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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549



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FORM 10-Q



(Mark One)

|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



For the quarterly period ended June 30, 2003



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from
 to
.



Commission File Number 000-25977



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LIQUID AUDIO, INC.

(Exact name of registrant as specified in its charter)



|Delaware                                                       |  | 77-0421089                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|888 Seventh Ave. 17th Floor, New York, NY                      |  | 10019                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(212) 974-5730

(Registrants telephone number, including area code)



---



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) had been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



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



As of August 13, 2003, there were 23,176,858 shares of registrants Common Stock outstanding.



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##### Table of Contents

LIQUID AUDIO, INC.



INDEX



|PART I.
FINANCIAL INFORMATION |  | 1                                                                                                               
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------------
|                              |  |                                                                                                                 
|ITEM 1.                       |  | FINANCIAL STATEMENTS (unaudited)                                                                                
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002                                 
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2003 and 2002
|                              |  |                                                                                                                 
|                              |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002                 
|                              |  |                                                                                                                 
|                              |  | Notes to Condensed Consolidated Financial Statements                                                            
|                              |  |                                                                                                                 
|ITEM 2.                       |  | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                           
|                              |  |                                                                                                                 
|ITEM 3.                       |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                      
|                              |  |                                                                                                                 
|ITEM 4.                       |  | CONTROLS AND PROCEDURES                                                                                         
|                              | 
|PART II.
OTHER INFORMATION    |  | 22                                                                                                              
|                              |  |                                                                                                                 
|ITEM 1.                       |  | LEGAL PROCEEDINGS                                                                                               
|                              |  |                                                                                                                 
|ITEM 2.                       |  | CHANGES IN SECURITIES AND USE OF PROCEEDS                                                                       
|                              |  |                                                                                                                 
|ITEM 4.                       |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                             
|                              |  |                                                                                                                 
|ITEM 5.                       |  | OTHER INFORMATION                                                                                               
|                              |  |                                                                                                                 
|ITEM 6.                       |  | EXHIBITS AND REPORTS ON FORM 8-K                                                                                
|                              | 
|SIGNATURES                    |  | 26                                                                                                              



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM 1. |  | FINANCIAL STATEMENTS
|------- |  | --------------------



LIQUID AUDIO, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands; unaudited)



|                                                                                    |  | June 30,2003 |          |   | December 31, 2002 |  
|----------------------------------------------------------------------------------- |  | ------------ | -------- | - | ----------------- | -
|Assets                                                                              |  |              |          |   |                   |  
|Current assets:                                                                     |  |              |          |   |                   |  
|Cash and cash equivalents                                                           |  | $            | 12,608   |   |                   | $
|Accounts receivable, less allowance for doubtful accounts of $146 for 2003 and 2002 |  |              | 11       |   |                   |  
|Restricted cash                                                                     |  |              | 826      |   |                   |  
|Other current assets                                                                |  |              | 423      |   |                   |  
|                                                                                    |  |              |          |   |                   |  
|Total current assets                                                                |  |              | 13,868   |   |                   |  
|Restricted cash                                                                     |  |              | 0        |   |                   |  
|Property and equipment, net                                                         |  |              | 0        |   |                   |  
|Other assets                                                                        |  |              | 8        |   |                   |  
|                                                                                    |  |              |          |   |                   |  
|Total assets                                                                        |  | $            | 13,876   |   |                   | $
|                                                                                    |  |              |          |   |                   |  
|Liabilities and stockholders equity                                                |  |              |          |   |                   |  
|Current liabilities:                                                                |  |              |          |   |                   |  
|Accounts payable                                                                    |  | $            | 536      |   |                   | $
|Accrued liabilities                                                                 |  |              | 3,791    |   |                   |  
|Distribution payable to stockholders                                                |  |              |         |   |                   |  
|Deferred revenue                                                                    |  |              |         |   |                   |  
|                                                                                    |  |              |          |   |                   |  
|Total current liabilities                                                           |  |              | 4,327    |   |                   |  
|                                                                                    |  |              |          |   |                   |  
|Stockholders equity:                                                               |  |              |          |   |                   |  
|Common stock                                                                        |  |              | 23       |   |                   |  
|Additional paid-in capital                                                          |  |              | 146,053  |   |                   |  
|Accumulated other comprehensive loss                                                |  |              | (75      | ) |                   |  
|Accumulated deficit                                                                 |  |              | (136,452 | ) |                   |  
|                                                                                    |  |              |          |   |                   |  
|Total stockholders equity                                                          |  |              | 9,549    |   |                   |  
|                                                                                    |  |              |          |   |                   |  
|Total liabilities and stockholders equity                                          |  | $            | 13,876   |   |                   | $
|                                                                                    |  |              |          |   |                   |  



See accompanying notes
to condensed consolidated financial statements



1



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##### Table of Contents

LIQUID AUDIO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts; unaudited)



|                                                   |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|-------------------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | -
|                                                   | 
|                                                   |  | 2003                        |        |   | 2002                      |  
|Net revenues:                                      |  |                             |        |   |                           |  
|License                                            |  | $                           |       |   |                           | $
|Services                                           |  |                             |       |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Total net revenues                                 |  |                             |       |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Cost of net revenues:                              |  |                             |        |   |                           |  
|License                                            |  |                             |       |   |                           |  
|Services                                           |  |                             |       |   |                           |  
|Non-cash cost of revenue                           |  |                             |       |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Total cost of net revenues                         |  |                             |       |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Gross profit (loss)                                |  |                             |       |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Operating expenses:                                |  |                             |        |   |                           |  
|Sales and marketing                                |  |                             | 5      |   |                           |  
|Non-cash sales and marketing                       |  |                             |       |   |                           |  
|Research and development                           |  |                             | 87     |   |                           |  
|Non-cash research and development                  |  |                             |       |   |                           |  
|General and administrative                         |  |                             | 1,248  |   |                           |  
|Restructuring                                      |  |                             | 3,569  |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Total operating expenses                           |  |                             | 4,909  |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Loss from operations                               |  |                             | (4,909 | ) |                           |  
|Other income (expense), net                        |  |                             | 15     |   |                           |  
|Gain on sale of digital music fulfillment business |  |                             |       |   |                           |  
|                                                   |  |                             |        |   |                           |  
|Net loss                                           |  | $                           | (4,894 | ) |                           | $
|                                                   |  |                             |        |   |                           |  
|Net loss per share:                                |  |                             |        |   |                           |  
|Basic and diluted                                  |  | $                           | (0.21  | ) |                           | $
|                                                   |  |                             |        |   |                           |  
|Weighted average shares                            |  |                             | 23,166 |   |                           |  
|                                                   |  |                             |        |   |                           |  



See accompanying notes
to condensed consolidated financial statements



2



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LIQUID AUDIO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands; unaudited)



|                                                                            |  | Six Months Ended June 30, |        
|--------------------------------------------------------------------------- |  | ------------------------- | -------
|                                                                            |  | 2003                      |        
|Cash flows from operating activities:                                       |  |                           |        
|Net loss                                                                    |  | $                         | (6,082 
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                           |        
|Depreciation and amortization                                               |  |                           | 222    
|Amortization of unearned compensation                                       |  |                           |       
|Gain on sale of digital music fulfillment business and related assets       |  |                           | (2,868 
|Non-cash cost of revenue                                                    |  |                           |       
|Changes in assets and liabilities:                                          |  |                           |        
|Accounts receivable                                                         |  |                           | 49     
|Other assets                                                                |  |                           | 929    
|Accounts payable                                                            |  |                           | (682   
|Accrued liabilities                                                         |  |                           | 1,643  
|Deferred revenue                                                            |  |                           | (39    
|                                                                            |  |                           |        
|Net cash used in operating activities                                       |  |                           | (6,828 
|                                                                            |  |                           |        
|                                                                            |  |                          
|Cash flows from investing activities:                                       |  |                           |        
|Acquisition of property and equipment                                       |  |                           |       
|Proceeds from sale of digital music fulfillment business and related assets |  |                           | 3,200  
|                                                                            |  |                           |        
|Net cash provided by (used in) investing activities                         |  |                           | 3,200  
|                                                                            |  |                           |        
|                                                                            |  |                          
|Cash flows from financing activities:                                       |  |                           |        
|Cash distribution to stockholders                                           |  |                           | (57,771
|Proceeds from issuance of common stock, net of repurchases                  |  |                           | 14     
|Payments made under capital leases                                          |  |                           |       
|Payments made under equipment loan                                          |  |                           |       
|                                                                            |  |                           |        
|Net cash used in financing activities                                       |  |                           | (57,757
|                                                                            |  |                           |        
|Effect of exchange rates on cash and cash equivalents                       |  |                           | 8      
|                                                                            |  |                           |        
|Net decrease in cash and cash equivalents                                   |  |                           | (61,377
|Cash and cash equivalents at beginning of period                            |  |                           | 73,985 
|                                                                            |  |                           |        
|Cash and cash equivalents at end of period                                  |  | $                         | 12,608 
|                                                                            |  |                           |        
|Non-cash investing and financing activities:                                |  |                           |        
|Issuance of warrants in connection with strategic marketing agreements      |  | $                         |       



See accompanying notes
to condensed consolidated financial statements



3



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##### Table of Contents

LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



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



The Company



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



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



On January 24,
2003, the Company sold its digital music fulfillment business and related assets to Geneva Media, LLC (Geneva), an affiliate of Anderson Merchandisers, LP for $3.2 million. As part of the sale, the Company also transferred ownership of
certain Liquid Audio related trademarks and the Microsoft License to Geneva. As a result of the sale, the Company is not currently operating any businesses and does not expect continuing revenue from sources the Company received revenue
from in the past; however, the Company is continuing as an operating entity and is currently exploring options for the use of its remaining assets.



The Companys common stock currently trades over the counter on the Nasdaq OTC Bulletin Board. Previously, the Companys common stock was traded
on the Nasdaq National Market. However, the market price per share dropped significantly subsequent to the payment of the $2.50 per share cash distribution to the Companys common stockholders. Thus, on June 5, 2003, the Company was notified by
Nasdaq that the Companys common stock was delisted because the closing price had been below $1 per share for 30 consecutive trading days and the Company does not conduct an operating business. At that time, the Companys common stock
began trading over the counter as a pink sheet security. On June 20, 2003, the Companys common stock began trading on the Nasdaq OTC Bulletin Board. The market price of the Companys common stock as of August 7, 2003 was $0.36
per share.



Basis of presentation



The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company and reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the interim periods presented. The results of operations for the three and six months ended June 30, 2003 are not
necessarily indicative of the results to be expected for any subsequent quarter or for the year ending December 31, 2003. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been condensed or omitted pursuant to the Securities and Exchange Commissions rules and regulations.



These unaudited condensed consolidated interim financial statements and notes included herein should be read in conjunction
with the Companys audited consolidated financial statements and notes as included in the Companys Annual Report on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission (the SEC)
on March 31, 2003.



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LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



Going concern consideration



The accompanying financial statements as of June 30, 2003 and for the three-month and six-month periods then ended have been
prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company has incurred losses and negative cash flows
from operations for every year since inception. For the six months ended June 30, 2003, the Company incurred a net loss of approximately $6.1 million and negative cash flows from operations of approximately $6.8 million. As of June 30, 2003, the
Company had accumulated losses of approximately $136.5 million. The Company has not yet settled on an operating plan, and can give no assurance that the Companys existing cash and cash equivalents are sufficient to fund the Companys
current operations and satisfy its obligations. The Company believes these obligations will primarily relate to costs associated with the operation as a public company (legal, accounting, insurance, etc.), as well as the satisfaction of any
potential legal judgments or settlements as well as the expenses associated with any new business activities, which may be undertaken by the Company. In addition, according to a settlement agreement with BeMusic, Inc. (BeMusic) (see Note
6), the Company agreed to maintain $2.0 million in available cash on hand to pay up to 50% of reasonable attorney fees and costs in connection with the defense of the patent action brought by SightSound, Inc. (SightSound) against
BeMusic, and $5.0 million in available cash on hand to apply towards the satisfaction of any adverse judgment in respect of which it is determined that the Company would be obligated to indemnify BeMusic. These factors, among others, indicate that
the Company may be unable to continue operations as a going concern. No adjustment has been made in the accompanying financial statements to the amounts and classifications of assets and liabilities which could result should the Company be unable to
continue as a going concern. The Company continues to consider future alternatives, including the possible acquisition of other businesses. However, the Company has not consummated any significant transactions to date and the Companys business
prospects remain uncertain. To the extent that management of the Company moves forward on any alternative strategy, such strategy may have an impact on the Companys liquidity.



Principles of consolidation



The financial statements include the accounts of the Company and its wholly-owned (inactive) subsidiary. Significant intercompany transactions and
balances have been eliminated. Investments in entities in which the Company can exercise significant influence, but are less than majority-owned and not otherwise controlled by the Company, are accounted for under the equity method.



Restricted cash



As of June 30, 2003, the Company had a restricted cash balance of $826,000 in the form of certificates of deposit, which
were restricted from withdrawal. The amount serves as collateral for a letter of credit issued by the Companys bank to the Companys lessor as a security deposit on a long-term lease. In July 2003, the letter of credit was returned to the
Company in accordance with a lease termination agreement reached with the Companys lessor.



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LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



Stock-based compensation



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, Transition and
Disclosure. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also requires that disclosures of the pro forma effect of using
the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS 148 requires disclosure of the pro forma effect in interim financial statements. The transition and
annual disclosure requirements of SFAS 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure requirements are effective for interim periods ending after December 15, 2002.



The Company accounts for stock issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) Issue No. 96-18 Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.



Consistent with the disclosure provisions of SFAS 123, the
Companys net loss and basic and diluted net loss per share would have been adjusted to the pro forma amounts indicated below (in thousands, except per share amounts):



|                                                                                                            |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|----------------------------------------------------------------------------------------------------------- |  | -------------------------- | ----- | ------------------------
|                                                                                                            |  | 2003                       |       | 2002                    
|Net lossas reported                                                                                        |  | $                          | 4,894 |                         
|Less stock-based compensation (income) expense determined under fair value based method, net of tax effects |  |                            | 212   |                         
|                                                                                                            |  |                            |       |                         
|Net losspro forma                                                                                          |  | $                          | 5,106 |                         
|                                                                                                            |  |                            |       |                         
|Basic and diluted net loss per shareas reported                                                            |  | $                          | 0.21  |                         
|Basic and diluted net loss per sharepro forma                                                              |  |                            | 0.22  |                         



Recent accounting pronouncements



In July 2002, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 nullifies the guidance of the Emerging Issues Task Force
(EITF) in 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, an entity
recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS 146, the FASB acknowledges that an entitys commitment to a plan does not, by itself, create a present obligation to other parties
that meets the definition of a liability and requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is incurred. It also establishes that fair value is the objective for the initial
measurement of the liability. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. The restructuring charges incurred for the three and six months ended June 30, 2003 were recorded in accordance with
SFAS 146.



In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires that a liability be recorded in the
guarantors balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entitys product warranty liabilities. The
initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantors fiscal year-end. The disclosure requirements of FIN
45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company believes that the adoption of FIN 45 will not have a material impact on its financial condition or results of operations.



In November 2002, the EITF reached a consensus on Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The
provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that the adoption of EITF Issue No. 00-21 will not have a material impact on its financial
condition or results of operations.



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##### Table of Contents

LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)





In January 2003, the
FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15, 2003. The Company believes that the adoption of FIN 46 will not have a material impact on its financial condition or results of operations.



In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities
under SFAS 133. The Statement is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003 and should be applied prospectively. The Company is currently evaluating
SFAS 149 and has not yet determined the impact of adopting its provisions.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 requires certain freestanding financial
instruments, such as mandatorily redeemable preferred stock, to be measured at fair value and classified as liabilities. The adoption of SFAS No. 150 is not expected to have a material effect on the Companys financial position or results of
operations.



NOTE 2ACCRUED LIABILITIES:



The components of accrued liabilities are as follows (in thousands):



|                                     |  | June 30,2003 |       | December 31,2002
|------------------------------------ |  | ------------ | ----- | ----------------
|Compensation and benefits            |  | $            | 7     |                 
|Consulting and professional services |  |              | 86    |                 
|Restructuring                        |  |              | 3,569 |                 
|Litigation settlement                |  |              |      |                 
|Other                                |  |              | 129   |                 
|                                     |  |              |       |                 
|                                     |  | $            | 3,791 |                 
|                                     |  |              |       |                 



In July 2003, the
Company incurred a one-time payout of $3,569,000 to terminate the remaining term of the Companys property lease on the Companys former headquarters located in Redwood City, CA.



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LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



NOTE 3COMPREHENSIVE LOSS:



Comprehensive loss includes net loss and other comprehensive income (loss). Other comprehensive income (loss) includes
accumulated translation adjustments and unrealized gains on investments. The components of comprehensive loss are as follows (in thousands):



|                                         |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|---------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | -
|                                         | 
|                                         |  | 2003                        |        |   | 2002                      |  
|Comprehensive loss:                      |  |                             |        |   |                           |  
|Net loss                                 |  | $                           | (4,894 | ) |                           | $
|Foreign currency translation adjustments |  |                             | 1      |   |                           |  
|                                         |  |                             |        |   |                           |  
|                                         |  | $                           | (4,893 | ) |                           | $
|                                         |  |                             |        |   |                           |  



NOTE 4NET LOSS PER SHARE:



Basic and diluted net loss per share is computed by
dividing the net loss for the period by the weighted average number of common shares outstanding during the period. The calculation of diluted net loss per share excludes potential common shares if the effect is anti-dilutive. Potential common
shares consist of unvested restricted common stock, incremental common shares issuable upon the exercise of stock options and common shares issuable upon the exercise of common stock warrants.



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##### Table of Contents

LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



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



|                                            |  | Three Months Ended June 30, |  | Six Months Ended June 30,
|------------------------------------------- |  | --------------------------- |  | -------------------------
|                                            |  | 2003                        |  | 2002                     
|Common stock options                        |  | 160                         |  | 2,604                    
|Common stock warrants                       |  | 431                         |  | 748                      
|Unvested common stock subject to repurchase |  | 0                           |  | 1                        
|                                            |  |                             |  |                          
|                                            |  | 591                         |  | 3,353                    
|                                            |  |                             |  |                          



NOTE 5RESTRUCTURINGS:



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



In January 2003, the
Company adopted another corporate restructuring program, consisting of a worldwide workforce reduction, in connection with the sale of the Companys digital music fulfillment business and related assets to Geneva Media, LLC
(Geneva), an affiliate of Anderson Merchandisers, LP. A restructuring charge of $4,411,000 was recorded in operating expense in the six months ended June 30, 2003. The restructuring charge included involuntary separation costs of
$796,000 for 29 employees worldwide, 5 in sales and marketing, 11 in research and development, 9 in general and administrative and 4 in operations functions in the U.S., lease termination fees of $3,569,000 and asset impairment costs of $46,000 for
prepaid expenses related to assets sold to Geneva. As of June 30, 2003, $24,000 related to involuntary separation costs remains unpaid and will be paid as employees are terminated through the fourth quarter of 2003.



In July 2003, the Company incurred a one-time payout of $3,569,000 to
terminate the remaining term of the Companys property lease on the Companys former headquarters located in Redwood City, CA. As of June 30, 2003, the Company had accrued for this liability and expensed it as a restructuring charge.



NOTE 6CONTINGENCIES AND LEGAL PROCEEDINGS:



On or about April 7, 2000, SightSound filed an amended complaint against one
of the Companys former customers, BeMusic, in the United States District Court for the Western District of Pennsylvania (Pennsylvania Court). The suit alleges that BeMusic infringes one or more of three patents (United States
Patent Nos. 5,191,573; 5,675,734 and 5,996,440). SightSound claims damages of $20 million plus an unspecified royalty. BeMusic filed an answer to the amended complaint on April 27, 2000, denying the material allegations of the complaint, and
asserting counterclaims for declaratory judgment of non-infringement and patent invalidity. Following a claims construction hearing in 2001 and an initial report and recommendation on claim construction by the magistrate judge in February 2002
(which ruling is on appeal to the district judge), the Company renegotiated its agreement with BeMusic concerning the defense of the case going forward. On December 16, 2002, BeMusic filed a lawsuit against the Company seeking to enjoin the payment
of a $2.50 per share return of capital cash distribution to our stockholders. On January 24, 2003, the Company entered into a settlement agreement with BeMusic, whereby the Company agreed to maintain $2.0 million in available cash on hand to pay up
to 50% of reasonable attorney fees and costs in connection with the defense of the patent action brought by SightSound against BeMusic, and $5.0 million in available cash on hand to apply towards the satisfaction of any adverse judgment in



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LIQUID AUDIO, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



respect of which it is determined that the Company would be obligated to indemnify BeMusic. The Company and BeMusic then dismissed the claims against each
other. The Company has now ceded control of the defense of the case to BeMusic, and is splitting the costs of the defense with BeMusic. The Company did not, by entering into the settlement agreement with BeMusic, agree, concede, or intend to suggest
that it has an obligation to indemnify any party with regard to an adverse judgment, and the Company specifically reserved its right to assert that it has no such obligation. The action currently is pending in the United States District Court of the
Western District of Pennsylvania. No trial date has been set at this time.



The Company, certain of its officers and directors, and various of the underwriters in the Companys initial public offering (IPO) and secondary offering, were named as defendants in a consolidated
action filed in the United States District Court for the Southern District of New York, In re Liquid Audio, Inc. Initial Public Offering Securities Litigation, CV-6611. The consolidated amended complaint generally alleges that various
investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in the Companys IPO and secondary offering of securities. The plaintiffs brought claims for violation of several provisions of the
federal securities laws against those underwriters, and also against the Company and certain of its directors and officers, seeking unspecified damages on behalf of a purported class of purchasers of the Companys common stock between July 8,
1999 and December 6, 2000. Various plaintiffs filed similar actions asserting virtually identical allegations against more than 40 investment banks and 250 other companies. All of these IPO allocation securities class actions currently
pending in the Southern District of New York have been assigned to Judge Shira A. Scheindlin for coordinated pretrial proceedings as In re Liquid Audio, Inc. Initial Public Offering Securities Litigation, 21 MC 92. Defendants have filed
motions to dismiss the actions. In October 2002, the directors and officers were dismissed without prejudice. A proposal has been made for the settlement and release of claims against the issuer defendants, including Liquid Audio, in exchange for a
contingent payment to be made by the issuer defendants insurance carriers and an assignment of certain claims. On July 16, 2003, the Companys Board of Directors approved participation in the settlement. The settlement is subject to a
number of conditions, including approval of the proposed settling parties and the court. If the settlement does not occur, and litigation against the Company continues, the Company believes that it has meritorious defenses and intends to defend the
case vigorously.



From time to time the Company receives
letters from corporations or other business entities notifying it of alleged infringement of patents held by them or suggesting that we review patents to which they claim rights. These corporations or entities often indicate a willingness to discuss
licenses to their patent rights.



NOTE 7CASH DISTRIBUTION TO
STOCKHOLDERS:



On December 6, 2002, the Company announced
a return of capital cash distribution to its stockholders of $2.50 per share, payable on December 20, 2002 to stockholders of record as of December 10, 2002. On December 16, 2002, BeMusic, Inc. (BeMusic), a subsidiary of Bertelsmann AG,
filed a lawsuit against the Company to prevent the Company from making the $2.50 per share cash distribution, based on concerns related to the Companys ability to indemnify them in a patent infringement action against BeMusic for technology
licensed from the Company. On January 24, 2003, the Company entered into a settlement with BeMusic, whereby the Company agreed to maintain $2,000,000 in available cash on hand to pay up to 50% of reasonable attorney fees and costs in connection with
the defense of such action, and $5,000,000 in available cash on hand to apply towards the satisfaction of any adverse judgment in respect of which the Company would be obligated to indemnify BeMusic. The Company and BeMusic then dismissed their
claims against each other. On January 29, 2003, the Company distributed $2.50 per share, for a total of $57,771,000, to its common stockholders of record as of December 10, 2002. The Company did not, by entering into the settlement agreement with
BeMusic agree, concede or intend to suggest that it has an obligation to indemnify any party with regard to an adverse judgment, and the Company specifically reserved its right to assert that it had no such obligation. As of July 31, 2003, the
Company understands that BeMusic had incurred approximately $570,764 in legal fees and expenses, of which the Company will be responsible for $285,382. As of June 30, 2003, the Company has paid approximately $280,000 related to this obligation.
BeMusics legal fees (and with them the Companys obligation to share the cost of defense) will continue to increase until the patent infringement action is resolved by settlement or a final court order that cannot be further appealed.



NOTE 8DECREASE IN STOCK OPTION EXERCISE PRICE:



On March 18, 2003, the Companys Board of Directors elected to reduce
the exercise price of all outstanding stock options by $2.50, but not lower than $0.10, to reflect the $2.50 cash distribution to the stockholders. Consequently, the Company will account for a portion of these stock options as variable, revaluing
the outstanding stock options at each balance sheet date until they are exercised, cancelled or forfeited.



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



The following Managements Discussion and Analysis contains forward-looking statements within the meaning of Federal
securities laws. You can identify these statements because they use forward-looking terminology such as may, will, expect, anticipate, estimate, continue, believe,
and intend or other similar words. These words, however, are not the exclusive means by which you can identify these statements. You can also identify forward-looking statements because they discuss future expectations, contain
projections of results of operations or of financial conditions, characterize future events or circumstances or state other forward-looking information. We have based all forward-looking statements included in Managements Discussion and
Analysis on information currently available to us, and we assume no obligation to update any such forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions,
actual results could differ materially from those projected in the forward-looking statements. Potential risks and uncertainty include, but are not limited to, those set forth under the caption Additional Factors Affecting Future Results
included in this Managements Discussion and Analysis of Financial Condition and Results of Operations.



While we believe that the discussion and analysis in this report is adequate for a fair presentation of the information, we recommend that you read this
discussion and analysis in conjunction with Managements Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities Exchange Commission (SEC).



Overview



During 2002, we continued to provide software products and services that enabled artists, record companies and retailers to
create, syndicate and sell music digitally over the Internet.



In the spring of 2002, it became apparent to our management that we could not achieve financial success as an independent company with our current business model. In June 2002 we announced a definitive agreement to merge with Alliance
Entertainment Corporation (Alliance), with the intent of combining into a physical and digital media distribution company. In November 2002, we terminated this agreement based upon the publicly expressed opposition to the proposed merger
by a significant percentage of our stockholders. We consequently paid a termination fee of $2.1 million to Alliance.



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



On December 6, 2002, we announced a return of capital cash distribution to
our stockholders of $2.50 per share, payable on December 20, 2002 to stockholders of record as of December 10, 2002. On December 16, 2002, BeMusic, Inc. (BeMusic), a subsidiary of Bertelsmann AG, filed a lawsuit against us to prevent us
from making the $2.50 per share cash distribution, based on concerns related to our ability to indemnify them in a patent infringement action against BeMusic for technology licensed from us. On January 24, 2003, we entered into a settlement with
BeMusic, whereby we agreed to maintain $2.0 million in available cash on hand to pay up to 50% of reasonable attorney fees and costs in connection with the defense of such action, and $5.0 million in available cash on hand to apply towards the
satisfaction of any adverse judgment in respect of which we would be obligated to indemnify BeMusic. We and BeMusic then dismissed our claims against each other. On January 29, 2003, we distributed $2.50 per share, for a total of $57.8 million, to
our common stockholders of record as of December 10, 2002. Following the cash distribution, we continued to explore options for the use of our remaining assets. We did not, by entering into the settlement agreement with BeMusic agree, concede or
intend to suggest that we have an obligation to indemnify any party with regard to an adverse judgment, and we specifically reserved our right to assert that we have no such obligation. As of July 31, 2003, we understand that BeMusic had incurred
approximately $570,764 in legal fees and expenses, of which we will be responsible for $285,382. As of June 30, 2003, the Company has paid approximately $280,000 related to this obligation. BeMusics legal fees (and with them our obligation to
share the cost of defense) will continue to increase until the patent infringement action is resolved by settlement or a final court order that cannot be further appealed.



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On January 24, 2003, we sold our digital music fulfillment business and related assets to Geneva Media,
LLC (Geneva), an affiliate of Anderson Merchandisers, LP for $3.2 million. As part of the sale, we also transferred ownership of the Microsoft License and certain Liquid Audio related trademarks to Geneva. As a result of the
sale, we are currently not operating any businesses, and are exploring options for the use of our remaining assets.



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



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



In April
2003, our Board repealed our Preferred Stock Rights Agreement, which could have impeded or discouraged an acquisition or other transaction by any entity which is not affiliated with Liquid Audio.



On June 5, 2003, we received a notification of stock delisting from Nasdaq
because the closing price of our stock had been below $1 per share for 30 consecutive trading days and we do not conduct an operating business. Our common stock now trades over the counter on the Nasdaq OTC Bulletin Board.



In July 2003, we terminated the remaining term of our property lease on our
former headquarters located in Redwood City, CA. The Companys principal executive offices are now located in New York, NY, in a space maintained by Barington Capital Group, L.P., a limited partnership whose general partner is a corporation of
which James Mitarotonda is Chairman, President and Chief Executive Officer. Mr. Mitarotonda is also the Co-Chairman and Co-Chief Executive Officer of the Company.



The accompanying financial statements as of June 30, 2003 and for the three-month and six-month periods then ended have been
prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company has incurred losses and negative cash flows
from operations for every year since inception. For the six months ended June 30, 2003, the Company incurred a net loss of approximately $6.1 million and negative cash flows from operations of approximately $6.8 million. As of June 30, 2003, the
Company had accumulated losses of approximately $136.5 million. The Company has not yet settled on an operating plan, and can give no assurance that the Companys existing cash and cash equivalents are sufficient to fund the Companys
current operations and satisfy its obligations. The Company believes these obligations will primarily relate to costs associated with the operation as a public company (legal, accounting, insurance, etc.), as well as the satisfaction of any
potential legal judgments or settlements as well as the expenses associated with any new business activities, which may be undertaken by the Company. In addition, according to a settlement agreement with BeMusic (see Note 6), the Company agreed to
maintain $2.0 million in available cash on hand to pay up to 50% of reasonable attorney fees and costs in connection with the defense of the patent action brought by SightSound against BeMusic, and $5.0 million in available cash on hand to apply
towards the satisfaction of any adverse judgment in respect of which it is determined that the Company would be obligated to indemnify BeMusic. These factors, among others, indicate that the Company may be unable to continue operations as a going
concern. No adjustment has been made in the accompanying financial statements to the amounts and classifications of assets and liabilities which could result should the Company be unable to continue as a going concern. The Company continues to
consider future alternatives, including the possible acquisition of other businesses. However, the Company has not consummated any significant transactions to date and the Companys business prospects remain uncertain. To the extent that
management of the Company moves forward on any alternative strategy, such strategy may have an impact on the Companys liquidity.



Corporate Restructurings



In May 2001, we adopted a corporate restructuring program to reduce expenses to preserve our cash position while the digital music market developed. The
restructuring included a worldwide workforce reduction, a consolidation of three Redwood City, California offices into one facility and other expense management initiatives. We de-emphasized our efforts in less productive, non-core business areas
that did not directly support secure digital download opportunities, including digital music kiosks, music hosting for independent artists and labels, music clips service and encoding services. We continued to focus on software licensing and digital
music delivery services that complemented our secure digital download business. We supported the emerging market for digital music subscriptions, enabling major portals, online retailers and secure audio device manufacturers to offer
subscription-based digital music download services.



In
September 2002, we adopted another corporate restructuring program, consisting of a worldwide workforce reduction, to reduce expenses in response to the digital music market not developing as soon as anticipated and de-emphasis of the Liquid Player
product line, and preparations for the then proposed merger with Alliance. A restructuring charge of $1.2 million was recorded in operating expense in the twelve months ended December 31, 2002. The restructuring charge included involuntary
separation costs of $852,000 for 34 employees worldwide, 5 in sales and marketing, 26 in research and development, 2 in general and administrative and 1 in operations functions in the U.S., asset impairment costs of $156,000 for property and
equipment, furniture and fixtures, computer software



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for assets abandoned from reductions in workforce and lease costs of $155,000 pertaining to non-cancelable lease payments for excess facilities that were
vacated due to reductions in workforce.



In January 2003, the
Company adopted another corporate restructuring program, consisting of a worldwide workforce reduction, in connection with the sale of the Companys digital music fulfillment business and related assets to Geneva. A restructuring charge of
$4,411,000 was recorded in operating expense in the six months ended June 30, 2003. The restructuring charge included involuntary separation costs of $796,000 for 29 employees worldwide, 5 in sales and marketing, 11 in research and development, 9 in
general and administrative and 4 in operations functions in the U.S., lease termination fees of $3,569,000 and asset impairment costs of $46,000 for prepaid expenses related to assets sold to Geneva.



As of June 30, 2003, $24,000 related to involuntary separation costs remains
unpaid and will be paid as employees are terminated through the fourth quarter of 2003.



In July 2003, the Company incurred a one-time payout of $3,569,000 to terminate the remaining term of the Companys property lease on the Companys former headquarters located in Redwood City, CA. As of June
30, 2003, the Company had accrued for this liability and expensed it as a restructuring charge.



Future Operations and Financial Results



In connection with the sale of our digital music fulfillment business and related assets to Geneva, we implemented the aforementioned workforce reduction in 2003. As a result, as of July 28, 2003, we had 2 full time
employees.



We are reviewing alternatives for the use of our
remaining assets while settling our remaining claims and liabilities. Our management intends to pursue other business opportunities and investments unrelated to the downloading of digital music.



Our common stock currently trades over the counter on the Nasdaq OTC Bulletin
Board. Previously, our common stock was traded on the Nasdaq National Market. However, the market price per share dropped significantly subsequent to the payment of the $2.50 per share cash distribution to our common stockholders. Thus, on June 5,
2003, we were notified by Nasdaq that our common stock was delisted because the closing price had been below $1 per share for 30 consecutive trading days and we do not conduct an operating business. At that time, our common stock began trading over
the counter as a pink sheet security. On June 20, 2003, our common stock began trading on the Nasdaq OTC Bulletin Board. The market price of our common stock as of August 7, 2003 was $0.36 per share.



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Results of Operations



The following table sets forth, for the periods presented, certain data derived from our unaudited condensed consolidated statement of operations as a
percentage of total net revenues. The operating results in any period are not necessarily indicative of the results that may be expected for any future period. In particular, we are not currently operating any businesses and do not expect continuing
revenue from sources we received revenue from in the past.



|                                                   |  | Three Months Ended June 30, |    |  | Six Months Ended June 30, |   
|-------------------------------------------------- |  | --------------------------- | -- |  | ------------------------- | --
|                                                   |  | 2003                        |    |  | 2002                      |   
|Net revenues:                                      |  |                             |    |  |                           |   
|License                                            |  |                            | %  |  | 26                        | % 
|Services                                           |  |                            |    |  | 74                        |   
|Business development (related party)               |  |                            |    |  |                          |   
|                                                   |  |                             |    |  |                           |   
|Total net revenues                                 |  |                            |    |  | 100                       |   
|                                                   |  |                             |    |  |                           |   
|Cost of net revenues:                              |  |                             |    |  |                           |   
|License                                            |  |                            |    |  | 56                        |   
|Services                                           |  |                            |    |  | 115                       |   
|Non-cash cost of revenue                           |  |                            |    |  | 24                        |   
|                                                   |  |                             |    |  |                           |   
|Total cost of net revenues                         |  |                            |    |  | 195                       |   
|                                                   |  |                             |    |  |                           |   
|Gross profit (loss)                                |  |                            |    |  | (95                       | ) 
|                                                   |  |                             |    |  |                           |   
|Operating expenses:                                |  |                             |    |  |                           |   
|Sales and marketing                                |  | 100                         |    |  | 679                       |   
|Non-cash sales and marketing                       |  |                            |    |  | (21                       | ) 
|Research and development                           |  | 100                         |    |  | 1,930                     |   
|Non-cash research and development                  |  |                            |    |  | 2                         |   
|General and administrative                         |  | 100                         |    |  | 1,262                     |   
|Non-cash general and administrative                |  |                            |    |  |                          |   
|Strategic marketing-equity instruments             |  |                            |    |  |                          |   
|Restructuring                                      |  | 100                         |    |  |                          |   
|                                                   |  |                             |    |  |                           |   
|Total operating expenses                           |  | 100                         |    |  | 3,852                     |   
|                                                   |  |                             |    |  |                           |   
|Loss from operations                               |  | (100                        | )  |  | (3,947                    | ) 
|Other income (expense), net                        |  |                            |    |  | 211                       |   
|Gain on sale of digital music fulfillment business |  |                            |    |  |                          |   
|                                                   |  |                             |    |  |                           |   
|Net loss                                           |  | (100                        | )% |  | (3,736                    | )%
|                                                   |  |                             |    |  |                           |   



Three Months Ended June 30, 2003
and 2002



Total Net Revenues



Total net revenues were $0 for the three months ended
June 30, 2003 as compared to $151,000 in the comparable period of 2002. We do not expect significant revenue in the remainder of 2003.



License. License revenues derived from our former operating business primarily consisted of fees from licensing our software products to third
parties. License revenues were $0 for the three months ended June 30, 2003 as compared to $40,000 in the comparable period of 2002. This decrease was due to the discontinuation of the Liquid Player product line and the sale of our digital music
fulfillment business to Geneva in January 2003.



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Services. Services revenues derived from our former operating business primarily consisted of
maintenance fees related to our licensed software products, hosting fees, encoding, music delivery and transaction fees, promotion and advertising services and kiosk-related equipment sales from third parties. Services revenues were $0 for the three
months ended June 30, 2003 as compared to $111,000 in the comparable period of 2002. This decrease was due to the discontinuation of our software license and our music hosting businesses and the sale of our digital music fulfillment business to
Geneva.



Total Cost of Net Revenues



We had no sales or costs relating to sales for the three months ended June
30, 2003. Our gross profit (loss) was approximately (95)% of total net revenues for the comparable three months ended June 30, 2002. Total cost of net revenues was $0 in the three months ended June 30, 2003 as compared to $294,000 in the three
months ended June 30, 2002. We do not expect significant cost of net revenues in the remainder of 2003 since we are not currently operating any businesses.



License. Cost of license revenues primarily consists of royalties paid for third-party technology and costs of documentation, duplication and
packaging. Cost of license revenues were $0 for the three months ended June 30, 2003 as compared to $84,000 in the comparable period of 2002. Cost of license revenues decreased due to our discontinuation of the digital music distribution business.



Services. Cost of services revenues primarily consists
of compensation for customer service, encoding and professional services personnel, kiosk-related equipment and an allocation of our occupancy costs and other overhead attributable to our services revenues. Cost of services revenues were $0 for the
three months ended June 30, 2003 as compared to $174,000 in the three months ended June 30, 2002. The decrease in cost of services revenues was due to the termination of all of our encoding, customer service and professional services personnel and
the sale of the digital music fulfillment business to Geneva.



Operating
Expenses



Sales and Marketing. Sales and marketing
expenses consist primarily of compensation for our sales, marketing and business development personnel, compensation for customer service and professional services personnel attributable to sales and marketing activities, advertising, trade show and
other promotional costs, design and creation expenses for marketing literature and our website and an allocation of our occupancy costs and other overhead. Sales and marketing expenses decreased 99% to $5,000 for the three months ended June 30, 2003
from $1.0 million in the comparable period of 2002. This decrease was due to the reduction in compensation and related expenses of approximately $755,000 from termination of all of our sales and marketing personnel, expense management initiatives,
and the sale of our digital music fulfillment service to Geneva, reduction in travel and entertainment expense of approximately $187,000 between the two periods, and allocation of occupancy costs and other overhead of approximately $324,000,
partially offset by a reduction in shared project costs with Radio and Records of approximately $451,000 in the comparable period of 2002. We do not expect to incur significant sales and marketing expenses in the remainder of 2003 since we are not
currently operating any businesses.



Research and
Development. Research and development expenses consist primarily of compensation for our research and development, network operations and product management personnel, payments to outside contractors and, to a lesser extent, depreciation on
equipment used for research and development and an allocation of our occupancy costs and other overhead. Research and development expenses decreased 97% to $87,000 for the three months ended June 30, 2003 from $2.9 million in the comparable period
of 2002. This decrease was due to the reduction in compensation and related expenses of approximately $1.6 million from termination of all of our research and development personnel and outside contractors, expense management initiatives, the sale of
our digital music fulfillment business to Geneva, depreciation and amortization of approximately $539,000 and allocation of occupancy costs and other overhead of approximately $640,000. We do not expect to incur significant research and development
expenses in the remainder of 2003 since we are not currently operating any businesses.



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General and Administrative. General and administrative expenses consist primarily of compensation
for personnel and payments to outside contractors for general corporate functions, including finance, information systems, human resources, facilities, legal and general management, fees for professional services, bad debt expense and an allocation
of our occupancy costs and other overhead. General and administrative expenses decreased 35% to $1.2 million for the three months ended June 30, 2003 from $1.9 million in the comparable period of 2002. This decrease was due to the reduction of rent
expense of our corporate office of $581,000, reduction in compensation and related expenses of approximately $817,000 from decreases in the number of general and administrative personnel from 17 to 2 and outside contractors, expense management
initiatives, the sale of our digital music fulfillment business to Geneva, and reduced legal fees of $412,000, offset by higher directors and officers insurance of approximately $355,000, and allocation of occupancy costs and other overhead of
approximately $899,000. Allocations of occupancy costs and other overhead, including salaries, leases and utilities, are allocated on a headcount basis, and the reduction of headcount in all other departments will leave these expenses as a general
and administrative expense.



Non-Cash Sales and Marketing,
Research and Development and General and Administrative. Non-cash sales and marketing, research and development and general and administrative expenses relate to stock-based employee compensation arrangements. The total unearned compensation
recorded by us from inception to June 30, 2003 was $3.5 million. We recognized $0 and ($28,000) of stock compensation expense for the three months ended June 30, 2003 and 2002, respectively.



Restructuring. Restructuring charge relates to costs associated with
our corporate restructuring program in connection with our exit of our digital music fulfillment business. The $3,569,000 charge in the three months ended June 30, 2003 is related to a one-time payout to terminate the remaining term of our property
lease on our former headquarters located in Redwood City, CA.



Other Income (Expense), Net. Interest income consists of earnings on our cash, cash equivalents and short-term investments. Interest expense consists of expenses related to our financing obligations, which include borrowings under
equipment loans and capital lease obligations. Other income (expense), net decreased to $15,000 for the three months ended June 30, 2003 from $318,000 in the comparable period of 2002. The decrease is due to the decrease in interest income of
approximately $321,000 from lower average cash and cash equivalent balances resulting from cash used in operating activities and lower interest rates.



Six Months Ended June 30, 2003 and 2002



Total Net Revenues



Total net revenues decreased 85% to $43,000 for the six months ended June 30, 2003 from $286,000 in the comparable period of 2002. We do not expect
significant revenue in the remainder of 2003.



License.
License revenues decreased 95% to $4,000 for the six months ended June 30, 2003 from $76,000 in the comparable period of 2002. This decrease was due to discontinuation of our software licensing business and the sale of our digital music fulfillment
business to Geneva in January 2003.



Services. Services
revenues decreased 81% to $39,000 for the six months ended June 30, 2003 from $210,000 in the comparable period of 2002. This decrease was due to the discontinuation of our software license business, our music hosting business for independent
artists and labels and the sale of our digital music fulfillment business to Geneva.



Total Cost of Net Revenues



Our gross profit
(loss) increased to approximately 84% of total net revenues for the six months ended June 30, 2003 from approximately (93)% of total net revenues in the comparable period of 2002. Total cost of net revenues decreased 99% to $7,000 for the six months
ended June 30, 2003 from $552,000 in the comparable period of 2002.



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License. Cost of license revenues decreased 97% to $5,000 for the six months ended June 30, 2003
from $181,000 in the comparable period of 2002. Cost of license revenues decreased due to the discontinuation of our licensing business.



Services. Cost of services revenues decreased 99% to $2,000 for the six months ended June 30, 2003 from $302,000 in the comparable period of 2002.
The decrease in cost of services revenues was due to the termination all of our encoding, customer service and professional services personnel, the elimination of all of our kiosk-related equipment due to our corporate restructuring and the sale of
our digital music fulfillment business to Geneva.



Non-Cash
Cost of Revenues. Non-cash cost of revenues were $0 for the six months ended June 30, 2003 and $69,000 in the comparable period of 2002.



Operating Expenses



Sales and Marketing. Sales and marketing expenses decreased 88% to $271,000 for the six months ended June 30, 2003 from $2.1 million in the
comparable period of 2002. This decrease was primarily due to decreases in the number of personnel and outside contractors due to our corporate restructuring and expense management initiatives.



Research and Development. Research and development expenses decreased
97% to $165,000 for the six months ended June 30, 2003 from $5.9 million in the comparable period of 2002. This decrease was primarily due to the termination of all of our personnel and outside contractors, expense management initiatives and the
sale of our digital music fulfillment business to Geneva.



General and Administrative. General and administrative expenses increased 41% to $4.3 million for the six months ended June 30, 2003 from $3.0 million in the comparable period of 2002. This increase was primarily due to allocation of
occupancy costs and other overhead of approximately $1,616,000, depreciation expense of $125,000, and directors and officers insurance premiums of $125,000, partially offset by decreases in the number of personnel and outside contractors due to our
corporate restructuring and expense management initiatives of $315,000, and a reduction in rent expense of $598,000. Allocations of occupancy costs and other overhead, including salaries, leases and utilities, are allocated on a headcount basis, and
the reduction of headcount in all other departments will leave these expenses as a general and administrative expense.



Non-Cash Sales and Marketing, Research and Development and General and Administrative. We recognized $0 and $(12,000) of non-cash sales and
marketing, research and development and general and administrative expenses for the six months ended June 30, 2003 and 2002, respectively.



Restructuring. Restructuring charge was $4.4 million and $0 for the six months ended June 30, 2003 and 2002, respectively. $3.6 million of the
charge in the six months ended June 30, 2003 consists of expense related to a one-time payment to terminate the remaining term of our real estate lease of our previous corporate offices, $796,000 of involuntary employee separation costs and $46,000
of prepaid expenses related to assets sold to Geneva.



Other
Income (Expense), Net. Other income (expense) decreased to $118,000 for the six months ended June 30, 2003 from $851,000 in the comparable period of 2002. The decrease was due to lower average cash and cash equivalent balances resulting from
cash used in operating activities, and lower interest rates.



Gain on sale of digital music fulfillment business. Gain on sale of digital music fulfillment business relates to the sale of our digital music fulfillment business and related assets to Geneva for $3.2 million in January 2003.



Liquidity and Capital Resources



Since inception, we have financed our operations primarily through the
initial and follow-on public offerings of common stock, private placements of our preferred stock, equipment financing, lines of credit and short-term loans. As of June 30, 2003, we had raised $65.9 million and $93.7 million through our initial and
follow-on public offerings of common stock, respectively, and $29.8 million through the sale of our preferred stock. As of June 30,



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2003, we had approximately $12.6 million of cash and cash equivalents; however, we incurred a one-time payout of $3,569,000 in July 2003, to terminate the
remaining term of our property lease on our former headquarters in Redwood City, CA.



Net cash used in operating activities was $6.8 million and $10.4 million for the six months ended June 30, 2003 and 2002, respectively. Net cash used for operating activities in the 2003 period was the result of net
losses from operations of $6.1 million, depreciation and amortization of $222,000, gain on sale of digital music fulfillment business and related assets of $2.9 million and a net increase in working capital items of $1.9 million. The net increase in
working capital items include an decrease in accounts receivable of $49,000, an increase in other assets of $929,000, a decrease in accounts payable of $682,000, an increase in accrued liabilities of $1.6 million and a decrease in deferred revenue
of $39,000. Net cash used for operating activities in the 2002 period was the result of net losses from operations of $10.5 million, depreciation and amortization of $1.3 million, amortization of unearned compensation of $13,000 and a net decrease
in working capital items of $1.2 million. The net decrease in working capital items include an increase in accounts receivable of $15,000, an increase in other assets of $471,000, an increase in accounts payable of $3,000, a decrease in accrued
liabilities of $1.7 million and a decrease in deferred revenue of $13,000.



Net cash provided by (used) in investing activities was $3.2 million and $(67,000) for the six months ended June 30, 2003 and 2002, respectively. Net cash provided by investing activities in the 2003 period was due to
the sale of our digital music fulfillment business and related assets to Geneva. Net cash used by investing activities in the 2002 period was due to the acquisition of property and equipment.



Net cash used in financing activities was $57.8 million and $112,000 for the
six months ended June 30, 2003 and 2002, respectively. The net cash used in financing activities in the 2003 period is due to the payments made to our stockholders in connection with the return of capital cash distribution declared on December 6,
2002 to stockholders of record on December 10, 2002. The net cash used in financing activities in the 2002 period is due primarily to payments made under our equipment loan and capital leases.



We currently are in the process of negotiating settlements with respect to
ongoing litigation matters. The largest potential payment relates to the ongoing matter with SightSound (see Part II. Item 1. LEGAL PROCEEDINGS). SightSound claims damages of $20 million plus an unspecified royalty. We might not be able to agree to
a settlement on reasonable terms, if at all. A significant settlement or the failure to obtain a settlement on acceptable terms would significantly decrease cash available for other purposes. We also continue to negotiate settlements with respect to
other ongoing litigation and claims, which settlements and related legal costs would also decrease cash available for other purposes.



As we settle our commitments and ongoing litigation, we continue to incur legal fees, salary expense and other costs that decrease cash available for
other purposes.



We have no material commitments for capital
expenditures or strategic investments and anticipate no capital expenditures during the remainder of 2003. We anticipate that we will experience a decline in our operating expenses for the foreseeable future and that our operating expenses will be a
material use of our cash resources. For instance, we had a $899,000 general and administrative charge in the three months ended June 30, 2003. Allocations of occupancy costs and other overhead, including salaries, leases and utilities, are allocated
on a headcount basis, and the reduction of headcount in all other departments will leave these expenses as a general and administrative expense.



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



In our sales agreements, we typically agree to indemnify our customers for any expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these
indemnification agreements are generally perpetual any time after execution of the agreement. The maximum amount of potential future indemnification is unlimited. Except for the SightSound legal matter (see Part II. Item 1. LEGAL PROCEEDINGS), to
date we have not paid any amounts to settle claims or defend lawsuits related to indemnification under our sales agreements.



We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures
in the near future. However, uncertainties exist as to the precise value of claims and liabilities, which may exceed our current existing cash and cash equivalents. In particular, we may be unable to negotiate settlements with respect to our
remaining liabilities and we face and might face intellectual property infringement claims, either of which, or collectively, could exceed our current existing cash and cash equivalents. Additionally, we do not currently have an operating business
and, consequently, we are currently exploring various options for the use of our remaining assets, including pursuit of a business strategy unrelated to digital music distribution. Acquisition and/or operation of any future business strategy may
require additional cash resources. See ADDITIONAL FACTORS AFFECTING FUTURE RESULTS below.



Market Risk



No
material changes exist to the market risk our investment portfolio of cash and money market funds faced during the six months ended June 30, 2003. For additional information, refer to Item 7A Quantitative and Qualitative Disclosures About
Market Risk in Managements Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K for the year ended December 31, 2002 filed with the SEC.



ADDITIONAL FACTORS AFFECTING FUTURE RESULTS



Before deciding to invest in us or 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 SEC, including our Annual Report on Form 10-K filed March 31, 2003. The risks and uncertainties
described below are not the only ones facing us. 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 of our common stock could decline and you may lose all or part of your investment.



We Currently Do Not Have an Operating Business, But Also Do Not Intend to Pursue a Course of Complete Liquidation and Dissolution, and
Accordingly, the Value of Your Shares May Decrease



We
currently do not have any operating business; we are considering various options for the use of our remaining assets, but have yet to approve any definitive plans. In the meantime, we will continue to incur operating



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expenses while we consider alternative operating plans. These plans may include business combinations with or investments in other operating companies, or
entering into a completely new line of business. We have not yet identified any such opportunities, and thus, you will not be able to evaluate the impact of such a business strategy on the value of your stock. In addition, we cannot assure you that
we will be able to identify any appropriate business opportunities. Even if we are able to identify business opportunities that our Board deems appropriate, we cannot assure you that such a strategy will provide you with a positive return on your
investment, and it may in fact result in a substantial decrease in the value of your stock. These factors will substantially increase the uncertainty, and thus the risk, of investing in our shares. You should also not expect any further cash
distributions.



We May Not Be Able to Identify or Fully Capitalize on Any
Appropriate Business Opportunities



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



Our Stock Has Been Delisted from The Nasdaq National Market, And Is Therefore Significantly Less Liquid than Before



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



We May Be Unable to Negotiate Settlements with Respect to Our Remaining Liabilities



We currently are in the process of negotiating settlements with respect to
our remaining obligations and liabilities, which include ongoing litigation matters. If we are unable to successfully negotiate the termination of these obligations, we will have fewer cash proceeds to use for ongoing business ventures.



Stockholders May Be Liable to Our Creditors for Up to Amounts Received From Us if Our
Reserves Are Inadequate



Under the Delaware General
Corporation Law, in the event we fail to create an adequate contingency reserve for payment of our expenses and liabilities, each stockholder could be held liable for payment to our creditors for such stockholders pro rata share of amounts
owed to creditors in excess of the contingency reserve. The liability of any stockholder would be limited, however, to the amounts previously received by such stockholder from us, including the return of capital cash distribution of $2.50 per share
paid to stockholders on January 29, 2003. Accordingly, in such event a stockholder could be required to return all distributions previously made to such stockholder. Moreover, in the event a stockholder has paid taxes on amounts previously received,
a repayment of all or a portion of such amount could result in a stockholder incurring a net tax cost if the stockholders repayment of an amount previously



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distributed does not cause a commensurate reduction in taxes payable. There can be no assurance that the contingency reserve maintained by us will be
adequate to cover any expenses and liabilities.



We Face and Might Face
Intellectual Property Infringement Claims that Might Be Costly to Resolve



From time to time, we have received letters from corporations and other entities suggesting that we review patents to which they claim rights or claiming that we infringe on their intellectual property rights. Such
claims may result in our being involved in litigation. Although we sold our digital music distribution business, we still have one outstanding claim of patent infringement. Further, we cannot assure you that other parties will not assert additional
claims in the future or that we will prevail against any such claims. We could incur substantial costs to defend any claims relating to proprietary rights, which would deplete our remaining cash assets. In addition, we are obligated under certain
agreements to indemnify the other party for claims that we infringe on the proprietary rights of third parties. If we are required to indemnify parties under these agreements, our remaining assets could be substantially reduced. If someone asserts a
claim against us relating to proprietary technology or information, we might seek settlement of such claim. We might not be able to agree to a settlement on reasonable terms, or at all. The failure to obtain a settlement on acceptable terms would
decrease cash for other purposes. See Legal Proceedings.



|ITEM 3. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- |  | ----------------------------------------------------------



See Market Risk in Part I, Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations.



|ITEM 4. |  | CONTROLS AND PROCEDURES
|------- |  | -----------------------



(a) Evaluation of Disclosure Controls and Procedures



Under the supervision and with the participation of our management, including our Co-Chief Executive Officers and Chief Financial Officer, we performed an
evaluation of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934 (the Exchange Act), within the 90-day period prior to
the date of this report. Based upon that evaluation, the Co-Chief Executive Officers and Chief Financial Officer concluded that our disclosure controls and procedures are effective at ensuring that required information relating to us will be
disclosed on a timely basis in our reports filed under the Exchange Act.



(b) Changes in Internal Controls



We maintain a system of internal controls that are designed to provide reasonable assurance that our books and records accurately reflect our transactions and that our established policies and procedures are followed. For the six months
ended June 30, 2003, there were no significant changes to our internal controls or in other factors that could significantly affect our internal controls. There were no significant deficiencies or material weaknesses, and therefore there were no
corrective actions taken.



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PART II. OTHER INFORMATION



|ITEM 1. |  | LEGAL PROCEEDINGS
|------- |  | -----------------



On or about April 7, 2000, SightSound, Inc. (SightSound) filed an amended complaint against one of our former customers, BeMusic, in the
United States District Court for the Western District of Pennsylvania (Pennsylvania Court). The suit alleges that BeMusic infringes one or more of three patents (United States Patent Nos. 5,191,573; 5,675,734 and 5,996,440). SightSound
claims damages of $20 million plus an unspecified royalty. BeMusic filed an answer to the amended complaint on April 27, 2000, denying the material allegations of the complaint, and asserting counterclaims for declaratory judgment of
non-infringement and patent invalidity. Following a claims construction hearing in 2001 and an initial report and recommendation on claim construction by the magistrate judge in February 2002 (which ruling is on appeal to the district judge), we
renegotiated our agreement with BeMusic concerning the defense of the case going forward. On December 16, 2002, BeMusic filed a lawsuit against the Company seeking to enjoin the payment of a $2.50 per share return of capital cash distribution to our
stockholders. On January 24, 2003, the Company entered into a settlement agreement with BeMusic, whereby the Company agreed to maintain $2.0 million in available cash on hand to pay up to 50% of reasonable attorney fees and costs in connection with
the defense of the patent action brought by SightSound against BeMusic, and $5.0 million in available cash on hand to apply towards the satisfaction of any adverse judgment in respect of which it is determined that the Company would be obligated to
indemnify BeMusic. The Company and BeMusic then dismissed the claims against each other. We have now ceded control of the defense of the case to BeMusic, and are splitting the costs of the defense with BeMusic. We did not, by entering into the
settlement agreement with BeMusic, agree, concede or intend to suggest that we have an obligation to indemnify any party with regard to an adverse judgment, and we specifically reserved our right to assert that we have no such obligation. The action
currently is pending in the United States District Court of the Western District of Pennsylvania. No trial date has been set at this time.



We, certain of our officers and directors, and various of the underwriters in our initial public offering (IPO) and secondary offering, were
named as defendants in a consolidated action filed in the United States District Court for the Southern District of New York, In re Liquid Audio, Inc. Initial Public Offering Securities Litigation, CV-6611. The consolidated amended complaint
generally alleges that various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in our IPO and secondary offering of securities. The plaintiffs brought claims for violation of several
provisions of the federal securities laws against those underwriters, and also against us and certain of our directors and officers, seeking unspecified damages on behalf of a purported class of purchasers of our common stock between July 8, 1999
and December 6, 2000. Various plaintiffs filed similar actions asserting virtually identical allegations against more than 40 investment banks and 250 other companies. All of these IPO allocation securities class actions currently
pending in the Southern District of New York have been assigned to Judge Shira A. Scheindlin for coordinated pretrial proceedings as In re Liquid Audio, Inc. Initial Public Offering Securities Litigation, 21 MC 92. Defendants have filed
motions to dismiss the actions. In October 2002, the directors and officers were dismissed without prejudice. A proposal has been made for the settlement and release of claims against the issuer defendants, including Liquid Audio, in exchange for a
contingent payment to be made by the issuer defendants insurance carriers and an assignment of certain claims. On July 16, 2003, the Companys Board of Directors approved participation in the settlement. The settlement is subject to a
number of conditions, including approval of the proposed settling parties and the court. If the settlement does not occur, and litigation against us continues, we believe that we have meritorious defenses to the claims against us and intend to
defend ourselves vigorously.



From time to time we receive
letters from corporations or other business entities notifying us of alleged infringement of patents held by them or suggesting that we review patents to which they claim rights. These corporations or entities often indicate a willingness to discuss
licenses to their patent rights.



|ITEM 2. |  | CHANGES IN SECURITIES AND USE OF PROCEEDS
|------- |  | -----------------------------------------



The effective date of our first registration statement, filed on Form S-1 under the Securities Act of 1933 (No. 333-82521) relating to our initial public
offering of common stock, was July 8, 1999. A total of 4,800,000 shares of common stock were sold at a price of $15.00 per share to an underwriting syndicate led by Lehman Brothers Inc., BancBoston Robertson Stephens Inc. and U.S. Bancorp Piper
Jaffray Inc. Offering proceeds, net of aggregate expenses of approximately $6.1 million, were approximately $65.9 million.



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The effective date of our second registration statement, filed on Form S-1 under the Securities Act of
1933 (No. 333-91541) relating to our follow-on public offering of common stock, was December 14, 1999. A total of 2,946,076 shares of Common Stock were sold at a price of $33.63 per share to an underwriting syndicate led by Lehman Brothers Inc.,
BancBoston Robertson Stephens Inc., U.S. Bancorp Piper Jaffray Inc., Dain Rauscher Wessells and Fidelity Capital Markets. An additional 503,924 shares of Common stock were sold on behalf of selling stockholders as part of the same offering. Offering
proceeds to us, net of aggregate expenses of approximately $5.4 million, were approximately $93.7 million. Offering proceeds to selling stockholders, net of expenses of approximately $847,000, were approximately $16.1 million.



From the time of receipt through June 30, 2003, our proceeds, except for the
return of capital cash distribution paid on January 29, 2003 of $57.8 million, were applied toward general corporate purposes, including the purchase of temporary investments consisting of cash, cash equivalents and short-term investments, working
capital and capital expenditures, enhancing research and development and attracting key personnel.



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



On April 24, 2003, we were notified by Nasdaq that pursuant to Marketplace Rule 4300(a)(3), it believes that we now lack tangible business operations and
informed us of its decision to delist our common stock from The Nasdaq National Market at the open of business on May 5, 2003. On May 2, 2003, we requested an oral hearing with The Hearings Department of Nasdaq to appeal its decision to delist our
common stock. As a result of this request, our common stock was not delisted on May 5, 2003, and continued to trade on The Nasdaq National Market until the date of the oral hearing which was scheduled for June 5, 2003. On June 5, 2003, we received a
notification of stock delisting from Nasdaq because the closing price of our stock had been below $1 per share for 30 consecutive trading days and we do not conduct an operating business. Our common stock now trades over the counter on the Nasdaq
OTC Bulletin Board.



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



There were no submissions of matter to a vote of securities holders during the quarter ended June 30, 2003.



|ITEM 5. |  | OTHER INFORMATION
|------- |  | -----------------



None.



|ITEM 6. |  | EXHIBITS AND REPORTS ON FORM 8-K
|------- |  | --------------------------------



(a) Exhibits



|      | 
|----- | 
|3.1   | 
|      | 
|3.2   | 
|      | 
|4.2   | 
|      | 
|4.3   | 
|      | 
|10.1  | 
|      | 
|10.2  | 
|      | 
|10.3  | 
|      | 
|10.21 | 



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|      | 
|----- | 
|10.42 | 
|      | 
|10.50 | 
|      | 
|10.56 | 
|      | 
|10.57 | 
|      | 
|10.58 | 
|      | 
|10.59 | 
|      | 
|10.60 | 
|      | 
|10.61 | 
|      | 
|10.62 | 
|      | 
|10.63 | 
|      | 
|10.64 | 
|      | 
|10.65 | 
|      | 
|10.66 | 
|      | 
|10.67 | 
|      | 
|10.70 | 
|      | 
|10.71 | 
|      | 
|10.72 | 
|      | 
|10.73 | 
|      | 
|11.1  | 
|      | 
|21.1  | 
|      | 
|23.1  | 
|      | 
|24.1  | 
|      | 
|31.1  | 
|      | 
|31.2  | 
|      | 
|31.3  | 
|      | 
|32.1  | 
|      | 
|32.2  | 
|      | 
|32.3  | 

---

|+ |  | confidential treatment received as to certain portions
|- |  | ------------------------------------------------------

|(1) |  | incorporated by reference to the Registration Statement on Form S-1 and all amendments thereto, Registration No. 333-77707, filed with the Securities and Exchange Commission on May
4, 1999 and declared effective July 8, 1999
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | incorporated by reference to the Form 10-Q filed with the Securities and Exchange Commission on August 14, 2000
|--- |  | ---------------------------------------------------------------------------------------------------------------

|(3) |  | this exhibit has been omitted because the information is shown in the financial statements or notes thereto
|--- |  | -----------------------------------------------------------------------------------------------------------

|(4) |  | incorporated by reference to Exhibits of the Form 8-K filed with the Securities and Exchange Commission on November 12, 2002
|--- |  | ----------------------------------------------------------------------------------------------------------------------------

|(5) |  | incorporated by reference to the Form 10-K filed with the Securities and Exchange Commission on March 31, 2003
|--- |  | --------------------------------------------------------------------------------------------------------------

|(6) |  | incorporated by reference to Exhibits of the Form 8-K filed with the Securities and Exchange Commission on January 17, 2003
|--- |  | ---------------------------------------------------------------------------------------------------------------------------

|(7) |  | incorporated by reference to Exhibits of the Form 8-K filed with the Securities and Exchange Commission on January 28, 2003
|--- |  | ---------------------------------------------------------------------------------------------------------------------------



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(b) Reports on Form 8-K



On April 24, 2003, we filed a report on Form 8-K which announced that PricewaterhouseCoopers LLP (PWC) resigned
as our independent auditors on April 17, 2003. PwC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. During the years ended December 31, 2001 and 2002 and through April 17, 2003, there were no disagreements between us and PwC on any matter of accounting principles or practices, financial statement
disclosure, auditing scope or procedure which, if not resolved to the satisfaction of PwC, would have caused PwC to make reference to the subject matter of the disagreement with its report. During the two most recent fiscal years and through April
17, 2003, there have been no reportable events (as defined in Regulation S-K 304(a)(1)(v)). On April 23, 2003, PwC provided a letter addressed to the Securities and Exchange Commission stating whether PwC agrees with the above statements and, if
not, stating the respects in which PwC does not agree. A copy of this letter was filed as an exhibit to the Form 8-K filed on April 24, 2003.



On May 8, 2003, we filed a report on Form 8-K which announced that we engaged Rothstein, Kass & Company, P.C. (RK) to serve as our
independent auditors as of May 1, 2003. RK will audit our financial statements for the fiscal year beginning January 1, 2003.



On June 9, 2003, we filed a report on Form 8-K which announced that we issued a press release on June 6, 2003 stating that we had received a notification
of delisting of our common stock from Nasdaq.



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LIQUID AUDIO, INC.



SIGNATURES



Pursuant to the requirements 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.



|DATE:        August 14, 2003 |  |  |  | LIQUID AUDIO, INC.                                                  
|---------------------------- |  |  |  | --------------------------------------------------------------------
|                             |  | 
|                             |  |  |  | /s/ James A. Mitarotonda                                            
|                             |  |  |  | James A. Mitarotonda                                                
|                             |  |  |  | Co-Chief Executive Officer (Principal Executive Officer)            
|                             |  | 
|                             |  |  |  | /s/ Seymour Holtzman                                                
|                             |  |  |  | Seymour Holtzman                                                    
|                             |  |  |  | Co-Chief Executive Officer (Principal Executive Officer)            
|                             |  | 
|                             |  |  |  | /s/ Melvyn Brunt                                                    
|                             |  |  |  | Melvyn Brunt                                                        
|                             |  |  |  | Chief Financial Officer (Principal Financial and Accounting Officer)



26