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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K
 
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from to
 Commission File Number: 000-30063 ARTISTDIRECT, INC.
  
 DELAWARE
    
    95-4760230(State or Other Jurisdiction
of Incorporation or Organization)
    
    (I.R.S. Employer Identification Number)
 10900 Wilshire Boulevard, Suite 1400, Los Angeles, California 90024
(Address of principal executive offices, including Zip Code)Registrants telephone number, including area code: (310) 443-5360 
 Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 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 þ No o Indicate by check mark whether the 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 o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes o No þ As of March 29, 2005, the aggregate market value of the voting common stock held by
non-affiliates of the Registrant was approximately $2,500,000, based on the closing price per share
of $0.79 for the Registrants common stock as reported on the OTC Bulletin Board on such date. As of March 29, 2005, there were 3,502,117 shares of the Registrants common stock, par value
$0.01 per share, issued and outstanding. Documents incorporated by reference: None




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ARTISTDIRECT INC. ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS PagePART I
    
    3ITEM 1. BUSINESS
    
    3ITEM 2. PROPERTIES
    
    18ITEM 3. LEGAL PROCEEDINGS
    
    18ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    18PART II
    
    19ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
    
    19ITEM 6. SELECTED FINANCIAL DATA
    
    20ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    21ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
    
    38ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    38ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
    
    38ITEM 9A. CONTROLS AND PROCEDURES
    
    39ITEM 9B. OTHER INFORMATION
    
    39PART III
    
    40ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    
    40ITEM 11. EXECUTIVE COMPENSATION
    
    42ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
    
    49ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    54ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    55PART IV
    
    56ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
    
    56SIGNATURES
    
    57EXHIBIT 23.1EXHIBIT 23.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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This Annual Report onForm 10-Kfor the fiscal year ended December 31, 2004 contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements
that include the words believes, expects, anticipates, or similar expressions. These forward
looking statements may include, among others, statements concerning the Companys expectations
regarding its business, growth prospects, revenue trends, operating costs, working capital
requirements, competition, results of operations and other statements of expectations, beliefs,
future plans and strategies, anticipated events or trends, and similar expressions concerning
matters that are not historical facts. The forward-looking statements in this Annual Report on
Form 10-KSB for the fiscal year ended December 31, 2004 involve known and unknown risks,
uncertainties and other factors that could cause the actual results, performance or achievements of
the Company to differ materially from those expressed or implied by the forward-looking statements
contained herein. Each forward-looking statement should be read in context with, and with an understanding of,
the various disclosures concerning the Company and its business made elsewhere in this Annual
Report onForm 10-Kfor the fiscal year ended December 31 ,2004, as well as other public reports
filed with the United States Securities and Exchange Commission. Investors should not place undue
reliance on any forward-looking statement as a prediction of actual results of developments.
Except as required by applicable law or regulation, the Company undertakes no obligation to update
or revise any forward-looking statement contained in this Annual Report onForm 10-KSBfor the
fiscal year ended December 31, 2004. 
 PART I 
 ITEM 1. BUSINESS OVERVIEW We are an online music entertainment company that provides an integrated offering for music fans,
artists and marketing partners. The ARTISTdirect Network (www.artistdirect.com) is a network of web
sites offering multi-media content, music news and information, community around shared music
interests, advertising sponsorships, music-related specialty commerce and digital music services. The ARTISTdirect Network consists of our music search engine and database containing information on
more than 100,000 artists, retail e-commerce offering a wide selection of artist merchandise and
music, our proprietary music guide that enables users to browse music by artist, genre or time
period, a music-oriented online community and the ability for users to download and listen to music
and view music videos.  
    ARTISTdirect.com  a comprehensive online music search engine and resource for music
information. ARTISTdirect.com provides information on more than 100,000 artists across
numerous musical genres, featuring news, concert information, artist biographies, album
reviews, contests, promotions, music samples and downloads. Artistdirect.com also offers
links to numerous other Web sites in the online music community;
    Community  a music-oriented online community providing message boards relating to
general music topics. The Community area allows fans to communicate with others around the
world to share interests and commentary about their favorite music and artists;
    The ARTISTdirect Shopping area  a retail site offering a wide selection of music titles
and artist and lifestyle merchandise:
    Music Streaming and Downloads and Video  a feature that enables users to stream,
download and listen to music from a variety of artists.
    Video  Users can view a variety of current music videos featuring popular and emerging
artists.
    Music Guide  a feature that allows users to navigate a large catalog of music by
artist, genre or time period (e.g., 60s Rock), facilitating both quick access to music
known to the user and the discovery of music that may be new to the user. The music guide
is designed to function with either short music clips or with full song files at such time
as we are able to enter into music licensing agreements on terms acceptable to us; 3




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RECENT EVENTS We underwent significant changes during the fiscal year ended December 31, 2004 as described below: Completion of Disposition of Assets Sale of ARTISTdirect Recordings to Radar Records Holdings Effective July 30, 2004, ARTISTdirect, Inc. (ADI) entered into a Termination Agreement with
BMG Music (BMG) and ARTISTdirect Records which extinguished all of ADIs obligations under its
funding guaranty, including the remaining $12.0 million funding obligation to ARTISTdirect Records,
LLC (ARTISTdirect Records). Effective as of December 31, 2004, ADI entered into a Transfer Agreement with ARTISTdirect
Recordings, Inc., a Delaware corporation and a wholly-owned subsidiary of ADI (ARTISTdirect
Recordings), and Radar Records Holdings, Inc. (Radar Records), a Delaware corporation
wholly-owned by ADIs Chairman, Frederick W. Field, pursuant to which ADI was obligated to sell its
common stock in ARTISTdirect Recordings to Radar Records for $115,000 in cash. ARTISTdirect
Recordings owned a 65% membership interest in ARTISTdirect Records. On February 28, 2005, ADI completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records pursuant to the Transfer Agreement, as a result of which ADI no longer
had any equity or other economic interest in ARTISTdirect Records, and Radar Records became the
owner of a majority of the membership interests in ARTISTdirect Records and also acquired the
receivable reflecting the $33.0 million of loan advances previously provided to ARTISTdirect
Records by ADI. In conjunction with this transaction, at February 28, 2005, ADI wrote-off the
intercompany balance due from ARTISTdirect Records ($80,000 at December 31, 2004), which was
eliminated in consolidation. Radar Records acquired the common stock of ARTISTdirect Recordings
subject to the rights of BMG. Radar Records also agreed to offer to investors who had provided
bridge funding to ARTISTdirect Records, excluding Frederick W. Field and entities related
or controlled by him, the right to acquire proportional shares (based on the amount of bridge
funding made by each bridge investor in ARTISTdirect Records) of the common stock of ARTISTdirect
Recordings on the same terms and conditions as set forth in the Transfer Agreement. As a result of the disposition of ADIs interest in ARTISTdirect Records effective February
28, 2005, ADI estimates that its will recognize a net non-cash gain in its consolidated statement
of operations for the three months ended March 31, 2005 of
approximately $21 million (unaudited),
primarily as a result of the elimination of the liabilities of ARTISTdirect Records. Discontinued Operations  iMusic Effective November 23, 2004, pursuant to a Trademark Assignment and Purchase Agreement dated
as of November 12, 2004, the Company sold all of its rights, title and interest in and to certain
trademarks, service markets and trade names, in certain countries of the world, that consist of or
incorporate the term iMusic (the Marks), including domain names that consist of or incorporate
the term iMUSIC (the Domain Names) and goodwill related to such marks or trade names, to Apple
Computer, Inc. for a cash payment of $500,000. The Marks and Domain Names that the Company sold
did not have any carrying value on the Companys books. As a result of the foregoing, during
December 2004, the Company ceased the sale of products under the iMusic label and discontinued the
operations of the iMusic record label. Departure of Directors Effective as of October 18, 2004, Stephen M. Krupa, Benjamin S. A. Moody and Marc
P. Geiger each resigned from the Board of Directors. Mr. Krupa and Mr. Moody were the only members
of the Companys Audit Committee. Effective November 29, 2004, pursuant to the Companys Bylaws,
the present directors of ADI elected Eric Pulier to fill a vacant seat on the Board of Directors,
to serve until his successor is duly elected and qualified, or until his earlier resignation or
removal as a director. Subsequently, effective January 18, 2005, pursuant to the Companys Bylaws,
the current directors of ADI elected Teymour Boutros-Ghali and Dimitri Villard to fill two vacant
seats on the Board of Directors, each to serve until his successor is duly elected and qualified,
or until his earlier resignation or removal as a director. 4




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ARTISTdirect BUSINESS SEGMENTS The ARTISTdirect Network is comprised of our Media and E-commerce operations. Media.Our Media operations include our content-oriented web sites, a collection of third party
music sites and our entertainment marketing initiatives. Revenue from Media operations is generated
from the sale of online advertising and integrated marketing solutions. We market and sell
advertising on a cost-per-impression (CPM) basis to advertising agencies and directly to various
companies as part of their marketing programs. Customers may purchase advertising space for the
entire ARTISTdirect Network, or they may tailor advertising based on music genre (e.g., jazz,
country, rock music) or based on functionality (e.g., directing advertising to customers using
music download features or broadband-only features of the ARTISTdirect Network). Since we are
increasingly aware of websites outside the ARTISTdirect Network that are frequently visited by
artists and music fans, we have also offered our customers advertising space on behalf of third
party music-related websites. E-Commerce.E-commerce operations consist of the sale of recorded music and artist-related
merchandise. Most of our sales come from our ARTISTdirect Shopping area, which offers a
comprehensive selection of music CDs and broad range of artist and lifestyle merchandise. INFRASTRUCTURE AND OPERATIONS TECHNOLOGY Our infrastructure is designed to be integrated, scalable, reliable and secure. The software that
we use supports the acquisition, management and publication of content on our web sites. During
2005, the management of our web sites and servers for content, applications, database and
electronic commerce is handled internally. Our servers are maintained at IX2 Networks, LLC, a
co-location facility in Los Angeles, California. Our operations depend on our and IX2s ability to
protect our systems against fire, power loss, telecommunications failure, break-ins and other
events. All web sites, servers, and systems are monitored and periodic backups are stored at our
downtown data center. Our current e-commerce system is based on SAP software with certain enhancements provided to us by
Pandesic, LLC, a joint venture between Intel and SAP that wound up operations in January 2001. Upon
Pandesics cessation of operations, we received the source code and executables for the e-commerce
system that had been provided previously by Pandesic, implemented SAPs software in house under a
two-year license from SAP. In December 2002, our two-year license expired and we entered into a
perpetual license agreement with SAP. ORDER PROCESSING AND FULFILLMENT Our web sites include an ordering system that is designed to facilitate convenient online
purchasing of pre-recorded music and merchandise. Customers can add items to their shopping cart
while surfing our web sites. At any time they can securely checkout, at which time they need to
register (if they are new customers), or enter a username and password to retrieve previously saved
billing, shipping and credit card information. We verify orders submitted for credit card payment
for fraud detection and sufficient funds before we release them for fulfillment. We also accept
alternative modes of payment, such as checks and money orders. Credit card numbers are encrypted,
and all customer, commerce and transactional data are stored in secure databases protected by
firewalls. The transmission of information over the Internet uses Secure Socket Layer security
technology verified by VeriSign. Alliance Entertainment. In August 1998, we entered into a five-year agreement with Alliance
Entertainment Corp. to be our primary supplier of music and music-related information for our
ARTISTdirect Superstore. This agreement is now month-to-month. Alliance owns the All Music Guide, a
comprehensive source of artist and album information that is supplied to our users primarily
through its integration into the UBL. Alliance fulfills compact discs ordered by our customers and
we pay Alliance the wholesale cost plus a fulfillment fee. In addition, Alliance provides warehouse
space and fulfillment services pursuant to an oral agreement that Alliance may terminate at any
time for a majority of the music-related merchandise that we offer which allows the consolidated
shipping of customer orders for both music and merchandise. We have integrated our order processing
system with Alliances information systems to assist in fulfillment tracking, inventory management
and customer service. We purchase almost all of the music titles available for sale on our web
sites from inventory held by Alliance. 5




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Benn Co. (formerly Old Glory).In November 2001, we entered into a six-month agreement with Old
Glory Boutique Distributing Inc. (Old Glory) to be a wholesale supplier of music-related merchandise and provide fulfillment
services for the products for which it sells to us. The agreement was renewed for a one-year period
in May 2002 and automatically renewed for an additional year in May 2003. In December 2002, this
agreement was assigned from Old Glory to Benn Co., LLC. This agreement is now month-to-month. If we are unable to continue our agreements with these suppliers, or if Alliance ceases to provide
fulfillment services for merchandise, our business could be adversely affected. CUSTOMER SERVICE In June 2001, we entered into a two-year agreement with AEC One-Stop Group, Inc. (Alliance
Entertainment) to provide customer support services for our Web sites consumers and respond to
customer inquiries, orders and other requests made by phone, fax, e-mail and regular mail. Prior to
entering into the agreement with Alliance, we provided customer service with an internal staff of
customer service representatives. This agreement is now month-to-month. SALES AND MARKETING ADVERTISING SALES We sell advertising and sponsorships to companies seeking to reach one or more of the distinct
demographic audiences viewing content in the ARTISTdirect Network. Advertisers may choose single
elements such as targeted or run-of-network banners or sponsorship of fixed placement on our web
sites. Pricing is negotiated based upon the size of the target audience, the duration and intensity
of the campaign and the size and placement of the advertisement. For the years ended December 31,
2002, 2003 and 2004, advertising revenue represented approximately 16%, 25% and 42%, respectively,
of total net revenue. In 2004, advertising revenue increased approximately 83% over the previous
year. MARKETING AND PROMOTION We use a number of methods to create awareness of the ARTISTdirect Network and drive traffic to our
web sites. We have focused much of our marketing activity on e-mail direct marketing to communicate
with registered users of specific artists and the ARTISTdirect Network. Campaigns have included
direct notification of special merchandise offers, contests, promotions and music downloads. COMPETITION The market for the online promotion and distribution of music and music-related products and
services is relatively new, highly competitive and rapidly changing. There are a large number of
Web sites competing for the attention and spending of consumers and advertisers, and we expect that
number to increase, because there are few barriers to entry to Internet commerce. In addition, the
competition for advertising revenue, both on Web sites and in more traditional media, is intense.
We compete as follows:  
    for music consumers and advertisers with providers of music information, community and
content such as MTV, America Online, MSN, Yahoo!, Listen.com and various other companies;
    with major online music retailers such as Amazon.com in selling music and merchandise;
    for music consumers and artist relationships with traditional music industry companies,
including Sony BMG Music Entertainment, EMI Music, a unit of EMI Group, Warner Music Group,
and Universal Music Group, a unit of Vivendi. Some of these companies have recently
established online presences to promote and distribute the music and tours of their
respective artists;
    for music consumers and advertisers with publishers and distributors of traditional
media, such as television, radio and print, including MTV, CMT, Rolling Stone and Spin and
their Internet affiliates; and
    with traditional retailers targeting music consumers, including Tower Records and Virgin
Megastore and their Internet affiliates, in selling music and merchandise. 6




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Our competitors have worked together to offer music over the Internet, and we may face increased
competitive pressures as a result. For instance, RealNetworks, Time Warner, Bertelsmann AG and EMI
Group formed MusicNet, a digital music subscription platform featuring on-demand downloads and
streaming. Various retailers such as BestBuy have cooperated to distribute music through the iTunes
platform. We believe that we are able to compete primarily on the bases of:  
    the breadth and quality of our search, database and the community features of our site;
    the variety, availability and price of music-related merchandise on our sites; and
    the ease of use and consumer acceptance of the ARTISTdirect Network. Competition is likely to increase significantly as new companies enter the market and current
competitors expand their services. Many of our current and potential competitors in the Internet
and music entertainment businesses may have substantial competitive advantages over us, including:  
    longer operating histories;
    significantly greater financial, technical and marketing resources;
    greater brand name recognition;
    larger existing customer bases; and
    more popular content or artists. These competitors may be able to respond more quickly to new or emerging technologies and changes
in customer requirements and to devote greater resources to the development, promotion and sale of
their products or services than we can. Web sites maintained by our existing and potential
competitors may be perceived by consumers, artists, talent management companies and other
music-related vendors or advertisers as being superior to ours. In addition, we may not be able to
maintain or increase our web site traffic levels, purchase inquiries and number of click-throughs
on our online advertisements. Further, our competitors may 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. GOVERNMENTAL 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. The following are some of
the evolving areas of law that are relevant to our business: CONTENT REGULATION Federal, state and foreign 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. For example, the Child Online Protection Act, or COPA, prohibits and imposes
criminal penalties and civil liability on anyone communicating material harmful to minors through
the Internet for commercial purposes, unless access to such material is blocked to minors under age
17. The Third U.S. Circuit Court of Appeals has upheld a preliminary injunction precluding
enforcement of COPA. In November 2001, the U.S. Supreme Court heard an appeal but no decision has
been issued yet. We could be liable if the injunction against COPA is lifted and if content
delivered by us or placed on our web sites violates COPA. On March 6, 2003, the Third U.S. Circuit
Court of Appeals issued a ruling that COPA restricts free speech because it is not narrowly focused
is enough to only target pornography, and is therefore unconstitutional. The Department of Justice
could appeal this ruling to the U.S. Supreme Court. 7




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PRIVACY LAW The state of privacy law is unsettled, and rapidly changing. 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. The FTC promulgated
regulations implementing COPPA on October 21, 1999, which became effective on April 21, 2000. The
principal COPPA requirement is that individually identifiable information about minors under the
age of 13 not be collected, used or displayed without first obtaining informed parental consent
that is verifiable in light of present technology. The FTC final regulations create a sliding
scale of permissible methods for obtaining such consent. Consent for internal use of the
individually identifiable information of children under the age of 13 can be obtained through
e-mail plus an additional safeguard, such as confirming consent with a delayed e-mail, telephone
call, or letter. Obtaining verifiable consent from a childs parent to share that childs
information with a third party or enable the child to publicly distribute the information by, for
example, allowing unrestricted access to a chat room or message board is significantly more
burdensome. While the temporary sliding scale implementation was due to expire on April 21, 2002,
on October 31, 2001, the FTC extended the implementation period through April 21, 2005. The FTC has required that parental consent for such higher risk activities be verified by more
secure methods than e-mail, such as a credit card in connection with a transaction, print-and-sign
forms, toll-free numbers staffed by trained operators, or digital signatures. Complying with the
new requirements is costly and will likely dissuade some of our customers. While we are attempting
to be fully compliant with the FTC requirements, our efforts may not be entirely successful. In
addition, at times we rely upon outside vendors to maintain data-collection software, and there can
be no assurance that they will at all times comply with our instructions to comply with COPPA. If
our methods of complying with COPPA are inadequate, we may face litigation with the FTC or
individuals, which would adversely affect our business. Moreover, we have posted a privacy policy pertaining to all users and visitors to our web site. By
doing so, we have subjected ourselves to the jurisdiction of the FTC. Should any of our business
practices be found to differ from our privacy policy, we could be subject to sanctions and
penalties from the FTC. It is also possible that users or visitors could try to recover damages in
a civil action as well. LAWS GOVERNING SENDING OF UNSOLICITED COMMERCIAL E-MAIL We typically provide our customers and other visitors to our Web sites with an opportunity to
opt-in, or agree to receive e-mailings from us. The federal government recently signed the
Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (CAN-SPAM) designed
to limit unsolicited commercial e-mail commonly referred to as spam. In addition, California and
a number of other states regulate the sending of e-mails for commercial purposes to third parties
where there is no preexisting business relationship. Further, several states give Internet service
providers (ISPs) a private right of action against those who send large e-mailings across their
servers in contravention of the ISPs posted policy. There is no guarantee that we will always be
fully compliant in all of our communications at all times. Our failure to comply with applicable
laws regarding these types of e-mails could result in significant fines, actual or statutory
damages, and injunctive actions. CONFORMANCE TO E-COMMERCE STATUTORY REQUIREMENTS FOR FORMATION OF CONTRACTS We conduct e-commerce on our web sites, and through affiliated web sites. The applicable law on
online formation of contracts has been unsettled and is evolving. On June 30, 2000, the federal
government enacted the E-Sign statute, which in limited cases permits online formation of
contracts. Similarly, on January 1, 2000, California adopted a standard version of the Uniform
Electronic Transactions Act (UETA), which also permits electronic signatures and record-keeping
for certain types of contracts. We attempt to comply with these laws, but there is no guarantee
that we will be successful. Judicial interpretation of their application could result in customer
contracts being set aside or modified. In that case, our e-commerce revenue could be materially
adversely affected. SALES TAX The tax treatment of goods sold over the Internet is currently unsettled. We collect sales taxes
for goods shipped to California and Florida, where we have a physical presence. A number of
proposals have been made at the state and local level 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. While the 8




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Internet Tax Freedom Act (ITFA) has placed a moratorium on new state and local taxes on Internet
commerce, the tax moratorium expired on November 1, 2003 and has not been re-enacted. At least some
state legislatures that will convene during early 2004 have indicated that they will move to expand
their sales taxes to cover Internet commerce, if the ITFA is not reinstated. Imposing state sales
taxes on Internet-based commerce would adversely affect our business. ONLINE CONTESTS AND SWEEPSTAKES We conduct online promotional contests and sweepstakes. No purchase is necessary to participate.
Our official rules, with all material terms, conditions of eligibility, dates of participation,
methods of entry and limitations, if any, along with the odds and prize offerings, are posted on
our web sites. In order to comply with New York and Florida state law, our prizes are limited in
value to less than $5,000, or we must comply with those states registration and bonding
requirements. While we attempt to comply with the law of all fifty state jurisdictions, we may not
be uniformly successful, and 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 OUR PROPRIETARY RIGHTS Copyrighted material that we develop, as well as our service marks and domain names relating
to the ARTISTdirect or UBL brands, and other proprietary rights are important to our business
prospects. We seek to protect our common-law trademarks through federal registration, but these
actions may be inadequate. Where consultants develop copyrighted content for us, our general policy
is to use written agreements prior to content creation to obtain ownership of that content. In
addition, we principally rely upon trademark, copyright, trade secret and contract law to protect
our proprietary rights. We generally enter into confidentiality agreements, work-made-for-hire
contracts and intellectual property licenses with our employees, consultants and corporate
partners, respectively, as part of our efforts to control access to and distribution of our
technologies, content and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties
may attempt to disclose or use our customer lists, Web site content, service marks, domain names or
confidential commercial data. The steps that we have taken may not prevent misappropriation of our
proprietary rights, particularly in foreign countries where laws or law enforcement practices may
not protect our proprietary rights at all, or as fully as in the United States. If third parties
were to use or otherwise misappropriate our copyrighted materials, trademarks or other proprietary
rights without our consent or approval, our competitive position could be harmed, or we could
become involved in costly and distracting litigation to enforce our rights. OUR WEB SITES FEATURE CONTENT THAT IS COPYRIGHTED BY MULTIPLE THIRD-PARTIES A copyright gives the owner divisible rights, including those of performance, reproduction and
distribution. The music featured by us is typically comprised of copyrighted works owned,
controlled or administered by multiple third parties, including record labels, artists,
songwriters, music publishers and performance rights and licensing organizations such as The Harry
Fox Agency, Broadcast Music Inc. and the American Society of Composers, Authors and Publishers.
Each song often has multiple copyright owners, who control rights which may include performance,
reproduction and distribution rights in the musical composition comprised of the lyrics and
music, as well as with the sound recording of the artists interpretation of the musical
composition. In the case of music videos, there are separate copyrights to the visual content, as
well as synchronization rights for integrating the music and video. We, or our artists, may have
different licensing arrangements with some or all of these parties to perform, reproduce and
distribute works depending upon how the song or music video is used by us. Our web sites, depending upon the specific musical work, may offer audio streaming of part or all
of an entire song or Web casting, or the downloading of an entire song in MP3 or other compressed
audio formats. Full-length streaming only occurs in special instances after obtaining an oral
license from the record label or band manager for the sound recording. In that case, an ASCAP or
BMI blanket music license is also obtained by us or by our artists for rights to perform the
associated underlying musical composition. Where we offer full-length downloads of songs in MP3
or other compressed audio formats, we seek to obtain the rights to transmit, reproduce and perform
the sound recording in writing from the person or entity owning or controlling copyrights in such
sound recording. With respect to rights in the musical compositions embodied in such sound
recordings offered for download, we seek to clear rights in musical composition in one of the
following three ways:  
    a license agreement with the publisher, writer or other owner of such copyright in the musical composition; 9




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
    a waiver of any fees or royalties that would otherwise be required for such use; or
    a representation and warranty from the owner of the copyrights in the sound recording
that no mechanical royalties are owed to any third parties. In the event that the foregoing steps are insufficient to clear rights, or we otherwise fail to
obtain rights, we could be exposed to claims of copyright infringement, with attendant disruption
to our operations and liability including potential statutory or actual damages and loss of profits
attributable to infringement, plus payment of attorneys fees to the claimant and entry of an
injunction. There are other situations, such as a limited 30-second sample of a song that is streamed, where
we use content relying upon a sub-license from an artists record label. However, the laws in this
area are uncertain, and we may be forced to obtain additional licenses or may be prevented from
third party content use, and may further be liable to pay actual or statutory damages, profits
attributable to any alleged infringement, as well as attorneys fees. Our licensing arrangements
for third-party content vary from formal contracts to informal agreements based on the promotional
nature of the content. In some cases we pay a fee to the licensor for use of the sound recording,
musical composition or music video and in other cases the use is free. We also use other
third-party content, including photographs, artist names, likenesses and concert reviews. While it
is our general policy to obtain a written release or license for such use, in many instances we
rely only upon an oral license for such use. We rely upon our positive working relationships with
copyright owners to obtain licenses on favorable terms. Any changes in the nature or terms of these
arrangements, including any requirement that we pay significant fees for the use of the content,
could have a negative impact on the availability of content or our business. For example, the Copyright Office recently opined that additional royalties, besides those
collected for musical compositions by ASCAP or BMI, are due for webcasted music that is selected by
or on behalf of the recipient pursuant to 17 U.S.C. sec. 114(j)(7). If upheld, that ruling would
prevent us from expanding our service to permit users to play a requested song via our Web site
without paying additional royalties. LINKING AND FRAMING OF THIRD-PARTY WEB SITES We link to and frame third-party web sites of our artists without express written permission to
do so. In addition, in the past we have provided a search feature to allow users to find music
residing elsewhere on the Internet. Those practices are controversial, and have, in instances not
involving us, resulted in litigation. Various claims, including trademark and copyright
infringement, unfair competition, and commercial misappropriation, as well as infringement of the
right of publicity may be asserted against us as a result of these practices. The law regarding
linking and framing remains unsettled; it is uncertain as to how existing laws, especially
trademark and copyright law, will be applied by the judiciary to the Internet. Also, Congress is
increasingly active in passing new laws related to the Internet, and there is uncertainty as to the
impact of future potential laws, especially those involving domain names, databases and privacy. DEFAMATION OR CONTRIBUTORY INFRINGEMENT Our web site features a community area where visitors can post comments We do not censor such
comments and it is possible that a customer could use our web sites as a forum to make false,
misleading or disparaging remarks about others. Such on-line comments could lead to claims for
defamation or infringement. As to libel claims brought in the United States, we believe that we
qualify for safe harbor protection for third-party postings under 47 U.S.C. sec. 230(c)(1).
However, other countries, notably the United Kingdom, may impose such liability, and it is possible
we could be sued there for third-party postings. Separately, our web sites allow consumers to use
our personal web publishing tools to post samples of their works. Such postings could be misused to
post unlicensed copyrighted content of others. We have obtained limited safe-harbor protection
under the recently enacted Digital Millennium Copyright Act against liability for infringing
material of which we do not have control and knowledge. SEASONALITY The seasonality of our e-commerce segment affects our revenue. Our CDs and other online goods are
most often purchased during the holiday season and also during the summer months, traditionally
when artists go on tour. 10




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EMPLOYEES As of March 31, 2005, we had 15 full-time employees and five part-time consultants. None of our
employees is represented by a labor union. We have not experienced any work stoppages and consider
our employee relations to be good. RISK FACTORS Before investing in our company or deciding to maintain or increase your investment, you should
carefully consider the risks described below, in addition to the other information contained in
this report and in our other filings with the Securities and Exchange Commission. The risks and
uncertainties described below are not the only ones facing our company. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial may also affect our
business operations. If any of these risks actually occur, our business, financial condition or
results of operations could be seriously harmed. In that event, the market price for our common
stock could decline and you may lose all or part of your investment. It Is Difficult To Evaluate Our Business And Prospects Because We Have A Limited Operating History
And Rapidly Evolving Business Our limited operating history and rapidly evolving business make it difficult to evaluate our
prospects or to accurately predict our future revenue or results of operations. Our revenue and
income potential are unproven, and our business model is constantly and rapidly evolving. In
particular, the Internet is constantly changing and we may need to modify our business model to
adapt to these changes. We Have A History Of Operating Losses And Anticipate Losses And Negative Cash Flow For The
Foreseeable Future The Company has incurred losses and negative cash flows from operations in every fiscal period
since inception and has an accumulated deficit of $226.0 million as of December 31, 2004. For the
year ended December 31, 2004, the Company incurred a net loss of $3.3 million (including $2.2
million from discontinued operations) and negative operating cash flows of $3.5 million. As of
December 31, 2004, the Company had a net working capital deficiency of $18.4 million (including
liabilities of discontinued operations held for disposal of $18.9 million, almost all of which were
liquidated effective February 28, 2005) and a stockholders deficiency of $20.3 million. Through
December 31, 2003, ADI had funded substantially all of the operations of ARTISTdirect Records.
Effective July 30, 2004, ADIs remaining $12.0 million funding obligation to ARTISTdirect Records
was extinguished, and effective February 28, 2005, ADI sold all of its interest in ARTISTdirect
Records to Radar Records for a cash payment of $115,000. During 2003, the Company restructured its operations, laid off most of its staff and reduced
operating costs. Subsequently, management has continued its efforts to improve and expand
operations and cash flows at its online music network. However, it is uncertain whether the
Companys available cash resources will be sufficient to meet anticipated capital requirements over
the next twelve months. If sufficient capital is not available, then the Company may not be able
to fund its operations. To the extent that the Company is unable to obtain the capital necessary
to fund its future cash requirements on a timely basis and/or under acceptable terms and
conditions, the Company will not have sufficient cash resources to maintain operations, and the
Company may consider a formal or informal restructuring or reorganization. The conditions
described above raise substantial doubt about the Companys ability to continue as a going concern.
The financial statements do not include any adjustments that might result from the outcome of this
uncertainty. Global Sales of Recorded Music Have Recently Declined and This Trend May Continue in the Future Based on data compiled by RIAA, The Recording Industry Association of America, after declining for
four consecutive years, the number of CDs shipped domestically from record companies to retail
distribution channels rose 5.3 percent, a 2.7 percent increase in value, in 2004, compared to the
previous year. When compared to year-end numbers five years ago, the number of overall units
shipped to retail in 2004 is down 21 percent. The decline, in sales had been due in part, to
widespread copying and illegal Internet downloading of music, according to the RIAA. If the overall
trend continues, it may affect our ecommerce business and have a material affect on our revenues. 11




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If We are Unable To Grow Our Online Advertising Significantly In The Near Future, Our Business May
Be Adversely Affected. If we do not increase advertising revenue, our business will be adversely affected. Increasing our
advertising revenue depends upon many factors, including our ability to:  
    respond to and anticipate fluctuations in the demand for, and pricing of, online
advertising;
    develop and maintain key advertising relationships and compete for advertisers with
Internet and traditional media companies;
    conduct successful selling and marketing efforts aimed at advertising agencies and direct marketing departments;
    successfully develop, sell and execute entertainment marketing solutions;
    increase the size of our audience and the amount of time that our audience spends on our Web sites;
    accurately measure the size and demographic characteristics of our audience;
    offer advertisers the means to effectively target their advertisements to our audience; and
    increase the amount of revenue per advertisement. Our failure to achieve one or more of these objectives could impair our ability to increase
advertising revenue, which could adversely affect our business. In addition to the above factors,
general economic conditions, as well as economic conditions specific to online advertising,
electronic commerce and the music industry, could affect our ability to increase our advertising
revenue. We May Not Be Able To Develop Or Obtain Sufficiently Compelling Content To Attract And Retain Our
Target Audience For our business to be successful, we must provide content and services that attract consumers who
will purchase music and related merchandise online. We may not be able to provide consumers with an
acceptable mix of products, services, information and community to attract them to our Web sites or
to encourage them to remain on our Web sites for an extended period of time. If our audience
determines that our content does not reflect its tastes, then our audience size could decrease or
the demographic characteristics of our audience could change and we may be unable to react to those
changes effectively or in a timely manner. Any of these results would adversely affect our ability
to attract advertisers and sell music and other related merchandise. Our ability to provide
compelling content could be impaired by any of the following:  
    reduced access to content controlled by record labels, music publishers and artists;
    diminished technical expertise and creativity of our production staff; and
    inability to anticipate and capitalize on trends in music. If We Do Not Build And Maintain Strong Brands, We May Not Be Able To Attract A Significant Number
Of Users To Our Web Sites To attract users we must develop a brand identity for ARTISTdirect and increase public awareness of
the ARTISTdirect Network; however to conserve cash, we have significantly decreased the amounts we
have spent and plan to spend on our offline and online advertising and promotional efforts to
increase brand awareness, traffic and revenue. Accordingly, our marketing activities may not result
in increased revenue and, even if they do, any increased revenue may not offset the expenses we
incur in building our brands. Moreover, despite these efforts we may be unable to increase public
awareness of our brands, which would have an adverse effect on our results of operations. 12




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Our Market Is Highly Competitive And We May Not Be Able To Compete Successfully Against Our Current
And Future Competitors The market for the online promotion and distribution of music and related merchandise is highly
competitive and rapidly changing. There are a significant number of Web sites promoting and
distributing music and related merchandise that compete for the attention and spending of
consumers, advertisers and users. We face competitive pressures from numerous actual and potential
competitors. Our competitors include America Online, MSN, Yahoo!, Amazon.com, MTV, other web sites
and traditional music companies. Competition is likely to increase significantly as new companies enter the market and current
competitors expand their services. Some of our competitors have announced agreements to work
together to offer music over the Internet, and we may face increased competitive pressures as a
result. Many of our current and potential competitors in the Internet and music entertainment
businesses may have substantial competitive advantages relative to us, including:  
    longer operating histories;
    significantly greater financial, technical and marketing resources;
    greater brand name recognition;
    larger existing customer bases; and
    more popular content or artists. These competitors may be able to respond more quickly to new or emerging technologies and changes
in customer requirements and devote greater resources to develop, promote and sell their products
or services than we can. Consumers, artists, talent management companies and other music-related
vendors or advertisers may perceive web sites maintained by our existing and potential competitors
as being superior to ours. In addition, increased competition could result in reduced advertising
rates and margins and loss of market share, any of which could harm our business. We Depend On A Limited Number Of Suppliers For Music Merchandise, Fulfillment And Distribution and
If We Cannot Secure Alternate Suppliers, Our Business May Be Harmed We rely to a large extent on timely distribution by third parties. During 2004, we relied on two
vendors, Alliance Entertainment, and Benn Co. (formerly Old Glory Boutique Distributing, Inc.) to
fulfill and distribute our orders for music and related merchandise. During the year ended December
31, 2004, approximately 93% and 7%, respectively, of our total customer orders were fulfilled by
Alliance and Benn Co., respectively. We purchase a significant portion of our artist-licensed
merchandise from Benn Co. and most all of our compact discs from Alliance. Our contracts with
Alliance and Benn Co. expired in August 2003 and April 2003, respectively, and we now operate with
these vendors on a month-to-month basis. Our business could be significantly disrupted if Alliance
or Benn Co. were to terminate or breach their agreements or suffer adverse developments that affect
their ability to supply products to us. If, for any reason, Alliance, Benn Co. or other vendors are
unable or unwilling to supply products to us in sufficient quantities and in a timely manner, we
may not be able to secure alternative suppliers, on acceptable terms, in a timely manner or at all. We Depend On Third Party Inventory And Financial Systems And Carrier Services Because we rely on third parties to fulfill orders, we depend on their systems for tracking
inventory and financial data. If our distributors systems fail or are unable to scale or adapt to
changing needs, or if we cannot integrate our information systems with the systems of any new
distributors, we may not have adequate, accurate or timely inventory or financial information. We
also rely on third-party carriers for shipments to and from distribution facilities. We are
therefore subject to the risks, including employee strikes and inclement weather, associated with
our carriers ability to provide delivery services to meet our distribution and shipping needs. In
the past, both Alliance and we have occasionally experienced an unusually high volume of orders,
which resulted in shipping delays to our customers. These delays did not have a material adverse
effect, however, our failure to deliver products to our customers in a timely and accurate manner
in the future could harm our reputation, our relationship with customers, the ARTISTdirect brand
and our results of operations. Our Business Is Subject To Seasonality, Which Could Adversely Affect Our Operating Results We have experienced and expect to continue to experience seasonal fluctuations in our online sales.
These seasonal patterns will cause quarterly fluctuations in our operating results. In particular,
a disproportionate amount of our online sales have been realized during the fourth calendar quarter
and during the summer months, traditionally when artists go on tour. Due to our limited operating
history, 13




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it is difficult to predict the seasonal pattern of our online sales and the impact of such
seasonality on our business and operating results. Our seasonal online sales patterns may become
more pronounced, strain our personnel, warehousing, and order shipment activities and cause our
operating results to be significantly less than expected for any given period. This would likely
cause our stock price to fall. We May Be Subject To System Disruptions, Which Could Reduce Our Revenue Our ability to attract and retain artists, users, advertisers and merchants for our online network
depends on the performance, reliability and availability of our Web sites and network
infrastructure. Our own staff performs the maintenance and operation of substantially all of our
Internet communications hardware and servers. We have periodic maintenance windows, and we
experience outages from time to time caused by temporary problems in our own systems or software.
While we have implemented procedures to improve the reliability of our systems, these interruptions
may continue to occur from time to time. Our users also depend on third party Internet service
providers and web site operators for access to our web sites. These entities have experienced
significant outages in the past, and could experience outages, delays and other difficulties due to
system failures in the future which are unrelated to our systems, but which could nonetheless
adversely affect our business. Computer Viruses, Electronic Break-Ins Or Similar Disruptive Events Could Disrupt Our Online
Services Computer viruses, electronic break-ins or similar disruptive events could disrupt our online
services. System disruptions could result in the unavailability or slower response times of our web
sites, which would reduce the number of advertisements delivered or commerce conducted on our web
sites and lower the quality of our users experience. Service disruptions could adversely affect
our revenue and, if they were prolonged, would seriously harm our business and reputation. Our
business interruption insurance may not be sufficient to compensate us for losses that may occur as
a result of these interruptions. The Loss Of Key Personnel, Including Ted Field or Jonathan Diamond, Could Adversely Affect Our
Business Because These Individuals Are Important To Our Business Our future success depends to a significant extent on the continued services of our senior
management, particularly Ted Field and Jonathan Diamond. The loss of either of these individuals
would likely have an adverse effect on our business. Competition for personnel throughout our
industry is intense and we may be unable to retain these key employees or attract, integrate or
retain other highly qualified employees in the future. We have in the past experienced, and we
expect to continue to experience, difficulty in hiring and retaining highly skilled employees with
appropriate qualifications. If we do not succeed in attracting new personnel or retaining and
motivating our current personnel, our business could be adversely affected. Recent changes in
corporate governance and securities laws and regulations, such as the Sarbanes-Oxley Act of 2002,
could make it more difficult for us to attract and retain qualified executive officers or qualified
members of our Board of Directors, particularly to serve on our audit committee. If We Are Unable To Protect Our Intellectual Property Rights, Our Competitive Position Could Be
Harmed Or We Could Be Required To Incur Expenses To Enforce Our Rights We rely upon registered trademark rights in the United States for our commercial use of the
ARTISTdirect, UBL, Ultimate Band List and other brand names and their respective associated domain
names, and the ARTISTdirect logo. We seek to protect our trademarks, copyrights and other
proprietary rights by registration and other means, but these actions may be inadequate. We have
trademark applications pending in several jurisdictions, but our registrations may not be accepted
or may be preempted by third parties and/or we may not be able to register our trademarks in all
jurisdictions in which we intend to do business. We generally enter into confidentiality or license
agreements with our employees, consultants and corporate partners, and generally control access to
and distribution of our proprietary information. The steps we have taken may not prevent
misappropriation of our proprietary rights, particularly in foreign countries where laws or law
enforcement practices may not protect our proprietary rights as fully as in the United States. If
third parties were to use or otherwise misappropriate our copyrighted materials, trademarks or
other proprietary rights without our consent or approval, our competitive position could be harmed,
or we could become involved in litigation to enforce our rights. In addition, policing unauthorized
use of our content, trademarks and other proprietary rights could be very expensive, difficult or
impossible, particularly given the global nature of the Internet. Our Access To Copyrighted Content Depends Upon The Willingness Of Content Owners To Make Their
Content Available The music content available on the ARTISTdirect Network is typically comprised of copyrighted works
owned or controlled by multiple third parties. Most of the content on our artist-specific web sites
is either owned or licensed by the artist. On other parts of the 14




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ARTISTdirect Network, depending on the nature of the content and how we use the music content, we
typically license such rights from publishers, record labels, performing rights societies or
artists. We frequently either do not have written contracts or have short-term contracts with
copyright owners, and, accordingly, our access to copyrighted content depends upon the willingness
of such parties to continue to make their content available. If the fees for music content increase
substantially or if significant music content becomes unavailable, our ability to offer music
content could be materially limited. We have not obtained a license for some of the content offered
on the ARTISTdirect Network, including links to other music-related sites and thirty-second
streamed song samples, because we believe that a license is not required under existing law.
However, this area of law remains uncertain and may not be resolved for a number of years. When
this area of law is resolved, we may be required to obtain licenses for such content, alter or
remove the content from our web sites and be forced to pay potentially significant financial
damages for past conduct. Intellectual Property Claims Against Us Could Be Costly And Could Result In The Loss Of Significant
Rights Third parties may assert trademark, copyright, patent and other types of infringement or unfair
competition claims against us. If we are forced to defend against any such claims, whether they are
with or without merit or are determined in our favor, we may face costly litigation, loss of access
to, and use of, content, diversion of technical and management personnel, or product shipment
delays. As a result of such a dispute, we may have to develop non-infringing technology or enter
into royalty or licensing agreements. Such royalty or licensing agreements, if required, may be
unavailable on terms acceptable to us, or at all. While we have resolved all such disputes in the
past, we may not be able to do so in the future. If there is a successful claim of infringement
against us and we are unable to develop non-infringing technology or license the infringed or
similar technology or content on a timely basis, it could harm our business. In addition, we rely
on third parties to provide services enabling our online product sales transactions, including
credit card processing, order fulfillment, shipping and customer service. We could become subject
to infringement actions by third parties based upon our use of intellectual property provided by
our third-party providers. It is also possible that we could become subject to infringement actions
based upon the content licensed from third parties. Any such claims or disputes could subject us to
costly litigation and the diversion of our financial resources and technical and management
personnel. Further, if our efforts to enforce our intellectual property rights are unsuccessful or
if claims by third parties against ARTISTdirect or the UBL are successful, we may be required to
change our trademarks, alter or remove content, pay financial damages, or alter our business
practices. These changes of trademarks, alteration of content, payment of financial damages or
alteration of practices may adversely affect our business. If Our Online Security Measures Fail, We Could Lose Visitors To Our Sites And Could Be Subject To
Claims For Damage From Our Users, Content Providers, Advertisers And Merchants Our relationships with consumers would be adversely affected and we may be subject to claims for
damage if the security measures that we use to protect their personal information, especially
credit card numbers, are ineffective. We rely on security and authentication technology that we
license from third parties to perform real-time credit card authorization and verification with our
bank. We cannot predict whether events or developments will result in a compromise or breach of the
technology we use to protect a customers personal information. Our infrastructure may be
vulnerable to unauthorized access, physical or electronic computer break-ins, computer viruses and
other disruptive problems. Internet service providers have experienced, and may continue to
experience, interruptions in service as a result of the accidental or intentional actions of
Internet users, current and former employees and others. Anyone who is able to circumvent our
security measures could misappropriate proprietary information or cause interruptions in our
operations. Security breaches relating to our activities or the activities of third-party
contractors that involve the storage and transmission of proprietary information could damage our
reputation and our relationships with our content providers, advertisers and merchants. We also
could be liable to our content providers, advertisers and merchants for the damages caused by such
breaches or we could incur substantial costs as a result of defending claims for those damages. We
may need to expend significant capital and other resources to protect against such security
breaches or to address problems caused by such breaches. Our security measures may not prevent
disruptions or security breaches. We May Be Subject To Liability If Private Information Provided By Our Users Were Misused Our privacy policy discloses how we use individually identifiable information that we collect. This
policy is displayed and accessible throughout the ARTISTdirect Network. Despite this policy,
however, if third persons were able to penetrate our network security or otherwise misappropriate
our users personal information or credit card information, we could be subject to liability. We
could also be subject to liability for claims for unauthorized purchases with credit card
information, impersonation or other similar fraud claims, or other misuses of personal information,
such as for unauthorized marketing purposes. These claims could result in costly and time-consuming
litigation. 15




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Laws Or Regulations May Adversely Affect Our Ability To Collect Demographic And Personal
Information From Users, Or To Display Certain Content On Our Sites, And Could Affect Our Ability To Attract Advertisers Legislatures and government agencies have adopted and are considering adopting additional laws and
regulations regarding the collection, use and disclosure of personal information obtained from
individuals when accessing web sites. For example, the Childrens Online Privacy Protection Act
restricts the ability of Internet companies to collect information from children under the age of
13 without their parents consent. In addition, the Federal Trade Commission and state and local
authorities have been investigating Internet companies regarding their use of personal information.
Our privacy programs may not conform with laws or regulations that are adopted. In addition, these
legislative and regulatory initiatives may adversely affect our ability to collect demographic and
personal information from users, which could have an adverse effect on our ability to provide
advertisers with demographic information. These initiatives may also affect our ability to conduct
electronic commerce. The European Union has adopted a directive that imposes restrictions on the collection and use of
personal data. The directive imposes restrictions that are more stringent than current Internet
privacy standards in the United States. If this directive were enforced against us, it could
prevent us from collecting data from users in European Union member countries or subject us to
liability for use of information in contravention of the directive. Other countries have adopted or
may adopt similar legislation. We could incur additional expenses if new regulations regarding the
use of personal information are introduced or if government authorities choose to investigate our
privacy practices. In addition, legislatures and government agencies have adopted and are considering adopting
additional laws and regulations governing the content of material transmitted over the Internet.
These include laws relating to obscenity, indecency, libel and defamation. For example, the Child
Online Protection Act, or COPA, prohibits and imposes criminal penalties and civil liability on
anyone communicating material harmful to minors through the Internet for commercial purposes,
unless access to such material is blocked to minors under age 17. The U.S. Supreme Court has
maintained a preliminary injunction precluding enforcement of COPA, pending the decision on
questions of COPAs constitutionality that the U.S. Supreme Court remanded to the Third U.S.
Circuit Court of Appeals. We could be liable if the injunction against COPA is lifted and if
content delivered by us or placed on our Web sites violates COPA. Such a result may adversely
affect our ability to attract users under age 17 and, consequently, may adversely affect our
ability to attract advertisers. We May Continue To Have Contingent Liability Due To Our Issuances Of Certain Unregistered
Securities Prior to our initial public offering, we issued a number of shares and options to purchase shares
of our common stock to our employees and to artists and their managers and advisors. Due to the
nature of the persons who received these shares and options in addition to our employees and the
total number of shares and options issued to them and our employees, the issuance of some of these
shares and options did not comply with the requirements of Rule 701 under the Securities Act of
1933, as amended (the Securities Act), or any other available exemptions from the registration
requirements of Section 5 of the Securities Act, and may not have qualified for any exemption from
qualification or registration under applicable state securities laws either. As a result, in November 2001, we made a rescission offer to all these persons pursuant to a
registration statement filed under the Securities Act and pursuant to applicable state securities
law. In the rescission offer, we offered to repurchase from these persons all shares purchased by
them pursuant to option exercises before the expiration of the rescission offer for an amount equal
to the purchase or exercise price paid for these purchased shares, plus interest from the date of
purchase until the expiration of the rescission offer, at the current statutory rate per year
mandated by the state in which the shares were purchased, or at 7% per year if a private
placement exemption was available in a particular state or if the shares were otherwise issued in
compliance with state law (less any amounts received by those persons who had already sold their
shares). We also offered to repurchase all unexercised options granted to these persons at 20% of
the option exercise price times the number of option shares, plus interest from the date the
options were granted until the rescission offer expires, at the current statutory rate per year
mandated by the state in which the options were granted, or at 7% per year if a private placement
exemption was available in a particular state or if the options were otherwise granted in
compliance with state law. The rescission offer was completed in December 2001, resulting in 83,403
shares and 636,740 options being tendered in the rescission offer at a cost to us to repurchase
such shares and options of approximately $10.2 million. The Securities Act does not expressly provide that a rescission offer will terminate a purchasers
right to rescind a sale of stock that was not registered under the Securities Act as required.
Accordingly, we may continue to be contingently liable under the Securities Act to any offerees
that rejected the rescission offer. In addition, it is possible that offerees may claim that the
consideration offered to them in the rescission offer was insufficient, in which case we may have
additional liability. 16




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We May Be Sued For Content Available Or Posted On Our Website Or Products Through Our Web Sites Or
For Linking And Framing Of Third-Party Web Sites We may be liable to third parties for content published on our web sites and other web sites where
our syndicated content appears if the music, artwork, text or other content available violates
their copyright, trademark or other intellectual property rights or if the available content is
defamatory, obscene or pornographic. Similar claims have been brought, sometimes successfully,
against web site operators in the past. We also may be liable for content uploaded or posted by our
users on our web sites, such as digitally distributed music files, postings on our message boards,
chat room discussions and copyrightable works. In addition, we could have liability to some of our
content licensors for claims made against them for content available on our web sites. We also
could be exposed to these types of claims for content that may be accessed from our web sites or
via links to other web sites or for products sold through our web site. While we have resolved all
of these types of claims made against us in the past, we may not be able to do so in the future. We
intend to implement measures to reduce exposure to these types of claims, but such measures may not
be successful and may require us to expend significant resources. Any litigation as a result of
defending these types of claims could result in substantial costs and damages. Our insurance may
not adequately protect us against these types of claims or the costs of their defense or payment of
damages. We link to and frame third-party web sites of our artists without express written
permission to do so. In addition, in the past we have provided a search feature to allow users to
find music residing elsewhere on the Internet. Those practices are controversial, and have, in
instances not involving us, resulted in litigation. Various claims, including trademark and
copyright infringement, unfair competition, and commercial misappropriation, as well as
infringement of the right of publicity may be asserted against us as a result. The law regarding
linking and framing remains unsettled; it is uncertain as to how existing laws, especially
trademark and copyright law, will be applied by the judiciary to the Internet. Also, Congress is
increasingly active in passing new laws related to the Internet, and there is uncertainty as to the
impact of future potential laws, especially those involving domain names, databases and privacy. We May Need To Change The Manner In Which We Conduct Our Business If Government Regulation
Increases There are currently few laws or regulations that specifically regulate communications or commerce
on the Internet. Laws and regulations may be adopted in the future, however, that address issues
such as user privacy, pricing, taxation, content, copyrights, distribution, security, and the
quality of products and services. Several telecommunications companies have petitioned the Federal
Communications Commission to regulate Internet service providers and online services providers in a
manner similar to long distance telephone carriers and to impose access fees on these companies.
Any imposition of access fees could increase the cost of transmitting data over the Internet. In
addition, the growth and development of the market for online commerce may lead to more stringent
consumer protection laws, both in the United States and abroad, that may impose additional burdens
on us. The United States Congress has enacted Internet laws regarding childrens privacy,
copyrights, taxation and the transmission of sexually explicit material. The law of the Internet,
however, remains largely unsettled, even in areas where there has been some legislative action.
Moreover, it may take years to determine the extent to which existing laws relating to issues such
as property ownership, libel and personal privacy are applicable to the web. Any new, or
modifications to existing, laws or regulations relating to the web could adversely affect our
business. Prohibition and restriction of Internet content and commerce could reduce or slow
Internet use, decrease the acceptance of the Internet as a communications and commercial medium and
expose us to liability. Any of these outcomes could have a material adverse effect on our business,
results of operations and financial condition. The growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws, both in the United
States and abroad, that may impose additional burdens on companies conducting business over the
Internet. The Internet Is Subject To Rapid Changes, Which Could Result In Significant Additional Costs The market for Internet products and services is characterized by rapid change, evolving industry
standards and frequent introductions of new technological developments. These new standards and
developments could make our existing or future products or services obsolete. Keeping pace with the
introduction of new standards and technological developments could result in significant additional
costs or prove difficult or impossible for us. The failure to keep pace with these changes and to
continue to enhance and improve the responsiveness, functionality and features of our web sites
could harm our ability to attract and retain users. Among other things, we will need to license or
develop leading technologies, enhance our existing services and develop new services and
technologies that address the varied needs of our users. Our Net Sales Could Be Adversely Affected If We Become Subject To Sales And Other Taxes If one or more states or any foreign country successfully asserts that we should collect sales or
other taxes on our sale of products over the Internet, our net sales and results of operations
could be harmed. We do not currently collect sales or other similar taxes for physical shipments of
goods into states other than California and Florida. However, one or more states may seek to impose
sales tax 17




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collection obligations on companies, such as ARTISTdirect, which engage in or facilitate online
commerce. A number of proposals have been made at the state and local level that would impose
additional taxes on the sale of goods and services 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. Moreover, if any state or
foreign country were to successfully assert that we should collect sales or other taxes on the
exchange of merchandise on its system, our results of operations could be adversely affected. In
addition, any operations in states outside California and Florida could subject our shipments in
such states to state sales taxes under current or future laws. Congress has enacted legislation
limiting the ability of the states to impose taxes on Internet-based transactions. This
legislation, known as the Internet Tax Freedom Act, imposes a moratorium ending on November 1, 2003
on state and local taxes on electronic commerce where such taxes are discriminatory and on Internet
access unless such taxes were generally imposed and actually enforced before October 1, 1998.
Failure to renew this legislation in the future would allow various states to impose taxes on
Internet-based commerce. 
 ITEM 2. PROPERTIES Our principal corporate offices are located in Los Angeles, California, where we sub-lease
approximately 2,000 square feet of office space from Radar Pictures Inc., a company owned by our
Chairman, Frederick W. Field. During 2003, we terminated a lease on approximately 64,000 feet of
office lease that we had previously occupied. 
 ITEM 3. LEGAL PROCEEDINGS In June 2003, we initiated discussions with our landlord regarding the potential termination
or restructuring of an office lease that had a term through April 2010. On June 24, 2003, the
landlord filed suit against us for unlawful detainer of our premises and in July 2003 the landlord
drew down the entire remaining $1.35 million letter of credit that we had provided as a security
deposit in conjunction with the execution of the original lease. In September 2003, we reached an
agreement to terminate our lease with the landlord. In conjunction with the termination, we issued
to the landlord a warrant to purchase 200,000 shares of the Companys common stock exercisable at
$0.50 per share through September 8, 2008. In October 2003, the legal proceedings against the
Company were dismissed with prejudice. The Company is periodically subject to various pending and threatened legal actions, which
arise in the normal course of business. The Companys management believes that the impact of any
such litigation will not have a material adverse impact on the Companys financial position or
results of operations. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holdings during the fourth quarter of
the fiscal year ended December 31, 2004. 18




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PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION ARTISTdirects common stock is listed for quotation on the Over-The-Counter Bulletin Board
under the symbol ARTD since May 9, 2003 and was listed on the Nasdaq National Market prior to
that date. The following table sets forth the high and low closing sale prices for our common
stock as reported by America Online for 2003 and 2004: High
    
    
    Low2003First Quarter
    
    $
    3.70
    
    
    $
    1.05Second Quarter
    
    
    2.00
    
    
    
    0.10Third Quarter
    
    
    1.20
    
    
    
    0.35Fourth Quarter
    
    
    0.85
    
    
    
    0.122004First Quarter
    
    
    0.35
    
    
    
    0.26Second Quarter
    
    
    0.62
    
    
    
    0.32Third Quarter
    
    
    0.45
    
    
    
    0.40Fourth Quarter
    
    
    0.40
    
    
    
    0.26
 HOLDERS As of March 29, 2005, the Company had 237 common shareholders of record, excluding 1,145,403
shares held in street name by brokerage firms and other nominees who hold shares for multiple
investors. The Company estimates that it has a total of approximately 3,000 beneficial common
shareholders as of March 29, 2005. DIVIDENDS To date, the Company has not declared or paid any dividends on its common stock. The payment
by the Company of dividends, if any, is within the discretion of the board of directors and will
depend on the Companys earnings, if any, its capital requirements and financial condition, as well
as other relevant factors. The board of directors does not intend to declare any dividends in the
foreseeable future but instead intends to retain earnings for use in the Companys business
operations. EQUITY COMPENSATION PLAN INFORMATION See ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS  Equity Compensation Plan Information for information regarding the number of
outstanding and reserved options, warrants and other derivative securities under our equity
compensation plans. SALES OF UNREGISTERED SECURITIES In September 2003, we issued a warrant to purchase 200,000 shares of common stock at $0.50 per
share as partial consideration for an office lease termination. In December 2003, we issued 40,000
shares of common stock to a consultant for services rendered which were valued at $0.50 per share.
We made such issuances in reliance upon Section 4(2) of the Securities Act. The parties to whom
securities were issued in connection with the foregoing, made an informed investment decision based
upon negotiation with us and were provided with access to material information regarding our
company. We believe that the party that acquired our securities pursuant to the foregoing had
knowledge and experience in financial matters such that such party was capable of evaluating the
merits and risks of acquisition of our securities. All certificates representing the shares issued
pursuant to the foregoing bear an appropriate legend restricting the transfer of such shares,
except in accordance with the Securities Act. In September 2003, we issued an option to purchase 259,659 shares of common stock at $0.85 per
share, the approximate fair market value of the stock at such time, to Jonathan V. Diamond in
connection with his appointment as our President. The option may 19




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be exercisable until August 15, 2010. 75% of the common stock underlying the options are
subject to a repurchase right at $0.85 per share by the Company upon his termination of employment.
This repurchase right lapses in three equal installments such that, the repurchase right will lapse
entirely upon the third anniversary of his employment. On March 29, 2005, the Board of Directors
granted Mr. Diamond a stock option for an additional 200,341 shares, exercisable at $0.79 per share
(the current market price on the date of grant) for seven years, vesting monthly over the remaining
term of employment contract which is through August 15, 2006. We made such issuance in reliance
upon Section 4(2) of the Securities Act. From May 2003 through December 31, 2003, ARTISTdirect Records had issued and sold from time to
time, an aggregate of $2.048 million in convertible notes (the Bridge Notes) to eight individual
investors. Of such amount, $898,000 was sold to our Chairman, Ted Field and $100,000 to Jonathan V.
Diamond, our President and Chief Executive Officer. During the year ended December 31, 2004, an
additional $2.778 million of Bridge Notes were sold to Ted Field. The Bridge Notes accrue interest
at 8% per annum, are due two years from the date of issuance, and are convertible into new
preferred equity of ARTISTdirect Records as part of its next equity financing. The holders of the
Bridge Notes also received warrants with a term of five years to purchase additional equity of
ARTISTdirect Records at $0.01 per unit equivalent to the number of units of new equity into which
their Bridge Notes are ultimately converted. We made issuances of such notes and warrants in
reliance upon Section 4(2) of the Securities Act. The parties to whom securities were issued in
connection with the foregoing, made an informed investment decision based upon negotiation with us
and were provided with access to material information regarding our company. We believe that the
parties that acquired our securities pursuant to the foregoing had knowledge and experience in
financial matters such that each such party was capable of evaluating the merits and risks of
acquisition of our securities. Effective January 9, 2004, we issued to Keith Yokomoto, our former President and Chief
Operating Officer, two non-qualified stock options to purchase 10,000 shares and 50,000 shares at
$0.50 per share, which was not less than the fair market value on the date of grant, exercisable
through January 9, 2011. The option for 10,000 shares was immediately vested upon issuance. The
option for 50,000 shares vests in increments of 10,000 shares on February 1, 2004, March 31, 2004,
June 30, 2004, September 30, 2004 and December 31, 2004, based on the accomplishment of certain
milestones by each respective date, which had not been attained as of March 31, 2004. Effective March 29, 2004, we issued to Robert N. Weingarten, our Chief Financial Officer, a
stock option to purchase 120,000 shares at $0.50 per share, which was not less than the fair market
value on the date of grant, exercisable through March 29, 2011. The option vests and becomes
exercisable in a series of 36 successive equal monthly installments upon the optionees completion
of service measured from March 29, 2004. On March 29, 2005, the Board granted Mr. Weingarten an
additional stock option for 110,000 shares, exercisable at $0.79 (the current market price on the
date of grant) for seven years, vesting monthly over three years. Effective August 31, 2004, we issued a warrant to a consultant for services rendered to
purchase 10,000 shares of common stock exercisable for a period of five years at $0.50 per share. Effective March 29, 2005, we issued stock options for 92,000 shares each, exercisable at $0.79
per share (the current market price on the grant date) for seven years, fully vested on date of
issuance, to Ted Field, Eric Pulier, Dimitri Villard and Teymour Boutros-Ghali and Nicholas Turner. The stock options were issued without registration in reliance upon the exemption afforded by
Section 4(2) of the Securities Act of 1933, as amended, based on certain representations made to
ADI by the recipients. REPURCHASES The Company did not repurchase any of its equity securities during the years ended December
31, 2003 and 2004. 
 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data with respect to the Companys consolidated statements of
operations for the years ended December 31, 2000, 2001, 2002, 2003 and 2004 and consolidated
balance sheets as of December 31, 2000, 2001, 2002, 2003 and 2004 are derived from the audited
consolidated financial statements of the Company. The following information should be read in 20




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conjunction with the consolidated financial statements of the Company and the related notes
thereto and Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations. TABLE OF SELECTED FINANCIAL DATA For the Years Ended and as of December 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(6)
    
    
    (6)
    
    
    (5)(6)
    
    
    (2)(5)(6)
    
    
    (2)(5)(6)(in thousands, except per share data)Net revenue (1)
    
    $
    18,370
    
    
    $
    10,421
    
    
    $
    5,637
    
    
    $
    4,632
    
    
    $
    5,143Loss from continuing operations
    
    
    (61,499
    )
    
    
    (61,276
    )
    
    
    (17,723
    )
    
    
    (6,892
    )
    
    
    (1,063
    )Net loss
    
    
    (59,308
    )
    
    
    (69,880
    )
    
    
    (48,192
    )
    
    
    (21,701
    )
    
    
    (3,311
    )Net loss attributable to common shareholders
    
    
    (85,178
    )(4)
    
    
    (70,571
    )
    
    
    (48,192
    )
    
    
    (21,701
    )
    
    
    (3,311
    )Loss from continuing operations per common share
    
    
    (27.52
    )
    
    
    (17.12
    )
    
    
    (5.12
    )
    
    
    (1.99
    )
    
    
    (0.30
    )Net loss per common share
    
    
    (26.83
    )
    
    
    (19.49
    )
    
    
    (13.92
    )
    
    
    (6.27
    )
    
    
    (0.94
    )Total assets
    
    
    117,762
    
    
    
    59,873
    
    
    
    15,925
    
    
    
    3,006
    
    
    
    2,413Long-term obligations
    
    
    12,308
    (3)
    
    
    903
    
    
    
    1,117
    
    
    
    
    
    
    
    Cash dividends declared per common share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    Excludes operations of the agency business, which were discontinued in December 2001 and
terminated in 2002, and which have been classified as a discontinued operation in 2000, 2001
and 2002. Also excludes operations of iMusic in 2002, 2003 and 2004 (see (5) below), and
ARTISTdirect Records in 2004 (see (6) below).(2)
    
    As a result of the adoption by the Company of Financial Accounting Standards Board
Interpretation No. 46, Consolidation of Variable Interest Entities effective December 31, 2003, the balance sheet of ARTISTdirect
Records was consolidated as of December 31, 2003 and the operations of ARTISTdirect Records were consolidated for the year
ended December 31, 2004.(3)
    
    Includes $10,778 of redeemable common stock which was converted into common stock in 2001.(4)
    
    Includes beneficial conversion feature on redeemable preferred stock of $24,375.(5)
    
    During 2002, the Company began operating a record label under the brand name iMusic. As a
result of the Companys sale of all rights with respect to the iMusic trade name in November
2004 and the related termination of the business in December 2004, the operations of iMusic
have been classified as a discontinued operation in 2002, 2003 and 2004.(6)
    
    Effective February 28, 2005, the Company sold all of its interest in ARTISTdirect Records and
has therefore accounted for its interest in ARTISTdirect Records as a discontinued operation for 2001, 2002, 2003 and 2004. 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial
statements and the notes to those financial statements included elsewhere in this Annual Report on
Form 10-K. The following discussion contains forward-looking statements based on our current
expectations, estimates and projections about our industry, managements beliefs and certain
assumptions made by us. Words such as anticipates, expects, intends, plans, believes,
may, will or similar expressions are intended to identify forward-looking statements. In
addition, any statements that refer to expectations, projections or other characterizations of
future events or circumstances, including any underlying assumptions, are forward-looking
statements. Such statements include, but are not limited to, statements concerning our business
model, competition in the industry, online product sales, advertising and other revenue streams,
our ability to increase visits to our web site, our ability to adequately fund our operations and
financial commitments, our ability to offer compelling content, our ability to fulfill on-line
music and merchandise orders in a timely manner, our ability to build brand recognition, our
ability to integrate acquisitions of technology and other businesses, our ability to protect and/or
obtain intellectual property rights, and our ability to manage growth. Such statements are not
guarantees of future performance and are subject to risks, uncertainties and assumptions that are
difficult to predict. Therefore, our actual results could differ materially and 21




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adversely from those expressed in any forward-looking statements as a result of various
factors. Factors that could cause or contribute to the differences are discussed in Risk Factors
and elsewhere in this Annual Report on Form 10-K. Except as required by law or regulation, we
undertake no obligation to revise or update publicly any forward-looking statements for any reason.
The information contained in this Annual Report on Form 10-K is not a complete description of our
business or the risks associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Annual Report on Form 10-K and in
our other filings with the Securities and Exchange Commission that discuss our business. GENERAL We are a music entertainment company that features an online music network appealing to music
fans, artists and marketing partners. The ARTISTdirect Network (www.artistdirect.com) is a network
of Web-sites offering multi-media content, music news and information, community around shared
music interests, music-related specialty commerce and digital music services. ARTISTdirect Records, LLC In May 2001, we entered into an agreement with veteran entertainment executive Frederick W.
(Ted) Field to become our Chairman and Chief Executive Officer and form a new record label in
partnership with us. On June 29, 2001, our stockholders approved the employment of Mr. Field and
the formation of the record label, ARTISTdirect Records, LLC, as a 50/50 co-venture between
ARTISTdirect and Radar Records Holdings, LLC, a company owned by Mr. Field (Radar Records), where
we agreed to provide a significant financial commitment. In addition to the formation of the
record label and our financial commitment, we entered into a five-year employment agreement with
Mr. Field to serve as Chairman and Chief Executive Officer. Mr. Field also serves as the Chief
Executive Officer of ARTISTdirect Records. During the year ended December 31, 2003, we restructured senior operating management and
significantly reduced overhead and operating activities at the parent company level and laid off
the majority of our staff. In conjunction with this restructuring, effective September 29, 2003,
we entered into an employment agreement with Jonathan V. Diamond to serve as our President and
Chief Executive Officer through August 15, 2006. We initially committed to fund a total of $50.0 million to ARTISTdirect Records over five
years at the rate of $15.0 million per year, subject to a limit of $33.0 million in any three year
period. Any funding in excess of these amounts required the approval of our Board of Directors.
We funded a total of $33.0 million through December 31, 2003. In November 2001, ARTISTdirect Records agreed in principle to enter into a preliminary North
America distribution agreement and worldwide license agreement with BMG Music, a wholly-owned
partnership of Bertelsmann Music Group, Inc., the global music division of Bertelsmann AG (BMG).
Under the terms of the agreement, BMG agreed to distribute the labels releases in North America,
and BMG licensed ARTISTdirect Records repertoire in territories throughout the world. In April
2002, the agreements with BMG were finalized, including BMGs purchase of 5% of the equity of
ARTISTdirect Records from us. As part of this transaction, BMG agreed to advance certain monies
against net sales proceeds under the agreements and also assumed $5.0 million of our funding
commitment to ARTISTdirect Records. As a result of the BMG equity purchase, our funding commitment
was reduced to $45.0 million. Our commitment to fund ARTISTdirect Records was subject to a
guaranty for the benefit of BMG. If we failed to meet our commitment, BMG had the right to choose
to enforce the guaranty or provide substitute financing that could have resulted in dilution of our
interest in ARTISTdirect Records. In December 2002, BMG exercised its option to extend the term of the distribution and license
agreement until September 2004. BMG did not renew its distribution agreement and license agreement
upon its expiration in September 2004. Under the distribution and license agreements, BMG made non-refundable advances to
ARTISTdirect Records of $2.5 million in 2001, $2.5 million in 2002 and $5.0 million in 2003 that
are recoupable from net sales proceeds from ARTISTdirect Records artist repertoire pursuant to a
defined calculation on a monthly basis. As of December 31, 2002, 2003 and 2004, the unrecouped
balances related to distribution advances from BMG were $4.1 million, $8.7 million and $8.9
million, respectively. In August 2002, our Board of Directors approved an agreement (the Accelerated Funding
Agreement) to accelerate up to $10.0 million of its funding commitment to ARTISTdirect Records.
This funding was in addition to the $15.0 million that we were obligated to advance to ARTISTdirect
Records in 2002 as part of the initial $50.0 million funding commitment. During 2002, we funded
our $15.0 million commitment plus the additional $10.0 million bridge loan for total advances to
the record label of $25.0 million in 2002 and $30.25 million from the inception of the record label
through December 31, 2002. The $10.0 million of 22




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accelerated funding was credited toward the satisfaction of our overall funding commitment and
funding obligation for 2003, resulting in a remaining funding commitment of $2.75 million for 2003
and $12.0 million for 2004. We advanced the $2.75 million during 2003. As consideration for entering into the Accelerated Funding Agreement, we received an
additional 20% interest in ARTISTdirect Records from Radar Records, the entity through which Mr.
Field owns his interest in ARTISTdirect Records, which resulted in an increase in our ownership
share of ARTISTdirect Records from 45% to 65% and a decrease in Mr. Fields ownership share from
50% to 30%. The Accelerated Funding Agreement also provided that any dilution from the issuance of
equity interests in ARTISTdirect Records that would have been borne solely by us would be borne
both by Radar Records and us pro rata with our then respective ownership interests. Furthermore,
the Accelerated Funding Agreement provides for Radar Records to guarantee a 25% minimum annual
compounded return to be realized from our advances and equity interests in ARTISTdirect Records.
Due to the uncertainty with respect to the realization of such rate of return, we have not recorded
any amounts related to the 25% minimum annual compounded return in our consolidated financial
statements. Because we did not have voting or operating control of ARTISTdirect Records, even with our
majority ownership position, through December 31, 2003 we did not consolidate the results of
ARTISTdirect Records; we recorded our share of losses based on the equity method of accounting as
loss from equity investments in our consolidated statements of operations. Prior to the completion
of BMGs purchase of a 5% interest in ARTISTdirect Records in April 2002 and BMGs assumption of
10% of our total funding commitment, we had committed to fund 100% of the operations of
ARTISTdirect Records and had recorded 100% of the losses attributable to that venture from the
inception of ARTISTdirect Records to April 30, 2002. From May 1, 2002 through December 31, 2002,
we have recorded only our proportionate share, on the basis of remaining relative funding
commitments, of any losses of ARTISTdirect Records. We have funded a total of $33.0 million of our
funding commitment. We recognized $8.6 million, $29.2 million and $9.3 million of equity loss from
ARTISTdirect Records for the years ended December 31, 2001, 2002 and 2003, respectively. The loss
for ARTISTdirect Records for the year ended December 31, 2004 was $4.881 million before
intercompany interest elimination of $2.011 million. In February 2003, the Financial Accounting Standards Board issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which addresses the consolidation by
business enterprises of variable interest entities. FIN 46 defines when a company should evaluate
controlling financial interest, and thus consolidation, based on factors other than voting
rights, and requires that a new risks and rewards model be applied in these situations. We
adopted FIN 46 as of December 31, 2003. As a result of the adoption of FIN 46, the balance sheet
of ARTISTdirect Records was consolidated beginning as of December 31, 2003, and the operations of
ARTISTdirect Records were consolidated beginning with the year ended December 31, 2004. There was
no change in the operating or business relationship between ADI and ARTISTdirect Records as a
result of the adoption of FIN 46. During the three months ended September 30, 2003, ARTISTdirect Records significantly reduced
its overhead costs and operating activities and laid off the majority of its staff while it
continued to restructure its operations and seek additional capital. During 2003, ARTISTdirect
Records relied on a loan advance from us of $2.75 million and bridge loans from Mr. Field and
outside investors aggregating $2.048 million to fund its operations. As of December 31, 2003,
ARTISTdirect Records did not have sufficient working capital resources to conduct operations.
During 2004, ARTISTdirect Records relied on bridge loans from Mr. Field of $2.778 million to fund
its reduced level of operations. Through December 31, 2004, Mr. Field had provided bridge funding
to ARTISTdirect Records aggregating $3.676 million, including $898,000 in 2003 and $2.778 million
in 2004. Effective July 30, 2004, we entered into a Termination Agreement with BMG and ARTISTdirect
Records which extinguished all of our obligations under our funding guaranty, including the
remaining $12.0 million funding obligation to ARTISTdirect Records. On February 28, 2005, we completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records pursuant to a Transfer Agreement for a cash payment of $115,000, as a
result of which we no longer had an equity or other economic interest in ARTISTdirect Records, and
Radar Records became the owner of a majority of the membership interests of ARTISTdirect Records
and also acquired the receivable reflecting the $33.0 million of loan advances previously provided
to ARTISTdirect Records by ADI. In conjunction with this transaction, at February 28, 2005, ADI
wrote-off the intercompany balance due from ARTISTdirect Records ($80,000 at December 31, 2004),
which was eliminated in consolidation. Radar Records acquired the common stock of ARTISTdirect
Recordings subject to the rights of BMG. Radar Records also agreed to offer to investors who had
provided bridge funding to ARTISTdirect Records, excluding Frederick W. Field and entities related
or controlled by him, the right to acquire proportional shares (based on the amount of bridge
funding made by each bridge investor in ARTISTdirect Records) of the common stock of ARTISTdirect
Recordings on the same terms and conditions as set forth in the Transfer Agreement. 23




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The amount of consideration received by us was determined with reference to various factors,
including, but not limited to, our future business plans and intention to focus on our internet and
web-site operations, ARTISTdirect Records current limited capital resources and substantially
reduced level of operations, ARTISTdirect Records future business plans and capital requirements
and the likelihood of obtaining such capital on a timely basis and under reasonable terms and
conditions, the unpaid costs that we have advanced ARTISTdirect Records to date, and would be
required to continue to advance ARTISTdirect Records in the future, and the probability of our
obtaining a return on our investment to date of $33.0 million in ARTISTdirect Records. As a result of the existence of various conflicts of interest with respect to this
transaction, full disclosure of these conflicts of interest was made to our Board of Directors and
the required approval by the disinterested members of our Board of Directors was obtained prior to
the closing of the transaction. As a result of the sale of all of our interest in ARTISTdirect Recordings to Radar Records
effective February 28, 2005, we have accounted for our interest in ARTISTdirect Records as a
discontinued operation at December 31, 2004 in accordance with SFAS No. 144. Accordingly, we have
restated our consolidated financial statements as of December 31, 2003 and for the years ended
December 31, 2002 and 2003 to reflect such accounting treatment, and the assets and liabilities of
ARTISTdirect Records have been classified as held for sale. As a result of the disposition of our interest in ARTISTdirect Records effective February 28,
2005, we estimate that we will recognize a net non-cash gain in our consolidated statement of
operations for the three months ended March 31, 2005 of
approximately $21 million (unaudited),
primarily as a result of the elimination of the liabilities of ARTISTdirect Records. A summary of ADIs pro forma consolidated balance sheet at December 31, 2004, assuming that
the disposition of ADIs interest in ARTISTdirect Records had been accomplished effective December
31, 2004, is presented below. December 31, 2004Pro Forma -As Reported
    
    
    As Adjusted(in thousands)AssetsCurrent assets
    
    $
    2,294
    
    
    $
    2,393Property and equipment, net
    
    
    99
    
    
    
    99Other non-current assets
    
    
    20
    
    
    
    20Total assets
    
    $
    2,413
    
    
    $
    2,512Liabilities and Stockholders Equity (Deficiency)Current liabilities
    
    $
    20,732
    
    
    $
    1,962Minority interest  discontinued operations
    
    
    1,940
    
    
    
    Stockholders equity (deficiency)
    
    
    (20,259
    )
    
    
    550Total liabilities and stockholders equity
(deficiency)
    
    $
    2,413
    
    
    $
    2,512
 iMusic Record Label During 2002, we began operating a record label under the brand name iMusic through our
wholly-owned subsidiary, ARTISTdirect Digital, Inc. Operations consisted primarily of the sale of
compact discs by artists signed to the iMusic record label. iMusics concept was to focus on the
signing of established artists with a proven sales base and an ability to generally make records
less expensively than developing artists. In addition, we expected that substantially less would
be spent on marketing and promotion of these releases than on those of new artists. During the
three months ended June 30, 2003, we decided to scale back the activity of its iMusic label in
order to conserve capital. During the three months ended September 30, 2003, we executed an
agreement with GC Music, pursuant to which we assigned its rights and obligations to six unreleased
artists in exchange for a cash payment of $100,000 as a reduction to prior advances related to the
six artists and a profit interest in the projects. We retained the distribution rights to the
albums previously released under the original terms of our distribution agreements with our other
signed artists, but we did not intend to sign any additional artists or release any additional
albums domestically or internationally under the iMusic label and therefore expected very minimal
sales activity subsequent to the transaction. At December 31, 2004, we have provided a sufficient
reserve for remaining contract obligations and estimated product returns. 24




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Effective November 23, 2004, pursuant to a Trademark Assignment and Purchase Agreement dated
as of November 12, 2004, we sold all of our rights, title and interest in and to certain
trademarks, service markets and trade names, in certain countries of the world, that consist of or
incorporate the term iMusic (the Marks), including domain names that consist of or incorporate
the term iMUSIC (the Domain Names) and goodwill related to such marks or trade names, to Apple
Computer, Inc. for a cash payment of $500,000. The Marks and Domain Names that we sold did not
have any carrying value on our books. As a result of the foregoing, during December 2004, we ceased the sale of products under the
iMusic label and discontinued the operations of the iMusic record label. Accordingly, we have
accounted for the operations of iMusic as a discontinued operation for all periods presented and
have restated our consolidated financial statements as of December 31, 2003 and for the years ended
December 31, 2002 and 2003 to reflect the termination of the business operations of iMusic. GOING CONCERN We have incurred losses and negative cash flows from operations in every fiscal period since
inception and have an accumulated deficit of $226.0 million as of December 31, 2004. For the year
ended December 31, 2004, we incurred a net loss of $3.3 million (including $2.2 million from
discontinued operations) and negative operating cash flows of $3.5 million. As of December 31,
2004, we had a net working capital deficiency of $18.4 million (including liabilities of
discontinued operations held for disposal of $18.9 million, almost all of which were liquidated
effective February 28, 2005) and a stockholders deficiency of $20.3 million. Through December 31,
2003, we had funded substantially all of the operations of ARTISTdirect Records. Effective July
30, 2004, our remaining $12.0 million funding obligation to ARTISTdirect Records was extinguished,
and effective February 28, 2005, we sold all of our interest in ARTISTdirect Records to Radar
Records for a cash payment of $115,000. During 2003, we restructured our operations, laid off most of our staff and reduced operating
costs. Subsequently, management has continued its efforts to improve and expand operations and
cash flows at its online music network. However, it is uncertain whether our available cash
resources will be sufficient to meet anticipated capital requirements over the next twelve months.
If sufficient capital is not available, then we may not be able to fund our operations. To the
extent that we are unable to obtain the capital necessary to fund our future cash requirements on a
timely basis and/or under acceptable terms and conditions, we will not have sufficient cash
resources to maintain operations, and we may consider a formal or informal restructuring or
reorganization. As a result of the conditions described above, our auditors have included an explanatory
paragraph in their 2004 report on our financial statements indicating that there is substantial
doubt about our ability to continue as a going concern. Our financial statements do not include
any adjustments that might result from the outcome of this uncertainty. A summary of how we conduct our business is presented below. REVENUE We had revenues from continuing operations from two sources at December 31, 2004: e-commerce
and media. During 2002, 2003 and 2004, the Company also had revenues from its iMedia record label,
which has been classified as a discontinued operation for all periods presented. E-Commerce Revenue. E-commerce revenue includes the sale of music and related merchandise,
such as apparel, collectibles and accessories, through the ARTISTdirect shopping mall of our
Network. We recognize the gross amount of product sales and shipping revenue upon shipment of the
item and record appropriate reserves for product returns. We have experienced seasonality with
respect to our online product sales. In particular, our e-commerce sales in the fourth quarter
have, on average, been higher than in other quarters. We believe that this trend may continue for
the foreseeable future. Media Revenue. Media revenue consists primarily of sales of banner advertisements and
sponsorships. In sales of banner advertisements, we principally earn revenue based on the number
of impressions or times an advertisement appears on pages viewed within our web-sites. Our banner
advertising commitments generally range from one to six months. Banner advertising revenue is
generally recognized as the impressions are served during the period in which the advertisement is
displayed, provided that we have no significant remaining obligations and collection of the
resulting receivable is probable. We typically guarantee a minimum number of impressions to the
advertiser. To the extent that minimum guaranteed page deliveries are not met, we defer
recognition of the corresponding revenue until the guaranteed impressions are delivered. We also
sell to advertisers the sponsorship of a web-page or event for a specified period of time. We
recognize sponsorship revenue over the period in which the sponsored page or event is 25




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displayed. To the extent that committed obligations under sponsorship agreements are not met,
revenue recognition is deferred until the obligations are met. Since most of our sponsorship and
advertising contracts are short-term in nature, our advertising revenue is susceptible to
significant fluctuation. Record Label Revenue.Record label revenue consisted of the sale of compact discs by artists
under contract to the iMusic record label in 2002, 2003 and 2004, and to ARTISTdirect Records in
2004. We recognized revenues upon the shipment of compact discs to retailers and independent
wholesalers and recorded appropriate reserves for product returns. We have accounted for our
iMusic record label and our interest in ARTISTdirect Records, LLC as discontinued operations for
all periods presented. Accordingly, the Company has restated its consolidated financial statements
as of December 31, 2003 and for the years ended December 31, 2002 and 2003. COST OF REVENUE Direct cost of product sales consists of the cost of merchandise sold, the amounts payable to
artists for their share of net proceeds, online transaction costs, including credit card fees,
warehousing and fulfillment charges and shipping costs. Direct cost of product sales also includes
manufacturing costs and distribution fees payable. Other cost of revenue consists primarily of
web-site hosting and maintenance costs, online content programming costs, online advertising
serving costs, record royalties payable to artists and payroll and related expenses for staff
involved with the Web-site. Stock-based compensation included in cost of revenue represents the
amortization of non-cash compensation expense related to vendor warrants and stock options granted
to artists and their advisors in connection with entering into contractual commitments to operate
their online commerce activities. OPERATING EXPENSES Web- Site Development. Web-site development expense consists primarily of expenses incurred to
update the content and design of our Web-sites and underlying technology infrastructure. These
expenses primarily include payments to third-party service vendors and personnel costs. Sales and Marketing. Sales and marketing expense consists primarily of advertising, marketing
and promotion expenses incurred to promote our Web-sites, as well as payroll and related expenses
for personnel engaged in marketing and advertising sales activities. General and Administrative. General and administrative expense consists of payroll and related
expenses for executive and administrative personnel, professional services expenses, facilities
expenses, insurance, travel and other general corporate expenses. Provision for Doubtful Accounts. Provision for doubtful accounts consists of provisions
related to uncollectible receivables. Stock-based Compensation. We record stock-based compensation expense (exclusive of amounts
recorded within cost of revenue) in connection with equity granted to employees, directors,
professional firms, artists and artist advisors during this period. We may grant additional equity
securities in the future to employees, directors and others. We record stock compensation for
employee option grants equal to the excess of the fair value of our common stock over the exercise
price on the grant date. We record the compensation over the vesting period. For options/warrants
granted to non-employees, we record as stock compensation the fair value of the options/warrants
(using the Black-Scholes option-pricing model) amortized over the related period of service. Depreciation and Amortization. Depreciation and amortization expense consists of the
depreciation of fixed assets. There were no intangible assets on the balance sheet at December 31,
2003 or 2004. Impairment of long-lived assets is monitored on a continuing basis, and is assessed based on
the undiscounted cash flows generated by the underlying assets. In the event that the carrying
amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of
such assets is adjusted to their fair value. Loss from Sale and Abandonment of Property and Equipment.Loss from sale and abandonment of
property and equipment consists of the costs associated with the sale and abandonment of the
property and equipment and leasehold improvements at our former offices. We determined that these
assets were impaired during 2003 as a result of various factors. Accordingly, we reduced the
carrying amount of these assets to their estimated fair value by recording a charge to operations
during 2003. The leasehold improvements were subsequently abandoned when the Company vacated the
premises, and most of the remaining assets were sold to third party liquidators for cash. This
amount has been reported as a loss from sale and abandonment of property and equipment in the
consolidated statement of operations for the year ended December 31, 2003. 26




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CRITICAL ACCOUNTING POLICIES We have identified the following as critical accounting policies: revenue recognition,
stock-based compensation, impairment of long-lived assets and income taxes. The discussion and analysis of our financial condition and results of operations is based upon
our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an on-going basis, we evaluate our estimates, including those related to bad debts, intangible
assets, income taxes, and contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. We believe the following
critical accounting policies affect our more significant judgments and estimates used in the
preparation of our consolidated financial statements. Revenue Recognition E-commerce revenue consists primarily of the gross amount of sales revenue paid by the
customer for recorded music and merchandise sold via the Internet, including shipping fees, and is
recognized when the products are shipped. We record e-commerce revenue on a gross basis as we
enter into sale transactions with customers, establish the prices of the products, choose the
suppliers of the products, assume the risk of inventory loss and collect all amounts from the
customers and assume the credit risk. E-commerce revenue is subject to amounts due to the
respective artists based on their contracts, and such expense is recorded as part of direct cost of
product sales. We record amounts charged to customers for shipping and handling in accordance with Emerging
Issues Task Force No. 00-10, Accounting for Shipping and Handling Fees and Costs. Pursuant to
EITF No. 00-10, we record amounts charged to customers for shipping and handling as revenue, and
the related costs incurred for shipping and handling are recorded to direct cost of product sales
in the consolidated statements of operations. Media revenue consists primarily of the sale of advertisements and sponsorships, both online
and offline, under short-term contracts. To date, the duration of our advertising and sponsorship
commitments has generally averaged from one to three months, with certain programs lasting up to
six months. Our online obligations typically include the guarantee of a minimum number of times
(impressions) that an advertisement appears in pages viewed by the users of our online
properties. Online advertising revenue is generally recognized as the impressions are served
during the period in which the advertisement is displayed, provided that we have no significant
remaining obligations and collection of the resulting receivable is reasonably assured. To the
extent that minimum guaranteed page deliveries are not met, recognition of the corresponding
revenue is deferred until the guaranteed impressions are delivered. We recognize revenue for sponsorship arrangements, both online and offline, over the period
during which the advertising is provided, generally on a straight-line basis. If the sponsorship
arrangement is for the sponsorship of a specific event, we recognize revenue when the event occurs.
We recognize revenue separately for each element of integrated entertainment marketing packages
that offer advertisers a combination of offline concert and tour sponsorships that are supported by
online banner advertising, web-page sponsorships, emails to our customers and custom content. We
determine the fair value of each deliverable based on the fair value of the different deliverables
when sold on a stand-alone basis. We recognize revenue for each deliverable as the services are
provided. We recognize revenue for the banner impression deliverable as the banner impressions are
delivered. We recognize revenue for the customer emails when the emails are sent. We recognize
revenue for web-page sponsorships on a straight-line basis over the term of the sponsorship. We
recognize revenue for the custom content when the content is provided to the customer. We
recognize revenue for event sponsorships when the event has occurred. Record label revenue consisted of the sale of compact discs by artists signed to iMusic and
ARTISTdirect Records. We recognized revenue upon the shipment of compact discs from our
distributor to retailers and independent wholesalers and recorded appropriate reserves for product
returns. At the time of the shipment of the product, the following criterion under Statement of
Financial Accounting Standards No. 48, Revenue Recognition When Right of Return Exists, had been
met: the sellers price to the buyer was substantially fixed or determinable at the date of sale;
the buyer had paid the seller, or the buyer was obligated to pay the seller and the obligation was
not contingent on resale of the product; the buyers obligation to the seller would not be changed
in the 27




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event of theft or physical destruction or damage of the product; the buyer acquiring the
product for resale had economic substance apart from that provided by the seller; the seller did
not have significant obligations for future performance to directly bring about resale of the
product by the buyer; and the amount of future returns could be reasonably estimated. Stock-Based Compensation We account for stock-based employee compensation in accordance with the provisions of
Accounting Principles Board (APB) Opinion No. 25 and FASB Interpretation No. 44 , Accounting
for Certain Transactions Involving Stock Compensation (FIN 46), and comply with the disclosure
requirements of SFAS No. 123, Accounting for Stock-Based Compensation. Under APB No. 25,
compensation expense is recorded based on the difference, if any, between the fair value of our
stock and the exercise price on the measurement date. We account for stock issued to non-employees
in accordance with SFAS No. 123, which requires entities to recognize as expense over the service
period the fair value of all stock-based awards on the date of grant and EITF No. 96-18,
Accounting for Equity Investments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services, which addresses the measurement date and recognition
approach for such transactions. We recognize compensation expense related to variable awards in accordance with FIN 28. For
fixed awards, we recognize expense over the vesting period or the period of service. Stock-based compensation included in cost of revenue represents the amortization of non-cash
compensation expense related to vendor warrants and stock options granted to artists and their
advisors in connection with entering into contractual commitments to operate their online commerce
activities. We record the fair value of options/warrants granted to non-employees as compensation
expense over the period of service. We determine the fair value of the options/warrants based on
the Black-Scholes option-pricing model. Stock-based compensation included in operating expenses represents the amortization of
non-cash compensation expense related to equity instruments granted to employees, directors,
professional firms, artists and artist advisors. Compensation for equity grants to non-employees is
recorded in the same manner as described above. We record stock compensation for employee option
grants equal to the excess of the fair value of our common stock over the exercise price on the
grant date. We record the compensation over the vesting period. Impairment of Long-Lived Assets Impairment of long-lived assets is monitored on a continuing basis, and is assessed based on
the undiscounted cash flows generated by the underlying assets. In the event that the carrying
amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of
such assets is adjusted to their fair value. Income Taxes We record a valuation allowance to reduce our deferred tax assets to the amount that is more
likely than not to be realized. In the event we determine that we would be able to realize our
deferred tax assets in the future in excess of our recorded amount, an adjustment to the deferred
tax assets would be credited to operations in the period such determination was made. Likewise,
should we determine that we would not be able to realize all or part of our deferred tax assets in
the future, an adjustment to the deferred tax assets would be charged to operations in the period
such determination was made. Presented below are the Companys consolidated statements of operations for the years ended
December 31, 2002, 2003 and 2004. Years Ended December 31,2002
    
    
    2003
    
    
    2004Net revenue:E-commerce
    
    $
    4,713
    
    
    $
    3,459
    
    
    $
    2,994Media
    
    
    924
    
    
    
    1,173
    
    
    
    2,149Total net revenue
    
    
    5,637
    
    
    
    4,632
    
    
    
    5,143Cost of revenue:Direct cost of product sales
    
    
    3,593
    
    
    
    2,552
    
    
    
    3,034Other cost of revenue
    
    
    2,738
    
    
    
    1,034
    
    
    
    518
 28




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Years Ended December 31,2002
    
    
    2003
    
    
    2004Stock-based compensation
    
    
    3,084
    
    
    
    33
    
    
    
    Total cost of revenue
    
    
    9,415
    
    
    
    3,619
    
    
    
    3,552Gross profit (loss)
    
    
    (3,778
    )
    
    
    1,013
    
    
    
    1,591Operating expenses:Web-site development
    
    
    53
    
    
    
    5
    
    
    
    Sales and marketing
    
    
    1,760
    
    
    
    410
    
    
    
    167General and administrative
    
    
    7,323
    
    
    
    4,134
    
    
    
    2,676Provision for doubtful accounts
    
    
    42
    
    
    
    83
    
    
    
    110Stock-based compensation
    
    
    1,897
    
    
    
    527
    
    
    
    7Depreciation and amortization
    
    
    2,814
    
    
    
    1,014
    
    
    
    223Loss from impairment of goodwill
    
    
    788
    
    
    
    
    
    
    
    Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    2,225
    
    
    
    Total operating costs
    
    
    14,677
    
    
    
    8,398
    
    
    
    3,183Loss from operations
    
    
    (18,455
    )
    
    
    (7,385
    )
    
    
    (1,592
    )Loss from equity investment
    
    
    (16
    )
    
    
    (64
    )
    
    
    Interest income, net
    
    
    748
    
    
    
    146
    
    
    
    29Forgiveness of debt by officer
    
    
    
    
    
    
    411
    
    
    
    Gain from sale of tradename
    
    
    
    
    
    
    
    
    
    
    500Loss from continuing operations
    
    
    (17,723
    )
    
    
    (6,892
    )
    
    
    (1,063
    )Income (loss) from discontinued operations:Agency business
    
    
    147
    
    
    
    
    
    
    
    iMusic record label
    
    
    (1,380
    )
    
    
    (298
    )
    
    
    (137
    )ARTISTdirect Records, LLC
    
    
    
    
    
    
    
    
    
    
    (2,111
    )Equity investment in ARTISTdirect Records, LLC
    
    
    (29,236
    )
    
    
    (9,256
    )
    
    
    Loss from discontinued operations
    
    
    (30,469
    )
    
    
    (9,554
    )
    
    
    (2,248
    )Loss before cumulative effect of change in accounting principles
    
    
    (48,192
    )
    
    
    (16,446
    )
    
    
    (3,311
    )Cumulative effect of consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    (5,255
    )
    
    
    Net loss
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )
 The Company evaluates the performance of its business segments based on earnings or loss
before interest, taxes, depreciation and amortization, including stock-based compensation,
impairment losses, and minority interest (EBITDA). Included in EBITDA are direct operating
expenses for each segment. The following table summarizes net revenue and EBITDA by segment for
the years ended December 31, 2002, 2003 and 2004. Corporate expenses consist of general operating
expenses that are not directly related to the operations of the segments. The segment data
presented below has been restated for all periods to reflect the segment structure at December 31,
2004. Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Net Revenue:E-commerce
    
    $
    4,713
    
    
    $
    3,459
    
    
    $
    2,994Media
    
    
    924
    
    
    
    1,173
    
    
    
    2,149$
    5,637
    
    
    $
    4,632
    
    
    $
    5,143EBITDA:E-commerce
    
    $
    (137
    )
    
    $
    553
    
    
    $
    293Media
    
    
    (3,065
    )
    
    
    (576
    )
    
    
    789(3,202
    )
    
    
    (23
    )
    
    
    1,082Corporate
    
    
    (6,670
    )
    
    
    (3,152
    )
    
    
    (1,944
    )$
    (9,872
    )
    
    $
    (3,175
    )
    
    $
    (862
    )
 Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Reconciliation of EBITDA to Net Loss:EBITDA per segments
    
    $
    (9,872
    )
    
    $
    (3,175
    )
    
    $
    (862
    )Stock-based compensation
    
    
    (4,981
    )
    
    
    (560
    )
    
    
    (7
    )Depreciation and amortization
    
    
    (2,814
    )
    
    
    (1,014
    )
    
    
    (223
    )
 29




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Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Loss from impairment of goodwill
    
    
    (788
    )
    
    
    
    
    
    
    Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    (2,225
    )
    
    
    Loss from equity investment
    
    
    (16
    )
    
    
    (64
    )
    
    
    Loss from discontinued operations  ARTISTdirect Records, LLC
    
    
    (29,236
    )
    
    
    (9,256
    )
    
    
    (2,111
    )Loss from discontinued operations  iMusic record label and
agency business
    
    
    (1,233
    )
    
    
    (298
    )
    
    
    (137
    )Interest income (expense), net
    
    
    748
    
    
    
    146
    
    
    
    29Cumulative effect of consolidation of ARTISTdirect Records,
LLC
    
    
    
    
    
    
    (5,255
    )
    
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )
 RESULTS OF OPERATIONS Overview: During the year ended December 31, 2003, we restructured senior operating management and
significantly reduced overhead and operating activities at the parent company level and laid off
the majority of our staff. In addition, during the year ended December 31, 2003, ARTISTdirect
Records significantly reduced its overhead costs and operating activities and laid off the majority
of its staff while it continued to restructure its operations and seek additional capital.
Subsequently, we have continued our efforts to improve and expand operations and cash flows at our
online music network. During 2005, we intend to focus on increasing revenue from our Media operations business
segment, which generates revenues from the sale of online advertising and sponsorships to companies
seeking to reach one or more of the distinct demographic audiences viewing content in the
ARTISTdirect Network. We market and sell advertising on a cost-per-impression (CPM) basis to
advertising agencies and directly to various companies as part of their marketing programs.
Customers may purchase advertising space on the entire ARTISTdirect Network, or they may tailor
advertising based on music genre or functionality. For the years ended December 31, 2002, 2003 and
2004, advertising revenue represented approximately 16%, 25% and 42%, respectively, of total net
revenue. In 2004, advertising revenue increased approximately 83% over the previous year. In
2005, we expect that advertising revenue will continue to increase to in excess of 50% of total net
revenue. We have recorded 100% of the losses attributable to ARTISTdirect Records from May 31, 2001
through April 30, 2002 based on our commitment to fund 100% of its operations up to that time.
From May 1, 2002 through December 31, 2002, we recorded approximately 83% of the losses of
ARTISTdirect Records as a result of BMGs equity purchase and their assumption of a portion of our
funding commitment to the record label. For the year ended December 31, 2003, we recorded
approximately 73% of the losses of ARTISTdirect Records. However, given that we did not have
voting or operating control, even with our majority ownership position in ARTISTdirect Records,
through December 31, 2003, we accounted for this investment under the equity method of accounting
as income (loss) from equity investments in our consolidated statements of operations. In February 2003, the Financial Accounting Standards Board issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which addresses the consolidation by
business enterprises of variable interest entities. FIN 46 defines when a company should evaluate
controlling financial interest, and thus consolidation, based on factors other than voting
rights, and requires that a new risks and rewards model be applied in these situations. We
adopted FIN 46 effective December 31, 2003. As a result of the adoption of FIN 46, the balance
sheet of ARTISTdirect Records was consolidated beginning as of December 31, 2003, and the
operations of ARTISTdirect Records were consolidated beginning with the year ended December 31,
2004. There was no change in the operating or business relationship between ADI and ARTISTdirect
Records as a result of the adoption of FIN 46. In addition, as a result of the consolidation of
ARTISTdirect Records as of December 31, 2003, we recorded a one-time charge to operations of $5.255
million in 2003 resulting from the cumulative effect on prior years of this change in accounting
method. On February 28, 2005, we completed the sale of our interest in ARTISTdirect Recordings to
Radar Records. ADI has accounted for its interest in ARTISTdirect Records as a discontinued
operation at December 31, 2004 in accordance with SFAS No. 144. Accordingly, the Company has
restated its consolidated financial statements as of December 31, 2003 and for the years ended
December 31, 2002 and 2003 to reflect such accounting treatment, and the assets and liabilities of
ARTISTdirect Records have been classified as held for sale. 30




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During December 2004, we discontinued the operations of our iMusic record label and have
therefore accounted for the operations of iMusic as a discontinued operation for all periods
presented. Accordingly, we have restated our consolidated financial statements as of December 31,
2003 and for the years ended December 31, 2002 and 2003 to reflect the termination of the business
operations of iMusic. YEARS ENDED DECEMBER 31, 2004 AND 2003 NET REVENUE Net revenue for the year ended December 31, 2004 increased to $5.143 million, from $4.632
million for the year ended December 31, 2003, an increase of $511,000 or 11%. E-commerce revenue decreased to $2.994 million for the year ended December 31, 2004, from
$3.459 million for the year ended December 31, 2003, a decrease of 13% or $465,000, primarily as a
result of lower traffic to the web-site, fewer sales orders and a decline in demand for music and
licensed artist merchandise in 2004. During the years ended December 31, 2003 and 2004,
approximately 45% and 70%, respectively, of revenues from E-commerce were generated from the
products related to one music merchandising entity. Media revenue increased to $2.149 million for the year ended December 31, 2004, from $1.173
million for the year ended December 31, 2003, an increase of 83% or $976,000, as a result of an
increase in the number of online advertisers and an increase in the CPM amounts earned from the
sales of impression and non-impression based advertising and offline sponsorships. Included in
media revenue for the year ended December 31, 2003 was $550,000 of sponsorship income from AT&T
Wireless. During the year ended December 31, 2004, most of our media revenues were generated by
one outside sales organization which represented us with respect to advertising and sponsorship
sales on our web-site. This relationship is continuing in 2005. COST OF REVENUE Direct Cost of Product Sales. Direct cost of product sales increased to $3.034 for the year
ended December 31, 2004, from $2.552 million for the year ended December 31, 2003, an increase of
$482,000 or 19%, primarily as a result of efforts to increase web-site traffic. Other Cost of Revenue. Other cost of revenue decreased to $518,000 for the year ended December
31, 2004, from $1.034 million for the year ended December 31, 2003, a decrease of $516,000 million
or 50%, primarily as a result of a decrease in customer service fees for e-commerce and a shift in
the media advertising sales function from an internal department to an outside firm. Stock-Based Compensation. For the year ended December 31, 2004, we did not record any
stock-based compensation. For the year ended December 31, 2003, we recorded non-cash stock-based
compensation charges of $33,000. Stock-based compensation expense relates primarily to the
amortization of the estimated value of stock options, calculated pursuant to the Black-Scholes
option-pricing model, previously issued to artists and their advisors in connection with the
operation of their stores and is amortized over the life of the associated contracts. OPERATING EXPENSES Web-Site Development. For the year ended December 31, 2004, we did not record any web-site
development expense. Web-site development expense was $5,000 for the year ended December 31, 2003. Sales and Marketing. Sales and marketing expense decreased to $167,000 for the year ended
December 31, 2004, from $410,000 for the year ended December 31, 2003, a decrease of $243,000 or
59%, primarily as a result of the expiration of the Ticketmaster agreement in 2003. General and Administrative. General and administrative expense decreased to $2.676 million for
the year ended December 31, 2004, from $4.134 million for the year ended December 31, 2003, a
decrease of $1.458 million or 35%. This decrease was primarily attributable to decreases in
payroll and related costs as a result of the personnel reductions as part of the mid-2003
restructuring and occupancy costs relating to the termination of our office lease in 2003.
Included in general and administrative expenses in 2004 were $204,000 of costs related to business
development activities. 31




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Provision for Doubtful Accounts.The provision for doubtful accounts increased to $110,000 for
the year ended December 31, 2004, from $83,000 for the year ended December 31, 2003, primarily as a
result of a higher level of uncollectible accounts receivable related to increased advertising
revenues in 2004. Stock-Based Compensation. We recorded stock-based compensation expense of $7,000 for the year
ended December 31, 2004, as compared to $527,000 for the year ended December 31, 2003 in connection
with previous stock-based compensation issued to employees, directors, professional firms, artists
and advisors for promotional services. The decrease was due to the amortization period for the
previously-issued stock-based compensation having been completed prior to 2004. Depreciation and Amortization. Depreciation and amortization expense decreased to $223,000 for
the year ended December 31, 2004, from $1.014 million for the year ended December 31, 2003, a
decrease of $791,000 or 78%. This decrease was primarily due to the write-down and abandonment of
property and equipment during 2003. Loss from Sale and Abandonment of Property and Equipment and Impairment of Goodwill. For the
year ended December 31, 2004, we did not record any loss from sale and abandonment of property and
equipment. During the year ended December 31, 2003, we recorded a loss from the sale and
abandonment of property and equipment of $2.225 million. This loss was mainly as a result of
vacating our office space following the termination of our lease. LOSS FROM EQUITY INVESTMENT We did not have any loss from equity investments for the year ended December 31, 2004. The
loss from equity investments was $64,000 for the year ended December 31, 2003. This equity loss
related to our investment in SnoCore, LLC. INTEREST INCOME, NET For the year ended December 31, 2004, net interest income was $29,000, as compared with net
interest income of $146,000 for the year ended December 31, 2003. This net decrease in interest
cost of $117,000 is primarily due to lower average cash balances held during 2004 as compared with
2003. FORGIVENESS OF DEBT BY OFFICER During 2002, our Chairmans employment agreement was amended whereby he agreed to defer his
future salary until we raised new debt or equity financing of at least $20 million. During the
three months ended June 30, 2003, our Chairmans employment agreement was further amended whereby
all deferred and any future salary, except a base amount, would be waived, even if new debt or
equity financing is raised. Accordingly, during the year ended December 31, 2003, $411,000 of
accrued compensation due to our Chairman was recorded as gain from forgiveness of debt in the
consolidated statement of operations. GAIN FROM SALE OF TRADENAME Effective November 23, 2004, pursuant to a Trademark Assignment and Purchase Agreement dated
as of November 12, 2004, we sold all of our rights, title and interest in and to certain
trademarks, service markets and trade names, in certain countries of the world, that consist of or
incorporate the term iMusic (the Marks), including domain names that consist of or incorporate
the term iMUSIC (the Domain Names) and goodwill related to such marks or trade names, to Apple
Computer, Inc. for a cash payment of $500,000. The Marks and Domain Names that we sold did not
have any carrying value on our books. DISCONTINUED OPERATIONS We recorded a loss from equity investments 100% of the loss of ARTISTdirect Records through
April 30, 2002 due to our commitment to fund 100% of its operations. From May 1, 2002 through
December 31, 2002, we recorded approximately 83% of the loss of ARTISTdirect Records based on our
relative share of the remaining funding commitment to ARTISTdirect Records. For the year ended
December 31, 2003, we recorded approximately 73% of the losses of ARTISTdirect Records. For the
year ended December 31, 2003, we recorded $9.256 million as our relative share of the loss of
ARTISTdirect Records. 32




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For the year ended December 31, 2004, we consolidated the operations of ARTISTdirect Records,
and recorded a related loss from discontinued operations of $2.111 million. For the year ended December 31, 2004, the operations of the iMusic record label generated a
loss of $137,000, as compared to $298,000 for the year ended December 31, 2003. A summary of the results of operations of ARTISTdirect Records and the iMusic record label for
the years ended December 31, 2004 and 2003 is presented below. CUMULATIVE EFFECT OF CONSOLIDATION OF ARTISTDIRECT RECORDS, LLC As a result of the consolidation of ARTISTdirect Records as of December 31, 2003, we recorded
a one-time charge to operations of $5.255 million in 2003 resulting from the cumulative effect on
prior years of the change in accounting method from equity to consolidation. NET LOSS As a result of the foregoing factors, net loss decreased to $3.311 million for the year ended
December 31, 2004, as compared to $21.701 million for the year ended December 31, 2003, a decrease
of $18.390 million or 85%. YEARS ENDED DECEMBER 31, 2003 AND 2002 NET REVENUE Net revenue for the year ended December 31, 2003 decreased to $4.632 million, from $5.637
million for the year ended December 31, 2002, a decrease of $1.005 million or 18%. E-commerce revenue decreased to $3.459 million for the year ended December 31, 2003, from
$4.713 million for the year ended December 31, 2002, a decrease of 27% or $1.254 million, primarily
as a result of lower traffic to the web-site, fewer sales orders and a decline in demand for music
and licensed artist merchandise in 2003. During the years ended December 31, 2002 and 2003,
approximately 25% and 45%, respectively, of revenues from E-commerce were generated from the
products related to one music merchandising entity. Media revenue increased to $1.173 million for the year ended December 31, 2003, from $924,000
for the year ended December 31, 2002, an increase of 27% or $249,000, as a result of an increase in
the number of online advertisers and an increase in the CPM amounts earned from the sales of
impression and non-impression based advertising and offline sponsorships. Included in media
revenue for the year ended December 31, 2003 was $550,000 of sponsorship income from AT&T Wireless. COST OF REVENUE Direct Cost of Product Sales. Direct cost of product sales decreased to $2.552 million for the
year ended December 31, 2003, from $3.593 million for the year ended December 31, 2002, a decrease
of $1.041 million or 29%, primarily as a result of the decrease in E-commerce revenues in 2003. Other Cost of Revenue. Other cost of revenue decreased to $1.034 million for the year ended
December 31, 2003, from $2.738 million for the year ended December 31, 2002, a decrease of $1.704
million or 62%, primarily as a result of a decrease in web-site hosting and maintenance costs due
to a reduction in headcount and a restructuring of our third party service provider agreements. Stock-Based Compensation. For the year ended December 31, 2003, we recorded non-cash
stock-based compensation charges of $33,000 as compared to $3.084 million for the year ended
December 31, 2002, a decrease of $3.051 million or 99%. Stock-based compensation expense relates
primarily to the amortization of the estimated value of stock options, calculated pursuant to the
Black-Scholes option-pricing model, previously issued to artists and their advisors in connection
with the operation of their stores and is amortized over the life of the associated contracts. The
decrease in stock-based compensation in 2003 is primarily due to completion of most of the
amortization of stock-based compensation during 2002 as a result of the terms of a number of artist
agreements expiring during 2002. The approximately $3.1 million in stock-based compensation
expense in 2002 consists of $2.1 million related to option 33




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grants to artists and advisors, $900,000 in compensation expense related to the rescission for
which services were being provided by artists and advisors in 2002, and $79,000 of expense related
to warrants granted to suppliers. OPERATING EXPENSE Web-Site Development. Web-site development expense decreased to $5,000 for the year ended
December 31, 2003, from $53,000 for the year ended December 31, 2002, a decrease of $48,000 or 91%,
primarily as a result of lower fees paid to third party service vendors relating to the enhancement
of our web-site. Sales and Marketing. Sales and marketing expense decreased to $410,000 million for the year
ended December 31, 2003, from $1.760 million for the year ended December 31, 2002, a decrease of
$1.350 million or 77%, primarily as a result of a decrease in online advertising expenditures
resulting from the restructuring of our agreement with Ticketmaster and lower marketing, payroll
and related costs. General and Administrative. General and administrative expense decreased to $4.134 million for
the year ended December 31, 2003, from $7.323 million for the year ended December 31, 2002, a
decrease of $3.189 million or 44%. This decrease was primarily attributable to a decrease in
payroll costs associated with the reduced headcount of approximately $2.3 million and an
approximately $1.2 million decrease in outside services and insurance costs. Provision for Doubtful Accounts.The provision for doubtful accounts increased to $83,000 for
the year ended December 31, 2003, from $42,000 for the year ended December 31, 2002, as a result of
higher level of uncollectible accounts receivable related to advertising revenues in 2003. Stock-Based Compensation. We recorded stock-based compensation expense of $527,000 for the
year ended December 31, 2003 in connection with previous stock-based compensation issued to
employees, directors, professional firms, artists and advisors for promotional services, a decrease
of $1.370 million or 72% from the $1.897 million expense for the year ended December 31, 2002.
Stock-based compensation represented the remaining amortization of such prepaid compensation paid
in prior years. The decrease in stock-based compensation in 2003 was primarily due to the
amortization period for most of such stock-based compensation being completed in 2002. Depreciation and Amortization. Depreciation and amortization expense decreased to $1.014
million for the year ended December 31, 2003, from $2.814 million for the year ended December 31,
2002, a decrease of $1.8 million or 64%. This decrease was primarily due to the write-down and
abandonment of property and equipment during 2003. Loss from Sale and Abandonment of Property and Equipment and Impairment of Goodwill. During
the year ended December 31, 2003, we recorded a loss from the sale and abandonment of property and
equipment of $2.225 million. This loss was mainly as a result of vacating our office space
following the termination of our lease. During the year ended December 31, 2002, we recorded a
loss on impairment of goodwill related to the write-off of the remaining goodwill associated with
our online operations of $788,000. This write-down was recorded due to declines in advertising
revenue on the Network and the determination that there was insufficient basis to support the
carrying amounts of goodwill based upon the projected undiscounted future cash flows related to the
underlying Network assets. LOSS FROM EQUITY INVESTMENT Loss from equity investments was $16,000 for the year ended December 31, 2002, as compared to
$64,000 for the year ended December 31, 2003. This equity loss related to our investment in
SnoCore, LLC. INTEREST INCOME, NET For the year ended December 31, 2003, net interest income was $146,000, as compared with net
interest income of $748,000 for the year ended December 31, 2002. This net decrease in interest
cost of $602,000 is primarily due to lower average cash balances held during 2003 as compared with
2002. 34




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FORGIVENESS OF DEBT BY OFFICER During 2002, our Chairmans employment agreement was amended whereby he agreed to defer his
future salary until we raised new debt or equity financing of at least $20 million. During the
three months ended June 30, 2003, our Chairmans employment agreement was further amended whereby
all deferred and any future salary, except a base amount, would be waived, even if new debt or
equity financing is raised. Accordingly, during the year ended December 31, 2003, $411,000 of
accrued compensation due to our Chairman was recorded as gain from forgiveness of debt in the
consolidated statement of operations. DISCONTINUED OPERATIONS We recorded a loss from equity investments 100% of the loss of ARTISTdirect Records through
April 30, 2002 due to our commitment to fund 100% of its operations. From May 1, 2002 through
December 31, 2002, we recorded approximately 83% of the loss of ARTISTdirect Records based on our
relative share of the remaining funding commitment to ARTISTdirect Records. For the year ended
December 31, 2003, we recorded approximately 73% of the losses of ARTISTdirect Records. For the
years ended December 31, 2002 and 2003, we recorded $29.236 million and $9.256 million,
respectively, as our relative share of the loss of ARTISTdirect Records. The decrease in the loss
was due to a reduced level of activity at ARTISTdirect Records in 2003 as compared to 2002. Income from the discontinued operations of the agency business was $147,000 for the year ended
December 31, 2002. The Company did not have any income (loss) from the discontinued operations of
the agency business for the year ended December 31, 2003. For the year ended December 31, 2003, the operations of the iMusic record label generated a
loss of $298,000, as compared to $1,380,000 for the year ended December 31, 2002. A summary of the results of operations of ARTISTdirect Records and the iMusic record label for
the years ended December 31, 2003 and 2002 is presented below. CUMULATIVE EFFECT OF CONSOLIDATION OF ARTISTDIRECT RECORDS, LLC As a result of the consolidation of ARTISTdirect Records as of December 31, 2003, we recorded
a one-time charge to operations of $5.255 million in 2003 resulting from the cumulative effect on
prior years of the change in accounting method from equity to consolidation. NET LOSS As a result of the foregoing factors, net loss decreased to $21.701 million for the year ended
December 31, 2003, as compared to $48.192 million for the year ended December 31, 2002, a decrease
of $26.491 million or 55%. ARTISTDIRECT RECORDS, LLC A summary of the operations of ARTISTdirect Records for the years ended December 31, 2002,
2003 and 2004, which has been accounted for as a discontinued operation for all periods presented,
is as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Net revenue
    
    $
    3,709
    
    
    $
    1,426
    
    
    $
    (19
    )Cost of revenue
    
    
    10,093
    
    
    
    1,798
    
    
    
    986Gross loss
    
    
    (6,384
    )
    
    
    (372
    )
    
    
    (1,005
    )Operating expenses:Sales and marketing
    
    
    12,029
    
    
    
    3,287
    
    
    
    285General and administrative
    
    
    14,374
    
    
    
    6,450
    
    
    
    393Depreciation and amortization
    
    
    36
    
    
    
    39
    
    
    
    22Loss from sale and abandonment of property and
Equipment
    
    
    
    
    
    
    100
    
    
    
    Total operating expenses
    
    
    26,439
    
    
    
    9,876
    
    
    
    700Loss from operations
    
    
    (32,823
    )
    
    
    (10,248
    )
    
    
    (1,705
    )
 35




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Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Minority interest
    
    
    
    
    
    
    
    
    
    
    759Interest expense
    
    
    (1,133
    )
    
    
    (2,244
    )
    
    
    (649
    )Amortization of bridge note warrants
    
    
    
    
    
    
    (203
    )
    
    
    (998
    )Forgiveness of debt
    
    
    
    
    
    
    
    
    
    
    482Net loss
    
    $
    (33,956
    )
    
    $
    (12,695
    )
    
    $
    (2,111
    )
 iMUSIC RECORD LABEL A summary of the operations of the iMusic record label for the years ended December 31, 2002,
2003 and 2004, which has been accounted for as a discontinued operation for all periods presented,
is as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Net revenue
    
    $
    613
    
    
    $
    1,352
    
    
    $
    (136
    )Cost of revenue
    
    
    1,325
    
    
    
    744
    
    
    
    (1
    )Gross profit (loss)
    
    
    (712
    )
    
    
    608
    
    
    
    (135
    )Operating expenses:Sales and marketing
    
    
    464
    
    
    
    810
    
    
    
    2General and administrative
    
    
    204
    
    
    
    96
    
    
    
    Total operating expenses
    
    
    668
    
    
    
    906
    
    
    
    2Net loss
    
    $
    (1,380
    )
    
    $
    (298
    )
    
    $
    (137
    )
 LIQUIDITY AND CAPITAL RESOURCES We have financed our activities during the past few years from the sale of our equity
securities. As of December 31, 2004, we had $1,156,000 of unrestricted cash and cash equivalents.
We had a working capital deficiency of $18.438 million at December 31, 2004, primarily because of
the consolidation of ARTISTdirect Records, which had liabilities of $18.768 million at such date.
Effective February 28, 2005, we sold 100% of our interest in ARTISTdirect Records for a cash
payment of $115,000, as a result of which we no longer had any equity or other economic interest in
ARTISTdirect Records. As a result of the disposition of our interest in ARTISTdirect Records
effective February 28, 2005, the liabilities of ARTISTdirect Records were eliminated from our
balance sheet at that date. During 2003, we restructured our operations, laid off most of our staff and reduced operating
costs. Subsequently, we have been attempting to improve and expand operations and cash flows at
our online music network. However, it is uncertain whether our available cash resources will be
sufficient to meet anticipated capital requirements over the next twelve months. If sufficient
capital is not available, then we may not be able to fund our operations. To the extent that we
are unable to obtain the capital necessary to fund our future cash requirements on a timely basis
and/or under acceptable terms and conditions, we will not have sufficient cash resources to
maintain operations, and we may consider a formal or informal restructuring or reorganization. As a result of the conditions described above, our auditors have included an explanatory
paragraph in their 2004 report on our financial statements indicating that there is substantial
doubt about our ability to continue as a going concern. Our financial statements do not include
any adjustments that might result from the outcome of this uncertainty. Operating.Net cash used in operating activities was $11.161 million, $5.423 million and
$3.473 million for the years ended December 31, 2002, 2003 and 2004, respectively. Net cash used
in continuing operations was $10.116 million, $5.139 million and $625,000 for the years ended
December 31, 2002, 2003 and 2004, respectively. Net cash used in discontinued operations was
$1.045 million, $284,000 and $2.848 million for the years ended December 31, 2002, 2003 and 2004,
respectively. Net cash used in operating activities for each of these periods consisted primarily
of net losses, partially offset by non-cash items such as loss from equity investments, stock-based
compensation, depreciation and amortization, and loss from impairment of goodwill and sale and
abandonment of property and equipment. Investing.Net cash provided by investing activities was $957,000 for the year ended December
31, 2004, which consisted of the proceeds from the sale/maturity of short-term investments of $1.012
million, offset by $55,000 of purchases of property and 36




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equipment. Net cash provided by investing activities was $2.425 million for the year ended
December 31, 2003, which consisted primarily of the proceeds from the sale/maturity of short-term
investments of $5.045 million, partially offset by our advance to ARTISTdirect Records of $2.75
million and the proceeds from the sales of equipment of $123,000. Net cash used in investing
activities for the year ended December 31, 2002 was $12.8 million, which consisted primarily of our
advances to ARTISTdirect Records of $25.0 million, partially offset by the proceeds from the
sale/maturity of short-term investments of $12.316 million and purchases of property and equipment
of $381,000. Financing.Net cash provided by financing activities was $2.953 million for the year ended
December 31, 2004, which consisted of a reduction in restricted cash of $175,000 and the issuance
of bridge notes by ARTISTdirect Records of $2.778 million. Net cash provided by financing
activities was $1.807 million for the year ended December 31, 2003, which consisted of a reduction
in restricted cash of $1.807, of which approximately $1.3 million was paid out to our landlord in
conjunction with the termination of our facilities lease. Net cash provided by financing
activities was $855,000 for the year ended December 31, 2002, which was primarily a result of the
release of restricted cash related to two letters of credit held by third parties related to our
office lease and e-commerce credit card processor. PRINCIPAL COMMITMENTS At December 31, 2004, we did not have any material commitments for capital expenditures. As
of December 31, 2004, excluding liabilities associated with ARTISTdirect Records, our principal
commitments consisted of funding commitments as summarized below. Payments Due by Period (in thousands)Less than
    
    
    Between
    
    
    Between
    
    
    AfterContractual cash obligations
    
    Total
    
    
    1 year
    
    
    2-3 years
    
    
    4-5 years
    
    
    5 yearsEmployment contracts
    
    $
    421
    
    
    $
    305
    
    
    $
    116
    
    
    $
    
    
    
    $
    Total contractual cash obligations
    
    $
    421
    
    
    $
    305
    
    
    $
    116
    
    
    $
    
    
    
    $
    
 OFF-BALANCE SHEET ARRANGEMENTS At December 31, 2004, we did not have any transactions, obligations or relationships that
could be considered off-balance sheet arrangements. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123
(revised 2004), Share Based Payment (SFAS 123R), a revision to SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS 123R supercedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows.
SFAS 123R requires that the Company measure the cost of employee services received in exchange for
equity awards based on the grant date fair value of the awards. The cost will be recognized as
compensation expense over the vesting period of the awards. The Company is required to adopt SFAS
123R effective January 1, 2006. Under this method, the Company will begin recognizing compensation
cost for equity-based compensation for all new or modified grants after the date of adoption. In
addition, the Company will recognize the unvested portion of the grant date fair value of awards
issued prior to adoption based on the fair values previously calculated for disclosure purposes
over the remaining vesting period of the outstanding options and warrants. The Company is
currently evaluating the potential effect that the adoption of SFAS 123R will have on the Companys
financial statement presentation and disclosures. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment
to APB Opinion No. 29 (SFAS 153). SFAS 153 amends Accounting Principles Board Opinion No. 29,
Accounting for Nonmonetary Transactions, to require that exchanges of nonmonetary assets be
measured and accounted for at fair value, rather than at carryover basis, of the assets exchanged.
Nonmonetary exchanges that lack commercial substance are exempt from this requirement. SFAS 153 is
effective for nonmonetary exchanges entered into in fiscal periods beginning after June 15, 2005.
The Company does not routinely enter into nonmonetary exchanges. Accordingly, the Company does not
expect that the adoption of SFAS 153 will have a significant effect on the Companys financial
statement presentation or disclosures. 37




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ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk The Company does not have any market risk with respect to such factors as commodity prices,
equity prices and other market changes that affect market risk sensitive investments. The Company does not have any foreign currency risk, as its revenues and expenses are
denominated and settled in United States dollars. Interest Rate Risk The Company is not exposed to any interest rate risk through its assets and liabilities. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our consolidated financial statements appear in a separate section of this Annual Report on
Form 10-K following Item 15. Such information is incorporated herein by reference. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Effective February 6, 2004, we dismissed KPMG LLP (KPMG) as our independent accountant. The
dismissal of KPMG was recommended by our Audit Committee and approved by our Board of Directors. KPMGs reports on our financial statements for the years ended December 31, 2001 and 2002 did
not contain an adverse opinion or a disclaimer of opinion, nor were they qualified or modified as
to uncertainty, audit scope, or accounting principles, except that KPMGs report, dated February
14, 2003, for the years ended December 31, 2002 and 2001 contained an explanatory paragraph stating
that the Company has incurred substantial operating losses and negative cash flows from operations
to date and has funding commitments related to its record label joint venture. The Company needs
additional capital to fund its operations and the operations of the record label joint venture.
These conditions raise substantial doubt about the Companys ability to continue as a going
concern. Managements plans in regard to these matters are also described in note 1. The financial
statements do not include any adjustments that might result from the outcome of this uncertainty. During the years ended December 31, 2001 and 2002, and the period from January 1, 2003 through
February 6, 2004, there were no disagreements with KPMG on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of KPMG, would have caused KPMG to make reference to the subject
matter of the disagreements in connection with its reports on the our financial statements. In
addition, none of the events described in Item 304(a)(1)(v) of Regulation S-K occurred during such
periods. Effective February 17, 2004, we retained Gumbiner Savett Inc. (GS) as our independent
accountant. The retention of GS was recommended by our Audit Committee and approved by our Board of
Directors. During the years ended December 31, 2002 and 2003, and the subsequent interim period from
January 1, 2004 through February 16, 2004, we did not, nor did anyone on our behalf, consult with
GS regarding either: (i) the application of accounting principles to a specified transaction,
either completed or proposed; or the type of audit opinion that might be rendered on our financial
statements, and no written report or oral advice was provided that GS concluded was an important
factor considered by us in reaching a decision as to the accounting, auditing or financial
reporting issue; or (ii) any matter that was either the subject of a disagreement as defined at
Item 304(a)(1)(iv) or a reportable event as defined at Item 304 (a)(1)(v) of Regulation S-K. 38




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ITEM 9A. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Disclosure controls and procedures are designed to ensure that information required to be
disclosed in the reports filed or submitted under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the rules and forms of the
Securities and Exchange Commission. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required to be disclosed in
the reports filed under the Securities Exchange Act of 1934 is accumulated and communicated to
management, including its principal executive and financial officers, as appropriate, to allow
timely decisions regarding required disclosure. We carried out an evaluation, under the supervision and with the participation of our
management, including its principal executive officer and financial officer, of the effectiveness
of the design and operation of our disclosure controls and procedures as of the end of the period
covered by this report. Based upon and as of the date of that evaluation, our principal executive
officer and financial officer concluded that there were material weaknesses in our internal
controls, including those which relate to the segregation of duties and the review, approval and
reconciliation of accounting data and entries. The Company is addressing these issues by reviewing
and revising its internal accounting policies and procedures, expanding the resources allocated to
the accounting department, and reviewing its accounting and management information systems
software. (b) Changes in Internal Controls There were no changes in our internal controls or in other factors that could have
significantly affected those controls subsequent to the date of our most recent evaluation. 
 ITEM 9B. OTHER INFORMATION Effective as of December 31, 2004, ARTISTdirect, Inc. (ADI), entered into a Transfer
Agreement with ARTISTdirect Recordings, Inc., a Delaware corporation and a wholly-owned subsidiary
of ADI (ARTISTdirect Recordings), and Radar Records Holdings, Inc. (Radar Records), a Delaware
corporation wholly-owned by ADIs Chairman, Frederick W. Field, pursuant to which ADI was obligated
to sell its common stock in ARTISTdirect Recordings to Radar Records for $115,000 in cash.
ARTISTdirect Recordings owned a 65% membership interest in ARTISTdirect Records, LLC (ARTISTdirect
Records). On February 28, 2005, ADI completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records pursuant the Transfer Agreement, as a result of which ADI no longer had
any equity or other economic interest in ARTISTdirect Records, and Radar Records became the owner
of a majority of the membership interests in ARTISTdirect Records and also acquired the receivable
reflecting the $33.0 million of loan advances previously provided to ARTISTdirect Records by ADI. This transaction was reported in a Current Report on Form 8-K filed with the Securities and
Exchange Commission on March 4, 2005. 39




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PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors and Executive Officers The following table sets forth certain information regarding our directors and executive
officers as of March 29, 2005: Name
    
    Age
    
    Positions with ARTISTdirectFrederick W. Field
    
    53
    
    Chairman of the BoardJonathan V. Diamond
    
    46

    
    Chief Executive Officer and directorRobert N. Weingarten
    

    52

    
    Chief Financial Officer and SecretaryNicholas Turner
    

    46
    
    Executive Vice PresidentEric Pulier
    
    39
    
    DirectorTeymour Boutros-Ghali
    
    50
    
    DirectorDimitri Villard
    
    62

    
    Director
 Our executive officers are elected by the Board of Directors on an annual basis and serve
until their successors have been duly elected and qualified. There are no family relationships
among any of the directors or executive officers. The Companys Certificate of Incorporation provides for a classified Board of
Directors consisting of three classes of directors with staggered three-year terms, with each class
as nearly equal in number as possible as determined by the Board. The Board currently consists of
five persons. Mr. Field is a member of Class I. Mr. Diamond and Mr. Pulier have been designated
as members of Class II. Mr. Butros-Ghali and Mr. Villard have been designated as members of Class
III. The Class I directors term expired at the 2004 annual meeting. The Class II directors terms
expire at the 2005 annual meeting. The Class III directors term expired at the 2003 annual
meeting. The following is a brief description of the background of our directors and executive officers
during the past five years. Frederick W. Field.Mr. Field has served as our Chairman of the Board since June 2001 and
served as our Chief Executive Officer from June 2001 until September 2003. Mr. Field also
currently serves as Chief Executive Officer of ARTISTdirect Records, LLC and as Chairman of the
Board and Chief Executive Officer of Radar Pictures, Inc., a film production company. From 1990 to
2001, Mr. Field served as Co-Chairman of Interscope Records, a music production company. From 1979
to 1997, Mr. Field served as Chairman of the Board and Chief Executive Officer of Interscope
Communications, Inc. Jonathan V. Diamond. Mr. Diamond has served our Chief Executive Officer and director since
September 2003. From January 2003 to the present, he has also served as the Chairman, Chief
Executive Officer and a director of YouthStream Media Networks, Inc., a publicly-traded company.
He was the co-founder of N2K, Inc. and served as its Vice Chairman and Chief Executive Officer
through its 1999 merger with CDnow, Inc., an e-commerce company. He continued to serve as Chairman
of the combined company until its sale to Bertelsmann Music Group in August 2000. Mr. Diamond was
a co-founder of GRP Records, an independent music label acquired by MCA in 1990. Mr. Diamond holds
an M.B.A. from the Columbia University Graduate School of Business and a B.A. in Economics and
Music from the University of Michigan Honors College. Robert N. Weingarten. Mr. Weingarten was appointed Chief Financial Officer and Secretary of
the Company in January 2004. From July 1992 to present, Mr. Weingarten has been the sole
shareholder of Resource One Group, Inc., a financial consulting and advisory company. From
February 2003 to present, he has served as the Chief Financial Officer of YouthStream Media
Networks, Inc., a publicly traded company. Since 1979, Mr. Weingarten has served as a consultant
to numerous public companies in various stages of development, operation or reorganization. Mr.
Weingarten received an M.B.A. Degree in Finance from the University of Southern California in 1975
and a B.A. Degree in Accounting from the University of Washington in 1974. Mr. Weingarten
currently serves as President, Chief Financial Officer and Chairman of the Board of Directors of
Aries Ventures Inc. and as Chief Financial Officer of Resource Ventures, Inc., both of which are
public companies. Mr. Weingarten was retained to assist in the
restructuring of the predecessor to both such companies in November
1998, and was an officer of such predecessor company when it filed
for reorganization under Chapter 11 of the United States Bankruptcy
Code in December 1999 and successfully confirmed its Plan of
Reorganization in March 2000. 40




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Teymour Boutros-Ghali.Mr. Boutros-Ghali has served as a director since January 18, 2005.
From January 2002 to present, Mr. Boutros-Ghali has served as the Managing Partner of Monitor
Ventures, an early stage venture investor and advisory firm that is part of the Monitor Group, a
global strategy consulting firm and merchant bank with almost $2 billion under management. From
January 2000 to January 2002, he worked as an independent consultant for Monitor Group and Digital
Evolution. He also served as the Chief Executive Officer for AllBusiness from April 1997 to
January 2000. For the past five years Mr. Boutros-Ghali has served as a director for various
private companies. From June 2004 to present he has served as a director for Hydropoint Data
Systems. From 2001 to 2002, and 2001 to 2003, Mr. Boutros-Ghali served as a director for
Switchouse and Digital Evolution, respectively. Mr. Boutris-Ghali received S.M. and a Ph.D.
Degrees from the Massachusetts Institute of Technology in 1982 and 1980, respectively. He also
received B.A. and M.A. Degrees in Electrical Engineering from Cambridge University in 1976. Dimitri Villard.Mr. Villard has served as a director since January 18, 2005. Mr. Villard
also currently serves as President and a director of Pivotal BioSciences, Inc. a position he has
held since September 1998. In addition, since January 1982 to present, he has served as President
and director of Byzantine Productions, Inc. Previously, Mr. Villard was a director at the
investment banking firm of SG Cowen and affiliated entities, a position he held from January 1997
to July 1999. Mr. Villard received a B.A. Degree in Government from Harvard University in 1964.
Mr. Villard currently serves as a director of Dax Solutions, Inc., an entertainment industry
digital asset management venture, a position he has held since May 2004. He is also a member of
the Executive Committee of the Los Angeles chapter of the Tech Coast Angels, a private venture
capital group. Eric Poulier.Mr. Poulier has served as a director since November 29, 2004. Currently, Mr.
Poulier serves as the Executive Chairman of SOA Software, Inc., a position which he has held since
2001. From 1998 to 2000, Mr. Poulier also served as a Director for MPOD, Inc. In addition, he has
served as a Director for various companies such as Gluecode, Inc. and CTM Center for Telecom
management. Mr. Pulier has been a pioneer in the software and digital interactive industries for
over 15 years. He has been instrumental in establishing ground-breaking technology companies in
several sectors including media management (IVT), Professional Services (US Interactive), voice
systems (VoiceTap), and peer-to-peer networking (Mediator). Mr. Poulier received a B.A. Degree
from Harvard University in 1988. Nicholas Turner.Mr. Turner has served as our Executive Vice President since January 1, 2005.
Mr. Turner has over twenty years experience as a senior level executive and entrepreneur in the
entertainment and new media industries. Mr. Turner has been a professional recording musician,
artist manager, record producer, new media pioneer and record label marketing executive, as well as
charity event creator and fundraiser. Mr. Turner has extensive expertise in guiding companies
through the transition from the analog to digital world. During the last ten years, Mr. Turner has
held senior executive positions with various companies, including N2K, Inc. and CDnow, Inc., with
responsibility for marketing and revenue generation activities. Compliance with Section 16(a) of the Securities Exchange Act of 1934 The members of our Board of Directors, our executive officers and persons who hold more than
10% of our outstanding common stock are subject to the reporting requirements of Section 16(a) of
the Securities Exchange Act of 1934 which require them to file reports with respect to their
ownership of our common stock and their transactions in such common stock. Based upon (i) the
copies of Section 16(a) reports which we received from such persons for their 2004 fiscal year
transactions in our common stock and their holdings of our common stock, and (ii) the written
representations received from one or more of such persons that no annual Form 5 reports were
required to be filed by them for the 2004 fiscal year, Mr. Weingarten filed a late Form 3 report
and Mr. Yokomoto filed a late Form 4 report covering one transaction. Other than the foregoing
instances, we believe that the reporting requirements under Section 16(a) for such fiscal year were
met in a timely manner by our other directors, executive officers and greater than ten percent
beneficial owners. Code of Ethics The Company has adopted a written Code of Business Conduct and Ethics, which applies to every
Director and Officer and member of senior management, including the Companys Chief Executive
Officer and Chief Financial Officer. A copy of the Companys Code of Ethics is available to any
shareholder that requests a copy, and has been filed as an exhibit to the Companys Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2003. Such request should be addressed to
the attention of the Secretary of the Company and mailed to the Companys corporate offices. Any
amendment to or waiver of the Code of Business Conduct and Ethics will be disclosed promptly
following the date of such amendment or waiver pursuant to a Form 8-K filing with the Securities
and Exchange Commission. 41




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Changes in Procedures to Nominate Directors Since the date of the Companys last disclosures pursuant to Item 7(d)(s)(ii)(G) of Schedule
14A of the Securities Exchange Act of 1934, as amended, there have been no material changes to the
procedures by which security holders may recommend nominees to the Companys Board of Directors. 
 ITEM 11. EXECUTIVE COMPENSATION Summary of Cash and Certain Other Compensation The following table provides certain summary information concerning the compensation earned by
ARTISTdirects Chief Executive Officer and each of the three other most highly compensated
executive officers of ARTISTdirect whose salary and bonus for the 2004 fiscal year was in excess of
$100,000, for services rendered in all capacities to ARTISTdirect and its subsidiaries for the
fiscal years ended December 31, 2002, 2003 and 2004. No other executive officers who would have
otherwise been includable in such table on the basis of salary and bonus earned for the 2004 fiscal
year has been excluded by reason of his or her termination of employment or change in executive
status during that year. The listed individuals shall be hereinafter referred to as the named
executive officers. SUMMARY COMPENSATION TABLE Long-Term Compensation AwardsAnnual Compensation
    
    
    SecuritiesName and Principal
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other Annual
    
    
    Underlying
    
    
    All OtherPositions
    
    Year
    
    
    Salary($)
    
    
    Bonus($)
    
    
    Compensation($)(1)
    
    
    Options (#)
    
    
    Compensation($)Frederick W. Field
    
    
    2004
    
    
    $
    28,080Chairman
    
    
    2003
    
    
    $
    56,160
    (2)2002
    
    
    $
    812,500
    (3)(4)Jonathan V. Diamond
    
    
    2004
    
    
    $
    185,000
    
    
    
    
    
    
    $
    7,800Chief Executive Officer
    
    
    2003
    
    
    $
    46,250
    (5)
    
    $
    4,315
    
    
    $
    1,9502002Robert N. Weingarten
    
    
    2004
    
    
    $
    120,000
    
    
    
    
    
    
    
    
    
    
    
    120,000
    (7)Chief Financial Officer
    
    
    20032002Keith Yokomoto
    
    
    2004
    
    
    $
    120,000
    
    
    
    
    
    
    
    
    
    
    
    60,000
    (8)Former President and
    
    
    2003
    
    
    $
    597,222
    (6)
    
    
    
    
    
    $
    7,800
    
    
    
    
    
    
    $
    76,924
    (6)Chief Operating Officer
    
    
    2002
    
    
    $
    402,778
    
    
    
    
    
    
    $
    7,800
   (1)
    
    Consists of car allowance.(2)
    
    Includes $28,080 of deferred salary received in connection with Mr. Fields service as Chief
Executive Officer of ARTISTdirect Records, LLC. ARTISTdirect Records was a co-venture which
was indirectly jointly owned by ARTISTdirect and Mr. Field. See the section below titled
Employment Contracts, Termination of Employment and Change in Control Arrangements for more
information.(3)
    
    Includes $541,667 of salary received in connection with Mr. Fields service as Chief
Executive Officer of ARTISTdirect Records, LLC. ARTISTdirect Records was a co-venture which
was indirectly jointly owned by ARTISTdirect and Mr. Field. See the section below titled
Employment Contracts, Termination of Employment and Change in Control Arrangements for more
information.(4)
    
    From July 16, 2002, Mr. Field elected to defer all of his salary under his employment
agreements with ARTISTdirect and ARTISTdirect Records. During 2002, Mr. Field deferred
$229,167 of salary from ARTISTdirect and $458,334 of salary from 42




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ARTISTdirect Records. In May 2003, all deferred salary totaling approximately $411,000 from the
Company and approximately $822,000 from ARTISTdirect Records was waived. See the section below
titled Employment Contracts, Termination of Employment and Change in Control Arrangements for
more information.(5)
    
    Mr. Diamond entered into an employment agreement on September 29, 2003 with the Company which
provides for an annual salary of $185,000, a signing bonus of $4,315 and a car allowance $650
per month.(6)
    
    Includes $412,847 in deferred salary and $76,924 in accrued vacation pay which were paid to
Mr. Yokomoto upon his termination as an employee on December 31, 2003. Of such amount,
$150,000 was repaid to the Company for a prepaid bonus that Mr. Yokomoto previously received.(7)
    
    Effective March 29, 2004, we issued to Robert N. Weingarten, our Chief Financial Officer, a
stock option to purchase 120,000 shares at $0.50 per share, which was not less than the fair
market value on the date of grant, exercisable through March 29, 2011. The option vests and
becomes exercisable in a series of 36 successive equal monthly installments upon the
optionees completion of service measured from March 29, 2004.(8)
    
    Effective January 9, 2004, we issued to Keith Yokomoto, our former President and Chief
Operating Officer, and a Director of the Company at that time, two non-qualified stock options
to purchase 10,000 shares and 50,000 shares at $0.50 per share, which was not less than the
fair market value on the date of grant, exercisable through January 9, 2011. The option for
10,000 shares was immediately vested upon issuance. The option for 50,000 shares was
scheduled to vest in increments of 10,000 shares on February 1, 2004, March 31, 2004, June 30,
2004, September 30, 2004 and December 31, 2004, based on the accomplishment of certain
milestones by each respective date, which were not attained. Accordingly, the option for
50,000 shares did not vest and thus expired. Stock Options In September 2003, we issued warrants to purchase 200,000 shares of common stock at $0.50 per
share as partial consideration for an office lease termination. In December 2003, we issued 40,000
shares of common stock to a consultant for services rendered which were valued at $0.50 per share.
We made such issuances in reliance upon Section 4(2) of the Securities Act. The parties to whom
securities were issued in connection with the foregoing, made an informed investment decision based
upon negotiation with us and were provided with access to material information regarding our
company. We believe that each party that acquired our securities pursuant to the foregoing had
knowledge and experience in financial matters such that such party was capable of evaluating the
merits and risks of acquisition of our securities. All certificates representing the shares issued
pursuant to the foregoing bear an appropriate legend restricting the transfer of such shares,
except in accordance with the Securities Act. Effective September 29, 2003, the Company entered into an employment agreement with Jonathan
V. Diamond to serve as the Companys President and Chief Executive Officer through August 15, 2006.
In conjunction with the employment agreement, the Company granted Mr. Diamond a non-plan,
non-qualified stock option to purchase 259,659 shares of common stock exercisable through August
15, 2010 at $0.85 per share, which was the approximate fair market value of the common stock on the
date of grant. Upon the termination of Mr. Diamonds employment with the Company prior to the
expiration of his employment agreement, 75% of the common stock underlying the option is subject to
a repurchase right by the Company at $0.85 per share. The repurchase right lapses in three equal
annual installments such that it will have lapsed in its entirety on the third anniversary of Mr.
Diamonds employment by the Company. We made such issuance in reliance upon Section 4(2) of the
Securities Act. From May 2003 through December 31, 2003, ARTISTdirect Records issued and sold from time to
time, an aggregate of $2.048 million in convertible notes (the Bridge Notes) to nine individual
investors. Of such amount, $898,000 of these notes was sold to our Chairman, Ted Field and $100,000
to Jonathan V. Diamond, our President and Chief Executive Officer. During 2004, ARTISTdirect
Records issued and sold an additional $2.777 million in convertible notes to Ted Field. The Bridge
Notes accrue interest at 8% per annum, are due two years from the date of issuance, and are
convertible into preferred equity of ARTISTdirect Records as part of its next equity financing.
The holders of the Bridge Notes also received warrants with a term of five years to purchase
additional equity of ARTISTdirect Records at $0.01 per unit equivalent to the number of units of
new equity into which their Bridge Notes are ultimately converted. We made the issuances of such
notes and warrants in reliance upon Section 4(2) of the Securities Act. The parties to whom the
securities were issued in connection with the foregoing made an informed investment decision based
upon negotiation with us and were provided with access to material information regarding
ARTISTdirect Records. We 43




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believe that the parties that acquired our securities pursuant to the foregoing had knowledge
and experience in financial matters such that each such party was capable of evaluating the merits
and risks of acquisition of our securities. Effective January 9, 2004, the Company issued to Mr. Yokomoto two non-qualified stock options
to purchase 10,000 shares and 50,000 shares exercisable at $0.50 per share, which was not less than
the fair market value on the date of grant, through January 9, 2011. The option for 10,000 shares
was immediately vested upon issuance. The option for 50,000 shares was scheduled to vest in
increments of 10,000 shares on February 1, 2004, March 31, 2004, June 30, 2004, September 30, 2004
and December 31, 2004, based on the accomplishment of certain milestones by each respective date,
which were not attained. Accordingly, the option for 50,000 shares did not vest and thus expired . Effective March 29, 2004, the Company issued to Robert N. Weingarten, its Chief Financial
Officer, a stock option to purchase 120,000 shares at $0.50 per share, which was not less than the
fair market value on the date of grant, exercisable through March 29, 2011. The option vests and
becomes exercisable in a series of 36 successive equal monthly installments upon the optionees
completion of service measured from March 29, 2004. Effective August 31, 2004, the Company issued a warrant to a consultant for services rendered
to purchase 10,000 shares of common stock exercisable for a period of five years at $0.50 per
share. The stock options were issued without registration in reliance upon the exemption afforded by
Section 4(2) of the Securities Act of 1933, as amended, based on certain representations made to
ADI by the recipients. Option Grants in 2004 The following table sets forth certain information regarding stock options granted to the
Companys executive officers during the year ended December 31, 2004. Individual Grants (1)
    
    
    
    
    
    
    
    
    
    
    Potential RealizableNumber of
    
    
    Percent of
    
    
    
    
    
    
    
    
    
    
    Value at AssumedSecurities
    
    
    Total Options
    
    
    
    
    
    
    
    
    
    
    Annual Rates ofUnderlying
    
    
    Granted to
    
    
    Exercise
    
    
    
    
    
    
    Stock PriceOptions
    
    
    Employees in
    
    
    Price Per
    
    
    Expiration
    
    
    Appreciation forName
    
    Granted
    
    
    2004 (2)
    
    
    Share ($)
    
    
    Date
    
    
    Option Term (3)5%
    
    
    
    10%Robert N. Weingarten
    
    
    120,000
    
    
    
    100.0
    %
    
    $
    0.50
    
    
    
    03/29/11
    
    
    $
    17,098
    
    
    $
    39,846
    (2) During the year ended December 31, 2004, the Company granted options to management and
employees to purchase an aggregate of 120,000 shares of common stock exercisable at $0.50 per
share. The fair market value on the date of grant was $0.35 per share. (3) Amounts represent hypothetical gains that could be achieved for the respective options if
such options appreciate based on the fair market value on the date of grant and if exercised at the
end of the option term. The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the rules of the Securities and Exchange Commission and do not represent the
Companys estimate or projection of future common stock price growth. These amounts represent
certain assumed rates of 44




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appreciation in the value of the Companys common stock from the fair market value on the date of
grant. Actual gains, if any, on stock option exercises are dependent on the future performance of
the common stock and overall stock market conditions. The amounts reflected in the table may not
necessarily be achieved. Aggregated Option Fiscal Year-End Value The following table provides information, with respect to the named executive officers,
concerning unexercised stock options held by them at December 31, 2004. None of the named
executive officers exercised any stock options during 2004. AGGREGATED FISCAL YEAR-END OPTION VALUES Number of Securities Underlying
    
    
    Value of UnexercisedUnexercised Options at Fiscal
    
    
    In-The-Money OptionsYear End
    
    
    at Fiscal Year End ($) (1)Name
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableFrederick W. Field
    
    
    302,370
    
    
    
    0
    
    
    $
    0
    
    
    $
    0Jonathan V. Diamond
    
    
    259,659
    
    
    
    0
    
    
    
    0
    
    
    
    0Robert N. Weingarten
    
    
    30,000
    (2)
    
    
    90,000
    (2)
    
    
    0
    
    
    
    0
   (1)
    
    Based on December 31, 2004 closing stock price of $0.26 per share.(2)
    
    The option vests and becomes exercisable in a series of 36 successive equal monthly
installments upon optionees completion
of each month of service measured from March 29, 2004. Employment Contracts, Termination of Employment and Change in Control Arrangements ARTISTdirect has entered into employment agreements with its current and former executive
officers as follows: Frederick W. Field In May 2001, ARTISTdirect entered into an employment agreement and stock option agreements
with Frederick W. Field to serve as Chairman of the Board and Chief Executive Officer. The
employment agreement generally provided for the following:  
    Mr. Field is paid an annual base salary of $500,000, plus bonus pool participation.  
    The term of the agreement expires May 31, 2006.  
    The employment agreement provides that if ARTISTdirect terminates Mr. Fields employment other than for cause, disability
or death, or Mr. Field terminates his employment for good reason, he will receive a lump sum payment equal to the amount of
his annual base salary for:  (1)
    50% of the remaining term of the employment agreement if the termination occurs within
the first 3 years of his employment,(2)
    12 months if the termination occurs in the fourth year of his employment, or(3)
    the full remaining term of the employment agreement if the termination occurs in the
fifth year of his employment.  
    The above payments also will be made if Mr. Field terminates his
employment by written notice upon the commencement of any arbitration
proceeding to determine whether or not his employment with
ARTISTdirect Records may be terminated for good reason and Mr. Fields
employment with ARTISTdirect Records is terminated for good reason. 45




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
    If Mr. Field terminates his employment by written notice upon the
commencement of any arbitration proceeding to determine whether or not
his employment with ARTISTdirect Records may be terminated for cause
and Mr. Field remains employed at ARTISTdirect Records because the
arbitrator determines that ARTISTdirect Records is not entitled to
terminate Mr. Fields employment for cause, then the above payments
will be made, but the applicable pay period will be reduced by 50%. ARTISTdirect also granted Mr. Field three non-plan, non-qualified stock options to purchase
444,480 shares of common stock at an exercise price of $7.50 per share, under the following stock
option agreements:  
    One of the stock option agreements generally provides that Mr. Fields
right to purchase 302,370 shares is immediately exercisable subject to
a right of repurchase, and vests in a series of 60 successive equal
monthly installments from June 29, 2001. The vesting fully accelerates
upon a change of control or upon Mr. Fields cessation of service with
ARTISTdirect pursuant to an involuntary termination. An involuntary
termination includes (i) ARTISTdirects termination of Mr. Fields
employment for reasons other than for cause, (ii) a cessation of
services pursuant to Mr. Fields permanent disability or death and
(iii) Mr. Fields voluntary resignation for good reason, as set forth
in the employment agreement. Permanent disability exists if Mr. Field
becomes unable to engage in any substantial gainful activity by reason
of any medically determinable physical or mental impairment that is
expected to result in death or has lasted or can be expected to last
for a continuous period of at least 12 months. In addition, if Mr.
Field terminates his employment upon written notice in connection with
the commencement of any arbitration proceeding to determine whether or
not his employment with ARTISTdirect Records may be terminated for
cause and Mr. Field remains employed at ARTISTdirect Records because
the arbitrator determined that ARTISTdirect Records was not entitled
to terminate Mr. Fields employment for cause, then 50% of the then
unvested option shares will automatically accelerate so that they are
immediately fully vested and exercisable.  
    A second stock option agreement generally provides that Mr. Fields
right to purchase 75,588 shares vests and becomes exercisable upon the
occurrence prior to June 29, 2004 of any one of the following events:
(i) the 30-day average closing sale price of ARTISTdirects common
stock or the consideration paid per share in an acquisition of
ARTISTdirect reaches a minimum of $35.00 per share; (ii)
ARTISTdirects common stock is re-listed on The Nasdaq National Market
following a delisting; (iii) a change of control occurs; or (iv) Mr.
Fields service with ARTISTdirect ceases pursuant to an involuntary
termination. If none of the foregoing events occurs by June 29, 2004,
then the option will terminate and none of the option shares subject
to the second stock option agreement will vest or become exercisable
by Mr. Field. This option terminated on June 29, 2004  
    The third stock option agreement generally provides that Mr. Fields
right to purchase 66,522 shares vests and becomes exercisable upon the
occurrence prior to June 29, 2004 of any one of the following events:
(i) the 30-day average closing sale price of ARTISTdirects common
stock or the consideration paid per share in an acquisition of
ARTISTdirect reaches a minimum of $70.00 per share; (ii)
ARTISTdirects common stock is re-listed on The Nasdaq National Market
following a delisting; (iii) a change of control occurs; or (iv) Mr.
Fields service with ARTISTdirect ceases pursuant to an involuntary
termination. If none of the foregoing events occurs by June 29, 2004,
then the option will terminate and none of the option shares subject
to the third option agreement will vest or become exercisable by Mr.
Field. This option terminated on June 29, 2004. All three stock options expire no later than May 30, 2008. All three stock options may also
terminate prior to the expiration date as follows: (i) upon the later of the 12 month anniversary
of Mr. Fields cessation of service or the expiration of Mr. Fields initial five-year employment
term with ARTISTdirect if Mr. Fields employment with ARTISTdirect ceases pursuant to an
involuntary termination; (ii) upon the earlier of the 12 month anniversary of Mr. Fields cessation
of service or the expiration of Mr. Fields initial five-year employment term with ARTISTdirect if
Mr. Field terminates his employment pursuant to a termination with justification; (iii) upon the
earlier of the 90-day anniversary of Mr. Fields cessation of service or the expiration date of the
stock option if Mr. Field ceases to remain in ARTISTdirects service for any reason other than an
involuntary termination or a termination with justification; (iv) immediately if ARTISTdirect
terminates Mr. Fields employment for cause; (v) upon the earlier of the 12 month anniversary of
Mr. Fields death or the expiration date of the stock option if Mr. Field ceases to remain in
ARTISTdirects service due to his death; and (vi) upon the latter of the 12 month anniversary of
Mr. Fields cessation of service with ARTISTdirect or the expiration of Mr. Fields initial
five-year employment term with ARTISTdirect if Mr. Field ceases to remain in ARTISTdirects service
due to his permanent disability. In addition, Mr. Field also serves as the Chief Executive Officer of ARTISTdirect Records. Mr.
Field has a five-year employment agreement with ARTISTdirect Records, pursuant to which he is paid
an annual base salary of $1,000,000 plus certain benefits. If Mr. Field terminates his employment
with ARTISTdirect Records for good reason, he will receive a lump sum payment equal to the amount
of his annual base salary for (i) 50% of the remaining term of the employment agreement if the
termination occurs within the first 3 years of his employment, (ii) 12 months if the termination
occurs in the fourth year of his employment or (iii) the full remaining 46




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term of the employment agreement if the termination occurs in the fifth year of his
employment. ARTISTdirect Records may not terminate Mr. Fields employment other than for cause or
due to his disability or death. From July 16, 2002, Mr. Field has elected to defer salary that he would have earned under his
employment agreements with ARTISTdirect and ARTISTdirect Records. In December 2002, ARTISTdirect
and ARTISTdirect Records amended Mr. Fields employment agreements to provide that the amount of
Mr. Fields deferred salary, net of applicable tax withholdings, will be paid in a cash lump sum by
ARTISTdirect and ARTISTdirect Records, respectively, within thirty days after the consummation of a
private financing of at least $20,000,000 or, if earlier, the occurrence of (i) a merger,
consolidation, sale of fifty percent (50%) or more of the voting securities or sale of all or
substantially all of the assets of ARTISTdirect or ARTISTdirect Records, respectively, (ii) Mr.
Fields attainment of age 65, or (iii) the termination of Mr. Fields employment with ARTISTdirect
or ARTISTdirect Records, respectively. In May 2003, Mr. Field agreed to reduce his annual salary under his employment agreements with
ARTISTdirect and ARTISTdirect Records to $28,080 under each agreement. Mr. Fields employment
agreement was further amended whereby all deferred salary totaling approximately $411,000 and
$822,000, respectively, was waived, even if new debt or equity financing is raised. As described below, Mr. Diamond replaced Mr. Field as Chief Executive Officer of the Company
effective September 29, 2003. Jonathan V. Diamond Effective September 29, 2003, the Company entered into an employment agreement with Jonathan
V. Diamond to serve as the Companys President and Chief Executive Officer through August 15, 2006,
which provided for the following:  
    Mr. Diamond will be paid an annual salary of $185,000 and a
discretionary bonus of up to $50,000 and a formula-based bonus of up
to $50,000 determined by the Board of Directors, pro rated for any
partial fiscal year. Mr. Diamond also received a signing bonus of
$4,315 and a car allowance of $650 per month.  
    The agreement provided for the payment of salary for eighteen months
after the date of termination (or, if a shorter period, the remaining
term under his employment agreement) and full vesting of his stock
option if the termination was:  (1)
    other than due to a disability,(2)
    other than for cause, such as the commission of a felony, material dishonesty against
ARTISTdirect, or gross negligence in the performance of duties,(3)
    other than due to Mr. Diamonds death, or(4)
    for good reason, such as an adverse change of duties, a reassignment of location, or a
material breach of ARTISTdirects obligations to Mr. Diamond.  
    The agreement also provided that if Mr. Diamonds employment was terminated for cause or
disability, or he resigned for other than good reason, he would be prohibited, for a period of
the later of one year after the early termination of his employment, or the expiration of the
term of his employment agreement, from attempting to hire any ARTISTdirect employees.  
    Mr. Diamond also received a stock option to purchase 259,659 shares of common stock
exercisable until August 15, 2010 at $0.85 per share, the approximate fair market value of the
stock at such time. Upon the termination of Mr. Diamonds employment with the Company prior to the
expiration of his employment agreement, 75% of the common stock underlying the option is subject to
a repurchase right by the Company at $0.85 per share. The repurchase right lapses in three equal
annual installments such that it will have lapsed in its entirety on the third anniversary of Mr.
Diamonds employment by the Company. . 47




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Keith Yokomoto Effective December 31, 2003, Keith Yokomoto, the Companys former President and Chief
Operating Officer, entered into a Termination Agreement and Mutual General Release. Mr. Yokomoto
subsequently resigned as a director of the Company on October 22, 2004. Mr. Yokomotos July 2001
employment agreement, which had an initial term extending through June 30, 2006, provided for an
annual salary of $500,000 plus certain benefits, and a commencement advance of $300,000,
representing a pre-payment of $60,000 against any monies that would otherwise become payable to Mr.
Yokomoto under the Companys executive performance bonus pool for each year of the initial
five-year term of the employment agreement. The employment agreement also provided that under
certain conditions, Mr. Yokomoto would receive a payment of $350,000 plus one years salary upon
the termination of his employment with the Company. In consideration for Mr. Yokomoto terminating
his employment agreement as an officer of the Company effective as of December 31, 2003 and waiving
all rights to $1.25 million of remaining compensation under the employment agreement, the Company
paid Mr. Yokomoto his accrued but unpaid salary at the rate of $500,000 per year through December
31, 2003 aggregating $412,847 and his accrued but unused vacation pay through December 31, 2003
aggregating $76,924, and Mr. Yokomoto repaid the Company the unearned portion of the commencement
advance of $150,000. Effective January 1, 2004, the Company entered into a one-year consulting agreement with Mr.
Yokomoto that provided for total compensation of $120,000. Effective January 9, 2004, the Company
also issued to Mr. Yokomoto two non-qualified stock options to purchase 10,000 shares and 50,000
shares exercisable at $0.50 per share, which was not less than the fair market value on the date of
grant, through January 9, 2011. The option for 10,000 shares was immediately vested upon issuance.
The option for 50,000 shares was scheduled to vest in increments of 10,000 shares on February 1,
2004, March 31, 2004, June 30, 2004, September 30, 2004 and December 31, 2004, based on the
accomplishment of certain milestones by each respective date, which were not attained.
Accordingly, the option for 50,000 shares did not vest and thus expired. Marc Geiger Effective May 31, 2003, Marc P. Geiger, the Companys former Vice Chairman of the Board of
Directors and President  Artist Services, resigned as an officer of the Company. Mr. Geiger
subsequently resigned as a director of the Company on October 18, 2004. Mr. Geigers July 2001
amended employment agreement, which had an initial term extending through June 30, 2006, provided
for an annual salary of $500,000 plus certain benefits. The amended employment agreement also
provided that under certain conditions, Mr. Geiger would receive a payment of $1,000,000 plus one
years salary upon the termination of his employment with the Company. In February 2001, the
Company loaned Mr. Geiger $150,000, with interest at 7%. The term of the loan was initially one
year, but was extended in September 2001 to five years commensurate with the amendment of Mr.
Geigers employment agreement in July 2001. Mr. Geiger was obligated to repay the loan in five
equal annual principal payments of $30,000, along with accrued interest to date, beginning in
September 2002. In consideration for Mr. Geiger terminating his employment agreement effective as
of the date of his resignation as an officer and waiving all rights to compensation under the
employment agreement, the Company paid Mr. Geiger his accrued compensation and benefits of
approximately $184,000, and Mr. Geiger repaid the $150,000 loan plus accrued interest to the
Company. Nicholas Turner Effective January 1, 2005, the Company entered into a one-year consulting agreement with
Nicholas Turner to serve as the Companys Executive Vice President with a base annual salary of
$120,000 per year plus certain benefits. In conjunction with the consulting agreement, the Company
granted Mr. Turner a non-plan, non-qualified stock option to purchase 92,000 shares of common stock
at an exercise price of $0.79 per share, which was the approximate fair market value of the common
stock on the date of grant, vesting monthly over a period of two years. Compensation Committee Interlocks and Insider Participation The Compensation Committee of the Board of Directors consisted of Mr. Krupa and Mr. Moody, who
each resigned from the Board of Directors effective October 18, 2004. Neither of these individuals
was an officer or employee of the Company at any time during 2003 or 2004. Since that date, the
full board has been acting in lieu of committees until new board committees are formed, which is
expected to occur sometime in 2005. Mr. Diamond and Mr. Weingarten are also executive officers of
YouthStream Media Networks, Inc., a publicly-traded company. No current executive officer of the
Company has ever served as a member of the board of directors or compensation committee of any
other entity that has or has had one or more executive officers serving as a member of the
Companys Board of Directors or Compensation Committee. 48




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Director Compensation Directors who are not employees of ARTISTdirect do not currently receive any cash compensation
from ARTISTdirect for their service as members of our Board of Directors or any Board committee.
However, directors are reimbursed for all reasonable travel and out-of-pocket expenses incurred by
them in attending Board and committee meetings. All directors are eligible to participate in the
ARTISTdirect 1999 Employee Stock Option Plan. Meetings and Committees of the Board of Directors The Board of Directors held two meetings during the year ended December 31, 2004; all other
matters were handled by unanimous written consent. The Board of Directors had an Audit Committee
and a Compensation Committee until certain Directors resigned in October 2004. Since that time,
the full board has been acting in lieu of committees until new board committees are formed, which
is expected to occur sometime in 2005. Each Director attended or participated in 75% or more of the aggregate of (i) the total number
of meetings of the Board and (ii) the total number of meetings held by all committees of the Board
of Directors on which such Director served during the year ended December 31, 2004. Compensation Committee The Compensation Committee reviews and approves the compensation and benefits of our key
executive officers, administers our employee benefit plans and makes recommendations to the Board
of Directors regarding such matters. The Compensation Committee held four meetings during the year
ended December 31, 2004. Audit Committee The Audit Committee reviews, acts on and reports to the Board of Directors with respect to
various auditing and accounting matters, including the selection of the Companys independent
auditors, the scope of the annual audits, fees to be paid to the auditors, the performance of the
auditors, services provided by the auditors and the Companys accounting practices. The
Audit Committee held two meetings during the year ended
December 31, 2004. Since there was substantial turnover in the
composition of the Companys Board of Directors in late 2004, an
Audit Committee had not been formed at December 31, 2004, and an
audit committee financial expert had therefore not been
designated. The Company will seek to add a person to its Board of
Directors in 2005 qualified to serve as an audit committee
financial expert. Long-Term Incentive Plans The Company does not have any long-term incentive plans. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information known to ARTISTdirect with respect to the
beneficial ownership of ARTISTdirects common stock as of March 22, 2005 by (i) all persons who are
beneficial owners of five percent (5%) or more of ARTISTdirects common stock, (ii) each current
director, (iii) the executive officers named in the Summary Compensation Table of the Executive
Compensation section of this Form 10-K and (iv) all current directors and executive officers as a
group. As of March 29, 2005, there were 3,502,117 shares of common stock outstanding. Unless
otherwise indicated, each of the stockholders has sole voting and investment power with respect to
the shares beneficially owned, subject to community property laws, where applicable. PercentageShares
    
    
    of SharesBeneficially
    
    
    BeneficiallyBeneficial Owner
    
    Owned
    
    
    Owned (1)Entities affiliated with Constellation Venture Capital, L.P. (2)
575 Lexington Avenue
New York, New York 10022
    
    
    275,113
    
    
    
    7.9
    %Universal Music Group, Inc.
2220 Colorado Avenue
Santa Monica, California 90404
    
    
    312,500
    
    
    
    8.9
    %
 49




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##### Table of Contents



PercentageShares
    
    
    of SharesBeneficially
    
    
    BeneficiallyBeneficial Owner
    
    Owned
    
    
    Owned (1)Donald P. Muller c/o Creative Artists Agency
9830 Wilshire Boulevard
Beverly Hills, California 90212
    
    
    329,177
    
    
    
    9.4
    %Rick Rubin c/o Alan S. Halfon & Company
9595 Wilshire Boulevard, Suite 505
Beverly Hills, California 90212
    
    
    362,022
    
    
    
    10.3
    %Coghill Capital Management, L.L.C.
One North Wacker Drive, Suite 4725
Chicago, Illinois 60606
    
    
    263,165
    
    
    
    7.5
    %Marc P. Geiger
    
    
    337,740
    
    
    
    9.6
    %Keith K. Yokomoto (3)
    
    
    188,905
    
    
    
    5.3
    %Frederick W. Field (4)
    
    
    394,374
    
    
    
    10.1
    %Jonathan V. Diamond (5)
    
    
    283,943
    
    
    
    7.5
    %Robert N. Weingarten (5)
    
    
    52,778
    
    
    
    1.5
    %Teymour Boutros-Ghali (4)
    
    
    92,000
    
    
    
    2.6
    %Eric Pulier (4)
    
    
    92,000
    
    
    
    2.6
    %Dimitri Villard (4)
    
    
    92,000
    
    
    
    2.6
    %Nicholas Turner (5)
    
    
    19,167
    
    
    
    0.5
    %All current directors and executive officers as a group (6 persons) (6)
    
    
    1,026,262
    
    
    
    22.7
    %
   (1)
    
    Beneficial ownership is determined in accordance with the rules of the Securities and
Exchange Commission and includes voting or investment power with respect to the securities.
Common stock subject to options or warrants that are currently exercisable or exercisable
within 60 days of March 29, 2005 are deemed to be outstanding and to be beneficially owned by
the person or group holding such options or warrants for the purpose of computing the
percentage ownership of such person or group, but are not treated as outstanding for the
purpose of computing the percentage ownership of any other person or group. Unless otherwise
indicated, the address for each of the individuals listed in the table is care of
ARTISTdirect, Inc., 10900 Wilshire Boulevard, Suite 1400, Los Angeles, California, 90024.
Unless otherwise indicated by footnote, the persons named in the table have sole voting and
sole investment power with respect to all shares of ARTISTdirect common stock shown as
beneficially owned by them, subject to applicable community property laws. The percentage of
beneficial ownership is based on 3,502,117 shares of common stock issued and outstanding as of
March 29, 2005, and reflects a one-for-ten reverse stock split effected in July 2001.(2)
    
    Consists of (a) 226,379 shares held by Constellation Venture Capital, L.P. and (b) 48,734
shares held by Constellation Ventures (BVI), Inc. One of ARTISTdirects former directors,
Clifford Friedman, is President and Chief Executive Officer of Constellation Ventures (BVI),
Inc. and a member of Constellation Ventures Management, LLC, the general partner of
Constellation Venture Capital, L.P. As such, Mr. Friedman may be deemed to exercise voting
and investment power over such shares. Mr. Friedman disclaims beneficial ownership of such
shares, except to the extent of his proportionate interest therein.(3)
    
    Includes (a) 37,102 shares held by Mr. Yokomoto as trustee of the Geiger Childrens Trust, (b)
37,102 shares held by Mr. Yokomoto as trustee of the Muller Childrens Trust and (c) 10,000 shares subject to
immediately exercisable options. Mr. Yokomoto has sole voting and dispositive power over these shares. Mr. Yokomoto disclaims
beneficial ownership of these shares.(4)
    
    Consists of shares subject to immediately exercisable options.(5)
    
    Consists of shares subject to options exercisable within 60 days of March 29, 2005.(6)
    
    Includes the information set forth in Notes 4 and 5 above. Equity Compensation Plan Information The following table provides information as of December 31, 2004 with respect to the shares of
our common stock that may be issued under our existing equity compensation plans. The table does
not include information with respect to shares subject to 50




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##### Table of Contents



outstanding options granted under equity compensation plans assumed by ARTISTdirect in
connection with mergers and acquisitions of the companies that originally granted those options. CA
    
    
    B
    
    
    Number of Securities RemainingNumber of Securities to be
    
    
    Weighted Average
    
    
    Available for Future IssuanceIssued Upon Exercise of
    
    
    Exercise Price of Outstanding
    
    
    Under Equity CompensationOutstanding Options,
    
    
    Options, Warrants
    
    
    Plans (Excluding SecuritiesWarrants and Rights
    
    
    and Rights
    
    
    Reflected in Column A)Equity Compensation Plans Approved
by Shareholders (1)
    
    
    302,370
    (3)
    
    $
    7.50
    
    
    
    137,831
    (4)Equity Compensation Plans Not
Approved by Shareholders (2)
    
    
    550,223
    
    
    $
    15.15
    
    
    
    2,289,998
    (5)Total
    
    
    852,593
    
    
    $
    12.44
    
    
    
    2,427,829
   (1)
    
    Consists solely of the 1999 Employee Stock Purchase Plan and the stock options granted to our
Chairman and former Chief Executive Officer, Frederick W. Field, as part of an individual
compensation arrangement in connection with his initial employment agreement with
ARTISTdirect.(2)
    
    Consists solely of the 1999 Employee Stock Option Plan, the 1999 Artist Stock Option Plan,
the 1999 Artist and Artist Advisor Stock Option Plan, the 2004 Consultant Stock Plan and the
non-plan stock options granted to our current Chief Executive Officer, Jonathan V. Diamond,
and our current Chief Financial Officer, Robert N. Weingarten, as part of their individual
compensation arrangements with ARTISTdirect.(3)
    
    Excludes purchase rights accruing under ARTISTdirects 1999 Employee Stock Purchase Plan (see
1999 Employee Stock Purchase Plan below). Under this plan, each eligible employee may
purchase up to 75 shares of common stock at semi-annual intervals on the last business day of
April and October each year at a purchase price per share equal to 85% of the lower of (i) the
fair market value per share of common stock on the employees entry date into the two-year
offering period in which that semi-annual purchase date occurs or (ii) the fair market value
per share on the semi-annual purchase date.(4)
    
    Consists of shares available for future issuance under the 1999 Employee Stock Purchase Plan.
As of December 31, 2004, an aggregate of 137,831 shares of common stock were available for
issuance under the 1999 Employee Stock Purchase Plan. The number of shares of common stock
available for issuance under the 1999 Employee Stock Purchase Plan increases on the first
trading day of January each calendar year by an amount equal to 1% of the total number of
shares of common stock outstanding on the last trading day of December in the immediately
preceding calendar year, but in no event will any such annual increase exceed 25,000 shares of
common stock.(5)
    
    Consists of shares available for future issuance under the 1999 Employee Stock Option Plan,
the 1999 Artist Stock Option Plan and the 1999 Artist and Artist Advisor Stock Option Plan.
As of December 31, 2004, an aggregate of 829,308 shares of common stock were available for
issuance under the 1999 Employee Stock Option Plan, 666,588 shares of common stock were
available for issuance under the 1999 Artist Stock Option Plan and 294,102 shares of common
stock were available for issuance under the 1999 Artist and Artist Advisor Stock Option Plan.
The number of shares of common stock available for issuance under each of the 1999 Employee
Stock Option Plan and the 1999 Artist Stock Option Plan automatically increases on the first
trading day of January each calendar year by an amount equal to 2% of the total number of
shares of common stock outstanding on the last trading day of December in the immediately
preceding calendar year, but in no event will any such annual increase exceed 87,500 shares of
common stock. The number of shares of common stock available for issuance under the 1999
Artist and Artist Advisor Stock Option Plan automatically increases on the first trading day
of January each calendar year by an amount equal to 1% of the total number of shares of common
stock outstanding on the last trading day of December in the immediately preceding calendar
year, but in no event will any such annual increase exceed 37,500 shares of common stock. We
do not intend to grant further options under the 1999 Artist Stock Option Plan or the 1999
Artist and Artist Advisor Stock Option Plan. 51




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2004 Consultant Stock Plan Effective September 29, 2004, the Companys Board of Directors adopted the ARTISTdirect, Inc.
2004 Consultant Stock Plan (the Consultant Plan) in order for the Company to be able to
compensate consultants, at the option of the Company, who provide bona fide services to the Company
not in connection with capital raising or promotion of the Companys securities. The Consultant
Plan will expire on September 29, 2014, and provides for the issuance of up to 500,000 shares of
common stock to consultants at fair market value. On January 13, 2005, the Company filed a
Registration Statement on Form S-8 with the Securities and Exchange Commission to register the
500,000 shares of common stock for future issuance under the Consultant Plan. As of December 31,
2004, no shares had been issued under the Consultant Plan. 1999 Employee Stock Option Plan The 1999 Employee Stock Option Plan became effective on October 6, 1999 in connection with our
conversion from ARTISTdirect, LLC into ARTISTdirect, Inc. All options to purchase membership units
in the limited liability company which were outstanding at the time of such conversion were assumed
by the corporation and converted into options for shares of our common stock. The number of shares
subject to each assumed and converted option was equal to the number of membership units in the
limited liability company which were subject to that option immediately prior to the conversion,
and the exercise price per share remained the same as the per unit exercise price in effect under
the option at the time of conversion. Except for the conversion of the securities subject to the
option into shares of our common stock, each option will continue to be governed by the terms of
the agreement evidencing that option at the time of our conversion into a corporation. The 1999 Employee Stock Option Plan is a non-shareholder approved plan under which options may
be granted to employees, non-employee members of our Board of Directors, and consultants and other
independent advisors in our employ or service. The number of shares of common stock issuable over
the term of the 1999 Employee Stock Option Plan was initially 650,000 shares and increased by
69,235 shares and 70,042 shares on January 1, 2003 and 2004, respectively, for a total of 940,462
shares on December 31, 2004 (subject to adjustment for certain changes in our capital structure).
The share reserve will automatically increase on the first trading day in January each calendar
year by an amount equal to 2% of the total number of shares of our common stock outstanding on the
last trading day in December in the immediately preceding calendar year, but in no event will any
such annual increase exceed 87,500 shares. All option grants under the 1999 Employee Stock Option Plan will have an exercise price per
share equal to the fair market value per share of our common stock on the grant date. Each option
will vest in installments over the optionees period of service with ARTISTdirect. The options will
vest on an accelerated basis in the event ARTISTdirect is acquired and those options are not
assumed or replaced by the acquiring entity. The options that were granted while we were a limited
liability company, however, will terminate in the event ARTISTdirect is acquired and those options
are not assumed by the acquiring entity (unless their vesting is accelerated by our Compensation
Committee). Each option will have a maximum term (not to exceed 10 years) set by the plan
administrator (our Compensation Committee) at the time of grant, subject to earlier termination
following the optionees cessation of employment. All options are non-statutory options under the
Federal tax law, unless they are incentive stock options granted to employees. 1999 Artist Stock Option Plan The 1999 Artist Stock Option Plan became effective on October 6, 1999 in connection with our
conversion from ARTISTdirect, LLC into ARTISTdirect, Inc. All options to purchase membership units
in the limited liability company which were outstanding at the time of such conversion were assumed
by the corporation and converted into options for shares of our common stock. The number of shares
subject to each assumed and converted option was equal to the number of membership units in the
limited liability company which were subject to that option immediately prior to the conversion,
and the exercise price per share remained the same as the per unit exercise price in effect under
the option at the time of conversion. Except for the conversion of the securities subject to the
option into shares of our common stock, each option will continue to be governed by the terms of
the agreement evidencing that option at the time of our conversion into a corporation. The 1999 Artist Stock Option Plan is a non-shareholder approved plan under which options were
granted to performing artists who provided products and services through the ARTISTchannel
web-sites we operate and maintain for them pursuant to ARTISTchannel agreements. The number of
shares of common stock issuable over the term of the 1999 Artist Stock Option Plan was initially
400,000 shares and increased by 69,235 shares and 70,042 shares on January 1, 2003 and 2004,
respectively, for a total of 690,462 shares as of December 31, 2004 (subject to adjustment for
certain changes in our capital structure). The share reserve will automatically increase on the
first trading day in January each calendar year by an amount equal to 2% of the total number of
shares of our common stock 52




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##### Table of Contents



outstanding on the last trading day in December in the immediately preceding calendar year,
but in no event will any such annual increase exceed 87,500 shares. All option grants under the 1999 Artist Stock Option Plan have an exercise price per share
equal to the fair market value per share of our common stock on the grant date. Each option vests
in installments over the period the optionees ARTISTchannel agreement remains in effect. The
options will vest on an accelerated basis in the event ARTISTdirect is acquired and those options
are not assumed or replaced by the acquiring entity. Each option has a maximum term (not to exceed
10 years) set by the plan administrator (our Compensation Committee) at the time of grant, subject
to earlier termination following the termination of the optionees ARTISTchannel agreement. All
options are non-statutory options under the Federal tax law. 1999 Artist and Artist Advisor Stock Option Plan The 1999 Artist and Artist Advisor Stock Option Plan became effective on October 6, 1999 in
connection with our conversion from ARTISTdirect, LLC into ARTISTdirect, Inc. All options to
purchase membership units in the limited liability company which were outstanding at the time of
such conversion were assumed by the corporation and converted into options for shares of our common
stock. The number of shares subject to each assumed and converted option was equal to the number of
membership units in the limited liability company which were subject to that option immediately
prior to the conversion, and the exercise price per share remained the same as the per unit
exercise price in effect under the option at the time of conversion. Except for the conversion of
the securities subject to the option into shares of our common stock, each option will continue to
be governed by the terms of the agreement evidencing that option at the time of our conversion into
a corporation. The 1999 Artist and Artist Advisor Stock Option Plan is a non-shareholder approved plan under
which options were granted to performing artists and their attorneys, business managers, agents and
other advisors who provided services to us. The number of shares of common stock issuable over the
term of the 1999 Artist and Artist Advisor Stock Option Plan was initially 185,000 shares and
increased by 34,617 shares and 35,021 shares on January 1, 2003 and 2004, respectively to a total
of 329,638 shares as of December 31, 2004 (subject to adjustment for certain changes in our capital
structure). The share reserve will automatically increase on the first trading day in January each
calendar year by an amount equal to 1% of the total number of shares of our common stock
outstanding on the last trading day in December in the immediately preceding calendar year, but in
no event will any such annual increase exceed 37,500 shares. All option grants under the 1999 Artist and Artist Advisor Stock Option Plan have an exercise
price per share equal to the fair market value per share of our common stock on the grant date.
Each option vests in installments over the optionees period of service with ARTISTdirect. The
options will vest on an accelerated basis in the event ARTISTdirect is acquired and those options
are not assumed or replaced by the acquiring entity. Each option has a maximum term (not to exceed
10 years) set by the plan administrator (our Compensation Committee) at the time of grant, subject
to earlier termination following the termination of the optionees service for cause. All options
are non-statutory options under the Federal tax law. Share issuances under the 1999 Employee Stock Option Plan, the 1999 Artist Stock Option Plan
and the 1999 Artist and Artist Advisor Stock Option Plan will not reduce or otherwise affect the
number of shares of common stock available for issuance under the 1999 Employee Stock Purchase
Plan, and share issuances under 1999 Employee Stock Purchase Plan will not reduce or otherwise
affect the number of shares of common stock available for issuance under the 1999 Employee Stock
Option Plan, the 1999 Artist Stock Option Plan and the 1999 Artist and Artist Advisor Stock Option
Plan. 1999 Employee Stock Purchase Plan In October 1999, the Company adopted the 1999 Employee Stock Purchase Plan that initially
reserved 50,000 shares of common stock for issuance under this plan. This plan was approved by the
Companys shareholders. As of December 31, 2004, this plan currently had reserved for issuance
150,000 shares, of which 137,831 shares remained available for future issuances. This share
reserve automatically increases on the first trading day in January each calendar year, by an
amount equal to 1% of the total number of shares of the Companys common stock outstanding on the
last trading day of December in the prior calendar year, but in no event will this annual increase
exceed 25,000 shares. Terms of the plan permit eligible employees to purchase common stock through
payroll deduction of up to 15% of each employees compensation. The accumulated deductions are
applied to the purchase of shares on each semi-annual purchase date at a purchase price per share
equal to 85% of the fair market value per share on the participants entry date into the offering
period or the semi-annual purchase date, whichever is lower. Pursuant to the provisions of APB No.
25, shares issued to employees under this plan are considered non-compensatory. During the years
ended December 31, 2000, 2001, 2002, 2003 and 2004, 6,758 shares, 3,902 shares, 1,134 shares, 375
shares and 0 shares, respectively, were issued under this plan. 53




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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Sale of ARTISTdirect Recordings to Radar Records Holdings Effective as of December 31, 2004, ARTISTdirect, Inc. (ADI), entered into a Transfer
Agreement with ARTISTdirect Recordings, Inc., a Delaware corporation and a wholly-owned subsidiary
of ADI (ARTISTdirect Recordings), and Radar Records Holdings, Inc. (Radar Records), a Delaware
corporation wholly-owned by ADIs Chairman, Frederick W. Field, pursuant to which ADI was obligated
to sell its common stock in ARTISTdirect Recordings to Radar Records for $115,000 in cash.
ARTISTdirect Recordings owned a 65% membership interest in ARTISTdirect Records, LLC (ARTISTdirect
Records). On February 28, 2005, ADI completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records pursuant the Transfer Agreement, as a result of which ADI no longer had
any equity or other economic interest in ARTISTdirect Records, and Radar Records became the owner
of a majority of the membership interests in ARTISTdirect Records and also acquired the receivable
reflecting the $33.0 million of loan advances previously provided to ARTISTdirect Records by ADI.
In conjunction with this transaction, at February 28, 2005, ADI wrote-off the intercompany balance
due from ARTISTdirect Records ($80,000 at December 31, 2004), which was eliminated in
consolidation. Radar Records acquired the common stock of ARTISTdirect Recordings subject to the
rights of BMG. Radar Records also agreed to offer to investors who had provided bridge funding to
ARTISTdirect Records, excluding Frederick W. Field and entities related or controlled by him, the
right to acquire proportional shares (based on the amount of bridge funding made by each bridge
investor in ARTISTdirect Records) of the common stock of ARTISTdirect Recordings on the same terms
and conditions as set forth in the Transfer Agreement. Bridge Notes Payable As of December 31, 2003 and 2004, ARTISTdirect Records had outstanding loans of $898,000 and
$3.676 million, respectively, due to Ted Field and $1.150 million of loans due to outside investors
(including $100,000 from Jonathan V. Diamond, the Companys President and Chief Executive Officer).
The total loans of $4.825 million at December 31, 2004 were obtained through the issuance of
convertible promissory notes (the Bridge Notes). The Bridge Notes accrue interest at 8% per
annum, are due two years from the date of issuance, and are convertible into new preferred equity
of ARTISTdirect Records as part of its next equity financing. The holders of the Bridge Notes
also received warrants with a term of five years to purchase additional equity of ARTISTdirect. Sub-lease with Company Owned by Frederick W. Field During 2003, the Company relocated its administrative offices to an office leased by Radar
Pictures, Inc., a company owned by
Frederick W. Field. The Company sub-leases these offices on a month-to-month basis. During
the years ended December 31, 2003 and 2004, the Company accrued $56,000 and $168,000, respectively,
to Radar Pictures, Inc. as rent and facilities usage expense. The Company paid Radar Pictures,
Inc. the accrued rent through December 31, 2004 of $224,000 on February 28, 2005. Termination Agreements During the year ended December 31, 2003, we entered into agreements with Keith Yokomoto and
Marc Geiger to terminate their positions as officers of the Company. See the section above titled
Employment Contracts, Termination of Employment and Change in Control Arrangements for
information on these agreements. Yokomoto Consulting Agreement. On January 1, 2004, we entered into a consulting agreement with Keith Yokomoto, a former
director, to provide services on a part-time basis for the year ended December 31, 2004. See the
section above titled Employment Contracts, Termination of Employment and Change in Control
Arrangements for information on this agreement. 54




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##### Table of Contents



Diamond Employment Agreement In September 2003, we entered into an employment agreement with Jonathan Diamond in connection
with his appointment as our chief executive officer. See the section above titled Employment
Contracts, Termination of Employment and Change in Control Arrangements for information on this
agreement. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES KPMG LLP was the Companys independent registered public accounting firm for the year ended
December 31, 2002 and for the interim period ended September 30, 2003. Gumbiner Savett Inc. was
the Companys independent registered public accounting firm for the years ended December 31, 2003
and 2004. A summary of payments to such accounting firms during the years ended December 31, 2003
and 2004 is as follows: Years Ended December 31,
    
    Audit Fees
    
    
    Audit-Related Fees
    
    
    Tax Fees
    
    
    All Other Fees2003:KPMG LLP
    
    $
    42,000
    (1)
    
    $
    
    
    
    $
    24,250
    (2)
    
    $
    Gumbiner Savett Inc.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2004:KPMG LLP
    
    
    16,000
    (1)
    
    
    1,800
    
    
    
    
    
    
    
    Gumbiner Savett Inc.
    
    
    159,395
    (1)
    
    
    
    
    
    
    25,730
    (2)
    
    
    7,255
    (3)
    (2) Consists of the preparation of federal and state corporate income tax returns for the Company
and federal and state partnership income tax returns for ARTISTdirect Records, LLC. (3) Consists of tax advisory services relating to local property and sales tax issues and to the
Companys federal net operating loss carryforward. Pre-Approval Policies and Procedures: The Audit Committee meets periodically to review and approve the scope of the services to be
provided to us by our independent registered public accounting firm, as well to review and discuss
any issues that may arise during an engagement. The Audit Committee considers various issues with
respect to the services to be provided by our independent registered public accounting firm,
including the complexity of any engagement, its expected cost, the knowledge and expertise of the
independent registered public accounting firms staff, any complex or unusual accounting or
disclosure issues, new accounting pronouncements, and the capability and adequacy of our financial

staff and financial reporting systems. 55




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PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (1) FINANCIAL STATEMENTS ARTISTdirect, Inc. and Subsidiaries Consolidated Financial Statements Reports of Independent Registered Public Accounting FirmGumbiner Savett Inc.Consolidated Balance SheetsConsolidated Statements of OperationsConsolidated Statements of Comprehensive LossConsolidated Statements of Changes in Stockholders Equity (Deficiency)Consolidated Statements of Cash FlowsNotes to Consolidated Financial Statements
 (2) FINANCIAL STATEMENT SCHEDULES Financial statement schedules have been omitted as they are not applicable, not required, or
the information is included in the consolidated financial statements or the notes thereto. (3) EXHIBITS A list of exhibits required to be filed as part of this Annual Report on Form 10-K is set
forth in the Index to Exhibits, which immediately precedes such exhibits, and is incorporated
herein by reference. 56




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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. ARTISTDIRECT, INC.(Registrant)Date:
May 13 , 2005
    
    By:
    
    /s/ Jonathan V. DiamondJonathan V. DiamondChief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on the
dates indicated. Signature
    
    Title
    
    Date/s/ Frederick W. Field
    
    Chairman of the Board of Directors
    
    May 13, 2005Frederick W. Field/s/ Jonathan V. Diamond
    
    President, Chief Executive Officer and Director
    
    May 13, 2005Jonathan V. Diamond/s/ Robert N. Weingarten
    
    Chief Financial Officer
    
    May 13, 2005Robert N. Weingarten/s/ Eric Pulier
    
    Director
    
    May 13, 2005Eric Pulier/s/ Teymour Boutros-Ghali
    
    Director
    
    May 13, 2005Teymour Boutros-Ghali/s/ Dimitri Villard
    
    Director
    
    May 13, 2005Dimitri Villard/s/ Nicholas Turner
    
    Executive Vice President
    
    May 13, 2005Nicholas Turner
 57




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##### Table of Contents



ARTISTDIRECT, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004 PAGEReport of Independent Registered Public Accounting Firm:Gumbiner Savett Inc.
    
    
    59Consolidated Financial Statements:Consolidated Balance Sheets  December 31, 2003 and 2004
    
    
    60Consolidated Statements of Operations  Years Ended December 31, 2002, 2003 and 2004
    
    
    61Consolidated Statements of Comprehensive Loss  Years Ended December 31, 2002, 2003 and 2004
    
    
    62Consolidated Statements of Changes in Stockholders Equity (Deficiency)   Years Ended December 31, 2002, 2003 and 2004
    
    
    63Consolidated Statements of Cash Flows  Years Ended December 31, 2002, 2003 and 2004
    
    
    64Notes to Consolidated Financial Statements  Years Ended December 31, 2002, 2003 and 2004
    
    
    65
 58




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders
ARTISTdirect, Inc. We have audited the accompanying consolidated balance sheets of ARTISTdirect, Inc. and subsidiaries
(the Company) as of December 31, 2003 and 2004 and the related consolidated statements of
operations, comprehensive loss, stockholders equity (deficiency) and cash flows for the years then
ended. These financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial statements based on our
audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the
overall consolidated 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 ARTISTdirect, Inc. and subsidiaries as of December
31, 2003 and 2004, and the consolidated results of their operations and their cash flows for the
years then ended, in conformity with accounting principles generally accepted in the United States
of America. As discussed in Note 1 to the consolidated financial statements, as of December 31, 2003, the
Company changed its method of accounting for its investment in its record label joint venture,
ARTISTdirect Records, LLC. The accompanying consolidated financial statements have been prepared assuming that the Company
will continue as a going concern. As more fully described in Note 1, the Company has incurred
substantial operating losses and negative cash flows from operations to date. As of December 31,
2004, the Company has a net working capital deficiency of $18,438,000 and stockholders deficiency
of $20,259,000. These conditions raise substantial doubt about the Companys ability to continue
as a going concern. Managements plans in regard to these matters are also described in Note 1.
The consolidated financial statements do not include any adjustments that might result from the
outcome of this uncertainty. /s/ GUMBINER SAVETT INC. Santa Monica, California
March 1, 2005 59




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ARTISTDIRECT, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA) December 31,2003
    
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    719
    
    
    $
    1,156Restricted cash
    
    
    350
    
    
    
    175Short-term investments
    
    
    1,022
    
    
    
    Accounts receivable, net
    
    
    287
    
    
    
    751Prepaid expenses and other current assets
    
    
    289
    
    
    
    196Assets of discontinued operations
    
    
    57
    
    
    
    16Total current assets
    
    
    2,724
    
    
    
    2,294Property and equipment, net
    
    
    267
    
    
    
    99Other non-current assets
    
    
    15
    
    
    
    20$
    3,006
    
    
    $
    2,413Liabilities and Stockholders DeficiencyCurrent liabilities:Accounts payable
    
    $
    215
    
    
    $
    538Accrued expenses
    
    
    1,022
    
    
    
    1,274Liabilities of discontinued operations
    
    
    17,402
    
    
    
    18,920Total current liabilities
    
    
    18,639
    
    
    
    20,732Minority interest  discontinued operations
    
    
    1,312
    
    
    
    1,940Commitments and contingenciesStockholders deficiency:Preferred
stock, $0.01 par value -
Authorized - 5,000,000 shares
Issued and outstanding  none
    
    
    
    
    
    
    Common
stock, $0.01 par value -
Authorized - 15,000,000 shares
Issued - 3,825,019 shares
Outstanding - 3,502,117 shares
    
    
    38
    
    
    
    38Treasury stock, 322,902 shares, at cost
    
    
    (3,442
    )
    
    
    (3,442
    )Additional paid-in-capital
    
    
    209,128
    
    
    
    209,135Accumulated deficit
    
    
    (222,679
    )
    
    
    (225,990
    )Unrealized gain on available for sale investments
    
    
    10
    
    
    
    Total stockholders deficiency
    
    
    (16,945
    )
    
    
    (20,259
    )$
    3,006
    
    
    $
    2,413
 See accompanying notes to consolidated financial statements. 60




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ARTISTDIRECT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR SHARE DATA) Years Ended December 31,2002
    
    
    2003
    
    
    2004Net revenue:E-commerce
    
    $
    4,713
    
    
    $
    3,459
    
    
    $
    2,994Media
    
    
    924
    
    
    
    1,173
    
    
    
    2,149Total net revenue
    
    
    5,637
    
    
    
    4,632
    
    
    
    5,143Cost of revenue:Direct cost of product sales
    
    
    3,593
    
    
    
    2,552
    
    
    
    3,034Other cost of revenue
    
    
    2,738
    
    
    
    1,034
    
    
    
    518Stock-based compensation
    
    
    3,084
    
    
    
    33
    
    
    
    Total cost of revenue
    
    
    9,415
    
    
    
    3,619
    
    
    
    3,552Gross profit (loss)
    
    
    (3,778
    )
    
    
    1,013
    
    
    
    1,591Operating expenses:Web-site development
    
    
    53
    
    
    
    5
    
    
    
    Sales and marketing
    
    
    1,760
    
    
    
    410
    
    
    
    167General and administrative
    
    
    7,323
    
    
    
    4,134
    
    
    

    2,676Provision for doubtful accounts
    
    
    42
    
    
    
    83
    
    
    
    110Stock-based compensation
    
    
    1,897
    
    
    
    527
    
    
    
    7Depreciation and amortization
    
    
    2,814
    
    
    
    1,014
    
    
    
    223Loss from impairment of goodwill
    
    
    788
    
    
    
    
    
    
    
    Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    2,225
    
    
    
    Total operating costs
    
    
    14,677
    
    
    
    8,398
    
    
    
    3,183Loss from operations
    
    
    (18,455
    )
    
    
    (7,385
    )
    
    
    (1,592
    )Loss from equity investment
    
    
    (16
    )
    
    
    (64
    )
    
    
    Interest income, net
    
    
    748
    
    
    
    146
    
    
    
    29Forgiveness of debt by officer
    
    
    
    
    
    
    411
    
    
    
    Gain from sale of tradename
    
    
    
    
    
    
    
    
    
    
    500Loss from continuing operations
    
    
    (17,723
    )
    
    
    (6,892
    )
    
    
    (1,063
    )Income (loss) from discontinued operations:Agency business
    
    
    147
    
    
    
    
    
    
    
    iMusic record label
    
    
    (1,380
    )
    
    
    (298
    )
    
    
    (137
    )ARTISTdirect Records, LLC
    
    
    
    
    
    
    
    
    
    
    (2,111
    )Equity investment in ARTISTdirect Records, LLC
    
    
    (29,236
    )
    
    
    (9,256
    )
    
    
    Loss from discontinued operations
    
    
    (30,469
    )
    
    
    (9,554
    )
    
    
    (2,248
    )Loss before cumulative effect of change in accounting principles
    
    
    (48,192
    )
    
    
    (16,446
    )
    
    
    (3,311
    )Cumulative effect of consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    (5,255
    )
    
    
    Net loss
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )Net loss per common share  basic and diluted:From continuing operations
    
    $
    (5.12
    )
    
    $
    (1.99
    )
    
    $
    (0.30
    )From discontinued operations
    
    
    (8.80
    )
    
    
    (2.76
    )
    
    
    (0.64
    )From cumulative effect of consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    (1.52
    )
    
    
    Net loss
    
    $
    (13.92
    )
    
    $
    (6.27
    )
    
    $
    (0.94
    )Weighted average number of common shares outstanding  basic and diluted
    
    
    3,461,057
    
    
    
    3,461,992
    
    
    
    3,502,117Pro forma amounts, assuming the consolidation of ARTISTdirect Records,
LLC was applied retroactively:Loss from continuing operations
    
    $
    (17,723
    )
    
    $
    (6,892
    )Loss from discontinued operations
    
    
    (34,236
    )
    
    
    (11,042
    )Net loss
    
    $
    (51,959
    )
    
    $
    (17,934
    )Net loss per common share  basic and diluted:From continuing operations
    
    $
    (5.12
    )
    
    $
    (1.99
    )From discontinued operations
    
    
    (9.89
    )
    
    
    (3.19
    )Net loss
    
    $
    (15.01
    )
    
    $
    (5.18
    )
 See accompanying notes to consolidated financial statements. 61




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ARTISTDIRECT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS) Years Ended December 31,2002
    
    
    2003
    
    
    2004Net loss
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )Other comprehensive loss:Unrealized loss on available for sale securities
    
    
    (78
    )
    
    
    (58
    )
    
    
    (10
    )Comprehensive loss
    
    $
    (48,270
    )
    
    $
    (21,759
    )
    
    $
    (3,321
    )
 See accompanying notes to consolidated financial statements. 62




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ARTISTDIRECT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIENCY)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS) AdditionalCommon Stock
    
    
    Treasury
    
    
    Paid-InShares
    
    
    Amount
    
    
    Stock
    
    
    CapitalBalance at January 1, 2002
    
    
    3,460,608
    
    
    $
    38
    
    
    $
    (3,442
    )
    
    $
    208,173Issuance of options/warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of securities for employee stock purchase plan
    
    
    1,134
    
    
    
    
    
    
    
    
    
    
    
    4Unrealized loss on available for sale investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2002
    
    
    3,461,742
    
    
    
    38
    
    
    
    (3,442
    )
    
    
    208,208Issuance of warrants for legal settlement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100Issuance of common stock for services
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    20Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of securities for employee stock purchase plan
    
    
    375
    
    
    
    
    
    
    
    
    
    
    
    Unrealized loss on available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Adjustment resulting from change to consolidation from
equity accounting for ARTISTdirect Records, LLC effective
December 31, 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800Net lossBalance at December 31, 2003
    
    
    3,502,117
    
    
    
    38
    
    
    
    (3,442
    )
    
    
    209,128Unrealized loss on available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of warrants as settlement and for services rendered
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2004
    
    
    3,502,117
    
    
    $
    38
    
    
    $
    (3,442
    )
    
    $
    209,135
 [Additional columns below] [Continued from above table, first column(s) repeated] UnrealizedGain (Loss)
    
    
    Totalon Available
    
    
    StockholdersUnearned
    
    
    Accumulated
    
    
    for Sale
    
    
    EquityCompensation
    
    
    Deficit
    
    
    Securities
    
    
    (Deficiency)Balance at January 1, 2002
    
    $
    (745
    )
    
    $
    (152,786
    )
    
    $
    146
    
    
    $
    51,384Issuance of options/warrants
    
    
    (31
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    336
    
    
    
    
    
    
    
    
    
    
    
    336Issuance of securities for employee stock purchase plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4Unrealized loss on available for sale investments
    
    
    
    
    
    
    
    
    
    
    (78
    )
    
    
    (78
    )Net loss
    
    
    
    
    
    
    (48,192
    )
    
    
    
    
    
    
    (48,192
    )Balance at December 31, 2002
    
    
    (440
    )
    
    
    (200,978
    )
    
    
    68
    
    
    
    3,454Issuance of warrants for legal settlement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100Issuance of common stock for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20Amortization of unearned compensation
    
    
    440
    
    
    
    
    
    
    
    
    
    
    
    440Issuance of securities for employee stock purchase plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized loss on available for sale securities
    
    
    
    
    
    
    
    
    
    
    (58
    )
    
    
    (58
    )Adjustment resulting from change to consolidation from
equity accounting for ARTISTdirect Records, LLC effective
December 31, 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800Net loss
    
    
    
    
    
    
    (21,701
    )
    
    
    
    
    
    
    (21,701
    )Balance at December 31, 2003
    
    
    
    
    
    
    (222,679
    )
    
    
    10
    
    
    
    (16,945
    )Unrealized loss on available for sale securities
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    (10
    )Issuance of warrants as settlement and for services rendered
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7Net loss
    
    
    
    
    
    
    (3,311
    )
    
    
    
    
    
    
    (3,311
    )Balance at December 31, 2004
    
    $
    
    
    
    $
    (225,990
    )
    
    $
    
    
    
    $
    (20,259
    )
 See accompanying notes to consolidated financial statements. 63




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ARTISTDIRECT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) Years Ended December 31,2002
    
    
    2003
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )Loss from discontinued operations
    
    
    1,233
    
    
    
    298
    
    
    
    2,248Loss from equity investment in ARTISTdirect Records, LLC
    
    
    29,236
    
    
    
    9,256
    
    
    
    Cumulative effect of consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    5,255
    
    
    
    Loss from continuing operations
    
    
    (17,723
    )
    
    
    (6,892
    )
    
    
    (1,063
    )Adjustments to reconcile net loss from continuing operations to
net cash used in continuing operating activities:Depreciation and amortization
    
    
    2,814
    
    
    
    1,014
    
    
    
    223Loss from equity investment
    
    
    16
    
    
    
    64
    
    
    
    Forgiveness of debt by officer
    
    
    
    
    
    
    (411
    )
    
    
    Loss from impairment of goodwill
    
    
    788
    
    
    
    
    
    
    
    Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    2,225
    
    
    
    Provision for doubtful accounts and sales returns
    
    
    63
    
    
    
    89
    
    
    
    110Stock-based compensation
    
    
    4,981
    
    
    
    560
    
    
    
    7Adjustment as a result of reclassification of assets and
liabilities of ARTISTdirect, LLC to assets and liabilities of
discontinued operations held for disposal
    
    
    
    
    
    
    (7
    )
    
    
    9Changes in operating assets and liabilities, net of effects
from consolidation of ARTISTdirect Records, LLC:(Increase) decrease in -Accounts receivable
    
    
    (90
    )
    
    
    (526
    )
    
    
    (574
    )Prepaid expenses and other current assets
    
    
    360
    
    
    
    882
    
    
    
    93Other assets
    
    
    (390
    )
    
    
    380
    
    
    
    (5
    )Increase (decrease) in -Accounts payable, accrued expenses and other liabilities
    
    
    (1,043
    )
    
    
    (2,373
    )
    
    
    575Deferred revenue
    
    
    108
    
    
    
    (144
    )
    
    
    Net cash used in continuing operations
    
    
    (10,116
    )
    
    
    (5,139
    )
    
    
    (625
    )Net cash used in discontinued operations
    
    
    (1,045
    )
    
    
    (284
    )
    
    
    (2,848
    )Net cash used in operating activities
    
    
    (11,161
    )
    
    
    (5,423
    )
    
    
    (3,473
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (381
    )
    
    
    
    
    
    
    (55
    )Proceeds from sales of equipment
    
    
    15
    
    
    
    123
    
    
    
    Sale/maturity of short-term investments, net
    
    
    12,316
    
    
    
    5,045
    
    
    
    1,012Investment in and advances to ARTISTdirect Records, LLC
    
    
    (25,000
    )
    
    
    (2,750
    )
    
    
    Sale of equity interest in ARTISTdirect Records, LLC
    
    
    250
    
    
    
    
    
    
    
    Consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    7
    
    
    
    Net cash provided by (used in) investing activities
    
    
    (12,800
    )
    
    
    2,425
    
    
    
    957Cash flows from financing activities:Decrease in restricted cash
    
    
    851
    
    
    
    1,807
    
    
    
    175Proceeds from issuance of bridge notes by ARTISTdirect Records, LLC
    
    
    
    
    
    
    
    
    
    
    2,778Proceeds from employee stock purchase plan
    
    
    4
    
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    855
    
    
    
    1,807
    
    
    
    2,953Cash and cash equivalents:Net increase (decrease)
    
    
    (23,106
    )
    
    
    (1,191
    )
    
    
    437Balance at beginning of year
    
    
    25,016
    
    
    
    1,910
    
    
    
    719Balance at end of year
    
    $
    1,910
    
    
    $
    719
    
    
    $
    1,156Supplemental disclosure of cash flow information:Cash paid for -Interest
    
    $
    
    
    
    $
    
    
    
    $
    Income taxes
    
    $
    
    
    
    $
    
    
    
    $
    
 See accompanying notes to consolidated financial statements. 64




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ARTISTDIRECT, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004 1. BASIS OF PRESENTATION ORGANIZATION ARTISTdirect, Inc., a Delaware corporation (ADI), was formed on October 6, 1999 upon its
merger with ARTISTdirect, LLC. The merger was only a change in the form of ownership of ADI.
ARTISTdirect, LLC was organized as a California limited liability company and commenced operations
on August 8, 1996. ARTISTdirect, LLC has a 99% ownership interest in ARTISTdirect Agency LLC,
Kneeling Elephant Records, LLC and ARTISTdirect New Media, LLC, all of which are currently
inactive, and consolidated their results since inception. On May 31, 2001, the Company, through its wholly-owned subsidiary, ARTISTdirect Recordings,
Inc., a Delaware corporation (ARTISTdirect Recordings), entered into an agreement to acquire a
50% equity interest in a co-venture with Radar Records Holdings, LLC (Radar Records), an entity
owned by Frederick W. (Ted) Field, the Companys Chairman, to form a new record label, ARTISTdirect
Records, LLC (ARTISTdirect Records). This transaction became effective as of June 29, 2001. In
April 2002, ADIs ownership position in ARTISTdirect Records decreased to 45% as a result of a sale
of a 5% interest to BMG (see Note 9). However, ADIs ownership position increased to 65% during
2002, as a result of ADIs agreement to accelerate its funding commitment to ARTISTdirect Records
in 2002 (see Note 9). On February 28, 2005, the Company completed the sale all of its interest in ARTISTdirect
Recordings to Radar Records (see Note 10). In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, the Company has determined that it complied with the
provisions of SFAS No. 144 at December 31, 2004 with respect to the classification of the
operations of ARTISTdirect Records as a discontinued operation. Accordingly, the Company has
accounted for its interest in ARTISTdirect Records as a discontinued operation at December 31,
2004, and has restated its consolidated financial statements as of December 31, 2003 and for the
years ended December 31, 2002 and 2003 to reflect such accounting treatment, and the assets and
liabilities of ARTISTdirect Records have been classified as held for sale. During December 2004, the Company discontinued the operations of its iMusic record label (see
Note 13) and has therefore accounted for the operations of iMusic as a discontinued operation for
all periods presented. Accordingly, the Company has restated its consolidated financial statements
as of December 31, 2003 and for the years ended December 31, 2002 and 2003 to reflect the
termination of the business operations of iMusic. Unless the context indicates otherwise, ARTISTdirect, Inc. and its subsidiaries are referred
to herein as the Company. BUSINESS ACTIVITIES The Company is a music entertainment company, headquartered in Los Angeles, California, that

features an online music network appealing to music fans, artists and marketing partners. The
ARTISTdirect Network (www.artistdirect.com) is a network of Web-sites offering multi-media content,
music news and information, community around shared music interests, music-related specialty
commerce and digital music services. PRINCIPLES OF CONSOLIDATION The accompanying financial statements include the consolidated accounts of ADI and its
subsidiaries in which it has controlling interests. All intercompany accounts and transactions
have been eliminated for all periods presented. ADI recorded 100% of the losses attributable to
ARTISTdirect Records from May 31, 2001 through April 30, 2002 based on ADIs commitment to fund
100% of ARTISTdirects operations during that period of time. From May 1, 2002 through December
31, 2002, ADI recorded approximately 83% of the losses of ARTISTdirect Records as a result of BMGs
equity purchase and from an assumption of a portion of ADIs funding commitment to the record
label. For the year ended December 31, 2003, ADI recorded approximately 73% of the losses of 65




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ARTISTdirect Records. However, as ADI did not have voting or operational control, even with
its majority ownership position in ARTISTdirect Records, through December 31, 2003, ADI accounted
for this investment using the equity method of accounting. In February 2003, the Financial Accounting Standards Board issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which addresses the consolidation by
business enterprises of variable interest entities. FIN 46 defines when a company should evaluate
controlling financial interest, and thus consolidation, based on factors other than voting
rights, and requires that a new risks and rewards model be applied in these situations. ADI
adopted FIN 46 as of December 31, 2003. As a result of the adoption of FIN 46, the balance sheet
of ARTISTdirect Records was consolidated beginning as of December 31, 2003, and the operations of
ARTISTdirect Records were consolidated beginning with the year ended December 31, 2004 (see Note
9). There was no change in the operating or business relationship between ADI and ARTISTdirect
Records as a result of the adoption of FIN 46. As a result of the sale of all of the Companys interest in ARTISTdirect Records effective
February 28, 2005 (see Note 10), ARTISTdirect Records was accounted for as a discontinued operation
at December 31, 2004. Accordingly, the Company has restated its consolidated financial statements
as of December 31, 2003 and for the years ended December 31, 2002 and 2003 to reflect such
accounting treatment, and the assets and liabilities of ARTISTdirect Records have been classified
as held for sale. The cumulative effect of the consolidation of ARTISTdirect Records as of December 31, 2003 on
prior years was to increase the loss for 2003 by $5.3 million ($1.52 per share). The consolidated
financial statements for 2002 have not been restated as a result of the adoption of FIN 46. The
cumulative effect of the change of $5.3 million ($1.52 per share) is shown as a one-time charge to
the consolidated statement of operations for the year ended December 31, 2003. For the year ended December 31, 2004, ADI recorded 70% of the losses (after intercompany
eliminations) of ARTISTdirect Records. Since Ted Field owns 30% of ARTISTdirect Records, 30% of
the losses (after intercompany eliminations) were offset against the minority interest of Ted
Field. This minority interest resulted from the beneficial conversion feature related to the
Bridge Notes (see Note 12). STATUS
OF REPORT OF PREDECESSOR ACCOUNTING FIRM The Companys consolidated financial statements for the year ended December 31, 2002 were audited
by the Companys previous independent registered public accounting firm. Such accounting firms
report dated February 14, 2003 was included in the Companys previous Annual Reports on Form 10-K.
However, the Companys consolidated financial statements for the year ended December 31, 2002 are
presented herein without an accompanying report from the accounting firm, as such firm is currently
reauditing the consolidated financial statements of the Company with respect to the effect on the
2002 consolidated financial statements from the operations discontinued in 2004 (see Notes 10 and
13). When the Company receives such reissued report from its previous accounting firm, it will
file it as an amendment to the Companys 2004 Annual Report on Form 10-K. GOING CONCERN The Company has incurred losses and negative cash flows from operations in every fiscal period
since inception and has an accumulated deficit of $226.0 million as of December 31, 2004. For the
year ended December 31, 2004, the Company incurred a net loss of $3.3 million (including $2.2
million from discontinued operations) and negative operating cash flows of $3.5 million. As of
December 31, 2004, the Company had a net working capital deficiency of $18.4 million (including
liabilities of discontinued operations held for disposal of $18.9 million, almost all of which were
liquidated effective February 28, 2005) and a stockholders deficiency of $20.3 million. Through
December 31, 2003, ADI had funded substantially all of the operations of ARTISTdirect Records.
Effective July 30, 2004, ADIs remaining $12.0 million funding obligation to ARTISTdirect Records
was extinguished, and effective February 28, 2005, ADI sold all of its interest in ARTISTdirect
Records to Radar Records for a cash payment of $115,000. During 2003, the Company restructured its operations, laid off most of its staff and reduced
operating costs. Subsequently, management has continued its efforts to improve and expand
operations and cash flows at its online music network. However, it is uncertain whether the
Companys available cash resources will be sufficient to meet anticipated capital requirements over
the next twelve months. If sufficient capital is not available, then the Company may not be able
to fund its operations. To the extent that the Company is unable to obtain the capital necessary
to fund its future cash requirements on a timely basis and/or under acceptable terms and
conditions, the Company will not have sufficient cash resources to maintain operations, and the
Company may consider a formal or informal restructuring or reorganization. The conditions
described above raise substantial doubt about the Companys ability to continue as a going concern.
The financial statements do not include any adjustments that might result from the outcome of this
uncertainty. 2. SIGNIFICANT ACCOUNTING POLICIES CASH EQUIVALENTS Cash equivalents consist of investments, which are readily convertible into cash and have
maturities of three months or less at the time of purchase. 66




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RESTRICTED CASH As of December 31, 2003 and 2004, restricted cash consisted of a bank certificate of deposit
with balances of $350,000 and $175,000, respectively, securing a bank letter of credit provided as
security for charge-backs to the Companys e-commerce credit card processor. SHORT-TERM INVESTMENTS The Company classifies its short-term investments as available-for-sale and has recorded the
investments at fair value, with the difference between amortized cost and fair value being recorded
as a component of stockholders equity (deficiency). The Company invests primarily in fixed income
securities with maturities of one year or less at the time of purchase. The Company did not have
any short-term investments at December 31, 2004. DEPRECIATION Depreciation is provided using the straight-line method over the following estimated useful
lives as follows: Category
    
    Estimated Useful LifeComputer equipment and software
    
    3 yearsFurniture and fixtures
    
    7 years
 REVENUE RECOGNITION E-commerce revenue consists primarily of the gross amount of sales revenue paid by the
customer for recorded music and merchandise sold via the Internet, including shipping fees, and is
recognized when the products are shipped. The Company records e-commerce revenue on a gross basis
as the Company enters into the sale transactions with customers, establishes the prices of the
products, chooses the suppliers of the products, assumes the risk of inventory loss and collects
all amounts from the customers and assumes the credit risk. E-commerce revenue is subject to
amounts due to the respective artists based on their contracts, and such expense is recorded as
part of direct cost of product sales. The Company records amounts charged to customers for shipping and handling in accordance with
Emerging Issues Task Force No. 00-10, Accounting for Shipping and Handling Fees and Costs (EITF
No. 00-10). Pursuant to EITF No. 00-10, the Company records amounts charged to customers for
shipping and handling as revenue, and records the related costs incurred for shipping and handling
to direct cost of product sales in the consolidated statements of operations. For the years ended
December 31, 2002, 2003 and 2004, the Company recorded $1.0 million, $806,000 and $705,000,
respectively, as revenue for shipping and handling fees charged to customers. For the years ended
December 31, 2002, 2003 and 2004, the Company recorded $736,000, $523,000 and $434,000,
respectively, of shipping and handling costs as direct cost of product sales in the consolidated
statements of operations. Media revenue consists primarily of the sale of advertisements and sponsorships, both online
and offline, under short-term contracts. To date, the duration of the Companys advertising and
sponsorship commitments has generally averaged from one to three months with certain programs
lasting up to six months. The Companys online obligations typically include the guarantee of a
minimum number of times (impressions) that an advertisement appears in pages viewed by the users
of the Companys online properties. Online advertising revenue is generally recognized as the
impressions are served during the period in which the advertisement is displayed, provided that no
significant obligations of the Company remain and collection of the resulting receivable is
reasonably assured. To the extent that minimum guaranteed page deliveries are not met, recognition
of the corresponding revenue is deferred until the guaranteed impressions are delivered. The Company recognizes revenue for sponsorship arrangements, both online and offline, over the
period during which the advertising is provided, generally on a straight-line basis. If the
sponsorship arrangement is for the sponsorship of a specific event, the Company recognizes revenue
when the event occurs. The Company recognizes revenue separately for each element of integrated
entertainment marketing packages that offers advertisers a combination of offline concert and tour
sponsorships that are supported by online banner advertising, web-page sponsorships, e-mails to the
Companys customers and custom content. The Company determines the fair value of each deliverable
based on the relative fair value of the different deliverables when sold on a stand-alone basis.
The Company recognizes revenue for each deliverable as the services are provided. The Company
recognizes revenue for the banner impression deliverable as the banner impressions are delivered.
The Company recognizes revenue for the customer e-mails when the e-mails are sent. The Company
recognizes revenue for web-page sponsorships on a straight-line basis over the term of the 67




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sponsorship. The Company recognizes revenue for custom content when the content is provided
to the customer. The Company recognizes revenue for event sponsorships when the event has
occurred. Record label revenue consisted of the sale of compact discs by artists under contract to the
iMusic record label in 2002, 2003 and 2004, and to ARTISTdirect Records in 2004. The Company
recognized revenues upon the shipment of compact discs from its distributor to retailers and
independent wholesalers and records appropriate reserves for product returns. At the time of the
shipment of the product, the following criterion under Statement of Financial Accounting Standards
No. 48, Revenue Recognition When Right of Return Exists, had been met: the sellers price to the
buyer was substantially fixed or determinable at the date of sale; the buyer had paid the seller,
or the buyer was obligated to pay the seller, and the obligation was not contingent on resale of the
product; the buyers obligation to the seller would not have been changed in the event of theft or
physical destruction or damage of the product; the buyer acquiring the product for resale had
economic substance apart from that provided by the seller; the seller did not have significant
obligations for future performance to directly bring about resale of the product by the buyer; and
the amount of future returns could be reasonably estimated. The Company estimated the provision for returns on a quarterly basis by album based on the
amount of time since the initial album release, the actual returns to date, the trend of sales
activity (sales by the retailers and wholesalers) and the number of unsold units at retailers and
wholesalers. Returns to the Companys distributor are deemed to be returns to the Company.
Returns in excess of the estimated current provision were charged to revenue. COST OF REVENUE Direct cost of product sales consists of amounts payable to artists related to e-commerce
sales, which includes the cost of merchandise sold and the share of net proceeds due to artists,
and online commerce transaction costs, including credit card fees, fulfillment charges and shipping
costs. Direct cost of product sales also includes manufacturing costs and distribution fees payable.
Manufacturing costs consist of the cost of pressing compact discs, manufacturing printed booklets
and packaging materials and a provision for the obsolescence of finished goods and components.
Distribution expenses consist of various distribution costs, including the cost of processing
returns and warehousing inventory. Artist advances and royalty expenses consist of payments made
to artists and others in connection with the recording of an album. Other cost of revenue consists primarily of Web-site hosting and maintenance costs, online
content programming costs, online advertising serving costs, record royalties payable and payroll
and related expenses for staff involved with the Web-site. Stock-based compensation expense
relates to non-cash charges in connection with options issued to artists and their advisors for the
right to operate their stores and warrants issued to vendors. Amounts payable to artists and
transaction costs are recognized upon shipment. Costs related to the Web-site are recognized
immediately when incurred. Payroll and related expenses are recognized in the period incurred. Non-cash stock-based
compensation charges are recognized over the period of the related agreements. ARTIST ADVANCES Artist advances consisted of the amounts advanced to artists in connection with the recording
of their albums. In addition, included in artist advances were costs expended for producer fees,
musician fees, engineering and studio costs, equipment costs, mastering and remix costs, sample
clearances and artist living expenses during recording. Artist advances were typically recoupable
from artist royalties earned from the sale of compact discs. The Company expensed these advances
when incurred as the Companys artists had limited or no history of album sales. DISCONTINUED OPERATIONS The Company has accounted for its former agency division as a discontinued operation in
accordance with Accounting Principles Board (APB) No. 30, Accounting for Discontinued Operations,
and recorded the net results of this business segment in a single line entitled income from
discontinued operations in the consolidated statement of operations for the year ended December 31,
2002. The classification of the agency division as a discontinued operation was made prior to the
initial application of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. 68




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The Company has accounted for its iMusic record label and its interest in ARTISTdirect
Records, LLC as discontinued operations for all periods presented in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, the Company has
restated its consolidated financial statements as of December 31, 2003 and for the years ended
December 31, 2002 and 2003 (see Notes 10 and 13). INVENTORIES Inventories, net of a provision for obsolescence, are included in prepaid expenses and other
current assets, and consist of compact discs maintained in the warehouse of the Companys
distributor and music-related merchandise. Inventories are stated at the lower of cost or net
realizable value. Cost is determined using the first-in, first-out method. INCOME TAXES The Company accounts for income taxes under the asset and liability method whereby deferred
tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change
in tax rates is recognized in the statement of operations in the period that includes the enactment
date. A valuation allowance is recognized if management cannot determine that it is more likely
than not that some portion or all of the tax asset will be realized. WEB-SITE DEVELOPMENT COSTS Web-site development costs consist primarily of third-party development costs and payroll and
related expenses for in-house Web-site development costs incurred in the start-up and production of
the Companys content and services. These costs are expensed as incurred. ADVERTISING COSTS Advertising costs are expensed as incurred and totaled $1.0 million, $333,000 and $0 during
the years ended December 31, 2002, 2003 and 2004, respectively. IMPAIRMENT OF LONG-LIVED ASSETS AND GOODWILL Prior to January 1, 2002, the Company amortized goodwill, which represents the excess of the
purchase price over the net assets acquired in business acquisitions, over five years. In January
2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, and as a result
ceased to amortize goodwill. Instead, the Company was required to perform a transitional
impairment review of its goodwill as of January 1, 2002 and an annual impairment review thereafter.
The Company evaluated the impact of the adoption of SFAS No. 142 and determined that no impairment
charge was required upon adoption of SFAS No. 142. The impairment test was performed through
comparison of the fair value of the reporting units with the carrying value of their assets. During
the three months ended June 30, 2002, the Company determined that the remaining goodwill associated
with the iMusic and UBL acquisitions of $788,000 was impaired due to a continuing decline in
e-commerce and advertising revenues, and recorded a loss from impairment of that amount. This
write-down was reflected in the Media segment operations. The fair value of the reporting unit to
which the goodwill impairment related was determined based on the discounted estimated future cash
flows. The discount rate used in the discounted cash flow analysis was determined based on the
estimated cost of capital in the industry in which the Media segment operates. As of December 31,
2002, all goodwill and intangible assets had been written off. Impairment of long-lived assets is monitored on a continuing basis, and is assessed based on
the undiscounted cash flows generated by the underlying assets. In the event that the carrying
amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of
such assets is adjusted to their fair value. See Note 6 for write-downs in 2003 with respect to the Companys property and equipment. 69




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CONCENTRATION OF RISK Financial instruments that potentially subject the Company to significant concentrations of
credit risk consist principally of cash, short-term investments and trade accounts receivable. The
Company places its cash and short-term investments in high credit quality instruments. Cash
balances at certain financial institutions may exceed the FDIC insurance limits. The Company
performs ongoing credit evaluations of its customers but does not require collateral. Exposure to
losses on receivables is principally dependent on each customers financial condition. The Company
monitors its exposure to credit losses and maintains allowances for anticipated losses. The Company purchases a large percentage of its music-related merchandise inventory from a
limited number of suppliers. The Company is subject to risk in the event that any of the suppliers
is unable to fulfill its orders. However, there are a number of different suppliers who can
provide such services for the Company. During the year ended December 31, 2003, AT&T Wireless accounted for $550,000 or 47% of total
media revenue. During the year ended December 31, 2004, Google accounted for $245,000 or 12% of
total media revenue. No other advertiser accounted for more than 10% of the Companys media
revenue during 2002, 2003 or 2004. There were no amounts due from AT&T Wireless at December 31,
2003. There was $34,000 due from Google at December 31, 2004. During the years ended December 31, 2002, 2003 and 2004, approximately 25%, 45% and 70%,
respectively, of revenues from E-commerce were generated from the products related to one music
merchandising entity. During the year ended December 31, 2004, most of the Companys media revenues were generated
by one outside sales organization which represented the Company with respect to advertising and
sponsorship sales on the Companys web-site. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of financial instruments, which includes cash and cash equivalents,
short-term investments, accounts receivable, accounts payable and accrued expenses, approximate
fair value because of the short maturity of these instruments. The carrying amount of the bridge notes payable approximates fair value as the related
effective interest rate (including the discount) approximates rates currently available to the
Company. LIABILITY ASSOCIATED WITH INVESTMENTS IN AFFILIATED COMPANIES Investments in affiliated companies in which ADIs voting interest is greater than 20% and in
which ADI does not have a controlling financial interest, or in which ADI is able to exert
significant influence in instances where the voting interest is less than 20%, are accounted for
under the equity method of accounting. Under this method, the investment, originally recorded at
cost, is adjusted to recognize ADIs share of the net earnings or losses of the affiliates as they
occur rather than as dividends or other distributions are received. ADIs share of losses is
generally limited to the extent of its investment in and advances to the investee. However, ADI
records losses in excess of its investment when funding commitments exist. Through December 31,
2003, ADI accounted for its investment in ARTISTdirect Records on the equity method of accounting
since ADI did not have voting or operational control of the investee. ADI had committed to fund
100% of the operations of ARTISTdirect Records and recorded 100% of the losses attributable to that
venture from May 31, 2001 to April 30, 2002. From May 1, 2002 to December 31, 2003, ADIs funding
commitment was reduced by the sale of 5% of the equity of ARTISTdirect Records to BMG and therefore
ADI recorded only its proportionate share, based on the relative funding commitments, of the losses
of ARTISTdirect Records. ADI has not recorded a valuation allowance for its loans to ARTISTdirect Records as the
carrying amount of the loans has been reduced to zero as a result of ADI recording its share of
losses of ARTISTdirect Records during the years ended December 31, 2001, 2002 and 2003. See
Note 9 with respect to the consolidation of ARTISTdirect Records as of December 31, 2003. LOSS PER COMMON SHARE The Company computes net loss per share in accordance with SFAS No. 128, Earnings per Share
and Securities and Exchange Commission Staff Accounting Bulletin No. 98 (SAB 98). SFAS No. 128
requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is
measured as the income or loss available to common shareholders divided by the weighted average
outstanding common shares for the period. Diluted EPS is similar to basic EPS but presents the
dilutive effect on a per share basis of potential common shares (e.g., convertible securities,
options and warrants) as if they had been converted at the 70




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beginning of the periods presented. Potential common shares that have an anti-dilutive effect
(i.e., those that increase income per share or decrease loss per share) are excluded from the
calculation of diluted EPS. The calculation of diluted loss per share excludes approximately 780,000, 1,111,000 and
1,119,000 of potential common shares for the years ended December 31, 2002, 2003 and 2004,
respectively, since the effect would be anti-dilutive. STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation in accordance with the provisions
of Accounting Principles Board (APB) Opinion No. 25 and FASB Interpretation No. 44 (FIN 44),
Accounting for Certain Transactions Involving Stock Compensation, and complies with the
disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation. Under APB No.
25, compensation expense is recorded based on the difference, if any, between the fair value of the
Companys stock and the exercise price on the measurement date. The Company accounts for stock
issued to non-employees in accordance with SFAS No. 123, which requires entities to recognize as
expense over the service period the fair value of all stock-based awards on the date of grant and
EITF No. 96-18, Accounting for Equity Investments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services, which addresses the measurement date
and recognition approach for such transactions. The Company recognizes compensation expense related to variable awards in accordance with FIN
28. For fixed awards, the Company recognizes expense over the vesting period or the period of
service. In addition to stock-based compensation classified as cost of revenue, stock-based
compensation is comprised of sales and marketing expense of $1.9 million for the year ended
December 31, 2002, and general and administrative expense of $31,000, $527,000 and $7,000 for the
years ended December 31, 2002, 2003 and 2004, respectively. Pro forma information regarding net loss per share is required by SFAS 123, and has been
determined as if the Company had accounted for its employee stock options under the fair value
method of such statement. The fair value for these options was estimated at the date of grant
using the Black-Scholes option-pricing model. The assumptions used in the model and the weighted
average fair value of each option granted for 2002, 2003 and 2004 are as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004Risk free interest rate
    
    
    4.00
    %
    
    
    3.00
    %
    
    
    4.0
    %Volatility
    
    
    120
    %
    
    
    388
    %
    
    
    388
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Weighted average expected life (years)
    
    
    5
    
    
    
    7
    
    
    
    7Weighted average fair value of option
    
    $
    6.13
    
    
    $
    0.89
    
    
    $
    0.35
 For purpose of pro forma disclosures, the estimated fair value of the options is amortized to
operations over the vesting period of the options or the expected period of benefit. The Companys
pro forma information is as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands,except for share data)Net loss  as reported
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )Add: Stock-based employee compensation expense reported in net loss
    
    
    31
    
    
    
    
    
    
    
    Deduct: Total stock-based employee compensation expense determined
under fair value methods for all awards
    
    
    (995
    )
    
    
    (2,263
    )
    
    
    (473
    )Net loss  pro forma
    
    $
    (49,156
    )
    
    $
    (23,964
    )
    
    $
    (3,784
    )Net loss per share (basic and diluted):As reported
    
    $
    (13.92
    )
    
    $
    (6.27
    )
    
    $
    (0.94
    )Pro forma
    
    $
    (14.20
    )
    
    $
    (6.92
    )
    
    $
    (1.08
    )
 71




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COMPREHENSIVE LOSS The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income (SFAS No. 130). SFAS No. 130 establishes standards for the
reporting and display of comprehensive income, its components and accumulated balances in a full
set of general purpose financial statements. SFAS No. 130 defines comprehensive income (loss) to
include all changes in equity except those resulting from investments by owners and distributions
to owners, including adjustments to minimum pension liabilities, accumulated foreign currency
translation, and unrealized gains or losses on marketable securities. The Companys only component of other comprehensive loss is the unrealized loss on available
for sale securities, consisting of losses of $78,000, $58,000 and $10,000 for the years ended
December 31, 2002, 2003 and 2004, respectively. These amounts have been recorded as a separate
component of stockholders equity (deficiency). ESTIMATES In preparing financial statements in conformity with generally accepted accounting principles,
management is required to make estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the date of the
financial statements and revenues and expenses during the reporting period. Some of the more
significant estimates include allowances for bad debts and sales returns, impairment of long-lived
assets, impairment of fixed assets, stock-based compensation and the valuation allowance on
deferred tax assets. Actual results could differ from those estimates. 3. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123
(revised 2004), Share Based Payment (SFAS 123R), a revision to SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS 123R supercedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows.
SFAS 123R requires that the Company measure the cost of employee services received in exchange for
equity awards based on the grant date fair value of the awards. The cost will be recognized as
compensation expense over the vesting period of the awards. The Company is required to adopt SFAS
123R effective January 1, 2006. Under this method, the Company will begin recognizing compensation
cost for equity-based compensation for all new or modified grants after the date of adoption. In
addition, the Company will recognize the unvested portion of the grant date fair value of awards
issued prior to adoption based on the fair values previously calculated for disclosure purposes
over the remaining vesting period of the outstanding options and warrants. The Company is
currently evaluating the potential effect that the adoption of SFAS 123R will have on the Companys
financial statement presentation and disclosures. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment
to APB Opinion No. 29 (SFAS 153). SFAS 153 amends Accounting Principles Board Opinion No. 29,
Accounting for Nonmonetary Transactions, to require that exchanges of nonmonetary assets be
measured and accounted for at fair value, rather than at carryover basis, of the assets exchanged.
Nonmonetary exchanges that lack commercial substance are exempt from this requirement. SFAS 153 is
effective for nonmonetary exchanges entered into in fiscal periods beginning after June 15, 2005.
The Company does not routinely enter into nonmonetary exchanges. Accordingly, the Company does not
expect that the adoption of SFAS 153 will have a significant effect on the Companys financial
statement presentation or disclosures. 4. SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS Significant non-cash investing and financing activities are as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Issuance/cancellation of options/warrants
    
    $
    31
    
    
    $
    
    
    
    $
    Cumulative effect of consolidation of ARTISTdirect Records, LLC:Losses previously allocated to minority members of
ARTISTdirect Records, LLC, resulting in an
    
    
    
    
    
    
    (5,255
    )
    
    
    
 72




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##### Table of Contents



increase in loans
payable The following is the adjustment resulting from the change to consolidation from equity
accounting for ARTISTdirect Records, LLC effective December 31, 2003: (in thousands)Cash
    
    $
    7Other assets
    
    
    40Accounts payable
    
    
    (901
    )Accrued expenses
    
    
    (1,212
    )Due to ARTISTdirect, Inc.
    
    
    (45
    )Net liability to BMG
    
    
    (8,749
    )Bridge notes payable  outside investors
    
    
    (755
    )Bridge notes payable  minority interest
    
    
    (481
    )Liability associated with record label joint venture
    
    
    14,208Minority interest
    
    
    (1,312
    )Adjustment resulting from change to consolidation from equity accounting for ARTISTdirect Records, LLC
    
    
    (800
    )$
    
 As a result of the consolidation of ARTISTdirect Records effective December 31, 2003, the
Company recorded a credit to additional paid-in capital of $800,000, which consisted of the net 65%
majority interest portion of the total debt forgiven in 2003 by the Chairman of ARTISTdirect
Records of $534,000 ($822,000 x 65%), and other adjustments aggregating $266,000. 5. SHORT-TERM INVESTMENTS The Companys short-term investments consist of the following: December 31,2003
    
    
    2004Fair
    
    
    
    
    
    
    FairMarket
    
    
    Amortized
    
    
    Market
    
    
    AmortizedValue
    
    
    Cost
    
    
    Value
    
    
    Cost(in thousands)United States corporate and bank debt
    
    $
    1,022
    
    
    $
    1,012
    
    
    $
    
    
    
    $
    
 6. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost and consist of the following: December 31,2003
    
    
    2004(in thousands)Computer equipment and software
    
    $
    8,679
    
    
    $
    8,735Furniture and fixtures
    
    
    707
    
    
    
    7069,386
    
    
    
    9,441Less accumulated depreciation
    
    
    (9,119
    )
    
    
    (9.342
    )Property and equipment, net
    
    $
    267
    
    
    $
    99
 In June 2003, the Company initiated discussions with its landlord regarding the potential
termination or restructuring of its office lease that had a term through April 2010. On June 24,
2003, the landlord filed a lawsuit against the Company for unlawful detainer of its premises and in
July 2003 the landlord drew down the entire remaining $1.35 million letter of credit that the
Company had provided as a security deposit in conjunction with the execution of the original lease.
In September 2003, the Company reached an agreement to terminate its lease with the landlord. In
conjunction with the termination, the Company issued to the landlord warrants to purchase 200,000
shares of the Companys common stock exercisable at $0.50 per share through September 8, 2008. In
October 2003, the legal proceedings against the Company were dismissed with prejudice. As a
result, the Company recorded an expense of $429,000, comprised of $1.35 million under the letter of
credit which was funded by the Company, plus $100,000 of expense related 73




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to the issuance of the warrants to the landlord, calculated pursuant to the Black-Scholes
option-pricing model, offset by deferred rent obligations and other credits of $1.021 million. Effective June 30, 2004, the Company settled a claim by a real estate broker related to the
termination of the Companys former office lease by issuing a warrant to purchase 10,000 shares of
common stock exercisable for a period of five years at $0.50 per share. The fair value of the
warrant was determined to be $4,000, calculated pursuant to the Black-Scholes option-pricing model,
and was charged to operations during 2004. Impairment of fixed assets is monitored on a continuing basis, and is assessed based on the
undiscounted cash flows generated by the underlying assets. In the event the carrying amount of
fixed assets exceeds the undiscounted future cash flows, then the carrying amount of such assets is
adjusted to their fair value. During the three months ended June 30, 2003, the Company determined
that its fixed assets were impaired due to continuing losses, going concern issues, the delisting
of its common stock from the NASDAQ Stock Market, and the likelihood that the majority of these
assets would likely be abandoned in the near future. The Company determined that these factors
were indicators of impairment and thus reduced the carrying amount of the fixed assets to their
estimated fair value by recording a write-off of $2.225 million during the three months ended June
30, 2003. The leasehold improvements were subsequently abandoned when the Company vacated the
premises, and most of the Companys remaining property and equipment was subsequently sold to third
party liquidators for cash. This amount has been reported as a loss from sale and abandonment of
property and equipment in the consolidated statement of operations for the year ended December 31,
2003. 7. ALLOWANCE FOR DOUBTFUL ACCOUNTS AND RESERVE FOR SALES RETURNS A summary of the activity with respect to the allowance for doubtful accounts is as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Balance, beginning of year
    
    $
    83
    
    
    $
    40
    
    
    $
    88Provision for doubtful accounts
    
    
    42
    
    
    
    83
    
    
    
    110Amounts charged off
    
    
    (85
    )
    
    
    (35
    )
    
    
    (27
    )Balance, end of year
    
    $
    40
    
    
    $
    88
    
    
    $
    171
 A summary of the activity with respect to the reserve for sales returns is as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Balance, beginning of year
    
    $
    11
    
    
    $
    18
    
    
    $
    12Provision for sales returns
    
    
    21
    
    
    
    6
    
    
    
    Amounts charged off
    
    
    (14
    )
    
    
    (12
    )
    
    
    (12
    )Balance, end of year
    
    $
    18
    
    
    $
    12
    
    
    $
    
 8. ACCRUED EXPENSES Accrued expenses are comprised of the following: December 31,2003
    
    
    2004(in thousands)Accrued cost of sales
    
    $
    180
    
    
    $
    239Accrued payroll and related
    
    
    78
    
    
    
    124Accrued professional fees
    
    
    174
    
    
    
    180Accrued rent
    
    
    56
    
    
    
    224Other accrued expenses
    
    
    534
    
    
    
    507Total accrued expenses
    
    $
    1,022
    
    
    $
    1,274
 74




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9. INVESTMENT IN AND ADVANCES TO ARTISTDIRECT RECORDS, LLC In May 2001, ADI, through its wholly-owned subsidiary, ARTISTdirect Recordings, Inc., a
Delaware corporation (ARTISTdirect Recordings), entered into an agreement with Radar Records
Holdings, LLC (Radar Records), a company owned by Frederick W. (Ted) Field, to form a new record
label, ARTISTdirect Records, LLC (ARTISTdirect Records), as a 50/50 co-venture between ADI and
Radar Records. On June 29, 2001, ADIs stockholders approved the employment of Mr. Field as
Chairman and Chief Executive Officer of ADI and the formation of the ARTISTdirect Records record
label. Mr. Field is the Chief Executive Officer of ARTISTdirect Records. ARTISTdirect Records, headquartered in Los Angeles, California, develops new musical artists
and produces and distributes their recordings as an independent label utilizing both traditional
channels and emerging Internet distribution channels. ADI initially committed to fund a total of $50.0 million to ARTISTdirect Records over five
years at the rate of $15.0 million per year, subject to a limit of $33.0 million in any three year
period. Any funding in excess of these amounts required the approval of ADIs Board of Directors.
ADI funded $33.0 million through December 31, 2003. In November 2001, ARTISTdirect Records agreed in principle to enter into a preliminary North
America distribution agreement and worldwide license agreement with BMG Music, a wholly-owned
partnership of Bertelsmann Music Group, Inc., the global music division of Bertelsmann AG (BMG).
Under the terms of the agreement, BMG agreed to distribute the labels releases in North America,
and BMG licensed ARTISTdirect Records repertoire in territories throughout the world. In April
2002, the agreements with BMG were finalized, including BMGs purchase of 5% of the equity of
ARTISTdirect Records from ADI. As part of this transaction, BMG agreed to advance certain monies
against net sales proceeds under the agreements and also assumed $5.0 million of ADIs funding
commitment to ARTISTdirect Records. As a result of the BMG equity purchase, ADIs funding
commitment was reduced to $45.0 million. ADIs commitment to fund ARTISTdirect Records was subject
to a guaranty for the benefit of BMG. If ADI failed to meet its commitment, BMG had the right to
choose to enforce the guaranty or provide substitute financing that could have resulted in dilution
of ADIs interest in ARTISTdirect Records. In December 2002, BMG exercised its option to extend the term of the distribution and license
agreement until September 2004. BMG did not renew its distribution agreement and license agreement
upon its expiration in September 2004. Under the distribution and license agreements, BMG made non-refundable advances to
ARTISTdirect Records of $2.5 million in 2001, $2.5 million in 2002 and $5.0 million in 2003 that
are recoupable from net sales proceeds from ARTISTdirect Records artist repertoire pursuant to a
defined calculation on a monthly basis. As of December 31, 2002, 2003 and 2004, the unrecouped
balances related to distribution advances from BMG were $4.1 million, $8.7 million and $8.9
million, respectively. In August 2002, ADIs Board of Directors approved an agreement (the Accelerated Funding
Agreement) to accelerate up to $10.0 million of its funding commitment to ARTISTdirect Records.
This funding was in addition to the $15.0 million that ADI was obligated to advance to ARTISTdirect
Records in 2002 as part of the initial $50.0 million funding commitment. During 2002, ADI funded
its $15.0 million commitment plus the additional $10.0 million bridge loan for total advances to
the record label of $25.0 million in 2002 and $30.25 million from the inception of the record label
through December 31, 2002. The $10.0 million of accelerated funding was credited toward the
satisfaction of ADIs overall funding commitment and funding obligation for 2003, resulting in a
remaining funding commitment of $2.75 million for 2003 and $12.0 million for 2004. ADI advanced
the $2.75 million during 2003. As consideration for entering into the Accelerated Funding Agreement, ADI received an
additional 20% interest in ARTISTdirect Records from Radar Records, the entity through which Mr.
Field owns his interest in ARTISTdirect Records, which resulted in an increase in ADIs ownership
share of ARTISTdirect Records from 45% to 65% and a decrease in Mr. Fields ownership share from
50% to 30%. The Accelerated Funding Agreement also provided that any dilution from the issuance of
equity interests in ARTISTdirect Records that would have been borne solely by ADI would be borne
both by Radar Records and ADI pro rata with their then respective ownership interests.
Furthermore, the Accelerated Funding Agreement provided for Radar Records
to guarantee a 25% minimum annual compounded return to be realized from ADIs advances and
equity interests in ARTISTdirect Records. Due to 75




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the uncertainty with respect to the realization of such rate of return, ADI has not recorded
any amounts related to the 25% minimum annual compounded return in its consolidated financial
statements. Because ADI did not have voting or operating control of ARTISTdirect Records, even with its
majority ownership position, through December 31, 2003 it did not consolidate the results of
ARTISTdirect Records; ADI recorded its share of losses based on the equity method of accounting as
loss from equity investments in its consolidated statements of operations. Prior to the completion
of BMGs purchase of a 5% interest in ARTISTdirect Records in April 2002 and BMGs assumption of
10% of ADIs total funding commitment, ADI had committed to fund 100% of the operations of
ARTISTdirect Records and had recorded 100% of the losses attributable to that venture from the
inception of ARTISTdirect Records to April 30, 2002. From May 1, 2002 through December 31, 2003,
ADI has recorded only its proportionate share, on the basis of remaining relative funding
commitments, of any losses of ARTISTdirect Records. ADI has funded a total of $33.0 million of its
funding commitment. ADI recognized $8.6 million, $29.2 million and $9.3 million of equity loss
from ARTISTdirect Records for the years ended December 31, 2001, 2002 and 2003, respectively. The
loss for ARTISTdirect Records for the year ended December 31, 2004 was $4.881 million before
intercompany interest elimination of $2.011 million. In February 2003, the Financial Accounting Standards Board issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which addresses the consolidation by
business enterprises of variable interest entities. FIN 46 defines when a company should evaluate
controlling financial interest, and thus consolidation, based on factors other than voting
rights, and requires that a new risks and rewards model be applied in these situations. ADI
adopted FIN 46 as of December 31, 2003. As a result of the adoption of FIN 46, the balance sheet
of ARTISTdirect Records was consolidated beginning as of December 31, 2003, and the operations of
ARTISTdirect Records were consolidated beginning with the year ended December 31, 2004. There was
no change in the operating or business relationship between ADI and ARTISTdirect Records as a
result of the adoption of FIN 46. ADI charged ARTISTdirect Records $1.35 million and $563,000 in 2002 and 2003, respectively,
for the reimbursement of overhead costs, including rent and other occupancy costs, telephone and
internet services, and the services of certain ADI personnel primarily in the areas of accounting,
legal, information technology, human resources and administration. These amounts were reflected as
a reduction to general and administrative expense in ADIs consolidated statements of operations
for such periods. The carrying amount of ADIs investment in and advances to ARTISTdirect Records at December
31, 2002 represents the difference between ADIs investment and advances and ADIs share of losses
from ARTISTdirect Records. Through December 31, 2003, ADI continued to record the losses of
ARTISTdirect Records. ADI recorded its loan advances to ARTISTdirect Records as additional equity
investments. As of December 31, 2002, ADIs share of losses exceeded the amount of ADIs
investment and advances at that date, resulting in a credit balance of approximately $7.7 million,
which was classified as a liability on ADIs consolidated balance sheet at December 31, 2002. As
of December 31, 2003 and 2004, the Company consolidated the balance sheet of ARTISTdirect Records. ADI has no recorded investment in its loans to ARTISTdirect Records, as the carrying amount of
the loans had been reduced to zero as a result of ADI recording its share of losses of ARTISTdirect
Records during the years ended December 31, 2001, 2002 and 2003. ADI did not record interest
income on the loans to ARTISTdirect Records. The interest expense of ARTISTdirect Records is
eliminated in consolidation. As such, interest expense related to ADI is not included in
allocating losses to the minority interest in ARTISTdirect Records. The loan advances provided to ARTISTdirect Records by ADI and BMG bear interest at a rate of
LIBOR plus 4% and the principal and interest are not repayable until December 31, 2015 or upon such
time as ARTISTdirect Records achieves certain defined levels of excess cash flow and available
cash. As of December 31, 2003 and 2004, ARTISTdirect Records had loans payable to ADI of $33.0
million, which have been eliminated in consolidation, and to BMG of $4.75 million. In addition, as
of December 31, 2003 and 2004, ARTISTdirect Records had accrued interest payable to ADI of $3.0
million and $5.0 million, respectively, which has been eliminated in consolidation, and to BMG of
$447,000 and $747,000, respectively. During the years ended December 31, 2003 and 2004, Mr. Field loaned $898,000 and $3.676
million, respectively, to ARTISTdirect Records (see Note 12). The activity with respect to ADIs net investment in ARTISTdirect Records for the years ended
December 31, 2002 and 2003 is as follows: 76




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December 31,2002
    
    
    2003(in thousands)Balance, beginning of year
    
    $
    (3,027
    )
    
    $
    (7,699
    )Investment and advances
    
    
    25,000
    
    
    
    2,750Sale of equity interests
    
    
    (250
    )
    
    
    Intercompany activity with ARTISTdirect Records, LLC
    
    
    (186
    )
    
    
    (3
    )Equity losses recorded
    
    
    (29,236
    )
    
    
    (9,256
    )Consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    14,208Balance, end of year
    
    $
    (7,699
    )
    
    $
    
 During the three months ended September 30, 2003, ARTISTdirect Records significantly reduced
its overhead costs and operating activities and laid off the majority of its staff while it
continued to restructure its operations and seek additional capital. During 2003, ARTISTdirect
Records relied on a loan advance from ADI of $2.75 million and bridge loans from Mr. Field and
outside investors aggregating $2.048 million to fund its operations. As of December 31, 2003,
ARTISTdirect Records did not have sufficient working capital resources to conduct operations.
During 2004, ARTISTdirect Records relied on bridge loans from Mr. Field of $2.778 million to fund
its reduced level of operations. Through December 31, 2004, Mr. Field had provided bridge funding
to ARTISTdirect Records aggregating $3.676 million, including $898,000 in 2003 and $2.778 million
in 2004 (see Note 12). Effective July 30, 2004, ADI entered into a Termination Agreement with BMG and ARTISTdirect
Records which extinguished all of ADIs obligations under its funding guaranty, including the
remaining $12.0 million funding obligation to ARTISTdirect Records. 10. DISCONTINUED OPERATIONS
 ARTISTDIRECT RECORDS, LLC On February 28, 2005, ADI completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records pursuant to a Transfer Agreement for a cash payment of $115,000, as a
result of which ADI no longer had any equity or other economic interest in ARTISTdirect Records,
and Radar Records became the owner of a majority of the membership interests in ARTISTdirect
Records and also acquired the receivable reflecting the $33.0 million of loan advances previously
provided to ARTISTdirect Records by ADI. In conjunction with this transaction, at February 28,
2005, ADI wrote-off the intercompany balance due from ARTISTdirect Records ($80,000 at December 31,
2004), which was eliminated in consolidation. Radar Records acquired the common stock of
ARTISTdirect Recordings subject to the rights of BMG. Radar Records also agreed to offer to
investors who had provided bridge funding to ARTISTdirect Records
(see Note 12), excluding
Frederick W. Field and entities related or controlled by him, the right to acquire proportional
shares (based on the amount of bridge funding made by each bridge investor in ARTISTdirect Records)
of the common stock of ARTISTdirect Recordings on the same terms and conditions as set forth in the
Transfer Agreement. The amount of consideration received by ADI was determined with reference to various factors,
including, but not limited to, ADIs future business plans and intention to focus on its internet
and web-site operations, ARTISTdirect Records current limited capital resources and substantially
reduced level of operations, ARTISTdirect Records future business plans and capital requirements
and the likelihood of obtaining such capital on a timely basis and under reasonable terms and
conditions, the unpaid costs that ADI has advanced ARTISTdirect Records to date, and would be
required to continue to advance ARTISTdirect Records in the future, and the probability of ADI
obtaining a return on its investment to date of $33.0 million in ARTISTdirect Records. As a result of the existence of various conflicts of interest with respect to this
transaction, full disclosure of these conflicts of interest was made to ADIs Board of Directors
and the required approval by the disinterested members of ADIs Board of Directors was obtained
prior to the closing of the transaction. As a result of the sale of all of ADIs interest in ARTISTdirect Recordings to Radar Records
effective February 28, 2005, ADI has accounted for its interest in ARTISTdirect Records as a
discontinued operation at December 31, 2004 in accordance with SFAS No. 144. Accordingly, the
Company has restated its consolidated financial statements as of December 31, 2003 and for the
years ended December 31, 2002 and 2003 to reflect such accounting treatment, and the assets and
liabilities of ARTISTdirect Records have been classified as held for sale. As a result of the disposition of ADIs interest in ARTISTdirect Records effective February
28, 2005, ADI estimates that it will recognize a net non-cash gain in its consolidated statement of
operations for the three months ended March 31, 2005 of
approximately $21 million (unaudited),
primarily as a result of the elimination of the liabilities of ARTISTdirect Records. A summary of ADIs pro forma consolidated balance sheet at December 31, 2004, assuming that
the disposition of ADIs interest in ARTISTdirect Records had been accomplished effective December
31, 2004, is presented below. 77




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December 31, 2004Pro Forma As Reported
    
    
    As Adjusted(in thousands)AssetsCurrent assets
    
    $
    2,294
    
    
    $
    2,393Property and equipment, net
    
    
    99
    
    
    
    99Other non-current assets
    
    
    20
    
    
    
    20Total assets
    
    $
    2,413
    
    
    $
    2,512Liabilities and Stockholders Equity (Deficiency)Current liabilities
    
    $
    20,732
    
    
    $
    1,962Minority interest  discontinued operations
    
    
    1,940
    
    
    
    Stockholders equity (deficiency)
    
    
    (20,259
    )
    
    
    550Total liabilities and stockholders equity (deficiency)
    
    $
    2,413
    
    
    $
    2,512
 A summary of the assets and liabilities of ARTISTdirect Records, which were classified as
discontinued operations on ADIs balance sheets at December 31, 2003 and 2004, is as follows: December 31,2003
    
    
    2004(in thousands)AssetsCurrent assetsCash
    
    $
    7
    
    
    $
    Property and equipment, net
    
    
    40
    
    
    
    16Total assets  discontinued operations
    
    
    47
    
    
    
    16LiabilitiesCurrent liabilitiesBank overdraft
    
    
    
    
    
    
    2Accounts payable and accrued expenses
    
    
    2,113
    
    
    
    399Net liability to BMG
    
    
    8,749
    
    
    
    8,862Current portion of bridge notes payable -Outside investors
    
    
    
    
    
    
    1,136Minority investor  Ted Field
    
    
    
    
    
    
    836Total current liabilities
    
    
    10,862
    
    
    
    11,235Non-current liabilitiesLoan due to BMG
    
    
    5,197
    
    
    
    5,498Non-current portion of bridge notes payable -Outside investors
    
    
    755
    
    
    
    Minority investor  Ted Field
    
    
    539
    
    
    
    2,037Total liabilities  discontinued operations
    
    
    17,353
    
    
    
    18,770Members deficit
    
    $
    (17,306
    )
    
    $
    (18.754
    )
 A summary of the operations of ARTISTdirect Records for the year ended December 31, 2004 is as
follows: (in thousands)Net revenue
    
    $
    (19
    )Cost of revenue
    
    
    986Gross loss
    
    
    (1,005
    )Operating expenses:Sales and marketing
    
    
    285General and administrative
    
    
    393Depreciation and amortization
    
    
    22Total operating expenses
    
    
    700
 78




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##### Table of Contents



(in thousands)Loss from operations
    
    
    (1,705
    )Interest expense
    
    
    (649
    )Amortization of bridge note warrants
    
    
    (998
    )Forgiveness of debt
    
    
    482Minority interest
    
    
    759Net loss
    
    $
    (2,111
    )
 11. INVESTMENTS IN OTHER AFFILIATED COMPANIES The Company had a 45% ownership in SnoCore, LLC and accounted for this investment under the
equity method through December 31, 2003. The Company recorded equity losses of $(16,000) and
$(64,000) with respect to this investment for the years ended December 31, 2002 and 2003,
respectively. Effective December 31, 2003, the Company exchanged its 45% ownership interest in
SnoCore, LLC for a 9% net profits interest. The Company did not record any gain or loss on this
transaction at December 31, 2003. The Company did not attribute any carrying value to the
Companys 9% net profits interest at December 31, 2003 or 2004, and the Company did not receive any
distribution with respect to this net profits interest in 2004. 12. BRIDGE NOTES PAYABLE As of December 31, 2003 and 2004, ARTISTdirect Records had outstanding loans of $898,000 and
$3.676 million, respectively, due to Ted Field and $1.150 million of loans due to outside investors
(including $100,000 from Jonathan V. Diamond, the Companys President and Chief Executive Officer).
The total loans of $4.826 million at December 31, 2004 were obtained through the issuance of
convertible promissory notes (the Bridge Notes). The Bridge Notes accrue interest at 8% per
annum, are due two years from the date of issuance, and are convertible into new preferred equity
of ARTISTdirect Records as part of its next equity financing. The Bridge Notes payable to Mr.
Field and to outside investors have been included in liabilities of discontinued operations held
for disposal in the consolidated balance sheets at December 31, 2003 and 2004. The holders of the Bridge Notes also received warrants with a term of five years to purchase
additional equity of ARTISTdirect Records at $0.01 per unit equivalent to the number of units of
new equity into which their Bridge Notes are ultimately converted. The relative fair value of the
warrants issued was $2.413 million (one-half of the amount funded by the investors in the Bridge
Notes), which was recorded as a reduction to the carrying amount of the Bridge Notes and a credit
to capital, and is being charged to operations as interest expense over the specified term of the
Bridge Notes. The Bridge Notes are convertible into equity based on their face amount, which results in a
beneficial conversion feature with a relative fair value of $2.413 million. Since the commitment
date for the beneficial conversion feature is contingent upon the completion of ARTISTdirect
Records next equity financing, the fair value of the beneficial conversion feature will be charged
to operations over the remaining life of the Bridge Notes at that time. During the years ended December 31, 2003 and 2004, ARTISTdirect Records recognized $203,000
and $998,000, respectively, as interest expense with respect to the amortization of the fair value
of the warrants. Additional interest expense of $1.2 million will be recognized ratably in 2005 and
2006 over the remaining term of the Bridge Notes. As of December 31, 2004, the carrying amount of
the Bridge Notes, including accrued interest of $396,000, was $4.009 million. A reconciliation of Bridge Notes payable issued by ARTISTdirect Records during 2003 and 2004
to amounts included in liabilities of discontinued operations in the consolidated balance sheets at
December 31, 2003 and 2004 is presented below. During the years ended December 31, 2003 and 2004,
ARTISTdirect Records recorded costs with respect to such bridge notes as summarized below. OutsideInvestors
    
    
    Ted Field(in thousands)Gross amount funded during 2003
    
    $
    1,150
    
    
    $
    898Deduct:Fair value of warrants
    
    
    (575
    )
    
    
    (449
    )Add:Accrued interest
    
    
    44
    
    
    
    23Amortization of fair value of warrants in 2003
    
    
    136
    
    
    
    67
 79




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##### Table of Contents



OutsideInvestors
    
    
    Ted Field(in thousands)Net liability at December 31, 2003
    
    
    755
    
    
    
    539Gross amount funded during 2004
    
    
    
    
    
    
    2,778Deduct:Fair value of warrants
    
    
    
    
    
    
    (1,389
    )Add:Accrued interest
    
    
    94
    
    
    
    235Amortization of fair value of warrants in 2004
    
    
    287
    
    
    
    710Net liability at December 31, 2004
    
    
    1,136
    
    
    
    2,873Less:Amounts due within one year
    
    
    (1,136
    )
    
    
    (836
    )Amounts due after one year
    
    $
    
    
    
    $
    2,037
 13. DISCONTINUED OPERATIONS  iMUSIC During 2002, the Company began operating a record label under the brand name iMusic through
its wholly-owned subsidiary, ARTISTdirect Digital, Inc. Operations consisted primarily of the sale
of compact discs by artists signed to the iMusic record label. iMusics concept was to focus on
the signing of established artists with a proven sales base and an ability to generally make
records less expensively than developing artists. In addition, the Company expected that
substantially less would be spent on marketing and promotion of these releases than on those of new
artists. During the three months ended June 30, 2003, management of the Company decided to scale
back the activity of its iMusic label in order to conserve capital. During the three months ended
September 30, 2003, the Company executed an agreement with GC Music, pursuant to which the Company
assigned its rights and obligations to six unreleased artists in exchange for a cash payment of
$100,000 as a reduction to prior advances related to the six artists and a profit interest in the
projects. The Company retained the distribution rights to the albums previously released under the
original terms of its distribution agreements with its other signed artists, but did not intend to
sign any additional artists or release any additional albums domestically or internationally under
the iMusic label and therefore expected very minimal sales activity subsequent to the transaction.
At December 31, 2004, the Company has provided a sufficient reserve for remaining contract
obligations and estimated product returns. Effective November 23, 2004, pursuant to a Trademark Assignment and Purchase Agreement dated
as of November 12, 2004, the Company sold all of its rights, title and interest in and to certain
trademarks, service markets and trade names, in certain countries of the world, that consist of or
incorporate the term iMusic (the Marks), including domain names that consist of or incorporate
the term iMUSIC (the Domain Names) and goodwill related to such marks or trade names, to Apple
Computer, Inc. for a cash payment of $500,000. The Marks and Domain Names that the Company sold
did not have any carrying value on the Companys books. As a result of the foregoing, during December 2004, the Company ceased the sale of products
under the iMusic label and discontinued the operations of the iMusic record label. Accordingly,
the Company has accounted for the operations of iMusic as a discontinued operation for all periods
presented and has restated its consolidated financial statements as of December 31, 2003 and for
the years ended December 31, 2002 and 2003 to reflect the termination of the business operations of
iMusic. A summary of the assets and liabilities of iMusic, which were classified as discontinued
operations on the Companys balance sheets at December 31, 2003 and 2004, is as follows: December 31,2003
    
    
    2004(in thousands)AssetsCurrent assetsAccounts receivable, net
    
    $
    10
    
    
    $
    Total assets  discontinued operations
    
    
    10
    
    
    
    LiabilitiesCurrent liabilitiesNet liability to BMG
    
    
    
    
    
    
    41Accounts payable and accrued expenses
    
    
    49
    
    
    
    49Reserve for product returns
    
    
    
    
    
    
    60Total current liabilities
    
    
    49
    
    
    
    150Total liabilities  discontinued operations
    
    
    49
    
    
    
    150Net deficit
    
    $
    (39
    )
    
    $
    (150
    )
 80




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##### Table of Contents



A summary of the operations of the iMusic record label for the years ended December 31, 2002,
2003 and 2004 is as follows: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Net revenue
    
    $
    613
    
    
    $
    1,352
    
    
    $
    (136
    )Cost of revenue
    
    
    1,325
    
    
    
    744
    
    
    
    (1
    )Gross profit (loss)
    
    
    (712
    )
    
    
    608
    
    
    
    (135
    )Operating expenses:Sales and marketing
    
    
    464
    
    
    
    810
    
    
    
    2General and administrative
    
    
    204
    
    
    
    96
    
    
    
    Total operating expenses
    
    
    668
    
    
    
    906
    
    
    
    2Net loss
    
    $
    (1,380
    )
    
    $
    (298
    )
    
    $
    (137
    )
 14. DISCONTINUED OPERATIONS  AGENCY BUSINESS In December 2001, the Company decided to exit the music talent agency business. As a result,
this segment has been classified as a discontinued operation in the consolidated statement of
operations for the year ended December 31, 2002 and its net results for such period are reflected
as income from discontinued operations. The agency business did not have any significant assets or
liabilities associated with it and no gain or loss was recognized as a result of its disposal. The
termination of operations of the agency business was completed during 2002. A summary of the
statements of operations of the agency business segment is as follows: Year EndedDecember 31,2002(in thousands)Agency commission revenues
    
    $
    259Cost of revenues
    
    
    85Gross profit
    
    
    174General and administrative
    
    
    27Income from discontinued operations
    
    $
    147
 15. INCOME TAXES Income taxes differ from the amount computed using a tax rate of 35% as a result of the
following: Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Computed expected tax benefit
    
    $
    (16,919
    )
    
    $
    (7,595
    )
    
    $
    (1,145
    )State and local income taxes, net of federal income tax benefit
    
    
    (2,311
    )
    
    
    (1,302
    )
    
    
    19Goodwill amortization/write-off
    
    
    276
    
    
    
    
    
    
    
    Amortization of bridge notes
    
    
    
    
    
    
    
    
    
    
    648Adjustments to deferred tax assets
    
    
    2,172
    
    
    
    28,396
    
    
    
    2,058Other
    
    
    20
    
    
    
    
    
    
    
    20(16,762
    )
    
    
    19,499
    
    
    
    1,600Increase (decrease) in valuation allowance
    
    
    16,762
    
    
    
    (19,499
    )
    
    
    (1,600
    )Total tax benefit
    
    $
    
    
    
    $
    
    
    
    $
    
 81




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##### Table of Contents



The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and liabilities at December 31, 2003 and 2004 are as follows: December 31,2003
    
    
    2004(in thousands)Deferred tax assets:Net operating loss carryforwards
    
    $
    60,933
    
    
    $
    58,152Amortization of stock-based compensation
    
    
    2,370
    
    
    
    Other
    
    
    2,674
    
    
    
    5,991Total deferred tax assets
    
    
    65,977
    
    
    
    64,143Less: valuation allowance
    
    
    (61,854
    )
    
    
    (60,087
    )Net deferred assets
    
    
    4,123
    
    
    
    4,056Deferred tax liability  state income taxes
    
    
    (4,123
    )
    
    
    (4,056
    )Net deferred tax assets
    
    $
    
    
    
    $
    
 At December 31, 2004, the Company had net operating loss carryforwards totaling approximately
$135 million for Federal income tax purposes expiring beginning in 2020 and California state net
operating loss carryforwards of approximately $123 million expiring beginning in 2008. As a result
of the disposition of ARTISTdirect Records effective February 28, 2005, the Company net operating
loss carryforwards for Federal income tax purposes were reduced by
approximately $21 million. In assessing the potential realization of deferred tax assets, management considers whether it
is more likely than not that some portion or all of the deferred tax assets will be realized. The
ultimate realization of deferred tax assets is dependent upon the Company attaining future taxable
income during the periods in which those temporary differences become deductible. In addition, Internal Revenue Code Section 382 substantially restricts the ability of a
corporation to utilize existing net operating losses in the event of a defined ownership change.
Accordingly, the Companys ability to utilize its net operating losses for Federal income tax
purposes in subsequent periods may be limited if the Company experiences a change in ownership in
the future. Due to the uncertainty surrounding the realization of the benefits of the Companys tax
attributes, primarily net operating loss carryforwards as of December 31, 2004, the Company has
recorded a 100% valuation allowance against its net deferred tax assets as of December 31, 2003 and
2004. 16. SIGNIFICANT CONTRACTS In February 2002, the Company amended an existing agreement with Ticketmaster pursuant to
which the Company agreed to purchase online advertising totaling $2.0 million from Ticketmaster and
in conjunction became entitled to certain non-exclusive opportunities to pre-sell tickets on the
ARTISTdirect web-site. The Company recognized as sales and marketing expense the amount paid on a
straight-line basis, which approximated how the services were received, over the amended term of
the agreement. The term of the amended agreement expired in April 2003. 17. RELATED PARTY TRANSACTIONS For the years ended December 31, 2002 and 2003, the Company incurred legal expenses of
approximately $260,000 and $156,000, respectively, for legal services provided by Lenard & Gonzalez
LLP and its successor firm, Lenard, Brisbin & Klotz LLP. Allen Lenard, a former director of the
Company who resigned from the board of directors in September 2002, was managing partner of Lenard
& Gonzalez LLP and is managing partner of Lenard, Brisbin & Klotz LLP. During the three months ended September 30, 2003, the Company significantly reduced its
overhead costs and operating activities and laid off the majority of its staff while it continued
to restructure its operations and seek additional capital. The Company also relocated its
administrative offices to an office leased by Radar Pictures, Inc., a company owned by Ted Field.
The Company sub-leases these offices on a month-to-month basis. During the years ended December
31, 2003 and 2004, the Company accrued $56,000 and $168,000, respectively, to Radar Pictures, Inc.
as rent and facilities usage expense. The Company paid Radar Pictures, Inc. the accrued rent
through December 31, 2004 of $224,000 on February 28, 2005. See
Notes 9, 10, 12, 19, 20 and 22 for additional related party transactions. 82




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##### Table of Contents



18. RESCISSION OFFER In December 2001, the Company completed a rescission offer in which it rescinded the purchase
of 83,403 shares of its common stock purchased upon the exercise of options and the issuance of
vested and unvested unexercised options to purchase 636,740 shares of common stock. The shares of
stock were repurchased at prices ranging from $12.40 to $40.00 per share and the unexercised
options that were rescinded had exercise prices ranging from $12.40 to $140.00 per share. In the
aggregate, the Company paid $10.2 million to rescind the shares and options. As a result of the completion of the rescission offer, the Company recorded stock compensation
expense of $1.9 million in 2002, which consisted of $900,000 reflected in cost of revenues and $1.0
million reflected in operating expenses. No additional compensation expense related to the
rescission offer was recorded in 2003 or 2004. The Company did not record any compensation expense related to the shares and options of those
holders who chose not to accept the rescission offer. The Securities Act of 1933, as amended (the
Securities Act), does not expressly provide that a rescission offer will terminate a purchasers
right to rescind a sale of stock that was not registered under the Securities Act as required.
However, federal courts in the past have ruled that a person who rejects or fails to accept a
rescission offer is precluded from later seeking similar relief. The Company believes that
subsequent to the rescission offer, any rights to rescind will be contingent upon legal rulings,
the outcome of which are not currently determinable. Accordingly, the Company has accounted for
shares and options that were not rescinded in the rescission offer as if there was no right of
rescission. In the event any rescissions occur subsequent to December 31, 2001, the Company will
account for those rescissions in the manner described above at the time those rescissions are
completed. 19. STOCKHOLDERS EQUITY (DEFICIENCY) COMMON STOCK On July 5, 2001, the Company effected a 1-for-10 reverse stock split. The outstanding common
securities, options and warrants have been retroactively adjusted to reflect the reverse stock
split. All references to equity amounts in these financial statements reflect the effect of the
reverse stock split. During December 2003, the Company issued 40,000 shares of common stock to a consultant for
services rendered which were valued at $0.50 per share, resulting in a charge to operations of
$20,000. WARRANTS AND NON-PLAN OPTIONS During 1999, the Company issued immediately exercisable warrants to purchase 35,967 shares of
common stock at $40.00 per share to two vendors from whom it purchased merchandise. None of the
warrants had been exercised as of December 31, 2004. The value of the warrants was $864,000, of
which $79,000 and $32,000 was recognized as stock-based compensation expense in cost of revenues
for the years ended December 31, 2002 and 2003, respectively. The term of the agreements expired
in 2003. The warrants expire in June 2007. In January 2000, the Company issued warrants to purchase 6,250 shares of common stock at
$139.28 per share in connection with an office lease. The warrants were exercisable upon grant and
expired unexercised in January 2005. The warrants were valued at $568,000 and were being amortized
over the term of the related lease. During the years ended December 31, 2002 and 2003, $57,000 and
$379,000, respectively, was recognized as stock-based compensation expense with respect to these
warrants. As a result of the termination of this office lease in 2003 (see Note 6), the
unamortized portion of these warrants was written off during 2003. Effective September 29, 2003, the Company entered into an employment agreement with Jonathan
V. Diamond to serve as the Companys President and Chief Executive Officer through August 15, 2006
(see Note 22). In conjunction with the employment agreement, the Company granted Mr. Diamond a
non-plan, non-qualified stock option to purchase 259,659 shares of common stock exercisable through
August 15, 2010 at $0.85 per share, which was the approximate fair market value of the common stock
on the date of grant. Upon the termination of Mr. Diamonds employment with the Company prior to
the expiration of his employment agreement, 75% of the common stock underlying the option is
subject to a repurchase right by the Company at $0.85 per share. The repurchase right lapses in
three equal annual installments such that it will have lapsed in its entirety on the third
anniversary of Mr. 83




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##### Table of Contents



Diamonds employment by the Company. The fair value of the stock option, determined pursuant
to the Black-Scholes option pricing model, was $221,000. On September 8, 2003, the Company issued a warrant to the Companys former landlord to
purchase 200,000 shares of common stock exercisable at $0.50 per share through September 8, 2008 as
part of the consideration for an office lease termination. The warrant was valued at $100,000
pursuant to the Black-Scholes option-pricing model and was charged to operations in 2003 (see Note
6). Effective January 1, 2004, the Company entered into a one-year consulting agreement with Keith
Yokomoto, the Companys then director and former President and Chief Operating Officer (see Note
22). Effective January 9, 2004, the Company also issued to Mr. Yokomoto two non-qualified stock
options to purchase 10,000 shares and 50,000 shares exercisable at $0.50 per share, which was not
less than the fair market value on the date of grant, through January 9, 2011. The option for
10,000 shares was immediately vested upon issuance. The option for 50,000 shares was scheduled to
vest in increments of 10,000 shares on February 1, 2004, March 31, 2004, June 30, 2004, September
30, 2004 and December 31, 2004, based on the accomplishment of certain milestones by each
respective date, which were not attained. Accordingly, the option for 50,000 shares did not vest
and thus expired. The fair value of the stock option for 10,000 shares, determined pursuant to the
Black-Scholes option pricing model, was $3,500. Effective March 29, 2004, the Company issued to Robert N. Weingarten, the Companys Chief
Financial Officer, a non-plan, non-qualified stock option to purchase 120,000 shares at $0.50 per
share, which was not less than the fair market value on the date of grant, exercisable through
March 29, 2011. The option vests and becomes exercisable in a series of 36 successive equal
monthly installments from March 29, 2004. The fair value of the stock option, determined pursuant
to the Black-Scholes option pricing model, was $42,000. Effective August 31, 2004, the Company issued a warrant to a consultant for services rendered
to purchase 10,000 shares of common stock exercisable for a period of five years at $0.50 per
share. The fair value of the warrant was determined to be $3,000, calculated pursuant to the
Black-Scholes option-pricing model, and was charged to operations during the year ended December
31, 2004. 20. STOCK OPTION AND STOCK PURCHASE PLANS CONSULTANT STOCK PLAN Effective September 29, 2004, the Companys Board of Directors adopted the ARTISTdirect, Inc.
2004 Consultant Stock Plan (the Consultant Plan) in order for the Company to be able to
compensate consultants, at the option of the Company, who provide bona fide services to the Company
not in connection with capital raising or promotion of the Companys securities. The Consultant
Plan will expire on September 29, 2014, and provides for the issuance of up to 500,000 shares of
common stock to consultants at fair market value. On January 13, 2005, the Company filed a
Registration Statement on Form S-8 with the Securities and Exchange Commission to register the
500,000 shares of common stock for future issuance under the Consultant Plan. As of December 31,
2004, no shares had been issued under the Consultant Plan. EMPLOYEE OPTION PLAN In October 1999, the Company implemented the 1999 Employee Stock Option Plan (the Employee
Plan) that replaced the 1998 Unit Option Plan. The Employee Plan has currently reserved 940,462
shares of the Companys common stock for issuance to employees, non-employee members of the board
of directors and consultants. This share reserve automatically increases on the first trading day
in January each calendar year by an amount equal to 2% of the total number of shares of the
Companys common stock outstanding on the last trading day of December in the prior calendar year,
but in no event will this annual increase exceed 87,500 shares. No option may have a term in
excess of ten years. The options generally vest within three years. As of December 31, 2004,
829,308 shares remained available for future option grant. The Company accounts for its Employee Plan in accordance with the provisions of Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, Interpretation
No. 44, and other related interpretations. As such, compensation expense would be recorded on the
date of grant only if the current market price of the underlying stock exceeded the exercise price. A summary of stock option activity under Employee Plan during the years ended December 31,
2002, 2003 and 2004 is as follows: 84




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##### Table of Contents



Options OutstandingWeightedNumber of
    
    
    AverageShares
    
    
    Exercise PriceOptions outstanding at December 31, 2001
    
    
    183,155
    
    
    $
    79.51Granted
    
    
    100,000
    
    
    
    5.94Exercised
    
    
    
    
    
    
    Cancelled
    
    
    (35,149
    )
    
    
    17.02Options outstanding at December 31, 2002
    
    
    248,006
    
    
    
    58.43Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    (129,109
    )
    
    
    98.63Options outstanding at December 31, 2003
    
    
    118,897
    
    
    
    14.79Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    (7,743
    )
    
    
    9.11Options outstanding at December 31, 2004
    
    
    111,154
    
    
    $
    15.18
 The Company recorded stock-based compensation of $31,000, $0 and $0 related to stock options
granted to employees under the Employee Plan during the years ended December 31, 2002, 2003 and
2004, respectively. The following table summarizes information regarding options outstanding and options
exercisable at December 31, 2004 under the Employee Plan: Options Outstanding and ExercisableWeightedAverageRemaining
    
    
    WeightedExercise
    
    
    Number
    
    
    Contractual
    
    
    AveragePrices
    
    
    of Shares
    
    
    Life
    
    
    Exercise Price$
    4.80
    
    
    
    33,332
    
    
    
    4.78
    
    
    $
    4.805.10
    
    
    
    10,000
    
    
    
    4.77
    
    
    
    5.107.50
    
    
    
    58,603
    
    
    
    3.74
    
    
    
    7.5012.40
    
    
    
    786
    
    
    
    0.58
    
    
    
    12.4036.00
    
    
    
    439
    
    
    
    1.78
    
    
    
    36.0040.00
    
    
    
    1,025
    
    
    
    2.44
    
    
    
    40.00139.28
    
    
    
    6,969
    
    
    
    2.24
    
    
    
    139.28$
    4.80 - $139.28
    
    
    
    111,154
    
    
    
    4.01
    
    
    $
    15.18
 ADVISOR OPTION PLAN In June 1999, and as amended in October 1999 and March 2000, the Company adopted the 1999
Artist and Artist Advisor Stock Option Plan (the Advisor Plan). The Advisor Plan has currently
reserved 329,638 shares of common stock for issuance to artists for whom the Company entered into
agreements related to online and e-commerce activities and their agents, business managers,
attorneys and other advisors. This share reserve automatically increases on the first trading day
in January each calendar year by an amount equal to 1% of the total number of shares of the
Companys common stock outstanding on the last trading day of December in the prior calendar year,
but in no event will this annual increase exceed 37,500 shares. As of December 31, 2004, 294,102
shares remained available for future option grants. The options expire seven years from the date
of grant and vesting generally varies between one to three years. In December 2001, a majority of
the outstanding options under the Advisor Plan were rescinded and cancelled. No new option grants
under this plan were made during 2002, 2003 or 2004. A summary of stock option activity under the Advisor Plan during the years ended December 31,
2002, 2003 and 2004 is as follows: 85




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##### Table of Contents



Options OutstandingWeightedNumber
    
    
    Averageof Shares
    
    
    Exercise PriceOptions outstanding at December 31, 2001
    
    
    35,536
    
    
    $
    123.29Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    Options outstanding at December 31, 2002
    
    
    35,536
    
    
    
    123.29Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    Options outstanding at December 31, 2003
    
    
    35,536
    
    
    
    123.29Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    Options outstanding at December 31, 2004
    
    
    35,536
    
    
    $
    123.29
 The following table summarizes information regarding options outstanding and options
exercisable under the Advisor Plan at December 31, 2004: Options Outstanding and ExercisableWeightedAverageRemaining
    
    
    WeightedNumber
    
    
    Contractual
    
    
    AverageExercise Prices
    
    
    of Shares
    
    
    Life
    
    
    Exercise Price$
    36.00
    
    
    
    1,250
    
    
    
    1.78
    
    
    $
    36.0040.00
    
    
    
    4,422
    
    
    
    1.60
    
    
    
    40.00139.28
    
    
    
    29,864
    
    
    
    2.24
    
    
    
    139.28$
    36.00 - $139.28
    
    
    
    35,536
    
    
    
    2.15
    
    
    $
    123.29
 ARTIST OPTION PLAN In June 1999, and as amended in October 1999, the Company adopted the 1999 Artist Stock Plan
(the Artist Plan). The Artist Plan currently has reserved 690,462 shares of common stock for
issuance to artists for whom the Company entered into agreements related to their online and
e-commerce activities. This share reserve automatically increases on the first trading day in
January each calendar year by an amount equal to 2% of the total number of shares of the Companys
common stock outstanding on the last trading day of December in the prior calendar year, but in no
event will this annual increase exceed 87,500 shares. As of December 31, 2004, 666,588 shares
remained available for future option grants. The options expire seven years from the date of grant
and vesting generally varies between one to three years. In December 2001, a majority of the
outstanding options under the Advisor plan were rescinded and cancelled. No new option grants
under this plan were made during 2002, 2003 or 2004. A summary of stock option activity under the Artist Plan during the years ended December 31,
2002, 2003 and 2004 is as follows: Options OutstandingWeightedNumber
    
    
    Averageof Shares
    
    
    Exercise PriceOptions outstanding at December 31, 2001
    
    
    23,874
    
    
    $
    83.15Granted
    
    
    
    
    
    
    
 86




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##### Table of Contents



Options OutstandingWeightedNumber
    
    
    Averageof Shares
    
    
    Exercise PriceExercised
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    Options outstanding at December 31, 2002
    
    
    23,874
    
    
    
    83.15Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    Options outstanding at December 31, 2003
    
    
    23,874
    
    
    
    83.15Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    Options outstanding at December 31, 2004
    
    
    23,874
    
    
    $
    83.15
 The following table summarizes information regarding options outstanding and options
exercisable under the Artist Plan at December 31, 2004: Options Outstanding and ExercisableWeightedAverage
    
    
    WeightedNumber
    
    
    Remaining
    
    
    AverageExercise Prices
    
    
    of Shares
    
    
    Contractual Life
    
    
    Exercise Price$
    40.00
    
    
    
    13,499
    
    
    
    1.66
    
    
    $
    40.00139.28
    
    
    
    10,375
    
    
    
    2.20
    
    
    
    139.28$
    40.00 - $139.28
    
    
    
    23,874
    
    
    
    1.89
    
    
    $
    83.15
 Total compensation expense related to the Advisor Plan and the Artist Plan (excluding the
impact of the rescission offer as described at Note 17) for the years ended December 31, 2002, 2003
and 2004 was $2.9 million, $540,000 and $0, respectively, of which $2.1 million, $33,000 and $0,
respectively, was included in cost of revenue, and $800,000, $527,000 and $0, respectively, was
included in operating expenses. EMPLOYEE STOCK PURCHASE PLAN In October 1999, the Company adopted the 1999 Employee Stock Purchase Plan that initially
reserved 50,000 shares of common stock for issuance under this plan. As of December 31, 2004, this
plan currently had reserved for issuance 150,000 shares, of which 137,831 shares remained available
for future issuances. This share reserve automatically increases on the first trading day in
January each calendar year, by an amount equal to 1% of the total number of shares of the Companys
common stock outstanding on the last trading day of December in the prior calendar year, but in no
event will this annual increase exceed 25,000 shares. Terms of the plan permit eligible employees
to purchase common stock through payroll deduction of up to 15% of each employees compensation.
The accumulated deductions are applied to the purchase of shares on each semi-annual purchase date
at a purchase price per share equal to 85% of the fair market value per share on the participants
entry date into the offering period or the semi-annual purchase date, whichever is lower. Pursuant
to the provisions of APB No. 25, shares issued to employees under this plan are considered
non-compensatory. During the years ended December 31, 2002, 2003 and 2004, 1,134 shares, 375
shares and 0 shares, respectively, were issued under this plan for total proceeds of $4,000, $440
and $0, respectively. See
Note 22 for a description of non-plan stock options to purchase 259,659 shares of common
stock issued to the Companys President and Chief Executive Officer, 120,000 shares of common stock
issued to the Companys Chief Financial Officer, and 444,480 shares of common stock issued to the
Companys Chairman, who is also the Chief Executive Officer of ARTISTdirect Records. 21. 401(K) PLAN The Company has adopted the Cash or Deferred Profit Sharing Plan and Trust under Section
401(k) of the Internal Revenue Code (the 401(k) Plan). Under the 401(k) Plan, participating
employees may defer a percentage (not to exceed 15%) of their eligible pretax earnings up to the
Internal Revenue Services annual contribution limit. All employees of the Company who are 21
years or 87




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##### Table of Contents



older and who complete three months of service are eligible to participate in the 401(k) Plan.
The Company does not match contributions by participants to the 401(k) Plan. Accordingly, there
is no related expense for the years ended December 31, 2002, 2003 and 2004. 22. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS As of December 31, 2004, the Company did not have any long-term commitments for operating
leases. Rent expense under operating leases for the years ended December 31, 2002, 2003 and 2004 was
$1,806,000, $2,144,000 and $173,000, respectively, including $56,000 and $168,000 to a related
party in 2003 and 2004, respectively (see Note 17). EMPLOYMENT AGREEMENTS Future payments under employment and consulting agreements are as follows: Years EndedDecember 31,(in thousands)2005
    
    $
    3052006
    
    
    116Total
    
    $
    421
 Effective January 1, 2005, the Company entered into a one-year consulting agreement with
Nicholas Turner to serve as the Companys Executive Vice President with a base annual salary of
$120,000 per year plus certain benefits. In conjunction with the consulting agreement, the Company
granted Mr. Turner a non-plan, non-qualified stock option to purchase 92,000 shares of common stock
at an exercise price of $0.79 per share, which was the approximate fair market value of the common
stock on the date of grant, vesting monthly over a period of two years. Effective September 29, 2003, the Company entered into an employment agreement with Jonathan
V. Diamond to serve as the Companys President and Chief Executive Officer through August 15, 2006
with a base annual salary of $185,000 plus certain benefits. In conjunction with the employment
agreement, the Company granted Mr. Diamond a non-plan, non-qualified stock option to purchase
259,659 shares of common stock exercisable through August 15, 2010 at $0.85 per share, which was
the approximate fair market value of the common stock on the date of grant. Upon the termination
of Mr. Diamonds employment with the Company prior to the expiration of his employment agreement,
75% of the common stock underlying the option is subject to a repurchase right by the Company at
$0.85 per share. The repurchase right lapses in three equal annual installments such that it will
have lapsed in its entirety on the third anniversary of Mr. Diamonds employment by the Company.
The fair value of the stock option, determined pursuant to the Black-Scholes option pricing model,
was $221,000. Effective May 31, 2003, Marc P. Geiger, the Companys former Vice Chairman of the Board of
Directors and President  Artist Services, resigned as an officer of the Company. Mr. Geiger
subsequently resigned as a director of the Company on October 18, 2004. Mr. Geigers July 2001
amended employment agreement, which had an initial term extending through June 30, 2006, provided
for an annual salary of $500,000 plus certain benefits. The amended employment agreement also
provided that under certain conditions, Mr. Geiger would receive a payment of $1,000,000 plus one
years salary upon the termination of his employment with the Company. In February 2001, the
Company loaned Mr. Geiger $150,000, with interest at 7%. The term of the loan was initially one
year, but was extended in September 2001 to five years commensurate with the amendment of Mr.
Geigers employment agreement in July 2001. Mr. Geiger was obligated to repay the loan in five
equal annual principal payments of $30,000, along with accrued interest to date, beginning in
September 2002. In consideration for Mr. Geiger terminating his employment agreement effective as
of the date of his resignation as an officer and waiving all rights to compensation under the
employment agreement, the Company paid Mr. Geiger his accrued compensation and benefits of
approximately $184,000, and Mr. Geiger repaid the $150,000 loan plus accrued interest to the
Company. 88




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Effective December 31, 2003, Keith Yokomoto, the Companys former President and Chief
Operating Officer, entered into a Termination Agreement and Mutual General Release. Mr. Yokomoto
subsequently resigned as a director of the Company on October 22, 2004. Mr. Yokomotos July 2001
employment agreement, which had an initial term extending through June 30, 2006, provided for an
annual salary of $500,000 plus certain benefits, and a commencement advance of $300,000,
representing a pre-payment of $60,000 against any monies that would otherwise become payable to Mr.
Yokomoto under the Companys executive performance bonus pool for each year of the initial
five-year term of the employment agreement. The employment agreement also provided that under
certain conditions, Mr. Yokomoto would receive a payment of $350,000 plus one years salary upon
the termination of his employment with the Company. In consideration for Mr. Yokomoto terminating
his employment agreement as an officer of the Company effective as of December 31, 2003 and waiving
all rights to $1.25 million of remaining compensation under the employment agreement, the Company
paid Mr. Yokomoto his accrued but unpaid salary at the rate of $500,000 per year through December
31, 2003 aggregating $412,847 and his accrued but unused vacation pay through December 31, 2003
aggregating $76,924, and Mr. Yokomoto repaid the Company the unearned portion of the commencement
advance of $150,000. Effective January 1, 2004, the Company entered into a one-year consulting agreement with Mr.
Yokomoto that provided for total compensation of $120,000. Effective January 9, 2004, the Company
also issued to Mr. Yokomoto two non-qualified stock options to purchase 10,000 shares and 50,000
shares exercisable at $0.50 per share, which was not less than the fair market value on the date of
grant, through January 9, 2011. The option for 10,000 shares was immediately vested upon issuance.
The option for 50,000 shares was scheduled to vest in increments of 10,000 shares on February 1,
2004, March 31, 2004, June 30, 2004, September 30, 2004 and December 31, 2004, based on the
accomplishment of certain milestones by each respective date, which were not attained.
Accordingly, the option for 50,000 shares did not vest and thus expired. The fair value of the
stock option for 10,000 shares, determined pursuant to the Black-Scholes option pricing model, was
$3,500. In May 2001, the Company entered into an agreement with Frederick W. (Ted) Field, to serve as
Chairman and Chief Executive Officer of the Company. In addition, on May 31, 2001, the Company,
through its wholly-owned subsidiary, ARTISTdirect Recordings, Inc., a Delaware corporation
(ARTISTdirect Recordings), entered into an agreement to acquire a 50% equity interest in a
co-venture with Radar Records Holdings, LLC (Radar Records), an entity owned by Mr. Field, to
form a new record label, ARTISTdirect Records, LLC (ARTISTdirect Records). On June 29, 2001, the
Companys stockholders approved the employment of Mr. Field and the formation of the ARTISTdirect
Records record label. Mr. Field is the Chief Executive Officer of ARTISTdirect Records. In
conjunction therewith, the Company entered into an employment agreement and stock option agreement
with Mr. Field. Mr. Fields employment agreement, which has an initial term extending through May 31, 2006,
provided for an annual base salary of $500,000 plus certain benefits. The employment agreement
also provided that under certain conditions, Mr. Field would receive a lump-sum payment equal to
his annual base salary for (i) 50% of the remaining term of the employment agreement if termination
occurs within the first three years of his employment, (ii) his annual base salary for one year if
termination occurs in the fourth year of his employment, and (iii) his annual base salary for the
full remaining term of the employment agreement if termination occurs in the fifth year of his
employment. In May 2001, the Company also granted Mr. Field three non-qualified stock options, which were
not part of any stock option plan maintained by the Company, to purchase 444,480 shares of common
stock at an exercise price of $7.50 per share. Options on 302,370 shares were exercisable
immediately (the underlying shares pursuant to the exercise of this option vested over five years
from the date of the option grant), options on 75,588 shares were exercisable in the event the
30-day average closing price of the Companys common stock on NASDAQ equaled or exceeded $35.00 per
share within three years from the grant date, and options on 66,522 shares were exercisable in the
event the 30-day average closing price of the Companys common stock on NASDAQ equaled or exceeded
$70.00 per share within three years of the grant date. The two options that were not exercisable
upon grant became exercisable in the event of a de-listing of the Companys common stock from
NASDAQ and a subsequent re-listing, a change in control of the Company or an involuntary
termination of the officer (within three years of the date of grant). Since the options for 75,588
shares and 66,522 shares did not vest pursuant to their respective terms on or before June 29,
2004, they expired on such date. During 2002, Mr. Fields employment agreement was amended whereby Mr. Field agreed to defer
his future salary until the Company raised new debt or equity financing of at least $20 million.
During the three months ended June 30, 2003, Mr. Fields employment agreement was further amended
whereby all deferred and any future salary, except a base amount, would be waived, even if new debt
or equity financing was raised. Accordingly, during the year ended December 31, 2003, $411,000 of
accrued compensation due to Mr. Field by the Company was recorded as gain from forgiveness of debt
in the consolidated statement of operations. As described above, Mr. Diamond replaced Mr. Field as
Chief Executive Officer of the Company effective September 29, 2003. 89




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LITIGATION The Company is periodically subject to various pending and threatened legal actions which
arise in the normal course of business. The Companys management believes that the impact of any
such litigation will not have a material adverse impact on the Companys financial position or
results of operations. 23. REPORTABLE SEGMENTS Information with respect to the Companys operating segments for the years ended December 31,
2002, 2003 and 2004 is presented below. During the years ended December 31, 2002, 2003 and 2004,
the Companys continuing operations consisted of two reportable segments: e-commerce
(E-commerce) and media (Media). The segment data presented below has been restated for all
periods to reflect the segment structure at December 31, 2004. In December 2001, the Company decided to exit the talent agency business and as a result it
has been shown as a discontinued operation in the consolidated statement of operations for the year
ended December 31, 2002. In December 2004, the Company discontinued the operations of its iMusic
record label and as a result it has been presented as a discontinued operation in the consolidated
statements of operations for the years ended December 31, 2002, 2003 and 2004. The Company accounted for its interest in ARTISTdirect Records on the equity method of
accounting during the years ended December 31, 2002 and 2003 and consolidated the operations of
ARTISTdirect Records for the year ended December 31, 2004. As a result of the sale of the
Companys interest in ARTISTdirect Records effective February 28, 2005, the operations of
ARTISTdirect Records have been presented as a discontinued operation for the years ended December
31, 2002, 2003 and 2004 and as of December 31, 2003 and 2004. As of December 31, 2002 and 2003, the Company had advanced $30.25 million and $33.0 million to
ARTISTdirect Records, and for the years ended December 31, 2002 and 2003, the Company had recorded
losses of approximately $29.2 million and $9.3 million, respectively, with respect to this
investment (see Note 9). For the year ended December 31, 2004, the Company recorded a loss of $2.1
million with respect to ARTISTdirect Records. E-commerce revenue is generated from the sale of recorded music and music-related merchandise.
Media revenue is generated from the sale of advertising and sponsorships, both online and offline. The factors for determining reportable segments were based on services and products. Each
segment is responsible for executing a unique marketing and business strategy. The accounting
policies of the segments are as described in the summary of significant accounting policies. The
Company evaluates performance based on earnings or loss before interest, taxes, depreciation and
amortization, including stock-based compensation, impairment losses, and minority interest
(EBITDA). Included in EBITDA are direct operating expenses for each segment. The following
table summarizes net revenue and EBITDA by segment for the years ended December 31, 2002, 2003 and
2004. Corporate expenses consist of general operating expenses that are not directly related to
the operations of the segments. Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Net Revenue:E-commerce
    
    $
    4,713
    
    
    $
    3,459
    
    
    $
    2,994Media
    
    
    924
    
    
    
    1,173
    
    
    
    2,149$
    5,637
    
    
    $
    4,632
    
    
    $
    5,143EBITDA:E-commerce
    
    $
    (137
    )
    
    $
    553
    
    
    $
    293Media
    
    
    (3,065
    )
    
    
    (576
    )
    
    
    789(3,202
    )
    
    
    (23
    )
    
    
    1,082Corporate
    
    
    (6,670
    )
    
    
    (3,152
    )
    
    
    (1,944
    )$
    (9,872
    )
    
    $
    (3,175
    )
    
    $
    (862
    )
 90




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##### Table of Contents



Years Ended December 31,2002
    
    
    2003
    
    
    2004(in thousands)Reconciliation of EBITDA to Net Loss:EBITDA per segments
    
    $
    (9,872
    )
    
    $
    (3,175
    )
    
    $
    (862
    )Stock-based compensation
    
    
    (4,981
    )
    
    
    (560
    )
    
    
    (7
    )Depreciation and amortization
    
    
    (2,814
    )
    
    
    (1,014
    )
    
    
    (223
    )Loss from impairment of goodwill
    
    
    (788
    )
    
    
    
    
    
    
    Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    (2,225
    )
    
    
    Loss from equity investment
    
    
    (16
    )
    
    
    (64
    )
    
    
    Loss from discontinued operations  ARTISTdirect Records, LLC
    
    
    (29,236
    )
    
    
    (9,256
    )
    
    
    (2,111
    )Loss from discontinued operations  iMusic record label and agency business
    
    
    (1,233
    )
    
    
    (298
    )
    
    
    (137
    )Interest income (expense), net
    
    
    748
    
    
    
    146
    
    
    
    29Cumulative effect of consolidation of ARTISTdirect Records, LLC
    
    
    
    
    
    
    (5,255
    )
    
    
    $
    (48,192
    )
    
    $
    (21,701
    )
    
    $
    (3,311
    )
 Assets as of December 31, 2003 and 2004 are summarized as follows: December 31,2003
    
    
    2004(in thousands)Assets:Corporate
    
    $
    2,066
    
    
    $
    1,313E-commerce
    
    
    528
    
    
    
    314Media
    
    
    355
    
    
    
    772Discontinued operations
    
    
    57
    
    
    
    14$
    3,006
    
    
    $
    2,413
 Assets by segment are those assets used in or employed by the operations of each segment.
Corporate assets are principally made up of cash and cash equivalents, short-term investments,
prepaid expenses, computer equipment, leasehold improvements and other assets. 24. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following table sets forth unaudited quarterly results of operations for the years ended
December 31, 2004 and 2003. This unaudited quarterly information has been derived from the
Companys unaudited financial statements and, in the Companys opinion, includes all adjustments,
including normal recurring adjustments, necessary for a fair presentation of the information for
the periods covered. The operating results for any quarter are not necessarily indicative of the
operating results for any future period. Three Months EndedMarch 31,
    
    
    June 30,
    
    
    September 30,
    
    
    December 31,
    
    
    Year Ended2004
    
    
    2004
    
    
    2004
    
    
    2004
    
    
    December 31, 2004(in thousands, except for share data)Net revenue
    
    $
    963
    
    
    $
    1,180
    
    
    $
    1,365
    
    
    $
    1,635
    
    
    $
    5,143Gross profit
    
    
    178
    
    
    
    456
    
    
    
    567
    
    
    
    390
    
    
    
    1,591Loss from continuing operations
    
    
    (489
    )
    
    
    (452
    )
    
    
    (93
    )
    
    
    (29
    )
    
    
    (1,063
    )Loss from discontinued operations
    
    
    (223
    )
    
    
    (214
    )
    
    
    (435
    )
    
    
    (1,376
    )
    
    
    (2,248
    )Net loss
    
    $
    (712
    )
    
    $
    (666
    )
    
    $
    (528
    )
    
    $
    (1,405
    )
    
    $
    (3,311
    )Net loss per common share  basic and diluted:From continuing operations
    
    $
    (0.14
    )
    
    $
    (0.13
    )
    
    $
    (0.03
    )
    
    $
    (0.01
    )
    
    $
    (0.30
    )From discontinued operations
    
    
    (0.06
    )
    
    
    (0.06
    )
    
    
    (0.12
    )
    
    
    (0.39
    )
    
    
    (0.64
    )Total
    
    $
    (0.20
    )
    
    $
    (0.19
    )
    
    $
    (0.15
    )
    
    $
    (0.40
    )
    
    $
    (0.94
    )Weighted average common shares outstanding 
basic and diluted
    
    
    3,502,117
    
    
    
    3,502,117
    
    
    
    3,502,117
    
    
    
    3,502,117
    
    
    
    3,502,117
 91




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##### Table of Contents



Three Months EndedMarch 31,
    
    
    June 30,
    
    
    September 30,
    
    
    December 31,
    
    
    Year Ended2003
    
    
    2003
    
    
    2003
    
    
    2003
    
    
    December 31, 2003(in thousands, except for share data)Net revenue
    
    $
    945
    
    
    $
    1,478
    
    
    $
    815
    
    
    $
    1,394
    
    
    $
    4,632Gross profit
    
    
    33
    
    
    
    353
    
    
    
    71
    
    
    
    556
    
    
    
    1,013Income (loss) from continuing operations
    
    
    (2,082
    )
    
    
    (3,155
    )
    
    
    (1,659
    )
    
    
    4
    
    
    
    (6,892
    )Loss from discontinued operations
    
    
    (5,049
    )
    
    
    (2,269
    )
    
    
    (11
    )
    
    
    (2,225
    )
    
    
    (9,554
    )Cumulative effect of consolidation of
ARTISTdirect Records, LLC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,255
    )
    
    
    (5,255
    )Net loss
    
    $
    (7,131
    )
    
    $
    (5,424
    )
    
    $
    (1,670
    )
    
    $
    (7,476
    )
    
    $
    (21,701
    )Net loss per common share  basic and diluted:From continuing operations
    
    $
    (0.60
    )
    
    $
    (0.91
    )
    
    $
    (0.48
    )
    
    $
    (0.00
    )
    
    $
    (1.99
    )From discontinued operations
    
    
    (1.46
    )
    
    
    (0.65
    )
    
    
    (0.00
    )
    
    
    (0.65
    )
    
    
    (2.76
    )From cumulative effect of consolidation of
ARTISTdirect Records, LLC
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1.52
    )
    
    
    (1.52
    )Total
    
    $
    (2.06
    )
    
    $
    (1.56
    )
    
    $
    (0.48
    )
    
    $
    (2.17
    )
    
    $
    (6.27
    )Weighted average common shares outstanding 
basic and diluted
    
    
    3,461,742
    
    
    
    3,461,983
    
    
    
    3,462,107
    
    
    
    3,462,117
    
    
    
    3,461,992
 25. SUBSEQUENT EVENTS During January and February 2005, Mr. Field advanced an additional $36,500 to ARTISTdirect
Records to fund operating expenses and the settlement of artist contracts. In consideration for
such advances, Mr. Field received Bridge Notes and warrants as
described at Note 12. On February 28, 2005, ADI completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records for a cash payment of $115,000, as a result of which ADI no longer had
any equity or other economic interest in ARTISTdirect Records, and Radar Records became the owner
of a majority of the membership interests in ARTISTdirect Records and also acquired the receivable
reflecting the $33.0 million of loan advances previously provided to ARTISTdirect Records by ADI
(see Note 10). 92




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##### Table of Contents



ARTISTDIRECT RECORDS, LLC INDEX TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002 AND 2003 PAGE Report
of Independent Registered Public Accounting Firm:Gumbiner Savett Inc.
    94Financial Statements:Balance Sheet  December 31, 2003
    95Statements of Operations  Years Ended December 31, 2002 and 2003
    96Statements of Members Deficit  Years Ended December 31, 2002 and 2003
    97Statements of Cash Flows  Years Ended December 31, 2002 and 2003
    98Notes
to Financial Statements  Years Ended December 31, 2002 and
2003
    99
 93




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Members
ARTISTdirect Records, LLC We have audited the accompanying balance sheet of ARTISTdirect Records, LLC (the Company) as of
December 31, 2003 and the related statements of operations, members deficit and cash flows for the
year then ended. These financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of ARTISTdirect Records, LLC as of December 31, 2003 and the
results of its operations and its cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that ARTISTdirect Records, LLC
will continue as a going concern. As more fully described in Note 1, the Company has incurred
substantial operating losses and negative cash flows from operations to date. The Company needs
additional capital to fund its operations. As of December 31, 2003, the Company has a net working
capital deficiency of $10.9 million and a members deficit of $53.355 million. These conditions
raise substantial doubt about the Companys ability to continue as a going concern. Managements
plans in regard to these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty. /s/ GUMBINER SAVETT INC.Santa Monica, CaliforniaApril 6, 2004,except for Note 14, which isMarch 1, 2005
 94




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ARTISTDIRECT RECORDS, LLC 
 BALANCE SHEET
(IN THOUSANDS)
DECEMBER 31, 2003 AssetsCurrent assets:Cash
    
    $
    7Accounts receivable, net
    
    
    Inventory, net
    
    
    Prepaid expenses
    
    
    Total current assets
    
    
    7Property and equipment, net
    
    
    40Other assets, net
    
    
    $
    47Liabilities and Members DeficitCurrent liabilities:Accounts payable
    
    $
    901Accrued expenses
    
    
    1,212Due to ARTISTdirect, Inc., a related party
    
    
    45Net liability to BMG, a distributor and related party
    
    
    8,749Total current liabilities
    
    
    10,907Non  current liabilities:Interest payable
    
    
    3,451Loan advances from ARTISTdirect, Inc., a related party, and BMG,
a distributor and related party
    
    
    37,750Bridge notes payable  outside investors
    
    
    755Bridge notes payable  Chief Executive Officer and related party
    
    
    539Total liabilities
    
    
    53,402Commitments and contingenciesMembers deficit
    
    
    (53,355
    )$
    47
 See accompanying notes to financial statements. 95




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ARTISTDIRECT RECORDS, LLC 
 STATEMENTS OF OPERATIONS
(IN THOUSANDS) Years Ended December 31,2002
    
    
    2003Net revenue
    
    $
    3,709
    
    
    $
    1,426Cost of revenue:Manufacturing and distribution expenses
    
    
    1,305
    
    
    
    420Advances and royalties, net
    
    
    8,788
    
    
    
    1,378Total cost of revenue
    
    
    10,093
    
    
    
    1,798Gross loss
    
    
    (6,384
    )
    
    
    (372
    )Operating expenses:Sales and marketing
    
    
    12,029
    
    
    
    3,287General and administrative
    
    
    14,374
    
    
    
    6,450Depreciation and amortization
    
    
    36
    
    
    
    39Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    100Total operating expenses
    
    
    26,439
    
    
    
    9,876Loss from operations
    
    
    (32,823
    )
    
    
    (10,248
    )Interest expense, net, including amortization of bridge
note warrants of $203 in 2003
    
    
    1,133
    
    
    
    2,447Net loss
    
    $
    (33,956
    )
    
    $
    (12,695
    )
 See accompanying notes to financial statements. 96




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ARTISTDIRECT RECORDS, LLC 
 STATEMENTS OF MEMBERS DEFICIT
(IN THOUSANDS) MembersDeficitBalance at January 1, 2002
    
    $
    (8,550
    )Net loss
    
    
    (33,956
    )Balance at December 31, 2002
    
    
    (42,506
    )Compensation forgiven by Chief Executive Officer and member
    
    
    822Issuance of bridge note warrants
    
    
    1,024Net loss
    
    
    (12,695
    )Balance at December 31, 2003
    
    $
    (53,355
    )
 See accompanying notes to financial statements. 97




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ARTISTDIRECT RECORDS, LLC 
 STATEMENTS OF CASH FLOWS
(IN THOUSANDS) Years Ended December 31,2002
    
    
    2003Cash flows from operating activities:Net loss
    
    $
    (33,956
    )
    
    $
    (12,695
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    36
    
    
    
    39Allowance for inventory obsolescence
    
    
    250
    
    
    
    204Allowance for sales returns
    
    
    800
    
    
    
    888Amortization of bridge note warrants
    
    
    
    
    
    
    203Loss from sale and abandonment of property and equipment
    
    
    
    
    
    
    100Changes in operating assets and liabilities:(Increase) decrease in -Accounts receivable
    
    
    (18
    )
    
    
    18Prepaid expenses and other current assets
    
    
    (394
    )
    
    
    (1
    )Other assets
    
    
    30
    
    
    
    85Increase (decrease) in -Accounts payable, accrued expenses and other liabilities
    
    
    1,673
    
    
    
    282Due to ARTISTdirect , Inc., a related party
    
    
    (186
    )
    
    
    44Net liability to BMG, a distributor and related party
    
    
    813
    
    
    
    3,748Net cash used in operating activities
    
    
    (30,952
    )
    
    
    (7,085
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (246
    )
    
    
    Proceeds from sale of property and equipment
    
    
    
    
    
    
    52Net cash provided by (used in) investing activities
    
    
    (246
    )
    
    
    52Cash flows from financing activities:Proceeds from issuance of bridge notes
    
    
    
    
    
    
    2,048Proceeds from loan advances from ARTISTdirect, Inc., a
related party
    
    
    25,000
    
    
    
    2,750Proceeds from loan advances from BMG, a distributor and
related party
    
    
    4,750
    
    
    
    Net increase in interest payable
    
    
    1,141
    
    
    
    2,242Net increase in cash overdraft
    
    
    242
    
    
    
    Net cash provided by financing activities
    
    
    31,133
    
    
    
    7,040Cash:Net increase (decrease)
    
    
    (65
    )
    
    
    7Balance at beginning of year
    
    
    65
    
    
    
    Balance at end of year
    
    $
    
    
    
    $
    7Supplemental disclosure of cash flow information:Cash paid for -Interest
    
    $
    
    
    
    $
    Income taxes
    
    $
    
    
    
    $
    
 See accompanying notes to financial statements. 98




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ARTISTDIRECT RECORDS, LLC 
 NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002 AND 2003  1.
    BASIS OF PRESENTATION ORGANIZATION AND BUSINESS ACTIVITIES ARTISTdirect Records, LLC (the Company) was formed in May 2001 as a 50/50 co-venture between
ARTISTdirect, Inc., a Delaware corporation (ADI), through its wholly-owned subsidiary,
ARTISTdirect Recordings, Inc., a Delaware corporation (ARTISTdirect Recordings), and Radar
Records Holdings, LLC (Radar Records), an entity owned by Frederick W. (Ted) Field, who was also
the Chairman and Chief Executive Officer of ADI at that time. At its formation, the Company issued
10,000,000 membership units for total proceeds of $100,000. The Company commenced operations in
July 2001. The Company, headquartered in Los Angeles, California, develops new musical artists and
produces and distributes their recordings as an independent label utilizing both traditional
channels and emerging Internet distribution channels. At the time of formation of the Company, ADI committed to provide funding of up to $50.0
million over five years at the rate of $15.0 million per year, subject to a limit of $33.0 million
in any three year period. Any funding in excess of these amounts required the approval of ADIs
Board of Directors. ADI has funded $33.0 million through December 31, 2003. In November 2001, ADI agreed to sell a 5% equity interest in the Company to BMG Music, a
wholly-owned partnership of Bertelsmann Music Group, Inc., the global music division of Bertelsmann
AG (BMG), in connection with entering into a North American distribution agreement and a
worldwide licensing agreement. In April 2002, these agreements were formally executed. As part of
these transactions, BMG agreed to advance certain monies against net sales proceeds under the
agreements and also assumed $5.0 million of ADIs funding commitment to the operations of the
Company. As a result of the BMG equity purchase, ADIs funding commitment was reduced to $45.0
million. ADIs commitment to fund the Company was subject to a guaranty for the benefit of BMG.
If ADI fails to meet its commitment, BMG has the right to choose to enforce the guaranty or provide
substitute financing that could result in dilution of ADIs interest in the Company. In December
2002, BMG exercised its option to extend the term of the distribution and license agreement until
September 2004. In August 2002, ADIs Board of Directors approved an agreement (the Accelerated Funding
Agreement) to accelerate up to $10.0 million of its funding commitment to the Company. This
funding was in addition to the $15 million that ADI was obligated to advance to the Company in 2002
as part of the initial $50.0 million funding commitment. During 2002, ADI funded its $15.0 million
commitment plus the additional $10.0 million bridge loan for total advances to the record label of
$25.0 million in 2002 and $30.25 million from the inception of the record label through December
31, 2002. The $10.0 million of accelerated funding was credited toward the satisfaction of ADIs
overall funding commitment and funding obligation for 2003, resulting in a remaining funding
commitment of $2.75 million for 2003 and $12.0 million for 2004. ADI advanced the $2.75 million
during 2003. As consideration for entering into the Accelerated Funding Agreement, ADI received an
additional 20% interest in the Company from Radar Records, the entity through which Mr. Field owns
his interest in the Company, which resulted in an increase in ADIs ownership share of the Company
from 45% to 65% and a decrease in Mr. Fields ownership share from 50% to 30%. BMGs ownership
percentage remained at 5%. The Accelerated Funding Agreement also provided that any dilution from
the issuance of equity interests in the Company that would have been borne solely by ADI would be
borne both by Radar Records and ADI pro rata with their then respective ownership interests.
Furthermore, the Accelerated Funding Agreement provided for Radar Records to guarantee a 25%
minimum annual compounded return to be realized from ADIs advances and equity interests in the
Company. The loan advances provided to the Company by ADI bear interest at a rate of LIBOR plus 4% and
the principal and interest are not repayable until December 31, 2015 or upon such time as the
Company achieves certain defined levels of excess cash flow and available cash. As of December 31,
2002 and 2003, the Company had loans payable to ADI of $30.25 million and $33.0 million,
respectively. In addition, as of December 31, 2002 and 2003, the Company had accrued interest
payable to ADI of $1.1 million and $3.0 million, respectively. 99




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STATUS
OF REPORT OF PREDECESSOR ACCOUNTING FIRM The Companys financial statements for the year ended December 31, 2002 were audited by the
Companys previous independent registered public accounting firm. Such accounting firms report
dated February 14, 2003 was included in ADIs previous Annual Reports on Form 10-K. However, the
Companys financial statements for the year ended December 31, 2002 are presented herein without an
accompanying report from the accounting firm, as such firm is currently reauditing the financial
statements of ADI with respect to the effect on ADIs 2002 consolidated financial statements from
the operations discontinued in 2004. When the Company receives such reissued report from its
previous accounting firm, it will file it as an amendment to ADIs 2004 Annual Report on Form 10-K. GOING CONCERN The Company has incurred losses and negative cash flows from operations since inception in
2001 and has an accumulated deficit of $53.4 million as of December 31, 2003. For the year ended
December 31, 2003, the Company incurred a net loss of $12.7 million and had negative working
capital of $10.9 million at December 31, 2003. The Company has relied on loan and distribution
advances to fund its operations to date. During 2003, the Company received loan advances of $2.75
million from ADI and has received a total of $37.75 million of loan advances through December 31,
2003. The Company also received bridge loans of $2.048 million in 2003, including $898,000 from
Ted Field. As of December 31, 2003, the Company did not have sufficient working capital resources
to conduct operations. Management expects the Company to continue to incur operating losses for
the foreseeable future. During the three months ended September 30, 2003, the Company significantly reduced its
overhead costs and operating activities and laid off the majority of its staff while it continued
to restructure its operations and seek additional capital. During 2003, the Company relied on a
loan advance of $2.75 million from ADI and loans from Ted Field of $898,000 and outside investors
of $1,150,000 to fund operations. The total loans of $2.048 million during 2003 were obtained
through the issuance of convertible promissory notes (see Note 10). ADI does not have the resources to meet its remaining $12.0 million funding commitment to the
Company for 2004. The Company requires additional capital in order to continue operations, and is
therefore continuing to pursue alternatives to raise additional capital. However, there can be no
assurances that additional capital can be obtained on reasonable terms or at all. Failure to raise
additional capital could seriously harm the Companys business. In such event, the Company may
seek to divest all or certain of its assets in order to raise the capital necessary to sustain
business operations. Should this fail, the Company may consider a formal or informal restructuring
or reorganization. The conditions described above raise substantial doubt about the Companys ability to continue
as a going concern. The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.  2.
    SIGNIFICANT ACCOUNTING POLICIES REVENUE RECOGNITION Revenue consists primarily of the sale of compact discs by artists signed under contract with
the Company. The Company recognizes revenues upon the shipment of compact discs from its
distributor to retailers and independent wholesalers and records appropriate reserves for product
returns. At the time of the shipment of the product, the following criterion under Statement of
Financial Accounting Standards No. 48, Revenue Recognition When Right of Return Exists, have been
met: the sellers price to the buyer is substantially fixed or determinable at the date of sale;
the buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation is
not contingent on resale of the product; the buyers obligation to the seller would not be changed
in the event of theft or physical destruction or damage of the product; the buyer acquiring the
product for resale has economic substance apart from that provided by the seller; the seller does
not have significant obligations for future performance to directly bring about resale of the
product by the buyer; and the amount of future returns can be reasonably estimated. The Company estimates the provision for returns on a quarterly basis by album based on the
amount of time since the initial album release, the actual returns to date, the trend of sales
activity (sales by the retailers and wholesalers) and the number of unsold units at retailers and
wholesalers. Returns to the Companys distributor are deemed to be returns to the Company.
Revenues recorded for the years ended December 31, 2002 and 2003 are net of a provision for actual
and estimated future returns of $1.7 million and $888,000, respectively. COST OF REVENUE Manufacturing expenses consist of the cost of pressing compact discs, manufacturing printed
booklets and packaging materials, and a provision for the obsolescence of finished goods and
components. Distribution expenses consist of the distribution fee payable to BMG and other
distribution expenses, including the cost of processing returns and warehousing inventory. Artist
advances and royalty expenses consist of payments made to artists and others in connection with the
recording of an album. 100




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ARTIST ADVANCES Artist advances consists of the amounts advanced to artists in connection with the recording
of their albums. In addition, included in artist advances are costs expended for producer fees,
musician fees, engineering and studio costs, equipment costs, mastering and remix costs, sample
clearances and artist living expenses during recording. Artist advances are typically recoupable
from artist royalties earned from the sale of compact discs. The Company expenses these advances
when incurred as the Companys artists have limited or no history of album sales. INVENTORY Inventory, net of a provision for obsolescence, consists of finished albums maintained in the
warehouse of the Companys distributor and is stated at the lower of cost or net realizable value.
Cost is determined using the first-in, first-out method. Inventory has been fully reserved at
December 31, 2003. DEPRECIATION Depreciation is provided using the straight-line method over the following estimated useful
lives: Category
    
    Estimated Useful LifeComputer equipment and software
    
    3 yearsFurniture and fixtures
    
    7 yearsStudio equipment
    
    7 years
 INCOME TAXES The Company is treated as a limited liability company for federal and state income tax
reporting purposes whereby its income (loss) is reported in the individual income tax returns of
the Companys members. STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation in accordance with the provisions
of Accounting Principles Board (APB) Opinion No. 25 and FASB Interpretation No. 44 (FIN 44),
Accounting for Certain Transactions Involving Stock Compensation, and complies with the
disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation. Under APB No.
25, compensation expense is recorded based on the difference, if any, between the fair value of the
Companys stock and the exercise price on the measurement date. The Company accounts for stock
issued to non-employees in accordance with SFAS No. 123, which requires entities to recognize as
expense over the service period the fair value of all stock-based awards on the date of grant and
EITF 96-18, Accounting for Equity Investments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services, which addresses the measurement date
and recognition approach for such transactions. The Company recognizes compensation expense
related to variable awards in accordance with FIN 28. For fixed awards, the Company recognizes
expense over the vesting period or the period of service The Company did not record any stock-based compensation expense for the years ended December
31, 2002 and 2003. IMPAIRMENT OF LONG-LIVED ASSETS Impairment of long-lived assets is monitored on a continuing basis, and is assessed based on
the undiscounted cash flows generated by the underlying assets. In the event that the carrying
amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of
such assets is adjusted to their fair value. See Note 5 for write-downs in 2003 with respect to the Companys property and equipment. CONCENTRATION OF CREDIT RISK AND SUPPLIER RISK Financial instruments that potentially subject the Company to significant concentrations of
credit risk consist principally of trade accounts receivable. The Companys exposure to losses on
receivables is dependent upon the financial condition of its distributor, BMG, which is responsible
for credit losses from retail and wholesale customers. 101




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The Company purchases its inventory from a limited number of suppliers. However, there are a
number of alternative suppliers who can provide such services for the Company. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of financial instruments, which includes cash and cash equivalents,
accounts receivable, accounts payable and accrued expenses, approximate fair value because of the
short maturity of these instruments. The carrying amount of the bridge notes payable approximates fair value as the related
effective interest rate (including the discount) approximates rates currently available to the
Company. COMPREHENSIVE INCOME (LOSS) The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income (SFAS No. 130). SFAS No. 130 establishes standards for the
reporting and display of comprehensive income, its components and accumulated balances in a full
set of general purpose financial statements. SFAS No. 130 defines comprehensive income (loss) to
include all changes in equity except those resulting from investments by owners and distributions
to owners, including adjustments to minimum pension liabilities, accumulated foreign currency
translation, and unrealized gains or losses on marketable securities. The Company did not have any
items of comprehensive income (loss) during 2002 or 2003 except the net loss. ESTIMATES In preparing financial statements in conformity with generally accepted accounting principles,
management is required to make estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the date of the
financial statements and revenues and expenses during the reporting period. Some of the more
significant estimates are the allowance for sales returns and inventory obsolescence. Actual
results could differ from those estimates.  3.
    RECENT ACCOUNTING PRONOUNCEMENTS In August 2001, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (SFAS No.
143). SFAS No. 143 addresses the diverse accounting practices for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement costs. The Company
adopted SFAS No. 143 effective January 1, 2003. The adoption of SFAS No. 143 did not have a
material impact on the Companys financial statement presentation or disclosures. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, it retains many of
the fundamental provisions of that statement. The Company adopted SFAS No. 144 effective January
1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Companys financial
statement presentation or disclosures. In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS 4,
which required all gains and losses from extinguishment of debt to be aggregated and, if material,
classified as an extraordinary item, net of related income tax effect. Upon adoption of SFAS No.
145, the Company will be required to apply the criteria in APB Opinion No. 30, Reporting the
Results of Operations  Reporting the Effects of a Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions (Opinion No. 30), in
determining the classification of gains and losses resulting from the extinguishment of debt.
Additionally, SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions to be accounted for in the same manner as
sale-leaseback transactions. The Company adopted SFAS No. 145 effective January 1, 2003. The
adoption of SFAS No. 145 for long-lived assets held for use did not have a material impact on the
Companys financial statement presentation or disclosures. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit and
Disposal Activities. SFAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). Under EITF Issue No. 94-3, a
liability for 102




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an exit cost is recognized at the date of an entitys commitment to an exit plan. Under SFAS
No. 146, the liabilities associated with an exit or disposal activity will be measured at fair
value and recognized when the liability is incurred and meets the definition of a liability in the
FASBs conceptual framework. SFAS No. 146 is effective for exit or disposal activities initiated
after December 31, 2002. The adoption of SFAS 146 did not have a material impact on the Companys
financial statement presentation or disclosures. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS No. 123. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure
requirements of SFAS No. 123 and APB Opinion No. 28, Interim Financial Reporting, to require
prominent disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method used on reported
results. The Company implemented SFAS No. 148 effective December 31, 2002. The Company has
determined that it will continue to account for stock-based employee compensation in accordance
with APB No. 25. In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities. SFAS No. 149 amends and clarifies under what circumstances a
contract with initial investments meets the characteristics of a derivative and when a derivative
contains a financing component. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on the Companys
financial statement presentation or disclosures. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an
issuer classifies and measures in its statement of financial position certain financial instruments
with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify
a financial instrument that is within its scope as a liability (or an asset in some circumstances)
because that financial instrument embodies an obligation of the issuer. SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at
the beginning of the first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting principle for financial
instruments created before the issuance date of SFAS No. 150 and still existing at the beginning of
the interim period of adoption. Restatement is not permitted. The adoption of SFAS No. 150 did
not have a material impact on the Companys financial statement presentation or disclosures. In November 2002, the FASB issued Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others
(FIN 45), an interpretation of FASB Statements Nos. 5, 57 and 107 and a rescission of FASB
Interpretation No. 34. FIN 45 elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees issued. FIN 45 also
clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for
the fair value of the obligation undertaken. The initial recognition and measurement provisions of
FIN 45 are applicable to guarantees issued or modified after December 31, 2002. The disclosure
requirements of FIN 45 are effective for financial statements of interim and annual periods ended
after December 15, 2002. The adoption of FIN 45 did not have a material impact on the Companys
financial statement presentation or disclosures. In November 2002, the Emerging Issues Task Force (EITF) of the FASB issued EITF No. 00-21
Revenue Arrangements with Multiple Deliverables. EITF No. 00-21 addresses certain aspects of the
accounting by a vendor for arrangements under which it will perform multiple revenue-generating
activities. Specifically, EITF No. 00-21 addresses how to determine whether an arrangement
involving multiple deliverables contains more than one unit of accounting. In applying EITF No.
00-21, separate contracts with the same entity or related parties that are entered into at or near
the same time are presumed to have been negotiated as a package and should, therefore, be evaluated
as a single arrangement in considering whether there are one or more units of accounting. That
presumption may be overcome if there is sufficient evidence to the contrary. EITF No. 00-21 also
addresses how arrangement consideration should be measured and allocated to the separate units of
accounting in the arrangement. The guidance in EITF No. 00-21 is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The Company adopted
EITF No. 00-21 effective July 1, 2003. The adoption of EITF No. 00-21 did not have a material
impact on the Companys financial statement presentation or disclosures. In February 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46), which addresses the consolidation by business enterprises of variable
interest entities, which have one or both of the following characteristics: (1) the equity
investment at risk is not sufficient to permit the entity to finance its activities without
additional financial support from other parties, or (2) the equity investors lack one or more of
the following essential characteristics of a controlling financial interest: (a) the direct or
indirect ability to make decisions about the entitys activities through voting or similar rights,
(b) the obligation to absorb the expected losses of the entity if they occur, or (c) the right to
receive the expected residual 103




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returns of the entity if they occur. In addition, FIN 46 contains detailed disclosure
requirements. FIN 46 applies immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an interest after that date.
FIN 46 applies in the first fiscal year or interim period ending after March 15, 2004, to variable
interest entities in which an enterprise holds a variable interest that it acquired before February
1, 2003. The Company adopted FIN 46 as of December 31, 2003. The adoption of FIN 46 did not have
a material impact on the Companys financial statement presentation or disclosures. However, as a
result of the adoption of FIN 46 by ADI as of December 31, 2003, the Companys balance sheet was
consolidated with ADIs balance sheet at December 31, 2003, and the Companys operations will be
consolidated with ADIs operations beginning January 1, 2004. ADI previously accounted for its
investment in the Company under the equity method of accounting.  4.
    ARTIST ADVANCES As of December 31, 2003, the Company had signed recording agreements with six artists and had
advanced a total of $1.238 million through such date with respect to these artists. The amount of
these advances is recoupable against royalties to be earned by the artists based on sales.
However, given that most of the artists signed by the record label have no previous track record,
the advances have been expensed by the Company as incurred. As of December 31, 2003, the Company
is contractually committed to additional minimum artist advances of approximately $1.5 million, all
of which is payable in 2004.  5.
    PROPERTY AND EQUIPMENT Property and equipment are recorded at cost and consist of the following: December 31,2002
    
    
    2003(in thousands)Computer equipment and software
    
    $
    71
    
    
    $
    58Furniture and fixtures
    
    
    29
    
    
    
    30Studio equipment
    
    
    169
    
    
    
    10269
    
    
    
    98Less accumulated depreciation
    
    
    (38
    )
    
    
    (58
    )Property and equipment, net
    
    $
    231
    
    
    $
    40
 Impairment of fixed assets is monitored on a continuing basis, and is assessed based on the
undiscounted cash flows generated by the underlying assets. In the event the carrying amount of
fixed assets exceeds the undiscounted future cash flows, then the carrying amount of such assets is
adjusted to their fair value. There was no impairment of long-lived assets as of December 31,
2002. During the three months ended June 30, 2003, the Company determined that its fixed assets
were impaired due to continuing losses, going concern issues, and the likelihood that the majority
of these assets would likely be abandoned in the near future. The Company determined that these
factors were indicators of impairment and thus reduced the carrying amount of the fixed assets to
their estimated fair value by recording a write-off of $100,000 during the three months ended June
30, 2003. Most of the Companys property and equipment was subsequently sold to third party
liquidators for cash. This amount has been reported as a loss from sale and abandonment of
property and equipment in the statement of operations for the year ended December 31, 2003.  6.
    RESERVE FOR SALES RETURNS A summary of the activity with respect to the reserve for sales returns is as follows: Years Ended December 31,2002
    
    
    2003(in thousands)Balance at beginning of year
    
    $
    
    
    
    $
    800Provision for sales returns
    
    
    1,689
    
    
    
    888Actual returns
    
    
    (889
    )
    
    
    (1,528
    )Balance at end of year
    
    $
    800
    
    
    $
    160
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7.
    ACCRUED EXPENSES Accrued expenses are comprised of the following: December 31,2002
    
    
    2003(in thousands)Accrued compensation and related
    
    $
    1,082
    
    
    $
    881Accrued sales and marketing
    
    
    530
    
    
    
    Accrued royalties
    
    
    245
    
    
    
    250Other accrued expenses
    
    
    265
    
    
    
    81Total accrued expenses
    
    $
    2,122
    
    
    $
    1,212
  8.
    SIGNIFICANT CONTRACTS In November 2001, the Company agreed in principle to enter into a preliminary North American
distribution agreement and worldwide license agreement with BMG Music (BMG), the global music
division of Bertelsmann AG. Under the terms of the agreement, BMG distributes the Companys
releases in North America, and BMG licenses the Companys repertoire in territories throughout the
world. In April 2002, the agreements with BMG were finalized, including BMGs purchase of 5% of
the equity of the Company from ADI. As part of this transaction, BMG agreed to advance certain
monies against net sales proceeds under the agreements and also assumed $5.0 million of ADIs
funding commitment to the Company, which was advanced during 2002. As a result of the BMG equity
purchase, ADIs funding commitment was reduced to $45.0 million. In December 2002, BMG exercised
its option to extend the term of the distribution and license agreement until September 2004. Under the distribution and license agreements, BMG made non-returnable advances to the Company
of $2.5 million in 2001, $2.5 million in 2002 and $5.0 million in 2003 that are recoupable from net
sales proceeds from the Companys artist repertoire pursuant to a defined calculation on a monthly
basis. As of December 31, 2002 and 2003, the unrecouped balances related to distribution advances
from BMG were $4.1 million and $8.7 million, respectively. The loan advances provided to the Company by BMG bear interest at a rate of LIBOR plus 4% and
the principal and interest are not repayable until December 31, 2015 or upon such time as the
Company achieves certain defined levels of excess cash flow and available cash. As of December 31,
2002 and 2003, the Company had loans payable to BMG of $4.75 million. In addition, as of December
31, 2002 and 2003, the Company had accrued interest payable to BMG of $189,000 and $447,000,
respectively.  9.
    RELATED PARTY TRANSACTIONS Allen Lenard, a former director of ADI who resigned from its board of directors in September
2002, is managing partner of Lenard, Brisbin & Klotz LLP. During the year ended December 31, 2003,
the Company paid $155,000 of legal fees to Lenard, Brisbin & Klotz LLP. ADI charged the Company $1.35 million and $563,000 in 2002 and 2003, respectively, for the
reimbursement of overhead costs, including rent and other occupancy costs, telephone and internet
services, and the services of certain ADI personnel primarily in the areas of accounting, legal,
information technology, human resources and administration. These amounts were included in general
and administrative expense. During the three months ended September 30, 2003, the Company significantly reduced its
overhead costs and operating activities and laid off the majority of its staff while it continued
to restructure its operations and seek additional capital. The Company also relocated its
administrative offices to offices leased by a company owned by Ted Field. The Company sub-leases
these offices on a month-to-month basis. Rent expense for the period September through December
2003 was not material. The Company entered into an employment agreement with Ted Field to serve as Chief Executive
Officer, which had an initial term extending through May 31, 2006, and which provided for an annual
base salary of $1,000,000 plus certain benefits. The employment agreement also provided that under
certain conditions, Mr. Field would receive a lump-sum payment equal to his annual base salary 105




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for (i) 50% of the remaining term of the employment agreement if termination occurs within the
first three years of his employment, (ii) his annual base salary for one year if termination occurs
in the fourth year of his employment, and (iii) his annual base salary for the full remaining term
of the employment agreement if termination occurs in the fifth year of his employment. During 2002, Mr. Fields employment agreement was amended whereby Mr. Field agreed to defer
his future salary until the Company raised new debt or equity financing of at least $20 million.
During the three months ended June 30, 2003, Mr. Fields employment agreement was further amended
whereby all deferred and any future salary, except a base amount, would be waived, even if new debt
or equity financing is raised. Accordingly, during the year ended December 31, 2003, $822,000 of
accrued compensation due to Mr. Field by the Company was credited to capital in the statement of
members deficit. See Notes 1, 10 and 14 for additional related party transactions.  10.
    BRIDGE NOTES PAYABLE As of December 31, 2003, the Company had received $898,000 of loans from Ted Field and
$1,150,000 of loans from outside investors (including $100,000 from Jonathan V. Diamond, ADIs
President and Chief Executive Officer). The total loans of $2.048 million during 2003 were
obtained through the issuance of convertible promissory notes (the Bridge Notes). The Bridge
Notes accrue interest at 8% per annum, are due two years from the date of issuance, and are
convertible into new preferred equity of the Company as part of its next equity financing. The
loans from Mr. Field and from outside investors of $898,000 and $1,150,000, respectively, have been
presented as Bridge Notes payable in the balance sheet at December 31, 2003. The holders of the Bridge Notes also received warrants with a term of five years to purchase
additional equity of the Company at $0.01 per unit equivalent to the number of units of new equity
into which their Bridge Notes are ultimately converted. The relative fair value of the warrants
issued was $1.024 million (one-half of the amount funded by the investors in the Bridge Notes),
which was recorded as a reduction to the carrying amount of the Bridge Notes and a credit to
capital, and is being charged to operations as interest expense over the specified term of the
Bridge Notes. The Bridge Notes are convertible into equity based on their face amount, which results in a
beneficial conversion feature with a relative fair value of $1.024 million. Since the commitment
date for the beneficial conversion feature is contingent upon the completion of the Companys next
equity financing, the fair value of the beneficial conversion feature will be charged to operations
over the remaining life of the Bridge Notes at that time. During the year ended December 31, 2003, the Company recognized $203,000 as interest expense
with respect to the amortization of the fair value of the warrants. Additional interest expense of
$821,000 will be recognized ratably in 2004 and 2005 over the remaining term of the Bridge Notes.
As of December 31, 2003, the carrying amount of the Bridge Notes, including accrued interest of
$67,000, was $1.294 million. A reconciliation of Bridge Notes payable issued by the Company during 2003 to amounts
presented in the balance sheet at December 31, 2003 is presented below. OutsideInvestors
    
    
    Ted Field(in thousands)Gross amount funded during 2003
    
    $
    1,150
    
    
    $
    898Deduct:Fair value of warrants
    
    
    (575
    )
    
    
    (449
    )Add:Accrued interest
    
    
    44
    
    
    
    23Amortization of fair value of warrants in 2003
    
    
    136
    
    
    
    67Net liability at December 31, 2003
    
    $
    755
    
    
    $
    539
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11.
    401(K) PLAN   In 2001, the Company adopted ADIs Cash or Deferred Profit Sharing Plan and Trust under
Section 401(k) of the Internal Revenue Code (the 401(k) Plan). Under the 401(k) Plan,
participating employees may defer a percentage (not to exceed 15%) of their eligible pretax
earnings up to the Internal Revenue Services annual contribution limit. All employees of the
Company who are 21 years or older and who complete three months of service are eligible to
participate in the 401(k) Plan. The Company does not match contributions by participants to the
401(k) Plan. Accordingly, there is no related expense for the years ended December 31, 2002 and
2003.  12.
    LITIGATION The Company is periodically subject to various pending and threatened legal actions, which
arise in the normal course of business. The Companys management believes that the impact of such
litigation will not have a material adverse impact on its financial position or results of
operations.  13.
    SUPPLEMENTAL DISCLOSURES TO STATEMENTS OF CASH FLOWS Significant non-cash investing and financing activities are as follows: Years Ended December 31,2002
    
    
    2003(in thousands)Compensation forgiven by Chief Executive Officer
    
    $
    
    
    
    $
    822Discount related to issuance of bridge note warrants
    
    
    
    
    
    
    1,024
  14.
    SUBSEQUENT EVENTS Upon its expiration in September 2004, BMG did not renew its distribution agreement and
license agreement with the Company. (see Note 8). During the year ended December 31, 2004, Mr. Field advanced an additional $2.778 million to
the Company to fund operating expenses and the settlement of artist contracts. In consideration
for such advances, Mr. Field received Bridge Notes and warrants as described at Note 10. During January and February 2005, Mr. Field advanced an additional $36,500 to the Company to
fund operating expenses and the settlement of artist contracts. In consideration for such
advances, Mr. Field received Bridge Notes and warrants as described at Note 10. Effective July 30, 2004, the Company entered into an agreement with BMG and ADI which
extinguished all of ADIs obligations under its funding guaranty, including the remaining $12.0
million funding obligation to the Company (see Note 1). On February 28, 2005, ADI completed the sale of 100% of the common stock of ARTISTdirect
Recordings to Radar Records for a cash payment of $115,000, as a result of which ADI no longer had
any equity or other economic interest in the Company, and Radar Records became the owner of a
majority of the membership interests of the Company and also acquired the receivable reflecting the
$33.0 million of loan advances previously provided to the Company by ADI (see Note 1). 107




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INDEX TO EXHIBITS EXHIBITNUMBER
    
    DESCRIPTION3.1
    
    Amended and Restated Certificate of Incorporation of the Registrant. Incorporated by
reference to Exhibit 3.1 in the Registrants Registration Statement on Form S-1
initially filed on September 22, 1999 (Registration No. 333-87547), as amended by
Amendment No.s 1  7 thereto.3.2
    
    Amended and Restated Bylaws of the Registrant. Incorporated by reference to Exhibit 3.2
in the Registrants Registration Statement on Form S-1 initially filed on September 22,
1999 (Registration No. 333-87547), as amended by Amendment No.s 1  7 thereto.3.3
    
    Certificate of Amendment of the Third Amended and Restated Certificate of Incorporation.
Incorporated by reference to Exhibit 3.3 in the Registrants Quarterly Report on Form
10-Q filed on August 14, 2001.3.4
    
    Certificate of Amendment, dated June 3, 2002, of the Third Amended and Restated
Certificate of Incorporation. Incorporated by reference to Exhibit 3.4 in the
Registrants Quarterly Report on Form 10-Q filed on August 14, 2002.4.1
    
    See Exhibits 3.1 and 3.2 for provisions of the Registrants Certificate of Incorporation
and Bylaws determining the rights of holders of the Registrants common stock.4.2
    
    Specimen common stock certificate. Incorporated by reference to Exhibit 4.2 in the
Registrants Registration Statement on Form S-1 initially filed on September 22, 1999
(Registration No 333-87547), as amended by Amendment No.s 1  7 thereto.4.3
    
    Registration Rights Letter Agreement dated May 31, 2001 between the Registrant and
Frederick W. Field. Incorporated by reference to Exhibit 3 filed in connection with the
Registrants Definitive Proxy Statement on June 11, 2001.10.1
    
    Amendment No. 1 dated February 27, 2002 to the Agreement dated July 19, 2000 between the
Registrant and Ticketmaster. Incorporated by reference to Exhibit 10.35 in the
Registrants Quarterly Report on Form 10-Q filed on May 15, 2002.10.2
    
    Escrow Agreement dated March 13, 2002 among the Registrant, Ticketmaster and JPMorgan
Chase Bank. Incorporated by reference to Exhibit 10.36 in the Registrants Quarterly
Report on Form 10-Q filed on May 15, 2002.10.3
    
    Agreement dated October 22, 2001 between the Registrant and Old Glory Boutique
Distributing, Inc. Incorporated by reference to Exhibit 10.37 in the Registrants
Quarterly Report on Form 10-Q filed on August 14, 2002.10.4
    
    Letter Agreement, dated as of December 9, 2002, by and between ARTISTdirect, Inc. and
Frederick Field to amend the Employment Agreement dated May 31, 2001 between
ARTISTdirect, Inc. and Mr. Field. Incorporated by reference to Exhibit 10.38 in the
Registrants Current Report on Form 8-K filed on December 13, 2002.10.5
    
    Letter Agreement, dated as of December 9, 2002, by and between ARTISTdirect Records,
L.L.C. and Frederick Field to amend the Employment Agreement dated May 31, 2001 between
ARTISTdirect Records, L.L.C. and Mr. Field. Incorporated by reference to Exhibit 10.39
in the Registrants Current Report on Form 8-K filed on December 13, 2002.10.6
    
    Letter Agreement, dated as of December 23, 2002, by and between ARTISTdirect, Inc. and
Keith Yokomoto to amend the Employment Agreement dated July 1, 2001 between
ARTISTdirect, Inc. and Mr. Yokomoto. Incorporated by reference to Amendment No. 1 to
Exhibit 10.40 in the Registrants Quarterly Report on Form 10-Q/A filed on December 23,
2002.10.7
    
    Letter Agreement, dated as of December 23, 2002, by and between ARTISTdirect, Inc. and
Marc Geiger to amend the Employment Agreement dated July 28, 1998, as amended on July 1,
2001, between ARTISTdirect, Inc. and Mr. Geiger. Incorporated by reference to Exhibit
10.41 in the Registrants Current Report on Form 8-K filed on December 23, 2002.
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EXHIBITNUMBER
    
    DESCRIPTION10.8
    
    Letter Agreement dated December 11, 2002 between the Registrant and Benn Co., LLC
consenting to the assignment by Old Glory Boutique Distributing, Inc. to Benn Co., LLC
of the Agreement dated October 22, 2001 between the Registrant and Old Glory Boutique
Distributing, Inc. Incorporated by reference to Exhibit 10.8 to Registrants Annual
Report on Form 10-K filed on March 31, 2003.10.9
    
    Agreement for Services dated as of June 13, 2002 between the Registrant and Frankel &
Company. Incorporated by reference to Exhibit 10.9 to Registrants Annual Report on Form
10-K filed on March 31, 2003.10.10
    
    Letter Agreement, dated as of May 1, 2003, by and between ARTISTdirect, Inc. and
Frederick Field to amend the Employment Agreement dated May 31, 2001 between
ARTISTdirect, Inc. and Mr. Field. Incorporated by reference to Exhibit 10.1 in the
Registrants Quarterly Report on Form 10-Q filed on August 14, 2003.10.11
    
    Letter Agreement, dated as of May 1, 2003, by and between ARTISTdirect Records, L.L.C.
and Frederick Field to amend the Employment Agreement dated May 31, 2001 between
ARTISTdirect Records, L.L.C. and Mr. Field. Incorporated by reference to Exhibit 10.2 in
the Registrants Quarterly Report on Form 10-Q filed on August 14, 2003.10.12
    
    Employment Agreement dated as of September 29, 2003 by and between the Registrant and
Jon Diamond. Incorporated by reference to Exhibit 10.3 in the Registrants Quarterly
Report on Form 10-Q filed on November 14, 2003.10.13
    
    Notice of Grant of Stock Option dated as of September 29, 2003 by and between the
Registrant and Jon Diamond. Incorporated by reference to Exhibit 10.4 in the
Registrants Quarterly Report on Form 10-Q filed on November 14, 2003.10.14
    
    Settlement, Release and Termination of Lease Agreement dated as of September 8, 2003, by
and between 5670 Wilshire L.P. and the Registrant. Incorporated by reference to Exhibit
10.5 in the Registrants Quarterly Report on Form 10-Q filed on November 14, 2003.10.15
    
    Termination Agreement and Mutual Release by Keith Yokomoto and the Registrant dated as
of December 31, 2003. Incorporated by reference to Exhibit 10.15 in the Registrants
Annual Report on Form 10-K filed on May 17, 2004.10.16
    
    Form of Director Indemnification Agreement. Incorporated by reference to Exhibit 10.29
in the Registrants Registration Statement on Form S-1 filed on September 22, 1999
(Registration No. 333-87547), as amended by Amendment No.s 1-7 thereto.10.17
    
    Form of Officer Indemnification Agreement. Incorporated by reference to Exhibit 10.30 in
the Registrants Registration Statement on Form S-1 filed on September 22, 1999
(Registration No. 333-87547), as amended by Amendment No.s 1-7 thereto.10.18
    
    Notice of Grant of Stock Option dated as of March 29, 2004 by and between the Registrant
and Robert N. Weingarten. Incorporated by reference to Exhibit 10.1 in the Registrants
Quarterly Report on Form 10-Q filed on August 20, 2004.10.19
    
    Termination Agreement made as of July 30, 2004 among the Registrant, ARTISTdirect
Records, LLC and BMG Music. Incorporated by reference to Exhibit 10.2 in the
Registrants Quarterly Report on Form 10-Q filed on August 20, 2004.10.20
    
    Trademark Assignment and Purchase Agreement between ARTISTdirect, Inc. and Apple
Computer, Inc. dated November 12, 2004. Incorporated by reference to Exhibit 10 in the
Registrants Current Report on Form 8-K filed on November 29, 2004.10.21
    
    Transfer Agreement between ARTISTdirect Recordings, Inc., ARTISTdirect, Inc. and Radar
Records Holdings, Inc. dated as of December 31, 2004. Incorporated by reference to
Exhibit 10.1 in the Registrants Current Report on Form 8-K filed on March 4, 2005.
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EXHIBITNUMBER
    
    DESCRIPTION14.1
    
    Code of Business Conduct and Ethics. Incorporated by reference to Exhibit 14.1 in the
Registrants Annual Report on Form 10-K filed on May 17, 2004.21.1
    
    Subsidiaries of the Registrant. Incorporated by reference to Exhibit 21.1 in the
Registrants Registration Statement on Form S-1 initially filed on November 22, 2000
(Registration No 333-50576), as amended by Amendment No.s 1  5 thereto.23.1
    
    Consent of Gumbiner Savett Inc., independent registered public accounting firm, with
respect to ARTISTdirect, Inc. and subsidiaries23.2
    
    Consent of Gumbiner Savett Inc., independent registered public accounting firm, with
respect to ARTISTdirect Records, LLC31.1
    
    Certifications of the Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act31.2
    
    Certifications of the Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act32.1
    
    Certifications of the Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act32.2
    
    Certifications of the Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act
 110