brand identity and customer loyalty. As a
result, we may not enjoy some of the first-to-market advantages
that we may have enjoyed in the United States.

In addition, international markets that we have
selected may not develop at a rate that supports our level of
investment. In particular, international markets typically have
been slower to adopt the Internet as an advertising and commerce
medium. Moreover, expansion into international markets will
require substantial management attention and financial
resources. We cannot be certain that revenues derived from our
international expansion will offset the significant investment
required to establish and maintain international web sites and
an international presence. In addition to uncertainty about our
ability to generate revenues from our foreign operations and
expand our international presence, there are certain risks
inherent in doing business on an international level. We are
subject to the normal risks of doing business internationally,
as well as risks specific to Internet-based companies in foreign
markets. These risks include:



| |   |                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | delays in the development of the Internet as a
	music delivery, advertising and commerce medium in international
	markets;                                                                        
|
| |  | difficulties in managing operations due to
	distance, language and cultural differences, including issues
	associated with establishing management systems infrastructures
	in individual markets;
|
| |  | unexpected changes in regulatory requirements;                                                                                                                                                    
|
| |  | the inability to obtain workable licenses to
	operate our My.MP3 or other MSP-related services internationally;                                                                                   
|
| |  | government-imposed restrictions on the
	publics access to the Internet;                                                                                                                          
|
| |  | legal uncertainty regarding liability for the
	content posted on our web site and the lack of clear legal
	precedent or applicable law;                                                           
|
| |  | legal systems that are less Internet-friendly
	than those in the United States;                                                                                                                   
|
| |  | different accounting practices;                                                                                                                                                                   
|
| |  | potential adverse tax consequences, such as those
	associated with cross-border use of intangible assets, and
	others;                                                                            
|
| |  | more stringent consumer protection laws;                                                                                                                                                          
|
| |  | higher costs of doing business in foreign
	countries;                                                                                                                                             
|
| |  | difficulties and costs of staffing and managing
	foreign operations;                                                                                                                              
|
| |  | increased risk of piracy and limits on our
	ability to enforce our intellectual property rights;                                                                                                  
|
| |  | the need to comply with different and often
	conflicting laws and regulations;                                                                                                                    
|
| |  | political and economic instability; and                                                                                                                                                           
|
| |  | other legal and political risks.                                                                                                                                                                  

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Any of these factors could harm our future
international operations, and consequently our business,
operating results and financial condition. In addition, we do
not currently hedge our foreign currency exposures.

For Content, We Rely Heavily On The
Contributions Of Artists Who, Over Time, May Be Difficult To
Attract And Retain.

Our success depends on having a web site that
offers high quality and diverse music choices. Our failure to
attract and retain artists who can provide us with music and
other content would limit the overall quality and quantity of
the offerings on our web site and harm our business. Because our
contracts with artists are, with few exceptions, non-exclusive
and can be terminated by the artist at any time, our retention
of artists requires that we offer sufficient benefits, including
artist services and artist-oriented content, to encourage them
to continue providing us with content. If we are not able to
maintain our ability to serve and provide valuable tools to
artists, artists may leave our web site and remove their music
and other content. This could also prevent us from attracting
new artists. We may also lose artists who gain recognition on
our web site and then are recruited by or attracted to the
traditional music industry. The loss of artists and the
inability to attract new artists would impair our ability to
generate advertising revenue, generate CD revenues and offer a
broad selection of content through our syndicated radio and
business music services.

Our Business Operations Could Be Significantly
Disrupted If We Lose Members Of, Or Fail To Properly Integrate,
Our Management Team.

Our future performance will be substantially
dependent on the continued services of our management and our
ability to retain and motivate them. The loss of the services of
any of our officers or senior managers could harm our business.
We do not have long-term employment agreements with any of our
key personnel, other than our chief executive officer, and we do
not maintain any key person life insurance policies
except on our chief executive officer. Almost all of our
management team joined MP3.com in 1999. Since the completion of
our initial public offering in July 1999, we have experienced
turnover in our management team, and we may continue to
experience turnover. Most of these individuals have not
previously worked together and are currently being integrated as
a management team. If our senior managers are unable to work
effectively as a team, our business operations could be
significantly disrupted.

We Rely On Cinram International, Inc. To
Fulfill The Production And Delivery Of Substantially All Of Our
DAM CDs And Other Merchandise, And We May Be Vulnerable To
Unexpected Interruptions Or Discontinuation Of Our Fulfillment
Operations.

In November 1999, we outsourced exclusively to
Cinram International, Inc. our just-in-time DAM CD production
and fulfillment process, as well as the production and
fulfillment of our other promotional CD products. The transition
of fulfillment operations to Cinram was completed at the end of
March 2000. For redundancy, we also currently maintain certain
minimal fulfillment capabilities at our main facility in San
Diego. Should Cinram cease to provide us with production and
fulfillment services for any reason, we cannot assure you that
we will be able to fulfill any of our customers orders for
DAM CDs and other merchandise without significant delays or
expense, or at all. Any such loss of fulfillment operations, for
any period of time no matter how brief, may substantially and
irreparably harm our business reputation and significantly
decrease our revenues and our total number of consumers, artists
and users.

We May Not Be Able To Hire And Retain A
Sufficient Number Of Qualified Employees, And As A Result We May
Not Be Able To Grow As We Expect, Or Maintain The Quality Of Our
Services.

Our future success will depend on our ability to
attract, train, retain and motivate other highly skilled
technical, managerial, marketing and customer support personnel.
Despite the recent downturn in the viability and attractiveness
of dot-com companies to the general workforce,
competition for these personnel has historically been intense,
especially for engineers, web designers and advertising sales
personnel, and we may be unable to successfully attract
sufficiently qualified personnel. Moreover, we may experience
significant turnover of our current employee workforce.
Substantially all of our employees joined us in 1999. If we
cannot integrate these employees into our business, we will not
be able to effectively manage our growth. Also, our

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inability to hire, integrate and retain qualified
personnel in sufficient numbers may reduce the quality of our
programs, products and services.


We Must Continue To Upgrade Our Technology
Infrastructure, Or We Will Be Unable To Effectively Meet Demand
On Our Web Site.

During the second quarter of 2001, approximately
672 gigabytes of musical content, 14,000 artists and 127,000
songs and audio files were added to our web site. We must
continue to add hardware and enhance software to accommodate the
increased content and continued use of our web site. If we are
unable to increase the data storage and processing capacity of
our systems at least as fast as the growth in demand, our web
site may become unstable and may fail to operate for unknown
periods of time. Unscheduled downtime could harm our business
and also could discourage users of our web site and reduce
future revenues.

Our Data Warehousing And Web Server Systems
May Stop Working Or Work Improperly Due To Natural Disasters,
Failure Of Third-Party Services, Rolling Blackouts And Other
Unexpected Problems.

Because our data warehousing, web server and
network facilities are all located in California, an earthquake
or other natural disaster could affect all of our facilities
simultaneously. An unexpected event like a power or
telecommunications failure, fire, flood or earthquake at our
on-site data warehousing facility or at either of our three
Internet service providers facilities could cause the loss
of critical data and prevent us from offering our services to
artists and consumers. In addition, California utility companies
are currently experiencing a financial crisis which have led to
brownouts, rolling blackouts and other
disruptions of power services to consumers. These losses of
power could continue or worsen due to circumstances out of our
control and adversely affect our business or shut down our web
site and other operations entirely. Our business interruption
insurance may not adequately compensate us for any losses that
may occur, and our web site may suffer irreparable harm in the
eyes of consumers and artists. In addition, we rely on third
parties to securely store our archived data, house our web
server and network systems, and connect us to the Internet. A
failure by any of these third parties to provide these services
satisfactorily would impair our ability to access archives and
operate our web site.

We May Lose Visitors To Our Web Site And Lose
Revenues If Our Online Security Measures Fail.

If the security measures that we use to protect
personal information are ineffective, we may lose visitors to
our web site that could reduce our revenues. We rely on security
and authentication technology licensed from third parties. With
this technology, we perform real-time credit card authorization
and verification. We cannot predict whether new technological
developments could allow these security measures to be
circumvented. In addition, our software, databases and servers
may be vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions. We may need to spend
significant resources to protect against security breaches or to
alleviate problems caused by any breaches. We cannot assure that
we can prevent all security breaches.

Government Regulation May Require Us To Change
The Way We Do Business.

The laws and regulations that govern our business
change rapidly. Although our operations are currently based in
California, the United States government and the governments of
other states and foreign countries have attempted to regulate
activities on the Internet. We do not know for certain how
existing laws governing issues such as property ownership,
copyright and other intellectual property issues, taxation,
illegal or obscene content, retransmission of media, and
personal privacy and data protection may 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. In addition, most of the laws that relate to the
Internet have not yet been fully interpreted by the various
courts and other authorities.

Furthermore, we have entered into agreements with
international entities, and anticipate entering into additional
agreements, to conduct business activities in foreign
jurisdictions. Because our services are accessible worldwide,
and because we facilitate sales of goods and provide services to
users worldwide, foreign

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jurisdictions may claim that we are required to
comply with their laws. For example, a French court has recently
ruled that a U.S. web site must comply with French laws
regarding content and, in December 2000, the highest court in
Germany ruled similarly with regard to German law.


On October 28, 1998, the Digital Millennium
Copyright Act (or DMCA) was enacted. The DMCA
includes statutory licenses for the performance of sound
recordings and for the making of recordings to facilitate
transmissions. Under these statutory licenses, depending on our
future business activities, we and our business partners may be
required to pay licensing fees for digital sound recordings we
deliver on our web site and through retransmissions of radio
broadcasts and/or other audio content. The DMCA does not specify
the rate and terms of such licenses, which will be determined
either through voluntary inter-industry negotiations or
arbitration. Moreover, with respect to digital publishing, sound
recording and other music licenses not directly covered by the
DMCA, we plan to engage in a proceeding before a tribunal of the
United States Copyright Office along with the Recording Industry
Association of America during 2001 to determine what, if any,
licensee fees should be paid to various rights holders.
Depending on the rates and terms adopted for the statutory
licenses, our business could be harmed both by increasing our
own cost of doing business, and by increasing the cost of doing
business for our customers.

The Child Online Privacy Protection Act (or
COPPA) and the Child Online Protection Act (or
COPA) were enacted in October 1998. COPPA imposes
civil and criminal penalties on persons distributing material
harmful to minors over the Internet to persons under the age of
17, or collecting personal information from children under the
age of 13. We do not knowingly collect and disclose personal
information from such minors. COPA, on the other hand, attempted
to regulate online content considered harmful to
minors prior to being ruled unconstitutional by the
Federal Court of Appeals for the Third Circuit in 2000. In May
2001, the U.S. Supreme Court agreed to review the case and has
not yet made its ruling. The manner in which COPPA and/or COPA
may be interpreted and enforced cannot be fully determined, and
future legislation similar to COPPA and/or COPA could subject us
to potential liability, which in turn could harm our business.
Such laws could also damage the growth of the Internet generally
and decrease the demand for our products and services.

Finally, there are a large number of legislative
proposals before the United States Congress and various state
legislatures regarding online and other 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.

Because of this rapidly evolving and uncertain
regulatory environment, both domestically and internationally,
we cannot predict how these laws and regulations may affect our
business. In addition, these uncertainties make it difficult to
ensure compliance with the laws and regulations governing the
Internet. These laws and regulations could harm us by subjecting
us to liability or forcing us to change how we do business.

We May Be Liable To Third Parties For Music,
Software And Other Content That Is Available On Our Web Site And
On The CDs We Distribute.

We may be liable to third parties for the content
on our web site and on the CDs we distribute:



| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | if the music, text, graphics, software or other
	content on our web site or CDs violates their copyright,
	trademark, or other intellectual property rights;
|
| |  | if our artists violate their contractual
	obligations to others by providing content on our web site or
	CDs; or                                            
|
| |  | if anything on our web site or CDs is deemed
	obscene, indecent, harmful to minors or defamatory.                                                           

Risks Related To Government Regulation,
Content and Intellectual Property.

We may also be liable for anything that is
accessible from our web site through links to other web sites.
We attempt to minimize these types of liability by requiring
representations and warranties relating to our artists
ownership of and rights to distribute and submit their content
and by taking related measures to review

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content on our web site and on our CDs. However,
alleged liability could harm our business by damaging our
reputation, requiring us to incur legal costs in defense,
exposing us to awards of damages and costs and diverting
managements attention away from our business. We are
currently involved in multiple litigation proceedings.


We May Not Be Able To Prevent Others From
Using Our Trademarks, Copyrights, Software And Other
Intellectual Property Assets. If Others Do Use These Assets,
Their Value To Us, And Our Ability To Use Them To Generate
Revenue, May Decrease.

Our intellectual property includes our trademarks
and copyrights, proprietary software, and other proprietary
rights. We believe that our intellectual property is important
to our success and our competitive position, and we try to
protect it. However, our efforts may be inadequate. Although we
have applied for a trademark registration for the
MP3.com name in numerous jurisdictions worldwide, we
do not currently have a registered trademark in nearly all of
these jurisdictions, including the most important jurisdictions
such as the United States, and we may not be able to prevent
others from using mp3 or MP3.com. Use of
the MP3.com name by others could dilute our brand
identity and confuse the market. Moreover, much of our
technology, including our Beam-it and Instant Listening
services, subscription channels, the business music services and
web site technology and software, are currently not protected by
patents or other protection which would prevent third parties,
including record companies and other rights holders, from
duplicating the technology and providing services identical to
ours. Although we have applied for patents with regard to a
number of these and other core technologies of our business,
none of these patents have yet been issued, nor is there any
guarantee that they will ever be issued (or prosecutable) in the
future. In addition, our ability to conduct our business may be
harmed if others claim we violate their intellectual property
rights. For example, certain entities have asserted that many
online music providers, including MP3.com, violate patent rights
that they allegedly own covering forms of distribution of music
over the Internet (including the sale of digital downloads and
certain music streaming technologies). If successful, these
claims, or similar claims by others, could seriously harm our
business by forcing us to cease using important intellectual
property or requiring us to pay monetary damages. Even if
unsuccessful, these claims could harm our business by damaging
our reputation, requiring us to incur legal costs and diverting
managements attention away from our business.




Item 3. Quantitative and Qualitative
Disclosures about Market Risk

Interest Rate Risk

The primary objective of our investment
activities is to preserve principal while at the same time
maximizing yields without significantly increasing risk. To
achieve this objective, we maintain a portfolio of cash
equivalents in a variety of securities, including U.S.
government agencies, commercial paper, and money market funds.
As of June 30, 2001, 100% of our total portfolio matures in
one year or less.

Under our current policies, we do not use
interest rate derivative instruments to manage exposure to
interest rate changes. A hypothetical 100 basis point adverse
move in interest rates along the entire interest rate yield
curve would not materially affect the fair value of interest
sensitive financial instruments at June 30, 2001. The
following table presents the fair value balances of our cash
equivalents that are subject to interest rate risk by year of
expected maturity and average interest rates as of June 30,
2001 (dollars in thousands):

|                          |  |      |        |  
|------------------------- |  | ---- | ------ | -
|                          |  | 2001
|                          |  |     
|Cash and cash equivalents |  | $    | 76,805 |  
|                         
|                         
|                         
|                         
|Average interest rates    |  |      | 3.811  | %

Strategic Portfolio Liquidity Risk

We have made strategic investments in certain
privately-held companies. As of June 30, 2001, these
investments had a net book value of approximately $10,200,000.
Because these companies are not publicly traded, it may be very
difficult for us to liquidate or sell all or part of our
ownership interest in one or all of these companies. In the
event we are able to sell all or part of our ownership interest,
we may need to do so at a substantial discount from our cost or
recorded basis. Additionally, it may be very difficult for these

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companies to obtain additional capital, if
necessary, to continue to operate. If one or all of these
companies are unable to obtain necessary capital to continue
their operations, they may file for bankruptcy or be forced into
bankruptcy by their creditors. This could further impair our
ability to sell or liquidate our ownership interest, which could
result in a significant charge to income for impairment of these
strategic investments.


Foreign Currency Risk

Currently, nearly all of our revenues and
expenses are denominated in U.S. dollars and as a result, we
have not experienced any significant foreign exchange gains or
losses.

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PART II  OTHER
INFORMATION




Item 1. Legal
Proceedings

Copyright Litigation

Major Label
Lawsuits.On January 21, 2000,
ten major recording companies filed a copyright infringement
lawsuit against MP3.com, Inc. in the United States District
Court for the Southern District of New York (the Major
Label Lawsuit). The complaint alleged that MP3.com, in
connection with certain content available in its My.MP3 service,
made unauthorized copies of tens of thousands of audio CDs in
violation of the Copyright Act. On April 28, 2000, the
court granted plaintiffs motion for summary judgment and
held that MP3.com was liable for infringing plaintiffs
copyrights, and the litigation proceeded with discovery on the
issues of willfulness and damages. On May 10, 2000, MP3.com
disabled all content within the My.MP3 service except as
expressly authorized by the copyright holders.

Between June and August 2000, MP3.com entered
into settlement and license agreements with Warner Music Group,
BMG Entertainment, Sony Music, and Capitol Records, Inc. (EMI),
which together represented eight of the ten major recording
companies that filed the Major Label Lawsuit. The settlement
agreements provide for a settlement amount to be paid in cash by
MP3.com in exchange for a release from the settling plaintiffs
and their affiliated entities (as defined in the settlement
agreements) of all claims related to the lawsuit and the My.MP3
service. Most-favored-nation provisions in these
settlement agreements require additional settlement amounts to
be paid under certain circumstances.

As a result of these settlements, the Major Label
Lawsuit was limited to a dispute with UMG Recordings, Inc.,
which represented two of the original plaintiffs. A trial in the
case was held from August 28 through September 6, 2000
on the issues of willfulness and damages. After hearing
evidence, the court ruled on September 6, 2000 that MP3.com
had willfully infringed UMGs copyrights and awarded
damages to UMG in an amount of $25,000 per CD. The Court then
scheduled a period to allow MP3.com to conduct discovery
concerning the certificates of registration for which plaintiffs
sought damages. On November 16,2000, UMG made a motion for
entry of judgment in the amount of $53,400,000 in statutory
damages, costs, and attorneys fees, which MP3.com did not
oppose. As a result, a judgment in that amount was entered.

MP3.com has also entered into a license agreement
with UMG. Subject to certain affirmative obligations of MP3.com
and other terms and conditions regarding the implementation of
the My.MP3 service, MP3.com is permitted to utilize the
recordings owned by Warner Music Group, BMG Entertainment, Sony
Music, EMI, and UMG as part of the My.MP3 service. The license
agreements have terms of approximately three to ten years, and
provide for payment of a one-time fee each time a
licensors recording is added to a separate My.MP3 account.
These licenses also provide for on-going royalty payments based
on the greater of (i) a specified percentage of net
revenues generated from or in connection with the My.MP3 service
or (ii) a specified amount accrued each time a
licensors recording is streamed from My.MP3. Although
MP3.com has obtained license agreements permitting the use of
recordings from BMG Entertainment, Warner Music Group, Sony
Music, UMG, EMI, and certain other independent labels, there can
be no guarantee that MP3.com will be able to secure similar
license agreements from any other recording company.

Other Record Label
Lawsuits.Over the course of 2000 and
2001, some other entities filed lawsuits against MP3.com based
on the same set of allegations as the Major Label Lawsuit. These
include: Tee Vee Toons, Inc.; Zomba Recording Corp. (the
Zomba case); Koch Entertainment and Velvel Records
LLC (the Koch case); EMusic.com, Inc., Fuel 2000
Records, Spinart, Inc., Gig Records, Fearless Records, and
Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case).
Additionally, several independent labels have sent MP3.com
demand letters alleging similar claims.

A jury trial in the Tee Vee Toons case commenced
on March 26, 2001. Prior to trial, in reliance on the
Courts rulings in the Major Label Lawsuit, the issues of
infringement, fair use, and willfulness were adjudicated against
MP3.com. As a result, the jury trial was limited to the issue of
damages. The trial concluded on April 6, 2001. The jury
considered 145 copyright certificates and returned a
verdict which the Court tabulated as totaling $292,968.
Subsequently, two jurors contacted the Court to inform it that
the verdict decided upon

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by the jurors contained discrepancies. The Court
interviewed all the jurors and set a briefing schedule on the
issue of the jurys verdict. On June 19, 2001, the
Court declared a mistrial, and set a new trial date of
November 5, 2001. On June 26, 2001, MP3.com filed a
motion to certify the ruling to the Court of Appeals pursuant to
28 U.S.C. sec. 1292(b). Tee Vee Toons response papers
were filed on June 29, 2001. The Court denied the motion on
July 27, 2001.


Discovery in the Zomba case closed
June 4, 2001.The final pre-trial
conference is scheduled for August 10, 2001, and the case
is set for trial on September 5, 2001. Like the Tee Vee
Toons case, the trial in the Zomba case will be limited to only
the issue of damages. The Koch case has been settled and the
case is now closed. The complaint in the EMusic case was filed
on December 14, 2000. MP3.coms response to the
complaint was filed on February 8, 2001. On June 20,
2001, MP3.com and EMusic filed a stipulation of dismissal of
their claims against each other without prejudice. The dismissal
was entered by the Court on June 21, 2001. Plaintiffs
counsels motion to withdraw as counsel to the remaining
plaintiffs was granted on July 23, 2001. On August 7,
2001, the Court will hear MP3.coms motion to dismiss the
case. The Unity case, which purports to be brought on behalf of
Unity, an independent record company whose works were allegedly
used in the My.MP3 service, and all other similarly situated
entities or individuals, was filed on November 7, 2000.
MP3.com answered the Complaint on January 16, 2001. On
April 16, 2001, the Court entered an order denying
plaintiffs motion for class certification without
prejudice to a renewal of the motion within 45 days. Unity
did not renew its motion within the 45 day deadline. Thus,
the case may proceed as an individual action only based on the
Unity sound recordings allegedly infringed by MP3.com.

Publisher Lawsuits.On March 14, 2000, two large music publishing companies,
MPL Communications, Inc. and Peer International Corporation,
with the assistance of The Harry Fox Agency, Inc.
(HFA), filed a copyright infringement lawsuit
against MP3.com in the United States District Court for the
Southern District of New York (the MPL/ Peer case).
The complaint alleged that MP3.com, in connection with its
My.MP3 service, made unauthorized copies of audio CDs containing
plaintiffs copyrighted works in violation of the Copyright
Act, and that MP3.com, in connection with the streaming of audio
content to users of the My.MP3 service, continued to make
unauthorized digital phonorecords in violation of the Copyright
Act. The complaint further alleged that MP3.coms actions
constituted unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs sought damages
(including statutory damages of up to $150,000 per violation)
and injunctive relief prohibiting MP3.com from operating its
My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works.

On October 17, 2000, MP3.com, the National
Music Publishers Association, Inc., and its licensing
subsidiary, HFA, entered into a preliminary agreement to be
approved by individual HFA music publisher-principals for
settlement and use of musical compositions on the My.MP3 service
for a three year term. As a result, MPL and Peer settled the
MPL/ Peer case with MP3.com, and a stipulation of dismissal with
prejudice was subsequently signed by the parties on
December 28, 2000 and entered by the Court on
January 2, 2001.

The three-year licensing arrangement provided
that MP3.com would pay up to $30,000,000 to HFA for the benefit
of up to 25,000 music publishers and their songwriter partners,
to be allocated to two equal funds. One fund was used to pay HFA
publisher-principals for past uses of music on the My.MP3
service, in exchange for a release from HFA publisher-principals
and their affiliated entities of all claims related to those
asserted in the MPL/ Peer case and the use of their compositions
on the My.MP3 service. The other fund provides advance payments
toward royalties earned under the prospective license. The terms
of the prospective license call for a payment of one-quarter
cent each time a song is streamed on demand to a customer from
his or her My.MP3 locker, along with a one-time fee per track
added to the My.MP3 service. The preliminary agreement with HFA
was finalized on February 28, 2001. Approximately 78% of
the publisher-principals HFA represents accepted and are bound
by the settlement agreement and approximately 90% accepted and
are bound by the licensing agreement. In April 2001, HFA
refunded to MP3.com approximately $4,600,000 pursuant to the
agreement, representing approximately $3,200,000 and $1,400,000
for the proportion of HFA publisher-principals that did not
settle or license content to MP3.com, respectively.

Zomba Enterprises, Inc. has filed its own music
publishing case against MP3.com making allegations like those
set forth in the MPL/ Peer case. The case is set for trial on
September 5, 2001. In the second quarter of

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2001, similar publisher lawsuits were filed by
Randy Newman, Tom Waits, and Ann and Nancy Wilson (the
Newman case) and Major Bob Music, Inc., Rio Bravo
Music, Inc., Castle Bound Music Inc., Dream Catcher Music, Inc.,
and Moon Catcher Music, Inc. (the Major Bob case).
The Newman case was filed on May 7, 2001 in the United
States District Court for the Central District of California.
MP3.com filed its answer to the complaint on June 15, 2001.
The Major Bob case was filed on May 14, 2001. MP3.com filed
its answer to the complaint on June 28, 2001. Additionally,
several other publishers, not affiliated with HFA, have sent
MP3.com demand letters alleging similar claims. In view of the
Courts rulings in the Tee Vee Toons and Zomba cases, there
is a substantial risk that the issues of infringement, fair use,
and willfulness may be adjudicated against MP3.com in any and
all publisher cases. This would mean that MP3.com would only be
able to litigate the issue of damages.


Artists
Class Action.On April 12,
2000, several artists filed a class action lawsuit in the United
States District Court for the Southern District of New York
against MP3.com and several major recording companies that
claimed to own copyrights in sound recordings featuring the
artists. The complaint alleged that the recording company
defendants in the Major Label Lawsuit claimed rights in
plaintiffs recordings that they did not possess. In
particular, the complaint alleged that the recording company
defendants did not possess any copyright protections with
respect to plaintiffs pre-1972 published and pre-1978
unpublished recordings, did not possess the right to digitally
transmit plaintiffs pre-1996 recordings over the Internet,
and did not possess the right to control the conversion of
plaintiffs recordings into mp3 files. The complaint
further alleged that MP3.com has used the names and likenesses
of plaintiffs without their consent or authorization and in a
deceptive manner, in violation of the federal Lanham Act, the
New York Civil Rights Law, and unspecified unfair competition
and misappropriation laws. In their prayer for relief,
plaintiffs asked to have their class action certified, to be
awarded unspecified damages and attorneys fees, to have
the defendants enjoined from using plaintiffs names and
likenesses to promote downloading music over the Internet, and
to receive declaratory relief regarding plaintiffs rights
in their pre- and post-1972 recordings. On August 28, 2000,
the Court issued an oral ruling dismissing all claims against
MP3.com. On December 7, 2000, judgment was entered
dismissing, with prejudice, the federal claims against the
defendants. All state claims were dismissed for lack of an
independently sufficient jurisdictional basis. Plaintiffs filed
a Notice of Appeal on January 5, 2001. Briefing on the
appeal concluded June 11, 2001. Oral argument on the appeal
has not yet been scheduled but is anticipated to occur after
October 21, 2001.

Copyright Settlement Discussions; Charge to
Operations.MP3.com has pursued and
continues to actively pursue settlement discussions with the
various plaintiffs and claimants in the cases and disputes
discussed above. The decision whether to enter into settlement
and/or license agreements with each party will be based upon a
number of factors related to both the lawsuits and
MP3.coms business in general. MP3.com cannot guarantee
that it will be able to enter into any additional settlement
agreements on terms favorable to MP3.com, if at all, or that any
settlement or license agreement will prove beneficial to its
business or stockholders. During the year ended
December 31, 2000, MP3.com recorded a charge for litigation
and copyright matters of $170,000,000. The charge for litigation
and copyright matters represented its estimate of the total
costs to be incurred only in connection with the resolution of
the various litigation and copyright matters associated with the
My.MP3 service, including the lawsuits filed by major recording
companies and other parties. Copyright issues associated with
the My.MP3 service also include but are not limited to
publishing rights, non-major label content, and legal and
advisory fees. This charge did not reflect or include any
amounts paid or payable in connection with forward-looking
licenses to use music recordings or compositions in connection
with the My.MP3 service. This charge reflects managements
expectations as of the date of this filing, and is based on
currently available information as well as significant
assumptions made by management regarding the various litigation
and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the
cumulative amount reserved as a result of this charge to
$41,328,000 as of June 30, 2001. MP3.com cannot guarantee
that future events or results will conform to its expectations
or assumptions regarding the various litigation and copyright
matters. If these expectations and significant assumptions prove
to be erroneous in light of future events, the actual amounts
incurred by MP3.com to resolve all copyright matters related to
the My.MP3 service could be materially different than those
recorded as of June 30, 2001, and could far exceed the
resources and market capitalization of MP3.com.

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Class Action and Derivative
Lawsuits

MP3.com and certain of its employees, officers,
and directors have been named as defendants in several lawsuits
alleging violations of the federal securities laws. The
complaints, which were filed between September 19, 2000 and
November 15, 2000 in the United States District Court for
the Southern District of California, each purport to be brought
on behalf of a class of stockholders. The complaints allege that
MP3.com and the other defendants violated the federal securities
laws by issuing materially false and misleading statements and
failing to disclose material information regarding its My.MP3
service and the litigation surrounding the service. Between
September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits
against MP3.com and certain of its employees, officers, and
directors in the Superior Court of the State of California,
County of San Diego. These complaints allege various statutory
and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud,
gross mismanagement, unjust enrichment, and waste of corporate
assets.

MP3.com and the representatives of the various
plaintiffs for both the class action lawsuits and derivative
lawsuit executed Stipulations of Settlement dated as of
March 20, 2001 (the Stipulations). Under the
terms of the Stipulations, the defendants, while continuing to
deny all liability, have paid into an escrow account $35,000,000
and agreed to issue 2.5 million shares of MP3.com common
stock which MP3.com valued at $5,391,000, in exchange for
complete dismissals and releases of all claims with prejudice.
The escrow amount and the 2.5 million shares of common
stock will be governed by the Stipulations. The distribution of
the escrow amount and the 2.5 million shares will not occur
prior to March 31, 2002, except under certain
circumstances, including the sale or other acquisition of
MP3.com prior to the distribution of the 2.5 million shares
of common stock, in which case the stock will be treated equally
with all other outstanding shares of MP3.com common stock. In
addition, under the Stipulations, MP3.com agreed to institute
certain corporate governance enhancements. On June 29,
2001, the State Superior Court issued final approval of the
settlement of the derivative cases. The Federal District Court
entered final approval of the settlement of the class action on
July 16, 2001. As part of the settlement agreement, counsel
for the plaintiffs are to receive 27.5% of the total settlement
fund. Plaintiffs counsels portion of the
2.5 million shares was issued to plaintiffs counsel
on July 31, 2001.

Charge Related to Class Action and
Derivative Lawsuits.In light of the
settlements of the class action and derivative lawsuits, MP3.com
has recorded a charge of $41,428,000 during the three months
ended March 31, 2001. The charge includes the cash paid
into the escrow account, the value of the 2.5 million
shares of common stock to be issued, and an estimate of its
defense and legal advisory costs. While the charge of
$41,428,000 excludes any potential recovery from its insurance
carriers, MP3.com is seeking to recover from its carriers the
full amount of the settlement together with its legal expenses.
National Union has agreed to pay its policy limit of $5,000,000
towards the securities case, but such amount has not yet been
paid. Prior to receiving payment from National Union, MP3.com is
required to provide certain releases. Currently, MP3.com is
reviewing those releases. If MP3.com receives insurance
proceeds, MP3.com will record the recovery as a gain in the
statement of operations caption Charge related to class
action and derivative lawsuits.

In May 2001, in light of the pending transaction
with Vivendi Universal, MP3.com finalized its negotiations with
its lead defense counsel pursuant to the terms of the fee
agreement and agreed to pay an additional $5,000,000 in fees. As
MP3.coms lead counsel also provided various legal services
and advice to MP3.com on matters other than the shareholder
class action and derivative lawsuits, including but not limited
to the copyright matters, insurance recovery, and the pending
merger of MP3.com with Vivendi Universal, MP3.com has allocated
and charged to expense the additional fee during the three
months ended June 30, 2001 as follows: (i) $3,270,000 to
charges related to class action and derivative lawsuits, (ii)
$1,402,000 to costs related to acquisition activities, and (iii)
$328,000 to reserve for litigation and copyright matters.

IPO Allocation Cases.

During May and June 2001, MP3.com and certain of
its current and former directors and officers were named
defendants in seven similar class actions pending in federal
district court in the Southern District of New

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York. The complaints allege that the prospectus
and registration statement in MP3.coms initial public
offering contained materially false and misleading statements
related to underwriting fees, commissions and other economic
benefits connected with the offering, including alleged tie-in
arrangements between the underwriters and their customers. The
complaints allege causes of action under Sections 11, 12(2)
and 15 of the Securities Act of 1933, as well as
Sections 10(b) and 20(a) and Rule 10b-5 of the
Securities Exchange Act of 1934. Similar cases have been filed
against a number of other companies and their underwriters.
There has been no activity in any of these cases to date.


Other Litigation

MP3.com is also involved in other legal matters
and claims of various types, and from time to time MP3.com may
also be involved in litigation relating to claims arising out of
its operations in the normal course of business.

In particular, the music industry in the United
States is generally regarded as extremely litigious in nature
compared to other industries. As a result, in the future MP3.com
may be engaged in litigation with others in the music industry,
including those entities with whom MP3.com has ongoing license
arrangements. For example, some of the major recording companies
that settled their portion of the Major Label Lawsuit with
MP3.com have asserted in writing that they believe the amount
paid by MP3.com to UMG in satisfaction of the Courts
judgment, together with the concurrent issuance of warrants to
UMG, triggered additional payments to them under the most
favored nations clause in their settlement agreement with
MP3.com. Although MP3.com does not believe they are entitled to
any such additional payments, there can be no assurances that
MP3.com will be successful in ultimately concluding this
particular matter in an amicable fashion, or defending any
resulting lawsuit. As a result, MP3.com may be forced to defend
one or more lawsuits on this and other issues in the future, and
in fact may be involved in a number of litigation proceedings
with the same group of related plaintiffs. MP3.com has not
recorded any charge related to any claims for additional
most favored nations payments as of June 30,
2001.

There can be no assurances that MP3.com will be
successful in ultimately defending any of these lawsuits, and
MP3.com may be required to pay license fees or substantial
damages, including statutory, punitive, or other damages that
far exceed the resources and overall market capitalization of
MP3.com, in which event MP3.com may have to significantly limit
or terminate its business operations, particularly because its
business is not yet profitable. At the rate of $25,000 per work
(which is the per CD amount of statutory damages awarded by the
court in the Major Label Lawsuit), MP3.coms aggregate
potential liability resulting from all of its copyright
litigation proceedings could exceed one billion dollars. If
successful, any one of these lawsuits could seriously harm its
business by forcing MP3.com to cease providing services to its
consumers or requiring MP3.com to pay monetary damages. Even if
unsuccessful, these lawsuits still can harm MP3.coms
business severely by damaging its reputation, requiring MP3.com
to incur legal costs, lowering its stock price and public demand
for MP3.com stock, and diverting managements attention
away from MP3.coms primary business activities in general.




Item 2. Changes in Securities and
Uses of Proceeds

Changes in Securities

None.

Use of Proceeds

MP3.coms registration statement
(No. 333-78545) under the Securities Act for its initial
public offering (the Registration Statement) was
declared effective by the SEC on July 20, 1999. Offering
proceeds, net of aggregate expenses of approximately
$20.6 million, were approximately $360.4 million. As
of June 30, 2001, MP3.com has used the net proceeds of
$360.4 million as follows: approximately $83.7 million
of the net offering proceeds for working capital paid directly
or indirectly to third parties; approximately $9.1 million for
the purchase or installation of machinery and equipment;
approximately $12.0 million for the purchase of various
strategic investments and issuance of a note receivable;
approximately $94.9 million for the settlement

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of certain litigation and copyright matters;
approximately $35.0 million for the settlement of derivative and
shareholder lawsuits; approximately $40.1 million for
prepaid multimedia content royalties; approximately
$4.0 million for the acquisition of the remaining 53.5% of
mp3radio.com; approximately $4.8 million for a loan to
MP3.coms chief executive officer; and approximately
$76.8 million for the purchase of temporary investments in
corporate commercial paper, U.S. government and agency notes,
and money market funds. As of June 30, 2001, no payments
had been made to directors, officers, or affiliates of MP3.com
or owners of 10% or more of the outstanding shares of common
stock of MP3.com, other than compensation payments to officers
of MP3.com and the loan to MP3.coms chief executive
officer.





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

MP3.coms Annual Meeting of Stockholders was
held on May 31, 2001.

The following nominees were elected as directors,
each to hold office until the 2004 Annual Meeting of
Stockholders or until his successor is elected and qualified, by
the vote set forth below:

|                           |  |             |            |                     |  |  |         | 
|-------------------------- |  | ----------- | ---------- | ------------------- |  |  | ------- | 
|Nominee                    |  | Affirmative |            | Negative/Abstaining
|                           |  |             |            |                    
|Mr. Lawrence F. Probst III |  |             | 60,523,797 |                     |  |  | 98,122  | 
|                          
|                          
|                          
|                          
|Mr. Robin D. Richards      |  |             | 60,521,194 |                     |  |  | 100,725 | 

The following directors term of office
continued after the Annual Meeting: Thomas A. Heymann, Michael
L. Robertson, Mark A. Stevens, Howard B. Wiener.

The selection of Ernst & Young LLP as
independent auditors of MP3.com, Inc. for the fiscal year ending
December 31, 2001 was ratified by the vote of the
stockholders. There were 60,569,697 votes for the proposal,
32,595 votes against the proposal, and 19,627 votes abstaining
from the proposal.

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Item 6. Exhibits and Reports on
Form 8-K

(a)  Exhibits:

|        |         |                         |  |                                                                                                                                                               
|------- | ------- | ----------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |         |                        
|Number  |         | Description of Document
|        |         |                        
|        | 2.1(1)  |                         |  | Agreement and Plan of Merger, dated as of
        May 20, 2001, by and among Vivendi Universal, S.A.,
        Metronome Acquisition Sub Inc. and MP3.com, Inc.
|        | 2.2     |                         |  | Modification Agreement, dated as of June 13,
        2001, by and among Vivendi Universal, S.A., Metronome
        Acquisition Sub Inc. and MP3.com, Inc.     
|        | 3.3     |                         |  | Amendment to Amended and Restated Bylaws of
        MP3.com, Inc. dated May 19, 2001.                                                                         
|        | 10.29   |                         |  | MP3.com Submission Agreement (Version 2.3 as of
        May 2, 2001)                                                                                          
|        | 10.36  |                         |  | Secured Promissory Note, dated April 2,
        2001, by Michael L. Robertson in favor of MP3.com.                                                            
|        | 10.37  |                         |  | Pledge and Security Agreement, dated
        April 2, 2001, between Michael L. Robertson and MP3.com.                                                         
|        | 10.38  |                         |  | Employment Agreement, dated May 20, 2001,
        among MP3.com, Inc., Vivendi Universal, S.A. and Greg Kostello.                                             
|        | 10.39  |                         |  | Employment Agreement, dated May 20, 2001,
        among MP3.com, Inc., Vivendi Universal, S.A. and Steve Sheiner.                                             
|        | 10.40  |                         |  | Employment Agreement, dated May 20, 2001,
        among MP3.com, Inc., Vivendi Universal, S.A. and Derrick Oien.                                              
|        | 99.1(1) |                         |  | Stockholder Agreement, dated as of May 20,
        2001, by and among Vivendi Universal, S.A. and certain
        stockholders of MP3.com, Inc.               




|  |                                                                 
|- | ----------------------------------------------------------------
| | Management contract or compensatory plan or
        arrangement.



|    |                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------
|(1) | Filed as an exhibit to MP3.coms Current
        Report on Form 8-K dated May 20, 2001, and
        incorporated herein by reference.

(b)  Reports on Form 8-K:

On May 22, 2001, MP3.com, Inc. filed a
report on Form 8-K, Items 5 and 7 reported, announcing
and describing the Agreement and Plan of Merger, dated
May 20, 2001, among Vivendi Universal, S.A., Metronome
Acquisition Sub Inc. and MP3.com.

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SIGNATURES

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



| |              
| | -------------
| | MP3.COM, INC.
| | (Registrant) 

Date: August 1, 2001



| |     |                     
| | --- | --------------------
| | By: | /s/ PAUL L.H. OUYANG

| |                                              
| | ---------------------------------------------
| |                                              
| | Paul L.H. Ouyang                             
| | Executive Vice President and                 
| | Chief Financial Officer(Authorized
	Officer) 
| | (Principal Financial and Accounting
	Officer)

62