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SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549



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FORM 10-K



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(Mark One)

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|[X]   |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    
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|      |  | SECURITIES EXCHANGE ACT OF 1934                         
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|      |  | For the fiscal year ended December 31, 2000.            
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|[   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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|      |  | SECURITIES EXCHANGE ACT OF 1934                         

For the transition period from ______ to _____.

Commission File Number 000-26697MP3.com, Inc.(Exact name of registrant as specified in its charter)

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|Delaware
(State or other jurisdiction of
incorporation or organization)    |  | 33-0840026
(I.R.S. Employer
Identification No.)
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|4790 Eastgate Mall, San Diego, CA
(Address of principal executive offices) |  | 92121-1970
(Zip Code)                          

(858) 623-7000
(Registrants telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act:
None

Securities registered under Section 12(g) of the Exchange 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 the 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. [X]

The aggregate market value of the voting stock held by non-affiliates computed
by using the closing price for the Common Stock as quoted by the Nasdaq Stock
Market as of December 31, 2000 was approximately
$115,241,000.*

As of December 31, 2000 there were 68,529,044 shares of the Registrants Common
Stock, $0.001 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Registrants proxy statement filed in connection with the solicitation of
proxies for its 2001 Annual Meeting of Stockholders is incorporated by
reference into Part III of this Form 10-K. Certain Exhibits filed with the
Registrants Registration Statement Form S-1 (333-78545), Form 10-K for the
Year Ended December 31, 1999 and Form 10-Q for each of the quarters ended
September 30, 1999, March 30, 2000, June 30 2000 and September 30, 2000 are
incorporated by reference into Part IV of this Form 10-K.



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|* |  | Excludes 36,464,340 shares of Common Stock held or beneficially held
by directors and executive officers and stockholders whose ownership exceeds
ten percent of the shares outstanding on December 31, 2000. Exclusion of shares
held by any person should not be construed to indicate that such person
possesses the power, directly or indirectly, to direct or cause the direction
of the management or policies of the registrant or that such person is
controlled by or under common control with the registrant.
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TABLE OF CONTENTS



|              |                                                                                                 |  |  |  |  |  |  | 
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|PART I       
|              | Item 1.  Business                                                                              
|              | Item 2. Properties                                                                             
|              | Item 3. Legal Proceedings                                                                      
|              | Item 4. Submission of Matter to a Vote of Security Holders                                     
|PART II      
|              | Item 5. Market for Registrant's Common Equity and Related Stockholder Matters                  
|              | Item 6.  Selected Financial Data                                                               
|              | Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations
|              | Item 7A. Quantitative and Qualitative Disclosures about Market Risk                            
|              | Item 8.   Consolidated Financial Statements and Supplementary Data                             
|              | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   
|PART III     
|              | Item 10. Directors and Executive Officers of the Registrant                                    
|              | Item 11. Executive Compensation                                                                
|              | Item 12. Security Ownership of Certain Beneficial Owners and Management                        
|              | Item 13. Certain Relationships and Related Transactions                                        
|PART IV      
|              | Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K                       
|              | Exhibit Index                                                                                  
|              | Signatures                                                                                     
|Exhibit 10.5 
|Exhibit 10.25
|Exhibit 10.26
|Exhibit 10.27
|Exhibit 23.1 



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MP3.com, Inc.

TABLE OF CONTENTS

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|Item 3.  |  | Legal Proceedings                                                                     |  |      | 43
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|         |  | PART III                                                                             
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|Item 10. |  | Directors and Executive Officers of the Registrant                                    |  |      | 89
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|Item 11. |  | Executive Compensation                                                                |  |      | 89
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|         |  | PART IV                                                                              
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|Item 14. |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  |      | 89
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|         |  | Exhibit Index                                                                        
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|         |  | Signatures                                                                           

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PART I

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

Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future events or results, levels
of activity, performance or achievements, all of which may differ materially.
We urge you to carefully review and consider the various disclosures made by
us, which attempt to describe some of the factors that affect our business and
may cause such material differences, including without limitation the
disclosures made under the caption Risk Factors and elsewhere in this annual
report on Form 10-K.

Neither our company nor any other person assumes responsibility for the
accuracy and completeness of the forward-looking statements made in this
document. Also, we are under no obligation, and we assume no obligation, to
update any of the forward-looking statements for any reason, even if new
information becomes available or other events occur in the future.







Item 1.Business

Overview

We have pioneered a revolutionary approach to the promotion and distribution of
digital music. The MP3.com web site is a premier online music destination featuring, as
of December 31, 2000, approximately 800,000 song and audio files from over
125,000 digital artists, representing one of the largest catalogs of digital
music available on the Internet today. We use the Internet and file formats
that make music files smaller to enable this growing number of artists to
broadly distribute and promote their music and to enable consumers around the
world to conveniently access this continually expanding music catalog.
Consumers can search for, listen to and download music free of charge on the
MP3.com web site.

In addition to the wide variety of music distributed by artists through our web
site, consumers have a substantial amount of music already in their personal
music collections that they want to access, manage and listen to in a variety
of ways. Just as consumers use an Internet service provider as the central
mechanism through which they interact with the Internet, individuals are
increasingly looking for one central resource that allows them to access,
manage and listen to all music not just new music, but music already in
their personal collections. We call this resource a Music Service Provider
or MSP. MP3.com is enhancing its offerings in a continued effort to be the
premier MSP for consumers.

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

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In February and March 2000, several major recording and publishing companies
led by the Recording Industry Association of America and the Harry Fox Agency,
Inc. commenced separate lawsuits against us alleging that the inclusion of
their respective content in the My.MP3 service infringed their copyrights. In
May 2000, pending resolution of these legal proceedings, we began limiting
consumers use of the My.MP3 service so they could only access and manage the
music that was posted on the MP3.com web site by artists. Following several
legal battles, we entered into license agreements with BMG Entertainment, Time
Warner, Inc., EMI Recorded Music, Sony Music, and Universal Music Group
covering the use of their master recordings in the My.MP3 service. We also
entered into a license agreement with the Harry Fox Agency, Inc. covering
certain uses of musical compositions in the My.MP3 service. In December 2000,
we again began to allow consumers to place music from their existing music CD
collections in their My.MP3 music lockers. In this current format, My.MP3 is
offered as both a free and premium subscription-based service.

We believe we have developed core competencies and created a technology
infrastructure system that will enable us to provide a wide variety of data
management and infrastructure services to businesses. Through our
ongoing efforts to develop, maintain and improve the MP3.com web site, we have
amassed a significant amount of expertise in data storage, delivery and
management; server-side security; and royalty tracking and payment systems. We
have also created a technology infrastructure system that stores, manages,
tracks and provides statistical analysis on a real-time basis for digital data
for over 125,000 artists and more than 13.5 million registered users. In
December 2000, our technology infrastructure system delivered an average of over
4.5 terabytes of data each day.

Leveraging these core competencies and our backbone technology infrastructure
system, we have developed a number of unique products and services designed to
further our primary mission to help grow the digital music space. These
products and services include the first-ever, on-demand Internet subscription
music channels, innovative business music services, a syndicated radio program,
a music promotions business, and business-to-business content management and
marketing services. We intend to continue working to develop innovative
products and services that leverage our core competencies and build upon this
powerful and robust backbone technology infrastructure system.

In order to maintain our leadership position in the digital music industry, we
intend to leverage our technology and strategic partnerships with leading web sites, broadband
application developers, device manufacturers, record labels, software and
hardware developers, wireless carriers, retailers and connectivity providers to (1) give consumers worldwide access
to their music, whenever they want it, wherever they want it, on any
web-enabled device or application; (2) provide artists with the greatest
potential for promotion and distribution of their music; and (3) expand the
potential commercial applications of our technology.

We generate revenues from online advertising, offline advertising, business
services and electronic commerce. For the year ended
December 31, 2000, 96.5%
of our revenues were from the sale of advertising. In July 1999, we entered
into an agreement with Groupe Arnault, now called Montaigne Participations Et
Gestion or MPG, under which MPG committed to purchase advertising, promotion
and marketing services from us over a three-year period. In the third quarter
of 2000, we entered into an amended and restated agreement with MPG. The
restated agreement extended our relationship with MPG through 2004, reduced to
$120 million the aggregate amount of services to be purchased by MPG over the
life of the agreement, and provided certain exceptions to the favored pricing
granted to MPG under the original agreement. We believe that the revised
commitment schedule will allow for more efficient use of our marketing services
for the mutual benefit of MPG, MPGs various companies and MP3.com.

Our Industries

The Traditional Recorded Music Industry

Music continues to be one of the most popular forms of entertainment in the
world. Music is also big business. According to the International Federation
of the Phonographic Industry, worldwide sales of recorded music were $38.5
billion in 1999, 37% of which were in the United States.

The structure and operation of the music industry has remained relatively
unchanged for many years. Artists are generally required to sign exclusive
contracts with record labels, which in turn develop, distribute and promote
their music. In addition, major record labels, as well as a few independent
labels, control to a large extent the type and quantity of recorded music
available to consumers.

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This existing system limits artists and consumers in the following ways:



| |  |  | Few artists can sell enough music to cover the high distribution and
promotion costs. These costs include producing CDs and tapes, inventory
and retail chain management, as well as television, print ad and radio
promotions and public relations efforts;                                      
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
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| |  |  | The majority of artists can only reach limited audiences due to finite
shelf space at retailers and limited airtime on radio and television
stations, thus limiting the choices available to consumers;                                                                                           
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| |  |  | In order to encourage the record companies up-front investment,
artists must generally commit to multi-year, multi-album contracts. These
contracts typically give the record company rights to and control of the
artists music, including all digital rights; and                             
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| |  |  | There is very little communication and exchange of information and data
between artists and consumers. For example, artists do not readily know
who is buying their music or how to contact them, and consumers often do
not have an opportunity to interact directly with their favorite artists.

Because of these limitations, the number of artists served by the existing
music distribution system is small compared to the universe of musicians with
commercial aspirations. According to a 2000 Gallup poll, approximately 50% of
U.S. households are active music-makers. In addition, according to the
National Association of Music Merchants, approximately 62% of U.S. households
contain an amateur musician. These musicians represent a broad spectrum of
artists including hobbyists, amateurs, semi-professional and professional
musicians.

The Internet and Portable Internet Devices

The Internet has emerged as a global platform that allows millions of people
and businesses to share information, communicate, conduct business and be
entertained. The Internet Industry Almanac estimates that the number of
Internet users worldwide will grow from approximately 280 million in 1999 to
601 million by the end of 2002. The Internet has become an attractive medium
for advertising and direct marketing because it allows for the collection of
key demographic data from consumers. Advertisers can better target individuals
based on their Internet use and buying patterns. According to Jupiter
Communications, the dollar volume of online advertising will increase from $5.3
billion in 2000 to $7.3 billion in 2001, and according to Merrill Lynchs
Advertising Internet Bureau, online e-mail marketing will increase from $600
million in 2000 to $1.3 billion in 2001.

As users online time increases, more and more users are transitioning to the
convenience of faster Internet connections, upgrading from 28.8 Kbps modems to
cable and xDSL modems. According to Forrester Research, the number of
subscribers using cable or xDSL modems is projected to increase from 5 million
in 2000 to 18 million in 2002.

Several recent technological developments have focused on providing wireless
access to the Internet. Microsoft Corporation, Lucent Technologies, Nokia
Corporation, Sprint Communications Company, Palm, Inc., Motorola, Inc. and
others have introduced technologies that integrate computer chips into portable
consumer handheld devices that enable wireless access to the Internet. Many of
these devices either are or will be enabled with audio capabilities. According
to industry sources, (i) in 2000 there were 6 million people worldwide who
accessed the Internet via wireless technology with 484 million people expected
by 2005; and (ii) by 2003 there will be one billion mobile devices in the world
that are enabled with wireless access to the Internet. Also, the Yankee Group
estimates there will be as many as 50 million U.S. wireless data subscribers by
2005 and ARC Group predicts that the number of mobile handsets capable of
downloads and playing digital music will increase to over 90 million by 2005.

Digital Music

In recent years, consumers have increasingly used their computers to play
music. Dataquest reported that in 1999, 43% of U.S. households had multimedia
PCs with a sound card, speakers and either a CD-ROM or DVD-ROM drive.
Forrester Research estimates that by 2003 downloading music files will add $1.1
billion to the United States music industry.Consumers can now play CDs on
their computers with the ease and fidelity formerly associated only with stereo
systems. However, music files that exist on physical CDs are very large and,
until fairly recently, inhibited users ability to store and transfer music
from the CD. For example, a three-minute song in its original

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format on a physical CD occupies more than thirty megabytes of storage. As a
result, storing and transferring audio files in their original format is
expensive and time-consuming. To address this problem, compression formats
have been developed.

One of the most widely accepted standards for the compression of music is mp3,
an open standard adopted by the Moving Picture Experts Group working under the
joint direction of the International Standards Organization and the
International Electro-Technical Commission. Several other compression formats
are also available, including proprietary audio formats from companies like
Microsoft Corporation, Real Networks, Liquid Audio and AT&T Corp. The mp3
standard offers approximately 10:1 compression and audio integrity at near-CD
quality. Free copies of mp3 playback software are widely available on the
Internet. The development of compression formats like mp3 has made it
practical to transmit music over the Internet. Mp3 playback is currently
available on most operating environments including Microsoft Windows 95,
Windows 98, Windows NT, Windows 2000, MacOS and Linux, most major versions of
UNIX and many other operating environments.

Traditional music industry companies, including BMG Entertainment, EMI Recorded
Music; Sony Music; Time Warner, Inc., and Universal Music Group, have made
public announcements that they are actively pursuing digital distribution and
online promotion of music through in-house development efforts and strategic
alliances.

Internet Infrastructure Content Distribution and Delivery

Today, there are essentially four basic types of content delivery and traffic
routing networks. These are: 1) content distribution networks for relatively
simple web pages and graphics, provided by companies such as Akamai and Mirror
Image Internet; 2) multimedia distribution networks for rich media such as
video and/or audio streaming files, provided by companies including iBeam,
Akamai, Axient; 3) streaming distribution networks designed to deliver large
files efficiently via satellite, provided by companies such as Cidera and
Edgix; and 4) e-commerce distribution networks designed to distribute highly
dynamic e-commerce content and application intelligence, provided by companies
such as epicRealm, AppStream and Akamai.

A factor driving the need for content distribution and delivery networks is
that more and more consumers and businesses are using the Internet for
mission-critical activities, with high requirements for speed and reliability.
International Data Corporation currently projects total e-commerce transactions
worldwide at approximately $1.6 trillion by 2003, six times the $268 billion
expected in 2000.

Driven by the increased level of Internet usage and commerce, the amount of
data traffic flowing over the Internet is growing dramatically, partly due to
increased transmission of bandwidth-intensive streaming video and audio files.
For example, Gartner Group estimates that by year-end 2001 over half of all web
sites will include some streaming content. Overall, International Data
Corporation has estimated that the amount of data flowing over the Internet
will grow from 56 trillion bytes per day in 1998 to 1,507 trillion bytes per
day in 2002, a compound annual growth rate of 158%.

Our MSP Solution

We provide a centralized solution to digital artists, record labels, businesses
and consumers. As an MSP, we facilitate consumers ability to store, access,
manage and listen to their music collections online, and digital artists and
record labels ability to promote, market and distribute their music directly
to consumers. Our powerful and robust technology infrastructure system
provides a number of advantages to digital artists, record labels,
consumers,
retail businesses and other commercial establishments. The discussion
below describes a number of these advantages.

Digital Artists and Record Labels

Distribution and Promotional Power.We offer digital artists and record labels
a distribution model that allows them to upload and promote their music through
their own MP3.com web page for no charge. We empower digital artists by
allowing them to post songs or audio files on our web site, control the
promotion of their music by specifying music genres and geographical
classifications, adding or deleting music selections at any time and selecting
price points for the sale of their CDs. We also provide artists with several
tools that enable them to interact with and present music, messages and other
content directly to their fans.

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Global and Local Exposure.Digital artists and record labels can use our web
site to reach a global and growing base of consumers immediately upon uploading
their music. Lesser-known local artists, as well as record labels, can
immediately promote and distribute their music to a targeted audience while
simultaneously reaching a broader worldwide audience to market concert
promotions, new song releases or directly contact fans. We facilitate artist
discovery by allowing users to browse the site alphabetically, geographically
from countries to local towns, or by music genre and style.

Access to Consumer Feedback and Statistics.Artists receive daily, detailed
information about how many people visited their web page, how many people
listened to their songs, how many people downloaded their music, how many times
their music was streamed in a business/retail establishment, and how many CDs
they sold during the day or over the past month. Digital artists can also
learn geographical information about their fan base. Our aggregated data and
demographics analyses allow us to offer artists sales, marketing and other
information that enables them to define, evaluate and connect with their fan
base.

Revenue Opportunities.Our digital artists control the pricing of their music
and can achieve superior economics through revenue sharing on sales of their
Digital Automatic Music (or DAM) CDs. Under our revenue sharing arrangement,
digital artists earn at least a 50% royalty on sales of their DAM CDs. In
addition, under our Payback for Playback program, which began in November 1999
and is currently extended on a month-to-month basis, artists have an
opportunity to earn money based on the popularity of their music. Artists can
also earn money through our business music services division based on the
number of times their music is played in retail and commercial establishments.

Consumers

Extensive New Music Selection.We offer consumers one of the largest databases
of independent musical content available on the Internet through our expanding
collection of artists from all 50 states and from over 190 foreign countries.
Consumers can search for, listen to or download thousands of song and audio
files posted on our web site by digital artists for no charge. Our music
collection spans approximately 250 categorized genres, including pop & rock,
classical, country, alternative, children, easy listening, electronic, hip
hop/rap, blues, jazz and world/folk.

Subscription Channels.In the second quarter of 2000, we began to offer what
we believe to be the first-ever on-demand music subscription channels on the
Internet. Offering both classical and childrens music subscription channels,
MP3.coms subscription channels, in contrast to other radio Internet
channels, give consumers control over their music to create custom play lists
and enable streaming access to a full music library of thousands of song and
audio files.

Personalized Music Experience.Consumers who visit our web site are able to find
the music that interests them by searching our music collection by genre,
artist, song, similar artists or location. As a result of our search
capabilities, fans can browse our increasing database of songs or audio files
and listen to only those selections in which they are interested. Consumers
can register profiles by providing their zip code, e-mail address and their
music preference, which allows us to suggest new songs to them based upon their
preferences and prior purchases. Consumers can also designate a language
preference and can currently browse our web site in Spanish, French and German,
in addition to English. Our personalized approach enhances the experience of
visiting our web site.

Communications with Artists and Other Fans.We allow fans to contact digital
artists directly via e-mail and to communicate with one another through message
boards. In addition, digital artists can use their web page to communicate
directly with their fans, advising them of concerts and new releases.

Convenient Access to Music Collections. The My.MP3 service allows users to
place songs from their favorite CDs and MP3.com artists online, organize their
music and receive personalized music services. Our Instant Listening service
allows consumers to purchase CDs from partner e-tailers and listen to music
from these CDs instantly using their My.MP3 account. The Instant Listening
service eliminates the hurry-up-and-wait reality that has been associated with
online purchasing. Our Beam-it technology allows users to place online
songs from their existing CD collection. The user simply places a CD into a
computer CD-ROM drive. Once the Beam-it proprietary software completes its
verification process, music from the CD is automatically added to the users
My.MP3 account. Owners can create a virtual jukebox, make customized play
lists and use My.MP3 to listen to their CD library seamlessly from anywhere
they are able to access a web-enabled device.

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Businesses

Centrally-Controlled Music.Our business music services deliver cost
effective and innovative ways for brick-and-mortar retail and other
businesses to centrally manage in-store music, advertising and messaging.
Designed to meet specific merchandising objectives, our management and
centralized account tools offer our clients control over the music and
messaging customers and employees hear. From an easy-to-use,
password-protected account on our web site, business subscribers may control
the overall feel of the music they select for broadcast in their
establishments. In addition, business subscribers may choose what is playing
and when, as well as how to customize advertising and messaging, and distribute
content to precisely the audience the subscriber chooses throughout all
locations, in a specific region, in an individual store, or even to customers
holding on the telephone. Continual playback for such system is fully
automated. Controlled messaging at store locations also offers business
subscribers the opportunity to sell highly targeted airtime to other businesses
while increasing sales and brand awareness of their own products.

Radio Offerings.Our syndicated radio division supplies syndicated radio shows
for traditional broadcast to local radio stations, as well as content offerings
to radio station web sites across the United States. Radio stations have
access to the event and community calendar on our web site, and a one-hour
syndicated radio programming featuring the Best of MP3.com highlighting some
of the finest undiscovered talent in the country. In addition, our
just-in-time compilation CD service allows stations to offer local music to
listeners in a co-branded format.

Direct Access to Music Consumers.Our products and services allow record
labels and other businesses to reach our growing community of over 13.5 million
registered users in extremely targeted ways. Our Singleserving product, for
example, is designed to introduce consumers to new music, typically from major
record labels, via geographically targeted e-mail campaigns. Singleserving
offers record labels the ability to complement traditional offline radio
promotion efforts by targeting and directly contacting music listeners in
important radio markets where the artist is receiving airplay. This
e-mail-based communication typically delivers thousands of song impressions to
a targeted market and also provides valuable market research.

Products and Services

Our products and services provide the advantages described above to our
different user groups. We also provide offerings such as various advertising
services to the companies that serve those user groups. The following lists
our current and expected products and services:

|                                               |  |                              
|---------------------------------------------- |  | -----------------------------
|ONLINE ADVERTISING                             |  | OFFLINE ADVERTISING AND OTHER
|                                              
|Web Site Advertising: banners portals, buttons |  | DAM CDs                      
|                                              
|                                              
|                                              
|                                              
|Web Site Sponsorships                          |  | Compilation CDs              
|                                              
|                                              
|                                              
|                                              
|E-Mail Marketing                               |  | Music-Related Merchandise    
|                                              
|                                              
|                                              
|                                              
|Greeting Cards                                 |  | Subscription Channels        
|                                              
|                                              
|                                              
|                                              
|My.MP3 Advertising                             |  | Sponsorship of Free CDs      
|                                              
|                                              
|                                              
|                                              
|                                               |  | Contests and Sweepstakes     
|                                              
|                                              
|                                              
|                                              
|                                               |  | MP3 Summit                   
|                                              
|                                              
|                                              
|                                              
|                                               |  | Syndicated Radio             
|                                              
|                                              
|                                              
|                                              
|                                               |  | Business Music Services      
|                                              
|                                              
|                                              
|                                              
|                                               |  | My.MP3 Subscriptions         
|                                              
|                                              
|                                              
|                                              
|                                               |  | Infrastructure Licensing*    
|                                              
|                                              
|                                              
|                                              
|                                               |  | Label Marketing & Promotions*
|                                              
|                                              
|                                              
|                                              
|                                               |  | Music Licensing*             



|* |  | Under Development
|- |  | -----------------

Online Advertising

For the twelve months ended December 31, 2000, 77.8% of our revenues were
derived from a portfolio of online advertising services. These services allow
our advertisers to maximize visibility for their products by placing them in
specifically targeted MP3.com categories, like hardware, software and artist
sign-up, as well as specific music

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genres. We can place advertisements in targeted areas or in general rotation
throughout the web site. Our online advertising products currently consist of
banners, portals, buttons, web site sponsorships, e-mail marketing and greeting
cards.

Banners, Portals and Buttons.Banners, portals and buttons are graphic
elements on a web page. Hypertext links are embedded in each of these
advertisements to provide the user with instant access to the advertisers web
site, additional information and/or products or services. A banner is the
largest size of advertising product available, with portals being next largest
and buttons being the smallest. Banners are displayed on the top and bottom of
each MP3.com web page. The location of portals and buttons is dependent on the
layout of the specific page where they appear. Pricing of banners, portals and
buttons are generally based on a Cost Per Thousand Impressions, or CPM, basis.
Impressions are the number of times an advertisement appears in pages viewed
by users of our web site, and revenue is earned as impressions are delivered.
Prices of each of these advertisements are based on the target audience,
desirability of location and volume of impressions.

Web Site Sponsorships.A web site sponsorship is an advertising plan that
enables sponsors products to be associated with a specific MP3.com category,
music genre, web page or event such as our software and hardware categories.
The sponsorships begin on the first page of the selected area and typically
appear on all related pages. We also offer listing sponsorships that allow
advertisers to purchase preferred placement in product listings. Prices of
sponsorships are based on the target audience and desirability of location.

E-Mail Marketing.Our e-mail marketing products consist primarily of text or
html-based advertisements inserted into messages delivered to our artists and
customers. Our e-mail marketing programs focus on customer retention and new
program acquisition, and allow advertisers to use our technology-based tools to
quickly reach a broad audience and generate feedback that can be used to tailor
new messages and targeted offers. Delivered weekly, MP3.Communicator is our official
periodic e-mail newsletter and our largest e-mail product. In addition to
advertisements, the newsletter is filled with song recommendations,
new web site features and services, and new and exclusive offers to
MP3.com users. Prices of e-mail advertisements are based on the target audience, desirability of
location and volume of impressions.

Greeting Cards.Greeting card marketing products are text or html-based
advertisements inserted into electronic greeting cards delivered through our
site. Greeting card advertisements offer advertisers the chance to send
marketing messages to targeted audiences using various criteria including
preferred artist or music genre, geographic location, or any of the customized
preferences users have entered into their personal profile. The greeting card
program leverages MP3.com music as its point of differentiation from other
greeting card programs. Users can select from a wide variety of occasions
(Valentines Day, birthdays, special holidays), attach any full-length song
from MP3.coms deep music catalog, personalize the message, and send to anyone
with an e-mail address. Prices for each of these advertisements are based on
the target audience and volume of impressions.

Offline Advertising and Other

For the year ended December 31, 2000, 22.2% of our revenues were
derived from a portfolio of offline advertising and other products and
services. Offline advertising services allow our advertisers to maximize
visibility for their products by providing them with advertising opportunities
beyond our traditional online products. Our offline and other advertising
products primarily consisted of free-CD product sponsorships, contests and
sweepstakes and MP3 Summit sponsorships in 2000. Other revenues were derived
from the sale of CDs, subscriptions, business music services, and other music-related merchandise.

Sponsorship of Free CDs.Our free CD products are CD ROMs that contain
collections of music and paid advertising that are distributed free of charge
to consumers. Each free CD contains a large selection of the most popular songs
of each major genre from our expanding roster of over 125,000 digital artists
and record labels. Free CD products may also include video entertainment,
multimedia video game samples and interactive contests. Our free CD product
allows advertisers to target specific consumers by selectively placing
advertisements, game samples and video clips within the genres of the CD.
Different versions of a free CD can be created to appeal to specific target
audiences. In 2000, we distributed 1 million individual free CD products.
Prices of these sponsorships are based on the placement and position within the
free CD, its packaging, as well as the nature of the advertisements to be
displayed.

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Contests and Sweepstakes.We have developed a number of contests and
sweepstakes products that are designed to create awareness of our advertisers
products and services. Each contest or sweepstakes is uniquely tailored to the
product being promoted and designed to most effectively attract customers from
a pre-determined target demographic. Prices of these contests and sweepstakes
are based on a variety of factors, including the complexity and duration of the
event.

MP3 Summit.Each year we hold an MP3 Summit for industry and technology
participants to showcase new trends for the online and offline delivery of
music and related technologies. Summit sponsorships are priced based on
placement and position within the Summit and our Summit advertising materials.
The 2001 MP3 Summit is scheduled for July 2001.

Syndicated Radio.MP3.coms syndicated radio division, which launched in early
2000, is responsible for supplying syndicated radio shows for traditional
broadcast to local radio stations, as well as content offerings to radio
station web sites across the United States. We design our syndicated radio
services to support local musicians by providing streams and downloads of their
music and web pages to selected local radio stations. All local music is also
made available for listeners to stream or download from local city charts at
a given radio station web site. Radio stations have access to MP3.coms event
and community calendars and our one-hour syndicated radio programming featuring
the Best of MP3.com highlighting some of the finest undiscovered talent in
the country. In addition, MP3.coms just-in-time compilation CD service
allows stations to offer the best local music to listeners in a co-branded
format. To date, MP3.com has signed over 200 radio stations as affiliates,
representing weekly cumulative audience levels of over 12 million people as
measured by the Arbitron rating service. Our syndicated radio efforts provide
another opportunity for digital artists on MP3.com to promote their music.

Business Music Services.MP3.com offers business music services that deliver
cost effective and innovative ways for brick-and-mortar retail and other
businesses to centrally manage in-store music, advertising and messaging.
Because of our technological expertise, rich digital music content and
Internet-based distribution, our business music services are able to offer
customizable and value-intensive programs available at what we believe is a
significant cost savings compared to existing business music services. Whether
for in-store customers or customers holding on the telephone, we offer a full
spectrum of business-music solutions that are designed to save money for our
clients. Our technology infrastructure enables us to offer a thoroughly
customized approach to managing music that is designed to meet specific
merchandising objectives. Our management and centralized account tools offer
our clients control over the music and messaging customers and employees hear.
From an easy-to-use, password-protected account on our web site, business
subscribers may control the overall feel of the music. In addition, business
subscribers may choose what music to play and when, as well as customize
advertising and messaging, and distribute content to precisely the audience the
subscriber chooses  throughout all locations, in a specific region, in an
individual store, or even to customers holding on the telephone. Playback for
this system is fully automated, so there is no need for an on-site attendant to
remember to switch on a tape or CD. In addition, business subscribers can use
in-store airtime to generate revenue. Through the use of interactive messages
at the point of sale, MP3.com offers business subscribers the opportunity to
sell highly targeted airtime to other businesses while increasing sales and
brand awareness of their own products.

Digital Automatic Music (DAM) CDs.The majority of our electronic commerce
revenues are generated from the sale of DAM CDs. DAM CDs are fully packaged
albums created by artists who post their music on our web site. The artists
choose the selling price of their CDs (the current range they can choose is
from $5.99 to $14.99). A typical DAM CD contains multiple songs that are
recorded, performed and uploaded to our web site by an artist or group of
artists. The music contained on DAM CDs is in both mp3 and standard audio CD
format, which means it can be played on a computer using mp3 player software
(an mp3 software player is imbedded on each DAM CD), a portable mp3 player or a
standard CD player. In addition, DAM CDs, at the artists discretion, can
contain multimedia features including artist-provided graphics, song lyrics and
biographical information. We produce and package the CDs, generally on the
same day the order is received, and mail them to our customers in one or two
days. During 2000, production and packaging of our DAM CDs was fulfilled by
Cinram International, Inc., which also provides production and fulfillment of
our other promotional CD products.

Compilation CDs.From time to time, we sell compilation CDs featuring various
artists who have posted their music on our web site. These CDs are usually
genre-specific, such as electronic music or Christmas music. Compilation CDs
are produced and sold in a similar manner to our DAM CDs.

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Music-Related Merchandise.We occasionally sell music-related promotional
merchandise from our web site including items like T-shirts, hats and other
apparel. We also occasionally auction items from our web site such as portable
mp3 players, celebrity guitars and other music-related memorabilia.

My.MP3 Subscriptions.Our upgraded My.MP3 service, which was launched in
January 2000 and re-introduced in December 2000, allows eligible users to place
songs from their favorite CDs and MP3.com artists online, organize their music
and receive personalized music services. We offer two related services with
My.MP3  Instant Listening and Beam-it. Our Instant Listening service
allows consumers to purchase CDs from partner e-tailers and listen to music
from these CDs instantly using their My.MP3 account. The Instant Listening
service eliminates the hurry-up-and-wait reality that has been associated with
online purchasing. Our Beam-it technology allows users to place in their
My.MP3 account songs from their existing CD collection. The user simply places
a CD into a computer CD-ROM drive. Once the Beam-it proprietary software
completes its verification process, music from the CD is automatically added to
the users My.MP3 account. Owners can create a virtual jukebox, make
customized play lists and use My.MP3 to listen to their licensed CD library
seamlessly from anywhere they are able to access a web-enabled device. The
My.MP3 service is offered for free or on a subscription basis. My.MP3
currently offers two pricing levels. The basic free account is
advertising-driven and allows the user to store music from up to 25 CDs through
the Beam-it technology and an unlimited number of CDs through the Instant Listening service.
The premier subscription account, available for an annual fee of $49.95, allows
storage of music from up to 500 CDs through the Beam-it technology, with
more functionality and less advertising. In light of our past litigation
proceedings, we have modified the My.MP3 service so that individual tracks are
made available only if they are covered by one of our master recording and musical
composition licenses. Currently, significantly less than all of the tracks
contained on any one CD may be made available through My.MP3s Beam-It and Instant
Listening features.

Music Subscription Channels.In the second quarter of 2000, we began offering
to consumers what we believe to be the first-ever, on-demand music subscription
channels on the Internet. Offering both classical and childrens music
subscription channels, consumers can subscribe for a monthly or annual fee to
an extensive variety of music. The classical music channel made its debut in
May 2000 by initially offering over 4,000 tracks including classical
masterworks from composers such as Mozart, Bach, Beethoven, Tchaikovsky and
Vivaldi for a $9.99 monthly subscription fee or $29.99 for a full year. We
launched our childrens channel during the third quarter of 2000, featuring
songs, stories and other audio content in English, French and Spanish geared
toward parents and their children. Our subscription channels, in contrast to
other radio Internet channels, give consumers complete control over their
music to create custom play lists and have unlimited streaming access to a full
music library of thousands of song and audio files.

Music Licensing.We are developing a music licensing service designed to
enable digital artists on MP3.com to license their music to music supervisors,
TV and film producers and directors, Broadway producers, broadcast advertising
agencies, jingle houses, webmasters and others looking for music to put into
their multimedia productions. Consistent with our tradition of pioneering new
ways to distribute and access music, it is our plan to help music supervisors,
film and television producers, and other multimedia creators to search for and
license music with a few clicks of the mouse. If successful, those seeking to
license music will hopefully no longer have to search through piles of CDs or
needledrop libraries, looking to find an appropriate track for a scene in a TV
show, only to then spend an extraordinary amount of time and effort searching
for the publishing and recording rights. This service is expected to be
completed seamlessly from the MP3.com web site.

Label Marketing and Promotion.We recently created a label marketing and promotion
group that is focused on generating revenues from the sale of promotional
products and services to record labels. These products and services allow
record labels to reach our growing community of over 13.5 million registered
users in extremely targeted ways. Our main product, Singleserving, is designed
to introduce consumers to new music, typically from major record labels, via
geographically targeted e-mail campaigns. Singleserving offers record labels
the ability to complement traditional offline radio promotion efforts by
targeting and directly contacting music listeners in important radio markets
where the artist is receiving airplay. This e-mail-based product adds thousands
of song impressions in the targeted market and provides market research
utilizing Singleservings proprietary data-capture functionality. Singleserving
delivers a streaming full-length song of an artists single, encoded in mp3
format, to consumers. The e-mail may also contain a link to the artist or
labels web site, a viral forward-to-a-friend feature, radio and MTV request
links, and a buy button allowing the user to purchase music immediately
online. Singleservings have been used by Elektra Entertainment, Atlantic
Records, Maverick Records and Interscope Records to target music fans and to
promote these music companies new releases. Other products we offer include
targeted e-mail campaigns that can be used to promote a wide variety of record
label events. For example, we recently developed a

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promotional effort for the Warner Music Group to promote their holiday offerings in retail
music stores. In December 2000, we signed a three-year non-exclusive agreement
with the Warner Music Group to market and promote various artists on our web
site. The effort could include Singleservings, other targeted e-mail
promotions, as well as various featured spots throughout the web site.

MSP Technologies

We recently launched a new initiative to focus on the growing number of
opportunities in the business-to-business infrastructure sector. The new
initiative, marketing and licensing our infrastructure technology, focuses on
our extensive experience in the acquisition, storage, delivery and promotion of
digital music. Our MSP technologies group was developed to leverage that
infrastructure to provide value to all of the participants in the digital music
space, including record labels and content owners, retailers, software and
hardware developers, device manufacturers and consumers. By marketing and
licensing our technology, we believe we add value to our customers by offering
customizable products and services including content acquisition, content
serving and content hosting tools, as well as data analysis and reporting tools
and revenue enhancing products. This centralized system allows businesses to
store and manage content, improving workflow and reducing redundancies
associated with the use of digital media. For example, major record companies
could capture critical business information, monitor product life cycle to
improve sales targeting, and evaluate promotion effectiveness utilizing our
data capture, analysis and reporting tools.

Sales and Marketing

General

We sell advertising, certain marketing products and sponsorships through our
internal, direct advertising sales department. On December 31, 2000, our sales
force consisted of 14 people located in our San Diego, California office and
in other locations. For our electronic commerce products,
we depend on our web site to attract consumers and encourage
purchases. In addition, we have an exclusive sales agency agreement with the online
national sales representative firm Interep Interactive. This agency agreement
is designed to offer advertisers customized programs that utilize streaming
ads, banners, sponsorships, e-commerce partnerships and other promotional
elements. Interep Interactive is expected to focus on sales to national
advertisers, including advertising to be placed through our syndicated radio
division. Interep is the largest independent sales and marketing company
specializing in radio, the Internet and new media, with offices in 15 cities
and annual billings in excess of $1.4 billion dollars.

We believe much of the public awareness of MP3.com has been generated by
frequent and high-visibility media exposure internationally and
locally, in addition to unsolicited third party promotion of our web site. We
have also used a combination of online and offline advertising to generate
awareness of our company and our web site. Also, we have pursued a number of
product marketing and e-mail marketing efforts to further promote our products, services
and brand awareness. We employ a public relations team that is focused on
generating awareness of MP3.com within the music and technology industries and
among the general public.

Product Marketing

We have established a product marketing group to create and implement a suite of
products and services that enhance a user's online music experience.
Examples of these products include:

Stations:Stations are make-your-own radio web sites created by listeners using
our database of hundreds of thousands of songs. Users can add as many songs to
their Station as they like and arrange their own radio playlist. Our Stations
Directory provides a central hub where music fans from all over the globe can
share their Stations and discover new music on other Stations. Users get
complete control and flexibility over their online music experience.

E-Mail Marketing.We actively market to our over 13.5 million registered users
via highly-personalized e-mail campaigns. This is an important marketing tool
that allows us to reach millions of our registered users with specific offers,
information and services several times each month. With continual testing,
tracking and analyses, our e-mail marketing campaigns are optimized to drive
visitors back to our web site. Examples of our e-mail
marketing campaigns include:

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| |  | MP3.Communicator:our official music
newsletter, delivered weekly, this
offering is filled with personal
song recommendations, new web site services and features, hardware
and software
updates, news, artist features and exclusive offers for MP3.com users;      
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Messenger:an opt-in email service that delivers personalized song
recommendations. Users select from several genres of music, frequency
(daily, weekly or monthly) and types of song files (links, 30 second
song samples or full MP3 files).                       
| 
| |  | Notify Me!:a customizable, opt-in email service that allows users to
receive an email notification each time songs in their My.MP3 account
have been activated or each time their favorite digital artist
releases a new song or CD or schedules a live performance.
| 
| |  | singleserving:an email service that enables users to receive new song
releases or event-related announcements from major label artists,
based on the users locality, genre preferences and past purchase
behavior.                                                  

Affiliate Program.Our affiliate program allows individuals and entities to
affiliate their web sites with MP3.com and offer links to certain content on
our web site. As of December 31, 2000, we had over 67,000 affiliated web
sites. This program has relatively low user acquisition costs for us because we
pay affiliates commissions based solely upon purchases of subscriptions or
merchandise on our site by referred users, or through various click-throughs or
other monetizable promotions. In addition, the affiliate program increases
exposure of our web site to otherwise unavailable audiences through creative
content and links provided by our affiliates.

MP3.com Music Greetings.The MP3.com music greetings program attempts to
capitalize on the popular practice of distributing electronic greeting cards
over the Internet. We leverage our MP3.com music greetings product by allowing
consumers to include the MP3.com music of their choice in these greetings.
Users can tailor their electronic greetings for a variety of occasions
(e.g., holidays, birthdays, and special occasions), attach any full-length
song from our catalog of music, personalize the message and send it to anyone
with a valid e-mail address.

New Music Army.Our New Music Army (or NMA) is a highly-specialized group of
affiliates that, as of December 31, 2000, consisted of over 22,700 members. The
NMAs mission is to promote MP3.com artists (both offline and online) and to
recruit new artists to our web site. We incentivize NMA members by paying them
commissions from a portion of their designated artists DAM CD sales and
Payback for Playback program earnings.

Payback for Playback.All eligible content owners who post music and audio
files on MP3.com have the opportunity to participate in the Payback for
Playback promotion. From November 1999 to December 31, 2000,
$9.2 million (currently $1 million per month) has been made available for
digital artists based on the popularity of their music. The Payback
for Playback program rewards an artists marketing, promotional
and musical efforts, but also represents a level of accountability
impossible before the Internet. Using our powerful technology, we can
monitor every performance and insure an equitable distribution based
on precise listening habits. Each artist has their own account where
they can track their earnings online on a daily basis. The amount
each artist earns is available for viewing by directing any browser
to the MP3.com web site or at each artists web site. This
program currently sets aside $1 million per month for artists
and is extended on a month-to-month basis.

Other Sales and Marketing Efforts

In addition to our viral and e-mail marketing efforts, we attempt to generate
additional brand awareness from specific promotional activities and other
products and services such as:

Sponsorships of Third Party Concerts.We utilize sponsorships to promote
artists that have posted music on our web site and mp3-related technologies and
products. In addition to headliner acts, these events typically feature artists
from our web site as opening acts and performers.

Online Contests and Sweepstakes.We actively conduct online promotional
contests and sweepstakes. Most of our promotions involve random drawing
sweepstakes whereby no purchase is necessary for our users to participate.
Periodically, we also conduct contests whereby users submit musical or other
content for consideration by various entertainment or other media entities and
companies. Examples of our recent promotions, contests and sweepstakes include
Who Wants To Be In A Movie Soundtrack contest, the Sephora.com/MP3.com
Sweepstakes, as well as the MP3 Your World and Metal Search 2000
contests.

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MP3 Summit. In June 2000 our third annual MP3 Summit was held for industry and
technology participants to showcase new trends for the online and offline
delivery of music and related technologies. In July 2001, MP3.com will host its
MP3.com Summit offering another look at the future of digital music.

Online Auctions.Periodically we will feature individual items of value or
interest to our users for auction on our web site. Historically, we have had
an arrangement with an external online auction provider to assist with such
auctions. These auctions generally serve as promotional vehicles for our web
site and sponsors, and are sometimes implemented in connection with charity
fundraisers.

Traditional Radio and Print Advertising.To date, we have not extensively
marketed our company through traditional radio and print advertising because of
exposure from general press and media coverage and our significant viral
marketing efforts. In 2000, we expanded our overall radio presence by launching
various syndicated radio programs for release in certain U.S. markets, and plan
to continue these programs in 2001.

Free CD Giveaways.We distribute a variety of promotional CDs to registered
users and other recipients worldwide. Each Free-CD contains certain promotional
items such as music from our web site, exclusive offers, free software and
information about MP3.com. The CDs provide exposure to the MP3.com brand, our
artist community and many of the tools and services available on the web site.

International Efforts

Europe

In 2000, we began to more closely assess our globalization opportunities and
strategy. Because music transcends cultural, language and geographic
boundaries, and since musicians outside the United States face the same
challenges in distributing and promoting their music as they do in the United
States, we believe that MP3.com has the potential for worldwide appeal and
reach. Without us having spent any resources to attract artists and visitors
from outside the United States, approximately 20% (as of June 2000) of both
artists and visitors on our web site came from outside the United States. As
of September 2000, Media Metrix ranked MP3.com as the 8th most popular
entertainment site among European Internet users.

In November 2000, to further capitalize on our global reach we launched our
first foreign language translated web sites in French (francais.mp3.com),
German (deutsch.mp3.com) and Spanish (espanol.mp3.com). This was a
labor-intensive task that initially required the translation of more than 1.5
million web pages and will require on-going maintenance. In 2001, we plan to
evaluate the translation of additional languages as well as country
localization opportunities.

Like our domestic business model, revenue opportunities for our European
division in the near future are expected to be derived primarily from
advertising, and to a lesser extent label promotions, licensing of our
technology infrastructure, business music services and syndicated radio.

With sophisticated data mining capabilities, we are able to offer creative and
innovative ways for advertisers to market to our user database, as well as
leverage our technology infrastructure. This includes the ability to design
promotions utilizing our large database of e-mail addresses, as well as target
web site visitors in real time based on their language preference and country
of origin. As of December 2000, 19% of our active e-mail addresses, or 2.5
million, are from Europe and 20% of our unique visitors have selected a
European country as their country of origin.

Asia

In late 2000, we formed an Asia division to expand our efforts into the Asia
Pacific region and to seek ways to increase our user base and regional
revenues. We intend to pursue a strategy in Asia to develop relationships with
music content holders in key Asian countries, to cooperate with regional
Internet service providers and portals and to offer our services through online
and offline music retail outlets.

Japan, our initial Asian market launch, contains the worlds second largest
online population and is the largest and fastest-growing Internet-enabled cell
phone market. Other Asian markets, such as South Korea and Singapore, have
fast-growing Internet economies, while the Chinese market shows great promise
as a center for Asian Internet usage.

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In order to help launch our first localized presence in Asia, in December 2000
we established a relationship in Japan with BMF Co., an integrated music and
media company. BMF has agreed to make Japanese music content available at the
URL japan.mp3.com, which we hope will lead to an increase in Japanese market
usage and revenue. In addition to content, BMF will market to its installed
base of music consumers and web site visitors to help accelerate the growth of
japan.mp3.com. BMF currently has established relationships with other record
labels, publishers and retailers throughout Japan.

Corporate Relationships

Relationship with Montaigne Partcipations Et Gestion (MPG) formerly Group Arnault

In July 1999, we entered into an agreement with MPG under which MPG committed
to purchase an aggregate of $150 million in advertising, promotion and
marketing services from us over three years. In July 1999, we received
prepayments from MPG totaling $45 million, which represented payment for these
services through the fourth quarter of 2000. In September 2000, we entered into
an amended and restated agreement with MPG. The restated agreement extended our
relationship with MPG through 2004, and reduced the aggregate amount of
services to be purchased by MPG over the life of the agreement (see the
revised commitment schedule below). Both MPG and MP3.com believe that the
revised commitment schedule will allow for more efficient use of our marketing
services for the mutual benefit of MPG, its various related companies, and
MP3.com. In addition, the restated agreement provides for a more streamlined
media management process and creates certain exceptions to the favored pricing
granted to MPG under the original agreement. Under the restated agreement, MPG
is now committed to purchase an aggregate of $120 million in advertising,
promotion and marketing services from us (including the $45 million purchased
through the fourth quarter of 2000). The remaining $75 million owed under the
restated agreement remains secured by an irrevocable letter of credit. The
restated agreement further provides MPG with potential additional financial
incentives of up to an aggregate of $5 million (up to $1 million in any one
calendar quarter) based on the number of companies that use our services under
the agreement. The financial incentives could result in the reduction of the
marketing and promotions commitment during the period incurred.

|                            |    |                  |   |                |        | 
|--------------------------- | -- | ---------------- | - | -------------- | ------ | 
|Quarterly Payment Schedule: |    | Purchase Amount:
|                            |    |                 
|                            |    |                  |   | (in thousands)
|2001                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 15,000         |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 12,250         |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 12,250         |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 12,250         |       
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|2002                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 6,000          |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 5,000          |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 5,000          |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 5,000          |       
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|2003                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 300            |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 300            |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|2004                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 275            |       
|                            |    |                  |   |                |       
|                            |    | Total:           |   | $              | 75,000 | 
|                            |    |                  |   |                |       

For the year ended December 31, 2000, 50.3% of our revenues were from the sale
of advertising to MPG. We expect that most of our revenues will continue to be
derived from third party advertising agreements like those we have with MPG.

15



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##### Table of Contents



PortalPlayer, Inc.

We formed a strategic relationship in February 2000 with PortalPlayer, Inc., a
provider of end-to-end systems for playback and recording of digital media
content for consumer electronics manufacturers. The relationship is intended to
facilitate the integration of our content and web site with next generation
Internet protocol-enabled, or IP-enabled consumer electronics devices. By
collaborating to help define these next-generation devices and their web
interfaces for products such as portable mp3 players and mini-component
systems, we hope to accelerate the introduction of devices that will allow
consumers to access their music when they want it, and where they want it. We
also purchased stock in PortalPlayers series B preferred stock financing.

Relationships with Artists

Our music submission agreement governs music submitted to us by artists for
free distribution from our web site, as well as music submitted to us for our
DAM CD program. Under this agreement, artists grant us a non-exclusive license
to distribute their music. Artists also make a number of representations and
warranties to us, including a representation and warranty that the music being
submitted will not infringe any third party rights. For music sold through our
DAM CD program, we typically pay artists 50% of the net revenue we receive.
Because this agreement is non-exclusive, artists are free to grant similar
rights to others during and after the term of the agreement. In addition, both
MP3.com and the artist may terminate the agreement at any time.

Licensing Agreements

Recording Company Licenses

Between June and December 2000, MP3.com entered into license agreements with
Warner Music Group, BMG Entertainment, Sony Music, Capitol Records, Inc. (EMI),
and Universal Music Group. Subject to certain affirmative obligations of
MP3.com and other terms and conditions regarding the implementation of the
My.MP3 service, these license agreements permit MP3.com to
utilize recordings owned by Warner Music Group, BMG Entertainment, Sony Music, EMI and UMG as part of the My.MP3 service. The
license agreements have terms of approximately three to ten years, and provide
for payment of a one-time fee each time a licensors recording is added
to a separate My.MP3 account. The licenses also provide for on-going royalty
payments based on the greater of (i) a specified percentage of net revenues
generated from or in connection with the My.MP3 service or (ii) a specified
amount accrued each time a licensors recording is streamed from My.MP3.

Publisher Reproduction Licenses

On October 17, 2000, MP3.com, the National Music Publishers Association, Inc.
and its licensing subsidiary, The Harry Fox Agency, Inc. entered into a
preliminary agreement that  if approved by individual HFA music
publisher-principals  would permit the use of up to one million musical
compositions on the My.MP3 service. The proposed, 3-year licensing arrangement
provides that MP3.com will pay up to $15,000,000 to HFA for the benefit of up
to 25,000 music publishers and their songwriter partners, to be used as an
advance payment to HFA publisher-principals toward royalties earned under the
prospective license. The terms of the prospective license call for a payment of
one-quarter cent each time a song is streamed on demand to a customer from his
or her My.MP3 locker, along with a one-time fee per track added to the My.MP3
service. In December 2000, MP3.com and HFA agreed to extend the period of time
during which individual HFA music publisher-principals could approve the
preliminary agreement and permit their musical compositions to be used on the
My.MP3 service.

Publisher Performance Licenses

ASCAP, BMI and SESAC.We have entered into agreements with ASCAP, BMI and
SESAC, three music performing rights organizations responsible for
administering performance rights for virtually all of the United States musical
composition market. Under these agreements, we obtained, subject to certain
terms and conditions, music performance licenses that allow interactive
performances on our web site of copyrighted works of ASCAP, BMI and SESAC
members. As part of the ASCAP agreement, we provide prominent exposure of the
benefits of ASCAP membership to all unaffiliated writers, composers, artists
and publishers using our web site, as well as help facilitate the processing of
membership applications.

16



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##### Table of Contents



Technology Infrastructure

Data Mining and Warehousing Activities

We maintain relational databases of all artists, music, electronic commerce and
other end-user information. These databases are used to enhance the user
experience at our web site and to provide us with information regarding our
users. Our content databases make content available for download, streaming, CD
purchase, web site ranking and cataloging, and are updated as artists and users
interact with our web site. Our statistical databases maintain traffic and site
analysis information including the number of times that web pages are viewed,
download and streaming counts, and artist, song and CD rankings. Our customer
and commerce databases, which are firewalled for protection, contain customer
information and transaction histories.

Infrastructure

Our technology infrastructure is based on an architecture designed to be
secure, reliable and expandable. Our software is a combination of proprietary
applications, third party database software and open operating systems that
support acquisition of content, management of that content, publication of our
web site, downloads of music and media files, production of CDs, registration
and tracking of users, and reporting information for both internal and external
use. We use software from Sun Microsystems, Inc., Microsoft Corporation,
RedHat Software, Inc., VERITAS Software Corporation, VeriSign, Inc., Real
Media, Inc., The Apache Group and Oracle Corporation. We run our software on
platforms from Intel Corporation, Sun Microsystems, Inc., Gateway, Inc. and
Dell Computer Corporation, among others. Our data storage infrastructure is
provided by IBM, EMC, Inc. and Storage Technology Corporation, and our
high-capacity networks are supported by equipment from Cisco Systems, Inc.,
Foundry Networks, Inc. and F5 Labs, Inc. During December 2000, our web site
delivered more than 167 million page views and over 52.7 million song listens.
We designed our infrastructure to allow each component to be independently
scalable, usually by purchasing additional readily available hardware and
software components, to meet or exceed future capacity requirements.

Data Center & Hosting Facilities

Our network infrastructure and our web site, e-commerce and database servers
are hosted in three data centers on three different networks in three different
cities. Our web site servers are hosted at AT&T CERFnet in San Diego, CA, at
Exodus Communications in Irvine, CA and at Global Crossings/Frontier
Communications GlobalCenter in Sunnyvale, CA. CERFnet, Exodus and Global
Crossings all maintain what we believe are suitable environmental conditions
and redundant power sources and network connectivity. Monitoring of all
servers, networks and systems is performed on a continuous basis. We employ
numerous levels of firewall systems to protect our databases, electronic
commerce servers, customer information and music archive. Backups of databases,
data and media files are performed on a regular basis. Data back-up tapes are
archived at Iron Mountain, Inc., a remote storage location.

Integration of Portable Devices

Our focus on portable devices is designed to extend the value of our
content and services to non-PC devices. A cornerstone of our Music
InterOperating System or Music IOS strategy is to allow listeners to access
digital music when they want it and where they want it. With the
millions of Internet users that stream or download mp3
files everyday, we believe the digital music industry can only enter the
mainstream when digital music is extended to consumer devices with simple
interfaces and easy access. We hope to tap into the huge potential of these
non-PC devices to turn them into distribution channels for the millions of
users of our content and services.

We are focusing our business development goals toward integrating our
application protocol interfaces or APIs into the products of the worlds
leading consumer electronics manufacturers. As part of our overall goal to grow
the digital music space, this effort facilitates our expansion from strictly web-based services
to device-specific services and complements the products of our consumer
electronics partners. These new tools will be a valuable component of
our newly introduced Music IOS device platform and the MP3 Developer Network, and will hopefully
provide device manufacturers with the content and services we believe will add
value to their products.

Our Music IOS device platform is currently under development with certain
elements already announced. This collection of APIs and other tools is designed
to enable users to access our content on non-PC devices. Products are planned
to simplify mobile access for car audio applications and wireless connectivity
to MP3.com content.

17



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##### Table of Contents



MSP Technologies

We recently launched a new initiative to focus on the growing number of
opportunities in the business-to-business infrastructure sector. The new
initiative, marketing and licensing our infrastructure technology, focuses on
our extensive experience in the acquisition, storage, delivery and promotion of
digital music. Our MSP technologies group was developed to leverage that
infrastructure to provide value to all of the participants in the digital music
space, including record labels and content owners, retailers, software and
hardware developers, device manufacturers and consumers. By marketing and
licensing our technology, we believe we add value to our customers by offering
customizable products and services including content acquisition, content
serving and content hosting tools, as well as data analysis and reporting tools
and revenue enhancing products. This centralized system allows businesses to
store and manage content, improving workflow and reducing redundencies
associated with the use of digital media. For example, major record companies
could capture critical business information, monitor product life cycle to
improve sales targeting, and evaluate promotion effectiveness utilizing our
data capture, analysis and reporting tools.

Operations, Fulfillment, Customer Service and Artist Support

Fulfillment Operations

Our operations are centered on a just-in-time fulfillment process which ties
together all of the proprietary and third party software tools in our system,
and allows us to minimize inventory. In November 1999, we outsourced
exclusively to Cinram International, Inc. our just-in-time DAM CD production
and fulfillment process, as well as the production and fulfillment of our other
promotional CD products. The transition of fulfillment operations to Cinram was
completed at the end of March 2000. Through Cinram, we are currently capable of
shipping 2,100 DAM CDs per day and have the combined infrastructure in place to
quickly scale operations by adding equipment and people as dictated by volume
needs. Orders for DAM CDs and other merchandise are received via our web site, queued up in our
database for processing and then transmitted to Cinram for fulfillment. A
confirming e-mail is sent to the customer indicating that the order was
received and providing an order number. The order is assembled, packed and
shipped to the customer usually within 24 hours of receipt of the order. The
transaction information is transmitted to our database and an e-mail is sent to
the customer indicating when their order has been shipped.

Customer Service

Support for our customers is provided 12 hours a day, seven days a week and
most issues are resolved within 36 hours of notice of the issue. Customer
service personnel respond to a broad range of questions and provide services
such as:



| |  |  | assisting customers with e-commerce transactions;                                                                       
| | - |  | ------------------------------------------------------------------------------------------------------------------------
|
| |  |  | tracking orders and questions related to fulfillment;                                                                   
|
| |  |  | providing technical support for web site issues including
problems with downloading or playing music;                   
|
| |  |  | maintaining the frequently-asked questions on our web site and
keeping relevant information available for customers; and
|
| |  |  | providing feedback internally to make improvements to the site to
enhance the overall customer experience.              

We utilize an e-mail management system to more efficiently address the external
e-mail received from customers and other users of our site. This system has a
rule-based process that directs e-mails to the appropriate individual and
escalates those issues requiring more attention. This system also enables the
customer service team to build a knowledge base to help maintain the
frequently-asked-questions on our web site.

Artist Support

We have an artist support department dedicated to addressing questions and
issues from artists that have posted or want to post music on our web site.
This team assists artists with technical issues related to publishing their
music and artwork on our site. Artist support is available six days a week, 12
hours a day.

18



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##### Table of Contents



Competition

The market for the online promotion and distribution of music and music-related
products is competitive. Barriers to entry on the Internet are relatively low,
and we expect competition to increase significantly in the future. We face
competitive pressures from numerous actual and potential competitors including:



|
|
|
|
|
|
|
|



| |  |  | Traditional music industry companies, including BMG Entertainment, EMI,
Sony Music, Time Warner Inc. and Universal Music Group, all of whom have
made public statements that they will pursue digital distribution and
online promotion of music through in-house development efforts and
strategic alliances.                                                                                                                                                                                                                                                                                                       
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
|
| |  |  | File-sharing web sites and applications, including Napster, Inc.,
Freenet and Gnutella. Although the legality of such applications is
currently in question, these applications boast large numbers of online
users which exceed our current user base. The alleged popularity of these
applications and web sites may continue whether or not such applications
and/or web sites may be deemed illegal in certain jurisdictions.
Moreover, in November 2000, Napster, Inc. entered into a partnership with
Bertelsmann AG to potentially develop a record industry-friendly version of
its file-sharing application.
|

Other companies have agreed to work together to offer music over the Internet,
and we may face increased competitive pressures as a result. For example, in
1999 Microsoft Corporation and Sony Corporation announced an agreement to
pursue a number of cooperative activities. Sony has announced that it will
make its music content downloadable from the Internet using Microsofts
multimedia software. In addition, Universal Music Group and BMG Entertainment
have announced a joint venture to form an online music store.

The bases of competition in the online music promotion and distribution
industry include:



| |  |  | quantity, quality and variety of digital recorded music content;                                                   
| | - |  | -------------------------------------------------------------------------------------------------------------------
|
| |  |  | ability of consumers to search and listen to music according to their
preferences;                                 
|
| |  |  | ease of downloading music;                                                                                         
|
| |  |  | fidelity and quality of sound of the music; and                                                                    
|
| |  |  | ability to promote its web site, both online and through traditional
marketing, concerts and business partnerships.

We believe that we generally compete favorably on each of these bases.
However, many of our existing and potential competitors have longer operating
histories, more recognizable content, greater brand name recognition, larger
consumer bases and significantly greater financial, technical and marketing
resources than we do. We cannot assure you that web sites or services
maintained by our existing and potential competitors will not be perceived by
consumers, artists, talent management companies and other music-related vendors
or advertisers as being superior to ours. We also cannot assure you that we
will be able to maintain or increase our web site traffic levels, purchase
inquiries and number of click-throughs on our online advertisements or that
competitors will not experience greater growth in these areas than we do.

Increased competition could result in advertising price reduction, reduced
margins or loss of market share, any of which could harm our business.

19



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##### Table of Contents



Government Regulation

The laws and regulations that govern our business change rapidly. Although our
operations are currently based in California, the United States government and
the governments of other states and foreign countries have attempted to
regulate activities on the Internet. Because of this rapidly evolving and
uncertain regulatory environment, we cannot predict how these laws and
regulations might affect our business. In addition, these uncertainties make
it difficult to ensure compliance with the laws and regulations governing the
Internet. These laws and regulations could harm us by subjecting us to
liability or forcing us to change how we do business. The following are some
of the evolving areas of law that are relevant to our business:

Privacy Laws

Current and proposed federal, state and foreign privacy regulations and other
laws restricting the collection, use and disclosure of personal information
could limit our ability to use the information in our databases to generate
revenues. In late 1998, the Childrens Online Privacy Protection Act, or COPPA,
was enacted, mandating that measures be taken to safeguard minors under the age
of 13. Although we believe that our information collection
activities do not fall within the scope of COPPA, we may need to comply with
its requirements in the future. Compliance with COPPA could be costly for us
and might likely dissuade some percentage of our users from accessing our web
site and related services. In addition, if implementing a system to adequately
verify parental consent is too expensive, we may not be able to provide our
services to children under the age of 13, which may adversely affect our
business. Requiring parental consent from children under the age of 13 may
drive them to use different Internet sites for their music needs, which may
adversely affect our business. If our methods of obtaining parental consent are
inadequate, we may face litigation with the FTC or individuals, which would
adversely affect our business.

Encryption Laws

Record industry associations have lobbied the federal government for laws
requiring music transmitted over the Internet to be digitally encrypted in
order to track music rights and prevent unauthorized use of copyrighted music.
If these laws are adopted, we may need to incur substantial costs to comply
with these requirements or change the way we do business.

Content Regulation

Both foreign and domestic governments have adopted and proposed laws governing
the content of material transmitted over the Internet. These include laws
relating to obscenity, indecency, libel and defamation. We could be liable if
content delivered by us or placed on our web site violates these regulations.

Sales and Use Tax

The taxation of goods sold over the Internet is currently unsettled. We collect
sales taxes for goods shipped to California, Colorado, Virginia, Washington,
Texas, and Massachusetts. A number of proposals have been made at the state and
local levels that would impose additional taxes on the sale of goods through
the Internet. Such proposals, if adopted, could substantially impair the growth
of electronic commerce and could adversely affect our opportunity to derive
financial benefit from electronic commerce. However, the Internet Tax Freedom
Act placed a three-year moratorium on new state and
local taxes on Internet commerce. Though there have been efforts to extend
this moratorium, it may not continue. Failure to renew this legislation would
allow various states to impose taxes on Internet-based Commerce, which could
adversely affect our business.

In addition, foreign jurisdictions may seek to impose tax collection
obligations on companies like ours that engage in online commerce. If they do,
these obligations could limit the growth of electronic commerce internationally
and limit our ability to profit from the sale of goods and services over the
Internet in foreign countries.

20



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##### Table of Contents



Contests and Sweepstakes

We actively conduct online promotional contests and sweepstakes. Most of our
promotions involve random drawing sweepstakes for which no purchase is
necessary to participate. Periodically, however, we also conduct contests
whereby users submit musical content for consideration by various entertainment
or other media entities and companies. We post the official rules for these
promotions, along with all material terms, conditions of eligibility, dates of
participation, prizes, methods of entry and limitations, if any, on our web
site. While we attempt to comply with the laws of all 50 state jurisdictions
and Canada when applicable, we may not be uniformly successful, and other
foreign jurisdictions may attempt to regulate or ban our promotional contests.
In that event, we could lose an effective tool for increasing and keeping
visitors to our web site, and our business could be adversely affected.

Intellectual Property

Content on Our Web Site and CDs

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



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

We may also be liable for anything that is accessible from our web site through
links to other web sites. We attempt to minimize these types of liability by
requiring representations and warranties relating to our artists ownership of
and rights to distribute and submit their content and by taking related
measures to review content on our web site and on our CDs. For example, we
require our artists to confirm that their content does not infringe on any
third-party copyrights, is not defamatory or obscene, and that they have the
right to provide their content and have obtained all third-party consents
necessary to do so. Artists also agree to indemnify us against liability we
might sustain due to the content they provide. Our in-house musicologists
listen to a significant amount of the music submitted to us for posting on our
web site. If we have good reason to suspect non-compliance with copyright or
trademark laws, we employ a system of verifying compliance through independent
investigation and cross-checking of license rights with our in-house
musicologists.

It is our belief that the artist is responsible for the material he or she
submits. Although we have not experienced a material loss due to
content-related liability to date, we cannot assure you that our measures to
limit this liability will continue to be successful or that we will not be held
liable for our content. Liability or alleged liability could harm our business
by damaging our reputation, requiring us to incur legal costs and diverting
managements attention away from our business. Moreover, future claims may not
be adequately covered by our insurance.

Our Proprietary Rights

Our intellectual property includes our trademarks and copyrights, proprietary
software, and other proprietary rights. We believe that our intellectual
property is important to our success and our competitive position and we seek
to protect it. However, our efforts may be inadequate. Although we own the
domain name mp3.com and have applied for U.S. federal trademark registration
for MP3.com, we do not have any registered trademarks in mp3 or any
variation of the term. Our trademark registration applications could be denied
for various reasons, including if the term mp3 is found to be a descriptive
term. This could limit our ability to use and to keep others from using the
term mp3 and further limit our ability to protect the mp3.com domain name.
Use of the mp3.com name by others could dilute our brand identity and
confuse the market.

21



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##### Table of Contents



Third Party Intellectual Property Claims

In addition, third parties have claimed and may claim in the future that we
have violated their intellectual property rights. For example, we are currently
a defendant in a lawsuit brought by several independent record labels. These
lawsuits claim that our My.MP3 service violated copyrights, including those of
the record companies and their affiliated artists and publishers, by making
available to consumers mp3 files containing music from the CDs they have in
their possession. To the extent that the courts find that we are in
violation of the copyright or other intellectual property laws with regard to
our My.MP3 service, we may be required to pay substantial damages, including
statutory or other damages that far exceed the resources and overall market
capitalization of our company. We also may be required at any time by the
courts to cease all operations of the My.MP3, Instant Listening, Beam-it or
other related services. Furthermore, our insurance coverage and other capital
resources, if any, may be inadequate to cover costs of these lawsuits or any
possible settlements or licenses.

In addition, other companies from time to time have asserted that online music
providers, including MP3.com, have violated various patent rights that they
allegedly own covering the sale or distribution of music over the Internet
through digital downloads, streams or other proprietary technologies. However,
to the extent that the patent rights are valid and enforceable and cover our
activities, we may be required to pay damages, obtain a license to use such
patents or use non-infringing methods to accomplish our activities with regard
to digital downloads, streams or other MSP services. It is possible that a
license from such entities would not be available on commercially acceptable
terms, or at all, or that we would be unable to provide digital downloads,
streams or other MSP services in a non-infringing manner.

If successful, any of the above-mentioned third party claims, or claims by
others that we violated their intellectual property rights, could seriously
harm our business by forcing us to cease using important intellectual property
or requiring us to pay monetary damages. Even if unsuccessful, these claims
still can harm our business severely by damaging our reputation, requiring us
to incur legal costs, lowering our stock price and public demand for our stock,
and diverting managements attention away from our primary business activities
in general.

Employees

On December 31, 2000, we had 308 employees, including 127 in sales and
marketing, 125 in engineering and product development and 56 in general
administration. We consider our relations with our employees to be good. We
have never had a work stoppage, and no employees are represented under
collective bargaining agreements. We believe that our future success will
depend in part on our continued ability to attract, integrate, retain and
motivate highly qualified personnel, and upon the continued service of our
senior management and key technical personnel. Competition for qualified
personnel in our industry and geographical location has historically been
intense, and we cannot assure you that we will be successful in attracting,
integrating, retaining and motivating a sufficient number of qualified
personnel to conduct our business in the future.

Legal Matters

We are currently involved in several lawsuits related to the availability of
content in our My.MP3 service, as well as several shareholder class action and
derivative suits. See Item 3. Legal Proceedings.

22



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##### Table of Contents



Directors, Executive Officers and Key Employees

The following table sets forth information about our directors, executive
officers and certain of our key employees as of January 31, 2001:

|                                 |  |     |    |          |  |                                                     
|-------------------------------- |  | --- | -- | -------- |  | ----------------------------------------------------
|Name                             |  | Age |    | Position
|                                
|Directors and Executive Officers
|                                
|                                
|                                
|                                
|                                
|                                
|                                
|                                
|                                
|Michael L. Robertson             |  |     | 33 |          |  | Chief Executive Officer and Chairman of the Board   
|                                
|                                
|                                
|                                
|Robin D. Richards                |  |     | 44 |          |  | President and Director                              
|                                
|                                
|                                
|                                
|Paul L. H. Ouyang                |  |     | 43 |          |  | Chief Financial Officer and Executive Vice President
|                                
|                                
|                                
|                                
|Steven G. Sheiner                |  |     | 46 |          |  | Executive Vice President, Sales and Marketing       
|                                
|                                
|                                
|                                
|Gregory P. Kostello              |  |     | 36 |          |  | Executive Vice President, Technology                
|                                
|                                
|                                
|                                
|Derrick R. Oien                  |  |     | 34 |          |  | Senior Vice President and Chief Operating Officer   
|                                
|                                
|                                
|                                
|Carolyn J. Kantor                |  |     | 38 |          |  | President of MP3.com International                  
|                                
|                                
|                                
|                                
|Thomas A. Heymann (1)            |  |     | 43 |          |  | Director                                            
|                                
|                                
|                                
|                                
|Lawrence F. Probst III (1)(2)    |  |     | 50 |          |  | Director                                            
|                                
|                                
|                                
|                                
|Mark A. Stevens (2)              |  |     | 41 |          |  | Director                                            
|                                
|                                
|                                
|                                
|Howard B. Weiner (1)             |  |     | 69 |          |  | Director                                            
|                                
|                                
|                                
|                                
|                                 |  |     |    |          |  |                                                     
|                                
|                                
|                                
|                                
|Key Employees                   
|                                
|                                
|                                
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|William P. Dow                   |  |     | 35 |          |  | Vice President and Controller                       
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|Daniel K. ONeill                |  |     | 39 |          |  | Vice President, Engineering                         



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|(1) |  | Member of Compensation Committee
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|   
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|(2) |  | Member of Audit Committee       

Michael L. Robertsonfounded MP3.com and has served as our Chief Executive
Officer and Chairman of the Board since March 1998. From September 1995 to
March 1998, Mr. Robertson operated several web sites that focused on merging
search technologies with commerce. From September 1995 to September 1996, Mr.
Robertson was President and Chief Executive Officer of Media Minds, Inc., a
developer of digital picture software. From January 1994 to August 1995, Mr.
Robertson was President and Chief Executive Officer of MR Mac Software, a
developer of networking and security tools. Mr. Robertson received his Bachelor
of Arts from the University of California, San Diego.

Robin D. Richardshas served as our President and as one of our directors since
January 1999. He also served as our Chief Operating Officer from January 1999
to January 2001. From October 1998 to January 1999 he served as Managing
Director of Tickets.com, Inc., an Internet ticketing company. From March 1986
to October 1997 he was
a founder and President and Chief Executive Officer of Lexi International, a
tele-services company. Mr. Richards is a director of Cash Technologies Inc., a
publicly-held company that provides solutions for coin and currency handling,
cash management and electronic commerce transactions. Mr. Richards holds a
Bachelor of Science from Michigan State University.

Paul L. H. Ouyanghas served as our Chief Financial Officer and Executive Vice
President since February 1999. From September 1998 to February 1999 he served
as Chief Financial Officer and Executive Vice President of Operations of
Tickets.com, Inc., an Internet ticketing company. From April 1998 to August
1998, Mr. Ouyang served as a consultant to UDP, Inc., a company involved in
dental practices management. From November 1996 to March 1998, he served as
Chief Financial Officer and Executive Vice President for Cheap Tickets, Inc., a
ticket distribution company. From June 1994 to November 1996, Mr. Ouyang served
as the Managing Director of Corporate Finance at KPMG Peat Marwick LLP. From
September 1982 to June 1994, Mr. Ouyang held various positions with J.P. Morgan
& Co., Incorporated ending with Vice President in Corporate Finance. Mr. Ouyang
holds a Bachelor of Arts from Amherst College and a Master in Business
Administration from the Wharton School of the University of Pennsylvania.

Steven G. Sheinerhas served as our Executive Vice President, Sales and
Marketing since February 1999. From October 1997 to January 1999 he served as
Vice President Business Development at Aegis Communications, Inc., a
telecommunications company. From May 1995 to September 1997 he served as a
direct marketing consultant. From June 1987 to April 1995 he served as
President of Sheiner Direct Marketing & Advertising, Inc., a marketing firm.
Mr. Sheiner holds a Bachelor of Arts from Concordia University.

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Gregory P. Kostellocame to MP3.com in June 1999 with more than a decade of
experience as a software engineer, most recently serving as engineering manager
at Netscape Communications. In 1995, Mr. Kostello co-founded Digital Style
Corporation, a software development company focused on creating Internet tools
for web sites. Digital Style was subsequently acquired by Netscape in 1997.
Before that, he held software engineering positions at Pages Software and
Claris Corporation. He earned his Bachelor of Science from the University of
California, Irvine.

Derrick R. Oienjoined MP3.com in July 1999 and currently
serves as our Senior Vice President and Chief Operating Officer. From
January 1993 to November 1997 he served as Assistant Manager,
Transportation at Sony Pictures Studios. From November 1997 to June
1998 Mr. Oien was an associate of business and technology
solutions for BDO Seidman, LLP. From June 1998 to April 1999 he
served as a staff consultant with Computer Sciences Corporation and
from April 1999 to July 1999 was the global project management office
manager with Universal Music Group. He
holds a Bachelor of Science from California State University.

Carolyn J. Kantorjoined MP3.com in July 1999 and currently serves as President
of MP3.com International. Prior to joining MP3.com, Ms. Kantor
was president of HK Entertainment Holdings, LLC from September 1998
to July 1999.
From March 1998 to September 1998, Ms. Kantor was self-employed as a
consultant to the financial and investment industries. From April
1996 to March 1998, she was president of the Brantrock Group, an
investment advisory firm. She received her Bachelor of Science from Brandeis
University and an MBA from the Anderson
School of Management at UCLA.

Thomas A. Heymannhas served as one of our directors since December 2000.
Mr. Heymann is managing director of Digital Coast Ventures
Corporation and has served in this capacity since May 2000. From
February 1999 to March 2000, Mr. Heymann served as Chairman and Chief Executive Officer of GT
Interactive Software, a leading global developer and publisher of interactive
entertainment. Prior to that, Mr. Heymann spent eight years with The Walt
Disney Company having joined the company in 1991 and was appointed President of
the Disney Stores, Inc. in 1994. Mr. Heymann holds a Bachelor of Arts and
Sciences from Northwestern University.

Lawrence F. Probst IIIhas served as one of our directors since April 1999.
Since June 1994, Mr. Probst has served as Chairman and Chief Executive Officer
of Electronic Arts, Inc., an interactive entertainment software company. Mr.
Probst holds a Bachelor of Science from the University of Delaware.

Mark A. Stevenshas served as one of our directors since January 1999. Since
1993, Mr. Stevens has been a General Partner of Sequoia Capital, a venture
capital investment firm. From 1989 to 1993, Mr. Stevens was an Associate with
Sequoia Capital. From 1982 to 1987, Mr. Stevens held technical sales and
marketing positions at Intel Corporation. Mr. Stevens currently serves on the
Board of Directors of NVIDIA Corp., Terayon Communications Systems, Inc.,
Medicalogic, Inc., Pixelworks, Inc., and several privately-held companies. Mr.
Stevens holds a Bachelor of Science, a Bachelor of Arts and a Master of Science
from the University of Southern California and a Master in Business
Administration from Harvard Business School.

Howard B. Weinerhas served as one of our directors since October 2000. Since
January 1994, Justice Howard B. Wiener (retired) has been engaged in private
dispute resolution, serving in more than 1,400 cases as a mediator, arbitrator
and private judge. From 1978 to 1994, Justice Wiener was an Associate Justice
of the California Court of Appeal, served on assignment to the California
Supreme Court, as well as an assigned settlement judge for the San Diego
Superior Court. From 1975 to 1978, he was on the Superior Court for San
Bernadino County. Justice Wiener is a Fellow of the American College of Civil
Trial Mediators and a member of the California Academy of Appellate Lawyers,
and is also on the Board of Trustees of California Western School Law. He
received his undergraduate degree from Brown University, his law degree from
Harvard Law School and a Master of Law degree in the judicial process from the
University of Virginia Law School.

William P. Dowhas served as our Controller since March 1999. From June 1997 to
March 1999, Mr. Dow served as Vice President of Finance for Data Tree
Corporation, an information services company. From April 1995 to June 1997, Mr.
Dow served as Controller of GTI Corporation, a supplier of networking and
network-access products. From September 1988 to April 1995, Mr. Dow was
employed by PriceWaterhouseCoopers LLP, serving most recently as Audit Manager.
Mr. Dow holds a Bachelor of Science from San Diego State University and is a
Certified Public Accountant.

Daniel K. ONeillhas served as our Vice President of Engineering since March
1999. From July 1990 to March 1999, Mr. ONeill held various technical and
management positions with Cadence Design Systems, Inc., a manufacturer of
semiconductor design automation software, serving most recently as a Senior
Member of the Consulting Staff. Mr. ONeill holds a Bachelor of Science and a
Master of Science from Santa Clara University.

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RISK FACTORS

THIS FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE EVENTS OR
OUR FUTURE FINANCIAL PERFORMANCE. YOU ARE CAUTIONED THAT SUCH STATEMENTS ARE
ONLY PREDICTIONS AND THAT ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY. IN
EVALUATING SUCH STATEMENTS, YOU SHOULD SPECIFICALLY CONSIDER THE VARIOUS
FACTORS IDENTIFIED IN THIS FORM 10-K, INCLUDING THOSE DISCUSSED BELOW, WHICH
COULD CAUSE ACTUAL EVENTS OR RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED
BY THE FORWARD-LOOKING STATEMENTS.

Litigation Risk

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

We are currently a named defendant in a number of copyright lawsuits, including
a class-action lawsuit and several individual lawsuits brought by independent
record companies, each alleging that, among other things, portions of our
My.MP3 and related services violated their respective copyrights. See
"Item 3 - Legal Proceedings". We were also
involved in similar significant litigation proceedings that either settled or
were brought to judgment in 2000. These included a lawsuit brought by two
major publishing companies and a lawsuit brought by ten major music recording
companies (the UMG case), each concerning copyright claims like those
described above. In the UMG case we were found by the court to have willfully
infringed plaintiffs copyrights. Eight plaintiffs in that case settled
through various agreements and two plaintiffs in that case proceeded through
judgment. In view
of the courts rulings in the UMG case, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be adjudicated against us
in the
copyright cases still pending. This would mean that we would only
be able to litigate the issue of damages. Although there were in excess of
78,000 CDs originally added to the My.MP3 service, we are unable to determine
the number of valid copyright registration certificates that may be
appropriately subject to an award of statutory or actual damages in these
pending cases. We do not yet know, for example, whether these other plaintiffs
will ultimately elect to recover statutory damages in lieu of actual damages,
nor are we able to speculate as to the likely size of any award of statutory
damages in these cases. At the rate of $25,000 per work (which is the
per CD amount of statutory damages awarded by the court in the UMG
case), our aggregate
potential liability resulting from all of our copyright litigation proceedings
could exceed one billion dollars.

During the year ended December 31, 2000, we recorded a charge for litigation
and copyright matters of $170.0 million. The charge for litigation and
copyright matters represented our estimate of the total costs to be incurred
only in connection with the resolution of the various litigation and copyright
matters associated with the My.MP3 service, including the lawsuits filed by
major recording companies and other parties. Copyright issues associated with
the My.MP3 service also include but are not limited to publishing rights,
non-major label content, and legal and advisory fees. This charge did not
reflect or include any amounts paid or payable in connection with
forward-looking licenses to use music recordings or compositions in connection
with the My.MP3 service. This charge reflects managements expectations as of the date of this
annual report, and is based on currently available information as well as
significant assumptions made by management regarding the various litigation and
copyright matters. Cash payments for the settlements and judgments discussed
above and other payments have reduced the cumulative amount reserved as a
result of this charge to $42.9 million as of December 31, 2000. We cannot
guarantee that future events or results will conform to our expectations or
assumptions regarding the various litigation and copyright matters. If these
expectations and significant assumptions prove to be erroneous in light of
future events, the actual amounts incurred by MP3.com to resolve all copyright
matters related to the My.MP3 service could be materially different than those
recorded as of December 31, 2000, and could far exceed the resources and market
capitalization of our company.

In addition to the copyright litigation discussed above, we and certain of our
employees, officers and directors have been named as defendants in several
lawsuits alleging violations of the federal securities laws. The complaints,
which were filed between September 19, 2000 and November 15, 2000 in the United
States District Court for the Southern District of California, each purport to
be brought on behalf of a class of stockholders. The complaints

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allege that we and the other the defendants violated the federal securities
laws by issuing materially false and misleading statements and failing to
disclose material information regarding our My.MP3 service and the litigation
surrounding the service. Also, between September 14, 2000 and October 26,
2000, certain stockholders of MP3.com filed shareholder derivative suits
against MP3.com and certain of its employees, officers and directors in the
Superior Court of the State of California, County of San Diego. These
complaints allege various statutory and common law claims relating to the
My.MP3 service. We have not recorded any charge related to these
claims as of December 31, 2000.

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

Risks Related To Our Business Model

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

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

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

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



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

Our historical revenue sources and our projected revenue sources have changed
as our business has evolved, and our revenue sources may change significantly
in the future. Since our business may continue to evolve rapidly, the

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above sources of revenues, including those derived from our My.MP3 and other
MSP-related services in development, may change, or increase or decrease in
importance.

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

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

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

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

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

In light of our past litigation proceedings, we have modified the My.MP3
service so that individual tracks are made available only if they are covered
by one of our master recording and musical composition licenses. Currently,
significantly less than all of the tracks contained on any one CD may be made
available through My.MP3s Beam-It and Instant Listening features. In order
to enhance the attractiveness of the My.MP3 service to consumers, and relatedly
increase the potential revenues to be generated by the service, we will need to
obtain additional licenses covering more content from record companies, music
publishing companies, performing arts societies and other third parties, and
allowing users outside the current licensed territories to access restricted
content. Although we have obtained several such licenses, including some in
connection with the settlement of lawsuits as described above, the success of
the My.MP3 Service may require that we be able to obtain licenses from enough
parties to be able to offer a broad range of content. Because of the large
number of potential parties from which we must obtain a license, we may never
be able to obtain a sufficient number of licenses to allow us to provide
services that will meet our customers expectations. The difficulty of obtaining negotiated license agreements with all the various third
parties in the fragmented music recording and publishing industries continues to pose a substantial
obstacle to our efforts to provide consumers with a fully satisfactory product.
In particular, users of our My.MP3 service may decide that we are not able to
provide them with access to enough of their music to make the service valuable,
and they may choose not to subscribe to the fee-based My.MP3 service or to use
other methods of accessing their music altogether. Even if we are able to
obtain a sufficient number of licenses, those licenses may not be on favorable
terms, and we may have to increase the amount that we charge consumers for our
services in order to cover the costs of these licenses. Consumers may not be
willing to pay the increased costs, and may discontinue the use of our
services.

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

In July 1999, we entered into an advertising, promotion and marketing agreement
with MPG. This agreement was amended effective September 2000. As amended, the
agreement provides for a significant scheduled decrease in advertising
commitments over the next two years, which we may not be able to make up in
revenue from other sources. For the quarter ended December 31, 2000, 61% of
our revenues came from sales of our advertising, promotion and marketing
services under this agreement. We anticipate that if we do not develop
significant alternative revenue sources, a substantial portion of our revenues
for the next year will come from sales under this agreement. Under this
agreement, MPGs quarterly advertising commitments are scheduled to decline by
60% after December 2001, from $15 million in the first quarter of 2001 to $6
million in the first quarter of 2002. Moreover, after December 2002, MPGs
quarterly commitments are scheduled to sharply decrease again, to only 2% or
less of the scheduled quarterly commitment for the first quarter of 2001.

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

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

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

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

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

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

We have significant licensing arrangements with major record labels and music
publishers that were only recently entered into, and were structured in the
context of litigation settlements or judgments rather than in the pursuit of

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

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

The music industry in the United States is generally regarded as extremely
litigious in nature compared to other industries. As a result, in the
future we may be engaged in litigation with others in the music industry, including those
entities with whom we have ongoing license arrangements. For example, some of the major recording companies that settled their
portion of the UMG case with us have asserted in writing that they believe the
amount paid by MP3.com to UMG in satisfaction of the
Courts judgment, together with the concurrent issuance of warrants to UMG,
triggered additional payments to them under the most favored nations clause
in their settlement agreement with MP3.com. Although we do not
believe they are entitled to any such additional payments, we cannot
assure you that we will be successful in ultimately concluding this
matter in an amicable fashion, or defending any resulting lawsuit. As a result, we may be forced to defend one or
more lawsuits on this and other issues in the future, and in fact may be
involved in a number of litigation proceedings with the same group of related
plaintiffs. These lawsuits could harm our business severely by damaging our
reputation, requiring us to incur legal costs, lowering our stock price and
public demand for our stock, and diverting managements attention away from our
primary business activities in general. We have not recorded any
charge related to claims for additional most favored
nations payments as of December 31, 2000.

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

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

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

The market for online music promotion and distribution is new and rapidly
evolving. As a result, demand and market acceptance for our products and
services expose us to a high degree of uncertainty and risk. We have
historically and are now largely attempting to capitalize on a talent pool of
artists not currently served by the traditional recording industry. We cannot
assure you that consumers will continue to be interested in listening to or
purchasing music from our artists or that the traditional music industry will
not successfully serve these artists in the future. If this new market fails to
develop, develops more slowly than expected or becomes saturated with
competitors, or our products and services do not achieve or sustain market
acceptance, our business could be harmed. We believe the future popularity of
downloadable digital music will depend, in part, on the availability of
portable devices to store and replay this music. In addition, we are attempting
to develop new features and services

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for our consumers based on our My.MP3 and other MSP-related services to allow
consumers additional ways to access, manage and listen to their music on any
web-enabled device or application. These efforts may not be successful and may
meet significant consumer and industry resistance. To the extent that consumer
acceptance or distribution of these portable devices and/or MSP services is
delayed or these devices or services are not available at affordable prices,
our market and thus a portion of our revenues, may not grow at a sufficient
pace and our business could ultimately be harmed.

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

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

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

The market for the online promotion and distribution of music and music-related
products is competitive. Barriers to entry on the Internet are relatively low,
and we expect competition to increase significantly in the future. Although we
have secured licenses from record companies and other third parties for some of
the content that we deliver, these licenses are generally non-exclusive.
Moreover, much of our technology, including our Beam-it and Instant Listening
services, subscription channels, the business music services and web site
technology and software, are currently not protected by patents or other
protection which would prevent third parties, including record companies and
other rights holders, from duplicating the technology and providing services
identical to ours. Although we have applied for patents with regard to a
number of these and other core technologies of our business, none of these
patents have yet been issued, nor is there any guarantee that they will ever be
issued in the future. We face competitive pressures from numerous actual and
potential competitors, many of which have longer operating histories, greater
brand name recognition, larger consumer bases and significantly greater
financial, technical and marketing resources than we do. We cannot assure you
that web sites maintained by our existing and potential competitors will not be
perceived by consumers, artists, talent management companies and other
music-related vendors or advertisers as being superior to ours. We also cannot
assure you that we will be able to maintain or increase our web site traffic
levels, purchase inquiries and number of click-throughs on our online
advertisements or that competitors will not experience greater growth in these
areas than we do. Increased competition could result in advertising price
reduction, reduced margins or loss of market share, any of which could damage
the long-term or short-term prospects of our business.

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

Although our business model contemplates multiple sources of revenue, we
anticipate that in the foreseeable future we will depend substantially on
revenue from advertising. During the year ended December 31, 2000, revenue from
advertising accounted for 96.5% of our net revenues, an increase of 3.0% from
the previous year. We currently depend on a small group of customers for our
revenue from advertising. During the fourth quarter of 2000, one customer
accounted for approximately 61% of net revenues, and our top ten customers
accounted for approximately 83% of net revenues. We expect that most of our
revenues will continue to be derived from third party advertising agreements. If any of our important customers were to leave
us, our business could be harmed. Similarly, our revenues may also be adversely
affected by the future insolvency of individual major customers or multiple
other customers within the volatile Internet and technology industries. If we
do not increase revenue from online advertising, our business may not grow or
survive. Increasing our revenue from online advertising depends largely on our
ability to:

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| |  |  | conduct successful selling and marketing efforts aimed at advertisers;                                                                                
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increase the size of the MP3.com audience by increasing both our artist
and consumer bases;                                                           
|
| |  |  | increase or at least maintain the amount of revenues per advertisement
in face of a recent industry-wide decline in online advertising prices and
use;
|
| |  |  | increase the size of our sales force, where appropriate;                                                                                              
|
| |  |  | target advertising to appropriate segments of our audience; and                                                                                       
|
| |  |  | measure accurately the size and demographic characteristics of our
audience.                                                                          

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

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

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

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

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

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

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

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

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

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

Since our inception in March of 1998, we have experienced extended periods of
rapid expansion in our web site traffic, personnel, facilities and
infrastructure. For example, the number of monthly page views on our web site
increased approximately 72% from December 1999 to December 2000. In addition,
our employees increased from eight on December 31, 1998, to 274 on December 31,
1999, to 308 on December 31, 2000. Further expansion may be required to
address potential growth in our artist and consumer bases, the breadth of our
product and service offerings, and other opportunities. Our expansion has
placed, and we expect it will continue to place, a significant

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strain on our management, operational and financial resources. Our failure to
manage growth could disrupt our operations and ultimately prevent us from
generating the revenues we expect.

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

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

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

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

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

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

Our business will depend on the ability of our artists and consumers to
continue to upload and download mp3 and other music files, as well as to
conduct commercial transactions with us, without significant delays or
aggravation that may be associated with decreased availability of Internet
bandwidth and access to our web site. Our penetration of a broader consumer
market will depend, in part, on continued proliferation of high speed Internet
access. Even compressed in mp3 format, a typical three minute song file can
occupy more than three megabytes of storage space. This file could take as much
as two minutes to download over an xDSL or cable modem compared to 10 to 20
minutes over a conventional 56Kbps modem. Since the Internet is likely to
continue to experience significant growth in the numbers of users and amount of
traffic, the Internet infrastructure may be unable to support the demands
placed on it. In addition, increased users or bandwidth requirements may harm
the performance of the Internet. The Internet has experienced a variety of
outages and other delays as a result of damage to portions of its
infrastructure, and it could face outages and delays in the future. The
infrastructure and complementary products or services

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necessary to make the Internet a viable commercial marketplace for the long
term may not be developed successfully or in a timely manner. Even if these
products or services are developed, the Internet may not become a viable
commercial marketplace for the products or services that we offer.

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

In the coming years, the number of individuals who access the Internet through
devices other than a personal computer, such as personal digital assistants and
cellular telephones, as well as automobile, portable and component or
home-based Internet-enabled radios and television set-top devices, is expected
to increase dramatically. A key part of our business strategy as an MSP is to
deliver music digitally to as many of these types of devices as possible. Our
services are designed to use rich graphical, audio and other resources such as
those available on personal and laptop computers. The lower resolution, poorer
sound quality, lower functionality, lower memory and typically slower Internet
access speeds associated with alternative devices may make the use of our
services through such devices difficult and we may be unsuccessful in our
efforts to modify our services to provide a compelling service for users of
alternative devices. As we have limited experience to date in operating
versions of our service developed or optimized for users of alternative
devices, it is difficult to predict the problems we may encounter in doing so
and we may need to devote significant resources to the creation, support and
maintenance of such versions.

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

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

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

Financial Risks

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

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

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

In 2000 and 1999, we had a net loss of approximately $279.5 million and $42.5
million, respectively. We expect substantial net losses and negative cash flow
for the foreseeable future. We believe it is critical to our long term success
that we continue to develop MP3.com brand awareness and loyalty through
marketing and promotion, expand our artist and consumer networks, develop our
online content and expand the commercial application of our other services. Our
operating expenses may continue to increase significantly during the next
several years, especially in sales and marketing and product development. We
may also incur significant litigation and settlement expenses, as we did in
2000, due to our pending litigation and any other lawsuits that may arise. With
increased expenses, we will need to generate significant additional revenues to
achieve profitability, especially in light of the dramatic scheduled reduction
in revenues from our agreement with MPG, discussed elsewhere. As a result, we
may never achieve or sustain profitability and, if we do achieve profitability
in any period, we may not be able to sustain or increase profitability on a
quarterly or annual basis.

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

Our available cash and equivalents and short and long-term investments in
marketable securities are expected to be sufficient to meet our cash
requirements for at least the next 12 months, even taking into account certain
litigation settlement payments that may be required in connection with claims
related to our My.MP3 service to the extent we have accrued such amounts as of
December 31, 2000. However, we may need to raise additional funds in order to:



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

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

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

We have made investments in and other business arrangements with companies that
have experienced financial and operational difficulties, including bankruptcy,
which could impair the overall value and potential value of these investments
and arrangements. This could, in turn, negatively impact our business
operations, financial accounting results and stock price. During the year
ended December 31, 2000, we recorded expenses related to the impairment of our
strategic investments equal to $50.7 million. We may have to record additional
impairment expenses in future quarters, and there can be no assurance that we
will ever benefit from these investments.

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

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



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

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

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

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

Holders of up to 17,088,152 shares of our common stock, as well as holders of
warrants to purchase up to 5,400,000 shares of common stock, have certain
registration rights. If such holders, by exercising either their registration
rights or their rights under Rule 144 or Rule 701, cause a large number of
securities to be registered and/or sold in the public market, such sales could
have an adverse effect on the market price for our common stock. If we were to
include in a company-initiated registration shares held by such holders
pursuant to the exercise of their registration rights, such sales may have an
adverse effect on our ability to raise needed capital.

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Risks Related To Sales and Marketing

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

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

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

We currently rely on mp3 technology for both brand identity and as a delivery
method for the digital distribution of music. We do not own or control mp3
technology. The onset of competing industry standards for the electronic
delivery of music could significantly affect the way we operate our business as
well as the publics perception of MP3.com as a company. For example, for
almost two years, some of the major recording studios devoted significant
resources into developing a universal standard for the electronic delivery of
music, called the Secure Digital Music Initiative, or SDMI. Although at this
time SDMI does not appear to be a viable standard, the development of which may
be abandoned entirely, the recording companies may continue to pursue SDMI or
similar efforts in the future. In addition, a number of corporations including
Microsoft Corporation, IBM Corporation, AT&T Corp., Liquid Audio, Inc.,
RealNetworks, Inc. and Sony Corporation have launched efforts to establish
proprietary audio formats to compete with the mp3 format. Some competitive
formats offer security and features that track the number of copies made or
designate each copy with an identifiable watermark. The mp3 technology we
currently use does not offer these features. These features are especially
popular among groups associated with the traditional music industry, and are
being promoted by some of our competitors. Widespread industry and consumer
acceptance of any of these audio formats could significantly harm our business
if we are unable to adapt and respond to these changing standards. Although we
are not tied exclusively to the use of mp3 technology or to any other specific
standard for the digital delivery of music, if a proprietary, or closed, music
delivery format receives widespread industry and consumer acceptance, we may be
required to license additional technology and information from third parties in
order to adopt that format. We cannot assure you that this third-party
technology and information will be available to us on commercially reasonable
terms, if at all. Any failure to obtain any of these technology and information
licenses or to successfully reconfigure our music library to support these
technologies could prevent us from making our music available in the most
widely accepted formats, which could make our offerings less popular or
inaccessible to both consumers and artists and thus harm our business.

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

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

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

The growth of our business will also depend in significant part on our ability
to develop a brand identity that transcends a mere association with the mp3
format. We must pursue a brand development strategy that identifies our

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company as a primary source for interesting and diverse high quality music and
artists above and beyond mp3 technology. Although MP3.com is not tied
exclusively to the use of mp3 technology or to any other specific standard for
the digital delivery of music, failure to achieve brand recognition apart from
the mp3 format could significantly affect the future viability of our brand
name and our ability to generate revenues.

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

We plan to use consumer data to expand, refine and target our marketing and
sales efforts. We collect most of our data from users who report information to
us as they conduct transactions on our web site. If a large proportion of users
impede our ability to collect data or if they falsify data, our marketing and
sales efforts would be less effective since advertisers generally require
detailed demographic data on their target audiences. In addition, laws relating
to privacy and the use of the Internet to collect personal information,
including strict laws relating to collecting information from children, could
limit our ability to collect data and utilize our database. Failure to collect
accurate and useful data could result in a substantial reduction in advertising
revenues, which represented 96.6% of our total revenues during 2000. Because we
use e-mail for direct marketing, any legislative or consumer efforts to
regulate unsolicited bulk e-mails, commonly referred to as spam, as well as
other laws regulating the use of e-mail, could significantly impair our sales
and marketing efforts and our associated advertising revenue.

Risks Related To Operations

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

We currently operate a small branch office in London, England, through which we
manage our European operations and attempt to market and sell our services in
several other countries. Our artists reside in over 190 countries as of
December 31, 2000, and customers visit our web site from all over the world.
We have also entered into relationships with third parties outside of the U.S.
to assist with our penetration of foreign markets.

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

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



| |  |  | delays in the development of the Internet as a music delivery,
advertising and commerce medium in international markets;                                                                       
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | difficulties in managing operations due to distance, language and
cultural differences, including issues associated with establishing
management systems infrastructures in individual markets;
|
| |  |  | unexpected changes in regulatory requirements;                                                                                                                                                 
|
| |  |  | the inability to obtain workable licenses to operate our My.MP3 or
other MSP-related services internationally;                                                                                 
|
| |  |  | government-imposed restrictions on the publics access to the Internet;                                                                                                                        
|
| |  |  | legal uncertainty regarding liability for the content posted on our web
site and the lack of clear legal precedent or applicable law;                                                          

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| |  |  | legal systems that are less Internet-friendly than those in the United
States;                                      
| | - |  | --------------------------------------------------------------------------------------------------------------------
|
| |  |  | different accounting practices;                                                                                     
|
| |  |  | potential adverse tax consequences, such as those associated with
cross-border use of intangible assets, and others;
|
| |  |  | more stringent consumer protection laws;                                                                            
|
| |  |  | higher costs of doing business in foreign countries;                                                                
|
| |  |  | difficulties and costs of staffing and managing foreign operations;                                                 
|
| |  |  | increased risk of piracy and limits on our ability to enforce our
intellectual property rights;                     
|
| |  |  | the need to comply with different and often conflicting laws and
regulations;                                       
|
| |  |  | political and economic instability; and                                                                             
|
| |  |  | other legal and political risks.                                                                                    

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

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

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

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

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

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

In November 1999, we outsourced exclusively to Cinram International, Inc. our
just-in-time DAM CD production and fulfillment process, as well as the
production and fulfillment of our other promotional CD products. The transition
of fulfillment operations to Cinram was completed at the end of March 2000.
For redundancy, we also currently maintain certain minimal fulfillment
capabilities at our main facility in San Diego. Should Cinram cease

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to provide us with production and fulfillment services for any reason, we
cannot assure you that we will be able to fulfill any of our customers orders
for DAM CDs and other merchandise without significant delays or expense, or at
all. Any such loss of fulfillment operations, for any period of time no matter
how brief, may substantially and irreparably harm our business reputation and
significantly decrease our revenues and our total number of consumers, artists
and users.

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

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

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

In 2000, approximately 2.1 terrabytes of
musical content was added to our web site, and the number of monthly
page views to our web site increased approximately 72% from December 1999 to
December 2000. We must continue to add hardware and enhance software to
accommodate the increased content and use of our web site. If we are unable to
increase the data storage and processing capacity of our systems at least as
fast as the growth in demand, our web site may become unstable and may fail to
operate for unknown periods of time. Unscheduled downtime could harm our
business and also could discourage users of our web site and reduce future
revenues.

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

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

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

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

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

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

Furthermore, we have entered into agreements with international entities, and
anticipate entering into additional agreements, to conduct business activities
in foreign jurisdictions. Because our services are accessible worldwide, and
because we facilitate sales of goods and provide services to users worldwide,
foreign jurisdictions may claim that we are required to comply with their laws.
For example, a French court has recently ruled that a U.S. web site must
comply with French laws regarding content and, in December 2000, the highest
court in Germany ruled similarly with regard to German law.

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

The Child Online Protection Act and the Child Online Privacy Protection Act (or
COPPA) were enacted in October 1998. COPPA imposes civil and criminal
penalties on persons distributing material harmful to minors over the Internet
to persons under the age of 17, or collecting personal information from
children under the age of 13. We do not knowingly collect and disclose personal
information from such minors. The manner in which COPPA may be interpreted and
enforced cannot be fully determined, and future legislation similar to COPPA
could subject us to potential liability, which in turn could harm our business.
Such laws could also damage the growth of the Internet generally and decrease
the demand for our products and services.

Finally, there are a large number of legislative proposals before the United
States Congress and various state legislatures regarding online and other
issues related to our business. It is not possible to predict whether or when
such legislation may be adopted, and certain proposals, if adopted, could
materially and adversely affect our business through a decrease in user
registration and revenue, and influence how and whether we can communicate with
our customers.

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

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

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



| |  |  | if the music, text, graphics, software or other content on our web site
or CDs violates their copyright, trademark, or other intellectual property
rights;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | if our artists violate their contractual obligations to others by
providing content on our web site or CDs; or                                            

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Risks Related To Government Regulation, Content and Intellectual Property



| |  |  | if anything on our web site or CDs is deemed obscene, indecent, harmful
to minors or defamatory.
| | - |  | ------------------------------------------------------------------------------------------------

We may also be liable for anything that is accessible from our web site through
links to other web sites. We attempt to minimize these types of liability by
requiring representations and warranties relating to our artists ownership of
and rights to distribute and submit their content and by taking related
measures to review content on our web site and on our CDs. However, alleged
liability could harm our business by damaging our reputation, requiring us to
incur legal costs in defense, exposing us to awards of damages and costs and
diverting managements attention away from our business. We are currently
involved in multiple litigation proceedings.

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

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







Item 2.Properties

Our principal administrative, marketing and product development facilities are
located in two buildings of approximately 61,000 and 47,000 square feet,
respectively, of office space in San Diego, California. Additionally, we have
four small offices in Encino, California, San Francisco, California, and
London, England that are primarily used for sales and marketing activities. We
also maintain a government relations office in Washington, DC. A listing of all
primary facilities and the corresponding location, square feet, expiration date
of the lease, and principal activities is set forth below.

|                                       |  |                                                            |  |             |        |                 |  |           
|-------------------------------------- |  | ---------------------------------------------------------- |  | ----------- | ------ | --------------- |  | ----------
|                                       |  |                                                            |  | Approximate |        | Expiration Date
|Location                               |  | Principal Activities                                       |  | Square Feet |        | of Lease       
|                                      
|4790 Eastgate Mall
San Diego, CA 92121 |  | Sales and Marketing, Operations
and General Administrative |  |             | 61,000 |                 |  | July 2005 
|                                      
|                                      
|                                      
|                                      
|                                       |  |                                                            |  |             |        |                 |  |           
|                                      
|                                      
|                                      
|                                      
|4780 Eastgate Mall
San Diego, CA 92121 |  | Engineering and Product Development                        |  |             | 47,000 |                 |  | March 2009

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Item 3.Legal Proceedings

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

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

As a result of these settlements, the Major Label Lawsuit was limited to a dispute with UMG Recordings, Inc., which represents
two of the original plaintiffs. A trial in the case was held from August 28
through September 6, 2000 on the issues of willfulness and damages. After
hearing evidence, the court ruled on September 6, 2000 that MP3.com had
willfully infringed UMGs copyrights and awarded damages to UMG in an amount of
$25,000 per CD. The Court then scheduled a period to allow MP3.com to conduct
discovery concerning the certificates of registration for which plaintiffs
sought damages. Prior to trial, UMG claimed that it held valid copyright
registrations on between 5,000 and 10,000 CDs. On November 16, 2000, UMG made
a motion for entry of judgment in the amount of $53,400,000 million in
statutory damages, costs and attorneys fees, which MP3.com did not oppose. As
a result, a judgment in that amount was entered.

MP3.com has also entered into a license agreement with UMG. Subject to certain
affirmative obligations of MP3.com and other terms and conditions regarding the
implementation of the My.MP3 service, the license agreements discussed above
permit MP3.com to utilize recordings owned by Warner Music Group, BMG
Entertainment, Sony Music, EMI and UMG as part of the My.MP3 service. The
license agreements have terms of approximately three to ten years, and provide
for payment of a one-time fee each time a licensor's recording is
added to a separate My.MP3 account. These licenses also provide for on-going royalty payments based on the greater of (i) a specified
percentage of net revenues generated from or in connection with the My.MP3
service or (ii) a specified amount accrued each time a licensors recording is
streamed from My.MP3. Although MP3.com has obtained license agreements permitting the use
of recordings from BMG Entertainment, Warner Music Group, Sony Music, UMG and
EMI, we cannot guarantee that MP3.com will be able to secure similar license
agreements from any other recording company.

Other Record Label Lawsuits. Over the course of 2000, some other entities filed lawsuits against us based on
the same set of allegations as the UMG case. These include: Zomba Recording
Corp.; Tee Vee Toons, Inc.; Koch Entertainment and Velvel Records LLC (the
Koch case); EMusic.com, Inc., Fuel 2000 Records, Spinart, Inc., Gig Records,
Fearless Records, and Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case). Additionally, several
independent labels have sent us demand letters alleging similar claims.
Discovery in the Tee Vee Toons case is scheduled to end on January 26, 2001,
the final pre-trial Conference is scheduled for February 27, 2001, and trial is
scheduled to commence on March 26, 2001. Discovery in the Zomba case is
currently being conducted and is scheduled to close on March 5, 2001, the
final pre-trial conference is scheduled for April 13, 2001 and pursuant to the
case management plan the case is to be ready for trial on April 16, 2001.
Discovery in the Koch case is scheduled to close on March 9, 2001 and the final
pre-trial conference is scheduled for April 23, 2001. The complaint in the
EMusic case was filed on December 14, 2000. MP3.coms response to the
complaint is currently due by February 8, 2001. The Unity case, which purports
to be brought on behalf of Unity, an independent record company whose works
were allegedly used in the My.MP3 service, and all other similarly situated
entities or individuals, was filed on November 7, 2000. MP3.com, Inc. answered
the Complaint on January 16, 2001. In view of the courts
rulings in the Major Label Lawsuit, there is a substantial risk that the issues of infringement, fair use,
and

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willfulness may be adjudicated against us in these cases. This could mean that
we would only be able to litigate the issue of damages.

Publisher Lawsuits.On March 14, 2000, two large music-publishing companies,
MPL Communications, Inc. and Peer International Corporation, with the
assistance of The Harry Fox Agency, Inc., filed a copyright
infringement lawsuit against MP3.com in the United States District Court for
the Southern District of New York (the MPL/Peer case). The complaint alleged
that MP3.com, in connection with its My.MP3 service, made unauthorized copies
of approximately 45,000 audio CDs in violation of the Copyright Act, and that
MP3.com, in connection with the streaming of audio content to users of the
My.MP3 service, continued to make unauthorized digital phonorecords in
violation of the Copyright Act. The complaint further alleged that MP3.coms
actions constituted unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs seek damages (including statutory damages of
up to $150,000 per violation) and injunctive relief prohibiting MP3.com from
operating its My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works. Additionally, Zomba
Enterprises, Inc. has filed its own music publishing case against us. In view
of the courts rulings in the Major Label Lawsuit, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be adjudicated against us
in these cases with publishers. This could mean that we would only be able to
litigate the issue of damages.

On October 17, 2000, MP3.com, the National Music Publishers Association, Inc.
and its licensing subsidiary, The Harry Fox Agency, Inc. entered into a
preliminary agreement that if approved by individual HFA music
publisher-principals would permit the use of up to one million musical
compositions on the My.MP3 service. In addition, MP3.com, MPL and Peer agreed
to settle the MPL/Peer case upon finalization of the preliminary agreement, and
agreed to stay the MPL/Peer case pending such finalization. In the
MPL/Peer case a stipulation of
dismissal with prejudice was subsequently signed by the parties on December 28,
2000 and so ordered by the Court on January 2, 2001.

The proposed, 3-year licensing arrangement provides that MP3.com will pay up to
$30,000,000 to HFA for the benefit of up to 25,000 music publishers and their
songwriter partners, to be allocated to two equal funds. One fund will be used
to pay HFA publisher-principals for past uses of music on the My.MP3 service,
in exchange for a release from HFA publisher-principals and their affiliated
entities of all claims related to the MPL/Peer case and the use of their
compositions on the My.MP3 service. The other fund will provide advance
payments toward royalties earned under the prospective license. The terms of
the prospective license call for a payment of one-quarter cent each time a song
is streamed on demand to a customer from his or her My.MP3 locker, along with a
one-time fee per track added to the My.MP3 service. In December 2000, MP3.com
and HFA agreed to extend the period of time during which individual HFA music
publisher-principals could approve the preliminary agreement and permit their
musical compositions to be used on the My.MP3 service.

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

Copyright Settlement Discussions; Charge to Earnings.MP3.com has pursued and
continues to actively pursue settlement discussions with the various plaintiffs
and claimants in the cases and disputes discussed above. The decision whether
to enter into settlement and/or license agreements with each party will be
based upon a number of factors related to both the lawsuits and MP3.coms
business in general. We cannot guarantee that we will be able to

44



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enter into any additional settlement agreements on terms favorable to MP3.com,
if at all, or that any settlement or license agreement will prove beneficial to
our business or stockholders. During the year ended December 31, 2000, we
recorded a charge for litigation and copyright matters of $170.0 million. The
charge for litigation and copyright matters represented our estimate of the
total costs to be incurred only in connection with the resolution of the
various litigation and copyright matters associated with the My.MP3 service,
including the lawsuits filed by major recording companies and other parties.
Copyright issues associated with the My.MP3 service also include but are not
limited to publishing rights, non-major label content, and legal and advisory
fees. This charge did not reflect or include any amounts paid or payable in
connection with forward-looking licenses to use music recordings or
compositions in connection with the My.MP3 service. This charge reflects managements expectations
as of the date of this annual report, and is based on currently available
information as well as significant assumptions made by management regarding the
various litigation and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the cumulative amount
reserved as a result of this charge to $42.9 million as of December 31, 2000.
We cannot guarantee that future events or results will conform to our
expectations or assumptions regarding the various litigation and copyright
matters. If these expectations and significant assumptions prove to be
erroneous in light of future events, the actual amounts incurred by MP3.com to
resolve all copyright matters related to the My.MP3 service could be materially
different than those recorded as of December 31, 2000, and could far exceed the
resources and market capitalization of our company.

Class Action Lawsuits.We and certain of our employees, officers and directors
have been named as defendants in several lawsuits alleging violations of the
federal securities laws. The complaints, which were filed between September 19,
2000 and November 15, 2000 in the United States District Court for the Southern
District of California, each purport to be brought on behalf of a class of
stockholders. The complaints allege that we and the other the defendants
violated the federal securities laws by issuing materially false and misleading
statements and failing to disclose material information regarding our My.MP3
service and the litigation surrounding the service. The court has entered an
order appointing lead counsel and identifying the representative plaintiffs.
The complaint does not specify the dollar amount of damages alleged. A
stipulated order has been entered providing the plaintiffs until March 2001 to
file a consolidated first amended complaint, after which MP3.com and the other
defendants will have 60 days to respond. We have not recorded any charge related
to these claims as of December 31, 2000.

Derivative Lawsuits.Between September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits against MP3.com and
certain of its employees, officers and directors in the Superior Court of the
State of California, County of San Diego. These complaints allege various
statutory and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud, gross
mismanagement, unjust enrichment and waste of corporate assets. Pursuant to a
stipulated order, plaintiffs filed a First Amended Consolidated Shareholder
Derivative Complaint on January 16, 2001. MP3.com and the other defendants
initial response to the consolidated complaint is due in March 2001.

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

In particular, the music industry in the United States is generally regarded as
extremely litigious in nature compared to other industries. As a result, in the future
we may be engaged in litigation with others in the music industry,
including those entities
with whom we have ongoing license arrangements. For example, some of the major
recording companies that settled their portion of the Major Label Lawsuit with us
have asserted in writing that they believe the amount paid by MP3.com to UMG in
satisfaction of the Court's judgment, together with the concurrent issuance of warrants to UMG,
triggered additional payments to them under the most favored nations clause in their
settlement agreement with MP3.com. Although we do not believe they are entitled to any such
additional payments, we cannot assure you that we will be successful in ultimately concluding
this particular matter in an amicable fashion, or defending any resulting lawsuit.
As a result, we may be forced to defend one or more lawsuits on this and other issues
in the future, and in fact may be involved in a number of litigation proceedings with the
same group of related plaintiffs. We have not recorded any charge
related to any claims
for additional most favored nations payments as of December 31, 2000.

45



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We cannot assure you that we will be successful in ultimately defending any of
these lawsuits, and we may be required to pay license fees or substantial
damages, including statutory, punitive or other damages that far exceed the
resources and overall market capitalization of MP3.com, in which event we might
have to significantly limit or terminate our business operations, particularly
because our business is not yet profitable. At the rate of $25,000
per work (which is the per CD amount of statutory damages awarded
by the court in the Major Label Lawsuit),
our aggregate potential liability resulting from all of our copyright
litigation proceedings could exceed one billion dollars. If successful, any one
of these lawsuits could seriously harm our business by forcing us to cease
providing services to our consumers or requiring us to pay monetary damages.
Even if unsuccessful, these lawsuits still can harm our business severely by
damaging our reputation, requiring us to incur legal costs, lowering our stock
price and public demand for our stock, and diverting managements attention
away from our primary business activities in general.







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

No matters were submitted to a vote of security holders during the fourth
quarter of 2000.

46



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##### Table of Contents









PART II







Item 5.Market for Registrants Common Equity and Related Stockholder Matters

(a) Our common stock began trading on the Nasdaq National Market under the
symbol MPPP on July 21, 1999. The following table sets forth the range of
high and low closing (last sale) prices for our common stock, as reported on
the Nasdaq National Market for the periods indicated:

|                                        |  |      |        |     |  |   |        | 
|--------------------------------------- |  | ---- | ------ | --- |  | - | ------ | 
|                                        |  | High |        | Low
|                                        |  |      |        |    
|1999                                   
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|Third Quarter (beginning July 21, 2000) |  | $    | 63.313 |     |  | $ | 26.750 | 
|                                       
|                                       
|                                       
|                                       
|Fourth Quarter                          |  | $    | 61.250 |     |  | $ | 25.250 | 
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|2000                                   
|                                       
|                                       
|                                       
|                                       
|                                        |  |      |        |     |  |   |        | 
|                                       
|                                       
|                                       
|                                       
|First Quarter                           |  | $    | 36.813 |     |  | $ | 16.375 | 
|                                       
|                                       
|                                       
|                                       
|Second Quarter                          |  | $    | 19.875 |     |  | $ | 7.000  | 
|                                       
|                                       
|                                       
|                                       
|Third Quarter                           |  | $    | 13.813 |     |  | $ | 3.938  | 
|                                       
|                                       
|                                       
|                                       
|Fourth Quarter                          |  | $    | 9.422  |     |  | $ | 2.625  | 

As of December 31, 2000, there were approximately 480 stockholders of record of
our common stock. We have never declared or paid any cash dividends on our
common stock, currently intend to retain any future earnings to finance the
growth and development of our business and do not anticipate paying any cash
dividends in the foreseeable future.

In November 2000 we sold to Universal Music Group (UMG Recording, Inc.), in
exchange for $250,000, warrants to purchase up to 3,000,000 shares of our
common stock. The warrants are exercisable at prices ranging from $3.75 to
$5.00 per share and range in term of one to three years. For the issuance of
these warrants, we relied on the exemption provided by Section 4(2) under the
Securities Act.

In December 2000, we sold to Warner Music Group, in exchange for $200,000,
warrants to purchase up to 2,400,000 shares of our common stock. The warrants
have exercise prices ranging from $6.50 to $7.25 per share, and are exercisable
for three successive one year periods commencing on the date of issuance. For
the issuance of these warrants, we relied on the exemption provided by Section
4(2) under the Securities Act.

(b) MP3.coms registration statement (No. 333-78545) under the Securities Act
for its initial public offering (the Registration Statement) was declared
effective by the SEC on July 20, 1999. Offering proceeds, net of aggregate
expenses of approximately $20.6 million, were approximately $360.4 million. As
of December 31, 2000, MP3.com has used the net proceeds of $360.4 million as
follows: approximately $79.7 million of the net offering proceeds for working
capital paid directly or indirectly to third parties; approximately $7.3
million for the purchase or installation of machinery and equipment;
approximately $12.0 million for the purchase of various strategic investments
and issuance of a note receivable; approximately $90.1 million for the
settlement of certain litigation and copyright matters; approximately $38.5
million for prepaid multimedia content royalties; approximately $4.0 million
for the acquisition of the remaining 53.5% of mp3radio.com; $30.0 million for
an escrow trust account; and approximately $98.8 million for the purchase of
temporary investments in corporate commercial paper and notes, U.S. government
and agency notes, and money market funds. No payments were made to directors,
officers, or affiliates of the Company or owners of 10% or more of the
outstanding Shares of common stock of the Company, other than compensation
payments to officers of the Company

47



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##### Table of Contents









Item 6.Selected Financial Data

In the table below, we provide you with selected historical financial data. We
have prepared this information using our audited consolidated financial
statements for the period from March 17, 1998 (inception) to December 31, 1998
and the years ended December 31, 1999 and 2000. When you read this selected
historical financial data, it is important that you read the historical
consolidated financial statements and related notes as well as the section
titled Managements Discussion and Analysis of Financial Condition and Results
of Operations included elsewhere in this Form 10-K. Historical results are not
necessarily indicative of future results. Amounts below are in thousands,
except per share data.

SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA

|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |        |  
|----------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------ | - | ----------------------- | ------- | ------------ | - | ------- | ------ | - | - | -------------- | ------ | -
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   | Period from   
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   | March 17, 1998
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   | (inception) to
|                                                                                                      |                                                                                                                                                  |   | Year
Ended December 31, |         | December 31,
|                                                                                                      |                                                                                                                                                  |   | 2000                    |         | 1999         |   | 1998   
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |        
|Consolidated Statement of Operations Data:                                                           
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Net revenues                                                                                          |                                                                                                                                                  | $ | 80,136                  |         |              | $ | 21,899  |        |   | $ | 1,162          |       
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Cost of revenues (excludes amortization of deferred
compensation of $128, $256, and $, respectively) |                                                                                                                                                  |   | 15,760                  |         |              |   | 9,211   |        |   |   | 215            |       
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|Gross profit                                                                                          |                                                                                                                                                  |   | 64,376                  |         |              |   | 12,688  |        |   |   | 947            |       
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Operating expenses:                                                                                  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Sales and marketing (excludes amortization of deferred
compensation of $1,884, $10,952, and $380, respectively)                                  |   |                         | 71,217  |              |   |         | 23,998 |   |   |                | 79     |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Engineering and product development (excludes
amortization of deferred compensation of $2,379,
$3,027, and $170, respectively)                   |   |                         | 22,447  |              |   |         | 9,417  |   |   |                | 395    |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | General and administrative (excludes amortization of
deferred compensation and stock-based compensation
of $7,615, $8,053, and $, respectively) |   |                         | 31,503  |              |   |         | 9,307  |   |   |                | 142    |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Charge for litigation and copyright matters                                                                                                      |   |                         | 170,000 |              |   |         |       |   |   |                |       |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Costs related to acquisition activities                                                                                                          |   |                         | 1,704   |              |   |         |       |   |   |                |       |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Amortization of deferred compensation and other stock
based compensation                                                                         |   |                         | 12,006  |              |   |         | 22,288 |   |   |                | 550    |  
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|                                                                                                      | Total operating expenses                                                                                                                         |   |                         | 308,877 |              |   |         | 65,010 |   |   |                | 1,166  |  
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|Loss from operations                                                                                  |                                                                                                                                                  |   | (244,501                | )       |              |   | (52,322 | )      |   |   | (219           | )     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Interest income, net                                                                                  |                                                                                                                                                  |   | 17,412                  |         |              |   | 10,852  |        |   |   | (4             | )     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Impairment of strategic investments and loss on sale
of short-term investments available for sale     |                                                                                                                                                  |   | (50,736                 | )       |              |   |        |        |   |   |               |       
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|Loss before minority interest and income taxes                                                        |                                                                                                                                                  |   | (277,825                | )       |              |   | (41,470 | )      |   |   | (223           | )     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Provision (benefit) for income taxes                                                                  |                                                                                                                                                  |   |                        |         |              |   | (93     | )      |   |   | 134            |       
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Minority interest in losses of an unconsolidated subsidiary                                           |                                                                                                                                                  |   | (1,668                  | )       |              |   | (1,105  | )      |   |   |               |       
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|Net loss                                                                                              |                                                                                                                                                  | $ | (279,493                | )       |              | $ | (42,482 | )      |   | $ | (357           | )     
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|Net loss per share(1):                                                                               
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Basic and diluted                                                                                                                                |   | $                       | (4.18   | )            |   | $       | (0.78  | ) |   | $              | (0.01  | )
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       
|                                                                                                      | Weighted average shares basic and diluted                                                                                                       |   |                         | 66,799  |              |   |         | 54,194 |   |   |                | 26,183 |  
|                                                                                                      |                                                                                                                                                  |   |                         |         |              |   |         |        |   |   |                |       

|                                                                   |  |      |         |      |  |              |         |  |  |   |     | 
|------------------------------------------------------------------ |  | ---- | ------- | ---- |  | ------------ | ------- |  |  | - | --- | 
|                                                                   |  |      |         |      |  | December 31,
|                                                                   |  |      |         |      |  |             
|                                                                   |  | 2000 |         | 1999 |  | 1998        
|                                                                   |  |      |         |      |  |             
|Consolidated Balance Sheet Data:                                  
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Cash, cash equivalents, short-term
investments and restricted cash |  | $    | 128,846 |      |  | $            | 427,981 |  |  | $ | 39  | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Working capital                                                    |  |      | 90,611  |      |  |              | 388,192 |  |  |   | 133 | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Total assets                                                       |  |      | 238,599 |      |  |              | 471,882 |  |  |   | 463 | 
|                                                                  
|                                                                  
|                                                                  
|                                                                  
|Total stockholders equity                                         |  |      | 173,716 |      |  |              | 417,550 |  |  |   | 195 | 



---

|(1) |  | See Note 1 of Notes to Consolidated Financial Statements for a
description of the computation of the net loss per share and the number of
shares used in the per share calculation.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

48



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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations

Overview

We have pioneered a revolutionary approach to the promotion and distribution of
music. The MP3.com web site is a premier online music destination featuring, as
of December 31, 2000, approximately 800,000 song and audio files from over
125,000 digital artists, representing one of the largest catalogs of digital
music available on the Internet today. We use the Internet and file formats
that make music files smaller to enable this growing number of artists to
broadly distribute and promote their music and to enable consumers around the
world to conveniently access this continually expanding music catalog.
Consumers can search for, listen to and download music free of charge on the
MP3.com web site.

In addition to the wide variety of music distributed by artists through our web
site, consumers have a substantial amount of music already in their personal
music collections that they want to access, manage and listen to in a variety
of ways. Just as consumers use an Internet service provider as the central
mechanism through which they interact with the Internet, individuals are
increasingly looking for one central resource that allows them to access,
manage and listen to all music not just new music, but music already in
their personal collections. We call this resource a Music Service Provider
or MSP, MP3.com is enhancing its offerings in a continued effort to be the
premier MSP for consumers.

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

We believe we have developed core competencies and created a technology
infrastructure system that will enable us to provide a wide variety of data
management and infrastructure services to other businesses. Through our
ongoing efforts to develop, maintain and improve the MP3.com web site, we have
amassed a significant amount of expertise in data storage, delivery and
management; server-side security; and royalty tracking and payment systems. We
have also created a technology infrastructure system that stores, manages,
tracks and provides statistical analysis on a real-time basis for digital data
for over 125,000 artists and more than 13.5 million registered users. In
December 2000, our technology infrastructure system managed an average of over
4.5 terabytes of data each day.

We generate revenue from online advertising, offline advertising and electronic
commerce. For the years ended December 31, 2000 and 1999, 96.5% and 93.5%,
respectively, of our revenues were from the sale of advertising space.

MP3.com was incorporated in March 1998. During 1998, our operations consisted
largely of developing the infrastructure necessary to download music on the
Internet. Since the beginning of 1999, our growth has been dramatic. The number
of employees increased from eight on December 31, 1998 to 274 on December 31,
1999 to 308 on December 31, 2000. In December 2000, we added over 240 artists
and over 1,550 new songs on average each day, which is an increase from over
150 artists and over 1,000 new songs that were added on average each day in
December 1999. During December 2000, visitors to our web site viewed over 167
million web pages and listened to or downloaded over 52.7 million songs, which
is an increase from December 1999 when visitors viewed over 97 million web
pages and listened to or downloaded over 18 million songs.

49



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##### Table of Contents



The Year Ended December 31, 2000 Compared to the Year Ended December 31, 1999:

Results of Consolidated Operations

The following table sets forth certain financial data for the periods indicated
as a percentage of total net revenues:

|                                                                                                  |                                                             |  |                         |       |      |  |        |       |  
|------------------------------------------------------------------------------------------------- | ----------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ------ | ----- | -
|                                                                                                  |                                                             |  | Year Ended December 31,
|                                                                                                  |                                                             |  | 2000                    |       | 1999
|                                                                                                  |                                                             |  |                         |       |     
|Net revenues:                                                                                    
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Online advertising                                          |  |                         | 77.8  | %    |  |        | 53.0  | %
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Offline advertising                                         |  |                         | 18.7  |      |  |        | 40.5  |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Electronic commerce                                         |  |                         | 3.5   |      |  |        | 6.5   |  
|                                                                                                  |                                                             |  |                         |       |      |  |        |      
|Total net revenues                                                                                |                                                             |  | 100.0                   |       |      |  | 100.0  |      
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Cost of revenues                                                                                  |                                                             |  | 19.7                    |       |      |  | 42.1   |      
|                                                                                                  |                                                             |  |                         |       |      |  |        |      
|Gross profit                                                                                      |                                                             |  | 80.3                    |       |      |  | 57.9   |      
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Operating expenses:                                                                              
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Sales and marketing                                         |  |                         | 88.9  |      |  |        | 109.6 |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Engineering and product development                         |  |                         | 28.0  |      |  |        | 43.0  |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | General and administrative                                  |  |                         | 39.3  |      |  |        | 42.5  |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Charge for litigation and copyright matters                 |  |                         | 212.1 |      |  |        |      |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Costs related to acquisition activities                     |  |                         | 2.1   |      |  |        |      |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Amortization of deferred and other stock based
compensation |  |                         | 15.0  |      |  |        | 101.8 |  
|                                                                                                  |                                                             |  |                         |       |      |  |        |      
|Total operating expenses                                                                          |                                                             |  | 385.4                   |       |      |  | 296.9  |      
|                                                                                                  |                                                             |  |                         |       |      |  |        |      
|Loss from operations                                                                              |                                                             |  | (305.1                  | )     |      |  | (239.0 | )    
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Interest income, net                                                                              |                                                             |  | 21.7                    |       |      |  | 49.6   |      
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Impairment of strategic investments and loss on sale of
short-term investments available for sale |                                                             |  | (63.3                   | )     |      |  |       |      
|                                                                                                  |                                                             |  |                         |       |      |  |        |      
|Loss before minority interest and income taxes                                                    |                                                             |  | (346.7                  | )     |      |  | (189.4 | )    
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Benefit for income taxes                                                                          |                                                             |  |                        |       |      |  | (0.4   | )    
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Minority interest in losses of unconsolidated subsidiary                                          |                                                             |  | (2.1                    | )     |      |  | (5.0   | )    
|                                                                                                  |                                                             |  |                         |       |      |  |        |      
|Net loss                                                                                          |                                                             |  | (348.8                  | )%    |      |  | (194.0 | )%   
|                                                                                                  |                                                             |  |                         |       |      |  |        |      

Net Revenues

For the year ended December 31, 2000, total net revenues were $80,136,000,
which were derived from online advertisements on our web site; offline
advertisements through various promotions and events that were not hosted on
our web site, sponsorship of various contests, sweepstakes, e-mail campaigns,
greeting cards and the MP3 Summit; and the online sale of CDs and
music-related merchandise. This compares to $21,899,000 during the same period
a year ago, an increase of 265.9%. The increase in net revenues during 2000
over the same period in 1999 was mostly attributable to a significant increase
in online advertisements, primarily as a result of our agreement with MPG, and
introduction of new online advertisement products such as e-mail campaigns and
greeting card advertisements; the introduction of various offline advertisement
products such as contests and sweepstakes; and to a lesser extent an increase
in CD sales on our web site.

Revenues from Online Advertising.For the year ended December 31, 2000,
revenues from online advertising were $62,317,000 or 77.8% of total net
revenues compared to $11,616,000 or 53.0% of total net revenues for the same
period one year ago. Online advertising revenues primarily consist of banner,
button, portal and sponsorship advertisements on our web site in addition to
advertisements placed in e-mail and greeting card campaigns. The duration of
our online advertising commitments range from one month to approximately four
years. Banner, button and portal advertisements are impression based, requiring
the advertisement to be displayed a minimum number of times over the contract
period. Sponsorship advertising contracts involve static advertisements,
whereby the advertisement is continually displayed on a specified area of our
web site during the contract period. E-mails containing various advertisements
are sent to our artists and users of our web site on a regular basis. Greeting
cards also contain advertisements and are sent electronically whenever a user
of our web site requests that a card be delivered to a person(s) of their
choice. The increase in revenues from online advertising for 2000 as compared
to the same period one year ago was primarily due to a significant increase in
page view volume resulting from significant increases in unique visitors, an
increase in our advertiser customer base, and a significant increase in revenue
from e-mail and greeting card products.

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Revenues from Offline Advertising.For the year ended December 31, 2000,
revenues from offline advertising were $15,045,000 or 18.7% of total net
revenues compared to $8,877,000 or 40.5% of total net revenues for the same
period one year ago. During 2000, offline advertising revenues primarily
consisted of contests and sweepstakes, and to a lesser extent advertising
sponsorships of free CD products. In 1999, offline revenue primarily consisted
of free CD products, the Music and Technology Tour (or M&T Tour), and the
MP3 Summit. We held contests and sweepstakes during the year that were
sponsored by MPG and provided prizes to the winners of each contest. Free CD
products are multi-media CDs containing advertising, free software, videos and
games as well as collections of music from artists that have posted music on
our web site. These free CDs are sponsored by several different advertisers and
distributed free of charge to users of our web site who register to receive the
CD. The increase in revenues from offline advertising was primarily due to the
introduction of contests and sweepstakes, and to a lesser extent increased
revenues associated with the MP3 Summit offset by a decrease in free CD
product revenues and the discontinuance of the M&T Tour. The decrease in
revenues from offline advertising, as a percentage of total net revenues, was
primarily attributable to the significant increase in online advertising
revenues, both in absolute dollars and as a percentage of total net revenues.

Revenues from Online Sales of CDs and Other Music-Related Merchandise.For the
year ended December 31, 2000, revenues from online sales of CDs and other
music-related merchandise were $2,774,000 or 3.5% of total net revenues
compared to $1,406,000 or 6.5% of total net revenues for the same period one
year ago. Online e-commerce sales consist of DAM and compilation CDs and, to a
lesser extent, other music-related merchandise. The increase in revenues from
online sales of CDs and other music-related merchandise during 2000 as compared
to the same period one year ago was primarily due to an increase in the sales
volume of DAM CDs (an increase of approximately 184,000 units or 130%)
resulting from increased musical content available on our web site offset by
decreased average selling prices of CDs. The decrease in revenue from online
sales of CDs and other music-related merchandise, as a percentage of total net
revenues, was primarily attributable to the significant increase in both online
and offline advertising revenues, both in absolute dollars and as a percentage
of total net revenues. In the future, if the number of visitors to our web site
continues to grow, and the musical content available continues to grow and
improve, revenue from the online sale of CDs could constitute an increasing
portion of total net revenues.

Revenue Concentration.For the years ended December 31, 2000 and 1999, 96.5%
and 93.5%, respectively, of our total net revenues were from the sale of both
online and offline advertising related products. Additionally, during the
years ended December 31, 2000 and 1999, we recognized revenue of $40,345,000 or
50.3% and $4,655,000, or 21.3%, respectively, of the total revenues, associated
with the MPG agreement. MPG revenues will be distributed between online and
offline sources based on a changing percentage from quarter to quarter. For at
least the next year, we expect that a significant amount of our revenues will
continue to be derived from third party advertising agreements like we have
with MPG.

In July 1999, we entered into an agreement with MPG under which MPG committed
to purchase an aggregate of $150 million in advertising, promotion and
marketing services from us over three years. In July 1999, we received
prepayments from MPG totaling $45 million, which represented payment for these
services through the fourth quarter of 2000. In September 2000, we entered into
an amended and restated agreement with MPG. The restated agreement extended our
relationship with MPG through 2004, and reduced the aggregate amount of
services to be purchased by MPG over the life of the agreement (see the revised
commitment schedule below). Both MPG and MP3.com believe that the revised
commitment schedule will allow for more efficient use of our marketing services
for the benefit of MPG and its various related companies. In addition, the
restated agreement provides for a more streamlined media management process and
creates certain exceptions to the favored pricing granted to MPG under the
original agreement. Under the restated agreement, MPG is now committed to
purchase an aggregate of $120 million in advertising, promotion and marketing
services from us (including the $45 million purchased through the fourth
quarter of 2000). The remaining $75 million to be received under the restated
agreement remains secured by an irrevocable letter of credit. The restated
agreement further provides MPG with potential additional financial incentives
of up to an aggregate of $5 million (up to $1 million in any one calendar
quarter) based on the number of different companies that use our services under
the agreement. The financial incentives could result in the reduction of the
marketing and promotions commitment during the period incurred. The following
represents the remaining gross contractual marketing and promotional commitment
by MPG to MP3.com:

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|                            |    |                  |   |                |        | 
|--------------------------- | -- | ---------------- | - | -------------- | ------ | 
|Quarterly Payment Schedule: |    | Purchase Amount:
|                            |    |                 
|                            |    |                  |   | (in thousands)
|2001                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 15,000         |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 12,250         |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 12,250         |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 12,250         |       
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|2002                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 6,000          |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 5,000          |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 5,000          |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 5,000          |       
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|2003                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 300            |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 300            |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|2004                       
|                           
|                           
|                           
|                           
|                            | Q1 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q2 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q3 |                  | $ | 275            |       
|                           
|                           
|                           
|                           
|                            | Q4 |                  | $ | 275            |       
|                            |    |                  |   |                |       
|                            |    | Total:           |   | $              | 75,000 | 
|                            |    |                  |   |                |       

During 1999 and 2000, we made certain strategic investments and entered into
certain marketing and promotion arrangements with these strategic investments.
In certain circumstances and pursuant to our accounting policies, we have
recognized revenue in connection with these marketing and promotion agreements.
Due to the recent financial uncertainty related to some of these strategic
investments, we have determined that we are unable to recognize revenue in
connection with some of our marketing and promotion arrangements for which we
have made a strategic investment until the significant uncertainties have been
satisfactorily resolved. These above factors, current financial and economic
conditions, and current litigation could have an adverse effect on our future
revenues.

Cost of Revenues

Cost of revenues for the year ended December 31, 2000 were $15,760,000 or 19.7%
of total net revenues compared to $9,211,000 or 42.1% of total net revenues
during the same period a year ago, resulting in gross margins of 80.3% and
57.9%, respectively. The increase in cost of revenues, in absolute dollar
amounts, was primarily due to increases in bandwidth requirements, royalties to
artists, costs related to contests and sweepstakes, and to a lesser extent an
increase in costs related to the MP3 Summit, offset by the
elimination of costs associated with the Music and Technology Tour (or M&T
Tour) which was discontinued in 2000. The increase in gross margins was
primarily due to a significant amount of online advertising purchased by MPG,
which typically has comparatively higher gross margins. Additionally, revenue
from offline contests and sweepstakes typically has significantly increased
gross margins when compared to other offline product margins. CD and other
music-related merchandise sales typically have substantially lower gross
margins which offset the higher gross margins from online and offline
advertising products. We anticipate that future gross margins will fluctuate
depending on changes in our revenue mix and the timing of expenditures in web
site and fulfillment operations. Additionally, future gross margins could
fluctuate depending on the amount of MPG quarterly revenues allocated between
online and offline advertising products, and the nature of the offline products
purchased. Additionally, we are including in cost of revenues the greater of
straight-line amortization or units of measure of certain prepaid multimedia
royalty licensing arrangements with certain major recording companies that
could result in cost of revenues substantially increasing both in absolute
dollars and as a percentage of total net revenue in future periods. For the
years ended December 31, 2000 and 1999, the amount of prepaid multimedia
content royalty license amortization recorded was approximately $610,000 and
zero, respectively.

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Sales and Marketing

During the year ended December 31, 2000, sales and marketing expense was
$71,217,000 or 88.9% of total net revenues compared to $23,998,000 or 109.6% of
total net revenues during the same period a year ago. The increase in sales and
marketing expense, in absolute dollar amounts, was primarily due to stock-based
charges of approximately $5,131,000 associated with the acceleration of stock
option vesting, the cost of our Payback for Playback program of approximately
$8,440,000, an increase in sales and marketing payroll and related expenses of
approximately $6,683,000, a charge associated with the impairment of certain
prepaid marketing expenses related to arrangements with internationally known
artists of approximately $2,587,000, new and increased marketing programs of
approximately $3,801,000, warrants issued for major label marketing and
promotions of approximately $18,078,000 and other general costs associated with
the growth of our business. This increase was reduced by marketing and
promotion costs of approximately $2,114,000 associated with the 1999 Alanis
Morissette and Tori Amos 5 -1/2 Weeks Summer tour sponsorship, and the
contribution of 100,000 shares of our common stock to the MP3 Foundation of
$767,000 that were incurred during 1999 but not incurred during 2000. The
decrease in sales and marketing costs as a percentage of total net revenues is
primarily due to the significant increase in total net revenues. Overall sales
and marketing expense, in absolute dollar terms, may continue to increase in
the foreseeable future; however, sales and marketing expense as a percentage of
total net revenues may fluctuate depending on the level of future total net
revenues, the timing of new marketing programs and the addition of sales and
marketing personnel.

In the future, we may enter into arrangements with additional artists and
creative talent agencies to secure their promotional and marketing services.
Future expenses may include costs related to promotional events, which will be
expensed to sales and marketing in the period the event is held. Depending upon
the terms and timing of promotional activities, substantial fluctuations in
sales and marketing expenses may occur in any quarterly period.

Engineering and Product Development

During the year ended December 31, 2000, engineering and product development
expense was $22,447,000 or 28.0% of total net revenues compared to $9,417,000
or 43.0% of total net revenues during the same period one year ago. The
increase in the level of engineering and product development expense, in
absolute dollar amounts, was primarily due to an increase in payroll and
related expenses of approximately $8,401,000, increased computer equipment
depreciation of approximately $4,129,000, increased consulting and temporary
labor of $988,000, increased computer supplies and maintenance of approximately
$1,016,000, and other general costs associated with the growth of our business.
These increases are offset by stock-based charges of approximately $2,592,000
associated with the acceleration of stock option vesting during 1999. The
decrease in engineering and product development expense as a percentage of
total net revenue is primarily due to a significant increase in total net
revenues. We anticipate that overall engineering and product development
expenses, in absolute dollar terms, will continue to increase in the
foreseeable future; however, engineering and product development expenses as a
percentage of net revenues may fluctuate depending on the level of future net
revenues and the timing of expenditures for engineering and product development
and hiring.

General and Administrative

During the year ended December 31, 2000, general and administrative expense was
$31,503,000 or 39.3% of total net revenues compared to $9,307,000 or 42.5% of
total net revenues during the same period one year ago. The increase in general
and administrative expense, in absolute dollar amounts, was primarily a result
of an increase in finance and administrative payroll and related expenses of
approximately $7,562,000; an increase in legal, accounting, and public
relations expenses of approximately $7,277,000; an increase insurance costs of
approximately $1,554,000; an increase in bad debt expense of approximately
$1,429,000; an increase in goodwill and other intangible assets amortization of
approximately $1,637,000; an increase in consulting and temporary labor of
approximately $1,533,000; and other general costs associated with the growth of
our business. General and administrative expense as a percentage of total net
revenues decreased primarily due to increased total net revenues. We anticipate
that overall general and administrative expenses, in absolute dollar terms,
will continue to increase in the foreseeable future; however, general and
administrative expense as a percentage of total net revenues may fluctuate
depending on the level of future total net revenues and the timing of
additional expenditures for general and administrative infrastructure.

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Charge for Litigation and Copyright Matters

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

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

As a result of these settlements, the Major Label Lawsuit was limited to a dispute with UMG Recordings, Inc., which represents
two of the original plaintiffs. A trial in the case was held from August 28
through September 6, 2000 on the issues of willfulness and damages. After
hearing evidence, the court ruled on September 6, 2000 that MP3.com had
willfully infringed UMGs copyrights and awarded damages to UMG in an amount of
$25,000 per CD. The Court then scheduled a period to allow MP3.com to conduct
discovery concerning the certificates of registration for which plaintiffs
sought damages. Prior to trial, UMG claimed that it held valid copyright
registrations on between 5,000 and 10,000 CDs. On November 16, 2000, UMG made
a motion for entry of judgment in the amount of $53,400,000 million in
statutory damages, costs and attorneys fees, which MP3.com did not oppose. As
a result, a judgment in that amount was entered.

MP3.com has also entered into a license agreement with UMG. Subject to certain
affirmative obligations of MP3.com and other terms and conditions regarding the
implementation of the My.MP3 service, the license agreements discussed above
permit MP3.com to utilize recordings owned by Warner Music Group, BMG
Entertainment, Sony Music, EMI and UMG as part of the My.MP3 service. The
license agreements have terms of approximately three to ten years, and provide
for payment of a one-time fee each time a licensor's recording is
added to a separate My.MP3 account. These licenses also provide for on-going royalty payments based on the greater of (i) a specified
percentage of net revenues generated from or in connection with the My.MP3
service or (ii) a specified amount accrued each time a licensors recording is
streamed from My.MP3. Although MP3.com has obtained license agreements permitting the use
of recordings from BMG Entertainment, Warner Music Group, Sony Music, UMG and
EMI, we cannot guarantee that MP3.com will be able to secure similar license
agreements from any other recording company.

Other Record Label Lawsuits. Over the course of 2000, some other entities filed lawsuits against us based on
the same set of allegations as the UMG case. These include: Zomba Recording
Corp.; Tee Vee Toons, Inc.; Koch Entertainment and Velvel Records LLC (the
Koch case); EMusic.com, Inc., Fuel 2000 Records, Spinart, Inc., Gig Records,
Fearless Records, and Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case). Additionally, several
independent labels have sent us demand letters alleging similar claims.
Discovery in the Tee Vee Toons case is scheduled to end on January 26, 2001,
the final pre-trial Conference is scheduled for February 27, 2001, and trial is
scheduled to commence on March 26, 2001. Discovery in the Zomba case is
currently being conducted and is scheduled to close on March 5, 2001, the
final pre-trial conference is scheduled for April 13, 2001 and pursuant to the
case management plan the case is to be ready for trial on April 16, 2001.
Discovery in the Koch case is scheduled to close on March 9, 2001 and the final
pre-trial conference is scheduled for April 23, 2001. The complaint in the
EMusic case was filed on December 14, 2000. MP3.coms response to the
complaint is currently due by February 8, 2001. The Unity case, which purports
to be brought on behalf of Unity, an independent record company whose works
were allegedly used in the My.MP3 service, and all other similarly situated
entities or individuals, was filed on November 7, 2000. MP3.com, Inc. answered
the Complaint on January 16, 2001. In view of the courts
rulings in the Major Label Lawsuit, there is a substantial risk that the issues of infringement, fair use,
and

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willfulness may be adjudicated against us in these cases. This could mean that
we would only be able to litigate the issue of damages.

Publisher Lawsuits.On March 14, 2000, two large music-publishing companies,
MPL Communications, Inc. and Peer International Corporation, with the
assistance of The Harry Fox Agency, Inc., filed a copyright
infringement lawsuit against MP3.com in the United States District Court for
the Southern District of New York (the MPL/Peer case). The complaint alleged
that MP3.com, in connection with its My.MP3 service, made unauthorized copies
of approximately 45,000 audio CDs in violation of the Copyright Act, and that
MP3.com, in connection with the streaming of audio content to users of the
My.MP3 service, continued to make unauthorized digital phonorecords in
violation of the Copyright Act. The complaint further alleged that MP3.coms
actions constituted unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs seek damages (including statutory damages of
up to $150,000 per violation) and injunctive relief prohibiting MP3.com from
operating its My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works. Additionally, Zomba
Enterprises, Inc. has filed its own music publishing case against us. In view
of the courts rulings in the Major Label Lawsuit, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be adjudicated against us
in these cases with publishers. This could mean that we would only be able to
litigate the issue of damages.

On October 17, 2000, MP3.com, the National Music Publishers Association, Inc.
and its licensing subsidiary, The Harry Fox Agency, Inc. entered into a
preliminary agreement that if approved by individual HFA music
publisher-principals would permit the use of up to one million musical
compositions on the My.MP3 service. In addition, MP3.com, MPL and Peer agreed
to settle the MPL/Peer case upon finalization of the preliminary agreement, and
agreed to stay the MPL/Peer case pending such finalization. In the
MPL/Peer case a stipulation of
dismissal with prejudice was subsequently signed by the parties on December 28,
2000 and so ordered by the Court on January 2, 2001.

The proposed, 3-year licensing arrangement provides that MP3.com will pay up to
$30,000,000 to HFA for the benefit of up to 25,000 music publishers and their
songwriter partners, to be allocated to two equal funds. One fund will be used
to pay HFA publisher-principals for past uses of music on the My.MP3 service,
in exchange for a release from HFA publisher-principals and their affiliated
entities of all claims related to the MPL/Peer case and the use of their
compositions on the My.MP3 service. The other fund will provide advance
payments toward royalties earned under the prospective license. The terms of
the prospective license call for a payment of one-quarter cent each time a song
is streamed on demand to a customer from his or her My.MP3 locker, along with a
one-time fee per track added to the My.MP3 service. In December 2000, MP3.com
and HFA agreed to extend the period of time during which individual HFA music
publisher-principals could approve the preliminary agreement and permit their
musical compositions to be used on the My.MP3 service.

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

Copyright Settlement Discussions; Charge to Earnings.MP3.com has pursued and
continues to actively pursue settlement discussions with the various plaintiffs
and claimants in the cases and disputes discussed above. The decision whether
to enter into settlement and/or license agreements with each party will be
based upon a number of factors related to both the lawsuits and MP3.coms
business in general. We cannot guarantee that we will be able to

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enter into any additional settlement agreements on terms favorable to MP3.com,
if at all, or that any settlement or license agreement will prove beneficial to
our business or stockholders. During the year ended December 31, 2000, we
recorded a charge for litigation and copyright matters of $170.0 million. The
charge for litigation and copyright matters represented our estimate of the
total costs to be incurred only in connection with the resolution of the
various litigation and copyright matters associated with the My.MP3 service,
including the lawsuits filed by major recording companies and other parties.
Copyright issues associated with the My.MP3 service also include but are not
limited to publishing rights, non-major label content, and legal and advisory
fees. This charge did not reflect or include any amounts paid or payable in
connection with forward-looking licenses to use music recordings or
compositions in connection with the My.MP3 service. This charge reflects managements expectations
as of the date of this annual report, and is based on currently available
information as well as significant assumptions made by management regarding the
various litigation and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the cumulative amount
reserved as a result of this charge to $42.9 million as of December 31, 2000.
We cannot guarantee that future events or results will conform to our
expectations or assumptions regarding the various litigation and copyright
matters. If these expectations and significant assumptions prove to be
erroneous in light of future events, the actual amounts incurred by MP3.com to
resolve all copyright matters related to the My.MP3 service could be materially
different than those recorded as of December 31, 2000, and could far exceed the
resources and market capitalization of our company.

Class Action Lawsuits.We and certain of our employees, officers and directors
have been named as defendants in several lawsuits alleging violations of the
federal securities laws. The complaints, which were filed between September 19,
2000 and November 15, 2000 in the United States District Court for the Southern
District of California, each purport to be brought on behalf of a class of
stockholders. The complaints allege that we and the other the defendants
violated the federal securities laws by issuing materially false and misleading
statements and failing to disclose material information regarding our My.MP3
service and the litigation surrounding the service. The court has entered an
order appointing lead counsel and identifying the representative plaintiffs.
The complaint does not specify the dollar amount of damages alleged. A
stipulated order has been entered providing the plaintiffs until March 2001 to
file a consolidated first amended complaint, after which MP3.com and the other
defendants will have 60 days to respond. We have not recorded any charge related
to these claims as of December 31, 2000.

Derivative Lawsuits.Between September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits against MP3.com and
certain of its employees, officers and directors in the Superior Court of the
State of California, County of San Diego. These complaints allege various
statutory and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud, gross
mismanagement, unjust enrichment and waste of corporate assets. Pursuant to a
stipulated order, plaintiffs filed a First Amended Consolidated Shareholder
Derivative Complaint on January 16, 2001. MP3.com and the other defendants
initial response to the consolidated complaint is due in March 2001.

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

In particular, the music industry in the United States is generally regarded as
extremely litigious in nature compared to other industries. As a result, in the future
we may be engaged in litigation with others in the music industry, including those
entities with whom we have ongoing license arrangements. For example, some of the major
recording companies that settled their portion of the Major Label Lawsuit with us
have asserted in writing that they believe the amount paid by MP3.com to UMG in
satisfaction of the Court's judgment, together with the concurrent issuance of warrants to UMG,
triggered additional payments to them under the most favored nations clause in their
settlement agreement with MP3.com. Although we do not believe they are entitled to any such
additional payments, we cannot assure you that we will be successful in ultimately concluding
this particular matter in an amicable fashion, or defending any resulting lawsuit.
As a result, we may be forced to defend one or more lawsuits on this and other issues
in the future, and in fact may be involved in a number of litigation proceedings with the
same group of related plaintiffs. We have not recorded any charge
related to any claims
for additional most favored nations payments as of December 31, 2000.

We cannot assure you that we will be successful in ultimately defending any of
these lawsuits, and we may be required to pay license fees or substantial
damages, including statutory, punitive or other damages that far exceed the
resources and overall market capitalization of MP3.com, in which event we might
have to significantly limit or terminate our business operations, particularly
because our business is not yet profitable. At the rate of $25,000
per work (which is the per CD amount of statutory damages awarded
by the court in the Major Label Lawsuit),
our aggregate potential liability resulting from all of our copyright
litigation proceedings could exceed one billion dollars. If successful, any one
of these lawsuits could seriously harm our business by forcing us to cease
providing services to our consumers or requiring us to pay monetary damages.
Even if unsuccessful, these lawsuits still can harm our business severely by
damaging our reputation, requiring us to incur legal costs, lowering our stock
price and public demand for our stock, and diverting managements attention
away from our primary business activities in general.

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Costs Related to Acquisition Activities

Acquisition related costs for 2000 were $1,704,000 compared to zero for the
same period one year ago. The increase in these costs was a result of certain
costs charged to expense associated with the acquisition of TransComputing
International Corporation (d.b.a. seeUthere.com), which was not completed.

Amortization of Deferred Compensation and Stock-Based Compensation

During the year ended December 31, 2000, total deferred compensation of
$8,975,000 was amortized to expense compared to $20,029,000 during the same
period one year ago. Deferred compensation is being amortized over the vesting
period of the relevant granted stock options, which is generally four years.
The decrease in the amortization is primarily a result of the accelerated
amortization method (as provided for in FASB Interpretation No. 28) to amortize
deferred compensation, which resulted in a greater amount of amortization
expense in the earlier years of the amortization period. During 2000, pursuant
to Accounting Principles Board Bulletin No. 25 (Interpretation No. 1), we
recognized stock-based compensation of approximately $3,031,000 related to
fully vested options to purchase an aggregate of 2,500,000 shares granted at a
discount from the fair market value on the grant date to certain executives by
our CEO on MP3.com shares he directly owns. This is an increase from
approximately $2,259,000 of stock bonus awards and other stock-based
compensation during the year ended December 31, 1999.

Interest Income, Net

Interest income (net of interest expense) during the year ended December 31,
2000 was $17,412,000 compared to $10,852,000 during the same period one year
ago. Interest income during 2000 is directly related to interest earned on
cash, cash equivalent balances and marketable securities associated with
proceeds of an aggregate of approximately $426,300,000 during 1999 from (i) the
issuance of common stock in connection with our initial public offering in July
1999, (ii) the exercise of stock options and a warrant for the purchase of
common stock, and (iii) the issuance of Series A, B, and C convertible
preferred stock.

Impairment of Strategic Investments and Loss on Sale of Short-Term Investments
Available for Sale

During the year ended December 31, 2000, we recorded a charge of $48,010,000
for the estimated impairment of our strategic investment portfolio and
short-term investments. The impairment is associated with a decrease in fair
value of certain strategic investments and an investment classified as
short-term investments, where the decrease in the fair market value of the
stock is considered other than temporary.

During the year ended December 31, 2000, we sold all of our common stock
holdings in Cinram for proceeds, net of brokerage commissions and exchange rate
translation, of approximately $2,921,000, resulting in a loss of approximately
$2,726,000.

Provision for Income Taxes

Due to the loss from operations for both book and tax purposes, no provision or
benefit for income taxes was recorded for both 2000 and 1999. Currently, we
provide a valuation allowance for all future tax benefits as utilization of the
future tax benefits are not known.

Minority Interest in Losses of an Unconsolidated Subsidiary

Minority interest in the losses of an unconsolidated subsidiary during the year
ended December 31, 2000 was $1,668,000 compared to $1,105,000 for the same
period a year ago. The increase in minority interest in the loss of an
unconsolidated subsidiary is directly related to mp3radio.com, our former joint
venture with Cox Interactive Media, Inc., and reflects expenses incurred to
grow the mp3radio.com business and to transition the business to San Diego,
California.

In April 2000, MP3.com agreed to purchase the remaining 53.5% ownership of
mp3radio.com, a joint venture with Cox Interactive Media, Inc., and paid
approximately $4,000,000 in cash. During the transition period ending June 30,
2000, the costs of relocating the joint ventures operations to San Diego were
shared pro rata based upon the

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parties existing ownership percentages and included in minority interest in
losses of an unconsolidated subsidiary. The acquisition was completed during
the third quarter of 2000 and was accounted for under the purchase method of
accounting. The excess purchase price over fair value of net assets acquired of
$4,000,000 was generally allocated to assembled work force; URLs, trademarks
and names; a radio station agreement; and goodwill. These intangibles are
amortized over twelve to twenty-four months using the straight-line method.
The amortization of goodwill is included in general and administrative expense.

The Year Ended December 31, 1999 Compared to the Period from March 17, 1998
(inception) to December 31, 1998:

Results of Operations

The following table sets forth certain financial data for the periods indicated
as a percentage of total net revenues:

|                                                       |                                                             |  |              |       |                |  |             |      |  
|------------------------------------------------------ | ----------------------------------------------------------- |  | ------------ | ----- | -------------- |  | ----------- | ---- | -
|                                                       |                                                             |  |              |       |                |  | Period from
|                                                       |                                                             |  |              |       |                |  | March 17,  
|                                                       |                                                             |  |              |       |                |  | 1998       
|                                                       |                                                             |  | Year Ended   |       | (inception) to
|                                                       |                                                             |  | December 31, |       | December 31,  
|                                                       |                                                             |  | 1999         |       | 1998          
|                                                       |                                                             |  |              |       |               
|Net revenues:                                         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Online advertising                                          |  |              | 53.0  | %              |  |             | 91.2 | %
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Offline advertising                                         |  |              | 40.5  |                |  |             |     |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Electronic commerce                                         |  |              | 6.5   |                |  |             | 8.8  |  
|                                                       |                                                             |  |              |       |                |  |             |     
|Total net revenues                                     |                                                             |  | 100.0        |       |                |  | 100.0       |     
|                                                      
|                                                      
|                                                      
|                                                      
|Cost of revenues                                       |                                                             |  | 42.1         |       |                |  | 18.5        |     
|                                                       |                                                             |  |              |       |                |  |             |     
|Gross profit                                           |                                                             |  | 57.9         |       |                |  | 81.5        |     
|                                                      
|                                                      
|                                                      
|                                                      
|Operating expenses:                                   
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Sales and marketing                                         |  |              | 109.6 |                |  |             | 6.8  |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Engineering and Product development                         |  |              | 43.0  |                |  |             | 34.0 |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | General and administrative                                  |  |              | 42.5  |                |  |             | 12.3 |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Amortization of deferred and other stock based
compensation |  |              | 101.8 |                |  |             | 47.3 |  
|                                                       |                                                             |  |              |       |                |  |             |     
|Total operating expenses                               |                                                             |  | 296.9        |       |                |  | 100.4       |     
|                                                       |                                                             |  |              |       |                |  |             |     
|Loss from operations                                   |                                                             |  | (239.0       | )     |                |  | (18.9       | )   
|                                                      
|                                                      
|                                                      
|                                                      
|Interest income (expense), net                         |                                                             |  | 49.6         |       |                |  | (0.3        | )   
|                                                       |                                                             |  |              |       |                |  |             |     
|Loss before minority interest and income taxes         |                                                             |  | (189.4       | )     |                |  | (19.2       | )   
|                                                      
|                                                      
|                                                      
|                                                      
|Provision (benefit) for income taxes                   |                                                             |  | (0.4         | )     |                |  | 11.6        |     
|                                                      
|                                                      
|                                                      
|                                                      
|Minority interest in loss of unconsolidated subsidiary |                                                             |  | (5.0         | )     |                |  |            |     
|                                                       |                                                             |  |              |       |                |  |             |     
|Net loss                                               |                                                             |  | (194.0       | )%    |                |  | (30.8       | )%  
|                                                       |                                                             |  |              |       |                |  |             |     

Net Revenues

For the year ended December 31, 1999, net revenues were $21,899,000, derived
from online advertisements on our web site, offline advertisements through
various promotions and events that were not hosted on our web site and the
online sale of CDs and music-related merchandise. This compares to $1,162,000
during the period from March 17, 1998 (inception) to December 31, 1998. The
increase in net revenues during the year ended December 31, 1999 over the
period from March 17, 1998 (inception) to December 31, 1998 was mostly
attributable to a significant increase in online advertisements, the
introduction of various offline advertisements and events and a significant
increase in CD sales on our web site.

Revenue from Online Advertising.For the year ended December 31, 1999, revenues
from online advertising were $11,616,000 or 53.0% of total net revenues
compared to $1,061,000 or 91.2% of total net revenues for the period from March
17, 1998 (inception) to December 31, 1998. Online advertising revenues
primarily consist of banner, button, portal and sponsorship advertisements on
MP3.coms web site in addition to advertisements placed in e-mail and greeting
card campaigns. The duration of MP3.coms online advertising commitments range
from one month to approximately three years. The increase in revenue from
online advertising for the year ended December 31, 1999 as compared to the
period from March 17, 1998 (inception) to December 31, 1998 was primarily due
to both a significant increase in page view volume resulting from a significant
increase in unique visitors, and a significant increase in MP3.coms advertiser
customer base resulting from increased awareness regarding MP3.com and the mp3
technology, development and expansion of music and other content on MP3.coms
web site, and the introduction of new product lines such as e-mail and greeting
cards.

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Revenue from Offline Advertising.For the year ended December 31, 1999,
revenues from offline advertising were $8,877,000 or 40.5% of total net
revenues compared to zero for the period from March 17, 1998 (inception) to
December 31, 1998. During the year ended December 31, 1999, offline advertising
revenues primarily consisted of advertising sponsorships of free CD products,
the M&T Tour, contests and special events. The M&T Tour united two
internationally known artists with a variety of MP3.com artists to perform at
28 college campuses across the nation. MP3.com recognized revenue from this
event in the form of tour sponsorships and ticket sales. MP3.com also held
contests during the year that were sponsored by various advertisers and
provided prizes to the winners of each contest. Special events consist of
functions such as the MP3 Summit, which is a two-day event consisting of
presentations, panel discussions and sponsors showcasing a variety of
technology products and services at the forefront of digital music. Revenues
from this event were recognized in the form of event sponsorships and attendee
registration fees. The increase in revenue from offline advertising is due to
the introduction of all offline products and events during the year ended
December 31, 1999.

Revenue from Online Sales of CDs and Other Music-Related Merchandise.For the
year ended December 31, 1999, revenues from online sales of CDs and other
music-related merchandise was $1,406,000 or 6.5% of total net revenues compared
to $101,000 or 8.8% of total net revenues for the period from March 17, 1998
(inception) to December 31, 1998. Online e-commerce sales consist of DAM and
compilation CDs and, to a lesser extent, other music-related merchandise. Since
these products were released during September 1998, there was minimal revenue
from online sales of CDs and music-related merchandise during the period from
March 17, 1998 (inception) to December 31, 1998. The increase in revenues from
online sales of CDs and other music-related merchandise during the year ended
December 31, 1999 as compared to the period from March 17, 1998 (inception) to
December 31, 1999 was primarily due to an increase in the sales volume of DAM
CDs (approximately 139,000 units) resulting from increased musical content
available on MP3.coms web site as a result of increased brand awareness, an
increase in the average selling price of CDs and, to a lesser extent, the
introduction of other music-related merchandise such as clothing and books.

Revenue Concentration; Revenues from MPG.For the year ended December 31, 1999
and for the period from March 17, 1998 to December 31,
1998, 93.5% and 91.2%,
respectively, of MP3.coms revenues were from the sale of both online and
offline advertising related products. Additionally, during the years ended
December 31, 1999, MP3.com recognized approximately $4,655,000 or 21.3% of
total net revenues from MPG. We expect that most of our revenues will continue
to be derived from third party advertising agreements like those we have with
MPG and other strategic partners. During the period from March 17, 1998
through December 31, 1998, three customers accounted for 19.0%, 12.2%, and
10.3% of total net revenues. MPG originally committed to purchase an aggregate
of $150.0 million in advertising, promotion and marketing services from MP3.com
over a three-year period beginning October 1999, including $5.0 million in
1999, $40.0 million in 2000, $70.0 million in 2001 and $35.0 million in the
first half of 2002. Under this agreement, MP3.com received pre-payments of
$45.0 million in July 1999 representing advertising, promotional and marketing
services to be delivered by MP3.com in the form of online and offline
advertisements from October 1, 1999 through December 31, 2000.

Cost of Revenues

Cost of revenues for the year ended December 31, 1999 were $9,211,000 or 42.1%
of total net revenues compared to $215,000 or 18.5% of total net revenues
during the period from March 17, 1998 (inception) to December 31, 1998,
resulting in gross margins of 57.9% and 81.5%, respectively. The increase in
cost of revenues and resulting decrease in gross margin, as a percentage of net
revenue, was primarily due to increases in CD and CD fulfillment costs of
$740,000 associated with increased CD volume, bandwidth requirements of
$626,000, royalties to artists of 494,000, and costs associated with newly
introduced products such as free CD production costs of $2,051,000, costs
incurred in conjunction with the M&T Tour of $3,443,000 and contest costs of
$1,075,000. CD and other music related merchandise sales typically have
unfavorable gross margins which offset the higher gross margins from online and
offline advertising products. Since the M&T Tour was a development stage
product, direct costs associated with it were substantially in excess of the
revenues earned. MP3.com discontinued the M&T Tour in 2000.

Sales and Marketing

During the year ended December 31, 1999, sales and marketing expense was
$23,998,000 or 109.6% of total net revenues compared to $79,000 or 6.8% of
total net revenues during the period from March 17, 1998 (inception) to
December 31, 1999. The increase in sales and marketing expense, both in
absolute dollar amounts and as a

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percentage of net revenue, was primarily due to new marketing programs of
$3,155,000, substantial increases in sales and marketing payroll and related
expenses of $6,542,000, cash and stock-based compensation associated with
accelerated stock option vesting of $1,889,000, marketing and promotion costs
associated with the Alanis Morissette and Tori Amos 5 1/2 Weeks Summer 1999
tour sponsorship of $3,424,000, marketing and promotion costs associated with
the M&T Tour of $3,538,000, amortization of prepaid marketing expenses in
connection with our arrangements with internationally known artists of
$1,274,000, stock-based contribution to the MP3 Foundation of $767,000, Payback
for Playback costs of $405,000, and other general costs associated with the
growth of our business. MP3.com anticipates that overall sales and marketing
expense, in absolute dollar terms, will increase significantly in the
foreseeable future; however, sales and marketing expense as a percentage of net
revenues may fluctuate depending on the level of future total net revenues, the
timing of new marketing programs and the addition of sales and marketing
personnel.

Engineering and Product Development

During the year ended December 31, 1999, product development expense was
$9,417,000 or 43.0% of total net revenues compared to $395,000 or 34.0% of
total net revenues during the period from March 17, 1998 (inception) to
December 31, 1998. The increase in the level of product development expense,
both in absolute dollar amounts and as a percentage of net revenue, was
primarily due to increased payroll and related expenses associated with
increased headcount of $4,254,000, recruiting and relocation costs of
$311,000,
stock-based compensation associated with accelerated stock option vesting of
$2,592,000, expensed computer supplies of $399,000, increased computer
equipment depreciation of $763,000, and other general costs associated with the
growth of MP3.coms business.

General and Administrative

General and administrative expense was $9,307,000 or 42.5% of total net
revenues during the year ended December 31, 1999 compared to $142,000 or 12.3%
of total net revenues during the period from March 17, 1998 (inception) to
December 31, 1998. The increase in general and administrative expense, both in
absolute dollar amounts and as a percentage of net revenue, was primarily a
result of increased finance and administrative payroll and related expenses of
$2,537,000, increased legal, accounting, consulting and investor relations
expenses of $1,821,000, increased facility related cost of $455,000, the
one-time non-cash charge associated with the relocation to MP3.coms new
facility of $815,000, insurance costs of $437,000, bad debt of $621,000, office
related costs of $524,000 and other general costs associated with the growth of
our business.

Amortization of Deferred Compensation and Other Stock-Based Compensation

During the year ended December 31, 1999, we recorded aggregate deferred
compensation of $37,999,000, net, for the grant of stock options, which were
granted at exercise prices less than the fair value on the grant date. Deferred
compensation is being amortized over the vesting period of the granted stock
options, which is generally four years. Of total deferred compensation,
$20,029,000 was amortized to expense during the year ended December 31, 1999
compared to $550,000 during the period from March 17, 1998 (inception) to
December 31, 1998. Additionally, we recorded $2,259,000 of other stock based
compensation expense during the year ended December 31, 1999, primarily related
to stock bonus awards and other stock based compensation. The increase in
deferred compensation and other stock based compensation expense is primarily
related to the increase in the granting of stock options to newly hired
executive management and employees, the issuance of stock bonus awards and
other director compensation.

Interest Income (Expense), Net

Interest income (net of interest expense) during the year ended December 31,
1999 was $10,852,000 compared to interest expense of $4,000 during the period
from March 17, 1998 (inception) to December 31, 1998. The interest income
during the year ended December 31, 1999 is directly related to interest income
earned on cash and cash equivalent balances and short term investments
associated with proceeds from the issuance of common stock in connection with
our initial public offering in July 1999, the exercise of stock options and a
warrant for the purchase of common stock, and the issuance of Series A, B, and
C convertible preferred stock for an aggregate of approximately $426.3 million
during 1999. Interest expense during the period from March 17, 1998 (inception)
to December 31, 1998 is due to interest incurred on a capital lease.

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Provision for Income Taxes

During the year ended December 31, 1999, MP3.com recorded an income tax benefit
of $93,000. The income tax benefit is a result of net operating losses incurred
during 1999 for which a portion will be carried back to 1998 to obtain an
income tax refund. Due to the loss from operations for both book and tax
purposes, no provision or benefit for income taxes was recorded for both 2000
and 1999. Currently, we provide a valuation allowance for all future tax
benefits. For the period from March 17, 1998 (inception) to December 31, 1998,
we recorded a provision for income taxes of $134,000 as a result of the
amortization of deferred compensation, which is not deductible for income tax
purposes.

Minority Interest in Loss of an Unconsolidated Subsidiary

Minority interest in the loss of a subsidiary during the year ended December
31, 1999 was $1,105,000 compared to zero for the period from March 17, 1998
(inception) to December 31, 1998. The increase in minority interest in the loss
of an unconsolidated subsidiary is directly related to the establishment of
mp3radio.com, a joint venture with Cox Interactive Media, Inc., and reflects
expenses incurred to grow the mp3radio.com business.

Liquidity and Capital Resources

Overview

To date, MP3.coms operations have been financed from internally generated
cash, proceeds from the sale of convertible preferred stock, the proceeds from
our initial public offering and, to a lesser extent, the exercise of stock
options and equipment financing through a line of credit. As of December 31,
2000, MP3.com had approximately $98.8 million in cash and cash equivalents and
short-term investment grade marketable securities.

Operating Activities

Net cash used in operating activities during the year ended December 31, 2000
was approximately $199,068,000, consisting primarily of the following:



| |  |  | net loss of approximately $279,493,000;                                                                                    
| | - |  | ---------------------------------------------------------------------------------------------------------------------------
|
| |  |  | amortization of deferred compensation and other stock based compensation of approximately
$12,006,000;                     
|
| |  |  | depreciation, amortization of goodwill and
amortization of prepaid multimedia royalty licenses of approximately $8,691,000;
|
|
| |  |  | charges and amortization of stock based
marketing costs of approximately $21,420,000;                                      
|
|
| |  |  | stock based charges associated with acceleration of stock option vesting of approximately $6,471,000;                      
|
| |  |  | impairment of strategic investments and loss on sale of short-term investments of approximately $50,736,000;               
|
| |  |  | charge for litigation and copyright matters of approximately $170,000,000;                                                 
|
| |  |  | an increase in restricted cash of approximately $30,000,000;                                                               
|
| |  |  | a decrease in accounts and unbilled receivables of approximately $1,720,000;                                               
|
| |  |  | an increase in prepaid expenses and other current assets of approximately $3,896,000;                                      
|
| |  |  | an increase in accounts payable and accrued expenses of approximately $10,544,000; and                                     
|
|
| |  |  | a decrease in the reserve for litigation and copyright matters of approximately $126,229,000; and                          
|
|
| |  |  | a decrease in deferred revenue of approximately $41,256,000.                                                               

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Investing Activities

Net cash provided by investing activities during the year ended December 31,
2000 was approximately $91,574,000, consisting primarily of property and
equipment expenditures of $12,912,000, net proceeds from short-term investment
grade marketable securities of $205,050,000, purchases of prepaid multimedia
royalty licenses of $51,000,000, the issuance of a note receivable of
$4,000,000, the acquisition of mp3radio.com for $3,816,000 net of cash
acquired, and purchases of strategic equity investments of approximately
$39,738,000.

Financing Activities

Net cash used in financing activities during the year ended December 31, 2000
was approximately $1,829,000, consisting primarily of repurchases of unvested
common stock of $2,400,000 and payments on the line of credit of $1,234,000
offset by proceeds from the issuance of common stock in connection with the
exercise of stock options of $1,805,000.

Financial Commitments

We have no material financial commitments other than obligations under our
operating leases. For 2001, we expect to substantially increase expenditures
for applications including:



| |  |  | computer equipment and furniture and fixtures associated with new employees;
| | - |  | ----------------------------------------------------------------------------
|
| |  |  | web site computer equipment;                                                
|
| |  |  | bandwidth and networking equipment and infrastructure;                      
|
| |  |  | additional sales and marketing employees;                                   
|
| |  |  | equipment and additional employees related to product development;          
|
| |  |  | development and acquisition of content.                                     

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

Future Capital Requirements

We believe that our cash, cash equivalent balances and short-term investments
in marketable securities will be sufficient to satisfy our cash requirements
for at least the next 12 months, after taking into consideration the payment of
our reserves for litigation and copyright matters accrued as of December 31,
2000. We intend to invest our cash in excess of current operating requirements
in short-term, interest-bearing, investment-grade securities.

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

We may need to raise additional capital if our business expands more rapidly
than initially planned, satisfy any damage awards or unanticipated settlement
costs related to our current or potential future litigation proceedings,
finance unanticipated working capital requirements, obtain additional licenses
in order to provide certain music services and/or specific content to
consumers, develop or enhance existing services or products, fund distribution

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relationships, respond to competitive pressures, acquire complementary
businesses, technologies, content or products. If additional funds are raised
through the sale of equity or convertible debt securities, the percentage
ownership of our stockholders will be reduced, our stockholders may experience
additional dilution and these securities may have rights, preferences or
privileges senior to those of our stockholders. There can be no assurance that
additional financing will be available at all or on terms favorable to us. If
adequate funds are not available or are not available on acceptable terms, our
ability to fund our expansion, take advantage of unanticipated opportunities,
develop or enhance products or services or otherwise respond to competitive
pressures could be significantly limited. Our business may be harmed by these
limitations.







Item 7A.Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

The primary objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly increasing risk.
To achieve this objective, we maintain a portfolio of cash equivalents and
short-term investments in a variety of securities, including U.S. government
and agencies, corporate debt securities, commercial paper, and money market
funds. As of December 31, 2000, 100% of our total portfolio matures in one year
or less. See Note 1 and 3 of Notes to Consolidated Financial Statements.

Under our current policies, we do not use interest rate derivative instruments
to manage exposure to interest rate changes. A hypothetical 100 basis point
adverse move in interest rates along the entire interest rate yield curve would
not materially affect the fair value of interest sensitive financial
instruments at December 31, 2000. The following table presents the fair value
balances of our cash equivalents and short-term investments that are subject to
interest rate risk by year of expected maturity and average interest rates as
of December 31, 2000 (dollars in thousands):

|                                                     |                        |   |                   |      |  
|---------------------------------------------------- | ---------------------- | - | ----------------- | ---- | -
|                                                     |                        |   | Year of          
|                                                     |                        |   | Expected Maturity
|                                                     |                        |   |                  
|                                                     |                        |   | 2001              |     
|                                                     |                        |   |                   |     
|Cash equivalents                                     |                        | $ | 83,858            |     
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Average interest rates |   |                   | 6.54 | %
|                                                    
|                                                    
|                                                    
|                                                    
|Short term investments, excluding equity investments |                        | $ | 14,988            |     
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Average interest rates |   |                   | 6.61 | %

Strategic Portfolio Liquidity Risk

We have made strategic investments in certain privately-held companies. Since these companies are not publicly traded, the ability for us to liquidate or sell all or part of our ownership interest in one or all of these companies may be very difficult.
In the event we are able to sell all or a portion of our ownership interest, we may need to do so at a substantial discount from our cost or recorded basis. Additionally, the ability of these companies to obtain additional capital, if necessary,
 to continue to operate may be very difficult. If one or all of these companies are unable to obtain necessary capital to continue their operations, they may file for bankruptcy or be forced into bankruptcy by their creditors. This could further impair
our ability to sell or liquidate our ownership interest, which could result in a significant charge to income for impairment of these strategic investments.

Foreign Currency Risk

Currently, nearly all of MP3.com, Inc.s revenues and expenses are denominated
in U.S. dollars and as a result we have experienced no significant foreign
exchange gains and losses.

63



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##### Table of Contents









Item 8.Consolidated Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

CONTENTS

|                                                                                                                                                                                    |  |  |      |  | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | ---- |  | 
|                                                                                                                                                                                    |  |  | Page
|                                                                                                                                                                                    |  |  |     
|Report of Ernst & Young LLP, Independent Auditors                                                                                                                                   |  |  | 65   | 
|Consolidated Financial Statements                                                                                                                                                  
|                                                                                                                                                                                   
|                                                                                                                                                                                   
|                                                                                                                                                                                   
|                                                                                                                                                                                   
|Consolidated Balance Sheets as of December 31, 2000 and 1999                                                                                                                        |  |  | 66   | 
|Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and the period
                    from March 17, 1998 (inception) to December 31, 1998           |  |  | 67   | 
|Consolidated Statements of Stockholders Equity for the years ended December 31, 2000, 1999 and
                    the period from March 17, 1998 (inception) to December 31, 1998 |  |  | 68   | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and the
                    period from March 17, 1998 (inception) to December 31, 1998           |  |  | 70   | 
|Notes to Consolidated Financial Statements                                                                                                                                          |  |  | 71   | 

64



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##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders of
MP3.com, Inc.

We have audited the accompanying consolidated balance sheets of MP3.com, Inc.
as of December 31, 2000 and 1999, and the related consolidated statements of
operations, stockholders equity and cash flows for the years ended December
31, 2000 and 1999, and for the period from March 17, 1998 (inception) to
December 31, 1998. Our audit also included the consolidated financial statement
schedule listed in the index at Item 14(a). These financial statements and schedule are the
responsibility of MP3.coms management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the 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. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of MP3.com, Inc. at
December 31, 2000 and 1999, and the consolidated results of its operations and
its cash flows for the years ended December 31, 2000 and 1999 and for the
period from March 17, 1998 (inception) to December 31, 1998, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related consolidated financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.



| | ERNST & YOUNG LLP
| | -----------------

San Diego, California
January 24, 2001

65



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##### Table of Contents



MP3.com, Inc.

CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)

ASSETS

|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |         |  
|---------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ------------ | -------- | ---- | - | ------- | ------- | -
|                                                           |                                                                                                                                                                                              |   | December 31,
|                                                           |                                                                                                                                                                                              |   |             
|                                                           |                                                                                                                                                                                              |   | 2000         |          | 1999
|                                                           |                                                                                                                                                                                              |   |              |          |     
|Current assets:                                           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Cash and cash equivalents                                                                                                                                                                    |   | $            | 83,858   |      |   | $       | 193,192 |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Short-term investments in marketable securities                                                                                                                                              |   |              | 14,988   |      |   |         | 234,789 |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Accounts receivable, net of allowance for doubtful
accounts of $1,810 and $600 in 2000 and 1999, respectively                                                                                |   |              | 4,409    |      |   |         | 6,871   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Restricted cash                                                                                                                                                                              |   |              | 30,000   |      |   |         |        |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Unbilled receivables                                                                                                                                                                         |   |              | 2,021    |      |   |         | 1,279   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Prepaid expenses and other current assets                                                                                                                                                    |   |              | 11,074   |      |   |         | 6,334   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Prepaid multimedia content royalties                                                                                                                                                         |   |              | 8,755    |      |   |         |        |  
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        
|                                                           | Total current assets                                                                                                                                                                         |   |              | 155,105  |      |   |         | 442,465 |  
|                                                          
|                                                          
|                                                          
|                                                          
|Property and equipment, net of accumulated depreciation    |                                                                                                                                                                                              |   | 20,270       |          |      |   | 13,849  |        
|                                                          
|                                                          
|                                                          
|                                                          
|Prepaid marketing and promotions expense                   |                                                                                                                                                                                              |   | 3,579        |          |      |   | 2,162   |        
|                                                          
|                                                          
|                                                          
|                                                          
|Prepaid multimedia content
royalties, less current portion |                                                                                                                                                                                              |   | 41,633       |          |      |   |        |        
|                                                          
|                                                          
|                                                          
|                                                          
|Strategic investments                                      |                                                                                                                                                                                              |   | 11,410       |          |      |   | 11,983  |        
|                                                          
|                                                          
|                                                          
|                                                          
|Other non-current assets                                   |                                                                                                                                                                                              |   | 6,602        |          |      |   | 1,423   |        
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        
|                                                           | Total assets                                                                                                                                                                                 |   | $            | 238,599  |      |   | $       | 471,882 |  
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        
|LIABILITIES AND STOCKHOLDERS' EQUITY                      
|Current liabilities:                                      
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Accounts payable                                                                                                                                                                             |   | $            | 4,767    |      |   | $       | 5,659   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Line of credit                                                                                                                                                                               |   |              |         |      |   |         | 1,234   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Accrued expenses                                                                                                                                                                             |   |              | 15,690   |      |   |         | 5,019   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Deferred revenues                                                                                                                                                                            |   |              | 1,104    |      |   |         | 42,361  |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Reserve for litigation and copyright matters                                                                                                                                                 |   |              | 42,933   |      |   |         |        |  
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        
|                                                           | Total current liabilities                                                                                                                                                                    |   |              | 64,494   |      |   |         | 54,273  |  
|                                                          
|                                                          
|                                                          
|                                                          
|Other liabilities                                          |                                                                                                                                                                                              |   | 389          |          |      |   | 59      |        
|                                                          
|                                                          
|                                                          
|                                                          
|Commitments and contingencies (Notes 6 and 9)             
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Stockholders equity:                                                                                                                                                                       
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Preferred stock, par value $0.001 per share; 15,000,000
authorized at December 31, 2000 and 1999, none
issued and outstanding at December 31, 2000 and 1999                                  |   |              |         |      |   |         |        |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Common stock, par value $0.001 per share; authorized
300,000,000 at December 31, 2000 and 1999; 68,529,044
and 68,620,913 issued and outstanding at December 31, 2000
and 1999, respectively |   |              | 69       |      |   |         | 69      |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Additional paid in capital                                                                                                                                                                   |   |              | 501,194  |      |   |         | 477,272 |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Notes receivable from stockholder                                                                                                                                                            |   |              | (258     | )    |   |         | (258    | )
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Deferred compensation                                                                                                                                                                        |   |              | (4,945   | )    |   |         | (18,148 | )
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Accumulated other comprehensive (loss) income                                                                                                                                                |   |              | (12      | )    |   |         | 1,454   |  
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Accumulated deficit                                                                                                                                                                          |   |              | (322,332 | )    |   |         | (42,839 | )
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        
|                                                           | Total stockholders equity                                                                                                                                                                   |   |              | 173,716  |      |   |         | 417,550 |  
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        
|Total liabilities and stockholders equity                 |                                                                                                                                                                                              | $ | 238,599      |          |      | $ | 471,882 |        
|                                                           |                                                                                                                                                                                              |   |              |          |      |   |         |        

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

66



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MP3.com, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)

|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |        |  
|----------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------- | - | ----------------------- | ------- | ------------ | - | ------- | ------ | - | - | -------------- | ------ | -
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   | Period from   
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   | March 17,     
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   | 1998          
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   | (inception) to
|                                                                                                      |                                                                                                                                           |   | Year Ended December 31, |         | December 31,
|                                                                                                      |                                                                                                                                           |   |                         |         |             
|                                                                                                      |                                                                                                                                           |   | 2000                    |         | 1999         |   | 1998   
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |        
|Net revenues                                                                                          |                                                                                                                                           | $ | 80,136                  |         |              | $ | 21,899  |        |   | $ | 1,162          |       
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Cost of revenues (excludes amortization of deferred
compensation of $128, $256, and $, respectively) |                                                                                                                                           |   | 15,760                  |         |              |   | 9,211   |        |   |   | 215            |       
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|Gross profit                                                                                          |                                                                                                                                           |   | 64,376                  |         |              |   | 12,688  |        |   |   | 947            |       
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Operating expenses:                                                                                  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Sales and marketing (excludes amortization of deferred
compensation of $1,884, $10,952, and $380, respectively)                           |   |                         | 71,217  |              |   |         | 23,998 |   |   |                | 79     |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Engineering and product development (excludes amortization of
deferred compensation of $2,379, $3,027, and $170, respectively)            |   |                         | 22,447  |              |   |         | 9,417  |   |   |                | 395    |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | General and administrative (excludes amortization of deferred
and other stock-based compensation of $7,615, $8,053, and $, respectively) |   |                         | 31,503  |              |   |         | 9,307  |   |   |                | 142    |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Charge for litigation and copyright matters                                                                                               |   |                         | 170,000 |              |   |         |       |   |   |                |       |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Costs related to acquisition activities                                                                                                   |   |                         | 1,704   |              |   |         |       |   |   |                |       |  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Amortization of deferred and other stock based compensation                                                                               |   |                         | 12,006  |              |   |         | 22,288 |   |   |                | 550    |  
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|                                                                                                      | Total operating expenses                                                                                                                  |   |                         | 308,877 |              |   |         | 65,010 |   |   |                | 1,166  |  
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|Loss from operations                                                                                  |                                                                                                                                           |   | (244,501                | )       |              |   | (52,322 | )      |   |   | (219           | )     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Interest income (expense), net                                                                        |                                                                                                                                           |   | 17,412                  |         |              |   | 10,852  |        |   |   | (4             | )     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Impairment of strategic investments and loss on sale of
short-term investments available for sale     |                                                                                                                                           |   | (50,736                 | )       |              |   |        |        |   |   |               |       
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|Loss before minority interest and income taxes                                                        |                                                                                                                                           |   | (277,825                | )       |              |   | (41,470 | )      |   |   | (223           | )     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Provision (benefit) for income taxes                                                                  |                                                                                                                                           |   |                        |         |              |   | (93     | )      |   |   | 134            |       
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|Minority interest in losses of an unconsolidated subsidiary                                           |                                                                                                                                           |   | (1,668                  | )       |              |   | (1,105  | )      |   |   |               |       
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|Net loss                                                                                              |                                                                                                                                           | $ | (279,493                | )       |              | $ | (42,482 | )      |   | $ | (357           | )     
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|Net loss per share:                                                                                  
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                     
|                                                                                                      | Basic and diluted                                                                                                                         |   | $                       | (4.18   | )            |   | $       | (0.78  | ) |   | $              | (0.01  | )
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       
|                                                                                                      | Weighted average shares basic and diluted                                                                                                |   |                         | 66,799  |              |   |         | 54,194 |   |   |                | 26,183 |  
|                                                                                                      |                                                                                                                                           |   |                         |         |              |   |         |        |   |   |                |       

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

67



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##### Table of Contents



MP3.com, Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(In Thousands, Except Per Share Amounts)

|                                                                                                           |                                              |  |         |           |  |           |     |        |  |        |        |         |  |   |    |   |  |   |         |            |  | 
|---------------------------------------------------------------------------------------------------------- | -------------------------------------------- |  | ------- | --------- |  | --------- | --- | ------ |  | ------ | ------ | ------- |  | - | -- | - |  | - | ------- | ---------- |  | 
|                                                                                                           |                                              |  |         |           |  |           |     |        |  |        |        |         |  |   |    |   |  |   |         | Additional
|                                                                                                           |                                              |  |         | Preferred |  | Preferred |     | Common |  | Common |        | Paid In
|                                                                                                           |                                              |  |         | Shares    |  | Stock     |     | Shares |  | Stock  |        | Capital
|                                                                                                           |                                              |  |         |           |  |           |     |        |  |        |        |        
|Issuance of common stock in exchange for certain assets and liabilities                                    |                                              |  |        |           |  | $         |    |        |  |        | 26,179 |         |  | $ | 26 |   |  | $ | (26     | )         
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of stock options                                                                                  |                                              |  |        |           |  |           |    |        |  |        | 3,071  |         |  |   | 3  |   |  |   | (1      | )         
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Deferred compensation related
to the grant of stock options for common stock                               |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   | 728     |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Amortization of deferred compensation                                                                      |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   |        |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Net loss and comprehensive loss                                                                            |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   |        |           
|                                                                                                           |                                              |  |         |           |  |           |     |        |  |        |        |         |  |   |    |   |  |   |         |           
|Balance at December 31, 1998                                                                               |                                              |  |        |           |  |           |    |        |  |        | 29,250 |         |  |   | 29 |   |  |   | 701     |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of stock options in
exchange for notes receivable from stockholders                               |                                              |  |        |           |  |           |    |        |  |        | 3,169  |         |  |   | 3  |   |  |   | 335     |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Cancellation of notes
receivable from stockholder                                                          |                                              |  |        |           |  |           |    |        |  |        | (724   | )       |  |   | (1 | ) |  |   | (77     | )         
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Repayment of note receivable from stockholder                                                              |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   |        |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of Series A, B
and C convertible preferred stock, net of issuance costs of $93                    |                                              |  | 12,872  |           |  |           | 13  |        |  |        |       |         |  |   |   |   |  |   | 60,977  |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of common stock in
conjunction with the initial public offering, net of issuance costs of $23,124 |                                              |  |        |           |  |           |    |        |  |        | 13,697 |         |  |   | 14 |   |  |   | 360,398 |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Conversion of convertible
preferred stock to common stock                                                  |                                              |  | (12,872 | )         |  |           | (13 | )      |  |        | 19,308 |         |  |   | 19 |   |  |   | (6      | )         
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of warrants in
connection with promotion agreement                                                |                                              |  |        |           |  |           |    |        |  |        | 659    |         |  |   | 1  |   |  |   | 2,410   |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of common stock in
connection with certain promotion agreements                                   |                                              |  |        |           |  |           |    |        |  |        | 112    |         |  |   | 1  |   |  |   | 2,610   |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of stock bonus awards                                                                             |                                              |  |        |           |  |           |    |        |  |        | 62     |         |  |   |   |   |  |   | 1,890   |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Contribution of common stock to MP3.com Foundation                                                         |                                              |  |        |           |  |           |    |        |  |        | 100    |         |  |   |   |   |  |   | 767     |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of common stock options                                                                           |                                              |  |        |           |  |           |    |        |  |        | 2,988  |         |  |   | 3  |   |  |   | 5,021   |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Stock based charges associated
with acceleration of stock option vesting                                   |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   | 4,247   |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Deferred compensation, net of forfeitures                                                                  |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   | 37,999  |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Amortization of deferred compensation                                                                      |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   |        |           
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Comprehensive loss:                                                                                       
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Net loss                                     |  |         |          |  |           |     |       |  |        |        |        |  |   |    |  |  |   |         |           | 
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Net unrealized gain on marketable securities |  |         |          |  |           |     |       |  |        |        |        |  |   |    |  |  |   |         |           | 
|                                                                                                           |                                              |  |         |           |  |           |     |        |  |        |        |         |  |   |    |   |  |   |         |           
|Total comprehensive loss                                                                                   |                                              |  |        |           |  |           |    |        |  |        |       |         |  |   |   |   |  |   |        |           
|                                                                                                           |                                              |  |         |           |  |           |     |        |  |        |        |         |  |   |    |   |  |   |         |           
|Balance at December 31, 1999                                                                               |                                              |  |        |           |  | $         |    |        |  |        | 68,621 |         |  | $ | 69 |   |  | $ | 477,272 |           

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                                                           |                                              |   |      |             |  |              |         |               |  |             |       |               |  |   |         |         |   |   |         |         |   | 
|---------------------------------------------------------------------------------------------------------- | -------------------------------------------- | - | ---- | ----------- |  | ------------ | ------- | ------------- |  | ----------- | ----- | ------------- |  | - | ------- | ------- | - | - | ------- | ------- | - | 
|                                                                                                           |                                              |   |      | Notes       |  |              |         |               |  | Accumulated
|                                                                                                           |                                              |   |      | Receivable  |  |              |         |               |  | Other       |       |               |  |   |         | Total  
|                                                                                                           |                                              |   |      | from        |  | Deferred     |         | Comprehensive |  | Accumulated |       | Stockholders
|                                                                                                           |                                              |   |      | Stockholder |  | Compensation |         | (Loss) Income |  | Deficit     |       | Equity       
|                                                                                                           |                                              |   |      |             |  |              |         |               |  |             |       |              
|Issuance of common stock in
exchange for certain assets and liabilities                                    |                                              | $ |     |             |  | $            |        |               |  | $           |      |               |  | $ |        |         |   | $ |        |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of stock options                                                                                  |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 2       |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Deferred compensation related
to the grant of stock options for common stock                               |                                              |   |     |             |  |              | (728    | )             |  |             |      |               |  |   |        |         |   |   |        |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Amortization of deferred compensation                                                                      |                                              |   |     |             |  |              | 550     |               |  |             |      |               |  |   |        |         |   |   | 550     |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Net loss and comprehensive loss                                                                            |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   | (357    | )       |   |   | (357    | )      
|                                                                                                           |                                              |   |      |             |  |              |         |               |  |             |       |               |  |   |         |         |   |   |         |        
|Balance at December 31, 1998                                                                               |                                              |   |     |             |  |              | (178    | )             |  |             |      |               |  |   | (357    | )       |   |   | 195     |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of stock options in
exchange for notes receivable from stockholders                               |                                              |   | (338 | )           |  |              |        |               |  |             |      |               |  |   |        |         |   |   |        |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Cancellation of notes
receivable from stockholder                                                          |                                              |   | 78   |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   |        |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Repayment of note receivable from stockholder                                                              |                                              |   | 2    |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 2       |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of Series A, B
and C convertible preferred stock, net of issuance costs of $93                    |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 60,990  |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of common stock in
conjunction with the initial public offering, net of issuance costs of $23,124 |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 360,412 |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Conversion of convertible
preferred stock to common stock                                                  |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   |        |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of warrants in
connection with promotion agreement                                                |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 2,411   |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of common stock in
connection with certain promotion agreements                                   |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 2,611   |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Issuance of stock bonus awards                                                                             |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 1,890   |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Contribution of common stock to MP3.com Foundation                                                         |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 767     |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Exercise of common stock options                                                                           |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 5,024   |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Stock based charges associated
with acceleration of stock option vesting                                   |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | 4,247   |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Deferred compensation, net of forfeitures                                                                  |                                              |   |     |             |  |              | (37,999 | )             |  |             |      |               |  |   |        |         |   |   |        |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Amortization of deferred compensation                                                                      |                                              |   |     |             |  |              | 20,029  |               |  |             |      |               |  |   |        |         |   |   | 20,029  |        
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|Comprehensive loss:                                                                                       
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Net loss                                     |   |      |            |  |              |         |              |  |             |       |              |  |   |         | (42,482 | ) |   |         | (42,482 | )
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                          
|                                                                                                           | Net unrealized gain on marketable securities |   |      |            |  |              |         |              |  |             |       | 1,454         |  |   |         |        |   |   |         | 1,454   |  
|                                                                                                           |                                              |   |      |             |  |              |         |               |  |             |       |               |  |   |         |         |   |   |         |        
|Total comprehensive loss                                                                                   |                                              |   |     |             |  |              |        |               |  |             |      |               |  |   |        |         |   |   | (41,028 | )      
|                                                                                                           |                                              |   |      |             |  |              |         |               |  |             |       |               |  |   |         |         |   |   |         |        
|Balance at December 31, 1999                                                                               |                                              | $ | (258 | )           |  | $            | (18,148 | )             |  | $           | 1,454 |               |  | $ | (42,839 | )       |   | $ | 417,550 |        

68



---



##### Table of Contents



MP3.com, Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(In Thousands, Except Per Share Amounts)

|                                                                         |                                                                                                 |  |   |   |           |   |           |   |        |  |        |   |         |   |    |   |  |   |         |       |            |  | 
|------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------- |  | - | - | --------- | - | --------- | - | ------ |  | ------ | - | ------- | - | -- | - |  | - | ------- | ----- | ---------- |  | 
|                                                                         |                                                                                                 |  |   |   |           |   |           |   |        |  |        |   |         |   |    |   |  |   |         |       | Additional
|                                                                         |                                                                                                 |  |   |   | Preferred |   | Preferred |   | Common |  | Common |   | Paid In
|                                                                         |                                                                                                 |  |   |   | Shares    |   | Stock     |   | Shares |  | Stock  |   | Capital
|                                                                         |                                                                                                 |  |   |   |           |   |           |   |        |  |        |   |        
|Balance at December 31, 1999                                             |                                                                                                 |  |  |   |           | $ |          |   |        |  | 68,621 |   |         | $ | 69 |   |  | $ | 477,272 |      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Exercise of common stock options and purchases through the ESPP          |                                                                                                 |  |  |   |           |   |          |   |        |  | 924    |   |         |   | 1  |   |  |   | 1,804   |      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Repurchase of common stock                                               |                                                                                                 |  |  |   |           |   |          |   |        |  | (1,016 | ) |         |   | (1 | ) |  |   | (2,399  | )    
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Fair value of stock options for common stock and warrants issued         |                                                                                                 |  |  |   |           |   |          |   |        |  |       |   |         |   |   |   |  |   | 19,243  |      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Stock based charges associated with acceleration of stock option vesting |                                                                                                 |  |  |   |           |   |          |   |        |  |       |   |         |   |   |   |  |   | 6,471   |      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Forfeiture of stock options                                              |                                                                                                 |  |  |   |           |   |          |   |        |  |       |   |         |   |   |   |  |   | (4,228  | )    
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Stock based compensation in connection with stock options granted to certain executive officers |  |   |  |           |   |           |  |        |  |        |  |         |   |    |  |  |   |         | 3,031 |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Amortization of deferred compensation                                    |                                                                                                 |  |  |   |           |   |          |   |        |  |       |   |         |   |   |   |  |   |        |      
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Comprehensive loss:                                                     
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net loss                                                                                        |  |   |  |           |   |           |  |        |  |        |  |         |   |    |  |  |   |         |      |           
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net unrealized loss on marketable securities                                                    |  |   |  |           |   |           |  |        |  |        |  |         |   |    |  |  |   |         |      |           
|                                                                         |                                                                                                 |  |   |   |           |   |           |   |        |  |        |   |         |   |    |   |  |   |         |      
|Total comprehensive loss                                                 |                                                                                                 |  |  |   |           |   |          |   |        |  |       |   |         |   |   |   |  |   |        |      
|                                                                         |                                                                                                 |  |   |   |           |   |           |   |        |  |        |   |         |   |    |   |  |   |         |      
|Balance at December 31, 2000                                             |                                                                                                 |  |  |   |           | $ |          |   |        |  | 68,529 |   |         | $ | 69 |   |  | $ | 501,194 |      
|                                                                         |                                                                                                 |  |   |   |           |   |           |   |        |  |        |   |         |   |    |   |  |   |         |      

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                         |                                                                                                 |   |      |   |             |   |              |   |               |   |             |        |               |   |          |          |       |   |          |          |   |  | 
|------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------- | - | ---- | - | ----------- | - | ------------ | - | ------------- | - | ----------- | ------ | ------------- | - | -------- | -------- | ----- | - | -------- | -------- | - |  | 
|                                                                         |                                                                                                 |   |      |   | Notes       |   |              |   |               |   | Accumulated
|                                                                         |                                                                                                 |   |      |   | Receivable  |   |              |   |               |   | Other       |        |               |   |          |          | Total
|                                                                         |                                                                                                 |   |      |   | from        |   | Deferred     |   | Comprehensive |   | Accumulated |        | Stockholders
|                                                                         |                                                                                                 |   |      |   | Stockholder |   | Compensation |   | (Loss) Income |   | Deficit     |        | Equity       
|                                                                         |                                                                                                 |   |      |   |             |   |              |   |               |   |             |        |              
|Balance at December 31, 1999                                             |                                                                                                 | $ | (258 | ) |             | $ | (18,148      | ) |               | $ | 1,454       |        |               | $ | (42,839  | )        |       | $ | 417,550  |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Exercise of common stock options and purchases through the ESPP          |                                                                                                 |   |     |   |             |   |             |   |               |   |            |        |               |   |         |          |       |   | 1,805    |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Repurchase of common stock                                               |                                                                                                 |   |     |   |             |   |             |   |               |   |            |        |               |   |         |          |       |   | (2,400   | )       
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Fair value of stock options for common stock and warrants issued         |                                                                                                 |   |     |   |             |   |             |   |               |   |            |        |               |   |         |          |       |   | 19,243   |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Stock based charges associated with acceleration of stock option vesting |                                                                                                 |   |     |   |             |   |             |   |               |   |            |        |               |   |         |          |       |   | 6,471    |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Forfeiture of stock options                                              |                                                                                                 |   |     |   |             |   | 4,228        |   |               |   |            |        |               |   |         |          |       |   |         |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Stock based compensation in connection with stock options granted to certain executive officers |   |      |  |             |   |              |  |               |   |             |       |               |   |          |         |       |   |          | 3,031    |  
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Amortization of deferred compensation                                    |                                                                                                 |   |     |   |             |   | 8,975        |   |               |   |            |        |               |   |         |          |       |   | 8,975    |         
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Comprehensive loss:                                                     
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net loss                                                                                        |   |      |  |             |   |              |  |               |   |             |       |               |   |          | (279,493 | )     |   |          | (279,493 | )
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                         | Net unrealized loss on marketable securities                                                    |   |      |  |             |   |              |  |               |   |             | (1,466 | )             |   |          |         |       |   |          | (1,466   | )
|                                                                         |                                                                                                 |   |      |   |             |   |              |   |               |   |             |        |               |   |          |          |       |   |          |         
|Total comprehensive loss                                                 |                                                                                                 |   |     |   |             |   |             |   |               |   |            |        |               |   |         |          |       |   | (280,959 | )       
|                                                                         |                                                                                                 |   |      |   |             |   |              |   |               |   |             |        |               |   |          |          |       |   |          |         
|Balance at December 31, 2000                                             |                                                                                                 | $ | (258 | ) |             | $ | (4,945       | ) |               | $ | (12         | )      |               | $ | (322,332 | )        |       | $ | 173,716  |         
|                                                                         |                                                                                                 |   |      |   |             |   |              |   |               |   |             |        |               |   |          |          |       |   |          |         

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

69



---



##### Table of Contents



MP3.com, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |                |      |  
|------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | -------------------------------------------- | -------- | ----------------------- | -------- | -------------- | -------- | ------ | ------ | - | ---- | -------------- | ---- | -
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      | Period from   
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      | March 17, 1998
|                                                                                                  |                                                                                                   |                                              |          | Year Ended December 31, |          | (inception) to
|                                                                                                  |                                                                                                   |                                              |          |                         |          | December 31,  
|                                                                                                  |                                                                                                   |                                              |          | 2000                    |          | 1999           |          | 1998  
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |       
|Operating activities:                                                                            
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Net loss                                                                                          |                                                                                                   | $                                            | (279,493 | )                       |          | $              | (42,482  | )      |        | $ | (357 | )             
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Adjustments to reconcile net loss to cash (used in) provided by
operating activities:            
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Depreciation, amortization of goodwill and amortization of
prepaid multimedia royalty licenses    |                                              |          | 8,691                   |          |                |          | 1,395  |        |   |      | 10             |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Deferred income taxes                                                                             |                                              |          |                        |          |                |          | (98    | )      |   |      | 98             |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Stock based charges associated with acceleration of stock option vesting                          |                                              |          | 6,471                   |          |                |          | 4,488  |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Amortization and charges of stock based marketing                                                 |                                              |          | 21,420                  |          |                |          | 2,857  |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Amortization of deferred and other stock based compensation                                       |                                              |          | 12,006                  |          |                |          | 22,288 |        |   |      | 550            |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Stock based consulting costs                                                                      |                                              |          | 127                     |          |                |          |       |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Charge for litigation and copyright matters                                                       |                                              |          | 170,000                 |          |                |          |       |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Impairment of strategic investments and loss on sale of short-term
investments available for sale |                                              |          | 50,736                  |          |                |          |       |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Loss on sale of fixed assets                                                                      |                                              |          | 91                      |          |                |          |       |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Contribution to the MP3.com Foundation                                                            |                                              |          |                        |          |                |          | 767    |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Non-cash lease abandonment expense                                                                |                                              |          |                        |          |                |          | 815    |        |   |      |               |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Changes in operating assets and liabilities:                                                     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Restricted cash                              |          |                         | (30,000  | )              |          |        |       |   |      |                |     |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Accounts receivable                          |          |                         | 2,462    |                |          |        | (6,578 | ) |      |                | (224 | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Unbilled receivables                         |          |                         | (742     | )              |          |        | (1,214 | ) |      |                | (65  | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Prepaid expenses and other current assets    |          |                         | (3,896   | )              |          |        | (5,353 | ) |      |                |     |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Accounts payable                             |          |                         | (893     | )              |          |        | 5,622  |   |      |                | 25   |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Accrued expenses                             |          |                         | 11,437   |                |          |        | 4,674  |   |      |                | 105  |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Reserve for litigation and copyright matters |          |                         | (126,229 | )              |          |        |       |   |      |                |     |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  |                                                                                                   | Deferred revenues                            |          |                         | (41,256  | )              |          |        | 42,405 |   |      |                | 15   |  
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |               
|Cash (used in) provided by operating activities                                                   |                                                                                                   |                                              | (199,068 | )                       |          |                | 29,586   |        |        |   | 157  |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Investing activities:                                                                            
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Purchase of property and equipment                                                                |                                                                                                   |                                              | (12,912  | )                       |          |                | (15,921  | )      |        |   | (29  | )             
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Maturities of marketable securities                                                               |                                                                                                   |                                              | 305,045  |                         |          |                | 45,000   |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Purchases of marketable securities                                                                |                                                                                                   |                                              | (99,995  | )                       |          |                | (278,335 | )      |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Purchases of strategic investments                                                                |                                                                                                   |                                              | (39,738  | )                       |          |                | (11,983  | )      |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Issuance of note receivable                                                                       |                                                                                                   |                                              | (4,000   | )                       |          |                |         |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Acquisition of MP3Radio.com, net of cash acquired                                                 |                                                                                                   |                                              | (3,816   | )                       |          |                |         |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Prepaid multimedia content royalties                                                              |                                                                                                   |                                              | (51,000  | )                       |          |                |         |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Other assets                                                                                      |                                                                                                   |                                              | (2,010   | )                       |          |                | (2,693   | )      |        |   | (14  | )             
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |               
|Cash provided by (used in) investing activities                                                   |                                                                                                   |                                              | 91,574   |                         |          |                | (263,932 | )      |        |   | (43  | )             
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Financing activities:                                                                            
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Proceeds from notes receivable                                                                    |                                                                                                   |                                              |         |                         |          |                | 2        |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Repurchase of unvested common stock                                                               |                                                                                                   |                                              | (2,400   | )                       |          |                |         |        |        |   | (73  | )             
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Payments under capital lease obligations                                                          |                                                                                                   |                                              |         |                         |          |                | (14      | )      |        |   | (19  | )             
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|(Payments) proceeds from line of credit                                                           |                                                                                                   |                                              | (1,234   | )                       |          |                | 1,234    |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Proceeds from the issuance of convertible preferred stock, common stock and
common stock warrants |                                                                                                   |                                              | 1,805    |                         |          |                | 426,277  |        |        |   | 2    |               
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |               
|Cash (used in) provided by financing activities                                                   |                                                                                                   |                                              | (1,829   | )                       |          |                | 427,499  |        |        |   | (90  | )             
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |               
|Translation adjustment                                                                            |                                                                                                   |                                              | (11      | )                       |          |                |         |        |        |   |     |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|(Decrease) increase in cash and cash equivalents                                                  |                                                                                                   |                                              | (109,334 | )                       |          |                | 193,153  |        |        |   | 24   |               
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Cash and cash equivalents at beginning of period                                                  |                                                                                                   |                                              | 193,192  |                         |          |                | 39       |        |        |   | 15   |               
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |               
|Cash and cash equivalents at end of period                                                        |                                                                                                   | $                                            | 83,858   |                         |          | $              | 193,192  |        |        | $ | 39   |               
|                                                                                                  |                                                                                                   |                                              |          |                         |          |                |          |        |        |   |      |               

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

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MP3.com, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. The Company and Summary of Significant Accounting Policies

The Company

MP3.com, Inc. (MP3.com) has pioneered a revolutionary approach to the
promotion and distribution of music. The MP3.com web site is a premier online
music destination featuring, representing one of the
largest catalogs of digital music available on the Internet today. MP3.com
uses the Internet and file formats that make music files smaller to enable this
growing number of artists to broadly distribute and promote their music and to
enable consumers around the world to conveniently access this continually
expanding music catalog. Consumers can search for, listen to and download
music free of charge on the MP3.com web site. In addition to the wide variety
of music distributed by artists through the MP3.com web site, consumers have a
substantial amount of music already in their personal music collections that
they want to access, manage and listen to in a variety of ways.

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

Consolidation

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

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exercise significant influence or for which there is not a readily determinable
market value, are accounted for under the cost method of accounting. Dividends
and other distributions of earnings from investees, if any, are included in
income when paid.

Use of Estimates

The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expense during
the reporting period. Examples include provisions for returns, bad debts,
valuation of privately-held strategic investments, the ultimate realizability
of the prepaid multimedia content royalties and the litigation and copyright
matters charge and reserve. Actual results could differ from those estimates.

Concentration of Credit Risks

Financial instruments that potentially subject MP3.com to significant
concentration of credit risk consist primarily of cash, cash equivalents,
short-term and strategic investments, and accounts receivable. Substantially
all of MP3.coms cash, cash equivalents, and short-term investments are managed
by three financial institutions. Accounts receivable are typically unsecured
and are derived from revenues earned from customers primarily located in the
United States and France. MP3.com maintains reserves for potential credit
losses.

One customer accounted for 50.4% of total net revenues for the year ended
December 31, 2000. One customer accounted for 21.3% of total net revenues for
the year ended December 31, 1999. Three customers accounted for 19.0%, 12.2%,
and 10.3%, respectively, of total net revenues for the period from March 17,
1998 (inception) to December 31, 1998. Additionally, MP3.com obtains a
significant percentage of its revenues by providing various advertising
products to Internet and high technology companies.

Cash and Cash Equivalents, Short and Long-Term Investments

MP3.com invests its excess cash in debt instruments of the U.S. Government and
its agencies, and in high-quality corporate issuers. All highly liquid
instruments with an original maturity of three months or less are considered
cash equivalents, and those with original maturities greater than three months
on the date of purchase are considered short-term investments.

MP3.coms short-term investments in marketable securities are classified as
available-for-sale and are reported at fair value, with unrealized gains and
losses, recorded in stockholders equity as a separate component of
comprehensive income. Realized gains or losses and permanent declines in value,
if any, on available-for-sale securities are reported in other income or
expense as incurred. As of December 31, 2000 and 1999, MP3.com recorded net
unrealized (losses) gains, net of income taxes, of approximately ($12,000) and
$1,454,000, respectively.

MP3.com also invests in equity instruments of privately-held Internet and other
technology companies for strategic business purposes. These investments are
included in strategic investments and are accounted for under the cost method
when ownership is less than 20%. For these investments, MP3.coms policy is to
regularly review the underlying operating performance, cash flow forecasts,
and recent private equity transactions in assessing the carrying values.
MP3.com assesses and records impairment losses in these long term investments
when events and circumstances indicate that such assets might be impaired. For
the year ended December 31, 2000, MP3.com has recorded impairment losses of
approximately $40,300,000 related to these strategic investments.

Restricted Cash

The restricted cash balance of $30,000,000 as of December 31, 2000 represents
cash equivalents held in escrow. This restriction will expire in February 2001
unless MP3.com is proven financially insolvent. The cash equivalents are
recorded at market value, which approximates cost. During the escrow period,
a third party earns the interest from the escrow funds.

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Fair Value of Financial Instruments

MP3.coms financial instruments include cash and cash equivalents, short-term
investments, accounts receivable, unbilled receivables, accounts payable,
deferred revenues, accrued expenses and a line of credit. Cash equivalents and
short-term investments are stated at fair value, based on quoted market prices.
The estimated value of all other financial instruments at December 31, 2000 and
1999 was not materially different from the values presented in the respective
balance sheets.

Computer Software for Internal Use

MP3.com does not sell or license the rights to future use of its software;
accordingly, software development costs, consisting of internally developed
software and web site development costs, are accounted for in accordance with
Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. In accordance with SOP 98-1,
internal and external costs incurred to develop internal-use computer software
during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation and testing. Costs of significant upgrades and enhancements that
result in additional functionality are also capitalized. Costs incurred for
maintenance and minor upgrades and enhancements are expensed as incurred.
Capitalized internal-use software development costs are included in property
and equipment and are amortized on a straight-line basis over the useful lives
of the related software application of up to three years. The estimated useful
lives are based on planned or expected significant modification or replacement
of software applications, in response to the rapid rate of change in the
Internet industry and technology in general. MP3.com capitalized $1,566,000 and
$410,000 of software development costs for the years ended December 31, 2000
and 1999, respectively. Depreciation associated with the capitalized software
development costs totaled $422,000, $48,000 and zero for the years ended
December 31, 2000 and 1999 and for the period from March 17, 1998 (inception)
to December 31, 1998, respectively.

Depreciation and Amortization

Property and equipment is stated at historical cost and depreciated using the
straight-line method over the estimated useful lives of 2 to 5 years. Leasehold
improvements are amortized over the shorter of their estimated useful lives,
generally five years, or the lease term. Acquired music catalog is stated at
historical cost and amortized using the straight-line method over the estimated
useful life of 15 years.

Prepaid Multimedia Content Royalties

MP3.com has obtained multimedia content licenses for the future use of both
video and audio music content from certain major recording companies. These
licensing agreements provide a non-refundable prepaid royalty for a fixed term
ranging from 3 to 10 years. MP3.com has capitalized the cost of these prepaid
royalty arrangements for both the video and music licenses. MP3.com has
recorded amortization expense at the greater of straight-line amortization or
units of measure to cost of revenues for music content, and will begin to
record expense for the video licenses upon both the receipt of the video content
and MP3.coms use of the video content on the same basis as the music content.
Periodically, MP3.com will assess these assets for impairment.

Impairment of Long-Lived Assets

MP3.com evaluates the recoverability of its long-lived assets in accordance
with Statement of Financial Accounting Standards No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. SFAS
121 requires recognition of impairment of long-lived assets in the event the
net book value of these assets exceeds the future undiscounted cash flows
attributable to these assets. MP3.com assesses potential impairments to its
long-lived assets when there is evidence that events or changes in
circumstances have made recovery of the assets carrying value unlikely. Should
an impairment exist, the impairment loss would be measured based on the excess
of the carrying value of the asset over the assets fair value or discounted
estimates of future cash flows. MP3.com has identified no such impairment
losses as of December 31, 2000. All of MP3.coms long-lived assets are located
in the United States.

Revenue Recognition

MP3.com recognizes revenue pursuant to Staff Accounting Bulletin No. 101
Revenue Recognition in Financial Statements. Accordingly, revenue is
recognized when all four of the following criteria are met: (i) persuasive

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evidence that arrangement exists; (ii) delivery of the products and/or services
has occurred; (iii) the selling price is both fixed and determinable and; (iv)
collectibility is reasonably probable.

MP3.coms revenues are derived from online advertising, offline advertising and
electronic commerce. Online advertising revenues primarily consist of banner,
button, portal and sponsorship advertisements on our web site in addition to
advertisements placed in e-mail and greeting card campaigns. Banner, button,
portal, e-mail and greeting card advertisements are impression based, requiring
the advertisement to be displayed or delivered a minimum number of times over
the contract period. Sponsorship advertising contracts generally involve static
advertisements, whereby the advertisement is continually displayed on a
specified area of the MP3.com web site during the contract period. Impression
based contract revenues are recognized as the impression is displayed on the
MP3.com web site or delivered via e-mail or greeting card to the intended
addressee. In these circumstances, MP3.com recognizes revenues as impressions
are delivered. To the extent minimum guaranteed impressions are not met,
MP3.com defers recognition of the corresponding revenues until the remaining
guaranteed impressions are delivered. Sponsorship advertisement contract
revenues are generally recognized evenly over the period in which the
advertisement is displayed.

Offline advertising revenues primarily consist of advertising sponsorships of
free CD products, sweepstakes, contests and special events. Free CD product
revenue is recognized upon the shipment of each CD to the registered recipient.
Contest and sweepstakes revenue is recognized upon determination and
notification of the contest winner. Special event revenue is recognized on the
date the event occurs.

Electronic commerce revenues primarily consist of online sales of DAM CDs and
other music-related merchandise. Revenue derived from the sale of DAM CDs and
music-related merchandise is recognized upon shipment at the total sales price.
The portion of the sales price payable to artists as royalties is expensed to
cost of revenues and accrued at the time revenue is recorded.

Deferred revenue represents payments or billings in excess of revenue
recognized. Unbilled receivables represent revenues recognized in excess of
payments or billings.

Pursuant to SAB No. 101, MP3.com recognizes revenue for multiple element
arrangements by the four criteria mentioned above. Additionally, MP3.com
values each element of the arrangement by using a three-month rolling average
for identical or very similar products sold over the last three months for
cash. In the event there is a discount or premium to the historical
three-month average cash selling prices, the resulting discount or premium is
allocated to each element on a pro-rata basis. MP3.com was required to adopt
SAB No. 101 during the fourth quarter of 2000. There was no financial
statement (including recording revenues gross versus net) effect to the
adoption of SAB No. 101.

MP3.com has entered into marketing and promotion arrangements and recognized
revenue with certain parties where MP3.com has also made a strategic
investment. MP3.com accounts for these arrangements under Accounting
Principal Board No. 29 Accounting for Nonmonetary Transactions (APB No.
29). Under APB No. 29, the fair value of the exchange is based upon the lower
of the products historically sold for cash as outlined under SAB 101 or the
valuation ascribed in the strategic investment. Additionally, there must be no
major uncertainties as to the realizability of the strategic investments
value. Further, all of the conditions to revenue recognition as they relate to
SAB 101 must be met before revenue is ultimately recorded. During the years
ended December 31, 2000 and 1999, MP3.com recognized $8,351,000 and $869,000,
respectively, of revenue in connection with strategic investments.

Engineering and Product Development Costs

Engineering and product development costs include expenses incurred by MP3.com
to manage, monitor, maintain and operate MP3.coms web site. Engineering and
product development costs are expensed as incurred.

Advertising Costs

MP3.com recognizes advertising expenses in accordance with Statement of
Position (SOP) 93-7 Reporting on Advertising Costs. As such, MP3.com
expenses the costs of producing advertisements at the time the respective
advertisement is first used. MP3.com does not incur any direct-response
advertising costs. Advertising expense

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totaled approximately $4,300,000, $2,000,000 and $10,000 for the years ended
December 31, 2000, 1999 and for the period from March 17, 1998 (inception) to
December 31, 1998, respectively.

Stock-Based Compensation

MP3.com accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees and complies with the disclosure
provisions of SFAS 123, Accounting for Stock-Based Compensation. Under APB
25, compensation cost is recognized over the vesting period based on the
excess, if any, on the date of grant of the deemed fair value of MP3.coms
stock over the employees exercise price. When the exercise price of the
employee stock option is less than the fair value price of the underlying stock
on the grant date, deferred stock compensation is recognized and amortized to
expense in accordance with FASB Interpretation No. 28 over the vesting period
of the individual options, generally four years. Deferred compensation for
options granted to non-employees has been determined in accordance with SFAS
No. 123 and Emerging Issues Task Force 96-18, Accounting for Equity Instruments that are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services (EITF 96-18). Accordingly, deferred compensation is determined using the fair
value of the consideration received or the fair value of the equity instruments
issued, whichever is more reliably measured. Deferred charges for options
granted to non-employees are periodically remeasured as the underlying options
vest. MP3.com has recorded amortization of deferred compensation corresponding to the
grants of stock options to employees and consultants of $8,975,000,
$20,029,000 and $550,000 during the years ended December 31, 2000, 1999 and for the period
from March 17, 1998 (inception) to December 31, 1998, respectively.

Net Loss Per Share

MP3.com computes net loss per share following SFAS No. 128, Earnings Per
Share and SEC Staff Accounting Bulletin No. 98. Under the provisions of SFAS
No. 128, basic net loss per share is computed by dividing the net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding during the period. Diluted net loss per share is
computed by dividing the net loss for the period by the weighted average number
of common and common equivalent shares outstanding during the period. Common
equivalent shares, composed of unvested restricted common shares and
incremental common shares issuable upon the exercise of stock options, are
included in diluted net loss per share to the extent these shares are dilutive.
Common equivalent shares are not included in the computation of dilutive net
loss per share for the years ended December 31, 2000, 1999 and for the period
from March 17, 1998 (inception) to December 31, 1998, because the effect would
be anti-dilutive.

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

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

|                                              |                                                                          |   |                         |        |              |   |         |        |   |   |                |        |  
|--------------------------------------------- | ------------------------------------------------------------------------ | - | ----------------------- | ------ | ------------ | - | ------- | ------ | - | - | -------------- | ------ | -
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   | Period from   
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   | March 17,     
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   | 1998          
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   | (inception) to
|                                              |                                                                          |   | Year Ended December 31, |        | December 31,
|                                              |                                                                          |   |                         |        |             
|                                              |                                                                          |   | 2000                    |        | 1999         |   | 1998   
|                                              |                                                                          |   |                         |        |              |   |        
|Numerator:                                   
|                                             
|                                             
|                                             
|                                             
|Net loss                                      |                                                                          | $ | (279,493                | )      |              | $ | (42,482 | )      |   | $ | (357           | )     
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   |                |       
|Denominator:                                 
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average shares outstanding                                      |   |                         | 68,193 |              |   |         | 59,306 |   |   |                | 26,200 |  
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average unvested common shares subject
to repurchase agreements |   |                         | (1,394 | )            |   |         | (5,112 | ) |   |                | (17    | )
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   |                |       
|Denominator for basic and diluted calculation |                                                                          |   | 66,799                  |        |              |   | 54,194  |        |   |   | 26,183         |       
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   |                |       
|Net loss per share:                          
|                                             
|                                             
|                                             
|                                             
|                                              | Basic and diluted                                                        |   | $                       | (4.18  | )            |   | $       | (0.78  | ) |   | $              | (0.01  | )
|                                              |                                                                          |   |                         |        |              |   |         |        |   |   |                |       

Dilutive common stock equivalents include common stock options, preferred
stock, and warrants for common stock as if converted and restricted stock that
has not yet fully vested. Potentially dilutive securities totaled approximately

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6,733,000, 5,050,000 and 17,000 for the years ended December 31, 2000, 1999 and
for the period from March 17, 1998 (inception) to December 31, 1998,
respectively, and were excluded from the diluted earnings per share because of
their anti-dilutive effect.

Comprehensive Income

MP3.com has adopted the provisions of SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes standards for reporting comprehensive income
and its components in financial statements. Comprehensive income, as defined,
includes all changes in equity (net assets) during a period from non-owner
sources. Net loss and other comprehensive loss, including foreign currency
translation adjustments, and unrealized gains and losses on investments shall
be reported, net of their related tax effect, to arrive at comprehensive loss.
There were no differences between MP3.coms net loss and its total
comprehensive loss for the year ended December 31, 2000 and 1999, except for
net unrealized gains and losses on investments of approximately $(1,466,000) and
$1,454,000, respectively.

Segment Information

MP3.com adopted the provisions of SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS 131 requires public companies to
report financial and descriptive information about their reportable operating
segments. MP3.com identifies its operating segments based on how management
internally evaluates separate financial information, business activities and
management responsibility. MP3.com believes it operates in a single business
segment. Through December 31, 2000, there have been insignificant foreign
operations.

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

|            |  |                         |        |              |  |      |        |  |  |                |       | 
|----------- |  | ----------------------- | ------ | ------------ |  | ---- | ------ |  |  | -------------- | ----- | 
|            |  |                         |        |              |  |      |        |  |  | Period from   
|            |  |                         |        |              |  |      |        |  |  | March 17, 1998
|            |  |                         |        |              |  |      |        |  |  | (inception) to
|            |  | Year Ended December 31, |        | December 31,
|            |  |                         |        |             
|            |  | 2000                    |        | 1999         |  | 1998
|            |  |                         |        |              |  |     
|Advertising |  | $                       | 77,362 |              |  | $    | 20,493 |  |  | $              | 1,061 | 
|           
|           
|           
|           
|Merchandise |  |                         | 2,774  |              |  |      | 1,406  |  |  |                | 101   | 
|            |  |                         |        |              |  |      |        |  |  |                |       | 
|            |  | $                       | 80,136 |              |  | $    | 21,899 |  |  | $              | 1,162 | 
|            |  |                         |        |              |  |      |        |  |  |                |       | 

Statements of Cash Flows

The table below discloses supplemental cash flow information and non-cash
activities (in thousands):

|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | ------------ |  | ---- | ------ | - |  | -------------- | --- | -
|                                                                                                                              |  |                         |        |              |  |      |        |   |  | Period from   
|                                                                                                                              |  |                         |        |              |  |      |        |   |  | March 17, 1998
|                                                                                                                              |  |                         |        |              |  |      |        |   |  | (inception) to
|                                                                                                                              |  | Year Ended December 31, |        | December 31,
|                                                                                                                              |  |                         |        |             
|                                                                                                                              |  | 2000                    |        | 1999         |  | 1998
|                                                                                                                              |  |                         |        |              |  |     
|Supplemental disclosures of cash flow information:                                                                           
|                                                                                                                             
|                                                                                                                             
|                                                                                                                             
|                                                                                                                             
|Interest paid                                                                                                                 |  | $                       | 75     |              |  | $    | 119    |   |  | $              | 3   |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Taxes received (paid)                                                                                                         |  | $                       | 126    |              |  | $    | (171   | ) |  | $              | (1  | )
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Supplemental schedule of non-cash activities:                                                                                
|                                                                                                                             
|                                                                                                                             
|                                                                                                                             
|                                                                                                                             
|Unrealized (loss) gain on marketable securities, net                                                                          |  | $                       | (1,466 | )            |  | $    | 1,454  |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Issuance of common stock, stock options for common stock and common stock
warrants for marketing, promotions and compensation |  | $                       | 19,243 |              |  | $    | 6,692  |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Stock based compensation associated with the acceleration
of stock option vesting                                             |  | $                       | 6,471  |              |  | $    | 4,247  |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Reduction in deferred compensation associated with
stock option forfeitures                                                   |  | $                       | 4,228  |              |  | $    |       |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Other stock-based compensation                                                                                                |  | $                       | 3,031  |              |  | $    | 369    |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Common stock issued for notes receivable                                                                                      |  | $                       |       |              |  | $    | 338    |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Cancellation of stockholder notes receivable                                                                                  |  | $                       |       |              |  | $    | 78     |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Contribution of common shares to the MP3.com
Foundation                                                                       |  | $                       |       |              |  | $    | 767    |   |  | $              |    |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Deferred compensation, net of forfeitures                                                                                     |  | $                       |       |              |  | $    | 37,999 |   |  | $              | 728 |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  
|Property and equipment acquired under capital leases                                                                          |  | $                       |       |              |  | $    |       |   |  | $              | 33  |  
|                                                                                                                              |  |                         |        |              |  |      |        |   |  |                |     |  

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Recent Accounting Pronouncements

In June 1999, the FASB issued Statement No. 137, Accounting for Derivative
Instruments and Hedging Activities Deferral of Effective Date of FASB
Statement No. 133 (SFAS No. 137). The Statement defers for one year the
effective date of FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS No. 133). SFAS No. 137 now will
apply to all fiscal quarters of all fiscal years beginning after June 15, 2000.
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 requires MP3.com to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the
hedged assets, liabilities, or firm commitments through earnings or recognized
in other comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivatives change in fair value will be
immediately recognized in earnings. As of December 31, 2000, MP3.com did not
hold any derivative instruments, except a warrant which had a full impairment
reserve, or conduct any hedging activities. Therefore, there is no anticipated
impact to the consolidated financial statements for the adoption of SFAS No.
133 and 137.

2. Balance Sheet Supplementary Disclosure

Property and equipment consist of the following (in thousands):

|                               |  |              |        |      |  |   |        |  
|------------------------------ |  | ------------ | ------ | ---- |  | - | ------ | -
|                               |  | December 31,
|                               |  |             
|                               |  | 2000         |        | 1999
|                               |  |              |        |     
|Compact disc database          |  | $            | 1,251  |      |  | $ | 385    |  
|                              
|                              
|                              
|                              
|Computer equipment             |  |              | 15,936 |      |  |   | 8,321  |  
|                              
|                              
|                              
|                              
|Software                       |  |              | 2,874  |      |  |   | 1,461  |  
|                              
|                              
|                              
|                              
|Office furniture and equipment |  |              | 4,331  |      |  |   | 3,711  |  
|                              
|                              
|                              
|                              
|Leasehold improvements         |  |              | 3,613  |      |  |   | 1,310  |  
|                               |  |              |        |      |  |   |        |  
|                               |  |              | 28,005 |      |  |   | 15,188 |  
|                              
|                              
|                              
|                              
|Accumulated depreciation       |  |              | (7,735 | )    |  |   | (1,339 | )
|                               |  |              |        |      |  |   |        |  
|                               |  | $            | 20,270 |      |  | $ | 13,849 |  
|                               |  |              |        |      |  |   |        |  

During the year ended December 31, 1999, MP3.com incurred a lease abandonment
charge of $815,000 when it moved to its new facilities. This charge includes a
write-off of certain furniture and leasehold improvements of $795,000, net of
accumulated depreciation of $66,000.

Accrued expenses consist of the following (in thousands):

|                                          |  |              |        |      |  |   |       | 
|----------------------------------------- |  | ------------ | ------ | ---- |  | - | ----- | 
|                                          |  | December 31,
|                                          |  |             
|                                          |  | 2000         |        | 1999
|                                          |  |              |        |     
|Accrued compensation and related expenses |  | $            | 6,560  |      |  | $ | 1,848 | 
|                                         
|                                         
|                                         
|                                         
|Accrued marketing and promotion expenses  |  |              | 797    |      |  |   | 480   | 
|                                         
|                                         
|                                         
|                                         
|Accrued professional fees                 |  |              | 1,914  |      |  |   | 499   | 
|                                         
|                                         
|                                         
|                                         
|Accrued artist earnings                   |  |              | 3,021  |      |  |   | 694   | 
|                                         
|                                         
|                                         
|                                         
|Other accrued liabilities                 |  |              | 3,398  |      |  |   | 1,498 | 
|                                          |  |              |        |      |  |   |       | 
|                                          |  | $            | 15,690 |      |  | $ | 5,019 | 
|                                          |  |              |        |      |  |   |       | 

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3. Investments

Marketable Securities

At December 31, 2000 and 1999, short-term investments in marketable securities
were classified as available-for-sale as follows (in thousands):

|                             |  |                   |        |            |  |            |     |            |  |   |   |  |  |   |        | 
|---------------------------- |  | ----------------- | ------ | ---------- |  | ---------- | --- | ---------- |  | - | - |  |  | - | ------ | 
|                             |  | December 31, 2000
|                             |  |                  
|                             |  | Gross             |        | Gross      |  | Gross     
|                             |  | Amortized         |        | Unrealized |  | Unrealized |     | Estimated 
|                             |  | Costs             |        | Gains      |  | Losses     |     | Fair Value
|                             |  |                   |        |            |  |            |     |           
|Short-term Investments:     
|                            
|                            
|                            
|                            
|Corporate debt securities    |  | $                 | 9,734  |            |  | $          | 254 |            |  | $ |  |  |  | $ | 9,988  | 
|                            
|                            
|                            
|                            
|U.S. government and agencies |  |                   | 5,000  |            |  |            |    |            |  |   |  |  |  |   | 5,000  | 
|                             |  |                   |        |            |  |            |     |            |  |   |   |  |  |   |        | 
|                             |  | $                 | 14,734 |            |  | $          | 254 |            |  | $ |   |  |  | $ | 14,988 | 
|                             |  |                   |        |            |  |            |     |            |  |   |   |  |  |   |        | 
|Cash Equivalents:           
|                            
|                            
|                            
|                            
|Commercial paper             |  | $                 | 42,257 |            |  | $          | 23  |            |  |   |  |  |  | $ | 42,280 | 
|                            
|                            
|                            
|                            
|Money market fund            |  |                   | 22,970 |            |  |            |    |            |  |   |  |  |  |   | 22,970 | 
|                            
|                            
|                            
|                            
|U.S. government and agencies |  |                   | 19,987 |            |  |            | 7   |            |  |   |  |  |  |   | 19,994 | 
|                             |  |                   |        |            |  |            |     |            |  |   |   |  |  |   |        | 
|                             |  | $                 | 85,214 |            |  | $          | 30  |            |  | $ |  |  |  | $ | 85,244 | 
|                             |  |                   |        |            |  |            |     |            |  |   |   |  |  |   |        | 

|                                  |  |                   |         |            |  |            |       |            |  |   |    |  |  |   |         | 
|--------------------------------- |  | ----------------- | ------- | ---------- |  | ---------- | ----- | ---------- |  | - | -- |  |  | - | ------- | 
|                                  |  | December 31, 1999
|                                  |  |                  
|                                  |  | Gross             |         | Gross      |  | Gross     
|                                  |  | Amortized         |         | Unrealized |  | Unrealized |       | Estimated 
|                                  |  | Costs             |         | Gains      |  | Losses     |       | Fair Value
|                                  |  |                   |         |            |  |            |       |           
|Short-term Investments:          
|                                 
|                                 
|                                 
|                                 
|Corporate debt securities         |  | $                 | 151,384 |            |  | $          | 22    |            |  | $ | 23 |  |  | $ | 151,383 | 
|                                 
|                                 
|                                 
|                                 
|U.S. government and agencies      |  |                   | 68,655  |            |  |            | 1     |            |  |   |   |  |  |   | 68,656  | 
|                                 
|                                 
|                                 
|                                 
|Publicly traded equity securities |  |                   | 13,347  |            |  |            | 1,403 |            |  |   |   |  |  |   | 14,750  | 
|                                  |  |                   |         |            |  |            |       |            |  |   |    |  |  |   |         | 
|                                  |  | $                 | 233,386 |            |  | $          | 1,426 |            |  | $ | 23 |  |  | $ | 234,789 | 
|                                  |  |                   |         |            |  |            |       |            |  |   |    |  |  |   |         | 
|Cash Equivalents:                
|                                 
|                                 
|                                 
|                                 
|Commercial paper                  |  | $                 | 102,962 |            |  | $          | 37    |            |  |   |   |  |  | $ | 102,999 | 
|                                 
|                                 
|                                 
|                                 
|Money market fund                 |  |                   | 17,307  |            |  |            |      |            |  |   |   |  |  |   | 17,307  | 
|                                 
|                                 
|                                 
|                                 
|U.S. government and agencies      |  |                   | 72,959  |            |  |            | 14    |            |  |   |   |  |  |   | 72,973  | 
|                                  |  |                   |         |            |  |            |       |            |  |   |    |  |  |   |         | 
|                                  |  | $                 | 193,228 |            |  | $          | 51    |            |  | $ |   |  |  | $ | 193,279 | 
|                                  |  |                   |         |            |  |            |       |            |  |   |    |  |  |   |         | 

As of December 31, 2000 and 1999, the balance sheet caption cash and cash
equivalents included a book cash deficit of approximately $1,386,000 and
$87,000, respectively.

MP3.com holds a warrant in a publicly traded company. At December 31, 1999, the
warrant was classified as available-for-sale marketable securities and reported
at fair value with unrealized gains recorded in stockholders equity as
comprehensive income. As of December 31, 1999, the fair value of the warrant
was determined using the Black-Scholes model based on the following
assumptions:

|                             |  |              |      |  
|---------------------------- |  | ------------ | ---- | -
|                             |  | December 31,
|                             |  | 1999        
|                             |  |             
|Risk free interest rate      |  |              | 5.5  | %
|                            
|                            
|                            
|                            
|Expected life (years)        |  |              | 4.0  |  
|                            
|                            
|                            
|                            
|Dividend yield               |  |              | 1.0  | %
|                            
|                            
|                            
|                            
|Expected volatility          |  |              | 46.7 | %
|                            
|                            
|                            
|                            
|Public price of common stock |  | $            | 8.09 |  

During the year ended December 31, 2000, MP3.com fully reserved for the
impairment of the warrant as the decline in the stock price was determined to
be other than temporary.

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The contractual maturities of debt securities classified as available-for-sale
as of December 31, 2000 and 1999 are as follows (in thousands):

|                                     |  |              |         |      |  |   |         | 
|------------------------------------ |  | ------------ | ------- | ---- |  | - | ------- | 
|                                     |  | December 31,
|                                     |  |             
|                                     |  | 2000         |         | 1999
|                                     |  |              |         |     
|Due within one year                  |  | $            | 100,232 |      |  | $ | 408,365 | 
|                                    
|                                    
|                                    
|                                    
|Due after one year through two years |  |              |        |      |  |   | 4,953   | 
|                                     |  |              |         |      |  |   |         | 
|                                     |  | $            | 100,232 |      |  | $ | 413,318 | 
|                                     |  |              |         |      |  |   |         | 

Realized gains and losses were immaterial to MP3.coms financial results for
the years ended December 31, 2000 and 1999.

Investments in Strategic Investments and Joint Venture

Investments in joint ventures and other companies that MP3.com does not control
but has the ability to exercise significant influence over operating and
financial policies are accounted for by the equity method. Equity method
investments are stated at their cost of acquisition adjusted for MP3.coms
equity in undistributed net income (loss) since the date of acquisition.
Investments that the MP3.com does not control and does not have the ability to
exercise significant influence over operating and financial policies are
accounted for by the cost method. Cost method investments are carried at their
cost of acquisition. Cost method investments in publicly traded companies or
securities are subsequently marked to market with unrealized gains and losses,
net of income taxes, reported as a component of accumulated other comprehensive
income (loss) within stockholders equity in the balance sheets.

During the year ended December 31, 2000 and 1999, MP3.com purchased a number of
investments focused on establishing strategic business relationships. These
investments provided MP3.com with equity ownership interests in Internet and
other technology-based companies in exchange for $39,700,000 and $25,300,000 in
cash, respectively.

Subsequent to an investment purchase, MP3.com evaluates whether subsequent
events and circumstances indicate that the carrying amount of such investment
is impaired. If a decline in fair value of the investment below its cost basis
is judged to be other than temporary, the investment is considered to be
impaired, and the carrying amount of the investment is written down to fair
value as a new cost basis. The new cost basis is not changed for subsequent
recovery, if any, in the fair value of the investment. MP3.coms future results
of operations for a quarter or a year could be materially affected by a future
write down in the carrying amount of these investments to recognize an
impairment loss due to an other than temporary decline in the value of these
investments. As of December 31, 2000, such impairments have occurred resulting
in impairment losses of approximately $40,300,000.

4. Related Party Transactions

On January 25, 1999, MP3.com loaned one of its executive
officers $260,000 which was used to exercise an option to purchase 2,437,500
shares of common stock that was granted to him under the Companys 1998 Equity
Incentive Plan. The loan, as amended, is a full recourse note secured by
187,500 shares of MP3.coms common stock that bears interest at 4.64% and is
due in January 2003. During the year ended December 31, 1999, payments totaling
approximately $2,000 were made to repay an amount equal to the par value of the
shares purchased. No payments were received during the year ended December 31,
2000.

During the years ended December 31, 2000 (until his resignation as of October
19, 2000) and 1999, the Chairman of Gateway, Inc. (Gateway) held a seat on
the Board of Directors of MP3.com. During this same period of time, MP3.com
purchased approximately $628,000 and $510,000 of computers and computer related
equipment from Gateway, respectively.

In October 2000, MP3.com entered into a three year consulting agreement with a
member of the Board of Directors. In connection with the consulting agreement,
this member will receive an annual consulting fee of $450,000 payable monthly
and an option to purchase 125,000 shares of MP3.com common stock at the fair
market value of MP3.coms common stock price on the grant date. The option was
issued pursuant to MP3.coms Amended and Restated 1998 Equity Incentive Plan.
The options vested 25% immediately with the remaining shares vesting in four
quarterly increments over the course of one year. See Note 7 for the
accounting of the stock option.

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In October and November 2000, our Chairman and Chief Executive Officer issued
an option on shares he directly owns to certain executive officers of MP3.com
to purchase an aggregate of 2,500,000 shares of MP3.com common stock. The
options are fully vested, have a term of five years and were issued at a
discount from fair market value of the MP3.com common stock price on the grant
date. See Note 7 for the accounting for these stock options.

5. Acquisition

In April 2000, MP3.com agreed to purchase 53.5% of mp3radio.com, a joint
venture with Cox Interactive Media, Inc. that it did not own. MP3.com paid
approximately $4,000,000 in cash, received tangible net assets of $47,000 and
assumed liabilities of $231,000. During the transition period ending June 30,
2000, the costs of relocating the joint ventures operations to San Diego were
shared pro rata based upon the parties existing ownership percentages and
included in minority interest in losses of an unconsolidated subsidiary. The
acquisition was completed during the third quarter of 2000 and was accounted
for under the purchase method of accounting. The excess purchase price over
fair value of net assets acquired was generally allocated to assembled work
force; URLs, trademarks and trade names; radio station agreements; and
goodwill. The excess purchase price over fair value of the assets acquired of
approximately $4,000,000 will be amortized over the following periods using the
straight-line method as follows (in thousands):

|                                  |  |        |       |      |  |  |           | 
|--------------------------------- |  | ------ | ----- | ---- |  |  | --------- | 
|Intangible Asset                  |  | Amount |       | Life
|                                  |  |        |       |     
|Assembled work force              |  | $      | 50    |      |  |  | 12 months | 
|                                 
|                                 
|                                 
|                                 
|URLs, trademarks and trade names |  | $      | 200   |      |  |  | 24 months | 
|                                 
|                                 
|                                 
|                                 
|Radio station agreement           |  | $      | 1,250 |      |  |  | 12 months | 
|                                 
|                                 
|                                 
|                                 
|Goodwill                          |  | $      | 2,500 |      |  |  | 24 months | 

The operating results of mp3radio.com have been included in the consolidated
statement of operations from the date of acquisition. The results of operations
for mp3radio.com in 2000 were insignificant to MP3.com. Therefore, the pro
forma net revenues, operating loss, net loss, net loss per share basic, and
net loss per share diluted are not disclosed.

6. Lease Commitments

MP3.com leases its facilities and some of its furniture under noncancellable
operating leases, expiring at various dates through March 2009.

Future minimum annual lease payments under noncancellable operating leases at
December 31, 2000 are as follows (in thousands):

|                        |            |                  |        |       | 
|----------------------- | ---------- | ---------------- | ------ | ----- | 
|Year ended December 31, |            | Operating Leases
|                        |            |                 
|                        | 2001       |                  | $      | 1,980 | 
|                       
|                       
|                       
|                       
|                        | 2002       |                  |        | 2,048 | 
|                       
|                       
|                       
|                       
|                        | 2003       |                  |        | 1,984 | 
|                       
|                       
|                       
|                       
|                        | 2004       |                  |        | 1,914 | 
|                       
|                       
|                       
|                       
|                        | 2005       |                  |        | 1,509 | 
|                       
|                       
|                       
|                       
|                        | Thereafter |                  |        | 3,045 | 
|                        |            |                  |        |      
|Minimum lease payments  |            | $                | 12,480 |      
|                        |            |                  |        |      

Rent expense totaled $2,414,000, $896,000 and $10,000 for the years ended
December 31, 2000 and 1999, and for the period from March 17, 1998 (inception)
to December 31, 1998, respectively.

7. Stockholders Equity

Common Stock

In July 1999, the Board of Directors authorized a 3-for-2 stock split of all
outstanding common stock. All share and per share information has been
retroactively restated to reflect the stock splits.

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In July 1999, MP3.com completed its initial public offering of common stock. A
total of 13,697,233 shares were sold at a price of $28.00 per share. The
offering resulted in net proceeds to MP3.com of approximately $360.4 million,
net of an underwriting fee of $20.6 million and offering expenses of $2.5
million. Upon the closing of MP3.coms initial public offering, all 12,871,681
shares of the Series A, B, and C Convertible Preferred Stock converted into
19,307,516 shares of common stock.

Stock Options

During 1998, MP3.com adopted the Founders Stock Option Plan (the Founders
Plan) and the 1998 Equity Incentive Plan (the Incentive Plan) for the
granting of both incentive and non-qualified stock options. In February 2000,
MP3.com adopted the 2000 Equity Incentive Plan (the 2000 Plan). The 1998
Equity Incentive Plan was subsequently amended and restated in 1999 and 2000.
Under the plans, incentive stock options may be granted to employees,
directors, and officers of MP3.com and non-qualified stock options may be
granted to consultants, employees, directors, and officers of MP3.com. Options
granted under the plans are for periods not to exceed ten years, and must be
issued at prices not less than 100% and 50%, for incentive and nonqualified
stock options, respectively, of the fair value of the stock on the date of
grant, as determined by the Board of Directors. Options granted to stockholders
who own greater than 10% of the outstanding stock are for periods not to exceed
five years and must be issued at prices not less than 110% of the fair value of
the stock on the date of grant, as determined by the Board of Directors.

The Founders Plan reserved 3,071,250 shares of common stock for grants to
founders of MP3.com. During 1998, all of the shares reserved in the Founders
Plan were granted, and in December 1998 all of the shares were exercised at
$0.001 per share. The Founders shares were obtained by an early exercise and
are subject to be repurchased by MP3.com at the original exercise price. As of
December 31, 2000, there were 2,022,789 shares exercised and vested, 415,905 were repurchased and cancelled
and 632,556 shares could be repurchased by MP3.com.

The Incentive Plan reserved 22,500,000 shares, as amended, of common stock for
granting to employees and non-employees of MP3.com. Grants under the Incentive
Plan generally vest over four years with 25% of the shares vesting on the first
anniversary of the grant and 1/36 of the remaining shares vesting in equal
installments monthly for the following 36 months.

The 2000 Plan contains the same provisions as the Incentive Plan with the
exception that the grant of common shares are nonstatutory stock options to
employees of MP3.com and no more than 40% of the shares reserved under the 2000
Plan may be granted to existing executive officers of MP3.com. The 2000 Plan
reserved 1,100,000 shares of common stock for grant.

The following table summarizes MP3.coms stock option activity for the Founders
Plan, Incentive Plan and 2000 Plan:

|                                      |                              |  |               |             |             |  |                |            |   |   |                  |       | 
|------------------------------------- | ---------------------------- |  | ------------- | ----------- | ----------- |  | -------------- | ---------- | - | - | ---------------- | ----- | 
|                                      |                              |  |               |             |             |  |                |            |   |   | Weighted Average
|                                      |                              |  | Available For |             | Options     |  | Exercise Price
|                                      |                              |  | Grant         |             | Outstanding |  | Per Share     
|                                      |                              |  |               |             |             |  |               
|Balance at March 17, 1998 (inception) |                              |  |              |             |             |  |               |            |   |   |                 |      
|                                     
|                                     
|                                     
|                                     
|                                      | Shares reserved              |  |               | 9,821,250   |             |  |                |           |   |   |                  |      | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares granted               |  |               | (3,071,250  | )           |  |                | 3,071,250  |   |   | $                | 0.001 | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares exercised             |  |               |            |             |  |                | (3,071,250 | ) |   | $                | 0.001 | 
|                                      |                              |  |               |             |             |  |                |            |   |   |                  |      
|Balance as of December 31, 1998       |                              |  | 6,750,000     |             |             |  |               |            |   |   |                 |      
|                                     
|                                     
|                                     
|                                     
|                                      | Increase in shares available |  |               | 6,000,000   |             |  |                |           |   |   |                  |      | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares granted               |  |               | (13,106,260 | )           |  |                | 13,106,260 |   |   | $                | 8.28  | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares exercised             |  |               |            |             |  |                | (5,769,479 | ) |   | $                | 0.85  | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares forfeited             |  |               | 902,600     |             |  |                | (902,600   | ) |   | $                | 3.66  | 
|                                      |                              |  |               |             |             |  |                |            |   |   |                  |      
|Balance as of December 31, 1999       |                              |  | 546,340       |             |             |  | 6,434,181      |            |   | $ | 15.53            |      
|                                     
|                                     
|                                     
|                                     
|                                      | Increase in shares available |  |               | 10,600,000  |             |  |                |           |   |   |                  |      | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares granted               |  |               | (8,653,881  | )           |  |                | 8,653,881  |   |   | $                | 8.51  | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares exercised             |  |               |            |             |  |                | (827,981   | ) |   | $                | 0.54  | 
|                                     
|                                     
|                                     
|                                     
|                                      | Shares forfeited             |  |               | 1,423,235   |             |  |                | (1,423,235 | ) |   | $                | 16.65 | 
|                                      |                              |  |               |             |             |  |                |            |   |   |                  |      
|Balance as of December 31, 2000       |                              |  | 3,915,694     |             |             |  | 12,836,846     |            |   | $ | 11.55            |      
|                                      |                              |  |               |             |             |  |                |            |   |   |                  |      

For the period from March 17, 1998 (inception) to December 31, 1998, the
weighted average exercise price and weighted average grant date fair value for
options to purchase 2,193,750 shares of common stock that were granted

81



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at exercise prices less than deemed fair value were approximately $0.001 and
$0.33, respectively. The remaining options to purchase 877,500 shares of common
stock were granted at exercise prices equal to the fair value. For the year
ended December 31, 1999, the weighted average grant date fair value for options
granted at exercise prices less than fair value was approximately $4.93 and
2,641,260 options were granted at exercise prices equal to or in excess of fair
value.

The following table summarizes information about stock options outstanding as
of December 31, 2000:

|                |  |                     |            |                     |  |           |     |             |  |          |       |  |  |          |           |  |  |   |       | 
|--------------- |  | ------------------- | ---------- | ------------------- |  | --------- | --- | ----------- |  | -------- | ----- |  |  | -------- | --------- |  |  | - | ----- | 
|                |  | Options Outstanding |            | Options Exercisable
|                |  |                     |            |                    
|                |  |                     |            |                     |  | Weighted 
|                |  |                     |            |                     |  | Average   |     | Weighted    |  |          |       |  |  | Weighted
|                |  |                     |            |                     |  | Remaining |     | Average     |  |          |       |  |  | Average 
|                |  | Number              |            | Contractual         |  | Exercise  |     | Number      |  | Exercise
|Exercise Prices |  | Outstanding         |            | Life                |  | Price     |     | Outstanding |  | Price   
|                |  |                     |            |                     |  |           |     |             |  |         
|$0.11 $12.13   |  |                     | 8,167,216  |                     |  |           | 9.3 |             |  | $        | 3.53  |  |  |          | 1,054,254 |  |  | $ | 2.40  | 
|               
|               
|               
|               
|$13.50 $31.13  |  |                     | 2,786,155  |                     |  |           | 9.2 |             |  | $        | 17.59 |  |  |          | 244,701   |  |  | $ | 22.44 | 
|               
|               
|               
|               
|$31.56 $55.63  |  |                     | 1,883,475  |                     |  |           | 8.9 |             |  | $        | 37.37 |  |  |          | 524,136   |  |  | $ | 37.69 | 
|                |  |                     |            |                     |  |           |     |             |  |          |       |  |  |          |           |  |  |   |       | 
|                |  |                     | 12,836,846 |                     |  |           | 9.2 |             |  | $        | 11.55 |  |  |          | 1,823,091 |  |  | $ | 15.23 | 

In October and November 2000, our Chairman and Chief Executive Officer issued
an option on shares he directly owns to certain executive officers of MP3.com
to purchase an aggregate of 2,500,000 shares of MP3.com common stock. The
options are fully vested, have a term of five years and were issued at a
discount from fair market value of the MP3.com common stock price on the grant
date. Pursuant to Interpretation No. 1 to Accounting Principles Board No. 25, MP3.com has accounted for these stock options as if MP3.com had granted
them. Therefore, MP3.com has recognized the intrinsic value of approximately
$3,031,000, the difference between the exercise price and the fair market value
of MP3.com common stock on the grant date as stock-based compensation during
the year ended December 31, 2000.

In October 2000, MP3.com entered into a three year consulting agreement with a
member of the board of directors. In connection with the consulting agreement,
the director also received an option to purchase 125,000 shares of MP3.com
common stock at the fair market value of MP3.com common stock price on the
grant date. The option was issued pursuant to MP3.coms Amended and Restated
1998 Equity Incentive Plan. The option vested 25% immediately with the
remaining shares vesting in four quarterly increments. MP3.com accounts for
the option pursuant to SFAS 123 and EITF 96-18. SFAS 123 and EITF
96-18 requires that the compensation amount should be measured at
the end of each period for the fair value that vests during the given
period. Changes in the quoted market value should be reflected as an adjustment of the
compensation expense in the periods which the changes occur. During the year
ended December 31, 2000, MP3.com recognized approximately $77,000 in
stock-based compensation associated to these options granted to the director.

Employee Stock Purchase Plan

In May 1999, MP3.coms Board of Directors adopted the Employee Stock Purchase
Plan (the Purchase Plan), which provides for the issuance of a maximum of
300,000 shares of common stock. Eligible employees can have up to 15% of their
earnings withheld, up to certain maximums, to be used to purchase shares of
MP3.coms common stock on every January 31 and July 31. The price of the common
stock purchased under the Purchase Plan will be equal to 85% of the lower of
the fair market value of the common stock on the commencement date of the
offering period or the specified purchase date. There were approximately 97,000
and zero shares purchased under the Purchase Plan during the year ended
December 31, 2000 and 1999, respectively.

Warrants for Common Stock

In May 2000, in connection with a legal consulting agreement, MP3.com issued a
five year warrant for the purchase of 75,000 shares of common stock. As of the
date of grant, the warrant was fully vested and non-forfeitable and provided
for an exercise price of $13.45 per share. The warrant is deemed to have a
fair value of approximately $794,000 using the Black-Scholes method of
valuation. The $794,000 was included in the charge for litigation and
copyright matters of $170 million. MP3.com calculated the minimum fair value
of the warrant on the grant date using the following assumptions:

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|                                                   |  |   |       |  
|-------------------------------------------------- |  | - | ----- | -
|Fair value of common stock on the date of issuance |  | $ | 11.00 |  
|                                                  
|                                                  
|                                                  
|                                                  
|Risk-free interest rate                            |  |   | 5.50  | %
|                                                  
|                                                  
|                                                  
|                                                  
|Expected life (in years)                           |  |   | 5.0   |  
|                                                  
|                                                  
|                                                  
|                                                  
|Dividend yield                                     |  |   | 0     | %
|                                                  
|                                                  
|                                                  
|                                                  
|Expected volatility                                |  |   | 184.5 | %

In December 2000, MP3.com issued three warrants for the purchase of an
aggregate of 2,400,000 shares of common stock. As of the date of grant, each
warrant is fully vested and non-forfeitable. The warrants in
aggregate were
deemed to have a fair value of approximately $10,528,000 using the
Black-Scholes method of valuation reduced by the receipt of $200,000 in cash.
The deemed fair value of $10,328,000 was included in sales and marketing
expense for the year ended December 31, 2000. The general terms of the
warrants and the calculated the fair value of the warrant on the grant date
using the following Black-Scholes assumptions are as follows:

|                                                   |  |            |         |            |  |            |         |   |  |   |         |  
|-------------------------------------------------- |  | ---------- | ------- | ---------- |  | ---------- | ------- | - |  | - | ------- | -
|                                                   |  | Warrant #1 |         | Warrant #2 |  | Warrant #3
|                                                   |  |            |         |            |  |           
|Terms                                              |  |            | 1 year  |            |  |            | 1 year  |   |  |   | 1 year  |  
|                                                  
|                                                  
|                                                  
|                                                  
|Number of shares exercisable                       |  |            | 800,000 |            |  |            | 800,000 |   |  |   | 800,000 |  
|                                                  
|                                                  
|                                                  
|                                                  
|Exercise prices                                    |  | $          | 6.50    |            |  | $          | 7.25    |   |  | $ | 7.25    |  
|                                                  
|                                                  
|                                                  
|                                                  
|Fair value of common stock on the date of issuance |  | $          | 5.688   |            |  | $          | 5.688   |   |  | $ | 5.688   |  
|                                                  
|                                                  
|                                                  
|                                                  
|Risk-free interest rates                           |  |            | 6.25    | %          |  |            | 6.25    | % |  |   | 6.25    | %
|                                                  
|                                                  
|                                                  
|                                                  
|Expected lives (in years)                          |  |            | 1.0     |            |  |            | 2.0     |   |  |   | 3.0     |  
|                                                  
|                                                  
|                                                  
|                                                  
|Dividend yields                                    |  |            | 0       | %          |  |            | 0       | % |  |   | 0       | %
|                                                  
|                                                  
|                                                  
|                                                  
|Expected volatilities                              |  |            | 184.5   | %          |  |            | 184.5   | % |  |   | 184.5   | %

In November 2000, MP3.com issued three warrants for the purchase
of an aggregate of 3,000,000 shares of common stock. As of the grant date, each
warrant is fully vested and non-forfeitable. The warrants in aggregate were
deemed to have a fair value of approximately $7,750,000 using the Black-Scholes
method of valuation. The deemed fair value of $7,750,000 was included in sales
and marketing for the year ended December 31, 2000. The general terms of the
warrants and the calculated fair value of the warrant on the grant date using
the following Black-Scholes assumptions are as follows:

|                                                   |  |            |           |            |  |            |           |   |  |   |           |  
|-------------------------------------------------- |  | ---------- | --------- | ---------- |  | ---------- | --------- | - |  | - | --------- | -
|                                                   |  | Warrant #1 |           | Warrant #2 |  | Warrant #3
|                                                   |  |            |           |            |  |           
|Terms                                              |  |            | 1 year    |            |  |            | 2 years   |   |  |   | 3 years   |  
|                                                  
|                                                  
|                                                  
|                                                  
|Number of shares exercisable                       |  |            | 1,000,000 |            |  |            | 1,000,000 |   |  |   | 1,000,000 |  
|                                                  
|                                                  
|                                                  
|                                                  
|Exercise prices                                    |  | $          | 3.75      |            |  | $          | 5.00      |   |  | $ | 5.00      |  
|                                                  
|                                                  
|                                                  
|                                                  
|Fair value of common stock on the date of issuance |  | $          | 3.375     |            |  | $          | 3.375     |   |  | $ | 3.375     |  
|                                                  
|                                                  
|                                                  
|                                                  
|Risk-free interest rates                           |  |            | 6.25      | %          |  |            | 6.25      | % |  |   | 6.25      | %
|                                                  
|                                                  
|                                                  
|                                                  
|Expected lives (in years)                          |  |            | 1.0       |            |  |            | 2.0       |   |  |   | 3.0       |  
|                                                  
|                                                  
|                                                  
|                                                  
|Dividend yields                                    |  |            | 0         | %          |  |            | 0         | % |  |   | 0         | %
|                                                  
|                                                  
|                                                  
|                                                  
|Expected volatilities                              |  |            | 184.5     | %          |  |            | 184.5     | % |  |   | 184.5     | %

Pro Forma Disclosures

Pro forma information regarding net loss is required by SFAS No. 123 and has
been determined as if MP3.com accounted for its employee stock options and
stock purchase plan under the fair value method of SFAS No. 123. The
compensation cost associated with MP3.coms stock-based compensation plans,
determined using the minimum value method prescribed by SFAS 123, did not
result in a material difference from the reported net loss for the period from
March 17, 1998 (inception) to December 31, 1998.

MP3.com calculated the minimum fair value of each option grant on the date of
grant using the Black-Scholes option pricing model as prescribed by SFAS 123
using the following assumptions:

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|                          |  |                         |     |              |  |      |     |   |  |                |     |  
|------------------------- |  | ----------------------- | --- | ------------ |  | ---- | --- | - |  | -------------- | --- | -
|                          |  |                         |     |              |  |      |     |   |  | Period from   
|                          |  |                         |     |              |  |      |     |   |  | March 17,     
|                          |  |                         |     |              |  |      |     |   |  | 1998          
|                          |  |                         |     |              |  |      |     |   |  | (inception) to
|                          |  | Year Ended December 31, |     | December 31,
|                          |  |                         |     |             
|                          |  | 2000                    |     | 1999         |  | 1998
|                          |  |                         |     |              |  |     
|Risk-free interest rates  |  |                         | 6.0 | %            |  |      | 5.3 | % |  |                | 5.5 | %
|                         
|                         
|                         
|                         
|Expected lives (in years) |  |                         | 4.0 |              |  |      | 4.6 |   |  |                | 5.0 |  
|                         
|                         
|                         
|                         
|Dividend yields           |  |                         | 0   | %            |  |      | 0   | % |  |                | 0   | %
|                         
|                         
|                         
|                         
|Expected volatilities     |  |                         | 170 | %            |  |      | 107 | % |  |                | 0   | %

The effect of compensation cost on net losses and losses per share for the year
ended December 31, 2000 and 1999 is as follows (in thousands, except per share
amounts):

|                                                               |  |                         |          |      |  |   |         |  
|-------------------------------------------------------------- |  | ----------------------- | -------- | ---- |  | - | ------- | -
|                                                               |  | Year Ended December 31,
|                                                               |  |                        
|                                                               |  | 2000                    |          | 1999
|                                                               |  |                         |          |     
|Net loss as reported                                           |  | $                       | (279,493 | )    |  | $ | (42,482 | )
|                                                               |  |                         |          |      |  |   |         |  
|Pro forma net loss under SFAS 123                              |  | $                       | (291,645 | )    |  | $ | (47,341 | )
|                                                               |  |                         |          |      |  |   |         |  
|Pro forma net loss per share, basic and diluted under SFAS 123 |  | $                       | (4.37    | )    |  | $ | (0.87   | )
|                                                               |  |                         |          |      |  |   |         |  
|Weighted average fair value of options granted                 |  | $                       | 7.96     |      |  | $ | 6.26    |  
|                                                               |  |                         |          |      |  |   |         |  

Because grants of additional stock options are expected to occur each year, the
above pro forma disclosures are not representative of pro forma effects on
reported financial results for future years.

Common Stock Reserved

The following represents the number of common shares reserved
for future issuances:

| |                              |  |                         |            |  | 
| | ---------------------------- |  | ----------------------- | ---------- |  | 
| |                              |  | Number of
Common Shares |           
| |                              |  |                        
| | Warrants for common stock    |  |                         | 5,475,000  | 
| | Options for common stock     |  |                         | 16,752,540 | 
| | Employee Stock Purchase Plan |  |                         | 203,423    | 
| |                              |  |                         |            | 
| | Total                        |  |                         | 22,430,963 | 
| |                              |  |                         |            | 

8. Income Taxes

MP3.com accounts for income taxes following the provisions of Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes, under
which the liability method is used to calculate deferred income taxes. Under
this method, deferred tax assets and liabilities are determined based on the
differences between financial reporting and income tax basis of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.

The (benefit) provision for income taxes is as follows (in thousands):

|                                     |         |                |   |                         |   |              |     |      |     |   |     |                |    | 
|------------------------------------ | ------- | -------------- | - | ----------------------- | - | ------------ | --- | ---- | --- | - | --- | -------------- | -- | 
|                                     |         |                |   |                         |   |              |     |      |     |   |     | Period from   
|                                     |         |                |   |                         |   |              |     |      |     |   |     | March 17,     
|                                     |         |                |   |                         |   |              |     |      |     |   |     | 1998          
|                                     |         |                |   |                         |   |              |     |      |     |   |     | (inception) to
|                                     |         |                |   | Year Ended December 31, |   | December 31,
|                                     |         |                |   |                         |   |             
|                                     |         |                |   | 2000                    |   | 1999         |     | 1998
|                                     |         |                |   |                         |   |              |     |     
|Current:                            
|                                    
|                                    
|                                    
|                                    
|                                     | Federal |                | $ |                        |   |              | $   | (93  | )   |   | $   | 28             |   
|                                    
|                                    
|                                    
|                                    
|                                     | State   |                |   |                        |   |              |     |     |     |   |     | 7              |   
|                                     |         |                |   |                         |   |              |     |      |     |   |     |               
|                                     |         | Total current  |   |                         |  |              |     |      | (93 | ) |     |                | 35 | 
|                                    
|                                    
|                                    
|                                    
|Deferred:                           
|                                    
|                                    
|                                    
|                                    
|                                     | Federal |                |   |                        |   |              |     |     |     |   |     | 77             |   
|                                    
|                                    
|                                    
|                                    
|                                     | State   |                |   |                        |   |              |     |     |     |   |     | 22             |   
|                                     |         |                |   |                         |   |              |     |      |     |   |     |               
|                                     |         | Total deferred |   |                         |  |              |     |      |    |   |     |                | 99 | 
|                                     |         |                |   |                         |   |              |     |      |     |   |     |               
|(Benefit) provision for income taxes |         | $              |  |                         |   | $            | (93 | )    |     | $ | 134 |               
|                                     |         |                |   |                         |   |              |     |      |     |   |     |               

Significant components of the net deferred tax assets are shown below (in
thousands). A valuation allowance of $106,033,000 and $6,078,000 has been
established at December 31, 2000 and 1999, respectively, as realization of such
assets is uncertain.

84



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|                          |                                              |   |              |         |      |   |        |       |  
|------------------------- | -------------------------------------------- | - | ------------ | ------- | ---- | - | ------ | ----- | -
|                          |                                              |   | December 31,
|                          |                                              |   |             
|                          |                                              |   | 2000         |         | 1999
|                          |                                              |   |              |         |     
|Deferred tax assets:     
|                         
|                         
|                         
|                         
|                          | Net operating loss                           |   | $            | 76,350  |      |   | $      | 5,723 |  
|                         
|                         
|                         
|                         
|                          | Reserve for litigation and copyright matters |   |              | 20,908  |      |   |        |      |  
|                         
|                         
|                         
|                         
|                          | Warrants                                     |   |              | 7,231   |      |   |        |      |  
|                         
|                         
|                         
|                         
|                          | Other reserves and accruals                  |   |              | 1,730   |      |   |        | 409   |  
|                          |                                              |   |              |         |      |   |        |      
|                          | Total deferred tax assets                    |   |              | 106,219 |      |   |        | 6,132 |  
|                         
|                         
|                         
|                         
|Deferred tax liabilities:
|                         
|                         
|                         
|                         
|                          | Depreciation                                 |   |              | (186    | )    |   |        | (42   | )
|                         
|                         
|                         
|                         
|                          | Other                                        |   |              |        |      |   |        | (12   | )
|                          |                                              |   |              |         |      |   |        |      
|                          | Total deferred tax liabilities               |   |              | (186    | )    |   |        | (54   | )
|                          |                                              |   |              |         |      |   |        |      
|                          | Total deferred tax assets                    |   |              | 106,033 |      |   |        | 6,078 |  
|                         
|                         
|                         
|                         
|Valuation allowance       |                                              |   | (106,033     | )       |      |   | (6,078 | )    
|                          |                                              |   |              |         |      |   |        |      
|Net deferred tax assets   |                                              | $ |             |         |      | $ |       |      
|                          |                                              |   |              |         |      |   |        |      

A reconciliation of income taxes at the statutory federal income tax rate to
the provision for income taxes is as follows (in thousands):

|                                                     |  |                         |         |                |  |      |         |   |  |             |     |  
|---------------------------------------------------- |  | ----------------------- | ------- | -------------- |  | ---- | ------- | - |  | ----------- | --- | -
|                                                     |  |                         |         |                |  |      |         |   |  | Period from
|                                                     |  |                         |         |                |  |      |         |   |  | March 17,  
|                                                     |  |                         |         |                |  |      |         |   |  | 1998       
|                                                     |  | Year Ended December 31, |         | (inception) to
|                                                     |  |                         |         | December 31,  
|                                                     |  | 2000                    |         | 1999           |  | 1998
|                                                     |  |                         |         |                |  |     
|U.S. federal taxes at the statutory rate             |  | $                       | (95,028 | )              |  | $    | (14,099 | ) |  | $           | (76 | )
|                                                    
|                                                    
|                                                    
|                                                    
|State taxes, net of federal benefit                  |  |                         | (11,258 | )              |  |      | 12      |   |  |             | 20  |  
|                                                    
|                                                    
|                                                    
|                                                    
|Non-deductible amortization of deferred compensation |  |                         | 4,082   |                |  |      | 7,578   |   |  |             | 187 |  
|                                                    
|                                                    
|                                                    
|                                                    
|Non-deductible stock based compensation              |  |                         | 2,200   |                |  |      | 1,780   |   |  |             |    |  
|                                                    
|                                                    
|                                                    
|                                                    
|Change in valuation allowance                        |  |                         | 99,955  |                |  |      | 4,578   |   |  |             |    |  
|                                                    
|                                                    
|                                                    
|                                                    
|Other non-deductible expenses                        |  |                         | 49      |                |  |      | 58      |   |  |             | 3   |  
|                                                     |  |                         |         |                |  |      |         |   |  |             |     |  
|                                                     |  | $                       |        |                |  | $    | (93     | ) |  | $           | 134 |  
|                                                     |  |                         |         |                |  |      |         |   |  |             |     |  

As of December 31, 2000, MP3.com has federal net operating loss carryforwards
of approximately $200,000,000 expiring through 2020 and state net operating
loss carryforwards of approximately $190,000,000 expiring through 2007. The
utilization of these loss carryforwards may be limited by certain events
including an ownership change as defined by the Internal Revenue Code.
Deferred tax assets relating to net operating loss carryforwards as of December
31, 2000 include approximately $350,000 associated with stock option activity
for which subsequent recognizable tax benefits, if any, will be credited
directly to shareholders equity.

9. Legal Proceedings

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

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

As a result of these settlements, the Major Label Lawsuit was limited to a dispute with UMG Recordings, Inc., which represents
two of the original plaintiffs. A trial in the case was held from August 28

85



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through September 6, 2000 on the issues of willfulness and damages. After
hearing evidence, the court ruled on September 6, 2000 that MP3.com had
willfully infringed UMGs copyrights and awarded damages to UMG in an amount of
$25,000 per CD. The Court then scheduled a period to allow MP3.com to conduct
discovery concerning the certificates of registration for which plaintiffs
sought damages. Prior to trial, UMG claimed that it held valid copyright
registrations on between 5,000 and 10,000 CDs. On November 16, 2000, UMG made
a motion for entry of judgment in the amount of $53,400,000 million in
statutory damages, costs and attorneys fees, which MP3.com did not oppose. As
a result, a judgment in that amount was entered.

MP3.com has also entered into a license agreement with UMG. Subject to certain
affirmative obligations of MP3.com and other terms and conditions regarding the
implementation of the My.MP3 service, the license agreements discussed above
permit MP3.com to utilize recordings owned by Warner Music Group, BMG
Entertainment, Sony Music, EMI and UMG as part of the My.MP3 service. The
license agreements have terms of approximately three to ten years, and provide
for payment of a one-time fee each time a licensor's recording is
added to a separate My.MP3 account. These licenses also provide for on-going royalty payments based on the greater of (i) a specified
percentage of net revenues generated from or in connection with the My.MP3
service or (ii) a specified amount accrued each time a licensors recording is
streamed from My.MP3. Although MP3.com has obtained license agreements permitting the use
of recordings from BMG Entertainment, Warner Music Group, Sony Music, UMG and
EMI, there cannot be any assurance that MP3.com will be able to secure similar license
agreements from any other recording company.

Other Record Label Lawsuits. Over the course of 2000, some other entities filed lawsuits against MP3.com based on
the same set of allegations as the UMG case. These include: Zomba Recording
Corp.; Tee Vee Toons, Inc.; Koch Entertainment and Velvel Records LLC (the
Koch case); EMusic.com, Inc., Fuel 2000 Records, Spinart, Inc., Gig Records,
Fearless Records, and Invisible Records (the EMusic case); and Unity
Entertainment Corporation (the Unity case). Additionally, several
independent labels have sent MP3.com demand letters alleging similar claims.
Discovery in the Tee Vee Toons case is scheduled to end on January 26, 2001,
the final pre-trial conference is scheduled for February 27, 2001, and trial is
scheduled to commence on March 26, 2001. Discovery in the Zomba case is
currently being conducted and is scheduled to close on March 5, 2001, the
final pre-trial conference is scheduled for April 13, 2001 and pursuant to the
case management plan the case is to be ready for trial on April 16, 2001.
Discovery in the Koch case is scheduled to close on March 9, 2001 and the final
pre-trial conference is scheduled for April 23, 2001. The complaint in the
EMusic case was filed on December 14, 2000. MP3.coms response to the
complaint is currently due by February 8, 2001. The Unity case, which purports
to be brought on behalf of Unity, an independent record company whose works
were allegedly used in the My.MP3 service, and all other similarly situated
entities or individuals, was filed on November 7, 2000. MP3.com, Inc. answered
the Complaint on January 16, 2001. In view of the courts
rulings in the Major Label Lawsuit, there is a substantial risk that the issues of infringement, fair use,
and willfulness may be adjudicated against us in these cases. This could mean that
MP3.com would only be able to litigate the issue of damages.

Publisher Lawsuits.On March 14, 2000, two large music-publishing companies,
MPL Communications, Inc. and Peer International Corporation, with the
assistance of The Harry Fox Agency, Inc., filed a copyright
infringement lawsuit against MP3.com in the United States District Court for
the Southern District of New York (the MPL/Peer case). The complaint alleged
that MP3.com, in connection with its My.MP3 service, made unauthorized copies
of approximately 45,000 audio CDs in violation of the Copyright Act, and that
MP3.com, in connection with the streaming of audio content to users of the
My.MP3 service, continued to make unauthorized digital phonorecords in
violation of the Copyright Act. The complaint further alleged that MP3.coms
actions constituted unauthorized copying and willful infringement of
plaintiffs copyrights. Plaintiffs seek damages (including statutory damages of
up to $150,000 per violation) and injunctive relief prohibiting MP3.com from
operating its My.MP3 service or any other service that uses unauthorized
reproductions of plaintiffs copyrighted works. Additionally, Zomba
Enterprises, Inc. has filed its own music publishing case against
MP3.com. In view
of the courts rulings in the Major Label Lawsuit, there is a substantial risk that the
issues of infringement, fair use, and willfulness may be adjudicated
against MP3.com
in these cases with publishers. This could mean that MP3.com would only be able to
litigate the issue of damages.

On October 17, 2000, MP3.com, the National Music Publishers Association, Inc.
and its licensing subsidiary, The Harry Fox Agency, Inc. entered into a
preliminary agreement that if approved by individual HFA music
publisher-principals would permit the use of up to one million musical
compositions on the My.MP3 service. In addition, MP3.com, MPL and Peer agreed
to settle the MPL/Peer case upon finalization of the preliminary agreement, and
agreed to stay the MPL/Peer case pending such finalization. In the
MPL/Peer case a stipulation of dismissal with

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prejudice was subsequently signed by the parties on December 28,
2000 and so ordered by the Court on January 2, 2001.

The proposed, 3-year licensing arrangement provides that MP3.com will pay up to
$30,000,000 to HFA for the benefit of up to 25,000 music publishers and their
songwriter partners, to be allocated to two equal funds. One fund will be used
to pay HFA publisher-principals for past uses of music on the My.MP3 service,
in exchange for a release from HFA publisher-principals and their affiliated
entities of all claims related to the MPL/Peer case and the use of their
compositions on the My.MP3 service. The other fund will provide advance
payments toward royalties earned under the prospective license. The terms of
the prospective license call for a payment of one-quarter cent each time a song
is streamed on demand to a customer from his or her My.MP3 locker, along with a
one-time fee per track added to the My.MP3 service. In December 2000, MP3.com
and HFA agreed to extend the period of time during which individual HFA music
publisher-principals could approve the preliminary agreement and permit their
musical compositions to be used on the My.MP3 service.

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

Copyright Settlement Discussions; Charge to Earnings.MP3.com has pursued and
continues to actively pursue settlement discussions with the various plaintiffs
and claimants in the cases and disputes discussed above. The decision whether
to enter into settlement and/or license agreements with each party will be
based upon a number of factors related to both the lawsuits and MP3.coms
business in general. There is no guarantee that MP3.com will be able to
enter into any additional settlement agreements on terms favorable to MP3.com,
if at all, or that any settlement or license agreement will prove
beneficial to MP3.com or its stockholders. During the year ended December 31, 2000, MP3.com
recorded a charge for litigation and copyright matters of $170.0 million. The
charge for litigation and copyright matters represented MP3.coms estimate of the
total costs to be incurred only in connection with the resolution of the
various litigation and copyright matters associated with the My.MP3 service,
including the lawsuits filed by major recording companies and other parties.
Copyright issues associated with the My.MP3 service also include but are not
limited to publishing rights, non-major label content, and legal and advisory
fees. This charge did not reflect or include any amounts paid or payable in
connection with forward-looking licenses to use music recordings or
compositions in connection with the My.MP3 service. This charge
reflects managements current expectations, and is based on currently available
information as well as significant assumptions made by management regarding the
various litigation and copyright matters. Cash payments for the settlements and
judgments discussed above and other payments have reduced the cumulative amount
reserved as a result of this charge to $42.9 million as of December 31, 2000.
MP3.com cannot guarantee that future events or results will conform
to management's
expectations or assumptions regarding the various litigation and copyright
matters. If these expectations and significant assumptions prove to be
erroneous in light of future events, the actual amounts incurred by MP3.com to
resolve all copyright matters related to the My.MP3 service could be materially
different than those recorded as of December 31, 2000, and could far exceed the
resources and market capitalization of MP3.com.

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Class Action Lawsuits.MP3.com and certain of the
Company's employees, officers and directors
have been named as defendants in several lawsuits alleging violations of the
federal securities laws. The complaints, which were filed between September 19,
2000 and November 15, 2000 in the United States District Court for the Southern
District of California, each purport to be brought on behalf of a class of
stockholders. The complaints allege that MP3.com and the other the defendants
violated the federal securities laws by issuing materially false and misleading
statements and failing to disclose material information regarding the My.MP3
service and the litigation surrounding the service. The court has entered an
order appointing lead counsel and identifying the representative plaintiffs.
The complaint does not specify the dollar amount of damages alleged. A
stipulated order has been entered providing the plaintiffs until March 2001 to
file a consolidated first amended complaint, after which MP3.com and the other
defendants will have 60 days to respond. MP3.com has not recorded any charge related
to these claims as of December 31, 2000.

Derivative Lawsuits.Between September 14, 2000 and October 26, 2000, certain
stockholders of MP3.com filed shareholder derivative suits against MP3.com and
certain of its employees, officers and directors in the Superior Court of the
State of California, County of San Diego. These complaints allege various
statutory and common law claims relating to the My.MP3 service, including
breach of fiduciary duty, abuse of control, constructive fraud, gross
mismanagement, unjust enrichment and waste of corporate assets. Pursuant to a
stipulated order, plaintiffs filed a First Amended Consolidated Shareholder
Derivative Complaint on January 16, 2001. MP3.com and the other defendants
initial response to the consolidated complaint is due in March 2001.

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

In particular, the music industry in the United States is generally regarded as
extremely litigious in nature compared to other industries. As a result, in the future
MP3.com may be engaged in litigation with others in the music industry, including those
entities with whom MP3.com has ongoing license arrangements. For example, some of the major
recording companies that settled their portion of the Major Label Lawsuit with MP3.com
have asserted in writing that they believe the amount paid by MP3.com to UMG in
satisfaction of the Court's judgment, together with the concurrent issuance of warrants to UMG,
triggered additional payments to them under the most favored nations clause in their
settlement agreement with MP3.com. Although MP3.com does not believe they are entitled to any such
additional payments, there cannot be any assurance that MP3.com will be successful in ultimately concluding
this particular matter in an amicable fashion, or defending any resulting lawsuit.
As a result, MP3.com may be forced to defend one or more lawsuits on this and other issues
in the future, and in fact may be involved in a number of litigation proceedings with the
same group of related plaintiffs. MP3.com has not recorded any charge
related to any claims
for additional most favored nations payments as of December 31, 2000.

There cannot be any assurance MP3.com will be successful in ultimately defending any of
these lawsuits, and MP3.com may be required to pay license fees or substantial
damages, including statutory, punitive or other damages that far exceed the
resources and overall market capitalization of MP3.com, in which
event, MP3.com might have to significantly limit or terminate its
business operation. At the rate of $25,000
per work (which is the per CD amount of statutory damages awarded
by the court in the Major Label Lawsuit),
MP3.com's aggregate potential liability resulting from all of the copyright
litigation proceedings could exceed one billion dollars. If successful, any one
of these lawsuits could seriously have a material adverse effect on
MP3.com's business by forcing MP3.com to cease
providing services to consumers or requiring MP3.com to pay monetary damages.
Even if unsuccessful, these lawsuits still can have a material
adverse effect on MP3.com's business by severely damaging MP3.com's reputation, requiring
MP3.com to incur legal costs, lowering MP3.com's stock
price and public demand for MP3.com's stock, and diverting managements attention
away from MP3.com's primary business activities in general.

10. Quarterly Financial Data (Unaudited) (In thousands, except per share amounts)

|                                                             |  |           |         |          |  |               |          |              |  |   |         |   |  |   |         |  
|------------------------------------------------------------ |  | --------- | ------- | -------- |  | ------------- | -------- | ------------ |  | - | ------- | - |  | - | ------- | -
|                                                             |  |           |         |          |  | Quarter Ended
|                                                            
|                                                             |  | March 31, |         | June 30, |  | September 30, |          | December 31,
|                                                             |  |           |         |          |  |               |          |             
|1999                                                        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|Net revenue                                                  |  | $         | 666     |          |  | $             | 1,911    |              |  | $ | 4,051   |   |  | $ | 15,271  |  
|                                                            
|                                                            
|                                                            
|                                                            
|Gross profit                                                 |  | $         | 460     |          |  | $             | 1,100    |              |  | $ | 2,364   |   |  | $ | 8,764   |  
|                                                            
|                                                            
|                                                            
|                                                            
|Net loss                                                     |  | $         | (1,406  | )        |  | $             | (6,343   | )            |  | $ | (19,869 | ) |  | $ | (14,864 | )
|                                                            
|                                                            
|                                                            
|                                                            
|Net loss per share basic and diluted                        |  | $         | (0.05   | )        |  | $             | (0.22    | )            |  | $ | (0.33   | ) |  | $ | (0.23   | )
|                                                            
|                                                            
|                                                            
|                                                            
|Shares used in the per share calculation -
basic and diluted |  |           | 27,537  |          |  |               | 28,838   |              |  |   | 60,333  |   |  |   | 63,316  |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|2000                                                        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |  |           |         |         
|                                                            
|                                                            
|                                                            
|                                                            
|Net revenue                                                  |  | $         | 17,495  |          |  | $             | 20,178   |              |  | $ | 20,459  |   |  | $ | 22,004  |  
|                                                            
|                                                            
|                                                            
|                                                            
|Gross profit                                                 |  | $         | 13,739  |          |  | $             | 16,366   |              |  | $ | 16,713  |   |  | $ | 17,558  |  
|                                                            
|                                                            
|                                                            
|                                                            
|Net loss                                                     |  | $         | (18,137 | )        |  | $             | (177,068 | )            |  | $ | (48,700 | ) |  | $ | (35,588 | )
|                                                            
|                                                            
|                                                            
|                                                            
|Net loss per share basic and diluted                        |  | $         | (0.28   | )        |  | $             | (2.71    | )            |  | $ | (0.74   | ) |  | $ | (0.54   | )
|                                                            
|                                                            
|                                                            
|                                                            
|Shares used in the per share calculation -
basic and diluted |  |           | 64,628  |          |  |               | 65,384   |              |  |   | 65,989  |   |  |   | 66,509  |  

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Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not Applicable.







PART III







Item 10.Directors and Executive Officers of the Registrant

The information required by this item is incorporated by reference from the
information under the caption Directors, Executive Officers and Key Employees
contained in Item 1 of Part I of this Form 10-K.







Item 11.Executive Compensation

The information required by this item is incorporated by reference from the
information under the caption Executive Compensation in our proxy statement
to be filed in connection with the solicitation of proxies for our 2001 Annual
Meeting of Stockholders (the Proxy Statement).







Item 12.Security Ownership of Certain Beneficial Owners and Management

The information required by this item is incorporated by reference from the
information under the caption Security Ownership of Certain Beneficial Owners
and Management contained in the Proxy Statement.







Item 13.Certain Relationships and Related Transactions

The information required by this item is incorporated by reference from the
information contained under the caption Certain Transactions in the Proxy
Statement.







PART IV







Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)(1) Financial Statements



| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | The financial statements required by this item are submitted in a separate
section with the index beginning on page 64 of this report.



| |                                  
| | ---------------------------------
| | (2) Financial Statement Schedules



| |                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The following financial statement schedule of MP3.com is included in Item
14(d):                                                                                                                                                        
|
| | Schedule II Valuation and Qualifying Accounts                                                                                                                                                                                          
|
| | All other schedules for which provisions are made in the applicable
accounting regulation of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore
have been omitted.



| |             
| | ------------
| | (3) Exhibits



| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | See Item 14 (c) below. Each management contract or compensatory plan or
arrangement is identified separately in Item 14(c).

(b)       Reports on Form 8-K



| |                                                                              
| | -----------------------------------------------------------------------------
| | No reports on Form 8-K were filed during the quarter ended December 31,
2000.

(c)       Exhibits

89



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##### Table of Contents









|          |  |                                                                                                                                                                                
|--------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit  
|Number    |  | Description of Document                                                                                                                                                        
|          |  |                                                                                                                                                                                
|3.1*      |  | Restated Certificate of Incorporation, as currently in effect.                                                                                                                 
|         
|         
|         
|         
|3.2*      |  | Bylaws, as currently in effect.                                                                                                                                                
|         
|         
|         
|         
|4.1       |  | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                     
|         
|         
|         
|         
|4.2*      |  | Specimen Stock Certificate.                                                                                                                                                    
|         
|         
|         
|         
|10.1(d)  |  | Amended and Restated 1998 Equity Incentive Plan (the 1998 Plan).                                                                                                             
|         
|         
|         
|         
|10.2*    |  | Form of Stock Option Agreement pursuant to the 1998 Plan.                                                                                                                      
|         
|         
|         
|         
|10.3(d)  |  | 2000 Equity Incentive Plan (the 2000 Plan).                                                                                                                                  
|         
|         
|         
|         
|10.4(d)  |  | Form of Stock Option Agreement pursuant to the 2000 Plan.                                                                                                                      
|         
|         
|         
|         
|10.5     |  | Employee Stock Purchase Plan, as amended, and related offering
documents.                                                                                                      
|         
|         
|         
|         
|10.6*     |  | Form of Indemnity Agreement between MP3.com and its directors
and officers.                                                                                                    
|         
|         
|         
|         
|10.7*     |  | Second Amended and Restated Investor Rights Agreement among
MP3.com and certain stockholders of MP3.com dated June 4, 1999.                                                    
|         
|         
|         
|         
|10.8*    |  | Founder Stock Purchase Agreement between MP3.com and Michael L.
Robertson dated March 18, 1998.                                                                                
|         
|         
|         
|         
|10.9*    |  | Employment Agreement between MP3.com and Michael L. Robertson
dated May 13, 1999.                                                                                              
|         
|         
|         
|         
|10.10*   |  | Letter Agreement regarding employment between MP3.com and Robin D.
Richards dated January 6, 1999.                                                                             
|         
|         
|         
|         
|10.11*   |  | Promissory Note from Robin D. Richards to MP3.com dated January 25,
1999.                                                                                                      
|         
|         
|         
|         
|10.12*   |  | Stock Pledge Agreement, as amended, from Robin D. Richards to
MP3.com dated January 25, 1999.                                                                                  
|         
|         
|         
|         
|10.133*  |  | Letter Agreement regarding employment between MP3.com and Paul L.
H. Ouyang dated February 19, 1999.                                                                           
|         
|         
|         
|         
|10.14*   |  | Letter Agreement regarding employment between MP3.com and Steven G.
Sheiner, as amended, dated May 19, 1999.                                                                   
|         
|         
|         
|         
|10.15(a)  |  | Sublease between MP3.com and ADC Wireless System, Inc. dated July
22, 1999, regarding property located at 4790 Eastgate Mall, San Diego,
California.                           
|         
|         
|         
|         
|10.16(b)  |  | Sublease between MP3.com and Franklin Resources, Inc. dated
December 13, 1999, regarding property located at 4780 Eastgate Mall,
San Diego, California.                        
|         
|         
|         
|         
|10.17(b)  |  | Manufacturing and Fulfillment Services Agreement between MP3.com
and Cinram, Inc. dated November 4, 1999.                                                                      
|         
|         
|         
|         
|10.18(c) |  | Separation Agreement between MP3.com and Thomas Spiegel dated
March 9, 2000.                                                                                                   
|         
|         
|         
|         
|10.19(d) |  | Settlement Agreement between MP3.com and BMG Entertainment dated
June 8, 2000.                                                                                                 
|         
|         
|         
|         
|10.20(d) |  | Settlement Agreement between MP3.com and Warner Music Group Inc.
dated June 8, 2000.                                                                                           
|         
|         
|         
|         
|10.21(e) |  | Settlement Agreement between MP3.com and Capitol Records, Inc.
(a.k.a. EMI) dated July 26, 2000.                                                                               
|         
|         
|         
|         
|10.22(e) |  | License Agreement between MP3.com and Virgin Holdings, Inc.
(a.k.a. EMI) dated July 26, 2000.                                                                                  
|         
|         
|         
|         
|10.23(e) |  | Settlement Agreement between MP3.com and Sony Music Entertainment
Inc. dated August 17, 2000.                                                                                  
|         
|         
|         
|         
|10.24(e) |  | Amended and Restated Advertising, Promotion and Marketing
Agreement between MP3.com and Montaigne Participations Et Gestion
(formerly Groupe Arnault) dated September 29, 2000.
|         
|         
|         
|         
|10.25     |  | Settlement Agreement between MP3.com and The Harry Fox Agency,
Inc., MPL Communications, Inc. and Peer International Corporation
dated October 17, 2000.                       
|         
|         
|         
|         
|10.26     |  | Amendment to Settlement Agreement between MP3.com and The Harry Fox
Agency, Inc., MPL Communications, Inc. and Peer International
Corporation dated December 28, 2000.         
|         
|         
|         
|         
|10.27    |  | License Agreement between MP3.com and UMG Recordings, Inc. dated November 14, 2000.                                                                                            
|         
|         
|         
|         
|23.1      |  | Consent of Ernst & Young LLP, Independent Auditors.                                                                                                                            

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---

| |    |  | Confidential treatment has been requested with respect to
certain portions of this exhibit. Omitted portions have been filed
separately with the Securities and Exchange Commission.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |  | Management contract or compensatory plan or
arrangement.                                                                                                                            
|
|
|
|
| | *   |  | Filed as an exhibit to MP3.coms Registration Statement on
Form S-1, Registration No. 333-78545, and incorporated herein by
reference.                                              
|
|
|
|
| | (a) |  | Filed as an exhibit to MP3.coms Form 10-Q for the quarter
ended September 30, 1999, and incorporated herein by reference.                                                          
|
|
|
|
| | (b) |  | Filed as an exhibit to MP3.coms Form 10-K for the year
ended December 31, 1999, and incorporated herein by reference.                                                              
|
|
|
|
| | (c) |  | Filed as an exhibit to MP3.coms Form 10-Q for the quarter
ended March 31, 2000, and incorporated herein by reference.                                                              
|
|
|
|
| | (d) |  | Filed as an exhibit to MP3.coms Form 10-Q for the quarter
ended June 30, 2000, and incorporated herein by reference.                                                               
|
|
|
|
| | (e) |  | Filed as an exhibit to MP3.coms Form 10-Q for the quarter
ended September 30, 2000, and incorporated herein by reference.                                                          

91



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(d) Financial Statement Schedules

Schedule II

MP3.com, Inc.

Valuation and Qualifying Accounts

|                                                                                   |  |            |         |            |  |           |           |            |  |            |   |            |  |   |         |  |  |   |           | 
|---------------------------------------------------------------------------------- |  | ---------- | ------- | ---------- |  | --------- | --------- | ---------- |  | ---------- | - | ---------- |  | - | ------- |  |  | - | --------- | 
|COL. A                                                                             |  | COL. B     |         | COL. C     |  | COL. D    |           | COL. E    
|                                                                                   |  |            |         |            |  |           |           |           
|                                                                                   |  |            |         |            |  | Additions |           | Deductions
|                                                                                   |  |            |         |            |  |           |           |           
|                                                                                   |  |            |         |            |  |           |           |            |  | Charged to
|                                                                                   |  | Balance at |         | Charged to |  | Other     |           |            |  |            |   | Balance at
|                                                                                   |  | Beginning  |         | Costs and  |  | Accounts- |           |            |  |            |   | End of    
|Description                                                                        |  | of Period  |         | Expenses   |  | Describe  |           | Write-Offs |  | Period    
|                                                                                   |  |            |         |            |  |           |           |            |  |           
|Allowance for doubtful accounts                                                   
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|For the year ended December 31, 2000                                               |  | $          | 600,000 |            |  | $         | 2,107,000 |            |  | $          |  |            |  | $ | 897,000 |  |  | $ | 1,810,000 | 
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|For the year ended December 31, 1999                                               |  | $          | 56,615  |            |  | $         | 677,819   |            |  | $          |  |            |  | $ | 134,434 |  |  | $ | 600,000   | 
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|For the period March 17, 1998 (inception)
to
                    December 31, 1998 |  | $          |        |            |  | $         | 56,615    |            |  | $          |  |            |  | $ |        |  |  | $ | 56,615    | 

92



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##### Table of Contents









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, on
January 31, 2001.



| | MP3.COM, INC.
| | -------------



| | By: /s/ 
           ROBIN D. RICHARDS
| | -------------------------------------
| | Robin D. RichardsPresident           

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.

|                                                    |  |                                                                                                   |  |                 
|--------------------------------------------------- |  | ------------------------------------------------------------------------------------------------- |  | ----------------
|Signature                                           |  | Title                                                                                             |  | Date            
|                                                    |  |                                                                                                   |  |                 
|                                                   
|/s/   MICHAEL L. ROBERTSON
Michael L. Robertson     |  | Chief Executive Officer and Director(Principal Executive Officer)                                 |  | January 31, 2001
|                                                   
|/s/   ROBIN D. RICHARDS
Robin D. Richards           |  | President and Director                                                                            |  | January 31, 2001
|                                                   
|/s/   PAUL L. H. OUYANG
Paul L. H. Ouyang           |  | Chief Financial Officer and Executive Vice
President (Principal Financial and
Accounting Officer) |  | January 31, 2001
|                                                   
|/s/   THOMAS A. HEYMANN
Thomas A. Heymann           |  | Director                                                                                          |  | January 31, 2001
|                                                   
|/s/   LAWRENCE F. PROBST III
Lawrence F. Probst III |  | Director                                                                                          |  | January 29, 2001
|                                                   
|/s/   MARK A. STEVENS
Mark A. Stevens               |  | Director                                                                                          |  | January 31, 2001
|                                                   
|/s/   HOWARD B. WIENER
Howard B. Wiener             |  | Director                                                                                          |  | January 31, 2001

93