<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                             ----------------------

                                    FORM 10-K
(Mark One)
[x]  Annual Report pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934
     For the fiscal year ended: December 31, 2004
                                       OR

[ ]  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 000-25977
                                               ---------
                              ---------------------

                              L Q CORPORATION, INC.
             (Exact name of Registrant as specified in its charter)

                  Delaware                                 77-0421089
      -------------------------------              ------------------------
      (State or other jurisdiction of                  (I.R.S. Employer
       incorporation or organization)                Identification Number)


       888 Seventh Ave., 17th Floor,                         10019
                New York, NY                       ------------------------
       -----------------------------                     (zip code)
  (address of principal executive offices)

Registrant's telephone number, including area code: (212) 974-5730
                                                    --------------

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
    Title of Each Class                Name of Each Exchange on Which Registered
    -------------------                -----------------------------------------
             None                                         None

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
               --------------------------------------------------
                         Common Stock, $0.001 par value


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

Yes [  X  ] No [     ]
     -----      -----

       Indicate by check mark if disclosure of delinquent filers pursuant to
item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

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

       The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant as of June 30, 2004 (the last business
day of the Registrant's most recently completed second fiscal quarter) was
approximately $6,715,037 based on the closing price of the Common Stock as
reported on The Nasdaq OTC Bulletin Board for that date.

       The number of shares outstanding of the registrant's Common Stock, par
value $.001 per share, as of March 17, 2005: 3,214,408.

<PAGE>

                                TABLE OF CONTENTS


                                                                            PAGE
                                                                            ----

PART I

ITEM 1.      BUSINESS..........................................................1
ITEM 2.      PROPERTIES........................................................4
ITEM 3.      LEGAL PROCEEDINGS.................................................4
ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............5

PART II

ITEM 5.      MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
             MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.................5
ITEM 6.      SELECTED FINANCIAL DATA...........................................7
ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
             AND RESULTS OF OPERATIONS.........................................8
ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......15
ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................15
ITEM 9.      CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
             AND FINANCIAL DISCLOSURE.........................................15
ITEM 9A.     CONTROLS AND PROCEDURES..........................................15
ITEM 9B.     OTHER INFORMATION................................................15

PART III

ITEM 10.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............16
ITEM 11.     EXECUTIVE COMPENSATION...........................................18
ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...23
ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................25
ITEM 14.     PRINCIPAL ACCOUNTANT FEES AND SERVICES...........................26

PART IV.

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES..........................27


<PAGE>

================================================================================

PART I

ITEM 1.  BUSINESS

     This Annual Report on Form 10-K contains forward-looking statements that
have been made in reliance on the provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are based on
current expectations, estimates and projections about our industry, management's
beliefs, and certain assumptions made by management. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks" and
"estimates" and similar expressions are intended to identify forward-looking
statements. These statements are not guarantees of future performance, and
actual actions or results may differ materially. These statements are subject to
certain risks, uncertainties and assumptions that are difficult to predict. We
undertake no obligation to update publicly any forward-looking statements as a
result of new information, future events or otherwise, unless required by law.
Readers should, however, carefully review the risk factors included herein and
in other reports or documents filed by us from time to time with the Securities
and Exchange Commission.

OVERVIEW

     L Q Corporation, Inc. was incorporated in California as "Liquid Audio,
Inc." in January 1996 and reincorporated in Delaware in April 1999. In July
1999, we completed our initial public offering of common stock. Our Board of
Directors (the "Board") received stockholder approval on July 30, 2003 to change
our name to "L Q Corporation, Inc." Our name was formally changed on January 7,
2004. Our principal executive offices are located at 888 Seventh Avenue, 17th
Floor, New York, NY 10019, and our telephone number is (212) 974-5730.

     Through January 2003, we provided an open platform that enabled the digital
delivery of media over the Internet.

     Since January 2003, we have not operated any business and have been
settling our remaining claims and liabilities while reviewing alternatives for
the use or disposition of our remaining assets. We intend to pursue other
business opportunities and investments unrelated to the downloading of digital
music. Neither our Board nor our stockholders have yet approved any such
opportunities. If we are unable to find any suitable business opportunities
and/or investments, we may pursue a plan of complete liquidation and
dissolution. If a complete liquidation and dissolution is approved, pursuant to
Delaware General Corporation Law, we will continue to exist for three years
after the dissolution becomes effective or for such longer period as the
Delaware Court of Chancery shall direct, for the purpose of prosecuting and
defending suits against us and enabling us gradually to close our business, to
dispose of our property, to discharge our liabilities and to distribute to our
stockholders any remaining assets.

     We entered into a Settlement Agreement and Mutual Release on February 12,
2004 with BeMusic, Inc. ("BeMusic") which finally resolved all matters between
BeMusic and us with respect to the litigation matter with SightSound, Inc.
("SightSound") alleging that certain former customers of ours (which have since
merged into BeMusic) infringed certain patents of SightSound. Under the terms of
this Agreement we paid approximately $1,452,000 to BeMusic as settlement
expenses and approximately $314,000 in legal fees relating to the SightSound
litigation. These payments were in addition to $335,827 previously paid by us
for our share of attorney fees incurred in connection with this matter.

     At our September 29, 2003 meeting of our stockholders, our stockholders
approved amendments to our certificate of incorporation to effect a 1-for-250
reverse stock split, to be followed immediately by a 35-for-1 forward stock
split (collectively, the "Reverse/Forward Stock Split"), as well as a reduction
in the number of common shares authorized for issuance from 50,000,000 shares to
30,000,000 shares (the "Share Reduction"). On June 7, 2004, we filed amendments
necessary to implement the Reverse/Forward Stock Split and the Share Reduction,
which took place on July 26, 2004 with an effective date as of June 8, 2004.

     Our common stock is reported currently on The Nasdaq OTC Bulletin Board.
Our common stock was traded on The Nasdaq National Market, but was delisted on
June 5, 2003. The market price per share of our stock increased significantly
following the implementation of the Reverse/Forward Stock Split. The market
price of our common stock as of March 17, 2005 was $1.67 per share.

                                       1
<PAGE>

     On July 21, 2004, Joseph R. Wright, Jr. was appointed to the Company's
Board of Directors. On December 27, 2004, Mr. Wright resigned from the Board of
Directors of the Company in order to devote additional time to his position as
President, Chief Executive Officer and a director of PanAmSat Corporation, a
global provider of satellite-based video, broadcasting and network distribution
and delivery services.

     On October 7, 2004, James Mitarotonda resigned as our President and Chief
Executive Officer. He continues to serve as a director and Chairman of the
Board. Mr. William Fox, a director of our Company, was appointed as our new
President and Chief Executive Officer on this date.

INTERNATIONAL OFFICES

     We closed our international offices in 2002.

     Information regarding financial data by geographic area, as well as
information regarding operating segments, is set forth in Part II, Item 8 on
this Form 10-K in the Notes to Consolidated Financial Statements at Note 1,
"Segment Information," which information is hereby incorporated by reference.

EMPLOYEES

     Following the sale of our digital music fulfillment business and related
assets in January 2003, we terminated substantially all of our employees and as
of December 31, 2004, we have no employees.

COMPANY RISK FACTORS

WE CURRENTLY DO NOT HAVE AN OPERATING BUSINESS, BUT ALSO DO NOT INTEND TO PURSUE
A COURSE OF COMPLETE LIQUIDATION AND DISSOLUTION,  AND ACCORDINGLY, THE VALUE OF
YOUR SHARES MAY DECREASE

     We currently do not have any operating business; we are considering various
options for the use of our remaining assets, but have yet to approve any
definitive plans. In the meantime, we will continue to incur operating expenses
while we consider alternative operating plans. These plans may include business
combinations with or investments in other operating companies, or entering into
a completely new line of business. We have not yet identified any such
opportunities, and thus, you will not be able to evaluate the impact of such a
business strategy on the value of your stock. In addition, we cannot assure you
that we will be able to identify any appropriate business opportunities. Even if
we are able to identify business opportunities that our Board deems appropriate,
we cannot assure you that such a strategy will provide you with a positive
return on your investment, and it may in fact result in a substantial decrease
in the value of your stock. These factors will substantially increase the
uncertainty, and thus the risk, of investing in our shares. Furthermore, we
currently do not intend to pursue a course of complete liquidation and
dissolution. As a result, you should not expect any further cash distributions.

WE MAY NOT BE ABLE TO IDENTIFY OR FULLY  CAPITALIZE ON ANY APPROPRIATE  BUSINESS
OPPORTUNITIES

     We are considering various options for the use of our remaining assets,
which may include business combinations with or investments in other operating
companies, or entering into a completely new line of business. Nevertheless, we
have not yet identified any appropriate business opportunities, and, due to a
variety of factors outside of our control, we may not be able to identify or
fully capitalize on any such opportunities. These factors include: (1)
competition from other potential acquirors and partners of and investors in
potential acquisitions, many of whom may have greater financial resources than
we do; (2) in specific cases, failure to agree on the terms of a potential
acquisition, such as the amount or price of our acquired interest, or
incompatibility between us and management of the company we wish to acquire; and
(3) the possibility that we may lack sufficient capital and/or expertise to
develop promising opportunities. Even if we are able to identify business
opportunities that our Board deems appropriate, we cannot assure you that such a
strategy will provide you with a positive return on your investment, and may in
fact result in a substantial decrease in the value of your stock. In addition,
if we enter into a combination with a business that has operating income, we
cannot assure you that we will be able to utilize all or even a portion of our
existing net operating loss carryover for federal or state tax purposes
following such a business combination. If we are unable to make use of our
existing net operating loss carryover, the tax advantages of such a combination
may be limited, which could negatively impact the price of our stock and the
value of your investment. These factors will substantially increase the
uncertainty, and thus the risk, of investing in our shares.

                                       2
<PAGE>

WE MAY HAVE TO TAKE ACTIONS THAT ARE DISRUPTIVE TO OUR BUSINESS STRATEGY TO
AVOID REGISTRATION UNDER THE INVESTMENT COMPANY ACT OF 1940.

     We traded shares of an available-for-sale security in August and September
of 2003. Although we liquidated our entire remaining position in this security
as of November 12, 2003 and do not intend to make any additional purchases of
available-for-sale securities, we may inadvertently have become, or may become
in the future, an investment company under the Investment Company Act as a
result of our lack of an operating business, our significant cash balance as a
percentage of our total assets and our recent trading activities. Although we
continue to consider future operating alternatives, including the possible
acquisition of one or more operating businesses, we could become subject to
regulation under the Investment Company Act. Registration as an investment
company would be very expensive and further deplete our cash balances, which
would leave us with fewer resources to pursue further operating alternatives.
Registration would also subject us to restrictions that may be inconsistent with
any future business strategy we may decide upon. In order to avoid these
regulations, we may have to take actions that we would not otherwise choose to
take to avoid registration under the Investment Company Act.

STOCKHOLDERS MAY BE LIABLE TO OUR CREDITORS FOR UP TO AMOUNTS RECEIVED FROM US
IF OUR RESERVES ARE INADEQUATE

     If we pursue a plan of complete liquidation and dissolution, a Certificate
of Dissolution will be filed with the State of Delaware after such plan is
approved by our stockholders. Pursuant to the Delaware General Corporation Law,
we will continue to exist for three years after the dissolution becomes
effective or for such longer period as the Delaware Court of Chancery shall
direct, for the purpose of prosecuting and defending suits against us and
enabling us gradually to close our business, to dispose of our property, to
discharge our liabilities and to distribute to our stockholders any remaining
assets. Under the Delaware General Corporation Law, in the event we fail to
create an adequate contingency reserve for payment of our expenses and
liabilities during this three-year period, each stockholder could be held liable
for payment to our creditors for such stockholder's pro rata share of amounts
owed to creditors in excess of the contingency reserve. The liability of any
stockholder would be limited, however, to the amounts previously received by
such stockholder from us (and from any liquidating trust or trusts), including
the return of capital cash distribution of $2.50 per share paid to stockholders
on January 29, 2003. Accordingly, in such event a stockholder could be required
to return all distributions previously made to such stockholder. In such event,
a stockholder could receive nothing from us under a plan of complete liquidation
and dissolution. Moreover, in the event a stockholder has paid taxes on amounts
previously received, a repayment of all or a portion of such amount could result
in a stockholder incurring a net tax cost if the stockholder's repayment of an
amount previously distributed does not cause a commensurate reduction in taxes
payable. There can be no assurance that the contingency reserve maintained by us
will be adequate to cover any expenses and liabilities.

OUR STOCK HAS BEEN DELISTED FROM THE NASDAQ NATIONAL MARKET, AND IS THEREFORE
SIGNIFICANTLY LESS LIQUID THAN BEFORE

     Our stock has been delisted from trading on The Nasdaq National Market by
reason of not maintaining listing requirements due to the lack of tangible
business operations and significantly reduced market price of our common stock.
As a result, our common stock currently trades over the counter on the Nasdaq
OTC Bulletin Board and the ability of our stockholders to obtain liquidity and
fair market prices for our shares has been significantly impaired.

WE WILL CONTINUE TO INCUR THE EXPENSE OF COMPLYING WITH PUBLIC COMPANY REPORTING
AND OTHER REQUIREMENTS

     We have an obligation to continue to comply with the applicable reporting
requirements of the Securities Exchange Act of 1934, as amended, and other
applicable requirements including those under the Sarbanes-Oxley Act of 2002
even though compliance with such requirements is economically burdensome. In
order to curtail expenses, if we elect to pursue a liquidation and dissolution
strategy, after we file our Certificate of Dissolution, we will seek relief from
the Securities and Exchange Commission from the reporting requirements under the
Exchange Act, which may or may not be granted. Until such relief is granted we
will continue to make obligatory Exchange Act filings. We anticipate that even
if such relief is granted in the future, we will continue to file current
reports on Form 8-K to disclose material events relating to our liquidation and
dissolution along with any other reports that the Securities and Exchange
Commission may require.

                                       3
<PAGE>

ITEM 2.  PROPERTIES

     Our principal executive offices are located in New York, New York, in a
space maintained by Barington Capital Group, L.P. ("Barington"), a limited
partnership whose general partner is a corporation of which James Mitarotonda is
Chairman, President and Chief Executive Officer. Mr. Mitarotonda is our Chairman
and former Chief Executive Officer. William Fox, the President, Chief Executive
Officer and a director of the Company, is the Vice Chairman of Barington. In
September 2004, we closed our office in Foster City, California and transferred
all of our administrative and accounting functions to our corporate headquarters
in New York, New York.

ITEM 3.  LEGAL PROCEEDINGS

     On or about April 7, 2000, SightSound filed an Amended Complaint in a
lawsuit in the United States District Court for the Western District of
Pennsylvania (the "Pennsylvania Court") alleging that certain former customers
of ours, N2K, Inc., CDNow, Inc. and CDNow Online, Inc., which have since merged
into BeMusic, infringed one or more of three patents of SightSound (Nos.
5,191,573; 5,675,734; and 5,996,440). In January 2002, we agreed to share evenly
with CDNow Online, Inc. all legal fees incurred by CDNow Online, Inc. in
defending the patent infringement action, but required BeMusic to consult in
good faith with us regarding its defense and/or settlement of the patent
infringement action. On February 20, 2004, an Order was entered in the
Pennsylvania Court ending the lawsuit by SightSound against BeMusic. As a result
of the entry of the Order and pursuant to a separate agreement between
SightSound and BeMusic executed on February 12, 2004, SightSound dismissed the
SightSound litigation and released all claims against us. Entry of the Order
also made effective a Settlement Agreement and Mutual Release executed on
February 13, 2004 by us and BeMusic (the "Settlement Agreement"). The Settlement
Agreement finally resolves all matters between BeMusic and us relating to the
SightSound litigation. Under the terms of the Settlement Agreement, we paid
$1,452,000 to BeMusic and approximately $314,000 in legal fees relating to the
SightSound litigation. These payments were in addition to $335,827 previously
paid by us for our share of attorney fees incurred in connection with this
matter. As a result of the Settlement Agreement, we have no further obligation
to maintain available cash on hand in connection with the SightSound litigation.
Neither party to the Settlement Agreement admitted any wrongdoing or any
indemnification obligations in connection with this litigation.

     We, certain of our former officers and directors, and various of the
underwriters in our initial public offering ("IPO") and secondary offering were
named as defendants in a consolidated action filed in the United States District
Court for the Southern District of New York on July 20, 2001, IN RE LIQUID
AUDIO, INC. INITIAL PUBLIC OFFERING SECURITIES LITIGATION, CV-6611. The
consolidated amended complaint generally alleges that various investment bank
underwriters engaged in improper and undisclosed activities related to the
allocation of shares in our IPO and secondary offering of securities. The
plaintiffs brought claims for violation of several provisions of the federal
securities laws against those underwriters, and also against us and certain of
our former directors and officers, seeking unspecified damages on behalf of a
purported class of purchasers of our common stock between July 8, 1999 and
December 6, 2000. Various plaintiffs filed similar actions asserting virtually
identical allegations against more than 40 investment banks and 250 other
companies. All of these "IPO allocation" securities class actions currently
pending in the Southern District of New York are assigned to Judge Shira A.
Scheindlin for coordinated pretrial proceedings as IN RE LIQUID AUDIO, INC.
INITIAL PUBLIC OFFERING SECURITIES LITIGATION, 21 MC 92. The issuer defendants
in the coordinated proceedings, including the Company, filed omnibus motions to
dismiss the actions. In October 2002, our former directors and officers named as
defendants were dismissed without prejudice pursuant to a tolling agreement. In
February 2003, the court issued a ruling denying the motion to dismiss with
respect to the claims against us. In June 2004, a stipulation of settlement for
the release of claims against the issuer defendants, including the Company, in
exchange for a contingent payment to be made by the issuer defendants' insurance
carriers and an assignment of certain claims, was submitted to the Court for
approval. The settlement is subject to a number of conditions, including
approval of the Court. On February 15, 2005, the Court granted a conditional
preliminary approval of the stipulation of settlement. If the settlement does
not occur, and litigation against us continues, we believe that we have
meritorious defenses to the claims against us and intend to defend ourselves
vigorously.

                                       4
<PAGE>

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

     We held our 2004 Annual Meeting of Stockholders on December 22, 2004 in New
York, New York.

     At this meeting, the stockholders approved a proposal to amend our Second
Amended and Restated Certificate of Incorporation to eliminate the
classification of our Board into three classes of directors serving staggered
three-year terms. Each director will hereafter be elected for a one-year term at
each annual meeting of our stockholders. There were 3,007,731 votes cast for the
amendment, 22,389 votes cast against the amendment and 360 abstentions.

     The stockholders also elected the following individuals to serve as
directors for the succeeding year or until their successors are duly qualified
and elected:

              Name                     Votes For            Votes Withheld
     ---------------------             ---------            --------------

     Joseph R. Wright, Jr.             3,021,177                9,303


      Stephen Liguori                  3,021,177                9.303

     Lastly, the stockholders approved the ratification of the appointment of
Rothstein, Kass & Company, P.C. as our independent auditors for the 2004 fiscal
year. There were 3,022,394 votes cast for the ratification, 7,957 votes cast
against the ratification and 129 abstentions.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

MARKET PRICE OF COMMON STOCK

     Our common stock was quoted on the Nasdaq National Market under the symbol
"LQID" from July 8, 1999, until it was delisted on June 5, 2003. On June 5,
2003, our common stock began trading over the counter as a "pink sheet"
security. On June 20, 2003, our common stock began trading on the Nasdaq OTC
Bulletin Board under the symbol "LQID.OB," and currently trades under the symbol
"LQCI.OB." The following table presents, for the periods indicated, the high and
low closing prices per share of our common stock as reported on the Nasdaq
National Market and/or the Nasdaq OTC Bulletin Board, as applicable.

                                                          HIGH         LOW
                                                      --------------------------
YEAR ENDED DECEMBER 31, 2004
----------------------------
   First Quarter.....................................     $ 3.1429     $ 2.0714
   Second Quarter....................................       3.3571       1.9357
   Third Quarter.....................................       2.1500       1.8000
   Fourth Quarter....................................       2.0000       1.7400

YEAR ENDED DECEMBER 31, 2003
----------------------------
   First Quarter.....................................      $0.32        $0.31
   Second Quarter....................................       0.37         0.35
   Third Quarter.....................................       0.32         0.32
   Fourth Quarter....................................       0.36         0.27


     The high and low closing prices for the year ending December 31, 2004
reflect the effect of the reverse/forward stock split. The high and low closing
prices for the year ending December 31, 2003 do not reflect the effect of the
reverse/forward stock split.

                                       5
<PAGE>

     The closing price per share of our common stock at March 17, 2005 was
$1.67. As of March 17, 2005, there were approximately 48 shareholders of record
of our common stock. Because many shares of our common stock are held by brokers
and other institutions on behalf of stockholders, we are unable to estimate the
total number of stockholders represented by these record holders.

DIVIDEND POLICY

     We have not declared any distributions since our $2.50 return of capital
distribution was paid on January 29, 2003.

     We continue to explore various ways of using and/or disposing of our
remaining assets and settling our final claims and liabilities. Depending on the
alternatives chosen, and the success of maximizing the return on assets and
minimizing the cost of settling claims and liabilities, we may or may not
declare future cash distributions to stockholders. If we choose to adopt a plan
of complete liquidation and dissolution, we intend to make a final cash
distribution to our stockholders in connection with this dissolution once all
our assets have been sold and obligations satisfied.

                                       6
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

     The following selected financial data should be read in conjunction with
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the consolidated financial statements and related notes
thereto included in Item 8 included elsewhere in this document to fully
understand factors that may affect the comparability of the information
presented below. Per share data reflects the revenue-forward split which took
place on June 7, 2004.

<TABLE>
<CAPTION>
                                                                             YEAR ENDED DECEMBER 31,
                                                         --------------------------------------------------------------
                                                            2004         2003         2002         2001        2000
                                                         ----------   ----------   ----------   ----------   ----------
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                      <C>          <C>          <C>          <C>          <C>
STATEMENT OF OPERATIONS DATA:
Net revenues:
   License ..........................................           --    $       4    $     108    $     682    $   1,284
   Services .........................................           --           39          374        1,173        2,977
   Business development (related party) .............           --           --           --        2,873        7,307
                                                         ----------   ----------   ----------   ----------   ----------
     Total net revenues .............................           --           43          482        4,728       11,568
                                                         ----------   ----------   ----------   ----------   ----------
Cost of net revenues:
   License ..........................................           --            5          388          491          290
   Services .........................................           --            2          654        1,503        2,722
   Business development (related party) .............           --           --           --           --           75
   Non-cash cost of revenues ........................           --           --           82          349           28
                                                         ----------   ----------   ----------   ----------   ----------
     Total cost of net revenues .....................           --            7        1,124        2,343        3,115
                                                         ----------   ----------   ----------   ----------   ----------
Gross profit (loss) .................................           --           36         (642)       2,385        8,453
                                                         ----------   ----------   ----------   ----------   ----------
Operating expenses:
   Sales and marketing ..............................           --          277        3,765       11,404       17,114
   Non-cash sales and marketing .....................           --           --          (28)         (43)         314
   Research and development .........................           --          165        9,111       16,957       22,917
   Non-cash research and development ................           --           --            6           --           80
   General and administrative .......................          968        6,658       10,712        9,077        7,131
   Non-cash general and administrative ..............           --           --            1          (14)          13
   Impairment loss ..................................           --           --          689           --           --
   Strategic marketing-equity instruments ...........           --           --           --          607        1,935
   Restructuring ....................................           --        4,411        1,163        4,497           --
                                                         ----------   ----------   ----------   ----------   ----------
     Total operating expenses .......................          968       11,511       25,419       42,485       49,504
                                                         ----------   ----------   ----------   ----------   ----------
Loss from operations ................................         (968)     (11,475)     (26,061)     (40,100)     (41,051)
Other income (expense), net .........................          121          313        1,886        4,170        8,236
Gain on sale of intellectual property ...............           --           --        7,000           --           --
Gain on sale of Digital Music fulfillment business...           --        2,868
Merger termination fee ..............................           --           --       (2,100)          --           --
Loss in equity investment ...........................           --           --           --       (1,254)        (870)
                                                         ----------   ----------   ----------   ----------   ----------
Net loss ............................................         (847)   $  (8,294)   $ (19,275)   $ (37,184)   $ (33,685)
                                                         ==========   ==========   ==========   ==========   ==========
Net loss per share:
   Basic and diluted ................................    $   (0.26)   $   (2.56)   $   (6.04)   $  (11.74)   $  (10.87)
   Weighted average shares ..........................        3,232        3,243        3,189        3,166        3,099

Cash distribution declared per common share .........    $      --    $      --    $    2.50    $      --    $      --

                                                                                  DECEMBER 31,
                                                         --------------------------------------------------------------
                                                            2004         2003         2002         2001        2000
                                                         ----------   ----------   ----------   ----------   ----------
                                                                                  (IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents ...........................    $   6,432    $   9,077    $  73,985    $  91,594    $  96,398
Short-term investments ..............................           --           --           --           --       27,378
Working capital .....................................        6,421        7,334       14,227       87,233      119,089

Total assets ........................................        6,535        9,269       76,797       97,415      138,210
Long-term debt, less current portion ................           --           --           --           --          564
Mandatorily redeemable convertible preferred stock...           --           --           --           --           --
Total stockholders' equity (deficit) ................        6,421        7,334       15,618       91,825      128,674
</TABLE>


                                       7
<PAGE>


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

     The following Management's Discussion and Analysis contains forward-looking
statements within the meaning of Federal securities laws. You can identify these
statements because they use forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," "continue," "believe" and "intend" or other
similar words. These words, however, are not the exclusive means by which you
can identify these statements. You can also identify forward-looking statements
because they discuss future expectations, contain projections of results of
operations or of financial conditions, characterize future events or
circumstances or state other forward-looking information. We have based all
forward-looking statements included in this Management's Discussion and Analysis
on information currently available to us, and we assume no obligation to update
any of these forward-looking statements. Although we believe that the
expectations reflected in any of these forward-looking statements are based on
reasonable assumptions, actual results could differ materially from those
projected in the forward-looking statements. Potential risks and uncertainty
include, among others, those set forth in the "Risk Factors" section. The
following discussion should be read in conjunction with the consolidated
financial statements and notes thereto included in Item 8 of this Form 10-K.

OVERVIEW

     Through January 2003, we provided an open platform that enabled the digital
delivery of media over the Internet.

     Since January 2003, we have not operated any business.

     On March 18, 2003, our Board acknowledged that many of our outstanding
options, whether or not currently exercisable, have exercise prices
significantly higher than the current market price of our current stock, and
therefore, in recognition of the $2.50 per share cash distribution made to
stockholders on January 29, 2003, unilaterally approved a reduction in the
exercise price for all options by $2.50. The Board further resolved that such
reduction will in no event reduce the exercise price of any options to less than
$0.10 per share.

     As a result of this reduction in option exercise price, all outstanding
options will be treated for financial reporting purposes as variable awards.
This means that we will be required to record non-cash accounting charges or
credits for compensation expense reflecting any increases and decreases in the
price of our common stock. We will have to continue to reflect decreases and
increases in the price of our common stock in our statement of operations with
respect to the options until they are exercised, forfeited or terminated. In
recording these accounting charges or credits, the higher the market value of
our common stock, the greater the non-cash compensation expense.

     We entered into a Settlement Agreement and Mutual Release on February 12,
2004 which finally resolved all matters between BeMusic and us with respect to
the litigation matter with SightSound. Under the terms of this Agreement, we
paid approximately $1,452,000 to BeMusic as settlement expenses and
approximately $314,000 in legal fees relating to the SightSound litigation.
These payments were in addition to $335,827 previously paid by us for our share
of attorney fees incurred in connection with this matter.

CORPORATE RESTRUCTURINGS

     In January 2003, we adopted a corporate restructuring program, consisting
of a worldwide workforce reduction, in connection with the sale of our digital
music fulfillment business and related assets to Geneva Media, LLC ("Geneva"),
an affiliate of Anderson Merchandisers, LP. A restructuring charge of $4,441,000
was recorded in operating expenses for the year. The restructuring charge
included involuntary separation costs of $796,000 for 29 employees worldwide,
lease termination fees of $3,569,000 and asset impairment costs of $46,000 for
prepaid expenses related to assets sold to Geneva. We terminated our last
remaining employee on September 4, 2004, as a result of which we paid
termination and accrued vacation payments of $10,592. We closed our office in
Foster City, California and as of September 30, 2004, we had no employees and
are focused on settling our claims and liabilities and pursuing other uses for
the remainder of our assets.

FUTURE OPERATIONS AND FINANCIAL RESULTS

     We have been settling our remaining claims and liabilities while reviewing
alternatives for the use or disposition of our remaining assets. We intend to
pursue other business opportunities and investments unrelated to the downloading
of digital music. Neither our Board nor our stockholders have yet approved any
such opportunities. If we are unable to find any suitable business opportunities
and/or investments, we may pursue a plan of complete liquidation and
dissolution. If a complete liquidation and dissolution is approved, pursuant to
Delaware General Corporation Law, we will continue to exist for three years
after the dissolution becomes effective or for such longer period as the
Delaware Court of Chancery shall direct, for the purpose of prosecuting and
defending suits against us and enabling us gradually to close our business, to
dispose of our property, to discharge our liabilities and to distribute to our
stockholders any remaining assets.

     Our common stock currently trades over the counter on The Nasdaq OTC
Bulletin Board. Our common stock was traded on The Nasdaq National Market, but
was delisted on June 5, 2003. The market price per share of our common stock
increased significantly following the implementation of the Reverse/Forward
stock split. The market price of our common stock as of March 17, 2005 was $1.67
per share.

     At our September 29, 2003 meeting of our stockholders, our stockholders
approved amendments to our certificate of incorporation to effect a 1-for-250
reverse stock split, to be followed immediately by a 35-for-1 forward stock
split (collectively, the "Reverse/Forward Stock Split"), as well as a reduction
in the number of common shares authorized for issuance from 50,000,000 shares to
30,000,000 shares (the "Share Reduction"). On June 7, 2004, we filed the
amendments necessary to implement the Reverse/Forward stock split and the Share
Reduction, which took place on July 26, 2004 with an effective date as of June
8, 2004.

                                       8
<PAGE>

RESULTS OF OPERATIONS

     The following table sets forth, for the periods presented, certain data
derived from our statement of operations as a percentage of total net revenues.
At present, we have no plans for operating any business, so the operating
results in any period are not indicative of the results, if any, that may be
expected for any future period.


                                                        YEAR ENDED DECEMBER 31,
                                                       -------------------------
                                                       2004    2003      2002
                                                       ----  ---------  --------
Net revenues:
   License............................................   --     9%         22%
   Services...........................................   --     91         78
   Business development (related party)...............   --     --         --
                                                             ---------  --------
      Total net revenues..............................   --    100        100
                                                             ---------  --------
Cost of net revenues:
   License............................................   --     12         80
   Services...........................................   --      5        136
   Business development (related party)...............   --     --         --
   Non-cash cost of revenues..........................   --     --         17
                                                             ---------  --------
      Total cost of net revenues......................   --     16        233
                                                             ---------  --------
Gross profit (loss)...................................   --     84       (133)
                                                             ---------  --------

Operating expenses:
   Sales and marketing................................   --    644        781
   Non-cash sales and marketing.......................   --     --        (6)
   Research and development...........................   --    384       1,890
   Non-cash research and development..................   --     --          1
   General and administrative.........................   --    155       2,223
   Non-cash general and administrative................   --     --         --
   Impairment loss....................................   --     --        143
   Strategic marketing-equity instruments.............   --     --         --
   Restructuring......................................   --   10,258      241
                                                             ---------  --------
      Total operating expenses........................   --   26,769     5,273
                                                             ---------  --------

Loss from operations..................................   --  (26,686)   (5,406)
Other income (expense), net...........................   --    728        390
Gain on sale of intellectual property.................   --     --       1,452
Gain on sale of Digital Music fulfillment business....   --    6,670       --
Merger termination fee................................   --     --       (435)
Loss in equity investment.............................   --     --         --
                                                             ---------  --------
Net loss..............................................   --  (14,288)%  (3,999)%
                                                             =========  ========

YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

     TOTAL NET REVENUES. Total net revenues were $0 in 2004 compared to $42,860
in 2003 and $482,000 in 2002.

     LICENSE. License revenues primarily consisted of fees from licensing our
software products to third parties. License revenues were $0 in 2004 compared to
$4,000 in 2003 and $108,000 in 2002. License revenues decreased 100% in 2004
from $4,000 in 2003. License revenues decreased 96% in 2003 from $108,000 in
2002. The decrease in 2004 and 2003 were due to the cessation of our operating
business activity.

     SERVICES. Services revenues consisted of maintenance fees related to our
licensed software products, hosting fees, encoding, music delivery and
transaction fees, promotion and advertising services and kiosk-related equipment
sales from third parties. Services revenues were $0 in 2004, $39,000 in 2003 and
$374,000 in 2002. Service revenues decreased 100% in 2004 from $39,000 in 2003.
Service revenues decreased 90% in 2003 from $374,000 in 2002. The decrease in
2004 and 2003 were primarily due to the cessation of our business activity.

                                       9
<PAGE>

TOTAL COST OF NET REVENUES

     Our gross profit (loss) decreased to approximately 0% of total net revenues
in 2004 from approximately 84% of total net revenues in 2003, and approximately
(133)% in 2002. Total cost of net revenues decreased 100% to $0 in 2004 from
$7,000 in 2003 and $1.1 million in 2002.

     LICENSE. Cost of license revenues primarily consisted of royalties paid to
third-party technology vendors and costs of documentation, duplication and
packaging. Cost of license revenues decreased 100% to $0 in 2004, 98% to $5,000
in 2003 from $388,000 in 2002. Cost of license revenue decreased in 2004 and
2003 due to the cessation of our operating business activity.

     SERVICES. Cost of services revenues primarily consisted of compensation for
customer service, encoding and professional services personnel, kiosk-related
equipment and an allocation of our occupancy costs and other overhead
attributable to our services revenues. Cost of services revenues decreased 100%
to $0 in 2004 from $2,000 in 2003, and 100% in 2003 from $654,000 in 2002. The
decreases in 2004 and 2003 in cost of services revenue were due to the cessation
of our operating business activity.

     NON-CASH COST OF REVENUES. Non-cash cost of revenues consisted of expenses
associated with the value of common stock and warrants issued to partners as
part of our content acquisition agreements and stock-based employee compensation
arrangements. Common stock expense is based on the fair value of the stock at
the time it was issued. Warrant expense is based on the estimated fair value of
the warrants based on the Black-Scholes option pricing model and the provisions
of EITF 96-18. In December 2000, we signed an agreement with BMG Entertainment
to obtain the right to distribute BMG sound recordings and related artwork
through kiosks. In connection with this agreement, we issued 50,000 shares of
common stock to BMG, valued at $195,000 and which was recognized ratably over
the initial one-year term of the agreement; as a result, $181,000 and $14,000
was recognized as non-cash cost of revenues in 2001 and 2000, respectively. In
connection with this agreement, we granted a warrant for a total of 233,300
shares of common stock. Of the total, warrants to purchase 77,768 shares vested
in December 2001, and the cost was remeasured each quarter until a commitment
for performance was reached or the warrant vested based on market data. At
December 4, 2001, the 77,768 shares under this warrant were valued at $175,000,
of which $163,000 and $12,000 was recognized as non-cash cost of revenues in
2001 and 2000, respectively. The remaining warrants to purchase common shares
were scheduled to vest at 6,481 shares per month commencing December 2001 for
one year and 6,480 shares per month commencing December 2002 for one year. We
had the option to terminate the agreement, repurchase the 50,000 shares of
common stock and provide for the warrants to expire immediately if BMG failed to
make available to us a specified minimum number of sound recordings in a
specific time period. BMG failed to make the minimum number of sound recordings
in the specific time period, and accordingly in August 2002, we terminated the
agreement, repurchased the 50,000 shares of common stock, notified BMG of the
immediate expiration of the warrants and ceased recognizing non-cash cost of
revenues for the warrants. We recorded a total of $82,000 as non-cash cost of
revenue in 2002 related to the remaining warrants. Such warrants were valued at
the fair market value of our common stock at each vesting date. Stock based
compensation expense (income) for customer service, encoding and professional
services personnel was $0 in 2004, 2003 and 2002. We have fully amortized stock
compensation expense related to these personnel in 2001, and accordingly no
future expense related to these stock options will be incurred.

OPERATING EXPENSES

     SALES AND MARKETING. Sales and marketing expenses consisted primarily of
compensation for our sales, marketing and business development personnel,
compensation for customer service and professional services personnel
attributable to sales and marketing activities, advertising, trade show and
other promotional costs, design and creation expenses for marketing literature
and our website and an allocation of our occupancy costs and other overhead.
Sales and marketing expenses decreased 100% to $0 in 2004 from $277,000 in 2003
and 99% in 2003 from $3.8 million in 2002. The decrease in 2004 and 2003 were
due to the cessation of business activity and termination of all remaining sales
and marketing personnel.

     RESEARCH AND DEVELOPMENT. Research and development expenses consisted
primarily of compensation for our research and development, network operations
and product management personnel, payments to outside contractors and, to a
lesser extent, depreciation on equipment used for research and development and
an allocation of our occupancy costs and other overhead. Research and


                                       10
<PAGE>

development expenses decreased 100% in 2004 to $0 from $165,000 in 2003 and
decreased 99% in 2003 from approximately $9.1 million in 2002. The decrease in
2004 and 2003 were due to the cessation of business activity and the termination
of all remaining research and development personnel.

     GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased
86% to $0.9 million in 2004 from $6.6 million in 2003. General and
administrative expenses decreased 38% to $6.6 million in 2003 from $10.7 million
in 2002. The decrease in 2004 was due to the cessation of operating business
activity. The decrease in 2003 was due to the cessation of business activity
and, with the exception of one employee, the termination of all remaining
general and administrative personnel and the termination of leases for all
company premises. General and administrative expenses in 2004 include, directors
and officers liability insurance premium payments of approximately $224,000,
legal expenses of approximately $229,000, professional services for audit and
accounting of approximately $77,000, management fees of approximately $141,000
and director remuneration of $116,000. General and administrative expenses in
2003 include, directors and officers liability insurance premium payments of
approximately $1.2 million, payments relating to facilities of approximately $2
million, legal expenses of approximately $1.5 million and consulting expenses of
approximately $1 million. General and administrative expenses in 2002 consist
primarily of compensation for personnel and payments to outside contractors for
general corporate functions, including finance, information systems, human
resources, facilities, legal and general management, fees for professional
services, bad debt expense and an allocation of our occupancy costs and other
overhead.

     IMPAIRMENT LOSS. Impairment loss consists of a write-down of our property
and equipment to fair value. Our property and equipment were impaired when we
terminated our merger agreement with Alliance in November 2002. If the merger
had been approved, our property and equipment would have remained in use with
the continuation of our digital music fulfillment business under the combined
entity. When we terminated our merger agreement with Alliance, certain property
and equipment were no longer in use and we had to impair the economic life of
the property and equipment remaining in use. In January 2003, we announced the
sale of our digital music fulfillment business and related assets to Geneva.
These assets included certain property and equipment. We determined the fair
value of the assets remaining in use and those assets sold to Geneva based on
quoted market prices obtained from a business auction and valuation firm dealing
in similar assets. As a result of the foregoing, we recorded an impairment loss
of $689,000 in the three months ended December 31, 2002.

     NON-CASH SALES AND MARKETING, RESEARCH AND DEVELOPMENT AND GENERAL AND
ADMINISTRATIVE. Non-cash sales and marketing, research and development and
general and administrative expenses relate to stock-based employee compensation
arrangements. The total unearned compensation recorded by us from inception to
December 31, 2004 was $3.5 million. We recognized $0, $0 and $(21,000) of stock
compensation expense (income) for 2004, 2003 and 2002, respectively. The income
amounts in 2004, 2003 and 2002 relate to the adjustment of cumulative expense
attributable to employees terminated in those periods from accelerated
amortization to straight-line amortization during the terminated employees'
service periods. We have fully amortized stock compensation expense related to
these personnel in 2002, and accordingly no future expense related to these
stock options will be incurred.

     RESTRUCTURING- RESTRUCTURING CHARGE RELATES TO COSTS ASSOCIATED WITH OUR
CORPORATE RESTRUCTURING PROGRAM. We had no costs related to our restructuring in
2004. A $4.4 million charge in 2003 consisted of involuntary employee separation
costs of $796,000 and costs of $3,569,000 pertaining to lease termination
payments for certain facilities that were vacated due to reductions in our work
force. A $1.2 million charge in 2002 consisted of involuntary separation costs
of $852,0000, lease termination costs of $155,000 and asset impairment costs of
$156,000 for property and equipment no longer in use.

     INTEREST INCOME. Interest income consists of earnings on our cash, cash
equivalents and short-term investments. Interest income decreased to $148,000 in
2004 from $242,200 in 2003, and decreased in 2003 from $1.3 million in 2002. The
decreases in 2004 and 2003 were due to lower average cash and cash equivalent
balances resulting from cash used in operating activities, and lower interest
rates.

     INTEREST EXPENSE. Interest expense consists of expenses related to our
financing obligations, which include borrowings under equipment loans,
short-term loans and capital lease obligations. Interest expense decreased to $0
in 2004 and 2003 from $(50,000) in 2002. The declines in 2004 and 2003 are due
to the expiration of several capital leases expiring prior to such periods.

                                       11
<PAGE>

     OTHER INCOME (EXPENSE), Other income (expense) decreased to $(27,000) in
2004 from $71,000 in 2003 and decreased from $489,000 in 2002. The decrease
reflects an overall decrease in investing activity. Other income of $489,000 in
2002 consists primarily of the extinguishment of a note payable to a related
party, which was canceled by the related party in December 2002.

     GAIN ON SALE OF INTELLECTUAL PROPERTY AND DIGITAL MUSIC FULFILLMENT
BUSINESS. Gain on sale of intellectual property relates to the sale of our
Digital Music fulfillment business to Microsoft Corporation in September 2002
and to Geneva in January 2003.

     MERGER TERMINATION FEE. Merger termination fee consists of a payment to
Alliance of $2.1 million in connection with the termination of the merger
agreement between us and Alliance in 2002.

CONTRACTUAL OBLIGATIONS

     We did not have any contractual commitments and obligations as of December
31, 2004, including any long-term debt obligations, capital lease obligations,
operating lease obligations or purchase obligations, within the meaning of the
current rules of the Securities and Exchange Commission.

CRITICAL ACCOUNTING POLICIES

     Our critical accounting policies are as follows:

     o   revenue recognition;

     o   estimating valuation allowances, specifically the allowance for
         doubtful accounts and sales returns reserve;

     o   accounting for contingencies; and

     o   accounting for income taxes.

     REVENUE RECOGNITION. To date, we have derived our revenues primarily from
the licensing of software products and service fees associated with business
development contracts. Business development revenues primarily consist of
license and maintenance fees from agreements under which we gave our strategic
related partners ("Partners") the right to license and use our digital recorded
music delivery technology. These U.S. dollar-denominated, non-refundable fees
are allocated among the various elements of the contract based on vendor
specific objective evidence ("VSOE") of fair value. VSOE of fair values for the
ongoing maintenance and support obligations are based upon the prices paid for
the separate renewal of these services by the customer or upon substantive
renewal rates stated in the contractual arrangements. VSOE of the fair value of
other services, primarily consulting services, is based upon separate sales of
these services. When VSOE of fair value exist for the undelivered elements,
primarily maintenance, we account for the license portion based on the "residual
method" as prescribed by SOP No. 98-9, "Modification of SOP 97-2 with Respect to
Certain Transactions." When VSOE of fair value does not exist for the
undelivered elements, we recognized the total fee from a business development
contract ratably over the term of the contract. The total fee from business
development arrangements was recognized when payments became due if extended
payment terms existed. Extended payment terms are defined as payment terms
outside our customary business practice, generally greater than 90 days. Revenue
is not recognized if the Partners stop making their contractual payments. We
also licensed our software products to original equipment manufacturers, record
companies, artists and websites. Software license revenues were recognized when
persuasive evidence of an arrangement exists, the fee is fixed and determinable,
collection is probable and delivery has occurred. Similarly with business
development contracts, the total fee from the arrangement is allocated among the
various elements based on VSOE of fair value. Maintenance revenue related to our
licensed software products and hosting revenue from record companies and artists
were recognized over the service period, typically one year. Revenue derived
from hosting services include subscription fees from artists for encoding and
storing music files, e-commerce services and transaction reporting. Music
delivery services revenues include transaction fees from sales of digital
recorded music through our LMN website affiliates and fees from music retailers
and websites related to the sample digital music clips delivery service. Revenue
from kiosk sales consisted of software licenses and services revenue from
equipment and kiosk-related services.

                                       12
<PAGE>

     ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS RESERVE. The preparation
of financial statements requires our management to make estimates and
assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Specifically, our management must make estimates of the uncollectability of our
accounts receivables. Management specifically analyzes accounts receivable and
analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in our customer payment terms
when evaluating the adequacy of the allowance for doubtful accounts. Similarly,
our management must make estimates of the potential future product returns
related to current period product revenue. Management analyzes historical
returns, current economic trends, and changes in customer demand and acceptance
of our products when evaluating the adequacy of the sales returns reserve.
Significant management judgments and estimates must be made and used in
connection with establishing the allowance for doubtful accounts and sales
returns reserve in any accounting period. Material differences may result in the
amount and timing of our revenue and bad debt expense for any period if
management made different judgments or used different estimates. Our accounts
receivable from third parties balance was $0, net as of December 31, 2004.

     ACCOUNTING FOR CONTINGENCIES. We are subject to various legal proceedings
and claims, the outcomes of which are subject to significant uncertainty. SFAS
5, Accounting for Contingencies, requires that an estimated loss from a loss
contingency should be accrued by a charge to income if it is probable that an
asset has been impaired or a liability has been incurred and the amount of the
loss can be reasonably estimated. Disclosure of a contingency is required if
there is at least a reasonable possibility that a loss has been incurred. We
evaluate, among other factors, the degree of probability of an unfavorable
outcome and the ability to make a reasonable estimate of the amount of loss.
Changes in these factors could materially impact our financial position or
results of operations.

     ACCOUNTING FOR INCOME TAXES. As part of the process of preparing our
consolidated financial statements we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves us
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred
revenue, for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within our consolidated balance
sheet. We must then assess the likelihood that our deferred tax assets will be
recovered from future taxable income and to the extent we believe that recovery
is not likely, we must establish a valuation allowance. To the extent we
establish a valuation allowance or increase this allowance in a period, we must
include an expense within the tax provision in the statement of operations.

     Significant management judgment is required in determining our provision
for income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. We have recorded a
valuation allowance of $8,701,000 as of December 31, 2004, due to uncertainties
related to our ability to utilize some of our deferred tax assets, primarily
consisting of certain net operating losses carried forward, before they expire.
The valuation allowance is based on our estimates of taxable income by
jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable. In the event that actual results differ from these
estimates or we adjust these estimates in future periods we may need to
establish an additional valuation allowance which could materially impact our
financial position and results of operations.


     NEW ACCOUNTING PRONOUNCEMENTS.

     In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123(R), "Accounting for Stock-Based Compensation (Revised)." SFAS No.
123(R) supersedes APB No. 25 and its related implementation guidance. SFAS No.
123(R) establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. SFAS No. 123(R)
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. SFAS No. 123(R) requires
a public entity to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period
during which an employee is required to provide service in exchange for the
award the requisite service period (usually the vesting period). No compensation
costs are recognized for equity instruments for which employees do not render
the requisite service. The grant-date fair value of employee share options and
similar instruments will be estimated using option-pricing models adjusted for


                                       13
<PAGE>

the unique characteristics of those instruments (unless observable market prices
for the same or similar instruments are available). If an equity award is
modified after the grant date, incremental compensation cost will be recognized
in an amount equal to the excess of the fair value of the modified award over
the fair value of the original award immediately before the modification.

     The Company has not completed its evaluation of SFAS No. 123(R) but expects
the adoption of this new standard will not have a material impact on operating
results of the Company.

LIQUIDITY AND CAPITAL RESOURCES

     Since inception, we have financed our operations primarily through the
initial and follow-on public offerings of common stock, private placements of
our preferred stock, equipment financing, lines of credit and short-term loans.
As of December 31, 2004, we had raised $65.9 million and $93.7 million through
our initial and follow-on public offerings of common stock, respectively, and
$29.8 million through the sale of our preferred stock. In January 2003, we
distributed $57.7 million to our common stockholders of record as of December
10, 2002. At December 31, 2004, we had approximately $6.4 million of cash and
cash equivalents.

     Net cash used in operating activities was $2.5 million, $10.3 million and
$18.1 million in 2004, 2003 and 2002, respectively. Net cash used in operating
activities in 2004 was primarily the result of net losses from operations of
$847,000, legal expense of $360,000 and the settlement in the BeMusic litigation
of $1.4 million. Net cash used in operating activities in 2003 was the result of
net losses from operations of $8.3 million, the gain on the sale of our digital
music fulfillment business and related assets of $2.8 million, a decrease in
accounts payable of $1.2 million, offset by a decrease in depreciation and
amortization of $226,000 and the recovery of restricted cash of $826,000
relating to the lease termination of our Redwood City facility. Net cash used
for operating activities in 2002 was primarily the result of net losses from
operations of $19.2 million, net of non-cash items including depreciation and
amortization of $2.3 million, amortization of unearned compensation of
$(21,000), note payable write-off of $(343,000) and loss on disposal and
impairment of property and equipment of $804,000, and a net decrease in working
capital items of $1.7 million. The net decrease in working capital items include
a decrease in accounts receivable of $70,000, increase in other assets of
$106,000, increase in accounts payable of $111,000, decrease in accrued
liabilities of $1.7 million and a decrease in deferred revenue of $83,000.

     Net cash provided by (used in) investing activities was $0, $3.2 million
and $(87,000) in 2004, 2003 and 2002, respectively. The net cash provided in
2003 was from the sale of our digital music fulfillment business and related
assets. The net cash used by investing activities in 2002 was due to the
acquisition of property and equipment.

     Net cash provided by (used in) financing activities was $(67,000), $(57.7)
million, and $626,000 in 2004, 2003 and 2002, respectively. The net cash used in
financing activities in 2004 was due to the purchase of fractional interests in
connection with the implementation of the Reverse/Forward stock split. The net
cash used in financing activities in 2003 of $57.7 million was from the cash
distribution to our shareholders of $2.50 per share on January 29, 2003. The net
cash provided in financing activities in 2002 was primarily due to proceeds from
sales of our common stock under our stock option and employee stock purchase
plans of $823,000, partially offset by payments of $169,000 made under our
equipment loan and $28,000 under capital leases.

     We have no material commitments for capital expenditures or strategic
investments and anticipate a low rate of capital expenditures. We anticipate
that we will experience a decline in our operating expenses for the foreseeable
future and that our operating expenses will be a material use of our cash
resources.

     We also, as permitted under Delaware law and in accordance with our Bylaws,
indemnify our officers and directors for certain events or occurrences, subject
to certain limits, while the officer is or was serving at our request in such
capacity. The term of the indemnification period is for the officer's or
director's lifetime. The maximum amount of potential future indemnification is
unlimited; however, we have a Director and Officer Insurance Policy that limits
our exposure and enables us to recover a portion of any future amounts paid. As
a result of our insurance policy coverage, we believe the fair value of these
indemnification agreements is minimal.

                                       14
<PAGE>

     We believe that our existing cash and cash equivalents will be sufficient
to meet our anticipated cash needs for working capital and capital expenditures
in the near future. However, uncertainties exist as to the precise value of
claims and liabilities, which may exceed our current existing cash and cash
equivalents. Additionally, if we decide to pursue a business strategy unrelated
to digital music distribution, we may need additional cash resources. See Part
I. "Business - Company Risk Factors"

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     None.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Reference is made to the Index to Financial Statements which appears on
page F-1 of this report. The Reports of Independent Registered Public Accounting
Firms, Financial Statements and Notes to Financial Statements which are listed
in the Index to Financial Statements and which appear beginning on page F-2 of
this report are incorporated into this Item 8.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     None.

ITEM 9A. CONTROLS AND PROCEDURES

     Based on the evaluation of the effectiveness of our disclosure controls and
procedures by our management, with the participation of our chief executive
officer and our chief financial officer, as of the end of the period covered by
this report, our chief executive office and our chief financial officer have
concluded that our disclosure controls and procedures were effective to ensure
that information required to be disclosed in the reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported, within the time periods specified in the Commission's rules and forms.

     No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended December 31, 2004 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.

ITEM 9B.  OTHER INFORMATION

     None.

                                       15
<PAGE>

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The following table presents our directors and executive officers, their
ages and the positions held by them as of March 17, 2005:

     NAME                                   AGE    POSITION
     William J. Fox.........................48     President, Chief Executive
                                                   Officer and Director
     Melvyn Brunt...........................61     Chief Financial Officer
                                                   and Secretary
     James A. Mitarotonda...................50     Chairman and Director
     Steven Berns...........................40     Director
     Stephen Liguori........................48     Director
     Michael A. McManus. Jr.................61     Director

     MR. FOX has served as one of our directors since April 2003 and has served
as our President and Chief Executive Officer since October 7, 2004. Mr. Fox was
Chairman, President and Chief Executive Officer of AKI Inc. and President and
CEO of AKI Holdings, Inc., an international specialty marketing services
business, from February 1999 until October 2004. From September 1991 until
January 1999, Mr. Fox was an executive of Revlon Inc. (NYSE: REV) and of Revlon
Consumer Products Corporation ("RCPC"), holding various positions, including
Senior Executive Vice President of Revlon, Inc., President of Strategic and
Corporate Development, Revlon Worldwide, Chief Executive Officer of Revlon
Technologies, and, until December 1997, was Chief Financial Officer of Revlon,
Inc. Mr. Fox was concurrently Senior Vice President of MacAndrews & Forbes
Holdings Inc. ("MacAndrews"). Mr. Fox was a director of Revlon Inc. and RCPC
from 1994 until April 1999. At various times, beginning in April 1983, Mr. Fox
was also an executive officer of several affiliates of MacAndrews and Revlon,
including Technicolor Inc., The Coleman Company, New World Entertainment and
Revlon Group Incorporated. Mr. Fox served as a director and non-executive
Co-Chairman of Loehmann's Holdings Inc. from October 2000 until October 2004.
Mr. Fox currently serves as Vice Chairman of Barington Capital Group, L.P. and
certain of its affiliates and has been the President, Chief Executive Officer
and a director of Dynabazaar, Inc. (OTCBB:FAIM) since December 2004. Mr. Fox is
also a director of Nephros, Inc. (AMEX:NEP).

     MR. BRUNT has served as our Chief Financial Officer and Secretary since
April 2003. He has also served as Chief Financial Officer to Barington Capital
Group, L.P. since January 2002 and as Chief Financial Officer and Secretary to
Dynbazaar, Inc. (OTCBB:FAIM) since January 2004. In addition, from January 2002
to May 2004, he served as Chief Financial Officer and Secretary to MM Companies,
Inc. (OTCBB:MMCO). From 1985 to 2001, Mr. Brunt was a Director and Chief
Financial Officer of Davies Turner & Co., an international freight forwarding
company with offices throughout the United States. From 1996 to 2001, Mr. Brunt
was President of Air Mar, Inc. and a Director of TCX International Inc. Both of
those companies provided logistics support services to a wide variety of
importing and exporting companies.

     MR. MITAROTONDA has served as one of our directors since September 2002,
our Co-Chairman from April 2003 until May 2004 and our sole Chairman since May
2004. He served as our Co-Chief Executive Officer from April 2003 until May 2004
and our sole Chief Executive Officer from May 2004 to October 7, 2004. Mr.
Mitarotonda is Chairman of the Board, President and Chief Executive Officer of
Barington Capital Group, L.P., an investment firm that he co-founded in November
1991. Mr. Mitarotonda is also the Managing Director of Barington Companies
Offshore Fund, Ltd. and President and Chief Executive Officer of Barington
Companies Investors, LLC, the general partner of Barington Companies Equity
Partners, L.P., a small capitalization value fund which seeks to be actively
involved with its portfolio companies in order to enhance shareholder value. Mr.
Mitarotonda is also a director of Register.com (NASDAQ:RCOM) and Dynabazaar,
Inc. (OTCBB:FAIM) and served as the President and Chief Executive Officer of
Dynabazaar, Inc. from January 2004 until December 2004. In May 1988, Mr.
Mitarotonda co-founded Commonwealth Associates, an investment banking, brokerage
and securities trading firm. Mr. Mitarotonda served as Chairman of the Board and
Co-Chief Executive Officer of JMJ Management Company Inc., the general partner
of Commonwealth Associates.

                                       16
<PAGE>

     MR. BERNS has served as one of our directors since October 2004. He has
been the Vice Chairman and Executive Vice President of MDC Partners, Inc.
(NASDAQ:MDCA) since September 2004. From August 1999 until September 2004, Mr.
Berns was the Senior Vice President and Treasurer of The Interpublic Group of
Companies, Inc. (NYSE:IPG), an organization of advertising agencies and
marketing services companies. Before that, Mr. Berns held a variety of positions
in finance at Revlon, Inc. (NYSE:REV) from April 1992 until August 1999,
becoming Vice President and Treasurer in 1996. Prior to joining Revlon, Mr.
Berns worked at Paramount Communications Inc. and at a predecessor public
accounting firm of Deloitte & Touche. Mr. Berns has served as a director for
Liveperson, Inc. (NASDAQ:LPSN) since April 2002.

     MR. LIGUORI has served as one of our directors since October 2004. From
January 2001 until January 2005, Mr. Liguori was a Managing Director and the
Chief Retail Marketing Officer of Morgan Stanley's Individual Investor Group, a
group that provides investment products and services for individuals. From June
2000 to October 2000, Mr. Liguori was the head of Citibanking North America's
E-Consumer Division and from June 1998 to June 2000, was a Business Manager at
Citibanking, N.A. Before joining Citibank, Mr. Liguori worked in general
management and strategic marketing with the Kraft/Phillip Morris organization
(NYSE:KFT) and Pepsico (NYSE:PEP).

     MR. MCMANUS has served as one of our directors since April 2003. Mr.
McManus has been President and Chief Executive Officer of Misonix, Inc.
(NASDAQ:MSON), a medical device company since November 1998. He was President
and Chief Executive Officer of New York Bancorp Inc. ("NYBI") from 1991 to 1998,
a director of NYBI from 1990 to 1998 and a director and Vice Chairman of Home
Federal Savings Bank, NYBI's subsidiary, from 1991 to 1998. He is also a
director of NWH, Inc. (NASDAQ:NWIR), American Home Mortgage Holdings, Inc.
(NYSE:AMH) and Novavax, Inc. (NASDAQ:NVAX). He has served in numerous government
capacities, including Assistant to the President of the United States from 1982
to 1985 and as Special Assistant to the Secretary of Commerce during the Ford
Administration.

     There is no family relationship between any of the foregoing directors or
between any of such directors and any of our executive officers.

AUDIT COMMITTEE

     The Audit Committee currently consists of Steven Berns (Chairman), Steve
Liquori and Michael McManus. The Board has determined that each member is
"independent" under the NASD's listing standards and the applicable rules of the
Securities Exchange Commission (the "SEC"), that each member is "financially
literate" under the NASD's listing standards and that Mr. Berns qualifies as an
Audit Committee Financial Expert under the applicable rules of the SEC.

     The Audit Committee hires our independent accountants and is charged with
the responsibility of overseeing our financial reporting process. In the course
of performing its functions, the Audit Committee reviews, with management and
the independent accountants, our internal accounting controls, the annual
financial statements, the report and recommendations of the independent
accountants, the scope of the audit and the qualifications and independence of
the auditors. A copy of the Audit Committee charter as adopted by the Board on
October 7, 2004 is available upon request to the following address: L Q
Corporation, Inc., 888 Seventh Avenue, 17th Floor, New York, NY, 10019, Attn:
Secretary.

CODE OF BUSINESS CONDUCT AND ETHICS

     We have adopted a Code of Business Conduct and Ethics that applies to our
directors, officers, senior management and certain other employees, including
our principal executive officer, principal financial officer, principal
accounting officer or controller or persons performing similar functions. We
will provide a copy of our Code of Business Conduct and Ethics to any person
without charge, upon request. Requests for a copy of the Code of Business
Conduct and Ethics can be made in writing to the following address: L Q
Corporation, Inc., 888 Seventh Avenue, 17th Floor, New York, NY, 10019, Attn:
Secretary.

                                       17
<PAGE>

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Section 16(a) of the Securities Exchange Act of 1934 requires our officers
and directors, and persons who own more than 10% of a registered class of the
our equity securities, to file certain reports regarding ownership of, and
transactions in, our securities with the SEC and with Nasdaq. Such officers,
directors and 10% shareholders are also required by SEC rules to furnish us with
copies of all Section 16(a) forms that they file.

     Based solely on our review of copies of Forms 3, 4, 5 and amendments
thereto furnished to us and representations made to us, we believe that during
the fiscal year ended December 31, 2004 all reports required by Section 16(a) to
be filed by our officers and directors and 10% beneficial owners were filed on a
timely basis, except as follows: (i) Joseph R. Wright, Jr. filed late his
Initial Statement of Beneficial Ownership of Securities on Form 3; and (ii)
James A. Mitarotonda filed late one Statement of Changes in Beneficial Ownership
on Form 4 relating to certain acquisitions of shares of common stock of the
Company.

BOARD COMPOSITION

     We currently have five directors. At our December 22, 2004 meeting of our
stockholders, our stockholders voted in favor of an amendment to our certificate
of incorporation to eliminate the classification of our board of directors into
three classes with staggered three-year terms, and all directors hereafter will
be elected for one-year terms at each annual meeting of stockholders.

     Our board of directors is currently comprised of five (5) members, namely,
James A. Mitarotonda, Steven Berns, William J. Fox, Michael A. McManus, Jr. and
Stephen Liguori.

     Each officer is elected by, and serves at the discretion of, the Board.
Each of our officers and directors, devote the amount of time necessary to
discharge their duties to the Company. There are no family relationships among
any of our directors, officers or key employees.


ITEM 11.  EXECUTIVE COMPENSATION

     The following table sets forth the total compensation received for services
rendered to us for the years ended December 31, 2004, 2003 and 2002 by our Chief
Executive Officer, individuals who served as our Chief Executive Officer during
2004 and our Chief Financial Officer (Named Executive Officers).


<TABLE>
<CAPTION>
                                                                                                  LONG-TERM
                                                                  ANNUAL COMPENSATION            COMPENSATION
                                                      ----------------------------------------   ------------
                                                                                                 # SECURITIES
                                                                                  OTHER ANNUAL    UNDERLYING
NAME AND PRINCIPAL POSITION                           YEAR    SALARY      BONUS   COMPENSATION   OPTIONS/SARS
----------------------------------------------------  ----    ------      -----   ------------   ------------
<S>                                                   <C>    <C>            <C>        <C>          <C>
  William J. Fox, Chief Executive Officer...........  2004   $15,000        --         --              --
                                                      2003      --          --         --              --
                                                      2002      --          --         --              --

  James A. Mitarotonda, Chairman and Chief..........  2004   $37,000        --         --              --
  Executive Officer (resigned as Chief Executive      2003   $46,487        --         --            63,000
  Officer on October 2004)                            2002      --          --         --              --

  Seymour Holtzman, Co-Chairman and Co-Chief........  2004   $20,000        --         --              --
  Executive Officer (resigned as Co-Chairman and      2003   $10,000        --         --            63,000
  Co-Chief Executive Officer in May 2004)             2002      --          --         --              --

  Melvyn Brunt, Chief Financial Officer.............  2004     (1)          --         --              --
                                                      2003     (1)          --         --            14,000
                                                      2002      --          --         --              --
________
</TABLE>

     (1) From April 2003 through May 16, 2004, the Company paid Barington
Capital Group, L.P. ("Barington") a monthly fee of $7,290 for certain
administrative and accounting services provided by Barington on its behalf,
which includes services performed by Mr. Brunt, the Chief Financial Officer of
Barington, on behalf of the Company. The Company entered into a new services
agreement with Barington dated as of November 18, 2004. Under this agreement,
the Company paid Barington $8,000 per month for providing certain
administrative, accounting and other services on its behalf in 2004. For more
information, see "Certain Relationships and Related Transactions" in Item 13 of
this Form 10-K.


                                      18
<PAGE>


OPTION GRANTS IN LAST FISCAL YEAR

     The following table provides information relating to stock options awarded
to each of the Named Executive Officers during the year ended December 31, 2004.
All such options were awarded under our 1996 Equity Incentive Plan. Number of
securities and exercise prices reflect the reverse-forward stock split which
took place on June 7, 2004.

     These options are either incentive stock options or nonqualified stock
options. Options are granted at an exercise price equal to the fair market value
of our Common Stock, as determined by the Board on the date of grant according
to the provisions of the 1996 Equity Incentive Plan.


<TABLE>
<CAPTION>
                                 INDIVIDUAL GRANTS
                   -----------------------------------------------
                                                                    POTENTIAL REALIZABLE
                                                                      VALUE AT ASSUMED
                                                                      ANNUAL RATES OF
                   NUMBER OF     PERCENT OF                             STOCK PRICE
                   SECURITIES  TOTAL OPTIONS                            APPRECIATION
                   UNDERLYING     GRANTED                            FOR OPTIONS TERM (1)
                    OPTIONS      IN FISCAL    EXERCISE  EXPIRATION  ----------------------
         NAME       GRANTED         2004        PRICE     DATE           5%        10%
-----------------  ----------  -------------  --------  ----------  ----------  ----------
<S>                 <C>             <C>         <C>     <C>
William Fox          67,347(2)       55         $1.82   11/16/2014    77,000     195,000
James Mitarotonda    56,000(3)       45         $1.82   11/16/2009    28,000      62,000
                   ----------  -------------
Total               123,347         100%
</TABLE>


(1)  The potential realizable value is calculated based on the term of the
     option at its time of grant, or 10 years. In accordance with the rules of
     the SEC, the following table also sets forth the potential realizable value
     over the term of the options, the period from the grant date to the
     expiration date, based on assumed rates of stock appreciation of 5% and 10%
     compounded annually. These amounts do not represent our estimate of future
     stock price performance. Actual realizable values, if any, of stock options
     will depend on the future performance of the common stock.

(2)  In November 2004, we granted options to purchase 67,347 shares of common
     stock to William J. Fox. One-third of the options vest on the one year
     anniversary of the grant date and the remainder vest ratably per month over
     the next two years.

(3)  In November 2004, we granted options to purchase 56,000 shares of common
     stock to Barington Capital Group, L.P. ("Barington") pursuant to the
     Administrative Services Agreement dated as of November 18, 2004. James
     Mitarotonda is the Chairman of the Board, President and Chief Executive
     Officer of Barington. The options granted to Barington are immediately
     exercisable.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES

     The following table provides summary information concerning stock options
held as of December 31, 2004 by each of the Named Executive Officers. Number of
securities and exercise prices reflect the reverse-forward stock split which
took place on June 7, 2004. The value of unexercised in-the-money options at
fiscal year-end is based on a price per share of $1.79 on December 31, 2004 less
the exercise price.


                                       19
<PAGE>

<TABLE>
<CAPTION>
                                                  NUMBER OF SECURITIES       VALUE OF UNEXERCISED
                                                 UNDERLYING UNEXERCISED     IN-THE-MONEY OPTIONS AT
                        SHARES      VALUE      OPTIONS AT FISCAL YEAR-END      FISCAL YEAR-END
                     ACQUIRED ON   REALIZED    --------------------------  --------------------------
NAME                  EXERCISE       ($)       EXERCISABLE  UNEXERCISABLE  EXERCISABLE  UNEXERCISABLE
-----------------    -----------   --------    -----------  -------------  -----------  -------------

<S>                    <C>                        <C>          <C>
James Mitarotonda         --          --          182,000(1)        --          --            --
William Fox               --          --           16,800       67,347          --            --
Melvyn Brunt              --          --           14,000           --          --            --
                      --------     --------     ----------   ---------       --------     -------
Total                     --          --          212,800       67,347          --            --
</TABLE>

(1)      In May 2004, 63,000 options were transferred to Mr. Mitarotonda from
         Mr. Holtzman pursuant to the terms of a securities purchase agreement
         by and among Jewelcor Management, Inc., Seymour Holtzman, Barington
         Capital Group, L.P., James A. Mitarotonda and Ramius Securities, LLC,
         dated as of May 13, 2004.


DIRECTOR COMPENSATION

     In February 2003, our Board approved a plan that provides our non-employee
directors with cash compensation of $10,000 upon initial election and on each
anniversary of becoming a director during their term of service, and $1,000 per
meeting of the Board attended during their term of service. Attendance at
Committee meetings will be compensated at the rate of $1,000 per meeting for
members and $2,000 per meeting for the chairperson. In 2004, we paid $116,000
for Board and Committee attendance. During the period of 2004, James Mitarotonda
received $37,000 and William J. Fox received $30,000 as compensation for their
service as directors while they were non-employee directors.

     Non-employee directors are granted a fully vested option to purchase 21,000
shares of common stock upon initial election and a fully vested option to
purchase 1,400 shares of common stock on each anniversary of becoming a director
during their term of service at an exercise price equal to the fair market value
of a share of common stock as of the date of grant.

EMPLOYMENT CONTRACT, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS

     None

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The compensation committee of the Board reviews and recommends to the Board
the compensation and benefits of all of our executive officers, administers our
stock and option plans and establishes and reviews general policies relating to
compensation and benefits. The compensation committee currently consists of
Stephen Liguori and Michael A. McManus, Jr. The compensation committee is
currently composed of independent, non-employee directors. No interlocking
relationships exist among our Board, compensation committee or executive
officers and the Board, compensation committee or executive officers of any
other company, nor has an interlocking relationship existed in the past.

BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

     The compensation committee generally believes that the compensation of the
executive officers, including that of the Chief Executive Officer (each, an
"Executive Officer" and collectively, the "Executive Officers"), should be
influenced by our performance. The compensation committee establishes the
salaries and bonuses of all of the Executive Officers by considering: (i) our
financial performance for the past year; (ii) the achievement of certain
objectives related to the particular Executive Officer's area of responsibility;
(iii) the salaries and bonuses of Executive Officers in similar positions of
comparably-sized companies; and (iv) the relationship between revenue and
Executive Officer compensation. No specific weight is given to any of these
factors in the evaluation of an executive officer's base salary.

     To contain expenses in 2004, the compensation committee established a
salary freeze on all of our employees. In approving the salary of the Company's
Chief Executive Officer, the compensation committee generally follows the
policies set forth above. However, as the Company does not have an operating
business, the Chief Executive Officer was compensated at a level deemed
reasonable and appropriate for the services being provided to the Company by the
Chief Executive Officer.

                                       20
<PAGE>

     In 2004, the compensation committee did not establish bonus targets for the
Executive Officers. In prior years, bonus targets have been equal to either 30%
or 50% of base salary. Actual bonus amounts were based on both corporate and
individual performance measurements. The corporate performance measurements were
based on revenue and operating loss targets. No bonus payouts were made in 2004.

     In addition to salary and bonus, the compensation committee, from time to
time, grants options to Executive Officers. The compensation committee views
option grants as an important component of its long-term, performance-based
compensation philosophy. Since the value of an option bears a direct
relationship to our stock price, the compensation committee believes that
options motivate Executive Officers to manage us in a manner that will also
benefit stockholders. As such, the specific number of stock options granted to
an Executive Officer is determined by the committee's perception of relative
contributions or anticipated contributions to overall corporate performance. The
committee also reviews the total number of options already held by individual
executive officers at the time of grant.

      In 2004, we granted options to purchase 67,347 shares of common stock to
William J. Fox and 56,000 shares to James Mitarotonda.

     In approving the Chief Executive Officers' salary, the compensation
committee generally follows the policies set forth above.

                                                     COMPENSATION COMMITTEE
                                                     OF L Q CORPORATION, INC.


                                                    /s/  Stephen Liguori
                                                    --------------------
                                                    Stephen Liguori


                                                    /s/  Michael A. McManus, Jr.
                                                    ----------------------------
                                                    Michael A. McManus, Jr.



                                       21
<PAGE>

PERFORMANCE GRAPH

     The following graph compares the cumulative total return to stockholders on
our common stock with the cumulative total return of the Nasdaq Stock Market
Index-U.S. and a group of former peer issuers selected in good faith and
comprised of Intertrust Technologies Corporation (ITRU) and RealNetworks, Inc.
(RNWK). The graph assumes that $100 was invested on July 9, 1999, the date of
our initial public offering, in our common stock, the Nasdaq Stock Market
Index-U.S. and the peer group, including reinvestment of dividends. No dividends
have been declared or paid on our common stock. Historic stock price performance
is not necessarily indicative of future stock price performance.

                 COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
         AMONG LQ CORPORATION INC, THE NASDAQ STOCK MARKET (U.S.) INDEX
                                AND A PEER GROUP

                                  [GRAPH HERE]

*    $100 invested on July 9, 1999 in stock or index, including reinvestment of
     dividends. Fiscal year ending December 31.

                                       22
<PAGE>

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table presents information with respect to beneficial
ownership of our common stock as of March 22, 2005 by:

     o   each person known by us who beneficially owns more than 5% of the
         common stock;

     o   each of our named executive officers;

     o   each of our directors; and

     o   all executive officers and directors as a group.

     Except as otherwise noted, the address of each 5% stockholder listed in the
table is c/o L Q Corporation, Inc., 888 Seventh Avenue, 17th Floor, New York, NY
10019. The table includes all shares of common stock issuable within 60 days of
March 22, 2005 upon the exercise of options and other rights beneficially owned
by the indicated stockholders on that date. Beneficial ownership is determined
in accordance with the rules of the SEC and includes voting and investment power
with respect to all shares of common stock. To our knowledge, except under
applicable community property laws or as otherwise indicated, the persons named
in the table have sole voting and sole investment control with respect to all
shares of common stock beneficially owned. The applicable percentage of
ownership for each stockholder is based on 3,214,408 shares of common stock
outstanding as of March 22, 2005, together with applicable options for that
stockholder. Shares of common stock issuable upon exercise of options and other
rights beneficially owned are deemed outstanding for the purpose of computing
the percentage ownership of the person holding those options and other rights,
but are not deemed outstanding for computing the percentage ownership of any
other person. Numbers of shares in the following table and footnotes thereto
have been adjusted to account for the Company's reverse-forward stock split
which took effect on June 7, 2004.


<TABLE>
<CAPTION>
                                                                     SHARES BENEFICIALLY
                                                                            OWNED
                                                                   ------------------------
NAME OF BENEFICIAL OWNER                                             NUMBER      PERCENT
-----------------------------------------------------------------  ------------ -----------
<S>                                                                  <C>         <C>
Lloyd I. Miller III(1)                                               408,446      12.71
   4550 Gordon Drive,
   Naples, Florida 34102
Phillip Goldstein(2)                                                 377,791      11.75
   60 Heritage Drive
   Plesantville, NY 10570
PNC Financial Services Group, Inc. and related entities(3)           339,694      10.57
   One PNC Plaza
   249 Fifth Avenue
   Pittsburgh, PA 15265
Coghill Capital Management, L.L.C. and related entities(4)           196,584       6.11
   One North Wacker Drive - Suite 4350
   Chicago, IL 60606
SC Fundamental Value Fund, L.P. and related entities(5)              195,660       6.09
   420 Lexington Avenue, Suite 2601
   New York, NY 10170
Jay Gottlieb(6)                                                      169,170       5.26
   27 Misty Brook Lane
   New Fairfield, CT 06812
Barington Companies Equity Partners, L.P. and related entities(7)    354,214      11.02
   c/o Barington Capital Group, L.P.
   888 Seventh Avenue, 17th Floor
   New York NY 10019
James A. Mitarotonda(8)                                              341,936      10.24
Steve Berns(9)                                                       21,000         *
Melvyn Brunt(10)                                                     14,000         *
William J. Fox(11)                                                   22,400         *
Steven Liquori(12)                                                   21,000         *
Michael McManus(13)                                                  22,400         *
All executive officers and directors as a group (6 persons)          442,736      13.14
</TABLE>
-------------------

                                       23
<PAGE>

(1)    On February 18, 2004, Lloyd I. Miller III filed an amendment to Schedule
       13G pursuant to Rule 13d-1 of the Securities Exchange Act of 1934 with
       the Securities and Exchange Commission, reporting combined ownership of
       408,446 shares of Common Stock. According to this Schedule 13G/A, Mr.
       Miller holds sole dispositive and voting power with respect to 68,748
       shares of the reported securities as (i) the manager of a limited
       liability company that is the general partner of a certain limited
       partnership and (ii) an individual and shared dispositive and voting
       power with respect to 2,426,398 shares of the reported securities as an
       advisor to the trustee of certain family trusts.
(2)    On March 16, 2004, Phillip Goldstein filed an amendment to Schedule 13D
       pursuant to Rule 13d-1 of the Securities Exchange Act of 1934 with the
       Securities and Exchange Commission, reporting combined ownership of
       377,791 shares of Common Stock.
(3)    On February 10, 2004, PNC Financial Services Group, Inc. filed an
       amendment to Schedule 13G pursuant to Rule 13d-1 of the Securities
       Exchange Act of 1934 with the Securities and Exchange Commission,
       reporting combined ownership of 339,694 shares of Common Stock as the
       total owned by three entities, PNC Financial Services Group, Inc., PNC
       Bancorp, Inc. and PNC Bank, National Association. The total shares of
       Common Stock reported are held in Trust Accounts created by an Amended
       and Restated Trust Agreement dated September 20, 1983, in which Lloyd I.
       Miller, Jr. was Grantor and for which PNC Bank, National Association
       serves as Trustee.
(4)    On February 16, 2005, Coghill Capital Management, L.L.C. filed a Schedule
       13G, pursuant to Rule 13d-1 of the Securities Exchange Act of 1934 with
       the Securities and Exchange Commission, reporting combined ownership of
       196,384 shares of Common Stock as the total owned.
(5)    On December 6, 2002, SC Fundamental Value Fund and related entities filed
       a Schedule 13G pursuant to Rule 13d-1 of the Securities Exchange Act of
       1934 with the Securities and Exchange Commission, reporting combined
       ownership of 1,195,660 shares of Common Stock as the total owned.
(6)    On November 17, 2004, Jay Gottlieb filed a Schedule 13D reporting
       ownership of 169,170 shares of Common Stock as the total owned.
(7)    On May 25, 2004, the Barington group jointly filed and amendment to
       Schedule 13D pursuant to Rule 13d-1 of the Securities Exchange Act of
       1934 with the Securities and Echange Commission, reporting combined
       ownership of 298,214 shares of Common Stock as the total owned by the
       four entities. According to that Schedule 13D/A, Barington Company Equity
       Partners L.P. owns 67,438 shares of Common Stock, Ramius Securities, LLC
       owns 34,512 shares of Common Stock. Barington Capital Group, L.P. owns
       80,598 shares of Common Stock and Starboard Value & Opportunity Fund, LLC
       owns 103,766 shares of Common Stock. Subsequent to this filing, Barington
       Capital Group, L.P. purchased an additional 11,900 shares of Common Stock
       and was granted an option to purchase 56,000 shares of Common Stock.
       Barington Companies Investors, LLC is the general partner of Barington
       Companies Equity Partners, L.P. James Mitarotonda is the managing member
       of Barington Companies Investors, LLC and Chairman of the Board,
       President and Chief Executive Officer of Barington Capital Group, L.P.
(8)    Includes 67,438 shares of Common Stock owned by Barington Companies
       Equity Partners, L.P., 148,498 shares of Common Stock owned by Barington
       Capital Group, L.P. and 126,000 shares of Common Stock issuable upon the
       exercise of stock options excercisable within 60 days of March 22, 2005.
       James A. Mitarotonda is President and Chief Executive Officer of
       Barington Companies Investors, LLC, the general partner of Barington
       Companies Equity Partner L.P., and Chairman of the Board, President and
       Chief Executive Officer of Barington Capital Group, L.P. Consequently,
       Mr. Mitarotonda may be deemed to beneficially own all of the shares held
       by Barington Companies Equity Partners, L.P. and Barington Capital Group,
       L.P. Mr. Mitarotonda disclaims beneficial ownership of such shares,
       except to the extent of his respective pecuniary interest therein.
(9)    Includes 21,000 shares of Common Stock issuable upon the exercise of
       stock options excercisable within 60 days of March 22,2005.
(10)   Includes 14,000 shares of Common Stock issuable upon the exercise of
       stock options exercisable within 60 days of March 22, 2005.
(11)   Includes 22,400 shares of Common Stock issuable upon the exercise of
       stock options exercisable within 60 days of March 22, 2005.
(12)   Includes 21,000 shares of Common Stock issuable upon the exercise of
       stock options exercisable within 60 days of March 22, 2005.
(13)   Includes 22,400 shares of Common Stock issuable upon the exercise of
       stock options exercisable within 60 days of March 22, 2005.

*  Does not exceed 1%.

                                       24
<PAGE>

EQUITY COMPENSATION PLAN INFORMATION

     The following table sets forth certain information, as of December 31,
2004, concerning shares of our common stock authorized for issuance under all of
our equity compensation plans (shares in thousands)

<TABLE>
<CAPTION>
                                                                                             NUMBER OF SECURITIES
                                NUMBER OF SECURITIES TO BE    WEIGHTED-AVERAGE EXERCISE     REMAINING AVAILABLE FOR
                                  ISSUED UPON EXERCISE OF       PRICE OF OUTSTANDING         FUTURE ISSUANCE UNDER
        PLAN CATEGORY              OUTSTANDING OPTIONS,         OPTIONS, WARRANTS AND      EQUITY COMPENSATION PLANS
                                    WARRANTS AND RIGHTS                RIGHTS                (EXCLUDING SECURITIES
                                                                                            REFLECTED IN COLUMN (a)
------------------------------- ---------------------------- ---------------------------- ----------------------------
                                            (a)                          (b)                          (c)
<S>     <C>
Equity compensation plans                   361                         1.93                         5,194
approved by security
holders

Equity compensation plans                    --                           --                            --
not approved by
security holders
                                     -------------                -------------                  -----------
         Total                              361                         1.93                         5,194
</TABLE>

     On March 18, 2003, our Board elected to reduce the exercise price of all
stock options by $2.50, but not lower than $0.10, to account for the $2.50 per
share return of capital distribution made on January 29, 2003.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     In July 2003, we relocated our principal executive offices to 888 Seventh
Avenue, 17th Floor, New York, 10019, an office maintained by Barington Capital
Group, LP ("Barington"), a limited partnership whose general partner is a
corporation of which James Mitarotonda is Chairman, President and Chief
Executive Officer. Mr. Mitarotonda is our Chairman and former Chief Executive
Officer. William Fox, the President, Chief Executive Officer and a director of
the Company, is the Vice Chairman of Barington. From April 2003 through May 16,
2004, we paid Barington a monthly fee of $7,290 for certain administrative and
accounting services provided by Barington on our behalf. During the same period,
we also paid Jewelcor Management, Inc. ("Jewelcor"), a corporation whose
Chairman and Chief Executive Officer is Seymour Holtzman, a fee of $5,000 for
certain administrative services provided by Jewelcor on our behalf. Mr. Holtzman
is a former Co-Chairman and Co-Chief Executive Officer of the Company. In May
2004, Mr. Holtzman resigned from the Board and Jewelcor ceased to provide
administrative services to us. The Board then decided to enter into a new
services arrangement with Barington, and it was agreed that all payments for
services would be suspended until a new services arrangement was negotiated,
although Barington continued to provide services on our behalf. We entered into
a new services agreement with Barington dated as of November 18, 2004. Under
this agreement, we agreed to pay Barington $8,000 per month for providing
certain administrative, accounting and other services on our behalf and a fee of
$125 per hour for any legal services provided by Barington at our request. We
also agreed that in the event Barington identifies for us at our request a
business transaction such as a merger, acquisition or joint venture, and
provides us with financial consulting services in connection with such business
transaction, we will pay Barington a fee of two percent of the amount of the
consideration paid in the transaction. In connection with the agreement, we
granted to Barington or its designees stock options to purchase 56,000 shares of
our Common Stock. The options are fully exercisable and were granted with an
exercise price per share equal to $1.82, the fair market value of our Common
Stock on the grant date.

     The services agreement with Barington was amended as of January 1, 2005 to,
among other things, increase the monthly fee payable by the Company to Barington
from $8,000 to $15,000 and increase the hourly fee payable for legal services
from $125 per hour to $175 per hour. We believe that the fees payable to
Barington are less than those that would be charged in arm's length transactions
between unaffiliated third parties.

     We have entered into indemnification agreements with our officers and
directors containing provisions which may require us, among other things, to
indemnify our officers and directors against certain liabilities that may arise
by reason of their status or service as officers or directors (other than
liabilities arising from willful misconduct of a culpable nature) and to advance
their expenses incurred as a result of any proceeding against them as to which
they could be indemnified. We also intend to execute such agreements with our
future directors and executive officers.

                                       25
<PAGE>

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

The public accounting firm of Rothstein Kass & Company, PC has served as our
independent accountant to perform the audit of our financial statements for the
fiscal year ended December 31, 2004 and December 31, 2003. The table below sets
forth the aggregate audit fees, audit-related fees, tax fees and all other fees
billed for services rendered by our principal accountants in our fiscal years
ended December 31, 2004 and 2003.

                                                            FISCAL      FISCAL
                               FEE CATEGORY                  2004        2003
                               Audit Fees (1)               $65,700     $42,500
                               Audit-Related Fees (2)          -           -
                               Tax Fees (3)                 $19,630     $12,780
                               All Other Fees (4)              -           -

                               Total All Fees               $85,330     $55,280

-----------------

(1) AUDIT FEES. These consist of fees billed for professional services rendered
for the audit of our annual financial statements and review of the interim
financial statements included in quarterly 10-Q reports and for services
normally provided in connection with statutory and regulatory filings.

(2) AUDIT-RELATED FEES. These consist of fees billed for assurance and related
services that are reasonably related to the performance of the audit or review
of our financial statements that are not reported under "Audit Fees," These
services include accounting consultations in connection with acquisitions and
consultations concerning financial accounting and reporting standards.

(3) TAX FEES. These consist of fees billed for professional services for tax
compliance, tax advice and tax planning. These services include

(4) ALL OTHER FEES. These consist of other fees not reported in the above
categories.

PRE-APPROVAL POLICIES AND PROCEDURES OF AUDIT COMMITTEE

     The Audit Committee has responsibility for the appointment, compensation
and oversight of the work of the independent accountant. As part of this
responsibility, the Audit Committee must pre-approve all permissible services to
be performed by the independent accountant.

     The Audit Committee has adopted an auditor pre-approval policy which sets
forth the procedures and conditions pursuant to which pre-approval may be given
for services per-approval may be given for services performed by the independent
auditor. Under the policy, the Committee must give prior approval for all
auditing services and the terms thereof (which may include providing comfort
letters in connection with securities underwritings) and non-audit services
(other than non-audit services prohibits under Section 10A(g) of the Exchange
Act or the applicable rules of the SEC or the Public Company Accounting
Oversight Board) to be provided. Prior approval need not be given with respect
to the provision of non-audit services if certain "de minimus" provisions of
Section 10A(i)(1)(B) of the Exchange Act are satisfied. The Audit Committee may
delegate to one or more of its members authority to approve a request for
pre-approval provided the member reports any approval so given to the Audit
Committee at its next scheduled meeting.

                                       26
<PAGE>

PART IV.

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 (a)(1) INDEX TO FINANCIAL STATEMENTS

     Please see the accompanying Index to Financial Statements which appears on
page F-1 of this report. The Report of Independent Registered Public Accounting
Firm, Financial Statements and Notes to Financial Statements which are listed in
the Index to Financial Statements and which appear beginning on page F-2 of this
report are included in Item 8 above.

(a)(2) The financial statement schedule of L Q Corporation, Inc. for the years
ended December 31, 2004, 2003 and 2002 included in subsection (c) below is filed
as part of this Annual Report and should be read in conjunction with the
Financial Statement of L Q Corporation, Inc. - Schedule II - Valuation and
Qualifying Accounts. Schedules not listed have been omitted because the
information required to be set forth therein is not applicable or is included in
the Financial Statements or notes thereto.

(a)(3)  EXHIBITS

     Please see subsection (b) below.


 (b) EXHIBITS

     The following exhibits are incorporated herein by reference or are filed
with this report as indicated below:

3.1      Certificate of Incorporation as currently in effect (6)
3.2      Bylaws as currently in effect (2)
4.2      Form of Specimen Stock Certificate (1)
4.3      Second Amended and Restated Investor Rights Agreement dated
         July 31, 1998 (1)
10.1     Form of Indemnification Agreement entered into between the registrant
         and each of its directors and executive officers (1)
10.2     1996 Equity Incentive Plan (1)
10.3     1999 Employee Stock Purchase Plan (1)
10.21    Summary Plan Description of 401(K) Plan (1)
10.50    2000 Nonstatutory Stock Option Plan (2)
10.71    Settlement Agreement with BeMusic, Inc. dated as of
         January 17, 2003 (3)
10.74    Settlement Agreement and Mutual Release with BeMusic, Inc. dated
         February 13, 2004 (5)
10.80    Administrative Services Agreement with Barington Capital Group, L.P.
         dated as of November 18, 2004
10.85    Amendment to Administrative Services Agreement with Barington Capital
         Group, L.P. dated as of January 1, 2005
11.1     Statement regarding computation of per share earnings (4)
23.1     Consent of PricewaterhouseCoopers LLP
23.2     Consent of Rothstein Kass & Company, PC
24.1     Power of Attorney (contained in the signature page to this report)
31.1     Certification of Chief Executive Officer pursuant to Section 302 of
         Sarbanes-Oxley Act of 2002
31.2     Certification of Chief Financial Officer pursuant to Section 302 of
         Sarbanes-Oxley Act of 2002
32.1     Certification of Chief Executive Officer pursuant to Section 906 of
         Sarbanes-Oxley Act of 2002
32.2     Certification of Chief Financial Officer pursuant to Section 906 of
         Sarbanes-Oxley Act of 2002

+     confidential treatment received as to certain portions

(1)   Incorporated by reference to the Registration Statement on Form S-1 and
      all amendments thereto, Registration No. 333-77707, filed with the
      Securities and Exchange Commission on May 4, 1999 and declared effective
      July 8, 1999
(2)   Incorporated by reference to the Form 10-Q filed with the Securities and
      Exchange Commission on August 14, 2000
(3)   Incorporated by reference to Exhibits on Form 8-K filed with the
      Securities and Exchange Commission on January 28, 2003
(4)   This exhibit has been omitted because the information is shown in the
      financial statements or notes thereto
(5)   Incorporated by reference to the Form 10-K filed with the Securities and
      Exchange Commission on March 30, 2004
(6)   Incorporated by reference to the Form 8-K filed with the Securities and
      Exchange Commission on July 16, 2004

                                       27
<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of New
York, State of New York on March 31, 2005.



                                       By: /s/  William J. Fox
                                           -------------------------------------
                                           William J. Fox
                                           President and Chief Executive Officer


<TABLE>
<CAPTION>
        SIGNATURE                                   TITLE                                  DATE


<S>                             <C>                                                    <C>
/s/ William J. Fox              President, Chief Executive Officer and Director        March 31, 2005
----------------------------             (Principal Executive Officer)
    William J. Fox


/s/ Melvyn Brunt                Chief Financial Officer (Principal Financial and       March 31, 2005
----------------------------                 Accounting Officer)
Melvyn Brunt


/s/ James A. Mitarotonda        Chairman and Director                                  March 31, 2005
----------------------------
James A. Mitarotonda


/s/ Stephen Liguori             Director                                               March 31, 2005
----------------------------
Stephen Liguori


/s/ Michael A. McManus, Jr.     Director                                               March 31, 2005
----------------------------
Michael A. McManus, Jr.


/s/ Steven Berns                Director                                               March 31, 2005
----------------------------
Steven Berns


</TABLE>

                                       28
<PAGE>

                              L Q CORPORATION, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                          Page
                                                                          ----
Reports of Independent Registered Public Accounting Firms............  F-2 - F-3
Consolidated Balance Sheets..........................................     F-4
Consolidated Statements of Operations................................     F-5
Consolidated Statements of Stockholders' Equity......................     F-6
Consolidated Statements of Cash Flows................................     F-7
Notes to Consolidated Financial Statements...........................     F-8
Financial Statement Schedule II - Valuation and Qualifying Account...     F-24

                                      F-1

<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders of
L Q Corporation, Inc.


We have audited the accompanying consolidated balance sheets of LQ Corporation,
Inc. and subsidiary (the "Company") as of December 31, 2004 and 2003 , and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the two-year period ended December 31, 2004.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of L Q Corporation,
Inc. and subsidiary as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.

In connection with out audit of the consolidated financial statements referred
to above, we audited the consolidated financial schedules listed under Item 15.
In our opinion, these consolidated financial schedules, when considered in
relation to the financial statements taken as a whole, present fairly, in all
material respects, the information stated therein.




/s/  Rothstein, Kass & Company, P.C.
Roseland, New Jersey
March 21, 2005


                                      F-2
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders of
   Liquid Audio, Inc.

     In our opinion, the accompanying consolidated statements of operations, of
stockholders' equity and of cash flows for the year ended December 31, 2002
present fairly, in all material respects, the results of operations and cash
flows of Liquid Audio Inc. (currently known as L Q Corporation, Inc.) and its
subsidiary for the year ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule for the year ended December 31,
2002 listed in the accompanying index, presented fairly, in all material
respects, the information set forth therein when read in conjunction with the
related financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audit. We conducted our audit of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provide a reasonable basis for our opinion.

     As discussed in Note 1, in January 2003, Liquid Audio sold the majority of
its operating assets, distributed $57.8 million to its stockholders and approved
a plan to pursue strategic alternatives for its remaining assets including
liquidation. A plan of liquidation would be subject to stockholder approval.



/s/ PRICEWATERHOUSECOOPERS LLP


San Jose, California
February 21, 2003,
except for Note 16,
as to which the date is March 25,2005.

                                      F-3
<PAGE>

<TABLE>
                              L Q CORPORATION, INC.

                           CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

<CAPTION>
                                                                    DECEMBER 31,
                                                               ---------------------
                                                                  2004       2003
                                                               ---------- ----------
                                     ASSETS
                                     ------
<S>                                                            <C>        <C>
Current assets:
   Cash and cash equivalents ...............................   $   6,432  $   9,077
   Accounts receivable, net ................................          --         28
   Other current assets ....................................         103        164
                                                               ---------- ----------
     Total current assets ..................................       6,535      9,269
                                                               ---------- ----------
              Total assets .................................   $   6,535  $   9,269
                                                               ========== ==========

                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------

Current liabilities:
   Accrued expenses and other current liabilities ..........   $     114  $   1,935
                                                               ---------- ----------


Stockholders' equity:
   Common stock, $0.001 par value; 30,000,000 shares
   authorized; 3,214,408 in 2004 and 23,176,858 in
   2003 shares issued and outstanding ......................           3         23
   Additional paid-in capital ..............................     146,006    146,053
   Accumulated deficit .....................................    (139,510)  (138,663)
   Accumulated other comprehensive income (loss) ...........         (78)       (79)
                                                               ---------- ----------
         Total stockholders' equity ........................       6,421      7,334
                                                               ---------- ----------
              Total liabilities and stockholders' equity ...   $   6,535  $   9,269
                                                               ========== ==========
</TABLE>


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

                                      F-4
<PAGE>

<TABLE>
                                      L Q CORPORATION, INC.

                              CONSOLIDATED STATEMENTS OF OPERATIONS
                            (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<CAPTION>

                                                               YEAR ENDED DECEMBER 31,
                                                         ---------------------------------
                                                           2004        2003         2002
                                                         ---------   ---------   ---------
<S>                                                      <C>         <C>         <C>
Net revenues:
   License ...........................................   $     --    $      4    $    108
   Services ..........................................         --          39         374
                                                         ---------   ---------   ---------
       Total net revenues ............................         --          43         482
                                                         ---------   ---------   ---------

Cost of net revenues:
   License ...........................................         --           5         388
   Services ..........................................         --           2         654
    Non-cash cost of revenues ........................         --          --          82
                                                         ---------   ---------   ---------
       Total cost of net revenues ....................         --           7       1,124
                                                         ---------   ---------   ---------

   Gross profit (loss) ...............................         --          36        (642)
                                                         ---------   ---------   ---------

Operating expenses:
   Sales and marketing ...............................         --         277       3,765
   Non-cash sales and marketing ......................         --          --         (28)
   Research and development ..........................         --         165       9,111
   Non-cash research and development .................         --          --           6
   General and administrative ........................        968       6,628      10,712
   Non-cash general and administrative ...............         --          --           1
   Impairment loss ...................................         --          --         689
   Restructuring .....................................         --       4,441       1,163
                                                         ---------   ---------   ---------
       Total operating expenses ......................        968      11,511      25,419
                                                         ---------   ---------   ---------

Loss from operations .................................       (968)    (11,475)    (26,061)
Interest income ......................................        148         242       1,347
Interest expense .....................................         --          --          50
Other income (expense), net ..........................        (27)         71         489
Gain on sale of intellectual property ................         --          --       7,000
Gain on sale of digital music fulfillment business ...         --       2,868          --
Merger termination fee ...............................         --          --      (2,100)
                                                         ---------   ---------   ---------
Net loss .............................................   $   (847)   $ (8,294)   $(19,275)
                                                         =========   =========   =========

Net loss per share:
   Basic and diluted .................................   $  (0.26)   $  (2.56)   $  (6.04)
                                                         =========   =========   =========
   Weighted average shares ...........................      3,232       3,243       3,189
                                                         =========   =========   =========


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

                                              F-5
</TABLE>
<PAGE>


<TABLE>
<CAPTION>
                              L Q CORPORATION, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

                                                                                             ACCUMULATED
                                                     ADDITIONAL                                 OTHER                  COMPREHENSIVE
                                   COMMON STOCK       PAID-IN     UNEARNED   ACCUMULATED    COMPREHENSIVE                   INCOME
                              SHARES       AMOUNT     CAPITAL   COMPENSATION   DEFICIT      INCOME (LOSS)      TOTAL        (LOSS)
                            ------------   -------   ----------   --------   ------------   ------------    ---------    ----------
<S>                          <C>           <C>       <C>          <C>        <C>            <C>             <C>          <C>
BALANCE AT DECEMBER 31,
 2001 ...................    22,709,305    $   23    $ 202,969    $   (43)   $  (111,094)   $       (30)    $ 91,825     $       0
Issuance of common stock
 for intellectual
 property ...............         4,071         0            0          0              0              0            0             0
Issuance of common stock
 warrants in connection
 with strategic marketing
 agreement ..............             0         0           82          0              0              0           82             0
Issuance of common stock
 in connection with
 employee stock
 purchase plan ..........        34,940         0           70          0              0              0           70             0
Issuance of common stock
 in connection with
 exercise of
 stock options ..........       396,512         O          753          0              0              0          753             0
Declared cash
 distribution payable
 to stockholders ........             0         0      (57,771)         0              0              0      (57,771)            0
Unearned compensation,
 net of effect of
  cancellations .........             0         0          (64)        64              0              0            0             0
Amortization of
 unearned Compensation ..             0         0            0        (21)             0              0          (21)            0
Cumulative translation
 adjustment .............             0         0            0          0              0            (45)         (45)          (45)
Net loss ................             0         0            0          0        (19,275)             0      (19,275)      (19,275)
                                                                                                                         ----------
Comprehensive loss ......             0         0            0          0              0              0            0     $ (19,320)

                            ------------   -------   ----------   --------   ------------   ------------    ---------    ==========
BALANCE AT DECEMBER 31,
 2002 ...................    23,144,828        23      146,039         --       (130,369)           (75)      15,618
                            ------------   -------   ----------   --------   ------------   ------------    ---------
Issuance of common stock
 in connection with
 exercise of stock
 options ................        32,030         0           14          0              0              0           14             0
Cumulative translation
 adjustment .............             0         0            0          0              0             (4)          (4)           (4)
Net loss ................             0         0            0          0         (8,294)             0       (8,294)       (8,294)
                                                                                                                         ----------
Comprehensive loss ......             0         0            0          0              0              0            0     $  (8,298)
                            ------------   -------   ----------   --------   ------------   ------------    ---------    ==========
BALANCE AT DECEMBER
 31, 2003 ...............    23,176,858        23      146,053         --       (138,663)           (79)       7,334
                            ------------   -------   ----------   --------   ------------   ------------    ---------

Effect of reverse forward                                                                             0            0             0
 split ..................   (19,932,879)      (20)          20          0              0
Cancellation of common                                                                                0            0             0
 stock ..................       (29,571)        0          (67)         0              0
Cumulative translation                                                                                1            1             1
 adjustments ............             0         0            0          0              0              0         (847)         (847)
Net loss ................             0         0            0          0           (847)                                ----------
Comprehensive loss ......             0         0            0          0              0              0            0     $    (846)
                            ------------   -------   ----------   --------   ------------   ------------    ---------    ==========
BALANCE AT DECEMBER 31,
 2004 ...................     3,214,408    $    3    $ 146,006    $     0    $  (139,510)   $       (78)    $  6,421
                            ============   =======   ==========   ========   ============   ============    =========


                                                                              F-6
</TABLE>

<PAGE>

<TABLE>
                                      L Q CORPORATION, INC.

                              CONSOLIDATED STATEMENTS OF CASH FLOWS
                                         (IN THOUSANDS)

<CAPTION>
                                                                             YEAR ENDED DECEMBER 31,
                                                                         2004        2003         2002
                                                                       ---------   ---------   ---------
<S>                                                                    <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ...........................................................   $   (847)   $ (8,294)   $(19,275)
Adjustments to reconcile net loss to net cash used
  in operating activities:
    Depreciation and amortization ..................................         --         226       2,328
    Amortization of unearned compensation ..........................         --          --         (21)
    Gain on extinguishment of debt .................................         --          --        (343)
    Gain on sale of digital music fulfillment business
      and related assets ...........................................         --      (2,868)         --
    Non-cash cost of revenue .......................................         --          --          82
    Loss on disposal of and impairment of property and equipment ...         --          --         804
    Changes in assets and liabilities: .............................         --          --          --
       Accounts receivable from third parties ......................         28          32          70
       Restricted cash .............................................         --         826          --
       Other assets ................................................         61       1,204        (106)
       Accounts payable ............................................         --      (1,218)        111
       Accrued liabilities .........................................     (1,821)       (216)     (1,670)
       Deferred revenue from third parties .........................         --         (39)        (83)
                                                                       ---------   ---------   ---------
       Net cash used in operating activities .......................     (2,579)    (10,347)    (18,103)

CASH FLOWS FROM INVESTING ACTIVITIES:
    Acquisition of property and equipment ..........................         --          --         (87)
    Proceeds from sale of digital music fulfillment
      business and related assets ..................................         --       3,200          --
                                                                       ---------   ---------   ---------
       Net cash provided by (used in) investing activities .........         --       3,200         (87)

CASH FLOWS FROM FINANCING ACTIVITIES:
    Cash distribution to stockholders ..............................         --     (57,771)         --
    Purchase of fractional shares ..................................        (67)         14         823
    Payments made under capital leases .............................         --          --         (28)
    Payments made under equipment loan .............................         --          --        (169)
                                                                       ---------   ---------   ---------
       Net cash provided by (used in) financing activities .........        (67)    (57,757)        626

Effect of exchange rates on cash and cash equivalents ..............          1          (4)        (45)
                                                                       ---------   ---------   ---------
Net decrease in cash and cash equivalents ..........................     (2,645)    (64,908)    (17,609)
Cash and cash equivalents at beginning of period ...................      9,077      73,985      91,594
                                                                       ---------   ---------   ---------

Cash and cash equivalents at end of period .........................   $  6,432    $  9,077    $ 73,985
                                                                       =========   =========   =========

SUPPLEMENTAL CASH FLOW DISCLOSURES:
    Cash paid for interest .........................................   $     --      $   24    $     31

SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:
    Declaration of cash distribution to stockholders ...............         --          --    $ 57,771
    Issuance of warrants in connection with strategic
      marketing agreements .........................................         --          --         822
     Issuance of common stock in connection with
       strategic marketing agreement ...............................         --          --          --


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

                                              F-7
</TABLE>
<PAGE>

                              L Q CORPORATION, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

THE COMPANY

     L Q Corporation, Inc. (formally known as Liquid Audio, Inc.) (the
"Company") was incorporated in California in January 1996 and reincorporated in
Delaware in April 1999. In July 2000, the Company established a wholly-owned
subsidiary in the United Kingdom, Liquid Audio Europe PLC, which was
reregistered in August 2001 as Liquid Audio Europe Limited, to develop sales in
Europe.

     In September 2002, the Company sold the domestic and foreign rights to its
entire patent portfolio for $7.0 million in cash to Microsoft Corporation. In
addition to the cash consideration, the Company received an assignable perpetual
royalty-free license to continue using the patented technology in its digital
distribution system (the "Microsoft License").

     On January 24, 2003, the Company announced the sale of its digital music
fulfillment business and related assets to Geneva Media, LLC ("Geneva"), an
affiliate of Anderson Merchandisers, LP for $3.2 million. As part of the sale,
the Company also transferred ownership of certain "Liquid Audio" related
trademarks to Geneva and the Microsoft License. As a result of the sale, the
Company is not currently operating any businesses.

     The Company has incurred losses and negative cash flows from operations for
every year since inception. For the year ended December 31, 2004, the Company
incurred a net loss of approximately $847,000 and negative cash flows from
operations of approximately $2.6 million. In July 2003, the Company incurred a
one-time payout of $3,569,000 to terminate the remaining term of its property
lease on its former headquarters located in Redwood City, California. As of
December 31, 2004, the Company had an accumulated deficit of approximately
$139.5 million. The Company has not yet settled on an operating plan, although
the Company feels its existing cash and cash equivalents are sufficient to fund
the Company's current operations and satisfy its obligations. The Company
believes these obligations will primarily relate to costs associated with the
operation as a public company (legal, accounting, insurance, etc.), as well as
the satisfaction of any potential legal judgments or settlements and the
expenses associated with any new business activities, which may be undertaken by
the Company. The Company continues to consider future alternatives, including
the possible acquisition of other businesses. However, the Company has not
consummated any significant transactions to date and the Company's business
prospects remain uncertain. To the extent that management of the Company moves
forward on any alternative strategy, such strategy may have an impact on the
Company's liquidity.

The Investment Company Act of 1940 provides a set of regulations for companies
that are or that hold themselves out as being engaged primarily in the business
of investing, reinvesting, owning, holding or trading in securities. A company
may also become subject to regulation under the Investment Company Act if it
owns "investment securities" with a value exceeding 40% of the value of its
total assets (exclusive of government securities and cash items). Securities
issued by companies other than majority-owned subsidiaries are generally
considered investment securities for purposes of the Investment Company Act. As
a result of the Company's lack of an operating business, the significant cash
balance as a percentage of the Company's total assets, the Company may have
inadvertently become, or may become in the future if it fails to obtain an
operating business, an investment company under the Investment Company Act.
Notwithstanding the foregoing, the Company believes that at all relevant times
prior to the date of filing this Annual Report on Form 10-K, the Company has not
been subject to regulation as an investment company under the Investment Company
Act. Although the Company continues to consider future operating alternatives,
including the possible acquisition of one or more operating businesses, the
Company could become subject to regulation under the Investment Company Act in
the future. Registration as an investment company would be very expensive and
further deplete the Company's cash balances, which would leave it with fewer
resources to pursue further operating alternatives. Registration would also
subject the Company to restrictions that may be inconsistent with any future
business strategy the Company may decide upon. In order to avoid these
regulations, the Company may have to take actions that it would not otherwise
choose to take to avoid registration under the Investment Company Act.

                                      F-8
<PAGE>

RECLASSIFICATIONS

     Certain reclassifications have been made to the prior years' consolidated
financial statements to conform to current period presentation.

PRINCIPLES OF CONSOLIDATION

     The financial statements include the accounts of the Company and its
wholly-owned (inactive) subsidiary. Significant intercompany transactions and
balances have been eliminated.

USE OF ESTIMATES

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


CASH AND CASH EQUIVALENTS

     The Company considers all highly-liquid debt instruments with original
maturities of three months or less to be cash equivalents. At December 31, 2004,
and at various times during the year, balances of cash at financial institutions
exceeded the federally insured limit. The Company has not experienced any losses
in such accounts and believes it is not subject to any significant credit risk
on cash and cash equivalents. The following schedule summarizes the estimated
fair value of the Company's cash and cash equivalents (in thousands):

                                                               DECEMBER 31,
                                                       ------------------------
                                                         2004            2003
                                                       -------          -------
Cash and cash equivalents:
   Cash ......................................         $   53           $1,010
   Money market funds ........................          6,379            8,067
                                                       -------          -------
                                                       $6,432           $9,077
                                                       =======          =======


CONCENTRATION OF CREDIT RISK

     Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash and cash equivalents,
short term investments and accounts receivable. Substantially all of the
Company's cash and cash equivalents are invested in a highly liquid money market
fund.

FAIR VALUE OF FINANCIAL INSTRUMENTS

     The Company's financial instruments, including cash and cash equivalents,
accounts receivable and accrued expenses payable are carried at cost. The
Company's financial instruments approximate fair value due to their relatively
short maturities. The Company does not hold or issue financial instruments for
trading purposes.

                                      F-9
<PAGE>

REVENUE RECOGNITION

     Software license revenues are recognized when persuasive evidence of an
arrangement exists, delivery has occurred, no significant Company obligations
with regard to implementation or integration exist, the fee is fixed or
determinable and collection is probable as prescribed in SOP No. 97-2, "Software
Revenue Recognition." For arrangements with multiple elements, the total fee
from the arrangement is allocated among each element based upon vendor specific
objective evidence ("VSOE") of fair value. VSOE of fair values for the ongoing
maintenance and support obligations are based upon the prices paid for the
separate renewal of these services by the customer or upon substantive renewal
rates stated in the contractual arrangements. VSOE of the fair value of other
services, primarily consulting services, is based upon separate sales of these
services. When VSOE of fair value exist for the undelivered elements, primarily
maintenance, the Company accounts for the license portion based on the "residual
method" as prescribed by SOP No. 98-9, "Modification of SOP 97-2 with Respect to
Certain Transactions." When VSOE of fair value does not exist for the
undelivered elements, the total fee from the arrangement is recognized ratably
over the period of the contract. The Company recognizes revenue allocated to
maintenance ratably over the contract period, which is generally twelve months.

     Business development revenue primarily consists of license and maintenance
fees from agreements under which the Company gives its strategic partners the
right to license and use the Company's digital recorded music delivery
technology. These U.S. dollar-denominated, non-refundable fees are allocated
among the various elements of the contract based on VSOE of fair value. When
VSOE of fair value exist for the undelivered elements, primarily maintenance,
the Company accounts for the license portion based on the "residual method" as
prescribed by SOP No. 98-9. When VSOE of fair value does not exist for the
undelivered elements, the total fee from the business development arrangement is
recognized ratably over the period of the contract. The total fee from business
development arrangements is recognized when payment becomes due if extended
payment terms exist. Extended payment terms are defined as payment terms outside
the Company's customary business practice, generally greater than 90 days.
Revenue is not recognized if the strategic partners stop making their
contractual payments.

     The Company also generated license and service revenues from digital music
kiosk sales and hosting services. Revenue derived from hosting services included
subscription fees from artists for encoding and storing music files, e-commerce
services and transaction reporting. Music delivery services revenue include
transaction fees from sales of digital recorded music through the Company's
website affiliates and fees from music retailers and websites related to the
sample digital music clips delivery service. Revenue from kiosk sales consist of
software licenses and services revenue from equipment and kiosk-related
services. The Company bears full credit risk with respect to substantially all
sales.

RESEARCH AND DEVELOPMENT COSTS

     Costs incurred in the research and development of new products and
enhancements of existing products are charged to expense as incurred until
technological feasibility had been established through the development of a
working model. After establishing technological feasibility, additional
development costs incurred through the date the product was available for
general release to customers was capitalized and amortized over the estimated
product life. The period between achieving technological feasibility and general
release was short and software development costs qualifying for capitalization
was insignificant. Accordingly, the Company has not capitalized any development
costs in the periods presented.

STOCK-BASED COMPENSATION

         In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure," which amended SFAS No. 123,
"Accounting for Stock-Based Compensation." This Statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based compensation. It also amends the disclosure
provisions to require more prominent disclosure about the effects on reported
net income (loss) of an entity's accounting policy decisions with respect to
stock-based employee compensation. The provisions of this Statement are to be
applied to financial statements for fiscal years ending after December 15, 2002.
As permitted by the Statement, the Company does not plan to adopt the fair value
recognition provisions of SFAS No. 123 at this time. However, the Company has
adopted the disclosure provisions of the Statement.

                                      F-10
<PAGE>

         The Company accounts for its stock-based employee compensation plans
under Accounting Principles Board Opinion No. 25, under which no compensation
cost has been recognized in the accompanying statements of operations, as all
options granted under those plans had an exercise price equal to or in excess of
the market value of the underlying common stock at the date of grant (see Note
7).

     Had compensation cost for these options been determined consistent with the
fair value method provided by SFAS No. 123, the Company's net loss and net loss
per common share would have been the following pro forma amounts in each of the
years during the three year period ended December 31, 2004.

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER, 31
                                                       ---------------------------------
                                                         2004        2003         2002
                                                       ---------   ---------   ---------
<S>                                                    <C>         <C>         <C>
Net loss--as reported ...............................  $   (847)   $ (8,294)   $(19,275)
Less stock-based compensation income (expense)
determined under fair value based method, net
of tax effects ......................................       (54)       (853)      1,399
                                                       ---------   ---------   ---------
Net loss--pro forma .................................  $   (901)   $ (9,147)   $(17,876)
                                                       =========   =========   =========
Basic and diluted net loss per share--as reported ...  $   (.26)   $  (2.56)   $  (6.04)
Basic and diluted net loss per share--pro forma .....      (.28)      (2.82)      (5.61)
</TABLE>

FOREIGN CURRENCY TRANSLATION

     The functional currency of the Company's subsidiary is its local currency.
Foreign currency assets and liabilities are translated at the current exchange
rate at each balance sheet date. Revenues and expenses are translated at
weighted average exchange rates in effect during the year. The related gains and
losses from foreign currency translation are recorded in accumulated other
comprehensive income. Realized gains and losses on foreign currency transactions
are included in other income (expense), net.

INCOME TAXES

     The Company complies with SFAS No. 109, "Accounting for Income Taxes,"
which requires an asset and liability approach to financial reporting for income
taxes. Deferred income tax assets and liabilities are computed for differences
between the financial statement and tax bases of assets and liabilities that
will result in future taxable or deductible amounts, based on enacted tax laws
and rates applicable to the periods in which the differences are expected to
affect taxable income. Valuation allowances are established, when necessary, to
reduce deferred income tax assets to the amount expected to be realized.

NET LOSS PER SHARE

     Loss per common share is based on the weighted average number of common
shares outstanding. The Company complies with SFAS No. 128, "Earnings Per
Share," which requires dual presentation of basic and diluted earnings per share
on the face of the statements of operations, which the Company has adopted.
Basic and diluted net loss per share is computed by dividing the net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding during the period. The calculation of diluted net
loss per share excludes potential common shares if the effect is anti-dilutive.
Potential common shares consist of unvested restricted common stock, incremental
common shares issuable upon the exercise of stock options and common shares
issuable upon the exercise of stock warrants.

                                      F-11
<PAGE>

     The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated (in thousands, except per share
amounts):

<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                                                       ---------------------------------
                                                         2004        2003        2002
                                                       ---------   ---------   ---------
<S>                                                    <C>         <C>         <C>
Numerator:
   Net loss ........................................   $   (847)   $ (8,294)   $(19,275)
                                                       =========   =========   =========

Denominator:
   Weighted average shares .........................      3,232       3,243       3,189
                                                       ---------   ---------   ---------

   Denominator for basic and diluted calculation ...      3,232       3,243       3,189
                                                       =========   =========   =========

Net loss per share:
   Basic and diluted ...............................   $  (0.26)   $  (2.56)   $  (6.04)
                                                       =========   =========   =========

     The following table sets forth potential shares of common stock that are
not included in the diluted net loss per share calculation above because to do
so would be anti-dilutive for the periods indicated (in thousands):

                                                                 DECEMBER 31,
                                                       ---------------------------------
                                                         2004         2003       2002
                                                       ---------   ---------   ---------

Common stock options ...............................        361       1,368       1,102
Common stock warrants ..............................         --         264         431
</TABLE>


COMPREHENSIVE INCOME (LOSS)

     The Company complies with the provisions of SFAS No. 130, "Reporting
Comprehensive Income" SFAS No. 130 establishes standards for disclosure and
financial statement presentation for reporting total comprehensive income (loss)
and its individual components. Comprehensive income (loss), as defined, includes
all changes in equity during a period from non-owner sources. The Company's
comprehensive income (loss) includes net income (loss), unrealized gains and
losses on investments and foreign currency translation adjustments and is
displayed in the statement of stockholders' equity.

SEGMENT INFORMATION

     Effective January 1, 1998, the Company adopted the provisions of SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for the method companies report information about
operating segments in financial statements. SFAS No. 131 focuses on the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. SFAS
No. 131 also requires disclosures about products and services, geographic areas
and major customers. The Company has determined that it operates in only one
operating segment.

                                      F-12
<PAGE>

     International revenues are based on the country in which the customer is
located. The following is a summary of total net revenues by geographic area (in
thousands):


                                                  YEAR ENDED DECEMBER 31,
                                             -----------------------------------
                                              2004          2003           2002
                                             -----          -----          -----
Domestic ..........................          $ --           $ 43           $435
International .....................            --             --             47
                                             -----          -----          -----
                                             $ --           $ 43           $482
                                             =====          =====          =====

     It is impractical for the Company to compute revenues by type of product
and service for the years ended December 31, 2004, 2003 and 2002

     Substantially all of the Company's assets as of December 31, 2004 and 2003
were located in the United States.

NEW ACCOUNTING PRONOUNCEMENTS

     In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123(R), "Accounting for Stock-Based Compensation (Revised)." SFAS No.
123(R) supersedes APB No. 25 and its related implementation guidance. SFAS No.
123(R) establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. SFAS No. 123(R)
focuses primarily on accounting for transactions in which an entity obtains
employee services in share-based payment transactions. SFAS No. 123(R) requires
a public entity to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period
during which an employee is required to provide service in exchange for the
award the requisite service period (usually the vesting period). No compensation
costs are recognized for equity instruments for which employees do not render
the requisite service. The grant-date fair value of employee share options and
similar instruments will be estimated using option-pricing models adjusted for
the unique characteristics of those instruments (unless observable market prices
for the same or similar instruments are available). If an equity award is
modified after the grant date, incremental compensation cost will be recognized
in an amount equal to the excess of the fair value of the modified award over
the fair value of the original award immediately before the modification.

     The Company has not completed its evaluation of SFAS No. 123(R) but expects
the adoption of this new standard will not have a material impact on operating
results of the Company.

NOTE 2--RELATED PARTIES:

     In July 2003, we relocated our principal executive offices to 888 Seventh
avenue, 17th Floor, New York, 10019, an office maintained by Barington Capital
Group, LP ("Barington"), a limited partnership whose general partner is a
corporation of which James Mitarotonda is Chairman, President and Chief
Executive Officer. Mr. Mitarotonda is our Chairman and former Chief Executive
Officer. William Fox, the President, Chief Executive Officer and a director of
the Company, is the Vice Chairman of Barington. From April 2003 through May 16,
2004, we paid Barington a monthly fee of $7,920 for certain administrative and
accounting services provided by Barington on our behalf. During the same period,
we also paid Jewelcor Management, Inc. (Jewelcor"), a corporation whose Chairman
and Chief Executive Officer is Seymour Holtzman, a fee of $5,000 for certain
administrative services provided by Jewelcor on our behalf. Mr. Holtzman is our
former Co-Chairman and Co-Chief Executive Officer. In May 2004, Mr. Holtzman
resigned from the Board and Jewelcor ceased to provide administrative services
to us. The Board then decided to enter into a new services arrangement with
Barington, and it was agreed that all payments for services would be suspended
until a new services arrangement was negotiated, although Barington continued to
provide services on our behalf during this suspension of payment. We entered
into a new services agreement with Barington dated as of November 18, 2004.
Under this agreement, we agreed to pay Barington $8,000 per month for providing


                                      F-13
<PAGE>

certain administrative, accounting and other services on our behalf and a fee of
$125 per hour for any legal services provided by Barington at our request. We
also agreed that in the event Barington identifies a business transaction such
as a merger, acquisition or joint venture, and provides us with financial
consulting services in connection with such business transaction, we will pay
Barington a fee of two percent of the a amount of the consideration paid in the
transaction. In connection with the agreement, we granted to Barington or its
designees stock options to purchase 56,000 shares of the our Common Stock. The
options are fully excercisable and were granted with an excercise price per
share equal to $1.82, the fair market value of our Common Stock on the grant
date. On January 1, 2005, we amended (the "Amendment") our services agreement
with Barington. The Amendment increased the monthly fee payable to Barington to
$15,000 and the hourly fee payable for legal services to $175.


NOTE 3--BALANCE SHEET COMPONENTS (IN THOUSANDS):

Depreciation expense for 2004, 2003 and 2002 was $0, 226 and $1,961
respectively. Amortization expense for purchased software, website and software
development costs for 2004, 2003 and 2002 was $0, $0 and $367 respectively.

     An impairment loss of $689 was recorded in the three months ended December
31, 2002 to write-down property and equipment to fair value. The Company's
property and equipment were devalued when the Company terminated its merger
agreement with Alliance in November 2002. If the merger had been approved, the
Company's property and equipment would have remained in use with the
continuation of its digital music fulfillment business under the combined
entity. When the Company terminated the merger agreement with Alliance, certain
property and equipment were no longer in use and the Company had to devalue the
economic life of the property and equipment remaining in use. In January 2003,
the Company announced the sale of its digital music fulfillment business and
related assets to Geneva. These assets included certain property and equipment.
The Company determined the fair value of the assets remaining in use and those
assets sold to Geneva based on quoted market prices obtained from a business
auction and valuation firm dealing in similar assets.

                                                                 DECEMBER 31,
                                                             -------------------
                                                              2004        2003
                                                             -------     -------
Accrued expenses and other current liabilities:

     Consulting and professional services ..............     $  104      $  124
     Litigation settlement .............................         --       1,766
     Other .............................................         10          45
                                                             -------     -------
                                                             $  114      $1,935
                                                             =======     =======


NOTE 4--COMMON STOCK:

     On December 6, 2002, the Company announced a return of capital cash
distribution to the Company's common stockholders of $2.50 per share, payable on
December 20, 2002 to stockholders of record as of December 10, 2002. After a
delay due to a lawsuit filed against the Company by BeMusic, Inc. (see Note
9--Commitments and Contingencies: Litigation), the Company paid this return of
capital cash distribution on January 29, 2003, for a total of $57.8 million.

     At the September 29, 2003 meeting of the Company's stockholders, the
stockholders approved amendments to the Company's certificate of incorporation
to effect a 1-for-250 reverse stock split, to be followed immediately by a
35-for-1 forward stock split (collectively, the "Reverse/Forward Stock Split"),
as well as a reduction in the number of common shares authorized for issuance
from 50,000,000 shares to 30,000,000 shares (the "Share Reduction"). On June 7,
2004, the Company filed amendments to its Certificate of Incorporation to
implement the Reverse/Forward Stock Split and the Share Reduction, which took
place on July 26, 2004. All weighted average and earnings per share amounts have
been restated to reflect the retroactive effect of the Reverse/Forward Stock
Split except for the capitalization of the Company.

     On August 4, 2004, the Company retired approximately 30,000 shares of
common stock.

                                      F-14
<PAGE>

NOTE 5--PREFERRED STOCK RIGHTS AGREEMENTS:

     On April 15, 2003, the Company's Board of Directors approved the repeal of
the Preferred Stock Rights Agreement. The Preferred Stock Rights Agreement gave
rights to stockholders, exercisable after a person or group announced
acquisition of 10% or more of the Company's common stock or announced
commencement of a tender or exchange offer the consummation of which would have
resulted in ownership by the person or group of 10% or more of the Company's
common stock to acquire shares of the Company's common stock or shares of any
company in which the Company was merged.

NOTE 6--WARRANTS:

     In June 1999, the Company signed an Advertising Agreement with Amazon.com,
Inc. ("Amazon.com") to collaborate on event-based advertising using the
Company's digital delivery services. In connection with this agreement, the
Company issued a fully vested warrant to purchase approximately 254,000 shares
of the Company's common stock to Amazon.com. The warrant was valued at
$2,022,000 and was recognized as strategic marketing-equity instruments expense
ratably over the one-year term of the agreement, which ended in June 2000. The
remaining warrants to purchase 254,000 shares of common stock expired in June
2004.

     In December 2000, the Company signed an agreement with BMG Entertainment to
obtain the right to distribute BMG sound recordings and related artwork through
kiosks. In connection with this agreement, the Company granted warrants to
purchase a total of 233,300 shares of common stock. Of the total, warrants to
purchase 77,768 shares vested in December 2001, and the cost was remeasured each
quarter until a commitment for performance was reached or the warrant vested
based on market data. At December 4, 2001, the 77,768 shares under this warrant
were valued at $175,000, of which $163,000 and $12,000 was recognized as
non-cash cost of net revenues in 2001 and 2000, respectively. The remaining
warrants to purchase common shares were scheduled to vest at 6,481 shares per
month commencing December 2001 for one year and 6,480 shares per month
commencing December 2002 for one year. The Company had the option to terminate
the agreement, repurchase the 50,000 shares of common stock and provide for the
warrants to expire immediately if BMG failed to make available to the Company a
specified minimum number of sound recordings in a specific time period. BMG
failed to make available the minimum number of sound recordings in the specific
time period, and accordingly in August 2002 the Company terminated the
agreement, repurchased the 50,000 shares of common stock, notified BMG of the
immediate expiration of the warrants and ceased recognizing non-cash cost of
revenues for the warrants. The Company recorded a total of $82,000 and $9,000 as
non-cash cost of revenue in 2002 and 2001 related to the warrants. No warrants
to purchase common stock are outstanding at December 31, 2004 and 2003,
respectively.

NOTE 7--EMPLOYEE BENEFIT PLANS:

401(k) SAVINGS PLAN

     The Company sponsored a 401(k) defined contribution plan covering eligible
employees who elect to participate. The Company elected to contribute matching
and discretionary contributions to the plan. The Company is not required to
contribute to the 401(k) plan, but in 2002 and 2001 elected to match
contributions up to a maximum of $2,000 per employee, with a two year vesting
schedule. As a result, the Company contributed and expensed $0, $0 and $95,000
for the years ended December 31, 2004, 2003 and 2002, respectively. The Company
is in the process of terminating the 401(K) plan.

STOCK OPTION PLANS

     In September 1996, the Board of Directors adopted the 1996 Equity Incentive
Plan (the "1996 Plan"), which initially provided for the granting of up to
1,144,000 incentive stock options and nonqualified stock options. In August
1997, October 1998 and April 1999, an additional 441,000, 88,000 and 1,600,000
shares, respectively, were authorized for grants under the 1996 Plan. Under the
1996 Plan, incentive stock options may be granted to employees of the Company
and nonqualified stock options and stock purchase rights may be granted to
consultants, employees, directors and officers of the Company. Options granted
under the 1996 Plan are for periods not to exceed ten years, and must be issued
at prices not less than 100% and 85%, for incentive and nonqualified stock
options, respectively, of the fair market value of the stock on the date of
grant as determined by the Board of Directors. Options granted under the 1996
Plan generally vest 25% after the first year and then 2.083% each month
thereafter until 100% vested. Options granted to stockholders who own greater
than 10% of the outstanding stock must be for periods not to exceed five years


                                      F-15
<PAGE>

and must be issued at prices not less than 110% of the estimated fair market
value of the stock on the date of grant as determined by the Board of Directors.
In April 1999, the 1996 Plan was also amended to provide for annual increases on
January 1 equal to the lesser of 1,500,000 shares, 5% of the outstanding shares
on such date or a lesser amount determined by the Board of Directors. For the
year ended December 31, 2004, approximately 188,000 options were granted under
the 1996 plan.

     In April 2000, the Board of Directors adopted the 2000 Nonstatutory Stock
Option Plan (the "2000 Plan"), which provided for the granting of up to 500,000
nonqualified stock options. Under the 2000 Plan, stock options may be granted to
employees of the Company. Options granted under the 2000 Plan are for periods
not to exceed ten years, and are issued at prices determined by the Board of
Directors or any of its committees. Options granted under the 2000 Plan vest at
terms and conditions determined by the Board of Directors or any of its
committees. Options granted for the year ended December 31, 2000 vest 25% after
the first year and then 2.083% each month thereafter until 100% vested. Options
granted for the year ended December 31, 2001 vest 2.083% each month until 100%
vested. No options were granted under the 2000 Plan for the year ended December
31, 2004 and 2003 respectively.

                                      F-16
<PAGE>

     The following table summarizes stock option activity under the plans
(shares in thousands):

                                                     OPTIONS OUTSTANDING
                                                     ------------------
                                                                WEIGHTED
                                        OPTIONS                 AVERAGE
                                       AVAILABLE                EXERCISE PRICE
                                       FOR GRANT     SHARES     PER SHARE
                                        -------      -------      -----

BALANCE AT DECEMBER 31, 2001 .........   1,928        2,921       6.84
  Additional options authorized ......   1,135           --         --
  Options granted ....................    (248)         248       2.45
  Options exercised ..................      --         (397)      1.90
  Options canceled ...................   1,670       (1,670)      7.08
                                        -------      -------     -----

BALANCE AT DECEMBER 31, 2002 .........   4,485        1,102       7.31
  Additional options authorized ......      --           --         --
  Options granted ....................  (1,690)       1,690       1.24
  Options exercised ..................      --          (32)       .22
  Options canceled ...................   1,392       (1,392)      7.41
                                        -------      -------     -----

BALANCE AT DECEMBER 31, 2003 .........   4,187        1,368        .29
  Options granted ....................    (188)         188       1.82
  Options exercised ..................      --           --         --
                                        -------      -------     -----
  Options canceled ...................   1,195       (1,195)       .29
                                        =======      =======     =====

BALANCE AT DECEMBER 31, 2004 .........   5,194          361       1.93
                                        =======      =======     =====

     The following table summarizes information concerning outstanding and
exercisable options for all stock option plans as of December 31, 2004 options
(shares in thousands):

<TABLE>
<CAPTION>
                                                                  OPTIONS VESTED AND
                           OPTIONS OUTSTANDING                    EXERCISABLE
                           -----------------------------------    ---------------------
                                        WEIGHTED       WEIGHTED                 WEIGHTED
                                        AVERAGE        AVERAGE                  AVERAGE
                                        REMAINING      EXERCISE                 EXERCISE
                           NUMBER       CONTRACTUAL    PRICE PER  NUMBER        PRICE PER
RANGE OF EXERCISE PRICES   OUTSTANDING  LIFE (YEARS)   SHARE      OUTSTANDING   SHARE
------------------------   -----------  ------------   -------    -----------   -------
<C>                               <C>           <C>    <C>               <C>    <C>
$.79 ...............                4           7.8    $  .79              4    $ 0.79
$2.07 ..............              169           8.3      2.07            169      2.07
$1.82 ..............              188           8.3      1.82             56      1.82
                           -----------                            -----------
                                  361             0    $ 1.89            230    $ 1.99
                           ===========                            ===========
</TABLE>

As of December 31, 2004 options were exercisable at weighted average exercise
prices of $2.02.

EMPLOYEE STOCK PURCHASE PLAN

     In April 1999, the Board of Directors adopted the 1999 Employee Stock
Purchase Plan (the "Purchase Plan") and reserved 500,000 shares of common stock
for issuance thereunder. The Purchase Plan was approved by the stockholders in
June 1999. On January 1, each year, the aggregate number of shares reserved for
issuance under the Purchase Plan is increased by the lesser of 750,000 shares,
3% of the outstanding shares on such date or a lesser amount determined by the
Board of Directors. The Purchase Plan became effective on the first business day
on which price quotations for the Company's common stock were available on the
Nasdaq National Market, which was July 8, 1999. Employees are eligible to
participate if they are customarily employed by the Company or any participating
subsidiary for at least 20 hours per week and more than five months in any
calendar year and do not (i) immediately after grant own stock possessing 5% or
more of the total combined voting capital stock, or (ii) possess rights to
purchase stock under all of the employee stock purchase plans at an accrual rate
which exceeds $25,000 worth of stock for each calendar year. The Purchase Plan
permits participants to purchase common stock through payroll deductions up to


                                      F-17
<PAGE>

15% of the participant's compensation, as defined in the Purchase Plan, but
limited to 2,500 shares per participant per purchase period. Each offering
period includes four six-month purchase periods, and the Purchase Plan was
amended in June 2000 so that purchase periods begin on April 1 and October 1 of
each year, except for the offering period which started on the first trading day
on or after the effective date of the public offering. The price at which the
common stock is purchased under the Purchase Plan is 85% of the lesser of the
fair market value at the beginning of the offering period or at the end of the
purchase period. The Purchase Plan will terminate after a period of ten years
unless terminated earlier as permitted by the Purchase Plan. Common stock issued
under the plan was 34,940. No shares of Common Stock were issued under the
Purchase Plan in 2004 and 2003 respectively.

FAIR VALUE DISCLOSURES

     Pro forma information regarding net loss and net loss per share is required
by SFAS No. 123, which also requires that the information be determined as if
the Company had accounted for its employee stock options and purchase rights
granted under the fair value method. The fair value for these options was
estimated using the Black-Scholes option pricing model.

     The Company calculated the fair value of each option grant on the date of
grant using the Black-Scholes option pricing method as prescribed by SFAS No.
123 using the following assumptions:

STOCK OPTIONS                                         YEAR ENDED DECEMBER 31,
-------------                                      -----------------------------
                                                    2004      2003       2002
                                                   -------  --------  ----------
Risk-free rates ..................................  4.00%     1.28%   1.74-3.71%
Expected lives (in years) ........................   5-10       1.0      1.0-3.1
Dividend yield ...................................   0.0%      0.0%         0.0%
Expected volatility .............................. 36.39%    140.0%        58.0%


EMPLOYEE STOCK PURCHASE PLAN                          YEAR ENDED DECEMBER 31,
----------------------------                       -----------------------------
                                                    2004      2003       2002
                                                   -------  --------  ----------
Risk-free rates ..................................     --         --  1.94-3.87%
Expected lives (in years) ........................     --         --     0.5-1.0
Dividend yield ...................................     --         --        0.0%
Expected volatility ..............................     --         --       20.2%

     The weighted average fair value of options granted were:

                                                      YEAR ENDED DECEMBER 31,
                                                   ----------------------------
                                                    2004      2003       2002
                                                   --------  --------  --------
Weighted average fair value of options
  granted during period .......................... $  1.82   $   .14   $  0.76
Weighted average fair value of purchase
  rights granted during period ...................      --        --      0.53


                                      F-18
<PAGE>

NOTE 8--INCOME TAXES:

     Deferred taxes are composed of the following (in thousands):

                                                                 DECEMBER 31,
                                                             -------------------
                                                               2004      2003
                                                             --------   --------
Deferred tax assets (liabilities)
   Net operating loss and tax credit carryforwards .......   $ 8,617    $ 7,845
   Depreciation and amortization .........................        45        652
   Accrual and other .....................................        38         46
                                                             --------   --------
   Total deferred tax assets .............................     8,701      8,543
   Less: Valuation allowance .............................    (8,701)    (8,543)
                                                             --------   --------
Net deferred tax assets ..................................   $    --    $    --
                                                             ========   ========

     At December 31, 2004, the Company had approximately $18.9 million of
federal and state net operating loss carryforwards available to offset future
taxable income. The federal and state net operating loss carryforwards expire
beginning in 2013. At December 31, 2004, the Company had approximately $2.0
million of federal and state research and development tax credit carryforwards
available to offset future taxes. The federal tax credit carryforward expire in
varying amounts beginning in 2011. The California tax credit carryforward can be
carried forward indefinitely.

     The total net operating loss carry-forwards ("NOL") of $18.9 million has
been reduced, for financial reporting purposes by $117.2 million for federal and
$48.9 million for state, which is unlikely ever to be utilized due to the
application of the Section 382 provisions. The remainder of the NOL also likely
might effectively be obviated if certain future events were to occur that would
invoke additional Section 382 provisions. Future use of the NOL's therefore is
extremely speculative and should not be presumed absent extensive analysis of
the complex Section 382 provisions.

     The Company has incurred a loss in each period since its inception. Based
on the available objective evidence, including the Company's history of losses,
management believes it is more likely than not that the net deferred tax assets
will not be fully realizable. Accordingly, the Company has provided for a full
valuation allowance against its total deferred tax assets at December 31, 2004
and 2003. The valuation allowance increased by approximately $158,000 in the
year ended December 31, 2004.

NOTE 9--COMMITMENTS AND CONTINGENCIES:

LEASES

     The Company terminated all property leases in 2003 other than a month to
month lease on a small office in Foster City, California . The office in Foster
City was vacated in September 2004.

                                                    YEAR ENDED DECEMBER 31,
                                                ------------------------------
                                                 2004        2003       2002
                                                -------     ------    --------
Rent expense (in thousands)................     $   10      $ 532     $ 2,340


LITIGATION

     From time to time, the Company has been subject to litigation including the
pending litigation described below. Because of the uncertainties related to both
the amount and range of loss on the pending litigation, management is generally
unable to make a reasonable estimate of the liability that could result from an
unfavorable outcome and has therefore not recorded a liability, except as
described below. As additional information becomes available, the Company will
assess its potential liability and revise its estimates. Pending or future
litigation could be costly, could cause the diversion of management's attention
and could upon resolution, have a material adverse effect on the Company's
business, results of operations, financial condition and cash flow.

                                      F-19
<PAGE>

     In addition, the Company is engaged in certain legal and administrative
proceedings incidental to its normal business activities and believes that these
matters will not have a material adverse effect on its financial position,
results of operations or cash flow.

     On or about April 7, 2000, SightSound filed an Amended Complaint in a
lawsuit in the United States District Court for the Western District of
Pennsylvania (the "Pennsylvania Court") alleging that certain former customers
of ours, N2K, Inc., CDNow, Inc. and CDNow Online, Inc., which have since merged
into BeMusic, infringed one or more of three patents of SightSound (Nos.
5,191,573; 5,675,734; and 5,996,440). In January 2002, we agreed to share evenly
with CDNow Online, Inc. all legal fees incurred by CDNow Online, Inc. in
defending the patent infringement action, but required BeMusic to consult in
good faith with us regarding its defense and/or settlement of the patent
infringement action. On February 20, 2004, an Order was entered in the
Pennsylvania Court ending the lawsuit by SightSound against BeMusic. As a result
of the entry of the Order and pursuant to a separate agreement between
SightSound and BeMusic executed on February 12, 2004, SightSound dismissed the
SightSound litigation and released all claims against us. Entry of the Order
also made effective a Settlement Agreement and Mutual Release executed on
February 13, 2004 by us and BeMusic (the "Settlement Agreement"). The Settlement
Agreement finally resolves all matters between BeMusic and us relating to the
SightSound litigation. Under the terms of the Settlement Agreement, we paid
$1,452,000 to BeMusic and approximately $314,000 in legal fees relating to the
SightSound litigation. These payments were in addition to $335,827 previously
paid by us for our share of attorney fees incurred in connection with this
matter. As a result of the Settlement Agreement, we have no further obligation
to maintain available cash on hand in connection with the SightSound litigation.
Neither party to the Settlement Agreement admitted any wrongdoing or any
indemnification obligations in connection with this litigation.

     We, certain of our former officers and directors, and various of the
underwriters in our initial public offering ("IPO") and secondary offering were
named as defendants in a consolidated action filed in the United States District
Court for the Southern District of New York, on July 20, 2001, IN RE LIQUID
AUDIO, INC. INITIAL PUBLIC OFFERING SECURITIES LITIGATION, CV-6611. The
consolidated amended complaint generally alleges that various investment bank
underwriters engaged in improper and undisclosed activities related to the
allocation of shares in our IPO and secondary offering of securities. The
plaintiffs brought claims for violation of several provisions of the federal
securities laws against those underwriters, and also against us and certain of
our former directors and officers, seeking unspecified damages on behalf of a
purported class of purchasers of our common stock between July 8, 1999 and
December 6, 2000. Various plaintiffs filed similar actions asserting virtually
identical allegations against more than 40 investment banks and 250 other
companies. All of these "IPO allocation" Securities class actions currently
pending in the Southern District of New York are assigned to Judge Shira A.
Scheindlin for coordinated pretrial proceedings as in re Liquid Audio, Inc.
Initial Public Offering Securities Litigation, 21 MC 92. The issuer defendants
in the coordinated proceedings, including Liquid Audio, filed omnibus motions to
dismiss the actions. In October 2002, our directors and officers were dismissed
without prejudice pursuant to a tolling agreement. In February 2003, the court
issued a ruling denying the motion to dismiss with respect to the claims against
us. In June 2004, a stipulation of settlement, for the release of claims against
the issuer defendants, including the Company, in exchange for a contingent
payment to be made by the issuer defendants' insurance carriers and an
assignment of certain claims, was submitted to the Court for approval. The
settlement is subject to a number of conditions, including approval of the
Court. On February 15, 2005, the Court granted a conditional preliminary
approval of the stipulation of settlement. If the settlement does not occur, and
litigation against us continues, we believe that we have meritorious defenses to
the claims against us and intend to defend ourselves vigorously.

GUARANTEES, WARRANTIES AND INDEMNIFICATION

     The Company, as permitted under Delaware law and in accordance with its
Bylaws, indemnify its officers and directors for certain events or occurrences,
subject to certain limits, while the officer is or was serving at the Company's
request in such capacity. The term of the indemnification period is for the
officer's or director's lifetime. The maximum amount of potential future
indemnification is unlimited; however, the Company has a Director and Officer
Insurance Policy that limits its exposure and enables it to recover a portion of
any future amounts paid. As a result of the Company's insurance policy coverage
it believes the fair value of these indemnification agreements is minimal.

                                      F-20
<PAGE>

     In the Company's sales agreements, the Company typically agrees to
indemnify its customers for any expenses or liability resulting from claimed
infringements of patents, trademarks or copyrights of third parties. The terms
of these indemnification agreements are generally perpetual any time after
execution of the agreement. The maximum amount of potential future
indemnification is unlimited. Except for the Sightsound legal matter (see
LITIGATION above), to date the Company has not paid any amounts to settle claims
or defend lawsuits related to indemnification under its sales agreements.

NOTE 10--RESTRUCTURING:

     In September 2002, the Company adopted a corporate restructuring program,
consisting of a worldwide workforce reduction, to reduce expenses in response to
the digital music market not developing as soon as anticipated and de-emphasis
of the Liquid Player product line, in preparation for the proposed merger with
Alliance Entertainment Corporation. The Company agreed to terminate the merger
agreement on November 8, 2002. A restructuring charge of $1,163,000 was recorded
in operating expense in the twelve months ended December 31, 2002. The
restructuring charge included involuntary separation costs of $852,000 for 34
employees worldwide, 5 in sales and marketing, 26 in research and development, 2
in general and administrative and 1 in operations functions in the U.S., asset
impairment costs of $156,000 for property and equipment, furniture and fixtures,
computer software for assets no longer in use from reductions in workforce and
lease costs of $155,000 pertaining to non-cancelable lease payments for excess
facilities that were vacated due to reductions in workforce.

     In January 2003, the Company adopted another corporate restructuring
program, consisting of a worldwide workforce reduction, in connection with the
sale of the Company's digital music fulfillment business and related assets to
Geneva Media, LLC ("Geneva"), an affiliate of Anderson Merchandisers, LP. A
restructuring charge of $4,411,000 was recorded in operating expense for the
year ended December 31, 2003. The restructuring charge included involuntary
separation costs of $796,000 for 29 employees worldwide, 5 in sales and
marketing, 11 in research and development, 9 in general and administrative and 4
in operations functions in the U.S., lease termination fees of $3,599,000 and
asset impairment costs of $46,000 for prepaid expenses related to assets sold to
Geneva.

     In July 2003, the Company incurred a one-time payout of $3,569,000 to
terminate the remaining term of its property lease on its former headquarters
located in Redwood City, CA. As of December 31, 2003, the Company paid this
liability and expensed it as a restructuring charge.

     In October 2003, the Company incurred a one-time payout of $30,000 to
terminate the remaining term of its property lease on an office located in Los
Angeles, California.

     The Company did not incur any restructuring charges during the year ended
December 31, 2004.

                                      F-21
<PAGE>

     A summary of the restructuring cost is outlined as follows (in thousands):


<TABLE>
<CAPTION>
                                                   SEVERANCE
                                                   AND                     ASSET
                                                   BENEFITS   FACILITIES   IMPAIRMENTS   TOTAL
                                                   --------   ----------   -----------   --------
<S>                                                <C>        <C>          <C>           <C>
       Restructuring reserve balance at January
          1, 2002 ..............................   $    --    $     523    $       --    $   523
     Severance and benefits ....................       852           --            --        852
     Accrued lease costs .......................        --          155            --        155
     Property and equipment impairment .........        --           --           156        156
                                                   --------   ----------   -----------   --------
     Total .....................................       852          678           156      1,686
     Cash paid .................................      (852)        (678)           --     (1,530)
     Non-cash ..................................        --           --          (156)      (156)
                                                   --------   ----------   -----------   --------
       Restructuring reserve balance at December
          31, 2002 .............................   $    --    $      --    $       --    $    --
                                                   --------   ----------   -----------   --------


     Severance and benefits ....................       796           --            --        796
     Lease termination fee .....................        --        3,599            --      3,599
     Asset  impairment .........................        --           --            46         46
                                                   --------   ----------   -----------   --------
     Total .....................................       796        3,599            46      4,441
     Cash paid .................................      (796)      (3,599)           --     (4,395)
                                                   --------   ----------   -----------   --------
     Non-cash ..................................        --           --           (46)       (46)
                                                   --------   ----------   -----------   --------
       Restructuring reserve balance at December
          31, 2003 .............................   $    --    $      --    $       --    $    --
                                                   ========   ==========   ===========  =========
</TABLE>


NOTE 11--MERGER:

     On June 12, 2002, the Company signed a definitive merger agreement with
Alliance Entertainment Corp. ("Alliance"), a privately-held home entertainment
product distribution, fulfillment and infrastructure company. On July 14, 2002,
the Company and Alliance executed an amended and restated merger agreement that
modified certain terms of the previously announced merger agreement. On November
8, 2002, the Company and Alliance agreed to terminate the merger agreement. The
Company consequently paid a termination fee of $2,100,000 to Alliance, which is
recorded as Merger Termination Fee in 2002.

NOTE 12--SALE OF INTELLECTUAL PROPERTY:

     In September 2002, the Company entered into an agreement with Microsoft
Corp. ("Microsoft") that enables Microsoft to acquire the domestic and foreign
rights to the Company's entire patent portfolio for $7,000,000 in cash. Since
its inception, the Company has been awarded several key patents related to its
technology and product architecture. These include patents in the areas of
digital rights management ("DRM"), technology for secure content transfer to
portable devices and the ability to honor territorial restrictions for digital
music content. The Company had not previously capitalized any costs with respect
to the patents. In addition to the cash consideration, the Company received an
assignable perpetual royalty-free license to continue using the patented
technology in its digital distribution system ("Microsoft License"). There are
no restrictions to the use of the patents under this royalty-free license other
than allowing only one transfer of such royalty-free license to another entity.
The $7,000,000 is recorded as Gain on Sale of Intellectual Property in 2002.

                                      F-22
<PAGE>

NOTE 13--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):

     The following is a summary of the unaudited quarterly results of operations
for the periods shown (in thousands except per share data):


<TABLE>
<CAPTION>
                                                                    THREE MONTHS ENDED
                                        ------------------------------------------------------------------------------
                                        MARCH     JUNE      SEPT.     DEC.      MARCH     JUNE      SEPT.     DEC.
                                        31, 2004  30, 2004  30, 2004  31, 2004  31, 2003  30, 2003  30, 2003  31, 2003
                                        -------------------------------------------------------------------------------
<S>                                     <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
Net revenue                             $   --    $   --    $   --    $   --        43    $    --   $  --     $    --
Gross profit (loss)                         --        --        --        --        36         --      --          --
Net loss                                  (134)     (353)     (185)     (175)   (1,188)    (4,894)   (426)     (1,786)
Net loss per share, basic and diluted     (.04)     (.11)     (.06)     (.05)     (.05)      (.21)   (.02)       (.08)
Weighted average shares used in per
share calculation                        3,245     3,243     3,238     3,213     3,241      3,243   3,246       3,246
-----------------------------------------------------------------------------------------------------------------------
</TABLE>

NOTE 14--SALE OF DIGITAL MUSIC FULFILLMENT BUSINESS

     In January 2003, the Company entered into an agreement to sell its digital
music fulfillment business and related assets (approximately $332,000) to Geneva
Media, LLC ("Geneva"), an affiliate of Anderson Merchandisers, LP for
$3,200,000. As part of the sale, the Company also transferred ownership of
certain "Liquid Audio" related trademarks to Geneva and the Microsoft License.
The Company recorded a gain on sale of Digital Music Fulfillment Business of
$2,868,000 in 2003. As a result of the sale, the Company is not currently
operating any businesses.

NOTE 15---DECREASE IN STOCK OPTION EXERCISE PRICE

     On March 18, 2003, the Company's Board of Directors elected to reduce the
exercise price of all outstanding stock options by $2.50, but not lower than
$0.10. Consequently, the Company accounts for approximately 61,000 of the stock
options as variable.

NOTE 16---REVERSE/FORWARD STOCK SPLIT

     At the September 29, 2003 meeting of the Company's stockholders, the
stockholders approved amendments to the Company's certificate of incorporation
to effect a 1-for-250 followed immediately by a 35-for-1 Reverse/Forward Stock
Split as well as the Share Reduction. On June 7, 2004, the Company filed
amendments to its Certificate of Incorporation to implement the Reverse/Forward
Stock Split and the Share Reduction, which took place on July 26, 2004. All
weighted average and earnings per amounts have been restated to reflect the
retroactive effect of the Reverse/Forward Stock Split except for the
capitalization of the Company.

                                      F-23
<PAGE>

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

     The following is a summary of valuation and qualifying accounts for the
periods shown:

<TABLE>
<CAPTION>
                                                 ADDITIONS
                                                  CHARGED
                                       BALANCE   (CREDITED)
                                       AT         TO COSTS                 BALANCE
                                       BEGINNING    AND                   AT END OF
                                       OF YEAR    EXPENSES    DEDUCTIONS    YEAR
                                       ---------  ---------   ----------  ---------
<S>                                    <C>        <C>         <C>         <C>
DECEMBER 31, 2002
Allowance for Doubtful Accounts        $    325   $      0    $    (179)  $    146

DECEMBER 31, 2003
Allowance for Doubtful Accounts        $    146   $      0    $    (146)  $      0

DECEMBER 31, 2004
Allowance for Doubtful Accounts
                                       $      0   $      0    $       0   $      0
</TABLE>


                                      F-24
<PAGE>

EXHIBIT INDEX


3.1      Certificate of Incorporation as currently in effect (6)
3.2      Bylaws as currently in effect (2)
4.2      Form of Specimen Stock Certificate (1)
4.3      Second Amended and Restated Investor Rights Agreement dated July 31,
         1998 (1)
10.1     Form of Indemnification Agreement entered into between the registrant
         and each of its directors and executive officers (1)
10.2     1996 Equity Incentive Plan (1)
10.3     1999 Employee Stock Purchase Plan (1)
10.22    Summary Plan Description of 401(K) Plan (1)
10.50    2000 Nonstatutory Stock Option Plan (2)
10.71    Settlement Agreement with BeMusic, Inc. dated as of
         January 17, 2003 (3)
10.74    Settlement Agreement and Mutual Release with BeMusic, Inc. dated
         February 13, 2004 (5)
10.80    Administrative Services Agreement with Barington Capital Group, L.P.
         dated as of November 18, 2004
10.85    Amendment to Administrative Services Agreement with Barington Capital
         Group, L.P. dated as of January 1, 2005
11.1     Statement regarding computation of per share earnings (4)
23.1     Consent of PricewaterhouseCoopers LLP
23.2     Consent of Rothstein Kass & Company, PC
24.1     Power of Attorney (contained in the signature page to this report)
31.1     Certification of Chief Executive Officer pursuant to Section 302 of
         Sarbanes-Oxley Act of 2002
31.2     Certification of Chief Financial Officer pursuant to Section 302 of
         Sarbanes-Oxley Act of 2002
32.1     Certification of Chief Executive Officer pursuant to Section 906 of
         Sarbanes-Oxley Act of 2002
32.2     Certification of Chief Executive Officer pursuant to Section 906 of
         Sarbanes-Oxley Act of 2002
32.2     Certification of Chief Financial Officer pursuant to Section 906 of
         Sarbanes-Oxley Act of 2002

--------------------

+     confidential treatment received as to certain portions

(1)  Incorporated by reference to the Registration Statement on Form S-1 and all
     amendments thereto, Registration No. 333-77707, filed with the Securities
     and Exchange Commission on May 4, 1999 and declared effective July 8, 1999
(2)  incorporated by reference to the Form 10-Q filed with the Securities and
     Exchange Commission on August 14, 2000
(3)  Incorporated by reference to Exhibits on Form 8-K filed with the Securities
     and Exchange Commission on January 28, 2003
(4)  this exhibit has been omitted because the information is shown in the
     financial statements or notes thereto
(5) Incorporated by reference to the Form 10-K filed with the Securities and
     Exchange Commission on March 30, 2004
(6)  Incorporated by reference to the Form 8-K filed with the Securities and
     Exchange Commission on July 16, 2004

                                      F-25