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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, DC 20549** **Form 10-K****ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE****SECURITIES EXCHANGE ACT OF 1934****For the fiscal year ended December 31, 2005****Commission File Number: 0-29583** **Loudeye Corp.***(Exact name of registrant as specified in its charter)*   **Delaware** **91-1908833***(State or other jurisdiction* *(I.R.S. Employer**of incorporation or organization)* *Identification No.)***1130 Rainier Avenue South, Seattle, WA 98144***(Address of principal executive offices) (Zip Code)***206-832-4000***(Registrant’s telephone number, including area code)* **Securities registered pursuant to Section 12(b) of theAct:****None****Securities registered pursuant to Section 12(g) of theAct:****Common Stock, par value $0.001 per share**      Indicate by check mark if the registrant is a well-seasonedissuer, as defined in Rule 405 of the SecuritiesAct.     Yes o          No þ     Indicate by check mark if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of theAct.     Yes o          No þ     Indicate by check mark whether the registrant (1) has filedall reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has beensubject to such filing requirements for the past90 days.     Yes þ          No o     Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 ofRegulation S-K isnot contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of thisForm 10-K or anyamendment to thisForm 10-K.     o     Indicate by check mark whether the registrant is a largeaccelerated filed, an accelerated filer, or a non-acceleratedfiled. See definition of “accelerated filed and largeaccelerated filed” inRule 12b-2 of theExchange Act. (Check one):Large acceleratedfiler o          Acceleratedfiler þ          Non-acceleratedfiler o     Indicate by check mark whether the registrant is a shell company(as defined in Rule 12b2-12 of theAct).     Yes o          No þ     The aggregate market value of the voting stock held bynon-affiliates of the registrant was approximately$80.4 million as of June 30, 2005, based upon theclosing sale price of $0.73 per share on The Nasdaq CapitalMarket reported for such date. Shares of Common Stock held byeach officer and director and by each person who owns 5% or moreof the outstanding Common Stock have been excluded in that suchpersons may be deemed to be affiliates. This determination ofaffiliate status is not necessarily a conclusive determinationfor other purposes.     Indicate the number of shares outstanding of each of theissuer’s classes of common stock, as of the latestpracticable date.       Common Stock     132,560,666**(Class)** **(Outstanding at March 1, 2006)**  

 
**LOUDEYE CORP.****ANNUAL REPORT ONFORM 10-K****For the Year Ended December 31, 2005****TABLE OF CONTENTS**             **Page**    **Number**          **PART I** Item 1.      Business  1  Item 1A.      Risk Factors  10  Item 1B.      Unresolved Staff Comments  31  Item 2.      Properties  31  Item 3.      Legal Proceedings  32  Item 4.      Submission of Matters to a Vote of Security    Holders  34       **PART II** Item 5.      Market for Registrant’s Common Equity,    Related Stockholder Matters and Issuer Purchases of Equity    Securities  34  Item 6.      Selected Financial Data  38  Item 7.      Management’s Discussion and Analysis    of Financial Condition and Results of Operations  40  Item 7A.      Quantitative and Qualitative Disclosures    about Market Risk  74  Item 8.      Financial Statements and Supplementary    Data  76  Item 9.      Changes in and Disagreements with    Accountants on Accounting and Financial Disclosure  118  Item 9A.      Controls and Procedures  118  Item 9B.      Other Information  120       **PART III** Item 10.      Directors and Executive Officers of the    Registrant  120  Item 11.      Executive Compensation  125  Item 12.      Security Ownership of Certain Beneficial    Owners and Management and Related Stockholder Matters  135  Item 13.      Certain Relationships and Related    Transactions  136  Item 14.      Principal Accountant Fees and Services  137       **PART IV** Item 15.      Exhibits, Financial Statement Schedules  138      Signatures  142  EXHIBIT 10.7 EXHIBIT 10.19 EXHIBIT 10.21 EXHIBIT 23.1 EXHIBIT 23.2 EXHIBIT 31.1 EXHIBIT 31.2 EXHIBIT 32.1 EXHIBIT 32.2     Market data and industry statistics used in Item 1“Business” of this annual report are based on industrypublications and other publicly available information. We do notguarantee, and we have not independently verified, thisinformation.     Loudeye®and the stylized Loudeye logo are registered trademarks ofLoudeye Corp. and DigitalMusicStoretmis also our trademark. All other brand names, trademarks orservice marks referred to in this report are the property oftheir respective owners.     In this annual report onForm 10-K,“Loudeye,” “we,” “us,” and“our” refer to Loudeye Corp.

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**PART I****DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS**     Statements in this annual report on Form 10-K, includingstatements in Item 1 “Business” and Item 7“Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” constituteforward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, asamended. Any statements about our expectations, beliefs, plans,objectives, assumptions or future events or performance are nothistorical facts and may be forward-looking. These statementsare often, but not always, made through the use of words orphrases like “anticipate,” “estimates,”“plans,” “projects,” “continuing,”“ongoing,” “expects,” “will”,“management believes,” “Loudeye believes,”“Loudeye intends,” “we believe,” “weintend” and similar words or phrases. Accordingly, thesestatements involve estimates, assumptions and uncertaintieswhich could cause actual results to differ materially from thoseexpressed in them. Any forward-looking statements are qualifiedin their entirety by reference to the factors discussed in thisannual report, including those factors discussed in “RiskFactors” beginning on page 10 of this annual report.     Because the factors discussed in this annual report could causeactual results or outcomes to differ materially from thoseexpressed in any forward-looking statement made by us or onbehalf of us, you should not place undue reliance on any suchforward-looking statement. Further, any forward-lookingstatement speaks only as of the date on which it is made, and weundertake no obligation to update any forward-looking statementto reflect events or circumstances after the date on which suchstatement is made or to reflect the occurrence of unanticipatedevents. New factors emerge from time to time, and it is notpossible for us to predict which will arise. In addition, wecannot assess the impact of each factor on our business or theextent to which any factor, or combination of factors, may causeactual results to differ materially from those contained in anyforward-looking statements.     You should assume that the information appearing in this annualreport is accurate only as of the date of this annual report.Our business, financial condition, results of operations andprospects may have changed since that date.**Item 1.     Business.****Loudeye Overview**     We are a worldwide leader in business-to-business digital mediaservices that facilitate the distribution, promotion and sale ofdigital media content for media and entertainment, mobilecommunications, consumer products, consumer electronics, retail,and ISP customers. Our services enable our customers tooutsource the management and distribution of audio and videodigital media content over the Internet and other electronic andwireless networks. Our proprietary consumer-facing e-commerceservices, combined with our technical infrastructure andback-end solutions, comprise an end-to-end service offering.These service offerings range from turn-key, fully-outsourceddigital media distribution and promotional services, such asprivate-labeled digital media store services, including mobilemusic services, to digital media content services, such asencoding, music samples services, hosting, webcasting andInternet radio services. Our outsourced solutions can decreasetime-to-market for our customers while reducing the complexityand cost of digital asset management and distribution comparedwith internally developed alternatives, and they enable ourcustomers to provide branded digital media service offerings totheir users while supporting a variety of digital mediatechnologies and consumer business models.     The use of the Internet and wireless networks as a medium formedia distribution has continued to evolve and grow in recentyears. Traditional media and entertainment companies, such asmajor record labels, have in recent years faced significantchallenges associated with the digital distribution of music.These companies have now licensed the rights to some of theircontent for certain forms of digital distribution over theInternet and wireless networks. Consumers enjoy this content bymeans of many different types of services and offerings,including purchased downloads, paid subscriptions, prepaidcredit offerings and streaming radio. Additionally, retailersand advertisers have expanded their use of digital
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content in the marketing and selling of their products andservices. As such, traditional distribution channels for mediahave expanded as content owners have begun to license anddistribute their content over the Internet and wireless networksthrough new and existing retail channels, and consumers havebegun to purchase and consume content using personal computers,mobile devices and other digital devices. In addition,traditional media formats have expanded to include a variety ofdigital technologies, rich media formats and digital rightsmanagement. Despite the increasing popularity of these licensedsources of digital media content over the Internet, piracy overpeer-to-peer networks remains a continuing challenge for thedigital media distribution industry as a whole.     During 2005, digital media continued to grow as a broad-basedtool for communications, online media promotions and thedistribution of content, particularly in the media,entertainment and corporate sectors. This growth has been drivenin large part by an increase in broadband adoption, growth inthe market for portable digital media devices and significantimprovements in streaming technologies capable of deliveringhigh quality content in smaller file sizes. A critical trend inthese technology and streaming format enhancements is a markedincrease in ease of use and effectiveness of streaming media,including, in some cases, instant access to streaming contentwithout buffering. At the same time, content owners such asmajor media companies, film studios and record labels areproviding more content in a digital format to capitalize onthese opportunities.     We continue to develop our services to address the changingdynamics of digital media distribution, promotion, consumptionand content management. Our digital media services enabledigital distribution of media over the Internet, mobile andwireless networks and other emerging technologies. We also offerrelated services that provide the primary components needed toaddress the management and delivery of digital media on behalfof our customers and content owners. Our service offerings aregrouped into the two primary categories: digital media storeservices, concentrated in Europe and around emerging mobiledistribution technologies and service offerings, and digitalmedia content services.     In February 2006 we announced a realignment of our productdevelopment, engineering, information technology and operationalresources relating to digital media store services behind ourlargest markets and customers. Our digital media store serviceoperations are now centralized at our European headquarters inBristol, United Kingdom.     *Digital media store services.*Digital media storeservices include our end-to-end digital music store servicesprovided on a “white-labeled” basis to retailers andbrands throughout the world. As a business-to-business provider,our services enable brands of varying types, including retailersand e-tailers, mobile operators, portals, and ISPs, to outsourceall or part of their digital media retailing activities.     We provide our customers with a highly scalable consumer-facingdigital media commerce and delivery solution that includes: •     hosting, publishing and managing digital media content, and    delivering such content to end consumers on behalf of our    customers;  •     support for private label user interfaces that have the look,    feel and branding of a customer’s existing commerce    platform;  •     delivery across both internet and mobile delivery protocols, and    in various forms, such as full-song download or streaming, for    both internet and mobile based applications;  •     integration to a customer’s website and mobile    applications, inventory, and account management;  •     localized end-consumer experience and content offering in over    20 countries;  •     integrated payment functionality supporting multiple end    consumer payment alternatives; and  •     digital rights management and licensing, usage reporting,    digital content royalty settlement, customer support and    publishing related services.
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     We expect to extend our digital media store services offeringsfrom our established base in music stores to other digitalmedia, such as music videos, as these digital media marketscontinue to develop.     A small number of customers in Europe generate a substantialmajority of our revenue from digital media store services. Thiscustomer concentration poses a significant risk to our businessand results of operation if any one or more of these customerswere to terminate or not renew their services.     We believe future growth in our digital media store servicesdepends significantly upon the growth of the mobile market fordigital content services, including music. We continue to investin our mobile music platform. The platform allows over-the-airsearch, purchase and download of music files. The servicepermits dual-delivery of downloaded music directly to the endconsumer’s mobile phone and personal computer. There are anumber of industry challenges that could impact the adoptionrate of mobile platforms as a leading method of digital musicpurchase, including the rate of adoption of compatible mobilehandsets, availability of high speed mobile data networks,adoption by mobile consumers of mobile data plans, any pricingdifferential (both wholesale and retail) between contentpurchased over-the-air to a mobile device and purchased by othermeans, development of content and digital rights managementstandards and technologies acceptable to content licensors, andthe impact on the economics of the mobile music business ofcertain issued patents. Significant growth in demand for ourmusic store services is likely to also depend on significantgrowth in adoption of Windows-compatible portable music devices.     As a business-to-business service provider, our growth andsuccess depends in large part on growth in the proliferation andexpanded music market share of digital media businessesgenerally and the willingness of those businesses to launch newdigital services and to support their digital store initiativeswith adequate marketing resources. While we do expect growth inour music store services revenue, our customers and potentialcustomers face a number of challenges in the current digitalmusic market, including: •     the dominance of Apple Computer’s iTunes service in certain    markets driven in part by sales of the popular iPod line of    portable digital media players,  •     a trend towards increasing wholesale cost of music content and    the apparent willingness of certain music services to set a    retail price to consumers that may be under the wholesale cost    of music content, and  •     a trend towards a requirement for substantial cash advances to    content owners, in particular the four major music labels, in    order to obtain some content distribution rights, such as use    for music subscription services.     We currently derive revenue from our music store servicesthrough a blend of higher margin business-to-business platformservice fees and lower margin transaction related promotion,distribution or revenue sharing business to consumer fees.Platform service fees represent charges in connection withenabling the service and maintaining its overall functionalityduring the term of a customer contract (typically three years),including customer support, merchandising, publishing and othercontent management related services that we provide during thecontract term. Growth in platform service fee revenue isdirectly related to our ability to renew existing serviceagreements as well as launch new digital media store services,and accordingly, competition for new services and saturation ofdigital media services in some markets may directly impact thisrevenue stream.     We also generally receive a fixed fee per transaction orpercentage of the revenue generated from the sale of content toend consumers. The margin associated with transactional revenueis dependent in large part upon factors outside our control suchas the wholesale rate charged for content by rights holders suchas the major record labels and transactional processing feessuch as credit card interchange fees. There is a trend towardsrecord labels increasing wholesale content charges, in anapparent attempt to cause an increase in the retail price ofpopular digital music content. We cannot be certain thatconsumers will be willing to pay more than the current,prevailing market prices for digital music content. As a result,operating margins on transactional revenue for us and ourcustomers may decrease and price sensitivities may impact thegrowth in digital music services.
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     The majority of our transactional revenue is generated throughthe sale of prepaid credit packages which entitle a consumer toaccess a specified number of digital music downloads or streamsfor a fixed price during a fixed time period. Prepaid creditpackages are also bundled with other end consumer offeringssponsored by our customers. Revenue from prepaid credit packagesand bundle promotions is deferred until the credits orpromotional offers are utilized or expire. Our margin on thesale of prepaid credit packages is dependent, in part, uponconsumers redeeming less than the full number of downloads orstreams covered by the prepaid credit packages, which we referto as “breakage.” Historically breakage ratesfluctuate causing variability in our transactional margins. Ourtransactional revenue in Europe is derived from relationshipswith several key customers, including MicrosoftCorporation’s MSN music services. If one or more of thesekey customers were to cancel our contract or not renew it, ourbusiness to consumer transactional revenue could decline.     As part of our current end-to-end music store services, we havesecured licenses, primarily for digital download, with the fourmajor recorded music companies and many independent recordlabels around the globe. Our rights portfolio currentlyavailable for inclusion in our music store services encompasseslicenses in over 20 countries. All of our significant licensingagreements require the content owner to pre-approve each of ourcustomers in advance of launching a new service.     While we typically secure content licenses on behalf of ourcustomers, there is a trend for certain of the major recordedmusic companies to want to provide licenses directly to newconsumer music services, and some consumer music services,especially those of household brand names, are requiring directlicensing arrangements with the labels. If these trends continueour business may be significantly impacted including byextending our sales cycle and requiring us to assist ourcustomers in obtaining licenses from content owners. This couldchange the way we report revenue because to the extent licenserights do not pass through Loudeye and our customers arerequired or elect to license and pay content owners directly, wewould report revenue on a net basis (net of third party contentfees) rather than on a gross basis. As a result, ourtransactional revenue may decrease and gross margins as apercentage of revenue may increase. Gross margin as an absolutedollar amount would not be impacted by a change in revenuereporting from a gross basis to a net basis.     *Digital media content services.*Digital media contentservices include a suite of digital media services provided toboth content owners and retailers, including encoding, musicsamples service, Internet radio, hosting and webcastingservices. Our digital media content services are operatedprimarily from our offices in Seattle, Washington.     *Encoding services.* Our patented systems and technologyenable the archiving and retrieval of large libraries of digitalmedia assets, or digital content. Digitized content masters ofmedia assets are stored on our high-capacity storage arraysystems and accessed via our proprietary, automated, web-basedaccess tools to search, deliver and manage such content. Thesestorage and access capabilities enable digital content to beprocessed and converted into different digital formats pursuantto our customers’ specifications via our proprietaryencoding and transcoding systems. To transmit digital contentover the Internet or other advanced digital distributionnetworks, the uncompressed, digitized content must be convertedinto compressed, network-compatible digital formats. Ourencoding services enable the conversion of such content into aparticular form, along with the relevant metadata, such that thecontent can be distributed over various distribution networks.Encoding large catalogs of content in an efficient manner is acomplex process that requires scalable technology and supportinginfrastructures. Digital encoding formats and technologiescontinue to evolve and often conflict with one another. As aresult, content owners often convert their digital assets intomultiple formats and codecs (which are algorithms that reducethe number of bytes consumed by large files and programs) tosupport their distribution strategies. Additionally, theencoding process for a particular item (or for an entirelibrary) is often repeated as a result of the introduction ofnew formats or distribution platforms. Our proprietary digitalmedia supply chain services address these challenges byproviding an outsourced solution for the archiving, management,processing and distribution of our customers’ digitalassets. We combine our encoding services with watermarking,encryption, metadata and other digital rights managementservices to enable our customers to protect and manage theircontent digitally. We also provide project analysis, as well as
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consulting and other related services to support the digitalfulfillment of encoded content libraries for content owners andretailers worldwide.     To date, we have generated substantially all of our encodingservices revenue from fees for delivering EMI Music content todigital service providers, or DSPs. EMI Music contracts directlywith its DSP partners for licenses to the EMI Music catalog. Wein turn contract directly with DSPs for providing encodingservices for digital music content from EMI Music and otherindependent record labels. In February 2006, we were notified byEMI Music that it intends to transition all encoding servicesfor EMI Music content to another service provider. According toinformation provided to us by EMI Music, the expected transitionplan will result in DSPs that are receiving encoded EMI Musiccontent from Loudeye being migrated to the new service providerduring the second quarter of 2006. We have entered intonegotiations with EMI Music regarding various elements of EMIMusic’s transition plan. We expect to continue generatingrevenue from encoding EMI Music catalog for DSPs during thefirst and second quarters of 2006 until EMI Music completes itstransition plan to another service provider. During 2006, wealso intend to continue our efforts to expand our encodingservices to additional customers and into additional markets,such as video encoding, but there can be no assurance that suchefforts will be successful. If these efforts are not successful,our revenue from encoding services will be materially adverselyaffected, and we may need to consider discontinuing suchservices. In addition, if we are unable to expand our encodingservices to additional customers and markets fast enough toreplace the revenue we would have expected to generate during2006 from our relationship with EMI Music, we would expect torestructure operations related to encoding services during thefirst half of 2006. EMI Music’s transition plan may alsohave an impact on our samples, internet radio, hosting andwebcasting services as these service offerings all utilizeshared resources.     *Music sample services.*We provide a hosted end-to-endstreaming samples service that delivers high quality musicsamples to customers in the online and mobile entertainmentsectors. Our music samples service consists of streaming digitalcontent, or more specifically selections of such content,commonly referred to as samples, clips or previews. Digitalmedia samples are used by customers for many purposes, includingincreasing online content sales, user traffic and customerretention. A majority of our revenue from our music samplesservices is derived from a single customer relationship that isrenewable annually. If that customer does not renew ourcontract, or if we were unsuccessful in securing license rightsfrom content owners to continue the samples service, revenuefrom our music samples services would decline.     *Internet radio, hosting and webcasting services.*OurInternet radio service offers 100 channels of CD-qualitystreaming music in the U.S. delivered through a customer’sown privately branded player interface. It is capable ofsupporting delivery to a range of consumer music devices andappliances. The Loudeye Internet radio service can be deployedonline for web-based retailers and portals, as well as offlinefor consumer electronic devices and appliances, digital homeentertainment systems and other digital broadcasting outlets.     Our hosting services allow digital media content to be hostedand streamed from a secure, redundant central media repository.A substantial majority of our revenue from hosting is derivedfrom a single customer relationship that is renewable annually.If that customer does not renew, revenue from our hostingservices would decline. Our webcasting services allow users tobroadcast audio, video and visually oriented communications overthe Internet. We are not actively pursuing upgrades to ourInternet radio, hosting or webcasting services and we anticipaterevenue from these services will decrease in future periods.**Sales and Marketing**     We sell our services through a combination of direct andindirect sales, with all channels and regional offices managedby five main sites, London, Cologne, Paris, Milan and Seattle.Our digital media services direct sales force markets ourservices to customers in a diverse range of markets, such asmedia and entertainment, on-line and physical retailers andISPs. We also have one sales representative in Holland.
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Sales employees are compensated with a salary and commissionbased upon business with existing and new clients.     Our sales group also targets resellers who market to theirestablished customer bases. We private label or co-brand ourservices for these customers depending on their requirements. Wealso partner with companies to resell our services through theirwebsites, or through co-branded websites, or to include ourservices with their offerings. We offer our reseller partnersour services at a discount to our traditional pricing model andour referral partners may receive a percentage of revenue.     Our marketing objectives are to build awareness for our brandamong key market segments and to maintain a position as aleading full-service digital media service provider. To supportthese objectives, we utilize public relations, trade shows,advertising and direct marketing.**Operations and Technology**     We manage our digital media services including encoding, contentpreparation, digital rights management, license verification,reporting and royalty payments, hosting and distribution to theInternet, and digital music licensing from our U.S. headquartersin Seattle, Washington, and our European headquarters inBristol, United Kingdom.     Our operations and production personnel are organized intofunctional teams which include project management, qualitycontrol, logistics operations, data management, audio captureand encoding, video capture and encoding, and systemsengineering support. In addition, we have a team that supportsour network and hosting services.**Foreign and Domestic Operations and Geographic Data**     Prior to 2004, all of our sales were derived from sellingactivities conducted within the United States. In June 2004, weacquired OD2, one of the largest digital music service providersin Europe. In 2005, approximately 25% of our revenue wasgenerated in the U.S., while 75% of our 2005 revenue wasgenerated outside the U.S., primarily in Europe. This comparesto approximately 61% of our 2004 revenue coming from customersin the U.S., while non-U.S. customers, primarily in Europe,accounted for 39% of our 2004 revenue. Prior to June 2004, allof our sales were derived from selling activities conductedwithin the United States. Additional information regardingfinancial data by geographic segment is set forth inPart II, Item 8 of this annual report in the Notes tothe Consolidated Financial Statements at Note 17,“Business Segment Information.”**Customers**     The target customers for our digital media services includemajor consumer electronics companies, traditional andInternet-based retailers, media and entertainment companies,wireless carriers and branded consumer products companies. In2005, we served over 200 customers, however our dependency onseveral key customers increased during 2005. MicrosoftCorporation’s MSN services accounted for 19% of totalrevenue in 2005 and 21% in 2004 and KPN Telecom B.V. accountedfor 10% of total revenue in 2005 and 2% in 2004. In 2003, TheCoca-Cola Company accounted for 11% of our revenue. Asignificant portion of our 2003 revenue from The Coca-ColaCompany related to media restoration services which we ceasedproviding with our sale of that business in early 2004. Wegenerate substantially all of our encoding services revenue fromencoding and fulfillment services fees for delivering EMI Musiccontent to digital service providers, or DSPs.**Competition**     The market for digital media services is rapidly evolving andintensely competitive. We expect competition to persist andintensify in the future. Although we do not currently competeagainst any one entity with respect to all aspects of ourservices, we do compete with various companies and technologiesin regards to specific elements of our services. In addition, weface competition from in-house solutions.
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     To date, Apple Computer’s popular iPod line of portabledigital media players and Apple’s iTunes music storeservice have dominated the market for digital audio and videocontent. The digital music stores we power compete withApple’s iTunes services for end consumers. While we areimplementing tiered-pricing for audio content across certain ofour stores in response to increased wholesale rates for content,Apple is currently maintaining a flat retail rate for audiocontent of €0.99in Europe and $0.99 in the U.S. In addition, Apple Computer hasnot designed its popular iPod line of portable digital mediaplayers to function with our music services and users whopurchase content through the digital music stores we power maynot be able to play music they purchase there on their iPods. Ifwe and the digital music services we power are unsuccessful incompeting with Apple’s services or making our servicescompatible with Apple’s devices, our business and resultsof operations could be harmed.     For our business-to-business digital media store services, wecompete against several companies providing similar levels ofoutsourced digital music services including Cable and Wirelessplc., Widerthan Co., Ltd., Digital World Services AG, GrooveMobile (formerly Chaoticom), Liquid Digital, Melodeo, Inc.,MusicNet, Inc., MusicNow LLC, MusiWave, MPO Group, Siemens AG,Soundbuzz Pte Ltd., as well as in-house efforts by our potentialcustomers. Our customers face significant competition from“free” peer-to-peer services, such as MetaMachineInc.’s eDonkey, Sharman Network Inc.’s KaZaA,StreamCast Networks, Inc.’s Morpheus, Grokster, Ltd. and avariety of other similar services that allow computer users toconnect with each other and to copy many types of program files,including music and other media, from one another’s harddrives, all without securing licenses from content providers.For our encoding services, we compete against companies such asConsolidated Independent ltd and Sony DADC. For our musicsamples services, we compete with companies including Muze Inc.and AEC One Stop Group, Inc.’s All Music Guide. Inaddition, well-capitalized, diversified digital media technologycompanies such as Microsoft Corporation, Apple Computer Inc.,Real Networks, Inc. and Napster, LLC compete with our customersand may compete with us in the future with their own services.For certain services, such as encoding and music distribution,the major record labels have acquired or otherwise invested indigital music services and technologies that could compete withour services. Traditional and satellite radio broadcasters havedeveloped online music and radio services which also competewith our services.     A significant source of competition includes our potentialcustomers who choose to independently invest in systems andinfrastructure to digitally manage, encode and/or host anddeliver their own media directly, thereby not requiring abusiness-to-business provider for such services. In-houseservices are expected to remain a significant competitor to ourservices, although we believe that as digital media strategiesexpand, and the scale of infrastructure and applicationsrequired to support business strategies increases, companiesthat currently manage these processes internally will see asignificant economic advantage to outsourcing.     We believe that the principal competitive factors in our marketinclude:       • Ability to offer a private branded solution     • Security of services    • Customer service and support     • Interoperability, across devices and formats    • Service functionality     • Breadth of content available    • Scalability of services     • Service performance    • Service quality       Although we believe that our services compete favorably withrespect to each of the competitive factors described above, themarket for our services is new and evolving rapidly. We may notcompete successfully against current or future competitors, manyof which have substantially more capital, longer operatinghistories, greater brand recognition, larger customer bases andsignificantly greater financial, technical and marketingresources than we do. These competitors may also engage in moreextensive development of their technologies, adopt moreaggressive pricing policies or establish more comprehensivemarketing and advertising campaigns than we can. Our competitorsmay develop service offerings that are more sophisticated thanour own. For these and other reasons, our competitors’services may achieve
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greater acceptance in the marketplace than our own, limiting ourability to gain market share and customer loyalty and togenerate sufficient revenue to achieve a profitable level ofoperations.     For additional discussion of the risks associated withcompetition in our industry, see Item 1A, Risk Factors“— Competition may decrease our market share, revenuesand gross margins,” and “ — Paid digitalmedia content services face competition from “free”peer-to-peer services.”**Operational Segments**     We have adopted Statement of Financial Accounting Standards(FAS) No. 131, “Disclosure about Segments of anEnterprise and Related Information” (FAS 131), whichestablishes annual and interim reporting standards for anenterprise’s operating segments and related disclosuresabout its services, geographic areas and major customers. Ourchief operating decision maker is considered to be our ChiefExecutive Officer and staff, or Senior Leadership Team (SLT).During 2004, the SLT reviewed discrete financial informationregarding profitability of our digital media services and mediarestoration services, and therefore in 2004 we reported those asoperating segments as defined by FAS 131. In January 2004, wetransferred substantially all of the assets of our mediarestoration services subsidiary, VidiPax, Inc., or VidiPax, to acompany controlled by VidiPax’s general manager. In May2004, we completed the sale of this media restoration servicesbusiness. While we will have ongoing rights to co-market andresell media restoration services for two years after the sale,media restoration services did not represent a significantportion of our revenue in 2005, nor do we expect it to representa significant portion of our revenue in the future. Managementhas determined that during the year ended December 31,2005, we operated in only one segment, digital media services.Media restoration services have been reclassified to a componentof digital media services in all prior periods presented.     In 2005, the majority of our revenue was derived from customersprincipally in Europe and in the United States of America. Ourinternational sales are attributable to our acquisition of OD2in June 2004. For more information regarding our operatingsegments, please see the Notes to Consolidated FinancialStatements at Note 17, “Business SegmentInformation” appearing on page 113 of this annualreport.**Research and Development**     We believe that significant research and development efforts areessential for us to maintain our market position, to continue toexpand our digital media services, in particular for our digitalmedia store services, and to develop additional serviceofferings. Accordingly, we anticipate that we will continue toinvest in research and development for the foreseeable future,primarily around our mobile digital music store services, and weanticipate that research and development costs as an absolutedollar amount will fluctuate, depending primarily upon the levelof future revenue, customer needs, staffing levels, overheadcosts and our assessment of market demands. Our research anddevelopment expenditures totaled approximately $8.4 millionin 2005, $3.7 million in 2004, and $1.7 million in2003. Primarily as a result of cost reductions undertaken in thefirst quarter 2006, we anticipate that research and developmentcosts in 2006 will be less than in 2005.**Proprietary Rights and Intellectual Property**     We rely primarily on a combination of copyrights, trademarks,trade secret laws and contractual obligations with employees andthird parties to protect our proprietary rights.     As of December 31, 2005, we had seven issued patents in theU.S., and we have numerous patent applications on file withrespect to various aspects of our technology. We arecontinuously evaluating potential additional patent applicationson other current and anticipated features of our technology.     Despite our efforts to protect our proprietary rights,unauthorized parties may copy aspects of our services and obtainand use information that we regard as proprietary. In addition,other parties may breach confidentiality agreements or otherprotective contracts we have entered into and we may not be ableto enforce our rights in the event of these breaches.Furthermore, we have and expect that we will
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continue to increase our international operations in the futureand the laws of many foreign countries do not protect ourintellectual property rights to the same extent as the laws ofthe United States.     The digital media industry is characterized by the existence ofa large number of patents, licenses and frequent litigationbased on allegations of patent infringement and the violation ofother intellectual property rights. Obtaining the requisitelicenses for digital media content distribution can bedifficult, as separate licenses often must be obtained from avariety of rights holders for distinct activities related to thedelivery of digital music, such as distribution and performance,which requires separate licensing arrangements. In addition,these copyrights may be held by different parties, such aspublishers, artists and record labels. The music industry in theUnited States is generally regarded as highly litigious. As aresult, in the future we may be engaged in litigation withothers in the music industry, including those entities withwhich we have ongoing content license arrangements.     Although we attempt to avoid infringing known proprietary rightsof third parties in our development efforts, we may be subjectto legal proceedings and claims for alleged infringement ofthird party proprietary rights, such as patents, trademarks orcopyrights, by us or our licensees, from time to time in theordinary course of business. Any claims relating to theinfringement of third party proprietary rights, even if notmeritorious, could result in costly litigation, divertmanagement’s attention and resources or require us to enterinto royalty or license agreements which are not advantageous tous. In addition, parties making these claims may be able toobtain an injunction, which could prevent us from providing ourservices in the United States or abroad. Any of these resultscould harm our business. We may increasingly be subject toinfringement claims if the number of services and competitors inour industry grow and the scope of services overlap.**Government Regulation**     We are not currently subject to direct regulation by anygovernmental agency, other than laws and regulations generallyapplicable to businesses. Export and import controls, includingcontrols on the use of encryption technologies, may apply to ourservices both in the U.S. and in Europe. In general, oure-commerce services are also regulated by laws and regulationscovering privacy and data protection and consumer rights.     Digital media content and its distribution, sale and licensingis generally subject to copyright law. Copyright law differs byjurisdiction, causing complexity and at times uncertainty. Inthe European Union, or E.U., the copyright landscape is complex,in particular with respect to publishing licenses and licenserates. Currently, each E.U. member country has its own licensingregime; anyone seeking to sell music in the E.U. over theInternet may need to negotiate with different royalty collectorsin each country. Furthermore, royalty collectors currently donot offer pan-European licenses. In July 2005, the EuropeanCommission proposed a copyright and licensing scheme that wouldconsolidate individual country negotiations and establish asmall number of multi-territorial E.U. licensing bodies. While apan-European licensing model for online music distribution couldmeasurably simplify the digital media content licensing inEurope, current proposals under consideration would leavestandards implementation to local governments and agencies.     In the U.S., the Digital Millennium Copyright Act, or DMCA,includes statutory licenses for the performance of soundrecordings and for the making of recordings to facilitatetransmissions. Under these statutory licenses, depending on ourfuture business activities, we and our customers may be requiredto pay licensing fees for digital sound recordings we deliver orour customers provide on their web site and throughretransmissions 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-industrynegotiations or arbitration. Moreover, with respect to digitalpublishing, sound recording and other music licenses notdirectly covered by the DMCA, various parties interested indistribution of digital music have engaged in proceedings beforea tribunal of the United States Copyright Office along with theRIAA to determine what, if any, licensee fees should be paid tovarious rights holders. Depending on the rates and
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terms adopted for the statutory licenses, our business could beharmed both by increasing our own cost of doing business, and byincreasing the cost of doing business for our customers.**Employees**     As of March 1, 2006, we had a total of 164 full-timeemployees, of which 57 were in operations, 48 were in researchand development, 29 were in sales and marketing, and 30 were ingeneral and administration. Of these, 74 employees were locatedin our Seattle, Washington offices, and 90 were located acrossour European operations (of which 81 were located in Bristol,U.K.). None of our employees are subject to a collectivebargaining agreement. We consider our relations with ouremployees to be good.**Available Information**     We were incorporated in the state of Delaware on March 18,1998. We are a reporting company and file annual, quarterly andcurrent reports, proxy statements and other information with theSEC. You may read and copy these reports, proxy statements andother information at the SEC’s public reference room at 450Fifth Street, NW, Washington, D.C. 20549. Please call the SEC at1-800-SEC-0330 for more information about the operation of thepublic reference room. Our SEC filings are also available at theSEC’s website at “http://www.sec.gov.” OurInternet address is http://www.loudeye.com. There we makeavailable, free of charge, our Annual Report on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports onForm 8-K, and any amendments to those reports, as soon asreasonably practicable after we electronically file suchmaterial with or furnish it to the SEC.**Item 1A.     Risk Factors.**     Loudeye operates in a dynamic and rapidly changing industry thatinvolves numerous risks and uncertainties, both in the U.S. andabroad. The risks and uncertainties described below are not theonly risks and uncertainties we face. Additional risks anduncertainties not presently known to us or that we currentlydeem immaterial may impair our business operations in thefuture. If any of the following risks actually occur, ourbusiness, operating results and financial position could beharmed.**     *****Risks Related to Our Business*****          *Wehave a history of losses, negative cash flows on a quarterly andannual basis, negative working capital as of December 31,2005, and we may experience greater losses from operations thanwe currently anticipate. These factors raise doubt about ourability to continue as a going concern.***     As of December 31, 2005, we had an accumulated deficit of$242.6 million. We have incurred net losses from inception,and we expect to continue to incur net losses in future periods.We had a negative working capital balance as ofDecember 31, 2005 of $1.9 million. To achieve futureprofitability, we will need to generate additional revenue orreduce expenditures. We can give no assurance that we willachieve sufficient revenue or reduced expenditures to beprofitable on either a quarterly or annual basis in the future.These factors, among others, raise substantial doubt about ourability to continue as a going concern. Even if we ultimately doachieve profitability, we may not be able to sustain or increaseprofitability on either a quarterly or annual basis.**          *Wemay need to raise additional capital to reachprofitability.***     Our unrestricted cash reserves as of December 31, 2005totaled approximately $9.0 million, and in February 2006 weclosed a private placement financing in which we raised netproceeds of approximately $7.6 million. These existing cashreserves may not be sufficient to fund operating and otherexpenses for the next twelve months, or until we reachprofitability. As a result, we may need to secure additionalfinancing to execute on our business plan. We may not be able toobtain such financing on acceptable terms, or at all. Ifadequate funds are not available or are not available onacceptable terms, we may need to sell assets or reduceexpenditures, or both, and we may not be able to pursue all ofour business
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objectives. Any inability to secure additional funding couldforce us to liquidate our business or otherwise seriously harmour business, results of operations and financial condition.**          *Ourquarterly and annual financial results will continue tofluctuate making it difficult to forecast our operatingresults.***     Our quarterly and annual operating results have fluctuated inthe past and we expect our revenue and operating results mayvary significantly from quarter to quarter and year to year dueto a number of factors, many of which are beyond our control,including: •     Market acceptance of our services;  •     Variability in demand for our digital media services;  •     Competition from other companies entering our markets;  •     Our customers’ commitment to adequately market and promote    their digital media stores;  •     Ability of our customers and us to procure necessary    intellectual property rights for digital media content;  •     Willingness of our customers to enter into longer-term volume or    recurring revenue digital media services agreements and purchase    orders in light of the economic and legal uncertainties related    to their business models;  •     Fluctuating wholesale costs for digital media content,    especially from major record labels;  •     Willingness of competitive consumer digital media services to    maintain a consumer retail price below the wholesale cost of the    content in an effort to gain market share or for other    competitive reasons;  •     Charges related to restructuring of our business, including    personnel reductions and excess facilities; and  •     Governmental regulations affecting use of the Internet,    including regulations concerning intellectual property rights    and security measures.     Our limited operating history, unproven business model andsignificant acquisitions and dispositions of businesses (inparticular our acquisition of OD2 in June 2004), furthercontribute to the difficulty of making meaningful quarterlycomparisons and forecasts. Our current and future levels ofoperating expenses and capital expenditures are based largely onour growth plans and estimates of expected future revenue. Theseexpenditure levels are, to a large extent, fixed in the shortterm and our sales cycle can be lengthy. Thus, we may not beable to adjust spending or generate new revenue sources in atimely manner to compensate for any shortfall in revenue, andany significant shortfall in revenue relative to plannedexpenditures could have an immediate adverse effect on ourbusiness and results of operations. If our operating resultsfall below the expectations of securities analysts and investorsin some future periods, our stock price could declinesignificantly.**          *Wehave restructured our business to focus on our digital mediastore services operated out of Europe. Even after giving effectto this restructuring, we may not have sufficient cash toexecute on our current business plan and any restructuring mayimpact our ability to execute on our business plan.***     We have taken steps to restructure certain aspects of ourbusiness, including through reducing our work force,discontinuing the operation of Overpeer Inc., and renegotiatingexisting agreements with customers. However, restructurings taketime to implement and themselves involve costs to implement,such as severance and contract and lease termination costs.There can be no assurance that we will be successful inrenegotiating any agreements or otherwise in implementing arestructuring. There can also be no assurance that following arestructuring we would have sufficient cash reserves until weachieve
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profitability. Furthermore, our restructuring could have amaterial adverse impact on our ability to execute on ourbusiness plan.**          *Wedepend on a limited number of customers for a significantpercentage of our digital media store services revenue. Thesecustomers may be able to terminate their service contracts withus on short notice, with or without cause. Accordingly, the lossof, or delay in payment from, one or a small number of customerscould have a significant impact on our revenue, operatingresults and cash flows.***     A small number of customers account for a significant percentageof our digital media store services revenue, which represented77% of our revenue in 2005, and may continue to do so for theforeseeable future. Microsoft Corporation’s MSN musicservices accounted for approximately 24% of our total digitalmusic store services revenue in 2005. The next four customersaccounted for an additional approximately 42% of total digitalmedia store services revenue in 2005. We believe that a smallnumber of customers may continue to account for a significantpercentage of certain of our revenue streams for the foreseeablefuture. Some of these customers can terminate their servicecontracts with us on short notice, with or without cause, and insome cases, without penalty. Due to high revenue concentrationamong a limited number of customers, the cancellation, reductionor delay of a large customer order or our failure to complete ordeliver a project on a timely basis during a given quarter islikely to significantly reduce revenue. In addition, if anysignificant customer fails to pay amounts it owes us, or doesnot pay those amounts on time, our financial condition, revenueand operating results could suffer.**          *EMIMusic is transitioning away from our encoding services and wemay not be successful in adding additional customers or marketsfor our encoding services, which would impact our revenue andresults of operations and could impact our other digital mediacontent services.***     To date, we have generated substantially all of our encodingservices revenue from fees for delivering EMI Music content todigital service providers, or DSPs. In February 2006, we werenotified by EMI Music that it intends to transition all encodingservices for EMI Music content to another service provider.According to information provided to us by EMI Music, theexpected transition plan will result in DSPs that are receivingencoded EMI Music content from Loudeye being migrated to the newservice provider during the second quarter of 2006. EMI Musiccould transition its customers faster than we anticipate, whichwould result in encoding service revenue below what we currentlyanticipate. We also may not succeed in our efforts to continueour efforts to expand our encoding services to additionalcustomers and into additional markets, such as video encoding.If these efforts are unsuccessful, our encoding services revenuecould be materially adversely affected, our results ofoperations could suffer, and we may need to considerdiscontinuing such services. In addition, if we are unable toexpand our encoding services to additional customers and marketsfast enough to replace the revenue we would have expected togenerate during 2006 from our relationship with EMI Music, wewould expect to restructure operations related to encodingservices during the first half of 2006. Our response to EMIMusic’s transition plan may also have an impact on oursamples, internet radio, hosting and webcasting services asthese service offerings all utilize shared resources.**          *Ifwe are unsuccessful in expanding our mobile music store serviceofferings to additional customers, we may fail to meetexpectations of our business plan and our results of operationscould be harmed.***     We believe future growth in our digital media store servicesdepends significantly upon the growth of the mobile market fordigital content services, including music and video. We continueto invest in our mobile music platform. There are a number ofindustry challenges that could impact the adoption rate ofmobile platforms as a leading method of digital music purchase,including the rate of adoption of compatible mobile handsets,availability of high speed mobile data networks, adoption bymobile consumers of mobile data plans, any pricing differential(both wholesale and retail) between content purchasedover-the-air to a mobile device and purchased by other means,development of content and digital rights management standardsand technologies acceptable to content licensors, and the impacton the economics of the mobile music business of certain issuedpatents. Significant growth in demand for our
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music store services is likely to also depend on significantgrowth in adoption of Windows compatible portable music devices.If we are unsuccessful in meeting the challenges andcomplexities of mobile music distribution or are unsuccessful insecuring additional customers for our services, our results ofoperations could be harmed. Furthermore, our relationship withNokia Corporation is an important element of our mobile musicstrategy. If we or Nokia were to terminate this relationship,our reputation and results of operations from mobile digitalmedia store services could be harmed.**          *Ourdigital media store services generally have relatively low grossmargins.***     On a blended basis, costs of our digital media store services asa percentage of the revenue generated by those services aregenerally higher than those of our digital media contentservices, such as encoding services. A trend towards more musicstore services as a percentage of our total revenue is likely toreduce our overall gross margins.**          *Increasesin wholesale rates for digital music content may negativelyimpact gross margins which could harm our business***     The margin associated with transactional revenue is highlydependent upon factors outside our control such as the wholesalerate charged for content by rights holders such as the majorrecord labels and transactional processing fees such as creditcard interchange fees. Some of the major record labels incertain territories have begun pricing their premium content atwholesale rates in excess of or very near to the prevailingretail price. Increased wholesale rates charged for populardigital music content may negatively impact our gross margins ifretail rates do not increase, which in turn may harm ourbusiness. Furthermore, increased wholesale rates that do nottranslate into increased retail rates in the digital musicmarket could limit the growth of new services.**          *Ourefforts to institute variable pricing rates for digital contentmay result in loss of end consumers and a reduction intransactional revenue, which could harm our business, reputationand results of operations.***     We have begun efforts to implement a variable price ratestructure in some of our key markets and music stores in Europedesigned to improve our margin associated with our transactionalrevenue. The immediate impact of these pricing changes is thatthe rates we charge for some digital content will be higher thanthe rates charged by our competitors, such as AppleComputer’s iTunes music service. If we lose customers as aresult of the higher prices we are charging, our business,reputation and results of operations could be harmed.**          *Ourmusic content licenses are generally for limited terms. If weare unable to reach agreement with recorded music companies,especially with the four major recorded music companies, torenew existing licenses or to grant us expanded license rights,portions of our services could be interrupted and our businessand results of operations could be harmed.***     We have digital download content license agreements with allfour major recorded music companies — EMI MusicMarketing, Sony BMG Music Entertainment, UMG Recordings, andWarner Music Group — and numerous independent recordlabels, and in each case our license grants are for finite termsand generally require the consent of the label to renew. Ourlicenses generally provide for the content owner to changewholesale content prices on advance notice and on renewal. Inaddition, these content licenses may be terminated by therecorded music companies at any time upon a specified period ofadvance notice or under circumstances such as our breach ofthese agreements. Our major label content licenses have limitedterritories, and as a result we have separate license agreementsfor major label content in the U.S., Europe and Australia and wewould require new licenses for other territories.     Content owners may use renewal time periods as leverage forincreasing wholesale content rates and making other changes suchas demanding royalty advances. There can be no assurance we willbe successful in renewing our content license agreements oncommercially reasonable terms, if at all. If we
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are unsuccessful in securing renewals of these label licenseagreements before expiration of existing agreements, our digitalmedia services with respect to any one or a number of thelabels’ content could be interrupted, and our business andresults of operations could be harmed.     In addition, we are seeking expanded license rights from themajor record labels and other content owners for rights such asover-the-air deliveries, unlimited streaming and music videostreaming. New license rights may be coupled with substantialup-front fees or advances and there can be no assurance we willbe successful in negotiating these expanded content licenseagreements on commercially reasonable terms, if at all. If weare unsuccessful in obtaining additional license rights from thecontent owners for emerging distribution methods, such asover-the-air deliveries, our business and results of operationscould be harmed.**          *Ourmusic content licenses generally require prior approval for usto distribute content to our customers. If approval is delayedor withheld, portions of our services could be interrupted andour business and results of operations could be harmed.***     Our content license agreements from the major recorded musiccompanies generally require prior approval before we candistribute content to our customers. We have experienced delaysand challenges in obtaining timely approval of certain new andexisting customers, especially for our music samples service. Ifapproval is delayed or withheld, we may not be able to satisfyour contractual obligations to our customers. As a result, ourreputation within the music industry could be harmed, ourservices could be interrupted and our business and results ofoperations could be harmed.**          *Recordedmusic companies and our customers may desire to have a directlicense relationship. This trend may lengthen our sales cycleand may result in us reporting certain music store servicesrevenue on a net basis rather than on a gross basis.***     While we typically secure content licenses on behalf of ourcustomers, there is a trend for certain of the major recordedmusic companies to want to provide licenses directly to newconsumer music services, and some consumer music services,especially those of household brand names, are requiring directlicensing arrangements with the labels. If these trends continueour business may be significantly impacted including byextending our sales cycle and requiring us to assist ourcustomers in obtaining licenses from content owners. This couldchange the way we report revenue because to the extent licenserights do not pass through Loudeye and our customers arerequired or elect to license and pay content owners directly,our transactional revenue may decrease and gross margins as apercentage of revenue may increase if we report revenue on a netbasis (net of third party content fees) rather than on a grossbasis.**          *Ourmusic content licenses could result in operational complexitythat may divert resources or make our business more expensive toconduct.***     The large number of licenses in Europe and in the U.S. that weneed to maintain in order to operate our music-related servicescreates operational difficulties in connection with tracking therights that we have acquired and the complex structures underwhich we have royalty and reporting obligations. In addition, insome circumstances, we are responsible for obtaining licensesfrom professional rights organizations, both in Europe and inthe U.S., such as The MCPS-PRS Alliance Limited in the UnitedKingdom, The American Society of Composers, Authors andPublishers, Inc. (ASCAP), Broadcast Music, Inc. (BMI), andSESAC, Inc. (SESAC), and for tracking and remitting royalties tothese rights organizations. There is uncertainty in certaingeographies over what license rights, or corresponding rates,are required, as evidenced by a lawsuit brought by SPEDIDAM, aroyalty collection agency in France, against OD2 and othersalleging royalties due for digital content reproduction anddistribution. The disparate types and shear quantity of licenseswe must obtain and track adds to the complexity of the royaltystructure in which we operate. The effort to obtain thenecessary rights from such third parties is often significant,and could disrupt, delay, or prevent us from executing ourbusiness plans. Because of the large number of potential partiesfrom which we must obtain licenses, we may never be able toobtain a sufficient number of licenses to allow us to provideservices that will meet our customers’ expectations.
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     Our licensing agreements typically allow the third party toaudit our royalty tracking and payment mechanisms to ensure thatwe are accurately reporting and paying royalties owed. If we areunable to accurately track amounts that we must pay to thenumerous parties with whom we have licenses in connection witheach delivery of digital music services or if we do not deliverthe appropriate payment in a timely fashion, we may riskfinancial penalties and/or termination of licenses.**          *Wemake estimates of music publishing and performance rates; adetermination of higher than estimated royalty rates couldnegatively impact our operating results.***     We make estimates of our music publishing and certain othermusic royalties owed for our domestic and international musicservices. Differences in judgments or estimates could result inmaterial differences in the amount and timing of our musicpublishing and royalty expense for any period. Under Europeanand U.S. copyright laws, we may be required to pay licensingfees for digital sound recordings and compositions we make anddeliver. Copyright law in the U.S. and in Europe generally doesnot specify the rate and terms of the licenses, which aredetermined by voluntary negotiations among the parties or, forcertain compulsory licenses where voluntary negotiations areunsuccessful, by arbitration. There are certain geographies andagencies for which we have not yet completed negotiations withregard to the royalty rate to be applied to our current orhistoric sales of our digital music offerings. In addition, thearena of royalty negotiations is litigious, evidenced forexample by a lawsuit brought by SPEDIDAM, a royalty collectionsociety in France, against OD2 and others in March 2006. We maybe required to pay a rate that is higher than we expect, orwhere we previously believed no royalty was due. Our estimatesare based on contracted or statutory rates, when established, ormanagement’s best estimates based on facts andcircumstances regarding the specific music services andagreements in similar geographies or with similar agencies.While we base our estimates on historical experience,established industry practice and on various other assumptionsthat management believes to be reasonable under thecircumstances, actual results may differ materially from theseestimates under different assumptions or conditions.**          *Wemay be liable or alleged to be liable to third parties formusic, software, and other content that we encode, distribute,archive or make available to our customers.***     We may be liable or alleged to be liable to third parties, suchas the recorded music companies, music publishers and performingrights organizations, for the content that we encode,distribute, archive or make available to our customers assamples, streams, downloads or otherwise: •     If the performance of our services is not properly licensed by    the content owners or their representatives such as the recorded    music companies, music publishers and performing rights    organizations;  •     If the content or the performance of our services violates third    party copyright, trademark, or other intellectual property    rights;  •     If our customers violate the intellectual property rights of    others by providing content to us or by having us perform    digital media services;  •     If the manner of delivery of content is alleged to violate terms    of use of third party delivery systems, such as peer-to-peer    networks; or  •     If content that we encode or otherwise handle for our customers    is deemed obscene, indecent, or defamatory.     Any alleged liability could harm our business by damaging ourreputation, requiring us to incur legal costs in defense,exposing us to awards of damages and costs and divertingmanagement’s attention which could have an adverse effecton our business, results of operations and financial condition.Our customers for encoding services generally agree to indemnifyand hold us harmless from claims arising from their failure tohave the right to encode the content given to us for thatpurpose. However, customers may contest this responsibility ornot have sufficient resources to defend claims and we havelimited or no insurance coverage for claims of this nature.
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     In certain aspects of our business, we rely on well-establishedindustry practice concerning rights matters. These industrypractices could change over time or certain rights holders couldbecome newly active in pursuing alleged licensing opportunitiesconcerning certain areas of our business. Changing industrypractices concerning intellectual property rights or anyrequirement that we litigate or settle questions of intellectualproperty rights as new matters arise could have a materialadverse affect on our results of operations, business andprospects.     Because we host, stream and webcast audio and video content onor from our website and on other websites for customers andprovide services related to digital media content, we facepotential liability or alleged liability for negligence,infringement of copyright, patent, or trademark rights,defamation, indecency and other claims based on the nature andcontent of the materials we host. Claims of this nature havebeen brought, and sometimes successfully prosecuted, againstcontent distributors. In addition, we could be exposed toliability with respect to the unauthorized encoding of contentor unauthorized use of other parties’ proprietarytechnology, including third party delivery systems such aspeer-to-peer networks. Any imposition of liability that is notcovered by insurance or is in excess of insurance coverage orany alleged liability could harm our business.     We cannot provide assurance that third parties will not claiminfringement by us with respect to past, current, or futuretechnologies or services. The music industry in particular hasrecently been the focus of infringement claims. We expect thatparticipants in our markets will be increasingly subject toinfringement claims as the number of services and competitors inour industry segment grows. In addition, these risks aredifficult to quantify in light of the continuously evolvingnature of laws and regulations governing the Internet. Any claimrelating to proprietary rights, whether meritorious or not,could be time-consuming, result in costly litigation, causeservice upgrade delays or require us to enter into royalty orlicensing agreements, and we can not assure you that we willhave adequate insurance coverage or that royalty or licensingagreements will be available on terms acceptable to us or at all.**          *Competitionmay decrease our market share, revenue, and grossmargins.***     We face intense and increasing competition in the global digitalmedia services market. If we do not compete effectively or if weexperience reduced market share from increased competition, ourbusiness will be harmed. In addition, the more successful we arein the emerging market for digital media services, the morecompetitors are likely to emerge.     To date, Apple Computer’s popular iPod line of portabledigital media players and Apple’s iTunes music storeservice have dominated the market for digital audio and videocontent. The digital music stores we power compete withApple’s iTunes services for end consumers. While we areimplementing tiered-pricing for audio content across certain ofour stores in response to increased wholesale rates for content,Apple is currently maintaining a flat retail rate for audiocontent of €0.99in Europe and $0.99 in the U.S. In addition, Apple Computer hasnot designed its popular iPod line of portable digital mediaplayers to function with our music services and users whopurchase content through the digital music stores we power maynot be able to play music they purchase there on their iPods. Ifwe and the digital music services we power are unsuccessful incompeting with Apple’s services or making our servicescompatible with Apple’s devices, our business and resultsof operations could be harmed.     For our business-to-business digital media store services, wecompete against several companies providing similar levels ofoutsourced digital music services including Cable and Wirelessplc., Widerthan Co., Ltd., Digital World Services AG, GrooveMobile (formerly Chaoticom), Liquid Digital, Melodeo, Inc.,MusicNet, Inc., MusicNow LLC, MusiWave, MPO Group, Siemens AG,Soundbuzz Pte Ltd., as well as in-house efforts by our potentialcustomers. Our customers face significant competition from“free” peer-to-peer services, such as MetaMachineInc.’s eDonkey, Sharman Network Inc.’s KaZaA,StreamCast Networks, Inc.’s Morpheus, Grokster, Ltd. and avariety of other similar services that allow computer users toconnect with each other and to copy many types of program files,including music and other media, from one another’s harddrives, all without securing licenses from content providers.For our encoding services, we compete against companies such asConsolidated Independent ltd and Sony DADC.
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For our music samples services, we compete with companiesincluding Muze Inc. and AEC One Stop Group, Inc.’s AllMusic Guide. In addition, well-capitalized, diversified digitalmedia technology companies such as Microsoft Corporation, AppleComputer Inc., Real Networks, Inc., and Napster, LLC competewith our customers and may compete with us in the future withtheir own services. For certain services, such as encoding andmusic distribution, the major record labels have acquired orotherwise invested in digital music services and technologiesthat could compete with our services. Traditional and satelliteradio broadcasters have developed online music and radioservices which also compete with our solutions.     Many of our competitors have substantially more capital, longeroperating histories, greater brand recognition, larger customerbases and significantly greater financial, technical andmarketing resources than we do. These competitors may alsoengage in more extensive development of their technologies,adopt more aggressive pricing policies and establish morecomprehensive marketing and advertising campaigns than we can.Our competitors may develop service offerings that we do notoffer or that are more sophisticated or more cost effective thanour own. For these and other reasons, our competitors’services may achieve greater acceptance in the marketplace thanour own, limiting our ability to gain or maintain market shareand customer loyalty and to generate sufficient revenue toachieve a profitable level of operations. Our failure toadequately address any of the above factors could harm ourbusiness and results of operations.**          *Ifwe do not continue to add customers for our services, ourrevenue and business will be harmed.***     In order to achieve return on our investments in all of ourservice offerings, we must continue to add new customers whileminimizing the rate of loss of existing customers. If our sales,marketing and promotional activities fail to add new customersat a rate significantly higher than our rate of loss, ourbusiness will suffer. In addition, if the costs of such sales,marketing and promotional activities increase in order to addnew customers, our margins and operating results will suffer.**          *Ourbusiness will suffer if we do not anticipate and meet specificcustomer requirements or respond to technological change.***     The market for digital media services is characterized by rapidtechnological change, frequent new service offerings, new deviceintroductions, new digital rights management standards andchanges in customer requirements, some of which are unique or ona customer by customer basis. We may be unable to respondquickly or effectively to these developments or requirements.Our future success will depend to a substantial degree on ourability to offer services that incorporate leading technology,address the increasingly sophisticated, varied or individualneeds of our current and prospective customers and respond totechnological advances and emerging industry standards andpractices on a timely and cost-effective basis. You should beaware that: •     Our technology or systems may become obsolete upon the    introduction of alternative technologies;  •     We may not have sufficient resources to develop or acquire new    technologies or the ability to introduce new services capable of    competing with future technologies or service offerings; and  •     The price of our services is likely to decline as rapidly as the    cost of any competitive alternatives.     The development of new or enhanced services through technologydevelopment activities is a complex and uncertain process thatrequires the accurate anticipation of technological and markettrends. We may experience design, manufacturing, marketing andother difficulties that could delay or prevent the development,introduction or marketing of new services and enhancements. Inaddition, our inability to effectively manage the transitionfrom older services to newer services could cause disruptions tocustomer orders and harm our business and prospects.
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**          *Paiddigital media content services face competition from“free” peer-to-peer services.***     Our customers’ digital media store services facesignificant competition from “free” peer-to-peerservices, such as Sharman Network Inc.’s KaZaA, StreamCastNetworks, Inc.’s Morpheus, and a variety of other similarservices that allow computer users to connect with each otherand to copy many types of program files, including music andother media, from one another’s hard drives, all withoutsecuring licenses from content providers. While the U.S. SupremeCourt’s July 2005 ruling in the peer-to-peer piracy case*MGM Studios, Inc. v. Grokster, Ltd.,*may mean thatpeer-to-peer networks that do not filter for unlicensed contentavailable over their networks could be liable for damages forcopyright infringement, enforcement efforts against peer-to-peernetworks have not effectively shut down all of these services todate, and there can be no assurance that these services willever be shut down. The ongoing presence of these“free” services substantially impairs themarketability of legitimate services, regardless of the ultimateresolution of their legal status.     Because digital recorded music formats, such as MP3, do notalways contain mechanisms for tracking the source or ownershipof digital recordings, users are able to download and distributeunauthorized or “pirated” copies of copyrightedrecorded music over the Internet. This piracy is a significantconcern to record companies and artists, and is a primary reasonmany record companies and artists are reluctant to digitallydeliver their recorded music over the Internet. As long aspirated recordings are available, many consumers will choosefree pirated recordings rather than paying for legitimaterecordings. Continued illegal content downloading and sharingmay slow growth in the market for paid digital music downloads,which could harm our results of operations.**          *Averageselling prices of our services may decrease, which maynegatively impact our gross margins.***     The average selling prices of our services may be lower thanexpected as a result of competitive pricing pressures,promotional programs and customers who negotiate pricereductions in exchange for longer term purchase commitments orotherwise. The pricing of services sold to our customers dependson the duration of the agreement, the specific requirements ofthe order, the sales and service support and other contractualagreements. We have experienced and expect to continue toexperience pricing pressure and anticipate that the averageselling prices and overall gross margins for our services may beimpacted. We may not be successful in developing and introducingon a timely basis new services with enhanced features orimproved versions of our existing services that can be sold athigher gross margins.**          *Ourmusic store services operating results fluctuate on a seasonaland quarterly basis.***     Sales of recorded music tend to be seasonal in nature, with adisproportionate percentage of annual music purchases occurringin the fourth quarter. We expect transactional related revenuefrom our digital media stores services to be impacted by suchseasonality long-term; however, increasing consumer adoption ofdigital media services should largely mitigate the impact ofsuch seasonality in the near term. This sales seasonality mayaffect our operating results from quarter to quarter. Prior toour acquisition of OD2 in June 2004 and the expansion of ourmusic store services, we did not experience significantseasonality in our business. Historically, our Europeanoperations tend to experience lower growth in the seasonallyslow third calendar quarter each year. We cannot assure you thatrevenue from our music store services will continue at the levelexperienced in prior quarters or that they will be higher thansuch revenue for our other quarters. Seasonality in our businessmakes it more difficult to make meaningful period to periodcomparisons for our business.**          *Adecline in current levels of consumer spending could reduce ourmusic store service revenue.***     Our music store services revenue is directly affected by thelevel of consumer spending. One of the primary factors thataffect consumer spending is the general state of the localeconomies in which we operate. Lower levels of consumer spendingin regions in which our customers operate music stores couldhave a negative impact on our business, financial condition orresults of operations.
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**          *Effortsby record labels to shore up declining sales of CDs may impactsales of digital content.***     Some record labels are refusing to license individual tracks ofmusic for digital download in an effort to block so-called“unbundling” of album sales. These efforts areapparently designed to shore up declining sales of CDs. Theseefforts could slow consumer adoption of digital mediaconsumption alternatives, which could harm our results ofoperations.**          *Oursuccess is dependent on the performance of our CEO and thecooperation, performance and retention of our executive officersand key employees.***     Michael Brochu joined as our chief executive officer onJanuary 31, 2005. Our business and operations aresubstantially dependent on the performance and integration ofour CEO, as well as the performance of our other executives. Wedo not maintain “key person” life insurance on any ofour executive officers. The loss of one or several key employeescould seriously harm our business. Any reorganization orreduction in the size of our employee base could harm ourability to attract and retain other valuable employees criticalto the success of our business.**          *Wecannot be certain that we will be able to protect ourintellectual property.***     Our intellectual property is important to our business, and weseek to protect our intellectual property through copyrights,trademarks, patents, trade secrets, confidentiality provisionsin our customer, supplier and strategic relationship agreements,nondisclosure agreements with third parties, and inventionassignment agreements with our employees and contractors. Therecan be no assurance that measures we take to protect ourintellectual property will be successful or that third partieswill not develop alternative solutions that do not infringe uponour intellectual property.**          *Wemay be subject to intellectual property infringement claimswhich are costly to defend and could limit our ability to usecertain technologies in the future.***     We could be subject to intellectual property infringement claimsby others. For example, in September 2004, Loudeye and Overpeerwere named in a patent infringement lawsuit brought by Altnet,Inc., and others involving two patents that appear to cover fileidentifiers for use in accessing, identifying and/or sharingfiles over peer-to-peer networks. The complaint alleges that theanti-piracy services formerly offered by our Overpeer subsidiaryinfringed the patents in question. The complaint does not statea specific damage amount.     In addition, we rely upon third party technologies in ourservice offerings. When we license third party technologies, wegenerally are indemnified by the third party service provideragainst liabilities arising from infringement of otherproprietary rights, however there can be no assurance that theseindemnification rights will be sufficient or that the thirdparty will have sufficient resources to fulfill its indemnityobligations.     Several public companies such as Napster, Inc. and Realnetworks,Inc. that offer digital music distribution services in the U.S.over the Internet, especially through subscription services,have disclosed that lawsuits have been filed against them byseveral companies alleging that their music distributionservices may infringe patents owned by those companies. Loudeyemay be subject to similar claims, demands or litigation in thefuture, if Loudeye offers subscription services on behalf of itscustomers in the U.S.     Potential customers may be deterred from distributing contentover the Internet for fear of infringement claims. The musicindustry in particular has recently been the focus of heightenedconcern with respect to copyright infringement and othermisappropriation claims, and the outcome of developing legalstandards in that industry is expected to affect music, videoand other content being distributed over the Internet. If, as aresult, potential customers forego distributing traditionalmedia content over the Internet, demand for our digital mediaservices could be reduced which would harm our business. Themusic industry in the U.S. is generally regarded as extremelylitigious in nature compared to other
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industries and we could become engaged in litigation with othersin the music industry. Claims against us, and any resultantlitigation, should they occur in regard to any of our digitalmedia services, could subject us to significant liability fordamages including treble damages for willful infringement. Inaddition, even if we prevail, litigation could be time-consumingand expensive to defend and could result in the diversion of ourtime and attention. Any claims from third parties may alsoresult in limitations on our ability to use the intellectualproperty subject to these claims. Further, we offer our digitalmedia services to customers in foreign countries that may offerless protection for our intellectual property than the UnitedStates. Our failure to protect against misappropriation of ourintellectual property, or claims that we are infringing theintellectual property of third parties could have a negativeeffect on our business, revenue, financial condition and resultsof operations.**          *Wecurrently maintain two service platforms for our digital mediastore services which represents potential additional significantexpense.***     We are developing enhancements to our European digital musicstore platform to support future mobile music store customers.We also launched a mobile music store service for a customer inGermany in the fourth quarter 2005 that is hosted on our Seattleplatform. We may migrate customers from this Seattle platform toour European platform. There can be no assurance our customerswill be satisfied with the operational specifications of the newplatform or that we will have successfully anticipated andaddressed all technological and operational issues associatedwith migrating customers to the European platform. We may incursignificant costs and expenses in completing the platformmigration which would negatively impact our results ofoperations.**          *Wemust enhance our existing digital media services and develop andintroduce new services in a timely manner to remain competitivein that segment. Any failure to do so in a timely manner willcause our results of operations to suffer.***     The market for digital media services is characterized byrapidly changing technologies and market offerings. This marketcharacteristic is heightened by the emerging nature of theInternet and the continuing trend of companies from manyindustries to offer Internet-based applications and services.The widespread adoption of the new Internet, networking,streaming media, or telecommunications technologies or othertechnological changes could require us to incur substantialexpenditures to modify or adapt our operating practices orinfrastructure. Our future success will depend in large partupon our ability to: •     Identify and respond to emerging technological trends in the    market;  •     Enhance our services by adding innovative features that    differentiate our digital media services from those of our    competitors;  **• **    Develop, acquire and license leading technologies;  •     Bring digital media services to market and scale our business    and operations on a timely basis at competitive prices; and  •     Respond effectively to new technological changes or new service    announcements by others.     We will not be competitive unless we continually introduce newservices or enhancements to existing services that meet evolvingindustry standards and customer needs. We must bring newservices and enhancements to market in a timely manner tosatisfy needs of existing and potential customers. In thefuture, we may not be able to address effectively thecompatibility and interoperability issues that arise as a resultof technological changes and evolving industry standards. Thetechnical innovations required for us to remain competitive areinherently complex, require long development schedules and aredependent in some cases on sole source suppliers. We will berequired to continue to invest in research and development inorder to attempt to maintain and enhance our existingtechnologies and services, but we may not have the fundsavailable to do so. Even if we have sufficient funds, theseinvestments may not serve the needs of customers or becompatible with changing technological requirements orstandards. Most development expenses must be incurred before thetechnical feasibility or commercial viability of new or enhanced
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services and applications can be ascertained. Revenue fromfuture services or enhancements to services may not besufficient to recover the associated development costs.**          *Delaysin technology enhancements could result in customer terminationswhich could cause our results of operations to suffer.***     We may experience delays in completing enhancements to ourexisting services required for current or potential customers.Any such delays could impact anticipated launch dates forcustomer services. In addition to customer satisfaction issuescaused by delays, we may incur additional expenses associatedwith efforts directed at speeding delivery of technologyenhancements and our customers may ultimately terminate theirservice agreements with us, either or both of which couldnegatively impact our results of operations.**          *Thesuccess of our digital media store services depends, in part, oninteroperability with our customer’s music playbackhardware.***     In order for our digital music services to continue to grow wemust design our services to interoperate effectively with avariety of hardware products, including personal computers,mobile handsets, portable digital media players, home stereos,and car stereos. We depend on significant cooperation withmanufacturers of these products and with software manufacturersthat create the operating systems for such hardware devices toachieve our business and design objectives. To date, AppleComputer has not designed its popular iPod line of portabledigital media players to function with our music services andusers who purchase content through the digital music stores wepower may not be able to play music they purchase there on theiriPods. If we cannot successfully design our service tointeroperate with the music playback devices that our customersown, through relationships with manufacturers or otherwise, ourbusiness will be harmed.**          *Thetechnology underlying our services is complex and may containunknown defects that could harm our reputation, result inliability or decrease market acceptance of our services.***     The technology underlying our digital media services is complexand includes software that is internally developed and softwarelicensed from third parties, including open source software.These software products may contain errors or defects,particularly when first introduced or when new versions orenhancements are released. We may not discover software defectsthat affect our current or new services or enhancements untilafter they are sold or commercially launched. Furthermore,because our digital media services are designed to work inconjunction with various platforms and applications, we aresusceptible to errors or defects in third-party applicationsthat can result in a lower quality service for our customers.Because our customers depend on us for digital media management,any interruptions could: •     Damage our reputation;  •     Cause our customers to initiate liability suits against us;  •     Increase our service development resources;  •     Cause us to lose revenue; and  •     Delay market acceptance of our digital media services.     We do not have product liability insurance, and our errors andomissions coverage is not likely to be sufficient to cover ourcomplete liability exposure.**          *Moreconsumers are utilizing non-PC devices to access digitalcontent, and we may not be successful in developing versions ofour services that will gain widespread adoption by users of suchdevices.***     In the coming years, the number of individuals who accessdigital content through devices other than a personal computer,such as portable digital media players, personal digitalassistants, cellular telephones, television set-top devices,game consoles and Internet appliances, may increasedramatically. Manufactur-
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ers of these types of products are increasingly investing inmedia-related applications, but these devices are in an earlystage of development and business models are new and unproven.If we are unable to offer our services on these alternativenon-PC devices, we may fail to capture a sufficient share of anincreasingly important portion of the market for digital mediaservices or our costs may increase significantly.     In addition, growth in demand for our music store services islikely to depend on growth in adoption of Windows Media Playercompatible portable music devices. For example, our digitalmusic store service is not compatible with the iPod musicplayer, the leader in the digital audio player market. Successof our services could also be impacted by the rate of adoptionof OMA version 2 DRM technologies.**          *Weprovide guarantees to some of our customers under service levelagreements and could be liable for service credits for failureto meet specified performance metrics.***     In connection with our encoding services and certain digitalmedia store services, we provide our customers with guaranteedservice performance levels. If we fail to meet these guaranteedperformance metrics, we could be liable for monetary credits orrefunds of service fees previously paid or owed to us. We haveprovided certain customers with credits for performance levelfailures and while we endeavor to avoid the imposition of suchcredits, we can not be certain we will always meet our servicelevel guarantees. Our contracts generally provide for credits ofa portion of the fees otherwise payable to us for the service inthe event of a service level failure. Any failure could alsoresult in termination of service contracts and could damage ourreputation and ability to attract or retain customers.**          *Ournetwork is subject to security and stability risks that couldharm our business and reputation and expose us to litigation orliability.***     Online commerce and communications depend on the ability totransmit confidential information and licensed intellectualproperty securely over private and public networks in Europe andin the U.S. Any compromise of our ability to transmit suchinformation and data securely or reliably, and any costsassociated with preventing or eliminating such problems, couldharm our business. Our systems and operations are susceptibleto, and could be damaged or interrupted by a number of securityand stability risks, including: outages caused by fire, flood,power loss, telecommunications failure, Internet breakdown,earthquake and similar events. Our systems are also subject tohuman error, security breaches, power losses, computer viruses,break-ins, “denial of service” attacks, sabotage,intentional acts of vandalism and tampering designed to disruptour computer systems, websites and network communications. Asudden and significant increase in traffic on our websites couldstrain the capacity of the software, hardware andtelecommunications systems that we deploy or use. This couldlead to slower response times or system failures.     Our operations also depend on receipt of timely feeds from ourcontent providers, and any failure or delay in the transmissionor receipt of such feeds could disrupt our operations. We alsodepend on web browsers, ISPs and online service providers toprovide access over the Internet to our service offerings. Manyof these providers have experienced significant outages orinterruptions in the past, and could experience outages, delaysand other difficulties due to system failures unrelated to oursystems. These types of interruptions could continue or increasein the future.     The occurrence of any of these or similar events could damageour business, hurt our ability to distribute services andcollect revenue, threaten the proprietary or confidential natureof our technology, harm our reputation, and expose us tolitigation or liability. We may be required to expendsignificant capital or other resources to protect against thethreat of security breaches, hacker attacks or systemmalfunctions or to alleviate problems caused by such breaches,attacks or failures.**          *Ourservices are complex and are deployed in complex environmentsand therefore may have errors or defects that could seriouslyharm our business.***     Our services are highly complex and are designed to be deployedin and across numerous large complex networks. Our digitaldistribution activities are managed by sophisticated softwareand computer
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systems. From time to time, we have needed to correct errors anddefects. In addition, we must continually develop and updatethese systems over time as our business needs grow and changeand these systems may not adequately reflect the current needsof our business. We may encounter delays in developing thesesystems, and the systems may contain undetected errors anddefects that could cause system failures. Any system error orfailure that causes interruption in availability of services orcontent or an increase in response time could result in a lossof potential or existing customers, users, advertisers orcontent providers. If we suffer sustained or repeatedinterruptions, our services and websites could be lessattractive to such entities or individuals and our businesscould be harmed.**          *Ourtransmission capacity is not entirely in our control, as we relyin part on transmission capacity provided by third parties.Insufficient transmission capacity could result in delays orinterruptions in our services and loss of revenue.***     Significant portions of our business are dependent on providingcustomers with efficient and reliable services to enablecustomers to broadcast content to large audiences on a live oron-demand basis. Our operations in Europe and in the U.S. aredependent in part upon transmission capacity provided bythird-party telecommunications network providers. Any failure ofnetwork providers to provide the capacity we require may resultin a reduction in, or interruption of, service to our customers.If we do not have access to third-party transmission capacity,we could lose customers and if we are unable to obtain suchcapacity on terms commercially acceptable to us, our businessand operating results could suffer.**          *Wemay need to make additional future acquisitions to remaincompetitive. The process of identifying, acquiring andintegrating these future acquisitions may have a materialadverse effect on our operating results.***     Integrating any potential future acquisitions could causesignificant diversions of management time and company resources.Our ability to integrate operations of acquired companies willdepend, in part, on our ability to overcome or address: •     The difficulties of assimilating the operations and personnel of    the acquired companies and realizing anticipated operational and    cost efficiencies without disruption to the ongoing business;  •     Impairment of relationships with employees, affiliates,    advertisers and content providers of our business and acquired    businesses;  •     The loss of key management and the difficulties in retaining key    management or employees of acquired companies;  •     Operational difficulties, including the need to attract and    retain qualified personnel and the need to attract customers;  •     The cost and challenges of integrating IT and financial systems;  •     Diversion of management’s attention from other business    concerns and the potential disruption of our ongoing business;  •     The need to incorporate successfully the acquired or shared    technology or content and rights into our services, including    maintaining customer satisfaction while migrating to a single    development platform; and  •     The difficulties of maintaining uniform standards, systems,    controls, procedures and policies.     In addition, completing acquisitions could require use of asignificant amount of our available cash. Furthermore, financingfor future acquisitions may not be available on favorable terms,if at all. If we identify an appropriate acquisition candidatefor any of our businesses, we may not be able to negotiate theterms of the acquisition successfully, finance the acquisitionor integrate the acquired business, technologies or employeesinto our existing business and operations. Future acquisitionsmay not be well-
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received by the investment community, which may cause our stockprice to fall. We cannot ensure that we will be able to identifyor complete any acquisition in the future.     If we acquire businesses, new services, or technologies in thefuture, we may be required to amortize significant amounts ofidentifiable intangible assets and we may record significantamounts of goodwill that will be subject to at least annualtesting for impairment. If we consummate one or more significantfuture acquisitions in which the consideration consists of stockor other securities, our existing stockholders’ ownershipwould be diluted significantly. If we were to proceed with oneor more significant future acquisitions in which theconsideration included cash, we could be required to use asubstantial portion of our available cash. The anticipatedbenefits of any acquisition may not be realized. If any of thenegative events occur, our results of operations and financialposition could be materially adversely affected.**          *Ouroperations could be harmed by factors including politicalinstability, natural disasters, fluctuations in currencyexchange rates and changes in regulations that governinternational transactions.***     We have substantial international operations, including in theUnited Kingdom, France, Germany and Italy. The risks inherent ininternational trade may reduce our international sales and harmour business and the businesses of our customers and oursuppliers. These risks include: •     Changes in tariff regulations;  •     Political instability, war, terrorism and other political risks;  •     Foreign currency exchange rate fluctuations;  •     Establishing and maintaining relationships with local    distributors and dealers;  •     Lengthy accounts receivable payment cycles;  •     Import and export licensing requirements;  •     Compliance with a variety of foreign laws and regulations,    including unexpected changes in taxation and regulatory    requirements;  •     Greater difficulty in safeguarding intellectual property than in    the U.S.;  •     Challenges caused by distance, language and cultural differences;  •     Potentially adverse tax consequences;  •     Difficulty in staffing and managing geographically diverse    operations; and  •     Higher costs associated with doing business internationally.     These and other risks may preclude or curtail internationalsales or increase the relative price of our services compared tothose of local competitors in other countries, reducing thedemand for our services.**          *Weare subject to exchange rate risk in connection with ourinternational operations.***     The results of operations of OD2 are exposed to foreign exchangerate fluctuations as the financial results of this subsidiaryare translated from the local currency to U.S. dollars uponconsolidation. Because of the significance of the operations ofOD2 to our consolidated operations, as exchange rates vary, netsales and other operating results, when translated, may differmaterially from our prior performance and our expectations. Inaddition, because of the significance of our overseasoperations, we could also be significantly affected by weakeconomic conditions in foreign markets that could reduce demandfor our services and further negatively impact results ofoperations in a material and adverse manner. As a result ofthese market risks, the price of our stock could declinesignificantly and rapidly.     We may in the future engage in hedging activities and may as aresult experience gains or losses from these hedging activities.As foreign currency exchange rates vary, the fluctuations inrevenue and expenses may materially impact the financialstatements upon consolidation. A weaker U.S. dollar would resultin
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an increase to revenue and expenses upon consolidation, and astronger U.S. dollar would result in a decrease to revenue andexpenses upon consolidation.**          *Thelease for our corporate headquarters in Seattle, Washington canbe terminated by the landlord on 150 days notice. If thelandlord terminates our lease, we most likely would be requiredto locate new facilities and make significant expenditures inrelocating our operations.***     The lease for our corporate headquarters in Seattle, Washingtoncan be terminated by the landlord on 150 days notice. If weare required to move to a new location, we could incursignificant expenditures in relocating our operations as well asa disruption of our business. In addition, we may need to committo a long term lease for a new location for our headquarters,which would impact the flexibility we would otherwise have torestructure our business in the future to reduce expenses ifnecessary.**          *Ourbusiness and operations may be especially subject to the risksof earthquakes and other natural catastrophes in the PacificNorthwest.***     Our U.S. computer and communications infrastructure is locatedat a single leased facility in Seattle, Washington, an area thatis at heightened risk of earthquake and volcanic events. We donot have fully redundant systems, and we may not have adequatebusiness interruption insurance to compensate us for losses thatmay occur from a system outage. Despite our efforts, our networkinfrastructure and systems could be subject to serviceinterruptions or damage and any resulting interruption ofservices could harm our business, operating results andreputation.**     *****Risks Related to Our Industry*****          *Wemust provide digital rights management solutions that areacceptable to both content providers and consumers.***     We must provide digital rights management solutions and othersecurity mechanisms in order to address concerns of contentproviders and artists, and we cannot be certain that we candevelop, license or acquire such solutions or that contentlicensors or consumers will accept them. Consumers may beunwilling to accept the use of digital rights managementtechnologies that limit their use of content, especially withlarge amounts of free content readily available. No assurancecan be given that such solutions will be available to us uponreasonable terms, if at all. If we are unable to acquire thesesolutions on reasonable or any terms, or if customers areunwilling to accept these solutions, our business and prospectscould be harmed.**          *Ourindustry is experiencing consolidation that may intensifycompetition.***     The Internet and digital media services industries areundergoing substantial change that has resulted in increasingconsolidation and a proliferation of strategic transactions.Many companies in these industries have failed or are beingacquired by larger entities. As a result, we are increasinglycompeting with larger competitors which have substantiallygreater resources than we do. We expect this consolidation andstrategic partnering to continue. Acquisitions or strategicrelationships could harm us in a number of ways. For example: •     Competitors could acquire or enter into relationships with    companies with which we have strategic relationships and    discontinue our relationship, resulting in the loss of    distribution opportunities for our services or the loss of    certain enhancements or value-added features to our services;  •     Competitors could obtain exclusive access to desirable    multimedia content and prevent that content from being available    in certain formats or markets, thus impairing our content    selection and our ability to attract customers;  •     Suppliers of important or emerging technologies could be    acquired by a competitor or other company which could prevent us    from being able to utilize such technologies in our offerings,    and disadvantage our offerings relative to those of competitors;
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 •     A competitor could be acquired by a party with significant    resources and experience that could increase the ability of the    competitor to compete with our services; and  •     Other companies with related interests could combine to form    new, formidable competition, which could preclude us from    obtaining access to certain markets or content, or which could    significantly change the market for our services.     Any of these results could put us at a competitive disadvantagethat could cause us to lose customers, revenue and market share.They could also force us to expend greater resources to meet thecompetitive threat, which could also harm our operating results.**          *Ourbusiness could be harmed by a lack of availability of popularcontent.***     Our digital media services business is affected by the releaseof “hit” music titles, which can create cyclicaltrends in sales distinctive to the music industry. It is notpossible to determine the timing of these cycles or the futureavailability of hit titles. We depend upon the music contentproviders to continue to produce hits. To the extent that newhits are not available, or not available at prices attractive toconsumers, our sales and margins may be adversely affected. Inaddition, to the extent other music services obtain exclusiverights to certain popular content and we are unable to offersuch content on our services, our revenues or operating resultsmay be adversely impacted.**          *Thegrowth of our business depends on the increased use of theInternet and wireless networks for communications, electroniccommerce and advertising.***     The growth of our business depends on the continued growth ofthe Internet and wireless networks as a medium for mediaconsumption, communications, electronic commerce andadvertising. Our business will be harmed if such usage does notcontinue to grow, particularly as a source of media informationand entertainment and as a vehicle for commerce. Our successalso depends on the efforts of third parties to develop theinfrastructure and complementary services necessary to maintainand expand the Internet and wireless networks as viablecommercial channels, and identifying additional viable revenuemodels for digital media-based businesses. We believe that otherInternet-related issues, such as security, privacy, reliability,cost, speed, ease of use and access, quality of service, andnecessary increases in bandwidth availability and access on anaffordable basis, remain largely unresolved and may affect theamount and type of business that is conducted over such mediums,and may adversely affect our ability to sell our services andultimately impact our business results and prospects.     If usage of the Internet and wireless networks grows, therespective infrastructure may not be able to support the demandsplaced on them by such growth, specifically the demands ofdelivering high-quality media content. As a result, theperformance and reliability of such mediums may decline. Inaddition, the Internet and wireless networks have experiencedinterruptions in service as a result of outages, system attacksand other delays occurring throughout the relevant networkinfrastructure. If these outages, attacks or delays occurfrequently or on a broad scale in the future, overall usage, aswell as the usage of our services could grow more slowly ordecline.**          *Ifbroadband technologies do not become widely available or widelyadopted, our online media distribution services may not achievebroad market acceptance, and our business may be harmed.***     We believe that increased Internet use and especially theincreased use of media over the Internet may depend on theavailability of greater bandwidth or data transmission speeds(also known as broadband transmission). If broadbandtechnologies do not become widely available or widely adopted,our online media distribution services may not achieve broadmarket acceptance and our business and prospects could beharmed. Congestion over the Internet and data loss may interruptaudio and video streams, resulting in unsatisfying userexperiences. The success of digital media distribution over theInternet depends on the continued rollout of broadband access toconsumers on an affordable basis. To date, we believe thatbroadband technologies have been adopted at a slower rate thanexpected, which we believe has delayed
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broader-based adoption of the Internet as a media distributionmedium. Our business and prospects may be harmed if the rate ofadoption does not increase.**          *Governmentregulation could adversely affect our business.***     We are not currently subject to direct regulation by anygovernmental agency, other than laws and regulations generallyapplicable to businesses. Export and import controls, includingcontrols on the use of encryption technologies, may apply to ourservices both in the U.S. and in Europe. In general, oure-commerce services are also regulated by laws and regulationscovering copyright, privacy and data protection and consumerrights. Changes in these laws and regulations could result inuncertainty and potentially adversely affect our business.**          *Wemay be subject to market risk and legal liability in connectionwith the data collection capabilities of our services.***     Many of our services leverage interactive applications that bytheir very nature require communication between a client andserver to operate. To provide better consumer experiences and tooperate effectively, our services send information to servers.Many of the services we provide also require that a user providecertain information to us. We post an extensive privacy policyconcerning the collection, use and disclosure of user datainvolved in interactions between our client and server products.Any failure by us to comply with our posted privacy policy andexisting or new legislation regarding privacy issues couldimpact the market for our services, subject us to litigation andharm our business.**     *Risks Related to Our CommonStock*****          *Ourfuture capital-raising activities could involve the issuance ofequity securities, which would dilute your investment and couldresult in a decline in the trading price of our commonstock.***     We may sell securities in the public or private equity marketsif and when conditions are favorable, even if we do not have animmediate need for additional capital at that time. Raisingfunds through the issuance of equity securities will dilute theownership of our existing stockholders. Furthermore, we mayenter into financing transactions at prices that represent asubstantial discount to the market price of our common stock. Anegative reaction by investors and securities analysts to anydiscounted sale of our equity securities could result in adecline in the trading price of our common stock.**          *Someprovisions of our amended and restated certificate ofincorporation and amended bylaws and of Delaware law may detertakeover attempts, which may limit the opportunity of ourstockholders to sell their shares at a favorable price.***     Some of the provisions of our amended and restated certificateof incorporation and amended bylaws could make it more difficultfor a third party to acquire us, even if doing so might bebeneficial to our stockholders by providing them with theopportunity to sell their shares possibly at a premium over thethen market price.     For example, our board of directors is divided into threeclasses. At each annual meeting of stockholders, the terms ofapproximately one-third of the directors will expire, and newdirectors will be elected to serve for three years. It will takeat least two annual meetings to effect a change in control ofour board of directors because a majority of the directorscannot be elected at a single meeting, which may discouragehostile takeover bids.     In addition, our amended and restated certificate ofincorporation authorizes the board of directors to issue up to5,000,000 shares of preferred stock. The preferred stock may beissued in one or more series, the terms of which may bedetermined at the time of issuance by our board of directorswithout further action by the stockholders. These terms mayinclude voting rights including the right to vote as a series onparticular matters, preferences as to dividends and liquidation,conversion rights, redemption rights and sinking fundprovisions. No shares of preferred stock are currentlyoutstanding and we have no present
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plans for the issuance of any preferred stock. The issuance ofany preferred stock, however, could diminish the rights ofholders of our common stock, and therefore could reduce thevalue of our common stock. In addition, specific rights grantedto future holders of preferred stock could be used to restrictour ability to merge with, or sell assets to, a third party. Theability of our board of directors to issue preferred stock couldmake it more difficult, delay, discourage, prevent or make itmore costly to acquire or effect a change in control, therebypreserving the current stockholders’ control.     Our amended bylaws contain provisions that require stockholdersto act only at a duly-called meeting and make it difficult forany person other than management to introduce business at aduly-called meeting by requiring such other person to followcertain notice procedures.     Finally, we are also subject to Section 203 of the DelawareGeneral Corporation Law which, subject to certain exceptions,prohibits a Delaware corporation from engaging in any businesscombination with any interested stockholder for a period ofthree years following the date that the stockholder became aninterested stockholder. The preceding provisions of ourcertificate of incorporation and bylaws, as well asSection 203 of the Delaware General Corporation Law, coulddiscourage potential acquisition proposals, delay or prevent achange of control and prevent changes in our management, even ifsuch things would be in the best interests of our stockholders.**          *Securitiesanalysts may not continue to cover our common stock or may issuenegative reports, and this may have a negative impact on ourcommon stock’s market price.***     There is no guarantee that securities analysts will continue tocover our common stock. If securities analysts do not cover ourcommon stock, the lack of research coverage may adversely affectour common stock’s market price. The trading market for ourcommon stock relies in part on the research and reports thatindustry or financial analysts publish about our business or us.If one or more of the analysts who cover us downgrades ourstock, our stock price may decline rapidly. If one or more ofthese analysts ceases coverage of our company, we could losevisibility in the market, which in turn could cause our stockprice to decline. In addition, recently adopted rules mandatedby the Sarbanes-Oxley Act of 2002, and a global settlementreached between the SEC, other regulatory analysts and a numberof investment banks in April 2003, may lead to a number offundamental changes in how analysts are reviewed andcompensated. In particular, many investment banking firms willnow be required to contract with independent financial analystsfor their stock research. It may be difficult for companies withsmaller market capitalizations, such as our company, to attractindependent financial analysts that will cover our common stock,which could have a negative effect on our market price.**          *Marketfluctuations and volatility could cause the trading price of ourcommon stock to decline and limit our ability to raisecapital.***     Our common stock trades on the Nasdaq Capital Market. Our commonstock has experienced extreme price and volume fluctuations todate. To illustrate, since January 1, 2003, the highest bidprice for our common stock was $3.48, while the lowest bid pricewas $0.18. In the future, the market price and trading volume ofour common stock could be subject to significant fluctuationsdue to general market conditions and in response toquarter-to-quarter variations in: •     Our anticipated or actual operating results;  •     Developments concerning our technologies and market offerings;  •     Technological innovations or setbacks by us or our competitors;  •     Conditions in the digital media and Internet markets;  •     Announcements of merger or acquisition transactions; and  •     Other events or factors and general economic and market    conditions.
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     In the past, securities class action litigation has been broughtagainst companies that experienced volatility in the tradingprice of their securities. Market fluctuations in the price ofour common stock could also adversely affect our ability to sellequity securities at a price we deem appropriate.**          *Futuresales of our common stock, or the perception that future salescould occur, may adversely affect our common stock price.***     If a large number of shares of our common stock are sold in theopen market, or if there is a perception that such sales couldoccur, the trading price of our common stock could declinematerially. In addition, the sale of these shares, orpossibility of such sale, could impair our ability to raisecapital through the sale of additional shares of common stock.     We are obligated to file a registration statement covering theresale of 28,875,000 shares of our common stock issued andissuable upon exercise of warrants issued to investors in ourFebruary 2006 private placement transaction. We are alsorequired to file an amendment to an existing registrationstatement covering the resale up to an additional 6,444,685shares issued and issuable upon exercise of outstanding optionsand warrants.     Sales of shares pursuant to exercisable options and warrantscould also lead to subsequent sales of the shares in the publicmarket. These sales, together with sales of shares by theselling stockholders, could depress the market price of ourstock by creating an excess in supply of shares for sale.Availability of these shares for sale in the public market couldalso impair our ability to raise capital by selling equitysecurities.**          *Ourcommon stock could be delisted from the Nasdaq Capital Market ifour stock price continues to trade below $1.00 per share.***     On July 7, 2005, we received a notice from The Nasdaq StockMarket that Loudeye’s common stock is subject to delistingfrom the Nasdaq Capital Market as a result of failure to complywith the $1.00 per share bid price requirement for 30consecutive days as required by Nasdaq MarketplaceRule 4310(c)(4). In the notice, Nasdaq informed us that wewill be provided a grace period of 180 calendar days, or untilJanuary 3, 2006, to regain compliance.     On January 4, 2006, we received a further notice fromNasdaq noting that we had not regained compliance with theminimum bid price rule as of January 3, 2006. However, theNasdaq notice also stated that as of January 3, 2006,Loudeye met all the initial inclusion criteria in NasdaqMarketplace Rule 4310(c) (except for the bid price). As aresult, we have been provided an additional 180 daycalendar compliance period, or until July 3, 2006, toregain compliance with Nasdaq minimum bid price requirements.According to the Nasdaq notice, if at anytime beforeJuly 3, 2006, the bid price of Loudeye’s common stockcloses at $1.00 per share or more for 10 consecutive days, theNasdaq staff will provide us written notification that Loudeyehas regained compliance with the Rule.     Delisting from the Nasdaq Capital Market could have an adverseeffect on our business and on the trading of our common stock.In order to maintain compliance with Nasdaq Capital listingstandards, we may consider several strategies. For example, atour 2005 annual meeting, Loudeye’s stockholders approved anamendment to Loudeye’s Certificate of Incorporation toeffect a reverse stock split of Loudeye’s authorized andissued and outstanding Common Stock at ratios of one-for-two,one-for-three, one-for-four, one-for-five, one-for-six,one-for-seven, one-for-eight, one-for-nine or one-for-ten. Theboard of directors may elect to affect a reverse stock split atany one of these ratios at any time before the 2006 annualmeeting of Loudeye’s stockholders. In February 2006,Loudeye and investors in a private placement transaction enteredinto a subscription agreement which contains a covenant byLoudeye that it will maintain its listing on the Nasdaq CapitalMarket. We cannot predict what effect a reverse stock splitwould have on the market price of our common stock or ourability to maintain compliance with the listing standards of theNasdaq Capital Market. If a delisting of our common stock wereto occur, our common stock would trade on the OTCBulletin Board or in the “pink sheets” maintainedby the National
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Quotation Bureau, Inc. Such alternatives are generallyconsidered to be less efficient markets, and our stock price, aswell as the liquidity of our common stock, may be adverselyimpacted as a result.**          *Wemay implement a reverse stock split in order to regaincompliance with Nasdaq listing requirements. If our stock pricedrops following a reverse stock split, we may owe amounts toinvestors in our February 2006 private placement transaction,which we may elect to satisfy by issuing additional shares ofour common stock.***     If we have not regained compliance with Nasdaq minimum bid pricerequirements by July 3, 2006 (the end of our current graceperiod), we expect to implement a reverse stock split to theextent necessary to regain compliance with Nasdaq minimum bidprice requirements. The transaction documents relating toLoudeye’s February 2006 private placement provide that ifLoudeye implements a reverse stock split within six months ofthe closing of the private placement and the volume weightedaverage trading price of Loudeye’s common stock on theNasdaq Capital Market for the twenty trading days immediatelyfollowing the date the effectiveness of such split is announcedis less than the lesser of $0.50 or the closing price ofLoudeye’s common stock on the Nasdaq Capital Market on thedate of the announcement of the effectiveness of such stocksplit is announced, then Loudeye will be required to pay anamount in cash or stock, at Loudeye’s election, to theinvestors in the private placement in the amounts describedbelow. The amount of any such payment to an investor will not inany event exceed ten percent (10%) of the aggregate purchaseprice paid by such investor in the private placement. Subject tosuch limitation, if Loudeye elects to make such payment (if any)in cash, the amount to be paid to an investor would equal thenumber of shares of common stock purchased by such investor inthe private placement that are then held by that investormultiplied by the lesser of (a) the difference between theclosing price of Loudeye’s common stock on the NasdaqCapital Market on the date of the announcement of theeffectiveness of such split and the volume weighted averagetrading price of Loudeye’s common stock on the NasdaqCapital Market for the twenty trading days immediately followingthe date the effectiveness of such split is announced, or (b)$0.50 less the average trading price of Loudeye’s commonstock on the Nasdaq Capital Market for the twenty trading daysimmediately following the date the effectiveness of such splitis announced. If Loudeye elects to make such payment (if any) inshares of Loudeye common stock, the amount of shares to beissued to an investor (the “Additional Shares”) wouldequal the cash amount to be paid to such investor describedabove divided by the volume weighted average trading price ofLoudeye’s common stock on the Nasdaq Capital Market for thetwenty trading days immediately following the date theeffectiveness of such split is announced. Any such issuance ofAdditional Shares would be subject to the approval ofLoudeye’s stockholders to the extent necessary to complywith the rules of the Nasdaq Capital Market.     If we elect to make any such payment in cash, our alreadylimited cash resources will be further reduced. If we elect tomake any such payment by issuing additional shares of Loudeyecommon stock to investors in our February 2006 private placementtransaction, our existing stockholders will be diluted.**          *Thelarge number of holders and lack of concentration of ownershipof our common stock may make it difficult for us to reach aquorum or obtain an affirmative vote of our stockholders atfuture stockholder meetings.***     Our stock is held in a large number of individual accounts withno one registered holder or group of registered holdersindividually accounting for more than 5% of our outstandingcommon stock. As a result, it may be difficult for us to reach aquorum or obtain an affirmative vote of a majority of ourstockholders where either of those thresholds are measured basedon the total number of shares of our common stock outstanding.Difficulty in obtaining a stockholder vote could impact ourability to complete any financing or strategic transactionrequiring stockholder approval or effect basic corporategovernance changes, such as an increase in the authorized numberof shares of our common stock.
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**          *Asa result of accounting regulations which will become applicableto us on January 1, 2006 requiring companies to expensestock options, our expenses will increase and our stock pricemay decline.***     A number of publicly-traded companies have recently announcedthat they will begin expensing stock option grants to employees.In addition, the Financial Accounting Standards Board(FASB) has adopted rule changes with an effective datebeginning January 1, 2006 requiring expensing of stockoptions. Currently, we include such expenses on a pro formabasis in the notes to our annual financial statements inaccordance with accounting principles generally accepted in theUnited States, but do not include stock option expense foremployee options in our reported financial statements. Thischange in accounting standards will require us to expense stockoptions, and as a result our reported expenses may increasesignificantly.**          *Recentlyenacted and proposed changes in securities laws and regulationshave increased and will continue to increase our costs.***     The Sarbanes-Oxley Act of 2002 along with other recent andproposed rules from the SEC and Nasdaq has required changes inour corporate governance, public disclosure and compliancepractices. Many of these new requirements have increased andwill continue to increase our legal and financial compliancecosts, and make some corporate actions more difficult. Thesedevelopments could make it more difficult and more expensive forus to obtain director and officer liability insurance, and wemay be required to accept reduced coverage or incursubstantially higher costs to obtain coverage. Thesedevelopments also could make it more difficult for us to attractand retain qualified executive officers and members of our boardof directors.**Item 1B. Unresolved Staff Comments.**     None.**Item 2.     Properties.**     Following is a summary of our properties and related leaseobligations. We do not own any real property. We believe ourEuropean and U.S. facilities are sufficient to support ouroperational, research and development and administrative needsunder our current operating plan.**Europe**     *72 Prince Street, Bristol, U.K.* OD2, our Europeansubsidiary, has headquarters situated in Bristol where it leasesapproximately 8,000 square feet of office space. The currentannual rent is approximately £116,000 (approximately$202,339 based on exchange rates on March 1, 2006) with thelease term expiring June 2009, with an option for OD2 toterminate the lease in June 2007.     *9 Argyle Street, Fourth Floor, London, U.K.* OD2 leasesapproximately 1,100 square feet for a sales, businessdevelopment, label relations and legal affairs office at anannual rent of approximately £34,500 (approximately $60,178based on exchange rates on March 1, 2006). The leaseexpires in October 2010.     *City Reach 6, Greenwich View Place, Millharbour, London,U.K.* OD2 leases approximately 65 square meters in a serverfacility which houses substantially all of the digital mediacontent and data supporting OD2’s operations. Annual rentat the facility is approximately £71,000 (approximately$123,845 based on exchange rates on March 1, 2006). Thelease is on a month-to-month basis.     *290 Boulevard Voltaire, 75011 Paris, France.* OD2 leasesapproximately 170 square meters for a sales office at an annualrent of approximately€22,000(approximately $26,120 based on exchange rates on March 1,2006). The lease expires in March 2010, with an option toterminate the lease in March 2007.     *Stamstrasse 90, 50823 Cologne, Germany.*OD2 leasesapproximately 120 square meters for a sales office at an annualrent of approximately€11,000(approximately $13,060 based on exchange rates on
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March 1, 2006). The lease is on a month-to-month basis,provided that six month advance notice of termination must beprovided by either the landlord or OD2 to terminate the lease.     *Via B. Luini n. 12, Milan, Italy.* OD2 leasesapproximately 75 square meters for a sales office at an annualrent of approximately€29,500(approximately $35,030 based on exchange rates on March 1,2006). The lease expires June 30, 2011, with an option forOD2 to terminate the lease on three months advance notice.**United States**     *1130 Rainier Avenue S, Seattle, WA.* Our corporateheadquarters and a majority of our digital media contentservices are located in Seattle, WA where we lease approximately41,800 square feet. On October 5, 2005, Loudeye and ourwholly-owned subsidiary Loudeye Enterprise Communications, Inc.entered into a First Amendment of Lease with 1130 Rainier LLC asLessor. This agreement amended the Lease Agreement datedDecember 23, 2003 in the following manner: 1.    The lease term was extended for a period of two (2) years    ending December 31, 2007. We retain an option to terminate    the Lease as of December 31, 2006, upon giving Lessor    written notice of its exercise of the option on or before    June 30, 2006. In addition, the landlord may terminate the    lease on 150 days advance notice.     2.     The annual basic rent payable byus under the lease was revised as follows         **Year** **Annual Rent** **Monthly Rent**         2006 $939,443  $78,269     2007 $960,319  $80,027      3.     We paid a security deposit inJanuary 2006, totaling $320,100. This security deposit will beapplied to the final four months of rent that become due priorto the scheduled termination of the extended term of the Leasein December 2007.     4.     We have one (1) option toextend the lease for the premises then leased for a period ofthree (3) years by providing Lessor with our writtennotice of exercise of the option no later than March 31,2007.     *24 West 40th Street, New York, NY.* In December 2004, oursubsidiary Overpeer Inc. entered into a lease for approximately5,140 square feet, with a term through September 2015. Under thelease, we were required to post an approximate $175,000 securitydeposit in the form of a letter of credit. FollowingOverpeer’s cessation of operations in December 2005, thelandlord drew down the letter of credit in full and terminatedthe lease. In February 2006, Overpeer, Loudeye and the landlordreached a settlement pursuant to which the Landlord releasedOverpeer and Loudeye from any future obligations with respect tothe lease in exchange for the landlord retaining the approximate$175,000 security deposit and certain Loudeye-owned furniturewith a net book value of approximately $80,000.**Item 3.     LegalProceedings.**     *Altnet Matter.*On September 10, 2004, Loudeye wasserved in a patent infringement lawsuit brought by Altnet, Inc.,and others against Loudeye, its Overpeer subsidiary, MarcMorgenstern, one of Loudeye’s executive officers, theRecording Industry Association of America and others. Thecomplaint, filed in federal district court in Los Angeles,California, involves two patents that appear to cover fileidentifiers for use in accessing, identifying and/or sharingfiles over peer-to-peer networks. The complaint alleges that theanti-piracy services previously offered by Loudeye’sOverpeer subsidiary infringed the patents in question. Thecomplaint does not state a specific damage amount. OnNovember 17, 2004, the court dismissed the complaintagainst Mr. Morgenstern with prejudice and dismissed thecomplaint against Loudeye and Overpeer. The plaintiffs filed anamended complaint on November 24, 2004 against Loudeye,Overpeer and other entity defendants. Discovery in this mattercommenced in January 2005 and is ongoing. Loudeye intends tofile a motion for summary judgment and to otherwise defenditself vigorously against the
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allegations contained in the amended complaint. The court hasset a trial date for June 2006. At present, Loudeye cannotassess the probability of an unfavorable outcome or themagnitude of any such outcome. However, if this case proceeds totrial against Loudeye, we anticipate we will incur significantlegal fees and expenses in our defense.     *Savvis Communications Corp.* On December 15, 2005,Savvis Communications Corp. filed a complaint in Superior Courtin Santa Clara County, California, against Overpeer and Loudeyerelating to a May 2002 Master Services Agreement between Savvisand Overpeer for collocation and bandwidth services (the“Overpeer-Savvis Agreement”). The complaint allegesOverpeer breached the Overpeer-Savvis Agreement for non-payment.The complaint also contains alter ego allegations againstLoudeye. The complaint seeks damages of $1.6 millionconsisting of $950,000 of allegedly unpaid invoices for servicesand approximately $600,000 in alleged early termination fees.The court has granted Savvis a writ of attachment overOverpeer’s assets located in the state of California. InFebruary 2006, Overpeer and Loudeye filed a joint motion tocompel arbitration of the dispute under the terms of theagreement between Savvis and Overpeer. The motion is scheduledto be heard on March 30, 2006. Loudeye assesses theprobability of a judgment against Overpeer relating to the$950,000 in unpaid invoices as high. Loudeye is not a party tothe Overpeer-Savvis Agreement. Loudeye intends to defend itselfvigorously concerning the alter ego claims brought by Savvis.However, Loudeye cannot assess at this time the probability ofan unfavorable outcome with respect to the claims broughtagainst Loudeye.     *IPO Class Action.*Between January 11 andDecember 6, 2001, class action complaints were filed in theUnited States District Court for the Southern District of NewYork. These actions were filed against 310 issuers (includingLoudeye), 55 underwriters and numerous individuals includingcertain of Loudeye’s former officers and directors. Thevarious complaints were filed purportedly on behalf of a classof persons who purchased Loudeye’s common stock during thetime period between March 15 and December 6, 2000. Thecomplaints allege violations of the Securities Act of 1933 andthe Securities Exchange Act of 1934, primarily based onallegations that Loudeye’s underwriters receivedundisclosed compensation in connection with our initial publicoffering and that the underwriters entered into undisclosedarrangements with some investors that were designed to distortand/or inflate the market price for Loudeye’s common stockin the aftermarket. These actions were consolidated forpre-trial purposes. No specific amount of damages has beenclaimed. Loudeye and the individual defendants have demanded tobe indemnified by underwriter defendants pursuant to theunderwriting agreement entered into at the time of the initialpublic offering. Presently all claims against the formerofficers have been withdrawn without prejudice. The Courtsuggested that the parties select six test cases to determineclass-action eligibility. Loudeye is not a party to any of thetest cases.     In March 2005, a proposed settlement among plaintiffs, issuerdefendants, issuer officers and directors named as defendants,and issuers’ insurance companies, was approved by theCourt. This proposed settlement provides, among other matters,that: •     issuer defendants and related individual defendants will be    released from the litigation without any liability other than    certain expenses incurred to date in connection with the    litigation;  •     issuer defendants’ insurers will guarantee    $1.0 billion in recoveries by plaintiff class members;  •     issuer defendants will assign certain claims against underwriter    defendants to the plaintiff class members; and  •     issuer defendants will have the opportunity to recover certain    litigation-related expenses if plaintiffs recover more than    $5.0 billion from underwriter defendants.     A fairness hearing on the proposed settlement is scheduled forApril 2006. Our board of directors approved the proposedsettlement in August 2003 and approved the final settlementterms in March 2005. Management does not anticipate that we willbe required to pay any amounts under this settlement; however,Loudeye can give no assurance that the underwriter defendantswill not bring a claim for indemnification against us under theterms of the underwriting agreement relating to Loudeye’sinitial public offering.
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     *Tennessee Pacific Group.* In October 2005, Loudeye wasserved in a breach of contract lawsuit brought by TennesseePacific Group, LLC, one of our customers for encoding services.In November 2005, Loudeye and Tennessee Pacific reached asettlement of the dispute pursuant to which Loudeye resumedon-going encoded content deliveries and paid Tennessee Pacific aone-time settlement amount of $25,000. The lawsuit was dismissedwith prejudice in December 2005.     *SPEDIDAM.* On March 6, 2006, On Demand DistributionSAS (France) (“OD2 France”), one of our wholly-ownedsubsidiaries, received a complaint filed by SPEDIDAM allegingdamages for the reproduction of performances of backgroundartists and performers on its servers and the making availableof such performances in the form of downloadable files for sale.SPEDIDAM is an organization representing artists and performersin France. Simultaneously, SPEDIDAM filed suit against otherleading digital music store operators in France including AppleComputer’s iTunes services, FNAC Music, eCompil, SonyConnect and Virgin Mega. The complaint alleges that OD2 Francedid not have prior authorization of SPEDIDAM or the relevantartists and performers for such reproduction and distribution.The complaint seeks damages of approximately€565,000(approximately $670,000 based on December 31, 2005 exchangerates). OD2 France intends to defend itself vigorouslyconcerning the claims brought by SPEDIDAM in this matter howeverOD2 France cannot at this time assess the probability or themagnitude of an unfavorable outcome, if any.     *Other.* Loudeye is involved from time to time in variousother claims and lawsuits incidental to the ordinary course ofour operations, including contract and lease disputes andcomplaints alleging employment discrimination. While the resultsof these matters cannot be predicted with certainty, Loudeyebelieves that the outcome of any such pending claims orproceedings individually or in the aggregate, will not have amaterial adverse effect upon Loudeye’s business orfinancial condition, cash flows, or results of operations.**Item 4.     Submission ofMatters to a Vote of Security Holders.**     None.**PART II****Item 5.****Market for Registrant’s Common Equity, Related    Stockholder Matters and Issuer Purchases of Equity    Securities.****Market Information**     Our common stock trades on The Nasdaq Capital Market under thesymbol LOUD. The following table sets forth, for the periodsindicated, the high and low sales prices for our common stock asreported on The Nasdaq Capital Market.           **High** **Low**     **Year Ended December 31, 2005**            First Quarter 2005 $2.13  $1.34     Second Quarter 2005  1.50   0.67     Third Quarter 2005  1.14   0.69     Fourth Quarter 2005  0.91   0.37 **Year Ended December 31, 2004**            First Quarter 2004 $2.57  $1.81     Second Quarter 2004  2.19   1.23     Third Quarter 2004  1.69   0.78     Fourth Quarter 2004  3.02   0.90 
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     On July 7, 2005, we received a notice from The Nasdaq StockMarket (“Nasdaq”) that our common stock is subject todelisting from the Nasdaq Capital Market as a result of failureto comply with the $1.00 per share bid price requirement for 30consecutive days as required by Nasdaq MarketplaceRule 4310(c)(4) (the “Rule”). In the notice,Nasdaq informed us that we would be provided a grace period of180 calendar days, or until January 3, 2006, to regaincompliance. Nasdaq also informed us in the notice that we mayqualify for an additional 180 day grace period if, as ofJanuary 3, 2006, Loudeye were in compliance with the otherinitial inclusion criteria of the Nasdaq Capital Market (otherthan the minimum bid price requirement).     On January 4, 2006, we received a further notice fromNasdaq noting that we had not regained compliance with theminimum bid price rule as of January 3, 2006. However, theNasdaq notice also stated that as of January 3, 2006,Loudeye met all the initial inclusion criteria in NasdaqMarketplace Rule 4310(c) (except for the bid price). As aresult, we have been provided an additional 180 daycalendar compliance period, or until July 3, 2006, toregain compliance with Nasdaq minimum bid price requirements.According to the Nasdaq notice, if at anytime beforeJuly 3, 2006, the bid price of Loudeye’s common stockcloses at $1.00 per share or more for 10 consecutive days, theNasdaq staff will provide us written notification that Loudeyehas regained compliance with the Rule.     Loudeye’s board of directors and stockholders have approvedan amendment to Loudeye’s Certificate of Incorporation toeffect a reverse stock split of Loudeye’s authorized andissued and outstanding Common Stock at ratios of one-for-two,one-for-three, one-for-four, one-for-five, one-for-six,one-for-seven, one-for-eight, one-for-nine or one-for-ten. Theboard of directors may elect to effect a reverse stock split atany one of these ratios at any time before the 2006 annualmeeting of Loudeye’s stockholders.     In February 2006, Loudeye and investors in a private placementtransaction entered into a subscription agreement which containsa covenant by Loudeye that it will maintain its listing on theNasdaq Capital Market. See “Recent Sales of UnregisteredSecurities” on page 37 for further informationregarding this transaction.**Holders**     As of March 1, 2006, there were 423 holders of record ofour common stock. Because many of the outstanding shares of ourcommon stock are held by brokers and other institutions onbehalf of the beneficial stockholders, we are unable to estimatethe total number of beneficial stockholders represented by therecord holders.**Dividends**     We have invested in the growth of our business and have incurrednet losses from inception. We expect to continue to invest ingrowing our business for the foreseeable future and may incurnet losses in future periods. As a result, we have not paid anycash dividends to date and do not intend to pay any cashdividends in the foreseeable future.
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**Description of Equity Compensation Plans**     The table below sets forth certain information as ofDecember 31, 2005 regarding the shares of our common stockavailable for grant or granted under stock option plans that(i) were approved by Loudeye’s stockholders, and(ii) were not approved by Loudeye’s stockholders.**Equity Compensation Plan Information**                **Number of**      **Securities to be** **Weighted-** **Number of Securities**  **Issued Upon** **Average** **Remaining Available for**  **Exercise of** **Exercise Price** **Future Issuance Under**  **Outstanding** **of Outstanding** **Equity Compensation Plans**  **Options,** **Options,** **(Excluding Outstanding**  **Warrants and** **Warrants and** **Options, Warrants and**  **Rights** **Rights** **Rights)(1)**           Equity compensation plans approved by security holders  12,318,756  $1.12   11,667,589     Equity compensation plans not approved by security holders  221,573(2) $0.001   —                Total  12,540,329  $1.10   11,667,589  (1)     Excludes securities reflected in the first column of the table. (2)     Represents options to purchase common stock issued to former OD2    shareholders in connection with our acquisition of OD2 in June    2004.**Stock Plans*****Incentive Award Plans***     Under our 2005 Incentive Award Plan, the board and itscompensation committee as its designee may grant to employees,consultants, and directors of Loudeye and its subsidiariesincentive and nonstatutory options to purchase our common stock,restricted stock awards to purchase shares of Loudeye commonstock that are subject to repurchase and are nontransferableuntil such shares have vested, and other forms of equitycompensation awards. In addition, Loudeye maintains a 2000 StockOption Plan, a 1998 Stock Option Plan, an Employee Stock OptionPlan and a Director Stock Option Plan.     At December 31, 2005, options to purchase up to 12,318,756shares of our common stock were outstanding under our variousstock option plans and restricted stock awards for an aggregateof 1,450,000 shares of our common stock were outstanding underour 2005 Incentive Award Plan. In addition, at December 31,2005, an aggregate of 11,667,589 shares were reserved forissuance under our 2005 Incentive Award Plan.     Our 2005 Incentive Award Plan provides for an automatic annualincrease on the first day of each of fiscal year beginning in2006 equal to the lesser of 5.0 million shares or 2% of ouroutstanding common stock on the last day of the immediatelypreceding fiscal year or a lesser number of shares as our boarddetermines. As a result, on January 1, 2006, the number ofshares reserved under our 2005 Incentive Award Planautomatically increased by 2,307,361 million shares of ourcommon stock. Option grants under the plans have terms of tenyears and generally vest over three to four and one half years.     An aggregate of 221,573 shares of common stock are issuable uponthe exercise of stock options held by former OD2 shareholders.These stock options were initially issued under the On DemandDistribution Limited Employee Share Option Plan and were assumedby Loudeye as part of our acquisition of OD2. All of the optionsare immediately exercisable at an exercise price of $0.001 pershare. The option grants have terms of ten years from the dateof original grant.
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***2000 Employee Stock Purchase Plan***     In December 1999, the board approved the creation of the 2000Employee Stock Purchase Plan (ESPP). At December 31, 2004,the total number of shares reserved for issuance was 1,375,175,and a total of 427,120 shares have been issued under the ESPP.On January 27, 2005, our board of directors terminated theESPP. As a result, the 948,055 shares previously reserved forissuance under the ESPP have reverted to our authorized butunissued capital stock.**Recent Sales of Unregistered Securities**     *February 2006 private placement transaction.*OnFebruary 20, 2006, Loudeye entered into a SubscriptionAgreement with a limited number of institutional investorspursuant to which Loudeye agreed to sell and issue to suchinvestors 16,500,000 shares of its common stock, together withwarrants to purchase 12,375,000 shares of common stock at anexercise price of $0.68 per share, for an aggregate purchaseprice of $8.25 million. The warrants are not exercisableuntil six months after the February 22, 2006 closing dateand are then exercisable until the fifth anniversary of theclosing date. We also granted the investors a one year right topurchase 30% of any securities sold by us in future financings,subject to exceptions. The transaction resulted in net proceedsto us of approximately $7.6 million.     The transaction documents provide that if we implement a reversestock split within six months of the closing of the privateplacement and the volume weighted average trading price of ourcommon stock on the Nasdaq Capital Market for the twenty tradingdays immediately following the date the effectiveness of suchsplit is announced is less than the lesser of $0.50 or theclosing price of our common stock on the Nasdaq Capital Marketon the date of the announcement of the effectiveness of suchstock split is announced, then we will be required to pay anamount in cash or stock, at our election, to the investors inthe private placement in the amounts described below. The amountof any such payment to an investor will not in any event exceedten percent (10%) of the aggregate purchase price paid by suchinvestor in the private placement. Subject to such limitation,if we elect to make such payment (if any) in cash, the amount tobe paid to an investor would equal the number of shares ofcommon stock purchased by such investor in the private placementthat are then held by that investor multiplied by the lesser of(a) the difference between the closing price of our commonstock on the Nasdaq Capital Market on the date of theannouncement of the effectiveness of such split and the volumeweighted average trading price of Loudeye’s common stock onthe Nasdaq Capital Market for the twenty trading daysimmediately following the date the effectiveness of such splitis announced, or (b) $0.50 less the average trading price ofLoudeye’s common stock on the Nasdaq Capital Market for thetwenty trading days immediately following the date theeffectiveness of such split is announced. If we elect to makesuch payment (if any) in shares of Loudeye common stock, theamount of shares to be issued to an investor (the“Additional Shares”) would equal the cash amount to bepaid to such investor described above divided by the volumeweighted average trading price of our common stock on the NasdaqCapital Market for the twenty trading days immediately followingthe date the effectiveness of such split is announced. Any suchissuance of Additional Shares would be subject to the approvalof our stockholders to the extent necessary to comply with therules of the Nasdaq Capital Market.     The offering was made only to accredited investors, as such termis defined in Regulation D under the Securities Act of1933, as amended. The shares of common stock and the warrants(and Additional Shares, if any) to be issued to the investorshave not been registered under the Securities Act of 1933, asamended, or any state securities laws. We are relying on theexemption from the registration requirements of the SecuritiesAct of 1933, as amended, by virtue of Section 4(2) thereofand Rule 506 of Regulation D promulgated thereunder.We have agreed to file a registration statement covering theresale of the shares of common stock and the shares of commonstock underlying the warrants (and of Additional Shares, if any).
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**Item 6.****Selected Financial Data.**     The following selected financial data should be read inconjunction with “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and ourconsolidated financial statements and the notes thereto includedelsewhere in this annual report. The selected consolidatedstatements of operations data for the years endedDecember 31, 2005, 2004, and 2003 and balance sheet data asof December 31, 2005 and 2004 have been derived from ouraudited financial statements appearing elsewhere in this annualreport. The selected consolidated statements of operations datafor the years ended December 31, 2002 and 2001 and selectedconsolidated balance sheet data as of December 31, 2002 and2001 have been derived from our audited consolidated financialstatements that are not included in this annual report. Theselected consolidated balance sheet data and selectedconsolidated statements of operations data for the year endedDecember 31, 2001 have been derived from consolidatedfinancial statements that were audited by independent auditorswho have ceased operations. The historical results are notnecessarily indicative of results to be expected for any futureperiod. During the preparation of our financial statements forthe year ended December 31, 2004, we made revisions ofclassification with regard to expenses incurred during the yearsended December 31, 2003 and 2002. Such revisions ofclassification had no impact on net loss, stockholders’equity or cash flows as previously reported. These revisionsrelated to the following: • *Regent Fees.* We revised our classification of $878,000    relating to service fees paid to Regent Pacific Management    Corporation (Regent) during the year ended December 31,    2003, from special charges — other to general and    administrative expense in the current presentation as we    determined that these expenses were more appropriately    classified as general and administrative.  • *Amortization of Intangible Assets.* We revised our    classification of amortization of acquired technology and    capitalized software costs totaling approximately $269,000 in    2003 and $1.3 million in 2002 from operating    expenses — amortization of intangibles to cost of    revenue in the current presentation as we determined that these    expenses were more appropriately classified as cost of revenue.  • *Impairment of Intangible Assets.* We revised our    classification of impairment charges related to acquired    technology and capitalized software costs totaling approximately    $601,000 in 2003 and $694,000 in 2002 from operating    expenses — special charges — other to cost    of revenue in the current presentation as we determined that    these charges were more appropriately classified as cost of    revenue.All amounts are presented in the table below in thousands exceptfor per share amounts.                         **Years Ended December 31,**   **Consolidated Statements of Operations Data** **2005** **2004** **2003** **2002** **2001**               REVENUE $27,041  $14,033  $11,948  $12,681  $10,388     COST OF REVENUE(2)  25,082   10,336   8,076   15,260   12,737                       Gross profit (loss)  1,959   3,697   3,872   (2,579)  (2,349)    OPERATING EXPENSES:                         Sales and marketing(2)  6,412   4,200   3,286   7,667   9,409      Research and development(2)  8,404   3,726   1,688   3,159   9,719      General and administrative(2)  13,057   10,658   8,656   11,375   11,102      Amortization of intangibles  235   92   831   1,790   8,173      Stock-based compensation(2)  250   199   1,298   (383)  359      Special charges — goodwill impairments(3)  —   —   5,307   —   9,418      Special charges — other(3)  (43)  312   1,913   6,152   27,843                       Total operating expenses  28,315   19,187   22,979   29,760   76,023                     LOSS FROM OPERATIONS  (26,356)  (15,490)  (19,107)  (32,339)  (78,372)
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                         **Years Ended December 31,**   **Consolidated Statements of Operations Data** **2005** **2004** **2003** **2002** **2001**               OTHER INCOME (EXPENSE):                         Interest income  625   377   347   1,149   3,157      Interest expense  (160)  (201)  (286)  (631)  (1,181)     Gain on sale of media restoration assets  —   156   —   —   —      Increase in fair value of common stock warrants  —   —   (248)  —   —      Other income (expense), net  313   (839)  120   659   —                       Total other income (expense)  778   (507)  (67)  1,177   1,976                     Loss from continuing operations  (25,578)  (15,997)  (19,174)  (31,162)  (76,396)    Loss from discontinued operations  (7,783)  (400)  —   —   —                     NET LOSS $(33,361) $(16,397) $(19,174) $(31,162) $(76,396)                    LOSS PER SHARE — BASIC AND DILUTED(4):                         From continuing operations $(0.24) $(0.22) $(0.39) $(0.75) $(1.84)     From discontinued operations  (0.07)  —   —   —   —                     NET LOSS PER SHARE — BASIC AND DILUTED $(0.31) $(0.22) $(0.39) $(0.75) $(1.84)                    Weighted average shares outstanding — basic and    diluted(4)  107,652   73,845   49,797   41,393   41,429                                        **at December 31,**   **Consolidated Balance Sheet Data** **2005** **2004** **2003** **2002** **2001**               Cash, cash equivalents and marketable securities $9,045  $37,994  $21,940  $11,758  $60,941     Restricted cash  1,810   2,393   316   1,500   —     Working capital  (1,895)  13,789   16,781   7,883   55,753     Total assets  69,408   103,708   27,044   29,529   80,883     Accrued acquisition consideration  —   15,924   —   1,059   3,000     Long-term obligations, less current portion  —   1,000   2,135   591   22,532     Total stockholders’ equity  49,638   66,450   17,033   20,352   49,194  (1)     Data for 2004 includes the results of On Demand Distribution    Limited, which we acquired in June 2004. Overpeer Inc., which we    acquired in March 2004, is presented as discontinued operations    in 2005 and 2004. Acquisition and disposition activity reduces    the meaningfulness of period to period comparisons based off    this and other periods. (2)     Stock-based compensation, consisting of amortization of deferred    stock-based compensation and the fair value of options issued to    non-employees for services rendered, is allocated as follows:                       **Years Ended December 31,**     **2005** **2004** **2003** **2002** **2001**               Cost of revenue $92  $117  $62  $(34) $30     Sales and marketing  (3)  49   47   (55)  50     Research and development  15   83   57   (21)  19     General and administrative  238   67   1,194   (307)  260 
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(3)     See Note 5 of Notes to Consolidated Financial Statements    for an explanation of the special charges for the years ended    December 31, 2005, 2004, and 2003. (4)     See Note 14 of Notes to Consolidated Financial Statements    for an explanation of the determination of the number of    weighted average shares used to compute net loss per share    amounts.**Item 7.*****Management’s Discussion and Analysis of Financial    Condition and Results of Operations.***     *The following discussion and analysis should be read inconjunction with the Consolidated Financial Statements and Notesthereto included elsewhere in this annual report onForm 10-K. Thisdiscussion contains certain forward-looking statements thatinvolve risks and uncertainties, such as statements of ourplans, objectives, expectations and intentions. Our actualresults could differ materially from those discussed here. Thecautionary statements made in this annual report onForm 10-K shouldbe read as being applicable to all forward-looking statementswherever they appear. Factors that could contribute to suchdifferences include those discussed in Item 1A —Risk Factors, as well as those discussed elsewhere herein. Weundertake no obligation to publicly release the result of anyrevision to these forward-looking statements that may berequired to reflect events or circumstances after the datehereof or to reflect the occurrence of unanticipated events.***Overview**     The following management’s discussion and analysis isintended to provide information necessary to understand ouraudited consolidated financial statements and highlight certainother information which, in the opinion of management, willenhance a reader’s understanding of our financialcondition, changes in financial condition and results ofoperations. In particular, the discussion is intended to providean analysis of significant trends and material changes in ourfinancial position and operating results of our business duringthe year ended December 31, 2005 as compared to the yearended December 31, 2004, and the year endedDecember 31, 2004 as compared to the year endedDecember 31, 2003. It is organized as follows: •      The section entitled “Loudeye Background” describes    our principal operational activities and summarizes significant    trends and developments in our business and in our industry.  •      “Critical Accounting Policies and Estimates” discusses    our most critical accounting policies.  •      “Recently Issued Accounting Standards” discusses new    accounting standards regarding accounting for conditional asset    retirement obligations, accounting changes and error corrections    and evaluating and recording other than temporary impairment    losses on debt and equity investments.  •      “Consolidated Results of Operations” discusses the    primary factors that are likely to contribute to significant    variability of our results of operations from period to period    and then provides a detailed narrative regarding significant    changes in our results of operations for the fourth quarter    compared to third quarter 2005, the year ended December 31,    2005 as compared to the year ended December 31, 2004, and    the year ended December 31, 2004 as compared to the year    ended December 31, 2003.  •      “Liquidity, Capital Resources and Going Concern”    discusses our liquidity and cash flow and factors that may    influence our future cash requirements including going concern    qualifications and the status of certain contractual obligations.  •      “Contractual Obligations” discusses our contractual    obligations as of December 31, 2005.  •      “Off-Balance Sheet Arrangements” discusses certain    indemnification and other obligations.     In addition, Item 7A “Quantitative and QualitativeDisclosures About Market Risk” discusses factors that couldaffect our financial results, in particular foreign exchangerate fluctuations, and Item 9A “Controls andProcedures” contains management’s assessment ofLoudeye’s internal control over financial reporting as ofDecember 31, 2005.
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**Loudeye Background**     We are a worldwide leader inbusiness-to-businessdigital media services that facilitate the distribution,promotion and sale of digital media content for media andentertainment, mobile communications, consumer products,consumer electronics, retail, and ISP customers. Our servicesenable our customers to outsource the management anddistribution of audio and video digital media content over theInternet and other electronic and wireless networks. Ourproprietary consumer-facinge-commerce services,combined with our technical infrastructure and back-endsolutions, comprise anend-to-end serviceoffering. These service offerings range from turn-key,fully-outsourced digital media distribution and promotionalservices, such as private-labeled digital media store services,including mobile music services, to digital media contentservices, such as encoding, music samples services, hosting,webcasting and Internet radio services. Our outsourced solutionscan decreasetime-to-market for ourcustomers while reducing the complexity and cost of digitalasset management and distribution compared with internallydeveloped alternatives, and they enable our customers to providebranded digital media service offerings to their users whilesupporting a variety of digital media technologies and consumerbusiness models.     The use of the Internet and wireless networks as a medium formedia distribution has continued to evolve and grow in recentyears. Traditional media and entertainment companies, such asmajor record labels, have in recent years faced significantchallenges associated with the digital distribution of music.These companies have now licensed the rights to some of theircontent for certain forms of digital distribution over theInternet and wireless networks. Consumers enjoy this content bymeans of many different types of services and offerings,including purchased downloads, paid subscriptions, prepaidcredit offerings and streaming radio. Additionally, retailersand advertisers have expanded their use of digital content inthe marketing and selling of their products and services. Assuch, traditional distribution channels for media have expandedas content owners have begun to license and distribute theircontent over the Internet and wireless networks through new andexisting retail channels, and consumers have begun to purchaseand consume content using personal computers, mobile devices andother digital devices. In addition, traditional media formatshave expanded to include a variety of digital technologies, richmedia formats and digital rights management. Despite theincreasing popularity of these licensed sources of digital mediacontent over the Internet, piracy overpeer-to-peer networksremains a continuing challenge for the digital mediadistribution industry as a whole.     During 2005, digital media continued to grow as a broad-basedtool for communications, online media promotions and thedistribution of content, particularly in the media,entertainment and corporate sectors. This growth has been drivenin large part by an increase in broadband adoption, growth inthe market for portable digital media devices and significantimprovements in streaming technologies capable of deliveringhigh quality content in smaller file sizes. A critical trend inthese technology and streaming format enhancements is a markedincrease in ease of use and effectiveness of streaming media,including, in some cases, instant access to streaming contentwithout buffering. At the same time, content owners such asmajor media companies, film studios and record labels areproviding more content in a digital format to capitalize onthese opportunities.     We continue to develop our services to address the changingdynamics of digital media distribution, promotion, consumptionand content management. Our digital media services enabledigital distribution of media over the Internet, mobile andwireless networks and other emerging technologies. We also offerrelated services that provide the primary components needed toaddress the management and delivery of digital media on behalfof our customers and content owners. Our service offerings aregrouped into the two primary categories: digital media storeservices, concentrated in Europe and around emerging mobiledistribution technologies and service offerings, and digitalmedia content services.     *Digital media store services.* Digital media storeservices include ourend-to-end digitalmusic store solution provided on a “white-labeled”basis to retailers and brands throughout the world. As abusiness-to-businessprovider, our services enable brands of varying types, includingretailers ande-tailers, mobileoperators, portals, and ISPs, to outsource all or part of theirdigital media retailing activities.
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     In February 2006 we announced a realignment of our productdevelopment, engineering, information technology and operationalresources relating to digital media store services behind ourlargest markets and customers. Our digital media store serviceoperations are now centralized at our European headquarters inBristol, United Kingdom.     We provide our customers with a highly scalable consumer-facingdigital media commerce and delivery services that include: •     hosting, publishing and managing digital media content, and    delivering such content to end consumers on behalf of our    customers;  •     support for private label user interfaces that have the look,    feel and branding of a customer’s existing commerce    platform;  •     delivery across both internet and mobile delivery protocols, and    in various forms, such as full-song download or streaming, for    both internet and mobile based applications;  •     integration to a customer’s website and mobile    applications, inventory, and account management;  •     localized end-consumer experience and content offering in over    20 countries,  •     integrated payment functionality supporting multiple end    consumer payment alternatives; and  •     digital rights management and licensing, usage reporting,    digital content royalty settlement, customer support and    publishing related services.     We expect to extend our digital media store services offeringsfrom our established base in music stores to other digitalmedia, such as music videos, as these digital media marketscontinue to develop.     A small number of customers in Europe generate a substantialmajority of our revenue from digital media store services. Thiscustomer concentration poses a significant risk to our businessand results of operation if any one or more of these customerswere to terminate or not renew their services.     We believe future growth in our digital media store servicesdepends significantly upon the growth of the mobile market fordigital content services, including music. We continue to investin our mobile music platform. The platform allowsover-the-air, search,purchase and download of music files. The service permitsdual-delivery of downloaded music directly to endconsumer’s mobile phone and personal computer. There are anumber of industry challenges that could impact the adoptionrate of mobile platforms as a leading method of digital musicpurchase, including the rate of adoption of compatible mobilehandsets, availability of high speed mobile data networks,adoption by mobile consumers of mobile data plans, any pricingdifferential (both wholesale and retail) between contentpurchased over-the-airto a mobile device and purchased by other means, development ofcontent and digital rights management standards and technologiesacceptable to content licensors, and the impact on the economicsof the mobile music business of certain issued patents.Significant growth in demand for our music store services islikely to also depend on significant growth in adoption ofWindows compatible portable music devices.     As abusiness-to-businessservice provider, our growth and success depends in large parton growth in the proliferation and expanded music market shareof digital media businesses generally and the willingness ofthose businesses to launch new digital services and to supporttheir digital store initiatives with adequate marketingresources. While we do expect growth in our music store servicesrevenue, our customers and potential customers face a number ofchallenges in the current digital music market, including: •      the dominance of Apple Computer’s iTunes service in certain    markets driven in part by sales of the market-share leading iPod    portable music devices;  •      a trend towards increasing wholesale cost of music content and    the apparent willingness of certain music services to set a    retail price to consumers that may be under the wholesale cost    of music content; and
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 •      a trend towards a requirement for substantial cash advances to    content owners, in particular the four major music labels, in    order to obtain some content distribution rights, such as use    for music subscription services.     We currently derive revenue from our music store servicesthrough a blend of higher marginbusiness-to-businessplatform service fees and lower margin transaction relatedpromotion, distribution or revenue sharing business to consumerfees. Platform service fees represent charges in connection withenabling the service and maintaining its overall functionalityduring the term of a customer contract (typically three years),including customer support, merchandising, publishing and othercontent management related services that we provide during thecontract term. Growth in platform service fee revenue isdirectly related to our ability to renew existing serviceagreements as well as launch new digital media store services,and accordingly, competition for new services and saturation ofdigital media services in some markets may directly impact thisrevenue stream.     We also generally receive a fixed fee per transaction orpercentage of the revenue generated from the sale of content toend consumers. The margin associated with transactional revenueis dependent in large part upon factors outside our control suchas the wholesale rate charged for content by rights holders suchas the major record labels and transactional processing feessuch as credit card interchange fees. There is a trend towardsrecord labels increasing wholesale content charges, in anapparent attempt to cause an increase in the retail price ofpopular digital music content. We cannot be certain thatconsumers will be willing to pay more than the current,prevailing market prices for digital music content. As a result,operating margins on transactional revenue for us and ourcustomers may decrease and price sensitivities may impact thegrowth in digital music services.     The majority of our transactional revenue is generated throughthe sale of prepaid credit packages which entitle a consumer toaccess a specified number of digital music downloads or streamsfor a fixed price during a fixed time period. Prepaid creditpackages are also bundled with other end consumer offeringssponsored by our customers. Revenue from prepaid credit packagesand bundle promotions is deferred until the credits orpromotional offers are utilized or expire. Our margin on thesale of prepaid credit packages is dependent, in part, uponconsumers redeeming less than the full number of downloads orstreams covered by the prepaid credit packages, which we referto as “breakage.” Historically breakage ratesfluctuate causing variability in our transactional margins.     As part of our currentend-to-end music storeservices, we have secured licenses, primarily for digitaldownload, with the four major recorded music companies and manyindependent record labels around the globe. Our rights portfoliocurrently available for inclusion in our music store servicesencompasses licenses in over 20 countries. All of oursignificant licensing agreements require the content owner topre-approve each of our customers in advance of launching a newservice.     While we typically secure content licenses on behalf of ourcustomers, there is a trend for certain of the major recordedmusic companies to want to provide licenses directly to newconsumer music services, and some consumer music services,especially those of household brand names, are requiring directlicensing arrangements with the labels. If these trends continueour business may be significantly impacted including byextending our sales cycle and requiring us to assist ourcustomers in obtaining licenses from content owners. This couldchange the way we report revenue because to the extent licenserights do not pass through Loudeye and our customers arerequired or elect to license and pay content owners directly, wewould report revenue on a net basis (net of third party contentfees) rather than on a gross basis. As a result, ourtransactional revenue may decrease and gross margins as apercentage of revenue may increase. Gross margin as an absolutedollar amount would not be impacted by a change in revenuereporting from a gross basis to a net basis.     *Digital media content services.* Digital media contentservices include a suite of digital media services provided toboth content owners and retailers, including encoding, musicsamples service, Internet radio, hosting and webcastingservices. Our digital media content services are operatedprimarily from our offices in Seattle, Washington.
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     *Encoding services.* Our patented systems and technologyenable the archiving and retrieval of large libraries of digitalmedia assets, or digital content. Digitized content masters ofmedia assets are stored on our high-capacity storage arraysystems and accessed via our proprietary, automated, web-basedaccess tools to search, deliver and manage such content. Thesestorage and access capabilities enable digital content to beprocessed and converted into different digital formats pursuantto our customers’ specifications via our proprietaryencoding and transcoding systems. To transmit digital contentover the Internet or other advanced digital distributionnetworks, the uncompressed, digitized content must be convertedinto compressed, network-compatible digital formats. Ourencoding services enable the conversion of such content into aparticular form, along with the relevant metadata, such that thecontent can be distributed over various distribution networks.Encoding large catalogs of content in an efficient manner is acomplex process that requires scalable technology and supportinginfrastructures. Digital encoding formats and technologiescontinue to evolve and often conflict with one another. As aresult, content owners often convert their digital assets intomultiple formats and codecs (which are algorithms that reducethe number of bytes consumed by large files and programs) tosupport their distribution strategies. Additionally, theencoding process for a particular item (or for an entirelibrary) is often repeated as a result of the introduction ofnew formats or distribution platforms. Our proprietary digitalmedia supply chain services address these challenges byproviding an outsourced solution for the archiving, management,processing and distribution of our customers’ digitalassets. We combine our encoding services with watermarking,encryption, metadata and other digital rights managementservices to enable our customers to protect and manage theircontent digitally. We also provide project analysis, as well asconsulting and other related services to support the digitalfulfillment of encoded content libraries for content owners andretailers worldwide.     To date, we have generated substantially all of our encodingservices revenue from fees for delivering EMI Music content todigital service providers, or DSPs. EMI Music contracts directlywith its DSP partners for licenses to the EMI Music catalog. Wein turn contract directly with DSPs for providing encodingservices for digital music content from EMI Music and otherindependent record labels. In February 2006, we were notified byEMI Music that it intends to transition all encoding servicesfor EMI Music content to another service provider. According toinformation provided to us by EMI Music, the expected transitionplan will result in DSPs that are receiving encoded EMI Musiccontent from Loudeye being migrated to the new service providerduring the second quarter of 2006. We have entered intonegotiations with EMI Music regarding various elements of EMIMusic’s transition plan. We expect to continue generatingrevenue from encoding EMI Music catalog for DSPs during thefirst and second quarters of 2006 until EMI Music completes itstransition plan to another service provider. During 2006, wealso intend to continue our efforts to expand our encodingservices to additional customers and into additional markets,such as video encoding, but there can be no assurance that suchefforts will be successful. If these efforts are not successful,our revenue from encoding services will be materially adverselyaffected, and we may need to consider discontinuing suchservices. In addition, if we are unable to expand our encodingservices to additional customers and markets fast enough toreplace the revenue we would have expected to generate during2006 from our relationship with EMI Music, we would expect torestructure operations related to encoding services during thefirst half of 2006. EMI Music’s transition plan may alsohave an impact on our samples, internet radio, hosting andwebcasting services as these service offerings all utilizeshared resources.     *Music sample services.* We provide a hostedend-to-end streamingsamples service that delivers high quality music samples tocustomers in the online and mobile entertainment sectors. Ourmusic samples service in the U.S. consists of streamingdigital content, or more specifically selections of suchcontent, commonly referred to as samples, clips or previews.Digital media samples are used by customers for many purposes,including increasing online content sales, user traffic andcustomer retention. A majority of our revenue from our musicsamples services is derived from a single customer relationshipthat is renewable annually. If that customer does not renew ourcontract, or if we were unsuccessful in securing license rightsfrom content owners to continue the samples service, revenuefrom our music samples services would decline.
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     *Internet radio, hosting and webcasting services.* OurInternet radio service offers 100 channels of CD-qualitystreaming music in the U.S. delivered through acustomer’s own privately branded player interface. It iscapable of supporting delivery to a range of consumer musicdevices and appliances. The Loudeye Internet radio service canbe deployed online for web-based retailers and portals, as wellas offline for consumer electronic devices and appliances,digital home entertainment systems and other digitalbroadcasting outlets.     Our hosting services allow digital media content to be hostedand streamed from a secure, redundant central media repository.A substantial majority of our revenue from hosting is derivedfrom a single customer relationship that is renewable annually.If that customer does not renew our contract, revenue from ourhosting services would decline. Our webcasting services allowusers to broadcast audio, video and visually orientedcommunications over the Internet. We are no longer activelyselling our Internet radio, hosting or webcasting services, andas a result, we expect revenue from these services will decreasein future periods.     *Media Restoration Services.*In January 2004, wetransferred substantially all of the assets of our mediarestoration services subsidiary, VidiPax, Inc., or VidiPax, to acompany controlled by VidiPax’s general manager. In May2004, we completed the sale of this media restoration servicesbusiness which involved restoring and migrating legacy mediaarchives to current digital media formats. While we will haveongoing rights to co-market and resell media restorationservices for two years after the sale, media restorationservices did not represent a significant portion of our revenuein 2004 or 2005, and we expect media restoration services willbe zero in future periods.     *Discontinued Operations.*In March 2004, we completed theacquisition of Overpeer, Inc., a privately held company based inNew York. On December 9, 2005, we announced that Overpeerhad ceased its content protection services operations effectiveimmediately. We had been funding Overpeer’s operationsunder an intercompany loan agreement pursuant to which we held asecurity interest in all of the assets of Overpeer. In November2005, we delivered to Overpeer a notice of default andacceleration of indebtedness pursuant to the intercompany loanagreement. Following Overpeer’s acknowledgment of defaultunder intercompany loan agreement, we took possession ofOverpeer’s assets and foreclosed on Overpeer’s assetsin partial satisfaction of Overpeer’s outstandingindebtedness to Loudeye.     We have recorded certain non-cash impairment charges relating toa write-down of the carrying value of all of the goodwill andsome of the long-lived assets associated with our Overpeersubsidiary, in connection with the discontinuance of theOverpeer business. The fair values of each of these assets wereestimated using primarily a probability weighted discounted cashflow method. The impairment of goodwill was determined under thetwo-step process required by FAS No. 142,“Goodwill and Other Intangible Assets” (FAS 142).The Overpeer technology, Overpeer’s customer relationships,Overpeer employee non-compete agreements, and Overpeertrademarks with an aggregate net book value of approximately$834,000 have no continuing value in ongoing operations as aresult of the cessation of the Overpeer business. In addition,we determined that the net book value of certain Overpeer fixedassets and leasehold improvements exceeded their estimated fairmarket value as of November 30, 2005, by approximately$591,000.     Overpeer incurred approximately $200,000 in severance andrelated payroll costs associated with the closing of itsoperations which was paid during December 2005. In addition, anon-cash stock compensation expense of approximately $40,000 wasrecorded relating to acceleration of vesting of a restrictedstock award to a former Overpeer employee.     Overpeer was a party to a lease agreement for premises locatedin New York City. The lease had a ten year term running throughSeptember 2015. Annual rent obligations under the lease wereapproximately $175,000, subject to annual adjustment. Under thelease, Loudeye was required to post an approximate $175,000security deposit in the form of a letter of credit. In December2005, the landlord drew down the letter of credit in full andterminated the lease. In February 2006, Overpeer, Loudeye andthe landlord reached a settlement pursuant to which the Landlordreleased Overpeer and Loudeye from any future obligations withrespect to the lease in exchange for the landlord retaining theapproximate
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$175,000 security deposit and certain Loudeye-owned furniturewith a net book value of approximately $78,000. For the yearended December 31, 2005, we included a charge ofapproximately $253,000 in loss from discontinued operationsrelating to the lease, offset in part by a deferred rent creditof approximately $80,000 resulting from the early leasetermination.     On December 15, 2005, Savvis Communications Corp. filed acomplaint in Superior Court in Santa Clara County,California, against Overpeer and Loudeye relating to a May 2002Master Services Agreement between Savvis and Overpeer forcollocation and bandwidth services (the “Overpeer-SavvisAgreement”). The complaint alleges Overpeer breached theOverpeer-Savvis Agreement for non-payment. The complaint alsocontains alter ego allegations against Loudeye. The complaintseeks damages of $1.6 million consisting of $950,000 ofallegedly unpaid invoices for services and approximately$600,000 in alleged early termination fees. The court hasgranted Savvis a writ of attachment over Overpeer’s assetslocated in the state of California. Loudeye has foreclosed onits first priority security interest in Overpeer’s assetsand Overpeer does not have sufficient assets in California (orelsewhere) to satisfy a judgment against it, if any. In February2006, Overpeer and Loudeye filed a joint motion to compelarbitration of the dispute under the terms of the agreementbetween Savvis and Overpeer. The motion is scheduled to be heardon March 30, 2006. Loudeye assesses the probability of ajudgment against Overpeer relating to the $950,000 in unpaidinvoices as high. Loudeye is not a party to the Overpeer-SavvisAgreement. Loudeye intends to defend itself vigorouslyconcerning the alter ego claims brought by Savvis. However, wecannot assess at this time the probability of an unfavorableoutcome with respect to the claims brought against Loudeye.     A summary of the special charges recorded during the year endedDecember 31, 2005 related to the cessation of the Overpeerbusiness is included in the table below.         Goodwill impairment $1,879     Acquired technology and customer lists impairment  834     Property and equipment impairment  591     Employee severance and termination benefits  244     Facilities related charges (credits)  173       $3,721          The closure of Overpeer meets the criteria of a “componentof an entity” as defined in FAS No. 144“Accounting for the Impairment or Disposal of Long-LivedAssets” (FAS 144). The operations and cash flow ofthose components have been eliminated from the ongoingoperations of Loudeye as a result of the disposal, and we do nothave any significant involvement in the operations of thatcomponent after the disposal transaction. Accordingly, inaccordance with the provisions of FAS 144, the results ofoperations of Overpeer are reported as discontinued operationsin the accompanying consolidated financial statements. Theprior-year results of operations for Overpeer have beenreclassified to conform to this presentation.     Operational data for Overpeer is summarized as follows (inthousands):           **For the Years Ended**  **December 31,**     **2005** **2004**         Revenue $1,823  $2,788     Loss from discontinued operations  (7,783)  (400)**Critical Accounting Policies and Estimates**     The SEC has defined a company’s critical accountingpolicies as the ones that are the most important to theportrayal of the company’s financial condition and resultsof operations, and those which require the company to make itsmost complex or subjective decisions or assessments. Ourcritical accounting policies and estimates include revenuerecognition, the estimates used in determining therecoverability of goodwill and other intangible assets, exitcosts, the amount of litigation accruals, and the amount of theallowance
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for income taxes. We have discussed the development andselection of these critical accounting policies and estimateswith the Audit Committee of our board of directors.     The preparation of financial statements in conformity withgenerally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and thereported amounts of revenue and expenses during the reportingperiod. Some of the critical estimates we make may includeamounts with respect to music publishing rights and musicroyalty accruals, litigation accruals, and the allowance forincome taxes. Actual results could differ from those estimates.***Revenue Recognition***     Substantially all of our revenue is derived from our digitalmedia service offerings including digital media store services(which include music store services), encoding services, samplesservices, Internet radio services, hosting services, and liveand on-demand webcasting services. In 2005, approximately 77% oftotal revenue was generated from our digital media storeservices, and substantially all of that revenue was generatedfrom our services in Europe. In 2005 and 2004, we experienced asignificant increase in deferred revenue which arises frompayments received in advance of the culmination of the earningsprocess. Deferred revenue expected to be realized within thenext twelve months is classified as current. Revenue fromsoftware license sales accounted for less than 1% of our revenuein 2005 and 2004 and less than 3% of our revenues in 2003. We donot anticipate that software license sales will constitute asignificant portion of our revenue in the future. Also, werecognized service revenue from media restoration services priorto our sale of that business in the first quarter 2004.     Our basis for revenue recognition is substantially governed bySecurities and Exchange Commission (SEC) Staff AccountingBulletin (SAB) 101, as superseded by SAB 104,“Revenue Recognition,” the FASB’s Emerging IssuesTask Force IssueNo. 00-21“Revenue Arrangements with Multiple Deliverables”(EITF 00-21), andin very limited cases as it relates to sales of softwareproducts Statement of Position No. 97-2 “SoftwareRevenue Recognition,” as amended by Statement of PositionNo. 98-4, 98-9, and related interpretations and TechnicalPractice Aids(SOP 97-2). Weexercise judgment and use estimates in connection with thedetermination of the amount of revenue and software licensesales revenue to be recognized in each accounting period. Theadoption of SAB 104 in December 2003 did not materiallyaffect our revenue recognition policies, results of operations,financial position or cash flows.     The following is a summary of the areas where we exercisejudgment and use estimates in connection with the determinationof the amount of revenue to be recognized in each accountingperiod:     *Determining Separate Elements and Allocating Value to ThoseElements.* If sufficient evidence of the fair values of thedelivered and undelivered elements of an arrangement does notexist, revenue is deferred using revenue recognition principlesapplicable to the entire arrangement as if it was a singleelement arrangement underEITF 00-21, and isrecognized on a straight-line basis over the term of thecontract.     For arrangements with multiple deliverables which are determinedto have separate units of accounting, revenue is recognized uponthe delivery of the separate units in accordance withEITF 00-21.Consideration from multiple element arrangements is allocatedamong the separate elements based on their relative fair values.In the event that there is no objective and reliable evidence offair value for the delivered item, the revenue recognized upondelivery is the total arrangement consideration less the fairvalue of the undelivered items. The maximum revenue recognizedon a delivered element is limited to the amount that is notcontingent upon the delivery of additional items. Managementapplies significant judgment in establishing the fair value ofmultiple elements within revenue arrangements. Estimates of fairvalue represent our best estimate, but changes in circumstancesrelating to the services sold in these arrangements may resultin one-time revenue charges as future elements of thearrangements are delivered.     In the limited circumstances where we sell software products, werecognize revenue associated with the license of software inaccordance with,SOP 97-2. Underthe provisions ofSOP 97-2, insoftware
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arrangements that involve rights to multiple services, weallocate the total arrangement consideration among each of thedeliverables using the residual method, under which revenue isallocated to the undelivered elements based on vendor-specificobjective evidence of the fair value of such undeliveredelements. Vendor-specific objective evidence is based on theprice charged when an element is sold separately or, in the caseof an element not sold separately, the price established bymanagement, if it is probable that the price, once established,will not change before market introduction.     Some of our arrangements may include consulting services soldseparately under professional services contracts. Professionalservices arrangements are billed on a time and materials basisand accordingly, revenue is recognized as the services areperformed.     *Digital media store services revenue.* Digital media storeservices, including music store services, grew significantlyfollowing our acquisition of OD2 in June 2004. We derive ourrevenue from digital media store services in three primary areas: •      We charge our digital media store customers fixed    business-to-business    platform fees, which generally consist of enabling and hosting    the service and maintenance of the service’s overall    functionality during the term of the customer contract.    Business-to-business platform services may include fees related    to integration to a customer’s website, wireless sites,    inventory, account management, and commerce and billing systems.    Additionally, platform fees associated with our digital media    store services include digital rights management, editorial    services, usage reporting, and digital content royalty    settlement. We charge platform fees to our customers in a    variety of manners, including initial    set-up fees, monthly    only fees, or a combination of initial    set-up and monthly fees.  •      We provide transactional    business-to-consumer    services including prepaid credit packages and digital downloads.  •      We provide corporate clients with bundles of music credit    packages for distribution to their end consumers as part of    marketing promotions. Although not a primary source of revenue,    we also provide a number of consultancy services, including    cover art and metadata publishing, and varied commerce and    content consumption alternatives for digital media content.     We follow the guidance inEITF 00-21 forpurposes of allocating the total consideration in its digitalmedia store services arrangements to the individualdeliverables. We evaluate whether each of the elements in thesearrangements represents a separate unit of accounting, asdefined byEITF 00-21, usingall applicable facts and circumstances, including whether(i) the delivered item(s) has value to the customer on astandalone basis, (ii) there is objective and reliableevidence of the fair value of the undelivered item(s) and(iii) there is a general right of return relative to thedelivered item(s), in which case performance of the undelivereditem(s) is considered probable and substantially in our control.     If we determine a given agreement involves separate units ofaccounting, we allocate the arrangement consideration to theseparate units of accounting based on their relative fairvalues, as determined by the price of the undelivered items whensold separately. Assuming all other criteria are met (i.e.,evidence of an arrangement exists, collectibility is probable,and fees are fixed or determinable), revenue is recognized asfollows: •  Business-to-business    platform service fees are generally recognized as revenue over    the term of the customer contract and represent charges in    connection with enabling the service and maintaining its overall    functionality during the term of the customer contract, which is    generally one to three years. We charge platform fees to    customers in a variety of manners, including initial    set-up fees, monthly    only fees, or a combination of initial    set-up and monthly fees.  •      We also share in the proceeds of    business-to-consumer    transactions such as digital downloads. Revenue from digital    downloads is recognized at the time the content is delivered,    digitally, to the consumer.
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 •      A majority of our    business-to-consumer    transactional revenue is generated through the sale of prepaid    credit packages which entitle a consumer to access a specified    number of digital music downloads or streams for a fixed price    during a fixed time period. Prepaid credit packages are also    bundled with other end consumer offerings sponsored by our    customers. Revenue from prepaid credit packages and bundle    promotions is deferred until the credits or promotional offers    are utilized or expire. Our margin on the sale of prepaid credit    packages fluctuates depending upon a number of factors,    including the type of service for which the consumer redeems the    credits (full downloads or streams), the royalty rate for the    download purchased and breakage.  •      Revenue from bundles of prepaid music credit packages is    deferred and then recognized as tracks are downloaded by the    consumer or as credits expire, whichever occurs earlier.     If evidence of fair value cannot be established for theundelivered elements of an agreement, the revenue from thearrangement is recognized ratably over the period that theseelements are delivered or, if appropriate, under the percentageof completion method based on the ratio of direct labor hoursincurred to date to total projected labor hours.     We recognize revenue gross or net in accordance withEITF 99-19. In most arrangements, we contract directly withend user consumers, we are the primary obligor and we carry allcollectibility risk. Revenue in these arrangements is recordedon a gross basis. In some cases, customers contract with musicpublishers and rights holders and sell products or servicesdirectly to end user consumers utilizing our services, and, assuch, we carry no collectibility risk. In those instances, inaccordance with EITF 99-19, we report revenue net ofamounts paid to the customer.     *Encoding services revenue.* Encoding services consist of(i) processing and conversion of digital content intodifferent digital formats pursuant to customers’specifications via the Company’s proprietary encoding andtranscoding systems and (ii) the delivery of such processedcontent to the customer. The encoded content is either deliveredelectronically to a file transfer protocol (FTP) site thatour customers access via a previously provided password or wephysically ship the content to our customers. In accordance withSAB 104, we recognize revenue when persuasive evidence ofan arrangement exists and the service has been rendered,provided the fee is fixed or determinable and collection isdeemed probable. We evaluate each of these criteria as follows: •     Evidence of an arrangement: We consider a non-cancelable    agreement signed by us and the customer to be evidence of an    arrangement.  •     Services have been rendered: We consider this criteria to be    satisfied when the content has been delivered.  •     Fixed or determinable fee: We assess whether fees are fixed or    determinable at the time of sale and recognize revenue if all    other revenue recognition requirements are met. We consider    these criteria to be satisfied when the payment terms associated    with the transaction are within our normal payment terms. If a    significant portion of a fee is due after the date that fees    would customarily be due under our normal payment terms, we    consider the fee to not be fixed and determinable, and in such    cases, we would defer revenue and recognize it when the fees    become due and payable.  •     Collection is deemed probable: We initially assess the    probability of collection to determine whether this criterion is    satisfied based on a number of factors, including past    transaction history with the customer and the current financial    condition of the customer. If we determine that collection of a    fee is not reasonably assured, we defer revenue until the time    collection becomes reasonably assured, which is generally upon    the receipt of cash.     *Samples services revenue.* Samples services are providedto customers using our proprietary streaming media software,tools, and processes. Music samples are streamed filescontaining selected portions, or samples, of a full music trackand are typically 30 to 60 seconds in length. Customer billingsare based on the volume of data streamed at rates agreed upon inthe customer contract, and may be
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subject to a nonrefundable monthly minimum fee. Under theprovisions of SAB 104 andEITF 00-21, werecognize revenue in the period in which the samples aredelivered.     *Internet radio, hosting and webcasting services revenue.*Internet radio services are provided to customers using ourproprietary media software, tools and processes. Internet radioservices can consist of the rebroadcast over the Internet of acustomer’sover-the-air radioprogramming. Services provided may also include play listselection and programming services for online radio channels.Under the provisions of SAB 104 andEITF 00-21,revenue from the sale of Internet radio services is recognizedon a monthly basis as the services are provided and customersare typically billed monthly in arrears.     Webcasting services are provided to customers using ourproprietary streaming media software, tools and processes.Services for live webcast events and services for on-demandwebcasting services are generally sold separately. For livewebcasting events, we charge a fixed fee. On demand webcastingservice fees are based on a contract with either set monthlyminimum fees which entitle the customer to a monthly volume ofstored and streamed data that is specified in the contract or acontract with charges based upon actual monthly volume of storedand streamed data with no monthly minimum fees. Additional feesare required to be paid under the contract if the volume of datastreamed in a particular month exceeds the specified monthlyvolume threshold, and the per unit charges for the additionalvolume approximate the per unit charges for the minimum volumes.Any unused volume of streamed or stored data expires at eachmonth end.     Because we separately sell services for live webcast events andservices for on-demand webcasting, we have verifiable andobjective evidence of the fair value for both the live andon-demand services. Under the provisions of SAB 104 andEITF 00-21, werecognize revenue for live webcasting and on-demand webcastingservices which are not subject to monthly minimums in the periodin which the webcast event, data storage or data streamingoccurs. Revenue for on-demand webcasting services subject tomonthly minimums is recognized monthly on a straight line basisover the contract period, based upon contracted monthly ratesfor the specified volume thresholds. Revenue for additionalusage fees is recognized in the period that the additional usageoccurs.     *Software license revenue.* In the limited circumstances inwhich we sell software products, we recognize revenue associatedwith the license of software in accordance withSOP 97-2. Revenuefrom software license sales accounted for less than 1% of ourrevenue in 2005 and 2004 and less than 3% of our revenue in2003. Under the provisions ofSOP 97-2, insoftware arrangements that involve rights to multiple services,we allocate the total arrangement consideration among each ofthe deliverables using the residual method, under which revenueis allocated to the undelivered elements based onvendor-specific objective evidence of the fair value of suchundelivered elements. Elements included in multiple elementarrangements consist of software, intellectual property,implementation services, maintenance and consulting services.Vendor-specific objective evidence is based on the price chargedwhen an element is sold separately or, in the case of an elementnot sold separately, the price established by management, if itis probable that the price, once established, will not changebefore market introduction.***Research and Development Costs***     We account for research and development costs in accordance withseveral accounting pronouncements, includingFAS No. 2, “Accounting for Research andDevelopment Costs,” and FAS No. 86,“Accounting for the Costs of Computer Software to Be Sold,Leased, or Otherwise Marketed” (FAS 86). Research anddevelopment costs associated with software development consistprimarily of salaries, wages and benefits for developmentpersonnel and are generally charged to expense untiltechnological feasibility has been established for the services.Once technological feasibility has been established, allsoftware costs are capitalized until the services are availablefor general release to customers. Capitalized costs are thenamortized on a straight-line basis over the term of theapplicable contract, or based on the ratio of current revenue tototal projected service revenue, whichever is greater.Technology acquired in business combinations is recorded inintangible assets and purchased software is recorded in propertyand equipment.
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***Marketable Securities***     We account for marketable securities in accordance withFAS No. 115, “Accounting for Certain Investmentsin Debt and Equity Securities,” and SAB 59,“Accounting for Noncurrent Marketable EquitySecurities,” which provide guidance on determining when aninvestment is other-than-temporarily impaired. Investments arereviewed quarterly for indicators of other-than-temporaryimpairment. This determination requires significant judgment. Inmaking this judgment, we evaluate, among other factors, theduration and extent to which the fair value of an investment isless than its cost; the financial health of and near-termbusiness outlook for the investee, including factors such asindustry and sector performance, changes in technology, andoperational and financing cash flow; and our intent and abilityto hold the investment. Investments with an indicator would befurther evaluated to determine the likelihood of a significantadverse effect on the fair value and amount of the impairment asnecessary. To date, we have not recognized any impairmentrelated to our long-term marketable securities portfolio. Ifmarket, industry and/or investee conditions deteriorate, we mayincur future impairments.***Accounts Receivable***     The allowance for doubtful accounts represents our best estimateof the amount of probable credit losses in our existing accountsreceivable. We perform a periodic analysis to determine theappropriate allowance for doubtful accounts. This analysisincludes various analytical procedures and a review of factors,including individual review of past due balances over90 days and greater than a specified amount, our history ofcollections, as well as the overall economic environment.***Long-lived Assets Including Goodwill and Other Acquired    Intangible Assets***     *Goodwill.* In connection with Loudeye’s acquisitionsof Overpeer and OD2 during 2004, management has allocated therespective purchase prices and transaction costs to theestimated fair values of assets acquired and liabilities assumedin accordance with FAS No. 141, “BusinessCombinations.” These purchase price estimates were based onmanagement’s estimates of fair value and estimates fromthird party consultants. These determinations requiresignificant judgment.     We account for goodwill and intangible assets in accordance withFAS 142. Under FAS 142, goodwill and intangible assetsdeemed to have indefinite lives are not amortized, but aresubject to, at a minimum, annual impairment tests. We assess theimpairment of long-lived assets, including goodwill andintangibles on an annual basis or whenever events or changes incircumstances indicate that the fair value is less than itscarrying value. Factors we consider important which couldtrigger an impairment review include the following: •     Poor economic performance relative to historical or projected    future operating results;  •     Significant negative industry, economic or company specific    trends;  •     Changes in the manner of our use of the assets or the plans for    our business;  •     Market price of our common stock; and  •     Loss of key personnel.     The goodwill impairment test involves a comparison of the fairvalue of each of our reporting units with the carrying amountsof net assets, including goodwill, related to each reportingunit. If the carrying amount exceeds a reporting unit’sfair value, the second step of the impairment test is performedto measure the amount of impairment loss, if any. The impairmentloss is measured based on the amount by which the carryingamount of goodwill exceeds the implied fair value of goodwill inthe reporting unit being tested. Fair values are determinedbased on valuations that rely on the income and market valueapproaches. The income approach uses future projections of cashflows from each of our reporting units and includes, among otherestimates, projections of future revenue and operating expenses,market supply and demand, projected capital spending and anassumption of our weighted average cost of capital and themarket value approach uses market value and other metrics ofcomparable companies. Our evaluations of
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fair values include analyses based on the future cash flowsgenerated by the underlying assets, estimated trends and otherrelevant determinants of fair value for these assets. If thefair value of the asset is less than its carrying amount, a lossis recognized for the difference between the fair value and itscarrying value. Changes in any of these estimates, projectionsand assumptions could have a material effect on the fair valueof these assets in future measurement periods and result in animpairment of goodwill which could materially affect our resultsof operations.     *Tangible Long-Lived Assets.* We evaluate therecoverability of the carrying amount of long-lived tangibleassets whenever events or changes in circumstances indicate thatthe carrying amount of an asset may not be fully recoverable asrequired by FAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” We use ourjudgment when applying the impairment rules to determine when animpairment test is necessary. Factors we consider which couldtrigger an impairment review include significantunderperformance relative to historical or forecasted operatingresults, a significant decrease in the market value of an asset,a significant change in the extent or manner in which an assetis used, and significant negative cash flows or industry trends.     Impairment losses are measured as the amount by which thecarrying value of an asset exceeds its estimated fair value,which is primarily based on future undiscounted cash flows. Inestimating these future cash flows, we use future projections ofcash flows directly associated with, and that were expected toarise as a direct result of, the use and eventual disposition ofthe assets. These projections rely on significant assumptions.If it is determined that a long-lived asset is not recoverable,an impairment loss would be calculated based on the excess ofthe carrying amount of the long-lived asset over its fair value.Changes in any of our estimates could have a material effect onthe estimated future cash flows expected to be generated by theasset and result in a future impairment of the involved assetswith a material effect on our future results of operations.***Purchase Price Allocation***     We account for acquisitions under the purchase method ofaccounting. Accordingly, any assets acquired and liabilitiesassumed are recorded at their respective fair values. Therecorded values of assets and liabilities are based on thirdparty estimates and independent valuations. The remaining valuesare based on management’s judgments and estimates.Accordingly, our financial position or results of operations maybe affected by changes in estimates and judgments used to valuethese assets and liabilities.***Stock-based Compensation***     We account for employee stock and stock-based compensation plansthrough the intrinsic value method in accordance with APBOpinion No. 25, “Accounting for Stock Issued toEmployees” (APB 25) as permitted byFAS No. 123, “Accounting for Stock-BasedCompensation” (FAS 123) and as such, generallyrecognize no compensation expense for employee stock options.     In December 2004, the FASB issued FAS No. 123R,“Share-Based Payment” (FAS 123R) that amendsFAS 123, and No. 95, “Statement of CashFlows” and supersedes APB 25. BeginningJanuary 1, 2006, this statement requires us to measure thecost of employee services received in exchange for an award ofequity instruments, such as stock options, based on thegrant-date fair value of the award and to recognize such costover the requisite period during which an employee providesservice. The grant-date fair value will be determined usingoption-pricing models adjusted for unique characteristics of theequity instruments. The statement also addresses the accountingfor transactions in which we incur liabilities in exchange forgoods or services that are based on the fair value of theCompany’s equity instruments or that may be settled throughthe issuance of such equity instruments. The statement does notchange the accounting for transactions in which we issue equityinstruments for services to non-employees or the accounting foremployee stock ownership plans. The pro forma disclosurespreviously permitted under FAS 123 no longer will be analternative to financial statement recognition.
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     FAS 123R permits public companies to adopt its requirementsusing one of two methods: •     A “modified prospective” method in which compensation    cost is recognized beginning with the effective date    (a) based on the requirements of FAS 123R for all    share-based payments granted after the effective date and    (b) based on the requirements of FAS 123R for all    awards granted to employees prior to the effective date of    FAS 123R that remain unvested on the effective date.  •     A “modified retrospective” method which includes the    requirements of the modified prospective method described above,    but also permits entities to restate based on the amounts    previously recognized under FAS 123 for purposes of pro    forma disclosures for either (a) all prior periods    presented or (b) prior interim periods of the year of    adoption.     We adopted FAS 123R on January 1, 2006 and will usethe modified prospective method in which compensation cost isrecognized beginning with the effective date (a) based onthe requirements of FAS 123R for all share-based paymentsgranted after the effective date and (b) based on therequirements of FAS 123R for all awards granted toemployees prior to the effective date of FAS 123R thatremain unvested on the effective date. We expect the adoption toresult in the recognition of stock-based compensation expense ofapproximately $1.3 million to $1.6 million, based on arange of estimated forfeiture rates, for stock options grantedprior to January 1, 2006 plus the expense related to stockoptions granted during 2006. The expense for stock optionsgranted during 2006 cannot be determined at this time due to theuncertainty of Loudeye’s stock price, the relatedBlack-Scholes fair value and the timing of future grants.     In November 2005, the FASB issued final FASB Staff PositionFAS No. 123R-3, “Transition Election Related toAccounting for the Tax Effects of Share-Based PaymentAwards” (“FSP 123 R-3”). FSP 123 R-3 provides analternative method of calculating excess tax benefits (theAdditional Paid in Capital (“APIC”) pool) from themethod defined in FAS 123R and requires us to follow eitherthe transition guidance for theadditional-paid-in-capitalpool as prescribed in FAS 123R, or the alternativetransition method as described in FSP 123 R-3. A one-timeelection to adopt the transition method in FSP 123 R-3 isavailable to us for up to one year from January 1, 2006,our initial adoption of FAS 123R. We continue to evaluatethe impact that the adoption of this FSP could have on ourconsolidated financial statements.***Music Publishing Rights and Music Royalty Accruals***     We make estimates of our music publishing rights and musicroyalties owed for our domestic and international musicservices. Differences in judgments or estimates could result inmaterial differences in the amount and timing of our musicpublishing and royalty expense for any period. Under Europeanand U.S. copyright laws, we may be required to paylicensing fees for digital sound recordings and compositions wedeliver. Copyright law generally does not specify the rate andterms of the licenses, which are determined by voluntarynegotiations among the parties or, for certain compulsorylicenses where voluntary negotiations are unsuccessful, byarbitration. There are certain geographies and agencies forwhich we have not yet completed negotiations with regard to theroyalty rate to be applied to our current or historic sales ofour digital music offerings. In addition, the arena of royaltynegotiations is litigious, as evidenced for example, by alawsuit brought by SPEDIDAM, a royalty collecting society inFrance, against OD2 and others in March 2006. Our estimates arebased on contracted or statutory rates, when established, ormanagement’s best estimates based on facts andcircumstances regarding the specific music services andagreements in similar geographies or with similar agencies.While we base our estimates on historical experience and onvarious other assumptions that management believes to bereasonable under the circumstances, actual results may differmaterially from these estimates under different assumptions orconditions.***Contingencies***     We become involved from time to time in various claims andlawsuits incidental to the ordinary course of our operations,including such matters as contract and lease disputes andcomplaints alleging
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employment discrimination. The outcomes of legal proceedings andclaims brought against us are subject to significantuncertainty. FAS No. 5, “Accounting forContingencies,” requires that an estimated loss from a losscontingency such as a legal proceeding or claim should beaccrued by a charge to income if it is probable that an assethas been impaired or a liability has been incurred and theamount of the loss can be reasonably estimated. Disclosure of acontingency is required if there is at least a reasonablepossibility that a loss has been incurred. In determiningwhether a loss should be accrued, we evaluate, among otherfactors, the degree of probability of an unfavorable outcome andthe ability to make a reasonable estimate of loss. Changes inthese factors could materially impact our financial position orour results of operations.***Income Taxes***     FAS No. 109, “Accounting for Income Taxes,”establishes financial accounting and reporting standards for theeffect of income taxes. Deferred tax assets and liabilities aredetermined based on the differences between the financialstatement and tax bases of assets and liabilities using theenacted tax rates in effect for the periods in which thedifferences are expected to reverse. Our net deferred tax assethas been reduced by a full valuation allowance based uponmanagement’s determination that the criteria forrecognition have not been met. Judgment is required in assessingthe future tax consequences of events that have been recognizedin our financial statements or tax returns. Variations in theactual outcome of these future tax consequences could materiallyimpact our financial position or our results of operations.***Recently Issued Accounting Standards***     In March 2005, the FASB issued FASB Interpretation(FIN) No. 47, “Accounting for Conditional AssetRetirement Obligations — an interpretation ofFAS No. 143.” FIN No. 47 clarifiesFAS No. 143, “Accounting for Asset RetirementObligations,” such that conditional asset retirementobligations require recognition at fair value if they can bereasonably estimated. These rules are effectiveDecember 31, 2005. We do not expect the impact of adoptingFIN 47 to have a material effect on our results ofoperations or financial position.     In May 2005, the FASB issued FAS No. 154,“Accounting Changes and Error Corrections”(FAS 154). FAS 154 is a replacement of APBNo. 20, “Accounting Changes” and FASB StatementNo. 3, “Reporting Accounting Changes in InterimFinancial Statements — (an Amendment of APB OpinionNo. 28)” and provides guidance on the accounting forand reporting of accounting changes and error corrections. Itestablishes retrospective application as the required method forreporting a change in accounting principle. FAS 154provides guidance for determining whether retrospectiveapplication of a change in accounting principle is impracticableand for reporting a change when retrospective application isimpracticable. The reporting of a correction of an error byrestating previously issued financial statements is alsoaddressed by FAS 154. FAS 154 is effective foraccounting changes and corrections of errors made in fiscalyears beginning after December 31, 2005. We will adopt thispronouncement beginning in fiscal year 2006.     In November 2005, the FASB issued FASB Staff PositionNo. FAS 115-1, “The Meaning ofOther-Than-Temporary Impairment and its Application to CertainInvestments” (FSP No. 115-1). FSP No. 115-1amends FAS No. 115, “Accounting for CertainInvestments in Debt and Equity Securities” and includesguidance for evaluating and recording impairment losses on debtand equity investments, as well as new disclosure requirementsfor investments that are deemed to be temporarily impaired. FSPNo. 115-1 alsorequires an other-than-temporary impairment of debt and equitysecurities to be written down to its impaired value, whichbecomes the new cost basis. FSP No. 115-1 is effective forfiscal years beginning after December 15, 2005. We willcontinue to evaluate the application of FSP No. 115-1;however, we do not believe adoption will have a material effecton our financial position, results of operations or cash flows.
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**Consolidated Results of Operations**     During the preparation of our financial statements for the yearended December 31, 2004, we revised our classification withregard to amortization of acquired technology and capitalizedsoftware costs, which resulted in the revision of classificationof expenses totaling approximately $439,000 for the year endedDecember 31, 2004 from operating expenses —amortization of intangibles to cost of revenue in the currentpresentation as we determined that these expenses were moreappropriately classified as cost of revenue in accordance withFAS 86 and related accounting literature. This revision ofclassification had no impact on net loss, stockholders’equity or cash flows as previously reported.     Overpeer, our wholly-owned subsidiary which provided contentprotection services, ceased operations in December 2005 and ispresented as a discontinued operation in all periods presented(and accordingly, the period to period comparisons below excludeOverpeer except where indicated).***Comparison of Fourth Quarter 2005 Operating Results to    Third Quarter 2005***     Revenue increased 35% for the fourth quarter 2005 to$8.8 million from $6.5 million in the third quarter2005. We experienced strong quarter-over-quarter growth indigital media store services revenue. Our digital media storeservices in the fourth quarter 2005 generated approximately$7.0 million in revenue, or 80% of total revenue, comparedto third quarter 2005 revenue from digital media store servicesof $4.8 million, or 74% of total revenue. Fourth quarter2005 revenue included approximately $1.3 million inpromotional credit revenue from one internet service provider inEurope that had been included in deferred revenue atSeptember 30, 2005. In each of the third and fourthquarters of 2005, approximately 24% of our digital media storeservices revenue was derived from Microsoft Corporation’sMSN music services offerings across thirteen countries inEurope. Substantially all of our store services revenue comesfrom our European operations.     In the fourth quarter 2005, we generated approximately$1.8 million in revenue from digital media contentservices, or 20% of total revenue. This is roughly consistentwith third quarter 2005 levels. Of this, approximately$1.3 million and $1.2 million in the fourth and thirdquarters of 2005 was from encoding services, a substantialportion of which is derived from our relationship with EMImusic. In February 2006, we were notified by EMI Music that itintends to transition all encoding services for EMI Musiccontent to another service provider.     We had a gross profit margin for fourth quarter 2005 ofapproximately $1.0 million or 12% of revenue compared to agross profit margin of approximately $350,000 or 5% of revenuefor the third quarter 2005. Operating expenses totaled$6.8 million in the fourth quarter, approximately $845,000less than third quarter 2005 operating expenses of approximately$7.7 million. The largest driver of thequarter-to-quarterdecrease was in general and administrative expense, whichdeclined approximately $500,000 in fourth quarter 2005 ascompared to third quarter 2005 levels.     During the fourth quarter 2005, we reported a loss fromcontinuing operations of approximately $5.7 millioncompared to a loss from continuing operations of approximately$7.2 million in the third quarter 2005. Loss fromdiscontinued operations was approximately $4.8 million and$1.3 million for the fourth and third quarters 2005. Thesignificant increase in the loss from discontinued operationsduring the fourth quarter was primarily due to the impairment ofcertain Overpeer fixed assets of approximately $591,000,goodwill related to the Overpeer acquisition of approximately$1.9 million and intangible assets of approximately$834,000. We also incurred approximately $244,000 in employeerelated severance costs associated with the cessation ofOverpeer’s operations.***Tabular Comparison of Annual Results of Operations***     Percentage comparisons have been omitted within the followingtable where they are not considered meaningful. Certaininformation reported in previous periods has been reclassifiedto conform to current presentation (see Item 6“Selected Financial Data” appearing on page 38 ofthis annual report for
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additional discussion regarding reclassifications). All amounts,except amounts expressed as a percentage, are presented in thefollowing table in thousands.                                      **Years Ended**   **Years Ended**    **December 31,** **Variance** **December 31,** **Variance**           **2005** **2004** **$** **%** **2004** **2003** **$** **%**                 **Revenue**                                     Digital media store services $20,902  $5,932  $14,970   252% $5,932  $171  $5,761   3369%      Encoding services  3,881   3,829   52   1%  3,829   2,377   1,452   61%      Samples services  1,171   1,589   (418)  (26)%  1,589   1,685   (96)  (6)%      Internet radio, hosting, and webcasting services  1,087   2,386   (1,299)  (54)%  2,386   5,832   (3,446)  (59)%      Media restoration services  —   297   (297)  (100)%  297   1,883   (1,586)  (84)%                                Total revenue  27,041   14,033   13,008   93%  14,033   11,948   2,085   17%**Cost of revenue**  25,082   10,336   14,746   143%  10,336   8,076   2,260   28%**Gross profit**  1,959   3,697   (1,738)  (47)%  3,697   3,872   (175)  (5)%**Operating expenses**                                     Sales and marketing  6,412   4,200   2,212   53%  4,200   3,286   914   28%     Research and development  8,404   3,726   4,678   126%  3,726   1,688   2,038   121%     General and administrative  13,057   10,658   2,399   23%  10,658   8,656   2,002   23%     Amortization of intangibles  235   92   143   155%  92   831   (739)  (89)%     Stock-based compensation  250   199   51   26%  199   1,298   (1,099)  (85)%     Special charges — goodwill impairments  —   —   —       —   5,307   (5,307)  (100)%     Special charges (credits) — other  (43)  312   (355)  (114)%  312   1,913   (1,601)  (84)%                                Total operating expenses  28,315   19,187   9,128   48%  19,187   22,979   (3,792)  (17)%    Interest income  625   377   248   66%  377   347   30   9%    Interest expense  (160)  (201)  41   (20)%  (201)  (286)  85   (30)%    Gain on sale of media restoration assets  —   156   (156)  (100)%  156   —   156         Increase in fair value of common stock warrants  —   —   —       —   (248)  248   (100)%    Other income (expense), net  313   (839)  1,152   (137)%  (839)  120   (959)  (799)%                                Total other income (expense)  778   (507)  1,285   (253)%  (507)  (67)  (440)  657%                             Loss from continuing operations  (25,578)  (15,997)  (9,581)  60%  (15,997)  (19,174)  3,177   (17)%    Loss from discontinued operations  (7,783)  (400)  (7,383)  1846%  (400)  —   (400)                                **Net loss** $(33,361) $(16,397) $(16,964)  103% $(16,397) $(19,174) $2,777   (14)%                         ***Comparison of Year Ended December 31, 2005 and    2004***     *Revenue.* Revenue increased for the year endedDecember 31, 2005, compared to the year endedDecember 31, 2004, as a result of the inclusion of OD2 forthe full year 2005 and as a result of growth in transactionaland promotional credit revenue from our digital media storeservices. OD2, which we
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acquired in June 2004, generated a substantial majority of our2005 digital media store services revenue. For the year endedDecember 31, 2005, the increase in digital media storeservices revenue was partially offset by declining revenue inour samples, internet radio, hosting and webcasting serviceofferings.     During the year ended December 31, 2005, two customersaccounted for approximately 29% of total revenue. During 2004,one customer accounted for approximately 21% of total revenue.In addition, a substantial portion of our encoding servicesrevenue was derived from our relationship with EMI Music.Revenue generated from our international operations, which isentirely related to the OD2 acquisition, was $20.3 millionand $5.5 million for the years ended December 31, 2005and 2004.     During 2004, our service mix changed significantly. We acquiredOD2 in late June 2004, which resulted in a significant increasein digital media store services revenue. In May 2004, wecompleted the sale of all of the assets of our media restorationservices business pursuant to an agreement datedOctober 31, 2003.     *Digital media store services revenue.* Substantially allof our digital media store services revenue is generated fromour operations in Europe. Revenue from digital media storeservices increased during the year ended December 31, 2005,as compared to the same period in 2004 primarily as a result ofthe inclusion of revenue from OD2 for the full year 2005 and thegrowth in transactional and promotional credit revenue fromthese services experienced since our acquisition of OD2 in June2004. Digital media store services revenue as a percentage oftotal revenue was 77% in the year ended December 31, 2005and 42% in the same period in 2004. During the year endedDecember 31, 2005, approximately 24% of our digital mediastore services revenue was derived from MicrosoftCorporation’s MSN music services offerings compared to 49%in 2004 and KPN Telecom B.V. accounted for 13% and 4% of digitalmedia store revenue in 2005 and 2004. The next four customersaccounted for an additional approximately 42% of total digitalmedia store services revenue in 2005. If one or more of thesekey customers were to cancel our contract or not renew it, ourbusiness to consumer transactional revenue could decline. Weanticipate that digital media store services will continue todemonstrate a faster growth rate than any of our other serviceofferings as we continue to deploy these services globally,including through mobile service offerings, and as consumeradoption increases. In addition, although in 2005 and 2004 ourdigital media store services revenue consisted exclusively ofmusic store services revenue, we plan to extend our storeservices offerings to other media, such as music videos, during2006 as those digital delivery markets develop.     Since our acquisition of OD2, revenue from digital media storeservices consists principally of platform service fees andtransaction related distribution or revenue sharing fees whichare summarized below. •     Platform service fees are generally recognized as revenue over    the term of the customer contract and represent charges in    connection with enabling the service and maintaining its overall    functionality during the term of the customer contract, which is    generally one to three years. We charge platform fees to our    customers in a variety of manners, including initial    set-up fees, monthly    only fees, or a combination of initial    set-up and monthly fees.  •     We also share in the proceeds of consumer transactions such as    digital downloads. Revenue from downloads is recognized at the    time the content is delivered, digitally, to the consumer.  •     A majority of our transactional revenue is generated through the    sale of prepaid credit packages which entitle a consumer to    access a specified number of digital music downloads or streams    for a fixed price during a fixed time period. Prepaid credit    packages are also bundled with other end consumer offerings    sponsored by our customers. Revenue from prepaid credit packages    and bundle promotions is deferred until the credits or    promotional offers are utilized or expire. Our margin on the    sale of prepaid credit packages fluctuates depending upon a    number of factors, including the type of service for which the    consumer redeems the credits (full downloads or streams), the    royalty rate for the download purchased and breakage.
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 •     Revenue from prepaid credit packages is deferred and then    recognized as tracks are downloaded by the consumer or as    credits expire, whichever occurs earlier.     *Encoding services revenue.* Revenue from encoding serviceswas relatively flat during the year ended December 31,2005, as compared to 2004. Substantially all of our encodingservices revenue is generated from encoding and fulfillmentservice fees for delivering EMI Music content to digital serviceproviders, or DSPs. In February 2006, we were notified by EMIMusic that it intends to transition all encoding services forEMI Music content to another service provider. According toinformation provided to us by EMI Music, the expected transitionplan will result in DSPs that are receiving encoded EMI Musiccontent from Loudeye being migrated to the new service providerduring the second quarter of 2006. We have entered intonegotiations with EMI Music regarding various elements of EMIMusic’s transition plan. We expect to continue generatingrevenue from encoding EMI Music catalog for DSPs during thefirst and second quarters of 2006 until EMI Music completes itstransition plan to another service provider. During 2006, wealso intend to continue our efforts to expand our encodingservices to additional customers and into additional markets,such as video encoding, but there can be no assurance that suchefforts will be successful. We expect that if the number of newDSPs that require encoding of substantial catalogs of digitalmedia decreases, revenue from our encoding services willsimilarly decrease. If we are unable to expand our encodingservices to additional customers and markets fast enough toreplace the revenue we would have expected to generate during2006 from our relationship with EMI Music, we would expect torestructure operations related to encoding services during thefirst half of 2006. Our response to EMI Music’s transitionplan may also have an impact on our samples, internet radio,hosting and webcasting services as these service offerings allutilize shared resources.     *Samples services revenue.* Revenue from samples servicesgenerally fluctuates based on the volume of content streamed forour customers, which is primarily driven by their needs and thelevel of activity on their websites. Samples services revenuedecreased during the year ended December 31, 2005, ascompared to the same period in 2004. This decrease wasattributable to a combination of pricing pressures and changesin the volume of paid content streamed. Samples service revenuefrom two customer relationships represented approximately 68% oftotal samples service revenue during the year endedDecember 31, 2005. If these customers do not renew, or ifwe were unsuccessful in securing license rights from contentowners to continue the samples service, revenue from our musicsamples services would decline. We expect that samples servicerevenue will continue to fluctuate in the future based on thesefactors, among others.     *Internet radio, hosting and webcasting services revenue.*In 2005, our most significant hosting services customer reducedits volume usage, resulting in a significant portion of thedecrease in Internet radio, hosting and webcasting servicesrevenue during the year ended December 31, 2005, ascompared to 2004. Revenue from hosting and webcasting servicesalso decreased during the year ended December 31, 2005, ascompared to the same period in 2004, primarily as a result ofcustomer terminations and other resulting decreases in thevolume of content streamed. Since late 2003, we ceased salesefforts for our hosting and webcasting services. Internet radioservices revenue was insignificant in 2005 and 2004. As theseservice offerings are not a strategic focus, we expect thatrevenue from these services will continue to decrease in thefuture.     *Media restoration services revenue.* Due to the transferof our media restoration business on January 30, 2004 andcompletion of the sale of those assets in May 2004, mediarestoration services revenue was zero for 2005 and we expectthat it will continue to be zero for future periods.     *Deposits and deferred revenue.* Deposits and deferredrevenue is comprised of the unrecognized revenue related tounearned platform fees, unutilized prepaid music creditpurchases and other prepayments for which the earnings processhas not been completed and is presented net of relatedreceivables. Deposits and deferred revenue at December 31,2005 was $6.4 million, net of related receivables ofapproximately $2.2 million, compared to approximately$5.7 million, net of related receivables of approximately$242,000, at December 31, 2004. The increase in deferredrevenue during the year ended December 31, 2005, isprimarily due to an increase in the number of deferred andunutilized prepaid credit packages and promotional music creditsfor our digital media store services.
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     Deposits and deferred revenue includes amounts related to atwelve month agreement entered into in the ordinary course ofbusiness with an internet service provider (ISP) in Europein February 2005, under which Loudeye is providing theISP’s customers promotional credits that may be redeemedfor a range of digital media download services through February2006. We will receive a fixed fee of approximately€1.8 million(approximately $2.2 million based on December 31, 2005exchange rates) under the agreement, of which we recognizedapproximately€1.4 million(approximately $1.7 million based on December 31, 2005exchange rates) in the fourth quarter 2005 and will recognizeapproximately€375,000(approximately $444,000 based on December 31, 2005 exchangerates) during the first quarter 2006. As of December 31,2005, deferred revenue related to this agreement was zero, netof related receivables of approximately€78,000(approximately $92,000 based on December 31, 2005 exchangerates), and deposits related to this agreement wereapproximately€300,000(approximately $355,000 based December 31, 2005 exchangerates). Because the transaction is denominated in Euros and wecurrently do not hedge the arrangement, we could be subject toforeign currency gains or losses. As of the date of this filing,no losses have been incurred or estimated under this agreement.     *Cost of revenue.* Cost of revenue includes the cost ofproduction, including personnel, cost of royalties to contentproviders and publishers, technical support, transactionprocessing fees, bandwidth and hosting costs, depreciation andamortization of infrastructure assets related to our serviceofferings, amortization of acquired technology resulting fromacquisitions, and an allocated portion of equipment, informationservices personnel and facility-related costs. Cost of revenueincreased during the year ended December 31, 2005, ascompared to the same period in 2004. Since we acquired OD2 inJune of 2004, we have continued to expand our digital mediaservices work force in order to meet the demands of anticipatedgrowth and new initiatives for our digital music store services.New initiatives during 2005 included development and enhancementof our mobile music platform, custom development for certain ofour music services and development of a subscription musicservice. Also, during 2005, we expanded our encoding serviceswork force and began making operational improvements to oursystems as we saw an increase in demand for EMI Music encodedproducts related to the launch and anticipated launch of severalnew DSPs. If we are unable to expand our encoding services toadditional customers and markets fast enough to replace the 2006revenue we expected to generate from our relationship with EMIMusic, we would expect our revenue from encoding services todecline significantly and we may, as a result, restructure theseoperations during the first half of 2006. Accordingly, cost ofrevenue could decline.     We also incurred increased fixed costs from investment in ourplatform, infrastructure and operations, as well as increasedlicensing costs. We expect these content licensing costs tocontinue to increase as recorded music companies continue theirefforts to raise wholesale content prices in an apparent attemptto cause an increase in prevailing retail prices of digitaldownloads of music content. There is also a trend, especiallyfor mobile operators, for recorded music labels to license theircontent directly to our customers, rather than through mastercontent licenses with us. The impact of this trend may be areduction in transactional revenue, and an increase in grossmargins as a percentage of revenue, if we report revenue on anet basis (net of third party content fees) rather than on agross basis. Gross margin as an absolute dollar amount would notbe impacted by a change in revenue reporting from a gross basisto a net basis. Gross profit margins are generally lower for ourmusic store services as compared to our other services,principally as a result of the significant royalties payable tothe content providers and publishers on each transaction.However, we earn a higher margin on platform service fees andour margins for our prepaid credit packages and promotionalbundling offerings will fluctuate, depending primarily uponbreakage levels experienced. As music store services grow, weexpect fluctuations in our overall gross profit marginpercentage depending upon our overall mix of revenue. We expectcost of revenue related to our digital media services tocontinue to increase in 2006, as revenue increases, as comparedto 2005.     Depreciation included in cost of revenue increased toapproximately $1.7 million in year ended December 31,2005 from approximately $1.2 million in the year endedDecember 31, 2004. This increase is due primarily to ouracquisition of OD2. Amortization expense included in cost ofrevenue was $378,000 in the year ended December 31, 2005and $439,000 in the year ended December 31, 2004 and isprimarily the result of the amortization of acquired technology.
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     *Sales and marketing.* Sales and marketing expenses consistprimarily of salaries, bonuses, commissions and benefits earnedby sales and marketing personnel, direct expenditures such astravel and communication, and marketing expenditures such asadvertising, public relations costs and trade show expenses andan allocated portion of equipment, information servicespersonnel and facility-related costs. Sales and marketingexpenses for the year ended December 31, 2005 increased ascompared to the same period in 2004, primarily due to increasedsales and marketing activities as a result of our acquisition ofOD2 in June 2004. Sales and marketing expenses as a percentageof total revenue declined during the year endedDecember 31, 2005 as compared to 2004, primarily as aresult of our increased revenue. We expect that we will continueto invest significantly in sales and marketing in 2006, as webelieve that a substantial sales and marketing effort isessential for us to grow our market position and increase marketacceptance of our digital media services, in particular ourdigital media store services.     *Research and development.* Research and developmentexpenses include labor and other related costs of the continueddevelopment and support of our digital media services and anallocated portion of equipment, information services personneland facility-related costs. To date, the substantial majority ofresearch and development costs have been expensed as incurred.Research and development expenses for the year endedDecember 31, 2005 continued to increase as compared to thesame period in 2004, as an absolute dollar amount and as apercentage of revenue, due both to the acquisition of OD2 andexpanded development efforts relating to our digital media storeservices offerings, including mobile offerings, as well as anincrease in allocated equipment and facility-related costs. Webelieve that a significant research and development investmentis essential for us to maintain our market position, to continueto expand our digital media services offerings, in particularour digital media store services, and to develop additionalapplications. Accordingly, we anticipate that we will continueto invest in research and development for the foreseeablefuture, and we anticipate research and development costs as anabsolute dollar amount will fluctuate, depending primarily uponthe volume of forecasted future revenue, customer needs,staffing levels, overhead costs and our assessment of marketdemands. Primarily as a result of cost reductions undertaken inthe first quarter 2006, we anticipate that 2006 research anddevelopment costs will be lower than in 2005. If we are unableto expand our encoding services to additional customers andmarkets fast enough to replace the 2006 revenue we expected togenerate from our relationship with EMI Music, we would expectto restructure these operations during the first half of 2006and research and development costs could decline as a result.     *General and administrative.* General and administrativeexpenses consist primarily of salaries, benefits and relatedcosts for executive, finance, legal and administrativepersonnel, legal expenses, an allocated portion of equipment,information services personnel and facility-related costs, andcosts associated with being a public company, including but notlimited to, consulting, audit and legal fees related to theSarbanes-Oxley internal control over financial reportingcertification requirements, annual and other public-reportingcosts, directors’ and officers’ liability insurance,investor relations, and professional services fees. General andadministrative expenses for the year ended December 31,2005 increased as compared to the same period in 2004 primarilyas a result of our acquisition of OD2 in 2004, increases in ourpersonnel costs and other resources to support our growth,severance costs, legal matters, costs related to SEC filings andadditional professional fees in order to comply with therequirements under the Sarbanes-Oxley Act of 2002, partiallyoffset by a decrease in the amount allocated for equipment,information services personnel and facility-related costs.General and administrative expenses as a percentage of totalrevenue declined during the year ended December 31, 2005 ascompared to the same period in 2004, primarily as a result ofour increased revenue. We expect that we will continue to incurgeneral and administrative expenses in varying degreesthroughout 2006.     *Amortization of intangibles.* Amortization of intangiblesincludes amortization of identified intangible assets related toacquisitions other than acquired technology, which is includedin cost of revenue. Beginning in the second quarter 2004 weincurred amortization expense related to our acquisition of OD2.In June 2005, we acquired a patent which defines a system forclosely imitating digital media files on peer to peer networks.Accordingly, we expect amortization expense on an annual basisfor 2006 to increase over 2005 levels.
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     *Stock-based compensation.* Stock-based compensation forthe year ended December 31, 2005 totaled $342,000, of which$92,000 was included in cost of revenue, and consistedprincipally of the vesting of restricted stock grants in theamount of $200,000, the amortization of deferred stockcompensation of $59,000, and $80,000 in amortization related towarrants granted in exchange for services. Stock-basedcompensation totaled $316,000 in 2004, of which $117,000 isincluded in cost of revenue, consisting primarily of theamortization of deferred stock compensation of $276,000. Weexpect stock based compensation expense to increase in futureperiods as compared to 2005, due primarily to the implementationof FAS 123R which will require us to recognize compensationcost related to options and vesting of restricted stock awardstotaling approximately 1.5 million shares that were grantedduring the year ended December 31, 2005.     *Special charges (credits).* For the year endedDecember 31, 2005 and 2004, the amounts recorded as specialcharges (credits) related to facilities consolidations, andwere charges (credits) of ($43,000) and $312,000 during theyear ended December 31, 2005 and 2004. In the first quarter2005, as discussed in Note 5 to the consolidated financialstatements, we paid $360,000 of the $403,000 then remainingaccrued special charge balance, as a final payment related toour former facility at 414 Olive Way, Seattle, Washington, andthe $43,000 difference between the amount previously recorded inaccrued special charges and the final settlement amounts of theunderlying liabilities was reflected as a net credit to specialcharges (credits) in the consolidated statements ofoperations. In 2004, as discussed in Note 5 to theconsolidated financial statements, we increased our estimate ofthe settlement and facilities related charges we wouldultimately be required to pay related to Loudeye’sunoccupied facility at 414 Olive Way, Seattle, Washington byapproximately $362,000. This increase was offset by a $50,000decrease in the accrual related to Loudeye’s Vidipaxfacility in New York, New York which was recognized as a creditto special charges in the first quarter 2004.     The following table reflects the activity in accrued specialcharges for the year ended December 31, 2005 (in thousands):       **Facilities-related**  **Charges**       Balance, December 31, 2004 $403     Additional accruals  —     Payments  (360)    Adjustments  (43)        Balance, December 31, 2005 $—          *Interest income.* Interest income consists of interestincome and realized gains and losses on sales of our marketablesecurities. Interest income for the year ended December 31,2005 increased as compared to the same period in 2004, primarilydue to higher average investment balance resulting from theproceeds received from the private equity financings completedin February 2004 and December 2004. We expect interest incomewill fluctuate during 2006 depending upon our average investmentbalances and yield rates throughout the year.     *Interest expense.* Interest expense for the year endedDecember 31, 2005 decreased as compared to the same periodin 2004, due to lower average debt balances but higher interestrates during 2005 as compared to 2004 and the voluntaryrepayment in full of our line of credit in March 2004. We expectthat interest expense will continue to fluctuate in 2006 inrelation to interest rates as we continue to make principalpayments against our term loan balance.     *Gain on sale of media restoration assets.* As discussedabove, we sold our media restoration business onJanuary 30, 2004 and completed the sale in May 2004. Thedifference between the proceeds received from after release ofcertain escrow claims and the carrying value of the assets was$156,000 and is reflected as a gain on the sale for the yearended December 31, 2004.
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     *Other income, net.* Other income for the year endedDecember 31, 2005 consists principally of net foreignexchange transaction gains of $367,000. These gains wereprimarily the result of the impact of the relativelystrengthened U.S. dollar on U.K. pound denominatedliabilities incurred in connection with our acquisition of OD2.Other expense for the year ended December 31, 2004consisted principally of foreign currency transaction losses onthe accrued acquisition consideration related to our acquisitionof OD2 in June 2004.     *Income taxes.* Loss before income taxes consists of thefollowing (in thousands):               **Years Ended December 31,**     **2005** **2004** **2003**           United States $(23,856) $(11,182) $(19,174)    Foreign  (9,505)  (5,215)  —             $(33,361) $(16,397) $(19,174)               Our income tax benefit differs from the expected income taxbenefit computed by applying the U.S. federal statutory rate of35% to net loss before income taxes as follows (in thousands):               **Years Ended December 31,**     **2005** **2004** **2003**           Income tax benefit at statutory rate of 35% $(11,676) $(5,575) $(6,519)    State taxes  (99)  —   —     International taxes, rate differential  778   209   —     Goodwill impairment  665   —   —     Research and development credit  (276)  (132)  —     Other  88   —   —     Change in valuation allowance  10,520   5,498   6,519               Income tax provision (benefit) $—  $—  $—                We have not recorded income tax benefits related to our netoperating losses in 2005 or 2004 as a result of theuncertainties regarding the realization of such net operatinglosses. Our foreign operations also have net operating losses.At December 31, 2005, Loudeye had U.S. operating netoperating loss carryforwards of approximately$232.8 million and foreign net operating loss carryforwardsof approximately $26.0 million. We also had research anddevelopment tax credit carryforwards of approximately $437,000as of December 31, 2005. Approximately $18.5 millionof our net operating loss carryforwards were acquired inbusiness combinations. If these acquired net operating losscarryforwards become recoverable in the future, they will beused to first reduce to zero any goodwill, and then reduce tozero any other non-current intangible assets associated with thebusiness combinations, and then any remaining net operating losscarryforwards recovered will be recognized as a reduction inincome tax expense. Under the provisions of Section 382 ofthe Internal Revenue Code, the Tax Reform Act of 1986 limits theuse of net operating loss and tax credit carryforwards incertain situations where changes occur in the stock ownership ofa company. Loudeye has experienced such ownership changes as aresult of its various stock offerings, and the utilization ofthe carry forwards could be limited such that a portion of thenet operating losses may never be utilizable. Approximately$1.1 million of the net operating loss carryforwards and aportion of the valuation allowance at December 31, 2005resulted from deductions associated with the exercise ofnon-qualified employee stock options, the realization of whichwould result in a credit to stockholders’ equity.     *Loss from Discontinued Operations.* In March 2004, wecompleted the acquisition of Overpeer. On December 9, 2005,we announced that Overpeer had ceased its content protectionservices operations effective immediately. Overpeer’s totalrevenue and operating losses for the year endedDecember 31, 2005 were approximately $1.8 million andwere approximately $7.8 million. Overpeer’s totalrevenue and
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operating losses for the period from acquisition (March 2004)through December 31, 2004 were approximately$2.8 million, and $400,000.     Included in Overpeer’s 2005 operating expenses were thefollowing special charges related to the cessation of theOverpeer business:         Goodwill impairment $1,879     Acquired technology and customer lists impairment  834     Property and equipment impairment  591     Employee severance and termination benefits  244     Facilities related charges (credits)  173       $3,721          The closure of Overpeer meets the criteria of a “componentof an entity” as defined in FAS 144. The operationsand cash flow of those components have been eliminated from theongoing operations of Loudeye as a result of the disposal, andwe do not have any significant involvement in the operations ofthat component after the disposal transaction. Accordingly, inaccordance with the provisions of FAS 144, the results ofoperations of Overpeer are reported as discontinued operationsin the accompanying consolidated financial statements. Theprior-year results of operations for Overpeer have beenreclassified to conform to this presentation.***Years ended December 31, 2004 and 2003***     *Revenue.* Revenue increased in 2004 to $14.0 millionfrom $11.9 million in 2003 due primarily to the acquisitionof OD2 (which generated a substantial majority of our 2004 musicstore services revenue) as well as increased encoding revenue,offset by declining revenue in our internet radio, hosting andwebcasting service offerings, and declining revenue followingthe sale of our media restoration services segment.     During 2004, one customer accounted for approximately 21% oftotal revenue. During the year ended December 31, 2003,revenue from two customers represented 16% of total revenue.Revenue generated from our international operations was$5.5 million in 2004 compared to zero in 2003, due to ouracquisition of OD2 in June 2004.     During 2004, our service mix changed significantly. We acquiredOD2 in late June 2004, which resulted in a significant increasein digital media store services revenue. In May 2004, wecompleted the sale of all of the assets of our media restorationservices business pursuant to an agreement datedOctober 31, 2003.     *Digital media store services revenue.* Revenue fromdigital media store services increased in 2004 as compared to2003 primarily as a result of our acquisition of OD2 in June2004. In June 2004, we acquired OD2, and our consolidatedfinancial statements include the results of their operationssince the June 22, 2004 closing date of the acquisition. Wealso launched a music store customer in the U.S. on theLoudeye-developed platform in September 2004. Digital mediastore services revenue, both in the U.S. and abroad, wasapproximately $5.9 million in 2004. In 2003, we generatedapproximately $171,000 of digital media store services revenuefrom fulfillment of ringtunes and rights clearing services.Digital media store services revenue as a percentage of totalrevenue was 42% in 2004 and 1% in 2003. In the fourth quarter2004, digital media store services revenue increasedsignificantly from $1.9 million in the third quarter of2004 to $3.7 million in the fourth quarter 2004, a 95%increase primarily attributable to increased transactionalvolume from our music store services.     *Encoding revenue.* Revenue from encoding servicesincreased to $3.8 million in 2004 from $2.4 million in2003. Revenue from encoding services generally fluctuates basedon the volume of the content delivered to our customers and theprice charged for the services provided. In 2004, there was
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increased demand from our customers for encoding services,primarily for the delivery of digital music, as our customersfocused on launching digital music services, which drove volumeup from 2003.     *Samples services revenue.* Revenue from samples servicesgenerally fluctuates based on the volume of content streamed forour customers, which is primarily driven by their needs and thelevel of activity on their websites. Samples services revenuedeclined approximately 6% for the year ended December 31,2004 compared to 2003 from $1.7 million to$1.6 million. This decrease was attributable to acombination of pricing pressures and changes in the volume ofpaid content streamed.     *Internet radio, hosting and webcasting services revenue.*Revenue from Internet radio, hosting and webcasting servicesdecreased to $2.4 million in 2004 from $5.8 million in2003. Revenue from Internet radio, hosting and webcastingservices generally fluctuates based on the volume of contentstreamed for our customers, which is primarily driven by theirneeds and the level of activity on their websites. During thefourth quarter 2003, we had a license sale of approximately$300,000 for hosting services. In late 2003, we refocused ourwebcasting services on customer relationships that providehigher margins. The decrease in internet radio, hosting andwebcasting services revenue for 2004 as compared to 2003primarily relates to a decreased volume of content streamed andthe fact that we had no license sales in 2004 similar to the2003 transaction.     *Media restoration services revenue.* Pursuant to anagreement dated October 31, 2003 we sold all of the assetsof our media restoration business on January 30, 2004 andcompleted the sale in May 2004. At closing, we also entered intoa co-marketing and reseller agreement with the purchaserpursuant to which we will sell, for a fee, media restorationservices on behalf of the purchaser for a two-year period. Theco-marketing and reseller agreement and earn-out provisions ofthe transaction constitute continuing involvement underFAS 144. Consequently, our media restoration business hasnot been reported as a discontinued operation. Because our mediarestoration subsidiary continued to be the primary obligor undercertain contracts with the U.S. General ServicesAdministrative (GSA) until their assignment on May 17,2004, revenue and cost of revenue in the consolidated statementsof operations of Loudeye for the year ended December 31,2004 include the revenue from services provided under the GSAContracts, totaling $213,000 for the year endedDecember 31, 2004. This revenue is entirely offset by theassociated cost of revenue.     *Deferred revenue.* Deferred revenue is comprised of theunrecognized revenue related to unearned platform fees and otherprepayments for which the earnings process has not beencompleted. Deferred revenue at December 31, 2004 was$7.5 million compared to approximately $0.7 million atDecember 31, 2003. As discussed above, in June 2004, weacquired OD2 and our consolidated financial statements includethe results of their operations since the date of acquisition.Deferred revenue at December 31, 2004 includes$5.2 million relating to OD2’s music store serviceswhich are a part of our digital media store services. Theremaining increase in deferred revenue during 2004 is primarilydue to recognition of revenue on existing contracts occurring ata slower rate than revenue deferrals under new contracts.     *Cost of revenue.* Cost of revenue increased to$10.3 million in 2004 from $8.1 million in 2003. Weimplemented cost reduction initiatives related to ourrestructuring in March 2003; however, in 2004 we began to expandour digital media services work force in order to meet thedemands of anticipated growth and new initiatives particularlyin relation to our music store services. In addition, costsassociated with the delivery of digital media store servicesrevenue from our acquisition of OD2 in late June 2004contributed to the increase in cost of revenue compared to 2003.     Depreciation included in cost of revenue increased toapproximately $1.7 million in year ended December 31,2004 from approximately $849,000 in 2003. This increase is dueprimarily to our acquisition of OD2. In addition, we purchased$1.5 million in equipment in the first quarter 2004 toupgrade the storage and access systems for our digital musicarchive. Amortization expense included in cost of revenue was$439,000 in the year ended December 31, 2004 and $269,000in the year ended December 31, 2003 and is primarily theresult of the amortization of acquired technology. In 2003, costof revenue also included $601,000 related to impairment ofacquired intangible assets.
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     *Sales and marketing.* Sales and marketing expenses for2004 increased to approximately $4.2 million fromapproximately $3.3 million in 2003, primarily due toincreases resulting from our acquisition of OD2. These expenseswere offset in part by cost reduction initiatives implemented in2003 and 2004. Sales and marketing expenses as a percentage oftotal revenue were 30% in 2004 and 28% in 2003.     *Research and development.* Research and developmentexpenses increased to approximately $3.7 million in 2004from approximately $1.7 million in 2003 primarily as aresult of the inclusion of research and development expensesrelated to the acquisition of OD2.     *General and administrative.* General and administrativeexpenses increased to approximately $10.7 million fromapproximately $8.7 million in 2003, primarily as a resultof our acquisition of OD2. We incurred costs associated with ourfirst annual Sarbanes-Oxley internal control assessment andcertification. We also incurred costs associated with turnoverin our accounting and finance department during the second halfof 2004.     *Amortization of intangibles.* We recorded impairmentcharges in the first quarter 2003 relating to our restructuring,and our remaining intangibles, other than those related to theOverpeer and OD2 acquisitions, were either written off or fullyamortized by the first quarter of 2004. Beginning in the firstquarter 2004 we incurred additional amortization expense relatedto our acquisition of OD2.     *Stock-based compensation.* Stock-based compensationtotaled $316,000 in 2004, of which $117,000 is included in costof revenue, consisting primarily of the amortization of deferredstock compensation of $276,000. Stock-based compensation for2003 totaled $1.3 million, consisting of the amortizationof deferred stock compensation of $398,000, stock-basedcompensation expense of $730,000 related to stock optionsgranted to a member of our board of directors for consultingservices provided through September 30, 2003, variablestock compensation expense of $64,000 related to stock optionsthat were repriced in 2001, stock and options issued to formeremployees as severance and termination benefits of $99,000, andstock options issued to a consultant of $7,000.     *Special charges.* We recorded special charges related tocorporate restructurings, facilities consolidations and theimpairment of assets in accordance with our long-lived assetpolicy. Following is a summary of special charges for 2004 and2003 (in thousands):           **Years Ended**  **December 31,**     **2004** **2003**         Goodwill impairment $—  $5,307     Customer lists and other intangible assets impairment  —   84     Property and equipment impairment  —   670     Employee severance and termination benefits  —   501     Facilities related charges  312   658          $312  $7,220             For certain lease terminations, the settlement amounts were lessthan we had accrued initially due to favorable negotiations withlandlords and improvements in real estate markets. In othercases, we increased our accruals as a result of our ongoingevaluations of our lease obligations. The adjustments resultingfrom these settlements and additional accruals were recorded inspecial charges in the consolidated statements of operations. In2004, as discussed in Note 5 to the consolidated financialstatements, we increased our estimate of the settlement amountand facilities related charges we would ultimately be requiredto pay related to Loudeye’s unoccupied facility at 414Olive Way, Seattle, Washington by approximately $362,000. Thisincrease was offset by a $50,000 decrease in the accrual relatedto Loudeye’s VidiPax facility in New York, New York whichwas recognized as a credit to special charges in first quarter2004.
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     The following table summarizes the activity in accrued specialcharges during the year ended December 31, 2004 (inthousands). The majority of these accrued charges, whichprimarily represent rent settlement obligations, were paid inJanuary 2005.       **Facilities-related**  **Charges**       Balance, December 31, 2003 $1,670     Additional accruals  362     Payments  (1,459)    Adjustments  (170)        Balance, December 31, 2004 $403          *Interest income.* Interest income totaled $377,000 in 2004compared to $347,000 in 2003. Interest income consists ofinterest income and realized gains and losses on sales of ourmarketable securities. The increase was due primarily to higheraverage investment balance resulting from the proceeds receivedfrom the private equity financings completed in August 2003,February 2004 and December 2004.     *Interest expense.* Interest expense totaled $201,000 in2004 compared to $286,000 in 2003, due to lower average debtbalances and lower interest rates during 2004 and the voluntaryrepayment in full of our line of credit in March 2004.     *Gain on sale of media restoration assets.* As discussedabove, we sold our media restoration business onJanuary 30, 2004 and completed the sale in May 2004. Thegain on sale of media restoration assets in 2004 represents thenet gain on the sale of net assets transferred under contractualarrangement and release of certain escrow claims. Thistransaction is described more fully in Note 6 to theconsolidated financial statements.     *Increase in fair value of common stock warrants.* Theincrease in fair value of common stock warrants of $248,000 in2003 represented the increase in the estimated fair value of thewarrants that we issued in connection with our private equityfinancing in August 2003.     *Other income (expense), net.* Other expense for 2004consists principally of net foreign exchange translation loss of$833,000. This loss was primarily the result of the impact ofthe weakened U.S. dollar on U.K. pound denominatedliabilities incurred in connection with our acquisition of OD2.Other income for 2003 of $120,000 consisted principally of gainson sales of excess equipment.     *Income taxes.* We have not recorded income tax benefitsrelated to our net operating losses in 2004 or 2003 as a resultof the uncertainties regarding the realization of such netoperating losses. Our foreign operations also have net operatinglosses. At December 31, 2004, Loudeye hadU.S. operating net operating loss carryforwards ofapproximately $210.0 million and foreign net operating losscarryforwards of approximately $5.0 million. We also hadresearch and development tax credit carryforwards ofapproximately $160,000 as of December 31, 2004. Certain ofour net operating loss carryforwards were acquired in businesscombinations. If these acquired net operating loss carryforwardsbecome recoverable in the future, they will be used to firstreduce to zero any goodwill, and then reduce to zero any othernon-current intangible assets associated with the businesscombinations, and then any remaining net operating losscarryforwards recovered will be recognized as a reduction inincome tax expense. Under the provisions of Section 382 ofthe Internal Revenue Code, the Tax Reform Act of 1986 limits theuse of net operating loss and tax credit carryforwards incertain situations where changes occur in the stock ownership ofa company. Loudeye has experienced such ownership changes as aresult of its various stock offerings, and the utilization ofthe carry forwards could be limited such that a portion of thenet operating losses may never be utilizable. The U.S. netoperating loss carryforwards increased during 2004 byapproximately $119,000 due to the acquisition of Overpeer. Theforeign net operating loss carryforwards increased byapproximately $5.0 million due to the acquisition of OD2.However, these losses will be subject to limitation under theprovisions of Section 382 discussed above. Approximately$2.7 million of the net operating loss carryforwards and aportion of the valuation allowance at December 31, 2004resulted from
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deductions associated with the exercise of non-qualifiedemployee stock options, the realization of which would result ina credit to stockholders’ equity.     *Loss from Discontinued Operations.* In March 2004, wecompleted the acquisition of Overpeer. On December 9, 2005,we announced that Overpeer had ceased its content protectionservices operations effective immediately. Overpeer’s totalrevenue and operating losses from acquisition (March 2004) toDecember 31, 2004 were approximately $2.8 million and$400,000, respectively. The closure of Overpeer in December of2005 meets the criteria of a “component of an entity”as defined in FAS 144. The operations and cash flow ofthose components have been eliminated from the ongoingoperations of Loudeye as a result of the disposal, and we do nothave any significant involvement in the operations of thatcomponent after the disposal transaction. Accordingly, inaccordance with the provisions of SFAS 144, the results ofoperations of Overpeer are reported as discontinued operationsin the accompanying consolidated financial statements.**Liquidity, Capital Resources and Going Concern**     We have financed our operations primarily through proceeds frompublic and private sales of our equity securities. To a lesserextent, we have financed our operations through equipmentfinancing and traditional lending arrangements. Our principalsource of liquidity at December 31, 2005 was our cash, cashequivalents and marketable securities. As of December 31,2005, we had approximately $9.0 million of unrestrictedcash, cash equivalents and marketable securities.     We have prepared our consolidated financial statements assumingthat we will continue as a going concern, which contemplatesrealization of assets and the satisfaction of liabilities in thenormal course of business. We have incurred net losses sinceinception, have an accumulated deficit of approximately$242.6 million at December 31, 2005, and haveexperienced negative cash flows from operations in substantiallyall quarters of our operations since inception. The expansionand development of our business will require significantcapital. As of December 31, 2005, we had negative workingcapital of $1.9 million compared with positive workingcapital of $13.8 million at December 31, 2004. Thesefactors, among others, raise substantial doubt aboutLoudeye’s ability to continue as a going concern.Management is implementing plans to address our liquidity needs,including restructuring our operations, reducing our work force,divesting or discontinuing the operations of acquired companies,renegotiating existing agreements with customers and vendors,and taking other actions to limit our expenditures. In February2006, we completed an equity financing transaction raising netproceeds of approximately $7.6 million. However, we mayrequire additional capital to fund our ongoing operations. Ourhistory of declining market valuation and volatility in ourstock price could make it difficult for us to raise capital onfavorable terms, or at all. Any financing we obtain may diluteor otherwise impair the ownership interest of our currentstockholders. If we fail to generate positive cash flows or failto obtain additional capital when required, we could modify,delay or abandon some or all of our business and expansionplans. The accompanying audited consolidated financialstatements do not include any adjustments that may result fromthe outcome of this uncertainty.     In March 2004, we completed the acquisition of Overpeer, Inc.(“Overpeer”), a privately held company based in NewYork. On December 9, 2005, we announced that Overpeer hadceased its content protection services operations effectiveimmediately. We had been funding Overpeer’s operationsunder an intercompany loan agreement pursuant to which we held asecurity interest in all of the assets of Overpeer. In November2005, we delivered to Overpeer a notice of default andacceleration of indebtedness pursuant to the intercompany loanagreement. Following Overpeer’s acknowledgment of defaultunder intercompany loan agreement, we took possession ofOverpeer’s assets and foreclosed on Overpeer’s assetsin partial satisfaction of Overpeer’s outstandingindebtedness to Loudeye. During the first half of 2006, weexpect to either use these assets in Loudeye’s ongoingoperations or determine a plan of sale.     We have recorded certain non-cash impairment charges relating toa write-down of the carrying value of all of the goodwill andsome of the long-lived assets associated with our Overpeersubsidiary in connection with the discontinuance of the Overpeerbusiness. The fair values of each of these assets were
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estimated using primarily a probability weighted discounted cashflow method. The impairment of goodwill was determined under thetwo-step process required by FAS 142. The Overpeertechnology, Overpeer’s customer relationships, Overpeeremployee non-compete agreements, and Overpeer trademarks with anaggregate net book value of approximately $834,000 have nocontinuing value in ongoing operations as a result of thecessation of the Overpeer business. In addition, we determinedthat the net book value of certain Overpeer fixed assets andleasehold improvements exceeded their estimated fair marketvalue as of November 30, 2005, by approximately $591,000.     Overpeer incurred approximately $200,000 in severance andrelated payroll costs associated with the closing of itsoperations which was paid during December 2005. In addition, anon-cash stock compensation expense of approximately $40,000 wasrecorded relating to acceleration of vesting of a restrictedstock award to a former Overpeer employee.     Overpeer was a party to a lease agreement for premises locatedin New York City. The lease had a ten year term running throughSeptember 2015. Annual rent obligations under the lease wereapproximately $175,000, subject to annual adjustment. Under thelease, Loudeye was required to post an approximate $175,000security deposit in the form of a letter of credit. In December2005, the landlord drew down the letter of credit in full andterminated the lease. In February 2006, Overpeer, Loudeye andthe landlord reached a settlement pursuant to which the Landlordreleased Overpeer and Loudeye from any future obligations withrespect to the lease in exchange for the landlord retaining theapproximate $175,000 security deposit and certain Loudeye-ownedfurniture with a net book value of approximately $78,000. Forthe year ended December 31, 2005, we included a non-cashcharge of approximately $253,000 in loss from discontinuedoperations relating to the lease, offset in part by a deferredrent credit of approximately $80,000 resulting from the earlylease termination.     On December 15, 2005, Savvis Communications Corp. filed acomplaint in Superior Court in Santa Clara County,California, against Overpeer and Loudeye relating to a May 2002Master Services Agreement between Savvis and Overpeer forcollocation and bandwidth services (the “Overpeer-SavvisAgreement”). The complaint alleges Overpeer breached theOverpeer-Savvis Agreement for non-payment. The complaint alsocontains alter ego allegations against Loudeye. The complaintseeks damages of $1.6 million consisting of $950,000 ofallegedly unpaid invoices for services and approximately$600,000 in alleged early termination fees. The court hasgranted Savvis a writ of attachment over Overpeer’s assetslocated in the state of California. In February 2006, Overpeerand Loudeye filed a joint motion to compel arbitration of thedispute under the terms of the agreement between Savvis andOverpeer. The motion is scheduled to be heard on March 30,2006. Loudeye assesses the probability of a judgment againstOverpeer relating to the $950,000 in unpaid invoices as high.Loudeye is not a party to the Overpeer-Savvis Agreement. Loudeyeintends to defend itself vigorously concerning the alter egoclaims brought by Savvis. However, we cannot assess at this timethe probability of an unfavorable outcome with respect to theclaims brought against Loudeye.     During 2005 and continuing in the first quarter 2006, weimplemented cost containment efforts and recorded specialcharges (included in discontinued operations) related tocorporate restructurings and facilities consolidation. Wecontinue to focus on maximizing the performance of our businessand controlling costs to respond to the economic environment andwill continue to evaluate our underlying cost structure toimprove our operating results and better position ourselves forgrowth. As such, we may incur further facility consolidations orrestructuring charges, including severance, benefits and relatedcosts due to a reduction in workforce and/or charges for assetsdisposed of or removed from operations as a direct result of areduction in workforce.     In March 2005, we completed a restructuring of remainingdeferred and contingent payment obligations to certain formershareholders of OD2. This restructuring was agreed to by all ofthe former OD2 shareholders entitled to receive additionaldeferred and contingent payment consideration and it satisfiesin full those obligations. As part of the restructuring, we paid$2.5 million in March 2005, $2.3 million in July 2005and $800,000 in December 2005 in cash in full satisfaction ofour obligations to the former shareholders of OD2.
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     On February 20, 2006, we entered into a SubscriptionAgreement with a limited number of institutional investorspursuant to which we agreed to sell and issue to such investors16,500,000 shares of its common stock, together withwarrants to purchase 12,375,000 shares of common stockat an exercise price of $0.68 per share, for an aggregatepurchase price of $8.25 million. We consummated thetransaction on February 22, 2006. The warrants are notexercisable until six months after the closing date and are thenexercisable until the fifth anniversary of the closing date. Wealso granted the investors a one year right to purchase 30%of any securities sold by Loudeye in future financings, subjectto exceptions. We have agreed to pay a placement fee ofapproximately $557,000 in connection with the financing. Thetransaction resulted in net proceeds of approximately$7.6 million.     The transaction documents relating to the February 2006 privateplacement provide that if we implement a reverse stock splitwithin six months of the closing of the private placement andthe volume weighted average trading price of Loudeye’scommon stock on the Nasdaq Capital Market for the twenty tradingdays immediately following the date the effectiveness of suchsplit is announced is less than the lesser of $0.50 or theclosing price of Loudeye’s common stock on the NasdaqCapital Market on the date of the announcement of theeffectiveness of such stock split is announced, then Loudeyewill be required to pay an amount in cash or stock, atLoudeye’s election, to the investors in the privateplacement in the amounts described below. The amount of any suchpayment to an investor will not in any event exceed ten percent(10%) of the aggregate purchase price paid by such investor inthe private placement. Subject to such limitation, if we electto make such payment (if any) in cash, the amount to be paid toan investor would equal the number of shares of common stockpurchased by such investor in the private placement that arethen held by that investor multiplied by the lesser of(a) the difference between the closing price ofLoudeye’s common stock on the Nasdaq Capital Market on thedate of the announcement of the effectiveness of such split andthe volume weighted average trading price of Loudeye’scommon stock on the Nasdaq Capital Market for the twenty tradingdays immediately following the date the effectiveness of suchsplit is announced, or (b) $0.50 less the average tradingprice of Loudeye’s common stock on the Nasdaq CapitalMarket for the twenty trading days immediately following thedate the effectiveness of such split is announced. If we electto make such payment (if any) in shares of Loudeye common stock,the amount of shares to be issued to an investor (the“Additional Shares”) would equal the cash amount to bepaid to such investor described above divided by the volumeweighted average trading price of Loudeye’s common stock onthe Nasdaq Capital Market for the twenty trading daysimmediately following the date the effectiveness of such splitis announced. Any such issuance of Additional Shares would besubject to the approval of Loudeye’s stockholders to theextent necessary to comply with the rules of the Nasdaq CapitalMarket.     In connection with the February 2006 financing, we are requiredto use our best efforts to file a registration statementcovering the shares of common stock to be issued and the commonstock underlying the warrants within 45 days after theclosing date. We are also required to use our best efforts tofile a registration statement covering any Additional Sharesthat we elect to issue to satisfy any amounts that may becomedue to investors following a reverse stock split, if any. We arealso required to use our commercially reasonable efforts to haveeither registration statement declared effective within120 days (or within 90 days if the Securities andExchange Commission does not review the registration statement).In the event we do not file the initial registration statementby the required filing date or if the initial registrationstatement is not declared effective by the requiredeffectiveness date, we would owe an investor liquidated damagesof 1% per month of the aggregate purchase price paid by theinvestor, pro rated for the days of noncompliance with theregistration requirements. The maximum aggregate amount ofliquidated damages payable to an investor pursuant to theseprovisions cannot exceed eight percent (8%) of the aggregatepurchase price paid by such investor.     By the end of 2006, we anticipate that our costs and operatingexpenses, excluding restructuring-related charges anddepreciation and amortization, will track to a level that isclose to our expected revenue while allowing us to continue toinvest in accordance with our strategic priorities. However, wemay be unable to achieve these expense levels without adverselyaffecting our business and results of
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operations. We may continue to experience losses and negativecash flows in the near term, even if sales of our services grow.     While we will continue to implement cost containment effortsacross our business, our operating expenses will consume amaterial amount of our cash resources. We are evaluating severalalternatives to address our liquidity needs, includingrestructuring our operations, reducing our work force,renegotiating existing agreements with customers and vendors,and taking other actions to limit our expenditures.     If we fail to generate positive cash flows or fail to obtainadditional capital when and if required, we could modify, delayor abandon some or all of our business and expansion plans. Ourconsolidated financial statements do not include any adjustmentsthat may result from the outcome of this uncertainty.     We believe that our financial resources, including proceeds fromour recent capital raise, will be sufficient to meet ouranticipated cash needs for working capital or other purposes forat least the next twelve months. However, we may requireadditional capital to fund our ongoing operations. There can beno assurance that capital will be available to us on acceptableterms, or at all. Our history of declining market valuation andvolatility in our stock price could make it difficult for us toraise capital on favorable terms. Any financing we obtain maydilute or otherwise impair the ownership interest of our currentstockholders.     Net cash used in operating activities was approximately$21.5 million, $14.7 million and $7.3 million forthe years ended December 31, 2005, 2004 and 2003. For 2005,cash used in operating activities resulted primarily from a lossfrom continuing operations of $25.6 million, adjusted bynon-cash charges for depreciation and amortization ofapproximately $3.3 million, stock-based compensationcharges and other non cash items aggregating $277,000, a netforeign currency transaction gain of $367,000, and other workingcapital changes. For the year ended December 31, 2004, cashused in operating activities resulted primarily from loss fromcontinuing operations of $16.0 million, partially offset bynon-cash charges for depreciation and amortization ofapproximately $2.3 million, stock based compensationcharges and other non cash items aggregating $152,000 and netforeign currency transaction losses of $833,000, and increasedby other adjustments and working capital changes. For 2003, cashused in operating activities resulted primarily from net lossesof $19.2 million, offset partially by charges, depreciationand amortization and increased by other adjustments and workingcapital charges. Cash used in operations is dependent upon ourability to achieve positive earnings and the timing of ourpayments and collections and we expect that it will continue tofluctuate from period to period.     Net cash provided by investing activities was approximately$492,000 for the year ended December 31, 2005 and consistedprincipally of payments made to former OD2 shareholders of$5.6 million and purchases of property and equipment of$2.3 million, partially offset by net sales of short-termmarketable securities of $9.7 million. In addition,investing cash flows from discontinued operations wereapproximately $1.3 million. In June 2005, Overpeer acquireda patent which defines a system for closely imitating digitalmedia files onpeer-to-peer networksfor $1.3 million. In December 2005, Overpeer ceasedoperations and its operating results are presented asdiscontinued operations in the consolidated financial statementsfor the years ended December 31, 2005 and 2004. For 2004,cash used in investing activities was approximately$9.4 million and consisted principally of the net purchasesof short-term marketable securities of $4.2 million andpurchases of property and equipment of $4.1 million,consisting principally of equipment to upgrade the storage andaccess systems for our digital music archive. Our discontinuedoperation, Overpeer, used net cash in investing activities ofapproximately $1.8 million, primarily related to purchasesof property and equipment. In addition, net cash ofapproximately $555,000 was used related to our acquisitions ofOD2 and Overpeer. This was partially offset by proceeds ofapproximately $1.0 million from assets held for sale. For2003, net cash provided by investing activities was$1.7 million and was comprised principally of net sales ofshort-term marketable securities of $518,000 and paymentsreceived on loans made to related parties of $1.2 million.     Cash used in financing activities in the year endedDecember 31, 2005 was approximately $872,000, consistingprimarily of principal payments on our debt and capital leaseobligations of $1.1 million, adjusted net proceeds fromprivate equity financing of negative $464,000, partially offsetby net proceeds
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from the exercise of stock options of $727,000. Cash provided byfinancing activities in 2004 was $41.0 million, consistingprimarily of net proceeds from the private equity financing inFebruary 2004 of $18.9 million, net proceeds from theprivate equity financing in December 2004 of $23.5 millionand proceeds from the exercise of stock options and warrants of$1.2 million. This was partially offset by principalpayments on our debt and capital lease obligations of$1.3 million and the repayment in full of our line ofcredit for $1.3 million. Cash provided by financingactivities was $16.3 million in 2003 and consistedprimarily of net proceeds from a private equity financingtransaction of $11.4 million in August 2003, net borrowingsunder our line of credit and term loan facilities of$3.3 million and proceeds from exercise of stock optionsand warrants of $2.0 million, offset partially byrepurchases of stock of $425,000.     We are subject to various debt covenants and other restrictions,including the requirement for early repayment upon theoccurrence of certain events, including a sale or transfer ofownership or control. If we violate these covenants orrestrictions, Silicon Valley Bank could require repayment ofoutstanding borrowings and our credit rating and access to otherfinancing could be adversely affected.     In March 2005, we entered into an Amended and Restated Loan andSecurity Agreement (the “Amended Term Loan”) withSilicon Valley Bank (“SVB”). The Amended Term Loanamends and restates our December 31, 2003 loan and securityagreement with SVB (the “Original Loan Agreement”).There are three primary components of the Amended Term Loan asfollows: •     A term loan in the amount of $3.0 million, with a balance    as of December 31, 2005, of approximately    $1.0 million. The term loan bears interest at an annual    rate of 0.5% above the prime interest rate (which rate was    previously 1.25% above the prime interest rate under the terms    of the December 31, 2003 loan and security agreement).    Payments of principal and interest total $83,333 per month    for 36 months from December 31, 2003. Once repaid, the    term loan may not be reborrowed.  •     An equipment term loan facility, which expired October 31,    2005, and with a balance as of December 31, 2005 of zero.  •     A guidance line facility in the amount of $1.5 million,    which is available through March 29, 2006, with a balance    as of December 31, 2005, of zero.     Borrowings under the Amended Term Loan are collateralized bysubstantially all of our assets. In addition, the Amended TermLoan restricts, among other things, our borrowings, dividendpayments, stock repurchases, and sales or transfers of ownershipor control, and contains certain other restrictive covenantsthat require Loudeye to maintain a certain quick ratio andtangible net worth, as defined in the Amended Term Loan.     In December 2005, we notified SVB that we were not in compliancewith a restrictive financial covenant under the Amended TermLoan agreement that requires us to maintain a certain minimumtangible net worth, as defined in the amended agreement. Wesubsequently established a certificate of deposit in the amountof approximately $1.0 million, which was equal to the thenoutstanding loan balance.     At December 31, 2005, approximately $810,000 of otherrestricted cash is held in investment accounts that are pledgedas collateral in connection with agreements with a customer,certain financial institutions and leasing companies.     We currently anticipate that we will continue to experiencefluctuations in results of operations for the foreseeable futureas we: •     Focus our operations on our key European markets and customers;  •     Seek to replace revenue from our anticipated loss of encoding    services revenue previously generated from encoding the EMI    Music catalog;  •     Continue efforts to develop our mobile music services offerings;
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 •     Increase or decrease research and development spending;  •     Increase or decrease sales and marketing activities; and  •     Improve our operational and financial systems.     We do not hold derivative financial instruments or equitysecurities in our investment portfolio. Our cash equivalents andmarketable securities consist primarily of highly liquid moneymarket funds, as specified in our investment policy guidelines.As a result, we would not expect our operating results or cashflows to be significantly affected by a sudden change in marketinterest rates in our securities portfolio.     We conduct our operations in two primary functional currencies:the United States dollar and the British pound. Since ouracquisition of OD2 in June 2004, fluctuations in foreignexchange rates have had a significant impact on our financialcondition and results of operations. We currently do not hedgeour foreign currency exposures and are therefore subject to therisk of exchange rate fluctuations. We invoice our internationalcustomers primarily in British pounds, except outside of the UK,where we invoice our customers primarily in euros. We areexposed to foreign exchange rate fluctuations as the financialresults of foreign subsidiaries are translated intoU.S. dollars in consolidation. In 2005 and 2004, ourexposure to foreign exchange rate fluctuations also aroseprimarily accrued acquisition consideration relating to the OD2transaction. In 2006 we expect our exposure to foreign exchangerate fluctuations to arise from intercompany payables andreceivables to and from our foreign subsidiaries. For the yearended December 31, 2005 and 2004, we recognized a nettransaction gain of approximately $367,000 and a net transactionloss of $833,000 of net transaction gains on accrued acquisitionconsideration related to the OD2 transaction.***Contractual Obligations***     The following table provides aggregated information about ourcontractual obligations as of December 31, 2005 (inthousands):                        **Payments Due by Period**       **Less Than**   **After**  **Total** **1 Year** **1-3 Years** **4-5 Years** **5 Years**           **Contractual Obligations**                         Long-term debt $1,000  $1,000  $—  $—  $—      Operating leases(1)  2,649   1,290   1,256   103   —      Bandwidth and co-location purchase obligations(2)  665   643   22   —   —                     Total contractual obligations $4,314  $2,933  $1,278  $103  $—                  (1)     Our future minimum rental commitments under noncancellable    leases comprise the majority of the operating lease obligations    presented above. We expect to fund these commitments with    existing cash and cash flows from operations. (2)     Many of the contracts underlying these obligations contain    renewal provisions, generally for a period of one year. In    addition, amounts payable under these contracts may vary based    on the volume of data transferred. The amounts in the table    represent the base fee amount. We also have contracts for    bandwidth and collocation services that run on a    month-to-month basis    and for which there are no unconditional obligations. Monthly    amounts due under the    month-to-month    contracts are not material and have been excluded from the table    above.    Also excluded from the table above are the following: •     Deposits and deferred revenue of $6.4 million, net of    related receivables, has been excluded from the table above as    the liabilities will not be settled in cash.  •     The expected issuance of up to approximately 222,000 additional    shares of Loudeye common stock, representing shares to be issued    to OD2 option holders issuable upon exercise of OD2 options    assumed by Loudeye in connection with the OD2 acquisition in    June 2004. The associated common
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     stock payable of approximately $321,000 has been excluded as the    related liability will not be settled in cash.  •     Purchase commitments represent obligations under agreements    which are not unilaterally cancelable by us, are legally    enforceable, and specifically fixed or minimum quantities of    goods or services at fixed or minimum prices. We generally    require purchase orders for vendor and third party spending.    There were no other known contracts or purchase orders exceeding    $100,000 in the aggregate.     Since inception, we have sustained substantial net losses tosustain our growth and establish our business. We expect thefollowing additional items, among others, may representsignificant uses of capital resources in the foreseeable future: •     We have continuing payment obligations under existing    arrangements with certain licensors of copyrighted materials    that will require payments for content fees and royalties on    music delivered to end consumers. As of December 31, 2005,    approximately $4.9 million of these amounts are included in    accrued and other liabilities in the accompanying consolidated    balance sheets. Content fees and royalties on music are due to    music labels based on net revenue and online music distribution    volumes. As net revenue and online service volumes fluctuate,    our payment obligations for content fees and royalties fluctuate    proportionally.  •     Loudeye has entered into various agreements that allow for    incorporation of licensed or copyrighted material into its    services. Under these agreements, Loudeye is required to make    royalty payments to the recorded music companies (record    labels), publishers and various other rights holders. Some of    these agreements require quarterly or annual minimum payments    which are or are not recoupable based upon actual usage, based    on the terms of the agreement. Other royalty agreements require    royalty payments based upon a percentage of revenue earned from    the licensed service. Royalty costs incurred under these    agreements are recognized over the periods that the related    revenue is recognized and are included in cost of revenue. As of    the date of this filing, obligations under these agreements    total approximately $1.3 million and are payable in various    quarterly installments through March 2007. Advances made under    the terms of these agreements are recoupable against future    royalty costs incurred during the applicable term.  •     The landscape for digital media content distribution licensing    is complex and changing, especially in Europe. We may in the    future be required to pay additional royalties in respect of our    use and licensing of copyrighted content, and we are currently a    party to litigation in France relating to alleged additional    royalty amounts owed for prior use of copyrighted content.  •     We may enter into future transactions where we acquire    complementary businesses. Such acquisitions may require the use    of our capital resources.**Off-Balance Sheet Arrangements**     *Indemnification Obligations.* In the normal course ofbusiness, we indemnify other parties, including businesspartners, lessors and parties to other transactions with us. Wehave agreed to hold the other parties harmless against lossesarising from a breach of representation or covenants, or out ofintellectual property infringement or other claims made by thirdparties. These agreements may limit the time within which anindemnification claim can be made. In addition, we have enteredinto indemnification agreements with certain of our officers anddirectors and our amended and restated certificate ofincorporation and amended bylaws contain similar indemnificationobligations to our officers and directors. For all agreementsentered into after December 31, 2002, the fair value ofpotential claims has not been recorded in our financialstatements because they are not material.     *Warrants.* At December 31, 2005, there were5,951,606 shares of common stock issuable upon the exerciseof outstanding warrants, with exercise prices ranging from $1.75to $9.55 and a weighted average exercise price of $2.22 pershare. Of these outstanding warrants, warrants topurchase 5,040,002 shares of our common stock wereissued on December 23, 2004, in connection with our privateplacement transaction to 14 accredited investors. These warrantshave an exercise price of $2.25 per share and areexercisable until the fifth
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anniversary of the date of issuance. If all of these warrantswere exercised in cash prior to their expiration dates, Loudeyewould receive aggregate proceeds of approximately$13.2 million. Certain of these warrants contain cashlessexercise provisions which permit the holders, under certaincircumstances, to deduct the exercise price of the warrants fromthe number of shares issued upon exercise of the warrants, whichwould reduce the proceeds we would receive upon such warrantexercise.     In addition, in February 2006, warrants topurchase 12,375,000 shares of Loudeye’s commonstock were issued in connection with a private placementtransaction. These warrants have an exercise price of$0.68 per share and are not exercisable untilAugust 22, 2006, and are then exercisable until the fifthanniversary of the date of issuance. These warrants may beexercised for cash or on a cashless exercise basis. If all ofthese warrants are exercised for cash, we would receiveaggregate gross proceeds of approximately $8.4 million.     Loudeye has issued warrants to investors in private placementtransactions as part of the consideration to such investors fortheir investment in Loudeye. Exercises of these warrants forcash would increase our cash balance, however we cannot assurewhether or when such warrants may be exercised, if at all.     *Other.* In February 2005, we entered into a twelve monthagreement in the ordinary course of business with an internetservice provider (ISP) in Europe, under which we willprovide the ISP’s customers with promotional credits thatmay be redeemed for a range of digital media download servicesthrough February 2006. We will receive a fixed fee ofapproximately€1.8 million(approximately $2.2 million based on December 31, 2005exchange rates) under the agreement, of which we recognizedapproximately€1.4 million(approximately $1.7 million based on December 31, 2005exchange rates) and will recognize approximately€375,000(approximately $444,000 based on December 31, 2005 exchangerates) during first quarter 2006. As of December 31, 2005,deferred revenue related to this agreement was zero, net ofrelated receivables of approximately€78,000(approximately $92,000 based on December 31, 2005 exchangerates), and deposits related to this agreement wereapproximately€300,000(approximately $355,000 based December 31, 2005 exchangerates). Because the transaction is denominated in Euros and wecurrently do not hedge the arrangement, we could be subject toforeign currency gains or losses. As of the date of this filing,no losses have been incurred or estimated under this agreement.**Item 7A.****Quantitative and Qualitative Disclosures About Market    Risk.**     We are exposed to the impact of interest rate changes andforeign currency exchange risk.     *Interest Rate Risk.* We typically invest our excess cashin high quality corporate and municipal debt instruments. As aresult, our related investment portfolio is exposed to theimpact of short-term changes in interest rates. Investments inboth fixed rate and floating rate interest earning instrumentscarries a degree of interest rate risk. Fixed rate securitiesmay have their fair market value adversely impacted by a rise ininterest rates, while floating rate securities may produce lessincome than expected if interest rates fall. As a result,changes in interest rates may cause us to suffer losses inprincipal if forced to sell securities that have declined inmarket value or may cause our future investment income to fallshort of expectations. Our investment portfolio is designated asavailable-for-sale, and accordingly is presented at fair valuein the consolidated balance sheet.     We protect and preserve our invested funds with investmentpolicies and procedures that limit default, market andreinvestment risk. We have not utilized derivative financialinstruments in our investment portfolio.     During the year ended December 31, 2005, the impact ofchanges in interest rates on the fair market value of our cashand cash equivalents and marketable securities caused aninsignificant change in our net loss. Based on our invested cashand cash equivalents, marketable securities and restricted cashbalances of approximately $10.9 million atDecember 31, 2005, a one percent change in interest rateswould cause a change in interest income of approximately$109,000 per year. Due to the investment grade level of ourinvestments, we anticipate no material market risk exposure. Inaddition, our term loan is based on the prime rate. Based on theapproximately $1.0 million balance outstanding atDecember 31, 2005, a one percent increase in the prime ratewould increase our interest expense by approximately$10,000 per year.
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We believe that the impact on the fair market value of oursecurities and on our operating results for 2005 from ahypothetical 1% increase or decrease in interest rates would notbe material.     *Foreign Currency Exchange Risk.* We develop services inthe United States and the United Kingdom and sell them in NorthAmerica and throughout Europe, and to a much lesser degree, inAustralia and Africa. As a result, our financial results couldbe affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in foreign markets.Our foreign subsidiaries’ expenses are incurred in theirlocal currency, principally British Pounds (£) or Euros(€). As exchangerates vary, their expenses, when translated, may vary fromexpectations and adversely impact overall expected results.     As foreign currency exchange rates vary, the fluctuations inrevenue and expenses may materially impact the financialstatements upon consolidation. A weaker U.S. dollar wouldresult in an increase to revenue and expenses uponconsolidation, and a stronger U.S. dollar would result in adecrease to revenue and expenses upon consolidation.     During the years ended December 31, 2005 and 2004, werecorded a net foreign exchange transaction gain ofapproximately $367,000 and a net foreign exchange transactionloss of approximately $833,000. In addition, the results ofoperations of OD2 are exposed to foreign exchange ratefluctuations as the financial results of this subsidiary aretranslated from the local currency to U.S. dollars uponconsolidation. Because of the significance of the operations ofOD2 to our consolidated operations, as exchange rates vary, netsales and other operating results, when translated, may differmaterially from our prior performance and our expectations. Inaddition, because of the significance of our overseasoperations, we could also be significantly affected by weakeconomic conditions in foreign markets that could reduce demandfor our services and further negatively impact the results ofour operations in a material and adverse manner. As a result ofthese market risks, the price of our stock could declinesignificantly and rapidly.
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**Item 8.     FinancialStatements.****LOUDEYE CORP. AND SUBSIDIARIES****INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**       **Page**  **Number**        Report of Independent Registered Public    Accounting Firm on Internal Control  77      Report of Independent Registered Public    Accounting Firm (Moss Adams LLP)  78      Report of Independent Registered Public    Accounting Firm (PricewaterhouseCoopers LLP)  79      Consolidated Balance Sheets  80      Consolidated Statements of Operations  81      Consolidated Statements of    Stockholders’ Equity  82      Consolidated Statements of Cash Flows  83      Notes to Consolidated Financial    Statements  84 
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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON****INTERNAL CONTROL**To the Board of Directors and Stockholders ofLoudeye Corp.     We have audited management’s assessment, included in theaccompanying Management’s Report on Internal Control overFinancial Reporting appearing under Item 9A, that LoudeyeCorp. and Subsidiaries (“the Company”) maintainedeffective internal control over financial reporting as ofDecember 31, 2005, based on criteria established inInternal Control-Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (“theCOSO criteria”). The Company’s management isresponsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectivenessof internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internalcontrol over financial reporting based on our audit.     We conducted our audit in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtainreasonable assurance about whether effective internal controlover financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding ofinternal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the designand operating effectiveness of internal control, and performingsuch other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonablebasis for our opinion.     A company’s internal control over financial reporting is aprocess designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation offinancial statements for external purposes in accordance withgenerally accepted accounting principles. A company’sinternal control over financial reporting includes thosepolicies and procedures that (1) pertain to the maintenanceof records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the companyare being made only in accordance with authorizations ofmanagement and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection ofunauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on thefinancial statements.     Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements.Also, projections of any evaluation of effectiveness to futureperiods are subject to the risk that controls may becomeinadequate because of changes in conditions, or that the degreeof compliance with the policies or procedures may deteriorate.     In our opinion, management’s assessment that Loudeye Corp.maintained effective internal control over financial reportingas of December 31, 2005, is fairly stated, in all materialrespects, based on the COSO criteria. Also, in our opinion,Loudeye Corp. maintained, in all material respects, effectiveinternal control over financial reporting as ofDecember 31, 2005, based on the COSO criteria.     We also have audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), theconsolidated balance sheet of Loudeye Corp. as ofDecember 31, 2005 and 2004, and the related consolidatedstatements of operations, stockholders’ equity, and cashflows for the two years then ended, and our report datedMarch 14, 2006 expressed an unqualified opinion thereon./s/ Moss Adams LLPSeattle, WashingtonMarch 14, 2006
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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON****FINANCIAL STATEMENTS**To the Board of Directors and Stockholders ofLoudeye Corp.     We have audited the accompanying consolidated balance sheets ofLoudeye Corp. and subsidiaries (“the Company”) as ofDecember 31, 2005 and 2004, and the related consolidatedstatements of operations, stockholders’ equity and cashflows for the years then ended. These financial statements arethe responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financialstatements based on our audit.     We conducted our audit in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing theaccounting principles used and significant estimates made bymanagement, as well as evaluating the overall financialstatement presentation. We believe that our audit provides areasonable basis for our opinion.     In our opinion, the financial statements referred to abovepresent fairly, in all material respects, the consolidatedfinancial position of Loudeye Corp. and subsidiaries as ofDecember 31, 2005 and 2004, and the consolidated results ofits operations and its cash flows for the years then ended, inconformity with accounting principles generally accepted in theUnited States of America.     The accompanying financial statements have been preparedassuming that the Company will continue as a going concern. Asdiscussed in Note 1 to the financial statements, theCompany has suffered recurring losses and negative cash flowsfrom operations, and has an accumulated deficit and a networking capital deficiency at December 31, 2005. Thesematters raise substantial doubt about the Company’s abilityto continue as a going concern. Management’s plans inregard to these matters are also described in Note 1. Thefinancial statements do not include any adjustments that mightresult from the outcome of this uncertainty.     We also have audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States), theeffectiveness of Loudeye Corp.’s internal control overfinancial reporting as of December 31, 2005, based oncriteria established in Internal Control— IntegratedFramework issued by the Committee of Sponsoring Organizations ofthe Treadway Commission, and our report dated March 14,2006 expressed an unqualified opinion thereon./s/ Moss Adams LLPSeattle, WashingtonMarch 14, 2006
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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**To the Board of Directorsand Stockholders of Loudeye Corp.     In our opinion, the accompanying consolidated statements ofoperations, of stockholders’ equity, and of cash flows forthe year ended December 31, 2003 present fairly, in allmaterial respects, the results of operations and cash flows ofLoudeye Corp. (formerly Loudeye Technologies, Inc.) and itssubsidiaries (the “Company”) for the year endedDecember 31, 2003, in conformity with accounting principlesgenerally accepted in the United States of America. Thesefinancial statements are the responsibility of theCompany’s management. Our responsibility is to express anopinion on these financial statements based on our audit. Weconducted our audit of these statements in accordance with thestandards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements,assessing the accounting principles used and significantestimates made by management, and evaluating the overallfinancial statement presentation. We believe that our auditprovides a reasonable basis for our opinion.     In June 2004, the Company acquired On Demand DistributionLimited (“OD2”). The terms of this acquisition requirethe payment of £9.6 million (approximately$17.3 million based on exchange rates as ofSeptember 30, 2004, including approximately$2.6 million to be held in escrow and not yet accountedfor) through November 30, 2005, to OD2 shareholders, plusadditional contingent consideration of up to£10.0 million (approximately $18.0 million basedon exchange rates as of September 30, 2004) if OD2 achievescertain financial performance targets during the period throughNovember 30, 2006. The payments are to be made in Britishpounds, and accordingly, the Company is exposed to risks withchanges in the prevailing exchange rate. Any decrease in thevalue of the U.S. dollar against the British pound will cause aproportional increase in the amount of the future considerationthe Company must pay to the former OD2 shareholders. The Companymay elect to pay the amounts due to OD2’s shareholders inshares of the Company’s common stock. As a result of theCompany’s acquisition of OD2, the Company will be requiredto provide additional funding to support OD2’s ongoingoperations. There can be no assurance that the Company’scash balances after December 31, 2004 will be sufficient tosustain its operations in 2005 and to fund the ongoingoperations of OD2./s/ PricewaterhouseCoopersLLPSeattle, Washington     March 18, 2004, except for the second, third and fourthparagraphs of Note 1, which appear in the consolidatedfinancial statements in the Company’s Form S-1 datedFebruary 9, 2005 and are not presented herein as to whichthe date is December 13, 2004; and except for the revisionsof classifications disclosed in Note 2 of thisForm 10-K as to which the date is March 30, 2005; andexcept for the reclassification of operating segments inNote 17 of thisForm 10-K as towhich the date is March 13, 2006.
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**LOUDEYE CORP. AND SUBSIDIARIES****CONSOLIDATED BALANCE SHEETS**            **December 31,**     **2005** **2004**       **(In thousands, except per**  **share amounts)****ASSETS**    Cash and cash equivalents $6,932  $28,978     Marketable securities  2,113   9,016     Accounts receivable, net of allowances of $292 and $200  5,132   4,847     Prepaids and other current assets  1,212   1,226     Restricted cash  1,810   —     Current assets of discontinued operations  5   1,444             Total current assets  17,204   45,511     Long-term marketable securities  —   2,288     Restricted cash  —   2,393     Property and equipment, net  4,686   4,129     Goodwill  44,213   41,070     Intangible assets, net  3,116   2,541     Other assets, net  189   431     Assets of discontinued operations  —   5,345             Total assets $69,408  $103,708        **LIABILITIES AND STOCKHOLDERS’ EQUITY**    Accounts payable $3,701  $3,443     Accrued compensation and benefits  825   923     Accrued and other liabilities  6,531   4,769     Accrued special charges  —   403     Accrued acquisition consideration  —   15,924     Deposits and deferred revenue  6,061   4,343     Current portion of long-term debt and capital lease obligations  1,000   1,135     Current liabilities of discontinued operations  981   782             Total current liabilities  19,099   31,722     Deposits and deferred revenue, net of current portion  350   1,343     Common stock payable related to acquisition  321   3,193     Long-term debt and capital lease obligations, net of current    portion  —   1,000             Total liabilities  19,770   37,258     Commitments and contingencies            STOCKHOLDERS’ EQUITY            Preferred stock, $0.001 par value, 5,000 shares    authorized, none outstanding  —   —     Common stock, additional paid-in capital and warrants; for    common stock $0.001 par value, 250,000 shares    authorized in 2005, 150,000 shares authorized in 2004;    115,368 shares issued and outstanding in 2005 and    99,021 shares issued and outstanding in 2004  296,020   273,958     Deferred stock compensation  (888)  (111)    Accumulated deficit  (242,645)  (209,284)    Accumulated other comprehensive income(loss)  (2,849)  1,887             Total stockholders’ equity  49,638   66,450             Total liabilities and stockholders’ equity $69,408  $103,708        See notes to consolidated financial statements
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**LOUDEYE CORP. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF OPERATIONS**                  **Years Ended December 31,**     **2005** **2004** **2003**         **(In thousands, except per share amounts)**    REVENUE $27,041  $14,033  $11,948     COST OF REVENUE(1)  25,082   10,336   8,076                 Gross profit  1,959   3,697   3,872     OPERATING EXPENSES:                 Sales and marketing(1)  6,412   4,200   3,286      Research and development(1)  8,404   3,726   1,688      General and administrative(1)  13,057   10,658   8,656      Amortization of intangible assets  235   92   831      Stock-based compensation(1)  250   199   1,298      Special charges — goodwill impairments  —   —   5,307      Special charges — other  (43)  312   1,913                 Total operating expenses  28,315   19,187   22,979     LOSS FROM OPERATIONS  (26,356)  (15,490)  (19,107)    OTHER INCOME (EXPENSE):                 Interest income  625   377   347      Interest expense  (160)  (201)  (286)     Gain on sale of media restoration assets  —   156   —      Increase in fair value of common stock warrants  —   —   (248)     Other income (expense), net  313   (839)  120                 Total other income (expense)  778   (507)  (67)              Loss from continuing operations  (25,578)  (15,997)  (19,174)    Loss from discontinued operations  (7,783)  (400)  —               NET LOSS $(33,361) $(16,397) $(19,174)              LOSS PER SHARE — BASIC AND DILUTED:                   From continuing operations $(0.24) $(0.22) $(0.39)       From discontinued operations  (0.07)  —   —               Net loss per share — basic and diluted $(0.31) $(0.22) $(0.39)              Weighted average shares outstanding — basic and diluted  107,652   73,845   49,797            (1)     Stock-based compensation, consisting of amortization of deferred    stock-based compensation and the fair value of options issued to    non-employees for services rendered, is allocated as follows:               **Years Ended December 31,**     **2005** **2004** **2003**           Cost of revenue $92  $117  $62     Sales and marketing  (3)  49   47     Research and development  15   83   57     General and administrative  238   67   1,194 See notes to consolidated financial statements
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**LOUDEYE CORP. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**                            **Common Stock,**          **Warrants and**          **Additional Paid-In**     **Accumulated**    **Capital** **Deferred**   **Other** **Total**    **Stock** **Accumulated** **Comprehensive** **Stockholders’**  **Shares** **Amount** **Compensation** **Deficit** **Income (Loss)** **Equity**               **(In thousands)**    BALANCES, January 1, 2003  47,176  $194,195  $(130) $(173,713) $—  $20,352     Repurchase of common stock  (1,469)  (425)  —   —   —   (425)    Stock option and warrant exercises and shares issued under ESPP  2,084   2,023   —   —   —   2,023     Shares issued in private placement  7,839   9,975   —   —   —   9,975     Conversion of common stock warrants from a liability to equity  —   1,704   —   —   —   1,704     Shares issued to pay accrued acquisition consideration  636   1,118   —   —   —   1,118     Shares issued for prior acquisitions and accrued bonus  629   25   —   —   —   25     Deferred stock-based compensation  —   544   (544)  —   —   —     Amortization of deferred stock-based compensation, net of    cancellations  —   —   460   —   —   460     Stock-based compensation  79   900   —   —   —   900     Issuance of common stock warrants  —   75   —   —   —   75     Net loss  —   —   —   (19,174)  —   (19,174)                       BALANCES, December 31, 2003  56,974   210,134   (214)  (192,887)  —   17,033     Stock option and warrant exercises and shares issued under ESPP  1,623   1,202   —   —   —   1,202     Shares issued in private placements  27,611   42,308   —   —   —   42,308     Shares issued for acquisitions  11,418   17,975   —   —   —   17,975     Shares issued in payment of accrued acquisition consideration  1,395   2,044   —   —   —   2,044     Deferred stock-based compensation  —   380   (380)  —   —   —     Amortization of deferred stock-based compensation, net of    cancellations  —   (207)  483   —   —   276     Stock-based compensation  —   (10)  —   —   —   (10)    Issuance of common stock warrants  —   132   —   —   —   132     Comprehensive loss:                             Unrealized loss on marketable securities  —   —   —   —   (85)  (85)     Foreign currency translation adjustment  —   —   —   —   1,972   1,972      Net loss  —   —   —   (16,397)  —   (16,397)                        Total comprehensive loss  —   —   —   —   —   (14,510)                       BALANCES, December 31, 2004  99,021   273,958   (111)  (209,284)  1,887   66,450     Stock option exercises  4,342   3,597   —   —   —   3,597     Damages related to 2004 private equity transaction  —   (464)  —   —   —   (464)    Cancellation of escrowed Overpeer and other shares  (83)  (182)  —   —   —   (182)    Issuance of escrowed shares  3,537   5,129   —   —   —   5,129     Shares issued in payment of accrued acquisition consideration  7,001   12,859   —   —   —   12,859     Issuance of restricted stock under stock-based compensation    plan, net of cancellations  1,550   1,131   (1,131)  —   —   —     Vesting of restricted stock  —   —   248   —   —   248     Deferred stock-based compensation      84   (84)  —   —   —     Amortization of deferred stock-based compensation, net of    cancellations  —   (104)  190   —   —   86     Stock-based compensation  —   12   —   —   —   12     Comprehensive loss:                             Unrealized gain on marketable securities  —   —   —   —   74   74      Foreign currency translation adjustment  —   —   —   —   (4,810)  (4,810)     Net loss  —   —   —   (33,361)  —   (33,361)                        Total comprehensive loss  —   —   —   —   —   (38,097)                       BALANCES, December 31, 2005  115,368  $296,020  $(888) $(242,645) $(2,849) $49,638                    See notes to consolidated financial statements
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**LOUDEYE CORP. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF CASH FLOWS**                  **Years Ended December 31,**     **2005** **2004** **2003**         **(In thousands)**    OPERATING ACTIVITIES                 Net loss $(33,361) $(16,397) $(19,174)     Adjustments to reconcile net loss to net cash used in operating    activities:                  Loss from discontinued operations  7,783   400   —       Depreciation and amortization  3,334   2,308   2,378       Special charges and other non cash items  (65)  (164)  6,744       Stock-based compensation  342   316   1,360       Foreign currency transaction (gain) loss  (367)  833   —       Increase in fair value of common stock warrants  —   —   248       Operating cash flows from discontinued operations  (1,705)  (513)  —      Changes in operating assets and liabilities, net of amounts    acquired in purchases of businesses:                  Accounts receivable  (423)  (1,610)  326       Prepaids and other assets  666   (299)  1,889       Accounts payable  357   (1,396)  36       Accrued compensation and benefits and accrued and other    liabilities  1,169   279   (1,916)      Accrued special charges  (360)  (1,024)  —       Deposits and deferred revenue  1,127   2,534   408       Assets and liabilities held for sale  —   —   402                  Net cash used in operating activities  (21,503)  (14,733)  (7,299)              INVESTING ACTIVITIES                 Purchases of property and equipment  (2,342)  (4,087)  (115)     Purchases of intangibles  (161)  —   —      Proceeds from sales of property and equipment  —   —   185      Cash paid for acquisition of businesses and technology, net  —   (555)  (82)     Proceeds received from assets and liabilities held for sale  —   996   —      Payments received on loans made to related party and related    interest  —   —   1,187      Payments of accrued acquisition consideration  (5,640)  —   —      Release of restricted cash  226   175   —      Purchases of marketable securities  (750)  (20,015)  (11,750)     Sales of marketable securities  10,411   15,834   12,268      Investing cash flows from discontinued operations  (1,252)  (1,785)  —                  Net cash provided by (used in) investing activities  492   (9,437)  1,693               FINANCING ACTIVITIES                 Proceeds from sale of stock and exercise of stock options and    warrants  727   1,202   2,023      Proceeds from private equity financings, net  (464)  42,403   11,431      Proceeds from line of credit and debt  —   —   8,320      Principal payments on debt, line of credit and capital lease    obligations  (1,135)  (2,644)  (5,043)     Repurchase of common stock from related party  —   —   (425)                 Net cash provided by (used in) financing activities  (872)  40,961   16,306                Effect of foreign currency translation on cash  (163)  (293)  —                Net increase (decrease) in cash and cash equivalents  (22,046)  16,498   10,700               Cash and cash equivalents, end of period $6,932  $28,978  $12,480           **Supplemental disclosures:**                Cash paid for interest $115  $216  $200 See notes to consolidated financial statements
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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****1.****Description of Business, Risks and Going Concern*****Business***     Loudeye is a worldwide leader inbusiness-to-businessdigital media services that facilitate the distribution,promotion and sale of digital media content for media andentertainment, mobile communications, consumer products,consumer electronics, retail, and ISP customers. Loudeye’sservices enable its customers to outsource the management anddistribution of audio and video digital media content over theInternet and other electronic networks. Loudeye’sproprietary consumer-facinge-commerce services,combined with our technical infrastructure and back-endsolutions, comprise anend-to-end serviceoffering, from digital media content services, such as thehosting, storage, encoding, and management of media assets forcontent owners, to turn-key, fully-outsourced digital mediadistribution and promotional services, such as private-labeleddigital music services, including mobile music services, todigital media content services, such as encoding, music samplesservices, Internet radio, hosting and webcasting services.Loudeye’s outsourced solutions can decreasetime-to-market whilereducing the complexity and cost of digital asset management anddistribution compared with internally developed alternatives,and they enable Loudeye’s customers to provide brandeddigital media service offerings to their users while supportinga variety of digital media technologies and consumer businessmodels.***Risks***     Inherent in Loudeye’s business are various risks anduncertainties, including the limited operating history ofcertain of its service offerings and challenges involved withthe licensing and digital distribution of audio and videocontent over the Internet. Loudeye’s success will depend,among other things, on the acceptance of its technology andservices, the ability to generate related revenue and theability to secure adequate funding to support ongoing operations.***Going Concern***     The accompanying audited consolidated financial statements havebeen prepared assuming that Loudeye will continue as a goingconcern, which contemplates realization of assets and thesatisfaction of liabilities in the normal course of business forthe twelve month period following the date of these financialstatements. However, Loudeye has incurred net losses sinceinception, has an accumulated deficit of approximately$242.6 million at December 31, 2005, has experiencednegative cash flows from operations in substantially allquarters of its operations since inception, had a negativeworking capital balance as of December 31, 2005 of$1.9 million, and the expansion and development ofLoudeye’s business will require significant capital. Thesefactors, among others, raise substantial doubt aboutLoudeye’s ability to continue as a going concern.Management is implementing plans to address Loudeye’sliquidity needs, including restructuring Loudeye’soperations, reducing its work force, divesting or discontinuingthe operations of acquired companies, renegotiating existingagreements with customers and vendors, and taking other actionsto limit Loudeye’s expenditures. In February 2006, Loudeyecompleted an equity financing transaction raising net proceedsof approximately $7.6 million. However, Loudeye may requireadditional capital to fund its ongoing operations.Loudeye’s history of declining market valuation andvolatility in Loudeye’s stock price could make it difficultfor Loudeye to raise capital on favorable terms, or at all. Anyfinancing Loudeye obtains may dilute or otherwise impair theownership interest of its current stockholders. If Loudeye failsto generate positive cash flows or fails to obtain additionalcapital when required, Loudeye could modify, delay or abandonsome or all of its business and expansion plans. Theaccompanying audited financial statements do not include anyadjustments that may result from the outcome of this uncertainty.
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**2.****Summary of Significant Accounting Policies*****Accounting Principles***     The financial statements and accompanying notes are prepared inaccordance with accounting principles generally accepted in theUnited States of America (GAAP).***Basis of Consolidation***     The consolidated financial statements include the accounts ofLoudeye Corp. and its wholly owned domestic and foreignsubsidiaries. All significant intercompany transactions andbalances have been eliminated in consolidation. Loudeye hasincluded the results of operations of acquired entities from thedates of acquisition (see Note 3).***Estimates and Assumptions***     The preparation of financial statements requires management tomake estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and thereported amounts of revenue and expenses during the reportingperiod. These estimates and assumptions are affected bymanagement’s application of accounting policies. Examplesinclude estimates of loss contingencies, when technologicalfeasibility is achieved, purchase accounting, music publishingrights and music royalty accruals, the potential outcome offuture tax consequences of events that have been recognized inour financial statements or tax returns, and determining wheninvestment impairments are other-than-temporary. Actual resultscould differ from those estimates.     Management evaluates the potential loss exposure on variousclaims and lawsuits arising in the normal course of business. Anaccrual is made if the amount of a particular claim or lawsuitis probable and reasonably estimable.***Cash and Cash Equivalents***     Loudeye considers all highly liquid investments purchased withan original maturity of three months or less to be cashequivalents. Cash and cash equivalents consist primarily ofdemand deposits and money market accounts maintained withfinancial institutions and certain other investment gradeinstruments, which at times exceed federally insured limits.Loudeye has not experienced any losses on its cash and cashequivalents.***Marketable Securities***     Loudeye has classified as available-for-sale all marketable debtand equity securities for which there is a determinable fairmarket value and no restrictions on Loudeye’s ability tosell within the next 24 months. Available-for-salesecurities are carried at fair value, with unrealized gains andlosses reported as a separate component of stockholders’equity. Realized gains and losses and declines in value judgedto be other-than-temporary on available-for-sale securities areincluded in other income (expense). Loudeye has classifiedsecurities with a remaining contractual maturity of greater thanone year as long term marketable securities. AtDecember 31, 2005, all of Loudeye’s available for salemarketable securities have contractual maturities within oneyear. The cost basis for determining realized gains and losseson available-for-sale securities is determined on the specificidentification method.
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     The following table summarizes the composition of Loudeye’scash, cash equivalents, and available-for-sale marketablesecurities at December 31, 2005 and 2004 (in thousands):             **December 31,**     **2005** **2004**         Cash and cash equivalents:             Cash $4,616  $5,721      Money market mutual funds  2,316   23,257              Total cash and cash equivalents  6,932   28,978            Marketable securities:             Corporate notes & bonds  2,113   5,738      Commercial paper & CDs  —   1,289      U.S. Government agency securities  —   1,989              Total marketable securities  2,113   9,016            Long-term marketable securities:             Corporate notes & bonds $—  $2,288              Total long-term marketable securities  —   2,288              Total cash, cash equivalents and marketable securities $9,045  $40,282             The gross unrealized gains or losses on available-for-salesecurities at December 31, 2005 and December 31, 2004and the gross realized gains or losses on the sale ofavailable-for-sale securities for the year endedDecember 31, 2005 and 2004 were immaterial and aretherefore not shown. Loudeye has concluded that unrealizedlosses are temporary due to Loudeye’s ability to realizeits investments at maturity.***Restricted Cash***     At December 31, 2005, restricted cash representsapproximately $1.0 million of cash equivalents pledged ascollateral against a term loan and approximately $810,000 ofcash equivalents pledged as collateral in connection withagreements with a customer, certain financial institutions andleasing companies. In accordance with the terms of theagreements, the restricted cash has been classified as currentin the accompanying consolidated balance sheets.***Accounts Receivable***     Accounts receivable are recorded at the invoiced amount and donot generally include interest. The allowance for doubtfulaccounts represents Loudeye’s best estimate of the amountof probable credit losses in Loudeye’s existing accountsreceivable. Loudeye performs a periodic analysis to determinethe appropriate allowance for doubtful accounts. This analysisincludes various analytical procedures and a review of factorswithin the context of the overall economic environment includingindividual review of past due balances over 90 days andgreater than a specified amount, Loudeye’s history ofcollections. Account balances are charged off against theallowance after the potential for recovery is considered remote.***Property and Equipment***     Property and equipment is stated at cost less accumulateddepreciation and impairment write-downs. Expenditures thatextend the life, increase the capacity, or improve theefficiency of property and equipment are capitalized, whileexpenditures for repairs and maintenance are expensed asincurred. Depreciation and amortization are calculated on thestraight-line method over the estimated useful lives of
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the assets, ranging from three to five years. Leaseholdimprovements are amortized over the lesser of the applicablelease term or the estimated useful life of the asset.***Goodwill***     Loudeye accounts for goodwill in accordance with Statement ofFinancial Accounting Standards (FAS) No. 142,“Goodwill and Other Intangible Assets” (FAS 142).Under FAS 142, goodwill deemed to have indefinite life isnot amortized, but is subject to, at a minimum, annualimpairment tests. Loudeye assesses the impairment of goodwill onan annual basis or whenever events or changes in circumstancesindicate that the fair value is less than its carrying value.Impairment is tested at the reporting unit level by comparingthe fair value of a reporting unit with its carrying amountincluding goodwill. Fair values are determined based onvaluations that rely on the market and income approaches. Themarket approach makes use of market price data of stocks ofcompanies engaged in the same or similar lines of business asLoudeye. The income approach uses future projections of cashflows from each of our reporting units and includes, among otherestimates, projections of future revenue and operating expenses,market supply and demand, projected capital spending and anassumption of our weighted average cost of capital. Ourevaluations of fair values include analyses based on the futurecash flows generated by the underlying assets, estimated trendsand other relevant determinants of fair value for these assets.If the carrying amount of the reporting unit exceeds its fairvalue, goodwill of the reporting unit is considered impaired andthe second step of the test is performed to determine the amountof impairment loss, if any. Loudeye has determined that it hadtwo reporting units for purposes of FAS 142 in 2005 and2004; its OD2 subsidiary, which was acquired in June 2004, andits Overpeer subsidiary, which was acquired in March 2004. Inconnection with the cessation of the Overpeer business, Loudeyedetermined that the goodwill related to the Overpeer acquisitionwas impaired as discussed further in Note 4. Loudeyeperforms its annual impairment test as of November 30 ofeach year, and determined there to be no impairment in 2005 or2004 other than the impairment which was recognized inconnection with the cessation of Overpeer’s operations.There were no events or circumstances from the date of ourassessment through December 31, 2005 that would impact thisassessment.     The changes in the carrying amount of goodwill for the yearsended December 31, 2005 and 2004 are as follows (inthousands):           **Years Ending**  **December 31,**     **2005** **2004**         Beginning balance $41,070  $—     Goodwill from OD2 acquisition  3,143   41,070          $44,213  $41,070        ***Impairment of Long-Lived Assets***     Long lived assets, other than goodwill, such as property, plant,and equipment, and purchased intangibles subject toamortization, are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of anasset may not be recoverable. Conditions that would necessitatean impairment assessment include a significant decline in theobservable market value of an asset, a significant change in theextent or manner in which an asset is used, or any othersignificant adverse change that would indicate that the carryingamount of an asset or group of assets is not recoverable.Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to estimatedundiscounted future cash flows expected to be generated by theasset. If the carrying amount of an asset exceeds its estimatedfuture cash flows, an impairment charge is recognized by theamount by which the carrying amount of the asset exceeds thefair value of the asset. Long-lived assets are considered heldfor sale when certain criteria are met, including: managementhas committed to a plan to sell the asset, the asset isavailable for sale in its immediate condition, and the sale isprobable within one year of the reporting date. Assets to bedisposed of would be separately presented in
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the balance sheet and reported at the lower of the carryingamount or fair value less costs to sell, and are no longerdepreciated. The assets and liabilities of a disposed groupclassified as held for sale would be presented separately in theappropriate asset and liability sections of the balance sheet.In connection with the cessation of the Overpeer business,Loudeye determined that the goodwill related to the Overpeeracquisition was impaired as discussed further in Note 4.Based on the annual goodwill test for impairment that Loudeyeperformed as of November 30 of each year, Loudeyedetermined there to be no impairment in 2005 or 2004 other thanthe impairment which was recognized in connection with thecessation of Overpeer’s operations. There were no events orcircumstances from the date of our assessment throughDecember 31, 2005 that would impact this assessment.***Fair Value of Financial Instruments and Concentrations of    Credit Risk***     Financial instruments that potentially subject Loudeye toconcentrations of credit risk consist of cash and cashequivalents, marketable securities, restricted cash, accountsreceivable, accounts payable, accrued liabilities and debt andcapital lease obligations. The fair values of these financialinstruments approximate their carrying value based on theirliquidity or short-term nature. The carrying value ofLoudeye’s long-term obligations approximate fair value dueto the variable nature of the interest.     Loudeye is exposed to credit risk due to its extension of creditto its customers. Loudeye’s customer base is dispersedacross different geographic areas throughout North America andEurope and consists of customers in numerous industries. Loudeyeperforms initial and ongoing evaluations of its customers’financial condition and generally extends credit on openaccount, requiring deposits or collateral as deemed necessary.At December 31, 2005, one customer accounted for 13% andanother customer accounted for 12% of Loudeye’s accountsreceivable.     During the year ended December 31, 2005, one customeraccounted for 10% of Loudeye’s revenue and another customeraccounted for approximately 19% of Loudeye’s revenue.During the year ended December 31, 2004 one customeraccounted for 21% of Loudeye’s revenue.***Revenue Recognition***     Substantially all of Loudeye’s revenue is derived fromLoudeye’s digital media service offerings including digitalmedia store services (which include music store services),encoding services, samples services, Internet radio services,hosting services, and live and on-demand webcasting services.     Deferred revenue arises from payments received in advance of theculmination of the earnings process. Deferred revenue expectedto be realized within the next twelve months is classified ascurrent.     Loudeye’s basis for revenue recognition is substantiallygoverned by Securities and Exchange Commission (SEC) StaffAccounting Bulletin (SAB) 101, as superseded bySAB 104, “Revenue Recognition,” the FASB’sEmerging Issues Task Force (EITF) IssueNo. 00-21,“Revenue Arrangements with Multiple Deliverables”(EITF 00-21), andEITF 99-19, “Reporting Revenue as a Principal VersusNet as an Agent” (EITF 99-19), and in very limitedcases as it relates to sales of software products, Statement ofPosition No. 97-2, “Software RevenueRecognition,” as amended by Statement of PositionNo. 98-4, 98-9, and related interpretations and TechnicalPractice Aids (SOP 97-2).     *Determining Separate Elements and Allocating Value to ThoseElements.* If sufficient evidence of the fair values of thedelivered and undelivered elements of an arrangement does notexist, revenue is deferred using revenue recognition principlesapplicable to the entire arrangement as if it were a singleelement arrangement underEITF 00-21 and isrecognized on a straight-line basis over the term of thecontract. For arrangements with multiple deliverables which aredetermined to have separate units of accounting, revenue isrecognized upon the delivery of the separate units in accordancewith EITFNo. 00-21.Consideration from multiple element arrangements is allocatedamong the separate elements based on their relative fair values.In the event that there is no objective and reliable evidence offair value for the delivered item, the revenue recognized upondelivery is the total arrangement consideration less the
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fair value of the undelivered items. The maximum revenuerecognized on a delivered element is limited to the amount thatis not contingent upon the delivery of additional items.     In the limited circumstances where Loudeye sells softwareproducts, Loudeye recognizes revenue associated with the licenseof software in accordance withSOP 97-2. Underthe provisions ofSOP 97-2, insoftware arrangements that involve rights to multiple services,Loudeye allocates the total arrangement consideration among eachof the deliverables using the residual method, under whichrevenue is allocated to the undelivered elements based onvendor-specific objective evidence of the fair value of suchundelivered elements. Vendor-specific objective evidence isbased on the price charged when an element is sold separatelyor, in the case of an element not sold separately, the priceestablished by management, if it is probable that the price,once established, will not change before market introduction.     Some of Loudeye’s arrangements may include consultingservices sold separately under professional services contracts.Professional services arrangements are billed on a time andmaterials basis and accordingly, revenue is recognized as theservices are performed.     *Digital media store services revenue.* Digital media storeservices, including music store services, grew significantlyfollowing Loudeye’s acquisition of OD2 in June 2004.Loudeye derives its revenue from digital media store services inthree primary areas: •      Loudeye charges its digital media store customers fixed    business-to-business    platform fees, which generally consist of enabling and hosting    the service and maintenance of the service’s overall    functionality during the term of the customer contract.    Business-to-business    platform services may include fees related to integration to a    customer’s website, wireless sites, inventory, account    management, and commerce and billing systems. Additionally,    platform fees associated with Loudeye’s digital media store    services include digital rights management, editorial services,    usage reporting, and digital content royalty settlement. Loudeye    charges platform fees to its customers in a variety of manners,    including initial    set-up fees, monthly    only fees, or a combination of initial    set-up and monthly fees.  •      Loudeye provides transactional    business-to-consumer    services including prepaid credit packages and digital downloads.  •      Loudeye provides corporate clients with bundles of music credit    packages for distribution to their end consumers as part of    marketing promotions. Although not a primary source of revenue,    Loudeye also provides a number of consultancy services,    including cover art and metadata publishing, and varied commerce    and content consumption alternatives for digital media content.     Loudeye follows the guidance inEITF 00-21 forpurposes of allocating the total consideration in its digitalmedia store services arrangements to the individualdeliverables. Loudeye evaluates whether each of the elements inthese arrangements represents a separate unit of accounting, asdefined byEITF 00-21, usingall applicable facts and circumstances, including whether(i) the delivered item(s) has value to the customer on astandalone basis, (ii) there is objective and reliableevidence of the fair value of the undelivered item(s) and(iii) there is a general right of return relative to thedelivered item(s), in which case performance of the undelivereditem(s) is considered probable and substantially inLoudeye’s control.     If Loudeye determines a given agreement involves separate unitsof accounting, Loudeye allocates the arrangement considerationto the separate units of accounting based on their relative fairvalues, as determined by the price of the undelivered items whensold separately. Assuming all other criteria are met (i.e.,evidence of an arrangement exists, collectibility is probable,and fees are fixed or determinable), revenue is recognized asfollows: •  Business-to-business    platform service fees are generally recognized as revenue over    the term of the customer contract and represent charges in    connection with enabling the service and maintaining its overall    functionality during the term of the customer contract, which is    generally one to three years. Loudeye charges platform fees to    its customers in a variety of manners, including initial    set-up fees, monthly    only fees, or a combination of initial    set-up and monthly fees.
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 •      Loudeye also shares in the proceeds of    business-to-consumer    transactions such as digital downloads. Revenue from digital    downloads is recognized at the time the content is delivered,    digitally, to the consumer.  •      A majority of Loudeye’s    business-to-consumer    transactional revenue is generated through the sale of prepaid    credit packages which entitle a consumer to access a specified    number of digital music downloads or streams for a fixed price    during a fixed time period. Prepaid credit packages are also    bundled with other end consumer offerings sponsored by    Loudeye’s customers. Revenue from prepaid credit packages    and bundle promotions is deferred until the credits or    promotional offers are utilized or expire. Loudeye’s margin    on the sale of prepaid credit packages fluctuates depending upon    a number of factors, including the type of service for which the    consumer redeems the credits (full downloads or streams), the    royalty rate for the download purchased and breakage.  •      Revenue from bundles of prepaid music credit packages is    deferred and then recognized as tracks are downloaded by the    consumer or as credits expire, whichever occurs earlier.     If evidence of fair value cannot be established for theundelivered elements of an agreement, the revenue from thearrangement is recognized ratably over the period that theseelements are delivered or, if appropriate, under the percentageof completion method based on the ratio of direct labor hoursincurred to date to total projected labor hours.     Loudeye recognizes revenue gross or net in accordance withEITF 99-19. In most arrangements, Loudeye contractsdirectly with end user consumers, is the primary obligor andcarries all collectibility risk. Revenue in these arrangementsis recorded on a gross basis. In some cases, customers contractwith music publishers and rights holders and sell products orservices directly to end user consumers utilizing Loudeye’sservices, and, as such, Loudeye carries no collectibility risk.In those instances, in accordance with EITF 99-19, Loudeyereports revenue net of amounts paid to the customer.     *Encoding services revenue.* Encoding services consist of(i) processing and conversion of digital content intodifferent digital formats pursuant to customers’specifications via Loudeye’s proprietary encoding andtranscoding systems and (ii) the delivery of such processedcontent to the customer. The encoded content is either deliveredelectronically to a file transfer protocol (FTP) site thatour customers access via a previously provided password orLoudeye physically ships the content to its customers. Inaccordance with SAB 104, Loudeye recognizes revenue whenpersuasive evidence of an arrangement exists and the service hasbeen rendered, provided the fee is fixed or determinable andcollection is deemed probable. Loudeye evaluates each of thesecriteria as follows: •      Evidence of an arrangement: Loudeye considers a non-cancelable    agreement signed by Loudeye and the customer to be evidence of    an arrangement.  •      Services have been rendered: Loudeye considers this criteria to    be satisfied when the content has been delivered.  •      Fixed or determinable fee: Loudeye assesses whether fees are    fixed or determinable at the time of sale and recognize revenue    if all other revenue recognition requirements are met. Loudeye    considers these criteria to be satisfied when the payment terms    associated with the transaction are within Loudeye’s normal    payment terms. If a significant portion of a fee is due after    the date that fees would customarily be due under Loudeye’s    normal payment terms, Loudeye considers the fee to not be fixed    and determinable, and in such cases, Loudeye would defer revenue    and recognize it when the fees become due and payable.  •      Collection is deemed probable: Loudeye initially assesses the    probability of collection to determine whether this criterion is    satisfied based on a number of factors, including past    transaction history with the customer and the current financial    condition of the customer. If Loudeye determines that collection    of a fee is not reasonably assured, Loudeye defers revenue until    the time collection becomes reasonably assured, which is    generally upon the receipt of cash.
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     *Samples services revenue.* Samples services are providedto customers using Loudeye’s proprietary streaming mediasoftware, tools, and processes. Music samples are streamed filescontaining selected portions, or samples, of a full music trackand are typically 30 to 60 seconds in length. Customer billingsare based on the volume of data streamed at rates agreed upon inthe customer contract, and may be subject to a nonrefundablemonthly minimum fee. Under the provisions of SAB 104 andEITF 00-21,Loudeye recognizes revenue in the period in which the samplesare delivered.     *Internet radio, hosting and webcasting services revenue.*Internet radio services are provided to customers usingLoudeye’s proprietary media software, tools and processes.Internet radio services can consist of the rebroadcast over theInternet of a customer’sover-the-air radioprogramming. Services provided may also include play listselection and programming services for online radio channels.Under the provisions of SAB 104 andEITF 00-21,revenue from the sale of Internet radio services is recognizedon a monthly basis as the services are provided and customersare typically billed monthly in arrears.     Webcasting services are provided to customers usingLoudeye’s proprietary streaming media software, tools andprocesses. Services for live webcast events and services foron-demand webcasting services are generally sold separately. Forlive webcasting events, Loudeye charges a fixed fee. On demandwebcasting service fees and hosting service fees are based on acontract with either set monthly minimum fees which entitle thecustomer to a monthly volume of stored and streamed data that isspecified in the contract or a contract with charges based uponactual monthly volume of stored and streamed data with nomonthly minimum fees. Additional fees are required to be paidunder the contract if the volume of data streamed or stored in aparticular month exceeds the specified monthly volume threshold,and the per unit charges for the additional volume approximatethe per unit charges for the minimum volumes. Any unused volumeof streamed or stored data expires at each month end.     Because Loudeye separately sells services for live webcastevents and services for on-demand webcasting, Loudeye hasverifiable and objective evidence of the fair value for both thelive and on-demand services. Under the provisions ofSAB 101, as amended by SAB 104, andEITF 00-21,Loudeye recognizes revenue for live webcasting and on-demandwebcasting services which are not subject to monthly minimums inthe period in which the webcast event, data storage or datastreaming occurs. Revenue for on-demand webcasting servicessubject to monthly minimums is recognized monthly on a straightline basis over the contract period, based upon contractedmonthly rates for the specified volume thresholds. Revenue foradditional usage fees is recognized in the period that theadditional usage occurs.     *Software license revenue.* In the limited circumstances inwhich Loudeye sells software products, Loudeye recognizesrevenue associated with the license of software in accordancewith SOP 97-2.Revenue from software license sales accounted for less than 1%of Loudeye’s revenue in 2005 and 2004 and less than 3% ofLoudeye’s revenue in 2003. Under the provisions ofSOP 97-2, insoftware arrangements that involve rights to multiple services,Loudeye allocates the total arrangement consideration among eachof the deliverables using the residual method, under whichrevenue is allocated to the undelivered elements based onvendor-specific objective evidence of the fair value of suchundelivered elements. Elements included in multiple elementarrangements consist of software, intellectual property,implementation services, maintenance and consulting services.Vendor-specific objective evidence is based on the price chargedwhen an element is sold separately or, in the case of an elementnot sold separately, the price established by management, if itis probable that the price, once established, will not changebefore market introduction.***Research and Development Costs***     Loudeye accounts for research and development costs inaccordance with several accounting pronouncements, includingFAS No. 2, “Accounting for Research andDevelopment Costs,” and FAS 86. Research anddevelopment costs associated with software development consistprimarily of salaries, wages and benefits for developmentpersonnel and are generally charged to expense untiltechnological feasibility has been established for the services.Once technological feasibility has been established, allsoftware costs are capitalized until the services are availablefor general release to customers. Capitalized costs are then
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amortized on a straight-line basis over the term of theapplicable contract, or based on the ratio of current revenue tototal projected service revenue, whichever is greater.Technology acquired in business combinations is recorded inintangible assets and purchased software is recorded in propertyand equipment.***Stock-Based Compensation***     Loudeye accounts for stock-based employee compensation plans byapplying the intrinsic value based method of accountingprescribed by Accounting Principles Board (APB) OpinionNo. 25, “Accounting for Stock Issued toEmployees” (APB 25), and related interpretationsincluding Financial Accounting Standards Board InterpretationNo. 44, “Accounting for Certain Transactions InvolvingStock Compensation an Interpretation of APB OpinionNo. 25” (FIN 44). Under this method, compensationexpense is recorded based on the difference between the purchaseprice of employee stock-based awards (restricted stock or stockoptions) and the fair value of Loudeye’s common stock atthe date of grant. Deferred compensation, if any, is amortizedover the vesting period of the related award, which is generallythree to four years.     Equity instruments issued to non-employees are accounted for inaccordance with the provisions of FAS No. 123,“Accounting for Stock-Based Compensation”(FAS 123) and EITF Issue No. 96-18, “Accountingfor Equity Investments that are Issued to Other than Employeesfor Acquiring or in Conjunction with Selling Goods orServices” (EITF 96-18), and related interpretations.     In December 2004, the FASB issued FAS No. 123R,“Share-Based Payment” (FAS 123R) that amendsFAS 123, and FAS No. 95, “Statement of CashFlows” and supersedes APB 25. As of January 1,2006, FAS 123R requires Loudeye to measure the cost ofemployee services received in exchange for an award of equityinstruments, such as stock options, based on the grant-date fairvalue of the award and to recognize such cost over the requisiteperiod during which an employee provides service. The grant-datefair value will be determined using option-pricing modelsadjusted for unique characteristics of the equity instruments.FAS 123R also addresses the accounting for transactions inwhich a company incurs liabilities in exchange for goods orservices that are based on the fair value of the Company’sequity instruments or that may be settled through the issuanceof such equity instruments. The statement does not change theaccounting for transactions in which Loudeye issues equityinstruments for services to non-employees or the accounting foremployee stock ownership plans. The pro forma disclosurespreviously permitted under FAS 123 no longer will be analternative to financial statement recognition.     FAS 123R permits public companies to adopt its requirementsusing one of two methods: •     A “modified prospective” method in which compensation    cost is recognized beginning with the effective date    (a) based on the requirements of FAS 123R for all    share-based payments granted after the effective date and    (b) based on the requirements of FAS 123R for all    awards granted to employees prior to the effective date of    FAS 123R that remain unvested on the effective date.  •     A “modified retrospective” method which includes the    requirements of the modified prospective method described above,    but also permits entities to restate based on the amounts    previously recognized under FAS 123 for purposes of pro    forma disclosures for either (a) all prior periods    presented or (b) prior interim periods of the year of    adoption.     In November 2005, the FASB issued final FASB Staff PositionFAS No. 123R-3, “Transition Election Related toAccounting for the Tax Effects of Share-Based PaymentAwards” (“FSP 123 R-3”). FSP 123 R-3 provides analternative method of calculating excess tax benefits (theAdditional Paid in Capital (“APIC”) pool) from themethod defined in FAS 123R and requires Loudeye to followeither the transition guidance for theadditional-paid-in-capitalpool as prescribed in FAS 123R, or the alternativetransition method as described in FSP 123 R-3. A one-timeelection to adopt the transition method in FSP 123 R-3 isavailable to Loudeye for up to one year from January 1,2006, Loudeye’s initial adoption of FAS 123R. Loudeyecontinues to evaluate the impact that the adoption of this FSPcould have on its consolidated financial statements.
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     Loudeye adopted FAS 123R on January 1, 2006 and willuse the modified prospective method in which compensation costis recognized beginning with the effective date (a) basedon the requirements of FAS 123R for all share-basedpayments granted after the effective date and (b) based onthe requirements of FAS 123R for all awards granted toemployees prior to the effective date of FAS 123R thatremain unvested on the effective date. Loudeye expects theadoption to result in the recognition of stock-basedcompensation expense of approximately $1.3 million to$1.6 million, based on a range of forfeiture rates, forstock options granted prior to January 1, 2006 plus theexpense related to stock options granted during 2006. Theexpense for stock options granted during 2006 cannot bedetermined at this time due to the uncertainty of Loudeye’sstock price, the related Black-Scholes fair value and the timingof future grants.     The following table illustrates the effect on net loss and netloss per share if Loudeye had applied the fair value recognitionprovisions of FAS 123 to stock-based employee compensationawards (in thousands except per share amounts):                **Years Ended December 31,**     **2005** **2004** **2003**           Net loss, as reported $(33,361) $(16,397) $(19,174)    Add: stock-based employee compensation expense under APB 25    included in reported net loss  275   239   593     Deduct: total stock-based employee compensation expense    determined under fair value method for all awards  (1,888)  (3,062)  (929)              Pro forma net loss $(34,974) $(19,220) $(19,510)              Net loss per share:                 Basic and diluted — as reported $(0.31) $(0.22) $(0.39)     Basic and diluted — pro forma $(0.32) $(0.26) $(0.39)     Pro forma stock-based compensation amounts reported abovereflect the correction of certain errors discovered inLoudeye’s stock option tracking software, which resulted inan overstatement of pro forma stock-based compensation disclosedin 2005 and in 2004. The most significant error was related tothe expected life assumption used in the Black-Scholes pricingmodel during 2004. The errors caused an overstatement of theexpected life variable used to value all stock options, which inturn resulted in a corresponding overstatement of stock-basedcompensation. These errors had the effect of overstating proforma stock-based compensation reported for the nine monthsended September 30, 2005 by $1.1 million and by$1.2 million for the year ended December 31, 2004. Proforma net loss per share reported for the nine months endedSeptember 30, 2005 was overstated by $0.02 per shareand by $0.01 per share for the year ended December 31,2004.     To determine compensation expense under FAS 123, Loudeyeused the following assumptions:               **2004** **2004** **2003**           Risk-free interest rates  2.33-5.71%  2.33-5.71%  2.68- 5.71%    Expected lives  2-3 years   3 years   5 years     Expected dividend yields  0%  0%  0%    Expected volatility  95-120%  115-120%  135- 136%***Advertising***     Advertising costs are expensed as incurred. Advertising expenseis included in sales and marketing expenses in the accompanyingconsolidated statements of operations and was not material in2005, 2004, and 2003.
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***Comprehensive Loss***     Comprehensive loss is comprised of net loss, foreign currencytranslation adjustments and net unrealized gains (losses) onavailable-for-sale marketable securities and is presented in theaccompanying consolidated statement of stockholders’ equity.***Foreign Currencies***     Loudeye considers the functional currency of its foreignsubsidiaries to be the local currency of the country in whichthe subsidiary operates. Assets and liabilities of foreignoperations are translated into U.S. dollars using rates ofexchange in effect at the end of the reporting period. Incomeand expense accounts are translated into U.S. dollars usingaverage rates of exchange. The net gain or loss resulting fromtranslation is shown as foreign currency translation adjustmentand included in accumulated other comprehensive income (loss) instockholders’ equity. Gains and losses from foreigncurrency transactions, which were a net gain of approximately$367,000 during the year ended December 31, 2005 and a netloss of $833,000 during the year ended December 31, 2004,are included in the consolidated statements of operations.***Income Taxes***     Loudeye accounts for income taxes under the asset and liabilitymethod as set forth in FAS No. 109, “Accountingfor Income Taxes,” under which deferred income taxes areprovided for the temporary differences between the financialreporting basis and the tax basis of our assets and liabilitiesand operating loss and tax credit carry forwards. A valuationallowance is established when necessary to reduce deferred taxassets to the amount expected to be realized. Deferred taxassets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to applyto taxable income in the years in which those temporarydifferences and operating loss and tax credit carry forwards areexpected to be recovered or settled.***Segments***     Loudeye has adopted FAS No. 131, “Disclosureabout Segments of an Enterprise and Related Information,”(FAS 131) which establishes annual and interim reportingstandards for an enterprise’s operating segments andrelated disclosures about its services, geographic areas andmajor customers. Loudeye’s chief operating decision makeris considered to be its Chief Executive Officer and staff, orSenior Leadership Team (SLT). During 2004, the SLT revieweddiscrete financial information regarding profitability ofLoudeye’s digital media services and media restorationservices, and therefore in 2004 Loudeye reported those asoperating segments as defined by FAS 131. In January 2004,Loudeye transferred substantially all of the assets of its mediarestoration services subsidiary, VidiPax, Inc., or VidiPax, to acompany controlled by VidiPax’s general manager. In May2004, Loudeye completed the sale of this media restorationservices business. While Loudeye will have ongoing rights toco-market and resell media restoration services for two yearsafter the sale, media restoration services did not represent asignificant portion of Loudeye’s revenue in 2005 or 2004,nor does Loudeye expect it to represent a significant portion ofour revenue in the future. Management has determined that duringthe year ended December 31, 2005, Loudeye operated in onlyone segment, digital media services. Media restoration serviceshave been reclassified to a component of digital media servicesin all prior periods presented.***Revisions of Classifications***     During the preparation of Loudeye’s financial statementsfor the year ended December 31, 2004, Loudeye maderevisions of classification with regard to expenses incurredduring the year ended December 31, 2003. Such revisions ofclassification had no impact on net loss, stockholders’equity or cash flows as previously reported. These revisionsrelated to the following: • *Regent Fees.* Loudeye revised its classification of    $878,000 relating to service fees paid to Regent Pacific    Management Corporation (Regent) during the year ended    December 31, 2003, from special
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     charges — other to general and administrative expense    in the current presentation as we determined that these expenses    were not restructuring charges in accordance with FAS 146,    “Accounting for Costs Association with Exit or Disposal    Activities” and were more appropriately classified as    general and administrative expense.  • *Amortization of Intangible Assets.* Loudeye revised its    classification of amortization of acquired technology and    capitalized software costs totaling approximately $269,000 in    2003 from operating expenses — amortization of    intangibles to cost of revenue in the current presentation as we    determined that these expenses were more appropriately    classified as cost of revenue in accordance with FAS 86 and    related accounting literature.  • *Impairment of Intangible Assets.* Loudeye revised its    classification of impairment charges related to acquired    technology and capitalized software costs totaling approximately    $601,000 in 2003 from operating expenses — special    charges — other to cost of revenue in the current    presentation as Loudeye determined that these charges were more    appropriately classified as cost of revenue in accordance with    FAS 86 and related accounting literature***Guarantees, Warranties, and Indemnification***     In the ordinary course of business, Loudeye is not subject topotential obligations under guarantees that fall within thescope of FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees and Indebtedness of Others”(FIN 45) an interpretation of FASB Statements No. 5,57, and 107 and rescission of FASB interpretation No. 34,except for standard indemnification and warranty provisions thatare contained within many of Loudeye’s customer license andservice agreements, and give rise only to the disclosurerequirements prescribed by FIN 45.     Indemnification and warranty provisions contained withinLoudeye’s customer license and service agreements aregenerally consistent with those prevalent in Loudeye’sindustry. The duration of Loudeye’s service warrantiesgenerally does not exceed 90 days following delivery ofLoudeye’s services. In the case of encoding services, ourservice agreements generally provide that we will replace adefective deliverable free of charge during a specified timeperiod not exceeding the term of the applicable agreement.Loudeye has not incurred significant obligations under customerindemnification or warranty provisions historically and does notexpect to incur significant obligations in the future.Accordingly, Loudeye does not maintain accruals for potentialcustomer indemnification or warranty-related obligations.***Recent Accounting Pronouncements***     In March 2005, the FASB issued FASB Interpretation(FIN) No. 47, “Accounting for Conditional AssetRetirement Obligations — an interpretation of FASBStatement No. 143.” FIN No. 47 clarifiesFAS No. 143, “Accounting for Asset RetirementObligations,” such that conditional asset retirementobligations require recognition at fair value if they can bereasonably estimated. These rules are effectiveDecember 31, 2005. Loudeye does not expect the impact ofadopting FIN 47 to have a material effect on its results ofoperations or financial position.     In May 2005, the FASB issued FAS No. 154,“Accounting Changes and Error Corrections”(FAS 154). FAS 154 is a replacement of APBNo. 20, “Accounting Changes” andFAS No. 3, “Reporting Accounting Changes inInterim Financial Statements — (an Amendment of APBOpinion No. 28)” and provides guidance on theaccounting for and reporting of accounting changes and errorcorrections. It establishes retrospective application as therequired method for reporting a change in accounting principle.FAS 154 provides guidance for determining whetherretrospective application of a change in accounting principle isimpracticable and for reporting a change when retrospectiveapplication is impracticable. The reporting of a correction ofan error by restating previously issued financial statements isalso addressed by FAS 154. FAS 154 is effective foraccounting changes and corrections of errors made in fiscalyears beginning after December 31, 2005. Loudeye will adoptthis pronouncement beginning in fiscal year 2006.
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     In November 2005, the FASB issued FASB Staff PositionNo. FAS 115-1, “The Meaning ofOther-Than-Temporary Impairment and its Application to CertainInvestments” (FSP No. 115-1). FSP No. 115-1amends FAS No. 115, “Accounting for CertainInvestments in Debt and Equity Securities” and includesguidance for evaluating and recording impairment losses on debtand equity investments, as well as new disclosure requirementsfor investments that are deemed to be temporarily impaired. FSPNo. 115-1 alsorequires an other-than-temporary impairment of debt and equitysecurities to be written down to its impaired value, whichbecomes the new cost basis. FSP No. 115-1 is effective forfiscal years beginning after December 15, 2005. Loudeyewill continue to evaluate the application of FSP No. 115-1;however, Loudeye does not believe adoption will have a materialeffect on its financial position, results of operations or cashflows.**3.****Acquisitions*****On Demand Distribution Limited***     On June 22, 2004, Loudeye commenced a tender offer toacquire 100% of the outstanding shares of On Demand DistributionLimited (“OD2”), a privately held digital musicprovider based in Europe. Loudeye acquired 93% of the shares ofOD2 upon commencement of the tender offer. As of August 17,2004 Loudeye acquired the remaining 7% of OD2’s shares onthe same terms from the remaining shareholders of OD2. Theacquisition was accounted for using the purchase method ofaccounting for business combinations in accordance withFAS 141.     The initial aggregate purchase price can be summarized atJune 22, 2004 and December 31, 2004 (based on exchangerates as of June 22, 2004) as follows (amounts inthousands):           **June 22,** **December 31,**  **2004** **2004**         Transaction related costs $1,527  $1,993     Cash paid and due on certain liabilities assumed  2,778   1,878     Accrued acquisition consideration  13,654   17,033     Common stock payable related to acquisition  2,596   3,208     Common stock issued in connection with acquisition  13,146   14,015          $33,701  $38,127             Certain of OD2’s principal shareholders agreed to have anaggregate of 15% of the total consideration payable in thetransaction held in escrow by Loudeye for 18 months tosatisfy claims Loudeye may have with respect to breaches ofrepresentations, warranties and covenants and indemnificationclaims. As of December 31, 2004, Loudeye had issued andplaced in escrow 2,315,775 shares of its common stock to17 former OD2 shareholders who had tendered theirshares of OD2 stock as of that date.     In connection with the OD2 acquisition, as of December 31,2004 Loudeye was obligated to pay to formerOD2 shareholders an additional £7.2 million(approximately $13.9 million based on exchange rates as ofDecember 31, 2004), in incremental deferred paymentsthrough November 30, 2005. In January 2005, Loudeye issued4,667,608 shares of its common stock to formerOD2 shareholders to satisfy an installment of its deferredconsideration payment obligation totaling approximately£4.0 million (approximately $7.7 million based onexchange rates as of December 31, 2004), of which 693,402were held in escrow. Pursuant to a restructuring of the terms ofthe transaction in March 2005, Loudeye issued3,026,405 shares (valued at approximately $5.2 millionbased on March 31, 2005 exchange rates) as satisfaction infull of the remaining deferred consideration obligations ofapproximately £3.2 million (or approximately$6.0 million based on March 31, 2005 exchange rates),of which 528,014 shares were held in escrow.     In addition to the deferred payment obligations, Loudeye couldhave become obligated to pay to former OD2 shareholderscontingent consideration of up to £10.0 million(approximately $19.3 million based on exchange rates as ofDecember 31, 2004) if OD2 achieved certain financialperformance targets
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during the period through November 30, 2006. As ofDecember 31, 2004, Loudeye had accrued£1.1 million (approximately $2.1 million based onexchange rates as of December 31, 2004 and excluding escrowrelating to the payment) with respect to the initial payment ofcontingent consideration for the period ended November 30,2004, based on management’s determination that thecontingency related to this payment obligation had been resolvedbeyond a reasonable doubt. Pursuant to the restructuring of theterms of the transaction, Loudeye paid $2.5 million inMarch 2005 and an additional $2.3 million in July 2005 incash in full satisfaction of the maximum potential contingentpayment obligations.     Accrued acquisition consideration consisted of the following (inthousands):           **December 31,**     **2005** **2004**         Accrued acquisition consideration $—  $13,877     Accrued contingent consideration  —   2,047          $—  $15,924             The escrow shares and additional contingent considerationdescribed above were not recorded as liabilities and were notincluded in determining the cost of acquiring OD2 as ofDecember 31, 2004, since the resolution of the escrowshares and additional contingent consideration was still pending.     In December 2005, upon expiration of the escrow period, Loudeyepaid to certain former OD2 shareholders an additional£465,000 (approximately $800,000 based on December 31,2005 exchange rates) that it had been holding in escrow andreleased the 3,537,191 shares that had been held in escrow.The additional consideration resulted in additional goodwillattributable to the OD2 acquisition.***Overpeer, Inc.***     In March 2004, Loudeye completed the acquisition of Overpeer,Inc. (“Overpeer”), a privately held company based inNew York. Pursuant to the Agreement and Plan of Merger andReorganization (“Merger Agreement”), among Loudeye,Privateer Acquisition Corp., a wholly owned subsidiary ofLoudeye, Overpeer and certain of Overpeer’s stockholders.Privateer Acquisition Corp. was merged with and into Overpeer,with Overpeer continuing as the surviving company and awholly-owned subsidiary of Loudeye (the “Merger”). Asa result of the Merger, all of the outstanding capital stock ofOverpeer was exchanged for a total of 1,752,772 shares ofLoudeye’s common stock. The number of shares issued in theMerger was calculated by dividing $4.0 million by thevolume weighted average closing share price of Loudeye’scommon stock on each of the thirty consecutive trading dayspreceding the closing of the Merger, or $2.2821 per share.Of the shares issued in the Merger, 262,916 were to be held inescrow for one year and would be available during that time tosatisfy indemnity claims under the Merger Agreement. In January2005, one of the former Overpeer stockholders substituted$425,000 in cash for 186,234 of the shares held in escrow,resulting in a remaining escrow balance of $425,000 in cash and76,682 shares of common stock. In February 2005, Loudeyedelivered notice to the escrow agent and representative of theformer Overpeer stockholders of claims for breach ofrepresentations and warranties under the merger agreement. InJune 2005, Loudeye reached a settlement with the representativeof the former Overpeer stockholders that resulted in the entireremaining escrow balance of cash and stock being returned toLoudeye. In connection with the settlement, Loudeye recorded areduction of goodwill and additional paid in capital ofapproximately $175,000, representing the initial recorded valueof the cancelled shares, and a reduction of goodwill ofapproximately $425,000 representing the escrowed cash which wasreturned. Overpeer ceased operations in December 2005 asdiscussed further in Note 4 “DiscontinuedOperations.”**4.****Discontinued Operations**     In March 2004, Loudeye acquired Overpeer. On December 9,2005, Loudeye announced that Overpeer had ceased its contentprotection services operations effective immediately. Loudeyehad been funding Overpeer’s operations under anintercompany loan agreement pursuant to which Loudeye held asecurity interest in all of the assets of Overpeer. In November2005, Loudeye delivered Overpeer notice of
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default and acceleration of indebtedness pursuant to theintercompany loan agreement. Following Overpeer’sacknowledgment of default under intercompany loan agreement,Loudeye took possession of Overpeer’s assets and foreclosedon Overpeer’s assets in partial satisfaction ofOverpeer’s outstanding indebtedness to Loudeye. Overpeer ispresented as discontinued operations in our consolidatedfinancial statements for the years ended December 31, 2005and 2004.     Loudeye has recorded certain non-cash impairment chargesrelating to a write-down of the carrying value of all of thegoodwill and some of the long-lived assets associated withLoudeye’s wholly-owned subsidiary, Overpeer, in connectionwith the discontinuance of the Overpeer business. The fairvalues of each of these assets were estimated using primarily aprobability weighted discounted cash flow method. The impairmentof goodwill was determined under the two-step process requiredby FAS 142. The Overpeer technology, Overpeer’scustomer relationships, Overpeer employee non-competeagreements, and Overpeer trademarks with an aggregate net bookvalue of approximately $834,000 have no continuing value inongoing operations as a result of the cessation of the Overpeerbusiness. In addition, Loudeye has determined that the net bookvalue of certain Overpeer fixed assets and leaseholdimprovements exceeded their estimated fair market value as ofNovember 30, 2005, by approximately $591,000.     *Severance.* Overpeer incurred approximately $200,000 inseverance and related payroll costs associated with the closingof its operations which was paid during December 2005. Inaddition, a non-cash stock compensation expense of approximately$40,000 was recorded relating to acceleration of vesting of arestricted stock award to a former Overpeer employee.     *Overpeer Lease.* Overpeer was a party to a lease agreementfor premises located in New York City. The lease had a ten yearterm running through September 2015. Annual rent obligationsunder the lease were approximately $175,000, subject to annualadjustment. Under the lease, Loudeye was required to post anapproximate $175,000 security deposit in the form of a letter ofcredit. In December 2005, the landlord drew down the letter ofcredit in full and terminated the lease. In February 2006,Overpeer, Loudeye and the landlord reached an agreement inprinciple for a settlement pursuant to which the Landlordreleased Overpeer and Loudeye from any future obligations withrespect to the lease in exchange for the landlord retaining theapproximate $175,000 security deposit and certain Loudeye-ownedfurniture with a net book value of approximately $80,000. Forthe year ended December 31, 2005, Loudeye included a chargeof approximately $253,000 in loss from discontinued operationsrelating to the lease, offset in part by a deferred rent creditof approximately $80,000 resulting from the early leasetermination.     *Savvis Communications Corp. Litigation.* OnDecember 15, 2005, Savvis Communications Corp. filed acomplaint in Superior Court in Santa Clara County,California, against Overpeer and Loudeye relating to a May 2002Master Services Agreement between Savvis and Overpeer forcollocation and bandwidth services (the “Overpeer-SavvisAgreement”). The complaint alleges Overpeer breached theOverpeer-Savvis Agreement for non-payment. The complaint alsocontains alter ego allegations against Loudeye. The complaintseeks damages of $1.6 million consisting of $950,000 ofallegedly unpaid invoices for services and approximately$600,000 in alleged early termination fees. The court hasgranted Savvis a writ of attachment over Overpeer’s assetslocated in the state of California. As noted above, Loudeye hasforeclosed on its first priority security interest inOverpeer’s assets and Overpeer does not have sufficientassets in California (or elsewhere) to satisfy a judgmentagainst it, if any. In February 2006, Overpeer and Loudeye fileda joint motion to compel arbitration of the dispute under theterms of the agreement between Savvis and Overpeer. The motionis scheduled to be heard on March 30, 2006. Loudeyeassesses the probability of a judgment against Overpeer relatingto the $950,000 in unpaid invoices as high. Loudeye is not aparty to the Overpeer-Savvis Agreement. Loudeye intends todefend itself vigorously concerning the alter ego claims broughtby Savvis. However, Loudeye cannot assess at this time theprobability of an unfavorable outcome with respect to the claimsbrought against Loudeye.
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     A summary of the special charges recorded during the year endedDecember 31, 2005 related to the cessation of the Overpeerbusiness is included in the table below.         Goodwill impairment $1,879     Customer lists and other intangible assets impairment  834     Property and equipment impairment  591     Employee severance and termination benefits  244     Facilities related charges (credits)  173       $3,721     The closure of Overpeer meets the criteria of a “componentof an entity” as defined in FAS No. 144“Accounting for the Impairment or Disposal of Long-LivedAssets” (FAS 144). The operations and cash flow ofthose components have been eliminated from the ongoingoperations of Loudeye as a result of the disposal, and Loudeyedoes not have any significant involvement in the operations ofthat component after the disposal transaction. Accordingly, inaccordance with the provisions of FAS 144, the results ofoperations of Overpeer are reported as discontinued operationsin the accompanying consolidated financial statements. Theprior-year results of operations for Overpeer have beenreclassified to conform to this presentation.     Operational data for Overpeer is summarized as follows (inthousands):           **For the Years Ended**  **December 31,**     **2005** **2004**         Revenue $1,823  $2,788     Net loss from discontinued operations  (7,783)  (400)     Current liabilities from discontinued operations ofapproximately $981,000 and $782,000 at December 31, 2005and 2004 are comprised primarily of $977,000 and $569,000 inaccounts payable.**5.****Special Charges (Credits)**     Special charges (credits) for the year endedDecember 31, 2005 were ($43,000) and related to facilitiesconsolidations. During 2005, Loudeye paid $360,000 of the$403,000 then remaining accrued special charge balance, as afinal payment related to Loudeye’s former facility at 414Olive Way, Seattle, Washington, and the $43,000 differencebetween the amount previously recorded in accrued specialcharges and the final settlement amounts of the underlyingliabilities was reflected as a net credit to special charges(credits) in the consolidated statements of operations.     Beginning in the fourth quarter of 2000 through the firstquarter of 2003, Loudeye commenced a series of operationalrestructurings and facilities consolidations. As a result ofthese activities, Loudeye has recorded special charges in theyears ended December 31, 2004 and 2003. Special charges forthe year ended December 31, 2004 were $312,000. During2004, Loudeye settled a suit for breach of lease related to itsunoccupied facility at 414 Olive Way, Seattle, Washington.Loudeye had recorded the estimated lease termination costs inaccrued special charges. Due to the settlement, Loudeyeincreased the amount in accrued special charges by $362,000during the year ended December 31, 2004. In addition, inFebruary 2004, Loudeye entered into a lease settlement agreementwith the landlord of its unoccupied facility in New York, NewYork pursuant to which Loudeye paid the landlord $450,000 andallowed the landlord to retain its security deposit of $212,000,for a total settlement of $662,000. The $50,000 differencebetween the amount recorded in accrued special charges and thefinal settlement amount was reflected as a credit to specialcharges during the first quarter 2004 in the consolidatedstatement of operations.     The facilities related charges and goodwill, and property andequipment impairment charges recorded in 2003 were the result ofLoudeye’s decision to exit certain domestic facilities andwere estimated based on the company’s evaluation of thencurrent market conditions relative to the company’sexisting special
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charges accrual. The estimated facilities related charges arebased on current comparable rates for leases and subleases of acomparable term or termination fees. Certain property andequipment and goodwill related to Loudeye’s mediarestoration services and enterprise communications servicesbusinesses were impaired, as the projected undiscounteddiscernible cash flows did not exceed the carrying value of theassets over their estimated useful lives. The fair values ofeach of these assets were estimated using primarily aprobability weighted discounted cash flow method. The fair valueof goodwill was estimated under the two-step process required byFAS 142.     The components of the special charges are summarized as follows(in thousands):               **Years Ended December 31,**     **2005** **2004** **2003**           Goodwill impairment $—  $—  $5,307     Customer lists and other intangible assets impairment  —   —   84     Property and equipment impairment  —   —   670     Employee severance and termination benefits  —   —   501     Facilities related charges (credits)  (43)  312   658             $(43) $312  $7,220                The following table reflects the activity in accrued specialcharges for the year ended December 31, 2005 (in thousands):       **Facilities-related**  **Charges (credits)**       Balance, December 31, 2004 $403     Additional accruals  —     Payments  (360)    Adjustments  (43)        Balance, December 31, 2005 $—          In January 2005, Loudeye paid $360,000 of the $403,000 thenremaining accrued special charge balance, as a final paymentrelated to Loudeye’s former facility at 414 Olive Way,Seattle, Washington.**6.****Sale of Media Restoration Business**     On January 30, 2004 (“Transfer Date”),Loudeye’s wholly-owned media restoration servicessubsidiary, VMRLE Co., Inc. (formerly VidiPax, Inc.),transferred substantially all of its assets and certainliabilities to a company controlled by the former generalmanager of VMRLE Co., Inc. pursuant to an asset purchaseagreement signed on October 31, 2003 and amended onJanuary 30, 2004. The total purchase price of$1.2 million was placed in escrow when the asset purchaseagreement was signed. Based on the January 30, 2004amendment, $900,000 of the $1.2 million purchase price wasto be released from escrow upon the assignment to the purchaserof contracts with the General Services Administration of theUnited States (“GSA Contracts”). If the GSA Contractswere not assigned within a certain time period after theTransfer Date, the purchaser had the option to unwind thetransfer and reclaim the $1.2 million held in escrow.Accordingly, the assets and liabilities transferred wererecorded on the consolidated balance sheet as assets andliabilities transferred under contractual arrangement at theircarrying value as of the Transfer Date. As of December 31,2003, these assets and liabilities were classified as held forsale. On May 17, 2004 (“Accounting ClosingDate”), the GSA Contracts were assigned to the purchaser,resulting in the subsequent release of the $900,000 from escrowto VMRLE Co., Inc. For the period from the Transfer Date to theAccounting Closing Date, VMRLE Co., Inc. continued to be thecontracting party with the GSA. The media restoration servicesprovided under the GSA Contracts during that period wereprovided by the purchaser as agent for VMRLE Co., Inc. and thepurchaser retained the profits or losses earned from suchservices. Because VMRLE Co., Inc. continued to be the primaryobligor under the GSA
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Contracts until their assignment, revenue and costs of revenuein the consolidated statement of operations of Loudeye reflectthe revenue and cost of revenue from services provided under theGSA Contracts totaling $213,000 for the period from the TransferDate through the Accounting Closing Date, of which $95,000 wasrecorded as revenue and cost of revenue in the first quarter2004 and $118,000 was recorded as revenue and cost of revenue inthe second quarter 2004. All other revenue and costs of VMRLECo., Inc.’s operations have been appropriately excludedfrom Loudeye’s statement of operations subsequent to theTransfer Date. The difference between the $900,000 proceedsreceived from escrow and the carrying value of the assets andliabilities transferred as of the Accounting Closing Date is$160,000 and was recorded as a loss on the sale of net assetstransferred under contractual arrangement in the second quarter2004.     With the GSA Contracts assigned to the purchaser, the remaining$300,000 of the $1.2 million originally held in escrow wasreleased during third quarter 2004 upon the execution of anagreement relating to certain rights associated with certainequipment owned by a third party and a net gain of $273,000 wasrecorded during the third quarter 2004.     Loudeye may receive up to an additional $500,000 based on thepurchaser achieving certain performance targets over a period oftwo years from the Transfer Date. At transfer, Loudeye alsoentered into a co-marketing and reseller agreement with thepurchaser pursuant to which Loudeye will sell, for a fee, mediarestoration services on behalf of the purchaser for a two-yearperiod. The co-marketing and earn-out provisions constitutecontinuing involvement by Loudeye under FAS No. 144,“Accounting for the Impairment or Disposal of Long-LivedAssets”. Consequently, VMRLE Co., Inc. has not beenreported as a discontinued operation.**7.****Allowance for Doubtful Accounts**     Activity in the allowance for doubtful accounts is as follows(in thousands):                   **Balance** **Charged**   **Balance**  **at** **(Credited)**   **at**  **Beginning of** **to** **Write-** **End of****Year ended December 31,** **Year** **Expense** **Offs** **Year**             2005 $200  $321  $(229) $292     2004  235   82   (117)  200     2003  254   129   (148)  235 **8.****Property and Equipment**     Property and equipment consists of the following (in thousands):                **December 31,**         **2005** **2004** **Depreciable Lives**           Production and computer equipment $11,965  $9,328   3 years     Furniture, fixtures and equipment  365   350   5 years     Leasehold improvements  355   355   3-5 years     Software  822   694   3 years                Subtotal  13,507   10,727         Accumulated depreciation and amortization  (8,821)  (6,598)                  Property and equipment, net $4,686  $4,129                    Depreciation and amortization expense related to property andequipment was approximately $2.7 million in 2005,$1.8 million in 2004, and $1.3 million in 2003.
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**9.****Intangible Assets**     Loudeye’s intangible assets at December 31, 2005 and2004 were as follows (in thousands):                           **Gross Carrying** **Accumulated**    **Amount** **Amortization** **Net Book Value**         **December 31,** **December 31,** **December 31,**         **2005** **2004** **2005** **2004** **2005** **2004**                 Patents $1,419  $—  $60  $—  $1,359  $—     Customer relationships  998   1,117   361   156   637   961     Acquired technology  1,590   1,778   576   246   1,014   1,532     Trademarks  106   48   —   —   106   48                      $4,113  $2,943  $997  $402  $3,116  $2,541                    In June 2005, Loudeye’s wholly-owned subdsidiary, Overpeer,acquired a patent which defines a system for closely imitatingdigital media files onpeer-to-peer networks.Overpeer recorded the gross book value of approximately$1.3 million as patent acquisition costs and beganamortizing the cost of the patent over its estimated useful lifeof 16 years. In December 2005, Loudeye foreclosed on theassets of Overpeer, including the patent.     Amortization of intangible assets totaled approximately$613,000, $532,000, and $1.1 million for the years endingDecember 31, 2005, 2004 and 2003, respectively.     Based on identified acquired intangible assets recorded as ofDecember 31, 2005, and assuming no subsequent impairment ofthe underlying assets, the related estimated annual amortizationexpense for the next five succeeding years is expected to be asfollows (in thousands):         2006 $643     2007  643     2008  643     2009  225     2010  103       $2,257     **10.****Accrued and Other Liabilities**     Other accrued expenses consisted of the following (in thousands):           **December 31,**     **2005** **2004**         Accrued royalties $4,885  $2,407     Accrued retailer commissions  517   553     Accrued legal and accounting fees  149   458     Accrued taxes  262   150     Accrued professional services  116   255     Accrued rent and utilities  49   108     Other accrued liabilities  553   838          $6,531  $4,769        **11.****Long-Term Debt and Capital Lease Obligations**     In March 2005, Loudeye entered into an Amended and Restated Loanand Security Agreement (the “Amended Term Loan”) withSilicon Valley Bank (“SVB”). The Amended Term Loanamends and
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restates Loudeye’s December 31, 2003 loan and securityagreement with SVB (the “Original Loan Agreement”).There are three primary components of the Amended Term Loan asfollows: •     A term loan in the amount of $3.0 million, with a balance    as of December 31, 2005, of approximately    $1.0 million. The term loan bears interest at an annual    rate of 0.5% above the prime interest rate (which rate was    previously 1.25% above the prime interest rate under the terms    of the December 31, 2003 loan and security agreement).    Payments of principal and interest total $83,333 per month    for 36 months from December 31, 2003. Once repaid, the    term loan may not be reborrowed.  •     An equipment term loan facility, which expired October 31,    2005, with a balance as of December 31, 2005, of zero.  •     A guidance line facility in the amount of $1.5 million,    which is available through March 29, 2006, with a balance    as of December 31, 2005, of zero.Borrowings under the Amended Term Loan are collateralized bysubstantially all of Loudeye’s assets. In addition, theAmended Term Loan restricts, among other things, Loudeye’sborrowings, dividend payments, stock repurchases, and sales ortransfers of ownership or control, and contains certain otherrestrictive covenants that require Loudeye to maintain a certainquick ratio and tangible net worth, as defined in the AmendedTerm Loan.     In December 2005, Loudeye notified SVB that it was not incompliance with a restrictive financial covenant under theAmended Term Loan Agreement that requires Loudeye to maintain acertain minimum tangible net worth financial covenant, asdefined by the amended loan agreement. Loudeye subsequentlyestablished a certificate of deposit in the amount ofapproximately $1.0 million, which was equal to the thenoutstanding loan balance. Restricted cash of $1.0 million isreflected on Loudeye’s December 31, 2005 consolidatedbalance sheet related to the certificate of deposit.***Capital Lease Obligations***     Loudeye financed the acquisition of certain equipment withcapital lease arrangements. As of December 31, 2005 and2004, the outstanding obligations under these capital leaseswere zero and $135,000. The leases bore interest at ratesranging from 5.01% to 7.52% and were collateralized by theequipment and standby letters of credit.**12. Stockholders’ Equity*****Preferred Stock***     The board of directors has the authority, without action by thestockholders, to designate and issue up to 5,000,000 shares ofpreferred stock in one or more series and to designate therights, preferences and privileges of each series, any or all ofwhich may be greater than the rights of the common stock. Noshares of preferred stock were outstanding during 2005, 2004 or2003.***Common Stock***     The holders of common stock are entitled to one vote per shareon all matters to be voted on by the stockholders. Subject topreferences that may be applicable to any outstanding preferredstock, the holders of common stock are entitled to receiveratably such dividends, if any, as may be declared from time totime by the board of directors out of funds legally availablefor that purpose. To date the Company has not declared anydividends on its common stock. In the event of a liquidation,dissolution or winding up of the Company, the holders of commonstock are entitled to share ratably in all assets remainingafter payment of liabilities, subject to prior distributionrights of preferred stock, if any, then outstanding. The commonstock has no preemptive or conversion rights or othersubscription rights. There are no redemption or sinking fundprovisions applicable to the common stock.
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     At Loudeye’s annual meeting of stockholders in May 2005,the stockholders approved an increase in the authorized numberof shares of Loudeye’s common stock from 150,000,000 to250,000,000. There were no changes to the rights, preferences orprivileges of Loudeye’s common stock.     As disclosed in Note 19, in February 2006, Loudeye issuedan additional 16.5 million shares, together with warrantsto purchase approximately 12.4 million shares of commonstock at an exercise price of $0.68 per share.     *December 2004 private placement transaction.*In December2004, Loudeye entered into a subscription agreement with alimited number of accredited investors pursuant to which Loudeyesold and issued to such investors 16,800,007 shares ofLoudeye’s common stock, together with warrants to purchase5,040,002 shares of common stock at an exercise price of $2.25per share, for an aggregate purchase price of $25.2 millionand net proceeds of $23.5 million. The warrants becameexercisable on June 23, 2005 and are exercisable until thefifth anniversary of the closing date, or December 23,2009. Loudeye also granted the investors a one year right topurchase 30% of any securities sold by Loudeye in futurefinancings, subject to exceptions. Loudeye filed a registrationstatement in February 2005 covering the resale of the shares ofcommon stock issued in this transaction and the shares of commonstock underlying the warrants. This registration statement wasdeclared effective by the SEC in April 2005. However, theregistration statement was not filed and was not declaredeffective by the SEC within the time periods required under thesubscription agreement. Loudeye adjusted net proceeds from theDecember 2004 private equity placement as a result ofcontractual damages of approximately $464,000 incurred relatingto the filing and effectiveness delays under the subscriptionagreement.     *February 2004 private placement transaction.*In February2004, Loudeye sold 10,810,811 shares of common stock at $1.85per share to a limited number of accredited investors. The grossproceeds received from the financing were $20.0 million.Loudeye paid a placement fee equal to 5% of the gross proceeds.The net proceeds of the offering, after commissions andexpenses, will be used for working capital and general corporatepurposes, including expansion of Loudeye’sbusiness-to-business digital music solutions in the U.S. andinternationally. Loudeye filed a registration statement in March2004 covering the resale of the shares sold in the financing andthe registration statement was declared effective by the SEC onMay 26, 2004.     *August 2003 private placement transaction.* OnAugust 28, 2003, the Company issued 7,838,708 shares ofcommon stock to institutional investors in a private placementtransaction for $1.55 per share, raising gross proceeds ofapproximately $12.1 million. In connection with thetransaction, the Company also issued warrants to the investorsto purchase 783,871 shares of the Company’s common stockand warrants to the placement agent to purchase 195,968 sharesof the Company’s common stock, representing total warrantshares of 979,839 shares of common stock. The exercise price ofthe warrants is $2.00 per share. The warrants were exercisablebeginning February 27, 2004 and expire February 27,2007. Net proceeds from the transactions, after issuance costsand a placement fee of 4% of the gross proceeds, wereapproximately $11.4 million. Loudeye filed a registrationstatement covering the resale of shares sold in the financingand the registration statement was declared effective in October2003.     In accordance with EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed To, and Potentially Settled In aCompany’s Own Stock,” and the terms of the warrants,the fair value of the warrants were accounted for as aliability, with an offsetting reduction to the carrying value ofthe common stock. The warrant liability was reclassified toequity as of the October 14, 2003 effective date of theregistration statement.     The fair value of the warrants was estimated using theBlack-Scholes option-pricing model with the followingassumptions: no dividends; risk-free interest rate of 2.71%, thecontractual life of 3.5 years and volatility of 136%. Thefair value of the warrants was estimated to be $1.5 millionon the closing date of the transaction. The fair value of thewarrants was re-measured at September 30, 2003 andestimated to be $1.7 million. The increase in the fairvalue of $248,000 from the transaction date to October 14,2003 was reflected as a charge to other expenses in thestatement of operations in 2003.
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***Stock Option Plans***     Under Loudeye’s 2005 Incentive Award Plan, the board andits compensation committee as its designee may grant toemployees, consultants, and directors of Loudeye and itssubsidiaries incentive and nonstatutory options to purchase ourcommon stock, restricted stock awards to purchase shares ofLoudeye common stock that are subject to repurchase and arenontransferable until such shares have vested, and other formsof equity compensation awards. In addition, Loudeye maintains a2000 Stock Option Plan, a 1998 Stock Option Plan, an EmployeeStock Option Plan and a Director Stock Option Plan.     At December 31, 2005, options to purchase up to 12,318,756shares of our common stock were outstanding under Loudeye’svarious stock option plans and restricted stock awards for anaggregate of 1,450,000 shares of our common stock wereoutstanding under Loudeye’s 2005 Incentive Award Plan. Inaddition, at December 31, 2005, an aggregate of 11,667,589shares were reserved for issuance under Loudeye’s 2005Incentive Award Plan.     Loudeye’s 2005 Incentive Award Plan provides for anautomatic annual increase on the first day of each of fiscalyear beginning in 2006 equal to the lesser of 5.0 millionshares or 2% of our outstanding common stock on the last day ofthe immediately preceding fiscal year or a lesser number ofshares as our board determines. As a result, on January 1,2006, the number of shares reserved under Loudeye’s 2005Incentive Award Plan automatically increased by2,307,361 million shares of our common stock. Option grantsunder the plans have terms of ten years and generally vest overthree to four and one half years.     *Restricted Stock Awards.* As of December 31, 2005,Loudeye had issued an aggregate of approximately1.5 million shares of restricted common stock, net ofcancellations, to certain employees under the 2005 IncentiveAward Plan. These restricted stock awards have a four-yearvesting period. The accrual for deferred compensation expenserelated to the restricted shares issued was recorded at themarket value on the date of the grant and the relatedcompensation expense is being amortized on a straight line basisover the vesting period.     The following summarizes restricted stock award activity during2005 (prior year grants were not material):              **Weighted Average**  **Number of** **Grant Date Fair**  **Shares** **Value per Share**         Outstanding, January 1, 2004  —   —      Granted  1,750,000  $0.74      Vested  (100,000)         Cancelled  (200,000)               Outstanding, December 31, 2005  1,450,000  $0.74             Scheduled annual vesting for restricted stock awards is asfollows:                       **2006** **2007** **2008** **2009** **Total**               Restricted stock awards  550,000   362,500   362,500   175,000   1,450,000      During the year ended December 31, 2005, Loudeye recordedstock based compensation expense related to the amortization ofrestricted stock grants of approximately $200,000. During 2004,stock-based compensation expense related to the amortization ofrestricted stock grants was not material.
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     Option activity under the plans was as follows:                  **Weighted Average**         **Grant Date**    **Number of** **Fair Value** **Exercise Price**  **Shares** **per Share** **per Share**           Outstanding, January 1, 2003  8,059,358      $0.98      Granted at below fair value  473,300  $1.12   0.29      Granted at fair value  4,867,490   0.52   0.52      Exercised  (1,998,452)      0.80      Cancelled  (4,717,989)      0.96               Outstanding, December 31, 2003  6,683,707       0.67      Granted at below fair value  168,048  $1.97   0.29      Granted at fair value  11,172,700  $1.27   1.27      Exercised  (1,465,505)      0.63      Cancelled  (2,774,801)      1.66               Outstanding, December 31, 2004  13,784,149       1.15      Granted at fair value  7,364,000  $1.05   1.05      Exercised  (2,368,359)      0.31      Cancelled  (6,461,034)      1.44               Outstanding, December 31, 2005  12,318,756(1   ) $1.12                The following information is provided for options outstandingand exercisable at December 31, 2005:                       **Options Outstanding** **Options Exercisable**         **Weighted Average**          **Weighted**    **Exercise** **Remaining**   **Average**  **Number of** **Price per** **Contractual** **Number of** **Exercise****Range of Exercise Prices** **Shares** **Share** **Life (in Years)** **Shares** **Price**               $0.27 — $0.39  1,031,551  $0.29   7.35   945,870  $0.28     $0.40 — $0.54  1,832,499  $0.49   8.72   42,374  $0.45     $0.55 — $0.80  586,249  $0.75   8.02   157,040  $0.71     $0.81 — $1.21  4,256,088  $0.99   8.49   1,398,540  $1.01     $0.55 — $0.80  3,215,083  $1.53   8.94   467,448  $1.52     $0.81 — $2.35  1,306,536  $2.09   7.81   950,593  $2.10     $2.36 — $3.00  90,750  $3.00   4.89   90,750  $3.00                     December 31, 2005  12,318,756(1) $1.12   8.42   4,052,615  $1.18                     December 31, 2004  13,784,149  $1.15   8.53   3,876,057  $0.64                     December 31, 2003  6,683,707  $0.67   8.99   3,085,362  $0.72                  (1)     An aggregate of 221,573 shares of common stock are issuable upon    the exercise of stock options held by former OD2 shareholders.    These stock options were initially issued under the On Demand    Distribution Limited Employee Share Option Plan and were assumed    by Loudeye as part of our acquisition of OD2. All of the options    are immediately exercisable at an exercise price of $0.001 per    share. The option grants have terms of ten years from the date    of original grant.*Warrants*     At December 31, 2005, there were 5,951,606 shares of commonstock issuable upon the exercise of outstanding warrants, withexercise prices ranging from $1.75 to $9.55 and a weightedaverage exercise
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price of $2.22 per share. Of these outstanding warrants,warrants to purchase 5,040,002 shares of our common stock wereissued on December 23, 2004, in connection with our privateplacement transaction to 14 accredited investors. These warrantshave an exercise price of $2.25 per share and are exercisableuntil the fifth anniversary of the date of issuance. Inaddition, in February 2006, warrants to purchase 12,375,000shares of Loudeye’s common stock were issued in connectionwith Loudeye’s private placement transaction as describedin Note 19. These warrants have an exercise price of $0.68per share and are not exercisable until six months after thedate of issuance and are then exercisable until the fifthanniversary of the date of issuance.*Shares Reserved for Future Issuance*     The following shares of common stock have been reserved forfuture issuance as of December 31, 2005:         Loudeye stock option plans  12,318,756     OD2 options assumed  221,573     Common stock warrants  5,951,606        18,491,935     **13. Income Taxes**     Loss before income taxes consists of the following (inthousands):               **Years Ended December 31,**     **2005** **2004** **2003**           United States $(23,856) $(11,182) $(19,174)    Foreign  (9,505)  (5,215)  —             $(33,361) $(16,397) $(19,174)               Loudeye’s income tax benefit differs from the expectedincome tax benefit computed by applying the U.S. federalstatutory rate of 35% to net loss before income taxes as follows(in thousands):               **Years Ended December 31,**     **2005** **2004** **2003**           Income tax benefit at statutory rate of 35% $(11,676) $(5,575) $(6,519)    State taxes  (99)  —   —     International taxes, rate differential  778   209   —     Goodwill impairment  665   —   —     Research and development credit  (276)  (132)  —     Other  88   —   —     Change in valuation allowance  10,520   5,498   6,519               Income tax provision (benefit) $—  $—  $—                Deferred income taxes reflect the net tax effects of temporarydifferences between the carrying amounts of assets andliabilities for financial reporting purposes and the amountsused for income tax purposes.     At December 31, 2005, Loudeye had U.S. net operating losscarryforwards of approximately $232.8 million and foreignnet operating loss carryforwards of approximately$26.0 million which will begin to expire in 2018 through2025. The Internal Revenue Code and similar state provisionsplace certain limitations on the annual amount of net operatingloss carryforwards that can be utilized if certain changes inthe Company’s ownership occur. Loudeye has experienced suchownership changes as a result of its
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various stock offerings, and the utilization of thecarryforwards could be limited such that a portion for the netoperating losses may never be utilizable.     Due to Loudeye’s business combinations, the realization ofapproximately $18.5 million of net operating losscarryforwards will be used to first reduce to zero any goodwill,and then reduce to zero any other non-current intangible assetsassociated with the business combinations, and then anyremaining net operating loss carryforwards recovered will berecognized as a reduction in income tax expense.     At December 31, 2005, Loudeye had research andexperimentation credit carryforwards of approximately $437,000,which will expire beginning in 2020.     Approximately $1.1 million of the valuation allowance atDecember 31, 2005 resulted from deductions associated withthe exercise of stock options, the realization of which willresult in a credit to stockholders’ equity.     The effects of temporary differences and carryforwards that giverise to deferred tax assets and liabilities are as follows (inthousands):            **Years Ended**  **December 31,**     **2005** **2004**         Deferred tax assets:             U.S. net operating loss carryforwards $81,121  $74,143      State net operating loss carryforwards  353   265      Foreign net operating loss carryforwards  7,798   5,200      Basis difference in depreciable assets  2,880   3,639      Capitalized research and development expenses  1,815   —      Accrued special charges  —   141      Stock options and warrants  91   421      Research and development credit carryforwards  437   160      Other  424   516            Total gross deferred tax assets  94,919   84,485     Valuation allowance  (94,340)  (83,358)           Deferred tax assets, net of valuation allowance  579   1,127            Deferred tax liabilities:             Purchased technology and other intangibles  (579)  (1,127)           Total gross deferred tax liabilities  (579)  (1,127)           Net deferred tax assets (liabilities) $—  $—             Loudeye has placed a 100% valuation allowance against itsdeferred tax assets due to the uncertainty surrounding theultimate realization of such assets. The valuation allowanceincreased by approximately $11.0 million in 2005,$9.1 million in 2004, and $5.5 million in 2003.     In addition to the change in valuation impacting the taxprovision of $10,520,000, the valuation allowance was impactedby stock compensation amounts of $462,000 that will be recordedto stockholder’s equity when realized.**14. Net Loss Per Share**     Basic loss per share is computed by dividing net loss by theweighted average number of shares of common stock outstandingduring the period. Diluted loss per share is computed bydividing net loss by the weighted average number of common anddilutive common equivalent shares outstanding during the period.Common equivalent shares consist of shares issuable upon theexercise of stock options and
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warrants (using the treasury stock method). Common equivalentshares are excluded from the calculation if their effect isantidilutive, which is the case for all periods presented.Loudeye has excluded the following numbers of shares using thismethod (in thousands):               **Years Ended December 31,**     **2005** **2004** **2003**           Options outstanding under Loudeye stock option plans  12,319   13,784   6,684     Restricted stock outstanding under Loudeye stock option plans  1,450   —   —     OD2 options assumed  222   2,202   —     Warrants outstanding  5,952   6,132   1,028               Shares excluded  19,943   22,118   7,712                Loudeye had no shares subject to repurchase at December 31,2005 or 2004. The impact of these unvested shares has beenremoved from the calculation of weighted average sharesoutstanding for purposes of determining basic and dilutedearnings per share and basic and diluted pro forma earnings pershare.     The following table presents a reconciliation of shares used tocalculate basic and diluted earnings per share (in thousands):               **Years Ended December 31,**     **2005** **2004** **2003**           Weighted average shares outstanding  107,652   73,845   49,798     Weighting of shares subject to repurchase  —   —   (1)              Weighted average shares used to calculate basic and diluted    earnings per share  107,652   73,845   49,797                As disclosed in Note 19, in February 2006, Loudeye issuedan additional 16.5 million shares, together with warrantsto purchase approximately 12.4 million shares of commonstock at an exercise price of $0.68 per share.**15. Defined Contribution Plan**     Loudeye maintains a defined contribution retirement plan foreligible employees under the provisions of Internal Revenue CodeSection 401(k). Participants may defer up to a portion oftheir annual compensation on a pretax basis, subject to maximumlimits on contributions. Contributions by Loudeye are at thediscretion of the Board of Directors. No discretionarycontributions have been made by Loudeye to date.     Loudeye’s wholly owned subsidiary, OD2, maintains a definedcontribution UK pension plan which provides for individualaccounts which are for the benefit of directors and certainemployees. The assets of the individual accounts areadministered by trustees in funds independent from those of OD2or Loudeye. OD2 pension plan contributions were approximately$225,000 for the year ended December 31, 2005 andapproximately $112,000 from date of acquisition (June 22,2004) through December 31, 2004.**16. Commitments and Contingencies*****Operating Leases***     Loudeye leases its facilities under non-cancelable operatingleases with various expiration dates through September 2010.
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     Future minimum rental payments under operating leases that haveinitial or remaining noncancelable lease terms in excess of oneyear as of December 31, 2005 are as follows (in thousands):       **Operating**  **Leases**       2006 $1,290     2007  1,186     2008  70     2009  70     2010  33     Thereafter  —       $2,649          Rent expense under operating leases totaled approximately$1.6 million, $1.0 million and $1.6 millionduring 2005, 2004 and 2003, respectively. In December 2004,Loudeye established a certificate of deposit with Silicon ValleyBank in the amount of $175,000 to collateralize a standby letterof credit required by a facility lease for Loudeye’ssubsidiary, Overpeer. As a result, Loudeye reflected thiscertificate of deposit in restricted cash in the accompanyingconsolidated balance sheets as of December 31, 2004. InDecember 2005, the landlord drew down the letter of credit infull. In February 2006, Overpeer, Loudeye and the landlordreached a settlement pursuant to which the Landlord releasedOverpeer and Loudeye from any future obligations with respect tothe lease in exchange for the landlord retaining the approximate$175,000 security deposit and certain Loudeye-owned furniturewith a net book value of approximately $80,000.     Loudeye has entered into various agreements that allow forincorporation of licensed or copyrighted material into itsservices. Under these agreements, Loudeye is required to makeroyalty payments to the recorded music companies (recordlabels), publishers and various other rights holders. Some ofthese agreements require quarterly or annual minimum paymentswhich are not recoupable based upon actual usage. Other royaltyagreements require royalty payments based upon a percentage ofrevenue earned from the licensed service. Royalty costs incurredunder these agreements are recognized over the periods that therelated revenue is recognized and are included in cost ofrevenue. These amounts totaled approximately $15.4 million,$3.0 million and $628,000 for the years endedDecember 31, 2005, 2004 and 2003.     *Other.*In February 2005, Loudeye entered into a twelvemonth agreement in the ordinary course of business with aninternet service provider (ISP) in Europe, under whichLoudeye will provide the ISP’s customers with promotionalcredits that may be redeemed for a range of digital mediadownload services through February 2006. We will receive a fixedfee of approximately€1.8 million(approximately $2.2 million based on December 31, 2005exchange rates) under the agreement, of which we recognizedapproximately€1.4 million(approximately $1.7 million based on December 31, 2005exchange rates) and will recognize approximately€375,000(approximately $444,000 based on December 31, 2005 exchangerates) during first quarter 2006. As of December 31, 2005,deferred revenue related to this agreement was zero, net ofrelated receivables of approximately€78,000(approximately $92,000 based on December 31, 2005 exchangerates), and deposits related to this agreement wereapproximately€300,000(approximately $355,000 based December 31, 2005 exchangerates). Because the transaction is denominated in Euros and wecurrently do not hedge the arrangement, we could be subject toforeign currency gains or losses. As of the date of this filing,no losses have been incurred or estimated under this agreement.*Nasdaq Listing Compliance*     On July 7, 2005, Loudeye received a notice from The NasdaqStock Market that Loudeye’s common stock is subject todelisting from the Nasdaq Capital Market as a result of failureto comply with the $1.00 per share bid price requirement for 30consecutive days as required by Nasdaq MarketplaceRule 4310(c)(4) (the “Rule”). In the notice,Nasdaq informed Loudeye that it will be provided a grace periodof 180 calendar days, or until January 3, 2006, to regaincompliance. If at anytime before
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January 3, 2006, the bid price of Loudeye’s commonstock closes at $1.00 per share for more for 10 consecutivedays, the Nasdaq staff will provide written notification thatLoudeye has regained compliance with the Rule. If Loudeye is notable to demonstrate compliance by January 3, 2006, Loudeyemay qualify for an additional 180 day grace period if it isthen in compliance with the other initial listing criteria ofthe Nasdaq Capital Market. Loudeye’s board of directors andstockholders have approved an amendment to Loudeye’sCertificate of Incorporation to effect a reverse stock split ofLoudeye’s authorized and issued and outstanding CommonStock at ratios of one-for-two, one-for-three, one-for-four,one-for-five, one-for-six, one-for-seven, one-for-eight,one-for-nine or one-for-ten. The board of directors may elect toaffect a reverse stock split at any one of these ratios at anytime before the 2006 annual meeting of Loudeye’sstockholders.     On January 4, 2006, Loudeye received a further notice fromNasdaq noting that it had not regained compliance with theminimum bid price rule as of January 3, 2006. However, theNasdaq notice also stated that as of January 3, 2006,Loudeye met all the initial inclusion criteria in NasdaqMarketplace Rule 4310(c) (except for the bid price). As aresult, Loudeye has been provided an additional 180 daycalendar compliance period, or until July 3, 2006, toregain compliance with Nasdaq minimum bid price requirements.According to the Nasdaq notice, if at anytime beforeJuly 3, 2006, the bid price of Loudeye’s common stockcloses at $1.00 per share or more for 10 consecutive days, theNasdaq staff will provide Loudeye written notification that ithas regained compliance with the Rule. The February 2006subscription agreement among Loudeye and investors in a privateplacement transaction described below contains a covenant byLoudeye that it will maintain its listing on the Nasdaq CapitalMarket.     In February 2006, Loudeye and investors in a private placementtransaction entered into a subscription agreement which containsa covenant by Loudeye that it will maintain its listing on theNasdaq Capital Market. The subscription agreement furtherprovides that if Loudeye implements a reverse stock split withinsix months of the closing of the private placement and thevolume weighted average trading price of Loudeye’s commonstock on the Nasdaq Capital Market for the twenty trading daysimmediately following the date the effectiveness of such splitis announced is less than the lesser of $0.50 or the closingprice of our common stock on the Nasdaq Capital Market on thedate of the announcement of the effectiveness of such stocksplit is announced, then Loudeye will be required to pay anamount in cash or stock, at our election, to the investors inthe private placement in the amounts described below. The amountof any such payment to an investor will not in any event exceedten percent (10%) of the aggregate purchase price paid by suchinvestor in the private placement. Subject to such limitation,if Loudeye elects to make such payment (if any) in cash, theamount to be paid to an investor would equal the number ofshares of common stock purchased by such investor in the privateplacement that are then held by that investor multiplied by thelesser of (a) the difference between the closing price ofour common stock on the Nasdaq Capital Market on the date of theannouncement of the effectiveness of such split and the volumeweighted average trading price of Loudeye’s common stock onthe Nasdaq Capital Market for the twenty trading daysimmediately following the date the effectiveness of such splitis announced, or (b) $0.50 less the average trading price ofLoudeye’s common stock on the Nasdaq Capital Market for thetwenty trading days immediately following the date theeffectiveness of such split is announced. If we elect to makesuch payment (if any) in shares of Loudeye common stock, theamount of shares to be issued to an investor (the“Additional Shares”) would equal the cash amount to bepaid to such investor described above divided by the volumeweighted average trading price of our common stock on the NasdaqCapital Market for the twenty trading days immediately followingthe date the effectiveness of such split is announced. Any suchissuance of Additional Shares would be subject to the approvalof our stockholders to the extent necessary to comply with therules of the Nasdaq Capital Market.***Legal Proceedings***     *Altnet Matter.*On September 10, 2004, Loudeye wasserved in a patent infringement lawsuit brought by Altnet, Inc.,and others against Loudeye, its Overpeer subsidiary, MarcMorgenstern, one of Loudeye’s executive officers, theRecording Industry Association of America and others. Thecomplaint, filed in federal district court in Los Angeles,California, involves two patents that appear to cover fileidentifiers for
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use in accessing, identifying and/or sharing files overpeer-to-peer networks. The complaint alleges that theanti-piracy solutions previously offered by Loudeye’sOverpeer subsidiary infringed the patents in question. Thecomplaint does not state a specific damage amount. OnNovember 17, 2004, the court dismissed the complaintagainst Mr. Morgenstern with prejudice and dismissed thecomplaint against Loudeye and Overpeer. The plaintiffs filed anamended complaint on November 24, 2004 against Loudeye,Overpeer and other entity defendants. Discovery in this mattercommenced in January 2005 and is ongoing. Loudeye intends tofile a motion for summary judgment and to otherwise defenditself vigorously against the allegations contained in theamended complaint. The court has set a trial date for June 2006.At present, Loudeye cannot assess the probability of anunfavorable outcome or the magnitude of any such outcome.However, if this case proceeds to trial against Loudeye, Loudeyeanticipates it will incur significant legal fees and expenses inits defense.     *Savvis Communications Corp.* On December 15, 2005,Savvis Communications Corp. filed a complaint in Superior Courtin Santa Clara County, California, against Overpeer and Loudeyerelating to a May 2002 Master Services Agreement between Savvisand Overpeer for collocation and bandwidth services (the“Overpeer-Savvis Agreement”). The complaint allegesOverpeer breached the Overpeer-Savvis Agreement for non-payment.The complaint also contains alter ego allegations againstLoudeye. The complaint seeks damages of $1.6 millionconsisting of $950,000 of allegedly unpaid invoices for servicesand approximately $600,000 in alleged early termination fees.The court has granted Savvis a writ of attachment overOverpeer’s assets located in the state of California. InFebruary 2006, Overpeer and Loudeye filed a joint motion tocompel arbitration of the dispute under the terms of theagreement between Savvis and Overpeer. The motion is scheduledto be heard on March 30, 2006. Loudeye assesses theprobability of a judgment against Overpeer relating to the$950,000 in unpaid invoices as high. Loudeye is not a party tothe Overpeer-Savvis Agreement. Loudeye intends to defend itselfvigorously concerning the alter ego claims brought by Savvis.However, Loudeye cannot assess at this time the probability ofan unfavorable outcome with respect to the claims broughtagainst Loudeye.     *IPO Class Action.*Between January 11 andDecember 6, 2001, class action complaints were filed in theUnited States District Court for the Southern District of NewYork. These actions were filed against 310 issuers (includingLoudeye), 55 underwriters and numerous individuals includingcertain of Loudeye’s former officers and directors. Thevarious complaints were filed purportedly on behalf of a classof persons who purchased Loudeye’s common stock during thetime period between March 15 and December 6, 2000. Thecomplaints allege violations of the Securities Act of 1933 andthe Securities Exchange Act of 1934, primarily based onallegations that Loudeye’s underwriters receivedundisclosed compensation in connection with our initial publicoffering and that the underwriters entered into undisclosedarrangements with some investors that were designed to distortand/or inflate the market price for Loudeye’s common stockin the aftermarket. These actions were consolidated forpre-trial purposes. No specific amount of damages has beenclaimed. Loudeye and the individual defendants have demanded tobe indemnified by underwriter defendants pursuant to theunderwriting agreement entered into at the time of the initialpublic offering. Presently all claims against the formerofficers have been withdrawn without prejudice. The Courtsuggested that the parties select six test cases to determineclass-action eligibility. Loudeye is not a party to any of thetest cases.     In March 2005, a proposed settlement among plaintiffs, issuerdefendants, issuer officers and directors named as defendants,and issuers’ insurance companies, was approved by theCourt. This proposed settlement provides, among other matters,that: •     issuer defendants and related individual defendants will be    released from the litigation without any liability other than    certain expenses incurred to date in connection with the    litigation;  •     issuer defendants’ insurers will guarantee    $1.0 billion in recoveries by plaintiff class members;
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 •     issuer defendants will assign certain claims against underwriter    defendants to the plaintiff class members; and  •     issuer defendants will have the opportunity to recover certain    litigation-related expenses if plaintiffs recover more than    $5.0 billion from underwriter defendants.     A fairness hearing on the proposed settlement is scheduled forApril 2006. Our board of directors approved the proposedsettlement in August 2003 and approved the final settlementterms in March 2005. Management does not anticipate that we willbe required to pay any amounts under this settlement; however,Loudeye can give no assurance that the underwriter defendantswill not bring a claim for indemnification against us under theterms of the underwriting agreement relating to Loudeye’sinitial public offering.     *Tennessee Pacific Group.* In October 2005, Loudeye wasserved in a breach of contract lawsuit brought by TennesseePacific Group, LLC, one of our customers for encoding services.In November 2005, Loudeye and Tennessee Pacific reached asettlement of the dispute pursuant to which Loudeye resumedon-going encoded content deliveries and paid Tennessee Pacific aone-time settlement amount of $25,000. The lawsuit was dismissedwith prejudice in December 2005.     *SPEDIDAM.* On March 6, 2006, On Demand DistributionSAS (France) (“OD2 France”), one of OD2’swholly-owned subsidiaries, received a complaint filed bySPEDIDAM alleging damages for the reproduction of performancesof background artists and performers on its servers and themaking available of such performances in the form ofdownloadable files for sale. SPEDIDAM is an organizationrepresenting artists and performers in France. Simultaneously,SPEDIDAM filed suit against other leading digital music storeoperators in France including Apple Computer’s iTunesservices, FNAC Music, eCompil, Sony Connect and Virgin Mega. Thecomplaint alleges that OD2 France did not have priorauthorization of SPEDIDAM or the relevant artists and performersfor such reproduction and distribution. The complaint seeksdamages of approximately€565,000(approximately $670,000 based on December 31, 2005 exchangerates). OD2 France intends to defend itself vigorouslyconcerning the claims brought by SPEDIDAM in this matter,however OD2 France cannot at this time assess the probability orthe magnitude of an unfavorable outcome, if any.     *Other.* Loudeye is involved from time to time in variousother claims and lawsuits incidental to the ordinary course ofour operations, including contract and lease disputes andcomplaints alleging employment discrimination. While the resultsof these matters cannot be predicted with certainty, Loudeyebelieves that the outcome of any such pending claims orproceedings individually or in the aggregate, will not have amaterial adverse effect upon Loudeye’s business orfinancial condition, cash flows, or results of operations.**17. Business Segment Information**     FAS 131 requires that companies report separately in thefinancial statements certain financial and descriptiveinformation about operating segments profit or loss, certainspecific revenue and expense items and segment assets. Themethod for determining what information is reported is based onthe way that management organizes the operating segments formaking operational decisions and assessments of financialperformance. During 2005, Loudeye operates in one businesssegment, digital media services. Members of Loudeye’s SLTreview financial information presented on a consolidated basis,accompanied by disaggregated information about services forpurposes of making decisions and assessing financial performance.     For 2004, the SLT reviewed discrete financial informationregarding profitability of Loudeye’s digital media servicesand media restoration services, and therefore in 2004 Loudeyereported those as operating segments as defined by FAS 131. InJanuary 2004, Loudeye transferred substantially all of theassets of its media restoration services subsidiary, VidiPax,Inc., or VidiPax, to a company controlled by VidiPax’sgeneral manager. In May 2004, Loudeye completed the sale of thismedia restoration services business. While Loudeye will haveongoing rights to co-market and resell media restorationservices for two years
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after the sale, media restoration services did not represent asignificant portion of Loudeye’s revenue in 2005 or 2004,nor does Loudeye expect it to represent a significant portion ofrevenue in the future. Accordingly, in 2005, Loudeye reports oneoperating segment, digital media services. Media restorationservices have been reclassified to a component of digital mediaservices in all periods presented.     In 2005, the majority of Loudeye’s revenue was derived fromcustomers principally in Europe and in the United States ofAmerica. Loudeye’s international sales are attributable toLoudeye’s OD2 subsidiary, which was acquired in June 2004.The following table provides information about revenue bygeographic region (in thousands):                **Years Ended December 31,**   **Revenue by Geographic Areas** **2005** **2004** **2003**           United States $6,779  $8,512  $11,948     Other countries  20,262   5,521   —                Total revenue $27,041  $14,033  $11,948                Long-lived assets are comprised of property and equipment andintangible assets, net of related accumulated depreciation andamortization. The following table presents information aboutLoudeye’s long-lived assets by geographic location (inthousands):            **at December 31,**   **Long-lived Assets** **2005** **2004**         United States $4,792  $2,927     United Kingdom  2,990   3,723     Other countries  20   20             Total long-lived assets $7,802  $6,670             Revenue from external customers is as follows (in thousands):                **Years Ended December 31,**   **Revenue:** **2005** **2004** **2003**           Digital media store services $20,902  $5,932  $171     Encoding services  3,881   3,829   2,377     Samples services  1,171   1,589   1,685     Internet radio, hosting and webcasting services  1,087   2,386   5,832     Media restoration services  —   297   1,883                Total revenue $27,041  $14,033  $11,948           
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**18. Quarterly Information**                                     **Three-Month Periods Ended(5)**     **Dec. 31,** **Sep. 30,** **June 30,** **March 31,** **Dec. 31,** **Sep. 30,** **June 30,** **March 31,**  **2005** **2005** **2005** **2005** **2004** **2004** **2004** **2004**                   **(In thousands, except per share amounts, unaudited)****Condensed Consolidated Statement of Operations Data**                                    REVENUE $8,833  $6,537  $6,501  $5,170  $5,472  $4,139  $2,586  $1.836     COST OF REVENUE(1)(3)(4)  7,810   6,185   5,621   5,466   4,271   3,204   1,527   1,334                              GROSS PROFIT (LOSS)  1,023   352   880   (296)  1,201   935   1,059   502     OPERATING EXPENSES:                                     Sales and marketing(1)  1,502   1,545   1,561   1,804   1,431   1,360   785   624      Research and development(1)  2,254   2,482   2,073   1,595   1,252   1,209   694   571      General and administrative(1)  2,954   3,464   3,142   3,497   3,103   3,593   2,056   1,906      Amortization of intangibles(3)  62   64   51   58   2   —   —   90      Stock-based compensation(1)  69   130   (3)  54   13   21   43   122      Special charges — other(4)  —   —   —   (43)  12   350   —   (50)                               Total operating expenses  6,841   7,685   6,824   6,965   5,813   6,533   3,578   3,263                              LOSS FROM OPERATIONS  (5,818)  (7,333)  (5,944)  (7,261)  (4,612)  (5,598)  (2,519)  (2,761)    Interest income  91   143   183   208   52   139   107   79     Interest expense  (18)  (40)  (28)  (74)  (25)  (46)  (59)  (71)    Gain (loss) on sale of media restoration assets  —   —   —   —   43   273   (160)  —     Other income (expense), net  47   31   75   160   (1,025)  —   183   3                              Loss from continuing operations  (5,698)  (7,199)  (5,714)  (6,967)  (5,567)  (5,232)  (2,448)  (2,750)    Loss from discontinued operations  (4,816)  (1,266)  (1,216)  (485)  (71)  (99)  (159)  (71)                             NET LOSS $(10,514) $(8,465) $(6,930) $(7,452) $(5,638) $(5,331) $(2,607) $(2,821)                             LOSS PER SHARE — BASIC AND DILUTED(2)                                     From continuing operations $(0.05) $(0.07) $(0.05) $(0.07) $(0.07) $(0.07) $(0.04) $(0.04)     From discontinued operations  (0.04)  (0.01)  (0.01)  (0.00)  (0.00)  (0.00)  (0.00)  (0.00)                             LOSS PER SHARE — BASIC AND DILUTED(2) $(0.09) $(0.08) $(0.06) $(0.07) $(0.07) $(0.07) $(0.04) $(0.04)                          (1)     Stock-based compensation, consisting of amortization of deferred    stock-based compensation and the fair value of options issued to    non-employees for services rendered, is allocated as follows:                                   **Dec. 31,** **Sep. 30,** **June 30,** **March 31,** **Dec. 31,** **Sep. 30,** **June 30,** **March 31,**  **2005** **2005** **2005** **2005** **2004** **2004** **2004** **2004**                     Cost of revenue $9  $18  $30  $35  $35  $44  $19  $19     Sales and marketing  9   (11)  (5)  4   4   (5)  18   32     Research and development  7   (2)  4   6   13   19   24   27     General and administrative  53   143   (2)  44   (4)  7   1   63 (2)     Loss per share is computed independently for each of the periods    presented. Therefore, the sum of the quarterly per share amounts    will not necessarily equal the total amount for the year. (3)     Loudeye revised its classification of amortization of acquired    technology and capitalized software costs from operating    expenses — amortization of intangibles to cost of    revenue in all 2004 quarterly periods presented as Loudeye    determined that these expenses were more appropriately    classified as cost of revenue. (4)     Loudeye revised its classification of impairment charges related    to acquired technology and capitalized software costs from    operating expenses  — special charges —    other to cost of revenue in all 2004 quarterly periods presented    as Loudeye determined that these charges were more appropriately    classified as cost of revenue.
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(5)     Data for 2004 includes the results of On Demand Distribution    Limited, which Loudeye acquired in June 2004. Overpeer Inc.,    which Loudeye acquired in March 2004, is presented as    discontinued operations in 2005 and 2004. Acquisition and    disposition activity reduces the meaningfulness of period to    period comparisons based off this and other periods.**19. Subsequent Events**     *February 2006 private placement transaction.* OnFebruary 20, 2006, Loudeye entered into a SubscriptionAgreement with a limited number of institutional investorspursuant to which Loudeye agreed to sell and issue to suchinvestors 16,500,000 shares of its common stock, together withwarrants to purchase 12,375,000 shares of common stock at anexercise price of $0.68 per share, for anaggregate purchase price of $8.25 million. Followingconsummation of the transaction, Loudeye had approximately133,901,757 shares of common stock outstanding (excludingshares issuable upon exercise of the warrants). The warrants arenot exercisable until six months after the closing date and arethen exercisable until the fifth anniversary of the closingdate. Loudeye paid a placement fee of $556,875 in connectionwith the financing. The net proceeds of the financing areexpected to be used for working capital and any other generalcorporate purposes. The subscription agreement contains acovenant by Loudeye that it will maintain its listing on theNasdaq Capital Market.     As Loudeye has previously reported, the Nasdaq Stock Market hasinformed Loudeye that Loudeye’s common stock is subject todelisting from the Nasdaq Capital Market as a result of itsfailure to comply with the $1.00 per share bid pricerequirement for 30 consecutive days as required by NasdaqMarketplace Rule 4310(c)(4). Loudeye has a grace perioduntil July 3, 2006 to regain compliance with Nasdaq minimumbid price requirements. Loudeye’s board of directors andstockholders have approved an amendment to Loudeye’sCertificate of Incorporation to effect a reverse stock split ofLoudeye’s authorized and issued and outstanding CommonStock at ratios of one-for-two, one-for-three, one-for-four,one-for-five, one-for-six, one-for-seven, one-for-eight,one-for-nine or one-for-ten. The board of directors may elect toeffect a reverse stock split at any one of these ratios at anytime before the 2006 annual meeting of Loudeye’sstockholders. Loudeye expects to implement such a reverse stocksplit prior to July 3, 2006 to the extent necessary toregain compliance with Nasdaq minimum bid price requirements.The transaction documents relating to the private placementprovide that if Loudeye implements a reverse stock split withinsix months of the closing of the private placement and thevolume weighted average trading price of Loudeye’s commonstock on the Nasdaq Capital Market for the twenty trading daysimmediately following the date the effectiveness of such splitis announced is less than the lesser of $0.50 or the closingprice of Loudeye’s common stock on the Nasdaq CapitalMarket on the date of the announcement of the effectiveness ofsuch stock split is announced, then Loudeye will be required topay an amount in cash or stock, at Loudeye’s election, tothe investors in the private placement in the amounts describedbelow. The amount of any such payment to an investor will not inany event exceed ten percent (10%) of the aggregate purchaseprice paid by such investor in the private placement. Subject tosuch limitation, if Loudeye elects to make such payment (if any)in cash, the amount to be paid to an investor would equal thenumber of shares of common stock purchased by such investor inthe private placement that are then held by that investormultiplied by the lesser of (a) the difference between theclosing price of Loudeye’s common stock on the NasdaqCapital Market on the date of the announcement of theeffectiveness of such split and the volume weighted averagetrading price of Loudeye’s common stock on the NasdaqCapital Market for the twenty trading days immediately followingthe date the effectiveness of such split is announced, or(b) $0.50 less the average trading price of Loudeye’scommon stock on the Nasdaq Capital Market for the twenty tradingdays immediately following the date the effectiveness of suchsplit is announced. If Loudeye elects to make such payment (ifany) in shares of Loudeye common stock, the amount of shares tobe issued to an investor (the “Additional Shares”)would equal the cash amount to be paid to such investordescribed above divided by the volume weighted average tradingprice of Loudeye’s common stock on the Nasdaq CapitalMarket for the twenty trading days immediately following thedate the effectiveness of such split is announced. Any suchissuance of Additional Shares would be subject to the approvalof Loudeye’s stockholders to the extent necessary to complywith the rules of the Nasdaq Capital Market.
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     The securities issued in the private placement were offered andsold without registration under the Securities Act of 1933 to alimited number of institutional accredited investors in relianceupon the exemption provided by Rule 506 ofRegulation D thereunder, and may not be offered or sold inthe United States in the absence of an effective registrationstatement or exemption from the registration requirements underthe Securities Act. An appropriate legend was placed on theshares and the warrants issued, and will be placed on the sharesissuable upon exercise of the warrants (and on AdditionalShares, if any), unless registered under the Securities Actprior to issuance. In connection with this financing, Loudeye isrequired to use its best efforts to file a registrationstatement covering the shares of common stock to be issued andthe common stock underlying the warrants within 45 daysafter the closing date. Loudeye would also be required to useits best efforts to file a registration statement covering anyAdditional Shares that it elects to issue to satisfy any amountsthat may become due to investors following a reverse stocksplit, if any. Loudeye is also required to use its commerciallyreasonable efforts to have either registration statementdeclared effective within 120 days (or within 90 daysif the Securities and Exchange Commission does not review theregistration statement). In the event Loudeye does not file theinitial registration statement by the required filing date or ifthe initial registration statement is not declared effective bythe required effectiveness date, Loudeye would owe liquidateddamage payments to the investors calculated at a rate of1% per month of the aggregate purchase paid by an investor,pro rated for the days of noncompliance with the registrationrequirements. The maximum aggregate amount of liquidated damagespayable to an investor pursuant to these provisions cannotexceed eight percent (8%) of the aggregate purchase price paidby such investor.
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**Item 9.****Changes in and Disagreements with Accountants on Accounting    and Financial Disclosure.**     None.**Item 9A.****Controls and Procedures.****Disclosure Controls and Procedures**     Our principal executive and principal financial officers, afterevaluating the effectiveness of our disclosure controls andprocedures (as defined inRule 13a-15(e) and15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “ExchangeAct”) as of the end of the period covered by this annualreport, have concluded that, based on such evaluation, ourdisclosure controls and procedures were effective as ofDecember 31, 2005.**Management’s Annual Report on Internal Control OverFinancial Reporting**     Internal control over financial reporting refers to the processdesigned by, or under the supervision of, our principalexecutive officer and principal financial officer, and effectedby our board of directors, management and other personnel, toprovide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statementsfor external purposes in accordance with generally acceptedaccounting principles, and includes those policies andprocedures that:     (1) Pertain to the maintenance of records that inreasonable detail accurately and fairly reflect the transactionsand dispositions of Loudeye’s assets;     (2) Provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financialstatements in accordance with generally accepted accountingprinciples, and that Loudeye’s receipts and expendituresare being made only in accordance with authorizations ofLoudeye’s directors and management; and     (3) Provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or dispositionof Loudeye’s assets that could have a material effect onthe financial statements.     Internal control over financial reporting cannot provideabsolute assurance of achieving financial reporting objectivesbecause of its inherent limitations. Internal control overfinancial reporting is a process that involves human diligenceand compliance and is subject to lapses in judgment andbreakdowns resulting from human failures. Internal control overfinancial reporting also can be circumvented by collusion orimproper management override. Because of such limitations, thereis a risk that material misstatements may not be prevented ordetected on a timely basis by internal control over financialreporting. However, these inherent limitations are knownfeatures of the financial reporting process. Therefore, it ispossible to design into the process safeguards to reduce, thoughnot eliminate, this risk. Management is responsible forestablishing and maintaining adequate internal control overfinancial reporting for Loudeye.     Management has used the framework set forth in the reportentitled “Internal Control — IntegratedFramework” published by the Committee of SponsoringOrganizations (“COSO”) of the Treadway Commission toevaluate the effectiveness of Loudeye’s internal controlover financial reporting. Management has concluded that theCompany’s internal control over financial reporting waseffective as of the end of the most recent fiscal year. MossAdams LLP has issued an attestation report on management’sassessment of Loudeye’s internal control over financialreporting which appears in this annual report in Item 8“Financial Statements.”     For the year ended December 31, 2005, management’sassessment of our internal control over financial reportingincluded operations of our Overpeer and OD2 subsidiaries.
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**Changes in Disclosure Controls and Procedures**     There were not any changes in our disclosure controls andprocedures, including our internal control over financialreporting, during the quarter ended December 31, 2005, thathad materially affected, or are reasonably likely to materiallyaffect, our disclosure controls and procedures, including ourinternal control over financial reporting, other than thefollowing: •     In October 2005, we filled the two new positions created in our    accounting and finance department at our OD2 subsidiary with    permanent personnel. With the completion of our hiring efforts    during October 2005, and other efforts completed in 2005, we    believe we have completed the remediation of the material    weaknesses we had assessed as of December 31, 2004,    pertaining to insufficiently skilled personnel and a lack of    human resources within our finance and accounting reporting    functions and relating to insufficient analysis, documentation    and review of the selection and application of generally    accepted accounting principles, or GAAP, to significant    non-routine transactions, including the preparation of financial    statement disclosures relating thereto.  •     During the fourth quarter 2005, we continued to improve controls    around our revenue and royalty accounting processes and    procedures by formalizing processes, procedures and    documentation standards and by further enhancing the levels of    review and accelerating the timing of the preparation of the    monthly and quarterly royalty calculation. We also continued to    enhance invoice processing to ensure appropriate segregation of    duties regarding preparation of invoices and the review and    authorization of revenue transactions prior to entry in the    general ledger at our operations including OD2. With these    efforts and others implemented in 2005, we believe we have    completed remediation of the material weakness we had assessed    as of December 31, 2004, pertaining to the lack of controls    or ineffectively designed controls.  •     During the fourth quarter 2005, as it relates to OD2, we    completed the process of assessing the effectiveness of controls    executed by third party service providers, and we also completed    our determination regarding the adequacy of customer level    controls related to the provision of services by third party    service providers. With these improvements and others    implemented in 2005, we believe we have completed our    remediation of the material weakness we had assessed as of    December 31, 2004, relating to assessing and monitoring the    effectiveness of controls executed by third party service    providers, and adequately implementing and/or maintaining    customer level controls related to the provision of services by    third party service providers.  •     During the fourth quarter 2005, we took additional steps to    improve general computer controls, including further    documentation of oversight controls and procedures and    transactional information flows for financially significant    applications; implementing additional controls for managing    security and physical access to systems, data, and applications    that support financial reporting; and continued documentation of    controls and procedures at OD2 designed to ensure proper    oversight of work performed by employees in our information    technology operations and program and development functions.    With these improvements and others implemented in 2005, we    believe we have completed our remediation of the material    weakness we had assessed as of December 31, 2004, in our    general computer controls relating to financially significant    applications and business processes, including application level    design and documentation deficiencies.  •     During the fourth quarter 2005, we continued implementation of    our ongoing monitoring system to facilitate continuous    monitoring of our internal control over financing reporting.    With these improvements, and others implemented earlier in 2005,    we believe we have completed our remediation of the material    weakness we had assessed as of December 31, 2004 relating    to inadequate entity level controls.
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**Item 9B.****Other Information.**     None.**PART III****Item 10.****Directors and Executive Officers of the Registrant.****Classified Board of Directors**     Pursuant to Loudeye’s Certificate of Incorporation,Loudeye’s Board is divided into three classes —Class I, II and III directors. Each director iselected for a three-year term of office, with one class ofdirectors being elected at each annual meeting of stockholders.Each director holds office until his successor is elected andqualified or until the earlier of his death, resignation orremoval. In accordance with the Certificate of Incorporation,Class III directors are to be elected at the annual meetingin 2006, Class I directors are to be elected at the annualmeeting in 2007, and Class II directors are to be electedat the 2008 Annual Meeting. If any director is unable to standfor re-election, the Board may reduce the size of the Board,designate a substitute or leave a vacancy unfilled. If asubstitute is designated, proxies which would have been votedfor the original director candidate will be cast for thesubstitute candidate.**Directors and Executive Officers**     The following table sets forth certain information regarding ourexecutive officers and directors as well as their ages andpositions as of March 1, 2006:         **Name** **Age** **Position with Loudeye**         Michael A. Brochu  52   President, Chief Executive Officer and Director     Chris J. Pollak  39   Chief Financial Officer     Charles Edward Averdieck  40   Managing Director, Europe     Jason S. Berman(1)  68   Director     Kurt R. Krauss(1),(2),(3)  56   Director     Johan C. Liedgren(1),(2),(3)  41   Director     Frank A. Varasano(2)  59   Director  (1)     Member of Loudeye’s audit committee. (2)     Member of Loudeye’s compensation committee. (3)     Member of Loudeye’s nominating and corporate governance    committee.     *Charles Edward Averdieck.* Mr. Averdieck has servedas Managing Director, Europe since January 2005 and prior tothat time served as Director International Sales and Marketingbeginning in June 2004 following Loudeye’s acquisition ofOD2. At OD2, Mr. Averdieck served as a director and ledOD2’s sales operations beginning in June 2000.Mr. Averdieck launched “Digital Download Day” inApril 2003, an initiative geared toward awareness of a viabledigital music services across Europe. Prior to joining OD2,Mr. Averdieck was a director at BMG UK and Castle Music, aleading U.K. based independent label, and prior to thatMr. Averdieck held various marketing management positionsas Proctor & Gamble. Mr. Averdieck holds aMaster’s Degree from The University of St. Andrews.     *Jason S. Berman.* Mr. Berman has served as a directorsince April 2005. Mr. Berman is a Class I directorserving for a term continuing until the 2007 annual meeting ofstockholders. Mr. Berman is a principal at Berman-RosenConsulting, a private consulting firm co-founded byMr. Berman in January 2006. During 2005, Mr. Bermanserved as Chairman Emeritus of the International Federation ofPhonographic Industries, or IFPI, the trade organization of theinternational recording industry whose members comprise morethan 1,500 record producers and distributors worldwide. FromJanuary 1999 to December 2004, Mr. Berman served asChairman and CEO of the IFPI. Prior to joining IFPI,
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Mr. Berman served as President of the Recording IndustryAssociation of America, RIAA, beginning in 1987, and as Chairmanbeginning in 1992, positions he held through May 1998.Mr. Berman also served as Special Counsel for Trade toPresident Clinton in the fall of 1998. Since February 2005, hehas served on the Board of Mohen, Inc. which operatesMusicloads, a private music download service company, and WurldMedia, Inc., a privately held digital media technology company.Mr. Berman holds a Masters Degree from NorthwesternUniversity.     *Michael A. Brochu.* Mr. Brochu has served asLoudeye’s President and Chief Executive Officer sinceJanuary 2005, and as a director since December 2003.Mr. Brochu is a Class III director serving for a termcontinuing until the 2006 annual meeting of stockholders. FromNovember 1997 to November 2004, Mr. Brochu served as thePresident and Chief Executive Officer of Primus KnowledgeSolutions, Inc. (“Primus”), a publicly traded softwarecompany. From November 1998 to November 2004, Mr. Brochualso served as Chairman of the Board of Directors of Primus.Mr. Brochu was President and Chief Operating Officer ofSierra On-Line, Inc., an interactive software publisher, fromJune 1994 until October 1997. Mr. Brochu currently serveson the board of directors of Art Technology Group, Inc. (ATG),an e-commerce softwareprovider, Emphysis Medical Management, a medical billing andphysicians’ service firm, and Allrecipes.com, Inc., aleading online food site. Mr. Brochu also sits on theadvisory board of Voyager Capital, a venture capital firm.Mr. Brochu holds a B.B.A. from the University of Texas,El Paso.     *Kurt R. Krauss.* Mr. Krauss has served as a directorsince September 2003. Mr. Krauss is a Class IIdirector serving for a term continuing until the 2008 annualmeeting of stockholders. Mr. Krauss is the founder ofSachem Investments LLC, a private investment firm in Greenwich,Connecticut, and serves on several for-profit and not-for-profitboards of directors. He was Chief Financial Officer ofBurson-Marsteller, the world’s largest public relations andmarketing communications firm, from 1997 to 2000. Prior toBurson-Marsteller, Mr. Krauss co-founded the Mead PointGroup, a management consulting firm, which was acquired byYoung & Rubicam in 1997. From 1978 until 1992,Mr. Krauss was a partner at Booz, Allen &Hamilton, where he was the global leader of the firm’sService Operations Practice and served for three years on thefirm’s board of directors. Mr. Krauss holds a Mastersdegree from Carnegie Mellon University.     *Johan C. Liedgren.* Mr. Liedgren has served as amember of the Board since April 1998. Mr. Liedgren is aClass I director serving for a term continuing until the2007 annual meeting of stockholders. Since October 1997,Mr. Liedgren has served as Chief Executive Officer ofHonkworm International, an entertainment consulting company.From January 1990 to August 1997, he worked for MicrosoftCorporation in several positions, most recently as Director ofChannel Development. Mr. Liedgren is an advisor andinvestor in several technology companies both in the U.S. and inEurope. Mr. Liedgren also works with film and televisionprojects and is currently in partnership with Digital KitchenLLC, a commercial production agency, to create and producebranded entertainment. Mr. Liedgren attended the Universityof Stockholm in Sweden.     *Chris J. Pollak.* Mr. Pollak has served as our ChiefFinancial Officer since November 2005 and prior to that timeserved as our Vice President Finance beginning in January 2005.From August 2000 to December 2004, Mr. Pollak was employedat Primus Knowledge Solutions, Inc., a publicly traded softwarecompany, most recently as Vice President of Finance. From July1998 to August 2000, Mr. Pollak was the Chief FinancialOfficer of Government Computer Sales, Inc., a privately-heldtechnology company. Mr. Pollak holds a B.A. in BusinessAdministration from Washington State University and is acertified public accountant.     *Frank A. Varasano.* Mr. Varasano has served as adirector since June 2005. Mr. Varasano is a Class IIIdirector serving for a term continuing until the 2006 annualmeeting of stockholders. From 1999 to 2001, Mr. Varasanoserved as Executive Vice President at Oracle Corporation wherehe was responsible for marketing, sales and consulting toOracle’s 400 largest product producing clients and was amember of the Executive Committee. Prior to that,Mr. Varasano held several senior management positionsduring his 25 year tenure at Booz Allen and Hamilton,designing and leading strategic programs for the firm’slargest clients to improve their competitive position. As aSenior Vice President he led the firm’s largest practice
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(Engineering and Manufacturing), office (New York) and regionalprofit center (United States). He served on the firm’sBoard of Directors and Executive Committee. Mr. Varasanoholds a B.S. Degree from the United States Naval Academy, and aMaster’s in Business Administration from Harvard BusinessSchool. He also served as an officer aboard the USS PatrickHenry, a nuclear submarine.**Independence of the Board of Directors**     After review of all relevant transactions or relationshipsbetween each director, or any of his family members, andLoudeye, the senior management of Loudeye and its independentregistered public accounting firm, the Board has affirmativelydetermined that Messrs. Berman, Krauss, Liedgren andVarasano are independent directors within the meaning of theNasdaq listing standards. Messrs. Berman, Krauss andLiedgren serve on Loudeye’s audit committee.**Committees, Charters and Policies**     Congress enacted the Sarbanes-Oxley Act of 2002 in July 2002.Since that time, the Securities and Exchange Commission and theNasdaq Stock Market have adopted a number of new rules toimplement that law affecting many aspects of the corporategovernance of publicly traded companies. Loudeye must be incompliance with a number of those rules, including rules on thecomposition and powers of the full Board of Directors and of thethree standing committees described below.     The Board believes that good corporate governance is importantto ensure that Loudeye is managed for the long-term benefit ofits stockholders. The Board has reviewed Loudeye’scorporate governance policies to comply with the new rules,including the requirements of Sarbanes-Oxley and the NasdaqStock Market. Following are Loudeye’s key corporategovernance policies or charters: •     Charter for the Audit Committee comprised of independent    directors;  •     Charter for the Compensation Committee comprised of independent    directors;  •     Charter for the Nominating and Governance Committee comprised of    independent directors; and  •     Code of Ethics, applicable to all officers, directors and    employees of Loudeye.     The Charters of the Committees, which have been adopted by theBoard, are available on the corporate governance section ofLoudeye’s website(http://*www.loudeye.com/en/aboutus/corpgovernance.asp*).     *Audit Committee.* The Audit Committee met nine times in2005. All members of the Audit Committee are independent inaccordance with the Nasdaq listing requirements andRule 10A-3(b)(1) under the Securities Exchange Act of 1934.The Audit Committee is generally responsible for: •     Appointing, compensating, retaining and overseeing    Loudeye’s independent registered public accounting firm;  •     Reviewing Loudeye’s independent registered public    accounting firm’s independence and qualifications;  •     Reviewing Loudeye’s annual and interim reports to the SEC,    including the financial statements and the    “Management’s Discussion and Analysis” portion of    those reports;  •     Reviewing Loudeye’s audit policies;  •     Reviewing before issuance Loudeye’s news releases regarding    annual and interim financial results and discussing with    management any related earnings guidance that may be provided to    analysts and rating agencies;  •     Discussing Loudeye’s audited financial statements with    management and the independent registered public accounting    firm; and
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 •     Reviewing and discussing the adequacy of both Loudeye’s    internal accounting controls and other factors affecting the    integrity of Loudeye’s financial reports with management    and Loudeye’s independent registered public accounting firm.     The Board has determined that all members of Loudeye’sAudit Committee are financially literate and have financialmanagement expertise, as the Board has interpreted suchqualifications in its business judgment. In addition, the Boardhas determined that Kurt R. Krauss, the Chairman of the AuditCommittee, is an audit committee financial expert as defined inItem 401 ofRegulation S-Kunder the Securities Exchange Act of 1934.     *Compensation Committee.* The Compensation Committee metsix times in 2005. All members of the Compensation Committee areindependent. The Compensation Committee is generally responsiblefor: •     Reviewing and approving Loudeye’s goals and objectives    relevant to compensation of executive officers including the CEO;  •     Evaluating the CEO’s performance in light of those goals    and objectives;  •     Setting the compensation of the CEO and other executive officers;  •     Making recommendations to the Board regarding incentive    compensation plans and equity-based plans for all executive    officers;  •     Developing and implementing a long term strategy for employee    compensation; and  •     Administering and making grants under Loudeye’s incentive    compensation plans and equity-based plans to the extent that    such functions are delegated to the Compensation Committee.     *Nominating and Governance Committee.* The Nominating andGovernance Committee met once in 2005. All members of theNominating and Governance Committee are independent inaccordance with Nasdaq listing requirements. The Nominating andGovernance Committee is generally responsible for: •     Overseeing the annual evaluation of the Board’s    effectiveness;  •     Identifying individuals qualified to become Board members;  •     Recommending persons to be nominated by the Board for election    of directors at the annual meeting of stockholders; and  •     Reviewing and advising the Board on the corporate governance    principles and policies applicable to Loudeye.**Stockholder Communication with the Board of Directors**     Stockholders may communicate directly with the Board. Allcommunications should be directed to Loudeye’s corporatesecretary at Corporate Secretary, 1130 Rainier Avenue South,Seattle, Washington 98144, and should prominently indicate onthe outside of the envelope that it is intended for the Board,or for non-management directors. Each communication intended forthe Board and received by the corporate secretary will be sentperiodically, but in any event prior to each regularly-scheduledBoard meeting, to the specified party following its clearancethrough normal security procedures. The communication will notbe opened, but rather will be forwarded unopened to the intendedrecipient.**Recommendations for Director**     There have been no changes in the procedures by which securityholders may recommend nominees to Loudeye’s board ofdirectors since Loudeye’s filed its definitive proxy onForm DEF 14A with the SEC on April 18, 2005.     The Nominating and Governance Committee has developed a list ofcriteria, which is discussed below, that are considered, alongwith other factors, in its evaluation of candidates fornomination as director. To comply with regulatory requirements,a majority of Board members must qualify as
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independent members under the rules of the Nasdaq Stock Market,and at least one member of the Audit Committee must be an expertin financial matters. The Nominating and Governance Committeewill consider all candidates properly recommended to theCommittee and will evaluate each of them, including incumbents,based on the same criteria.     Stockholders of record of Loudeye may recommend directorcandidates for inclusion in the slate of nominees that the Boardrecommends to stockholders for election. The Nominating andGovernance Committee will review the qualifications ofrecommended candidates. If the Committee determines to nominatea stockholder-recommended candidate and recommends his or herelection as a director by the stockholders, his or her name willbe included in Loudeye’s proxy card for the stockholdermeeting at which his or her election is recommended.     Stockholders may recommend individuals to the Nominating andGovernance Committee for consideration as potential directorcandidates by submitting their names and other informationdetailed below in writing to: Corporate Secretary, LoudeyeCorp., 1130 Rainier Avenue South, Seattle, Washington, 98144.The Nominating and Governance Committee will consider asubmission of a stockholder candidate only if the submission isdelivered to, or mailed and received at, the above address notearlier than 90 days and not later than 60 days beforethe anniversary date of the prior year’s annual meeting ofstockholders; provided, however, that in the event that(i) the date of the annual meeting is more than30 days prior to or more than 60 days after theanniversary date of the prior year’s annual meeting, and(ii) less than 60 days notice or prior publicdisclosure of the date of the meeting is given or made tostockholders, for the submission by the stockholder to be timelyit must be so received not later than the close of business onthe 10th day following the day on which such notice of themeeting was mailed or such public disclosure was made. Astockholder’s submission of a potential director candidatemust include the following information as to each person whomthe stockholder proposes to be nominated for election as adirector: (a) the name, age, business address and residenceaddress of such person, (b) the principal occupation oremployment of such person for the five years preceding the dateof the submission, and (c) the class and number of sharesof Loudeye stock which are beneficially owned by such person.Such submission must also include the nominee’s writtenconsent to be named in the proxy statement as a nominee. TheNominating and Governance Committee will evaluate candidatesrecommended by stockholders by following the same process, andapplying the same criteria, as for candidates submitted by Boardmembers or by other persons.     The process followed by the Nominating and Governance Committeeto identify and evaluate candidates includes requests to Boardmembers and others for recommendations, meetings from time totime to evaluate biographical information and backgroundmaterial relating to potential candidates and interviews ofselected candidates by members of the Nominating and GovernanceCommittee and the Board. In considering whether to recommend anycandidate for inclusion in the Board’s slate of recommendeddirector nominees, including candidates recommended bystockholders, the Nominating and Governance Committee will applysuch criteria as it determines to be relevant, including, butnot necessarily limited to, the following: •     experience;  •     judgment;  •     diversity;  •     ability and willingness to devote the necessary time;  •     familiarity with domestic and/or international markets, all in    the context of an assessment of the perceived needs of    Loudeye; and  •     a reputation for integrity, honesty and adherence to high    ethical standards.     The Nominating and Governance Committee does not assign specificweights to particular criteria and no particular criterion isnecessarily applicable to all prospective nominees. Loudeyebelieves that the backgrounds and qualifications of thedirectors, considered as a group, should provide a significant
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composite mix of experience, knowledge and abilities that willallow the Board to fulfill its responsibilities. The Nominatingand Governance Committee has not established any specificminimum criteria or qualifications that a nominee must possess.**Employment and Related Agreements**     Information related to compensation arrangements with executiveofficers is included in Item 11. Executive Compensationbelow.**Section 16(a) Beneficial Ownership Compliance**     Section 16(a) of the Securities Exchange Act of 1934requires Loudeye’s executive officers and directors, andpersons who own more than ten percent of the outstanding CommonStock, to file reports of ownership and changes in ownershipwith the Securities and Exchange Commission. Such persons arerequired by Securities and Exchange Commission regulations tofurnish Loudeye with copies of all Section 16(a) forms theyfile.     Based upon the written representations of Loudeye’sdirectors and executive officers, and copies of the reports thatthey have filed with the Securities and Exchange Commission,Loudeye believes that during fiscal year 2004, all personssubject to the reporting requirements pursuant toSection 16(a) during the fiscal year endedDecember 31, 2004, filed the required reports on a timelybasis with the SEC, except that Michael A. Brochu filed one lateForm 4 relating to an option grant, and Lawrence J. Maddenfiled one late Form 4 relating to an option grant.**Code of Ethics**     We have adopted a code of ethics that applies to our directors,officers and employees. We have posted a copy of the code on ourwebsite at the Internet address http://www.loudeye.com. Copiesof the code may be obtained free of charge from our website atthe above Internet address. We intend to satisfy the disclosurerequirement under Item 5.05 ofForm 8-K regardingan amendment to, or waiver from, a provision of this code byposting such information on our website, at the Internet addressspecified above.**Item 11.****Executive Compensation.****Compensation Committee Report on Executive Compensation**     **Introductory Note:** The following report is not deemed tobe incorporated by reference by any general statementincorporating by reference this annual report onForm 10-K into anyfiling under the Securities Act or under the Exchange Act,except to the extent that Loudeye specifically incorporates thisinformation by reference, and shall not otherwise be deemedsoliciting material or filed under such laws.***General Compensation Policy***     Loudeye’s compensation policy is designed to attract andretain qualified key executives critical to Loudeye’sgrowth and long-term success. It is the objective of the Boardof Directors to have a portion of each executive’scompensation contingent upon Loudeye’s performance as wellas upon the individual’s personal performance. Accordingly,each executive officer’s compensation package is comprisedof three elements: (i) base salary, which reflectsindividual performance and expertise, (ii) variable bonusawards payable in cash which are tied to Loudeye’s overallperformance and individual performance objective, subject tolimitations on the amount of cash bonuses tied to Loudeye’spositive EBITDA balance, and (iii) long-term stock-basedincentive awards which are designed to strengthen the mutualityof interests between the executive officers and Loudeye’sstockholders.     The summary below describes in more detail the factors that theCompensation Committee considers in establishing each of thethree primary components of the compensation package provided tothe executive officers.
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***Base Salary***     The level of base salary is established primarily on the basisof the individual’s qualifications and relevant experience,the strategic goals for which he or she has responsibility, thecompensation levels at similar companies and the incentivesnecessary to attract and retain qualified management. Basesalary is reviewed each year to take into account theindividual’s performance and to maintain a competitivesalary structure. Loudeye’s performance does not play asignificant role in the determination of base salary.***Long Term Incentive Compensation***     Loudeye has utilized its stock option plans to provideexecutives and other key employees with incentives to maximizelong-term stockholder value. The Compensation Committee believesgranting non-cash equity compensation as a primary component ofexecutive’s overall compensation, as opposed to cashbonuses, is in the best interests of the Company and itsstockholders in most cases. Awards under the plans havehistorically been in the form of stock options designed to givethe recipient a significant equity stake and thereby closelyalign his or her interests with those of Loudeye’sstockholders. Option grants allow the recipient to acquireshares of common stock at a fixed price per share (typically thefair market value on the date of grant) over a specified periodof time (up to 10 years). Since fair market value stockoptions can only produce value to an executive if the price ofLoudeye’s stock increases above the exercise price, optiongrants provide a direct link between executive compensation andLoudeye’s stock price performance.     Following approval by Loudeye’s stockholders ofLoudeye’s 2005 Incentive Award Plan in May 2005, theCompensation Committee approved restricted stock awards tocertain executive and key employees in lieu of options. Arestricted stock award is a grant of a right to receive sharesthat vests over time. Restricted stock awards are direct awardsof shares of common stock and no exercise price is payable. Asthe stock award vests, the individual receives Loudeye CommonStock that they own outright. The Compensation Committeebelieves that stock awards may represent a better way to providesignificant equity compensation to individuals that providesmore predictable long-term reward than stock options.     Stock options and restricted stock awards typically vest inperiodic installments over a four-year period, contingent uponcontinued employment. Vesting may accelerate based on the termsof employment contracts or separate option or restricted stockaward agreements.     Factors considered in making stock option and restricted stockawards include the individual’s position, his or herperformance and responsibilities, competitive employmentopportunities and internal comparability considerations. Loudeyebelieves that stock options and restricted stock awards directlymotivate an executive to maximize long-term stockholder value.The awards also utilize vesting periods that encourage keyexecutives to continue their employment with Loudeye.***Cash Based Incentive Compensation***     Historically, Loudeye has awarded cash bonuses on adiscretionary basis to executive officers on the basis of theirsuccess in achieving designated individual goals andLoudeye’s success in achieving specific company-wide goalsfor revenue growth and profitability. Goals are established atthe beginning of each year. Annual bonus payments under theincentive plan are generally computed as a percentage of theexecutive’s base salary, with the actual percentages beinga function of the extent to which goals were achieved as well asother significant accomplishments.     Beginning with the appointment of Michael Brochu asLoudeye’s President and Chief Executive Officer in January2005, cash based performance compensation for Loudeye’sexecutive leadership team (including Mr. Brochu) will bebased primarily on Loudeye’s overall performance. Each yearthe compensation committee sets both a performance target andmaximum performance goal for executives for the fiscal year. If,based on Loudeye’s audited financial statements, theperformance target is met, and if Loudeye’s EBITDA ispositive (as determined in accordance with Generally AcceptedAccounting Principles (“GAAP”)), executives will beeligible for an annual bonus of up to fifty percent (50%) of
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their base salary. If, based on Loudeye’s audited financialstatements, the maximum performance goal is met, and ifLoudeye’s EBITDA is positive, executives will be eligiblefor an annual bonus of up to one hundred percent (100%) of theirbase salary.     The compensation committee has established limitations on theforegoing cash based incentive compensation to provide that inany year no more than twenty five percent (25%) of thatyear’s total positive EBITDA balance be paid as bonuscompensation individually or collectively to Loudeye’sexecutive leadership team (including the Chief Executive Officerand Loudeye’s other senior executives). Any potential bonusamount that is not payable because it would exceed 25% of thatyear’s total positive EBITDA balance will not be earned andwill not be accrued by the Company.***Compensation of the Chief Executive Officer***     Jeffrey M. Cavins served as the Company’s Chief ExecutiveOfficer until his resignation on January 31, 2005. His basesalary was $250,000. Mr. Cavins did not receive any cashbonus compensation in 2005. Effective January 31, 2005,Mr. Cavins resigned for good reason as the President andChief Executive Officer and as a member of the Company’sboard of directors. Loudeye agreed to pay Mr. Cavins atotal of one year of base compensation as severance, less lawfulwithholdings, all of which was paid in 2005. As additionalseverance, the Company agreed to extend until December 31,2005 the period during which Mr. Cavins may exercise anystock options that vested on or before March 17, 2005, theperiod through which Mr. Cavins remained a consultant toLoudeye.     On January 31, 2005, Michael A. Brochu was appointed asLoudeye’s Chief Executive Officer. Loudeye andMr. Brochu entered into an amended and restated executiveemployment agreement dated March 30, 2005, pursuant towhich Mr. Brochu is employed as Loudeye’s Presidentand Chief Executive Officer. The executive employment agreementprovides for a base salary of $325,000 together with a signingbonus of $25,000. The initial term of the executive employmentagreement ran until December 31, 2005, and the agreementhas been renewed through December 31, 2006. Mr. Brochureceived an option grant to purchase 1,500,000 sharesof Loudeye’s common stock for an exercise price of$1.53 per share. This option vests over a four yearperiod — 25% as of January 31, 2006, and theremainder monthly thereafter over three years. Mr. Brochualso received a restricted stock award of 750,000 shareswhich vested 25% on January 31, 2006, and vests quarterlythereafter for 12 consecutive quarters. If Mr. Brochu isterminated in connection with a change of control of Loudeye orotherwise terminated without cause or if Mr. Brochuterminates his employment for good reason, his stock options andrestricted stock grant will vest in full. The employmentagreement provides for the opportunity to receive a bonus of upto 50% of base salary if Mr. Brochu meets targetperformance goals identified by the Compensation Committee ofthe Board and up to 100% of base salary if Mr. Brochu meetsmaximum performance goals identified by the CompensationCommittee of the Board. The actual amount of performance bonuseswill be determined by the Compensation Committee of the Board,provided that no bonuses will be paid in the event Loudeye doesnot have a positive balance of earnings before interest, tax,depreciation and amortization expenses (“EBITDA”) andnot more than 25% of any such positive balance will be paid asbonus compensation individually or collectively toLoudeye’s executive leadership team (includingMr. Brochu). In the event that Mr. Brochu isterminated by Loudeye without cause, or he resigns for goodreason, dies or becomes disabled, Mr. Brochu will beentitled to severance equal to eight months base salary. Thisseverance amount will increase to 12 months of base salaryon December 31, 2006. In the event Mr. Brochu isterminated in connection with a change of control or terminateshis employment for good reason following a change of control,Mr. Brochu will be entitled to severance equal to12 months of base salary. Mr. Brochu has agreed not tocompete with Loudeye or solicit customers or employees ofLoudeye for one year following termination of employment. Thesenon-compete and non-solicitation agreements may not beenforceable in some jurisdictions. Mr. Brochu will beentitled to participate in all benefit plans or arrangementsapplicable to senior executives of Loudeye.     The factors discussed above in “Base Salary,”“Cash-Based Incentive Compensation,” and“Long-Term Incentive Compensation” were applied inestablishing the amount, and determining the continuingappropriateness of, Mr. Brochu’s compensation.Significant factors in establishing Chief Executive Officer
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compensation were compensation levels at similarly situatedcompanies and assigned responsibilities. The compensationcommittee engaged an outside independent consulting firm toassist in reviewing the appropriate level of cash and equitycompensation for Mr. Brochu. As part of this review, theindependent consulting firm also reviewed compensation levelsfor other members of Loudeye’s executive management team.The consulting firm reviewed a variety of benchmarks includingcompensation levels of chief executive officers in comparablebusinesses. The Compensation Committee received a written reportfrom the independent consulting firm concerningMr. Brochu’s compensation arrangement which indicatesthat, in the opinion of the independent consulting firm,Mr. Brochu’s compensation is fair and reasonable basedupon competitive practices in the marketplace. In November 2005,prior to the annual expiration date of Mr. Brochu’semployment agreement, the Compensation Committee reviewed theoverall compensation package available to Mr. Brochu,including in contexts such as a change of control of Loudeye,and unanimously voted to renew the terms ofMr. Brochu’s contract for an additional year extendingthrough December 31, 2006.***Deductibility of Executive Compensation***     Loudeye has considered the impact of Section 162(m) of theInternal Revenue Code adopted under the Omnibus BudgetReconciliation Act of 1993, which section disallows a deductionfor any publicly held corporation for individual compensationexceeding $1 million in any taxable year for the CEO andfour other most highly compensated executive officers,respectively, unless such compensation meets the requirementsfor the “performance-based” exception toSection 162(m). As the cash compensation paid by Loudeye toeach of its executive officers is expected to be below$1 million and the committee believes that options grantedto such officers will meet the requirements for qualifying asperformance-based, the committee believes thatSection 162(m) will not affect the tax deductions availableto Loudeye with respect to the compensation of its executiveofficers. It is Loudeye’s policy to qualify, to the extentreasonable, the executive officers’ compensation fordeductibility under applicable tax law. However, Loudeye mayfrom time to time pay compensation to its executive officersthat may not be deductible.     The Compensation Committee of the Board of Directors of Loudeye    Corp.      Johan C. Liedgren, Chairman     Kurt R. Krauss     Frank A. Varasano**Compensation Committee Interlocks and InsiderParticipation**     The Compensation Committee of the Board currently consists ofJohan C. Liedgren (chairman), Kurt R. Krauss and Frank A.Varasano. No member of the committee or executive officer ofLoudeye has a relationship that would constitute an interlockingrelationship with executive officers or directors of anotherentity.**Compensation Arrangements with Directors**     Each non-employee director currently receives an annual retainerof $30,000 in connection with his service on the Board, paid inquarterly installments (but contingent on his attending aspecific number of Board meetings). In addition, allnon-employee directors receive an option topurchase 100,000 shares of Common Stock upon initialappointment to the Board. At each annual meeting ofLoudeye’s stockholders, each non-employee director who willcontinue serving on the Board following the meeting, and who hasbeen a director for at least six months prior to the meeting,receives an option to purchase an additional 25,000 sharesof Common Stock. These options are exercisable for ten years.The shares underlying the initial grant vest monthly insubstantially equal increments over twelve months, commencing onthe grant date. Annual grants also vest monthly in substantiallyequal increments over twelve or twenty-four months, commencingon the grant date. The exercise price of options granted todirectors must be at least 100% of
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the fair market value of the Common Stock on the date of grant.The options may be exercised only (a) while the individualis serving as a director on the Board, (b) within twelvemonths after termination by death or disability, or(c) within three months after the individual’s term asdirector ends.**Compensation Arrangements with Executive Officers**     Following are summaries of employment agreements between Loudeyeand each of its executive officers, Mike Brochu, Chris Pollakand Charles Edward Averdieck.     *Michael A. Brochu.* Loudeye and Mr. Brochu enteredinto an amended and restated executive employment agreementdated March 30, 2005, pursuant to which Mr. Brochu isemployed as Loudeye’s President and Chief ExecutiveOfficer. The executive employment agreement provides for a basesalary of $325,000 together with a signing bonus of $25,000. Theinitial term of the executive employment agreement ran untilDecember 31, 2005, and the agreement has been renewedthrough December 31, 2006. Mr. Brochu received anoption grant to purchase 1,500,000 shares ofLoudeye’s common stock for an exercise price of$1.53 per share. This option vests over a four yearperiod — 25% as of January 31, 2006, and theremainder monthly thereafter over three years. Mr. Brochualso received a restricted stock award of 750,000 shareswhich vested 25% on January 31, 2006, and vests quarterlythereafter for 12 consecutive quarters. If Mr. Brochuis terminated in connection with a change of control of Loudeyeor otherwise terminated without cause or if Mr. Brochuterminates his employment for good reason, his stock options andrestricted stock grant will vest in full. The employmentagreement provides for the opportunity to receive a bonus of upto 50% of base salary if Mr. Brochu meets targetperformance goals identified by the Compensation Committee ofthe Board and up to 100% of base salary if Mr. Brochu meetsmaximum performance goals identified by the CompensationCommittee of the Board. The actual amount of performance bonuseswill be determined by the Compensation Committee of the Board,provided that no bonuses will be paid in the event Loudeye doesnot have a positive balance of earnings before interest, tax,depreciation and amortization expenses (“EBITDA”) andnot more than 25% of any such positive balance will be paid asbonus compensation individually or collectively toLoudeye’s executive leadership team (includingMr. Brochu). In the event that Mr. Brochu isterminated by Loudeye without cause, or he resigns for goodreason, dies or becomes disabled, Mr. Brochu will beentitled to severance equal to eight months base salary. Thisseverance amount will increase to 12 months of base salaryon December 31, 2006. In the event Mr. Brochu isterminated in connection with a change of control or terminateshis employment for good reason following a change of control,Mr. Brochu will be entitled to severance equal to12 months of base salary. Mr. Brochu has agreed not tocompete with Loudeye or solicit customers or employees ofLoudeye for one year following termination of employment. Thesenon-compete and non-solicitation agreements may not beenforceable in some jurisdictions. Mr. Brochu will beentitled to participate in all benefit plans or arrangementsapplicable to senior executives of Loudeye.     *Chris J. Pollak.* On November 18, 2005, Loudeyeentered into an Amended and Restated Executive EmploymentAgreement with Mr. Pollak, pursuant to whichMr. Pollak serves as Chief Financial Officer.Mr. Pollak joined Loudeye as Vice President, Finance inJanuary 2005. The employment agreement provides for a basesalary of $175,000. Following annual compensation review by theCompensation Committee and Chief Executive Officer,Mr. Pollak’s base salary will be raised to $200,000effective March 15, 2006. Mr. Pollak received a stockoption grant to purchase 150,000 shares ofLoudeye’s common stock at an exercise price per share of$0.47. This option grant has a ten year term from the date ofgrant and vests over a four year period — 25% atNovember 18, 2006, and monthly thereafter for36 consecutive months. Mr. Pollak also received arestricted stock award of 50,000 shares which vests 25% atJuly 21, 2006, and quarterly thereafter for 12 consecutivequarters. If Mr. Pollak is terminated without cause inconnection with a change of control of Loudeye orMr. Pollak terminates his employment for good reason inconnection with a change of control, his stock options andrestricted stock grant will vest in full. The employmentagreement provides for the opportunity to receive a bonus of upto 50% of base salary if Mr. Pollak meets targetperformance goals identified by the compensation committee ofthe board of directors and up to 100% of base salary ifMr. Pollak meets maximum performance goals identified bythe compensation committee of the board of directors. The actualamount of performance bonuses will be
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determined by the compensation committee of the board, providedthat no bonuses will be paid in the event Loudeye does not havea positive EBITDA balance and not more than 25% ofLoudeye’s positive EBITDA balance will be distributed asbonus compensation individually or collectively toLoudeye’s executive leadership team, includingMr. Pollak. In addition, Mr. Pollak will be entitledto receive a bonus of $40,000 upon the earliest of thefollowing: (i) filing of Loudeye’s annual report onForm 10-K for theyear ended December 31, 2005, (ii) filing ofLoudeye’s last public filing prior to a Change of Control,or (iii) termination by Loudeye of Mr. Pollak’semployment without “Cause” or for failure to meet“performance or quarterly goals.” In the event thatMr. Pollak is terminated by Loudeye without cause, or heresigns for good reason, or is terminated in connection with achange of control or terminates his employment for good reasonfollowing a change of control, Mr. Pollak will be entitledto severance equal to six months base salary if the terminationoccurs prior to December 31, 2006, and nine months basesalary if the termination occurs after January 1, 2007.Mr. Pollak has agreed not to compete with Loudeye orsolicit customers or employees of Loudeye for one year followingtermination of employment. These non-compete andnon-solicitation agreements may not be enforceable in somejurisdictions. Mr. Pollak will be entitled to participatein all benefit plans or arrangements applicable to seniorexecutives of Loudeye.     *Charles Edward Averdieck.* On March 15, 2006, Loudeyeentered into an Amended and Restated Executive ServicesAgreement with Mr. Averdieck, pursuant to whichMr. Averdieck serves as Managing Director Europe.Mr. Averdieck joined Loudeye as Director InternationalSales and Marketing in June 2004 following Loudeye’sacquisition of OD2. The employment agreement provides for a basesalary of £123,750 (approximately $215,900 based onMarch 1, 2006 exchange rates). Mr. Averdieck receiveda stock option grant to purchase 300,000 shares ofLoudeye’s common stock at an exercise price per share of$0.46. This option grant has a ten year term from the date ofgrant and vests over a four year period — 25% atDecember 1, 2006, and monthly thereafter for 36 consecutivemonths. Mr. Averdieck also received a restricted stockaward of 100,000 shares which vests 25% at December 1,2006, and quarterly thereafter for 12 consecutive quarters. Theemployment agreement provides for the opportunity to receive abonus of up to 50% of base salary if Mr. Averdieck meetstarget performance goals identified by the compensationcommittee of the board of directors and up to 100% of basesalary if Mr. Averdieck meets maximum performance goalsidentified by the compensation committee of the board ofdirectors. The actual amount of performance bonuses will bedetermined by the compensation committee of the board, providedthat no bonuses will be paid in the event Loudeye does not havea positive EBITDA balance and not more than 25% ofLoudeye’s positive EBITDA balance will be distributed asbonus compensation individually or collectively toLoudeye’s executive leadership team, includingMr. Averdieck. In the event that Mr. Averdieck isterminated by Loudeye without cause, or he resigns for goodreason, or is terminated in connection with a change of controlor terminates his employment for good reason following a changeof control, Mr. Averdieck will be entitled to severanceequal to six months base salary if the termination occurs priorto December 31, 2006, and nine months base salary if thetermination occurs after January 1, 2007. In addition, inthe event Mr. Averdieck is terminated by Loudeye withoutcause or Mr. Averdieck terminates his employment for goodreason or in the event of a change in control,Mr. Averdieck’s stock options and restricted stockgrant will vest in full. Mr. Averdieck has agreed not tocompete with Loudeye or solicit customers or employees ofLoudeye for six months following termination of employment ifsuch termination occurs in 2006 and nine months if suchtermination occurs after January 1, 2007. These non-competeand non-solicitation agreements may not be enforceable in somejurisdictions. Mr. Averdieck will be entitled toparticipate in all benefit plans or arrangements applicable tosenior executives of Loudeye.     Loudeye has entered into indemnification agreements with each ofits directors, current executive officers and certain otherofficers. Generally, the purpose of the indemnificationagreements is to provide the maximum indemnification permittedby law to Loudeye’s directors and officers with respect toactions they take or omit to take in their capacities asofficers and directors. The indemnification agreements providethat Loudeye will pay certain amounts incurred by an officer inconnection with any civil or criminal action or proceeding,specifically including actions by Loudeye or in its name(derivative suits), where the individual’s involvement isby reason of the fact that he is or was a director or officer.Such amounts include, to the maximum extent permitted by law,attorneys’ fees, judgments, civil or criminal fines,settlement amounts and other expenses customarily incurred inconnection with legal proceedings.
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Under the indemnification agreements, a director or officer willnot receive indemnification if he or she is found not to haveacted in good faith and in a good manner he or she reasonablybelieved to be in or not opposed to Loudeye’s bestinterests. The individual will only be indemnified in connectionwith any criminal proceeding if such individual had noreasonable belief that his or her conduct was unlawful.**Summary Compensation Table**     The following Summary Compensation Table sets forth thecompensation during the last three fiscal years of each personwho served as Chief Executive Officer during the fiscal yearended December 31, 2005, and the four most highlycompensated persons other than the Chief Executive Officer whowere serving as executive officers of Loudeye or for whomdisclosures would have been provided but for the fact that theperson was not serving as an executive officer as ofDecember 31, 2005. These individuals are collectivelyreferred to as “Named Executive Officers.”**Summary Compensation Table**                                        **Long-Term**        **Annual Compensation** **Compensation Awards** **Payouts**                   **Other Annual** **Restricted** **Securities** **LTIP** **All Other**  **Fiscal** **Salary** **Bonus** **Compensation** **Stock** **Underlying** **Payouts** **Compensation****Name & Principal Position** **Year** **($)(1)** **($)(2)** **($)** **Award(s)** **Options(#)** **($)** **($)**                     Michael A. Brochu(3)  2005  $299,166  $25,000  $1,650  $555,000(4)  1,500,000   —   —      President and Chief  2004   30,000   —   —   —   25,000   —   —      Executive Officer and  2003   7,500   —   —   —   100,000   —   —      Director                                    Chris J. Pollak(5)  2005   139,718   10,000   1,800   40,000(6)  375,000   —   —      Chief Financial Officer                                    Charles Edward Averdieck(7)  2005   373,110   —   15,583   46,000(8)  300,000   —   —      Managing Director,  2004   171,474   —   23,914   —   215,000   —   —      Europe                                    Jason E. McCartney(9)  2005   205,416       1,725   100,000(10)  300,000   —   —      Vice President,  2004   152,077   48,500   —   —   450,000   —   —      Development                                    Eric S. Carnell(11)  2005   197,278   15,000   1,800   36,500(12)  —   —   —      Vice President, General  2004   69,375   25,000   675       200,000   —   —      Counsel & Secretary                                    Jeffrey M. Cavins(13)  2005   270,833   —   150   —   —   —   —      Chief Executive Officer  2004   250,000   —   —   —   1,250,000   —   —     2003   269,375   62,500   —   —   1,500,000   —   —    (1)     Includes amounts deferred under Loudeye’s 401(k) plan.   (2)     Includes bonuses earned in the indicated year and paid in the    subsequent year.   (3)     Mr. Brochu became President and Chief Executive Officer or    Loudeye on January 31, 2005. Prior to that time,    Mr. Brochu was a director of Loudeye. Bonus compensation in    2005 represents a signing bonus paid pursuant to the terms of    the Executive Employment Agreement between Loudeye and    Mr. Brochu dated January 31, 2005. Other annual    compensation in the fiscal year ended December 31, 2005    represents cell phone allowance. Compensation in fiscal years    2004 and 2003 represents compensation received by    Mr. Brochu in his capacity as a director. Securities    underlying options in fiscal years 2004 and 2003 represents    option awards to Mr. Brochu in his capacity as a director.   (4)     Represents the dollar value of a restricted stock award to    Mr. Brochu for 750,000 shares granted July 13,    2005, at a closing market price on such date of $0.74. As of    December 31, 2005, Mr. Brochu continued to hold    750,000 shares of restricted stock valued at $285,000 using    the value of Loudeye’s common stock on December 30,    2005.
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  (5)     Mr. Pollak became Chief Financial Officer in November 2005,    and prior to that time served as Vice President Finance    beginning in January 2005.   (6)     Represents the dollar value of a restricted stock award to    Mr. Pollak for 50,000 shares granted July 31,    2005, at a closing market price on such date of $0.80. As of    December 31, 2005, Mr. Pollak continued to hold    50,000 shares of restricted stock valued at $19,000 using    the value of Loudeye’s common stock on December 30,    2005.   (7)     Compensation data for Mr. Averdieck in fiscal year ended    2004 is for the period from June 22, 2004, the date of    Loudeye’s acquisition by merger of OD2, to    December 31, 2004. Other annual compensation consists of an    employee pension benefit and employee National Insurance    Contribution paid by OD2.   (8)     Represents the dollar value of a restricted stock award to    Mr. Averdieck for 100,000 shares granted    December 15, 2005, at a closing market price on such date    of $0.46. As of December 31, 2005, Mr. Averdieck    continued to hold 100,000 shares of restricted stock valued    at $46,000 using the value of Loudeye’s common stock on    December 30, 2005.   (9)     Mr. McCartney joined Loudeye in January 2004.(10)     Represents the dollar value of a restricted stock award to    Mr. McCartney for 100,000 shares granted    September 15, 2005, at a closing market price on such date    of $1.00. As of December 31, 2005, Mr. McCartney    continued to hold 100,000 shares of restricted stock valued    at $38,000 using the value of Loudeye’s common stock on    December 30, 2005. (11)     Mr. Carnell joined Loudeye in August 2004. (12)     Represents the dollar value of a restricted stock award to    Mr. Carnell for 50,000 shares granted June 30,    2005, at a closing market price on such date of $0.73. As of    December 31, 2005, Mr. Carnell continued to hold    50,000 shares of restricted stock valued at $19,000 using    the value of Loudeye’s common stock on December 30,    2005. (13)     Mr. Cavins resigned as Loudeye’s Chief Executive    Officer on January 31, 2005. Under the terms of a    separation agreement between Mr. Cavins and Loudeye,    Mr. Cavins served as a consultant through March 17,    2005. As part of this agreement, Mr. Cavins received a    separation payment equal to one year’s salary, or $250,000,    in 2005. Other annual compensation in the fiscal year ended    December 31, 2005 represents cell phone allowance.    Compensation in fiscal year 2003 includes amounts earned by    Mr. Cavins as Senior Vice President of Sales for part of    the year prior to becoming President and Chief Executive Officer    in March 2003.**Stock Option Grants**     The following table shows all stock options granted during thefiscal year ended December 31, 2005 to the Named ExecutiveOfficers. No stock appreciation rights were granted during thelast fiscal year.
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**Option Grants in the Last Fiscal Year**                               **Individual Grants(1)**      **Potential Realizable**    **Percent of**   **Value at Assumed**  **Number of** **Total Options**   **Annual Rates of Stock**  **Securities** **Granted to** **Exercise** **Grant Date**   **Price Appreciation for**  **Underlying** **Employees in** **of Base** **Market**   **Option Term(2)**  **Options** **Fiscal Year** **Price** **Price** **Expiration**  **Name** **Granted(#)(3)** **(%)(4)** **($/sh.)** **($/sh.)** **Date** **5%($)** **10%($)**                   Michael A. Brochu  1,500,000(5)  20.37%  $1.53  $1.53   1/31/2015  $1,443,325  $3,657,655     Chris J. Pollak  150,000(6)  2.04%  $0.47  $0.47   11/18/2015   44,350   112,375    50,000(6)  0.68%  $0.80  $0.80   7/29/2015   25,168   63,766    175,000(5)  2.38%  $1.53  $1.53   1/31/2015   168,399   426,740     Charles Edward Averdieck  300,000(6)  4.07%  $0.46  $0.46   12/15/2015   57,871   146,640     Jason E. McCartney  300,000(6)  4.07%  $1.00  $1.00   9/15/2015   188,681   478,139     Eric S. Carnell  —   —   —   —                 Jeffrey M. Cavins  —   —   —   —              (1)     The options have a    10-year term, but are    subject to earlier termination in connection with termination of    employment. (2)     The potential realizable value illustrates value that might be    realized upon exercise of the options immediately prior to    expiration of their terms, assuming the specified compounded    rates of appreciation of the market price per share from the    date of grant to the end of the option term. Actual gains, if    any, on stock option exercises are dependent upon a number of    factors, including the future performance of the Common Stock    and the timing of option exercises, as well as the    optionees’ continued employment throughout the vesting    period. These are calculated based on the requirements    promulgated by the SEC and do not reflect Loudeye’s    estimate of future stock price appreciation. (3)     The options vest 25% on the one year anniversary of the date of    grant and then quarterly thereafter over three additional years.    In the event of a change of control of Loudeye, as defined in    Loudeye’s 2005 Incentive Award Plan, vesting will    accelerate on 25% of the unvested shares under the option grant.    In the event an acquiring entity in a change of control does not    assume these options, vesting in the unaccelerated options will    accelerate 100%. (4)     The Company granted stock options representing    7,364,000 shares to employees in the fiscal year ended    December 31, 2005. (5)     These option were granted under Loudeye’s 2000 Stock Option    Plan. (6)     These options were granted under Loudeye’s 2005 Incentive    Award Plan.**Stock Option Exercises and Holdings**     The following table shows stock options exercised during thefiscal year ended December 31, 2005 and unexercised optionsheld at the end of the year by each of the Named ExecutiveOfficers. No stock appreciation rights were outstanding atfiscal year end.
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**Aggregated Option Exercises in Last Fiscal Year and FiscalYear-End Option Values**                               **Number of Securities**        **Underlying Unexercised** **Value of Unexercised**      **Options at** **In-the-Money Options at**  **Shares** **Value** **December 31, 2005** **December 31, 2005(2)**  **Acquired on** **Realized**    **Name** **Exercise(#)** **($)(1)** **Exercisable** **Unexercisable** **Exercisable** **Unexercisable**                 Michael A. Brochu  —   —   125,000   1,500,000   —   —     Chris J. Pollak  —   —   0   375,000   —   —     Charles Edward Averdieck  —   —   80,625   434,375   —   —     Jason E. McCartney  —   —   158,350   591,650   —   —     Eric S. Carnell  —   —   66,667   133,333   —   —     Jeffrey M. Cavins  1,790,623  $2,138,442   0   0   —   —  (1)     The “value realized” reflects the appreciation on the    date of exercise (based on the excess of the fair market value    of Common Stock on the date of exercise over the exercise    price). However, because the Named Executive Officers may keep    the shares they acquired upon the exercise of the options (or    sell them at a different price), these amounts do not    necessarily reflect cash realized upon the sale of those shares. (2)     Based on the $0.38 closing price of Loudeye common stock as of    December 30, 2005.**Performance Graph**     **Introductory Note:** The stock price performance graphbelow is required by the SEC and will not deemed to beincorporated by reference by any general statement incorporatingby reference this Proxy Statement into any filing under theSecurities Act or under the Exchange Act, except to the extentthat Loudeye specifically incorporates this information byreference, and shall not otherwise be deemed soliciting materialor filed under such laws.     Set forth below is a graph comparing the cumulative total returnto stockholders on the Common Stock with the cumulative totalreturn of the Nasdaq Stock Market (U.S. companies) Index,Internet Holders Trust (Amex: HHH), and the RDG InternetComposite Index, in each case for the period beginning onMarch 15, 2000 (the date of Loudeye’s initial publicoffering and based upon the price to the public in the initialpublic offering of $16.00 per share), and ending onDecember 31, 2005.     The comparisons shown in the graph below are based uponhistorical data and Loudeye cautions that the stock priceperformance shown in the graph below is not indicative of, norintended to forecast, the potential future performance ofLoudeye’s Common Stock. Information used in the graph wasobtained from a source believed to be reliable, but Loudeye isnot responsible for any errors or omissions in such information.
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**COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN***AMONG LOUDEYE CORP., THE NASDAQ STOCK MARKET (U.S.) INDEX,THE RDG INTERNET COMPOSITE INDEX AND INTERNET HOLDERS TRUST