##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549


FORM 10-Q

(Mark One)

|  |  |                                                                                        
|- |  | ---------------------------------------------------------------------------------------
|x |  | Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the quarterly period ended June 30, 2003

or

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|o |  | Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the transition period from      to

Commission File Number: 0-29583

Loudeye Corp.

(Exact name of registrant as specified in its charter)


|                                                                        |  |                                                
|----------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization) |  | 91-1908833
(I.R.S. Employer 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)

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

Yes   x    No  o

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

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

|        |  |  |                                | 
|------- |  |  | ------------------------------ | 
|Common  |  |  | 48,008,925                     | 
|        |  |  |                                | 
|(Class) |  |  | (Outstanding at July 31, 2003) | 





---

TABLE OF CONTENTS



|                               |                                                                                               |  |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | ITEM I FINANCIAL STATEMENTS                                                                  
|                               | CONSOLIDATED STATEMENTS OF OPERATIONS                                                        
|                               | CONSOLIDATED STATEMENTS OF CASH FLOWS                                                        
|                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                   
|                               | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                               | Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            
|                               | Item 4 DISCLOSURE CONTROLS AND PROCEDURES                                                    
|PART II. OTHER INFORMATION    
|                               | ITEM 1: LEGAL PROCEEDINGS                                                                    
|                               | ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                               | ITEM 3: DEFAULTS UPON SENIOR SECURITIES                                                      
|                               | ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                               | ITEM 5: OTHER INFORMATION                                                                    
|                               | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                    
|EXHIBIT 10.40                 
|EXHIBIT 10.41                 
|EXHIBIT 10.42                 
|EXHIBIT 10.43                 
|EXHIBIT 10.45                 
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



---



##### Table of Contents



Loudeye Corp.

Form 10-Q Quarterly Report
For the Quarter Ended June 30, 2003

TABLE OF CONTENTS

|     |  |     |  |                                                                                       |  |     
|---- |  | --- |  | ------------------------------------------------------------------------------------- |  | ----
|     |  |     |  |                                                                                       |  | Page
|     |  |     |  |                                                                                       |  |     
|PART |  | I.  |  | Financial Information (unaudited)                                                     |  |     
|Item |  | 1   |  | Financial Statements                                                                  |  |     
|     |  |     |  | Consolidated Balance Sheets                                                           |  | 3   
|     |  |     |  | Consolidated Statements of Operations                                                 |  | 4   
|     |  |     |  | Consolidated Statements of Cash Flows                                                 |  | 5   
|     |  |     |  | Notes to Consolidated Financial Statements                                            |  | 6   
|Item |  | 2   |  | Managements Discussion and Analysis of Financial Condition
and Results of Operations |  | 12  
|Item |  | 3   |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 30  
|Item |  | 4   |  | Disclosure Controls and Procedures                                                    |  | 30  
|PART |  | II. |  | Other Information                                                                     |  |     
|Item |  | 1   |  | Legal Proceedings                                                                     |  | 30  
|Item |  | 2   |  | Changes in Securities and Use of Proceeds                                             |  | 31  
|Item |  | 3   |  | Defaults Upon Senior Securities                                                       |  | 31  
|Item |  | 4   |  | Submission of Matters to a Vote of Security Holders                                   |  | 31  
|Item |  | 5   |  | Other Information                                                                     |  | 31  
|Item |  | 6   |  | Exhibits and Reports on Form 8-K                                                      |  | 31  

2



---



##### Table of Contents






PART I  FINANCIAL INFORMATION




ITEM I                      FINANCIAL STATEMENTS

LOUDEYE CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands)

|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |         |   |        | 
|------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------ | ------- | -------- | ------ | ------------ | ------- | - | ------ | 
|                                     |                                                                                                                                                                                                                                     |  |                                            |         | June 30, |        | December 31,
|                                     |                                                                                                                                                                                                                                     |  |                                            |         | 2003     |        | 2002        
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |             
|ASSETS                               |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     | Cash and cash equivalents                                                                                                                                                                                                           |  | $                                          | 5,049   |          |        | $            | 1,889   |  
|                                     | Restricted cash                                                                                                                                                                                                                     |  |                                            | 650     |          |        |              |        |  
|                                     | Short-term investments                                                                                                                                                                                                              |  |                                            | 4,158   |          |        |              | 9,978   |  
|                                     | Accounts receivable, net of allowances of $262 and $290                                                                                                                                                                             |  |                                            | 2,626   |          |        |              | 2,501   |  
|                                     | Notes receivable from related parties                                                                                                                                                                                               |  |                                            | 74      |          |        |              | 1,187   |  
|                                     | Prepaid expenses and other                                                                                                                                                                                                          |  |                                            | 554     |          |        |              | 914     |  
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     |                                                                                                                                                                                                                                     |  | Total current assets                       |         |          | 13,111 |              |         |   | 16,469 | 
|                                     | Restricted investments                                                                                                                                                                                                              |  |                                            | 556     |          |        |              | 1,500   |  
|                                     | Property and equipment, net                                                                                                                                                                                                         |  |                                            | 2,251   |          |        |              | 3,590   |  
|                                     | Goodwill                                                                                                                                                                                                                            |  |                                            |        |          |        |              | 5,307   |  
|                                     | Intangible assets, net                                                                                                                                                                                                              |  |                                            | 344     |          |        |              | 1,758   |  
|                                     | Other assets                                                                                                                                                                                                                        |  |                                            | 522     |          |        |              | 905     |  
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     |                                                                                                                                                                                                                                     |  | Total assets                               |         | $        | 16,784 |              |         | $ | 29,529 | 
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     | Accounts payable                                                                                                                                                                                                                    |  | $                                          | 1,619   |          |        | $            | 1,203   |  
|                                     | Line of credit                                                                                                                                                                                                                      |  |                                            | 2,500   |          |        |              |        |  
|                                     | Accrued compensation and benefits                                                                                                                                                                                                   |  |                                            | 883     |          |        |              | 904     |  
|                                     | Other accrued expenses                                                                                                                                                                                                              |  |                                            | 1,183   |          |        |              | 1,424   |  
|                                     | Accrued special charges                                                                                                                                                                                                             |  |                                            | 1,545   |          |        |              | 2,903   |  
|                                     | Accrued acquisition consideration                                                                                                                                                                                                   |  |                                            | 1,059   |          |        |              | 1,059   |  
|                                     | Deposits and deferred revenues                                                                                                                                                                                                      |  |                                            | 964     |          |        |              | 305     |  
|                                     | Current portion of long-term debt                                                                                                                                                                                                   |  |                                            | 717     |          |        |              | 788     |  
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     |                                                                                                                                                                                                                                     |  | Total current liabilities                  |         |          | 10,470 |              |         |   | 8,586  | 
|                                     | Deposits and deferred revenue                                                                                                                                                                                                       |  |                                            | 404     |          |        |              |        |  
|                                     | Long-term debt, net of current portion                                                                                                                                                                                              |  |                                            | 338     |          |        |              | 591     |  
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     |                                                                                                                                                                                                                                     |  | Total liabilities                          |         |          | 11,212 |              |         |   | 9,177  | 
|                                     | Commitments and contingencies                                                                                                                                                                                                       |  |                                            |         |          |        |              |         |  
|STOCKHOLDERS EQUITY                 |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     | Preferred stock, $0.001 par value, 41,000 shares                                                                                                                                                                                    |  |                                            |         |          |        |              |         |  
|                                     | authorized, none outstanding                                                                                                                                                                                                        |  |                                            |        |          |        |              |        |  
|                                     | Common stock, additional paid-in capital and warrants,
$0.001 par value, 100,000 shares authorized; issued
June 30, 2003  54,927 and December 31, 2002 - 53,871;
outstanding June 30, 2003  47,074 and December 31,
2002  47,158 |  |                                            | 194,449 |          |        |              | 194,195 |  
|                                     | Deferred stock compensation                                                                                                                                                                                                         |  |                                            | (44     | )        |        |              | (130    | )
|Accumulated deficit                  |                                                                                                                                                                                                                                     |  | (188,833                                   | )       |          |        | (173,713     | )      
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     |                                                                                                                                                                                                                                     |  | Total stockholders equity                 |         |          | 5,572  |              |         |   | 20,352 | 
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        
|                                     |                                                                                                                                                                                                                                     |  | Total liabilities and stockholders equity |         | $        | 16,784 |              |         | $ | 29,529 | 
|                                     |                                                                                                                                                                                                                                     |  |                                            |         |          |        |              |        

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

3



---



##### Table of Contents






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

|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |       |      |  
|------------------------------------------------------- | -------------------------------------------- | ------------------- | ------ | ------------------ | ----- | ---------------- | ------ | ----- | ---- | ---- | ------- | ----- | ----- | - | ------- | ----- | ---- | -
|                                                        |                                              |                     |        | Three Months Ended |       | Six Months Ended
|                                                        |                                              |                     |        | June 30,           |       | June 30,        
|                                                        |                                              |                     |        |                    |       |                 
|                                                        |                                              |                     |        | 2003               |       | 2002             |        | 2003  |      | 2002
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |     
|REVENUES                                                |                                              | $                   | 2,903  |                    |       | $                | 3,217  |       |      | $    | 6,213   |       |       | $ | 6,477   |      
|COST OF REVENUES                                        |                                              |                     | 1,678  |                    |       |                  | 3,632  |       |      |      | 4,219   |       |       |   | 6,877   |      
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|                                                        |                                              | Gross profit (loss) |        |                    | 1,225 |                  |        |       | (415 | )    |         |       | 1,994 |   |         |       | (400 | )
|OPERATING EXPENSES                                      |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|                                                        | Research and development                     |                     |        | 392                |       |                  |        | 974   |      |      |         | 969   |       |   |         | 2,264 |     
|                                                        | Sales and marketing                          |                     |        | 835                |       |                  |        | 2,245 |      |      |         | 2,381 |       |   |         | 4,461 |     
|                                                        | General and administrative                   |                     |        | 1,740              |       |                  |        | 2,762 |      |      |         | 4,492 |       |   |         | 6,237 |     
|                                                        | Amortization of intangibles and other assets |                     |        | 260                |       |                  |        | 713   |      |      |         | 786   |       |   |         | 1,409 |     
|                                                        | Stock-based compensation                     |                     |        | 195                |       |                  |        | 102   |      |      |         | 238   |       |   |         | (554  | )   
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|                                                        |                                              |                     | 3,422  |                    |       |                  | 6,796  |       |      |      | 8,866   |       |       |   | 13,817  |      
|                                                        | Special charges                              |                     |        |                   |       |                  |        | 1,142 |      |      |         | 8,437 |       |   |         | 1,890 |     
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|OPERATING LOSS                                          |                                              |                     | (2,197 | )                  |       |                  | (8,353 | )     |      |      | (15,309 | )     |       |   | (16,107 | )    
|OTHER INCOME (EXPENSE)                                  |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|                                                        | Interest income                              |                     | 101    |                    |       |                  | 309    |       |      |      | 187     |       |       |   | 642     |      
|                                                        | Interest expense                             |                     |        | (48                | )     |                  |        | (235  | )    |      |         | (97   | )     |   |         | (452  | )   
|                                                        | Other                                        |                     |        | 82                 |       |                  |        |      |      |      |         | 99    |       |   |         |      |     
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|                                                        |                                              | Total other income  |        |                    | 135   |                  |        |       | 74   |      |         |       | 189   |   |         |       | 190  |  
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|Net loss                                                |                                              | $                   | (2,062 | )                  |       | $                | (8,279 | )     |      | $    | (15,120 | )     |       | $ | (15,917 | )    
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|Basic and diluted net loss per share                    |                                              | $                   | (0.04  | )                  |       | $                | (0.21  | )     |      | $    | (0.33   | )     |       | $ | (0.39   | )    
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      
|Weighted average shares outstanding
 basic and diluted |                                              |                     | 45,931 |                    |       |                  | 40,229 |       |      |      | 46,215  |       |       |   | 40,330  |      
|                                                        |                                              |                     |        |                    |       |                  |        |       |      |      |         |       |       |   |         |      

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

4



---



##### Table of Contents






LOUDEYE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |        |         |        |         |  
|--------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------- | ---------------------------------------------------- | ------- | ---------------- | ------ | ------ | ------- | ------ | ------- | -
|                                                                            |                                                                                               |                                                   |                                                      |         | Six Months Ended
|                                                                            |                                                                                               |                                                   |                                                      |         | June 30,        
|                                                                            |                                                                                               |                                                   |                                                      |         |                 
|                                                                            |                                                                                               |                                                   |                                                      |         | 2003             |        | 2002  
|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |       
|Operating Activities                                                        |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|                                                                            | Net loss                                                                                      |                                                   | $                                                    | (15,120 | )                |        | $      | (15,917 | )     
|                                                                            | Adjustments to reconcile net loss to net cash used in
operating activities:                   |                                                   |                                                      |         |                  |        |        |         |       
|                                                                            |                                                                                               | Depreciation and amortization                     |                                                      |         | 1,598            |        |        |         | 3,450  |        
|                                                                            |                                                                                               | Special charges                                   |                                                      |         | 6,573            |        |        |         | 25     |        
|                                                                            |                                                                                               | Stock-based compensation                          |                                                      |         | 238              |        |        |         | (554   | )      
|                                                                            | Changes in operating assets and liabilities, net of
amounts acquired in purchase of business: |                                                   |                                                      |         |                  |        |        |         |       
|                                                                            |                                                                                               | Accounts receivable                               |                                                      |         | (125             | )      |        |         | (245   | )      
|                                                                            |                                                                                               | Prepaid expenses and other assets                 |                                                      |         | 947              |        |        |         | 291    |        
|                                                                            |                                                                                               | Accounts payable                                  |                                                      |         | 416              |        |        |         | 423    |        
|                                                                            |                                                                                               | Accrued compensation, benefits and other expenses |                                                      |         | (150             | )      |        |         | (1,129 | )      
|                                                                            |                                                                                               | Accrued special charges                           |                                                      |         | (1,358           | )      |        |         | 236    |        
|                                                                            |                                                                                               | Deposits and deferred revenues                    |                                                      |         | 1,063            |        |        |         | (486   | )      
|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|                                                                            |                                                                                               |                                                   | Net cash used in operating activities                |         |                  | (5,918 | )      |         |        | (13,906 | )
|Investing Activities                                                        |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|                                                                            | Purchases of property and equipment                                                           |                                                   |                                                      | (50     | )                |        |        | (1,192  | )     
|                                                                            | Proceeds from sales of property and equipment                                                 |                                                   |                                                      | 164     |                  |        |        |        |       
|                                                                            | Cash paid for acquisition of business and technology, net                                     |                                                   |                                                      | (82     | )                |        |        | (266    | )     
|                                                                            | Loans made to related party and related interest                                              |                                                   |                                                      |        |                  |        |        | (771    | )     
|                                                                            | Payments received on loans made to related party and
related interest                         |                                                   |                                                      | 1,113   |                  |        |        |        |       
|                                                                            | Purchases of short-term investments                                                           |                                                   |                                                      |        |                  |        |        | (11,763 | )     
|                                                                            | Sales of short-term investments                                                               |                                                   |                                                      | 5,820   |                  |        |        | 4,798   |       
|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|                                                                            |                                                                                               |                                                   | Net cash provided by (used in) investing activities  |         |                  | 6,965  |        |         |        | (9,194  | )
|Financing Activities                                                        |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|                                                                            | Proceeds from sale of stock and exercise of stock options                                     |                                                   |                                                      | 475     |                  |        |        | 40      |       
|                                                                            | Proceeds from line of credit and long-term debt                                               |                                                   |                                                      | 2,500   |                  |        |        |        |       
|                                                                            | Principal payments on long-term debt and capital lease
obligations                            |                                                   |                                                      | (436    | )                |        |        | (813    | )     
|                                                                            | Repurchase of common stock                                                                    |                                                   |                                                      | (426    | )                |        |        |        |       
|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|                                                                            |                                                                                               |                                                   | Net cash provided by (used in) financing activities  |         |                  | 2,113  |        |         |        | (773    | )
|                                                                            |                                                                                               |                                                   | Net increase (decrease) in cash and cash equivalents |         |                  | 3,160  |        |         |        | (23,873 | )
|Cash and cash equivalents, beginning of period                              |                                                                                               |                                                   | 1,889                                                |         |                  |        | 37,159 |        
|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|Cash and cash equivalents, end of period                                    |                                                                                               | $                                                 | 5,049                                                |         |                  | $      | 13,286 |        
|                                                                            |                                                                                               |                                                   |                                                      |         |                  |        |        |         |       
|Supplemental disclosures:                                                   |                                                                                               |                                                   |                                                      |         |                  |        |        |        
|Cash paid for interest                                                      |                                                                                               | $                                                 | 37                                                   |         |                  | $      | 217    |        
|Assets acquired under capital lease obligations                             |                                                                                               |                                                   | 112                                                  |         |                  |        | 74     |        
|Issuance of common stock for acquisition of business and
technology         |                                                                                               |                                                   |                                                     |         |                  |        | 408    |        
|Reversal of deferred stock compensation as a result of
option cancellations |                                                                                               |                                                   |                                                     |         |                  |        | 1,170  |        

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

5



---



##### Table of Contents






LOUDEYE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)

1. ORGANIZATION, RISKS, and GOING CONCERN

The Company

Loudeye Corp. (the Company) provides the business infrastructure and
services for managing, promoting, and distributing digital content for the
entertainment and corporate markets. The Company is headquartered in Seattle,
Washington with offices in New York, NY, Hollywood, CA, and Washington D.C.,
and conducts business in two business segments, digital media services and
media restoration services.

Risks

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

Going Concern

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
realization of assets and the satisfaction of liabilities in the normal course
of business. The Company has incurred losses since inception, has an
accumulated deficit of $188.8 million at June 30, 2003, has experienced
negative cash flows from operations since inception and the expansion and
development of the Companys business may require additional capital. These
matters raise substantial doubt about the Companys ability to continue as a
going concern.

Management has restructured the Companys operations, reduced its work
force, renegotiated leases, and taken other actions to limit the Companys
expenditures. However, there can be no assurance that the Companys cash
balances will be sufficient to sustain its operations until profitable
operations and positive cash flows are achieved. Consequently, the Company may
require additional capital to fund its operations. There can be no assurance
that capital will be available to the Company on acceptable terms, or at all.

If the Company fails to generate positive cash flows or fails to obtain
additional capital when required, the Company could continue to modify, delay
or abandon some or all of the Companys business and expansion plans. The
accompanying consolidated financial statements do not include any adjustments
that may result from the outcome of this uncertainty.

Basis of Consolidation

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

Unaudited Interim Financial Data

The interim consolidated financial statements are unaudited and have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. These consolidated financial statements should be read in
conjunction with the audited financial statements and
notes thereto included in the Companys Annual Report on Form 10-K as
filed with the Securities and Exchange Commission on April 15, 2003. The
financial information included herein reflects all adjustments (consisting only
of normal recurring adjustments) that are, in the opinion of management,
necessary for a fair presentation of the results for interim periods. The
results of operations for the three and six months ended June 30, 2003 and 2002
are not necessarily indicative of the results to be expected for the full
years.

Use of Estimates

6



---



##### Table of Contents



The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and that affect the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates and
assumptions. The recoverability of long-lived assets, which include property
and equipment ($2.3 million) and intangible assets ($344,000), is a sensitive
accounting estimate for which changes could result in additional charges in the
near term. Additional impairment analyses could be required in a number of
circumstances, including if the Companys plans for the assets change, if
operating results decline further, or if the price of the Companys stock
declines.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and Cash Equivalents

Cash and cash equivalents consist of demand deposits and money market
accounts maintained with financial institutions and certain other investment
grade instruments. The Company considers all cash deposits and highly liquid
investments with an original maturity at the date of acquisition of three
months or less to be cash equivalents.

Short Term Investments

The Company has invested amounts in investment-grade government
obligations, institutional money market funds and other obligations with FDIC
insured U.S. banks. Short-term investments are generally held to maturity and
are accounted for as available for sale. These securities all mature within one
year and reported amounts approximate fair value due to the relatively short
maturities of these investments.

Restricted Cash and Investments

The Company has $1.2 million of restricted cash and investments which are
utilized as collateral for certain irrevocable standby letters of credit. These
securities all mature within one year and reported amounts approximate fair
value due to the relatively short maturities of these investments.

Impairment of Long-lived Assets

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

Stock Based Compensation

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

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

Stock compensation was $195,000 for the quarter ended June 30, 2003,
consisting of the amortization of deferred stock compensation of $44,000, stock
issued to former employees as severance and termination benefits of $30,000 and
options with an estimated fair value, accounted for under FAS 123, of $121,000
granted to a member of the Companys board of directors for consulting
services, and approximately $102,000 for the quarter ended June 30, 2002,
consisting of the amortization of deferred stock compensation.

Stock compensation was $238,000 for the six months ended June 30, 2003,
consisting of the amortization of deferred stock compensation of $87,000, stock
issued to former employees as severance and termination benefits of $30,000,
and options with an estimated fair value, accounted for under FAS 123, of
$121,000 granted to a member of the Companys board of directors for

7



---



##### Table of Contents



consulting
services, and a credit of approximately $554,000 for the quarter ended June 30,
2002, consisting primarily of the reversal of expense related to accelerated
amortization for options that were cancelled.

The Company records stock-based compensation charges as a separate
component of operating expenses. These amounts can be allocated to the other
expense categories in the accompanying consolidated statements of operations as
follows (in thousands):

|                           |  |                    |     |                  |  |      |     |      |  |   |     |  |  |   |      |  
|-------------------------- |  | ------------------ | --- | ---------------- |  | ---- | --- | ---- |  | - | --- |  |  | - | ---- | -
|                           |  | Three Months Ended |     | Six Months Ended
|                           |  | June 30,           |     | June, 30        
|                           |  |                    |     |                 
|                           |  | 2003               |     | 2002             |  | 2003 |     | 2002
|                           |  |                    |     |                  |  |      |     |     
|Cost of revenues           |  | $                  | 4   |                  |  | $    | 9   |      |  | $ | 7   |  |  | $ | (46  | )
|Research and development   |  |                    | 2   |                  |  |      | 5   |      |  |   | 5   |  |  |   | (29  | )
|Sales and marketing        |  |                    | 6   |                  |  |      | 14  |      |  |   | 12  |  |  |   | (77  | )
|General and administrative |  |                    | 183 |                  |  |      | 74  |      |  |   | 214 |  |  |   | (402 | )
|                           |  |                    |     |                  |  |      |     |      |  |   |     |  |  |   |      |  
|                           |  | $                  | 195 |                  |  | $    | 102 |      |  | $ | 238 |  |  | $ | (554 | )
|                           |  |                    |     |                  |  |      |     |      |  |   |     |  |  |   |      |  

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

|                                                                                                          |                                 |   |                             |       |                           |   |        |       |      |   |         |       |   |   |         |       |  
|--------------------------------------------------------------------------------------------------------- | ------------------------------- | - | --------------------------- | ----- | ------------------------- | - | ------ | ----- | ---- | - | ------- | ----- | - | - | ------- | ----- | -
|                                                                                                          |                                 |   | Three Months Ended June 30, |       | Six Months Ended June 30,
|                                                                                                          |                                 |   |                             |       |                          
|                                                                                                          |                                 |   | 2003                        |       | 2002                      |   | 2003   |       | 2002
|                                                                                                          |                                 |   |                             |       |                           |   |        |       |     
|Net loss, as reported                                                                                     |                                 | $ | (2,062                      | )     |                           | $ | (8,279 | )     |      | $ | (15,120 | )     |   | $ | (15,917 | )    
|Add: stock-based employee
compensation expense (credit)
under APB 25 included in
reported net loss        |                                 |   | 44                          |       |                           |   | 102    |       |      |   | 87      |       |   |   | (554    | )    
|Deduct: total stock-based
employee compensation expense
determined under fair value
method for all awards |                                 |   | (226                        | )     |                           |   | (320   | )     |      |   | (15     | )     |   |   | (867    | )    
|                                                                                                          |                                 |   |                             |       |                           |   |        |       |      |   |         |       |   |   |         |      
|Pro forma net loss                                                                                        |                                 | $ | (2,244                      | )     |                           | $ | (8,497 | )     |      | $ | (15,048 | )     |   | $ | (17,338 | )    
|                                                                                                          |                                 |   |                             |       |                           |   |        |       |      |   |         |       |   |   |         |      
|Loss per share:                                                                                           |                                 |   |                             |       |                           |   |        |       |      |   |         |       |   |   |         |      
|                                                                                                          | Basic and diluted  as reported |   | $                           | (0.04 | )                         |   | $      | (0.21 | )    |   | $       | (0.33 | ) |   | $       | (0.39 | )
|                                                                                                          | Basic and diluted  pro-forma   |   | $                           | (0.05 | )                         |   | $      | (0.20 | )    |   | $       | (0.33 | ) |   | $       | (0.43 | )

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

|                           |  |         |           |         |  |  |           |  
|-------------------------- |  | ------- | --------- | ------- |  |  | --------- | -
|                           |  | 2003    |           | 2002   
|                           |  |         |           |        
| Risk-free interest rates |  |         | 2.68-5.71 | %       |  |  | 3.93-5.71 | %
| Expected lives           |  | 5 years |           | 5 years
| Expected dividend yields |  |         | 0         | %       |  |  | 0         | %
| Expected volatility      |  |         | 136       | %       |  |  | 75        | %

Reclassifications

Certain information reported in previous periods has been reclassified to
conform to the current period presentation.

3. SPECIAL CHARGES

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

8



---



##### Table of Contents



|                                            |  |                             |   |                          |  |      |       |      |  |   |       |  |  |   |       | 
|------------------------------------------- |  | --------------------------- | - | ------------------------ |  | ---- | ----- | ---- |  | - | ----- |  |  | - | ----- | 
|                                            |  | Three Months Ended June 30, |   | Six Months Ended June 30
|                                            |  |                             |   |                         
|                                            |  | 2003                        |   | 2002                     |  | 2003 |       | 2002
|                                            |  |                             |   |                          |  |      |       |     
|Goodwill impairment                         |  | $                           |  |                          |  | $    |      |      |  | $ | 5,307 |  |  | $ |      | 
|Intangible assets impairment                |  |                             |  |                          |  |      |      |      |  |   | 685   |  |  |   |      | 
|Property and equipment impairment           |  |                             |  |                          |  |      |      |      |  |   | 601   |  |  |   |      | 
|Employee severance and termination benefits |  |                             |  |                          |  |      | 1,142 |      |  |   | 501   |  |  |   | 1,890 | 
|Facilities related charges                  |  |                             |  |                          |  |      |      |      |  |   | 465   |  |  |   |      | 
|Other restructuring charges                 |  |                             |  |                          |  |      |      |      |  |   | 878   |  |  |   |      | 
|                                            |  |                             |   |                          |  |      |       |      |  |   |       |  |  |   |       | 
|                                            |  | $                           |  |                          |  | $    | 1,142 |      |  | $ | 8,437 |  |  | $ | 1,890 | 
|                                            |  |                             |   |                          |  |      |       |      |  |   |       |  |  |   |       | 

Six Months Ended June 30, 2003

On February 4, 2003, the Companys Chairman and Chief Executive Officer, John
T. Baker, resigned and the Company engaged Regent Pacific Management
Corporation to provide management services to the Company. On March 7, 2003,
Regent Pacific resigned from the engagement and Jeffrey M. Cavins was elected
President and Chief Executive Officer. These events are described more fully in
the Companys Annual Report on Form 10-K for the year ended December 31, 2002.
During and subsequent to Regent Pacifics engagement, the Company undertook a
strategic and operational analysis of its business and product lines. This
analysis resulted in the development of a new strategic and operational plan,
under which the Company will restructure itself to focus on its core
competencies in digital media services and on core strategic customers and
markets for its enterprise communications services. A revised corporate
forecast was developed in connection with this plan. The revised forecast also
considered that the Company had learned that revenue from a significant
customer in its Media Restoration Services segment would be less than
originally anticipated. Utilizing the revised forecast, the Company performed a
reassessment of the carrying value of all of its assets, both tangible and
intangible. The revised forecast demonstrated that certain tangible and
intangible assets and goodwill related to its media restoration services and
enterprise communications services businesses were impaired, as the projected
undiscounted discernible cash flows did not exceed the carrying value of the
assets over their estimated useful lives. The fair values of each of these
assets were estimated using primarily a discounted cash flow method. The
estimated fair values of each of the assets were then compared to their
carrying values to measure the impairments. As a result of this analysis, the
Company recorded impairment charges for goodwill, intangible assets, and
property and equipment related to its enterprise communication services and
media restoration services businesses of $5.3 million, $685,000, and $601,000,
respectively.

In addition to the impairment charges above, the Company recorded severance and
termination benefits of $204,000 associated with a reduction in force announced
on March 14, 2003 of approximately 35% of its consolidated staffing. In
addition, the Company recorded $297,000 of severance and termination benefits
with respect to certain changes in senior management in the first quarter of
2003. The Company incurred costs of approximately $465,000 related to the
termination or renegotiation of certain facilities leases in connection with
its facilities consolidation. The other restructuring charges of $878,000
represent fees and costs paid to Regent Pacific Management Corporation with
respect to interim management services provided to the Company in connection
with its management and operational restructuring.

In March 2003, the Company reduced by approximately half the space it occupies
for its principal operating facility on Rainier Avenue, Seattle, Washington
from a base rent of approximately $108,000 per month with a term expiring on
November 30, 2005 to a base rent of approximately $33,000 per month for the
remainder of the term which was shortened to June 30, 2003. The Company
exercised its option to extend the term for a 3-month period at a base rent
of $100,000 and pre-paid utility expenses of $60,000, and has
the option of extending the term for an additional 3-month period, under the same terms. As consideration for the reduction of
space and lease term, the Company allowed its landlord to retain its security
deposit in the amount of $218,500 and made cash payments of $276,000.

In April, 2003, the Company entered into a lease termination agreement with the
landlord of its unoccupied facility on Fourth Avenue, Seattle, Washington.
Under the terms of the agreement, the Company paid a lease termination fee of
$200,000. As a result, all of the Companys obligations under the lease were
terminated effective April 30, 2003. In accordance with
EITF 94-3 the lease termination fee was included in
accrued special charges at December 31, 2002. The Company had
been paying approximately $29,000 per month under this lease.

In May, 2003, the Company entered into a lease termination agreement with the
landlord of its unoccupied facility in Ardsley, New York. Under the terms of
the agreement, the Company paid a lease termination fee of approximately
$114,000 which included its

9



---



##### Table of Contents



security deposit of $29,000. As a result, all of the Companys obligations
under the lease were terminated effective May 19, 2003. In accordance with EITF
94-3, the lease termination fee was included in accrued special charges at
December 31, 2002. The Company had been paying approximately
$19,000 per month under this lease.

Six Months Ended June 30, 2002

The Company recorded special charges totaling $748,000 and $1.1 million in the
three and six months ended June 30, 2002, respectively. These special charges
were for severance and related termination benefits.

The following table summarizes the activity in accrued special charges during
the six months ended June 30, 2003 (in thousands):

|                            |  |              |       |            |  |          |       |      |  |          |        |   |  |   |       | 
|--------------------------- |  | ------------ | ----- | ---------- |  | -------- | ----- | ---- |  | -------- | ------ | - |  | - | ----- | 
|                            |  | December 31, |       | Additional |  |          |       |      |  | June 30,
|                            |  | 2002         |       | Accruals   |  | Payments |       | 2003
|                            |  |              |       |            |  |          |       |     
|Employee severance          |  | $            | 104   |            |  | $        | 501   |      |  | $        | (514   | ) |  | $ | 91    | 
|Facilities related charges  |  |              | 2,799 |            |  |          | 465   |      |  |          | (1,810 | ) |  |   | 1,454 | 
|Other restructuring charges |  |              |      |            |  |          | 878   |      |  |          | (878   | ) |  |   |      | 
|                            |  |              |       |            |  |          |       |      |  |          |        |   |  |   |       | 
|Total                       |  | $            | 2,903 |            |  | $        | 1,844 |      |  | $        | (3,202 | ) |  | $ | 1,545 | 
|                            |  |              |       |            |  |          |       |      |  |          |        |   |  |   |       | 

4. NET LOSS PER SHARE

Basic earnings per share is computed by dividing net loss by the weighted
average number of shares of common stock outstanding during the period. Diluted
earnings per share is computed by dividing net loss by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. Common equivalent shares consist of shares of common stock issuable
upon the exercise of stock options and warrants (using the treasury stock
method); common equivalent shares are excluded from the calculation if their
effect is antidilutive. The Company has excluded the following numbers of
shares using this method (in thousands):

|         |  |  |       | 
|-------- |  |  | ----- | 
|Options  |  |  | 8,050 | 
|Warrants |  |  | 295   | 
|         |  |  |       | 
|         |  |  | 8,345 | 
|         |  |  |       | 

The Company had 603 and 1,812 shares outstanding that were subject to
repurchase at June 30, 2003 and 2002, respectively. The impact of these unvested but exercised options has been
removed from the calculation of weighted average shares outstanding for
purposes of determining basic and diluted net loss per share.

The following table presents a reconciliation of shares used to calculate basic
and diluted earnings per share (in thousands):

|                                                                           |  |                             |        |                           |  |      |        |      |  |  |        |   |  |  |        |  
|-------------------------------------------------------------------------- |  | --------------------------- | ------ | ------------------------- |  | ---- | ------ | ---- |  |  | ------ | - |  |  | ------ | -
|                                                                           |  | Three-months ended June 30, |        | Six-months ended June 30,
|                                                                           |  |                             |        |                          
|                                                                           |  | 2003                        |        | 2002                      |  | 2003 |        | 2002
|                                                                           |  |                             |        |                           |  |      |        |     
|Weighted average shares outstanding                                        |  |                             | 45,932 |                           |  |      | 40,255 |      |  |  | 46,216 |   |  |  | 40,375 |  
|Weighted average shares subject to repurchase                              |  |                             | (1     | )                         |  |      | (26    | )    |  |  | (1     | ) |  |  | (45    | )
|                                                                           |  |                             |        |                           |  |      |        |      |  |  |        |   |  |  |        |  
|Weighted average shares outstanding  basic
and diluted earnings per share |  |                             | 45,931 |                           |  |      | 40,229 |      |  |  | 46,215 |   |  |  | 40,330 |  
|                                                                           |  |                             |        |                           |  |      |        |      |  |  |        |   |  |  |        |  

5. LINE OF CREDIT

In June, 2003, the Company entered into a revolving credit facility (the 2003
Revolving Facility) with a bank under which it may borrow up to
$2.5 million based on a certain percentage of eligible accounts receivable. The 2003
Revolving Facility expires in June, 2004 and is collateralized by substantially
all of the Companys assets. The initial advance was for $2.5 million on June
30, 2003 and bears interest at the greater of the prime rate plus 1.5% (5.5% at
June 30, 2003) or 5%. Subsequent borrowings bear interest at the greater of
the prime rate plus 1.75% (5.75% at June 30, 2003) or 5.75%. The Company also
issued a warrant to the lender to purchase 45,700 shares of its common stock at
$0.89 per share. The warrant expires on June 27, 2010. In addition, the
Company is required to establish a lockbox account with the lender to which all
payments from customers will be deposited. The lender will apply such deposits
to the outstanding borrowings and transfer any excess funds to the Companys
operating bank account. Fees for the lockbox arrangement are 0.35% of the
average daily outstanding principal balance. On June 30, 2003, outstanding
borrowings under the 2003

10



---



##### Table of Contents



Revolving Facility were $2.5 million. The Company repaid the balance in full
in July, 2003. The Company intends to utilize borrowings under the 2003
Revolving Facility for working capital and general corporate purposes.

6. SEGMENT INFORMATION

The Company operates in two business segments, Digital Media Services and Media
Restoration Services. The following information summarizes the Companys
segments (in thousands):

|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|-------------------------- |  | --------------------------- | ------ | ------------------------- |  | ---- | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                           |  | Three Months Ended June 30, |        | Six Months Ended June 30,
|                           |  |                             |        |                          
|                           |  | 2003                        |        | 2002                      |  | 2003 |        | 2002
|                           |  |                             |        |                           |  |      |        |     
|Revenues                   |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Digital Media Services     |  | $                           | 2,499  |                           |  | $    | 2,352  |      |  | $ | 5,159   |   |  | $ | 4,850   |  
|Media Restoration Services |  |                             | 404    |                           |  |      | 865    |      |  |   | 1,054   |   |  |   | 1,627   |  
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|                           |  | $                           | 2,903  |                           |  | $    | 3,217  |      |  | $ | 6,213   |   |  | $ | 6,477   |  
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Gross Profit               |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Digital Media Services     |  | $                           | 1,246  |                           |  | $    | (846   | )    |  | $ | 1,866   |   |  | $ | (1,178  | )
|Media Restoration Services |  |                             | (21    | )                         |  |      | 431    |      |  |   | 128     |   |  |   | 778     |  
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|                           |  | $                           | 1,225  |                           |  | $    | (415   | )    |  | $ | 1,994   |   |  | $ | (400    | )
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Net Loss                   |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Digital Media Services     |  | $                           | (1,727 | )                         |  | $    | (8,195 | )    |  | $ | (14,076 | ) |  | $ | (15,790 | )
|Media Restoration Services |  |                             | (335   | )                         |  |      | (84    | )    |  |   | (1,044  | ) |  |   | (127    | )
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|                           |  | $                           | (2,062 | )                         |  | $    | (8,279 | )    |  | $ | (15,120 | ) |  | $ | (15,917 | )
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Total Assets               |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|Digital Media Services     |  | $                           | 15,213 |                           |  | $    | 60,432 |      |  | $ | 15,213  |   |  | $ | 60,432  |  
|Media Restoration Services |  |                             | 1,571  |                           |  |      | 2,463  |      |  |   | 1,571   |   |  |   | 2,463   |  
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  
|                           |  | $                           | 16,784 |                           |  | $    | 62,895 |      |  | $ | 16,784  |   |  | $ | 62,895  |  
|                           |  |                             |        |                           |  |      |        |      |  |   |         |   |  |   |         |  

During the three and six months ended June 30, 2003 and 2002, the Company had
sales to certain significant customers, as a percentage of revenues, as
follows:

|           |  |                    |    |                  |  |      |    |      |  |  |    |   |  |  |    |  
|---------- |  | ------------------ | -- | ---------------- |  | ---- | -- | ---- |  |  | -- | - |  |  | -- | -
|           |  | Three Months Ended |    | Six Months Ended
|           |  | June 30,           |    | June 30,        
|           |  |                    |    |                 
|           |  | 2003               |    | 2002             |  | 2003 |    | 2002
|           |  |                    |    |                  |  |      |    |     
|Customer A |  |                    | 9  | %                |  |      | 14 | %    |  |  | 11 | % |  |  | 13 | %
|Customer B |  |                    | 6  | %                |  |      | 15 | %    |  |  | 7  | % |  |  | 10 | %
|           |  |                    |    |                  |  |      |    |      |  |  |    |   |  |  |    |  
|           |  |                    | 15 | %                |  |      | 29 | %    |  |  | 18 | % |  |  | 23 | %
|           |  |                    |    |                  |  |      |    |      |  |  |    |   |  |  |    |  

Revenue from Customer A was derived primarily from the Media Restoration
Services segment and revenue from Customer B was derived primarily from the
Digital Media Services segment.

7. CONTINGENCIES

Between July 26, 2001 and August 30, 2001, four substantially similar class
action complaints were filed in the Untied States District Court for the
Southern District of New York against the Company and certain of its former
officers and directors, as well as against certain underwriters who handled its
March 15, 2000 initial public offering of common stock. The various complaints
were purportedly filed on behalf of a class of persons who purchased the
Companys common stock during the time period beginning on March 15, 2000 and
ending on December 6, 2000. The complaints together allege violations of the
Securities Act of 1933 and the Securities Exchange Act of 1934, primarily based
on the allegation that there was undisclosed compensation received by the
Companys underwriters in connection with its initial public offering and the
allegation that the underwriters entered into undisclosed arrangements with
some investors that were designed to distort and/or inflate the market price
for the Companys common stock in the aftermarket following the initial public
offering. These actions have all been consolidated before the same judge for
pretrial purposes. No specific amount of damages has been claimed. The
individual defendants and the Company have demanded to be indemnified by the
underwriter defendants pursuant to the underwriting agreement entered into at
the time of the initial public offering. Presently, all claims against the
former officers have been withdrawn without prejudice. The Company, along with
the many other issuer defendants, moved to dismiss the claims in the complaint.
By decision dated February 19, 2003 the court denied the Companys motion. The
Company has approved a settlement proposal made by the plaintiffs. As a
result, all of plaintiffs claims against the

11



---



##### Table of Contents



Company will be dismissed with prejudice. The settlement proposal has yet to
be approved by the other defendants and an estimate of the likelihood or range
of possible loss for this matter cannot be made at this time.

On or about January 8, 2003 a company known as Dominion Venture Finance,
L.L.C. commenced an action against the Company and John Doe defendants in the
Superior Court of the State of California, County of San Francisco. In its
complaint, plaintiff alleged that pursuant to a loan and security agreement and
a master lease agreement (the Agreements) (the liabilities for which
agreement, plaintiff alleged, were acquired by the Company when the Company
merged with an entity known as DiscoverMusic.com, Inc.) the Company failed to
make certain required payments to plaintiff. On August 5, 2003,
the Company agreed to
settle all claims under the suit for a cash payment of approximately $228,000,
which represented the outstanding principal and interest under the Agreements.

On February 3, 2003, the Company entered into an agreement (Agreement)
with Regent Pacific Management Corporation (Regent Pacific) pursuant to which
Regent Pacific would provide management services to the Company. The Agreement
was for a term of 26 weeks with an option to renegotiate certain terms
of the Agreement after 13 weeks, and was terminable by either party under certain circumstances. Under the Agreement, the Company paid certain fees
to Regent Pacific. In addition, Regent Pacific was to receive stock options to
purchase up to 4,000,000 shares of the Companys common stock based on Regent
Pacifics length of service. These options were to be granted at various times
throughout their engagement at exercise prices based on the closing market
price on each grant date. On March 7, 2003, Regent Pacific
resigned from the engagement. On July 25, 2003, Regent Pacific filed suit against
the Company for breach of the Agreement. In this complaint, Regent Pacific is
seeking unspecified damages and specific performance of the Companys alleged
obligation to grant the stock options due them under the contract. The Company
believes that it has meritorious defenses to the claims made in the
suit, intends to defend vigorously this suit, and intends to bring certain counterclaims
against Regent Pacific. An estimate of the range of possible loss for this
matter can not be made at this time.

In April 2003, the landlord of one of the Companys unoccupied facilities
filed suit against the Company for breach of its lease and is seeking an
unspecified amount of damages. The Company believes that it has meritorious
defenses to the claims made in the suit and intends to vigorously defend this
suit and may also bring certain counterclaims against the landlord. An
estimate of the range of possible losses for this matter can not be made at
this time.

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




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

Forward-Looking Statements

The following discussion of our financial condition and results of
operations contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, and are made under the safe harbor
provisions thereof. In some cases, you can identify forward-looking statements
by terminology such as may, will, should, expect, plan, anticipate,
believe, estimate, predict, potential or continue, the negative of
terms like these or other comparable terminology. These forward-looking
statements are only predictions and actual events or results may differ
materially from those projected. Specific factors that could cause actual
results to differ materially from those projected include, but are not limited
to, uncertainties related to our early stage; uncertainties related to the
effectiveness of our technology and development of our products and services;
dependence on and management of existing and future corporate relationships;
dependence on licensed content and technology; dependence on proprietary
technology and uncertainty of patent protection; management of growth; history
of operating losses; future capital needs and uncertainty of additional
funding; dependence on key personnel; competition; existing governmental
regulations and changes in, or the failure to comply with, government
regulations, and other risks detailed below, including the Risk Factors set for
the below in this Managements Discussion and Analysis of Financial Condition
and Results of Operations, and those included from time to time in the
Companys other reports filed with the SEC and press releases, copies of which
are available from the Company upon request. All forward-looking statements
included in this document are based on information available to us on the date
hereof, and we assume no obligation to publicly release any revisions of the
forward-looking statements contained herein to reflect events or circumstances
after the date hereof. Readers are cautioned not to place undue reliance on
these forward-looking statements, as our business and financial performance are
subject to substantial risks and uncertainties.

12



---



##### Table of Contents



Results of Operations

Three Months Ended June 30, 2003 and 2002

Revenues.Revenues totaled $2.9 million and $3.2 for the second quarter of
2003 and 2002, respectively.

Revenue from our digital media services segment increased slightly in the
second quarter of 2003 to $2.5 million from $2.4 million in the second quarter
of 2002. This increase is due primarily to an increase in the volume of
encoding and other fulfillment services in the second quarter of 2003 compared
to the prior year, offset partially by decreases in webcasting services.

Media restoration revenues totaled $404,000 in the second quarter of 2003
compared to $865,000 in the second quarter of 2002. This decrease was primarily
the result of decreased customer spending on discretionary projects due to
current economic conditions.

Cost of Revenues.Cost of revenues decreased to $1.7 million for the
second quarter of 2003 from $3.6 million for the second quarter of 2002. Cost
of revenues include the cost of production, including personnel, an
allocated portion of facilities and equipment, and other supporting functions
related to the delivery of digital media services and applications and media
restoration services. Excluding depreciation, cost of revenues decreased to
$1.4 million for the second quarter of 2003 from $2.8 million for the second
quarter of 2002. This decrease is due primarily to cost reduction initiatives
implemented in the second half of 2002 and the first quarter of 2003.
Accordingly, we anticipate that cost of revenues for the second half of 2003
will continue to be lower than 2002.

Depreciation included in cost of revenues decreased to approximately $240,000
in the second quarter of 2003 from $812,000 in the second quarter of 2002. This
decrease is due primarily to impairment charges recorded in the fourth quarter
of 2002 and the first quarter of 2003 for certain assets of our digital media
services and media restoration services segments. These charges decreased the
cost basis of the assets, resulting in lower depreciation charges.

Research and Development.Research and development expenses totaled
$392,000 and $974,000 in the second quarter of 2003 and 2002, respectively.
This decrease is due primarily to the reduction in the number of development
personnel as a result of the corporate restructurings. Research and development
expenses include labor and other related costs of the continued support of
our digital media offerings, the recently announced Quick Clips media player
application, and enhanced webcasting offerings, including the recently
announced Loudeye Express and the development of internal operational solutions
necessary to fully integrate previous acquisitions.

We believe that continued investment in research and development is critical to
attaining our strategic objectives. However, due to our operational
restructurings and a sharper focus on opportunities which we believe will
result in near term results, development headcount was significantly reduced in
2003 as compared to 2002 and, as a result, research and development expenses
declined in 2003 as compared to 2002. We expect research and development
expenses to remain relatively stable in the foreseeable future. Accordingly,
research and development expenses for the remainder of 2003 should continue to
be lower than 2002.

Sales and Marketing.Sales and marketing expenses totaled $835,000 and
$2.2 million in the second quarter of 2003 and 2002, respectively. Sales and
marketing expenses consist primarily of salaries, commissions, product branding
costs, advertising, trade show expenses, and cost of marketing collateral. The
decrease in sales and marketing expenses was primarily due to the decreased
personnel subsequent to our reductions in force in the second half of 2002 and
first quarter of 2003, as well as a lower level of marketing activity in 2003.
Accordingly, we anticipate that sales and marketing expenses for the second
half of 2003 will continue to be lower than 2002.

General and Administrative.General and administrative expenses decreased
to $1.7 million for the second quarter of 2003 from $2.8 million for the second
quarter of 2002. This decrease was due primarily to the decrease in personnel
subsequent to our reductions in force in the second half of 2002 and first
quarter of 2003 and related cost reduction initiatives. Accordingly, we
anticipate that general and administrative expenses for the second half of 2003
will continue to be lower than 2002. General and administrative expenses
consist primarily of rent, facilities and information technology charges,
salaries, legal expenses, investor relations costs, and other costs associated
with being a public company.

Amortization of Intangible and Other Assets.Amortization of intangibles
and other assets totaled $260,000 and $713,000 for the second quarter of 2003
and 2002, respectively, and includes amortization of identified intangible
assets related to past acquisitions. The decrease was due primarily to the
impairment charges recorded in the fourth quarter of 2002 and first quarter of
2003, which resulted in lower amortization charges during the second quarter of
2003.

13



---



##### Table of Contents



Stock-Based Compensation.Stock-based compensation charges for the second
quarter 2003 were $195,000, consisting of the amortization of deferred stock
compensation of $44,000, stock granted to former employees for severance and
termination benefits of $30,000, and options granted to a member of our board
of directors for consulting services for $121,000. For the second quarter of
2002, stock compensation was $102,000, consisting primarily of the amortization
of deferred stock compensation. The balance of deferred stock compensation was
$44,000 at June 30, 2003 and will be fully amortized in the third quarter of
2003.

Special Charges.We recorded special charges in the second quarter of
2002 associated with a reduction in force in June of 2002 of approximately 37%
of consolidated staffing. The special charge of $1.1 million was for severance
and related termination benefits. There were no such charges in the second
quarter of 2003.

Interest Income.Interest income totaled $101,000 and $309,000 in the
second quarter of 2003 and 2002, respectively. The decrease was due primarily
to the lower average cash and investment balances in 2003 resulting from the
voluntary repayment of our credit facility in the third quarter of 2002,
utilization of cash to fund operations, and lower interest rates in 2003. We
expect that our interest income will decrease in the future as our cash and
investment balances are used to fund our operations.

Interest Expense.Interest expense consists of interest expense related to
our debt instruments, including capital lease obligations. Interest expense
totaled $48,000 and $235,000 in the second quarter of 2003 and 2002,
respectively. The decrease was due primarily to lower average debt balances in
2003 due to the voluntary repayment of our credit facility in the third quarter
of 2002 and lower interest rates in 2003.

Other
Income.Other income for the second quarter of 2003 consisted of
gains on sales of excess equipment. There were no such transactions in the
second quarter of 2002.

Six Months Ended June 30, 2003 and 2002

Revenues.Revenues totaled $6.2 million $6.5 million for the first six
months of 2003 and 2002, respectively.

We recorded approximately $5.2 million of revenue from our digital media
services segment in the first six months of 2003 compared to $4.9 million in
the first six months of 2002. This increase is due primarily to an increase in
the volume of encoding and other fulfillment services in the first half of 2003
compared to the prior year, offset partially by decreases in webcasting
services.

Media restoration revenues totaled $1.1 million in the first six months of 2003
compared to $1.6 million in the first six months of 2002. This decrease was
primarily the result of decreased spending by our customers on discretionary
projects due to current economic conditions.

Cost of Revenues.Cost of revenues decreased to $1.7 million for the first
six months of 2003 from $3.6 million for the first six months of 2002. Cost of
revenues include the cost of production including personnel, an allocated
portion of facilities and equipment and other supporting functions related to
the delivery of digital media services and applications, and media restoration
services. Excluding depreciation, cost of revenues decreased to $3.8 million
for the first six months of 2003 from $5.2 million for the first six months of
2002. This decrease is due primarily to cost reduction initiatives implemented
in the second half of 2002 and the first quarter of 2003. Accordingly, we
anticipate that cost of revenues for the second half of 2003 will continue to
be lower than 2002.

Depreciation included in cost of revenues decreased to approximately $456,000
in the first six of 2003 from $1.6 million in the first six months of 2002.
This decrease is due primarily to impairment charges recorded in the fourth
quarter of 2002 and first quarter of 2003 for certain assets of our Digital
Media Services and Media Restoration Services segments. These charges decreased
the cost basis of the assets, resulting in lower depreciation charges.

Research and Development.Research and development expenses totaled
$969,000 and $2.3 million in the first six months of 2003 and 2002,
respectively. This decrease is due primarily to the reduction in the number of
development personnel as a result of the corporate restructurings. Research and
development expenses include labor and other related costs of the continued
support of our digital media offerings, the recently announced Quick Clips
media player application, enhanced webcasting offerings, including the recently
announced Loudeye Express, and the development of internal operational
solutions necessary to fully integrate previous acquisitions.

14



---



##### Table of Contents



We believe that continued investment in research and development is critical to
attaining our strategic objectives. However, due to our operational
restructurings and a sharper focus on opportunities which we believe will
result in near term results, development headcount was reduced significantly in
2003 as compared to 2002 and, as a result, research and development expenses
declined in 2003 as compared to 2002. We expect research and development
expenses to remain relatively stable in the foreseeable future. Accordingly,
research and development expenses for the remainder of 2003 should continue
to be lower than 2002.

Sales and Marketing.Sales and marketing expenses totaled $2.4 million and
$4.5 million in the first six months of 2003 and 2002, respectively. Sales and
marketing expenses consist primarily of salaries, commissions, product branding
costs, advertising, trade show expenses, and cost of marketing collateral. The
decrease in sales and marketing expenses was primarily due to the decreased
personnel subsequent to our reductions in force in the second quarter of 2002
and first quarter of 2003, as well as a lower level of marketing activity in 2003. Accordingly, we anticipate that sales and marketing
expenses for the second half of 2003 will continue to be lower than 2002.

General and Administrative.General and administrative expenses decreased
to $4.5 million for the first six months of 2003 from $6.2 million for the
first six months of 2002. This decrease was due primarily to the decrease in
personnel subsequent to our reductions in force in the second half of 2002 and
first quarter of 2003, and related cost reduction initiatives. Accordingly, we
anticipate that general and administrative expenses for the second half of 2003
will continue to be lower than 2002. General and administrative expenses
consist primarily of rent, facilities and information technology charges,
salaries, legal expenses, investor relations costs, and other costs associated
with being a public company.

Amortization
of Intangible and Other Assets.Amortization of intangible and other assets totaled $786,000 and $1.4 million for the first six months of
2003 and 2002, respectively, and includes amortization of identified intangible
assets related to past acquisitions. The decrease was due primarily to the
impairment charges recorded in the fourth quarter of 2002 and first quarter of
2003, which resulted in lower amortization charges during the first six months
of 2003.

Stock-Based Compensation.Stock-based compensation charges for 2003
consisted of the amortization of deferred stock compensation, stock granted to
former employees, and options granted to a member of our board of directors for
consulting services. For the first six months of 2002, stock compensation was a
credit of $554,000, resulting from reversals of previously recorded deferred
stock compensation associated with the terminated employees in connection with
our restructuring initiatives, offset partially by the amortization of deferred
stock compensation. The balance of deferred stock compensation was $44,000 at
June 30, 2003 and will be fully amortized in the third quarter of 2003.

Special
Charges.We have recorded special charges related to corporate
restructurings, facilities consolidations and the impairment of assets
in accordance with our long-lived asset policy. Following is a summary of
special charges for the six months ended June 30, 2003 and 2002:



| |  | Six Months Ended June 30, 2003
| |  | ------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On February 4, 2003, our Chairman and Chief Executive Officer, John T.
Baker, resigned and we engaged Regent Pacific Management Corporation to
provide management services. On March 7, 2003, Regent Pacific
resigned from the engagement and Jeffrey M. Cavins was elected President and Chief Executive
Officer. These events are described more fully in our Annual Report on Form
10-K for the year ended December 31, 2002. During and subsequent to Regent
Pacifics engagement, we undertook a strategic and operational analysis of
our business and product lines. This analysis resulted in the development of
a new strategic and operational plan, under which we restructured our
business to focus on our core competencies in digital media services and on
core strategic customers and markets for our enterprise communications
services. We developed a revised corporate forecast in connection with this
plan. The revised forecast also considered that we had learned that revenue
from a significant customer in our Media Restoration Services segment would
be less than originally anticipated. Utilizing the revised forecast, we
performed a reassessment of the carrying value of all of our assets, both
tangible and intangible. The revised forecast demonstrated that certain
tangible and intangible assets and goodwill related to our media restoration
services and enterprise communications services businesses were impaired, as
the projected undiscounted discernible cash flows did not exceed the carrying
value of the assets over their estimated useful lives. The fair values of each
of these assets were estimated using primarily a discounted cash flow method.
The estimated fair values of each of the assets were then compared to their
carrying values to measure the impairments. As a result of this analysis, we
recorded impairment charges for goodwill, intangible assets, and property and
equipment related to our enterprise communication services and media
restoration services businesses of $5.3 million, $685,000, and $601,000,
respectively.

15



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In addition to the impairments above, we recorded severance and
termination benefits of $204,000 associated with a reduction in force
announced on March 14, 2003 of approximately 35% of our consolidated
staffing. In addition, we recorded $297,000 of severance and termination
benefits with respect to certain changes in senior management in the first
quarter of 2003. We incurred costs of approximately $465,000 related to the
termination or renegotiation of certain facilities leases in connection with
our ongoing facilities consolidation. The other restructuring charges of
$878,000 represent fees and costs paid to Regent Pacific Management
Corporation with respect to interim management services provided to us in
connection with our management and operational restructuring.



| |                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We will continue to review the carrying value of our long-lived assets
for impairments. Future adverse developments in our business could result in
additional impairments.



| |  | The following table summarizes the activity in accrued special charges during
the six months ended June 30, 2003 (in thousands):
| |  | --------------------------------------------------------------------------------------------------------------------------------

|                            |  |              |       |            |  |          |       |      |  |          |        |   |  |   |       | 
|--------------------------- |  | ------------ | ----- | ---------- |  | -------- | ----- | ---- |  | -------- | ------ | - |  | - | ----- | 
|                            |  | December 31, |       | Additional |  |          |       |      |  | June 30,
|                            |  | 2002         |       | Accruals   |  | Payments |       | 2003
|                            |  |              |       |            |  |          |       |     
|Employee severance          |  | $            | 104   |            |  | $        | 501   |      |  | $        | (514   | ) |  | $ | 91    | 
|Facilities related charges  |  |              | 2,799 |            |  |          | 465   |      |  |          | (1,810 | ) |  |   | 1,454 | 
|Other restructuring charges |  |              |      |            |  |          | 878   |      |  |          | (878   | ) |  |   |      | 
|                            |  |              |       |            |  |          |       |      |  |          |        |   |  |   |       | 
|Total                       |  | $            | 2,903 |            |  | $        | 1,844 |      |  | $        | (3,202 | ) |  | $ | 1,545 | 
|                            |  |              |       |            |  |          |       |      |  |          |        |   |  |   |       | 



| |                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Six months ended June 30, 2002                                                                                                                                                                                                                                                  
|
| | We recorded special charges in the six months ended June 30, 2002
associated with reductions in force of approximately 40% of our consolidated
staffing together in March and June, 2002. The special charge of $1.9 million
was for severance and related termination benefits.

Interest Income.Interest income totaled $187,000 and $642,000 in the
first six months of 2003 and 2002, respectively. The decrease was due primarily
to the lower average cash and investment balances in 2003 resulting from the
voluntary repayment of our credit facility in the third quarter of 2002,
utilization of cash to fund operations, and lower interest rates in 2003. We
expect that our interest income will decrease in the future as our cash and
investment balances are used to fund our operations.

Interest Expense.Interest expense consists of interest expense related to
our debt instruments, including capital lease obligations. Interest expense
totaled $97,000 and $452,000 in the first six months of 2003 and 2002,
respectively. The decrease was due primarily to lower average debt balances in
2003 due to the voluntary repayment of our credit facility in the third quarter
of 2002 and lower interest rates in 2003.

Other
Income.Other income for the first six months of 2003 consisted of
gains on sales of excess equipment. There were no such transactions in the
first six months of 2002.

Liquidity and Capital Resources

As of June 30, 2003, we had approximately $10.4 million of cash, cash
equivalents, short-term investments, and restricted investments. Of these
funds, $1.2 million is held in investment accounts that serve as collateral for
standby letters of credit for certain of our capital lease and other
obligations.

Net cash used in operating activities was $5.9 million and $13.9 million for
the six months ended June 30, 2003 and 2002, respectively. For 2003, cash used
in operating activities resulted primarily from a net loss of $15.1 million
partially offset by non-cash charges for depreciation, amortization, special
charges, and stock-based compensation expense aggregating $8.4 million and
other working capital changes totaling $800,000. For 2002, cash used in
operating activities resulted primarily from a net loss of $15.9 million, and
working capital and other changes totaling $900,000, partially offset by
non-cash charges totaling $2.9 million related to stock-based compensation,
depreciation and amortization.

16



---



##### Table of Contents



Net cash provided by investing activities was $7.0 million in the first six
months of 2003, consisting principally of the proceeds from sales of short-term
investments of $5.8 million and payments received on notes receivable from
related parties of $1.1 million. For the first six months of 2002, net cash
used in investing activities of $9.2 million was primarily related to purchases
of property and equipment of $1.2 million, net purchases of short-term
investments of $7.0 million, and loans made to related parties of $771,000.

Net cash provided by financing activities was $2.1 million for the first six
months of 2003, consisting primarily of proceeds from the 2003 Revolving
Facility described below. Cash used in financing activities was $773,000 for
the first six months of 2002, consisting primarily of payments of our long-term
debt and capital lease obligations.

As discussed in Note 5 to the consolidated financial statements, in June, 2003,
we entered into a revolving credit facility (the 2003 Revolving Facility)
with a bank under which we may borrow up to $2.5 million based on a certain
percentage of eligible accounts receivable. The 2003 Revolving Facility
expires on June, 2004 and is collateralized by substantially all of the our
assets. The initial advance was for $2.5 million on June 30, 2003 and bears
interest at the greater of the prime rate plus 1.5% (5.5% at June 30, 2003) or
5%. Subsequent borrowings bear interest at the greater of the prime rate plus
1.75% (5.75% at June 30, 2003) or 5.75%. We also issued a warrant to the
lender to purchase 45,700 shares of our common stock at $0.89 per share. The
warrant expires on June 27, 2010. On June 30, 2003, outstanding borrowings
under the 2003 Revolving Facility were $2.5 million. In July, 2003, we repaid
the balance in full. We intend to utilize borrowings from the 2003 Revolving
Facility for working capital and general corporate purposes.

As of June 30, 2003, our principal commitments consisted of obligations
outstanding under the 2003 Revolving Facility and operating and capital leases.
We have other credit facilities and leasing arrangements that, in general, may
not be prepaid without penalty. Total principal amounts outstanding under these
arrangements were $1.2 million at June 30, 2003. These instruments bear
interest ranging from approximately 6.9% to 9.7% and mature at various times
through 2005. Letters of credit of approximately $576,000 collateralize certain
of these capital lease obligations and we have $576,000 of short-term
investments that are utilized as collateral for these letters of credit. These
short-term investments have been classified as restricted investments on the
accompanying balance sheets. In addition, we have notes payable aggregating
approximately $1.1 million with respect to our acquisition of Streampipe in
November, 2002. The notes bear interest at 5% and mature in January,
2004, as described below.

Contractual Obligations and Commercial Commitments

The following table provides aggregated information about our contractual
obligations as of June 30, 2003.

|                                      |  |                        |        |        |  |           |       |           |  |         |       |  |  |   |     |       |  |   |       | 
|------------------------------------- |  | ---------------------- | ------ | ------ |  | --------- | ----- | --------- |  | ------- | ----- |  |  | - | --- | ----- |  | - | ----- | 
|                                      |  | Payments Due by Period
|                                      |  |                       
|                                      |  |                        |        |        |  | Less      |       |           |  |         |       |  |  |   |     |       |  |  
|                                      |  |                        |        |        |  | than      |       |           |  |         |       |  |  |   |     | After
|                                      |  | Total                  |        | 1 year |  | 1-3 years |       | 4-5 years |  | 5 years
|                                      |  |                        |        |        |  |           |       |           |  |        
|Line of credit                        |  | $                      | 2,500  |        |  | $         | 2,500 |           |  | $       |      |  |  | $ |    |       |  | $ |      | 
|Capital lease obligations (1)         |  |                        | 899    |        |  |           | 512   |           |  |         | 387   |  |  |   |    |       |  |   |      | 
|Operating leases                      |  |                        | 7,969  |        |  |           | 2,196 |           |  |         | 2,363 |  |  |   | 953 |       |  |   | 2,457 | 
|Other obligations                     |  |                        | 488    |        |  |           | 488   |           |  |         |      |  |  |   |    |       |  |   |      | 
|Accrued acquisition consideration (2) |  |                        | 1,059  |        |  |           | 1,059 |           |  |         |      |  |  |   |    |       |  |   |      | 
|                                      |  |                        |        |        |  |           |       |           |  |         |       |  |  |   |     |       |  |   |       | 
|Total contractual obligations         |  | $                      | 12,915 |        |  | $         | 6,755 |           |  | $       | 2,750 |  |  | $ | 953 |       |  | $ | 2,457 | 
|                                      |  |                        |        |        |  |           |       |           |  |         |       |  |  |   |     |       |  |   |       | 



---

|(1) |  | Capital lease obligations represent the total minimum future obligations,
including interest.                                                                                                                                                                                                                                                                                                                                                    
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Accrued acquisition consideration represents promissory notes related to
the acquisition of Streampipe. The notes contain an equity redemption
option pursuant to which we may, at our option, subject to certain
conditions including the continued listing of our common stock on a
principal securities exchange (excluding the over-the-counter market),
satisfy our obligation under the notes by issuing additional shares of
common stock.

In July, 2003, we repaid in full the $2.5 million outstanding under our line of
credit. We anticipate that we may make additional borrowings and repayments in
the future for working capital and other general corporate purposes. We do not
have significant capital spending plans for 2003.

Of the $2.2 million in operating leases due in less than one year,
approximately $1.1 million relates to a facility which we no longer occupy and
$0.4 million relates to a new facility for our media restoration services
operations. We are presently negotiating lease termination or reduction
agreements for these leases that we believe will result in a substantial
reduction to future obligations under

17



---



##### Table of Contents



these leases, although we may have to make up-front cash payments to do so and
we may not be successful in our negotiations. At June 30, 2003, accrued
special charges includes amounts accrued for rent obligations which meet the
criteria for accrual under FAS 146.

In March 2003, we reduced by approximately half the space we occupy for our
principal operating facility on Rainier Avenue, Seattle, Washington from a base
rent of approximately $108,000 per month with a term expiring on November 30,
2005 to a base rent of approximately $33,000 per month for the remainder of the
term which was shortened to June 30, 2003. We exercised an option to extend the
term for a 3-month period at a base rent of $100,000 and pre-paid utility
expenses of $60,000 and we have an option to extend the term for an additional
three months under the same terms. As consideration for the reduction of space
and lease term, we have allowed our landlord to retain our security deposit in
the amount of $218,500 and made cash payments of $276,000.

In April 2003, we entered into a lease termination agreement with the landlord
of our unoccupied facility on Fourth Avenue, Seattle, Washington. Under the
terms of the agreement, we paid a lease termination fee of $200,000. As a
result, all of our obligations under the lease were terminated effective April
30, 2003. In accordance with EITF 94-3, the lease termination fee was included
in accrued special charges at December 31, 2002. We had been
paying approximately $29,000 per month under this lease.

In May 2003, we entered into a lease termination agreement with the landlord of
our unoccupied facility in Ardsley, New York. Under the terms of the agreement,
we paid a lease termination fee of approximately $114,000, which included our
security deposit of $29,000. As a result, all of our obligations under the
lease were terminated effective May 19, 2003. In accordance with EITF 94-3, the
lease termination fee was included in accrued special charges at December 31,
2002. We had been paying approximately $19,000 per month
under this lease.

We believe that our that our existing cash, cash equivalents, and
short-term investments, combined with funding available from our line of
credit, will be sufficient to fund our operations and meet our working capital
and capital expenditure requirements for the next year. However, if revenue and
cash receipts do not meet our expectations, we may find it necessary to secure
additional financing, sell assets or reduce expenditures further. In the event
additional financing is required, we may not be able to obtain such financing
on acceptable terms, or at all. In addition, we may choose to secure
additional sources of capital to enhance our financial position and
better position ourselves to take advantage of current and future
business opportunities.

Going Concern

The accompanying consolidated financial statements have been prepared
under the assumption that we will continue to operate as a going concern, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. We have incurred losses since inception, have an
accumulated deficit, and have experienced negative cash flows from operations
since our inception and the expansion and development of our business may
require additional capital. As a result of these issues, our independent
accountants included an explanatory paragraph in their opinion on our audited
consolidated financial statements for the year ended December 31, 2002 raising
substantial doubt about our ability to continue as a going concern.

Management has restructured our operations, reduced our work force,
renegotiated leases, and taken other actions to limit our expenditures.
However, there can be no assurance that our cash balances will be sufficient to
sustain our operations until profitable operations and positive cash flows are
achieved. Consequently, we may require additional capital to fund our
operations. There can be no assurance that capital will be available to us on
acceptable terms, or at all.

If we fail to generate positive cash flows or obtain additional capital
when required, we could continue to modify, delay or abandon some or all of our
business and expansion plans.

Recent Developments

In January 2003, we engaged Regent Pacific Management Corporation (Regent
Pacific) to provide certain management consulting and advisory services. This
agreement contemplated the payment to Regent Pacific of $200,000 for a two
month consulting engagement.

On February 3, 2003, our former Chairman and Chief Executive Officer, John
T. Baker IV, resigned. Simultaneous with Mr. Bakers resignation, we entered
into a new agreement with Regent Pacific, expanding its role. Pursuant to the
Regent Pacific agreement, we agreed to pay Regent Pacific $60,000 per week, and
four weeks of payments in advance. This agreement provided for a minimum term
of six months, with a review and restructuring of fees after three months. The
agreement also provided for the issuance to Regent Pacific of stock options to
purchase up to 4,000,000 shares of our common stock, based upon length of
service. These

18



---



##### Table of Contents



options were to be granted at various times throughout their engagement at
exercise prices based on the closing market price on each grant date. The
agreement was terminable by either party under certain circumstances. In
connection with that agreement, we appointed Philip J. Gioia, a principal of
Regent Pacific, to serve as our President and Chief Executive Officer and
agreed to have selected Regent Pacific principals, including Mr. Gioia, serve
as part of our executive management team. Additionally, Mr. Gary J. Sbona, the
chairman and Chief Executive Officer of Regent Pacific, was elected to our
board of directors and Charles P. Waite, Jr., a member of our board of
directors and a partner of OVP Venture Partners, was elected as Chairman.

On
March 7, 2003, Regent Pacific resigned from the engagement, and the involvement of
Regent Pacific principals as part of our executive management team concluded.
As a result, Mr. Gioia resigned as President and Chief Executive Officer, and
Mr. Sbona resigned from his seat on our board of directors. On March 11, 2003,
the our board of directors appointed Jeffrey M. Cavins, who had been the Senior
Vice President of Sales, as our President and Chief Executive Officer, and
elected him to our board of directors. Our board of directors appointed Anthony
J. Bay, a three-year member of the board, as chairman of the board, replacing
Mr. Waite, who resigned. We entered into an employment agreement dated as of
April 1, 2003 with Mr. Cavins. The agreement provides for a base salary of
$250,000 and the granting of options to purchase 1,500,000 shares of our common
stock. The agreement also provides for the opportunity to receive bonuses based
upon the Companys achievement of certain performance criteria in the event of
a sale of all of our stock or all or substantially all of our assets.

We entered into an employment agreement dated as of April 1, 2003 with
Jerold J. Goade, Jr., our Vice President and Chief Financial Officer. The
agreement provides for a base salary of $161,000 and the granting of options to
purchase 350,000 shares of our common stock. The agreement also provides for
the opportunity to receive bonuses based upon the achievement of certain
performance criteria by the Company and in the event of a sale of all of our
stock or all or substantially all of our assets.

We entered into an employment agreement dated as of April 1, 2003 with
Michael S. Dougherty, our Vice President of Business Development. The
agreement provides for a base salary of $150,000 and the granting of options to
purchase 250,000 shares of our common stock. The agreement also provides for
the opportunity to receive bonuses based upon the achievement of certain
performance criteria by the company and in the event of a sale of all of our
stock or all or substantially all of our assets.

We entered into an employment agreement dated as of June 16, 2003 with
Michael R. Harburg, our Chief Technology Officer. The agreement provides
for a base salary of $175,000 and the granting of options to purchase 80,000
shares of our common stock. The agreement also provides for the opportunity to
receive bonuses based on the achievement of certain performance criteria by the
Company and in the event of a sale of all of our stock or all or substantially
all of our assets.

We entered into a consulting agreement dated as of April 1, 2003 with
Anthony Bay, our Chairman. The agreement provides for a base compensation of
$100,000 and the granting of options to purchase 500,000 shares of our common
stock. The agreement provides for the opportunity to receive bonuses based upon
the achievement of certain performance criteria by the Company and in the event
of a sale of all of our stock or all or substantially all of our assets.

From July 30, 2001 to July 3, 2003, our common stock failed to maintain a
minimum closing bid price of $1.00 per share for at least 10 consecutive days,
which caused our stock to fail to meet one of the minimum standards required by
the Nasdaq SmallCap Market for continued listing as a Nasdaq SmallCap Market
security. On June 27, 2003 we were notified by Nasdaq that we had not regained
compliance with the minimum $1.00 closing bid price per share and that our
stock would be delisted. On July 3, 2003, we requested a hearing which
automatically stayed the delisting until a final determination was to be made.
However, on July 18, 2003, our common stock maintained a minimum closing bid
price of $1.00 per share for 10 consecutive days. As a result, on July 21,
2003 we received notification from Nasdaq that we had regained compliance with
the minimum $1.00 closing bid price per share and that our stock would not be
delisted.

On March 11, 2003, we received an affirmative vote at a special meeting of
stockholders permitting our board of directors, should it deem beneficial, to
effect a reverse stock split at one of three ratios at any time prior to
December 31, 2003. The purpose of this reverse split would be to achieve
compliance with the Nasdaq SmallCap Markets minimum bid price of $1.00 per
share for at least 10 consecutive days.

Critical Accounting Policies and Estimates

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

19



---



##### Table of Contents



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

Managements assessments of the impairment of property and equipment,
intangible assets and goodwill are sensitive accounting estimates that could
result in additional impairment charges in the near term. Factors that impact
these estimates include, but are not limited to, possible changes in business
plans, market price of our common stock and declining financial results. Net
long-term assets subject to impairment review in the future totaled
$2.6 million at June 30, 2003. We will continue to review the carrying value of our
long-lived assets for impairments. Future adverse developments in our business
may result in additional charges.

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

Revenue Recognition.We generate revenues primarily from two sources: (1)
digital media services, licensing and selling digital media applications and
(2) media restoration services.

Digital media services: We recognize encoding services revenues when
the services have been rendered and we have no continuing involvement in the
goods and services delivered, which is generally the date the finished media is
shipped to our customer. Other revenues are generated from our music samples
service business. We sell digital media applications in application service
provider arrangements. We are required to host the applications and the
customer does not have the ability to have the application hosted by another
entity without penalty to the customer. Billings are made based upon quantity
of content streamed, and revenue is recognized as the services are delivered. We recognize enterprise webcasting services revenues as services are rendered.

Media restoration services: We recognize revenues as services are rendered
and we have no continuing involvement in the goods and services delivered,
which generally is the date the finished media is shipped to the customer.

RISK FACTORS

We have incurred losses and negative cash flows since inception and have an
accumulated deficit at June 30, 2003, raising substantial doubt about our
ability to continue as a going concern.

Our consolidated financial statements have been prepared under the
assumption that the we will continue to operate as a going concern. We have
incurred losses from inception, have an accumulated deficit, and have
experienced negative cash flows from operations since our inception. As a
result of these issues, our independent accountants included an explanatory
paragraph in their opinion on our audited consolidated financial statements for
the year ended December 31, 2002 raising substantial doubt about our ability to
continue as a going concern.

We have restructured our operations, reduced our work force, renegotiated
leases, and taken other actions to limit our expenditures. While we believe
that our existing cash, cash equivalents, and short-term investments, combined
with funding available from our line of credit, will be sufficient to fund our
operations and meet our working capital and capital expenditure requirements
for the next year, if revenue and cash receipts do not meet our expectations,
we may find it necessary to secure additional financing, sell assets or reduce
expenditures further. In the event additional financing is required, we may not
be able to obtain such financing on acceptable terms, or at all.

If we fail to generate positive cash flows or obtain additional capital
when required, we could continue to modify, delay or abandon some or all of our
business and expansion plans. Our consolidated financial statements do not
include any adjustments that may result from the outcome of this uncertainty.

We have a limited operating history, making it difficult for you to evaluate
our business and your investment.

Loudeye was formed as a limited liability company in August 1997 and
incorporated in March 1998. We still have a very limited

20



---



##### Table of Contents



operating history upon which an investor may evaluate our operations and
future prospects, as well as limited insight into trends that may emerge and
affect our business. In addition, the revenue and income potential of our
business and market are unproven. Because of the emerging nature of the
industry, our executives have limited experience in it. As a young company
operating in an emerging industry, we face risks and uncertainties relating to
our ability to implement our business plan successfully. Our potential for
future profitability must be considered in light of these risks, uncertainties
and difficulties.

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

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



| |  |  | Variability in demand for our
digital media and webcasting services and applications;                                                                                                                                 
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Market acceptance of our digital media and webcasting services and applications offered by us and our competitors;                                                                                                    
|
| |  |  | Ability of our customers and
ourselves to procure necessary intellectual property
rights for digital media content;                                                                                                   
|
| |  |  | Willingness of our customers to enter into longer-term volume digital
media and applications service agreements and purchase orders in light
of the economic and legal uncertainties related to their business
models;
|
| |  |  | Governmental regulations affecting use of the Internet, including
regulations concerning intellectual property rights and security
measures; or                                                                       
|
| |  |  | Competition from other companies entering our markets.                                                                                                                                                                

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

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

As of June 30, 2003, we had approximately $10.4 million in cash and cash
equivalents, short-term investments, and restricted investments. Our existing
cash, cash equivalents, short-term investments and restricted investments may
not be sufficient to fund our operations and meet our working capital and
capital expenditure requirements for the next year. Accordingly, if we are
unable to fund operating and other expenses, working capital and capital
expenditures from our operations, we may find it necessary to secure additional
financing, sell assets or reduce expenditures further. In the event additional
financing is required, we may not be able to obtain such financing on
acceptable terms, or at all. If adequate funds are not available or are not
available on acceptable terms, we may not be able to pursue our business
objectives. This inability could seriously harm our business, results of
operations and financial condition.

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

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

21



---



##### Table of Contents



As of June 30, 2003, we had an accumulated deficit of $188.8 million. We
have incurred net losses from inception, and we expect to continue to incur net
losses for the foreseeable future.

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



| |  |  | Achieve broad customer adoption and acceptance of our products and services;      
| | - |  | ----------------------------------------------------------------------------------
|
| |  |  | Successfully execute our digital
media and webcasting services strategies;        
|
| |  |  | Successfully integrate, leverage and expand our sales force;                      
|
| |  |  | Successfully scale our current operations;                                        
|
| |  |  | Implement and execute our business and marketing strategies;                      
|
| |  |  | Address copyright issues that affect our business;                                
|
| |  |  | Develop and maintain strategic relationships to enhance our products and services;
|
| |  |  | Respond to competitive developments in the digital media infrastructure industry; 

We might not be successful in achieving any or all of these objectives in
a cost-effective manner, if at all, and the failure to achieve these could have
a serious adverse impact on our business, results of operations and financial
position. Each of these objectives may require significant additional
expenditures on our part. Even if we ultimately do achieve profitability, we
may not be able to sustain or increase profitability on a quarterly or annual
basis.

If we are unable to maintain compliance with NASDAQs continued listing
requirements, our common stock could be delisted from the Nasdaq SmallCap
Market.

We may not be able to maintain compliance with all requirements for
continued listing of our common stock on the Nasdaq SmallCap Market, including
the minimum bid price requirement and minimum tangible assets or stockholders
equity requirements. If we are unable to maintain compliance with Nasdaq
requirements in the future, our stock will be subject to delisting, which may
have a material adverse effect on the price of our common stock and the levels
of liquidity currently available to our stockholders. Delisting may also make
it more difficult for us to raise capital in the future. If our common stock is
removed from the Nasdaq SmallCap Market, an investor could find it more
difficult to dispose of, or to obtain accurate quotations as to the market
value of, our common shares. Additionally, our stock may then be subject to
penny stock regulations.

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

Our business and operations are substantially dependent on the performance
of our executive officers and key employees who have worked together for only a
relatively short period of time. We do not maintain key person life insurance
on any of our executive officers. In addition, we have hired or named new
employees in 2003 in key executive positions, including Jeffrey Cavins, our
Chief Executive Officer. The loss of one or several key executives could
seriously harm our business. Any reorganization or reduction in the size of our
employee base could harm our ability to attract and retain other valuable
employees critical to the success of our business.

Acquisitions we have made or may make could disrupt our business and harm our
financial condition.

We recently acquired TT Holding Corp., and have a limited operating
history as a combined company and therefore limited experience in addressing
emerging trends that may affect our combined business. The integration of this
and any future acquisitions

22



---



##### Table of Contents



into our operations may place a significant strain on our employees,
systems and other resources. If any acquisition fails to integrate well, our
operations and financial position could be harmed.

We expect to continue to evaluate the acquisition of businesses,
technologies, services, or products that we believe are a strategic fit with
our existing business. Acquisitions require integrating the business,
personnel, technology and products of the acquired entity and may result in
unforeseen operating difficulties and expenditures. In addition, acquisitions
may absorb significant management attention that would otherwise be available
for ongoing development of our business. The anticipated benefits of any
acquisition may not be realized. Acquisitions could result in potentially
dilutive issuances of equity securities, the incurrence of debt, the assumption
of known and unknown liabilities associated with the acquired business, or
amortization expenses related to goodwill and other intangible assets and the
incurrence of large and immediate write-offs, any of which could seriously harm
our business, results of operations and financial condition.

We are dependent on the development and rate of adoption of digital media and
the delay or failure of this development would seriously harm our business.

We are dependent on the development and rate of adoption of digital media
services and applications and the delay or failure of this development would
seriously harm our business. The development of commercial services and
applications for digital media content is in its relatively early stages. If
the Internet does not become established as an effective medium for the
distribution of digital media content to consumers or if businesses predicated
on the distribution of digital media content are not profitable or are unable
to raise necessary operating capital, then we may not succeed in executing our
business plan. Many factors could inhibit the growth of the distribution of
digital media content, including concerns about the profitability of
Internet-related businesses, uncertainty about intellectual property rights
associated with music and other digital media, bandwidth constraints, piracy
and privacy.

Our success depends on users having access to the necessary hardware,
software and bandwidth, or data transmission capability, to receive and
broadcast high quality digital media over the Internet. Congestion over the
Internet and data loss may interrupt audio and video streams, resulting in
unsatisfying user experiences. The success of digital media distribution over
the Internet depends on the continued rollout of broadband access to consumers
on an affordable basis. Widespread adoption of digital media technology depends
on overcoming obstacles to the deployment and use of digital media software,
identifying additional viable revenue models for digital media-based
businesses, improving audio and video quality and educating customers and users
in the use of digital media technology. If digital media technology fails to
overcome these obstacles, our business could be seriously harmed.

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

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

A limited number of customers have accounted for a majority of our
revenues and may continue to do so for the foreseeable future. During the year
ended December 31, 2002, two of our customers accounted for 23% of our revenues
and during the year ended December 31, 2001, one of our customers accounted for
approximately 17% of our revenues. During each of the first six months of 2003
and 2002, one customer accounted for approximately 11% and 13% of our revenues.
We believe that a small number of customers may continue to account for a
significant percentage of our revenues for the foreseeable future. Due to high
revenue concentration among a limited number of customers, the cancellation,
reduction or delay of a large customer order or our failure to timely complete
or deliver a project during a given quarter is likely to significantly reduce
revenues. In addition, if any significant customer fails to pay amounts it owes
us, or does not pay those amounts on time, our revenues and operating results
could suffer. If we are unsuccessful in increasing and broadening our customer
base, our business could be harmed.

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

The average selling prices of our products and services may be lower than
expected as a result of competitive pricing pressures, promotional programs and
customers who negotiate price reductions in exchange for longer term purchase
commitments or otherwise. The pricing of services sold to our customers depends
on the duration of the agreement, the specific requirements of the order,

23



---



##### Table of Contents



purchase volumes, the sales and service support and other contractual
agreements. We have experienced and expect to continue to experience pricing
pressure and anticipate that the average selling prices and gross margins for
our products will decrease over product life cycles. We may not be successful
in developing and introducing on a timely basis new products with enhanced
features that can be sold at higher gross margins.

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

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



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

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

Because we host, stream and Webcast audio and video content on or from our
Web site and on other Web sites for customers and provide services related to
digital media content, we face potential liability or alleged liability for
negligence, infringement of copyright, patent, or trademark rights, defamation,
indecency and other claims based on the nature and content of the materials we
host. Claims of this nature have been brought, and sometimes successfully
prosecuted, against content distributors. In addition, we could be exposed to
liability with respect to the unauthorized duplication of content or
unauthorized use of other parties proprietary technology. Any imposition of
liability that is not covered by insurance or is in excess of insurance
coverage or any alleged liability could harm our business.

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

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

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

In addition, we could be subject to intellectual property infringement
claims by others. Potential customers may be deterred from distributing content
over the Internet for fear of infringement claims. The music industry in
particular has recently been the focus of heightened concern with respect to
copyright infringement and other misappropriation claims, and the outcome of
developing legal standards in that industry is expected to impact music, video
and other content being distributed over the Internet. If, as a result,
potential customers forego distributing traditional media content over the
Internet, demand for our digital media services and applications could be
reduced which would harm our business. The music industry in the U.S. is
generally regarded as extremely litigious in nature compared to other
industries and we could become engaged in litigation with others in the music
industry. Claims

24



---



##### Table of Contents



against us, and any resultant litigation, should it occur in regard to any
of our digital media services and applications, could subject us to significant
liability for damages including treble damages for willful infringement. In
addition, even if we prevail, litigation could be time-consuming and expensive
to defend and could result in the diversion of our time and attention. Any
claims from third parties may also result in limitations on our ability to use
the intellectual property subject to these claims. Further, we plan to offer
our digital media services and applications to customers worldwide including
customers in foreign countries that may offer less protection for our
intellectual property than the United States. Our failure to protect against
misappropriation of our intellectual property, or claims that we are infringing
the intellectual property of third parties could have a negative effect on our
business, revenues, financial condition and results of operations.

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

Between July 26, 2001 and August 30, 2001, four substantially similar class
action complaints were filed in the Untied States District Court for the
Southern District of New York against us and certain of its former officers and
directors, as well as against certain underwriters who handled our March 15,
2000 initial public offering of common stock. The various complaints were
purportedly filed on behalf of a class of persons who purchased our common
stock during the time period beginning on March 15, 2000 and ending on December
6, 2000. The complaints together allege violations of the Securities Act of
1933 and the Securities Exchange Act of 1934, primarily based on the allegation
that there was undisclosed compensation received by our underwriters in
connection with our initial public offering and the allegation that the
underwriters entered into undisclosed arrangements with some investors that
were designed to distort and/or inflate the market price for our common stock
in the aftermarket following the initial public offering. These actions have
all been consolidated before the same judge for pretrial purposes. No specific
amount of damages has been claimed. We and the individual defendants have
demanded to be indemnified by the underwriter defendants pursuant to the
underwriting agreement entered into at the time of the initial public offering.
Presently, all claims against the former officers have been withdrawn without
prejudice. We, along with the many other issuer defendants, moved to dismiss
the claims in the complaint. By decision dated February 19, 2003 the court
denied our motion. We have approved a settlement proposal made by the
plaintiffs. As a result, all of plaintiffs claims against us will be
dismissed with prejudice. The settlement proposal has yet to be approved by
the other defendants and an estimate of the likelihood or range of possible
loss for this matter cannot be made at this time. In addition, the costs to us
of defending any litigation or other proceeding, even if resolved in our favor,
could be substantial. Such litigation could also substantially divert the
attention of our management and our resources in general. Uncertainties
resulting from the initiation and continuation of any litigation or other
proceedings could harm our ability to compete in the marketplace. In addition,
because class action litigation has often been brought against companies
following periods of volatility in their stock prices, we could become involved
in additional litigation

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

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

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

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

25



---



##### Table of Contents



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

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

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



| |  |  | Service functionality, quality and performance;                        
| | - |  | -----------------------------------------------------------------------
|
| |  |  | Ease of use, reliability, scalability and security of services;        
|
| |  |  | Establishing a significant base of customers and distribution partners;
|
| |  |  | Ability to introduce new services to the market in a timely manner;    
|
| |  |  | Customer service and support;                                          
|
| |  |  | Attracting third-party web developers; and                             
|
| |  |  | Pricing.                                                               

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

Our industry is experiencing consolidation that may intensify competition.

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



| |  |  | Competitors could acquire or enter into relationships with companies
with which we have strategic relationships and discontinue our
relationship, resulting in the loss of distribution opportunities for
our products and services or the loss of certain enhancements or
value-added features to our products and services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Competitors could obtain exclusive access to desirable multimedia
content and prevent that content from being available in certain
formats, thus decreasing the use of our products and services to
distribute and experience the content that audiences most desire, and
hurting 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;                                                                    

26



---



##### Table of Contents





| |  |  | A competitor could be acquired by a party with significant resources
and experience that could increase the ability of the competitor to
compete with our products and services; and                                                               
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Other companies with related interests could combine to form new,
formidable competition, which could preclude us from obtaining access to
certain markets or content; or which could dramatically change the
market for our products and services.

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

If we fail to enhance our existing services and applications products or
develop and introduce new digital media services, applications and features in
a timely manner to meet changing customer requirements and emerging industry
trends or standards, our ability to grow our business will suffer.

The market for digital media service solutions is characterized by rapidly
changing technologies and short product life cycles. These market
characteristics are heightened by the emerging nature of the Internet and the
continuing trend of companies from many industries to offer Internet-based
applications and services. The widespread adoption of the new Internet,
networking, streaming media, or telecommunications technologies or other
technological changes could require us to incur substantial expenditures to
modify or adapt our operating practices or infrastructure. Our future success
will depend in large part upon our ability to:



| |  |  | Obtain the necessary intellectual property rights from music
companies and other content owners to be able to legally provide our
services;     
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Identify and respond to emerging technological trends in the market;                                                                            
|
| |  |  | Enhance our products by adding innovative features that differentiate
our digital media services and applications from those of our
competitors;
|
| |  |  | Acquire and license leading technologies;                                                                                                       
|
| |  |  | Bring digital media services and applications to market and scale our business on a timely basis at competitive prices; and                     
|
| |  |  | Respond effectively to new technological changes or new product announcements by others.                                                        

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

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

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



| |  |  | Damage our reputation;
| | - |  | ----------------------

27



---



##### Table of Contents





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

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

Our business will suffer if our systems fail or our operations facilities
become unavailable.

A reduction in the performance, reliability and availability of our
systems and network infrastructure may harm our ability to distribute our
products and services to our customers and other users, as well as harm our
reputation and ability to attract and retain customers and content providers.
Our systems and operations are susceptible to, and could be damaged or
interrupted by, outages caused by fire, flood, power loss, telecommunications
failure, Internet breakdown, earthquake and similar events. We do not have any
redundancy in our Webcasting facilities and therefore any damage or destruction
to these would significantly harm our Webcasting business. Our systems are also
subject to human error, security breaches, power losses, computer viruses,
break-ins, denial of service attacks, sabotage, intentional acts of vandalism
and tampering designed to disrupt our computer systems, Web sites and network
communications. A sudden and significant increase in traffic on our Web sites
could strain the capacity of the software, hardware and telecommunications
systems that we deploy or use. This could lead to slower response times or
system failures.

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

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

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

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

Because our principal stockholders and management may have the ability to
control a significant percentage of stockholder votes , the premium over market
price that an acquiror might otherwise pay may be reduced and any merger or
takeover may be prevented or delayed.

28



---



##### Table of Contents



Our officers and directors beneficially own or control the voting of
approximately 14% of our outstanding common stock. As result, these
stockholders, acting together, have the ability to substantially influence all
matters submitted to our stockholders for approval, including:



| |  |  | Election or removal of our board of directors;                                                                                               
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Amendment of our certificate of incorporation or bylaws; and                                                                                 
|
| |  |  | Adoption of measures that could delay or prevent a change in control
or impede a merger, takeover or other business combination involving us.

These stockholders have substantial influence over our management and our
affairs. Accordingly, this concentration of ownership may have the effect of
impeding a merger, consolidation, takeover or other business consolidation
involving us, or discouraging a potential acquirer from making a tender offer
for our shares. This concentration of ownership could also adversely affect our
stocks market price or lessen any premium over market price that an acquiror
might otherwise pay.

Certain provisions of our certificate of incorporation and bylaws and the
provisions of Delaware law could also have the effect of delaying, deferring or
preventing an acquisition of Loudeye, even if an acquisition would be
beneficial to our stockholders.

Government regulation could adversely affect our business prospects.

We do not know with certainty how existing laws governing issues such as
property ownership, copyright and other intellectual property issues, taxation,
illegal or obscene content, retransmission of media, personal privacy and data
protection will apply to the Internet or to the distribution of music and other
proprietary content over the Internet. Most of these laws were adopted before
the advent of the Internet and related technologies and therefore do not
address the unique issues associated with the Internet and related
technologies. Depending on how these laws develop and are interpreted by the
judicial system, they could have the effect of:



| |  |  | Limiting the growth of the Internet;                                                                                       
| | - |  | ---------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Creating uncertainty in the marketplace that could reduce demand for our products and services;                            
|
| |  |  | Increasing our cost of doing business;                                                                                     
|
| |  |  | Exposing us to significant liabilities associated with content distributed or accessed through our products or services; or
|
| |  |  | Leading to increased product and applications development costs, or otherwise harm our business.                           

Specifically with respect to one aspect of copyright law, on October 28,
1998, the Digital Millennium Copyright Act (or DMCA) was enacted. The DMCA
includes statutory licenses for the performance of sound recordings and for the
making of recordings to facilitate transmissions. Under these statutory
licenses, depending on our future business activities, we and our customers may
be required to pay licensing fees in connection with digital sound recordings
we deliver or our customers provide on their web site and through
retransmissions of radio broadcasts and/or other audio content. A Copyright
Arbitration Royalty Panel has determined that, for eligible non-subscription
services, sound recording performance rates should be $0.0014 per performance
for the period October 1998-2000, with a surcharge of 9% of the total
performance fee for the ephemeral copies used to facilitate such performances.
However, that decision is subject to review and revision by the U.S. Copyright
Office, and several appeal petitions have been filed. Furthermore, the
Copyright Offices review is subject to an appeal to a Federal Court of
Appeals. The fees for the same types of transmissions offered on a subscription
basis have not been determined and will be the subject of another Copyright
Arbitration Royalty Panel proceeding, as will fees for digital phono-record
deliveries pursuant to the mechanical license provisions of the U.S.
Copyright Act. Depending on the rates and terms adopted for the statutory
licenses, our business could be harmed both by increasing our own cost of doing
business, and by increasing the cost of doing business for our customers.

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

29



---



##### Table of Contents






Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We provide Internet media infrastructure services and applications. Our
financial results could be affected by factors such as changes in interest
rates and fluctuations in the stock market. As substantially all sales are
currently made in U.S. dollars, a strengthening of the dollar could make our
services less competitive in foreign markets. We do not use derivative
instruments to hedge our risks. Our interest income is sensitive to changes in
the general level of U.S. interest rates. Based on our invested cash balances of 10.4 million at
June 30, 2003, a one percent change in interest rates would cause a change in
interest income of $104,000 per year. Due to the limited duration of our
short-term investments and their investment grade level, we anticipate no
material market risk exposure. In addition, our 2003 Revolving Facility has a
term of one year and bears interest based on the prime rate. We repaid the
balance in full in July, 2003, but we may borrow some or all of the amount
available under the line of credit in the future. Based on the $2.5 million
balance outstanding at June 30, 2003, a one percent increase in the prime rate
would increase our interest expense by $25,000 per year.

We invest in investment-grade government obligations, institutional money
market funds and other obligations with FDIC insured US banks. Concentration is
limited to 10% in any one instrument or issuer. Our primary investment focus is
to preserve capital and earn a market rate of return on our investments. We do
not speculate nor invest in publicly traded equity securities and therefore do
not believe that our capital is subject to significant market risk. The average
portfolio balance must remain under one year in duration.




Item 4 DISCLOSURE CONTROLS AND PROCEDURES

We maintain a set of disclosure controls and procedures designed to ensure
that information required to be disclosed by us in the reports filed under the
Securities Exchange Act, is recorded, processed, summarized and reported within
the time periods specified by the SECs rules and forms. Disclosure Controls
are also designed with the objective of ensuring that this information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.

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

There have been no significant changes in our internal during the period
covered by this report.




PART II. OTHER INFORMATION




ITEM 1: LEGAL PROCEEDINGS

Between July 26, 2001 and August 30, 2001, four substantially similar class
action complaints were filed in the Untied States District Court for the
Southern District of New York against us and certain of our former officers and
directors, as well as against certain underwriters who handled our March 15,
2000 initial public offering of common stock. The various complaints were
purportedly filed on behalf of a class of persons who purchased our common
stock during the time period beginning on March 15, 2000 and ending on December
6, 2000. The complaints together allege violations of the Securities Act of
1933 and the Securities Exchange Act of 1934, primarily based on the allegation
that there was undisclosed compensation received by our underwriters in
connection with our initial public offering and the allegation that the
underwriters entered into undisclosed arrangements with some investors that
were designed to distort and/or inflate the market price for our common stock
in the aftermarket following the initial public offering. These actions have
all been consolidated before the same judge for pretrial purposes. No specific
amount of damages has been claimed. We and the individual defendants have
demanded to be indemnified by the underwriter defendants pursuant to the
underwriting agreement entered into at the time of the initial public offering.
Presently, all claims against the former officers have been withdrawn without
prejudice. We, along with the many other issuer defendants, moved to dismiss
the claims in the complaint. By decision dated February 19, 2003 the court
denied our motion. We have approved a settlement proposal made by the
plaintiffs. As a result, all of plaintiffs claims against us will be
dismissed with prejudice. The settlement proposal has yet to be approved by
the other defendants and an estimate of the likelihood or range of possible
loss for this matter cannot be made at this time.

On February 3, 2003, we entered into an agreement (Agreement) with
Regent Pacific Management Corporation (Regent Pacific) pursuant to which
Regent Pacific would provide management services. The Agreement was
for a term of 26 weeks, with an option to renegotiate certain terms
of the Agreement after 13 weeks, and was terminable
by either party under

30



---



##### Table of Contents



certain circumstances. Under
the Agreement, we paid certain fees to Regent Pacific. In addition, Regent
Pacific was to receive stock options to purchase up to 4,000,000 shares of our
common stock based on Regent Pacifics length of service. These options were
to be granted at various times throughout their engagement at exercise prices
based on the closing market price on each grant date. On
March 7, 2003, Regent Pacific resigned from the engagement. On July 25, 2003, Regent
Pacific filed suit against us for breach of the Agreement. In this complaint,
Regent Pacific is seeking unspecified damages and specific
performance of our alleged obligation to grant the stock options due them under the contract.
We believe that we have meritorious defenses to the claims made in
the suit,
intend to defend vigorously this suit, and intend to bring certain
counterclaims against Regent Pacific. An estimate of the range of possible
loss for this matter can not be made at this time.

On or about January 8, 2003 a company known as Dominion Venture Finance,
L.L.C. commenced an action against us and other defendants in the Superior
Court of the State of California, County of San Francisco. In its complaint,
plaintiff alleged that pursuant to a loan and security agreement and a master
lease agreement (the Agreements) (the liabilities for which agreement,
plaintiff alleged, were acquired by us when we merged with an entity known
as DiscoverMusic.com, Inc.), we failed to make certain required payments to
plaintiff. On August 5, 2003, we agreed to settle all claims under the suit
for a cash payment of approximately $228,000, which represented the outstanding
principal and interest under the Agreements.

In April 2003, the landlord of one of our unoccupied facilities filed suit
against us for breach of its lease and is seeking an unspecified amount of
damages. We believe that we have meritorious defenses to the claims made in the
suit and intend to vigorously defend this suit and may also bring certain
counterclaims against the landlord.

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




ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS



| | (c) |  | Recent Sales of Unregistered Securities
| | --- |  | ---------------------------------------

As discussed in Note 5 to the consolidated financial statements, in June,
2003, we entered into a revolving credit facility with a bank. In connection
with this transaction we issued a warrant to the lender to purchase 45,700
shares of our common stock at $0.89 per share. The warrant expires on June 27,
2010. The warrant was issued without registration under the Securities Act of
1933 (the Act) to an accredited investor in reliance on the exemption
provided by Section 4(2) of the Act. An appropriate legend was placed on the
warrant and will be placed on the shares issuable upon exercise of the warrant.




ITEM 3: DEFAULTS UPON SENIOR SECURITIES

None.




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

None.




ITEM 5: OTHER INFORMATION

None.




ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibits.
| | --- |  | ---------

|       |  |                                                                                                                              
|------ |  | -----------------------------------------------------------------------------------------------------------------------------
|2.1(1) |  | Agreement and Plan of Reorganization dated November 19, 1999 between
Loudeye Corp. and Alive.com, Inc.                       
|      
|2.2(5) |  | Agreement and Plan of Merger among Loudeye.Corp., DiscoverMusic.com,
Inc. and Santa Acquisition, Inc. dated January 30, 2001.

31



---



##### Table of Contents



|          |  |                                                                                                                                                                            
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1(1)    |  | Fifth Amended and Restated Certificate of Incorporation of Loudeye Corp.                                                                                                   
|         
|3.2(1)    |  | Form of Amended and Restated Certificate of Incorporation of Loudeye Corp.                                                                                                 
|         
|3.4(8)    |  | Amended Bylaws of Loudeye Corp. dated January 18, 2002.                                                                                                                    
|         
|10.1(1)   |  | Form of Indemnification Agreement between Loudeye Corp. and each of its officers and directors.                                                                            
|         
|10.2(1)   |  | 1998 Stock Option Plan, as amended.                                                                                                                                        
|         
|10.3(1)   |  | Alive.com, Inc. 1998 Stock Option Plan.                                                                                                                                    
|         
|10.4(1)   |  | 2000 Stock Option Plan.                                                                                                                                                    
|         
|10.5(1)   |  | 2000 Director Stock Option Plan.                                                                                                                                           
|         
|10.6(1)   |  | 2000 Employee Stock Purchase Plan.                                                                                                                                         
|         
|10.7(1)   |  | Amended and Restated Investors Rights Agreement dated December 14,
1999 among Loudeye Corp. and certain former holders of our preferred
stock.                            
|         
|10.8(1)   |  | Agreement dated August 10, 1999 between Loudeye Corp. and Times
Square Building L.L.C. for offices at Times Square Building, 414 Olive
Way, Suite 300, Seattle, Washington.
|         
|10.9(1)   |  | Lease Agreement dated September 1, 1998 between Loudeye Corp. and
Martin Tobias for offices at 3406 E. Union Street, Seattle, Washington.                                  
|         
|10.10(1)  |  | Lease Agreement dated October 28, 1999 between Loudeye Corp. and
Westlake Park Associates for offices at Centennial Building, 1904 Fourth
Avenue, Seattle, Washington.     
|         
|10.11(1)  |  | Lease Agreement dated November 9, 1999 between Loudeye Corp. and
Downtown Entertainment Associates, LP for offices at 1424 Second Street,
Santa Monica, California.        
|         
|10.12(1)  |  | Loan and Security Agreement with Dominion Venture Finance L.L.C.
dated June 15, 1999 between Loudeye Corp. and Dominion Venture Finance
L.L.C.                             
|         
|10.16(1)  |  | Services Agreement between Loudeye Corp. and Akamai Technologies,
Inc. dated as of February 15, 2000.                                                                      
|         
|10.17(2)  |  | Amended and Restated Loan and Security Agreement between Imperial
Bank and Loudeye Corp. dated May 17, 2000.                                                               
|         
|10.18(2)  |  | Amended and Restated Services Agreement between Valley Media, Inc.
and Loudeye Corp. dated April 2000.                                                                     
|         
|10.20(2)  |  | First Amendment of Office Lease Agreement dated April 3, 2000
between Times Square Building L.L.C. and Loudeye Corp.                                                       
|         
|10.21(2)  |  | Second Amendment of Office Lease Agreement dated May 1, 2000 between
Times Square Building L.L.C. and Loudeye Corp.                                                        
|         
|10.22(2)  |  | Lease Agreement dated June 14, 2000 between Brown Bear Realty
Corporation and Loudeye Corp.                                                                                
|         
|10.23(3) |  | Volume Purchase Order dated July 19, 2000 by and between MusicBank
and Loudeye Corp.                                                                                       
|         
|10.25(4)  |  | Underlease Agreement and Agreement to Lease dated December 21, 2000
between WCRS Limited and Loudeye Corp.                                                                 

32



---



##### Table of Contents



|           |  |                                                                                                                                                                                                                         
|---------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.26(4)  |  | Encoding Services and Compact Disc Purchase Agreement between XM
Satellite Radio, Inc., and Loudeye Corp., dated August 25, 2000.                                                                                       
|          
|10.27(4)  |  | First Addendum to Encoding Services and Compact Disc Purchase
Agreement between XM Satellite Radio, Inc., and Loudeye Corp., dated
October 10, 2000.                                                                    
|          
|10.28(6)   |  | 2000 Employee Stock Option Plan as amended March 5, 2001.                                                                                                                                                               
|          
|10.29(6)   |  | Offer Letter to Joel McConaughy dated March 14, 2001.                                                                                                                                                                   
|          
|10.30(6)   |  | Offer Letter to John Shaw dated April 4, 2001.                                                                                                                                                                          
|          
|10.31(6)   |  | Offer Letter to John Baker dated February 23, 2001.                                                                                                                                                                     
|          
|10.32(5)   |  | Registration Rights Agreement among Loudeye Corp. and the former stockholders of DiscoverMusic.                                                                                                                         
|          
|10.33(7)   |  | Credit Agreement between US Bank National Association and Loudeye Corp., dated as of August 22, 2001.                                                                                                                   
|          
|10.34(7)   |  | First Amendment to Credit Agreement between US Bank National
Association and Loudeye Corp., dated as of October 25, 2001.                                                                                               
|          
|10.35(8)   |  | Martin Tobias Credit Arrangement.                                                                                                                                                                                       
|          
|10.36(9)   |  | Agreement and Plan of Reorganization with TT Holding Corp.                                                                                                                                                              
|          
|10.37(10)  |  | Retainer Agreement with Regent Pacific Management Corporation.                                                                                                                                                          
|          
|10.38 (12) |  | Fifth Amendment and Assignment of Lease dated April 1, 2003
among 1130 Rainier, LLC, Activate.Net Corporation, and Loudeye
Enterprise Communications, Inc. for offices at 1130 Rainier Avenue
South, Seattle, Washington
|          
|10.39 (12) |  | Lease Termination Agreement dated April 28, 2003 between
Westlake Park Associates and Loudeye Corp. with respect to offices at
1904 Fourth Avenue, Seattle, Washington.                                                 
|          
|10.40      |  | Consulting Agreement dated April 1, 2003 between Anthony J. Bay and Loudeye Corp., filed herewith.                                                                                                                      
|          
|10.41      |  | Employment Agreement dated April 1, 2003 between Jeffrey M. Cavins and Loudeye Corp., filed herewith.                                                                                                                   
|          
|10.42      |  | Employment Agreement dated April 1, 2003 between Jerold J. Goade, Jr. and Loudeye Corp., filed herewith.                                                                                                                
|          
|10.43      |  | Employment Agreement dated April 1, 2003 between Michael S. Dougherty and Loudeye Corp., filed herewith.                                                                                                                
|          
|10.44 (13) |  | Accounts Receivable Financing Agreement dated June 27, 2003
between Silicon Valley Bank and Loudeye Corp. and related modification
agreement and warrant agreement                                                      
|          
|10.45      |  | Offer letter dated June 16, 2003 between Michael R. Harburg and
Loudeye Corp., filed herewith.                                                                                                                          
|          
|21.1(11)   |  | Subsidiaries of Loudeye Corp.                                                                                                                                                                                           
|          
|31.1       |  | Certification of Jeffrey M. Cavins, President and Chief Executive
Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                    
|          
|31.2       |  | Certification of Jerold J. Goade Jr., Vice President and Chief
Financial Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002             

33



---



##### Table of Contents



|     |  |                                                                                                                                                                                                            
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|32.1 |  | Certification of Jeffrey M. Cavins, President and Chief Executive
Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002       
|    
|32.2 |  | Certification of Jerold J. Goade Jr., Vice President and Chief
Financial Officer of Loudeye Corp., Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



---

|    |  | Confidential treatment has been requested as to certain portions of this
Exhibit.                     
|---- |  | ------------------------------------------------------------------------------------------------------
|    
|(1)  |  | Incorporated by reference to Loudeye Corp.s registration statement on
Form S-1 file number 333-93361.
|    
|(2)  |  | Incorporated by reference to Loudeye Corp.s Form 10-Q, for the period
ending June 30, 2000.          
|    
|(3)  |  | Incorporated by reference to Loudeye Corp.s Form 10-Q, for the period
ending September 30, 2000.     
|    
|(4)  |  | Incorporated by reference to Loudeye Corp.s Form 10-K, for the period
ending December 31, 2000.      
|    
|(5)  |  | Incorporated by reference to Loudeye Corp.s Report on Form 8-K dated
March 13, 2001.                 
|    
|(6)  |  | Incorporated by reference to Loudeye Corp.s Form 10-Q, for the period
ending March 31, 2001.         
|    
|(7)  |  | Incorporated by reference to Loudeye Corp.s Form 10-Q, for the period
ending September 30, 2001.     
|    
|(8)  |  | Incorporated by reference to Loudeye Corp.s Form 10-K for the period
ended December 31, 2001.        
|    
|(9)  |  | Incorporated by reference to Loudeye Corp.s Form 8-K dated November 19,
2002                         
|    
|(10) |  | Incorporated by reference to Loudeye Corp.s Form 8-K dated February 3,
2003                          
|    
|(11) |  | Incorporated by reference to Loudeye Corp.s Form 10-K dated April 15,
2003.                          
|    
|(12) |  | Incorporated by reference to Loudeye Corp.s Form 10-Q dated May 20, 2003                             
|    
|(13) |  | Incorporated by reference to Loudeye Corp.s Form 8-K dated July 15,
2003.                            



| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------
|
| |     |  | none               

34



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report on Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Seattle, State of
Washington, August 8, 2003

| |  |               |  |                                                                                                            
| |  | ------------- |  | -----------------------------------------------------------------------------------------------------------
| |  | LOUDEYE CORP.
| |  |               |  |                                                                                                            
| |  | BY:           |  | /s/         JEFFREY M. CAVINS                                                                              
| |  |               |  |                                                                                                            
| |  |               |  | Jeffrey M. Cavins
President and Chief Executive Officer
(Principal Executive Officer)                      
| |  |               |  |                                                                                                            
| |  | BY:           |  | /s/          JEROLD J. GOADE, JR.                                                                          
| |  |               |  |                                                                                                            
| |  |               |  | Jerold J. Goade Jr.
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

35