Loudeye 10Q 2002 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)

[X]	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2002
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:0-29583

Loudeye Technologies, Inc.
(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		91-1908833 (I.R.S. Employer Identification No.)

1130 Rainier Avenue South, Seattle, WA 98144
(Address of principal executive offices) (Zip Code)

206-832-4000
(Registrant’s telephone number, including area code)

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

Yes [X] No [ ]

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


Common		39,962,219

(Class)		(Outstanding at April 30, 2002)

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	ITEM I FINANCIAL STATEMENTS
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		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
PART II. OTHER INFORMATION
	ITEM 1: LEGAL PROCEEDINGS
	ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 3: DEFAULTS UPON SENIOR SECURITIES
	ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY SHAREHOLDERS
	ITEM 5: OTHER INFORMATION
	ITEM 6: EXHIBITS AND REPORTS ON FORM 10-Q
SIGNATURES

Loudeye Technologies, Inc.

Form 10-Q Quarterly Report
For the Quarter Ended March 31, 2002

TABLE OF CONTENTS


		Page
		Number

PART I.	Financial Information
Item 1	Financial Statements		3
	Condensed Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001		3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001		4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001		5
	Notes to Unaudited Condensed Consolidated Financial Statements		6
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3	Quantitative and Qualitative Disclosures About Market Risk		33
PART II.	Other Information
Item 1	Legal Proceedings		34
Item 2	Changes in Securities and Use of Proceeds		34
Item 3	Defaults Upon Senior Securities		34
Item 4	Submission of Matters to a Vote of Security Holders		34
Item 5	Other Information		34
Item 6	Exhibits and Reports on Form 8-K		34
	Signatures		35

PART I — FINANCIAL INFORMATION

ITEM I FINANCIAL STATEMENTS

LOUDEYE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except share and per share amounts)


			Mar. 31,			Dec. 31,
			2002			2001

			(Unaudited)
ASSETS
	Cash and cash equivalents		$	28,546		$	37,159
	Short-term investments			23,754			23,782
	Accounts receivable, net of allowances of $259 and $492			2,335			2,200
	Prepaid and other current assets			1,141			1,769

		Total current assets		55,776			64,910
	Property and equipment, net			7,412			7,306
	Goodwill, net			1,532			1,310
	Intangibles and other long-term assets, net			6,478			7,357

		Total assets	$	71,198		$	80,883

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
	Accounts payable		$	1,229		$	913
	Accrued compensation and benefits			997			1,439
	Other accrued expenses			1,269			1,859
	Accrued special charges			2,415			2,939
	Deposits and deferred revenues			334			639
	Current portion of long-term debt			1,446			1,368

		Total current liabilities		7,690			9,157
	Accrued acquisition consideration			3,000			3,000
	Long-term debt, net of current portion			19,582			19,532

		Total liabilities		30,272			31,689
	Commitments and contingencies
STOCKHOLDERS’ EQUITY (DEFICIT)
	Preferred stock, $0.001 par value, 41,000,000 shares authorized, none outstanding			—			—
	Common stock, additional paid-in capital and warrants, $0.001 par value, 100,000,000 shares authorized; 44,506,170 and 40,506,170 issued and outstanding in 2002 and 44,475,174 issued and 40,475,174 outstanding in 2001			191,484			192,627
	Deferred stock compensation			(370	)		(883	)
	Accumulated deficit			(150,188	)		(142,550	)

		Total stockholders’ equity		40,926			49,194

		Total liabilities and stockholders’ equity	$	71,198		$	80,883

The accompanying notes are an integral part of these statements.

LOUDEYE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Dollars in thousands except share and per share amounts)


			Three Months Ended
			March 31,

			2002			2001

REVENUES			$	3,260		$	1,929
COST OF REVENUES
	Cost of revenues, excluding depreciation			2,410			2,280
	Depreciation			835			991

		Total cost of revenues		3,245			3,271
		Gross margin		15			(1,342	)
OPERATING EXPENSES
	Research and development			1,290			2,670
	Sales and marketing			2,216			2,612
	General and administrative			3,475			2,750
	Amortization of intangibles and other assets			696			2,228
	Stock-based compensation			(656	)		893

				7,021			11,153
Special charges				748			14,623

OPERATING LOSS				(7,754	)		(27,118	)
OTHER INCOME (EXPENSE), net
	Interest income			333			1,262
	Interest expense			(217	)		(342	)

		Total other income		116			920

Net loss			$	(7,638	)	$	(26,198	)

Basic and diluted net loss per share			$	(0.19	)	$	(0.68	)

Weighted average shares outstanding
	- basic and diluted net loss per share			40,431,732			38,283,453

The accompanying notes are an integral part of these statements.

LOUDEYE TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Dollars in thousands except share and per share amounts)


				Three Months Ended
				March 31,

				2002			2001

Cash flows from operating activities:
	Net loss			$	(7,638	)	$	(26,198	)
	Adjustments to reconcile net loss to net cash from operating activities:
		Depreciation and amortization			1,733			4,191
		Special charges and other			20			13,630
		Stock-based compensation			(656	)		893
	Changes in operating assets and liabilities, net of amounts acquired in purchase of business:
		Accounts receivable			(135	)		2,110
		Prepaid expenses and other assets			830			(379	)
		Accounts payable			316			181
		Accrued compensation, benefits and other expenses			(791	)		1,344
		Accrued special charges			(524	)		—
		Deposits and deferred revenues			(305	)		(480	)

			Net cash from operating activities		(7,150	)		(4,708	)
Cash flows from investing activities:
	Purchases of property and equipment and other				(915	)		(2,060	)
	Cash paid for acquisition of business and technology, net				—			(4,219	)
	Sales (purchases) of short-term investments, net				28			6,605

			Net cash from investing activities		(887	)		326
Cash flows from financing activities:
	Proceeds from sale of stock and exercise of stock options, net				6			28
	Proceeds from long-term debt				—			131
	Principal payments on long-term debt				(232	)		(1,256	)
	Loans made to related party				(350	)		—

			Net cash from financing activities		(576	)		(1,097	)
			Net decrease in cash and cash equivalents		(8,613	)		(5,479	)
Cash and cash equivalents, beginning of period					37,159			51,689

Cash and cash equivalents, end of period				$	28,546		$	46,210

Supplemental disclosure of cash flow information:
Cash paid for interest				$	217		$	275
Issuance of common stock for acquisition of business and technology					—			6,750
Issuance of common stock and common stock warrants to strategic partners					—			50

The accompanying notes are an integral part of these statements.

LOUDEYE TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)

1. ORGANIZATION AND DEVELOPMENT STAGE RISKS

The Company

Loudeye Technologies, Inc. (the Company) provides enterprise webcasting, related digital media services and media restoration services. The Company is headquartered in Seattle, Washington and to-date has conducted business in the United States, Canada and Europe in two business segments, digital media services and media restoration services.

The Company is subject to a number of risks similar to other companies in a comparable stage of development including reliance on key personnel, successful marketing of its services in an emerging market, competition from other companies with greater technical, financial, management and marketing resources, successful development of new services, successful integration of acquired businesses and technology, the enhancement of existing services, and the ability to secure adequate financing to support future operations.

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Data

The interim condensed consolidated financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 28, 2002. The financial information included herein reflects all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the quarters ended March 31, 2002 and 2001 are not necessarily indicative of the results to be expected for the full years.

Cash and Cash Equivalents

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

Short-term Investments

The Company has invested amounts in investment-grade government obligations, institutional money market funds and other obligations with FDIC insured U.S. banks. Concentration is limited to 10% in any one instrument or issuer. The Company’s primary focus is to preserve capital and earn a market rate of return on its investments. The Company does not speculate or invest in publicly traded equity securities and, therefore, does not believe that its capital is subject to significant market risk. Short-term investments are generally held to maturity. These securities all mature within one year.

As described further in Note 7, an investment account that holds at least $30.0 million of short-term investments and cash equivalents is utilized as collateral for the Company’s credit facility. Additionally, the Company has approximately $1.4 million of short-term investments which are utilized as collateral for certain irrevocable standby letters of credit.

Long-lived Assets

The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances have made recovery of the asset’s carrying value unlikely. An impairment loss is recognized when the sum of the expected future undiscounted net cash flows over the remaining useful life is less than the carrying amount of the asset. As described in Note 4, the Company recorded impairment charges of $13.6 million in the quarter ended March 31, 2001.

The Company will continue to evaluate the recoverability of its long-lived assets in accordance with the above policy, however, as of March 31, 2002, no additional impairments are anticipated.

Reclassifications

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

3. REVENUE RECOGNITION

The Company generates revenues primarily from two sources: (1) digital media services, licensing and selling digital media applications and (2) media restoration services.

DIGITAL MEDIA SERVICES AND OTHER

Corporate Webcasting Services use licensed and proprietary streaming media software, tools and processes to provide corporations with the ability to communicate to their large, online communities over the Internet. Customers use these communication services to announce financial, legal, product and training information in real-time to thousands of investors, partners, employees and customers located all over the world. The Company recognizes revenues as services are rendered.

Encoding Services consist of encoding services to convert audio and video content into Internet media formats. Sales of digital media services are generally under nonrefundable time and materials or per unit contracts. Under these contracts, the Company recognizes revenues as services are rendered and the Company has no continuing involvement in the goods and services delivered, which generally is the date the finished media is shipped to the customer.

Other revenues are generated from the Company’s music samples service business. The Company sells digital media applications in application service provider arrangements. The Company is required to host the applications and the customer does not have the ability to have the application hosted by another entity without penalty to the customer. Billings are made based upon volumes of data delivered or minutes of content streamed, and revenue is recognized as the services are delivered.

MEDIA RESTORATION SERVICES

Media Restoration Services consist of services provided by the Company’s VidiPax subsidiary to restore and upgrade old or damaged archives of traditional media. The Company recognizes revenues as services are rendered and the Company has no continuing involvement in the goods and services delivered, which generally is the date the finished media is shipped to the customer.

4. SPECIAL CHARGES

The Company has recorded Special Charges in each of the six quarters ended March 31, 2002 related to ongoing corporate restructuring, facilities consolidations and the impairment of assets in accordance with

its long-lived asset policy (see Note 2). The following table summarizes such charges recorded in the three months ended March 31, 2002 and 2001:


	Three Months Ended
	March 31,

	2002		2001

	(in thousands)
Impairment of goodwill associated with the acquisition of Alive.com	$	—	$	10,612
Impairment of property and equipment related to video encoding operations		—		1,272
Impairment of deferred charge related to terminated customer agreement		—		781
Employee severance		748		682
Other		—		677
Impairment of duplicative music sampling platform		—		599

	$	748	$	14,623

Quarter ended March 31, 2002

The Company recorded special charges in the quarter ended March 31, 2002 associated with a reduction in force announced March 8, 2002 of approximately 12% of consolidated staffing. The special charge of $748,000 was for severance and related termination benefits incurred during the quarter. The Company does not anticipate future special charges at this time.

Quarter ended March 31, 2001

The Company recorded special charges in the quarter ended March 31, 2001 totaling $14.6 million related to the market trends at the time. The Company had experienced decreasing demand for its video services. Accordingly, the Company’s board of directors approved a plan to close the Company’s Santa Monica facility and reduce video production capacity in Seattle, which resulted in an impairment in the value of its video encoding equipment as well as existing tenant improvements at its Santa Monica facility which was closed in the first quarter of 2001. Management decided in the first quarter of 2001 to focus primarily upon audio or music related sources of revenues as that area appeared to be more fully developed. As a result of this decision, the Company will no longer provide and support certain products, and therefore, certain related assets became impaired. In accordance with its accounting policy for long-lived assets, the Company adjusted certain property, equipment and intangibles to estimated fair market value as of March 31, 2001.

The Company determined that due to the acquisition of an archival platform for music samples acquired from DiscoverMusic, the previously capitalized software costs associated with Loudeye’s separately developed music samples platform were redundant and not recoverable. Accordingly, since the code base developed by Loudeye will not be sold or otherwise used, it was determined to have no further value and the remaining unamortized cost, approximately $600,000, was adjusted to zero.

The Company also decided to cease supporting its Media Syndicator and Alive technology platforms in conjunction with the overall efforts to focus on the music related business opportunities. The goodwill previously recognized associated with the Alive.com acquisition became impaired as a result of the refocused business. Accordingly, the Company determined that an impairment analysis was necessary for these assets. As each of these assets had no determinable cash flows associated with them, they were deemed fully impaired and remaining unamortized balances totaling $10.9 million, were written off.

As of March 31, 2002, approximately $2.4 million was included in accrued expenses related to special charges recorded in 2002 and 2001. The following table represents a rollforward of the accrued special charges account. The Company believes that it will ultimately pay all of these accrued charges in cash.


	(in thousands)

December 31, 2001	$	2,939
Additional accruals		748
Paid in cash		(1,272	)

March 31, 2002	$	2,415

5. NET LOSS PER SHARE

In accordance with Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings Per Share,” basic earnings per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net loss by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of shares of common stock issuable upon the conversion of the convertible preferred stock (using the if-converted method) and shares issuable upon the exercise of stock options and warrants (using the treasury stock method); common equivalent shares are excluded from the calculation if their effect is antidilutive, which is the case in all periods presented. The Company has excluded the following numbers of shares using this method:


Options outstanding			6,777,327
Warrants outstanding			162,978

Shares excluded			6,940,305

The Company had 38,021 and 218,818 stock options outstanding that had been exercised but which were subject to repurchase at March 31, 2002 and 2001, respectively. The weighted average repurchase price of these options subject to repurchase was $0.21 and $0.34, at March 31, 2002 and 2001, respectively. The impact of these unvested but exercised options has been removed from the calculation of weighted average shares outstanding for purposes of determining basic and diluted earnings per share.

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


	Three Months Ended March 31,

	2002			2001

Weighted average shares outstanding		40,494,947			38,568,478
Weighting of shares subject to repurchase		(63,215	)		(285,025	)

Weighted average shares outstanding — basic and diluted earnings per share		40,431,732			38,283,453

6. CONCENTRATION OF RISK AND SEGMENT DISCLOSURES

Financial instruments that potentially subject the Company to concentrations of market risk consist of cash and cash equivalents, short-term investments and long-term obligations. Fair values of cash and cash equivalents and short-term investments approximate cost due to the short period of time to maturity. The fair values of financial instruments that are short-term and/or that have little or no market risk are

considered to have a fair value equal to book value. The Company maintains cash and cash equivalents on deposit at various institutions that at times exceed the insured limits by the Federal Deposit Insurance Corporation. This exposes the Company to potential risk of loss in the event the institutions become insolvent. The Company does not use derivative financial instruments; accordingly SFAS No. 133 has no impact on results.

The Company is exposed to credit risk since it extends credit to its customers. The Company performs initial and ongoing evaluations of its customers’ financial positions, and generally extends credit on open account, requiring collateral as deemed necessary.

During the quarters ended March 31, 2002 and 2001, the Company had sales to certain significant customers, as a percentage of revenues, as follows:


	Three Months Ended
	March 31,

	2002			2001

Customer A		—			25	%
Customer B		12	%		15	%

		12	%		40	%

The Company operates in two business segments, digital media services and media restoration services, for which the Company receives revenues from its customers. The Company’s Chief Operating Decision Maker is considered to be the Company’s Executive Team (CET) that is comprised of the Company’s Chief Executive Officer, Chief Financial Officer and certain of its Vice Presidents. The CET reviews financial information presented on a consolidated basis accompanied by disaggregated information about products and services for purposes of making decisions and assessing financial performance. The following table provides information about the Company’s segments.


	Three Months Ended March 31, 2002									Three Months Ended March 31, 2001

	Digital									Digital
	Media			Media						Media			Media
(in thousands)	Services			Restoration			Consolidated			Services			Restoration		Consolidated

Revenues	$	2,498		$	762		$	3,260		$	1,369		$	560	$	1,929
Gross margin		(332	)		347			15			(1,730	)		388		(1,342	)
Net loss		(7,595	)		(43	)		(7,638	)		(26,201	)		3		(26,198	)
Total assets	$	69,024		$	2,174		$	71,198		$	115,171		$	1,924	$	117,095

7. LONG-TERM DEBT, COMMITMENTS AND CONTINGENCIES

Long-term Debt

As of March 31, 2002, the Company’s principal commitments consisted of obligations outstanding under operating leases, capital leases and credit facilities with its bank. On August 22, 2001, the Company entered into a credit agreement with a bank providing for a revolving credit facility and letters of credit aggregating up to $15.0 million to be used for working capital and general corporate needs, and to refinance existing long-term debt. On October 25, 2001, the Credit Agreement was amended to increase the principal sum to $19.0 million. Obligations under the Credit Agreement are collateralized by a security interest in an investment account that must hold short-term investments and cash equivalents with a value of at least $30.0 million. The revolving facility requires monthly payments of interest only until maturity on July 31, 2003. On July 31, 2002, the Company has an option to extend the maturity date to July 31, 2004, provided that the Company is not in default at that time. At March 31, 2002, $19.0 million was outstanding

under the revolving facility.

Loans under the revolving facility bear interest, at the Company’s option, at the bank’s prime rate, or the London Interbank Offered Rate (“LIBOR”) plus 100 basis points. Our interest rate on the outstanding principal balance was 2.91% at March 31, 2002. The interest rates will be adjusted after each LIBOR term to reflect the LIBOR rate in effect at that time.

The Company has multiple other credit facilities and leasing arrangements that, in general, are not prepayable without penalty. Total amounts outstanding under these arrangements are $2.0 million as of March 31, 2002. The interest rates on these instruments range from 4.75% to 9.65%. The instruments have various maturity rates through November 2005. Letters of credit of approximately $800,000 back certain of these notes and capital lease obligations.

If certain events occur, such as the Company’s common stock not being listed on the Nasdaq National Market, the Company may be required to pay $1.5 million of the accrued acquisition consideration in cash instead of having the option to pay the entire $3.0 million balance with the Company’s common stock in September 2002.

8. LEGAL PROCEEDINGS

Between July 26, 2001 and August 30, 2001, several substantially similar class action complaints were filed in the United States District Court for the Southern District of New York against us and certain of our present and former officers and directors, as well as against certain underwriters who handled our March 15, 2000 initial public offering of common stock. The various complaints were purportedly filed on behalf of a class of persons who purchased our common stock during the time period beginning on March 15, 2000 and ending on December 6, 2000. The complaints together allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, primarily based on the allegation that there was undisclosed compensation received by our underwriters in connection with the our initial public offering and the allegation that the underwriters entered into undisclosed arrangements with some investors that were designed to distort and/or inflate the market price for our common stock in the aftermarket following the initial public offering. The allegations set forth in these complaints are substantially similar to those made in class actions filed against over 300 other companies that issued securities within the past three years. These actions have all been consolidated before the same judge for pretrial purposes. No specific amount of damages has been claimed. The individual defendants and we have demanded to be indemnified by the underwriter defendants pursuant to the underwriting agreement entered into at the time of the initial public offering.

The Company believes that the individual defendants and we have meritorious defenses to the claims made in the complaint and we intend to defend the actions vigorously. However, there can be no assurance that we will be successful on our defenses or in our assertion of indemnification, and an adverse resolution of the lawsuit could have a material adverse affect on our financial position and results of operation in the period in which the lawsuit is resolved. We are not presently able to reasonably estimate potential losses, if any, related to the lawsuit, although we do not believe it will have a material adverse impact on our financial condition or results of operations.

On May 8, 2001, the Company filed an arbitration demand with the American Arbitration Association (“AAA”) against Valley Media, Inc (“Valley”). The Company alleges that Valley is liable for substantial damages for material breaches of a Services Agreement between the companies dated as of December 17, 1999, in which Valley made representations and warranties and agreed to perform certain obligations to facilitate the creation of a venture to create and market an Internet music clip streaming service. The Company provided notice of its intent to terminate that agreement by letter dated February 6, 2001, and that termination was effective 30 days thereafter. The Company has also alleged claims for misrepresentation, fraud, unjust enrichment and promissory estoppel. Valley has filed an answer in which it denies liability, and asserts counterclaims for breach of contract, conversion, and declaratory relief. The arbitration was stayed by Valley’s filing of a petition in bankruptcy, and the company intends to pursue a claim in the bankruptcy proceedings.

The Company is subject to legal proceedings and claims that arise in the ordinary course of business. As of March 31, 2002, management is not aware of any asserted or pending litigation or claims against the Company that would have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

9. RELATED PARTY TRANSACTIONS

On October 26, 2001, the Company entered into an agreement with Martin and Alex Tobias, pursuant to which Loudeye purchased four million shares of Loudeye common stock from the Tobias’s for $2.0 million, or $0.50 per share, and also entered into a comprehensive agreement with the Tobias’s, including the extension of a $2.0 million secured line of credit to the Tobias’s (“the Loan”). The Loan is collateralized by liens on certain real property assets owned by Mr. Tobias, as well as all his remaining 4.6 million Loudeye shares. Under the terms of the agreement, the collateral shares will be restricted from public market sale, without Loudeye’s consent, until the later of January 31, 2003, or the full repayment of the Loan. The Loan matures June 30, 2003. As of March 31, 2002, there was $1,350,000 advanced under the credit line, which is presented in intangibles and other long-term assets in the accompanying balance sheets. In April 2002 another $400,000 was advanced under the credit line and subsequently Mr. Tobias made a Loan payment of $378,552. As of May 1, 2002, Mr. Tobias could draw an additional $250,000 under this arrangement.

In addition, if Mr. Tobias is unable to sell shares of Loudeye common stock so that the proceeds from these sales equal the lesser of (a) $500,000 or (b) the proceed from sales of 150% of the maximum number of shares that could have been sold by Mr. Tobias under Rule 144 during the calendar quarter multiplied by the Discounted Share Price (as defined below) (the “Minimum Liquidity Commitment”), then Mr. Tobias may require the Company to purchase shares from him at the Discounted Share Price so that his total proceeds for the quarter equal the Minimum Liquidity Amount. The Discounted Share Price is the lesser of (x) the average closing bid price of the Company’s common stock for the trailing 30 trading days or (y) 95% of the closing bid price of the Company’s common stock on the last trading day of the quarter. This right expires on the earlier of (i) three business days following June 30, 2003, (ii) repayment in full of the Loan or (iii) such time as Mr. Tobias ceases to be the beneficial or record owner of any shares of the Company’s common stock. Pursuant to the Minimum Liquidity Commitment, the Company bought 613,040 shares of its common stock from Mr. Tobias in April 2002 at a price of $0.6175 per share. As required by the agreements, Mr. Tobias used the $378,552 paid for those shares to reduce the outstanding balance of the Loan.

10. RECENT ACCOUNTING PRONOUNCEMENT

Effective January 1, 2002, the Company adopted FAS 142, “Goodwill and Other Intangible Assets,” (FAS 142) which stipulates that goodwill can no longer be amortized. FAS 142 also establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The initial phase of the impairment test is required to be completed by June 30, 2002, and if the fair value of the reporting unit is less than its carrying value, the second phase to determine the amount of the impairment is to be completed by December 31, 2002. Management is in the process of completing the goodwill impairment testing required by this standard. Management expects the impairment test to be completed within the timeframe stipulated by the pronouncement. At January 1, 2002, the Company had net goodwill of $1.3 million. The implementation of FAS 142 decreased amortization expense by approximately $459,000 in the three months ended March 31, 2002.

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

Forward-Looking Statements

Except for the historical information contained in this Report on Form 10-Q, the matters discussed herein, including, but not limited to management’s discussion and analysis of financial condition and results of operations in Item 2 hereof, and statements regarding regulatory approvals, operating results and capital requirements, are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, and are made under the safe harbor provisions thereof. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of terms like these or other comparable terminology. These forward-looking statements are only predictions and actual events or results may differ materially from those projected. Specific factors that could cause actual results to differ materially from those projected include, but are not limited to, uncertainties related to our early stage; uncertainties related to the effectiveness of our technology and the development of our products and services; dependence on and management of existing and future corporate relationships; dependence on licensed content and technology; dependence on proprietary technology and uncertainty of patent protection; management of growth; history of operating losses; future capital needs and uncertainty of additional funding; dependence on key personnel; intense competition; existing government regulations and changes in, or the failure to comply with, government regulations, and other risks detailed below, including the Risk Factors in Item 2, the Risk Factors set forth in our Annual Reports on Form 10-K, and those included from time to time in the Company’s other reports with the SEC and press releases, copies of which are available from the Company upon request. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to publicly release any revisions of the forward-looking statements contained herein to reflect events or circumstances after the date hereof. Readers are cautioned not to place undue reliance on these forward-looking statements, as our business and financial performance are subject to substantial risks and uncertainties.

Company Overview

We are a leading provider of services that facilitate the use of digital media for live and on-demand applications in enterprise communication, marketing and entertainment. Our services enable our customers to outsource the management and delivery of audio, video and other visual content on the Internet and other digital distribution platforms. Our technical infrastructure and proprietary applications comprise an end-to-end solution, including rich media application support, webcasting, hosting, storage, encoding, capture and media restoration. Our solutions reduce complexity and cost of internal solutions, while supporting a variety of digital media strategies and customer business models.

We provide our services via two primary business segments, Digital Media Services and Media Restoration Services.

Digital Media Services.Our Digital Media Services enable enhanced enterprise communication, digital media management and distribution via the Internet and other emerging technologies.

Our enhanced enterprise communication services include highly scalable, live and “on-demand” audio and video Webcasting services, supported by proprietary applications such as synchronized streaming slide presentation capabilities. Using our services, enterprises can offer small and large audiences access to Webcasts of a variety of corporate events, such as product launches, investor earnings calls, conferences and distance learning seminars. The target customers for these solutions include medium and large-sized enterprises across a range of industry segments. We recognize revenues as services are rendered.

Our other Digital Media Services encompass a variety of related services primarily focused on the digital music market, including digital music encoding, metadata licensing, audio fingerprint database generation, hosted music sample services, hosted music download services, digital rights management license clearing, online radio solutions and rich media advertisement insertion and sales. Supporting some of these offerings, we have certain music licenses and relationships with the five major recording labels and over 800 independent record labels. The target customers for our digital music services include traditional and Internet-based retailers, media & entertainment companies, including media portals, broadcasters, the major record labels and advertisers.

Sales of these other digital media services are generally under nonrefundable time and materials or per unit contracts. Under these contracts, we recognize revenues as services are rendered and we have no continuing involvement in the goods and services delivered, which generally is the date the finished media is shipped to the customer.

We sell our music samples service in application service provider arrangements. We are required to host the applications and the customer does not have the ability to have the application hosted by another entity without penalty to the customer. Billings are made based upon volumes of data delivered or minutes of content streamed, and revenue is recognized as the services are delivered.

Media Restoration Services.Our Media Restoration Services solutions address the need to restore and migrate legacy media archives to current media formats. The target customers for these services include many of the customers for our Digital Media Services as well as large legacy media archives, specifically including those found at major libraries, universities and enterprises. We recognize revenues as services are rendered and we have no continuing involvement in the goods and services delivered, which generally is the date the finished media is shipped to the customer.

One of our key strategies has been to pursue selectively strategic acquisitions to enter new markets, expand our suite of services and product offering, increase our customer base and strengthen our market position. In 2000 and 2001 we completed five acquisitions.

	•		Vidipax Acquisition.In June 2000, we acquired Vidipax, a New York company which performs audio and video media restoration and migration services. The acquisition price was $1.9 million in cash, 68,284 shares of common stock and an additional contingent payment in July 2001 of 2,189,111 shares.

	•		DiscoverMusic Acquisition.In March 2001, we acquired DiscoverMusic, a Seattle company which is the largest provider of music samples on the Internet. The acquisition price was $4.6 million in cash plus acquisition costs and accrued liabilities, net of DiscoverMusic’s cash, and 3,677,013 shares of common stock.

	•		Online Radio Acquisitions.In March and June 2001, we acquired the assets and technology of two online radio companies, OnAir Streaming Networks and theDial. The acquisition price was $2.2 million in cash and 645,096 shares of common stock.

	•		Addition Systems Acquisition.In June 2001, we acquired Addition Systems, Inc., a Los Angeles company which develops proprietary content insertion technology. The acquisition price was $1.5 million in cash plus acquisition costs and 550,000 shares of common stock.

	•		Activate Acquisition.In September 2001, we acquired Activate.net Corporation, a Seattle company which provides live and on-demand webcasting services for a variety of enhanced enterprise communication needs. The acquisition price was $1.0 million in cash, $2.4 million of assumed liabilities and a deferred payment of $3.0 million in stock or cash one year from the initial close of the transaction.

In 2001 we implemented operational consolidation and cost saving initiatives, which included the integration and realignment processes related to our acquisition activity. As a result of these initiatives, we consolidated our production operations from three separate facilities to the one facility acquired in the Activate transaction, and implemented a reduction in personnel. Details related to these initiatives are described in more detail below under Special Charges. We believe that as a result of these actions in 2001 and additional operational and management realignment actions taken in March 2002, gross margins and operating margins should improve.

We estimate that a significant majority of our cost of revenues, general and administrative expenses and research and development expenses are fixed or semi-fixed. Sales commissions are variable depending upon orders booked and when revenue is recognized. We have sustained losses on a quarterly and annual basis since inception and we expect to sustain losses for the foreseeable future as we invest in and grow our operations. As of March 31, 2002, we had an accumulated deficit of $150.2 million. Operating losses resulted from significant costs incurred in the development and sale of our products and services as well as significant non-cash charges related to stock-based compensation and amortization of intangibles and other assets. Special charges related to property and equipment impairments, intangibles impairments and facilities shut-downs have been a material component of operating losses as well. We expect our operating expenses to decrease on an annual basis as we execute our business plan.

We anticipate that operating expenses, as well as planned capital expenditures, debt repayments and any acquisitions, will constitute a material use of our cash resources in 2002. We expect to incur additional losses and continued negative cash flow from operations in 2002. We cannot assure you that we will achieve or sustain profitability or positive operating cash flow.

Our limited operating history makes the prediction of future operating results difficult. In view of our limited operating history and the early and rapidly evolving nature of our business, we believe that interim and annual period-to-period comparisons of our operating results are not meaningful and should not be relied upon as an indication of future performance. Our business prospects must be considered in light of the risks and uncertainties often encountered by early-stage companies in the Internet-related products and services market. We may not be successful in addressing these risks and uncertainties. We have experienced significant percentage growth in revenues in certain previous periods; however, we do not believe that prior growth rates or possibly even sequential quarterly growth are sustainable or indicative of future growth rates (see “Forward-Looking Statements”). In some future quarter our operating results may fall below our expectations as well as those of securities analysts and investors. In this event, the trading price of our common stock may fall significantly.

Results of Operations

Three Months Ended March 31, 2002 compared to 2001

Revenues. Revenues totaled $3.3 million and $1.9 million for the three months ended March 31, 2002 and 2001, respectively. The increase was due primarily to the acquisition of DiscoverMusic in March 2001 and the acquisition of Activate in September 2001.

We recorded approximately $1.1 million from our Webcasting services in the first quarter of 2002. In addition, we recognized three months of revenues in the quarter ended March 31, 2002 from the music sample service acquired from DiscoverMusic in March 2001 compared to one month in the first quarter of 2001. This service contributed approximately $400,000 to the increase in revenues compared to the same period in 2001. We also recognized revenues of approximately $260,000 in the first quarter of 2002 associated with the termination of a service contract. Payment had previously been received under this contract and a portion of it was included in deferred revenues at December 31, 2001. The increases described above were offset by amounts related to products and services that were supported in 2001, but are no longer supported. Such products and services represented approximately $400,000 in revenues in the quarter ended March 31, 2001. We also generated a lower level of revenues from encoding services as compared to the prior year. We expect total revenues to increase each quarter throughout 2002.

Media restoration revenues totaled $762,000 in 2002, as compared to $560,000 in 2001. This increase was the result of increased orders from customers, notably Coca-Cola, which provided approximately 12% of consolidated revenues in the first quarter of 2002. We expect revenues generated from VidiPax to increase each quarter in 2002.

Cost of Revenues. Cost of revenues decreased to $3.2 million in the three months ended March 31, 2002 from $3.3 million in the period ended March 31, 2001. Costs, excluding depreciation and amortization, to generate the revenues described above increased to $2.4 million in 2002 from $2.3 million in 2001. This was primarily due to the significantly lower number of personnel involved in digital media services production, more than offset by increases in personnel and other expenses as a result of the acquisition of Activate. This reduction in headcount came as a result of the completion of our digital media archive system, which has allowed us to fulfill digital music encoding orders in a more automated manner rather than the historical method requiring significant manual processing. The non-cash component of cost of revenues, which is primarily depreciation, decreased to $835,000 from $1.0 million in the first quarter of 2001 as a result of the property and equipment write-downs recorded during 2001. We believe that margins should improve as a result of the consolidation of our production operations from three separate facilities to one facility and the related reduction in personnel. This integration should result in lower overhead costs. We expect margins on traditional service offerings to improve as product mix changes towards enterprise webcasting, subscription services and offerings based upon our archival systems platform. Additionally, our margins should improve on a quarterly basis as production efficiency increases. We expect our capacity to be more fully utilized as our recently increased sales force realizes greater market penetration.

Media restoration cost of sales totaled $415,000 in 2002, an increase from $171,000 in 2001. The increase rose at a higher percentage rate than revenues due to the incremental fixed nature of adding equipment and personnel necessary to generate the increased revenues. Additionally, the facility expansion at VidiPax has led to higher levels of depreciation on a comparative basis. We expect the margins on media restoration services to remain relatively unchanged in the future.

Research and Development Expenses.Research and development expenses totaled $1.3 million and $2.7 million in the three months ended March 31, 2002 and 2001, respectively. The decrease over the same period in 2001 is primarily due to the significant reduction in the number of development personnel as a result of the corporate restructurings. Costs of enhancing webcasting offerings, the continued support of our music platform and the continued development of online radio technology and other applications and service offerings comprised a majority of our research and development expenses in 2002.

We believe that continued investment in research and development is critical to attaining our strategic objectives. However, due to our operational restructuring and focus on digital audio opportunities and enterprise webcasting services, development headcount was significantly reduced and, as a result, we expect research and development expenses to decline in 2002 compared to 2001. We had no media restoration services costs classified as research and development.

Sales and Marketing Expenses.Sales and marketing expenses totaled $2.2 million and $2.6 million in the three months ended March 31, 2002 and 2001, respectively. Sales and marketing expenses consist primarily of salaries, commissions, co-marketing expenses, trade show expenses, product branding costs, advertising and cost of marketing collateral. The decrease in sales and marketing expenses was primarily due to the decreased personnel subsequent to our January 2001 reduction in force partially offset by an increase in sales and marketing expenses from our acquisition of Activate.

Media restoration services sales and marketing expenses totaled $46,000 and $64,000 in 2002 and 2001, respectively.

General and Administrative Expenses. General and administrative expenses totaled $3.5 million and $2.8 million in the three months ended March 31, 2002 and 2001, respectively. General and administrative expenses consist primarily of unallocated rent, facilities and information technology charges, salaries, legal expenses, investor relation costs, and other costs associated with being a public company. The increase over the same period in 2001 reflects the impact of integrating of Activate’s operations. We expect future

levels of general and administrative expenses to decrease slightly from the first quarter of 2002 as the full impact of our restructuring is realized.

Amortization of Intangibles and Other Assets.Amortization of intangibles and other assets totaled $696,000 and $2.2 million in the three months ended March 31, 2002 and 2001, respectively, and includes amortization of goodwill and identified intangible assets related to past acquisitions. The decrease was primarily due to the impairment charges recorded during 2001, which led to lower balances of intangible assets, and in turn, lower amortization charges. In addition. effective January 1, 2002, the Company adopted FAS 142, which stipulates that goodwill can no longer be amortized. Amortization expense decreased by $459,000 as a result of the implementation of FAS 142.

Stock-Based Compensation. Stock-based compensation charges were lower as a result of previous reductions in force. These reductions have resulted in significant reversals of previously recorded deferred stock compensation associated with the terminated employees. We expect future amortization of deferred stock compensation to decline on a monthly basis. Future stock-based compensation charges may vary as a result of variable accounting following our option exchange in the third quarter of 2001. Additionally, as a result of stock option cancellations, we recorded a stock-based compensation credit of $835,000 in the first quarter of 2002. The remaining charge was due to normal, recurring amortization totaling $179,000.

Special Charges.We have recorded Special Charges in each of the six quarters ended March 31, 2002 related to ongoing corporate restructuring, facilities consolidations and the impairment of assets in accordance with our long-lived asset policy (see Note 2). The following table summarizes such charges recorded in the three-month periods ended March 31, 2002 and 2001:


	Three Months Ended
	March 31,

	2002		2001

	(in thousands)
Impairment of goodwill associated with the acquisition of Alive.com	$	—	$	10,612
Impairment of property and equipment related to video encoding operations		—		1,272
Impairment of deferred charge related to terminated customer agreement		—		781
Employee severance		748		682
Other		—		677
Impairment of duplicative music sampling platform		—		599

	$	748	$	14,623

Quarter ended March 31, 2002

We recorded special charges in the quarter ended March 31, 2002 associated with a reduction in force announced March 8, 2002 of approximately 12% of consolidated staffing. The special charge of $748,000 was for severance and related termination benefits incurred during the quarter. We do not anticipate future special charges at this time.

Quarter ended March 31, 2001

We recorded special charges in the quarter ended March 31, 2001 totaling $14.6 million related to the market trends at the time. We had experienced decreasing demand for our video services. Accordingly, our board of directors approved a plan to close our Santa Monica facility and reduce video production capacity in Seattle, which resulted in the impairment of our video encoding equipment as well as existing tenant improvements at our Santa Monica facility that was closed in the first quarter of 2001. Management decided in the first quarter of 2001 to focus primarily upon audio or music related sources of revenues as that area appeared to be more fully developed. As a result of this decision, we no longer provides and supports certain products, and therefore, related assets became impaired. In accordance with our accounting policy for long-lived assets, we adjusted certain property, equipment and intangibles to estimated fair market value as of March 31, 2001.

We determined that due to the acquisition of DiscoverMusic, the previously capitalized software costs associated with our separately developed music samples platform were redundant and not recoverable. Accordingly, since the code base developed by us will not be sold or otherwise used, it was determined to have no further value and the remaining unamortized cost, approximately $600,000, was adjusted to zero.

We also decided to cease supporting certain digital media technology platforms in conjunction with the overall efforts to focus on the music related business opportunities. The goodwill previously recognized associated with the Alive.com acquisition became impaired as a result of the refocused business. Accordingly, we determined that an impairment analysis was necessary for these assets. As each of these assets had no determinable cash flows associated with them, they were deemed fully impaired and remaining unamortized balances totaling $10.9 million, were written off.

Interest Income.Interest income representing earnings on our cash, cash equivalents and short-term investments totaled $333,000 and $1.3 million in the three months ended March 31, 2002 and 2001, respectively. The decreased income was due primarily to the lower average cash and investment balances in 2002 as well as the lower interest rates. We expect that our interest income will decrease in the future as our cash balances are used to fund our operating, investing and financing activities.

Interest Expense.Interest expense consists of interest expense related to our debt instruments as well as amortization of financing charges related to our debt instruments. This totaled $217,000 and $342,000 in the three months ended March 31, 2002 and 2001, respectively. The decrease was due primarily to lower interest rates partially offset by higher borrowed balances.

Liquidity and Capital Resources

As of March 31, 2002, we had approximately $52.3 million of cash, cash equivalents and short-term investments. A portion of these funds is held in an investment account that serves as collateral for the credit facility. Pursuant to the terms of that facility, we are required to keep at least $30.0 million in that investment account.

Net cash used in operating activities was $7.2 million and $4.7 million in the quarters ended March 31, 2002 and 2001, respectively. For 2002, cash used in operating activities resulted primarily from a net loss of $7.6 million, working capital and other changes totaling $85,000, partially offset by non-cash charges totaling $1.1 million related to stock-based compensation, depreciation and amortization and other. Additional uses of cash related to the approximately $1.0 million in severance related payments and approximately $524,000 in rent and other payments for previously accrued special charges. For 2001, cash used in operating activities resulted primarily from a net loss of $26.2 million, a decrease of approximately $2.1 million in accounts receivable and an increase in accrued compensation, benefits and other expenses of $1.3 million, partially offset by non-cash charges totaling $18.7 million related to stock-based compensation, depreciation and amortization, and the non-cash component of the special charges.

Net cash used in investing activities was $887,000 in the quarter ended March 31, 2002, and net cash provided of $326,000 in the quarter ended March 31, 2001. For 2002, cash used in investing activities was primarily related to purchases of property and equipment including tenant improvements at the Activate offices prior to facilities consolidation. For 2001, cash provided by investing activities was primarily related to the net sales of short-term investments, partially offset by purchases of property and equipment and cash paid for the acquisition of DiscoverMusic and certain assets and technology of OnAir in March 2001.

Net cash provided by financing activities was $576,000 and $1.1 million in the quarters ended March 31, 2002 and 2001, respectively. The cash used in financing activities in 2002 primarily resulted from $232,000 in principal payments of our long-term debt as well as $350,000 of additional funding of a secured related party loan. In 2001, financing activities consisted primarily of $1.3 million in long-term debt principal payments.

As of March 31, 2002, our principal commitments consisted of obligations outstanding under operating leases, capital leases and credit facilities with our bank. On August 22, 2001, we entered into a credit agreement with a bank providing for a revolving credit facility and letters of credit aggregating up to $15.0 million to be used for working capital and general corporate needs, and to refinance existing long-term debt. On October 25, 2001, the Credit Agreement was amended to increase the principal sum to $19.0 million. Obligations under the Credit Agreement are collateralized by a security interest in an investment account that must hold short-term investments and cash equivalents with a value of at least $30.0 million. The revolving facility requires monthly payments of interest only until maturity on July 31, 2003. On July 31, 2002, we have an option to extend the maturity date to July 31, 2004, provided that we are not in default at that time. At March 31, 2002, $19.0 million was outstanding under the revolving facility.

Loans under the revolving facility bear interest, at our option, at the bank’s prime rate, or the London Interbank Offered Rate (“LIBOR”) plus 100 basis points. Our interest rate on the outstanding principal balance was 2.91% at March 31, 2002. The interest rates will be adjusted after each LIBOR term to reflect the LIBOR rate in effect at that time.

We have multiple other credit facilities and leasing arrangements that, in general, are not prepayable without penalty. Total amounts outstanding under these arrangements are $2.0 million as of March 31, 2002. The interest rates on these instruments range from 4.75% to 9.65%. The instruments have various maturity rates through November 2005. Letters of credit of approximately $800,000 back certain of these notes and capital lease obligations.

We believe that our existing cash, cash equivalents and short-term investments will be sufficient to fund our operations and meet our working capital and capital expenditure requirements during 2002. Thereafter, if we cannot fund operating and other expenses, working capital and capital expenditure requirements from our operations, we may find it necessary to obtain additional equity or debt financing, sell assets or reduce spending plans. In the event additional equity or debt financing is required, we may not be able to raise or borrow it on acceptable terms, or at all.

Since our inception, our operating expenses have significantly increased in order to support our growth. We currently anticipate that such expenses will continue to be a material use of our cash resources. We expect that the following items may be a significant use of our capital resources in 2002:

	•		Capital expenditures, excluding acquisitions, are expected to total approximately $1.0 million in the remainder of calendar year 2002.

	•		Acquisition consideration resulting from the Activate.net acquisition in September 2001, totaling $3.0 million is due in September 2002. This can be settled in a combination of stock and cash. If certain events occur, such as our common stock not being listed on the Nasdaq National Market, we may be required to pay $1.5 million of this consideration in cash.

	•		Additional commitments are outstanding under the existing facilities leases that have previously been expensed by us in the special charges. We expect to pay approximately $1.3 million in rental charges during the remainder of 2002 for the facilities that we no longer occupy.

	•		Under our secured loan agreement with Martin Tobias, we made advances of $350,000 in loans in March 2002, $400,000 in April 2002, and may extend up to an additional $250,000 in 2002.

CRITICAL ACCOUNTING POLICIES

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

Long-lived Assets.Management periodically evaluates the recoverability of its long-lived assets in accordance with SFAS No. 121, as amended by SFAS No. 144. When doing so, management is required to evaluate the recoverability of an asset’s (or group of asset’s) carrying value through estimates of undiscounted future cash flows. If the assets are deemed impaired, they are written down to estimated fair value. There is a risk that projected cash flows may be different than actual cash flows, particularly in light of the rapidly changing environment in which the company operates, or that the estimates of fair value differ from the actual amount that could be realized if the Company were to sell its assets.

Exit Costs. The company follows the provisions of Emerging Issues Task Force (EITF) 94-3 to record the costs associated with exit activities. Management is required to make its best estimates of exit costs such as remaining lease obligations and/or termination fees. These estimates may be different than the actual amounts that will be paid under existing lease arrangements.

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

Digital media services and other. The Company recognizes enterprise Webcasting services revenues as services are rendered. We recognize encoding services revenues when the services have been rendered and the Company has no continuing involvement in the goods and services delivered, which generally is the date the finished media is shipped to the customer. Other revenues are generated from our music samples service business and in the prior year from licensing and selling of software and through application service provider arrangements. We sell services in application service provider arrangements. We are required to host the applications and the customer does not have the ability to have the application hosted by another entity without penalty to the customer. Billings are made based upon quantity of volume of data delivered or minutes of content streamed, and revenue is recognized as the services are delivered.

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

We believe that our revenue recognition policy is consistent with the provisions of Staff Accounting Bulletin No. 101, “Revenue Recognition.”

RECENT ACCOUNTING PRONOUNCEMENTS

Effective January 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” (FAS 142) which stipulates that goodwill can no longer be amortized. FAS 142 also establishes a new method of testing goodwill for impairment on an annual basis or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. The initial phase of the impairment test is required to be completed by June 30, 2002, and if the fair value of the reporting unit is less than its carrying value, the second phase to determine the amount of the impairment is to be completed by December 31, 2002. Management is in the process of completing the goodwill impairment testing required by this standard. Management expects the impairment test to be completed within the timeframe stipulated by the pronouncement. At January 1, 2002, the Company had net goodwill of $1.3 million. The implementation of FAS 142 decreased amortization expense by approximately $459,000 in the three months ended March 31, 2002.

In August 2001, the FASB issued FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” effective for the Company on January 1, 2002. This Statement supersedes FASB Statement

No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” and other related accounting guidance. This had no impact on our financial statements.

RISK FACTORS

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

Loudeye was formed as a limited liability company in August 1997 and incorporated in March 1998. Following our acquisition of Activate in 2001, we began to place greater emphasis on our enterprise Webcasting services. We therefore still have a very limited operating history upon which an investor may evaluate our operations and future prospects, as well as limited insight into trends that may emerge and affect our business. In addition, the revenue and income potential of our business and market are unproven. Because of the emerging nature of the industry, our executives have limited experience in it. As a young company operating in an emerging industry, we face risks and uncertainties relating to our ability to implement our business plan successfully. Our potential for future profitability must be considered in light of these risks, uncertainties and difficulties.

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

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

	•		Variability in demand for our Webcasting services and our other digital media services and applications;

	•		Market acceptance of new Webcasting and other digital media services and applications offered by us and our competitors;

	•		Ability of our customers to procure necessary intellectual property rights for the digital media content they intend to utilize in their businesses;

	•		Willingness of our customers to enter into longer-term volume digital media and applications service agreements and purchase orders in light of the economic and legal uncertainties related to their business models;

	•		Governmental regulations affecting use of the Internet, including regulations concerning intellectual property rights and security measures; or

	•		Competition from other companies entering our markets.

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

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

As of March 31, 2002, we had approximately $52.3 million in cash, cash equivalents and short-term investments, $30.0 million of which is used as collateral for our credit facility. We believe that our existing and available funds will be sufficient to meet the anticipated needs for our operations, working capital, debt service and capital expenditures through 2002. Thereafter, we may need to raise additional funds. We may have to raise funds even sooner in order to fund more rapid expansion, to develop new or enhanced services or products, to respond to competitive pressures, to acquire complementary products, businesses or technologies or otherwise to respond to unanticipated requirements. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our current stockholders will be reduced and these securities may have rights and preferences superior to that of our current stockholders. If we raise capital through debt financing, we may be forced to accept restrictions affecting our liquidity, including restrictions on our ability to incur additional indebtedness or pay dividends. We cannot assure you that additional financing will be available on favorable terms or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to pursue our business objectives. This inability could seriously harm our business, results of operations and financial condition.

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

We have incurred quarterly net losses totaling $136.0 million from August 12, 1997 (inception) through March 31, 2002, and we expect to continue to incur net losses for the foreseeable future. As of March 31, 2002, we had an accumulated deficit of $150.2 million. We may increase our operating expenses and capital expenditures in the future as we attempt to expand our Webcasting services, digital media service and application offerings, enter into licensing agreements with copyright holders, grow our customer base, enhance our brand image and improve our technology infrastructure. This would likely increase our quarterly net losses and negative cash flows.

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

	•		Achieve broad customer adoption and acceptance of our products and services;

	•		Successfully integrate our acquisition of Activate and execute our Webcasting services strategy;

	•		Successfully integrate, leverage and expand our sales force;

	•		Incorporate our online radio technology strategy;

	•		Successfully scale our current operations;

	•		Implement and execute our business and marketing strategies;

	•		Address copyright issues that effect our business;

	•		Develop and maintain strategic relationships to enhance our products and services;

	•		Respond to competitive developments in the digital media infrastructure industry;

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

Even if we ultimately do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

Our stock price has been and may continue to be volatile and is likely to be subject to National Market listing compliance proceedings with Nasdaq

The trading price of our common stock has been and is likely to continue to be highly volatile. For example, during the 52-week period ended April 30, 2002, the price of our common stock ranged from $0.32 to $1.97 per share. Our stock price could be subject to wide fluctuations in response a variety of factors, including, but not limited to, to actual or anticipated variations in quarterly operating results, competitors announcements, changes in recommendations by securities analysts, and conditions in the digital media services markets.

Our stock price has traded below $1.00 per share for over 30 consecutive trading days and on April 2, 2002 we received notice from Nasdaq that we need to comply with the $1.00 minimum bid requirement for continued listing on the Nasdaq National Market for 10 consecutive trading days by July 1, 2002 or be moved to, and traded on, the Nasdaq SmallCap Market. We believe the Company currently meets all listing requirements of the Nasdaq National Market, except the $1.00 minimum bid price. If our stock listing is transitioned to the Nasdaq SmallCap Market, we would have up to 360 days from April 2, 2002 to trade above $1.00 per share for 30 consecutive trading days. If we fail to do that, we would be delisted from Nasdaq and would most likely be quoted on the OTC Bulletin Board. If our stock is removed from the Nasdaq National Market or the Nasdaq SmallCap Market, an investor could find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock. Additionally, our stock may be subject to “penny stock” regulations.

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

Our business and operations are substantially dependent on the performance of our executive officers and key employees, all of whom are employed on an at-will basis and have worked together for only a relatively short period of time. We do not maintain “key person” life insurance on any of our executive officers. In addition, we hired or named new employees in 2001 in key executive positions, including our John Baker, our Chief Executive Officer, and Joel McConaughy, our Senior Vice President and Chief Technical Officer. The loss of one or several key executives could seriously harm our business. Any reorganization or reduction in the size of our employee base could harm our ability to attract and retain other valuable employees critical to the success of our business.

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

We expect to continue to evaluate and acquire businesses, technologies, services, or products that we believe are a strategic fit with our business. In December 1999, we acquired Alive.com, Inc., in June 2000 we acquired VidiPax, Inc., in June 2001 we acquired Addition Systems, Inc., in March 2001 we acquired DiscoverMusic, and in September 2001 we acquired Activate. We have also acquired certain assets and technology from OnAir and theDial.com. We have limited operating history as a combined company and therefore limited experience in addressing emerging trends that may affect our combined business. The integration of these and any future acquisitions into our operations may place a significant strain on our employees, systems and other resources. If any acquisition fails to integrate well, our operations and financial position could be harmed.

Acquisitions require integrating the business, personnel, technology and products of the acquired entity and may result in unforeseen operating difficulties and expenditures. In addition, acquisitions may absorb significant management attention that would otherwise be available for ongoing development of our business. Moreover, we cannot assure you that the anticipated benefits of any acquisition will be realized. Acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, the assumption of known and unknown liabilities associated with the acquired business, or amortization

expenses related to intangible assets and the incurrence of large and immediate write-offs, any of which could seriously harm our business, results of operations and financial condition.

Our acquisition of Activate could cause significant dilution to existing stockholders which could decrease the trading price of our common stock

As a result of the Activate acquisition, we will be required to make payments totaling $3.0 million on or about September 25, 2002. Pursuant to the merger agreement, we can make this payment in either cash or stock or a combination of the two; provided, however, we may not issue more than 15% of our outstanding capital stock in payment of such obligation, calculated post-issuance. Our existing stockholders, therefore, could face significant dilution if we elect to issue the maximum permissible amount of stock in making such payment.

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

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

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

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

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

A limited number of customers have accounted for a significant portion of our revenues and may continue to do so for the foreseeable future. During the quarter ended March 31, 2002, one of our customers accounted for 12% of our revenues and during the quarter ended March 31, 2001, two of our customers accounted for approximately 40% of our revenues. We believe that a small number of customers may continue to account for a significant percentage of our revenues for the foreseeable future. Due to high revenue concentration among a limited number of customers, the cancellation, reduction or delay of a large customer order or our failure to timely complete or deliver a project during a given quarter is likely to significantly reduce revenues. In addition, if any significant customer fails to pay amounts it owes us, or

does not pay those amounts on time, our revenues and operating results could suffer. If we are unsuccessful in increasing and broadening our customer base, our business could be harmed.

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

The average selling prices of our products and services may be lower than expected as a result of competitive pricing pressures, promotional programs and customers who negotiate price reductions in exchange for longer term purchase commitments or otherwise. The pricing of services sold to our customers depends on the duration of the agreement, the specific requirements of the order, purchase volumes, the sales and service support and other contractual agreements. We have experienced and expect to continue to experience pricing pressure and anticipate that the average selling prices and gross margins for our products will decrease over product life cycles. We may not be successful in developing and introducing on a timely basis new products with enhanced features that can be sold at higher gross margins.

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

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

	•		If the content or the performance of our services violates third party copyright, trademark, or other intellectual property rights;

	•		If our customers violate the intellectual property rights of others by providing content to us or by having us perform digital media services; or

	•		If content that we encode or otherwise handle for our customers is deemed obscene, indecent, or defamatory.

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

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

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

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

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

In addition, we could be subject to intellectual property infringement claims by others. Potential customers may be deterred from distributing content over the Internet for fear of infringement claims. The music industry in particular has recently been the focus of heightened concern with respect to copyright infringement and other misappropriation claims, and the outcome of developing legal standards in that industry is expected to impact music, video and other content being distributed over the Internet. If, as a result, potential customers forego distributing traditional media content over the Internet, demand for our digital media services and applications could be reduced which would harm our business. The music industry in the U.S. is generally regarded as extremely litigious in nature compared to other industries and we could become engaged in litigation with others in the music industry. Claims against us, and any resultant litigation, should it occur in regard to any of our digital media services and applications, could subject us to significant liability for damages including treble damages for willful infringement. In addition, even if we prevail, litigation could be time-consuming and expensive to defend and could result in the diversion of our time and attention. Any claims from third parties may also result in limitations on our ability to use the intellectual property subject to these claims. Further, we plan to offer our digital media services and applications to customers worldwide including customers in foreign countries that may offer less protection for our intellectual property than the United States. Our failure to protect against misappropriation of our intellectual property, or claims that we are infringing the intellectual property of third parties could have a negative effect on our business, revenues, financial condition and results of operations.

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

We and certain of our current or former officers and directors are named as defendants in a purported class action complaint which has been filed allegedly on behalf of certain persons who purchased our common stock during the time period beginning on March 15, 1999 and ending on December 6, 2000. The complaint alleges violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.

Primarily it alleges that there was undisclosed compensation received by our underwriters in connection with our initial public offering. We can provide no assurance as to the outcome of this matter. Any resolution of this matter in a manner adverse to us could have a material adverse affect on our financial position and results of operation. In addition, the costs to us of defending any litigation or other proceeding, even if resolved in our favor, could be substantial. Such litigation could also substantially divert the attention of our management and our resources in general. Uncertainties resulting from the initiation and continuation of any litigation or other proceedings could harm our ability to compete in the marketplace. In addition, because class action litigation has often been brought against companies following periods of volatility in their stock prices, we could become involved in additional litigation.

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

Our ability to provide our services to users of multiple technologies and platforms depends significantly on our ability to develop and maintain our strategic relationships with key streaming media technology companies and content providers. We rely on these relationships for licensed technology and content. We also rely on relationships with major recording labels for our music content licensing strategy. Obtaining

comprehensive music content licenses is challenging, as doing so may require us to obtain copyright licenses with various third parties in the fragmented music recording and publishing industries. These copyrights often address differing activities related to the delivery of digital media, including reproduction and performance, some of which may require separate licensing arrangements from various rights holders such as publishers, artists and record labels. The effort to obtain the necessary rights by such third parties is often significant, and could disrupt, delay, or prevent us from executing our business plans. Because of the large number of potential parties from which we must obtain licenses, we may never be able to obtain a sufficient number of licenses to allow us to provide services that will meet our customers’ expectations.

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

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

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

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

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

	•		Service functionality, quality and performance;

	•		Ease of use, reliability, scalability and security of services;

	•		Establishing a significant base of customers and distribution partners;

	•		Ability to introduce new services to the market in a timely manner;

	•		Customer service and support;

	•		Attracting third-party web developers; and

	•		Pricing.

Although we do not currently compete against any one entity with respect to all aspects of our digital media services, there are two principal types of companies we do compete with: enterprise Webcasting companies and digital media services companies.

Enterprise Webcasting Competition. Our primary competitors are content distribution networks, such as Akamai and iBEAM, and Internet broadcasters, such as Yahoo!Broadcast. Each of these companies provide services similar to ours and each has a well-established market presence. We also compete with providers of traditional communications technologies, such as teleconferencing and videoconferencing, as

well as applications software and tools companies, such as Centra Software, Evoke Communications, Lotus (SameTime), Microsoft (NetMeeting) and Placeware. There are also smaller competitors that focus on certain of our individual market segments, such as investor relations webcasts.

Other Digital Media Services Competition. There are a number of companies that provide outsourced digital media services. As the digital media services market continues to develop, we expect to see increased competition from traditional telecommunication service providers or resellers of those services. We also face competition from the in-house encoding services, streaming networks and content management systems and encoding services.

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

Our industry is experiencing consolidation that may intensify competition

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

	•		Competitors could acquire or enter into relationships with companies with which we have strategic relationships and discontinue our relationship, resulting in the loss of distribution opportunities for our products and services or the loss of certain enhancements or value-added features to our products and services;

	•		Competitors could obtain exclusive access to desirable multimedia content and prevent that content from being available in certain formats, thus decreasing the use of our products and services to distribute and experience the content that audiences most desire, and hurting our ability to attract customers;

	•		Suppliers of important or emerging technologies could be acquired by a competitor or other company which could prevent us from being able to utilize such technologies in our offerings, and disadvantage our offerings relative to those of competitors;

	•		A competitor could be acquired by a party with significant resources and experience that could increase the ability of the competitor to compete with our products and services; and

	•		Other companies with related interests could combine to form new, formidable competition, which could preclude us from obtaining access to certain markets or content; or which could dramatically change the market for our products and services.

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

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

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

	•		Obtain the necessary intellectual property rights from music companies and other content owners to be able to legally provide our services;

	•		Identify and respond to emerging technological trends in the market;

	•		Enhance our products by adding innovative features that differentiate our digital media services and applications from those of our competitors;

	•		Acquire and license leading technologies;

	•		Bring digital media services and applications to market and scale our business on a timely basis at competitive prices; and

	•		Respond effectively to new technological changes or new product announcements by others.

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

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

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

	•		Damage our reputation;

	•		Cause our customers to initiate product liability suits against us;

	•		Increase our product development resources;

	•		Cause us to lose sales; and

•

Delay market acceptance of our digital media services and applications.

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

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

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

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

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

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

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

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

Our officers and directors beneficially own or control the voting of approximately 23% of our outstanding common stock. Martin Tobias, our former chief executive officer and former member of the board of directors, has given the board of directors, an irrevocable proxy to vote all of the approximately 4.0 million shares of our Common Stock that he owns. See Notes to Consolidated Financial Statements and our Report on Form 8-K as filed with the Securities and Exchange Commission on October 30, 2001 for a more complete description of the proxy. As a result, these stockholders, acting together, have the ability to substantially influence all matters submitted to our stockholders for approval, including:

	•		Election or removal of our board of directors;

	•		Amendment of our certificate of incorporation or bylaws; and

	•		Adoption of measures that could delay or prevent a change in control or impede a merger, takeover or other business combination involving us.

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

Certain provisions of our certificate of incorporation and bylaws and the provisions of Delaware law could also have the effect of delaying, deferring or preventing an acquisition of Loudeye, even if an acquisition would be beneficial to our stockholders. See “Description of Capital Stock” for more information on our charter and by-law provisions.

Government regulation could adversely affect our business prospects

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

	•		Limiting the growth of the Internet;

	•		Creating uncertainty in the marketplace that could reduce demand for our products and services;

	•		Increasing our cost of doing business;

	•		Exposing us to significant liabilities associated with content distributed or accessed through our products or services; or

	•		Leading to increased product and applications development costs, or otherwise harm our business.

Specifically with respect to one aspect of copyright law, on October 28, 1998, the Digital Millennium Copyright Act (or “DMCA”) was enacted. The DMCA includes statutory licenses for the performance of sound recordings and for the making of recordings to facilitate transmissions. Under these statutory licenses, depending on our future business activities, we and our customers may be required to pay licensing fees in connection with digital sound recordings we deliver or our customers provide on their web

site and through retransmissions of radio broadcasts and/or other audio content. A Copyright Arbitration Royalty Panel has determined that, for eligible non-subscription services, sound recording performance rates should be $0.0014 per performance for the period October 1998-2000, with a surcharge of 9% of the total performance fee for the ephemeral copies used to facilitate such performances. However, that decision is subject to review and revision by the U.S. Copyright Office, and several appeal petitions have been filed. Furthermore, the Copyright Office’s review is subject to an appeal to a Federal Court of Appeals. The fees for the same types of transmissions offered on a subscription basis have not been determined and will be the subject of another Copyright Arbitration Royalty Panel proceeding, as will fees for digital phono-record deliveries pursuant to the “mechanical license” provisions of the U.S. Copyright Act. Depending on the rates and terms adopted for the statutory licenses, our business could be harmed both by increasing our own cost of doing business, and by increasing the cost of doing business for our customers.

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We provide Internet media infrastructure services and applications as well as media restoration services. Our financial results could be affected by factors such as changes in interest rates and fluctuations in the stock market. As substantially all sales are currently made in U.S. dollars, a strengthening of the dollar could make our services less competitive in foreign markets. We do not use derivative instruments to hedge our risks. Our interest income and expense is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we anticipate no material market risk exposure. Therefore, no quantitative tabular disclosures are presented.

PART II. OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

In connection with the acquisition of DiscoverMusic, Loudeye assumed certain liabilities, including a patent infringement law suit filed on March 31, 2000, as amended April 26, 2000, by InTouch, a California corporation, against Amazon.com Inc., a Delaware corporation, Liquid Audio, Inc., a Delaware corporation, Listen.com, Inc., a California corporation, Entertaindom LLC, a Delaware limited liability company, Muze, Inc., a New York corporation, and DiscoverMusic.com, Inc., a California corporation. On February 6, 2002, the Company executed an agreement with Intouch to settle all disputes. The settlement amount was immaterial to the financial statements presented herein. Pursuant to this agreement, Intouch released all claims against Loudeye Technologies, Loudeye Sample Services, Inc., and DiscoverMusic.com, and granted a license under Intouch’s patents that extends to all customers of Loudeye’s sample services customers to the extent that the customers are operating in connection with Loudeye. Through their attorneys, Loudeye and Intouch have stipulated to a dismissal of their claims in the action.

ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

None

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

None

ITEM 5: OTHER INFORMATION

None

ITEM 6: EXHIBITS AND REPORTS ON FORM 10-Q

(a) Exhibits.

None

(b) Reports on Form 8-K

None

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, on May 7, 2002.


	LOUDEYE TECHNOLOGIES, INC.

	By	/s/ BRADLEY A. BERG

	Bradley A. Berg Senior Vice President, Chief Financial Officer and Principal Financial Officer


	By	/s/ JEROLD J. GOADE, JR.

	Jerold J. Goade, Jr. Vice President Finance, Controller and Principal Accounting Officer

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Readability	8th grade Avg

Loudeye Inactive 10-Q2002 Q1 Quarterly report

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